<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-QSB
(X) QUARTERLY REPORT PURSUANT SECTION 13 OF 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999.
( ) TRANSITION REPORT PURSUANT SECTION 13 OF 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission file number 333-38697
PHYSICAL SPA & FITNESS, INC.
(Exact name of small business as specified in its charter)
Delaware 13-1026995
---------------------- ----------------
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
12/F - 15/F Lee Theatre Plaza
99 Percival St., Causeway Bay
Hong Kong
(Address of principal executive offices)
(011) (852) 2572-8888
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act during the past 12 months (or for
such shorter period that the registrant was required to file such reports) and
(2) has been subject to such filing requirements for the past 90 days.
Yes X No
---- ----
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable dated : June 1, 1999, 10,000,000 shares.
Transitional Small Business Disclosure Format (check one) :
Yes No X
---- ----
<PAGE>
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION PAGE
----
ITEM 1 - FINANCIAL STATEMENTS
Consolidated Statements of Operations
for the six months ended June
31, 1999 and 1998 (Unaudited) 3
Consolidated Balance Sheets at June 30, 1999
and December 31,1998 (Unaudited) 4
Consolidated Statements of Cash Flows
for the six months ended June 30, 1999
and 1998 (Unaudited) 5
Notes to Consolidated Financial Statements 7
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OR PLAN OF OPERATION 14
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS 18
ITEM 2 - CHANGE IN SECURITIES 18
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES 18
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE
OF SECURITY HOLDERS 18
ITEM 5 - OTHER INFORMATION 18
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K 18
2
<PAGE>
<TABLE>
PHYSICAL SPA & FITNESS, INC., AND SUBSIDIARIES
----------------------------------------------
CONSOLIDATED CONDENSED STATEMENTS OF INCOME (UNAUDITED)
-------------------------------------------------------
THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 1998 AND 1999
(Amounts in thousands, except number of shares and per share data)
<CAPTION>
Three months ended June 30 Six months ended June 30
1998 1999 1999 1998 1999 1999
---------- ---------- ---------- ---------- ---------- ----------
HK$ HK$ US$ HK$ HK$ US$
<S> <C> <C> <C> <C> <C> <C>
Operating Revenues
Fitness service 34,751 42,482 5,469 62,644 79,397 10,232
Beauty treatments 16,061 18,856 2,427 29,694 35,955 4,633
Others 16 10 1 43 15 2
---------- ---------- ---------- ---------- ---------- ----------
Total operating revenues 50,828 61,348 7,897 92,381 115,367 14,867
---------- ---------- ---------- ---------- ---------- ----------
Operating Expenses
Salaries and commissions 13,275 20,434 2,631 25,691 33,283 4,290
Rent and related expenses 10,458 14,364 1,849 19,622 26,891 3,465
Depreciation 5,691 7,875 1,013 11,614 14,777 1,904
Other selling and administrative
expenses 13,064 9,457 1,216 22,532 24,780 3,193
---------- ---------- ---------- ---------- ---------- ----------
Total operating expenses 42,488 52,130 6,709 79,459 99,731 12,852
---------- ---------- ---------- ---------- ---------- ----------
Income from operations 8,340 9,218 1,188 12,922 15,636 2,015
---------- ---------- ---------- ---------- ---------- ----------
Non-operating (income) expenses
Other (income), net (220) (180) (23) (458) (233) (30)
Interest expenses 913 847 109 2,044 1,582 204
---------- ---------- ---------- ---------- ---------- ----------
Total non-operating (income) expenses 693 667 86 1,586 1,349 174
---------- ---------- ---------- ---------- ---------- ----------
Income before income taxes and
minority interests 7,647 8,551 1,100 11,336 14,287 1,841
Provision for income taxes 1,337 2,297 294 2,400 3,294 425
---------- ---------- ---------- ---------- ---------- ----------
Income before minority interests 6,310 6,254 806 8,936 10,993 1,416
Minority interests 81 457 59 333 723 93
---------- ---------- ---------- ---------- ---------- ----------
Net income 6,229 5,797 747 8,603 10,270 1,323
========== ========== ========== ========== ========== ==========
Earnings per common share 0.62 0.58 0.07 0.86 1.03 0.13
========== ========== ========== ========== ========== ==========
Number of shares outstanding (in
thousands) 10,000 10,000 10,000 10,000 10,000 10,000
========== ========== ========== ========== ========== ==========
</TABLE>
Translation of amounts from Hong Kong Dollars ("HK$") into United States Dollars
("US$") for the convenience of the reader has been made at the exchange rate
quoted by Hong Kong Bank on June 30, 1999 of US$1.00 = HK$7.76. No
representation is made that the Hong Kong Dollar amounts could have been, or
could be, converted into United States Dollars, at that rate on June 30, 1999 or
at any other certain rate.
