<PAGE> 1
SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(a) OF THE SECURITIES
EXCHANGE ACT OF 1934 (AMENDMENT NO. )
[X] Filed by the Registrant [ ] Filed by Party other than the Registrant
Check the appropriate box:
[X] Preliminary Proxy Statement
[ ] Confidential, for Use of the Commission Only (as permitted by
Rule 14a-6(e)(2))
[ ] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to Section 240.14a-11(c) or Section 240.14a-12
Eye Technology, Inc.
- --------------------------------------------------------------------------------
(Name of Registrant as Specified in its Charter)
- --------------------------------------------------------------------------------
(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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(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
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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 the filing for which the offsetting fee was
paid previously. Identify the previous filing by registration statement
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<PAGE> 2
EYE TECHNOLOGY, INC.
----------
NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
TO BE HELD SEPTEMBER 28, 1998
----------
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 Monday,
September 28, 1998, at 10:00 a.m., local time. At the Annual Meeting,
stockholders will consider and vote upon the following proposals:
1. To elect three (3) directors to hold office until the next Annual
Meeting.
2. To amend the Company's Certificate of Incorporation to change the
name of the Company to "Star Scientific Corp."
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 August 17, 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,
David P. Sheets
President and Chief Executive Officer
Petersburg, Virginia
___________, 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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_____________________, 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.............................................................................2
Information with Respect to Nominees.....................................................................2
Vote Required; Recommendation of the Board of Directors..................................................3
Board Meetings and Committees............................................................................3
Committee Interlocks and Insider Participation...........................................................3
Remuneration of Directors................................................................................3
PROPOSAL NO. 2--AMENDMENT TO THE COMPANY'S CERTIFICATE OF INCORPORATION
TO CHANGE THE NAME OF THE COMPANY TO "STAR SCIENTIFIC CORP.".............................................3
PROPOSAL NO. 3--APPROVAL OF THE COMPANY'S 1998 STOCK OPTION PLAN..................................................4
Vote Required; Recommendation of Board of Directors......................................................4
Summary of the Plan......................................................................................4
Tax Information..........................................................................................6
PROPOSAL NO. 4--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 ..........................................................................7
The Transaction..........................................................................................8
Background and Reasons for the Reverse Acquisition.......................................................9
Interests of Certain Persons in the Reverse Acquisition.................................................10
Accounting Treatment....................................................................................11
Tax Consequences........................................................................................11
Management After the Reverse Acquisition................................................................11
Restrictions on Resale of Securities....................................................................11
Appraisal and Dissenters' Rights........................................................................12
No Opinion of Financial Adviser or Stockholder Vote.....................................................12
Market for Common Stock and Related Stockholder Matters.................................................12
PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS............................................................13
Pro Forma Condensed Consolidated Balance Sheet as of December 31, 1997..................................14
Pro Forma Condensed Consolidated Statement of Operations For the Year Ended December 31, 1997...........15
Notes to Pro Forma Condensed Consolidated Financial Statements..........................................16
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR
THREE-MONTH PERIOD ENDED MARCH 31, 1998.................................................................17
Condensed Consolidated Balance Sheet For Three-Month Period Ended March 31, 1998........................17
Condensed Consolidated Statements of Operations For Three-Month Periods
Ended March 31, 1998 and 1997......................................................................18
Condensed Consolidated Statements of Cash Flows For Three-Month Periods
Ended March 31, 1998 and 1997......................................................................19
Notes to Condensed Consolidated Financial Statements....................................................21
</TABLE>
i
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<TABLE>
<S> <C>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS...............................................................................23
Results of Operations for the Three Months Ended March 31, 1998 Compared to Three Months
Ended March 31, 1997...............................................................................23
Liquidity and Capital Resources.........................................................................24
MANAGEMENT.......................................................................................................25
Executive Officers......................................................................................25
Summary Compensation Table..............................................................................25
Options.................................................................................................26
Employment Contracts and Change of Control Arrangements.................................................26
Other Information.......................................................................................26
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT...................................................26
BUSINESS OF STAR.................................................................................................28
History and Introduction................................................................................28
Proprietary Technology and Related Products.............................................................28
Smoking Cessation Products..............................................................................29
Conventional Cigarette Business.........................................................................31
License Agreement.......................................................................................33
Patents and Proprietary Rights..........................................................................33
Government Regulation...................................................................................34
Litigation/Product Liability............................................................................36
Facilities..............................................................................................36
Employees...............................................................................................37
Summary Compensation of Management......................................................................37
Certain Transactions....................................................................................37
STAR MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS...........................................................38
Results of Operations for Year Ended December 31, 1997 Compared to
Year Ended December 31, 1996.......................................................................38
Financial Condition and Liquidity.......................................................................39
BUSINESS OF ETI..................................................................................................40
General.................................................................................................40
Products of ETI.........................................................................................40
Sales and Marketing.....................................................................................40
Competition.............................................................................................41
Transaction with Ophthalmic Innovations International, Inc..............................................41
FDA Regulation..........................................................................................42
Research and Development................................................................................42
Product Liability.......................................................................................43
Raw Materials...........................................................................................43
Patents, Trademarks, and Licenses.......................................................................43
Employees...............................................................................................43
Properties..............................................................................................43
Legal Proceedings.......................................................................................43
Certain Transactions....................................................................................44
Principal Executive Office..............................................................................44
</TABLE>
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<TABLE>
<S> <C>
ETI MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS...........................................................44
Results of Operations for Year Ended December 31, 1997 Compared to
Year Ended December 31, 1996.......................................................................44
Liquidity and Capital Resources.........................................................................45
SECURITIES REPORTING COMPLIANCE..................................................................................46
INDEPENDENT AUDITORS.............................................................................................46
STOCKHOLDER PROPOSALS............................................................................................46
SOLICITATION.....................................................................................................46
OTHER BUSINESS...................................................................................................46
ANNUAL REPORT....................................................................................................47
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE..................................................................47
</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 Monday, September 28, 1998, at 10:00 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 _________,
1998.
RECORD DATE AND SHARE OWNERSHIP
Stockholders of record at the close of business on August 17, 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 13,756 shares of Series B Convertible Preferred
Stock outstanding (the "Series B Preferred Stock") and ten 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 6,915,500 votes,
representing approximately 58.4%, 0.1% and 41.5%, 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 revote 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. 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 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 a majority of
the votes of Common Stock, Class A Preferred Stock and Series B Preferred Stock,
voting as a single class. In accordance with the Company's Bylaws, the approval
of Proposal 3 requires a majority of the votes of Common Stock, Class A
Preferred
<PAGE> 8
Stock and Series B Preferred Stock, voting 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 a majority of the outstanding votes of the Common Stock, voting as a
separate class, and a majority of the outstanding votes of the Common Stock,
Class A Preferred Stock and Series B Preferred Stock, voting together as a
single class.
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 the election of directors, 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.
PROPOSAL NO. 1
ELECTION OF DIRECTORS
At the Annual Meeting, three (3) directors will be elected by the
stockholders of the Company to serve until the next 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). David P. Sheets and Robert J. DeLorenzo, M.D., Ph.D.
currently serve as Class Three directors, Malcolm L. "Mac" Bailey currently
serves as the Class One director and there are no Class Two directors. In order
that each class include the same number of directors, the stockholders are being
requested at the Annual Meeting to elect a director for each class as follows:
Malcolm L. "Mac" Bailey, Class One; Robert J. DeLorenzo, Class Two; and David P.
