<PAGE> 1
SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(a)
OF THE SECURITIES EXCHANGE ACT OF 1934
[X] Filed by the Registrant [ ] Filed by a party other than the Registrant
Check the appropriate box:
[ ] Preliminary Proxy Statement
[ ] Confidential, for Use of the Commission Only (as permitted by Rule
14a-6(e)(2))
[X] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to Section 240.14a-11(c) or Section 240.14a-12
Eye Technology, Inc.
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(Name of Registrant as Specified in its Charter)
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(Name of Person(s) Filing Proxy Statement, if other than the Registrant)
Payment of Filing Fee (Check the appropriate box):
[X] No fee required
[ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11
1) Title of each class of securities to which transaction applies:
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2) Aggregate number of securities to which transaction applies:
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3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11 (Set forth the amount on which
the filing fee is calculated and state how it was determined):
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4) Proposed maximum aggregate value of transaction:
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5) Total fee paid:
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[ ] Fee paid previously with preliminary materials.
[ ] Check box if any part of the fee is offset as provided by Exchange Act
Rule 0-11(a)(2) and identify identify the filing for which the
offsetting fee was paid previously. Identify the previous filing by
registration statement number, or the Form or Schedule and the date of
its filing.
1) Amount Previously Paid:
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2) Form, Schedule or Registration Statement No.:
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4) Date Filed:
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<PAGE> 2
EYE TECHNOLOGY, INC.
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NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
TO BE HELD DECEMBER 15, 1998
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The Annual Meeting of Stockholders ("Annual Meeting") of Eye
Technology, Inc. (the "Company") will be held at the Conference Room, Virginia
Biotechnology Research Park, 800 E. Leigh Street, Richmond, Virginia, on
Tuesday, December 15, 1998, at 11:00 a.m., local time. At the Annual Meeting,
stockholders will consider and vote upon the following proposals:
1. To elect five (5) directors, two of whom to hold office until the
next Annual Meeting, one of whom to hold office until the 2000
Annual Meeting of Stockholders, and two of whom to hold office
until the 2001 Annual Meeting of Stockholders.
2. To amend the Company's Certificate of Incorporation to change the
corporate name of the Company to "Star Scientific, Inc."
3. To approve the Company's 1998 Stock Option Plan.
4. To amend the Company's Certificate of Incorporation to increase
the number of authorized shares of Common Stock from 10,000,000 to
100,000,000, with such additional authorized shares to be
available for (i) conversion of the Company's Series B Convertible
Preferred Stock issued in connection with the "reverse
acquisition" of the Company by Star Tobacco and Pharmaceuticals,
Inc. in February 1998; conversion of other outstanding shares of
the Company's Series B Convertible Preferred Stock and of
outstanding shares of the Company's Class A Preferred Stock; (ii)
exercise of employee and director stock options and outstanding
warrants, and (iii) future financings and such other corporate
purposes as may be determined by the Board of Directors.
5. To transact such other business as may properly come before the
Annual Meeting or any adjournment thereof.
Stockholders of record at the close of business on October 20, 1998
will be entitled to notice of and to vote at the Annual Meeting of Stockholders
and any adjournment thereof.
By Order of the Board of Directors,
Malcolm L. Bailey
President
Petersburg, Virginia
November 12, 1998
PLEASE SIGN, DATE, AND RETURN THE ENCLOSED PROXY AS PROMPTLY AS POSSIBLE. YOU
MAY REVOKE YOUR PROXY AT ANY TIME BEFORE THE SHARES TO WHICH IT RELATES ARE
VOTED AT THE MEETING.
<PAGE> 3
EYE TECHNOLOGY, INC.
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PROXY STATEMENT
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NOVEMBER 12, 1998
<PAGE> 4
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
INTRODUCTION......................................................................................................1
RECORD DATE AND SHARE OWNERSHIP...................................................................................1
VOTING .........................................................................................................1
PROPOSAL NO. 1--ELECTION OF DIRECTORS.............................................................................3
Information with Respect to Nominees.....................................................................3
Vote Required; Recommendation of the Board of Directors..................................................5
Board Meetings and Committees............................................................................5
Committee Interlocks and Insider Participation...........................................................5
Remuneration of Directors................................................................................5
PROPOSAL NO. 2--PROPOSED AMENDMENT TO CERTIFICATE OF INCORPORATION
TO CHANGE CORPORATE NAME TO "STAR SCIENTIFIC, INC."......................................................6
PROPOSAL NO. 3--ADOPTION OF 1998 STOCK OPTION PLAN................................................................7
Vote Required; Recommendation of Board of Directors......................................................7
Interest of Management in the Plan.......................................................................7
Summary of the Plan......................................................................................7
Tax Information..........................................................................................9
Insufficient Authorized Shares of Common Stock..........................................................10
PROPOSAL NO. 4--PROPOSED AMENDMENT TO THE CERTIFICATE OF INCORPORATION
TO INCREASE THE NUMBER OF AUTHORIZED SHARES OF COMMON STOCK
FROM 10,000,000 TO 100,000,000 .........................................................................11
Interest of Management in the Proposal..................................................................13
The Transaction.........................................................................................13
Events Leading to the Reverse Acquisition...............................................................13
Reasons for the Reverse Acquisition.....................................................................15
Reasons for the Structure of the Transactions...........................................................16
Interests of Certain Persons in the Reverse Acquisition.................................................16
No Fairness Opinion.....................................................................................17
Accounting Treatment....................................................................................17
Tax Consequences........................................................................................18
Management After the Reverse Acquisition................................................................18
Restrictions on Resale of Securities....................................................................18
Appraisal and Dissenters' Rights........................................................................18
Market for Common Stock and Related Stockholder Matters.................................................18
PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS............................................................19
Pro Forma Condensed Consolidated Balance Sheet as of December 31, 1997..................................20
Pro Forma Condensed Consolidated Statement of Operations For the Year Ended December 31, 1997...........21
Notes to Pro Forma Condensed Consolidated Financial Statements..........................................22
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR
SIX-MONTH PERIOD ENDED JUNE 30, 1998....................................................................24
Condensed Consolidated Balance Sheet as of June 30, 1998................................................24
Condensed Consolidated Statements of Operations For Six-Month Periods
Ended June 30, 1998 and 1997......................................................................25
</TABLE>
i
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<TABLE>
<S> <C>
Condensed Consolidated Statements of Cash Flows For Six-Month Periods
Ended June 30, 1998 and 1997.......................................................................26
Notes to Condensed Consolidated Financial Statements...................................................28
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.....................................................................30
Overview................................................................................................30
Results of Operations for the Six Months Ended June 30, 1998 Compared to Six Months
Ended June 30, 1997................................................................................30
Liquidity and Capital Resources.........................................................................31
Recent Financial Developments...........................................................................32
Year 2000 Issues........................................................................................33
STAR MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.................................................................33
Results of Operations for Year Ended December 31, 1997 Compared to
Year Ended December 31, 1996.......................................................................33
Financial Condition and Liquidity.......................................................................34
ETI MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS........................................................35
Results of Operations for Year Ended December 31, 1997 Compared to
Year Ended December 31, 1996.......................................................................35
Liquidity and Capital Resources.........................................................................36
MANAGEMENT.......................................................................................................36
Executive Officers......................................................................................36
Compensation Summary....................................................................................37
Option Exercises and Year-End Values....................................................................38
Employment Contracts and Change of Control Arrangements.................................................38
Other Information.......................................................................................39
CERTAIN TRANSACTIONS.............................................................................................39
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT...................................................39
BUSINESS OF STAR.................................................................................................41
History and Introduction................................................................................41
Proprietary Technology..................................................................................41
Products Utilizing TSNA-Free Tobacco....................................................................42
Tobacco-Flavored Chewing Gum............................................................................44
Conventional Cigarette Business.........................................................................45
License Agreement.......................................................................................46
Patents and Proprietary Rights..........................................................................47
Government Regulation...................................................................................47
Litigation/Product Liability............................................................................49
Facilities..............................................................................................50
Employees...............................................................................................50
Compensation Summary....................................................................................50
Certain Transactions....................................................................................51
BUSINESS OF ETI..................................................................................................51
General.................................................................................................51
Products of ETI.........................................................................................52
Sales and Marketing.....................................................................................52
Competition.............................................................................................53
Transaction with Ophthalmic Innovations International, Inc............................................. 53
</TABLE>
ii
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<TABLE>
<S> <C>
FDA Regulation..........................................................................................53
Research and Development................................................................................54
Product Liability.......................................................................................54
Raw Materials...........................................................................................54
Patents, Trademarks, and Licenses.......................................................................55
Employees...............................................................................................55
Properties..............................................................................................55
Legal Proceedings.......................................................................................55
Certain Transactions....................................................................................56
Principal Executive Office............................................................................. 56
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE..........................................................56
INDEPENDENT AUDITORS.............................................................................................56
STOCKHOLDER PROPOSALS............................................................................................56
SOLICITATION.....................................................................................................57
OTHER BUSINESS...................................................................................................57
ANNUAL REPORT....................................................................................................57
INDEX TO FINANCIAL STATEMENTS...................................................................................F-1
</TABLE>
iii
<PAGE> 7
INTRODUCTION
This Proxy Statement is furnished in connection with the Annual Meeting
of Stockholders of Eye Technology, Inc. (the "Company") to be held at the
Conference Room, Virginia Biotechnology Research Park, 800 E. Leigh Street,
Richmond, Virginia, on Tuesday, December 15, 1998, at 11:00 a.m., local time,
for the purposes set forth in the accompanying notice. By executing and
returning the enclosed Proxy, you authorize the person named in the enclosed
Proxy to represent you and vote your shares at the Annual Meeting. This Proxy
Statement is first being sent or given to stockholders on or about November 12,
1998.
RECORD DATE AND SHARE OWNERSHIP
Stockholders of record at the close of business on October 20, 1998
(the "Record Date") are entitled to notice of and to vote at the Annual Meeting.
As of the close of business on the Record Date, the Company had approximately
9,669,740 shares of Common Stock outstanding and approximately 583 stockholders
of Common Stock of record; 250 shares of Class A Convertible Preferred Stock
(the "Class A Preferred Stock") outstanding and one stockholder of Class A
Preferred Stock of record; and 14,086 shares of Series B Convertible Preferred
Stock outstanding (the "Series B Preferred Stock") and 20 stockholders of Series
B Preferred Stock of record.
VOTING
Except as otherwise provided by Delaware law, the holders of Common
Stock, Class A Preferred Stock and Series B Preferred Stock vote as a single
class. Each holder of Common Stock is entitled to one vote for each share held
on the Record Date. Each holder of Class A Preferred Stock is entitled to 80
votes for each share held on the Record Date. Each holder of Series B Preferred
Stock is entitled to 500 votes for each share held on the Record Date.
Consequently, as of the close of business on the Record Date, the holders of
Common Stock had 9,669,740 votes, the holders of Class A Preferred Stock had
20,000 votes and the holders of Series B Preferred Stock had 7,043,000 votes,
representing approximately 57.7%, 0.1% and 42.0%, respectively, of the combined
voting power of all such securities, voting as a single class. Holders of Common
Stock, Class A Preferred Stock, and Series B Preferred Stock do not have
cumulative voting rights.
Stockholders may vote in person or by proxy at the Annual Meeting. A
proxy may be revoked in writing at any time before it is exercised at the Annual
Meeting by written notice of revocation executed and delivered to the Secretary
or by executing and delivering a later-dated proxy to the Secretary. Attendance
at the Annual Meeting will not be effective to revoke the proxy, unless written
notice of revocation also has been given to the Secretary before the proxy is
exercised or you vote your share in person at the Annual Meeting.
The required quorum for the transaction of business at the Annual
Meeting is a majority of the outstanding votes of Common Stock, Class A
Preferred Stock and Series B Preferred Stock taken together as a single class.
If a quorum is not present, the stockholders entitled to vote who are present at
the Annual Meeting have the power to adjourn the Annual Meeting from time to
time, without notice, other than an announcement at the Annual Meeting, until a
quorum is present. At any adjourned Annual Meeting at which a quorum is present,
any business may be transacted that might have been transacted at the Annual
Meeting as originally notified.
In accordance with the Company's Bylaws, the directors will be elected
by a plurality of the votes cast by the holders of Common Stock, Class A
Preferred Stock and Series B Preferred Stock, voting together as a single class,
present and entitled to vote at the Annual Meeting. In accordance with Delaware
corporate law, the approval of the proposed amendment to the Company's
Certificate of Incorporation to change the corporate name requires the vote of a
majority of the outstanding shares of Common Stock, Class A Preferred Stock and
Series B Preferred Stock, voting together as a single class. In accordance with
the Company's Bylaws, the approval of the Company's 1998 Stock Option Plan
requires a majority of the votes cast by holders of Common Stock, Class A
Preferred Stock and Series B Preferred Stock, voting together as a single class,
present and entitled to vote at the Annual Meeting. In accordance with Delaware
corporate law, the approval of the proposed amendment to the Company's
Certificate of Incorporation to increase the number of authorized shares of
Common Stock requires the vote of a majority of the outstanding shares of the
Common Stock, voting as a separate class, and a vote of a majority of the
outstanding shares of Common Stock, Class A Preferred Stock and Series B
Preferred Stock, voting together as a single class.
<PAGE> 8
For purposes of establishing a quorum, abstentions and broker non-votes
will count in determining whether a quorum is present at the Annual Meeting. For
purposes of proposal 1, neither abstentions nor broker non-votes will have any
effect on the outcome of the vote. For purposes of the approval of proposals 2
and 4, the proposed amendments to the Company's Certificate of Incorporation,
both abstentions and broker non-votes will have the same effect as votes against
the proposed amendments. For purposes of the approval of proposal 3, abstentions
will have the same effect as votes against this proposal, and broker non-votes
will not have any effect on the outcome of the vote.
2
<PAGE> 9
PROPOSAL NO. 1
ELECTION OF DIRECTORS
At the Annual Meeting, five directors will be elected by the
stockholders of the Company, two of whom are to serve until the next Annual
Meeting and until their successors are elected and qualified, one of whom is to
serve until the 2000 Annual Meeting and until his successor is elected and
qualified, and two of whom are to serve until the 2001 Annual Meeting and until
their successors are elected and qualified..
Pursuant to the Company's Certificate of Incorporation and Bylaws, the
Board of Directors is divided into three classes. Each class serves for a
three-year term. The term of office of the first class expires at the annual
meeting of stockholders to be held in 1999 (Class One), the term of office of
the second class expires at the annual meeting of stockholders to be held in
2000 (Class Two) and the term of office of the third class expires at the Annual
Meeting (Class Three). Malcolm L. "Mac" Bailey currently serves as a Class One
director, Jonnie R. Williams serves as a Class Two Director, and Robert J.
DeLorenzo, M.D., Ph.D. and Leo S. Tonkin currently serve as Class Three
directors. Each incumbent director was appointed by the remaining members of the
Board of Directors at different dates in 1998. The stockholders are being
requested at the Annual Meeting to elect a director for each class as follows:
Malcolm L. "Mac" Bailey, Class One; James A. McNulty, Class One; Jonnie R.
Williams, Class Two; Robert J. DeLorenzo, Class Three; and Leo S. Tonkin, Class
Three.
Because the Board is divided into classes, only those directors in a
single class may be changed in any one year. Consequently, changing a majority
of the Board would generally require two years. Having a classified Board, which
may be regarded as an "anti-takeover" provision, may make it more difficult for
the Company's stockholders to change the majority of directors and thus have the
effect of maintaining the continuity of management.
The Bylaws specify that the size of the Board of Directors is fixed
from time to time by action of the Board of Directors, or if the number is not
fixed, the number shall be three. The number of directors currently fixed by the
Board of Directors is five. The Company is currently seeking another independent
director to serve on the Board.
INFORMATION WITH RESPECT TO NOMINEES
Set forth below are the names, ages and positions of the nominees, as
well as certain information furnished by them as to their business experience
for the last five years, and the years in which Messrs. Bailey, DeLorenzo,
Williams and Tonkin first became directors of the Company, as of the Record
Date. None of the incumbent Directors has been previously elected by the
stockholders. Messrs. Bailey, DeLorenzo, Williams and Tonkin were appointed by
the Board of Directors to fill vacancies caused by resignations.
<TABLE>
<CAPTION>
Director If Elected, Term as
Name Age Since Director Expires
---- --- -------- -------------------
<S> <C> <C> <C>
Malcolm L. "Mac" Bailey 55 May 1998 1999
(Class One)
James A. McNulty 48 - 1999
(Class One)
Jonnie R. Williams 43 September 1998 2000
(Class Two)
Robert J. DeLorenzo, M.D., Ph.D. 50 February 1998 2001
(Class Three)
Leo S. Tonkin 61 October 1998 2001
(Class Three)
</TABLE>
Malcolm L. "Mac" Bailey has served as the President of the Company
since October 1998, and as a director since May 1998. Mr. Bailey is the owner of
the second largest tobacco growing operation in the Commonwealth of Virginia and
has been the owner and President of Golden Leaf Tobacco Company, a tobacco leaf
dealer, for over 20
3
<PAGE> 10
years. Since 1994, Mr. Bailey has also been owner and President of S&M Brands,
Incorporated, a manufacturer of cigarettes. Mr. Bailey is also President of the
Virginia Agricultural Growers Association, a trade association which includes
approximately 85% of the flue-cured tobacco farms in Virginia.
James A. McNulty, is a certified public accountant with over 25 years
of experience in accounting, auditing, tax planning, management consulting and
litigation support. From 1989 to 1997, Mr. McNulty was a principal of McNulty &
Company, a certified public accounting firm in Tampa, Florida. In 1997, Mr.
McNulty co-founded and is the Chairman of the Board of BusinessLinks
International, Inc., a company specializing in interactive sales training. In
addition, Mr. McNulty currently serves as a consultant to Divot Golf
Corporation, a publicly-held golf accessories company headquartered in Tampa,
Florida.
Jonnie R. Williams has served as the Company's Chief Operating Officer
and Executive Vice President since October 1998, and as a Director since
September 1998, and has been Director of Product Development and Director of
Marketing of Star Tobacco and Pharmaceuticals, Inc. ("Star") since 1994. Mr.
Williams is a principal stockholder of the Company and, until February 6, 1998,
when the Company acquired all of the capital stock of Star, was a principal
stockholder of Star. Mr. Williams, a co-founder of Star, is also the co-inventor
of the proprietary tobacco-curing process for the removal or virtual elimination
of tobacco-specific nitrosamines ("TSNAs") which has been exclusively licensed
to the Company. Since the late 1980's, Mr. Williams has been owner and President
of Jonnie R. Williams Venture Capital Company, an entity engaged in providing
venture capital financing to start-up businesses. Without admitting or denying
any allegations, Mr. Williams entered into a consent decree with the Securities
Division of the Commonwealth of Massachusetts and the Securities and Exchange
Commission in December 1993 and January 1994, respectively. Pursuant to these
decrees, Mr. Williams paid an amount representing profits from trading in the
securities of Spectra Pharmaceutical Services, Inc. and agreed to be enjoined
from future violations of Section 10(b) and 13(d) and Rules 10b- 5 and 13d-2 of
the Securities Exchange Act of 1934, as amended, and comparable Massachusetts
provisions.
Robert J. DeLorenzo, M.D., Ph.D. has served as Chief Executive Officer
of the Company since October 1998 and as a director since February 1998. Since
1985, he has served as the Neurologist-in-Chief and Professor of Pharmacology
and Toxicology at the Medical College of Virginia Hospitals, Professor and
Chairman, Neurology at the Medical College of Virginia ("MCV"), and Director,
Molecular Neurobiology Laboratories at MCV. Since 1992, Dr. DeLorenzo has also
served as Professor, Biochemistry and Molecular Biophysics at MCV. Dr. DeLorenzo
received a Ph.D. in neuropharmacology from Yale University Graduate School, an
M.D. from Yale University School of Medicine and an M.P.H. from the Yale School
of Epidemiology and Public Health.
Leo S. Tonkin is a director of the Washington Workshops Foundation
which he founded in 1967. The Foundation is a non-profit educational institution
for high school and junior high students focusing on the federal government and
congress. Mr. Tonkin has served in a variety of capacities addressing
educational concerns, including serving as a member of the White House
Conference on Youth in 1971, and as Special Assistant to the Chairman of the
United States House of Representatives Select Committee on Crime in 1972. Mr.
Tonkin has served as the chairman of the board of trustees of St. Thomas Aquinas
College, New York and as a trustee of Immaculata College, Washington, D.C. Mr.
Tonkin received a J.D. from Harvard Law School and an A.B. from Johns Hopkins
University.
The Company believes that as a controlling stockholder and key
executive of the Company, Mr. Williams is qualified to serve as a member of the
Board of Directors. The Company believes that Dr. DeLorenzo, Mr. Bailey and Mr.
McNulty have the experience, knowledge of the tobacco industry (Mr. Bailey), the
pharmaceutical industry (Dr. DeLorenzo) and financial accounting and reporting
(Mr. McNulty) and qualifications to serve as members of the Board of Directors.
The Company believes that given the future role to be played by targeted
education regarding adult choice for smoking and/or cessation products, Mr.
Tonkin, as an educational administrator with a legal background, is qualified to
serve as a member of the Board of Directors. The Company also believes that
their election will enhance the Board of Directors.
VOTE REQUIRED; RECOMMENDATION OF THE BOARD OF DIRECTORS
In order to be elected, a nominee must receive the vote of a plurality
of the votes cast by holders of Common Stock, Class A Preferred Stock and Series
B Preferred Stock, voting together as a single class, present and entitled to
vote at the Annual Meeting. THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" EACH
NOMINEE.
4
<PAGE> 11
BOARD MEETINGS AND COMMITTEES
The Board of Directors did not hold any meetings during 1997.
The Board of Directors intends to establish an Audit Committee and a
Compensation Committee comprised of two independent directors. The functions of
the Audit Committee will be to make recommendations to the Board of Directors
regarding the engagement of the Company's independent auditors and to review
with management and the independent auditors the Company's financial statements,
basic accounting and financial policies and practices, audit scope and
competency of accounting personnel. Members of the Audit Committee will be
appointed annually by the Board of Directors. If elected to the Board, Dr.
DeLorenzo and Mr. Tonkin are expected to be appointed to serve on the initial
Audit Committee.
The Compensation Committee will be responsible for reviewing and making
recommendations to the Board of Directors with respect to compensation of
executive officers, other compensation matters and awards under the Company's
stock option plan. Members of the Compensation Committee will be appointed
annually by the Board of Directors. If elected to the Board, Dr. DeLorenzo and
Mr. Tonkin are expected to be appointed to serve on the initial Compensation
Committee.
The Company is currently seeking another independent director who will
be appointed to serve on the Audit Committee and the Compensation Committee.
COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
All decisions relating to the compensation of executive officers for
the year ended December 31, 1997 were made by the Board of Directors, acting as
a whole. No executive officer of the Company serves as a member of the board of
directors or compensation committee of any entity which has one or more
executive officers serving as a member of the Company's Board of Directors.
REMUNERATION OF DIRECTORS
Directors receive no compensation for their services as directors. They
are reimbursed for their expenses.
5
<PAGE> 12
PROPOSAL NO. 2
PROPOSED AMENDMENT TO CERTIFICATE OF INCORPORATION
TO CHANGE CORPORATE NAME TO "STAR SCIENTIFIC, INC."
The Board of Directors has approved an amendment to the Company's
Certificate of Incorporation to change the name of the Company to "Star
Scientific, Inc." The Company desires to change the name of the Company from Eye
Technology, Inc. to Star Scientific, Inc. in order to align the Company's name
with the business of its wholly-owned subsidiary, Star Tobacco and
Pharmaceuticals, Inc., and to reflect the Company's emphasis on its proprietary
technology to prevent the formation in tobacco of tobacco-specific nitrosamines
and the development of reduced-risk tobacco products and cessation
pharmaceutical products.
In accordance with Delaware corporate law, if approved by the
stockholders, the proposed amendment will become effective upon the filing of a
certificate of amendment relating thereto with the Secretary of State of
Delaware, which will occur as promptly as practicable after the date of the
Annual Meeting. Assuming this proposal is adopted, it will not be necessary for
stockholders to surrender stock certificates. Instead, when certificates are
presented for transfer, new certificates bearing the new name will be issued.
A majority of the outstanding votes of holders of Common Stock, Class A
Preferred Stock and Series B Preferred Stock, voting together as a single class,
present and entitled to vote at the Annual Meeting, is required to approve the
amendment to the Certificate of Incorporation to change the name of the Company
to Star Scientific, Inc. THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE
PROPOSAL TO AMEND THE CERTIFICATE OF INCORPORATION TO CHANGE THE NAME OF THE
COMPANY.
6
<PAGE> 13
PROPOSAL NO. 3
ADOPTION OF 1998 STOCK OPTION PLAN
The Company believes it is desirable for stockholders to approve the
1998 Stock Option Plan (the "Plan") in order to provide an effective method of
recognizing contributions to the success of the Company by executive officers,
key employees, consultants and nonemployee directors. The Company also believes
that its ability to grant stock options is critical to its success in attracting
and retaining experienced and qualified employees.
VOTE REQUIRED; RECOMMENDATION OF BOARD OF DIRECTORS
A majority of the votes cast by holders of Common Stock, Class A
Preferred Stock and Series B Preferred Stock, voting together as a single class,
present and entitled to vote at the Annual Meeting is required to approve the
adoption of the 1998 Stock Option Plan. THE BOARD OF DIRECTORS UNANIMOUSLY
RECOMMENDS A VOTE "FOR" THE ADOPTION OF THE 1998 STOCK OPTION PLAN.
INTEREST OF MANAGEMENT IN THE PLAN
The Company intends to grant a nonqualified stock option under the Plan
for 200,000 shares of Common Stock to the Company's President, who is also a
Director, at a price of $2.00 per share. Such option will vest in two equal
annual installments commencing June 1999. See "Management--Employment Contracts
and Change of Control Arrangements."
SUMMARY OF THE PLAN
Purpose. The purposes of the Plan are to provide additional incentives
to those executive officers, key employees, consultants and nonemployee
directors of the Company and its subsidiaries whose substantial contributions
are essential to the continued growth and success of the Company's business, to
strengthen their commitment to the Company and its subsidiaries, to motivate
those executive officers, key employees, nonemployee directors and consultants
to perform their assigned responsibilities faithfully and diligently, and to
attract and retain competent and dedicated individuals whose efforts will result
in the long-term growth and profitability of the Company.
Incentive and Nonqualified Stock Options. The Plan permits the granting
of stock options that either qualify as incentive stock options ("Incentive
Stock Options" or "ISOs") under Section 422 of the Internal Revenue Code of
1986, as amended (the "Code"), or do not so qualify ("Nonqualified Stock
Options" or "NSOs").
Eligibility. The Plan provides that NSOs may be granted to executive
officers, key employees, consultants and nonemployee directors of the Company or
any subsidiary of the Company. ISOs may be granted only to employees, including
executive officers and directors who are employees, of the Company or any
subsidiary of the Company.
Number of Shares Subject to Stock Options. The maximum number of shares
of Common Stock that may be issued upon exercise of options granted under the
Plan is 4,000,000. However, under the Plan, no eligible employee shall receive
in any fiscal year of the Company options to purchase in excess of 1,000,000
shares.
The term of each option is fixed by the administrator but may not
exceed ten years from the date of grant in the case of ISOs or five years from
the date of grant in the case of ISOs granted to a holder of Common Stock
possessing more than 10% of the total combined voting power of all classes of
stock of the Company or any subsidiary (a "10% Stockholder"). When the fair
market value of shares subject to ISOs first exercisable in one calendar year is
greater than $100,000, the excess options shall be treated as NSOs. For these
purposes, fair market value is determined on the date of grant, and ISOs shall
be taken into account in the order in which they were granted. The administrator
determines the time or times each option may be exercised. Options may be made
exercisable in installments, and the exercisability of options may be
accelerated by the administrator.
Option Price. The option exercise price for each share covered by an
ISO may not be less than 100% of the fair market value of a share of Common
Stock on the date of grant of such option. In the case of ISOs or NSO's granted
to a 10% Stockholder, the option exercise price for each share covered by such
option may not be less than 110% of the
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<PAGE> 14
fair market value of a share of Common Stock on the date of grant of such
option. For so long as there exists a public market for the Company's Common
Stock, the fair market value of a share of Common Stock shall be the last sales
price for such stock on the last market trading day prior to the day of
determination (or if no sales were reported on that date, on the last trading
day on which sales were reported) on the stock exchange determined by the
administrator to be the primary market for the Common Stock or the Nasdaq
National Market whichever is applicable or if the Common Stock is not traded on
any such exchange or natural market system, the average of the closing bid and
asked prices of the Common Stock on the Nasdaq Smallcap Market for the day prior
to the time of determination as reported in The Wall Street Journal, or, in the
absence of an established market, as determined by the administrator in good
faith.
Consideration. The consideration to be paid for shares issued upon
exercise of options granted under the Plan, including the method of payment, is
determined by the administrator (and, in the case of ISOs, determined at the
time of grant) and may consist entirely of (1) cash, (2) check, (3) shares of
Common Stock including withholding of shares otherwise deliverable on exercise
of the option, which have a fair market value on the date of surrender equal to
the aggregate exercise price of the shares being purchased, or (4) any
combination of the foregoing methods.
Miscellaneous Provisions. Under the Plan, in the event of an optionee's
termination of employment or consulting relationship for any reason other than
death or total and permanent disability, an option shall terminate immediately.
If an optionee retires in good standing for reasons of age (but not due to a
total and permanent disability), the option will be exercisable for three months
following such retirement, but only to the extent it was exercisable at the date
of such retirement and to the extent that the term of the option has not
expired. If an optionee's employment or consulting relationship is terminated as
a result of the optionee's total and permanent disability, the option will be
exercisable for twelve months following such termination, but only to the extent
it was exercisable at the date of termination and to the extent that the term of
the option has not expired. If an optionee's employment or consulting
relationship is terminated by reason of the optionee's death, the option will be
exercisable by the optionee's estate or successor for twelve months following
death, but only to the extent it was exercisable at the date of death and to the
extent that the term of the option has not expired.
All options granted under the Plan are evidenced by a stock option
agreement between the Company and the optionee to whom such option is granted.
Options granted to persons who are subject to Section 16 of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), are subject to any
additional restrictions applicable to options granted to such persons in
compliance with Rule 16b-3 of the Exchange Act.
Nontransferability of Options. Options granted pursuant to the Plan are
nontransferable by the optionee, other than by will or by the laws of descent
and distribution and may be exercised, during the lifetime of the optionee, only
by the optionee.
Adjustment Upon Changes in Capitalization. In the event any change,
such as a stock split or dividend, is made in the Company's capitalization which
results in an increase or decrease in the number of outstanding shares of Common
Stock without receipt of consideration by the Company, an appropriate adjustment
shall be made in the number of shares which have been reserved for issuance
under the Plan and the price per share covered by each outstanding option.
Change of Control. In the event of a Change in Control, (i) all options
outstanding on the date of such Change in Control shall become immediately and
fully exercisable and (ii) an optionee will be permitted to surrender for
cancellation within 60 days after such Change in Control any option or portion
of any option to the extent not yet exercised, and the optionee will be entitled
to receive a cash payment in an amount equal to the excess, if any, of (x) (A)
in the case of NSOs, the greater of (1) the fair market value, on the date
preceding the date of surrender, of the shares subject to the option or portion
thereof surrendered or (2) the adjusted fair market value of the shares subject
to the option or portion thereof surrendered, or (B) in the case of an ISO, the
fair market value, at the time of surrender, of the shares subject to the option
or portion thereof surrendered, over (y) the aggregate purchase price of such
shares under the option; provided, however, that in the case of an option
granted within six months prior to the Change in Control to any optionee who may
be subject to liability under Section 16(b) of the Exchange Act, such optionee
shall be entitled to surrender for cancellation such optionee's option during
the 60-day period commencing upon the expiration of six months from the date of
grant of any such option. A Change of Control is defined under the Plan as (i)
the acquisition (other than from the Company) by any "Person" (as the term is
used for purposes of Sections 13(d) or 14(d) of the Exchange Act) of beneficial
ownership of 20% or more of the combined voting power of the Company's then
outstanding voting securities; or (ii) the individuals who, immediately after
the 1998 annual meeting of stockholders of the Company, are members of the Board
(the "Incumbent Board"), cease for any reason to constitute at least a majority
of the Board;
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or (iii) approval by the stockholders of the Company of (a) a merger or
consolidation involving the Company if the Company's stockholders, immediately
before such merger or consolidation, do not, as a result of such merger or
consolidation, own, directly or indirectly, more than 70% of the combined voting
power of the then outstanding voting securities of the corporation resulting
from such merger or consolidation in substantially the same proportion as their
ownership of the combined voting power of the voting securities of the Company
outstanding immediately before such merger or consolidation or (b) a complete
liquidation or dissolution of the Company or an agreement for the sale or other
disposition of all or substantially all of the assets of the Company; provided,
however, a Change in Control shall not be deemed to occur solely because 20% or
more of the combined voting power of the Company's then outstanding securities
is acquired by a trustee or other fiduciary holding securities under one or more
employee benefit plans maintained by the Company or any Subsidiary or any
corporation which, immediately prior to such acquisition, is owned directly or
indirectly by the stockholders of the Company in the same proportion as their
ownership of stock in the Company immediately prior to such acquisition.
