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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-KSB
(Mark One)
[X] Annual report under Section 13 or 15(d) of the Securities Exchange Act of
1934 For the fiscal year ended December 31, 1998
[ ] Transition report under Section 13 or 15(d) of the Securities Exchange Act
of 1934 For the transition period from _____________ to ______________
Commission File Number: 0-15324
STAR SCIENTIFIC, INC.
(formerly Eye Technology, Inc.)
(Name of Small Business Issuer in its Charter)
DELAWARE 52-1402131
(State of incorporation) (IRS Employer Identification No.)
16 SOUTH MARKET STREET, PETERSBURG, VIRGINIA 23803
(Address of Principal Executive Offices, Zip Code)
(804) 861-0681
(Issuer's Telephone Number, Including Area Code)
Securities Registered under Section 12(g) of the Exchange Act:
COMMON STOCK, $.01 PAR VALUE
(Title of Class)
Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Check if there is no disclosure of delinquent filers in response to item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy of information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [X]
Issuer's revenues for its most recent fiscal year: $19,445,000.
Aggregate market value of the Common Stock held by non-affiliates (approximately
10,015,738 shares) computed by reference to the average bid and asked price of
the Common Stock as of March 31, 1999 was $20,631,476.
Number of shares outstanding of each class of common equity as of March 31,
1999: 51,414,880 shares of Common Stock; 250 shares of Class A Convertible
Preferred Stock; 1,351 shares of Series B Convertible Preferred Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Annual Report on Form 10-KSB incorporates by reference
information from the Company's definitive Proxy Statement relating to its 1999
Annual Meeting of Stockholders.
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This Annual Report on Form 10-KSB ("Form 10-KSB") contains forward-looking
statements within the meaning of Section 21E of the Securities Exchange Act of
1934, as amended, that reflect the Company's current expectations regarding the
future results of operations, performance and achievements of the Company. These
forward-looking statements are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995. The Company has tried,
wherever possible, to identify these forward-looking statements by using words
such as "anticipates," "believes," "estimates," "expects," "plans," "intends"
and similar expressions. These statements reflect the Company's current beliefs
and are based on information currently available to it. Accordingly, these
statements are subject to certain risks, uncertainties and contingencies which
could cause the Company's actual results, performance or achievements to differ
materially from those expressed in, or implied by, such statements. These risks,
uncertainties and contingencies include, without limitation, the development and
commercialization of the Company's proprietary process for reducing or virtually
eliminating the tobacco specific nitrosamines in the processing of tobacco leaf,
potential delays in obtaining any necessary governmental approvals of the
Company's proposed cigarette products, market acceptance of the Company's
products, the Company's decision not to join the Master Tobacco Settlement
Agreement, the adoption of required state statutes, and any subsequent
modification of the Master Tobacco Settlement Agreement. The Company undertakes
no obligation to update or revise any such forward-looking statements that may
be made to reflect events or circumstances after the date of this Form 10-KSB or
to reflect the occurrence of unanticipated events.
PART I
ITEM 1. BUSINESS.
GENERAL
Star Scientific, Inc. ("Star" or the "Company") is engaged in: (1) the
development of proprietary scientific technology for the curing of tobacco so as
to prevent or retard the formation of certain toxic carcinogens present in
tobacco and tobacco smoke, namely, the tobacco specific nitrosamines (TSNAs),
(2) the development of less harmful tobacco products which have been cured
pursuant to the Company's patented proprietary process, (3) the manufacture and
sale of discount cigarettes, without additives, and with activated charcoal
filters, and (4) the research and development of tobacco-cessation products.
The Company's primary corporate mission is to demonstrate the
commercial viability of less harmful tobacco products and to encourage other
tobacco manufacturers to utilize and/or license Star's proprietary curing
technology.
The Company has pioneered the development of a high-speed, patented and
economically feasible curing technology process for removing virtually all the
tobacco-specific nitrosamines from tobacco, as well as from second-hand tobacco
smoke.
The Company has exclusive worldwide license under patents and patents
pending relating to methods to prevent the formation of TSNAs in tobacco.
Certain TSNAs are generally regarded by tobacco chemists as the most abundant
and powerful carcinogens in tobacco and tobacco smoke.
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The Company's licensed processes employ the application of an energy source to
tobacco leaf shortly following the harvesting of the leaf and prior to
completion of the curing (drying) process. No chemicals are used. The Company's
processes prevent TSNAs from forming in the tobacco leaf, a natural process
which otherwise occurs during the curing period. Independent tests have
confirmed that Star's processes reduce the amount of TSNAs in tobacco and
tobacco smoke to either undetectable levels or to de minimis levels. The Company
has successfully tested its processes in both Virginia flue-cured and burley
tobacco, the two most prevalent varieties of tobacco used in cigarettes sold in
the United States, and the Company believes that its processes may achieve
similar results on other varieties of tobacco.
PRODUCTS
Discount Cigarettes.
Star manufactures and sells four brands of discount cigarettes -
GUMSMOKE(R), VEGAS(R), SPORT(R), and MAIN STREET(R) through approximately 300
tobacco and food product distributors ("T&F Distributors") throughout the United
States. The cigarettes are sold as "deep discount" products, i.e., at or near
the lowest price range in the wholesale market and, consequently, in the retail
market as well. Star does not engage in extensive advertising or marketing
programs for its cigarette products directly to consumers but, rather, Star
relies primarily upon price and, to a lesser extent, on product appearance and
taste in order to compete in the marketplace. Star's primary advertising focus
is its core of approximately 300 distributors in 48 states. Star has also
engaged in contract manufacturing, i.e., the manufacture of products under
brands owned by others. The production and sale of such products are an
immaterial portion of sales in 1998. Export sales are also immaterial.
In an effort to implement Star's mandate to develop less toxic and less
hazardous tobacco products, Star intends to phase into its discount cigarettes
tobacco which has been cured through its proprietary scientific technology over
the next three years and to utilize activated charcoal filters in its
cigarettes.
Tobacco-Flavored Chewing Gum and Lozenges and Chewing Gum Containing Tobacco
Extract.
Star has developed several products containing low-TSNA tobacco as an
ingredient, but has not yet marketed any such products. It has developed both a
chewing gum and a lozenge, each containing low-TSNA tobacco, as products for the
smoking cessation market. The gum/lozenge products contain nicotine, as well as
the MAO-inhibitor known to be present in tobacco. In anticipation of a then
pending legislative proposal to provide the Food and Drug Administration ("FDA")
with new authority to regulate tobacco products, Star submitted and received
approval of an Investigational New Drug application ("IND") for the gum product
from the FDA, Star commenced a Phase I human clinical trial in the second
quarter of 1998 in order to demonstrate the safety of the product for smoking
cessation purposes. Star has also developed lozenges, which contain low-TSNA
tobacco that is added in either a finely-ground powder or liquid extract form to
typical lozenge ingredients. Star has not yet filed an IND application with the
FDA covering lozenges, and in the current regulatory environment it is unlikely
to do so absent a change in that climate. Neither the gum nor the lozenge may be
sold in the United States unless and until the FDA has approved a New Drug
Application ("NDA") for such product, and no assurances can be given when or if
Star might obtain such an approval or that, even
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if such approvals are obtained, whether there will be significant revenues from
the sale of either. Given the uncertain status of the FDA's authority to
regulate tobacco products, it now appears that these tobacco-containing
cessation products would be required to undergo all of the preclinical and
clinical testing required of a new drug product. It seems unlikely at the
present time that undertaking such testing would produce an adequate return on
investment. Star continues to investigate and explore opportunities in Western
and Eastern Europe, and in other countries where regulating authorities appear
to be more receptive to the development of reduced risk and less hazardous
tobacco products.
In January 1998, Star introduced to the market a chewing gum, under the
label GUMSMOKE(TM), which contains an FDA-approved tobacco flavoring but no
tobacco extract. The gum was being promoted by Star as an alternative to smoking
to be chewed when the consumer either is unable to smoke or desires to reduce
the amount of smoking. The gum was test marketed in the United States through
the T&F Distributors, as well as directly to certain large retail chains. The
product was also being distributed in certain countries in Europe through a
single distributor. GUMSMOKE(TM) is a food product for which Star asserts no
health or therapeutic claims and is, therefore, distinguished from the
therapeutic chewing gum described above. Since the product appeared to have
limited market acceptance and Star anticipated potential regulatory issues which
could have been costly to resolve, Star discontinued the development and sale of
that product.
Sale of Processed Tobacco.
Star has to date received only modest revenues from the production and
sale of pilot amounts (approximately 86,000 pounds) of processed tobacco, which
was sold to several major producers in the U.S. and abroad during the 1998
harvest season. Star intends to purchase, treat with its proprietary process and
sell the processed tobacco during the 1999 tobacco harvest season (July -
October), to manufacturers of tobacco products.
Star has a contract to sell to a major tobacco company 1.2 million
pounds of processed tobacco at $3.00 per pound during the 1999 harvest season.
Products Containing Low-TSNA Tobacco.
Star has developed a cigarette product, currently designated CigRx(TM),
containing Virginia tobacco from which virtually all TSNA has been removed and
utilizing an activated charcoal filter. Although Star can now market such a
product in the United States, existing federal law would preclude Star from
making any health/therapeutic claims for the product, and even disclosure of the
absence of TSNAs might arguably be interpreted as an implied health claim. Star
has chosen to make its data available to the FDA, although it is not required to
do so. Star originally positioned the product so that if approved it would be
sold by physician's prescription only as part of a smoking cessation regimen to
be used by a patient who relapses from his/her cessation effort and who is being
prepared for a subsequent cessation attempt. Based on discussions with the FDA,
it has become apparent that the FDA will neither approve nor disapprove this
product at the present time.
SALES AND MARKETING
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.
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Star utilizes its own specified blend of tobaccos in each brand. The blend
consists of Virginia flue- cured, burley and oriental varieties of tobacco,
which is typical of American-style cigarettes. Star does not utilize
"reconstituted" tobacco, which is tobacco leaf which has been cut, combined with
various chemicals and formed into paper-like sheets which are in turn cut and
utilized as filler in the production of cigarettes.
Star uses stylized packaging designs for its four brands of cigarettes.
As is typical in the cigarette industry, Star utilizes different colors, e.g.,
green for menthol, but similar designs, on its packaging to denote different
product styles.
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 the
distributor an incentive to promote to retailers Star's brand without being
undercut on a price basis by a competitor. In 1998 Star sold its cigarettes to a
total of approximately 300 distributors located in 48 states. The distributors
maintain state and, where applicable, municipal government tobacco product
licenses, apply cigarette 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 1998. Star's distributor customers primarily serve
convenience stores, gas stations and other outlets and stores.
COMPETITION
Star's primary competition for conventional cigarettes is from the four
"majors," that is, Philip Morris, the brands of which account for slightly more
than 50% of the cigarette sales in the United States, R.J. Reynolds, Brown &
Williamson and Lorillard, each of which has substantially greater financial and
operating resources than Star. Star also encounters significant competition from
several other United States manufacturers of cigarettes as well as importers of
cigarettes manufactured in foreign countries. Some of these manufacturers and
importers have substantially greater financial and operating resources than
Star.
Star's products compete principally on the basis of price. Generally
speaking, there are three price categories of cigarettes in the United States,
"premium," which includes such brands as Marlboro(R) and Camel(R), "discount" or
"generic," which includes such brands as Doral(R) and GPC(R), and "deep
discount," which as a group account for only a small percentage (less than 3%)
of the United States cigarette market. Each of Star's brands is priced in the
deep discount category. Other
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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.
Star also encounters competition in the sales of smoking cessation
products. Smoking cessation products that are approved for sale in the United
States by the FDA 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(R) to date have been substantial
and that Zyban(R) is often prescribed by physicians to be used in conjunction
with nicotine delivery products.
Star's principal competitors in the cessation and reduction market
would include Smith Kline 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 can overcome regulatory barriers
to marketing its tobacco-containing cessation products or 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.
PURCHASING
Tobacco used in Star cigarettes 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. In the future, the Company expects to purchase tobacco
directly from tobacco farmers and to erect curing barns on their property to
permit the Company to cure the tobacco using its proprietary technology on site.
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MANUFACTURING
Star manufactures cigarettes at its facility in Petersburg, Virginia.
The tobacco is 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. Star has
sufficient manufacturing capacity at its Petersburg facility to produce its
low-TSNA cigarettes for the foreseeable future.
Amana Company, L.P. ("Amana") is manufacturing the specialized
equipment that incorporates the Company's proprietary technology for processing
tobacco under a 15-year exclusive supply agreement. The Company believes that
Amana has sufficient manufacturing capacity to supply all of the Company's
foreseeable requirements for the specialized equipment.
Chicles Canel's, S.A. de C.V., of San Luis Potosi, Mexico ("Canel's"),
a large gum manufacturing company in Mexico, has produced all sample and
clinical trial quantities of gum and lozenge products for Star. Star, which does
not have an on-going agreement with Canel's, is currently dependent upon Canel's
as a sole supplier of 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.
GOVERNMENT REGULATION
The manufacture and sale of cigarettes and other tobacco products and
of pharmaceutical products are subject to extensive federal and state government
regulations in the United States and by comparable authorities in many foreign
countries. These national agencies and other federal, state and local entities
regulate, among other things, research and development activities and the
testing, manufacture, safety, effectiveness, labeling, storage, record keeping,
approval, advertising and promotion of Star's products.
There are multiple bills pending before the 106th Congress and in
several state legislatures which, if enacted, would significantly change the
United States tobacco industry. Some of these federal bills contain provisions
which would provide substantial federal government funds for smoking cessation
programs and products, as well as incentives to tobacco companies and others to
produce less harmful or reduced-risk tobacco products. Star is unable to predict
what effect, if any, these provisions, if enacted, would have on Star's
technology or the sale of Star's smoking cessation products (if approved by the
FDA) and/or reduced-hazard tobacco products. The Company believes, however, that
any bill that requires manufacturers to reduce or eliminate or disclose
additional known toxic ingredients (other than nicotine or tar levels) in
tobacco could have a beneficial effect on the Company.
FDA Regulation.
The FDA has adopted extensive regulations governing the sale and
advertising of tobacco products designed primarily to discourage the sale to,
and consumption by, adolescents and children. The "major" manufacturers of
tobacco products challenged the authority of the FDA to promulgate such
regulations in the federal courts. A federal District Court upheld the FDA's
authority to
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promulgate such regulations, but ruled that certain of the regulations
restricting advertising were invalid as violative of the constitutional right of
free speech. The United States Court of Appeals affirmed that portions of the
District Court opinion that held the FDA could not regulate tobacco advertising
and ruled that the executive branch of the United States government, in
particular the FDA, does not have any authority to regulate tobacco products
generally, such authority being reserved to Congress. The federal government has
appealed the Appeals Court's ruling and the matter is now pending before the
United States Supreme Court. To the knowledge of Star, the FDA has not attempted
to enforce these regulations, and the tobacco industry, including Star, have
generally operated as if the regulations were not in effect.
It is difficult for Star to predict what effect full implementation of
the FDA regulations referred to in the preceding paragraph would have upon its
conventional cigarette business. Those regulations significantly limit the
manner in which cigarettes may be sold and displayed in retail stores,
requiring, among other restrictions, that cigarettes be kept "behind the
counter" and out of the 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 on brand loyalty or
brand recognition to generate sales. Consequently, implementation of the
existing FDA regulations would have an adverse affect upon Star's sales of
conventional cigarettes.
The Company has shared its product data with the FDA and plans to
continue to do so, depending only on the FDA's willingness to comment on the
data submitted to it. The Company's decision to share its product data with the
FDA was made with long-term objectives in mind and in light of the uncertainties
in the regulatory environment. The Company believes that the commercial value of
its tobacco curing process will depend upon validation by the scientific and
health care communities. The Company believes that tests and clinical trials
conducted under FDA quality protocols would further its objective of attaining
scientific validation for its technology. It is uncertain, however, whether any
competitive advantage would be achieved by submission of its tobacco-containing
products to the FDA, especially if such submission is not required.
