SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
(Mark One)
|
|
|
þ |
|
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2010
|
|
|
o |
|
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: 000-15324
STAR SCIENTIFIC, INC.
(Exact name of registrant as specified in its charter)
|
|
|
Delaware
|
|
52-1402131 |
(State or other jurisdiction of
|
|
(I.R.S. Employer |
incorporation or organization)
|
|
Identification No.) |
|
|
|
4470 Cox Road, Suite 110, Glen Allen, VA 23060
|
|
(804) 527-1970 |
(Address of principal executive offices)
|
|
(Registrants telephone number, including area code) |
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.0001 par value
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined by Rule 405 of
the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or
Section 15(d) of the Act. Yes o No þ
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 þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of
Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was
required to submit and post such files). Yes o No o
Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a small reporting company.
|
|
|
|
|
|
|
Larger accelerated filer o
|
|
Accelerated filer þ
|
|
Non-accelerated filer o
|
|
Small reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Act). Yes o No þ
The aggregate market value of the Registrants voting stock held by non-affiliates of the
Registrant as of June 30, 2010 was approximately $140 million. Shares of voting stock held by each
executive officer and director and by each person who owns 10% or more of the Registrants voting
stock have been excluded in that such persons may be deemed affiliates of the Registrant. This
determination of affiliate status is not necessarily a conclusive determination for other purposes.
Number of shares outstanding for each class common equity as of March 15, 2011 134,026,053 shares
of common stock, par value $0.0001 per share.
DOCUMENTS INCORPORATED BY REFERENCE:
None.
CERTAIN DEFINITIONS
Unless the context requires otherwise, all references in this annual report on Form 10-K, or
this Report, to Star Scientific, Company, we, our, us, our company and similar terms refer
to Star Scientific, Inc. and its wholly owned subsidiaries Star Tobacco, Inc., a Virginia
corporation, and Rock Creek Pharmaceuticals, Inc., a Delaware corporation, which also may be
referred to in this Report as Star Tobacco and Rock Creek, respectively.
SPECIAL NOTE ON FORWARD-LOOKING STATEMENTS
Certain statements in this Report other than purely historical information, including
estimates, projections, statements relating to our business plans, objectives, and expected
operating results, and the assumptions upon which those statements are based, are forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A
of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. We have tried, whenever possible, to identify these forward-looking statements using
words such as anticipates, believes, estimates, continues, likely, may, opportunity,
potential, projects, will, expects, plans, intends and similar expressions to identify
forward-looking statements, whether in the negative or the affirmative. These statements reflect
our current beliefs and are based on information currently available to us. Accordingly, such
forward-looking statements involve known and unknown risks, uncertainties and other factors which
could cause our actual results, performance or achievements to differ materially from those
expressed in, or implied by, such statements. These risks, uncertainties, factors and contingencies
include, without limitation, the challenges inherent in new product development initiatives through
Star Tobacco and Rock Creek, the uncertainties inherent in the progress of scientific research, our
ability to raise additional capital in the future that is necessary to maintain our business,
potential disputes concerning our intellectual property, risks associated with litigation regarding
such intellectual property, uncertainties associated with the development, testing and regulatory
approvals of our low-TSNA tobacco, related tobacco products and pharmaceutical and nutraceutical
products, market acceptance of our new smokeless tobacco products and nutraceutical and
pharmaceutical products, competition from companies with greater resources than us, our dependence
on key employees and on our prior strategic relationships with Brown
& Williamson Tobacco
Corporation in light of its combination with R.J. Reynolds Tobacco Company, Inc.
Forward-looking statements reflect our managements expectations or predictions of future
conditions, events or results based on various assumptions and managements estimates of trends and
economic factors in the markets in which we are active, as well as our business plans. They are not
guarantees of future performance. By their nature, forward-looking statements are subject to risks
and uncertainties. Our actual results and financial condition may differ, possibly materially, from
the anticipated results and financial condition indicated in these forward-looking statements.
There are a number of factors that could cause actual conditions, events or results to differ
materially from those described in the forward-looking statements contained in this Report. A
discussion of factors that could cause actual conditions, events or results to differ materially
from those expressed in any forward-looking statements appears in Item 1A. Risk Factors.
Readers are cautioned not to place undue reliance on forward-looking statements in this Report
or that we make from time to time, and to consider carefully the factors discussed in Item 1A.
Risk Factors of this Report in evaluating these forward-looking statements. These forward-looking
statements are representative only as of the date they are made, and we undertake no obligation to
update any forward-looking statement as a result of new information, future events or otherwise.
3
PART I
Overview
We are a technology-oriented company with a mission to reduce the harm associated with the use
of tobacco at every level. We are primarily engaged in:
|
|
|
the development, implementation and licensing of our proprietary
technology for the curing of tobacco so as to substantially prevent
the formation of carcinogenic toxins present in tobacco and tobacco
smoke, primarily the tobacco-specific nitrosamines, or TSNAs; |
|
|
|
|
the manufacture, sales, marketing and/or development of very low-TSNA
dissolvable smokeless tobacco products that carry enhanced warnings
beyond those required by the Surgeon General, including ARIVA®
compressed powdered tobacco cigalett®pieces and STONEWALL
Hard Snuff® and modified risk tobacco products as defined
in the Family Smoking Prevention and Tobacco Control Act of 2009, or
the FDA Tobacco Act; |
|
|
|
|
the development of pharmaceutical products, particularly products that
have a botanical, tobacco-based component, that are designed to treat
tobacco dependence and a range of neurological conditions, including
Alzheimers disease, Parkinsons disease, schizophrenia and
depression; and |
|
|
|
|
the manufacture, sale, marketing and development of non-nicotine and
non-tobacco nutraceutical products designed to assist individuals who
are seeking a smoking alternative as well as related nutraceutical
products that are designed to promote the maintenance of a healthy
metabolism. |
Since the 1990s, we have sought to develop processes and products that significantly reduce
the levels of toxins, principally TSNAs, in tobacco compared to traditional smoked and smokeless
tobacco products. Our development of technology for reducing TSNA levels has lead to our focus on
the development of tobacco-based pharmaceutical products and non-nicotine nutraceuticals that we
are pursuing through our Rock Creek subsidiary. Given our long-term focus on reducing the levels of
toxins in tobacco and the harm associated with tobacco use, we believe we are uniquely positioned
to pursue a range of very-low TSNA smokeless tobacco products as modified risk products under the
FDA Tobacco Act. We also believe we are positioned to utilize our technology to produce a range of
non-nicotine nutraceuticals and tobacco-based pharmaceuticals furthering our mission to reduce the
harm associated with tobacco use at every level as well as to develop related products that are
designed to promote the maintenance of a healthy metabolism.
The following discussion of our historical results of operations and financial condition
should be read in conjunction with our consolidated financial statements and the notes thereto
included in Item 15. Exhibits, Financial Statement Schedules of this Report. In August 2010, our
Rock Creek subsidiary introduced a non-nicotine, non-tobacco nutraceutical designed to curb the
urge to smoke. Beginning in our quarterly report on Form 10-Q for the period ended September 30,
2010, we began utilizing segment reporting for each of our operating subsidiaries. See note 17 to
our consolidated financial statements included in Item 15. Exhibits, Financial Statement
Schedules of this Report for further information on our segment reporting.
Our History
Since December 1998, our primary corporate focus has centered on the sales, marketing and
development of tobacco products that expose adult tobacco users to lower levels of toxins and,
beginning in 2007, tobacco-based pharmaceuticals and related non-nicotine nutraceutical products.
Until 2007, our revenues were generated principally through the sale of discount cigarettes by
our companys wholly owned subsidiary Star Tobacco. Star Tobacco was incorporated in 1990 and,
until 1994, was primarily a contract manufacturer of cigars and cigarettes. In late 1994, we
commenced development and commercialization of its own brands of discount cigarettes using
primarily Virginia flue-cured tobacco,
which competed principally on the basis of price. Around the same time, we commenced a
research and development program relating to a range of tobacco products that deliver fewer toxins
as well as tobacco cessation products. Shortly thereafter, upon concluding that there was no way
to develop a completely safe cigarette, we shifted the near-term research by Star Tobacco to the
development of very-low TSNA smokeless tobacco products containing lower levels of carcinogenic
TSNAs, particularly NNNs and NNKs, that are formed principally during the curing of tobacco. In
connection with that effort, we announced that our company would seek to transition from the sale
of cigarette products as soon as practically possible. To facilitate that transition, in May 2007
we entered into an agreement with Tantus Tobacco LLC, or Tantus, for the exclusive license of our
cigarette trademarks Sport®, MainStreet® and GSmoke® and discontinued manufacturing any cigarette
products as of June 2007. Since 2007 our tobacco revenues have been generated exclusively through
the sale of our low-TSNA smokeless tobacco products. In August 2010 we introduced into the market
CigRx®, our non-nicotine, non-tobacco dietary supplement and we have been generating revenue from
the sale of CigRx® since that time.
4
Our Strategy
Our long-term focus is the research, development, manufacturing and licensing of technology
that can lessen reliance on and the impact of the use of all forms of tobacco, reduce the range of
serious health hazards associated with the use of smoked and smokeless tobacco and more generally
assist consumers in maintaining a healthy metabolism. We have pursued these objectives through:
|
|
|
the production of very low-TSNA tobacco; |
|
|
|
dissolvable smokeless tobacco products that expose adult tobacco users to substantially
lower levels of toxins as compared to other smoked and smokeless tobacco products; |
|
|
|
the development of non-nicotine, non-tobacco nutraceuticals; |
|
|
|
the submission of applications to have variants of our low-TSNA smokeless products
designated as modified risk tobacco products under the FDA Tobacco Act; and |
|
|
|
the ongoing research and development efforts of Rock Creek on related non-nicotine
nutraceuticals and pharmaceutical products. |
We fully accept the evidence that links smoking tobacco with a variety of diseases and
premature death. We believe it is highly unlikely that the health risks of smoked tobacco can be
completely eliminated, and that no safe cigarettes will ever be manufactured. We believe we were
the first company to state unequivocally that there is no such thing as a safe cigarette.
Further, we were the first company to affix to the back of the package of our first premium
low-TSNA product, Advance®, a package onsert that contained not only scientifically verified
comparative product content data, but also additional health warnings beyond those required by the
Surgeon General. Despite worldwide efforts to curb tobacco use, the American Cancer Society
continues to report that an estimated 1.3 billion people smoke and use other conventional tobacco
products. Given the reality of tobacco use, we continue to believe that there is an urgent need to
reduce the toxicity of tobacco products to the maximum extent possible, using available technology
and to provide alternatives to those products for persons seeking to maintain a nicotine-free
metabolism.
Over the last several years, we have expended significant time and resources: (i) on our
ongoing patent infringement litigation with R.J. Reynolds Tobacco Company, or RJR, a wholly owned
subsidiary of Reynolds American, Inc., or RAI, which we are continuing to pursue on appeal
following an unsuccessful verdict in our jury trial in that case which took place between May 18
and June 16, 2009 in the United States District Court for the District of Maryland, or District
Court, (see Item 3. Legal Proceedings for further details) (ii) the development of ARIVA® and
STONEWALL Hard Snuff®, our low-TSNA dissolvable smokeless tobacco products and, more recently,
modified risk tobacco products under the FDA Tobacco Act, (iii) the licensing of low-TSNA
products and the technology behind our StarCured® tobacco curing process, and (iv) the efforts of
Rock Creek in developing botanical tobacco-based
pharmaceutical products, non-nicotine nutraceuticals and related products. Our future success
will depend largely on the successful results of these initiatives. While product licensing
royalties and smokeless tobacco sales have been de minimis to date, we intend to continue our
efforts to develop and sell low-TSNA smokeless tobacco products, develop pharmaceutical products to
treat tobacco addiction and a range of neurological conditions and related non-nicotine
nutraceuticals, and to pursue licensing arrangements for those products and related technology.
We believe our proprietary technology related to the curing of very-low TSNA tobacco and the
development of related products, including tobacco-based pharmaceuticals and non-nicotine
nutraceuticals, positions us to a be a leader in producing products designed to lower the harm
associated with the use of tobacco at all levels.
5
Our Technology
Our Current Intellectual Property Rights
Our proprietary technology for producing low-TSNA tobacco which is utilized in ARIVA® and
STONEWALL Hard Snuff®, our low-TSNA dissolvable smokeless tobacco products, has been licensed
exclusively from Regent Court Technologies, LLC, or Regent Court, a company in which Jonnie R.
Williams Sr., the technologys inventor, our founder, Chief Executive Officer and one of our
largest stockholders, is a part owner. The license agreement with Regent Court grants us exclusive
worldwide rights to and a right of sublicense for the StarCured® process, related patents covering
the production of low-TSNA dissolvable smokeless tobacco products and the use of certain
tobacco-based monoamine oxidase inhibitors, or MAO, agents in treating neurological conditions. For
additional information related to our proprietary curing process, see Our Patents, Trademarks
and Licenses. Two of the patents under our license with Regent Court that relate to our method for
producing low-TSNA tobacco are the subject of our ongoing lawsuit against RJR. Accordingly, we have
dedicated substantial time and resources to defend and enforce our proprietary rights with respect
to these patents. See Item 3. Legal Proceedings. It is our objective to achieve widespread
acceptance of our tobacco curing technology as a standard for the manufacture of less toxic and
potentially less harmful smoked and smokeless tobacco products and, in the future, as a basis for
the use of very low-TSNA tobacco in the production of smoking cessation products.
Our Recent Intellectual Property Initiatives
In December 2008, we filed a new U.S. patent application for a variant of our patented curing
technology that results in the production of cured tobacco that contains virtually undetectable
levels of carcinogenic TSNAs as measured by prevailing standards. In 2010 Rock Creek filed three
patent applications relating to our CigRx® product, and a patent application for a relapse
prevention product. Rock Creek also has several provisional patent applications pending that we expect to
mature into one or more non-provisional patent applications relating to the administration of
anatabine, or an isomer or salt thereof, for treating chronic inflammation that may be associated
with disorders such as thyroiditis, cancer, arthritis, Alzheimers disease, and multiple sclerosis.
The StarCured® Process
The process of curing or drying tobacco so that it is suitable for use in the production of
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 used in the production of Virginia flue-cured tobacco, the
leaves are placed in enclosed barns and are then exposed to gas-fired heat, while burley tobacco
undergoes a curing process where the leaves are hung in sheds to dry naturally. The curing process
for Virginia flue-cured tobacco takes approximately five to seven days, and the curing process used
with burley tobacco generally last a month or more. Our proprietary StarCured® technology is
applicable to the curing of Virginia flue-cured tobacco on a broad-scale commercial basis and, we
believe, is also applicable to the
curing of burley tobacco as well as other varieties of tobacco. Our proprietary curing process
essentially arrests or eliminates microbial activity that normally occurs during curing, thereby
preventing the formation of TSNAs. Our StarCured® curing technology does not, however, alter or
affect taste, color or the nicotine content of tobacco. We make no claim or representation that our
StarCured® tobacco curing process precludes the formation of harmful chemical constituents found in
tobacco and tobacco smoke, other than TSNAs. Additionally, we make no claim that the elimination of
TSNAs reduces the risk of disease. We have been careful not to make any health claims, directly or
indirectly, even though peer-reviewed scientific literature continues to emerge pointing out that a
reduction of these carcinogens in smokeless tobacco can be expected to reduce health risks.
We believe that through our StarCured® process we have the technology to reduce exposure to
carcinogenic TSNAs, particularly the subgroups of nitrosamines commonly referred to as NNNs and
NNKs, to very low levels (with carcinogenic NNNs and NNKs that measure 200 parts per billion and
below) and that we have demonstrated that our process for curing tobacco using the StarCured®
method can be scaled up to meet broad commercial needs in the United States and abroad. Our focus
on very low-TSNA, non-fermented smokeless tobacco products, and the licensing of our technology, is
based, in part, on the fact that there is broad agreement among tobacco researchers that tobacco
smoke contains over 4,000 constituents, 65 of which are known carcinogens. While TSNAs are
considered to be one of the most significant groups of carcinogens in tobacco and tobacco smoke,
they are recognized as being the only major or biologically significant group of carcinogenic
toxins in smokeless tobacco. In December 2008 we filed a new U.S. patent application for a variant
of our patented curing technology that results in the production of cured tobacco that consistently
contains virtually undetectable levels of carcinogenic TSNAs as measured by prevailing standards.
We are using tobacco cured by this process in the products included in the applications that we
submitted to the FDA for the modified risk tobacco designation. The use of this tobacco allows us
to produce a tobacco product that has levels of the carcinogenic TSNA comparable to those found in
nicotine replacement therapy products.
6
Our Current Products
Smokeless Tobacco Products
Over the past nine years, we have been engaged in the development of very low-TSNA,
non-fermented smokeless tobacco products designed to provide adult tobacco users with a viable
alternative to cigarettes and traditional smokeless tobacco products in situations and environments
where they cannot or choose not to use such products. This development effort was encouraged by our
companys Scientific Advisory Board and other independent scientific, medical and public health
advisors who in 1999 and in 2000 urged us to accelerate the development of smokeless products using
100% StarCured® very low-TSNA tobacco because our smokeless products have far fewer toxins than
conventional cigarettes and traditional smokeless tobacco products. This position is supported by a
2002 report issued by the Royal College of Physicians in Great Britain that concluded the
consumption of non-combustible tobacco is of the order of 10-1,000 times less hazardous than
smoking, depending on the product. It is broadly agreed among tobacco researchers that cigarette
smoke contains more than 4,000 chemical compounds, 65 of which are known to be carcinogenic. In
contrast, it is generally recognized that the only major or biologically significant carcinogenic
toxins in non-fermented smokeless tobacco are the TSNAs, particularly the NNNs and NNKs.
In November 2001, we introduced ARIVA® cigalett® pieces, or ARIVA®, as our first dissolvable
hard tobacco smokeless tobacco product. ARIVA® is a compressed powdered tobacco product designed to
dissolve completely in the mouth without leaving any residue or requiring expectoration. During the
second quarter of 2003, in an effort to market a dissolvable hard tobacco product to adult users of
traditional smokeless tobacco products such as moist snuff, we introduced a non-fermented spit-free
hard tobacco product called STONEWALL Hard Snuff®. Both ARIVA® and STONEWALL Hard Snuff® are made
from non-fermented 100% low-TSNA StarCured® tobacco plus natural and artificial flavorings, as well
as other ingredients. In 2007, we introduced two new blends of STONEWALL Hard Snuff®, Natural and
Java in addition to the original Wintergreen blend. We introduced a Java blend of ARIVA® in
2008 and in the first quarter of 2010 we introduced Cinnamon, Mint and Citrus blends of
ARIVA® and a new packaging format (10-piece sleeves) for ARIVA®.
ARIVA® and STONEWALL Hard Snuff® have been marketed nationwide through tobacco distributors
and wholesalers who have direct arrangements with several national retail chains and through other
national distributors experienced with consumer products. In 2009 we restructured our smokeless
tobacco operations to reduce costs while concentrating our efforts on a more narrow geographic area
and continuing sales to our established regional and national retail chain customers. Our domestic
sales of ARIVA® and STONEWALL Hard Snuff® have been de minimis to date and we did not have any
international sales in 2010. We believe that in order to successfully market ARIVA® and STONEWALL
Hard Snuff® on a broad basis we must develop additional distribution channels for these products.
We also will be required to expend substantial funds on the marketing of these products to
consumers, which we will need to obtain from external financing, the availability of which cannot
be assured. For additional information relating to our liquidity, see Item 6. Managements
Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital
Resources.
CigRx®
CigRx®, our non-nicotine, non-tobacco nutraceutical intended to temporarily reduce the desire
to smoke, was introduced into the market in August 2010 in the Richmond, Virginia area. Since its
introduction, we have been working with InVentiv Health to develop awareness for the CigRx®
product through an outreach program involving visits to physicians and other health care
professionals. We also market CigRx® through an interactive website, infomercials and limited
direct advertising at the consumer level. In late February 2011,
we began testing CigRx®
on a national basis through expanded infomercials and radio spots. We believe that these marketing avenues will
allow us to increase sales of CigRx® and provide a viable platform for the expansion of CigRx®
sales on a national basis. SeeOur Sales and Marketing EffortsDietary Supplement-CigRx® for
a discussion of our manufacturing, storage, order processing and delivery arrangements with
third parties related to CigRx®.
Our Current Product Development Initiatives
Pharmaceutical Products and Nutraceuticals
Through our companys Rock Creek subsidiary, we are pursuing the development of botanical
based products for the treatment of tobacco dependence, as well as products that would utilize
certain MAO agents in tobacco to treat a range of neurological conditions, including Alzheimers
disease, Parkinsons disease, schizophrenia and depression. Rock Creek also has been involved in
developing non-nicotine nutraceutical products that may assist persons who have ceased using
tobacco or who are in the process of stopping tobacco use maintain a balanced metabolism and
related non-nicotine products that may be helpful to consumers in maintaining a healthy metabolism.
Rock Creek operates pursuant to a sublicense under our exclusive license with Regent Court, which
includes patents for producing tobacco with very low-TSNA levels. The sublicense also covers
patents for the use of MAO inhibitors in tobacco to treat various neurological conditions.
7
These research efforts are headed by Curtis Wright, MD, MPH who joined our company as Senior
Vice President, Medical/Clinical Director of Rock Creek in 2008. Dr. Wright previously served as
Vice President of Clinical and Regulatory Affairs for Adolor Corporation, Executive Director,
Medical Affairs and subsequently Executive Director of Risk Assessment for Purdue Pharma and most
recently, as Executive Vice President for Risk Management and Regulatory Affairs at Javelin
Pharmaceuticals, Inc. Dr. Wrights career at the FDA, from 1989 through October 1997, included
multiple senior scientific positions in the Center for Drug Evaluation and Research, including
Deputy Director and Acting Director of his division.
Low-TSNA Tobacco and modified risk tobacco products
In the mid-1990s, we commenced research and development activities based on newly conceived
technology for the processing of tobacco that substantially prevents the formation of TSNAs in
cured tobacco. Our research and development efforts culminated in the development of our
proprietary technology relating to various aspects of the process for producing very low-TSNA
tobacco and tobacco
products. In 2008 we filed a patent application with the U.S. Patent and Trademark Office for
a variant of our process for producing low-TSNA tobacco that results in even lower levels of
carcinogenic TSNAs in cured tobacco. For additional information related to our intellectual
property, see Our Patents, Trademarks and Licenses. Two of the patents that relate to our
method for producing low-TSNA tobacco are the subject of our ongoing lawsuit against RJR. See Item 3. Legal
Proceedings for further details.
In 2009 and 2010 we developed Ariva-BDL and Stonewall-BDL, variants of our ARIVA® and
STONEWALL Hard Snuff® smokeless tobacco products, that have significantly lower levels of
carcinogenic TSNAs as well as other toxins compared to conventional tobacco products and which are
at a levels comparable to those found in nicotine replacement therapy products. These products use
tobacco cured by our StarCured® tobacco processes. We filed applications with the FDA in 2010 to
have Ariva-BDL and Stonewall-BDL designated as modified risk tobacco products under the FDA
Tobacco Act. On February 1, 2011, we filed a third application with the FDA for a modified risk
moist snuff product, Stonewall Moist-BDL. If our application for the designation of Ariva-BDL,
Stonewall-BDL and Stonewall Moist-BDL as modified risk tobacco products are approved by the FDA,
we believe our company will gain an advantage in marketing our very-low TSNA smokeless tobacco
products, because we would be able to provide information to tobacco users on the levels of such
toxins in those products. Absent receiving an order approving a products designation as a
modified risk tobacco product, the FDA Tobacco Act prohibits a company from making any claims
relating to a products reduced levels of toxins or reduced risk.
Our ability to continue our research efforts, including advancement of the research and
development activities of Rock Creek, will depend in large part on our working capital constraints,
ability to procure funding for these initiatives, and the successful outcome of our ongoing patent
infringement litigation with RJR. See Item 7. Managements Discussion and Analysis of Results of
Operations Liquidity and Capital Resources and our consolidated financial statements included
in Item 15. Exhibits, Financial Statement Schedules of this Report for further information on our
working capital constraints and results of operations.
Discontinued Products
We exited from the cigarette business in June 2007. Prior to that time, the majority of our
revenues were derived from the sale of discount cigarettes. Although we retain the right to
manufacture and sell other branded cigarettes, we plan to continue to focus our efforts in the
tobacco area on the sale of our low-TSNA dissolvable smokeless tobacco products, as opposed to
cigarettes.
Our Prior Research and Development Efforts
In the past we have developed several products and initiated several research and development
efforts based on our StarCured® low-TSNA tobacco technology which, although not currently active,
we believe could serve as the basis for future product development efforts.
8
Low-TSNA Moist and Dry Snuff Products
In September 2001, we introduced our first two very low-TSNA snuff products (a moist and dry
snuff) under the brand name Stonewall®. In light of our focus on dissolvable hard tobacco products,
we discontinued the manufacture of Stonewall® moist snuff and we have not sought to continue to
market Stonewall® dry snuff. In January 2011, we filed an application with the FDA for the
designation of Stonewall Moist-BDL, a moist snuff product, as a modified risk tobacco product.
Stonewall Moist-BDL is a variant of our original Stonewall® moist snuff product and we are also
considering filing an application with the FDA for this same designation for a Stonewall Dry
Snuff-BDL, a variant of our original Stonewall® Dry Snuff product.
Advance® Low-TSNA Cigarettes
We launched the first low-TSNA cigarette, Advance®, in October 2000. Advance® was the first
conventional cigarette specifically manufactured to diminish the amount of exposure to highly
carcinogenic TSNAs. The Advance® cigarette reduced additional toxic smoke constituents through a
unique activated carbon/acetate filter. Advance® also provided adult tobacco consumers with
enhanced health warnings beyond those required by the Surgeon General on the back of the package,
and through onserts that contained comparative content information and additional health-related
information.
INDs for a Low-TSNA Cigarette and
a Tobacco-Flavored Chewing Gum
In
1997, we submitted an Investigational New Drug Application, or IND, for a cigarette product made from low-TSNA flue-cured tobacco to the FDA as
an investigational drug. This product was designed to offer a low-TSNA product to help patients,
who had relapsed after a trial of smoking cessation, prepare for another cessation attempt. A Phase
I study, under an FDA-reviewed protocol, was completed at the Virginia Commonwealth University. The
study contrasted our test product that had TSNA levels of about 100 parts per billion with
conventional brands of cigarettes in terms of breath levels of carbon monoxide, blood levels of
nicotine and urinary levels of TSNAs. With regard to the test product, blood nicotine levels were
somewhat higher and carbon monoxide was substantially lower. The subjects urinary levels of TSNA
(as measured by NNAL) were reduced substantially, consistent with published data showing that TSNAs
leave the body over 90 to 120 days in an initial rapid phase and then in a slower phase during this
period. The results of this study were significant in demonstrating that reductions of TSNA levels
in tobacco resulted in reduced levels of TSNAs in the human body when study subjects smoked
cigarettes containing tobacco with reduced levels of TSNAs.
Prior to the decision to concentrate on the development of tobacco products that incorporate
very low-TSNA StarCured® tobacco, we also sought to develop a gum product designed to help patients
who had relapsed after a trial of smoking cessation to prepare for another cessation attempt.
Although we secured an additional IND from the FDA for
this product, we determined that further testing and submission of required marketing applications
to the FDA would not only be overly costly and time consuming, but also would require a major
scientific infrastructure which we neither had in place nor could afford at the time. As noted
above, in June 2007, we formed Rock Creek to pursue the development of a range of pharmaceutical
products, including products having a tobacco-based component, designed to treat tobacco related
dependence and certain neurological conditions and related products such as nutraceuticals.
Our Sales and Marketing Efforts
Dissolvable Tobacco
Our dissolvable tobacco sales and marketing activities are lead by Mr. Jonnie R. Williams Sr.,
our Chief Executive Officer, Mr. David M. Dean, our Vice President of Sales and Marketing and Mr.
Sheldon Bogaz, our Vice President of Trade Operations. We have a two-fold strategy with respect to
selling our dissolvable tobacco products to retailers. We provide local distributors with product
information and upon request point of sale material for our dissolvable tobacco products. We also
market our products directly to large retail chains which order product and point of sale material
directly from us. In late 2009 we restructured our tobacco operations by reducing our sales force
outside of Virginia and concentrating our in-store sales effort on a more narrow geographic area in
Virginia and contiguous states. At the same time we continue to service our established regional
and national retail chain customers through employees working out of our offices in the Richmond,
Virginia area.
We currently sell our smokeless tobacco products through approximately 107 tobacco
distributors throughout the United States. The distributors and other customers maintain state and,
where applicable, municipal government tobacco product licenses and apply state and/or local tax
stamps when needed to resell our tobacco products. We deliver our products mainly by common carrier
trucks. Our distributor customers primarily service convenience stores, gas stations, retail stores
and other outlets.
9
Dietary Supplement-CigRx®
CigRx®, our dietary supplement, is manufactured and sold through our Rock Creek subsidiary.
CigRx® currently is being sold through an interactive website, infomercials and, to a limited
extent, through direct retail sales. We also have been working jointly with InVentiv Health to
develop awareness for the CigRx® product through an outreach program involving visits to physicians
and other health care professionals and through direct advertising at the consumer level. Our
in-house marketing personnel also have been assisting on the CigRx® launch and associated marketing
activities associated with the launch
In order to facilitate the launch of CigRx® and limit capital expenditures, we have outsourced
the manufacturing, storage, order processing and delivery of CigRx® through contracts and
arrangements with a number of third party suppliers. We anticipate that the arrangements which
have been put in place with these various entities should be sufficient to meet our manufacturing
and distribution needs for CigRx® for the foreseeable future. We also believe that the current
marketing initiatives we have put into place will allow us to increase sales of
CigRx®
as we move forward on the national test market of
CigRx®
that began in late February 2011.
Our Availability of Raw Materials and our Manufacturing Capabilities
Dissolvable Tobacco
All of the flue-cured tobacco used in our smokeless tobacco products has been or will be cured
in specially manufactured curing barns using our StarCured® tobacco curing process. The StarCured®
tobacco curing process involves controlling certain conditions in the tobacco curing barns, and in
certain applications, uses microwave and/or electron beam technology. In March 2007, we sold
approximately 990 of our tobacco curing barns. The sale of these barns was made exclusively to
farmers who had been participants in our StarCured® tobacco curing program. We sold our 37
remaining StarCured® barns in late 2009 to growers who previously had participated in the
StarCured® program. While we currently do not own any StarCured® barns, we have a significant
amount of StarCured® tobacco in inventory and access to StarCured® tobacco through growers who
previously participated in our StarCured® tobacco curing program. We believe that our existing
inventory of StarCured® tobacco and our relationships with growers who maintain StarCured® barns
will permit us to obtain sufficient amounts of StarCured® tobacco for our low-TSNA dissolvable
smokeless tobacco products, and for other needs.
We have a high-speed manufacturing line at our leased facility in Chase City, Virginia, which
is currently used for the production of our ARIVA® and STONEWALL Hard Snuff® dissolvable smokeless
tobacco products. In 2009 we consolidated our manufacturing operations into a larger immediately
adjacent facility, which we lease from the Mecklenburg County Industrial Development Authority. See
Item 2. Properties. We do not anticipate ordering additional equipment for manufacturing our
dissolvable smokeless tobacco products until the existing production line is operating at nearly
full capacity. We believe both our current availability of StarCured® tobacco and our manufacturing
facilities provide more than sufficient capacity to meet both the current demand for our very
low-TSNA dissolvable smokeless products and our manufacturing needs in the foreseeable future.
Dietary SupplementCigRx®
We obtain all of the raw materials and packaging supplies for the manufacture of CigRx® from
various vendors and we maintain an inventory of critical raw materials and packaging at the
manufacturing location where CigRx® is produced. We believe that the vendors from whom we obtain
raw materials and packaging have sufficient capacity to meet our supply needs on a timely basis and
to allow us maintain inventory levels adequate to meet expected sales volume for the foreseeable
future.
We have outsourced the product manufacturing for CigRx® to a cGMP contract manufacturer which
has sufficient capacity to provide us finished product timely and at quantities necessary to
fulfill expected product sales volume for the foreseeable future. To facilitate this contract
manufacturing arrangement we purchased and installed, at the manufacturing location, a dedicated
packaging equipment line that is used in
conjunction with the production of CigRx®. The machinery, while located at the contract
manufacturers facility, remains titled in our companys name.
10
Our Competition
Tobacco Products
Traditionally, tobacco products have been divided between smoked products (cigarettes, cigars,
roll-your-own tobacco and pipe tobacco) and smokeless tobacco (moist snuff, chewing tobacco and dry
snuff). The predominant competitors in the smoked tobacco market have been the major tobacco
companies, Philip Morris USA, Inc., or Phillip Morris, RJR, Lorillard, Inc. and, prior to its
combination with RJR, Brown and Williamson Tobacco Corporation, or B&W. UST, Inc., or UST, has been the dominant manufacturer in the smokeless
segment of the market, which also includes companies such as Conwood Company, LLC, or Conwood, a
wholly owned subsidiary of RAI, and Swedish Match AB, or Swedish Match. In 2009 Altria Group, Inc.,
or Altria, Philip Morriss parent company expanded its role in the smokeless tobacco market through
the acquisition of UST. As a result of the acquisition of UST by Altria Group, Inc and Conwood by
RJR, those companies now control approximately ninety percent of the smokeless tobacco market.
Recently, there has been increased competition between the smoked and smokeless tobacco markets as
companies have begun to market smokeless tobacco as an alternative to cigarettes in situations
where adult tobacco users cannot or choose not to smoke. Swedish Match has worked with selected
varieties of tobacco under crop management environments and other methods in an effort to maintain
low-TSNA levels in its smokeless tobacco products. In 2001, Swedish Match introduced a new
smokeless tobacco product in the United States that claimed to have reduced levels of carcinogens.
UST has also test marketed a pouch-style smokeless tobacco product, which it claimed has low levels
of TSNAs. Industry analysts have reported that the smokeless tobacco market has been expanding at a
rate of approximately 2-3% per year since 2003, while the cigarette market has been contracting
over the same period. In 2007, both Philip Morris and RJR introduced smokeless tobacco pouch
products that utilize their primary brand names (Marlboro Snus and Camel Snus, respectively) as
alternatives to cigarettes and in 2009 RJR introduced several dissolvable smokeless tobacco
products in test markets in the U.S.
ARIVA® compressed tobacco cigalett® pieces are intended to compete with conventional
cigarettes and to be used by adult smokers in situations and environments when they cannot or
choose not to smoke. Each ARIVA® compressed tobacco cigalett piece delivers approximately 1.5 mg of
nicotine, approximately the same level of nicotine as a light cigarette. Accordingly, we believe
ARIVA® primarily competes for market share against large tobacco manufacturers that dominate the
cigarette industry, as opposed to our traditional competitors in the smokeless market. ARIVA® is
priced competitively with cigarettes.
Our STONEWALL Hard Snuff® dissolvable tobacco product primarily competes with other smokeless
tobacco companies such as UST, Conwood and Swedish Match, because STONEWALL Hard Snuff® is intended
for use by adult users of moist snuff or other forms of smokeless tobacco. However, STONEWALL Hard
Snuff® is also used by heavy smokers (those who smoke more than two packs of cigarettes a day) as
an alternative to their traditional cigarette products. Each STONEWALL Hard Snuff® piece contains
about 4.0 mg of nicotine, roughly the same as a pinch of snuff. STONEWALL Hard Snuff® is priced at
a discount to traditional moist snuff products. Our sales of STONEWALL Hard Snuff® also face
further competition with the recent introduction of smokeless tobacco products by Philip Morris and
RJR.
The FDA Tobacco Act permits companies to apply to have products designated as modified risk
tobacco products, however, barring such designation, the FDA restricts the types of claims and
descriptions that can be made with respect to various components in tobacco products, including any
claims relating to reduced levels of toxins or reduced risk. In February 2010 we submitted an
application to the FDA for the approval of Ariva-BDL as the first modified risk tobacco product
under the FDA Tobacco Act and we filed a similar application for Stonewall-BDL in June 2010. In
February 2011, we filed a third application with the FDA to have a moist snuff product, Stonewall
Moist-BDL, designated as a modified risk tobacco product. In 2002 the United States Department
of Agriculture, or USDA,
announced that it would provide full price supports only for flue-cured tobacco that was cured
in a manner to reduce or limit the levels of TSNAs in the cured tobacco leaf, and the tobacco
industry earlier had announced an initiative to facilitate the production of low-TSNA flue-cured
tobacco. As a result, virtually all flue-cured tobacco grown in the United States since that time
has been cured in a manner to reduce the levels of TSNAs. We believe that if we are successful in
commercializing our unique low-TSNA tobacco products, enforcing the patents for the technology used
to produce such products, to which we are the exclusive licensee, or obtaining approval to market
our low-TSNA products as modified risk tobacco products under the FDA Tobacco Act, many of the
major tobacco companies will also seek to market such low-TSNA tobacco products and may seek to
sublicense the technology for producing low-TSNA tobacco from us.
Pharmaceuticals, Nutraceuticals and Other Products and Services
Smoking cessation products that are approved by the FDA for sale in the United States are
designed to wean the smoker from nicotine addiction over a period of time ranging from 30 days to
six weeks. These products are referred to as nicotine replacement therapies. Some of these
products are sold over the counter and others are available by prescription. Although such
pharmaceutical products are not intended to be substitutes for tobacco products, we believe that
many smokers use such products for nicotine maintenance.
There are also non-tobacco cigarettes produced with fillers such as lettuce and herbs and
variations of cigarettes that do not burn tobacco, such as E-cigarettes. Also, there are
non-nicotine nutraceuticals that are marketed as assisting to maintain a nicotine free metabolism
or to balance metabolism in the absence of nicotine. 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.
11
In August 2010, we introduced, CigRx® as a tobacco alternative designed to temporarily reduce
the desire to smoke. CigRx® is a nutraceutical product that allows individuals to use a
non-tobacco, non-nicotine product in situations where they are not in a position to use tobacco or
wish to have an alternative to a tobacco product.
CigRx® and other non-tobacco products compete with smokeless tobacco products in the When You
Cant Smoke® market, which we believe includes our ARIVA® and STONEWALL Hard Snuff ® tobacco
products. Also, to the extent that the FDA approves cessation products for nicotine maintenance,
we believe our CigRx® product and our dissolvable smokeless tobacco products ARIVA® and STONEWALL
Hard Snuff® would be positioned to compete in this market.
There can be no assurance that in the future our competitors will not succeed in developing
technologies and products that are more effective than the products we develop, that are less toxic
than our products, or that would render our products obsolete or non-competitive.
Our Prior Relationship with B&W
Beginning in October 1999, we entered into a series of agreements with B&W including an
agreement to finance approximately $29 million of debt used to support our purchase of StarCured®
tobacco curing barns. The loan balance on this debt was approximately $7.5 million as of December
31, 2010. On July 30, 2004, RAI combined the U.S. assets, liabilities and operations of Brown &
Williamson Holdings, Inc. (formerly B&W), hereinafter referred to as B&W Holdings, an indirect,
wholly owned subsidiary of British American Tobacco p.l.c., with RJR. In our ongoing patent
infringement litigation with RJR, RJR took the position that this business combination had assumed
all of the rights and obligations under the agreements previously entered into with B&W, and moved
to dismiss the patent infringement lawsuit on this basis. The District Court denied RJRs motion to
dismiss. In its ruling the District Court did leave open the question of
what impact, if any, the combination may have on the future licensing arrangements with RJR,
but noted that those considerations did not impact the claims asserted in the patent litigation.
Our Patents, Trademarks and Licenses
License Agreement with Regent Court
We are the exclusive licensee under a License Agreement with Regent Court that provides, among
other things, for the grant of an exclusive, worldwide, irrevocable license to us, with the right
to grant sublicenses, to make, use and sell tobacco and tobacco containing products using Regent
Courts patent rights and know-how relating to the processes for curing tobacco so as to
substantially prevent the formation of TSNAs, whether such patent rights and know-how are now in
existence or hereafter developed. The License Agreement provides us exclusive rights to any
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 to any method of extracting one or more substances from tobacco for the purpose of
incorporating such substance or substances in a product or products. Absent a material breach, the
License Agreement will continue until the expiration of the last of the applicable patents, which
includes 12 U.S. patents and 51 foreign patents, as well as any additional patents issued to
Regent Court during the term of the License Agreement. Generally, patents have a term of 20 years
from the initial date of filing of a patent application. The U.S. patents subject to the License
Agreement expire at various dates between June 28, 2016 and May 6, 2021.
We are obligated to pay to Regent Court a royalty of 2% on the net sales of our products and
the products of any affiliated sublicensees, and 6% on all fees and royalties received by us from
unaffiliated sublicensees, less any related research and development costs incurred by us as well
as costs incurred in enforcing the patent rights. The License Agreement may be terminated by us
upon 30 days written notice. Regent Court may terminate the License Agreement 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 from Regent Court, a material breach of any other of our obligations
under the License Agreement continuing for at least 60 days after written notice from Regent Court,
or in the event of a change of control resulting from the purchase of our stock or all or
substantially all of our assets. The License Agreement obligates us to enforce and pay for United
States and foreign patent rights and contains other provisions typically found in patent license
agreements, such as provisions governing patent enforcement and the defense of any infringement
claims asserted against us or our sublicensees. The License Agreement further provides that any and
all costs, obligations or liabilities related to patent infringement matters brought against us
will be borne by us. We have agreed to indemnify and defend Regent Court and its affiliates against
losses incurred in connection with our 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
us in any document regarding the efficacy of the licensed technology. Two of the patents under our
license with Regent Court that relate to our method for producing low-TSNA tobacco are the subject
of our ongoing lawsuit against RJR. See Item 3. Legal Proceedings for further details.
12
Patents and Proprietary Rights
We believe that our patent portfolio under the License Agreement with Regent Court establishes
us as a world leader in curing technology that consistently produces very low-TSNA tobacco. Under
the agreement with Regent Court, we have exclusive rights to the issued patents listed below, which
are the only United States patents issued to Regent Court. The patents cover the current
technology for substantially preventing the formation of TSNAs in tobacco, as well as patents
relating to the production of low-TSNA dissolvable smokeless tobacco products and the use of
certain tobacco-based MAO inhibitor agents in treating neurological conditions. We have filed
corresponding patent applications in numerous foreign countries, some of which have been granted.
Also, in December 2008 we filed a new U.S. patent application for a variant of our patented curing
technology that results in the production of cured tobacco
that contains virtually undetectable levels of carcinogenic TSNAs as measured by prevailing
standards. In 2010, Rock Creek filed three patent applications relating to our CigRx® product, and
a patent application for a relapse prevention product. Rock Creek
also has several provisional patent applications pending that we expect to mature into one or more non-provisional patent
applications relating to the administration of anatabine, or an isomer or salt thereof, for
treating chronic inflammation that may be associated with disorders such as thyroiditis, cancer,
arthritis, Alzheimers disease, and multiple sclerosis.
There can be no assurances that the claims that have been or may be granted to us under these
patents will be sufficient to protect the intellectual property licensed to us, or that we or
Regent Court will develop or obtain the rights to any additional products or processes that are
patentable. Further, no assurances can be given that any patents licensed to us will not be
challenged, invalidated, infringed or circumvented, or that the rights granted thereunder will
provide competitive advantages to us.
We are the exclusive licensee to the following United States patents pursuant to our License
Agreement with Regent Court:
|
|
|
|
|
|
|
|
|
Date of |
|
|
|
|
Patent Number |
|
Issue |
|
Description |
|
Expiration Date |
U.S. Patent No. 5,803,081 |
|
09/08/1998 |
|
Method of Treating Tobacco with Microwave Radiation to Prevent Formation of Nitrosamines |
|
06/28/2016 |
|
|
|
|
|
|
|
U.S. Patent No. 5,845,647 |
|
12/08/1998 |
|
Tobacco Products Improved by the Use of Propolis |
|
06/28/2016 |
|
|
|
|
|
|
|
U.S. Patent No. 6,135,121
(Reissued as RE 38,123 E) |
|
10/24/2000 |
|
Tobacco Products Having Reduced Nitrosamine Content |
|
06/28/2016 |
|
|
|
|
|
|
|
U.S. Patent No. 6,202,649 |
|
03/20/2001 |
|
Method of Preventing Nitrosamine Formation by Treating Tobacco in Controlled Environment |
|
12/02/2016 |
|
|
|
|
|
|
|
U.S. Patent No. 6,311,695 B1 |
|
11/06/2001 |
|
Method of Treating Tobacco With High Frequency Energy to Prevent Nitrosamine Formation |
|
06/28/2016 |
|
|
|
|
|
|
|
U.S. Patent No. 6,338,348 B1 |
|
01/15/2002 |
|
Method of Treating Tobacco With Microwave Energy to Prevent Nitrosamine Formation |
|
06/28/2016 |
|
|
|
|
|
|
|
U.S. Patent No. 6,350,479 B1 |
|
02/26/2002 |
|
Method of Administering Alcohol Extracts of Tobacco |
|
06/04/2019 |
|
|
|
|
|
|
|
U.S. Patent No. 6,425,401 |
|
07/30/2002 |
|
Method of Preventing Nitrosamine Formation By Treating Tobacco in Controlled Environment |
|
12/02/2016 |
|
|
|
|
|
|
|
U.S. Patent No. 6,569,470 B2 |
|
05/27/2003 |
|
Method of Administering Alcohol Extracts of Tobacco |
|
06/04/2019 |
|
|
|
|
|
|
|
U.S. Patent No. 6,668,839 B2 |
|
12/30/2003 |
|
Smokeless Tobacco Products Made from Powdered Tobacco |
|
05/06/2021 |
|
|
|
|
|
|
|
U.S. Patent No. 6,834,654 |
|
12/28/2004 |
|
Smokeless Tobacco Product Made from Compressed Powdered Tobacco |
|
05/01/2021 |
|
|
|
|
|
|
|
U.S. Patent No. 6,929,811 B2 |
|
8/16/2005 |
|
Method of Modulating Monoamine Oxidase (MAO) Activity Using Tobacco Alkaloids |
|
06/04/2019 |
13
Government Regulation
Overview
The manufacture and sale of cigarettes and other tobacco products are subject to extensive
federal governmental regulation in the United States and by comparable authorities in many foreign
countries. In addition to federal statutes and regulations, many states also require manufacturers
of tobacco products to obtain a cigarette license or a tobacco product license in order to sell
tobacco products. States also regulate the age at which adult consumers may purchase tobacco
products and the locations where tobacco products can be sold. Many states over the past few years
have placed increased restrictions on the purchase and use of tobacco products.
FDA Regulation
Tobacco products and all products derived from tobacco are subject to multiple, overlapping
federal and state regulations. Any products derived from tobacco could be viewed as tobacco
products, or drug products depending upon their chemical composition, intended use and claims.
