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EXCEL - IDEA: XBRL DOCUMENT - ROCK CREEK PHARMACEUTICALS, INC. | Financial_Report.xls |
EX-31.2 - EXHIBIT 31.2 - ROCK CREEK PHARMACEUTICALS, INC. | c23973exv31w2.htm |
EX-32.1 - EXHIBIT 32.1 - ROCK CREEK PHARMACEUTICALS, INC. | c23973exv32w1.htm |
EX-32.2 - EXHIBIT 32.2 - ROCK CREEK PHARMACEUTICALS, INC. | c23973exv32w2.htm |
EX-31.1 - EXHIBIT 31.1 - ROCK CREEK PHARMACEUTICALS, INC. | c23973exv31w1.htm |
Table of Contents
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2011
or
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: 0-15324
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 Rd, 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)
Common Stock, $0.0001 par value
(Title of Class)
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 (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files).
Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer or a smaller reporting company
Large accelerated filer o | Accelerated filer þ | Non-accelerated filer o | Smaller reporting company o | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act). Yes o No þ
As of October 21, 2011, 135,055,505 shares of the registrants common stock, par value $0.0001 per
share, were outstanding.
TABLE OF CONTENTS
2
Table of Contents
CERTAIN DEFINITIONS
Unless the context requires otherwise, all references in this quarterly report on Form 10-Q,
or 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 Part II Item 1A Risk
Factors of this Report and Part I Item 1A Risk Factors of our Annual Report on Form 10-K
for the year ended December 31, 2010, or Annual Report, filed with the Securities and Exchange
Commission, or SEC, on March 16, 2011.
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 Part II
Item 1A Risk Factors of this Report and Part I Item 1A Risk Factors of our Annual
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
Table of Contents
PART IFINANCIAL INFORMATION
Item 1. | Financial Statements |
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
($ in thousands except per share data)
September 30, | December 31, | |||||||
2011 | 2010 | |||||||
(Unaudited) | ||||||||
ASSET |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 10,362 | $ | 13,193 | ||||
Trade accounts receivable, net |
63 | 52 | ||||||
Receivable from sale of licensing rights |
32 | 27 | ||||||
Inventories, net |
2,780 | 3,419 | ||||||
Prepaid expenses and other current assets |
682 | 350 | ||||||
Total current assets |
13,919 | 17,041 | ||||||
Property, plant and equipment, net |
2,404 | 2,169 | ||||||
Intangible assets, net of accumulated amortization |
587 | 627 | ||||||
Receivable from sale of licensing rights, less current maturities |
55 | 80 | ||||||
MSA escrow funds |
368 | 368 | ||||||
Total assets |
$ | 17,333 | $ | 20,285 | ||||
LIABILITIES AND STOCKHOLDERS EQUITY |
||||||||
Current liabilities: |
||||||||
Current maturities of long-term debt |
$ | 2,518 | $ | 2,518 | ||||
Accounts payable, trade |
2,295 | 1,585 | ||||||
Accrued expenses |
669 | 424 | ||||||
Due to stockholders |
50 | 50 | ||||||
Total current liabilities |
5,532 | 4,577 | ||||||
Long-term debt, less current maturities |
3,160 | 5,049 | ||||||
Total liabilities |
8,692 | 9,626 | ||||||
Commitments and contingencies (note 6) |
| | ||||||
Stockholders equity: |
||||||||
Common stock(A) |
14 | 13 | ||||||
Additional paid-in capital |
196,964 | 181,336 | ||||||
Accumulated deficit |
(188,337 | ) | (170,690 | ) | ||||
Total stockholders equity |
8,641 | 10,659 | ||||||
Total liabilities and stockholders equity |
$ | 17,333 | $ | 20,285 | ||||
(A) | $0.0001 par value per share, 187,500,000 shares authorized, 135,055,505 and 127,119,323
shares issued and outstanding as of September 30, 2011 and December 31, 2010, respectively. |
See notes to condensed consolidated financial statements.
4
Table of Contents
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
($ in thousands except per share data)
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
(Unaudited) | ||||||||||||||||
Net sales |
$ | 401 | $ | 211 | $ | 819 | $ | 695 | ||||||||
Less: |
||||||||||||||||
Product cost of goods sold |
1,571 | 422 | 2,544 | 1,635 | ||||||||||||
Federal excise taxes and USDA tobacco buyout
program assessment |
3 | 3 | 8 | 10 | ||||||||||||
Gross loss |
(1,173 | ) | (214 | ) | (1,733 | ) | (950 | ) | ||||||||
Operating expenses: |
||||||||||||||||
Marketing and distribution |
815 | 703 | 2,207 | 1,986 | ||||||||||||
General and administrative |
3,467 | 3,611 | 11,350 | 17,708 | ||||||||||||
Research and development |
1,059 | 210 | 2,186 | 2,371 | ||||||||||||
Total operating expenses |
5,341 | 4,524 | 15,743 | 22,065 | ||||||||||||
Operating loss |
(6,514 | ) | (4,738 | ) | (17,476 | ) | (23,015 | ) | ||||||||
Other income (expense): |
||||||||||||||||
Interest income |
12 | 11 | 41 | 62 | ||||||||||||
Interest expense |
(63 | ) | (96 | ) | (207 | ) | (300 | ) | ||||||||
Miscellaneous income |
| | (5 | ) | 4 | |||||||||||
Net loss before income taxes |
(6,565 | ) | (4,823 | ) | (17,647 | ) | (23,249 | ) | ||||||||
Income tax expense |
| | | | ||||||||||||
Net loss |
$ | (6,565 | ) | $ | (4,823 | ) | $ | (17,647 | ) | $ | (23,249 | ) | ||||
Net loss basic and diluted per common share |
$ | (0.05 | ) | $ | (0.04 | ) | $ | (0.13 | ) | $ | (0.20 | ) | ||||
Weighted average shares outstanding, basic and diluted |
135,055,505 | 119,503,888 | 132,995,471 | 116,416,525 |
See notes to condensed consolidated financial statements.
5
Table of Contents
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2011 (UNAUDITED)
($ in thousands except per share data)
Additional | ||||||||||||||||||||
Common stock | Paid-In | Accumulated | ||||||||||||||||||
Shares | Amount | Capital | Deficit | Total | ||||||||||||||||
Balances, December 31, 2010 |
127,119,323 | $ | 13 | $ | 181,336 | $ | (170,690 | ) | $ | 10,659 | ||||||||||
Stock issuance |
5,111,182 | 1 | 9,999 | | 10,000 | |||||||||||||||
Warrant and option exercise |
2,825,000 | | 3,159 | | 3,159 | |||||||||||||||
Stock-based compensation |
| | 2,470 | | 2,470 | |||||||||||||||
Net Loss |
| | | (17,647 | ) | (17,647 | ) | |||||||||||||
Balances, September 30, 2011 (unaudited) |
135,055,505 | $ | 14 | $ | 196,964 | $ | (188,337 | ) | $ | 8,641 | ||||||||||
See notes to condensed consolidated financial statements.