In 1997 Star submitted its initial research plan on GUMSMOKE(TM) gum to
the FDA as a therapeutic drug product for smoking cessation purposes. However,
absent new authority for FDA to regulate products containing tobacco, it now
seems unlikely that any product based in part on a tobacco extract would be
approved by FDA, as that agency is currently configured. As a result, further
development of this product has been suspended.
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
under authority of the Internal Revenue Code of 1986, as amended. The Company's
tobacco products will continue to be subject to tax under such regulations.
State and Municipal Laws.
The sale of tobacco products is subject to taxation in all fifty
states. In addition, some states permit municipalities to impose an additional
sales tax, and many municipalities do so. The state and municipal taxes are
imposed upon wholesalers and/or retailers but not manufacturers, and therefore
Star
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has no liability for such taxes. Star is required by many states, however, to
report its shipments of cigarettes to distributors/retailers located within
their jurisdiction. Star is aware of at least two states, Massachusetts and
Minnesota, which have recently adopted laws and regulations regarding the
disclosure by manufacturers of certain chemical constituents in their products.
Star intends to fully comply with such laws and believes it will benefit from
such disclosure.
Master Tobacco Settlement Agreement.
In February, the Company's Board of Directors voted unanimously not to
join the Master Tobacco Settlement Agreement ("MSA") among forty-six states,
several U.S. territories and a number of tobacco manufacturers, as a Subsequent
Participating Manufacturer. The MSA and the proposed model statute that each
participating state is obligated to enact as part of the MSA, do not contain any
provisions that reward or encourage companies, like Star, that have sought to
develop and promote safer tobacco products. To rectify this inequality, the
Company proposed an amendment to the MSA that would have recognized its
commitment to R&D over the past several years and would have allowed it to
continue to promote those efforts under the grandfather provisions in the MSA
that apply to Subsequent Participating Manufacturers. The Company was advised,
without receiving any adequate explanation, that the proposed amendment, which
it believed was not only fair but magnanimous, was rejected.
After careful consideration, the Board of Directors determined that it
was not in Star's long term interest to join in the MSA without an acceptable
amendment. As a Non-Participating Manufacturer, Star, absent a successful legal
challenge, some subsequent agreement to modify the MSA or individual state
amendments to the proposed model statutes, could be required to establish escrow
funds under model statutes to be enacted by each participating state that would
be available to pay for tobacco-related judgments or settlements, if claims are
asserted by participating states against Star. These escrow payments could be
substantial. To date, Star has not been named as a party in any tobacco related
litigation. Star is continuing to assess the impact that opting out of the MSA,
and potentially having to fund state-specific escrow accounts, will have on its
ability to fully fund the development of less hazardous tobacco products.
Star has engaged special outside counsel in order to assist the Board
in its continuing evaluation of this situation and/or to be prepared to
challenge, if necessary the enactment of model state statutes, mandated by the
MSA, which may well constitute an unconstitutional "taking" of Star's property,
among other things, in violation of state and/or federal constitutional
protections. The Board of Directors of Star is committed to implementing all
feasible measures to achieve the development and production of safer tobacco. In
an effort to implement Star's mandate to develop less toxic and safer tobacco
products, the Board of Directors ratified management's decision to put activated
charcoal filters on all of its four discount brands of cigarettes within the
next 30 to 45 days. Although this is a more costly approach to cigarette
manufacturing, such approach was highly recommended by respected scientists and
physicians during the recent Food and Drug Symposium on the development of less
toxic tobacco products held at the Georgetown University Medical Center.
Virginia Incentive Rebates.
The Company proposed to the Virginia General Assembly an amendment to
the model state statute. Although the proffered Amendment was not enacted, the
General Assembly and Governor of the Commonwealth of Virginia did, in fact,
provide some relief and assistance to Star indirectly by passing
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legislation which was signed by the Governor that explicitly encourages the
manufacture and sale of "products that reduce the carcinogenic tobacco specific
nitrosamines (TSNAs) levels in tobacco products." That legislation, pursuant to
House Bill 2635 and Senate Bill 1165 (1999), provides that $2,000,000 shall be
made available to the Virginia Economic Development Partnership to provide for
economic development incentive rebates to assist Virginia companies that reduce
the carcinogenic (TSNAs) levels in tobacco products. The Company believes that
it is the only company in Virginia and/or in the U.S. that has comprehensive
patent protection for its proprietary technology to reduce to de minimis levels
the TSNAs in tobacco and tobacco smoke.
Canadian Proposed Regulations for Tobacco Packaging.
The Canadian government has recently proposed new regulations that
would require disclosure of the amount of selected toxic constituents, including
TSNAs, in tobacco products sold in Canada. Star believes that the proposed
regulations, which would require disclosure of the levels of TSNAs on cigarette
labels covering 60% of the top of the display panel, could benefit the Company
to the extent that Star or any future licensees market tobacco in Canada. Star
is currently exploring opportunities to enter the Canadian market with its
low-TSNA cigarettes, either directly or through a license granted by Star to a
major tobacco company which markets cigarettes in Canada.
RESEARCH AND DEVELOPMENT
In late 1994, Star commenced research and development activities based
upon newly-conceived technology, which it had licensed from the technology's
inventor, Jonnie R. Williams, for the processing of tobacco so as to eliminate
or reduce to insignificant levels TSNAs. TSNAs are generally recognized by
tobacco chemists to be among the most powerful and abundant carcinogens in
tobacco and tobacco smoke. Star's research and development activities have
focused on (1) perfecting and testing its proprietary methods for processing
tobacco, (2) developing products which incorporate Star's specially-processed
tobacco, including products for the smoking cessation and reduced-risk smoking
markets, (3) establishing a patent position, and (4) developing relationships
with tobacco farmers, as well as the tobacco industry, with a view to the
commercialization of Star's processes.
Star is not aware of any other entity which utilizes a process to
reduce significantly tobacco- specific nitrosamines that are found in cured
tobacco leaf. At least one Swedish Company, Swedish Match Co., has worked with
various varieties of smokeless tobacco under crop management environments in an
effort to reduce the amount of the nitrosamine content in tobacco. The Company
understands that Swedish Match Co. has been successful in those efforts, but not
to the extent of reducing nitrosamines below the level which the Company
understands would be considered inconsequential.
Proprietary Technology.
The process of curing, or drying, tobacco so that it is suitable for
production into tobacco products begins immediately upon harvesting of the
tobacco leaf. The tobacco leaves are brought to enclosed barns or sheds to be
hung or placed on racks. The two principal varieties of tobacco leaf in the
United States are Virginia flue-cured tobacco and burley tobacco, both of which
are typically used in American-made cigarettes to produce what is referred to
as an American blend. Under conventional curing methods with Virginia flue-cured
tobacco, the leaves that are hung to cure are exposed to gas-fired heat, while
with burley tobacco the leaves dry naturally. The curing process for Virginia
flue-cured tobacco takes approximately five days and for burley tobacco a month
or more.
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Star's proprietary curing technology is applicable to Virginia
flue-cured tobacco as well as burley tobacco, and most likely to other varieties
widely used throughout the world. Star's curing process essentially arrests or
eliminates microbial activity that normally occurs during curing, thereby
preventing the production of TSNAs. Star's curing technology does not, however,
alter or affect taste, color or the nicotine content of tobacco. The Company
makes no claim or representation that its proprietary curing process reduces any
harmful chemical constituents in tobacco and/or tobacco smoke other than
tobacco-specific nitrosamines.
Star's proprietary curing technology was conceived by Jonnie R.
Williams and has been licensed to Star in an agreement which grants to Star
certain exclusive worldwide rights with a right of sublicense.
See "Patents, Trademarks and Licenses" 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.
Star conducted at its own expense a pilot program during the 1998
United States tobacco harvest season (July through October). The purposes of
this program were: (1) to continue to test and perfect Star's curing processes
in quantities and under conditions which will serve as a model for future
operations; (2) to test custom designed equipment; (3) to provide processed
tobacco to major manufacturers in quantities for testing and test market
purposes; and (4) to demonstrate the commercial feasibility of adoption of
Star's processes for widespread use in the production of tobacco products. The
program was operated from a leased facility in Chase City, Virginia, which is
located in the tobacco growing regions of Virginia and North Carolina. The
Company has completed the pilot program and has achieved the objectives
described above.
Star has had extensive discussions with several major tobacco product
manufacturers. Several have purchased samples of its processed tobacco, and it
has been advised by many of the companies that tests conducted by or for the
major manufacturers confirm Star's claim that its processed tobacco is virtually
free of TSNAs.
Development of CigRx(TM).
In 1997 Star voluntarily elected to submit CigRx(TM) 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's
strategy has since changed, and it will not seek FDA approval for CigRx(TM). The
Company, however, intends to submit data from a recently completed Phase I
clinical study of CigRx(TM) to the FDA for its review and comment.
In October 1998, a Phase I study of CigRx(TM) under an FDA-reviewed
protocol was completed at the Medical College of Virginia under the direction of
Professor William Barr, Chairman of the Department of Pharmaceutics and Director
for the Center for Drug Studies as its principal investigator. The study,
involving male and female subjects, was a 19-day cross-over study designed to
test the in vivo elimination or reduction of nitrosamines following the smoking
of CigRx(TM) cigarettes compared to leading-brand conventional cigarettes. As
measured by the current Federal Trade Commission method,
10
<PAGE> 12
the CigRx(TM) cigarettes used in the study delivered substantially less carbon
monoxide (4.8 milligrams versus 12.2 milligrams) and about half as much tar (7.0
milligrams versus 14.0 milligrams) compared to an average of the best selling
full-flavored cigarettes. It is anticipated that analytical data from the study
will be compiled and analyzed within the next 60 days. The study contrasted
Star's product with conventional brands in terms of breath levels of carbon
monoxide, blood levels of nicotine, and urinary levels of TSNAs. Additional data
has been received from the American Health Foundation pursuant to a contract to
analyze biological specimens obtained in the study. It is anticipated that the
analysis of this data will be completed shortly and publication of the results
will follow.
The Company intends to continue to test CigRx(TM) and similar products.
Since it is unlikely that the product can be formally approved by the FDA as
presently configured, the Company intends in the meantime to proceed with plans
to produce and test market the product, most likely under another name.
Beginning in the last half of 1999, the Company expects to conduct a limited
test market of this product using tobacco processed in the Company's pilot
program described above. Any marketing of products using Star's tobacco produced
with Star's curing technology will not be undertaken until the last months of
1999, since the Company will not have enough tobacco for these purposes until
the 1999 tobacco crop has been harvested.
Star's new cigarette products will be sold without any therapeutic
claims or special disclosures in the United States. However, Canada and other
countries have proposed new regulations that will require manufacturers to
disclose levels of carbon monoxide, tar, nicotine and TSNA.
PRODUCT LIABILITY
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: (1) manufacturer defendants
have deceived consumers about the health risks imposed by tobacco product
consumption; (2) 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 (3) such defendants knew of
the addictive attributes of nicotine and have purposefully manipulated their
product ingredients so as to enhance the delivery of nicotine.
Star believes that its risk of liability in any lawsuit of the type
described above, and therefore the risk of being named a defendant in such a
lawsuit, is relatively low because (1) Star has not at any time advertised its
tobacco products to consumers except for point-of-purchase materials; (2) it has
conducted research on the chemical or other constituents of its products only in
the course of trying to reduce the delivery of toxic materials; (3) it does not
own or operate, and has never owned or operated, laboratory or other research
facilities; and (4) Star has not "manipulated" the nicotine content or delivery
of its tobacco products. Moreover, Star brands have been sold for only a
relatively short period of time, i.e., since late 1994, and the volume of sales
has not been substantial in relation to the volume generated by the larger
manufacturers.
Star maintains product liability insurance which is limited to any
claims that tobacco products manufactured by or for Star contain any foreign
object. Such insurance does not cover health-related claims such as those that
have been made against the major manufacturers of tobacco products. Star does
11
<PAGE> 13
not believe that such insurance can currently be obtained. A lawsuit against the
Company based upon claims not covered by its product liability insurance may
have a materially adverse effect upon the financial condition of the Company.
PATENTS, TRADEMARKS AND LICENSES
License Agreement.
Star is the licensee under a license agreement (the "License
Agreement") with the licensor, Regent Court Technologies, a partnership of which
Jonnie R. Williams and Francis E. O'Donnell, Jr., M.D. are partners. The License
Agreement provides, among other things, for the grant of an exclusive,
worldwide, irrevocable license to Star, with the right to grant sublicenses, to
make, use and sell tobacco and products containing tobacco under the licensor's
patent rights and know-how relating to the processes for curing tobacco so as to
eliminate or reduce to insignificant levels tobacco-specific nitrosamines and to
products containing such tobacco of the licensor and its affiliates, whether
such patent rights and know-how are now in existence or hereinafter developed.
This license includes inventions of the licensor and its affiliates during the
term of this Agreement relating to the production, treatment or curing of
tobacco, or a method of manufacturing a product containing tobacco, or of
extracting one or more substances from tobacco for the purpose of incorporating
such substance or substances in a product or products. The only right retained
by the licensor is to conduct research.
The License Agreement may be terminated by Star upon 30 days' written
notice. The License Agreement may also be terminated by the licensor (a) upon a
default in the payment of royalties or a failure to submit a correct accounting
continuing for at least 30 days after written notice, or (b) upon a material
breach of any other obligation of Star under the License Agreement continuing
for at least 60 days after written notice. A material breach may include a
sublicense of the Patent Rights (as defined in the License Agreement) without
obtaining a written agreement of the sublicensee to be obligated to the licensor
under the License Agreement. The licensee is also obligated to provide the
licensor with copies of all patent applications by it relating to the Patent
Rights. For purposes of determining materiality, and provided the nature of the
breach may be determined in material terms, a breach shall be deemed material if
such breach results in a loss of royalties exceeding $100,000.
Star is obligated to pay to the licensor a royalty of 2% on all net
sales of products by it and any affiliated sublicensees, and 6% on all fees and
royalties received by it from unaffiliated sublicensees. The License Agreement
expires with the expiration of the last of any applicable patents. Two United
States patents have been issued, and additional patent applications are pending
in the United States and in approximately 80 foreign jurisdictions.
The License Agreement obligates Star to prosecute and pay for United
States and foreign patent rights. The agreement contains other provisions
typically found in a patent license agreement, such as provisions governing
patent enforcement and the defense of any infringement claims against Star and
its sublicensees. The License Agreement further provides that any obligation or
liability related to patent infringement matters brought against Star will be
borne by Star. Star has agreed to indemnify and defend the licensor and its
affiliates against losses incurred in connection with Star's use, sale or other
disposition of any licensed product or the exercise of any rights under the
License Agreement. The licensor has made no representations to Star in any
documents regarding the efficacy of the licensed technology.
12
<PAGE> 14
Patents and Proprietary Rights.
Star's success in commercially exploiting its licensed tobacco curing
technology depends in large part on the ability of Star to defend issued
patents, to obtain further patent protection for the technology in the United
States and other jurisdictions, to maintain trade secrets, to operate without
infringing upon the patents and proprietary rights of others, and to obtain
appropriate licenses to patents or proprietary rights held by third parties if
infringement would otherwise occur, both in the United States and in foreign
countries. The Company has exclusive rights to two issued patents, and Star has
patent protection covering the technology for reducing the level of TSNAs in
tobacco leaf. Additionally, the Company is an exclusive licensee to a patent
application pending in the United States for additional methods covering the
tobacco curing technology and for products containing low-TSNA tobacco.
Corresponding patent filings have been initiated in numerous foreign countries.