FDA Tobacco Act. The Family Smoking Prevention and Tobacco Control Act, or FDA Tobacco Act,
which went into effect on June 22, 2009, provides the FDA with broad authority over all tobacco
products through a new division within the FDA (The Center for Tobacco Products). The FDA Tobacco
Act grants the Center for Tobacco Products broad authority over the manufacturing, sale and
distribution of tobacco products including expanded control over the introduction of new tobacco
products, warnings that must be included on all tobacco products and the manner in which tobacco
products may be marketed and sold. Many of the changes specified in the FDA Act will be implemented
gradually over a period of several years. Tobacco manufacturers were required to register with the
FDA by the end of February 2010 and file annually thereafter. We timely submitted our initial
registration and filed our annual registration in December 2010. Under the FDA Tobacco Act new
labeling requirements with expanded health warnings,
additional warnings and restrictions on advertising of tobacco products were put into place
during 2010. In April 2010, we submitted a new labeling plan to the FDA along with new package
labeling to comply with those changes in the law and have supplemented those materials since that
time. The FDA Tobacco Act permits companies to apply to have products designated as modified
risk tobacco products, and we filed applications seeking this designation for our Ariva-BDL our
Stonewall-BDL products in 2010 and for a moist snuff product, Stonewall Moist-BDL in February,
2011. Those applications are currently pending. Under the FDA Tobacco Act, a manufacturer also may
seek to have products that are substantially similar to a product that was marketed and sold prior
to February 15, 2007 designated as a substantially equivalent tobacco product. Such a
designation would allow the continued marketing of these products without the need to file an
application with the FDA for a new tobacco product designation. We intend to file applications
with the FDA seeking to have certain of our blends for ARIVA® and STONEWALL Hard Snuff® designated
as substantially equivalent to our ARIVA® and STONEWALL Hard Snuff® blends that were manufactured
and sold prior to February 15, 2007. The FDA Tobacco Act also contains provisions that we believe
eventually could be beneficial to us in marketing our very-low TSNA smokeless tobacco products,
such as those that would require a listing of various constituents and the publication of
ingredients in all tobacco products with notations as to the harmfulness of those ingredients, but
under the provisions of the FDA Tobacco Act those types of labeling changes and comparative
ingredient information will not be put into place for at least two years from the June 2009
effective date of the legislation. In the interim, the FDA Tobacco Act attempts to level the
playing field for all tobacco products by restricting the types of claims and descriptions that can
be made with respect to various components in tobacco products, including any claims relating to
reduced levels of toxins or reduced risk, unless a product receives a designation as a modified
risk tobacco product. The FDA Tobacco Act also imposes user fees on tobacco manufactures to cover
the cost of the FDA process. Given the low volume of sales of our tobacco products since 2009, the
impact of the user fee under the FDA Tobacco Act has not been significant to date. However, if
sales of our smokeless tobacco products increase substantially, we would have increased user-fee
obligations which could become substantial in the future.
Food Drug and Cosmetic Act. Under the Food, Drug, and Cosmetic Act, the FDA has authority for
reviewing and approving any new drug product prior to its introduction into commerce. The process
of seeking regulatory clearance or approval to market a pharmaceutical product is expensive and
time consuming. The FDA-approval process involves, among other things, successfully completing
clinical trials under an IND and obtaining a premarket approval
after filing a New Drug Application, or NDA. The NDA process requires a company to prove the safety and
efficacy of a new drug product to the FDAs satisfaction. Also, any FDA approved product is subject
to continuing review and the labeling, packaging, adverse event reporting, storage, advertising and
promotion of any such product is subject to extensive regulation. Violations of the Food, Drug, and
Cosmetic Act can result in Warning Letters from FDA, injunctions, product seizure, and civil and
criminal penalties.
14
Dietary Supplement Act. The Dietary Supplement Health Education Act or DSHEA, provides the FDA
with authority over the production and marketing of dietary supplements. In certain cases DSHEA
also requires notification to the FDA before a company begins to market a dietary supplement and,
if structure or function claims are made for a product in the product labeling, notification of
such claims within 30 days of the introduction of the product into commerce. DSHEA requires that
dietary supplements be manufactured under good manufacturing practices and that the label,
labeling and advertising for such products meet specific requirements set forth in DSHEA and its
implementing regulations. DSHEA does not require prior approval by the FDA for the introduction of
dietary supplements into the market, but does require that nutraceutical products comply with the
requirements of DSHEA prior to and after their introduction into commerce. If products are
manufactured and sold as dietary supplements it is possible that FDA may challenge the status of a
product classification. FDA may also challenge the types of claims made for a dietary supplement or
its indications for use. Our CigRx® product was introduced in August 2010 as a dietary supplement
that is intended to be a smoking alternative that temporarily reduces the desire to smoke. We
believe that we have appropriately marketed CigRx® as a nutraceutical and have made claims for the
product that are consistent with those for a dietary supplement tobacco alternative. If CigRx® was
determined. to be a pharmaceutical product, as opposed to a dietary supplement, the product would
need to be submitted to the FDA for approval as a new drug prior to its being sold in the United
States.
Institute of Medicine Report and Potential Reduced-Exposure Products. On February 22, 2001,
the Institute of Medicine issued a comprehensive report, entitled Clearing the Smoke: Assessing
the Science Base for Tobacco Harm Reduction, in response to a request from the FDA to assess the
scientific basis for potentially reducing the health risks associated with tobacco use. This
voluminous report suggested, among other findings, that it is scientifically feasible to design and
manufacture a range of Potential Reduced Exposure Products, or PREPs, but that, without appropriate
governmental regulation and independent scientific evaluation of PREPs, the public is left without
clear information regarding the degree to which these products reduce the risks associated with the
use of traditional tobacco products. Since 2001, support for PREPs has been the subject of an
ongoing debate concerning whether any tobacco products should be considered less toxic and a viable
alternative to traditional tobacco products. Over the last several years, the scientific community
has begun to recognize that certain forms of tobacco products, particularly low-TSNA smokeless
tobacco products, deliver fewer toxins than smoked tobacco. At the same time, concern has been
expressed by certain members of the public health community about the use of smokeless tobacco
because of potential unintended consequences that may accompany a switch from the most lethal
form of tobacco to a less toxic tobacco product. The FDA Tobacco Act specifically allows companies
to seek approval of products as modified risk tobacco products if they contain substantially less
toxins than other products on the market and can be demonstrated to reduce the risk associated with
tobacco use.
Federal Trade Commission
Requirements for health warnings on cigarettes have been governed by the Federal Cigarette
Labeling and Advertising Act and are currently being transitioned to the FDA under provisions
contained in the FDA Tobacco Act. Prior to the passage of the FDA Tobacco Act, warning
requirements for smokeless tobacco products were mandated under the Comprehensive Smokeless Tobacco
Health Education Act of 1986. Those Acts imposed labeling and advertising requirements on the
manufacturers, packagers and importers of cigarettes and smokeless tobacco products and required
any company wishing to sell such products within the United States to submit a plan to the FTC
explaining how it would comply with the warning label display requirements. We submitted labeling
plans for smokeless products to the FTC in accordance with these acts. Under the FDA Tobacco Act
labeling plans for smokeless tobacco products are now submitted to the FDA for approval and the
type and form of warnings that must be included on packages and labeling for smokeless tobacco
products are now governed by the statutory requirements of the FDA Tobacco Act and its implementing
regulations. We submitted a labeling plan to the FDA along with new package labeling to comply with
the changes in the FDA Tobacco Act in April 2010 and have supplemented those materials since that
time. Although the FTC no longer has authority over the labeling for smokeless tobacco products, it
does have concurrent jurisdiction with the FDA over advertising claims made for tobacco products as
well as jurisdiction over claims made for nutraceuticals and other OTC products. The FTC requires
that all claims for such products be adequately substantiated. Violations can result in cease and
desist orders and consumer redress, such as refunds, among other things.
15
Tax and Trade Bureau
Manufacturers and importers of tobacco products are taxed pursuant to regulations promulgated
by the Tax and Trade Bureau, or TTB under authority of the Internal Revenue Code of 1986, as amended. Our tobacco products
are subject to tax under such regulations. The Federal excise tax rate for smokeless tobacco is
$1.51 per pound. The manufacturing of tobacco products is also subject to regulation by the TTB. We
currently have a license from the TTB to manufacture smokeless tobacco products at our Chase City,
Virginia facility. Our TTB license requires that we adhere to strict regulations regarding the
manufacturing and transportation of our tobacco products.
Fair and Equitable Tobacco Reform Act
In October 2004, Congress passed the Fair and Equitable Tobacco Reform Act of 2004, or
FSC/ETI, which provides for the end of the federal tobacco quota program by means of a $10 billion
buyout of the tobacco quota system that is being financed by assessments on tobacco manufacturers.
The buyout is paid for by all tobacco manufacturers over a ten-year period based on each companys
percentage of sales. The
apportionment of responsibility for payments to quota holders is approximately 96% to
cigarette manufacturers, and the remaining 4% is divided among other tobacco product manufacturers,
based on market share. Given the low volume of sales of our dissolvable low-TSNA smokeless tobacco
products to date, the fact that 96% of the assessment for the tobacco quota payment is directed
towards cigarette sales, and the discontinuation of our cigarette operations in June, 2007, our
payment obligations under the FSC/CTI were negligible in 2010. Absent a substantial increase in our
sales of smokeless tobacco products, we believe that our payment obligations under the FSC/CTI
should also be de minimis in 2011.
State and Municipal Laws
The sale of smokeless tobacco is taxed in most jurisdictions. One state has no excise tax on
smokeless tobacco and the rates in other states vary significantly from state to state using
formulas based on weight or on a percentage of the wholesale price of the product. For example, the
states of Alabama and Maine tax smokeless products at a rate of $0.12 per ounce and $2.02 per
ounce, respectively, while the states of South Carolina and Wisconsin impose an excise tax of 5.0%
and 100% of wholesale cost, respectively. 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 on manufacturers, and therefore we have no
liability for such taxes.
In November 1998, 46 states and the District of Columbia, or the Settling States, entered into
the Master Settlement Agreement, or MSA, to resolve litigation that had been instituted against the
major tobacco manufacturers. We did not join the MSA and as a non-participating manufacturer, we
were required to satisfy certain escrow obligations pursuant to statutes that the MSA required the
Settling States to adopt in order for such states to receive the full benefits of the settlement.
On March 14, 2007, we sold the rights, title and interest in and to all income from and
reversionary interest in our MSA escrow accounts, including our 2006 MSA escrow deposits made in
April 2007. Although we sold the rights in and to all income from and reversionary interest in the
funds deposited into the MSA escrow accounts for the years up to and including 2006, these MSA
escrow funds remain in our name and the principal amount of these accounts will be available to
satisfy portions of any state judgments or settlements for the type of claims asserted against the
major tobacco manufacturers in the suits that resulted in the negotiation of the MSA, if such
claims are successfully asserted in litigation against us as a result of our prior sale of
cigarettes.
In May 2007, we entered into a license agreement with Tantus for the exclusive licensing of
our cigarette trademarks Sport ®, MainStreet® and GSmoke®. We ceased manufacturing cigarettes in
June 2007 and, thereafter, we withdrew the certifications for cigarette sales that we previously
had obtained in all applicable Settling States. Given the discontinuation of our cigarette
operations in June 2007 we did not have any MSA obligation for cigarette sales in MSA states since
2007 and do not anticipate having MSA escrow obligations in the future.
World Health Organization Global Public Health Advocacy; Framework Convention on Tobacco Control
Members of our management team testified in October 2000, at the World Health Organization, or
WHO, public hearings in Geneva, Switzerland on the structure of a Global Framework Convention on
Tobacco Control, or FCTC. In that testimony we reiterated our support for reasoned regulation of
all tobacco products in the U.S. and worldwide to create a more rational environment in which
toxicity reduction rather than marketing creativity would determine relevant market share. Members
of our management team also testified before the WHO Scientific Advisory Committee on Tobacco
Product Regulation in February 2001, and reiterated our support for reasoned world-wide tobacco
regulation within the FCTC-proposed structure. On February 27, 2005, the FCTC went into effect.
Although the U.S. signed the FCTC in May 2004, the White House has not sent the Treaty to the
Senate for ratification by the requisite two-thirds majority. The State Department has reported
that it is reviewing the FCTC for legal issues, particularly those impacting on commercial free
speech. The U.S. has opposed the blanket advertising prohibitions in the FCTC, although prior to
promulgation of the FCTC, nations with commercial free speech protections could have opted out of
that provision in the treaty and retained the
ability to become a signatory to the FCTC. To date, 172 of the 195 nations that signed the
FCTC have ratified this comprehensive document.
16
UK Royal College of Physicians Statement on Tobacco Regulation and Statement on European Union
Policy on Smokeless Tobacco
In December 2002, the British Royal College of Physicians issued a report titled Protecting
Smokers, Saving Lives. In that report, the Royal College of Physicians concluded that the
consumption of non-combustible tobacco is in the order of 10-1,000 times less hazardous than
smoking, depending on the product. In February 2003, an independent group of researchers and
public health educators issued a report titled: European Union Policy on Smokeless Tobacco A
Statement in Favor of Evidence-Based Regulation. In this report, the researchers called on the
European Union, or EU, to reconsider the ban on smokeless tobacco products applicable to all EU
members except Sweden, which received an exemption when it joined the EU in 1992. As stated in the
report, the request to lift the ban was made in part because smokeless tobacco is substantially
less harmful than smoking, and evidence from Sweden suggest it is used as a substitute for
smoking. In 2002, Swedish Match challenged the validity of the EUs ban on the sale of smokeless
tobacco products in all member countries in Great Britains High Court. The British High Court
stayed the proceeding and referred the challenge to the EUs High Court of Justice. Oral arguments
were heard in September 2004, during which Swedish Match pointed out that maintaining a prohibition
of the sale of snus did not take into account the development of scientific information about the
relatively decreased health risks associated with oral tobacco use as compared to data relating to
the health risks associated with smoking. In December 2004, the EU High Court ruled that the
prohibition, while in need of reformulation by the EU legislature, continues to be valid in
principle.
The Tobacco Advisory Group of the UK Royal College of Physicians also issued a report in
October 2008, Ending Tobacco Smoking in Britain: Radical Strategies for Prevention and Harm
Reduction in Nicotine Addiction. One of the major premises of the report argues again that harm
reduction strategies offer a major opportunity to reduce the prevalence and health impact of
smoking. The report identifies compressed smokeless tobacco as a harm reduction product.
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, healthcare 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 on one or more of the following: (i) that manufacturer defendants have deceived
consumers about the health risks associated with tobacco product consumption; (ii) 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 (iii) such
defendants knew of the addictive attributes of nicotine and have purposefully manipulated their
product ingredients so as to enhance the delivery of nicotine.
We believe that we have conducted our business in a manner that decreases the risk of
liability in a lawsuit of the type described above because we:
|
|
|
have attempted to consistently present to the public the most current information
regarding the health risks of long-term smoking and tobacco use generally; |
|
|
|
have always acknowledged the addictive nature of nicotine; |
|
|
|
have never targeted adolescent or young persons as customers; |
|
|
|
have not advertised our cigarette products to consumers except for point-of-sale
materials; |
|
|
|
have conducted research on the chemical or other constituents of our products only in
the course of efforts to reduce the delivery of toxins; |
|
|
|
have 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; |
|
|
|
did not produce our own brands of cigarettes until the mid-1990s, and our sales volumes
were never substantial in relation to the volume generated by the major manufacturers; and |
|
|
|
discontinued our cigarette operations in June 2007, in favor of our very low-TSNA
dissolvable smokeless tobacco products. |
17
In the past, we maintained product liability insurance only with respect to claims that
tobacco products manufactured by or for us contained any foreign object (i.e., any object that is
not intended to be included in the manufactured product). We currently do not maintain such
insurance. The product liability insurance previously maintained did not cover health-related
claims such as those that have been made against the major manufacturers of tobacco products. We do
not believe that insurance for health-related claims can currently be obtained. Although to date,
no health-related lawsuit has ever been filed against us, a lawsuit based on such claims could have
a materially adverse effect upon our company.
Prior to the introduction of CigRx® we obtained product liability insurance for CigRx® as a
nutraceutical product. This insurance covers claims arising from product defects or claims arising
out of the sale, distribution and marketing of our CigRx® product. There have been no claims
asserted with respect to our CigRx® product. If any such claims are asserted in the future and
ultimately result in liability that exceeds the limits of our insurance coverage, this could have a
materially adverse effect on our financial condition.
Our Employees and Consultants
As of December 31, 2010, we employed 31 full-time employees, as compared to 39 employees as of
December 31, 2009.
From time to time, we engage temporary personnel to augment our regular employee staff.
Further, we utilize the services of consultants, scientific and technical experts and, from
time-to-time, independent contractors to provide key functions in the scientific, medical, public
healthcare, compliance, technology, legal, communications, financial and related fields. The use of
such third-party providers enables us to secure unique expertise on both a formal and informal
basis in a wide variety of areas that we might otherwise not be in a position to obtain or which we
would otherwise be required to obtain through the hiring of additional employees at a potentially
greater cost to us. Substantially all of the our research and development efforts have been, and
are expected to continue to be, conducted pursuant to contractual arrangements with universities,
scientific, medical and public health consultants, independent investigators and research
organizations.
Internet Address and Internet Access to Periodic and Current Reports
Our Internet address is www.starscientific.com. You may obtain through our Internet website,
free of charge, copies of our annual reports on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K and Proxy Statements on Schedule 14A, including any amendments to those reports
or other information filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act.
These reports will be available as soon as reasonably practicable after we electronically file such
material with, or furnish such material to, the Securities and Exchange Commission, or SEC. You can
also obtain these reports directly from the SEC at their website, www.sec.gov, or you may visit the
SEC in person at the SECs Public Reference Room at Station Place, 100 F. Street, N.E., Washington,
DC 20549. You may obtain information on the operation of the Public Reference Room by calling the
SEC at 1-800-SEC-0330. We will also provide a copy of our annual report on Form 10-K upon any
written request by a shareholder.
We have incurred losses for the past eight years and operating expenses are likely to continue
to be greater than operating revenues in the foreseeable future.
We have incurred operating losses for eight consecutive fiscal years beginning with the year
ended December 31, 2003. Our net losses were approximately $(18.3) million for the year ended
December 31, 2008, $(22.8) million for the year ended December 31, 2009 and $(28.3) million for the
year ended December 31, 2010. Our accumulated deficit as of December 31, 2010 was approximately
$(170.7) million. Additionally, a majority of our historical operating revenues have been derived
from sales of our discount cigarettes. However, in May 2007, we entered into a license agreement
with Tantus for the exclusive license of our trademarks MainStreet®, Sport® and GSmoke®, in return
for licensing fees during the seven-year term of the license agreement and beyond, if the license
is renewed. Although we retain the right to manufacture and sell other branded cigarettes, we
discontinued the manufacture and sale of our discount cigarettes in June 2007 and are focusing our
efforts in the tobacco area on the sale of low-TSNA dissolvable smokeless tobacco products and the
licensing of the related technology, as opposed to cigarettes. In August 2010, we introduced
CigRx®, a non-nicotine, non-tobacco nutraceutical, in the Richmond, Virginia area. Sales of CigRx®
were de minimis in 2010 and it would take a substantial increase in sales of CigRx® and our
dissolvable tobacco products for operating revenues to exceed expenses.
18
Our future prospects, therefore, are dependent on the expanded distribution and consumer
acceptance of our low-TSNA dissolvable smokeless tobacco products as well as CigRx® our ability to
support the expansion of the market for these products and the continued development of new
low-TSNA smokeless tobacco products, related pharmaceutical products and nutraceuticals,
independently and through alliances with other tobacco manufacturers or pharmaceutical companies.
Our future results of operations are also dependent on our ability to begin generating significant
revenues through royalties from the patented tobacco curing process to which we are the exclusive
licensee. However, our ability to generate revenues through sales of our smokeless tobacco products
and the licensing of related products will substantially be dependent on the successful completion
of our ongoing patent infringement lawsuit against RJR.
In the future, we may not be able to secure financing necessary to operate and grow our
business as planned.
The recurring losses generated by our operations continue to impose significant demands on our
liquidity. Over the last several years our liquidity demands have been met principally by private
placements of our common stock and the cash exercise of related warrants and stock options. In 2010
our company received proceeds of approximately $27.8 million through private placements and we
obtained an additional $11.0 million in private placement transactions subsequent to December 31,
2010. See note 15 to our consolidated financial statements
included in Item 15. Exhibits, Financial Statement
Schedules for further details of the latter transaction. Absent the exercise of outstanding warrants and options for cash or a substantial
improvement in sales and revenues and/or royalties, we believe that the recent funding will support
our operations through the first quarter 2012. Additionally, although options or warrants are currently or
in the future may be in-the-money, there can be no assurances that holders of these derivatives
will exercise these securitites.
However, our business and operations may consume resources faster than we anticipate, and
depending upon market conditions and the price of our common stock, we may decide to seek
additional funds before that time. Additional financing may not be available on favorable terms, if
at all. If adequate funds are not available on acceptable terms, we may be unable to fund the
expansion of our sales and marketing and research and development efforts or take advantage of
other opportunities, which could seriously harm our business and operating results. If we issue
additional equity securities, existing stockholders will experience dilution.
Levels of market volatility have been unprecedented in recent years.
The capital and credit markets experienced volatility and disruption at unprecedented levels
in 2008 and 2009, which continued to a lesser extent in 2010. In some cases, the markets have
produced downward pressure on stock prices and credit availability for certain issuers without
regard to those issuers underlying financial strength. If market disruption and volatility worsen
in the future, there can be no assurance that we will not experience an adverse effect, which may
be material, on our ability to access capital and on our business, financial condition and results
of operations.
If we are unable to protect our intellectual property rights, our competitive position could
be harmed and we could be required to incur significant expenses to enforce our rights.
Our future success will depend in part on obtaining patent and other intellectual property
protection for the technologies contained in our products, and on successfully defending our
patents and other intellectual property against third-party challenges. In particular, our success
in commercially marketing our licensed tobacco curing technology and low-TSNA smokeless tobacco
products, and our development of tobacco-based pharmaceutical products to treat tobacco-related
dependence and related products, depends in large part on our ability to protect the patents
related to our low-TSNA technology for which we are the exclusive licensee, to obtain further
patent protection for this technology in the United States and other jurisdictions, and to operate
without infringing upon the patents and proprietary rights of others. We have incurred, and expect
to continue to incur, substantial costs in obtaining patents and, if necessary, defending our
proprietary rights. In particular, we have been prosecuting patent infringement claims against RJR
in the United States District Court for the District of Maryland with respect to two patents used
in our low-TSNA tobacco technology. Following remand from an earlier appeal to the Federal Circuit
Court of Appeals, the case was tried to a jury in the District Court between May 18, 2009 and June
16, 2009. At the conclusion of the trial, the jury returned a verdict in favor of RJR holding that
there was no infringement of the two patents at issue in the case and that the patents were invalid
due to anticipation, obviousness, indefiniteness and failure to disclose best mode. We appealed the
jury verdict to the Federal Circuit Court of Appeals in December 2010 and the case was argued
before a three-judge panel of the Federal Circuit on January 11, 2011. We are currently awaiting a
decision on the appeal. On May 29, 2009, we filed a new complaint against RJR for patent
infringement during the period beginning 2003 through the filing date of the complaint. The future
prosecution of the new complaint will be dependent on our achieving a reversal of the jury verdict
of invalidity in our initial RJR action, which is uncertain at this time.
19
Also, since 2008 Rock Creek has developed several processes and product formulations relating
to our non-nicotine nutraceutical (CigRx®), a relapse prevention product and a compound (RCP006)
that may be useful in maintaining a healthy metabolism. In 2010, Rock Creek filed three patent
applications relating to our CigRx® product, and a patent application for a relapse prevention
product. Further, there are several provisional patent applications pending that we expect to
mature into one or more non-provisional patent applications relating to the administration of
anatabine, or an isomer or salt thereof, for treating chronic inflammation that may be associated
with disorders such as thyroiditis, cancer, arthritis, Alzheimers disease, and multiple sclerosis.
We believe this technology will be important for our business going forward, however, there
can be no assurances that we will be able to mature these provisional patent applications into
non-provisional applications or that any related non-provisional patent applications will be
granted.
We do not know whether we will obtain the patent protection we seek through our existing
patents or patent applications that are pending, or that the protection we do obtain will be found
valid and enforceable, if challenged. If we fail to obtain adequate protection of our intellectual
property, or if any protection we obtain is reduced or eliminated, others could use our
intellectual property without compensating us, resulting in harm to our business. We may also
determine that it is in our best interests to voluntarily challenge a third partys products or
patents in litigation or administrative proceedings, including patent interferences or
reexaminations. In the event that we seek to enforce any of our owned or exclusively licensed
patents against an infringing party, it is likely that the party defending the claim will seek to
invalidate the patents we assert. If successful this could result in the loss of the entire patent
or the relevant portion of our patent, which would not be limited to any particular party. Any
litigation to enforce or defend our patent rights, even if we were to prevail, could be costly and
time-consuming and could divert the attention of our management and key personnel from our business
operations. Our competitors may
independently develop similar or alternative technologies or products without infringing any
of our patent or other intellectual property rights, or may design around our proprietary
technologies.
U.S. patents and patent applications may also be subject to interference proceedings and U.S.
patents may be subject to reexamination proceedings in the U.S. Patent and Trademark Office.
Foreign patents may be subject to opposition or comparable proceedings in the corresponding foreign
patent offices, and those proceedings could result in either loss of the patent or denial of the
patent application, or loss or reduction in the scope of one or more of the claims of the patent or
patent application. In addition, such interference, reexamination and opposition proceedings may be
costly. Thus, any patents that we own or license from others may provide limited or no protection
against competitors. Our pending patent applications, those we may file in the future, or those we
may license from third parties, may not result in patents being issued. If issued, they may not
provide us with proprietary protection or competitive advantages against competitors with similar
technology.
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.
Our growth strategy anticipates that we will create new products and distribution channels and
expand existing distribution channels for our low-TSNA smokeless tobacco products, for CigRx® and
for other products developed by Rock Creek. Our future growth is also heavily dependent upon
increased consumer acceptance of our low-TSNA smokeless tobacco products, CigRx® and other
non-nicotine nutraceuticals and pharmaceutical products, as well as on increased demand to license
our related technology. If we are unable to effectively manage these initiatives, our business,
financial condition, results of operations and cash flows would be adversely affected.
Our long-term growth strategy includes an increased focus on the sales and marketing of our
low-TSNA smokeless tobacco products ARIVA® and STONEWALL Hard Snuff®, our dietary supplement CigRx®
and the introduction of other non-nicotine nutraceuticals and tobacco-based pharmaceuticals as well
as the receipt of royalty fees for the licensing of our patented technology for producing low-TSNA
tobacco. However, to date sales of our smokeless tobacco products and CigRx®, as well as our
ability to derive revenue from the licensing of our low-TSNA technology, have been de minimis.
20
Additionally, our success will be dependent on our ability to develop other non-nicotine
products that may be helpful to consumers in maintaining a healthy metabolism, as well as
tobacco-based pharmaceutical products. The introduction of pharmaceutical products will require a
substantial period of time in order to obtain FDA approval to market such products. As a result, we
do not anticipate introducing any pharmaceutical products into the market for the foreseeable
future but will focus on the research and development aspects of a range of pharmaceuticals,
including tobacco-based drug products, in addition to the development of non-nicotine nutraceutical
products. Assuming that we are successful in introducing such products into the market, the success
of those products and the success of our low-TSNA smokeless tobacco products and CigRx® will depend
on the willingness and ability of retail customers to market and sell our products to consumers, as
well as our success in developing new distribution channels for those products. If our significant
retail customers or independent distributors were to reduce the quantity of any of our smokeless
tobacco products they currently sell or stop selling our products, or if we are unable to open
distribution channels for our new products, our financial condition and results of operations could
be adversely affected.
It is not certain whether CigRx® or our low-TSNA smokeless tobacco products will be accepted
by the market in sufficient volume to support our operations. Adult tobacco users may decide not to
purchase our products due to taste or other preferences, including a preference for our
competitors products or because of the extensive health warnings contained on the packaging for
our tobacco products. There can be no assurance that in the future our competitors will not succeed
in developing technologies and products that
are more effective than the products we develop, that are less toxic than our products, or
that would render our products obsolete or non-competitive.
Further, an inability to successfully increase consumer awareness of and demand for our very
low-TSNA smokeless tobacco products would negatively affect our ability to license our patented
technology for producing low-TSNA tobacco. This accordingly would materially diminish our ability
to derive royalty fees from the license of this technology. If we are unable to license our
patented technology for producing low-TSNA tobacco, our financial condition and results of
operations could be adversely affected.
Our efforts to successfully market CigRx® and ARIVA® and STONEWALL Hard Snuff® also will
require the expenditure of substantial funds that we will need to obtain from external financing,
the availability of which cannot be assured, and ultimately these products may not be accepted in
the national marketplace. If we are not successful in our efforts to offer CigRx® or our low-TSNA
smokeless tobacco products to adults as alternatives to cigarettes and other smokeless products, to
generate revenue through the license of the related technology to which we are the exclusive
licensee or to introduce new nutraceutical and pharmaceutical products, we will not have sufficient
sales volumes to support our operations.
We are subject to increased regulation relating to our tobacco products as a result of the FDA
assuming jurisdiction over all tobacco products under the FDA Tobacco Act.
The FDA Tobacco Act, which went into effect on June 22, 2009, provides a new division within
the FDA (The Center for Tobacco Products) with. broad authority over the manufacturing, sale and
distribution of tobacco products including expanded control over the introduction of new tobacco
products, warnings that must be included on all tobacco products and the manner in which tobacco
products may be marketed and sold. Many of the changes specified in the FDA Act will be implemented
gradually over a period of several years. We have sought to comply with these requirements by
registering with the FDA as a tobacco manufacturer and taking other
steps to comply with the FDA Tobacco
Act requirements with respect to the manufacture, sale and marketing of our low-TSNA smikelsss
tobacco products. Also, in 2010 we filed applications seeking to have varients of our ARIVA® and
STONEWALL Hard Snuff® products (Ariva-BDL and Stonewall-BDL) approved as modified
risk products. We filed a similar application for a Stonewall Moist-BDL product in February, 2011. Those
applications are pending. If we are not successful in meeting the requirements of the FDA Tobacco
Act with respect to our current low-TSNA smokeless tobacco products, or obtaining approval to
market any new tobacco products, our effort to expand the distribution and sales of our low-TSNA smokeless tobacco products or other tobacco products could be adversely affected which
could have an adverse effect on our results of operations, financial position and cash flows.
The tobacco industry as well as the market for non-nicotine tobacco alternatives are highly
competitive, we may not be able to effectively compete in these markets and our competitors may
develop technology for the production of low-TSNA tobacco that does not infringe on the technology
to which we are the exclusive licensee, or they may develop technology for low-TSNA tobacco or
other cigarette alternatives that could make our technology obsolete.
Virtually all flue-cured tobacco grown in the United States since 2001 has been cured in a
manner to reduce the levels of TSNAs. If our competitors produce low-TSNA tobacco that does not
infringe on the technology to which we are the exclusive licensee, or develop other tobacco
products with less toxins that can compete with our very low-TSNA products, this could adversely
affect our operating income and cash flows.
21
The tobacco industry is highly competitive. STONEWALL Hard Snuff® competes with major
manufacturers of smokeless tobacco products and ARIVA® competes with traditional cigarette
manufacturers because ARIVA® is positioned as an alternative to cigarettes in situations where
adult cigarette users cannot or choose not to smoke. Those companies generally have substantially
greater financial and operating resources than we do. Also, these companies have a more established
presence in
the smokeless tobacco industry than we do. Certain of the major cigarette makers are marketing
alternative cigarette products. For example, Philip Morris has developed an alternative cigarette
called Accord in which the tobacco is heated rather than burned. RJR has developed an alternative
cigarette called Eclipse in which the tobacco is primarily heated, with only a small amount of
tobacco burned. Vector Tobacco Inc. developed a cigarette offered in several packings with
declining levels of nicotine, called Quest. Further, in 2006 and 2007, both Philip Morris and RJR
introduced into test market smokeless tobacco pouch products designed to provide alternatives to
cigarettes that utilize their primary brand names (Marlboro Snus and Camel Snus, respectively), and
other smokeless tobacco manufactures have introduced products that claim to have reduced levels of
carcinogens. In 2009 Altria, Philip Morriss parent company expanded its role in the smokeless
tobacco market through its acquisition of UST. Also, in 2009 RJR introduced into test market three
dissolvable smokeless tobacco products that compete directly with our ARIVA® and STONEWALL Hard
Snuff® low-TSNA dissolvable smokeless tobacco products. If these initiatives are successful or if
our competitors develop new technology for low-TSNA tobacco for use in smokeless tobacco products,
we will be subject to increased competition for market share and our current technology for the
production of low-TSNA tobacco could become obsolete.
CigRx®
may compete with both FDA approved smoking cessation products and
neutraceutical tobacco alternatives. Smoking cessation products that are approved by the FDA for
sale in the United States are designed to wean the smoker from nicotine addiction over a period of
time and are marketed by the leading pharmaceutical companies as alternatives to cigarettes. Also
there are other tobacco alternatives, such as E-cigarettes, and non-nicotine nutraceuticals that
are marketed as assisting to maintain a nicotine free metabolism or to balance metabolism in the
absence of nicotine. Many companies marketing smoking cessation products or related neutraceutical
alternatives have substantially greater financial and operating resources than we do. To the extent
competitors in these markets are able to develop products that are accepted as tobacco
alternatives, the sale of our low-TSNA smokeless tobacco products could be adversely affected,
which could have a material adverse effect on our results of operations, financial position and
cash flows.
We may not be successful in introducing and marketing our non-nicotine, non-tobacco CigRx®
product.
We introduced into test market in August 2010 CigRx®, a non-nicotine nutraceutical product
that is intended to temporarily reduce the desire to smoke Currently CigRx® is being sold through
an interactive website, an infomercial and, to a limited extent, through direct retail sales.
Our success in marketing CigRx® will be dependent on consumer acceptance of this product and our
ability to have the product sold to consumers principally through our website and though
infomercials. If we are not able to attract interest in the product at the consumer level, expand
on the distribution channels for CigRx®
or compete with other companies marketing alternatives to
tobacco products our financial condition and results of operations could be adversely affected.
Sales of tobacco products have been declining, which could have a material adverse effect on
our revenues and cash flows.
The overall U.S. market for cigarettes has generally been declining in terms of volume of
sales, as a result of restrictions on advertising and promotions; funding of smoking prevention
campaigns; increases in regulation and excise taxes; a decline in the social acceptability of
smoking, and other factors, and sales are expected to continue to decline. While the sales of
smokeless tobacco products have been increasing over the last several years, the smokeless tobacco
market is substantially smaller than the cigarette market. Prior to our exit from the discount
cigarette business, we experienced a similar decline in sales of our discount cigarette products,
and this downward trend may adversely impact our ability to sell and market our low-TSNA smokeless
tobacco products or
CigRx®
as an alternative to cigarettes. This could have a material adverse effect
on our results of operations, financial position and cash flows.
We may face delays in obtaining very low-TSNA tobacco or other raw materials to adequately
manufacture our products.
As a result of the discontinuation of our business relationship with B&W, and the ongoing
burden and expense of the pending patent infringement litigation with RJR, during 2007 we sold
approximately 990 tobacco curing barns used for the production of our low-TSNA StarCured® tobacco.
We sold our remaining 37 StarCured® tobacco curing barns in December 2009 to growers who had
previously participated in the StarCured® program. While we currently do not own any StarCured®
barns, we have a significant amount of StarCured® tobacco in inventory and access to StarCured®
tobacco through growers who previously participated in our StarCured® tobacco curing program.
However, given the sale of our remaining barns, we cannot be assured that we will have sufficient
availability to curing barns to meet future demand for our low-TSNA tobacco, particularly if the
sales volumes of our very low-TSNA smokeless tobacco products substantially increase over a short
period of time. Further, in the event that we are unable to obtain adequate amounts of StarCured®
tobacco and other raw materials to meet product demands, our customers may seek to fulfill their
supply needs by purchasing competing brands, which in turn would reduce our market share and
ability to successfully commercialize our very low-TSNA smokeless tobacco products. This could have
a material adverse effect on our results of operations, financial position and cash flows.
22
We may face disruptions relating to the manufacture and sale of CigRx® based on the fact that
we have arranged for third parties to manufacture and distribute
CigRx®.
In order to facilitate the launch of CigRx® and limit capital expenditures, we have outsourced
the manufacturing, storage, order processing and delivery of CigRx® through contracts and
arrangements with a number of third-party suppliers. We anticipate that the arrangements that have
been put in place with these various entities should be sufficient to meet our manufacturing and
distribution needs for CigRx® for the foreseeable future. However, these contractors may
experience delays or disruptions that could adversely impact on their ability to meet our
manufacturing and distribution needs. In the event that our third-party contractors are unable to
meet our needs, we would need to find alternative sources for the manufacturing and/or distribution
of CigRx®, which may be difficult to obtain in a timely and cost effective manner, or at all.
Also, if sales volumes for CigRx® increase substantially over a short period of time, our current
contractors may have difficulty meeting our manufacturing and supply demands. In the event we are
not able to obtain adequate amounts of CigRx® or if we are not able to supply product to consumers
on a timely basis, our customers may seek to fulfill their supply needs by purchasing competing
products, which, in turn would reduce our market share and ability to successfully commercialize
CigRx®, which could have a material adverse effect on our results of operations, financial position
and cash flows.
Our research & development efforts may not result in commercially viable products and may
continue to be curtailed by our lack of available research funds.
Our companys long-term focus is the research, development, manufacturing and licensing of
technology that can lessen reliance on and the impact of the use of all forms of tobacco, reduce
the range of serious health hazards associated with the use of smoked and smokeless tobacco and
more generally assist consumers in maintaining a health metabolism. We have pursued these
objectives through the production of very low-TSNA tobacco and the development of dissolvable
smokeless tobacco products, Also, through Rock Creek we have pursed the development of our
non-nicotine, non-tobacco nutraceutical CigRx® and ongoing research and development efforts
directed to botanical based products for the treatment of tobacco dependence, products that would
utilize certain MAO agents in tobacco to treat a range of neurological conditions, including
Alzheimers disease, Parkinsons disease, schizophrenia and depression as well as non-nicotine
nutraceuticals. Our current and future product development initiatives will be substantially
dependent on our ability to continue our research initiatives and to obtain the funding necessary
to support these initiatives. Our inability to continue these initiatives and initiate new research
and development efforts could result in a failure to develop new products or to improve upon
existing products, which could have a material and adverse impact on our sales, operating income
and cash flows.
We are subject to risks inherent in new product development initiatives, particularly with
respect to our goal of developing pharmaceutical products to treat tobacco-related dependence and
other
neurological conditions, which are subject to FDA regulation and approval, and for related
products such as nutraceuticals.
Our future success is substantially dependent upon implementation of our business strategy
related to our new product initiatives. Since 2007, through our Rock Creek subsidiary, we have been
exploring the development of botanical-based products for the treatment of tobacco dependence, as
well as products that would utilize certain MAO agents in tobacco to treat a range of neurological
conditions, including Alzheimers disease, Parkinsons disease, schizophrenia and depression. Rock
Creek also has been involved in pursuing the development of a non-nicotine nutraceutical product
that was introduced in 2010 under the name CigRx® and other nutraceuticals that could be used to
support a healthy metabolism. The ongoing product development initiatives of Rock Creek are
subject to high levels of risk, uncertainties and contingencies, including the challenges inherent
in new product development, FDA regulatory approval for any new pharmaceutical products that we
develop and FDA regulatory oversight for nutraceuticals. Since the passage of the FDA Tobacco Act,
all tobacco products are now regulated under the FDA Tobacco Act. They
are also, subject to multiple,
overlapping federal and state regulations and products derived from tobacco could be classified as
tobacco products or drug products depending on their chemical composition, intended use and claims.
23
Additionally, the Dietary Supplement Health Education Act, DSHEA, provides the FDA with
authority over the production and marketing of dietary supplements. In certain cases DSHEA also
requires notification to the FDA before a company begins to market a dietary supplement and, if
structure or function claims are made for a product in the product labeling, notification of such
claims within thirty days of the introduction of the product into commerce. DSHEA also implements
significant manufacturing and marketing requirements, including that dietary supplements be
manufactured under good manufacturing practices and that the label, labeling and advertising for
such products meet specific requirements. DSHEA does not require prior approval by the FDA for the
introduction of dietary supplements into the market, but does require that the nutraceutical
products being developed by our Rock Creek subsidiary comply with the requirements of DSHEA prior
to and after their introduction into commerce. If products are manufactured and sold as dietary
supplements it is possible that FDA may challenge the status of a product classification. FDA may
also challenge the types of claims made for a dietary supplement or its indications for use and the
FTC also has jurisdiction over advertising of nutraceuticals and other OTC products.
In marketing CigRx®, we will have to comply with the requirements of DSHEA, which could impact
the time required to fully commercialize this product. We do not have any pharmaceutical products
cleared or approved for commercialization and we do not expect to obtain approval for any drug
products for the foreseeable future. The future success of our pharmaceutical, and to a more
limited extent, our neutriceutical, business will depend on our ability to obtain regulatory
clearance or approval to market new drug products and our ability to comply with statutory and
regulatory requirements for any nutraceuticals products, create product sales, successfully
introduce new products, establish our sales force and distribution network, and obtain access to
additional working capital to finance our development initiatives, all of which we may be unable to
realize. Additionally, if any dietary supplement developed by us is determined to be a
pharmaceutical product, as opposed to a dietary supplement, the product would need to be submitted
to the FDA for approval as a new drug prior to it being sold in the United States.
Even if we develop a viable pharmaceutical product, we may not obtain or maintain the
necessary FDA approvals for our product, or such approvals may be delayed, which would mean that we
would be unable to commercially distribute and market our product. The process of seeking
regulatory clearance or approval to market a pharmaceutical product is expensive and time consuming
and, notwithstanding the effort and expense incurred, clearance or approval is never guaranteed.
Also, the FDA has substantial discretion in the drug approval process. We cannot market a drug
product in the United States unless it has been approved by the FDA. The FDA approval process
involves, among other things, successfully completing clinical trials under an IND
and obtaining a premarket approval after filing a NDA. Clinical
trials are expensive and uncertain. The NDA process would require us to prove the safety and
efficacy of our product to the FDAs satisfaction. If our clinical trials fail to produce
sufficient data to support an NDA, it will take us longer to ultimately commercialize a product and
generate
revenue, or the delay could result in our being unable to do so. Moreover, our development
costs will increase if, to achieve sufficient data to support an NDA, we need to perform more or
larger clinical trials than planned. Even if we are successful in developing a pharmaceutical
product, if we are not successful in obtaining timely clearance or approval of the product from the
FDA, we may never be able to generate sufficient revenue to support the successful
commercialization of the product. Also any FDA approved product will be subject to continuing
review and the labeling, packaging, adverse event reporting, storage, advertising and promotion of
any such product will be subject to extensive regulation.
We do not have long-term contracts with any of our retail customers or independent
distributors selling our low-TSNA smokeless tobacco products and a loss or material reduction in
their business with us could result in reduced sales of our products.
Our success in marketing our low-TSNA smokeless tobacco products is dependent upon the
willingness and ability of retail customers to market and sell our products to consumers, as well
as our success in developing new channels for our low-TSNA smokeless tobacco products. If any of
our significant retail customers or independent distributors were to reduce the quantity of the
products we sell, or to stop selling our products, or if we are unable to open new distribution
channels for our products, our financial condition and results of operations could be adversely
affected.
Our retail customers and independent distributors generally purchase products from us on a
purchase-order basis and do not have long-term contracts with us. Consequently, with little or no
notice and without penalty, our retail customers and independent distributors may terminate their
relationships with us or materially reduce the level of their purchases of our products. If this
were to occur with one or more retail customers or independent distributors, who purchase
significant quantities of our products, it may be difficult for us to establish substitute
relationships in a timely manner, which could have a material adverse effect on our financial
condition and results of operations.
We are dependent on domestic sales of CigRx® and our low-TSNA smokeless tobacco products.
All of our revenues are currently derived from domestic sales of CigRx® and our low-TSNA
smokeless tobacco products. The overall market for tobacco products in the U.S. has been declining
on a year-to-year basis for the last several years, even as the market for smokeless tobacco
products has been growing. Because CigRx® and our low-TSNA smokeless tobacco products are being
marketed only in the U.S., we do not currently have access to any foreign markets, which access
could help offset the impact of declining sales of tobacco products in the U.S.
24
If we experience product recalls, we may incur significant and unexpected costs and our
business reputation could be adversely affected.
We may be exposed to product recalls and adverse public relations if our nutraceuticals
products or our low-TSNA smokeless tobacco products are alleged to cause illness or injury, or if
we are alleged to have violated governmental regulations. A product recall could result in
substantial and unexpected expenditures, which could reduce operating profits and cash flow. In
addition, a product recall may require significant management time and attention and may adversely
impact on the value of our brands. Product recalls may lead to greater scrutiny by federal or state
regulatory agencies and increased litigation, which could have a material adverse effect on our
financial condition and results of operations.
The tobacco industry is subject to substantial and increasing regulation and taxes with
respect to the sale and marketing of its products.
The FDA Tobacco Act provides The Center for Tobacco Products, a new division within the FDA,
with broad authority over the manufacturing, sale and distribution of tobacco products including
expanded control over the introduction of new tobacco products, warnings that must be included on
all tobacco products and the manner in which tobacco products may be marketed and sold.. The FDA
Tobacco Act also provides for the establishment of a Scientific Advisory Committee that, among
other initiatives, has been designated to undertake an analysis of dissolvable tobacco products and
to provide a report on such
products within two years from the date on which this committee was first convened. As
currently implemented, we do not believe the FDA Tobacco Act presents a material risk to our
business activities, but there is no assurance that the current legislation as implemented by the
FDA will not limit or delay our future initiatives or that difficulties and/or delays in obtaining
approvals from the FDA will not have an adverse impact on our ability to market our low-TSNA
smokeless tobacco products and the applications that we have filed to have variants of our existing
products designated as modified risk tobacco products.
We have a license from the TTB to manufacture smokeless tobacco products.. To the extent that
we are unable to maintain our current TTB license or to obtain any additional licenses required by
the TTB, this could materially and adversely affect our operations. Also, we are subject to
assessments based on our sales volume to cover a portion of the fund established in 2004 to
compensate growers and quota holders at the time that the U.S. Congress eliminated the federal
tobacco quota system and price support system. While the impact of this legislation is less
significant in relation to the sale of smokeless tobacco products than for cigarettes, if sales of
our smokeless tobacco products increase substantially, we would have increased obligations during
the ten-year period in which the buyout program is in effect.
The federal excise tax on smokeless tobacco products is substantially lower than the excise
tax for cigarettes, but smokeless tobacco products are subject to substantial and increasing excise
taxes. The current federal excise tax for snuff is $1.51 per pound. It is possible that increased
use of smokeless tobacco products could result in more stringent regulation and higher taxes.
Recently a number of states have considered increases in state excise taxes on smoked and
smokeless tobacco products. At the state level the rate of tax on smokeless tobacco varies
significantly. For example, one state imposes no tax on smokeless tobacco products while another
state imposes a tax of $2.02 per ounce. New or increased excise taxes or restrictions on the use of
tobacco products may result in declines in sales volume for the industry generally, and our
low-TSNA smokeless tobacco products in particular, which could adversely affect our operating
income and cash flows.
We have had substantial obligations under state laws adopted under the Master Settlement
Agreement.
In November 1998, 46 states and the District of Columbia, or the Settling States, entered into
the Master Settlement Agreement, or MSA, to resolve litigation that had been instituted against the
major tobacco manufacturers. We did not join the MSA and while we manufactured and sold cigarette
products we were required to satisfy certain escrow obligations pursuant to statutes that the MSA
required the Settling States to adopt in order for such states to receive the full benefits of the
settlement. We discontinued the sale of any cigarette products in June 2007 and we sold the
rights, title and interest in and to all income from and reversionary interest in our MSA escrow
accounts in May 2007. Although we sold the rights in and to all income from and reversionary
interest in the funds deposited into the MSA escrow accounts for sales through 2006, these MSA
escrow funds remain in our name and the principal amount of these accounts will be available to
satisfy portions of any state judgments or settlements for the type of claims asserted against the
major tobacco manufacturers in the suits that resulted in the negotiation of the MSA. However, if
such claims are successfully asserted in litigation against us in the future, the claims could
exceed the amounts that have been deposited into escrow under the MSA which could adversely affect
our operating income and cash flows.
25
We have many potentially dilutive derivative securities outstanding and the issuance of these
securities as well as the future sales of our common stock would have a dilutive effect on current
stockholders.
At March 15, 2011, we had outstanding options granted to directors, employees and consultants
to purchase approximately 8,620,200 shares of our common stock, with a weighted-average exercise
price of $2.31 per share, of which options for 8,220,200 shares were exercisable at March 15,
2011. We also have outstanding warrants, which are currently exercisable into 35,897,255 shares of
our common stock, with a weighted-average exercise price of $1.75 per share. Exercise of
outstanding stock options or warrants would cause dilution, which could adversely affect the market
price of our common stock. If we issue
additional shares of our common stock for sale in connection with future financings, our
stockholders would experience further dilution.
The combination transaction between RJR and B&W may negatively impact us.
