UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C., 20549
FORM 10-KSB
ANNUAL REPORT FILED PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES ACT OF 1934
For the fiscal year ended December 31, 1998
Commission file No. 0-29414
PREMIUM CIGARS INTERNATIONAL, LTD.
(Name of small business issuer in its charter)
Arizona 86-0846405
(state or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
15849 North 77th Street
Scottsdale, AZ 85260
(Address of principal office) (Zip code)
Issuer's telephone number, including area code: (602) 922-8887
Securities registered pursuant to Section 12(b) of the Act:
Title of each class: Name of each exchange on which registered:
No par value Common Stock Boston Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
No par value Common Stock
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 periods that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-B is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [ ]
Issuer's revenues for its most recent fiscal year were $6,900,927.
The aggregate market value of voting stock held by non-affiliates of the Company
was approximately $1,640,100 as of March 26, 1999.
The number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date of March 31, 1999 was 3,839,092.
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PREMIUM CIGARS INTERNATIONAL, LTD.
FORM 10-KSB
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
TABLE OF CONTENTS
PAGE
PART I........................................................................ 4
Item 1 - Description of Business......................................... 4
Item 2 - Description of Property.........................................16
Item 3 - Legal Proceedings...............................................16
Item 4 - Submission of Matters to a Vote of Security Holders.............17
PART II.......................................................................18
Item 5 - Market for Common Equity and Related Stockholder Matters........18
Item 6 - Management's Discussion and Analysis of Financial Condition
and Results of Operation.......................................21
Item 7 - Financial Statements and Supplementary Data.....................26
Item 8 - Changes in and Disagreements with Accountants on Accounting
Financial Disclosure...........................................26
PART III..................................................................... 27
Item 9 - Directors and Executive Officers, Promoters and
Control Persons; Compliance with Section 16(a)
of the Exchange Act...........................................27
Item 10 - Executive Compensation.........................................30
Item 11 - Security Ownership of Certain Beneficial Owners
and Management................................40
Item 12 - Certain Relationships and Related Transactions.................37
Item 13 - Exhibits and Reports on Form 8-K...............................37
SIGNATURES....................................................................39
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS....................................40
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Special Note Regarding Forward-looking Statements
Some of the statements contained in this report discuss future
expectations, contain projections of results of operations or financial
condition or state other "forward-looking" information. Those statements are
subject to known and unknown risks, uncertainties and other factors that could
cause the actual results to differ materially from those contemplated by the
statements. The forward-looking information is based on various factors and was
derived using numerous assumptions. Important factors that may cause actual
results to differ from forward-looking statements and projections include, for
example:
* failure of our products, particularly new products such as PrimeTime(TM)
and Humidibox(TM), to be accepted and have a lasting presence in the
marketplace;
* our ability to maintain an adequate capital position and a sufficient cash
flow as we add retail stores and new products;
* our ability to obtain funding to enable us to maintain sufficient working
capital for operating activities;
* any decision by major retail chains to discontinue selling all tobacco
products or to place our humidors or countertop control units in a
disadvantageous location within their stores;
* a decline in the popularity of cigar smoking and/or possible adverse public
opinion against cigars and cigar smoking;
* interruptions in the availability of PrimeTime(TM);
* changes in government regulations, tax rates, the manner of tax calculation
and collection and similar matters relating to our products, including any
restriction on the self-service nature of merchandising displays and
marketing promotions particularly or any retroactive application of such
changes;
* our ability to negotiate and maintain favorable distribution arrangements
with our customers;
* the effect of changing economic conditions;
* the risk of any significant uninsured loss from settlement dealing with
Proposition 65;
* our ability to buy quality premium cigars at favorable prices and the
effect on cigar prices and availability, of weather and other conditions in
the countries that import cigars to the U.S. and Canada; and
* other risks which may be described in our future filings with the SEC. We
do not promise to update forward-looking information to reflect actual
results or changes in assumptions or other factors that could affect those
statements.
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PART I
ITEM 1 - DESCRIPTION OF BUSINESS
HISTORY. PCI was incorporated in Arizona on December 16, 1996 to be a national
and international distributor of premium cigars from humidors in high traffic
retail outlets. Shortly after incorporation, PCI acquired CAN-AM International
Investments Inc. ("CAN-AM"), a Canadian corporation which owned all cigar
accounts, inventory and humidors formerly owned by Rose Hearts Inc. ("Rose
Hearts") of Seattle, Washington, and J&M Wholesale, Inc. ("J&M") located near
Vancouver, British Columbia. PCI began trading on the NASDAQ Small Cap Market
August 28, 1997 under the stock symbol PCIG.
OPERATIONS.
WHAT WE WERE TO ACCOMPLISH DURING 1998. In our 1997 Annual Report on Form 10-KSB
we outlined what changes we believed would occur during 1998 and the rationale
for the changes. The following summarizes those key changes we anticipated:
* To be a distributor is not enough; PCI must be a marketer. - The premise on
which PCI was founded - distributing premium cigars via humidors in
convenience, gas and high-volume retail outlets - is fundamentally sound,
but it must focus on the needs of the consumer and the unique needs of each
distribution channel.
* Managing PCI's expanded operations requires different management skills and
experience. - PCI assembled a new management team, particularly in
marketing, sales, finance and executive management.
* Computer systems are critical to control and management decision-making. -
The existing systems were totally inadequate to manage our business.
* Improved sensitivity to our customer service function is critical. -
Outsourcing customer service failed.
* Brand names must be included in our product line. - The availability of
premium cigars was different in early 1998 than when PCI began its
expansion.
WHAT WE ACCOMPLISHED DURING 1998. PCI aggressively implemented the changes
outlined in our 1997 10-KSB. Specifically:
* During 1998, we pursued the premise on which PCI was founded, with
increased focus on the needs of the consumer and the unique needs of each
distribution channel.
- We developed and implemented a complete in-store humidor program,
advertised the program in key trade publications and participated in
key trade shows.
- We improved our understanding of the consumer who buys cigars in our
customers' retail outlets, and refined our cigar selection and price
points, even differing the selection by geographic location.
- We improved our merchandising by helping our customers present our
humidor program to their consumers more effectively.
- Through analyzing order patterns, we learned that a humidor in every
outlet may not be justified; we turned down orders for some placements
that did not meet the criteria we developed.
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- We applied UPC stickers to individual cigars in order to help our
customers with scanning capabilities on retail pricing and inventory
control.
- To expand beyond the convenience store market, we developed a
gift-pack sell-through program that met the requirements of specific
distribution channels (e.g., grocery stores, drug stores, mass
merchandisers, warehouse clubs).
- We tested the use of a convenience store broker and its in-store
merchandising sales force within a limited geographic area to see if
humidor productivity could be improved.
* During 1998, PCI assembled a new management team, particularly in
marketing, sales, finance and executive management.
- John Greenwell was made CEO on March 1,1998. He has 28 years of
marketing and executive management experience within the consumer
package goods industry.
- Brendan McGuinness was made Vice President of Sales and brought his 28
years of managing consumer package goods sales forces to PCI along
with his executive management experience.
- Stan Hall was hired as the Controller early in 1998. In addition to
the strong controller skills, he brought with him the systems skills
the Company needed.
* We installed and integrated computer systems.
- PCI invested time and money in refining our systems that deal with
order solicitation, processing and shipping small packages to
thousands of locations.
- We substantially reduced our fulfillment time, shipping time, lowered
labor costs per shipment, improved our ability to track shipments,
reduced our shipping costs, and improved our ability to prove store
receipt of the shipment.
- The result was steadily improving gross margins as 1998 progressed.
- Our new systems improved our ability to manage inventory associated
with merchandise that turns at retail.
* We improved customer service.
- We developed and implemented an in-house Customer Service Department
that regularly called every store location to solicit orders and to
help ensure the in-store humidor was maintained and properly
merchandised.
* We added brand names to our cigar product line.
- During 1998, PCI obtained and offered our customers and consumers the
number one selling premium cigar in the United States, and six of the
top ten selling premium cigar brands in the United States -
MACANUDO(TM), H. UPMANN(TM), PARTAGAS(TM), BERING(TM), TE-AMO(TM), DON
TOMAS(TM) (SOURCE: CIGAR INSIDER, 1997 Unit Sales).
- We implemented a cigar trade-out program replacing slower moving SKU's
with more appropriate cigars and price points for each store's
consumer base.
WHAT WE LEARNED DURING 1998. Although our operations expanded dramatically in
1998, results of operations were disappointing in several aspects. See Item 6 -
"Management's Discussion and Analysis of Financial Condition" later in this
report. We gained further insights into PCI operations, and initiated major
changes designed to improve our business during 1998 and beyond. The following
summarizes that activity:
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* OUR ORIGINAL BUSINESS ALONE WILL NOT SUPPORT PCI; DISTRIBUTING/MARKETING
PREMIUM CIGARS IN HUMIDORS IS LIMITING IN TERMS OF REVENUE GENERATION AND
EXPENSIVE TO IMPLEMENT. - During 1998, we aggressively pursued the premise
on which PCI was founded, with an increased focus on the needs of the
consumer and the unique needs of each distribution channel. However,
revenues generated were disappointing, even with the program improvements.
At the same time, our efforts to improve the programs increased our
overhead burden, and negatively impacted profitability.
* IN GENERAL, CIGARS WITHOUT WELL-KNOWN BRAND NAMES PROVED TO BE DIFFICULT TO
SELL, CREATING AN INVENTORY PROBLEM. - PCI started 1998 with a heavy
inventory of cigars that were purchased in anticipation of a rapid increase
in humidor placements. This inventory consisted primarily of lesser-known
cigars PCI had purchased when name brands were in short supply during 1997.
Shipments of these lesser known cigars to our customers during the Fourth
Quarter of 1997 and the First Quarter of 1998 resulted in slow-turning
retail inventory. We initiated a cigar trade-out program beginning in the
Second Quarter of 1998, replacing the lesser known cigars with more
established brands in order to improve retail inventory movement. While
this strategy worked in certain locations, it was not universally
successful. The return of these cigars added to our already heavy
inventory. Efforts to sell this inventory have met with difficulty as the
entire cigar industry is suffering from oversupply.
* FULLY INTEGRATED SYSTEMS PROVED TO BE A VALUABLE INVESTMENT. - The
development and implementation of an integrated order solicitation, order
processing, inventory management, and shipping system was instrumental in
improving our gross margins.
* ACCOUNT RELATIONSHIPS CONTINUE TO BE STRONG. - We improved our customer
relations. Our customers have expressed appreciation for our efforts, our
increasing knowledge of the convenience store retail channel and consumer
package goods marketing. As a result, our customers continue to view PCI
favorably.
* CANADA CONTINUES TO BE A DIFFICULT OPERATING ENVIRONMENT. - Can-Am revenues
increased during 1998 as we added new accounts. Adjustment in products,
along with the installation of an integrated accounting platform, resulted
in improved gross margins. However, increasingly aggressive tobacco taxes
in Canada continued to restrict our margin improvement. We expect that
Can-Am margins will continue to lag the US operations.
* OUR PERFORMANCE MADE TRADITIONAL FINANCING DIFFICULT TO OBTAIN. - Our
difficulties in generating increased revenues via our in-store humidor
program, combined with our significant investment in systems and continuing
administrative overhead, resulted in continuing operating losses throughout
1998. To maintain adequate available funds for operations, we attempted to
obtain a revolving credit line that would be secured by our accounts
receivable and inventories. Unfortunately, we did not find financing during
1998. However, in March 1999, we obtained a $1,000,000 Accounts Receivable
Financing package through Alliance Financial Capital.
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WHAT WE CHANGED DURING 1998. We recognized the need to expand beyond the
limitations of the in-store humidor program, and began to pursue new products
and new methods of distributing our products leveraging PCI's experience.
* PCI BEGAN DEVELOPING NEW PRODUCTS DURING THE THIRD QUARTER; WE INTRODUCED
THEM TO OUR CUSTOMERS DURING THE FOURTH QUARTER TO SUPPLEMENT OUR IN-STORE
HUMIDOR PROGRAM.
* During the Fourth Quarter, we directed sales efforts at convenience
store chain acceptance of PrimeTime(TM) - a small tubed cigar, in four
flavor variations, designed to sell for $.49 to $.69 in convenience
stores. We signed an exclusive contract on October 5, 1998 with Single
Cigars, who will act as our sole supplier of PrimeTime. Single Cigars
supplies the retail countertop control units to us at no cost.
* During the Fourth Quarter, we obtained verbal commitments from 24 of
the top 25 convenience store chains to test PrimeTime beginning early
1999. Unfortunately, production start-up problems with PrimeTime,
combined with the Thanksgiving/Christmas holidays, impeded sales. We
shipped PrimeTime to only one account, Clark Oil (680 stores), during
1998. Through the end of March, 1999, PCI shipped approximately 4,000
countertop PrimeTime displays. Based on interest expressed from new
and existing accounts, we believe that PrimeTime could be in more than
6,000 locations nationwide by the end of April, 1999. We believe that
this new product should provide significant revenue to PCI.
* We recognize that a large, maintenance-intensive humidor program may
be viable only to a limited number of the estimated 100,000
convenience stores in the United States. To expand PCI's premise, we
developed the Humidibox(TM), a small, disposable, humidor, that
effectively merchandises 25 cigars in a counter space of only 4"x4".
We introduced the Humidibox in late 1998. It has generated interest,
not only among small convenience stores, but other locations PCI had
not previously pursued (e.g., golf courses, bowling centers).
* PrimeTime and Humidibox are examples of our re-engineering efforts to
reduce PCI's reliance on our in-store humidor program while leveraging
PCI's knowledge and experience.
* DURING THE FOURTH QUARTER, WE BEGAN WORK ON DEVELOPING AN E-COMMERCE SITE
THAT LEVERAGES PCI'S CORE COMPETENCIES - INTEGRATED SYSTEMS AND CONVENIENCE
STORE EXPERIENCE . THE SITE - PRODUCTEXPRESS.COM - WAS ACTIVATED IN LATE
MARCH, 1999.
* We leveraged our integrated order solicitation, order processing,
inventory management, and shipping system via a March, 1999 launch of
ProductExpress.com - a unique internet site that offers retail
consumers a variety of cigar gift packs and multi-brand humidor
assortments. We intend to add other products to the site.
ProductExpress.com also has a wholesale side that offers store
managers PCI's traditional products along with other products designed
and packaged for the needs of convenience stores. The site features
online wholesale purchases and 72-hour direct store delivery. PCI
intends to expand the site to inform retailers about sales order
history, selling techniques, merchandising suggestions, consumer
demographics, price point comparisons and provide them with the
ability to share their experiences with other retailers.
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* DURING THE FOURTH QUARTER, PCI DEVALUED ITS CIGAR INVENTORY.
* Despite PCI's efforts throughout 1998 to sell our lesser-known cigar
inventory purchased in late 1997, including the inventory that was
returned during the 1998 cigar trade-out program, we were unsuccessful
in our efforts to sell this product at prices at or above our cost
basis. Compounding our problems were heavy retail inventories in the
industry generally and a decline in imports of premium cigars,
suggesting a market slowdown.
* PCI wrote down the value of its inventory to the lower of cost or
estimated market value. PCI recognized the writedown of approximately
$430,000 during the Fourth Quarter, 1998.
* We were able to sell some of this inventory during the First Quarter,
1999 at lower prices.
* PCI REDUCED STAFF DURING THE FIRST QUARTER, 1999. - Our new products,
integrated systems, and declining importance of our in-store humidor
program lead us to reassess our staffing needs. We reduced staff in the
U.S. by 50% in the First Quarter,1999 and PCI expects to benefit from
reduced operating costs during 1999.
OUR CUSTOMERS. We sell virtually all of our cigars through convenience stores,
including stores affiliated with The Southland Corporation and Southland Canada,
Inc. which do business as 7-Eleven(TM). We also sell through convenience stores
affiliated with Circle K(TM), Mobil(TM), AM/PM(TM), Petro Canada(TM), Mac's(TM)
and stores supplied by the McLane Company.
PrimeTime and Humidibox, our new products introduced late in 1998, enable us to
increase our potential customer base beyond just the large convenience stores.
We believe we can market Humidibox to smaller convenience stores, along with
specialty retail stores like golf courses and bowling centers. PrimeTime is
suitable for sale in casinos, bars, liquor stores, etc.
OUR LARGEST CUSTOMER. Corporate and franchise stores affiliated with Southland
USA and Southland Canada (7-Eleven) accounted for approximately 33% of our U.S.
sales and 44% of our Canadian sales during 1998. We have steadily expanded our
customer base throughout 1998 and these percentages have steadily declined
throughout the year.
PCI, Southland USA, or any U.S. franchisee has the right to terminate the
agreement for any reason upon 60 day's notice. Southland Canada can terminate
its arrangement with us at any time without notice. Problems with 7-Eleven
stores, our major customer in Canada and the United States, would have a
material, adverse impact on our business. A substantial reduction in our
7-Eleven business could result in diminished revenues for several quarters or
more as we attempt to replace that business.
CANADIAN SALES. CAN-AM, our wholly-owned subsidiary, has secured a strong
foothold in the convenience industry with 7-Eleven stores, and chains such as
Petro-Canada, Esso, Mohawk, Mac's, TRA, Sobey's, as well as other independent
retail outlets. Through December 31, 1998, CAN-AM had secured retail outlets in
the Canadian provinces of British Columbia, Alberta, Saskatchewan, Manitoba,
Ontario, Quebec, Nova Scotia, Prince Edward Island, Newfoundland and New
Brunswick. With a warehouse near Vancouver B.C., a national distribution system
and an in-house Customer Service Department, CAN-AM net sales for the twelve
month period ending December 31, 1998 were approximately US $3.2 million.
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U.S. SALES. As of December 31, 1998 our United States operations distributes to
stores throughout the United States. PCI U.S. net sales for the twelve-month
period ended December 31, 1998 were approximately $3.7 million. Our U.S.
accounts include nationally-recognized accounts such as 7-Eleven(TM); Circle
K(TM); Mobil(TM); AM/PM(TM) and stores supplied by the McLane Company. Other
than 7-Eleven, which represents approximately 33% of our total U.S. sales, no
other individual customer represents more than 12% of our U.S. sales.
DIRECT AND THIRD-PARTY DISTRIBUTION. To effectively market and distribute
premium cigars and in-store humidors, we primarily distribute directly to
national convenience store chains, and to a smaller degree through independent
national, regional and local distributors. Direct sales accounted for
approximately 86% of our total sales and third-party distribution accounted for
14% of our total sales for the twelve-month period ended December 31, 1998.
CUSTOMER SERVICE. The ongoing success of our "full-service" PCI Cigar Program
depends, in part, upon a strong customer service department. Our goal is to be a
working partner with each of our customers, both at an individual store level,
and at the headquarters level. Our customer service representatives in both the
US and Canada use databases to analyze store volume, price points, cigar
selection, provide counsel relative to proper humidification, maintenance,
merchandising, humidor placement and reorders.
HUMIDORS, PRIMETIME COUNTERTOP CONTROL UNITS, HUMIDIBOX. We provide, and retain
ownership of, all countertop and free-standing cigar humidors shipped to retail
outlets. We do not own PrimeTime countertop control units or Humidiboxes. Our
humidors provide an attractive product display and increased counter space
available for PCI's products. Each PCI in-store humidor is a sealed case or box
that displays premium cigars in an optimal environment of humidity.
Throughout 1998 we used two suppliers of humidors based in Arizona and Canada.
Although we have specially designed our humidors to meet our business needs, we
believe any reputable cabinet making company could meet our production
specifications and requirements. For this reason, we do not believe we are
dependent upon a single humidor supplier. Furthermore, we expect our future
humidor purchases to be minimal.
