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.
<PAGE>
                       Premium Cigars International, Ltd.

                                   FORM 10-KSB

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997

<TABLE>
<CAPTION>
TABLE OF CONTENTS
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                                                                                         PAGE
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<S>      <C>                                                                              <C>
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
</TABLE>
                                        2
<PAGE>
                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
<PAGE>
                                     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
<PAGE>
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
<PAGE>
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
<PAGE>
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
<PAGE>
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
<PAGE>
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
<PAGE>
   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
<PAGE>
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
<PAGE>
   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
<PAGE>
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
<PAGE>
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
<PAGE>
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
<PAGE>
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
<PAGE>
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
<PAGE>
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
<PAGE>
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
<PAGE>
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
<PAGE>
                                     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
<PAGE>
            (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
<PAGE>
            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
<PAGE>
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
<PAGE>
                       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
<PAGE>
   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
<PAGE>
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
<PAGE>
   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
<PAGE>
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
<PAGE>
                                    PART III


Item 9 - Directors, Executive Officers, Promoters and Control Persons;
----------------------------------------------------------------------
Compliance with Section 16(a) of the Exchange Act
-------------------------------------------------

Directors and Executive Officers

Name                   Age                  Position
----                   ---                  --------
John E. Greenwell.......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
<PAGE>
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
<PAGE>
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
<PAGE>
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
<PAGE>
   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
<PAGE>
Item 10 - Executive Compensation
--------------------------------

Summary Compensation Table
<TABLE>
<CAPTION>
(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
--------        ----    ----------    ---------     ----------    ----------    --------     -----------   ------------
<S>             <C>        <C>             <C>        <C>              <C>        <C>             <C>         <C>
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
</TABLE>

(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
<PAGE>
Option/SAR Grants in Last Fiscal Year

                                Individual Grants
<TABLE>
<CAPTION>
        (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
       ----        -----------      -----------        ------     ---------------
<S>                  <C>               <C>             <C>      <C>
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
</TABLE>
(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 $2.5625
         per share.
                                       36
<PAGE>
Director Compensation Table
<TABLE>
<CAPTION>
(a)                  (b)                 (c)                  (d)                 (e)                  (f)
                                                                                                       Number of
                                                                                                       Securities
                     Annual                                   Consulting                               Underlying
Name                 Retainer            Meeting              Fees/Other          Number of            Options/SAR
----                 Fees ($)            Fees ($)             Fees ($)            Shares (#)           s (#)
                     --------            --------             --------            ----------           -----
<S>                     <C>                <C>                <C>                    <C>            <C>
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)
</TABLE>

(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
<PAGE>
   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
<PAGE>
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
<PAGE>
   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
<PAGE>
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
<PAGE>
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
<PAGE>
   Security Ownership of Certain Beneficial Owners
<TABLE>
<CAPTION>
Title of          Name and Address of                         Amount and Nature of               Percent
Class             Beneficial Owner                            Beneficial Ownership               of Class
-----             ----------------                            --------------------               --------
<S>               <C>                                             <C>                            <C>
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
</TABLE>

(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
<PAGE>
   Security Ownership of Management
<TABLE>
<CAPTION>
Title of          Name and Address of                         Amount and Nature of               Percent
Class             Beneficial Owner                            Beneficial Ownership               of Class
-----             ----------------                            --------------------               --------
<S>               <C>                                         <C>                                <C>
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)
</TABLE>

(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
<PAGE>
         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
<PAGE>
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
<PAGE>
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
<PAGE>
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
<PAGE>
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
<PAGE>
   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
<PAGE>
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
<PAGE>
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
<PAGE>
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
<PAGE>
**       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
<PAGE>
                                   SIGNATURES

   In accordance  with Section 13 or 15(d) of the Exchange  Act, the  registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.

PREMIUM CIGARS INTERNATIONAL, LTD.


By:     /s/ John E. Greenwell
    ------------------------------
     John E. Greenwell, President, Chief Executive
     Officer and Chief Operating Officer

Date:     March 31, 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.
<TABLE>
<CAPTION>
         Signature                          Title                                                Date
         ---------                          -----                                                ----
<S>                                         <C>                                                  <C>
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
</TABLE>
                                       55
<PAGE>
<TABLE>
<S>                                         <C>                                                  <C>
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
</TABLE>




                   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
<PAGE>
                       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
<PAGE>



                          INDEPENDENT AUDITORS' REPORT
                          ----------------------------



To The Board of Directors of
Premium Cigars International, Ltd.


