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Registration No. 333-32364
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MAY 8, 2000.
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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AMENDMENT NO. 1 TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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STAR SCIENTIFIC, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 3523 52-1402131
(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)
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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. [X]
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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Title of each Class of Securities to be Amount to be Proposed Maximum Proposed Maximum Amount of
Registered Registered Offering Price Per Aggregate Registration Fee
Share(1) Offering Price(1)
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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 and based on the closing
asked price of the Common Stock quoted by the OTC Bulletin Board on March
10, 2000.
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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE
A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE
SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING
PURSUANT TO SAID SECTION 8(a), MAY DETERMINE.
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Registration No. 333-32364
300,000 SHARES
STAR SCIENTIFIC, INC.
COMMON STOCK
Our common stock is traded on the NASDAQ National Market System 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 May 8, 2000.
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TABLE OF CONTENTS
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SUMMARY 1
RISK FACTORS 2
FORWARD-LOOKING STATEMENTS 6
USE OF PROCEEDS 6
SELLING STOCKHOLDERS 6
PLAN OF DISTRIBUTION 6
DESCRIPTION OF SECURITIES 7
EXPERTS 7
BUSINESS 8
SELECTED CONSOLIDATED FINANCIAL DATA 24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS 25
MANAGEMENT 28
EXECUTIVE COMPENSATION AND OTHER MATTERS 33
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 41
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 42
SHARES ELIGIBLE FOR FUTURE SALE 43
WHERE YOU CAN FIND MORE INFORMATION 43
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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, through our wholly-owned
subsidiary, Star Tobacco & Pharmaceuticals, Inc. ("ST&P"); (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 NASDAQ National Market
System. Our principal executive offices are located at 801 Liberty Way, Chester,
VA 23836. Our phone number is (804) 530-0535. 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
by the selling stockholders.
NASDAQ National Market System symbol.................. "STSI"
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RISK FACTORS
You should read the following risk factors carefully before purchasing our
common stock. (Some of the matters described in these risk factors are discussed
in greater detail in other parts of this Prospectus.)
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. The U.S. cigarette business has been contracting in
recent years. 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. Our primary competition
for conventional cigarettes is from the "major" cigarette manufacturers, each of
which has substantially greater financial and operating resources than we do. We
also encounter significant competition from several other smaller 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 we do.
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, we believe other major tobacco companies will follow
our 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.
Additionally, 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 U.S. Food and Drug Administration ("FDA") has promulgated
regulations governing the sale and advertising of tobacco products. These
regulations are designed primarily to discourage the
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sale to, and consumption by, adolescents and children. The authority of the FDA
to promulgate such regulations was challenged in the federal courts. On March
21, 2000, the United States Supreme Court in a five to four decision held that
the Congress has not given the FDA authority to regulate tobacco products as
customarily marketed. Given the decision by the Supreme Court it is unclear
whether the 106th or 107th Congress will act to grant such authority to the FDA,
although legislation that would create such authority has already been
introduced in Congress.
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 entered into in 1998
between the major tobacco companies and 46 states, or an agreement with the
National Association of Attorneys General ("NAAG") with respect to the funding
of the required escrow amount, in April of each year, beginning April 2000, we
are obligated to place in escrow accounts 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), for sales of
cigarettes occurring in the prior year in each such state after the effective
date of each state specific statute. The failure to place such required amounts
into escrow could result in penalties to us and potential restrictions on our
ability to sell tobacco products within particular states. Because of this
escrow requirement, which currently applies to approximately 75% of our
cigarette sales, a substantial portion of our net income from operations will be
unavailable for our use and the amount required to be placed in escrow for each
carton sold may exceed the net cash flow generated by each carton sold. 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 and growth of our business. In addition, the escrow
obligations will impede our ability to distribute dividends to our stockholders.
The Company placed approximately $11.6 million into escrow in April 2000.
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: (1) loaned us the
capital necessary to finance the purchase of up to 600 specially manufactured
curing barns, (2) agreed to manufacture cigarettes for us and (3) agreed to
supply tobacco to us. The termination of any of these agreements could
negatively affect our business operations.
Lawsuits May Affect Our Profitability; We Have Limited Insurance
Coverage
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. We maintain product
liability
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insurance which is limited to any claims that tobacco products manufactured by
or for us 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. We do not believe that such insurance
currently can be obtained. Accordingly, 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 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.
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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 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 March 31, 2000, our executive
officers, directors and their associates, own an aggregate of approximately 70%
of our outstanding shares. As a result, these persons acting together may have
the ability to control matters submitted to our stockholders 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 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 of Directors is divided
into classes, only those directorships in a single class will be eligible to be
filled at each annual meeting of stockholders. Consequently, changing a majority
of the Board of Directors generally would require two years. A classified Board
of Directors, 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.
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FORWARD-LOOKING STATEMENTS
CERTAIN STATEMENTS IN THIS PROSPECTUS, 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 PROSPECTUS
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.
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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Shares Beneficially Shares Beneficially
Name and Address 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 NASDAQ
National Market System. No underwriter is currently expected to be involved in
the sale of the shares of common stock.
The Selling Stockholders may also sell shares under Rule 144 under the
Securities Act, if available, rather than under this Prospectus.
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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 March 31, 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 preferred stock which may at the time be outstanding,
holders of common stock are 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 at the time may be
outstanding, 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.
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 of Directors is divided
into classes, only those directorships in a single class will be eligible to be
filled at each annual meeting of stockholders. Consequently, changing a majority
of the Board of Directors generally would require two years. A classified Board
of Directors, 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 certified 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 certified 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.
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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, through our wholly-owned
subsidiary, ST&P; (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. (When used in this Prospectus,
Star Scientific, Inc. and its wholly-owned subsidiary, Star Tobacco &
Pharmaceuticals, Inc. are sometimes individually and/or collectively referred to
as "Star" or the "Company".)
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 to be among
the most abundant and potent carcinogens in tobacco and tobacco smoke.
The Company has pioneered the development of an economically feasible
curing (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.
Today, the Company's revenues are generated principally through ST&P.
ST&P's predecessor, a closely held private 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 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 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 and, on a more
long-term basis, the development of smoking cessation products with a joint
venture partner; most likely, a pharmaceutical company.
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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 the Company's 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. In 1999, the Company processed over 3.5 million pounds of very low-TSNA
flue-cured tobacco using the StarCure(TM) process, and believes that this
process is applicable to burley and other varieties of tobacco on a broad-scale
commercial basis.
