<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
____________________
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
[ ] TRANSITION REPORT PURSUANT TO 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.
(Exact Name of Registrant as Specified in its charter)
Delaware
(State of incorporation)
52-1402131
(IRS Employer Identification No.)
801 Liberty Way
Chester, VA 23836
(Address of Principal Executive Offices)
(804) 530-0535
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 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
---- ----
At September 30, 2000, there were 59,741,460 shares outstanding of the
Registrant's common stock, par value $.01 per share.
<PAGE>
Table of Contents
<TABLE>
<CAPTION>
Page
<S> <C>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of September 30, 2000 (Unaudited)
and December 31, 1999 1
Condensed Consolidated Statements of Operations for the three months and
nine months ended September 30, 2000 and 1999 (Unaudited) 2
Condensed Consolidated Statements of Cash Flows for the nine months ended
September 30, 2000 and 1999 (Unaudited) 3
Notes to Condensed Consolidated Financial Statements 4
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 7
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 14
Signatures 15
</TABLE>
<PAGE>
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- -------------
(Unaudited)
<S> <C> <C>
ASSETS
------
Current assets:
Cash and cash equivalents $ 6,555,669 $ 17,205,248
Accounts receivable, trade 6,785,309 3,599,965
Inventories 8,971,682 3,570,609
Prepaid expenses and other current
assets 546,332 338,790
Deferred tax asset 21,000 2,303,000
------------- -------------
Total current assets 22,879,992 27,017,612
Property, plant and equipment, net 26,208,258 10,974,029
MSA Escrow Fund 11,605,155 -
Intangibles, net of accumulated
amortization 324,337 338,043
Other assets 129,285 296,263
Deferred tax asset - 83,000
Deposits on property and equipment 1,270,704 -
------------- -------------
$ 62,417,731 $ 38,708,947
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Current maturities of notes payable $ 5,074,557 $ 275,000
Accounts payable, trade 3,867,754 3,492,755
Federal excise taxes payable 965,000 1,476,524
Accrued expenses 4,220,170 1,442,521
Income taxes payable 527,000 6,198,000
Customer deposit - 6,000,000
------------- -------------
Total current liabilities 14,654,481 18,884,800
Notes payable, less current maturities 25,023,939 7,504,679
Deferred tax liability 610,000 -
------------- -------------
Total liabilities 40,288,420 26,389,479
------------- -------------
Commitments and contingencies - -
Stockholders' equity:
Common stockA 597,416 587,493
Preferred stockB - -
Additional paid-in capital 12,811,168 10,631,875
Retained earnings 12,608,533 4,187,906
Notes receivable, officers (3,887,806) (3,087,806)
------------- -------------
Total stockholders' equity 22,129,311 12,319,468
------------- -------------
$62,417,731 $38,708,947
============= =============
</TABLE>
A $.01 par value, 100,000,000 shares authorized, 59,741,460 and 58,749,200
shares issued and outstanding 2000 and 1999, respectively
B Series B, convertible; $.01 par value 15,000 shares authorized and none
outstanding
1
<PAGE>
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net sales $75,600,259 $27,700,054 $164,351,909 $58,917,606
----------- ----------- ------------ -----------
Less:
Cost of goods sold 40,393,312 9,236,341 66,838,364 17,372,531
Excise taxes on products 19,656,607 8,972,076 61,436,752 21,499,171
----------- ----------- ------------ -----------
Gross profit 15,550,340 9,491,637 36,076,793 20,045,904
----------- ----------- ------------ -----------
Operating expenses:
Marketing and distribution expenses 3,835,940 1,563,316 10,625,058 4,544,895
General and administrative expenses 3,492,295 3,145,548 9,732,103 6,410,619
Research and development 525,891 101,910 1,204,659 467,431
----------- ----------- ------------ -----------
Total operating expenses 7,854,126 4,810,774 21,561,820 11,422,945
----------- ----------- ------------ -----------
Operating income 7,696,214 4,680,863 14,514,973 8,622,959
----------- ----------- ------------ -----------
Other (income) expenses:
Interest expense (net of interest income) 98,991 (57,076) 219,050 (18,833)
Other (11,040)
-----------
Income from continuing operations before 7,597,223 4,737,939 14,269,998 8,652,832
income taxes
Income tax expense 2,910,000 1,331,000 5,850,000 2,406,000
----------- ----------- ------------ -----------
Net income $ 4,687,223 $ 3,406,939 $ 8,420,628 $ 6,246,832
=========== =========== ============ ===========
Basic income per common share:
Net income $0.08 $0.06 $0.14 $0.15
Diluted income per common share:
Net income $0.08 $0.06 $0.14 $0.11
Weighted average shares outstanding 58,769,140 57,870,048 58,764,488 41,649,923
Diluted weighted average shares outstanding 61,531,427 59,991,198 61,024,855 59,195,614
</TABLE>
2
<PAGE>
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
<TABLE>
<CAPTION>
2000 1999
------------------ ------------------
(Unaudited) (Unaudited)
<S> <C> <C>
Operating activities:
Net income $ 8,420,628 $ 6,246,832
Adjustments to reconcile net income
to net cash provided by
operating activities:
Depreciation and amortization 1,730,391 569,802
Deferred income taxes (2,696,000)
Stock-based compensation expense 209,696 414,675