3
<PAGE>
<TABLE>
PHYSICAL SPA & FITNESS, INC., AND SUBSIDIARIES
----------------------------------------------
CONSOLIDATED CONDENSED BALANCE SHEETS (UNAUDITED)
-------------------------------------------------
DECEMBER 31, 1998 and June 30, 1999
(Amounts in thousands, except number of shares and per share data)
<CAPTION>
December 31,
1998 June 30, 1999
-------------- ---------------------
HK$ HK$ US$
ASSETS (Unaudited)(Unaudited)
<S> <C> <C> <C>
Current assets
Cash and cash equivalents 1,721 7,228 931
Trade receivables 7,364 7,430 957
Rental and utility deposits 9,829 9,974 1,285
Prepayments to vendors and suppliers and other
current assets 5,232 8,420 1,085
Inventories 2,504 2,495 322
Due from related companies 8,413 8,693 1,120
Due from a shareholder - current portion 4,404 4,043 521
---------- ---------- ----------
Total current assets 39,467 48,283 6,221
---------- ---------- ----------
Due from a shareholder - non-current portion - - -
Prepayments for construction-in-progress 6,614 21,165 2,727
Property, plant and equipment, net 127,774 116,296 14,987
---------- ---------- ----------
Total assets 173,855 185,744 23,935
========== ========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Short-term bank loans 6,232 4,585 591
Long-term bank loans - current portion 4,327 6,958 897
Accounts payable and accrued expenses 21,362 14,770 1,903
Loans from third parties - - -
Obligations under finance leases- current portion 4,924 3,951 509
Deferred income 30,098 31,438 4,051
Deferred liabilities 4,269 9,897 1,275
Income taxes payable 4,066 6,040 778
Taxes other than income 8,952 8,930 1,151
---------- ---------- ----------
Total current liabilities 84,230 86,569 11,155
---------- ---------- ----------
Long-term bank loans 6,519 6,530 841
Long-term loans from third parties - - -
Loans from minority shareholders of subsidiaries 4,200 4,200 541
Obligations under finance leases - non current portion 4,215 3,269 421
Deferred taxation 4,712 4,712 607
Minority interests 7,835 7,723 995
Shareholders' equity:
Common stock, par value US$ 0.001 each, 100
million shares authorized; 10 million shares
outstanding 78 78 10
Cumulative translation adjustment 116 (358) (45)
Retained earnings 61,950 73,021 9,410
---------- ---------- ----------
Total shareholders' equity 62,144 72,741 9,375
---------- ---------- ----------
Total liabilities and shareholders' equity 173,855 185,744 23,935
========== ========== ==========
</TABLE>
Translation of amounts from Hong Kong Dollars ("HK$") into United States Dollars
("US$") for the convenience of the reader has been made at the exchange rate
quoted by Hong Kong Bank on June 30, 1999 of US$1.00 = HK$7.76. No
representation is made that the Hong Kong Dollar amounts could have been, or
could be, converted into United States Dollars, at that rate on June 30, 1999 or
at any other certain rate.
4
<PAGE>
<TABLE>
PHYSICAL SPA & FITNESS, INC., AND SUBSIDIARIES
----------------------------------------------
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
-----------------------------------------------------------
SIX MONTHS ENDED JUNE 30, 1998 AND 1999
(Amounts in thousands)
<CAPTION>
1998 1999
---------- ---------------------
HK$ HK$ US$
<S> <C> <C> <C>
Cash flows from operating activities:
Net income 8,603 10,270 1,323
Adjustments to reconcile net income to net
cash provided by operating activities:
Minority interests 333 723 93
Depreciation 11,614 14,777 1,904
Loss (Gain) on disposal of fixed assets 129 71 9
(Increase) Decrease in assets:
Trade receivables 2,412 (66) (9)
Deposits, prepayments and other current assets (1,388) (3,333) (430)
Inventories (2) 9 2
Due from related companies (2,253) (280) (36)
Increase (Decrease) in liabilities:
Accounts payable and accrued expenses 7,918 (6,592) (849)
Deferred income (6,050) 1,340 173
Deferred liabilities (372) 5,628 725
Income taxes payable (32) 1,974 254
Taxes other than income 305 (22) (3)
Deferred taxation - - -
---------- ---------- ----------
Net cash provided by operating activities 21,217 24,499 3,156
---------- ---------- ----------
Cash flows from investing activities:
(Prepayments for construction-in-progress)
Transfer to fixed assets 9,160 (14,551) (1,875)
Acquisition of property, plant and
equipment (26,523) (3,543) (457)
Sales proceeds from disposal of property,
plant and equipment - 140 18
---------- ---------- ----------
Net cash used in investing activities (17,363) (17,954) (2,314)
---------- ---------- ----------
Cash flows from financing activities
(Settlement) Proceeds of short-term bank loans 351 (1,647) (212)
Decrease (Increase) in due from a shareholder 8,612 361 47
Payment of dividends to a shareholders - - -
Payment of dividend to minority shareholders - - -
Proceeds from long-term bank loans 4,000 3,800 490
Repayment of long-term bank loans (5,763) (1,159) (149)
Settlement of long-term loans from third parties (6,649) - -
Assumption of finance lease obligations 847 500 64
Capital element of finance lease rental payments (2,311) (2,419) (312)
Capital contribution of the Chinese joint
venture partner into a joint venture - - -
Repayment of loans from minority
shareholders of subsidiaries (960) - -
---------- ---------- ----------
</TABLE>
5
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Net cash provided by (used in) financing
activities (1,873) (564) (72)
---------- ---------- ----------
Net increase (decrease) in cash and cash
equivalents 1,981 5,981 770
Cash and cash equivalents, at beginning of
year 1,954 1,721 222
Cumulative translation adjustments 14 (474) (61)
---------- ---------- ----------
Cash and cash equivalents, at end of year 3,949 7,228 931
========== ========== ==========
</TABLE>
Translation of amounts from Hong Kong Dollars ("HK$") into United States Dollars
("US$") for the convenience of the reader has been made at the exchange rate
quoted by Hong Kong Bank on June 30, 1999 of US$1.00 = HK$7.76. No
representation is made that the Hong Kong Dollar amounts could have been, or
could be, converted into United States Dollars, at that rate on June 30, 1999 or
at any other certain rate.