Adjusted fair market value is defined in the Plan as the greater of (i)
the highest price per share of Common Stock paid to stockholders in any
transaction (or series of transactions) constituting or resulting in a Change in
Control or (ii) the highest fair market value of a share of Common Stock during
the 90-day period ending on the date of a Change of Control.
Liquidation, Dissolution, Merger or Consolidation. Subject to the
provisions regarding a Change of Control, in the event of (i) the liquidation or
dissolution of the Company or (ii) a merger or consolidation of the Company (a
"Transaction"), all outstanding options shall continue in effect in accordance
with their respective terms and each optionee shall be entitled to receive in
respect of each share subject to any outstanding options, as the case may be,
upon exercise of any option, the same number and kind of stock, securities,
cash, property or other consideration that each holder of a share was otherwise
entitled to receive in the Transaction in respect of a share.
Amendment and Termination. The Board may at any time amend, suspend or
terminate the Plan so long as the rights of any optionee will not be impaired by
such amendment, suspension or termination. The Plan will terminate on September
1, 2008, unless earlier terminated by the Board. To the extent necessary and
desirable to comply with applicable state and federal laws and the Code, the
Company shall obtain stockholder approval of any amendment to the Plan in such a
manner and to such a degree as required.
Administration. The Plan provides for administration by the
Compensation Committee of the Board, which shall consist of two or more "outside
directors." Subject to the other provisions of the Plan, the administrator has
the authority to determine the employees, nonemployee directors or consultants
to whom, and the time or times at which, options are granted, the number of
shares to be represented by each option and the other terms and conditions of
such option. The interpretation and construction of any provision of the Plan by
the administrator shall be final and binding.
For information on the market value of the underlying shares of Common
Stock see "Proposal No. 4 - Market for Common Stock and Related Stockholder
Matters."
TAX INFORMATION
Options granted under the Plan may be either ISOs or NSOs.
An optionee who is granted an ISO will not recognize income either at
the time the option is granted or upon its exercise, although the exercise may
subject the optionee to the alternative minimum tax. Upon a sale or exchange of
the shares more than two years after the grant of the option and one year after
its exercise, any gain or loss will be treated as long-term capital gain or
loss. If these holding periods are not satisfied, the optionee will recognize
ordinary income at the time of the sale or exchange equal to the difference
between the exercise price and the lower of (i) the fair market value of the
shares on the date of exercise or (ii) the sale price of the shares. A different
rule of measuring ordinary income upon such a premature disposition may apply if
the optionee is also an officer, director, or 10% Stockholder of the Company.
Any gain or loss recognized on such a premature disposition of the
shares in excess of the amount treated as ordinary income will be characterized
as long-term or short-term capital gain or loss, depending on the holding
period. Generally, the Company will be entitled to a deduction in the same
amount as the ordinary income recognized by the optionee at the time of such
disposition.
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<PAGE> 16
Options that do not qualify as ISOs are referred to as NSOs. An
optionee will not recognize income at the time an NSO is granted. However, upon
its exercise, the optionee will recognize ordinary income generally measured as
the excess of the then fair market value of the shares over the exercise price.
Any ordinary income recognized in connection with the exercise of an NSO by an
optionee who is also an employee of the Company will be subject to tax
withholding by the Company. Generally, the Company will be entitled to a tax
deduction in the same amount as the ordinary income recognized by the optionee
upon exercise of an NSO.
Upon resale of the shares by the optionee, any difference between the
sale price and the optionee's purchase price, to the extent not recognized as
ordinary income as described above, will be treated as long-term or short-term
capital gain or loss, depending on the holding period.
Potential Limitation on Company Deductions. As part of the Omnibus
Budget Reconciliation Act of 1933, the U.S. Congress amended the Code to add
Section 162(m) which denies a deduction to any publicly held corporation for
compensation paid to a covered employee in a taxable year to the extent that
non-performance-based compensation paid to such covered employee exceeds $1
million. It is possible that compensation attributable to stock options granted
under the Option Plan, when combined with all other types of compensation
received by a covered employee from the Company, may cause this limitation to be
exceeded in any particular year.
Certain kinds of compensation, including qualified "performance-based
compensation," are disregarded for purposes of the deduction limitation.
Treasury regulations issued under Section 162(m) of the Code provide that
compensation attributable to stock options will qualify as performance-based
compensation if: (i) the stock option plan contains a per-employee limitation on
the number of shares for which stock options may be granted during a specified
period; (ii) the per-employee limitation is approved by the stockholders; (iii)
the stock option is granted by a compensation committee comprised solely of
"outside directors;" and (iv) the exercise price of the stock option is no less
than the fair market value of the stock on the date of grant.
INSUFFICIENT AUTHORIZED SHARES OF COMMON STOCK
There is currently insufficient shares of authorized Common Stock
available for issuance on the exercise of options granted or to be granted under
the Plan. The availability of a sufficient number of shares of authorized Common
Stock for issuance upon exercise of the options is dependent upon stockholder
approval of the proposed amendment to the Certificate of Incorporation to
increase the number of authorized shares from 10,000,000 to 100,000,000. See
"Proposal No. 4."
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<PAGE> 17
PROPOSAL NO. 4
PROPOSED AMENDMENT TO CERTIFICATE OF INCORPORATION TO INCREASE THE NUMBER
OF AUTHORIZED SHARES OF COMMON STOCK FROM 10,000,000 TO 100,000,000, WITH SUCH
ADDITIONAL SHARES TO BE AVAILABLE FOR: (i) CONVERSION OF THE COMPANY'S SERIES B
PREFERRED STOCK ISSUED IN CONNECTION WITH THE "REVERSE ACQUISITION" OF THE
COMPANY BY STAR TOBACCO AND PHARMACEUTICALS, INC. IN FEBRUARY 1998;
CONVERSION OF OTHER OUTSTANDING SHARES OF THE COMPANY'S SERIES B PREFERRED
STOCK AND OF OUTSTANDING SHARES OF THE COMPANY'S CLASS A PREFERRED STOCK,
(ii) EXERCISE OF EMPLOYEE AND DIRECTOR STOCK OPTIONS AND OUTSTANDING
WARRANTS, AND (iii) FUTURE FINANCINGS AND SUCH OTHER CORPORATE PURPOSES AS MAY
BE DETERMINED BY THE BOARD OF DIRECTORS
The Board of Directors has recommended an amendment to the Company's
Certificate of Incorporation to increase the number of authorized shares of
Common Stock from 10,000,000 to 100,000,000, with such additional authorized
shares to be available for (i) conversion of the Company's Series B Preferred
Stock issued in connection with the "reverse acquisition" of the Company by Star
Tobacco and Pharmaceuticals, Inc. ("Star") in February 1998; conversion of other
outstanding shares of the Company's Series B Preferred Stock and of outstanding
shares of the Company's Class A Preferred Stock; (ii) exercise of employee stock
options and outstanding warrants, and (iii) future financings and other
corporate purposes as may be determined by the Board of Directors. As of the
close of business on the Record Date, there were 9,669,740 shares of Common
Stock issued and outstanding. Approval of this proposal is necessary to give
effect to the transfer of control over matters governed by the holders of Common
Stock, as contemplated by the Stock Exchange Agreement, dated February 6, 1998,
between the Company and the holders of all of the outstanding Common Stock of
Star.
The Board of Directors believes that it is in the best interests of the
stockholders to increase the number of authorized shares of Common Stock in
order to have additional authorized but unissued shares available for issuance
for appropriate corporate purposes. Of the additional shares of authorized
Common Stock, 20,000 shares will be reserved for the issuance of Common Stock
upon conversion of the Class A Preferred Stock, approximately 45,119,680 shares
will be reserved for the issuance of Common Stock upon conversion of the Series
B Preferred Stock, 4,000,000 shares will be reserved for issuance of Common
Stock upon exercise of options which may be granted under the Company's Plan,
including outstanding options to purchase 1,000,000 shares, and 850,000 shares
will be reserved for issuance of Common Stock upon exercise of warrants now
outstanding. The additional shares of Common Stock proposed to be authorized
will be identical to the outstanding shares of Common Stock. For further
information regarding the number of shares of Common Stock, Class A Preferred
Stock and Series B Preferred Stock outstanding and the respective number of
votes per share, see "Record Date and Share Ownership" and "Voting."
The holders of Series B Preferred Stock have advised the Company of
their intent to convert an aggregate of 14,086 shares of Series B Preferred
Stock, representing all of the outstanding shares of Series B Preferred Stock,
into 46,202,080 shares of Common Stock (3,280 shares of Common Stock per share
of Series B Preferred Stock) upon the adoption of this amendment, representing
approximately 82.6% of the then outstanding shares of Common Stock.
The Board of Directors believes that the availability of the additional
shares of authorized Common Stock is essential to provide the Company the
ability to raise additional capital, to develop the Company's proprietary
technology, and to attract and retain key personnel. It will also permit the
elimination of the dividend payment to holders of Series B Preferred Stock,
thereby conserving the Company's cash flow, as well as permit the elimination of
the liquidation preference of the Series B Preferred Stock.
The Board of Directors has made no agreement or arrangement to issue
any of the shares for which approval is sought, other than the issuance of
Common Stock upon conversion of the Class A Preferred Stock and the Series B
Preferred Stock and upon exercise of outstanding options and warrants. In
accordance with Delaware corporate law, the additional shares of Common Stock to
be authorized pursuant to the proposed amendment may be issued by the Company
without the expense and delay of a special stockholders' meeting. If the
amendment is approved by the stockholders, the Board of Directors does not
intend to solicit further stockholder approval prior to the issuance of any
additional shares of Common Stock. Frequently, opportunities arise that require
prompt action, and the Company
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<PAGE> 18
believes that the delay necessitated for stockholder approval of a specific
issuance could be to the detriment of the Company and its stockholders.
Dilution. The issuance of 45,119,680 shares of Common Stock upon
conversion of the Series B Preferred Stock will have an immediate effect on
existing stockholders' ownership of Common Stock, which will decline from 100%
to 17.6%. To the extent that additional authorized shares are issued in the
future, except in the case of a stock split or stock dividend, such issuances
will further dilute existing stockholders' percentage ownership of Common Stock.
Any such issuance of additional stock could have the effect of diluting the
earnings per share and book value per share of outstanding ownership of Common
Stock.
Anti-Takeover Effect. The increase in the authorized number of shares
of Common Stock and the subsequent issuance of such shares without further
action by the stockholders could have the effect of delaying, deferring or
preventing a change in control of the Company. This proposal is intended to
provide sufficient additional shares of authorized Common Stock for conversion
of Preferred Stock, to exercise options to be granted pursuant to the Plan and
to finance the development of the Company's tobacco-processing technology. This
proposal is not part of a plan by management to adopt a series of anti-takeover
measures, nor does management have any present intention to propose any
anti-takeover measures.
More than five years ago, the Board of Directors and stockholders of
the Company approved certain anti-takeover measures. The classification of the
Board of Directors, the authorization of the "blank-check" preferred stock and
other provisions in the Company's Certificate of Incorporation that prohibit
stockholder action by written consent, require vacancies on the Board to be
filled only by the remaining directors, permit only the Board of Directors by
resolution approved by a majority of the directors to call special meetings of
stockholders, and require an 80% stockholder vote to remove directors and amend
the Company's Certificate of Incorporation may also have the effect of delaying,
deferring or preventing a change in control of the Company.
Class Voting. Existing holders of Common Stock currently have the
ability to reject any matter which under Delaware law requires the approval of a
majority of the outstanding shares of Common Stock, voting as a separate class.
The existing holders of Common Stock will lose their ability to reject any such
matters as a result of dilution, if this proposal is approved. These matters
include amendments to the Company's Certificate of Incorporation that would
increase or decrease the aggregate number of authorized shares of Common Stock,
increase or decrease the par value of such shares, or alter adversely the
powers, preferences or rights of such shares. If the proposal to increase the
number of authorized shares of Common Stock is adopted and all of the Series B
Preferred Stock is converted into shares of Common Stock, the former
stockholders of Star will then own 82.4% of the outstanding shares of Common
Stock and will have the ability to approve all matters submitted to holders of
the Common Stock.
In accordance with Delaware corporate law, if approved by the
stockholders, the proposed amendment will become effective upon the filing of a
certificate of amendment with the Secretary of State of Delaware, which will
occur as promptly as practicable after the date of the Annual Meeting.
The vote of a majority of the outstanding shares of Common Stock,
voting as a separate class, and a majority of the outstanding votes of Common
Stock, Class A Preferred Stock and Series B Preferred Stock, voting together as
a single class, present and entitled to vote at the Annual Meeting, are required
to approve the amendment to the Certificate of Incorporation to increase the
number of authorized shares of Common Stock from 10,000,000 to 100,000,000.
NEITHER THE APPROVAL NOR THE REJECTION OF THIS PROPOSAL IS A SUBSEQUENT
CONDITION TO, OR AN EVENT OF TERMINATION OF, THE "REVERSE ACQUISITION" OF THE
COMPANY BY STAR, OR A CONDITION SUBSEQUENT TO, OR AN EVENT OF REDEMPTION OF, THE
SERIES B PREFERRED STOCK. THE REJECTION OF THIS PROPOSAL WOULD ENABLE EXISTING
HOLDERS OF COMMON STOCK TO RETAIN CLASS RIGHTS AND PREVENT AN IMMEDIATE AND
SUBSTANTIAL DILUTION OF THEIR OWNERSHIP OF COMMON STOCK. THE REJECTION OF THIS
PROPOSAL WOULD, HOWEVER, SUBSTANTIALLY IMPAIR THE ABILITY OF THE COMPANY TO
OBTAIN ADDITIONAL FUNDS FOR THE DEVELOPMENT OF ITS PROPRIETARY TECHNOLOGY. THE
BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE PROPOSAL TO AMEND THE CERTIFICATE
OF INCORPORATION TO INCREASE THE NUMBER OF AUTHORIZED SHARES OF COMMON STOCK
FROM 10,000,000 TO 100,000,000.
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BECAUSE THE PROPOSED INCREASE IN THE NUMBER OF AUTHORIZED COMMON STOCK
WILL BE USED, IN PART, FOR THE CONVERSION OF THE SERIES B PREFERRED STOCK ISSUED
IN CONNECTION WITH THE "REVERSE ACQUISITION" OF EYE TECHNOLOGY, INC. ("ETI") BY
STAR, HOLDERS OF COMMON STOCK ARE URGED TO CONSIDER CAREFULLY THE FOLLOWING
INFORMATION, INCLUDING BUSINESS OF STAR, BUSINESS OF ETI, THE PRO FORMA
FINANCIAL STATEMENTS AND THE FINANCIAL STATEMENTS INCLUDED ELSEWHERE IN THIS
PROXY STATEMENT.
INTEREST OF MANAGEMENT IN THE PROPOSAL
Executive officers and directors of the Company since the Reverse
Acquisition own in the aggregate 11,899 shares of Series B Preferred Stock,
which are convertible into 39,028,720 shares of Common Stock only if this
proposal is approved. See "Security Ownership of Certain Beneficial Owners and
Management."
In connection with the July 1998 issuance to an investment fund of
2,500,000 shares of Common Stock, 763 shares of Series B Preferred Stock and a
warrant to purchase 500,000 shares of Common Stock, Mr. Williams and Mr. Francis
E. O'Donnell, a principal stockholder of the Company, have agreed to convert all
of their respective shares of Class B Preferred Stock into Common Stock upon
stockholder approval of the increase in the authorized number of shares of
Common Stock of the Company. Mr. Williams also has agreed to vote all of his
shares of Series B Preferred Stock beneficially owned by him in favor of any
amendment to the Company's Certificate of Incorporation to increase the number
of the Company's authorized shares of Common Stock. See "Security Ownership of
Certain Beneficial Owners and Management."
THE TRANSACTION
On February 6, 1998, the Company issued 13,831 shares of Series B
Preferred Stock, convertible into 45,365,680 shares of Common Stock of the
Company, in exchange for all of the capital stock of Star in a transaction
accounted for as a "reverse acquisition" (the "Reverse Acquisition"). Upon
consummation of the Reverse Acquisition, Star became a wholly-owned subsidiary
of ETI and the former stockholders of Star acquired Series B Preferred Stock
constituting approximately 90% of the total number of shares of Common Stock
calculated on a fully diluted basis and approximately 58% of the combined voting
power of the Company's securities and acquired the ability to approve all
matters submitted to a vote of stockholders of the Company, except for those
matters which under Delaware law require the approval of holders of the majority
of the outstanding shares of Common Stock, voting separately as a class. The
holders of Series B Preferred Stock are entitled to receive dividends of $150
per share annually out of earnings, if any. Upon liquidation, dissolution or
winding up of the Company, the holders of Series B Preferred Stock are entitled
to receive $3,000 per share, plus all declared and unpaid dividends, prior to
any distribution or payment to holders of Common Stock. The Company may redeem
the Series B Preferred Stock on or after December 31, 2022, at $3,000 per share,
plus all declared and unpaid dividends. Each share of Series B Preferred Stock
is convertible at any time at the option of the holder into 3,280 shares of
Common Stock. Each holder of Series B Preferred Stock is entitled to 500 votes
per share and certain class voting rights on matters relating to the Series B
Preferred Stock.
The business of Star consists primarily of (a) the development of
proprietary technology for the curing of tobacco to prevent, among other things,
the formation of certain carcinogens known as tobacco-specific nitrosamines
("TSNAs"), (b) the development of smoking cessation products utilizing TSNA-free
tobacco, (c) the development of reduced-risk smoking products utilizing
TSNA-free tobacco and (d) the manufacture and sale of cigarettes and little
cigars for the deep discount market. The business of Star accounted for
approximately 74% of the Company's consolidated tangible assets at June 30, 1998
and approximately 95% of the Company's consolidated revenues at June 30, 1998
for the quarter then ended. See "Business of Star" and "Star Management's
Discussion and Analysis of Financial Condition and Results of Operations."
In connection with the Reverse Acquisition, the Company acquired
indirect ownership of all of Star's property, plant and equipment, consisting
primarily of cigarette production facilities, including buildings, equipment and
inventory, located in Petersburg, Virginia. See "Business of Star."
EVENTS LEADING TO THE REVERSE ACQUISITION
During 1997, Star's controlling stockholders, Jonnie R. Williams and
Francis E. O'Donnell, Jr., M.D., and its Chief Executive Officer and counsel,
Samuel P. Sears, Jr., had numerous discussions concerning the future financing
of Star, particularly for the purpose of financing research and development
activities relating to Star's proprietary
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<PAGE> 20
technology for the curing of tobacco so as to prevent the formation of certain
carcinogens known as tobacco-specific nitrosamines. In January 1998, those
discussions focused on the possibilities of entering into a "reverse
acquisition" transaction with a corporation whose securities were
publicly-traded, such as ETI. Messrs. Williams, O'Donnell and Sears were
familiar with the operations and financial condition of ETI. In 1985, Mr.
Williams and Dr. O'Donnell had been early-stage investors in ETI, and Dr.
O'Donnell had briefly served on its Board of Directors in 1985 and 1986. Mr.
Sears had been a Director and the Secretary of ETI from 1985 until the time of
the Reverse Acquisition and had served as its outside general counsel during
that time, but did not represent ETI in connection with the Reverse Acquisition.
During the week of January 19, 1998, Mr. Williams telephoned Robert J.
Fitzsimmons, the Chief Executive Officer of ETI, and proposed that ETI enter
into a "reverse acquisition" transaction with the stockholders of Star
(hereinafter "Williams/O'Donnell") by which Williams/O'Donnell would obtain
approximately 90% of the capital stock of ETI, and Star would become a
wholly-owned subsidiary of ETI. Mr. Fitzsimmons indicated his individual and
preliminary approval to such a transaction.
During the period of January 26-28, 1998, Mr. Sears, representing
Williams/O'Donnell, and Mr. Fitzsimmons had numerous telephone conversations
regarding the specific terms and conditions of the proposed transaction. The
principal conditions to be satisfied before any definitive agreement could be
reached were Williams/O'Donnell's conditions that: (a) certain creditors of ETI,
including persons and entities who had unresolved claims against ETI, would
agree to settlements satisfactory to Williams/O'Donnell; (b) all outstanding
stock options of ETI would be terminated in exchange for shares of Common Stock
of ETI in amounts satisfactory to Williams/O'Donnell; (c) certain accrued
liabilities for compensation due Mr. Fitzsimmons, as well as other present and
past employees and accrued legal fees due Mr. Sears, would be satisfied by the
issuance of Common Stock in amounts satisfactory to Williams/O'Donnell; (d) Mr.
Fitzsimmons would agree that his personal loans to ETI would be satisfied by the
issuance of Common Stock in amounts satisfactory to Williams/O'Donnell; (e)
because ETI did not have sufficient authorized shares of Common Stock to permit
Williams/O'Donnell to obtain approximately 90% of the total issued and
outstanding shares of capital stock of ETI following the transaction, ETI would
authorize a new series of preferred stock which would be converted into shares
of Common Stock once stockholder authorizations were obtained for an increase in
the number of authorized shares of Common Stock; and (f) upon consummation of
the reverse acquisition, Star's designees would be elected as directors and
officers of ETI.
On January 29, 1998, Mr. Sears and outside counsel to
Williams/O'Donnell met in Minneapolis, Minnesota, with outside counsel to ETI.
The subject matter of the meeting was the proposed structure of the Reverse
Acquisition, due diligence and documentation, as well as procedures by which
satisfaction of certain of the conditions imposed by Williams/O'Donnell, as
described above, would be addressed.
During the period of January 28 through February 5, 1998, Messrs. Sears
and Fitzsimmons, and outside counsel of ETI spoke with some of the creditors of
ETI regarding a settlement of their claims against ETI. Also during this period,
Mr. Sears and Mr. Fitzsimmons had several telephone discussions regarding a
settlement of amounts due to Mr. Fitzsimmons by ETI.
On February 3, 1998, outside counsel for Williams/O'Donnell presented a
first draft of documentation to outside counsel for ETI. Shortly thereafter, Mr.
Sears, on behalf of Williams/O'Donnell, suggested various changes to the
documentation. Outside counsel to Williams/O'Donnell then sent revised
documentation to outside counsel for ETI.
On February 5, 1998, Mr. Sears advised Mr. Fitzsimmons that it appeared
likely that the various conditions imposed by Williams/O'Donnell to the proposed
reverse acquisition transaction would be met to the satisfaction of
Williams/O'Donnell and that the parties should prepare for execution of the
documentation. On that same day, the three- member Board of Directors of ETI,
together with outside counsel to ETI, held a meeting by telephone conference
call. With Mr. Sears, a director of ETI, abstaining from voting on any matters
relating to the proposed reverse acquisition, the remaining members of the
Board, Mr. Fitzsimmons and Larry Leiske, M.D., unanimously approved the Reverse
Acquisition.
On February 6, 1998, a definitive agreement was executed by the
stockholders of Star and by ETI, and shares of Series B Preferred Stock were
issued to those stockholders in exchange for all of the outstanding capital
stock of Star.
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REASONS FOR THE REVERSE ACQUISITION
During 1996, 1997 and early 1998 until the date of the Reverse
Acquisition, ETI's financial condition and business prospects became
increasingly precarious. Its intraocular lens business was continuing to decline
during this period with few prospects for improvement unless significant working
capital funds could be obtained. In addition, various steps which ETI had taken
in previous years to augment its intraocular business, most notably an
investment in corneal topography technology and the acquisition of rights to
microlamellar keratomileusis equipment, had proven unsuccessful and in fact had
compounded ETI's negative cash flow situation.
During the period referred to above, ETI management investigated
possibilities for various transactions which would alleviate ETI's financial
condition and/or provide a base of operation from which positive cash flow might
be generated. Management investigated, for example, the following: the sale of
its interest in corneal topography technology; the sale of its rights to
microlamellar keratomileusis equipment; the acquisition or development of rights
to manufacture "soft" intraocular lens; the licensing of rights to its
intraocular lens technology; the sale of capital stock in private placements;
institutional borrowings; and various business combinations. ETI was
unsuccessful in all of these endeavors except for the licensing of certain
rights to Ophthalmic Innovations International, Inc. (see "Business of ETI-
Transaction With Ophthalmic Innovations International, Inc."), which transaction
did not provide ETI with funds to alleviate sufficiently its financial
condition. With respect to ETI's activities for the sale of rights for either
its corneal topography technology or microlamellar keratomileusis equipment,
ETI's goal was to engage in a transaction which would recover ETI's investment,
in each case in excess of $600,000. No broker or investment banker was engaged
for those purposes. The sale of ETI's interest in the corneal topography rights
was hindered by the fact that ETI's interest was in the form of an illiquid
minority stock position in a corporation and, therefore, any acquiror would not
have control of the technology. ETI's discussions with third parties for a sale
of its rights in microlamellar keratomileusis equipment failed to result in a
sale transaction at the price levels being sought by ETI management. During the
second quarter of 1998, the Company elected not to make any further investment
in the equipment and the carrying asset value of ETI's original investment
therein was reduced to zero.
In determining whether to enter into the proposal from Star for the
Reverse Acquisition, ETI's Board of Directors gave consideration to the
unsuccessful efforts of ETI, as described above, to effect transactions by which
ETI's financial condition and business prospects would be enhanced. The Board
was aware, moreover, that several creditors were pressing for payment, including
creditors who had initiated lawsuits and, in one case, was threatening to
enforce a judgment that ETI could not satisfy from its cash position. ETI's
Board believed that the only feasible alternative to the Star proposal was a
filing under Chapter 7 or Chapter 11 of the Federal Bankruptcy Code. The Board
believed further that any such filing would most probably result in a complete
loss of stockholder value.
The purpose of the Reverse Acquisition for ETI, therefore, was to give
its stockholders, following several years of substantially declining stockholder
value, the opportunity to participate through equity ownership in the
development and commercialization of new technology. Star is the exclusive
worldwide licensee of proprietary technology for the curing of tobacco to
prevent the formation of TSNAs which are generally considered by scientists to
be the most abundant and powerful carcinogens in tobacco and tobacco smoke. Star
is developing a reduced-risk smoking product which uses TSNA-free tobacco cured
by its proprietary process and for which it has conducted a Phase I clinical
study pursuant to an FDA reviewed protocol. In addition, Star has developed
several potential pharmaceutical products containing TSNA-free tobacco for
smoking cessation purposes, in respect to one such product it has filed an
investigational new drug application with the United States Food and Drug
Administration. A further purpose for ETI to enter into the Reverse Acquisition
was management's belief that an affiliation with Star would stabilize an
otherwise precarious financial condition. See "Consolidated Financial Statements
of Eye Technology, Inc."
In analyzing the proposal from Star that ETI issue capital stock that
would represent approximately 90% of the Common Stock of ETI in exchange for all
of the Common Stock of Star, ETI's management took into account the factors
described below under "Reasons for the Reverse Acquisition." In addition, ETI's
management considered ETI's total market valuation at the time and for the
previous six months (less than $100,000, determined by multiplying total Common
Stock outstanding by the per share quoted market price for the stock). ETI's
management reasoned that the potential for market appreciation of its Common
Stock that existed if the Reverse Acquisition transaction were to be consummated
outweighed the significant dilution to the interests of existing stockholders as
a result of the transaction. ETI did not, however, have the benefit of a
"fairness opinion" from an independent financial advisor. See "No Fairness
Opinion" below.
15
<PAGE> 22
The purpose of the Reverse Acquisition for Star was to gain access to
the public securities markets and to facilitate equity financings.
REASONS FOR THE STRUCTURE OF THE TRANSACTION
Star's stockholders sought the receipt of an equity interest in ETI
that would represent approximately 90% of the total Common Stock of ETI. ETI's
authorized Common Stock, was 10,000,000 shares, of which 3,435,190 shares were
outstanding at the time of the offer. Star's offer was conditioned upon the
ability of ETI and/or Star to effect various settlements of outstanding debt and
to eliminate outstanding stock options in exchange for Common Stock, and the 90%
calculation was to occur after those settlements and eliminations were to be
effected. A total of 1,402,550 shares of Common Stock were issued on account of
these settlements and eliminations. An additional 205,600 shares of Common Stock
were subject to issuance upon conversion of outstanding shares of Class A
Preferred Stock. Thus, for purposes of the 90% calculation, a total of 5,043,340
shares of Common Stock were used.
Because ETI did not have a sufficient number of authorized but unissued
shares of Common Stock in order to issue an amount of shares which would equal
90% after the issuance, Star's stockholders proposed that they be issued shares
of a new class of preferred stock convertible into shares of Common Stock,
subject to ETI stockholder approval of an increase in the number of authorized
shares of Common Stock so they could exercise their conversion privilege. Star's
stockholders further stipulated that the closing occur as soon as practicable,
in order to raise additional funds to finance the development of its
tobacco-processing technology. ETI did not have the funds to call and hold a
stockholders meeting.
As a result of these factors affecting the structure of the Reverse
Acquisition, Star's stockholders received 13,831 shares of Series B Preferred
Stock, convertible into 45,365,680 shares of Common Stock, (i.e., approximately
90% of the sum of 45,365,680 plus 5,043,340) and representing a total of
6,915,500 votes (i.e., approximately 58% of the sum of 6,915,500 plus
5,043,340). It was at the time of the Reverse Acquisition, and is currently, the
intention of Star's former stockholders to convert their shares of Series B
Preferred Stock into Common Stock as soon as there is a sufficient number of
authorized but unissued shares of Common Stock to allow such a conversion. The
difference in conversion ratio (3,280-to-1) and voting rights (500-to-1) of
shares of Series B Preferred Stock was established to demonstrate to all
stockholders of the Company the advantages of conversion and to counter any
perception among stockholders that the former stockholders of Star might have
received in the Reverse Acquisition shares of a class of stock that, taken as a
whole, might be considered more advantageous than shares of Common Stock of the
Company.
INTERESTS OF CERTAIN PERSONS IN THE REVERSE ACQUISITION
On the date of the Reverse Acquisition, February 6, 1998, ETI owed
Robert J. Fitzsimmons, Chairman of the Board, President and Chief Executive
Officer of ETI, the sum of $172,500 plus accrued interest of approximately
$50,000 for loans provided by Mr. Fitzsimmons in March 1994 and April 1995.
During a period of approximately two years prior to February 6, 1998,
due to shortages of working capital of ETI, Mr. Fitzsimmons did not receive
payments of compensation to which he was entitled under the terms of his
employment agreement. See "Management" elsewhere in this Proxy Statement. At
February 6, 1998, the total amount of such accrued, but unpaid compensation was
approximately $240,000.
On February 6, 1998, Mr. Fitzsimmons and ETI were parties to an
employment agreement which had originally been entered into in 1989 and been
amended and extended in 1994. The expiration date of the agreement was October
31, 1999. Mr. Fitzsimmons' employment agreement provided for an annual salary of
$192,000 and contained provisions by which Mr. Fitzsimmons would be entitled to
receive a cash payment equal to 299.99% of his salary in the event his
employment were terminated following a "change-in-control," as defined in the
agreement.
In February 1994, ETI issued to Mr. Fitzsimmons a stock option to
acquire 150,000 shares of Common Stock at $0.50 per share. The option was due to
expire on February 28, 1999. On February 6, 1998, 50,000 of such shares were
exercisable and options to purchase 100,000 shares were exercisable only upon
satisfaction of certain conditions which had not yet occurred.
On February 6, 1998, as a result of the Reverse Acquisition, ETI agreed
to issue to Mr. Fitzsimmons a total of 887,500 shares of Common Stock of ETI in
consideration for (i) cancellation of indebtedness of ETI to Mr. Fitzsimmons
16
<PAGE> 23
for unpaid compensation and for the loans of Mr. Fitzsimmons to ETI in the
aggregate amount of $378,950, (ii) the mutual termination of Mr. Fitzsimmons'
employment contract with ETI, and (iii) cancellation of options held by Mr.
Fitzsimmons to purchase shares of Common Stock of ETI, as described above.
