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Registration No. 333-_____
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 13, 2000.
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
----------------
STAR SCIENTIFIC, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 3851 52-1402131
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(STATE OR OTHER JURISDICTION (PRIMARY STANDARD INDUSTRIAL (IRS EMPLOYER
OF INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
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801 LIBERTY WAY
CHESTER, VA 23836
(804) 530-0535
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
PAUL L. PERITO, ESQ.,
PRESIDENT AND CHIEF OPERATING OFFICER
STAR SCIENTIFIC, INC.
801 LIBERTY WAY
CHESTER, VA 23836
(804) 530-0535
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF AGENT FOR SERVICE)
----------------
COPIES TO:
ESTEBAN A. FERRER, ESQ.
PAUL, HASTINGS, JANOFSKY & WALKER LLP
1055 WASHINGTON BOULEVARD
STAMFORD, CONNECTICUT 06901
(203) 961-7444
APPROXIMATE DATE OF PROPOSED SALE TO THE PUBLIC: As soon as practicable
after the effective date of this Registration Statement.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. [ ]
CALCULATION OF REGISTRATION FEE
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Proposed Maximum Proposed Maximum
Title of each Class of Securities to be Amount to be Offering Price Per Aggregate Amount of
Registered Registered Share(1) Offering Price(1) Registration Fee
- ---------------------------------------------------------------------------------------------------------------------------
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Common Stock, $.01 par value 300,000 shares 6.75 $2,025,000 $562.95
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(1) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457 under the Securities Act.
----------------
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED.
THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE
TIME THIS PROSPECTUS IS DELIVERED IN FINAL FORM. THIS PROSPECTUS IS NOT AN
OFFER TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES IN ANY JURISDICTION WHERE THE OFFER OF SALE IS NOT PERMITTED.
================================================================================
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Registration No. 333-_____
300,000 SHARES
STAR SCIENTIFIC, INC.
COMMON STOCK
Our common stock is traded on the OTC Bulletin Board under the symbol
"STSI." The selling stockholders identified in this prospectus are offering
300,000 shares of our common stock. We will not receive any of the proceeds
from the sale of shares by the selling stockholders. The market price of
our common stock after this offering may be higher or lower than the actual
price at which the shares of our common stock will be sold in this
offering.
SEE "RISK FACTORS" BEGINNING ON PAGE 2 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK
OFFERED HEREBY.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON
THE ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
The date of this prospectus is ________________.
<PAGE> 3
TABLE OF CONTENTS
Page
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SUMMARY......................................................................1
RISK FACTORS.................................................................1
FORWARD-LOOKING STATEMENTS...................................................4
DIVIDEND POLICY..............................................................4
CAPITALIZATION...............................................................4
SELECTED CONSOLIDATED FINANCIAL DATA.........................................5
BUSINESS.....................................................................6
WHERE YOU CAN FIND MORE INFORMATION.........................................18
RESULTS OF OPERATIONS.......................................................18
MANAGEMENT..................................................................22
EXECUTIVE COMPENSATION AND OTHER MATTERS....................................25
STOCK OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.................27
DESCRIPTIONS OF EMPLOYEE PLANS..............................................29
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..............................29
LEGAL MATTERS...............................................................34
EXPERTS.....................................................................35
ADDITIONAL INFORMATION......................................................35
OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION..................................1
INDEMNIFICATION OF DIRECTORS AND OFFICERS....................................1
-i-
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SUMMARY
THIS SUMMARY HIGHLIGHTS CERTAIN INFORMATION CONTAINED ELSEWHERE IN THIS
PROSPECTUS. THIS SUMMARY IS NOT COMPLETE AND DOES NOT CONTAIN ALL OF THE
INFORMATION YOU SHOULD CONSIDER BEFORE INVESTING IN OUR COMMON STOCK. YOU SHOULD
READ THE ENTIRE PROSPECTUS CAREFULLY, ESPECIALLY THE RISKS OF INVESTING IN OUR
COMMON STOCK DISCUSSED UNDER "RISK FACTORS." REFERENCES IN THIS PROSPECTUS TO
THE "COMPANY," "WE," "OUR" AND "US" REFER TO STAR SCIENTIFIC, INC., A DELAWARE
CORPORATION.
STAR SCIENTIFIC, INC.
We 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 less harmful smoked tobacco products utilizing tobacco with very
low levels of TSNAs (measured in parts per billion) which has been cured using
the Company's proprietary StarCure(TM) process; (3) the manufacture and sale of
discount cigarettes, with activated charcoal filters; (4) the research and
development of tobacco cessation products; and (5) the development of smokeless
tobacco products utilizing tobacco with very low levels of TSNAs (measured in
parts per billion) which has been cured using the Company's proprietary
StarCure(TM) process.
Our central focus is the reduction of the range of serious health
hazards associated with the use of tobacco products. Accordingly, our 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 our proprietary curing technology.
We are a Delaware corporation traded on the OTC Bulletin Board. Our
principal executive offices are located at 801 Liberty Way, Chester, VA 23831.
Our phone number is (804) 861-0681. Our Web site is located at
www.starscientific.com.
THE OFFERING
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Common stock offered by Star Scientific, Inc.......... Zero shares
Common stock offered by the selling stockholders...... 300,000 shares
Common stock to be outstanding after the offering..... 58,749,201 shares
Use of proceeds....................................... We will not receive any of the
proceeds from the sale of shares
OTC Bulletin Board symbol............................. "STSI"
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RISK FACTORS
You should read the following risk factors carefully before purchasing our
common stock.
FACTORS THAT MAY AFFECT FUTURE RESULTS
We Are Dependent on the Domestic Tobacco Business
Substantially all of our revenues in 1999 were derived from sales
in the United States of our four brands of discount cigarettes, and sales of our
very low-TSNA tobacco . If the U.S. cigarette market continues to contract, we
may not have significant tobacco sales abroad or sales of other products to
offset these effects. This trend could adversely affect our sales volumes,
operating income and cash flows.
Competition From Other Cigarette Makers Could Adversely Affect Us
The cigarette industry is highly competitive. The majority of our
competitors have substantially greater financial, marketing, personnel and other
resources than we have. While we are not aware of any other company which
produces very low-TSNA tobacco for commercial use or incorporates very low-TSNA
tobacco into their cigarettes or other tobacco products, other major tobacco
companies will undoubtedly follow Star's lead. Additionally, our competitors may
also develop other less toxic tobacco products that can compete with our very
low-TSNA products.
Very Low-TSNA Tobacco May Not Be Accepted by the Marketplace
While we have produced and test marketed limited quantities of our very
low-TSNA cigarette and have been encouraged by the initial results, very
low-TSNA tobacco may not be accepted ultimately by adult smokers. Adult smokers
may decide not to purchase tobacco products made with very low-TSNA tobacco due
to taste or other preferences, particularly in light of Star's decision to
introduce its new very low-TSNA cigarette product with an activated charcoal
filter.
The Cigarette Industry is Subject to Substantial and Increasing
Regulation and Taxation
Various federal, state and local laws limit the advertising, sale and
use of cigarettes, and these laws have proliferated in recent years. If this
trend continues, it may have material and adverse effects on our sales volumes,
operating income and cash flows. In addition, cigarettes are subject to
substantial and increasing excise taxes. The federal excise tax on cigarettes
will rise from $.24 per pack in 1999 to $.34 in 2000, and to $.39 in 2002.
President Clinton has proposed a further increase of $.55 per pack. Additional
state excise taxes range from $.025 per pack in Virginia to $.87 per pack in
California. Increased excise taxes may result in declines in overall sales
volume. This result could adversely affect our operating income and cash flows.
The FDA has adopted extensive regulations governing the sale and advertising of
tobacco products. It is difficult to predict what effect implementation of the
FDA regulations, if allowed, would have upon our conventional cigarette
business. The FDA 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 "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
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could have an adverse affect upon our sales of cigarettes and could materially
and adversely affect our sales volumes, operating income and cash flows.
We Have Substantial Obligations Under State Laws Adopted Under the
Master Settlement Agreement
Absent a successful legal challenge to the statutes passed by various
states in connection with the Master Settlement Agreement, or an agreement with
the National Association of Attorneys General ("NAAG") with respect to the
funding of the required escrow accounts, we would be obligated to place an
amount equal to $1.88 per carton for 1999, and increased amounts per carton for
subsequent years ($2.09 in 2000, $2.72 in 2001-2002, $3.35 in 2003-2006 and
$3.77 thereafter), in escrow accounts beginning April 2000 for sales of
cigarettes occurring in each such state after the effective date of each state
specific statute. The failure to pay such required escrow amounts could result
in penalties to us and potential restrictions on our ability to sell tobacco
products within particular states. Because of the escrow payment requirement, a
substantial portion of our net income from operations will be unavailable for
our use. This will adversely affect our ability to apply the capital generated
from our present cigarette sales toward the further scientific development of
less hazardous tobacco products growth of our business. In addition, the escrow
obligations will impede the Company's ability to distribute dividends to its
stockholders.
Our Current Supply Contracts and Other Contracts with B&W May Not Be
Extended
We have entered into a supply agreement ("Supply Agreement") with Brown
& Williamson Tobacco Corporation ("B&W") under which B&W agreed to purchase
StarCure(TM) tobacco in the period 2000-2001, with the right to purchase tobacco
from us on a long-term basis in later years. If B&W were to stop purchasing our
tobacco that has been cured using the StarCure(TM) process, it could adversely
affect our sales volumes, operating income and cash flows. Additionally, we
currently have other business relationships with B&W. B&W has agreed to: (1)
loan us the capital necessary to finance the purchase of up to 600 specially
manufactured curing barns and potentially up to 1,000 curing barns, (2)
manufacture cigarettes for us and (3) supply tobacco to us. The termination of
any of these agreements could negatively affect our business operations.
Lawsuits May Affect Our Profitability
We are not named as a defendant in any legal actions affecting the
tobacco industry, including proceedings and claims arising out of the sale,
distribution, manufacture, development, advertising, marketing and claimed
health effects of cigarettes. While we believe that the risk of being named a
defendant in such a lawsuit is relatively low, we may be named as a defendant in
the future as there has been a noteworthy increase in the number of these cases
pending. Punitive damages, often in amounts ranging into the hundreds of
millions, or even billions of dollars, are specifically pleaded in a number of
these cases in addition to compensatory and other damages. Our inclusion in any
of these actions or any future action could have a material and adverse effect
on our financial condition.
We May Not Properly Manage Our Growth
If we are successful in maintaining and increasing market acceptance
for our products, we will be required to manage substantial volume from our
customers. To accommodate any such growth and compete effectively, we will be
required to attract, integrate, motivate and retain additional highly skilled
sales, technical and other employees. We face competition for these people. Our
ability to successfully manage such volume also will be dependent on our ability
to scale up our tobacco processing and production operations. There can be no
assurance that we can overcome the challenge
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of scaling our processing and production operations or that our personnel,
systems, procedures and controls will be adequate to support our future
operations. Any failure to implement and improve our operational, financial and
management systems or to attract, integrate, motivate and retain additional
employees required by future growth, if any, could have a material and adverse
effect on our business and prospects, financial condition and results of
operations.
We May Not Be Successful in Protecting Our Proprietary Rights
Our success in commercially exploiting our licensed tobacco curing
technology depends in large part on our ability to defend issued patents, to
obtain further patent protection for the technology in the United States and
other jurisdictions, and to operate without infringing upon the patents and
proprietary rights of others. Additionally, we must be able 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.
Patent positions, including our patent positions (owned or licensed)
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 our patents and limit our ability to obtain meaningful patent protection. If
patents are issued to other companies that contain competitive or conflicting
claims, we may be required to obtain licenses to these patents or to develop or
obtain alternative technology. Such licensing agreements, if required, may be
unavailable on acceptable terms or at all. If such licenses are not obtained, we
could be delayed in or prevented from pursuing the development or
commercialization of our products.
Litigation which could result in substantial cost may also be necessary
to enforce any patents to which we have rights, or to determine the scope,
validity and unenforceability of other parties' proprietary rights which may
affect our rights. U.S. patents carry a presumption of validity and generally
can be invalidated only through clear and convincing evidence. We may also
have to participate in interference proceedings declared by the U.S. Patent
and Trademark Office to determine the priority of an invention, which could
result in substantial cost. There can be no assurance that our 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 and adverse effect on our business
and prospects.
We may also rely on unpatented trade secrets and know-how to maintain
our competitive position, which we seek 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 we will
have adequate remedies for any breach, or that our trade secrets will not
otherwise become known or be independently discovered by competitors.
We Depend On Key Personnel
We depend upon the continued services of our senior management for our
continued success. The loss of either of the Company's Chief Executive Officer,
Mr. Jonnie R. Williams, or the Company's President and Chief Operating Officer,
Paul L. Perito, Esquire, could have a serious negative impact upon our business
and operating results. To minimize the present risk of the loss of either one of
these two senior executives, the Company has initiated a search for another
senior
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executive who would share some of the present responsibilities now assumed by
either Mr. Williams and/or Mr. Perito.
Management and Significant Stockholders Can Exercise Influence over the
Company
Based upon stock ownership as of February 28, 2000, our executive
officers, directors, and their associates, own an aggregate of aproximately 70%
of our outstanding shares. As a result, these persons acting together may have
the ability to control matters submitted to our shareholders for approval and
to control the management and affairs of the Company. This concentration of
ownership may have the effect of delaying or preventing a change in control of
the Company, impede a merger, consolidation, or takeover or other business
combination, or discourage a potential acquiror from attempting to obtain
control. This concentration of control could also have a negative effect on the
market price of our shares.
Pursuant to the our Certificate of Incorporation and Bylaws, the Board
of Directors is divided into three classes. Members of each class serve for a
three-year term and until the election and qualification of their successors, or
their earlier resignation or removal. Because the Board is divided into
classes, only those directors in a single class may be changed in any one year.
Consequently, changing a majority of the Board generally would require two
years. A classified Board, which may be regarded as an "anti-takeover"
provision, may make it more difficult for our stockholders to change the
majority of directors and thus have the effect of maintaining continuity of
management.
FORWARD-LOOKING STATEMENTS
CERTAIN STATEMENTS IN THIS REGISTATION STATEMENT, UNDER THE SECTIONS "RISK
FACTORS, " "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS," "BUSINESS" AND ELSEWHERE RELATE TO FUTURE EVENTS AND
EXPECTATIONS AND AS SUCH CONSTITUTE "FORWARD-LOOKING STATEMENTS," WITHIN THE
MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. THE WORDS
"BELIEVES," "ANTICIPATES," "PLANS," "EXPECTS," AND SIMILAR EXPRESSIONS IN THIS
REPORT ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS. SUCH FORWARD-LOOKING
STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES, AND OTHER FACTORS
WHICH MAY CAUSE THE ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS OF THE COMPANY
TO BE MATERIALLY DIFFERENT FROM ANY FUTURE RESULTS, PERFORMANCE OR ACHIEVEMENTS
EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS AND TO VARY
SIGNIFICANTLY FROM REPORTING PERIOD TO REPORTING PERIOD. SUCH FACTORS INCLUDE,
AMONG OTHERS, THOSE LISTED IN "RISK FACTORS" ABOVE AND OTHER FACTORS DETAILED
FROM TIME TO TIME IN THE COMPANY'S OTHER FILINGS WITH THE SECURITIES AND
EXCHANGE COMMISSION.
USE OF PROCEEDS
All of the shares of common stock offered hereby are being sold by the selling
stockholders. We will not receive any of the proceeds from the sale of the
shares of common stock by the selling stockholders.
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SELLING STOCKHOLDERS
The following table sets forth as of March 13, 2000, and upon
completion of the offering described in this Prospectus, information regarding
the beneficial ownership of our common stock by the selling stockholders. The
shares beneficially owned by the selling stockholders represents less than 1% of
the outstanding shares of common stock.
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Name and Address Shares Beneficially Shares Beneficially
- ---------------- Owned Before Shares to Owned After Offering
Offering be Offered Number
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Nusum Holdings 200,000 200,000 0
c/o MFC Merchant Bank SA
53 route de Malagnov
P.O. Box 509
1211 Geneva 17
MFC Merchant Bank SA 300,080 100,000 200,080
53 route de Malagnov
P.O. Box 509
1211 Geneva 17
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PLAN OF DISTRIBUTION
To our knowledge, the selling stockholders currently have no plan of
distribution, agreement, arrangement or understanding with any broker or dealer
that has been entered into prior to the date of this Prospectus. The Company
expects that the shares of common stock, when sold, will be sold for cash at the
then-prevailing market price less the standard broker's commission. It is
expected that the shares of common stock will be sold through the OTC Bulletin
Board. No underwriter is currently expected to be involved in the sale of the
shares of common stock.
DESCRIPTION OF SECURITIES
The authorized capital stock of the Company consists of 100,000,000 shares
of common stock, $.01 par value per share, and 15,000 shares of Series B
Preferred Stock. There are 58,749,201 shares of common stock outstanding and
zero shares of Series B Preferred Stock outstanding on February 28, 2000. All of
the shares being sold by the selling stockholders offered hereby are common
stock.
COMMON STOCK
The holders of common stock are entitled to one vote for each share held of
record on all matters submitted to a vote of the stockholders. Subject to the
rights of holders of any shares of preferred stock which may at the time be
outstanding, holders of common stock will be entitled to such dividends as the
Board of Directors may declare out of funds legally available therefor. Subject
to the prior rights of creditors and holders of any preferred stock which may be
outstanding from time to time, the holders of common stock are entitled, in the
event of our liquidation, dissolution or winding up to share pro rata in the
distribution of all remaining assets. The common stock is not liable for any
calls or assessments and is not convertible into any other securities. In
addition, there are no redemption or sinking fund provisions applicable to the
common stock. We have never declared or paid cash dividends on our common stock.
We do not expect to pay any cash dividends on our common stock in the
foreseeable future.
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Pursuant to the Company's Certificate of Incorporation and Bylaws, the
Board of Directors is divided into three classes. Members of each class serve
for a three-year term and until the election and qualification of their
successors, or their earlier resignation or removal. Because the Board is
divided into classes, only those directors in a single class may be changed in
any one year. Consequently, changing a majority of the Board generally would
require two years. A classified Board, which may be regarded as an
"anti-takeover" provision, may make it more difficult for the Company's
stockholders to change the majority of directors and thus have the effect of
maintaining continuity of management.
EXPERTS
The consolidated financial statements of the Company for the years ended
December 31, 1999 and 1998 appearing in this registration statement have been
audited by Aidman, Piser & Company, P.A., independent public accountants, as set
forth in their report and are included in reliance upon the authority of said
firm as experts in giving said report. The financial statements of the
Company for the year ended December 31, 1997 appearing in this registration
statement have been audited by Keiter, Stephens, Hurst, Gary & Shreaves, P.C.,
independent public accounts, as set forth in their report and are included in
reliance upon the authority of said firm as experts in giving said report.
BUSINESS
GENERAL
We 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 less harmful smoked tobacco products utilizing tobacco with very
low levels of TSNAs (measured in parts per billion) which has been cured using
the Company's proprietary StarCure(TM) process; (3) the manufacture and sale of
discount cigarettes, with activated charcoal filters; (4) the research and
development of tobacco cessation products; and (5) the development of smokeless
tobacco products utilizing tobacco with very low levels of TSNAs (measured in
parts per billion) which has been cured using the Company's proprietary
StarCure(TM) process.
Star's central focus is the reduction of the range of serious health
hazards associated with the use of tobacco products. Accordingly, Star'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 an economically feasible
curing technology (StarCure(TM)) process for preventing the formation of
virtually all of the carcinogenic TSNAs in tobacco. This, in turn, reduces these
carcinogens in secondhand smoke. Star's non-chemical StarCure(TM) curing process
does not affect the taste, color or nicotine content of tobacco.
The Company has an 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 cancer researchers as the most
abundant and potent carcinogens in tobacco and tobacco smoke.