Under our prior agreements with B&W, B&W loaned us $29 million to fund our purchase of
StarCured® tobacco curing barns. The balance on this loan was approximately $7.5 million as of
December 31, 2010. Previously, B&W granted us a number of concessions under our loan agreement,
including deferring interest and principal payments and consenting to our incurrence of additional
indebtedness. In 2004 B&W and RJR completed a combination of their United States tobacco business
through a new entity Reynolds American, Inc. We are currently involved in a significant patent
infringement litigation with RJR, which, in effect, is the successor of the RJR and B&W
combination. Although our current loan is unsecured, RJRs failure to grant us concessions under
our loan could have a number of adverse consequences, including restricting our pursuit of business
opportunities with third parties, limiting our ability to raise funds through debt financing and
requiring payment of our obligations in circumstances where we may not have sufficient funds
available to do so. Since the combination of B&W and RJR, we have had no operational relationship
with RJR and given our ongoing patent litigation against RJR, we do not anticipate that we would
have the same type of cooperative relationship with RJR as we had with B&W, or that RJR would be
inclined to grant concessions similar to those that we received from B&W.
We may be assessed additional sales and use taxes by the Commonwealth of Virginia.
In 2002, the Virginia Department of Taxation asserted a Virginia Sales and Use Tax assessment
for the period January 1, 1999, through March 31, 2002, against us with respect to our
tobacco-curing barns in the amount of $860,115. We applied for a correction of the assessment and a
total abatement of the tax on the grounds that our barns are exempt from sales and use taxes under
the industrial use and processing exemption and/or the agricultural exemption. In a letter dated
October 7, 2004, our company received notification from the Commonwealth of Virginia that an
adverse decision had been made by the Commissioner of Taxation with respect to the sales and use
tax assessment previously issued to our company. On August 10, 2010 the Commonwealth of Virginia
responded to our request for reconsideration of the states sales and use tax assessment with
respect to our tobacco curing barns. The Commonwealth disagreed with our position that the barns
are part of the manufacturing process and, therefore, exempt from sales and use taxes under the
industrial use and processing exemption and/or the agricultural exemption, concluding that the
barns are taxable under the Commonwealths sales tax laws and regulation. We disagree with the
ruling by the Commissioner and intend to timely pursue this matter through all available means. The
sales and use tax assessment plus penalties and interest together, as of December 31, 2010, totaled
$1.5 million. Interest will continue to accrue during our continued pursuit of a resolution of this
matter.
Lawsuits may affect our profitability and we have limited insurance coverage for any damages
for which we may become liable.
We are not, nor have we ever been, named as a defendant in any legal proceedings involving
claims arising out of the sale, distribution, manufacture, development, advertising, marketing and
claimed health effects relating to the use of our tobacco products. 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
asserted in a number of these cases in addition to compensatory and other damages. In the past, we
maintained product liability insurance only with respect to claims that tobacco products
manufactured by or for us contained any foreign object, i.e. any object that is not intended to be
included in the manufactured product. We currently do not maintain such insurance. The product
liability insurance we previously maintained did not cover health-related claims such as those that
have been made against the major manufacturers of tobacco products. We currently do not have and do
not believe that such insurance coverage for health-related claims can be obtained. If, in the
future, we are named as a defendant in any actions related to our smokeless tobacco products, we
will not have insurance coverage for damages relating to any such claims, which could have a
material adverse effect on our financial condition. We may also face lawsuits relating to
our dietary supplement CigRx®, although CigRx® is not a tobacco product and does not contain
nicotine. Prior to the introduction of CigRx®, we obtained product liability insurance for CigRx®
as a nutraceutical product. This insurance covers claims arising from product defects or claims
arising out of the sale, distribution and marketing of our CigRx® product. There have been no
claims asserted with respect to the manufacturer, sale or use of our CigRx® product to date. If
any such claims are asserted in the future and ultimately result in liability that exceeds the
limits of our insurance coverage, this could have a materially adverse effect on our financial
condition.
26
If we do not effectively manage our growth, we may be unable to successfully develop, market
and sell our products.
Our future revenue and operating results will depend on our ability to manage the anticipated
growth of our business. If we are successful in 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. Also, if we are successful in marketing our CigRx®
dietary supplement we will have to maintain sufficient capacity for the contract manufacturing of
the product and for its sales and distribution though third-party contractors. There can be no
assurance that we can overcome the challenge of scaling up our processing and production
operations, that our personnel, systems, procedures and controls will be adequate to support our
future operations or that we will be able to increase or secure additional capacity through
third-party contractors for the manufacturing, sale and distribution of CigRx®. Any failure to
implement and improve our operational, financial and management systems, to attract, integrate,
motivate and retain additional employees required by future growth, if any, or to secure any
needed capacity through third party contractors, if required, could have a material and adverse
effect on our business and prospects, financial condition and results of operations.
We may lose our key personnel or fail to attract and retain additional personnel.
We are highly dependent upon the continued services of our senior management team for our
continued success. The loss of any one of Jonnie R. Williams, our Chief Executive Officer, Paul L.
Perito, our Chairman, President and Chief Operating Officer, David M. Dean, our Vice President of
Sales and Marketing, Park A. Dodd III, our Chief Financial Officer, Robert E. Pokusa, our General
Counsel or Curtis Wright, M.D., MPH, Senior Vice-President Medical/Clinical Director of Rock Creek
could have a serious negative impact on our business and operating results.
Our future success depends in large part on our ability to attract and retain, on a continuing
basis, consulting services from highly qualified scientific, technical, management, financial and
marketing personnel. Competition for such personnel is intense and there can be no assurance that
we will be able to attract and retain the personnel necessary for the development and operation of
our business or that given the operating losses we have suffered over
the past eight years we will
have the financial ability to do so. The loss of the services of key personnel or the termination
of relationships with independent scientific and medical investigators could have a material and
adverse effect on our business.
Our directors and executive officers own a large percentage of our voting stock, which allows
them to exercise significant control over us, and they may make decisions with which you disagree.
Based on stock ownership as of March 15, 2011, our directors and executive officers and their
affiliates, own an aggregate of approximately 10.6% of our currently issued and outstanding common stock. As a result,
these persons acting together may have the ability to influence matters submitted to our
stockholders for approval and to control the management and affairs of our company. This
concentration of ownership may have the effect of delaying or preventing a change in control of our
company, impede a merger, consolidation, or takeover or other business combination, or discourage a
potential acquirer from attempting to obtain control. This concentration of control could also have
a negative effect on the market price of our shares.
27
Our stock price has been and may continue to be volatile and an investment in our common stock
could suffer a decline in value.
The trading price of the shares of our common stock has been, and may continue to be, highly
volatile. Our stock has traded at prices ranging from $0.51 to $3.84
for the period January 1, 2010 to March 15, 2011. We receive only limited attention from securities analysts and may experience an imbalance between
supply and demand for our common stock resulting from low trading volumes. The market price of our
common stock may fluctuate significantly in response to a variety of factors, most of which are
beyond our control, including the following:
|
|
|
developments related to our patents or other proprietary rights, including developments
in our litigation against RJR; |
|
|
|
developments in our efforts to market smokeless tobacco products; |
|
|
|
our success in marketing, CigRx®, our non-nicotine, non-tobacco smoking alternative
designed to temporarily reduce the desire to smoke, related nutraceuticals designed to
assist in maintaining a healthy metabolism, a pharmaceutical product to treat
tobacco-related dependence and related pharmaceutical products; |
|
|
|
announcements of new products, technological innovations, contracts, acquisitions,
financings, corporate partnerships or joint ventures by us or our competitors; |
|
|
|
negative regulatory action or regulatory approval with respect to our products or our
competitors products; and |
|
|
|
market conditions for the tobacco, pharmaceutical and dietary supplement industries in
general. |
The stock market has, from time to time, and in particular over the last 24 months,
experienced extreme price and volume fluctuations that have particularly affected the market prices
for small companies, and which have often been unrelated to their operating performance or
prospects for future operations. These broad fluctuations may adversely impact the market price of
our common stock. In addition, sales of substantial amounts of our common stock in the public
market could lower the market price of our common stock.
On November 5, 2009, we received a NASDAQ Staff Deficiency Letter, indicating that we were not
in compliance with the minimum bid price requirement for continued listing set forth in NASDAQ
Marketplace Rule 5450(a)(1), because the bid price per share of the our common stock closed below
$1.00 per share for 30 consecutive business days. On March 16, 2010, we announced that we had
received a notice from NASDAQ confirming that we were once again in compliance with the minimum bid
price requirement and we have remained complaint with this requirement since that time.
28
|
|
|
ITEM 1B. |
|
UNRESOLVED STAFF COMMENTS |
We have not received any written comments from the SEC staff regarding our companys Quarterly
Reports on Form 10-Q or Current Reports on Form 8-K in the 180 days preceding December 31, 2010.
Until February 2010 we occupied approximately 6,000 square feet of office space in Petersburg,
Virginia that housed our executive, marketing and administrative offices. In October 2009, we sold
our Petersburg property and entered into a leaseback of the office space. As of February 2010 we
began leasing approximately 2,500 square feet of office space for our executive, marketing and
administrative offices in Glen Allen, Virginia, which is located in the Richmond, Virginia
metropolitan area. We terminated the leaseback for the Petersburg property in February, 2010, once
we completed our transition to the property in Glen Allen.
Until July 2007, our executive, administrative, legal and scientific offices were located in a
5,600 square foot leased office space in Bethesda, Maryland. We terminated that lease in July 2007
and entered into a lease for a smaller amount of office space in Bethesda. We also have been
utilizing space in a nearby location in Washington, DC to support our executive, administrative and
scientific activities for both Star Scientific and Rock Creek. The Washington, DC area was selected
as the primary location for our executive, administrative, legal and scientific activities to
provide our executives and scientific and medical consultants access to the FDA, National
Institutes of Health and the U.S. National Medical Library, as well as access to the U.S. Congress,
the Executive branch of the federal government and the various related federal agencies located in
the greater Washington, DC area. Rock Creek also has scientific and research offices in Gloucester,
MA consisting of approximately 3,200 square feet of office space.
We lease from the Mecklenburg County Industrial Development Authority approximately nine acres
of land in Chase City, Virginia. This lease also includes a building containing approximately
91,000 square feet of space that accommodates our manufacturing operations, an expanded testing
facility and office space. We have approximately one year remaining on the initial ten-year
portion of the lease for this facility, which is then subject to renegotiation of the lease
payments for the additional ten years of the lease. We also have an option to buy the property at
any time during the lease.
We believe our manufacturing facilities and other facilities will be sufficient to allow us to
respond to the demand for our smokeless tobacco products for the foreseeable future.
|
|
|
ITEM 3. |
|
LEGAL PROCEEDINGS |
RJR Litigation
In May 2001, we filed a patent infringement action against RJR in the United States District
Court for Maryland, Southern Division, or District Court, to enforce our companys rights under
U.S. Patent No. 6,202,649 (649 Patent), which claims a process for substantially preventing the
formation of TSNAs in tobacco. On July 30, 2002, we filed a second patent infringement lawsuit
against RJR in the District Court based on a new patent issued by the U.S. Patent and Trademark
Office on July 30, 2002 (Patent No. 6,425,401). The new patent is a continuation of the 649
Patent, and on August 27, 2002 the two suits were consolidated.
In April 2003, the parties filed dispositive Motions for Summary Judgment. After appointment
of a Special Master to prepare Reports and Recommendations, or R&Rs, for the District Court on six
of the Summary Judgment Motions, the District Court adopted without modification the Special
Masters R&Rs, which collectively recommended that the District Court deny RJRs Summary Judgment
Motions, and that our Motion for Summary Judgment on claim construction and definiteness be granted
in part and denied in part. The District Court also issued an order denying RJRs other Motion for
Summary Judgment seeking to limit our damages claim.
29
On August 17, 2004, the case was transferred from Judge Alexander Williams to Judge Marvin J.
Garbis. Judge Garbis over the next several months issued a series of orders concerning various
aspects of the case and ordered that the RJRs defense of inequitable conduct before the patent
office be bifurcated from the remaining issues and tried before Judge Garbis beginning on January
31, 2005. That portion of the case was tried during the period January 31, 2005 to February 8,
2005. At the conclusion of the bench trial, the District Court advised the parties that it would
take the matter under advisement, and expected to rule on this portion of the case at the same time
that it ruled on the two additional Summary Judgment Motions that were filed by RJR on January 25,
2005. On January 19, 2007, the District Court granted RJRs Motions for Summary Judgment in part
and denied these motions in part. On RJRs Motion for Summary Judgment on the Effective Filing Date
of the patents, the District Court established September 15, 1999 as the effective filing date, but
denied RJR Summary Judgment of Invalidity with regard to the patents-in-suit. On RJRs Motion for
Summary Judgment on Indefiniteness, the District Court granted the motion on the basis that the
term anaerobic condition was indefinite. On June 26, 2007 the District Court issued its ruling on
RJR inequitable conduct defense. In its ruling the District Court held the two patents
unenforceable due to inequitable conduct in their procurement and a final judgment against our
company was docketed on June 27, 2007. We immediately filed a notice of appeal as to the rulings
issued in January 2007 and as to the ruling on the inequitable conduct defense with the United
States Court of Appeals for the Federal Circuit, or Court of Appeals.
Following briefing and oral argument, the Court of Appeals on August 25, 2008 issued a
unanimous opinion reversing the rulings by the District Court that had found the patents at issue
in the RJR litigation invalid because of inequitable conduct during the prosecution of the patents
and because the patents were indefinite. As part of its opinion, the Court of Appeals ordered that
the case be remanded to the District Court for further proceedings on the infringement complaint.
Following remand from the Court of Appeals, the
case was tried to a jury in the District Court between May 18, 2009 and June 16, 2009. At the
conclusion of the trial, the jury returned a verdict in favor of RJR holding that there was no
infringement of the two patents at issue in the case and that the patents were invalid due to
anticipation, obviousness, indefiniteness and failure to disclose best mode. On July 7, 2009, we
filed a motion with the District Court for Judgment as a Matter of Law or, in the Alternative, for
a New Trial. That motion was denied on December 21, 2009 and judgment was entered on the jury
verdict that day. We filed a Notice of Appeal to the United States Court of Appeals for the Federal
Circuit Court of Appeals on December 22, 2009 and our opening brief was filed on May 5, 2010. RJR
filed its brief on August 2, 2010 and our reply was filed on September 20, 2010. Oral argument on
the appeal was held before a three-judge Panel of the Federal Circuit Court of Appeals on January
11, 2011. We are currently awaiting a decision from the Federal Circuit Court of Appeals on the
appeal.
On November 30, 2009, RJR filed a motion for a bill of cost for $442,388.05. RJR also filed a
motion requesting the District Court to determine that this is an exceptional case under 35
U.S.C. § 285 and award attorneys fees of approximately $35 million under that provision and/or
under 28 U.S.C. § 1927 on the basis that attorneys fees were unreasonably multiplied during the
litigation. As part of the Orders issued on December 21, 2009, the District Court stayed the motion
for attorneys fees until after a ruling on the pending appeal and the reexamination before the
U.S. Patent and Trademark Office. The Court on January 8, 2010 stayed any further briefing on the
renewed petition for a bill of cost that RJR filed on December 30, 2009. Any potential award of
attorneys fees should be eliminated if the Court of Appeals for the Federal Circuit overturns the
jury verdict in the District Court or if the claims at issue in the reexamination proceeding in the
U.S. Patent and Trademark Office are determined to be valid, and any award of costs should also be
eliminated if the Federal Circuit overturns the jury verdict in favor of RJR. Because the
likelihood of an unfavorable ruling on the fee motion and bill of cost is not determinable at this
time and the amount of any potential assessment cannot be reasonably estimated, no amounts have
been accrued for these items in the accompanying condensed consolidated financial statements.
On May 29, 2009, we filed a new complaint against RJR for patent infringement during the
period beginning 2003 through the filing date of the complaint. In an Order dated January 8, 2010,
the Court stayed any further action in this case until after a ruling on the appeal in the initial
infringement action against RJR. The future prosecution of the new complaint will be dependent on
our achieving a reversal of the jury verdict of invalidity in our initial RJR action.
On December 31, 2008 and January 2, 2009, RJR filed requests in the U.S. Patent and Trademark
Office to reexamine the two patents that are the subject of the patent infringement litigations
described above. In February and March 2009, the Patent and Trademark Office granted the
reexamination requests, agreeing to review the patentability of the subject matter claims 4, 12 and
20 of the 649 patent and claim 41 of the 401 patent.
On March 10, 2011, the Patent and Trademark Office confirmed the validity of each of the
claims of the 649 and 401 patents that were under reexamination and closed each of the
reexamination proceedings.
30
We entered into fee arrangements with counsel in several litigation and related matters under
which certain costs related to the litigation are being advanced by counsel on our companys
behalf. Given the contingent nature and the fact that a probability assessment of liability cannot
be made at this time, no accrual has been made for this contingent liability. We have paid or
accrued all existing obligations. Also, as part of our fee arrangements in certain of these
matters, we have agreed to pay counsel a percentage of any damage
awards, a percentage of the
resulting payments we actually receive or a result fee in the event that the litigation is resolved in our favor,
in return for a cap on fee payments during the litigation.
Internal Revenue Service Examination
In 2004, we were notified that our companys 2001 tax return had been selected for examination
by the Internal Revenue Service, or IRS. In the course of its conduct of this examination, the IRS
expanded the scope of the examination to include all of our companys returns that had been filed
for the years ended December 31, 2002 through 2004. In 2005, our request for a private letter
ruling, or PLR, which related to the years under IRS examination, was resolved generally in our
favor and an amended private letter ruling, or Amended PLR, was issued by the IRS in January 2009.
The Amended PLR confirmed that our companys deductions taken for MSA escrow payments, which were
the subject of the IRS ongoing audit for tax years 2001 through 2004 and a pending tax appeal, were
fully deductible and appropriate in the years taken. Based on the Amended PLR, we entered into a
closing agreement with the IRS which confirmed the deductions taken for those years and,
thereafter, the IRS confirmed that our companys tax returns for the years 2001 through 2004 were
correct as filed. As a result of the notification by the IRS in the Amended PLR, we reversed our
position of recording this income tax expense as of December 31, 2008, which resulted in a $2.2
million income tax benefit.
Virginia Sales and Use Tax Assessment
In 2002, the Virginia Department of Taxation asserted a Virginia Sales and Use Tax assessment
for the period January 1, 1999, through March 31, 2002, against us with respect to our
tobacco-curing barns in the amount of $860,115. We applied for a correction of the assessment and a
total abatement of the tax on the grounds that our barns are exempt from sales and use taxes under
the industrial use and processing exemption and/or the agricultural exemption. In a letter dated
October 7, 2004, our company received notification from the Commonwealth of Virginia that an
adverse decision had been made by the Commissioner of Taxation with respect to the sales and use
tax assessment previously issued to our company. On August 10, 2010 the Commonwealth of Virginia
responded to our request for reconsideration of the states sales and use tax assessment with respect to our tobacco curing
barns. The Commonwealth disagreed with our position that the barns are part of the manufacturing
process and, therefore, exempt from sales and use taxes under the industrial use and processing
exemption and/or the agricultural exemption, concluding that the barns are taxable under the
Commonwealths sales tax laws and regulation. We disagree with the ruling by the Commissioner and
intend to timely pursue this matter through all available means. The sales and use tax assessment
plus penalties and interest together, as of December 31, 2010, totaled $1.5 million. Interest will
continue to accrue during our companys continued pursuit of a resolution of this matter.
Except as set forth above, there are no other litigation matters pending that could be
expected to materially harm our results of operations and financial condition.
|
|
|
ITEM 4. |
|
(RESERVED AND REMOVED) |
31
PART II
|
|
|
ITEM 5. |
|
MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS |
Our companys common stock, par value $0.0001 per share, is traded on the NASDAQ Global Market
under the symbol CIGX (formerly STSI). On
March 15, 2011, the closing price of our common stock as reported on the NASDAQ Global Market was $2.94. Set forth below are the high and low sales
prices for each full quarterly period during 2010 and 2009, as reported by NASDAQ. From time to
time, during the periods indicated, trading activity in our common stock was infrequent. As of
March 15, 2011, there were approximately 630 registered holders of our common stock.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2010 |
|
|
2009 |
|
|
|
High |
|
|
Low |
|
|
High |
|
|
Low |
|
Quarter |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First |
|
$ |
3.00 |
|
|
$ |
0.66 |
|
|
$ |
4.75 |
|
|
$ |
2.11 |
|
Second |
|
|
3.05 |
|
|
|
1.07 |
|
|
|
5.89 |
|
|
|
0.84 |
|
Third |
|
|
2.32 |
|
|
|
1.40 |
|
|
|
1.15 |
|
|
|
0.84 |
|
Fourth |
|
|
2.12 |
|
|
|
1.64 |
|
|
|
1.02 |
|
|
|
0.51 |
|
We have never paid dividends on our common stock, and our Board of Directors currently intends
to retain any earnings for use in our business for the foreseeable future. Any future determination
as to the payment of such cash dividends would depend on a number of factors including future
earnings, results of operations, capital requirements, our financial condition and any restrictions
under credit agreements outstanding at the time, as well as such other factors as the Board of
Directors might deem relevant. No assurance can be given that we will pay any dividends in the
future.
Securities Authorized for Issuance Under Equity Compensation Plan
The following table provides certain information as of December 31, 2010, with respect to our
equity compensation plans under which our common stock is authorized for issuance:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted- |
|
|
|
|
|
|
Number of Shares |
|
|
Average |
|
|
Number of Securities |
|
|
|
to be Issued Upon |
|
|
Exercise |
|
|
Remaining Available |
|
|
|
Exercise of |
|
|
Price of |
|
|
for Future Issuance |
|
|
|
Outstanding |
|
|
Outstanding |
|
|
Under Equity |
|
|
|
Options |
|
|
Options |
|
|
Compensation Plans |
|
Plan Category |
|
and Rights(1) |
|
|
and Rights |
|
|
(excluding Column (a)) |
|
|
|
(a) |
|
|
(b) |
|
|
(c) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity
Compensation Plans
Approved by
Shareholders |
|
|
7,716,200 |
|
|
$ |
2.31 |
|
|
|
2,684,000 |
|
|
|
|
(1) |
|
We have also granted warrants to purchase shares of our common stock to consultants.
Specifically, on December 20, 2000, we issued 210,526 warrants to purchase shares of our
common stock at an exercise price of $2.375 to a consultant. These warrants fully vested on
the date of issuance and expired on December 20, 2010. |
32
Five-year financial performance graph: 2006-2010
Comparison of five-year cumulative return among Star Scientific, the S&P Tobacco Industry Group,
and the S&P Composite
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
FISCAL YEAR ENDING |
|
COMPANY / INDEX / MARKET |
|
2005 |
|
|
2006 |
|
|
2007 |
|
|
2008 |
|
|
2009 |
|
|
2010 |
|
Star Scientific, Inc. |
|
|
100.00 |
|
|
|
138.50 |
|
|
|
33.87 |
|
|
|
162.98 |
|
|
|
29.79 |
|
|
|
82.98 |
|
S&P Tobacco Group |
|
|
100.00 |
|
|
|
115.79 |
|
|
|
122.16 |
|
|
|
76.96 |
|
|
|
97.33 |
|
|
|
111.99 |
|
S&P Composite |
|
|
100.00 |
|
|
|
122.16 |
|
|
|
146.41 |
|
|
|
119.69 |
|
|
|
150.34 |
|
|
|
191.98 |
|
The current composition of S&P Industry Group 30203010 Tobacco is as follows:
ALTRIA GROUP, INC.
PHILIP MORRIS INTERNATIONAL, INC.
LORILLARD, INC.
REYNOLDS AMERICAN, INC.
The Stock Performance Graph shall not be deemed to be soliciting materials or to be filed
with the SEC or subject to the liabilities of Section 18 under the Securities Exchange Act of 1934,
as amended, or Exchange Act. In addition, it shall not be deemed incorporated by reference by any
statement that incorporates this Annual Report on Form 10-K by reference into any filing under the
Securities Act of 1933, as amended, or Securities Act, or the Exchange Act, except to the extent
that we specifically incorporate this information by reference.
33
Option Grants and Stock Awards
In 2010, we granted our directors, or the Purchaser Class, options to purchase our common
stock as described in our Quarterly Reports on Form 10-Q filed during 2010 or during the fourth
quarter of 2010 from our companys 2008 Incentive Award Plan. On October 22, 2010, the Board of
Directors elected Burton J. Haynes, Esquire as an Independent Director. Upon his election to the
Board, Mr. Haynes was awarded a stock option grant in the amount of 50,000 option shares. Those
options have a strike price of $2.03 per share and aggregate stock compensation of $86 thousand,
which will be recognized in the financial statements over the two year vesting period of the
options. On November 20, 2010, 50,000 options for shares of our common stock with an exercise price
of $1.75 were granted to one member of the Purchaser Class.
|
|
|
ITEM 6. |
|
SELECTED FINANCIAL DATA |
The selected consolidated financial data of our company, for and as of the end of each of the
periods indicated in the five-year period ended December 31, 2010, have been derived from our
companys audited consolidated financial statements. The selected consolidated financial data
should be read in conjunction with Item 7. Managements Discussion and Analysis of Financial
Condition and Results of Operations and our consolidated financial statements and the related
notes included in Item 15. Exhibits, Financial Statement Schedules of this Report.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31, |
|
|
|
2010 |
|
|
2009 |
|
|
2008 |
|
|
2007 |
|
|
2006 |
|
|
|
(In thousands, except per share data) |
|
Statement of Operations Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
848 |
|
|
$ |
708 |
|
|
$ |
451 |
|
|
$ |
482 |
|
|
$ |
391 |
|
Cost of goods sold (excludes federal
excise tax) |
|
|
2,172 |
|
|
|
2,612 |
|
|
|
2,116 |
|
|
|
2,067 |
|
|
|
1,791 |
|
Gross margin (loss) |
|
|
(1,337 |
) |
|
|
(1,920 |
) |
|
|
(1,672 |
) |
|
|
(1,604 |
) |
|
|
(1,404 |
) |
Loss from continuing operations before
income taxes |
|
|
(28,281 |
) |
|
|
(22,800 |
) |
|
|
(20,564 |
) |
|
|
(40,882 |
) |
|
|
(13,790 |
) |
Discontinued operations income(loss) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(451 |
) |
|
|
1,505 |
|
Net income (loss) |
|
|
(28,281 |
) |
|
|
(22,800 |
) |
|
|
(18,339 |
) |
|
|
(41,458 |
) |
|
|
(12,285 |
) |
Basic and diluted income (loss) per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Continuing operations |
|
$ |
(0.24 |
) |
|
$ |
(0.22 |
) |
|
$ |
(0.20 |
) |
|
$ |
(0.51 |
) |
|
$ |
(0.18 |
) |
Discontinued operations |
|
|
|
|
|
|
|
|
|
$ |
|
|
|
$ |
(0.01 |
) |
|
$ |
0.02 |
|
Total basic and diluted income (loss) per
share |
|
$ |
(0.24 |
) |
|
$ |
(0.22 |
) |
|
$ |
(0.20 |
) |
|
$ |
(0.52 |
) |
|
$ |
(0.16 |
) |
Weighted average shares outstanding |
|
|
118,384 |
|
|
|
101,907 |
|
|
|
89,844 |
|
|
|
80,395 |
|
|
|
77,836 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31, |
|
|
|
2010 |
|
|
2009 |
|
|
2008 |
|
|
2007 |
|
|
2006 |
|
|
|
(In thousands, except per share data) |
|
Balance Sheet Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
13,192 |
|
|
$ |
12,360 |
|
|
$ |
6,473 |
|
|
$ |
8,881 |
|
|
$ |
4,297 |
|
Property and equipment |
|
|
2,169 |
|
|
|
1,057 |
|
|
|
1,668 |
|
|
|
1,986 |
|
|
|
9,515 |
|
MSA escrow funds |
|
|
368 |
|
|
|
365 |
|
|
|
365 |
|
|
|
4 |
|
|
|
38,329 |
|
Discontinued operations assets |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,041 |
|
Total assets |
|
|
20,285 |
|
|
|
15,234 |
|
|
|
12,252 |
|
|
|
14,827 |
|
|
|
60,937 |
|
Long-term obligations |
|
|
5,049 |
|
|
|
7,518 |
|
|
|
9,499 |
|
|
|
11,111 |
|
|
|
14,975 |
|
Discontinued operations liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,443 |
|
Stockholders equity (deficit) |
|
$ |
10,659 |
|
|
$ |
2,288 |
|
|
$ |
(498 |
) |
|
$ |
(1,988 |
) |
|
$ |
38,909 |
|
|
|
|
ITEM 7. |
|
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The following discussion provides an assessment of our consolidated results of operations,
capital resources, and liquidity and should be read together with our consolidated financial
statements and related notes in Item 15. Exhibits, Financial Statement Schedules of this Report,
including note 17 thereof for information on the segment reporting for each of our operating
subsidiaries. This discussion includes forward-looking statements based on current expectations
that involve risks and uncertainties and should be read together with Item 1A. Risk Factors and
Special Note on Forward-Looking Statements elsewhere in this Report.
34
Overview
We are a technology-oriented company with a mission to reduce the harm associated with the use
of tobacco at every level. We are primarily engaged in:
|
|
|
the development, implementation and licensing of our proprietary
technology for the curing of tobacco so as to substantially prevent
the formation of carcinogenic toxins present in tobacco and tobacco
smoke, primarily the tobacco-specific nitrosamines, or TSNAs; |
|
|
|
|
the manufacture, sales, marketing and/or development of very low-TSNA
dissolvable smokeless tobacco products that carry enhanced warnings
beyond those required by the Surgeon General, including ARIVA®
compressed powdered tobacco cigalett®pieces and STONEWALL
Hard Snuff® and modified risk tobacco products as defined
in the Family Smoking Prevention and Tobacco Control Act of 2009, or
the FDA Tobacco Act; |
|
|
|
|
the development of pharmaceutical products, particularly products that
have a botanical, tobacco-based component, that are designed to treat
tobacco dependence and a range of neurological conditions, including
Alzheimers disease, Parkinsons disease, schizophrenia and
depression; and |
|
|
|
|
the manufacture, sale, marketing and development of non-nicotine
nutraceutical products designed to assist individuals who are seeking
a smoking alternative as well as related non-nicotine products that
are designed to assist consumers in maintaining a healthy metabolism. |
Since the 1990s, we have sought to develop processes and products that significantly reduce
the levels of toxins, principally TSNAs, in tobacco compared to traditional smoked and smokeless
tobacco products. Given our long-term focus on reducing the levels of toxins in tobacco and the
harm associated with tobacco use, we believe we are uniquely positioned to pursue a range of
very-low TSNA smokeless tobacco products as modified risk tobacco products under the FDA Tobacco
Act. We also believe that we are positioned to utilize our technology to produce a range of
non-nicotine nutraceuticals and tobacco-based pharmaceuticals furthering our mission to reduce the
harm associated with tobacco use at every level.
We currently are focusing our efforts on the manufacture and sale of CigRx®, our new dietary
supplement launched in test market during August 2010, and ARIVA ® and STONEWALL Hard Snuff®, our
dissolvable low-TSNA smokeless tobacco products. CigRx®, a non-nicotine, non-tobacco dietary
supplement manufactured and sold through our Rock Creek Pharmaceutical subsidiary, is designed to
temporarily reduce the desire to smoke. Rock Creek also continues to pursue the development of
botanical based products for the treatment of tobacco dependence, as well as products that would
utilize certain MAO agents in tobacco to treat a range of neurological conditions, including
Alzheimers disease, Parkinsons disease, schizophrenia and depression and other non-nicotine
nutraceutical products that may be helpful to consumers in maintaining a health metabolism. Our
significant experience with the proprietary technology related to the development of tobacco
products with reduced levels of toxins also has positioned us to seek the approval of a variant of
our very-low TSNA smokeless tobacco products as modified risk tobacco products by the FDA under
the FDA Tobacco Act. In the past we deferred the initiation and continuation of certain research
projects because of the lack of working capital. Our success in promoting the sale of our low-TSNA
dissolvable smokeless tobacco products and CigRx® as well as our ability to resume our prior
research activities and continue the research efforts by Rock Creek will in large part depend on
our working capital constraints, ability to procure funding for these initiatives, and the
successful outcome of our ongoing patent infringement litigation with RJR.
Over the last several years, we have expended significant time and resources on our ongoing
patent infringement litigation with RJR, the development of ARIVA® and STONEWALL Hard Snuff®, our
low-TSNA dissolvable smokeless tobacco products, the licensing of low-TSNA products and the
technology behind, our StarCured® tobacco curing process, and the development efforts of Rock
Creek, particularly with respect to our CigRx® dietary supplement. Our future success will largely
depend on the successful results of these initiatives. While product licensing royalties and
smokeless tobacco sales have been de minimis to date, we intend to continue our efforts to develop
and sell smokeless tobacco products, develop pharmaceutical products to treat tobacco addiction and
a range of neurological conditions and the development of related non-nicotine nutraceutical
products, and to pursue licensing arrangements for those products and related technology.
35
Prospects for Our Operations
The recurring losses generated primarily by our smokeless tobacco business continue to impose
significant demands on our liquidity. Product licensing royalties and smokeless tobacco sales have
been de minimis to date. We introduced CigRx® into test market in August 2010 as a non-nicotine,
non-tobacco nutraceutical product that temporarily reduces the desire to smoke. Sales of CigRx®
have also been de minimis to date. Rock Creek also is pursuing the development of other
non-nicotine nutraceutical products, as well as pharmaceutical products that would utilize certain
MAO agents in tobacco to treat a range of neurological conditions, including Alzheimers disease,
Parkinsons disease, schizophrenia and depression. Given the typical long lead time for federal
approval of pharmaceutical products, we do not expect that Rock Creek will generate any revenues
for the foreseeable future from the sale of pharmaceutical products. Rather, we expect that Rock
Creek, in addition to the manufacturer and sale of CigRx®, will focus in the near time on the
development of other non-nicotine nutraceutical products and, on a longer-term basis, on the
research and development aspects of a range of pharmaceuticals, including tobacco-based drug
products.
Our future prospects are also dependent on the distribution and consumer acceptance of our
low-TSNA dissolvable smokeless tobacco products, our ability to support the expansion of the market
for these products and our continued development of new low-TSNA smokeless tobacco products, such
as the
modified risk tobacco products for which applications are currently pending before the FDA,
independently and through alliances with other tobacco manufacturers and pharmaceutical companies.
Our future results of operations are also dependent on our ability to begin generating significant
revenues through royalties from the patented tobacco curing process to which we are the exclusive
licensee. However, our ability to generate revenues through sales of our smokeless tobacco products
as well as the licensing of such products and the technology related to our patented curing process
will substantially be dependent upon the successful completion of the ongoing patent infringement
lawsuit against RJR.
We experienced revenue of approximately $0.8 million for 2010 and an operating loss from
continuing operations of approximately $(28.3) million. The recurring losses generated by
operations continue to impose significant demands on our companys liquidity. As of December 31,
2010, we had approximately $12.6 million of working capital, of which approximately $13.2 million
was cash and cash equivalents. Between January 1, 2010 and March 15, 2010, our company received
proceeds of approximately $13.8 million and on November 4, 2010 we received proceeds of $14.0
million, all from the sale of common stock in private placements.
Subsequent to December 31, 2010, we received proceeds of $11.0
million through the sale of common stock and the exercise of a
warrant in private placements. See Note 15 to our Consolidated
Financial Statements included in Item 15, Exhibits, Financial
Statement Schedules.
Absent the exercise of
outstanding warrants and options for cash or a substantial improvement in sales and revenues and/or
royalties, we believe that the recent funding will support our operations through the first quarter
2012. However, depending upon market conditions and the price of the common stock, we may decide to
seek additional funds before that date.
Smokeless Tobacco. Net Sales were $0.8 million in 2010 compared to $0.7 million in 2009.
STONEWALL Hard Snuff® represents a majority of our dissolvable tobacco sales. We continue to work
to increase the distribution and consumer acceptance of low-TSNA smokeless tobacco products as well
as the improvement of our existing very low-TSNA products, and the development of other smokeless
tobacco products, independently and through alliances with other tobacco manufacturers. While our
working capital constraints over the last several years have limited both our direct marketing of
smokeless products and our research and development efforts, we introduced in the first
quarter of 2010 three additional blends of our Ariva® low-TSNA smokeless tobacco product and a new
packaging format (10-piece sleeves) for ARIVA®.
Modified risk tobacco products. In 2009 and 2010 we developed Ariva-BDL and Stonewall-BDL,
as variants of our ARIVA® and STONEWALL Hard Snuff® smokeless tobacco
products that have significantly lower levels of carcinogenic TSNAs as well as other toxins
compared to conventional tobacco products and which are at levels comparable to those found in
nicotine replacement therapy products. In February, 2010, we submitted an application to the FDA
for the approval of Ariva-BDL as the first modified risk tobacco product under the FDA Tobacco Act
and we filed a similar application for Stonewall-BDL in June 2010. In February 2011, we filed a
third application with the FDA related to a moist snuff product, Stonewall Moist-BDL, also
requesting its designation as a modified risk tobacco product.
Introduction of CigRx® and Development of Tobacco-based Pharmaceutical Products and other
Nutraceuticals. In 2009, Rock Creek developed a non-nicotine, non-tobacco nutraceutical that is
intended to temporarily reduce the desire to smoke. This product, CigRx®, was introduced in August
2010 in the Richmond, Virginia area. We have been working jointly with InVentiv Health to develop
awareness for the CigRx® product through an outreach program involving visits to physicians and
other health care professionals and though direct advertising at the consumer level. In late
February 2011, we began testing
CigRx®
on a national basis through expanded infomercials and radio spots.
Through Rock Creek we are exploring the development of other related nutraceutical products that
may assist in stabilizing metabolism, pharmaceutical products with clinical claims, a
relapse prevention product to assist smokers during nicotine withdrawal, with the goal of higher
quit rates, as well as pharmaceutical products, including products for the treatment of tobacco
dependence, and a range of neurological conditions, including Alzheimers disease, Parkinsons
disease, schizophrenia and depression.
36
Discount Cigarettes. Until June 2007 we manufactured and sold a line of discount cigarette
products. In May 2007, we entered into an exclusive license agreement with Tantus for our cigarette
trademarks
MainStreet®, Sport® and GSmoke® in return for licensing fees during the seven-year term of the
license agreement and beyond, if the license is renewed. As part of the license agreement, we
stopped selling cigarettes under the MainStreet®, Sport® and GSmoke® brands in June 2007 and
discontinued our cigarette operations at that time. Although we retain the right to manufacture and
sell other cigarette brands, we are focusing our efforts on the sale of low-TSNA dissolvable
smokeless tobacco products, as opposed to cigarettes, consistent with our expressed intention to
transition from the sale of cigarette products to our low-TSNA smokeless tobacco products.
Licensing. We have an exclusive, worldwide license from Regent Court under 12 U.S.
patents and
51 foreign patents as well as additional patents pending in the U.S. and foreign countries relating
to methods to substantially prevent the formation of TSNAs in tobacco, including the StarCured®
tobacco curing process and the production of very low-TSNA tobacco products. The StarCured®
tobacco curing process involves the control of certain conditions in tobacco curing barns, and in
certain applications, the use of microwave and/or electron beam technology. The StarCured® process
substantially prevents the formation in the tobacco leaf of the carcinogenic TSNAs, which are
widely believed by medical and scientific experts to be among the most abundant and powerful
cancer-causing toxins present in tobacco and in tobacco smoke. Two of the patents under our license
with Regent Court that relate to our method for producing low-TSNA tobacco are the subject of our
ongoing lawsuit against RJR.
See Item 3 Legal Proceedings for further details.
We continue to pursue means of collecting royalties for our curing technology through
licensing arrangements and through our patent infringement lawsuit against RJR. Any royalties
arising from the license of our curing technology will be dependent on the successful completion of
our patent litigation against RJR. While licensing of our exclusive patent rights is a major
potential source of additional revenue for us, full realization of this potential also will depend
on our ability to successfully defend and enforce our patent rights.
Federal and State Legislation Relating to Cigarettes and Smokeless Tobacco Products. On June
22, 2009, President Barack Obama signed into law the
FDA Tobacco Act, which provides a new division within the FDA (The Center for Tobacco Products)
broad authority over the way tobacco products are manufactured and sold, including requiring
expanded warnings on all tobacco products and imposing restrictions on the manner in which tobacco
products may be marketed. The FDA Tobacco Act permits companies to apply to have products designated as
modified risk tobacco products and in February 2010 we filed an application to have our
Ariva-BDL product designated as a modified risk tobacco product because of the lower levels of
toxins (principally the carcinogenic TSNAs) in this product. We filed a similar application for a
Stonewall-BDL product in June 2010 and an application for a third product Stonewall Moist-BDL in
February 2011. The FDA Tobacco Act also contains provisions that eventually could be beneficial to us in
marking our very-low TSNA smokeless tobacco products, such as those that would require a listing of
various constituent elements and the publication of ingredients in all tobacco products with
notations as to the harmfulness of those ingredients, but under the
provisions of the FDA Tobacco Act those
types of labeling changes and comparative ingredient information will not be put into place for at
least two years. In the interim, the FDA Tobacco Act restricts the types of claims and descriptions that
can be made with respect to various components in tobacco products, including any claims relating
to reduced levels of toxins or reduced risk, absent receiving a designation of a product as a
modified risk tobacco product.
Manufacturers and importers of tobacco products are taxed pursuant to regulations promulgated
by the TTB under authority of the Internal Revenue Code of 1986, as amended, and we have a license
from the TTB to manufacture smokeless tobacco products at our Chase City, Virginia facility. In
addition, states and local jurisdictions impose additional taxes on tobacco products and regulate
the manner in which such products are sold. In recent years there have been increased taxes and
restrictions imposed on the use of tobacco products at the local and state levels, including
efforts to impose limits on flavors that could be used for smoked, as well as smokeless tobacco
products. These as well as other current and future state and
federal statutes and regulations could have a significant impact on our future prospects and
results of operations, see Item 1. Business Government Regulation.
Impact of the Tobacco Master Settlement Agreement, or MSA. In November 1998, 46 states and the
District of Columbia, or the Settling States, entered into the MSA, to resolve litigation that had
been instituted against the major tobacco manufacturers. Manufacturers who did not join the MSA
were required to satisfy escrow requirements for any cigarette sales in the MSA states. We did not
join the MSA and we were required to satisfy escrow obligations for cigarette sales in the MSA
states until we exited from the cigarette business in May 2007. Given the discontinuation of our
cigarette operations, we do not anticipate having material MSA escrow obligations in the future.
37
Critical Accounting Policies and Estimates
Accounting principles generally accepted in the United States of America, or GAAP, require
estimates and assumptions to be made that affect the reported amounts in our companys consolidated
financial statements and accompanying notes. Some of these estimates require difficult, subjective
and/or complex judgments about matters that are inherently uncertain and, as a result, actual
results could differ from those estimates. Due to the estimation processes involved, the following
summarized accounting policies and their application are considered to be critical to understanding
our business operations, financial condition and results of operations.
Revenue Recognition
Revenue is recognized when products are shipped to customers and title passes. We also record
appropriate provisions for rebates and discounts and credits for returns. These amounts are
estimated due to the variability in credits (as a result of promotional programs in the field),
allowances for collectability, and allowances for product which may be returned by customers after
a sale is completed. In order to quantify these estimates, we make quarterly estimates in these
areas based on the available quarterly information and historical experience. Revenue for our
dietary supplement that is shipped to our direct buying consumers is recognized upon
shipment of the product from our third-party fulfillment vendor. The dietary supplement product is
shipped once our company has received confirmation of a valid credit card charge, which is the only
payment option offered to consumers of the dietary supplement at this time.
Sales Incentives Estimates
We record consumer incentives and trade promotion activities as a reduction of revenues based
on amounts estimated as being due to customers and consumers at the end of a period. The estimates
are based principally on historical utilization and redemption rates of our products. Such programs
include discounts, coupons, rebates, slotting fees, in-store display incentives and volume-based
incentives. To the extent that redemption rates exceed our estimates, this would increase our
liability related to outstanding coupons.
Cost of Goods Sold
Cost of Goods Sold consists of the direct and indirect costs to produce and distribute our
products. Inventory related costs include materials, inbound freight, production costs, inventory
obsolescence and shrinkage. In addition to the aforementioned costs, the cost for our dietary
supplement product, CigRx®, includes fulfillment partner fees, credit card processing fees, and
costs of consumer support.
Impairment of Long-Lived Assets
We review the carrying value of our amortizing long-lived assets whenever events or changes in
circumstances indicate that the historical cost-carrying value of an asset may no longer be
appropriate. We also assess recoverability of the asset by estimating the future undiscounted net
cash flows expected to result from the asset, including eventual disposition. If the estimated
future undiscounted net cash flows are less than the carrying value of the asset, an impairment
loss is recorded equal to the difference between the assets carrying value and its fair value.
Non-amortizing intangibles (trademarks) are reviewed annually for impairment.
Depreciation Estimates
We generally determine depreciation based on the estimated useful lives of the assets and
record depreciation on a straight-line method over such lives. With regard to the tobacco curing
barns, depreciation had been recognized using a units of production method of accounting to more
closely match depreciation with the period during which such depreciation takes place. As of
December 2009 we sold our remaining 37 curing barns.
MSA Escrow Fund
Amounts
deposited into MSA escrow accounts are required to be held in escrow
for twenty-five years and
had been reported as a non-current asset in our companys consolidated financial statements, given
the restrictions placed on the use of these funds. In March 2007, we sold the rights, title and
interest in and to all income from and reversionary interest in our MSA escrow accounts, including
our 2006 MSA escrow deposits made in April 2007 for total cash proceeds of approximately $11.6
million in return for assigning to the purchasers the right to interest paid on our companys
escrow fund and to any releases of the escrow principal for any overpayments, or, if these funds
are not used to satisfy judgments or settlements by the Settling States, releases of the principal
on a rolling basis after twenty-five years. As a result of the sale of all rights to the interest
stream and reversionary interest in the MSA escrow funds, we wrote off the value of the MSA escrow
accounts in March 2007, at the time of the transaction. We have maintained separate MSA accounts
for payments made in 2007 and 2008 relating to cigarette sales in 2007. The amounts held in escrow
for 2007 sales total approximately $0.4 million. We discontinued any sale of cigarette products in
2007. As a result, we have not incurred MSA escrow obligations for the sale of cigarette products
after 2007 and do not expect having any MSA escrow obligations in the future.
38
Commitment and Contingency Accounting
We evaluate each commitment and/or contingency in accordance with the accounting standards
which state that if the item is more likely than not to become a direct liability then our company
will record the liability in the financial statements. If not, we will disclose any material
commitments or contingencies that may arise.
Sale of Licensing Rights
In May 2007, we entered into an exclusive seven-year license agreement with Tantus for our
companys cigarette trademarks Sport®, MainStreet® and GSmoke® and the sale of an amount of Star
Tobaccos inventoried cases of cigarettes bearing these trademarks. The licensing rights became
effective in June 2007, or the Effective Date. Pursuant to the license agreement, Tantus made an
initial payment of $600,000 on the agreement date and made monthly payments of $100,000 per month
until July 2009. Since that time it has been making payments of $3,000 per month which will continue
through the remaining five years of the agreement. As of December 31, 2010, our company has an
outstanding note receivable balance due from Tantus of $0.1 million and we have received payments
totaling $3.1 million through December 31, 2010. While we continue to have the ability to
manufacture and sell cigarettes, we discontinued our cigarette operations in June 2007, and are
focusing our efforts on the manufacture and sale of our dissolvable low-TSNA smokeless tobacco
products. Although we continue to hold legal ownership of the licensed trademarks, we have
accounted for this licensing agreement as a sale since the agreement is non-cancellable, has
established a fixed fee for the rights to the trademarks and our company under the license
agreement has no significant obligation to provide future services beyond maintenance of the
trademarks. Therefore, on the Effective Date, we recorded a gain on the sale of the licensing
rights based on the present value of the total proceeds to be received of approximately $2.9
million using a discount rate of 9.25% net of the $600,000 payment received on the Effective Date.
Year Ended December 31, 2010 Compared to Year Ended December 31, 2009
Please refer to Item 5. Selected Financial Data elsewhere in this Report to view the
five-year comparison of our results of operations and selected financial data.
