<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
[x] Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 [Fee Required]
For the fiscal year ended December 31, 1998
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 [No Fee Required]
For the transition period from ____________________ to __________________
Commission file number 333-38697
---------
PHYSICAL SPA & FITNESS, INC.
- --------------------------------------------------------------------------------
(Exact name of small business issuer in its charter)
DELAWARE 13-1026995
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
12/F - 15/F Lee Theatre Plaza
99 Percival St., Causeway Bay
Hong Kong Not applicable
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 011 8522 572-8888
-------------------
Securities registered pursuant to Section 12(b) of the Act: None
----------------
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
------------------------------
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 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 NO X
----- -----
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B is not contained in this form, and no disclosure will
be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in part III of this Form 10-K
or any amendment to this Form 10-K. [ ]
State issuer's revenues for its most recent fiscal year: $27,123,000
The aggregate market value of the voting stock held by non-affiliates
of the registrant as of June 18, 1999 was $300,000 based upon the average of the
bid and asked price of the Common Stock of $0.15 as of June 18, 1999.
The number of shares outstanding of the issuer's classes of Common
Stock as of June 1, 1999: 10,000,000
Common Stock, $.001 Par Value 10,000,000 shares
DOCUMENTS INCORPORATED BY REFERENCE: NONE
<PAGE>
PART I
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.
ITEM 1. DESCRIPTION OF BUSINESS
BACKGROUND OF THE COMPANY
Physical Spa & Fitness, Inc. (the "Company"), through its subsidiaries,
operates fitness and spa centers in Hong Kong and the People's Republic of China
("China" or the "PRC"). The Company currently operates eleven facilities: eight
in Hong Kong and three in China under the name "Physical Ladies' Club", with the
exception of two centers (Mei Foo and Renaissance Beauty Centre - see "Company
Organization"). All of the Company's operations, including the operating of the
fitness and spa centers, property holding, investment holding and other
corporate activities are conducted through the Company's wholly-owned or
majority-owned subsidiaries or joint ventures. See "Business of the Company
Organization". The fitness and spa centers in Hong Kong are operated by two of
the Company's subsidiaries. Physical Health Centre Hong Kong Limited, a Hong
Kong corporation and a majority (91.4%) owned subsidiary of the Company,
operates the following centers in Hong Kong: Causeway Bay, Tsimshatsui, Shatin,
Mei Foo, Kowloon City, Tsuen Wan (opened in July, 1988) and Sheraton Hotel,
Tsimshatsui (opened in mid-1999). The eight center, Renaissance Beauty Centre,
is operated by the Company's majority (70%) owned subsidiary, Supreme Resources
Limited, a Hong Kong corporation.
The Company's facilities in China are operated by two joint ventures:
Shanghai Physical Ladies' Club Co., Ltd. ("Shanghai Joint Venture"), which
operates two centers in the city of Shanghai, and Dalian Physical Ladies' Club
Co., Ltd. ("Dalian Joint Venture"), which operates fitness and spa facility in
the city of Dalian. The Company, through its subsidiaries, holds a 88.5%
interest in the Shanghai Joint Venture and a 90% interest in the Dalian Joint
Venture. The minority interest in the respective joint ventures is held by the
joint venture's Chinese partner. China regulations of the fitness and spa
facilities encourage joint ventures with a foreign company and provide less
restrictive regulations of such form of business entities. See "Government
Regulation - China".
The Company provides its customers, at each location, with access to a
wide range of U.S.- styled fitness and spa services. The Company offers to its
customers a membership for the use of its fitness facilities, which include
extensive aerobics programs, personalized training, cardiovascular conditioning
and strength training. The facilities are equipped with the latest in Western
exercise equipment, including LifeFitness, Cybex, Flex and Reebok Skywalker. Spa
and beauty treatment services are provided to both members and visitors, and
include skin care and facial treatments, massage, relaxation programs,
weight-management programs and personalized make-up consultations. The Company
also sells at the facilities a variety of exercise clothing and European beauty
products and cosmetics. Based on the number of the Company's facilities members,
management believes that the Company is among the top providers of fitness,
exercise, and spa/beauty treatment services in Hong Kong and China, with
approximately 55,000 members.
<PAGE>
The Company's strategy is to provide a one-stop fitness and beauty
center for women. With the exception of the Mei Foo location in Hong Kong, all
other facilities in Hong Kong and China are exclusively for women. Management
believes that the Company's strong market presence in Hong Kong and its
successful entrance into China's market is a result of its strategy of combining
fitness and beauty services in a single facility that offers state-of-the art
exercise equipment, high quality beauty treatments and professional staff.