On February 6, 1998, Samuel P. Sears, Jr. was a Director, Chairman and
Chief Executive Officer of Star. He was also a Director and the Secretary of
ETI. From February 6, 1998 to May 19, 1998, Mr. Sears served as Chairman and CEO
of the Company. Since Mr. Sears was Chairman and Chief Executive Officer of
Star, upon the closing of the Reverse Acquisition, Mr. Sears assumed the
positions of Chairman and Chief Executive Officer of ETI. In addition, Mr. Sears
had acted as outside general counsel to ETI since 1985. At that date, ETI was
indebted to Mr. Sears in the amount of $56,332 for legal services provided
during the years 1994-1996. In addition, Mr. Sears held a stock option, which
had been issued in 1993, to acquire 50,000 shares of Common Stock of ETI at $.50
per share. The option was due to expire on January 31, 2001.
On February 6, 1998, as a result of the Reverse Acquisition, ETI issued
to Mr. Sears 225,300 shares and 15,000 shares, for a total of 240,300 shares of
Common Stock of ETI, in consideration for, respectively, the release of
indebtedness to Mr. Sears for legal fees and the termination of the stock
option.
ETI did not solicit a vote of stockholders on the Reverse Acquisition
in order to avoid the expense and delay in doing so. Under Delaware corporate
law, neither a fairness opinion from a financial adviser nor stockholder
approval was required for the Reverse Acquisition or the issuance of the Series
B Preferred Stock.
NO FAIRNESS OPINION
The number and structure of shares of capital stock of ETI issued to
the stockholders of Star in the Reverse Acquisition were determined by
negotiation between the parties. Often, a publicly-owned company will engage an
independent financial advisor to render a "fairness opinion" with respect to the
financial terms of a proposed merger or acquisition transaction. The purposes of
such an opinion are generally (a) to confirm to management of an entity that the
proposed transaction is fair from a financial point of view, as considered by an
independent, objective and qualified party, and therefore that management has
acted properly in the exercise of its business judgment in its negotiation of
the financial terms, and (b) to advise stockholders that the proposed terms of a
transaction are fair from a financial point of view.
ETI did not obtain a "fairness opinion" from an independent financial
advisor with respect to the fairness of the financial terms of the Reverse
Acquisition. The ETI Board of Directors did not believe that such an opinion was
necessary because of the precarious financial condition of the Company discussed
above under "Reasons for the Reverse Acquisition." Moreover, ETI did not have
available to it sufficient funds with which to pay for a meaningful fairness
opinion. Directors who voted upon the Reverse Acquisition did not have any
particular expertise in financial matters which would qualify either of them as
experts in financial matters. The analysis undertaken by the Board of Directors
of ETI in determining that the financial terms of the Reverse Acquisition were
fair to ETI and its stockholders is described above under "Reasons for the
Reverse Acquisition." The Board believed that the risks associated with the
failure in obtaining a "fairness opinion," that is, the failure to receive an
independent, objective and qualified opinion for the benefit of management and
stockholders, were outweighed by (a) the exigencies of ETI's situation, that is,
the lack of an available and viable course of action as an alternative to the
Reverse Acquisition, (b) the obvious benefits to ETI and its stockholders of the
Reverse Acquisition, in particular, the enhanced potential for increased market
value of shares of Common Stock and the enhanced prospects for financial
stability of ETI following the Reverse Acquisition, and (c) the lack of ETI
funds to obtain such an opinion.
ACCOUNTING TREATMENT
For accounting purposes, the exchange transaction was recorded as a
"reverse acquisition," with Star as the accounting acquirer. In a "reverse
acquisition," the accounting acquirer is treated as the surviving entity, even
though ETI's legal existence does not change and the financial statements refer
to ETI, not Star. The accounting acquirer treats the merger as a purchase
acquisition. As a result, the Reverse Acquisition has been recorded using the
historical cost basis for the assets and liabilities of Star, as adjusted, and
the estimated fair value of ETI and its subsidiaries' assets and liabilities.
17
<PAGE> 24
TAX CONSEQUENCES
The Reverse Acquisition qualified for federal income tax purposes as a
tax-free reorganization within the meaning of Section 368 of the Internal
Revenue Code of 1986, as amended. Holders of Series B Preferred Stock recognized
no gain or loss for federal income tax purposes as a result of the exchange of
their shares of Star Common Stock for shares of Series B Preferred Stock.
Effective February 6, 1998, Star has no longer been treated as a Subchapter S
Corporation for tax purposes and is subject to corporate income taxes.
MANAGEMENT AFTER THE REVERSE ACQUISITION
Upon consummation of the Reverse Acquisition, designees of Star became
executive officers and directors of the Company. See "Management" and "Proposal
No. 1."
RESTRICTIONS ON RESALE OF SECURITIES
The issuance of shares of the Series B Preferred Stock by the Company
pursuant to the Reverse Acquisition was not registered under the Securities Act
of 1933, as amended (the "Securities Act"). Such shares, and any Common Stock
issuable upon conversion of such shares, may not be publicly offered or sold,
except pursuant to an effective registration statement or the availability of an
exemption from the registration requirements of the Securities Act.
APPRAISAL AND DISSENTERS' RIGHTS
Holders of the Company's Common Stock did not have appraisal or
dissenters' rights under Delaware corporate law in connection with the Reverse
Acquisition.
MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Common Stock of the Company is traded in the over-the-counter
market and is quoted on the Electronic Bulletin Board under the symbol "EYTC."
Set forth below are the high and low bid prices (which reflect prices between
dealers and do not include retail markup, markdown or commission and may not
represent actual transactions) for each full quarterly period during 1996 and
1997, as reported by the National Quotation Bureau. From time to time, during
the periods indicated, trading activity in the Company's stock was infrequent.
No dividends have ever been declared by the Company. As of November 10, 1998,
there were approximately 570 record holders of the Company's Common Stock.
<TABLE>
<CAPTION>
Quarter Ended High Bid Low Bid
- ------------- -------- -------
<S> <C> <C>
03-31-96 $ 0.125 $ 0.125
06-30-96 $ 1.0625 $ 0.125
09-30-96 $ 0.75 $0.40625
12-31-96 $0.40625 $0.09375
03-31-97 $0.21875 $0.09375
06-30-97 $0.21875 $0.01563
09-30-97 $ 0.035 $ 0.01
12-31-97 $ 0.01 $ 0.01
03-31-98 $ 5.9375 $ 0.01
06-30-98 $ 5.625 $ 3.00
09-30-98 $ 3.50 $ 1.4375
</TABLE>
The closing bid and asked prices on February 5, 1998, the date
preceding the date on which the Reverse Acquisition occurred, were $.01 and
$.04, respectively. The closing bid and asked prices on November 10, 1998, were
$3.3125 and $3.4375, respectively.
Prior to the Reverse Acquisition, Star was a private company.
Subsequent to the Reverse Acquisition, Star is a wholly-owned subsidiary of the
Company.
18
<PAGE> 25
EYE TECHNOLOGY, INC. AND SUBSIDIARIES
AND
STAR TOBACCO & PHARMACEUTICALS INC.
Pro Forma Condensed Consolidated Financial Statements
(Unaudited)
December 31, 1997
The following unaudited pro forma condensed consolidated financial
statements reflect the February 6, 1998 merger of ETI and subsidiaries, a
publicly-owned company, and Star, a privately-owned company. The pro forma
balance sheet and statement of operations present the balance sheet as if the
transaction occurred to correspond with the Companies' year end and the
statement of operations as if the transaction occurred at the beginning of the
year presented. For accounting purposes, the transaction is recorded as a
reverse acquisition with Star as the accounting acquirer. In a reverse
acquisition, the accounting acquirer is treated as the surviving entity, even
though the registrant's legal existence does not change and the financial
statements refer to ETI not Star. The accounting acquirer treats the merger as a
purchase acquisition. As a result , the merger has been recorded using the
historical cost basis for the assets and liabilities of Star as adjusted, and
the estimated fair value of ETI and subsidiaries assets and liabilities. A
further description of merger and pro forma adjustments follow the unaudited pro
forma condensed consolidated financial statements.
The unaudited pro forma condensed consolidated financial statements
below should be read in conjunction with the following: the consolidated
financial statements of ETI and its subsidiaries for the two years ended
December 31, 1997, appearing on pages F-16 to F-25 of this Proxy Statement, and
to ETI'S Management's Discussion and Analysis of Financial Condition and Results
of Operations relating thereto appearing on pages 35-36 of this Proxy Statement;
and to the financial statements of Star for the two years ended December 31,
1997, appearing on pages F2 through F-15 of this Proxy Statement, and to Star
Management's Discussion and Analysis of Financial Condition and Result of
Operations relating thereto appearing on pages 33-35 of this Proxy Statement.
19
<PAGE> 26
EYE TECHNOLOGY, INC. AND SUBSIDIARIES
AND
STAR TOBACCO & PHARMACEUTICALS INC.
Pro Forma Condensed Consolidated Balance Sheet
(Unaudited)
December 31, 1997
<TABLE>
<CAPTION>
PRO FORMA PRO FORMA
ASSETS ETI STAR ADJUSTMENTS CONSOLIDATION
---- ---- ----------- -------------
<S> <C> <C> <C> <C>
Current assets:
Cash $ 3,243 $ 10,929 $ -- $ 14,172
Accounts receivable 52,214 775,168 -- 827,382
Inventories 894,077 605,392 -- 1,499,469
Other current assets 7,177 89,989 -- 97,166
------------ ------------ ------------ ------------
Total current assets 956,711 1,481,478 -- 2,438,189
------------ ------------ ------------ ------------
Property and equipment, net 48,514 2,415,632 -- 2,464,146
------------ ------------ ------------ ------------
Other assets:
Intangibles, net of amortization 193,793 157,557 748,445 1,099,795
Other assets 54,225 64,969 -- 119,194
------------ ------------ ------------ ------------
Total other assets 248,018 222,526 748,445 1,218,989
------------ ------------ ------------ ------------
$ 1,253,243 $ 4,119,636 $ 748,445 $ 6,121,324
============ ============ ============ ============
Liabilities and Stockholders' Deficit
Current liabilities:
Line of credit $ -- $ 1,294,138 $ -- $ 1,294,138
Current maturities of notes
payable 452,638 647,947 ( 156,000)(1) 944,585
Accounts payable 478,348 2 375,903 -- 2,854,251
Federal excise taxes payable -- 359,783 -- 359,783
Accrued expenses 1,280,484 85,108 ( 310,782)(1) 1,054,810
------------ ------------ ------------ ------------
Total current liabilities 2,211,470 4,762,879 (466,782) 6,507,567
Notes payable, less current
maturities -- 1,099,242 -- 1,099,242
------------ ------------ ------------ ------------
Total liabilities 2,211,470 5,862,121 (466,782) 7,606,809
------------ ------------ ------------ ------------
Commitments and contingencies
Redeemable preferred stock 257,000 -- 138 (2) 257,138
------------ ------------ ------------ ------------
Stockholders' deficit:
Common stock 34,352 383,557 12,388 46,740
-- -- ( 383,557)(2) --
Additional paid-in capital 8,777,505 1,004,607 454,394 1,341,286
-- -- ( 8,895,220)(2) --
Accumulated deficit (10,027,084) (3,130,649) 10,027,084 (3,130,649)
------------ ------------ ------------ ------------
Total stockholders' deficit (1,215,227) (1,742,485) 1,215,089 (1,742,623)
------------ ------------ ------------ ------------
$ 1,253,243 $ 4,119,636 $ 748,445 $ 6,121,324
============ ============ ============ ============
</TABLE>
See notes to pro forma condensed consolidated financial statements.
20
<PAGE> 27
EYE TECHNOLOGY, INC. AND SUBSIDIARIES
AND
STAR TOBACCO & PHARMACEUTICALS INC.
Pro Forma Condensed Consolidated Statement of Operations
(Unaudited)
For the Year Ended December 31, 1997
<TABLE>
<CAPTION>
PRO FORMA PRO FORMA
ETI STAR ADJUSTMENTS CONSOLIDATION
--- ---- ----------- ------------
<S> <C> <C> <C> <C>
Net sales $ 1,333,431 $ 20,763,856 $ -- $ 22,097,287
Cost of goods sold 748,018 10,033,330 -- 10,781,348
Excise taxes on products -- 7,810,720 -- 7,810,720
------------ ------------ ------------ ------------
Gross profit 585,413 2,919,806 -- 3,505,219
------------ ------------ ------------ ------------
Operating expenses:
Marketing and distribution
expenses 197,422 1,111,420 -- 1,308,842
General and administrative
expenses 888,746 1,425,299 149,689(3) 2,463,734
Research and development -- 2,134,656 -- 2,134,656
------------ ------------ ------------ ------------
Total operating expenses 1,086,168 4,671,375 149,689 5,907,232
------------ ------------ ------------ ------------
Operating loss (500,755) (1,751,569) (149,689) (2,402,013)
------------ ------------ ------------ ------------
Other income (expenses):
Other 331,140 21,073 -- 352,213
Interest expense (160,576) (256,001) -- (416,577)
------------ ------------ ------------ ------------
Net other income
(expense) 170,564 (234,928) -- (64,364)
------------ ------------ ------------ ------------
Net loss $ (330,191) $ (1,986,497) $ (149,689) $ (2,466,377)
============ ============ ============ ============
Pro forma presentation applicable
to conversion from S corporation
to C corporation:
Net loss before pro forma
income tax expense $ (330,191) $ (1,986,497) $ (2,466,377)
Pro forma income tax expense -- -- --
------------ ------------ ------------
Pro forma net loss $ (330,191) $ (1,986,497) $ (2,466,377)
============ ============ ============
Pro forma basic loss per
common share $ (.10) $ (9,932) $ (.53)
============ ============ ============
P
Weighted average number of
shares 3,435,190 200 4,673,990
============ ============ ============
</TABLE>
See notes to pro forma condensed consolidated financial statements.
21
<PAGE> 28
EYE TECHNOLOGY, INC. AND SUBSIDIARIES
AND
STAR TOBACCO & PHARMACEUTICALS INC.
Notes to Pro Forma Condensed Consolidated Financial Statements
(Unaudited)
A. Description of Reverse Acquisition:
On February 6, 1998, ETI and subsidiaries, a publicly-owned company
entered into a stock exchange agreement with Star, a privately-owned
company. Under the agreement, Star exchanged all of its common stock
for 13, 831 shares of series B convertible voting preferred stock, par
value $0.01 per share. When converted this stock would equal 45,367,251
shares of common stock, approximately 90% of the outstanding common
stock of ETI and subsidiaries as of the transaction date. These
potential common shares have not been included in the pro forma basic
loss per common share calculation as it would be antidilutive.
At the time of the transaction there were no active markets for ETI
stock. Thus, management relied on the fair value of the assets received
and liabilities assumed to determine fair value. While an independent
appraisal was not performed, management believes that based on its
knowledge of the business and industry , the Company's assets and
liabilities are stated at estimated fair value. The excess of
liabilities assumed over assets acquired amounted to $748,445 and was
assigned to goodwill.
The preliminary allocation of the purchase price adjusting to fair
value the assets and liabilities ETI is based upon estimates that are
currently available and may be subject to change based upon final
numbers. The pro forma presentation does not necessarily reflect the
results of operations as if these two companies had operated as a
single entity.
The preliminary allocation of purchase price is as follows:
<TABLE>
<S> <C>
Consideration and liabilities assumed:
Fair value of stock $ --
Liabilities assumed, including redeemable preferred stock 2,001,688
-------------
2,001,688
Allocated to:
Tangible assets acquired $ 1,059,450
Purchase Technology 193,793
Goodwill 748,445
-------------
$ 2,001,688
=============
</TABLE>
B. Pro Forma adjustments:
The following is a description and summary of the pro forma adjustments
for the consolidated balance sheet:
<TABLE>
DR (CR)
---------
<S> <C> <C>
(1) Notes payable $ 156,000
Accrued expenses 310,782
Common stock (12,388)
Additional paid-in capital (454,394)
To record issuance of 1,238,800 shares of common stock used to
reduce a related party note payable and various accrued
expenses as part of the stock exchange agreement.
</TABLE>
22
<PAGE> 29
EYE TECHNOLOGY, INC. AND SUBSIDIARIES
AND
STAR TOBACCO & PHARMACEUTICALS INC.
Notes to Pro Forma Condensed Consolidated Financial Statements
(Unaudited)
<TABLE>
<S> <C> <C>
(2) Goodwill $ 748,445
Common stock 383,557
Additional paid-in capital 8,895,220
Redeemable preferred stock (138)
Accumulated deficit (10,027,084)
To record purchase accounting adjustments based upon terms of
the transaction in accordance with Accounting Principles Board
Statement No. 16.
The pro forma adjustment associated with the consolidated statement of
operations is as follows:
Goodwill amortization $149,689
</TABLE>
To record amortization of goodwill based upon a 5-year life.
23
<PAGE> 30
EYE TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
AS OF JUNE 30, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
ASSETS JUNE 30, 1998
-------------
<S> <C>
Current assets:
Cash $ 13,367
Accounts receivable 736,804
Inventories 1,654,248
Other current assets 143,239
-----------
Total current assets 2,547,658
-----------
Property and equipment, net 1,655,737
-----------
Other assets:
Intangibles, net of amortization 837,504
Other assets 118,172
-----------
Total other assets 955,676
-----------
$ 5,159,071
===========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Notes payable - current $ 1,380,339
Accounts payable 3,733,537
Accrued expenses 1,136,051
-----------
Total current liabilities 6,249,927
Notes payable, less current maturities 809,086
-----------
Total liabilities 7,059,013
-----------
Commitments and contingencies
Redeemable preferred stock 40,800
-----------
Stockholders' deficit:
Preferred stock 168
Common stock 71,698
Additional paid-in capital 3,087,301
Accumulated deficit (5,099,909)
-----------
Total stockholders' deficit (1,940,742)
-----------
$ 5,159,071
===========
</TABLE>
See notes to condensed consolidated financial statements.
24
<PAGE> 31
EYE TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND 1997
(UNAUDITED)
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Net sales $ 6,837,765 $ 11,909,260
Cost of goods sold 3,053,965 5,710,139
Excise taxes on products 2,954,950 4,333,709
------------ ------------
Gross profit 828,850 1,865,412
------------ ------------
Operating expenses:
Marketing and distribution expenses 569,058 564,427
General and administrative expenses 1,364,953 780,399
Research and development 702,058 521,398
------------ ------------
Total operating expenses 2,636,069 1,866,224
------------ ------------
Operating income (loss) (1,807,219) (812)
Other income (expenses):
Other (298,536) 15,830
Interest expense (157,111) (119,128)
------------ ------------
Income (loss) before extraordinary item (2,262,866) (104,110)
Extraordinary gain from extinguishment of debt 293,606 --
(no applicable income taxes) ------------ ------------
Net income (loss) $ (1,969,260) $ (104,110)
============ ============
Basis and diluted earnings (loss) per common share:
Income (loss) before extraordinary item $ (.39) $ (521)
Extraordinary item $ .05 $ --
Net income (loss) $ (.34) $ (521)
Weighted average number of shares 5,850,000 200
============ ============
</TABLE>
See notes to condensed consolidated financial statements.
25
<PAGE> 32
EYE TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND 1997
(UNAUDITED)
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Operating activities:
Net loss $(1,969,260) $ (104,110)
Adjustments to reconcile net loss to
net cash provided (used) by operating activities:
Depreciation and other non-cash charges 840,752 211,735
Extraordinary gain from extinguishment of debt (293,606) --
(Increase) decrease in current assets (116,305) 1,017,672
(Decrease) increase in current liabilities 1,055,531 (540,110)
----------- -----------
Net cash provided (used) by operating activities (482,888) 585,187
----------- -----------
Investing activities:
Purchases of property and equipment (98,500) (432)
Purchases of intangible assets (460) --
Proceeds from sale of property and equipment 175,000 --
----------- -----------
Net cash provided (used) by investing activities 76,040 (432)
----------- -----------
Financing activities:
Proceeds from notes payable 48,500 137,972
Proceeds from capital contribution 1,488,679 --
Payments on notes payable (1,127,893) (644,996)
Stockholder distributions -- (77,401)
Net cash provided (used) by financing activities 409,286 (584,425)
----------- -----------
Increase in cash 2,438 330
Cash, beginning of period 10,929 10,584
----------- -----------
Cash, end of period $ 13,367 $ 10,914
=========== ===========
Cash paid for:
Interest $ 140,631 $ 126,887
</TABLE>
See notes to condensed consolidated financial statements.
26
<PAGE> 33
EYE TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND 1997
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
------------------------------
1998 1997
----------- -----------
<S> <C> <C>
Non-cash investing and financing activities:
Repayment of related party note payable with
related party note receivable $ -- $ 759,439
===========
Conversion of related party note payable to equity $ -- $ 923,499
===========
Conversion of redeemable preferred stock to equity $ 232,000 $ --
===========
Notes payable reduced by proceeds from equipment sale $ 255,000 $ --
===========
Issuance of common stock as compensation $ 90,900 $ --
===========
Acquisition:
Fair value of assets acquired $ 1,237,238 $ --
Liabilities assumed (2,001,688)
----------- -----------
Excess assigned to goodwill $ 764,450 $ --
=========== ===========
</TABLE>
See notes to condensed consolidated financial statements.
27
<PAGE> 34
EYE TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
A. Basis of presentation:
The financial information included herein is unaudited; however, such
information reflects all adjustments (consisting solely of normal
recurring adjustments) which are, in the opinion of management, necessary
for a fair statement of results for the interim periods.
The results of operations for the six months ended June 30, 1998 are not
necessarily indicative of the results to be expected for the full year.
B. Description of acquisition:
On February 6, 1998, the Company and its subsidiaries, entered into a
stock exchange agreement with the stockholders of Star. Under the
agreement, Star stockholders exchanged all of their common stock for
13,831 shares of Series B Preferred Stock, par value $.01 per share. When
converted this stock would equal 45,365,680 shares of common stock,
approximately 90% of the outstanding common stock of the Company and its
subsidiaries as of the transaction date.
APB No. 16, paragraph 70 states that presumptive evidence of the acquiring
corporation in combinations effected by an exchange of stock is obtained
by identifying the former common stockholder interest of a combining
company which either retain or receive the larger portion of the voting
rights in the combined corporation. That corporation should be treated as
the acquirer unless other evidence clearly indicates that another
corporation is the acquirer. As the former stockholders of Star hold the
larger portion of the voting rights of the combined corporation, the
transaction has been recorded as a reverse acquisition with Star as the
accounting acquirer. In a reverse acquisition, the accounting acquirer is
treated as the surviving entity, even though the registrant's legal
existence does not change. The accounting acquirer treats the merger as a
purchase acquisition. As a result, the merger has been recorded using the
historical cost basis for the assets and liabilities of Star, as adjusted,
and the estimated fair value of the Company's and its subsidiaries assets
and liabilities. The excess of the Company's and its subsidiaries'
liabilities assumed over assets acquired amounts to $764,450 and was
assigned to goodwill which is being amortized over five years on a
straight-line basis.
The results of operations of Eye Technology, Inc. and Subsidiaries are
included in the accompanying condensed consolidated financial statements
from the date of acquisition.
The following summarized pro forma information assumes the acquisition had
occurred as of January 1, 1997.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
--------
1998 1997
------------ ------------
<S> <C> <C>
Net sales $ 6,896,658 $ 12,643,903
Operating loss $ (1,837,338) $ (178,203)
Net loss $ (2,004,376) $ (51,432)
Earnings (loss) per shares:
Basic and diluted $ (.29) $ (.01)
</TABLE>
28
<PAGE> 35
EYE TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(UNAUDITED)
C. Income taxes:
Effective February 6, 1998, Star is no longer treated as an S Corporation
for tax purposes and will be subject to corporate income taxes. If the
Company had been subject to corporate income taxes during 1997 and through
February 6, 1998, it would not have any current income tax liability due
to its operating losses. Star would have a deferred income tax asset
resulting from the net operating losses and a deferred income tax
liability resulting primarily from temporary differences in depreciation.
A valuation allowance would have been established to fully reserve the
excess of the deferred tax asset over the deferred tax liability due to
the uncertainty of the utilization of the operating loss carryforward.
D. Extraordinary item:
During the first quarter of 1998, the Company recognized an extraordinary
gain of $293,606 as the result of negotiated settlements with various
vendors for trade accounts payable. There was no income tax effect on the
transactions.
E. Earnings (loss) per common share:
Earnings (loss) per common share is computed under the provisions of
Statement of Financial Accounting Standards No. 128, "Earnings per Share".
Basic earnings (loss) per common share is computed by dividing net
earnings (loss) by the weighted average number of common shares
outstanding during the period. Diluted earnings (loss) per common share
includes the dilutive effect of potential common shares outstanding. The
Company's potential common shares outstanding are from preferred stock.
Basic and diluted earnings (loss) per share were the same in 1998 because
all potential common shares were antidilutive.
F. Related party transactions:
During the first quarter of 1998, a total of $167,355 was advanced to
Jonnie R. Williams. These advances were repaid during the second quarter
of 1998.
G. Purchased technology:
The Company maintained certain purchased technologies in connection with
its Microlamellar Keratomileusis (MKM) product line. Additional
development was needed to sustain marketability of the technology and
during the second quarter of 1998 management elected not to make such
improvements. Under guidance of Statement of Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of," management has determined that
the value of such technology has been impaired and should be written-off.
The carrying value of the technology amounted to $180,000 and was
written-off as a charge to general and administrative expense.
H. Subsequent events:
The Company maintained a $1.5 million revolving line of credit pursuant to
which borrowings were available to the Company with advances limited by
formula to specified levels of accounts receivable and inventory. This
credit facility was to expire on March 31, 1998, but was extended to June
30, 1998. The Company was in default of certain covenants, a situation
which had existed for over two years. Subsequently, in July 1998, the
Company's bank loan arrangements were assigned to a different bank and the
loan terms were modified. As a result, the term of the loan was extended
to January 1, 1999, and existing defaults were waived.
In July 1998, the Company sold to a single institutional investor
2,500,000 shares of Common Stock, 763 shares of Series B Preferred Stock
convertible into 2,502,640 shares of Common Stock, and a one-year warrant
to purchase 500,000 shares of Common Stock of the Company at a price of
$2.00 per share for a total price of $2,500,000. Simultaneously with that
transaction, certain controlling stockholders of the Company contributed
to the Company 1,144 shares of Series B Preferred Stock convertible into
3,752,320 shares of common stock. Additional warrants to purchase 350,000
shares of common stock at a price of $2.00 per/share were issued to other
parties in connection with this transaction.
29
<PAGE> 36
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
This Proxy Statement contains forward-looking statements that involve
risks and uncertainties, including statements about the financial condition,
results of operations, plans, objectives, future performance and business of the
Company, ETI and Star. These forward-looking statements include: (1) statements
relating to the impact on revenues of the Reverse Acquisition; (2) statements
preceded by, followed by or that include the words "believes," "expects,"
"anticipates," or similar expressions; (3) reimbursement and other governmental
or private agency actions adversely affect the revenue of the Company, ETI and
Star; (4) competition which may adversely affect the results of the Company, ETI
and Star; (5) legislative or regulatory changes adversely affect the businesses
in which the Company, ETI and Star will be engaged; and (6) changes in the
securities markets affect the performance of the Company's shares.
OVERVIEW
All revenues of the Company for the six-month period ended June 30,
1998 were generated from either the sale by Star of conventional tobacco
products or the sale by ETI of ophthalmic products. As explained elsewhere in
this Proxy Statement, the Company's current primary emphasis is upon the
development and commercialization of its technology to reduce or eliminate
tobacco-specific nitrosamines from tobacco and the development of products
incorporating such technology. No revenues, however, have been generated to date
as a result of these developments and commercialization activities.
RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO SIX
MONTHS ENDED JUNE 30, 1997
The results of operations for the first six months of 1998 includes the
results of operations of Star for the entire period, consolidated with those of
ETI and its subsidiaries since the beginning of February, 1998, while results of
operations for the first six months of 1997 include only those of Star.
Net sales declined by 42.3%, or slightly more than $5 million, from the
first six months of 1997 to the first six months of 1998, which includes sales
of $390,000 of ETI. The decline in sales is attributed to: (i) the decision by
the new owners of Swisher International, Inc. to bring in-house the manufacture
of small cigars and, consequently, the loss of contract manufacturing sales to
Swisher which declined from $2.67 million in the 1997 period to less than
$20,000 in the 1998 period; (ii) lower sales of Star brand cigarettes due to
price competition from premium brand cigarette manufacturers; and (iii) a
decision by the Company's management to emphasize the development of its
proprietary tobacco processing technology as well as to bring to market a less
hazardous smoking product using its proprietary tobacco processing technology.
Costs of goods sold ("COGS") declined as a percentage of sales from
47.9% in the first half of 1997 to 44.7% in the first half of 1998. The
percentage decline reflects improvements in manufacturing efficiencies and
product configurations, as well as an increase in average profit margins per
sale due to higher average selling prices in the 1998 period compared to the
1997 period. These improvements were slightly offset by COGS of 76% in the
Company's ETI operations.
Excise taxes, as a percentage of sales, increased from 36.4% in the
first half of 1997 to 43.2% in the first half of 1998. The increase is
attributable primarily to the fact that no federal tobacco excise taxes were
payable by Star on its sales of little cigars to Swisher International, Inc. The
1997 period also included a one-time export transaction on which no excise taxes
were payable.
As a result of the above-described factors, gross profit margins of the
Company declined from 15.7% in the 1997 period to 12.1% in the 1998 period.
Marketing and distribution expenses remained essentially the same in
the two fiscal periods being compared, but, as a percentage of sales, this
category of expense increased from 4.7% in 1997 to 8.3% in 1998. The percentage
increase is attributable to three factors: (1) the effect of relatively fixed
overhead costs, which become a larger percentage of sales as sales volume
declines; (2) expenses incurred in the introduction in January 1998 of a new
product; and (3) a revised method of compensating sales persons which resulted
in higher selling expense, i.e., a shift from salary-based compensation to
commission-based compensation in order to provide greater incentive to sales
persons.
30
<PAGE> 37
General and administrative expenses increased significantly from the
first half of 1997 to the first half of 1998 --from $780,399, or 6.6% of sales,
in 1997 to $1,364,953, or 19.9% of sales in 1998. The 1998 figure includes
$398,231 incurred at ETI, $180,000 of which represents a write-off in the second
quarter of 1998 of the entire balance of the carrying value of ETI's investment
in microlamellar keratomileusis ("MKM")/laser assisted in-situ keratomileusis
("LASIK") technology resulting from the Company's decision not to invest further
in this asset. The increases are also due to the following factors: (1)
substantially higher legal and accounting expenses due primarily to the
Company's need to bring itself into compliance with Securities and Exchange
Commission reporting requirements following the "reverse acquisition" of ETI by
Star in February, 1998; (2) increased management compensation expense related to
the hiring of a new Chief Executive Officer, and (3) goodwill expense in 1998 of
$58,000 resulting from the "reverse acquisition" transaction. Moreover, the
percentage increase may be attributed in part to the fact that relatively fixed
expenses constitute a higher proportion of a lesser sales figure.
Research and development expenses increased from $521,396 in the first
half of 1997 to $702,058. All of these expenses, 100% of which were incurred by
Star and not ETI, are related to the development of the Company's proprietary
technology for the elimination of nitrosamines from tobacco, and were not
related to the Company's revenue-producing operations in the two periods of 1997
and 1998 being compared.
The expense of $298,536 included under "Other" in the six-month period
of 1998 reflects primarily a non-recurring loss resulting from a sale of surplus
cigarette manufacturing equipment in the second quarter of 1998.
The extraordinary gain in 1998 of $293,606 reflects settlements with
various creditors of ETI entered into at the time of the "reverse acquisition"
transaction between Star and ETI in February, 1998.
As a result of all of the above factors, the Company's net loss
increased from $104,110 in the first half of 1997 to $1,969,260 in the first
half of 1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company's balance sheet at June 30, 1998, reflects an illiquid
position with a current asset-to-liability ratio of 1 - 2.45. Operations at Star
have been financed over the past several years primarily through borrowed funds
from institutional and private lenders and increases in accounts payable and
accrued expenses. In the first six months of 1998, borrowings were reduced
(partially through an equipment sale described above) and the Company's
dependence on trade debt and other short-term indebtedness increased. The
Company's liquidity has significantly improved, however, by the receipt of 2.5
million dollars from an equity private placement in July, 1998, described below.
Throughout 1998 until early July, the Company maintained with a bank a
revolving line-of-credit pursuant to which borrowings of up to $1.5 million were
available to the Company with advances limited by formula to specified levels of
accounts receivable and inventory of the Company's tobacco products business.
This credit facility was due to expire on June 30, 1998. The Company was in
default of certain financial covenants but not in any of the loan's repayment
terms. In early July, 1998, the bank loan was assigned to a different bank, the
loan terms were modified with the term being extended to January 1, 1999, and
existing defaults being waived.
