-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, JfHJgkObUlfpr62T/sfuDLKKLoXUPi3Q15tWp2MEbjHKqTvDyvr0pmc9EymfFWyP fkcmXFX6wO08TavQqkwHOw== 0000950147-98-000245.txt : 19980401 0000950147-98-000245.hdr.sgml : 19980401 ACCESSION NUMBER: 0000950147-98-000245 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: PREMIUM CIGARS INTERNATIONAL LTD CENTRAL INDEX KEY: 0001041479 STANDARD INDUSTRIAL CLASSIFICATION: TOBACCO PRODUCTS [2100] IRS NUMBER: 860846405 STATE OF INCORPORATION: AZ FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10KSB SEC ACT: SEC FILE NUMBER: 001-13273 FILM NUMBER: 98581334 BUSINESS ADDRESS: STREET 1: 15651 N 83RD WAY STREET 2: STE 3 CITY: SCOTTSDALE STATE: AZ ZIP: 85260 BUSINESS PHONE: 6029228887 MAIL ADDRESS: STREET 1: 15651 N 83RD WAY STREET 2: SUITE 3 CITY: SCOTTSDALE STATE: AZ ZIP: 85260 10KSB 1 ANNUAL REPORT 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 [Fee Required] For the fiscal year ended December 31, 1997 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) 15651 North 83rd Way, Suite 3 Scottsdale, Arizona 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 $3,362,275. The aggregate market value of voting stock held by non-affiliates of the Company was approximately $2,824,425 as of March 24, 1998. The number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date of March 31, 1998 was 3,469,092. Premium Cigars International, Ltd. FORM 10-KSB FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
TABLE OF CONTENTS - ----------------- PAGE ---- PART I.....................................................................................4 Item 1 - Description of Business..................................................4 Item 2 - Description of Property.................................................19 Item 3 - Legal Proceedings.......................................................20 Item 4 - Submission of Matters to a Vote of Security Holders.....................20 PART II...................................................................................21 Item 5 - Market for Common Equity and Related Stockholder Matters................21 Item 6 - Management's Discussion and Analysis or Plan of Operation...............23 Item 7 - Financial Statements and Supplementary Data.............................29 Item 8 - Changes in and Disagreements with Accountants on Accounting Financial Disclosure...........................................29 PART III..................................................................................30 Item 9 - Directors and Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act............................................30 Item 10 - Executive Compensation.................................................35 Item 11 - Security Ownership of Certain Beneficial Owners and Management.........42 Item 12 - Certain Relationships and Related Transactions.........................45 Item 13 - Exhibits and Reports on Form 8-K.......................................52 SIGNATURES................................................................................55 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS................................................56
2 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: o our ability to maintain an adequate capital position and a sufficient cash flow as we add retail stores required by commitments with our customers and distributors; o our ability to raise additional capital, if current financing is depleted, to enable us to maintain sufficient working capital for operating activities; o any decision by major retail chains to discontinue selling all tobacco products or to place our humidors in a disadvantageous location within their stores; o changes in government regulations, tax rates and similar matters, including any restriction on the self-service nature of merchandising displays and marketing promotions; o the ability of our in-house Customer Service Department to significantly improve over the support and sales order processing results previously managed by an out-sourced telemarketing contractor; o our ability to establish a stable management team and attract and retain quality employees; o the risk of any significant uninsured loss from potential passenger claims as a result of a September 1997 automobile accident in which one of our employees was the driver; o the possible negative impact of a settlement announced June 20, 1997 of litigation among 40 States and major U.S. cigarette manufacturers; o 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; o our ability to negotiate and maintain favorable distribution arrangements with our customers; o the effect of changing economic conditions; o a decline in the popularity of cigar smoking and/or possible adverse public opinion against cigars and cigar smoking; and o 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. 3 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. On September 29, 1997, the Company completed an initial public offering which raised approximately $10.4 million in capital. We are continuing to use this capital to expand the PCI Cigar Program in high volume retail outlets in the United States and Canada. Operations - What We Have Learned. Our operations expanded dramatically in 1997. However, results of operations were disappointing in several aspects. See Item 6 "Management's Discussion and Analysis of Financial Condition or Plan of Operation" below. In our relatively short history, we have gained significant insights on PCI operations, and we have initiated major changes to improve our business. We believe these changes are critical to help achieve the revenue and profit growth necessary for success. The following summarizes our key insights into PCI, based on our experience to date, and the changes we have made (or are making) as a result of our experience. Much of the information set forth below, particularly all of the statements made under "Our Focus - Vision, Mission, Strategic Goals," each "Strategic Goal," and "Key 1998 Strategies" constitutes "forward looking" information, and should be considered in light of the "Special Notes Regarding Forward-looking Statements" on page 3. 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 needs focus. We must focus more on the needs of the consumer and the unique needs of each distribution channel. We believe that PCI must differentiate itself from "distributors of premium cigars" and become a "marketer of premium cigars." We have learned that a complete program is critical to our long-term success; simply placing a humidor at retail has proven not to be sufficient. We are gaining a greater understanding of the consumer who buys cigars in our customers' retail outlets, and are acting to improve our cigar selection and price points, differing by geographic location. We are acting to improve our merchandising by helping our customers present our humidor program to their consumers more effectively. We believe that a consistent, quality message to customers and consumers, combined with a fact-based understanding of individual store order patterns, will help build equity behind our name, and credibility with our customers. We have learned that a humidor in every outlet may not be justified. Some retail stores are not appropriate for our program - the store's consumer base may not be large enough or demographically consistent with our product offerings. We have also identified 4 opportunities to place humidified, premium cigars in high volume retail outlets by making adjustments in the size of our humidors, and structuring sell-through programs to meet the unique requirements of each distribution channel (e.g., grocery stores, drug stores, mass merchandisers, warehouse clubs). 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. We retained purchasing and operations management. Founding Management realized that in order to maximize our potential, PCI needed Management with extensive consumer products operations experience. John Greenwell was recruited as the Chief Executive Officer, President and Chief Operating Officer to build a Management team with the necessary skills. He obtained the services of Brendan McGuinness as Acting Vice-President of Sales, David Hodges as interim Chief Financial Officer, and Stan Hall as Controller. We believe that these experienced individuals (detailed biographies are included in Item 9 of this Report) can provide the critical leadership and skills appropriate to these functions. Mr. Greenwell's consumer package goods marketing background enhances his ability to provide the leadership for this critical function. We confirmed that purchasing and operations functions were effectively managed, and no changes were necessary. Computer systems are critical to control and management decision-making. Our existing systems were totally inadequate to manage our business. We have nearly completed implementing our new computer systems. The number of transactions associated with our dramatically increased customer base quickly overwhelmed PCI's existing systems in the Third Quarter of 1997. Although we made some progress in getting new systems on line, we did not progress fast enough to handle the growing number of transactions, or provide adequate information required to make management decisions. After January 1998, Mr. Hodges and Mr. Hall provided the necessary leadership and skills to accelerate system installation. Although we expect PCI's fully integrated system to be completely installed and operating during the Second Quarter, 1998, we have already made significant progress. Our system has helped to improve accounts receivable management, sales forecasting, budget and expense control. We believe that inventory management and sales tracking functions will come on-line in the next two months. We anticipate that a fully integrated system will aid us in better cash management, along with significant improvements in customer service capabilities. Improved sensitivity to our customer service function is critical. Outsourcing customer service failed. We are bringing that function in-house. PCI elected to outsource customer service in the United States, but retained the customer service function in-house in Canada. Outsourcing this critical function and failing to provide appropriate Management attention proved to be a mistake. Order rates, 5 percent of accounts reordering, and credibility with our customers were all at very disappointing levels versus our in-house Canadian experience. Our new Management team has addressed this problem and we intend that all customer service functions will be in-house as of April 1, 1998. We are currently hiring or reassigning personnel and training them to manage all customer service matters. Brand names must be included in our product line. The availability of premium cigars is different now than when PCI began its expansion. We have made arrangements to distribute major brand names. Only limited quantities of brand name premium cigars were available in 1997, and PCI's size and status did not afford us access to brand name premium cigars when we first expanded our PCI Cigar Program. As our Program grew, so did our credibility with suppliers and the availability of brand names to us increased. We expect that as of mid-April, 1998, PCI will be able to offer our customers and consumers the number one selling premium cigar in the United States, and five of the top ten selling premium cigar brands in the United States - Macanudo(TM), H. Upmann(TM), Partagas(TM), Te-Amo(TM), Don Tomas(TM)(1) (source: Cigar Insider, 1997 Unit Sales). We believe there is a demand for brand names, and intend to provide our customers and consumers with the best premium cigars at key price points. We are planning a cigar trade-out program replacing slower moving SKU's with more appropriate cigars and price points for each store's consumer base. Our Transition. PCI is in a "transition" period where we are implementing the changes described above. Management believes that by making these changes, PCI will significantly improve its ability to generate increased revenue, and to attain and grow profitability. Our Focus - Vision, Mission, Strategic Goals. To provide long-term focus, our new Management team has developed the following Vision, Mission, and Strategic Goals for PCI. We intend to implement business plans designed to achieve each of our seven strategic goals. VISION. We intend to be the international leader in marketing premium cigars to the mass markets. - -------------------- (1) Believed to be trademarks of third parties. We have no ownership interest in any of the intellectual property indicated by trademark or service mark symbols in this document. 6 MISSION. We intend to continuously improve our position in the marketing of premium cigars by: o Delivering superior customer satisfaction o Understanding and meeting our consumer's needs o Creating an environment that inspires our employees to reach their full potential This will allow us to prosper as a business and provide a reasonable return to our owners...the shareholders. STRATEGIC GOALS. 1. During the next three years, PCI intends to increase sales, increase gross margins and improve net margins. 2. Improve/build PCI brand equity. 3. Identify and improve three key processes per year for the next three years. 4. Establish preferred relationships with accounts representing the large majority of our sales within three years. 5. Establish preferred relationships with suppliers representing the large majority of our cost of goods within three years. 6. Increase organizational capacity, flexibility and responsiveness by increasing the effectiveness of individuals and teams. 7. Establish a contingency plan that addresses three key threats each year for the next three years. Key 1998 Strategies. To achieve PCI's seven strategic goals, we intend to implement the following key strategies during 1998: During the next three years, PCI intends to increase sales each year, increase the gross margins, and improve net margins. Increase PCI's direct humidor placements in convenience stores. Increase the percent of accounts reordering. Increase average order rate. Implement sell-through programs to alternative channels (grocery, mass merchandisers, drug, warehouse clubs). Reduce the overall freight percentage of net sales. Reduce the overall packaging materials expense. Use detailed and accurate sales forecasting to reduce overall operations payroll expense. 7 Price sell-through gift packs to improve gross margin. Ensure Canadian subsidiary infrastructure is capable of handling growth. Increase inventory turnover. Establish aggressive receivables management program. Improve/build PCI brand equity Understand and deliver products that meet consumers' needs and wants. Develop and implement a new PCI logo that projects a memorable, consistent image of quality to the consumer and the customer. Communicate the PCI Program in consumer and trade advertisements, consumer and trade promotions, special event sponsorship, trade show participation, editorials and web page. Identify and improve three key processes per year for the next three years. Establish a system platform to ensure ease of use, timeliness and accuracy of information. Develop appropriate interaction with our customers that establishes our category leadership. Process map critical operations activity to identify opportunities. Establish preferred relationships with accounts representing the large majority of our sales within three years. Increase the contact frequency with key account's decision makers. Implement single cigar UPC stickers. Establish a PCI identity with our customers by emphasizing communication and teamwork between the Sales and Customer Service departments. Increase PCI response level to customer needs. Increase the quality of category information available for our customers. Enhance PCI's position as an industry leader. Increase face to face contact with broker representatives. Improve the flow of critical information. Ship orders on-time and complete. Establish preferred relationships with suppliers representing the large majority of our cost of goods within three years. Ensure shipping configurations meet supplier requirements. Utilize computer system to improve inventory management. Provide suppliers with appropriate lead times and timely payment. Increase organizational capacity, flexibility and responsiveness by increasing the effectiveness of individuals and teams. Use cross-functional teams with empowered members. Improve individual and team skills via training and/or seminars Establish clearly understood policies, procedures and job descriptions. Implement competitive compensation strategy. 8 Establish a contingency plan that addresses three key threats each year for the next three years. Increase informational resources and build relationships in the industry. Use proactive approach to managing investor expectations. Use the mutual resources of the industry to address issues. Management Changes. As a response to perceived needs for different management skills, virtually all of PCI's Management team, except purchasing and operations managers, has changed since completion of our initial public offering in September, 1997. Changes include: o John E. Greenwell was hired as PCI's President and Chief Operating Officer on December 15, 1997; he became PCI's Chief Executive Officer on March 1, 1998. o Colin A. Jones, Director, was terminated as Vice President of International Sales on January 16, 1998. o R. Allen Vaughan, hired as Vice President of Corporate Planning and Investor Relations on October 1, 1997, left PCI on January 23, 1998. o David E. Hodges, Director, replaced Karissa B. Nisted as Chief Financial Officer on January 31, 1998, and became Treasurer on March 4, 1998. o Brendan McGuinness was hired as a sales consultant on February 1, 1998 and on March 13, 1998 began serving as Acting Vice President of Sales. o Ms. Nisted left PCI on February 3, 1998. o Stanley R. Hall was employed as Controller on February 7, 1998. o Steven A. Lambrecht, Director, stepped down as President on December 15, 1997 and was terminated as Chief Executive Officer on March 1, 1998. o Greg P. Lambrecht, Director, was terminated as Vice President of National Sales on March 2, 1998, and as Secretary and Treasurer on March 4, 1998. o Mr. Hodges resigned from each of his capacities as a Director and officer on March 24, 1998. Mr. Hall assumed PCI's financial reporting responsibilities on that date. 9 Components of the PCI Cigar Program. We compete by marketing our PCI Cigar Program as a total package of service, convenience and quality. Our cigars represent an excellent value as high quality products at competitive prices and in convenient locations. Our complete PCI Cigar Program includes: o quality premium and mass-market cigars at key price points; o imported, hand-rolled short, medium and long-leaf filler premium cigars from the Dominican Republic, Honduras, Nicaragua, Mexico and the Philippines; o domestic machine-made mass market cigars; o in-store, countertop and free-standing, custom made wood humidors; o training materials and sales support to individual stores; o point-of-purchase information cards and cigar magazine racks; o customer service telephone contact for sales and store support; o large, "walk-in" humidors for distribution center cigar inventory storage; o spokesman relationship with Arie Luyendyk, the recent winner of the Indianapolis 500; and o merchandising arrangements with leading cigar publications such as Smoke(TM) and Cigar Aficionado(TM). 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. We had placed our PCI Cigar Program in over 6,000 directly-serviced stores in the U.S. and Canada as of December 31, 1997. Our Largest Customer. Corporate and franchise stores affiliated with Southland USA and Southland Canada (7-Eleven) accounted for over 82% of our sales in the period ended March 31, 1997. We have expanded our customer base, but sales to 7-Eleven stores still 10 accounted for approximately 73% of our sales for the nine-month period ended December 31, 1997. We expect that sales to 7-Eleven stores will continue to account for a substantial percentage of our sales. PCI, Southland USA, or any U.S. franchisee have the right to terminate our agreement for any reason upon 60 days 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, is believed to be the first company to market premium cigars sold via in-store humidors to a major Canadian national convenience store chain. The first major presentation of what is now the PCI Cigar Program was to Southland Canada (7-Eleven). An initial test that began in June, 1996 was conducted in 45 stores in Vancouver, B.C. and 15 stores in Edmonton, Alberta, with a possibility of expansion in 60 days if the test market was successful. After three weeks, the premium cigar program was so successful that 7-Eleven began a national program, and the PCI Cigar Program is currently in virtually all of 7-Eleven's Canadian stores. CAN-AM secured a strong foothold in the convenience industry with 7-Eleven stores, and is pursuing expansion through chains such as Petro-Canada, Mac's, TRA, PRIDA, as well as other independent retail outlets. Through December 31, 1997, CAN-AM had secured retail outlets in the Canadian provinces of British Columbia, Alberta, Saskatchewan, Manitoba, Ontario, Nova Scotia, Prince Edward Island and New Brunswick. With a warehouse near Vancouver B.C., a national distribution system and an in-house Customer Service Department, current CAN-AM revenue in the nine-month period ended December 31, 1997 was approximately US $1,317,688. 11 U.S. Sales. As of December 31, 1997 our United States operations distribute to stores in 42 states and the District of Columbia as follows: Alabama Illinois Missouri Pennsylvania Alaska Indiana Nebraska Rhode Island Arizona Iowa Nevada Texas Arkansas Kansas New Hampshire Utah California Louisiana New Jersey Virginia Colorado Maine New Mexico Washington Connecticut Maryland New York West Virginia Delaware Massachusetts North Carolina Wisconsin Florida Michigan Ohio Virginia Georgia Minnesota Oklahoma Idaho Mississippi Oregon PCI U.S. revenue for the nine-month period ended December 31, 1997 was $2,044,587. 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 62% of our total U.S. sales, no other individual customer represents more than 17% 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 90% of our total sales and third-party distribution accounted for 10% of our total sales for the nine-month period ended December 31, 1997. 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 will use databases to analyze store volume, price points, cigar selection, provide counsel relative to proper humidification, maintenance, merchandising, humidor placement and reorders. We have been very successful in Canada with an in-house customer service department; however, our U.S. test of out-sourcing this function was below Management's expectations. Although it is an investment in staff, equipment, training, systems, office space and supervision, Management believes the investment is justified, and we will be bringing all customer service in-house as of April 1, 1998. Humidors. We provide, and retain ownership of, all countertop and free-standing cigar humidors shipped to retail outlets. Our humidors provide an attractive product display and increased counter space available for PCI's products. A magazine rack can be attached that can be used to display and sell cigar-related magazines such as Smoke(TM) and Cigar Aficionado(TM). The celebrity covers used by such magazines, when displayed in the magazine rack, provide high 12 impact, point of purchase signage. Each PCI in-store humidor is a sealed case or box that displays premium cigars in an optimal environment of humidity. Our standard in-store humidors come in three sizes that can store and display 75, 125 or 200 cigars. We currently have two suppliers of humidors which are based in Arizona and Canada, and our largest supplier has been The Wildwood Collection of Tempe, Arizona. 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. Our Cigars. We sell name-brand and our own private-label cigars from our humidors, typically retailing from $1 to $8. We also distribute a line of cigar-related accessories as a service to our customers, although revenue is very minor in relation to cigar sales. During our initial start-up phase, we were distributing as many as 60 different cigar products from more than a dozen different brands. We have subsequently reduced our product offerings to approximately 35-40 cigar products to optimize our product quality and mix, to more efficiently manage our inventory and to focus our efforts on our best-selling and most profitable products. A smaller product line also makes it easier for individual store personnel to become familiar with, and knowledgeably recommend, our cigars and accessories. 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. From time to time, we may take advantage of opportunities to sell other products from our humidors which are compatible with, or conducive to, cigar sales. For example, we currently have joint merchandising agreements with leading cigar publications such as Smoke(TM) and Cigar Aficionado(TM). These programs encourage the display of the magazines from integrated magazine racks on some of our humidors. PCI receives advertising and editorial support as well as the category-building power of the magazines while the magazines enjoy the exposure and visibility of the association with our humidors. We also have distribution arrangements with other cigar-related accessories such as cutters, lighters and breath fresheners, such as Cigar Gone(TM). We may elect to continue or discontinue offering these 13 products in the future and revenue from non-cigar product sales is not significant in comparison to revenue from cigar sales. Price Point Supplies. Our PCI Cigar Program currently provides each customer with a number of cigars at each price point established between PCI and the specific store or distributor. This strategy allows us to substitute various premium cigar brands in each price group, depending upon supplies available from time to time. Our typical humidor displays premium cigars in three or five different price point SKUs. In addition, we maintain large custom-designed display case humidors with eight SKUs for selected customers and high-volume retail locations. Cigar Trade-Out Program. The relationship we have with our customers is very important to us and 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. Historically, we have had few returns. Nevertheless, a recent analysis of retail outlets with substandard sales performance indicated opportunities to improve product mix. These opportunities were primarily in the stores serviced by out-sourced customer service, which were not receiving the attention necessary to insure an optimal program. As a reflection of our commitment to our customers to provide them with the optimum program, we are offering to trade out slower moving store inventory and replace it with an improved product mix. The estimated cost of this trade-out program is included in the cost of sales for the nine months ended December 31, 1997. The trade-out program will be available for each of the outlets we service. 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. To our knowledge, these cigar manufacturing and wholesale companies, have not yet entered the retail convenience store distribution market. These companies include 800 JR Cigar Company, Inc., Consolidated Cigar Company, Culbro Corporation, General Cigar Company, Swisher, Caribbean Cigar Company, US Tobacco and others. These companies may enter the retail convenience store distribution market in the future and may currently indirectly compete with us, for example, through operating retail warehouse outlets or mail-order retail distribution centers. Also, a number of large distribution companies, such as McLane Company and Core~Mark, who are currently in the convenience outlet distribution business, but who have not entered the cigar distribution business, may do so in the future. These cigar manufacturing and wholesale companies have larger resources than PCI and would, if they enter the cigar distribution market, constitute formidable competition for our business. However, the McLane Company is a current third-party distributor utilizing the PCI Cigar Program. 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 14 cigars. Typically, we do not have supply agreements, but submit purchase orders for cigars. We currently purchase cigars from over 20 suppliers. We have decreased our dependence on any one supplier since the quarter ended June 30, 1997, for which we previously reported that two suppliers accounted for approximately 75% of our total cigar purchases. For the nine-month period ended December 31, 1997 our largest supplier, Latin Partners, accounted for approximately 22% of our total U.S. cigar purchases. Our second largest supplier, Caribbean Cigar Company, accounted for approximately 20% of our total U.S. purchases and our purchases from Caribbean have currently decreased to less than 15% of our U.S. supply. House of Horvath accounted for approximately 77% of total Canadian cigar purchases for the nine months December 31, 1997, but our dependence on House of Horvath is expected to decrease significantly in the next few months as we shift a portion of our purchases to other suppliers to enhance our competitive pricing position. Apart from the named suppliers, no other supplier accounts for more than 12% of our overall U.S. cigar purchases. We have executed supply contracts with a few minor suppliers, but with none of our major suppliers. We are currently negotiating with manufacturers in the Dominican Republic and elsewhere to secure multiple sources of cigars. 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. 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 adequate 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 15 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. In addition, we recently filed a federal trademark application with the United States Patent and Trademark Office to register the trademark PREMIUM CIGARS INTERNATIONAL. We have researched and are developing other trademarks and tradenames, and intend to file additional applications when appropriate. The Company currently owns no patents. 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. Although regulation initially focused on cigarette manufacturers, it has begun to have a broader impact on the tobacco industry as a whole. Regulation may focus more directly on cigars in the future because of the recent increase in popularity of cigars. Current regulations include labeling requirements, limitations on advertising and prohibition of sales to minors, and laws restricting smoking from public places including offices, office buildings, restaurants and other eating establishments. In addition, cigars have been subject to substantial excise taxation at the federal and state levels, as well as substantial taxation in foreign jurisdictions, such as Canada, and those taxes may increase in the future. Recently, several states have enacted increases in cigar tobacco taxes. Future regulations and tax policies may have a material adverse effect upon the ability of cigar companies, including PCI, to generate revenue and profits. Taxes. In recent years, federal and state governments have proposed and implemented increases in cigarette excise taxes. The "balanced budget" legislation signed into law by President Clinton on August 5, 1997 increases federal excise taxes on each pack of cigarettes by 10(cent) in 2000 and an additional 5(cent) in 2002. These particular increases do not, but other future increases may, apply to cigars. Each Canadian province in which CAN-AM is operating has approved CAN-AM to collect provincial taxes. The tax rates vary from province to province, but range from 45% to 95%. Tax Filing Compliance Issues. During 1997, PCI registered with appropriate taxing authorities and paid taxes due in Arizona, Washington and in the Canadian provinces where PCI began doing business. However, PCI failed to register with taxing authorities and pay taxes due on a timely basis in a number of states where PCI began doing business as a result of its aggressive roll-out schedule. 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 has complied with New York's request and has now paid all taxes, 16 penalties and interest due. PCI was subsequently approved to resume shipments to New York retail accounts. Management does not consider this brief shipment interruption to be material to its operations. Other states have not yet, but may, in the future, request temporary suspension of shipments to their states until PCI is in full compliance with tobacco tax and other tax requirements. The impact of possible suspensions is not currently known, but we are currently taking steps to comply with all tax jurisdictions in which it does business. Severe action by one or more states could adversely impact our operations. Health Regulations. Together with changing public attitudes toward smoking, the trend is toward increasing health regulation of the tobacco industry. Although a variety of bills relating to tobacco issues have been introduced in the United States Congress, only one bill relating to a minimum age of 18 years for the sale of tobacco products has passed to date. Future enactment of the other bills may have an adverse effect on the sales or operations of PCI. Litigation is still pending by Philip Morris and five other representatives of the tobacco manufacturing and distribution industries against the U.S. Environmental Protection Agency (the "EPA") is still pending to determine whether the EPA has statutory authority to regulate environmental tobacco smoke. A federal trial court recently ruled that the U.S. Food and Drug Administration (the "FDA") has authority to regulate tobacco products under the Federal Food, Drug and Cosmetic Act, but ultimate resolution of the litigation is still pending. The tobacco industry is challenging proposed regulations by the federal Occupational Safety and Health Administration (OHSA) that seeks to eliminate nonsmoker exposure to environmental tobacco smoke in the workplace. The ultimate effect that these regulation efforts may have on PCI's operations is uncertain. State Regulation. 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 have also increasingly moved to curtail smoking by prohibiting smoking in certain buildings or areas or by requiring designated "smoking" areas. In a few states, legislation has been introduced, but has not passed, which would require all little cigars sold in those states to be "fire-safe" little cigars, i.e., cigars which extinguish themselves if not continuously smoked. Passage of similar restrictions or regulations could adversely affect our sales or operations. Massachusetts lawmakers have introduced several bills to require warning labels on cigars, but none has yet passed. 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." Warning Labels. 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. During 1988, 26 manufacturers of tobacco products, including the largest mass-marketers of cigars, entered into a settlement of legal proceedings filed against them pursuant to California's Proposition 65. Under the terms of the settlement, the defendants agreed to label retail packages or containers of cigars, pipe tobaccos and other smoking tobaccos other than cigarettes manufactured or imported for sale in California with the following specified 17 warning label: "This Product Contains/Produces Chemicals Known To The State of California To Cause Cancer, And Birth Defects or Other Reproductive Harm." Because it is not practical for national cigar manufacturers to confine their warning labels to cigars earmarked for sale in California, most packaged mass market cigars manufactured in the United States carry cancer warning labels. 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. Litigation, including class actions, is pending against leading United States cigarette manufacturers seeking compensatory and, in some cases, punitive damages for cancer and other health effects alleged to have resulted from cigarette smoking. 