The Company believes that it is one of the first companies to provide
Western fitness and spa services in China. In 1994, the predecessor companies of
Physical Beauty & Fitness Holdings Limited, a British Virgin Islands corporation
("Physical Limited"), the holding company of the Company's subsidiaries, began a
process of expansion into targeted market segments in China. In 1994, the
Company through Shanghai Joint Venture opened the Company's first China
operation in Huangpu, Shanghai, with a fitness center comprising of
approximately 15,000 square feet to provide fitness and spa treatment
facilities. Since then the center has been operating profitably, and another
center of similar size was opened in Hongqiao, Shanghai in September 1995,
through Shanghai Joint Venture. A third China operation in Dalian commenced in
April 1996 and is conducted through Dalian Joint Venture. See "Business of the
Company - Organization". The Company's facilities in China are operated under
the name "Physical Ladies' Club", and the Company registered a servicemark under
that name in Chinese language, which precludes others from the use of the same
name. See "Business of the Company - Trademarks and Trade Names".
In the opinion of the Company's management, current competition in China
is, in general, comprised mainly of government operated facilities that offer
either fitness or beauty services, in small facilities that lack modern
equipment. The Company is aware of no Western quality facilities of comparable
size to that of the Company's facilities currently operating in China. The
Company expects that rising consumer incomes, increasing health awareness and
growing access to foreign goods and trends, should continue to create increased
demand for fitness and spa services in China. In 1996, the Company (through its
subsidiaries) entered into two additional joint ventures to open fitness and spa
facilities in Zhongshan (Zhongshan Joint Venture) and Shenzhen (Shenzhen Joint
Venture), China, however, such joint ventures have not commenced any operations
yet. The Company explores the possibilities of opening the centers in Zhongshan
and Shenzhen in the future, however, there can be no assurances given that such
joint ventures will start operations or that such centers will be opened as
currently contemplated by the management. See "Business of the Company -
Business Strategy".
The Company's strategy for maintaining its strong presence in Hong Kong
is to continue to provide existing and new members with high quality services at
an affordable price and by periodically upgrading the facilities as new
developments and technology emerge in the industry. The Company's objective is
to add new services and treatments to keep the Company current with market
trends and to promote and enhance the Company's reputation of providing value-
driven services to its customers. The Company places heavy emphasis on staff
training which is supported by an in-house training department and on-going
classes. The Company opened a new center a new center in Tsuen Wan, a major
district of the Western Kowloon province of Hong Kong in July, 1998 and
additional facilities in Sheraton Hotel, Tsimshatsui, Hong Kong in mid-1999. See
"Business of the Company - Properties".
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. Prior to acquisition of 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"). Subsequently, the Company changed its name to "Physical Spa &
Fitness Inc." in November, 1996, to reflect the new business operations of the
Company. As a part of the above transaction, certain shareholders of the Company
also transferred 990,000 shares of Common Stock to Goodchild Investments
Limited, a British Virgin Islands corporation ("Goodchild"). Goodchild
subsequently disposed of its shares. See "Certain Transactions". Neither Ngai
Keung Luk (Serleo) nor Goodchild were parties affiliated with the Company prior
to or at the time of the acquisition of Physical Limited. At the Closing the
then current management of the Company resigned and was replaced by the current
management of the Company. See "Management."
<PAGE>
The Company effected a 1.333333-for-1 reverse split of its common stock
in October 1997 and a 1-for-1.333333 forward split of its common stock in June
1998. All references in this Report to shares of Common Stock of the Company
have been adjusted for the effects of the reverse stock split and forward stock
split.
The Company maintains its executive and administrative office Hong Kong
at:
Lee Theatre Plaza 12/F - 15/F
99 Percival St., Causeway Bay, HONG KONG
The telephone number of the Company in Hong Kong is (852) 2572-8888.
Unless the context requires otherwise, as used herein, any reference to the
Company includes the Company's subsidiaries Physical Beauty & Fitness Holdings
Limited, Physical Health Centre Hong Kong, Ltd., Regent Town Holdings Ltd.,
Mighty System Ltd., Supreme Resources Ltd., Physical Health Centre (Zhong Shan)
Ltd., Zhongshan Physical Ladies' Club, Ltd., Ever Growth Ltd., Proline Holdings
Ltd., Shanghai Physical Ladies' Club Company Ltd., Shanghai Physical Ladies'
Club Co., Ltd., Jade Regal Holdings Ltd., Physical Health Centre( Dalian) Ltd.,
Dalian Physical Ladies' Club Co. Ltd., Star Perfection Holdings Ltd., Physical
Health Centre (Shenzhen) Ltd., and Shenzhen Physical Ladies' Club Company Ltd.,
Physical Health Centre (Tsuen Wan) Limited, Physical Health Centre (Macau)
Limited, Physical Health Centre (TST) Limited. See also "Business of the Company
- Organization".