Increase (decrease) in cash resulting from changes in:
Current assets (8,793,960) (1,964,828)
Current liabilities 3,465,063 1,977,475
Other assets - (513,700)
------------------ ------------------
Net cash provided by (used in) operating activities 2,335,818 6,730,256
------------------ ------------------
Investing activities:
Collections of notes receivable (28,444)
Purchases of property, plant and equipment (16,783,936) (5,459,838)
Deposits on property and equipment (1,270,704) -
Advances to related parties (800,000) -
------------------ ------------------
Net cash used in investing activities (18,854,640) (5,488,282)
------------------ ------------------
Financing activities:
Proceeds from notes payable 21,950,000 -
Payments on notes payable (455,122) (226,604)
Proceeds from sale of stock 1,979,520
Customer deposit (6,000,000) -
------------------ ------------------
Net cash provided by financing activities 17,474,398 (226,604)
------------------ ------------------
MSA escrow fund (11,605,155) -
------------------ ------------------
Increase (Decrease) in cash and cash
Equivalents (10,649,579) 1,015,370
Cash and cash equivalents,
beginning of period 17,205,248 102,695
------------------ ------------------
Cash and cash equivalents,
end of period $ 6,555,669 $ 1,118,065
================== ==================
Supplemental disclosure of cash flow
information:
Cash paid during the year for:
Interest $ 716,731 $ 65,875
================== ==================
Income taxes $ 8,958,000 $ 385,000
================== ==================
</TABLE>
3
<PAGE>
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Accounting Policies:
The financial statements and notes thereto should be read in conjunction with
the financial statements and notes for the year ended December 31, 1999.
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 and nine months ended September 30, 2000 and 1999 are
not necessarily indicative of the results for a full year.
Star Scientific, Inc. ("Star") and its wholly-owned subsidiary, Star Tobacco &
Pharmaceuticals, Inc. ("ST&P" and together with Star, the "Company") generated
net income for all periods presented. Diluted earnings per share assumes
conversion of outstanding common stock options and warrants.
Change in Accounting Method
The Company has changed its method of depreciating the tobacco processing barns.
Effective July 1, 2000, the barns have been depreciated using the units of
production method. This method was adopted because it more accurately matches
revenues with expenses for the Company's seasonal leaf production segment and
provides fairer presentation of the financial statements. This change did not
have a material effect on the Company's results of operations for the three and
nine months ended September 30, 2000 and 1999.
2. Obligations under Master Settlement Agreement- MSA Escrow Fund:
In November 1998, 46 states and several U.S. territories entered into a
settlement agreement to resolve litigation that had been instituted by them
against the major tobacco manufacturers. The Company was not named as a
defendant in any of the litigation matters and chose not to become a
participating manufacturer under the terms of the Master Settlement Agreement
("MSA"). Nonparticipating manufacturers are required to fund escrow accounts
pursuant to the MSA based on the volume of cigarette sales into States that are
participating members of the MSA.
In April 2000, Star, on behalf of ST&P, deposited into escrow $11.6 million to
fund its purported escrow obligations, with respect to sales volume in 1999,
under the MSA and specific state statutes that were passed by states that are
participating members of the MSA. The so-called "level playing field" statutes
require non-participating manufacturers to fund escrow accounts that could be
used to satisfy judgments or settlements in lawsuits that may at some future
date be filed by the participating states. In the foreseeable future, the
Company expects that a material portion of its sales will continue to be subject
to such purported escrow obligations. To date no states have filed suits
against the Company to compel any payments under the MSA and state statutes. In
fact, there are no pending lawsuits against the Company in any state or federal
court. If not used to satisfy judgments or settlements, the funds will be
returned to the Company 25 years after the applicable date of deposit on a
rolling basis. The Company does, however, continue to receive interest earnings
on the invested escrowed amounts.
The Company believes that its existing working capital, together with
anticipated earnings from its tobacco-leaf operations and available funding on
existing lines of credit, will be sufficient to meet its liquidity and capital
requirements in the foreseeable future. The Company's need, if any, to raise
additional funds to meet its working capital and capital requirements will
depend upon numerous factors, including the results of its marketing and sales
activities, any escrow obligations the Company may be required to comply with
under the MSA, the success of the Company's new product development efforts and
the other factors described under "Factors That May Affect Future Results" in
the Company's Annual Report on Form 10-K/A for the fiscal year ended December
31, 1999.