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. Proposed Settlement with States. Several states have sued tobacco companies seeking to recover the monetary benefits paid under Medicaid to treat residents allegedly suffering from tobacco-related illnesses. On June 20, 1997 the Attorneys General of 40 States and the major U.S. cigarette tobacco companies announced a proposed settlement of the litigation, which, if approved by the United States Congress, would require significant changes in the way U.S. cigarette and tobacco companies do business. The final form of the settlement and the potential impact, if any, on the cigar industry is uncertain, as the settlement continues to be the subject of ongoing political debate. Until the multi-state settlement is reached, the individual state actions against the tobacco companies will continue. FTC Regulations. The Federal Trade Commission ("FTC") recently issued an order requiring the five largest cigar manufacturers (Swisher International Group, Inc., Consolidated Cigar Co., General Cigar Co., Havatampa, Inc. and John Middleton, Inc.) to report annual sales figures and advertising and marketing expenses. Such reporting would include promotional expenses, such as expenditures related to product placement in motion pictures. Cigarette and smokeless tobacco manufacturers are already required to report similar information. The FTC is also contemplating requiring cigar ads to include the same health warning as cigarette adds. Approximately 90% of all U.S. cigars, and primarily mass-market cigars, already carry such a warning label. National Cancer Institute Report. The National Cancer Institute is expected to release a report sometime this spring which focuses on the health dangers related to cigar smoking. The American Lung Association has reported that cigar smokers are 34% more likely to get lung cancer than nonsmokers, and have a four to ten times higher incidence of cancer of the mouth, 18 larynx and esophagus. In addition, secondhand cigar smoke is thought to be even more toxic than secondhand cigarette smoke. It remains to be seen what effect, if any, the FTC order and the National Cancer Institute report will have on the cigar industry or on the Company's operations. Research and Development; Environmental Compliance. We have not consistently incurred substantial research and development costs associated with our products. Historically, PCI has acquired cigars and accessory product lines from its suppliers and contract manufacturers and has typically allowed the suppliers and manufacturers to incur the costs of product research and development. PCI's research and development expense was insignificant in 1997. 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, 1997, we had 39 employees in the U.S. and Canada, of which 37 were employed full-time. None of our employees are represented by a labor union and we believe that employee relations are good. Item 2 - Description of Property - -------------------------------- We sublease, 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. Our sublease agreement expires on May 31, 1999. The annual rent for the first year (June 1997 through May 1998) is approximately $83,571 and the annual rent for the second year (June 1998 through May 1999) is approximately $85,609. We will be moving out of this facility in late April of 1998 to a larger facility described below. We are in the process of formalizing a verbal understanding with our current sublessor to release us from the remainder of the sublease when we move to our new facility. Because we have outgrown our current 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. The new leased facilities are less than one mile from our current facilities. We plan to move 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. 19 Item 3 - Legal Proceedings - -------------------------- PCI is not a party to any pending lawsuits. PCI may become a defendant, however, in an automobile accident injury claim in which PCI's insurer has disputed coverage. See "Management's Discussion and Analysis or Plan of Operation." Item 4 - Submission of Matters to a Vote of Security Holders - ------------------------------------------------------------ None 20 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(sm) "PCIG" and on the Boston Stock Exchange "PCI." Set forth below are the high and low closing prices for PCI's common stock as reported on either the NASDAQ SmallCap Market(sm) or The Boston Stock Exchange for the quarters ended September 30, 1997 and December 31, 1997: Quarter High Low - ------- ---- --- September 30, 1997 $ 5.8125 $ 4.3750 December 31, 1997 $ 5.5625 $ 2.0000 As of December 31, 1997, 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. Our 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. (b) Use of Proceeds. PCI provides the following information in accordance with Item 701(f) of Regulation S-B: 1. Our 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 21 (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 the Company'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. 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, 1997, the net offering proceeds were applied as follows: $1,200,000 to repayment of debt, $478,753 to purchase humidors, $1,572,276 to purchase inventory, $731,977 for sales and marketing and $4,147,658 in temporary investments and 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 22 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." Payout of Management Fees. On or about 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." 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: (x) agreed to extend his non-compete clause for six months, for a total of 18 months; and (y) 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". On February 18, 1998, PCI and Karissa B. Nisted executed a severance agreement confirming that PCI will pay her $40,000 in severance compensation over six months according to the terms of her Employment Agreement and in exchange for a limited release. The aggregate total of these settlement and severance payments is $353,320. Item 6 - Management's Discussion and Analysis or Plan of Operation - ------------------------------------------------------------------ You must read the following discussion of the results of the operations and financial conditional 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, as well as 23 the predecessor cigar sales activity of J&M and Rose Hearts. All significant intercompany balances and transactions were eliminated in consolidation. Results of Operation. The following table sets forth a summary of PCI's consolidated statements of operations for the nine months ending December 31, 1997, and for the period from the date of inception, June 1, 1996 through March 31, 1997: For the Ten Month For the Nine Month Period From Inception Period Ending June 1, 1996 Through December 31, 1997 March 31, 1997 ----------------- -------------- Net Sales $3,362,275 $845,571 Cost of Sales 2,798,672 643,790 --------- ------- Gross Profit $563,603 $201,781 S,G & A $2,273,725 $323,776 Stock Based Compensation 110,000 207,625 ------- ------ Loss From Operations ($1,820,122) ($329,620) Other Income (Expense) $59,739 ($21,522) ------ ------- Net Loss ($1,760,383) ($351,142) ========== ======== Loss Per Share ($.82) ($.24) ==== ==== Weighted Average Number of Shares Outstanding 2,156,076 1,480,500 For The Nine Month Period Ending December 31, 1997 Sales. Sales of cigars and related items for the nine month period ending December 31, 1997 were $3,362,275. The following table summarizes Quarterly results. Fourth Quarter 1997 Net Sales were $1,361,779, flat versus the prior period. 24 Quarters (Unaudited Results) 9 Months 2nd Quarter 3rd Quarter 4th Quarter Ending Dec. 31, 1997 ----------- ----------- ----------- -------------------- Net Sales $628,180 $1,372,316 $1,361,779 $3,362,275 Despite a 42% increase in the number of directly serviced humidor placements at retail (Dec. 31 vs. Sept. 30), Fourth Quarter revenue results were disappointing. Revenue per store declined because of internal problems in insuring adequate call frequency to all of our accounts, along with Management's lack of appropriate attention to the customer service function. Revenue per store presented mixed results, with some stores indicating strong reorder rates while others were very disappointing. This problem extended into the First Quarter, 1998. The call frequency and Management attention issues have been addressed via bringing the customer service function in-house as of April 1, 1998. Unfortunately, PCI missed many October to March sales opportunities. Customer service training and staffing are in progress, and for April 1, 1998 changeover will be met. In addition to bringing customer service in-house, we believe that implementing the 1998 Strategies outlined earlier (See Item 1 under "Strategic Goals") will enable us to return to revenue growth. Management believes that a combination of increased humidor placements, the pursuit of sell-through programs designed to meet the needs of grocery, mass merchandisers, drug, and warehouse clubs, leveraged with an effective customer service department, represent significant opportunities to increase revenues. Gross Margins. Gross margin for the nine month period ending December 31, 1997 was 17%. The following table summarizes Quarterly results, and reflects a Fourth Quarter gross margin of 5%. Several factors affected the margin: (1) Fourth Quarter cost of sales was increased by a one-time charge of $110,000 for the estimated cost of the Cigar Trade-out Program, discussed under Item I, to ensure our customers the optimum product selection and once executed, this investment should result in higher revenue as store SKU's better match consumer wants; (2) a $60,000 inventory write down to provide for damaged, unsalable product received from a vendor we no longer do business with; (3) PCI's Canadian subsidiary, which has a lower gross margin than the U.S., represented a greater percentage of sales in the Fourth Quarter than the prior quarter; (4) accrual of tobacco taxes that were associated with prior quarters as discussed under Item 1 - - "Tax Filing Compliance Issues"; and (5) increased warehousing and shipping overhead in anticipation of higher sales volume. Quarters (Unaudited Results) 9 Months 2nd Quarter 3rd Quarter 4th Quarter Ending Dec. 31, 1997 ----------- ----------- ----------- -------------------- Gross Margin 19% 26% 5% 17% As discussed earlier in Item 1 under "Strategic Goals", PCI's new Management has identified and is pursuing opportunities to improve gross margins. With higher margin sell-through programs, more efficient shipping, and continuing improvements in our Canadian subsidiary's gross margin, Management fully expects to see margin improvement beginning in the Second Half of 1998. 25 Selling, General & Administrative. The S, G & A expense for the nine month period ending December 31, 1997 was $2,273,725. The following table summarizes Quarterly results, and reflects an increase versus the prior period. Quarters (Unaudited Results) 9 Months 2nd Quarter 3rd Quarter 4th Quarter Ending Dec. 31, 1997 ----------- ----------- ----------- -------------------- S, G & A $309,199 $814,846 $1,149,680 $2,273,725 S, G & A costs were disproportionately high in relation to sales because an infrastructure (people, offices, equipment, etc.) has been created that is necessary to generate future revenue and manage operations; unfortunately, issues discussed earlier have negatively impacted revenue growth. The Fourth Quarter also reflects several one-time expenses necessary in order to build a sound company. An accrual of $76,000 was established to offset anticipated collection of doubtful accounts; $10,252 was expensed to adjust depreciation write-off for computers in order to reflect a more reasonable useful life; $18,640 in expenses incurred related to moving to a new facility; $41,640 in estimated fees, penalties/interest on tobacco taxes that have not been filed (See Item 1 under "Tax Filing Compliance Issues"). PCI anticipates taking a one-time restructuring charge during First Quarter 1998 in order to reflect additional one-time expenses (severance packages for previous Management, relocation of our offices, and moving customer service department functions in-house). These expenses will be reflected in S, G & A. S, G & A should begin to decrease as a percent of sales in the Second Quarter, 1998 as revenues are anticipated to regain momentum. Stock Based Compensation. During the Second Quarter, 1997, certain employees purchased Common Stock at a price per share that has been determined to have market value in excess of the amount paid by the employees. Additional compensation was recorded in the amount of $110,000. Other Income/(Expenses). Other Income/(Expense) for the Nine Month Period Ending December 31, 1997 was a total of $59,739. This income was made up of $113,131 in interest income, $44,272 in interest expense, $10,038 in foreign currency transaction losses, and $918 in miscellaneous income. Ten Month Period From Date of Inception (June 1, 1996) through March 31, 1997 Sales. Sales of cigar and cigar accessories for the ten month period ended March 31, 1997 were $845,571. Cost of Sales. Cost of Sales for the period from the date of inception, June 1, 1996 through March 31, 1997 was $643,790, with a gross profit of approximately 24%. Gross 26 profit for the ten month period ended March 31, 1997 was low due to the lack of volume purchasing bargaining power during the initial startup phase. Selling, General and Administrative Expenses. Selling, general and administrative expenses for the period from the date of inception (June 1, 1996) through March 31, 1997, were $323,776, or 38.3% of sales. These costs were disproportionately high during the initial 10 months of operations in relation to sales due to the addition of personnel to establish market positions with various national chains. In addition, administrative costs increased significantly as we prepared for our increased volume. Stock Based Compensation. During January and March of 1997 certain employees purchased Common Stock at a price per share that has been determined to have market value in excess of the amount paid by the employees. Additional compensation was recorded in the amount of the excess market value, or $207,625. Other Income/(Expenses). Other income and expense for the period from the date of inception, June 1, 1996 through March 31, 1997, was an expense of $21,522. This expense is made up of $21,292 in interest, $1,193 foreign currency transaction loss, and an offset of $963 in miscellaneous income. Seasonality. Our operational history and the new nature of distributing cigars to convenience outlets does not yet permit us to identify clear seasonal trends, but we believe that 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. During the period from the date of inception, June 1, 1996, through March 31, 1997, we financed our operating and business development activities by issuing notes payable of approximately $180,000, and shares of common stock for approximately $212,050. These funds were used to acquire equipment in the approximate amount of $23,000, humidors in the approximate amount of $71,000, pay organizational and deferred offering costs in the approximate amount of $86,000, and advance funds to affiliates to pay their prior commitments, in the approximate amount of $86,000. 27 After March 31, 1997, we obtained additional bridge financing in the amount of $1,000,000 (including conversion of existing debt of $100,000) which was used primarily to fund additional expansion of operations. During the quarter ended June 30, 1997, we used the net proceeds from the bridge financing of $810,000 to accelerate the expansion of the PCI Cigar Program throughout the U.S. and to cover costs associated with the initial public offering. Humidor purchases for the quarter were approximately $175,000, and we purchased equipment costing approximately $81,000. Deferred costs incurred with the initial public offering were approximately $157,000. In addition, $343,000 was used for working capital to fund sales growth and the related trade receivables and deposits for cigar purchases. In addition, on July 25, 1997, we obtained a $200,000 line of credit with a bank to assist with working capital requirements until the completion of the initial public offering. On August 11, 1997, we received an additional capital contribution of $150,000 from certain existing shareholders. On September 29, 1997, the Company completed an initial public offering, including the closing of an overallotment option, of a total of $10,440,108, with net offering proceeds of $8,131,664. For application of initial public offering proceeds, see Item 5(b), "Use of Proceeds." We believe that the remaining net proceeds of the initial public offering will be sufficient to meet our anticipated expansion and working capital needs for the foreseeable future. However, we cannot assure you that we will be able to maintain an adequate capital position and a sufficient cash flow as we add retail stores required by our commitments with our customers and distributors. Nor can we assure you that we will be able to raise additional capital, if current financing is depleted, to enable us to maintain sufficient working capital for operating activities. We have no plans to perform any significant product research and development, to purchase or sell any significant plant or equipment, to significantly change our number of employees or to obtain additional outside capital. However, if additional funding is required, we may raise capital through the issuance of long-term or short-term debt or the issuance of securities in private or public transactions. We cannot assure you that we can generate sufficient revenues to satisfy the cash flow necessary to meet our anticipated future expansion or our working capital needs. Known Trends, Events or Uncertainties that May Impact Our Financial Condition or Operations. Automobile Accident. On September 16, 1997, a PCI employee 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. 28 PCI has disputed the carrier's denial of coverage and we have asserted that PCI obtained an oral binder of such coverage prior to the accident. PCI believes that it has a strong basis for coverage and intends to vigorously pursue its defenses and indemnification should an action be filed. None of the passengers have indicated what damages they will seek against PCI. At this stage of the claims, we cannot predict the likelihood of an unfavorable outcome or whether the claims will have a material impact on PCI's financial condition. Year 2000 Issues. In 1997, PCI purchased and installed an integrated software system for financial management and accounting, upon which PCI relies heavily and which PCI purchased, in part, upon the representation that the software was designed to correctly process date information as the year 2000 approached and is reached (commonly known as the "year 2000 problem"). PCI largely uses newer computers and software which was sold as "year 2000 compliant." PCI continues to rely, to a lesser degree, on other programs in its operations, however, which were originally designed to recognize calendar years by their last two digits. PCI is in the process of initiating a review of its business systems, including its computer systems, to identify and address any problems that any of its systems may experience as the year 2000 approaches. PCI does not expect that the incremental costs of its review or correction of any year 2000 problem will have a material, adverse effect on PCI's financial condition, operations or financial statements. Item 7 - Financial Statements - ----------------------------- PCI's audited financial statements for the nine-month period ended December 31, 1997 are set forth commencing on page F-1, following the Index to Financial Statements on Page 56. Item 8 - Changes in and Disagreements with Accountants on Accounting and - ------------------------------------------------------------------------ Financial Disclosure - -------------------- None 29 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.......50 Director, Chief Executive Officer, President, Chief Operating Officer Scott I. Lambrecht......26 Vice President of Operations and Secretary James B. Stanley........34 Vice President of Purchasing and Assistant Secretary William L. Anthony......54 Chairman and Independent Director Colin A. Jones..........31 Director Greg P. Lambrecht.......35 Director Steven A. Lambrecht.....46 Director Robert H. Manchot.......54 Independent Director Atul Vashistha..........32 Independent Director John E. Greenwell has been a director and the Company's Chief Executive Officer since March 1, 1998 and the Company'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 28 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 30 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. 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. William L. Anthony has been Chairman of the Board since June 20, 1997 and a consultant to PCI from April 1, 1997 to August 31, 1997. He has agreed to serve as PCI's Chairman for a period of up to five years. He is currently the Chief Operating Officer and Chief Financial Officer for BioMedic, which has developed Philosophy, one of the world's leading medically-endorsed skin care lines. He has 30 years of business and management experience and a "Big Six" accounting background with the New York office of KPMG Peat Marwick, LLP. Mr. Anthony worked for The Dial Corp. from 1984 until August, 1996 culminating his position as Executive Vice President for the Consumer Products Division with annual revenue in excess of $1 billion. He has held key management positions with Bechtel, the U.S. Chamber of Commerce, MAPCO and The Dial Corp. He is the owner, President and sole shareholder of Quality Computer Services, Inc. He received both a B.B.A. and an M.A. in Accounting from the University of Mississippi in 1965 and 1966 respectively. Mr. Anthony was certified as a public accountant in Louisiana in 1969. 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 12 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 31 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 23 years of marketing and sales experience and 17 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. Robert H. Manschot has been a director and an independent director since July 25, 1997. He has been the President and Chief Executive Officer of the NVD and Seceurop Security Services Group, an emergency services corporation in the Netherlands and the United Kingdom, since 1995. He is also the Chairman of RHEM International Enterprises, Inc., an investment, consulting and venture capital company. He was the President and Chief Executive Officer of Rural/Metro Corporation, a Nasdaq-listed emergency services corporation, from 1987 to 1995. He has served in senior management positions with KLM's hotel management company, Sheraton, and Inter Continental Hotels in the U.S., Europe, Middle East and Africa. He has served and continues to serve on numerous public and private company and institution boards, including Nasdaq-listed Action Performance Industries, Inc., and Toronto Stock Exchange-listed Samouth Capital Corporation. He holds a bachelors degree in hotel management from the School for Hospitality Management in the Hague, Netherlands, an MBA from Boston University and is a graduate of Stanford Business School's Financial Management Program. Atul Vashistha has been a director and an independent director since November 19, 1997. Since 1996, Mr. Vashistha has been the Vice President, Marketing and Business Development, of Rural/Metro Corporation, a publicly-traded, $425 million company which provides medical transportation, personal health management and safety solutions in 25 states to a population exceeding 20 million. Mr. Vashistha served Rural/Metro in a variety of marketing and executive management capacities from 1991 to 1996, culminating in his position as Regional President of the company's Southern Arizona operations. He holds an M.B.A. from Arizona State University, where he graduated first in his class, and a B.S. in Engineering from the Institute of Technology, Benaras Hindu University. Other Executives and Key Employees Brendan M. McGuinness has been a sales consultant to the Company since February 1, 1998 and the Acting Vice President of Sales since March 3, 1998. Mr. McGuinness 32 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. 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 Six" 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 and the Arizona Society of Certified Public Accountants. R. Allen Vaughan was PCI's Vice President of Corporate Planning and Investor Relations from October 1, 1997 to January 23, 1998 when he left to pursue other opportunities. Karissa B. Nisted was PCI's Chief Financial Officer from June 20, 1997 to February 3, 1998, when she left PCI. David S. Hodges resigned as a director, Chief Financial Officer and Treasurer on March 24, 1998 to pursue other opportunities. 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 on a timely basis reports required by Section 16(a) during the most recent fiscal year or prior years which have not previously been disclosed: Steven A. Lambrecht and David S. Hodges each filed one late Form 5 in March 1998 reporting one transaction that was not reported on a timely basis and that should have been reported previously in a Form 4 or Form 5. 33 Colin A. Jones filed one late Form 5 in March 1998 reporting two transactions that were not reported on a timely basis and that should have been reported previously in a Form 4 or Form 5. 34 Item 10 - Executive Compensation - -------------------------------- Summary Compensation Table
(a) (b) (c) (d) (e) (f) (g) (h) (i) Other Securities Name and Annual Restricted Underlying Principal Compen- Stock Options/ LTIP All Other Position Year Salary ($) Bonus ($) sation ($) Awards ($) SARs (#) Payouts ($) Compensation - -------- ---- ---------- --------- ---------- ---------- -------- ----------- ------------ Steve 1997 48,832 -- $7,500(1) -- 20,000(2) -- _ Lambrecht ($18,600) /CEO Greg 1997 48,832 -- $7,500(1) -- -- -- 83,000(3)(4) Lambrecht /VP Sales Colin Jones 1997 48,832 -- -- -- -- -- 83,000(3)(4) /VP Int. Sales
(1) Represents payments for consulting services at $2,500 per month during the first quarter of 1997. (2) Represents shares of Common Stock underlying options granted on November 19, 1997 in conjunction with Mr. Lambrecht's transition from President and Chief Executive Officer. The fair market value at the time of the award was $0.93 per share or $18,600. See "Option SAR/Grants in Last Fiscal Year" and "Employment Agreements" below. (3) Includes the payment of a one-time "Management Fee" under Greg Lambrecht's and Colin Jones' Employment Agreements. See "Employment Agreements" below. (4) Includes reimbursement of $3,000 each to Colin A. Jones and Greg P. Lambrecht for attorneys' fees related to the negotiation of various personal agreements or agreements of J&M or Rose Hearts with PCI. 35 Option/SAR Grants in Last Fiscal Year Individual Grants
(a) (b) (c) (d) (e) Number of % of Total Securities Options / SARs Exercise Underlying Granted to or Base Options / SARs Employees in Price Name Granted (#) Fiscal Year ($/Sh) Expiration Date ---- ----------- ----------- ------ --------------- Steve Lambrecht 20,000(1) 100% $5.25 11/19/2002 (10,000) / CEO 03/01/2003 (10,000) Greg Lambrecht -- -- -- -- / VP Sales Colin Jones / VP -- -- -- -- Int. Sales
(1) Options granted pursuant to an "Amendment to Employment Agreement" dated November 19, 1997. Options to purchase 10,000 shares vested immediately upon the date that Lambrecht ceased to be President, or November 19, 1997. Options to purchase an additional 10,000 shares vested on March 1, 1998 after the Board of Directors made a determination that Mr. Lambrecht had cooperated in a management transition to the next Chief Executive Officer. Aggregated Option/SAR Exercises in Last Fiscal Year and FY-End Option/SAR Values (a) (b) (c) (d) (e) Number of Securities Value of Underlying Unexercised Unexercised In-the-Money Options/SARs Options/SARs Shares at FY-End (#) at FY-End ($) Acquired Value on Realized Exercisable / Exercisable / Name Exercise ($) Unexercisable Unexercisable ---- -------- --- ------------- ------------- Steve Lambrecht -- -- 20,000 Not In-the- / CEO Unexercisable Money and (1) Unexercisable (1) Greg Lambrecht -- -- -- -- / VP Sales Colin Jones / VP -- -- -- -- Int. Sales (1) Options to purchase 20,000 shares at $5.25 per share, unexercisable until November 19, 1998 (10,000) and March 1, 1999 (10,000). Closing price of the Company's Common Stock on December 31, 1997 was $2.5625 per share. 36 Director Compensation Table
(a) (b) (c) (d) (e) (f) Number of Securities Annual Consulting Underlying Name Retainer Meeting Fees/Other Number of Options/SAR - ---- Fees ($) Fees ($) Fees ($) Shares (#) s (#) -------- -------- -------- ---------- ----- William L. -- 3,150 10,000(1) -- 156,250(2) Anthony ($340,625) Robert H. -- 3,500 -- -- 5,000(2) Manschot ($10,900) David S. -- 3,150 93,445(3) -- 5,000(2) Hodges ($4,650) Atul -- 350 -- -- 1,250(2) Vashistha ($1,163)
(1) Consulting fees paid pursuant to a verbal consulting agreement effective from April 1, 1997 to August 31, 1997 for assistance in the initial public offering and certain aspects of ongoing strategic planning, business analysis and operations. See "Employment Agreements" below. (2) Represents shares of Common Stock underlying options granted for service as a director. The date of grant and fair market value at the time of the awards was as follows: Anthony, June 20 and August 7, 1997, $2.18 per share or $340,625; Manschot, August 7, 1997, $2.18 per share or $10,900; Hodges, November 19, 1997, $0.93 per share or $4,650; Vashistha, November 19, 1997, $0.93 per share or $1,163. (3) Consulting fees paid pursuant to, and as termination payments under, a Business Consulting Agreement dated June 2, 1997 and which terminated August 25, 1997 for assistance in the initial public offering and certain additional projects related to strategic planning, budgeting, accounting and reporting, business analysis, information systems and operations. See "Employment Agreements" below. Also includes reimbursement of $1,200 in legal fees. Employment Agreements Steven A. Lambrecht had an at-will Employment Agreement with PCI as Chief Executive Officer dated June 13, 1997 which was amended on November 19, 1997 and terminated on March 1, 1998. Under the original agreement, effective May 1, 1997, he received an annual salary of $60,000. He agreed to devote his full time to PCI activities. PCI had the right to terminate his employment at any time, with or without cause. Upon termination for any reason other than for cause, as defined in the agreement, PCI was obligated to pay him his then-current compensation on a regular basis and premiums for continued health insurance coverage for nine (9) months, unless he is disqualified from receiving continued compensation and benefits based on certain conduct or breaches of the Employment Agreement. 37 On September 17, 1997, Mr. Lambrecht's salary was raised to $84,000 annually. See "Certain Relationships and Related Transactions - Raises to Certain Founders and Other Key Employees." On November 19, 1997, PCI entered an Amendment to Employment Agreement with Steven A. Lambrecht in which, among other terms, PCI granted Mr. Lambrecht (i) options to purchase 10,000 shares of Common Stock at $5.25 per share, which vested immediately upon his termination as President that same day, for his services in conjunction with PCI's public offering and (ii) options to purchase an additional 10,000 shares at $5.25 per share, which vested on March 1, 1998 when he was terminated as Chief Executive Officer, upon the Board's determination that he had cooperated in a smooth transition to the next Chief Executive Officer. The Amendment also provided that Lambrecht would complete his unexpired term as a director, affirmed that he would receive the severance compensation set forth in his original Employment Agreement and that, upon the Company's request, he would provide consulting services without additional charge during the severance payout period. Steve Lambrecht subsequently disputed the compensation and severance compensation due to him under his Employment Agreement. PCI settled the dispute in an Agreement with Mr. Lambrecht dated March 3, 1998, which recognized the termination of his employment effective March 1, 1998. See "Settlement of Compensation Disputes with Founders" below. Colin A. Jones had an at-will Employment Agreement with PCI as Vice President of International Sales dated June 13, 1997 which was terminated on January 16, 1998. Under the Employment Agreement effective May 1, 1997, he received an annual salary of $60,000. He was also entitled to a one-time management fee of $80,000, payable over a 16-month period commencing July 1, 1997 at $5,000 per month or in a lump sum upon the Company's obtaining of certain financing, to compensate him for his expertise in sales, marketing, operations, management and existing contacts with major retail distributors. Mr. Jones agreed to devote his full time to PCI activities. The Employment Agreement allowed PCI to terminate his employment at any time, with or without cause. Upon a termination for any reason other than for cause, as defined in the agreement, PCI was required to continue paying him his then-current compensation on a regular basis and premiums for continued health insurance coverage for nine months, unless he is disqualified from receiving continued compensation and benefits based on certain conduct or breaches of the Employment Agreement. On September 17, 1997, Mr. Jones' salary was raised to $84,000 annually. See "Certain Relationships and Related Transactions - Raises to Certain Founders and Other Key Employees." Mr. Jones's employment was terminated on January 16, 1998, and he subsequently disputed the compensation and severance compensation due to him under his Employment 38 Agreement. PCI settled the dispute in an Agreement with Mr. Jones dated March 3, 1998. See "Settlement of Compensation Disputes with Founders" below. Greg P. Lambrecht had an at-will Employment Agreement with PCI as Vice President of International Sales dated June 13, 1997 and which was terminated on March 2, 1998. Under the Employment Agreement and effective May 1, 1997, he received an annual salary of $60,000. He was also entitled to a one-time management fee of $80,000, payable over a 16- month period commencing July 1, 1997 at $5,000 per month or in a lump sum upon the Company's obtaining of certain financing, to compensate him for his expertise in sales, marketing, operations, management and existing contacts with major retail distributors. He agreed to devote his full time to PCI activities. The Employment Agreement allowed PCI to terminate his employment at any time, with or without cause. Upon a termination for any reason other than for cause, as defined in the agreement, PCI must continue paying him his then-current compensation on a regular basis and premiums for continued health insurance coverage for nine months, unless he is disqualified from receiving continued compensation and benefits based on certain conduct or breaches of the Employment Agreement. On September 17, 1997, Mr. Lambrecht's salary was raised to $84,000 annually. See "Certain Relationships and Related Transactions - Raises to Certain Founders and Other Key Employees." Greg Lambrecht subsequently disputed the compensation and severance compensation due to him under his Employment Agreement. PCI settled the dispute in an Agreement with Mr. Lambrecht dated March 3, 1998, which recognized the termination of his employment effective March 2, 1998. See "Settlement of Compensation Disputes with Founders" below. Payout of Management Fees. When PCI received proceeds from its initial public offering, its asset increase triggered an obligation of PCI to pay the management fees of $80,000 each to Greg P. Lambrecht and Colin A. Jones in a lump sum after offset of amounts due PCI from Messrs. Lambrecht or Jones, respectively or Rose Hearts, Inc. and J&M Wholesale, Ltd., the companies they respectively own and control. On October 15, 1997, PCI reached an agreement with Mr. Lambrecht, which was approved by the Independent Directors on November 3, 1997, to release the remaining portion of his management fee, without offset, in consideration for the right to deduct offsetting amounts from commissions and other payments due to Rose Hearts, Inc. or to become due in the future. At the time, PCI considered the balance not to be significant, and not necessary of deduction in the context of the ongoing relationship. Under the agreement, PCI also reimbursed Mr. Lambrecht $3,338 for interest on personal loans which he incurred during the period that PCI delayed payment of his management fee. The agreement with Mr. Lambrecht did not affect Mr. Jones' management fee, which was paid after deducting amounts then known to be due from him. 39 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 conditionally guaranteed bonus of $50,000 for the fiscal year ending December 31, 1998, unless the Company terminates for cause and itself did not materially breach the agreement. The agreement may be terminated upon four weeks' written notice. The agreement provides severance compensation of 3 months compensation in the first 6 months or 9 months compensation for a termination after 6 months. The agreement contains a covenant not to compete which extends 12 months after termination of employment. The Board of Directors, on November 19, 1997, also granted Mr. Greenwell stock options to purchase 70,000 shares according to a vesting schedule from the date of the agreement until June 30, 1999 and which are exercisable from 1 to 5 years after the options vest and are subject to other conditions and restrictions. Settlement of Compensation Disputes with Founders. PCI's employment of Colin A. Jones terminated on January 16, 1998. On about January 19, 1998, Mr. Jones raised claims that his Employment Agreement with PCI entitled him to receive automatic percentage increases in compensation so that his compensation (including stock options and other benefits) would equal that of the most highly compensated officer of PCI. He asserted that his compensation should have retroactively increased to reflect higher compensation granted to Mr. Greenwell, who was hired in December, 1997. Mr. Jones retained counsel to pursue his claims, and his counsel subsequently brought similarly-based claims on behalf of Greg P. Lambrecht. On February 23, 1998, Steven A. Lambrecht asserted his position that the identical automatic raise clause contained in the Employment Agreements of each of the three individuals required that he receive equal compensation to Mr. Jones and Greg Lambrecht. PCI Management (other than those who asserted the claims) disagreed with the claimants' interpretation of their Employment Agreements, but determined that a quick resolution of the issues was preferable to a protracted legal dispute, and that settlement was in PCI's best interests. 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 the Company. The Company paid each individual a lump sum payment of $40,000 in addition to severance compensation of nine months' salary and other benefits payable over nine months under their individual Employment Agreements. Each of the individuals agreed to extend their non-compete clauses for an additional six months for a total of a full year and a half following termination of employment and released PCI from all claims or causes of action relating to their respective Employment Agreement and their employment with PCI. 40 Consulting Agreements. During 1997, we also had arrangements with the following consultants: David S. Hodges was a director and had a Business Consulting Agreement with PCI dated June 2, 1997, which was terminated on August 25, 1997. In accordance with the agreement, Mr. Hodges assisted PCI with its initial public offering and additional projects. Mr. Hodges received $60 per hour and reimbursement for business expenses and health care coverage during the term of the agreement. Upon termination PCI was required to pay Mr. Hodges biweekly payments of $4,800 each for a six month period. William L. Anthony, the Chairman of PCI's Board, entered a verbal agreement with PCI, on April 1, 1997, to act as a consultant to PCI's management to assist PCI with its initial public offering and advise them regarding certain aspects of strategic planning, business analysis and operations, including merchandising, marketing and supply chain issues as requested by PCI's management. PCI agreed to pay Mr. Anthony $2,000 per month and to reimburse certain related expenses. The consulting agreement was terminated on August 31, 1997, shortly after completion of PCI's initial public offering. L.G. Zangani, Inc. and Leonardo G. Zangani Agreements. PCI entered a Consulting Agreement, effective September 16, 1997, with L.G. Zangani, Inc. as PCI's financial public relations consultant for $3,000 per month and a Stock Option Agreement, for the purchase by Leonardo G. Zangani, as further consideration for the entry into the Consulting Agreement of 50,000 shares at $8.40 per share, which vest in increments of 10,000 shares from September 16, 1999 to 2003. Reimbursement of Attorneys' Fees. PCI reimbursed Greg P. Lambrecht and Colin A. Jones for approximately $6,000 in attorneys fees related to the negotiation of various personal agreements or agreements of J&M or Rose Hearts with PCI. The Company also directly paid John E. Greenwell's attorney approximately $4,000 in fees in January 1998 for legal services provided in November and December 1997 related to the negotiation of his Employment Agreement. PCI reimbursed David S. Hodges for $1,200 in attorney's fees related to the negotiation of his consulting relationship. None of the law firms involved have any affiliation with PCI. 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. PCI also pays all outside 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. 41 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, 1998 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 3,469,092 shares outstanding on March 31, 1998 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: 42 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 Colin Jones 371,357 10.70% Suite 606, 888 Pacific Street Vancouver, B.C. CANADA V6Z-2S6 Common Greg P. Lambrecht 363,708(1) 10.48% 6980 East Sahuaro Drive Apt. 1129 Scottsdale, AZ 85254 Common Steven A. Lambrecht 256,584(1) 7.40% 12072 North 118th Street Scottsdale, AZ 85259 Common Lincoln Heritage Life 210,476(2) 5.75% Insurance Company 4343 E. Camelback Rd. #400 Phoenix, AZ 85018 Common Londen Insurance Group 210,476(2) 5.75% 4343 E. Camelback Rd. #400 Phoenix, AZ 85018