Sheets, 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.
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 each of them first became a
director of the Company, as of the Record Date:
<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)
Robert J. DeLorenzo, M.D., Ph.D. 50 February 1998 2000
(Class Two)
David P. Sheets 52 May 1998 2001
(Class Three)
</TABLE>
David P. Sheets has served as President and Chief Executive of the
Company since May 1998. From July 1996 to November 1997, he was Vice President
and Chief Financial Officer of Tri-Valley Growers, a manufacturer of canned
fruits and vegetables, and from April 1995 to July 1996, he was Executive Vice
President and Chief Financial Officer
2
<PAGE> 9
of Liggett Group, Inc., a manufacturer of tobacco products. From 1984 to
December 1994, Mr. Sheets held various executive positions with R.J. Reynolds
and its subsidiaries, including its U.S. and international tobacco products
companies and its Planters-Lifesavers subsidiary, a snack food and confectionary
products company.
Robert J. DeLorenzo, M.D., Ph.D. has served as the
Neurologist-in-Chief, Medical College of Virginia Hospitals, Professor and
Chairman, Neurology, Medical College of Virginia ("MCV"), Professor,
Biochemistry and Molecular Biophysics, MCV, Professor, Pharmacology and
Toxicology, MCV, and Director, Molecular Neurobiology Laboratories, MCV, for
more than five years.
Malcolm L. "Mac" Bailey has been the owner and President of Golden Leaf
Tobacco Company, a tobacco leaf dealer, and owner and President of S&M Brands,
Incorporated, a manufacturer of cigarettes, for more than five years. Mr. Bailey
is also President of the Virginia Agricultural Growers Association, a trade
association which includes approximately 85% of the tobacco farms in Virginia.
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 the holders of Common Stock, Class A Preferred Stock and
Series B Preferred Stock, voting as a single class, present and entitled to vote
at the Annual Meeting. THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" EACH
NOMINEE.
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. Bailey are expected to be appointed to serve on the 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. Bailey are expected to be appointed to serve on 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.
3
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PROPOSAL NO. 2
PROPOSED AMENDMENT TO CERTIFICATE OF INCORPORATION
TO CHANGE CORPORATE NAME TO "STAR SCIENTIFIC CORP."
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 Corp." If the corporate name change is approved by the stockholders,
the Company intends to apply to have the Common Stock quoted under the symbol
"_____."
The Company desires to change the name of the Company from Eye
Technology, Inc. to Star Scientific Corp. in order to align the Company's name
with the business of Eye Technology, Inc.'s wholly-owned subsidiary, Star
Tobacco and Pharmaceuticals, Inc. and the Company's emphasis on its proprietary
technology to prevent the formation in tobacco of tobacco-specific nitrosamines.
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 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 Corp. THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE PROPOSAL TO
AMEND THE CERTIFICATE OF INCORPORATION TO CHANGE THE NAME OF THE COMPANY.
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 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.
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 and nonemployee directors 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").
4
<PAGE> 11
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 2,000,000. The Company has granted NSOs for 1,000,000 shares to the
Company's Chief Executive Officer. See "Management."
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. The Company reserves the right under the Plan
to pay an optionee the net cash value (the fair market value less the exercise
price) of the stock subject to an option at the time the Company receives a
notice of exercise of the option from the optionee.
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 granted to a 10%
Stockholder, the option exercise price for each share covered by such option may
not be less than 110% of the fair market value of a share of Common Stock on the
date of grant of such option. In the case of an NSO, the per share exercise
price shall be determined by the administrator. For so long as the Company's
Common Stock is traded on the Nasdaq National Market, the fair market value of a
share of Common Stock shall be the last sales price for such stock (or the
closing bid if no sales were reported) as quoted on such system on the date of
grant.
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 which, in the case of shares acquired upon exercise of an option,
have been beneficially owned for at least six months or which were not acquired
directly or indirectly from the Company, with a fair market value on the
exercise date 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 1998
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.
5
<PAGE> 12
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 1998 Plan and the price per share covered by each outstanding option.
Change of Control. In the event of a Change in Control (as defined in
the Plan), (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 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 (as determined pursuant to the 1998 Plan) 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 (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.
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, alter,
suspend or terminate the Plan, but such amendment, alteration, suspension or
termination shall not adversely affect any stock option then outstanding under
the Plan, without the written consent of the optionee. 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 1998 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.
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.
6
<PAGE> 13
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.
THE FOREGOING IS ONLY A SUMMARY OF THE EFFECT OF FEDERAL INCOME
TAXATION UPON THE OPTIONEE AND THE COMPANY WITH RESPECT TO THE GRANT AND
EXERCISE OF OPTIONS UNDER THE PLAN. IT DOES NOT PURPORT TO BE COMPLETE, AND IT
DOES NOT DISCUSS THE TAX CONSEQUENCES OF THE OPTIONEE'S DEATH OR THE INCOME TAX
LAWS OF ANY MUNICIPALITY, STATE OR FOREIGN COUNTRY IN WHICH THE OPTIONEE MAY
RESIDE.
PROPOSAL NO. 4
PROPOSED AMENDMENT TO CERTIFICATE OF INCORPORATION TO INCREASE THE NUMBER
OF AUTHORIZED SHARES 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 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
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 Convertible 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.
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 45,118,720 shares
will be reserved for the issuance of Common Stock upon conversion of the Series
B Preferred Stock, 2,000,000 shares will be reserved for issuance of Common
Stock upon exercise of options which may be granted under the Company's 1998
Stock Option 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 13,756 shares of Series B Preferred
Stock, representing all of the outstanding shares of Series B Preferred Stock,
into 45,118,720 shares of Common Stock (3,280 shares of Common Stock per share
of Series B Preferred Stock) upon the adoption of this amendment.
7
<PAGE> 14
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,
conserving the Company's cash flow, as well as 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, unless stockholder action is required by
applicable law, the Company's Certificate of Incorporation or Bylaws or the
rules of any stock exchange or market system on which the Company's securities
are then listed or traded. Frequently, opportunities arise that require prompt
action, and the Company 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 45,118,720 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 could have the effect
of delaying, deferring or preventing a change in control of the Company without
further action by the stockholders. Shares of authorized and unissued Common
Stock could (within the limits imposed by applicable law) be issued in one or
more transactions which would make a change in control of the Company more
difficult and affect voting rights of persons seeking to obtain 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 outstanding shares of Common Stock. These matters include (a)
amending the Company's Certificate of Incorporation to (i) change the corporate
name, (ii) change the period of its duration, (iii) change the nature of the
business or its corporate powers and purposes, (iv) increase, decrease or
reclassify its authorized capital stock, (v) create new classes of stock, or
(vi) cancel or otherwise affect the rights of stockholders of any class; (b)
approval of a merger or sale of assets of the Company; and (c) effecting a
dissolution of the Company. 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, former stockholders of Star will have the
ability to approve all matters submitted to holders of Common Stock, voting as a
separate class.
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.
A majority of the outstanding votes of Common Stock, voting as a
separate class, and a majority of the 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 WILL, 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.
8
<PAGE> 15
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.
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 "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 the formation of
certain carcinogens, known as tobacco-specific nitrosamines ("TSNA's"),
otherwise present in tobacco and tobacco smoke, (b) the development of products
utilizing tobacco which has been cured pursuant to the Company's proprietary
process described above, and (c) the manufacture and sale of cigarettes and
little cigars. The business of Star accounted for approximately 82% of the
Company's consolidated assets at March 31,1998 and approximately 94% of the
Company's consolidated revenues at March 31, 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."