6
Table of Contents
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
($ in thousands except per share data)
Nine Months Ended September 30, | ||||||||
2011 | 2010 | |||||||
(Unaudited) | (Unaudited) | |||||||
Operating activities: |
||||||||
Net loss |
$ | (17,647 | ) | $ | (23,249 | ) | ||
Adjustments to reconcile net loss to net cash flows from operating activities: |
||||||||
Depreciation and amortization |
275 | 220 | ||||||
Provision for bad debt |
(39 | ) | 44 | |||||
Provision for inventory obsolescence |
676 | 59 | ||||||
Loss (gain) on asset disposal |
5 | | ||||||
Stock-based compensation |
2,470 | 8,724 | ||||||
Increase (decrease) in cash resulting from changes in: |
||||||||
Current assets |
(341 | ) | (3,626 | ) | ||||
Current liabilities |
955 | 208 | ||||||
Net cash flows from operating activities |
(13,646 | ) | (17,620 | ) | ||||
Investing activities: |
||||||||
Purchase of intangible assets |
(10 | ) | (61 | ) | ||||
Purchase of property and equipment |
(465 | ) | (990 | ) | ||||
Proceeds from sale of licensing rights |
20 | 18 | ||||||
Net cash flows from investing activities |
(455 | ) | (1,033 | ) | ||||
Financing activities: |
||||||||
Proceeds from issuance of common stock |
10,000 | 13,832 | ||||||
Proceeds from stock and warrant exercise |
3,159 | | ||||||
Payments on long-term debt and capital lease obligation |
(1,889 | ) | (1,365 | ) | ||||
Net cash flows from financing activities |
11,270 | 12,467 | ||||||
Deposits to MSA escrow |
| (3 | ) | |||||
Increase (decrease) in cash and cash equivalents |
(2,831 | ) | (6,189 | ) | ||||
Cash and cash equivalents, beginning of period |
13,193 | 12,360 | ||||||
Cash and cash equivalents, end of period |
$ | 10,362 | $ | 6,171 | ||||
Supplemental disclosure of cash flow information: |
||||||||
Cash paid during the period for interest |
$ | 65 | $ | 91 | ||||
See notes to condensed consolidated financial statements.
7
Table of Contents
STAR SCIENTIFIC, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED STATEMENTS
1. Basis of Preparation
The accompanying unaudited condensed consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States (GAAP) for
interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for
complete financial statements. In the opinion of management, all adjustments (consisting of
normal recurring accruals) considered necessary for a fair presentation of the results of
operations for the periods presented have been included. Operating results for the three and nine
months ended September 30, 2011 and 2010 are not necessarily indicative of the results that may
be expected for the fiscal year. The balance sheet at December 31, 2010 has been derived from the
audited financial statements at that date, but does not include all of the information and
footnotes required by GAAP for complete financial statements. You should read these consolidated
financial statements together with the historical consolidated financial statements of the
Company for the years ended December 31, 2010, 2009, and 2008 included in the Companys Annual
Report on Form 10-K for the year ended December 31, 2010, filed with the Securities and Exchange
Commission (SEC) on March 16, 2011 (the Annual Report).
2. Significant Accounting Policy
The Company enters into royalty contracts under which royalty payments may be due for product
sales. The contracts require the other party to perform research and development services at a
minimum investment level before royalties are payable. The royalty is a percentage of gross sales
and recorded at the contracted rate, however the royalty is subject to adjustment annually based
on the other party performing research and development services at a required minimum level.
Changes in the estimated royalty to be paid are treated as changes in estimates and are
recognized in the period of change.
3. Liquidity and Capital Resources
The Company has been operating at a loss for the past nine years. The Companys prospects will
depend on its ability to generate and sustain increased revenue levels in future periods, which
will largely be dependent on increased distribution and consumer acceptance of :
| Anatabloc, a
nutraceutical dietary supplement for anti-inflammatory support introduced on August
30, 2011 |
||
| CigRx®,
a non-nicotine, non-tobacco nutraceutical dietary supplement to temporarily decrease the desire
to smoke |
||
| Ariva® and STONEWALL Hard Snuff®, low-TSNA smokeless tobacco products. |
Anatabloc was available for sale only during the last month of the third quarter and the final
two days of August, but during this period revenues exceeded the quarterly revenue for both the
Companys CigRx® product and for its dissolvable tobacco products. CigRx®, Rock Creeks first
dietary supplement product was introduced into the market in August 2010. Rock Creek had no
revenue stream prior to the introduction of CigRx® in 2010. In late February 2011, the Company
began testing CigRx® on a national basis through expanded infomercial airings, radio spots and
selected retail sales. The Companys very-low tobacco specific nitrosamine (TSNA) dissolvable
tobacco products, Ariva® and STONEWALL Hard Snuff®, are manufactured and sold by its other
subsidiary, Star Tobacco. In 2010 the Company filed applications with the Food and Drug
Administration ( FDA), to have variants of its ARIVA® and STONEWALL Hard Snuff® low TSNA
dissolvable products designated by the FDA as modified risk tobacco products under the Family
Smoking Prevention and Tobacco Control Act (FDA Tobacco Act). On March 17, 2011 the FDA issued
a decision holding that it currently does not have jurisdiction over the Ariva-BDL and
Stonewall-BDL products. The Company is now reviewing its manufacturing and marketing
opportunities related to these products.
The Companys future prospects also will be dependent on Rock Creeks ability to develop
additional nutraceutical products and pharmaceutical products and on the Companys ability to
begin generating significant revenues through royalties from the patented tobacco curing process
for which it is the exclusive licensee. Two of those patents have been the subject of prolonged
litigation with R.J. Reynolds Tobacco Company, Inc. (RJR) that began in 2001. A jury trial in
that case took place 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. In a decision issued on August 26, 2011, the
United States Court of Appeals for the Federal Circuit reversed the jury finding as to the patent
defenses of anticipation, obviousness, indefiniteness and failure to
disclose best mode and reconfirmed the validity of the patent claims at issue in the litigation.
At the same time, the Court affirmed the jury finding of noninfringement for the growing years at
issue in the litigation (2001 and 2002). RJR has sought reconsideration of the finding with
respect to definitiveness and its Petition for Rehearing or Rehearing En Banc is currently
pending before the Federal Circuit. 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. Unless the Federal Circuit issues a new decision with respect to its ruling on
definiteness, the Company will be free to pursue its claims against RJR in the new case filed in
2009 as well as to enforce its patents rights against any other persons or entities infringing
the patents that were at issue in the initial RJR litigation.
8
Table of Contents
As of September 30, 2011, the Company had a working capital surplus of approximately $8.4
million, which included cash of approximately $10.4 million. Future anticipated cash needs during
2011 and 2012 include:
| remaining litigation costs in connection with the RJR patent infringement trial and
related appeal of approximately $1.4 million; |
||
| 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. Sales of smokeless tobacco have been stable over the
past several quarters but remain at low levels as the Company, beginning in 2009, restructured
the smokeless tobacco operations to reduce costs while concentrating sales efforts on a more
narrow geographic area and to selected regional and national retail chain customers. A
substantial increase in sales would be required to reach a breakeven level for these products.
Rock Creek had no revenues prior to the introduction of CigRx® in August 2010. The Company
expects that Rock Creek will be deriving increased revenues from the sales of Anatabloc and
CigRx® on a going forward basis as it expands distribution of Anatabloc and CigRx®, but the
Company had only limited revenue from the sale of these products to date.
During the first nine months of 2011, the Company received proceeds of $12.0 million through the
sale of 5,111,182 shares of common stock and new warrants to purchase up to 5,111,182 shares of
common stock as well as the exercise for cash of warrants to purchase 2,000,000 shares of common
stock and the issuance of new warrants to purchase up to 2,000,000 shares of common stock. See
Note 5 to the Companys consolidated financial statements included in this Report for details of
those transactions. During the first nine months of 2011, stock options for 625,000 option shares
were exercised resulting in proceeds of $1.0 million and warrants for 200,000 warrant shares were
exercised resulting in an additional $0.2 million of proceeds. The total proceeds from these
transactions for the first nine months ending September 30, 2011 were $13.2 million. Absent
exercise of additional 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 through the first quarter of 2012, but that it will be necessary to pursue additional
sources of funds during the first quarter of 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, if at all.