We signed an exclusive contract with Single Cigars, October 5, 1998. Single
Cigars will act as the sole supplier to PCI of PrimeTime. Single Cigars will
also furnish, at no cost, the retail dispensing mechanisms known as countertop
control units.
The mold for Humidibox is owned by PCI and is injection molded for us by a
supplier in Tempe, Arizona. We believe that any reputable injection molder could
meet our production specifications and requirements.
OUR CIGARS. We sell name-brand and our own private-label cigars from our
humidors, typically retailing from $1 to $8. We sell PrimeTime little cigars,
targeted at 49(cent) to 69(cent) retail, from countertop control units. We also
distribute cigar-related accessories as a service to our customers, although
revenue is very minor.
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PREMIUM CIGARS. Our premium cigars are generally hand-rolled and sell
at retail price points above $1.00/cigar. Through the PCI Cigar Program
we distribute primarily large premium cigars with long-filler,
long/medium, and medium/short filler tobacco and high quality, natural
leaf wrappers and binders. In order to make hand-made cigars, binder
tobacco is hand-wrapped around filler to create the "bunch" which is
placed into a mold. Then, "wrapper" tobacco is hand-wrapped around the
bunch, creating a premium cigar.
MASS MARKET CIGARS. Mass market cigars are machine-made and generally
have a retail price point of approximately $1.00/cigar or less. Mass
market cigars use less expensive tobacco than premium cigars.
Manufacturers use a variety of techniques and grades of tobacco to
produce mass market cigars that sell at PCI's low price points. Mass
market cigars include large cigars (weighing more than three
pounds/1,000 cigars) and smaller, natural leaf cigars (weighing less
than three pounds/1,000 cigars).
OTHER PRODUCTS SOLD FROM HUMIDORS. We also sell other cigar-related
accessories such as cutters and breath fresheners. We may elect to
continue or discontinue offering these products in the future and
revenue from non-cigar product sales is not significant.
PRIMETIME is a machine-made small cigar that uses premium cigar tobacco
and flavorings. PrimeTime cigars are sold individually from a
countertop control unit, rather than from a humidor.
CIGAR TRADE-OUT PROGRAM. The relationship we have with our customers is very
important to us. We have a policy to contact each store to provide an optimum
selection of fresh, humidified premium cigars at appropriate price points for
that store's consumer base. We endeavor to work with personnel from each store
to maintain proper humidity and placement of our humidor and cigars. Early in
1998 we analyzed retail outlets with substandard sales performance, and
identified opportunities to improve product mix. As a result, we traded out
slower moving store inventory and replaced it with an improved product mix.
COMPETITION. PCI competes with a smaller number of primarily regional
distributors, including Southern Wine and Spirits, Specialty Cigars, Inc.,
Cohabico, Old Scottsdale Cigar Company, Inc. and other small tobacco
distributors and jobbers that service convenience stores.
The cigar industry is dominated by a small number of companies which are well
known to the public; however, during the four year cigar industry growth period
from 1993-1997, many new but small cigar companies also entered the market. To
our knowledge, these cigar manufacturing companies have not yet entered the
retail convenience store market with an in store humidor program. These
companies include 800 JR Cigar Company, Inc., Consolidated Cigar Holdings
(acquired by SEITA, a French company which is a major international tobacco
manufacturer), General Cigar Company, Swisher, Havatampa/Phillies Cigar
Corporation (acquired in 1998 by Tabacalera) and others. These companies may
offer an in-store humidor program in the future and may currently indirectly
compete with us, for example, through operating retail warehouse outlets or
mail-order retail distribution centers. These cigar manufacturing companies have
larger resources than PCI and would, if they enter the in-store humidor market,
constitute formidable competition for our business. Large wholesale distribution
companies such as McLane Company and Core~Mark could also be competitors if
they choose to aggressively pursue an in-store humidor program.
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DECREASING DEPENDENCE ON PRINCIPAL SUPPLIERS. We do not directly manufacture or
import any cigars, and depend entirely on third party manufacturers, suppliers
and importers for our cigars. Typically, we do not have supply agreements, but
submit purchase orders for cigars. We currently purchase cigars from
approximately 10 suppliers.
We have steadily decreased our dependence on any one supplier. For the
twelve-month period ended December 31, 1998 our largest supplier, Latin
Partners, accounted for approximately 43% of our total U.S. cigar purchases.
House of Horvath accounted for approximately 59% of total Canadian cigar
purchases for the twelve months December 31, 1998. Apart from the named
suppliers, no other supplier accounts for more than 15% of our overall U.S.
cigar purchases. We believe that we could quickly replace our main suppliers
with alternative sources at comparable prices and terms and a disruption in the
supply of cigars from our principal suppliers would not have a significant
adverse impact on our operations.
We do have an exclusive contract with Single Cigars to provide us with PrimeTime
small cigars. While we believe other suppliers could provide us with PrimeTime
products, it would probably take some time to arrange for production.
CIGAR SUPPLY GENERALLY. We primarily sell moderately-priced cigars which are
hand-rolled or machine-made from tobacco aged six months to two years. At the
present time, we believe there is an supply of tobacco available in a number of
countries for these types of cigars. However, we also sell a limited number of
higher priced premium cigars which require higher quality, longer-aged cigar
tobacco. Our ability to acquire these cigars in the future may be constrained by
a shortage of premium cigars made with longer-aged cigar tobacco. At times,
producers have suspended shipping certain brands of cigars when excessive demand
results in a shortage of properly aged and blended tobacco. Accordingly,
increases in demand may adversely affect our ability to acquire higher priced
premium cigars.
We purchase cigars which are manufactured by suppliers outside the United
States. The price and availability of these cigars are subject to numerous
factors out of our control, including weather conditions, foreign government
policies, potential trade restrictions, social, political and economic
conditions and the overall demand for cigars. While we have expanded our base of
suppliers, we have no significant written agreements with suppliers, only
ongoing relationships. Loss of these relationships may make it difficult for us
to replace sources of cigars of the same quality, price and quantities. We
cannot assure that our current suppliers of cigars will be able to supply us
with sufficient quantities or at reasonable prices.
INTELLECTUAL PROPERTY RIGHTS. PCI has obtained Arizona state trademark
registrations from the Arizona Secretary of State's office for the trademarks
PREMIUM CIGARS INTERNATIONAL and PCI. These registrations provide trademark
protection only within the borders of the State of Arizona.
PCI does not currently own any United States federal trademark registrations. We
have filed trademark applications in the United States Patent and Trademark
Office for the trademarks on some of our in-house, private label brands. We are
already using these marks in interstate commerce. We filed a federal trademark
application with the United States Patent and Trademark Office to register the
trademark PREMIUM CIGARS INTERNATIONAL and PRIMETIME. PCI currently owns no
patents. We have filed and obtained a domain name registration for our
e-commerce site, ProductExpress.com.
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NASDAQ LISTING. NASDAQ advised PCI by letter on October 23, 1998 that it had 90
calendar days in which to regain compliance with the minimum $1.00 closing bid
price requirement for its shares, If the closing bid price did not exceed $1.00
for 10 straight days, PCI's shares would be delisted from the NASDAQ Small Cap
Market. PCI satisfied the minimum bid price requirements in late November and
early December, 1998. Nevertheless, on January 12, 1999 NASDAQ advised PCI that
despite its compliance with technical requirements, the staff exercised its
broad discretions and recommended delisting of PCI shares as of January 23,
1999. PCI disagreed with the proposed action, and requested an oral hearing on
this matter. PCI will present its case for continued listing at an oral hearing
on April 8, 1999. Any delisting has been stayed pending the outcome of the
hearing.
BOARD OF DIRECTORS. In October, 1998 Atul Vashistha, an outside director,
resigned due to his moving out of state. During January, 1999 Mark Jazwin,
President, W.B. McKee Securities, Inc. was added to the PCI Board of Directors
as an additional independent director. During March, 1999 Bill Anthony and
Robert Manschot resigned as independent directors due to the time requirements
of their primary business commitments. During March, 1999 Gary Sherman,
Executive Vice President, Heritage West Securities, Inc. was appointed as an
independent director.
GOVERNMENT REGULATION
GENERAL. The tobacco industry in general has been subject to regulation by
federal, state and local governments, and recent trends have been toward
increased regulation. Federal law requires states, in order to receive full
funding for federal substance abuse block grants, to establish a minimum age of
18 years for the purchase of tobacco products, together with an appropriate
enforcement program. The recent trend is toward increasing regulation of the
tobacco industry, and the recent increase in popularity and visibility of cigars
could lead to an increase in the regulation of cigars. A variety of bills
relating to tobacco issues have been introduced in recent sessions of the U.S.
Congress and various state legislatures, including bills that would have: (1)
prohibited or restricted the advertising and promotion of all tobacco products
or restricted or eliminated the deductibility of such advertising expenses, (2)
increased labeling requirements on tobacco products to include, among other
things, addiction warnings and lists of additives and toxins, (3) banned self
service displays of all tobacco products, (4) shifted regulatory control of
tobacco products and advertisements, (5) substantially increased tobacco excise
taxes and (6) required tobacco companies to pay for health care costs incurred
by the federal government in connection with tobacco related diseases.
Respected members of the public health community and others have called for
Federal Food and Drug Administration ("FDA") jurisdiction over all tobacco
products which contain nicotine. While no reliable standard testing procedure
has been established for cigars because of their many types, sizes and shapes,
and manner of use, it is undisputed that cigars contain nicotine and some will
call for FDA regulation of cigars for that reason.
Cigarette manufacturers mounted a court challenge to the FDA's existing
statutory authority to regulate tobacco and, after a U.S. District Court found
that the FDA was not precluded from such regulatory authority in general, but
was prohibited from restricting advertising or promotion of tobacco products,
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<PAGE>
appealed the matter to the United States Court of Appeals for the Fourth
Circuit. In 1998, the Court of Appeals reversed the District Court decision and
held that the FDA has no jurisdiction to regulate tobacco. The FDA has
petitioned the United States Supreme Court to review that decision.
In 1997, the five largest tobacco companies announced a proposed settlement of a
number of cases brought by the Attorneys General of several states to recoup
Medicare expenses. Congress introduced legislation to implement the settlement
by increasing the price of cigarettes, regulating all tobacco products
including, in certain versions of the legislation, those manufactured by cigar
companies (which were not a party to the suits being settled), imposing full FDA
regulation and adopting new and highly restrictive marketing requirements.
Although Congress failed to adopt the legislation, the five tobacco companies
engaged in the 1997 proposed settlement entered into separate settlement
agreements in 1998 with the Attorneys General pursuant to which they agreed to
pay significant amounts annually and to certain marketing restrictions. The
Master Settlement Agreement ("MSA") was signed on November 23, 1998 and since
then additional tobacco product manufacturers have joined as subsequent
participating parties to the MSA.
The FDA considered asserting jurisdiction over little cigars in 1995. It
declined to do so in the final rule issued in 1996 principally because the FDA
concluded that little cigars were not used significantly by teenagers. In May
1997, the Center for Disease Control (CDC") issued a widely publicized report
that has come most often to be cited for the claim that "more than a quarter of
the nation's teenagers have smoked a cigar in the past year." While the Company
believes the incidence of youth usage of cigars has been exaggerated, the CDC
report is being cited as justification for extending legislation to all cigars,
and for FDA jurisdiction of all cigars.
In addition, the majority of states restrict or prohibit smoking in certain
public places and restrict the sale of tobacco products to minors. Local
legislative and regulatory bodies also have increasingly moved to curtail
smoking by prohibiting smoking in certain building or areas or by requiring
designated "smoking" areas. Further restrictions of a similar nature could have
an adverse effect on the sales or operations of PCI. Numerous proposals also
have been considered at the state and local level restricting smoking in certain
public areas, regulating point of sale placement, and promotions and requiring
warning labels. In California, the exemption from no-smoking regulations
accorded taverns, bars and cigar bars expired January 1, 1998. On June 16, 1997,
Texas passed a law which prohibits offering cigarettes or tobacco products
(including cigars) in a manner that permits a customer direct access to the
products, but the law specifically does not apply to "that part of a business
that is a humidor or other enclosure designed to store cigars in a
climate-controlled environment."
California requires "clear and reasonable" warnings to consumers who are exposed
to chemicals determined by the state to cause cancer or reproductive toxicity,
including tobacco smoke and several of its constituent chemicals. As a result,
PCI has gone to significant lengths to ensure the following warning label is
attached to its humidors in California: "WARNING: This product contains/produces
chemicals known to the State of California to cause cancer, and birth defects or
other reproductive harm." In Massachusetts, regulations mandating warning labels
on machine made cigars were recently issued by the outgoing Attorney General.
Unless revised, these regulations will become effective August 1, 1999. In
addition, Texas and Minnesota have recently passed ingredient, additive and/or
nicotine disclosure laws applicable to cigars. We cannot assure that such
legislation introduced in other states will not be passed in the future or that
other states will not enact similar legislation.
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Although federal law has required health warnings on cigarettes since 1965 and
on smokeless tobacco since 1986, there is no federal law requiring that cigars
carry such warnings. In February 1998, the Federal Trade Commission ("FTC")
issued orders to five of the largest cigar companies requiring them to file
"special reports" on their sales and advertising expenditures. This could lead
to regulations and/or legislation respecting cigar advertising and promotion,
including health warning labels. The FTC is expected to send a report to
Congress in 1999 which could include, among other things, a recommendation for a
federal warning label on cigars. A petition for such a label ("WARNING: This
product is not a safe alternative to cigarettes") was submitted by Action on
Smoking or Health last year and remains pending before the FDA. In addition, the
"Cigars Are No Safe Alternative Act", introduced in Congress in 1998, contains a
provision which would require the FDA to develop a warning label for cigars.
Consideration at both the federal and state level also has been given to
consequences of tobacco smoke on non-smokers (so called "second-hand" smoke).
The expressed concern of the California legislators who supported the above
referred to expiration of the no-smoking exemption for taverns, bars and cigar
bars was the effect of second-hand smoke on the employees of such
establishments. In 1998, plaintiffs representing the cities of Los Angeles and
San Francisco filed suit against several cigar manufacturers with respect to the
adequacy of the presently required warning as it relates to non-smokers exposed
to second hand smoke. We cannot assure that regulations relating to second-hand
smoke will not be adopted.
The U.S. Environmental Protection Agency (EPA") published a report in 1993 with
respect to the respiratory health effects of second-hand smoke, which concluded
that widespread exposure to environmental tobacco smoke presents a serious and
substantial public health concern. In 1998, the EPA report was invalidated by a
Federal District Court.
In 1998, the National Cancer Institute issued a report describing statistical
and other research into cigars and health. The report was widely publicized and
could affect pending and future tobacco regulation and litigation.
Increased cigar consumption and the publicity such increase has received may
increase the risk of additional regulation. There can be no assurance as to the
ultimate content, timing or effect of any additional regulation of tobacco
products by any federal, state, local or regulatory body, and any such
legislation or regulation may have a material adverse affect on PCI's
operations.
TAXES. Cigars long have been subject to federal, state and local excise taxes,
and such taxes frequently have been increased or proposed to be increased, in
some cases significantly, to fund various legislative initiatives. The federal
excise tax rate on large cigars (weighing more than three pounds per thousand
cigars) is 12.75% of the manufacturer's selling price, capped at $30.00 per
thousand cigars.
Based on scheduled increases to the federal excise tax on cigarettes, which
result in proportionate tax increases to the federal excise tax on all other
tobacco products, the tax on large cigars will increase to 18.06% on January 1,
2000, capped at $42.50 per thousand large cigars. On January 1, 2002 the tax is
scheduled to be raised to 20.71% and capped at $48.75 per thousand large cigars.
14
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In 1999, the Clinton administration proposed additional increases in federal
excise tax on cigarettes which, if enacted as proposed, would increase the
cigarette tax by approximately 141% over the already scheduled increases. If
passed, these taxes will have a proportionately significant impact on all other
tobacco products. PCI believes that the enactment of significantly increased
excise taxes could have a material adverse effect on our business. We cannot
predict the likelihood of the passage or the enactment of future increases in
tobacco excise taxes as they relate to cigars.
Tobacco products also are subject to certain state and local taxes. As evidenced
by the passage of the Proposition 10 referendum in California, an act used to
fund early childhood development programs, children's' health and development
concerns at the state level exert pressure to increase tobacco taxes.
Proposition 10, which became effective on January 1, 1999, raises the tax on
cigars in California from 26.17% of the manufacturer's selling price to 61.53%.
42 states currently impose excise taxes on cigars. Of the eight states without
tobacco taxes, proposals to add such taxes are pending in Maryland, New
Hampshire, Wyoming and West Virginia. State cigar excise taxes are not subject
to caps similar to the federal excise tax. The enactment of new state excise
taxes and the increase in existing state excise taxes are likely to have an
adverse effect on regional sales as cigar consumption generally declines.
TAX FILING COMPLIANCE ISSUES. In March 1998, the State of New York asked PCI to
suspend shipments of cigars to that state until the proper tax applications had
been processed and taxes, penalties and interest had been paid. PCI complied
with New York's request and was subsequently approved to resume shipments to New
York retail accounts. Management did not consider this brief shipment
interruption to be material to its operations.
PCI has registered with the appropriate taxing authorities in the Canadian
provinces and in most of the states in which it currently does business.
Currently, PCI is in arrears in the payment of tobacco taxes in several states
in which it does business. Although we have posted payment bonds in several of
the states, failure to remit taxes could have a material adverse effect on our
operations if one or more of the states initiate enforcement actions.
CANADIAN REGULATIONS. The Canadian Tobacco Act of 1997 was enacted to protect
the health of Canadians, especially young people. The new tobacco legislation
affects all persons who promote or sell tobacco products. The Act prohibits the
sale to persons under 18 years of age, restricts access to tobacco products
through self-service displays and vending machines, direct mail and regulates
advertising and promotions.
TOBACCO INDUSTRY LITIGATION. Historically, the cigar industry has experienced
less health-related litigation than the cigarette and smokeless tobacco
industries have experienced. We carry general commercial liability insurance
with an aggregate limit of $10,000,000. However, we cannot assure you that we
will not be subject to liability which is not covered beyond the limits of our
general liability insurance coverage, and which may have a material adverse
effect upon our business.
RESEARCH AND DEVELOPMENT; ENVIRONMENTAL COMPLIANCE. We have not incurred
research and development costs associated with our products. Historically, PCI
has acquired cigars and accessory product lines from its suppliers and contract
15
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manufacturers and has typically allowed the suppliers and manufacturers to incur
the costs of product research and development. Our policy is to not warehouse or
handle in our facilities any products that require Material Safety Data Sheet
("MSDS") reporting and compliance. Currently, the costs and effects of
environmental compliance do not have a material effect on our financial
condition or operations.
EMPLOYEES. As of December 31, 1998, we had 69 employees in the U.S. and Canada.
Currently we have approximately 44 employees. None of our employees are
represented by a labor union and we believe that employee relations are good.
ITEM 2 - DESCRIPTION OF PROPERTY
At the beginning of 1998, we subleased, from an independent third party,
approximately 8,500 square feet for our corporate offices, warehouse, humidor
storage and distribution facilities located in the Scottsdale Airpark area of
Scottsdale, Arizona. Because we outgrew our facilities, we entered into a new
building lease on February 25, 1998 for approximately 20,434 square feet of
office and warehouse space at 15849 North 77th Street, Scottsdale, Arizona
85260, and moved our operations to the new facilities in late April of 1998. The
new lease expires on April 30, 2003. The monthly rent for the first three years
(May 1998 through April 2001) is $18,000 and the monthly rent for years four and
five (May 2001 through April 2003) is $19,000. PCI is also responsible for
common area maintenance, taxes and certain other incidental costs.