"Intangibles" reflects primarily the recording of $764,000 of goodwill
incurred in the Company's February, 1998 "reverse acquisition" transaction. This
item is being amortized over a five-year period at the rate of $153,000 per
year, or $38,250 per quarter.
In March 1998, 2,320 shares of Class A Preferred Stock (listed as
"Redeemable preferred stock" on the balance sheet) were converted into 232,000
shares of Common Stock of the Company. Under the terms of the Class A Preferred
Stock, outstanding shares of the stock are redeemable at the option of the
holder in the event that more than $500,000 in cash in consideration for the
issuance of capital stock had been received by Eye Technology, Inc. since the
issuance date of the preferred stock. That condition was satisfied in March,
1998. Because the Company wished to conserve its cash resources, it offered to
the holders of Class A Preferred Stock (five persons) that it could convert its
shares into Common Shares at a ratio of 100-to-1 instead of the ratio of 80-to-1
as was set forth in the terms of the preferred stock. Holders of 2,320 out of
2,570 shares of Class A Preferred Stock accepted the Company's proposal. If such
holders had exercised their right to redeem such shares, rather than to convert
them, the Company would have been obligated to expend $378,624 in redemption
distributions.
31
<PAGE> 38
As of February 9, 1998, the Company sold an additional 2,900,000 shares
of Common Stock in a private placement for $1,450,000. The proceeds were used
primarily to reduce indebtedness originally incurred for working capital
purposes, including research and development. A portion of the funds received by
the Company from this private placement, together with issuance of Common Stock
in satisfaction of accrued indebtedness, resulted in a reduction of outstanding
indebtedness of the Company of approximately $700,000.
In July, 1998, the Company sold to a single institutional investor
2,500,000 shares of Common Stock, 763 shares of Series B Preferred Stock
convertible into 2,502,640 shares of Common Stock, and a one-year warrant to
purchase 500,000 shares of Common Stock of the Company at a price of $2.00 per
share for a total price of $2,500,000. Simultaneously with that transaction,
certain controlling stockholders of the Company contributed to the Company 1,144
shares of Series B Preferred Stock convertible into 3,752,320 shares. The net
effect of these capital stock transactions was the receipt by the Company of
$2,500,000 and the increase of outstanding capital stock of 1,250,330 shares of
Common Stock on a fully-diluted basis. The Company will use the proceeds of this
equity financing primarily for continued research and development of Star's
technology for the removal from tobacco of tobacco-specific nitrosamines and for
the acquisition of tobacco-processing equipment. See "Business of Star."
With the extension of the Company's bank loan and receipt of equity
funds described above, the Company believes that it has adequate working capital
for the remainder of 1998. The process of developing and commercializing the
Company's tobacco-processing technology and smoking cessation and reduced-risk
smoking products will require additional funds in 1999 and beyond. Although the
Company is unable at this time to precisely estimate its long-term funding
requirements, the Company believes that a minimum of several million dollars is
necessary, although the actual required amount of funds could be substantially
higher. The Company intends to seek such additional funding through public or
private financings, including additional bank financing arrangements, and/or
through collaboration or other arrangements with corporate partners. There can
be no assurances that such additional financing will be available from any
sources or, if available, will be available on acceptable terms or that the
Company will be able to establish corporate collaboration on acceptable terms,
or at all. Any shortfall in funding could result in the Company having to
curtail its operations including its development and commercialization
activities which could have a material adverse effect on the Company's business,
financial condition and results of operations.
The Company does not intend to allocate any substantial part of its
foreseeable capital expenditures to either the conventional cigarette
manufacturing operations of Star or the operations of ETI, the latter of which
are currently cash flow negative and produce an operating loss. While the
Company believes that the deployment of capital funds by ETI, estimated at a
minimum of $250,000, may bring ETI's operations to a positive cash flow and
operating income basis, the Company has concluded that the potential return on
investment from an allocation of available funds to ETI's operations would be
less than the return from an allocation of such funds to the Company's
tobacco-processing technology. As a result of these decisions, the remaining
balance of ETI's investment in MKM/LASIK technology, that is, $187,000 at March
31, 1998, was reduced to zero at June 30, 1998.
The Company is exploring alternative strategies for the disposition or
liquidation of product lines and assets, including those of ETI, which do not
comport with and do not sufficiently contribute to the Company's emphasis on the
development and commercialization of its tobacco-processing technology, as
described above under "Overview."
RECENT FINANCIAL DEVELOPMENTS
Based on preliminary results, in the third fiscal quarter ended
September 30, 1998, sales for the Company were approximately $4,450,000, a
decline of approximately 15% from the corresponding period in 1997, but an
increase of approximately 18% from the second quarter ended June 30, 1998. The
Company expects to show a net loss of approximately $1,200,000 for the quarter
ended September 30, 1998, for an aggregate net loss of approximately $3,200,000
for the nine months ended September 30, 1998. These results reflect, as did the
results for the first six months of 1998, continued emphasis by the Company upon
development of the Company's proprietary process for curing tobacco and expenses
related to such development.
32
<PAGE> 39
YEAR 2000 ISSUES
The Company has made an assessment of its information technology
systems relating to year 2000 issues at Star's Virginia facilities. The
assessment resulted in the development of a preliminary plan to prepare Star for
year 2000 readiness. The plan includes replacement of certain hardware systems
and the upgrading or replacement of software applications. The Company estimates
that the costs for implementation of Star's plan will be in the $40,000-$60,000
range; all such costs will be expensed as incurred. The Company expects that
implementation will be completed prior to the year 2000 and that the domestic
operations of Star will not be materially disrupted by the implementation
process.
Star has begun the process of contacting key vendors to obtain
assurances that the operations of a key vendor, as they affect Star, will not be
interrupted because of year 2000 issues. Star has received assurances from some
but not all of the vendors and therefore has not completed this process. Star
does not rely upon vendors for products or services that are data-dependent and
believes that its customers are not data-dependent with respect to the
purchasing and reselling of products such as those sold by Star. Therefore, Star
believes that the failure of its vendors to be compliant with Year 2000 issues
will not cause a material interruption in Star's business operations. Any such
interruption, however, would likely have a material adverse effect upon the
operations of Star. ETI does not rely upon vendors for products or services that
are data-dependent and believes that its customers are not data-dependent with
respect to the purchasing and reselling of products such as those sold by ETI.
Therefore, ETI believes that the failure of its vendors to be compliant with
Year 2000 issues will not cause a material interruption in ETI's business
operations. Any such interruption, however, would likely have a material adverse
effect upon the operations of ETI.
The Company has made only a preliminary assessment of its information
technology systems relating to year 2000 issues with respect to the ETI
operations in Minnesota and Mexico, and is unable at this time to assess either
the cost of year 2000 readiness or the extent to which operations would be
interrupted by the failure to adequately and timely address these issues. In
addition, the Company has not yet begun the process of determining whether key
vendors expect to be in compliance with year 2000 issues.
The Company does not have a contingency plan in the event that its
systems or those of any third parties are not year 2000 compliant by the end of
the century. The failure of the Company to address adequately all year 2000
issues may have a material adverse impact upon its financial condition and/or
business operations.
STAR MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of operating results of Star and
of the liquidity and capital resources of Star at December 31, 1997, should be
read in conjunction with the Financial Statements of Star and its subsidiaries
appearing on pages F-2 through F-15 of this Proxy Statement.
RESULTS OF OPERATIONS FOR YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED
DECEMBER 31, 1996
Net sales, representing the sale of conventional cigarettes and little
cigars, declined 39% from $34,260,000 in fiscal/calendar year 1996 to
$20,764,000 in the same period 1997. In 1996, sales from contract manufacturing,
i.e., the manufacturing of products under brand names owned and marketed by
others, was $9,197,100, $7,629,700 of which were sales of little cigars to
Swisher International, Inc. ("Swisher"). The balance of sales of 1996 were sales
of Star's own brands of cigarettes. In late 1996, Swisher began its own
manufacturing operations for little cigars, which are manufactured on
cigarette-making machines, and thus to phase out its dependence on Star. In
1997, Star's sales to Swisher were $3,872,250, a 49% decline from 1996, with
each quarter of the year showing a declining sales volume.
In 1996, sales of Star-brand cigarettes were $25,063,200, compared to
$16,163,100 in 1997, a decline of 36%. In 1996, it was Star's practice to make
certain large volume sales with low or no profit margins in order to attempt to
establish a brand name presence in a particular region or to establish a
relationship with a particular distributor/customer.
This practice was de-emphasized in 1997.
Export sales in both 1996 and 1997 were not material.
33
<PAGE> 40
Cost of goods sold, as a percentage of net sales volume, was
essentially the same in 1996 and 1997, 47.14% versus 48.32%, respectively.
Profit margins on contract manufacturing are slightly higher than the margins on
Star-brand cigarettes. In 1997, profit margins declined slightly because
improved profit margins on Star-brand cigarettes, due to the deemphasis on high
volume, low-margin sales described above, only partially offset the loss of
profit margins resulting from the decline in sales volume from contract
manufacturing.
Marketing and distribution expenses declined 44% from 1996 to 1997.
Star does not incur any significant expense in this category with respect to
contract manufacturing customers; almost all of such expense is incurred with
respect to Star-brand cigarettes. In 1996, these expenses were 4.5% of the
sales volume of Star-brand cigarettes, versus 3.7% in 1997. The decrease is
attributable to a more widespread use of point-of-purchase and other marketing
materials in 1996 and costs associated with the recruitment of a greater number
of new distributors in 1996.
General and administrative expenses declined 13% from 1996 to 1997, but
increased as a percentage of sales from 4.78% to 6.86%. Many of these expenses
are relatively fixed and therefore increase as a percentage of sales as sales
volume declines. In addition, the contract manufacturing business requires a
lower level of general and administrative support; consequently the higher
percentage of this category of expense in 1997 may be attributed to the fact
that contract manufacturing represented a smaller portion of total sales volume.
Research and development expense represents primarily expenditures
related to the development of Star's proprietary technology for the processing
of tobacco so as to prevent the formation of tobacco-specific nitrosamines, but
also expenses for the development of a tobacco-flavored, non-nicotine chewing
gum which Star is no longer developing. Star does not maintain its own research
laboratories or other physical assets for research and development; it is
dependent upon the services of third parties for these services. Similarly, it
does not employ a scientific staff and instead relies upon scientific and
medical consultants and third-party service providers. Expenditures in this
category include payments for such consultants, contract research organizations,
laboratory testing, research grants, raw materials, equipment, legal and
regulatory fees, including expenses for the filing and prosecution of patents,
and allocations of management personnel and general and administrative expenses.
This category includes payments of $751,057 and $489,413 in 1997 and 1996
respectively, to Jonnie R. Williams, the inventor of Star's proprietary
technology for the processing of tobacco. See "Management" and "Security
Ownership of Certain Beneficial Owners and Management" elsewhere in this Proxy
Statement.
Interest expense was $477,000 in 1996 and $256,000 in 1997. The 1996
amount includes $171,000 of interest accrued to a related party for debt
incurred primarily in connection with the acquisition of manufacturing equipment
in 1994. This debt was eliminated at the beginning of 1997. In addition, in both
1996 and 1997, interest expense was incurred in connection with a bank revolving
line of credit, the borrowing levels of which were determined by levels of
accounts receivable and inventory. Since these levels were lower in 1997 than in
1996, due to lower sales volume, average line of credit borrowing levels were
lower, resulting in lower interest expense.
The net losses in 1996 and 1997 were a result of the factors discussed
above. Most significant, the increase in net loss from 1996 to 1997, that is, an
increase of $1,234,000, may be attributed to an increase of $803,000 in research
and development expenses, which were not related to sales volume in either year,
and to a lower volume of operating profits resulting from a declining sales
volume.
FINANCIAL CONDITION AND LIQUIDITY
Star's 1997 year-end balance sheet reflects an illiquid position and a
stockholders' deficit of $1,742,000. Cash flow to maintain operations has been
provided primarily through increases in accounts payable and, to a lesser
extent, through equipment loans. With respect to stockholders' deficit,
substantial net losses in both 1996 and 1997 were partially offset by a
contribution to capital of $923,000 by stockholders by means of a forgiveness of
secured long-term notes.
Throughout 1997, Star maintained, and was dependent upon, a bank
revolving line of credit with the level of borrowings being determined by levels
of accounts receivable and inventory, with a limit of 1.5 million dollars. The
loan was and is secured by a first security interest on accounts receivable and
inventory. Star was in default of certain financial and other covenants under
its loan agreement, but not in payments. This bank loan, which was due to mature
on March 31, 1998, was extended to June 30, 1998. In early July, 1998, the loan
and security position were assigned to another bank, the term was extended to
January 1, 1999, and the existing defaults were waived. The bank loan is
guaranteed by certain major stockholders.
34
<PAGE> 41
On February 6, 1998, Star entered into a "reverse acquisition"
transaction with Eye Technology, Inc. ("ETI") and became its wholly-owned
subsidiary. The purpose of the transaction for Star was to gain access, through
ETI, the common stock of which is publicly traded, to equity financing markets.
In February and March, 1998, ETI sold in a private placement 2.9 million shares
of common stock for 1.45 million dollars, most of which was contributed to the
capital of Star. In July, 1998, ETI sold in a private placement the equivalent
of five million shares of common stock for 2.5 million dollars, most of which
was contributed to the capital of Star. To partially offset the dilutive effect
of this latter sale of stock, certain controlling stockholders of ETI
contributed to ETI the equivalent of 3.75 million shares of common stock of ETI.
Star may require additional capital financing in order to continue its
activities beyond 1998 with respect to the research, development and
commercialization of its proprietary methods to prevent the formation of
tobacco-specific nitrosamines in tobacco and of Star's products which utilize
tobacco which has been processed with such methods. ETI and Star will seek
additional equity funds for these purposes.
There can be no assurances that ETI and Star will be successful in
obtaining additional capital financing, as described above.
ETI MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of operating results of ETI and
of the liquidity and capital resources of ETI at December 31, 1997, should be
read in conjunction with the Consolidated Financial Statements of ETI appearing
on pages F-16 through F-25 of this Proxy Statement.
RESULTS OF OPERATIONS FOR YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED
DECEMBER 31, 1996
Net sales for the year ended December 31, 1997 were $1,333,431, a
decrease of $959,880 (42%) from sales of $2,293,311 for the year ended December
31, 1996. In 1997, 69% of ETI's sales were in the domestic market and 31% were
in the international market. This compares to a market mix of 75% domestic sales
and 25% international sales in 1996.
Sales of IOLs comprised 94% of net sales in 1997, with the balance of
sales being primarily MKM and LASIK equipment. This compares to 88% IOL sales in
1996.
In 1997, industry-wide pricing pressures were reflected in a decrease
in the average unit price per domestic sale of 9% from 1996. Unit sales in the
United States also decreased from 1996 by 38%, reflecting continuing industry
trend of greater sales of soft/foldable lenses, which ETI does not offer, as
well as ETI's lack of working capital to provide marketing and sales support for
its independent sales force. ETI's unit sales in the United States were also
adversely affected by a reduction in the number of sales representatives
soliciting sales of ETI's products.
Sales of MKM and LASIK equipment declined 74% in 1997 from 1996, or
from $275,000 to $70,000. The decline is principally attributable to the
inability of ETI to conduct sales promotion activities, such as skills transfer
courses, and to provide product design improvements in both cases due to a lack
of working capital funds. More than 95% of sales revenue of this equipment in
1997 reflects export sales, as was the case in 1996. Because of declining sales
of this equipment, ETI reduced the remaining useful life of its investment in
this asset to three years, beginning in the 1996 fiscal/calendar year and
resulting in an annual amortization expense of $193,000 for each of 1996 and
1997.
Gross profit, as a percentage of net sales, decreased significantly to
44% in 1997 from 65% in 1996. The decrease is attributable primarily to three
factors: a higher percentage of IOL sales were export sales (27% in 1997 versus
15% in 1996) for which the gross profit margin is substantially less than for
domestic sales; manufacturing overhead, primarily rent, which is relatively
fixed in cost, becomes a greater percentage of sales as sales volume declines;
and both domestic and international prices continued to decline.
Selling and marketing expenses decreased $415,552 to 15% of net sales
from 27% in 1996. The significant decline in IOL domestic sales (from $2.018
million in 1996 to $.915 million in 1997), on which sales commissions are
payable, and the decline in in-house personnel, a portion of which is allocated
to selling and marketing expense, account for more than 90% of the decline, with
the balance attributable to reduced marketing and promotional expenses due to a
lack of working capital.
35
<PAGE> 42
General and administrative expenses were 67% of net sales in 1997
compared to 46% in 1996, despite the reduction of $155,543 of such expenses. ETI
was unable to reduce costs, such as rent, insurance, professional fees, and
management compensation, at the same rate as sales declined.
Research and development expense decreased from $24,530 in 1996 to zero
in 1997. Because of a severe lack of working capital, ETI abandoned, in late
1995 and early 1996, research and development projects related to potential new
products in the fields of corneal topography and glaucoma. A project to develop
a soft/foldable IOL was significantly cut back and only relatively immaterial
expense was incurred on this project in 1997, which expense was accounted for as
manufacturing labor.
Interest expense increased from $144,627 in 1996 to $160,576 in 1997.
In both years, the amount of borrowed debt of ETI was related principally to
accounts receivable which were lower throughout 1997 compared to 1996 because of
lower sales, resulting in lower interest accruals. The decrease in interest on
borrowed debt was more than offset by a higher amount of interest incurred with
respect to certain past due obligations to creditors who charged interest on
past due amounts.
Net loss in 1997 was $330,191 compared to net loss of $213,816 in 1996.
The increase was due to the factors noted above. 1997 results were significantly
and favorably impacted by the receipt of a one-time $325,000 license fee for the
grant of a license by ETI to a manufacturer of IOLs to manufacture and sell IOLs
under ETI's PMA approvals. Also, 1996 results were favorably impacted by a
judgment of $161,053 received by ETI in a lawsuit against a competitor for
wrongful product disparagement, netting approximately $56,000 to ETI after
offsetting legal fees.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, and continuing in 1998 until the date of the
Reverse Acquisition, ETI had a significant working capital deficit. Its ability
to maintain operations was dependent upon the forbearance of a sufficient number
of creditors from enforcing ETI's obligations to them and upon the willingness
of employees, primarily the Chief Executive Officer, to defer compensation owed
to them. ETI's ability to remain in business was in substantial doubt.
On January 31, 1997, ETI received a one-time license payment of
$325,000 pursuant to the License Agreement with OII. See "Business of
ETI--Transaction with Ophthalmic Innovations International, Inc." The cash
received allowed ETI to retire secured indebtedness to an institutional lender
to whom it had been in a material default of its loan agreement. ETI thereupon
entered into a new financing arrangement by which its eligible receivables are
factored to a third party. Notwithstanding the cash infusion received pursuant
to the License agreement with OII, and the factoring arrangement described in
the preceding sentence, ETI continued throughout 1997 to have significant
liquidity shortages and to be in default of a number of contractual obligations
by reason of its inability to make timely payments.
ETI had been unable to obtain adequate capital financing, either debt
or equity, for at least several years to alleviate its severe cash flow
deficits. In addition, ETI was not in compliance with its reporting requirements
under the Securities Act of 1934, and therefore access to the public securities
markets was closed to it.
As a condition to the Reverse Acquisition, and contemporaneously with
it, ETI was able to settle a number of pending claims against it, including
obligations of ETI to current and former employees, including the Chief
Executive Officer. See "Business of ETI--Legal Proceedings."
36
<PAGE> 43
MANAGEMENT
EXECUTIVE OFFICERS
Set forth below is information regarding the executive officers of the
Company, and their respective ages and positions as of the Record Date:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Robert J. DeLorenzo, M.D., Ph.D. 50 Chairman of the Board and Chief Executive Officer
Malcolm L. Bailey 55 President and Director
Jonnie R. Williams 43 Chief Operating Officer, Executive Vice President and
Director; Director of Product Development of Star,
Director of Marketing of Star
James A. McNulty 48 Chief Financial Officer
</TABLE>
For information regarding Dr. DeLorenzo and Messrs. Bailey, Williams
and McNulty, see "Proposal No. 1--Election of Directors."
Officers of the Company serve at the discretion of the Board. There are
no family relationships among the Company's directors and executive officers.
COMPENSATION SUMMARY
The following table sets forth certain information concerning
compensation paid and accrued to the Chairman, Chief Executive Officer and
President of the Company for the three fiscal years ended December 31, 1997. Mr.
Fitzsimmons resigned as Chief Executive Officer and Chairman of the Board on
February 6, 1998 and resigned as President on May 18, 1998. Mr. Fitzsimmons was
the only executive officer or significant employee whose total annual salary and
bonus exceeded $100,000 in any of such fiscal years.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL LONG-TERM
COMPENSATION COMPENSATION
------------ ------------
SECURITIES
UNDERLYING ALL OTHER
NAME SALARY BONUS OPTIONS COMPENSATION
---- ------ ----- ------------ ------------
<S> <C> <C> <C> <C> <C>
Robert J. Fitzsimmons
Chairman of the Board, 1995 $192,000(1) -- (2) $24,887(3)
President and Chief 1996 $192,000(1) -- (2) $15,706(4)
Executive Officer 1997 $192,000(1) -- (2) $15,706(4)
</TABLE>
- -----------------------
(1) Includes salary accrued but not paid in the amounts of $58,831 and
$147,619 for the years ended December 31, 1996 and 1997, respectively.
See "Proposal No. 4--Interests of Certain Persons in the Reverse
Acquisition" regarding the issue to Mr. Fitzsimmons of shares of Common
Stock of the Company in partial consideration for the cancellation of
indebtedness of the Company to Mr. Fitzsimmons, including indebtedness
for accrued compensation in the amount of $179,156, $103,177 and
$15,456 for the years ended December 31, 1995, 1996 and 1997,
respectively.
(2) No options were granted to Mr. Fitzsimmons during the years ended
December 31, 1995, 1996 and 1997.
(3) Represents payment of life and disability insurance premiums and
reimbursement for automobile expenses.
(4) Represents payments of life and disability insurance premiums.
37
<PAGE> 44
OPTION EXERCISES AND YEAR-END VALUES
The following table sets forth certain information with respect to Mr.
Fitzsimmons concerning unexercised options held as of December 31, 1997. No
options were exercised by Mr. Fitzsimmons during such year, and no stock
appreciation rights were outstanding on December 31, 1997.
AGGREGATED OPTION EXERCISES IN THE YEAR ENDED DECEMBER 31, 1997
AND YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT FISCAL YEAR-END AT FISCAL YEAR-END (1)
-------------------------- ----------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Robert J. Fitzsimmons (2) 50,000 100,000 -- --
</TABLE>
- --------------------
(1) The closing bid and asked prices on December 31, 1997 were $.01 and
$.03, respectively.
(2) In 1994, Mr. Fitzsimmons was granted an option to acquire 150,000
shares of Common Stock at an exercise price of $0.50 per share and
expiring on February 28, 1999. The option was canceled as of February
6, 1998 upon termination of Mr. Fitzsimmons' employment agreement. No
options were granted to Mr. Fitzsimmons in 1997.
EMPLOYMENT CONTRACTS AND CHANGE OF CONTROL ARRANGEMENTS
The Company entered into a five-year employment agreement with Robert
J. Fitzsimmons on November 1, 1989, which provided that Mr. Fitzsimmons would
serve as Chief Executive Officer of the Company at an annual salary of $120,000
subject to increase by the Board of Directors. Such agreement was renewed for an
additional five-year term beginning November 1, 1994. Mr. Fitzsimmons' annual
salary was increased twice by the Board, once in 1990 and again in 1991, to a
level of $192,000. (Subsequent to 1991, Mr. Fitzsimmons accrued a portion of his
annual compensation.) Mr. Fitzsimmons' employment agreement provided that, in
the event of a hostile change in control of the Company, and in the event Mr.
Fitzsimmons' employment was terminated as a result thereof, the Company was
obligated to make a cash payment to Mr. Fitzsimmons totaling 299.99% of his
average annual base salary during the five-year period prior to termination.
This employment agreement was canceled on February 6, 1998, with Mr. Fitzsimmons
releasing the Company from any liability under the agreement in consideration
for the issue of shares of Common Stock of the Company to Mr. Fitzsimmons.
The Company intends to enter into an executive employment agreement
with Mr. Bailey, the Company's President, to provide for, among other things,
(a) that Mr. Bailey will devote such amount of his time and attention to the
business of the Company as both Mr. Bailey and the Board of Directors of the
Company shall agree is necessary and appropriate, (b) the payment to Mr. Bailey
of an annual salary of $130,000, (c) the issuance to Mr. Bailey of five shares
of Series B Preferred Stock as a signing bonus, and (d) the grant to Mr. Bailey
of an option to purchase up to 200,000 shares of Common Stock at an exercise
price of $2.00 per share exercisable in two equal annual installments commencing
June 1999.
The Company also intends to enter into an executive employment
agreement with each of Mr. Williams, the Company's Chief Operating Officer and
Executive Vice President, and Mr. McNulty, its Chief Financial Officer, to
provide for, among other things, their full time employment with the Company and
the payment of an annual salary of $120,000 and $150,000, respectively.
The Company does not intend to enter into any employment agreement with
Dr. DeLorenzo or provide for the payment of any compensation to him (other than
the reimbursement of out-of-pocket expenses) for the performance of his duties
as Chief Executive Officer of the Company. The Company has been advised by Dr.
DeLorenzo that he will devote such amount of his time and attention to the
business of the Company that is compatible with his on-going duties as
Neurologist-in-Chief at the Medical College of Virginia.
OTHER INFORMATION
For information regarding compensation paid to the management of Star
for periods prior to the date of the Reverse Acquisition, see "Business of
Star--Compensation Summary."
38
<PAGE> 45
CERTAIN TRANSACTIONS
During the first quarter of 1998, the Company advanced a total of
$167,355 in interest-free demand loans to Mr. Williams. All the loans were
repaid in full in the second quarter of 1998.
In October 1997, Star paid approximately $32,000 to Golden Leaf Tobacco
Company, a company owned by Mr. Bailey, for the purchase of tobacco leaf.
In September and October 1998 in connection with its pilot program to
test its tobacco curing process, Star paid (a) approximately $128,000 to Golden
Leaf Tobacco Company for the purchase of tobacco leaf and tobacco curing
equipment used by Star in the pilot program, and (b) approximately $60,000 to
Mr. Bailey for consulting services rendered in connection with the pilot
program.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The table below sets forth as of the Record Date certain information
with respect to the beneficial ownership of the Company's Common Stock, Class A
Preferred Stock and Series B Preferred Stock by each beneficial owner of more
than 5% of each class of the Company's voting securities, each Director of the
Company, the Named Executive Officer (as defined below) and all Directors and
Officers and significant personnel of the Company as a group. Shares of Class A
Preferred Stock are convertible into shares of Common Stock at a rate of 80
shares of Common Stock for each share of Class A Preferred Stock. Shares of
Series B Preferred Stock are convertible into shares of Common Stock at a rate
of 3,280 shares of Common Stock for each share of Series B Preferred Stock.
Consequently, shares of Common Stock shown in the table include shares of Common
Stock into which the shares of Class A Preferred Stock and Series B Preferred
Stock are convertible. Shares of Common Stock, Class A Preferred Stock and
Series B Preferred Stock all vote as one class, except as otherwise provided by
applicable law. Holders of Common Stock are entitled to one vote for each share
held, holders of Class A Preferred Stock are entitled to 80 votes for each share
held, and holders of Series B Preferred Stock are entitled to 500 votes for each
share held.
39
<PAGE> 46
<TABLE>
<CAPTION>
PERCENTAGE OF AMOUNT AND
VOTING POWER OF PERCENTAGE OF
NAME AND ADDRESS OF AMOUNT OF COMMON STOCK CLASS A
INDIVIDUAL OR IDENTITY COMMON VOTING AS A PREFERRED
OF GROUP STOCK SEPARATE CLASS STOCK
-------- ----- -------------- -----
<S> <C> <C> <C>
Jonnie R. Williams 38,747,125(1)(2) 0% 0
16 S. Market Street 0%
Petersburg, VA 23803
Francis E. O'Donnell, 38,747,125(1)(3) 0% 0
Jr., M.D 0%
709 The Hamptons Lane
Chesterfield, MO 63017
Robert J. DeLorenzo, 500,000(4) 3.1% 0
M.D., Ph.D., M.P.H 0%
Medical College of
Virginia
MCV Box 980599
Richmond, VA 23298
Malcolm L. "Mac" Bailey 82,000(5) 0% 0
16 S. Market Street 0%
Petersburg, VA 23803
James A. McNulty 0 0% 0
16 S. Market Street 0%
Petersburg, VA 23803
Leo S. Tonkin 0 0% 0
c/o Washington Workshops 0%
Foundation
3222 N St., N.W., Suite 340
Washington, D.C. 20007
Edward L. Tucker 200,000 2.0% 250
55 Union Avenue 100%
Sudbury, MA 01776
Robert J. Fitzsimmons 1,152,281 11.9% 0
1997 Sloan Place 0%
St. Paul, MN 55117
Prometheus Pacific Growth 5,502,640(6) 25.8% 0
Fund, LDC 0%
P.O. Box 1062
George Town, Grand Cayman,
B.W.I
All Directors and Officers 39,329,125(1)(2)(4)(5) 3.1% 0
and Significant Personnel 0%
(5 Persons)
</TABLE>
<TABLE>
<CAPTION>
PERCENTAGE OF
VOTING POWER OF
PERCENTAGE OF SECURITIES OWNED
VOTING POWER OF IF ALL SHARES OF
AMOUNT AND ALL SECURITIES SERIES B
NAME AND ADDRESS OF PERCENTAGE OF OWNED AS OF THE PREFERRED STOCK
INDIVIDUAL OR IDENTITY SERIES B RECORD ARE
OF GROUP PREFERRED STOCK DATE CONVERTED
-------- --------------- ---- ---------
<S> <C> <C> <C>
Jonnie R. Williams 11,813(1)(2) 35.2% 69.3%
16 S. Market Street 83.8%
Petersburg, VA 23803
Francis E. O'Donnell, 11,813(1)(3) 35.2% 69.3%
Jr., M.D 83.8%
709 The Hamptons Lane
Chesterfield, MO 63017
Robert J. DeLorenzo, 60.9756 1.9% .8%
M.D., Ph.D., M.P.H .4%
Medical College of
Virginia
MCV Box 980599
Richmond, VA 23298
Malcolm L. "Mac" Bailey 25 0% .1%
16 S. Market Street .1%
Petersburg, VA 23803
James A. McNulty 0 0% 0%
16 S. Market Street 0%
Petersburg, VA 23803
Leo S. Tonkin 0 0% 0%
c/o Washington Workshops 0%
Foundation
3222 N St., N.W., Suite 340
Washington, D.C. 20007
Edward L. Tucker 0 1.1% .3%
55 Union Avenue 0%
Sudbury, MA 01776
Robert J. Fitzsimmons 0 6.8% 2.0%
1997 Sloan Place 0%
St. Paul, MN 55117
Prometheus Pacific Growth 763 17.2% 9.7%
Fund, LDC 5.4%
P.O. Box 1062
George Town, Grand Cayman,
B.W.I
All Directors and Officers 11,899 37.3% 70.3%
and Significant Personnel 84.4%
(5 Persons)
</TABLE>
- ----------
(1) Includes no shares of Common Stock and 10,430 shares of Series B
Preferred Stock convertible into 34,210,400 shares of Common Stock and
owned of record by Regent Court Technologies, a general partnership of
which Jonnie R. Williams and Francis E. O'Donnell, Jr. are the sole
partners.
(2) Includes 691.5740 shares of Series B Preferred Stock convertible into
2,268,362 shares of Common Stock and owned by a trust for the benefit of
the children of Jonnie R. Williams. Mr. Williams disclaims beneficial
ownership of these shares.
(3) Includes 691.5740 shares of Series B Preferred Stock convertible into
2,268,362 shares of Common Stock and owned by a trust for the benefit of
the descendants of Francis E. O'Donnell, Jr. Also includes 691.5740
shares of Series B Preferred Stock convertible into 2,268,362 shares of
Common Stock and owned by trusts of which Dr. O'Donnell is trustee but in
which neither he nor any member of his family has a beneficial interest.
Dr. O'Donnell disclaims any beneficial interest in such shares.
(4) Includes 300,000 shares of Common Stock and 60.9756 shares of Series B
Preferred Stock convertible into 200,000 shares of Common Stock.
(5) Includes no shares of Common Stock and 25 shares of Series B Preferred
Stock convertible into 82,000 shares of Common Stock.
(6) Includes 2,500,000 shares of Common Stock, 763 shares of Series B
Preferred Stock convertible into 2,502,640 shares of Common Stock, and
500,000 shares of Common Stock issuable upon exercise of a stock purchase
warrant after the effective date of the amendment to the Company's
Certificate of Incorporation to increase the number of authorized shares
of Common Stock.