6
<PAGE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
--------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
(Amounts in thousands, except number of shares,
per share data and unless otherwise stated)
1. ORGANIZATION AND PRINCIPAL ACTIVITIES
-------------------------------------
Physical Spa & Fitness Inc. ("the Company") a Delaware Corporation, acquired
Physical Beauty & Fitness Holdings Limited ("Physical Holdings") and Physical
Holdings' subsidiaries in October of 1996, issuing 8,000,000 shares (80% of the
Company's outstanding shares) to the shareholder of Physical Holdings ("the
Shareholder"). Physical Holdings and its subsidiaries operate fitness and beauty
centres in Hong Kong and the Peoples Republic of China ("PRC") and other related
businesses.
Physical Holdings was incorporated on March 8, 1996 under the laws of the
British Virgin Islands ("BVI") with a capital of one common share being held by
the Shareholder.
As part of the above transaction, certain shareholders of the Company also
transferred 990,000 common shares to Goodchild Investments Limited
("Goodchild"). Accordingly, the Shareholder and Goodchild became the major
shareholders of the Company. In February, 1998, Goodchild sold all its common
shares of the Company in a private transaction to a Japanese institutional
investor.
On November 27, 1996, the Company changed its name to Physical Spa & Fitness,
Inc.
The transfer of the Shareholder's interests in Physical Holdings and the
Operating Subsidiaries was a reorganization of companies under common control
and has been accounted for effectively as a pooling of interests, and the
consolidated financial statements of the Company have been presented as if the
Operating Subsidiaries had been owned by the Company since their date of
incorporation or acquisition by the Shareholder whichever is later.
The details of Physical Holdings and the Operating Subsidiaries and their
principal activities as of the date of this report are summarized below:
<TABLE>
<CAPTION>
Date of Equity interest
acquisition/ Place of owned by the
Name of Company formation incorporation Company Principal activities
- ------------------------------------ ----------------------------- ----------------- ------------------------
Direct Indirect
------ --------
<S> <C> <C> <C> <C> <C>
Physical Beauty & Fitness Holdings March 8, 1996 BVI 100% - Investment holding
Limited ("Physical Holdings")
Physical Health Centre Hong Kong March 2, 1990 Hong Kong 91.4% - Operating 5 Fitness
Limited ("Physical HK") Centres in Hong Kong
Regent Town Holdings Limited September 20, BVI 92.5% - Investment holding
("Regent") 1993
Operating a beauty
Supreme Resources Limited September 29, Hong Kong 70% - treatment centre in
("Supreme") 1994 Hong Kong
Physical Health Centre (Zhong September 29, Hong Kong 100% - Investment holding
Shan) Limited ("Zhongshan 1994 (formerly operating
Physical") (formerly known as a beauty treatment
Famerich Development Limited centre in Hong Kong)
("Famerich"))
Zhongshan Physical Ladies' Club October 29, The PRC - 95% Fitness Centre in
Ltd. (owned by Zhongshan 1996 Zhongshan, the PRC
Physical) not yet open
</TABLE>
7
<PAGE>
1. ORGANIZATION AND PRINCIPAL ACTIVITIES (Cont'd)
-------------------------------------
<TABLE>
<CAPTION>
Date of Equity interest
acquisition/ Place of owned by the
Name of Company formation incorporation Company Principal activities
- ------------------------------------ ----------------------------- ----------------- ------------------------
Direct Indirect
------ --------
<S> <C> <C> <C> <C> <C>
Ever Growth Limited ("Ever Growth") September 29, Hong Kong 100% - Property holding
1994
Proline Holdings Limited ("Proline") September 28, BVI - 92.5% Investment holding
(wholly owned by Regent) 1994
Shanghai Physical Ladies' Club September 28, Hong Kong - 92.5% Investment holding
Company Limited ("Shanghai 1994
Physical") (wholly owned by
Proline)
Shanghai Physical Ladies' Club September 28, The PRC - 92.5% Operating two
Co., Ltd. (owned by Shanghai 1994 Fitness Centres in
Physical) Shanghai, the PRC
Mighty System Limited ("Mighty") December 15, BVI 100% - Provision of marketing
services 1994 for cosmetics sales
Jade Regal Holdings Limited ("Jade March 15, 1996 BVI 100% - Investment holding
Regal")
Physical Health Centre (Dalian) March 15, 1996 Hong Kong - 100% Investment holding
Limited ("Dalian Physical")
(wholly owned by Jade Regal)
Dalian Physical Ladies' Club Co., March 15, 1996 The PRC - 90% Operating a
Ltd. (90% owned by Dalian Physical) Fitness Centre in
Dalian, the PRC
Star Perfection Holdings Limited April 15, 1996 BVI 100% - Investment holding
("Star Perfection")
Physical Health Centre (Shenzhen)
Limited ("Shenzhen Physical")
(wholly-owned by Star Perfection) April 15, 1996 Hong Kong - 100% Investment holding
Shenzhen Physical Ladies' Club Co. August 16, The PRC - 90% Fitness Centre in
Ltd. (owned by "Shenzhen Physical") 1996 Shenzhen, the PRC
not yet open
Physical Health Centre (Macau) March 21, 1997 Hong Kong 100% - Investment holding
Limited ("Macau Physical")
Operating a
Physical Health Centre (Tsuen September 8, Hong Kong 100% - Fitness Centre in
Wan) Limited ("Tsuen Wan Physical") 1997 Hong Kong
Operating a
Physical Health Centre (TST) December 1, Hong Kong 100% - Fitness Centre in
Limited 1998 Hong Kong
Global Resources Limited December 1, Hong Kong 100% - Investment holding
1998
</TABLE>
Regent was originally 67% owned by Physical HK upon its incorporation. In June,
1995, Physical HK increased its equity interest to 83.5% by acquiring additional
shares issued by Regent at the par value of the shares. In June, 1996, 5% of the
equity interest of Regent owned by a minority shareholder was acquired by the
Shareholder. All the shares owned by Physical HK and the Shareholder were then
transferred to Physical Holdings at the original cost of their investment to
Physical HK and the Shareholder. In January 1998 Physical Holdings increased its
equity interest to 92.5% by acquiring additional shares owned by a minority
shareholder.