PCI also leases, from an independent third party, approximately 3,064 square
feet of office and warehouse space in Burnaby, British Columbia (a suburb of
Vancouver) for CAN-AM's Canadian operations. The lease expires July 14, 2000 and
the rent is approximately U.S. $1,190, $1,373 and $1,556 per month for the
first, second and third years of the lease, respectively.
ITEM 3 - LEGAL PROCEEDINGS
AUTOMOBILE ACCIDENT. On September 16, 1997, a PCI employee Pete Charleston, was
involved in an automobile accident in which he was the driver and four
passengers were injured. Attorneys for the first three passengers have indicated
that their clients will pursue personal injury claims against PCI, but no
lawsuit has been filed. A fourth passenger has made a demand against the
employee-driver and his insurer only. PCI tendered defense of the claims to, and
requested indemnification from, our commercial general liability carrier, but
the carrier has initially declined coverage on grounds that the endorsement
covering Hired and Non-Owned Auto Liability was not yet effective. We have
disputed the carrier's denial of coverage and we have asserted that PCI obtained
an oral binder of such coverage prior to the accident. We have negotiated and
executed a settlement with the potential claimants pursuant to which Mr.
Charleston's own insurer will pay its policy limits, $300,000 to the claimants.
The claimants have provided to PCI a covenant not to execute against PCI or Mr.
Charleston, and PCI has assigned to the claimants any claims which PCI might
have against its insurer for denying coverage.
PROP 65. PCI and at least two of its customers, Mobil and Southland, have
received notice of violations of Proposition 65, a California regulation which
requires warning labels on certain cancer causing products, including cigars.
Proposition 65 can be enforced by private litigants, and PCI received a letter
from a California attorney, Morse Mehrban, which demanded compliance and
requested settlement. PCI has since distributed to all of its retail outlets in
California a warning label to be attached to each humidor. However, Mr. Mehrban
has brought legal action for sales which occurred prior to PCI's compliance. PCI
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has learned that both Mobil and Southland also have been named in lawsuits
initiated by Mr. Mehrban. Southland claims that the lawsuit filed against it
arose solely from the sale of PCI's products. Pursuant to the agreement between
Southland and PCI, Southland has requested that it be indemnified for these
claims. Mobil has not made a similar indemnification request, and based on the
agreement between Mobil and PCI, Mobil probably cannot claim any indemnification
rights. PCI is currently exploring the possibility of settling with Mr. Mehrban
all claims against PCI and its customers, including Mobil and Southland. In the
meantime, PCI has filed a demurrer and retained California counsel to defend the
cases brought against it and Southland.
LATIN PARTNERS. An agreement has been reached with counsel for Latin Partners,
relating to a delay in payment for merchandise. The lawsuit will be dismissed
with prejudice upon receipt of the final payment and they have agreed to stay
all proceedings in the litigation as long as payments are made in accordance
with the schedule.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
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PART II
ITEM 5 - MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(a) Market for Common Equity.
PCI's common stock under the registered name of Premium Cigars
International, Ltd. is traded on the NASDAQ SmallCap Market as "PCIG" and on the
Boston Stock Exchange as "PCI."
Set forth below are the high and low closing prices for PCI's common
stock as reported on either the NASDAQ SmallCap Market or The Boston Stock
Exchange for the last six quarters.
Quarter High Low
- - ------- ---- ---
September 30, 1997 $5.8125 $4.3750
December 31, 1997 $5.5625 $2.0000
March 31, 1998 $ 2.563 $ 1.313
June 30, 1998 $ 2.438 $ 1.313
September 30, 1998 $ 1.750 $ 0.750
December 31, 1998 $ 1.250 $ 0.500
As of December 31, 1998, there were approximately 30 holders of record
of PCI's common shares, not including those shares held in brokerage accounts.
PCI has never declared or paid a cash dividend on its shares. PCI's
Board of Directors will determine whether to pay cash dividends based upon
results of operations, cash flows, financial condition and liquidity. However,
at present, PCI intends to retain any earnings to fund the development and
growth of its business and does not anticipate paying any cash dividends in the
foreseeable future.
SALE OF UNREGISTERED SECURITIES
During 1998 and through the filing of this annual report, PCI sold a total of
370,000 unregistered securities in private transactions with accredited
investors under Sections 4(2) and 4(6) of the Securities Act, as amended, as
follows:
(a) In January 1999, RCG Capital, Inc. purchased 100,000 restricted shares
from PCI at a price of $0.01 per share. These shares were acquired in connection
with PCI's consulting agreement with RCG as a public relations consultant. PCI
may repurchase the shares over the term of the agreement, at the original
issuance price ($0.01 per share) if certain criteria are not met. If and when
RCG requests removal of the restrictive legends on the shares, RCG must pay PCI
sums ranging from $0.99 to $1.49 per share.
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(b) On January 27, 1999, John Greenwell purchased 70,000 restricted shares
at a purchase price of $0.50 per share.
(c) In February 1999, Clemons F. Walker, Keith A. Cannon and Daniel V.
McLeon purchased 100,000, 60,000 and 40,000 restricted shares, respectively, at
a purchase price of $0.50 per share.
(b) Use of Proceeds.
PCI provides the following information in accordance with Item 701(f) of
Regulation S-B:
1. PCI's Registration Statement on Form SB-2 (File No. 333-29985)
was declared effective on August 21, 1997.
2. The offering commenced on August 21, 1997.
3. The offering did not terminate before any securities were sold.
4(i). On August 29, 1997, PCI closed the sale of 1,900,000 shares of
its common stock to W.B. McKee Securities, Inc., the
Underwriters' Representative (the "main offering"). On September
24, 1997, W.B. McKee Securities, Inc. purchased 88,592 of the
285,000 shares available for the over-allotment option provided
for in PCI's Underwriting Agreement (the "over-allotment
offering"). See "Underwriting" section of PCI's Registration
Statement on Form SB-2 and Item 5 herein. The over-allotment
option on the remaining 196,408 shares of common stock expired
on September 29, 1997. Therefore, the main offering terminated
on August 29, 1997, after the sale of all of the securities
registered; the over-allotment offering terminated on September
29, 1997, with 196,408 registered shares unsold.
4(ii). W.B. McKee Securities, Inc. served as the managing underwriter
for the offering.
4(iii). PCI registered common stock, no par value, in this Registration
Statement on Form SB-2.
4(iv). PCI registered 2,185,000 shares of common stock, no par value,
in its Registration Statement on Form SB-2, for an aggregate
offering price of $11,471,250. These figures include the full
over-allotment of 285,000 shares; however, as stated above, only
88,592 over-allotment shares were purchased by the Underwriters'
Representative. Accordingly, PCI has sold 1,988,592 shares at an
aggregate offering price of $10,440,108.
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4(v). The amount of expenses incurred through December 31, 1997 in
connection with the issuance and distribution of the securities
registered was $2,309,444. This amount is made up of $1,044,011
in underwriter's discounts and commissions, $313,203 in
underwriter's non-accountable expenses, and $952,230 in other
expenses, including consulting fees of $108,662 to David S.
Hodges ($92,245 of which was paid in 1997 and $16,417 was
accrued in 1997 for amounts paid in 1998) and consulting fees of
$10,000 to director William L. Anthony.
4(vi). The net offering proceeds after deducting the above expenses
were $8,130,664.
4(vii). From the effective date of PCI's Registration Statement, August
21, 1997 to December 31, 1998, the net offering proceeds were
applied as follows: $1,200,000 to repayment of debt, $1,289,849
to purchase humidors, $2,030,445 to purchase inventory,
$2,641,867 for sales and marketing and $968,503 in other net
working capital.
4(viii).In addition, net offering proceeds were applied to the
following items, which represent a material change from the use
of proceeds described in the Prospectus dated August 21, 1997:
RAISES TO CERTAIN FOUNDERS AND OTHER KEY EMPLOYEES. Effective
October 1, 1997, certain founders and other key employees
received raises in the range of 17% to 40% which, in the
aggregate, totalled $150,000 on an annualized basis. The
independent directors approved these raises based upon
management's recommendation that the raises be funded from cash
generated from operations. Management implemented the raises
using offering proceeds prior to the availability of operating
proceeds. Subsequently, an independent study performed for PCI
in conjunction with its analysis of incentive compensation
alternatives supports that the majority of the resulting salary
levels were within the market value base compensation ranges for
qualified individuals in these positions. See "Certain
Relationships and Related Transactions - Raises to Certain
Founders and Other Key Employees" in PCI's 10-KSB filed for the
fiscal year ended December 31, 1997.
PAYOUT OF MANAGEMENT FEES. On November 3, 1997, PCI paid each of
Colin A. Jones and Greg P. Lambrecht $80,000, for a total of
$160,000, as lump sum payments of their management fees, which
became due under their Employment Agreements as a result of
PCI's receipt of financing from its initial public offering. See
"Certain Relationships and Related Transactions - Payout of
Management Fees to Greg Lambrecht and Colin Jones" in PCI's
10-KSB filed for the fiscal year ended December 31, 1997.
SEVERANCE COMPENSATION AND SETTLEMENT PAYMENTS. On March 3,
1998, PCI entered into settlement agreements with each of
Messrs. Jones, Greg Lambrecht and Steve Lambrecht acknowledging
the termination of their employment relationships with PCI. PCI
paid each individual: (a) a lump sum payment of $40,000; and (b)
severance compensation of $63,000 and other benefits payable
over nine months under his individual Employment Agreement. In
exchange for the lump sum payment, each individual: (i) agreed
to extend his non-compete clause for six months, for a total of
18 months; and (ii) released PCI from all claims relating to his
Employment Agreement and employment with PCI. See "Certain
Relationships and Related Transactions - Settlement of
Compensation Disputes with Founders" in PCI's 10-KSB filed for
the fiscal year ended December 31, 1997. In 1998, PCI paid
Karissa B. Nisted $40,000 in severance compensation over six
months according to the terms of her Employment Agreement and in
exchange for a limited release. In addition, severance benefits
were paid to Murphy Pierson during 1998 pursuant to the terms of
an Employment Agreement. The aggregate total of these settlement
and severance payments was $395,200.
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ITEM 6 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATION
You must read the following discussion of the results of the operations and
financial condition of PCI in conjunction with PCI's consolidated financial
statements, including the notes included elsewhere in this 10-KSB filing.
Historical results are not necessarily an indication of trends in operating
results for any future period. The consolidated financial statements present the
accounts of PCI and its wholly-owned subsidiary, CAN-AM. All significant
intercompany balances and transactions were eliminated in consolidation.
RESULTS OF OPERATIONS. The following table sets forth a summary of PCI's
consolidated statements of operations for the twelve months ending December 31,
1998, the nine month period ended December 31, 1997 and the pro-forma twelve
month period ended December 31, 1997.
<TABLE>
<CAPTION>
Nine Month Pro-Forma Twelve
Year ended Period Ended Months Ended
December 31, 1998 December 31, 1997 December 31, 1997
----------------- ----------------- -----------------
(Unaudited)
($000) ($000) ($000)
<S> <C> <C> <C>
Net Sales $ 6,900.9 $ 3,362.3 $ 3,695.2
Gross Profit 1,319.1 563.6 646.4
S,G & A and other
operating expenses 5,435.7 2,383.7 2,795.3
Loss From Operations (4,116.5) (1,820.1) (2,148.9)
Other Income 86.7 59.7 48.0
--------- --------- ---------
Net Loss $(4,029.8) $(1,760.4) $(2,100.9)
========= ========= =========
Loss Per Share $ (1.16) $ (.82) $ (.97)
========= ========= =========
Weighted Average Number of
Shares Outstanding 3,469,092 2,156,076 2,160,419
</TABLE>
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FISCAL 1998 COMPARED TO FISCAL 1997
SALES. Sales of cigars and related items for the twelve month period ending
December 31, 1998 were $6,900,927, an increase of 105% versus fiscal 1997 and an
increase of 86.7% compared to the twelve month proforma 1997 period. The
following table summarizes unaudited quarterly results.
Net Sales ($000) (Unaudited)
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Total Year
----------- ----------- ----------- ----------- ----------
1997 $ 332.9 $ 628.2 $1,372.3 $1,361.8 $3,695.2
1998 $1,255.9 $2,018.6 $2,000.6 $1,625.8 $6,900.9
As 1998 progressed, sales associated with the base humidor program became more
difficult to generate. The U.S. Customer Service Department made steady progress
on improving the number of completed calls; however, the humidor productivity
(as measured by average reorder rates) and the close ratio did not improve. If
the program is "working", the average dollars/reorder and the close ratio should
increase. The mid-year Cigar Trade Out program briefly accelerated the close
ratios and the average reorder amount, but once the program was completed, these
key numbers began to decline. There continues to be an opportunity to improve
humidor productivity (e.g., more appropriate SKU's and price points); however,
there may be greater opportunity to focus only on those stores that have
acceptable order history, and alter the approach (i.e., humidibox, instead of a
large humidor, eliminating the account) among accounts who show continued
reluctance to support the humidor program via their lack of order history.
GROSS MARGINS. Gross profit margin for the year ended December 31, 1998 was 19%
versus 17% for fiscal 1997 and 17% for the pro forma twelve month period ended
December 31, 1997. Excluding the effect of a writedown of inventory in the
fourth quarter of 1998 discussed in Item 1 above, gross profit margin for the
year ended December 31, 1998 was 25%. Gross margin has steadily improved as a
result of PCI's integrated systems and more favorable purchasing arrangements
with key suppliers and greater fixed overhead absorption due to higher sales;
however, Can-Am continues to lag the U.S. and we expect that it will continue to
do so in the future. A major problem with Canadian margins is the significantly
higher tobacco taxes. During 1998, U.S. tobacco taxes were 6.4% of Net Sales,
while in Canada, they were 31.4% of Net Sales. The lower margins during the
First Quarter were due mainly to a higher percentage of lower margin cigars that
were sold in Canada, as well as increased labor costs incurred in consolidating
warehouse space and inspecting inventory for possible damage.
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1998 Gross Margins (Unaudited)
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Total Year
----------- ----------- ----------- ----------- ----------
U.S. 18% 31% 34% 40%* 30%*
Canada 8% 23% 20% 19% 19%
Total
Company 14% 27% 27% 29%* 25%*
* Before adjustment to write down inventory to the lower of cost or market.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses (SG&A) were $5,435,700 for the year ended December 31, 1998 compared to
$2,383,700 for fiscal 1997 and $2,795,300 unaudited for the pro forma twelve
month period ended December 31, 1997. As a percentage of sales, SG&A was 79% for
the year ended December 31, 1998 versus 71% for fiscal 1997 and 76% for the pro
forma twelve month period ended December 31, 1997. Excluding the effect of
payment of severance compensation during 1998, SG&A as a percentage of sales in
1998 was 73%.
SG&A is disproportionately high relative to net sales due to the creation of an
intrastructure (people, offices, equipment, etc.) to generate future revenue and
manage operations; however, issues discussed previously have negatively impacted
revenue growth (see Part I - Item 1 - Description of Business). SG&A includes
amortization of humidors which are amortized over two years; however, we
anticipate that the humidors may continue to produce revenue beyond that period.
PCI has taken steps to reduce its SG&A in 1999, including staff reductions that
were announced previously.
OTHER INCOME/EXPENSES. Other income for the year ended December 31, 1998 totaled
$86,700 compared to $59,700 in fiscal 1997 and $48,000 unaudited for the pro
forma twelve month period ended December 31, 1997. Other income consists mainly
of interest income which was earned from the investment of the proceeds from the
initial public offering in August of 1997, offset by interest expense. Interest
expense was incurred in 1997 on bridge loans and other debt that was incurred
prior to PCI's initial public offering. The invested proceeds have since been
used to fund operations. PCI will incur interest expense in 1999 on its accounts
receivable financing agreement.
SEASONALITY.
Our operational history suggests some variation in convenience store impulse
cigar purchases may be tied to outdoor weather conditions. In the northern U.S.
and Canada, sales appear to improve in the warmer months and in the southern
U.S. sales appear to improve in the cooler months. Because we distribute across
the U.S. and Canada, we anticipate that any seasonal variances in the northern
and southern regions will be offsetting and not have a material impact on our
financial condition or operations.
LIQUIDITY AND CAPITAL RESOURCES.
We require capital to market our PCI Cigar program, obtain additional inventory
and humidors to supply our increasing distribution network, and develop the
personnel, facilities, assets, and organization infrastructure necessary to
support our expanding business. Prior to our initial public offering, we raised
capital through the issuance of stock and notes payable, as well as obtaining a
line of credit from a bank. On September 29, 1997 we completed an initial public
offering that resulted in net proceeds to PCI of $8,130,664. See Item 2(c), "Use
of Proceeds" for application of the proceeds.
23
<PAGE>
PCI used $3.1 million for operating activities for the year ended December 31,
1998, which was largely attributable to the net loss incurred during the period.
Non-cash expenses (depreciation and amortization) totalled $794,000. Cash used
for operations includes $395,000 in severance compensation paid to former
management of PCI.
As of December 31, 1998 the combined balance of cash and available for sale
securities totaled $168,000, a decrease of $4,567,000 or 96% from December 31,
1997. The decline is due to the net loss incurred for the year ended December
31, 1998 as well as PCI's continued additional investments in humidors and
property and equipment.
Accounts receivable at December 31, 1998 decreased $76,000 or 12% from December
31, 1997. The decrease is largely due to improved collection efforts in the U.S.
during 1998. A general overall increase in the receivables balance due to
increased sales in 1998 was offset by the write-off of some old balances that
existed at December 31, 1997.
Net inventories at December 31, 1998 increased $3,000, or less than 1% from
December 31, 1997. The change is attributable to: 1) inventory returned by
customers as part of the cigar trade-out program that was implemented during the
first half of 1998; 2) a gradual shift in inventory mix to higher priced, and
therefore, higher cost cigars and 3) an overall increase in the number of cigars
on hand to support a higher volume of sales. This was offset by a $428,000
write-down of our non-core inventory to estimated market value. We are
developing programs to eliminate our investment in obsolete and discontinued
cigars and expect to reduce this figure over the next several months.
As part of PCI's humidor program, a humidor is sent with each initial order of
cigars as new stores are added. While PCI retains ownership of the humidor, the
store is not charged for the humidor unless it is lost or damaged by the store.
Therefore, as new stores continue to be added, PCI requires capital to purchase
the humidors it sends out as part of the initial order. As discussed in Part I -
Item 1 - Description of Business - we expect future humidor purchases to be
minimal.
Capital expenditures (excluding humidors) totaled $592,000 for the year ended
December 31, 1998. This included the cost of new office furniture and leasehold
improvements for our new facility, continued investment in computer equipment
and software applications, and warehouse machinery and equipment. We do not
anticipate any significant capital spending needs for the foreseeable future.
Accounts payable and accrued expenses at December 31, 1998 increased $21,500, or
2% from December 31, 1997. Decreases in the amount of tobacco taxes payable were
largely offset by increases in trade payables due to our inability to secure
financing until 1999.
We have no current plans that represent a material change from the use of
proceeds described in the Prospectus dated August 21, 1997. We have secured a
$1,000,000 accounts receivable financing package which, assuming sales forecasts
are achieved, we believe will provide the necessary working capital for our
immediate ongoing needs; however, we cannot assure you that we can generate
24
<PAGE>
sufficient revenues to provide the cash flow necessary to meet our ongoing
working capital needs, nor to repay prior existing trade indebtedness. We have
raised an additional $135,000 during the first quarter of 1999 through the
issuance of additional shares of PCI's stock. The Board of Directors has
authorized the issuance of additional shares for up to an additional $200,000.