(1) 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. (2) 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. 43 Security Ownership of Management
Title of Name and Address of Amount and Nature of Percent Class Beneficial Owner Beneficial Ownership of Class - ----- ---------------- -------------------- -------- Common Colin Jones 371,357 10.70% Suite 606, 888 Pacific Street Vancouver, B.C. CANADA V6Z-2S6 Common Greg P. Lambrecht 363,708(1) 10.48% 6980 East Sahuaro Drive Apt. 1129 Scottsdale, AZ 85254 Common Steven A. Lambrecht 256,584(1) 7.40% 12072 North 118th Street Scottsdale, AZ 85259 Common Scott I. Lambrecht 86,250(1) 2.49% 15651 N. 83rd Way #3 Scottsdale, AZ 85260 Common James B. Stanley 26,250 (3) 15651 N. 83rd Way #3 Scottsdale, AZ 85260 Common David S. Hodges 21,048(2) (3) 5043 E. Desert Jewel Paradise Valley, AZ 85253 Common William L. Anthony 20,048(2) (3) 7254 East Whitethorn Scottsdale, AZ 85262 - --------------------------------------------------------------------------------------------------------- Common All Officers and Directors 1,145,245(1)(2) 32.65% as a group (10 persons)
(1) 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. (2) Includes shares which may be acquired by the exercise of options or warrants within 60 days as follows: William L. Anthony, 19,048 shares, David S. Hodges, 19,048 shares. Excludes shares underlying options 44 which are not currently exercisable as follows: William L. Anthony, 158,125 shares, John E. Greenwell, 70,000 shares Steven A. Lambrecht, 21,250, Robert H. Manschot and David S. Hodges, 6,250 shares each, Atul Vashistha, 2,250 shares, Colin A. Jones and Greg P. Lambrecht, 1,250 shares each. (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 three independent directors, William L. Anthony, Robert H. Manschot and Atul Vashistha. 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. However, we entered into a number of transactions described below before we adopted our current conflicts of interest policy and before we had sufficient disinterested, independent directors to ratify the transactions. We have subsequently terminated the Rose Hearts Distributorship Agreement because we determined that the ongoing net effect was not as favorable to PCI as distributorship relationships generally available with unaffiliated third parties. CAN-AM Acquisition of J&M and Rose Hearts. On December 31, 1996, CAN-AM issued shares of its stock in exchange for the assets and liabilities of the cigar operations of 45 J&M and Rose Hearts, including the cigar distribution accounts of each entity. PCI director Colin A. Jones is the President and sole shareholder of J&M. PCI director Greg P. Lambrecht is the President and sole shareholder of Rose Hearts. Messrs. Jones and Greg Lambrecht owned 100% of the voting stock of CAN-AM, and three others held non-voting shares. As set forth in PCI's consolidated financial statements for the fiscal year ended March 31, 1997, the cost of the net assets to J&M and Rose Hearts and the amount at which CAN-AM acquired the net assets was the same as its historical net cost in J&M and Rose Hearts. The combined cost, net of liabilities assumed, was approximately $1,000. The asset purchases are closed transactions and we entered the asset purchase agreements before we had sufficient disinterested, independent directors to ratify the transactions. PCI Acquisition of CAN-AM. Subsequent to the asset purchase transactions, but also on December 31, 1996, PCI acquired all of the issued and outstanding shares of CAN-AM in exchange of PCI shares. No written agreement was entered between PCI and CAN-AM's shareholders to formalize the acquisition or share exchange. As adjusted by the May 31, 1997 3:1 stock split (as defined below "3:1 Stock Split"), and including shares issued on December 31, 1996 and January 9, 1997, CAN-AM's five shareholders received 817,500 shares of PCI Common Stock, representing all of the then-issued and outstanding shares of Common Stock of PCI. Mr. Jones received 371,250 or 45.4% and Greg Lambrecht received 363,750 or 44.5%. At the time PCI acquired CAN-AM's shares, neither Greg P. Lambrecht nor Colin A. Jones had any formal relationship as an incorporator, officer, director or shareholder of PCI. PCI was formed with a view to purchasing the cigar operations of the entities they owned and controlled, however, and both Greg P. Lambrecht and Colin A. Jones were affiliated with PCI as promoters at the time PCI acquired CAN-AM's shares. Colin A. Jones was elected a director of PCI on January 9, 1997, shortly after PCI acquired CAN-AM's shares. The CAN-AM acquisition is a closed transaction and we acquired CAN-AM before we had sufficient disinterested, independent directors to ratify the transaction. 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. We negotiated these notes receivable before we had sufficient disinterested, independent directors to ratify the transaction, but Messrs. Jones' and Lambrecht's obligation for repayment of the notes is ongoing, and our independent directors have ratified the transaction. J&M Management Agreement. On January 1, 1997, CAN-AM entered a Management Agreement with J&M to enable CAN-AM to reimburse J&M for any services provided to CAN-AM or on CAN-AM's behalf during the transition of J&M's Canadian operations to CAN-AM. J&M received no additional sum, fee or commission other than reimbursement for J&M's expenses which were directly incurred in providing services to or on behalf of CAN-AM. At CAN-AM's sole discretion, CAN-AM could offset the reimbursement due under the Management Agreement against any related-party receivables that J&M owed to 46 CAN-AM. We entered this Management Agreement before we had sufficient disinterested, independent directors to ratify the agreement. Our independent directors subsequent ratified the agreement, but our relationship with J&M terminated during the quarter ended September 30, 1997. J&M, as a Canadian corporation wholly-owned by PCI director Colin A. Jones, continues to distribute certain wholesale and impulse purchase items to convenience stores and other accounts entirely located in Canada. J&M has, in the past, distributed certain cigars of Cuban origin to its convenience store accounts. Neither PCI nor its wholly-owned Canadian subsidiary CAN-AM currently distributes any cigars or other products of Cuban origin either in the United States or Canada. PCI's standard form supplier agreement strictly prohibits its suppliers from providing any product containing any component of Cuban origin. Luyendyk Endorsement Agreement. On May 1, 1997, PCI entered an Endorsement Agreement with Arie Luyendyk under which PCI would issue 15,000 shares of Common Stock (as adjusted for the 3:1 Stock Split) to Mr. Luyendyk subject to a six-month vesting schedule. In order to meet its obligations under the Endorsement Agreement without diluting the relative security positions of other shareholders prior to the Offering, PCI repurchased 15,000 (as adjusted by the 3:1 Stock Split) shares of its Common Stock from its Chief Executive Officer and Chairman, Steven A. Lambrecht, at $0.33 per share. We entered the Endorsement Agreement before we had sufficient disinterested, independent directors to ratify the agreement, but our relationship with Mr. Luyendyk under the agreement is ongoing, and our independent directors have ratified the agreement. Rose Hearts Distributorship Agreement. On June 13, 1997, PCI entered a Distributorship Agreement with Rose Hearts for the non-exclusive distribution to Associated Grocers, SuperValu and other accounts in the states of Alaska, Idaho, Oregon, Washington and Northern California. The agreement provides that any master agreement with a national PCI account or national distributor shall supersede the Rose Hearts agreement. We pay Rose Hearts a commission equal to 10% of the wholesale cost to the store of products PCI ships to third-party stores where Rose Hearts provides only in-store merchandising support services. We pay Rose Hearts a commission equal to 22% of the wholesale cost to the store of PCI products that Rose Hearts delivers to the stores directly. Greg P. Lambrecht is the President and sole shareholder of Rose Hearts and a director and substantial shareholder of PCI. We entered this Distributorship Agreement before we had sufficient disinterested, independent directors to ratify the agreement, but our independent directors subsequently ratified the agreement. On February 27, 1998, the Company notified Rose Hearts, Inc. that its Distributorship Agreement with PCI would terminate on March 28, 1998. See "Termination of Rose Hearts Distributorship Agreement." Employment Agreements with Founders. On June 13, 1997, PCI entered Employment Agreements with Colin A. Jones, Greg P. Lambrecht and Steven A. Lambrecht. See "Executive Compensation - Employment Agreements." We entered the 47 Employment Agreements before we had sufficient disinterested, independent directors to ratify the agreements. Barton Financing Settlement. On June 13, 1997, PCI entered a Full Settlement and Full Release of Equity Interest agreement among CAN-AM, Rose Hearts, J&M, Greg P. Lambrecht, Colin A. Jones, Greg S. Barton and two of Mr. Barton's lenders. The agreement settled potential equity claims by Mr. Barton and his lenders regarding a September 5, 1996 loan for $110,000 at an annual interest rate of 36% to Rose Hearts, J&M, Greg P. Lambrecht, Colin A. Jones and CAN-AM. CAN-AM had expressly accepted liability for the loan under the terms of each of the Asset Purchase Agreements with J&M and Rose Hearts on December 31, 1996. After PCI purchased all of CAN-AM's shares, PCI desired to extinguish the loan obligation primarily to eliminate the burden on CAN-AM's cash requirements, but also to avoid any potential, but unasserted equity claims against PCI from Mr. Barton's lenders related to the loan obligation. As a result of the settlement, PCI paid $10,000 to one of Mr. Barton's lenders, the loan was reduced to $100,000 and Mr. Barton converted the loan to bridge financing. Mr. Barton's forgiveness of the reduced $100,000 loan is the consideration he gave in exchange for an 8% bridge note for $100,000 and bridge warrants to purchase approximately 38,023 shares of PCI Common Stock at 50% of the initial public offering price. Greg P. Barton is a 7.56% beneficial owner of PCI's Common Stock. Greg P. Lambrecht and Colin A. Jones own and control Rose Hearts and J&M, respectively, and are substantial shareholders and directors of PCI. The settlement transaction is a closed transaction and we entered the settlement before we had sufficient disinterested, independent directors to ratify the transaction. Barton and Mullavey Loans. On or about June 18, 1996, Greg S. Barton loaned Greg P. Lambrecht and Rose Hearts $50,000 in a transaction which included an option for Mr. Barton to convert the debt to equity of Rose Hearts. Between approximately May and September 1996, Ben P. Mullavey, a prior Rose Hearts consultant, loaned $50,000 to Rose Hearts in an undocumented transaction and provided consulting services to Rose Hearts. PCI, Rose Hearts and Greg P. Lambrecht agree that the Barton and Mullavey loans are solely Rose Hearts' debt obligations which CAN-AM did not assume as a part of the December 31, 1996 Asset Purchase Agreement for Rose Hearts' cigar operations. Ben P. Mullavey communicated to PCI on April 23, 1997, that he believes he has rights to convert his debt to shares of PCI Common Stock. Mr. Mullavey did not specify any number of shares that he believes he is entitled to, but instead demanded payment of $55,000, representing the principal from his undocumented loan and $5,000 for consulting services he provided to Rose Hearts. PCI will not be a party to any settlement between Greg P. Lambrecht, Rose Hearts and either of Messrs. Barton or Mullavey regarding a settlement of these claims, and will not directly issue any Common Stock to Barton or Mullavey. Because PCI is not a party to these Barton and Mullavey loans, our independent directors did not, and were not required to, review or approve the transactions. Lambrecht-LBIC Stock Sale. On June 17, 1997, Steven A. Lambrecht sold 20,000 shares of PCI Common Stock to Life of Boston Insurance Company, an Oklahoma 48 corporation ("LBIC"). The Lambrecht-LBIC transaction was to provide additional incentive to LBIC to invest the final $250,000 to complete the Bridge Financing. Steven A. Lambrecht was PCI's President and Chief Executive Officer and a substantial PCI shareholder at the time of the transaction. Lincoln Heritage Life Insurance Company, an Illinois corporation ("Lincoln"), owns 79% of the stock of LBIC. The Londen Insurance Group, an Arizona holding corporation, is the sole shareholder of Lincoln and the beneficial owner of the Shares of Common Stock held by LBIC and the bridge warrants held by Boston and Lincoln. Anthony Stock Purchase and Option Agreement. On June 20, 1997, PCI Chairman William L. Anthony entered an Agreement to purchase 66,000 shares of PCI Common Stock for $22,000 from Steven A. Lambrecht (60,000), Colin A. Jones (3,000) and Greg P. Lambrecht (3,000). PCI, also a party to the Agreement, granted Anthony a non-qualified stock option to purchase 20,000 shares at the offering price from the effective date of the offering and for one year thereafter. PCI also agreed to obtain, and did obtain, within 30 days after completion of the initial public offering, director and officer insurance at coverage levels which are standard for distribution companies comparable to PCI. Anthony agreed to serve as Chairman of the Board for up to five years, subject to appropriate approvals and the provisions of PCI's Bylaws. The agreement is a closed transaction that occurred before we had sufficient disinterested, independent directors to ratify the transaction. Mr. Anthony's ongoing relationship to the Board as its Chairman is subject to ongoing Board approval, and Mr. Anthony's continued service as a director generally is subject to annual shareholder reelection. On August 7, 1997, to remove certain potentially compensatory aspects of the June 20, 1997 Agreement and to maintain Mr. Anthony's status as an independent director, the parties entered a Modification Agreement which rescinded and modified certain aspects of the June 20, 1997 Agreement. The August 7, 1997 Modification Agreement rescinded the private stock purchase for all but 1,000 of the 66,000 shares and restructured the transaction so that Mr. Anthony purchased the 1,000 shares at a settlement price of $2.50 per share, received options to acquire an additional 136,250 shares at $5.25 per share, and modified the exercise period for all of the options one to five years after completion of the offering. Lambrecht-Stanley Stock Sale. On June 20, 1997, Steven A. Lambrecht sold 15,000 shares of PCI Common Stock to James B. Stanley for $5,000. James B. Stanley is PCI's Vice President of Purchasing. PCI was not a party to the transaction. Credit Line Guarantees. On July 25, 1997 PCI obtained a $200,000 credit line from Biltmore Investor Bank, N.A., an independent third-party lender. The credit line was at 1% above the prime rate and terminated upon completion of the Company's initial public offering. Greg P. Lambrecht and Colin A. Jones, PCI directors and officers at the time, personally guaranteed the credit line. The Board of Directors ratified the entry into the credit line and ratified Messrs. Lambrecht and Jones' entry into personal guarantees on PCI's behalf. 49 Manschot Stock Option Grant. By resolutions dated July 30, 1997 and August 7, 1997, PCI's Board of Directors granted Robert H. Manschot a non-qualified stock option to purchase 5,000 shares at the initial public offering price of $5.25 from one to five years after completion of the initial public offering. The option was issued in the name of RHEM Enterprises, Inc., a Company that Mr. Manschot beneficially owns and controls. The stock grant was approved by the other disinterested directors and independent director. Capital Contribution Agreement. On August 8, 1997, certain holders of PCI's shares who are classified as "Promoters" under applicable state securities laws and regulations, contributed a total of $150,000 as additional capital to PCI. Contributors included Steven A. Lambrecht, Greg P. Lambrecht, Colin A. Jones and a number of other founders. This contribution was made to comply with promoters' equity requirements set forth in the North American Securities Administrators Association, Inc. ("NASAA") Statement of Policy Regarding Promoters' Equity Investment. No shares were issued as a result of this equity contribution and the number of outstanding shares did not change. All monies contributed came from contributors' personal funds. In order to make their contributions, Greg P. Lambrecht and Colin A. Jones obtained loans for $39,371 and $37,871 respectively from an independent third-party bank, but William B. Anthony personally guaranteed the private loans. All of PCI's directors, including the other independent director Robert H. Manschot, ratified the Capital Contribution Agreement. Raises to Certain Founders and Other Key Employees. On September 17, 1997, the respective Boards of Directors of PCI and CAN-AM and each of the Independent Directors of PCI, where applicable, ratified management's grant of salary increases, effective October 1, 1997, for certain PCI and CAN-AM officers and employees in the following amounts: Annualized Officer / Employee Salary Increase ------------------ --------------- Steve Lambrecht $24,000 Greg Lambrecht $24,000 Colin Jones $24,000 Karissa Nisted $20,000 Scott Lambrecht $9,000 James Stanley $9,000 Pete Charleston $9,000 Corey Lambrecht $9,000 Murphy Pierson $9,000 Mark Jensen $6,500 Amrik Gill $6,500 -------- TOTAL: $150,000 Based on Management's recommendation, the Board expressly approved such salary increases subject to: (i) the availability of operating proceeds and that salary increases could 50 not be paid from initial public offering proceeds; (ii) presentation and approval of a budget showing profitability; (iii) possible adjustment after receipt of actual results for October 1997. 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. PCI continues to pay compensation which includes the raises. Payout of Management Fees. When PCI received proceeds from its initial public offering, its asset increase triggered an obligation of PCI to pay the management fees of $80,000 each to Greg P. Lambrecht and Colin A. Jones in a lump sum after offset of amounts due PCI from Messrs. Lambrecht or Jones, respectively or Rose Hearts, Inc. and J&M Wholesale, Ltd., the companies they respectively own and control. On October 15, 1997, PCI reached an agreement with Mr. Lambrecht, which was approved by the Independent Directors on November 3, 1997, to release the remaining portion of his management fee, without offset, in consideration for the right to deduct offsetting amounts from commissions and other payments due to Rose Hearts, Inc. or to become due in the future. At the time, PCI considered the balance not to be significant, and not necessary of deduction in the context of the ongoing relationship. Under the agreement, PCI also reimbursed Mr. Lambrecht $3,338 for interest on personal loans which he incurred during the period that PCI delayed payment of his management fee. The agreement with Mr. Lambrecht did not affect Mr. Jones' management fee, which was paid after deducting amounts then known to be due from him. Amendment to Steve Lambrecht's Employment Agreement. On November 19, 1997, PCI entered an Amendment to Employment Agreement with Steven A. Lambrecht in which, among other terms, PCI granted Mr. Lambrecht (i) options to purchase 10,000 shares of Common Stock at $5.25 per share, which vested immediately upon his termination as President that same day, for his services in conjunction with PCI's public offering and (ii) options to purchase an additional 10,000 shares at $5.25 per share, which vested on March 1, 1998, when he was terminated as Chief Executive Officer upon the Board's determination that he had cooperated in a smooth transition to the next Chief Executive Officer. The Amendment was ratified by all disinterested directors, including the independent directors. Settlement of Compensation Disputes with Founders. On March 3, 1998, PCI entered into settlement agreements with each of Messrs. Jones, Greg Lambrecht and Steve Lambrecht relating to their compensation disputes with PCI. The terms of the settlements are set forth under "Executive Compensation - Employment Agreements - Settlement of Compensation Disputes with Founders." The settlements were approved by all disinterested directors, including the independent directors. Termination of Rose Hearts Distributorship Agreement. On February 27, 1998, PCI notified Rose Hearts, Inc. that its Distributorship Agreement with PCI would terminate on March 28, 1998. Rose Hearts is wholly-owned and controlled by director and former officer 51 Greg P. Lambrecht. We originally entered a distributorship relationship with this related-party company when PCI acquired Rose Hearts' cigar accounts and needed Rose Hearts' initial assistance in servicing these direct delivery accounts which are primarily located in the northwest U.S. The Rose Hearts distribution relationship differed from our other third-party distribution relationships in that we sell our cigars directly to our other third-party distributors who, in turn, ship or deliver directly to their own affiliated stores, perform their own collections and pay PCI directly. Currently Rose Hearts distributes PCI-owned cigars to stores operating under PCI retail distribution agreements and does not collect account payments, except for C.O.D. deliveries. Prior to September 30, 1997, and before we fully implemented our accounting and reporting systems, Rose Hearts provided invoicing and collection services for PCI. We had a related-party receivable from Rose Hearts of $11,772 at September 30, 1997, which was reduced to $886 as of December 31, 1997. Since September 30, 1997, Rose Hearts has continued to collect C.O.D. sales on account for PCI. We estimate that as of December 31, 1997 approximately $8,500 was due from Rose Hearts to PCI for C.O.D. sales. This amount and subsequent amounts for C.O.D. sales have not been received by PCI to date, although they may be offset by commissions owed to Rose Hearts. In addition, PCI incurred expenses for accounting services and warehouse support of approximately $14,000 relating to Rose Hearts sales. The December 31, 1997 balance of trade receivables relating to PCI accounts serviced by Rose Hearts, but for which PCI has ultimate collection responsibility, was approximately $80,000, of which $67,000 remains uncollected. A reserve of $18,000 for potential uncollectibility of this balance is recorded in our financial statements for the nine-month period ended December 31, 1997. PCI paid commissions on these sales by Rose Hearts based on our wholesale list price that includes applicable state tobacco taxes. Management terminated the Rose Hearts Distributorship Agreement after it determined that in practice, the Rose Hearts Distributorship Agreement was not as favorable to PCI as distributorship relationships generally available with unaffiliated third parties. Item 13 - Exhibits and Reports on Form 8-K - ------------------------------------------ (a) Exhibits Exhibit Exhibit Name Method of Filing - ------- ------------ ---------------- Number - ------ 3.1 Articles of Incorporation ** 3.2 By-Laws, as amended *** 52 4.1 Specimen Common Stock Certificate **** 4.2 Description of Rights of Security Holders ***** 10.1 Working Agreement, dated November 12, Exhibit filed herewith* 1997, between CAN-AM and TRA Maritimes 10.2 Amendment to Employment Agreement, dated Exhibit filed herewith November 19, 1997, between PCI and Steven A. Lambrecht 10.3 Retail Agreement, dated December 4, 1997, Exhibit filed herewith* between PCI and Mobil Oil Corporation 10.4 Employment Agreement, dated December 15, Exhibit filed herewith 1997, between PCI and John E. Greenwell 10.5 Letter agreement, dated February 18, 1998, Exhibit filed herewith between PCI and Karissa B. Nisted 10.6 Industrial Real Estate Lease, dated February Exhibit filed herewith 25, 1998, between PCI and Palo Cristi Airpark III, L.L.C. 10.7 First Amendment to Industrial Real Estate Exhibit filed herewith Lease, dated February 26, 1998, between the Company and Palo Cristi Airpark III, L.L.C. 10.8 Agreement, dated March 3, 1998, between the Exhibit filed herewith Company and Colin A. Jones 10.9 Agreement, dated March 3, 1998, between the Exhibit filed herewith Company and Greg P. Lambrecht 10.10 Agreement, dated March 3, 1998, between the Exhibit filed herewith Company and Steven A. Lambrecht 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. 53 ** Incorporated by reference to Exhibit 3.1 of Registration Statement on Form SB-2 (file no. 333-29985) declared effective on August 21, 1997. *** 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 ------ ----- ----------- 10/23/97 11/05/97 Reporting change in fiscal year end from March 31 to December 31. 11/19/97 03/6/98 Subsequent to the December 31, 1997 fiscal year end, reporting Management and Director changes and settlement of dispute with departing officers. 54 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, 1998 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/ William L. Anthony Chairman of the Board of Directors 03/31/98 ------------------------------ William L. Anthony By: /s/ John E. Greenwell Director, President, Chief Executive 03/31/98 ------------------------------ Officer and Chief Operating Officer John E. Greenwell By: /s/ Stanley R. Hall Controller and principal accounting 03/31/98 ------------------------------ officer Stanley R. Hall By: /s/ Colin A. Jones Director 03/31/98 ------------------------------ Colin A. Jones By: /s/ Greg P. Lambrecht Director 03/31/98 ------------------------------ Greg P. Lambrecht By: /s/ Steven A. Lambrecht Director 03/31/98 ------------------------------ Steven A. Lambrecht By: /s/ Robert H. Manschot Director 03/31/98 ------------------------------ Robert H. Manschot By: /s/ Atul Vashistha Director 03/31/98 ------------------------------ Atul Vashistha
55 By: /s/ Scott I. Lambrecht Vice President of Operations and 03/31/98 ------------------------------ Secretary Scott I. Lambrecht By: /s/ James B. Stanley Vice President of Purchasing and 03/31/98 ------------------------------ Assistant Secretary James B. Stanley
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PAGE INDEPENDENT AUDITORS' REPORT.................................................F-1 CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1997...........................F-2 CONSOLIDATED STATEMENT OF OPERATIONS FOR THE NINE MONTH PERIOD ENDED DECEMBER 31, 1997 AND FOR THE PERIOD FROM THE DATE OF INCEPTION, JUNE 1, 1996 UNTIL MARCH 31, 1997............................................................F-3 CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE NINE MONTH PERIOD ENDED DECEMBER 31, 1997 AND FOR THE PERIOD FROM THE DATE OF INCEPTION, JUNE 1, 1996 UNTIL MARCH 31, 1997.........................................F-4 CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE NINE MONTH PERIOD ENDED DECEMBER 31, 1997 AND FOR THE PERIOD FROM THE DATE OF INCEPTION, JUNE 1, 1996 UNTIL MARCH 31, 1997......................................................F-5 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS...................................F-7 56 PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY CONSOLIDATED FINANCIAL STATEMENTS For The Nine Months Ended December 31, 1997 and For The Period From The Date of Inception, June 1, 1996 Through March 31, 1997 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, 1997, and the related consolidated statements of operations, changes in stockholders' equity, and cash flows for the nine months ended December 31, 1997, and for the period from the date of inception, June 1, 1996 through March 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, 1997, and the results of its operations, changes in stockholders' equity, and its cash flows for the nine months ended December 31, 1997, and for the period from the date of inception, June 1, 1996 through March 31, 1997, in conformity with generally accepted accounting principles. Semple & Cooper, LLP Phoenix, Arizona March 5, 1998 PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY CONSOLIDATED BALANCE SHEET December 31, 1997 ASSETS Current Assets: Cash and cash equivalents (Notes 1 and 2) $ 1,264,365 Available for sale securities (Notes 1 and 3) 3,470,471 Accounts receivable - trade, net (Note 1) 637,478 Inventory, net (Notes 1 and 6) 1,322,258 Other current assets 68,876 ----------- Total Current Assets 6,763,448 ----------- Property and Equipment, net (Notes 1 and 7) 195,201 ----------- Other Assets: Humidors, net (Note 1) 761,135 Notes receivable - related parties (Note 4) 93,123 Organizational costs, net (Note 1) 34,700 Deposits 3,286 ----------- 892,244 ----------- Total Assets $ 7,850,893 =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable - trade 469,989 Accrued expenses - tobacco taxes 408,129 - other (Note 9) 273,880 ----------- Total Current Liabilities 1,151,998 ----------- Commitments and Contingencies: (Notes 4 and 11) -- ----------- Stockholders' Equity: (Note 12) 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 (Note 15) 3,371 Accumulated deficit (2,111,525) ----------- Total Stockholders' Equity 6,698,895 ----------- Total Liabilities and Stockholders' Equity $ 7,850,893 =========== The Accompanying Notes are an Integral Part of the Consolidated Financial Statements F-2 PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS For The Nine Months Ended December 31, 1997 and For The Period From The Date of Inception, June 1, 1996 Through March 31, 1997 Nine Months Inception Ended Through December 31, March 31, 1997 1997 ---- ---- Net Sales $ 3,362,275 $ 845,571 Cost of Sales (Note 9) 2,798,672 643,790 ----------- ----------- Gross Profit 563,603 201,781 Selling, General and Administrative 2,273,725 323,776 Stock Based Compensation (Note 12) 110,000 207,625 ----------- ----------- Loss from Operations (1,820,122) (329,620) ----------- ----------- Other Income (Expense): Interest income 113,131 -- Interest expense (44,272) (21,292) Other 918 963 Foreign currency transaction gain (loss) (10,038) (1,193) ----------- ----------- 59,739 (21,522) ----------- ----------- Net Loss $(1,760,383) $ (351,142) =========== =========== Loss per Share (Note 1) $ (.82) $ (.24) =========== =========== Weighted Average Number of Shares Outstanding 2,156,076 1,480,500 =========== =========== The Accompanying Notes are an Integral Part of the Consolidated Financial Statements F-3 PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY For The Nine Months Ended December 31, 1997 and For The Period From The Date of Inception, June 1, 1996 Through March 31, 1997
Common Stock Additional -------------------------- Paid-in Common Stock Shares Amount Capital Warrants ------ ------ ------- -------- Balance, June 1, 1996 -- $ -- $ -- $ -- Shares issued for cash 1,433,400 212,050 -- -- Shares issued for services 47,100 207,625 -- -- Net loss for the period from the date of inception, June 1, 1996 through March 31, 1997 -- -- -- -- ----------- ----------- ----------- ----------- 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 months ended December 31, 1997 -- -- -- -- ----------- ----------- ----------- ----------- Balance at December 31, 1997 3,469,092 $ 8,655,339 $ 150,000 $ 1,710 =========== =========== =========== ===========
The Accompanying Notes are an Integral Part of the Consolidated Financial Statements F-4 PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (CONTINUED) For The Nine Months Ended December 31, 1997 and For The Period From The Date of Inception, June 1, 1996 Through March 31, 1997