Today, the Company's revenue generation is principally through its
wholly-owned subsidiary, Star Tobacco & Pharmaceuticals, Inc. ("ST&P"). ST&P's
predecessor, a closely held private
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company, was organized in 1990 and, until 1994, primarily was engaged in the
business of manufacturing cigars and cigarettes for others as a contract
manufacturer. By late 1994, ST&P had commenced development and commercialization
of its own brands of discount cigarettes using primarily Virginia flue-cured
tobacco, without additives, and competed principally on the basis of price. At
about that same time, ST&P commenced a program of research and development
relating to a range of potentially less harmful tobacco products and tobacco
cessation products wherein ST&P secured certain Investigatory New Drug
applications ("INDs") from the U. S. Food and Drug Administration ("FDA") to
commence human clinical testing. Shortly thereafter, ST&P shifted its near-term
research focus to a technological development phase focused upon reducing the
carcinogenic TSNAs in the tobacco leaf and tobacco smoke. In February 1998, ST&P
merged with Eye Technology, Inc., a publicly-held OTC Bulletin Board company
based in Minneapolis, Minnesota. While Eye Technology technically was the
surviving corporation, in effect, in the merger, control of the surviving
corporation shifted to the former stockholders of ST&P and the management of
ST&P became the control management of the survivor in the merger. By December
30, 1998, the assets and liabilities that comprised the pre-merger business of
Eye Technology, Inc. had been sold or liquidated, and the stockholders of Eye
Technology voted to change its name to Star Scientific, Inc. The Company's
primary corporate focus from that time forward has centered upon the development
of reduced toxin, and potentially reduced risk, tobacco products, plus continued
focus upon the long term development of smoking cessation products either with a
joint venture partner or a corporate pharmaceutical partner.
Thereafter, in pursuance of the Company's focus to reduce the
carcinogenic TSNAs in the tobacco leaf and tobacco smoke, the Company obtained
the exclusive right to patent and patent applications which are now pending,
pertaining to various aspects of the tobacco leaf curing process which has been
named StarCure(TM). The proprietary StarCure(TM) process, to which the Company
has an exclusive license from Regent Court Technologies LLC (as discussed
herein), involves the use of specially designed curing barns and a microwave
curing process using specially designed industrial size microwave ovens
(operated presently from its Chase City, Virginia processing center). This
proprietary StarCure(TM) process virtually precludes and/or substantially
reduces the formation in the tobacco leaf of the carcinogenic TSNAs, which are
widely believed by medical and scientific experts to be among the most potent
and powerful cancer-causing toxins present in tobacco and in side stream tobacco
smoke.
The Company's long-term strategy is to aggressively increase and expand
its production capacity for its proprietary StarCure(TM) process to produce a
very low TSNA tobacco (carcinogenic NNKs and NNNs at less than 400 parts per
billion). Further, the Company is committed to continue to explore the
development of potentially less harmful smoked and smokeless tobacco products,
as well as the development of tobacco cessation products. The Company has
started the process of integrating its very low-TSNA StarCure(TM) tobacco into
its present discount cigarette brands. Star presently markets four brands,
namely, SPORT(R), MAINSTREET(R), VEGAS(R) and G-SMOKE(R) all of which now have
activated charcoal filters and contain approximately 3% of very low-TSNA
flue-cured tobacco because of limited availability of very low-TSNA tobacco at
this time. It is anticipated that in light of Star's projected increased
StarCure(TM) production during the year 2000, between 20-25 million pounds of
very low-TSNA tobacco will be processed during this year's growing season. With
such increased production, Star expects to be able to totally phase into its
four brands all very low-TSNA flue-cured tobacco over the next 24 months, launch
a new very low-TSNA cigarette brand that also will have activated charcoal
filters, and contemporaneously fulfill its tobacco supply commitments to B&W,
the third largest tobacco company in the United States.
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The Company has announced plans to launch before the end of the third
quarter of 2000, the first very low-TSNA cigarette which will have an activated
charcoal filter with a new brand name chosen by late Spring 2000. The Company's
central focus will continue to be to be aimed at reducing the health hazards
associated with the use of smoked and smokeless tobacco products. The Company
fully accepts the evidence showing links between tobacco smoking 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 1.1 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 using available technology. 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 safe as technologically
possible. The Company has now demonstrated that the method it has developed for
curing tobacco using its proprietary StarCure(TM) process, can be scaled up to
meet broad commercial needs in the United States and abroad.
In the year 2000, the Company anticipates that it will have the ability
to produce in excess of 20 million pounds of its proprietary StarCure(TM)
processed tobacco in order not only to fulfill its contractual obligations under
its recently executed Supply Agreement (see "Relationship With B&W"), but to
integrate a significant portion of its StarCure(TM) processed tobacco into its
presently marketed four brands, as well as having sufficient supplies of very
low-TSNA tobacco to launch a new brand before the end of the third quarter of
2000. This new brand will be the first cigarette to be launched in the United
States which utilizes StarCure(TM) very low-TSNA flue-cured tobacco, as well as
burley tobacco selected for its low-TSNA content, and a small portion of sun
dried oriental tobacco. The new brand will also use an activated charcoal filter
aimed at reducing the levels of certain vapor phase toxins.
PRODUCTS
Discount Cigarettes
Star currently manufactures and sells four brands of discount
cigarettes, MAIN STREET(R), SPORT(R), VEGAS(R) and G.SMOKE(R) (formerly
GUNSMOKE(TM)), through approximately 325 tobacco distributors throughout the
United States. The cigarettes are sold as discount brands. Star does not engage
in extensive advertising or marketing programs for its cigarette products, but
relies primarily upon price communications with distributors and, to a lesser
extent, on product appearance and taste in order to compete in the marketplace.
There were no export sales by the Company in 1999.
In an effort to implement Star's corporate mission to develop
potentially less harmful tobacco products, Star intends to phase its very
low-TSNA tobacco which has been cured through its proprietary StarCure(TM)
process into its discount cigarettes within the next 24 months. As of July 1,
1999, Star changed all of its filters to activated charcoal because of
recommendations from leading health advocates and respected research scientists
to the effect that activated charcoal filters reduce certain vapor phase toxins
in tobacco smoke. Star intends to continue to use activated charcoal filters in
all of its discount cigarettes, as well as in its new brand.
Processed Tobacco
In 1999, Star processed and sold over 3.5 million pounds of low-TSNA
tobacco that had been cured using its proprietary StarCure(TM) process. All of
these sales were made to B&W, pursuant to Star's contractual arrangements with
B&W described elsewhere in this Prospectus. These sales
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accounted for approximately 10% of the Company's net sales in 1999. During 2000,
Star expects to process, sell and/or use for its own brands in excess of 20
million pounds of very low-TSNA tobacco cured using the StarCure(TM) process.
Star expects that a minimum of 8 million pounds will be sold to B&W pursuant to
its Supply Agreement. The remaining portion will be used in Star's own discount
cigarette brands and/or will be available for sale to B&W or other cigarette
manufacturers. The Company's long-term goal is to derive an increasingly larger
percentage of its revenues from sub-licensing its StarCure(TM) process to major
cigarette manufacturers.
Smokeless Tobacco Products Containing Very Low-TSNA Tobacco
Scientific research has shown that TSNAs may be the most significant
carcinogens in smokeless tobacco products commonly known as "chew", "dip" and
"snuff". Accordingly, in the year 2000 Star intends to devote substantial
resources toward the development of very low-TSNA smokeless tobacco products.
Star expects to undertake those projects in concert with a major tobacco company
as a strategic partner or licensee. No assurance can be given that such a
product will be developed and successfully commercialized at this time.
Tobacco-Flavored Chewing Gum and Lozenges and Chewing Gum Containing
Tobacco Extract
The Company is in current discussions with a major pharmaceutical
company to joint venture, partner and/or license its technology to produce
tobacco cessation products. Star has produced for pilot Phase I testing both a
chewing gum and a tobacco lozenge, each containing very low-TSNA tobacco, as
potential smoking cessation products. 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 FDA with new legislative
authority to regulate tobacco products, Star submitted and received approval of
an 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 developed lozenges which
contain tobacco extract. 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. Neither the gum nor the lozenge may be sold in the United States as
pharmaceutical products unless and until the FDA has approved a New Drug
Application ("NDA") for such products. No assurances can be given when or if
Star might obtain such approvals or that, even if such approvals are obtained,
whether there will be significant revenues from the sale of either. Given the
present uncertain status of the FDA's authority to regulate tobacco products, it
now appears that to be sold as pharmaceutical products 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 for these
products 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. Star has taken a public position, unanimously
supported by its Board of Directors, that it is in favor of comprehensive FDA
regulation of all tobacco products.
SALES AND MARKETING
Star's four brands of discount 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
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lights. Star utilizes its own specified blend of tobaccos in each brand. The
blend consists of Virginia flue-cured, burley and oriental varieties of tobacco,
which is typical of American-style cigarettes.
Star uses stylized packaging designs for its four brands of discount
cigarettes. As is typical in the cigarette industry, Star utilizes different
colors, e.g., green for menthol and similar designs, on its packaging to denote
different product styles. Star primarily conducts trade journal and direct mail
advertising to the industry, but not directly to consumers. Star does provide to
its distributor customers, for redistribution to retailers, point-of-sale
materials such as posters, pull signs, display racks as well as counter top and
floor displays. Also, Star produces marketing materials for use by distributors
and their direct sales force to promote Star cigarettes to their retail
customers.
It is Star's strategy to rely to a large degree upon distributors to
promote and sell Star's brands to retail customers. In 1999 Star sold its
discount cigarettes to a total of approximately 325 distributors located in 48
states. The distributors maintain state and, where applicable, municipal
government tobacco product licenses, apply state and/or local cigarette tax
stamps when needed, and resell the cigarettes to retailers. Star delivers its
products directly to distributors mainly by common carrier trucks. Star's
distributor customers primarily serve convenience stores, gas stations and other
outlets and stores. No one distributor accounted for more than 10% of Star's
revenues in 1999.
During 1999, Star experienced substantial sales growth. Star believes
that the price increases imposed upon the major cigarette manufacturers created
an increased demand for low-price cigarettes. In late 1999, Star initiated an
aggressive expansion of its marketing and sales organization to respond to its
anticipated increase in demand, not only for its present products, but for what
the Company believes will be a demand by knowledgeable smokers for products
which deliver less toxins, i.e. Star's new brand expected to be launched in the
third quarter. This growth began under the leadership of its Chief Executive
Officer, Mr. Jonnie R. Williams, and then under the leadership of its Vice
President of Sales and Marketing, Mr. David M. Dean and Mr. Sheldon Bogaz, Vice
President of Trade Operations. Mr. Dean, who came to Star with extensive health
care oriented marketing expertise, supervises a staff of eleven regional sales
representatives who direct a field sales force. By the end of 2000, Star plans
to increase its sales force to cover a greater number of distributors located
throughout the 48 contiguous states.
PURCHASING
During 1999, the majority of tobacco used in Star's cigarettes was
purchased from a recognized leaf dealer in "cut rag" form, meaning that the
tobacco has been cut, processed and flavored to Star's specifications, and is
ready when delivered to Star for the manufacturing process. The Company expects
during 2000 and thereafter to purchase increasing amounts of the tobacco needed
for its business directly from tobacco farmers.
MANUFACTURING
All of the tobacco planned to be used by the Company in 2000 in the
production of its very low-TSNA tobacco either for sale to B&W and potentially
other parties, or for incorporation into Star's own cigarettes, or in the
development by Star of smokeless tobacco products, will be cured using Star's
proprietary StarCure(TM) process. The StarCure(TM) process utilizes specially
equipped curing barns and microwave technology. The specially designed curing
barns, which incorporate the StarCure(TM) processing technology, are
manufactured exclusively for Star by Powell Manufacturing Company of
Bennettsville, South Carolina ("Powell"). Powell is the largest manufacturer of
curing
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barns in the U.S. These specially designed barns are erected on site at the
tobacco farms which provide Star with its tobacco. Approximately 550 of these
barns have already been manufactured and contracts with tobacco farmers for
approximately 900 additional curing barns have either been signed or are being
negotiated. Star anticipates that Powell will have provided Star with over
1,000 such barns by the end of 2000. Financing for a majority of these barns is
provided by B&W (see "Relationship With B&W"). The Company's StarCure(TM) very
low-TSNA tobacco is also processed in specially designed microwaves at its
StarCure(TM) processing facility, a leased facility in Chase City, Virginia.
Star's processing facility in Chase City is presently undergoing construction
to substantially expand its capacity to process larger amounts of very low-TSNA
tobacco. Star anticipates that it will be able to produce in excess of 20
million pounds of StarCure(TM) tobacco (both flue-cured and burley) during the
year 2000 growing season.
Star's cigarettes are manufactured at its facility in Petersburg,
Virginia and under contract. 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 believes its manufacturing facilities, plus the additional
manufacturing contract relationship now in place, will allow Star to respond to
its growing demand for the foreseeable future.
RELATIONSHIP WITH B&W
On October 12, 1999, the Company and B&W entered into a Supply
Agreement under which B&W agreed to purchase Star Cure(TM) tobacco. During the
third quarter and early fourth quarter of 1999, the Company produced and
delivered to B&W approximately 3.5 million pounds of very low-TSNA Star Cure(TM)
processed tobacco. This tobacco will be used to explore the production
feasibility and commercial acceptance of very low-TSNA cigarettes. In each of
the years 2000 and 2001, B&W is obligated to purchase from Star 5.0 million
pounds of Virginia flue-cured tobacco that has been cured using the Star
Cure(TM) process; and B&W has an option to purchase three million pounds of
burley tobacco cured using the same process. B&W also has the option to become
the exclusive purchaser of tobacco cured using the Star Cure(TM) process in each
of the years 2002 through 2004, if it purchases from the Company at least 30
million pounds of tobacco in each of those years. During the same period and
beyond that period if certain conditions are met, the Company has agreed to
provide sufficient quantities of tobacco cured using the Star Cure(TM) process
to meet the demands of B&W and all participating B&W affiliates, including
British American Tobacco PLC, the second largest tobacco company in the world.
Further, B&W has agreed to finance the Company's purchase of 600 of the
specially designed curing barns and, subject to certain preconditions, an
additional 400 such barns. In addition, B&W has agreed to collaborate with the
Company in the development of a new very low-TSNA cigarette and the possible
licensing of trademark rights to B&W in connection with the sale of this new
product.
Star in 1999 entered into a manufacturing agreement under which B&W has
agreed to manufacture cigarettes for Star. Also, Star has entered into an
agreement under which B&W is supplying leaf tobacco to Star for use in its
tobacco products.
COMPETITION
Star's primary competition for conventional cigarettes is from the four
"majors," that is, Philip Morris, the brands of which accounted for
approximately 50% of all cigarette sales in the United States in 1999, R.J.
Reynolds, B&W and Lorillard, each of which has substantially greater financial
and operating resources than Star. Star also encounters significant competition
from several other smaller
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U.S. manufacturers of cigarettes, as well as importers of cigarettes
manufactured in foreign countries. Many of these manufacturers and importers
have substantially greater financial, manufacturing, marketing and other
resources than Star.
Star's current conventional smoked products compete principally on the
basis of price and possibly quality of product. Generally speaking, there are
three price categories of cigarettes in the United States, "premium," which
includes such brands as Marlboro(R) and Camel(R), "full-price," which
includes such brands as Doral(R) and GPC(R), and "discount," which as a group
account for only a small percentage (approximately 3%) of the U.S. cigarette
market. Each of Star's brands is priced in the discount category. Other
competitive factors include package design, taste and the amount of marketing
support provided to distributors and retailers. At the consumer level, brand
"loyalty" also is a significant factor.
Star is not aware of any other company which currently produces very
low-TSNA tobacco on a commercial basis, although one Swedish company, Swedish
Match, has worked with various varieties of tobacco under crop management
environments and other methods in an effort to maintain low-TSNAs in its
smokeless products. Star is not aware of any other company that now incorporates
very low-TSNA tobacco into their cigarettes or other tobacco products. B&W now
has in its possession approximately 3.5 million pounds of very low-TSNA tobacco,
but has not made a public announcement of when it will start using that tobacco
in its current products or in a new product. However, recent announcements by
several of the major tobacco companies indicate that certain of these companies
either have commenced exploration or intend to explore the production of
low-TSNA tobacco in the next few years and the incorporation of low-TSNA tobacco
into their cigarettes. Star believes that if it is successful in commercializing
its unique very low-TSNA cigarettes and/or in developing and commercializing
very low-TSNA smokeless tobacco, it is inevitable that many of the major tobacco
companies will follow its lead.
If the Company is successful in developing and commercializing smoking
reduction or cessation products, it will encounter stiff competition. Smoking
cessation products that are approved for sale in the United States by the FDA
are primarily nicotine delivery products (nicotine only) 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 substantially
all of the U.S. pharmaceutical nicotine market in 1999. All of these products
are sold over-the-counter. Zyban(R), (bupropion), a prescription drug which
originally was developed and is still sold under another proprietary name as an
antidepressant was introduced to the market in 1997 and has been demonstrated to
be useful as a cessation product. 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
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 also are 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 as help in the reduction of
smoking. For example, at least one of the leading United States confectionery
chewing gum manufacturers has advertised its gum products as an alternative to
cigarettes. There are also non-tobacco cigarettes
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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 less toxic than Star's
products or that would render Star's products obsolete or non-competitive.
GOVERNMENT REGULATION
The manufacture and sale of cigarettes and other tobacco products and
of pharmaceutical products are subject to extensive federal and state
governmental regulation 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 for very low-TSNA tobacco or the sale of Star's smoking cessation
products and/or reduced-risk tobacco products. The Company believes, however,
that any bill that requires manufacturers to reduce or disclose levels of TSNAs
in tobacco or tobacco smoke would be beneficial. Star announced on February 29,
at a press conference held at the Dirksen Senate Office Building, its support of
a bi-partisan tobacco labeling Bill (S. 2525) introduced by Senators Frank
Lautenberg (D. N.J.), Richard Lugar (R. IND.), Richard J. Durbin, (D. ILL.), and
Lincoln D. Chafee (R. R.I.). The Senate Bill, entitled the "Smoker's Right to
Know and Truth in Tobacco Labeling Act", would, if enacted, significantly
enhance the current tobacco package warning labels and require disclosure of
toxic ingredients and health affects. The Bill would require all manufacturers
to disclose cancer-causing agents, including carcinogenic TSNAs, as well as the
percentage of such carcinogens "relative to the average of such concentration
of such carcinogen in the sales weighted average of all cigarettes marketed in
the United States." If enacted, Star believes such mandated disclosure would
be beneficial to informed adult smokers, as well as the Company.
FDA Regulation
The FDA has promulgated regulations governing the sale and advertising
of tobacco products designed primarily to discourage the sale to, and
consumption by, adolescents and children. The authority of the FDA to promulgate
such regulations was challenged in the federal courts. A federal District Court
upheld the FDA's authority to promulgate such regulations but ruled that certain
of the regulations restricting advertising were invalid as violative of the
constitutional right of free speech. On appeal, the United States Court of
Appeals for the Fourth Circuit affirmed 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. The federal
government appealed the Appeals Court's ruling and the matter was heard by the
United States Supreme Court in late 1999. A decision by the Supreme Court
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is expected later this year. To the knowledge of Star, the FDA has not attempted
to enforce these regulations.
Star cannot predict what effect full implementation of the FDA
regulations referred to in the preceding paragraph would have upon its 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 "discount" products which rely more upon the price of
the product than on brand loyalty or brand recognition to generate sales.
Consequently, the Company believes that implementation of the existing FDA
regulations may have an adverse affect upon Star's sales of present discount
cigarettes.
Star believes that in the future reasoned FDA regulation will better
enable the Company to compete in its particular market niche. Accordingly, the
Company has publicly announced its support for comprehensive FDA regulation of
tobacco products. The Company has shared the results of its proprietary curing
process with the FDA. The Company believes that the commercial value of its
proprietary StarCure(TM) tobacco curing process will depend in part upon its
validation by the scientific, health care and public health communities. The
Company believes that well designed and carefully executed tests and clinical
trials with resulting data shared with the scientific and public health
communities would further its objective of attaining more general acceptance for
its unique proprietary StarCure(TM) technology.
Federal Trade Commission
The requirements for health warnings on cigarettes is governed by the
Federal Cigarette Labeling and Advertising Act ("Labeling Act"). The Labeling
Act imposes labeling and advertising requirements on the manufacturers,
packagers, and importers of cigarettes and requires any company wishing to sell
cigarettes within the United States to submit a plan to the Federal Trade
Commission explaining how it will comply with the warning label display
requirements. Star has submitted such plans in the past, and the Federal Trade
Commission has approved its labeling plans.
