<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
____________________
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2000
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________ to ______________
Commission File Number: 0-15324
STAR SCIENTIFIC, INC.
(Exact Name of Registrant as Specified in its charter)
Delaware
(State of incorporation)
52-1402131
(IRS Employer Identification No.)
801 Liberty Way
Chester, VA 23836
(Address of Principal Executive Offices)
(804) 530-0535
(Registrant's telephone number, including area code)
________________________________________________________________________________
Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ___
----
At July 31, 2000, there were 58,769,020 shares of the Registrant's common stock,
par value $.01 per share outstanding.
<PAGE>
Table of Contents
<TABLE>
<CAPTION>
Page
<S> <C>
PART I Item 1 - Financial Statements 1
Condensed Consolidated Balance Sheets as of June 30, 2000 (Unaudited)
and December 31, 1999 2
Condensed Consolidated Statements of Operations for the three months
and six months ended June 30, 2000 and 1999 (Unaudited) 3
Condensed Consolidated Statements of Cash Flows for the six months
ended June 30, 2000 and 1999 (Unaudited) 4
Notes to Condensed Consolidated Financial Statements 7
Item 2 - Management's Discussion and Analysis or Plan of Operation 13
PART II Item 6 - Exhibits and Reports on Form 8-K 14
Signatures
</TABLE>
<PAGE>
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, December 31,
2000 1999
---------- -----------
(Unaudited)
ASSETS
------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 9,278,123 $17,205,248
Accounts receivable, trade 7,621,321 3,599,965
Inventories 4,060,471 3,570,609
Prepaid expenses and other current
assets 577,385 338,790
Deferred tax asset 2,200,000 2,303,000
----------- -----------
Total current assets 23,737,300 27,017,612
Property, plant and equipment, net 22,045,802 10,974,029
MSA Escrow Fund 11,605,156 --
Intangibles, net of accumulated
amortization 327,732 338,043
Other assets 129,178 296,263
Deferred tax asset -- 83,000
----------- -----------
$57,845,168 $38,708,947
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Current maturities of notes payable $ 213,124 $ 275,000
Accounts payable, trade 6,624,606 3,492,755
Federal excise taxes payable 4,412,678 1,476,524
Accrued expenses 1,338,296 1,442,521
Income taxes payable 206,000 6,198,000
Customer deposit 11,000,000 6,000,000
----------- -----------
Total current liabilities 23,794,704 18,884,800
Notes payable, less current maturities 17,607,331 7,504,679
Deferred tax liability 200,000 --
----------- -----------
Total liabilities 41,602,035 26,389,479
----------- -----------
Commitments and contingencies -- --
Stockholders' equity:
Common stock/A/ 587,692 587,493
Additional paid-in capital 10,822,566 10,631,875
Retained earnings 7,920,681 4,187,906
Notes receivable, officers (3,087,806) (3,087,806)
----------- -----------
Total stockholders' equity 16,243,133 12,319,468
----------- -----------
$57,845,168 $38,708,947
=========== ===========
</TABLE>
/A/ $.01 par value, 100,000,000 shares authorized, 58,769,020 and 58,749,200
shares issued and outstanding 2000 and 1999, respectively
See notes to condensed consolidated financial statements.