4
<PAGE>
3. Notes payable:
Notes payable consists of the following:
<TABLE>
<CAPTION>
2000
------------
<S> <C>
Note payable under a $13,200,000 credit facility restricted for the
purchase of tobacco curing barns; interest at the stated rate of prime plus
1% payable commencing December 2000; accrued at the effective rate;
principal payable in 60 equal monthly installments commencing September
2004; collateralized by the Company's curing barns, leaf tobacco inventory
and intellectual property. $13,837,241
Note payable, due December 2001, with principal reductions made available
by delivery of flue-cured green tobacco in 2001; interest at the stated
rate of prime plus 1%; collateralized by the Company's curing barns, leaf
tobacco inventory and intellectual property. 11,129,739
Note payable, due August 2001, interest at the stated rate of prime plus
1%; collateralized by the Company's curing barns, leaf tobacco inventory
and intellectual property. 5,006,959
Term note payable, finance company, due in monthly installments of $7,262,
including interest at 9.31% through October 2001; secured by manufacturing
equipment. 89,479
Other 35,078
-----------
30,098,496
Less current maturities of notes payable 5,074,557
-----------
Notes payable, less current maturities $25,023,939
===========
</TABLE>
The annual maturities of notes payable are as follows:
<TABLE>
<CAPTION>
Year ending September 30,
------------------------------
<S> <C>
2001 5,074,557
2002 11,219,218
2005 2,767,448
Thereafter 11,037,273
-----------------
$30,098,496
=================
</TABLE>
5
<PAGE>
4. Income tax expense consists of the following:
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, 2000 September 30, 2000
------------------ ------------------
<S> <C> <C>
Current $ 321,000 $ 2,875,000
Deferred 2,589,000 2,975,000
------------- --------------
$ 2,910,000 $ 5,850,000
============= ==============
</TABLE>
5. Segment information:
<TABLE>
<CAPTION>
Segment of Business
---------------------------------------------------------------------------------------
Three months ended September 30, 2000
---------------------------------------------------------------------------------------
Discount
Cigarettes Tobacco Leaf Consolidated
<S> <C> <C> <C>
Revenue $ 42,468,355 $ 33,131,904 $ 75,600,259
Cost of sales and excise taxes 32,286,106 27,763,813 60,049,919
------------------------ --------------------------- ------------------------
Gross margin 10,182,249 5,368,091 15,550,340
------------------------ --------------------------- ------------------------
Research and development - 525,891 525,891
------------------------ --------------------------- ------------------------
Segment assets $ 29,621,274 $ 32,796,457 $ 62,417,731
======================== =========================== ========================
Three months ended September 30, 1999
---------------------------------------------------------------------------------------
Revenue $ 27,700,054 $ - $ 27,700,054
Cost of sales and excise taxes 18,208,417 - 18,208,417
------------------------ --------------------------- ------------------------
Gross margin 9,491,637 - 9,491,637
------------------------ --------------------------- ------------------------
Research and development 101,910 - 101,910
------------------------ --------------------------- ------------------------
Segment assets $ 12,847,531 $ - $ 12,847,531
======================== =========================== ========================
Segment of Business
---------------------------------------------------------------------------------------
Nine months ended September 30, 2000
---------------------------------------------------------------------------------------
Discount
Cigarettes Tobacco Leaf Consolidated
Revenue $ 131,197,798 $ 33,154,111 $ 164,351,909
Cost of sales and excise taxes 99,471,066 28,804,050 128,275,116
------------------------ --------------------------- ------------------------
Gross margin 31,726,732 4,350,061 36,076,793
------------------------ --------------------------- ------------------------
Research and development - 1,204,659 1,204,659
------------------------ --------------------------- ------------------------
Segment assets $ 29,621,274 $ 32,796,457 $ 62,417,731
======================== =========================== ========================
Nine months ended September 30, 1999
---------------------------------------------------------------------------------------
Revenue $ 58,917,606 $ - $ 58,917,606
Cost of sales and excise taxes 38,871,702 - 38,871,702
------------------------ --------------------------- ------------------------
Gross margin 20,045,904 - 20,045,904
------------------------ --------------------------- ------------------------
Research and development 467,431 - 467,431
------------------------ --------------------------- ------------------------
Segment assets $ 12,847,531 $ - $ 12,847,531
======================== =========================== ========================
</TABLE>
6
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
General; Recent Developments
Star Scientific, Inc. ("Star") and its wholly-owned subsidiary, Star
Tobacco & Pharmaceuticals, Inc. ("ST&P" and together with Star, the "Company")
are engaged in: (1) the development of proprietary scientific technology for the
curing of tobacco so as to prevent, retard or significantly reduce the formation
of carcinogenic toxins present in tobacco and tobacco smoke, primarily, the
tobacco specific nitrosamines ("TSNAs"); (2) the development of tobacco products
that deliver substantially less carcinogenic toxins, namely TSNAs, along with
enlarged health warnings and comparative content information so that adult
tobacco consumers will have the option to make informed choices about the use of
tobacco products which pose a range of health related risks (the TSNA levels in
the Company's tobacco products will continue to be substantially reduced to very
low levels, measured in parts per billion, using its proprietary curing
process); (3) the manufacture and sale of four discount cigarette brands which
contain only a small portion of very low-TSNA StarCure(TM) tobacco (only because
of Star's initial limited supply and its existing contractual delivery
requirements of millions of pounds of very low-TSNA tobacco to Brown &
Williamson Tobacco Corporation, as the Company remains committed to increase the
percentage of very low-TSNA tobacco in its discount products as its supply of
very low-TSNA tobacco increases in the next two growing seasons); (4) the
development of very low nitrosamine ("VLN") smokeless tobacco products, i.e.,
moist snuff and hard snuff tobacco, using its proprietary process to produce
cured tobacco with very low levels of carcinogenic TSNAs; and (5) the research
and continued development of smoking cessation products, hopefully with a co-
venturer or major company with significant resources, and/or an experienced
scientific and regulatory infrastructure so as to assist and accelerate the Food
and Drug Administration's New Drug Application regulatory process necessary for
market entry.