There can be no assurance that patents will issue from any of the pending
applications, that claims allowed will be sufficient to protect the intellectual
property owned or licensed by Star, or that Star or its licensor has or will
develop or obtain the rights to any additional products or processes that are
patentable. In addition, no assurance can be given that any patents issued to or
licensed by Star will not be challenged, invalidated, infringed or circumvented,
or that the rights granted thereunder will provide competitive advantages to
Star.
The patent positions of research and development 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 "USPTO") to
determine the priority of an invention, which could result in substantial cost
to Star. There can be no assurance that Star's licensed patents would be held
valid by a court or administrative body or that an alleged infringer would be
found to be infringing. The mere uncertainty resulting from the institution and
continuation of any technology-related litigation or interference proceeding
could have a material adverse effect on Star's business and prospects.
Star may also rely on unpatented trade secrets and know-how to maintain
its competitive position, which it seeks to protect, in part, by confidentiality
agreements with employees, consultants, suppliers and others. There can be no
assurance that these agreements will not be breached or terminated, that Star
will have adequate remedies for any breach, or that Star's trade secrets will
not otherwise become known or be independently discovered by competitors.
13
<PAGE> 15
SALE OF OPHTHALMIC BUSINESS
As a result of the poor results of its ophthalmic business, the Company
sold its ophthalmic business, effective as of December 30, 1998. The purchaser
assumed most of the liabilities of the Company's ophthalmic business. The
purchaser deposited into escrow 250,000 shares of the Company's common stock to
secure the payment of these liabilities.
EMPLOYEES
As of December 31, 1998, the Company had approximately 100 full-time
employees. From time to time, the Company engages temporary personnel to augment
its regular employee staff. The Company 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. The Company'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 the Company 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 the Company's business.
ITEM 2. PROPERTIES.
The Company's executive offices and manufacturing facilities are
located in Petersburg, Virginia. The Company 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. The Company leases a 10,000
square foot warehouse in Petersburg, Virginia, about one mile from its
manufacturing facilities, pursuant to a month-to-month lease. The warehouse is
used for storing and shipping conventional cigarette products. The Company also
leases a single office at the Biotechnology Office Park of the Medical College
of Virginia in Richmond, Virginia, on a tenancy-at-will basis.
The Company has leased seven acres of land and an approximately 50,000
square foot building thereon in Chase City, Virginia, for the processing of
tobacco utilizing the Company's proprietary methods to prevent the formation of
tobacco-specific nitrosamines. The lease is for a term of ten years, expiring in
2008. The Company has an option to purchase the property at any time during the
term of the lease.
The Company considers its facilities adequate for the purposes for
which they are used.
ITEM 3. LEGAL PROCEEDINGS.
The Company is not involved in any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The annual meeting of stockholders of the Company (the "Meeting") was
held on December 15, 1998. At the Meeting, the stockholders voted upon a number
of proposals, each of which is summarized below, along with the votes cast for
and against each such proposal, votes withheld or abstaining therefrom and
broker non-votes.
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<PAGE> 16
ELECTION OF DIRECTORS. At the Meeting, the stockholders elected the
following persons to the Board of Directors of the Company until the date of the
annual stockholders meeting in the calendar year set forth opposite the name of
each such person:
<TABLE>
<CAPTION>
VOTES BROKER
NAME TERM VOTES FOR AGAINST ABSTAINING NON-VOTES
---- ---- ---------- ------- ---------- ---------
<S> <C> <C> <C> <C> <C>
Malcolm L. "Mac" Bailey 1999 10,991,769 0 435,021 0
James A. McNulty 1999 10,991,769 0 435,021 0
Jonnie R. Williams 2000 10,987,469 0 439,321 0
Robert J. DeLorenzo, M.D., Ph.D. 2001 10,991,769 0 435,021 0
Leo S. Tonkin 2001 10,991,769 0 435,021 0
</TABLE>
AMENDMENT OF CERTIFICATE OF INCORPORATION CHANGING THE CORPORATE NAME.
At the Meeting, the stockholders of the Company voted on and approved an
amendment to the Certificate of Incorporation of the Company to change the
corporate name of the Company to Star Scientific, Inc. 11,379,359 votes were
cast for such proposal, 36,821 votes were cast against or withheld, with 10,610
votes abstaining and no broker non-votes.
1998 STOCK OPTION PLAN. At the Meeting, the stockholders of the Company
voted on and approved the 1998 Stock Option Plan, attached hereto as Exhibit
10(x) and incorporated herein by reference (the "Plan"). The Plan authorizes the
Compensation Committee of the Board of Directors to grant options to purchase up
to an aggregate of 4,000,000 shares of Common Stock of the Company to executive
officers, key employees, non-employee directors and consultants of the Company.
10,981,807 votes were cast for such proposal, 428,643 votes were cast against or
withheld, with 16,340 votes abstaining and no broker non-votes.
AMENDMENT OF CERTIFICATE OF INCORPORATION INCREASING THE NUMBER OF
AUTHORIZED SHARES OF COMMON STOCK TO 100,000,000. At the Meeting, the
stockholders of the Company voted on and approved an amendment to the
Certificate of Incorporation of the Company to increase the number of authorized
shares of Common Stock of the Company from 10,000,000 to 100,000,000. The
additional shares of Common Stock are to be available for (i) conversion of the
Company's Series B Preferred Stock issued in connection with the "reverse
acquisition" of the Company by Star Tobacco and Pharmaceuticals, Inc. In
February 1998, conversion of other outstanding shares of the Company's Series B
Preferred Stock and 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. 10,973,097 votes were cast for such
proposal, 440,000 votes were cast against or withheld, with 13,693 votes
abstaining and no broker non-votes.
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<PAGE> 17
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Common Stock of the Company is traded in the over-the-counter
market and is quoted on the Electronic Bulletin Board under the symbol "STSI."
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 1997 and
1998, 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 March 31, 1999, there
were approximately 575 record holders of the Company's Common Stock.
<TABLE>
<CAPTION>
QUARTER ENDED HIGH BID LOW BID
------------- -------- -------
<S> <C> <C>
03-31-97 $ 0.21875 $ 0.09375
06-30-97 $ 0.21875 $ 0.01563
09-30-97 $ 0.035 $ 0.01
12-31-97 $ 0.01 $ 0.01
03-31-98 $ 5.9375 $ 0.01
06-30-98 $ 5.625 $ 3.00
09-30-98 $ 3.50 $ 1.4375
12-31-98 $ 3.50 $ 1.375
03-31-99 $ 2.375 $ 1.625
</TABLE>
The closing bid and asked prices on April 12, 1999, were $1.6875 and
$1.875, respectively.
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<PAGE> 18
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
The following discussion and analysis of operating results of the
Company and of the liquidity and capital resources of the Company at December
31, 1998 should be read in conjunction with the consolidated financial
statements of the Company and the notes thereto.
RESULTS OF OPERATIONS - FISCAL 1998 COMPARED TO FISCAL 1997
Net sales for 1998 of $19,445,000, consisting almost entirely of the
sale of Star-brand cigarettes (GUMSMOKE(R), VEGAS(R), MAIN STREET(R) and
SPORT(R)) were approximately equal to 1997 sales of $20,763,000. Sales in 1997
included sales to Swisher (a long-time private brand customer) of $3,872,000.
There were no sales to Swisher in 1998. However, fourth quarter 1998 sales of
$8,666,000 compared favorably with the prior year's fourth quarter sales of
$3,613,553, and was a result of the Company's efforts in expanding the base of
distributors in order to take advantage of the anticipated roll-out in 1999 of
the Company's products to include a phase-in of the TSNA-free tobacco. The
Company received its patent in September 1998, after which the sales force
accelerated its plan to increase its distribution channel. In 1998, sales from
contract manufacturing, i.e. the manufacturing of products under brand names
owned and marketed by others, was $1,251,000, compared to $3,872,000 in 1997.
Export sales in 1997 and 1998 were not material.
Cost of goods sold, as a percentage of net sales volume, was 39% in
1998 versus 48% in 1997. Profit margins on contract manufacturing are slightly
higher than the margins on Star-brand cigarettes. In 1998, profit margins
increased because of December 1998 price increases on Star-brand cigarettes, a
factor that affected positively the sales of the entire cigarette manufacturing
industry.
Marketing and distribution expenses increased slightly from $1,111,000
in 1997 to $1,199,000 in 1998. 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, the Company spent approximately $2 million in marketing and
distribution expenses, or 5.8% of sales; in 1997, this line item decreased to
$1,111,000, and was 5.4% of sales. In 1998, the marketing and distribution
expenses were $1,199,000, reflecting 6.2% of sales.
General and administrative expenses increased from $1,425,000 in 1997
to $3,174,000 in 1998, primarily as a result of the legal and accounting costs
associated with the public company issues, including the hiring of additional
personnel.
Research and development expense represents primarily expenditures
related to the development of Star's proprietary technology for the processing
of tobacco so as to prevent the formation of tobacco- specific nitrosamines, but
also expenses for the development of a tobacco-flavored, non-nicotine chewing
gum which Star is no longer developing. Star does not maintain its own research
laboratories or other physical assets for research and development; it is
dependent upon the services of third parties for these services. Similarly, it
does not employ a scientific staff and instead relies upon scientific and
medical consultants and third-party service providers. Expenditures in this
category include payments for such consultants, contract research organizations,
laboratory testing, research grants, raw materials, equipment, legal and
regulatory fees, including expenses for the filing and prosecution of patents,
and allocations of management personnel and general and administrative expenses.
This category includes payments of
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<PAGE> 19
$400,000 in 1998 and $565,000 in 1997, respectively, to Jonnie R. Williams, the
inventor of Star's proprietary technology for the processing of tobacco.
Net interest expense was $238,000 in 1998 and $235,000 in 1997,
consisting primarily of interest incurred in connection with a bank revolving
line of credit, the borrowing levels of which were determined by levels of
accounts receivable and inventory. The Company had several injections of capital
during 1998, thereby reducing costs associated with borrowing.
The increased loss in 1998 can be attributed to several factors,
including the expenses associated with the public Company, and research and
development costs incurred. The Company has emphasized throughout the last
several years its commitment to develop safer tobacco products, and the
resources needed to continue that effort, while lower in 1998 than 1997,
resulted in the issuance of the first patent ever for the production of
nitrosamine-free tobacco. In addition, the sale of the ophthalmic business in
December 1998 resulted in a charge to earnings for the discontinued operations
of $751,000. This was in addition to a loss on the disposal (sale) of the
ophthalmic business of $221,000. The Company also either wrote off or disposed
of various pieces of equipment no longer used in the tobacco business, resulting
in a charge to earnings of $425,316. The extraordinary gain of $252,000 is a
result of various settlements with the Company's creditors, reached prior to the
reverse acquisition in February 1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company improved its balance sheet during 1998 through various
means. While the last quarter of 1998 generated 45% of the year's sales, it also
enabled the Company to establish a line of credit under customary industry
terms, and allowed the Company to bring virtually all of its vendors current by
year's end. The balance sheet also reflects only the assets and liabilities of
the tobacco business, since the sale of the ophthalmic business was effected as
of December 30, 1998.
In addition, one of the Company's principal shareholders periodically
loaned funds to the Company during 1998, with no interest, totaling $715,000,
all of which was repaid by December 31, 1998.
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 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. 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. The balance of this loan at December
31, 1998 was zero.
The Company established a line of credit with a bank in December 1998
in the amount of $1 million, secured by accounts receivable, as well as the
personal guaranty of two of the Company's major shareholders. As of December 31,
1998, there was no outstanding balance on the newly established line.
In February and March, 1998, Star 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, Star 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 Star contributed to Star the equivalent of 3.75 million shares
of Star's Common Stock.
18
<PAGE> 20
In September 1998, the Company sold the equivalent of one million
shares in a private placement at $1.00 per share.
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 Star's products which utilize
tobacco which has been processed with such methods. Star will seek additional
equity funds for these purposes.
There can be no assurances that Star will be successful in obtaining
additional capital financing, as described above.
YEAR 2000 ISSUES
The Company has made an assessment of its information technology
systems relating to year 2000 issues at Star's Virginia facilities. The
assessment resulted in the development of a preliminary plan to prepare Star for
year 2000 readiness. The plan includes replacement of certain hardware systems
and the upgrading or replacement of software applications. The costs for
implementation of Star's plan is in the $50,000-$60,000 range; all such costs
have been expensed as incurred. Implementation has been substantially completed
and the domestic operations of Star have not been materially disrupted by the
implementation process.
Star has contacted key vendors to obtain assurances that the operations
of a key vendor, as they affect Star, will not be interrupted because of year
2000 issues. Star has received assurances from some but not all of the vendors
and therefore has not completed this process. Star does not rely upon vendors
for products or services that are data-dependent and believes that its customers
are not data-dependent with respect to the purchasing and reselling of products
such as those sold by Star. Therefore, Star believes that the failure of its
vendors to be compliant with Year 2000 issues will not cause a material
interruption in Star's business operations. Any such interruption, however,
would likely have a material adverse effect upon the operations of Star.
ITEM 7. FINANCIAL STATEMENTS.
This information is contained on Pages F-1 through F-18 hereof and is
incorporated into Part I of this report by reference.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE.
The information required by this item with respect to the change in the
Company's principal independent accountants (1) from Price Waterhouse LLP to
Olsen, Thielen & Co., Ltd., effective March 5, 1998, has been previously
reported in the Company's Current Report on Form 8-K dated March 30, 1998, (2)
from Olsen, Thielen & Co., Ltd. to Keiter, Stephens, Hurst, Gary & Shreaves,
P.C., effective September 4, 1998, has been previously reported in the Company's
Current Report on Form 8-K/A dated September 16, 1998, and (3) from Keiter,
Stephens, Hurst, Gary & Shreaves, P.C. to Aidman, Piser & Company, effective
January 15, 1999, has been previously reported in the Company's Current Report
on Form 8-K dated January 15, 1999.
19
<PAGE> 21
PART III
Pursuant to Instruction E.3. to Form 10-KSB, the information in Items
9-12 is incorporated by reference from the Company's definitive proxy statement
which will be filed with the Commission pursuant to Regulation 14A on or about
April 30, 1999. If such proxy statement is not filed by such date, this Form
10-KSB will be amended to include Items 9-12 on or about April 30, 1999.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
<TABLE>
<CAPTION>
NUMBER DESCRIPTION LOCATION
------ ----------- --------
<S> <C> <C>
2(a) Asset Purchase Agreement dated as of December Filed as Exhibit 10.1 to the
30, 1998 between Star Scientific, Inc., a Company's Current Report
Delaware Corporation and Eyetech, LLC, a on Form 8-K dated March 2,
Minnesota Limited Liability Company, by Robert 1999.
J. Fitzsimmons, an individual residing in
St. Paul, Minnesota
2(b) Escrow Agreement between Star Scientific, Inc., Filed as Exhibit 10.2 to the
a Delaware Corporation, Eyetech, LLC, a Company's Current Report
Minnesota Limited Liability Company on Form 8-K dated March 2,
and Robert J. Fitzsimmons, an individual residing in 1999.