The Company's long-term strategy is to aggressively increase and expand
its production capacity for its proprietary StarCure(TM) process to produce 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 excess of 20 million pounds of very
low-TSNA tobacco will be processed during the 2000 growing season. With such
increased production, Star expects over the next 24 months to be able to totally
convert its four existing brands into cigarette brands with very low-TSNA
flue-cured tobacco, to launch a new very low-TSNA cigarette brand that also will
have activated charcoal filters, and contemporaneously to fulfill its tobacco
supply commitments to B&W, the third largest tobacco company in the United
States. (See "Relationship with B&W").
The Company has announced plans to launch, before the end of the third
quarter of 2000, the first very low-TSNA cigarette. This cigarette, which will
have a new name chosen by late Spring 2000, also will have an activated charcoal
filter aimed at reducing the levels of certain vapor phase toxins. The Company's
central focus will continue to be 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 an
estimated 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.
PRODUCTS
Discount Cigarettes
Star currently manufactures and sells four brands of discount
cigarettes, SPORT(R), MAINSTREET(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
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not engage in extensive advertising or marketing programs for its cigarette
products, but relies primarily upon communications with distributors, pricing
appropriate for discount cigarettes, and, to a lesser extent, on brand, 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
flue-cured 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
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 of the very low-TSNA tobacco cured using the
StarCure(TM) process will be integrated into Star's own discount cigarette
brands over the next 24 months and/or will be available for sale to B&W or other
cigarette manufacturers. The bulk of these sales will occur in the third and
fourth quarters of each year resulting in higher revenues in those quarters. 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 at this time that
such a product will be developed and successfully commercialized.
Tobacco-Flavored Chewing Gum and Lozenges and Chewing Gum Containing
Tobacco Extract
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 this product
for smoking cessation purposes. Star has developed lozenges
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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 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. The Company is exploring entering into a
joint venture, partnership and/or technology license, preferably with a major
pharmaceutical company, to produce tobacco cessation products.
SALES AND MARKETING
Star's four brands of discount cigarettes are each sold in a variety of
sizes and styles, e.g., king size and 100s, soft pack and hinged box, regular
flavor and menthol, and full flavor, lights and ultra lights. Star utilizes its
own specified blend of tobaccos in each brand. The blend consists of Virginia
flue-cured, burley and oriental varieties of 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 and not advertising directed to consumers. It is
Star's strategy to rely to a large degree upon distributors to promote and sell
Star's brands to retail customers. Star provides to its distributor customers,
for redistribution to retailers, point-of-sale materials such as posters, pole
signs, display racks and 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.
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, arising
from the settlement of major litigation, 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; for example, Star's new brand expected to be launched in the third
quarter of 2000. Three of the Company's officers, Mr. Jonnie R. Williams, its
Chief Executive Officer, Mr. David M. Dean, its Vice President of Sales and
Marketing, and Mr. Sheldon Bogaz, its Vice President of Trade Operations, lead
the Company's sales and marketing activities. 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.
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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. The Company anticipates that it
will be able to process the tobacco purchased from the farmers within its Chase
City processing facility within one to three days of delivery to the facility.
MANUFACTURING
All of the tobacco planned to be used by the Company in 2000 and
thereafter 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 barns in the U.S. These specially designed barns are erected on site at
the tobacco farms which provide Star with its tobacco. Approximately 650 of
these barns have already been manufactured and delivered and contracts with
tobacco farmers for approximately 250 additional curing barns have either been
executed or are anticipated to be executed in 2000. 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 with B&W. 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 with B&W, 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 has 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
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and commercial acceptance of very low-TSNA cigarettes. In each of the years 2000
and 2001, B&W is obligated to purchase from Star five 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.
B&W also 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 (See "Management's Discussion and Analysis of
Financial Condition and Results of Operation-Liquidity and Capital Resources").
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. B&W
also has agreed to manufacture cigarettes for Star and to supply 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 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. There have been published reports that
at least one of the major cigarette manufacturers is developing its own low-TSNA
cigarettes, which may or may not be brought to market. 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-TSNA
levels in its smokeless products. Star is not aware of any other company that
now incorporates very low-TSNA tobacco into their cigarettes or other smoked
tobacco products. B&W now has in its possession
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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 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.
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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,
2000, at a press conference held at the Dirksen Senate Office Building in
Washington, D.C., its support of a bi-partisan tobacco labeling Bill (S. 2125)
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 effects. 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. On March 21, 2000, the Supreme Court
in a five to four decision held that Congress has not given the FDA authority to
regulate tobacco products as customarily marketed. Given the decision by the
Supreme Court it is unclear whether the 106th or 107th Congress will act to
grant such authority to the FDA, although legislation that would create such
authority has already been introduced in Congress.
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
StarCure(TM) tobacco curing process with the FDA. (See also "Research and
Development-Prior Development of CigRx(TM)" for a discussion of the Company's
prior submission of a cigarette product to the FDA.) The Company believes that
the commercial value of its proprietary 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.
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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. Labeling plans for Star's new very
low-TSNA cigarette are currently being reviewed with the FTC.
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 sales 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. 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. Additionally, state excise
taxes range from $.025 per pack in Virginia to $.87 per pack in California. Star
is aware of at least two states, Massachusetts and Minnesota, which have
recently adopted laws and regulations regarding the disclosure by manufacturers
of certain chemical constituents in their products. Star intends to fully comply
with such laws and believes it will benefit from such disclosure.
Master Tobacco Settlement Agreement
In 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 and annually thereafter, for sales of cigarettes occurring
in the prior year 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 25
years after the applicable date of deposit on a rolling basis. Also, absent a
challenge to the state specific statutes or
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some accommodation as to the escrow amounts, the failure to place the required
amounts in 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-eight states had adopted model "level
playing field" statutes and Star's purported obligations under those statutes is
approximately $11.6 million with respect to 1999 sales. The Company's Board of
Directors authorized the Company to fund the escrow obligations for 1999 under
protest and to prepare a draft complaint for consideration by the Company's
Board of Directors. 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.
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 labels covering 60% of the top of the principal display panel of each
pack, 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 for the processing of tobacco so as to
preclude, eliminate or substantially reduce TSNAs to very low levels. This
technology is under exclusive license from a company in which the technology's
inventor and the Company's founder and current Chief Executive Officer, Jonnie
R. Williams, is part owner. (See "Patents, Trademarks and Licenses.") 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
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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 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 and, the Company believes, to burley tobacco, and
most likely to other varieties widely used throughout the world on a broad-scale
commercial basis. 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 curing
technology as a standard for the manufacture of potentially less harmful tobacco
products and as a basis for the use of very low-TSNA 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 previously, Star expects to process over 20
million pounds of very low-TSNA tobacco during the 2000 growing season.