Throughout the year 2000, sales of ST&P's four discount cigarette brands
continued to be strong, while the Company established record revenues from sales
of its StarCure(TM) flue-cured tobacco leaf utilizing its proprietary curing
process as part of its expanded farmers' barn program. Simultaneously, ST&P
restructured and repositioned its sales force so as to maximize future profits
from cigarette sales and minimize the adverse cash flow impact of the purported
MSA escrow obligations. This new sales and marketing approach has allowed ST&P
to achieve record cigarette sales growth compared with the 1999 third quarter.
The Company's StarCure TM leaf sales were achieved through the October 12, 1999
supply agreement with Brown & Williamson Tobacco Corporation ("B&W"). During the
third quarter, the Company sold approximately 12.9 million pounds of
StarCure(TM) tobacco to B&W. It is anticipated that a total of approximately
18.6 million pounds of flue-cured tobacco processed using the Company's
proprietary curing method will be sold to B&W during this year's growing season,
all of which will have been received and processed at Star's newly expanded
processing center in Chase City, Virginia.
B&W is obligated to purchase from the Company 5 million pounds of Virginia
flue-cured StarCure TM in 2001; and B&W has an option to purchase 3 million
pounds of burley tobacco cured using the Company's proprietary process. It is
anticipated that B&W will continue to purchase amounts of StarCure(TM) tobacco
in excess of its contractual obligations.
On October 2, 2000, the Company announced that it began a limited test
market (Richmond, Virginia and Lexington, Kentucky) of what it believes is the
first very low-TSNA cigarette, called Advance(R), manufactured to deliver less
cancer causing TSNAs along with a special activated charcoal/acetate filter
which reduces additional toxic smoke constituents. The Company believes that
Advance(R) is the first premium cigarette to have enhanced health warnings
prominently displayed on the entire back of the pack with an attached
"instructional package onsert" with comparative toxic content disclosure.
Additionally, in an effort to implement the Company's corporate mission to
develop potentially less toxic tobacco products, the Company intends to
increasingly phase its very low-TSNA tobacco, which has been cured through its
proprietary process, into ST&P's discount cigarettes which currently contain
approximately 3% of the StarCureTM tobacco. The Company has also accelerated the
development of its VLN smokeless tobacco products with the expectation to begin
manufacturing in 2001.
On October 24, 2000, the Company announced it had been issued what it
believes to be the first U.S. patent for tobacco products made from tobacco
having very low levels of TSNAs.
The Company's central focus will continue to be the research and
development of products that reduce the range of serious health hazards
associated with the use of smoked and smokeless tobacco products. The Company
7
<PAGE>
fully accepts the evidence showing links between smoking tobacco and a variety
of diseases and premature death and believes that it is unlikely that the health
risks of smoked tobacco can be completely eliminated. Nevertheless, in a world
where an estimated 1.2 billion people smoke and use other tobacco products,
there is an urgent need to reduce the toxicity of tobacco products to the
maximum extent possible given available technologies. The Company believes that
it has a corporate responsibility to continue to expand its research and
development efforts to manufacture tobacco products that are as less hazardous
as is technologically possible. The Company believes it has the technology to
reduce TSNAs to the lowest levels and has demonstrated that the method it has
developed for curing tobacco using its proprietary process, can be scaled up to
meet broad commercial needs in the United States and abroad.
