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  • Did Star Scientific And RJR/RAI Just Shake Up "Tobacco" ... And No One Noticed?

    With so little time to do this right now, I will have to, here, cater to those who have some knowledge of the following situation, with only the barest of "background".

    Star Scientific and R.J. Reynolds (now a part of Reynolds American, Inc. ... RAI) have been battling it out in court for 11 years now over Star's allegations of infringement by RJR to do with Star's tobacco curing patents. These patents hold the secret to eliminating a, and perhaps the, major cancer causer in cured tobacco and the products made therefrom, both smoked and smokeless.

    As the patents were originally allowed by the U.S.P.T.O., Star had what was probably an excellent case against RJR, and probably the other big tobacco players, regarding an allegation of infringement on those patents. However, years ago, after suit was brought against RJR by Star for infringement, a court made a very unfavorable "construction" of one of the terms in the crucial claims of the patents involved (a construction of the term "substantially prevent") which made it very nearly impossible for Star to prove significant infringement (apparently, as subsequent events seem to have shown).

    After more strange and perhaps suspicion-generating events, in this court or that, in June of 2009 a jury trial, and the subsequent appeal process that followed, left things this way: the Star patents are valid, but Star did not prove infringement by RJR for the years 2001 and 2002. Star had subsequently filed suit on later years, which suit was left in limbo by the above detailed process.

    Flash forward to this year, when the parties agreed to mediation, something that would inspire any long-time watcher of all of this to say, "Fat chance".

    WELL, in September of this year it was announced that Star and RJR had indeed reached a settlement. I will leave it to the reader to stop and investigate the details of that by searching on "Star Scientific RJR settlement", if great detail is needed.

    Briefly, it was then announced that all litigation was brought to an end by the settlement (including a bid by RJR for the Supreme Court to look into the matter), and that both sides would cover their own costs and fees (RJR claiming that to be about $36M for them), and that RJR would give Star about $7.5M ($5M in cash). The last item was a bit amazing, its purpose unstated at the time, considering all that had gone before.

    Both parties stated that all other details were confidential. It has been assumed by many that this meant that the details would be forthcoming in the quarterly reports by both companies. Yet RJR's quarterly report a couple of weeks ago revealed nothing more.

    That left it to Star to perhaps reveal some additional details in its 10-Q filed after market close on Friday, 11/9/2012. As a matter of fact IT DID reveal what appear to me to have the potential to be industry-shaking details, and strangely no one seems to have noticed it ... or else I've somehow misread it. I'll let you be the judge.

    First let me quote from that Star 10-Q the parts pertinent to my discussion. I have added a bit of editing to help me, if no one else, read it (by breaking up long paragraphs) ... plus I have added a few [bracketed] comments by me.

    ===== quote =====

    6. Commitments, Contingencies and Other Matters

    The Company is involved in litigation and claims arising in the ordinary course of business where either the ultimate outcome of these matters is not presently determinable or where it is the opinion of management that the resolution of outstanding claims will not have a material adverse effect on the financial position or results of operations of the Company.

    [This seems a nod to the new "safe harbor" SEC provision regarding reporting of "material" events. May this also a 'confuser" with regard to hiding from other big tobacco companies the intent and purpose of the settlement, re synergism that may be derived from, finally, a "first use" of the patents by a big tobacco company, namely RJR? I will explain the latter thought later.]

    RJR Litigation:

    On September 21, 2012 the Company and RJR entered into a confidential settlement agreement of the RJR litigation matters that limits disclosure on information relating to the settlement to that required in SEC filings or by Exchange Act rules.

    [Again, that apparently now, in light of a new "Safe Harbor" provision, means that only "calculable" disclosures are required, and those situations that are still "developing" are not necessarily required to be guessed at as to monetary effect until the effects can be calculated.]