Sales. Gross sales were $1.0 million in 2010, reflecting a $0.1 million increase from 2009
gross sales. Dissolvable tobacco products sales year-over-year were approximately the same, but
were augmented by the sales of CigRx® following its introduction in August 2010. Net Sales (gross
sales reduced by sales returns and allowances, cash discount and promotion expenses such as
coupons, buy downs and slotting fees) were $0.8 million in 2010 compared to $0.7 million for 2009,
with the increase primarily related to our reduction of dissolvable tobacco promotion expenses and
price increases that were partially offset by a decrease in sales volume of approximately 26%.
Prices on our dissolvable tobacco products were raised $0.10 per pack on January 1, 2009 and $0.50
per pack on December 1, 2009.
We believe that the acceptance of dissolvable tobacco is adversely impacted by a number of
factors, including, among others: (i) lack of consumer familiarity with the products; (ii) the fact
that dissolvable tobacco requires a change in habit by smokers, i.e. using a smokeless product
rather than a smoked product; (iii) dissolvable tobacco requires Federally mandated smokeless
warning labels that may be unfamiliar to and/or misunderstood by cigarette smokers; (iv) the need
to develop brand name recognition with consumers; and (v) difficulty in obtaining capital required
for large-scale consumer education and marketing directed to adult tobacco users.
Prior to the introduction of CigRx® Rock Creek had no source of revenue. CigRx® was initially
launched in the Richmond, Virginia area. In late February 2011,
we began testing
CigRx®
on a national basis through expanded infomercials and radio spots.
Gross Margin. In 2010, overall gross margin loss (net revenue less costs of goods sold and
federal excise taxes) decreased to $(1.3) million compared to $(1.9) million in 2009, a $0.6
million improvement. Both the dissolvable tobacco products and CigRx® had negative gross margins in
2010. The negative gross margin for dissolvable tobacco decreased by $0.7 million in 2010
primarily due to the reduction in force implemented in December 2009. CigRx® had a gross margin
loss of $0.1 million in 2010. The consolidated gross loss was due primarily to the underutilization
of manufacturing and packaging equipment.
39
Total Operating Expenses
Total operating expenses increased approximately $6.1 million, or 28.6%, to $26.9 million in
2010 from $20.8 million in 2009. This included increases in marketing and distribution expenses of
$0.2 million general and administrative expenses of $5.3 million, and research and development
expenses of $1.2 million. These increases were partially offset by the fact that there were no
severance costs in 2010 compared to $0.6 million in 2009
|
|
|
Marketing and Distribution Expenses. Marketing and distribution expenses for our
dissolvable tobacco products were $1.3 million in 2010, a decrease of approximately $1.3
million from approximately $2.6 million in 2009, which reflected decreased expenses of $0.5
million attributable to our reduction of sales personnel, reductions for in store
promotional materials of $0.3 million, sales personnel travel and tradeshow attendance of
$0.3 million and a reduction in general brand advertising of $0.2 million. Marketing
and advertising costs related to the CigRx® launch totaled $1.5 million and offset the
reductions related to our dissolvable tobacco products. |
|
|
|
General and Administrative Expenses. General and administrative expenses were
approximately $21.1 million in 2010, an increase of approximately $5.3 million from
approximately $15.8 million in 2009. Legal expenses were reduced
by $3.9 million due to the fact that in 2009 was incurred cost
of approximately
$3.8 million in connection with the trial of our patent infringement case
against RJR. This reduction was more than offset by the increased
non-cash stock based compensation
charge of $8.2 million related to the issuance of stock options to senior management,
employees, directors and a consultant in April 2010. In addition we had increased costs for
consulting fees related to raw material sourcing, executive travel and other consulting
related to the CigRx® launch of $0.9 million. |
|
|
|
Research and Development Expenses. We expended substantially more on research in 2010
(approximately $3.0 million) compared to our expenditures in 2009 (approximately $1.8
million). Of this amount, we spent approximately $0.2 million on product development for
our modified risk versions of our dissolvable tobacco products and approximately $2.8
million for development of our CigRx® product and for other costs related to Rock Creeks
pharmaceutical and nutraceutical development efforts. |
|
|
|
Restructuring. During the quarter ending December 31, 2009, we restructured and reduced
our tobacco sales force and certain general and administrative personnel in response to the
slower than expected sales of our dissolvable tobacco products. As part of the
restructuring effort, we limited the day-to-day activities of our
sales force and are
focusing our companys marketing efforts on store level support and consumer marketing in
Virginia and contiguous states, with the intent of gaining more extensive market
penetration and product acceptance in those areas. Our companys restructuring efforts were
announced on December 3, 2009 and separation dates for effected employees occurred on
various dates through January 31, 2010. The restructuring charge of $0.6 million in our
accompanying consolidated financial statements for the year ended December 31, 2009
reflects severance in the form of salary and benefit continuation payments for periods of
up to twelve months for employees affected by the restructuring effort as of the close of
business on December 31, 2009. There were no restructuring charges in 2010. |
Interest Income/Expense. In 2010, interest income was approximately $0.1 million and interest
expense was approximately $0.4 million for a net interest expense of approximately $0.3 million as
compared to interest income of approximately $0.2 million and interest expense of approximately
$0.4 million for a net interest expense of approximately $0.2 million in 2009. The lower interest
income during 2010 reflected the decreased interest earned on available cash balances in 2010.
Income Tax Benefit/Expense. Due to a history of recurring operating losses we had no income tax expense or
benefit to be recognized for the year ended December 31, 2010.
In order to recognize the deferred tax asset, our company must generate sufficient taxable income. The valuation allowance is regularly reviewed for adequacy.
Net Loss. Our company had a net loss of approximately $(28.3) million in 2010 compared to
approximately $(22.8) million in 2009. The net loss in 2010 reflected the increased cost related to
the non-cash stock based compensation charge of approximately $8.2 million and increased research
cost (approximately $1.2 million), partially offset by the reduction of legal expenses in 2010 of
approximately $3.8 million.
In 2010, our company had basic and diluted net loss per share of $(0.24) compared to basic and
diluted net loss per share of $(0.22) in 2009.
40
Year Ended December 31, 2009 Compared to Year Ended December 31, 2008
Please refer to Item 5. Selected Financial Data elsewhere in this Report to view the
five-year comparison of our results of operations and selected financial data.
Sales. Gross sales of our dissolvable tobacco products were $0.9 million in 2009, reflecting a
$0.1 increase from 2008 gross sales. Net Sales (gross sales reduced by sales returns and
allowances, cash discount and promotion expenses such as coupons, buy downs and slotting fees) were
$0.7 million in 2009 compared to $0.5 million for 2008 primarily due to our reduction of promotion
expenses and price increases. Volume sales were essentially flat between years. We raised prices
$0.10 per pack on January 1, 2009 and $0.50 per pack on December 1, 2009.
We believe that the acceptance of dissolvable tobacco is adversely impacted by a number of
factors, including, among others: (i) lack of consumer familiarity with the products; (ii) the fact
that dissolvable
tobacco requires a change in habit by smokers, i.e. using a smokeless product rather than a
smoked product; (iii) dissolvable tobacco requires Federally mandated smokeless warning labels that
may be unfamiliar to and/or misunderstood by cigarette smokers; (iv) the need to develop brand name
recognition with consumers; and (v) difficulty in obtaining capital required for large-scale
consumer education and marketing directed to adult tobacco users.
Gross Margin. In 2009, overall gross margin loss (net revenue less costs of goods sold and
federal excise taxes) increased to $(1.9) million compared to $(1.7) million in 2008. The negative
gross margin for dissolvable tobacco was due primarily to the underutilization of manufacturing and
packaging equipment. The estimated excess cost was $1.4 million and $1.8 million for 2009 and 2008,
respectively.
Historically MSA escrow payments have neither been expensed nor accrued for income statement
purposes, but the escrow deposits remained the property of our company on our balance sheet. In
March 2007, we assigned our companys rights to the interest earned on the MSA deposits and to any
releases of principal in return for a payment of approximately $11.6 million, and we wrote off the
value of the MSA escrow deposits at that time. In 2008 we deposited approximately $0.4 million in
escrow for cigarette sales for the year ended December 31, 2007. Amounts deposited into escrow for
2007 sales or for adjustments after 2007 for prior year sales remain the property of our company
and we receive interest on these deposits. We discontinued any sales of cigarette products in 2007
and, as a result, we have not incurred MSA escrow obligations for the sale of cigarette products
after 2007.
Total Operating Expenses
Total operating expenses increased approximately $1.6 million, or 8.3%, to $20.8 million for
2009 from $19.2 million in 2008. The increase was due to an increase in general and administrative
expenses of $0.4 million, research and development expenses of $1.5 million, and severance costs
related to our tobacco operation reduction in force of $0.6 million, partially offset by reduced
marketing and distribution expenses of $0.9 million.
|
|
|
Marketing and Distribution Expenses. Marketing and distribution expenses for our
dissolvable tobacco products were $2.6 million in 2009, a decrease of approximately $0.9
million from approximately $3.5 million in 2008, which reflects decreased expenses for
consumer promotions of $0.2 million and promotional consultants of $0.7 million and reduced
trade show attendance cost of $0.2 million partially offset by a one-time compensation
expense of $0.1 million related to stock grants from our 2008 Incentive Award program and
$0.1 million for marketing consulting. |
|
|
|
General and Administrative Expenses. General and administrative expenses were
approximately $15.8 million in 2009, an increase of approximately $0.4 million from
approximately $15.4 million in 2008. The 2009 expenses included $3.8 million in costs
incurred in connection with was stock based funds the trial of our patent infringement case against RJR in May
and June 2009. The cost in 2008 included a non-cash stock based compensation charge of $2.8
million related to the issuance of stock options to senior management in May 2008. In 2009,
we had decreased executive travel costs of $0.3 million and a decrease of $0.1 million in
directors and officers insurance premiums. |
|
|
|
Research and Development Expenses. We expended substantially more on research in 2009
(approximately $1.8 million) compared to our expenditures in 2008 (approximately $0.3
million). Of this amount, we spent approximately $0.4 million on product development for
our new blends and formula improvements of our dissolvable tobacco products and
approximately $1.4 million for development of our non-nicotine nutraceutical and for other
costs related to Rock Creeks nutraceutical and pharmaceutical development efforts. |
41
|
|
|
Restructuring. During the quarter ending December 31, 2009, we restructured and reduced
our tobacco sales force and certain general and administrative personnel in response to the
slower than expected sales of our dissolvable tobacco products. As part of the
restructuring effort, we limited the day-to-day activities of our sales force and are focusing our companys marketing efforts on
store level support and consumer marketing in Virginia and contiguous states, with the
intent of gaining more extensive market penetration and product acceptance in those areas.
Our companys restructuring efforts were announced on December 3, 2009 and separation dates
for effected employees occurred on various dates through January 31, 2010. The
restructuring charge of $0.6 million in our accompanying consolidated financial statements
for the year ended December 31, 2009 reflects severance in the form of salary and benefit
continuation payments for periods of up to twelve months for employees affected by the
restructuring effort as of the close of business on December 31, 2009. |
Interest Income/Expense. In 2009, interest income was approximately $0.2 million and interest
expense was approximately $0.4 million for a net interest expense of approximately $0.2 million as
compared to interest income of approximately $0.4 million and interest expense of approximately
$0.7 million for a net interest expense of approximately $0.3 million in 2008. The lower interest
expense, during 2009 reflected reductions in the outstanding balance on our RJR debt and lower
interest rates. The lower interest income during 2009 reflected the decreased interest earned on
available balances in 2009.
Income Tax Benefit/Expense. During 2007 and during the nine months ended September 30, 2008,
pursuant to Generally Accepted Accounting Standards we recorded an expense of $2.2 million for the
uncertainties of our companys returns under examination for the years 2001 through 2004. In 2005,
our request for a private letter ruling which related to the years under IRS examination was
resolved generally in our favor and an amended private letter ruling was issued by the IRS in
January 2009. The Amended PLR confirmed that our companys deductions taken for MSA escrow
payments, which were the subject of the IRS ongoing audit for tax years 2001 through 2004 and a
pending tax appeal, were fully deductible and appropriate in the years in which they were taken.
Based on the Amended PLR, we entered into a closing agreement with the IRS which confirmed the
deductions taken for those years and, thereafter, the IRS confirmed that our companys tax returns
for the years 2001 through 2004 were correct as filed. As a result of the notification by the IRS
in the Amended PLR, we reversed our position of recording this income tax expense as of December
31, 2008, which resulted in a $2.2 million income tax benefit. Due to the operating loss we had no
income tax expense or benefit to be recognized for 2009.
Net Loss. Our company had a net loss of approximately $(22.8) million in 2009 compared to
approximately $(18.3) million in 2008. The net loss in 2009 reflects the increased cost related to
the trial of the RJR patent infringement case (approximately $3.8 million), increased research cost
(approximately $1.5 million) and a $0.1 million loss on the sale of our remaining tobacco curing
barns, offset, in part, by a gain of approximately $0.2 million relating to the sale of our
Petersburg real estate. The net loss in 2008 reflects the impact of the $0.6 million gain related
to the assignment of purchase rights to one of our leased facilities in Chase City, Virginia.
In 2009, our company had basic and diluted net loss per share of $(0.22) compared to basic and
diluted net loss per share of $(0.20) in 2008.
Liquidity and Capital Resources
Our company has been operating at a loss for the past eight years. Our prospects will depend
on our ability to generate and sustain increased revenue levels in future periods, which will
largely be dependent on the distribution and consumer acceptance of our companys new CigRx®
product, a non-nicotine, non-tobacco nutraceutical developed by our Rock Creek subsidiary to
temporarily decrease the desire to smoke and introduced in Richmond, Virginia in August 2010. Our
future prospects also will be dependent on increased distribution and consumer acceptance of our
companys low-TSNA smokeless tobacco products, as well as our ability to begin generating
significant revenues through royalties from the patented tobacco curing process for which we are
the exclusive licensee. CigRx® is Rock Creeks first product introduction and Rock Creek had no
revenue stream prior to the introduction of CigRx® and little revenue from CigRx® in 2010. In late
February 2011, we began testing CigRx®
on a national basis through expanded infomercials and radio spots.
Our prospects also will be dependent on Rock Creeks ability to develop additional pharmaceutical
and non-nicotine nutraceutical products and the approval by the FDA of our
applications to market variations of our ARIVA® and STONEWALL Hard Snuff® smokeless tobacco
products as well our Stonewall Moist-BDL low TSNA smokeless tobacco product as modified risk
tobacco products under the FDA Tobacco Act. The ability to generate revenues through royalty
payments will be dependent on the success of our companys ongoing patent infringement lawsuit
against RJR which has been pending since 2001. In that litigation, following a jury trial that took
place between May 18, 2009 and June 16, 2009, the jury returned a verdict in favor of RJR holding
that there was no infringement of the two patents at issue in the case and that the patents were
invalid due to anticipation, obviousness, indefiniteness and failure to disclose best mode. That
decision has been appealed to the United States Court of Appeals for the Federal Circuit and oral
argument before a three-judge panel of the Court was held on January 11, 2011. We are currently
awaiting a ruling on the appeal from the Federal Circuit Court of Appeals. On May 29, 2009 we
filed a new complaint against RJR for patent infringement during the period beginning 2003 and
continuing to the filing date of the new complaint. The new case has been stayed pending the
outcome of the appeal to the Federal Circuit and the prosecution of the new complaint will be
dependent on our achieving a reversal of the jury verdict of invalidity in the initial RJR action.
42
As of December 31, 2010, we had a working capital surplus of approximately $12.6 million,
which included cash of approximately $13.2 million. Future cash needs during 2011 include:
|
|
|
litigation costs in connection with the RJR patent infringement trial of approximately $1.4 million; |
|
|
|
|
monthly principal and interest payments of approximately $245 thousand
in connection with the repayment of our companys long-term debt; and |
|
|
|
|
funding of other aspects of our companys current operations in light of continued operating losses. |
We expect to continue to incur losses in connection with the sale of our smokeless tobacco
products for the foreseeable future. While net sales of smokeless tobacco have been increasing year
over year, substantially increased sales will be required to reach a breakeven level for these
products. Rock Creek had no revenues prior to the introduction of CigRx® in August 2010. We expect
that Rock Creek will be deriving revenues from the sales of CigRx® on a going forward basis as it
expands distribution of CigRx®, but we have had only limited revenue from the sale of CigRx® to
date.
Given the typical long lead time for federal approval of any pharmaceutical products, we do
not expect that Rock Creek will generate any revenues from the sale of pharmaceutical products, as
opposed to nutraceuticals, for the foreseeable future. Rather, Rock Creek will focus its future
development efforts on the research and development aspects of a range of pharmaceuticals,
including products having a botanical, tobacco-based component and related nutraceuticals products
that may assist in stabilizing metabolism, assuming sufficient capital can be generated to support
such activities.
During the period January 1, 2010 through March 15, 2010, we received proceeds of
approximately $13.8 million through the sale of 11,727,120 shares of our common stock, new warrants
to purchase up to 6,323,727 shares of our common stock and the repricing and immediate exercise
into cash of warrants exercisable into 5,402,393 shares of our common stock. On November 5, 2010,
our company received proceeds of $14.0 million through the sale of 7,615,435 shares of our common
stock and new warrants to purchase up to 7,615,435 shares of our common stock. Subsequent to
December 31, 2010, we received proceeds of $11.0 million through the sale of 4,856,730 shares of
our common stock and new warrants to purchase up to 4,856,730 shares of our common stock as well as
the immediate exercise for cash of warrants to purchase 2,000,000 shares of our common stock in
exchange for a new warrant to purchase 2,000,000 shares of our common stock. See note 15 to our
consolidated financial statements included in Item 15. Exhibits, Financial Statement Schedules
and our current reports on Form 8-K, filed with the SEC on March 5, 2010, March 15, 2010, November
9, 2010 and March 4, 2011, for a further description of these transactions. Absent exercise of
outstanding warrants and options for cash or a substantial improvement in revenues and/or
royalties, we believe that we have sufficient funding to support our operations through the first
quarter 2012, but that it will be necessary to pursue additional sources of funds during the
first quarter 2012. Depending upon market conditions and the price of our common stock, we
may decide to seek additional funds before that time. There can be no assurance that we will
be successful in obtaining such funding at commercially reasonable terms.
We expect to continue to pursue opportunities for licensing our low-TSNA smokeless tobacco
products, expanding the sales and marketing efforts for those products and for our non-nicotine
nutraceutical product, CigRx®, and continuing the work of Rock Creek in developing other
pharmaceutical and nutraceutical products. While we may seek to obtain funds in the future through
debt financing, there are significant limitations on our ability to obtain new debt financing,
including our agreements with B&W. Moreover, our ability to raise future financings on terms
acceptable to us (including through the exercise of outstanding warrants) will depend on a number
of factors, including the performance of our stock price and our operational performance. Any
equity financing will be dilutive to our existing shareholders.
43
Summary of Balances and Recent Sources and Uses
Net Cash From Operating Activities. In 2010, approximately $23.7 million of cash was used in
operating activities compared to approximately $19.0 million of cash used in operating activities
in 2009. The increase is due primarily to higher development expenses associated with our
non-nicotine nutraceutical product and the pay down of expenses incurred in connection with the
2009 jury trial in our patent litigation against RJR.
Net Cash From Investing Activities. During 2010, we expended $1.3 million of cash primarily
for the CigRx® packaging equipment line installed at our manufacturing vendor. In 2009, we
generated $1.4 million of cash from primarily the sale of our remaining 37 tobacco curing barns,
the sale of our Petersburg, Virginia factory and office and proceeds from Tantus licensing rights
receivable.
Net Cash From Financing Activities. During 2010, we generated net cash of approximately $25.8
million. Approximately $27.8 million was generated from common stock sales to accredited investors
in private placement transactions and was partially offset by $2.0 million in the repayment of our
long term debt with RJR. In 2009, we generated net cash of approximately $23.5 million from
financing activities. Approximately $25.0 million was generated by the exercise of common stock
options, warrants and the private placement of common stock and warrants, and was partially offset
by $1.5 million in the repayment of our long term debt with RJR.
Net Cash Used in MSA Escrow Payments. In March 2007, we assigned all of our rights to the
interest stream and any reversionary interest in the MSA escrow accounts that we deposited for
cigarette sales through 2006. While the escrow accounts will remain in our companys name and be
available to satisfy judgments or settlements by the Settling States for twenty-five years after
deposit, we no longer receive the interest generated by those MSA escrow accounts and have no right
to receive a release of the funds after twenty-five years, to the extent the funds are not used to
satisfy judgments or settlements by the Settling States. In 2008, we deposited approximately $0.4
million into escrow for sale of cigarettes in the Settling States in 2007. We will continue to
receive the interest earned on the approximately $0.4 million deposited into escrow for 2007
cigarette sales. Given the fact that we discontinued the manufacturing of cigarette in June 2007 and stopped
selling cigarettes at that time, we did not have any MSA escrow obligations for cigarette sales in
2008 and 2009. In 2010 we deposited $3 thousand into escrow for sales the 2006 and 2007 in the
State of Tennessee, based on an audit of cigarette sales for those years. We do not anticipate
having any material MSA obligation for cigarette sales in 2011.
Cash Demands on Operations
In 2010, our company had operating losses from continuing operations that totaled $(28.3)
million.
In addition, in 2009 we spent a significant amount of money in connection with the development
and protection of our intellectual property portfolio, principally in connection with our patent
infringement litigation against RJR. We recognize that in order to protect and defend our
intellectual property, additional capital will need to be spent in connection with our ongoing
patent litigation matters. Also, we will need to
budget for expenditures of funds in connection with the anticipated development efforts in
regard to tobacco-based pharmaceuticals, non-nicotine, non-tobacco nutraceuticals and related
products through Rock Creek.
Our inability to improve operations or to raise funds during the next twelve months could have
a material adverse effect on our ability to meet our working capital needs and continue operations.
Contingent Liabilities and Cash Demands
B&W Agreements. Under the Restated Master Agreement with B&W, as amended by letter agreements
dated December 4, 2002 and August 14, 2003, we currently owe approximately $7.5 million on our
long-term tobacco curing barn loan. Interest began to accrue on this debt at prime plus 1% as of
January 1, 2006, and payment of principal and interest is due in 96 monthly payments that began on
January 1, 2006. The debt is unsecured.
Litigation Costs. We have entered into fee arrangements with counsel in several litigation and
related matters under which certain costs related to the litigation are being advanced by counsel
on our behalf. Given the contingent nature and the fact that a probability assessment of liability
cannot be made at this time, no accrual has been made for this contingent liability.
We have paid or accrued all existing obligations. Also, as part of our fee arrangements in
certain of these matters, we have agreed to pay counsel a percentage of any damage award, a
percentage of the resulting payments we actually receive in the event that the litigation is
resolved in our favor or a result fee in return for a cap on fee payments during the litigation.
44
We anticipate incurring significant expenses in terms of legal fees and costs in connection
with our litigation against RJR for the foreseeable future.
In the past, we have maintained product liability insurance only with respect to claims that
tobacco products manufactured by or for us contain any foreign object, i.e. any object that is not
intended to be included in the manufactured product. We currently do not maintain such insurance
and as a result are self-insured for this risk. The product liability insurance that we previously
maintained did 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.
We have never been named as a defendant in any legal proceedings involving claims arising out of
the sale, distribution, manufacture, development, advertising, marketing or claimed health effects
relating to the use of our tobacco products. While we may be named as a defendant in the future, we
believe we have conducted our business in a manner which decreases the risk of liability in a
lawsuit relating to product liability because we have:
|
|
|
attempted to consistently present to the public the most current information regarding
the health effects of long-term smoking and tobacco use; |
|
|
|
always acknowledged the addictive nature of nicotine; |
|
|
|
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;
and |
|
|
|
|
ceased selling cigarettes in June 2007 in favor of our very low-TSNA dissolvable smokeless
tobacco products. |
Prior to the introduction of CigRx® we obtained product liability insurance for CigRx® as a
nutraceutical product. This insurance covers claims arising from product defects or claims arising
out of the sale, distribution and marketing of our CigRx® product. There have been no claims
asserted with respect to the manufacturer, sale or use of our CigRx® product to date. If any such
claims are asserted in the future and ultimately result in liability that exceeds the limits of our
insurance coverage, we would be liable for any such excess amount.
Virginia Sales and Use Tax Assessment. In 2002, the Virginia Department of Taxation asserted a
Virginia Sales and Use Tax assessment for the period January 1, 1999, through March 31, 2002,
against us with respect to our tobacco-curing barns in the amount of $860,115. We applied for a
correction of the assessment and a total abatement of the tax on the grounds that our barns are
exempt from sales and use taxes under the industrial use and processing exemption and/or the
agricultural exemption. In a letter dated October 7, 2004, our company received notification from
the Commonwealth of Virginia that an adverse decision had been made by the Commissioner of Taxation
with respect to the sales and use tax assessment previously issued to our company. On August 10,
2010 the Commonwealth of Virginia responded to our request for reconsideration of the states
sales and use tax assessment with respect to our tobacco curing barns. The Commonwealth disagreed
with our position that the barns are part of the manufacturing process and, therefore, exempt from
sales and use taxes under the industrial use and processing exemption and/or the agricultural
exemption, concluding that the barns are taxable under the Commonwealths sales tax laws and
regulation. We disagree with the ruling by the Commissioner and intend to timely pursue this matter
through all available means. The sales and use tax assessment plus penalties and interest together,
as of December 31, 2010, totaled $1.5 million. Interest will continue to accrue on this amount
during our pursuit of a final resolution of this matter.
Recent Transactions and Potential for Additional Financing
On February 28, 2011, we entered into a securities purchase and registration rights agreement,
or the February 28 Agreement, with an accredited investor who previously held warrants exercisable
into 2,000,000 shares of our common stock for $1.00 per share. Pursuant to the February 28
Agreement, in order to induce the investor to immediately exercise these warrants, we agreed to
grant the investor new warrants with an exercise price of $2.00 per share exercisable into 2,000,000
shares of our common stock in exchange for the investors immediate and full exercise of his
previously held warrants into 2,000,000 shares of our common stock, which resulted in gross
proceeds to our company of $2.0 million. We refer to the before mentioned private placement as the
February 28 Private Placement. The warrants purchased in the February 28 Private Placement are
exercisable immediately into an aggregate of 2,000,000 shares of our common stock and expire on
February 28, 2016. Additionally, the February 28 Agreement grants the investor certain customary
resale registration rights with respect to the shares of common stock underlying the warrants
purchased in the February 28 Private Placement.
45
On March 4, 2011, we entered into a securities purchase and registration rights agreement, or
the March 4 Agreement, with certain accredited investors, including Jonnie R. Williams, or Chief
Executive Officer, for the purchase of 4,856,730 shares of our common stock for $1.84 per
share and new warrants to purchase up to 4,856,730 shares of our common stock with an exercise
price $2.00 per share, which resulted in proceeds to our company of $9.0 million. We refer to the
before mentioned private placement as the March 4 Private Placement. In addition to purchasing
his respective shares of common stock for $1.84 per share, Mr. Williams also paid our company
$0.125 per warrant purchased in the March 4 Private Placement. The warrants purchased in the March
4 Private Placement are first exercisable on September 4, 2011 and expire on September 4, 2016.
Additionally, the March 4 Agreement granted the investors certain customary resale registration
rights with respect to the shares of common stock and the shares of common stock underlying the
warrants purchased in the March 4 Private Placement. Mr. Williams participation in the March 4
Private Placement transaction was approved by our companys Audit Committee on March 4, 2011.
The offerings referred to above were made only to accredited investors, as such term is
defined in Rule 501 of Regulation D promulgated under the Securities Act. Our company relied on the
exemption from the registration requirements of the Securities Act set forth in Section 4(2)
thereof and the rules and regulations promulgated thereunder.
See note 15 to our consolidated financial statements included in Item 15. Exhibits, Financial
Statement Schedules of this Report and our report on Form 8-K, filed with the SEC on March 4, 2011,
for a further description of these transactions.
Off-Balance Sheet Arrangements
Our company does not have any off-balance sheet arrangements as defined by Item 303(a)(4) of
Regulation S-K.
Contractual Obligations
At December 31, 2010, our companys contractual cash obligations, with initial or remaining
terms in excess of one year, were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amount of |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commitment ($) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expired By Year |
|
|
|
|
|
|
|
|
|
|
Less Than 1 |
|
|
Ended December 31, 2010 |
|
|
More than 5 |
|
|
|
TOTAL |
|
|
Year |
|
|
1-3 Years |
|
|
3-5 Years |
|
|
Years |
|
Long-term Debt |
|
$ |
7,567 |
|
|
$ |
2,518 |
|
|
$ |
5,049 |
|
|
$ |
|
|
|
$ |
|
|
Operating Leases |
|
$ |
1,195 |
|
|
$ |
150 |
|
|
$ |
394 |
|
|
$ |
266 |
|
|
$ |
385 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TOTAL |
|
$ |
8,762 |
|
|
$ |
2,668 |
|
|
$ |
5,443 |
|
|
$ |
266 |
|
|
$ |
385 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Our company had purchase commitments as of December 31, 2010 totaling $1.1 million.
Employment contracts are not included in the above table. For information on employment
contracts with obligations in excess of one year, see Item 11. Executive Compensation-Employment
and Severance Agreements.
Accounting and Reporting Developments
See note 1 to our consolidated
financial statements included in Item, 15 Exhibits, Financial Statement Schedules
of this Report.
|
|
|
ITEM 7A. |
|
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Our company has not entered into any transactions using derivative financial instruments or
derivative commodity instruments and believes that our exposure to market risk associated with
other financial instruments (such as investments and borrowings) and interest rate risk is not
material.
Our companys $7.5 million outstanding debt due to RJR, consisting of a long-term loan, bears
an interest rate of prime plus 1%. As a result, our company is subject to interest rate exposure on
this obligation.
46
|
|
|
ITEM 8. |
|
CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
Our consolidated financial statements and notes thereto and the Report of Cherry, Bekaert &
Holland, L.L.P. are included in Item 15. Exhibits,
Financial Statement Schedules and are incorporated herein by reference.
|
|
|
ITEM 9. |
|
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
None.
|
|
|
ITEM 9A. |
|
CONTROLS AND PROCEDURES |
(a) Disclosure Controls and Procedures.
As required by Rule 13a-15 under the Exchange Act management has evaluated, with the
participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our
disclosure controls and procedures as of the end of the period covered by this Report. Disclosure
controls and procedures refer to controls and other procedures designed to provide reasonable
assurance that information required to be disclosed in the reports we file or submit under the
Exchange Act is recorded, processed, summarized and reported within the time periods specified in
the rules and forms of the SEC. Disclosure controls and procedures include, without limitation,
controls and procedures designed to provide reasonable assurance that information required to be
disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and
communicated to management, including our Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding our required disclosure. In designing and
evaluating our disclosure controls and procedures, management recognizes that any controls and
procedures, no matter how well designed and operated, can provide only reasonable assurance of
achieving the desired control objectives, and management was required to apply its judgment in
evaluating and implementing possible controls and procedures.
Our Chief Executive Officer and Chief Financial Officer have concluded, based on this
evaluation, that as of December 31, 2010, the end of the period covered by this Report, our
disclosure controls and procedures were effective at a reasonable assurance level.
(b) Managements Annual Report on Internal Control Over Financial Reporting.
Our management is responsible for establishing and maintaining adequate internal control over
financial reporting. Internal control over financial reporting, as defined in rules promulgated
under the Exchange Act, is a process designed by, or under the supervision of, our Chief Executive
Officer and Chief Financial Officer and effected by our Board of Directors, management and other
personnel to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with accounting principles
generally accepted in the United States of America, or GAAP. Internal control over financial
reporting includes those policies and procedures that:
|
|
|
pertain to the maintenance of records that in reasonable detail accurately and
fairly reflect the transactions and dispositions of our assets; |
|
|
|
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with GAAP, and that our
receipts and expenditures are being made only in accordance with authorizations of our
management and our Board of Directors; and |
|
|
|
provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of our assets that could have a material
effect on our financial statements. |
Our internal controls over financial reporting are evaluated on an ongoing basis by personnel
in our organization. The overall goals of these various evaluation activities are to monitor our
disclosure and internal controls and to make modifications as necessary, as disclosure and internal
controls are intended to be dynamic systems that change (including improvements and corrections) as
conditions warrant. Part of this evaluation is to determine whether there were any significant
deficiencies or material weaknesses in our internal controls, or whether we had identified any acts
of fraud involving personnel who have a significant role in the our internal controls. Significant
deficiencies are control issues that could have a significant adverse effect on the ability to
record, process, summarize and report financial data in the financial statements. Material
weaknesses are particularly serious conditions where the internal control does not reduce to a
relatively low level the risk that misstatements caused by error or fraud may occur in amounts that
would be material in relation to the financial statements and not be detected within a timely
period by employees in the normal course of performing their assigned functions.
47
Management conducted an assessment of the effectiveness of our companys internal control over
financial reporting as of December 31, 2010, utilizing the framework established in INTERNAL
CONTROLINTEGRATED FRAMEWORK issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Based on this assessment, management has determined that our internal controls over
financial reporting as of December 31, 2010 were effective.
All internal control systems, no matter how well designed, have inherent limitations.
Therefore, even those systems determined to be effective can provide only reasonable assurance with
respect to financial statement preparation and presentation. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or procedures may
deteriorate.
Cherry, Bekaert & Holland L.L.P., an independent registered public accounting firm, has
audited the effectiveness of our internal control over financial reporting as of December 31, 2010,
as stated in their report, which appears on page F-2 of Item 15,
Exhibits, Financial Statement Schedules of this Report.
|
(c) |
|
Changes in Internal Control Over Financial Reporting. |
During 2010, in connection with the evaluation of internal controls described above in
paragraph (b) of this Item 9A, we identified areas requiring changes or improvements. New controls
related to the CigRx® production, inventories, sales and collection were implemented based on the
outsourcing of all production, product fulfillment and direct sales to consumers. We are
performing reconciliations for all product movement and obtaining verification documents of
delivery of raw materials and packaging shipped to our contract manufacturer. Physical inventories
are occurring monthly with internal audits of quantities on hand periodically.
|
|
|
ITEM 9B. |
|
OTHER INFORMATION |
Following approval by our Board of Directors, upon recommendation of the Compensation
Committee, on March 14, 2011, our company entered into an executive employment agreement with
Jonnie R. Williams, our companys Chief Executive Officer, a third amended and restated executive
employment agreement with Paul L. Perito, our companys President and Chief Operating Officer, and
an amended and restated executive employment agreement with Curtis
Wright, IV, MD, MPH, the Senior
Vice President, Medical/Clinical Director of Rock Creek. We refer to the before mentioned employment agreements as the Williams
Employment Agreement, Perito Employment Agreement and the Wright Employment Agreement,
respectively.
The
Williams Employment Agreement
Under the Williams Employment Agreement, Mr. Williams will be provided an annual base salary
payable in cash in such amounts as approved by our Board of Directors, upon the recommendation of
the Compensation Committee, which initially will be $1,000,000, Mr. Williams base salary for each
of the years ended December 31, 2010, 2009 and 2008, and which base salary will be subject to
further adjustment from time-to-time in the good faith discretion of our Board of Directors. Mr.
Williams also will be eligible to receive discretionary bonuses under the Williams Employment
Agreement upon our companys achievement of certain performance goals established by the
Compensation Committee and approved by our Board of Directors. The Williams Employment Agreement
further provides that Mr. Williams will be awarded performance based options to purchase 4,900,000
shares of our common stock under our companys 2008 Incentive Award Plan. These options will vest
in such amounts and upon the achievement of the performance goals set forth on Schedule 2.3 to the
Williams Employment Agreement, provided that such performance goals and vesting schedule is
approved by our companys stockholders. The options are for a 10-year term from March 14, 2011 and have an exercise price of $2.95 per share.
The estimated maximum
value of the
options, as determined by the Black Scholes valuation method, is $12.3 million, and we
expect to record a substantial portion of the related compensation expense in our companys
consolidated financial statements for the year ending December 31, 2011 with the remainder recorded
in our companys consolidated financial statements for the year ending December 31, 2012. The
Williams Employment Agreement is effective immediately and will
expire on December 31, 2012, absent an extension thereof following the non-binding discussions
regarding an extension that are mutually agreed to commence in September 2012 as provided therein.
In addition, the Williams Employment Agreement will entitle Mr. Williams to paid vacation and
other bonuses and benefits in accordance with our companys plans and arrangements, on the same
basis as other employees of our company, as well as reimbursement of general business and travel
expenses.
48
In the event the Mr. Williams employment is terminated without Cause or Mr. Williams
resigns his employment for Good Reason (as such terms are defined in the Williams Employment
Agreement), Mr. Williams will be entitled to all salary, benefits, bonuses and other compensation
that would be due thereunder through the end of the term thereof had our company not terminated
Mr. Williams employment or had Mr. Williams not so resigned.
The Perito Employment Agreement
Under the Perito Employment Agreement, Mr. Perito will be provided an annual base salary
payable in cash in such amounts as approved by our Board of Directors, upon the recommendation of
the Compensation Committee, which initially will be $1,000,000, Mr. Peritos base salary for each
of the years ended December 31, 2010, 2009 and 2008, and which base salary will be subject to
further adjustment from time-to-time in the good faith discretion of our Board of Directors. Mr.
Perito also will be eligible to receive discretionary bonuses under the Perito Employment
Agreement upon our companys achievement of certain performance goals established by the
Compensation Committee and approved by our Board of Directors. The Perito Employment Agreement
further provides that Mr. Perito will be awarded performance based options to purchase 4,000,000
shares of our common stock under our companys 2008 Incentive Award Plan. These options will vest
in such amounts and upon the achievement of the performance goals set forth on Schedule 2.3 to the
Perito Employment Agreement, provided that such performance goals and vesting schedule is approved
by our companys stockholders. The options are for a 10-year term from March 14, 2011 and have an exercise price of $2.95 per share.
The estimated maximum value of the options, as determined by the Black Scholes valuation method, is
$10.0 million, and we expect to record a substantial portion of the related compensation expense in our companys consolidated
financial statements for the year ending December 31, 2011 with the remainder recorded in our
companys consolidated financial statements for the year ending December 31, 2012. The Perito
Employment Agreement is effective immediately and will expire on December 31, 2012, absent an
extension thereof following the non-binding discussions regarding an extension that are mutually
agreed to commence in September 2012 as provided therein.
In addition, the Perito Employment Agreement will entitle Mr. Perito to paid vacation and
other bonuses and benefits in accordance with our companys plans and arrangements, on the same
basis as other employees of our company, as well as reimbursement of general business and travel
expenses and professional education expenses and fees.
In the event the Mr. Peritos employment is terminated without Cause or Mr. Perito resigns
his employment for Good Reason (as such terms are defined in the Perito Employment Agreement),
Mr. Perito will be entitled to all salary, benefits, bonuses and other compensation that would be
due thereunder through the end of the term thereof had our company not terminated Mr. Peritos
employment or had Mr. Perito not so resigned.
The Wright Employment Agreement
Under the Wright Employment Agreement, Dr. Wright will be provided an annual base salary of
$330,000 payable in cash. The Wright Employment Agreement further provides that Dr. Wright will be
awarded performance based options to purchase 300,000 shares of our common stock under our
companys 2008 Incentive Award Plan. These options will vest ratably on an annual basis subject to
the achievement of certain performance goals set forth in Section 2(b)(iii) of the Wright Employment
Agreement. The options are for a 10-year term from March 14, 2011 and have an exercise price of $2.95 per share.
The estimated maximum value of the options, as determined by the Black Scholes valuation method, is $0.7 million and we will record the related
compensation expense in our companys consolidated financial statements for the years ending December 31, 2011, 2012 and
2013. The Wright Employment Agreement is effective beginning on March 14, 2011 and will expire on
March 14, 2014. The Wright Employment Agreement provides our company on option to renew the Wright
Employment Agreement for successive 12-month terms by providing Dr. Wright notice of such an
extension at least 30 days prior to the expiration of the then applicable term. Absent such an
extension, following expiration on March 14, 2014, the Wright Employment Agreement will continue on
a month-to-month basis upon mutual agreement of the parties thereto.
In addition, the Wright Employment Agreement will entitle Dr. Wright to paid vacation and
other bonuses and benefits in accordance with our companys plans and arrangements, on the same
basis as other employees of our company, as well as reimbursement of general business and travel
expenses and professional education expenses and fees.
In the event the Dr. Wrights employment is terminated without Cause or Dr. Wright resigns
his employment for Good Reason (as such terms are defined in the Wright Employment Agreement),
Dr. Wright will be entitled to all salary, benefits, bonuses and other compensation that would be
due thereunder through the end of the term thereof had our company not terminated Dr. Wrights
employment or had Dr. Wright not so resigned.
49
The foregoing summary is qualified in its entirety by reference to the full text of each of
the Williams Employment Agreement, Perito Employment Agreement and Wright Employment Agreement,
copies of which are attached as Exhibits 10.78, 10.79 and 10.80 respectively, to this Annual
Report on Form 10-K and are incorporated by reference into this Item 9B.
PART III
|
|
|
ITEM 10. |
|
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE |
Directors
The following table and text set forth the name, age and positions of each of our directors
elected by our common stockholders:
|
|
|
|
|
Name |
|
Age |
|
Position |
Burton J. Haynes(1) |
|
63 |
|
Director |
Christopher C. Chapman, Jr., M.D.(1)(2)(3) |
|
58 |
|
Director |
Neil L. Chayet(2) |
|
72 |
|
Director |
Mario Mirabelli(1)(3) |
|
71 |
|
Director |
Paul L. Perito |
|
74 |
|
Chairman, President and Chief Operating Officer |
Leo S. Tonkin(1)(2)(3) |
|
73 |
|
Director |
Jonnie R. Williams, Sr |
|
55 |
|
Chief Executive Officer |
|
|
|
(1) |
|
Member of the Audit Committee. |
|
(2) |
|
Member of the Compensation Committee. |
|
(3) |
|
Member of the Nominating Committee. |
Set forth below is biographical information for each director of our company.
Christopher C. Chapman, Jr., 58, has served as a member of our Board of Directors since
September 2005. Since its inception in 1999, Dr. Chapman has served as Chairman and Chief Executive
Officer of Chapman Pharmaceutical Consulting, Inc., which provides expert medical consultation on
the development and management of domestic and global product development programs for biotech,
pharmaceutical and medical device products. He served as Senior Director of Medical Affairs with
Quintiles/BRI, the largest contract research organization in the U.S., from 1995 until 2000. In
that capacity, Dr. Chapman had oversight responsibility for the support of new drug applications,
clinical studies and device submissions to the FDA for approval. From 1992 until 1994, Dr. Chapman
was Medical Director at Regeneron
Pharmaceuticals. He currently serves as Chairman of the Chapman Pharmaceutical Health Foundation
and is also a member of the Board of Directors of Biovest International, Inc. and Acentia
Biopharmaceuticals, Inc. Dr. Chapman is a graduate of the Georgetown University School of Medicine
in Washington, DC.
Dr. Chapman was nominated to serve on our Board of Directors in connection with our companys
increased efforts to expand the acceptance of our very-low TSNA smokeless tobacco products as a
viable alternative to more toxic forms of tobacco and at the time that our company was seeking to
establish a pharmaceutical subsidiary that would focus on tobacco-based products, including FDA
approved cessation products. Dr. Chapmans training as a physician and his experience in the
biotech and pharmaceutical areas, particularly his experience in dealing with new drug
applications, clinical studies and device submissions, lead our Board of Directors to conclude that
he could provide valuable assistance in connection with the development of both our low-TSNA
smokeless tobacco products and the anticipated activities of a new subsidiary that would focus on
tobacco-based pharmaceuticals, nutraceuticals and related products. Consistent with Dr. Chapmans
areas of expertise, he has served as a director of Rock Creek, since its incorporation in 2007 and
has been active in advising our company on issues relating to new drug development and the
potential for the expansion of our companys mission in the area of pharmaceutical and
nutraceutical products.
Neil L. Chayet, 72, has served as a member of our Board of Directors since September
2007. Mr. Chayet is President of Chayet Communications Group, Inc., a consulting organization that
specializes in building deep coalitions to address difficult public policy issues, including
those related to health care, addiction and mental health services, energy and communications. Mr.
Chayet is a member of the faculty of the Harvard Medical School, serving in the Department of
Psychiatry and at McLean Hospital. He is also a member of the faculties of the Tufts University
School of Dental Medicine and the Tufts University Cummings School of Veterinary Medicine, and
serves as a member of the Board of the Tisch College of Citizenship and Public Service at Tufts. He
is President of the Harvard Law School Association of Massachusetts. Mr. Chayet also serves as a member of the
Advisory Council of MassINC, the Board of Mass.
50
Humanities, and the Board of Associates of the Whitehead Institute for Biomedical Research. He previously served as the Chairman of the Massachusetts Mental
Health Institute, Inc., a member of the Research Grants Review Committee for the Studies of
Narcotic Drug Abuse at the National Institute of Mental Health, and was a Delegate to the U.N.
Conference on Psychotropic Substances, which followed the Single Convention on Narcotic Drugs.
Since 1976, Mr. Chayet has hosted a daily radio feature, Looking at the
Lawtm, which is syndicated by CBS, and he frequently lectures on topics
related to the intersection of health sciences and the law. He also
serves as acting Executive Director of GEO (Geothermal Exchange
Organization), Mr. Chayet earned an undergraduate
degree from Tufts University in 1960, and a law degree from Harvard Law School in 1963. In April
2007, Mr. Chayet received the Civic Achievement Award from the
American Jewish Committee and in 2008 received the Tufts
Distinguished Service Award.
Mr.
Chayet was nominated to serve on our Board of Directors shortly after our company formed its
pharmaceutical subsidiary, Rock Creek. As part of his legal and consulting practice, Mr. Chayet for
many years has been involved with issues relating to the healthcare field and the intersection of
health science and the law. Given the public health aspects of tobacco use, the related mission of
our company to reduce the harm associated with tobacco use and the expectation that Congress would
eventually grant the FDA authority over tobacco products, our Board of Directors believed that Mr.
Chayet could provide unique insight and assistance to our company as we sought to grow our
pharmaceutical business and continue the development of very-low TSNA smokeless tobacco products.
Like Dr. Chapman, Mr. Chayet has provided valuable counsel and guidance as a member of the Board of
Rock Creek, in addition to serving as a member of our Board of Directors.
Burton J. Haynes, 63, has served as a member of our Board of Directors since October
22, 2010. Since 1997, Mr. Haynes has served as the sole principal in Burton J. Haynes PC, a law
firm specializing in income tax matters, estate and tax planning and complex civil and criminal tax
cases. Between 1988 and 1996, Mr. Haynes practiced law as a named partner in the law firm of
Bodzin, Haynes & Golub, specializing in civil and criminal tax cases. Mr. Haynes was a partner at
the law firm of Finley, Kumble, Wagner, Heine, Underberg, Manley, Myerson & Casey from 1981 to
1988. Prior to entering private practice, Mr. Haynes served as a Special Agent, IRS Criminal
Investigation Division from 1973 to 1981. As a Special Agent, Mr. Haynes worked closely with the
FBI and U.S. Attorneys Office on criminal investigations and was named criminal investigator of
the year in 1980 by the Association of Federal
Investigators. Mr. Haynes received his Bachelor of Arts Degree in Business Administration from the
University of Maryland in 1972 and received a Masters Degree in Business Administration from the
University of Maryland Graduate School in 1975. He received his law degree in 1979 from the
University of Maryland, where he was the recipient of the W. Calvin Chestnut award and the John L.
Thomas prize for outstanding scholarship and was elected Order of the Coif. Mr. Haynes is a member
of the bars of the District of Columbia, Maryland and Virginia and is a Certified Public Accountant
(although his CPA license is in inactive status because his primary focus is on the practice of
law). He served as an adjunct professor from 1979 to 1981 at Towson State University in Maryland,
where he taught courses in accounting and tax law.
