<PAGE> 1
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-QSB
(Mark One)
[X] Quarterly report under Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the quarterly period ended March 31, 1999
-------------------------------------------------
[ ] Transition report under Section 13 or 15(d) of the Exchange Act
For the transition period from to
---------------------- ---------------------
Commission file number 0-15324
---------------------------------------------------------
Star Scientific, Inc.
- --------------------------------------------------------------------------------
(Exact Name of Small Business Issuer as Specified in Its Charter)
Delaware 52-1402131
- --------------------------------------------------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
16 South Market Street, Petersburg, Virginia 23803
- --------------------------------------------------------------------------------
(Address of Principal Executive Offices)
(804) 861-0681
- --------------------------------------------------------------------------------
(Issuer's Telephone Number, Including Area Code)
Eye Technology, Inc.
- --------------------------------------------------------------------------------
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Check whether the issuer: (1) filed all reports 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 [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Check whether the registrant filed all documents and reports required
to be filed by Section 12, 13 or 15(d) of the Exchange Act after the
distribution of securities under a plan confirmed by a court.
Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date: 52,072,700 shares of Common
Stock, $.01 par value, 250 shares of Class A Convertible Preferred Stock
(convertible into 20,000 shares of Common Stock), 61 shares of Series B
Convertible Preferred Stock (convertible into 200,080 shares of Common Stock),
outstanding as of May 10, 1999.
Transitional Small Business Disclosure Format (check one):
Yes [ ] No [X]
<PAGE> 2
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
An index to the financial statements of the Company filed as a part of
this report appears at Page F-1. The financial statements of the Company appear
at Pages F-2 through F-5 of this report.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
Sales for the first quarter of 1999 were $15,781,000, an approximately
536% increase over sales of $2,941,000 in the first quarter of 1998. The 1999
sales increase reflects management's continued emphasis since October 1998 on
expanding its wholesale customer base, as plans to use tobacco which has been
cured through the Company's proprietary scientific technology in the Company's
discount cigarettes is scheduled for a three year phase-in beginning in the
summer of 1999. Product price increases resulting from the effects of the Master
Tobacco Settlement Agreement on product demand during December 1998 continued
into the first quarter of 1999, contributing to higher than normal profits.
Volume buying at higher market prices by many long-term customers as well as new
customers contributed to higher gross profits than in prior periods.
Cost of sales in the first quarter of 1999 (reflected as a percentage)
changed measurably from the same period in 1998, from 48 % to 24% in 1999,
reflecting higher fixed costs associated with manufacturing but reducing
substantially with volume increases. Excise taxes remained in line at 42% in
1998 versus 41% in 1999.
During the first quarter of 1998, the Company introduced to the market
a chewing gum under the label, Gumsmoke(TM), which contained an FDA approved
tobacco flavoring but no actual tobacco extract. The gum was being promoted by
the Company 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 Company was
initially heavily involved in broadly test-marketing and producing its
anticipated new product with almost 50% of its research and development costs
for the first quarter of 1998 committed to this product. The Company was
constrained to conclude at the conclusion of this large scale test-marketing
through its tobacco and food product distributors that there was not sufficient
market acceptability for such product. The Gumsmoke(TM) food product did not
contain any labeling which asserted, directly or indirectly, any health or
therapeutic claims. Since the product appeared to have limited market acceptance
and the Company anticipated, given the then nature of the regulatory climate,
potential regulatory issues which could have been costly to resolve, albeit non
meritorious. The Company made a business decision to discontinue the development
and sale of that product. Accordingly, in 1999, there were no costs associated
with the further production and/or test marketing of this product since it has
been discontinued. The Company's primary research and development activity
during this period was focused around university-contract testing for low
nitrosamine content in tobacco and tobacco smoke. A significant portion of that
research was conducted by Dr. and Professor Harold Burton at the University of
Kentucky, as well as through contract laboratories. Additional funds were
expended in 1999 relating to an earlier Phase I October 1998 study of CigRx(TM)
under an FDA reviewed protocol which was completed at the Medical College of
Virginia (Virginia Commonwealth University) under the direction of Professor
William Barr, Chairman of the Department of Pharmaceutics and Director for the
Center for Drug Studies. In connection with that Phase I clinical testing
program, funds were committed for payment to secure additional data relating to
the Phase I study from the American Health Foundation in Valhalla, New York,
pursuant to a contract to analyze biological specimens obtained in that study.