8
<PAGE>
1. ORGANIZATION AND PRINCIPAL ACTIVITIES (Cont'd)
-------------------------------------
The Group operates Fitness Centres in the PRC through some of its Operating
Subsidiaries which are Sino-foreign joint ventures established in the PRC.
Detailed information in connection with these joint ventures is as follows:
<TABLE>
<CAPTION>
Term
Type of Interest of the
Name of the Joint joint owned by joint Registered
Venture Location venture the Group venture capital Profit sharing arrangement
- ------------------------ ------------ ---------- ---------- -------- ------------ ---------------------------
<S> <C> <C> <C> <C> <C> <C>
Shanghai Physical Huangpu Co-operative 92.5% 10 years Originally None. Joint venturer
Ladies' Club Co., Ltd. and US$1,000 receives rent for
("Shanghai JV") Hongqiao, in cash locations and will
Shanghai and receive equipment when
increased the Joint venture is
to dissolved.
US$2,000
in cash in
1995
Dalian Physical Dalian Equity 90% 12 years Originally Pro-rata to equity
Ladies' Club Co., Ltd. Rmb10,000 interests
("Dalian JV") in cash
and
changed
to
Rmb1,000
in cash
and
Rmb9,000
in form of
fixed
assets and
renovation
materials
in 1996
Shenzhen Physical Shenzhen Co-operative 90% 10 years HK$4,600 Pro-rata to equity
Ladies' Club Co. Ltd. in form interests
("Shenzhen JV") of cash
and fixed
assets
Zhongshan Physical Zhongshan Co-operative 95% 10 years US$500 in Pro-rata to equity
Ladies' Club Co. Ltd. form of interests
("Zhongshan JV") cash and
fixed
assets
</TABLE>
2. BASIS OF PRESENTATION
---------------------
The accompanying consolidated financial statements were prepared in accordance
with generally accepted accounting principles in the United States of America .
This basis of accounting differs from that used in the statutory financial
statements of the BVI and Hong Kong Operating Subsidiaries and the PRC joint
ventures, which were prepared in accordance with generally accepted accounting
principles in Hong Kong and the accounting principles and the relevant financial
regulations applicable to enterprises with foreign investments as established by
the Ministry of Finance of China respectively.
9
<PAGE>
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------
a. Basis of Consolidation
----------------------
The consolidated financial statements include the financial statements
of the Company, its majority-owned and controlled subsidiaries and
joint ventures. All material intercompany balances and transactions
have been eliminated on consolidation.
b. Revenue & Deferred Income
-------------------------
Revenue represents membership fees and service income in connection
with the provision of physical fitness and beauty treatment services
and other related income, net of the related sales tax, if any. Annual
membership fees and service income and other related income are
recognized when services are rendered. During 1996, the Company changed
its membership policy so that the annual membership fee was replaced by
a non-refundable membership admission fee and monthly dues. The
admission fee is recognized as revenue on a pro-rata basis over the
estimated membership term whereas the monthly dues are recognized as
revenue on a monthly basis.
Deferred income represents membership fees, admission fees and service
fees billed but for which the related services, or portion of the
services, have not yet been rendered.
c. Property, Plant and Equipment
-----------------------------
Property, plant and equipment are stated at cost less accumulated
depreciation. Depreciation of property, plant and equipment is computed
using the straight line method over the assets' estimated useful lives.
The estimated useful lives are as follows:
Leasehold land held under long-term lease Over the lease term
Buildings 20 to 50 years
Leasehold improvements Over the lease term
Machinery and equipment 5 to 10 years
Furniture and fixtures 5 years
Computers 4 to 5 years
Motor vehicles 4 to 5 years
The Group recognizes an impairment loss on a fixed asset when evidence,
such as the sum of expected future cash flows (undiscounted and without
interest charges), indicates that future operations will not produce
sufficient revenue to cover the related future costs, including
depreciation, and when the carrying amount of asset cannot be realized
through sale. Measurement of the impairment loss is based on the fair
value of the assets.