The Company had a consolidated loss for the three and nine months ended September 30, 2011 of
approximately $6.6 million and $17.6 million, respectively.
4. Inventories
Inventories consist of the following as of September 30, 2011:
$ thousands | ||||
Raw materials |
$ | 1,632 | ||
Packaging materials |
1,815 | |||
Work in process |
210 | |||
Finished goods |
407 | |||
Obsolescence allowance |
(1,284 | ) | ||
Total |
$ | 2,780 | ||
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5. Long-Term Debt
Long-term debt consists of the following as of September 30, 2011:
$ thousands | ||||
Notes payable to RJR in monthly installments of
principal at $208,000 until fully paid in December 2013 plus
interest at prime plus 1% (4.25% at September 30, 2011) |
$ | 5,645 | ||
Vehicle note payable in monthly installments of $1,700
including interest at 1.9% annually for 36 months ending
April 2013 |
33 | |||
Total long term debt |
5,678 | |||
Less current maturities |
(2,518 | ) | ||
Long term portion of debt |
$ | 3,160 | ||
The future maturities of long-term debt are as follows:
Twelve months ending September 30, | $ thousands | |||
2012 |
$ | 2,518 | ||
2013 |
2,510 | |||
2014 |
650 | |||
Total notes payable and long term debt |
$ | 5,678 | ||
6. Stockholders Equity
Stock Option Plans:
Prior to 2008 the Company adopted a 1998 Stock Option Plan and 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 or greater than the fair market value on the date
of grant in the case of qualified options granted to employees.
On January 31, 2011 the Companys Board of Directors approved option grants to certain officers
and employees for an aggregate of 604,000 shares at an exercise price of $2.00 per share. The
options were fully vested as of the grant date and have a ten-year term. The Company has recorded
an expense for the options of $779 thousand, as calculated using the Black-Scholes option pricing
model which is recognized by accounting principles generally accepted in the United States.
On March 14, 2011, the Company entered into amended and restated executive employment contracts
with Jonnie R. Williams, Sr. the Companys Chief Executive Officer, Paul L. Perito, Esquire, the
Companys President, Chief Operating Officer and Chairman of the Board and Dr. Curtis Wright IV,
Rock Creeks Senior Vice President for Medical/Clinical affairs. The executive employment
agreements with Messrs. Perito and Williams provide for performance-based stock options that will
vest in such amounts and upon the achievement of the performance goals set forth in the
agreements, provided that such stock option grants are approved by the Companys stockholders.
The options are for a ten-year term from March 14, 2011 and have an exercise price of $2.95 per
share. Because the options issued to Messrs. Perito and Williams are subject to stockholder
approval and performance criteria, the Company has not recognized an expense for the options
during the nine months ended September 30, 2011. See the Companys Annual Report filed with the SEC on March
16, 2011 for details of these agreements.
The executive
employment agreement with Dr. Wright provides Dr. Wright
with 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 over a three year period subject to the
achievement of certain performance goals set forth in Dr. Wrights employment agreement. The
options are for a ten-year term from March 14, 2011 and have an exercise price of $2.95 per
share. The options were valued at $751 thousand, as calculated using the Black-Scholes option
pricing model which is recognized by accounting principles generally accepted in the United
States. The option value will be amortized over the vesting period. As of September 30, 2011,
$385 thousand of the option value has been recorded as an expense by the Company.
On March 17, 2011, the Board of Directors elected Richard L. Sharp to the Board as an Independent
Director. Upon his election to the Board, Mr. Sharp was awarded a stock option grant in the
amount of 50,000 option shares. Those options have a strike price of $2.90 per share and
aggregate stock compensation of $123 thousand. As of September 30, 2011, $33 thousand of the option
value has been recorded as an expense by the Company.
10
Table of Contents
During the nine months ended September 30, 2011, 625,000 stock options were exercised resulting
in proceeds to the company of $1.0 million with an intrinsic value of $1.8 million.
At September 30, 2011, there were 8,225,200 options issued and outstanding with a weighted
average exercise price of $2.39 per share.
A summary of the status of the Companys unvested stock options at September 30, 2011, and
changes during the nine months then ended, is presented below.
Weighted | ||||||||
Average | ||||||||
Fair Value at | ||||||||
Nonvested Stock Options (in thousands) | Shares | Grant Date | ||||||
Nonvested at December 31, 2010 |
100,000 | $ | 1.74 | |||||
Granted |
380,000 | 3.03 | ||||||
Vested |
150,000 | 2.65 | ||||||
Forfeited |
| | ||||||
Nonvested at September 30, 2011 |
330,000 | $ | 2.91 | |||||
As of September 30, 2011, there was $632 thousand of unrecognized compensation cost related to
unvested share-based compensation arrangements granted under the Plans, which will be amortized
to expense through September 2014.
The intrinsic value of the exercisable options at September 30, 2011 was $2.2 million.
Warrant activity:
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, at an exercise price of $1.00 per share (the Prior Warrants). Pursuant to
the February 28 Agreement, the Warrant Holder exercised on the Prior Warrants and the Company
granted the Warrant Holder new warrants with an exercise price of $2.00 per share for the same
amount of shares of common stock as the Prior Warrants (the New Warrants). The February 28
Agreement resulted in gross proceeds to the Company of $2.0 million. The New Warrants are
exercisable immediately into an aggregate of 2,000,000 shares of common stock and expire on
February 28, 2016.
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),
to sell 4,856,730 shares of common stock (the March 4 Shares) 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). The March 4 Offering resulted in gross
proceeds to the Company of $9.0 million. The Warrants were first exercisable on September 4, 2011
and expire on September 4, 2016.
On March 30, 2011, the Company entered into a Securities Purchase and Registration Rights
Agreement (the March 30 Agreement) with an accredited investor (the March 30 Investor), to
sell 254,452 shares of common stock (the March 30 Shares), and warrants to purchase an
aggregate of 254,452 shares of common stock at an exercise price of $4.00 per share (the
Warrants) (collectively, the March 30 Offering). The March 30 Offering resulted in gross
proceeds to the Company of $1.0 million. The Warrants were first exercisable on September 30, 2011
and expire on September 30, 2016.
On June 4, 2011, 200,000 warrants were exercised resulting in proceeds to the Company of $0.2
million.
As of September 30, 2011 the Company had 35,951,707 warrants outstanding with a weighted average
exercise price of $1.77 per share. The intrinsic value of exercisable warrants was $20.5 million
on September 30, 2011
Net Loss Basic and Diluted Per Common Share:
Due to the Companys net losses, both basic and diluted loss per share were $(0.13) and $(0.20)
for the nine months ended September 30, 2011 and 2010, respectively. An aggregate of 44,176,907
at September 30, 2011 and 31,930,816 at September 30,
2010 of stock options and warrants outstanding were excluded from this computation because they
would have had an anti-dilutive effect.
11
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7. Commitments, Contingencies and Other Matters
RJR Litigation:
In 2001, the Company filed a complaint against R.J. Reynolds Tobacco Company, Inc. (RJR) in the
United States District Court for the District of Maryland for infringement of two of the
Companys patents relating to the curing of tobacco to substantially prevent the formation of
tobacco specific nitrosamines. In that litigation a jury trial took place 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. In a decision issued on August 26, 2011, the United States Court of Appeals for the
Federal Circuit reversed the jury finding as to the patent defenses of anticipation, obviousness,
indefiniteness and failure to disclose best mode and reconfirmed the validity of the patent
claims at issue in the litigation. At the same time, the Court affirmed the jury finding of
non-infringement for the growing years at issue in the litigation (2001 and 2002). RJR has
sought reconsideration of the decision with respect to definitiveness and its Petition for
Rehearing or Rehearing En Banc is currently pending before the Federal Circuit.