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<PAGE> 22
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, compared to leading brands, this
cigarette will achieve up to a 90% reduction of the carcinogenic TSNAs in the
tobacco and more than an 80% reduction of TSNAs in tobacco smoke (measured by
the FTC method), 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 3,000 parts per billion in popular brands. As
measured by the current FTC 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.
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:
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<PAGE> 23
(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.
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 incurred by Star. 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 under the
License Agreement in 1999 and will not pay royalties to Regent Court in 2000.
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
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<PAGE> 24
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, which are the only patents issued to or
applied for by the licensor. 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. Star has no rights to
any other patent or patent applications. 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.
EMPLOYEES AND CONSULTANTS
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, experts and independent contractors to provide key functions in
the scientific, medical, health care, legal, communications, financial and
related areas. The use of such outside providers enables the Company to secure
expertise in a wide variety of areas that it might otherwise not be in a
position to secure or which it would otherwise be required to secure through the
hiring of additional Company-employed personnel at potentially greater cost to
the Company. 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, on a
continuing basis, consulting services from highly
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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,
marketing, sales and administrative offices to Chester, Virginia, a neighboring
area, and anticipates establishing an additional executive/scientific office in
the Washington, D.C./Bethesda, Maryland area in the near future so that Star's
scientific and medical consultants will have improved access to the FDA,
National Institutes of Health and U.S. National Medical Library. 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. 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.
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<PAGE> 26
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Until March 21, 2000, the Common Stock of the Company was traded in the
over-the-counter market and was quoted on the OTC Bulletin Board under the
symbol "STSI." On March 21, 2000, the Common Stock of the Company commenced
trading on the NASDAQ National Market System under the symbol "STSI." Set forth
below are the high and low bid prices (which reflect prices between dealers and
do not include retail markup, markdown or commission and may not represent
actual transactions) for each full quarterly period during 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
1998 High Bid Low Bid
-------- -------
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 price on the NASDAQ National Market System on March 31, 2000, was
$6.625.
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<PAGE> 27
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 accountants (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>
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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.
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, and were 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
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<PAGE> 29
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, pursuance of its legal and public health strategies in
the legislative, regulatory and executive agency arenas, its technical
recruitment efforts, expansion of its Scientific Advisory Board and increased
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 programs.
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.
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
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<PAGE> 30
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 $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. B&W has agreed to loan the Company capital necessary to
finance the purchase of curing barns, designed by the Company and specially
manufactured for the Company by Powell, in the form of a $13,200,000 long-term
credit facility restricted for the purchase of tobacco curing barns.
Approximately 650 of these barns have already been manufactured and delivered
and contracts with tobacco farmers for approximately 250 additional curing barns
have either been executed or are anticipated to be executed in 2000. At December
31, 1999, the Company had borrowed $7.2 million under the long-term credit
facility with B&W and at March 31, 2000, the Company had borrowed $13.2 million
under this facility. Interest accrues on this credit facility at prime plus 1%
commencing December 2000 and is payable monthly. Principal is payable in 60
equal monthly installments commencing September 2004. The credit facility is
non-recourse to the Company, but is collateralized by the Company's curing barns
and leaf tobacco inventory.
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<PAGE> 31
Subsequent to the end of the fiscal year ended December 31, 1999, 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 $7.5 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 the
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 is purportedly obligated to place an amount equal
to $1.88 per carton for 1999, and increased amounts per carton for subsequent
years, in escrow 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 if not so used, returned
to the Company after 25 years. On April 14, 2000, the Company placed into escrow
approximately $11.6 million 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, and the amount required to be
placed in escrow for each carton sold may exceed the net cash flow generated by
each carton sold. 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.
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<PAGE> 32
MANAGEMENT
All references to the "Company" in this section mean Star Scientific, Inc.
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 and Paul L.
Perito, Esquire (ex officio). Our audit committee consists of Mark W. Johnson
(Chairman) and Dr. Elliot D. Prager.
<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
Christopher G. Miller 41 Acting 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 &
Pharmaceuticals, Inc.
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>
JONNIE R. WILLIAMS. Mr. 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 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 stockholder 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.
29
<PAGE> 33
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 University School of Medicine and his M.P.H. from the Yale School of
Epidemiology and Public Health.
CHRISTOPHER G. MILLER. Mr. Miller, 41, has served as the
Company's Acting Chief Financial Officer since April 2000. He also serves as
Chief Executive Officer of Special Opportunities Group LLC. Prior to his service
at Special Opportunities Group LLC, Mr. Miller served as Chief Financial Officer
of The Gilder Group from 1998 to 1999, Chief Executive Officer of American
Healthcare Ltd. from 1994 to 1998, Chief Executive Officer of International
Medical Care, Ltd. from 1992 to 1993, and Chief Financial Officer and Executive
Vice President of Hospital Corporation International from 1991 to 1992. Upon his
graduation from Harvard Business School, Mr. Miller was employed by Bear Stearns
Companies Inc. in New York as an Associate in Investment Banking. Mr. Miller
serves on the Board of Directors of XiTec, SignalQuest, Ana Mandara and Zhou
Li's Marco Polo Collections. Mr. Miller graduated from the U.S. Military Academy
at West Point in 1980 with a B.S. in Engineering and received an MBA from
Harvard Business School in 1987.
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
30
<PAGE> 34
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 B&W
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. 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
31
<PAGE> 35
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.
BOARD OF DIRECTORS COMPENSATION
The non-employee directors who are elected to the Company's
Board of Directors after September 1998 ("Independent Directors") generally are
granted a stock option to purchase up to 50,000 shares of Common Stock on the
date each such Independent Director is first elected to the Board of Directors.
As an annual retainer, each Independent Director will receive a stock option to
purchase up to 25,000 shares of Common Stock, granted on the date of each annual
meeting subsequent to the Independent Director's initial election to the Board
of Directors. Each stock option granted to an Independent Director is granted
under the Company's Amended and Restated 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 Independent Director also receives a fee of $1,500 in
cash for his participation in each meeting of the Board of Directors and any
committee meeting. Directors who are employees also may receive compensation in
their capacity as Company employees, as described elsewhere in this Prospectus.
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<PAGE> 36
EXECUTIVE COMPENSATION AND OTHER MATTERS
SUMMARY COMPENSATION TABLE
The following table sets forth, for each individual who served as Chief
Executive Officer and the other most highly compensated officers of the Company
in 1999, certain information concerning their compensation.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------
Long Term
Annual Compensation Compensation Awards
------------------- -------------------
- ----------------------------------------------------------------------------------------------------------------------
Other Annual Restricted Securities
Salary Bonus Compensation Stock Underlying All Other
Name and Principal Position Year ($) ($) ($) Award ($)(1/) Options (#) Compensation
--------------------------- ---- --- --- --- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
1999 2,400,000 -- -- -- -- --
Jonnie R. Williams, Chief 1998 400,000 -- -- -- -- --
Executive Officer (2/) 1997 -- -- 565,000(3/) -- -- --
Robert J. DeLorenzo, M.D., 1999 -- -- -- -- 1,000,000 --
Chairman (4/) 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/) 25,000(9/) -- 1,000,000 --
Malcolm L. Bailey(10/) 1999 118,000 -- -- -- 200,000 $8,304
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
- ------------------------------
(1/) The Company did not award any stock appreciation rights to the
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 average of the
closing bid and asked prices 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 prior to his
employment with the Company.