The Company had an outstanding balance on its line of credit of
$860,000 in 1998, and zero in 1999.
While accounts receivable reflect balances of $1,768,000 in the first
quarter of 1999 and $1,497,000 for the same period in 1998, on sales of $15.7
million and $2.9 million, respectively, the balances reflect
2
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an industry standard of short-term receivables paid by customers' electronic
transfer, generally within a few days, and rarely extending beyond 30 days.
The excise tax liability reflects the amount paid on April 14, 1999 for
the last half of March, plus the assessment of an additional $296,000 (including
interest of $37,000), as a result of a Bureau of Alcohol, Tobacco and Firearms
(BATF) audit covering the years 1996 through 1998. The Company intends to
attempt recovery of a portion of this audit assessment by locating records
substantiating export rules compliance held by commercial carriers involved in
the transportation issue in years when the Company was a privately-owned entity.
Increases in property, plant and equipment are related to an investment
of approximately $950,000 toward an initial purchase order of approximately
$1,400,000 for the manufacture of 115 tobacco-curing barns. These "Starcure"
barns are being specially manufactured for the Company utilizing the patented
technology developed and licensed to Star. The Company has also purchased office
furniture and renovated its administrative offices at a cost of $40,000.
Capitalized computer software and hardware upgrades to be Year 2000 compliant,
as well as implementation of the new system, has cost approximately $45,000.
Accounts payable and accrued expenses during the first quarter of 1999
decreased from $2,516,000 and $646,000 to $1,828,000 and $43,000, respectively,
for the equivalent period in 1998 as a result of operating cash flow that
enabled the Company to be current with its vendors and suppliers in 1999, which
was not possible in 1998.
PART II
OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Subject to stockholder approval of certain amendments to the 1998 Stock
Option Plan, on March 9, 1999, the Company granted to Dr. Robert DeLorenzo,
Chief Executive Officer and Chairman of the Board of the Company, (a) an option
to purchase 500,000 shares of Common Stock at an exercise price of $2.00 per
share, vesting in two equal installments on September 6, 2000 and March 6, 2002,
and (b) an option to purchase an additional 500,000 shares of Common Stock at an
exercise price of $3.00 per share, vesting in two equal installments on June 1,
2000 and December 1, 2001.
ITEM 5. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In June 1995, the Company, as a privately-held entity, acquired its
Petersburg facility from a partnership comprised of Francis E. O'Donnell, Jr.,
M.D., Jonnie R. Williams and Paul Lamb, for a note in the principal amount of
$300,000, which was subsequently reissued as three notes of $100,000 each
payable to Dr. O'Donnell, Mr. Lamb, and a trust for the benefit of Mr. Williams'
children. The notes to Dr. O'Donnell and Mr. Williams' children trust were paid
in February 1998. In February 1999, accrued but unpaid interest in the
approximate amount of $16,000 was paid to Dr. O'Donnell and the trust for the
children of Mr. Williams. Mr. Lamb did not receive any interest payments in the
first quarter of 1999 and was paid all accrued interest and a $10,000 principal
reduction on December 31, 1998. A payment of $100,000 was inadvertently paid to
Dr. O'Donnell in February 1999 and was subsequently refunded to the Company.
3
<PAGE> 4
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.