However, it is likely that PCI will have to raise additional capital through the
sale of some of its assets in order to raise the necessary capital to repay the
trade debt it has incurred over the past several months. We cannot assure you
that we will be able to sell sufficient assets to enable us to repay our
outstanding trade debt in a timely manner.
KNOWN TRENDS, EVENTS OR UNCERTAINTIES THAT MAY IMPACT OUR FINANCIAL CONDITION OR
OPERATIONS.
YEAR 2000 ISSUES. We purchased most of our computers within the past year and do
not anticipate any significant problems relative to their Year 2000 ("Y2K")
capabilities. Testing of each machine's capabilities is expected to be completed
by the end of the Second Quarter, 1999. We have not yet implemented a plan to
identify the non-IT (Information Technology) systems (i.e., those systems with
an imbedded technology such as microcontrollers) which may require repair or
replacement; however, given the nature of our operations and the age of our
business, we do not believe that we face any material risk from these types of
systems.
Our business relies to a large extent on our integrated accounting, order entry,
and inventory control systems (SBT Pro Series 5.0), which is represented by the
vendor as being Y2K compliant. We also rely on standard office productivity
software (Microsoft Office 97) which is also represented as being Y2K compliant.
Our EDI software, which we use to transmit invoices and receive payment
information from our largest U.S. customer is represented to be non-compliant.
The cost to replace this software is not expected to be material and we intend
to identify suitable alternatives by the end of the Second Quarter, 1999. We are
in the process of determining the compliance of our other software and expect to
have this completed by the end of the Second Quarter.
We have begun the process of contacting key customers, vendors, service
providers and other third parties with whom business is conducted to determine
what impact, if any, their Y2K readiness will have on us; this process is
expected to be completed by the end of the Second Quarter, 1999. Although we do
not anticipate any material adverse effect on our business as a result of such
parties failure to achieve Y2K readiness, we cannot assure you that these
parties will have accurately assessed their Y2K readiness status.
At this time, we do not believe that we will incur any material expenditures to
identify and replace, as necessary, any Y2K non-compliant systems. We do not
anticipate any material effect to our business from any non-compliant PCI-owned
systems; however, we are unable at this time to determine what, if any, effect
on our business will occur from any third parties non-compliant systems. We
expect to be better able to assess this uncertainty as we obtain more Y2K
information from these parties.
We do not currently have a contingency plan in place to handle a "worst case
scenario", as we believe that any non-compliant systems on our part do not pose
a material risk to PCI. If, and to the extent that we identify material risks to
PCI from third parties non-compliance, we will formulate a plan at that time.
25
<PAGE>
ITEM 7 - FINANCIAL STATEMENTS
PCI's audited financial statements for the year ended December 31, 1998 and the
nine month period ended December 31, 1997 are set forth commencing on page F-1,
following the Index to Financial Statements on Page xx.
ITEM 8 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
26
<PAGE>
PART III
ITEM 9 - DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT DIRECTORS AND EXECUTIVE
OFFICERS
Name Age Position
- - ---- --- --------
John E. Greenwell......... 51 Director, Chief Executive Officer, President,
Chief Operating Officer
Scott I. Lambrecht........ 27 Vice President of Operations and Secretary
James B. Stanley.......... 35 Vice President of Purchasing and Assistant
Secretary
Brendan McGuinness........ 51 Vice President of Sales
Colin A. Jones............ 32 Director
Greg P. Lambrecht......... 36 Director
Steven A. Lambrecht....... 47 Director
Mark Jazwin............... 33 Independent Director
Gary Sherman.............. 50 Independent Director
JOHN E. GREENWELL has been a director and PCI's Chief Executive Officer since
March 1, 1998 and PCI's President and Chief Operating Officer since December 15,
1997. Mr. Greenwell previously was employed by The Dial Corporation from 1984 to
1996, culminating with his position as Executive Vice President and the General
Manager of Dial's Detergent Division. He has 29 years of marketing and executive
management experience in the consumer package goods industry. Prior to his
Executive Vice President role with The Dial Corporation, Mr. Greenwell was
Senior Vice President and General Manager of Dial's Food Division. He has served
in consumer marketing responsibilities for The Dial Corporation, Texize (a
former division of Morton Thiokol), Drackett (a former division of Bristol
Myers), the advertising agency of Leo Burnett Company and a sales position with
The Chicago Tribune. Mr. Greenwell has also served as a member of the Board of
Directors for the Soap & Detergent Association and the National Food Processors
Association. Mr. Greenwell received a B.S. degree in Business from Indiana
University in 1969.
SCOTT I. LAMBRECHT has been the Vice President of Operations since August 7,
1997 and PCI's Secretary since March 4, 1998. He previously served as PCI's
Assistant Secretary from May 31, 1997 to March 4, 1998. He served as a director
from December 31, 1996 to February 17, 1997 and as PCI's interim President from
December 31, 1996 to May 3, 1997. From July 1993 through December 1996 he served
as President of SDCC. Inc., a Scottsdale, Arizona general contracting firm owned
by Steve Lambrecht. He received a Bachelors degree in Construction Management in
1993 from Arizona State University in Tempe, Arizona. Scott Lambrecht is the son
of Steven A. Lambrecht and the nephew of Greg P. Lambrecht.
27
<PAGE>
JAMES B. STANLEY has been Vice President of Purchasing since June 20, 1997
and PCI's Assistant Secretary since March 4, 1998. From November 1996 to June
1997, he served as Purchasing Director for PCI. From May 1996 to October 1996 he
served as an Account Executive for Computer Credit Insurance Corp. of Brea,
California in the real estate loan and mortgage insurance market. From November
1995 to May 1996 he was an Account Executive for Senior Estate Services, a
Bellevue, Washington estate planning and investment firm. From June 1994 to
November 1995 he was Operations Manager for Promark Armrest, Inc. of Everett,
Washington, a product development firm. He has owned and developed two
successful restaurants in the Seattle area over the previous six years. Mr.
Stanley received a B.A. in Business Administration from Washington State
University in 1985.
BRENDAN M. MCGUINNESS has been the Vice President of Sales since May 12,
1998. Prior to that, he was a sales consultant to PCI from February 1, 1998 and
the Acting Vice President of Sales from March 3, 1998. Mr. McGuinness previously
was employed by The Dial Corporation from 1973 to 1997, culminating with his
position as the Vice President of Sales- Personal Care Division. Prior to that
position he was Vice President and General Manager of Dial's Commercial Markets
Division, which markets and distributes products serving the Lodging,
Industrial, and Medical classes of trade. He has held additional sales
management positions at The Dial Corporation, including Vice President of
National Field Sales, with responsibility for the direction of 250 consumer
products sales professionals generating annual sales exceeding $1 billion
dollars. Mr. McGuinness received a B.S. in Business from Bryant College in 1970.
He is a board member of the Arizona Chapter of the Juvenile Diabetes Foundation.
COLIN A. JONES has been a director since May 3, 1997. He previously served as
Vice President of International Sales from May 31, 1997 to January 16, 1998. He
has 13 years of experience managing, marketing and selling to the convenience
store and grocery store market. In 1985, he founded J&M Wholesale, Ltd., a
British Columbia corporation which delivers various wholesale products primarily
to convenience store accounts in Canada. He continues to be the President and
Chief Executive Officer of J&M. Mr. Jones attended Douglas College of New
Westminster, British Columbia, Canada.
GREG P. LAMBRECHT has been a director since August 7, 1997. He previously
served as PCI's Vice President of National Sales from May 31, 1997 to March 2,
1998 and as PCI's Secretary and Treasurer from May 31, 1997 to March 4, 1998. He
has 14 years of experience managing, marketing and selling to the convenience
store and grocery store market. In 1984, he founded Rose Hearts, Inc., a
Washington company which delivers various impulse purchase products in
Washington, Oregon and California. He graduated with a B.A. in Communications
from Western Washington University in 1984. Greg P. Lambrecht is the brother of
Steven A. Lambrecht and the uncle of Scott I. Lambrecht.
STEVEN A. LAMBRECHT has been a director since December 31, 1996. He
previously served as PCI's Chief Executive Officer from December 31, 1996 to
March 1, 1998, as President from May 3, 1997 to December 15, 1997 and as
Chairman of the Board from December 31, 1996 to June 20, 1997. He has 24 years
of marketing and sales experience and 18 years of management experience; most of
his business experience has been in real estate development and construction. He
is the owner of Forum Import/Export Company, a sole proprietorship, and was
co-owner of Forum Development and Construction Company, Inc., a Washington
corporation. He also owns SDCC, Inc., an Arizona development and construction
corporation that he founded in 1992. He has developed and sold over 20 million
dollars worth of real estate since 1974. Steven A. Lambrecht is the brother of
Greg P. Lambrecht and the father of Scott I.
Lambrecht.
28
<PAGE>
MARK JAZWIN has been an independent director since January 1999. Since
1997, Mr. Jazwin has been the President of W.B. McKee Securities, a regional
securities broker/dealer headquartered in Scottsdale. Previously Mr. Jazwin
served W.B. McKee Securities in a variety of positions in Corporate Finance from
1995 to 1997. Prior to 1995 Mr. Jazwin was a securities analyst at StockVal, a
privately held research firm. Prior to StockVal, Mr. Jazwin worked in a branch
office of Merrill Lynch. He holds a Bachelors degree in Finance from Arizona
State University.
GARY SHERMAN has been an independent director since March 1999. He is
currently Executive Vice President of Heritage West Securities, a regional
broker/dealer in Scottsdale. Mr. Sherman has 25 years of management and sales
experience. Since 1990, he has been President of both W.B. McKee Securities,
Inc. and Owen-Joseph Asset Management. From 1976 to 1990, he served as a General
Partner with Boettcher & Company, a NYSE Member headquartered in Denver,
Colorado; as well as Senior Vice President and Regional Director of Kemper
Securities after their purchase of Boettcher in 1986. Mr. Sherman majored in
Finance at the University of Denver and attended the Securities Institute at the
Wharton School of Finance.
OTHER EXECUTIVES AND KEY EMPLOYEES
STANLEY R. HALL has been the Controller since February 7, 1998. From April,
1997 to February, 1998, Mr. Hall served as Chief Financial Officer and
Controller for Pro-Innovative Concepts, Inc., a Phoenix, Arizona premium
promotion company. From January, 1995 to March, 1997 he served in various
financial management and accounting capacities in The Dial Corp's Household
Consumer Products Division and Corporate Controller's department. From 1983 to
1994, he served as Chief Financial Officer and Controller for Hyder Jojoba,
Inc., a Phoenix-based grower and marketer of jojoba seeds and oil. From 1981 to
1982, he served as Controller for The Thirteenth Regional Corporation, an
Alaskan Native Corporation based in Seattle, WA. From 1977 to 1981, he was a
Senior Accountant for Deloitte Haskins & Sells, a "Big Five" public accounting
firm. Mr. Hall received a B.B.A. in accounting from the University of Washington
in 1977. He is licensed as a Certified Public Accountant in the State of
Washington and is a member of the American Institute of Certified Public
Accountants.
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
The following persons were, during the last fiscal year, either directors,
officers, or beneficial owners of more than ten percent (10%) of a class of
equity securities registered pursuant to Section 12 of the Exchange Act of 1934
and failed to file the following reports required by Section 16(a) during the
most recent fiscal year or prior years which have not previously been disclosed:
The following persons did not file any Forms 4 during the fiscal year
ended December 31, 1998 and have not provided PCI with a written representation
that no such forms were required: William Anthony and Robert Manschot.
29
<PAGE>
ITEM 10 - EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Other Securities
Name and Annual Restricted Underlying All Other
Principal Bonus Compen Stock Awards Options/ LTIP Compen-
Position Year Salary ($) ($) -sation($) ($) Sars (#) Payouts ($) sation
- - -------- ---- ---------- --- ---------- ----------- -------- ----------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
John
Greenwell/CEO(1) 1998 144,231 -- -- -- -- -- --
Steve 80,546 42,850
Lambrecht/CEO(2) 1998 (5) -- -- -- -- -- (3)(4)
Greg
Lambrecht/ 83,777 42,500
VP Sales 1998 (5) -- -- -- -- -- (3)(4)
Colin Jones /VP 75,564 43,600
Int. Sales 1998 (5) -- -- -- -- -- (3)(4)
</TABLE>
(1) Took office March 1, 1998.
(2) Left office March 1, 1998.
(3) Includes $40,000 payment to settle compensation dispute. See "Executive
Compensation - Employment Agreements Settlement of Compensation Disputes
with Founders" in PCI's Form 10-KSB filed for the fiscal year ended
December 31, 1997.
(4) Includes fees paid for attendance at Board of Directors meetings.
(5) Includes nine months salary for severance compensation in accordance
with terms of employment agreements. See "Executive Compensation -
Employment Agreements" in PCI's Form 10-KSB filed for the fiscal year
ended December 31, 1997.
30
<PAGE>
OPTION/SAR GRANTS IN LAST FISCAL YEAR
Individual Grants
Number of % of Total
Securities Options/SARs
Underlying Granted to Exercise or
Options/SARs Employees in Base Price
Name Granted (#) Fiscal Year ($/Sh) Expiration Date
--------- --------- ----------- ---------- ---------------
John
Greenwell / CEO -- -- -- --
Brendan
McGuinness / VP Sales 20,000 100% $5.25 --
(1) Options granted pursuant to a Stock Option Agreement dated May 8, 1998.
Options to purchase 10,000 shares vested on May 8, 1998. Options to
purchase an additional 10,000 shares vested on September 1, 1998.
31
<PAGE>
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES
<TABLE>
<CAPTION>
Number of
Securities Value of
Underlying Unexercised
Unexercised In-the-Money
Options/SARs Options/SARs
at FY-End(#) at FY-End ($)
Shares
Acquired on Value Exercisable / Exercisable /
Name Exercise Realized ($) Unexercisable Unexercisable
--------- --------- ----------- ------------- -------------
<S> <C> <C> <C> <C>
40,000 Not in-the-Money and
Exercisable Exercisable
10,000 Not-in-the-Money and
John Greenwell / CEO -- -- Unexercisable(1) Unexercisable
Steve Lambrecht / 20,000 Not-in-the-Money and
Former CEO -- -- Exercisable Exercisable
Brendan McGuinness 20,000 Not-in-the-Money and
/ VP Sales -- -- Exercisable Exercisable
(1) Options to purchase 10,000 shares at $5.25 per share, unexercisable
until June 30, 1999.
</TABLE>
32
<PAGE>
DIRECTOR COMPENSATION TABLE
<TABLE>
<CAPTION>
Annual Retainer Consulting Number of
Name Fees ($) Meeting Fees ($) Fees/other Fees ($) Shares (#)
- - ---- -------- ---------------- ------------------- ----------
<S> <C> <C> <C> <C>
William L. Anthony -- 4,650 -- --
Robert H. Manschot -- 2,850 -- --
David S. Hodges -- 3,150 19,200(1) --
Atul Vashistha -- 3,600 -- --
Steve Lambrecht -- 2,850 -- --
Greg Lambrecht -- 2,500 -- --
Colin Jones -- 3,600 -- --
</TABLE>
(1) Consulting fees paid as termination payments under a Business Consulting
Agreement dated June 2, 1997 as more fully described in PCI's Form
10-KSB filed for the fiscal year ended December 31, 1997.
EMPLOYMENT AGREEMENTS
JOHN E. GREENWELL has an at-will Employment Agreement with PCI as President,
Chief Executive Officer and Chief Operating Officer. The initial salary was
$120,000, but increased, pursuant to the agreement's terms, to $150,000 a year
upon his becoming Chief Executive Officer on March 1, 1998. Mr. Greenwell is
eligible for any bonus plan or stock option plan offered to other comparable
executives and was granted a bonus of $50,000 for the fiscal year ending
December 31, 1998. At this time, Mr. Greenwell has agreed to defer payment of
the $50,000 bonus for the fiscal year ending December 31, 1998. Additionally, as
of January 18, 1999 and to date, Mr. Greenwell has declined to accept any
payment for his services rendered to PCI.
CONSULTING AGREEMENTS. During 1998, we also had arrangements with the following
consultants:
L.G. ZANGANI, INC. AND LEONARDO G. ZANGANI AGREEMENTS. PCI entered a Consulting
Agreement, effective September 16, 1997, with L.G. Zangani, Inc., which is
discussed in further detail in PCI's Form 10-KSB filed for the fiscal year
ending December 31, 1997. On approximately December 2, 1998, PCI notified L.G.
Zangani, Inc. of the termination of the Consulting Agreement.
33
<PAGE>
RCG CAPITAL, INC. On or about December 14, 1998, RCG Capital, Inc. (Mr. Max
Ramras, President/CEO) entered into a Consulting Agreement with PCI to represent
PCI as its financial public relations consultant for $5,500 per month, plus
expenses, and the ability to purchase 100,000 restricted shares of PCI's common
stock at a price of $.01 per share. The shares are subject to repurchase by PCI
in the event certain incentive goals are not achieved. RCG Capital, Inc. has
agreed to pay PCI an amount ranging from $0.99 to $1.49 per share upon the
removal of any and all restrictive legends.
STANDING ARRANGEMENTS FOR OUTSIDE DIRECTOR COMPENSATION. PCI has standing
arrangements to grant each outside director options to purchase 5,000 shares of
common stock and the Chairman additional options to purchase 2,500 shares of
common stock on February 1 of each year at the market price on the date of the
grant, but not less than $5.25 per share, to vest in quarterly increments of
1,250 (1,875 for the Chairman) and which shall be exercisable 1 to 5 years from
the date each quarterly increment vests. The options are non-qualified. To date,
PCI has not formally granted any such options to the outside directors. PCI also
pays all outside directors, including non-employee directors, for all meetings
attended (whether regular or additional meetings) at the rate of $350 per
meeting for meetings of up to four (4) hours and $750 per meeting for meetings
over four (4) hours.
ITEM 11 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following tables set forth certain information regarding shares of common
stock beneficially owned as of March 31, 1999 by (i) each person or group known
to PCI, which beneficially owns more than 5% of the common stock; (ii) each of
PCI's officers and directors; and (iii) all officers and directors as a group.
The percentage of beneficial ownership is based on 3,839,092 shares outstanding
on March 31, 1999 plus, for each person or group, any securities that person or
group has the right to acquire within 60 days pursuant to options, warrants,
conversion privileges or other rights. Unless otherwise indicated, the following
persons have sole voting and investment power with respect to the number of
shares set forth opposite their names:
34
<PAGE>
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
Title of Name and Address of Amount and Nature of Percent
Class Beneficial Owner Beneficial Ownership of Class
----- ---------------- -------------------- --------
Common John E. Greenwell 476,600(1) 12.41%
16216 North 63rd Place
Scottsdale, Arizona 85254
Common Greg P. Lambrecht 246,770(1)(2) 6.44%
2323 North Central Avenue
Suite 2004
Phoenix, Arizona 85004
Common Steven A. Lambrecht 266,256(1)(2) 6.94%
11259 East Via Linda
Suite 100-102
Scottsdale, Arizona 85259
Common Lincoln Heritage Life 210,476(3) 5.48%
Insurance Company
4343 E. Camelback Rd. #400
Phoenix, Arizona 85018
Common Londen Insurance Group 210,476(3) 5.48%
4343 E. Camelback Rd. #400
Phoenix, Arizona 85018
(1) Includes shares which may be acquired by the exercise of options or
warrants within 60 days as follows: John E. Greenwell, 40,000 shares,
Steven A. Lambrecht, 21,250 shares, and Greg. P. Lambrecht, 1,250
shares. Excludes shares underlying options which are not currently
exercisable as follows: John E. Greenwell, 10,000 shares.