10
<PAGE>
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont'd)
------------------------------------------
d. Taxation: Income Taxes
----------------------
No provision for withholding or U.S. federal income taxes or tax
benefits on the undistributed earnings and/or losses of the Company and
its Operating Subsidiaries has been provided as the earnings of the
Operating Subsidiaries, in the opinion of the management, will be
reinvested indefinitely.
Provision for income and other related taxes have been provided in
accordance with the tax rates and laws in effect in the various
countries of operations.
The Group provides for deferred income taxes using the liability
method, by which deferred income taxes are recognized for all
significant temporary differences between the tax and financial
statement bases of assets and liabilities. The tax consequences of
those differences are classified as current or non-current based upon
the classification of the related assets or liabilities in the
financial statements. A valuation allowance is provided for the portion
of deferred tax assets that is not currently realizable, since the
realization of these benefits depends upon the ability of the relevant
entity to generate income in future years.
e. Foreign Currency Translation
----------------------------
The Company and its subsidiaries maintain their accounting books and
records in Hong Kong Dollars HK$, except for the PRC Joint Ventures
which maintain their accounting books and records in Renminbi. Foreign
currency transactions during the year are translated in HK$ at rates of
exchange prevailing at the time of the transactions. Monetary assets
and liabilities denominated in foreign currencies at year end are
translated at the rates of exchange prevailing at the balance sheet
date. Non-monetary assets and liabilities are translated at the rates
of exchange prevailing at the time the asset or liabilty ws acquired.
Exchange gains or losses are recorded in the consolidated statements of
income.
On consolidation, the financial statements of the PRC Joint Ventures
are translated into HK$ using the closing rate method, whereby the
balance sheet items are translated into HK$ using the unified exchange
rates at the respective balance sheet dates. The share capital and
retained earnings are translated at historical unified exchange rates
prevailing at the time of the transactions while income and expense
items are translated at the average unified exchange rates for the
years. The resultant translation differences are recorded in the
consolidated balance sheets as cumulative translation adjustments which
are included as a separate account in shareholders' equity in the
accompanying balance sheets.
11
<PAGE>
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont'd)
------------------------------------------
f. Finance Leases
--------------
Leases that substantially transfer to the Group all the rewards and
risks of ownership of assets, other than legal title, are accounted for
as finance leases.
Fixed assets held under finance leases are initially recorded at the
present value of the minimum lease payments at the inception of the
leases, with equivalent liabilities categorized as appropriate under
current or non-current liabilities.
Finance charges, which represent the difference between the minimum
lease payments at the inception of the leases and the fair value of the
assets acquired, are allocated to accounting periods over the period of
the relevant leases so as to produce a constant periodic rate of charge
on the outstanding balances.
g. Operating Leases
----------------
Leases where substantially all the rewards and risks of ownership of
assets remain with the lessors are accounted for as operating leases.
Rental payments under operating leases are expensed as incurred.
h. Related companies
-----------------
A related company is a company in which one or more of the directors or
shareholders of the Company have direct or indirect beneficial
interests.
i. Deferred liabilities
--------------------
Deferred liabilities represent the benefit arose from the operating
leases. The deferred liabilities are amortized within the lease term,
and the amortization is recorded in the statement of income.
4. SHORT-TERM BANK LOANS
---------------------
The short-term bank loans are secured and repayable within one year.
5. LONG-TERM BANK LOANS
--------------------
As of June 30, 1999, the Group had various banking facilities available from
financial institutions. These facilities were secured by:
(i) leasehold property in Hong Kong owned by Evergrowth;
(ii) leasehold property in Hong Kong owned by relatives of the Principal
Shareholders;
(iii) leasehold property in Hong Kong owned by a related company; and
(iv) personal guarantees from the Principal Shareholders and their relatives.
12
<PAGE>
6. PROVISION FOR INCOME TAXES
--------------------------
Hong Kong profits tax was provided at 16% on the assessable profits of Hong Kong
subsidiaries.
Enterprise income tax was provided at 33% on the assessable income of the
Shanghai and Dalian JVs in accordance with the relevant tax regulations of the
PRC.
The other BVI and Hong Kong Operating Subsidiaries, except Physical HK, did not
provide for any income taxes during the years as they did not have any
assessable income.
The tax impact of temporary differences between financial and taxable income
that give rise to deferred tax (assets) liabilities are related to the
accelerated depreciation allowances on fixed assets in Hong Kong.
7. DISTRIBUTION OF PROFIT
----------------------
In the opinion of management, any undistributed earnings of Physical Holdings
and the Operating Subsidiaries will be reinvested indefinitely.