Date: May 17, 1999 /s/ James A. McNulty
---------------------------------
Authorized Signatory and
Chief Financial Officer
4
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INDEX TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
F-2 Star Scientific, Inc. and Subsidiaries Condensed Consolidated Balance
Sheets
F-3 Star Scientific, Inc. and Subsidiaries Condensed Consolidated
Statements of Operations for the Three Month Periods Ended March 31,
1999 and 1998 (Unaudited)
F-4 Star Scientific, Inc. and Subsidiaries Condensed Consolidated
Statements of Cash Flows for the Three Month Periods Ended March
31, 1999 and 1998
F-5 Star Scientific, Inc. and Subsidiaries Notes to Condensed Financial
Statements for the Three Month ended March 31, 1999 and 1998
(Unaudited)
F-1
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CONDENSED CONSOLIDATED BALANCE SHEETS
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
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Assets (Unaudited)
<S> <C> <C>
Current assets:
Cash $ 692,224 $ 102,695
Accounts receivable:
Trade, net 1,768,403 1,497,457
Other 35,150 68,271
Inventories 1,151,598 636,456
Prepaid expenses and Other
Current Assets 100,216 197,401
Due from related party 104,434 --
------------- -------------
Total current assets 3,852,025 2,502,280
Property and equipment, net 2,668,909 1,704,569
Other Assets
Intangibles, net of amortization 122,113 135,928
Notes receivable, net 132,395 92,379
------------- -------------
$ 6,775,442 $ 4,435,156
============= =============
Liabilities and Stockholders' Equity (Deficit)
Current liabilities:
Notes payable - current $ 464,000 $ 379,082
Accounts payable 1,828,147 2,516,658
Federal excise taxes payable 1,491,025 876,875
Accrued expenses 42,766 646,115
Federal income taxes payable 775,000 --
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Total current liabilities 4,600,938 4,418,730
Notes payable, less current maturities 533,559 611,584
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Total liabilities 5,134,497 5,030,314
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Commitments and contingencies
Redeemable preferred stock (Series A, convertible, 250 shares issued
and outstanding, at liquidation value) 44,000 44,000
------------- -------------
Stockholders' equity (deficit):
Common stock(A) 515,878 98,198
Preferred stock(B) 14 143
Additional paid-in capital 6,954,484 6,668,392
Accumulated deficit (5,191,788) (7,326,724)
Unearned compensation (680,500) (79,167)
Less treasury stock (1,143.30 shares at cost) (1,143) --
------------- -------------
Total stockholders' equity (deficit) 1,596,945 (639,158)
------------- -------------
$ 6,775,442 $ 4,435,156
============= =============
</TABLE>
(A) ($.01 par value, 100,000,000 shares authorized 51,587,846 shares issued and
outstanding)
(B) (Series B, convertible; 15,000 shares authorized, 2,494 shares issued and
1,351 shares outstanding)
See notes to condensed consolidated financial statements.
F-2
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STAR SCIENTIFIC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTH PERIODS ENDED MARCH 31, 1999 AND 1998
(UNAUDITED)
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Net Sales $15,781,466 $ 2,941,653
Less:
Cost of goods sold 3,830,052 1,402,798
Excise taxes on products 6,392,340 1,236,807
----------- -----------
Gross profit 5,559,074 302,048
----------- -----------
Operating Expenses:
Marketing and distribution expenses 1,411,263 298,244
General and administrative expenses 1,075,489 290,589
Research and development 117,841 247,310
----------- -----------
Total operating expenses 2,604,593 836,143
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Operating income (loss) 2,954,481 (534,095)
----------- -----------
Other Expenses:
Interest expense (net of interest income) 44,543 70,622
Other -- 16,417
----------- -----------
Income (loss) from continuing operations before
income taxes 2,909,938 (621,134)
----------- -----------
Income tax expenses from continuing operations 775,000 --
----------- -----------
Loss from discontinued operations (no applicable income taxes) -- (83,633)
----------- -----------
Income (loss) before extraordinary item 2,134,938 (704,767)
----------- -----------
Extraordinary gain from extinguishment of
debt (no applicable income taxes) -- 251,767
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Net income (loss) $ 2,134,938 $ (453,000)
=========== ===========
Basic income (loss) per common share:
Continuing operations $ .22 $ (.17)
----------- -----------
Discontinued operations -- (.02)
Extraordinary gains -- (.07)
----------- -----------
Net income (loss) $ .22 $ (.17)
=========== ===========
Diluted income (loss) per common share (open):
Continuing operations $ .04 (.17)
Discontinued operations -- (.02)
Extraordinary gain -- .07
----------- -----------
Net income (loss) $ .04 $ (.12)
=========== ===========
Weighted average shares outstanding 9,819,740 3,622,262