(4/) Dr. DeLorenzo served as the Company's Chief Executive Officer from
October 1998 until November 1999. During 1998 and 1999, Dr. DeLorenzo
did not receive compensation from the Company for serving as Chief
Executive Officer other than the stock options listed and
reimbursement for expenses.
(5/) Mr. McNulty was appointed to the position of Chief Financial Officer
of the Company in October 1998 and resigned from such position in
April 2000.
(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, Secretary and
Chief Ethics Officer from June 1999 until November 1999.
(8/) The Company paid Mr. Perito $250,000 in the form of a signing bonus in
1999 and paid Mr. Perito a bonus of $250,000, based on the Company's
and Mr. Perito's performance in March 2000.
(9/) Represents the difference between the price paid by Mr. Perito for
2,000,000 shares of the Company's Common Stock and the fair market
value of such stock as determined by the Company in compliance with
Internal Revenue Service regulations.
(10/) Mr. Bailey served as the Company's President from October 1998 until
November 1999.
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<PAGE> 37
OPTION GRANTS DURING 1999
The following table sets forth, for each individual who served as Chief
Executive Officer and the other most highly compensated officers of the Company,
certain information concerning stock options granted to them during 1999. We
have never issued stock appreciation rights. Options were generally granted at
an exercise price equal to the fair market value of the Common Stock at the date
of grant. The term of each option granted is generally ten years from the date
of grant. Options may terminate before their expiration dates, if the optionee's
status as an employee or a consultant is terminated or upon the optionee's death
or disability.
<TABLE>
<CAPTION>
Potential Realizable
Value at Assumed Rates
of Stock Price
Appreciation for
Individual Grants Option Term(1/)
---------------------------- ------------------------
% of Total
Options
Granted to Market
Employees Exercise or Price on
Options in Fiscal Base Price Date of
Name Granted Year ($/Sh) Grant ($) Expiration Date 5%($) 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 3/9/09 628,895 1,593,742
500,000 20.83 3.00 2.00 3/9/09 628,895 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 7/1/09 1,059,687 2,685,456
Malcolm L. Bailey 200,000 8.33 1.00 2.00 4/12/09 125,779 318,749
</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.
AGGREGATED OPTION EXERCISES IN 1999 AND YEAR-END OPTION VALUES
The following table sets forth, for each of the five most highly compensated
officers of the Company, 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, no stock options were
exercised by any optionee.
34
<PAGE> 38
SUMMARY OF THE COMPANY'S AMENDED AND RESTATED 1998 STOCK OPTION PLAN
The Company's 1998 Stock Option Plan was adopted by the Board of
Directors on October 2, 1998 and approved by the stockholders on December 15,
1998. The Plan was amended by the Board of Directors on April 12, 1999 and the
amendment was approved by the stockholders on September 24, 1999.
The purposes of the Plan are to provide additional incentives to those
executive officers, key employees, consultants and non-employee directors
("Independent Directors") of the Company and its subsidiaries whose substantial
contributions are essential to the continued growth and success of the Company's
business. The Plan permits the granting of stock options ("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").
The Plan provides that NSOs may be granted to executive officers, key
employees, consultants and Independent 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. 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.
The Plan provides for administration by the Compensation Committee of
the Board of Directors, which shall consist of two or more Independent
Directors. Subject to the other provisions of the Plan, the administrator has
the authority to determine the employees, Independent Directors or consultants
(the "Optionees") 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.
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.
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 applicable Option Agreement, to the extent
that the Option is vested on the date of termination, to the extent that the
term of the option has not expired.
35
<PAGE> 39
Except as otherwise approved by the Board of Directors, 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.
In the event any change, such as a stock split or dividend, is made in
the Company's capitalization which results in an increase or decrease in the
number of outstanding shares of Common Stock without receipt of consideration by
the Company, an appropriate adjustment shall be made in the number of shares
which have been reserved for issuance under the Plan and the price per share
covered by each outstanding option.
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) each 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 in
exchange 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 Securities Exchange Act of
1934, 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; (ii) the cessation of
the individuals who, immediately after the 1998 annual meeting of stockholders
of the Company, were members of the Board, of Directors of the Company 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.
36
<PAGE> 40
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 of Common Stock subject to
any outstanding Options, upon exercise of any Option, the same number and kind
of stock, securities, cash, property or other consideration that each holder of
a share of Common Stock was otherwise entitled to receive in the Transaction in
respect of a share.
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 Option Agreement without the
Optionee's consent.
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.
Each Independent Directors of the Company shall be granted, upon his or
her first election as an Independent Director, NSOs to purchase up to 50,000
shares of Common Stock. Options granted to Independent Directors shall be
exercisable over a two year period with respect to (i) 50% of the number of
shares originally underlying such 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 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 of Common Stock on the date of grant. Each such
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 Independent Directors, Options
granted to Independent 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 Independent Directors shall preclude the payment by the
Company to Independent Directors of any other form of compensation, including
the granting of Options pursuant to other provisions of the Plan.
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 may be required.
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 $1,200,000 ("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 in
the employment agreement). 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.
37
<PAGE> 41
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 $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, of which 85% 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 or by Mr. Perito for Good Reason (as defined in the employment agreement),
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 Code 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 REPORT
The Company did not form a Compensation Committee until after its
Annual Stockholders Meeting on December 10, 1999. Since its formation, the
Compensation Committee, comprised of Dr. Elliot D. Prager (Chairman) and Leo S.
Tonkin, Esquire, has met on several occasions in order to examine the Company's
compensation structure generally, and to determine the proper levels and
components of the compensation of the Company's senior management. In pursuance
of this objective, in March 2000, the Committee adopted a performance-based
bonus plan for certain of its executive officers. The Committee anticipates
adopting a number of changes to the Company's compensation structure, and
particularly to the compensation of the Company's officers, with a view toward
maximizing the deductibility of such compensation under the Code, better
aligning the interests of such officers with the interests of the Company's
stockholders and its strategic direction, and taking into consideration the
compensation of senior officers at similarly situated companies.