Foreign Currency Total Treasury Translation Accumulated Stockholders' Stock Adjustment Deficit Equity ----- ---------- ------- ------ Balance, June 1, 1996 $ -- $ -- $ -- $ -- Shares issued for cash -- -- -- 212,050 Shares issued for services -- -- -- 207,625 Net loss for the period from the date of inception, June 1, 1996 through March 31, 1997 -- -- (351,142) (351,142) ----------- ----------- ----------- ----------- Balance, March 31, 1997 -- -- (351,142) 68,533 Purchase of treasury stock (5,000) -- -- (5,000) Treasury shares issued for services 5,000 -- -- 37,500 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 -- -- -- 8,130,664 Proceeds from issuance of warrants -- -- -- 1,710 Aggregate adjustment resulting from translation of financial statements into U.S. dollars -- 3,371 -- 3,371 Net loss for the nine months ended December 31, 1997 -- -- (1,760,383) (1,760,383) ----------- ----------- ----------- ----------- Balance at December 31, 1997 $ -- $ 3,371 $(2,111,525) $ 6,698,895 =========== =========== =========== ===========
The Accompanying Notes are an Integral Part of the Consolidated Financial Statements F-5 PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS For The Nine Months Ended December 31, 1997 and For The Period From The Date of Inception, June 1, 1996 Through March 31, 1997
Nine Months Inception Ended Through December 31, March 31, 1997 1997 ---- ---- Increase (Decrease) in Cash and Cash Equivalents: Cash flows from operating activities: Cash received from customers $ 2,560,015 $ 782,234 Cash paid to suppliers and employees (5,014,455) (827,701) Interest paid (44,272) (21,292) Interest received 47,659 -- ----------- ----------- Net cash used for operating activities (2,451,053) (66,759) ----------- ----------- Cash flows from investing activities: Purchase of investments (3,411,897) -- Purchase of property and equipment (201,829) (23,302) Purchase of humidors (865,340) (71,451) Disbursements for notes receivable - related parties -- (86,225) Organizational costs (8,151) (32,386) Deferred offering costs -- (53,550) ----------- ----------- Net cash used by investing activities (4,487,217) (266,914) ----------- ----------- Cash flows from financing activities: Proceeds from notes payable 850,000 50,000 Payments on notes payable (900,000) -- Proceeds from notes payable - related parties 150,000 129,641 Payments on notes payable - related parties (279,641) -- Proceeds from issuance of common stock 8,179,214 212,050 Proceeds from issuance of common stock warrants 1,710 -- Contributed capital 150,000 -- ----------- ----------- Net cash provided by financing activities 8,151,283 391,691 ----------- ----------- Effect of exchange rate changes on cash and cash equivalents (6,666) -- ----------- ----------- Net increase in cash and cash equivalents 1,206,347 58,018 Cash and cash equivalents at beginning of period 58,018 -- ----------- ----------- Cash and cash equivalents at end of period $ 1,264,365 $ 58,018 =========== ===========
The Accompanying Notes are an Integral Part of the Consolidated Fi nancial Statements F-6 PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) For The Nine Months Ended December 31, 1997 and For The Period From The Date of Inception, June 1, 1996 Through March 31, 1997
Nine Months Inception Ended Through December 31, March 31, 1997 1997 ---- ---- Reconciliation of Net Loss to Net Cash Used for Operating Activities: Net Loss $(1,760,383) $ (351,142) ----------- ----------- Adjustments to reconcile net loss to net cash used for operating activities: Depreciation and amortization 200,210 11,212 Accrued interest added to principal of notes receivable - related parties (6,898) -- Stock issued for services 110,000 207,625 Accrued interest added to available for sale securities (58,574) -- Effect of changes in foreign currency 10,038 -- Changes in Assets and Liabilities: Accounts receivable - trade (573,178) (64,300) - related parties 8,497 (8,497) Inventory (1,195,921) (126,337) Other current assets (53,269) (15,607) Deposits (3,286) -- Accounts payable - trade 360,735 109,254 Accrued expenses - tobacco taxes 307,796 100,333 - other 203,180 70,700 ----------- ----------- (690,670) 284,383 ----------- ----------- Net cash used for operating activities $(2,451,053) $ (66,759) =========== ===========
The Accompanying Notes are an Integral Part of the Consolidated Financial Statements F-7 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. Significant Transactions: Prior to January 1, 1997, CAN-AM acquired all existing cigar accounts, cigar related inventory, humidors, other assets and the related trade accounts payable and tobacco tax liabilities from J&M Wholesale, Ltd. and Rose Hearts, Inc. These corporations were owned by certain members of the founding group of Premium Cigars International, Ltd. As all acquisitions and account purchases were consummated within a controlled group, the cigar operations of J&M Wholesale, Ltd. and Rose Hearts, Inc. are included in the accompanying financial statements from the date of commencement of cigar sales, June 1, 1996. Principles of Consolidation: The consolidated financial statements include the activity of Premium Cigars International, Ltd., together with its wholly-owned subsidiary, CAN-AM, and its predecessors cigar related activity of J&M Wholesale, Ltd. and Rose Hearts, Inc. The activity of CAN-AM and its predecessors is included in the consolidated financial statements from the date of commencement of cigar operations, June 1, 1996. 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. F-8 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) Investments: The Company has classified its investment portfolio as available-for-sale in accordance with the provisions of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities". Available-for-sale securities are stated at fair value with unrealized gains and losses included in stockholders' equity. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest income. Realized gains and losses are included in other income (expense). The cost of securities sold is based on the specific identification method. 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, 1997, an allowance has been provided for potentially uncollectible accounts receivable in the amount of $74,198. Inventory: Inventory quantities and valuation were determined based upon a physical count, and pricing of same at December 31, 1997. 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 an allowance is established to provide for same. 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 nine months ended December 31, 1997, and for the period from the date of inception, June 1, 1996 through March 31, 1997, depreciation expense was $30,096 and $247, 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 nine months ended December 31, 1997, and for the period from the date of inception, June 1, 1996 through March 31, 1997, amortization expense was $164,691 and $10,965, respectively. Advertising Costs: Advertising costs are charged to operations when incurred. For the nine months ended December 31, 1997 and for the period from the date of inception, June 1, 1996 through March 31, 1997, advertising expense was $113,596 and $9,264, 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. F-9 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) 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. 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 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: During the period ended March 31, 1997, the Company's Board of Directors approved an Initial Public Offering of its common stock which was completed on August 29, 1997. The Initial Public Offering price to the public was $5.25 per share. Pursuant to the Securities and Exchange Commission rules, common stock issued for consideration below the $5.25 per share Initial Public Offering price during the twelve (12) months prior to filing the Registration Statement, have been included in the weighted average number of shares outstanding from the beginning of the period. Diluted earnings per share are not presented, as their effect is anti-dilutive. F-10 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) 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 nine months ended December 31, 1997 and the period from the date of inception, June 1, 1996 through December 31, 1997, this statement has no effect on its reported loss per share. During the nine months 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. Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS No. 130) is effective for financial statements with fiscal years beginning after December 15, 1997. Earlier application is permitted. 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 does not expect adoption of SFAS No. 130 to have a material effect, if any, on its financial position or results of operations. 2. Concentration of Credit Risk: The Company maintains cash balances at various financial institutions. Deposits not to exceed $100,000 at the financial institution are insured by the Federal Deposit Insurance Corporation. As of December 31, 1997, the Company had approximately $1,183,013 of uninsured cash. 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. The following securities mature contractually in February, 1998. Securities available for sale are as shown below: Securities Available-for-Sale ----------------------------- Amortized Cost Fair Value ---- ---------- U.S. Treasury Bills $3,470,471 $3,470,471 ========== ========== F-11 PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 4. Related Party Transactions: Notes Receivable - Related Parties: At December 31, 1997, notes receivable - related parties are comprised of 6% interest bearing notes from two (2) stockholders in the aggregate amount of $86,225. The notes and all accrued interest are due on March 31, 1999. Included in the principal balance at December 31, 1997 is accrued interest in the amount of $6,898, earned during the nine months period ended December 31, 1997. Notes Payable - Related Parties: For the nine months ended December 31, 1997, and for the period from the date of inception, June 1, 1996 through March 31, 1997, interest expense under a note payable to a related party was $10,773 and $19,800, respectively. The note was converted to a bridge note during June, 1997 (See Note 12). Commitments: During the nine months 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 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. Subsequent to year end, 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: Estimated fair values of the Company's financial instruments are as follows: December 31, 1997 ----------------- Carrying Amount Fair Value ------ ---------- Available for sale securities $3,470,471 $3,470,471 ========== ========== The carrying amount of available for sale securities approximates fair value. The fair market value of notes receivable - related parties cannot be determined due to its related party nature. 6. Inventory: As of December 31, 1997, inventory consists of the following: Cigars $1,281,488 Cigar accessories 100,867 Reserve for inventory spoilage (60,097) ---------- $1,322,258 ========== F-12 PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 7. Property and Equipment: At December 31, 1997, property and equipment consists of the following: Computer equipment $ 137,373 Equipment 49,456 Furniture and fixtures 38,273 ---------- 225,102 Less: accumulated depreciation (29,901) ---------- $ 195,201 ========== 8. Line of Credit: As of December 31, 1997, the Company has a $1,000,000 revolving line of credit with Johnson Bank. The line expires on December 31, 1998, and provides for interest at the prime rate. The line is secured by available for sale securities. At December 31, 1997, there was no outstanding balance under the line of credit. 9. Accrued Expenses - Other: Included in accrued expenses - other as of December 31, 1997, is an accrual for a cigar trade-out program in the amount of $110,000 which has been charged against cost of sales for the nine months ended December 31, 1997. The program, which was implemented during the first quarter of 1998 for cigars sold during 1997, is targeted at replacing slower selling cigars with an improved product mix. The charge consists of management's best estimate of the shipping costs and the impairment of value of the cigars to be returned under the program. This program is anticipated to be completed during the second quarter of 1998. The establishment of this accrual required the use of significant estimates by management. The Company believes the techniques and assumptions used in establishing this accrual are appropriate. 10. Income Taxes: At December 31, 1997, the Company has available approximately $1,400,000 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 $135,000 (Canadian dollars). The United States and Canadian operating losses will expire primarily through 2012 and 2004, respectively. As of December 31, 1997, deferred income tax assets consist of: Net operating loss carryforwards $ 570,000 Other 100,000 ---------- 670,000 Less: valuation allowance (670,000) ---------- 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. F-13 PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 11. 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. A schedule of future minimum lease payments due under the non-cancellable operating lease agreements for each of the next five (5) years, is as follows: Year Ending December 31, Amount ------------ ------ 1998 $ 144,000 1999 216,000 2000 216,000 2001 224,000 2002 228,000 Subsequent 76,000 ---------- $1,104,000 ========== For the nine months ended December 31, 1997, rent expense under the aforementioned operating lease agreements was $54,628. Employment Agreements: During 1997, the Company entered into employment agreements with three (3) former officers of the Corporation. The agreements were cancellable at any time by either party. The Company also has agreed to pay two (2) of the officers a management fee in the amount of $80,000 each. The fee was to be paid over a sixteen (16) month period. During the nine month period ended December 31, 1997, the management fees were paid in full. Subsequent to December 31, 1997, the above employment agreements were terminated (See Note 16). 12. Stockholders' Equity: Stock-Based Compensation: During the period from the date of inception, June 1, 1996 through March 31, 1997, the Company sold 175,500 common shares for $16,750. The stock was valued at $1.25 per share, resulting in compensation of $202,625. In addition, 15,000 shares were issued for services valued at $5,000. During the nine months 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). F-14 PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 12. Stockholders' Equity: (Continued) Common Stock Options and Warrants: 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 exercisable one (1) year after the vesting date. As of December 31, 1997, none of the options have been exercised. During the nine months 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, 1997, none of the warrants have been exercised. During the nine months 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, 1997, none of the warrants have been exercised. During the nine months ended December 31, 1997, the Company issued 50,000 options to its 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, 1997, none of the options have been exercised. 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 ======= ======= =====
Information relating to stock options and warrants at December 31, 1997, 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 -- $5.25 266,511 5 19,011 $8.40 220,952 5 -- F-15 PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 12. Stockholders' Equity: (Continued) Common Stock Options and Warrants: (Continued) 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 nine months ended December 31, 1997. Pro forma information regarding net income (loss) and earnings (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 nine months ended December 31, 1997 would have been increased to the pro forma amounts presented below: Nine Months Ended December 31, 1997 ----------------- Net loss: As reported $(1,760,383) Pro forma (2,160,321) Net loss: As reported $ (.82) Pro forma (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 1997; expected life of options three (3) years, expected volatility of 55%, risk-free interest rate of 6%, and a 0% dividend yield. The weighted average fair value at date of grant for options granted during 1997 approximated $1.55. 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. 13. Concentrations: Economic Dependency: For the nine months 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. As of December 31, 1997, amounts due to these suppliers included in accounts payable were approximately $29,500, $1,000, and $52,000, respectively. For the period from the date of inception, June 1, 1996 through March 31, 1997, the Company had a supplier who accounted for approximately seventy-one percent (71%) of the Company's cigar purchases. For the nine months ended December 31, 1997, and the period from the date of inception, June 1, 1996 through March 31, 1997, the Company's largest customer accounted for approximately seventy percent (70%) and eighty-two percent (82%) of the Company's sales, respectively. As of December 31, 1997, there are accounts receivable of approximately $82,500 due from this customer. F-16 PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 13. Concentrations: (Continued) Foreign Operations: For the nine months ended December 31, 1997 and for the period from the date of inception, June 1, 1996 through March 31, 1997, the Company's foreign subsidiary recorded revenue representing approximately thirty-nine percent (39%) and ninety-three percent (93%) of total revenues, respectively. 14. Statements of Cash Flows: Non-Cash Financing and Investing Activities: During the nine months 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. 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. During the period from the date of inception, June 1, 1996 through March 31, 1997, the Company recognized 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: Common stock was issued for services and compensation valued at $207,625. This was based upon 175,500 shares sold on March 5, 1997 for $16,750, which were valued at $1.25 per share. 15. Foreign Currency: Foreign currency transactions resulted in an aggregate exchange loss of $10,038 for the nine months ended December 31, 1997, and $1,193 for the period from the date of inception, June 1, 1996 through March 31, 1997. Foreign currency translations resulted in an aggregate exchange gain of $3,371 for the nine months ended December 31, 1997, and were immaterial for the period from the date of inception, June 1, 1996 through March 31, 1997. 16. Subsequent Events: In February, 1998, the Company terminated its Distributorship Agreement with Rose Hearts, Inc. Subsequent to the year end, the Company terminated its Employment Agreements with its then Chief Executive Officer and two (2) Vice Presidents. As part of the severance compensation, each officer was paid nine (9) months of salary as specified under their employment agreements, and an additional lump-sum payment of $40,000 each as settlement for potential claims against the Company. As part of the settlement each of the individuals agreed to extend their non-compete clauses for an additional six months for a total of a full year and a half following termination of employment and released the Company from all claims or causes of action relating to their respective employment agreement and their employment with the Company. F-17 EX-10.1 2 WORKING AGREEMENT EXHIBIT 10.1 WORKING AGREEMENT Can-Am International Investment Corporation/TRA Maritimes
Can-Am International Investment Corporation TRA Maritimes #106-3738 North Fraser Way P.O. Box 790 Burnaby, BC V5J 5G1 Middleton, Nova Scotia BOX IPO Tel: 604-435-1705 Fax: 604-431-7673 Tel: (902) 825-3404 Fax: (902) 825-2425
Effective Date: November 12, 1997 Between Can-Am International Investment Corporation (Can-Am) and TRA Maritimes (Distributor) THIS agreement is a working agreement between Can-Am and the Distributor to introduce the Premium Cigar Program. The parties agree to the following terms with the understanding that a complete and formal agreement has been presented to the Distributor by Can-Am and is forthcoming and in the same general description of this agreement. This Working Agreement, however, does not supersede the formal agreement forthcoming. Agreement: Can-Am will provide Distributor with humidors, cigars and related products. The Distributor will promote and sell those cigars and related products as authorized by Can-Am, and any other Can-Am authorized products ("Can-Am Products") on the term of this agreement. 1. Can-Am Responsibilities. Can-Am will provide Distributor with a Can-Am Humidor, which will be owned by Can-Am and used exclusively for the display, storage and sale of Can-Am Products. Can-Am will manage the program through its telemerchandising and merchandising and training of Distributor's management and field staff. Can-Am will provide training materials to accounts at the store level. 2. Distributor Responsibilities. Distributor will display the Can-Am Humidor on the front or main counter of Distributor's Location. Each Can-Am Humidor will be positioned so that (a) no non-Can-Am display, signs, labels or other materials block a customer's view of the Can- Am Humidor, and (b) customers bays easy access to the Can-Am Humidor. The Humidor cannot be construed as self-serve. Distributor will display only labels, displays or signs approved by Can-Am in or on the Can-Am Humidor. Distributor will actively promotes, market and sell Can-Am Products in or on the Can-Am Humidor. Distributor will not sell any product from humidors other than Can-Am authorized products, and will not display, sell or store other produces in, on or from its Can-Am Humidor. Distributor will comply with all applicable federal, provincial, and local laws and regulations of Can-Am Products. Distributor is to assist in merchandising and management efforts where needed to make the program as effective as possible. 3. Term of Agreement. The initial term of this Agreement shall be for two (2) calendar years from the date first written above (the "First Term"). This Agreement shall automatically * Confidential portions omitted and filed separate with the Commission. renew at the expiration of the First Term for up to three (3) additional one (1) year terms (each an "Additional Term") unless either of the parties, at least thirty (30) calendar days prior to the expiration of the then existing First Term or Additional Term, gives written notice to the other party not to renew this Agreement or unless this Agreement is terminated under other terms of this Agreement. 4. Humidors. Can-Am will provide one Can-Am Humidor to the Retail Location at no cost. Can-Am will repair or replace, at its cost, a Can-Am Humidor damaged due to manufacturing defects or normal wear and tear. The Retailer will care for and maintain the Can-Am Humidor provided to Retailer. Any Can-Am Humidor damaged by misuse, lost or stolen may be repaired or replaced only by Can-Am; the Retailer will pay the cost of any such repair or replacements. The replacement cost to the Retailer for any Can-Am Humidor will be * Upon termination of this Agreement for any reason, the Retailer, at its cost, will return all Can-Am Humidors to Can-Am within 30 calendar days. 5. Payments. Can-Am will invoice the Distributor for Can-Am products. Distributor agrees to pay Can-Am seven days from receipt of the invoice, including a late charge of * of the total past due payments should there be any. The Distributor shall collect the full invoice amount from the Retail locations. 6. Marketing Rights. Can-Am hereby grants, and Distributor hereby accepts, the exclusive right to sell and market Can-Am Products to and through the convenience, grocery and gas Retail Locations in the Territory of Atlantic Canada pursuant to the terms and provisions of this Agreement, so long as the following conditions have been met: (i) Within the first 90 days of this Agreement, Distributor contracts and obtains a signed Can-Am Single Location Retailer Agreement (or, in the event of a chain of stores, an agreement signed by the corporation or other entity governing such stores) * ; and (ii) 7. Pricing The current price schedule for Can-Am products to be provided is based on a price margin of approximately * before tobacco tax for distributors and approximately * after tobacco taxes for retailers. Notwithstanding the foregoing, no assurance can be given by Can-Am as to what actual retail price for Can-Am Products to the marketplace will be or what the actual margins for Can-Am Products for distributors or retailer will be since such margins are determined by the marketplace and customer demand, and the actual price charged by distributors and retailers for Can-Am Products will be independently determined by each distributor and retailer. Can-Am shall pay a * rebate for the stores selling in excess of a certain dollar amount per quarter. Subject to revision by Can-Am, which revision shall be effective upon 90 days prior notice, Can-Am shall initially pay a * rebate for individual stores with retail sales of Can-Am Products in excess of * Canadian per quarter (or, in the event of chains of stores governed by the same entity, a * rebate for chains with stores averaging retail sales of the Can-Am Products in excess of * Canadian per quarter). * Confidential portions omitted and filed separate with the Commission. Notwithstanding the foregoing, the pricing of the Can-Am Products charged by Can-Am may be subject to change as determined by Can-Am at Can-Am's sole discretion. 8. Shipping. Can-Am direct ships the product to the stores and is responsible for all shipping costs related to the product. Can-Am is not responsible for correspondence originating from the Distributor to Can-Am. 9. Sales of Product. Can-Am, in conjunction with the Distributor, will make a best effort to sell all product placed in a humidor. However, Can-Am does not guarantee the sale of any product. 10. Independent Contractors; No interest in Goodwill. Distributor is, and will be, an independent contractor. Except for tobacco taxes paid by Can-Am on the Can-Am Products, Distributor will be responsible for obtaining and paying for any and all taxes, cost, bonds, insurance and licenses required for Distributor's business and its distribution, sale and marketing of the Can- Am Products. Distributor will not acquire any interest in any good will or trademarks associated with the Can-Am Products. 11. Confidential Information. Distributor recognizes that as a result of this relationship, Distributor has in the past and may in the future develop, obtain or learn about Confidential information which is the property of Can-Am or which Can-Am is under an obligation to treat as confidential. Distributor agrees to use its best efforts and the utmost diligence to guard, protect and keep confidential said Confidential Information sand Distributor agrees that Distributor will not, during or after the period of this Agreement, use for Distributor or others, or divulge to others any of said Confidential Information which Distributor may develop, obtain or learn about during or as a result of its Distributor relationship with Can- Am, unless authorized to do so by Can-Am in writing. 12. No Warranties. Can-Am does not give or imply any warranties relating to Can-Am Products, including any implied warranties of merchantability and fitness for a particular purpose. Can- Am liability, if any, to the Distributor for alleged defective products will, under all circumstances, be limited to repair or replacement of a product, at Can-Am's sole option, and shall not include damages of any kind. 13. Indemnification. Distributor and Can-Am will each indemnify and hold each other harmless, and any of their related parties, from any and all liability directly or indirectly based upon or related to any acts omissions of each party's employees or agents arising in connection with this agreement. 14. Governing Law; Legal Costs. This agreement will be governed in accordance with the laws of the Province of British Columbia and Canada and the Courts of British Columbia shall have the exclusive jurisdiction to hear and resolve any dispute between the parties related to this Agreement. The prevailing party in any such dispute relating to this Agreement shall be entitled to be paid its costs and expenses including its legal costs on a solicitor and own client basis. * Confidential portions omitted and filed separate with the Commission. 15. Notices. Service of any notice pursuant to this Agreement is complete and effective: (1) three days from the date of mailing via Registered Mail, return receipt requested and addressed to the party at the then current address; (b) upon receipt by facsimile at the party's facsimile number given under this Agreement. Distributor will notify Can-Am within 5 days in written of any changes to Distributor's name, address, facsimile or phone number. 16. Severability. In case any one or more of the provisions of this Agreement is held to be invalid, illegal, or unenforceable in any respect, such invalidity, illegality, or unenforceability shall not affect other provisions. This Agreement shall be construed as if such invalid, illegal or unenforceable provision had never been included in this Agreement. 17. Binding on Successors and Assigns. This Agreement shall extend to and be binding upon the heirs, legal representatives, successors and assigns of the parties. EXECUTED as of the Effective Date set forth above. "Can-Am" "Distributor" By: /s/ [signature] By: /s/ [illegible] ---------------------------------- ------------------------------------- Title: [Can-Am Officer] Title: C Store Merchandising Manager ------------------------------- ---------------------------------- Date: 11/17/97 Date: 11/17/97 -------------------------------- ----------------------------------- * Confidential portions omitted and filed separate with the Commission. EX-10.2 3 AMENDMENT TO EMPLOYMENT AGREEMENT EXHIBIT 10.2 AMENDMENT TO EMPLOYMENT AGREEMENT This Amendment ("Amendment") to that Employment Agreement between Steven A. Lambrecht ("Lambrecht") and Premium Cigars International, Ltd., an Arizona corporation ("PCI") dated June 13, 1997 ("Original Agreement") is entered into this 19th day of November, 1997. RECITALS -------- WHEREAS, PCI and Lambrecht desire that the Original Agreement continue to govern the employment relationship between them with certain modifications to ensure a smooth transition in leadership of the Company should Lambrecht, in the future, be replaced as President or Chief Executive Officer; NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, PCI and Lambrecht agree as follows: 1. Scope of Amendment. The terms of this Amendment and all other terms not inconsistent with this Amendment from the Original Agreement, which is incorporated herein by this reference, will govern the employment relationship. If any term of this Amendment conflicts with a term of the Original Agreement, the terms of this Amendment shall control. 2. Option Grant. Subject to (i) approval by the Board of Directors, the Independent Directors and W. B. McKee Securities, Inc. as Underwriters' Representative (pursuant to paragraphs 4(m) and (p) of the Underwriting Agreement dated August 25, 1997) and ratification by shareholders at the Company's next annual shareholder meeting, (ii) the vesting schedule set forth below, (iii) the Company's acceptance of an Accredited Investor Representation Letter from Mr. Lambrecht and (iv) the Company's and Lambrecht's entrance into a Stock Option Agreement, the Company shall grant to Lambrecht non-qualified options to purchase Twenty Thousand (20,000) Shares at the initial public offering price of $5.25 per Share, exercisable beginning one (1) year after the date of this Amendment and continuing until five (5) years after such Amendment date (the "Options"). After such five (5) year period, the Options shall expire. The Options shall vest as follows: (i) Options to purchase 10,000 shares for Lambrecht's valuable services as President in conjunction with taking the Company public, during the Company's early stages as a public Company, shall vest immediately upon the date that Lambrecht ceases to be President; (ii) Options to purchase 10,000 shares for Lambrecht's cooperation in a smooth transition to the next Chief Executive Officer shall vest immediately upon the date Lambrecht ceases to be Chief Executive Officer and does not elect to remain in any executive position in the Company, provided that the Board of Directors, in its sole discretion, makes a determination that Lambrecht has: (a) fully cooperated with the Chief Executive Officer successor ("Successor"); (b) fully disclosed all information to his Successor which is necessary to his Successor's performance as Chief Executive Officer; (c) has exhibited positive support for his Successor before Company employees, shareholders, market participants and the general public; and (iv) has resolved any issues relating to his Successor confidentially with his Successor or the Board of Directors. Only Options which have vested, as set forth above, shall be exercisable during the exercise period. 3. Status as a Director. The parties acknowledge that Lambrecht is currently a director of the Company. If Lambrecht is replaced as Chief Executive Officer, he will complete his term as a director and agrees to serve the Board in such other capacities as the Board shall request. 4. Severance Compensation. The Severance Compensation provisions of Paragraph 7 of the Original Agreement shall remain in force according to the conditions set forth therein, and shall be applicable in the case of Lambrecht's replacement as CEO. 5. Payment as a Consultant. If, upon the date that Lambrecht ceases to be President and Chief Executive Officer, Lambrecht is receiving compensation pursuant to the Severance Compensation provisions of Paragraph 7 of the Original Agreement, Lambrecht agrees to provide consulting services to the Company for the period of such Severance Compensation, from time to time and as reasonably requested by the Company, without additional compensation to Lambrecht. If the Company requests that Lambrecht provide such consulting services after any such Severance Compensation terminates, the Company shall pay Lambrecht $45 per hour and shall reimburse Lambrecht for his reasonable expenses incurred as a consultant. EXECUTED as of the first date set forth above. "PCI" "Lambrecht Premium Cigars International, Ltd. /s/ William L. Anthony /s/ Steven A. Lambrecht - ------------------------------------- ---------------------------------------- William L. Anthony, Chairman Steven A. Lambrecht 2 EX-10.3 4 RETAIL AGREEMENT EXHIBIT 10.3 RETAIL AGREEMENT This agreement ("Agreement") between Premium Cigars International (PCI) and Mobile Oil Corporation is effective this 4 day of December, 1997. 1. Scope of Outlets Covered. This Agreement covers all Mobil retail outlets owned or operated by Mobil ("Mobil Outlets"). PCI will offer the products covered by this Agreement to the Mobil retail outlets operated by Mobil's franchised dealers ("Dealer Outlets") through separate agreements, the substantive terms of which must be the same as this Agreement. PCI will provide Mobil with a monthly list of all Mobil Outlets and Dealer Outlets serviced by PCI and will make a copy of any Dealer Outlet agreement available to Mobil on request. 2. PCI Products. PCI will provide each Mobil Outlet with a PCI Humidor, which will be owned by PCI and will be used exclusively for the display, storage and sale of PCI Products. PCI or its authorized distributors will stock the PCI Humidor with PCI Products. PCI will also provide each Mobil Outlet with, cigars and related products, and each Mobil Outlet will promote and sell those cigars and related products as authorized by PCI, including Cigar Gone Breath Cleanser, PCI featured magazines such as Smoke Magazine and any other PCI-authorized and Mobil approved products ("PCI Products") according to the terms of this Agreement. * Confidential portions omitted and filed separately with the Commission. 3. Product Presentation and Promotion. Each Mobil Outlet will display the PCI humidor on the front or main counter of the Outlet's location or such other location on which the manager of the Outlet and PCI may agree. Each PCI Humidor will be positioned so that (a) no non-PCI displays, signs, labels or other materials block a customer's view of the PCI Humidor. Each Mobil Outlet will display only labels, displays or signs approved by PCI in, on or directly around the PCI Humidors. PCI will use no PCI displays, signs or labels in any Mobil Outlet or Dealer Outlet that Mobil, in its sole discretion, determines are unsuitable. Each Mobil Outlet will actively promote, market and sell only PCI Products, on or around the PCI Humidor, and will not display, sell or store other products in, on or from the PCI Humidor. Each Mobil Outlet will comply with all applicable federal, provincial, state and local laws and regulations and will hold and maintain all federal, state, provincial, and local licenses and permits required for the sale, distribution and marketing of PCI Products. PCI will assist Mobil by providing any information PCI may have concerning the federal, state, provincial and local laws, regulations, permits and licenses. 