=========== ===========
Diluted weighted average shares outstanding 56,731,581 3,662,262
=========== ===========
</TABLE>
F-3
<PAGE> 8
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTH PERIOD ENDED MARCH 31, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Operating Activities:
Net Income (loss) $ 2,134,938 $ (453,000)
Adjustments to reconcile net income (loss)
to net cash provided by (used in) operating activities:
Depreciation and amortization 53,865 150,358
Compensation expense resulting from
issuance of common stock and options 101,167 --
Extraordinary gain on extinguishment of debt -- 251,767
Increase (decrease) in cash resulting from changes in:
Current assets (655,782) (29,098)
Current liabilities 97,281 (263,436)
----------- -----------
Net cash provided by (used in) operating activities 1,731,479 (343,409)
----------- -----------
Investing activities
Increase in notes receivable (40,019) (167,355)
----------- -----------
Purchases of property and equipment (1,004,390) (98,500)
----------- -----------
Proceeds from disposal of property and equipment -- 175,000
Purchases of intangible assets -- (460)
Advances to related party (104,434) --
----------- -----------
Net cash used in investing activities (1,148,843) (91,315)
----------- -----------
Financing activities:
Proceeds from notes payable 75,000 --
Payments on notes payable (68,107) (947,073)
Proceeds from sale of stock -- 1,488,679
----------- -----------
Net cash provided by financing activities 6,893 542,606
----------- -----------
Increase in cash 589,529 107,882
Cash, beginning of period 102,695 10,929
----------- -----------
Cash, end of period $ 692,224 $ 118,811
=========== ===========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 65,020 $ 81,231
=========== ===========
</TABLE>
F-4
<PAGE> 9
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO CONDENSED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998
(UNAUDITED)
1. The financial statements and notes thereto should be read in conjunction
with the financial statements and notes for the year ended December 31,
1998.
2. In the opinion of management, all adjustments (consisting only of normal
recurring accruals) necessary for a fair presentation of the results of
operations for the periods presented have been included. The results of
operations for the three months ended March 31, 1999 and 1998 are not
necessarily indicative of the results for a full year.
3. The Company generated net income for the three months ended March 31, 1999.
Diluted earnings per share assumes conversion of convertible preferred
stock (Class A and Series B) and common stock warrants.
4. In March 1999, the Company granted to Dr. Robert DeLorenzo, a non-employee,
Chief Executive Officer and Chairman of the Board of the Company, (a) an
option to purchase 500,000 shares of Common Stock at an exercise price of
$2.00 per share, vesting in two equal installments on September 6, 2000 and
March 6, 2002, and (b) an option to purchase an additional 500,000 shares
of Common Stock at an exercise price of $3.00 per share, vesting in two
equal installments on June 1, 2000 and December 1, 2001. The Company has
recognized compensation expense associated with these options of $22,000
during the quarter ended March 31, 1999, and unearned compensation of
$680,500 at March 31, 1999.
5. Income taxes consist of the following:
<TABLE>
<S> <C>
Current $ 775,000
Deferred 184,000
Change in deferred tax asset valuation
allowance (184,000)
-----------
$ 775,000
===========
</TABLE>
Income tax expense differs from that which would result from applying
statutory tax rates to pre-tax income. A reconciliation is as follows:
<TABLE>
<S> <C>
Statutory rate 34.0%
State income taxes 7.0
Effect of change in deferred tax asset valuation
allowance (13.5)
----------
Effective rate 27.5%
==========
</TABLE>
6. 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
F-5
<PAGE> 10
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. The Company has retained outside counsel with an
expertise in constitutional issues relating to the wrongful taking of
property in order to assess the appropriateness of challenging the MSA in
certain of the states which have or may be enacting model statutes.
<PAGE> 11
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 692,224
<SECURITIES> 0
<RECEIVABLES> 1,899,189
<ALLOWANCES> 95,636
<INVENTORY> 1,151,598
<CURRENT-ASSETS> 3,852,025
<PP&E> 3,966,632
<DEPRECIATION> 1,297,723
<TOTAL-ASSETS> 6,775,442
<CURRENT-LIABILITIES> 4,600,938
<BONDS> 0
44,000
25
<COMMON> 480,579
<OTHER-SE> 1,116,341
<TOTAL-LIABILITY-AND-EQUITY> 6,775,442
<SALES> 15,781,466
<TOTAL-REVENUES> 15,781,466
<CGS> 3,250,025
<TOTAL-COSTS> 9,659,365
<OTHER-EXPENSES> 3,167,620
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 44,543
<INCOME-PRETAX> 2,909,938
<INCOME-TAX> 775,000
<INCOME-CONTINUING> 2,134,938
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,134,938
<EPS-PRIMARY> .22
<EPS-DILUTED> .04
</TABLE>