<PAGE>
THE COMPANY'S BUSINESS
General
The Company's fitness and spa centers are located in or near urban areas
in highly populated areas of Hong Kong and major metropolitan cities in China
and most of them are operated under long-term leases. With the exception of Mei
Foo center, a portion of which is owned by the Company (see "Business
Properties"), the Company does not own the real property on which the centers
are located, but owns the leasehold improvements and equipment with respect to
each center. Generally, the Company's centers average 20,000 square feet and
include a workout area including a broad range of fitness equipment, changing
room, sauna and steam facilities and a separate area devoted exclusively to
professional spa and beauty treatment programs. Each center typically includes a
laser TV room with lounge, health drink bar and sells a range of exercise
clothing, European beauty products and cosmetics.
The Company's strategy is to grow through expansion of its fitness and
spa facilities in Hong Kong and China, as well as to explore the opportunities
for its fitness and spa services in other countries of Far East. The Company
intends to build on its 11-year continuous operating presence in Hong Kong, the
relationships in China established by the Company's executives and senior staff
and the Company's policy of offering what it believes are the state-of-the-art
exercise and spa facilities and beauty treatments at affordable prices in their
respective markets. In addition, the Company is closely monitoring potential
opportunities in the Philippines, Taiwan, Malaysia and Indonesia.
Organization
- ------------
The Company's operations are conducted through its subsidiaries in Hong
Kong and Sino-foreign joint ventures in China. A number of the Company's
subsidiaries have been incorporated in the British Virgin Islands, primarily for
tax reasons. Such structure provides greater flexibility for the Company in
obtaining tax benefits, especially in case of corporate accounts. Set forth
below is the description of the Company's subsidiaries and their respective
roles in the organizational structure of the Company.
<PAGE>
<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 Limited")
Limited")
Physical Health Centre Hong Kong March 2, 1990 Hong Kong 91.4% - Operating 5 Fitness
Limited ("Hong Kong Limited") Centres in Hong Kong
Regent Town Holdings Limited September 20, 1993 BVI 92.5% - Investment holding
("Regent")(1)
Supreme Resources Limited ("Supreme") September 29, 1994 Hong Kong 70% - Operating a beauty treatment center
in Hong Kong
Physical Health Centre (Zhong Shan) September 29, 1994 Hong Kong 100% - Investment holding
Limited ("Zhongshan Physical") (formerly operating a
formally known as Famerich beauty treatment center in
Development Limited) in Hong Kong
Zhongshan Physical Ladies' Club Ltd. October 29, 1996 The PRC - 95% Operating a Fitness Centre in
(owned by Zhongshan Physical) in Zhongshan, the PRC
Ever Growth Limited ("Ever Growth") September 29, 1994 Hong Kong 100% - Property holding
Proline Holdings Limited ("Proline") September 28, 1994 BVI - 92.5% Investment holding
(wholly owned by Regent)
Shanghai Physical Ladies' Club Company September 28, 1994 Hong Kong - 92.5% Investment holding
Limited ("Shanghai Physical")
(wholly owned by Proline)
Shanghai Physical Ladies' Club Co., Ltd. September 28, 1994 The PRC - 92.5% Operating two Fitness Centres in
(owned by Shanghai Physical) in Shanghai, the PRC
Mighty System Limited ("Mighty") December 15, 1994 BVI 100% - Provision of marketing services for
cosmetic sales
Jade Regal Holdings Limited ("Jade March 15, 1994 BVI 100% - Investment holding
Regal")
Physical Health Centre (Dalian) Limited March 15, 1996 Hong Kong - 100% Investment holding
(Dalian Physical") (wholly
owned by "Jade Regal")
Dalian Physical Ladies' Club Co., Ltd. March 15, 1996 The PRC - 90% Operating a Fitness Centre in
(90% owned by Dalian Physical) in Dalian, the PRC
Star Perfection Holdings April 15, 1996 BVI 100% - Investment holding
Limited ("Star Perfection")
Physical Health Centre (Shenzhen) April 15. 1996 Hong Kong - 100% Investment holding
Limited ("Shenzhen Physical")
(wholly owned by Star
Perfection)
Shenzhen Physical Ladies' Club Co. Ltd. August 16, 1996 PRC - 90% Operating a Fitness Centre in
(owned by "Shenzhen Physical") in Shenzhen, PRC
Physical Health Centre March 21, 1997 Hong Kong 100% - Investment holding,
(Macau) Limited* ** Operating a Macau Centre
Physical Health Centre ** September 8, 1997 Hong Kong 100% - Operating a Fitness Centre
(Tsuen Wan) Limited in Hong Kong
Physical Health Centre ** June, 1998 Hong Kong 100% - Operating a Fitness Centre
(TST) Limited in Hong Kong
- -------------------
</TABLE>
<PAGE>
(1) See Notes to the Financial Statements * Proposed new center; not opened yet.