Master Tobacco Settlement Agreement
In November 1998, 46 states and several U.S. territories entered into a
settlement agreement (the "Master Settlement Agreement" or "MSA") to resolve
litigation that had been instituted by them against the major tobacco
manufacturers. The Company was not named as a defendant in any of the
litigation matters and chose not to become a participating manufacturer under
the terms of the MSA for a range of reasons previously set forth in its filings
with the Securities and Exchange Commission. As a nonparticipating
manufacturer, the Company is required to satisfy escrow obligations under
statutes which the MSA required participating states to pass, if they were to
receive the full benefits of the settlement. The so-called "level playing
field" statutes require nonparticipating manufacturers to fund escrow accounts
that could be used to satisfy judgments or settlements in lawsuits that may at
some future date be filed by the participating states against such
nonparticipating tobacco manufacturers. Absent a legal challenge to the state
specific statutes or an agreement with respect to the funding of the required
escrow accounts, beginning April 2000 and annually thereafter the Company is
purportedly obligated to place an amount equal to $2.09 per carton for 2000, and
increased amounts per carton for subsequent years ($2.72 in 2001-2002, $3.35 in
2003-2006 and $3.77 thereafter), in escrow accounts, for sales of cigarettes
occurring in the prior year in each such state after the effective date of each
state specific statute. An inflation adjustment is also added to these deposits
at the higher of 3% or the Consumer Price Index each year. In April 2000, Star,
on behalf of ST&P, deposited into escrow $11.6 million to fund the Company's
purported escrow obligations under the MSA in respect of 1999 sales. In the
foreseeable future, the Company expects that a material portion of its cigarette
sales will continue to be subject to such purported escrow obligations. If not
used to satisfy judgments or settlements, the funds will be returned to the
Company 25 years after the applicable date of deposit on a rolling basis. The
failure to place such required amounts into escrow could result in penalties and
potential restrictions on the Company's ability to sell tobacco products within
particular states. Because of the escrow requirement, for the foreseeable
future, a substantial portion of the Company's net income from operations will
be unavailable for the Company's use and the amount required to be placed in
escrow may exceed the net operating cash flow generated by the Company (See
Liquidity and Capital Resources). In the first quarter of 2000, the Company's
Board of Directors authorized the Company to deposit the escrow obligations for
1999 under protest and to prepare a draft complaint for consideration by the
Company's Board of Directors. A complaint has been prepared by three law firms
highly respected for their trial court experience. The funds placed in escrow
continue to be an asset of the Company and the Company receives the interest
income generated by the escrow deposit.
8
<PAGE>
Results of Operations
The Company's unaudited condensed consolidated results for the periods ended
September 30, 2000 and 1999 are summarized in the following table:
Three Months Ended September 30, Nine Months
Ended September 30,
<TABLE>
<CAPTION>
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net sales $75,600,259 $27,700,054 $164,351,909 $58,917,606
----------- ----------- ------------ -----------
Cost of goods sold 40,393,312 9,236,341 66,838,364 17,372,531
Excise taxes on products 19,656,607 8,972,076 61,436,752 21,499,171
----------- ----------- ------------ -----------
Gross profit 15,550,340 9,491,637 36,076,793 20,045,904
----------- ----------- ------------ -----------
Operating income (loss) 4,687,223 3,406,939 8,420,628 6,246,832
----------- ----------- ------------ -----------
Net income (loss) $ 4,687,223 $ 3,406,939 $ 8,420,628 $ 6,246,832
=========== =========== ============ ===========
Basic income per common share:
Net income $ 0.08 $ 0.06 $ 0.14 $ 0.15
Diluted income per common share:
Net income $ 0.08 $ 0.06 $ 0.14 $ 0.11
Weighted average shares outstanding 58,769,140 57,870,048 58,764,488 41,649,923
Diluted weighted average shares outstanding 61,531,427 59,991,198 61,024,855 59,195,614
</TABLE>
THIRD QUARTER 2000 COMPARED WITH THIRD QUARTER 1999
During the third quarter of 2000, the Company's net sales increased to
$75.6 million, reflecting an increase of $47.9 million, or 173% over the
comparable 1999 period. This increase was primarily due to the Company's sale
of 12.9 million pounds of StarCureTM tobacco leaf to B&W. In addition to $33.1
million in leaf sales, ST&P's cigarette sales increased to $42.5 million in the
third quarter of 2000 from $14.8 million in the third quarter of 1999. This
increase was due to increased cigarette shipment volume by ST&P and higher
pricing, reflecting a January 1, 2000 federal excise tax increase from $0.24 per
pack to $0.34 per pack. ST&P's shipment volume during the third quarter of 2000
increased approximately 56% over the comparable 1999 period to 1.2 billion
units. ST&P's excise taxes for the third quarter 2000 increased to $19.6 million
from $8.9 million for the comparable 1999 period. All net sales in the third
quarter of 1999 were from the sale of cigarettes by ST&P.
During the third quarter of 2000, the Company's gross profit increased to
$15.5 million, reflecting an increase of $6.1 million over the comparable 1999
period, as increases in net sales of $47.9 million, were partially offset by
increases in cost of goods sold of $31.1 million and increases in excise taxes
of $10.7 million. Increases in cost of goods sold primarily related to volume
increases for both cigarettes and StarCureTM tobacco leaf.
Marketing and distribution expenses totaled $3.8 million for the third
quarter of 2000, an increase of $2.3 million over the comparable 1999 period
reflecting a larger sales force and higher promotional expenses. Sales and
marketing efforts by ST&P are higher than the 1999 comparable period, but have
been and will be strategically focused on regions with the highest profit and
cash flow opportunities.