Dr. DeLorenzo served as the Company's Chief Executive Officer from
October 1998 to November 1999 on an outsourced basis. He was not employed by the
Company and was not paid a salary or other cash compensation 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, as well as his anticipated contributions 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. The Committee has been
evaluating the compensation of Mr. Williams along with the Company's other
executive officers. The Company's two other executive officers during 1999 were
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.
38
<PAGE> 42
PERFORMANCE GRAPH
The following Performance Graph compares the performance of the
Company's cumulative stockholder return with that of a broad market index (S&P
500 ) and a published industry index (S&P Tobacco Index) for each of the most
recent two fiscal years. The cumulative stockholder return for shares of Common
Stock is calculated assuming that $100 was invested on February 6, 1998, the
date of the merger between Eye Technology, Inc. and the Company. The total
return of each of the indices was calculated assuming $100 was invested on
December 31, 1997. The performance of the indices is shown on a total return
(dividends reinvested) basis. The Company paid no cash dividends during the
periods shown. The graph lines merely connect year-end dates and do not reflect
fluctuations between those dates.
The S&P Tobacco Index includes leaf tobacco dealers and manufacturers
of cigarettes and other tobacco products. While the Company currently derives
most of its revenues from the sale of cigarettes, its 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. Star is also involved in the research and
development of tobacco cessation products. For these reasons, the Company does
not believe that the S&P Tobacco Index is closely representative of the
Company's business. However, the unique nature of the Company's business does
not easily lend itself to comparison with other industry indices.
[LINE GRAPH]
<TABLE>
<CAPTION>
1997 1998 1999
- ---------------------------------------------------------------------------
<S> <C> <C> <C>
S&P 500 100 128.32 155.31
S&P Tobacco Index 100 154.72 76.04
Star Scientific Inc. 100 379.21 905.90
</TABLE>
39
<PAGE> 43
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth as of March 31, 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 each executive officer, and all Directors,
executive officers and officers of the Company as a group, except as qualified
by the information set forth in the notes to this table.
<TABLE>
<CAPTION>
SHARES
BENEFICIALLY PERCENTAGE OWNED(2)
NAME OWNED(1) -------------------
---- --------
<S> <C> <C>
Irrevocable Trust #1 FBO(3) 19,058,576 32.4%
Francis E. O'Donnell, M.D.
709 The Hamptons Lane
Chesterfield, MO 63017
Jonnie R. Williams(4) 17,215,264 29.3%
801 Liberty Way
Chester, VA 23836
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%
801 Liberty Way
Chester, VA 23836
Robert DeLorenzo, M.D., Ph.D., M.P.H.(7) 500,000 *
Malcolm L. Bailey(8) 301,000 *
James A. McNulty, C.P.A.(9) 300,000 *
Leo S. Tonkin, Esquire(10) 50,000 *
Mark W. Johnson(11) 93,000 *
Elliot D. Prager, M.D.(12) 127,445 *
All Directors, Executive Officers and Officers 21,601,709 37.3%
(11 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 May 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
40
<PAGE> 44
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.
(2) The "Percentage Owned" calculations are based on the outstanding shares of
Common Stock as of March 31, 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. Mr. McNulty
resigned as the Company's Chief Financial Officer in April 2000.
(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 its manufacturing facility in Petersburg, Virginia
in June 1995 from a partnership comprised of Francis E. O'Donnell, Jr., M.D.,
Jonnie R. Williams, the Chief Executive Officer of the Company and Paul Lamb,
the President and Chief Executive Officer of ST&P 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' children's 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 to Dr.
O'Donnell and Mr. Williams 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, 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 Malcolm L. "Mac" Bailey, a director of the Company and the
Company's President from October 1998 to November 1999, 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 sale of tobacco
to Golden Leaf.
Additionally, pursuant to a consulting agreement entered into between
the Company and Mr. Bailey, Mr. Bailey agreed to provide consulting services to
the Company. The consulting agreement will expire in October 2003, unless
extended at the option of the Company. The Company is required to pay Mr. Bailey
$80,000 per year plus a commission equal to $.10 per pound on all flue-cured
tobacco that is processed at Star's facility in Chase City, Virginia. Any
commission payable to Mr.
41
<PAGE> 45
Bailey in the years 2000 and thereafter will be reduced by any and all operating
costs incurred by the Company in connection with the receipt and processing of
tobacco at the Chase City, Virginia facility. The Company paid Mr. Bailey
$118,000 in 1999 pursuant to this agreement.
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.
The Company employs Mark W. Johnson, a director of the Company, as a
consultant on a month-to-month basis. Services rendered by Mr. Johnson include
the development of a strategic plan for the Company and recommendations to
implement such plan. In this capacity, beginning in January 2000, Mr. Johnson
has been compensated at a rate of $20,000 per month on a month-to-month basis.
In 1999, Mr. Johnson received options to purchase 43,000 shares of Common Stock
at an exercise price of $3.375 in exchange for consulting services.
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.
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).
42
<PAGE> 46
CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Public Accountants.......................... F-2
Consolidated Balance Sheets....................................... F-3
Consolidated Statements of Operations............................. F-4
Consolidated Statements of Stockholders' Equity................... F-5
Consolidated Statements of Cash Flows............................. F-7
Notes to Consolidated Financial Statements........................ F-9
</TABLE>
F-1
<PAGE> 47
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
Tampa, Florida
F-2
<PAGE> 48
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
(Class 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.
F-3
<PAGE> 49
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.
F-4
<PAGE> 50
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
F-5
<PAGE> 51
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
F-6
<PAGE> 52
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.
F-7
<PAGE> 53
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.
F-8
<PAGE> 54
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.
F-9
<PAGE> 55
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.
F-10
<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 (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.
F-11
<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):
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 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.
F-12
<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):
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.
F-13
<PAGE> 59
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>
F-14
<PAGE> 60
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 at the stated rate of prime
plus 1% commencing December 2000; accrued at the effective rate; principal
payable in 60 equal monthly installments commencing September 2004;
collateralized by the Company's curing barns 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>
F-15
<PAGE> 61
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.
F-16
<PAGE> 62
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.
F-17
<PAGE> 63
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.
F-18
<PAGE> 64
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>
F-19
<PAGE> 65
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.
F-20
<PAGE> 66
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 (d) $ 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.
(d) In 1999, the Company paid $940,000 to Paul, Hastings, Janofsky &
Walker LLP with respect to various legal matters. An executive
officer of the Company is senior counsel and a former partner of
this firm.
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.
F-21
<PAGE> 67
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>
F-22
<PAGE> 68
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
$11,600,000 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.
F-23
<PAGE> 69
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.
F-24
<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 (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>
F-25
<PAGE> 71
================================================================================
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.