8. STOCK OPTION PLAN
-----------------
The Company has a Stock Option Plan which was adopted by the Company's
stockholders and its Board of Directors on April 23, 1997. Under the Plan, the
Company may issue incentive stock options, non-qualified options, restricted
stock grants, and stock appreciation rights to selected directors, officers,
advisors and employees of the Company. A total of 500,000 shares of Common Stock
of the Company are reserved for issuance under the Plan. Stock options may be
granted as non-qualified or incentive options. Incentive stock options may not
be granted at a price less than the fair market value of the stock as of the
date of grant while non-qualified stock options may not be granted at a price
less than 85% of the fair market value of the stock as of the date of grant. The
plan will be administered by an Option Committee which is to be composed of two
or more disinterested directors of the Board of Directors. The option can be
exercised during a period of time fixed by the Committee except that no may be
exercised more than ten years after the date of grant of three years after death
or disability , whichever is later. As of the date of this report, no stock
options have been granted by the Company.
13
<PAGE>
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
PRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
ALL FORWARD-LOOKING STATEMENTS CONTAINED HEREIN ARE DEEMED BY THE COMPANY TO BE
COVERED BY AND TO QUALIFY FOR THE SAFE HARBOR PROTECTION PROVIDED BY THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995 THE 1995 ACT SHAREHOLDERS AND
PROSPECTIVE SHAREHOLDERS SHOULD UNDERSTAND THAT SEVERAL FACTORS GOVERN WHETHER
ANY FORWARD - LOOKING STATEMENT CONTAINED HEREIN WILL BE OR CAN BE ACHIEVED. ANY
ONE OF THOSE FACTORS COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE
PROJECTED HEREIN. THESE FORWARD - LOOKING STATEMENTS INCLUDE PLANS AND
OBJECTIVES OF MANAGEMENT FOR FUTURE OPERATIONS, INCLUDING PLANS AND OBJECTIVES
RELATING TO THE PRODUCTS AND THE FUTURE ECONOMIC PERFORMANCE OF THE COMPANY.
ASSUMPTIONS RELATING TO THE FOREGOING INVOLVE JUDGMENTS WITH RESPECT TO, AMONG
OTHER THINGS, FUTURE ECONOMIC, COMPETITIVE AND MARKET CONDITIONS, FUTURE
BUSINESS DECISIONS, AND THE TIME AND MONEY REQUIRED TO SUCCESSFULLY COMPLETE
DEVELOPMENT PROJECTS, ALL OF WHICH ARE DIFFICULT OR IMPOSSIBLE TO PREDICT
ACCURATELY AND MANY OF WHICH ARE BEYOND THE CONTROL OF THE COMPANY. ALTHOUGH THE
COMPANY BELIEVES THAT THE ASSUMPTIONS UNDERLYING THE FORWARD - LOOKING
STATEMENTS CONTAINED HEREIN ARE REASONABLE, ANY OF THOSE ASSUMPTIONS COULD PROVE
INACCURATE AND, THEREFORE, THERE CAN BE NO ASSURANCE THAT THE RESULTS
CONTEMPLATED IN ANY OF THE FORWARD - LOOKING STATEMENTS CONTAINED HEREIN WILL BE
REALIZED. BASED ON ACTUAL EXPERIENCE AND BUSINESS DEVELOPMENT, THE COMPANY MAY
ALTER ITS MARKETING, CAPITAL EXPENDITURE PLANS OR OTHER BUDGETS, WHICH MAY IN
TURN AFFECT THE COMPANY'S RESULTS OF OPERATIONS. IN LIGHT OF THE SIGNIFICANT
UNCERTAINTIES INHERENT IN THE FORWARD - LOOKING STATEMENTS INCLUDED THEREIN, THE
INCLUSION OF ANY SUCH STATEMENT SHOULD NOT BE REGARDED AS A REPRESENTATION BY
THE COMPANY OR ANY OTHER PERSON THAT THE OBJECTIVES OR PLANS OF THE COMPANY WILL
BE ACHIEVED.
Overview of Company's Business:
The Company, through its predecessor companies and its subsidiaries,
has been an established commercial operator of fitness and spa centers in Hong
Kong and China since 1986. The Company currently operates eleven facilities:
eight in Hong Kong and three in China. Management believes that the Company is
one of the top providers of fitness facilities and spa and beauty treatment
services in Hong Kong and China, with approximately 55,000 members. The Company
offers to its customers, at each location, access to a wide range of U.S.-
styled fitness and spa services.
The Company was incorporated on September 21, 1988 in the state of
Delaware under the name of "Foreclosed Realty Exchange, Inc", a development
stage company seeking acquisitions with no material assets or liabilities. Prior
to acquisition of Physical Beauty & Fitness Holdings Limited, a British Virgin
Islands corporation ("Physical Limited"), the Company had no revenue producing
operations, but planned to enter into joint ventures and/or acquisitions
originally in the area of real estate, to expand its operations. In October,
1996, the Company closed a transaction with Ngai Keung Luk (Serleo), a 100%
shareholder of Physical Limited, whereby the Company entered into a Share
Exchange Agreement with Ngai Keung Luk (Serleo), pursuant to which the Company
issued 8,000,000 shares of its Common Stock to Ngai Keung Luk (Serleo) in
exchange for all of the outstanding shares of Physical Limited (the "Closing").
At the Closing, the then current management of the Company resigned and was
replaced by the current management of the Company.
The Company derives its revenues from two main lines of business:
fitness and spa services.
14
<PAGE>
RESULTS OF OPERATIONS
The Company's revenues are derived from its two main lines of business
of fitness and spa services in three principal ways: sale of memberships to
fitness facilities, monthly membership fees and the sale of beauty treatments .