(2) Steven A. Lambrecht is the brother of Greg P. Lambrecht and the father
of Scott I. Lambrecht. Each of the Lambrechts disclaims any beneficial
interest in the shares held by the others.
(3) Represents beneficial ownership of 20,000 shares held of record by Life
of Boston Insurance Company and of 95,057 shares each which may be
acquired directly by the exercise of stock warrants within 60 days by
Lincoln Heritage Life Insurance Company and Life of Boston Insurance
Company. The Londen Insurance Group is the sole shareholder of the
Lincoln Heritage Life Insurance Company. Lincoln Heritage Life Insurance
Company owns 79% of the shares of Life of Boston Insurance Company.
35
<PAGE>
SECURITY OWNERSHIP OF MANAGEMENT
Title of Name and Address of Amount and Nature of Percent
Class Beneficial Owner Beneficial Ownership of Class
----- ---------------- -------------------- --------
Common Mark Jazwin 14,226(1) (3)
7702 E. Doubletree Ranch Rd.
Suite 230
Scottsdale, AZ 85258
Common John Greenwell 476,600(1) 12.41%
16216 North 63rd Place
Scottsdale, Arizona
Common Gary Sherman 27,846(1) (3)
6063 E. Cortez Drive
Scottsdale, AZ 85254
Common Colin Jones 138,972 3.62%
7349 Via Paseo del Sur
Suite 515-166
Scottsdale, Arizona 85258
V6Z-2S6
Common Greg P. Lambrecht 246,770(1)(2) 6.94%
6980 East Sahuaro Drive
Apt. 1129
Scottsdale, Arizona 85254
Common Steven A. Lambrecht 266,256(1)(2) 6.38%
11259 East Via Linda
Suite 100-102
Scottsdale, Arizona 85259
Common Scott I. Lambrecht 86,250(1)(2) 2.25%
15849 North 77th Street
Scottsdale, Arizona 85260
Common James B. Stanley 26,250 (3)
15849 North 77th Street
Scottsdale, Arizona 85260
Common Brendan N. McGuinness 20,222(1) (3)
Common All Officers and Directors 1,284,246(1)(2) 33.45%
as a group (10 persons)
36
<PAGE>
(1) Includes shares which may be acquired by the exercise of options or
warrants within 60 days as follows: John E. Greenwell, 40,000 shares,
Steven A. Lambrecht, 21,250 shares, Colin A. Jones and Greg P.
Lambrecht, 1,250 shares each, Brendan McGuinness, 20,000 shares, Gary
Sherman, 9,573 shares and Mark Jazwin, 9,456 shares. Excludes shares
underlying options which are not currently exercisable as follows: John
E. Greenwell, 10,000 shares.
(2) Steven A. Lambrecht is the brother of Greg P. Lambrecht and the father
of Scott I. Lambrecht. Each of the Lambrechts disclaims any beneficial
interest in the shares held by the others.
(3) Less than 1%.
ITEM 12 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
RESOLVING CONFLICTS OF INTEREST.
A number of the transactions described in this section involve inherent
conflicts of interest because an officer, director, significant shareholder,
promoter or other person with a material business or professional relationship
with PCI is a party to the transaction. Our current policy adopted by our board
of directors regarding transactions involving conflicts of interest, is:
(i) we will not enter into any material transaction or loan with a related
or affiliated party unless the transaction or loan is on terms that are no less
favorable to us than we could obtain from an unrelated or unaffiliated third
party; and
(ii) a majority of the independent directors (those who do not have a
material business or professional relationship with PCI other than being a
director) who have no interest in the transactions must review and approve
transactions involving related parties or conflicts of interest after having
been given access, at our expense, to our counsel or to their own independent
legal counsel; and
(iii) when there are only two independent directors, both directors must
approve the transaction; and
(iv) the independent director approval applies to all related-party
transactions and loans, whether or not to a related-party.
We currently have two independent directors, Mark Jazwin and Gary Sherman. Our
independent directors have had access, at our expense, to our counsel or to
independent counsel, and a majority of the independent directors have ratified
all related-party transactions that are ongoing.
JONES/LAMBRECHT NOTES RECEIVABLE. Colin A. Jones and Greg P. Lambrecht each
delivered to PCI long term promissory notes for $43,112.50. The notes are dated
December 31, 1996, accrue interest at six percent, and all interest and
principal are due on March 31, 1999. The notes relate to CAN-AM receivables
which accrued prior to PCI's acquisition of all of CAN-AM's outstanding stock on
December 31, 1996. The independent directors have approved a one-time extension
for the repayment of these notes to September 30, 1999. In exchange, Messrs.
Jones and Lambrecht have agreed to increase the interest rate for the notes from
six to ten percent.
37
<PAGE>
SINGLE CIGARS, INC. As discussed in PCI's Form 10QSB filed for the quarter ended
September 30, 1998, PCI entered into a Supplier Agreement with Single Cigars,
Inc., a wholly owned subsidiary of Single Stick, Inc., dated October 5, 1998,
under which Single Cigars, Inc. will supply little cigars known as Prime
Time(TM) and countertop control units exclusively to PCI for distribution by
PCI. Greg Lambrecht, a director of PCI, has entered into a consulting
arrangement with Single Stick, Inc. Pursuant to his relationship with Single
Stick, Inc., Greg Lambrecht will receive consideration including two percent
(2%) of the net collected sales price received by Single Stick, Inc. from sales
of Prime Time(TM) to PCI, as well as shares of Single Stick, Inc. if certain
sales criteria are met for the Prime Time(TM) product. Additionally, Greg
Lambrecht received a retainer and shares of Single Stick, Inc. under his
consulting agreement with Single Stick, Inc. PCI's Board of Directors including
all of PCI's independent directors, have approved the transaction with Single
Stick, Inc. and have found the terms to be fair to PCI.
ITEM 13 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
Number Exhibit Name Method of Filing
- - ------ ------------ ----------------
3.1 Articles of Incorporation **
3.2 By-Laws, as amended ***
4.1 Specimen Common Stock Certificate ****
4.2 Description of Rights of Security Holders *****
10.1 Accounts Receivable Line of Credit with
Alliance Financial Capital dated
March 12, 1999. Exhibit filed herewith*
10.2 Consulting Agreement with RCG Capital, Inc.
dated December 14, 1998. Exhibit filed herewith*
27.1 Financial Data Schedule Exhibit filed herewith
99.1 "Underwriting" section of Registration
Statement on Form SB-2 ******
* Portions of the exhibit omitted and filed separately with the Commission
pursuant to the Confidential Treatment provisions of Regulation ss.
230.406.
** Incorporated by reference to Exhibit 3.1 of Registration Statement on
Form SB-2 (file no. 333-29985) declared effective on August 21, 1997.
38
<PAGE>
*** Incorporated by reference to Exhibit 3.2 of Registration Statement on
Form SB-2 (file no. 333-29985) declared effective on August 21, 1997.
*** Incorporated by reference to Exhibit 4.2 of Registration Statement on
Form SB-2 (file no. 333-29985) declared effective on August 21, 1997.
**** Incorporated by reference to Exhibit 4.1 of Registration Statement on
Form SB-2 (file no. 333-29985) declared effective on August 21, 1997.
***** Incorporated by reference to pages 56-57 of Registration Statement on
Form SB-2 (file no. 333-29985) declared effective on August 21, 1997.
(b) Reports on Form 8-K
Date of Date
Report Filed Description
------ ----- -----------
January 15, 1999 January 15, 1999 Disclosure of Proposition 65 Litigation
Potential Nasdaq Delisting and Status
of Financing
39
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
PREMIUM CIGARS INTERNATIONAL, LTD.
By: /s/ John E. Greenwell
---------------------------------------------
John E. Greenwell, President, Chief Executive
Officer and Chief Operating Officer
Date: March 31, 1999
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
Signature Title Date
--------- ----- ----
By: /s/ John E. Greenwell Director, President, 03/31/99
--------------------------- Chief Executive Officer
John E. Greenwell and Chief Operating Officer
By: /s/ Stanley R. Hall Controller and principal 03/31/99
--------------------------- accounting officer
Stanley R. Hall
By: /s/ Colin A. Jones Director 03/31/99
---------------------------
Colin A. Jones
By: /s/ Greg P. Lambrecht Director 03/31/99
---------------------------
Greg P. Lambrecht
By: /s/ Steven A. Lambrecht Director 03/31/99
---------------------------
Steven A. Lambrecht
By: /s/ Mark Jazwin Director 03/31/99
---------------------------
Mark Jazwin
By: /s/ Gary Sherman Director 03/31/99
---------------------------
Gary Sherman
By: /s/ Scott I. Lambrecht Vice President of Operations 03/31/99
--------------------------- and Secretary
Scott I. Lambrecht
By: /s/ James B. Stanley Vice President of Purchasing 03/31/99
--------------------------- and Assistant Secretary
James B. Stanley
40
<PAGE>
PREMIUM CIGARS INTERNATIONAL, LTD.
AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
For The Year Ended December 31, 1998 and
For The Nine Month Period Ended
December 31, 1997
<PAGE>
INDEPENDENT AUDITORS' REPORT
To The Board of Directors of
Premium Cigars International, Ltd.
We have audited the accompanying consolidated balance sheet of Premium Cigars
International, Ltd. and Subsidiary as of December 31, 1998, and the related
consolidated statements of operations, comprehensive operations, changes in
stockholders' equity, and cash flows for the year ended December 31, 1998, and
for the nine month period ended December 31, 1997. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
consolidated financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Premium Cigars
International, Ltd. and Subsidiary as of December 31, 1998, and the results of
its operations, statements of comprehensive income, changes in stockholders'
equity, and its cash flows for the year ended December 31, 1998, and for the
nine month period ended December 31, 1997, in conformity with generally accepted
accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 19 to the
financial statements, the Company's significant operating losses raise
substantial doubt about its ability to continue as a going concern. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
Semple & Cooper, LLP
Phoenix, Arizona
March 18, 1999
<PAGE>
PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEET
December 31, 1998
ASSETS
Current Assets:
Cash and cash equivalents (Notes 1 and 2) $ 168,216
Accounts receivable - trade, net (Note 1) 561,259
Notes receivable - related parties (Note 4) 100,021
Inventory, net (Notes 1 and 6) 1,325,282
Other current assets 39,106
-----------
Total Current Assets 2,193,884
-----------
Property and Equipment, net (Notes 1 and 7) 627,210
-----------
Other Assets:
Humidors, net (Note 1) 888,925
Organizational costs, net (Note 1) 26,536
Deposits 29,577
-----------
945,038
-----------
Total Assets $ 3,766,132
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable - trade $ 849,748
Accrued expenses
- tobacco taxes 103,330
- other (Note 8) 220,427
-----------
Total Current Liabilities 1,173,505
-----------
Commitments and Contingencies: (Notes 4, 10 and 17) --
-----------
Stockholders' Equity: (Note 11)
Common stock - no par value, 10,000,000 shares
authorized, 3,469,092 shares issued and
outstanding 8,655,339
Additional paid-in capital 150,000
Common stock warrants 1,710
Foreign currency translation adjustment (Notes 1 and 14) (73,072)
Accumulated deficit (6,141,350)
-----------
Total Stockholders' Equity 2,592,627
-----------
Total Liabilities and Stockholders' Equity $ 3,766,132
===========
The Accompanying Notes are an Integral Part
of the Consolidated Financial Statements
F-2
<PAGE>
PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
For The Year Ended December 31, 1998 and
For The Nine Month Period Ended December 31, 1997
Nine Month
Year Ended Period Ended
December 31, December 31,
1998 1997
----------- -----------
Net Sales $ 6,900,927 $ 3,362,275
Cost of Sales 5,153,947 2,798,672
Charge for inventory adjustment (Note 8) 427,830 --
----------- -----------
Gross Profit 1,319,150 563,603
Selling, General and Administrative 5,040,507 2,273,725
Officers severence 395,173 --
Stock Based Compensation (Note 11) -- 110,000
----------- -----------
Loss from Operations (4,116,530) (1,820,122)
----------- -----------
Other Income (Expense):
Interest income 96,520 113,131
Interest expense (46) (44,272)
Loss on sale of fixed assets and humidors (15,492) --
Other 9,567 918
Foreign currency transaction loss (3,844) (10,038)
----------- -----------
86,705 59,739
----------- -----------
Net Loss $(4,029,825) $(1,760,383)
=========== ===========
Basic loss per Share (Note 1) $ (1.16) $ (.82)
=========== ===========
Weighted Average Number of Shares Outstanding 3,469,042 2,156,076
=========== ===========
The Accompanying Notes are an Integral Part
of the Consolidated Financial Statements
F-3
<PAGE>
PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
For The Year Ended December 31, 1998 and
For The Nine Month Period Ended December 31, 1997
Nine Month
Year Ended Period Ended
December 31, December 31,
1998 1997
---------- ----------
Net Loss $(4,029,825) $(1,760,383)
Other Comprehensive Income (Loss):
Foreign currency translation adjustment (76,443) 3,371
----------- -----------
Comprehensive Loss $(4,106,268) $(1,757,012)
=========== ===========
The Accompanying Notes are an Integral Part
of the Consolidated Financial Statements
F-4
<PAGE>
PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For The Year Ended December 31, 1998 and
For The Nine Month Period Ended December 31, 1997
Common Stock Additional
------------------- Paid-in Common Stock
Shares Amount Capital Warrants
------ ------ ------- --------
Balance, March 31, 1997 1,480,500 $ 419,675 $ -- $ --
Purchase of treasury
stock (15,000) -- -- --
Treasury shares issued
for services 15,000 32,500 -- --
Additional compensation
recorded on private
transactions -- 72,500 -- --
Additional capital
contribution -- -- 150,000 --
Shares issued in initial
public offering, net of
offering costs of
$2,309,444 1,988,592 8,130,664 -- --
Proceeds from issuance
of warrants -- -- -- 1,710
Aggregate adjustment
resulting from
translation of
financial statements
into U.S. dollars -- -- -- --
Net loss for the nine
month period ended
December 31, 1997 -- -- -- --
--------- ---------- -------- ------
Balance at
December 31, 1997 3,469,092 8,655,339 150,000 1,710
Aggregate adjustment
resulting from
translation of
financial statements
into U.S. dollars -- -- -- --
Net loss for the nine
month period ended
December 31, 1997 -- -- -- --
--------- ---------- -------- ------
Balance at
December 31, 1998 3,469,092 $8,655,339 $150,000 $1,710
========= ========== ======== ======
Foreign
Currency Total
Treasury Translation Accumulated Stockholders'
Stock Adjustment Deficit Equity
----- ---------- ------- ------
$ -- $ -- $ (351,142) $ 68,533
Balance, March 31, 1997
Purchase of treasury (5,000) -- -- (5,000)
stock
Treasury shares issued 5,000 -- -- 37,500
for services
Additional compensation
recorded on private -- -- -- 72,500
transactions
Additional capital -- -- -- 150,000
contribution
Shares issued in initial
public offering, net of
offering costs of -- -- -- 8,130,664
$2,309,444
Proceeds from issuance -- -- -- 1,710
of warrants
Aggregate adjustment
resulting from
translation of
financial statements -- 3,371 -- 3,371
into U.S. dollars
Net loss for the nine
month period ended -- -- (1,760,383) (1,760,383)
December 31, 1997 ------- -------- ----------- -----------
Balance at -- 3,371 (2,111,525) 6,698,895
December 31, 1997
Aggregate adjustment
resulting from
translation of
financial statements -- (76,443) -- (76,443)
into U.S. dollars
Net loss for the nine
month period ended -- -- (4,029,825) (4,029,825)
December 31, 1997 ------- -------- ----------- -----------
Balance at $ -- $(73,072) $(6,141,350) $ 2,592,627
December 31, 1998 ======= ======== =========== ===========
The Accompanying Notes are an Integral Part
of the Consolidated Financial Statements
F-5
<PAGE>
PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
For The Year Ended December 31, 1998 and
For The Nine Month Period Ended December 31, 1997
Nine Month
Year Ended Period Ended
December 31, December 31,
1998 1997
------------ -----------
Increase (Decrease) in Cash and
Cash Equivalents:
Cash flows from operating activities:
Cash received from customers $ 6,783,202 $ 2,560,015
Cash paid to suppliers and employees (10,015,845) (5,014,455)
Interest paid (46) (44,272)
Interest received 89,622 47,659
------------ -----------
Net cash used for operating activities (3,143,067) (2,451,053)
------------ -----------
Cash flows from investing activities:
Purchase of investments -- (3,411,897)
Proceeds from sale of investments 3,470,471 --
Purchase of property and equipment (591,647) (201,829)
Proceeds from sale of fixed assets 8,284 --
Purchase of humidors (799,947) (865,340)
Organizational costs -- (8,151)
------------ -----------
Net cash provided (used) by
investing activities 2,087,161 (4,487,217)
------------ -----------
Cash flows from financing activities:
Proceeds from notes payable -- 850,000
Payments on notes payable -- (900,000)
Proceeds from notes payable - related parties -- 150,000
Payments on notes payable - related parties -- (279,641)
Proceeds from issuance of common stock -- 8,179,214
Proceeds from issuance of common stock warrants -- 1,710
Contributed capital -- 150,000
------------ -----------
Net cash provided by financing activities -- 8,151,283
------------ -----------
Effect of exchange rate changes on cash
and cash equivalents (40,243) (6,666)
------------ -----------
Net increase (decrease) in cash and
cash equivalents (1,096,149) 1,206,347
Cash and cash equivalents at beginning
of period 1,264,365 58,018
------------ -----------
Cash and cash equivalents at end of period $ 168,216 $ 1,264,365
============ ===========
The Accompanying Notes are an Integral Part
of the Consolidated Financial Statements
F-6
<PAGE>
PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
For The Year Ended December 31, 1998 and
For The Nine Month Period Ended December 31, 1997
Nine Month
Year Ended Period Ended
December 31, December 31,
1998 1997
----------- -----------
Reconciliation of Net Loss to Net Cash
Used for Operating Activities:
Net Loss $(4,029,825) $(1,760,383)
----------- -----------
Adjustments to reconcile net loss to net
cash used for operating activities:
Depreciation and amortization 793,649 200,210
Loss on sale of fixed assets and humidors 15,492 --
Accrued interest added to principal of notes
receivable - related parties (6,898) (6,898)
Stock issued for services -- 110,000
Accrued interest added to available for
sale securities -- (58,574)
Effect of changes in foreign currency 3,844 10,038
Changes in Assets and Liabilities:
Accounts receivable
- trade 58,436 (573,178)
- related parties -- 8,497
Inventory (19,542) (1,195,921)
Other current assets 22,278 (53,269)
Deposits (19,460) (3,286)
Accounts payable - trade 387,296 360,735
Accrued expenses
- tobacco taxes (299,507) 307,796
- other (48,830) 203,180
----------- -----------
886,758 (690,670)
----------- -----------
Net cash used for operating activities $(3,143,067) $(2,451,053)
=========== ===========
The Accompanying Notes are an Integral Part
of the Consolidated Financial Statements
F-7
<PAGE>
PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies, Nature of Operations and
Use of Estimates:
Nature of Operations:
Premium Cigars International, Ltd. (the "Company") is a Corporation organized
under the laws of the State of Arizona on December 16, 1996. CAN-AM
International Investments Corp. (CAN-AM), a British Columbia Canadian
corporation, was incorporated on June 20, 1996. The Company acquired all of the
outstanding stock of CAN-AM on December 31, 1996. The business purpose of the
Company is the distribution of premium cigars using countertop humidors in
convenience stores, grocery stores and other retail outlet markets. The Company
conducts business throughout the United States. The Company's wholly-owned
subsidiary, CAN-AM, operates throughout greater Canada.