================================================================================
SUMMARY 1
RISK FACTORS 2
FORWARD-LOOKING STATEMENTS 6
USE OF PROCEEDS 6
SELLING STOCKHOLDERS 6
PLAN OF DISTRIBUTION 6
DESCRIPTION OF SECURITIES 7
EXPERTS 7
BUSINESS 8
SELECTED CONSOLIDATED FINANCIAL DATA 24
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS 25
MANAGEMENT 28
EXECUTIVE COMPENSATION
AND OTHER MATTERS 33
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT 41
CERTAIN RELATIONSHIPS AND
RELATED TRANSACTIONS 42
SHARES ELIGIBLE FOR FUTURE SALE 43
WHERE YOU CAN FIND MORE INFORMATION 43
================================================================================
================================================================================
300,000 SHARES
STAR SCIENTIFIC, INC.
COMMON STOCK
----------------
PROSPECTUS
----------------
----------------
May 8, 2000
================================================================================
<PAGE> 72
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 70,000
Accounting fees and expenses 15,000
-------------
TOTAL: $ 85,563
=============
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.
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.
II-1
<PAGE> 73
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 ("Class B Stock"), all of which were 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 granted 200,000 shares of Common Stock to
a director of the Company for services rendered to the Company.
In June 1998, the Company sold 304 shares of Class B 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 shares of Class B Stock have
been converted. *
In July 1998, the Company sold 763 shares of Class B 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 shares of Class B Stock have been
converted. *
In December 1998, the Company issued 25 shares of Class B Stock (all of
the shares of Class B Stock have been converted) to a director of the Company,
100,000 shares of Common Stock to an executive officer of the Company and 50,000
shares of Common Stock to a consultant of the Company.
In April 1999, the Company sold 2,000,000 shares of Common Stock to an
executive officer in exchange for a note receivable for $2,000,000.
In April 1999, the Company issued 38,000 shares of Common Stock to
three employees and a director.
In November 1999, the Company issued 1,000 shares of Common Stock to an
individual in exchange for securities of Eye Technology, Inc.
* These securities were issued in reliance upon an exemption from registration
under the Securities Act set forth in section 4(2) of the Securities Act. Such
issuances were, in each case, made to a limited number of investors, who based
on facts known to the Company were either accredited or sophisticated, and the
securities were acquired for investment only and not with a view to subsequent
distribution. No general solicitation was made in connection with any such
issuance.
II-2
<PAGE> 74
Item 16. Exhibits and Financial Statement Schedules.
<TABLE>
<CAPTION>
a. Exhibits
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)*
5.1 Opinion of Paul, Hastings, Janofsky & Walker LLP
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)*
10.21 Exclusive Supply Agreement between Star Tobacco and
Pharmaceuticals, Inc. and Amana Company, L.P., dated August 18,
1998 (Form 10-QSB for quarterly period ended September 30, 1998)*
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)*
</TABLE>
*These items are hereby incorporated by reference from the exhibits of
the filing or report indicated (Commission File No. 0-15324) and are hereby made
a part of this Registration Statement.
II-3
<PAGE> 75
<TABLE>
<S> <C>
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, as amended (Form 10-K for the fiscal year
ended December 31, 1999) *
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)*
10.31 Amended and Restated Manufacture and License Agreement between the
Company and Powell Manufacturing Company, Inc., dated October 12,
1999 (Form 10-K for the fiscal year ended December 31, 1999) *
10.32 Agreement between the Company and Brown & Williamson Tobacco
Corporation, dated October 12, 1999 (Form 10-K for the fiscal year
ended December 31, 1999) *
10.33 Loan Agreement between the Company and Brown & Williamson Tobacco
Corporation, dated October 12, 1999 (Form 10-K for the fiscal year
ended December 31, 1999) *
10.34 Security Agreement between the Company and Brown & Williamson
Tobacco Corporation, dated December 16, 1999 (Form 10-K for the
fiscal year ended December 31, 1999) *
10.35 Supply Agreement between Star Tobacco & Pharmaceuticals, Inc. and
Brown & Williamson Tobacco Corporation, dated January 1, 2000
(Form 10-K for the fiscal year ended December 31, 1999) *
10.36 Cigarette Manufacturing Agreement between Star Tobacco &
Pharmaceuticals, Inc. and Brown & Williamson Tobacco Corporation,
dated January 1, 2000 (Form 10-K for the fiscal year ended
December 31, 1999) *
10.37 Loan and Security Agreement between Star Tobacco &
Pharmaceuticals, Inc. and Finova Capital Corporation, dated
January 20, 2000 (Form 10-K for the fiscal year ended December 31,
1999) *
</TABLE>
*These items are hereby incorporated by reference from the exhibits of
the filing or report indicated (Commission File No. 0-15324) and are hereby made
a part of this Registration Statement.
II-4
<PAGE> 76
<TABLE>
<S> <C>
10.38 Lease and Purchase Option Contract between the Company and the
Industrial Development Authority of the Town of Chase City,
Virginia, dated March 10, 2000 (Form 10-K for the fiscal year
ended December 31, 1999) *
10.39 Form of Director Indemnification Agreement (Form 10-K for the
fiscal year ended December 31, 1999) *
10.40 Form of Officer Indemnification Agreement (Form 10-K for the
fiscal year ended December 31, 1999) *
10.41 First Amendment to Loan and Security Agreement between Star
Tobacco & Pharmaceuticals, Inc. and Finova Capital Corporation,
Business Credit, dated April 12, 2000.
10.42 Modification Agreement among the Company, Jonnie R. Williams and
Paul L. Perito, Esquire, dated December 1, 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, 1999*
23.1 Consent of Aidman, Piser & Company, P.A. (Previously filed with
the registration statement on Form S-1 filed with the Commission
on March 13, 2000)*
23.2 Consent of Keiter, Stephens, Hurst, Gary & Shreaves, P.C.
(Previously filed with the registration statement on Form S-1
filed with the Commission on March 13, 2000)*
23.3 Consent of Paul, Hastings, Janofsky & Walker LLP (included in
Exhibit 5.1)
27 Financial Data Schedule
</TABLE>
b. Financial Statement Schedules
<TABLE>
<CAPTION>
Schedule Page
- -------- ----
<S> <C>
Report of Independent Public Accountants F-2
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-4
Consolidated Statements of Stockholders' Equity F-5
Consolidated Statements of Cash Flows F-7
Notes to Consolidated Financial Statements F-9
</TABLE>
*These items are hereby incorporated by reference from the exhibits of
the filing or report indicated (Commission File No. 0-15324) and are hereby made
a part of this Registration Statement.
II-5
<PAGE> 77
Item 17. Undertakings.