40
<PAGE> 47
BUSINESS OF STAR
HISTORY AND INTRODUCTION
From 1990 until 1994, Star was a contract manufacturer of little cigars
and cigarettes under brand names owned by others. During most of this period, a
majority of its sales volume were to a single customer, Swisher International,
Inc. ("Swisher"), for which Star manufactured little cigars under the brand
names "SWISHER SWEETS(R)" and "PRINCE EDWARD(R)." The contract manufacturing
relationship with Swisher was mostly phased out beginning in 1996 and continuing
throughout 1997.
In late 1994, Star developed and began marketing its own branded
cigarettes under the trade names "GUNSMOKE(R)," "VEGAS(R)" and "VALENTINE(R),"
the last of which was abandoned in 1995. In 1995, Star added the brands
"SPORT(R)" and "MAIN STREET(R)."
In late 1994, Star commenced research and development activities based
upon newly-conceived technology, which it had licensed from the technology's
inventor, Jonnie R. Williams, for the processing of tobacco so as to eliminate
or reduce to insignificant levels tobacco-specific nitrosamines in tobacco
("TSNAs"). TSNAs are generally recognized by tobacco chemists to be among the
most powerful and abundant carcinogens in tobacco and tobacco smoke. Star's
research and development activities have focused on (1) perfecting and testing
its proprietary methods for processing tobacco, (2) developing products which
incorporate Star's specially-processed tobacco, including products for the
smoking cessation and reduced-risk smoking markets, (3) establishing a patent
position, (4) initiating the FDA-approval process for its smoking cessation
products, and (5) developing relationships within the tobacco industry with a
view to the commercialization of Star's processes.
Star is not aware of any other entity which utilizes a process to reduce
significantly tobacco-specific nitrosamines that are found in cured tobacco
leaf. At least one Swedish company, Swedish Match Co., has worked with various
varieties of smokeless tobacco under crop management environments in an effort
to reduce the amount of the nitrosamine content in tobacco. The Company
understands that Swedish Match Co. has been successful in those efforts, but not
to the extent of reducing nitrosamines below the level which the Company
understands would be considered inconsequential.
Currently, Star manufactures and sells throughout the United States four
brands of cigarettes--GUNSMOKE(R), VEGAS(R), SPORT(R) and MAIN STREET(R)--with
contract manufacturing being an insubstantial portion of its business. Star's
primary focus, however, is on the continued development of it proprietary
technology for the processing of tobacco and on products incorporating such
technology.
PROPRIETARY TECHNOLOGY
Process. The process of curing, or drying, tobacco so that it is suitable
for production into tobacco products begins immediately upon harvesting of the
tobacco leaf. The tobacco leaves are brought to enclosed barns or sheds to be
hung or placed on racks. The two principal varieties of tobacco leaf in the
United States are Virginia flue-cured tobacco and burley tobacco, both of which
are typically used in American-made cigarettes to produce what is referred to as
an American blend. Under conventional curing methods with Virginia flue-cured
tobacco, the leaves that are hung to cure are exposed to gas-fired heat, while
with burley tobacco the leaves dry naturally. The curing process for Virginia
flue-cured tobacco takes approximately five days and for burley tobacco a month
or more.
Star's proprietary curing technology is applicable to Virginia flue-cured
tobacco as well as burley tobacco, and most likely to other varieties widely
used throughout the world. Star's curing process essentially arrests or
eliminates microbial activity that normally occurs during curing, thereby
preventing the production of TSNAs. Star's curing technology does not, however,
alter or affect taste, color or the nicotine content of tobacco. The Company
makes no claim or representation that its proprietary curing process reduces any
harmful chemical constituents in tobacco and/or tobacco smoke other than
tobacco-specific nitrosamines.
Star's proprietary curing technology was conceived by Jonnie R. Williams
(see "Management" and "Security Ownership of Certain Beneficial Owners and
Management") and has been licensed to Star in an agreement which grants to Star
certain exclusive worldwide rights with a right of sublicense. See "License
Agreement" below.
41
<PAGE> 48
It is Star's objective to achieve widespread acceptance of its tobacco
curing technology as a standard for the manufacture of less harmful tobacco
products and as a basis for the use of tobacco in the production of smoking
cessation products.
Current Status. Star conducted at its own expense a pilot program during
the 1998 United States tobacco harvest season (July through October). The
purposes of this program were: (1) to continue to test and perfect Star's curing
processes in quantities and under conditions which will serve as a model for
future operations; (2) to test custom designed equipment; (3) to provide
processed tobacco to major manufacturers in quantities for testing and test
market purposes; and (4) to demonstrate the commercial feasibility of adoption
of Star's processes for widespread use in the production of tobacco products.
The program was operated from a leased facility in Chase City, Virginia, which
is located in the tobacco growing regions of Virginia and North Carolina. The
Company has completed the pilot program and has achieved the objectives
described above.
Star has had extensive discussions with several major tobacco product
manufacturers. It has provided to them samples of its processed tobacco and has
been advised by them that tests conducted by or for the major manufacturers
confirm Star's claim that its processed tobacco is free of TSNAs. The Company is
in the process of finalizing orders for the 1999 growing season for tobacco to
be processed by Star using its proprietary tobacco processing technology.
PRODUCTS UTILIZING TSNA-FREE TOBACCO
Star has developed several products containing TSNA-free tobacco. Those
products and the development status of each are as follows:
Smoking Cessation Products
GUMSMOKE-Rx(TM). Star has developed GUMSMOKE-Rx, a chewing gum which
contains TSNA-free tobacco that has been ground to a powder-like consistency and
added to traditional chewing gum ingredients. The finished product resembles in
all respects a typical chewing gum product except that, depending upon the level
of nicotine in the finished product, the consumer will detect a distinct tobacco
flavor and nicotine effect upon the taste buds and senses within a relatively
short time after initiation of chewing. To enable a physician prescribing the
gum to patients to regulate the amount of nicotine delivery, Star can establish
uniform nicotine levels in the tobacco and adjust the amount of tobacco in the
gum product. Star filed an IND application covering its GUMSMOKE-Rx chewing gum
in July 1997 for smoking cessation therapies, for cessation of selected
smoking-cessation aids and for cessation of smokeless tobacco product use. Star
intends to complete human clinical trials for this product, subject to the
availability of funds and further clarification of the regulatory environment.
Star currently believes that the FDA, given the current status of its regulatory
powers with respect to tobacco products, will be particularly reluctant to
approve for therapeutic purposes any product containing tobacco. See "Government
Regulation."
GoldSmoke(TM) Lozenges. Star has developed GoldSmoke, a lozenge which
contains TSNA-free tobacco that is added in either a finely-ground powder or
liquid extract form to typical lozenge ingredients. The taste,
nicotine-sensation characteristics and nicotine levels of the tobacco lozenge
are comparable to that of GUMSMOKE-Rx chewing gum. Star has not yet filed an IND
application with the FDA covering its GoldSmoke lozenges. Further plans to
develop this product will be dependent on the availability of funds and further
clarification of the regulatory environment.
Product Attributes. Star believes that its prescription gum and lozenge
products would have a number of advantages over other smoking cessation products
now on the market for the following reasons:
Taste. Both the gum and lozenge products have an agreeable
taste, especially to a smoker or smokeless tobacco product consumer.
Star's gum and lozenge products taste like a typical confectionary
product with a detectable and familiar tobacco flavor.
Nicotine Delivery. Star's smoking cessation gum and lozenge
products begin to deliver detectable amounts of nicotine within two
minutes. This is an important consideration to the nicotine-addicted
individual who has been accustomed to almost instant nicotine
gratification from his tobacco product.
Price. The cost of manufacture of Star's gum and lozenge
products in believed to be significantly lower than any of the other
smoking cessation products on the market, thus allowing for lower retail
prices. Star believes
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that the pricing of smoking cessation products is an important factor in
consumer acceptance of and compliance with a smoking cessation regimen.
Reduced-Risk Smoking Products
CigRx(TM). Star has developed CigRx, a cigarette which contains TSNA-free
tobacco and is manufactured in the same manner as conventional cigarettes. Star
voluntarily elected to submit CigRx to the FDA as a therapeutic pharmaceutical
product with health-related claims to help prevent a relapse of a patient
undergoing a smoking cessation program. Star is not aware of any other company
submitting a tobacco product for FDA clearance. Star filed an IND application
with the FDA covering its CigRx cigarettes for smoking cessation therapies in
1997. Star's strategy has since changed and it will not seek FDA approval for
CigRx. The Company, however, intends to submit data from clinical studies of
CigRx to the FDA for its review.
In October, 1998, a Phase I study of CigRx under a FDA-reviewed protocol
was completed at the Medical College of Virginia. The study, involving male and
female subjects, was a 19-day cross-over study designed to test the in vivo
elimination or reduction of nitrosamines following the smoking of CigRx
cigarettes compared to leading-brand conventional cigarettes. The CigRx
cigarettes used in the study delivered substantially less carbon monoxide (4.8
milligrams versus 12.2 milligrams) and about half as much tar (7.0 milligrams
versus 14.0 milligrams) compared to an average of the best selling full-flavored
cigarettes, as measured by the widely recognized Federal Trade Commission
methods. Analytical data from the study will be compiled and completed in the
beginning months of 1999.
While the Company intends to continue to test CigRx in clinical studies
and to submit data therefrom to the FDA, it intends in the meantime to proceed
with plans to produce and test market CigRx. Beginning in the first half of
1999, the Company expects to conduct a limited test market of CigRx using
tobacco processed in the Company's pilot program described above. Any marketing
of CigRx beyond the planned test market could not be undertaken until the last
several months of 1999 since the Company cannot process enough tobacco for these
purposes and using its proprietary methods until the 1999 tobacco harvest season
allows the Company to do so.
CigRx will be sold without any therapeutic claims. The Company intends,
however, to disclose on the cigarette package and elsewhere carbon monoxide and
tobacco-specific nitrosamine levels.
Marketing and Distribution
Subject to regulatory approval, Star intends to target consumers of
tobacco products who seek either to cease or reduce cigarette smoking and/or the
consumption of smokeless tobacco products. Star is exploring entering into a
collaborative relationship with a corporate partner for the manufacturing and/or
distribution of these smoking cessation and reduced-risk smoking products, in
which it will retain for itself the right to supply the TSNA-free tobacco. Star
is also exploring entering into a collaborative relationship regarding marketing
and distribution of its products in foreign countries in which the regulatory
regimen is more favorable to such products. There can be no assurance, however,
that Star will be able to enter into any collaborative relationship on terms
satisfactory to Star, or at all.
Manufacturing
Chicles Canel's, S.A. de C.V., of San Luis Potosi, Mexico ("Canel's"), a
large gum manufacturing company in Mexico, has produced all sample and clinical
trial quantities of gum and lozenge products for Star. Star believes that
Canel's has sufficient capacity to produce Star's requirements for the
prescription-only market. Star, which does not have an on-going agreement with
Canel's, is currently dependent upon Canel's as a sole supplier of its gum and
lozenge products. Star may need to identify alternative manufacturers for the
production of these products to reduce its dependence on Canel's and to ensure
that in the event that market demand increases beyond Canel's capacity, Star
would be able to meet such demand. Star has sufficient manufacturing capacity to
produce CigRx cigarettes for clinical trial purposes and for subsequent initial
market distribution.
Amana Company, L.P. ("Amana") is manufacturing the specialized equipment
that incorporates the Company's proprietary technology for processing tobacco
under a 15-year exclusive supply agreement. The Company believes that Amana has
sufficient manufacturing capacity to supply all of the Company's foreseeable
requirements for the specialized equipment.
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Market and Competition
It is commonly believed that many tobacco product consumers are addicted
to tobacco because of the presence of nicotine in tobacco. The addictive
qualities of nicotine have been well publicized. It has been estimated that
approximately 70% of American adult smokers (approximately 32 million persons)
desire to quit smoking, but of that number approximately 75% believe that they
are unable to do so. It is further estimated that 15 million Americans attempt,
unsuccessfully, at least once a year to quit smoking, and only 1.2 million
Americans are successful in quitting. In the United States the percentage of
adults who regularly smoke cigarettes has decreased over the past 25 years,
although in recent years the number of adult smokers has not materially changed.
Tobacco users who attempt to quit typically experience craving,
headaches, irritability and nausea when the body stops receiving nicotine.
Smoking cessation products that are approved for sale in the United States are
primarily synthetically-produced nicotine delivery products designed to wean the
patient from nicotine addiction over a period of time ranging from 30 days to
six weeks. Three products, Nicorette(R), a nicotine chewing gum, and Nicotrol(R)
and NicoDerm(R), both transdermal nicotine patches, constituted 99% of the U.S.
market of $398 million in sales in 1996. All of these products are sold
over-the-counter. Recently, Zyban(R), a prescription drug which, when taken in
pill form, chemically acts upon the brain to simulate the "reward" attributes of
nicotine while at the same time decreasing the craving for nicotine, was
introduced to the market in 1997 following FDA approval. Star understands that
sales of Zyban to date have been substantial and that Zyban is often prescribed
by physicians to be used in conjunction with nicotine delivery products. Sales
of nicotine delivery, smoking cessation products outside of the United States
are estimated by Star at over $700 million in 1996. None of the smoking
cessation products currently on the market have FDA approval as smokeless
tobacco cessation products, and the FDA has not granted any approval for a
product with such indications.
The smoking cessation and reduction market is highly competitive. Star's
competitors would include SmithKline Beecham, the McNeil Consumer Division of
Johnson & Johnson, Glaxo-Wellcome and Pharmacia-Upjohn, all of which have
capital resources, research and development staffs, facilities, experience in
conducting clinical trials and obtaining regulatory approvals and experience in
manufacturing and marketing their products which are significantly greater than
those of Star. In addition, there are several companies developing new
technologies aimed at smoking cessation therapies. There are also a number of
consumer products which do not require FDA approval as therapeutic drug products
but which nevertheless are advertised as alternatives to smoking or to help in
the reduction of smoking. For example, at least one of the leading United States
confectionary chewing gum manufacturers has advertised its gum products as an
alternative to cigarettes. There are also several non-tobacco cigarettes
produced with fillers such as lettuce and herbs. In addition to the use of
consumable products for smoking cessation or reduction purposes, medical
practitioners and others have developed a variety of programs intended to assist
a person in withdrawing from nicotine dependence. Treatments used include
psychological counseling, hypnosis, group therapy and behavior modification
techniques. There can be no assurance that Star's competitors will not succeed
in developing technologies and products that are more effective than Star's
product candidates, that are safer than Star's products or that would render
Star's products obsolete or non-competitive. Star's inability to compete
successfully may have a material adverse effect on Star's business, financial
condition and results of operations.
Star expects its products, if approved for sale, would compete primarily
on the basis of product efficacy, patient convenience and compliance, price, and
patent position. There can be no assurance that Star will be able to compete
successfully with respect to any of these factors.
TOBACCO-FLAVORED CHEWING GUM
In January 1998, Star test marketed on a national basis a confectionary
gum product which contained an FDA-approved tobacco flavoring but not tobacco
itself nor any nicotine. The product had been developed for adult smokers who
also chewed gum. In light of poor market receptivity, the Company has no present
plans to further promote the product.
CONVENTIONAL CIGARETTE BUSINESS
Star is engaged in the business of manufacturing and selling cigarettes,
primarily within the United States. Until 1994 Star was exclusively a contract
manufacturer of little cigars and cigarettes under brand names owned by Star's
customers. One customer, Swisher International, Inc., for which Star
manufactured "Swisher Sweets" and "Prince Edward" little cigars, accounted for
more than half of Star's business during that time. In late 1994, Star commenced
selling its own brands of cigarettes. Currently Star manufactures and sells
GUNSMOKE(R), VEGAS(R), SPORT(R) and MAIN STREET(R) cigarettes,
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and sales of these brands have accounted for most of Star's revenues over the
past 24 months. Star's brands are sold in the "deep discount" category of the
cigarette industry.
Products. Star's four brands of cigarettes are each sold in a variety of
sizes and styles, i.e., king size and 100s, soft pack and hinged box, regular
flavor and menthol, and full flavor, lights and ultra lights. Star utilizes its
own specified blend of tobaccos in each brand. The blend consists of Virginia
flue-cured, burley and oriental varieties of tobacco, which is typical of
American-style cigarettes. Star does not utilize "reconstituted" tobacco, which
is tobacco leaf which has been cut, combined with various chemicals and formed
into paper-like sheets which are in turn cut and utilized as filler in the
production of cigarettes.
Star uses stylized packaging designs for its four brands of cigarettes.
As is typical in the cigarette industry, Star utilizes different colors, e.g.,
green for menthol, but similar designs, on its packaging to denote different
product styles.
Manufacturing. Star manufactures cigarettes at its facility in
Petersburg, Virginia. Tobacco is purchased from a recognized leaf dealer in "cut
rag" form, meaning that the tobacco has been cut, processed and flavored to
Star's specifications, and is ready when delivered to Star for the manufacturing
process. The tobacco is then combined with filters, and paper in a "maker" which
produces finished cigarettes, which in turn are placed in a "packer" which
provides packaging into standard 20-cigarette packs and ten-pack cartons.
Distribution. Star's own-branded cigarettes are sold primarily to tobacco
product distributors, typically referred to in the industry as "tobacco and
candy distributors." In 1997 Star sold its cigarettes to a total of 285
distributors located in the United States. The distributors maintain state and,
where applicable, municipal government tobacco product licenses, apply to
cigarette packs state and/or local tax stamps when needed, and resell the
cigarettes to retailers. Star delivers its products directly to distributors
mainly by common carrier trucks. No one distributor accounted for more than 10%
of Star's revenues in 1997. Star's distributor customers primarily serve
convenience stores and gas stations, but not grocery stores and large discount
or department stores.
Marketing and Selling. Star does not conduct any consumer advertising and
only an insubstantial amount of trade journal and direct mail advertising. Star
does provide to its distributor customers for redistribution to retailers,
point-of-sale materials such as posters, banners and display racks. Also, Star
produces marketing materials for use by distributors to promote Star cigarettes
to their retail customers.
Star's brands of cigarettes are sold by two full-time in-house
employee-salesmen, augmented by three part-time independent contractor
representatives, all of whom are compensated principally on a commission basis.
Because of Star's limited sales force and advertising and marketing
resources, it is Star's strategy to rely to a large degree upon distributors to
promote and sell Star brands to retail customers. Distributors are generally
able to obtain substantially higher profit margins, albeit lower volume, on
Star's products than on products sold by the four major United States
manufacturers of cigarettes, and therefore they have an incentive to promote
Star's brands. Furthermore, in many markets, Star will grant to a distributor
exclusivity within a defined region for one or more brands, thus giving to the
distributor an incentive to promote to retailers Star's brand without being
undercut on a price basis by a competitor.
Competition. Star's primary competition for conventional cigarettes is
from the four "majors," that is, Philip Morris, the brands of which account for
slightly more than 50% of the cigarette sales in the United States, R.J.
Reynolds, Brown & Williamson, and Lorillard, each of which has substantially
greater financial and operating resources than Star. Star also encounters
significant competition from several other United States manufacturers of
cigarettes as well as importers of cigarettes manufactured in foreign countries.
Some of these manufacturers and importers have substantially greater financial
and operating resources than Star.
Star's products compete principally on the basis of price. Generally
speaking, there are three price categories of cigarettes in the United States,
"premium," which includes such brands as Marlboro(R) and Camel(R), "discount" or
"generic," which includes such brands as Doral(R) and GPC(R), and "deep
discount," which as a group account for only a small percentage (less than 3%)
of the United States cigarette market. Each of Star's brands is priced in the
deep discount category. Other competitive factors include package design, taste,
and the amount of marketing support provided to distributors and retailers. At
the consumer level, brand "loyalty" is also a significant factor.
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Contract Manufacturing. Star also manufactures cigarettes under brand
names owned by unaffiliated parties. In these instances, packaging is provided
by the customer who has also selected its own tobacco blend, and Star
manufactures against a specific purchase order. The final product is invariably
delivered to a single location and Star has no responsibility for marketing or
selling. Currently, contract manufacturing is an insignificant portion of Star's
cigarette operations.
LICENSE AGREEMENT
Star is the licensee under a license agreement (the "License Agreement")
with the licensor, Regent Court Technologies, a partnership of which Jonnie R.
Williams and Francis E. O'Donnell, Jr., M.D. are partners (see "Management" and
"Security Ownership of Certain Beneficial Owners and Management"). The License
Agreement provides, among other things, for the grant of an exclusive,
worldwide, irrevocable license to Star, with the right to grant sublicenses, to
make, use and sell tobacco and products containing tobacco under the licensor's
patent rights and know-how relating to the processes for curing tobacco so as to
eliminate or reduce to insignificant levels tobacco-specific nitrosamines and to
products containing such tobacco of the licensor and its affiliates, whether
such patent rights and know-how are now in existence or hereinafter developed.
This license includes inventions of the licensor and its affiliates during the
term of this Agreement relating to the production, treatment or curing of
tobacco, or a method of manufacturing a product containing tobacco, or of
extracting one or more substances from tobacco for the purpose of incorporating
such substance or substances in a product or products. The only right retained
by the licensor is to conduct research.
The License Agreement may be terminated by Star upon 30 days' written
notice. The License Agreement may also be terminated by the licensor (a) upon a
default in the payment of royalties or a failure to submit a correct accounting
continuing for at least 30 days after written notice, or (b) upon a material
breach of any other obligation of Star under the License Agreement continuing
for at least 60 days after written notice. A material breach may include a
sublicense of the Patent Rights without obtaining a written agreement of the
sublicensee to be obligated to the licensor under the License Agreement. The
licensee is also obligated to provide the licensor with copies of all patent
applications by it relating to the Patent Rights. For purposes of determining
materiality and provided the nature of the breach may be determined in material
terms, a breach shall be deemed material, if such breach results in a loss of
royalties exceeding $100,000.
Star is obligated to pay to the licensor a royalty of 2% on all net sales
of products by it and any affiliated sublicensees and 6% on all fees and
royalties received by it from unaffiliated sublicensees. The License Agreement
expires on the last to expire of any applicable patents. One United States
patent has been issued and additional patent applications are pending in the
United States and in approximately 80 foreign jurisdictions. See "Business of
Star--Patents and Proprietary Rights."
The License Agreement obligates Star to prosecute and pay for United
States and foreign patent rights. The agreement contains other provisions
typically found in a patent license agreement, such as provisions governing
patent enforcement and the defense of any infringement claims against Star and
its sublicensees. The License Agreement further provides that any obligation or
liability related to patent infringement matters brought against Star will be
borne by Star. Star has agreed to indemnify and defend the licensor and its
affiliates against losses incurred in connection with Star's use, sale or other
disposition of any licensed product or the exercise of any rights under the
License Agreement. The licensor has made no representations to Star in any
documents regarding the efficacy of the licensed technology.
PATENTS AND PROPRIETARY RIGHTS
Star's success in commercially exploiting its licensed tobacco curing
technology depends in large part on the ability of Star to defend issued
patents, to obtain further patent protection for the technology in the United
States and other jurisdictions, to maintain trade secrets, to operate without
infringing upon the patents and proprietary rights of others, and to obtain
appropriate licenses to patents or proprietary rights held by third parties if
infringement would otherwise occur, both in the United States and in foreign
countries. The Company has exclusive rights to one issued patent covering the
technology for reducing the level of TSNAs in tobacco leaf. Additionally, the
Company is an exclusive licensee to a patent application pending in the United
States for additional methods covering the tobacco curing technology and for
products containing TSNA-free tobacco. Corresponding patent filings have been
initiated in numerous foreign countries. There can be no assurance that patents
will issue from any of the pending applications, that claims allowed will be
sufficient to protect the intellectual property owned or licensed by Star, or
that Star or its licensor has or will develop or obtain the rights to any
additional products or processes that are patentable. In addition, no assurance
can be given that any patents issued to or licensed by Star will not be
challenged, invalidated, infringed or circumvented, or that the rights granted
thereunder will provide competitive advantages to Star.
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The patent positions of pharmaceutical companies, including those of
Star, are uncertain and involve complex legal and factual questions for which
important legal principles are unresolved. Any conflicts resulting from third
party patent applications and patents could significantly reduce the coverage of
the patents or patent applications licensed to Star and limit the ability of
Star or its licensors to obtain meaningful patent protection. If patents are
issued to other companies that contain competitive or conflicting claims, Star
may be required to obtain licenses to these patents or to develop or obtain
alternative technology. There can be no assurance that Star will be able to
obtain any such license on acceptable terms or at all. If such licenses are not
obtained, Star could be delayed in or prevented from pursuing the development or
commercialization of its products.
Litigation which could result in substantial cost to Star may also be
necessary to enforce any patents to which Star has rights, or to determine the
scope, validity and unenforceability of other parties' proprietary rights which
may affect Star's rights. United States patents carry a presumption of validity
and generally can be invalidated only through clear and convincing evidence.
Star's licensors may also have to participate in interference proceedings
declared by the United States Patent and Trademark Office (the "PTO") to
determine the priority of an invention, which could result in substantial cost
to Star. There can be no assurance that Star's licensed patents would be held
valid by a court or administrative body or that an alleged infringer would be
found to be infringing. The mere uncertainty resulting from the institution and
continuation of any technology-related litigation or interference proceeding
could have a material adverse effect on Star's business and prospects.
Star may also rely on unpatented trade secrets and know-how to maintain
its competitive position, which it seeks to protect, in part, by confidentiality
agreements with employees, consultants, suppliers and others. There can be no
assurance that these agreements will not be breached or terminated, that Star
will have adequate remedies for any breach, or that Star's trade secrets will
not otherwise become known or be independently discovered by competitors.
GOVERNMENT REGULATION
The manufacture and sale of cigarettes and other tobacco products and of
pharmaceutical products are subject to extensive federal and state government
regulations in the United States and by comparable authorities in many foreign
countries. These national agencies and other federal, state and local entities
regulate, among other things, research and development activities and the
testing, manufacture, safety, effectiveness, labeling, storage, record keeping,
approval, advertising and promotion of Star's products.
There are multiple bills pending in the United States Congress and in
several state legislatures which, if enacted, would significantly change the
United States tobacco industry. Some of these federal bills contain provisions
which would provide substantial federal government funds for smoking cessation
programs and products, as well as incentives to tobacco companies and others to
produce less harmful or reduced-risk tobacco products. Star is unable to predict
what effect, if any, these provisions, if enacted, would have on Star's
technology or the sale of Star's smoking cessation products (if approved by the
FDA) and/or reduced-risk products. The Company believes, however, that any bill
that requires manufacturers to reduce or eliminate or disclose additional known
toxic ingredients (other than nicotine or tar levels) in tobacco could have a
beneficial effect on the Company.
The FDA has adopted extensive regulations governing the sale and
advertising of tobacco products designed primarily to discourage the sale to,
and consumption by, adolescents and children. The "major" manufacturers of
tobacco products challenged the authority of the FDA to promulgate such
regulations in the federal courts. A federal District Court upheld the FDA's
authority to promulgate such regulations, but ruled that certain of the
regulations restricting advertising were invalid as violative of the
constitutional right of free speech. Recently, the United States Court of
Appeals ruled that the executive branch of the United States government, in
particular the FDA, does not have the authority to regulate tobacco products,
such authority being reserved to Congress. The federal government has appealed
the Appeals Court's ruling and the matter is now pending before the United
States Supreme Court. To the knowledge of Star, the FDA has not attempted to
enforce these regulations, and the tobacco industry, including Star, have
generally operated as if the regulations were not in effect.
It is difficult for Star to predict what effect full implementation of
the FDA regulations referred to in the preceding paragraph would have upon its
conventional cigarette business. Those regulations significantly limit the
manner in which cigarettes may be sold and displayed in retail stores,
requiring, among other restrictions, that cigarettes be kept "behind the
counter" and out of reach of customers. These point-of-purchase restrictions
would tend to favor the more well-known brand names and disfavor "deep discount"
products which rely more upon the price of the product than to brand loyalty or
brand
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recognition to generate sales. Consequently, implementation of the existing FDA
regulations would have an adverse affect upon Star's sales of conventional
cigarettes.
The Company's decision to share its product data with the FDA was made
with long-term objectives in mind and in light of the uncertainties in the
regulatory environment. As a small company without its own laboratory or other
research facilities, the Company believed that the commercial value of its
tobacco curing process would depend upon validation by the scientific and health
care communities. The Company believes that tests and clinical trials conducted
under FDA reviewed protocols would further its objective of attaining scientific
validation for its technology. It is uncertain, however, whether any competitive
advantage would be achieved by submission of products to the FDA, especially if
such submission is not required. Moreover, by submitting products to the FDA
when the same may not be required, the Company may be subjecting itself to
additional costs of research and unnecessary governmental regulation.
U.S. Food and Drug Administration. Star has submitted its GUMSMOKE gum to
the FDA as therapeutic drug products for smoking cessation purposes. As a
result, the marketing, manufacture, and distribution of such smoking cessation
products are and will be subject to rigorous preclinical testing and clinical
trials and other approval procedures mandated by the FDA. The purpose of the
FDA's testing procedures is to determine the safety and efficacy of drug
candidates, and compliance of manufacturing facilities with the FDA's QSRs (good
manufacturing practices).
The steps typically required to be taken before a new prescription drug
may be marketed in the United States include (i) preclinical laboratory and
animal tests, (ii) the submission to the FDA of an Investigational New Drug
("IND") application, which must be evaluated and found acceptable by the FDA
before human clinical trials may commence, (iii) adequate and well-controlled
human clinical trials to establish the safety and efficacy of the drug, (iv) the
submission of a New Drug Application ("NDA") to the FDA and (v) FDA approval of
the NDA. Prior to obtaining FDA approval of an NDA, the facilities that will be
used to manufacture the drug must undergo a pre-approval inspection to ensure
compliance with the FDA's QSRs.
Clinical trials are typically conducted in three sequential phases, but
the phases may overlap. In Phase I, the initial introduction of the drug into
healthy human subjects is performed to test for safety. Phase II involves
studies in a limited patient population to determine the efficacy of the product
for specific, targeted uses, to determine dosage tolerance and optimal dosage
and to identify possible adverse effects and safety risks. When Phase II
evaluations demonstrate that a product is effective and has an acceptable safety
profile, Phase III trials are undertaken to further evaluate clinical efficacy
and to further test for safety within an expanded patient population at
geographically dispersed clinical study sites. The results of product
development, preclinical studies and clinical studies are submitted to the FDA
as an NDA for approval of the marketing and commercial shipment of the product.
In addition, domestic drug product manufacturing establishments must be
registered with, and approved by, the FDA. Drug product manufacturing
establishments located in certain states also must be licensed by such states.
Establishments handling controlled substances must be licensed by the United
States Drug Enforcement Administration. Domestic manufacturing establishments
are also subject to biennial inspections by the FDA for compliance with QSRs
after an NDA is filed.
There can be no assurance that approvals from the FDA will be obtained on
a timely basis or at all. The process of obtaining these approvals and the
subsequent compliance with appropriate United States statutes and regulations
are time-consuming and require the expenditure of substantial resources. Among
the uncertainties and risks of the FDA approval process are the following: the
possibility that studies and clinical trials shall fail to prove that Star's
products are "safer" than conventional tobacco products; the possibility that
the costs of obtaining such approvals could far exceed any current estimates of
Star and may render commercialization of the products marginally profitable or
altogether unprofitable; and the possibility that the amount of time required
for FDA approval of a product may extend for years beyond that which is
originally estimated. The FDA may also require additional clinical trials, which
could result in increased costs and significant development delays. Furthermore,
there can be no assurance that even after substantial time and expenditures, any
of Star's products will be approved for marketing as proposed by Star in the
United States on a timely basis or at all. The effect of governmental regulation
may be to delay the marketing of Star's smoking cessation products and to impose
costly requirements on Star's activities or to provide a competitive advantage
to the companies that compete with Star. Product approvals may be withdrawn if
compliance with regulatory standards is not maintained or if problems occur
after the product reaches the market. The failure to obtain FDA approval of its
products, or any material delays in obtaining such approval, may have a material
adverse effect upon Star's business, financial condition and results of
operations.
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Bureau of Alcohol, Tobacco and Firearms. Manufacturers and importers of
tobacco products are taxed pursuant to regulations promulgated by the federal
Bureau of Alcohol, Tobacco and Firearms ("BATF") under authority of the Internal
Revenue Code of 1986, as amended. The Company's tobacco products will continue
to be subject to tax under such regulations.