Virginia Sales and Use Tax Assessment:
On July 14, 2011 the Company filed a complaint in the Circuit Court for Mecklenburg County,
Virginia seeking a determination that the purchase of the Companys curing barns was exempt from
Virginia sales and use tax and an abatement of all taxes and interest assessed against the
Company by Virginias Commissioner of Revenue. The Commonwealth of Virginia filed an answer to
the complaint on July 29, 2011 asserting that the assessment
amount was properly determined.
Employment Contracts:
The Company entered into amended and restated executive employment agreements on March 14, 2011,
with Jonnie R. Williams, Sr., the Companys Chief Executive Officer, Paul L. Perito, Esquire, the
Companys President, Chief Operating Officer and Chairman of the Board and Dr. Curtis Wright, IV,
Rock Creeks Senior Vice President for Medical/Clinical affairs. Additional information relating
to these executive employment agreements can be found in Item 9B, Other Information, of the
Companys Annual Report filed with the SEC on March 16, 2011.
Commitments:
The Company has commitments totaling $406 thousand as of September 30, 2011 for normal operating
expenses.
8. Related Party Transaction
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 warrants 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 4, 2011.
9. Segment Information
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.
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Nine months ended September 30 | ||||||||
2011 | 2010 | |||||||
$ thousands | ||||||||
Revenues: |
||||||||
Dissolvable tobacco |
$ | 354 | $ | 667 | ||||
Dietary supplement |
465 | 28 | ||||||
Total revenue |
819 | 695 | ||||||
Operating losses: |
||||||||
Dissolvable tobacco |
(2,234 | ) | (2,634 | ) | ||||
Dietary supplement |
(5,221 | ) | (4,383 | ) | ||||
Depreciation and amortization |
(275 | ) | (221 | ) | ||||
Corporate expenses |
(9,746 | ) | (15,777 | ) | ||||
Operating losses |
(17,476 | ) | (23,015 | ) | ||||
Interest (expense) income-net |
(166 | ) | (238 | ) | ||||
Miscellaneous (expense) income-net |
(5 | ) | 4 | |||||
Income tax benefit |
| | ||||||
Net losses |
$ | (17,647 | ) | $ | (23,249 | ) | ||
The following table provides allocation of assets by segment.
September 30, | December 31, | |||||||
2011 | 2010 | |||||||
$ thousands | ||||||||
Net assets: |
||||||||
Dissolvable tobacco |
1,613 | 2,039 | ||||||
Dietary supplement |
4,219 | 4,451 | ||||||
Corporateincludes $10,252 and $13,193 in cash, respectively |
11,501 | 13,795 | ||||||
Total net assets |
17,333 | 20,285 | ||||||
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Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations |
In preparing the discussion and analysis contained in this Item 2, we presume that persons
reviewing this Item have read or have access to the discussion and analysis contained in our Annual
Report, filed with the SEC on March 16, 2011. In addition, persons reviewing this Report should
read the discussion and analysis of our financial condition and results of operations in
conjunction with our consolidated financial statements and related notes included elsewhere in this
Report. The following results of operations include a discussion of the three and nine months ended
September 30, 2011 as compared to the three and nine months ended September 30, 2010.
Overview
We are a technology-oriented company with a mission to reduce the harm associated with the use
of tobacco at every level and, more generally, to promote a healthy
metabolism through dietary supplements and, potentially,
pharmaceutical products. 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 Family
Smoking Prevention and Tobacco Control Act (FDA Tobacco Act), including ARIVA® compressed
powdered tobacco cigalett® pieces, STONEWALL Hard Snuff® and modified risk tobacco
products; |
||
| the manufacture, sale,
marketing and development of non-nicotine nutraceutical dietary
supplements designed to assist individuals who are seeking a smoking alternative as well as related
nutraceutical dietary supplements that are designed to promote the maintenance of a healthy metabolism;
and |
||
| 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. |
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 led 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 tobacco products
under both the provisions of the FDA Tobacco Act and as tobacco products over which the FDA has
not asserted jurisdiction 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, as well as to develop related products that are designed to promote the maintenance of a
healthy metabolism.
We currently are focusing our efforts on the manufacture and sale of:
| Anatabloc, a
nutraceutical dietary supplement for anti-inflammatory support introduced on August
30, 2011; |
||
| CigRx®,
a non-nicotine, non-tobacco nutraceutical dietary supplement designed to temporarily reduce
the desire to smoke; and |
||
| ARIVA® and STONEWALL Hard Snuff®, our dissolvable low-TSNA smokeless tobacco
products. |
Anatabloc and CigRx® are manufactured and sold through our Rock Creek subsidiary. Anatabloc
became available for sale beginning August 30, 2011 and,
accordingly, our results of operations for
the three and nine month periods ended September 30, 2011 reflect sales of Anatabloc for
approximately a one-month period. CigRx®, Rock Creeks first dietary supplement product, was
introduced into the market in August 2010. 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 Monoamine oxidase (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 are designed to promote the maintenance of a healthy
metabolism. Currently Rock Creek is
working with the Roskamp Institute in connection with a multi-site clinical trial of Rock
Creeks RCP-006 compound to examine the effect of RCP-006 on chronic inflammation in individuals
who have elevated blood levels of C-reactive protein (CRP). That study began in mid-May 2011 and
is ongoing at several sites. Rock Creek also is conducting an in-house study of approximately 100
smokers to determine the potential for Anatabloc to lower CRP levels and curb the urge to smoke
and is in the process of coordinating a study that will be conducted by the University of Pisa to
determine the effect of RCP-006 on Hashimoto Autoimmune Thyroiditis.
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Our very-low TSNA dissolvable tobacco products, Ariva® and STONEWALL Hard Snuff®, are
manufactured and sold by our other subsidiary, Star Tobacco. Our significant experience with the
proprietary technology related to the development of tobacco products with reduced levels of toxins
has positioned us to seek approval to market variants of our very-low TSNA smokeless tobacco
products as modified risk tobacco products. In 2010 we filed applications with the FDA to have a
version of our low-TSNA products (Ariva-BDL and Stonewall-BDL) designated by the FDA as modified
risk tobacco products and we filed a similar application for a Stonewall Moist-BDL, a traditional
moist snuff product, on February 1, 2011. On March 17, 2011, the FDA issued a decision holding that
it currently does not have jurisdiction over the Ariva-BDL and Stonewall-BDL products. The
decision by the FDA clears the way for us to proceed with marketing of the Ariva-BDL and
Stonewall-BDL products without the regulatory restrictions applicable to tobacco products over
which the FDA has asserted jurisdiction and we are considering the manufacturing and marketing
opportunities related to these products.
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, the technology behind our StarCured® tobacco curing process and the development efforts of Rock
Creek, particularly with respect to our Anatabloc and CigRx® dietary supplements and related
nutraceuticals. Our future results will largely depend on the success 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 our very-low TSNA smokeless tobacco
products, develop pharmaceutical products to treat tobacco addiction and a range of neurological
conditions, develop related non-nicotine nutraceutical products, and to pursue licensing
arrangements for those products and related technology. Our success in promoting the sale of our
low-TSNA dissolvable smokeless tobacco products and dietary supplements, as well as our ability to
continue the research efforts by Rock Creek, will in large part depend on our working capital
constraints and ability to procure funding for these initiatives.