Change in Year End:
The Company elected to change its year end to December 31, effective with the
period ended December 31, 1997. The Company previously used a March 31 fiscal
year end. As a result of the change, the period ended December 31, 1997
represents a nine month period.
Principles of Consolidation:
The consolidated financial statements include the activity of Premium Cigars
International, Ltd., together with its wholly-owned subsidiary, CAN-AM. All
significant intercompany accounts and transactions have been eliminated.
Pervasiveness of Estimates:
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets, and liabilities and disclosure of
contingent assets and liabilities, at the date of the financial statements, and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Significant estimates are used when accounting for allowance for doubtful
accounts, inventory reserves, depreciation and amortization, accruals, taxes,
contingencies and sales returns, which are discussed in the respective notes to
the consolidated financial statements.
Cash and Cash Equivalents:
Cash equivalents are considered to be all highly liquid investments purchased
with a maturity of three (3) months or less.
Accounts Receivable - Trade:
Accounts receivable - trade represents amounts earned but not collected in
connection with the sale of cigars and cigar accessories.
The Company follows the allowance method of recognizing uncollectible accounts
receivable. The allowance method recognizes bad debt expense as a percentage of
accounts receivable based on prior collection history and a review of individual
accounts outstanding. At December 31, 1998 and 1997, allowances have been
provided for potentially uncollectible accounts receivable in the amounts of
$37,980 and $74,198, respectively.
Inventory:
Inventory quantities and valuation were determined based upon a physical count,
and pricing of same at December 31, 1998. Inventory is stated at the lower of
cost, first-in, first-out method, or market. Inventory quantities are
periodically reviewed by management for spoilage, and/or obsolescence, and an
allowance is established to provide for same.
F-8
<PAGE>
PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. Summary of Significant Accounting Policies, Nature of Operations and
Use of Estimates: (Continued)
Property and Equipment:
Property and equipment are recorded at cost. Depreciation is provided for on the
straight-line method, over the following estimated useful lives.
Computer equipment 3 years
Equipment 5-7 years
Furniture and fixtures 5-7 years
Maintenance and repairs that neither materially add to the value of the property
nor appreciably prolong its life are charged to expense as incurred. Betterments
or renewals are capitalized when incurred. For the year ended December 31, 1998
and for the nine month period ended December 31, 1997, depreciation expense was
$138,049 and $30,096, respectively.
Humidors:
Humidors are used to display cigars available for sale at retail outlets. The
humidors are being amortized ratably over a two (2) year period. For the year
ended December 31, 1998 and for the nine month period ended December 31, 1997,
amortization expense was $647,435 and $164,691, respectively.
Advertising Costs:
Advertising costs are charged to operations when incurred. For the year ended
December 31, 1998 and for the nine month period ended December 31, 1997,
advertising expense was $120,152 and $113,596, respectively.
Organization Costs:
Organization costs consist of costs incurred in relation to the formation of the
Corporation and its wholly-owned subsidiary. These costs are being amortized
ratably over five (5) years. For the year ended December 31, 1998 and for the
nine month period ended December 31, 1997, amortization expense was $8,165 and
$5,837, respectively.
Income Taxes:
Deferred income taxes are provided on an asset and liability method, whereby
deferred tax assets are recognized for deductible temporary differences and
operating loss carryforwards. Deferred tax liabilities are recognized for
taxable temporary differences. Deferred tax assets are reduced by a valuation
allowance when, in the opinion of management, it is more likely than not that
some portion or all of the deferred tax assets will not be realized. Deferred
tax assets and liabilities are adjusted for the effects of changes in tax laws
and rates on the date of enactment.
Translation of Foreign Currencies:
Account balances and transactions denominated in foreign currencies and the
accounts of the Corporation's foreign operations have been translated into
United States funds, as follows:
Assets and liabilities at the rates of exchange prevailing at the
balance sheet date;
Revenue and expenses at average exchange rates for the period in which
the transaction occurred;
Exchange gains and losses arising from foreign currency transactions
are included in the determination of net earnings for the period;
Exchange gains and losses arising from the translation of the
Corporation's foreign operations are deferred and included as a
separate component of stockholders' equity.
F-9
<PAGE>
PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
1. Summary of Significant Accounting Policies, Nature of Operations and
Use of Estimates: (Continued)
Stock-Based Compensation:
The Company has elected to follow Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees (APB 25) and related interpretations in
accounting for its employee stock options. Under APB 25, because the exercise
price of employee stock options equals or exceeds the market price of the
underlying stock on the date of grant, no compensation expense is recorded. The
Company has adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation (Statement
123).
Loss per Share:
Basic loss per share of common stock was computed by dividing net earnings by
the weighted average number of common shares.
Diluted earnings per share are computed based on the weighted average number of
shares of common stock and dilutive securities outstanding during the period.
Dilutive securities are options and warrants that are freely exercisable into
common stock at less than market exercise prices. Dilutive securities are not
included in the weighted average number of shares when inclusion would increase
the earnings per share or decrease the loss per share.
New Accounting Pronouncements:
During the nine months ended December 31, 1997, the Company adopted Statement of
Financial Accounting Standards No. 128, "Earnings per Share" (SFAS No. 128).
This pronouncement provides a different method of calculating earnings per share
than was required by APB 15, Earnings per Share. SFAS No. 128 provides for the
calculation of Basic and Diluted earnings per share. Basic earnings per share
include no dilution and is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding for the
period. Diluted earnings per share reflects the potential dilution of securities
that could share in the earnings of an entity similar to fully diluted earnings
per share. Due to net losses for the year ended December 31, 1998, and for the
nine month period ended December 31, 1997, this statement has no effect on its
reported loss per share.
During the nine month period ended December 31, 1997, the Company adopted
Statement of Financial Accounting Standards No. 129, "Disclosure of Information
about Capital Structure" (SFAS No. 129). The new standard reinstates various
securities disclosure requirements previously in effect under Accounting
Principles Board Opinion No. 15, which has been superseded by SFAS No. 128. The
adoption of SFAS No. 129 did not have a material effect on the Company's
financial position or results of operations.
During the year ended December 31, 1998, the Company adopted Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS
No. 130). SFAS No. 130 establishes standards for reporting and display of
comprehensive income and its components in a full set of general-purpose
financial statements. The Company's adoption of SFAS 130 did not have a material
effect on its financial position or results of operation.
During the year ended December 31, 1998, the Company adopted Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information", ("SFAS No. 131"). SFAS No. 131 requires
that public companies report certain information about operating segments,
products, services and geographical areas in which they operate and their major
customers. The Company's adoption of SFAS No. 131 did not have a material effect
on its financial position or results of operations.
F-10
<PAGE>
PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
2. Concentration of Credit Risk:
The Company maintains cash balances at various financial institutions. Deposits
not to exceed $100,000 at U.S. financial institutions are insured by the Federal
Deposit Insurance Corporation. Deposits not to exceed $60,000 (CAD) at Canadian
Institutions are insured by the Canadian Deposit Insurance Corporation. As of
December 31, 1998 and 1997, the Company had approximately $23,500 and $1,183,000
of uninsured cash, respectively.
3. Investment Securities:
The amortized cost and fair value (based on quoted market prices) of debt
securities at December 31, 1997 are shown below. Expected maturities will differ
from contractual maturities because issuers may have the right to call or prepay
obligations with or without call or prepayment penalties.
Securities Available-for-sale
-----------------------------
Amortized
Cost Fair Value
---------- ----------
U.S. Treasury Bills $3,470,471 $3,470,471
========== ==========
During the year ended December 31, 1998, the Company recognized proceeds from
the sale of available for sale securities in the amount of $3,470,471.
4. Related Party Transactions:
Notes Receivable - Related Parties:
At December 31, 1998, notes receivable - related parties are comprised of 6%
interest bearing notes from two (2) stockholders and directors in the aggregate
amount of $100,021. The notes and all accrued interest are due on March 31,
1999. Included in the balance at December 31, 1998 is accrued interest in the
amount of $13,796. In March, 1999, the Company's independent members of the
Board of Directors granted a six month extension of time for repayment of the
notes, along with an increase in the interest rate to ten percent (10%) per
annum during the extension.
Notes Payable - Related Parties:
For the nine month period ended December 31, 1997, interest expense under a note
payable to a related party was $10,773. The note was converted to a bridge note
during June, 1997 (See Note 11).
Commitments:
During the nine month period ended December 31, 1997, the Company entered into a
distributorship agreement with Rose Hearts, Inc., which is wholly-owned by a
director of the Company, which provides for commission payments of ten percent
(10%) to twenty-two percent (22%) of the product cost to the stores. Although
the Company has no other written distributor agreements at this time, it was
management's belief that at the inception of the agreement the distribution fee
represented a reasonable cost if the services were to be performed by an
independent party. During the nine months ended December 31, 1997, the Company
incurred approximately $67,000 in commission expense under this agreement.
During 1998, management terminated the agreement after it determined that in
practice, the agreement was not as favorable to the Company as those generally
available with unaffiliated third parties.
5. Fair Value of Financial Instruments:
The fair market value of notes receivable - related parties cannot be determined
due to its related party nature.
F-11
<PAGE>
PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
6. Inventory:
As of December 31, 1998, inventory consists of the following:
Cigars $1,585,352
Cigar accessories 178,066
----------
1,763,418
Less: reserve for inventory spoilage
and obsolescence (438,136)
----------
$1,325,282
==========
7. Property and Equipment:
At December 31, 1998, property and equipment consists of the following:
Computer equipment $ 253,125
Equipment 203,568
Furniture and fixtures 291,305
Leasehold improvements 44,971
----------
792,969
Less: accumulated depreciation (165,759)
-----------
$ 627,210
===========
8. Inventory Adjustment:
As of December 31, 1998 the Company had a significant investment in its non-core
inventory items; i.e., products that were no longer listed on the Company's
current price sheet. In order to reduce the investment in this inventory,
Management has implemented a strategy to sell these items at a substantial
discount. Accordingly, as of December 31, 1998 the Company recognized an
inventory adjustment of $427,830 to write down the value of the inventory to the
lower of cost or market.
9. Income Taxes:
At December 31, 1998, the Company has available approximately $5,300,000 of U.S.
operating loss carryforwards that may be applied against future taxable income.
In addition, the Company has a Canadian net operating loss carryforward in the
approximate amount of $480,000 (Canadian dollars). The United States and
Canadian operating losses expire as follows:
Amount of Unused
Expiration During Operating Loss Carryforwards
Year Ended December 31, United States Canadian
----------------------- ------------- --------
2004 $ -- $ 135,000
2005 -- 345,000
2012 1,400,000 --
2013 3,900,000 --
---------- ----------
$5,300,000 $ 480,000
========== ==========
F-12
<PAGE>
PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
9. Income Taxes: (Continued)
As of December 31, 1998, deferred income tax assets consist of:
Net operating loss carryforwards $1,550,000
Other 100,000
----------
1,650,000
Less: valuation allowance (1,650,000)
----------
Total deferred taxes $ --
==========
The Company has established a valuation allowance equal to the full amount of
the deferred tax asset because the utilization of the assets is uncertain.
10. Commitments and Contingencies:
Operating Leases:
During the nine months ended December 31, 1997, the Company leased office and
warehouse space in Scottsdale, Arizona. In February, 1998, the parties under the
aforementioned lease mutually agreed to cancel the agreement, and the Company
entered into a non-cancellable agreement for new property at a different
location, expiring April 30, 2003. The terms of this lease provide for monthly
payments ranging from $18,000 to $19,000. The lease terms also require the
Company to pay common area maintenance, taxes, and certain other incidental
costs.
The Company also leases office and warehouse space in Vancouver, British
Columbia under a non-cancellable operating lease agreement, expiring in
February, 2001. The lease requires monthly payments ranging from $1,915 to
$2,170 Canadian, and also requires the Company to pay common area maintenance,
taxes, and certain other incidental costs.
In addition to the above, the Company leases office equipment under various
cancellable and non-cancellable lease agreements expiring through May, 2003. The
leases require monthly payments ranging from $70 Canadian to $645 U.S.
A schedule of future minimum lease payments due under the above mentioned
non-cancellable operating lease agreements for each of the next five (5) years,
is as follows:
Year Ending
December 31, Amount
------------ ------
1999 $ 242,170
2000 243,499
2001 237,013
2002 235,945
2003 76,000
----------
$1,034,627
==========
For the year ended December 31, 1998 and for the nine month period ended
December 31, 1997, rent expense under the aforementioned operating lease
agreements was $281,750 and $54,628, respectively.
The schedule above represents future minimum payments for leases in both the
U.S. and Canada. Future minimum payments for leases transacted in Canada have
been translated into U.S. dollars, using the exchange rate in effect as of
December 31, 1998.
F-13
<PAGE>
PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
10. Commitments and Contingencies: (Continued)
Purchase Agreement:
In October, 1998, the Company entered into an agreement with a supplier for
product purchases. The agreement is for a period of five (5) years with an
automatic five (5) year renewal. In order for supplier to exclusively supply
products to the Company, the Company must satisfy the following minimum purchase
requirements:
Year Ended
December 31, Cost
------------ ----
1999 $ 3,040,000
2000 7,200,000
2001 15,360,000
2002 20,640,000
2003 28,000,000
The agreement is subject to negotiation after the initial five (5) year period.
Payment for the minimum purchase requirements is not guaranteed under the
agreement; the Company is obligated to pay only for products which have been
ordered and delivered. If the Company fails to meet the minimum purchase
requirements the contract is cancellable at the suppliers option, and if
cancelled, the Company will transfer to supplier all rights to the trademarks
associated with the product.
Financial Relations Agreement:
On December 15, 1998, the Company entered into an agreement for the performance
of various financial and public relation duties. The agreement is for a term of
eighteen (18) months, cancellable after nine (9) months, with monthly payments
of $5,500. In addition to the monthly payments, the Company is required to pay
certain incidental and out-of-pocket costs. The agreement also requires that the
Company sell the provider 100,000 shares of restricted common stock at an
initial price of $.01 per share; to be held by the Company. The Company may then
repurchase the stock over the life of the contract, at the original issue price,
if certain performance criteria are not met. No compensation has been recorded
in the accompanying financial statements for the year ended December 31, 1998,
pending attainment of the performance criteria. If the provider achieves the
performance criteria, they have the right to request the removal of the
restrictive legend from the shares. At that time the provider shall pay between
$.99 and $1.49 per share as additional consideration.
F-14
<PAGE>
PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
11. Stockholders' Equity:
Stock-Based Compensation:
During the nine month period ended December 31, 1997, the Company's then Chief
Executive Officer sold common stock at a price below fair market value. As such,
an additional $110,000 was recorded as compensation.
Bridge Notes:
During the nine months ended December 31, 1997, the Company obtained $1,000,000
in bridge notes with various investors, including two (2) related parties. The
net proceeds on $900,000 of the debt was $810,000, with an additional $100,000
of related party debt converted to bridge notes. The bridge notes were paid in
full with the proceeds of the initial public offering. As the notes were paid in
full, the $90,000 in loan fees was expensed during the period. For the nine
months ended December 31, 1997, interest expense on the notes was approximately
$33,500.
The investors of the bridge financing were also issued common stock purchase
warrants (See below).
Common Stock Options and Warrants:
During the year ended December 31, 1998, the Company issued 20,000 options to an
officer of the Company. The options are exercisable at $5.25 per share and
expire five (5) years from the date of issuance. As of December 31, 1998, none
of the options have been exercised.
During the nine months ended December 31, 1997, the Company issued 257,500
options to directors and officers of the Company, with 247,500 exercisable at
$5.25 per share, and 10,000 exercisable at $2.69 per share. The options expire
five (5) years from the date of issuance, with vesting periods of zero (0) to
three (3) years and are exercisable one (1) year after the vesting date. As of
December 31, 1998, none of the options have been exercised.
During the nine month period ended December 31, 1997, the Company, in connection
with the bridge financing, issued warrants to purchase 380,226 shares of common
stock with 361,215 exercisable at $2.63 per share, and 19,011 exercisable at
$5.25 per share. The warrants expire five (5) years from the date of issuance.
As of December 31, 1998, none of the warrants have been exercised.
During the nine month period ended December 31, 1997, the Company issued
underwriter warrants to purchase 170,952 shares of common stock, exercisable at
$8.40 per share, expiring five (5) years from the date of issuance, and
exercisable one (1) year after grant date. As of December 31, 1998, none of the
warrants have been exercised.
During the nine month period ended December 31, 1997, the Company issued 50,000
options to its then public relations firm, exercisable at $8.40 per share,
expiring five (5) years from the date of issuance. The options vest ratably over
a five (5) year period and become exercisable one (1) year after the vest date.
No value was assigned on this transaction. As of December 31, 1998, none of the
options have been exercised.
F-15
<PAGE>
PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
11. Stockholders' Equity: (Continued)
Common Stock Options and Warrants: (Continued)
The following summarizes stock option and warrant transactions:
Stock Weighted Average
Options Warrants Exercise Price
------- -------- --------------
Outstanding at March 31, 1997 -- -- $ --
Granted 307,500 551,178 4.93
Exercised -- -- --
Expired -- -- --
------- ------- --------
Outstanding at December 31, 1997 307,500 551,178 4.93
Granted 20,000 -- 5.25
Exercised -- -- --
Expired -- -- --
------- ------- --------
Outstanding at December 31, 1998 327,500 551,178 $ 4.94
======= ======= ========
Information relating to stock options and warrants at December 31, 1998,
summarized by exercise price, are as follows:
Exercise Weighted
Price Average
per Number Life Number
Share Outstanding (Years) Exercisable
----- ----------- ------- -----------
$2.63 361,215 5 361,215
$2.69 10,000 5 10,000
$5.25 286,511 5 280,511
$8.40 220,952 5 220,952
All stock options issued to employees have an exercise price not less than the
fair market value of the Company's common stock on the date of grant. In
accordance with accounting for such options utilizing the intrinsic value
method, there is no related compensation expense recorded in the Company's
financial statements for the year ended December 31, 1998 and for the nine month
period ended December 31, 1997. Pro forma information regarding net loss and
loss per share are required by SFAS No. 123. Had compensation cost for
stock-based compensation been determined based on the fair value of the options
at the grant dates consistent with the method of SFAS No. 123, the Company's net
loss and loss per share for the year ended December 31, 1998 and for the nine
month period ended December 31, 1997, would have been increased to the pro forma
amounts presented below:
Year Ended Period Ended
December 31, December 31,
1998 1997
------------ ------------
Net Loss:
As reported $(4,029,825) $(1,760,383)
Pro forma (4,105,725) (2,160,321)
Loss per Share:
As reported $ (1.16) $ (.82)
Pro forma (1.18) (1.05)
The fair value of the option grants is estimated as of the date of grant
utilizing the Black-Scholes option-pricing model with the following weighted
average assumptions for grants in 1998 and 1997 respectively; expected life of
options three (3) years, expected volatility of 129% and 55% respectively,
risk-free interest rate of 6%, and a 0% dividend yield. The weighted average
fair value at date of grant for options granted during 1998 and 1997
approximated $1.35 and $1.55, respectively.
F-16
<PAGE>
PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
11. Stockholders' Equity: (Continued)
Public Offering:
During the nine month period ended December 31, 1997, the Company completed an
initial public offering during which it sold 1,988,592 shares of its no par
value common stock at a price of $5.25 per share, sold under its Registration
Statement No. 33-29985 Prospectus dated August 21, 1997. Gross proceeds of
approximately $10,440,000 were received by the Company.