** Not shown on the organizational chart.
The Company opened new centers in Tsuen Wan in July, 1998 and Sheraton Hotel,
Tsimshatsui,Hong Kong in mid-1999.
See also "Company - Properties". The Company's
organizational chart is set forth below on the next page.
<TABLE>
<CAPTION>
ORGANIZATION CHART OF PHYSICAL SPA & FITNESS, INC.
--------------------------------------------------
Physical Spa & Fitness, Inc.
US
|
| 100%
|
Physical Beauty & Fitness
Holdings Limited
BVI
|
|
<S> <C> <C> <C> <C> <C> <C> <C>
- ---------------------------------------------|----------------------------------------------------
|92.5% |100% |100% |91.40% |70% |100%* |100%* |100%
- ----------- --------- ---------- -------------- ---------- ---------- ------------ -----------
Regent Town Mighty Jade Regal Physical Health Supreme Star Physical Ever Growth
Holdings System Holdings Centre Resources Perfection Health Limited
Limited Limited Limited Hong Kong Limited Holdings Centre
Limited Limited (Zhong Shan)
Limited
BVI BVI BVI HK HK BVI HK HK
- ----------- --------- ---------- -------------- ---------- ---------- ------------ -----------
| | | | | | |
|100% |100%* |100% |100% |100%* |95% |100%
Proline Holdings Physical Health | | Physical Health | |
Limited Centre (Dalian) | | Centre (Shenzhen) | |
Limited | | Limited | |
BVI HK | | HK | |
- ----------- ---------- | | ----------- | |
| | | | | | |
|100%* |90% | | |90% | |
Shanghai | | | | | |
Physical | | | | | |
Ladies' Club | | | | | |
Company | | | | | |
Limited | | | | | |
HK | | | | | |
|100% | Causeway Bay | | | |
| | Tsimshatsui | | | |
Shanghai Dalian Shatin Renaissance Shenzhen Zhongshan Property in
Joint Joint Mei Foo Beauty Joint Joint Mei Foo
Venture Venture Kowloon City Centre Venture Venture
(Central Branch)
Operation
* 50% held by one nominee shareholder. Since the Companies Ordinance of Hong
Kong requires a minimum of 2 shareholders for each limited company, Mr. Luk
holds the remaining shares on behalf of Physical Beauty & Fitness Holdings Ltd.
</TABLE>
<PAGE>
<TABLE>
OWNERSHIP STRUCTURES IN CHINA
The organizational structure of the Company's operations in China is set forth below.
<CAPTION>
TYPE OF INTERESTS PROFIT
NAME OF THE JOINT OWNED BY THE TERM OF THE REGISTERED SHARING
JOINT VENTURE LOCATION VENTURE COMPANY JOINT VENTURE CAPITAL* ARRANGEMENT
Foreign Chinese
partner partner
------- -------
<S> <C> <C> <C> <C> <C> <C>
Shanghai Physical Huangpu and Co-operative 92.5%(1) 10 years Originally See Shanghai Joint Venture below
Ladies' Club Co., Hongqiao, (exp. 2003) US$1000 in
Ltd. ("Shanghai Shanghai cash and
Joint Venture") increased to
US$2000 in
cash in 1995
Dalian Physical Dalian Equity Originally 12 years Originally Pro-rata to equity interests
Ladies' Club Co., 55% and (exp. 2007) Rmb10,000 in
Ltd. ("Dalian changed to cash and
Joint Venture") 90% in 1996 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 in Pro-rata to equity interests
Ladies' Club Co., (exp. 2006) form of cash
Ltd. ("Shenzhen and fixed
Joint Venture")** assets
Zhongshan Physical Zhongsan Equity 95% 10 years US$500 in Pro-rata to equity interests
Ladies Club Co., Ltd. (exp. 2006) form of cash
("Zhongshan and fixed
Joint Venture")** assets
</TABLE>
- -------------------------------------------------------
(1) See Notes to the Financial Statements.