Increased research and development costs in the third quarter of 2000
compared to the third quarter of 1999 reflects the Company's continued focus on
researching and developing products that reduce the range of serious health
hazards associated with the use of smoked and smokeless tobacco products. The
Company plans to release two smokeless tobaccco products under a VLN (very low
nitrosarine) brand concept, a hard tobacco product and a moist snuff product,
the latter of which is anticipated to be introduced into the market in early
2001.
Higher net interest expense in the third quarter of 2000 was the result of
interest expense from the credit facility with B&W, that is being used for the
purchase of tobacco curing barns, and additional borrowings by the Company used
to cover periodic working capital needs, partially offset by interest income
generated by the Company's deposit into its MSA Escrow Fund.
9
<PAGE>
Higher income tax expense for the third quarter of 2000 reflects higher
income and the use of net operating loss carryover from 1998 to lower the
Company's 1999 income tax expense.
Net income of $4.6 million for third quarter 2000 is an increase of 35%
from the $3.4 million reported in the comparable 1999 period. In the third
quarter 2000, the Company had basic and diluted earnings per share of $0.08
compared to basic and diluted per share earnings of $0.06 in the comparable 1999
period. This increase in earnings per share reflects the increase in net income
for third quarter 2000, partially offset by an increase in the weighted average
number of shares outstanding primarily due to the effect given to the exercise
of warrants in the third quarters of both 1999 and 2000.
FIRST NINE MONTHS 2000 COMPARED WITH FIRST NINE MONTHS 1999
During the first nine months of 2000, the Company's net sales increased to
$164.3 million, reflecting an increase of $105.4 million, or 179% over the
comparable 1999 period. All net sales in the first nine months of 1999 were
from the sale of cigarettes by ST&P while sales in the first nine months of 2000
reflect an increase in cigarette sales volume and the sale of StarCure(TM) leaf
tobacco to B&W. ST&P's shipment volume during the first nine months of 2000
increased 125% over the comparable 1999 period from 1.6 billion units to 3.6
billion units. Excise taxes included in net sales for the first nine months of
2000 increased to $61.4 million from $21.4 million in the comparable 1999 period
due to the increased shipment volume and higher federal excise tax rate.
During the first nine months of 2000, the Company's gross profit increased
to $36.1 million, reflecting an increase of $16.0 million over the comparable
1999 period, as increases in net sales of $105.4 million, were partially offset
by increased cost of goods sold ($49.5 million) and increased excise taxes
($39.9 million). Increases in cost of goods sold primarily related to volume
increases for both cigarettes and StarCureTM tobacco leaf.
Marketing and distribution expenses totaled $10.6 million for the first
nine months of 2000, an increase of $6.1 million over the comparable 1999
period. This increase reflects the expansion of the sales force and marketing
efforts, which are consistent with increased cigarette sales volume from the
comparable 1999 period.
General and administrative expenses totaled $9.7 million for the first nine
months of 2000, an increase of $3.3 million over the comparable 1999 period.
This increase was attributable primarily to expenses related to the relocation
of the Company's executive, marketing, sales and administrative offices to
Chester, Virginia, expansion of the warehouse facility in Chase City, Virginia
and associated costs in operating and maintaining these facilities, as well as
the expansion of the Company's scientific, medical and public health consultants
and advisors who continue to assist senior management in carrying out several of
the suggestions that Star has received from its independent Scientific Advisory
Board.
Research and development expenses increased from $0.4 million for the first
nine months of 1999 to $1.2 million for the comparable period in 2000. This
increase reflects the development of the proprietary low nitrosamine curing
process for burley tobacco, as well as development of two smokeless tobacco
products nitrosanive under a VLN (very low nitrosarie) brand concept, a hard
tobacco product and a moist snuff product, the latter of which is anticipated to
be introduced into the market in early 2001.
Higher net interest expense in the first nine months of 2000 was the result
of interest expense from the credit facility from B&W, that is being used for
the purchase of tobacco curing barns, and additional borrowings by the Company
used to cover periodic working capital needs, partially offset by interest
income generated by the Company's deposit into its MSA Escrow Fund.
Higher income tax expense for the first nine months of 2000 reflects higher
income and the use of net operating loss carryover from 1998 to lower the
Company's 1999 income tax expense.
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Net income of $8.4 million for the first nine months of 2000 increased 35%
from the $6.2 million reported in the comparable 1999 period. In the first nine
months of 2000, the Company had basic and diluted earnings per share of $0.14
per share versus basic and diluted earnings per share of $0.15 and $0.11 per
share, respectively, in the first nine months of 1999. These per share earnings
reflect an increase in net income and an increase in the weighted average shares
outstanding. The increase in the weighted average shares outstanding is
primarily due to the conversion of the Company's Class B Preferred Stock into
shares of the Company's Common Stock..