BACKGROUND AND REASONS FOR THE REVERSE ACQUISITION
The purpose of the Reverse Acquisition for ETI 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 tobacco-specific nitrosamines, which are generally
considered by chemists to be the most abundant and powerful carcinogens in
tobacco and tobacco smoke. In addition, Star has developed several
pharmaceutical products containing tobacco with potential applications for
smoking cessation purposes, and it has filed investigational new drug
applications with the United States Food and Drug Administration with respect to
its pharmaceutical products. A further purpose for ETI to enter into the Reverse
Acquisition was that ETI had a severe cash flow deficit, its ability to continue
operating was in doubt and it had been unable to obtain either equity or debt
financing by which to alleviate such deficit. The management believed that an
affiliation with Star might help to stabilize an otherwise precarious financial
condition. See Consolidated Financial Statements of Eye Technology, Inc.
The purpose of the Reverse Acquisition for Star was to gain access to
the public securities markets and to facilitate equity financings.
During 1997, Star's controlling shareholders, 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
9
<PAGE> 16
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.
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 shareholders 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 shareholder 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
shareholders of Star and by ETI, and shares of Series B Preferred Stock were
issued to those shareholders in exchange for all of the outstanding capital
stock of Star.
10
<PAGE> 17
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 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. 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.
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.
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.
11
<PAGE> 18
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 -- Election of Directors."
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.
NO OPINION OF FINANCIAL ADVISER OR STOCKHOLDER VOTE
Because of the extreme financial position of the Company and the
assessment by the Board of Directors in the exercise of its reasonable business
judgment of the opportunities presented by Star to be affiliated with it, the
Board of Directors decided to avoid the expense and delay which would have
resulted from obtaining a fairness opinion from a financial adviser or
soliciting a vote of stockholders on the Reverse Acquisition. 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.
MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Common Stock of the Company is traded in the over-the-counter
("OTC") market and is quoted on the National Service "Pink Sheets". 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 July 15, 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
</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.
Prior to the Reverse Acquisition, Star was a private company.
12
<PAGE> 19
PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following unaudited pro forma condensed consolidated financial
statements reflect the Reverse Acquisition of ETI by Star on February 6, 1998.
For accounting purposes, the exchange 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 the Company, 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 the Company's and subsidiaries' assets
and liabilities. The following pro forma balance sheet and statements of
operations present the balance sheet as if the transaction occurred to
correspond with ETI's year end and the statement of operations as if the
transaction occurred at the beginning of the year presented.
The unaudited pro forma condensed consolidated financial statements
below should be read in conjunction with the following: the consolidated
financial statements of Eye Technology, Inc. and its subsidiaries for the two
years ended December 31, 1997, appearing on pages F-16 through F-25 of this
Proxy Statement, and to ETI Management's Discussion and Analysis of Financial
Condition and Results of Operations relating thereto appearing on page 44 of
this Proxy Statement; and to the financial statements of Star for the two years
ended December 31, 1997, appearing on pages F-2 through F-15 of this Proxy
Statement, and to Star Management's Discussion and Analysis of Financial
Condition and Results of Operations relating thereto appearing on page 38 of
this Proxy Statement.
13
<PAGE> 20
PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
December 31, 1997
(Unaudited)
<TABLE>
<CAPTION>
PRO FORMA PRO FORMA
ASSETS ETI STAR ADJUSTMENTS CONSOLIDATION
------ --- ---- ----------- -------------
Current assets:
<S> <C> <C> <C> <C>
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(2) 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 (1) 46,740
(383,557)(2)
Additional paid-in capital 8,777,505 1,004,607 454,394 (1) 1,341,286
(8,895,220)(2)
Accumulated deficit (10,027,084) (3,130,649) 10,027,084 (2) (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.
14
<PAGE> 21
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
For the Year Ended December 31, 1997
(Unaudited)
<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)
=========== ============ ============
Weighted average number of
shares 3,435,190 200 4,673,990
=========== ============ ============
</TABLE>
See notes to pro forma condensed consolidated financial statements.
15
<PAGE> 22
NOTES TO PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
A. Description of reverse acquisition:
On February 6, 1998, ETI entered into a stock exchange agreement with
Star. Under the agreement, Star exchanged all of its 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 ETI 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.
The value assigned the net assets of ETI and subsidiaries was based on
fair value. The excess of liabilities assumed over assets acquired
amounted to $748,445 and was assigned to goodwill.
B. Pro forma adjustments:
The following is a description and summary of the pro forma adjustments
for the consolidated balance sheet:
<TABLE>
<CAPTION>
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.
(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
To record amortization of goodwill based upon a 5-year life.
</TABLE>
16
<PAGE> 23
UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR
THREE-MONTH PERIOD ENDED MARCH 31, 1998
STAR TOBACCO AND PHARMACEUTICALS, INC.
(Accounting Acquirer of the Company and Subsidiaries)
CONDENSED CONSOLIDATED BALANCE SHEET
For Three-Month Period Ended March 31, 1998
(Unaudited)
<TABLE>
<CAPTION>
Assets
------
Current assets:
<S> <C>
Cash $ 118,811
Accounts receivable 621,007
Inventories 1,743,122
Advances to related parties 167,355
Other current assets 82, 398
-----------
Total current assets 2,732,693
-----------
Property and equipment, net 2,177,992
-----------
Other assets:
Intangibles, net of amortization 1,531,526
Other assets 118,729
-----------
Total other assets 1,650,255
-----------
$ 6,560,940
===========
Liabilities and Stockholders' Deficit
-------------------------------------
Current liabilities:
Notes payable - current $ 1,478,711
Accounts payable 3,169,269
Accrued expenses 896,085
-----------
Total current liabilities 5,544,065
Notes payable, less current maturities 994,035
-----------
Total liabilities 6,538,100
-----------
Commitments and contingencies
Redeemable preferred stock 25,000
-----------
Stockholders' deficit:
Preferred stock 138
Common stock 79,698
Additional paid-in capital 3,029,007
Accumulated deficit (3,111,003)
-----------
Total stockholders' deficit (2,160)
-----------
$ 6,560,940
===========
</TABLE>
See notes to condensed consolidated financial statements.
17
<PAGE> 24
STAR TOBACCO AND PHARMACEUTICALS, INC.
(Accounting Acquirer of the Company and Subsidiaries)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For Three-Month Periods Ended March 31, 1998 and 1997
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTH PERIOD ENDED
MARCH 31
------------------------
1998 1997
---- ----
<S> <C> <C>
Net sales $ 3,069,636 $ 6,201,279
Cost of goods sold 1,505,003 3,111,150
Excise taxes on products 1,236,807 2,186,216
----------- -----------
Gross profit 327,826 903,913
----------- -----------
Operating expenses:
Marketing and distribution expenses 310,120 312,158
General and administrative expenses 395,808 435,642
Research and development 247,310 270,762
----------- -----------
Total operating expenses 953,238 1,018,562
----------- -----------
Operating loss (625,412) (114,649)
Other income (expenses):
Other (13,569) 12,851
Interest expense (76,985) (55,320)
----------- -----------
Loss before extraordinary item (715,966) (157,118)
Extraordinary gain from extinguishment of debt
(no applicable income taxes) 735,612 --
----------- -----------
Net income (loss) $ 19,646 $ (157,118)
=========== ===========
Basic and diluted earnings (loss) per common share:
Loss before extraordinary item $ (.19) $ (786)
Extraordinary item $ .20 $ --
Net income (loss) $ .01 $ (786)
Weighted average number of shares 3,662,262 200
=========== ===========
</TABLE>
See notes to condensed consolidated financial statements.