Mr. Haynes was nominated to serve on our Board of Directors based on his extensive experience
in business, legal and complex tax, litigation and regulatory matters. His background as an
accountant and attorney provides a unique combination of disciplines as does his long career in
dealing with complex civil and criminal tax matters. Our Board of Directors viewed Mr. Haynes
combination of training and experience as a valuable source of expertise, particularly in the areas
of financial analysis and planning. Mr. Haynes expertise is also valuable in dealing with the type
of regulatory issues facing our company as a tobacco manufacturer and in connection with our
ongoing efforts relating to the development and marketing of pharmaceutical and nutraceutical
products.
Mario V. Mirabelli, 71, has served as a member of our Board of Directors since July
2010. Mr. Mirabelli was a partner and presently serves in an Of Counsel capacity to the Washington
D.C. law firm Patton Boggs LLP. Prior to joining Patton Boggs, he served as Managing Partner of the
Washington, DC office of Shea & Gould for fourteen years from 1977 to 1991 and later as a partner
at Baker Hostetler from 1991 to 2001, where he represented domestic and international clients on
federal securities law and corporate and transactional matters, including privatization, corporate
formation and mergers and acquisitions. Prior to entering private practice, Mr. Mirabelli served as
a trial attorney with the Securities and Exchange Commission in the Office of Administrative
Proceedings and Investigations within the Division of Corporate Finance, and with the Federal Trade
Commission in the Bureau of Deceptive Practices. Mr. Mirabelli has served as a director of RNA
Pharmacy Solutions of Dallas, TX, a pharmaceutical management software company, since 2009. Mr.
Mirabelli is President of the John R. Mott Scholarship Foundation, Inc. Mr. Mirabelli formerly
served as a director of Atlantic Bank of New York, Guest Services Inc. of Fairfax, VA, as a member
of The Metropolitan Washington Airport Authority Advisory Board, and as a director and the
Treasurer of the National Italian American Foundation. Mr. Mirabelli received his undergraduate
degree from Georgetown University in 1961 and his law degree from the American University,
Washington College of Law in 1964. He is a member of the District of Columbia bar.
51
Mr. Mirabelli was nominated to serve on our Board of Directors based on his
extensive experience in representing start-up companies and other corporate clients on a range of
corporate law issues including federal securities law and transactional matters, corporate
formation, organization and maintenance issues, and matters relating to mergers and acquisitions.
Mr. Mirabellis extensive corporate experience combined with his public sector work were viewed by
the Board as providing the type of experience in both business and corporate legal matters that
would be beneficial to our company, particularly as we seek to expand into new products and
continue to be an innovative force in the area of tobacco harm reduction.
Paul L. Perito, 74, is our companys President and Chief Operating Officer, or COO, and has
served in that capacity since November 1999. He has served as a member of our Board of Directors
since December 1999 and as the Chairman of our Board of Directors since August 2000. Mr. Perito
served as our companys 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, or PHJ&W, from July 1991 until June 1999 when he became a
senior counsel to the firm at the time he joined our company. Mr. Perito resigned his position as
senior counsel to PHJ&W as of March 31, 2001, after serving as National Co-Chair of the White
Collar Corporate Defense Practice Group at PHJ&W since 1991, and Chair of the Litigation Department
in that firms Washington, DC 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 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 from 1966 to 1970. Mr. Perito graduated from Tufts
University, Magna Cum Laude and Phi Beta Kappa, and from the 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 1960-1961 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. Mr. Perito was the President of the Harvard Law School
Association of the District of Columbia from 1990 to 2010 and is now Chair Emeritus. He is also a
member of the Executive Committee of the Harvard Law School Association and was Secretary to the
Harvard Law School Association for the past 15 years. In June 2010, Mr. Perito was elected First Vice President of the Harvard Law School Association
for a two-year term and will assume the role of President of that association in June 2014 for a further two-year term. He served as Chairman of the Harvard Law
School Class of 1964 Reunion and Fund Committees from 1995 to 2010 and served as Co-Chair of the
World Alumni Congress in 2006-2007, and Class Agent for the Harvard Law School Fund in 2006-2007.
Mr. Perito is Chair of the Harvard Law School 45th Reunion Committee and Co-Chair of the Gift Committee
Class of 1964. Mr. Perito is a member of the International Board of Overseers of Tufts University,
a former member of the Board of Georgetown Visitation Preparatory School in Washington, DC, and
Co-Chair Emeritus of Treliant Risk Advisors, LLC.
52
Prior to joining our companys Board of Directors, Mr. Perito had a long and
distinguished legal and governmental career that focused not only on highly complex litigation
matters, but also a variety of health related regulatory and legal matters, including issues
relating to addiction and harm reduction as part of his
service in the Legislative and Executive branches of government. Given our companys mission to act
as a catalyst for change in the highly regulated tobacco industry, our emerging intellectual
property portfolio and our focus on the health aspects of tobacco use, it was evident to our Board
of Directors that our company would benefit from having Mr. Peritos legal and management skills
and expertise in coordinating our companys intellectual property and litigation efforts as well as
his input on how best to interact at the highest levels of the federal government on a wide variety
of healthcare and legal issues related to the regulation of tobacco products. In light of the
significant legal and regulatory matters facing our company, the need for the type of expertise and
experience possessed by Mr. Perito has remained. Additionally, given our increased emphasis on a
variety of tobacco-based pharmaceutical products, non-nicotine nutraceuticals and related products
and the expanded focus of our company in seeking to reduce the harm related to tobacco use at every
level, Mr. Peritos expertise has become more essential to our companys business strategy.
Leo S. Tonkin, 73, has served as a member of our Board of Directors since November
1998. He established the Washington Workshops Foundation in 1967, and has served as Founding
Director since that time. Since 1999, he also has served as President and Director of Travel
Seminars, Inc. He served as a member of the White House Conference on Youth in 1971, Special
Assistant to the Chairman of the U.S. House of Representatives Select Committee on Crime, Legal
Consultant to the U.S. House of Representatives Higher Education Subcommittee, Minority Counsel to
the U.S. House of Representatives Select Committee on Government Research and Executive Director of
the Commissioners Council on Higher Education in Washington, DC. He has served as Chairman of the
Board of Trustees of St. Thomas Aquinas College and as a Board member of Southeastern University
and Immaculata College. He is a vice president of the London, England Federation of Youth Clubs and
is an advisor to the Retinitis Pigmentosa Foundation in California. He was awarded the 1973 George
Washington Americanism Award of the Valley Forge Freedoms Foundation, presented by President Gerald
L. Ford in a 1974 White House ceremony. Mr. Tonkin is a graduate of Johns Hopkins University and
received his law degree from Harvard Law School. He holds an honorary Doctor of Pedagogy degree
from St. Thomas Aquinas College and the State University of New York.
Prior to joining our Board of Directors, Mr. Tonkin had extensive business and
legislative experience. He was elected to our Board of Directors at a time when our company first
announced its intention to act as a catalyst for change in the tobacco industry, particularly in
dealing in the way that tobacco had traditionally been grown and cured. Mr Tonkins business and
legislative background were viewed by our Board of Directors as providing the type of expertise
that would be of assistance to our company as we sought to further our corporate mission to reduce
the harm associated with tobacco use at every level, given the highly regulated nature of the
tobacco industry and Mr. Tonkins familiarity with regulated industries and the legislative and
regulatory processes impacting on our industry, particularly as they relate to preventing youth
access to tobacco products.
Jonnie
R. Williams, Sr., 55, has served as our companys Chief Executive Officer, or
CEO, since November 1999 and has served as a member of our Board of Directors since October 1998.
Mr. Williams was one of the original founders of Star Tobacco, our companys
wholly owned subsidiary, and served as its Chief Operating Officer and Executive Vice President
until July 1999. On July 1, 1999, in order to concentrate on the expanding demands of our companys
sales and new product development, Mr. Williams resigned from his positions with Star Tobacco
initially to assume the primary responsibilities of Director of Product Development and Sales of
our company and then the position of CEO. Mr. Williams, a principal stockholder of our company, is
also the inventor of the StarCured ® tobacco curing process for preventing or
significantly retarding the formation of 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 and VISX.
Mr. Williams is also one of the owners of Regent Court Technologies LLC and was a principal in
Jonnie Williams Venture Capital Corp.
Mr. Williams has played a prominent role in our company since its inception as the
inventor of the
StarCured® tobacco curing process, as a significant contributor to our
companys product development initiatives relating to our very-low TSNA products and our new
product initiates in the pharmaceutical and nutraceutical areas and, since 1999, as our CEO. Also,
he has been active in capital raising initiatives and related interactions with investors. Given
his activities and skills in these areas, it was evident to our Board of Directors that Mr.
Williams guidance as a director would be beneficial to our company in each of these areas and in
assessing the direction and focus of our company as we have moved forward with our mission of
reducing the harm related to tobacco use at all levels.
53
Executive Officers
The following table sets forth certain information with respect to our executive officers,
other than Messrs. Paul L. Perito and Jonnie R. Williams, whose information is set forth above
under the caption Directors.
|
|
|
|
|
Name |
|
Age |
|
Position |
David M. Dean |
|
51 |
|
President of Star Tobacco, Inc. |
Park A. Dodd, III |
|
58 |
|
Chief Financial Officer |
Robert E. Pokusa |
|
60 |
|
General Counsel |
Curtis Wright, MD, MPH |
|
61 |
|
Senior Vice President, Medical/Clinical Director of Rock Creek Pharmaceuticals, Inc. |
Set forth below is biographical information for each executive officer of our company who
is not also a director.
David M. Dean, 51, has served as Vice President of Sales and Marketing of our company since
November 1999 and as President of Star Tobacco since February 2010. From 1998 to October 1999, he
served as a Principal of Group Insurance Concepts of Virginia, L.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 was the largest
health insurer in Virginia and was purchased during 2002 by Anthem. Mr. Dean is a graduate of Elon
College.
Park A. Dodd, III, 58, has served as our companys Chief Financial Officer, Treasurer, and
Assistant Secretary since October 2007. Mr. Dodd was a special advisor to our company from May 2007
until assuming the role as Chief Financial Officer in October 2007. Mr. Dodds experience includes
a thirty-year career in strategic financial planning and accounting. From 1980 to 2000 he held a
number of management positions with Philip Morris, Inc. with increasing responsibilities in
accounting and reporting, business decision support, financial planning and analysis during that
time, including his service as Senior Manager and Director of Financial Planning and Analysis from
1992 to 1998 and Director of Finance Reengineering and Technology Upgrade from 1998 to 2000. Mr.
Dodd was special advisor to the Chief Financial Officer of the United States Olympic Committee
during 2000, and from 2001 to 2005 he served as Director in Accounting and Reporting of Capital One
Financial Corporation in Richmond, Virginia. Between 2005 and the end of 2009, Mr. Dodd was a
partner with Tatum, LLC, a national executive services firm that specializes in providing interim
financial leadership to client organizations. Mr. Dodd received an undergraduate degree in
Accounting from Virginia Tech in 1975 and an MBA from Virginia
Commonwealth University in 1986. He is a licensed Certified Public Accountant
in the State of Virginia.
Robert E. Pokusa, 60, has served as our companys General Counsel and Secretary since March
2001. From 1991 until joining our company, he was associated with Paul, Hastings, Janofsky & Walker
LLP during which time he worked on a number of matters for our company and concentrated his
practice in the areas of complex civil litigation and administrative law. From 1980 to 1991, Mr.
Pokusa was associated with the law firms of Perito, Duerk & Carlson; Finley, Kumble, Wagner, Hiney,
Underburg, Manley, Meyerson & Casey, and Washington, Perito and Dubuc. Mr. Pokusa received his
Bachelor of Arts Degree from Montclair State University and his law degree from The American
University, Washington College of Law. He is a member of the Virginia and District of Columbia
bars.
Curtis Wright, MD, MPH, 61, has served as Senior Vice-President, Medical/Clinical Director of
our pharmaceutical subsidiary, Rock Creek Pharmaceuticals, Inc. since February 2008. Dr. Wright
previously served as Vice President of Clinical and Regulatory Affairs for Adolor Corporation from
1997 to 1998, and Executive Director, Medical Affairs and subsequently Executive Director of Risk
Assessment for Purdue Pharma from 1998 to 2004. Immediately prior to joining Rock Creek
Pharmaceuticals, Inc., Dr. Wright served as Executive Vice President for Risk Management and
Regulatory Affairs at Javelin Pharmaceuticals, Inc., Cambridge, MA from 2004 to 2008. Dr. Wrights
career at the FDA, from 1989 through October 1997, included multiple senior scientific positions in
the Center for Drug Evaluation and Research, including Deputy Director and subsequently Acting
Director of his division. Dr. Wright received his medical degree, with distinction, from George
Washington University and received a masters degree in Public Health from the John Hopkins
University.
Section 16 (a) Beneficial Ownership Reporting Compliance
Section 16 of the Securities Exchange Act of 1934, as amended, requires directors and
executive officers and persons, if any, owning more than ten percent of a class of our companys
equity securities to file with the Securities and Exchange Commission initial reports of ownership
and reports of changes in ownership of our companys equity and equity derivative securities. Based
solely upon a review of the copies of such reports and written representations from reporting
persons, we believe that all Section 16(a) filing requirements applicable to our officers,
directors and greater than ten percent stockholders were complied with on a timely basis for the
year ended December 31, 2010.
54
Code of Ethics
We have adopted a Code of Ethics that applies to all of our companys directors, officers
(including our Chief Executive Officer, Chief Financial Officer, Controller and any person
performing similar functions) and employees. We have filed a copy of this Code of Ethics as Exhibit
14.1 to this Report. We also have made the Code of Ethics available on our companys website at:
www.starscientific.com. Information contained on our website is not part of this Report and
is not incorporated in this Report by reference.
Audit Committee
We currently maintain an Audit Committee which has responsibility for the appointment of our
independent registered public accountants, reviews our internal accounting procedures and financial
statements, and consults with and reviews the services provided by our independent registered
public accountants, including the results and scope of their audits. The Audit Committee is
currently comprised of Messrs. Chapman, Haynes, Mirabelli and Tonkin, each of whom are independent under
the applicable rules of the Securities and Exchange Commission and The NASDAQ Global Market. The
Board of Directors has determined that Burton J. Haynes qualifies as an Audit Committee Financial
Expert as defined by the rules of the Securities and Exchange Commission.
|
|
|
ITEM 11. |
|
EXECUTIVE COMPENSATION |
Compensation Discussion and Analysis
Our companys Named Executive Officers include Jonnie R. Williams, our CEO, Park A
Dodd, III, our Chief Financial Officer, or CFO, Paul L Perito, our Chairman, President and COO,
Robert E. Pokusa, our General Counsel, David M. Dean, our Vice President of Sales and Marketing and
Dr. Curtis Wright our Senior Vice President, Medical/Clinical Director of our pharmaceutical
subsidiary, Rock Creek. We collectively refer to these executive officers as the Named
Executives. The following discussion summarizes the compensation awarded to the Named Executives
during 2010.
Overview
Our companys mission has been, and continues to be, to reduce the harm associated
with the use of tobacco at every level. In fulfilling that mission we have sought to reduce the
range of serious health hazards associated with the use of smoked and smokeless tobacco products by
reducing the toxins in the tobacco leaf; offering less toxic alternatives to traditional tobacco
products; demonstrating the viability of our less toxic tobacco technology; and sublicensing that
technology to the tobacco industry. Also, since 2007, we have been pursuing the development of
related pharmaceutical products that are designed to treat tobacco dependence and a range of
neurological conditions including a non-nicotine, non-tobacco nutraceutical product that is
designed to temporarily reduce the urge to smoke and related products that may assist in
maintaining a balanced metabolism.
That mission has been a principal driver in decisions regarding the determination of
total compensation for our senior executives, as well as the compensation for members of our Board
of Directors and consultants who have been retained to assist our company in these long-term
objectives. As part of this mission, we have
sought to affect a major shift in the way tobacco is grown and cured, as well as in the use of
tobacco products generally.
55
In its structure and functioning, our companys goal has been to act as a disruptive
force in the tobacco industry, and to challenge many of what we believe are preconceived
assumptions that have governed the manufacture and sale of tobacco products over a number of
decades. As we worked to achieve these objectives, we initially utilized our companys existing
cigarette business as a platform to provide a base of financial support for our intellectual
property, licensing and development initiatives, and as a demonstration vehicle for the manufacture
and sale of a range of low-TSNA tobacco products and related pharmaceutical and non-nicotine
nutraceuticals. However, in May 2007, we licensed three of our companys cigarette trademarks on an
exclusive basis in return for licensing fees to be received over the term of the license agreement
and, in June, 2007, we ceased manufacturing any cigarette products. Currently, we are focusing our
tobacco operations on the sale of our companys dissolvable low-TSNA smokeless tobacco products,
ARIVA®® and STONEWALL Hard Snuff®. Also, we are
pursuing approval from the FDA of two related products, Ariva-BDLm and
Stonewall-BDL that have levels of the carcinogenic TSNA comparable to those found in nicotine
replacement therapy products as well as a Stonewall Moist-BDL as modified risk tobacco
products under the FDA Tobacco Act. Consistent with our goals and objectives, in 2007 we also
incorporated our pharmaceutical subsidiary, Rock Creek, to pursue the development of botanical
based products for the treatment of tobacco dependence, pharmaceutical products that would utilize
certain MAO agents in tobacco to treat a range of neurological conditions, including Alzheimers
disease, Parkinsons disease, schizophrenia and depression, a non-nicotine, non-tobacco
nutraceutical product to temporarily reduce the urge to smoke and related nutraceuticals that may
assist in maintaining a balanced metabolism.
We also have sought to develop a sophisticated superstructure for our innovative,
technology-based company that could interact at all levels of the government, regulatory, medical
and industrial sectors on a broad range of issues relating to the health impact of tobacco, the
regulation of emerging forms of potentially less hazardous tobacco products and the development of
tobacco based pharmaceutical products and related products such as non-nicotine nutraceuticals. To
achieve this objective, our company sought a Chief Executive Officer, or CEO, in 1999 who could
oversee our companys existing business and facilitate the kind of capital raising initiatives and
investor support necessary to promote an aggressive and far-ranging approach to the issues facing
the tobacco industry. At the same time, our company made efforts to identify and hire a President
and Chief Operating Officer, or COO, with a substantial legislative, regulatory and litigation
background and who had relationships with the relevant scientific and research communities that are
critical to our goals and objectives. We felt that this individual should be able to coordinate our
companys intellectual property and litigation efforts, interact at the highest levels of the
federal government on a wide variety of health and legal issues involved in the regulation of
tobacco products, and be in a position to enlist other individuals as employees and consultants to
assist in those initiatives. Further, we worked to staff key executive positions in sales and
marketing, finance, legal, investor relations and medical research with individuals who would
complement our companys senior management and provide a level of expertise that would minimize the
need to procure those services through external third parties. Because we set out to be a force for
change in the tobacco industry, we understood that our company needed to be able to attract and
maintain a high-caliber group of executives to further these goals and objective.
Our mission over the years has been to challenge and transform the constructs
relating to cigarettes and tobacco use generally. In this respect, our long-term focus has been,
and continues to be, the research, development, and sale of products, particularly very low-TSNA
smokeless tobacco products that expose adult tobacco users to lower levels of toxins, non-nicotine,
non-tobacco dietary supplements that provide viable alternatives to tobacco products, tobacco-based
pharmaceutical products for the treatment of tobacco dependence and other diseases as well as
related non-nicotine nutraceuticals designed to maintain a healthy
metabolism and the licensing of our companys low-TSNA technology and other technology.
Compensation Objectives
In establishing compensation for our companys executive officers, we have sought to:
|
|
|
attract and retain individuals of superior ability and managerial talent; |
|
|
|
|
ensure that the compensation for senior executive officers
is aligned with our companys corporate strategies,
business objectives and long term interests; and |
|
|
|
|
enhance the incentive of our companys executive officers
to maximize shareholder value by providing opportunities
for direct ownership in our company through awards of stock
options and stock grants. |
56
Over
the last eight years our company has experienced operating losses on an annual
basis, and, accordingly, prior to 2008, we had chosen to limit compensation of our executive
officers to base salary and benefits. As a result, we have not utilized an incentive-based
compensation structure as a means of determining levels of compensation for our executive officers
or other employees. Except for nominal amounts, and for an initial signing bonus in the case of
Curtis Wright, MD, MPH, who joined our company in March 2008 as Senior Vice President,
Medical/Clinical Director of Rock Creek, no cash bonuses have been paid to executive officers since
2002.
In conducting our risk assessment analysis of employee compensation policies and practices,
including those for our Named Executives, we have taken into account the fact that our
compensation levels have been limited to base salary and benefits and have not been tied to
additional compensation for meeting specific performance objectives. Based on those consideration
we have concluded that our employee compensation policies and practices, including those applicable
to our Named Executives, do not create risks that are reasonably likely to have a material adverse
effect on us and do not result in an incentive for our Named Executives to take undue risk in
order to increase their levels of compensation.
From 2003 until May 2008, we did not issue any stock options or stock grants to our
companys executive officers, except as noted below in the case of Park A. Dodd, III and Dr.
Wright, in each case upon their commencement of service to our company. However, in May 2008 and
April 2010, our Board of Directors, based on the recommendation of the Compensation Committee,
awarded a total of 1,625,000 and 3,590,000 stock options, respectively, to several employees,
executive officers, one consultant and our Independent Board members. The 2010 awards included
1,250,000 stock options issued to Messrs. Perito and Williams, respectively, 200,000 stock options
issued to Dr Wright and 50,000 stock options issued to Mr. Dodd. Those stock options were awarded
in recognition of the Named Executives continued contribution towards our companys goals and
objections, particularly the product development initiatives of Rock Creek. On January 31, 2011 our
Board of Directors on recommendation of the Compensation Committee awarded a total of 604,000 stock
options to three employees who had an equal number of stock options expire during 2010. On March
14, 2011 our Board of Directors, upon recommendation of the Compensation Committee, approved an
additional award of stock options to Messrs. Perito and Williams, and Dr. Wright as part of new
employment agreements entered into with these Named Executives. The stock option awards for
Messrs. Perito and Williams are subject to shareholder review and approval. See Item 9B. Other
Information.
Compensation determinations have been driven primarily by considerations relating to the
ability to attract and retain individuals who could help our company carry out its long-term
objective to act as a catalyst for significant change in the tobacco industry and to reduce the
harm associated with tobacco at every level. The determinations also have involved an assessment of
our companys progress in obtaining and protecting the intellectual property to which we are the
exclusive licensee, the success of our ongoing patent litigation against RJR, our success in
introducing new low-TSNA smokeless tobacco products to the market, non-nicotine nutraceuticals and
tobacco based pharmaceuticals through Rock Creek and our success in generating increased awareness
of the differences in toxicity among various forms of tobacco products.
Our Board of Directors has provided its Compensation Committee the primary authority
to determine the compensation awards available to our companys executive officers and the
Compensation Committee, in turn, makes recommendations on compensation levels to the Board after
undertaking an analysis of appropriate levels of compensation for the executive officers. To aid
the Compensation Committee in making its determinations, on a yearly basis the Compensation
Committee is provided an analysis of the compensation levels of its executive officers based on the
review of job functions and job responsibilities that have been assumed by particular executive
officers and compensation ranges available in comparable positions for individuals with like
training and experience. The analysis is prepared by our companys General Counsel working with our
COO. Our CEO and COO also provide recommendations, as appropriate, regarding compensation for all
executive officers, including themselves. Our company has not engaged a compensation consultant to
undertake this analysis. Given our companys unique position as a force for change in the tobacco
industry, we have not used benchmarks from the tobacco industry in setting compensation levels for
our companys most senior executives, since the unique nature of our business does not easily lend
itself to comparisons with tobacco industry indices. Instead, the Compensation Committee has
informally considered general market information for similar senior level executives in setting
base compensation. Given our decision in recent years to limit compensation to base salary and
benefits, our companys focus has been on salary levels and benefits for executives in the
manufacturing sector in the relevant geographic markets (Richmond, Virginia, Washington, DC and
Boston, Massachusetts). We have utilized a comparison to the manufacturing sector since our company
prior to August 2010 generated income solely from the sale of tobacco products, and since 2007
exclusively low-TSNA smokeless tobacco products and in August introduced a non-nicotine,
non-tobacco nutraceutical (CigRx®) that is being manufactured and sold
57
by Rock Creek. In addition
to Rock Creeks sale of CigRx®, we intend in the future to manufacture other nutraceuticals and
pharmaceuticals through Rock Creek. Accordingly, going forward we will consider the appropriate
industry comparison based on the mix of products being sold by our company. In the case of our
companys COO and General Counsel, the Compensation Committee also has undertaken an analysis of
compensation for senior partners at major law firms in the Washington, DC area, given the
background of our CEO and General Counsel in the litigation, regulatory and legislative areas and
their active involvement in implementing and coordinating our companys activities in these areas.
The general market information is publicly available aggregated pooled data and, while the
Compensation Committee reviews the general market information, it does not see the identity of any
of the surveyed companies. Further, the analysis has focused on the extent to which executive
officers have assumed multiple functions relating to various aspects of our companys mission and
long-term objectives that in different circumstances likely would have been assumed by other
employees. Also, the Compensation Committee considers other factors such as the seniority of its
senior executives, and for newer hires, the executives base salary at his/her prior place of
employment, the duties and responsibilities that the individual will be assuming, the availability
of other well-qualified candidates that would be available to carry out our companys goals and
objectives, and the compensation level a potential executive would be able to demand in a similar
position with another company or institution. The Compensation Committee reviews the information
provided by management and makes its recommendation to the Board of Directors with respect to
appropriate compensation levels.
In 2010, except with regard to Dr. Wright with whom our company entered into an
employment agreement in 2008 and for Park Dodd with whom we entered into a contract in 2010, the
Compensation
Committee recommended and the Board of Directors approved the continuation of salary and benefits
for our Named Executives on a month-to-month basis in accordance with employment agreements that
had expired or are continuing on a month-to-month basis, without any provisions for bonus or stock
awards. Given the losses suffered by our company in 2010 and the adverse jury verdict in our RJR
patent litigation in 2009 for which an appeal is pending in the Federal Circuit Court of Appeals,
management did not recommended any form of cash bonuses for 2010 and the Compensation Committee and
the Board concurred in that recommendation. However, our Compensation Committee continues to
believe that entering into employment agreements with our executive officers that have terms that
extend beyond a month-to-month basis assists us in attracting and retaining qualified executive
officers. Accordingly, on March 14, 2011 our Board of Directors, upon recommendation of the
Compensation Committee, approved new employment agreements for Messrs. Perito and Williams and Dr.
Wright. See Item 9B. Other Information.
Base Salary
In 2010, the base salary for each of our Named Executives was set in accordance with
the terms of contracts that were entered into in years prior to 2008 and which have been continued
on a month-to-month basis, or entered into in 2008 for Dr. Wright and in 2010 for Park Dodd. As
discussed above, in assessing compensation levels for all executive officers, the Compensation
Committee has focused on the extent to which executive officers have been assuming multiple
functions relating to our companys mission and long-term objectives. The Compensation Committee
also has considered salary levels and benefits for executives in the manufacturing sector in the
relevant geographic markets (Richmond, Virginia, Washington, DC and Boston, Massachusetts) and, in
the case of our companys COO and General Counsel, compensation levels for senior partners at major
law firms in the Washington, DC area.
Ancillary Bonuses
In 2008, an initial signing bonus in the amount of $100,000 was paid to Dr. Curtis
Wright at the time he joined our company as Senior Vice President, Medical/Clinical Director of
Rock Creek, our wholly owned subsidiary. Under his employment agreement, Dr. Wright would have been
entitled to a performance bonus in the amount of $100,000 in the event the FDA did not impose a
clinical hold on the initiation of a Phase 1 Clinical study for a tobacco-based drug product or any
other pharmaceutical for the treatment of smoking or smokeless tobacco cessation within eighteen
months from the date of his employment agreement. The bonus provision in Dr. Wrights agreement
expired in August 2009. The bonus and performance bonus provision were provided as an inducement
for Dr. Wright to leave his then current employment situation and assume the role as
Medical/Clinical Director of our newly incorporated subsidiary. In January 2010 we entered into a
new employment agreement with our CFO at the time he transitioned fully from Tatum Partners LLC.
Under this agreement, Mr. Dodd received salary payments comparable to those that he received in
2009. Also, under his employment agreement, management has agreed that, to the extent a cash bonus
or stock award is made to our CEO or COO, it would recommend to the Board/Compensation Committee
that it consider a similar type of award to the CFO taking into account the differences in
annualized salary and the contribution of the CFO to our companys success that resulted in the
award to the CEO or COO.
58
On an annual basis, we have paid an ancillary holiday bonus in the amount of $1,500
to executive officers, except for our companys CEO, COO and at times our CFO. An identical bonus
has been paid to our other employees. Such bonuses have been paid as part of a long-standing
holiday bonus policy and are not based on executive officers meeting achievement or performance
goals.
Discretionary Equity Incentive Awards
While our Board of Directors believes compensating our executive officers with
equity awards helps align the interests of our executive officers with that of our shareholders and
enhances the incentive of our companys executive officers to maximize shareholder value, our Board
of Directors recognizes that the number of our shares owned by any director or executive is a
personal decision and has not adopted a policy requiring ownership by directors or executives of a
minimum number of our shares.
Our executive officers, along with our other employees, are eligible to participate in the
award of stock options or restricted stock grants or stock appreciation rights under our 2000
Equity Incentive Plan, or 2000 Plan, and our 2008 Incentive Award Plan. However, to date we have
only granted stock options and not shares of restricted stock or stock appreciation rights to our
executive officers. In October 2007, Mr. Dodd was granted options to purchase up to 250,000 shares
of our common stock in connection with his appointment to the position of CFO, Treasurer and
Assistant Secretary of our company. Of the 250,000 stock options granted, 90,000 options vested on
October 10, 2007 and 80,000 options vested on October 10, 2008 and on October 10, 2009
respectively. In February 2008, Dr. Wright was granted options to purchase 200,000 shares of our
common stock in connection with his appointment to the position of Senior Vice President,
Medical/Clinical Director of Rock Creek. Of the 200,000 stock options granted, 100,000 options
vested on Dr. Wrights first day of employment and 50,000 options vested on February 26, 2009 and
February 26, 2010 respectively. These levels of option grants are similar in level to grants made
to other executive officers of our company upon their commencement of employment with us. Neither
of the discretionary equity incentive awards was granted based on the achievement of performance
goals, but rather to provide incentives for future performance, as an additional incentive to have
these individuals accept positions with our company and to align the interests of these individuals
with the interests of our shareholders.
In April 2010, our Board of Directors, based on the recommendation of the
Compensation Committee, awarded a total of 3,590,000 stock options, respectively, to several of our
executive officers, other employees, one consultant and our Independent Board members. On January
31, 2011 our Board of Directors on recommendation of the Compensation Committee awarded a total of
604,000 stock options to three employees who had an equal number of stock options expire during
2010. On March 14, 2011 our Board of Directors, upon recommendation of the Compensation Committee,
approved additional of stock option awards to Messrs. Perito and Williams and Dr. Wright as part of
the terms of employment agreements entered into with these executive officers on that date. See
Item 9B. Other Information.
At December 31, 2010, there were 7,716,200 options issued and outstanding with a weighted average
exercise price of $2.31 per share.
Benefits Plans
In order to attract and retain individuals who are capable of carrying out and
enhancing our mission, we have provided certain benefits and perquisites to our senior executives
that are comparable to those generally available to senior management and were available to those
executives in previous positions. In the case of our CEO and COO these benefits and perquisites
have included the items listed below. Where noted, such benefits also have been provided to other
executive officers:
|
|
|
reimbursement for life insurance coverage in the amount of $10
million for our companys CEO, $5 million for our COO and $1 million
for our General Counsel; |
|
|
|
|
additional disability insurance for our COO and General Counsel; |
|
|
|
|
a Company automobile and reimbursement for all costs associated with
the operation of the automobile for our companys CEO and COO and
reimbursement of automobile expenses for our companys Vice
President of Sales and Marketing; |
|
|
|
|
monthly or annual club membership dues for our companys CEO and COO; |
|
|
|
|
a mobile phone and phone costs for our companys CEO, COO, CFO and
Vice President of Sales and Marketing; and |
|
|
|
|
reimbursement for the cost of outside counsel retained by our
companys CEO and/or COO in connection with advice and counsel
related to the negotiation, drafting, and execution of their
employment agreements. |
59
Employment and Severance Arrangements
The executive employment agreements with Messrs. Williams and Perito that had
contained severance provisions expired prior to 2010 and, as a result, those provisions were not
in effect in 2010. The executive employment agreement with Mr. Dean was modified to eliminate any
severance payments when his contract was continued on a month-to-month basis after expiration and
in connection with the decision to limit Mr. Deans compensation to his base salary payments and
benefits. We did not seek to renew certain terms in these prior agreements as we chose to limit the
compensation of our executive officers to base salary and benefits only, in light of operating
losses that we had been experiencing. We believe that such written agreements are in the best
interest of our company to retain our current executive officers and to attract prospective
executive officers to our company and to provide such individuals with assurances of continued
salary and benefits in the event of the termination of their employment relationship. Absent such
provisions, we believe that we would have difficulty attracting and retaining the type of executive
officers that we believe are critical to our mission and long-term objectives. In 2010, except in
the case of the Executive Employment Agreement we entered into with Park Dodd, our CFO, in January
2010 at the time he transitioned fully from Tatum Partners, LLC, we did not enter into any new
employment agreements with our executive officers. On March 14, 2011 we entered into new employment
agreements with Messrs. Perito and Williams and an amended and restated employment agreement with
Dr. Wright. See Item 9B. Other Information. We intend to enter into new executive employment
agreements with our executive officers in the future although we have deferred entering into any
additional agreements at this time When we are in a position to enter into new contracts with our
other executives in the future, it is expected that such contracts will be for multiple-year terms
and will contain provisions for base salary, and provisions covering a combination of some or all
of bonuses, equity incentive awards and severance provisions.
Under the terms of Mr. Pokusas employment agreement, at the conclusion of the
initial three-year term in 2004, the agreement continued in place, but on a month-to-month basis.
Pursuant to the terms of his employment agreement, Mr. Pokusa is entitled to severance payments
equal to six months salary in the event of his termination without cause. Those payments would be
due on a monthly basis. Mr. Pokusas employment agreement has not been modified to eliminate
severance because the agreement has continued under its original terms, although on a
month-to-month basis. In December 2008, Mr. Pokusas employment agreement was modified to ensure
that the severance payments complied with the requirements of Section 409A of the Internal Revenue
Code.
Under the terms of Dr. Wrights employment agreement in effect during 2010, he was
entitled to severance payments equal to all salary that would have been due under his agreement
through the end of its term and all accrued vacation in the event the agreement was terminated
without cause or for Good Reason, as defined in the agreement. Any severance payments would have
been made at the same time and in the same manner as salary payments paid to Dr. Wright during
the term of his agreement. Dr. Wrights employment agreement in effect during 2010 was due to
expire on March 17, 2011 and, on March 14, 2011, our company entered into an amended and restated
employment agreement with Dr. Wright that extends the term of his prior agreement for three years
beginning on March 14, 2011. The amended and restated employment agreement contains severance
provisions identical to those in his initial employment agreement. See Item 9B. Other
Information. Under the terms of Mr. Dodds employment agreement he is entitled to severance
payments equal to six months base salary, based on his average salary over the past twelve months
or lesser period as applicable, in the event the agreements is terminated without cause or for
Good Reason, as defined in the agreement. Any severance payments would be made at the same time
and in the same manner as salary payments would have been paid to Mr. Dodd during the term of his
agreement. Under the prior agreement with Mr. Dodd through Tatum Partners LLC he was not entitled
to any severance payments in the event of the termination of his employment. The employment
agreement entered into with Messrs. Perito and Williams on March 14, 2011 contain severance
provisions identical to those contained in the executive employment agreements with Messrs. Perito
and Williams that expired prior to 2010. See Item 9B. Other Information.
Under the employment agreements with Messrs. Dean, Dodd, Pokusa and Wright, these
executive officers are subject to noncompetition covenants following the termination of employment
as well as covenants relating to the treatment of confidential information disclosed to them during
their employment with our company. The noncompetition covenants prohibit the executive officers
from owning a company or accepting employment with an entity that competes in the same field as our
company or soliciting business of the same or similar type being carried on by our company for a
period of one year following termination of employment. The employment agreements entered into
with Messrs. Perito and Williams on March 14, 2011 contain
similar noncompetiton and confidentiality covenants. See
Item 9B. Other Information.
60
Taxation of Executive Compensation
We seek to compensate our executive officers in a manner that is tax effective for
our company. As appropriate, we seek to structure these compensation arrangements, to the extent
applicable, to comply with the requirements of Section 162(m) of the Internal Revenue Code of 1986,
as amended.
Compensation Committee Report
The Compensation Committee held four meetings during fiscal year ended December 31,
2010. Given the continued losses suffered by our company, the Compensation Committee in September
2010 undertook an interim review of compensation levels for our companys Named Executives. Based
on our companys progress in 2010 in meeting certain goals relating to our smokeless tobacco
products and the research and development activities of our companys Rock Creek subsidiary,
including the introduction of a non-nicotine, non-tobacco dietary supplement, the Compensation
Committee, at that time, determined that the current compensation levels were appropriate. The
Compensation Committee subsequently undertook a further review of compensation issues and has reviewed and
discussed with management the Compensation Discussion and Analysis for the year ended December 31,
2010. Based upon such review and discussion, the Compensation Committee recommended to our Board of
Directors that the Compensation Discussion and Analysis section be included in this Annual Report
on Form 10-K for the year ended December 31, 2010. Additionally, based on such review, the related
discussions and such other matters deemed relevant and appropriate by the Compensation Committee,
the Compensation Committee has determined that the current
levels of compensation of our executive officers are appropriate given their experience, job
responsibilities and the diverse management roles that have been assumed by the executive officers.
Given the continued losses suffered by our company, the Compensation Committee will undertake a
further review of compensation levels for the Companys Named Executives in mid-2011.
Christopher C. Chapman, M.D. (Chairman)
Leo S. Tonkin, Esquire
Neil L. Chayet, Esquire
The foregoing report shall not be deemed incorporated by reference by any general statement
incorporating by reference this proxy statement into any filing under the Securities Act of 1933 or
under the Securities Exchange Act of 1934, as amended (together, the Acts), except to the extent
that the Company specifically incorporates this information by reference, and shall not otherwise
be deemed filed under the Acts.
61
The following table summarizes the compensation paid to the Named Executives employed by
our company during 2008, 2009 and 2010, for services rendered in all capacities to our company and
its subsidiaries.
SUMMARY COMPENSATION TABLE
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
All Other |
|
|
|
|
|
|
|
|
|
|
Salary |
|
|
Bonus |
|
|
Options |
|
|
Compensation |
|
|
|
|
Name and Principal Position |
|
Year |
|
|
($) |
|
|
($)(1) |
|
|
($)(2) |
|
|
($) |
|
|
Total($) |
|
|
Jonnie R. Williams, Sr. |
|
|
2008 |
|
|
|
1,000,000 |
|
|
|
|
|
|
|
806,650 |
|
|
|
52,423 |
|
|
|
1,859,073 |
|
Chief Executive Officer |
|
|
2009 |
|
|
|
1,000,000 |
|
|
|
|
|
|
|
|
|
|
|
80,582 |
|
|
|
1,080,582 |
|
|
|
|
2010 |
|
|
|
1,000,000 |
|
|
|
|
|
|
|
2,858,625 |
|
|
|
95,158 |
(3) |
|
|
3,953,783 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Park A. Dodd, III |
|
|
2008 |
|
|
|
236,400 |
|
|
|
1,500 |
|
|
|
66,630 |
|
|
|
52,500 |
|
|
|
357,030 |
|
Chief Financial Officer |
|
|
2009 |
|
|
|
202,350 |
|
|
|
1,500 |
|
|
|
|
|
|
|
54,930 |
|
|
|
258,780 |
|
|
|
|
2010 |
|
|
|
221,483 |
|
|
|
1,500 |
|
|
|
114,345 |
|
|
|
5,342 |
(8) |
|
|
342,670 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Paul L. Perito |
|
|
2008 |
|
|
|
1,000,000 |
|
|
|
|
|
|
|
832,875 |
|
|
|
141,662 |
|
|
|
1,974,537 |
|
Chairman, President and |
|
|
2009 |
|
|
|
1,000,000 |
|
|
|
|
|
|
|
|
|
|
|
152,694 |
|
|
|
1,152,694 |
|
Chief Operating Officer |
|
|
2010 |
|
|
|
1,000,000 |
|
|
|
|
|
|
|
2,858,625 |
|
|
|
236,833 |
(4) |
|
|
4,095,458 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
David M. Dean |
|
|
2008 |
|
|
|
295,054 |
|
|
|
1,500 |
|
|
|
|
|
|
|
42,041 |
|
|
|
338,595 |
|
Vice President of Sales and |
|
|
2009 |
|
|
|
295,054 |
|
|
|
1,500 |
|
|
|
|
|
|
|
37,159 |
|
|
|
333,713 |
|
Marketing
|
|
|
2010 |
|
|
|
295,054 |
|
|
|
1,500 |
|
|
|
|
|
|
|
36,055 |
(5) |
|
|
332,610 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Robert E. Pokusa |
|
|
2008 |
|
|
|
385,000 |
|
|
|
1,500 |
|
|
|
299,835 |
|
|
|
18,781 |
|
|
|
705,116 |
|
General Counsel |
|
|
2009 |
|
|
|
385,000 |
|
|
|
1,500 |
|
|
|
|
|
|
|
18,937 |
|
|
|
405,437 |
|
|
|
|
2010 |
|
|
|
385,000 |
|
|
|
1,500 |
|
|
|
|
|
|
|
17,815 |
(6) |
|
|
404,315 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Curtis Wright, MD |
|
|
2008 |
|
|
|
236,538 |
|
|
|
101,500 |
|
|
|
292,000 |
|
|
|
8,827 |
|
|
|
638,865 |
|
Senior Vice President, |
|
|
2009 |
|
|
|
300,000 |
|
|
|
1,500 |
|
|
|
|
|
|
|
10,987 |
|
|
|
312,487 |
|
Medical/Clinical Director, |
|
|
2010 |
|
|
|
300,000 |
|
|
|
1,500 |
|
|
|
457,380 |
|
|
|
10,904 |
(7) |
|
|
769,784 |
|
Rock Creek |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Represents our companys yearly Holiday bonus of $1,500 paid to all employees, except the
CEO, COO and with respect to Dr. Wright, the $100,000 signing bonus paid in 2008. |
|
(2) |
|
Amounts represent the grant date fair value of the stock options issued in the respective
year. For the assumptions used in calculating the value of this award, see Note 8 to our
consolidated financial statements included in Item 15 of this Report. |
|
(3) |
|
Represents $41,889 in automobile expenses, $33,779 in life insurance premiums and $19,490 in
club memberships. |
|
(4) |
|
Represents $38,286 in automobile expenses, $186,956 in life and disability insurance premiums
and $11,591 in club memberships. |
|
(5) |
|
Represents $25,842 in automobile expenses and $10,213 of matching contributions by our
company under our 401(k) Plan. |
|
(6) |
|
Represents $6,265 in life and disability insurance premiums and $11,550 of matching
contributions by our company under our 401(k) Plan. |
|
(7) |
|
Represents matching contributions by our company under our 401(k) Plan. |
Grants of Plan Based Awards During 2010
On April 5, 2010, our Board of Directors, based on the recommendation of the Compensation
Committee, awarded a total of 3,590,000 stock options to several employees, executive officers, one
consultant and our Independent Board members. All grants were fully vested on the grant date.
The table below summarizes information relating to the grants to our Named Executives in 2010.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Securities |
|
|
Option |
|
|
Option |
|
|
|
Underlying |
|
|
Exercise |
|
|
Expiration |
|
Name |
|
Unexcercised Options |
|
|
Price |
|
|
Date |
|
Jonnie R. Williams, Sr. |
|
|
1,250,000 |
|
|
$ |
2.72 |
|
|
|
4/5/2020 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Park A. Dodd, III |
|
|
50,000 |
|
|
$ |
2.72 |
|
|
|
4/5/2020 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Paul L. Perito |
|
|
1,250,000 |
|
|
$ |
2.72 |
|
|
|
4/5/2020 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Curtis Wright M.D. |
|
|
200,000 |
|
|
$ |
2.72 |
|
|
|
4/5/2020 |
|
62
As of December 31, 2010, our company did not have any long term incentive compensation awards
for cash or equity that were subject to future vesting and we have not provided incentives in the
form of stock awards for our Named Executives. However, on March 14, 2010, we entered into new
employment agreements with each of Messrs. Williams and Perito and Dr. Wright each of which granted
stock options that are subject to vesting based upon the achievement of certain performance goals.
See Item 9B. Other Information. All grants in 2010 were in the form of stock options that vested
on the date of the grant. Therefore, the value of the options awarded represent the aggregate grant
date fair value, which is included in the executive compensation table above. For the assumptions
used in calculating the value of this award, see note 10 to our consolidated financial statements
included in Item 15. Exhibits, Financial Statement Schedules of this Report.
Outstanding Equity Awards at Fiscal Year
The following table provides information regarding the stock options held by the Named
Executives as of December 31, 2010. All stock options were fully vested and exercisable as of
December 31, 2010.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of |
|
|
Number of |
|
|
|
|
|
|
|
|
|
Securities |
|
|
Securities |
|
|
|
|
|
|
|
|
|
Underlying |
|
|
Underlying |
|
|
Option |
|
|
|
|
|
|
Unexercised |
|
|
Unexercised |
|
|
Exercise |
|
|
Option |
|
|
|
Options (#) |
|
|
Options (#) |
|
|
Price |
|
|
Expiration |
|
Name |
|
Exercisable |
|
|
Unexercisable |
|
|
($) |
|
|
Date |
|
Jonnie R. Williams, Sr. |
|
|
125,000 |
|
|
|
|
|
|
$ |
1.89 |
|
|
|
5/6/13 |
|
|
|
|
500,000 |
|
|
|
|
|
|
$ |
1.72 |
|
|
|
5/6/18 |
|
|
|
|
1,250,000 |
|
|
|
|
|
|
$ |
2.72 |
|
|
|
4/5/20 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Park A. Dodd, III |
|
|
250,000 |
|
|
|
|
|
|
$ |
1.19 |
|
|
|
10/10/17 |
|
|
|
|
50,000 |
|
|
|
|
|
|
$ |
1.72 |
|
|
|
5/6/18 |
|
|
|
|
50,000 |
|
|
|
|
|
|
$ |
2.72 |
|
|
|
4/5/20 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Paul L. Perito |
|
|
625,000 |
|
|
|
|
|
|
$ |
1.72 |
|
|
|
5/6/18 |
|
|
|
|
1,250,000 |
|
|
|
|
|
|
$ |
2.72 |
|
|
|
4/5/20 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Robert E. Pokusa |
|
|
50,000 |
|
|
|
|
|
|
$ |
1.47 |
|
|
|
3/30/11 |
|
|
|
|
200,000 |
|
|
|
|
|
|
$ |
1.12 |
|
|
|
5/31/12 |
|
|
|
|
225,000 |
|
|
|
|
|
|
$ |
1.72 |
|
|
|
5/6/18 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Curtis Wright, MD |
|
|
200,000 |
|
|
|
|
|
|
$ |
1.84 |
|
|
|
2/26/18 |
|
|
|
|
200,000 |
|
|
|
|
|
|
$ |
2.72 |
|
|
|
4/5/20 |
|
Option Exercises and Stock Vested
There were no stock options exercised during 2010.