Common Stock Split:
On May 31, 1997, the Company declared a three for one (3-1) split of its common
stock. The accompanying consolidated financial statements give retroactive
effect to the stock split.
12. Concentrations:
Economic Dependency:
For the year ended December 31, 1998, the Company had two (2) suppliers which
accounted for approximately fourteen percent (14%) and thirteen percent (13%) of
the Company's cigar purchases, respectively. As of December 31, 1998, amounts
due to these suppliers included in accounts payable were approximately $49,480
and $50,520, respectively. For the nine month period ended December 31, 1997,
the Company had three (3) suppliers which accounted for approximately twenty
percent (20%), fifteen percent (15%) and fourteen percent (14%) of the Company's
cigar purchases, respectively.
For the year ended December 31, 1998 and for the nine month period ended
December 31, 1997, the Company's largest customer accounted for approximately
thirty-eight (38%) and seventy percent (70%) of the Company's sales,
respectively. As of December 31, 1998, there are accounts receivable of
approximately $83,120 due from this customer.
Foreign Operations:
For the year ended December 31, 1998 and for the nine month period ended
December 31, 1997, the Company's foreign subsidiary recorded revenue
representing approximately forty-six percent (46%) and thirty-nine percent (39%)
of total revenues, respectively.
13. Statements of Cash Flows:
Non-Cash Financing and Investing Activities:
During the year ended December 31, 1998, the Company recognized financing
activities that affected its assets and equity, but did not result in cash
receipts or cash payments. These non-cash activities are as follows:
Accrued interest in the amount of $6,898 was added to the principal of notes
receivable - related parties.
During the nine month period ended December 31, 1997, the Company recognized
investing and financing activities that affected its assets, liabilities and
equity, but did not result in cash receipts or payments. These non-cash
activities are as follows:
Sales of shares of common stock by the Company's Chief Executive
Officer were valued at $2.50 per share, which exceeded the cash sales
price. Therefore, an additional $110,000 was reported as compensation.
F-17
<PAGE>
PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
13. Statements of Cash Flows: (Continued)
Non-Cash Financing and Investing Activities: (Continued)
Accrued interest in the amount of $6,898 was added to the principal of
notes receivable - related parties.
A related party note payable in the amount of $100,000 was converted
into a bridge financing loan.
The Company added accrued interest to the principal balance of
available for sale securities in the amount of $58,574.
The Company offset $53,550 of deferred offering costs from the prior
year against the proceeds of the initial public offering.
14. Foreign Currency:
Foreign currency transactions resulted in an aggregate exchange loss of $3,844
for the year ended December 31, 1998, and $10,038 for the nine month period
ended December 31, 1997. Foreign currency translations resulted in an aggregate
exchange loss of $73,072 as of December 31, 1998, and an aggregate exchange gain
of $3,371 as of December 31, 1997.
15. Subsequent Events:
Subsequent to December 31, 1998, the Company was notified by NASDAQ Listing
Qualifications that the staff was recommending the de-listing of PCI shares from
the NASDAQ Small Cap Market, despite the Company's technical compliance with
NASDAQ's continuing listing requirements. The Company intends to defend their
current listing and has scheduled a hearing with the NASDAQ later this year.
Subsequent to December 31, 1998, two of the Company's independent directors
resigned due to the time requirements of their primary business commitments, and
two new independent directors have been appointed.
Subsequent to December 31, 1998, the Company entered into an agreement with
Alliance Financial Capital, Inc. (AFC) for the factoring of the Company's
accounts receivable. The terms of the agreement provide for a total credit
facility of $1,000,000 at an initial advance rate of 80% of eligible accounts
receivable. The agreement is for a period of one year, and is collateralized by
various corporate assets. The agreement provides AFC with full recourse.
Subsequent to December 31, 1998, the Company executed a settlement and covenant
not to execute agreement with several individuals regarding a lawsuit filed
against the Company in relation to an automobile accident involving an employee
of the Company. The Company was effectively released from any obligation under
the agreement.
16. Year 2000 Issue: (Unaudited)
Like other companies, the Company could be adversely affected if the computer
systems it, its suppliers or customers use do not properly process and calculate
date-related information and data from the period surrounding and including
January 1, 2000. This is commonly known as the "Year 2000" issue. Additionally,
this issue could impact non-computer systems and devices such as production
equipment, elevators, etc. At this time, the Company does not believe that it
will incur any material expenditures to identify and replace, as necessary, any
Y2K non-compliant systems. It does not anticipate any material effect to its
business from any non-compliant Company owned systems; however, it is unable at
this time to determine what, if any, effect on its business will occur from any
third parties non-compliant systems. It expects to be better able to assess this
uncertainty as it obtains more Y2K information from these parties.
F-18
<PAGE>
PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
17. Litigation Matters:
At December 31, 1998, the Company is involved in litigation with an individual
who alleges that the Company violated the requirements of Proposition 65, a
California Statutory Scheme which requires that manufacturers, distributors and
retailers of certain products provide warnings to consumers of the potential
harm which may result from the consumption of those products. The complaint
seeks unspecified statutory penalties along with costs and attorney's fees. The
Company intends to vigorously contest the case. The Company's legal counsel
cannot estimate a reasonable range for potential outcome at this time. As such,
no amount has been accrued for any potential loss as of December 31, 1998 in the
accompanying financial statement.
18. Segment Information:
The Company's products and services are broken down in the following divisions
for financial reporting purposes:
(1) Premium Cigars (U.S. Operations)
(2) Can-Am (Canadian Operations)
Following is selected segment information:
<TABLE>
<CAPTION>
Nine Month Period
Year Ended December 31, 1998 Ended December 31, 1997
---------------------------- -----------------------
Premium Premium
Cigars Can-am Total Cigars Can-am Total
------ ------ ----- ------ ------ -----
<S> <C> <C> <C> <C> <C> <C>
Sales, Net $3,697,338 $3,203,589 $6,900,927 $2,044,587 $1,317,688 $3,362,275
Interest
Income 96,520 -- 96,520 113,131 -- 113,131
Interest
Expense -- 46 46 33,489 10,783 44,272
Depreciation
and Amort-
ization 593,081 200,568 793,649 164,163 36,047 200,210
Operating
Loss 3,759,310 357,220 4,116,530 1,739,172 80,950 1,820,122
</TABLE>
F-19
<PAGE>
PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
December 31, 1998
-----------------
Premium
Cigars Can-Am Total
--------- --------- ---------
Total Assets 2,475,543 1,290,589 3,766,132
========= ========= =========
During the year ended December 31, 1998, Premium Cigars and Can-Am made
disbursements for the purchase of fixed assets and humidors in the amounts of
$807,509 and $ 584,085, respectively.
19. Going Concern:
The accompanying financial statements have been prepared in conformity with
generally accepted accounting principles, which contemplates continuation of the
Company as a going concern. However, the Company has sustained continuing
operating losses.
As shown in the accompanying statements of operations the Company has incurred
net losses of $4,029,825 and $1,760,383, for the year and the nine month period
ended December 31, 1998 and 1997, respectively. Unaudited information subsequent
to December 31, 1998 indicates that the losses are continuing, albeit at a
reduced rate.
The above conditions indicate that the Company may be unable to continue in
existence. The financial statements do not include any adjustments relating to
the recoverability and classification of recorded asset amounts, or the amounts
and classification of liabilities that might be necessary should the Company be
unable to continue in existence.
Management has implemented a plan to address the operating losses and the
resultant need for additional capital. The following highlights the key
components of this plan:
+ The Company has introduced a new product line of small, flavored, tubed
cigars targeted at the convenience store market. This new product will also
allow the company to pursue channels of distribution (casinos, bars, liquor
stores, bowling alleys, etc.) that were not previously available to it.
+ A small, disposable humidor has been developed which will allow the Company
to place humidified cigars in smaller convenience stores where a full size
humidor would be space prohibitive.
+ An e-commerce site was opened in March 1999 which will leverage the
Company's core competencies - knowledge of the convenience store industry
and its integrated order processing and shipping systems.
+ The Company raised $135,000 during the first quarter of 1999 through the
sale of restricted stock. The Board of Directors has authorized the
issuance of up to an additional $200,000 in stock.
+ The Company obtained a $1,000,000 accounts receivable financing package in
March 1999 that will enable it to turn its receivables into cash quicker
than the current operating cycle allows. In addition, the Company continues
to explore financing alternatives for its inventory and furniture and
fixtures.
+ The Company reduced its U.S. personnel headcount by 50% based on its
changing business needs.
+ The Company is exploring alternatives to sell some of its assets in order
to raise additional capital.
F-20
ACCOUNTS RECEIVABLE FINANCING AGREEMENT
Alliance Financial Capital, Inc. (hereby "AFC"), a California corporation,
having its offices at 700 Airport Boulevard, Burlingame, California 94010 and
the undersigned SELLER (hereafter "SELLER") hereby agree as follows:
A. On a transaction-by-transaction basis and at each party's sole and absolute
discretion, AFC hereby agrees to buy SELLER'S accounts receivable (hereafter
"accounts") on a discounted basis. Including, without limitation, full power to
collect, compromise, sue for, assign, or in any manner enforce collection
thereof, in the name of AFC, or otherwise. Each transaction for said purchase
and sale of accounts should be on a daily batch basis, which is defined as all
original Invoices submitted to AFC by SELLER on a particular day. AFC shall
purchase said accounts, subject to the foregoing, as a group (hereafter "BULK")
and each of said Bulks shall be treated as a separate transaction on AFC's books
and records, which shall be accounted for as between AFC and SELLER separately
and independently from all other such transactions entered into between AFC and
SELLER. Each of said transactions shall be supported by a Bulk Assignment
Schedule, an exemplar of which is attached hereto and made a part hereof by this
reference as Exhibit "A", executed by SELLER, setting forth the transaction
amount, (which is defined as the total gross face amount of all Invoice(s)
included in each transaction), the consideration (hereafter "ADVANCE") paid by
AFC therefor, the contingency reserve, and the discount, therefor. Each of said
Bulk Assignment Schedules shall be deemed a separate sale and assignment of
accounts, regardless of the number of invoices listed therein, and shall
incorporate the terms, conditions and provisions of this agreement.
B. AFC shall advance to SELLER toward the purchase of said accounts, the
following percentage of each BULK, less sales tax, so long as SELLER is not in
breach of this agreement: 80%
Account Credit Limit $1,000,000.00.
C. SELLER makes the following representations, warranties and covenants with
respect to each such transaction which may be entered into between AFC and
SELLER hereafter:
1. SELLER shall be the sole and absolute owner of said account(s), and
shall have the full legal power to make said sales, assignments and
transfers.
2. Said account(s) shall be presently due and owing to SELLER with
terms not to exceed net 30 days, the amount(s) thereof shall not be in
dispute, and the payment of said account(s) shall not be in dispute or
contingent upon the fulfillment of this, or any other contract(s), past
or future.
3. There shall not be any set-offs or counterclaims against said
account(s), and said account(s) shall not have been previously assigned
or encumbered by SELLER in any manner whatsoever.
4. AFC shall have the right to reduce contingencies, (the total of each
Bulk, less ADVANCE and net discount) and to apply contingencies, as
defined hereafter, from any transaction(s) to any other transaction(s)
between the parties by the amount of any dispute(s), discount(s),
return(s), defense(s), or offset(s) taken by any account debtor(s). If
contingencies are inadequate AFC shall have the right to deduct said
amount(s) from any other billing rights purchased by AFC from SELLER to
demand payment of any other accounts receivable of SELLER, whether or
not purchased by AFC, and/or demand reimbursement from SELLER.
5. Said account(s) shall be the property of and shall be collected by
AFC, but if for any reason any amount(s) thereof should be paid to
SELLER by any of said account debtor's, SELLER shall immediately
deliver all such checks or other instruments in kind to AFC.
6. AFC shall have the power of endorsement for any purpose on any and
all checks, drafts, money orders, or any other instruments in AFC's
possession and payable to SELLER, SELLER hereby appoints AFC its agent
for said purpose.
D. A gross discount of Twenty Percent (20%), less any applicable fees, as
described below, shall be retained by AFC from the collection of each total
transaction amount, SELLER, however shall be entitled to a rebate, regarding
each transaction, which shall be deducted from said gross discount, if each
transaction amount is paid within 90 days by said account debtor(s), as follows:
FEES:
[ * ]% on funds employed.
[ * ]% administrative fee, per 30 day period, or a part thereof, per invoice
amount, up to the maximum gross discount.
Documentation and due diligence fee of $[*], payable upon acceptance of the
proposal.
TERM:
12 months with a minimum monthly fee of [*]% of the account credit limit for the
first 3 months, and [*]% for the balance of the term.
All checks received by AFC will be credited on the actual date of receipt. The
collection period, regarding each specific BULK, shall be calculated by counting
the days from the date of each ADVANCE through and including three (3) days
after the date upon which the total monies collected from said account
debtor(s), is equal to or greater than the sum of the ADVANCE and the net
discount (gross discount less rebate). AFC shall remit to SELLER its contingency
reserve (all sums collected in excess of a sum equal to the net discount and
advance) regarding each BULK, providing SELLER is not in default or breach of
this agreement.
E. should any of the above warranties expressed by SELLER be inaccurate, and it
becomes necessary for AFC to utilize an attorney to enforce its rights against
SELLER, SELLER agrees that such attorneys' fees shall be borne by SELLER.
F. AFC shall have the right in its sole discretion after 90 days from the
invoice date or if any of the representations, warranties or covenants are
inaccurate and reasonable notice to SELLER to demand payment from SELLER of any
unpaid invoices sold, assigned and transferred to AFC by SELLER pursuant to the
terms and conditions hereof or to proceed against SELLER or against any account
debtor(s) for the collection or offset of any unpaid invoice or amount due.
Interest on the outstanding balance shall otherwise accrue from said time, at
the rate of one and a half (1 & 1/2) of the monthly discount rate. As security
for the payment of AFC's fees and other charges and for the payment of advances
made by AFC to or on behalf of SELLER, SELLER hereby grants a security interest
in and to the following described property, whether now or hereafter owned or
existing, leased, consigned by or to, acquired by Debtor and regardless of where
located: (1) All accounts, contract rights, chattel paper, general intangibles,
instruments, documents, letter of credit, bankers acceptances, drafts, claims,
causes of action, rights in and under insurance policies, rights to tax refunds
and inventory and all proceeds of the foregoing. Including Debtor's rights to
any returned or rejected good: (2) All Debtor's rights to monies, refunds, and
other amounts, due from whatever source, including Debtor's right of offset and
recoupment: (3) All goods, including but not limited to equipment, farm
products, machinery, furniture, furnishings, fixtures, tools, supplies, and
motor vehicles, and (4) All proceeds of the foregoing, whether due to voluntary
or involuntary disposition, including insurance proceeds and reserving the right
to file and prosecute lawsuits, pertaining thereto, in SELLER's or AFC's name or
otherwise. (5) All books and records relating to the same. (6) Seller
irrevocably appoints Buyer and any of Buyer's officers as Seller's attorney to
execute such financing statements, continuations and amendments and to take such
other actions as Buyer deems appropriate to perfect and continue the perfection
of the security interest granted hereunder.
G. AFC warrants that it will use its best efforts to collect the amounts due
under this Agreement, and SELLER agrees that AFC may, in its sole discretion,
settle, compromise, or otherwise accept payment of less than the full amount, if
in its judgment such action is necessary to effect collection. SELLER agrees
that the amount of such reduction shall be applied as a reduction of the
contingency reserve.
H. If it should become necessary for AFC to enforce its rights against the
account debtor(s) SELLER agrees that AFC may apply a maximum sum equal to the
total unpaid contingency reserve of SELLER, to compensate AFC for its attorney's
fees therefore. AFC may correct patent errors herein or in any BULK Assignment
Schedule executed by SELLER and fill in blanks. Any provision hereof contrary
to, prohibited by or invalid under applicable laws or regulations shall be
inapplicable and deemed omitted herefrom, but shall not invalidate the remaining
provisions hereof. The laws of the State of California shall govern the
validity, interpretation, enforcement and effect of this agreement, and SELLER
hereby consents to the exclusive jurisdiction of all courts in the County of San
Mateo, in the State of California. SELLER acknowledges receipt of a true copy
and waives acceptance hereof. If the SELLER is a corporation, this agreement is
executed pursuant to the authority of its Board of Directors. AFC and SELLER as
used in this agreement include the heirs, executors, or administrators,
successors or assigns of those parties. The obligations of SELLER and guarantors
herein shall be joint and several. AFC is hereby authorized to obtain periodic
Expertan credit reports concerning all signatories hereof. AFC may inspect and
audit SELLER's guarantor's books and records during normal business hours, the
actual cost of which shall be reimbursed by SELLER to AFC.
I. SELLER agrees to reimburse AFC for any of its out-of-pocket incidental costs
and expenses, including but not limited to, wire transfers of funds, delivery
expenses and postage.
J. This agreement contains the entire agreement between the parties with respect
to the contemplated transactions, and it may not be modified or any of its terms
waived, except by an instrument in writing signed by the party or parties to be
charged, and no collateral representation, whether oral or written, shall
survive execution of this agreement.
* Confidential Portion Deleted
ENGAGEMENT AGREEMENT
December__, 1998
Mr. John E. Greenwell
Chairman and Chief Executive Officer
Premium Cigars International, Ltd.
15849 N. 77th Street
Scottsdale, Arizona 85260
1. This letter will confirm the understanding between Premium Cigars
International, Ltd. and/or its affiliates and successors (the "Company" or
"PCIG") and RCG Capital Markets Group, Inc. and/or any affiliates and successors
("RCG"). The letter and the attachments hereto, as amended, shall be
collectively referred to as the "Agreement". RCG will provide consulting and
other services described by the attachment ("services") and will represent the
Company during the engagement as exclusive Financial Relations Consultants of
the kind described by that attachment, all on the terms and conditions set forth
in this letter agreement. That attachment is incorporated in this letter
agreement and forms a part hereof. Unless otherwise terminated as provided in
paragraph nine of this letter agreement, the contract period will be for an
Eighteen (18) month period commencing, immediately upon execution of this
agreement. During this engagement period, PCIG or RCG may terminate the contract
after Nine (9) months by providing written notice of Thirty (30) days.
2. The Company agrees to furnish or cause to be furnished to RCG all
information concerning the Company as RCG reasonably requests and deems
appropriate for purposes of this engagement. The Company and RCG represent and
warrant to each other that all information provided and representations made,
with respect to the Company, to third parties will be complete and correct in
all material respects and will not contain any untrue statement of a material
fact or omit to state a material fact necessary in order to make the statements
therein not misleading in light of the circumstances under which such statements
are made. In rendering RCG's services hereunder, PCIG understands that RCG will
be using and relying on publicly available information and the information
furnished to RCG by PCIG without independent verification thereof. RCG will
treat as confidential any non-public information provided to it hereunder and
will not disclose the same to third parties unless required by applicable law.
In the event disclosure has been or will be made by RCG, RCG will use it's best
efforts to cooperate as reasonably requested by the Company in minimizing any
potential loss or injury to the Company as a consequence of any such necessary
disclosure. In addition, RCG will use its best efforts to comply with all
applicable state and Federal securities laws in the performance of this
agreement.
3. RCG will be generally available to you in connection with its
rendering of services. Specifically, RCG (a) will outline, develop and implement
a financial relations program to assist the Company in creating and/or enhancing
a positive and more visible public image, (b) may contact existing shareholders,
broker/dealers, potential investors, registered representatives, institutions,
mutual fund managers, investment banking sources, securities analysts,
<PAGE>
November 12, 1998
Page 2
independent portfolio managers, and other professional investment community
contacts including certain financial media sources for the purpose of enhancing
the Company's public image and perceived value, (c) will assist the Company in
the creation, production and distribution of certain financial markets and
investor/shareholder corporate image materials, including corporate profiles,
due diligence manual and investor packages, as well as all financial press
releases; (d) when appropriate, assist the Company in its endeavor to secure
research analyst through a targeted securities professionals campaign.