    Pursuant to the agreement, the two consolidated cases pending in the United States District Court for Maryland, a separate action filed by the Company in 2009 for growing seasons after 2002, and a related action in the United States District Court for the Middle District of North Carolina that had been stayed since the early 2000s, were dismissed with prejudice [thus cannot be revived in court] upon joint stipulation of the parties[,] with each side bearing their own costs and attorneys' fees.

    [Again, RJR claims that amount to be about $36M for them.]

    Previously, RJR had filed a motion for an award of costs for $442,388.05 and for legal fees of approximately $35.0 million against the Company.

    Further, the Company's remaining obligation to RJR for unsecured promissory notes with a principal balance of $3.4 million as of August 1, 2012 and accrued interest on the notes was satisfied and extinguished[,] and the Company received a one-time payment of $5.0 million as discussed further in Note 9 of the consolidated financial statements.

    [The Star debt to RJR was inherited by RJR from B&W when, having formerly been Star's partner in developing Star's patents, B&W suddenly broke that off and merged with RJR, forming Reynolds American Inc. ... RAI.]

    [And now THE HEADLINE ... material not previously revealed]

    As part of the settlement, the Company covenanted not to sue RJR and its affiliates and related parties with respect to the method of curing of tobacco or tobacco products made therefrom for RJR's use[,] including those that would infringe ["would" includes, apparently, in the future] the patents in suit in the RJR consolidated cases and/or the Company's related curing technology[,] and both sides exchanged general releases.

    [One important clarification I hope to soon extract from the company is to specify which IP is "related technology" ... specifically whether that includes use of Star's new BDL curing technology for its proposed ultra-low TSNA smokeless products.]

    Also, as part of the settlement agreement, RJR's petition for certiorari that was filed with the United States Supreme Court in March 2012 was dismissed on joint motion of the parties prior to consideration of the petition for certiorari by the United States Supreme Court.

    [I still can't see what either side gained here, except for not accruing the added legal fees of RJR and Star IF the S.C. had taken the case ... but that outcome was extremely unlikely. Whether or not the S.C. would take it would be another box checked off that affects the worth of the patents to either/both side/s.]

    [The NEXT head line:]

    The covenant not to sue RJR, its affiliates and related entities does not preclude the Company from pursuing claims against other tobacco companies that infringe on its tobacco curing patents. Star will continue to monitor industry practices regarding nitrosamine levels in order to vigilantly protect its valid patents, which were affirmed by the United States Court of Appeals for the Federal Circuit and left unchanged by the Supreme Court, as a result of the joint dismissal of the petition for certiorari as part of this settlement.

    [It may be important to note that RJR's use of Star's technology is worth little in term of industry advantage if Star were to not enforce its patents against other tobacco companies. However, as this agreement stands, Star has in essence handed RJR a possible magic sword to use against its rivals. I speculate that one part of the confidential agreement may be RJR's willingness to pay for, in part or whole, Star's litigation costs in pursuing any other infringer ... thus protecting RJR's "investment" of something like $45M so as to have the possibility to use Star's IP to gain a market advantage.]

    RJR Litigation Fees

    The Company [Star] previously has accrued obligations for legal fees actually incurred in connection with the RJR litigation of approximately $0.9 million. It also had entered into agreements with counsel in connection with the RJR litigation matters that were contingent on the outcome of the litigation. The contingent fee amounted to $1.3 million and is included in the financial statements in this Report, although the Company anticipates negotiating the final amount of any fees payable to its litigation counsel in connection with the settlement of the RJR litigation.

    ........ [non-pertinent material omitted] ........

    Commitments

    The Company has purchase order and other operating supply commitments totaling $1.3 million [to their counsel in the suits against RJR, which may not "cover it all" ... further compensation to be negotiated] as of September 30, 2012.

    9. Miscellaneous Income

    The Company has been engaged in patent infringement litigation against RJR since 2001. On September 21, 2012 the Company and RJR entered into a settlement of the RJR litigation that fully resolved the ongoing patent infringement litigation as more fully described in Note 6 of the Financial Statements.