Prospects for Our Operations
The recurring losses generated by our business continue to impose significant demands on our
liquidity. Product licensing royalties and sales of our low-TSNA smokeless tobacco products and
dietary supplements have been de minimis to date. We introduced Anatabloc, a dietary supplement
for anti-inflammatory support, on August 30, 2011. While Anatabloc was only available for
approximately one-month during the three month period ended September 30, 2011, sales during that
period exceeded the quarterly revenue for both our CigRx® and our dissolvable tobacco products. We
introduced CigRx® into test market in August 2010 as a non-nicotine, non-tobacco nutraceutical
product that temporarily reduces the desire to smoke. In late February 2011, we began testing
CigRx® on a national basis through expanded infomercial airings, radio spots and selected retail
sales. CigRx® sales responded favorably to these national tests and to our increased retail
presence in the New England and mountain west states through arrangements with distributors who
have an active presence in these geographic areas. Sales of our dietary supplement products
increased in October 2011 by approximately thirty-five percent over
September 2011 sales, primarily as a
result of increases in sales of Anatabloc as we continued our introduction of Anatabloc into the market. While Rock Creek also is pursuing the
development of 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, in addition to the manufacture and sale of Anatabloc and
CigRx®, Rock Creek will focus in the near term on the development and market introduction 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 also will be dependent on the distribution and consumer acceptance of our
low-TSNA dissolvable smokeless tobacco products Ariva® and STONEWALL Hard Snuff®. In addition, we
intend to continue to explore the development of new low-TSNA smokeless tobacco products, such as
modified risk tobacco products and dietary supplements and pharmaceutical products, 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.
15
Table of Contents
We generated revenue of approximately $0.8 million for the nine months ended September 30,
2011, and an operating loss from continuing operations of approximately $17.5 million. The
recurring losses generated by operations continue to impose significant demands on our companys
liquidity. As of September 30, 2011, we had approximately $8.4 million of working capital, with
approximately $10.4 million of our current assets in cash and cash equivalents. Between
January 1, 2011 and June 30, 2011, our company received proceeds of approximately $13.2 million
through the sale of common stock and the exercise of stock options and warrants. See Note 6 to our
Consolidated Financial Statements included in this Report. 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 our common stock, we may decide to seek
additional funds before that date.
Smokeless Tobacco. Net sales were $0.4 million in the nine months ended September 30, 2011,
compared to $0.7 million in the nine months ended September 30, 2010. In 2010 we introduced new
blends of Ariva® into the market in the first half of the year, which accounted, in part, for the
higher sales levels in 2010. Currently, 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 2010 we filed applications with the FDA to have these products designated by the FDA
as modified risk tobacco products. We also filed an application for a Stonewall Moist-BDL
product on February 1, 2011. On March 17, 2011, the FDA issued a decision holding that it currently
does not have jurisdiction over the Ariva-BDL and Stonewall-BDL products. The decision by the FDA
clears the way for us to proceed with marketing of the Ariva-BDL and Stonewall-BDL products and
we are now considering the manufacturing and marketing opportunities related to these products. At
the same time, the FDA has announced that it will issue new proposed regulations relating to its
authority over other products that meet the definition of tobacco products under the FDA Tobacco
Act, which could further impact the status of Ariva-BDL and Stonewall-BDL. In August 2011 we
voluntarily withdrew our application for our Stonewall Moist-BDL product in order to allow us to
meet with FDA to address questions relating to additional testing that FDA indicated would be
required for FDA to consider this application. Depending on the outcome of those anticipated
meetings, we may seek to refile our Moist Snuff-BDL application with the FDA.
Dietary Supplements and Development of Tobacco-based Pharmaceutical
Products. On August 30,
2011 Rock Creek launched Anatabloc its second dietary supplement. Anatabloc, which is intended
to provide anti-inflammatory support, is currently being sold through an interactive website and
call center. Marketing of Anatabloc has been primarily directed toward physician and other
healthcare professionals. In 2009, Rock Creek developed a non-nicotine, non-tobacco nutraceutical,
CigRx®, that is intended to temporarily reduce the desire to smoke. CigRx® was introduced in August
2010 in the Richmond, Virginia area. We had 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. At the
present time, the Company has decided to focus its outreach to physicians and healthcare
professionals through in-house resources as opposed to continuing its relationship with InVentiv
Health. In late February 2011, we began testing CigRx® on a national basis through expanded
infomercial airings, radio spots and selected retail sales and we have significantly increased our
retail presence in the New England and mountain west states through arrangements with distributors
who have an active presence in these geographic areas. Product sales of CigRx® responded
favorably to these efforts. 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 for the treatment of tobacco
dependence, and a range of neurological conditions, including Alzheimers disease, Parkinsons
disease, schizophrenia and depression.
Licensing and Intellectual Property. We have an exclusive, worldwide license from Regent Court
Technologies LLC (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 Part II-Item 1 Legal Proceedings for further details. 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 had several provisional patent applications pending
that were merged into a utility application filed on September 19, 2011 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. During the second quarter of 2011, Rock Creek was issued a design patent for
the CigRx® container by the United States Patent and Trademark Office. This was the first patent
issued to Rock Creek.
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Table of Contents
We continue to pursue means of collecting royalties for our curing technology through
licensing arrangements and through our ongoing patent litigation with
RJR. See Part II-Item 1 Legal
Proceedings for further details of the status of this litigation 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. 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. Under the FDA Tobacco Act, the Center for Tobacco Products within the FDA has broad
authority over the manufacturing, sale and distribution of cigarettes and smokeless 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. On March 17, 2011, the FDA issued a decision holding that it currently does not have
authority to regulate our Ariva-BDL and Stonewall-BDL products since they do not fall within one
of the categories of tobacco products over which the FDA has assumed jurisdiction. The FDA also has
announced that it intends to issue a proposed regulation relating to its authority over products
other than cigarettes, smokeless tobacco and snuff that meet the definition of tobacco products
under the FDA Tobacco Act. On July 21 and 22, 2011, we made presentations to the Tobacco Products
Scientific Advisory Committee (TPSAC) on the issue of dissolvable tobacco. Under the FDA Tobacco
Act, the TPSAC is required to consider and issue a report to the FDA on the status of dissolvable
tobacco products by March 2012. 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.
Federal Regulations of Dietary Supplements and Drug Products. 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 FDA approval process involves, among
other things, successfully completing clinical trials under an Investigational New Drug Application
and obtaining a premarket approval after filing a New Drug Application, (NDA). The NDA process
requires a company to prove the safety and efficacy of a new drug product to the FDAs
satisfaction. 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. DSHEA does not
require prior approval by the FDA for the introduction of dietary supplements into the market, but
does require that such products comply with the requirements of DSHEA prior to and after
their introduction into commerce. See Item 1. Business Government Regulation of our Annual
Report filed with the SEC on March 16, 2011 for more information relating to governmental
regulation of tobacco products, nutraceuticals and drug products.
Off-Balance Sheet Arrangements
None.
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.