18
<PAGE> 25
STAR TOBACCO AND PHARMACEUTICALS, INC.
(Accounting Acquirer of the Company and Subsidiaries)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For Three-Month Periods Ended March 31, 1998 and 1997
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTH PERIOD ENDED
MARCH 31
------------------------
1998 1997
---- ----
<S> <C> <C>
Operating activities:
Net income (loss) $ 19,646 $ (157,118)
Adjustments to reconcile net income (loss) to
net cash provided (used) by operating activities:
Depreciation and other non-cash charges 150,358 105,865
Extraordinary gain from extinguishment of debt (735,612) --
(Increase) decrease in current assets (29,098) 585,722
(Decrease) increase in current liabilities 251,297 180,737
----------- -----------
Net cash provided (used) by operating activities (343,409) 715,206
----------- -----------
Investing activities:
Advances to related parties (167,355) --
Purchases of property and equipment (98,500) (432)
Purchases of intangible assets (460) --
Proceeds from sale of property and equipment 175,000 --
----------- -----------
Net cash used by investing activities (91,315) (432)
----------- -----------
Financing activities:
Proceeds from notes payable 48,500 --
Proceeds from capital contribution 1,488,679 --
Payments on notes payable (994,573) (676,074)
Stockholder distributions -- (38,700)
----------- -----------
Net cash provided (used) by financing activities 542,606 (714,774)
----------- -----------
Increase in cash 107,882 --
Cash, beginning of period 10,929 10,584
----------- -----------
Cash, end of period $ 118,811 $ 10,584
=========== ===========
Cash paid for:
Interest $ 81,231 $ 58,952
</TABLE>
See notes to condensed consolidated financial statements.
19
<PAGE> 26
STAR TOBACCO AND PHARMACEUTICALS, INC.
(Accounting Acquirer of the Company and Subsidiaries)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
For Three-Month Periods Ended March 31, 1998 and 1997
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTH PERIOD ENDED
MARCH 31
------------------------
1998 1997
---- ----
<S> <C> <C>
Non-cash investing and financing activities:
Repayment of related party note payable with
related party note receivable $ -- $ 759,489
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 $ 105,000 $ --
Acquisition:
Fair value of assets acquired $1,237,134 $ --
Liabilities assumed 2,468,366 --
---------- ----------
Excess assigned to goodwill $1,231,232 $ --
========== ==========
</TABLE>
See notes to condensed consolidated financial statements.
20
<PAGE> 27
STAR TOBACCO AND PHARMACEUTICALS, INC.
(Accounting Acquirer of the Company 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 three month period ended March 31, 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 shareholders of Star. Under the agreement,
Star's shareholders 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 $1,231,232 and was assigned to goodwill which is
being amortized over five years on a straight-line basis.
The results of operations of the Company and its 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>
Three Month Period Ended
March 31
------------------------
1998 1997
---- ----
<S> <C> <C>
Net sales $ 3,128,529 $ 6,571,365
Operating loss $ (641,710) $ (193,996)
Net income (loss) $ (2,169) $ 24,879
Earnings per share:
Basic and diluted $ -- $ .005
</TABLE>
21
<PAGE> 28
STAR TOBACCO AND PHARMACEUTICALS, INC.
(Accounting Acquirer of the Company and Subsidiaries)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(Unaudited)
C. Income taxes:
Effective February 6, 1998, Star 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 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 $735,612 as the result of its extinguishment of certain notes and
trade accounts payable. Certain of the debt was extinguished through the
exchange of shares of common stock amounting to approximately 1,238,800
shares resulting in a gain of $442,006. The remaining gain of $293,606
resulted from negotiated settlements with creditors. 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 and in 1997 because all
potential common shares were antidilutive.
F. Related party transactions:
During the first quarter of 1998, $167,355 was advanced to related parties.
These advances are scheduled to be repaid during 1998.
G. Common Stock:
The holders of Common Stock are entitled to receive dividends when, as and
if declared by the Board of Directors from legally available funds, subject
to preferential dividend payments to holders of Class A Preferred Stock and
Series B Preferred Stock. Holders of Common Stock do not have any
preemptive, subscription, redemption or conversion rights.
22
<PAGE> 29
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.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 1998 COMPARED TO
THREE MONTHS ENDED MARCH 31, 1997
The results of operations for the first quarter of 1998 include the results
of operations of Star for the entire quarter, consolidated with those of ETI and
its subsidiaries for the months of February and March 1998, while results of
operations for the first quarter of 1997 include only those of Star.
Net sales declined by slightly more than 50% from the first quarter of 1997
to the first quarter of 1998, which includes $128,000 from the sale of
intraocular lenses by ETI. Sales of cigarettes and small cigars by the Company's
tobacco products division, Star, declined by more than 52%. This decline is
attributable to: (i) the loss of contract manufacturing business, primarily
sales to Swisher International, Inc. for the manufacture of small cigars, which
declined from $1,550,000 in the first quarter of 1997 to $17,000 in the first
quarter of 1998; and (ii) declining sales of Star brand cigarettes due to the
reallocation of financial resources throughout 1997 and 1998 to date from
marketing, selling and promotional expenses to research and development expenses
devoted to tobacco processing and the development of new products containing
tobacco which is free of tobacco-specific nitrosamines. Net sales in the 1998
first quarter include $247,000 from the sale of a tobacco-flavored, non-nicotine
chewing gum, first introduced to the market in the 1998 first quarter.
Excise taxes, as a percentage of sales, increased from 35% in the 1997
first quarter to 40% in the 1998 first quarter. This change can be attributed to
the fact that tobacco excise taxes are not payable by the Company on its sales
of little cigars to Swisher International.
Costs of goods sold ("COGS") remained relatively stable, as a percentage of
sales, from 1997 first quarter to 1998 first quarter. Tobacco and gum COGS of
approximately 48% in the first quarter of 1998 were only slightly adversely
affected by COGS of 80% in the Company's ETI division.
Gross profit margin was 11% in the first quarter of 1998 compared to 15% in
the first quarter of 1997. The decline is due primarily to the impact of the
increase in excise taxes calculated as a percentage of sales.
Marketing and distribution expenses, as a percentage of sales, doubled from
1997's first quarter to the same quarter of 1998. The percentage increase is
attributable to the effect of overhead costs, which become a larger percentage
of sales as sales decline, and to expenses incurred in the introduction of the
Company's gum product in the first quarter of 1998.
General and administrative costs declined by approximately 10% from first
quarter 1997 to first quarter 1998, but increased as a percentage of sales from
7% to 13%. The percentage increase is due to the following factors: (i) overhead
costs increase as a percentage against a declining sales volume; (ii) a portion
of general and administrative costs is related to research and development
activities of the Company, from which no revenues have been derived, and which
did not decline in the two periods being compared; (iii) an increase in
accounting costs were incurred as a result of the "Reverse Acquisition" and as a
result of the Company's efforts to file delinquent periodic reports required by
the Securities and Exchange Commission (which reports were successfully filed as
of May 1, 1998); and (iv) 38% of this category of expenses was attributable to
ETI, the results of which for February and March are included in the 1998
operating results but not in the 1997 operating results.