1
<PAGE>
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
$42,238,508 $15,436,086 $88,751,650 $31,217,552
Net sales ----------- ----------- ----------- -----------
Less:
Cost of goods sold 12,355,654 4,285,304 26,445,052 8,136,190
Excise taxes on products 19,187,820 6,134,755 41,780,145 12,527,095
----------- ----------- ----------- -----------
Gross profit 10,695,034 5,016,027 20,526,453 10,554,267
----------- ----------- ----------- -----------
Operating expenses:
Marketing and distribution expenses 3,376,326 1,570,316 6,789,118 2,981,579
General and administrative expenses 3,280,107 2,189,582 6,239,808 3,265,071
Research and development 575,268 247,680 678,768 365,521
----------- ----------- ----------- -----------
Total operating expenses 7,231,701 4,007,578 13,707,694 6,612,171
----------- ----------- ----------- -----------
Operating income 3,463,333 1,008,449 6,818,759 3,942,096
----------- ----------- ----------- -----------
Other (income) expenses:
Interest expense (net of interest income) 146,420 14,534 145,984 38,243
Other (11,036) (11,036)
----------- ----------- ----------- -----------
Income from continuing operations before
income taxes 3.316,913 1,004,951 6,672,775 3,914,889
Income tax expense 1,590,000 300,000 2,940,000 1,075,000
----------- ----------- ----------- -----------
Net income $ 1,726,913 $ 704,951 $ 3,732,775 $ 2,839,889
=========== =========== =========== ===========
Basic Net Income per common share $ 0.03 $0.01 $0.06 $0.08
Diluted income per common share $ 0.03 $0.01 $0.06 $0.05
Basic weighted average shares outstanding 58,769,000 57,259,982 58,762,220 33,539,861
Diluted weighted average shares outstanding 61,830,738 59,340,931 62,240,681 59,095,820
</TABLE>
See notes to consolidated financial statements.
2
<PAGE>
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX
MONTHS ENDED JUNE 30, 2000 AND 1999
<TABLE>
<CAPTION>
2000 1999
-------------- --------------
(Unaudited) (Unaudited)
<S> <C> <C>
Operating activities:
Net income $ 3,732,775 $ 2,839,889
Adjustments to reconcile net income
to net cash provided by
operating activities:
Depreciation and amortization 986,573 208,968
Deferred income taxes 386,000 --
Loss on fixed asset disposal 26,525 --
Stock-based compensation expense 151,250 296,090
Increase (decrease) in cash resulting
from changes in:
Current assets (4,396,729) (962,264)
Current liabilities 4,723,905 1,340,052
------------ -----------
Net cash provided by operating activities 5,610,299 3,722,685
------------ -----------
Investing activities:
Collections of notes receivable -- (39,677)
Purchases of property, plant and equipment (12,074,560) (2,514,055)
------------ -----------
Net cash used in investing activities (12,074,560) (2,553,732)
------------ -----------
Financing activities:
Proceeds from revolving loan agreement 3,758,182 --
Proceeds from notes payable 6,585,922 75,000
Payments on notes payable (241,452) (216,957)
Proceeds from sale of stock 39,640 --
------------ -----------
Net cash provided by (used in) financing activities 10,142,292 (141,957)
------------ -----------
MSA Escrow Fund (11,605,156) --
------------ -----------
Increase (decrease) in cash and cash
Equivalents (7,927,125) 1,026,996
Cash and cash equivalents,
beginning of year 17,205,248 102,695
------------ -----------
Cash and cash equivalents,
end of period $ 9,278,123 $ 1,129,691
============ ===========
Supplemental disclosure of cash flow
information:
Cash paid during the year for:
Interest $ 587,858 $ 44,657
============ ===========
Income taxes $ 8,958,000 $ --
============ ===========
</TABLE>
See notes to condensed consolidated financial statements.
3
<PAGE>
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2000
(UNAUDITED)
1. Accounting Policies:
The financial statements of Star Scientific, Inc. and subsidiaries (the
"Company") and notes thereto should be read in conjunction with the Company's
financial statements and notes for the year ended December 31, 1999.
In the opinion of management of the Company, all adjustments (consisting only of
normal recurring accruals) necessary for a fair presentation of the results of
operations for the periods presented have been included. The results of
operations for the three and six months ended June 30, 2000 and 1999 are not
necessarily indicative of the results for a full year.
The Company generated net income for the periods ended June 30, 2000. Diluted
earnings per share assumes conversion of all outstanding common stock options
and warrants.
2. Obligations under Master Settlement Agreement- MSA Escrow Fund:
In November 1998, 46 states and several U.S. territories entered into a
settlement agreement to resolve litigation that had been instituted by them
against the major tobacco manufacturers. The Company was not named as a
defendant in any of the litigation matters and chose not to become a
participating manufacturer under the terms of the Master Settlement Agreement
("MSA"). Nonparticipating manufacturers are required to fund escrow accounts
pursuant to the MSA.