State and Municipal Laws. The sale of tobacco products is subject to
taxation in all fifty states. In addition, some states permit municipalities to
impose an additional sales tax, and many municipalities do so. The state and
municipal taxes are imposed upon wholesalers and/or retailers but not
manufacturers, and therefore Star has no liability for such taxes. Star is
required, however, by many states to report its shipments of cigarettes to
distributors/retailers located within their jurisdiction. Star is aware of at
least two states, Massachusetts and Minnesota, which have recently adopted laws
and regulations regarding the disclosure by manufacturers of certain chemical
constituents in their products. Star intends to fully comply with such laws and
believes it will benefit from such disclosure requests.
LITIGATION/PRODUCT LIABILITY
Star is not a party to any material litigation.
In the United States, there have been numerous and well-publicized
lawsuits against the largest manufacturers of cigarettes and other tobacco
products initiated by state and municipal governmental units, health care
providers and insurers, individuals (for themselves and on a class-action basis)
and by others. The legal theories underlying such lawsuits are varied, but are
generally based upon one or more of the following: manufacturer defendants have
deceived consumers about the health risks imposed by tobacco product
consumption; such defendants knew or should have known about various harmful
ingredients of their products and failed to adequately warn consumers about the
potential harmful effects of those ingredients; and such defendants knew of the
addictive attributes of nicotine and have purposefully manipulated their product
ingredients so as to enhance the delivery of nicotine.
Star believes that its risk of liability in any lawsuit of the type
described above, and therefore the risk of being named a defendant in such a
lawsuit, is relatively low for the following reasons: Star has not at any time
advertised its tobacco products to consumers except for point-of-purchase
materials; it has never conducted research on the chemical or other constituents
of its products and does not have, and has never had, laboratory or other
research facilities; and Star has not "manipulated' the nicotine content or
delivery of its tobacco products. Moreover, Star brands have been sold for only
a relatively short period of time, i.e., since late 1994, and the volume of
sales has not been substantial in relation to the volume generated by the larger
manufacturers.
Star maintains product liability insurance which is limited to any claims
that tobacco products manufactured by or for Star contain any foreign object.
Such insurance does not cover health-related claims such as those that have been
made against the major manufacturers of tobacco products. Star does not believe
that such insurance can currently be obtained. A lawsuit against the Company
based upon claims not covered by its product liability insurance may have a
materially adverse effect upon the financial condition of the Company.
FACILITIES
Star's executive offices and manufacturing facilities are located in
Petersburg, Virginia. Star owns such facilities which consist of a 50,000 square
foot, four-story manufacturing building and 3,000 square foot, single-story
office and storage building. Star leases a 10,000 square foot warehouse in
Petersburg, Virginia, about one mile from its manufacturing facilities, pursuant
to a month-to-month lease. The warehouse is used for storing and shipping
conventional cigarette products. Star also leases a single office at the
Biotechnology Office Park of the Medical College of Virginia in Richmond,
Virginia, on a tenancy-at-will basis.
Star has leased seven acres of land and an approximately 50,000 square
foot building thereon in Chase City, Virginia, for the processing of tobacco
utilizing Star's proprietary methods to prevent the formation of
tobacco-specific nitrosamines. The lease is for a term of ten years, expiring in
2008. Star has an option to purchase the property at any time during the term of
the lease.
Star considers its facilities adequate for the purposes for which they
are used.
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EMPLOYEES
As of June 30, 1998, Star has 47 full-time employees. From time to time,
Star engages temporary personnel to augment its regular employee staff. Star
utilizes from time to time the services of consultants and independent
contractors to provide key functions that might otherwise be provided by
Company-employed personnel. Star's success depends in large part on its ability
to attract and retain highly qualified scientific, technical, management and
marketing personnel. Competition for such personnel is intense and there can be
no assurance that Star will be able to attract and retain the personnel
necessary for the development and operation of its business. The loss of the
services of key personnel could have a material adverse effect on Star's
business.
COMPENSATION SUMMARY
The following table sets forth, for the years 1996 and 1997, the
compensation paid to the Chief Executive Officer of Star and to each other
officer of Star who received at least $100,000 in such years. The table does not
include payments to Jonnie R. Williams, who did not hold any office in Star
during the periods covered. For information regarding such payments, see
"Business of Star--Certain Transactions" elsewhere in this Proxy Statement.
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
ANNUAL LONG-TERM
COMPENSATION COMPENSATION
------------ ------------
SECURITIES
UNDERLYING All Other
NAME SALARY BONUS OPTIONS Compensation
---- ------ ----- --------- ------------
<S> <C> <C> <C> <C> <C>
Samuel P. Sears, Jr.
Chairman of the Board and 1996 $186,265 -- (1) 12,809 (2)
Chief Executive Officer 1997 $249,231 -- (1) 9,743 (2)
John M. Gallahan.
President and Chief 1996 $120,384 -- (1) 12,035 (2)
Executive Officer 1997 $178,192 -- (1) 12,580 (2)
</TABLE>
- -----------------------
(1) No options were granted to Mr. Sears or Mr. Gallahan during the years
ended December 31, 1996 and 1997.
(2) Represents reimbursement for automobile expenses.
CERTAIN TRANSACTIONS
Until February 6, 1998, the date of the Reverse Acquisition, the
capital stock of Star was owned and controlled by Francis E. O'Donnell, Jr.,
M.D. and Jonnie R. Williams and their families. See "Management" and "Security
Ownership of Certain Beneficial Owners and Management." Many of the practices
and expenditures described in the remainder of this section were undertaken in
the context of a privately-owned corporation and were phased out following the
Reverse Acquisition.
Jonnie R. Williams and entities owned or controlled by him or his
family have from time to time borrowed from, and made loans to, Star. At
December 31, 1997, total borrowings of the Company from related parties amounted
to $392,012. All such loans were on a demand basis and provided for interest at
the minimum levels specified by the Internal Revenue Service for the avoidance
of imputed interest.
Mr. Williams or entities controlled by or affiliated with him were paid
$565,000 and $387,500 in 1997 and 1996, respectively, for services rendered. The
services primarily consisted of work performed on the research and development
of Star's licensed technology for the prevention of the formation of
nitrosamines in tobacco and of products which include tobacco processed under
Star's technology.
Mr. Williams owns an unoccupied house in Richmond, Virginia, which is
used by Star from time to time to lodge visitors to Star and to provide
temporary housing to employees, independent sales persons and others working on
behalf of Star. In each of 1996 and 1997, Star made payments for the maintenance
of such house in an amount of less than $10,000.
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<PAGE> 57
Mr. Williams and Dr. O'Donnell have jointly owned airplanes from time
to time. Star has utilized the airplanes for travel throughout the United States
and to Mexico for meetings at Canel's. Payments made by Star with respect to
those airplanes were $238,750 in 1997. There were no payments in 1996.
For the interest of Samuel P. Sears, Jr., an executive officer and
director of Star on the date of the Reverse Acquisition, in ETI and the Reverse
Acquisition transaction, see "Proposal No. 4--Interests of Certain Persons in
the Reverse Acquisition" elsewhere in this Proxy Statement.
The Board of Directors has adopted a policy that any future
transactions with affiliates of the Company will be on terms no less favorable
to the Company than are reasonably available from unrelated third parties and
shall have been approved by a majority of the Company's directors who do not
have a material interest in the transaction.
BUSINESS OF ETI
GENERAL
ETI develops, manufactures, sells and distributes intraocular lenses
and other ophthalmic products. Intraocular lenses ("IOLs") are medical devices
implanted in the human eye by ophthalmic surgeons to correct vision loss
resulting from the removal of the natural crystalline lens during cataract
surgery. Beginning in 1992, ETI sought to broaden its product line in the
ophthalmic field. Consequently, ETI began to market and distribute in the United
States and for export titanium diamond knives, hand-held instruments,
pachymeters and diamond knife calibration units; however, marketing efforts were
largely unsuccessful and sales of such products in 1997 were immaterial. As part
of its efforts to diversify its product line, in 1994 ETI acquired proprietary
rights to a microlamellar keratomileusis ("MKM") system and developed a modified
version of its MKM system for a surgical procedure known as laser assisted
in-situ keratomileusis ("LASIK").
Throughout 1997 and continuing into 1998, ETI had severe financial
difficulties characterized by declining revenue and a lack of working capital.
As a result, operations were contracted, an operating loss was incurred and
research and development efforts to bring on new products or to improve existing
products were curtailed.
The IOL industry specifically, as well as the medical device industry
in general, is subject to significant governmental regulations, particularly by
the United States Food and Drug Administration ("FDA"). The IOL industry's
pricing policies are directly impacted by the maximum allowable charges of an
IOL implant procedure as established by the United States Health Care Financing
Administration ("HCFA"). ETI's business is not seasonal in nature.
PRODUCTS OF ETI
IOLs. ETI manufactures and markets eleven different series of lens
styles. These series of lenses, which incorporate over 63 lens configurations,
include both single-piece and multi-piece lens designs, blue
polymethylmethacrylate ("PMMA") loops, optics in 5.0mm, 5.5mm, 6.0mm, 6.5mm, and
7.0mm sizes, and optics of biconvex and convex-plano designs. ETI also offers
its UltraThin series, notch, double eyelet and left-handed IOLs to address
certain segments of the small incision and capsulorhexis market. Sales of IOLs
accounted for more than approximately 94% of net sales in 1997.
Microlamellar Keratomileusis (MKM). The 1990s has seen an increasing
use in the United States, and throughout the world, of a number of surgical
procedures and devices to correct human vision impairment, including myopia
(nearsightedness), hyperopia (farsightedness) and astigmatism. Such procedures
include radial keratotomy ("RK"), in which incisions are made in the cornea to
flatten the anterior surface and photorefractive keratotomy ("PRK") in which
excimer or solid-state lasers are employed to alter the surface and shape of the
cornea. MKM procedure employs a microkeratome device to remove the patient's
corneal cap after which a second resection is made in the stroma. The cap is
then replaced, adhering to the eye without the aid of sutures. LASIK is a
combined procedure, utilizing a microkeratome to make a "flap" on the cornea,
folding the flap back and employing a laser to alter the stroma, and then
replacing the corneal flap to its original position. Sales of MKM and LASIK
equipment by ETI during 1997, almost all of which were export sales, accounted
for approximately 6% of all net sales of ETI.
The marketability of ETI's MKM/LASIK equipment suffers from ETI's
failure to improve the equipment by making certain design enhancements estimated
to cost between $50,000 and $100,000. Prior to the Reverse Acquisition, ETI did
not have available to it sufficient funds to undertake such design enhancements.
After the Reverse Acquisition, the Company
51
<PAGE> 58
has elected not to make a further investment in this equipment, and the carrying
asset value resulting from ETI's original investment in this equipment was
reduced to zero in the second quarter of 1998. Currently the Company is
attempting to sell its rights in this equipment.
SALES AND MARKETING
ETI markets its products in the United States through field sales
representatives to ophthalmologists, hospitals, health-care buyer groups,
outpatient clinics, health maintenance organizations and surgicenters. At
December 31, 1997, ETI had six field sales representatives, several of which are
corporate entities employing more than one representative, compared to eight
representatives at December 31, 1996. All such representatives are independent
contractors of ETI and are not employees. Declining sales volume over the last
several years, coupled with ETI's lack of a soft lens product (see "IOLs",
below), has resulted in a number of representatives who have ceased to represent
ETI's IOL product line, a situation which has added to ETI's sales decline. ETI
has lacked sufficient working capital and a positive business outlook so as to
attract experienced independent sales representatives to replace the ones who
have terminated their relationship with ETI.
ETI's domestic customers generally obtain lenses on a consignment basis
with actual title passing and invoicing occurring when the lens is implanted. As
of December 31, 1997, ETI had approximately 5,000 lenses on consignment. No
single customer accounted for ten percent or more of ETI's net sales for any of
the last three fiscal years.
For international sales, ETI generally grants nonexclusive distribution
rights for specified countries or territories to independent distributors.
Exclusive distribution rights, which are rarely granted, are awarded based upon
superior performance and distribution capabilities. ETI presently distributes
its products through 15 international distributors whose agreements are subject
to renewal based on performance. Export sales in 1997 and 1996 were $408,227 and
$578,812, respectively.
COMPETITION
The markets for ETI's products are characterized by rapidly evolving
technology and intense competition. ETI competes with major pharmaceutical and
medical device companies. Most of these companies have substantially greater
financial and other resources, larger research and development staffs, and more
extensive marketing and manufacturing organizations than ETI.
IOLs. ETI's competitors with respect to IOLs include Iolab, Chiron
Ophthalmics, Storz (by the end of 1997, Iolab, Chiron Ophthalmics, and Storz
were all owned by Bausch & Lomb), Staar, Alcon, Allergan, and Mentor
Ophthalmics, all of which sell IOLs domestically and internationally. ETI also
competes in the United States with several small manufacturers, as well as in
the international market with several United States manufacturers who sell
exclusively in that market.
Throughout the 1990s, the use of "soft" or "foldable" IOLs have grown
in popularity among surgeons. ETI does not offer soft lenses, which ETI
estimates comprised approximately 60% of the United States IOL market in 1997.
In the "hard" lens segment of the United States market, ETI relies upon
a varied product selection, aggressive pricing and individualized customer
service. ETI estimates that its sales of IOLs accounted for less than one
percent of the United States IOL market in 1997.
In the international market, the primary competitive factors are price
and product offerings. The fact that ETI's products are approved by the FDA for
sale in the United States is an important factor in ETI's ability to make export
sales. In 1997, export sales accounted for 25% of the total Company IOL sales
volume on a revenue basis and approximately 55% on a units-sold basis.
MKM and LASIK Equipment. Domestic sales of ETI's MKM and LASIK
equipment in 1997, and to date in 1998, have been insignificant, as lack of
working capital to market and promote ETI's products and to make desired product
improvements have hampered ETI's sales efforts for this product line.
The United States domestic market is dominated by Chiron Ophthalmics,
which has far greater financial, technical and market resources than ETI.
52
<PAGE> 59
Export sales of MKM and LASIK equipment in 1997 were $70,227, but ETI
does not maintain an established sales, distribution and service network in the
international market for its MKM and LASIK equipment.
TRANSACTION WITH OPHTHALMIC INNOVATIONS INTERNATIONAL, INC.
On January 31, 1997, ETI entered into a license agreement (the "License
Agreement") with Ophthalmic Innovations International, Inc. ("OII"), of
Claremont, California. Pursuant to the terms of the License Agreement, ETI
granted to OII a non-exclusive license under ETI's pre-market approvals (PMAs)
granted to ETI by the FDA to manufacture and market IOLs designed and
manufactured in compliance with the PMAs. ETI received a one-time license fee of
$325,000.
In connection with the License Agreement, ETI and OII entered into a
Supply Agreement on January 31, 1997, by which OII agreed to manufacture and
sell to ETI certain IOLs at predetermined fixed prices. During 1997, and to date
in 1998, ETI has not purchased any IOLs from OII pursuant to the Supply
Agreement or otherwise, and ETI has no current plans to purchase IOLs in the
future from OII.
FDA REGULATION
The manufacture and sale of IOLs requires prior approval by the FDA of
an application for an Investigational Device Exemption ("IDE") on a parent lens.
The "Parent Lens" is the original lens involved in a patient study undertaken to
approve the safety and effectiveness of the materials used in forming the lens
and the lens design. This application contains, among other things, a
description of the lens design, the materials to be used, and the proposed
manufacturing process. Upon FDA acceptance of an IDE, a company may commence
sales to a group of ophthalmologists who serve as clinical investigators for the
lens (the "Core Group"). The Core Group performs a defined number of implant
procedures for each intraocular lens style. The results of the implant
procedures are then submitted to the FDA. If the results are favorable, the FDA
will permit ETI on whose behalf the IDE is filed to sell the lens on a less
restricted basis. The final stage of review involves filing an application for
pre-market approval ("PMA") with the FDA. PMA is granted based on results of
clinical investigations and, if approved, allows the lens to be sold for general
domestic implant purposes. Each new lens design must comply with these
procedures. (See "Products of ETI").
FDA regulations require ETI to comply with "Good Manufacturing
Practices" ("GMPs") regarding the manufacture of IOLs and to maintain complete
traceability of each lens implanted, including pertinent information about each
patient. Any adverse reactions to an implant must be reported to the FDA.
In June 1990, ETI received pre-market approval ("PMA") on its Parent
Lens and three supplements, which included several three-piece lens designs with
PMMA loops. In September 1990, ETI received approvals for supplements on both
single-piece and biconvex lens designs introduced by ETI to address the fastest
growing segment of the IOL market, small incision products. In September 1991,
ETI's 5.0mm lens received PMA status from the FDA. As a result of the above
approvals, 90% of ETI's IOL product line has received FDA approval.
In March 1994, ETI acquired certain assets of a company manufacturing a
microkeratome unit under the name of MicroPrecision(TM). The assets included
patent rights and FDA 510(k) approval of the keratome system. These products are
manufactured under the name MicroPrecision(TM).
RESEARCH AND DEVELOPMENT
In 1991, ETI entered into an agreement with Ronald P. Jensen, M.D., to
consult with ETI with respect to the development of viscoelastic material
whereby he granted to ETI a right of first refusal for the development of any
such viscoelastic material that may be developed by Dr. Jensen for a five-year
period beginning December 1993. ETI was required to pay to Dr. Jensen $200,000
over such five-year period.
In 1997, ETI was not working with any viscoelastic material developed
by Dr. Jensen and was in default of its payments to Dr. Jensen. In February
1998, ETI renegotiated its contract with Dr. Jensen, which now extends to the
year 2000 and requires further payments totaling $100,000. ETI still does not
work on any viscoelastic material developed by Dr. Jensen.
53
<PAGE> 60
In 1995, ETI conducted research and development primarily for research
in the fields of corneal topography, glaucoma and soft/foldable lens technology.
In 1996, due to a lack of working capital, ETI ceased research and development
activities on corneal topography and glaucoma technologies and reduced work on
soft/foldable lens technology to in-house research. Costs for such research were
not material. This situation continued throughout 1997 and into 1998 to date.
PRODUCT LIABILITY
The testing, marketing, and sale of human health care products entail
an inherent risk of allegations of product liability. Although ETI has not
incurred any material product liability to date, whether insured or uninsured,
there can be no assurance that substantial product liability claims will not be
asserted against ETI.
In 1996, ETI allowed its product liability insurance to lapse so that
there is no insurance coverage in the event ETI is confronted with any product
liability claims. Accordingly, a significant amount of claims against ETI for
product liability, if resolved against ETI, would have a material adverse effect
on ETI's business, results of operations and financial condition.
RAW MATERIALS
The raw materials used by ETI in the manufacture of IOLs are cast PMMA
and extruded PMMA (See "Products of ETI"). Although these raw materials are only
available through a limited number of suppliers, they are generally available.
ETI has an adequate supply of the PMMA materials on hand to meet short-term
production requirements and does not anticipate that the availability of PMMA
will restrict its ability to meet production demands.
PATENTS, TRADEMARKS, AND LICENSES
ETI is not reliant upon patent protection for the marketing of its IOLs
and believes that its ability to effectively compete in the IOL marketplace is
dependent upon other factors. (See "Competition"). There are no patents,
trademarks, or licenses which are material to the business and operations of
ETI, except its approvals from the FDA to market IOLs in the United States. (See
"FDA Regulation").
EMPLOYEES
As of June 30, 1998, ETI had six full-time employees in the United
States, in addition to the 47 full-time employees of Star. ETI also employs
approximately 25 full-time employees in its Mexicali, Mexico facility.
PROPERTIES
ETI's executive, manufacturing, and administrative offices are located
in approximately 19,500 square feet of leased space in St. Paul, Minnesota. ETI
also leases 7,400 square feet in a building located in Mexicali, Mexico for use
as a manufacturing plant pursuant to the Maquiladora program administered by the
United States and Mexican governments. In general, all of ETI's premises are
nearly fully utilized and considered to be in good condition and adequate for
the purposes for which they are being used.
LEGAL PROCEEDINGS
ETI was a defendant in 1997 and early 1998 in several lawsuits brought
by creditors of ETI to collect monies due and payable by ETI, including the
following five lawsuits:
Dr. Ronald P. Jensen brought suit in 1996 in the United States
District Court for the Central District of California for breach of a
consulting contract, claiming damages of $111,000 plus interest and
costs. The suit was settled in February 1998 in the amount of $25,000
plus a renegotiated consulting arrangement providing for the payment by
ETI of $100,000 over a two-year period beginning June 1, 1998.
Dr. Richard Lindstrom brought suit in 1996 in the District Court,
Second Judicial District, County of Ramsey, Minnesota, against ETI
alleging breach of agreement of ETI arising out of payments due to Dr.
Lindstrom and a leasing company for the lease of equipment by ETI.
Plaintiff sought damages in excess of $50,000. The matter was settled
in June 1997 through the provision of IOLs to Dr. Lindstrom in lieu of
cash payments.
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<PAGE> 61
The law firm of Christie, Parker & Hale brought suit in 1996
against ETI to collect legal fees owing to it in connection with that
law firm's representation of ETI in a patent infringement suit against
ETI that was settled in 1995. The suit was entered in the Superior
Court of California, County of Los Angeles. Default judgment in the
amount of approximately $43,000 was entered against ETI in 1996.
Christie, Parker & Hale has agreed to forego action against ETI on its
judgment as long as ETI remains current on a schedule of payments
totaling $43,000, agreed upon by the parties. As of April 1998, ETI was
current in its payment schedule.
In early 1997, Tracy Hoffman, a former employee of ETI, brought
suit in the District Court, Second Judicial District, County of Ramsey,
Minnesota, against ETI, alleging monies due for compensation and
damages for sexual harassment. This suit was settled in February 1998
by ETI's agreement to pay to Ms. Hoffman and to her attorneys a total
of $30,000.
In September 1996, Dr. Samuel Yankelove brought suit against ETI
in the 164th Judicial District Court of Harris County, Texas, claiming
damages for an alleged defective item of equipment sold by ETI to Dr.
Yankelove. In March 1998, ETI entered into an Agreed Judgment with the
plaintiff providing for the payment by ETI of $30,000 over more than a
three-year period.
There are several other lawsuits pending against ETI which individually
or in the aggregate are not material to the business or financial condition of
the Company, either because the amounts are not material or the liability is
covered by applicable insurance.
CERTAIN TRANSACTIONS
For information regarding certain relationships and related
transactions involving ETI, see "Proposal No. 4--Interests of Certain Persons in
the Reverse Acquisition" and "Management--Employment Contracts and Change of
Control Arrangements."
The Board of Directors has adopted a policy that any future
transactions with affiliates of the Company will be on terms no less favorable
to the Company than are reasonably available from unrelated third parties and
shall have been approved by a majority of the Company's directors who do not
have a material interest in the transaction.
PRINCIPAL EXECUTIVE OFFICE
ETI's principal executive office is located at 16 South Market Street,
Petersburg, Virginia 23803, and its telephone number is (804) 861-0681.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended,
requires the Company's officers and directors and persons who own more than 10%
of a registered class of the Company's equity securities to file reports of
ownership and changes in ownership with the Securities and Exchange Commission
(the "SEC"). Officers, directors and greater than 10% beneficial owners are
required by SEC regulations to furnish the Company with copies of all Section
16(a) forms they file. Based solely on a review of the copies of the forms
furnished to the Company, or written representations that no Forms 5 were
required, the Company believes that during the fiscal year ended December 31,
1997 all Section 16(a) filing requirements applicable to its officers, directors
and greater than 10% beneficial owners were complied with, except that Mr.
Fitzsimmons acquired 6,481 shares of Common Stock in December 1997 for which a
Form 4 was filed in March 1998.
INDEPENDENT AUDITORS
For accounting purposes, the transaction was recorded as a Reverse
Acquisition, with Star as the accounting acquirer. Keiter, Stephens, Hurst, Gary
& Shreaves, P.C. served as independent auditors for Star for the year ended
December 31, 1997 and has been selected as the independent auditors of Star for
the year ending December 31, 1998. Representatives of Keiter, Stephens, Hurst,
Gary & Shreaves, P.C. are expected to attend the Annual Meeting to respond to
appropriate questions and will have an opportunity to make a statement if they
desire to do so.
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On March 5, 1998, the Company engaged Olsen, Thielen & Co., Ltd.
("Olsen, Thielen") as its independent auditors to audit its financial statements
for the years ended December 31, 1996 and December 31, 1997. There have been no
disagreements between the Company and Olsen, Thielen on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope or
procedure, which disagreement, if not resolved to their satisfaction, would have
caused such firm to make reference in connection with its opinions to the
subject matter of the disagreement. Representatives of Olsen, Thielen are not
expected to attend the Annual Meeting.
STOCKHOLDER PROPOSALS
Proposals of stockholders of the Company that are intended to be
presented by such stockholders at the Company's 1999 Annual Meeting must be
received by the Company, addressed to the President, Eye Technology, Inc., 16
South Market Street, Petersburg, Virginia 23803, no later than January 15, 1999,
for inclusion in the proxy statement relating to that meeting.
SOLICITATION
This solicitation of proxies is being made on behalf of the Board of
Directors and may be made by mail, personal interview, telephone and delivery
services by officers, directors and employees of the Company. The Company may
also request banking institutions, brokerage firms, custodians, nominees and
fiduciaries to forward solicitation material to the beneficial owners of the
Class A Preferred Stock, Series B Preferred Stock and Common Stock that those
companies or persons hold of record. The Company will pay all costs of the
solicitation and will reimburse forwarding expenses.
OTHER BUSINESS
The Board of Directors is not aware of any other matter which may be
presented for action at the Annual Meeting, other than the matters set forth in
this Proxy Statement.
ANNUAL REPORT
A copy of the Company's Annual Report on Form 10-K for the year ended
December 31, 1997 will be sent to any stockholder, without charge, upon written
request addressed to the President, Eye Technology, Inc., 16 South Market
Street, Petersburg, Virginia 23803.
IT IS IMPORTANT THAT PROXIES BE RETURNED PROMPTLY. WHETHER OR NOT YOU
EXPECT TO ATTEND THE MEETING IN PERSON. YOU ARE URGED TO COMPLETE, SIGN AND
RETURN THE PROXY IN THE ENCLOSED POSTAGE-PAID, ADDRESSED ENVELOPE.
By Order of the Board of Directors
Malcolm L. Bailey
President
Petersburg, Virginia
November 12, 1998
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<PAGE> 63
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
STAR TOBACCO AND PHARMACEUTICALS, INC.
Independent Auditors' Report F-2
Balance Sheet as of December 31, 1997 F-3
Statements of Operations
for the Years Ended December 31, 1997 and 1996 F-5
Statements of Stockholders' Deficit
for the Years Ended December 31, 1997 and 1996 F-6
Statements of Cash Flows
for the Years Ended December 31, 1997 and 1996 F-7
Notes to Financial Statements F-9
EYE TECHNOLOGY, INC.
Independent Auditors' Report F-16
Consolidated Balance Sheet as of December 31, 1997 F-17
Consolidated Statements of Operations F-18
for the Years Ended December 31, 1997 and 1996
Consolidated Statements of Stockholders' Deficit F-19
for the Years Ended December 31, 1997 and 1996
Consolidated Statements of Cash Flows F-20
for the Years Ended December 31, 1997 and 1996
Notes to Consolidated Financial Statements F-21
</TABLE>
F-1
<PAGE> 64
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Star Tobacco and Pharmaceuticals, Inc.
Petersburg, Virginia:
We have audited the accompanying balance sheet of Star Tobacco and
Pharmaceuticals, Inc. as of December 31, 1997 and the related statements of
operations, stockholders' deficit, and cash flows for the years ended December
31, 1997 and 1996. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Star Tobacco and
Pharmaceuticals, Inc. as of December 31, 1997 and the results of its operations
and its cash flows for the years ended December 31, 1997 and 1996 in conformity
with generally accepted accounting principles.
KEITER, STEPHENS, HURST, GARY & SHREAVES, P.C.
Richmond, Virginia
March 24, 1998
F-2
<PAGE> 65
STAR TOBACCO AND PHARMACEUTICALS, INC.
BALANCE SHEET
December 31, 1997
<TABLE>
<CAPTION>
================================================================================
Assets
<S> <C>
Current assets:
Cash $ 10,929
Accounts receivable:
Trade, net 760,941
Other 14,227
Inventories 605,392
Prepaid expenses 33,264
Notes receivable, current 56,725
----------
Total current assets 1,481,478
----------
Property and equipment:
Land 172,572
Buildings and improvements 269,484
Machinery and equipment 2,360,784
Sales equipment 441,932
Office equipment 116,074
----------
3,360,846
Less accumulated depreciation 945,214
----------
Property and equipment, net 2,415,632
----------
Other assets:
Intangibles, net of amortization of
$ 157,557
Notes receivable, long-term 64,969
----------
Total other assets 222,526
----------
$4,119,636
==========
</TABLE>
See accompanying notes to financial statements.
F-3
<PAGE> 66
STAR TOBACCO AND PHARMACEUTICALS, INC.
BALANCE SHEET, CONTINUED
December 31, 1997
<TABLE>
<CAPTION>
================================================================================
Liabilities and Stockholders' Deficit
<S> <C>
Current liabilities:
Cash overdraft $ 198,337
Line of credit 1,095,801
Current maturities of notes payable 647,947
Accounts payable 2,375,903
Federal excise taxes payable 359,783
Accrued expenses:
Salaries and wages 39,038
Interest 39,263
Other 6,807
-----------
Total current liabilities 4,762,879
Notes payable, less current maturities 1,099,242
-----------
Total liabilities 5,862,121
-----------
Commitments and contingencies
Stockholders' deficit:
Common stock, no par value per share:
1,000 shares authorized, 200 shares
issued and outstanding 383,557
Additional paid-in capital 1,004,607
Accumulated deficit (3,130,649)
-----------
Total stockholders' deficit (1,742,485)
-----------
$ 4,119,636
===========
</TABLE>
See accompanying notes to financial statements.
F-4
<PAGE> 67
STAR TOBACCO AND PHARMACEUTICALS, INC.
STATEMENTS OF OPERATIONS
For the Years Ended December 31, 1997 and 1996
<TABLE>
<CAPTION>
===============================================================================================
1997 1996
------------ ------------
<S> <C> <C>
Net sales $ 20,763,856 $ 34,260,279
Cost of goods sold 10,033,330 16,150,442
Excise taxes on products 7,810,720 13,471,282
------------ ------------
Gross profit 2,919,806 4,638,555
------------ ------------
Operating expenses:
Marketing and distribution expenses 1,111,420 1,991,130
General and administrative expenses 1,425,299 1,637,417
Research and development 2,134,656 1,331,218
------------ ------------
Total operating expenses 4,671,375 4,959,765
------------ ------------
Operating loss (1,751,569) (321,210)
------------ ------------
Other income (expenses):
Other 21,073 44,795
Interest expense (256,001) (476,542)
------------ ------------
Net other expense (234,928) (431,747)
------------ ------------
Net loss $ (1,986,497) $ (752,957)
============ ============
Pro forma presentation applicable to
conversion from S corporation to
C corporation:
Net income before pro forma income
tax expense $ (1,986,497)
Pro forma income tax expense --
------------
Pro forma net loss $ (1,986,497)
============
Pro forma basic loss per common share $ (9,932)
============
</TABLE>
See accompanying notes to financial statements.
F-5
<PAGE> 68
STAR TOBACCO AND PHARMACEUTICALS, INC.
STATEMENTS OF STOCKHOLDERS' DEFICIT
For the Years Ended December 31, 1997 and 1996
================================================================================
<TABLE>
<CAPTION>
Common Stock Additional Notes
----------------------------- Paid-In Accumulated Receivable
Shares Amount Capital Deficit Stockholders Total
------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
December 31, 1995 200 $ 383,557 $ 16,320 $ (93,210) $ (250,000) $ 56,667
Net loss -- -- -- (752,957) -- (752,957)
Distributions -- -- -- (141,837) -- (141,837)
------------ ------------ ------------ ------------ ------------ ------------
December 31, 1996 200 383,557 16,320 (988,004) (250,000) (838,127)
Collection of note
receivable -- -- -- -- 250,000 250,000
Conversion of note
payable to equity -- -- 923,499 -- -- 923,499
Capital contribution -- -- 64,788 -- -- 64,788
Net loss -- -- -- (1,986,497) -- (1,986,497)
Distributions -- -- -- (156,148) -- (156,148)
------------ ------------ ------------ ------------ ------------ ------------
December 31, 1997 200 $ 383,557 $ 1,004,607 $ (3,130,649) $ -- $ (1,742,485)
============ ============ ============ ============ ============ ============
</TABLE>
See accompanying notes to financial statements.
F-6
<PAGE> 69
STAR TOBACCO AND PHARMACEUTICALS, INC.
STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 1997 and 1996
================================================================================
<TABLE>
<CAPTION>
1997 1996
------------- -------------
<S> <C> <C>
Operating activities:
Net loss $ (1,986,497) $ (752,957)
Adjustments to reconcile net loss to
net cash provided (used) by operating activities:
Depreciation 355,292 362,555
Amortization 68,385 62,468
Gain on fixed asset disposal -- (21,376)
(Increase) decrease in:
Accounts receivables 540,248 672,427
Inventories 1,011,439 400,932
Prepaid expenses 24,324 (22,998)
(Decrease) increase in:
Accounts payable 458,300 (416,548)
Federal excise taxes payable (178,086) (66,912)
Accrued expenses (52,093) (231,119)
------------- -------------
Net cash provided (used) by operating activities 241,312 (13,528)
------------- -------------
Investing activities:
Collections of notes receivable 19,045 98,522
Purchases of property and equipment (3,530) (170,725)
Proceeds from disposal of property and equipment -- 76,443
Purchases of intangible assets -- (47,452)
------------- -------------
Net cash provided (used) by investing activities 15,515 (43,212)
------------- -------------
Financing activities:
Lease deposits collected -- 2,600
Payments on line of credit, net (274,118) (257,711)
Proceeds from notes payable 300,000 1,580,000
Payments on notes payable (198,788) (1,251,035)
Increase in cash overdraft 7,784 131,594
Proceeds from capital contribution 64,788 --
Stockholder distributions (156,148) (141,837)
------------- -------------
Net cash provided (used) by financing activities (256,482) 63,611
------------- -------------
</TABLE>
See accompanying notes to financial statements.
F-7
<PAGE> 70
STAR TOBACCO AND PHARMACEUTICALS, INC.
STATEMENTS OF CASH FLOWS, CONTINUED
For the Years Ended December 31, 1997 and 1996
================================================================================
<TABLE>
<CAPTION>
1997 1996
------------ ------------
<S> <C> <C>
Increase in cash $ 345 $ 6,871
Cash, January 1 10,584 3,713
------------ ------------
Cash, December 31 $ 10,929 $ 10,584
============ ============
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $ 230,370 $ 496,806
============ ============
Supplemental schedule of noncash investing
and financing activities:
Issuance of note receivable for sale of building $ -- $ 68,800
Repayment of related party note payable with
related party note receivable $ 759,489 $ --
Conversion of related party note payable to equity $ 923,499 $ --
</TABLE>
See accompanying notes to financial statements.
F-8
<PAGE> 71
STAR TOBACCO AND PHARMACEUTICALS, INC.
NOTES TO FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
a. Nature of business:
Star Tobacco and Pharmaceuticals, Inc., formerly named Star
Tobacco Corporation, was incorporated under the laws of the
Commonwealth of Virginia on November 14, 1990.
The Company has been engaged since 1991 in the manufacture and
sale of tobacco products. Since 1994, the Company has also
engaged in extensive research and development activities
relating to the production of less harmful tobacco and to the
development of tobacco products and smoking cessation products
which contains less harmful tobacco. Through the year ended
December 31, 1997, the Company had not yet marketed or
received any revenues from products developed from its
research and development activities.
In January, 1998, the Company introduced to the consumer
market a chewing gum containing an FDA-approved tobacco
flavoring.
During both 1997 and 1996, the Company had sales to one
customer which represented approximately 19% and 22%,
respectively, of net sales. No one geographical area was
significant.
b. Use of estimates:
Management uses estimates and assumptions in preparing these
financial statements in accordance with generally accepted
accounting principles. Those estimates and assumptions affect
the reported amount of assets and liabilities, the disclosure
of contingent assets and liabilities, and the reported
revenues and expenses. Actual results could vary from the
estimates that were used.
c. Fair value of financial instruments:
The Company's financial instruments consist of cash,
short-term trade receivables and payables for which the
current carrying amounts approximate fair market value.
Additionally, the borrowing rates currently available to the
Company approximate the rates for debt agreements with similar
terms and average maturities.
d. Cash:
The Company's definition of cash includes items such as
short-term, highly liquid investments with maturities of three
months or less at date of purchase.
e. Accounts receivable:
The Company uses the reserve method of accounting for bad
debts for financial reporting. At both December 31, 1997 and
1996, all accounts are considered collectible. The Company
also records an allowance for returns and discounts. These
allowances amounted to $167,091 and $122,940 at December 31,
1997 and 1996, respectively.
f. Inventories:
Inventories are valued at the lower of cost or market. Cost is
determined on the first-in, first-out (FIFO) method.
F-9
<PAGE> 72
STAR TOBACCO AND PHARMACEUTICALS, INC.
NOTES TO FINANCIAL STATEMENTS, CONTINUED
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
g. Property and equipment:
Property and equipment are recorded at cost. Depreciation is
computed by the straight-line method over the estimated useful
lives of three to seven years for sales equipment, office
equipment and machinery and equipment and thirty-nine years
for buildings and improvements. Expenditures for maintenance,
repairs and minor renewals to property and equipment are
expensed in the year in which incurred.
h. Intangibles:
Intangibles consist primarily of trademarks and packaging
design costs. Intangibles are amortized by the straight-line
method over a period of 15 years for trademarks and 5 years
for packaging design costs.
I. Income taxes:
The Company has been an S Corporation since August 1, 1991 for
federal income tax purposes. Accordingly, the taxable income
or loss of the Company has been "passed-through" to its
stockholders, and they have been subject to the tax on any
income earned by the Company.
As more fully described in Note 12, the Company had a change
in ownership and merged with a public company, which caused
the income tax status of the Company to change. Management
believes that the Company is no longer eligible for S
corporation status effective February 6, 1998. As a C
corporation, the Company will be responsible for income taxes
payable resulting from earnings subsequent to February 6,
1998. Additionally, under the provisions of Financial
Accounting Standards Board ("FASB") Statement No. 109,
Accounting for Income Taxes, deferred tax assets and
liabilities are computed based on the difference between the
financial statement and tax bases of assets and liabilities
using currently enacted tax rates.
j. Credit risk:
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash and
receivables.
The Company maintains its cash balances in two financial
institutions. Each of the balances are insured by the Federal
Deposit Insurance Corporation up to $100,000.
Trade accounts receivable result from sales of tobacco
products to its various customers throughout the United
States. Credit is extended to customers after an evaluation
for credit worthiness; however, the Company does not require
collateral or other security from customers.
k. Research and development costs:
Research and development costs are charged to expense when
incurred.
F-10
<PAGE> 73
STAR TOBACCO AND PHARMACEUTICALS, INC.
NOTES TO FINANCIAL STATEMENTS, CONTINUED
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
l. Net loss per common share:
In 1997, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 128, Earnings per Share. SFAS No. 128 replaced
the previously reported primary and fully diluted earnings per
share with basic and diluted earnings per share. Unlike
primary earnings per share, basic earnings per share excludes
any dilutive effects of options, warrants and convertible
securities. Diluted earnings per share is very similar to the
previously reported fully diluted earnings per share. Basic
earnings per share is computed using the weighted-average
number of common shares outstanding during the period. Diluted
earnings per share is computed using the weighted-average
number of common shares and potential common shares
outstanding during the period. Potential common shares are
excluded from the computation if their effect is antidilutive.
Pro forma basic loss per common share was computed using 200
shares, the weighted-average number of common shares
outstanding. The Company had no potential common shares
outstanding.
2. INVENTORIES:
The following summarizes inventories at December 31, 1997:
<TABLE>
<CAPTION>
<S> <C>
Raw materials $ 282,594
Packaging materials 203,102
Finished goods 119,696
---------------
$ 605,392
===============
</TABLE>
3. NOTES RECEIVABLE:
Notes receivable consists of the following at December 31, 1997:
<TABLE>
<CAPTION>
<S> <C>
Note receivable from an unrelated entity for
the sale of the Factory Cigarette Outlets.
Interest at 9.25%, due upon demand. $ 54,807
Note receivable from an unrelated entity for
the sale of a building. Interest at 8.00%,
due in monthly installments of $600 through
November, 2001. 66,887
---------------
Total notes receivable 121,694
Less current portion $ 56,725
---------------
$ 64,969
===============
</TABLE>
F-11
<PAGE> 74
STAR TOBACCO AND PHARMACEUTICALS, INC.
NOTES TO FINANCIAL STATEMENTS, CONTINUED
4. LINE OF CREDIT:
The Company has a revolving line of credit agreement with NationsBanc
Commercial Corporation that provides up to $2,000,000 for working
capital requirements with interest charged monthly on outstanding
amounts at 1.25% above the prime interest rate. Amounts borrowed are
collateralized by the inventory, receivables and equipment and are
guaranteed by the stockholders. At December 31, 1997, borrowings under
the line of credit agreement amounted to $1,095,801.
At December 31, 1997, the Company was not in compliance with various
covenants required by the line of credit and the bank considers the
loan to be in default. The bank has agreed to extend the termination
date of the loan to April 30, 1998.
5. NOTES PAYABLE:
Notes payable consists of the following at December 31, 1997:
Related parties (note 6):
<TABLE>
<CAPTION>
<S> <C>
Term note payable to a related entity in
three annual installments of $100,000
commencing in January, 1996. Interest at
9.5% is payable monthly. Subordinated to the
NationsBanc Commercial Corporation note. $ 295,000
Term note payable to a related entity in sixteen quarterly
installments of $50,000 commencing in August, 1996 and
one final payment of $700,000 in June, 2000. Interest at
9.5% is payable monthly. Subordinated to the NationsBanc
Commercial Corporation note. 97,012
-------------
Total notes payable to related parties 392,012
Other:
Term note payable to Regency Bank in 59 monthly
installments of $3,111 of principal and interest
commencing January, 1997 and a final principal payment of
$244,762 due December, 2001. Interest is at prime plus 1%
and the note is secured by a first deed of trust on
certain real property and personal
guaranty of stockholders. 289,995
</TABLE>
F-12
<PAGE> 75
STAR TOBACCO AND PHARMACEUTICALS, INC.
NOTES TO FINANCIAL STATEMENTS, CONTINUED
5. NOTES PAYABLE, CONTINUED:
Other, continued:
<TABLE>
<CAPTION>
<S> <C>
Term note payable to G.E. Capital Corporation in
61 monthly installments of $21,047 of principal
and interest through September, 2001. Interest
is at a rate of 10.15% and the note is secured by
various manufacturing equipment. $ 785,149
Term note payable to G.E. Capital Corporation in
50 monthly installments of $7,262 of principal
and interest through October, 2001. Interest
is at a rate of 9.31% and the note is secured by
various manufacturing equipment. 280,033
-------------
Total notes payable 1,747,189
Less current portion 647,947
-------------
$ 1,099,242
=============
The annual maturities of notes payable are as follows:
Year Ended
December 31,
-----------
1998 $ 647,947
1999 282,444
2000 311,702
2001 505,096
-------------
$ 1,747,189
=============
</TABLE>
6. RELATED PARTY TRANSACTIONS:
The Company has entered into certain transactions with companies and
trusts that are owned by members of management and stockholders. The
following is a summary of related party balances as of December 31,
1997 and transactions for the years ended December 31, 1997 and 1996.
<TABLE>
<CAPTION>
1997 1996
------------- -------------
<S> <C> <C>
Related party transactions:
Interest income $ -- $ 20,402
Interest expense 28,975 171,000
Management fees 565,000 387,500
Aircraft expenses 238,750 --
Related party balances:
Notes payable (note 5) 392,012
Accrued interest expense 21,330
</TABLE>
F-13
<PAGE> 76
STAR TOBACCO AND PHARMACEUTICALS, INC.
NOTES TO FINANCIAL STATEMENTS, CONTINUED
6. RELATED PARTY TRANSACTIONS, CONTINUED:
On January 1, 1997, the Company consolidated the majority of the
related party notes payable and all of the related party notes
receivable and repaid $759,489 of the related party note payable by
offsetting the related party note receivable. The remaining related
party note payable of $923,499 was then converted to equity.
The Company paid a related entity $565,000 in 1997 and $387,500 in 1996
for management fees. The Company is also leasing an aircraft from a
related entity on a short-term basis with all expenses associated with
the use of the aircraft amounting to $238,750 in 1997 and $-0- in 1996.
7. EMPLOYEE BENEFIT PLAN:
In 1995, the Company adopted Internal Revenue Code Section 401(k) and
became the sponsor of a defined contribution retirement plan covering
all employees who meet certain eligibility and participation
requirements. Participants may contribute up to 15% of their
compensation. The Company may make an annual discretionary
contribution. The Company made no contribution for 1997 or 1996.
8. LEASES:
The following is a schedule by years of future minimum rental payments
required under operating leases (primarily for vehicles) that have
initial or remaining noncancellable lease terms in excess of one year
as of December 31, 1997:
<TABLE>
<CAPTION>
Year Amount
---- ------
<S> <C>
1998 $ 99,508
1999 56,707
2000 3,304
---------------
$ 159,519
===============
</TABLE>
Lease expense for all leases, including leases with terms of less than
one year, amounted to $169,988 and $204,845 for the years ended
December 31, 1997 and 1996, respectively.
9. LITIGATION:
The Company is involved in legal actions in the ordinary course of its
business. Although the outcome of any such legal actions cannot be
predicted, in the opinion of management, there are no legal proceedings
pending against or involving the Company whose outcome is likely to
have a material adverse effect upon the financial position or results
of operations of the Company.
10. RISKS AND UNCERTAINTIES:
The Company has incurred losses from operations, has a net working
capital and equity deficit and is in default on its line of credit.
These factors are substantially due to the Company's significant
investment in research and development activities. Management is in the
process of raising additional capital which it believes will be
sufficient for the Company to continue its research and development
activities and normal operations. In addition, the stockholders of the
Company have agreed to financially support the operations of the entity
and have the ability to do so.
F-14
<PAGE> 77
STAR TOBACCO AND PHARMACEUTICALS, INC.
NOTES TO FINANCIAL STATEMENTS, CONTINUED
11. ADVERTISING COSTS:
Advertising costs are expensed as incurred and are included in
marketing and distribution expenses. For the years ended December 31,
1997 and 1996, the costs were $59,930 and $254,306, respectively.
12. SUBSEQUENT EVENTS:
Merger:
On February 6, 1998, the holders of all of the outstanding Common Stock
of Star Tobacco and Pharmaceuticals, Inc. ("Star") entered into a stock
exchange agreement with Eye Technology, Inc., a publicly-owned company.
Under the agreement, the Company exchanged all of its common stock for
shares of series B convertible preferred stock, which when converted
would equal approximately 90% of the outstanding common stock of Eye
Technology, Inc. For accounting purposes, the acquisition has been
treated as a reverse acquisition with Star as the accounting acquirer.
The accounting acquirer expects to treat the merger as a purchase
acquisition.
Income taxes:
As discussed in Note 1, effective February 6, 1998, the Company will no
longer be treated as an S Corporation for tax purposes and will be
subject to corporate income taxes. If the Company had been subject to
corporate income taxes during 1997, it would not have any current
income tax liability due to its operating losses. The Company would
have a deferred income tax asset resulting from the net operating
losses and a deferred income tax liability resulting primarily from
temporary differences in depreciation. A valuation allowance would have
been established to fully reserve the excess of the deferred tax asset
over the deferred tax liability due to the uncertainty of the
utilization of the operating loss carryforward.
At the date of the change in tax status, the Company had approximately
$100,000 in deferred income tax liabilities that will be realized in
future tax periods.
F-15
<PAGE> 78
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
Eye Technology, Inc.
St. Paul, Minnesota
We have audited the accompanying consolidated balance sheet of Eye Technology,
Inc. (a Delaware corporation) and subsidiaries as of December 31, 1997 and the
related consolidated statements of operations, stockholders' deficit, and cash
flows for the years ended December 31, 1997 and 1996. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Eye Technology, Inc.
and subsidiaries as of December 31, 1997 and the results of their operations and
their cash flows for the years ended December 31, 1997 and 1996 in conformity
with generally accepted accounting principles.
St. Paul, Minnesota OLSEN THIELEN & CO., LTD.
April 13, 1998
F-16
<PAGE> 79
EYE TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
December 31, 1997
================================================================================
<TABLE>
<CAPTION>
ASSETS
<S> <C>
CURRENT ASSETS:
Cash $ 3,244
Accounts Receivable, Net of Allowance for Doubtful
Accounts of $202,000 52,214
Inventories 894,077
Prepaid Expenses and Other 7,177
------------
Total Current Assets 956,712
------------
PROPERTY AND EQUIPMENT:
Machinery and Equipment 498,516
Furniture and Fixtures 272,040
Leasehold Improvements 1,750
------------
Total 772,306
Less Accumulated Depreciation 723,793
------------
Net Property and Equipment 48,513
------------
OTHER ASSETS
Purchased Technology 193,793
Other 54,225
------------
Total Other Assets 248,018
------------
TOTAL ASSETS $ 1,253,243
============
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES:
Notes Payable $ 269,639
Notes Payable to Related Party 183,000
Accounts Payable 478,347
Accrued Professional Fees 548,154
Accrued Compensation 450,580
Accrued Commissions 107,240
Other Accrued Liabilities 174,510
------------
Total Current Liabilities 2,211,470
------------
COMMITMENTS AND CONTINGENCIES
REDEEMABLE PREFERRED STOCK, Class A, Convertible,
2,570 shares issued and outstanding at liquidation value 257,000
------------
STOCKHOLDERS' DEFICIT:
Common Stock, $.01 par value, 10,000,000 shares authorized
3,435,190 shares issued and outstanding 34,352
Additional Paid-In Capital 8,777,505
Accumulated Deficit (10,027,084)
------------
Total Stockholders' Deficit (1,215,227)
------------
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT $ 1,253,243
============
</TABLE>
The accompanying notes are an integral part of
the consolidated financial statements.
F-17
<PAGE> 80
EYE TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 1997 and 1996
================================================================================
<TABLE>
<CAPTION>
1997 1996
------------- -------------
<S> <C> <C>
SALES $ 1,333,431 $ 2,293,311
COST OF GOODS SOLD 748,018 810,373
------------- -------------
GROSS PROFIT 585,413 1,482,938
------------- -------------
OPERATING EXPENSES:
Selling and Marketing 197,422 612,974
General and Administrative 888,746 1,044,289
Research and Development -- 24,530
------------- -------------
Total Operating Expenses 1,086,168 1,681,793
------------- -------------
LOSS FROM OPERATIONS (500,755) (198,855)
------------- -------------
OTHER INCOME (EXPENSES):
Sale of License 325,000 --
Litigation Settlement -- 161,053
Interest Expense (160,576) (144,627)
Other 6,140 (31,387)
------------- -------------
Total Other Income (Expenses) 170,564 (14,961)
------------- -------------
NET LOSS $ (330,191) $ (213,816)
============= =============
BASIC AND DILUTED NET LOSS PER SHARE $ (.10) $ (.06)
============= =============
WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING $ 3,435,190 $ 3,436,923
============= =============
</TABLE>
The accompanying notes are an integral part of
the consolidated financial statements.
F-18
<PAGE> 81
EYE TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
Years Ended December 31, 1997 and 1996
================================================================================
<TABLE>
<CAPTION>
Common Stock Additional
------------------------------ Paid-In Accumulated
Shares Amount Capital Deficit
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
BALANCE on December 31, 1995 3,438,656 $ 34,387 $ 8,777,505 $ (9,483,077)
Stock Canceled (3,466) (35) (213,816)
------------ ------------ ------------ ------------
Net Loss
BALANCE on December 31, 1996 3,435,190 34,352 8,777,505 (9,696,893)
(330,191)
------------ ------------ ------------ ------------
Net Loss
BALANCE on December 31, 1997 3,435,190 $ 34,352 $ 8,777,505 $(10,027,084)
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of
the consolidated financial statements.
F-19
<PAGE> 82
EYE TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 1997 and 1996
================================================================================
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss $ (330,191) $ (213,816)
Adjustments to Reconcile Net Loss
to Net Cash Provided By Operating Activities:
Depreciation and Amortization 249,133 236,884
Gain on Disposal of Property and Equipment -- (8,847)
(Increase) Decrease In:
Accounts Receivable 50,409 376,802
Inventories 52,750 36,610
Prepaid Expenses and Other (33,764) 30,422
Increase (Decrease) In:
Accounts Payable and Accrued Liabilities 384,592 (255,023)
----------- -----------
Net Cash Provided By
Operating Activities 372,929 203,032
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds Received on Sale of Equipment -- 10,000
----------- -----------
Net Cash Provided By Investing Activities -- 10,000
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from Issuance of Notes Payable 437,610 516,832
Principal Payments on Notes Payable (871,561) (671,212)
Common Stock Cancelled -- (35)
----------- -----------
Net Cash Used In Financing Activities (433,951) (154,415)
----------- -----------
NET INCREASE (DECREASE) IN CASH (61,022) 58,617
CASH at Beginning of Year 64,266 5,649
----------- -----------
CASH AT End of Year $ 3,244 $ 64,266
=========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest Paid $ 189,974 $ 87,399
Non Cash Transactions:
Debt Issued for Accrued Liabilities 20,000 --
Inventory Exchanged for Payment of Debt 102,430 --
</TABLE>
The accompanying notes are an integral part of
the consolidated financial statements.
F-20
<PAGE> 83
EYE TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A. Nature of Business - Eye Technology, Inc. (the Company) researches, designs,
develops, manufactures and sells intraocular lenses and other ophthalmic
products. Export sales in 1997 and 1996 were approximately $408,000 and
$579,000. No one geographical area was significant. No customer accounted for
10% or more of the Company's net sales during any of the periods presented.
B. Operations and Cash Flow - As reflected in the accompanying consolidated
financial statements, the Company has incurred losses from operations and has a
net capital deficiency. In addition, the limited availability of additional
working capital indicates uncertainty as to whether current financing
arrangements will be sufficient to fund current operations and financial
commitments. The Company has significant current debt obligations and is in
default under these debt obligations which gives the lenders the right to call
the obligations at their discretion. No waivers of default have been requested
or received. The Company also is in technical default on its obligations in
conjunction with the purchase of technology (See Note 6).
Management continues to pursue various financing alternatives, and is in the
process of raising additional capital which it believes will be sufficient for
the Company to continue normal operations.
C. Consolidation - The accompanying consolidated financial statements include
the accounts of the Company and its subsidiaries, all of which are wholly-owned.
All intercompany accounts and transactions have been eliminated in
consolidation.
D. Use of Estimates - The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
E. Fair Value of Financial Instruments - The Company's financial instruments
consist of cash, short-term trade receivables and payables for which the current
carrying amounts approximate fair market value. Additionally, the borrowing
rates currently available to the Company approximate the rates for debt
agreements with similar terms and average maturities.
F. Inventories - Inventories are recorded at the lower of first-in, first-out
cost or market. Inventories consist of the following:
<TABLE>
<CAPTION>
1997
----------
<S> <C>
Raw Materials $ 8,108
Work in Process 440,672
Finished Goods 445,297
----------
$ 894,077
==========
</TABLE>
G. Property and Equipment - Property and equipment are recorded at cost.
Additions, improvements or major renewals are capitalized. Any gains or losses
on property and equipment retirements are reflected in the current years
operations. Depreciation is computed using the straight-line method over
estimated useful lives as follows:
<TABLE>
<S> <C>
Machinery and equipment 10 years
Furniture and fixtures 3 to 5 years
Leasehold improvements Term of lease
</TABLE>
H. Research and Development Costs - Research and development costs are expensed.
F-21
<PAGE> 84
I. Purchased Technology - As of January 1, 1996, the unamortized cost of
technology acquired in 1994 (See Note 6) is being amortized over its estimated
remaining life of three years. Amortization expense included on the statement of
operations was $220,641 in 1997 and $221,075 in 1996. Accumulated amortization
was $512,617 as of December 31, 1997.
J. Revenue Recognition - For domestic intraocular lens sales, which are
regulated by the Food and Drug Administration, the Company generally recognizes
revenue after the intraocular lenses have been surgically implanted and
notification has been received from the physician or institution. For
international sales, which are not regulated by the FDA, the Company recognizes
revenue when the lenses are shipped. The Company generally recognizes revenue on
equipment sales upon shipment of the product. A one-time license fee of $325,000
received by the Company was recognized upon receipt.
K. Loss Per Common Share - Net loss per common share is computed under the
provisions of Statement of Financial Accounting Standards No. 128, "Earnings per
Share". Basic loss per common share is computed by dividing net loss by the
weighted average number of common shares outstanding during the period. Diluted
loss per common share includes the dilutive effect of potential common shares
outstanding. The Company's potential common shares outstanding include stock
options and preferred stock. Basic and diluted earnings per share were the same
in 1997 and in 1996 because all potential common shares were antidilutive.
NOTE 2 - ACCOUNTS RECEIVABLE
During 1997, the Company entered into an agreement with a financial institution
to sell the institution substantially all domestic trade receivables with full
recourse. The financial institution purchases the receivables subject to a
variable discount based on a daily aging of amounts receivable. At December 31,
1997, $47,631 of receivables sold remained uncollected and are subject to
repayment.
NOTE 3 - NOTES PAYABLE AND CREDIT FACILITY
Notes payable and credit facility obligations consisted of the following:
<TABLE>
<CAPTION>
1997
---------
<S> <C>
Obligation in conjunction with technology purchase, payable in monthly
installments through May 1996, with 12% interest. Secured by purchased
technology (See Note 6). This obligation is callable by the holder and subject
to surrender of purchased technology due to the Company's default on scheduled
installments $ 84,804
Unsecured note payable to a partnership with 8% interest in monthly installments
of $2,350, through June 1996. This obligation is callable by the holder due to
the Company's default on scheduled installments 72,164
Unsecured notes payable to four individuals in various weekly installments
through May 1999 and May 2000, with 14% interest. These obligations are callable
by the holders due to the Company's default on scheduled installments 53,819
Obligations in conjunction with settlement of a lawsuit payable in various
monthly and quarterly installments through May 1997, with 10% to 13% interest
This obligation is callable by the holder due to the Company's default on
schedules installments 36,715
Contracts payable in various monthly installments with 8% to 8.5% interest
Collateralized by equipment 22,137
Line of credit facility with a finance company, which provides for borrowings
determined periodically based on contractual percentages of accounts receivable
and inventories, as defined in the loan agreement Borrowings under the credit
facility are payable on demand and bear interest at the bank's reference rate
plus six percent. The agreement was terminated in February 1997 --
</TABLE>
F-22
<PAGE> 85
<TABLE>
<CAPTION>
1997
-----------
<S> <C>
Obligation to a finance company payable in monthly payments of $2,499 and $1,169
through December 1996 with 9% and 13% interest --
Term note payable to bank --
-----------
Total $ 269,639
===========
</TABLE>
NOTE 4 - NOTES PAYABLE TO RELATED PARTY
The Company has various unsecured notes payable to an officer/stockholder. The
notes are payable on demand with interest at 2% in excess of the prime rate
(8.5% at December 31, 1997).
NOTE 5 - PREFERRED STOCK AND STOCKHOLDERS' EQUITY
PREFERRED STOCK
The Company has 100,000 shares of $.01 par value preferred stock authorized
which includes 4,000 shares of Class A Convertible Redeemable preferred stock.
During May 1993, the Company sold 2,000 shares of Class A Convertible Redeemable
Preferred Stock for $100 per share and issued 570 shares to retire debt. Each
share of the Preferred Stock is convertible into 80 shares of common stock of
the Company at the option of the holder and has voting rights equal to the
number of common shares issuable if converted. The Preferred Stock has the right
to share in dividends declared on the Company's common stock and has certain
liquidation preferences.
The Preferred Stock must be redeemed by the Company on June 30, 2000 at $100 per
share. In addition, redemption of the Preferred Stock may be accelerated, at the
option of the holder or the Company, subject to the Company receiving cumulative
proceeds from the sale of shares of qualifying capital stock, as defined, of not
less than $500,000. In the event of acceleration, the Preferred Stock would be
redeemable at a price of $120 per share through July 1, 1994, and increasing at
a rate of 8% each July 1 thereafter. The carrying value of the Preferred Stock
does not include the potential additional acceleration premium as the Company
has not sold this level of qualifying capital stock. Had accelerated redemption
been required, the carrying value of the Preferred Stock would be $419,424 at
December 31, 1997.
COMMON STOCK
The Company has reserved up to 40,000 shares of common stock for issuance to
certain sales representatives under an incentive stock performance plan. Under
this plan, the Company may award shares of common stock as an incentive to the
sales representatives who achieve designated sales performance criteria. Through
December 31, 1997, the Company has awarded a total of 30,000 shares of common
stock to four sales representatives. No awards were given in 1997 or 1996.
STOCK OPTIONS AND WARRANTS
The Company has reserved 200,000 shares of its common stock for issuance to
officers and key employees under an incentive stock option plan. Generally,
options become exercisable over a three year period and expire five years after
the date of grant. Options are granted at an excess of the fair market value of
the common stock on the date of grant. The following is a summary of Plan
activity:
<TABLE>
<CAPTION>
Number of Exercise
Shares Price
---------- ----------
<S> <C> <C>
Balance, December 31, 1995 58,000 $ .38
Canceled 2,000 .38
----------
Balance, December 31, 1996 56,000 .38
Canceled 29,500 .38
----------
Balance, December 31, 1997 26,500 .38
==========
</TABLE>
F-23
<PAGE> 86
At December 31, 1997, options granted under the Plan to acquire 26,500 shares of
common stock were exercisable and 139,250 were available for grant.
In November 1993, the Company issued a stock option, outside of the Plan, to a
director of the Company to purchase 50,000 shares of common stock at an exercise
price of $.50 per share. The option expires on January 31, 2001.
In February 1994, the Company issued a stock option, outside of the Plan, to the
president/director of the Company to purchase 150,000 shares of common stock at
an exercise price of $.50 per share. The option expires on February 28, 1999.
Options to acquire 50,000 shares are presently exercisable. Options to purchase
100,000 shares are exercisable contingent upon the satisfaction of certain
conditions which have not yet occurred.
NOTE 6 - COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
The Company leases certain of its facilities under noncancelable operating
leases which expire in 2001. Rent expense and future minimum rental commitments
for these leases are as follows:
<TABLE>
<CAPTION>
Expense:
<S> <C>
1997 $ 101,568
1996 256,424
Commitments:
1998 $ 78,948
1999 78,948
2000 78,948
2001 59,211
-----------
Total Commitments $ 296,055
===========
</TABLE>
TECHNOLOGY PURCHASE AGREEMENT
In March 1994, the Company entered into an agreement with a developer of a
microkeratome unit to acquire certain of the company's technology including an
FDA 510K certification for consideration of $769,500. Upon signing the
agreement, the Company made a nonrefundable deposit of $200,000. Under the terms
of the agreement, the Company is required to pay the balance of the purchase
price in varying installments through May 1996. Should the Company be unable to
comply with the payment terms of this agreement, the $200,000 deposit along with
50% of any payments made in excess of this amount will be forfeited and the
Company will be required to surrender any and all rights to the assets referred
to above. The Company is currently in default on its payments, however, the
Company has not received notice from the note holder of mandatory surrender of
the acquired technology and is attempting to become current on this past due
amount.
CONSULTING AGREEMENTS
In connection with a negotiated settlement in August 1991, the Company entered
into an agreement with a medical professional for consulting services to be
rendered during the five-year period 1994 through 1998. Consulting fees under
the agreement are $50,000 per year. In February 1998, the Company agreed to
settle this agreement including amounts in arrears for a fee of $25,000 and
further agreed to consulting services for quarterly fees of $12,500 from June
1998 through March 2000.
LITIGATION
The Company is involved in legal actions in the ordinary course of its business.
Although the outcome of any such legal actions cannot be predicted, in the
opinion of management, there is no legal proceeding pending against or involving
the Company whose outcome is likely to have a material adverse effect upon the
consolidated financial position or results of operations of the Company.
F-24
<PAGE> 87
NOTE 7 - INCOME TAXES
At December 31, 1997 and 1996, the Company had net operating loss carryforwards
of approximately $8.1 million and $7.8 million expiring from 2003 to 2012. No
provision for income taxes has been reflected in the accompanying consolidated
statements of operations. A valuation allowance has been established for the
entire 1997 and 1996 net deferred tax benefit of $3.2 million and $3.1 million
because its realization is not likely.
The provision for income taxes varied from the federal statutory tax rate as
follows:
<TABLE>
<CAPTION>
1997 1996
<S> <C> <C>
Statutory Federal Income Tax Rate (35)% (35)%
State Tax, Net of Federal Benefit -- --
Increase in Net Operating Loss Carryforwards 35 35
-------- -------
Effective Rate --% --%
</TABLE> -------- --------
NOTE 8 - SUBSEQUENT EVENTS
On February 6, 1998, the Company entered into a stock exchange agreement with
the stockholders of Star Tobacco and Pharmaceuticals, Inc. (Star) to exchange
shares of Series B Convertible Voting Preferred Stock of Eye Technology, Inc.
for 100% of the issued common stock of Star.