23
<PAGE> 30
Research and development expenses were substantially the same in the two
quarters being compared, and all such expenses are attributable to Star's
research and development activities described in the second paragraph of this
section.
LIQUIDITY AND CAPITAL RESOURCES
The Company's balance sheet at March 31, 1998, reflects an illiquid
position with a current asset-to-liability ratio of 1 - 2.02. Operations at Star
have been financed over the past several years primarily through increases in
accounts payable, accrued expenses and borrowed funds from institutional
lenders.
Star 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.
This credit facility was to expire on March 31, 1998, but was extended to June
30, 1998. The Company was in default of certain non-voting covenants, a
situation which has existed for over two years. In early 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.
The significant increase in inventories at March 31, 1998, compared to
December 31, 1997, reflects primarily the inclusion of inventories of over
$800,000 maintained by ETI. The Company has begun preliminary discussions with
third parties regarding a sale of assets related to the intraocular lens
business of ETI. In the event of such a sale, the Company does not expect that
there would be any significant financial gain or loss to the Company.
The significant increase in "intangibles" reflects primarily the recording
of $1,231,000 of goodwill incurred in the "reverse acquisition" transaction
described above. This item is being amortized over a five-year period at the
rate of $246,000 per year, or $62,000 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. 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, including funds to conduct the pilot program for the
processing of tobacco described in "Business of Star." The Company will
continue, however, to seek to obtain additional capital financing to assure that
its research and development activities and activities to commercialize its
proprietary tobacco-processing technology are not constrained by a lack of
working capital or by the cash needs of its operating businesses. There can be
no assurances that the Company will be able to obtain additional capital
financing or that it can obtain such financing on favorable terms.
24
<PAGE> 31
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>
David P. Sheets 52 President and Chief Executive Officer, Director
Jonnie R. Williams 43 Director of Product Development of Star, Director
of Marketing of Star
</TABLE>
For information regarding Mr. Sheets, see "Proposal No. 1 -- Election of
Directors."
Jonnie R. Williams has been Director of Product Development and Director of
Marketing of 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. While not holding a
position as director or other officer position of the Company or Star, Mr.
Williams exercises significant control over, and spends substantial amounts of
business time to, the affairs of the Company and Star, and is considered a key
executive and a controlling person of the Company. Since the late 1980s, 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. In January 1994, Mr. Williams entered into a consent decree with the
Securities and Exchange Commission. Without admitting or denying any
allegations, he paid an amount representing profits from trading in the
securities of Spectra Pharmaceutical Services, Inc. and agreed to be enjoined
from future violations of Sections 10(b) and 13(d) and Rules 10b-5 and 13d-2 of
the Securities Exchange Act of 1934, as amended. In December 1993, Mr. Williams
entered into a similar decree and paid an amount relating to the same matter to
the Securities Division of the Commonwealth of Massachusetts.
Officers of the Company serve at the discretion of the Board. There are no
family relationships among the Company's directors and executive officers.
SUMMARY COMPENSATION TABLE
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 annual compensation exceeded
$100,000 in any of such fiscal years.
<TABLE>
<CAPTION>
Annual Annual Compensation All Other
Name Compensation Paid Accrued But Not Paid Compensation
---- ----------------- -------------------- ------------
<S> <C> <C> <C> <C> <C> <C>
Robert J. Fitzsimmons 1995 - $179,156 1995 - $ --- 1995 - (2)
Chairman of the Board, 1996 - 103,179 1996 - 58,831(1) 1996 - $ 15,706
President and Chief 1997 - 15,456 1997 - 147,619(1) 1997 - 15,706
Executive Officer
</TABLE>
- ----------
(1) See "Certain Relationships and Related Transactions" below
regarding the issue to Mr. Fitzsimmons of shares of Common Stock
of the Company in partial consideration of the cancellation of
indebtedness of the Company to Mr. Fitzsimmons, including
indebtedness for accrued compensation set forth in the above
table.
(2) Less than 10% of compensation paid for the year.
25
<PAGE> 32
OPTIONS
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. The option was exercisable
with respect to 50,000 shares at year-end. The option was to expire on February
28, 1999. These options were canceled as of February 6, 1998. See "Certain
Relationships and Related Transactions." 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. 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.
In May 1998, the Company entered into a two-year employment agreement with
David P. Sheets to serve as President and Chief Executive Officer of the
Company. The agreement provides for a base salary of $250,000 per year with a
targeted bonus of up to 50% of the base salary based upon certain performance
criteria. Mr. Sheets received 200,000 shares of Common Stock and an option to
acquire an additional one million shares at a price of $2.00 per share with such
options vesting over the two-year period of the agreement. In addition, Mr.
Sheets is entitled to various benefits, including health insurance, use of an
automobile, reimbursement of relocation expenses, and death and disability
benefits. In the event of a change of control and if Mr. Sheets' employment is
terminated either by the Company or by Mr. Sheets, Mr. Sheets is entitled to
receive an amount equal to two times his base salary.
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--Summary Compensation Table."
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.
26
<PAGE> 33
<TABLE>
<CAPTION>
PERCENTAGE OF AMOUNT AND
VOTING POWER OF PERCENTAGE OF AMOUNT AND
NAME AND ADDRESS OF AMOUNT OF COMMON STOCK CLASS A PERCENTAGE OF
INDIVIDUAL OR IDENTITY COMMON VOTING AS A PREFERRED SERIES B
OF GROUP STOCK SEPARATE CLASS STOCK PREFERRED STOCK
-------- ----- -------------- ----- ---------------
<S> <C> <C> <C> <C>
Jonnie R. Williams 38,749,190(1)(2) --% -0- 11,814(1)(2)
16 S. Market Street --% 85.9%
Petersburg, VA 23803
Francis E. O'Donnell, 38,749,190(1)(3) --% -0- 11,814(1)(3)
Jr., M.D. --% 85.9%
709 The Hamptons Lane
Chesterfield, MO 63017
David P. Sheets 200,000 2.1% -0- -0-
16 S. Market Street --%
Petersburg, VA 23803
Robert J. DeLorenzo, 500,000(4) 3.1% -0- 60.9756
M.D., Ph.D., M.P.H. --% .4%
Medical College of
Virginia
MCV Box 980599
Richmond, VA 23298
Malcolm L. "Mac" Bailey -0- --% -0- -0-
Route 3, Box 90 --% --%
Keysville, VA 23947
Edward L. Tucker 200,000 2.1% 250 -0-
55 Union Ave. 100% --%
Sudbury, MA 01776
Robert J. Fitzsimmons 1,152,281 11.9% -0- -0-
1997 Sloan Place --% --%
St. Paul, MN 55117
Prometheus Pacific Growth 5,502,640(5) 25.9% -0- 763
Fund, LDC --% 5.5%
P.O. Box 1062
George Town, Grand Cayman,
B.W.I.
All Directors and Officers and 39,449,190 5.2% -0- 11,915
Significant Personnel --% 86.3%
(4 Persons)
<CAPTION>
PERCENTAGE OF
VOTING POWER OF
PERCENTAGE OF SECURITIES
VOTING POWER OWNED IF ALL
OF ALL SECURITIES SHARES OF SERIES
NAME AND ADDRESS OF OWNED AS OF THE B PREFERRED
INDIVIDUAL OR IDENTITY RECORD STOCK ARE
OF GROUP DATE CONVERTED
-------- ---- ---------
<S> <C> <C>
Jonnie R. Williams 35.7% 70.7%
16 S. Market Street
Petersburg, VA 23803
Francis E. O'Donnell, 35.7% 70.7%
Jr., M.D.