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 are subject to tax under such regulations.
State and Municipal Laws
The sale of tobacco products is subject to taxation in all fifty
states. In addition, some states permit municipalities to impose an additional
sales tax, and many municipalities do so. The state and municipal taxes are
imposed upon wholesalers and/or retailers but not manufacturers, and therefore
Star has no liability for such taxes. Star is required 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.
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Master Tobacco Settlement Agreement
In November 1998, 46 states and several U.S. territories entered into a
settlement agreement (the "Master 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. As a nonparticipating manufacturer, the Company is
required to satisfy certain escrow obligations under statutes which the Master
Settlement Agreement 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, the
Company is obligated to place an amount equal to $1.88 per carton for 1999, and
increased amounts per carton for subsequent years ($2.09 in 2000, $2.72 in
2001-2002, $3.35 in 2003-2006 and $3.77 thereafter), in escrow accounts
beginning April 2000 for sales of cigarettes occurring in each such state after
the effective date of each state specific statute. Such escrowed funds will be
available to satisfy tobacco-related judgments or settlements, if any, in some
states. If not used to satisfy judgments or settlements, the funds will be
returned to the Company after 25 years on a rolling basis. Also, absent a
challenge to the state specific statutes or some accommodation as to the payment
of the escrow amounts, the failure to pay the required escrow could result in
penalties to the Company and potential restrictions on its ability to sell
tobacco products within particular states. The Company is continuing to assess
its options with respect to the state specific statutes, including a range of
potential legal challenges to the statutes and/or the Master Settlement
Agreement under a variety of legal theories, including unconstitutional taking
of property.
As of January 1, 2000, thirty-seven states had adopted model "level
playing field" statutes and Star's purported obligations under these statutes is
approximately $10.6 million with respect to 1999 sales.
Virginia Incentive Rebates
In 1999, the Commonwealth of Virginia enacted legislation that
explicitly encourages the manufacture and sale of "products that reduce the
carcinogenic TSNA 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
carcinogenic TSNA levels in tobacco products and pass a portion of that rebate
on to tobacco farmers. The Company believes that it is the only company in
Virginia that produced any very low-TSNA tobacco in Virginia during the 1999
growing season and, thus, the only company that could qualify for these rebates.
Canadian Proposed Regulations for Tobacco Packaging
The Canadian government in 1999 proposed new labeling regulations that
would require disclosure of the amount of selected toxic emissions and
constituents, including TSNAs, in tobacco products sold in Canada, as well as an
explanatory phrase regarding each such toxic substance. The proposed phrase
regarding TSNAs would require a warning, that "NITROSAMINES CAUSE CANCER. THEY
ARE THE MOST ACTIVE CANCER-CAUSING AGENTS IN TOBACCO." Star believes that, if
adopted, the proposed regulations, which would require such disclosure on
cigarette
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labels covering 60% of the top of the principal display panel, could benefit the
Company to the extent that Star or any future Star licensee markets tobacco in
Canada. Star is currently exploring opportunities for the use of its very
low-TSNA tobacco in Canada, either directly or through a license granted by Star
to one or more tobacco companies which market cigarettes in Canada.
RESEARCH AND DEVELOPMENT
In the mid-1990's, Star commenced research and development activities
based upon newly-conceived technology, which it had licensed from the
technology's inventor and the Company's founder and current Chief Executive
Officer, Jonnie R. Williams, for the processing of tobacco so as to preclude,
eliminate or substantially reduce TSNAs to very low levels. TSNAs are generally
recognized by health researchers to be among the most potent 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 smoked and smokeless
tobacco 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's research and development
efforts culminated in the development of various aspects of the StarCure(TM)
process, with respect to which Star has exclusive rights to patents as well as
patent applications which are pending (see "Patents, Trademarks and Licenses").
Star has convened a Scientific Advisory Board of highly regarded physicians,
scientists, and public health experts to provide it with counsel on how best to
proceed forward in a variety of scientific and research oriented areas. The
Scientific Advisory Board is chaired ex officio by Dr. Jerome H. Jaffe, Star's
Medical and Scientific Director.
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 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 are hung in enclosed barns and are then exposed to gas-fired heat, while
with burley tobacco the leaves are hung in sheds to dry naturally. The curing
process for Virginia flue-cured tobacco takes approximately 5 to 7 days and for
burley tobacco a month, or more.
The Company's StarCure(TM) 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 StarCure(TM)
proprietary curing process reduces any harmful chemical constituents in tobacco
and/or tobacco smoke other than TSNAs. Additionally, the Company makes no claim
that the elimination of TSNAs reduces the risk of disease from smoking. Star has
been careful not to make any health claims, directly or indirectly, since there
is not yet clinical evidence to show that a reduction in these specific
carcinogens in tobacco will translate into a reduced health risk.
Star's proprietary curing technology 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 proprietary tobacco
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curing technology as a standard for the manufacture of potentially less harmful
tobacco products and as a basis for the use of tobacco in the production of
smoking cessation products.
Star conducted a pilot program during the 1998 U.S. 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 would 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 the Company's facility in Chase City, Virginia. The Company completed the
pilot program and believes it achieved the objectives described above. In 1999,
Star processed over 3.5 million pounds of very low-TSNA tobacco using the
StarCure(TM) process. As discussed above, Star expects to process over 20
million pounds of very low-TSNA tobacco during the 2000 growing season.
Development of Very Low-TSNA Cigarette
Star plans to market the first very low-TSNA cigarette to be sold in
the United States before the end of the third quarter of 2000. This cigarette
will use Virginia flue cured tobacco processed using the proprietary
StarCure(TM) process, as well as other tobaccos (burley and oriental) selected
for low-TSNA levels. It is anticipated that it will achieve up to a 90%
reduction of the carcinogenic TSNAs in the tobacco and more than an 80%
reduction in tobacco smoke (measured by the FTC method) compared to the leading
brands with comparable tar and nicotine yields. Also, the product will have an
activated charcoal filter that, it is anticipated, will reduce certain gas and
vapor phase toxic substances.
Prior Development of CigRx(TM)
In 1997 Star submitted a cigarette product that it called "CigRx(TM)"
to the FDA as a pharmaceutical product. The objective was to offer a product to
help patients who relapse after a trial of smoking cessation to prepare for
another cessation attempt while reducing exposure to TSNAs. 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). A
Phase I study, under an FDA-reviewed protocol, was completed at the Virginia
Commonwealth University under the direction of Professor William Barr, Director
of the Center for Drug Studies. The study, involving male and female subjects,
was a cross-over study designed to test in vivo elimination or reduction of
TSNAs following the smoking of CigRx(TM) cigarettes compared to the subjects'
normally used cigarettes. These test cigarettes were made entirely from
flue-cured Virginia tobacco with no added flavorings. The average total TSNA
levels in the tobacco itself at the time of testing were about 100 parts per
billion, as compared to more than 3 parts per million in popular brands. As
measured by the current Federal Trade Commission method, 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. 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. On the CigRx(TM) product, blood nicotine levels were somewhat
higher and carbon monoxide was substantially lower. Urinary levels of TSNA (as
measured by NNAL) were analyzed by the American Health Foundation. The average
levels of NNAL and its metabolite after 9 days on the CigRx(TM) product were
reduced substantially, consistent with published data showing that TSNAs leave
the body slowly over 90 to 120 days.
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<PAGE> 22
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 associated with 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 the risk of being named a defendant in a lawsuit of
the type described above is relatively low, and therefore the risk of liability
in any such lawsuit is relatively low, because Star: (1) has not at any time
advertised its tobacco products to consumers except for point-of-purchase
materials; (2) 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) has not "manipulated" the nicotine content or delivery of its
tobacco products; and (4) has stated unequivocally that smoking involves a range
of serious health risks, is addictive, and that smoked cigarettes products can
never be produced in a "safe" fashion. Moreover, Star's brands have been sold
for only a relatively short period of time, i.e., since 1994, and the volume of
sales has not been substantial in relation to the volume generated by the larger
manufacturers.
Star maintains product liability insurance which is limited to any
claims that tobacco products manufactured by or for Star contain any foreign
object. Such insurance does not cover health-related claims such as those that
have been made against the major manufacturers of tobacco products. Star does
not believe that such insurance currently can be obtained. A lawsuit against the
Company based upon claims not covered by its product liability insurance could
have a materially adverse effect upon the Company.
PATENTS, TRADEMARKS AND LICENSES
License Agreement with Regent Court Technologies
Star is the licensee under a license agreement (the "License
Agreement") with the licensor, Regent Court Technologies LLC ("Regent Court"), a
limited liability company of which Jonnie R. Williams, the Company's founder and
Chief Executive Officer and Francis E. O'Donnell, Jr., M.D. are the sole
members. 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 TSNAs or reduce them to insignificant levels, and to
develop products containing such tobacco, whether such patent rights and
know-how are now in existence or hereinafter developed. This license includes
inventions of Regent Court and its affiliates during the term of the License
Agreement relating to the production, treatment or curing of tobacco, or a
method of manufacturing a product containing tobacco, and of extracting one or
more substances from tobacco for the purpose of incorporating such substance or
substances in a product or products.
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<PAGE> 23
Star is obligated to pay to Regent Court 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, less any related
research and development costs. The License Agreement expires with the
expiration of the last of any applicable patents. Two U.S. patents have been
issued, and additional patent applications are pending in the United States and
in approximately 80 foreign jurisdictions. Star paid no royalties to the
licensor in 1999.
The License Agreement may be terminated by Star upon 30 days written
notice. The License Agreement may also be terminated by Regent Court (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 Regent Court
under the License Agreement. Star is also obligated to provide Regent Court with
copies of all patent applications by it relating to the Patent Rights. For
purposes of determining materiality, a breach shall be deemed material if such
breach results in a loss of royalties exceeding $100,000.
The License Agreement obligates Star to prosecute and pay for U.S. and
foreign patent rights. The License 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. Regent Court has made no representations to Star in any
documents regarding the efficacy of the licensed technology.
Patents and Proprietary Rights
Under the License Agreement, Star has exclusive rights to two issued
patents and pending patent applications. The issued and pending patents cover
the current technology for reducing the level of TSNAs in 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 which may be allowed thereunder will be sufficient to protect the
intellectual property owned or licensed by Star, or that Star or Regent Court
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.
SALE OF OPHTHALMIC BUSINESS
By the end of 1998, the Company sold its ophthalmic business. This sale
was viewed as necessary due to the poor results of such business and to enable
the Company to focus on its core business strengths. The purchaser assumed most
of the liabilities of the ophthalmic business. The purchaser deposited into
escrow 250,000 shares of the Company's common stock to secure the payment of
these liabilities.
20
<PAGE> 24
EMPLOYEES
As of December 31, 1999, the Company had approximately 140 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. Substantially all of the
Company's research and development efforts have been, and are expected to
continue to be, conducted pursuant to contractual arrangements with universities
and scientific, medical and public health consultants and investigators under
the leadership of Dr. Jerome H. Jaffe, the Company's Medical and Scientific
Director, an internationally recognized and respected neuropsychopharmacologist,
and addiction specialist. The Company's success depends in large part on its
ability to attract and retain highly qualified scientific, technical,
management, financial 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 its key personnel or the
termination of its contracts with independent scientific and medical
investigators could have a material and adverse effect on the Company's
business.
LEGAL PROCEEDINGS
The Company is not involved in any material legal proceedings.
PROPERTIES
The Company's executive offices and manufacturing facilities have been
located in Petersburg, Virginia. The Company recently relocated its executive
offices to its Chester, Virginia facility and anticipates establishing an
additional executive/scientific office in Washington, D.C. within the next two
months. The Company owns the Petersburg facilities, which consist of a 50,000
square foot, four-story manufacturing building and an adjacent 6,000 square
foot, single-story office 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 Company recently entered
into a five-year lease for a 45,000 square foot warehouse facility, including
7,000 square feet of office space in Chester, Virginia. The warehouse space is
used for storing and shipping 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 leases seven acres of land and an approximately 50,000
square foot building thereon in Chase City, Virginia, that is used in processing
tobacco utilizing the Company's proprietary StarCure(TM) method to prevent the
formation of TSNAs. The existing facility is currently being expanded from
50,000 square feet to 100,000 square feet. The Company has recently entered into
a new ten-year lease for the Chase City property, which covers the expanded
facility and it 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.
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 OTC 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
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<PAGE> 25
commission and may not represent actual transactions) for each full quarterly
period during 1998 and 1999, 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
December 31, 1999, there were approximately 649 record holders of the Company's
Common Stock.
<TABLE>
<CAPTION>
1999 High Bid Low Bid
-------- -------
<S> <C> <C>
First Quarter $2.1250 $1.6250
Second Quarter $3.6250 $1.5625
Third Quarter $5.1875 $3.1250
Fourth Quarter $8.5625 $5.0625
<CAPTION>
1998 High Bid Low Bid
-------- -------
<S> <C> <C>
First Quarter $5.9375 $0.0100
Second Quarter $5.6250 $3.0000
Third Quarter $3.5000 $1.4375
Fourth Quarter $3.5000 $1.3750
</TABLE>
The closing bid and asked prices on February 28, 2000, were $6.8750 and
$7.0000, respectively.
22
<PAGE> 26
SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The following selected consolidated financial data should be read in
conjunction with our consolidated financial statements and related notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" appearing elsewhere in this Prospectus. The statement of operations
data for the years ended December 31, 1999, 1998, 1997, 1996, and 1995 and the
balance sheet data as of December 31, 1999, 1998, 1997, 1996, and 1995 are
derived from our consolidated financial statements which have been audited by
Aidman, Piser & Company, P.A., independent certified public accountants (years
1999 and 1998) and Keiter, Stephens, Hurst, Gary & Shreaves, P.C., independent
certified public accountant s (years 1995 through 1997), and are included
elsewhere in this Prospectus. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations." We have calculated pro forma
basic net loss per share assuming the conversion of the outstanding preferred
stock on their issue date into common stock.
<TABLE>
<CAPTION>
1999 1998 1997 1996 1995
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
(In Thousands except per share data)
Statement of Operations Data:
Net Sales $99,325 $19,445 $20,764 34,260 33,158
Cost of goods sold 31,878 7,669 10,033 16,150 16,340
Gross Profit 33,624 2,938 2,920 4,639 4,295
Operating income (loss) 17,078 (3,475) (1,986) (753) 10
Net income (loss) 11,515 (4,196) (1,986) (753) 10
Basic income (loss) per share 0.32 (0.42) (0.58) (0.22) 0.00
Diluted income (loss) per share 0.30 (0.42) (0.58) (0.22) 0.00
Weighted average shares outstanding 36,207 8,327 3,435 3,437 3,437
Balance Sheet Data:
Cash and cash equivalents 17,205 103 11 11 4
Property, Plant & equipment 10,974 1,704 2,416 2,767 3,187
Total assets 38,709 4,435 4,120 6,644 8,050
Long-term obligations 7,505 612 1,099 2,655 2,625
Stockholders' equity (deficit) 12,319 (639) (1,742) (838) 57
</TABLE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion of the results of operations and financial
condition of Star Scientific, Inc. should be read in conjunction with our
consolidated financial statements and related notes included elsewhere in this
prospectus. This discussion contains forward-looking statements based on current
expectations that involve risks and uncertainties. Please see "Risk Factors"
and "Forward-Looking Statements.
RESULTS OF OPERATIONS - FISCAL 1999 COMPARED TO FISCAL 1998
The following discussion and analysis of operating results of the Company
and of the liquidity and capital resources of the Company at December 31, 1999
should be read in conjunction with the consolidated financial statements of the
Company and the notes thereto.
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<PAGE> 27
During 1999, the Company's net sales increased to $99.3 million,
reflecting an increase of $79.9 million, or 411% over 1998 net sales. Net sales
in 1999 included $9.3 million in very low-TSNA tobacco sold to B&W, delivered
primarily in the third and fourth quarters of 1999. There were no such sales in
1998, except for minor leaf deliveries to major tobacco companies during the
development stage of the Company's very low-TSNA program.
Other than very low-TSNA tobacco sales made to B&W, substantially all
of the Company's revenues in 1999 have been derived from sales of its four
brands of "discount" cigarettes. The Company's shipment volume during 1999
increased approximately 276% over 1998 to 2.6 billion units, reflecting a
continued upswing in sales of the Company's cigarettes as a result of growing
the customer base across the country, including the addition of several major
retail chains. Slight increases in product pricing also contributed to higher
net sales.
During 1999, the Company's gross profit increased to $33.6 million,
reflecting an increase of $30.7 million over 1998, as increases in net sales of
$79.9 million were partially offset by increased costs of goods sold ($24.2
million) and increased excise taxes ($25.0 million). Increased costs of goods
sold were related to volume increases, partially offset by a decrease in the
average cost of tobacco purchased by the Company.
Marketing and distribution expenses totaled $6.3 million for 1999, an
increase of $5.1 million over 1998 which is in line with the increased sales
volume and reflects salary and incentive compensation payments to sales
personnel. The Company's marketing and distribution expenses are expected to
grow significantly during 2000 as the Company expands its commercialization
capabilities.
General and administrative expenses for 1999 totaled $9.9 million for
1999, an increase of $6.7 million partially attributable to operating costs for
the Company's Chase City facility. This facility processes the very low-TSNA
tobacco during the months of June through November. Chase City facility costs in
1998 were significantly lower, due to the experimental nature of the operation
at the time, and were classified in 1998 as research and development costs, in
keeping with the Company's mission at the time to develop the StarCure(TM)
process to a commercially feasible production level, which was accomplished in
1999. Other general and administrative costs are relatively flat when compared
to the comparable periods in 1998; however, there are some cost increases
associated with the higher sales volume, as well as increased legal and
consulting costs associated with the Company's fulfillment of its compliance
obligations as a publicly-held company, its legal and public health strategies
in the legislative, regulatory and executive agency arenas, its technical
recruitment efforts, expansion of its Scientific Advisory Board as well as
the costs of scientific consulting.
Research and development expenses were significantly higher in 1998
primarily as a result of costs incurred in this period specifically related to
the development of the Company's TSNA reduction technology. Research and
development expenses in 1999 consist primarily of costs incurred by the Company
for consulting services, professional fees and expenses in connection with the
Company's continuing research and development associated with scientific,
medical and health related matters.
Net interest income in 1999 reflects positively against net interest
expense in 1998, reflecting interest on higher 1999 cash balances generated by
the improved operating results.
Income tax expense reflects use of the Company's net operating loss
carryover from 1998, the benefit of which was previously reserved.
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<PAGE> 28
In 1998, the Company recorded charges to earnings for the discontinued
operations of the ophthalmic business and a loss on the disposal (sale) of such
business totaling $972,000. These charges resulted in a loss from discontinued
operations equal to ($0.12) per share. As a result of various settlements with
the Company's creditors, reached prior to the merger with Eye Technology in
February 1998, the Company also recorded an extraordinary gain of $252,000 in
1998 or $0.03 per share.
Net income of $11.5 million for 1999 compared favorably with a net loss
of ($4.2) million for 1998. In 1999, the Company had basic and diluted earnings
per share from continuing operations equal to $0.32 per share and $0.30,
respectively versus basic and diluted losses per share from continuing
operations of ($0.42) per share for 1998. In 1999, weighted average shares
outstanding were 36,207,390 versus 8,327,345 for 1998.
RESULTS OF OPERATIONS - FISCAL 1998 COMPARED TO FISCAL 1997
Net sales for 1998 of $19,445,000, consisting almost entirely of the
sale of branded cigarettes, 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. 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.
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 branded cigarettes. In 1998, profit margins increased
because of December 1998 price increases on branded 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 did not incur any significant expense in
this category with respect to contract manufacturing customers; almost all of
such expense was incurred with respect to branded cigarettes
General and administrative expenses increased from $1,425,000 in 1997
to $3,174,000 in 1998, primarily as a result of the legal, consulting and
accounting costs associated with the merger with Eye Technology and resulting
status as a publicly-held company, including the hiring of additional personnel.
Research and development expense represents primarily expenditures
related to the development of Star's proprietary StarCure(TM) technology for the
processing of tobacco so as to prevent, reduce an/or significantly decrease the
formation of carcinogenic TSNAs, as well as expenses for the development of the
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 did not employ a scientific staff in 1997 or
1998 and instead relied 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> 29
$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 less harmful 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 very
low-TSNA tobacco.