In conjunction with this agreement, the Company entered into a number of
subscription and stock acquisition agreements with employees, ex-employees,
vendors, and board members to settle stock options and claims for back wages or
services. As a result of these agreements, 1,402,550 shares of common stock were
issued. In addition, judgements or claims for products or services were settled
for payments of $178,000 less than face value. In February and March 1998, an
additional 2,900,000 shares of common stock was sold for $1.45 million.
F-25
<PAGE> 88
EYE TECHNOLOGY, INC.
1998 STOCK OPTION PLAN
1. PURPOSE. The purposes of the Eye Technology, Inc. 1998 Stock
Option Plan (the "Plan") are to provide additional incentives to those
officers, key employees, nonemployee Directors and Consultants of the Eye
Technology, Inc. and its Subsidiaries (as hereinafter defined) whose
substantial contributions are essential to the continued growth and success of
the Company's business, to strengthen their commitment to the Company and its
Subsidiaries, to motivate those officers, key employees, nonemployee Directors
and Consultants to perform their assigned responsibilities faithfully and
diligently, and to attract and retain competent and dedicated individuals whose
efforts will result in the long-term growth and profitability of the Company.
To accomplish these purposes, the Plan provides that the Company may grant
Stock Options and Nonqualified Stock Options (as each term is hereinafter
defined).
2. DEFINITIONS. For purposes of the Plan:
a. "ADJUSTED FAIR MARKET VALUE" means, in the event of a
Change in Control, the greater of (i) the highest price per Share paid
to holders of the Shares in any transaction (or series of transactions)
constituting or resulting in a Change in Control or (ii) the highest
Fair Market Value of a Share during the ninety (90) day period ending
on the date of a Change in Control.
b. "AGREEMENT" means the written agreement between the Company
and an Optionee evidencing the grant of an Option and setting forth the
terms and conditions thereof.
c. "APPLICABLE LAWS" mean the legal requirements relating to
the administration of stock option plans, if any, under applicable
provisions of federal securities laws, state corporate and securities
laws, the Code, the rules of any applicable stock exchange or national
market system, and the rules of any foreign jurisdiction applicable to
Options granted to residents therein.
d. "BOARD" means the Board of Directors of the Company.
e. "CHANGE IN CAPITALIZATION" means any increase or reduction
in the number of Shares, or any change (including, but not limited to,
a change in value) or exchange of Shares for a different number or kind
of shares or other securities of the Company, by reason of a
reclassification, recapitalization, merger, consolidation,
reorganization, spin-off, split-up, issuance of warrants or rights or
debentures, stock dividend, stock split, or reverse stock split, cash
dividend, property dividend, combination or exchange of shares,
repurchase of shares, public offering, private placement, change in
corporate structure or otherwise, which in the judgment of the
Compensation Committee is material or significant.
<PAGE> 89
f. "CHANGE IN CONTROL" means any of the following events:
(i) The acquisition (other than from the Company) by
any "Person" (as the term is used for purposes of Sections
13(d) or 14(d) of the Exchange Act) of beneficial ownership
(within the meaning of Rule 13d-3 promulgated under the
Exchange Act) of twenty percent (20%) or more of the combined
voting power of the Company's then outstanding voting
securities; or
(ii) The individuals who, immediately after the 1998
annual meeting of stockholders of the Company, are members of
the Board (the "Incumbent Board"), cease for any reason to
constitute at least a majority of the Board; provided,
however, that if the election, or nomination for election by
the Company's shareholders, of any new Director was approved
by a vote of at least two-thirds of the Incumbent Board, such
new Director shall, for purposes of this Agreement, be
considered as a member of the Incumbent Board; or
(iii) Approval by the shareholders of the Company of
(a) a merger or consolidation involving the Company if the
Company's shareholders, immediately before such merger or
consolidation, do not, as a result of such merger or
consolidation, own, directly or indirectly, more than seventy
percent (70%) of the combined voting power of the then
outstanding voting securities of the corporation resulting
from such merger or consolidation in substantially the same
proportion as their ownership of the combined voting power of
the voting securities of the Company outstanding immediately
before such merger or consolidation or (b) a complete
liquidation or dissolution of the Company or an agreement for
the sale or other disposition of all or substantially all of
the assets of the Company.
Notwithstanding the foregoing, a Change in Control shall not be deemed to occur
pursuant to clause (i) above solely because twenty percent (20%) or more of the
combined voting power of the Company's then outstanding securities is acquired
by (i) a trustee or other fiduciary holding securities under one or more
employee benefit plans maintained by the Company or any Subsidiary or (ii) any
corporation which, immediately prior to such acquisition, is owned directly or
indirectly by the shareholders of the Company in the same proportion as their
ownership of stock in the Company immediately prior to such acquisition.
g. "CODE" means the Internal Revenue Code of 1986, as amended.
h. "COMPANY" means Eye Technology, Inc., a Delaware
corporation.
i. "COMPENSATION COMMITTEE" means a committee consisting of at
least two (2) Disinterested Persons appointed by the Board to
administer the Plan and to perform the functions set forth herein and
which committee shall otherwise be constituted in such a manner as to
satisfy the Applicable Laws and to permit grants of options and related
transactions under the Plan to be exempt from Section 16(b) of the
Exchange Act in accordance with Rule 16b-3.
2
<PAGE> 90
j. "CONSULTANT" means any person performing consulting or
advisory services for the Company or any Subsidiary, with or without
compensation, to whom the Company chooses to grant Nonqualified Stock
Options in accordance with the Plan, provided that bona fide services
must be rendered by such person and such services shall not be rendered
in connection with the offer or sale of securities in a capital-raising
transaction.
k. "DIRECTOR" means a member of the Board.
l. "DISINTERESTED PERSON" means a disinterested administrator
with respect to the Company or any Subsidiary as described in Rule
16b-3(b)(2) under the Exchange Act.
m. "DIVISION" means any of the operating units or Divisions of
the Company designated as a Division by the Compensation Committee.
n. "ELIGIBLE EMPLOYEE" means any officer or other designated
employees of the Company or a Subsidiary designated by the Compensation
Committee as eligible to receive Options subject to the conditions set
forth herein.
o. "EMPLOYEE" means an employee of the Company or any
Subsidiary of the Company that adopts the Plan, as defined under
Section 3401(C) of the Code and regulations thereunder.
p. "EXCHANGE ACT" means the Securities Exchange Act of 1934,
as amended.
q. "FAIR MARKET VALUE" means, as of any date, the value of the
Shares.
(i) Where there exists a public market for the
Shares, the Fair Market Value shall be (A) the closing sales
price for a Share for the last market trading day prior to the
time of the determination (or, if no sales were reported on
that date, on the last trading date on which sales were
reported) on the stock exchange determined by the Compensation
Committee to be the primary market for the Common Stock or the
Nasdaq National Market, whichever is applicable or (B) if the
Common Stock is not traded on any such exchange or national
market system, the average of the closing bid and asked prices
of a Share on the Nasdaq SmallCap Market for the day prior to
the time of the determination (or, if no such prices were
reported on that date, on the last date on which such prices
were reported), in each case, as reported in The Wall Street
Journal or such other source as the Administrator deems
reliable; or
(ii) In the absence of an established market of the type
described in (i), above, for the Shares, the Fair Market Value
thereof shall be determined by the Compensation Committee in
good faith.
3
<PAGE> 91
r. "NONQUALIFIED STOCK OPTION" means an Option which is not a
Stock Option.
s. "OPTION" means a Stock Option, a Nonqualified Stock Option,
or either or both of them.
t. "OPTIONEE" means a person to whom an Option has been
granted under the Plan.
u. "SHARES" means the Common Stock, one cent ($.01) par value
per share, of the Company (including any new, additional or different
stock or securities resulting from a Change in Capitalization).
v. "STOCK OPTION" means an Option within the meaning of
Section 422 of the Code.
w. "SUBSIDIARY" means any corporation in an unbroken chain of
corporations, beginning with the Company, if each of the corporations,
other than the last corporation in the unbroken chain, owns stock
possessing fifty percent (50%) or more of the total combined voting
power of all classes of stock in one of the other corporations in such
chain.
x. "TEN PERCENT SHAREHOLDER" means an Eligible Employee, who,
at the time a Stock Option is to be granted to such Eligible Employee,
owns (within the meaning of Section 422(b)(6) of the Code) stock
possessing more than ten percent (10%) of the total combined voting
power of all classes of stock of the Company, or of a parent or a
Subsidiary within the meaning of Section 422(b)(6) of the Code.
3. ADMINISTRATION
a. The Plan shall be administered by the Compensation
Committee. No member of the Compensation Committee shall be personally
liable for any action, determination or interpretation made in good
faith with respect to the Plan, Agreements or Options, and all members
of the Compensation Committee shall be fully indemnified by the Company
with respect to any such action, determination or interpretation.
b. Subject to the express terms and conditions set forth
herein, the Compensation Committee shall have the power from time to
time to determine those Eligible Employees, nonemployee Directors or
Consultants to whom Options shall be granted under the Plan, the number
of Stock Options and/or Nonqualified Stock Options to be granted to
each Eligible Employee, the number of Nonqualified Stock Options to be
granted to each nonemployee Director or Consultant, and to prescribe
the terms and conditions (which need not be identical) of each Option,
including the purchase price per Share subject to each Option, and make
any amendment or modification to any Agreement consistent with the
terms of the Plan.
4
<PAGE> 92
c. Subject to the express terms and conditions set forth
herein, the Compensation Committee shall have the power from time to
time:
(i) to construe and interpret the Plan and the Options
granted thereunder and to establish, amend and revoke rules
and regulations for the administration of the Plan, including,
without limitation, correcting any defect or supplying any
omission, or reconciling any inconsistency in the Plan or in
any Agreement, in the manner and to the extent it shall deem
necessary or advisable to make the Plan fully effective, and
all decisions and determinations by the Compensation Committee
in the exercise of this power shall be final, binding and
conclusive upon the Company, a Subsidiary, and the Optionees;
(ii) to determine the duration and purposes for leave of
absence which may be granted to an Optionee on an individual
basis without constituting a termination of employment or
service for purposes of the Plan;
(iii) to exercise its discretion with respect to the
powers and rights granted to it as set forth in the Plan; and
(iv) generally, to exercise such powers and to perform
such acts as are deemed necessary or advisable to promote the
best interests of the Company with respect to the Plan.
4. STOCK SUBJECT TO PLAN.
a. The maximum number of Shares that may be issued or
transferred pursuant to Options under the Plan is 4,000,000 Shares (or
the number and kind of shares of stock or other securities to which
such Shares are adjusted upon a Change in Capitalization pursuant to
Section 7) and the Company shall reserve for the purposes of the Plan,
out of its authorized but unissued Shares or out of Shares held in the
Company's treasury, or partly out of each, such number of Shares as
shall be determined by the Board.
b. Whenever any outstanding Option or portion thereof expires,
is canceled or is otherwise terminated for any reason (other than by
exercise of the Option), the Shares allocable to the canceled or
otherwise terminated portion of such Option may again be the subject of
Options hereunder.
c. Whenever any Shares subject to an Option are forfeited for
any reason pursuant to the terms of the Plan, such Shares may again be
the subject of Options hereunder.
5. ELIGIBILITY. Subject to the provisions of the Plan, the
Compensation Committee shall have full and final authority to select those
Eligible Employees who will receive Options and those nonemployee Directors and
Consultants who will receive Nonqualified Stock Options; provided, however,
that no Eligible Employee shall receive any Stock Options, unless such Eligible
Employee is an employee of the Company or a Subsidiary (within the meaning of
Section 422 of the
5
<PAGE> 93
Code) at the time the Stock Option is granted. Stock Options may be granted only
to persons who are Eligible Employees.
6. OPTIONS. The Compensation Committee may grant Options in
accordance with the Plan, and the terms and conditions of the Option shall be
set forth in an Agreement; provided, however, no Eligible Employee shall
receive in any fiscal year of the Company options to purchase in excess of
1,000,000 Shares. Each Option and Agreement shall be subject to the following
conditions:
a. DESIGNATION OF OPTIONS. Each Option shall be designated as
either a Stock Option or a Nonqualified Stock Option. However,
notwithstanding such designation, to the extent that the aggregate Fair
Market Value of Shares subject to Options designated as Stock Options
which become exercisable for the first time by an Optionee during any
calendar year (under all plans of the Company or Subsidiary) exceeds
one hundred thousand dollars ($100,000), such excess Options, to the
extent of the Shares covered thereby in excess of the foregoing
limitation, shall be treated as Nonqualified Stock Options. For this
purpose, Stock Options shall be taken into account in the order in
which they were granted, and the Fair Market Value of the Shares shall
be determined as of the date the Option with respect to such Shares is
granted.
b. PURCHASE PRICE. The purchase price or the manner in which
the purchase price is to be determined for Shares under each Option
shall be set forth in the Agreement, provided that the purchase price
per Share under each Stock Option shall not be less than (i) one
hundred percent (100%) of the Fair Market Value of a Share at the time
the Stock Option is granted, and (ii) one hundred ten percent (110%) in
the case of a Stock Option granted to a Ten Percent Shareholder.
c. DURATION. Options granted hereunder shall be for such term
as the Compensation Committee shall determine, provided that no Stock
Option shall be exercisable after the expiration of ten (10) years from
the date it is granted (five (5) years in the case of a Stock Option
granted to a Ten Percent Shareholder). The Compensation Committee may,
subsequent to the granting of any Option, extend the term thereof but
in no event shall the term as so extended exceed the maximum term
provided for in the preceding sentence.
d. NON-TRANSFERABILITY. No Option hereunder shall be
transferable by the Optionee to whom granted otherwise than by will or
the laws of descent and distribution or pursuant to a qualified
domestic relations order as defined by the Code or Title I of the
Employee Retirement Income Security Act, and an Option may be exercised
during the lifetime of such Optionee only by the Optionee or such
Optionee's guardian or legal representative. The terms of such Option
shall be final, binding and conclusive upon the beneficiaries,
executors, administrators, heirs and successors of the Optionee.
e. VESTING. Subject to Section 6(j) hereof, each Option shall
be exercisable in such installments (which need not be equal) and at
such times as may be designated by the Compensation Committee and set
forth in the Agreement. To the extent not exercised,
6
<PAGE> 94
installments shall accumulate and be exercisable, in whole or in part,
at any time after becoming exercisable, but not later than the date the
Option expires. The Compensation Committee may accelerate the
exercisability of any Option or portion thereof at any time.
f. METHOD OF EXERCISE. The exercise of any Option shall be
made only by a written notice delivered in person or by mail to the
Secretary of the Company at the Company's principal executive office,
specifying the number of Shares to be purchased and accompanied by
payment therefor and otherwise in accordance with the Agreement
pursuant to which the Option was granted. The purchase price for any
Shares purchased pursuant to the exercise of an Option shall be paid in
full upon such exercise, as determined by the Compensation Committee.
In addition to any other types of consideration the Compensation
Committee may determine, the Compensation Committee is authorized to
accept as consideration for Shares issued under the Plan the following:
(i) cash; (ii) check; (iii) delivery of Optionee's promissory note with
such recourse, interest, security, and redemption provisions as the
Compensation Committee determines as appropriate; (iv) surrender of
Shares (including, withholding of Shares otherwise deliverable upon
exercise of the Option) which have a Fair Market Value on the date of
surrender equal to the aggregate exercise price of the Shares as to
which said Option shall be exercised; or (v) any combinations of the
foregoing. The written notice pursuant to this Section 6(f) may also
provide instructions from the Optionee to the Company that upon receipt
of the purchase price in cash from the Optionee's broker or dealer,
designated as such on the written notice, in payment for any Shares
purchased pursuant to the exercise of an Option, the Company shall
issue such Shares directly to the designated broker or dealer. If
requested by the Compensation Committee, the Optionee shall deliver the
Agreement evidencing the Option to the Secretary of the Company, who
shall endorse thereon a notation of such exercise and return such
Agreement to the Optionee. No fractional Shares shall be issued upon
exercise of an Option, and the number of Shares that may be purchased
upon exercise shall be rounded to the nearest number of whole Shares.
g. RIGHTS OF OPTIONEES. No Optionee shall be deemed for any
purpose to be the owner of any Shares subject to any Option unless and
until (i) the Option shall have been exercised pursuant to the terms
thereof, (ii) the Company shall have issued and delivered the Shares to
the Optionee, and (iii) the Optionee's name shall have been entered as
a shareholder of record on the books of the Company. Thereupon, the
Optionee shall have full voting, dividend and other ownership rights
with respect to such Shares.
h. TERMINATION OF EMPLOYMENT OR SERVICE.
(i) Termination of Employment or Service Other Than Upon
Retirement In Good Standing, Disability or Death of Optionee.
Upon termination of an Optionee's status as an Employee,
Director or Consultant, other than upon the Optionee's
retirement in good standing for reason of age, death or
disability, the Option shall terminate immediately as of the
date of termination and the Optionee may exercise his or her
Option at any time prior to the date of termination to the
extent that the Option is vested on the date of termination
(but in no event later than the
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expiration of the term of such Option as set forth in the
Agreement). If, on the date of termination, the Optionee is
not vested as to his or her entire Option, the Shares covered
by the unvested portion of the Option shall revert to the
Plan.
(ii) Retirement in Good Standing of Optionee. Upon
termination of an Optionee's status as an Employee, Director
or Consultant, as a result of retirement in good standing for
reason of age but not due to disability, the Optionee may
exercise his or her Option at any time within three (3) months
following the Optionee's termination, to the extent that the
Option is vested on the date of termination (but in no event
later than the expiration of the term of such Option as set
forth in Option Agreement). If on the date of termination, the
Optionee is not vested as to his or her entire Option, the
Shares covered by the unvested portion shall revert to the
Plan. If, after termination, the Optionee does not exercise
his or her Option within the time specified by the
Administrator, the Option shall terminate, and the Shares
covered by such Option shall revert to the Plan.
(iii) Disability of Optionee. If an Optionee's status as
an Employee, Director or Consultant terminates as a result of
the Optionee's disability, the Optionee may exercise the
Option to the extent the Option is vested on the date of
termination, but only within twelve (12) months from the date
of such termination (and in no event later than the expiration
date of the term of such Option as set forth in the Option
Agreement). If such disability is not a "disability" as such
term is defined in Section 22(e)(3) of the Code, in the case
of a Stock Option, such Stock Option shall automatically
convert to a Nonqualified Stock Option on the day three (3)
months and one (1) day following such termination. If, on the
date of termination, the Optionee is not vested as to the
entire Option, the Shares covered by the unvested portion of
the Option shall revert to the Plan. If, after termination,
the Option is not exercised within the time specified herein,
the Option shall terminate, and the Shares covered by such
Option shall revert to the Plan.
(iv) Death of Optionee. In the event of the death of an
Optionee, the Option may be exercised at any time within
twelve (12) months following the date of death (but in no
event later than the expiration of the term of such Option as
set forth in the Agreement) to the extent vested on the date
of death. If, at the time of death, the Optionee is not vested
as to the entire Option, the Shares covered by the unvested
portion of the Option shall revert to the Plan. The Option may
be exercised by the executor or administrator of the
Optionee's estate or, if none, by the person(s) entitled to
exercise the Option under the Optionee's will or the laws of
descent or distribution. If the Option is not so exercised
within the time specified herein, the Option shall terminate,
and the Shares covered by such Option shall revert to the
Plan.
i. MODIFICATION OR SUBSTITUTION. Subject to the terms of the
Plan, the Compensation Committee may, in its discretion, modify
outstanding Options or accept the surrender of outstanding Options (to
the extent not exercised) and grant new Options in substitution for
them. Notwithstanding the foregoing, no modification of an Option shall
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<PAGE> 96
adversely alter or impair any rights or obligations under any Agreement
without the Optionee's consent.
j. EFFECT OF CHANGE IN CONTROL. Notwithstanding anything
contained in the Plan or any Agreement to the contrary, in the event of
a Change in Control, (i) all Options outstanding on the date of such
Change in Control shall become immediately and fully exercisable and
(ii) an Optionee will be permitted to surrender for cancellation within
sixty (60) days after such Change in Control any Option or portion of
an Option to the extent not yet exercised, and the Optionee will be
entitled to receive a cash payment in an amount equal to the excess, if
any, of (x)(A) in the case of Nonqualified Stock Options, the greater
of (1) the Fair Market Value, on the date preceding the date of
surrender, of the Shares subject to the Option or portion thereof
surrendered or (2) the Adjusted Fair Market Value of the Shares subject
to the Option or portion thereof surrendered or (B) in the case of a
Stock Option, the Fair Market Value, at the time of surrender, of the
Shares subject to the Option or portion thereof surrendered, over (y)
the aggregate purchase price for such Shares under the Option;
provided, however, that in the case of an Option granted within six (6)
months prior to the Change in Control to any Optionee who may be
subject to liability under Section 16(b) of the Exchange Act, such
Optionee shall be entitled to surrender for cancellation such
Optionee's Option during the sixty (60) day period commencing upon the
expiration of six (6) months from the date of grant of any such Option.
k. BUYOUT PROVISIONS. The Compensation Committee may at any
time offer to buy out for a payment in cash or Shares, an Option
previously granted, based on such terms and conditions as the
Compensation Committee shall establish and communicate to the Optionee
at the time that such offer is made.
7. ADJUSTMENT UPON CHANGE IN CAPITALIZATION.
a. In the event of a Change in Capitalization, the
Compensation Committee shall conclusively determine the appropriate
adjustments, if any, to the maximum number and class of Shares or other
stock or securities with respect to which Options may be granted under
the Plan, the number and class of Shares or other stock or securities
which are subject to outstanding Options granted under the Plan, and
the purchase price therefor, if applicable.
b. Any such adjustment in the Shares or other stock or
securities subject to outstanding Stock Options (including any
adjustments in the purchase price) shall be made in such manner as not
to constitute a modification as defined by Section 424(h)(3) of the
Code and only to the extent otherwise permitted by Sections 422 and 424
of the Code.
c. If, by reason of a Change in Capitalization, an Optionee
shall be entitled to exercise an Option with respect to, new,
additional or different shares of stock or securities (other than
rights or warrants to purchase securities), such new, additional or
different shares shall thereupon be subject to all of the conditions,
restrictions and performance criteria which were applicable to the
Shares subject to the Option prior to such Change in Capitalization.
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<PAGE> 97
8. EFFECT OF CERTAIN TRANSACTIONS. Subject to Section 6(j), in
the event of (i) the liquidation or dissolution of the Company or (ii) a merger
or consolidation of the Company (a "Transaction"), all Options issued hereunder
shall continue in effect in accordance with their respective terms and each
Optionee shall be entitled to receive in respect of each Share subject to any
outstanding Options, as the case may be, upon exercise of any Option, the same
number and kind of stock, securities, cash, property or other consideration
that each holder of a Share was otherwise entitled to receive in the
Transaction in respect of a Share.
9. RELEASE OF FINANCIAL INFORMATION. A copy of the Company's
annual report to shareholders shall be delivered to each Optionee at the time
such report is distributed to the Company's shareholders.
10. TERMINATION AND AMENDMENT OF THE PLAN.
a. The Plan shall terminate on September 1, 2008, and no
Option may be granted thereafter. The Board may sooner terminate or
amend the Plan (other than to reduce the rights of Optionees under
Section 6(j), at any time and from time to time; provided, however,
that to the extent necessary under Section 16(b) of the Exchange Act
and the rules and regulations promulgated thereunder, no amendment
shall be effective unless approved by the shareholders of the Company
in accordance with applicable law and regulations at an annual or
special meeting held within twelve (12) months before or after the date
of adoption of such amendment.
b. Except as provided in Sections 7 and 8 hereof, rights and
obligations under any Option granted before any amendment of the Plan
shall not be adversely altered or impaired by such amendment, except
with the consent of the Optionee.
11. NON-EXCLUSIVITY OF THE PLAN. The adoption of the Plan by the
Board shall not be construed as amending, modifying or rescinding any
previously approved incentive arrangement or as creating any limitations on the
power of the Board to adopt such other incentive arrangements as it may deem
desirable.
12. LIMITATION OF LIABILITY. As illustrative of the limitations of
liability of the Company, but not intended to be exhaustive thereof, nothing in
the Plan shall be construed to:
a. give any person any right to be granted an Option other
than at the sole discretion of the Compensation Committee;
b. give any person any rights whatsoever with respect to
Shares except as specifically provided in the Plan;
c. limit in any way the right of the Company to terminate the
employment of any person at any time; or
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<PAGE> 98
d. be evidence of any agreement or understanding, expressed or
implied, that the Company will employ any person in any particular
position at any particular rate of compensation or for any particular
period of time.
13. REGULATIONS AND OTHER APPROVALS; GOVERNING LAW.
a. This Plan and the rights of all persons claiming hereunder
shall be construed and determined in accordance with the laws of the
State of Delaware without giving effect to the conflicts of laws
principles thereof, except to the extent that such law is preempted by
federal law.
b. The obligation of the Company to sell or deliver Shares
with respect to Options granted under the Plan shall be subject to all
applicable laws, rules and regulations, including all applicable
federal and state securities laws, and the obtaining of all such
approvals by governmental agencies as may be deemed necessary or
appropriate by the Compensation Committee.
c. The Plan is intended to comply with Rule 16b-3 promulgated
under the Exchange Act, and the Compensation Committee shall interpret
and administer the provisions of the Plan or any Agreement in a manner
consistent therewith Any provisions inconsistent with such Rule shall
be inoperative and shall not affect the validity of the Plan.
d. The Board may make such changes as may be necessary or
appropriate to comply with the rules and regulations of any government
authority or to obtain for Eligible Employees granted Stock Options the
tax benefits under the applicable provisions of the Code and
regulations promulgated thereunder.
e. Each Option is subject to the requirement that, if at any
time the Compensation Committee determines, in its discretion, that the
listing, registration or qualification of Shares issuable pursuant to
the Plan is required by any securities exchange or under any state or
federal law, or the consent or approval of any governmental regulatory
body is necessary or desirable as a condition of, or in connection
with, the grant of an Option or the issuance of Shares, no Options
shall be granted or payment made or Shares issued, in whole or in part,
unless listing, registration, qualification, consent or approval has
been effected or obtained free of any conditions as acceptable to the
Compensation Committee.
f. Notwithstanding anything contained in the Plan to the
contrary, in the event that the disposition of Shares acquired pursuant
to the Plan is not covered by a then current registration statement
under the Securities Act of 1933, as amended (the "Act"), and is not
otherwise exempt from such registration, such Shares shall be
restricted against transfer to the extent required by the Act and Rule
144 or other regulations thereunder. The Compensation Committee may
require any individual receiving Shares pursuant to the Plan, as a
condition precedent to receipt of such Shares (including upon exercise
on an Option), to represent and warrant to the Company in writing, in
addition to other applicable representations, that the Shares acquired
by such individual are acquired without a view to
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<PAGE> 99
any distribution thereof and will not be sold or transferred other than
pursuant to an effective registration thereof under the Act or pursuant
to an exemption applicable under the Act or the rules and regulations
promulgated thereunder. The certificates evidencing any of such Shares
shall be appropriately legended to reflect their status as restricted
securities as aforesaid.
14. MISCELLANEOUS.
a. MULTIPLE AGREEMENTS. The terms of each Option may differ
from other Options granted under the Plan at the same time, or at some
other time. The Compensation Committee may also grant more than one
Option to a given Eligible Employee, nonemployee Director or Consultant
during the term of the Plan, either in addition to, or in substitution
for, one or more Options previously granted to that Eligible Employee,
nonemployee Director or Consultant. The grant of multiple Options may
be evidenced by a single Agreement or multiple Agreements, as
determined by the Compensation Committee.
b. WITHHOLDING OF TAXES.
(i) The Company shall have the right to deduct from any
distribution of cash to any Optionee an amount equal to the
federal, state and local income taxes and other amounts as may
be required by law to be withheld (the "Withholding Taxes")
with respect to any Option. If an Optionee is entitled to
receive Shares upon exercise of an Option, the Optionee shall
pay the Withholding Taxes to the Company prior to the issuance
or release from escrow of such Shares. In satisfaction of the
Withholding Taxes to the Company, the Optionee may make a
written election (the "Tax Election"),which may be accepted or
rejected in the discretion of the Compensation Committee, to
have withheld a portion of the Shares issuable to such
Optionee upon exercise of the Option having an aggregate Fair
Market Value equal to the Withholding Taxes, provided that:
(i) in respect of an Optionee who may be subject to liability
under Section 16(b) of the Exchange Act (unless such
Optionee's employment was terminated due to disability or
death), the Tax Election is made either at least six (6)
months prior to the date that the amount of the Withholding
Taxes are determined (the "Tax Date") or during the ten (10)
day period beginning on the third (3rd) business day and
ending on the twelfth (12th) business day following the
release for publication of the Company's quarterly or annual
statements of earnings, (ii) the Tax Election is made prior to
the Tax Date, and (iii) the Tax Election is irrevocable;
provided, however, in the event that the Tax Date occurs
subsequent to the exercise of the Option or issuance of
Shares, the Optionee shall tender back to the Company on the
Tax Date that number of Shares having a Fair Market Value on
the date preceding the Tax Date at least equal to the
Withholding Taxes.
(ii) If an Optionee makes a disposition, within the
meaning of Section 424(c) of the Code and regulations
promulgated thereunder, of any Share or Shares issued to
Optionee pursuant to Optionee's exercise of an Option within
the
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<PAGE> 100
two (2) year period commencing in the day after the date of
the grant or within the one (1) year period commencing on the
day after the date of transfer of such Share or Shares to the
Optionee pursuant to such exercise, the Optionee shall, within
ten (10) days of such disposition, notify the Company thereof,
by delivery of written notice to the Company at its principal
executive office, and immediately deliver to the Company the
amount of Withholding Taxes.
c. DESIGNATION OF BENEFICIARY. Each Optionee may
designate a person or persons to receive, in the event of such
Optionee's death, any Option or any amount payable pursuant
thereto, to which such Optionee would then be entitled. Such
designation will be made upon forms supplied by and delivered
to the Company and may be revoked in writing. If an Optionee
fails effectively to designate a beneficiary, then such
Optionee's estate will be deemed to be the beneficiary.
15. EFFECTIVE DATE. The effective date of the Plan shall be June
29, 1998.
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EYE TECHNOLOGY, INC.
16 S. MARKET STREET, PETERSBURG, VIRGINIA 23803
PROXY SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS OF THE COMPANY
FOR THE ANNUAL MEETING OF STOCKHOLDERS--DECEMBER 15, 1998
The undersigned hereby constitutes and appoints Malcolm L. Bailey and
_________________, and each of them, his true and lawful agents and proxies with
full power of substitution in each, to represent the undersigned at the Annual
Meeting of Stockholders of Eye Technology, Inc. to be held at the Conference
Room, Virginia Biotechnology Research Park, 800 E. Leigh Street, Richmond,
Virginia, on Tuesday, December 15, 1998 at 11:00 a.m., local time, and at any
adjournments thereof, on all matters coming before said meeting.
1. Election of Directors.
Nominees: [ ] FOR all [ ] WITHHOLD vote for [ ] FOR all nominees
nominees all nominees except vote withheld
for those named below
Malcolm L. "Mac" Bailey - Class One
James A. McNulty - Class One
Jonnie R. Williams - Class Two
Robert J. DeLorenzo, M.D., Ph.D. - Class Three
Leo S. Tonkin - Class Three
(To withhold vote for any individual nominee, write the nominee's name below.)
- --------------------------------------------------------------------------------
2. Approval of amendment to the Company's Certificate of Incorporation to
change the name of the Company to "Star Scientific, Inc."
[ ] For [ ] Against [ ] Withheld
3. Approval of the Company's 1998 Stock Option Plan.
[ ] For [ ] Against [ ] Withheld
4. Approval of amendment to the Company's Certificate of Incorporation to
increase the number of authorized shares of Common Stock from
10,000,000 to 100,000,000, for the purposes stated in the accompanying
proxy statement.
[ ] For [ ] Against [ ] Withheld
5. In their discretion, upon such other business as may properly come
before the Annual Meeting.
(Continued and to be signed on the other side.)
<PAGE> 102
(Continued from other side.)
This proxy, when properly executed, will be voted in the manner
directed herein by the undersigned stockholder. If no direction is made, this
proxy will be voted "for" the election of the directors named in this proxy card
and "for" Proposals 2, 3 and 4.
----------------------------------------
----------------------------------------
Signature of Stockholder(s)
Please sign your name exactly as it
appears hereon. Joint owners must each
sign. When signing as attorney,
executor, administrator, trustee or
guardian, please give your full title as
it appears thereon.
Date: , 1998.
----------------------------
PLEASE MARK, SIGN, DATE AND RETURN USING THE ENCLOSED ENVELOPE.