709 The Hamptons Lane
Chesterfield, MO 63017
David P. Sheets 1.2% .4%
16 S. Market Street
Petersburg, VA 23803
Robert J. DeLorenzo, 2.0% .9%
M.D., Ph.D., M.P.H.
Medical College of
Virginia
MCV Box 980599
Richmond, VA 23298
Malcolm L. "Mac" Bailey --% --%
Route 3, Box 90
Keysville, VA 23947
Edward L. Tucker 1.3% .4%
55 Union Ave.
Sudbury, MA 01776
Robert J. Fitzsimmons 7.0% 2.1%
1997 Sloan Place
St. Paul, MN 55117
Prometheus Pacific Growth 17.4% 9.1%
Fund, LDC
P.O. Box 1062
George Town, Grand Cayman,
B.W.I.
All Directors and Officers and 38.9% 72.0%
Significant Personnel
(4 Persons)
</TABLE>
- ----------
(1) Includes no shares of Common Stock and 10.430 shares of Series B
Preferred Stock, convertible into 34,210 shares of Common Stock, 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, 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, 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, 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 outstanding shares of Common Stock and 60.9756
outstanding shares of Series B Preferred Stock convertible into 200,000
shares of Common Stock.
(5) Includes 2,500,000 outstanding shares of Common Stock and 763 outstanding
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 an outstanding stock purchase warrant.
27
<PAGE> 34
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 1994, Star developed and began marketing its own branded cigarettes
under the trade names "GUMSMOKE(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 1995, 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 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 market, (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.
Currently, Star manufactures and sells throughout the United States four
brands of cigarettes -- GUMSMOKE(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 AND RELATED PRODUCTS
Process. The process of curing, or drying, tobacco so that it is suitable
for production into tobacco products begins immediately upon harvestation of the
tobacco leaf. The tobacco leaves are brought to enclosed barns or sheds to be
hung or placed on racks. The two principle 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 both Virginia
flue-cured tobacco and burley tobacco, and most likely to other varieties widely
used throughout the world. Star's process involves taking tobacco leaf which has
been harvested and shortly thereafter subjecting it to specialized drying
machinery. This process takes only minutes to produce cured tobacco leaf. Star's
curing process essentially kills the microbial activity and cell degradation
that is initiated by harvestation. In doing so, the nitrates in tobacco are
substantially eliminated and the natural nitrosation process that results in the
formation of TSNAs is precluded. Star's curing technology does not, however,
alter the nicotine content of tobacco nor does it significantly affect the taste
characteristics of the cured tobacco.
Star's proprietary curing technology was conceived by Jonnie R. Williams
(see "Management" and "Principal Stockholders" below) 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.
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.
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<PAGE> 35
Current Status. Star is organizing a pilot program for the 1998 United
States tobacco harvest season (July through October). The purposes of this
program are: (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 will be operated from a leased facility in Chase City, Virginia, which
is located in the tobacco growing regions of Virginia and North Carolina. Star
expects to process up to two million pounds of tobacco leaf during the 1998
season (approximately 1.4 billion pounds of tobacco are grown annually in the
United States).
Star is currently negotiating with one of the three major tobacco leaf
dealers in the United States for a joint venture or other relationship by which
the dealer would assume management of the pilot program and a portion of the
costs of the program. If Star does not satisfactorily conclude such
negotiations, it intends itself to manage and pay for the pilot program.
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. Several of the
manufacturers have verbally committed to buying in 1998 tobacco processed in
Star's pilot program. Those manufacturers include cigarette as well as smokeless
tobacco product manufacturers.
SMOKING CESSATION PRODUCTS
Star has developed several products which it believes have potential to
be successfully used for smoking cessation and smoking reduction purposes. Those
products and the development status of each are as follows:
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 has not yet scheduled human clinical trials.
Star is also considering the merits of producing a tobacco chewing gum,
containing TSNA-free tobacco, as a tobacco product to be marketed without
therapeutic claims, thereby avoiding the necessity of obtaining FDA approval for
the product as a drug. Star does not have at this time, however, any definitive
plans to begin the production and sale of such a product.
CigRx(TM). Star has developed CigRx, a cigarette which contains TSNA-free
tobacco and is manufactured in the same manner as conventional cigarettes.
Because the Company's curing technology does not significantly alter the taste
characteristics of tobacco, there is little taste difference between the CigRx
brand of cigarettes and popular cigarette brands. Star has voluntarily chosen 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 covering its CigRx
cigarettes for smoking cessation therapies in 1997, and has scheduled clinical
trials to begin in the Summer of 1998.
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 for smoking cessation
therapies and for cessation of smokeless tobacco product use.
Product Attributes. Star believes that its prescription gum and lozenge
products have a number of advantages over other smoking cessation products now
on the market for the following reasons:
29
<PAGE> 36
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 prescription gum product begins to
deliver detectable amounts of nicotine almost immediately (within two
minutes), in contrast to Nicorette(R) or the nicotine patch products
which typically provide nicotine in slower intervals. This is an
important consideration to the nicotine-addicted individual who has been
accustomed to almost instant nicotine gratification from his tobacco
product. Star's lozenge also delivers nicotine almost immediately but in
a more measured manner than the gum (over a 12-minute period).
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 that the pricing of smoking cessation products in
an important factor in patient acceptance of and compliance with a
smoking cessation regimen.
Product Image. Star's gum and lozenge products contain only
natural ingredients. Star believes it will be psychologically easier for
consumers to accept, in replacement for a cigarette or other tobacco
product, a product that is nearly identical to food products of long
standing in the market and which do not contain synthetic chemicals.
Marketing and Distribution. If FDA approvals are obtained, Star intends
to target consumers of tobacco products who seek either to cease cigarette
smoking and/or the consumption of smokeless tobacco products or to reduce their
level of such smoking or consumption. Star will seek to enter into a
collaborative relationship with a pharmaceutical company or a pharmaceutical
distribution company with substantial marketing and distribution capabilities
with respect to the gum and lozenge products. The structure and terms of such a
relationship may include any of the following forms: (i) Star manufactures the
products and sells them on an exclusive basis to a distributor who would have
complete marketing and sales responsibility; (ii) Star manufactures the products
and conducts direct marketing and sales functions, but contracts with a third
party for distribution; or (iii) Star grants exclusive manufacturing, marketing
and distribution rights to a third party in exchange for royalty income. In any
case, Star expects to retain for itself the right to supply the TSNA-free
tobacco for its products. There can, however, be no assurance that Star will be
able to enter into a collaborative relationship with a third-party on terms
satisfactory to Star.
Star's CigRx product, if approved by the FDA, would be initially marketed
through physicians for use in a relapse therapy in conjunction with a smoking
cessation therapy. Star intends to seek to establish a collaborative
relationship with a company with demonstrated capabilities to market and
distribute pharmaceutical products. Star expects that, at least initially, the
CigRx cigarette products would be sold by prescription only.