4. The Company will use its best efforts to afford RCG 48 hours to
review any disclosure, prior to its release, which the Company plans to make to
any of the sources described in paragraph (3) within the general terms of the
proposal. In addition, RCG will be responsible for assisting the Company in
writing and/or editing, producing, coordinating and disseminating all financial
industry press releases. RCG agrees that it will not release or distribute any
press release without the Company's prior consent.
5. In consideration of RCG's services hereunder, the Company agrees to
pay RCG, promptly when due, the compensation described by and in strict
accordance with the attachment ("Compensation") to this engagement letter.
Should RCG and the Company determine to extend the term of the engagement or
change the scope of the engagement, then a mutually acceptable amendment or
supplement to that attachment shall be promptly executed at the time by RCG and
Company. Absent any such amendment, all terms and conditions of this agreement
shall be binding to the parties.
6. RCG shall be entitled to such additional fees as may be mutually
agreed upon by separate agreement between the parties hereto, for additional
consulting services rendered during the engagement term.
7. The Company agrees to pay all of RCG's direct and indirect
out-of-pocket expenses reasonably incurred, in connection with this engagement.
An expense retainer shall be utilized for this purpose. Amounts and limitations
shall be set forth in the attachment ("Compensation").
8. The Company acknowledges that RCG will be acting on the Company's
behalf, therefore, RCG requires indemnification, and assumes the Company
requires and agrees to the same. A copy of the indemnification provisions
("Indemnification Provisions") is attached to this engagement letter and is
incorporated herein and made a part hereof.
9. Either party hereto may terminate this engagement as follows:
(a) WITHOUT CAUSE. The Company may terminate this Agreement
during the eighteen-month period "without cause", upon providing RCG 30 days
written notice. In the event of such termination by the Company, "without
cause", RCG shall be entitled to receive cash compensation to the extent it is
unpaid for (i) the remaining term of this Agreement or (ii) four and one-half (4
1/2) months, whichever period is shorter, pro-rated from the notice date of
termination, along with reimbursement of any non paid, out-of-pocket expenses up
to the effective date of termination. Such payment is due and payable on the
effective date of termination.
<PAGE>
November 12, 1998
Page 3
(b) WITH CAUSE. In addition, the Company may terminate this
Agreement at any time upon written notice to RCG and the Company may immediately
exercise its rights to repurchase the Shares as provided in the Financial
Relations Compensation Attachment:
(i) If RCG fails to cure any material breach of any
provision of this Agreement within thirty (30) days from written
notice from the Company (unless such breach cannot be reasonably
cured within the thirty (30) days and RCG is actively pursuing to
cure said breach).
(ii) For RCG's negligence, willful misconduct, fraud,
misappropriation, embezzlement, or other dishonesty;
(iii) Upon RCG's failure to materially comply with
applicable law or regulation relating to the Services it will
perform; or
(iv) Upon the filing by or against RCG of a petition to have
RCG adjudged as bankrupt or a petition for reorganization or
arrange met under any law relating to bankruptcy, and where any
such involuntary petition is not dismissed within 90 days.
(c) RENEWAL. This Agreement shall renew if not specifically
terminated. The Company agrees to notify RCG Thirty (30) days prior to the end
of the Eighteen (18) month period of its intent to not renew. Should the Company
fail to notify RCG, the contract will revert to a month to month agreement until
specifically renewed in writing for the next consecutive contract period or
terminated with the Thirty (30) day notice. Such renewal or month to month
engagement shall be on the same terms and conditions contained herein, unless
modified and agreed in writing by both parties.
(d) RCG may terminate this Agreement at any time upon written
notice to the Company.
(i) If the Company fails to cure any material breach of any
provision of this Agreement with thirty (30) days from written
notice from the Company (unless such breach cannot be reasonably
cured within the thirty (30) days and the Company is actively
pursuing to cure said breach);
(ii) For the Company's negligence, willful misconduct, fraud
or misrepresentation;
<PAGE>
November 12, 1998
Page 4
Such termination under 9(d)(i or ii) shall be deemed to be a
termination by the Company "without cause" as provided in
paragraph 9 (a) above.
(iii) Upon the Company's failure to materially comply with
any applicable law or regulation relating to the Services being
provided; or
(iv) Upon the filing by or against the Company of a petition
to have the Company adjudged as bankrupt or a petition for
reorganization or arrangement under any law relating to
bankruptcy, and where any such involuntary petition is not
dismissed within 90 days.
Upon termination under Subsections 9 (b) above, the Company shall have no
liability to RCG for Compensation accruing after such termination, and RCG shall
have no further entitlement thereto. Upon such termination, RCG shall be
entitled to receive and retain only accrued Compensation to the date of such
termination, to the extent it is unpaid, together with expenses not yet
reimbursed and the Company may immediately exercise its right to repurchase the
Shares in accordance with the terms set forth in the Financial Relations
Compensation Attachments
10. RCG hereby fully discloses that certain associates, affiliates,
officers and employees of RCG are:
A) Licensed as Registered Securities Principals issued by the
National Association of Securities Dealers ("NASD"); and/or
B) Licensed as Registered Representatives issued by the NASD.
All NASD registrations are carried BTS (Brokers Transaction Services),
which is a non-RCG affiliated NASD-registered broker/dealer.
RCG FURTHER DISCLOSES AND THE COMPANY SPECIFICALLY ACKNOWLEDGES THAT
RCG IS NOT A BROKER/DEALER REGISTERED WITH THE NASD OR ANY OTHER REGULATORY
AGENCY, NOR IS IT, OR ANY OF ITS OFFICERS, AFFILIATES AND EMPLOYEES AN OWNER IN
ANY BROKER/DEALER. FURTHERMORE, IN THE PERFORMANCE OF SERVICES UNDER THE TERMS
AND CONDITIONS OF THIS AGREEMENT, SUCH SERVICES SHALL NOT BE CONSIDERED TO BE
ACTING IN ANY BROKER/DEALER OR UNDERWRITING CAPACITY AND THEREFORE RCG IS NOT
RECEIVING ANY COMPENSATION FROM THE COMPANY AS SUCH.
11. The Company understands and acknowledges that RCG provides other
and similar consulting services to companies which may or may not conduct
business and activities similar to those of the Company. RCG is not required to
devote its full time and attention to the performance of its duties detailed in
this Agreement, and may devote only so much of its time and attention as it
deems reasonable or necessary.
12. The validity and interpretation of this Agreement shall be governed
by the laws of the State of Arizona applicable to agreements made and to be
fully performed therein.
<PAGE>
November 12, 1998
Page 5
13. In the event of any controversy or dispute arising out of, or
relating to this Agreement or breach thereof, RCG and PCIG agree to settle such
controversy by arbitration pursuant to Arizona Revised Statutes, 12-1501 et seq.
and in accordance with the rules, of the American Arbitration Association
governing commercial transactions then existing, to the extent that such Rules
are not inconsistent with said Statutes and this Agreement. Judgment upon the
award rendered under arbitration may be entered in any court having
jurisdiction. The cost of the arbitration procedure shall be borne by the losing
party, or, if the decision is not clearly in favor of one party or the other,
the costs shall be borne as determined by the arbitrator. The parties agree that
the arbitration procedure provided herein shall be the sole and exclusive remedy
to resolve any controversy or dispute arising hereunder, and that the proper
venue for such arbitration proceeding shall be Maricopa County, Arizona.
14. For the convenience of the parties, any number of counterparts of
this letter agreement may be executed by the parties hereto. Each such
counterpart shall be deemed to be an original instrument, but all such
counterparts taken together shall constitute one and the same letter agreement.
If the foregoing correctly sets forth our agreement, please sign the
enclosed copy of the letter in the space provided and return it to us, whereupon
all parties will be bound to the terms of this engagement.
Very truly yours, Confirmed and agreed to:
RCG Capital Markets Group, Inc. This ____ day of ________, 1998.
By: Premium Cigars International, Ltd.
-----------------------------
Title: By:
-------------------------- ------------------------------
Title:
----------------------------
<PAGE>
November 12, 1998
Page 6
INDEMNIFICATION PROVISIONS
The Company agrees to defend, indemnify and hold harmless RCG, its
officers, directors, and employees (hereafter jointly referred to as RCG)
against any and all losses, claims, demands, suits, actions, judgments, awards,
damages, liabilities, costs, reasonable attorneys' fees (and all actions in
respect thereof and any reasonable real or other expenses in giving testimony or
furnishing documents in response to a subpoena or otherwise) including the costs
of investigating, preparing or defending any such action or claim, whether or
not in connection with litigation in which RCG is a party, directly or
indirectly caused by, relating to, or asserted by a third party, based upon or
arising out of (a) the Company's breach of or the incorrectness of any
representation, warranty, or covenant of Company contained in this Agreement;
and/or (b) failure of Company to perform any term condition, or obligation
required by this Agreement to be performed by Company; or (c) any Services
rendered by the Company as defined in or contemplated by the Agreement to which
these Provisions are attached, as it may be amended from time to time; or (d)
any act or omission by the Company in connection with its performance of its
obligations under the Agreement. Notwithstanding the foregoing, the Company
shall not have any liability to RCG for, or in connection with, the engagement
of RCG or with any of the foregoing, for any such liability for losses, claims,
demand, suits, actions, judgments, awards, damages, liabilities, costs or
expenses that is found in a final judgment by a court of competent jurisdiction
or mutually acceptable arbitrator to have resulted from RCG's gross negligence,
willful misconduct, RCG's material breach or the incorrectness of any
representation, warranty or covenant of RCG contained in this Agreement.
RCG agrees to defend, indemnify and hold harmless the Company, its
officers, directors, and employees (hereafter jointly referred to as the
Company) against any and all losses, claims, demands, suits, actions, judgments,
awards, damages, liabilities, costs, reasonable attorneys' fees (and all actions
in respect thereof and any reasonable real or other expenses in giving testimony
or furnishing documents in response to a subpoena or otherwise) including the
costs of investigating, preparing or defending any such action or claim, whether
or not in connection with litigation in which the Company is a party, directly
or indirectly caused by, relating to, or asserted by a third party, based upon
or arising out of (a) RCG's breach of or the incorrectness of any
representation, warranty, or covenant RCG contained in this Agreement; and/or or
(b) failure of RCG to perform any term condition, or obligation required by this
Agreement to be performed by RCG; or (c) any Services rendered by RCG as defined
in or contemplated by the Agreement to which these Provisions are attached, as
it may be amended from time to time; or (d) any act or omission by RCG in
connection with its performance of its obligations under the Agreement.
Notwithstanding the foregoing, RCG shall not have any liability to the Company
for, or in connection with, the engagement of RCG or with any of the foregoing,
for any such liability for losses, claims, demands, suits, actions, judgments,
awards, damages, liabilities, costs or expenses that is found by a court of
competent jurisdiction or mutually acceptable arbitrator to have resulted from
the Company's gross negligence, willful misconduct, the Company's material
breach or the incorrectness of any representation, warranty or covenant of the
Company contained in this Agreement.
<PAGE>
November 12, 1998
Page 7
As a condition to the foregoing indemnity, in the event of the
assertion of any claim or demand, or the institution of any suit or action with
respect to which either party is required by this paragraph to Indemnify the
other party (the indemnifying party hereinafter referred to as the "Indemnitor",
and the party entitled to indemnification hereinafter referred to as the
"Indemnitee") the Indemnitee will give notice thereof to the Indemnitor and will
afford the Indemnitor the opportunity to defend , settle, or compromise the
same. Unless the Indemnitor agrees to duly, promptly and diligently discharge or
defend against such claim, demand, suit or action in such manner as will, in the
Indemnitee's reasonable judgment, protect the Indemnitee from any liability,
loss, cost or damage as a result thereof, the Indemnitee may, at the
Indemnitee's option, for the Indemnitor's account and risk, assume the defense
of the same, may implead, interplead or claim over against the Indemnitor and
may thereafter hold the Indemnitor responsible for all sums paid and all costs,
expenses and reasonable attorney's fees incurred by the Indemnitee in so doing.
The Indemnitee may, at the Indemnitee's option, participate in any legal
proceedings being conducted by the Indemnitor hereunder with counsel of the
Indemnitee's choosing, but such participation shall be at the Indemnitee's sole
expense, so long as the Indemnitor is diligently conducting the same in the
Indemnitee's reasonable judgment, and the Indemnitee's counsel shall to the
fullest extent consistent with its professional responsibilities cooperate with
the Indemnitor and any counsel designated by the Indemnitor.
In the event that a court of competent jurisdiction, or an arbitrator
mutually acceptable to the parties, determines that the Indemnification provided
for hereunder is unavailable hereunder, but that both Company and RCG are liable
to a third party asserting a claim against Company and RCG, then as between
Company and RCG, they each agree to contribute such amounts as may be necessary
to satisfy such liability, in amounts proportionate to their respective
comparative negligence/responsibility as determined by a court of competent
jurisdiction or a mutually acceptable arbitrator. If either Company or RCG pays
such third party more than its proportionate share as determined above, then it
shall be entitled to seek contribution from the other party to the extent of
such excess.
No person or affiliated entity found liable for a fraudulent
misrepresentation shall be entitled to contribution from any person or
affiliated entity that is not also found liable for such fraudulent
misrepresentation.
These Indemnification Provisions shall be in addition to any liability,
which either party may otherwise have to the other party or their respective
controlling persons within the meaning of the federal securities laws. The
foregoing Indemnification Provisions are in addition to any rights or remedies
available under applicable law and are not to the exclusion of any such rights
or remedies.
<PAGE>
November 12, 1998
Page 8
FINANCIAL RELATIONS
COMPENSATION ATTACHMENT
In accordance with the contract terms for Premium Cigars International,
Ltd. ("PCIG"), the following is the compensation required by RCG Capital Markets
Group, Inc. and/or its affiliates ("RCG") to perform the Financial Relations
services outlined herein. The contract period for Financial Relations services
will be for an eighteen (18) month period from the date of execution of the
Agreement. During this engagement period, PCIG or RCG may terminate the contract
after nine (9) months by providing written notice of thirty (30) days.
During the term of the Agreement, RCG shall receive $5,500 per month in
compensation. In addition, RCG requires reimbursement for all direct and certain
pre-approved indirect miscellaneous expenses and out of pocket costs, such as,
but not limited to photocopying, messenger service, long-distance telephone
calls, printing charges or similar expenses. It is the policy of RCG that an
expense debit account of $5,000 be utilized for these direct allocable costs.
RCG will provide PCIG with a detailed breakdown of all reimbursable expenses
debited against the remaining monthly balance by the twentieth (20th) day of the
following month of service. When the remaining unused portion of the expense
debit account falls below $1,500, PCIG will be required to reinstate the account
balance to $5,000.
RCG will obtain prior approval from PCIG if any single miscellaneous
expense item is in excess of $600. RCG acknowledges and understands that PCIG
will have specific amounts budgeted for these expenditures and will use its best
efforts to ensure those budget amounts are not exceeded.
As additional compensation for Financial Relation Services,
PCIG will sell to RCG 100,000 shares of PCIG common stock (the "Shares") at a
price of $.01 per Share, for a total price of $1,000. On or before January 1,
1999, RCG will pay the purchase price for the Shares to PCIG, which will then
promptly issue the Shares in the name of RCG, however such Shares shall be held
by PCIG. On or after one year from their issuance or earlier as provided for in
the Agreement, and on or before January 28, 2000, PCIG may repurchase Shares
from RCG, at the same price paid by RCG to PCIG for the Shares, upon the
following conditions:
1. PCIG may repurchase 25,000 Shares if PCIG's stock price fails to
hold and maintain a closing bid equal to or greater than $1.00
per share for ten (10) consecutive trading days (the "Trading
Period") prior to January 23, 1999; or the applicable date if
extended
2. PCIG may repurchase 25,000 additional Shares if: (i) PCIG's stock
fails to satisfy the requirements set forth in paragraph 1 above,
or (ii) after the Trading Period and for a period of six months
thereafter, PCIG's stock fails to maintain sufficient levels such
that the stock does not become subject to a delisting letter from
NASDAQ.
<PAGE>
November 12, 1998
Page 9
3. PCIG may repurchase up to 30,000 additional Shares unless, prior
to the repurchase date, PCIG has received reasonably acceptable
proof for each new institutional investor who has purchased a
total of $100,000 or more worth of PCIG's stock. PCIG's right to
repurchase Shares shall expire as to 10,000 Shares at the time
that proof of such purchase is provided as to each institutional
investor, up to a total of three (3). For example, if only
$200,000 worth of PCIG stock is purchased by new investors, then
only 10,000 Shares may be repurchased by PCIG.
4. PCIG may repurchase an additional 5,000 Shares unless PCIG
receives a written publication confirming corporate research
coverage of PCIG by a buy or sell side analyst, or endorsement by
an appropriate investment newsletter from a pre-approved list of
such publications.
5. PCIG may repurchase an additional 15,000 shares unless the
average weekly trading volume of PCIG stock for the six months
ended December 31, 1999 exceeds the average weekly trading volume
of PCIG stock for the six months ended June 30, 1999 by at least
20%.
In order to repurchase Shares, PCIG shall give RCG at least five (5)
days written notice of its intent to repurchase any Shares. Upon receipt of the
repurchase price in full, RCG shall execute such documents as PCIG shall
reasonably request to transfer Shares back to PCIG.
RCG acknowledges that the Shares discussed herein shall be restricted
securities subject to the provisions of S.E.C. Rule 144, 17 C.F.R. ss.230.144
and that all such Shares shall bear an appropriate restrictive legend to that
effect. Certificates representing Shares shall be held by PCIG unless and until
RCG formally requests that the restrictive legend be removed from such
certificates. PCIG shall provide acceptable evidence to RCG that such Shares
have been issued and are held in safe keeping for the benefit of RCG and without
additional conditions other than what is provided for in this Agreement. At the
time that RCG requests the removal of a restrictive legend from certificates
representing any Shares, RCG shall pay to PCIG: (a) $.99 per Share as to the
first 50,000 Shares covered under items 1 and 2 above; and (b) $1.49 per Share
as to the second 50,000 Shares covered under items 3, 4 and 5 above. Upon
payment of the required amount, PCIG shall promptly forward the certificate to
its transfer agent, together with appropriate instructions for the removal of
restrictive legends and delivery to RCG of certificates without restrictive
legends for the requested number of Shares.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 1998 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 168,216
<SECURITIES> 0
<RECEIVABLES> 561,259
<ALLOWANCES> 37,980
<INVENTORY> 1,325,282
<CURRENT-ASSETS> 2,193,884
<PP&E> 627,210
<DEPRECIATION> 165,759
<TOTAL-ASSETS> 3,766,132
<CURRENT-LIABILITIES> 1,173,505
<BONDS> 0
0
0
<COMMON> 8,655,339
<OTHER-SE> 78,638
<TOTAL-LIABILITY-AND-EQUITY> 3,766,132
<SALES> 6,900,927
<TOTAL-REVENUES> 0
<CGS> 5,186,604
<TOTAL-COSTS> 11,017,457
<OTHER-EXPENSES> (86,705)
<LOSS-PROVISION> 172,467
<INTEREST-EXPENSE> 46
<INCOME-PRETAX> (4,029,825)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (4,029,825)
<EPS-PRIMARY> (1.16)
<EPS-DILUTED> 0
</TABLE>