On April 14, 2000, the Company, on behalf of its subsidiary, Star Tobacco &
Pharmaceuticals, Inc. ("ST&P"), deposited into escrow $11.6 million to fund
ST&P's purported escrow obligations under the MSA and specific state statutes
that were passed in 1999 by states that are participating members of the MSA.
The so-called "level playing field" statutes require non-participating
manufacturers to fund escrow accounts that could be used to satisfy judgments or
settlements in lawsuits that may at some future date be filed by the
participating states. To date no states have filed suits against the Company or
ST&P to compel any payments under the MSA and state statutes. In fact, there are
no pending lawsuits against the Company or ST&P in any state or federal court.
ST&P will have to pay significant sums into these escrow accounts to meet the
MSA requirements. If not used to satisfy judgments or settlements, the funds
will be returned to the Company 25 years after the applicable date of deposit on
a rolling basis. The Company will, however, receive interest earnings on the
invested escrowed amounts.
The Company believes that its existing working capital, together with
anticipated earnings from its tobacco-leaf operations and new products, and
available funding on existing lines of credit, will be sufficient to meet its
liquidity and capital requirements in the near term. 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 "Factors That May
Affect Future Results" in the Company's Annual Report on Form 10-K/A for the
fiscal year ended December 31, 1999. (See also "Master Tobacco Settlement
Agreement" under Item 2 of this Report.)
4
<PAGE>
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2000
(UNAUDITED)
3. Notes payable:
Notes payable consists of the following:
<TABLE>
<CAPTION>
2000
------------
<S> <C>
Loan balance on a $7.5 million revolving line of credit facility
secured by the Company's eligible accounts receivables; effective rate
of interest at stated rate of prime plus .5% through an initial term
ending in January 2005. $ 3,758,182
Note payable under a $13,200,000 credit facility restricted for the
purchase of tobacco curing barns; interest at the stated rate of prime
plus 1% payable commencing December 2000; accrued at the effective
rate; principal payable in 60 equal monthly installments commencing
September 2004; collateralized by the Company's curing barns and leaf
tobacco inventory. $13,612,294
Note payable, bank, due in monthly installments of $3,111, including
interest at prime plus 1%, through December 2001; secured by real
property and guaranteed by certain stockholders. $ 255,882
Term note payable, finance company, due in monthly installments of
$5,004, including interest at 10.15% through September 2001; secured
by manufacturing equipment. $ 70,218
Term note payable, finance company, due in monthly installments of
$7,262, including interest at 9.31% through October 2001; secured by
manufacturing equipment. $ 101,618
Other $ 22,261
-----------
$17,820,455
Less current maturities 213,124
-----------
$17,607,331
===========
</TABLE>
The annual maturities of notes payable are as follows:
Year ending June 30,
--------------------
2001 172,408
2002 277,571
2005 6,026,902
Thereafter 11,343,574
-----------
$17,820,455
===========
5
<PAGE>
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2000
(UNAUDITED)
4. Income tax expense consists of the following:
Three Months Ended Six Months Ended
June 30, 2000 June 30, 2000
Current $1,384,000 $2,554,000
Deferred 206,000 386,000
---------- ----------
1,590,000 2,940,000
========== ==========
5. Segment information:
<TABLE>
<CAPTION>
Segment of Business
----------------------------------------------
Three Months Ended June 30, 2000
----------------------------------------------
Discount
Cigarettes Tobacco Leaf Consolidated
------------ ------------- ------------
<S> <C> <C> <C>
Revenue $42,238,508 $ -- $42,238,508
Cost of sales and excise taxes 30,928,582 614,892 31,543,474
----------- ----------- -----------
Gross margin 11,309,926 (614,892) 10,695,034
----------- ----------- -----------
Research and development - 575,267 525,267
----------- ----------- -----------
Segment assets $37,767,417 $ 23,077,751 $57,845,168
=========== ============ ===========
Three Months Ended June 30, 1999
----------------------------------------------
Revenue $15,436,086 $ -- $15,436,086