17
Table of Contents
Results of Operations
Our companys unaudited condensed consolidated results for the three and nine month periods
ended September 30, 2011 and 2010 are summarized in the following table:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
$ and shares in thousands except per share data | 2011 | 2010 | 2011 | 2010 | ||||||||||||
(Unaudited) | ||||||||||||||||
Net sales |
$ | 401 | $ | 211 | $ | 819 | $ | 695 | ||||||||
Cost of goods sold |
1,571 | 422 | 2,544 | 1,635 | ||||||||||||
Federal excise tax and Department of Agriculture
payment |
3 | 3 | 8 | 10 | ||||||||||||
Gross loss |
(1,173 | ) | (214 | ) | (1,733 | ) | (950 | ) | ||||||||
Total operating expenses |
5,341 | 4,524 | 15,743 | 22,065 | ||||||||||||
Operating loss |
(6,514 | ) | (4,738 | ) | (17,476 | ) | (23,015 | ) | ||||||||
Net loss |
$ | (6,565 | ) | $ | (4,823 | ) | $ | (17,647 | ) | $ | (23,249 | ) | ||||
Basic and diluted net loss per common share |
$ | (0.05 | ) | $ | (0.04 | ) | $ | (0.13 | ) | $ | (0.20 | ) | ||||
Basic and diluted weighted average shares outstanding |
135,055,505 | 119,503,888 | 132,995,471 | 116,416,525 |
Three Months Ended September 30, 2011 Compared to Three Months Ended September 30, 2010
Net Sales. For the three months ended September 30, 2011, net sales (gross sales less cash
discounts, product discounts and product return allowance) were $0.4 million compared to $0.2
million during same period in 2010. Sales of our CigRx® and Anatabloc dietary supplements
contributed $0.3 million of our net sales during the three months ended September 30, 2011 compared
to $28 thousand for the same period in 2010. During the three months ended September 30, 2010,
CigRx® was on the market for only a portion of the period and Anatabloc was not on the market,
which accounted for the lower sales volume during that period as compared to the three months ended
September 30, 2011. During the three months ended September 30, 2011, our dissolvable tobacco
revenue decreased $0.1 million from the same period in 2010 during which period we continued the
introduction of the new blends of
Ariva®
into the market, which introduction began in the three month period
ending March 31, 2010. Sales of smokeless tobacco have been stable over the past several quarters
but remain at low levels as we continue to focus our sales efforts on a more narrow geographic area
and to selected regional and national retail chain customers.
Gross Profit (Loss). Gross loss increased $1.0 million in the three months ended September 30,
2011 to $1.2 million from $0.2 million for the same period in 2010. The increased loss was primarily
attributed to an overstock inventory reserve for CigRx® packaging materials and raw materials of
$0.9 million.
Total Operating Expenses. Total operating expenses were approximately $5.3 million for the
three months ended September 30, 2011, an increase of approximately $0.8 million, or 18.2%, from
approximately $4.5 million for the same period in 2010. General and administrative expenses
decreased by approximately $0.1 million and marketing and distribution costs increased by
approximately $0.1 million. Research and development costs increased approximately $0.8 million.
Marketing and Distribution Expenses. Marketing and distribution expenses were approximately
$0.8 million for the three months ended September 30, 2011, an increase of approximately $0.1
million, or 17.4%, from approximately $0.7 million for the same period in 2010. Our dissolvable
tobacco marketing expense decreased approximately $0.1 million during the three months ended
September 30, 2011 consistent with our business decision to concentrate sales efforts to a more
narrow geographic area and to selected regional and national retail chain customers. During the
three months ended September 30, 2011, marketing costs for our CigRx® and Anatabloc dietary
supplement products increased $0.2 million related primarily to costs associated with the
introduction of Anatabloc. During the three months ended September 30, 2010, we had pre-launch
and post-launch marketing costs of $0.4 million associated with the introduction of CigRx®.
General and Administrative Expenses. General and administrative expenses were approximately
$3.5 million for the three months ended September 30, 2011, a decrease of approximately $0.1
million, or 3.8%, from approximately $3.6 million for the same
period in 2010. The net decrease primarily reflected an increase in stock based compensation costs of $0.5 million (non-cash
charges), offset by decreased consulting expenses of $0.4 million
and reduced executive travel expenses of $0.2 million.
Research and Development Expenses. Research and development expenses were approximately $1.0
million in the three months ended September 30, 2011 compared to approximately $0.2 million in the
same period in 2010. Our research and development expenses in the three months ended September 30,
2011 related primarily to the ongoing initiatives surrounding our RCP-006 compound. In the same
period in 2010, we had limited research and development expenses as we had completed the majority
of our initial research and development work for our CigRx® dietary supplement product prior to
that period.
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Interest Income and Expense. We had interest income of $12 thousand and interest expense of
$63 thousand for the three months ended September 30, 2011, for a net interest expense of $51
thousand during the period. For the same period in 2010, we had interest income of $11 thousand and
interest expense of $96 thousand, for a net interest expense of $85 thousand. The lower interest
expense for the three months ended September 30, 2011 reflected the lower balance on our
outstanding debt. The lower interest income during the three months September 30, 2011 reflected
the decrease in the prevailing rate of interest on our account balances.
Net Loss. We had a net loss of approximately $6.6 million for the three months ended September
30, 2011 compared to a net loss of approximately $4.8 million for the same period in 2010. The
increased net loss for the three months ended September 30, 2011 primarily reflected increased
costs in 2011 for our CigRx® packaging and raw material overstock reserve and research and
development costs related to our RCP-006 compound.
At September 30, 2011, we had a basic and diluted loss per share of $(0.05) compared to a
basic and diluted loss per share of $(0.04) at September 30, 2010.
Nine Months Ended September 30, 2011 Compared to Nine Months Ended September 30, 2010
Net Sales. For the nine months ended September 30, 2011, net sales (gross sales less cash
discounts, product discounts and product return allowance) were approximately $0.8 million compared
to approximately $0.7 million during the same period in 2010. Our CigRx® and Anatabloc dietary
supplements contributed $0.5 million to the net sales figure during the first nine months of 2011
compared to $28 thousand in the comparable period in 2010. Anatabloc, which was introduced on
August 30, 2011, had no sales in the comparable prior year period. CigRx®, which was introduced in
August 2010 had limited sales in the third quarter of 2010. We introduced new blends of Ariva®
into the market during the first half of 2010 and there were increased sales during that period as
a result of the new product introduction. Sales of smokeless tobacco have been stable over the past
several quarters, but remain at low levels as we continue to focus our sales efforts on a more
narrow geographic area and to selected regional and national retail chain customers.
Gross Profit (Loss). Gross loss increased by $0.8 million during the nine months ended
September 30, 2011 to $1.7 million from $0.9 million for the same period in 2010. This change was
attributable primarily to an overstock inventory reserve for CigRx® packaging materials and raw
materials of $0.9 million.
Total Operating Expenses. Total operating expenses were approximately $15.8 million for the
nine months ended September 30, 2011, a decrease of approximately $6.3 million, or 28.6%, from
approximately $22.1 million for the same period in 2010. General and administrative expenses
decreased by approximately $6.3 million and marketing and distribution costs increased by
approximately $0.2 million. Research and development costs decreased approximately $0.2 million.
Marketing and Distribution Expenses. Marketing and distribution expenses were approximately
$2.2 million for the nine months ended September 30, 2011, an increase of approximately $0.2
million, or 11.7%, from approximately $2.0 million for the same period in 2010. During the first
nine months of 2011, there was a reduction of $0.4 million in connection with the product promotion
of our dissolvable tobacco products consistent with our efforts to concentrate our dissolvable
tobacco sales efforts to a more narrow geographic area and to selected regional and national retail
chain customers. That decrease was offset by increased marketing costs of $0.6 million related to
the expanded distribution and promotion of CigRx® that began in late February 2011 and to a lesser
degree the introduction of Anatabloc on August 30, 2011.
General and Administrative Expenses. General and administrative expenses were approximately
$11.4 million for the nine months ended September 30, 2011, a decrease of approximately $6.3
million, or 35.7%, from approximately $17.7 million for the same period in 2010. The decrease
primarily reflected reduced cost related to the issuance of stock options. During the nine months
ended September 30, 2011, we had a non-cash charge of $2.5 million for stock based compensation
compared to a charge of $8.5 million during the same period in 2010. This resulted in a net
decrease of $6.0 million in general and administrative expenses for the first nine months of 2011.