4. Term of Agreement. Unless terminated by a provision of this Agreement, this Agreement has a term of one year from the Effective Date. It will automatically renew for three additional one-year terms, unless written notice is provided by either party no less than sixty (60) days prior to the renewal period. PCI or Mobil, upon any breach of this Agreement by the other Party which has not cured within thirty (30) days of written * Confidential portions omitted and filed separately with the Commission. 2 notice of breach, may terminate this Agreement for any Mobil Outlet and/or Dealer Outlet or all Mobil Outlets and Dealer Outlets at any time by written notice to the other party which will be effective thirty (30) days after receipt. 5. Humidors. PCI will provide one PCI Humidor to each Mobil Outlet at no cost. PCI will repair or replace, at its cost, a PCI Humidor damaged due to manufacturing defects or normal wear and tear. Each Mobil Outlet will care for and maintain the PCI Humidor provided by PCI. Any PCI Humidor damaged by misuse, lost or stolen may be repaired or replaced only by PCI; Mobil will pay the cost of any such repairs or replacements. The replacement cost to Mobil will be * Upon termination of this Agreement for any reason, Mobil will make the PCI Humidors available at each Mobil Outlet to PCI for collection and return to PCI. After collecting the PCI Humidors, PCI will discontinue any further business with any and all Mobil Outlets or Dealer Outlets. 6. Payment and Price. Each Mobil Outlet will pay PCI for PCI Products pursuant to a purchase order, * otherwise from receipt of goods, including a late charge of * of the total past due payments. All Mobil Outlets and Dealer Outlets will be charged a price by PCI that will provide a * margin. 7. Independent Contractor; No Interest in Goodwill. PCI and Mobil are, and will be, independent contractors, and no other relationship may be inferred form this Agreement. * Confidential portions omitted and filed separately with the Commission. 3 Except for all state cigar taxes, which will be filed and paid by PCI on the PCI Products, each Mobil Outlet will be responsible for obtaining and paying all taxes, costs, bonds, insurance and licenses required for the business and its distribution, sale and marketing of the PCI Products. Mobil will not acquire any interest in any goodwill or trademarks associated with the PCI Products. 8. No Warranties. PCI does not give or imply any warranties relating to PCI Products, including any implied warranties of merchantability and fitness for a particular purpose. PCI liability, if any, to Mobil for alleged defective products will, under all circumstances be limited to repair or replacement of a product, at PCI's sole option. 9. Reporting. PCI will provide Mobil with a Quarterly Cigar Category Velocity Report detailing purchases at each location. This report will be due no later than thirty (30) days after the end of each calendar quarter and will include detail for each location by the Mobil station number, which will be provided by Mobil. 10. Indemnification. Mobil and PCI will indemnify and hold each and any of their related parties of the other harmless from any and all liability directly or indirectly based upon or related to any acts or omissions of each party's employees or agents arising in connection with this Agreement. Section 8 not withstanding, PCI will indemnify and * Confidential portions omitted and filed separately with the Commission. 4 hold Mobil and Mobil's related parties harmless from any and all liability from the use of the PCI Products by any person or entity. 11. Governing Law; Attorney's Fees. This Agreement will be governed by the law of the State of Virginia without consideration of Virginia's conflict of law principals. The Courts of Fairfax County, Virginia, including any applicable Federal Courts, will be the exclusive legal forum to resolve any dispute between the parties related to this Agreement. The prevailing party in any dispute relating to this Agreement will be entitled to receive its costs, fees, and expenses, including reasonable attorney's fees. 12. Notices. Each party will provide the other an address and point of contact. Any notice sent pursuant to this Agreement is presumed received five (5) days after deposit in the US Mail, postage paid addressed, to the party at its current address. Notice send by certified or registered mail or other delivery method providing for a signed receipt will be effective on the date of the signed receipt. Either party will notify the other in writing within five (5) days of any change in name, address, phone number or person to serve as the point of contact. 13. Severability. If any one or more of the provisions of this Agreement are held to be invalid, illegal, or unenforceable in any respect, such invalidity, illegality, or unenforceability will not affect any other provision, and this Agreement will be construed * Confidential portions omitted and filed separately with the Commission. 5 as if such invalid, illegal, or unenforceable provision had never been included in the Agreement. 14. Binding on Successors and Assigns. This Agreement will extend to and be binding upon the heirs, legal representatives, successors and assigns of the parties. EXECUTED as of the Effective Date set forth above. 15. Assignment. Neither Party may assign all or any part of this Agreement without the written consent of the other, except that Mobil may assign this Agreement to any parent or subsidiary company of Mobil. Premium Cigars International Mobil Oil Corporation By: /s/ Steven A. Lambrecht 12-4-97 By: /s/ [illegible] ------------------------------------ -------------------------------- Its: C.E.O. Its: Group Category Manager ----------------------------------- ------------------------------- * Confidential portions omitted and filed separately with the Commission. 6 EX-10.4 5 EMPLOYMENT AGREEMENT EXHIBIT 10.4 EMPLOYMENT AGREEMENT -------------------- This Employment Agreement is made and entered into this 15th day of December, 1997, by and between Premium Cigars International, Ltd., an Arizona corporation (the "Company") and John E. Greenwell ("Employee"). W I T N E S S E T H: -------------------- WHEREAS, the Company and the Employee mutually desire to agree upon the terms and conditions of the Employee's employment with the Company; NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties to this Agreement hereby agree as follows: 1. Employment. The Company agrees to employ the Employee as President and Chief Operating Officer for the Company and the Employee shall at all times exercise his best judgment in the performance of his duties. As President, the Employee shall report directly to the Chief Executive Officer and the Board of Directors until Employee assumes the position of Chief Executive Officer and then shall at all times report to the Board of Directors of the Company. The Employee shall perform such further duties as may be required by the Company under and subject to the instruction, direction and control of the Chief Executive Officer or Board of Directors of the Company as applicable. All vice-presidents and division managers shall report directly to the Chief Operating Officer. Employee shall become the Chief Executive Officer of the Company and the Board of Directors shall create a vacancy and appoint Employee to such vacancy on the Board of Directors on March 1, 1998, unless this Agreement is terminated prior to such date. Employee shall, after March 1, 1998, also retain the capacity of Chief Operating Officer until the Board of Directors determines otherwise. Employee's duties under this Agreement shall be principally carried out in Maricopa County, Arizona and the parties agree to renegotiate this Agreement should the principal geographical focus of Employee's duties require that Employee be based elsewhere due to the relocation of the Company's executive offices, sale of the Company or change in the location of the Company's business. Except as otherwise provided herein, as long as Employee remains employed with the Company, the Company shall not alter the terms of this Agreement unless Employee and the Company agree to such modifications in writing. 2. Devotion to Employment. Employee accepts employment with the Company on the terms and conditions herein set forth and agrees to devote his full time and effort to perform his duties on behalf of the Company in his position as set forth in paragraph 1. Employee shall begin full-time execution of his duties with the Company on Monday, December 15, 1997. The Employee shall not during the term of this Agreement be actively engaged in any other business activity which will in any way impair his ability to properly meet his obligations to the Company or engage in any activity competitive with the Company or detrimental to its business. Employee agrees to comply with the policies, standards and regulations of the Company from time to time established. 3. Compensation. The Company agrees to pay the Employee compensation for services as follows: a. Commencing December 15, 1997, the initial annual salary shall be One Hundred Twenty Thousand Dollars ($120,000) payable bi-weekly during the term of this Agreement. Employee's annual salary shall increase to One Hundred Fifty Thousand Dollars on the date that Employee becomes the Chief Executive Officer of the Company. Such salary may be adjusted by the Board of Directors of the Company at its sole discretion. Employee understands and acknowledges that Employee is exempt from the overtime pay requirements of the Fair Labor Standards Act, 29 U.S.C. ss. 201 et seq. b. Employee shall be covered under the Company's then existing medical insurance plan. The Company retains the right to modify medical insurance coverage as it deems appropriate. Except as otherwise provided for by law or in paragraph 7 herein, the Company is under no obligation or duty to provide medical coverage to the Employee after such Employee has ceased to serve as an employee of the Company. c. Vacation. The Employee shall be entitled to vacation as set forth in the Company's employee manual. All vacation days must be taken in accordance with the Company's policies, as those policies are established from time to time. d. Bonus Plan; Stock Option Plan. Employee shall be eligible under a bonus plan ("Bonus Plan") and/or a stock option plan ("Stock Option Plan") based upon the future performance of the Company in the same manner as offered to other comparable executives of the Company. As a part of his duties, Employee shall develop and propose to the Board of Directors a Bonus Plan and Stock Option Plan for executives and/or other employees of the Company on or before March 1, 1998. Notwithstanding the foregoing, the parties agree that Employee's bonus for the year ending December 31, 1998, shall be guaranteed to be at least $50,000.00, to be paid in cash on or before January 15, 1999. Other than as provided in the following sentence, if this Agreement is terminated by the Company or Employee for any reason on or before December 31, 1998, then Employee shall be entitled to no bonus payment hereunder. However, even if Employee's employment is terminated, Employee shall be entitled to the entire bonus of at least $50,000.00, to be paid in cash on or before January 15, 1999, in any of the following two situations: (i) the Company terminates this Agreement without Cause (as defined in paragraph 7 below) after March 31, 1998 but on or before December 31, 1998; or (ii) Employee terminates this Agreement on account of a Material Breach by the Company -2- (as defined in paragraph 7 below) after March 31, 1998 but on or before December 31, 1998. e. Additional Benefits. Employee shall also be offered other benefits, insurance, stock interest savings loans or bonuses which may be offered to other comparable executives of the Company. 4. Insurance. The Company shall maintain during the Employee's term of employment, at the Company's expense, Director and Officer Liability Insurance. 5. Employee at Will. Employee is employed "at will". Subject to the notice requirements set forth in paragraph 6 below, either Employee or the Company may terminate Employee's employment at any time, for any reason, with or without cause. Employee understands that no manager, supervisor or representative of the Company has any authority to enter into any agreement with Employee for employment for any specified period of time or to make any promise or commitment contrary to the foregoing. Further, no amendment to this Agreement will be valid or enforceable unless it is in writing and signed by the Chairman of the Board of Directors of the Company. 6. Termination. The Employee's continued employment may be terminated by the Employee by delivery to the other party of a written notice of termination at least four (4) weeks prior to the termination date. The Company may terminate Employee's continued employment at any time upon notice of termination delivered to Employee. Upon termination of employment, the Employee agrees to promptly return to the Company all customer records as that term is defined in paragraph 8 herein, all confidential information, as that term is defined in paragraph 9 herein, and all other documents and equipment pertaining to the business of the Company. Employee further agrees that the Employee will not at any time use any information acquired by him during the term of this Agreement in a manner contrary to the interest of the Company, nor will the Employee do any act or acts which may directly or indirectly induce any person to terminate his relationship with the Company. 7. Severance Compensation. In the event Employee is terminated by the Company, for any reason other than for "Cause" as defined below or if Employee terminates his employment on account of a "Material Breach by the Company" as defined below, Employee shall be entitled to the following: a. If such termination is within the first six (6) months from the date of this Agreement, Employee shall be entitled to his then current salary payable bi-weekly for a three (3) month period. If such termination is after the first six (6) months from the date of this Agreement, Employee shall be entitled to his then current salary payable bi-weekly for a nine (9) month period. During the period such severance payments are made by the Company to Employee, Employee will have no duty to mitigate the receipt of such severance payment by obtaining other employment, and if Employee should -3- obtain other employment, the Company shall not receive a credit for any compensation earned by Employee and shall continue to pay the entire severance payments required hereunder. b. To the extent Employee has a vested interest in any stock of the Company as of the date of termination of employment, such stock shall be the sole property of Employee and shall be under the sole control of the Employee; however, Employee shall have no ownership right to any stock which has not vested. c. Employee and his family shall continue to be eligible for group medical coverage, at Employee's personal expense, under the Consolidated Omnibus Budget Reconciliation Act of 1986 ("COBRA"), as amended, for such duration as provided by existing law at the time of termination. d. The Board of Directors agrees to define terms to protect Employee's and other Company executives' compensation from the effects of certain material changes in control of the Company. Such terms shall be agreed to on or before March 1, 1998. Employee shall not be entitled to any severance compensation as provided in this paragraph 7 if the Employee has committed any of the following which shall constitute dismissal for "Cause": (i) willful malfeasance, willful misconduct or gross negligence in connection with his employment; (ii) continuing refusal or inability to perform Employee's material duties hereunder after the Company has given written notice to Employee specifying such refusal or inability to perform such duties and, if curable, Employee cures such refusal or inability within 30 days following the date such notice is received by Employee, unless such refusal or inability cannot be cured within such 30 day period at which time Employee will have an additional 30 day period to cure such breach as long as Employee diligently pursues the cure of such refusal or inability as set forth in such notice; (iii) any material breach by Employee of the provisions of paragraphs 8, 9 or 10 of this Agreement after the Company has given written notice to Employee specifying such material breach and, if curable, Employee cures such material breach within 30 days following the date such notice is received by Employee, unless such material breach cannot be cured within such 30 day period at which time Employee will have an additional 30 day period to cure such breach as long as Employee diligently pursues the cure of such material breach as set forth in such notice; or (iv) the commission of any felony or the conviction of a misdemeanor involving moral turpitude on the part of Employee. Further, if during the term of payment of severance compensation, Employee commits any of the above acts or omissions, no further severance payments shall be made to Employee. For purposes of this Agreement, a "Material Breach" by the Company shall only mean any one or more of the following: (i) Employee's title or substantial duties are changed contrary to the title and duties set forth in paragraph 1 of this Agreement; or -4- (ii) Employee is required to report to persons other than as required by paragraph 1 of this Agreement; or (iii) Employee is required to live in a location other than Maricopa County, Arizona, in order to perform his responsibilities and duties under this Agreement; or (iv) The Company fails to pay any amounts due to Employee hereunder within ten (10) days of receipt by the Company of written notice from Employee specifying such failure to pay. Notwithstanding anything mentioned to the contrary herein, in the event Employee resigns or terminates this Agreement with the Company other than for a Material Breach by the Company or if the Company terminates Employee's employment for Cause, Employee shall not be entitled to any severance compensation. 8. Customer Records. a. Employee's Obligations Regarding Customer Records. The Employee acknowledges that the list of the Company's customers or clients as it may exist from time to time is a valuable, special and unique asset of the Company's business. The Employee shall not, during or after his employment with the Company, divulge, furnish or make accessible to anyone (other than in the regular course of the Company's business) any names, addresses or telephone numbers of those individuals who conduct business with the Company. In addition, the contents of customers' files or portfolios, or any other such information shall be kept confidential during and after the Employee's employment with the Company. All original records and all copies thereof of those customers who do business with the Company, including names, or any other such information, as well as all other secrets and confidential information of the Company shall remain the property of the Company during and after the Employee's term of employment with the Company. b. Injunctive Relief for Breach. In the event of a breach or threatened breach by the Employee of the provisions of this section, the Company shall be entitled to an injunction restraining the Employee from disclosing, in whole or in part, the list of the Company's customers, any names, addresses or telephone numbers of those individuals who conduct business with the Company, or from rendering any services to any person, firm, partnership, joint venture, association, or other entity to whom such information, in whole or in part, has been disclosed or is threatened to be disclosed. Nothing herein shall be construed as prohibiting the Company from pursuing any other remedies available to the Company for such breach or threatened breach, including the recovery of damages from the Employee. -5- 9. Confidential Information. a. Employee's Obligations Regarding Confidential Information. Employee has in the past and may in the future develop, obtain or learn about confidential information which is the property of the Company or which the Company is under obligation not to disclose. Employee agrees to use his best efforts and the utmost diligence to guard and protect said information, to treat such information as confidential, and Employee agrees that the Employee will not, during or after the period of his performing services for the Company, use for Employee or others, or divulge to others any of said confidential information which Employee may develop, obtain or learn about during or as a result of performing services for the Company, unless authorized to do so by the Company in writing. Employee further agrees that if this Agreement is terminated for any reason, Employee will not take, but will leave with the Company or return to the Company, all documents, records and papers and all matters of whatever nature which bears or may bear the Company's confidential information or which is in any way related, directly or indirectly to the Company. b. Definition of Confidential Information. For the purposes of this Agreement, the term "confidential information" shall include but not be limited to the following: customer lists; product designs; pricing policies; marketing strategies; business contacts; business plans; computer software, including all rights under licenses and other contracts relating thereto; source code and all documents relating thereto; all intellectual property including without limitation all trademarks, trademark registrations and applications, service marks, copyrights, patents, trade secrets, proprietary marketing information and know-how; books and records including lists of customers; credit reports; sales records; price lists; sales literature; advertising material; manuals; processes; technology; designs; statistics data; techniques; or any information of whatever nature which gives to the Company an opportunity to obtain an advantage over its competitors who do not know or use it, but it is understood that said terms do not include knowledge, skills or information which is common to the trade or profession of the Employee. c. Contact with Customers and Third Parties. Upon Employee's termination of employment with the Company, Employee agrees that for a period of twelve (12) months from the date of termination of employment that he shall not contact directly or indirectly any of the Company's customers or companies which have any direct cigar-related business dealings with the Company. Notwithstanding the foregoing, Employee may contact customers or companies with which the Company does business provided such business contacts do not relate directly or indirectly to the cigar-related business. d. Injunctive Relief for Breach. In the event of a breach or threatened breach by the Employee of the provisions of this section, the Company shall be entitled to an injunction restraining the Employee from disclosing, in whole or in part, any -6- confidential information, or from rendering any services to any person, firm, partnership, joint venture, association, or other entity to whom such confidential information, in whole or in part, has been disclosed. Nothing herein shall be construed as prohibiting the Company from pursuing any other remedies available to the Company for such breach or threatened breach, including the recovery of damages from the Employee. 10. Covenant Not To Compete. a. Interests to be Protected. The parties acknowledge that during the term of this employment, Employee will perform essential services for the Company and for clients of the Company. Therefore, Employee will be given an opportunity to meet, work with and develop close working relationships with the Company's clients on a first-hand basis and will gain valuable insight as to the clients' operations, personnel and need for services. In addition, Employee will be exposed to, have access to, and be required to work with, a considerable amount of the Company's confidential and proprietary information, including but not limited to: information concerning the Company's methods of operation, financial information, strategic planning, operational budget and strategies, payroll data, computer systems, marketing plans and strategies, merger and acquisition strategies, and customer lists. The parties also expressly acknowledge that Employee holds a highly specialized, professional position that is the key position in one of the Company's most significant divisions and replacing Employee in this position would require the Company to incur substantial expense. The parties expressly recognize that should Employee compete with the Company in any manner whatsoever, it could seriously impair the goodwill and diminish the value of the Company's business. The parties acknowledge that the covenant not to compete contained in this section has an extended duration; however, they agree that this covenant is reasonable and it is necessary for the protection of the Company, its shareholders and employees. For these and other reasons, and the fact that there are many other employment opportunities available to the Employee if he should terminate, the parties are in full and complete agreement that the following restrictive covenants are fair and reasonable and are freely, voluntarily and knowingly entered into. Further, each party was given the opportunity to consult with independent legal counsel before entering into this Agreement. b. Restrictions on Competition. Employee agrees that he shall not during the term of this Agreement and for a period of twelve (12) months from the date of his termination of employment from the Company, directly or indirectly, either as principal, partner, shareholder, joint venturer, officer, director, consultant, member, employee or otherwise, own any interest in, manage, control, participate in, consult with, render services for, or in any manner engage in any business competing, directly or indirectly, with the business of the Company (which is cigar distribution) in any state of the United States or foreign country in which the Company is conducting business on the date of Employee's termination. At any time and from time to time, each party agrees, at its expense, to take action and to execute and deliver documents as may be reasonably necessary to effectuate the purposes of this Covenant. -7- c. Judicial Amendment. If the scope of any provision of this Agreement is found by any Court to be too broad to permit enforcement to its full extent, then such provision shall be enforced to the maximum extent permitted by law. The parties agree that the scope of any provision of this Agreement may be modified by a judge in any proceeding to enforce this Agreement, so that such provision can be enforced to the maximum extent permitted by law. If any provision of this Agreement is found to be invalid or unenforceable for any reason, it shall not affect the validity of the remaining provisions of this Agreement. d. Injunction; Remedies for Breach. Since a breach of the provisions of this section of this Agreement could not adequately be compensated by money damages, the Company shall be entitled, in addition to any other right or remedy available to it at law or equity, to an injunction restraining the breach or threatened breach and to specific performance of any provision of this section of this Agreement, and, in either case, no bond or other security shall be required in connection therewith, and the parties hereby consent to the issuance of such an injunction and to the ordering of specific performance. 11. Notices. All notices provided for by this Agreement shall be made in writing either (i) by actual delivery of the notice into the hands of the parties thereunto entitled or (ii) the mailing of the notice in the United States mail to the address, as stated below (or at such other address as may have been designated by written notice) of the party entitled thereto, by certified mail, return receipt requested. The notice shall be deemed to be received on the date of its actual receipt of the party entitled thereto. All communications hereunder shall be in writing and, if sent to the Company, shall be delivered to: Premium Cigars 15651 N. 83rd Way Suite 3, Building C Scottsdale, Arizona 85260 Fax 992-6026 Attention: David Hodges with a copy to: Titus, Brueckner & Berry, P.C. 7373 North Scottsdale Road Suite B-252 Scottsdale, Arizona 85253 Attention: Kurt M. Brueckner -8- and, if sent to the Employee, shall be delivered to: John E. Greenwell 16216 North 63rd Place Scottsdale, Arizona 85254 with a copy to: Charles W. Whetstine 8777 North Gainey Center Drive Suite 162 Scottsdale, Arizona 85258-2106 12. Assignment. This Agreement shall inure to the benefit of and shall be binding on and enforceable by the parties and their respective successors and permitted assigns, as the case may be. Except as provided for herein, neither party shall have the right to assign its rights or obligations hereunder, without the prior written consent of the other party. 13. Miscellaneous. a. Governing Law. This Agreement shall be governed by and construed in accordance with the law of the State of Arizona. b. Waiver. No waiver or modification of this Agreement shall be valid unless in writing and duly executed by the party to be charged therewith. Waiver by either party hereto of any breach or default by the other party of any of the terms and provisions of this Agreement shall not operate as a waiver of any other breach or default, whether similar to or different from the breach or default waiver. c. Severability. All agreements, provisions, representations, warranties and covenants contained herein are severable, and in the event that any one or more of them shall be held to be invalid, illegal or unenforceable in any respect by any court of competent jurisdiction, the validity, legality and enforceability of the remaining provisions contained herein shall not in any way be affected thereby, and this Agreement shall be interpreted as if such invalid, illegal or unenforceable agreements, provisions or covenants were not contained herein. d. Gender. Whenever the context requires, the masculine shall include the feminine and neuter. e. Entire Agreement. This Agreement constitutes and embodies the full and complete understanding and agreement of the parties hereto provided, and supersedes all prior understandings or agreements, whether oral or in writing. Any and all agreements -9- between the parties hereto, whether oral or in writing, prior to the date hereof shall be deemed null and void. f. Parties. This Agreement shall be binding upon and inure to the benefit to the parties hereto, their officers, directors, shareholders, successors, legal representatives, heirs and successors and assigns, and no other person shall have or be construed to have any legal or equitable right, remedy or claim under or in respect of, or by virtue of, this Agreement or any provision herein contained. g. Mediation; Arbitration. If a dispute arises out of or relates to this Agreement, or the breach thereof, and if the dispute cannot be settled through negotiation, the parties agree first to try in good faith to settle the dispute by mediation administered by the American Arbitration Association under its Commercial Mediation Rules. If the dispute cannot be settled through negotiation or mediation, the Parties agree to submit the dispute to arbitration administered by the American Arbitration Association under its Commercial Arbitration Rules, and judgment on the award rendered by the arbitrator(s) may be entered in any court having jurisdiction thereof. Venue for all such mediation and/or arbitration proceedings shall be in Maricopa County, Arizona. h. Attorney's Fees. The prevailing party in any litigation hereunder shall be entitled to the recovery of its reasonable attorneys' fees and costs from the other party. Upon Employee's entry into this Agreement, the Company shall undertake to bear Employee's attorney's fees incurred in the negotiation of this Agreement, in an amount not to exceed $4,000.00. i. Counterparts. This Agreement may be executed in two (2) or more counterparts, each of which shall be deemed an original and all of which, together, shall constitute one and the same instrument. IN WITNESS WHEREOF, the parties have executed this Agreement the day and year first above-written. "COMPANY" "EMPLOYEE" PREMIUM CIGARS INTERNATIONAL, LTD. By: /s/ Greg Lambrecht /s/ John Greenwell ------------------------------- ---------------------------------------- Its: Secretary John E. Greenwell -10- EX-10.5 6 LETTER REGARDING SEVERANCE COMPENSATION EXHIBIT 10.5 [TITUS BRUECKNER & BERRY, P.C. LETTERHEAD] February 18, 1998 HOLD FOR PICK-UP Karissa Nisted 6746 S. Bonarden Lane Tempe, Arizona 85283 Re: Premium Cigars International, Ltd. ("PCI") Severance Compensation Dear Karissa: This letter responds to your request that PCI confirm with you the compensation and other benefits which you are entitled to upon termination under the terms of your Employment Agreement dated October 15, 1997 ("Employment Agreement"). Please confirm below that the following represents your understanding of the terms of your severance with PCI in accordance with Section 7 of your Employment Agreement: 1. That your employment with PCI terminated effective at the end of the workday Monday, February 9, 1998; 2. For a six (6) month period, you will continue to receive your normal salary amount, at the salary level in effect on the date your employment was terminated minus all applicable deductions (such as for taxes, etc.) payable biweekly; 3. Section 7(c) provides for group medical insurance eligibility, at your own expense, under the Consolidated Omnibus Budget Reconciliation Act of 1986 ("COBRA"), as amended, for such duration as provided by existing law at the time of your termination; it is PCI's understanding that, because the Company normally employed fewer than 20 employees on a typical business day during the calendar year preceding the date of your termination, you are not eligible for COBRA coverage; 4. That you understand that, without limitation, Sections 8, 9 and 10 of your Employment Agreement dated October 15, 1997 represent ongoing obligations on your part relating to PCI's customer records, confidential information and your covenant not to compete with PCI. Karissa Nisted February 18, 1998 Page 2 In addition to the foregoing severance terms from the Employment Agreement, PCI waives any and all claims that it might have against you in exchange for your mutual waiver below. Please contact me if you have any questions regarding this letter. Very truly yours, TITUS, BRUECKNER & BERRY, P.C. /s/ Michael F. Patterson ----------------------------------- Michael F. Patterson MS. NISTED'S ACKNOWLEDGEMENT AND RELEASE: I acknowledge that except for the items set forth in this letter, I have no other claims and waive all other claims to compensation or other benefits from PCI. I waive all other claims against the Company, its directors, officers, shareholders and agents in exchange for the Company's mutual waiver of all claims against me. My foregoing waiver shall not, however, be deemed to prevent me from asserting any defense in any action brought against me by any third party and which relates to the Company's business. Additionally, I reserve any rights I may have under the Articles of Incorporation, Bylaws or common law for indemnification. Date: February 18, 1998 /s/ Karissa Nisted ---------------------------------------- Karissa Nisted COMPANY AGREEMENT TO THE TERMS SET FORTH ABOVE: PREMIUM CIGARS INTERNATIONAL, LTD. By: /s/ David S. Hodges Date: February 18, 1998 -------------------------------- Printed Name: David S. Hodges Its: Chief Financial Officer EX-10.6 7 INDUSTRIAL REAL ESTATE LEASE EXHIBIT 10.6 INDUSTRIAL REAL ESTATE LEASE (SINGLE TENANT NET FORM) ARTICLE ONE: BASIC TERMS This Article One contains the Basic Terms of this Lease between the Landlord and Tenant named below. Other Articles, Sections and Paragraphs of the Lease referred to in this Article One explain and define the Basic Terms and are to be read in conjunction with the Basic Terms. Section 1.01. Date of Lease: February 25, 1998. Section 1.02. Landlord (include legal entity): Palo Cristi Airpark III, L.L.C., and Arizona limited liability company, whose address is 15685 N. Greenway-Hayden Loop, Suite 200, Scottsdale, AZ 85260. Section 1.03. Tenant (include legal entity): Premium Cigars International, LTD. an Arizona corporation, whose address is 15651 N. 83rd Way, Suite 3, Scottsdale, AZ 85260. Section 1.04. Property: The Property is Landlord's 20,434 approximate s.f. real property located at 15849 N. 77th Street, Scottsdale, AZ 85260-1754 and described or depicted in Exhibit "A" (the "Project"). The Project includes the land, the buildings and all other improvements located on the land. The Properly is will be improved substantially in accordance with the space plan ("Exhibit B") and the Standard Tenant Improvements and Allowances schedule ("Exhibit C"), both attached hereto and incorporated herein by reference. Section 1.05. Lease Term: Five (5) years beginning May 1, 1998 and ending on April 30, 2003. a) Delay in Possession: If for any reason Landlord cannot deliver possession of the Property to Tenant by April 15, 1998, Landlord shall not be subject to any liability therefor, nor shall such failure affect the validity of this Lease or the obligations of Tenant hereunder, but in such case Tenant shall receive one (1) day of free Base Rent for each day of delay. * * Notwithstanding the foregoing, if Landlord does not deliver possession of the Property to Tenant on or before May 1, 1998 (except as for delays as a result of acts of God), Landlord shall pay to Tenant a per day penalty of $1,000 payable on Monday of each applicable week. If Landlord does not deliver possession of the Property to Tenant on or before May 15, 1998, in addition to the foregoing remedies, Tenant may at its option cancel this Lease. b) Option to Extend: Provided Tenant is not then in default, Tenant shall have the option to extend the Lease Term for one additional three (3) year period by giving Landlord notice one hundred twenty (120) days prior to the expiration of the original Lease Term. In such event the Base Rent for the extended Lease Term shall be the then existing market rental rate for an approximate 20,000 s.f. comparable properly which is 100% airconditioned with 50% office and 50% warehouse, but in no event lower than $19,000.00 per month. Section 1.06. Permitted Uses: (See Article Five) Corporate office and warehousing/distribution of Premium Cigars International related products. Section 1.07. Tenant's Guarantor: None. Section 1.08. Brokers. Landlord's Broker: Classic Real Estate; Tenant's Broker: Grubb and Ellis Section 1.09. Commission Payable to Landlord's Broker: (See Article Fourteen) By separate agreement. Section 1.10. Initial Security Deposit: (See Section 3.03) $18,000.00. Section 1.11. Vehicle Parking Spaces Allocated to Tenant: (See Section 4.05) 10 covered, 100% open. Section 1.12. Rent and Other Charges Payable by Tenant: (a) Base Rent: Eighteen Thousand and no/100 Dollars ($18,000.00) per month for months 1 through 36, Nineteen Thousand and no/100 Dollars ($19,000.00) for months 37 through 60. (b) OTHER PERIODIC PAYMENTS: (i) Real Property Taxes (See Section 4.02); (ii) Utilities (See Section 4.03); (iii) Insurance Premiums (See Section 4.04); (iv) Tenant's Pro Rata Share of Common Area Expenses (100%) (See Section 4.05); (v) ---- Impounds for Insurance Premiums and Property Taxes (See Section 4.08); (vi) Maintenance, Repairs and Alterations (See Article Six). Section 1.13. Landlord's Share of Profit on Assignment or Sublease: (See Section 9.05) 100%) of the Profit (the "Landlord's Share"). Section 1.14 Riders: The following Riders are attached to and made a part of this Lease: None. Section 2.01. Lease of Property For Lease Term. Landlord leases the Property to Tenant and Tenant leases the Property from Landlord for the Lease Term. The Lease Term is for the period stated in Section 1.05 above and shall begin and end on the dates specified in Section 1.05 above, unless the beginning or end of the Lease Term is changed under any provision of this Lease. The "Commencement Date" shall be the date specified in Section 1.05 above for the beginning of the Lease Term, unless advanced or delayed under any provision of this Lease. 