Gross margin 5,016,027 -- 5,016,027
Research and development 247,680 -- 247,680
</TABLE>
<TABLE>
<CAPTION>
Six Months Ended June 30, 2000
---------------------------------------------
Discount
Cigarettes Tobacco Leaf Consolidated
------------- ------------- ------------
<S> <C> <C> <C>
Revenue $88,729,443 $ 22,207 $88,751,650
Cost of sales and excise taxes 67,184,959 1,040,238 68,225,197
----------- ----------- -----------
Gross margin 21,544,483 (1,018,031) 20,526,453
----------- ----------- -----------
Research and development -- 678,767 678,767
----------- ----------- -----------
Segment assets $37,767,417 $23,077,751 $57,845,168
=========== =========== ===========
</TABLE>
<TABLE>
<CAPTION>
Six Months Ended June 30, 1999
---------------------------------------------
<S> <C> <C> <C>
Revenue $31,217,552 $ -- $31,217,552
Gross margin 10,554,267 -- 10,554,267
Research and development 365,521 365,521
</TABLE>
6
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
General; Recent Developments
Star Scientific, Inc. and its subsidiary (the "Company") are engaged in:
(1) the development of proprietary scientific technology for the curing of
tobacco so as to prevent, retard or significantly reduce the formation of
carcinogenic toxins present in tobacco and tobacco smoke, primarily, the tobacco
specific nitrosamines ("TSNAs"); (2) the development of less toxic smoked
tobacco products utilizing StarCure(TM) tobacco with very low levels of TSNAs
(measured in parts per billion) which has been cured using the Company's
proprietary process; (3) the manufacture and sale of discount cigarettes, with
activated charcoal filters, through its 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 StarCure tobacco with very low levels of TSNAs (measured in parts per
billion) which have been cured using the Company's proprietary process.
In the second quarter and first six months of 2000, the Company's revenues
were generated through the sale of discount cigarettes by ST&P. ST&P currently
manufactures and sells four brands of discount cigarettes, SPORT(R),
MAINSTREET(R), VEGAS(R) and G-SMOKE(R), through approximately 350 tobacco
distributors throughout the United States. During the second quarter and first
six months of 2000, ST&P's cigarette sales continued to experience substantial
sales growth compared to the same periods in 1999.
In an effort to implement the Company's corporate mission to develop
potentially less toxic tobacco products, the Company intends to continue to
phase in very low-TSNA StarCure(TM) tobacco, which has been cured through the
Company's proprietary process, into ST&P's discount cigarettes. These cigarette
brands currently contain approximately 3% of very low TSNA flue-cured tobacco
because of current limited availability. The Company has announced plans to
launch, before the end of the fourth quarter of 2000, the first very low-TSNA
cigarette. This cigarette also will have an activated charcoal filter aimed at
reducing the levels of certain vapor phase toxins. The Company has also
accelerated the development and manufacturing of a new flagship smokeless
tobacco product which will contain exceedingly low to undetectable levels of
TSNAs.
The Company's central focus will continue to be the research and
development of products that reduce the range of serious health hazards
associated with the use of smoked and smokeless tobacco products. The Company
fully accepts the evidence showing links between smoking tobacco and a variety
of diseases and premature death and believes that it is unlikely that the health
risks of smoked tobacco can be completely eliminated. Nevertheless, in a world
where an estimated 1.2 billion people smoke and use other tobacco products,
there is an urgent need to reduce the toxicity of tobacco products to the
maximum extent possible 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 deliver less toxins and
are less hazardous as is technologically possible, given available technologies.
The Company has now demonstrated that the method it has developed for curing
flue-cured tobacco using its proprietary process can be scaled up to meet broad
commercial needs in the United States and abroad. In the second quarter of 2000,
the Company increased its capabilities for curing burley tobacco using its
proprietary process in cooperation with The Burley Tobacco Growers Cooperative
Association.