Liquidity and Capital Resources
In the first nine months of 2000, $2.3 million of cash was provided by
operating activities due primarily to positive cash flow effects of cigarette
and leaf sales in the third quarter partially offset by an investment in working
capital.
During the first nine months of 2000, the Company incurred $16.8 million in
capital expenditures, virtually all of it as part of the StarCure(TM) barn
production program relating to the exclusive contractual arrangement between the
Company and Powell Manufacturing Company, the largest barn manufacturer in the
United States. Approximately 1,100 of these barns have already been
manufactured. The Company has also finalized arrangements and provided deposits
of $1.3 million for a lease of manufacturing equipment, with a cost of $3.1
million, relating to the new smokeless tobacco products.
In 1999, B&W and the Company entered into a loan agreement ("Loan
Agreement"). Under this Loan Agreement, B&W agreed to loan the Company capital
necessary to finance the purchase of curing barns in the form of a $13.2 million
long-term credit facility restricted for the purchase of tobacco curing barns.
The Company has borrowed the entire $13.2 million under this credit facility.
Interest accrues on this credit facility at prime plus 1% commencing December
2000 and is payable monthly. Principal is payable in 60 equal monthly
installments commencing September 2004. The Company may borrow up to an
additional $8.8 million to finance the purchase of curing barns subject to
certain conditions.
On August 21, 2000, the Company and ST&P entered into a second loan
agreement ("Restated Loan Agreement") with B&W to restate the terms of the Loan
Agreement with B&W. In connection with the Restated Loan Agreement, B&W
advanced an additional $11 million to the Company. The principal balance of
this note will be reduced by deliveries by the Company to B&W of StarCure flue-
cured tobacco from the year 2001 flue-cured tobacco crop. If the required
StarCure flue-cured tobacco deliveries are not made by December 2001, then the
outstanding principal will be payable on demand. Any outstanding principal on
this advance after December 31, 2001 will bear interest at prime plus 1%.
Additionally, under the Restated Loan Agreement, B&W agreed to make a working
capital loan of approximately $4.9 million to ST&P due August 2001 at prime plus
1%. Under the Restated Loan Agreement, B&W was granted a first priority security
interest in the Company's curing barns and leaf inventory and the Company's and
ST&P's respective intellectual property as collateral for all of the loans and
advances from B&W. In addition, the Company and ST&P have each guaranteed the
payment of the other's obligations.
In the third quarter of 2000, all of the holders of previously issued stock
warrants exercised such stock warrants for 977,280 shares of common stock,
generating $2.0 million in new stockholders' equity for the Company.
The Company has a working capital line of credit with a financial
institution, which is collateralized by accounts receivable from its cigarette
business, in the amount of $7.5 million. The Company had no borrowings under
this credit facility at September 30, 2000.
In April 2000, Star, on behalf of ST&P, deposited into escrow $11.6 million
to fund the Company's purported escrow obligations under the Master Settlement
Agreement with respect to sales volume in 1999. In the foreseeable future, the
Company expects that a material portion of its cigarette sales will continue to
be subject to such purported escrow obligations. If not used to satisfy
judgments or settlements, the funds will be returned to the Company 25 years
after the applicable date of deposit on a rolling basis.
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The Company believes that its existing working capital, together with
anticipated earnings from its existing operations and new products, will be
sufficient to meet its liquidity and capital requirements in the foreseeable
future, including the amount of any escrow obligations under the MSA. The
Company's need, if any, to raise additional funds to meet its working capital
and capital requirements will depend upon numerous factors, including the
results of its marketing and sales activities, the amount of any escrow
obligations it may be required to comply with under the MSA, the success of the
Company's new VLN smokeless tobacco product development efforts and the other
factors described under "Factors That May Affect Future Results" in the
Company's Annual Report on Form 10-K/A for the fiscal year ended December 31,
1999.
The foregoing discussion of the results of operations and financial
condition of the Company should be read in conjunction with the Company's
condensed consolidated financial statements and related notes included elsewhere
in this Report.
Note on Forward-Looking Statements
THIS REPORT ON FORM 10-Q CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS WITHIN THE
MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. THE COMPANY
HAS TRIED, WHENEVER POSSIBLE, TO IDENTIFY THESE FORWARD-LOOKING STATEMENTS USING
WORDS SUCH AS "ANTICIPATES", "BELIEVES", "ESTIMATES", "EXPECTS", "PLANS",
"INTENDS" AND SIMILAR EXPRESSIONS. THESE STATEMENTS REFLECT THE COMPANY'S
CURRENT BELIEFS AND ARE BASED UPON INFORMATION CURRENTLY AVAILABLE TO IT.
FORWARD-LOOKING STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES AND
OTHER FACTORS WHICH COULD CAUSE THE COMPANY'S ACTUAL RESULTS, PERFORMANCE OR
ACHIEVEMENTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED IN, OR IMPLIED BY, SUCH
STATEMENTS, AND ANY SUCH STATEMENTS ARE QUALIFIED BY REFERENCE TO THE FOLLOWING
FACTORS.