St. Paul, Minnesota, and Jonnie R. Williams and Vincent
Ellis as Escrow Agents
3(i)(a) Restated Certificate of Incorporation Filed as Exhibit No. 3a to the
Company's Annual Report on
Form 10-KSB for fiscal year
ended December 31, 1992
3(i)(b) Certificate of Amendment of Restated Certificate Filed as Exhibit No. 3(i)(b) to
of Incorporation dated effective April 2, 1993 the Company's Annual
Report on Form 10-KSB for
fiscal year ended
December 31, 1996
3(i)(c) Certificate of Amendment of Restated Certificate Filed as Exhibit No. 3(i)(c) to
of Incorporation dated effective April 2, 1993 the Company's Annual
Report on Form 10-KSB for
fiscal year ended December
31, 1996
</TABLE>
20
<PAGE> 22
<TABLE>
<S> <C> <C>
3(i)(d) Certificate of Amendment of Certificate of Filed as Exhibit No. 3 to the
Incorporation dated December 15, 1998 Company's Current Report
on Form 8-K dated January
15, 1999
3(ii) Bylaws of the Company as Amended to Date Filed as Exhibit No. 3b to the
Company's Annual Report on
Form 10-FSB for fiscal year
ended December 31, 1992
4(a) Option to Purchase Shares of Common Stock Filed as Exhibit No. 4c to the
dated as of December 1, 1993, to Samuel P. Company's Annual Report on
Sears, Jr. Form 10-FSB for fiscal year
ended December 31, 1994
4(b) Certificate of Designations, Preferences and Filed as Exhibit No. 4h to the
Rights of Class A Convertible Preferred Stock Company's Annual Report on
Form 8-KSB, dated June 7,
1993
4(c) Certificate of Designation of Series B Filed as Exhibit No. 4c to the
Convertible Preferred Stock Company's Annual Report on
Form 10-KSB for fiscal year
ended December 31, 1996
4(d) Option to Purchase Shares of Common Stock Filed as Exhibit 4d to the
dated as of February 28, 1994, to Robert J. Company's Annual Report on
Fitzsimmons Form 10-KSB for fiscal year
ended December 31, 1994
10(a) Employment Agreement dated November 1, Filed as Exhibit No. 10ii to
1989, between Robert J. Fitzsimmons and Eye the Company's Annual
Technology, Inc. Report on Form 10-K for
fiscal year ended
December 31, 1989
10(b) Lease Agreement dated August 1990 for lease of Filed as Exhibit No. 10f to
offices and manufacturing space in St. Paul, the Company's Annual
Minnesota Report on Form 10-K for
fiscal year ended
December 31, 1990
10(c) First Amendment to Lease Agreement for lease Filed as Exhibit No. 10i to the
of office and manufacturing space in St. Paul, Company's Annual Report on
Minnesota Form 10-KSB for fiscal year
ended December 31, 1992
</TABLE>
21
<PAGE> 23
<TABLE>
<S> <C> <C>
10(d) License Agreement by and between Eye Filed as Exhibit No. 10w to
Technology, Inc. and Ioptex Research, Inc., the Company's Annual
dated September 28, 1990 Report on Form 10-K for
fiscal year ended
December 31, 1990
10(e) Addendum to License Agreement by and Filed as Exhibit No. 10n to
between Eye Technology, Inc. and Ioptex the Company's Annual
Research, Inc., dated January 13, 1994 Report on Form 10-KSB for
fiscal year ended
December 31, 1993
10(f) License Agreement by and between Eye Filed as Exhibit No. 10(f) to
Technology, Inc. and OII International, Inc., the Company's Annual
dated January 31, 1997 Report on Form 10-KSB for
fiscal year ended December
31, 1997
10(g) Equipment Lease Agreement by and between Eye Filed as Exhibit No. 10y to
Technology, Inc. And Noel G. Bissonette, dated the Company's Annual
August 31, 1990 Report on Form 10-K for
fiscal year ended December
31, 1990
10(h) Joint Venture Agreement by and among Eye Filed as Exhibit No. 10y to
Technology, Inc., Kera-Metrics, Inc., and the the Company's Annual
Stockholders of Kera-Metrics, Inc., dated Report on Form 10-KSB for
November 27, 1992 fiscal year ended
December 31, 1992
10(i) Distribution Agreement by and between Kera- Filed as Exhibit No.10z to the
Metrics Corporation and Eye Technology, Inc., Company's Annual Report on
dated November 27, 1992 Form 10-KSB for fiscal year
ended December 31, 1992
10(j) Promissory Note from Eye Technology, Inc. to Filed as Exhibit No. 10dd to
Burns & Levinson, dated June 4, 1993 the Company's Annual
Report on Form 10-KSB for
fiscal year ended
December 31, 1993
10(k) Consulting and License Agreement by and Filed as Exhibit No. 10ee to
between Eye Technology, Inc. and Paul Fyfe, the Company's Annual
dated October 29, 1993 Report on Form 10-FSB for
fiscal year ended
December 31, 1993
</TABLE>
22
<PAGE> 24
<TABLE>
<S> <C> <C>
10(l) Accounts Receivable Financing Agreement dated Filed as Exhibit No. 10z to
June 2, 1994 between the Company and Republic the Company's Annual
Acceptance Corporation Report on Form 10-KSB for
fiscal year ended
December 31, 1994
10(m) Security Agreement dated June 2, 1994, between Filed as Exhibit No. 10aa to
the Company and Republic Acceptance the Company's Annual
Corporation Report on Form 10-KSB for
fiscal year ended December
31, 1994
10(n) Security Agreement dated June 2, 1994, between Filed as Exhibit No. 10bb to
Eye Technology International, Inc. and Republic the Company's Annual
Acceptance Corporation Report on Form 10-FSB for
fiscal year ended December
31, 1994
10(o) Guaranty of Payment for Existing and/or Future Filed as Exhibit No. 10cc to
Indebtedness, dated June 2, 1994 between Eye the Company's Annual
Technology International, Inc. and Republic Report on Form 10-KSB for
Acceptance Corporation fiscal year ended
December 31, 1994
10(p) Amendment to Agreement by and between the Filed as Exhibit No. 10ee to
Company and Microprecision Instrument the Company's Annual
Company, Inc., dated December 31, 1994 Report on Form 10-KSB for
fiscal year ended
December 31, 1994
10(q) Amendment to Agreement by and between the Filed as Exhibit No. 10ff to
Company and Microprecision Instrument the Company's Annual
Company, Inc., dated March 28, 1995 Report on Form 10-KSB for
fiscal year ended
December 31, 1994
10(r) Stock Exchange Agreement dated February 6, Filed as Exhibit No. 10.1 to
1998 between the Company and the stockholders the Company's Current
of Star Tobacco and Pharmaceuticals, Inc. Report on Form 8-K, dated
February 19, 1998
10(s) License Agreement dated January 5, 1998 by and Filed as Exhibit No. 10 to the
between Star Tobacco and Pharmaceuticals, Inc., Company's Quarterly Report
as Licensee and as Licensor, Regent on Form 10-QSB for the
Technologies, Jonnie R. Williams, and Francis E. quarterly period ended March
O'Donnell, Jr., M.D. 31, 1998.
</TABLE>
23
<PAGE> 25
<TABLE>
<S> <C> <C>
10(t) Letter Agreement dated July 6, 1998, between Filed as Exhibit No. 10(a) to
the Company and MFC Merchant Bank S.A. the Company's Quarterly
Report on Form 10-QSB for
the quarterly period ended
September 30, 1998.
10(u) Exclusive Supply Agreement dated August 18, Filed as Exhibit No. 10(b) to
1998, between Star Tobacco and Pharmaceutical, the Company's Quarterly
Inc. And Amana Company, L.P. Report on Form 10-QSB for
the quarterly period ended
September 30, 1998.
10(v) Purchase and Sale Agreement dated July 10, Filed as Exhibit 10 to the
1998 by and between Prometheus Pacific Growth Company's Current Report
Fund LDC, a Cayman Island Limited Duration on Form 8-K dated July 15,
Company, and Eye Technology, Inc., a Delaware 1998.
Corporation
10(w) Amendment No. 1 to License Agreement dated Filed as Exhibit 10 to the
August 3, 1998 among Regent Court Company's Current Report
Technologies, Jonnie R. Williams, Francis E. on Form 8-K dated
O'Donnell, Jr., M.D. and Star Tobacco and September 11, 1998.
Pharmaceuticals, Inc.
10(x) 1998 Stock Option Plan Filed herewith.
16(a) Response Letter dated April 10, 1998 from Price Incorporated by reference to
Waterhouse LLP Exhibit 1 to the Company's
Current Report on Form 8-K
dated April 10, 1998.
16(b) Response Letter dated September 15, 1998 from Incorporated by reference to
Olsen, Thielen & Co., Ltd Exhibit 16 of the Company's
Current Report on Form 8-K/A
dated September 16, 1998.
16(c) Response Letter dated January 20, 1999 from Incorporated by reference to
Keiter, Stephens, Hurst, Gary & Shreaves Exhibit 16 of the Company's
Current Report on Form 8-K
dated January 15, 1999.
21 Subsidiaries of the Company Filed herewith.
23 Consent of Independent Public Accountants Filed herewith.
27 Financial Data Schedule Filed herewith.
</TABLE>
(b) Reports on Form 8-K
None
24
<PAGE> 26
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant
caused this Report to be signed on its behalf by the undersigned, thereunto duly
authorized.
STAR SCIENTIFIC, INC.
(Registrant)
By: /s/ Robert J. DeLorenzo
-----------------------------------------------------
Robert J. DeLorenzo, Chairman of the Board and
Chief Executive Officer (Principal Executive Officer)
Date: April 14, 1999
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By: /s/ Robert J. DeLorenzo
-----------------------------------------------------
Robert J. DeLorenzo, Chairman of the Board and
Chief Executive Officer (Principal Executive Officer)
Date: April 14, 1999
By: /s/ James A. McNulty
-----------------------------------------------------
James A. McNulty, Chief Financial Officer and
Director (Principal Financial and Accounting Officer)
Date: April 14, 1999
By: /s/ Malcolm L. Bailey
-----------------------------------------------------
Malcolm L. Bailey, President and Director
Date: April 14, 1999
By: /s/ Jonnie R. Williams
-----------------------------------------------------
Jonnie R. Williams, Chief Operating Officer, Executive
Vice President and Director
Date: April 14, 1999
By: /s/ Leo S. Tonkin
-----------------------------------------------------
Leo S. Tonkin, Director
Date: April 14, 1999
<PAGE> 27
STAR SCIENTIFIC, INC.
Index to Consolidated Financial Statements
<TABLE>
<CAPTION>
Description Page(s)
----------- -------
<S> <C>
Independent Auditors' Report F-2
Balance Sheet as of December 31, 1998 F-3
Statements of Operations
for the Years Ended December 31, 1998 and 1997 F-4
Statements of Stockholders' Deficit
for the Years Ended December 31, 1998 and 1997 F-5
Statements of Cash Flows
for the Years Ended December 31, 1998 and 1997 F-6
Notes to Financial Statements F-8 - F-19
</TABLE>
F-1
<PAGE> 28
Independent Auditors' Report
To the Board of Directors and Stockholders of
Star Scientific, Inc. and Subsidiaries
Petersburg, Virginia
We have audited the accompanying consolidated balance sheet of Star Scientific,
Inc. and Subsidiaries (formerly known as Eye Technology, Inc. and Subsidiaries)
as of December 31, 1998 and the related consolidated statements of operations,
stockholders' deficit, and cash flows for the year then ended. 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 audit. The financial statements of Star Scientific, Inc. and Subsidiaries
for the year ended December 31, 1997 were audited by other auditors whose report
dated March 24, 1998, expressed an unqualified opinion on those statements.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
As discussed in Note 13, the Company elected not to join in the Master
Settlement Agreement ("MSA") among forty-six states, several U.S. territories
and a number of tobacco manufacturers, as a Subsequent Participating
Manufacturer. The ultimate impact of opting out of the "MSA" on the Company's
future operations is not presently determinable.
In our opinion, the consolidated 1998 financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Star Scientific, Inc. and Subsidiaries as of December 31, 1998 and the
consolidated results of their operations and their cash flows for the year then
ended in conformity with generally accepted accounting principles.
/s/ Aidman, Piser & Company, P.A.
March 26, 1999
Tampa, Florida
F2
<PAGE> 29
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1998
<TABLE>
<S> <C>
ASSETS
Current assets:
Cash $ 102,695
Accounts receivable:
Trade, net of $95,636 allowance for
doubtful accounts 1,497,457
Other 68,271
Inventories 636,456
Prepaid expenses and other current
assets 197,401
-----------
Total current assets 2,502,280
Property, plant and equipment, net 1,704,569
Intangibles, net of $162,045 accumulated
amortization 135,928
Notes receivable, net of $27,400
allowance for uncollectible accounts 92,379
-----------
$ 4,435,156
===========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Current maturities of notes payable $ 379,082
Accounts payable, trade 2,516,658
Federal excise taxes payable 876,875
Accrued expenses 646,115
-----------
Total current liabilities 4,418,730
Notes payable, less current maturities 611,584
-----------
Total liabilities 5,030,314
Commitments and contingencies
Redeemable preferred stock (Series A,
convertible, 250 shares issued and
outstanding, at liquidation value) 44,000
-----------
Stockholders' deficit:
Common stock(A) 98,198
Preferred stock(B) 143
Additional paid-in capital 6,668,392
Accumulated deficit (7,326,724)
Unearned compensation (79,167)
-----------
Total stockholders' deficit (639,158)
-----------
$ 4,435,156
===========
</TABLE>
(A) ($.01 par value, 100,000,000 shares authorized, 9,819,740 shares issued and
outstanding)
(B) (Series B, convertible; 15,000 shares authorized, 14,267 shares issued and
outstanding)
See notes to consolidated financial statements.
F3
<PAGE> 30
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Net sales $ 19,445,491 $ 20,763,856
Less:
Cost of goods sold 7,669,428 10,033,330
Excise taxes on products 8,837,868 7,810,720
------------ ------------
Gross profit 2,938,195 2,919,806
------------ ------------
Operating expenses:
Marketing and distribution expenses 1,198,757 1,111,420
General and administrative expenses 3,173,991 1,425,299
Research and development 1,377,657 2,134,656
------------ ------------
Total operating expenses 5,750,405 4,671,375
------------ ------------
Operating loss (2,812,210) (1,751,569)
------------ ------------
Other expenses:
Interest expense (net of interest income;
1998, $17,167; 1997, $21,073) (237,946) (234,928)
Loss on disposal of assets (425,316) --
------------ ------------
(663,262) (234,928)
------------ ------------
Loss from continuing operations (3,475,472) (1,986,497)
Discontinued operations:
Loss from discontinued operations (no applicable
income taxes) (751,080) --
Loss on disposal of business segment (no
applicable income taxes) (221,290) --
------------ ------------
Loss before extraordinary item (4,447,842) (1,986,497)
Extraordinary gain from extinguishment of
debt (no applicable income taxes) 251,767 --
------------ ------------
Net loss $ (4,196,075) $ (1,986,497)
============ ============
Basic and diluted loss per common share:
Continuing operations $ (.42) $ (.58)
Discontinued operations (.12) --
Extraordinary gain .03 --
------------ ------------
Net loss $ (.51) $ (.58)
============ ============
Weighted average shares outstanding 8,327,345 3,435,190
============ ============
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 $ (1,986,487)
------------
Pro forma basic loss per share $ (.58)
============
</TABLE>
See notes to consolidated financial statements.