The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this Registration Statement:
(i) To include any prospectus required by section 10(a)(3) of the
Securities Act;
(ii) To reflect in the prospectus any facts or events arising after the
effective date of this Registration Statement (or the most recent
post-effective amendment thereof) which, individually or in the aggregate,
represent a fundamental change in the information set forth in this
Registration Statement. Notwithstanding the foregoing, any increase or decrease
in volume of securities offered (if the total dollar value of securities
offered would not exceed that which was registered) and any deviation from the
low or high end of the estimated maximum offering range may be reflected in the
form of prospectus filed with the SEC pursuant to Rule 424(b) if, in the
aggregate, the changes in volume and price represent no more than 20 percent
change in the maximum aggregate offering price set forth in the "Calculation of
Registration Fee" table in the effective registration statement.
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the Registration Statement or any
material change to such information in the Registration Statement;
(2) That, for the purpose of determining any liability under the
Securities Act, each such post-effective amendment 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.
(3) To remove from registration by means of a post-effective amendment any
of the securities being registered which remain unsold at the termination of
the offering.
(4) 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.
II-6
<PAGE> 78
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant has
duly caused this Amendment No. 1 to the Registration Statement to be signed on
its behalf by the undersigned, thereunto duly authorized.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
*
- -------------------------------------------------- Chief Executive Officer and Director May 8, 2000
Jonnie R. Williams (Principal Executive Officer)
/s/ Christopher G. Miller
- -------------------------------------------------- Acting Chief Financial Officer May 8, 2000
Christopher G. Miller (Principal Financial Officer)
*
- -------------------------------------------------- Chairman of the Board May 8, 2000
Robert J. DeLorenzo, M.D., Ph.D., M.P.H.
*
- -------------------------------------------------- Director May 8, 2000
Malcolm L. Bailey
*
- -------------------------------------------------- Director May 8, 2000
Mark W. Johnson
*
- -------------------------------------------------- Director May 8, 2000
Elliot D. Prager, M.D.
*
- -------------------------------------------------- Director May 8, 2000
Leo S. Tonkin, Esquire
</TABLE>
*The Undersigned, by signing his name hereto, does sign this document on behalf
of himself and each of Mr. Williams, Dr. DeLorenzo, Mr. Bailey, Mr. Johnson,
Dr. Prager and Mr. Tonkin.
STAR SCIENTIFIC, INC.
/s/ Paul L. Perito
----------------------------------
Paul L. Perito, Esquire, Chief Operating Officer, President and Director
May 8, 2000
<PAGE> 1
EXHIBIT 5.1
May 8, 2000
Star Scientific, Inc.
801 Liberty Way
Chester, Virginia 23836
Re: Star Scientific, Inc. Registration Statement on Form S-1
No. 333-32364 (the "Registration Statement")
Ladies and Gentlemen:
We are furnishing this opinion of counsel to Star Scientific, Inc., a
Delaware corporation (the "Company"), for filing as Exhibit 5.1 to the
Registration Statement, relating to the resale by certain of the Company's
stockholders of up to 300,000 shares of the Company's common stock, par value
$.01 per share (the "Shares").
For the purpose of rendering this opinion, we have examined the
Certificate of Incorporation and Bylaws, each as amended to date, of the
Company, and the originals, or copies certified or otherwise identified to our
satisfaction, of records of corporate action of the Company as furnished to us
by the Company, certificates of public officials and of representatives of the
Company, and such other instruments and documents as we deemed necessary. Such
examination included, without limitation, a review of that certain Stock
Exchange Agreement, dated February 6, 1998, by and among Eye Technology, Inc.
and certain individuals and other entities (the "Stock Exchange Agreement"). In
such examination we have assumed the genuineness of all signatures, the
authenticity of all corporate records and other documents submitted to us as
originals, the conformity to original documents of documents submitted to us as
certified or photostatic copies and the validity, binding effect and
enforceability upon each party thereto of each agreement (including the Stock
Exchange Agreement) examined by us.
Based upon our examination as aforesaid, and upon our examination of such
questions of law as we deemed relevant under the circumstances, we are of the
opinion that the Shares are validly issued, fully paid and nonassessable.
We hereby consent to the filing of this opinion of counsel as Exhibit 5
to the Registration Statement.
Very truly yours,
<PAGE> 1
EXHIBIT 10.41
FIRST AMENDMENT
TO LOAN AND SECURITY AGREEMENT
BETWEEN STAR TOBACCO AND PHARMACRUTICALS, INC.
AND FINOVA CAPITAL CORPORATION, BUSINESS CREDIT
This FIRST AMENDMENT TO LOAN AND SECURITY AGREEMENT (this
"Amendment") is made as of April 12, 2000 by and between FINOVA CAPTIAL
CORPORATION, BUSINESS CREDIT ("FINOVA") and STAR TOBACCO AND PHARMACEUTICALS,
INC., ("BORROWER"), in light of the following:
WHEREAS, Borrower and FINOVA entered into a Loan and Security
Agreement dated January 20, 2000 (as amended from time to time, the "Loan
Agreement"). Capitalized terms used herein shall have the meanings set forth in
the Loan Agreement unless specifically defined herein); and
WHEREAS, Borrower and FINOVA wish to amend the Loan Agreement set
forth herein:
NOW THEREFORE, in consideration of the mutual promises and
agreements of the parties hereinafter set forth and for other good and valuable
consideration, the receipt and sufficiency of which is hereby acknowledged, the
parties hereto agree as follows:
1. Section 2.1 of the Loan Agreement is deleted in its
entirety and replaced with the following:
2.1 REVOLVING ADVANCES. Upon the request of Borrower,
made at any time during the term hereof, and so long as no Event
of Default exists, FINOVA shall, in its sole discretion, make
advances (the Revolving Advances) to Borrower in an amount equal
to eighty percent (80%) of the aggregate outstanding amount of
Eligible Accounts; PROVIDED, HOWEVER, that in no event shall the
aggregate amount of the outstanding Revolving Advances be greater
than, at any time, the sum of Seven Million Five Hundred Thousand
Dollars ($7,500,000) (the Revolving Advance Limit). FINOVA may
reduce its advance rates on Eligible Accounts, reduce the
Revolving Advance Limit or establish reserves with respect to
borrowing availability if FINOVA determines, in its sole
discretion, that there has occurred, or is likely to occur, an
impairment of the prospect of repayment of all or any portion of
the Obligations, the value of the Collateral or the validity or
priority of FINOVA's security interests in the Collateral.
2. Borrower affirms, ratifies and confirms its Obligations
under the Loan Agreement, acknowledges that all of the terms and conditions in
the Loan Agreement (except as amended herein) remain in full force and effect
and further
<PAGE> 2
acknowledges that the security interest granted to FINOVA in the Collateral is
valid and perfected.