On October 12, 1999, the Company and the Brown & Williamson Tobacco
Corporation ("B&W") entered into a supply agreement ("Agreement") under which
B&W has agreed to purchase StarCure(TM) tobacco. During the third and fourth
quarters of 1999, the Company produced and delivered to B&W approximately 3.5
million pounds of very low-TSNA StarCure(TM) tobacco. These sales accounted for
approximately 10% of the Company's consolidated net sales in 1999. The Company
expects that in 2000 a minimum of 15 million pounds will be sold to B&W pursuant
to the Agreement. The bulk of these sales will occur in the third and fourth
quarter of this year resulting in higher revenues in those quarters.
7
<PAGE>
In each of the years 2000 and 2001, B&W is obligated to purchase from the
Company 5 million pounds of Virginia flue-cured StarCure(TM) tobacco that has
been cured using the Company's proprietary process; and B&W has an option to
purchase 3 million pounds of burley tobacco cured using the same process. B&W
also has financed the purchase of 600 of the Company's specially designed curing
barns (see "Liquidity and Capital Resources" below).
Master Tobacco Settlement Agreement
In November 1998, 46 states and several U.S. territories entered into a
settlement agreement (the "Master Settlement Agreement" or "MSA") to resolve
litigation that had been instituted by them against the major tobacco
manufacturers. The Company was not named as a defendant in any of the
litigation matters and chose not to become a participating manufacturer under
the terms of the Master Settlement Agreement. As a nonparticipating
manufacturer, the Company is required to satisfy 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. If not used to satisfy
judgments or settlements, the funds will be returned to the Company 25 years
after the applicable date of deposit on a rolling basis. The failure to place
such required amounts into escrow could result in penalties and potential
restrictions on the Company's ability to sell tobacco products within particular
states.
On April 14, 2000, the Company deposited, on behalf of ST&P and under
protest, $11.6 million into escrow accounts, representing ST&P's purported
escrow obligations for 1999 cigarette sales. Absent a legal challenge to the
state specific statutes or an agreement with respect to the funding of the
required escrow accounts, ST&P will be obligated to place in escrow accounts an
amount equal to $2.09 per carton for sales of cigarettes occurring in each such
state in 2000 and increased amounts per carton in subsequent years. The
purported per carton obligation increases to $2.72 in 2001-2002, $3.35 in 2003-
2006 and $3.77 thereafter, which may be increased based on the inflation rate.
This escrow requirement currently applies to a majority of ST&P's cigarette
sales. Based on ST&P's projected increase in sales for future years, ST&P will
have to pay significant sums into these escrow accounts. While all 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, as a result of
these escrow obligations, a substantial portion of the Company's net income from
operations will be unavailable for the Company's use and the amount required to
be placed in escrow may exceed the net operating cash flow generated by the
Company (see "Liquidity and Capital Resources" below).
While the Company is engaging in meaningful dialogue with the National
Association of Attorneys General ("NAAG") to alleviate the effects of the MSA
escrow requirements, the Company's Board of Directors has authorized the Company
to prepare a draft complaint for consideration by the Company's Board of
Directors and to proceed forward to prosecute what outside trial counsel advises
the Company to be meritorious constitutional claims, if an equitable resolution
is not effected with NAAG.