Potential Payments Upon Termination or Change of Control
Except for Mr. Pokusa, Dr. Wright and Mr. Dodd, none of the Named Executives are entitled to
severance upon a termination of employment or any severance or benefits in connection with a change
of control of our company or any of its affiliates under agreements
that were in effect as of December 31, 2010. The employment agreements for the Named
Executives are described above under Employment and Severance Arrangements. The following chart
sets forth the severance Mr. Pokusa, Dr. Wright and Mr. Dodd would be entitled to receive upon
certain terminations of employment, assuming the relevant event occurred on December 31, 2010.
|
|
|
|
|
|
|
|
|
|
|
Description of |
|
Termination without |
|
Name |
|
Severance |
|
Cause |
|
Robert E. Pokusa(1) |
|
Salary Continuation |
|
$ |
192,500 |
|
Dr. Curtis Wright, MD(1) |
|
Salary Continuation |
|
$ |
64,166 |
|
Park A. Dodd, III(1) |
|
Salary Continuation |
|
$ |
100,000 |
|
|
|
|
(1) |
|
Messrs. Pokusa, Wright and Dodd would also be entitled to receive the above salary
continuation payments upon a termination of employment by them for Good Reason, as defined
in their employment agreements effective as of December 31, 2010, to generally mean (i) a material diminution in their position,
duties, responsibilities, functions or status with us, or the removal, or our failure to
re-elect them to, any of such positions, (ii) a material reduction by us of their base salary
or benefits or (iii) any other material breach by us of their employment agreement, which
breach is not cured within 20 days of notice. |
63
Board of Director Compensation
In compensating directors, our company has sought to use a combination of payments for
participation in director and committee meetings and initial and anniversary stock option grants.
The combination of payments for meeting attendance and stock option grants is intended to motivate
and align the interest of the directors with that of our company. Also, given our companys mission
to act as a disruptive force in the tobacco industry, we have sought to use the combination of
payments to directors for attendance at meetings and stock option grants to attract directors who
have particular skills and expertise that would complement our companys mission, particularly in
the area of finance, new product development, medical research, and other health-related areas.
Each of our companys independent directors, as so classified by our Board of Directors, or
the Independent Directors, is granted a stock option to purchase up to 50,000 shares of our common
stock on the date such Independent Director is first elected to the Board of Directors, vesting in
equal installments on each of the first two anniversaries of the date of grant. As an annual
retainer, each Independent Director additionally receives a stock option to purchase up to 50,000
shares of our common stock granted on each anniversary of such Independent Directors initial
election to the Board of Directors, exercisable immediately.
Each Independent Director also receives a payment of $4,500 for his participation in each
meeting of the Board of Directors and any committee meeting attended personally and $3,500 for his
participation in each meeting of the Board of Directors and any committee meeting attended
telephonically, subject to a cap of $6,000 for multiple in-person or telephonic meetings on the
same day. Additionally, the chairman of the Audit Committee is to receive a separate fee of
$20,000 per year for services in that capacity, although the fee has been waived in the past, and
beginning in 2011 the chairman of the Compensation Committee is to receive a separate fee of
$15,000 per year for services in that capacity.
Messrs. Chapman, Chayet, Haynes, Mirabelli, and Tonkin have been designated as Independent
Directors. This designation of independence is intended solely for the purpose of clarifying which
directors are entitled to compensation for their services as directors. Directors not designated as
Independent Directors generally are those who in the past have been employees of our company, or
who have waived their right to receive director compensation. Directors who are employees of our
company receive compensation in their capacity as employees but do not receive any compensation for
board or committee meetings, nor do they receive the options package made available to
individuals serving as Independent Directors. Our CEO does not, and has not, served as the Chairman
of our Board of Directors. Since 2000 our Chairman has been Mr. Perito, who serves as our Companys
President and COO.
The following table sets forth, for our companys Independent Directors, certain information
regarding fees earned and equity awards granted during the year ended December 31, 2010.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fees Earned or |
|
|
|
|
|
|
|
|
|
|
|
|
Paid in Cash |
|
|
Option Awards |
|
|
All Other |
|
|
Total |
|
Name |
|
($thousand)(1) |
|
|
($)(2) |
|
|
Compensation |
|
|
($) |
|
Burton J. Haynes |
|
$ |
8,000 |
|
|
$ |
88,380 |
|
|
|
|
|
|
$ |
19,038 |
|
Christopher C. Chapman, MD |
|
|
66,000 |
|
|
|
257,308 |
|
|
|
|
|
|
|
323,308 |
|
Neil L. Chayet, Esquire(3) |
|
|
44,000 |
|
|
|
242,123 |
|
|
$ |
60,000 |
|
|
|
346,123 |
|
Mario V. Mirabelli |
|
|
24,000 |
|
|
|
90,945 |
|
|
|
|
|
|
|
42,936 |
|
Leo S. Tonkin, Esquire |
|
|
69,500 |
|
|
|
245,423 |
|
|
|
|
|
|
|
314,923 |
|
Alan Weichselbaum(4) |
|
|
31,500 |
|
|
|
242,123 |
|
|
|
|
|
|
|
273,623 |
|
|
|
|
(1) |
|
This column represents the amount of compensation earned by each Independent Director during
2010 in the form of director fees. |
|
(2) |
|
Amounts represent our companys aggregate compensation cost. All options vested on the date
of the grant except for the options granted Messrs. Mirabelli and Haynes, which vest over a
two-year period. For the assumptions used in calculating the value of this award, see Note 10
to our consolidated financial statements included in Item 15 of this Report. The amounts set
forth in this column reflect our
companys accounting expense for these awards and do not correspond to the actual value that may
be realized by the Independent Director receiving the award. |
|
(3) |
|
Mr. Chayet received an additional $60,000 under a consulting contract approved by our Board
of Directors in March 2010. See note 10 of to our consolidated financial statements included
in Item 15. Exhibits, Financial Statement Schedules of this Report for further details. |
|
(3) |
|
Mr. Weichselbaum did not stand for re-election to the Board at the annual meeting held on
December 10, 2010. |
64
The following represents the number of options granted to each Independent Director in 2010
and the total number of options held by each Independent Director as of December 31, 2010.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Option |
|
|
Option |
|
|
Total Options |
|
|
|
Options |
|
|
2010 Vested |
|
|
Exercise Price |
|
|
Expiration |
|
|
outstanding as of |
|
Name |
|
Granted 2010 |
|
|
Options |
|
|
($) |
|
|
Date |
|
|
December 31, 2010 |
|
Burton J. Haynes, Esquire |
|
|
50,000 |
|
|
|
|
|
|
|
2.03 |
|
|
|
10/22/20 |
|
|
|
50,000 |
|
Christopher C. Chapman, M.D. |
|
|
50,000 75,000 |
(2) |
|
|
50,000 75,000 |
|
|
|
2.03 2.72 |
|
|
|
9/22/20 4/5/20 |
|
|
|
375,000 |
|
Neil L. Chayet, Esquire |
|
|
50,000 75,000 |
(2) |
|
|
50,000 75,000 |
|
|
|
1.67 2.72 |
|
|
|
9/7/20 4/5/20 |
|
|
|
286,200 |
|
Mario V. Mirabelli, Esquire |
|
|
50,000 |
|
|
|
|
|
|
|
2.08 |
|
|
|
10/11/20 |
|
|
|
50,000 |
|
Leo S. Tonkin, Esquire |
|
|
50,000 75,000 |
(2) |
|
|
50,000 75,000 |
|
|
|
1.75 2.72 |
|
|
|
11/20/20 4/5/20 |
|
|
|
550,000 |
|
Alan Weichselbaum(1) |
|
|
50,000 |
|
|
|
50,000 |
|
|
|
1.67 |
|
|
|
9/7/20 |
|
|
|
275,000 |
|
|
|
|
75,000 |
(2) |
|
|
75,000 |
|
|
|
2.72 |
|
|
|
4/5/20 |
|
|
|
|
|
|
|
|
(1) |
|
Mr. Weichselbaum did not stand for re-election to the Board at the annual meeting held on
December 10, 2010. |
|
(2) |
|
On April 5, 2010 the Board of Directors upon recommendation from the Compensation Committee
awarded a one-time stock option to the Independent Directors noted above. |
Compensation Committee Interlocks and Insider Participation
No member of our Board of Directors Compensation Committee, each of whom is listed under
Compensation Committee Report, has served as one of our officers or employees at any time. None
of our executive officers served during 2010 as a member of the board of directors or as a member
of a compensation committee of any other company that has an executive officer serving as a member
of our Board of Directors or Compensation Committee.
|
|
|
ITEM 12. |
|
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
MATTERS |
The following table sets forth as of March 15, 2011 certain information with respect to the
beneficial ownership of our companys common stock by each beneficial owner of more than 5% of our
companys voting securities, each director and each Named Executive Officer, and all directors and
executive officers of our company as a group. As of March 15, 2011, there were 134,026,053 shares
of our companys common stock outstanding.
|
|
|
|
|
|
|
|
|
|
|
Shares |
|
|
|
|
|
|
Beneficially |
|
|
Percentage |
|
Name |
|
Owned (1) |
|
|
Owned (2) |
|
Named Executive Officers |
|
|
|
|
|
|
|
|
David M. Dean(3) |
|
|
602,842 |
|
|
|
* |
|
Park A. Dodd, III(4) |
|
|
360,000 |
|
|
|
* |
|
Paul L. Perito(5) |
|
|
3,855,000 |
|
|
|
2.8 |
|
Robert E. Pokusa(6) |
|
|
476,199 |
|
|
|
* |
|
Jonnie R. Williams, Sr.(7) |
|
|
20,224,029 |
|
|
|
14.6 |
|
Curtis Wright, MD(8) |
|
|
400,000 |
|
|
|
* |
|
|
|
|
|
|
|
|
|
|
Directors Who Are Not Named Executive Officers |
|
|
|
|
|
|
|
|
Christopher C. Chapman, Jr., M.D.(9) |
|
|
375,000 |
|
|
|
* |
|
Neil Chayet(10) |
|
|
290,200 |
|
|
|
* |
|
Burton J. Haynes(11) |
|
|
44,700 |
|
|
|
* |
|
Mario V. Mirabelli(12) |
|
|
109,000 |
|
|
|
* |
|
Leo S. Tonkin(13) |
|
|
500,000 |
|
|
|
* |
|
All Directors and Named Executive Officers (11 Persons) |
|
|
27,236,970 |
|
|
|
19.0 |
|
|
|
|
|
|
|
|
|
|
Other Beneficial Owners of 5% or More of the Outstanding Common Stock of the Company |
|
|
|
|
|
|
|
|
Tradewinds Investment Management, LP(14) |
|
|
20,327,489 |
|
|
|
14.6 |
|
65
|
|
|
* |
|
Denotes less than 1% beneficial ownership. |
|
(1) |
|
Beneficial ownership is determined in accordance with rules of
the SEC and includes shares over which the indicated beneficial
owner exercises voting and/or investment power. Shares of common
stock subject to options or warrants currently exercisable or exercisable
within 60 days are deemed outstanding for purposes of computing
the percentage ownership of the person holding such securities,
but not deemed outstanding for purposes of computing the
percentage ownership of any other person. Except as indicated,
and subject to community property laws where applicable, the
persons named in the table above have sole voting and investment
power with respect to all shares of voting stock shown as
beneficially owned by them. Unless otherwise noted, the address
for each of the above stockholders is c/o Star Scientific, Inc.,
4470 Cox Road, Glen Allen, Virginia 23060. |
|
(2) |
|
The Percentage Owned calculations are based on the outstanding shares of our common stock as
of March 15, 2011. |
|
(3) |
|
Includes 251,742 shares held by Mr. Dean, 1,100 shares owned by Mr. Deans spouse and 350,000
shares that Mr. Dean has the right to acquire upon exercise of stock options. |
|
(4) |
|
Includes 350,000 shares that Mr. Dodd has the right to acquire upon exercise of stock options
and 10,000 shares held by Mr. Dodd. |
|
(5) |
|
Includes 1,881,000 shares held by Mr. Perito, 50,000 shares that Mr. Perito has the right to
acquire upon exercise of a warrant, 1,875,000 shares which Mr. Perito has the right to acquire
upon exercise of stock options, and an aggregate of 49,000 shares held by his children or in
trust for the benefit of his children, of which Mr. Perito disclaims beneficial ownership. |
|
|
|
(6) |
|
Includes 1,199 shares held by Mr. Pokusa and 475,000 shares that Mr. Pokusa has the right to
acquire upon exercise of stock options. |
|
(7) |
|
Includes 11,891,907 shares held by Mr. Williams, 3,088,761 shares that Mr. Williams has the
right to acquire upon exercise of warrants, 1,875,000 shares that Mr. Williams has the right to
acquire upon exercise of stock options and 2,268,361 held by his children or in trust for his
children, of which he disclaims beneficial interest. Also includes 1,100,000 shares held by
Regent Court of which Mr. Williams shares voting and investment power. |
|
(8) |
|
Includes 400,000 shares that Dr. Wright has the right to acquire upon exercise of stock options. |
|
(9) |
|
Includes 375,000 shares that Mr. Chapman has the right to acquire upon exercise of stock options. |
|
(10) |
|
Includes 2,000 shares held by Mr. Chayet, 2,000 shares that Mr. Chayet has the right to acquire
upon exercise of a warrant and 286,200 shares that Mr. Chayet has the right to acquire upon
exercise of stock options. |
|
(11) |
|
Includes 10,000 shares held by Mr. Haynes, 10,000 shares that Mr. Haynes has the right to
acquire upon exercise of a warrant and 24,700 shares held by Mr. Haynes in an individual
retirement account. |
|
(12) |
|
Includes 74,000 shares held by Mr. Mirabelli in an individual retirement account, 20,000 shares
owned by Mr. Mirabelli individually, and 15,000 shares held jointly between Mr. Mirabelli and
his spouse. |
|
(13) |
|
Includes 500,000 shares that Mr. Tonkin has the right to acquire upon exercise of stock options. |
|
(14) |
|
Based on reported filings and representation from Tradewinds Management and other filings,
includes 14,789,854 shares for which Tradewinds Master Fund (BVI) Ltd., Feehan Partners, L.P.
and P.V. Partners, L.P. share voting and dispositive power. Also
includes 5,537,635 warrants that are currently exercisable, expiring on September 14, 2013 and November 5, 2015. Robert W. Scannell is a director
of Tradewinds Master Fund (BVI) Ltd. and the General Partner of Feehan Partners, L.P. and has
voting and investment power over each entitys respective securities. Mr. Peters is a director
of Tradewinds Master Fund (BVI) Ltd. and the General Partner of P.V. Partners, L.P. and has
voting and investment power over each entitys respective securities. Tradewinds Master Fund
(BVI) Ltd. is a business company organized in the British Virgin Islands. Tradewinds Investment
Management, L.P. is its investment manager pursuant to an investment management agreement over
which Messrs. Scannell and Peters exercise voting and investment authority and control. Mr.
Peters disclaims beneficial ownership of and receives no pecuniary interest from the securities
held by Feehan Partners, L.P., which are held for the benefit of Mr. Scannell, and Mr. Scannell
disclaims beneficial ownership of and receives no pecuniary interest from the securities held by
P.V. Partners, L.P. and the securities held in Mr. Peters retirement accounts, in each case,
which are held for the benefit of Mr. Peters. The address for these stockholders is c/o
Tradewinds Investment Management, L.P. Three Harbor Drive, Suite 213, Sausalito, California
94965 |
66
Equity Compensation Plan Information
The following table provides certain information as of December 31, 2010, with respect to our
equity compensation plans under which our common stock is authorized for issuance:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted- |
|
|
|
|
|
|
Number of Shares |
|
|
Average |
|
|
Number of Securities |
|
|
|
to be Issued Upon |
|
|
Exercise |
|
|
Remaining Available |
|
|
|
Exercise of |
|
|
Price of |
|
|
for Future Issuance |
|
|
|
Outstanding |
|
|
Outstanding |
|
|
Under Equity |
|
|
|
Options |
|
|
Options |
|
|
Compensation Plans |
|
Plan Category |
|
and Rights |
|
|
and Rights |
|
|
(excluding Column a) |
|
|
|
(a) |
|
|
(b) |
|
|
(c) |
|
Equity
Compensation Plans
Approved by
Shareholders |
|
|
7,716,200 |
|
|
$ |
2.31 |
|
|
|
2,684,000 |
|
|
|
|
(1) |
|
We have granted warrants to purchase shares of our common stock to two consultants.
Specifically, on December 20, 2000, we issued 210,526 warrants to purchase shares of our
common stock at an exercise price of $2.375 to a consultant. These warrants fully vested on
the date of issuance and expired on December 20, 2010. |
|
|
|
ITEM 13. |
|
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE |
Transactions with Related Persons
Our company is the licensee under a license agreement, or License Agreement, with Regent Court
Technologies, LLC, of which Jonnie R. Williams, our companys CEO, and Francis E. ODonnell, Jr.,
M.D., the beneficiary of the ODonnell Trust, are the owners. The License Agreement provides, among
other things, for the grant of an exclusive, worldwide, irrevocable license to our company, with
the right to grant sublicenses, to make, use and sell tobacco and products containing tobacco under
the licensors patent rights and know-how relating to the processes for curing tobacco so as to
significantly prevent the formation of certain toxic carcinogens present in tobacco and tobacco
smoke, namely TSNAs, and to develop products containing such tobacco, whether such patent rights
and know-how are now in existence or hereinafter developed. Our company is obligated to pay to
Regent Court a royalty of 2% on all net sales
of products by it and any affiliated sub-licensees, and 6% on all fees and royalties received by it
from unaffiliated sub-licensees, less any related research and development costs incurred by our
company. The License Agreement expires with the expiration of the last of any applicable patents.
Twelve United States patents have been issued, and additional patent applications are pending. To
date, our company has paid no royalties under the License Agreement. The License Agreement may be
terminated by our company upon thirty days written notice or by Regent Court if there is a default
in paying royalties or a material breach by our company or the purchase of our companys stock or
assets.
67
Starwood Industries, LLC, or Starwood, a company in which Mr. Williams, our CEO,
and Dr. Francis ODonnell, who at the time was one of our largest shareholders, each held a fifty
percent interest, for several years owned an aircraft that was used by our company from time to
time. We had an agreement with Starwood to pay a contracted rate per hour for the use of the
aircraft. This agreement did not provide for an adjustment based on the increased cost of fuel.
During the year ended December 31, 2007, and the three months ended March 31, 2008, fuel costs
exceeded the standard rate set forth in the agreement and, accordingly, Starwood requested a fuel
surcharge applicable to our companys use of the aircraft, a practice common in the aircraft
industry. Given Mr. Williams relationship with Starwood, any payment to Starwood by our company
constitutes a related party transaction that must be pre-approved by our companys Audit Committee.
On May 6, 2008, our companys Audit Committee approved a $529,672 payment to Starwood in
satisfaction of the fuel surcharge related to our companys use of the aircraft during this period.
In 2008 the aircraft owned by Starwood was sold and Starwood Aviation, Inc., or
Starwood Aviation, a company wholly owned by Mr. Williams, purchased another aircraft. Effective
September 1, 2008, we entered into an agreement for our companys use of the aircraft owned by
Starwood Aviation. Under this agreement, we have agreed to pay an hourly rate for the use of the
aircraft of approximately $3,970 each month until the monthly fixed rental cost for the aircraft of
approximately $51,000 has been met. If the aircraft is used beyond the monthly fixed cost, we are
required to pay an hourly rate of approximately $1,200 to cover related costs. In accordance with
our companys related party transaction policy, the agreement with Starwood Aviation was
recommended for approval to the Board of Directors by our companys Audit Committee, and it was
approved by the Board of Directors at a meeting held on October 6, 2008. As of May 5, 2010, the
agreement with Starwood Aviation was amended to clarify the types of items that would be included
as out of pocket expenses and to recognize that certain costs, such as for fuel, would be
variable depending on the actual cost of the item at the time of use. Payments made by our company
to Starwood, Starwood Aviation or Messrs. Williams and ODonnell as predecessors-in-interest to the
aircrafts with respect to related expenses were $1,654,000 In 2010, $1,560,000 in 2009, $1,401,582
in 2008, and were billed at cost.
On March 9, 2010 Mr. Williams purchased 2,371,541 shares of our common stock at a price of
$1.14 per share and, for a price of $0.125 per share, purchased a warrant for an equal number of
warrant shares at an exercise price of $1.50 per share and on November 5, 2010 Mr. Williams
purchased 717,220 shares of our common stock at a price of $1.80 per share and, for a price of
$0.125 per share, purchased a warrant for an equal number of warrant shares at an exercise price
of $1.80 per share. On November 5, 2010 Messrs. Chayet, Haynes and Perito purchased 2,000, 10,000
and 50,000 shares respectively of our common stock at a price of $1.80 per share and, for a price
of $0.125 per share, purchased a warrant for an equal number of warrant shares at an exercise price
of $1.80 per share In accordance with our companys related party transaction policy, Mr.
Williams intention to purchase shares and warrant shares of our companys stock was considered by
the Audit Committee at meetings held on March 9, 2010 and November 5, 2010 respectively and was
approved by the Audit Committee and the Board of Directors on those dates. The purchase of shares
by Messrs. Chayet, Haynes and Perito also was approved by the Audit Committee at the meeting held
on November 5, 2010.
On March 4, 2011 Mr. Williams purchased 508,905 shares of our common stock at a price of $1.84
per share and, for a price of $0.125 per share, purchased a warrant for an equal number of warrant
shares at an exercise price of $2.00 per share. In accordance with our companys related party
transaction policy, Mr.
Williams intention to purchase shares and warrant exercisable into shares of our common stock
was considered and approved by the Audit Committee of our Board of Directors on March 4, 2011. See
note 15 to our consolidated financial statements included in Item 15. Exhibits, Financial
Statement Schedules of this Report for details of this transaction.
On March 15, 2010, Rock Creek entered into a consulting agreement with Neil L. Chayet,
Esquire, for Mr. Chayet to assist Rock Creek in the recruitment and recommendation of
members to be appointed to a Scientific Advisor Board of our company and in communicating to the
public health community and others information regarding Rock Creeks products and mission. The
agreement runs for a period of one year from March 15, 2010, is terminable by
either party without cause on fifteen days written notice and may be extended thereafter at our
companys discretion for one month periods. Under the agreement, Mr. Chayet
acts as an independent contractor and receives a consulting fee of $6,000 per month and reimbursement for
reasonable business expenses. Given Mr. Chayets status as a Director of our company, the
consideration of the consulting agreement and its potential impact on Mr. Chayets status as an
Independent Director was considered by our companys Audit Committee as a related party transaction
in accordance with our companys related party transaction policy. At a meeting held on March 9,
2010, the Audit Committee approved the consulting agreement and recommended approval to the Board
of Directors. The agreement was thereafter approved by the Board on March 15, 2010.
68
Procedures for Approval of Related Party Transactions
Pursuant to the charter of our Audit Committee, all transactions between us and any of our
directors, executive officers or related parties are subject to the review by our Audit Committee.
Director Independence
The standards relied upon by our Board of Directors in affirmatively determining whether a
director is independent in compliance with the rules of The NASDAQ Global Market are the
standards set forth in the NASDAQ Marketplace Rules and the applicable listing requirements
thereof. In addition, no director will qualify as independent unless our Board of Directors
affirmatively determines that the director has no material relationship with our company (directly
or as a partner, shareholder or officer of an organization that has a relationship with us).
Our Board of Directors, in applying the above-referenced standards, has affirmatively
determined that our current independent directors are: Messrs. Chapman, Chayet, Tonkin, Haynes and
Mirabelli. As part of the Board of Directors process in making such determination, each such
director has provided responses to questionnaires confirming that (i) all of the above-cited
objective criteria for independence are satisfied and (ii) he has no other material relationship
with us that could interfere with his ability to exercise independent judgment.
69
|
|
|
ITEM 14. |
|
PRINCIPAL ACCOUNTANT FEES AND SERVICES |
The Audit Committee has established its pre-approval policies and procedures, pursuant to
which the Audit Committee approved the following audit services, provided by Cherry, Bekaert &
Holland L.L.P. in 2010. Consistent with the Audit Committees responsibility for engaging our
companys independent auditors, all audit and permitted non-audit services require pre-approval by
the Audit Committee. The full Audit Committee approves proposed services and fee estimates for
these services. The Audit Committee chairperson or his designee has been designated by the Audit
Committee to approve any services arising during the year that were not pre-approved by the Audit
Committee. Services approved by the Audit Committee chairperson are communicated to the full Audit
Committee at its next regular meeting and the Audit Committee reviews services and fees for the
fiscal year. Pursuant to these procedures, the Audit Committee approved the following audit
services provided by Cherry, Bekaert & Holland L.L.P.:
Audit Fees:
Cherry, Bekaert & Holland L.L.P. billed our company $235 thousand for professional services
for the audits of our companys annual consolidated financial statements and the effectiveness of
internal control over financial reporting for the year ended December 31, 2010, the reviews of the
interim financial statements included in our companys Forms 10-Q filed during the fiscal year
ended December 31, 2010, and other required Securities Act filings.
Cherry, Bekaert & Holland L.L.P., billed our company $189 thousand for professional services
for the audits of our companys annual consolidated financial statements, managements assessment
of the effectiveness of internal control over financial reporting and the effectiveness of internal
control over financial reporting for the year ended December 31, 2009, the reviews of the interim
financial statements included in our companys Forms 10-Q filed during the fiscal year ended
December 31, 2009, and other required Securities Act filings.
Tax Fees:
Cherry Bekaert & Holland L.L.P. billed our company $32 thousand for services related to tax
Compliance (federal and state tax reporting, tax planning and tax consulting services in connection
with analysis of impact on net operating loss carryovers due to changes in Company ownership) in
2010.
Cherry, Bekaert & Holland L.L.P., billed our company $72 thousand for services related to tax
compliance (federal and state tax reporting and tax planning) in 2009.
All Other Fees:
None.
70
PART IV
|
|
|
ITEM 15. |
|
EXHIBITS, FINANCIAL STATEMENT SCHEDULES |
(a) Documents filed as part of this Report.
1. Consolidated Financial Statements
|
|
|
|
|
|
|
Page |
|
|
|
|
F-1 |
|
|
|
|
|
F-2 |
|
|
|
|
|
F-3 |
|
|
|
|
|
F-4 |
|
|
|
|
|
F-5 |
|
|
|
|
|
F-6 |
|
|
|
|
|
F-7 |
|
2. Financial Statements Schedules
None.
(b) Exhibits.
An index to exhibits has been filed as part of this Report beginning on page E-1 and is
incorporated herein by reference.
71
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto
duly authorized.
|
|
|
|
|
|
STAR SCIENTIFIC, INC.
|
|
|
By: |
/s/ Jonnie R. Williams, Sr.
|
|
|
|
Jonnie R. Williams, Sr. |
|
|
|
Chief Executive Officer |
|
|
Date: March 16, 2011
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been
signed below by the following persons on behalf of the registrant and in the capacities and on the
dates indicated.
|
|
|
|
|
Signature |
|
Title |
|
Date |
|
|
|
|
|
/s/ Jonnie R. Williams, Sr.
Jonnie R. Williams, Sr.
|
|
Chief Executive Officer and Director
(Principal Executive Officer)
|
|
March 16, 2011 |
|
|
|
|
|
/s/ Paul L. Perito
Paul L. Perito
|
|
Chairman of the Board, President and
Chief Operating Officer
|
|
March 16, 2011 |
|
|
|
|
|
/s/ Park A. Dodd, III
Park A. Dodd, III
|
|
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
|
|
March 16, 2011 |
|
|
|
|
|
/s/ Christopher C. Chapman
Christopher C. Chapman
|
|
Director
|
|
March 16, 2011 |
|
|
|
|
|
/s/ Neil L. Chayet
Neil L. Chayet
|
|
Director
|
|
March 16, 2011 |
|
|
|
|
|
/s/ Burton J. Haynes
Burton J. Haynes
|
|
Director
|
|
March 16, 2011 |
|
|
|
|
|
/s/ Mario V. Mirabelli
Mario V. Mirabelli
|
|
Director
|
|
March 16, 2011 |
|
|
|
|
|
/s/ Leo S. Tonkin
Leo S. Tonkin
|
|
Director
|
|
March 16, 2011 |
72
INDEX TO EXHIBITS
|
|
|
|
|
Item |
|
Description |
|
|
|
|
|
|
2.1 |
|
|
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(1) |
|
|
|
|
|
|
3.1 |
|
|
Sixth Amended and Restated Certificate of Incorporation of Star Scientific, Inc.(2) |
|
|
|
|
|
|
3.2 |
|
|
Amended and Restated Bylaws of Star Scientific, Inc.(3) |
|
|
|
|
|
|
10.1 |
|
|
License Agreement between Star Tobacco and Pharmaceuticals, Inc., as Licensee and
Regent Court Technologies, Jonnie R. Williams, and Francis E. ODonnell, Jr.,
M.D., as Licensor, dated January 5, 1998(4) |
|
|
|
|
|
|
10.2 |
|
|
Amendment No. 1 to License Agreement between Regent Court Technologies, Jonnie R.
Williams, Francis E. ODonnell, Jr., M.D. and Star Tobacco and Pharmaceuticals,
Inc., dated August 3, 1998(5) |
|
|
|
|
|
|
10.3 |
|
|
1998 Stock Option Plan, as amended(6) |
|
|
|
|
|
|
10.4 |
|
|
2000 Equity Incentive Plan, as amended(7) |
|
|
|
|
|
|
10.5 |
|
|
Qualified Stock Option Agreement dated as of April 27, 1999 between Star
Scientific, Inc. and Paul L. Perito(8) |
|
|
|
|
|
|
10.6 |
|
|
Lease and Purchase Option Contract between Star Scientific, Inc. and the
Industrial Development Authority of the Town of Chase City, Virginia, dated March
10, 2000(6) |
|
|
|
|
|
|
10.7 |
|
|
Form of Director Indemnification Agreement(6) |
|
|
|
|
|
|
10.8 |
|
|
Form of Officer Indemnification Agreement(6) |
|
|
|
|
|
|
10.9 |
|
|
Executive Employment Agreement between Star Scientific, Inc. and David M. Dean,
dated October 6, 2000(7) |
|
|
|
|
|
|
10.10 |
|
|
Restated Loan Agreement between Star Scientific, Inc., Star Tobacco and
Pharmaceuticals, Inc. and Brown & Williamson Tobacco Corporation, dated August 21,
2000(9) |
|
|
|
|
|
|
10.11 |
|
|
Restated Security Agreement between Star Scientific, Inc. and Brown & Williamson
Tobacco Corporation, dated August 21, 2000(9) |
|
|
|
|
|
|
10.12 |
|
|
Security Agreement between Star Tobacco and Pharmaceuticals, Inc. and Brown &
Williamson Tobacco Corporation, dated August 21, 2000(9) |
|
|
|
|
|
|
10.13 |
|
|
Guaranty Agreement between Star Scientific, Inc. and Brown & Williamson Tobacco
Corporation, dated August 21, 2000(9) |
|
|
|
|
|
|
10.14 |
|
|
Guarantee Agreement between Star Tobacco and Pharmaceuticals, Inc. and Brown &
Williamson Tobacco Corporation, dated August 21, 2000(9) |
|
|
|
|
|
|
10.15 |
|
|
Amended and Restated Executive Employment Agreement dated as of March 15, 2001
between Star Scientific, Inc. and Christopher G. Miller(7) |
|
|
|
|
|
|
10.16 |
|
|
Executive Employment Agreement dated as of March 30, 2001 between Star Scientific,
Inc. and Robert E. Pokusa(7) |
|
|
|
|
|
|
10.17 |
|
|
Restated Master Agreement, dated April 25, 2001, by and between Star Scientific,
Inc. and Brown & Williamson Tobacco Corporation(10) |
|
|
|
|
|
|
10.18 |
|
|
First Amendment to Restated Loan Agreement dated April 25, 2001, among Star
Scientific, Inc., Star Tobacco & Pharmaceuticals, Inc. and Brown & Williamson
Tobacco Corporation(10) |
|
|
|
|
|
|
10.19 |
|
|
Trademark License and Royalty Agreement, dated April 25, 2001, between Star
Scientific, Inc. and Brown & Williamson Tobacco Corporation(10) |
E-1
|
|
|
|
|
Item |
|
Description |
|
|
|
|
|
|
10.20 |
|
|
Other Low TSNA Tobacco Royalty Agreement, dated April 25, 2001 by and between Star
Scientific, Inc. and Brown & Williamson Tobacco Corporation(10) |
|
|
|
|
|
|
10.21 |
|
|
First Amendment to Regent/B&W License Agreement, dated April 25, 2001, by and
among Regent Court Technologies, Jonnie R. Williams, Francis ODonnell, Jr., Star
Scientific, Inc. and Brown & Williamson Tobacco Corporation(10) |
|
|
|
|
|
|
10.22 |
|
|
Exclusive License Agreement dated as of March 16, 2001 by and among Regent Court
Technologies and Star Scientific, Inc.(11) |
|
|
|
|
|
|
10.23 |
|
|
Consent to Assignment dated March 16, 2001 by and among Regent Court Technologies,
Jonnie R. Williams, Francis ODonnell, Jr., M.D., Star Tobacco & Pharmaceuticals,
Inc., Star Scientific, Inc. and Brown & Williamson Tobacco Corporation(11) |
|
|
|
|
|
|
10.24 |
|
|
Amendment No. 1 dated April 5, 2001 to Exclusive License Agreement by and among
Regent Court Technologies and Star Scientific, Inc.(11) |
|
|
|
|
|
|
10.25 |
|
|
Contract with Lease and Option to Purchase by and among The Industrial Development
Authority of Mecklenburg County, Virginia, The Industrial Development Authority of
the Town of Chase City, Virginia, and Star Scientific, Inc., dated April 10,
2002(12) |
|
|
|
|
|
|
10.26 |
|
|
Convertible Debenture, dated March 25, 2004, issued by Star Scientific, Inc. to
Manchester Securities Corp. Debenture was amended and then converted(13) |
|
|
|
|
|
|
10.27 |
|
|
Warrant, dated March 25, 2004, issued by Star Scientific, Inc. to Manchester
Securities Corp.(13) |
|
|
|
|
|
|
10.28 |
|
|
Securities Purchase Agreement, dated March 25, 2004, between Star Scientific, Inc.
and Manchester Securities Corp.(13) |
|
|
|
|
|
|
10.29 |
|
|
Registration Rights Agreement, dated March 25, 2004, between Star Scientific, Inc.
and Manchester Securities Corp.(13) |
|
|
|
|
|
|
10.30 |
|
|
Common Stock Purchase Warrant, dated as of March 25, 2004, issued by Star
Scientific, Inc. to Reedland Capital Partners, an Institutional Division of
Financial West Group(13) |
|
|
|
|
|
|
10.31 |
|
|
Executive Employment Agreement, dated December 30, 2005 between Star Scientific,
Inc. and Jonnie R. Williams(14) |
|
|
|
|
|
|
10.32 |
|
|
Second Amended and Restated Employment Agreement, dated December 30, 2005 between
Star Scientific, Inc. and Paul L. Perito(14) |
|
|
|
|
|
|
10.33 |
|
|
Securities Purchase and Registration Rights Agreement, dated as of March 3, 2006,
between Star Scientific, Inc. and Joseph L. Schwarz(15) |
|
|
|
|
|
|
10.34 |
|
|
Common Stock Purchase Warrant, dated as of March 3, 2006, issued by Star
Scientific, Inc. to Joseph L. Schwarz(15) |
|
|
|
|
|
|
10.35 |
|
|
Securities Purchase and Registration Rights Agreement, dated July 14, 2006, by and
between Star Scientific, Inc. and Iroquois Capital(16) |
|
|
|
|
|
|
10.36 |
|
|
Common Stock Purchase Warrant, dated July 14, 2006, issued by Star Scientific,
Inc. to Iroquois Capital(16) |
|
|
|
|
|
|
10.37 |
|
|
Securities Purchase and Registration Rights Agreement, dated July 14, 2006, by and
between Star Scientific, Inc. and Delaware Charter Guarantee and Trust Company,
FBO Joseph L. Schwarz, IRA(16) |
|
|
|
|
|
|
10.38 |
|
|
Common Stock Purchase Warrant, dated July 14, 2006, issued by Star Scientific,
Inc. to Delaware Charter Guarantee and Trust Company, FBO Joseph L. Schwarz
IRA(16) |
|
|
|
|
|
|
10.39 |
|
|
First Amendment to Executive Employment Agreement, dated December 15, 2006 between
Star Scientific, Inc. and Jonnie R. Williams(3) |
|
|
|
|
|
|
10.40 |
|
|
First Amendment to Second Amended Executive Employment Agreement, dated December
15, 2006 between Star Scientific, Inc. and Paul L. Perito(3) |
E-2
|
|
|
|
|
Item |
|
Description |
|
|
|
|
|
|
10.41 |
|
|
Escrow Releases Purchase Agreement dated March 14, 2007 by and among QVT
Associates LP, Whitebox Hedged High Yield Partners, LP, Star Scientific, Inc. and
Star Tobacco, Inc.(17) |
|
|
|
|
|
|
10.42 |
|
|
Second Amendment to Second Amended Executive Employment Agreement, dated March 23,
2007 between Star Scientific, Inc. and Paul L. Perito(18) |
|
|
|
|
|
|
10.43 |
|
|
License Agreement, dated May 10, 2007 between Star Tobacco, Inc., Star Scientific,
Inc. and Tantus Tobacco, LLC (19) |
|
|
|
|
|
|
10.44 |
|
|
Securities Purchase and Registration Rights Agreement, dated June 29, 2007, by and
between Star Scientific, Inc. and Joseph L. Schwarz(20) |
|
|
|
|
|
|
10.45 |
|
|
Common Stock Purchase Warrant dated June 29, 2007, issued by Star Scientific, Inc.
to Pershing LLC, FBO Joseph L. Schwarz Roth IRA(20) |
|
|
|
|
|
|
10.46 |
|
|
Common Stock Purchase Warrant dated June 29, 2007 issued by Star Scientific, Inc.
to Joseph L. Schwarz(20) |
|
|
|
|
|
|
10.47 |
|
|
Securities Purchase and Registration Rights Agreement, dated June 29, 2007 by and
between Star Scientific, Inc. and Joseph Rice(20) |
|
|
|
|
|
|
10.48 |
|
|
Common Stock Purchase Warrant dated June 29, 2007 issued by Star Scientific, Inc.
to Joseph Rice(20) |
|
|
|
|
|
|
10.49 |
|
|
Agreement dated October 10, 2007 by and between Christopher G. Miller and Star
Scientific, Inc.(21) |
|
|
|
|
|
|
10.50 |
|
|
Agreement dated October 10, 2007 by and between Park A. Dodd, III and Star
Scientific, Inc.(21) |
|
|
|
|
|
|
10.51 |
|
|
Securities Purchase and Registration Rights Agreement, dated March 13, 2008 by and
between Star Scientific, Inc. and the several Investors party thereto, including
the form of Warrant thereunder(22) |
|
|
|
|
|
|
10.52 |
|
|
Securities Purchase and Registration Rights Agreement, dated March 14, 2008 by and
between Star Scientific, Inc. and the several Investors party thereto, including
the form of Warrant thereunder(22) |
|
|
|
|
|
|
10.53 |
|
|
Securities Purchase and Registration Rights Agreement, dated May 12, 2008 by and
between Star Scientific, Inc. and the several Investors party thereto, including
the form of Warrant thereunder(23) |
|
|
|
|
|
|
10.54 |
|
|
Letter Agreement with Jonnie R. Williams, dated March 14, 2008(23) |
|
|
|
|
|
|
10.55 |
|
|
Executive Employment Agreement dated February 26, 2008 between Star Scientific,
Inc. and Curtis Wright, M.D. MPH(22) |
|
|
|
|
|
|
10.56 |
|
|
2008 Incentive Award Agreement(24) |
|
|
|
|
|
|
10.57 |
|
|
Amendment to Executive Employment Agreement dated as of December 19, 2008 between
Star Scientific, Inc. and Robert E. Pokusa(25) |
|
|
|
|
|
|
10.58 |
|
|
Securities Purchase and Registration Rights Agreement, dated March 2, 2009 by and
between Star Scientific, Inc. and the several Investors party thereto, including
the form of Warrant thereunder (26) |
|
|
|
|
|
|
10.59 |
|
|
Securities Purchase and Registration Rights Agreement, dated September 22, 2009 by
and between Star Scientific, Inc. and the Investor party thereto, including the
form of Warrant thereunder (27) |
|
|
|
|
|
|
10.60 |
|
|
Executive Employment Agreement dated January 1, 2010 between Star Scientific, Inc.
and Park A. Dodd, III(28) |
|
|
|
|
|
|
10.61 |
|
|
Securities Purchase and Registration Rights Agreement, dated March 5, 2010, by and
between Star Scientific, Inc. and the several Investors party thereto. (29) |
|
|
|
|
|
|
10.62 |
|
|
Amended Warrant, dated March 5, 2010, by and between Star Scientific, Inc. and
Iroquois Master Fund Ltd. (29) |
E-3
|
|
|
|
|
Item |
|
Description |
|
|
|
|
|
|
10.63 |
|
|
Amended Warrant, dated March 5, 2010, by and between Star Scientific, Inc. and
Iroquois Capital, LP. (29) |
|
|
|
|
|
|
10.64 |
|
|
Securities Purchase and Registration Rights Agreement, dated March 9, 2010, by and
between Star Scientific, Inc. and the several Investors party thereto.(30) |
|
|
|
|
|
|
10.65 |
|
|
Amended Warrant No. 1, dated March 9, 2010, by and between Star Scientific, Inc.
and Tradewinds Master Fund (BVI), Ltd.(30) |
|
|
|
|
|
|
10.66 |
|
|
Amended Warrant No. 2, dated March 9, 2010, by and between Star Scientific, Inc.
and Tradewinds Master Fund (BVI), Ltd.(30) |
|
|
|
|
|
|
10.67 |
|
|
Amended Warrant No. 1, dated March 9, 2010, by and between Star Scientific, Inc.
and Feehan Partners, L.P.(30) |
|
|
|
|
|
|
10.68 |
|
|
Amended Warrant No. 2, dated March 9, 2010, by and between Star Scientific, Inc.
and Feehan Partners, L.P.(30) |
|
|
|
|
|
|
10.69 |
|
|
Amended Warrant No. 1, dated March 9, 2010, by and between Star Scientific, Inc.
and PV Partners, L.P.(30) |
|
|
|
|
|
|
10.70 |
|
|
Amended Warrant No. 2, dated March 9, 2010, by and between Star Scientific, Inc.
and PV Partners, L.P.(30) |
|
|
|
|
|
|
10.71 |
|
|
Securities Purchase and Registration Rights Agreement, dated March 9, 2010, by and
between Star Scientific, Inc. and the several Investors party thereto, including
the form of Warrant attached as Exhibit A thereon.(30) |
|
|
|
|
|
|
10.72 |
|
|
Securities Purchase and Registration Rights Agreement, dated March 10, 2010, by
and between Star Scientific, Inc. and the Investor party thereto, including the
form of Warrant attached as Exhibit A thereon.(30) |
|
|
|
|
|
|
10.73 |
|
|
Amended Securities Purchase and Registration Rights Agreement, dated March 12,
2010, by and between Star Scientific, Inc. and the Investor party thereto.(30) |
|
|
|
|
|
|
10.74 |
|
|
Securities Purchase and Registration Rights Agreement, dated March 12, 2010, by
and between Star Scientific, Inc. and the several Investor party thereto,
including the form of Warrant attached as Exhibit A thereon.(30) |
|
|
|
|
|
|
10.75 |
|
|
Securities Purchase and Registration Rights Agreement, dated November 5, 2010, by
and between Star Scientific, Inc. and the several Investors party thereto,
including the form of Warrant attached as Exhibit A thereon.(31) |
|
|
|
|
|
|
10.76 |
|
|
Securities Purchase and Registration Rights Agreement, dated February 28, 2011, by
and between Star Scientific, Inc. and the Investor party thereto, including the
form of Warrant attached as Exhibit A thereon.(32) |
|
|
|
|
|
|
10.77 |
|
|
Securities Purchase and Registration Rights Agreement, dated March 4, 2011, by and
between Star Scientific, Inc. and the several Investors party thereto, including
the form of Warrant attached as Exhibit A thereon.(32) |
|
|
|
|
|
|
10.78 |
|
|
Executive Employment Agreement, dated March 14, 2011, between Star Scientific,
Inc. and Jonnie R. Williams. |
|
|
|
|
|
|
10.79 |
|
|
Third Amended and Restated Executive Employment Agreement, dated March 14, 2011,
between Star Scientific, Inc. and Paul L. Perito. |
|
|
|
|
|
|
10.80 |
|
|
Amended and Restated Executive Employment Agreement, dated March 14, 2011, between
Star Scientific, Inc. and Curits Wright, IV, MD, MPH. |
|
|
|
|
|
|
14.1 |
|
|
Corporate Code of Business Conduct and Corporate Ethics, dated March 2004 (13) |
|
|
|
|
|
|
21.1 |
|
|
Subsidiaries of the Company |
|
|
|
|
|
|
23.1 |
|
|
Consent of Cherry, Bekaert & Holland, L.L.P. |
E-4
|
|
|
|
|
Item |
|
Description |
|
|
|
|
|
|
31.1 |
|
|
Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 |
|
|
|
|
|
|
31.2 |
|
|
Certification of Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002 |
|
|
|
|
|
|
32.1 |
|
|
Certification of the Chief Executive Officer pursuant to 18 U.S.C. § 1350, as
created by Section 906 of the Sarbanes-Oxley Act of 2002 |
|
|
|
|
|
|
32.2 |
|
|
Certification of the Chief Financial Officer pursuant to 18 U.S.C. § 1350, as
created by Section 906 of the Sarbanes-Oxley Act of 2002 |
|
|
|
(1) |
|
Incorporated by reference to Current Report on Form 8-K filed on March 3, 1999 |
|
(2) |
|
Incorporated by reference to Current Report on Form 8-K filed on December 1, 2010 |
|
(3) |
|
Incorporated by reference to Current Report on Form 8-K filed on December 21, 2006 |
|
(4) |
|
Incorporated by reference to Quarterly Report on Form 10-QSB for the quarter ended March 31,
1998 |
|
(5) |
|
Incorporated by reference to Current Report on Form 8-K filed on September 14, 1998 |
|
(6) |
|
Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1999 |
|
(7) |
|
Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 2000 |
|
(8) |
|
Incorporated by reference to Quarterly Report on Form 10-QSB for the quarter ended June 30,
1999 |
|
(9) |
|
Incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended September
30, 2000 |
|
(10) |
|
Incorporated by reference to Current Report on Form 8-K filed on May 17, 2001 |
|
(11) |
|
Incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended September
30, 2001 |
|
(12) |
|
Incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended June 30, 2002 |
|
(13) |
|
Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 2003 |
|
(14) |
|
Incorporated by reference to Current Report on Form 8-K filed on December 30, 2005 |
|
(15) |
|
Incorporated by reference to Current Report on Form 8-K filed on March 7, 2006 |
|
(16) |
|
Incorporated by reference to Current Report on Form 8-K filed on July 18, 2006 |
|
(17) |
|
Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 2006 |
|
(18) |
|
Incorporated by reference to Current Report on Form 8-K filed on March 28, 2007 |
|
(19) |
|
Incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended June 30, 2007 |
|
(20) |
|
Incorporated by reference to Current Report on Form 8-K filed on July 6, 2007 |
|
(21) |
|
Incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended September
30, 2007 |
|
(22) |
|
Incorporated by reference to Annual Report on Form 10-K filed for the year ended December 31,
2007 |
E-5
|
|
|
(23) |
|
Incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended March 31,
2008 |
|
(24) |
|
Incorporated by reference to Definitive Proxy Statement on Schedule 14A filed on October 14,
2008 |
|
(25) |
|
Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 2008 |
|
(26) |
|
Incorporated by reference to Current Report on Form 8-K filed on March 3, 2009 |
|
(27) |
|
Incorporated by reference to Current Report on Form 8-K filed on September 25, 2009 |
|
(28) |
|
Incorporated by reference to Current Report on Form 8-K filed on January 28, 2010 |
|
(29) |
|
Incorporated by reference to Current Report on Form 8-K filed on March 5, 2010 |
|
(30) |
|
Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 2009 |
|
(31) |
|
Incorporated by reference to Registration Statement on Form S-3 filed on December 10, 2010 |
|
(32) |
|
Incorporated by reference to Current Report on Form 8-K filed on March 4, 2011 |
E-6
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
|
|
|
|
|
|
|
Page |
|
|
|
|
|
|
|
|
|
F-2 |
|
|
|
|
|
|
|
|
|
F-3 |
|
|
|
|
|
|
|
|
|
F-4 |
|
|
|
|
|
|
|
|
|
F-5 |
|
|
|
|
|
|
|
|
|
F-6 |
|
|
|
|
|
|
|
|
|
F-7 |
|
|
|
|
|
|
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Star Scientific, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Star Scientific, Inc. and
Subsidiaries (the Company) as of December 31, 2010 and 2009, and the related statements of
operations, stockholders equity (deficit) and cash flows for each of the years in the three-year
period ended December 31, 2010. We also have audited the Companys internal control over financial
reporting as of December 31, 2010, based on criteria established in Internal ControlIntegrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
The Companys management is responsible for these financial statements, for maintaining effective
internal control over financial reporting, and for its assessment of the effectiveness of internal
control over financial reporting, included in Managements Annual Report on Internal Control over
Financial Reporting included in Item 9AControls and Procedures in the Companys 2010 Annual
Report on Form 10-K. Our responsibility is to express an opinion on these financial statements and
an opinion on the Companys internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free of material
misstatement and whether effective internal control over financial reporting was maintained in all
material respects. Our audits of the financial statements included examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and evaluating the overall
financial statement presentation. Our audit of internal control over financial reporting included
obtaining an understanding of internal control over financial reporting, assessing the risk that a
material weakness exists, and testing and evaluating the design and operating effectiveness of
internal control based on the assessed risk. Our audits also included performing such other
procedures as we considered necessary in the circumstances. We believe that our audits provide a
reasonable basis for our opinions.