* In thousands
** Those joint ventures have not commenced operations yet. See below.
SHANGHAI JOINT VENTURE. The Shanghai Joint Venture is a Sino-foreign
cooperative joint venture established on September 7, 1993 in Shanghai, China.
The Chinese joint venture partner is a state-owned enterprise in the PRC,
Shanghai Ti Yu Guan (SHTYG). Shanghai Physical Ladies' Club Company Limited, a
Hong Kong corporation ("Shanghai Physical") authorized Physical Health Centre
Hong Kong Limited, a Hong Kong corporation, to enter into a joint venture
contract with SHTYG. The joint venture period is 10 years from the date of issue
of the business license on September 7, 1993. SHTYG is paid rent of RMB950,000
for the first 3 years of the joint venture. Rent for the fourth to tenth years
will be 110% of the preceding year, except where the inflation rate in the PRC
exceeds 16% in which case, the rental increase would be indexed to the inflation
rate.
DALIAN JOINT VENTURE. On April 11, 1995, Physical Health Centre
(Dalian) Limited, a Hong Kong corporation ("Dalian Physical") formed a
Sino-foreign equity joint venture with a Chinese enterprise to operate a
fitness/ spa center in Dalian, China. The joint venture period is 12 years from
the issue of the business license on April 11, 1995. The equity interest of
Dalian Physical is 90% and the Chinese joint venture partner's equity interest
is 10%. The joint venture commenced effective operations in April 1996.
<PAGE>
ZHONGSHAN JOINT VENTURE. In June 1996, Physical Health Center (Zhong
Shan) Ltd. ("Zhongshan Physical"), entered into a joint venture contract, as
supplemented in August, 1996, with a Chinese enterprise in Zhongshan, China to
establish a Sino-foreign cooperative joint venture for the provision of fitness
and spa services. The joint venture period is 10 years from issue date of the
business license on October 29, 1996. The Chinese joint venture partner will be
entitled to HK$30,000 per annum in the form of a technology introduction fee.
The Chinese joint venture partner will not be entitled to share in profits after
receipt of the technology introduction fee. All the benefits and liabilities of
the joint venture will be assumed by Zhongshan Physical. The agreement is
subject to approval by relevant PRC authorities in Zhongshan. As of the date of
this report, however, both joint venture partners have not contributed the
required capital according to the requirements of the contract. Such default in
the funding obligations will require renegotiations between the two partners and
may also trigger default remedies as specified in the joint venture contract.
Further, a failure to meet regulatory time limits set by the State
Administration of Industry and Commerce for capital contributions could result
in the cancellation of the approval of the joint venture's business license.
Both joint venture partners are in the process of applying to the relevant
authorities for an extension of such time limits. The joint venture has not yet
commenced operations as of this date.
SHENZHEN JOINT VENTURE. In 1996, Shenzhen Physical Ladies' Club Co.,
Ltd., entered into a joint venture contract with a Chinese enterprise in
Shenzhen, China to establish a Sino-foreign cooperative joint venture for the
provision of fitness and spa services. According to the laws in the PRC and the
terms of the joint venture contract, both joint venture partners are obliged to
fulfill their capital contribution requirements into the joint venture within a
specified period of time after the issue of the business license. As of the date
of this Report, however, both joint venture partners have not contributed the
required capital according to the requirements of the contract. Such default in
the funding obligations will require renegotiations between the two partners and
may also trigger default remedies as specified in the joint venture contract.
Further, a failure to meet regulatory time limits set by the State
Administration of Industry and Commerce for capital contributions could result
in the cancellation of the approval of the joint venture's business license.
Both joint venture partners are in the process of applying to the relevant
authorities for an extension of such time limits.
Since Shanghai Joint Venture and Dalian Joint Venture operate in China,
they are subject to special considerations and significant risks not typically
associated with investments in equity securities of the United States or Western
European countries.
OVERVIEW OF THE COMPANY'S MARKETS
HONG KONG
- ---------
FITNESS
- -------
The concept of preventive health care and physical fitness, which
became popular in Hong Kong in the early 1980's, was introduced from the United
States and Europe. With the growing affluence of the local population and
improvement in their standard of living, people began to immerse in physical
exercise to maintain a fit and healthy body. The fitness trend grew in Hong Kong
and gained popularity within the high income group initially.