2 Section 2.02. Delay in Commencement. Except as provided in paragraph 1.05(a) herein. Landlord shall not be liable to Tenant if Landlord does not deliver possession of the Property to Tenant on the Commencement Date. Landlord's non-delivery of the Property to Tenant on that date shall not affect this Lease or the obligations of Tenant under this Lease except that the Commencement Date shall be delayed until Landlord delivers possession of the Property to Tenant and the Lease Term shall be extended for a period equal to the delay in delivery of possession of the Property to Tenant, plus the number of days necessary to end the Lease Term on the last day of a month. If Landlord does not deliver possession of the Property to Tenant on or before May 15, 1998 Date, Tenant may elect to cancel this Lease by giving written notice to Landlord ends. If Tenant gives such notice, the Lease shall be cancelled and neither Landlord nor Tenant shall have any further obligation to the other. If Tenant does not give such notice, Tenant's right to cancel the Lease shall expire and the Lease Term shall commence upon the delivery of possession of the Property to Tenant. If delivery of possession of the Property to Tenant is delayed, Landlord and Tenant shall, upon such delivery, execute an amendment to this Lease setting forth the actual Commencement Date and expiration date of the Lease. Failure to execute such amendment shall not affect the actual Commencement Date and expiration date of the Lease. Section 2.03. Early Occupancy. f Tenant occupies the Property prior to the Commencement Date, Tenant's occupancy of the Property shall be subject to all of the provisions of this Lease. Early occupancy of the Property shall not advance the expiration date of this Lease. Tenant shall pay all other charges except Base Rent specified in this Lease for the early occupancy period. Section 2.04. Holding Over. Tenant shall vacate the Property upon the expiration or earlier termination of this Lease. Tenant shall reimburse Landlord for and indemnify Landlord against all damages which Landlord incurs from Tenant's delay in vacating the Property. If Tenant does not vacate the Property upon the expiration or earlier termination of the Lease and Landlord thereafter accepts rent from Tenant, Tenant's occupancy of the Property shall be a "month-to-month" tenancy, subject to all of the terms of this Lease applicable to a month-to- month tenancy, except that the Base Rent then in effect shall be increased by fifteen percent (15%). ARTICLE THREE: BASE RENT Section 3.01. Time and Manner of Payment. Upon execution of this Lease, Tenant shall pay Landlord the Base Rent in the amount stated in Paragraph 1.12(a) above for the first month of the Lease Term. On the first day of the second month of the Lease Term and each month thereafter, Tenant shall pay Landlord the Base Rent, in advance, without offset, deduction or prior demand. The Base Rent shall be payable at Landlord's address or at such other place as Landlord may designate in writing. Section 3.02. Deleted. 3 Section 3.03. Security Deposit; Increases. (a) Upon the execution of this Lease, Tenant shall deposit with Landlord a cash Security Deposit in the amount set forth in Section 1.10 above. Landlord may apply all or part of the Security Deposit to any unpaid rent or other charges due from Tenant or to cure any other defaults of Tenant. If Landlord uses any part of the Security Deposit, Tenant shall restore the Security Deposit to its full amount within ten (10) days after Landlord's written request. Tenant's failure to do so shall be a material default under this Lease. No interest shall be paid on the Security Deposit. Landlord shall not be required to keep the Security Deposit separate from its other accounts and no trust relationship is created with respect to the Security Deposit. (b) Each Time the Base Rent is increased, Tenant shall deposit additional funds with Landlord sufficient to increase the Security Deposit to an amount which bears the same relationship to the adjusted Base Rent as the initial Security Deposit bore to the initial Base Rent. Section 3.04. Termination; Advance Payments. Upon termination of this Lease under Article Seven (Damage or Destruction), Article Eight (Condemnation) or any other termination not resulting from Tenant's default, and after Tenant has vacated the Property in the manner required by this Lease, Landlord shall refund or credit to Tenant (or Tenant's successor) the unused portion of the Security Deposit, any advance rent or other advance payments made by Tenant to Landlord, and any amounts paid for real property taxes and other reserves which apply to any time periods after termination of the Lease. ARTICLE FOUR: OTHER CHARGES PAYABLE BY TENANT Section 4.01. Additional Rent. All charges payable by Tenant other than Base Rent are called "Additional Rent." Unless this Lease provides otherwise, Tenant shall pay all Additional Rent then due with the next monthly installment of Base Rent. The term "rent" shall mean Base Rent and Additional Rent. Section 4.02. Property Taxes. (a) Real Property Taxes. Tenant shall pay all real property taxes on the Property (including any fees, taxes or assessments against, or as a result of, any tenant improvements installed on the Property by or for the benefit of Tenant) during the Lease Term. Subject to Paragraph 4.02(c) and Section 4.07 below, such payment shall be made at least ten (10) days prior to the delinquency date of the taxes. Within such ten (10) day period, Tenant shall furnish Landlord with satisfactory evidence that the real property taxes have been paid. Landlord shall reimburse Tenant for any real property taxes paid by Tenant covering any period of time prior to or after the Lease Term. If Tenant fails to pay the real property taxes when due, Landlord may pay the taxes and Tenant shall reimburse Landlord for the amount of such tax payment as Additional Rent. 4 (b) Definition of "Real Property Tax." "Real property tax" means: (i) any fee, license fee, license tax, business license fee, commercial rental tax, levy, charge, assessment, penalty or tax imposed by any taxing authority against the Property; (ii) any tax on the Landlord's right to receive, or the receipt of, rent or income from the Property or against Landlord's business of leasing the Property; (iii) any tax or charge for fire protection, streets, sidewalks, road maintenance, refuse or other services provided to the Property by any governmental agency; (iv) any tax imposed upon this transaction or based upon a re-assessment of the Property due to a change of ownership, as defined by applicable law, or other transfer of all or part of Landlord's interest in the Property; and (v) any charge or fee replacing any tax previously included within the definition of real property tax. "Real property tax" does not, however, include Landlord's federal or state income, franchise, inheritance or estate taxes. (c) Joint Assessment. If the Property is not separately assessed, Landlord shall reasonably determine Tenant's share of the real property tax payable by Tenant under Paragraph 4.02(a) from the assessor's worksheets or other reasonably available information. Tenant shall pay such share to Landlord within fifteen (15) days after receipt of Landlord's written statement. (d) Personal Property Taxes. (i) Tenant shall pay all taxes charged against trade fixtures, furnishings, equipment or any other personal property belonging to Tenant. Tenant shall try to have personal property taxed separately from the Property. (ii) If any of Tenant's personal property is taxed with the Property, Tenant shall pay Landlord the taxes for the personal property within fifteen (15) days after Tenant receives a written statement from Landlord for such personal property taxes. (e) Tenant's Right to Contest Taxes. Tenant may attempt to have the assessed valuation of the Property reduced or may initiate proceedings to contest the real property taxes. If required by law, Landlord shall join in the proceedings brought by Tenant. However, Tenant shall pay all costs of the proceedings, including any costs or fees incurred by Landlord. Upon the final determination of any proceeding or contest, Tenant shall immediately pay the real property taxes due, together with all costs, charges, interest and penalties incidental to the proceedings. If Tenant does not pay the real property taxes when due and contests such taxes, Tenant shall not be in default under this Lease for nonpayment of such taxes if Tenant deposits funds with Landlord or opens an interest-bearing account reasonably acceptable to Landlord in the joint names of Landlord and Tenant. The amount of such deposit shall be sufficient to pay the real property taxes plus a reasonable estimate of the interest, costs, charges and penalties which may accrue if Tenant's action is unsuccessful, less any applicable tax impounds previously paid by Tenant to Landlord. The deposit shall be applied to the real property taxes due, as determined at such proceedings. The real property taxes shall be paid under protest from such deposit if such payment under protest is necessary to prevent the Property from being sold under a "tax sale" or similar enforcement proceeding. 5 Section 4.03. Utilities. Tenant shall pay, directly to the appropriate supplier, the cost of all natural gas, heat, light, power, sewer service, telephone, water, refuse disposal and other utilities and services supplied to the Property. However, if any services or utilities are jointly metered with other property, Landlord shall make a reasonable determination of Tenant's proportionate share of the cost of such utilities and services and Tenant shall pay such share to Landlord within fifteen (15) days after receipt of Landlord's written statement. Section 4.04. Insurance Policies. (a) Liability Insurance. During the Lease Term, Tenant shall maintain a policy of commercial general liability insurance (sometimes known as broad form comprehensive general liability insurance) insuring Tenant against liability for bodily injury, property damage (including loss of use of property) and personal injury arising out of the operation, use or occupancy of the Property. Tenant shall name Landlord as an additional insured under such policy. The initial amount of such insurance shall be One Million Dollars ($1,000,000) per occurrence and shall be subject to periodic increase based upon inflation, increased liability awards, recommendation of Landlord's professional insurance advisers and other relevant factors. The liability insurance obtained by Tenant under this Paragraph 4.0(a) shall (i) be primary and non-contributing; (ii) contain cross-liability endorsements; and (iii) insure Landlord against Tenant's performance under Section 5.05, if the matters giving rise to the indemnity under Section 5.05 result from the negligence of Tenant. The amount and coverage of such insurance shall not limit Tenant's liability nor relieve Tenant of any other obligation under this Lease. Landlord may also obtain comprehensive public liability insurance in an amount and with coverage determined by Landlord insuring Landlord against liability arising out of ownership, operation, use or occupancy of the Property. The policy obtained by Landlord shall not be contributory and shall not provide primary insurance. (b) Property and Rental Income Insurance. During the Lease Term, Landlord shall maintain policies of insurance covering loss of or damage to the Property in the full amount of its replacement value. Landlord shall obtain 3 bids for such insurance policies and select the lowest bid. Such policy shall contain an inflation Guard Endorsement and shall provide protection against all perils included within the classification of fire, extended coverage, vandalism, malicious mischief, special extended perils (all risk), sprinkler leakage and any other perils which Landlord deems reasonably necessary. Landlord shall have the right to obtain flood and earthquake insurance if required by any lender holding a security interest in the Property. Landlord shall not obtain insurance for Tenant's fixtures or equipment or building improvements installed by Tenant on the Property. During the Lease Term, Landlord shall also maintain a rental income insurance policy, with loss payable to Landlord, in an amount equal to one year's Base Rent plus estimated real property taxes and insurance premiums. Tenant shall be liable for the payment of any deductible amount under Landlord's or Tenant's insurance policies maintained pursuant to this Section 4.04, in an amount not to exceed Two Thousand Dollars ($2,000). Tenant shall not do or permit anything to be done which invalidates any such insurance policies. 6 (c) Payment of Premiums. Subject to Section 4.07, Tenant shall pay all premiums for the insurance policies described in Paragraphs 4.04(a) and (b) (whether obtained by Landlord or Tenant) within fifteen (15) days after Tenant's receipt of a copy of the premium statement or other evidence of the amount due, except Landlord shall pay all premiums for non-primary comprehensive public liability insurance which Landlord elects to obtain as provided in Paragraph 4.04(a). If insurance policies maintained by Landlord cover improvements on real property other than the Property, Landlord shall deliver to Tenant a statement of the premium applicable to the Property showing in reasonable detail how Tenant's share of the premium was computed. If the Lease Term expires before the expiration of an insurance policy maintained by Landlord, Tenant shall be liable for Tenant's prorated share of the insurance premiums. Before the Commencement Date, Tenant shall deliver to Landlord a copy of any policy of insurance which Tenant is required to maintain under this Section 4.04. At least thirty (30) days prior to the expiration of any such policy, Tenant shall deliver to Landlord a renewal of such policy. As an alternative to providing a policy of insurance, Tenant shall have the right to provide Landlord a certificate of insurance, executed by an authorized officer of the insurance company, showing that the insurance which Tenant is required to maintain under this Section 4.04 is in full force and effect and containing such other information which Landlord reasonably requires. * *Tenant shall have the right to approve the insurance carrier and insurance coverage prior to paying any insurance premiums. (d) General Insurance Provisions. (i) Any insurance which Tenant is required to maintain under this Lease shall include a provision which requires the insurance carrier to give Landlord not less than thirty (30) days' written notice prior to any cancellation or modification of such coverage. (ii) If Tenant fails to deliver any policy, certificate or renewal to Landlord required under this Lease within the prescribed time period or if any such policy is cancelled or modified during the Lease Term without Landlord's consent, Landlord may obtain such insurance, in which case Tenant shall reimburse Landlord for the cost of such insurance within fifteen (15) days after receipt of a statement that indicates the cost of such insurance. (iii) Tenant shall maintain all insurance required under this Lease with companies holding a "General Policy Rating" of A-12 or better, as set forth in the most current issue of "Best Key Rating Guide". Landlord and Tenant acknowledge the insurance markets are rapidly changing and that insurance in the form and amounts described in this Section 4.04 may not be available in the future. Tenant acknowledges that the insurance described in this Section 4.04 is for the primary benefit of Landlord. If at any time during the Lease Term, Tenant is unable to maintain the insurance required under the Lease, Tenant shall nevertheless maintain insurance coverage which is customary and commercially reasonable in the insurance industry for Tenant's type of business, as that 7 coverage may change from time to time. Landlord makes no representation as to the adequacy of such insurance to protect Landlord's or Tenant's interests. Therefore, Tenant shall obtain any such additional property or liability insurance which Tenant deems necessary to protect Landlord and Tenant. (iv) Unless prohibited under any applicable insurance policies maintained, Landlord and Tenant each hereby waive any and all rights of recovery against the other, or against the officers, employees, agents or representatives of the other, for loss of or damage to its property or the property of others under its control, if such loss or damage is covered by any insurance policy in force (whether or not described in this Lease) at the time of such loss or damage. Upon obtaining the required policies of insurance, Landlord and Tenant shall give notice to the insurance carriers of this mutual waiver of subrogation. Section 4.05. Deleted. Section 4.06. Interest on Past Due Obligations. Any amount owed by Tenant to Landlord which is not paid when due shall bear interest at the rate of fifteen percent (15%) per annum from the due date of such amount. However, interest shall not be payable on late charges to be paid by Tenant under this Lease. The payment of interest on such amounts shall not excuse or cure any default by Tenant under this Lease. If the interest rate specified in this Lease is higher than the rate permitted by law, the interest rate is hereby decreased to the maximum legal interest rate permitted by law. Section 4.07. Impounds for Insurance Premiums and Real Property Taxes. Tenant shall pay Landlord a sum equal to one-twelfth (1/12) of the annual real property taxes and insurance premiums payable by Tenant under this Lease, together with each payment of Base Rent. Landlord shall hold such payments in a non-interest bearing impound account. If unknown, Landlord shall reasonably estimate the amount of real property taxes and insurance premiums when due. Tenant shall pay any deficiency of funds in the impound account to Landlord upon written request. If Tenant defaults under this Lease, Landlord may apply any funds in the impound account to any obligation then due under this Lease. ARTICLE FIVE: USE OF PROPERTY. Section 5.01. Permitted Uses. Tenant may use the Property only for the Permitted Uses set forth in Section 1.06 above. Section 5.02. Manner of Use. Tenant shall not cause or permit the Property to be used in any way which constitutes a violation of any law, ordinance, or governmental regulation or order, which interferes with the rights of other tenants of Landlord, or which constitutes a nuisance or waste. Tenant shall obtain and pay for all permits, including a Certificate of Occupancy, required for Tenant's occupancy of the Property and shall promptly take all actions necessary to comply with all applicable statutes, ordinances, rules, regulations, orders and 8 requirements regulating the use by Tenant of the Property, including the Occupational Safety and Health Act. Section 5.03. Hazardous Materials. As used in this Lease, the term "Hazardous Material" means any flammable items, explosives, radioactive materials, hazardous or toxic substances, material or waste or related materials, including any substances defined as or included in the definition of "hazardous substances", "hazardous wastes", "hazardous materials" or "toxic substances" now or subsequently regulated under any applicable federal, state or local laws or regulations, including without limitation petroleum-based products, paints, solvents, lead, cyanide, DDT, printing inks, acids, pesticides, ammonia compounds and other chemical products, asbestos, PCBs and similar compounds, and including any different products and materials which are subsequently found to have adverse effects on the environment or the health and safety of persons except warehousing/distribution of cigars and related cigar products and other consumer packaged goods. Tenant shall not cause or permit any Hazardous Materials to be generated, produced, brought upon, used, stored, treated or disposed of in or about the Property by Tenant, its agents, employees, contractors, sublessees or invitees without the prior written consent of Landlord. Landlord shall be entitled to take into account such other factors or facts as Landlord may reasonably determine to be relevant in determining whether to grant or withhold consent to Tenant's proposed activity with respect to Hazardous Material. In no event, however, shall Landlord be required to consent to the installation or use of any storage tanks on the Property. Section 5.04. Signs and Auctions. Tenant shall not place any signs on the Property without Landlord's prior written consent. Tenant shall not conduct or permit any auctions or sheriff's sales at the Property. Section 5.05. Indemnity. Tenant shall indemnify Landlord against and hold Landlord harmless from any and all costs, claims or liability arising from: (a) Tenant's use of the Property; (b) the conduct of Tenant's business or anything else done or permitted by Tenant to be done in or about the Property, including any contamination of the Property or any other property resulting from the presence or use of Hazardous Material caused or permitted by Tenant; (c) any breach or default in the performance of Tenant's obligations under this Lease; (d) any misrepresentation or breach of warranty by Tenant under this Lease; or (e) other acts or omissions of Tenant. Tenant shall defend Landlord against any such cost, claim or liability at Tenant's expense with counsel reasonably acceptable to Landlord or, at Landlord's election, Tenant shall reimburse Landlord for any legal fees or costs incurred by Landlord in connection with any such claim. As a material part of the consideration to Landlord, Tenant assumes all risk of damage to property or injury to persons in or about the Property arising from any cause, and Tenant hereby waives all claims in respect thereof against Landlord, except for any claim arising out of Landlord's gross negligence or willful misconduct. As used in this Section, the term "Tenant" shall include Tenant's employees, agents, contractors and invitees, if applicable. Landlord shall indemnify Tenant from damages or injury to any person arising from the use of the common areas arising from Landlord's negligence in maintaining the common areas. 9 Section 5.06. Landlord's Access. Landlord or its agents may enter the Property at all reasonable times to show the Property to potential buyers, investors or tenants or other parties; to do any other act or to inspect and conduct tests in order to monitor Tenant's compliance with all applicable environmental laws and all laws governing the presence and use of Hazardous Material; or for any other purpose Landlord deems necessary. Landlord shall give Tenant prior notice of such entry, except in the case of an emergency. Landlord may place customary "For Sale" or "For Lease" signs on the Property. Section 5.07. Quiet Possession. If Tenant pays the rent and complies with all other terms of this Lease, Tenant may occupy and enjoy the Property for the full Lease Term, subject to the provisions of this Lease. ARTICLE SIX: CONDITION OF PROPERTY; MAINTENANCE, REPAIRS AND ALTERATIONS Section 6.01. Existing Conditions. Tenant accepts the Property in its condition as of the execution of the Lease, subject lo all recorded matters, laws, ordinances, and governmental regulations and orders. Except as provided herein, Tenant acknowledges that neither Landlord nor any agent of Landlord has made any representalion as to the condition of the Property or the suitability of the Property for Tenant's intended use. Tenant represents and warrants that Tenant has made its own inspection of and inquiry regarding the condition of the Property and is not relying on any representations of Landlord or any Broker with respect thereto. If Landlord or Landlord's Broker has provided a Property Information Sheet or other Disclosure Statement regarding the Property, a copy is attached as an exhibit to the Lease. Section 6.02. Exemption of Landlord from Liability. Landlord shall not be liable for any damage or injury to the person, business (or any loss of income therefrom), goods, wares, merchandise or other property of Tenant, Tenant's employees, invitees, customers or any other person in or about the Properly, whether such damage or injury is caused by or results from: (a) fire, steam, electricity, water, gas or rain; (b) the breakage, leakage, obstruction or other defects of pipes, sprinklers, wires, appliances, plumbing, air conditioning or lighting fixtures or any other cause; (c) conditions arising in or about the Property or upon other portions of the Project, or from other sources or places; or (d) any act or omission of any other tenant of the Project. Landlord shall not be liable for any such damage or injury even though the cause of or the means of repairing such damage or injury are not accessible to Tenant. The provisions of this Section 6.02 shall now, however, exempt Landlord from liability for Landlord's gross negligence or willful misconduct. Section 6.03. Landlord's Obligations. Subject to the provisions of Article Seven (Damage or Destruction) and Article Eight (Condemnation), Landlord shall have absolutely no responsibility to repair, maintain or replace any portion of the Property at any time except Landlord shall be responsible for maintenance of the roof. Tenant also beneficiary of warranties on HVAC Systems. If Landlord does have responsibility to repair or replace any portion of the 10 property and fails to do so, within three (3) business days, Tenant may at its option make such repairs and deduct the cost of such repairs due to Landlord from the rent. Section 6.04. Tenant's Obligations. (a) Except as provided in Article Seven (Damage or Destruction), Section 6.03 (maintaining the roof) and Article Eight (Condemnation), Tenant shall keep all portions of the Property (including structural, nonstructural, interior, exterior, and landscaped areas, portions, systems and equipment) in good order, condition and repair (including interior repainting and refinishing, as needed). If any portion of the Property or any system or equipment in the Property which Tenant is obligated to repair cannot be fully repaired or restored, Tenant shall promptly replace such portion of the Property or system or equipment in the Property, regardless of whether the benefit of such replacement extends beyond the Lease Term; but if the benefit or useful life of such replacement extends beyond the Lease Term (as such term may be extended by exercise of any options), the useful life of such replacement shall be prorated over the remaining portion of the Lease Term (as extended), and Tenant shall be liable only for that portion of the cost which is applicable to the Lease Term (as extended). Tenant shall maintain a preventive maintenance contract providing for the regular inspection and maintenance of the heating and air conditioning system by a licensed heating and air conditioning contractor. If any part of the Property is damaged by any act or omission of Tenant, Tenant shall pay Landlord the cost of repairing or replacing such damaged property, whether or nol Landlord would otherwise be obligated to pay the cost of maintaining or repairing such property. It is the intention of Landlord and Tenant that at all times Tenant shall maintain the portions of the Property which Tenant is obligated to maintain in an attractive, first-class and fully operative condition. (b) Tenant shall fulfill all of Tenant's obligations under this Section 6.04 at Tenant's sole expense. If Tenant fails to maintain, repair or replace the Property as required by this Section 6.04, Landlord may, upon ten (10) days' prior notice to Tenant (except that no notice shall be required in the case of an emergency), enter the Property and perform such maintenance or repair (including replacement, as needed) on behalf of Tenant. In such case, Tenant shall reimburse Landlord for all costs incurred in performing such maintenance or repair immediately upon demand. Section 6.05. Alterations, Additions, and Improvements. (a) Tenant shall not make any alterations, additions, or improvements to the Property without Landlord's prior written consent, except for non-structural alterations which do not exceed Ten Thousand Dollars ($10,000) in cost cumulatively over the Lease Term and which are not visible from the outside of any building of which the Property is part. Landlord may require Tenant to provide demolition and/or lien and completion bonds in form and amount satisfactory to Landlord. Tenant shall promptly remove any alterations, additions, or improvements constructed in violation of this Paragraph 6.05(a) upon Landlord's written request. Ail alterations, additions, and improvements shall be done in a good and workmanlike manner, 11 in conformity with all applicable laws and regulations, and by a contractor approved by Landlord. Upon completion of any such work, Tenant shall provide Landlord with "as built" plans, copies of all construction contracts, and proof of payment for all labor and materials. (b) Tenant shall pay when due all claims for labor and material furnished to the Property. Tenant shall give Landlord at least twenty (20) days' prior written notice of the commencement of any work on the Property, regardless of whether Landlord's consent to such work is required. Landlord may elect to record and post notices of non-responsibility on the Property. Section 6.06. Condition upon Termination. Upon the termination of the Lease, Tenant shall surrender the Property to Landlord, broom clean and in the same condition as received except for ordinary wear and tear which Tenant was not otherwise obligated to remedy under any provision of this Lease. However, Tenant shall not be obligated to repair any damage which Landlord is required to repair under Article Seven (Damage or Destruction). in addition, Landlord may require Tenant to remove any alterations, additions or improvements (whether or not made with Landlord's consent) prior to the expiration of the Lease and to restore the Property to its prior condition, all at Tenant's expense. All alterations, additions and improvements which Landlord has not required Tenant to remove shall become Landlord's property and shall be surrendered to Landlord upon the expiration or earlier termination of the Lease, except that Tenant may remove any of Tenant's machinery or equipment which can be removed without material damage to the Property. Tenant shall repair, at Tenant's expense, any damage to the Property caused by the removal of any such machinery or equipment. In no event, however, shall Tenant remove any of the following materials or equipment (which shall be deemed Landlord's property) without Landlord's prior written consent: any power wiring or power panels; lighting or lighting fixtures; wall coverings; drapes, blinds or other window coverings; carpets or other floor coverings; heaters, air conditioners or any other heating or air conditioning equipment; fencing or security gates; or other similar building operating equipment and decorations. ARTICLE SEVEN: DAMAGE OR DESTRUCTION Section 7.01. Partial Damage to Property. (a) Tenant shall notify Landlord in writing immediately upon the occurrence of any damage to the Property. If the Property is only partially damaged (i.e., less than fifty percent (50%) of the Property is untenantable as a result of such damage or less than fifty percent (50%) of Tenant's operations are materially impaired) and if the proceeds received by Landlord from the insurance policies described in Paragraph, 4.04(b) are sufficient to pay for the necessary repairs, this Lease shall remain in effect and Landlord shall repair the damage within thirty (30) days. Landlord may elect (but is not required) to repair any damage to Tenant's fixtures, equipment, or improvements. 