<PAGE>
Results of Operations
The Company's unaudited condensed consolidated results for the periods ended
June 30, 2000 and 1999 are summarized in the following table:
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
$42,238,508 $15,436,086 $88,751,650 $31,217,552
Net sales ----------- ----------- ----------- -----------
Cost of goods sold 12,355,654 4,285,304 26,445,052 8,136,190
Excise taxes on products 19,187,820 6,134,755 41,780,145 12,527,095
----------- ----------- ----------- -----------
Gross profit 10,695,034 5,016,027 20,526,453 10,554,267
----------- ----------- ----------- -----------
Operating income 3,463,333 1,008,449 6,818,759 3,942,096
----------- ----------- ----------- -----------
Net income $ 1,726,913 $ 704,951 $ 3,732,775 $ 2,839,889
=========== =========== =========== ===========
Basic income per common share:
Continuing operations $ 0.03 $ 0.01 $ 0.06 $ 0.05
Net income $ 0.03 $ 0.01 $ 0.06 $ 0.05
Diluted income per common share:
Continuing operations $ 0.03 $ 0.01 $ 0.06 $ 0.05
Net income $ 0.03 $ 0.01 $ 0.06 $ 0.05
Basic weighted average shares 58,769,000 57,259,982 58,762,220 33,539,861
outstanding
Diluted weighted average shares 61,830,738 59,340,931 62,240,681 59,095,820
outstanding
</TABLE>
SECOND QUARTER 2000 COMPARED WITH SECOND QUARTER 1999
During the second quarter of 2000, the Company's consolidated net sales
increased to $42.2 million, reflecting an increase of $26.8 million, or 174%
over the comparable 1999 period. This increase was due to an increase in
cigarette shipment volume by ST&P and higher pricing, reflecting a January 1,
2000 federal excise tax increase. ST&P's shipment volume during the second
quarter of 2000 increased approximately 123% over the comparable 1999 period to
1.1 billion units, reflecting a continued upswing in sales of ST&P's cigarettes
as a result of growing the customer base, including sales in additional major
retail chains. Excise taxes included in net sales for the second quarter of 2000
increased to $19.2 million from $6.1 million in the comparable 1999 period due
to the increased shipment volume and the higher federal excise tax rate. All net
sales in the second quarters of 1999 and 2000 were from the sale of cigarettes
by ST&P.
During the second quarter of 2000, the Company's consolidated gross profit
increased to $10.7 million, reflecting an increase of $5.7 million over the
comparable 1999 period, as increases in net sales of $26.8 million over the
comparable 1999 period were partially offset by increased costs of goods sold
($8.1million) and increased excise taxes ($13.1 million). Increased costs of
goods sold were primarily related to volume increases for the Discount Cigarette
segment, and costs of goods sold for the Tobacco Leaf segment.
Marketing and distribution expenses, on a consolidated basis, totaled $3.4
million for the second quarter of 2000, an increase of $1.8 million over the
comparable 1999 period reflecting a larger sales force and higher promotional
expenses. During the second quarter of 2000, due to the costs associated with
the MSA and other changes occurring in the market, the Company decided to focus
its sales force in regions with the greatest potential for profit and downsized
its sales staff and allied administrative support in states that enacted the
state-specific statutes mandated by the MSA.
General and administrative expenses, on a consolidated basis, totaled $3.3
million for the second quarter of 2000, an increase of $1.1 million over the
comparable 1999 period, attributable primarily to expenses associated with the
expansion of the warehouse facilities in Chase City, Virginia and associated
costs
9
<PAGE>
in maintaining executive, marketing, sales and administrative offices in
Chester, Virginia, higher personnel 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.
Increased interest income in the second quarter of 2000 reflects interest
on higher cash balances on hand, generated by the Company's $11.6 million
deposit into its MSA Escrow Fund and the improved operating results. Interest
expense for the second quarter was the result of the credit facility from B&W
that is being used for the purchase of tobacco curing barns and borrowings from
the Company's revolving line of credit used to cover periodic working capital
needs.
Higher income tax expense for the second quarter of 2000 compared to the
second quarter of 1999 reflects higher income and the use of net operating loss
carryover from 1998 to lower the Company's 1999 income tax expense.
Consolidated net income of $1.7 million for the second quarter of 2000 was
up 145% from the $0.7 million reported in the comparable 1999 period. In the
second quarter of 2000, the Company had basic and diluted earnings per share
equal to $.03 per share versus basic and diluted earnings per share of $.01 in
the second quarter of 1999. The increase in earnings per share reflects
increased earnings partially offset by an increase in the weighted average
shares outstanding.