F4
<PAGE> 31
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
Preferred Stock Common Stock
------------------ ------------------
Series B Additional Unearned
------------------ Paid-In Accumulated Treasury Compen-
Shares Amount Shares Amount Capital Deficit Shares Amount sation
-------- -------- --------- -------- ---------- ----------- ---------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balances, January 1, 1997 -- $ -- 200 $383,557 $ 16,320 $ (988,004) -- $ -- $ --
Collection of note receivable
Conversion of note payable to
equity 923,499
Capital contribution 64,788
Net loss for the year (1,986,497)
Distributions (156,148)
-------- -------- --------- -------- ---------- ----------- ---------- -------- --------
Balances, December 31, 1997 -- -- 200 383,577 1,004,607 (3,130,649) -- -- --
Conversion of debt to equity 1,402,550 14,026 483,623
Reverse merger and reorganization 3,434,900 (349,205) (117,577)
Stock issued pursuant to merger 13,831 138 (138)
Mandatory redeemable preferred
stock converted to common 232,000 2,320 229,680
Increase of Series A Preferred
Stock to Redemption value (19,000)
Exchange of common stock for
preferred 305 3 -- (3) (1,000,000) --
Shares gifted to company and
retired (1,144) (11) 11
Issuance of common stock pursuant
to private placements 763 8 4,400,000 44,000 3,905,992 1,000,000 --
Issuance of preferred stock
pursuant to private placements 304 3 999,997
Stock issuance costs (220,000)
Stock issued for current and
future services 208 2 300,000 3,000 243,098 (79,167)
Warrants issued for services -- -- -- 51,660
Conversion of debt to equity -- -- 50,000 500 106,442
Net loss for the year (4,196,075)
-------- -------- --------- -------- ---------- ----------- ---------- -------- --------
Balances, December 31, 1998 14,267 $ 143 9,819,740 $ 98,198 $6,668,392 $(7,326,724) -- -- (79,167)
======== ======== ========= ======== ========== =========== ========== ======== ========
<CAPTION>
Notes
Receivable
Stockholders Total
-------------- -----------
<S> <C> <C>
Balances, January 1, 1997 $ (250,000) $ (838,127)
Collection of note receivable 250,000 250,000
Conversion of note payable to
equity 923,499
Capital contribution 64,788
Net loss for the year (1,986,497)
Distributions 156,148)
-------------- -----------
Balances, December 31, 1997 -- (1,742,485)
Conversion of debt to equity 497,649
Reverse merger and reorganization (466,782)
Stock issued pursuant to merger --
Mandatory redeemable preferred
stock converted to common 232,000
Increase of Series A Preferred
Stock to Redemption value (19,000)
Exchange of common stock for
preferred --
Shares gifted to company and
retired --
Issuance of common stock pursuant
to private placements 3,950,000
Issuance of preferred stock
pursuant to private placements 1,000,000
Stock issuance costs (220,000)
Stock issued for current and
future services 166,933
Warrants issued for services 51,660
Conversion of debt to equity 106,942
Net loss for the year (4,196,075)
-------------- -----------
Balances, December 31, 1998 -- $ (639,158)
============== ===========
</TABLE>
See notes to consolidated financial statements.
F5
<PAGE> 32
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Operating activities:
Net loss $(4,196,075) $(1,986,497)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation 359,135 355,292
Amortization of intangibles and other
non-cash charges 610,077 68,385
Increase in allowance for doubtful accounts 27,400 --
Loss on fixed asset disposal 425,316 --
Compensation and consulting fee expense
resulting from issuance of common stock and
warrants 325,535 --
Extraordinary gain on extinguishment of debt (251,766)
Increase (decrease) in cash resulting from
changes in:
Accounts receivable, trade (722,289) 540,248
Accounts receivable, other (68,271) --
Inventories (31,064) 1,011,439
Prepaid expenses (164,137) 24,324
Accounts payable (57,582) 458,300
Federal excise taxes payable 517,092 (178,086)
Accrued expenses 561,007 (52,093)
----------- -----------
Net cash provided by (used in) operating activities (2,665,622) 241,312
----------- -----------
Investing activities
Collections of notes receivable 1,915 19,045
Purchases of property and equipment (454,888) (3,530)
Proceeds from disposal of property and equipment 175,000 --
Purchases of intangible assets (48,815) --
----------- -----------
Net cash provided by (used in) investing
activities (326,788) 15,515
----------- -----------
</TABLE>
Continued
F6
<PAGE> 33
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
STATEMENT OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Financing activities:
Payments on line of credit, net (1,095,801) (266,334)
Proceeds from notes payable -- 300,000
Payments on notes payable (550,023) (198,788)
Proceeds from sale of stock 4,950,000 64,788
Stockholder distributions -- (156,148)
Stock offering costs paid (220,000) --
----------- -----------
Net cash provided (used in) by financing
activities 3,084,176 (256,482)
----------- -----------
Increase in cash 91,766 345
Cash, beginning of year 10,929 10,584
----------- -----------
Cash, end of year $ 102,695 $ 10,929
=========== ===========
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest $ 254,713 $ 230,370
=========== ===========
Supplemental schedule of noncash 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 $ 255,000 $ --
=========== ===========
Acquisition (reverse merger):
Fair value of assets acquired $ 1,237,238 $ --
Liabilities assumed (2,001,688) --
----------- -----------
Excess assigned to goodwill $ 764,450 $ --
=========== ===========
</TABLE>
See notes to consolidated financial statements.
F7
<PAGE> 34
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Organization and basis of presentation:
Star Scientific, Inc. and Subsidiaries was formerly known as Eye
Technology, Inc. and Subsidiaries (the "Company"). During December
1998, the Company changed its name to Star Scientific, Inc.
On February 6, 1998, the Company and its subsidiaries, entered into a
stock exchange agreement with the stockholders of Star Tobacco and
Pharmaceuticals, Inc. ("Star"), a privately owned corporation. Under
the agreement, Star stockholders exchanged all of their common stock
for 13,831 shares of Series B Preferred Stock, par value $.01 per
share. When converted, this stock would equal 45,365,680 shares of
common stock, or approximately 90% of the outstanding common stock of
the Company and its subsidiaries as of the conversion date.
Accounting Principles Board Opinion No. 16 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 retains or
receives 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 amounted to
$764,450 and was assigned to goodwill which was being amortized over
five years on a straight line basis (see Note 2 for disposal of this
business segment).
The accompanying consolidated financial statements include the accounts
of Star, and the Company and its Subsidiaries. All intercompany
accounts and transactions have been eliminated. The results of
operations of the Company are included in the accompanying consolidated
financial statements from the date of acquisition.
F8
<PAGE> 35
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
The following summarized pro forma information assumes the acquisition
had occurred as of January 1, 1997.
<TABLE>
<CAPTION>
1998 1997
------------------ ------------------
<S> <C> <C>
Net sales $ 20,134,099 $ 22,097,287
Operating loss $ (3,299,669) $ (2,252,324)
Net loss $ (4,209,784) $ (2,316,688)
Loss per share:
Basic and diluted $ (.51) $ (.67)
</TABLE>
Nature of business:
Star has been engaged since 1991 in the manufacture and sale of tobacco
products. Since 1994, Star has also engaged in extensive research and
development activities relating to the production of less harmful
tobacco products and to the development of tobacco products and smoking
cessation products which contain 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, Star introduced to the consumer market a chewing gum
containing an FDA-approved tobacco flavoring.
During 1997, Star had sales to one customer which represented
approximately 19% of net sales. There were no sales to this customer in
1998.
Advertising Costs:
Advertising costs are expensed as incurred and are included in
marketing and distribution expenses. For the years ended December 31,
1998 and 1997, advertising costs were $38,000 and $60,000,
respectively.
Use of estimates:
Management uses estimates and assumptions in preparing financial
statements in accordance with generally accepted accounting principles.
Those estimates and assumptions affect the reported amount of assets
and liabilities, the disclosure of contingent assets and liabilities,
and the reported revenues and expenses. Actual results could vary from
the estimates that were used.
F9
<PAGE> 36
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
Fair value of financial instruments:
Financial instruments consist of cash, short-term trade receivables and
payables for which the current carrying amounts approximate fair value.
Additionally, the borrowing rates currently available to the Company
approximate the rates for debt agreements with similar terms and
average maturities.
Inventories:
Inventories are valued at the lower of cost or market. Cost is
determined on the first-in, first-out (FIFO) method.
Property, plant and equipment:
Property, plant 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 office equipment and machinery and equipment
and thirty-nine years for buildings and improvements.
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.
Income taxes:
Star has been an S Corporation since August 1, 1991 for federal income
tax purposes. Accordingly, the taxable income or loss of Star 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 1, Star had a change in ownership and
merged with the Company, which caused the income tax status of Star to
change. Management believes that Star was no longer eligible for S
corporation status effective February 6, 1998. As a C corporation, Star
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.
F10
<PAGE> 37
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
Credit risk:
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash and accounts
and notes receivables.
The Company maintains its cash balances in three financial
institutions, including approximately $64,000 in one foreign bank. Each
of the balances in the two domestic banks 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.
Notes receivable are unsecured, but management believes they are
collectible in the ordinary course of business.
Employee stock-based compensation:
The Company accounts for compensation costs associated with stock
options and warrants issued to employees under the provisions of
Accounting Principle Board Opinion No. 25 ("APB 25") whereby
compensation is recognized to the extent the market price of the
underlying stock exceeds the exercise price of the option at the date
of grant. The Company has adopted the disclosure provisions of
Financial Accounting Standard No. 123 - Accounting for Stock-Based
Compensation ("FAS 123"), which requires disclosure of compensation
expense that would have been recognized if the fair-value based method
of determining compensation had been used for all arrangements under
which employees receive shares of stock or equity instruments (warrants
and options).
Research and development costs:
Research and development costs are charged to expense when incurred.
F11
<PAGE> 38
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
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.
Basic loss per common share was computed using the weighted-average
number of common shares outstanding. Potential common shares
outstanding were excluded as their effect was antidilutive.
2. DISCONTINUED OPERATIONS:
On December 30, 1998, the Company completed the sale of its opthalmic
and intraocular business. As a result thereof, the Company has recorded
an after tax loss on the disposal of $221,290. Results of operations of
the discontinued business segment have been classified as discontinued
operations from the date of the Eye Tech acquisition in February 1998
through December 31, 1998.
Net sales and loss from discontinued operations are as follows:
<TABLE>
<S> <C>
Net sales $ 629,715
-------------
Operating losses $ 751,080
-------------
Income taxes -
-------------
Loss from discontinued operations $ 751,080
-------------
Loss on disposal $ 221,090
-------------
</TABLE>
F12
<PAGE> 39
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
3. INVENTORIES:
Inventories consist of the following:
<TABLE>
<S> <C>
Raw materials $ 329,238
Packaging materials 262,467
Finished goods 44,751
------------
$ 636,456
============
</TABLE>
4. PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment consists of the following:
<TABLE>
<S> <C>
Land $ 172,572
Buildings and improvements 269,484
Machinery and equipment 1,973,926
Sales equipment 403,302
Office equipment 116,074
------------
2,935,358
Less accumulated depreciation 1,230,789
------------
$ 1,704,569
============
</TABLE>
5. NOTES RECEIVABLE:
Notes receivable consists of the following:
Note receivable from an unrelated entity.
Interest at 9.25%, due upon demand. $ 54,807
Note receivable from an unrelated entity.
Interest at 8.00%, due in monthly
installments of $600 through November, 2001. 64,972
------------
119,779
Less allowance for doubtful accounts 27,400
------------
$ 92,379
============
6. LINE OF CREDIT:
The Company has a revolving line of credit agreement with a bank that
provides up to $1,000,000 for working capital requirements with
interest charged monthly on outstanding amounts at 9.875%. Amounts
borrowed are collateralized by the accounts receivable. At December 31,
1998, there were no borrowings under the line of credit agreement.
F13
<PAGE> 40
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
7. NOTES PAYABLE:
Notes payable consists of the following:
<TABLE>
<S> <C>
Note payable, bank due in monthly
installments of $3,111, including interest
at prime plus 1%, to 2001; secured by real
property and guaranteed by certain
stockholders. 275,393
Term note payable, finance company, due in
monthly installments of $21,047, including
interest at 10.15% through September 2001;
secured by manufacturing equipment. 362,247
Term note payable, finance company, due in
monthly installments of $7,262, including
interest at 9.31% through October 2001;
secured by manufacturing equipment. 216,292
Term note payable, finance company, due in
monthly installments of $1,206, including
interest at 8.95% through January 2002;
secured by manufacturing equipment. 40,622
Term note payable due in 1999. Interest at
9.5% is payable monthly. 85,000
Other 11,112
---------
990,666
Less current maturities 379,082
---------
$ 611,584
=========
</TABLE>
The annual maturities of notes payable are as follows:
<TABLE>
<CAPTION>
Year ending December 31
-----------------------
<S> <C>
1999 $ 379,082
2000 274,939
2001 333,373
2002 3,272
----------
$ 990,666
==========
</TABLE>
F14
<PAGE> 41
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
8. STOCKHOLDERS' EQUITY:
Increase in authorized common stock:
During the year ended December 31, 1998, the Company increased its
authorized shares of common stock from 10,000,000 shares to 100,000,000
shares.
Preferred stock:
Series A:
The Company has authorized 4,000 shares of $.01 par value Class A
Convertible Redeemable preferred stock. Each share of the Preferred
Stock is convertible into 100 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. Redemption of the Preferred Stock may be accelerated,
at the option of the holder or the Company, upon the Company's receipt
of 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
$176 per share at December 31, 1998, and increasing at a rate of 8%
each July 1 thereafter. The carrying value of the Preferred Stock
reflects the additional acceleration premium as the Company has raised
funds in excess of the defined amounts.
Series B:
During the year ended December 31, 1998, the Company authorized 15,000
shares of $.01 par value Series B Preferred Stock. The stock bears
discretionary dividends at $150 per share annually. The stock is
redeemable at the Company's option at $3,000 per share, plus unpaid
accrued dividends, on or after December 31, 2022. The stock is
convertible into common stock at the holders' option prior to December
31, 2002 at 3,280 shares of common for each share of Series B
Preferred. Holders of Series B Preferred Stock are entitled to 500
votes for each share held.
F15
<PAGE> 42
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
8. STOCKHOLDERS' EQUITY, CONTINUED:
Common stock warrants:
Common stock warrants issued, redeemed and outstanding during the year
ended December 31, 1998 are as follows:
<TABLE>
<S> <C>
Issued in connection with private placement
of stock, exercise price of $2 per share,
expiring September 2000 (remaining
contractual life 1.75 years). 1,000,000
----------
Warrants issued and outstanding at
December 31, 1998 1,000,000
==========
</TABLE>
No warrants were exercised or forfeited during 1998.
Stock option plan:
The Company has adopted a stock option and rights plan (the "Plan")
covering 4,000,000 shares of the Company's common stock, pursuant to
which employees of the Company are eligible to receive qualified
incentive as well as non-qualified stock options. Options granted under
the Plan are exercisable up to 10 years from the date of grant at an
exercise price not less than the fair market value of the common stock
on the date of the grant. The Company may also issue stock options to
non-employees outside of the plan.
Stock options issued in 1998 and outstanding at December 31, 1998 are
as follows:
<TABLE>
<CAPTION>
Exercise
Price Expiration Number
-------- ---------- ---------
<S> <C> <C> <C>
Issued to officers and directors
for past and future services $ 2.00 Dec. 2008 800,000
Issued to a director for past
services $ 1.00 Dec. 2008 200,000
Issued to employees for past
services $ 2.00 Dec. 2008 15,000
---------
1,015,000
=========
</TABLE>
F16
<PAGE> 43
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
8. STOCKHOLDERS' EQUITY, CONTINUED:
The number and weighted average exercise price of options are as
follows:
<TABLE>
<CAPTION>
1998
------------------------
Weighted
Average
Exercise
Price Per
Number Share
----------- ---------
<S> <C> <C>
Outstanding at beginning of year 0 $ -
Granted during year 1,015,000 $ 1.80
----------- ---------
Outstanding at end of year 1,015,000 $ 1,80
=========== =========
</TABLE>
The weighted average remaining contractual life of options outstanding
at December 31, 1998 was approximately ten years. No options were
exercised, forfeited or expired during 1998 or 1997.
As discussed in Note 1, the Company has adopted the disclosure
provisions only of FAS 123. The fair value of 415,000 options issued to
employees in 1998 aggregated approximately $36,000 as determined using
the "Black Scholes" option-pricing model. Compensation cost of
approximately $36,000 would have been recognized in 1998 had the
Company adopted the accounting provisions of FAS 123 for options issued
to employees.