The sale of beauty products and exercise clothing also contributes an
insignificant amount to the total revenues. In respect to fitness services,
customers are invited to join as a member at a fee currently set at
HK$1,000(US$129) for one person. A monthly subscription fee of HK$299 (US$39) is
charged to each customer for the usage of the fitness center and spa area.
In respect to beauty treatments, the customers may purchase single
treatments, or in packages of ten or more treatments, with quantity discounts
available. There is a wide range of beauty treatments available at prices
ranging from HK$200 (US$26) to HK$3,000 (US$387).
The following table sets forth selected income data as a percentage of
total operating revenue for the periods indicated.
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended Six Months Ended
December 31, June 30
1996 1997 1998 1998 1999
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Operating Revenues 100.00% 100.00% 100.00% 100.00% 100.00%
Total operating expenses 71.52% 80.37% 89.69% 86.01% 86.45%
Operating income 28.48% 19.62% 10.31% 13.99% 13.55%
Income before income taxes and minority
interests 28.52% 18.31% 8.74% 12.27% 12.38%
Provision for income and deferred taxes 7.55% 4.68% (0.05%) 2.60% 2.86%
Minority interests 1.99% 1.23% 0.54% 0.36% 0.63%
Net income 18.98% 12.40% 8.25% 9.31% 8.90%
======== ======== ======== ======== ========
</TABLE>
SIX MONTHS ENDED JUNE 30, 1999 (UNAUDITED) COMPARED TO SIX MONTHS ENDED JUNE 30,
1998 (UNAUDITED).
- ----------------------------------------------------------------------------
OPERATING REVENUES. The Company's operating revenues enjoyed strong
growth in the first six months of 1999 as compared to the first six months of
1998. Operating revenues for the first six months of 1999 totaled HK$115,367,000
(US$14,867,000) compared to HK$92,381,000 (US$11,905,000) in the first six
months of 1998, representing an increase of 25%. Operating revenues derived by
the Company's fitness services increased 27% to HK$79,397,000 (US$10,232,000)
compared to HK$62,644,000 (US$8,073,000) in the first six months of 1998.
Fitness revenues as a percentage of total revenues were 69% in the first six
months of 1999 as compared to 68% in the first six months of 1998.
Operating revenues from the Company's beauty treatment business totaled
HK$35,955,000 (US$4,633,000) compared to HK$29,694,000 (US$3,827,000) in the
first six months of 1999, representing an increase of 21%. Beauty treatment
revenues as a percentage of total revenues were 31% in the first six months of
1999 as compared to 32% in the first six months of 1998.
15
<PAGE>
OPERATING EXPENSES. The Company's operating expenses for the first six
months of 1999 totaled HK$99,731,000 (US$12,851,000) compared to HK$79,459,000
(US$10,240,000) in the first six months of 1998, representing an increase of
26%. The increase in operating expenses was primarily due to higher salaries and
commissions as a result of increased revenues and additional costs incurred by
the new center which opened in July 1998. Total operating expenses, after taking
into account all corporate expenses, were 86% of total operating revenue,
representing the same level of the first six months of 1998.
TOTAL NON-OPERATING EXPENSES (INCOME). Total non-operating expenses
(income) for the first six months of 1999 totaled a net expense of HK$1,349,000
(US$174,000) compared to a net expense of HK$1,586,000 (US$204,000) in the first
six months of 1998, representing a decrease of 15% due to lower interest
expenses incurred.
PROVISION FOR INCOME TAXES. Provision for income taxes for the first
six months of 1999 totaled HK$3,294,000 (US$425,000) compared to HK$2,400,000
(US$309,000) in the first six months of 1998, representing an increase of 37%.
The increase was mainly due to the increase in taxable income. The effective tax
rate of operating income was 23% as compared to 21% of last year.
NET INCOME. The Company's net income for the first six months of 1999
totaled HK$10,270,000 (US$1,323,000) compared to HK$8,603,000 (US$1,109,000) for
the first six months of 1998, representing an increase of 19%. The net income
margin in the first six months of 1999 was 9%, same as last year.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations primarily through cash
generated from operations, short-term bank credit, long-term bank loans, long
term loans from minority shareholders of subsidiaries, advances from customers
relating to prepaid fitness and spa income, and leasing arrangements with
financial institutions.
Cash and cash equivalent balances for the respective periods ended June
30, 1999 and December 31, 1998 were HK$7,228,000 (US$931,000) and HK$1,721,000
(US$222,000), while total indebtedness at June 30, 1999 was HK$29,493,000
(US$3,800,000) and HK$30,417,000 (US$3,920,000) at December 31,
1998.
Net cash provided by operating activities were HK$47,075,000
(US$6,066,000) and 24,499,000 (US$3,156,000) for Fiscal Year 1998, and the
six-month period ended June 30, 1999, respectively. The Company's operating
activities are historically financed by cash flows from operations. Net cash
used in investing activities were HK$37,700,000 (US$4,858,000) and HK$17,954,000
(US$2,314,000) for Fiscal Year 1998 and the six-month period ended June 30,
1999, primarily as a result of expenditures for property, plant and equipment.