12 (b) If the insurance proceeds received by Landlord are not sufficient to pay the entire cost of repair, or if the cause of the damage is not covered by the insurance policies which Landlord maintains under Paragraph 4.04(b), Landlord may elect either to (i) repair the damage as soon as reasonably possible, in which case this Lease shall remain in full force and effect, or (ii) terminate this Lease as of the date the damage occurred. Landlord shall notify Tenant within thirty (30) days after receipt of notice of the occurrence of the damage whether Landlord elects to repair the damage or terminate the Lease. If Landlord elects to repair the damage, Tenant shall pay Landlord the "deductible amount" (if any) under Landlord's insurance policies. If Landlord elects to terminate the Lease, Tenant may elect to continue this Lease in full force and effect, in which case Tenant shall repair any damage to the Property and any building in which the Property is located. Tenant shall pay the cost of such repairs, except that upon satisfactory completion of such repairs, Landlord shall deliver to Tenant any insurance proceeds received by Landlord for the damage repaired by Tenant. Tenant shall give Landlord written notice of such election within ten (10) days after receiving Landlord's termination notice. (c) If the damage to the property occurs during the last six (6) months of the Lease Term and such damage will require more than thirty (30) days to repair, either Landlord or Tenant may elect to terminate this Lease as of the date the damage occurred, regardless of the sufficiency of any insurance proceeds. The party electing to terminate this Lease shall give written notification to the other party of such election within thirty (30) days after Tenant's notice to Landlord of the occurrence of the damage. Section 7.02. Substantial or Total Destruction. If the Property is substantially or totally destroyed by any cause whatsoever (i.e., the damage to the Property is greater than partial damage as described in Section 7.01), and regardless of whether Landlord receives any insurance proceeds, this Lease shall terminate as of the date the destruction occurred. Notwithstanding the preceding sentence, if the Property can be rebuilt within thirty (30) days after the date of destruction, Landlord may elect to rebuild the Property at Landlord's own expense, in which case this Lease shall remain in full force and effect. Landlord shall notify Tenant of such election within thirty (30) days after Tenant's notice of the occurrence of total or substantial destruction. If Landlord so elects, Landlord shall rebuild the Property at Landlord's sole expense, except that if the destruction was caused by an act or omission of Tenant, Tenant shall pay Landlord the difference between the actual cost of rebuilding and any insurance proceeds received by Landlord. Section 7.03. Temporary Reduction of Rent. If the Property is destroyed or damaged and Landlord or Tenant repairs or restores the Property pursuant to the provisions of this Article Seven, any rent payable during the period of such damage, repair and/or restoration shall be reduced according to the degree, if any, to which Tenant's use of the Property is impaired. However, the reduction shall not exceed the sum of one year's payment of Base Rent, insurance premiums and real property taxes. Except for such possible reduction in Base Rent, insurance premiums and real property taxes, Tenant shall not be entitled to any compensation, reduction, or reimbursement from Landlord as a result of any damage, destruction, repair, or restoration of or to the Property. 13 Section 7.04. Waiver. Tenant waives the protection of any statute, code or judicial decision which grants a tenant the right to terminate a lease in the event of the substantial or total destruction of the leased property. Tenant agrees that the provisions of Section 7.02 above shall govern the rights and obligations of Landlord and Tenant in the event of any substantial or total destruction to the Property. ARTICLE EIGHT: CONDEMNATION If all or any portion of the Property is taken under the power of eminent domain or sold under the threat of that power (all of which are called "Condemnation"), this Lease shall terminate as to the part taken or sold on the date the condemning authority takes title or possession, whichever occurs first. If more than twenty percent (20%) of the floor area of the building in which the Property is located, or which is located on the Property, is taken, either Landlord or Tenant may terminate this Lease as of the date the condemning authority takes title or possession, by delivering written notice to the other within ten (10) days after receipt of written notice of such taking (or in the absence of such notice, within ten (10) days after the condemning authority takes title or possession). If neither Landlord nor Tenant terminates this Lease, this Lease shall remain in effect as to the portion of the Property not taken, except that the Base Rent and Additional Rent shall be reduced in proportion to the reduction in the floor area of the Property. Any Condemnation award or payment shall be distributed in the following order: (a) first, to any ground lessor, mortgagee or beneficiary under a deed of trust encumbering the Property, the amount of its interest in the Property; (b) second, to Tenant, only the amount of any award specifically designated for loss of or damage to Tenant's trade fixtures or removable personal property; and (c) third, to Landlord, the remainder of such award, whether as compensation for reduction in the value of the leasehold, the taking of the fee, or otherwise. If this Lease is not terminated, Landlord shall repair any damage to the Property caused by the Condemnation, except that Landlord shall not be obligated to repair any damage for which Tenant has been reimbursed by the condemning authority. If the severance damages received by Landlord are not sufficient to pay for such repair, Landlord shall have the right to either terminate this Lease or make such repair at Landlord's expense. ARTICLE NINE: ASSIGNMENT AND SUBLETTING Section 9.01. Landlord's Consent Required. No portion of the Property or of Tenant's interest in this Lease may be acquired by any other person or entity, whether by sale, assignment, mortgage, sublease, transfer, operation of law, or act of Tenant, without Landlord's prior written consent, except as provided in Section 9.02 below. Landlord has the right to grant or withhold its consent as provided in Section 9.05 below. Any attempted transfer without consent shall be void and shall constitute a non-curable breach of this Lease. Section 9.0. Tenant Affiliate. Tenant may assign this Lease or sublease the Property, without Landlord's consent, to any corporation which controls, is controlled by or is under common control with Tenant, or to any corporation resulting from the merger of or 14 consolidation with Tenant ("Tenant's Affiliate"). In such case, any Tenant's Affiliate shall assume in writing all of Tenant's obligations under this Lease. Section 9.03. No Release of Tenant. No transfer permitted by this Article Nine, whether with or without Landlord's consent, shall release Tenant or change Tenant's primary liability to pay the rent and to perform all other obligations of Tenant under this Lease. Landlord's acceptance of rent from any other person is not a waiver of any provision of this Article Nine. Consent to one transfer is not a consent to any subsequent transfer. If Tenant's transferee defaults under this Lease, Landlord may proceed directly against Tenant without pursuing remedies against the transferee. Landlord may consent to subsequent assignments or modifications of this Lease by Tenant's transferee, without notifying Tenant or obtaining its consent. Such action shall not relieve Tenant's liability under this Lease. Section 9.04. Offer to Terminate. If Tenant desires to assign the Lease or sublease the Property, Tenant shall have the right to offer, in writing, to terminate the Lease as of a date specified in the offer. If Landlord elects in writing to accept the offer to terminate within twenty (20) days after notice of the offer, the Lease shall terminate as of the date specified and all the terms and provisions of the Lease governing termination shall apply. If Landlord does not so elect, the Lease shall continue in effect until otherwise terminated and the provisions of Section 9.05 with respect to any proposed transfer shall continue to apply. Section 9.05. Landlord's Consent. (a) Tenant's request for consent to any transfer described in Section 9.01 shall set forth in writing the details of the proposed transfer, including the name, business and financial condition of the prospective transferee, financial details of the proposed transfer (e.g., the term of and the rent and security deposit payable under any proposed assignment or sublease), and any other information Landlord deems relevant. Landlord shall have the right to withhold consent, if reasonable, or to grant consent, based on the following factors: (i) the business of the proposed assignee or subtenant and the proposed use of the Property; (ii) the net worth and financial reputation of the proposed assignee or subtenant; (iii) Tenant's compliance with all of its obligations under the Lease; and (iv) such other factors as Landlord may reasonably deem relevant. If Landlord objects to a proposed assignment solely because of the net worth and/or financial reputation of the proposed assignee, Tenant may nonetheless sublease (but not assign), all or a portion of the Property to the proposed transferee, but only on the other terms of the proposed transfer. (b) If Tenant assigns or subleases, the following shall apply: (i) Tenant shall pay to Landlord as Additional Rent under the Lease the Landlord's Share (stated in Section 1.13) of the Profit (defined below) on such transaction as and when received by Tenant, unless Landlord gives written notice to Tenant and the assignee or subtenant that Landlord's Share shall be paid by the assignee or subtenant to Landlord directly. The "Profit" means (A) all amounts paid to Tenant for such assignment or 15 sublease, including "key" money, monthly rent in excess of the monthly rent payable under the Lease, and all fees and other consideration paid for the assignment or sublease, including fees under any collateral agreements, less (B) costs and expenses directly incurred by Tenant in connection with the execution and performance of such assignment or sublease for real estate broker's commissions and costs of renovation or construction of tenant improvements required under such assignment or sublease. Tenant is entitled to recover such costs and expenses before Tenant is obligated to pay the Landlord's Share to Landlord. The Profit in the case of a sublease of less than all the Property is the rent allocable to the subleased space as a percentage on a square footage basis. (ii) Tenant shall provide Landlord a written statement certifying all amounts to be paid from any assignment or sublease of the Property within thirty (30) days after the transaction documentation is signed, and Landlord may inspect Tenant's books and records to verity the accuracy of such statement. On written request, Tenant shall promptly furnish to Landlord copies of all the transaction documentation, all of which shall be certified by Tenant to be complete, true and correct. Landlord's receipt of Landlord's Share shall not be a consent to any further assignment or subletting. The breach of Tenant's obligation under this Paragraph 9.05(b) shall be a material default of the Lease. Section 9.06. No Merger. No merger shall result from Tenant's sublease of the Property under this Article Nine, Tenant's surrender of this Lease or the termination of this Lease in any other manner. In any such event, Landlord may terminate any or all subtenancies or succeed to the interest of Tenant as sublandlord under any or all subtenancies. ARTICLE TEN: DEFAULTS; REMEDIES Section 10.01. Covenants and Conditions. Tenant's performance of each of Tenant's obligations under this Lease is a condition as well as a covenant. Tenant's right to continue in possession of the Property is conditioned upon such performance. Time is of the essence in the performance of all covenants and conditions. Section 10.02. Defaults. Tenant shall be in material default under this Lease: (a) If Tenant abandons the Property or if Tenant's vacation of the Property results in the cancellation of any insurance described in Section 4.04; (b) If Tenant fails to pay rent or any other charge when due, and such failure continues for ten business days following written notice from Landlord to Tenant thereof; (c) If Tenant fails to perform any of the Tenant's non-monetary obligations under this Lease for a period of thirty (30) days after written notice from Landlord; provided that if more than thirty (30) days are required to complete such performance, Tenant shall not be in default if Tenant commences such performance within the thirty (30)-day period and thereafter diligently 16 pursues its completion. However, Landlord shall not be required to give such notice if Tenant's failure to perform constitutes a non-curable breach of this Lease. The notice required by this Paragraph is intended to satisfy any and all notice requirements imposed by law on Landlord and is not in addition to any such requirement. (d) (i) If Tenant makes a general assignment or general arrangement for the benefit of creditors; (ii) if a petition for adjudication of bankruptcy or for reorganization or rearrangement is filed by or against Tenant and is not dismissed within thirty (30) days; (iii) if a trustee or receiver is appointed to take possession of substantially all of Tenant's assets located at the Property or of Tenant's interest in this Lease and possession is not restored to Tenant within thirty (30) days; or (iv) if substantially all of Tenant's assets located at the Property or of Tenant's interest in this Lease is subjected to attachment, execution or other judicial seizure which is not discharged within thirty (30) days. If a court of competent jurisdiction determines that any of the acts described in this subparagraph (d) is not a default under this Lease, and a trustee is appointed to take possession (or if Tenant remains a debtor in possession) and such trustee or Tenant transfers Tenant's interest hereunder, then Landlord shall receive, as Additional Rent, the excess, if any, of the rent (or any other consideration) paid in connection with such assignment or sublease over the rent payable by Tenant under this Lease. (e) If any guarantor of the Lease revokes or otherwise terminates, or purports to revoke or otherwise terminate, any guaranty of all or any portion of Tenant's obligations under the Lease. Unless otherwise expressly provided, no guaranty of the Lease is revocable. Section 10.03. Remedies. On the occurrence of any material default by Tenant, Landlord may, at any time thereafter, with or without notice or demand and without limiting Landlord in the exercise of any right or remedy which Landlord may have: (a) Terminate Tenant's right to possession of the Property by any lawful means, in which case this Lease shall terminate and Tenant shall immediately surrender possession of the Property to Landlord. In such event, Landlord shall be entitled to recover from Tenant all damages incurred by Landlord by reason of Tenant's default, including (i) the worth at the time of the award of the unpaid Base Rent, Additional Rent and other charges which Landlord had earned at the time of the termination; (ii) the worth at the time of the award of the amount by which the unpaid Base Rent, Additional Rent and other charges which Landlord would have earned after termination until the time of the award exceeds the amount of such rental loss that Tenant proves Landlord could have reasonably avoided; (iii) the worth at the time of the award of the amount by which the unpaid Base Rent, Additional Rent and other charges which Tenant would have paid for the balance of the Lease Term after the time of award exceeds the amount of such rental loss that Tenant proves Landlord could have reasonably avoided; and (iv) any other amount necessary to compensate Landlord for all the detriment proximately caused by Tenant's failure to perform its obligations under the Lease or which in the ordinary course of things would be likely to result therefrom, including, but not limited to, any cost or expenses Landlord incurs in maintaining or preserving the Property after such default, the cost of recovering possession of the Property, expenses of reletting, including necessary renovation or 17 alteration of the Property, Landlord's reasonable attorneys' fees incurred in connection therewith, and any real estate commission paid or payable. As used in subparts (i) and (ii) above, the "worth at the time of the award" is computed by allowing interest on unpaid amounts at the rate of fifteen percent (15%) per annum, or such lesser amount as may then be the maximum lawful rate. As used in subpart (iii) above, the "worth at the time of the award" is computed by discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of the award, plus one percent (1%). If Tenant has abandoned the Property, Landlord shall have the option of (i) retaking possession of the Property and recovering from Tenant the amount specified in this Paragraph 10.03(a), or (ii) proceeding under Paragraph 10.03(b); (b) Deleted. (c) Pursue any other remedy now or hereafter available to Landlord under the laws or judicial decisions of the state in which the Property is located. Section 10.04. Repayment of "Free" Rent. If this Lease provides for a postponement of any monthly rental payments, a period of "free" rent or other rent concession, such postponed rent or "free" rent is called the "Abated Rent". Tenant shall be credited with having paid all of the Abated Rent on the expiration of the Lease Term only if Tenant has fully, faithfully, and punctually performed all of Tenant's obligations hereunder, including the payment of all rent (other than the Abated Rent) and all other monetary obligations and the surrender of the Property in the physical condition required by this Lease. Tenant acknowledges that its right to receive credit for the Abated Rent is absolutely conditioned upon Tenant's full, faithful and punctual performance of its obligations under this Lease. If Tenant defaults and does not cure within any applicable grace period, the Abated Rent shall immediately become due and payable in full and this Lease shall be enforced as if there were no such rent abatement or other rent concession. In such case Abated Rent shall be calculated based on the full initial rent payable under this Lease. Section 10.05. Automatic Termination. Notwithstanding any other term or provision hereof to the contrary, the Lease shall terminate on the occurrence of any act which affirms the Landlord's intention to terminate the Lease as provided in Section 10.03 hereof, including the filing of an unlawful detainer action against Tenant. On such termination, Landlord's damages for default shall include all costs and fees, including reasonable attorneys' fees that Landlord incurs in connection with the filing, commencement, pursuing and/or defending of any action in any bankruptcy court or other court with respect to the Lease; the obtaining of relief from any stay in bankruptcy restraining any action to evict Tenant; or the pursuing of any action with respect to Landlord's right to possession of the Property. All such damages suffered (apart from Base Rent and other rent payable hereunder) shall constitute pecuniary damages which must be reimbursed to Landlord prior to assumption of the Lease by Tenant or any successor to Tenant in any bankruptcy or other proceeding. 18 Section 10.06. Cumulative Remedies. Landlord's exercise of any right or remedy shall not prevent it from exercising any other right or remedy. ARTICLE ELEVEN: PROTECTION OF LENDERS Section 11.01. Subordination. Landlord shall have the right to subordinate this Lease to any ground lease, deed of trust or mortgage encumbering the Property, any advances made on the security thereof and any renewals, modifications, consolidations, replacements or extensions thereof, whenever made or recorded. Tenant shall cooperate with Landlord and any lender which is acquiring a security interest in the Property or the Lease. Tenant shall execute such further documents and assurances as such lender may require, provided that Tenant's obligations under this Lease shall not be increased in any material way (the performance of ministerial acts shall not be deemed material), and Tenant shall not be deprived of its rights under this Lease. Tenant's right to quiet possession of the Property during the Lease Term shall not be disturbed if Tenant pays the rent and performs all of Tenant's obligations under this Lease and is not otherwise in default. If any ground lessor, beneficiary or mortgagee elects to have this Lease prior to the lien of its ground lease, deed of trust or mortgage and gives written notice thereof to Tenant, this Lease shall be deemed prior to such ground lease, deed of trust or mortgage whether this Lease is dated prior or subsequent to the date of said ground lease, deed of trust or mortgage or the date of recording thereof. Section 11.02. Attornment. If Landlord's interest in the Property is acquired by any ground lessor, beneficiary under a deed of trust, mortgagee, or purchaser at a foreclosure sale, Tenant shall attorn to the transferee of or successor to Landlord's interest in the Property and recognize such transferee or successor as Landlord under this Lease. Tenant waives the protection of any statute or rule of law which gives or purports to give Tenant any right to terminate this Lease or surrender possession of the Property upon the transfer of Landlord's interest. Section 11.03. Signing of Documents. Tenant shall sign and deliver any instrument or documents necessary or appropriate to evidence any such attornment or subordination or agreement to do so. If Tenant fails to do so within ten (10) days after written request, Tenant hereby makes, constitutes and irrevocably appoints Landlord, or any transferee or successor of Landlord, the attorney-in-fact of Tenant to execute and deliver any such instrument or document. Section 11.04. Estoppel Certificates. (a) Upon Landlord's written request, Tenant shall execute, acknowledge and deliver to Landlord a written statement certifying: (i) that none of the terms or provisions of this Lease have been changed (or if they have been changed, stating how they have been changed); (ii) that this Lease has not been cancelled or terminated; (iii) the last date of payment of the Base Rent and other charges and the time period covered by such payment; (iv) that Landlord is not in default under this Lease (or, if Landlord is claimed to be in default, stating why); and (v) such other representations or information with respect to Tenant or the Lease as Landlord may 19 reasonably request or which any prospective purchaser or encumbrancer of the Property may require. Tenant shall deliver such statement to Landlord within ten (10) days after Landlord's request. Landlord may give any such statement by Tenant to any prospective purchaser or encumbrancer of the Property. Such purchaser or encumbrancer may rely conclusively upon such statement as true and correct. (b) If Tenant does not deliver such statement to Landlord within such ten (10)-day period, Landlord, and any prospective purchaser or encumbrancer, may conclusively presume and rely upon the following facts: that the terms and provisions of this Lease have not been changed except as otherwise represented by Landlord; (ii) that this Lease has not been cancelled or terminated except as otherwise represented by Landlord; (iii) that not more than one month's Base Rent or other charges have been paid in advance; and (iv) that Landlord is not in default under the Lease. In such event, Tenant shall be estopped from denying the truth of such facts. Section 11.05. Tenant's Financial Condition. Within ten (10) days after written request from Landlord, Tenant shall deliver to Landlord such financial statements as Landlord reasonably requires to verify the net worth of Tenant or any assignee, subtenant, or guarantor of Tenant. In addition, Tenant shall deliver to any lender designated by Landlord any financial statements required by such lender to facilitate the financing or refinancing of the Property. Tenant represents and warrants to Landlord that each such financial statement is a true and accurate statement as of the date of such statement. All financial statements shall be confidential and shall be used only for the purposes set forth in this Lease. ARTICLE TWELVE: LEGAL COSTS Section 12.01. Legal Proceedings. If Tenant or Landlord shall be in breach or default under this Lease, such party (the "Defaulting Party") shall reimburse the other party (the "Nondefaulting Party") upon demand for any costs or expenses that the Nondefaulting Party incurs in connection with any breach or default of the Defaulting Party under this Lease, whether or not suit is commenced or judgment entered. Such costs shall include legal fees and costs incurred for the negotiation of a settlement, enforcement of rights or otherwise. Furthermore, if any action for breach of or to enforce the provisions of this Lease is commenced, the court in such action shall award to the party in whose favor a judgment is entered, a reasonable sum as attorneys' fees and costs. The losing party in such action shall pay such attorneys' fees and costs. Tenant shall also indemnify Landlord against and hold Landlord harmless from all costs, expenses, demands and liability Landlord may incur if Landlord becomes or is made a party to any claim or action (a) instituted by Tenant against any third party, or by any third party against Tenant, or by or against any person holding any interest under or using the Property by license of or agreement with Tenant; (b) for foreclosure of any lien for labor or material furnished to or for Tenant or such other person; (c) otherwise arising out of or resulting from any act or transaction of Tenant or such other person; or (d) necessary to protect Landlord's interest under this Lease in a bankruptcy proceeding, or other proceeding under Title 11 of the United States Code, as amended. Tenant shall defend Landlord against any such claim or action at Tenant's 20 expense with counsel reasonably acceptable to Landlord or, at Landlord's election, Tenant shall reimburse Landlord for any legal fees or costs Landlord incurs in any such claim or action. Section 12.02. Landlord's Consent. Tenant shall pay Landlord's reasonable attorneys' fees incurred in connection with Tenant's request for Landlord's consent under Article Nine (Assignment and Subletting), or in connection with any other act which Tenant proposes to do and which requires Landlord's consent. ARTICLE THIRTEEN: MISCELLANEOUS PROVISIONS Section 13.01. Non-Discrimination. Tenant promises, and it is a condition to the continuance of this Lease, that there will be no discrimination against, or segregation of, any person or group of persons on the basis of race, color, sex, creed, national origin or ancestry in the leasing, subleasing, transferring, occupancy, tenure or use of the Property or any portion thereof. Section 13.02. Landlord's Liability; Certain Duties. (a) As used in this Lease, the term "Landlord" means only the current owner or owners of the fee title to the Property or the leasehold estate under a ground lease of the Property at the time in question. Each Landlord is obligated to perform the obligations of Landlord under this Lease only during the time such Landlord owns such interest or title. Any Landlord who transfers its title or interest is relieved of all liability with respect to the obligations of Landlord under this Lease to be performed on or after the date of transfer. However, each Landlord shall deliver to its transferee all funds that Tenant previously paid if such funds have not yet been applied under the terms of this Lease. (b) Tenant shall give written notice of any failure by Landlord to perform any of its obligations under this Lease to Landlord and to any ground lessor, mortgagee or beneficiary under any deed of trust encumbering the Property whose name and address have been furnished to Tenant in writing. Landlord shall not be in default under this Lease unless Landlord (or such ground lessor, mortgagee or beneficiary) fails to cure such non-performance within thirty (30) days after receipt of Tenant's notice. However, if such non-performance reasonably requires more than thirty (30) days to cure, Landlord shall not be in default if such cure is commenced within such thirty (30)-day period and thereafter diligently pursued to completion. (c) Notwithstanding any term or provision herein to the contrary, the liability of Landlord for the performance of its duties and obligations under this Lease is limited to Landlord's interest in the Property, and neither the Landlord nor its partners, shareholders, officers or other principals shall have any personal liability under this Lease. Section 13.03. Severability. A determination by a court of competent jurisdiction that any provision of this Lease or any part thereof is illegal or unenforceable shall not cancel or 21 invalidate the remainder of such provision or this Lease, which shall remain in full force and effect. Section 13.04. Interpretation. The captions of the Articles or Sections of this Lease are to assist the parties in reading this Lease and are not a part of the terms or provisions of this Lease. Whenever required by the context of this Lease, the singular shall include the plural and the plural shall include the singular. The masculine, feminine and neuter genders shall each include the other. In any provision relating to the conduct, acts or omissions of Tenant, the term "Tenant" shall include Tenant's agents, employees, contractors, invitees, successors or others using the Property with Tenant's express or implied permission. Section 13.05. Incorporation of Prior Agreements; Modifications. This Lease is the only agreement between the parties pertaining to the lease of the Property and no other agreements are effective. All amendments to this Lease shall be in writing and signed by all parties. Any other attempted amendment shall be void. Section 13.06. Notice. All notices required or permitted under this Lease shall be in writing and shall be personally delivered or sent by certified mail, return receipt requested, postage prepaid. Notices to Tenant shall be delivered to the address specified in Section 1.03 above, except that upon Tenant's taking possession of the Property, the Property shall be Tenant's address for notice purposes. Notices to Landlord shall be delivered to the address specified in Section 1.02 above. All notices shall be effective upon delivery. Either party may change its notice address upon written notice to the other party. Section 13.07. Waivers. All waivers must be in writing and signed by the waiving party. Landlord's failure to enforce any provision of this Lease or its acceptance of rent shall not be a waiver and shall not prevent Landlord from enforcing that provision or any other provision of this Lease in the future. Section 13.08. No Recordation. Tenant shall not record this Lease without prior written consent from Landlord. However, either Landlord or Tenant may require that a "Short Form" memorandum of this Lease executed by both parties be recorded. The party requiring such recording shall pay all transfer taxes and recording fees. Section 13.09. Binding Effect; Choice of Law. This Lease binds any party who legally acquires any rights or interest in this Lease from Landlord or Tenant. However, Landlord shall have no obligation to Tenant's successor unless the rights or interests of Tenant's successor are acquired in accordance with the terms of this Lease. The laws of the state in which the Property is located shall govern this Lease. Section 13.10. Corporate Authority; Partnership Authority. If Tenant is a corporation, each person signing this Lease on behalf of Tenant represents and warrants that he has full authority to do so and that this Lease binds the corporation. Within thirty (30) days after this Lease is signed, Tenant shall deliver to Landlord a certified copy of a resolution of Tenant's 22 Board of Directors authorizing the execution of this Lease or other evidence of such authority reasonably acceptable to Landlord. If Tenant is a partnership, each person or entity signing this Lease for Tenant represents and warrants that he or it is a general partner of the partnership, that he or it has full authority to sign for the partnership and that this Lease binds the partnership and all general partners of the partnership. Tenant shall give written notice to Landlord of any general partner's withdrawal or addition. Within thirty (30) days after this Lease is signed, Tenant shall deliver to Landlord a copy of Tenant's recorded statement of partnership or certificate of limited partnership. Section 13.11. Joint and Several Liability. All parties signing this Lease as Tenant shall be jointly and severally liable for all obligations of Tenant. Section 13.12. Force Majeure. If Landlord cannot perform any of its obligations due to events beyond Landlord's control, the time provided for performing such obligations shall be extended by a period of time equal to the duration of such events. Events beyond Landlord's control include, but are not limited to, acts of God, war, civil commotion, labor disputes, strikes, fire, flood or other casualty, shortages of labor or material, government regulation or restriction and weather conditions. Section 13.13. Execution of Lease. This Lease may be executed in counterparts and, when all counterpart documents are executed, the counterparts shall constitute a single binding instrument. Landlord's delivery of this Lease to Tenant shall not be deemed to be an offer to lease and shall not be binding upon either party until executed and delivered by both parties. Section 13.14. Survival. All representations and warranties of Landlord and Tenant shall survive the termination of this Lease. ARTICLE FOURTEEN: BROKERS Section 14.01. Deleted. Section 14.02. Deleted. Section 14.03. Agency Disclosure; No Other Brokers. Landlord and Tenant each warrant that they have dealt with no other real estate broker(s) in connection with this transaction except: CB Commercial Real Estate Group, Inc., who represents ____________________________________________________ and ____________________________________________________________________________ who represents _________________________________________________________________ _______________________________________________________________________________. 23 ARTICLE FIFTEEN: COMPLIANCE The parties hereto agree to comply with all applicable federal, state and local laws, regulations, codes, ordinances and administrative orders having jurisdiction over the parties, property or the subject matter of this Agreement, including, but not limited to, the 1964 Civil Rights Act and all amendments thereto, the Foreign Investment In Real Property Tax Act, the Comprehensive Environmental Response Compensation and Liability act, and The Americans With Disabilities Act. ADDITIONAL PROVISIONS MAY BE SET FORTH IN A RIDER OR RIDERS ATTACHED HERETO OR IN THE BLANK SPACE BELOW. IF NO ADDITIONAL PROVISIONS ARE INSERTED, PLEASE DRAW A LINE THROUGH THE SPACE BELOW. Landlord and Tenant have signed this Lease at the place and on the dates specified adjacent to their signatures below and have initialled all Riders which are attached to or incorporated by reference in this Lease. "LANDLORD" Signed on _____________________, 19____ Palo Cristi Airpark III, L.L.C. at___________________________________ By: /s/ Scott P. LeMarr, President ------------------------------- Its: Palo Cristi Investments, Inc. Managing Member "TENANT" Signed on _____________________, 19____ Premium Cigars International, Ltd. at___________________________________ By: /s/ John Greenwell ------------------------------- Its: President and COO IN ANY REAL ESTATE TRANSACTION, IT IS RECOMMENDED THAT YOU CONSULT WITH A PROFESSIONAL, SUCH AS A CIVIL ENGINEER, INDUSTRIAL HYGIENIST OR OTHER PERSON WITH EXPERIENCE IN EVALUATING THE CONDITION OF THE PROPERTY, INCLUDING THE POSSIBLE PRESENCE OF ASBESTOS, HAZARDOUS MATERIALS AND UNDERGROUND STORAGE TANKS. 24 THIS PRINTED FORM LEASE HAS BEEN DRAFTED BY LEGAL COUNSEL AT THE DIRECTION OF THE SOUTHERN CALIFORNIA CHAPTER OF THE SOCIETY OF INDUSTRIAL AND OFFICE REALTORS, INC. NO REPRESENTATION ON RECOMMENDATION IS MADE BY THE SOUTHERN CALIFORNIA CHAPTER OF THE SOCIETY OF INDUSTRIAL AND OFFICE REALTORS, INC., ITS LEGAL COUNSEL, THE REAL ESTATE BROKERS NAMED HEREIN, OR THEIR EMPLOYEES OR AGENTS, AS TO THE LEGAL SUFFICIENCY, LEGAL EFFECT OR TAX CONSEQUENCES OF THIS LEASE OR OF THIS TRANSACTION. LANDLORD AND TENANT SHOULD RETAIN LEGAL COUNSEL TO ADVISE THEM ON SUCH MATTERS AND SHOULD RELY UPON THE ADVICE OF SUCH LEGAL COUNSEL. 25 EX-10.7 8 FIRST AMENDMENT TO INDUSTRIAL REAL ESTATE LEASE EXHIBIT 10.7 FIRST AMENDMENT TO INDUSTRIAL REAL ESTATE LEASE PARTIES: PALO CRISTI AIRPARK III, L.L.C., (LANDLORD) PREMIUM CIGARS INTERNATIONAL, LTD. (TENANT) DATE: February 26, 1998 The parties have heretofore entered into a real estate lease agreement entitled Industrial Real Estate Lease (Single Tenant Net Form) dated February 25, 1998 for Landlord's Project located at 15849 N. 77th Street, Scottsdale, Arizona ("Lease"). THE PARTIES HEREBY AGREE AS FOLLOWS: In the event the provisions of this First Amendment conflict with the Lease, the provisions of this First Amendment shall prevail. All other terms and conditions of the Lease to remain the same, and except as expressly amended hereby, the provisions of the Lease are hereby reaffirmed. 1. COMMENCEMENT DATE: Landlord will make every reasonable effort to complete the Property substantially in accordance with Exhibit B in order for Tenant to take early occupancy by April 15, 1998. In the event the Property is not complete to the extent that Tenant can move in and conduct its business, and Tenant is not responsible for the delay, Landlord will grant Tenant one (1) day free Base Rent for each day of delay beyond April 15, 1998. 