The "Black Scholes" option-pricing model assumptions are as follows:
<TABLE>
<S> <C>
Underlying stock price at grant date $2.00
Exercise price $1.00-2.00
Dividend yield 0%
Risk-free interest rate 6%
Volatility 10%
</TABLE>
F17
<PAGE> 44
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
9. INCOME TAXES:
At December 31, 1998 the Company had a net operating loss carryforward
of approximately $4,000,000 in 2013. No provision for income taxes has
been reflected in the accompanying consolidated statements of
operations since a valuation allowance has been established for the net
deferred tax benefit of $1,400,000 because it is not possible to
determine the recoverability of such tax benefits.
The provision for income taxes varies from that which would be expected
based upon applying the statutory federal rate to pre-tax accounting
loss as follows:
<TABLE>
<CAPTION>
1998 1997
--------- ----------
<S> <C> <C>
Statutory federal rate (35)% (35)%
Increase in deferred tax asset valuation
allowance 35% 35%
--------- ----------
Effective rate 0% 0%
========= ==========
</TABLE>
F18
<PAGE> 45
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
10. 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 transactions for the years
ended December 31, 1998 and 1997.
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Interest expense $ 15,000 $ 28,975
Management fee expense - 565,000
Aircraft expenses 185,544 238,750
</TABLE>
Effective January 1, 1998, Star has entered into a license agreement
with a partnership owned by certain principal stockholders wherein Star
has the exclusive world-wide rights to produce and sell tobacco
products with TSNA (tobacco specific nitrosomines) - free tobacco. In
connection with this agreement, Star is obligated to pay royalties
equal to 2% of all product sales (less certain costs) and 6% of any
royalty income earned from sublicensing (less certain costs). There
were no sales of this product in 1998 and, as such, no royalties are
due.
11. EMPLOYEE BENEFIT PLAN:
In 1995, the Company became the sponsor of a defined contribution
retirement plan under Section 401(K) of the Internal Revenue Code. The
plan covers 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 1998 or 1997.
F19
<PAGE> 46
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
12. LEASES:
The following represents the 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, 1998.
<TABLE>
Year ending December 31, Amount
------------------------ ------------
<S> <C>
1999 $ 104,013
2000 6,808
------------
$ 110,821
============
</TABLE>
Lease expense for all leases, including leases with terms of less than
one year, amounted to approximately $107,000 and $170,000 for the years
ended December 31, 1998 and 1997, respectively.
13. CONTINGENT LIABILITIES:
Master settlement agreement:
In February 1999, the Company's Board of Directors voted unanimously
not to join the Master Tobacco Settlement Agreement ("MSA") among
forty-six states, several U.S. territories and a number of tobacco
manufacturers, as a Subsequent Participating Manufacturer. The MSA and
the proposed model statutes that each participating state is obligated
to enact as part of the MSA, do not contain any provisions that reward
or encourage companies like Star that have sought to develop and
promote safer tobacco products. To rectify this inequality, the Company
proposed an amendment to the MSA that would have recognized its
commitment to research and development over the past several years and
would have allowed it to continue to promote those efforts under the
grandfather provisions in the MSA that apply to Subsequent
Participating Manufacturers. The Company was subsequently advised that
its proposal was rejected.
After careful consideration, the Board of Directors determined that it
was not in Star's long term interest to join in the MSA without an
acceptable amendment. As a Non-Participating Manufacturer, Star, absent
a successful legal challenge, some subsequent agreement to modify the
MSA or individual state amendments to the proposed model statutes,
could be required to establish escrow funds under model statutes to be
enacted by each participating state that would be available to pay for
tobacco-related judgments or settlements, if claims are asserted by
participating states against Star. These escrow payments could be
substantial. To date, Star has not been named as a party in any tobacco
related litigation. Star is continuing to assess the impact that opting
out of the MSA, and potentially having to fund state-specific escrow
accounts, will have on its future business operations.
F20
<PAGE> 47
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
14. RISKS AND UNCERTAINTIES:
The Company has incurred losses from operations and has a net working
capital and equity deficit. These factors are due in part to the
Company's significant investment in research and development activities
as well as legal and consulting fees resulting from matters related to
the Master Settlement Agreement discussed in Note 13. The major
stockholders of the Company have agreed to financially support the
operations of the entity and have the ability to do so.
F21
<PAGE> 48
CONSENT OF INDEPENDENT CERTIFIED ACCOUNTANTS
Star Scientific, Inc. and Subsidiaries
Petersburg, Virginia
As independent certified public accountants for Star Scientific, Inc. and
Subsidiaries, we hereby consent to the use in this Form 10-KSB Annual Report for
Star Scientific, Inc. and Subsidiaries of our report included herein, which has
a date of March 26, 1999 relating to the consolidated balance sheet of Star
Scientific, Inc. and Subsidiaries as of December 31, 1998 and the related
consolidated statements of operations, cash flows, and stockholders' equity for
the year then ended.
/s/ Aidman, Piser & Company, P.A.
Tampa, Florida
April 15, 1999
F22
<PAGE> 49
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
NUMBER DESCRIPTION LOCATION
------ ----------- --------
<S> <C> <C>
2(a) Asset Purchase Agreement dated as of December Filed as Exhibit 10.1 to the
30, 1998 between Star Scientific, Inc., a Company's Current Report
Delaware Corporation and Eyetech, LLC, a on Form 8-K dated March 2,
Minnesota Limited Liability Company, by Robert 1999.
J. Fitzsimmons, an individual residing in
St. Paul, Minnesota
2(b) Escrow Agreement between Star Scientific, Inc., Filed as Exhibit 10.2 to the
a Delaware Corporation, Eyetech, LLC, a Company's Current Report
Minnesota Limited Liability Company on Form 8-K dated March 2,
and Robert J. Fitzsimmons, an individual residing in 1999.
St. Paul, Minnesota, and Jonnie R. Williams and Vincent
Ellis as Escrow Agents
3(i)(a) Restated Certificate of Incorporation Filed as Exhibit No. 3a to the
Company's Annual Report on
Form 10-KSB for fiscal year
ended December 31, 1992
3(i)(b) Certificate of Amendment of Restated Certificate Filed as Exhibit No. 3(i)(b) to
of Incorporation dated effective April 2, 1993 the Company's Annual
Report on Form 10-KSB for
fiscal year ended
December 31, 1996
3(i)(c) Certificate of Amendment of Restated Certificate Filed as Exhibit No. 3(i)(c) to
of Incorporation dated effective April 2, 1993 the Company's Annual
Report on Form 10-KSB for
fiscal year ended December
31, 1996
3(i)(d) Certificate of Amendment of Certificate of Filed as Exhibit No. 3 to the
Incorporation dated December 15, 1998 Company's Current Report
on Form 8-K dated January
15, 1999
3(ii) Bylaws of the Company as Amended to Date Filed as Exhibit No. 3b to the
Company's Annual Report on
Form 10-FSB for fiscal year
ended December 31, 1992
4(a) Option to Purchase Shares of Common Stock Filed as Exhibit No. 4c to the
dated as of December 1, 1993, to Samuel P. Company's Annual Report on
Sears, Jr. Form 10-FSB for fiscal year
ended December 31, 1994
</TABLE>
<PAGE> 50
<TABLE>
<S> <C> <C>
4(b) Certificate of Designations, Preferences and Filed as Exhibit No. 4h to the
Rights of Class A Convertible Preferred Stock Company's Annual Report on
Form 8-KSB, dated June 7,
1993
4(c) Certificate of Designation of Series B Filed as Exhibit No. 4c to the
Convertible Preferred Stock Company's Annual Report on
Form 10-KSB for fiscal year
ended December 31, 1996
4(d) Option to Purchase Shares of Common Stock Filed as Exhibit 4d to the
dated as of February 28, 1994, to Robert J. Company's Annual Report on
Fitzsimmons Form 10-KSB for fiscal year
ended December 31, 1994
10(a) Employment Agreement dated November 1, Filed as Exhibit No. 10ii to
1989, between Robert J. Fitzsimmons and Eye the Company's Annual
Technology, Inc. Report on Form 10-K for
fiscal year ended
December 31, 1989
10(b) Lease Agreement dated August 1990 for lease of Filed as Exhibit No. 10f to
offices and manufacturing space in St. Paul, the Company's Annual
Minnesota Report on Form 10-K for
fiscal year ended
December 31, 1990
10(c) First Amendment to Lease Agreement for lease Filed as Exhibit No. 10i to the
of office and manufacturing space in St. Paul, Company's Annual Report on
Minnesota Form 10-KSB for fiscal year
ended December 31, 1992
10(d) License Agreement by and between Eye Filed as Exhibit No. 10w to
Technology, Inc. and Ioptex Research, Inc., the Company's Annual
dated September 28, 1990 Report on Form 10-K for
fiscal year ended
December 31, 1990
10(e) Addendum to License Agreement by and Filed as Exhibit No. 10n to
between Eye Technology, Inc. and Ioptex the Company's Annual
Research, Inc., dated January 13, 1994 Report on Form 10-KSB for
fiscal year ended
December 31, 1993
</TABLE>
<PAGE> 51
<TABLE>
<S> <C> <C>
10(f) License Agreement by and between Eye Filed as Exhibit No. 10(f) to
Technology, Inc. and OII International, Inc., the Company's Annual
dated January 31, 1997 Report on Form 10-KSB for
fiscal year ended December
31, 1997
10(g) Equipment Lease Agreement by and between Eye Filed as Exhibit No. 10y to
Technology, Inc. And Noel G. Bissonette, dated the Company's Annual
August 31, 1990 Report on Form 10-K for
fiscal year ended December
31, 1990
10(h) Joint Venture Agreement by and among Eye Filed as Exhibit No. 10y to
Technology, Inc., Kera-Metrics, Inc., and the the Company's Annual
Stockholders of Kera-Metrics, Inc., dated Report on Form 10-KSB for
November 27, 1992 fiscal year ended
December 31, 1992
10(i) Distribution Agreement by and between Kera- Filed as Exhibit No.10z to the
Metrics Corporation and Eye Technology, Inc., Company's Annual Report on
dated November 27, 1992 Form 10-KSB for fiscal year
ended December 31, 1992
10(j) Promissory Note from Eye Technology, Inc. to Filed as Exhibit No. 10dd to
Burns & Levinson, dated June 4, 1993 the Company's Annual
Report on Form 10-KSB for
fiscal year ended
December 31, 1993
10(k) Consulting and License Agreement by and Filed as Exhibit No. 10ee to
between Eye Technology, Inc. and Paul Fyfe, the Company's Annual
dated October 29, 1993 Report on Form 10-FSB for
fiscal year ended
December 31, 1993
10(l) Accounts Receivable Financing Agreement dated Filed as Exhibit No. 10z to
June 2, 1994 between the Company and Republic the Company's Annual
Acceptance Corporation Report on Form 10-KSB for
fiscal year ended
December 31, 1994
10(m) Security Agreement dated June 2, 1994, between Filed as Exhibit No. 10aa to
the Company and Republic Acceptance the Company's Annual
Corporation Report on Form 10-KSB for
fiscal year ended December
31, 1994
</TABLE>
<PAGE> 52
<TABLE>
<S> <C> <C>
10(n) Security Agreement dated June 2, 1994, between Filed as Exhibit No. 10bb to
Eye Technology International, Inc. and Republic the Company's Annual
Acceptance Corporation Report on Form 10-FSB for
fiscal year ended December
31, 1994
10(o) Guaranty of Payment for Existing and/or Future Filed as Exhibit No. 10cc to
Indebtedness, dated June 2, 1994 between Eye the Company's Annual
Technology International, Inc. and Republic Report on Form 10-KSB for
Acceptance Corporation fiscal year ended
December 31, 1994
10(p) Amendment to Agreement by and between the Filed as Exhibit No. 10ee to
Company and Microprecision Instrument the Company's Annual
Company, Inc., dated December 31, 1994 Report on Form 10-KSB for
fiscal year ended
December 31, 1994
10(q) Amendment to Agreement by and between the Filed as Exhibit No. 10ff to
Company and Microprecision Instrument the Company's Annual
Company, Inc., dated March 28, 1995 Report on Form 10-KSB for
fiscal year ended
December 31, 1994
10(r) Stock Exchange Agreement dated February 6, Filed as Exhibit No. 10.1 to
1998 between the Company and the stockholders the Company's Current
of Star Tobacco and Pharmaceuticals, Inc. Report on Form 8-K, dated
February 19, 1998
10(s) License Agreement dated January 5, 1998 by and Filed as Exhibit No. 10 to the
between Star Tobacco and Pharmaceuticals, Inc., Company's Quarterly Report
as Licensee and as Licensor, Regent on Form 10-QSB for the
Technologies, Jonnie R. Williams, and Francis E. quarterly period ended March
O'Donnell, Jr., M.D. 31, 1998.
10(t) Letter Agreement dated July 6, 1998, between Filed as Exhibit No. 10(a) to
the Company and MFC Merchant Bank S.A. the Company's Quarterly
Report on Form 10-QSB for
the quarterly period ended
September 30, 1998.
10(u) Exclusive Supply Agreement dated August 18, Filed as Exhibit No. 10(b) to
1998, between Star Tobacco and Pharmaceutical, the Company's Quarterly
Inc. And Amana Company, L.P. Report on Form 10-QSB for
the quarterly period ended
September 30, 1998.
</TABLE>
<PAGE> 53
<TABLE>
<S> <C> <C>
10(v) Purchase and Sale Agreement dated July 10, Filed as Exhibit 10 to the
1998 by and between Prometheus Pacific Growth Company's Current Report
Fund LDC, a Cayman Island Limited Duration on Form 8-K dated July 15,
Company, and Eye Technology, Inc., a Delaware 1998.
Corporation
10(w) Amendment No. 1 to License Agreement dated Filed as Exhibit 10 to the
August 3, 1998 among Regent Court Company's Current Report
Technologies, Jonnie R. Williams, Francis E. on Form 8-K dated
O'Donnell, Jr., M.D. and Star Tobacco and September 11, 1998.
Pharmaceuticals, Inc.
10(x) 1998 Stock Option Plan Filed herewith.
16(a) Response Letter dated April 10, 1998 from Price Incorporated by reference to
Waterhouse LLP Exhibit 1 to the Company's
Current Report on Form 8-K
dated April 10, 1998.
16(b) Response Letter dated September 15, 1998 from Incorporated by reference to
Olsen, Thielen & Co., Ltd Exhibit 16 of the Company's
Current Report on Form 8-K/A
dated September 16, 1998.
16(c) Response Letter dated January 20, 1999 from Incorporated by reference to
Keiter, Stephens, Hurst, Gary & Shreaves Exhibit 16 of the Company's
Current Report on Form 8-K
dated January 15, 1999.
21 Subsidiaries of the Company Filed herewith.
23 Consent of Independent Public Accountants Filed herewith.
27 Financial Data Schedule Filed herewith.
</TABLE>
<PAGE> 1
EXHIBIT 10(x)
EYE TECHNOLOGY, INC.
1998 STOCK OPTION PLAN
1. PURPOSE. The purposes of the Eye Technology, Inc. 1998 Stock
Option Plan (the "Plan") are to provide additional incentives to those
officers, key employees, nonemployee Directors and Consultants of the Eye
Technology, Inc. and its Subsidiaries (as hereinafter defined) whose
substantial contributions are essential to the continued growth and success of
the Company's business, to strengthen their commitment to the Company and its
Subsidiaries, to motivate those officers, key employees, nonemployee Directors
and Consultants to perform their assigned responsibilities faithfully and
diligently, and to attract and retain competent and dedicated individuals whose
efforts will result in the long-term growth and profitability of the Company.
To accomplish these purposes, the Plan provides that the Company may grant
Stock Options and Nonqualified Stock Options (as each term is hereinafter
defined).