Consulting expenses decreased $0.4 million in the current period primarily due to the fact that the
initial commercial production of Rock Creeks RCP-006 as a nutraceutical was completed during 2010.
Legal expense decreased $0.8 million in the current period primarily related to decreased expenses
related to the RJR appealate case. However, this amount was partially offset by increased cost of
$0.6 million for patent prosecution work relating to our RCP-006 compound and Anatabloc product,
and for related legal costs associated with the introduction of Anatabloc, resulting in a
reduction in net legal expenses of $0.2 million. Executive travel increased $0.2 million related to
CigRx® product promotions and Anatabloc product development and launch activities.
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Research and Development Expenses. During the nine months ended September 30, 2011, we
expended approximately $2.2 million in connection with the refinement of our product formulation
for
CigRx®, Anatabloc product development, ongoing research directed to the effects of our
RCP-006 compound on chronic inflammation in individuals who have elevated blood levels of CRP and
for other uses of RCP-006. During the nine months ended September 30, 2010, Rock Creek incurred
approximately $2.4 million primarily in connection with the initial product development and
premarket testing of the dietary ingredients in CigRx®. Given our working capital constraints, our
ability to continue the research efforts of Star Scientific and to advance the research and
development activities of Rock Creek will depend on our ability to obtain funding for these
initiatives through improved revenues from our smokeless tobacco sales and sales of our dietary
supplements or from other funding sources.
Interest Income and Expense. We had interest income of $41 thousand and interest expense of
$207 thousand for the nine months ended September 30, 2011, for a net interest expense of $166
thousand during the period. For the same period in 2010, we had interest income of $62 thousand and
interest expense of $300 thousand, for a net interest expense of $238 thousand. The lower interest
expense for the nine months ended September 30, 2011 reflected lower outstanding balance on our
long-term debt. The lower interest income during the nine months ended September 30, 2011 was
primarily due to a decrease in prevailing interest rates.
Income Tax Expense. During the nine months ended September 30, 2011, we had no income tax
obligation due to our net operating losses.
Net Loss. We had a net loss of approximately $17.6 million for the nine months ended September
30, 2011 compared to a net loss of approximately $23.2 million for the same period in 2010. The
lower net loss in 2011 was attributable primarily to decreased charges for stock based compensation
awards to officers, employees, directors and consultants in 2010 of $8.5 million compared to a
charge of $2.5 million for the comparable period in 2011. Also, we had decreased expenses
associated with research and development of $0.2 million, offset by increased marketing expenses
largely due to CigRx® promotion and advertising of $0.2 million. We also had a $0.9 million reserve
for overstock CigRx® packaging and raw material inventory in 2011 and no comparable charge in 2010.
For the nine months ended September 30, 2011, we had a basic and diluted loss per share of
$(0.12) compared to a basic and diluted loss per share of $(0.20) for the nine months ended
September 30, 2010.
Liquidity and Capital Resources
We have been operating at a loss for the past nine years. Our future prospects will depend on
our ability to generate and sustain increased revenue levels in future periods, which will largely
be dependent on increased distribution and consumer acceptance of :
| Anatabloc, a
nutraceutical dietary supplement for anti-inflammatory support introduced on August
30, 2011; |
||
| CigRx®,
a non-nicotine, non-tobacco nutraceutical dietary supplement to temporarily decrease the desire
to smoke; and |
||
| Ariva® and STONEWALL Hard Snuff®, low-TSNA smokeless tobacco products. |
While Anatabloc was only available for approximately one-month during the three month period
ended September 30, 2011, sales during that period exceeded the quarterly revenue for both our
CigRx®
and our dissolvable tobacco products. CigRx®, Rock Creeks first dietary supplement product,
was introduced into the market in August 2010. Rock Creek had no revenue stream prior to the
introduction of CigRx® in 2010. In late February 2011, we began testing CigRx® on a national basis
through expanded infomercial airings, radio spots and selected retail sales. Our very-low TSNA
dissolvable tobacco products, Ariva® and STONEWALL Hard Snuff®, are manufactured and sold by our
other subsidiary, Star Tobacco. In 2010 we filed applications with the FDA, to have variants of
its ARIVA® and STONEWALL Hard Snuff® low TSNA dissolvable products designated by the FDA as
modified risk tobacco products under the FDA Tobacco Act. On March 17, 2011 the FDA issued
a decision holding that it currently does not have jurisdiction over our Ariva-BDL and
Stonewall-BDL products. We are now reviewing the manufacturing and marketing opportunities related
to these products.
Our future prospects also will be dependent on Rock Creeks ability to develop additional
nutraceutical products and pharmaceutical products and on our ability to begin generating
significant revenues through royalties from the patented tobacco curing process for which we are
the exclusive licensee. Two of those patents have been the subject of prolonged litigation with
RJR that began in 2001. A jury trial in that case took place 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. In a
decision issued on August 26, 2011, the United States Court of Appeals for the Federal Circuit
reversed the jury finding as to the patent defenses of anticipation, obviousness, indefiniteness
and failure to disclose best mode and reconfirmed the validity of the patent claims at issue in
the litigation. At the same time the Court affirmed the jury finding of noninfringement for the
growing years at issue in the litigation (2001 and 2002). RJR has sought reconsideration of the
finding with respect to definitiveness and its Petition for Rehearing or Rehearing En Banc is
currently pending before the Federal Circuit. On May 29, 2009 our 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. That new case has been stayed pending the outcome of the appeal to the
Federal Circuit. Unless the Federal Circuit issues a new decision with respect to its ruling on
definiteness, we will be free to pursue our claims against RJR in the new case filed in 2009 as
well as to enforce our patents rights against any other persons or entities infringing the patents
that were at issue in the initial RJR litigation.
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As of September 30, 2011, we had a working capital surplus of approximately $8.4 million,
which included cash of approximately $10.4 million. Future anticipated cash needs during 2011 and
2012 include:
| Remaining 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. Sales of smokeless tobacco have been stable over the past
several quarters but remain at low levels. Beginning in 2009 we restructured our smokeless tobacco
operations to reduce costs while concentrating sales efforts on a more narrow geographic area and
to selected regional and national retail chain customers. Substantially increased sales would 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 increased
revenues from the sales of CigRx® and Anatabloc on a going-forward basis as it expands
distribution of Anatabloc and CigRx®, but we have had only limited revenue from the sale of these
products to date.
During the first three months of 2011, our company received proceeds of $12.0 million through
the sale of 5,111,182 shares of common stock and new warrants to purchase up to 5,111,182 shares of
common stock as well as the exercise for cash of warrants to purchase 2,000,000 shares of common
stock and the issuance of new warrants to purchase up to 2,000,000 shares of common stock. See Note
6 to our Consolidated Financial Statements included in this Report for details of those
transactions. During the first six months of 2011, 625,000 stock options for option shares were
exercised resulting in proceeds of $1.0 million and warrants for 200,000 warrant shares were
exercised resulting in an additional $0.2 million of proceeds. The total proceeds from these
transactions during the six months ended June 30, 2011 was $13.2 million. Absent exercise of
additional outstanding warrants and options for cash or a substantial improvement in revenues
and/or royalties, we believe that we will have sufficient funding to support our operations through
the first quarter of 2012, but that it will be necessary to pursue additional sources of funds
during the first quarter of 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 continuing the work of
Rock Creek in developing other nutraceutical products and pharmaceuticals. 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 Brown & Williamson Tobacco Corporation
(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.
Summary of Balances and Recent Sources and Uses
As of September 30, 2011, we had a working capital surplus of approximately $8.4 million,
which included cash of approximately $10.4 million.