    The Company has accounted for the financial benefit of the agreement as Miscellaneous Income given that this income reflects a one-time event and there are no other matters similar in nature involving the Company and no contemplated future actions.

    [This obviously means no other suits ... but does it mean there is no other revenue to be derived in the future from this arrangement with RJR? "The agreement" includes unlimited use of some portion of Star's curing IP ... apparently most or all of it. Does this mean that the $$ exchanged in the agreement are the total ever due Star from RJR no matter what else happens?].

    The Miscellaneous Income is comprised of the satisfaction and extinguishment of unsecured promissory notes in the amount of $3.4 million as of August 1, 2012 that has been payable to RJR following its combination with B&W in 2004[,] and a separate cash payment of $5.0 million for a total of $8.4 million.

    [I can only see the $5M as a token payment to "tell the world" that this was seen by the parties as a mutually beneficial settlement, not just a "walk away".]

    The company had previously entered into a contingent fee arrangement with counsel regarding this litigation. The resulting fee from the arrangement is $1.3 million which is included in this Miscellaneous Income item. Therefore, the net Miscellaneous Income reported is $7.1 million, although the Company anticipates negotiating the final amount of any fees payable to its litigation counsel in connection with the settlement of the RJR litigation.

    ===== end quote =====

    So there you have it. Does anyone else feel the earth shaking a bit ... the parts where tobacco grows? Star has just granted RJR, for about $7.5M "and other valuable consideration", the unlimited use of Star's very low TSNA curing technology without fear of suit for infringement. Sounds crazy to some, after all the years of blood, sweat, and litigation. To be sure Star and its investors (which include me) hoped for much more. Many have characterized this as a paltry sum, and perhaps it is.

    However, I have seen no one yet who seems to have noticed "the rest of the story" ... and what I see as a very interesting development.

    Consider this: suppose you are a company who has IP that SHOULD be worth a great deal to the big players ... big tobacco companies in this case ... in a big industry. However, any proceeds from that IP can never be realized until ONE of them uses it, either in an infringing manner or by licensing.

    Suppose the industry decides to protect themselves and snub you by getting together and refusing to use that technology by the usual licensing route. Suppose instead the entire industry decides to cleverly "almost infringe" on it, to an extent that all get some benefit thereby, partially, in this case, lowering TSNAs in their products, all by about the same amounts. In this case that "almost infringing use" was made possible by that very unfavorable construction of the term "substantially prevent" by a district court.

    You, the IP owner, try for a decade, spending millions, to sue one of the "almost infringers" unsuccessfully. You can't prove infringement to any appreciable extent because of the unfavorable way the courts construed one term in your patents ("substantially prevent" TSNA formation). The life of the patents is nearing an end and litigation is going nowhere.

    Enter the FDA/TP ... the newly minted (2009) FDA arm charged with, finally, bringing some meaningful regulatory measures to bear on tobacco. It turns out that they are about to force tobacco manufacturers (April 2013 or so) to list potentially harmful ingredients and constituents, including TSNA, that are in their tobacco products.

    With the status quo that existed until this RJR/Star settlement, the big tobacco companies would have been listing TSNA numbers similar to each other when the time comes, with TSNA lowered quite a lot thanks to tobacco curing by all of them that is "almost infringing" on Star's curing patents.

    HEADLINE: that status quo has changed, at least potentially.

    RJR now has the ability to use Star's pioneering curing technology to produce smoked and smokeless tobacco products with, in the U.S., unheard of low TSNA numbers (except for Star's own little-known but pioneering smokeless products, Ariva and Stonewall).

    Furthermore, RJR's competition DOES NOT.

    Suddenly as of 11/9/2012 we now know that RJR can beat the rest of the U.S. tobacco industry in what should become this important new arena of competition, if the consumer is informed about it (and RJR is very good about shining any possible good light on its products).

    IF RJR produces infringing tobacco products, now with Star's permission, that give them a market advantage over other big tobacco companies, then it is an advantage ONLY if the others fear litigation over their own infringement if they do so.