A companys internal control over financial reporting is a process designed to provide
reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting
principles. A companys internal control over financial reporting includes those policies and
procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately
and fairly reflect the transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and
directors of the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the companys assets that could have
a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent
or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated 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, 2010 and 2009, and the results of their operations and their cash flows for each of
the years in the three-year period ended December 31, 2010 in conformity with accounting principles
generally accepted in the United States of America. Also, in our opinion the Company maintained, in
all material respects, effective control over financial reporting as of December 31, 2010, based on
criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
/s/ Cherry, Bekaert & Holland, L.L.P.
Richmond, Virginia
March 16, 2011
F-1
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2010 AND 2009
($ and shares in thousands except per share data)
|
|
|
|
|
|
|
|
|
|
|
2010 |
|
|
2009 |
|
ASSETS |
|
|
|
|
|
|
|
|
Current assets: |
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
13,193 |
|
|
$ |
12,360 |
|
Accounts receivable, trade, net of allowance for doubtful accounts of $48 (2010) and $36 (2009) |
|
|
52 |
|
|
|
59 |
|
Receivable from sale of licensing rights |
|
|
27 |
|
|
|
25 |
|
Inventories |
|
|
3,419 |
|
|
|
230 |
|
Prepaid expenses and other current assets |
|
|
350 |
|
|
|
404 |
|
|
|
|
|
|
|
|
Total current assets |
|
|
17,041 |
|
|
|
13,078 |
|
Property and equipment, net |
|
|
2,169 |
|
|
|
1,057 |
|
Intangible assets, net of accumulated amortization |
|
|
627 |
|
|
|
626 |
|
Receivable from sale of licensing rights, less current maturities (note 3) |
|
|
80 |
|
|
|
108 |
|
MSA escrow funds |
|
|
368 |
|
|
|
365 |
|
|
|
|
|
|
|
|
Total assets |
|
$ |
20,285 |
|
|
$ |
15,234 |
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT) |
|
|
|
|
|
|
|
|
Current liabilities: |
|
|
|
|
|
|
|
|
Current maturities of long-term debt |
|
$ |
2,518 |
|
|
$ |
1,981 |
|
Accounts payable, trade |
|
|
1,585 |
|
|
|
2,419 |
|
Accrued expenses |
|
|
424 |
|
|
|
978 |
|
Due to stockholders |
|
|
50 |
|
|
|
50 |
|
|
|
|
|
|
|
|
Total current liabilities |
|
|
4,577 |
|
|
|
5,428 |
|
Long-term debt, less current maturities |
|
|
5,049 |
|
|
|
7,518 |
|
|
|
|
|
|
|
|
Total liabilities |
|
|
9,626 |
|
|
|
12,946 |
|
Commitments and contingencies (Notes 10 and 13) |
|
|
|
|
|
|
|
|
Stockholders equity (deficit): |
|
|
|
|
|
|
|
|
Common stock (A) |
|
|
13 |
|
|
|
11 |
|
Additional paid-in capital |
|
|
181,336 |
|
|
|
144,686 |
|
Accumulated deficit |
|
|
(170,690 |
) |
|
|
(142,409 |
) |
|
|
|
|
|
|
|
Total stockholders equity (deficit) |
|
|
10,659 |
|
|
|
2,288 |
|
|
|
|
|
|
|
|
Total liabilities and stockholders equity (deficit) |
|
$ |
20,285 |
|
|
$ |
15,234 |
|
|
|
|
|
|
|
|
|
|
|
(A) |
|
$.0001 par value, 187,500,000 shares authorized; 127,119,322 and 107,676,768 shares issued
and outstanding 2010 and 2009, respectively. |
|
(B) |
|
Class A, convertible, $.01 par value, 4,000 shares authorized, no shares issued or
outstanding; Series B, convertible; $.01 par value 15,000 shares authorized, no shares issued
or outstanding. |
See notes to consolidated financial statements.
F-2
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2010, 2009 AND 2008
($ and share in thousands except per share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2010 |
|
|
2009 |
|
|
2008 |
|
Net sales |
|
$ |
848 |
|
|
$ |
708 |
|
|
$ |
451 |
|
Less: |
|
|
|
|
|
|
|
|
|
|
|
|
Cost of goods sold |
|
|
2,172 |
|
|
|
2,612 |
|
|
|
2,116 |
|
Excise taxes on products |
|
|
12 |
|
|
|
15 |
|
|
|
6 |
|
Department of Agriculture tobacco buyout program assessment |
|
|
1 |
|
|
|
1 |
|
|
|
1 |
|
|
|
|
|
|
|
|
|
|
|
Gross margin loss |
|
|
(1,337 |
) |
|
|
(1,920 |
) |
|
|
(1,672 |
) |
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
Marketing and distribution |
|
|
2,760 |
|
|
|
2,584 |
|
|
|
3,538 |
|
General and administrative |
|
|
21,084 |
|
|
|
15,820 |
|
|
|
15,352 |
|
Research and development |
|
|
3,033 |
|
|
|
1,798 |
|
|
|
317 |
|
Restructuring |
|
|
|
|
|
|
639 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
26,877 |
|
|
|
20,841 |
|
|
|
19,207 |
|
|
|
|
|
|
|
|
|
|
|
Operating loss from continuing operations |
|
|
(28,214 |
) |
|
|
(22,761 |
) |
|
|
(20,879 |
) |
Other income (expense): |
|
|
|
|
|
|
|
|
|
|
|
|
Interest income |
|
|
73 |
|
|
|
202 |
|
|
|
400 |
|
Interest expense |
|
|
(383 |
) |
|
|
(439 |
) |
|
|
(741 |
) |
Gain(loss) on retirement of assets |
|
|
240 |
|
|
|
251 |
|
|
|
(4 |
) |
Gain(loss) on sale of tobacco curing barns |
|
|
|
|
|
|
(100 |
) |
|
|
|
|
Derivative expense |
|
|
|
|
|
|
(67 |
) |
|
|
|
|
Other |
|
|
3 |
|
|
|
114 |
|
|
|
660 |
|
|
|
|
|
|
|
|
|
|
|
Total other expense |
|
|
(67 |
) |
|
|
(39 |
) |
|
|
315 |
|
Loss from continuing operations before income taxes |
|
|
(28,281 |
) |
|
|
(22,800 |
) |
|
|
(20,564 |
) |
Income tax benefit (expense) |
|
|
|
|
|
|
|
|
|
|
2,225 |
|
|
|
|
|
|
|
|
|
|
|
Net loss |
|
$ |
(28,281 |
) |
|
$ |
(22,800 |
) |
|
$ |
(18,339 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss per common share; basic and diluted: |
|
$ |
(0.24 |
) |
|
$ |
(0.22 |
) |
|
$ |
(0.20 |
) |
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding basic and diluted |
|
|
118,384 |
|
|
|
101,907 |
|
|
|
89,844 |
|
|
|
|
|
|
|
|
|
|
|
See notes to consolidated financial statements.
F-3
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (DEFICIT)
YEARS ENDED DECEMBER 31, 2010, 2009 AND 2008
($ and shares in thousands except per share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional |
|
|
|
|
|
|
|
|
|
Common Stock |
|
|
Paid-in |
|
|
Accumulated |
|
|
|
|
|
|
Shares |
|
|
Amount |
|
|
Capital |
|
|
Deficit |
|
|
Total |
|
Balances, January 1, 2008 |
|
|
81,488 |
|
|
$ |
8 |
|
|
$ |
99,274 |
|
|
$ |
(101,270 |
) |
|
$ |
(1,988 |
) |
Stock-based compensation |
|
|
|
|
|
|
|
|
|
|
3,173 |
|
|
|
|
|
|
|
3,173 |
|
Stock option exercise |
|
|
58 |
|
|
|
|
|
|
|
156 |
|
|
|
|
|
|
|
156 |
|
Issuance of common stock and warrant exercise |
|
|
10,700 |
|
|
|
1 |
|
|
|
16,499 |
|
|
|
|
|
|
|
16,500 |
|
Net loss |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(18,339 |
) |
|
|
(18,339 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances, December 31, 2008 |
|
|
92,246 |
|
|
$ |
9 |
|
|
$ |
119,102 |
|
|
$ |
(119,609 |
) |
|
$ |
(498 |
) |
Stock-based compensation |
|
|
186 |
|
|
|
|
|
|
|
498 |
|
|
|
|
|
|
|
498 |
|
Stock option exercise |
|
|
2,597 |
|
|
|
1 |
|
|
|
4,933 |
|
|
|
|
|
|
|
4,934 |
|
Issuance of common stock and warrant exercise |
|
|
12,648 |
|
|
|
1 |
|
|
|
20,840 |
|
|
|
|
|
|
|
20,841 |
|
Derivative liability adjustment resulting
from adoption of new accounting policy (Note
2) |
|
|
|
|
|
|
|
|
|
|
(687 |
) |
|
|
|
|
|
|
(687 |
) |
Net loss |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(22,800 |
) |
|
|
(22,800 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances, December 31, 2009 |
|
|
107,677 |
|
|
$ |
11 |
|
|
$ |
144,686 |
|
|
$ |
(142,409 |
) |
|
$ |
2,288 |
|
Stock-based compensation |
|
|
100 |
|
|
|
|
|
|
|
8,823 |
|
|
|
|
|
|
|
8,823 |
|
Issuance of common stock and warrant exercise |
|
|
19,342 |
|
|
|
2 |
|
|
|
27,827 |
|
|
|
|
|
|
|
27,829 |
|
Net loss |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(28,281 |
) |
|
|
(28,281 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances, December 31, 2010 |
|
|
127,119 |
|
|
$ |
13 |
|
|
$ |
181,336 |
|
|
$ |
(170,690 |
) |
|
$ |
10,659 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See notes to consolidated financial statements.
F-4
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2010, 2009 AND 2008
($ in thousands except per share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2010 |
|
|
2009 |
|
|
2008 |
|
Operating activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Net loss |
|
$ |
(28,281 |
) |
|
$ |
(22,800 |
) |
|
$ |
(18,339 |
) |
Adjustments to reconcile net loss to net cash flows from operating activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
|
312 |
|
|
|
315 |
|
|
|
602 |
|
Loss (Gain) on sale of curing barns |
|
|
|
|
|
|
100 |
|
|
|
|
|
Loss (Gain) on disposal of property and equipment |
|
|
|
|
|
|
(251 |
) |
|
|
3 |
|
Deferred income taxes |
|
|
|
|
|
|
|
|
|
|
(2,225 |
) |
Stock-based compensation expense |
|
|
8,823 |
|
|
|
498 |
|
|
|
3,173 |
|
Provision for (recovery of) bad debts |
|
|
41 |
|
|
|
(30 |
) |
|
|
(11 |
) |
Provision for inventory writeoff |
|
|
59 |
|
|
|
414 |
|
|
|
|
|
Derivative expense |
|
|
|
|
|
|
67 |
|
|
|
|
|
Increase (decrease) in cash resulting from changes in: |
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable, trade |
|
|
(36 |
) |
|
|
58 |
|
|
|
30 |
|
Inventories |
|
|
(3,248 |
) |
|
|
69 |
|
|
|
(293 |
) |
Prepaid expenses and other current assets |
|
|
54 |
|
|
|
848 |
|
|
|
(646 |
) |
Accounts payable, trade |
|
|
(834 |
) |
|
|
1,290 |
|
|
|
241 |
|
Accrued expenses |
|
|
(554 |
) |
|
|
383 |
|
|
|
(335 |
) |
|
|
|
|
|
|
|
|
|
|
Net cash flows from operating activities |
|
|
(23,664 |
) |
|
|
(19,039 |
) |
|
|
(17,800 |
) |
Investing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Purchases of property and equipment |
|
|
(990 |
) |
|
|
(22 |
) |
|
|
(112 |
) |
Proceeds from sale of tobacco curing barns |
|
|
|
|
|
|
200 |
|
|
|
|
|
Proceeds from sale of real estate |
|
|
|
|
|
|
630 |
|
|
|
|
|
Proceeds from sale of licensing rights |
|
|
25 |
|
|
|
589 |
|
|
|
1078 |
|
Purchase of intangible assets |
|
|
(65 |
) |
|
|
(14 |
) |
|
|
(10 |
) |
Deposits (made) returned on property and equipment |
|
|
(307 |
) |
|
|
|
|
|
|
(114 |
) |
|
|
|
|
|
|
|
|
|
|
Net cash flows from investing activities |
|
|
(1,337 |
) |
|
|
1,383 |
|
|
|
842 |
|
Financing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Payments on long-term debt and capital leases |
|
|
(1,994 |
) |
|
|
(1,478 |
) |
|
|
(1,746 |
) |
Proceeds from sale of stock and warrant exercise |
|
|
27,831 |
|
|
|
20,087 |
|
|
|
16,500 |
|
Proceeds from exercise of options |
|
|
|
|
|
|
4,934 |
|
|
|
156 |
|
|
|
|
|
|
|
|
|
|
|
Net cash flows from financing activities |
|
|
25,837 |
|
|
|
23,543 |
|
|
|
14,910 |
|
Deposits to MSA escrow fund |
|
|
(3 |
) |
|
|
|
|
|
|
(360 |
) |
Change in cash and cash equivalents |
|
|
833 |
|
|
|
5,887 |
|
|
|
(2,408 |
) |
Cash and cash equivalents, beginning of year |
|
|
12,360 |
|
|
|
6,473 |
|
|
|
8,881 |
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents, end of year |
|
$ |
13,193 |
|
|
$ |
12,360 |
|
|
$ |
6,473 |
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosure of cash flow information: |
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid during the year for: |
|
|
|
|
|
|
|
|
|
|
|
|
Interest paid |
|
$ |
370 |
|
|
$ |
404 |
|
|
$ |
831 |
|
|
|
|
|
|
|
|
|
|
|
Supplemental schedule of non-cash investing and financing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
During the year ended December 31, 2010, the Company
purchased a vehicle financed through long-term debt. See note 6 |
|
$ |
63 |
|
|
$ |
|
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
See notes to consolidated financial statements.
F-5
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. |
|
Nature of business and summary of significant accounting policies: |
Nature of business:
Star Scientific is a technology-oriented company with a mission to reduce the harm associated with
the use of tobacco at every level. The Company is primarily engaged in:
|
|
|
the development, implementation and licensing of proprietary technology for the curing of
tobacco so as to substantially prevent the formation of carcinogenic toxins present in tobacco and
tobacco smoke, primarily the tobacco-specific nitrosamines, or TSNAs; |
|
|
|
|
the manufacture, sales, marketing and/or development of very low-TSNA dissolvable smokeless
tobacco products that carry enhanced warnings beyond those required by the Surgeon General,
including ARIVA® compressed powdered tobacco cigalett®pieces and STONEWALL
Hard Snuff® and modified risk tobacco products as defined in the Family Smoking Prevention and
Tobacco Control Act of 2009, or the FDA Tobacco Act; |
|
|
|
|
the development of pharmaceutical products, particularly products that have a botanical,
tobacco-based component, that are designed to treat tobacco dependence and a range of
neurological conditions, including Alzheimers disease, Parkinsons disease, schizophrenia and
depression; and |
|
|
|
|
the manufacture, sales, marketing and development of non-nicotine nutraceutical products
designed to assist individuals who are seeking a smoking alternative as well as related
non-nicotine products that may be helpful to consumers in maintaining a healthy metabolism. |
|
|
Principles of consolidation: |
|
|
The accompanying consolidated financial statements include the accounts of Star Scientific and
its wholly owned subsidiaries, Star Tobacco and Rock Creek. All intercompany accounts and
transactions have been eliminated. |
|
|
Cash and Cash equivalents: |
|
|
For purposes of the statements of cash flows, the Company classifies all highly liquid
investments with an original maturity of three months or less as cash equivalents. |
|
|
The Master Settlement Agreement (MSA or Master Settlement Agreement) escrow fund: |
|
|
Cash deposits to which the
Company has not transferred its ownership rights and which are restricted pursuant to the MSA have been reflected as a non-current asset in the
Companys consolidated financial statements. Amounts deposited into MSA escrow accounts are
required to be held in escrow for 25 years. See note 13 for contingency discussion. |
|
|
Accounts receivable, trade and allowance for doubtful accounts: |
|
|
Accounts receivable are customer obligations due under normal trade terms. The Company sells its
tobacco products to distributors and retail customers. The Company performs continuing credit
evaluations of its customers financial condition and does not require collateral. The
Companys nutraceutical product, CigRx®, is sold directly to consumers and through credit card
transactions that are approved prior to shipment. |
F-6
|
|
Management reviews accounts receivable on a monthly basis to determine if any receivables will
potentially be uncollectible. Any accounts receivable balances that are determined to be
uncollectible are included in the allowance for doubtful accounts. The allowance for doubtful
accounts contains a general accrual for remaining possible bad debts. The allowance for doubtful
accounts at December 31, 2010 and 2009 was $48 and $36 thousands, respectively. Based on the
information available, management believes the allowance is adequate. However, actual write-offs
might exceed the recorded allowance. |
|
|
Inventories are valued at the lower of cost or market. Cost is determined on the first-in,
first-out (FIFO) method. |
|
|
The Company accounts for idle facility expense, freight, handling and wasted materials costs as
current period charges. The allocation of fixed production overhead to the costs of conversion
is based on the normal capacity of the production facilities. |
|
|
Property 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, machinery
and equipment and thirty-nine years for buildings and improvements. The Company had 37 barns
accounted for as idle equipment until their sale in December 2009 for $200 thousand. The Company
currently does not own any curing barns. |
|
|
Intangible assets consist primarily of licensing costs, patents and trademarks and packaging
design costs. Intangibles are amortized using the straight-line method over a period of 17 years
for patents and licensing costs and 5 years for packaging design costs (the assets estimated
lives). Substantially all trademarks owned by the Company have indefinite lives and, as such,
the cost of trademarks are not amortized, but are periodically evaluated for impairment. |
|
|
Deferred income tax assets and liabilities are computed annually for differences between the
financial statement and federal income tax bases of assets and liabilities that will result in
taxable or deductible amounts in the future, based on enacted tax laws and rates applicable to
the periods in which the differences are expected to affect taxable income. Valuation allowances
are established when necessary to reduce deferred tax assets to the amount expected to be
realized. |
|
|
Employee stock-based compensation: |
|
|
The Company uses a 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). |
|
|
Impairment of long-lived assets: |
|
|
The Company reviews the carrying value of its amortizing long-lived assets whenever events or
changes in circumstances indicate that the historical cost-carrying value of an asset may no
longer be appropriate. |
|
|
The Company assesses recoverability of the asset by estimating the future undiscounted net cash
flows expected to result from the asset, including eventual disposition. If the estimated future
undiscounted net cash flows are less than the carrying value of the asset, an impairment loss is
recorded equal to the
difference between the assets carrying value and its fair value. Non-amortizing intangibles
(trademarks) are reviewed annually for impairment. |
|
|
Basic loss per common share is computed using the weighted-average number of common shares
outstanding. |
|
|
Diluted loss per share is computed assuming conversion of all potentially dilutive stock options
and warrants. Potential common shares outstanding are excluded from the computation if their
effect is anti-dilutive (See Note 8). |
F-7
|
|
Revenue from the sale of the Companys tobacco products is recognized net of cash discounts,
sales returns and allowances and sales incentives (such as coupons, slotting fees and other buy
down promotions). Federal Excise Taxes are included in net sales and account receivable billed
to customers. Revenue for our dietary supplement that is shipped directly to our direct buying
consumers is recognized upon shipment of the product from our third party fulfillment vendor.
The dietary supplement product is shipped once the Company has received confirmation of a valid
credit card charge, which is the only payment option offered to consumers of the dietary
supplement at this time. |
|
|
Star records consumer incentives and trade promotion activities as a reduction of revenues based
on amounts estimated as being due to customers and consumers at the end of a period. The
estimates are based principally on historical utilization and redemption rates of the Companys
products. Such programs include discounts, coupons, rebates, slotting fees, in-store display
incentives and volume-based incentives. |
|
|
Cost of Goods Sold consists of the direct and indirect costs to produce and distribute our
products. Inventory related costs include materials, inbound freight, production costs,
inventory obsolescence and shrinkage. In addition to the aforementioned, the costs for our
dietary supplement product, CigRx, include fulfillment partner fees, credit card processing
fees, and costs of consumer support. |
|
|
Shipping costs for our tobacco products are included in marketing and distribution expenses,
since we do not charge for freight to our wholesale and distributor customers. Shipping costs
for our tobacco products aggregated $39, $38, and $35 thousand, in 2010, 2009 and 2008,
respectively. Shipping cost to consumers purchasing our CigRx® product are included in the cost
of the product price since we charge consumers shipping and handling fees. Shipping costs for
CigRx® to wholesaler and distribution customers will be charged to marketing and distribution
since we will not charge a separate fee shipping. |
|
|
Advertising costs are expensed as incurred and are included in marketing and distribution
expenses. Advertising costs for the years 2010, 2009 and 2008, were $556, $123, and $199
thousand, respectively. |
|
|
The preparation of financial statements in conformity with accounting principles generally
accepted in the United States 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. |
|
|
Research and Development: |
|
|
Research and development costs are expensed as incurred. |
Commitment
and contingency accounting:
The Company evaluates each commitment and/or contingency in accordance with the accounting
standards which state that if the item is more likely than not to become a direct liability then
the Company will record the liability in the financial statements. If not, we will disclose any
material commitments or contingencies that may arise.
Recent Accounting and Reporting Pronouncements:
From time to time, new accounting pronouncements are issued by the Financial Accounting Standards
Board or other standard setting bodies that may have an impact on our accounting and reporting. We
believe that such recently issued accounting pronouncements and other authoritative guidance for
which the effective date is in the future either will not have an impact on our accounting or
reporting or that such impact will not be material to our financial position, results of
operations, and cash flows when implemented.
F-8
2. |
|
Liquidity and managements plans: |
The Company has been operating at a loss for the past eight years. The Companys prospects will
depend on its ability to generate and sustain increased revenue levels in future periods. This will
largely be dependent on the distribution and consumer acceptance of the Companys new CigRx®
product, a non-nicotine, non-tobacco nutraceutical developed by its Rock Creek Pharmaceutical
subsidiary to temporarily decrease the desire to smoke introduced in Richmond, Virginia in August
2010. It also will be dependent on increased distribution and consumer acceptance of its low-TSNA
smokeless tobacco products, as well as its ability to begin generating significant revenues through
royalties from the patented tobacco curing process for which it is the exclusive licensee. CigRx®
is Rock Creeks first product introduction and Rock Creek had no revenue stream prior to the
introduction of
CigRx®
and little revenue from
CigRx®
in 2010. In late February 2011, the Company began testing
CigRx®
on a national basis through expanded infomercials and radio spots. The Companys prospects also will be dependant on
Rock Creeks ability to develop additional pharmaceutical and non-nicotine nutraceutical products
and the approval by the Food and Drug Administration, (FDA), of Star Tobaccos applications to
market variations of its Ariva® and Stonewall Hard Snuff
® smokeless tobacco products as well as a Stonewall Moist-BDL product as
modified risk tobacco products. The ability to generate revenues through royalty payments will be
dependent upon the success of the Companys ongoing patent infringement lawsuit against R J
Reynolds Tobacco (RJR) which has been pending since 2001. In that litigation, following a jury
trial that took place between May 18, 2009 and June 16, 2009, the jury returned a verdict in favor
of RJR holding that there was no infringement of the two patents at issue in the case and that the
patents were invalid due to anticipation, obviousness, indefiniteness and failure to disclose best
mode. That decision has been appealed to the United States Court of Appeals for the Federal Circuit
and oral argument before a three-judge panel of the Court was held on January 11, 2011. The Company
is currently awaiting a ruling on the appeal from the Federal Circuit Court of Appeals. On May 29,
2009 the Company filed a new complaint against RJR for patent infringement during the period
beginning 2003 and continuing to the filing date of the new complaint. The new case has been stayed
pending the outcome of the appeal to the Federal Circuit and the prosecution of the new complaint
will be dependant on the Company achieving a reversal of the jury verdict of invalidity in the
initial RJR action.
As of December 31, 2010, the Company had a working capital surplus of approximately $12.6 million,
which included cash of approximately $13.2 million. Future cash needs during 2011 include:
|
|
|
litigation costs in connection with the RJR patent infringement trial of approximately $1.4
million thousand; |
|
|
|
|
monthly principal and interest payments of approximately $245 thousand in connection with
the repayment of the Companys long-term debt; and |
|
|
|
funding of other aspects of the Companys current operations in light of continued operating
losses. |
The Company expects to continue to incur losses in connection with the sale of its smokeless
tobacco products for the foreseeable future. While net sales of smokeless tobacco have been
increasing year over year, substantially increased sales will be required to reach a breakeven
level for these products. Rock Creek had no revenues prior to the introduction of CigRx® in August
2010. It is expected that Rock Creek will be deriving revenues from the sales of CigRx® on a going
forward basis as it expands distribution of CigRx®, but the Company has had only limited revenue
from the sale of CigRx® to date.
Given the typical long lead time for federal approval of any pharmaceutical products, the
Company does not expect that Rock Creek will generate any revenues from the sale of pharmaceutical
products, as opposed to nutraceuticals, for the foreseeable future. Rather, Rock Creek will focus
its future development efforts on the research and development aspects of a range of
pharmaceuticals, including products having a botanical, tobacco-based component and related
nutraceuticals products that may assist in stabilizing metabolism, assuming sufficient capital can
be generated to support such activities.
During the period January 1, 2010 through March 15, 2010, the Company received proceeds of
approximately $13.8 million through the sale of 11,727 thousand shares of common stock and a
combination of new warrants for an aggregate of 6,324 thousand shares and the repricing of 5,403
thousand shares of previously issued warrants. On November 5, 2010, the Company received proceeds
of $14 million through the sale of 7,615 thousand shares of common stock and 7,615 thousand in new
warrants. See note 7 for a further description of these transactions. Subsequent to December 31,
2010 the Company received proceeds of $11.0 million through the
sale of 4,856 thousand shares of common
stock, the exercise of 2,000 thousand warrants and the issuance of
6,856 thousand in new
warrants. See Note 15 for a further description of this transaction.
Absent the exercise of
outstanding warrants and options for cash or a substantial improvement in revenues and/or
royalties, the Company believes that it has sufficient funding to support its operations into the
first quarter of 2012, but that it will be necessary to pursue additional sources of funds during
the first quarter 2012. Depending upon market conditions and the price of its common stock, the
Company may decide to seek additional funds before that time. There can be no assurance that the
Company will be successful in obtaining such funding at commercially reasonable terms.
F-9
The Company expects to continue to pursue opportunities for licensing its low-TSNA smokeless
tobacco products, expanding the sales and marketing efforts for those products, and its
non-nicotine nutraceutical product, CigRx® that was introduced in August 2010 in the Richmond,
Virginia area and continuing the work of Rock Creek in developing other pharmaceutical and
nutraceutical. While the Company may seek to obtain funds in the future through debt financing,
there are significant limitations on the ability to obtain new debt financing, including the
agreements with B&W. Moreover, the ability to raise future financings on acceptable terms
(including through the exercise of outstanding warrants) will depend on a number of factors,
including the performance of the Company stock price and its operational performance. Any equity
financing will be dilutive to the Companys existing shareholders.
|
|
Inventories consist of the following: |
|
|
|
|
|
|
|
|
|
$ Thousands |
|
2010 |
|
|
2009 |
|
Raw materials |
|
$ |
1,636 |
|
|
$ |
119 |
|
Packaging materials |
|
|
1,911 |
|
|
|
446 |
|
Work-in-process |
|
|
91 |
|
|
|
|
|
Finished goods |
|
|
300 |
|
|
|
80 |
|
|
|
|
|
|
|
|
Total inventories |
|
|
3,938 |
|
|
$ |
645 |
|
Less obsolescence and overstock reserve |
|
|
(519 |
) |
|
|
(415 |
) |
|
|
|
|
|
|
|
Net inventories |
|
$ |
3,419 |
|
|
$ |
230 |
|
|
|
|
|
|
|
|
|
|
The Company had product manufacturing cost that exceeded its normal capacity cost of
approximately $1.8 million and $1.4 million for 2010 and 2009, respectively. These costs are
included in cost of goods sold in the accompanying consolidated statements of operations. |
4. |
|
Property and equipment: |
|
|
Property and equipment consists of the following: |
|
|
|
|
|
|
|
|
|
$ Thousands |
|
2010 |
|
|
2009 |
|
Leasehold improvements |
|
$ |
553 |
|
|
$ |
451 |
|
Machinery and equipment |
|
|
5,107 |
|
|
|
4,529 |
|
Vehicles |
|
|
85 |
|
|
|
|
|
Office and sales equipment |
|
|
674 |
|
|
|
838 |
|
Construction in Progress |
|
|
571 |
|
|
|
|
|
|
|
|
|
|
|
|
Total property and equipment |
|
|
6,990 |
|
|
|
5,818 |
|
Less accumulated depreciation |
|
|
(4,821 |
) |
|
|
(4,761 |
) |
|
|
|
|
|
|
|
Property and equipment-net |
|
$ |
2,169 |
|
|
$ |
1,057 |
|
|
|
|
|
|
|
|
|
|
In 2000 the Company entered into a ten-year lease of a building and land in Chase City, Virginia
that has been used for the Companys tobacco receiving and manufacturing operations. The lease
contained a provision that granted the Company an option to purchase the leased premises. In
November 2008, the Company assigned its option rights under the lease to a third party that, in
turn, exercised the rights under the option in December 2008. As a result of the transaction,
the Company received a net payment of approximately $0.6 million on January 6, 2009. The Company
later transitioned the manufacturing operation that had been carried on in that facility to an
adjacent facility in Chase City that it also leases. |
|
|
On October 30, 2009, the Company sold a 3.5 acre parcel of land in Petersburg, Virginia along
with improvements consisting of the factory that until May 2007 was used for the manufacturing
of its cigarette products and the adjacent 6,000 square feet office building that formerly
housed its executive, marketing, sales and administrative offices, for gross proceeds of $630
thousand. The Company entered into a leaseback of the office building for up to two years with a
15 day notice clause to exit the building and lease. The Company terminated the lease in April
2010, after it completed the transition to leased space in Glen Allen, VA. The Company recorded
a gain on the sale of the property, plant and equipment of approximately $245 thousand in the
fourth quarter 2009 to reflect the difference between the carrying value of the Petersburg
property and buildings and the sales price. |
F-10
|
|
Depreciation expense is included in the consolidated statement of operations for the years ended
December 31, 2010, 2009 and 2008, as follows: |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ thousands |
|
2010 |
|
|
2009 |
|
|
2008 |
|
Cost of Goods Sold |
|
$ |
156 |
|
|
$ |
163 |
|
|
$ |
420 |
|
Operating Expenses |
|
|
91 |
|
|
|
90 |
|
|
|
121 |
|
|
|
|
|
|
|
|
|
|
|
Total Depreciation Expense |
|
$ |
247 |
|
|
$ |
253 |
|
|
$ |
541 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Intangible assets consist of the following: |
|
|
|
|
|
|
|
|
|
$ thousands |
|
2010 |
|
|
2009 |
|
Patents |
|
$ |
1,114 |
|
|
$ |
1,049 |
|
Trademarks and other intangibles |
|
|
90 |
|
|
|
90 |
|
|
|
|
|
|
|
|
|
|
|
1,204 |
|
|
|
1,139 |
|
Less: Accumulated Amortization |
|
|
(577 |
) |
|
|
(513 |
) |
|
|
|
|
|
|
|
|
|
$ |
627 |
|
|
$ |
626 |
|
|
|
|
|
|
|
|
|
|
Amortization expense associated with the intangibles was $66, $62 and $61 thousand in 2010, 2009
and 2008, respectively. An aggregate of $84 thousand in trademarks have indefinite lives and are
therefore not amortized. Expected future amortization of intangibles with finite lives is as
follows: |
|
|
|
|
|
Years ending December 31, |
|
$ thousands |
|
2011 |
|
$ |
62 |
|
2012 |
|
|
62 |
|
2013 |
|
|
62 |
|
2014 |
|
|
62 |
|
2015 |
|
|
62 |
|
Thereafter |
|
|
233 |
|
|
|
|
|
|
|
$ |
543 |
|
|
|
|
|
|
|
In the event the Company is unsuccessful in its patent infringement litigation, as discussed in
Note 13, recognition of an impairment loss related to certain patents with a carrying value of
approximately $71 thousand as of December 31, 2010 may be necessary. The consolidated financial
statements do not include any adjustments that might result from this uncertainty. |
Long-term debt consists of the following as of December 31, 2010:
|
|
|
|
|
|
|
$ thousands |
|
Notes payable to RJR in monthly principal installments
of $134 thousand until August 2010 and $208 thousand
thereafter until fully paid in December 2013, plus interest
at prime plus 1% (4.25% at December 31, 2010) |
|
$ |
7,518 |
|
|
Vehicle note payable in monthly installments of $1.7
thousands including interest at 1.9% annually for 36 months
ending April 2013 |
|
|
49 |
|
|
|
|
|
|
Total long-term debt |
|
|
7,567 |
|
Less current maturities |
|
|
(2,518 |
) |
|
|
|
|
Long term portion of debt |
|
$ |
5,049 |
|
|
|
|
|
|
|
The future maturities of long-term debt without regard to potential royalty offsets are as
follows: |
|
|
|
|
|
Twelve months ending December 31, |
|
$ thousands |
|
2011 |
|
$ |
2,518 |
|
2012 |
|
|
2,519 |
|
2013 |
|
|
2,530 |
|
|
|
|
|
Total notes payable and long term debt |
|
$ |
7,567 |
|
|
|
|
|
F-11
|
|
The Company grants common stock warrants in connection with direct equity shares purchases by
investors as an additional incentive for providing long-term equity capital to the Company and
as additional compensation to consultants and advisors. The warrants are granted at negotiated
prices in connection with the equity share purchases and at the market price of the common stock
in other instances. The warrants have been issued for various terms ranging from several months
to ten years. |
|
|
Common stock warrants issued, redeemed and outstanding during the years ended December 31, 2010,
2009 and 2008 are as follows: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average |
|
|
|
|
|
|
|
Exercise |
|
|
|
|
|
|
|
Price Per |
|
|
|
Number |
|
|
Share |
|
Warrants |
|
|
|
|
|
|
|
|
Warrants outstanding at January 1, 2008 |
|
|
5,252,513 |
|
|
$ |
2.20 |
|
Warrants issued during 2008 |
|
|
10,686,508 |
|
|
|
2.01 |
|
Warrants exercised during 2008 |
|
|
(200,000 |
) |
|
|
(2.02 |
) |
Warrants expired during 2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrants outstanding at December 31, 2009 |
|
|
15,739,021 |
|
|
$ |
2.06 |
|
Warrants issued during 2009 |
|
|
9,320,460 |
|
|
|
2.43 |
|
Warrants exercised during 2009 |
|
|
(7,647,592 |
) |
|
|
(2.07 |
) |
Warrants expired during 2009 |
|
|
(100,000 |
) |
|
|
(4.49 |
) |
|
|
|
|
|
|
|
Warrants outstanding at December 31, 2009 |
|
|
17,311,889 |
|
|
$ |
2.11 |
|
Warrants issued during 2010 |
|
|
13,939,162 |
|
|
|
1.65 |
|
Warrants exercised during 2010 |
|
|
|
|
|
|
|
|
Warrants expired during 2010 |
|
|
(210,526 |
) |
|
|
(2.38 |
) |
|
|
|
|
|
|
|
Warrants outstanding at December 31, 2010 |
|
|
31,040,525 |
|
|
$ |
1.65 |
|
|
|
|
|
|
|
|
|
|
Sale of equity securities and exercise of warrants 2008 |
|
|
March 2008 Private Placements: |
|
|
On March 13, 2008 and March 14, 2008, the Company entered into Securities Purchase and
Registration Rights Agreements (the March Agreements) with selected accredited investors (the
March Investors), to sell 4,838,711 shares of its common stock, par value $0.0001 per share
(Common Stock), at $1.55 per share and 3,311,259 shares of its Common Stock at $1.51 per
share, respectively (collectively, the March Shares), and warrants to purchase an aggregate of
8,149,970 shares of Common Stock at an exercise price of $2.00 per share (the March Warrants
and together with the March Shares, the March Securities), which resulted in gross proceeds to
the Company of $12.5 million (the March Offering). The March Warrants were first exercisable
in September 2008, six months after the closing of the March Offering, and expire five years
after the date that the March Warrants were first exercisable. The March Warrants are also
callable by the Company if the price of the Common Stock exceeds $6.00 per share as quoted on an
approved market for 20 consecutive trading days. Additionally, the March Agreements granted the
March Investors certain registration rights with respect to the March Securities. The March
Offering was made only to accredited investors, as such term is defined in Rule 501 of
Regulation D promulgated under the Securities Act. The Company relied on the exemption from the
registration requirements of the Securities Act set forth in Section 4(2) thereof and the rules
and regulations promulgated thereunder. In March 2009 holders of March warrants for 4,311,259
shares exercised these warrants in full at a reduced price per share. |
|
|
In connection with the March 2008 Agreements, the Company was required to adjust the exercise
price and the number of warrants issued to Manchester under a 2004 warrant agreement with
Manchester for 541,987 shares as previously and subsequently adjusted (the 2004 Warrants).
Under the terms of the 2004 Warrants, since the Company, pursuant to the March 2008 Agreements,
sold shares of Common Stock at an effective price per share below $3.71 per share, Manchester
was entitled to a reduction in the exercise price of the 2004 Warrants from $3.71 per share to
approximately $3.38 per share and to receive 52,647 additional warrants to purchase Common
Stock. |
F-12
|
|
May 2008 Private Placements: |
|
|
On May 12, 2008, the Company entered into a Securities Purchase Agreement and Registration
Rights Agreement (the May Agreement) with certain accredited investors (the May Investors),
to sell 2,469,135 shares of its Common Stock at $1.62 per share (collectively, the May Shares)
and warrants to purchase an aggregate of 2,469,135 shares of Common Stock at an exercise price
of $2.00 per share (the May Warrants and together with the May Shares, the May Securities),
in return for gross proceeds to the Company of $4.0 million (the May Offering). The May
Warrants were first exercisable in November 2008, six months after the closing of the May
Offering and expire five years after the date that the May Warrants were first exercisable. The
May Warrants are also callable by the
Company if the price of the Common Stock exceeds $6.00 per share as quoted on an approved market
for twenty consecutive trading days. Additionally, the May Agreement granted the May Investors
certain registration rights with respect to the Securities. The May Offering was made only to
accredited investors, as such term is defined in Rule 501 of Regulation D promulgated under the
Securities Act. The Company relied on the exemption from the registration requirements of the
Securities Act set forth in Section 4(2) thereof and the rules and regulations promulgated
thereunder. |
|
|
In connection with the May 2008 agreements, the Company was required to further adjust the
exercise price and the number of warrants issued to Manchester under the 2004 warrant agreement
with Manchester for 594,634 shares as previously adjusted. Under the terms of the 2004 Warrants,
since the Company, pursuant to the May 2008 Agreements, sold shares of Common Stock at an
effective price per share below $3.38 per share, Manchester was entitled to a reduction in the
exercise price of the 2004 Warrants from $3.38 per share to approximately $3.29 per share and to
receive 14,756 additional warrants to purchase Common Stock. |
|
|
Additionally, on March 14, 2008, Jonnie R. Williams, the Companys largest shareholder and Chief
Executive Officer, executed a letter agreement under which he committed to make available to the
Company up to $2.0 million until the earlier of March 31, 2009, and the date the Company
received an additional $2.0 million in capital through an equity investment. Because the Company
received over $2.0 million in proceeds from the May Offering, the March 14, 2008 agreement with
Mr. Williams is no longer in effect in accordance with its terms. |
|
|
On September 25, 2008, the holder of a warrant for 200,000 shares of Common Stock exercised the
warrant in its entirety. The warrant holder elected to exercise the warrant utilizing the
warrants net share settlement provision and was issued 81,488 shares of Common Stock based on a
price of $3.41 per share of Common Stock, the average closing price of the Common Stock over a
30 day period ending three calendar days prior to the date of exercise, in accordance with that
provision. |
|
|
Sale of equity securities and exercise of warrants 2009: |
|
|
On February 20 and 25, 2009, the Company reduced the exercise price of 1,967,742 Prior Warrants
to $1.25 in exchange for the immediate and full exercise thereof by the Investors holding such
Prior Warrants (collectively, the February Transactions). The February Transactions resulted
in gross proceeds to the Company of approximately $2.5 million. |
|
|
On March 2, 2009, the Company entered into a securities purchase and registration rights
agreement with certain prior Investors whereby the Company: (i) reduced the exercise price of
1,000,000 Prior Warrants with an exercise price of $3.00 per share to $2.50 in exchange for the
immediate and full exercise thereof by the Investors holding such Prior Warrants and provided
such Investors with warrants having an exercise price of $3.50 per share for the same number of
warrant shares of Common Stock as their respective Prior Warrants and (ii) provided Investors holding
3,311,259 Prior Warrants with an exercise price of $2.00 per share with warrants having an
exercise price of $3.50 per share for the same number of shares of Common Stock as their
respective Prior Warrants in exchange for the immediate and full exercise of such Investors
Prior Warrants (collectively, the March Transaction and together with the February
Transactions, the Recent Transactions). The warrants issued in the March Transaction are
exercisable immediately into an aggregate of 4,311,259 shares of Common Stock and expire on
March 2, 2014 and are callable by the Company beginning on September 2, 2009 if the price of the
Common Stock exceeds $10.00 per share as quoted on an approved market for twenty consecutive
trading days. The March Transaction resulted in gross proceeds to the Company of approximately
$9.1 million. The Recent Transactions were made only to accredited investors, as such term is
defined in Rule 501 of Regulation D promulgated under the Securities Act of 1933, as amended
(the Securities Act). The Company relied on the exemption from the registration requirements
of the Securities Act set forth in Section 4(2) thereof and the rules and regulations
promulgated thereunder. |
F-13
|
|
As a result of the warrant exercise transactions, the Company was required to adjust the
exercise price and the number of warrants issued to Manchester, under a 2004 warrant agreement
with Manchester
pursuant to which Manchester received warrants for 609,390 shares of common stock, as previously
adjusted. Since the warrant exercise transactions involved the sale of shares of common stock at
an effective price per share below $3.29 per share, Manchester was entitled to a reduction in
the exercise price of its warrants from $3.29 per share to approximately $3.24 per share and to
receive approximately 9,201 additional warrants to purchase common stock. |
|
|
On March 23, 2009 Manchester fully exercised its warrant for 618,591 shares, at the stated
exercise price of $3.24 per share, providing the Company approximately $2.1 million of
additional capital. |
|
|
On March 30, April 30 and May 4, 2009, the holder of a warrant for 1,103,960 shares exercised on
250,000 warrant shares on each of the respective dates, for an aggregate of 750,000 warrant
shares at a price of $2.00 per share for proceeds of $1.5 million. |
|
|
On September 22, 2009, the Company entered into a securities purchase and registration rights
agreement with an accredited investor (The Investor), to sell 5,000,000 of its common stock at
$1.00 per share and warrants to purchase an aggregate of 5,000,000 shares of common stock at an
exercise price of $1.50 per share (the September Transaction and the September Warrants).
The September Warrants are first exercisable on February 22, 2010 and expire five years after
the date that the September Warrants are first exercisable. The September Warrants are also
callable by the Company if the price of the Common Stock exceeds $3.00 per share as quoted on an
approved market for twenty consecutive trading days. Additionally, the agreement grants The
Investor certain registration rights with respect to the Securities. The September transaction
resulted in gross proceeds to the Company of $5.0 million. The Offering was made only to an
accredited investor as such term is defined in Rule 501 of Regulation D promulgated under the
Securities Act. The Company relied on the exemption from the registration requirements of the
Securities Act set forth in Section 4(2) thereof and the rules and regulations promulgated
thereunder |
|
|
Sale of equity securities and exercise of warrants 2010: |
|
|
Between March 5 and March 12, 2010, the Company entered into Securities Purchase Agreements and
Registration Rights Agreements (the Agreements) with accredited investors (individually
Investor and collectively Investors) for an aggregate of 11,727,120 shares of its common
stock at the consolidated closing bid price and a combination of new warrants for an aggregate
of 6,323,727 shares and the repricing of 5,403,393 shares of previously issued warrants. In the
aggregate the transactions resulted in gross proceeds to the Company of $13.8 million. The
details of the transactions follow: |
|
|
On March 5, 2010 the Company sold to Investors 3,649,007 shares of its Common Stock at $1.05 per
share and reduced the exercise price on 3,649,007 warrants previously issued to the Investors
from $3.50 to $1.50 per warrant and on March 9, 2010 the Company sold to other Investors
1,754,386 shares of its Common Stock at $1.14 per share and reduced the exercise price on
1,754,386 warrants previously issued to the investors from $2.00 to $1.50 per warrant.
Additionally, the Agreements grant the Investor certain registration rights with respect to the
Common Stock. |
|
|
On March 9, 2010 the Company also entered into an Agreement with another Investor who purchased
4,385,965 shares of the Common Stock at $1.14 per share and received a warrant to purchase an
equal number of warrant shares at an exercise price of $1.50 per share. On the same day, a
Company Insider purchased 2,371,541 shares Common Stock at $1.14 per share and, for a price of
$0.125 per share, purchased a warrant for an equal number of warrant shares at an exercise price
of $1.50 per share. On March 10, 2010, the Company also entered into an Agreement with an
Investor who purchased 769,230 shares of the Common Stock at $1.30 per share and received a
warrant to purchase an equal number of warrant shares at an exercise price of $1.50 per share.
On March 12, 2010, the Company also entered into an Agreement with an Investor who purchased
1,428,571 shares of the Common Stock at $1.40 per share and received a warrant to purchase an
equal number of warrant shares at an exercise price of $1.50 per share. The warrants, in all
cases, are first exercisable six months after the closing of the offering and expire five years
after the date that the warrants are first exercisable. The warrants issued on March 9, 2010 and
March 10, 2010 are callable by the Company if the price of the Common Stock
exceeds $3.00 per share as quoted on an approved market for twenty consecutive trading days. The
warrants issued on March 12, 2010 are callable by the Company if the price of the Common Stock
exceeds $10.00 per share as quoted on an approved market for twenty consecutive trading days.