Net Cash From Operating Activities. During the nine months ended September 30, 2011,
approximately $13.6 million of cash was used in operating activities compared to approximately
$17.6 million of cash used in operating activities during the same period in 2010. Cash used in
operations was approximately $4.0 million lower during the nine months ended September 30, 2011 as
compared
to the same period in 2010. The increased cash usage for the first
nine months of 2010 related
primarily to the purchase of inventory for the initial startup of CigRx® manufacturing and related
research and development expenditures for CigRx®.
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Net Cash From Investing Activities. During the nine months ended September 30, 2011, a total
of $0.5 million of cash was used for investing activities, primarily for equipment purchases
related to the manufacturing of our CigRx® and Anatabloc dietary supplements. During the same
period in 2010, we used $1.0 million of cash for investing activities related primarily to
equipment purchases for the production of CigRx®, which was introduced in August 2010.
Net Cash From Financing Activities. During the nine months ended September 30, 2011, we
generated net cash from financing activities of approximately $11.3 million, primarily through the
sale of common stock, stock options and warrant exercises for gross proceeds of approximately
$13.2 million. During the same period in 2010, we generated net cash from financing activities of
approximately $12.5 million, primarily through the sale of common stock for gross proceeds of
approximately $13.8 million. During the nine month periods ended September 30, 2011 and 2010, we
repaid debt in the amounts of $1.9 million and $1.3 million, respectively.
Net Cash Used in MSA Escrow Payments. Given the fact that we discontinued the sale of
cigarettes in June 2007, we did not make any deposits into escrow during the nine months ended
September 30, 2011 and 2010 for the sale of cigarettes in the MSA states and we do not expect to
have any material MSA obligations in the future.
Cash Demands on Operations
During the nine months ended September 30, 2011, we had losses from continuing operations that
totaled $17.5 million.
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 $5.6 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 continue
until December 2013. 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 of these arrangements 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.
Following the August 26, 2011 decision issued by the Federal Circuit Court of Appeals in our
RJR patent infringement litigation, RJR filed a Petition for Rehearing and Rehearing En Banc as to
the Courts determination on the issue of the definiteness of
the patent claims at issue in the
case and we are continuing to purse that issue before the Federal Circuit. We anticipate incurring
significant expenses for legal fees and costs in connection with this appeal and the RJR litigation
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 that 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. |
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Prior to the introduction of CigRx® and Anatabloc we obtained product liability insurance for
these products as nutraceutical products. This insurance covers claims arising from product defects
or claims arising out of the sale, distribution and marketing of CigRx® or Anatabloc. There have
been no claims asserted to date with respect to the manufacturer, sale or use of our CigRx® or
Anatabloc products. 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.
MSA Escrow Obligations. Since June 2007 we have been focusing our activities on the sale of
smokeless tobacco products, as opposed to cigarettes. As a result, we do not anticipate incurring
MSA escrow obligations for cigarette sales in 2011 or thereafter.
Virginia Sales and Use Tax Assessment. On July 14, 2011 we filed a complaint in the Circuit
Court for Mecklenburg County, Virginia seeking a determination that the purchase of our companys
curing barns was exempt from Virginia sales and use tax and an abatement of all taxes and interest
assessed against our company by Virginias Commissioner of Revenue. The Commonwealth of Virginia
filed an answer to our complaint on July 29, 2011 asserting that
the assessment amount was
properly determined.
Item 3. | Qualitative and Quantitative Disclosures About Market Risk |
We have not entered into any transactions using derivative financial instruments or derivative
commodity instruments and believe that our exposure to market risk associated with other financial
instruments (such as investments and borrowings) and interest rate risk is not material.
Our outstanding
long-term debt of $5.7 million bears interest at a rate of prime plus 1%. As a
result, our company is subject to interest rate exposure on this obligation.
Item 4. | Controls and Procedures |
Evaluation of 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 September 30, 2011, the end of the period covered by this Report, our
disclosure controls and procedures were effective at a reasonable assurance level.
Changes in Internal Control Over Financial Reporting
Management has evaluated, with the participation of our Chief Executive Officer and Chief
Financial Officer, whether any changes in our internal control over financial reporting that
occurred during our last fiscal quarter have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting. Based on the evaluation we
conducted, management has concluded that no such changes have occurred.
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PART IIOTHER INFORMATION
Item 1. | Legal Proceedings |
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) (401
Patent). 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.
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 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 unenforceable because of inequitable conduct during the prosecution of the
patents before the United States Patent and Trademark Office and invalid 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 merits of the infringement claims. 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 Court of Appeals on December 22,
2009. In a decision issued on August 26, 2011, the Court of Appeals reversed the
jury finding as to the patent defenses of anticipation, obviousness, indefiniteness and failure to
disclose best mode and reconfirmed the validity of the patent claims at issue in the litigation.
At the same time the Court of Appeals affirmed the jury finding of non-infringement for the growing years at
issue in the litigation (2001 and 2002). RJR has sought reconsideration of the decisions with
respect to definitiveness and its Petition for Rehearing or Rehearing En Banc is currently pending
before the Court of Appeals.
On November 30, 2009, RJR filed a motion for a
bill of costs in the amount of $442 thousand.
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
resolution of the reexamination before the U.S. Patent and Trademark Office. The District Court on
January 8, 2010 stayed any further briefing on the renewed petition for a bill of costs that RJR
filed on December 30, 2009. Any arguable basis for an award of attorneys fees should be eliminated
based on the decision by the Federal Circuit upholding the validity of each of the claims in the
patents at issue in the RJR litigation and the earlier decision by the U.S. Patent and Trademark
Office, in March 2011, confirming that the claims at issue in the RJR case were valid over the
prior art. 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.
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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 District Court stayed any further action in this case until after a ruling on the appeal in the
initial infringement action against RJR. Unless the Court of Appeals issues a new decision with
respect to its ruling on definiteness, we will be free to pursue our claims against RJR in the new
case filed in 2009 as well as to enforce our patents rights against any other persons or entities
infringing the patents that were at issue in the initial RJR litigation.
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 of 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.
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 of these arrangements 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.
Item 1A. | Risk Factors |
There are no material changes from risk factors previously disclosed in Part I Item 1A of
our Annual Report on Form 10-K for the year ended December 31, 2010, filed with the SEC on March
16, 2011.
Item 6. | Exhibits |
(a) Exhibits
Number | Description | |||
3.1 | Sixth Amended and Restated Certificate of Incorporation of Star Scientific, Inc.(1) |
|||
3.2 | Amended and Restated Bylaws of Star Scientific, Inc.(2) |
|||
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(3) |
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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(3) |
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101 |
The following financial information from the Quarterly Report on Form
10-Q for the three and nine months ended September 30, 2011,
formatted in XBRL (Extensible Business Reporting Language): (i) the
Condensed Consolidated Balance Sheets, (ii) the Condensed
Consolidated Statement of Operations, (iii) the Condensed
Consolidated Statement of Stockholders Equity, (iv) the
Condensed Consolidated Statements of Cash Flows, and (v) the
Unaudited Notes to Condensed Consolidated Financial Statements (4) |
(1) | Incorporated by reference to Current Report on Form 8-K filed on December 15, 2010. |
|
(2) | Incorporated by reference to Current Report on Form 8-K filed on December 21, 2006. |
|
(3) | This certificate is being furnished solely to accompany the report pursuant to 18 U.S.C. §
1350 and is not being filed for purposes of Section 18 of the Securities Exchange Act of 1934,
as amended, and is not to be incorporated by reference into any filing of the Company, whether
made before or after the date hereof, regardless of any general incorporation language in such
filing. |
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(4) | Furnished electronically
herewith. |
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