FIRST SIX MONTHS 2000 COMPARED WITH FIRST SIX MONTHS 1999
During the first six months of 2000, the Company's consolidated net sales
increased to $88.8 million, reflecting an increase of $57.5 million, or 184%
over the comparable 1999 period. This increase was due to an increase in
cigarette shipment volume by ST&P and higher pricing, reflecting a January 1,
2000 federal excise tax increase. ST&P's shipment volume during the first six
months of 2000 increased approximately 165% over the comparable 1999 period to
2.5 billion units, reflecting a continued upswing in sales of ST&P's cigarettes
as a result of growing the customer base, including sales to additional major
retail chains. Excise taxes included in net sales for the first six months of
2000 increased to $41.8 million from $12.5 million in the comparable 1999 period
due to the increased shipment volume and the higher federal excise tax rate. All
net sales in the first six months of 1999 and 2000 were from the sale of
cigarettes by ST&P. The Company anticipates sales of very low-TSNA tobacco to
B&W in the third and fourth quarters of 2000.
During the first six months of 2000, the Company's consolidated gross
profit increased to $20.5 million, reflecting an increase of $10.0 million over
the comparable 1999 period, as increases in net sales of $57.5 million over the
comparable 1999 period were partially offset by increased costs of goods sold
($18.3 million) and increased excise taxes ($29.3 million). Increased costs of
goods sold were primarily related to volume increases for the Discount Cigarette
segment, and costs of goods sold for the Tobacco Leaf segment.
Marketing and distribution expenses, on a consolidated basis, totaled $6.8
million for the first six months of 2000, an increase of $ 3.8 million over the
comparable 1999 period, reflecting a larger sales force and higher promotional
expenses.
General and administrative expenses, on a consolidated basis, totaled $6.2
million for the first six months of 2000, an increase of $ 3.0 million over the
comparable 1999 period, attributable primarily to expenses related to the
relocation of its executive, marketing, sales and administrative offices to
Chester, Virginia, expansion of the warehouse facilities in Chase City, Virginia
and associated costs in maintaining that facility, higher personnel 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.
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Increased interest income in the first six months of 2000 reflects interest
on higher cash balances on hand, generated by the Company's $11.6 million
deposit into its MSA Escrow Fund and the improved operating results. Increased
interest expense for the first six months was the result of the credit facility
from B&W that is being used for the purchase of tobacco curing barns and
borrowings from the Company's revolving line of credit used to cover periodic
working capital needs.
Higher income tax expense for the first six months of 2000 compared to the
first six months of 1999 reflects higher income and the use of net operating
loss carryover from 1998 to lower the Company's 1999 income tax expense.
Consolidated net income of $3.7 million for the first six months of 2000
was up 31% from the $2.8 million reported in the comparable 1999 period. In the
first six months of 2000, the Company had basic and diluted earnings per share
equal to $.06 per share versus basic and diluted earnings per share of $.08 and
$.05 per share, respectively, in the first six months of 1999 The increase in
earnings per share reflects increased earnings partially offset by an increase
in the weighted average shares outstanding. The increase in the basic weighted
average shares outstanding in the first six months of 2000 versus the comparable
1999 period is due primarily to the conversion of the Company's Class B
Preferred Stock into shares of the Company's Common Stock.
Liquidity and Capital Resources
In the first six months of 2000, $5.6 million of cash was provided by
operating activities due primarily to increased sales levels and an increase in
customer deposits.
During the first six months of 2000, the Company incurred $12.1 million in
capital expenditures, virtually all of it as part of the StarCure barn
production program with the Powell Manufacturing Company. To date, approximately
1,000 barns for flue-cured and burley tobacco have already been manufactured and
delivered.
B&W agreed to loan the Company capital necessary to finance the purchase of
curing barns in the form of a $13.2 million long-term credit facility restricted
for the purchase of tobacco curing barns. At June 30, 2000, the Company had
borrowed the entire $13.2 million under this facility. Interest accrues on this
credit facility at prime plus 1% and is payable monthly commencing in December
2000. 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.