2. PENALTY: In addition to the free Base Rent outlined above in Section 1.05(a), Landlord agrees to pay Tenant a penalty of $500.00 per day in the event Tenant is not able to occupy the Property by May 5, 1998. Said penalty is for each and every date after May 5, 1998 until such time that Project Architect issues a Certificate of Substantial Completion. It is expressly understood by Landlord and Tenant that events beyond the control of Landlord or acts of God could delay the Occupancy Date. In the event that unavoidable delays occur beyond the control of Landlord, the aforementioned penalty will be extended accordingly. Landlord and Tenant further agree that work between Tenant and other parties are not a party of the Lease, normal punchlist items and exterior covered carport erection are expressly excluded from this penalty clause. 3. INSURANCE. Pursuant to Section 3.03(b) Tenant shall have the right to approve insurance coverage obtained by Landlord prior to issuance of the insurance policy. Said approval to be granted within three (3) business days from time of presentation for review by Landlord's insurance representative and such approval shall not be unreasonably withheld. In the event Tenant rejects Landlords selected insurance carrier and coverage, the Tenant shall be required to provide comparable coverage on the Property and liability risk naming Landlord as co-insured simultaneously with disapproving Landlord's selected insurance package. 4. LATE CHARGES AND INTEREST ON PAST DUE OBLIGATIONS. Landlord agrees to waive provisions for late charges in Section 4.05 of the Lease and increase the interest on past due obligations specified in Section 4.06 to twenty percent (20%) per annum. 5. LANDLORD'S OBLIGATIONS TO REPAIR. In the event that it becomes Landlord's responsibility under Section 6.03 to perform repairs of the Property, such action will be commenced within 5 business days after notice in writing by Tenant of such event. Every effort will be made to expedite all repairs or alterations and Landlord will assist Tenant in protecting Tenant's inventory wherever possible. Landlord and Tenant further agree that all roof warranties and HVAC warranties will also list Tenant as beneficiary and that Tenant agrees to provide quarterly preventative mechanical service and maintenance while Landlord assumes the responsibility for roof maintenance. In the event Landlord does not respond to Tenant's written notice of repair obligation within 5 business days, Tenant may, at its option, make such repairs and bill Landlord for reasonable reimbursement. 6. SUBSTANTIAL OR TOTAL DESTRUCTION. Pursuant to Section 7.02, Landlord and Tenant agree that if the damaged Property cannot be substantially rebuilt within 60 days, Tenant may elect to cancel its Lease obligations excluding any remedies Landlord may have against Tenant for any previously existing Default. 7. RIGHT OF FIRST REFUSAL. At any time during the term of this Lease, Landlord shall have the right to sell the leased premises to any third party, provided, however, that Tenant shall have the right of first refusal during the term of the Lease to meet any bona fide offer to purchase on the same terms and conditions of such offer. Tenant's right of first refusal may be exercised only if Tenant is not in default in the performance of any of the covenants, conditions and agreement required to be performed by Tenant under this Lease subject to all applicable cure periods. Upon receipt of a bona fide offer to purchase the premises which Landlord desires to accept, Landlord shall give written notice thereof to Tenant, which shall include the name of the third party offeror and the terms and conditions of its offer to purchase, and Tenant shall have fifteen (15) days after receipt of such notice to meet the terms of the offer. In the event Tenant fails to enter into an agreement to match the third party offer within such fifteen (15) day period, Landlord shall be free to sell the leased premises to the third party in accordance with the terms and conditions of its offer and Tenant's right of first refusal shall terminate and be of no further force or effect. If the Landlord substantially revises the price or payments terms of such bona fide offer to purchase, Tenant shall have a right of first refusal as to such revised terms. If Tenant fails to exercise its right of first refusal and the premises are sold to the third party, the third party shall acquire the premises subject to the Lease, without Tenant's right of first refusal, which shall continue until the expiration or termination hereof in accordance with its term. In the event tenant exercises its right of first refusal and purchases the premises, the Lease shall terminate at the closing and Tenant shall be credited any refunds prepaid in advance. 2 8. RIGHT OF CANCELLATION. Landlord and Tenant acknowledge that each has a significant invested interest in occupying the Project by April 15, 1998 and free Base Rent penalty clauses have already been included elsewhere in this Agreement. In the event that Landlord cannot obtain a Certificate of Substantial Completion from the Project Architect by June 1, 1998, Tenant is not responsible for the delay and no avoidable delays beyond the control of the Landlord have extended the time allowed for completion of the Tenant improvement outlined on Exhibit B and Exhibit C, Tenant may, at its sole discretion, notify landlord in writing of its intent to cancel the Lease. From the date of the written notice, Landlord shall have ten (10) business days to complete said improvements before cancellation. Tenant agrees to waive its Security Deposit and hold Landlord harmless for any other claims. IN WITNESS WHEREOF, the parties have executed this First Amendment as of this 26th day of February 1998. "LANDLORD" "TENANT" Palo Cristi Airpark II, L.L.C., Premium Cigars International, LTD., an Arizona limited liability company an Arizona corporation By: /s/ Scott P. LeMarr By: /s/ John Greenwell ------------------------------- -------------------------------- Scott P. LeMarr John Greenwell, President and CEO President of Palo Cristi Investments, Inc. Managing Member 3 EX-10.8 9 SETTLEMENT AGREEMENT EXHIBIT 10.8 AGREEMENT --------- THIS AGREEMENT (the "Agreement") is made and entered into by and between Premium Cigars International, Ltd., an Arizona corporation ("PCI") and Colin A. Jones ("Jones"). PCI and Jones are collectively referred to herein as the "Parties." R E C I T A L S: ---------------- A. Jones entered an Employment Agreement with PCI dated June 13, 1997 (the "Employment Agreement"). B. PCI terminated Jones' employment on January 16, 1998. C. Jones is the maker under a Promissory Note dated December 31, 1996 in favor of PCI (the "Note"). D. PCI and Jones have certain disputes regarding Jones' severance compensation and other sums payable to Jones after his termination. E. Without any admission of liability by either Party, the Parties desire to avoid and resolve any further dispute or litigation regarding any compensation or payments to Jones from the Company. F. It is of utmost importance to PCI that Jones not compete with PCI after his termination and PCI wishes to extend the current covenant not-to-compete in Jones' Employment Agreement. FOR GOOD AND VALUABLE CONSIDERATION, the receipt and sufficiency of which is hereby acknowledged, the Parties agree as follows: 1. Settlement Contingent Upon PCI's Simultaneous Settlement with Steve and Greg Lambrecht. This settlement is contingent upon PCI's entering into separate settlement agreements with both Steven A. Lambrecht and Greg P. Lambrecht regarding certain compensation and other payments that they are claiming. If PCI has not entered into such settlement agreements with Steven A. Lambrecht and Greg P. Lambrecht on or before 5:00 p.m. on March 3, 1998, then this Agreement shall be null and void and of no force and effect whatsoever against PCI or Jones. 2. Payment. Provided that the contingency in Paragraph 1 is met, PCI shall pay Jones, within ten (10) business days after the execution of this Agreement, the sum of Forty Thousand Dollars ($40,000.00) (the "Payment"). The Payment is an amount which was negotiated by the Parties in exchange for the release of claims set forth in paragraph 8 herein and in exchange for the extension of the covenant not-to-compete in the Employment Agreement. 3. Severance Compensation. Jones acknowledges that he has already been paid for all amounts owing at his termination, including payment for all vacation and other benefits. He further acknowledges that he has been paid $6,461.54 in severance compensation since his termination and that the sole remaining amount of severance compensation to be paid is $56,538.46, which PCI shall pay bi-weekly over a period of 35 weeks. PCI shall also pay Jones $73.85 per bi-weekly period until the nine (9) months following his termination is completed, as a cash payment in lieu of the health insurance premium PCI was paying for Jones at the time of his termination. Jones will be responsible to obtain his own health insurance. Jones acknowledges that, except for the severance compensation described in this Paragraph and the Payment and any applicable ongoing compensation as a director, he has been paid for all services rendered to PCI as an employee and has no right to any additional employment compensation or employment benefits of any kind from PCI. Jones acknowledges that the payment of severance compensation remains subject to the conditions of the Employment Agreement, including, without limitation, the conditions of Paragraph 7 of the Employment Agreement as that Section relates to paragraphs 8, 9 & 10 of the Employment Agreement. 4. Withholding. PCI shall make no deduction or withholding from the Payment in Paragraph 2 in reliance upon Jones affirmative representation that he will be solely responsible for any and all taxes and other amounts owed on such payments. PCI will be required to withhold all taxes and other normal withholdings from the severance compensation amounts described in Paragraph 3. 5. Employment Agreement. a. Compensation. Except for the Payment and severance compensation as described in paragraphs 2 and 3 herein, Jones hereby waives any and all rights to any monetary or other compensation under the Employment Agreement, including without limitation, any compensation pursuant to paragraph 3 of the Employment Agreement or any severance compensation pursuant to paragraph 7 of the Employment Agreement. Jones expressly acknowledges that he has been paid in full for all services rendered to PCI prior to the date of this Agreement including without limitation wages and vacation pay through the date of termination. b. No Options or Bonus. Jones expressly waives any right to any options or bonuses which have been or may in the future be offered to any employee of PCI. c. Continuing Obligations; Extension of Covenant Not To Compete. Notwithstanding anything contained within this Agreement to the contrary, Jones expressly acknowledges that his obligations pursuant to Paragraphs 8, 9, 10 and 13 of the Employment Agreement relating to Customer Records, Confidential Information and the Covenant Not To Compete and PCI's remedies under the Employment Agreement for Jones' violations of said provisions and Miscellaneous Provisions provided therein 2 shall continue and remain in full force and effect for the term set forth in the Employment Agreement. However, in exchange for the Payment, the term of the Covenant Not To Compete as set forth in paragraph 10(b) of the Employment Agreement shall be extended for an additional six (6) months for a total of 18 months from the date of Jones' termination from PCI. 6. Status as a Director. This Agreement shall not affect Jones' status as a director of PCI, and Jones shall be entitled to the compensation paid to, or options granted to, outside directors and Jones shall be treated as an outside director effective upon the date of termination of his employment with PCI. 7. Note; No Defense Related to This Settlement. The Parties agree that this Agreement shall have no effect upon the principal amount or interest due under, or due date of, the Note and Jones expressly acknowledges that the Note, and his obligations thereunder, remain in full force and effect. Jones agrees that he shall not, directly or indirectly, raise this Agreement, or any of the terms of this Agreement, or the claims settled hereby, as a defense or offset to his obligations and liability under the Note. 8. Release of Claims. Except for the obligations created by and the rights expressly reserved within this Agreement, Jones does hereby and forever discharge PCI and each of its stockholders, predecessors, successors, assigns, agents, directors, officers, employees, representatives, consultants, affiliates, lawyers, and all persons acting by, through, under, or in concert with them, or any of them, of and from any and all manners of action or actions, cause or causes of action, in law or in equity, suits, liabilities, claims, demands, damages, losses, costs or expenses, of any nature whatsoever, (hereinafter collectively "claims") arising out of or relating to the Employment Agreement or Jones' employment with PCI. As stated more particularly in Paragraph 9 herein, both Parties expressly reserve the right to bring an action to enforce this Agreement and the obligations and rights expressly reserved herein. It is the Parties intention that the foregoing release shall be effective as a full and final accord and satisfaction, and as a bar to all claims against PCI as set forth above, except for an action to enforce this Agreement or any rights expressly reserved within this Agreement. 9. Further Actions. The Parties may plead this Agreement as a full and complete defense to, and as the basis for an injunction against, any action, suit or other proceeding which either Party hereto may institute, prosecute or attempt in breach of this Agreement. 10. Costs. The Parties will bear their own costs, expenses and attorneys' fees, whether taxable or otherwise, incurred in or arising out of or connected with the negotiation of this Agreement and the disputes settled herein. 11. Construction of this Agreement. This Agreement has been freely entered into by the Parties, each of whom has been represented by separate counsel. The validity, effect and performance of this Agreement shall be governed and construed by the laws of the State of Arizona. This Agreement shall be construed liberally to effect its purpose, and the Parties waive 3 any rule requiring strict construction against or in favor of either Party. The Agreement shall be construed as if drafted by the Parties jointly. 12. Integration Clause. This Agreement embodies the full and complete understanding and agreement between the Parties with respect to the matters addressed herein. This paragraph may be waived or modified only in a writing signed by the party to be charged. 13. Severability. If any term of this Agreement shall be found invalid, void or unenforceable, that term shall be severed from this Agreement and the remaining terms enforced as specified herein. 14. Prevailing Party. In any action arising out of this Agreement, the prevailing party or parties shall be entitled to an award of reasonable attorneys' fees and costs incurred in such action, which award shall be made by the Court, and shall be in addition to any other relief to which such party or parties are entitled. The Parties expressly consent to the jurisdiction and venue of Maricopa County, Arizona Superior Court for the resolution of any future disputes. 15. Binding Effect. This Agreement shall be binding upon, and shall inure to the benefit of, the Parties, their officers, directors, representatives, agents, employees, attorneys, heirs, personal representatives, successors and assigns. 16. No Admission of Liability. The Parties agree that this final compromise and settlement is not and shall not be used as an admission of liability or responsibility. 17. Counterparts. This Agreement may be executed in counterparts which together shall constitute one and the same instrument. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of this ____ day of March, 1998. PREMIUM CIGARS INTERNATIONAL, LTD. By /s/ John E. Greenwell /s/ Colin A. Jones -------------------------------------- ----------------------------------- John E. Greenwell, President Colin A. Jones and Chief Executive Officer 4 EX-10.9 10 SETTLEMENT AGREEMENT EXHIBIT 10.9 AGREEMENT --------- THIS AGREEMENT (the "Agreement") is made and entered into by and between Premium Cigars International, Ltd., an Arizona corporation ("PCI") and Greg P. Lambrecht ("Lambrecht"). PCI and Lambrecht are collectively referred to herein as the "Parties." R E C I T A L S: ---------------- A. Lambrecht entered an Employment Agreement with PCI dated June 13, 1997 (the "Employment Agreement"). B. PCI terminated Lambrecht's employment on March 2, 1998. C. Lambrecht is the maker under a Promissory Note dated December 31, 1996 in favor of PCI (the "Note"). D. PCI and Lambrecht have certain disputes regarding Lambrecht's severance compensation and other sums payable to Lambrecht. E. Without any admission of liability by either Party, the Parties desire to avoid and resolve any further dispute or litigation regarding any severance compensation or payments to Lambrecht from the Company. F. It is of utmost importance to PCI that Lambrecht not compete with PCI in the future and PCI wishes to extend the current covenant not-to-compete in Lambrecht's Employment Agreement. FOR GOOD AND VALUABLE CONSIDERATION, the receipt and sufficiency of which is hereby acknowledged, the Parties agree as follows: 1. Settlement Contingent Upon PCI's Simultaneous Settlement with Steve Lambrecht and Colin Jones. This settlement is contingent upon PCI's entering into separate settlement agreements with both Steven A. Lambrecht and Colin A. Jones regarding certain compensation and other payments that they are claiming. If PCI has not entered into such settlement agreements with Steven A. Lambrecht and Colin A. Jones on or before 5:00 p.m. on March 3, 1998, then this Agreement shall be null and void and of no force and effect whatsoever against PCI or Lambrecht. 2. Payment. Provided that the contingency in Paragraph 1 is met, PCI shall pay Lambrecht, within ten (10) business days after the execution of this Agreement, the sum of Forty Thousand Dollars ($40,000.00) (the "Payment"). The Payment is an amount which was 1 negotiated by the Parties in exchange for the release of claims set forth in paragraph 8 herein and in exchange for the extension of the covenant not-to-compete in the Employment Agreement. 3. Severance Compensation. Lambrecht acknowledges that the sole remaining amount of severance compensation to be paid is $63,000, which PCI shall pay bi-weekly over a period of 39 weeks. PCI shall also pay Lambrecht $73.85 per bi-weekly period until the nine (9) months following his termination is completed, as a cash payment in lieu of the health insurance premium for Lambrecht at the time of his termination. Lambrecht will be responsible to obtain his own health insurance. Lambrecht acknowledges that, except for the severance compensation described in this Paragraph and the Payment and any applicable ongoing compensation as a director, he has been paid for all services rendered to PCI as an employee and has no right to any additional employment compensation or employment benefits of any kind from PCI. Lambrecht acknowledges that he is not entitled to any vacation or compensation in lieu of vacation. Lambrecht acknowledges that the payment of severance compensation remains subject to the conditions of the Employment Agreement, including, without limitation, the conditions of Paragraph 7 of the Employment Agreement as that Section relates to paragraphs 8, 9 & 10 of the Employment Agreement. 4. Withholding. PCI shall make no deduction or withholding from the Payment in Paragraph 2, in reliance upon Lambrecht's affirmative representation that he will be solely responsible for any and all taxes and other amounts owed on, or ordinarily withheld from, such Payment. PCI will be required to withhold all taxes and other normal withholdings from the severance compensation amounts described in Paragraph 3. 5. Employment Agreement. a. Compensation. Except for the Payment and severance compensation described in paragraphs 2 and 3 herein, Lambrecht hereby waives any and all rights to any monetary or other compensation under the Employment Agreement, including without limitation, any compensation pursuant to paragraph 3 of the Employment Agreement or any severance compensation pursuant to paragraph 7 of the Employment Agreement. Lambrecht expressly acknowledges that he has been paid in full for all services rendered to PCI prior to the date of this Agreement, including without limitation wages and vacation pay through the date of termination. b. No Options or Bonus. Lambrecht expressly waives any right to any options or bonuses which have been or may in the future be offered to any employee of PCI. c. Continuing Obligations; Extension of Covenant Not To Compete. Notwithstanding anything contained within this Agreement to the contrary, Lambrecht expressly acknowledges that his obligations pursuant to Paragraphs 8, 9, 10 and 13 of the Employment Agreement relating to Customer Records, Confidential Information and the Covenant Not To Compete and PCI's remedies under the Employment Agreement for Lambrecht' violations of said provisions and Miscellaneous Provisions provided therein shall continue and remain in full force and effect for the term set forth in the 2 Employment Agreement. However, in exchange for the Payment, the term of Covenant Not To Compete as set forth in paragraph 10(b) of the Employment Agreement shall be extended for an additional six (6) months for a total of 18 months from the date of Lambrecht's termination from PCI. 6. Status as a Director. This Agreement shall not affect Lambrecht's status as a director of PCI, and Lambrecht shall be entitled to the compensation paid to, or options granted to, outside directors and Lambrecht shall be treated as an outside director effective upon the date of termination of his employment with PCI. 7. Note; No Defense Related to This Settlement. The Parties agree that this Settlement shall have no effect upon the principal amount or interest due under, or due date of, the Note and Lambrecht expressly acknowledges that the Note, and his obligations thereunder, remain in full force and effect. Lambrecht agrees that he shall not, directly or indirectly, raise this Agreement, or any of the terms of this Agreement, or the claims settled hereby, as a defense or offset to his obligations and liability under the Note. 8. Release of Claims. Except for the obligations created by and the rights expressly reserved within this Agreement, Lambrecht does hereby and forever discharge PCI and each of its respective stockholders, predecessors, successors, assigns, agents, directors, officers, employees, representatives, consultants, affiliates, lawyers, and all persons acting by, through, under, or in concert with them, or any of them, of and from any and all manner of action or actions, cause or causes of action, in law or in equity, suits, liabilities, claims, demands, damages, losses, costs or expenses, of any nature whatsoever, (hereinafter collectively "claims") arising out of or relating to the Employment Agreement or Lambrecht's employment with PCI. As stated more particularly in Paragraph 9 herein, both Parties expressly reserve the right to bring an action to enforce this Agreement and the obligations and rights expressly reserved herein. It is the Parties intention that the foregoing release shall be effective as a full and final accord and satisfaction, and as a bar to all claims against PCI as set forth above, except for an action to enforce this Agreement or any rights expressly reserved within this Agreement. 9. Further Actions. The Parties may plead this Agreement as a full and complete defense to, and as the basis for an injunction against, any action, suit or other proceeding which either Party hereto may institute, prosecute or attempt in breach of this Agreement. 10. Costs. The Parties will bear their own costs, expenses and attorneys' fees, whether taxable or otherwise, incurred in or arising out of or connected with the negotiation of this Agreement and the disputes settled herein. 11. Construction of this Agreement. This Agreement has been freely entered into by the Parties, each of whom has been represented by separate counsel. The validity, effect and performance of this Agreement shall be governed and construed by the laws of the State of Arizona. This Agreement shall be construed liberally to effect its purpose, and the Parties waive any rule requiring strict construction against or in favor of either Party. The Agreement shall be construed as if drafted by the Parties jointly. 3 12. Integration Clause. This Agreement embodies the full and complete understanding and agreement between the Parties with respect to the matters addressed herein. This paragraph may be waived or modified only in a writing signed by the party to be charged. 13. Severability. If any term of this Agreement shall be found invalid, void or unenforceable, that term shall be severed from this Agreement and the remaining terms enforced as specified herein. 14. Prevailing Party. In any action arising out of this Agreement, the prevailing party or parties shall be entitled to an award of reasonable attorneys' fees and costs incurred in such action, which award shall be made by the Court, and shall be in addition to any other relief to which such party or parties are entitled. The Parties expressly consent to the jurisdiction and venue of Maricopa County, Arizona Superior Court for the resolution of any future disputes. 15. Binding Effect. This Agreement shall be binding upon, and shall inure to the benefit of, the Parties, their officers, directors, representatives, agents, employees, attorneys, heirs, personal representatives, successors and assigns. 16. No Admission of Liability. The Parties agree that this final compromise and settlement is not and shall not be used as an admission of liability or responsibility. 17. Counterparts. This Agreement may be executed in counterparts which together shall constitute one and the same instrument. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of this 3rd day of March, 1998. PREMIUM CIGARS INTERNATIONAL, LTD. By /s/ John E. Greenwell /s/ Greg P. Lambrecht ---------------------------------- ----------------------------------- John E. Greenwell, President Greg P. Lambrecht and Chief Executive Officer 4 EX-10.10 11 SETTLEMENT AGREEMENT EXHIBIT 10.10 AGREEMENT --------- THIS AGREEMENT (the "Agreement") is made and entered into by and between Premium Cigars International, Ltd., an Arizona corporation ("PCI") and Steven A. Lambrecht ("Lambrecht"). PCI and Lambrecht are collectively referred to herein as the "Parties." R E C I T A L S: ---------------- A. Lambrecht entered an Employment Agreement with PCI dated June 13, 1997 (the "Employment Agreement"). B. Lambrecht entered an Amendment to Employment Agreement with PCI on November 19, 1997 (the "Amendment"). C. PCI terminated Lambrecht's employment on March 1, 1998. D. PCI and Lambrecht have certain disputes regarding Lambrecht's severance compensation and other sums payable to Lambrecht. E. Without any admission of liability by either Party, the Parties desire to avoid and resolve any further dispute or litigation regarding any compensation or payments to Lambrecht from the Company. F. It is of utmost importance to PCI that Lambrecht not compete with PCI after his termination and PCI wishes to extend the current covenant not-to-compete in Lambrecht's Employment Agreement. FOR GOOD AND VALUABLE CONSIDERATION, the receipt and sufficiency of which is hereby acknowledged, the Parties agree as follows: 1. Settlement Contingent Upon PCI's Simultaneous Settlement with Colin A. Jones and Greg P. Lambrecht. This settlement is contingent upon PCI's entering into separate settlement agreements with both Colin A. Jones and Greg P. Lambrecht regarding certain compensation and other payments that they are claiming. If PCI has not entered into such settlement agreements with Steven A. Lambrecht and Greg P. Lambrecht on or before 5:00 p.m. on March 3, 1998, then this Agreement shall be null and void and of no force and effect whatsoever against PCI or Lambrecht. 2. Payment. Provided that the contingency in Paragraph 1 is met, PCI shall pay Lambrecht, within ten (10) business days after the execution of this Agreement, the sum of Forty Thousand Dollars ($40,000.00) (the "Payment"). The Payment is an amount which was 1 negotiated by the Parties in exchange for the release of claims set forth in paragraph 7 herein and in exchange for the extension of the covenant not-to-compete in the Employment Agreement. 3. Severance Compensation. Lambrecht acknowledges the sole remaining amount of severance compensation to be paid is $63,000, which PCI shall pay bi-weekly over a period of 39 weeks. PCI shall also pay Lambrecht $73.85 per bi-weekly period until the nine (9) months following his termination is completed, as a cash payment in lieu of the health insurance premium for Lambrecht at the time of his termination. Lambrecht will be responsible to obtain his own health insurance. Lambrecht acknowledges that, except for the severance compensation described in this Paragraph, the Payment and the 20,000 options to purchase PCI Common Stock, which rights have vested and approved by the Board of Directors as described in Paragraph 2 (i) and (ii) of the Amendment, and any applicable ongoing compensation as a director, he has been paid for all services rendered to the PCI as an employee and has no right to any additional employment compensation or employment benefits of any kind from PCI. Lambrecht acknowledges that he is not entitled to any vacation or compensation in lieu of vacation. Lambrecht acknowledges that the payment of severance compensation remains subject to the conditions of the Employment Agreement, including, without limitation, the conditions of Paragraph 7 of the Employment Agreement as that Section relates to paragraphs 8, 9 & 10 of the Employment Agreement. 4. Withholding. PCI shall make no deduction or withholding from the Payment or payment in lieu of health insurance premium in Paragraphs 2 and 3, in reliance upon Lambrecht affirmative representation that he will be solely responsible for any and all taxes and other amounts owed on such payments. 5. Employment Agreement. a. Compensation. Except for the Payment and severance compensation described in paragraphs 2 and 3 herein, Lambrecht hereby waives any and all rights to any monetary or other compensation under the Employment Agreement. Lambrecht expressly acknowledges that he has been paid in full for all services rendered to PCI prior to the date of this Agreement, including without limitation wages and vacation pay through the date of termination. b. No Options or Bonus. Except for the options described in Paragraph 2(ii) of the Amendment, Lambrecht expressly waives any right to any options or bonuses which have been or may in the future be offered to any employee of PCI. c. Continuing Obligations; Extension of Covenant Not To Compete. Notwithstanding anything contained within this Agreement to the contrary, Lambrecht expressly acknowledges that his obligations pursuant to Paragraphs 8, 9, 10 and 13 of the Employment Agreement relating to Customer Records, Confidential Information and the Covenant Not To Compete and PCI's remedies under the Employment Agreement for Lambrecht's violations of said provisions and Miscellaneous Provisions provided therein shall continue and remain in full force and effect for the term set forth in the 2 Employment Agreement. However, in exchange for the Payment, the term of the Covenant Not To Compete as set forth in paragraph 10(b) of the Employment Agreement shall be extended for an additional six (6) months for a total of 18 months from the date of Lambrecht's termination from PCI. During the duration of the Covenant Not To Compete, Lambrecht shall present to the Board any potential conflict with such covenant and a majority of the Board of Directors shall determine whether an actual conflict exists with the business of the Company (which is cigar distribution). 6. Status as a Director. This Agreement shall not affect Lambrecht's status as a director of PCI, and Lambrecht shall be entitled to the compensation paid to, or options granted to, outside directors and Lambrecht shall be treated as an outside director effective upon the date of termination of his employment with PCI. 7. Release of Claims. Except for the obligations created by and the rights expressly reserved within this Agreement, Lambrecht does hereby and forever discharge PCI and each of its respective stockholders, predecessors, successors, assigns, agents, directors, officers, employees, representatives, consultants, affiliates, lawyers, and all persons acting by, through, under, or in concert with them, or any of them, of and from any and all manner of action or actions, cause or causes of action, in law or in equity, suits, liabilities, claims, demands, damages, losses, costs or expenses, of any nature whatsoever, (hereinafter collectively "claims") arising out of or relating to the Employment Agreement or Lambrecht's employment with PCI. As stated more particularly in Paragraph 8 herein, both Parties expressly reserve the right to bring an action to enforce this Agreement and the obligations and rights expressly reserved herein. It is the Parties intention that the foregoing release shall be effective as a full and final accord and satisfaction, and as a bar to all claims against PCI as set forth above, except for an action to enforce this Agreement or any rights expressly reserved within this Agreement. 8. Further Actions. The Parties may plead this Agreement as a full and complete defense to, and as the basis for an injunction against, any action, suit or other proceeding which either Party may institute, prosecute or attempt in breach of this Agreement. 9. Costs. The Parties will bear their own costs, expenses and attorneys' fees, whether taxable or otherwise, incurred in or arising out of or connected with the negotiation of this Agreement and the disputes settled herein. 10. Construction of this Agreement. This Agreement has been freely entered into by the Parties. PCI has been represented by counsel and PCI advised Mr. Lambrecht of his right to seek counsel, but Mr. Lambrecht elected to represent himself. The validity, effect and performance of this Agreement shall be governed and construed by the laws of the State of Arizona. This Agreement shall be construed liberally to effect its purpose, and the Parties waive any rule requiring strict construction against or in favor of either Party. The Agreement shall be construed as if drafted by the Parties jointly. 3 11. Integration Clause. This Agreement embodies the full and complete understanding and agreement between the Parties with respect to the matters addressed herein. This paragraph may be waived or modified only in a writing signed by the party to be charged. 12. Severability. If any term of this Agreement shall be found invalid, void or unenforceable, that term shall be severed from this Agreement and the remaining terms enforced as specified herein. 13. Prevailing Party. In any action arising out of this Agreement, the prevailing party or parties shall be entitled to an award of reasonable attorneys' fees and costs incurred in such action, which award shall be made by the Court, and shall be in addition to any other relief to which such party or parties are entitled. The Parties expressly consent to the jurisdiction and venue of Maricopa County, Arizona Superior Court for the resolution of any future disputes. 14. Binding Effect. This Agreement shall be binding upon, and shall inure to the benefit of, the Parties, their officers, directors, representatives, agents, employees, attorneys, heirs, personal representatives, successors and assigns. 15. No Admission of Liability. The Parties agree that this final compromise and settlement is not and shall not be used as an admission of liability or responsibility. 16. Counterparts. This Agreement may be executed in counterparts which together shall constitute one and the same instrument. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of this 3rd day of March, 1998. PREMIUM CIGARS INTERNATIONAL, LTD. By /s/ John E. Greenwell /s/ Greg P. Lambrecht ---------------------------------- ----------------------------------- John E. Greenwell, President Greg P. Lambrecht and Chief Executive Officer 4 EX-27.1 12 FINANCIAL DATA SCHEDULE
5 1 U.S. Dollars YEAR DEC-31-1997 APR-01-1997 DEC-31-1997 1 1,264,365 3,470,471 637,478 (74,198) 1,322,258 6,763,448 195,201 (29,201) 7,850,893 1,151,988 0 0 0 8,655,339 155,081 7,850,893 3,362,275 0 2,798,672 5,182,397 (59,739) 0 44,272 (1,760,383) 0 0 0 0 0 (1,760,383) (0.82) 0
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