To cater to this new industry, a number of fitness centers were
established in Hong Kong which provided a variety of exercise equipment as well
as aerobic dance classes. Private clubs (dining clubs, marina clubs,
entertainment clubs) targeted towards the upper income group also began to
provide similar services to their members or expanded their existing facilities.
<PAGE>
The majority of these fitness centers targeted the high income group,
were very exclusive, and entrance fees or membership fees were generally high.
Under this marketing strategy, these fitness centers were restricted to a
comparatively small number of potential customers. Additionally, some of these
fitness centers were affected by the migration boom of Hong Kong in the mid
1980's. At that time, a large number of professionals migrated from Hong Kong to
other countries to pursue educational and economic opportunities. This migration
boom affected the customer base of these fitness centers and thus decreased the
viability of their business. As a result, fitness centers targeting the high
income group in Hong Kong were vulnerable and underwent a period of
consolidation. Later on, as the market developed, a market niche emerged for
fitness centers catering to the middle income group.
SPA
- ---
The spa industry in Hong Kong, which includes the skin care or beauty
industry, is rather fragmented with a large number of small operations. It is
common that certain spa and beauty treatments are provided by a wide range of
establishments including beauty salons, hair salons, and even cosmetic counters
situated in department stores. The standard of services for beauty treatments
varies widely. Normally, the customer base of these operations is confined to a
relatively limited number of frequent customers. Exclusive private clubs that
cater to a small percentage of wealthy Hong Kong women and the inconsistent
quality and skill level of small operations have increased the demand for middle
market skin care treatments in the recent years.
CHINA
- -----
FITNESS
- -------
In China, the concept of physical fitness has a long history, but it was
not widely practiced, except by the 50+ generation. Even China's famous Tai' Chi
is seldom practiced by young people. Organized sports for recreation are more
popular, though sports centers are in the Management's opinion generally ill
equipped and out of date. It appears that intensive training in a particular
sport is only available to a minority of people. Physical fitness centers are
usually in the form of gymnasiums run by state-owned sports authorities.
A handful of small clubs with standard facilities have opened in recent
years, but offer, in the Management's opinion, a limited selection of locally
made, out- of-date equipment (as compared to the equipment used in the Company's
centers). Such facilities are frequented by more men than women, as they tend to
be equipped with barbells and weights.
The Company believes that aerobics is gaining popularity with the recent
influx of follow-along television programs. The Management observed that the
overall improved lifestyle; availability of fast food and convenience foods,
increased spending power, and increasingly sedentary lifestyles of Chinese
people, has led to a widespread concern for weight control. The Management
believes that aerobics especially appeals to women in China, as large
percentages of women seem to be concerned with losing weight.
A number of five-star hotels in China have luxury spas and fitness
centers, well-equipped with the latest brands of Western-styled exercise
machines (as compared to the Company's facilities). However, the Management
believes that the exorbitant fees (in the Company's opinion) prevent any
significant competitive impact on the industry. Private dining clubs have become
increasingly popular throughout China in the recent years, and usually include
small fitness and beauty centers. However, the Company believes that as the
focus of these clubs is usually dining, drinking, karaoke and entertainment,
they have contributed insignificantly to the industry. (See "Competition")
<PAGE>
SPA
- ---
The Company noted that Western-styled spa and beauty treatments has
become increasingly common and popular in China. Home-treatments, using
cosmetics purchased in department stores, have also become very common. However,
in the Management's opinion standards of skill and hygiene tend to be poor, as
is the quality of products used, as compared to those provided by the Company's
centers.
In recent years, several Hong Kong and Japanese companies have entered
the market with small, limited service salons. Several internationally
recognized skin care lines, such as Dior, Channel and Elizabeth Arden have
recently become available in department stores. Those department stores often
hold in-house promotions to demonstrate their products and educate potential
customers. It appears that the desire to own anything imported, including
cosmetics, is considered prestigious and is therefore highly desired by Chinese
women. The Management noticed that the demand for "foreign" spa treatments and
beauty salons, and imported products is high. The local and international media
is introducing fitness and skin care news to a growing receptive audience. The
Company believes that the demand for affordable, value-driven beauty and skin
care has increased.