LIQUIDITY AND CAPITAL RESOURCES
Accounts receivable and accounts payable throughout 1999 were current
and the Company has normal industry terms with all of its suppliers, a situation
that did not exist in 1998. This favorable situation is primarily due to cash
generated by operating activities resulting primarily from higher net income in
1999 and a $6,000,000 non-refundable deposit from B&W in connection with the
Supply Agreement, which is to be applied toward B&W's year 2000 StarCure(TM)
tobacco purchase orders. In 1999, $20.8 million of cash was provided by
operating activities compared to $2.7 million of cash used in operating
activities in 1998.
During 1999, the Company incurred $10.0 million in capital
expenditures, virtually all of it as part of the StarCure(TM) barn production
program with Powell Manufacturing. As described previously in this report, B&W
has agreed to loan the Company capital necessary to finance the purchase of up
to 1,000 curing barns designed by the Company and specially manufactured for the
Company by Powell Manufacturing. Approximately 550 of these barns have already
been manufactured and contracts with tobacco farmers for approximately 900
additional curing barns have either been signed or are being negotiated. At
December 31, 1999, the Company has borrowed $7.2 million under the credit
facility with B&W.
During January 2000, the Company negotiated a line of credit with a new
working capital lender, which is to be collateralized by accounts receivable
from its cigarette business, in the amount of $3 million.
In October 1999, the Company also received approximately $1.0 million
in proceeds from the exercise of a warrant to purchase 522,920 shares of
Company's common stock. The Company currently has warrants outstanding to
purchase a total of 977,080 shares of common stock that are exercisable until
September 2000. All of such warrants have exercise prices of $2.00 per share.
In 1998, the Company sold common and preferred stock in several private
placements, which generated net proceeds of approximately $4.7 million.
Under the Master Settlement Agreement, absent a successful legal
challenge to the state specific statutes or an agreement with the National
Association of Attorneys General with respect to the funding of the required
escrow accounts, the Company will be obligated to place an amount equal to $1.88
per carton for 1999, and increased amounts per carton for subsequent years, in
escrow accounts for sales of cigarettes occurring in each such state after the
effective date of each state specific statute. Such escrowed funds will be used
to fund tobacco-related litigation or settlements and
26
<PAGE> 30
if not so used, returned to the Company after 25 years. The Company will be
obligated to put into escrow approximately $10.6 million in April 2000 for
sales made in 1999. The funds placed in escrow will continue to be an asset of
the Company and the Company will receive the interest income generated by the
escrow deposit. However, these escrow obligations will significantly impede the
Company's ability to apply the Capital generated from its cigarette sales as it
sees fit. Based on Star's projected increase in sales for future years, the
Company will have to pay significant sums into these escrow accounts to meet
the Master Settlement Agreement requirements.
The Company believes that its existing working capital, together with
anticipated earnings from its operations, 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 it may be required to
comply with under the Master Settlement Agreement, the success of the Company's
new product development efforts and the other factors described under "Risk
Factors."
YEAR 2000 ISSUES
The Company undertook an assessment of its information technology
systems relating to year 2000 issues at its Virginia facilities and contacted
major customers and vendors to assess their status. The assessment resulted in
the development of a plan to prepare Star for year 2000 readiness. The costs for
implementation of Star's plan were not material. Such costs were capitalized or
expensed as appropriate. No additional Year 2000 costs are anticipated. As of
the date of this filing, the Company has not experienced any disruption of its
operations due to Year 2000 issues.
MANAGEMENT
EXECUTIVE OFFICERS, DIRECTORS AND KEY EMPLOYEES
The following table sets forth certain information regarding the executive
officers and directors of Star Scientific, Inc.. Our compensation committee
consists of Dr. Elliot D. Prager (Chairman), Leo S. Tonkin, Esquire, Jonnie R.
Williams and Paul L. Perito, Esquire (ex officio). Our audit committee consists
of Mark N. Johnson (Chairman), and Dr. Elliott D. Prager and James A. McNulty
(ex officio).
<TABLE>
<CAPTION>
OFFICERS AND DIRECTORS AGE POSITION
- ---------------------- --- --------
<S> <C> <C>
Jonnie R. Williams 44 Chief Executive Officer and Director
Paul L. Perito, Esquire 62 President, Chief Operating Officer and Director
Robert J. DeLorenzo, M.D., Ph.D., M.P.H. 52 Chairman of the Board and Director
James A. McNulty 49 Chief Financial Officer
Jerome H. Jaffe, M.D. 66 Medical and Scientific Director
Paul H. Lamb III 67 President and Chief Executive Officer of Star Tobacco &
David M. Dean 39 Vice President of Sales and Marketing
Sheldon Bogaz 34 Vice President of Trade Operations
Malcolm L. Bailey 55 Director
Mark W. Johnson 36 Director
Elliot D. Prager, M.D. 58 Director
Leo S. Tonkin, Esquire 61 Director
</TABLE>
27
<PAGE> 31
JONNIE R. WILLIAMS, 44, is a Class Two director of the
Company and the Company's Chief Executive Officer. Mr Williams was one of the
original founders of ST&P, a wholly owned subsidiary of the Company,
and served subsequently as Chief Operating Officer ("COO"), Executive Vice
President ("EVP") and a Director of the Company since October 1998. On July 1,
1999, in order to concentrate upon the expanding demands of Star's sales and
new product development, Mr. Williams resigned as COO and EVP to assume the
primary responsibilities of Director of Product Development and Sales.
Mr. Williams, a principal shareholder of the Company, is also the inventor of
Star's proprietary tobacco curing process (StarCure(TM)) for the elimination of
virtually all of the tobacco specific nitrosamines (TSNAs) in tobacco and
tobacco smoke. Mr. Williams has been involved in venture capital start-up
bio-tech companies for over a decade where he has been either a major
shareholder or a co-founder of the following companies: LaserSight, LaserVision,
VISX and APP (a New York based pharmaceutical company). Also, Mr. Williams is a
member of Regent Court Technologies, LLC and is a principal in Jonnie
Williams Venture Capital Corp., as well as a principal in Hopkins Capital
Partners, Ltd., a closely held bio-tech company engaged in developing drugs for
the treatment of AIDS and cancer, some of which are now undergoing FDA clinical
trials.
PAUL L. PERITO, ESQUIRE. Mr. Perito, 62, is a Class One
director of the Company and the Company's President and Chief Operating Officer.
He has served as a director of the Company since December 1999 and has served as
the Company's President and Chief Operating Officer since November 1999. Mr.
Perito served as the Company's Executive Vice President, General Counsel and
Chief Ethics Officer from June 1999 through November 1999. Previously, Mr.
Perito was a senior partner in the law firm of Paul, Hastings, Janofsky & Walker
LLP ("PHJ&W") from July 1991 until he assumed responsibilities at the Company.
Mr. Perito has assumed the role of senior counsel to PHJ&W. Mr. Perito was
National Co-Chair of the White Collar Corporate Defense Practice Group at PHJ&W
since 1991, and Chair of the Litigation Department in that firm's Washington,
D.C. office since 1995. Prior to his re-entry into private practice, he served
as Chief Counsel and Deputy Director of the White House Special Action Office on
Drug Abuse Prevention ("Drug Czar's Office") from 1971 to 1973. Mr. Perito was
confirmed by the Senate for that position in March 1972. From 1970 to 1971, Mr.
Perito served as Chief Counsel and Staff Director to the U.S. House of
Representatives Select Committee on Crime. Immediately prior to serving the
Congress, Mr. Perito was an Assistant United States Attorney in the Southern
District of New York, U.S. Department of Justice. Mr. Perito graduated from
Tufts University and Harvard Law School. Mr. Perito was a Rotary International
Scholar at the Victoria University of Manchester in Manchester, England and in
Lund University, Lund, Sweden in P.P.E. in 1960-61 before entering Harvard Law
School. Mr. Perito graduated from Harvard Law school (LLB/JD), as an Edward
John Noble Scholar, in 1964 and was thereafter admitted to the Bar of the
Commonwealth of Massachusetts. He is also a member of the District of Columbia
Bar and is admitted to practice in numerous federal District Courts, Courts of
Appeal and the United States Supreme Court.
ROBERT J. DELORENZO, M.D., PH.D., M.P.H. Dr. DeLorenzo, 52, is
a Class Three director of the Company and Chairman of the Company's Board of
Directors. He has served as a director of the Company and Chairman of the
Company's Board of Directors since February 1998. Dr. DeLorenzo served as the
Company's Chief Executive Officer from October 1998 through November 1999. Since
1985, he has served as Chairman of the Department of Neurology, the George B.
Bliley Professor of Neurology, and Professor of Pharmacology and Toxicology and
Biochemistry and Biophysics at Virginia Commonwealth University, as well as
Neurologist-in-Chief of the Medical College of Virginia Hospitals and Director
of the Molecular Neurobiology Laboratories at the Medical College of Virginia.
Prior to 1985, Dr. DeLorenzo was on the neurology faculty at Yale University.
Dr. DeLorenzo has published over 300 original publications and has received
numerous research awards including the Jacob Javits Award from the National
Institutes of Health and the Jordi-Folch-Pi Award from the American Society of
Neurochemistry. He serves on the editorial boards of several scientific
journals and served on and chaired the National Institutes of Health Study
Sections. Dr. DeLorenzo holds his Ph.D. in neuropharmacology from Yale
University, his M.D. from Yale
28
<PAGE> 32
University School of Medicine and his M.P.H. from the Yale School of
Epidemiology and Public Health.
JAMES A. MCNULTY. Mr. McNulty, 49, is the Company's Chief
Financial Officer. He has served as the Company's Chief Financial Officer since
October 1998. He served as a director of the Company from December 1998 to
December 1999. Mr. McNulty also has served as a director and as the Treasurer
and Secretary of ST&P, a wholly owned subsidiary of the Company, since December
1998. From 1979 to 1997, he was a principal of McNulty & Company, a
certified public accounting firm. In 1997, he co-founded and is the Chairman of
the Board of BusinessLinks International, Inc., a company specializing in
interactive sales training. Mr. McNulty also has served as a director of
Pinnacle Group Holdings, Inc. since 1995. Mr. McNulty is a Certified Public
Accountant and a member of the American Institute of Certified Public
Accountants, the Florida Institute of Certified Public Accountants and the
National Association of Certified Valuation Analysts.
JEROME H. JAFFE, M.D. Dr. Jaffe, 66, has served as the
Medical and Scientific Director of the Company since March 2000. In addition,
he presently serves as Chairman ex officio of the Company's Scientific Advisory
Board. Prior to March 2000, Dr. Jaffe served as Senior Medical Consultant to
the Company. In addition, Dr. Jaffe currently serves as a Clinical Professor of
Psychiatry at the University of Maryland School of Medicine and as an Adjunct
Professor for the Department of Mental Hygiene in the School of Hygiene and
Public Health at Johns Hopkins University. From 1990 to 1997, Dr. Jaffe served
as Director, Office of Evaluation, Scientific Analysis and Synthesis at the
Center for Substance Abuse Treatment, Substance Abuse and Mental Health Services
Administration (formerly Office for Treatment Improvement), Alcohol, Drug Abuse
and Mental Health Administration in Rockville, Maryland. Dr. Jaffe also served
as Special Consultant to the President and Director of the Special Action Office
for Drug Abuse Prevention during the Nixon administration. Dr. Jaffe was
confirmed by the Senate for that position in March 1972. Dr. Jaffe is the
author or co-author of more than 200 publications and he has served as a member
of and consultant to the World Health Organization Expert Committee on Drug
Dependence for more than two decades, among numerous other advisory groups and
editorial boards. Dr. Jaffe holds his M.A. in Experimental Psychology from
Temple University and his M.D. from Temple University School of Medicine. Dr.
Jaffe is Board Certified in Psychiatry, with Extra Qualifications in Addiction
Psychiatry.
PAUL H. LAMB, III. Mr. Lamb, 67, has served as a director
and as President and Chief Executive Officer of ST&P, a wholly-owned subsidiary
of the Company, since December 1999. From 1990 to 1994, he served as President
of ST&P, and he has served as a director of that company since 1990. He served
as a consultant to the Company until assuming his current position in January
1999. From 1986 to 1990, Mr. Lamb founded and operated Lamb Services, Ltd., an
engineering consulting firm, and from 1958 to 1986 he was employed with Brown &
Williamson Tobacco Corporation where he held a variety of engineering positions.
Mr. Lamb has served as a director of the Southside Regional Medical Center in
Petersburg, Virginia for twenty-six years. Mr. Lamb graduated from Virginia
Military Institute (VMI) with a degree in civil engineering.
DAVID M. DEAN. Mr. Dean, 39, has served as Vice President of
Sales and Marketing of the Company since November 1999. From 1998 to October
1999, he served as a Principal of Group Insurance Concepts of Virginia, L.C., an
employee benefits consulting firm and an affiliate of Northwestern Mutual. From
1984 to 1998, Mr. Dean was employed with Trigon Blue Cross/Blue Shield in
Richmond, Virginia, where he held a variety of executive positions over a 14
year period, including Vice President of the Eastern Region from 1994 to 1996,
Vice President of Sales from 1996 to 1997 and Vice President of Sales and
Account Management for the Eastern and Western Regions from 1997 to 1998.
29
<PAGE> 33
Trigon Blue Cross/Blue Shield is the largest health insurer in Virginia. Mr.
Dean is a graduate of Elon College.
SHELDON L. BOGAZ. Mr. Bogaz, 34, is the Company's Vice
President of Trade Operations and is responsible for managing customer
relationships, developing new business, and formulating and implementing pricing
and trade programs. He has served as the Company's Vice President of Trade
Operations since November 1999. He served as the Vice President of Sales and
Trade Operations of the Company from September 1995 to October 1999. Prior to
joining the Company in 1995, Mr. Bogaz served as a Commercial Lender with
NationsBank from 1992 to 1995. He holds a Bachelor of Science Degree in Business
Administration from Virginia Commonwealth University.
MALCOLM L. BAILEY. Mr. Bailey, 55, is a Class One director of
the Company. He has served as a director of the Company since May 1998. He
served as the Company's President from October 1998 through November 1999. Mr.
Bailey owns the second largest tobacco-growing operation in Virginia and has
owned and served as the President of Golden Leaf Tobacco Company, a tobacco leaf
dealer, for over twenty years. Since 1994, Mr. Bailey has owned and served as
President of S&M Brands, Incorporated, a cigarette manufacturing company. Mr.
Bailey is President of the Virginia Agricultural Growers Association, the
largest trade association for flue-cured tobacco farmers in Virginia.
MARK W. JOHNSON. Mr. Johnson, 36, is a Class Two director of
the Company. He has served as a director of the Company since June 1999. He
currently serves as Chief Operating Officer of innosight, LLC. Prior to his
service at innosight, LLC, Mr. Johnson served as Senior Vice President of the
Gilder Group. From 1994 to 1999, he served as a management consultant with
Booz-Allen & Hamilton, Inc. From 1989 to 1994, he served as a nuclear power
trained Naval officer in Virginia Beach, Virginia and Washington, D.C. He also
serves as a director of the Washington Workshops Foundation. Mr. Johnson
graduated from the United States Naval Academy, received a Masters of Science
in Civil Engineering and Engineering Mechanics from Columbia University and
subsequently graduated from the Harvard Business School.
ELLIOT D. PRAGER, M.D. Dr. Prager, 58, is a Class One
director of the Company. He has served as a director of the Company since
August 1999. From 1974 to the present, he has performed colon and rectal
surgery at the Sansum Medical Clinic in Santa Barbara, California, and served on
its Board of Directors from 1980 to 1986. From 1995 to September 1999, he
served as Chairman of the Residency Review Committee for Colon and Rectal
Surgery. From 1998 to the present he has served as Medical Director of the
Cottage Hospital Operating Room. He holds an appointment as Associate Clinical
Professional at the University of Southern California. Dr. Prager graduated
from Dartmouth College and holds his M.D. from Harvard Medical School.
LEO S. TONKIN, ESQUIRE. Mr. Tonkin, 61, is a Class Three
director of the Company. He has served as a director of the Company since
October 1998. He is a founder of the Washington Workshops Foundation established
in 1967 and currently serves as a director of the Washington Workshops
Foundation. He served as a member of the White House Conference on Youth in 1971
and as Special Assistant to the Chairman of the United States House of
Representatives Select Committee on Crime in 1972. He has served as Chairman of
the Board of Trustees of St. Thomas Aquinas College and as a trustee of
Immaculata College. Mr. Tonkin is a graduate of Johns Hopkins University and
received his law degree from Harvard Law School.
30
<PAGE> 34
BOARD COMPENSATION
The non-employee directors of the Company ("Outside Directors")
generally are granted a stock option to purchase up to 50,000 shares of common
stock on the date each such Outside Director is first elected to the Board of
Directors. Each stock option granted to an Outside Director is granted under the
Company's 1998 Stock Option Plan (the "Plan") and is exercisable at a price
equal to the fair market value of the Common Stock on the date of grant (as
determined in accordance with the Plan). Each Outside Director also receives a
fee of $1,000.00 for his participation in each meeting of the Board of Directors
and any committee meeting. Directors who are employees also may receive
compensation in their capacity as Company employees, as described elsewhere in
this Prospectus.
EXECUTIVE COMPENSATION AND OTHER MATTERS
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------
Long Term
Annual Compensation Compensation Awards
- --------------------------------------------------------------------------------------------------------------------------
Other Annual Restricted Securities
Salary Bonus Compensation Stock Underlying All Other
Name and Principal Position Year ($) ($) ($) Award ($)1/ Options (#) Compensation
--------------------------- ---- ------ ----- ------------ ----------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Jonnie R. Williams, Chief 1999 2,400,000 -- -- -- -- --
Executive Officer (2/) 1998 400,000 -- -- -- -- --
1997 -- -- 565,000 3/ -- -- --
Robert J. DeLorenzo, M.D.,
Chairman (4/) 1999 -- -- -- -- 1,000,000 --
1998 -- -- -- -- -- --
James A. McNulty, Chief 1999 206,064 -- -- -- 200,000 --
Financial Officer (5/) 1998 29,423 80,000 -- 250,000 -- $15,000 6/
Paul L. Perito, Esquire,
President and Chief Operating
Officer (7/) 1999 350,432 250,000 8/ -- -- 1,000,000 --
Malcolm L. Bailey (9/) 1999 118,000 -- -- -- 200,000 $8,304
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
- ----------------------
1/ The Company did not award any restricted stock appreciation rights to
the named executive officers or make any long-term incentive plan
payouts in 1999, 1998 and 1997. The value of the restricted stock has
been determined by multiplying the number of shares by the closing sale
price as of the day prior to the date of grant.
2/ Mr. Williams was appointed Chief Executive Officer in November 1999.
Mr. Williams served as Senior Vice President of Marketing and Product
Development of the Company from June 1999 to November 1999 and served
as the Company's Chief Operating Officer and Executive Vice President
from October 1998 through June 1999.
3/ Represents management fees paid to Mr. Williams
4/ Dr. DeLorenzo served as the Company's Chief Executive Officer from
October 1998 through November 1999. During 1998 and 1999, Dr. DeLorenzo
did not receive compensation from the Company for serving as Chief
Executive Officer other than reimbursement for expenses.
5/ Mr. McNulty was appointed to the position of Chief Financial Officer of
the Company in October 1998.
6/ Represents reimbursement for temporary housing in Richmond, Virginia.
7/ Mr. Perito was appointed as the Company's President and Chief Operating
Officer in November 1999. Mr. Perito served as the Company's Executive
Vice President, General Counsel and Chief Ethics Officer from June 1999
through November 1999.
8/ The Company has paid Mr. Perito $250,000 in the form of a signing bonus
and will pay Mr. Perito an annual bonus in an amount not less than
$250,000, which was based on the Company's and/or Mr. Perito's
performance in 1999.
9/ Mr. Bailey served as the Company's President from October 1998 through
November 1999.
- ------------
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<PAGE> 35
OPTION GRANTS DURING 1999
The following table sets forth the five most highly compensated officers
and certain information concerning stock options granted to them during 1999. We
have never issued stock appreciation rights. Options were generally granted at
an exercise price equal to the fair market value of the common stock at the date
of grant. The term of each option granted is generally ten years from the date
of grant. Options may terminate before their expiration dates, if the optionee's
status as an employee or a consultant is terminated or upon the optionee's death
or disability.