THE COMPANY IS SUBJECT TO RISKS, UNCERTAINTIES AND CONTINGENCIES THAT INCLUDE,
WITHOUT LIMITATION, THE RISKS OF OPERATING IN THE TOBACCO INDUSTRY EVEN AS A
HEALTH ORIENTED TOBACCO TECHNOLOGY COMPANY, THE CHALLENGES INHERENT IN NEW
PRODUCT DEVELOPMENT INITIATIVES, INCLUDING MARKET ACCEPTANCE OF THE COMPANY'S
PRODUCTS AND PROPOSED NEW PRODUCTS, THE COMPANY'S ABILITY TO RAISE THE CAPITAL
NECESSARY TO GROW ITS BUSINESS AND UNFORESEEN DIFFICULTIES IN THE MANAGEMENT OF
GROWTH, POTENTIAL DISPUTES CONCERNING THE COMPANY'S INTELLECTUAL PROPERTY,
COMPETITION FROM COMPANIES THAT MAY HAVE CERTAIN COMPETITIVE ADVANTAGES OVER THE
COMPANY, THE COMPANY'S DEPENDENCE ON KEY EMPLOYEES AND ITS RELATIONSHIP WITH
BROWN & WILLIAMSON TOBACCO CORPORATION, A KEY STRATEGIC CUSTOMER, SUPPLIER AND
LENDER, AND THE COMPANY'S DECISION NOT TO JOIN THE MASTER SETTLEMENT AGREEMENT
("MSA"). OTHER RISKS INCLUDE FURTHER REGULATORY RESTRICTIONS ON THE SALE AND
MARKETING OF TOBACCO PRODUCTS GIVEN THE HEALTH CONCERNS RELATED TO THE USE OF
TOBACCO PRODUCTS GENERALLY, THE EFFECT OF STATE STATUTES ADOPTED
UNDER THE MSA AND ANY SUBSEQUENT MODIFICATION OF THE MSA, LITIGATION, INCLUDING
LITIGATION RELATED TO THE MSA, AND THE EFFECTS OF EXCISE TAX INCREASES ON
TOBACCO CONSUMPTION RATES.
SEE ADDITIONAL DISCUSSION UNDER "FACTORS THAT MAY AFFECT FUTURE RESULTS" IN THE
COMPANY'S ANNUAL REPORT ON FORM 10-K/A FOR THE YEAR ENDED DECEMBER 31, 1999, AND
OTHER FACTORS DETAILED FROM TIME TO TIME IN THE COMPANY'S OTHER FILINGS WITH THE
SECURITIES AND EXCHANGE COMMISSION. THE COMPANY UNDERTAKES NO OBLIGATION TO
UPDATE OR ADVISE UPON ANY SUCH FORWARD-LOOKING STATEMENTS.
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Item 3. Exhibits and Reports on Form 8-K
(a) Exhibits
Number Description
------ -----------
3.01 Restated Certificate of Incorporation (Form 10-KSB for fiscal year ended
December 31, 1992)*
3.02 Certificate of Amendment of Restated Certificate of Incorporation, dated
March 25, 1993, and effective April 2, 1993 (Form 10-KSB for fiscal year
ended December 31, 1996)*
3.03 Certificate of Amendment of Restated Certificate of Incorporation, dated
March 25, 1993, and effective April 2, 1993 (Form 10-KSB for fiscal year
ended December 31, 1996)*
3.04 Certificate of Amendment of Certificate of Incorporation, dated December
15, 1998 (Form 8-K dated January 15, 1999)*
3.05 Bylaws of the Company, as amended to date
10.42 Restated Loan Agreement between the Company, Star Tobacco &
Pharmaceuticals, Inc. and Brown & Williamson Tobacco Corporation, dated
August 21, 2000
10.43 Restated Security Agreement between the Company and Brown & Williamson
Tobacco Corporation, dated August 21, 2000
10.44 Security Agreement between Star Tobacco & Pharmaceuticals, Inc. and
Brown & Williamson Tobacco Corporation, dated August 21, 2000
10.45 Guaranty Agreement between the Company and Brown & Williamson Tobacco
Corporation, dated August 21, 2000
10.46 Guarantee Agreement between Star Tobacco & Pharmaceuticals, Inc. and
Brown & Williamson Tobacco Corporation, dated August 21, 2000
10.47 Executive Employment Agreement dated as of September 15, 2000 entered
into by the Company and Christopher G. Miller
27 Financial Data Schedule
(b) Reports on Form 8-K
The Company filed a current report on Form 8-K on August 22, 2000
describing the Company's financing arrangements with B&W.
* These items are hereby incorporated by reference from the exhibits to the
filing or report indicated (Commission File No. 0-15324) and are hereby
made a part of this report.
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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: November 13, 2000 /s/ Christopher G. Miller
-----------------------------------------
Authorized Signatory and
Chief Financial Officer
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