Star has no current plans regarding marketing and distribution of its
products in foreign countries. If it decides to expand distribution to other
countries, Star will be required to meet all applicable regulatory requirements
and standards of such countries, of which there can be no assurance. In the
event that it decides to market and distribute its products internationally,
Star expects that it would enter into collaborative relationships with
third-party pharmaceutical companies to perform all marketing and distribution
functions. There can be no assurance that Star would be able to enter into a
satisfactory relationship with any such third-party on terms satisfactory to
Star.
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 the prescription 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 is therefore
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 the prescription-only market if the FDA
grants marketing approval to Star.
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<PAGE> 37
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.
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
GUMSMOKE(R), VEGAS(R), SPORT(R) and MAIN STREET(R) cigarettes, 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
31
<PAGE> 38
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 is from the four "majors," i.e.,
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 are 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.
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.
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<PAGE> 39
Confectionary Gum Product. In the first quarter of 1998, Star introduced
a confectionary chewing gum branded "GUMSMOKE,(TM)" which contains no tobacco
but which does contain a FDA-approved tobacco flavoring. Sales of this product,
which were mostly to Star's regular distributors of its cigarette products, were
not material and are not expected to be material in the coming months. Star has
not applied substantial marketing and promotional efforts or expenditures to
this product and does not expect to do so in the foreseeable future. GUMSMOKE
was produced at Canel's. See "Manufacturing" under "Smoking Cessation Products."
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. are partners (see "Management" and
"Principal Stockholders"). 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 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.
Star is obligated to pay to the licensor a royalty of two percent (2%) on
all net sales of products by it and any affiliated sublicensees and six percent
(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.
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.
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 obtain patent
protection for the technology, to defend patents once obtained, 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. There are two patent applications
pending in the United States for method patents covering the tobacco curing
technology, and, in one case, for products containing TSNA-free tobacco.
Corresponding patent filings have been initiated in numerous foreign countries.
There can be no assurance that Star or its licensor has or will develop or
obtain the rights to products or processes that are patentable, that patents
will issue from any of the pending applications or that claims allowed will be
sufficient to protect the intellectual property owned or licensed by Star. 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.
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.
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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 pending in the United States Congress several bills which, if
enacted, would provide significant changes to the United State tobacco industry.
Some of these bills contain provisions which would provide substantial federal
government funds for smoking cessation programs and products. Star is unable to
predict what affect, if any, these provisions, if enacted, would have on sale of
smoking cessation products such as Star's products (if approved by the FDA),
although it is likely that any such affect would be beneficial.
Some of these bills also contain provisions authorizing the FDA to adopt
regulations which promote the sale of "less harmful" tobacco products, including
regulations which would require manufacturers to adopt technologies and methods
that result in "less harmful" products. Star believes that TSNA-free tobacco
would or should qualify as a means by which "less harmful" products may be
produced. There can be no assurances, however, that any of the bills now before
Congress, or that may be proposed in the future, will be enacted or, if enacted,
would contain provisions that would result in a demand for TSNA-free tobacco.
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 have 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. Both the federal government and the
manufacturers have appealed the District Court's ruling and the matter is now
pending before the United States Court of Appeals. 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 recognition to generate sales. Consequently, implementation of the
existing FDA regulations may have an adverse affect upon Star's sales of
conventional cigarettes.
U.S. Food and Drug Administration. Star has submitted its GumSmoke gum
and its CigRx cigarette to the FDA for approval to market these products as
therapeutic drug products for smoking cessation purposes. As a result, the
marketing, manufacture, and distribution of Star's 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
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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.
In July 1997, Star filed an IND application for its GumSmoke tobacco
chewing gum for (1) smoking cessation, (2) as a therapy to be used for the
cessation of selected smoking cessation aids, including Nicorette(R) gum,
Nicotrol(R) nasal spray, nicotine patches and Nicotrol(R) inhaler and (3) for
smokeless tobacco product cessation. In August 1997, Star filed an IND
application for Star's cigarette for smoking cessation program relapse
intervention. Star's IND applications have been accepted by the FDA and Star
will commence human clinical trials in the summer of 1998, at the Medical
College of Virginia. Star expects that the FDA's review of its gum product will
not be completed for at least eighteen months, and that the FDA's review of its
cigarette product well take longer.
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, would have a
material adverse effect upon Star's business, financial condition and results of
operations.
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.
Currently, cigarettes are taxed at the rate of $.24 per pack of twenty
cigarettes. Star intends to apply to the BATF for a ruling that its TSNA-free
cigarettes should be exempt from federal taxes since, if the cigarettes are
approved by the FDA for sale to the public under a physician's prescription, the
cigarettes would be classified as therapeutic drugs. Star believes that Congress
did not intend for therapeutic drug products to be taxed as cigarettes and that
such taxation would be inconsistent with public policy. There can be no
assurance that Star's application for such an exemption would be approved.
The BATF also taxes "smokeless tobacco" which is defined as "any snuff or
chewing tobacco." Star has received a preliminary ruling from the BATF that
Star's GumSmoke chewing gum would be classified as "chewing tobacco,"
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which is currently taxed at the rate of $.12 per pound. Star has not received a
ruling from the BATF as to how its tobacco lozenge, which, unlike its tobacco
chewing gum, contains liquid tobacco extract and not finely ground tobacco leaf,
would be classified under its regulations. If Star's lozenge were to be taxed as
"snuff," then it would be currently taxed at the rate of $.36 per pound. Star
intends to apply to the BATF for a ruling that neither its GumSmoke chewing gum
or tobacco lozenge should be taxed as "smokeless tobacco." There can be no
assurance that Star would receive a favorable ruling with respect to either
product.
The Federal Cigarette Labeling and Advertising Act. The Federal Cigarette
labeling and Adverting Act (the "Advertising Act"), prohibits the advertising of
tobacco products on television and radio and provides for the imposition of
certain health-warning labels on tobacco product packaging and advertising
materials. The Advertising Act is administered by the Federal Trade Commission
("FTC"). Star has received a preliminary ruling from the FTC that, as
FDA-approved pharmaceutical products, Star's GumSmoke chewing gum and tobacco
lozenge products would not be subject to the Advertising Act. Star has not
sought a similar ruling with respect to its CigRx cigarettes.
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 welcomes
such laws and regulations and intends to fully comply with them.
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 know 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; 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 have not been substantial in
relation to the volume generated by the larger manufacturers.
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 short-term 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.
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Star has leased seven acres of land and a 10,000 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. 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.
EMPLOYEES
Star currently 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.
SUMMARY COMPENSATION OF MANAGEMENT
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>
Annual Annual Compensation All Other
Name Compensation Paid Accrued But Not Paid Compensation
---- ----------------- -------------------- ------------
<S> <C> <C> <C> <C> <C> <C>
Samuel P. Sears, Jr.
Chairman of the Board and 1996 - $ 186,265 1996 - $ --- 1996 - $ (1)
Chief Executive Officer 1997 - 249,231 1997 - --- 1997 - (1)
John M. Gallahan
President and Chief 1996 - $ 120,384 1996 - $ --- 1996 - $ (1)
Operating Officer 1997 - 178,192 1997 - --- 1997 - (1)
</TABLE>
- ------------------------
(1) Less than 10% of compensation paid for the year.
CERTAIN TRANSACTIONS
Until February 6, 1998, the date of the Reverse Acquisition, Star was a
private company, the capital stock of which was owned and controlled by Francis
E. O'Donnell, Jr., M.D., and Jonnie R. Williams and their families. See
"Management" and "Principal Shareholders." 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 discontinued following the
Reverse Acquisition.