<TABLE>
<CAPTION>
Potential Realizable
Value at Assume Rates
of Stock Price
Appreciation for
Individual Grants Option Term (1/)
------------------------- ----------------------
% of Total
Options
Granted to
Employees Exercise or Market Price
Options in Fiscal Base Price on Date of Expiration
Name Granted (2/)(#) Year ($/Sh) Grant ($) Date 5% ($) 10% ($)
---- -------------- ---- ------ --------- ---- ------ -------
<S> <C> <C> <C> <C> <C> <C> <C>
Jonnie R. Williams -- -- -- -- -- -- --
Robert J. DeLorenzo, M.D. 500,000 20.83 2.00 2.00 03/09/09 $628,895 $1,593,742
500,000 20.83 3.00 2.00 03/09/09 $628,895 $1,593,742
James A. McNulty 200,000 8.33 2.00 2.00 10/15/09 $251,558 $637,497
Paul L. Perito, Esquire 1,000,000 41.67 1.685 1.685 07/01/09 $1,059,687 $2,685,456
Malcolm L. Bailey 200,000 8.33 1.00 1.00 04/12/09 $125,779 $318,749
</TABLE>
- ----------------------
1/ The dollar amounts under these columns are the result of calculations
at the 5% and 10% rates set by the Securities and Exchange Commission
and therefore are not intended to forecast possible future
appreciation, if any, of the stock price of the Company. If the
Company's stock price were in fact to appreciate at the assumed 5% or
10% annual rate for the ten year term of these options, a $1,000
investment in the Common Stock of the Company would be worth $1,629 and
$2,594, respectively, at the end of the term.
2/ The exercise prices were based on the fair market value (as determined
in accordance with the Company's 1998 Stock Option Plan) of the shares
of Common Stock at the time the options were granted. Generally,
options terminate ten years after the date of grant or within three
months following termination of the optionee's employment, whichever
occurs earlier.
- ----------
32
<PAGE> 36
AGGREGATED OPTION EXERCISES IN 1999 AND YEAR-END OPTION VALUES
The following table sets forth for each of the five most highly compensated
officers certain information concerning options exercised during fiscal 1999 and
the number of shares subject to both exercisable and unexercisable stock options
as of December 31, 1999. The values for "in-the-money" options are calculated by
determining the difference between the fair market value of the securities
underlying the options as of December 31, 1999 ($8.0625 per share) and the
exercise price of the officer's options. We have never issued stock appreciation
rights.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED IN-
NUMBER OF OPTIONS AT THE-MONEY OPTIONS AT
SHARES DECEMBER 31, 1999 DECEMBER 31, 1999($)
ACQUIRED ON VALUE ------------------------------- -------------------------
NAME EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- -------------- ------------ ------------ ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Jonnie R. Williams -- -- -- -- -- --
Robert J. DeLorenzo, M.D. -- -- -- 1,000,000 -- 5,562,500
James A. McNulty -- -- 200,000 -- 1,212,500 --
Paul L. Perito, Esquire -- -- 1,000,000 -- 6,375,000 --
Malcolm L. Bailey -- -- 200,000 1,412,500 --
</TABLE>
The Company does not have a defined benefit plan or actuarial pension plan.
During 1999, the Company did not have a "long-term incentive plan", and the
Company did not make any "long-term incentive awards", as such terms are defined
in Item 402 of Regulation S-K. During 1999, none of the Named Executive Officers
exercised any stock options.
SUMMARY OF THE AMENDED AND RESTATED 1998 STOCK OPTION PLAN
Purpose. The purposes of the Plan are to provide additional incentives
to those executive officers, key employees, consultants and non-employee
directors of the Company and its subsidiaries whose substantial contributions
are essential to the continued growth and success of the Company's business, to
strengthen their commitment to the Company and its subsidiaries, to motivate
those executive officers, key employees, non-employee directors and consultants
to perform their assigned responsibilities faithfully and diligently, and to
attract and retain competent and dedicated individuals whose efforts will result
in the long-term growth and profitability of the Company.
Incentive and Nonqualified Stock Options. The Plan permits the granting
of stock options that either qualify as incentive stock options ("Incentive
Stock Options" or "ISOs") under Section 422 of the Internal Revenue Code of
1986, as amended (the "Code"), or do not so qualify ("Nonqualified Stock
Options" or "NSOs").
Eligibility. The Plan provides that NSOs may be granted to executive
officers, key employees, consultants and non-employee directors of the Company
or any subsidiary of the Company. ISOs may be granted only to employees,
including executive officers and directors who are employees, of the Company or
any subsidiary of the Company.
Number of Shares Subject to Stock Options. The maximum number of shares
of Common Stock that may be issued upon exercise of options granted under the
Plan is 4,000,000. However, under the Plan, no eligible employee shall receive
in any fiscal year of the Company options to purchase in excess of 1,000,000
shares.
Administration. The Plan provides for administration by the
Compensation Committee of the Board, which shall consist of two or more "outside
directors." Subject to the other provisions of the
33
<PAGE> 37
Plan, the administrator has the authority to determine the employees,
nonemployee directors or consultants to whom, and the time or times at which,
options are granted, the number of shares to be represented by each option and
the other terms and conditions of such option. The interpretation and
construction of any provision of the Plan by the administrator shall be final
and binding.
The term of each option is fixed by the administrator but may not
exceed ten years from the date of grant in the case of ISOs or five years from
the date of grant in the case of ISOs granted to a holder of Common Stock
possessing more than 10% of the total combined voting power of all classes of
stock of the Company or any subsidiary (a "10% Stockholder"). When the fair
market value of shares subject to ISOs first exercisable in one calendar year is
greater than $100,000, the excess options shall be treated as NSOs. For these
purposes, fair market value is determined on the date of grant, and ISOs shall
be taken into account in the order in which they were granted. The administrator
determines the time or times each option may be exercised. Options may be made
exercisable in installments, and the exercisability of options may be
accelerated by the administrator.
Option Price. The option exercise price for each share covered by an
ISO may not be less than 100% of the fair market value of a share of Common
Stock on the date of grant of such option. In the case of ISOs or NSO's granted
to a 10% Stockholder, the option exercise price for each share covered by such
option may not be less than 110% of the fair market value of a share of Common
Stock on the date of grant of such option. For so long as there exists a public
market for the Company's Common Stock, the fair market value of a share of
Common Stock shall be the last sales price for such stock on the last market
trading day prior to the day of determination (or if no sales were reported on
that date, on the last trading day on which sales were reported) on the stock
exchange determined by the administrator to be the primary market for the Common
Stock or the Nasdaq National Market whichever is applicable or if the Common
Stock is not traded on any such exchange or natural market system, the average
of the closing bid and asked prices of the Common Stock on the Nasdaq Smallcap
Market for the day prior to the time of determination as reported in The Wall
Street Journal, or, in the absence of an established market, as determined by
the administrator in good faith.
Consideration. The consideration to be paid for shares issued upon
exercise of options granted under the Plan, including the method of payment, is
determined by the administrator (and, in the case of ISOs, determined at the
time of grant) and may consist entirely of (1) cash, (2) check, (3) promissory
note with such recourse, interest, security and redemption provisions as the
Board determines appropriate, (4) shares of Common Stock including withholding
of shares otherwise deliverable on exercise of the option, which have a fair
market value on the date of surrender equal to the aggregate exercise price of
the shares being purchased, or (4) any combination of the foregoing methods.
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.
Termination of Employment or Service. 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 Optionee
may exercise his or her Option within such period of
34
<PAGE> 38
time as is specified in the Agreement 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 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. If, after
termination, the Optionee does not exercise his or her Option within the time
specified in the Agreement, the Option shall terminate, and the Shares covered
by such Option shall revert to the Plan. 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 within such period of time as is specified in the Agreement,
to the extent that the Option is vested on the date of termination, but only to
the extent it was exercisable at the date of such termination and to the extent
that the term of the option has not expired. 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. If, after termination,
the Optionee does not exercise his or her Option within the time specified in
the Agreement, the Option shall terminate, and the Shares covered by such Option
shall revert to the Plan. If an Optionee's status as an Employee, Director or
Consultant terminates as a result of the optionee's total and permanent
disability, the Optionee may exercise his or her Option within such period of
time as is specified in the Agreement, to the extent that the Option is vested
on the date of termination, but only to the extent it was exercisable at the
date of such termination and to the extent that the term of the option has not
expired. 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 her or her entire Option, the
Shares covered by the unvested portion of the Option shall revert to the Plan.
If, after termination, the Option does not exercise his or her Option within the
time specified in the Agreement, the Option shall terminate, and the Shares
covered by such Option shall revert to the Plan. If an Optionee's status as an
Employee, Director or Consultant terminates as a result of the death of the
Optionee, the Option may be exercised at any time within such period of time as
is specified in the Agreement, to the extent the Option is vested on the date of
death (but in no event later than the expiration of the term of such Option as
set forth in the Agreement). If, at the time of death, 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. If the Option is not exercised
within the time specified in the Agreement, the Option shall terminate, and the
Shares covered by such 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.
Agreements. All options granted under the Plan are evidenced by a stock
option agreement between the Company and the optionee to whom such option is
granted. Options granted to persons who are subject to Section 16 of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), are subject to
any additional restrictions applicable to options granted to such persons in
compliance with Rule 16b-3 of the Exchange Act.
Nontransferability of Options. Options granted pursuant to the Plan are
nontransferable by the optionee, other than by will or by the laws of descent
and distribution and may be exercised, during the lifetime of the optionee, only
by the optionee.
Adjustment Upon Changes in Capitalization. In the event any change,
such as a stock split or dividend, is made in the Company's capitalization which
results in an increase or decrease in the number of outstanding shares of Common
Stock without receipt of consideration by the Company, an
35
<PAGE> 39
appropriate adjustment shall be made in the number of shares which have been
reserved for issuance under the Plan and the price per share covered by each
outstanding option.
Change of Control. In the event of a Change in Control, (i) all options
outstanding on the date of such Change in Control shall become immediately and
fully exercisable and (ii) an optionee will be permitted to surrender for
cancellation within 60 days after such Change in Control any option or portion
of any option to the extent not yet exercised, and the optionee will be entitled
to receive a cash payment in an amount equal to the excess, if any, of (x) (A)
in the case of NSOs, the greater of (1) the fair market value, on the date
preceding the date of surrender, of the shares subject to the option or portion
thereof surrendered or (2) the adjusted fair market value of the shares subject
to the option or portion thereof surrendered, or (B) in the case of an ISO, the
fair market value, at the time of surrender, of the shares subject to the option
or portion thereof surrendered, over (y) the aggregate purchase price of such
shares under the option; provided, however, that in the case of an option
granted within six months prior to the Change in Control to any optionee who may
be subject to liability under Section 16(b) of the Exchange Act, such optionee
shall be entitled to surrender for cancellation such optionee's option during
the 60-day period commencing upon the expiration of six months from the date of
grant of any such option. A Change of Control is defined under the Plan as (i)
the acquisition (other than from the Company) by any "Person" (as the term is
used for purposes of Sections 13(d) or 14(d) of the Exchange Act) of beneficial
ownership of 20% or more of the combined voting power of the Company's then
outstanding voting securities; or (ii) the individuals who, immediately after
the 1998 annual meeting of stockholders of the Company, are members of the Board
(the "Incumbent Board"), cease for any reason to constitute at least a majority
of the Board; or (iii) approval by the stockholders of the Company of (a) a
merger or consolidation involving the Company if the Company's stockholders,
immediately before such merger or consolidation, do not, as a result of such
merger or consolidation, own, directly or indirectly, more than 70% of the
combined voting power of the then outstanding voting securities of the
corporation resulting from such merger or consolidation in substantially the
same proportion as their ownership of the combined voting power of the voting
securities of the Company outstanding immediately before such merger or
consolidation or (b) a complete liquidation or dissolution of the Company or an
agreement for the sale or other disposition of all or substantially all of the
assets of the Company; provided, however, a Change in Control shall not be
deemed to occur solely because 20% or more of the combined voting power of the
Company's then outstanding securities is acquired by a trustee or other
fiduciary holding securities under one or more employee benefit plans maintained
by the Company or any Subsidiary or any corporation which, immediately prior to
such acquisition, is owned directly or indirectly by the stockholders of the
Company in the same proportion as their ownership of stock in the Company
immediately prior to such acquisition.
Adjusted fair market value is defined in the Plan as the greater of (i)
the highest price per share of Common Stock paid to stockholders in any
transaction (or series of transactions) constituting or resulting in a Change in
Control or (ii) the highest fair market value of a share of Common Stock during
the 90-day period ending on the date of a Change of Control.
Liquidation, Dissolution, Merger or Consolidation. Subject to the
provisions regarding a Change of Control, in the event of (i) the liquidation or
dissolution of the Company or (ii) a merger or consolidation of the Company (a
"Transaction"), all outstanding options shall continue in effect in accordance
with their respective terms and each optionee shall be entitled to receive in
respect of each share subject to any outstanding options, as the case may be,
upon exercise of any option, the same number and kind of stock, securities,
cash, property or other consideration that each holder of a share was otherwise
entitled to receive in the Transaction in respect of a share.
36
<PAGE> 40
Modification or Substitution. Subject to the terms of the Plan, the
Board 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 adversely alter or impair any rights or obligations under any
Agreement without the Optionee's consent.
Buyout Provisions. The Board 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 Board shall establish and communicate to the Optionee at the
time that such offer is made.
Annual Automatic Awards to Outside Directors. Each non-employee
director of the Company shall be granted, upon his or her election as an Outside
Director, Nonqualified Stock Options to purchase up to 50,000 Shares.
Nonqualified Stock Options granted to Outside Directors shall be exercisable
over a two year period with respect to (i) 50% of the number of Shares
originally underlying such Nonqualified Stock Option (or 25,000 Shares) after
the first anniversary of the date of grant and (ii) the remaining 50% of the
number of Shares originally underlying such Nonqualified Stock Option (or 25,000
Shares) after the second anniversary of the date of grant, in each case at a
purchase price equal to the Fair Market Value of the Shares on the date of
grant. Each such Nonqualified Stock Option shall expire ten (10) years after the
date of grant and shall be subject to earlier termination as provided in the
Plan. Except as modified by the provisions pertaining to the grant of options to
Outside Directors, Nonqualified Stock Options granted to Outside Directors shall
remain subject to all provisions of the Plan applicable to Options generally.
Nothing in the provisions pertaining to the grant of options to Outside
Directors shall preclude the payment by the Company to Outside Directors of any
other form of compensation, including the granting of Options pursuant to other
provisions of the Plan.
Withholding Of Taxes. 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 Board, 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. 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 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
37
<PAGE> 41
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.
Release Of Financial Information. A copy of the Company's annual report
to stockholders shall be delivered to each Optionee at the time such report is
distributed to the Company's stockholders.
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 (1) give any person any right to be granted an
Option other than at the sole discretion of the Board; (2) give any person any
rights whatsoever with respect to Shares except as specifically provided in the
Plan; (3) limit in any way the right of the Company to terminate the employment
of any person at any time; or (4) 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.
Amendment and Termination. The Board may at any time amend, suspend or
terminate the Plan so long as the rights of any optionee will not be impaired by
such amendment, suspension or termination. The Plan will terminate on September
1, 2008, unless earlier terminated by the Board. To the extent necessary and
desirable to comply with applicable state and federal laws and the Code, the
Company shall obtain stockholder approval of any amendment to the Plan in such a
manner and to such a degree as required.
Regulations and Other Approvals; Governing Law. The 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. 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 Board. The Plan is
intended to comply with Rule 16b-3 promulgated under the Exchange Act, and the
Board 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.
EMPLOYMENT AGREEMENTS
As of June 15, 1999, in consideration for Mr. Perito's resignation of
full-time employment as a senior partner of Paul, Hastings, Janofsky & Walker
LLP ("PHJ&W"), the Company entered into a three-year employment agreement with
Mr. Perito pursuant to which the Company is obligated to pay Mr. Perito an
annual salary of not less than $600,000 ("Base Salary"). In addition to the Base
Salary, the Company has paid Mr. Perito $250,000 in the form of a signing bonus
and will pay Mr. Perito an annual bonus in an amount not less than $250,000,
based on the Company's and/or Mr. Perito's performance (as defined). The Company
also is obligated to maintain for the term of the employment agreement a term
life insurance policy in the amount of $1,500,000 and a disability insurance
policy for the amount of $35,000 per month for the benefit of Mr. Perito and/or
his beneficiaries.
The Company also has sold 2,000,000 shares of Common Stock to Mr.
Perito for $1.00 per share, for which Mr. Perito delivered to the Company a
promissory note in the principal amount of
38
<PAGE> 42
$2,000,000, bearing interest at 7% per annum (the "Note"). The interest on the
Note, which is non-recourse to Mr. Perito, is payable annually and the unpaid
balance of the Note, a substantial portion of which is non-recourse to Mr.
Perito, is payable in full on the fifth anniversary date of the Note. Under the
employment agreement, Mr. Perito also was awarded a stock option to purchase up
to 1,000,000 shares of Common Stock, at a purchase price of $1.685 per share,
which was fully vested as of June 15, 1999.
Upon termination by the Company of Mr. Perito's employment without
Cause (as defined) or by Mr. Perito for Good Reason (as defined), the Company
will be obligated to pay to Mr. Perito all salary, benefits, bonuses and other
compensation that would be due under the employment agreement through the end of
the term of the employment agreement. Upon termination of Mr. Perito's
employment as a result of his death or disability, the Company will be obligated
to pay to Mr. Perito all salary, benefits, bonuses and other compensation that
would be due under the employment agreement for a period of one year from the
date of such termination.
In connection with certain transactions that may result in a change in
voting control of the Company (each, a "Disposition Transaction") or certain
changes in the Company's senior management, Mr. Perito will be entitled to
terminate the employment agreement, to a one-time termination payment of
$2,500,000 and to participate in the Disposition Transaction upon the same terms
and conditions as certain principal stockholders of the Company. The Company
also will be obligated to reimburse Mr. Perito for any taxes which may become
due as a result of the application of Section 280G of the Internal Revenue Code
of 1986, as amended, to the payment described in the preceding sentence.
The employment agreement provides for Mr. Williams to provide security
for the obligations of the Company thereunder.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Mr. Jonnie R. Williams, the Company's Chief Executive Officer serves on
the Compensation Committee.
COMPENSATION COMMITTEE REPORT
During 1999, there was no Compensation Committee. Dr. DeLorenzo, was
the Company's Chief Executive Officer from October 1998 to November 1999. He was
not employed by the Company and not paid a salary in connection with his
position as Chief Executive Officer. However, in light of the unique academic
and scientific experience that senior management believed Dr. DeLorenzo would
bring to the Company, he was granted stock options to purchase up to an
aggregate of 1,000,000 shares of the Company's common stock. Mr. Williams was
elected the Company's Chief Executive Officer in November 1999. A Compensation
Committee was appointed on December 10, 1999. The Committee has been evaluating
the compensation of Mr. Williams and the Company's other executive officers.
The two remaining executive officers during 1999 are being compensated
in accordance with employment contracts which were approved by the Board of
Directors. In approving such employment contracts, the Board considered the
level of responsibility at the Company of the individuals involved, and in one
case gave strong consideration to the fact that the employment contract was an
inducement for the individual to resign his partnership at a major law firm.
39
<PAGE> 43
STOCK OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth as of February 28, 2000 certain
information with respect to the beneficial ownership of the Company's Common
Stock by each beneficial owner of more than 5% of the Company's voting
securities, each Director and Named Executive Officer and all Directors and
Officers and significant personnel of the Company as a group, except as
qualified by the information set forth in the notes to this table.
<TABLE>
<CAPTION>
SHARES
BENEFICIALLY
NAME OWNED(1) PERCENTAGE OWNED(2)
---- ------------ -------------------
<S> <C> <C>
Irrevocable Trust #1 FBO(3) 19,058,576 32.5%
Francis E. O'Donnell, M.D.
709 The Hamptons Lane
Chesterfield, MO 63017
Jonnie R. Williams(4) 17,215,264 29.4%
16 S. Market Street
Petersburg, VA 23803
Prometheus Pacific Growth Fund, LDC 5,202,640 8.9%
P.O. Box 1062
George Town, Grand Cayman, B.W.I.