Net cash used in financing activities, which mainly include proceeds from bank
loans, net interest and repayment, were HK$9,593,000 (US$1,236,000) and
HK$564,000 (US$72,000) in Fiscal Year 1998 and the six-month period ended June
30, 1999, respectively.
16
<PAGE>
In November 1997, the Company entered into a banking facility
arrangement with Shanghai Commercial Bank Limited. The Company replaced a term
loan of HK$1,000,000 (US$129,000) with a new loan of the same amount repayable
by sixty (60) equal monthly installment payments commencing November, 1997. The
Company also obtained a new term loan in the amount of HK$2,500,000(US$322,000)
repayable in one lump sum on November 3, 1999. The loans are collectively
secured by leasehold property in Hong Kong owned by relatives of Mr. Luk. No
consideration has been paid by the Company for such security.
In March 1999, the Company obtained a new loan from Shanghai Commercial
Bank Limited in the amount of HK$2,800,000 (US$361,000) for securing a bank
guarantee on the rental deposit in favor of the landlord of the new premises in
Hong Kong. The loan is halfly repayable by twelve (12) equal monthly
installments and halfly repayable in one lump sum on May 24, 2000. The loan is
secured by a fixed deposit in the amount of HK$2,800,000 (US$361,000) pledged by
the Company.
In March, 1997 the Company entered into a capital lease agreement with
the Hongkong and Shanghai Banking Corporation Limited for the purchase of
exercise equipment in the amount of HK$7,432,320 (US$958,000)for the centers in
Hong Kong. The lease is repayable in sixty (60) monthly installments, commencing
April, 1997. In May, 1997 the Company entered into a capital lease agreement
with East Asia Finance Company, Limited for the purchase of exercise equipment
in the amount of HK$7,742,000 (US$998,000) for the Hong Kong centers. The lease
is repayable in thirty (30) monthly installments, commencing May, 1997.
The Company has revolving lines of credit with three banks - The
Kwangtung Provincial Bank, Dao Heng Bank, and Shanghai Commercial Bank Limited.
As of June 30, 1999, the Company has utilized HK$4,585,000 (US$591,000) of these
lines of credit. The Company draws down from the lines of credit primarily for
general working capital purposes. The lines of credit contain covenants
requiring the maintenance of minimum net worth.
Consistent with the general practice of the fitness and spa industry,
the Company receives prepaid memberships to fitness facilities, which are
non-refundable, and spa treatment dues from its customers. This practice creates
working capital that the Company generally utilizes for working capital
purposes. However, the unused portion of the pre-paid membership and spa
treatment dues is characterized as deferred income, a current liability, for
accounting purposes.
The Company's trade receivable balance at June 30, 1999, was
HK$7,430,000 (US$957,000). The Company has never experienced any significant
problems with collection of accounts receivable from its customers.
Capital expenditure for fiscal year 1998, and the six-month period
ended June 30, 1999, were HK$38,416,000 (US$4,951,000) and HK$18,094,000
(US$2,332,000) respectively. The Company believes that cash flow generated from
its operations and its existing credit facilities should be sufficient to
satisfy its working capital and capital expenditure requirements for at least
the next 12 months.
YEAR 2000 DISCLOSURE
The Year 2000 Issue is the result of computer programs being written
using two digits rather than four digits to define the applicable year. Computer
programs that have sensitive software may recognize a date using "00" as the
year 1900 rather than the year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar normal business activities.
The Company underwent a system redevelopment project to improve the
efficiency of the system with respect to changing its computer programs to
properly identify a year in the year field. The new system which is year 2000
compliant was implemented by July 1, 1999.
17
<PAGE>
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
NONE
ITEM 2 - CHANGES IN SECURITIES
NONE
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
NONE
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS
NONE
ITEM 5 - OTHER INFORMATION
NONE
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
Form 8-K, Item. 4 Change in Registrant's Certifying Accountant,
was filed in July, 1999.
18
<PAGE>
SIGNATURES
Pursuant to the requirements of the Exchange Act, the registrant has
duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
PHYSICAL SPA & FITNESS, INC.
(Registrant)
Date: August 12, 1999 /S/Ngai Keung Luk
----------------------------------
Ngai Keung Luk,
Chairman and Chief Executive Officer
Date: August 12, 1999 /S/ Robert Chui
----------------------------------
Robert Chui,
Chief Financial Officer
19
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 931
<SECURITIES> 0
<RECEIVABLES> 957
<ALLOWANCES> 0
<INVENTORY> 322
<CURRENT-ASSETS> 6,221
<PP&E> 2,727
<DEPRECIATION> 0
<TOTAL-ASSETS> 23,935
<CURRENT-LIABILITIES> 11,155
<BONDS> 0
0
0
<COMMON> 10
<OTHER-SE> 9,365
<TOTAL-LIABILITY-AND-EQUITY> 23,935
<SALES> 14,867
<TOTAL-REVENUES> 14,867
<CGS> 0
<TOTAL-COSTS> 12,852
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 204
<INCOME-PRETAX> 1,841
<INCOME-TAX> 425
<INCOME-CONTINUING> 1,416
<DISCONTINUED> 0
<EXTRAORDINARY> (93)
<CHANGES> 0
<NET-INCOME> 1,323
<EPS-BASIC> .13
<EPS-DILUTED> .13
</TABLE>