Jonnie R. Williams, and entities owned or controlled by him or his
family, has 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.
Mr. Williams, or entities controlled by or affiliated with him, was 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.
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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.
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 "Interests of Certain Persons in the Reverse
Acquisition" under Proposal No. 4 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.
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.
Cost of goods sold, as a percentage of net sales volume, were 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
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volume declines. In addition, 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 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-favored, non-nicotine chewing gum. 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 consultants and third-party service providers. Expenditures in this
category include payments for consultants, contract research organizations,
laboratory testing, research grants, raw materials, equipment, legal fees,
including patent expense, 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 "Principal Stockholders" 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, i.e., 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.
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, 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 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. It is also Star and ETI's intent, in
order to facilitate such financings, to qualify for stock exchange listing or
for listing on the National Market or Small-Cap Company segment of the National
Association of Securities Dealers Automated Quotation system.
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There can be no assurances that ETI and Star will be successful in
obtaining either additional capital financing or stock market listing, as
described above.
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 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.
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
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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's IOL sales
volume on a revenue basis and 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.
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.
41
<PAGE> 48
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.
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").
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 510K 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.
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.
42
<PAGE> 49
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 more
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"). 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 6 full-time employees in the United States.
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.
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.
43
<PAGE> 50
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 "The Reverse Acquisition--Interests of Certain Persons in the
Reverse Acquisition" and "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.
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
44
<PAGE> 51
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.
Gross profit, as a percentage of net sales, decreased significantly to
44% in 1997 from 65% in 1996. The decrease is attributable primarily to four
factors: a higher percentage of IOL sales were export sales for which the gross
profit margin is substantially less than for domestic sales; manufacturing
overhead, which is relatively fixed in cost, becomes a greater percentage of
sales as sales volume declines; both domestic and international prices continued
to decline; and high return of MKM/LASIK equipment adversely affected margins.
Selling and marketing expenses decreased $415,552 to 15% of net sales
from 27% in 1995, due primarily to the increase in the percentage of
international sales, which are associated with lower commission rates than are
domestic sales, and to reduced marketing and promotional expenses due to a lack
of working capital.
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 and management compensation,
at the same rate as sales declined. In addition, ETI incurred unanticipated
legal fees as a result of litigation by certain creditors for collections.
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 $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.
As a consequence of the factors described above, ETI incurred an
operating loss of $625,000 in 1998's first quarter compared to $115,000 in
1997's first quarter. The 1998 results include an operating loss of $35,000 at
the parent company.
ETI showed net income for the first quarter of almost $20,000, despite
its operating loss of $625,000, due to an extraordinary gain of $736,000, as a
result of the compromise and settlement of certain indebtedness effected on
February 6, 1998, for which ETI issued a total of approximately 1,238,800 shares
of its Common Stock.
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.
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.
45
<PAGE> 52
As a condition to the Reverse Acquisition, and contemporaneously with it,
ETI was able to settle a number of pending claims against it (see "Business of
ETI -- Legal Proceedings"), including obligations of ETI to current and former
employees, including the Chief Executive Officer.
SECURITIES 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 is expected to be 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.
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 Secretary, Eye Technology, Inc., 16 South
Market Street, Petersburg, Virginia 23803, no later than _______________, 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 Secretary, Eye Technology, Inc., 16 South Market Street,
Petersburg, Virginia 23803.
46
<PAGE> 53
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
All documents filed by the Company pursuant to Sections 13(a), 13(c), 14
or 15(d) of the Securities Exchange Act of 1934, as amended, subsequent to the
date hereof and prior to the time at which the Annual Meeting has been finally
adjourned shall be deemed to be incorporated herein by referenced and to be a
part hereof from the date of such filing. Any statement contained herein or in a
document incorporated by reference in this Proxy Statement shall be deemed to be
modified or superseded to the extent that a statement contained in any document
subsequently filed with the Securities and Exchange Commission modifies or
supersedes such statement.
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
David P. Sheets
President and Chief Executive Officer
Petersburg, Virginia
__________, 1998
47
<PAGE> 54
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 Two Years Ended December 31, 1997 and 1996
Consolidated Statements of Stockholders' Deficit F-19
for the Two Years Ended December 31, 1997 and 1996
Consolidated Statements of Cash Flows F-20
for the Two Years Ended December 31, 1997 and 1996
Notes to Consolidated Financial Statements F-21
</TABLE>
F-1
<PAGE> 55
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.
March 24, 1998
F-2
<PAGE> 56
STAR TOBACCO AND PHARMACEUTICALS, INC.
BALANCE SHEET
December 31, 1997
================================================================================
<TABLE>
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
$178,254 157,557
Notes receivable, long-term 64,969
----------
Total other assets 222,526
----------
$4,119,636
==========
</TABLE>
See accompanying notes to financial statements.
F-3
<PAGE> 57
STAR TOBACCO AND PHARMACEUTICALS, INC.
BALANCE SHEET, CONTINUED
December 31, 1997
================================================================================
<TABLE>
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> 58
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> 59
STAR TOBACCO AND PHARMACEUTICALS, INC.
STATEMENTS OF STOCKHOLDERS' DEFICIT
For the Years Ended December 31, 1997 and 1996
================================================================================
<TABLE>
<CAPTION>
Additional Notes
Common Stock 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> 60
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> 61
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> 62
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 policies. 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. The Company also records an
allowance for returns and discounts. Allowances amounted to
$167,091 at December 31, 1997.
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> 63
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> 64
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>
<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>
<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> 65
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:
<TABLE>
<S> <C>
Related parties (note 6):
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> 66
STAR TOBACCO AND PHARMACEUTICALS, INC.
NOTES TO FINANCIAL STATEMENTS, CONTINUED
5. NOTES PAYABLE, CONTINUED:
<TABLE>
<S> <C>
Other, continued:
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
=============
</TABLE>
The annual maturities of notes payable are as follows:
<TABLE>
<CAPTION>
Year Ended
December 31,
------------
<S> <C> <C>
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> 67
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> 68
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, 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> 69
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> 70
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> 71
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> 72
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)
Net Loss (213,816)
------------ ------------ ------------ ------------
BALANCE on December 31, 1996 3,435,190 34,352 8,777,505 (9,696,893)
Net Loss (330,191)
------------ ------------ ------------ ------------
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> 73
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> 74
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. 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. In addition, the stockholders of the
Company have agreed to financially support the operations of the entity and
believe they have the ability to do so.
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> 75
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.
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>
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
</TABLE>
F-22
<PAGE> 76
<TABLE>
<CAPTION>
1997
--------
<S> <C>
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 --
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> 77
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>
<S> <C>
Expense:
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> 78
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> 79
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 -- SEPTEMBER 28, 1998
The undersigned hereby constitutes and appoints David P. Sheets 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 Monday,
September 28, 1998 at 10:00 a.m., local time, and at any adjournments thereof,
on all matters coming before said meeting.
<TABLE>
<S> <C> <C> <C>
1. ELECTION OF DIRECTORS. Nominees: [ ] FOR [ ] WITHHELD
</TABLE>
Malcolm L. "Mac" Bailey -- Class One
Robert J. DeLorenzo, M.D., Ph.d. -- Class Two
David P. Sheets -- 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 Corp."
[ ] 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> 80
(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.
Date: , 1998.
------------------
-------------------------------
-------------------------------
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.
PLEASE MARK, SIGN, DATE AND RETURN USING THE ENCLOSED ENVELOPE.