Francis E. O'Donnell, Jr., M.D.(5) 3,368,362 5.7%
709 The Hamptons Lane
Chesterfield, MO 63017
Paul L. Perito, Esquire(6) 3,015,000 5.1%
c/o Paul, Hastings, Janofsky & Walker LLP
1299 Pennsylvania Avenue, 10th Floor
Washington, DC 20004-2400
Robert DeLorenzo, M.D., Ph.D., M.P.H.(7) 500,000 2.6%
Medical College of Virginia
MCV Box 980599
Richmond, VA 23298
Malcolm L. Bailey(8) 301,000 *
16 S. Market Street
Petersburg, VA 23803
James A. McNulty, C.P.A.(9) 300,000 *
16 S. Market Street
Petersburg, VA 23803
Leo S. Tonkin, Esquire(10) 50,000 *
c/o Washington Workshops Foundation
3222 N St. N.W., Suite 340
Washington, D.C. 20007
</TABLE>
40
<PAGE> 44
<TABLE>
<CAPTION>
<S> <C> <C>
Mark W. Johnson(11) 93,000 *
10 Museum Way
Apt. 2023
Cambridge, MA 02141
Elliot D. Prager, M.D.(12) 127,445 *
1685 East Valley Road
Montecito, CA 93108
All Directors and Named Executive Officers 21,601,709 36%
(8 Persons)
</TABLE>
(1) Beneficial ownership is determined in accordance with rules of the
Securities and Exchange Commission and includes shares over which the indicated
beneficial owner exercises voting and/or investment power. Shares of Common
Stock subject to options currently exercisable or exercisable within 60 days, by
April 30, 2000, are deemed outstanding for purposes of computing the percentage
ownership of the person holding such securities, but not deemed outstanding for
purposes of computing the percentage ownership of any other person. Except as
indicated, and subject to community property laws where applicable, the persons
named in the table above have sole voting and investment power with respect to
all shares of voting stock shown as beneficially owned by them. The shares
beneficially owned by Irrevocable Trust #1 FBO, Jonnie R. Williams and Francis
E. O'Donnell reflect the transfer of shares from Regent Court Technologies, LLC
("Regent Court").
(2) The "Percentage Owned" calculations are based on the outstanding shares of
Common Stock as of February 28, 2000.
(3) Includes 19,058,576 shares owned by a trust for the benefit of Francis E.
O'Donnell, Jr., M.D., over which Kathleen O'Donnell has sole voting and
investment power. Excludes 2,268,362 shares owned by a trust for the benefit of
Dr. O'Donnell's children, over which Ms. O'Donnell has sole voting and
investment power.
(4) Includes 16,115,264 shares held by Mr. Williams. Also includes 1,100,000
shares held by Regent Court of which Mr. Williams is deemed to have beneficial
ownership by virtue of his membership in Regent Court and over which he shares
voting and investment power with Dr. O'Donnell.
(5) Includes 2,268,362 shares owned by a trust for the benefit of Mr. Williams'
children, over which Dr. O'Donnell has sole voting and investment power. Also
includes 1,100,000 shares held by Regent Court of which Dr. O'Donnell is deemed
to have beneficial ownership by virtue of his membership in Regent Court and
over which he shares voting and investment power with Mr. Williams.
(6) Includes 2,000,000 shares held by Mr. Perito, 1,000,000 shares which Mr.
Perito has the right to acquire upon exercise of stock options and an aggregate
of 15,000 shares held by his children or in trust for the benefit of his
children, of which Mr. Perito disclaims beneficial ownership.
(7) Includes 30,000 shares held by Dr. DeLorenzo's children, Dr. DeLorenzo
disclaims beneficial ownership of shares held by his children. Excludes
1,000,000 shares which Dr. DeLorenzo has the right to acquire upon exercise of
stock options which are not exercisable within 60 days.
(8) Includes 101,000 shares held by Mr. Bailey and 200,000 shares which Mr.
Bailey has the right to acquire upon exercise of stock options.
(9) Includes 100,000 shares held by Mr. McNulty and 200,000 shares which Mr.
McNulty has the right to acquire upon exercise of stock options.
(10) Includes 50,000 shares which Mr. Tonkin has the right to acquire upon
exercise of stock options.
(11) Includes 93,000 shares which Mr. Johnson has the right to acquire upon
exercise of stock options.
(12) Includes 50,000 shares which Dr. Prager has the right to acquire upon
exercise of stock options.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company acquired a facility in Petersburg, Virginia in June 1995
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, a trust for the benefit of Mr. Williams' children and Mr. Lamb. The
notes to Dr. O'Donnell and the Williams' childrens' trust were paid in 1998
and the note to Mr. Lamb was paid in 1999.
Mr. Williams and Dr. O'Donnell jointly own an airplane. The Company has
utilized the airplane for business travel throughout the United States and to
Mexico to client locations that are not near airports with regularly scheduled
or frequent commercial airline services. Payments made by the Company with
respect to aircraft expenses were $442,238 in 1999 and $185,544 in 1998, and
were billed at cost.
During 1998, Mr. Williams made loans to the Company on a short-term
basis at the minimum level of interest provided for by the Internal Revenue
Service. These loans amounted to $710,000 in 1998. All such loans were repaid in
full during the year in which they were made. On December 31,
41
<PAGE> 45
1999, Mr. Williams signed a promissory note for $1,087,806. The promissory note
is repayable on December 31, 2000 and bears interest at 5.66%.
The Company paid to Golden Leaf Tobacco Company ("Golden Leaf"), a
company owned by Mr. Bailey, approximately $610,000 in 1999 and $60,000 in 1998
for tobacco purchases and commissions and the Company received $580,000 in 1999
and $165,000 in 1998 for the sales of tobacco to Golden Leaf.
In 1999, the Company paid $940,000 to Paul, Hastings, Janofsky &
Walker LLP with respect to various legal matters. Mr. Perito is senior counsel
and a former partner of such firm.
SHARES ELIGIBLE FOR FUTURE SALE
Future sales of substantial amounts of common stock in the public market
could adversely affect market prices prevailing from time to time. Upon
completion of the offering, Star Scientific, Inc. will have outstanding an
aggregate of 58,749,201 shares of common stock, assuming no exercise of
outstanding options or warrants. Of these shares, 50,038,521 shares will be
freely tradable without restriction or further registration under the
Securities Act, except that any shares held by "affiliates" of Star Scientific,
Inc., as that term is defined in Rule 144 of the Securities Act, may generally
only be sold in compliance with the limitations of Rule 144.
WHERE YOU CAN FIND MORE INFORMATION
The Securities Exchange Act of 1934 requires Star Scientific, Inc. to
file annual, quarterly and other reports with the Securities and Exchange
Commission. Star Scientific, Inc. intends to provide annual reports containing
audited financial statements to its stockholders in connection with its annual
meetings of stockholders.
You should rely only on the information in this document or to which we
have referred you. We have not authorized anyone to provide you with information
that is different. If you are in a jurisdiction where offers to exchange or
sell, or solicitations of offers to exchange or purchase, the securities offered
by this document or the solicitation of proxies is unlawful, or if you are a
person to whom it is unlawful to direct these types of activities, then the
offer presented in this document does not extend to you. The information
contained in this documents speaks only as of the date of this document unless
the information specifically indicates that another date applies.
42
<PAGE> 46
You may read and copy the registration statement and other materials
that Star Scientific, Inc. files with the Securities and Exchange Commission at
the Public Reference Room of the Securities and Exchange Commission, 450 Fifth
Street, Washington, D.C. 20549 and at the Securities and Exchange commission's
regional offices at 7 World Trade Center, Suite 1300, New York,, New York 10048
and at 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. You can
request copies of these documents, upon payment of a duplication fee, by writing
to the Securities Exchange Commission's Public Reference Section. Please call
the Securities and Exchange Commission at 1-800-SEC-0330 for further information
on the operation of the Public Reference Rooms. The Securities and Exchange
Commission filings of Star Scientific, Inc. are also available to the public on
the Securities and Exchange Commission internet site (www.sec.gov).
43
<PAGE> 47
STAR SCIENTIFIC, INC. INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
STAR SCIENTIFIC, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Public Accountants................................................
Consolidated Balance Sheets.............................................................
Consolidated Statements of Operations...................................................
Consolidated Statements of Stockholders' Equity.........................................
Consolidated Statements of Cash Flows...................................................
Notes to Consolidated Financial Statements..............................................
</TABLE>
44
<PAGE> 48
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 sheets of Star Scientific,
Inc. and Subsidiaries as of December 31, 1999 and 1998 and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the years 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 audits. 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 audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
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. As a result thereof, the Company is required to annually
contribute funds into escrow under statutes which the MSA required participating
states to pass if they were to receive the full benefits of the settlement. Such
escrowed funds will be used to pay tobacco-related litigation and, if not used,
returned to the Company in twenty-five years. The Company's 1999 escrow
obligation must be funded by April 2000 and this escrow funding obligation is
expected to increase in future years.
In our opinion, the consolidated 1999 and 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, 1999 and
1998 and the consolidated results of their operations and their cash flows for
the years then ended in conformity with generally accepted accounting
principles.
/s/ Aidman, Piser & Company, P.A.
February 9, 2000
<PAGE> 49
Tampa, Florida
<PAGE> 50
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1999 AND 1998
ASSETS
<TABLE>
<CAPTION>
1999 1998
--------------------- --------------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 17,205,248 $ 102,695
Accounts receivable trade,
net of allowance for
doubtful accounts (1999,
$225,870; 1998, $95,636) 3,599,965 1,497,457
Inventories 3,570,609 636,456
Prepaid expenses and other current
assets 338,790 265,672
Deferred tax asset 2,303,000 -
--------------------- --------------------
Total current assets 27,017,612 2,502,280
Property, plant and equipment, net 10,974,029 1,704,569
Intangibles, net of accumulated
amortization, (1999, $205,217;
1998, $162,045) 338,043 135,928
Other assets 296,263 92,379
Deferred tax asset 83,000 -
--------------------- --------------------
$ 38,708,947 $ 4,435,156
===================== ====================
LIABILITIES AND STOCKHOLDERS' EQUITY
1999 1998
--------------------- --------------------
Current liabilities:
Current maturities of notes payable $ 275,000 $ 379,082
Accounts payable, trade 3,492,755 2,516,658
Federal excise taxes payable 1,476,524 876,875
Accrued expenses 1,442,521 646,115
Income taxes payable 6,198,000 -
Customer deposit 6,000,000 -
--------------------- --------------------
Total current liabilities 18,884,800 4,418,730
Notes payable, less current
maturities 7,504,679 611,584
--------------------- --------------------
Total liabilities 26,389,479 5,030,314
--------------------- --------------------
Commitments and contingencies - -
Redeemable preferred stock
(Series A, convertible, 250
shares issued and outstanding in 1998,
at liquidation value) - 44,000
--------------------- --------------------
Stockholders' equity (deficit):
Common stock(A) 587,493 98,198
Preferred stock(B) - 143
Additional paid-in capital 10,631,875 6,668,392
Retained earnings (accumulated
deficit) 4,187,906 ( 7,326,724)
Unearned compensation - ( 79,167)
Notes receivable, officers ( 3,087,806) -
--------------------- ---------------------
Total stockholders' equity (deficit) 12,319,468 ( 639,158)
--------------------- ---------------------
$ 38,708,947 4,435,156
===================== =====================
</TABLE>
(A) ($.01 par value, 100,000,000 shares authorized, 58,749,200 and 9,819,740
shares issued and outstanding 1999 and 1998, respectively)
(B) (Series B, convertible; $.01 par value 15,000 shares authorized, 14,084
shares issued and outstanding in 1998)
See notes to consolidated financial statements.
<PAGE> 51
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
<TABLE>
<CAPTION>
1999 1998 1997
------------------ ------------------- -----------------
<S> <C> <C> <C>
Net sales $ 99,324,789 $ 19,445,491 $ 20,763,856
Less:
Cost of goods sold 31,878,879 7,669,428 10,033,330
Excise taxes on products 33,821,112 8,837,868 7,810,720
------------------ ------------------- -----------------
Gross profit 33,624,798 2,938,195 2,919,806
------------------ ------------------- -----------------
Operating expenses:
Marketing and distribution 6,253,265 1,198,757 1,111,420
General and administrative 9,899,165 3,173,991 1,425,299
Research and development 535,782 1,377,657 2,134,656
------------------ ------------------- -----------------
Total operating expenses 16,688,212 5,750,405 4,671,375
------------------ ------------------- -----------------
Operating income (loss) 16,936,586 ( 2,812,210) ( 1,751,569)
------------------ ------------------- -----------------
Other income (expenses):
Interest income 227,648 17,167 21,073
Interest expense ( 85,604) ( 255,113) ( 256,001)
Loss on disposal of assets - ( 425,316) -
------------------ ------------------- -----------------
142,044 ( 663,262) ( 234,928)
------------------ ------------------- -----------------
Income (loss) from continuing operations
before income taxes 17,078,630 ( 3,475,472) ( 1,986,497)
Income tax expense 5,564,000 - -
------------------ ------------------- -----------------
Income (loss) from continuing operations 11,514,630 ( 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) -
------------------ ------------------- -----------------
Income (loss) before extraordinary item 11,514,630 ( 4,447,842) ( 1,986,497)
Extraordinary gain from extinguishment
of debt (no applicable income taxes) - 251,767
------------------ ------------------- -----------------
Net income (loss) $ 11,514,630 ($ 4,196,075) ($ 1,986,497)
================== =================== ==================
Basic income (loss) per common share:
Continuing operations $ .32 ($ .42) ($ .58)
Discontinued operations - ( .12) -
Extraordinary gain - .03 -
------------------ ------------------- -----------------
Net income (loss) $ .32 ($ .51) ($ .58)
================== =================== ==================
Diluted income (loss) per share $ .30 ($ .51) ($ .58)
================== =================== ==================
Weighted average shares outstanding basic 36,207,390 8,327,345 3,435,190
================== =================== ==================
Weighted average shares outstanding diluted 38,765,251 8,327,345 3,435,190
================== =================== ==================
Pro forma presentation applicable to conversion
from S Corporation to C Corporation:
Net loss 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.
<PAGE> 52
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
<TABLE>
<CAPTION>
Preferred Stock
---------------------
Series B Common Stock
--------------------- ----------------------- Additional
Paid-In
Shares Amount Shares Amount Capital
------------- -------- ---------- ---------- ----------------
<S> <C> <C> <C> <C> <C>
Balances, January 1997 - $ - 200 $ 383,557 $ 16,320
Collection of notes receivable
Conversion of debt to equity 923,499
Capital contribution 64,788
Net loss for the year
Distributions ------------- -------- ---------- ---------- ----------------
Balances,December 31, 1997 - - 200 383,557 1,004,607
Conversion of debt to equity 1,402,550 14,026 483,623
Reverse merger and reorganization 3,434,990 ( 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 preferred stock for
common 305 3 ( 3)
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
Issuance of preferred stock pursuant
to private placements 304 3 999,997
Stock issuance costs ( 220,000)
Stock issued for current and future
services 25 2 350,000 3,500 401,200
Net loss for the year
------------- -------- ---------- ---------- ----------------
Balances, December 31, 1998 14,084 143 9,819,740 98,198 6,668,392
------------- -------- ---------- ---------- ----------------
<CAPTION>
Retained Earnings Treasury Stock Unearned
(Accumulated ----------------------- Compen- Notes
Deficit) Shares Amount sation Receivable
----------------------- ------------ ---------- ------------- --------------
<S> <C> <C> <C> <C> <C>
Balances, January 1, 1997 ($ 988,004) - $ - $ - ($ 250,000)
Collection of notes receivable 250,000
Conversion of debt to equity
Capital contribution
Net loss for the year ( 1,986,497)
Distributions ( 156,148)
--------------------- ------------ ---------- ------------- --------------
Balances,December 31, 1997 ( 3,130,649) - - - -
Conversion of debt to equity
Reverse merger and reorganization
Stock issued pursuant to merger
Mandatory redeemable preferred ( 1,000,000)
stock converted to common
Increase of Series A Preferred
Stock to Redemption value
Exchange of preferred stock for
common
Shares gifted to company and
retired
Issuance of common stock pursuant to
private placements 1,000,000
Issuance of preferred stock pursuant
to private placements
Stock issuance costs
Stock issued for current and future
services ( 79,167)
Net loss for the year ( 4,196,075)
--------------------- ------------ ---------- ------------- --------------
Balances, December 31, 1998 ( 7,326,724) - - ( 79,167) -
--------------------- ------------ ---------- ------------- --------------
<CAPTION>
Total
------------------
<S> <C>
Balances, January 1, 1997 ($ 838,127)
Collection of notes receivable 250,000
Conversion of debt 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 preferred stock for
common -
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 325,535
Net loss for the year ( 4,196,075)
--------------------
Balances, December 31, 1998 ( 639,168)
--------------------
</TABLE>
See notes to consolidated financial statements
<PAGE> 53
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
<TABLE>
<CAPTION>
Preferred Stock
----------------------
Series B Common Stock Additional
---------------------- -------------------------- Paid-In
Shares Amount Shares Amount Capital
--------- -------- ------------- ----------- ------------------
<S> <C> <C> <C> <C> <C>
Balances, December 31, 1998 -
carried forward 14,084 143 9,819,740 98,198 6,668,392
Conversion of preferred
stock to common ( 14,084) ( 143) 46,127,500 462,175 ( 462,032)
Amortization of unearned
stock - based compensation
Mandatory redeemable
preferred stock converted
to common 20,000 200 43,800
Issuance of stock 2,000,000 20,000 1,980,000
Stock issued for services 39,000 390 97,405
Issuance of common stock to
charitable organizations 130,000 1,300 767,342
Common stock options and
stock purchase rights issued 536,278
Warrants exercised 522,920 5,229 1,040,691
Stock issuance costs
associated with
warrants ( 40,000)
Note receivable issued
Net income
========= =========== ============= ================= ====================
Balances, December 31, 1999 - $ - 58,749,200 $ 587,493 $10,631,875
========= =========== ============= ================= ====================
</TABLE>
<TABLE>
<CAPTION>
Retained Earnings Treasury Stock Unearned
(Accumulated -------------------------- Compen- Notes
Deficit) Shares Amount sation Receivable Total
------------------ ------------- ------------ --------------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Balances, December 31, 1998 -
carried forward ( 7,326,724) - - ( 79,167) - ( 639,158)
Conversion of preferred
stock to common -
Amortization of unearned
stock - based compensation 79,167 79,167
Mandatory redeemable
preferred stock converted
to common 44,000
Issuance of stock ( 2,000,000) -
Stock issued for services 97,795
Issuance of common stock to
charitable organizations 768,642
Common stock options and
stock purchase rights
issued 536,278
Warrants exercised 1,045,920
Stock issuance costs
associated with warrants ( 40,000)
Note receivable issued ( 1,087,806) ( 1,087,806)
Net income 11,514,630 11,514,630
Balances, December 31, 1999 4,187,906 - $ - $ - ($ 3,087,806) $ 12.319.468
================== ============= ============ =============== ============== =============
</TABLE>
See notes to consolidated financial statements
<PAGE> 54
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
<TABLE>
<CAPTION>
1999 1998 1997
---------------- ---------------- --------------
<S> <C> <C> <C>
Operating activities:
Net income (loss) $ 11,514,630 ($ 4,196,075) ($ 1,986,497)
Adjustments to reconcile net income
(loss) to net cash provided by
(used in) operating activities:
Depreciation 745,205 359,135 355,292
Amortization of intangibles and
other non-cash charges 38,546 637,478 68,385
Deferred income taxes ( 2,386,000) - -
Loss on fixed asset disposal - 425,316 -
Stock-based compensation expense 1,481,882 325,535 -
Extraordinary gain on
extinguishment of debt - ( 251,767) -
Increase (decrease) in cash resulting
from changes in:
Accounts receivable, trade ( 2,102,508) ( 722,289) 540,248
Accounts receivable, other 68,271 ( 68,271) -
Inventories ( 2,934,153) ( 31,064) 1,011,439
Prepaid expenses and other
current assets ( 168,786) ( 164,137) 24,324
Accounts payable 976,097 ( 57,582) 458,300
Federal excise taxes payable 599,649 517,092 ( 178,086)
Income taxes payable 6,198,000 - -
Accrued expenses 796,406 561,007 ( 52,093)
Customer deposit 6,000,000 - -
---------------- ---------------- --------------
Net cash provided by (used in) operating
activities 20,827,239 ( 2,665,622) 241,312
---------------- ---------------- --------------
Investing activities:
Collections of notes receivable 17,213 1,915 19,045
Purchases of property, plant and equipment ( 10,014,665) ( 454,888) (3,530)
Proceeds from disposal of property
and equipment - 175,000 -
Purchases of intangible assets ( 240,681) ( 48,815) -
Deposits on property and equipment (193,700) - -
Note receivable from stockholder (1,087,806) - -
Net cash provided by (used in)
investing activities ( 11,519,639) ( 326,788) 15,515
---------------- ---------------- --------------
</TABLE>
See notes to consolidated financial statements.