    Only Star (as exclusive licensee of the technology/IP) can sue to protect the IP (unless the technology were relinquished by Star at some future point). Thus I speculate that the agreement between Star and RJR may include plans for Star to (if RJR were using the IP) sue any other tobacco company for infringement ... with, perhaps, RJR even financing, fully or partly, the effort.

    Such an arrangement would seem to have the effect of "licensing" the technology" to RJR, and leaving Star the possibility of gaining royalties from the other tobacco companies ... RJR'S competitors, if they are forced by market pressures to follow suit (as seems likely if RJR adopts).

    For Star, this finally seems to offer the chance to actually end the stalemate between big tobacco and Star (and end the dollar-draining litigation with RJR)... point goes to Star. This also has the chance to give struggling 3rd place U.S. tobacco company, RJR, a market advantage (plus ending annoying litigation)... point goes to RJR. Plus, this has the chance to force the other two big tobacco companies (at a minimum) to strike up a royalty agreement with Star.

    What I do not know is whether or not Star would be required to "make the same [royalty] deal" with other tobacco companies as this arrangement is with RJR. With limited time at present, I will have to defer to those who know patent law well to suggest answers to that question. Star has agreed, "for $5M and other valuable consideration", to not ever sue RJR for infringement of some subset of its tobacco curing IP. Under the concept of fairness in royalty agreements (if there is such a thing, and I think there is), does that mean that Star must, for like compensation (probably relative to extent of use), license the IP to the other tobacco companies?

    At worst (for Star) it would seem that RJR can use Star's IP and thus likely force the other tobacco companies to do so ... and the other tobacco companies would owe Star a like "consideration" according to how much the use means to the other companies. (Because they are bigger, the worth of use should be more to RJR's bigger competitors.)

    So it appears to me that for Star the dollar-bleeding litigation stops, and at worst Star gains some relatively small total compensation from the industry.

    At best, perhaps Star could end up with more significant royalty extraction from the other two big tobacco companies.

    I believe that, under the considered circumstances, this is a soft landing for Star with regards to the prospects for its tobacco litigation. They dare not simply not pursue infringement on their IP ... yet it is clear that to continue to pursue the RJR litigation would likely be fruitless.

    Some, those just thinking of what Star has ended up with in terms of payment from RJR, have implied that this is an insane end to the 11 years of litigation. On the other hand, considering where it seemed to be going ... nowhere ... this move by Star may be actually "crazy like a fox", making the best out of the situation. That remains to be seen.

    We are left with questions. What other provisions does the agreement/settlement contain? In my mind there is certainly room to justify such secrecy almost no matter what. Perhaps the RJR online presentation Monday morning 11/12 will shed some light ... or not.

    I see this as a hopeful end to the horrendous distraction that "tobacco" has become for Star (I term it "the coal mine") ... a distraction from the incredible prospects for Star's Rock Creek pharma arm (I term it "the gold mine"), and thus the boosting of the latter's amazing new pharmaceutical product: an OTC anti-inflammatory product that for all but a very few can be taken for life for relief of, or protection from, tens of ailments (including perhaps most autoimmune disorders such as MS and thyroiditis, and perhaps Alzheimer's and traumatic brain injury).

    How gainful this end may be to Star remains to be seen. Too remains to be seen the possible gain for RJR, with what could be a very significant "leg up" on its competition if it plays the cards right.

    I have found the revelations in Star's 11/9/2012 10-Q possibly earth-shaking, speaking of tobacco growing country. Have I overstated the matter some how?

    Disclosure: I own no RJR stock. I own a sizeable position (for an average individual) in Star stock. I do not plan to make any changes in that status in the next 72 hours.

    Disclosure: I am long STSI.

    Additional disclosure: I have no position in RAI, nor do I intend to take one in the next 72 hours.

    Tags: RCPI, RAI, MO, BTI, tobacco
    Nov 11 5:56 AM | Link | Comment!
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