HISTORY
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. 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 early 1991, the Company was planning to become a
public company and issued 750,000 shares of common stock with certain
registration rights to an unrelated corporation for services in connection with
the Company's efforts to become a public company. That corporation, in turn
distributed the 750,000 shares as dividends to its shareholders. The Company has
not filed a registration statement as originally planned and the shares became
free trading pursuant to Rule 144, after the expiration of the applicable
restrictive period. 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). Physical
Limited was incorporated on March 8, 1996 under the laws of British Virgin
Islands and has interests in various companies operating fitness and beauty
centers and other related businesses in Hong Kong and China (see "Company-
Organization"). Pursuant to the Share Exchange Agreement, 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"). Subsequently,
the Company changed its name to "Physical Spa & Fitness Inc." in November, 1996,
to reflect the new business operations of the Company. As a part of the above
transaction, certain shareholders of the Company also transferred 990,000 shares
of Common Stock to Goodchild Investments Limited, a British Virgin Islands
corporation ("Goodchild"). Goodchild subsequently disposed of its shares. See
"Certain transactions". Neither Ngai Keung Luk (Serleo) nor Goodchild were
parties affiliated with the Company prior to or at the time of the acquisition
of Physical Limited. At the Closing the then current management of the Company
resigned and was replaced by the current management of the Company. See
"Management."
<PAGE>
In 1986, the founder and principal shareholder of the Company, Ngai
Keung Luk (Serleo), set up the first fitness center under the name of "Physical
Health Club" with the objective of providing physical fitness and spa treatment
services at prices which could be afforded by a rapidly growing middle class
population in Hong Kong. Two years later in 1988, another center was founded
under the name of "Physical Ladies' Club" in Hong Kong. The businesses of these
centers were operated in a form of a sole proprietorship and were subsequently
transferred to Physical Health Centre Hong Kong Limited, a Hong Kong corporation
established on March 2, 1990 ("Hong Kong Limited"). During the period from 1990
to 1996, Hong Kong Limited and Physical Limited expanded their scope of
operations by acquiring and establishing several subsidiaries and by forming
Sino- foreign joint ventures in China to operate six additional fitness/spa
centers in Hong Kong, three in China and other related businesses (see "Company
- - Organization"). The subsidiary companies were all formerly owned by Mr. Luk
and other principal shareholders, or solely by Mr. Luk. The respective equity
interests were transferred by Mr. Luk and other principal shareholders to Hong
Kong Limited or Physical Limited throughout 1993 to 1996 at the original cost of
the respective investments. In October, 1996, 91.4% of the equity interests of
Hong Kong Limited was transferred by the principal and other shareholders
(including Mr. Luk) to Physical Limited at the par value of the shares
transferred. In addition, all the equity interests of Hong Kong Limited in
various subsidiaries and Sino-foreign joint-ventures were also transferred to
Physical Limited at the recorded cost of these investments.
HONG KONG
The first facility was opened in the Mei Foo Sun Chuen area of Hong
Kong, which has a population of approximately 680,000. The Company's first
center offered fitness training and spa treatment facilities at a price thought
to be affordable by its target middle-class customers. The Mei Foo Center
operates under a membership basis and is open to both male and female customers
and is the Company's only center that has male members. The Mei Foo Center
proved profitable and within a year, it had enrolled more than 700 members and
1,000 clients for spa treatments. In 1990 the Mei Foo Center was expanded by
acquiring by the Company's subsidiary an additional 700 square feet, immediately
above the existing facility, resulting in a total of 8,000 square feet. The Mei
Foo center operates under the name "Physical Health Club".
The second fitness and spa center under the name "Physical Ladies' Club"
was opened in July 1988 on Nathan Road, Tsimshatsui, Kowloon, which is one of
the busiest commercial and entertainment areas in the Kowloon area of Hong Kong.
The Tsimshatsui Center, consisting at that time of 12,000 sq. ft. (currently
expanded to 25,000 sq. ft) is, to the best of the Management's knowledge, to be
the first fitness and spa center to provide high quality, Western-styled
professional services for fitness training and spa treatment for middle income
women customers in Hong Kong. Tsimshatsui Center within a year of its opening,
had approximately 2,000 fitness members and 2,000 patrons for spa treatments.
In March 1990, the business of Physical Health Club and Physical Ladies'
Club was transferred to, and consolidated under, Hong Kong Limited (see above).
To broaden its geographical diversification, Hong Kong Limited opened
its third fitness and spa center in Causeway Bay Plaza, Causeway Bay in August,
1990. Located in one of the most popular entertainment areas on Hong Kong
Island, the Causeway Bay Center initially occupied a floor space of
approximately 18,000 square feet. In the first year of operation, the Causeway
Bay Center had approximately 5,000 members and 2,000 patrons for spa services.