We have audited the  accompanying  consolidated  balance sheet of Premium Cigars
International,  Ltd. and  Subsidiary  as of December  31, 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
<PAGE>
                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
<PAGE>
                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
<PAGE>
                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


<TABLE>
<CAPTION>

                                      Common Stock          Additional
                               --------------------------     Paid-in    Common Stock
                                  Shares         Amount       Capital      Warrants
                                  ------         ------       -------      --------

<S>                            <C>            <C>           <C>           <C>
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
                               ===========    ===========   ===========   ===========
</TABLE>

                   The Accompanying Notes are an Integral Part
                    of the Consolidated Financial Statements
                                      F-4
<PAGE>
                PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY
     CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (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


<TABLE>
<CAPTION>
                                               Foreign
                                               Currency                        Total
                                Treasury     Translation    Accumulated     Stockholders'
                                  Stock       Adjustment      Deficit          Equity
                                  -----       ----------      -------          ------

<S>                            <C>            <C>            <C>            <C>
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
                               ===========    ===========    ===========    ===========
</TABLE>

                   The Accompanying Notes are an Integral Part
                    of the Consolidated Financial Statements
                                       F-5
<PAGE>
                PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                 For The Nine Months Ended December 31, 1997 and
 For The Period From The Date of Inception, June 1, 1996 Through March 31, 1997

<TABLE>
<CAPTION>
                                                          Nine Months     Inception
                                                             Ended         Through
                                                          December 31,     March 31,
                                                              1997           1997
                                                              ----           ----
<S>                                                       <C>            <C>
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
                                                          ===========    ===========
</TABLE>

                   The Accompanying Notes are an Integral Part
                    of the Consolidated Fi
nancial Statements
                                       F-6
<PAGE>
                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

<TABLE>
<CAPTION>
                                                                               Nine Months     Inception
                                                                                  Ended         Through
                                                                               December 31,     March 31,
                                                                                   1997           1997
                                                                                   ----           ----
<S>                                                                            <C>            <C>
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)
                                                                               ===========    ===========
</TABLE>

                   The Accompanying Notes are an Integral Part
                    of the Consolidated Financial Statements
                                       F-7
<PAGE>
                PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.       Summary of Significant  Accounting  Policies,  Nature of Operations and
         Use of Estimates:

         Nature of Operations:

         Premium  Cigars  International,  Ltd. (the  "Company") is a Corporation
         organized  under the laws of the State of Arizona on December 16, 1996.
         CAN-AM  International  Investments Corp.  (CAN-AM),  a British Columbia
         Canadian  corporation,  was  incorporated on June 20, 1996. The Company
         acquired all of the  outstanding  stock of CAN-AM on December 31, 1996.
         The  business  purpose of the  Company is the  distribution  of premium
         cigars using countertop humidors in convenience stores,  grocery stores
         and  other  retail  outlet  markets.   The  Company  conducts  business
         throughout the United States.  The Company's  wholly-owned  subsidiary,
         CAN-AM, operates throughout greater Canada.

         Change in Year End:

         The Company  elected to change its year end to December  31,  effective
         with the period ended December 31, 1997. The Company  previously used a
         March 31 fiscal year end. As a result of the change,  the period  ended
         December 31, 1997 represents a nine month period.

         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
<PAGE>
                PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

1.       Summary of Significant  Accounting  Policies,  Nature of Operations and
         Use of Estimates: (Continued)

         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
         <PAGE>
                PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

1.       Summary of Significant  Accounting  Policies,  Nature of Operations and
         Use of Estimates: (Continued)

         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
<PAGE>
                PREMIUM CIGARS INTERNATIONAL, LTD. AND SUBSIDIARY
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

1.       Summary of Significant  Accounting  Policies,  Nature of Operations and
         Use of Estimates: (Continued)

         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
<PAGE>
                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
<PAGE>
                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
<PAGE>
                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
<PAGE>
                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:

<TABLE>
<CAPTION>
                                                Stock                  Weighted Average
                                               Options      Warrants    Exercise Price
                                               -------      --------    --------------
<S>                                            <C>           <C>             <C>
         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
                                               =======       =======        =====
</TABLE>

         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
<PAGE>
                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
<PAGE>
                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