3. Borrower is not aware of any events which now constitute,
or with the passage of time or the giving of notice would constitute, an Event
of Default under the Loan Agreement.
4. This Amendment constitutes the entire agreement of the
parties in connection with the subject matter of this Amendment and cannot be
changed or terminated orally. All prior agreements, understandings,
representations, warranties and negotiations regarding the subject matter
hereof, if any, are merged into this Amendment.
5. This Amendment may be executed in counterparts, each of
which when so executed and delivered shall be deemed an original, and all of
such counterparts together shall constitute but one and the same agreement.
6. In consideration of the increase to the Revolving Advance
Limit granted hereby, Borrower shall pay FINOVA a fee of Twenty Two Thousand
Five Hundred Dollars ($22,500), which shall be fully earned and due and payable
on the date hereof.
7. This Amendment shall be governed by, and construed and
enforced in accordance with, the laws of the State of Arizona.
IN WITNESS WHEREOF, Borrower and FINOVA have executed this
Amendment as of the date first written above.
FINOVA CAPITAL CORPORATION,
BUSINESS CREDIT, a Delaware
Corporation
By:
-----------------------------------
Print Name:
Title/Capacity:
STAR TOBACCO AND
PHARMACEUTICALS, INC., a Virginia
Corporation
By:
-----------------------------------
Print Name:
Title/Capacity
<PAGE> 3
OFFICER'S CERTIFICATE
The undersigned, a duly authorized officer of STAR TOBACCO & PHARMACEUTICALS,
INC. ("Borrower"), certifies to FINOVA CAPITAL CORPORATION ("FINOVA") as
follows:
1. Borrower has requested that FINOVA amend the Loan and Security Agreement
dated January 20, 2000 (as amended, the "Loan Agreement") as provided in the
First Amendment to Loan and Security Agreement dated the date hereof (the
"Amendment").
2. No further corporate approvals or authorizations are necessary for
Borrower to execute the Amendment.
3. As of the date set forth below, (a) all of the representations and
warranties in the Loan Agreement are true and accurate, and (b) no "Event of
Default" (as defined in the Loan Agreement) has occurred and is continuing.
--------------------------------------
Title:
<PAGE> 1
EXHIBIT 10.42
MODIFICATION AGREEMENT
THIS MODIFICATION AGREEMENT, dated as of December 1, 1999, by and among
STAR SCIENTIFIC, INC., a Delaware corporation (the "Company"), JONNIE R.
WILLIAMS ("Mr. Williams"), and PAUL L. PERITO, ESQUIRE ("Executive").
Recitals
A. The Company, Mr. Williams and Executive are parties to that
certain Star Scientific, Inc. Executive Employment Agreement, dated as of April
27, 1999 (The "Employment Agreement"), pursuant to which Executive was employed
by the Company as General Counsel, Executive Vice President and Secretary of the
Company. Certain of the Company's obligations to Executive are secured by the
terms of that certain Pledge Agreement, dated as of April 27, 1999 (the "Pledge
Agreement"), from Mr. Williams in favor of Executive.
B. The Company has elected Executive as President and Chief Operating
Officer of the Company, and Executive has accepted such offices, subject to and
in accordance with the terms set forth in this Modification Agreement, on or
about November 20, 1999 (pursuant to a vote at a duly constituted meeting of the
Board of Directors of the Company), to commence duties on or before December 1,
1999.
Agreement
NOW, THEREFORE, in consideration of these premises, the mutual covenants
and agreements of the parties hereunder, and for other good and valuable
consideration the sufficiency and receipt of which are hereby acknowledged, the
parties hereto hereby agree as follows:
1. Employment Agreement. The Employment Agreement is modified
and amended as follows:
a. Section 1.a. is deleted and replaced with the following:
a. Position. The Company hereby employs
Executive, and Executive hereby accepts employment with the
Company, as President and Chief Operating Officer of the
Company.
b. Section 1.b. is deleted and replaced with the following:
b. Duties. Executive agrees to devote his best
efforts, and shall have primary responsibility within the
Company, to oversee and manage (i) development and
management of the intellectual property, including all
matters relating to science and technology related to the
Company's business and all related research and
development, (ii) legal affairs of the Company, including
all matters concerning the Company's corporate governance
and structure, securities laws and other regulatory
compliance, employment laws compliance and counseling,
contract negotiation and dispute resolution, and litigation
involving the Company,
<PAGE> 2
(iii) financial affairs of the Company, (iv) government
relations and lobbying concerning the Company's business
and affairs, (v) public and investor relations concerning
the Company's business and affairs, and (vi) such other
duties, including management and oversight functions,
consistent with the foregoing, assigned to him by the Board
of Directors of the Company (the "Board of Directors").
Executive shall perform his duties in a trustworthy,
businesslike and loyal manner.
c. Section 1.g. is modified by replacing the phrase
"seventy percent (70%)" with "ninety percent (90%)" and by replacing the
phrase "thirty percent (30%)" with "ten percent (10%)", in the first
sentence of Section 1.g.
d. Section 1.h. is modified by replacing the phrase
"thirty percent (30%)" with "ten percent (10%)" everywhere such phrase is
found in Section 1.h.
e. Section 1.i is modified by replacing the phrase
"June 15, 20002" with "December 1, 2002."
f. Section 2.a. is modified by replacing the phrase
"Six Hundred Thousand Dollars ($600,000)" with "One Million Two Hundred
Thousand Dollars ($1,200,000)."
g. Except as expressly modified above in Sections
1.a.-1.f., all of the terms of the Employment Agreement are hereby
ratified and confirmed and remain in full force and effect.
2. Pledge Agreement. Mr. Williams hereby ratifies and confirms
the terms of the Pledge Agreement which is hereby ratified and confirmed and
remains in full force and effect.
3. Governing Law. This Agreement shall in all respects be
construed according to the laws of the Commonwealth of Virginia, without regard
to its conflict of laws principles.
4. Counterparts. This Agreement may be executed in any number
of counterparts, each of which may be executed by less than all of the parties
to this Agreement, each of which shall be enforceable against the parties
actually executing such counterparts, and all of which together shall constitute
one instrument.
5. Signatures. The parties shall be entitled to rely upon and
enforce a facsimile of any authorized signatures as if it were the original.
[Signatures on following page.]
<PAGE> 3
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of
the date first above written.
COMPANY:
STAR SCIENTIFIC, INC.
By:_________________________[SEAL]
Jonnie R. Williams
Chief Executive Officer
Mr. Williams:
____________________________[SEAL]
Jonnie R. Williams
EXECUTIVE
____________________________[SEAL]
Paul L. Perito
<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>