Subsequent to the end of the fiscal year ended December 31, 1999, the
Company negotiated a revolving line of credit facility with a new working
capital lender in the amount of $7.5 million, which is collateralized by
accounts receivable from its cigarette business,. The Company has borrowings of
$3.8 million under this credit facility at June 30, 2000.
The Company believes that its existing working capital, together with
anticipated earnings from its tobacco-leaf operations and new products, and
available funding on existing lines of credit will be sufficient to meet its
liquidity and capital requirements in the near term. 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 "Factors That May
Affect Future Results" in the Company's Annual Report on Form 10-K/A for the
fiscal year ended December 31, 1999. See also "Master Tobacco Settlement
Agreement" above.
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The foregoing discussion of the results of operations and financial
condition of the Company should be read in conjunction with the Company's
condensed consolidated financial statements and related notes included elsewhere
in this Report.
Note on Forward-Looking Statements
CERTAIN STATEMENTS IN THIS REPORT ON FORM 10-Q, UNDER THE SECTION "MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS,"
RELATE TO FUTURE EVENTS AND EXPECTATIONS AND AS SUCH CONSTITUTE "FORWARD-LOOKING
STATEMENTS," WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT
OF 1995. THE WORDS "BELIEVES," "ANTICIPATES," "PLANS," "EXPECTS," AND SIMILAR
EXPRESSIONS IN THIS REPORT ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS.
SUCH FORWARD-LOOKING STATEMENTS INVOLVE KNOWN AND UNKNOWN RISKS, UNCERTAINTIES,
AND OTHER FACTORS WHICH MAY CAUSE THE ACTUAL RESULTS, PERFORMANCE OR
ACHIEVEMENTS OF THE COMPANY TO BE MATERIALLY DIFFERENT FROM ANY FUTURE RESULTS,
PERFORMANCE OR ACHIEVEMENTS EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING
STATEMENTS AND TO VARY SIGNIFICANTLY FROM REPORTING PERIOD TO REPORTING PERIOD.
SUCH FACTORS INCLUDE, AMONG OTHERS, THOSE LISTED IN "FACTORS THAT MAY AFFECT
FUTURE RESULTS" IN THE COMPANY'S ANNUAL REPORT ON FORM 10-K/A FOR THE YEAR ENDED
DECEMBER 31, 1999 AND OTHER FACTORS DETAILED FROM TIME TO TIME IN THE COMPANY'S
OTHER FILINGS WITH THE SECURITIES AND EXCHANGE COMMISSION.
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Item 3. Exhibits and Reports on Form 8-K
(a) Exhibits
Number Description
------ -----------
3.01 Restated Certificate of Incorporation (Form 10-KSB for fiscal
year ended December 31, 1992)*
3.02 Certificate of Amendment of Restated Certificate of
Incorporation, dated March 25, 1993, and effective April 2, 1993
(Form 10-KSB for fiscal year ended December 31, 1996)*
3.03 Certificate of Amendment of Restated Certificate of
Incorporation, dated March 25, 1993, and effective April 2, 1993
(Form 10-KSB for fiscal year ended December 31, 1996)*
3.04 Certificate of Amendment of Certificate of Incorporation, dated
December 15, 1998 (Form 8-K dated January 15, 1999)*
3.05 Bylaws of the Company as Amended to Date (Form 10-KSB for fiscal
year ended December 31, 1992)*
10.41 First Amendment to Loan and Security Agreement between Star
Tobacco & Pharmaceuticals, Inc. and Finova Capital Corporation,
Business Credit, dated April 12, 2000 (Form S-1/A dated May 8,
2000)*
27 Financial Data Schedule
(b) Reports on Form 8-K
None
* These items are hereby incorporated by reference from the
exhibits to the filing or report indicated (Commission File No.
0-15324) and are hereby made a part of this Report.
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SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this Report to be signed on its behalf by the undersigned, thereunto duly
authorized.
STAR SCIENTIFIC, INC.
Date: August 14, 2000 /s/ Christopher G. Miller
-----------------------------
Authorized Signatory and
Acting Chief Financial Officer
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