<PAGE> 55
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
<TABLE>
<CAPTION>
1999 1998 1997
------------ ------------- -------------
<S> <C> <C> <C>
Financing activities:
Payments on line of credit, net - ( 1,095,801) (266,334)
Proceeds from notes payable 7,172,000 - 300,000
Payments on notes payable ( 382,967) ( 550,023) ( 198,788)
Proceeds from sale of stock 1,045,920 4,950,000 64,788
Stockholder distributions - - ( 156,148)
Stock offering costs paid ( 40,000) ( 220,000) -
------------- -------------- -------------
Net cash provided by (used in)
financing activities 7,794,953 3,084,176 ( 256,482)
------------- -------------- -------------
Increase in cash and cash
equivalents 17,102,553 91,766 345
Cash and cash equivalents,
beginning of year 102,695 10,929 10,584
------------- -------------- -------------
Cash and cash equivalents,
end of year $ 17,205,248 $ 102,695 $ 10,929
============= ============== =============
Supplemental disclosure of cash
flow information:
Cash paid during the year for:
Interest $ 123,119 $ 254,713 $ 230,370
============= ============== =============
Income taxes $ 1,752,000 $ - $ -
============= ============== =============
Supplemental schedule of non-cash
investing and financing activities:
Repayment of related party note
payable with related party
note receivable $ 759,489
=============
Conversion of debt to equity $ 497,649 $ 923,499
============== =============
Conversion of redeemable preferred
stock to equity $ 44,000 $ 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.
<PAGE> 56
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 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"). In 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 46,127,500 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.
<PAGE> 57
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
Organization and basis of presentation:
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 engaged in extensive research and
development activities relating to (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, (2) the
development of less harmful tobacco products which have been cured
pursuant to licensed patented technology and (3) the development of
tobacco-smoking cessation products. The Company is also engaged in the
manufacture and sale of discount cigarettes, without additives, and
with activated charcoal filters. Through the year ended December 31,
1998, the Company had not yet marketed or received any revenues from
products developed from its research and development activities.
During 1997, Star had sales to one customer which represented
approximately 19% of net sales. There were no sales to this customer in
1999 or 1998. During 1999, Star had purchases from a major domestic
tobacco company which represented 21% of cost of sales. The Company
also borrowed $7,172,000 from this same company to finance property,
plant and equipment acquisitions in 1999. (See Notes 5 and 6)
Advertising Costs:
Advertising costs are expensed as incurred and are included in
marketing and distribution expenses. For the years ended December 31,
1999, 1998 and 1997, advertising costs were $36,000, $38,000 and
$60,000, respectively.
<PAGE> 58
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
Use of estimates:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of income and
expenses during the reporting period. Actual results could differ from
those estimates.
Cash equivalents:
For purposes of the statement of cash flows, the Company classifies all
highly liquid investments with an original maturity of three months or
less as cash equivalents.
Fair value of financial instruments:
Financial instruments consist of cash, cash equivalents, short-term
trade receivables and short-term trade 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
determined using 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 licensing costs, trademarks and
packaging design costs. Intangibles are amortized by the straight-line
method over a period of 15 years for trademarks 17 years for licensing
costs and 5 years for packaging design costs.
<PAGE> 59
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
Income taxes:
Star was an S Corporation from August 1, 1991 through February 6, 1998
for federal income tax purposes. Accordingly, the taxable income or
loss of Star had been "passed-through" to its stockholders, and they
have been subject to the tax on any income earned by the Company. As a
result of the change in ownership discussed in Note 1, Star was no
longer eligible for S corporation status and became a C Corporation
effective February 6, 1998. As a C corporation, Star is 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 recorded based on the
difference between the financial statement and tax bases of assets and
liabilities using currently enacted tax rates.
Credit risk:
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash and cash
equivalents and accounts receivable.
The Company maintains its cash and cash equivalents balances in 5
financial institutions, including approximately $64,000 in one foreign
bank. Each of the balances in the 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.
Employee stock-based compensation:
During 1999, the Company adopted the accounting and disclosure
provisions of Financial Accounting Standard No. 123 -- Accounting for
Stock-Based Compensation ("FAS 123"), which requires use of the
fair-value based method to determine compensation for all arrangements
under which employees and others receive shares of stock or equity
instruments (warrants and options). There were no stock-based
compensation transactions with employees in 1998 or 1997 that would
have been subject to the accounting or disclosure provisions of FAS
123.
<PAGE> 60
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED):
Research and development costs:
Research and development costs are charged to expense when incurred.
Segment reporting:
During 1999, the Company commenced operations in a new business segment
and as a result, adopted the Statement of Financial Accounting
Standards Number 131, "Disclosures about Segments of an Enterprise and
Related Information". Statement No. 131 establishes standards for
reporting information about operating segments in annual financials
statements. Operating segments are defined as components of an
enterprise about which separate financial information is available that
is evaluated on a regular basis by the chief operating decision maker
or decision making group, in deciding how to allocate resources to an
individual segment and in assessing performance of the segment. The
Company has identified these segments based on the nature of business
conducted by each. The identifiable segments at December 31, 1999 are
1) the manufacture and sale of discount cigarettes to wholesalers, and
2) the sale of tobacco cured utilizing its proprietary technology. This
second segment also includes costs incurred in the research and
development of methods of manufacturing a less harmful tobacco product.
Net income (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.
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 income (loss) per common share was computed using the
weighted-average number of common shares outstanding. Potential common
shares outstanding were excluded in 1998 and 1997, as their effect was
antidilutive.
Diluted earnings per share was computed assuming conversion of all
potentially dilutive stock options and warrants.
<PAGE> 61
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
2. DISCONTINUED OPERATIONS:
On December 30, 1998, the Company completed the sale of its ophthalmic
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 Technology, Inc. acquisition in
February 1998 through December 31, 1998.
Net sales and loss from discontinued operations are as follows for
1998:
<TABLE>
<S> <C>
Net sales $629,715
--------
Operating losses $751,080
--------
Income taxes -
--------
Loss from discontinued operations $751,080
--------
Loss on disposal $221,290
--------
</TABLE>
3. INVENTORIES:
Inventories consist of the following:
<TABLE>
<CAPTION>
1999 1998
---------- -----------
<S> <C> <C>
Raw materials $ 623,692 $ 329,238
Packaging materials 781,448 262,467
Finished goods 2,165,469 44,751
---------- ----------
$3,570,609 $ 636,456
========== ==========
</TABLE>
4. PROPERTY, PLANT AND EQUIPMENT:
<TABLE>
<CAPTION>
Property, plant and equipment consists of the
following: 1999 1998
----------- -----------
<S> <C> <C>
Land $ 172,572 $ 172,572
Buildings and improvements 340,139 269,484
Tobacco curing barns 8,661,312 -
Machinery and equipment 3,202,577 2,180,653
Office and sales equipment 586,087 312,649
----------- -----------
12,962,687 2,935,358
Less accumulated depreciation 1,988,658 1,230,789
----------- -----------
$10,974,029 $ 1,704,569
=========== ===========
</TABLE>
<PAGE> 62
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
5. CUSTOMER DEPOSIT AND LONG-TERM SUPPLY AGREEMENT:
During October 1999, the Company entered into an agreement with a major
domestic tobacco company ("customer"), whereby that customer will, subject
to certain conditions, purchase quantities of the Company's low
nitrosamine tobacco leaf (StarCure(TM) tobacco) and evaluate the potential
for that tobacco in the marketplace. In that regard, the customer has made
a $6,000,000 non-refundable deposit to the Company toward its purchase of
tobacco in 2000. Additionally, the customer has agreed to finance the
purchase/construction of tobacco curing barns which will assist the
Company in its production of low nitrosamine tobacco products to be
marketed by the Company, the customer and others in the industry (see Note
6 regarding financing provided through December 31, 1999). Tobacco leaf
sales under this agreement during 1999 were approximately $9,300,000. In
each of the years 2000 and 2001, the customer is obligated to purchase
five million pounds of Virginia flue-cured tobacco that has been cured
using the StarCure(TM) process, and the customer has an option to purchase
three million pounds of burley tobacco cured using the same process. The
customer also has the option to become the exclusive purchaser of tobacco
cured using the StarCure(TM) process in each of the years 2002 through
2004, if it purchases at least thirty million pounds of tobacco in each of
those years. If the customer were to stop purchasing flue-cured tobacco
that has been cured using the StarCure(TM) process after the year 2001,
the Company's sales volume, operating income and cash flows could be
negatively effected.
6. NOTES PAYABLE:
Notes payable consists of the following:
<TABLE>
<CAPTION>
1999 1998
---------- -----------
<S> <C> <C>
Note payable under a $13,200,000 credit facility restricted for the
purchase of tobacco curing barns; interest accrues at prime plus 1%
commencing December 2000-payable monthly thereafter; principal
payable in 60 equal monthly installments commencing September 2004;
collateralized by the Company's curing barns and leaf tobacco
inventory. $ 7,172,000 $ -
Note payable, bank, due in monthly installments of $3,111,
including interest at prime plus 1%, through 2001; secured by real
property and guaranteed by certain stockholders. 259,343 275,393
</TABLE>
<PAGE> 63
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
6. NOTES PAYABLE (CONTINUED):
<TABLE>
<S> <C> <C>
Term note payable, finance company, due in monthly installments of
$21,047, including interest at 10.15% through September 2001;
secured by manufacturing equipment. 172,469 362,247
Term note payable, finance company, due in monthly installments of
$7,262, including interest at 9.31% through October 2001; secured
by manufacturing equipment. 146,356 216,292
Other 29,514 136,734
----------- --------------
7,779,679 990,666
Less current maturities 275,000 379,082
----------- --------------
$ 7,504,679 $ 611,584
=========== ==============
</TABLE>
The annual maturities of notes payable are as follows:
<TABLE>
<CAPTION>
Year ending December 31
-------------------------
<S> <C>
2000 275,000
2001 332,679
2005 7,172,000
-----------
$ 7,779,679
===========
</TABLE>
7. STOCKHOLDERS' EQUITY:
Preferred stock:
Class 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 80 shares of common stock of the Company at
the option of the holder and has voting rights equal to the number of
common shares issuable if converted. The Preferred Stock has the right
to share in dividends declared on the Company's common stock and has
certain liquidation preferences. The carrying value of the Preferred
Stock at December 31, 1998 reflected an additional acceleration premium
as the Company has raised funds in excess of defined amounts. At
December 31, 1999 all Class A preferred shares had been converted to
common.
<PAGE> 64
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
7. STOCKHOLDERS' EQUITY (CONTINUED):
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 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. During 1999, holders of all of the 14,084
shares of Series B Preferred Stock converted their shares to common.
Common stock warrants:
Common stock warrants issued, redeemed and outstanding during the year
ended December 31, 1999 and 1998 are as follows:
<TABLE>
<S> <C>
Issued in 1998 in connection with private placement of stock,
exercise price of $2 per share, expiring September 2000 1,500,000
----------------
Warrants issued and outstanding at December 31, 1998 1,500,000
Warrants exercised in 1999 ( 522,920)
----------------
Warrants issued and outstanding at
December 31, 1999, expiring September
2000 (remaining contractual life .75 years) 977,080
================
</TABLE>
Stock option plan:
In 1998, the Company adopted the 1998 Stock Option Plan (the "Plan")
which provides for grants of options to those officers, key employees,
directors and consultants whose substantial contributions are essential
to the continued growth and success of the Company. The Plan provides
for grants of both qualified and non-qualified stock options to
purchase up to 4,000,000 shares at a purchase price equal to the fair
market value on the date of grant in the case of qualified options
granted to employees. The Company amended the Plan on April 12, 1999.
There were no options outstanding as of December 31, 1998. During 1999,
3,258,406 options were granted with a weighted average exercise price
of $2.17 per share. No options were exercised or forfeited in 1999.
<PAGE> 65
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
7. STOCKHOLDERS' EQUITY (CONTINUED):
The following table summarizes information for options outstanding and
exercisable at December 31, 1999 all of which were granted in 1999.
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
----------------------------------------------- -------------------------------
Range of Weighted Avg. Weighted Avg. Weighted Avg.
Prices Number Remaining Life Exercise Price Number Exercise Price
------------- --------- -------------- --------------- ---------- ---------------
<S> <C> <C> <C> <C> <C>
$ 1.00-2.00 2,500,000 9.71 yrs. $ 1.79 2,000,000 $ 1.74
$ 2.01-3.00 500,000 9.79 yrs. $ 3.00 - $ -
$ 3.01-4.00 175,000 9.52 yrs. $ 3.34 175,000 $ 3.34
$ 4.01-5.00 50,000 9.33 yrs. $ 4.13 50,000 $ 4.13
$ 5.01-8.56 33,406 9.92 yrs. $ 8.56 33,406 $ 8.56
--------- -------------- --------------- ---------- ---------------
$ 1.00-8.56 3,258,406 9.71 yrs. $ 2.17 2,258,406 $ 2.02
========== ============== =============== ========== ===============
</TABLE>
The weighted average grant-date fair value of options granted during
1999 was $2.07 per share ($2.00 per share for those issued whose
exercise price was different from the market price of the stock at
date of grant).
In addition to stock options, the Company granted a stock purchase
right to acquire 2,000,000 shares of common stock at $1.00 per share.
This stock purchase right was accounted for as an option (see Note 13)
and had a grant-date fair value of $48,400.
The fair value of options and the stock purchase right granted in 1999
were estimated on the date of grant using the Black-Scholes option
pricing model with the following weighted average assumptions:
<TABLE>
<S> <C>
Expected life of options 1.25 years
Risk free interest rate 5.03%
Expected volatility 39%
Expected dividend yield 0%
</TABLE>
Total compensation cost recognized in 1999 for all stock-based employee
compensation awards was $265,618.
<PAGE> 66
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
8. EARNINGS PER SHARE:
The following table sets forth the computation of basic and diluted
earnings per share for the years ended December 31,
<TABLE>
<CAPTION>
1999 1998 1997
--------------- -------------- ---------------
<S> <C> <C> <C>
Net income (loss)
$ 11,514,630 ($ 4,196,075) ($ 1,986,497)
=============== ============== ===============
Denominator for basic earnings per
share-weighted average shares 36,207,390 8,327,345 3,435,190
Effect of dilutive securities:
Warrants outstanding 729,621 - -
Stock options outstanding 1,828,240 - -
--------------- -------------- ---------------
Denominator for diluted earnings
per share- weighted average shares
adjusted for dilutive securities 38,765,251 8,327,345 3,435,190
=============== ============== ===============
Earnings (loss) per common share $ .32 ($ .51) ($ .58)
=============== ============== ===============
Earnings (loss) per common share-
diluted $ .30 ($ .51) ($ .58)
=============== ============== ===============
</TABLE>
9. INCOME TAXES:
Net deferred tax assets and liabilities consist of the following:
<TABLE>
<CAPTION>
1999 1998
------------------------ --------------------
<S> <C> <C>
Deferred tax assets:
Non-refundable deposit taxable currently $ 2,280,000 -
Net operating loss carryforwards (subject
to annual limitation) 423,000 2,000,000
Other 43,000 -
------------------------ -------------------
2,746,000 2,000,000
------------------------ -------------------
Deferred tax liabilities:
Differing bases in property, plant and
equipment for tax and financial reporting
purposes ( 360,000) ( 200,000)
------------------------ --------------------
2,386,000 1,800,000
Less valuation allowance - ( 1,800,000)
------------------------ --------------------
$ 2,386,000 $ -
======================== ====================
</TABLE>
Net deferred tax assets are reflected in the accompanying 1999 balance
sheet as follows:
<TABLE>
<S> <C>
Current asset $ 2,303,000
Non-current asset 83,000
-------------------
$ 2,386,000
===================
</TABLE>
<PAGE> 67
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
9. INCOME TAXES (CONTINUED):
Income tax expense consists of the following:
<TABLE>
<CAPTION>
1999 1998 1997
------------------ ----------------- -------------
<S> <C> <C> <C>
Current:
Federal $ 6,114,000 $ - -
State 1,250,000 - -
------------------ ----------------- --------------
7,364,000 - -
Deferred ( 586,000) ( 1,325,000) -
Increase (decrease) in valuation
allowance(a) ( 1,800,000) 1,325,000 -
------------------ ----------------- --------------
$ 5,564,000 $ - -
=================== ================= ==============
</TABLE>
(a)During 1999, the Company reevaluated the deferred tax asset
valuation allowance based on the Company's current operations and
determined that it is more likely than not that these deferred tax
assets will be recoverable and, as such, has decreased the previously
recorded valuation allowance.
The provision for income tax expense (income tax benefit) varies from
that which would be expected based upon applying the statutory federal
rate to pre-tax accounting income (loss) as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---------------- ---------------- --------------
<S> <C> <C> <C>
Statutory federal rate 34% ( 34%) ( 34%)
Non-deductible compensation
for stock options and grants 4 -
Other 3 - -
Non-deductible officer
compensation 4 - -
Change in deferred tax
asset valuation allowance ( 12) 34 34
---------------- ---------------- --------------
33% - % - %
================ ================ =============
</TABLE>
At December 31, 1999 the Company had a net operating loss carryforward
of approximately $1,100,000, which expires from 2003 through 2009.
<PAGE> 68
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 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 the significant related party transactions
for the years ended December 31, 1999, 1998 and 1997.
<TABLE>
<CAPTION>
1999 1998 1997
---------------- --------------- ------------
<S> <C> <C> <C>
Management fee expense $ - $ - $ 565,000
Business travel - aircraft expense $ 442,238 185,544 238,750
Loan repayments $ - 200,000 -
Legal fees paid to law firm affiliated
with employee/officer $ 940,000 $ - $ -
Advance to officers (a) (b) $ 1,143,134 - -
Note receivable, officer
(See Note 13-Employment
Agreement) $ 2,000,000 $ - $ -
Interest receivable on stock note
receivable officer (c) $ 94,889 $ - $ -
Tobacco purchases from/commissions
paid to organization controlled by an
officer/director $ 627,577 $ 59,429 $ -
Tobacco sales to an organization
controlled by an officer/director $ 578,683 $ 165,347 $ -
</TABLE>
(a) $55,328 of which is unsecured and included in prepaid expenses
and other current assets in the accompanying 1999 balance sheet.
(b) Includes a $1,087,806 unsecured note receivable due from officer,
bearing interest at 5.66% due December 31, 2000.
(c) Included in prepaid expenses and other current assets in the
accompanying 1999 balance sheet.
Effective January 1, 1998, Star entered into a license agreement with
the principal stockholder wherein Star has the exclusive world-wide
rights to produce and sell tobacco products with low-TSNA (tobacco
specific nitrosamines) 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 royalties due under this agreement
for 1999 or 1998.
<PAGE> 69
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
11. EMPLOYEE BENEFIT PLAN:
The Company is 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 annual compensation. The
Company may make an annual discretionary contribution (approximately
$44,000 in 1999 and no contribution in 1998 or 1997).