2. DEFINITIONS. For purposes of the Plan:
a. "ADJUSTED FAIR MARKET VALUE" means, in the event of a
Change in Control, the greater of (i) the highest price per Share paid
to holders of the Shares in any transaction (or series of transactions)
constituting or resulting in a Change in Control or (ii) the highest
Fair Market Value of a Share during the ninety (90) day period ending
on the date of a Change in Control.
b. "AGREEMENT" means the written agreement between the Company
and an Optionee evidencing the grant of an Option and setting forth the
terms and conditions thereof.
c. "APPLICABLE LAWS" mean the legal requirements relating to
the administration of stock option plans, if any, under applicable
provisions of federal securities laws, state corporate and securities
laws, the Code, the rules of any applicable stock exchange or national
market system, and the rules of any foreign jurisdiction applicable to
Options granted to residents therein.
d. "BOARD" means the Board of Directors of the Company.
e. "CHANGE IN CAPITALIZATION" means any increase or reduction
in the number of Shares, or any change (including, but not limited to,
a change in value) or exchange of Shares for a different number or kind
of shares or other securities of the Company, by reason of a
reclassification, recapitalization, merger, consolidation,
reorganization, spin-off, split-up, issuance of warrants or rights or
debentures, stock dividend, stock split, or reverse stock split, cash
dividend, property dividend, combination or exchange of shares,
repurchase of shares, public offering, private placement, change in
corporate structure or otherwise, which in the judgment of the
Compensation Committee is material or significant.
<PAGE> 2
f. "CHANGE IN CONTROL" means any of the following events:
(i) The acquisition (other than from the Company) by
any "Person" (as the term is used for purposes of Sections
13(d) or 14(d) of the Exchange Act) of beneficial ownership
(within the meaning of Rule 13d-3 promulgated under the
Exchange Act) of twenty percent (20%) or more of the combined
voting power of the Company's then outstanding voting
securities; or
(ii) The individuals who, immediately after the 1998
Annual Meeting of Stockholders of the Company are members of
the Board (the "Incumbent Board"), cease for any reason to
constitute at least a majority of the Board; provided,
however, that if the election, or nomination for election by
the Company's shareholders, of any new Director was approved
by a vote of at least two-thirds of the Incumbent Board, such
new Director shall, for purposes of this Agreement, be
considered as a member of the Incumbent Board; or
(iii) Approval by the shareholders of the Company of
(a) a merger or consolidation involving the Company if the
Company's shareholders, immediately before such merger or
consolidation, do not, as a result of such merger or
consolidation, own, directly or indirectly, more than seventy
percent (70%) of the combined voting power of the then
outstanding voting securities of the corporation resulting
from such merger or consolidation in substantially the same
proportion as their ownership of the combined voting power of
the voting securities of the Company outstanding immediately
before such merger or consolidation or (b) a complete
liquidation or dissolution of the Company or an agreement for
the sale or other disposition of all or substantially all of
the assets of the Company.
Notwithstanding the foregoing, a Change in Control shall not be deemed to occur
pursuant to clause (i) above solely because twenty percent (20%) or more of the
combined voting power of the Company's then outstanding securities is acquired
by (i) a trustee or other fiduciary holding securities under one or more
employee benefit plans maintained by the Company or any Subsidiary or (ii) any
corporation which, immediately prior to such acquisition, is owned directly or
indirectly by the shareholders of the Company in the same proportion as their
ownership of stock in the Company immediately prior to such acquisition.
g. "CODE" means the Internal Revenue Code of 1986, as amended.
h. "COMPANY" means Eye Technology, Inc., a Delaware
corporation.
i. "COMPENSATION COMMITTEE" means a committee consisting of at
least two (2) Disinterested Persons appointed by the Board to
administer the Plan and to perform the functions set forth herein and
which committee shall otherwise be constituted in such a manner as to
satisfy the Applicable Laws and to permit grants of options and related
transactions under the Plan to be exempt from Section 16(b) of the
Exchange Act in accordance with Rule 16b-3.
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j. "CONSULTANT" means any person performing consulting or
advisory services for the Company or any Subsidiary, with or without
compensation, to whom the Company chooses to grant Nonqualified Stock
Options in accordance with the Plan, provided that bona fide services
must be rendered by such person and such services shall not be rendered
in connection with the offer or sale of securities in a capital-raising
transaction.
k. "DIRECTOR" means a member of the Board.
l. "DISINTERESTED PERSON" means a disinterested administrator
with respect to the Company or any Subsidiary as described in Rule
16b-3(b)(2) under the Exchange Act.
m. "DIVISION" means any of the operating units or Divisions of
the Company designated as a Division by the Compensation Committee.
n. "ELIGIBLE EMPLOYEE" means any officer or other designated
employees of the Company or a Subsidiary designated by the Compensation
Committee as eligible to receive Options subject to the conditions set
forth herein.
o. "EMPLOYEE" means an employee of the Company or any
Subsidiary of the Company that adopts the Plan, as defined under
Section 3401(C) of the Code and regulations thereunder.
p. "EXCHANGE ACT" means the Securities Exchange Act of 1934,
as amended.
q. "FAIR MARKET VALUE" means, as of any date, the value of the
Shares.
(i) Where there exists a public market for the
Shares, the Fair Market Value shall be (A) the closing sales
price for a Share for the last market trading day prior to the
time of the determination (or, if no sales were reported on
that date, on the last trading date on which sales were
reported) on the stock exchange determined by the Compensation
Committee to be the primary market for the Common Stock or the
Nasdaq National Market, whichever is applicable or (B) if the
Common Stock is not traded on any such exchange or national
market system, the average of the closing bid and asked prices
of a Share on the Nasdaq SmallCap Market for the day prior to
the time of the determination (or, if no such prices were
reported on that date, on the last date on which such prices
were reported), in each case, as reported in The Wall Street
Journal or such other source as the Administrator deems
reliable; or
(ii) In the absence of an established market of the type
described in (i), above, for the Shares, the Fair Market Value
thereof shall be determined by the Compensation Committee in
good faith.
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<PAGE> 4
r. "NONQUALIFIED STOCK OPTION" means an Option which is not a
Stock Option.
s. "OPTION" means a Stock Option, a Nonqualified Stock Option,
or either or both of them.
t. "OPTIONEE" means a person to whom an Option has been
granted under the Plan.
u. "SHARES" means the Common Stock, one cent ($.01) par value
per share, of the Company (including any new, additional or different
stock or securities resulting from a Change in Capitalization).
v. "STOCK OPTION" means an Option within the meaning of
Section 422 of the Code.
w. "SUBSIDIARY" means any corporation in an unbroken chain of
corporations, beginning with the Company, if each of the corporations,
other than the last corporation in the unbroken chain, owns stock
possessing fifty percent (50%) or more of the total combined voting
power of all classes of stock in one of the other corporations in such
chain.
x. "TEN PERCENT SHAREHOLDER" means an Eligible Employee, who,
at the time a Stock Option is to be granted to such Eligible Employee,
owns (within the meaning of Section 422(b)(6) of the Code) stock
possessing more than ten percent (10%) of the total combined voting
power of all classes of stock of the Company, or of a parent or a
Subsidiary within the meaning of Section 422(b)(6) of the Code.
3. ADMINISTRATION
a. The Plan shall be administered by the Compensation
Committee. No member of the Compensation Committee shall be personally
liable for any action, determination or interpretation made in good
faith with respect to the Plan, Agreements or Options, and all members
of the Compensation Committee shall be fully indemnified by the Company
with respect to any such action, determination or interpretation.
b. Subject to the express terms and conditions set forth
herein, the Compensation Committee shall have the power from time to
time to determine those Eligible Employees, nonemployee Directors or
Consultants to whom Options shall be granted under the Plan, the number
of Stock Options and/or Nonqualified Stock Options to be granted to
each Eligible Employee, the number of Nonqualified Stock Options to be
granted to each nonemployee Director or Consultant, and to prescribe
the terms and conditions (which need not be identical) of each Option,
including the purchase price per Share subject to each Option, and make
any amendment or modification to any Agreement consistent with the
terms of the Plan.
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c. Subject to the express terms and conditions set forth
herein, the Compensation Committee shall have the power from time to
time:
(i) to construe and interpret the Plan and the Options
granted thereunder and to establish, amend and revoke rules
and regulations for the administration of the Plan, including,
without limitation, correcting any defect or supplying any
omission, or reconciling any inconsistency in the Plan or in
any Agreement, in the manner and to the extent it shall deem
necessary or advisable to make the Plan fully effective, and
all decisions and determinations by the Compensation Committee
in the exercise of this power shall be final, binding and
conclusive upon the Company, a Subsidiary, and the Optionees;
(ii) to determine the duration and purposes for leave of
absence which may be granted to an Optionee on an individual
basis without constituting a termination of employment or
service for purposes of the Plan;
(iii) to exercise its discretion with respect to the
powers and rights granted to it as set forth in the Plan; and
(iv) generally, to exercise such powers and to perform
such acts as are deemed necessary or advisable to promote the
best interests of the Company with respect to the Plan.
4. STOCK SUBJECT TO PLAN.
a. The maximum number of Shares that may be issued or
transferred pursuant to Options under the Plan is 4,000,000 Shares (or
the number and kind of shares of stock or other securities to which
such Shares are adjusted upon a Change in Capitalization pursuant to
Section 7) and the Company shall reserve for the purposes of the Plan,
out of its authorized but unissued Shares or out of Shares held in the
Company's treasury, or partly out of each, such number of Shares as
shall be determined by the Board.
b. Whenever any outstanding Option or portion thereof expires,
is canceled or is otherwise terminated for any reason (other than by
exercise of the Option), the Shares allocable to the canceled or
otherwise terminated portion of such Option may again be the subject of
Options hereunder.
c. Whenever any Shares subject to an Option are forfeited for
any reason pursuant to the terms of the Plan, such Shares may again be
the subject of Options hereunder.
5. ELIGIBILITY. Subject to the provisions of the Plan, the
Compensation Committee shall have full and final authority to select those
Eligible Employees who will receive Options and those nonemployee Directors and
Consultants who will receive Nonqualified Stock Options; provided, however,
that no Eligible Employee shall receive any Stock Options, unless such Eligible
Employee is an employee of the Company or a Subsidiary (within the meaning of
Section 422 of the
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<PAGE> 6
Code) at the time the Stock Option is granted. Stock Options may be granted only
to persons who are Eligible Employees.
6. OPTIONS. The Compensation Committee may grant Options in
accordance with the Plan, and the terms and conditions of the Option shall be
set forth in an Agreement; provided, however, no Eligible Employee shall
receive in any fiscal year of the Company options to purchase in excess of
1,000,000 Shares. Each Option and Agreement shall be subject to the following
conditions:
a. DESIGNATION OF OPTIONS. Each Option shall be designated as
either a Stock Option or a Nonqualified Stock Option. However,
notwithstanding such designation, to the extent that the aggregate Fair
Market Value of Shares subject to Options designated as Stock Options
which become exercisable for the first time by an Optionee during any
calendar year (under all plans of the Company or Subsidiary) exceeds
one hundred thousand dollars ($100,000), such excess Options, to the
extent of the Shares covered thereby in excess of the foregoing
limitation, shall be treated as Nonqualified Stock Options. For this
purpose, Stock Options shall be taken into account in the order in
which they were granted, and the Fair Market Value of the Shares shall
be determined as of the date the Option with respect to such Shares is
granted.
b. PURCHASE PRICE. The purchase price or the manner in which
the purchase price is to be determined for Shares under each Option
shall be set forth in the Agreement, provided that the purchase price
per Share under each Stock Option shall not be less than (i) one
hundred percent (100%) of the Fair Market Value of a Share at the time
the Stock Option is granted, and (ii) one hundred ten percent (110%) in
the case of a Stock Option granted to a Ten Percent Shareholder.
c. DURATION. Options granted hereunder shall be for such term
as the Compensation Committee shall determine, provided that no Stock
Option shall be exercisable after the expiration of ten (10) years from
the date it is granted (five (5) years in the case of a Stock Option
granted to a Ten Percent Shareholder). The Compensation Committee may,
subsequent to the granting of any Option, extend the term thereof but
in no event shall the term as so extended exceed the maximum term
provided for in the preceding sentence.
d. NON-TRANSFERABILITY. No Option hereunder shall be
transferable by the Optionee to whom granted otherwise than by will or
the laws of descent and distribution or pursuant to a qualified
domestic relations order as defined by the Code or Title I of the
Employee Retirement Income Security Act, and an Option may be exercised
during the lifetime of such Optionee only by the Optionee or such
Optionee's guardian or legal representative. The terms of such Option
shall be final, binding and conclusive upon the beneficiaries,
executors, administrators, heirs and successors of the Optionee.
e. VESTING. Subject to Section 6(j) hereof, each Option shall
be exercisable in such installments (which need not be equal) and at
such times as may be designated by the Compensation Committee and set
forth in the Agreement. To the extent not exercised,
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<PAGE> 7
installments shall accumulate and be exercisable, in whole or in part,
at any time after becoming exercisable, but not later than the date the
Option expires. The Compensation Committee may accelerate the
exercisability of any Option or portion thereof at any time.
f. METHOD OF EXERCISE. The exercise of any Option shall be
made only by a written notice delivered in person or by mail to the
Secretary of the Company at the Company's principal executive office,
specifying the number of Shares to be purchased and accompanied by
payment therefor and otherwise in accordance with the Agreement
pursuant to which the Option was granted. The purchase price for any
Shares purchased pursuant to the exercise of an Option shall be paid in
full upon such exercise, as determined by the Compensation Committee.
In addition to any other types of consideration the Compensation
Committee may determine, the Compensation Committee is authorized to
accept as consideration for Shares issued under the Plan the following:
(i) cash; (ii) check; (iii) delivery of Optionee's promissory note with
such recourse, interest, security, and redemption provisions as the
Compensation Committee determines as appropriate; (iv) surrender of
Shares (including, withholding of Shares otherwise deliverable upon
exercise of the Option) which have a Fair Market Value on the date of
surrender equal to the aggregate exercise price of the Shares as to
which said Option shall be exercised; or (v) any combinations of the
foregoing. The written notice pursuant to this Section 6(f) may also
provide instructions from the Optionee to the Company that upon receipt
of the purchase price in cash from the Optionee's broker or dealer,
designated as such on the written notice, in payment for any Shares
purchased pursuant to the exercise of an Option, the Company shall
issue such Shares directly to the designated broker or dealer. If
requested by the Compensation Committee, the Optionee shall deliver the
Agreement evidencing the Option to the Secretary of the Company, who
shall endorse thereon a notation of such exercise and return such
Agreement to the Optionee. No fractional Shares shall be issued upon
exercise of an Option, and the number of Shares that may be purchased
upon exercise shall be rounded to the nearest number of whole Shares.
g. RIGHTS OF OPTIONEES. No Optionee shall be deemed for any
purpose to be the owner of any Shares subject to any Option unless and
until (i) the Option shall have been exercised pursuant to the terms
thereof, (ii) the Company shall have issued and delivered the Shares to
the Optionee, and (iii) the Optionee's name shall have been entered as
a shareholder of record on the books of the Company. Thereupon, the
Optionee shall have full voting, dividend and other ownership rights
with respect to such Shares.
h. TERMINATION OF EMPLOYMENT OR SERVICE.
(i) Termination of Employment or Service Other Than Upon
Retirement In Good Standing, Disability or Death of Optionee.
Upon termination of an Optionee's status as an Employee,
Director or Consultant, other than upon the Optionee's
retirement in good standing for reason of age, death or
disability, the Option shall terminate immediately as of the
date of termination and the Optionee may exercise his or her
Option at any time prior to the date of termination to the
extent that the Option is vested on the date of termination
(but in no event later than the
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<PAGE> 8
expiration of the term of such Option as set forth in the
Agreement). If, on the date of termination, the Optionee is
not vested as to his or her entire Option, the Shares covered
by the unvested portion of the Option shall revert to the
Plan.