Additionally, the Agreements grant the Investors certain registration rights with respect to the
Common Stock and warrant shares. |
|
|
On March 12, 2010, the Company and an Investor in the Second March 9 Offering agreed to amend
the Second March 9 Agreement only to reduce each of the number of shares of Common Stock and
warrants purchased by such Investor to 1,754,385 from 4,385,965 (the Amended Agreement). After
giving effect to the Amended Agreement, the Second March 9 Offering resulted in gross proceeds
to the Company of approximately $2,000,000 and a reduction of the amount of the Second March 9
Offering by approximately $3,000,000. |
F-14
|
|
The Securities sold to the Investors have not been registered under the Securities Act of 1933,
as amended (the Securities Act), or any state securities laws, and may not be offered or sold
in the United States in the absence of an effective registration statement or exemption from the
registration requirements. The Offering was made only to accredited investors, as such term is
defined in Rule 501 of Regulation D promulgated under the Securities Act. The Company relied on
the exemption from the registration requirements of the Securities Act set forth in Section 4(2)
thereof and the rules and regulations promulgated thereunder. |
|
|
On November 5, 2010, the Company entered into a Securities Purchase Agreement and Registration
Rights Agreement (the November Agreement) with certain accredited investor (the Investors),
including several executive officers and directors of the Company (the Executives), to sell
7,615 thousand shares of Common Stock at $1.80 per share and warrants to purchase an aggregate
of 7,615 thousand shares of Common Stock at an exercise price of $1.80 per share. In addition to
purchasing their respective shares of Common Stock for $1.80 per share, the executives and
directors also paid the Company $0.125 per warrant purchased in the offering. The offering
resulted in gross proceeds to the Company of $14.0 million. The warrants are first exercisable
six months after the closing of the offering and expire five years after the date that the
warrants are first exercisable. The warrants are also callable by the Company if the price of
the Common Stock exceeds $10.00 per share as quoted on an approved market for twenty consecutive
trading days. Additionally, the November Agreement grants the Investors certain customary resale
registration rights with respect to the Shares and shares of Common Stock underlying the
warrants. |
|
|
The offerings referred to above were made only to accredited investors, as such term is defined
in Rule 501 of Regulation D promulgated under the Securities Act. The Company relied on the
exemption from the registration requirements of the Securities Act set forth in Section 4(2)
thereof and the rules and regulations promulgated thereunder in connection with this
transaction. In accordance with the Companys related party transaction policy, the Executives
intention to purchase shares and warrant shares of the Companys stock was considered by the
Audit Committee at a meeting held on November 3, 2010 and was approved by the Audit Committee on
that date and the Board of Directors at a meeting held on November 5, 2010. |
|
|
The Company had no warrants exercised during the twelve months ended December 31, 2010. As of
December 31, 2010 the Company had 31,040,525 warrants outstanding with a weighted average
exercise price of $1.65 per share. |
|
|
See Note 15 for securities sold, warrants and options issued subsequent to December 31, 2010. |
|
|
Prior to 2008 the Company adopted a 1998 Stock Option Plan, a 2000 Equity Incentive Plan, and in
September 2008 it adopted a 2008 Incentive Award Plan (the Plans). The Plans provide 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. In the aggregate the Plans provide
for grants of both qualified and non-qualified stock options to
purchase up to 14,000,000 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. |
|
|
Common stock options issued, redeemed and outstanding during the years ended December 31, 2010,
2009 and 2008 are as follows: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
|
|
Average |
|
|
|
|
|
|
|
|
|
|
Exercise |
|
|
|
|
|
|
|
|
|
|
Price Per |
|
|
Grant Date Fair |
|
|
|
Number |
|
|
Share |
|
|
Value |
|
Options |
|
|
|
|
|
|
|
|
|
|
|
|
Options outstanding at January 1, 2008 |
|
|
5,658,200 |
|
|
$ |
2.56 |
|
|
|
|
|
Options forfeited during 2008 |
|
|
(50,000 |
) |
|
|
(3.58 |
) |
|
|
|
|
Options exercised during 2008 |
|
|
(58,000 |
) |
|
|
(2.70 |
) |
|
|
|
|
Options issued during 2008 |
|
|
2,075,000 |
|
|
|
1.94 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options outstanding at December 31, 2008 |
|
|
7,625,200 |
|
|
$ |
2.38 |
|
|
$ |
1.49 |
|
Options forfeited during 2009 |
|
|
(681,400 |
) |
|
|
4.34 |
|
|
|
|
|
Options exercised during 2009* |
|
|
(2,638,600 |
) |
|
|
1.92 |
|
|
|
|
|
Options issued during 2009 |
|
|
250,000 |
|
|
|
0.93 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options outstanding at December 31, 2009 |
|
|
4,555,200 |
|
|
$ |
2.28 |
|
|
$ |
0.77 |
|
Options forfeited during 2010 |
|
|
(729,000 |
) |
|
|
(3.97 |
) |
|
|
|
|
Options exercised during 2010 |
|
|
|
|
|
|
|
|
|
|
|
|
Options issued during 2010 |
|
|
3,890,000 |
|
|
|
2.65 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options outstanding at December 31, 2010 |
|
|
7,716,200 |
|
|
|
2.31 |
|
|
$ |
1.74 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* |
|
Includes 75,000 share options exercised as non cash, resulting in 33,268 shares issued. |
F-15
|
|
The following table summarizes information for options outstanding and exercisable at December
31, 2010. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding |
|
|
Exercisable |
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
|
|
Avg. |
|
|
Weighted |
|
|
|
|
|
|
|
|
|
|
Avg. |
|
|
Aggregate |
|
|
|
|
|
|
|
Remaining |
|
|
Avg. Exercise |
|
|
Aggregate |
|
|
|
|
|
|
Exercise |
|
|
Intrinsic |
|
Range of Prices |
|
Number |
|
|
Life Years |
|
|
Price |
|
|
Intrinsic Value |
|
|
Number |
|
|
Price |
|
|
Value |
|
$0.702.00 |
|
|
3,100,000 |
|
|
|
6.70 |
|
|
|
1.51 |
|
|
$ |
1,370 |
|
|
|
3,100,000 |
|
|
|
1.51 |
|
|
$ |
1,370 |
|
2.013.00 |
|
|
4,091,200 |
|
|
|
8.83 |
|
|
|
2.70 |
|
|
|
|
|
|
|
3,991,200 |
|
|
|
2.71 |
|
|
|
|
|
3.014.00 |
|
|
350,000 |
|
|
|
4.87 |
|
|
|
3.67 |
|
|
|
|
|
|
|
350,000 |
|
|
|
3.67 |
|
|
|
|
|
4.014.95 |
|
|
175,000 |
|
|
|
4.82 |
|
|
|
4.69 |
|
|
|
|
|
|
|
175,000 |
|
|
|
4.69 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$0.704.95 |
|
|
7,716,200 |
|
|
|
7.70 |
|
|
|
2.31 |
|
|
|
|
|
|
|
7,616,200 |
|
|
|
2.31 |
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
A summary of the status of the Companys nonvested stock options as of December 31, 2010, and
changes during the year then ended, is presented below. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
Average |
|
|
|
|
|
|
|
Grant-Date Fair |
|
Nonvested Stock Options |
|
Shares |
|
|
Value |
|
Nonvested at December 31, 2009 |
|
|
50,000 |
|
|
$ |
1.46 |
|
Granted |
|
|
100,000 |
|
|
|
1.74 |
|
|
Vested |
|
|
(50,000 |
) |
|
|
(1.46 |
) |
Forfeited |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonvested at December 31, 2010 |
|
|
100,000 |
|
|
$ |
1.74 |
|
|
|
|
|
|
|
|
|
|
As of December 31, 2010, there was approximately $149 thousand of total unrecognized
compensation cost related to non-vested share-based compensation arrangements granted under the
Plans. That cost will be recognized over the next two years. There were no options exercised in
the year ended December 31, 2010. |
|
|
The fair value of options was estimated on the date of grant issuance using the Black-Scholes
option pricing model with the following weighted average assumptions: |
|
|
|
|
|
|
|
|
|
2010 |
|
2009 |
|
2008 |
Expected life of options based on simplified method for employees |
|
2 5 years |
|
2 5 years |
|
2.5 5 years |
Risk free interest rate |
|
1.152.75% |
|
0.93 2.47% |
|
2.223.15% |
Expected volatility |
|
122.85125.79% |
|
121.2138.33% |
|
103.4112.0% |
Expected dividend yield |
|
0% |
|
0% |
|
0% |
|
|
Total stock-based compensation (stock and stock option) cost recognized is as follows: |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ thousands |
|
2010 |
|
|
2009 |
|
|
2008 |
|
Employee |
|
$ |
8,320 |
|
|
$ |
75 |
|
|
$ |
2,470 |
|
Non-employee consultants and directors |
|
|
229 |
|
|
|
250 |
|
|
|
703 |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
8,549 |
|
|
$ |
325 |
|
|
$ |
3,173 |
|
|
|
|
|
|
|
|
|
|
|
|
|
In 2009 the Company issued 186,000 shares of common shares with a fair value of $117 thousand.
These shares were issued from the Companys 2008 Incentive Award Plan. |
|
|
The Company issued options for an aggregate of 604,000 shares of common stock to several
employees subsequent to December 31, 2010 that vested as of the date of the grant and, as part
of employment agreements entered into on March 14, 2011, issued stock option whose vesting is
contingent on the satisfaction of retention or performance criteria and, in some cases, on
shareholder approval of the option grants. See Note 15, Subsequent Events for more details. |
F-16
|
|
The following table sets forth the computation of basic and diluted earnings per share for the
years ended December 31: |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ and shares in thousands except per share data |
|
2010 |
|
|
2009 |
|
|
2008 |
|
Net loss |
|
$ |
(28,281 |
) |
|
$ |
(22,744 |
) |
|
$ |
(18,339 |
) |
|
|
|
|
|
|
|
|
|
|
Denominator for basic earnings per share-weighted average shares |
|
|
118,384 |
|
|
|
101,907 |
|
|
|
89,844 |
|
Effect of dilutive securities: stock options and warrants outstanding (a) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted earnings per shareweighted average shares
adjusted for dilutive securities |
|
|
118,384 |
|
|
|
101,907 |
|
|
|
89,844 |
|
Loss per common sharebasic |
|
$ |
(0.24 |
) |
|
$ |
(0.22 |
) |
|
$ |
(0.20 |
) |
|
|
|
|
|
|
|
|
|
|
Loss per common sharediluted |
|
$ |
(0.24 |
) |
|
$ |
(0.22 |
) |
|
$ |
(0.20 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
Securities outstanding that were excluded from the computation because they would have been
anti-dilutive are as follows: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2010 |
|
|
2009 |
|
|
2008 |
|
Stock options and warrants |
|
|
38,756,725 |
|
|
|
21,867,089 |
|
|
|
10,231,213 |
|
|
|
In 2007, the Company recognized a $2.1 million liability for alternative minimum tax and
interest.. The Companys potential liability resulted primarily from timing differences for
deductions for amounts paid to the Companys MSA escrow accounts. The Company recognized
interest related to the liability for uncertain tax positions in income tax expense. During the
first three fiscal quarters of 2008, the Company recognized approximately $120 thousand , of
interest expense associated with uncertain tax positions. In 2005, the Companys request for a
private letter ruling, or PLR, which related to the years under IRS examination, was resolved
generally in its favor and an amended private letter ruling, or Amended PLR, was issued by the
IRS in January 2009. The Amended PLR confirmed that the Companys deductions taken for MSA
escrow payments, which were the subject of the IRS ongoing audit for tax years 2001 through 2004
and a pending tax appeal, were fully deductible and appropriate in the years taken. Based on the
Amended PLR, the Company entered into a closing agreement with the IRS which confirmed the
deductions taken for those years and, thereafter, the IRS confirmed that the Companys tax
returns for the years 2001 through 2004 were correct as filed. As a result of the
notification by the IRS in the Amended PLR, the Company derecognized its position of recording
this income tax expense as of December 31, 2008, which resulted in a $2.2 million income tax
benefit. |
|
|
Net deferred tax assets and liabilities consist of the following: |
|
|
|
|
|
|
|
|
|
$ thousand |
|
2010 |
|
|
2009 |
|
Deferred tax assets: |
|
|
|
|
|
|
|
|
Net operating loss carry-forwards (portions subject to annual limitation) |
|
$ |
54,853 |
|
|
$ |
47,778 |
|
Credit carry-forward |
|
|
477 |
|
|
|
501 |
|
Stock option compensation |
|
|
4,639 |
|
|
|
1,442 |
|
Differing basis in property and equipment for tax and financial reporting purposes |
|
|
(38 |
) |
|
|
17 |
|
Inventory Reserve |
|
|
194 |
|
|
|
|
|
Other |
|
|
82 |
|
|
|
20 |
|
|
|
|
|
|
|
|
|
|
|
60,207 |
|
|
|
49,758 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred tax liabilities: |
|
|
|
|
|
|
|
|
MSA escrow payments taxable in future |
|
|
(138 |
) |
|
|
(137 |
) |
|
|
|
|
|
|
|
|
|
Valuation Allowance* |
|
|
(60,069 |
) |
|
|
(49,621 |
) |
|
|
|
|
|
|
|
|
|
$ |
|
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
* |
|
Based on the information available, management believes the allowance is appropriate. |
F-17
|
|
Income tax benefit consists of the following: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2010 |
|
|
2009 |
|
|
2008 |
|
Current: |
|
|
|
|
|
|
|
|
|
|
|
|
Federal |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
State |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred benefit |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The provision for income tax expense varies from that which would be expected based on applying
the statutory federal rate to pre-tax accounting loss as follows: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2010 |
|
|
2009 |
|
|
2008 |
|
Statutory federal rate |
|
|
(34.00 |
)% |
|
|
(34.00 |
)% |
|
|
(34.0 |
)% |
Permanent items |
|
|
(0.33 |
) |
|
|
0.57 |
|
|
|
0.44 |
|
State tax provision, net of federal benefit |
|
|
(3.45 |
) |
|
|
(3.45 |
) |
|
|
(3.45 |
) |
Valuation allowance |
|
|
37.78 |
|
|
|
36.88 |
|
|
|
37.01 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(0.00 |
)% |
|
|
(0.0 |
)% |
|
|
(0.0 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2010, the Company had net operating loss carry-forwards of approximately $148
million, which expire from 2010 through 2030. As a result of previous ownership changes, an
aggregate of $532 thousand in Federal loss carry-forwards are limited to $116 thousand annually. |
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 year- ended December 31: |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ thousands |
|
2010 |
|
|
2009 |
|
|
2008 |
|
Business travel aircraft expense |
|
$ |
1,654 |
|
|
$ |
1,560 |
|
|
$ |
1,402 |
|
|
|
The Company from time to time during a portion of 2008 used an aircraft owned by
Starwood Industries LLC, a company in which Jonnie R. Williams, Stars CEO and one of its
largest shareholders, is a principal. In 2008 the aircraft owned by Starwood Industries LLC
was sold and
another aircraft that is owned by Starwood Aviation, Inc. (Starwood Aviation), a company
wholly owned by Mr. Williams, was purchased. Effective September 1, 2008, the Company entered
into an agreement for the use of the aircraft owned by Starwood Aviation. The 2008 agreement
with Starwood Aviator was amended in May 2010 to clarify the types of items that would be
included as out of pocket expenses and to recognize that certain costs, such as for fuel,
would be variable depending on the actual cost of the item at the time of use. |
|
|
Related party license agreement: |
|
|
Effective January 1, 1998, Star entered into an exclusive license agreement with Regent Court
Technology, LLC, of which the Companys founder, Chief Executive Officer and one of the
Companys largest shareholders, and the beneficiary of the ODonnell Trust, are the owners.
Pursuant to this license agreement, Star has the exclusive world-wide rights to produce and sell
tobacco products with low-TSNA tobacco and to sublicense that technology to third parties. In
connection with this agreement, Star is obligated to pay royalties equal to 2% of all product
sales (less certain costs incurred by the Company) and 6% of any royalty income earned from
sublicensing (less certain costs incurred by the Company). Since the costs incurred by the
Company were in excess of the royalty obligations there were no royalties due under this
agreement for 2010, 2009 or 2008. |
|
|
Due (to) from stockholders: |
|
|
Due (to) from Stockholders consists of unsecured non-interest bearing advances of $(50) thousand
as of December 31, 2010 and December 31, 2009. |
|
|
On March 9, 2010 Mr. Williams purchased 2,371,541 shares of the Companys common stock at a price
of $1.14 per share and, for a price of $0.125 per share, purchased a warrant for an equal number
of warrant shares at an exercise price of $1.50 per share and on November 5, 2010 Mr. Williams
purchased 717,220 shares of our common stock at a price of $1.80 per share and, for a price of
$0.125 per share, purchased a warrant for an equal number of warrant shares at an exercise price
of $1.80 per share. On November 5, 2010 Messrs. Chayet, Haynes and Perito purchased 2,000,
10,000 and 50,000 shares respectively of our common stock at a price of $1.80 per share and, for
a price of $0.125 per share, purchased a warrant for an equal number of warrant shares at an
exercise price of $1.80 per share. In accordance with the Companys related party transaction
policy, Mr. Williams intention to purchase shares and warrant shares of our companys stock was
considered by the Audit Committee at meetings held on March 9, 2010 and November 5, 2010
respectively and was approved by the Audit Committee and the Board of Directors on those dates.
The purchase of shares by Messrs. Chayet, Haynes and Perito also was approved by the Audit
Committee at the meeting held on November 5, 2010. |
F-18
|
|
On March 4, 2011 Mr. Williams purchased 508,905 shares of our common stock at a price of
$1.84 per share and, for a price of $0.125 per share, purchased a warrant for an equal
number of warrant shares at an exercise price of $2.00 per share. In accordance with the
Companys related party transaction policy, Mr. Williams intention to purchase shares and
warrant shares of the Companys stock was considered and approved by the Audit Committee of
the Board of Directors on March 4th. .. See Note 15, Subsequent Events for
details of the transaction. |
|
|
On March 15, 2010, Rock Creek entered into a consulting agreement with Neil L. Chayet, Esquire
for Mr. Chayet to assist Rock Creek in the recruitment and recommendation of members
to be appointed to a Scientific Advisor Board for the company and in communicating to the public
health community and others information regarding Rock Creeks products and mission. The
agreement runs for a period of one year from March 15, 2010, is terminable by
either party without cause on fifteen days written notice and may be extended thereafter by the
company at its discretion for one month periods. Under the agreement,
Mr Chayet acts
as an independent contractor and receives a consulting fee of $6,000 per month and
reimbursement for reasonable business expenses. Given
Mr. Chayets status as a Director of our
company, the consideration of the consulting agreement and its potential impact on Mr. Chayets
status as an Independent Director was considered by the Companys Audit Committee as a related party transaction in
accordance with the Companys
related party transaction policy. At a meeting held on March 9, 2010, the Audit Committee
approved the consulting agreement and recommended approval to the Board of Directors. The
agreement was thereafter approved by the Board on March 15, 2010. |
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 matches these contributions at a rate of $0.75 for each $1.00 of employee
contribution. The Company made contributions of approximately $83, $103, and $98 thousand, in
2010, 2009 and 2008, respectively. |
12. |
|
Fair value of financial instruments, concentrations and credit risk and major customer
information: |
|
|
Fair value of financial instruments: |
|
|
The estimated fair value of cash and cash equivalents, trade receivables, licensing rights
receivable, MSA escrow funds, due from and to stockholders and trade payables approximate the
carrying value due to their short-term nature, variable interest rates or interest rates charged
at rates at which the Company can currently borrow. In applying the accounting standards for
fair value determination the Company has modified its approach taking into account what the
Company would have to pay someone to take over its debt obligations. The Company believes that
it could pay someone the carrying value of the debt based on the current market conditions for
obtaining credit. Considerable judgment is required in developing estimates of fair value;
therefore, the estimates presented herein are not necessarily indicative of the amounts that the
Company would realize in a current market exchange. |
|
|
The estimated fair value of long-term debt is summarized as follows ($ thousand): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2010 |
|
|
2009 |
|
Carrying |
|
Estimated |
|
|
Carrying |
|
|
Estimated |
|
Amount |
|
Fair Value |
|
|
Amount |
|
|
Fair Value |
|
$ |
7,567 |
|
$ |
7,567 |
|
|
$ |
9,499 |
|
|
$ |
9,499 |
|
|
|
Differences between fair value and carrying amount of long-term debt are primarily due to
instruments that provide fixed interest or zero interest rates or contain fixed interest rate
elements. Inherently, such instruments are subject to fluctuations in fair value due to
subsequent movements in interest rates. |
F-19
|
|
Credit risk and major customer information: |
|
|
Financial instruments which potentially subject the Company to concentrations of credit risk
consist principally of cash and cash equivalents, accounts receivable and licensing rights
receivable. |
|
|
The Federal Deposit Insurance Corporation, insures up to $250,000 for substantially all
depository accounts. During 2010 the Company had amounts on deposit which exceed these insured
limits and as of December 31, 2010, had $10.2 million which exceeded these insured limits. |
|
|
Trade accounts receivable for the Companys smokeless tobacco products result from sales of
tobacco products to 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. |
|
|
The receivable from the sale of licensing rights is collectible in monthly installments and $3.1
million of the $3.2 million due under the agreement had been collected by December 31, 2010. All
required
payments to date have been timely received. As such, management believes this receivable is
fully collectible. |
|
|
In 2010 the Company had no customers who accounted for more than 10% of sales or accounts
receivable, however in the prior years the Company had the following customers who represented
in excess of 10% of sales or accounts receivable. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009 |
|
|
2008 |
|
|
|
|
|
|
|
Accounts |
|
|
|
|
|
|
Accounts |
|
|
|
Sales |
|
|
Receivable |
|
|
Sales |
|
|
Receivable |
|
McLane Company, Inc. |
|
|
10.21 |
% |
|
|
3.50 |
% |
|
|
|
|
|
|
|
|
Starco Inpex, Inc DBA Wholesale Outlet |
|
|
6.44 |
% |
|
|
10.56 |
% |
|
|
8.7 |
% |
|
|
13.8 |
% |
Food Lion |
|
|
7.62 |
% |
|
|
21.94 |
% |
|
|
11.6 |
% |
|
|
1.2 |
% |
13. |
|
Commitments, contingencies, and other matters: |
Operating leases:
|
|
The Company also leases certain of its office, warehouse and manufacturing facilities under
non-cancelable operating leases for approximately $7 thousand per month; expiring in 2022. The
Company leases office space for its Rock Creek subsidiary in Gloucester, Massachusetts for
approximately $3 thousand per month, maintains space for Star Scientific and Rock Creek in the
Washington, DC area at a cost of approximately $7 thousand per month and began leasing office
space in February 2010 in Glen Allen, Virginia for its corporate functions and the tobacco
marketing and administrative activities of Star Tobacco for approximately $3 thousand per month. |
|
|
The following represents the future minimum rental payments required under operating leases that
have initial or remaining non-cancelable terms in excess of one year as of December 31, 2010. |
|
|
|
|
|
Year ending December 31, |
|
$ thousand |
|
2011 |
|
$ |
150 |
|
2012 |
|
|
130 |
|
2013 |
|
|
131 |
|
2014 |
|
|
133 |
|
2015 |
|
|
133 |
|
Thereafter |
|
|
518 |
|
|
|
|
|
|
|
$ |
1,195 |
|
|
|
|
|
|
|
Rent expense for all operating leases was approximately $258, $124, and $217 thousand, for the
years ended December 31, 2010, 2009 and 2008, respectively. |
F-20
|
|
Obligations under master settlement agreement: |
|
|
In November 1998, 46 states and the District of Columbia, the Settling States, entered into the
Master Settlement Agreement, or MSA, to resolve litigation that had been instituted against the
major cigarette manufacturers. The Company was not named as a defendant in any of the litigation
matters and chose not to become a participating manufacturer under the terms of the MSA. As a
non-participating manufacturer, the Company was required to satisfy certain escrow obligations
for cigarette sales pursuant to statutes that the MSA required the Settling States to adopt in
order for such states to receive the full benefits of the settlement. On March 14, 2007, the
Company sold the rights, title and interest in and to all income from and reversionary interest
in its MSA escrow accounts, including its 2006 MSA escrow deposits made in April 2007. Although
the Company sold the rights in and to all income from and reversionary interest in the funds
deposited into the MSA escrow accounts for the years up to and including 2006, these MSA escrow
funds remain in the Companys name and the principal amount of these accounts will be available
to satisfy portions of any state judgments or settlements for the type of claims asserted
against the major tobacco manufacturers in the suits that resulted in the negotiation of the
MSA, if such claims are successfully asserted in litigation against the Company. |
|
|
As of December 31, 2010, the Company had deposited into escrow a net amount of approximately
$368 million for sales of cigarettes in Settling States, in addition to deposits for which the
Company previously sold its rights, title and interest as part of the March 2007 transaction noted
above. The Companys total escrow obligation for 2007 sales (paid in April of 2008) was $365 thousand. In May 2007, the Company entered into
a license agreement with Tantus for the exclusive licensing of its trademarks Sport®,
MainStreet® and GSmoke® and ceased manufacturing cigarettes in June 2007. Given the
discontinuation of the Companys cigarette operations in June 2007, and the focus on the sale of
smokeless tobacco products, the Company does not anticipate having any material MSA escrow
obligations in the future. |
|
|
In May 2001, the Company filed a patent infringement action against RJR in the United States
District Court for Maryland, Southern Division, or District Court, to enforce the Companys
rights under U.S. Patent No. 6,202,649 (649 Patent), which claims a process for substantially
preventing the formation of TSNAs in cured tobacco. On July 30, 2002, the Company filed a second
patent infringement lawsuit against RJR in the District Court based on a new patent issued by
the U.S. Patent and Trademark Office on July 30, 2002 (Patent No. 6,425,401). On August 27, 2002
the two suits were consolidated. |
|
|
In April 2003, the parties filed dispositive Motions for Summary Judgment. After appointment of
a Special Master to prepare Reports and Recommendations, or R&Rs, for the District Court on six
of the Summary Judgment Motions, the District Court adopted without modification the Special
Masters R&Rs, which collectively recommended that the District Court deny RJRs Summary
Judgment Motions, and that the Motion for Summary Judgment on claim construction and
definiteness be granted in part and denied in part. The District Court also issued an order
denying RJRs other Motion for Summary Judgment seeking to limit the Companys damages claim. |
|
|
On August 17, 2004, the case was transferred from Judge Alexander Williams to Judge Marvin J.
Garbis. Judge Garbis over the next several months issued a series of orders concerning various
aspects of the case and ordered that RJRs defense of inequitable conduct before the patent
office be bifurcated from the remaining issues and tried before Judge Garbis beginning on
January 31, 2005. That portion of the case was tried during the period January 31, 2005 to
February 8, 2005. At the conclusion of the bench trial, the District Court advised the parties
that it would take the matter under advisement, and expected to rule on this portion of the case
at the same time that it ruled on two additional Summary Judgment Motions that were filed by RJR
on January 25, 2005. On January 19, 2007, the District Court granted RJRs Motions for Summary
Judgment in part and denied these motions in part. On RJRs Motion for Summary Judgment on the
Effective Filing Date of the patents, the District Court held that September 15, 1999 was the
effective filing date, but denied RJR Summary Judgment of Invalidity with regard to the
patents-in-suit. On RJRs Motion for Summary Judgment on Indefiniteness, the District Court
granted the motion on the basis that the term anaerobic condition was indefinite. On June 26,
2007 the District Court issued its ruling on RJR inequitable conduct defense. In its ruling the
District Court held the two patents unenforceable due to inequitable conduct in their
procurement and a final judgment against our company was docketed on June 27, 2007. The Company
immediately filed a notice of appeal as to the rulings issued in January 2007 and as to the
ruling on the inequitable conduct defense with the United States Court of Appeals for the
Federal Circuit, or Court of Appeals. |
|
|
After full briefing by both parties and oral argument on March 7, 2008, the Court of Appeals on
August 25, 2008 issued a unanimous opinion reversing the rulings by the District Court that had
found the patents at issue in the RJR litigation invalid because of inequitable conduct during
the prosecution of the patents and because the patents were indefinite. In October 2008 the case
was remanded to the District Court. Following remand from the Court of Appeals, the case was tried to
a jury in the District Court between May 18, 2009 and June 16, 2009. At the conclusion of the
trial, the jury returned a verdict in favor of RJR holding that there was no infringement of the
two patents at issue in the case and that the patents were invalid due to anticipation,
obviousness, indefiniteness and failure to disclose best mode. On July 7, 2009, the Company filed
a motion with the District Court for Judgment as a Matter of Law or, in the Alternative, for a
New Trial. That motion was denied on December 21, 2009 and judgment was entered on the jury
verdict that day. The Company filed a Notice of Appeal to the United States Court of
Appeals for the Federal Circuit Court of Appeals on December 22, 2009 and its opening brief was filed on May 5, 2010. RJR filed its brief on August
2, 2010 and the Companys reply was filed on September 20, 2010. Oral argument on the appeal was held
before a three-judge Panel of the Federal Circuit Court of Appeals on January 11, 2011. The
Company is currently awaiting a decision from the Federal Circuit Court of Appeals on the appeal. |
F-21
|
|
On November 30, 2009, RJR filed a motion for a bill of cost for $442 thousand RJR also filed a
motion requesting the District Court to determine that this is an exceptional case under 35
USC § 285 and award attorneys fees of approximately $35 million under that provision and/or
under 28 USC § 1927 on the basis that attorneys fees were unreasonably multiplied during the
litigation. As part of the Orders issued on December 21, 2009, the District Court stayed the
motion for attorneys fees until after a ruling on the pending appeal and the reexamination
before the U.S. Patent and Trademark Office. The Court on January 8, 2010 stayed any further
briefing on a renewed petition for a bill of cost that RJR filed on December 30, 2009. Any
potential award of attorneys fees should be eliminated if the Court of Appeals for the Federal
Circuit overturns the jury verdict in the District Court or if the claims at issue in the
reexamination proceeding in the U.S. Patent and Trademark Office are determined to be valid, and
any award of costs should also be eliminated if the Federal Circuit overturns the jury verdict
in favor of RJR. Because the likelihood of an unfavorable ruling on the fee motion and bill of
cost and the amount of any potential assessment cannot be reasonably estimated, no amounts have
been accrued for these items in the accompanying consolidated financial statements. |
|
|
On May 29, 2009, the Company filed a new complaint against RJR for patent infringement during
the period beginning 2003 through the filing date of the complaint. In an Order dated January 8,
2010, the Court stayed any further action in this case until after a ruling on the appeal in the
initial infringement action against RJR. The future prosecution of the new complaint will be
dependant on our achieving a reversal of the jury verdict of invalidity in the initial RJR
action. |
|
|
On December 31, 2008 and January 2, 2009, RJR filed requests in the U.S. Patent and Trademark
Office to reexamine the two patents that are the subject of the patent infringement litigations
described above. In February and March 2009, the Patent and Trademark Office granted the
reexamination requests, agreeing to review the patentability of the subject matter claims 4, 12
and 20 of the 649 patent and claim 41 of the 401 patent.
On March 10, 2011, the Patent and Trademark Office confirmed the
validity of each of the claims of the 649 and 401 patents
that were under reexamination and closed each of the reexamination
proceedings. |
|
|
The Company has entered into fee arrangements with counsel in several litigation and related
matters under which certain costs related to the litigation are being advanced by counsel on the
Companys behalf. Given the contingent nature and the fact that a probability assessment of
liability cannot be made at this time, no accrual has been made for this contingent liability.
The Company has paid or accrued all existing obligations. Also, as part of its fee arrangements
in certain of these matters, the Company has agreed to pay counsel a percentage of any damage
award, a percentage of the resulting payments the Company actually receives in the event that
the litigation is resolved in its favor or a result fee, in return for a cap on fee payments
during the litigation. |
|
|
Virginia Sales and Use Tax Assessment |
|
|
In 2002, the Virginia Department of Taxation asserted a Virginia Sales and Use Tax assessment for
the period January 1, 1999, through March 31, 2002, against
the Company with respect to its tobacco-curing
barns in the amount of $860,115. This Company applied for a correction of the assessment and a total abatement of
the tax on the grounds that the barns are exempt from sales and use taxes under the industrial
use and processing exemption and/or the agricultural exemption. In a letter dated October 7,
2004, the Company received notification from the Commonwealth of Virginia that an adverse
decision had been made by the Commissioner of Taxation with respect to the sales and use tax
assessment previously issued to the Company. On August 10, 2010 the Commonwealth of Virginia
responded to the Companys request for reconsideration of the states sales and use tax
assessment with respect to our tobacco curing barns. The Commonwealth disagreed with the
Companys position that the barns are part of the manufacturing process and, therefore, exempt
from sales and use taxes under the industrial use and processing exemption and/or the
agricultural exemption, concluding that the barns are taxable under the Commonwealths sales tax
laws and regulation. The Company disagrees with the ruling by the Commissioner and intends to
timely pursue this matter through all available means. The sales and use tax assessment plus
penalties and interest together, as of December 31, 2010, totaled $1.5 million. Interest will
continue to accrue during the Companys continued pursuit of a resolution of this matter. |
|
|
Except as set forth above, there are no other litigation matters pending that could be expected
to materially harm the Companys results of operations and financial condition. |
F-22
|
|
During the quarter ending December 31, 2009 the Company restructured and reduced its tobacco
sales force and certain general and administrative personnel in response to the slower than
expected sales of its dissolvable tobacco products. As part of the restructuring effort, the
Company has limited the day-to-day activity of its sales force and is focusing its marketing
efforts on store level support and consumer marketing in Virginia and contiguous states, with
the intent of gaining more extensive market penetration and product acceptance in those areas.
Notice of the Companys restructuring effort was announced on December 3, 2009 and separation
dates for effected employees occurred on various dates through January 31, 2010. The
restructuring charge in the accompanying consolidated financial statements reflects severance in
the form of salary continuation and benefit continuation payments for periods up to twelve
months for those employees who accepted the voluntary termination as part of the restructuring
effort prior to December 31, 2009. |
|
|
On January 31, 2011 the Companys Board of Directors on recommendation of the Compensation
Committee awarded a total of 604,000 stock options to three employees who had an equal number of
stock options expire during 2010. The Black Scholes value charged to the first quarter operating
expense amounted to $779 thousand. |
|
|
On March 14, 2011 the Companys Board of Directors, on recommendation of the Compensation
Committee, approved the issuance of additional stock option awards to three off the Companys
Named Executives as part of the terms of employment agreements entered into with these
executives on the same date. Two of the option grants require shareholder approval. |
|
|
On February 28, 2011, the Company entered into a Securities Purchase and Registration Rights
Agreement (the February 28 Agreement) with an accredited investor who held previously
issued warrants (the Warrant Holder) for 2,000,000 shares of the Companys common
stock, par value $0.0001 per share (Common Stock), at an exercise price of $1.00 per
share (the Prior Warrant). |
|
|
Pursuant to the February 28 Agreement, in order to induce the Warrant Holder to immediately
exercise the Prior Warrant, the Company agreed to grant the Warrant Holder a new warrant with an
exercise price of $2.00 per share for the same amount of shares of Common Stock as the Prior
Warrant (the New Warrant) in exchange for the Warrant Holders immediate and full
exercise of the Prior Warrant
whereby the Warrant Holder purchased 2,000,000 shares of Common Stock. The February 28 Agreement
resulted in gross proceeds to the Company of $2.0 million. The New Warrant is exercisable
immediately into an aggregate of 2,000,000 shares of Common Stock and expires on February 28,
2016. Additionally, the February 28 Agreement grants the Warrant Holder certain customary resale
registration rights with respect to the shares Common Stock underlying the New Warrant. |
|
|
On March 4, 2011, the Company entered into a Securities Purchase and Registration Rights
Agreement (the March 4 Agreement) with certain accredited investors (the March 4
Investors), including Jonnie R. Williams, a member of the Companys Board of Directors and
the Companys Chief Executive Officer, to sell 4,856,730 shares of Common Stock (the March
4 Shares), at $1.84 per share and warrants to purchase an aggregate of 4,856,730 shares of
Common Stock at an exercise price of $2.00 per share (the Warrants) (collectively, the
March 4 Offering). In addition to purchasing his respective shares of Common Stock for
$1.84 per share, Mr. Williams also paid the Company $0.125 per Warrant purchased in the March 4
Offering. The March 4 Offering resulted in gross proceeds to the Company of $9.0 million. The
Warrants are first exercisable on September 4, 2011 and expire on September 4, 2016.
Additionally, the March 4 Agreement granted the March 4 Investors certain customary resale
registration rights with respect to the March 4 Shares and shares of Common Stock underlying the
Warrants. Mr. Williams participaton in the March 4 transaction was approved by the Companys
Audit Committee on March 4, 2011. |
F-23
|
|
Employment agreements and performance stock options |
|
|
Following approval by the Board of Directors, upon recommendation of the Compensation
Committee, on March 14, 2011, the Company entered into an executive employment agreement with
Jonnie R. Williams, the Companys Chief Executive Officer, a third amended and restated
executive employment agreement with Paul L. Perito, the Companys President and Chief Operating
Officer, and an amended and restated executive employment agreement with Curtis Wright, IV, MD,
MPH, the Senior Vice President, Medical/Clinical Director of Rock Creek Pharmaceuticals, Inc.,
the companys wholly owned subsidiary. The before mentioned employment agreements are referred to as
the Williams Employment Agreement, Perito Employment Agreement and the Wright Employment
Agreement, respectively. |
The
Williams Employment Agreement
|
|
Under the Williams Employment Agreement, Mr. Williams will be provided an annual base salary
payable in cash in such amounts as approved by the Companys Board of Directors, upon the recommendation
of the Compensation Committee, which initially will be the same base salary of $1,000,000 that
Mr. Williams has been receiving and which will be subject to further adjustment from
time-to-time in the good faith discretion of the Board of Directors. Mr. Williams also will be
eligible to receive discretionary bonuses under the Williams Employment Agreement upon the
Companys achievement of certain performance goals established by the Compensation Committee
and approved by the Board of Directors. The Williams Employment Agreement further provides that
Mr. Williams will be awarded performance based options to purchase 4,900,000 shares of
common stock under the Companys 2008 Incentive Award Plan. These options will vest in such
amounts and upon the achievement of the performance goals set forth on Schedule 2.3 to the
Williams Employment Agreement, provided that such performance goals and vesting schedule is
approved by the Companys stockholders. The options are for a 10-year term from March 14, 2011 and have an exercise price of $2.95 per share.
The estimated maximum value of the options, as determined by the
Black Scholes valuation method, is $12.3 million. The Company
expects that substantially all of this amount would be recorded in the Companys
financial statements for the 2011 fiscal year ending December 31, 2011 with the remainder in
fiscal year 2012. The Williams Employment Agreement is effective immediately and will expire
on December 31, 2012, absent an extension thereof following the non-binding discussions
regarding an extension that are mutually agreed to commence in September 2012 as provided
therein. |
|
|
In addition, the Williams Employment Agreement will entitle Mr. Williams to paid vacation and
other bonuses and benefits in accordance with the Companys plans and arrangements, on the same
basis as
other employees of the Company, as well as reimbursement of general business and travel
expenses. |
|
|
In the event the Mr. Williams employment is terminated without Cause or Mr. Williams resigns
his employment for Good Reason (as such terms are defined in the Williams Employment
Agreement), Mr. Williams will be entitled to all salary, benefits, bonuses and other
compensation that would be due thereunder through the end of the term of thereof had the Company
not terminated Mr. Williams employment or had Mr. Williams not so resigned. |
The
Perito Employment Agreement
|
|
Under the Perito Employment Agreement, Mr. Perito will be provided an annual base salary
payable in cash in such amounts as approved by the Companys Board of Directors, upon the recommendation
of the Compensation Committee, which initially will be the same base salary of $1,000,000 that
Mr. Williams has been receiving and which will be subject to further adjustment from
time-to-time in the good faith discretion of the Board of Directors. Mr. Perito also will be
eligible to receive discretionary bonuses under the Perito Employment Agreement upon the
Companys achievement of certain performance goals established by the Compensation Committee
and approved by the Board of Directors. The Perito Employment Agreement further provides that Mr. Perito will be awarded performance based options to purchase 4,000,000 shares of
common stock under the Companys 2008 Incentive Award Plan. These options will vest in such
amounts and upon the achievement of the performance goals set forth on Schedule 2.3 to the
Perito Employment Agreement, provided that such performance goals and vesting schedule is
approved by the Companys stockholders. The options are for a 10-year term from March 14, 2011 and have an exercise price of $2.95 per share.
The estimated maximum value of the options, as determined by the Black Scholes valuation method,
is $10.0 million. The Company expects that substantially all of this amount would be recorded in the Companys
financial statements for the 2011 fiscal year ending December 31, 2011 with the remainder in
fiscal year 2012. The Perito Employment Agreement is effective immediately and will expire on
December 31, 2012, absent an extension thereof following the non-binding discussions regarding
an extension that are mutually agreed to commence in September 2012 as provided therein. |
|
|
In addition, the Perito Employment Agreement will entitle Mr. Perito to paid vacation and other
bonuses and benefits in accordance with the Companys plans and arrangements, on the same basis
as other employees of the Company, as well as reimbursement of general business and travel
expenses and professional education expenses and fees. |
F-24
|
|
In the event the Mr. Peritos employment is terminated without Cause or Mr. Perito resigns
his employment for Good Reason (as such terms are defined in the Perito Employment
Agreement), Mr. Perito will be entitled to all salary, benefits, bonuses and other compensation
that would be due thereunder through the end of the term of thereof
had the Company not
terminated Mr. Peritos employment or had Mr. Perito not so resigned. |
The
Wright Employment Agreement
|
|
Under the Wright Employment Agreement, Dr. Wright will be provided an annual base salary of
$330,000 payable in cash. The Wright Employment Agreement further provides that Dr. Wright will
be awarded performance based options to purchase 300,000 shares of common stock under the Companys 2008 Incentive Award Plan. These options will vest ratably on an annual basis subject
to the achievement certain performance goals set forth in Section 2(b)(iii) of the Wight
Employment Agreement. The options are for a 10-year term from March 14, 2011 and have an exercise price of $2.95 per share.
The estimated maximum value of the options, as determined by the Black Scholes valuation method, is $0.7 million which will be recorded
in the Companys financial statements during the fiscal period 2011 thru 2013. The Wright
Employment Agreement is effective beginning on March 14, 2011 and will expire on March 14,
2014. The Wright Employment Agreement provides the Company an option to renew the Wright
Employment Agreement for successive 12 month terms by providing Dr. Wright notice of such an
extension at least 30 days prior to the expiration of the then applicable term. Absent such an
extension, following expiration on March 14, 2014, the Wright Employment Agreement will continue on a month-to-month
basis upon mutual agreement of the parties thereto. |
|
|
In addition, the Wright Employment Agreement will entitle Dr. Wright to paid vacation and other
bonuses and benefits in accordance with the Companys plans and arrangements, on the same basis
as other employees of the Company, as well as reimbursement of general business and travel
expenses and professional education expenses and fees. |
|
|
In the event the Dr. Wrights employment is terminated without Cause or Dr. Wright resigns
his employment for Good Reason (as such terms are defined in the Wright Employment
Agreement), Dr. Wright will be entitled to all salary, benefits, bonuses and other compensation
that would be due thereunder through the end of the term of thereof
had the Company not terminated Dr. Wrights employment or had Dr. Wright not so resigned. |
|
|
The foregoing summary is qualified in its entirety by reference to the full text of each of
the Williams Employment Agreement, Perito Employment Agreement and Wright Employment Agreement,
copies of which are attached as Exhibits 10.78, 10.79 and 10.80 respectively, to this Annual Report
on Form 10-K. |
16. |
|
Quarterly results
(unaudited): |
|
|
The following is a summary of quarterly unaudited results of operations for the years ended
December 31, 2010, 2009 and 2008. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ thousands except per share data |
|
March |
|
|
June |
|
|
September |
|
|
December |
|
2010 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues |
|
$ |
149 |
|
|
$ |
335 |
|
|
$ |
211 |
|
|
$ |
153 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit(loss) |
|
|
(322 |
) |
|
|
(414 |
) |
|
|
(197 |
) |
|
|
(364 |
) |
Net loss |
|
|
(4,925 |
) |
|
|
(13,501 |
) |
|
|
(4,823 |
) |
|
|
(4,952 |
) |
EPS net loss basic and diluted |
|
|
(0.04 |
) |
|
|
(0.11 |
) |
|
|
(0.04 |
) |
|
|
(0.04 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March |
|
|
June |
|
|
September |
|
|
December |
|
2009 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues |
|
$ |
148 |
|
|
$ |
238 |
|
|
$ |
232 |
|
|
$ |
90 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit(loss) |
|
|
(292 |
) |
|
|
(589 |
) |
|
|
(400 |
) |
|
|
(639 |
) |
Net loss |
|
|
(5,231 |
) |
|
|
(7,026 |
) |
|
|
(4,902 |
) |
|
|
(5,562 |
) |
EPS net loss basic and diluted |
|
|
(0.06 |
) |
|
|
(0.07 |
) |
|
|
(0.05 |
) |
|
|
(0.05 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March |
|
|
June |
|
|
September |
|
|
December |
|
2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues |
|
$ |
146 |
|
|
$ |
52 |
|
|
$ |
137 |
|
|
$ |
117 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit(loss) |
|
|
(324 |
) |
|
|
(497 |
) |
|
|
(436 |
) |
|
|
(416 |
) |
Net loss |
|
|
(5,517 |
) |
|
|
(6,387 |
) |
|
|
(4,397 |
) |
|
|
(2,036 |
) |
EPS net loss basic and diluted |
|
|
(0.07 |
) |
|
|
(0.07 |
) |
|
|
(0.05 |
) |
|
|
(0.01 |
) |
Per share amounts for each quarter are required to be computed independently and, therefore, may
not equal amounts computed on an annual basis.
F-25
|
|
The Companys operating subsidiaries manufacture, distribute and sell two lines of consumer
products, dissolvable tobacco and dietary supplements. These products constitute the Companys
reportable segments. |
|
|
Star Scientifics chief operating decision maker reviews the income from the operating companies
to evaluate segment performance and allocate resources. The income from the Companys operating
segments excludes general corporate expenses and amortization of intangibles. Interest and other
debt expense, net, and provision for income taxes are centrally managed at the corporate level
and, accordingly, such items are not presented by segment since they are excluded from the
measure of segment profitability reviewed by the Companys chief operating decision maker. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2010 |
|
|
2009 |
|
|
2008 |
|
|
|
$ thousands |
|
Revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
Dissolvable tobacco |
|
$ |
785 |
|
|
$ |
708 |
|
|
$ |
451 |
|
Dietary supplement |
|
|
63 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue |
|
|
848 |
|
|
|
708 |
|
|
|
451 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating losses: |
|
|
|
|
|
|
|
|
|
|
|
|
Dissolvable tobacco |
|
|
(3,401 |
) |
|
|
(6,462 |
) |
|
|
(6,499 |
) |
Dietary supplement |
|
|
(5,928 |
) |
|
|
(2,270 |
) |
|
|
|
|
Depreciation and amortization |
|
|
(311 |
) |
|
|
(315 |
) |
|
|
(602 |
) |
Corporate expenses |
|
|
(18,574 |
) |
|
|
(13,714 |
) |
|
|
(13,778 |
) |
|
|
|
|
|
|
|
|
|
|
Operating losses |
|
|
(28,214 |
) |
|
|
(22,761 |
) |
|
|
(20,879 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
(expense) income-net |
|
|
(311 |
) |
|
|
(237 |
) |
|
|
(342 |
) |
Miscellaneous
(expense) income-net |
|
|
244 |
|
|
|
198 |
|
|
|
657 |
|
Income tax benefit |
|
|
|
|
|
|
|
|
|
|
2,225 |
|
|
|
|
|
|
|
|
|
|
|
Net losses |
|
$ |
(28,281 |
) |
|
$ |
(22,800 |
) |
|
$ |
(18,339 |
) |
|
|
|
|
|
|
|
|
|
|
The following table provides allocation of assets by segment.
|
|
|
|
|
|
|
|
|
|
|
December 31, |
|
|
December 31, |
|
|
|
2010 |
|
|
2009 |
|
|
|
$ thousands |
|
Net assets: |
|
|
|
|
|
|
|
|
Dissolvable tobacco |
|
$ |
2,039 |
|
|
$ |
1,756 |
|
Dietary supplement |
|
|
4,451 |
|
|
|
27 |
|
Corporateincludes $12,693 and $12,314 in cash, respectively |
|
|
13,795 |
|
|
|
13,451 |
|
|
|
|
|
|
|
|
Total net assets |
|
$ |
20,285 |
|
|
$ |
15,234 |
|
|
|
|
|
|
|
|
F-26