12. SEGMENT REPORTING:
As discussed in Note 1, the Company adopted FAS No. 131, "Disclosures
about Segments of an Enterprise and Related Information". The Company's
reportable segments are strategic business units that offer different
products and have separate management teams. These segments are 1) the
manufacture and sale of discount cigarettes and 2) the sale of tobacco
cured using licensed technology, which commenced in 1999. Financial
information by business segment is as follows:
<TABLE>
<CAPTION>
Leaf Discount
Tobacco Cigarettes Consolidated
---------------- ------------------- ---------------------
<S> <C> <C> <C>
Sales $ 9,845,516 $ 89,479,273 $ 99,324,789
---------------- ------------------- ---------------------
Cost of sales 6,565,901 25,312,978 31,878,879
---------------- ------------------- ---------------------
Depreciation 407,011 338,194 745,205
---------------- ------------------- ---------------------
Research and development 535,782 - 535,782
---------------- ------------------- ---------------------
Property and equipment 9,107,039 1,866,990 10,974,029
---------------- ------------------- ---------------------
Capital expenditures 9,150,000 864,665 10,014,665
---------------- ------------------- ---------------------
</TABLE>
<PAGE> 70
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
13. COMMITMENTS AND CONTINGENT LIABILITIES:
Obligations under master settlement agreement:
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"). As a nonparticipating manufacturer, the Company
would be required to satisfy certain 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 judgements of settlements
in lawsuits 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, the Company is obligated to place an
amount equal to $1.88 per carton sold in 1999, and increased amounts
per carton for subsequent years, in escrow accounts beginning April
2000 for sales of cigarettes occurring in each such state after the
effective date of each state specific statute. The Company's escrow
funding requirement in April 2000 for 1999 sales is approximately
$10,600,000 and is expected to increase in future years. Such escrowed
funds will be used to fund tobacco-related litigation or settlements
and if not so used, returned to the Company after 25 years (the Company
will, however, receive interest earnings on the invested escrowed
amounts). Also, absent a challenge to the state-specific statutes or
some accommodation as to the payment of the escrow amounts, the failure
to pay the required escrow could result in penalties to the Company and
potential restrictions on its ability to sell tobacco products within
particular states. The Company has the resources to meet its April 2000
escrow funding obligation and expects it will be able to do so in
future years. However, the degree to which these escrow requirements
negatively impact the Company's liquidity position in future years is
not presently determinable. Notwithstanding, the Company is continuing
to assess its options with respect to the state specific statutes,
including a variety of legal challenges to the statutes and/or MSA.
<PAGE> 71
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
13. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED):
Leases:
The Company leases its office and warehouse facilities and various
vehicles and operating equipment under non-cancelable operating leases.
The following represents the future minimum rental payments required
under operating leases that have initial or remaining non-cancelable
lease terms in excess of one year as of December 31, 1999.
<TABLE>
<CAPTION>
Year ending December 31, Amount
------------------------ ---------------
<S> <C> <C>
2000 $ 99,024
2001 76,736
2002 74,948
2003 74,948
2004 74,948
Thereafter 256,073
---------------
$ 656,677
===============
</TABLE>
Rent expense for all operating leases amounted to approximately
$153,000, $107,000, and $170,000 for the years ended December 31, 1999,
1998 and 1997, respectively.
Employment Agreement:
During April 1999, the Company entered into an employment agreement
with an Executive Officer (the "officer"), which expires June 15, 2002.
In addition to a $600,000 base salary as of December 31, 1999, the
agreement provides for a minimum annual performance bonus of $250,000.
Compensation expense pursuant to this agreement in 1999 was
approximately $860,000.
<PAGE> 72
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
13. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED):
Employment Agreement (continued):
The agreement also granted the officer the right to purchase 2,000,000
shares of the Company's common stock at $1 per share, and the Company
agreed to finance the purchase with interest due annually at 7% and all
principal due July 2005. The stock purchase occurred in 1999, and the
related $2,000,000 note receivable is presented as a reduction of
stockholders' equity in the accompanying 1999 balance sheet. Since the
note is non-recourse with respect to accrued unpaid interest and 85% of
the principal, this stock purchase right has been accounted for as an
option. The Company has recognized interest income of approximately
$90,000 during 1999 in connection with the note. In connection with the
aforementioned agreement, the officer was also granted qualified stock
options to purchase 1,000,000 shares of stock at $1 - 11/16 per share,
the price of the Company's common stock on the date of grant. Such
options vested immediately.
14. SUBSEQUENT EVENT:
During January 2000 the Company obtained a $3,000,000 revolving line of
credit. Borrowings under the line of credit are limited to 80% of
eligible accounts receivable, as defined, and bear interest at a rate
linked to the prime rate. The agreement places restrictions on new debt
and the Company's ability to further pledge its assets and stipulates a
minimum fixed charge coverage ratio, as defined. Borrowings under the
line of credit are secured by substantially all assets not otherwise
pledged.
During January 2000 the Company also entered into a long-term lease
arrangement for warehouse and office space. Future minimum rental
payments adjusted for amounts required under this agreement are as
follows:
<TABLE>
<CAPTION>
Year ending Amount
----------------- ------------------
<S> <C>
December 31, 2000 $ 293,887
2001 271,599
2002 269,811
2003 281,273
2004 281,273
Thereafter 897,973
------------------
$ 2,295,816
==================
</TABLE>
<PAGE> 73
================================================================================
YOU MAY RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE HAVE NOT
AUTHORIZED ANYONE TO PROVIDE INFORMATION DIFFERENT FROM THAT CONTAINED IN THIS
PROSPECTUS. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR SALE OF COMMON STOCK
MEANS THAT INFORMATION CONTAINED IN THIS PROSPECTUS IS CORRECT AFTER THE DATE OF
THIS PROSPECTUS. THIS PROSPECTUS IS NOT AN OFFER TO SELL OR SOLICITATION OF AN
OFFER TO BUY THESE SHARES OF COMMON STOCK IN ANY CIRCUMSTANCES UNDER WHICH THE
OFFER OR SOLICITATION IS UNLAWFUL.
----------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary...............................
Risk Factors.....................................
Use of Proceeds..................................
Dividend Policy..................................
Capitalization...................................
Selected Consolidated Financial Data.............
Management's Discussion and Analysis of
Financial Condition and Results of Operations...
Business.........................................
Management.......................................
Financing and Related Party Transactions.........
Principal and Selling Stockholders...............
Description of Capital Stock.....................
Shares Eligible for Future Sale..................
Material United States Tax
Consideration for Non-U.S. Holders..............
Underwriting.....................................
Legal Matters....................................
Experts..........................................
Additional Information...........................
Index to Consolidated Financial Statements.......
</TABLE>
----------------
UNTIL ________ (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS THAT
BUY, SELL OR TRADE THESE SHARES OF COMMON STOCK, WHETHER OR NOT PARTICIPATING IN
THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO
THE DEALERS' OBLIGATION TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND
WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
================================================================================
300,000 SHARES
STAR SCIENTIFIC, INC.
COMMON STOCK
----------------
PROSPECTUS
----------------
----------------
March ___, 2000
================================================================================
<PAGE> 74
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution.
The following table sets forth the various expenses payable by the
Company in connection with the sale of the Shares being registered. All of the
amounts shown are estimates except the registration fee.
Registration fee $...........563
Legal fees and expenses .......________
Accounting fees and expenses .......________
Miscellaneous ......________
TOTAL: $..............
===============
Item 14. Indemnification of Directors and Officers.
Article Eleven of our Restated Certificate of Incorporation, as
amended, provides generally for indemnification of our officers, directors,
agents and employees to the extent authorized by the General Corporation Law of
the State of Delaware. Pursuant to Section 145 of the Delaware General
Corporation Law, a corporation generally has the power to indemnify its present
and former directors, officers, employees and agents against expenses incurred
by them in connection with any suit to which they are, or are threatened to be
made, a party by reason of their serving in such positions so long as they acted
in good faith and in a manner they reasonably believed to be in, or not opposed
to, the best interests of a corporation, and with respect to any criminal
action, they had no reasonable cause to believe their conduct was unlawful. With
respect to suits by or in the right of a corporation, however, indemnification
is not available if such person is adjudged to be liable for negligence or
misconduct in the performance of his duty to the corporation unless the court
determines that indemnification is appropriate. In addition, a corporation has
the power to purchase and maintain insurance for such persons. We currently
maintain such directors' and officers' insurance. The statute also expressly
provides that the power to indemnify authorized thereby is not exclusive of any
rights granted under any bylaw, agreement, vote of stockholders or disinterested
directors, or otherwise.
We have entered into indemnification agreements with our directors and
officers. These agreements provide broader indemnity rights than those provided
under the Delaware General Corporation Law and our Restated Certificate of
Incorporation. The indemnification agreements are not intended to deny or
otherwise limit third party or derivative suits against us or our directors or
officers, but to the extent a director or office were entitled to indemnity or
contribution under the indemnification agreement, the financial burden of a
third party suit would be borne by us, and we would not benefit from derivative
recoveries against the director or officer. Such recoveries would accrue to our
benefit but would be offset by our obligations to the director or officer under
the indemnification agreement.
<PAGE> 75
The above discussion of our Restated Certificate of Incorporation,
indemnification agreements and of Section 145 of the Delaware General
Corporation Law is not intended to be exhaustive and is qualified in its
entirety by such Restated Certificate of Incorporation, indemnification
agreements and statute.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers or persons controlling the
registrant pursuant to the foregoing provision, the registrant has been informed
that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Act and is
therefore unenforceable.
Item 15. Recent Sales of Unregistered Securities
In February 1998, ST&P merged with Eye Technology, Inc., a
publicly-held company based in Minneapolis, Minnesota. While Eye Technology,
Inc. technically was the surviving corporation in the merger, control of the
surviving corporation shifted to the former shareholders of ST&P and the
management of ST&P became the management of the survivor in the merger and the
shareholders of Eye Technology voted to change its name to Star Scientific, Inc.
(the "Company") As a result of the merger, the Company issued 13,831 shares of
Class B Preferred Stock, all of which have been converted into shares of Common
Stock of the Company by February 28, 2000. Since the merger, the Company has
issued or sold the following securities:
In February 1998, the Company sold 2,900,000 shares of Common Stock to
a group of sixteen individuals for gross proceeds of $1,450,000.
In February 1998, the Company issued 200,000 shares of Common Stock to
an individual for future services to be rendered to the Company.
In June 1998, the Company sold 304 shares of Class B Preferred Stock,
convertible into 997,120 shares of Common Stock and warrants to purchase
1,000,000 shares of Common Stock for gross proceeds of $2,500,000 to a group of
individuals. 22,920 of these warrants have been exercised. All of the Class B
shares have been converted.
In July 1998, the Company sold 763 shares of Class B Preferred Stock,
convertible into 2,502,640 shares of Common Stock, 2,500,000 shares of Common
Stock and warrants to purchase 500,000 shares of Common Stock for gross proceeds
of $2,500,000 to a Cayman Island limited duration corporation. All of these
warrants have been exercised and all of the Class B shares have been converted.
In December 1998, the Company issued 25 shares of Class B Preferred
Stock and 150,000 shares of Common Stock to three individuals in exchange for
services to be rendered to the Company. All of the Class B shares have been
converted.
In April 1999, the Company sold 2,000,000 shares of Common Stock to an
individual in exchange for a note receivable for $2,000,000.
In April 1999, the Company issued 38,000 shares of Common Stock to four
individuals in exchange for services to be rendered to the Company.
In November 1999, the Company issued 1,000 shares of Common Stock to an
individual in exchange for securities of Eye Technology, Inc.
<PAGE> 76
Item 16. Exhibits and Financial Statement Schedules.
a. Exhibits
<TABLE>
<CAPTION>
Exhibit No. Description
- ------------------ -----------
<S> <C>
2.01 Asset Purchase Agreement between Star Scientific, Inc., a Delaware Corporation
and Eyetech, LLC, a Minnesota Limited Liability Company, by Robert J.
Fitzsimmons, an individual residing in St. Paul, Minnesota, dated December 30,
1998 (Form 8-K dated March 2, 1999)
2.02 Escrow Agreement between Star Scientific, Inc., a Delaware Corporation, Eyetech,
LLC, a Minnesota Limited Liability Company and Robert J. Fitzsimmons, an
individual residing in St. Paul, Minnesota, and Jonnie R. Williams and Vincent
Ellis as Escrow Agents, dated February 16, 1999, and effective December 30, 1998
(Form 8-K dated March 2, 1999)
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 (Form 10-KSB for fiscal year ended
December 31, 1992)
10.18 Stock Exchange Agreement between the Company and the stockholders of Star Tobacco
and Pharmaceuticals, Inc., dated February 6, 1998 (Form 8-K dated February 19, 1998)
10.19 License Agreement between Star Tobacco and Pharmaceuticals, Inc., as Licensee and
Regent Technologies, Jonnie R. Williams, and Francis E. O'Donnell, J.R. , M.D.,
as Licensor, dated January 5, 1998 (Form 10-QSB for quarterly period ended March
31, 1998)
10.20 Letter Agreement between the Company and MFC Merchant Bank S.A., dated July 6,
1998 (Form 10-QSB for quarterly period ended September 30, 1998)
10.21 Exclusive Supply Agreement between Star Tobacco and Pharmaceutical, Inc. and
Amana Company, L.P., dated August 18, 1998 (Form 10-QSB for quarterly period
ended September 30, 1998)
</TABLE>
<PAGE> 77
<TABLE>
<S> <C>
10.22 Purchase and Sale Agreement between Prometheus Pacific Growth Fund LDC, a Cayman
Island Limited Duration Company, and Eye Technology, Inc., a Delaware
Corporation, dated July 10, 1998 (Form 8-K dated July 15, 1998)
10.23 Amendment No. 1 to License Agreement between Regent Court Technologies, Jonnie R.
Williams, Francis E. O'Donnell, J.R., M.D. and Star Tobacco and Pharmaceuticals,
Inc., dated August 3, 1998 (Form 8-K dated September 11, 1998)
10.24 1998 Stock Option Plan (Form 10-KSB for the fiscal year ended December 31, 1998)
10.26 Executive Employment Agreement dated as of April 27, 1999 entered into by the
Company, Jonnie R. Williams and Paul L. Perito (Form 10-QSB for quarterly period
ended June 30, 1999)
10.27 Qualified Stock Option Agreement dated as of April 27, 1999 between the Company
and Paul L. Perito (Form 10-QSB for quarterly period ended June 30, 1999)
10.28 Executive Employment Agreement dated as of April 12, 1999 entered into by the
Company and James A. McNulty (Form 10-QSB for quarterly period ended September
30, 1999)
10.29 Stock Option Agreement dated as of April 12, 1999 entered into by the Company and
James A. McNulty (Form 10-QSB for quarterly period ended September 30, 1999)
10.30 Restricted Stock Award Agreement dated as of April 12, 1999 entered into by the
Company and James A. McNulty (Form 10-QSB for quarterly period ended September
30, 1999)
16.01 Response Letter from Price Waterhouse LLP, dated April 10, 1998 (Form 8-K/A dated
April 10, 1998)
16.02 Response Letter from Olsen, Thielen & Co., Ltd, dated September 15, 1998 (Form
8-K/A dated September 16, 1998)
16.03 Response Letter from Keiter, Stephens, Hurst, Gary & Shreaves, dated January 20,
1999 (Form 8-K dated January 15, 1999)
21 Subsidiaries of the Company (Form 10-KSB for the fiscal year ended December 31,
1998)
23.1 Consent of Aidman, Piser & Company, P.A.
23.2 Consent of Keiter, Stephens, Hurst, Gary & Shreaves, P.C.
27 Financial Data Schedule
</TABLE>
<PAGE> 78
b. Financial Statement Schedules
<TABLE>
<CAPTION>
Schedule Page
- -------- ----
<S> <C>
Report of Independent Public Accountants ---
Consolidated Balance Sheets ---
Consolidated Statements of Operations ---
Consolidated Statements of Stockholders' Equity ---
Consolidated Statements of Cash Flows ---
Notes to Consolidated Financial Statements ---
</TABLE>
Item 17. Undertakings.
The undersigned registrant hereby undertakes:
(a) For purposes of determining any liability under the Securities
Act, each filing of the registrant's annual report pursuant to Section 13(a) or
Section 15(d) of the Exchange Act that is incorporated by reference in the
Registration Statement shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of such securities
at that time shall be deemed to be the initial bona fide offering thereof.
(b) In the event that a claim for indemnification against such
liabilities (other than the payment by the registrant of expenses incurred or
paid by a director, officer or controlling person of the registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
<PAGE> 79
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1933, the
registrant has duly caused this registration statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the city of Petersburg,
state of Virginia, on March 13, 2000.
STAR SCIENTIFIC, INC.
By: /s/ Jonnie R. Williams
-------------------------------------------
Jonnie R. Williams, Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Jonnie R. Williams and Paul L. Perito,
Esquire, or any of them, his attorney-in-fact, each with the power of
substitution, for him in any and all capacities, to sign any amendments to this
registration statement, and to file the same, with exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission,
hereby ratifying and confirming all that each of said attorneys-in-fact, or his
substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1933,
this report has been signed by the following persons in the capacities
indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- -----
<S> <C> <C>
/s/ Jonnie R. Williams
- -----------------------------------------------------
Jonnie R. Williams Chief Executive Officer and Director March 13, 2000
(Principal Executive Officer)
/s/ Paul L. Perito, Esquire
- -----------------------------------------------------
Paul L. Perito, Esquire Chief Operating Officer, President and
Director March 13, 2000
/s/ James A. McNulty
- -----------------------------------------------------
James A. McNulty Chief Financial Officer (Principal
Financial and Accounting Officer) March 13, 2000
/s/ Robert J. DeLorenzo, M.D., Ph.D., M.P.H.
- --------------------------------------------
Robert J. DeLorenzo, M.D., Ph.D., M.P.H. Chairman of the Board March 13, 2000
/s/ Malcolm L. Bailey
- -----------------------------------------------------
Malcolm L. Bailey Director March 13, 2000
/s/ Mark W. Johnson
- -----------------------------------------------------
Mark W. Johnson Director March 13, 2000
/s/ Elliot D. Prager, M.D.
- -----------------------------------------------------
Elliot D. Prager, M.D. Director March 13, 2000
/s/ Leo S. Tonkin, Esquire
- -----------------------------------------------------
Leo S. Tonkin, Esquire Director March 13, 2000
</TABLE>
<PAGE> 1
CONSENT OF INDEPENDENT CERTIFIED PUBLIC 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 Registration
Statement filed on Form S-1 for Star Scientific, Inc. and Subsidiaries of our
report included herein, which has a date of February 9, 2000, relating to the
consolidated balance sheet of Star Scientific, Inc. and Subsidiaries as of
December 31, 1999 and 1998 and the related consolidated statements of
operations, cash flows, and stockholders' equity for the years then ended.
/s/ Aidman, Piser & Company, P.A.
Tampa, Florida
March 13, 2000
<PAGE> 1
EXHIBIT 23.2
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Star Scientific, Inc. and Subsidiaries
Petersburg, Virginia
As former independent certified public accountants for Star Tobacco and
Pharmaceuticals, Inc., we hereby consent to the use in this Registration
Statement filed on Forms S-1 for Star Scientific, Inc. and Subsidiaries of our
report included herein, which has a date of March 24, 1998, relating to the
balance sheet of Star Tobacco and Pharmaceuticals, Inc. as of December 31, 1997
and the related statements of operations, cash flows, and stockholders' deficit
for the year then ended.
Keiter, Stephens, Hurst, Gary, & Shreaves, P.C.
Richmond, Virginia
March 11, 2000
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 17,205,248
<SECURITIES> 0
<RECEIVABLES> 3,825,835
<ALLOWANCES> 225,870
<INVENTORY> 3,570,609
<CURRENT-ASSETS> 27,017,612
<PP&E> 12,962,687
<DEPRECIATION> 1,988,658
<TOTAL-ASSETS> 38,708,947
<CURRENT-LIABILITIES> 18,884,800
<BONDS> 0
0
0
<COMMON> 587,493
<OTHER-SE> 11,731,975
<TOTAL-LIABILITY-AND-EQUITY> 38,708,947
<SALES> 99,324,789
<TOTAL-REVENUES> 99,552,437
<CGS> 31,878,879
<TOTAL-COSTS> 65,699,991
<OTHER-EXPENSES> 16,688,212
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 85,604
<INCOME-PRETAX> 17,078,630
<INCOME-TAX> 5,564,000
<INCOME-CONTINUING> 11,514,630
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 11,514,630
<EPS-BASIC> .32
<EPS-DILUTED> .30
</TABLE>