(ii) Retirement in Good Standing of Optionee. Upon
termination of an Optionee's status as an Employee, Director
or Consultant, as a result of retirement in good standing for
reason of age but not due to disability, the Optionee may
exercise his or her Option at any time within three (3) months
following the Optionee's termination, to the extent that the
Option is vested on the date of termination (but in no event
later than the expiration of the term of such Option as set
forth in Option Agreement). If on the date of termination, the
Optionee is not vested as to his or her entire Option, the
Shares covered by the unvested portion shall revert to the
Plan. If, after termination, the Optionee does not exercise
his or her Option within the time specified by the
Administrator, the Option shall terminate, and the Shares
covered by such Option shall revert to the Plan.
(iii) Disability of Optionee. If an Optionee's status as
an Employee, Director or Consultant terminates as a result of
the Optionee's disability, the Optionee may exercise the
Option to the extent the Option is vested on the date of
termination, but only within twelve (12) months from the date
of such termination (and in no event later than the expiration
date of the term of such Option as set forth in the Option
Agreement). If such disability is not a "disability" as such
term is defined in Section 22(e)(3) of the Code, in the case
of a Stock Option, such Stock Option shall automatically
convert to a Nonqualified Stock Option on the day three (3)
months and one (1) day following such termination. If, on the
date of termination, the Optionee is not vested as to the
entire Option, the Shares covered by the unvested portion of
the Option shall revert to the Plan. If, after termination,
the Option is not exercised within the time specified herein,
the Option shall terminate, and the Shares covered by such
Option shall revert to the Plan.
(iv) Death of Optionee. In the event of the death of an
Optionee, the Option may be exercised at any time within
twelve (12) months following the date of death (but in no
event later than the expiration of the term of such Option as
set forth in the Agreement) to the extent vested on the date
of death. If, at the time of death, the Optionee is not vested
as to the entire Option, the Shares covered by the unvested
portion of the Option shall revert to the Plan. The Option may
be exercised by the executor or administrator of the
Optionee's estate or, if none, by the person(s) entitled to
exercise the Option under the Optionee's will or the laws of
descent or distribution. If the Option is not so exercised
within the time specified herein, the Option shall terminate,
and the Shares covered by such Option shall revert to the
Plan.
i. MODIFICATION OR SUBSTITUTION. Subject to the terms of the
Plan, the Compensation Committee may, in its discretion, modify
outstanding Options or accept the surrender of outstanding Options (to
the extent not exercised) and grant new Options in substitution for
them. Notwithstanding the foregoing, no modification of an Option shall
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<PAGE> 9
adversely alter or impair any rights or obligations under any Agreement
without the Optionee's consent.
j. EFFECT OF CHANGE IN CONTROL. Notwithstanding anything
contained in the Plan or any Agreement to the contrary, in the event of
a Change in Control, (i) all Options outstanding on the date of such
Change in Control shall become immediately and fully exercisable and
(ii) an Optionee will be permitted to surrender for cancellation within
sixty (60) days after such Change in Control any Option or portion of
an Option to the extent not yet exercised, and the Optionee will be
entitled to receive a cash payment in an amount equal to the excess, if
any, of (x)(A) in the case of Nonqualified Stock Options, the greater
of (1) the Fair Market Value, on the date preceding the date of
surrender, of the Shares subject to the Option or portion thereof
surrendered or (2) the Adjusted Fair Market Value of the Shares subject
to the Option or portion thereof surrendered or (B) in the case of a
Stock Option, the Fair Market Value, at the time of surrender, of the
Shares subject to the Option or portion thereof surrendered, over (y)
the aggregate purchase price for such Shares under the Option;
provided, however, that in the case of an Option granted within six (6)
months prior to the Change in Control to any Optionee who may be
subject to liability under Section 16(b) of the Exchange Act, such
Optionee shall be entitled to surrender for cancellation such
Optionee's Option during the sixty (60) day period commencing upon the
expiration of six (6) months from the date of grant of any such Option.
k. BUYOUT PROVISIONS. The Compensation Committee may at any
time offer to buy out for a payment in cash or Shares, an Option
previously granted, based on such terms and conditions as the
Compensation Committee shall establish and communicate to the Optionee
at the time that such offer is made.
7. ADJUSTMENT UPON CHANGE IN CAPITALIZATION.
a. In the event of a Change in Capitalization, the
Compensation Committee shall conclusively determine the appropriate
adjustments, if any, to the maximum number and class of Shares or other
stock or securities with respect to which Options may be granted under
the Plan, the number and class of Shares or other stock or securities
which are subject to outstanding Options granted under the Plan, and
the purchase price therefor, if applicable.
b. Any such adjustment in the Shares or other stock or
securities subject to outstanding Stock Options (including any
adjustments in the purchase price) shall be made in such manner as not
to constitute a modification as defined by Section 424(h)(3) of the
Code and only to the extent otherwise permitted by Sections 422 and 424
of the Code.
c. If, by reason of a Change in Capitalization, an Optionee
shall be entitled to exercise an Option with respect to, new,
additional or different shares of stock or securities (other than
rights or warrants to purchase securities), such new, additional or
different shares shall thereupon be subject to all of the conditions,
restrictions and performance criteria which were applicable to the
Shares subject to the Option prior to such Change in Capitalization.
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8. EFFECT OF CERTAIN TRANSACTIONS. Subject to Section 6(j), in
the event of (i) the liquidation or dissolution of the Company or (ii) a merger
or consolidation of the Company (a "Transaction"), all Options issued hereunder
shall continue in effect in accordance with their respective terms and each
Optionee shall be entitled to receive in respect of each Share subject to any
outstanding Options, as the case may be, upon exercise of any Option, the same
number and kind of stock, securities, cash, property or other consideration
that each holder of a Share was otherwise entitled to receive in the
Transaction in respect of a Share.
9. RELEASE OF FINANCIAL INFORMATION. A copy of the Company's
annual report to shareholders shall be delivered to each Optionee at the time
such report is distributed to the Company's shareholders.
10. TERMINATION AND AMENDMENT OF THE PLAN.
a. The Plan shall terminate on September 1, 2008, and no
Option may be granted thereafter. The Board may sooner terminate or
amend the Plan (other than to reduce the rights of Optionees under
Section 6(j), at any time and from time to time; provided, however,
that to the extent necessary under Section 16(b) of the Exchange Act
and the rules and regulations promulgated thereunder, no amendment
shall be effective unless approved by the shareholders of the Company
in accordance with applicable law and regulations at an annual or
special meeting held within twelve (12) months before or after the date
of adoption of such amendment.
b. Except as provided in Sections 7 and 8 hereof, rights and
obligations under any Option granted before any amendment of the Plan
shall not be adversely altered or impaired by such amendment, except
with the consent of the Optionee.
11. NON-EXCLUSIVITY OF THE PLAN. The adoption of the Plan by the
Board shall not be construed as amending, modifying or rescinding any
previously approved incentive arrangement or as creating any limitations on the
power of the Board to adopt such other incentive arrangements as it may deem
desirable.
12. LIMITATION OF LIABILITY. As illustrative of the limitations of
liability of the Company, but not intended to be exhaustive thereof, nothing in
the Plan shall be construed to:
a. give any person any right to be granted an Option other
than at the sole discretion of the Compensation Committee;
b. give any person any rights whatsoever with respect to
Shares except as specifically provided in the Plan;
c. limit in any way the right of the Company to terminate the
employment of any person at any time; or
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d. be evidence of any agreement or understanding, expressed or
implied, that the Company will employ any person in any particular
position at any particular rate of compensation or for any particular
period of time.
13. REGULATIONS AND OTHER APPROVALS; GOVERNING LAW.
a. This Plan and the rights of all persons claiming hereunder
shall be construed and determined in accordance with the laws of the
State of Delaware without giving effect to the conflicts of laws
principles thereof, except to the extent that such law is preempted by
federal law.
b. The obligation of the Company to sell or deliver Shares
with respect to Options granted under the Plan shall be subject to all
applicable laws, rules and regulations, including all applicable
federal and state securities laws, and the obtaining of all such
approvals by governmental agencies as may be deemed necessary or
appropriate by the Compensation Committee.
c. The Plan is intended to comply with Rule 16b-3 promulgated
under the Exchange Act, and the Compensation Committee shall interpret
and administer the provisions of the Plan or any Agreement in a manner
consistent therewith. Any provisions inconsistent with such Rule shall
be inoperative and shall not affect the validity of the Plan.
d. The Board may make such changes as may be necessary or
appropriate to comply with the rules and regulations of any government
authority or to obtain for Eligible Employees granted Stock Options the
tax benefits under the applicable provisions of the Code and
regulations promulgated thereunder.
e. Each Option is subject to the requirement that, if at any
time the Compensation Committee determines, in its discretion, that the
listing, registration or qualification of Shares issuable pursuant to
the Plan is required by any securities exchange or under any state or
federal law, or the consent or approval of any governmental regulatory
body is necessary or desirable as a condition of, or in connection
with, the grant of an Option or the issuance of Shares, no Options
shall be granted or payment made or Shares issued, in whole or in part,
unless listing, registration, qualification, consent or approval has
been effected or obtained free of any conditions as acceptable to the
Compensation Committee.
f. Notwithstanding anything contained in the Plan to the
contrary, in the event that the disposition of Shares acquired pursuant
to the Plan is not covered by a then current registration statement
under the Securities Act of 1933, as amended (the "Act"), and is not
otherwise exempt from such registration, such Shares shall be
restricted against transfer to the extent required by the Act and Rule
144 or other regulations thereunder. The Compensation Committee may
require any individual receiving Shares pursuant to the Plan, as a
condition precedent to receipt of such Shares (including upon exercise
on an Option), to represent and warrant to the Company in writing, in
addition to other applicable representations, that the Shares acquired
by such individual are acquired without a view to
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any distribution thereof and will not be sold or transferred other than
pursuant to an effective registration thereof under the Act or pursuant
to an exemption applicable under the Act or the rules and regulations
promulgated thereunder. The certificates evidencing any of such Shares
shall be appropriately legended to reflect their status as restricted
securities as aforesaid.
14. MISCELLANEOUS.
a. MULTIPLE AGREEMENTS. The terms of each Option may differ
from other Options granted under the Plan at the same time, or at some
other time. The Compensation Committee may also grant more than one
Option to a given Eligible Employee, nonemployee Director or Consultant
during the term of the Plan, either in addition to, or in substitution
for, one or more Options previously granted to that Eligible Employee,
nonemployee Director or Consultant. The grant of multiple Options may
be evidenced by a single Agreement or multiple Agreements, as
determined by the Compensation Committee.
b. WITHHOLDING OF TAXES.
(i) The Company shall have the right to deduct from any
distribution of cash to any Optionee an amount equal to the
federal, state and local income taxes and other amounts as may
be required by law to be withheld (the "Withholding Taxes")
with respect to any Option. If an Optionee is entitled to
receive Shares upon exercise of an Option, the Optionee shall
pay the Withholding Taxes to the Company prior to the issuance
or release from escrow of such Shares. In satisfaction of the
Withholding Taxes to the Company, the Optionee may make a
written election (the "Tax Election"), which may be accepted
or rejected in the discretion of the Compensation Committee,
to have withheld a portion of the Shares issuable to such
Optionee upon exercise of the Option having an aggregate Fair
Market Value equal to the Withholding Taxes, provided that:
(i) in respect of an Optionee who may be subject to liability
under Section 16(b) of the Exchange Act (unless such
Optionee's employment was terminated due to disability or
death), the Tax Election is made either at least six (6)
months prior to the date that the amount of the Withholding
Taxes are determined (the "Tax Date") or during the ten (10)
day period beginning on the third (3rd) business day and
ending on the twelfth (12th) business day following the
release for publication of the Company's quarterly or annual
statements of earnings, (ii) the Tax Election is made prior to
the Tax Date, and (iii) the Tax Election is irrevocable;
provided, however, in the event that the Tax Date occurs
subsequent to the exercise of the Option or issuance of
Shares, the Optionee shall tender back to the Company on the
Tax Date that number of Shares having a Fair Market Value on
the date preceding the Tax Date at least equal to the
Withholding Taxes.
(ii) If an Optionee makes a disposition, within the
meaning of Section 424(c) of the Code and regulations
promulgated thereunder, of any Share or Shares issued to
Optionee pursuant to Optionee's exercise of an Option within
the
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two (2) year period commencing on the day after the date of
the grant or within the one (1) year period commencing on the
day after the date of transfer of such Share or Shares to the
Optionee pursuant to such exercise, the Optionee shall, within
ten (10) days of such disposition, notify the Company thereof,
by delivery of written notice to the Company at its principal
executive office, and immediately deliver to the Company the
amount of Withholding Taxes.
c. DESIGNATION OF BENEFICIARY. Each Optionee may
designate a person or persons to receive, in the event of such
Optionee's death, any Option or any amount payable pursuant
thereto, to which such Optionee would then be entitled. Such
designation will be made upon forms supplied by and delivered
to the Company and may be revoked in writing. If an Optionee
fails effectively to designate a beneficiary, then such
Optionee's estate will be deemed to be the beneficiary.
15. EFFECTIVE DATE. The effective date of the Plan shall be June
29, 1998.
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EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
<TABLE>
<CAPTION>
Name State of Incorporation
---- ----------------------
<S> <C>
Star Tobacco & Pharmaceuticals, Inc. Virginia
</TABLE>
<PAGE> 1
EXHIBIT 23
CONSENT OF INDEPENDENT CERTIFIED ACCOUNTANTS
Star Scientific, Inc. and Subsidiaries
Petersburg, Virginia
As independent certified public accountants for Star Scientific, Inc. and
Subsidiaries, we hereby consent to the use in this Form 10-KSB Annual Report for
Star Scientific, Inc. and Subsidiaries of our report included herein, which has
a date of March 26, 1999 relating to the consolidated balance sheet of Star
Scientific, Inc. and Subsidiaries as of December 31, 1998 and the related
consolidated statements of operations, cash flows, and stockholders' equity for
the year then ended.
AIDMAN, PISER & CO.
Tampa, Florida
April 15, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-START> JAN-01-1998 JAN-01-1997
<PERIOD-END> DEC-31-1998 DEC-31-1997
<CASH> 102,695 102,695
<SECURITIES> 0 0
<RECEIVABLES> 1,781,143 1,781,143
<ALLOWANCES> 123,036 123,036
<INVENTORY> 636,456 636,456
<CURRENT-ASSETS> 2,502,280 2,502,280
<PP&E> 2,935,358 2,935,358
<DEPRECIATION> 1,230,789 1,230,789
<TOTAL-ASSETS> 4,435,156 4,435,156
<CURRENT-LIABILITIES> 4,418,730 4,418,730
<BONDS> 0 0
44,000 44,000
143 143
<COMMON> 98,198 98,198
<OTHER-SE> (737,499) (737,499)
<TOTAL-LIABILITY-AND-EQUITY> 4,435,156 4,435,156
<SALES> 19,445,491 19,445,491
<TOTAL-REVENUES> 19,445,491 19,445,491
<CGS> 7,669,428 7,669,428
<TOTAL-COSTS> 16,507,296 16,507,296
<OTHER-EXPENSES> 6,175,766 6,175,766
<LOSS-PROVISION> 27,400 27,400
<INTEREST-EXPENSE> 255,113 255,113
<INCOME-PRETAX> (3,475,472) (3,475,472)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (3,475,472) (3,475,472)
<DISCONTINUED> (972,370) (972,370)
<EXTRAORDINARY> 251,767 251,767
<CHANGES> 0 0
<NET-INCOME> (4,196,075) (4,196,075)
<EPS-PRIMARY> (.51) (.51)
<EPS-DILUTED> (.51) (.51)
</TABLE>