The Causeway Bay Center experienced an ongoing strong demand for its fitness and
spa services, and the Company relocated the Causeway Bay Center to a new 30,000
sq. ft center in June, 1997.
<PAGE>
In order to cater to the market demand in the New Territories area of
Hong Kong, Hong Kong Limited opened its fourth fitness and spa center in New
Town Tower, Shatin, in September 1992. The Shatin Center is located in a
commercial complex in the heart of the densely populated residential and popular
entertainment areas in the New Territories. It occupies a floor space of
approximately 15,000 square feet. In March 1993, Hong Kong Limited opened
another fitness and spa center of approximately 3,000 square feet in Kowloon
City to provide facilities to members residing in the south-eastern area of
Kowloon.
As a result of a growing demand for upscale facilities and amenities for
spa services in the upper middle market, the Company opened through a newly
formed subsidiary, Supreme Resources Limited (see "Company - Organization"), its
first upscale market spa treatment center; "Renaissance Beauty Centre". The
Renaissance center is situated in an upper income residential area in Central,
Hong Kong and provides spa treatment services.
CHINA
Commencing in the mid-1980's, China commenced market-oriented reforms
that were designed to open up and improve the economy and the Chinese standard
of living. As economic reforms became successful in China and a large,
middle-class market developed, China was targeted as an expansion market where
the success in Hong Kong could be duplicated.
Shanghai, with a booming economy, an influx of foreign investment, and a
population of 14 million, was the logical choice for the Company to start its
first China location. In January of 1994, the Huang Pu branch was opened in one
of Shanghai's busiest shopping districts, through a joint venture company formed
between a Chinese enterprise and a newly formed subsidiary of the Company. The
center has an area of 15,000 sq. ft. , and within the first year there were over
2,000 fitness members and spa clients. Based upon the positive response to the
first facility in Shanghai, the decision was made to open a second Shanghai
branch.
September, 1995 marked the opening of the second center in Shanghai-Hong
Qiao branch in Shanghai, situated in the fashionable Hong Qiao Special Economic
Development Zone. This center contains approximately 12,000 sq. ft. and is
easily accessible to a large residential area and busy commercial district.
In April, 1996, the Company opened its third fitness/spa center in China
in the city of Dalian. Dalian, China, located on the northern peninsula near
Korea, is the third largest seaport in China and has a population of
approximately 5,600,000. Dalian is the fashion capital of China, hosting the
world renowned International Fashion Festival annually, and is also a major
tourist destination. Dalian has seen an influx of foreign investment in the past
several years, and the purchasing power of these citizens ranks high in the
nation. The Company's market research showed a strong existing interest in
fitness and spa services, with few choices available to potential customers.
Within the first six months of opening, Dalian center had over one thousand
fitness members and nearly one thousand spa clients.
BUSINESS STRATEGY
The Company believes that it has a strong reputation in the Hong Kong
and China markets in which it presently operates. This belief is based on
several factors, including continuous operating presence of the Company in Hong
Kong for the past 11 years, and the relationships in China established by the
Company's executives, management and staff over the last several years. The
Company intends to continue its policy of providing what it believes are
first-quality, comprehensive fitness and spa services in their respective
markets at affordable prices.
<PAGE>
The Company seeks to expand its fitness and spa business from the ground
up as opposed to acquiring health and fitness clubs that are poorly managed
and/or financially distressed. The Company believes that the end result of
repositioning an existing center, which typically includes rebuilding a
membership base, renovations, additional equipment leasing, and re-training
existing staff, is less desirable than developing a new center.
The Company intends to build on its momentum, relationships and standard
of quality in several ways. First, the Company intends to expand its presence in
Hong Kong and China through the establishment of new fitness and spa centers in
Hong Kong (see "Business-Organization-Hong Kong") and China (See "Business
Organization - Shenzhen Joint Venture and Zhongshan Joint Venture"), and through
the addition of qualified personnel, including fitness instructors and spa
personnel in the existing facilities. Second, in conjunction with its expansion,
the Company intends to increase the variety of fitness and spa services provided
and products sold on a retail basis at each location. For example, the Company
currently is developing plans to develop corporate and personal fitness training
services in China.
The Company believes that its experience in and knowledge of the fitness
and spa industry in Hong Kong and China, as well as management's continuous
presence in Hong Kong (13 years ) and China (over the past 5 years), positions
the Company to take advantage of perceived opportunities in this market.
Further, demographic developments in Hong Kong and China, continue to create
increasing demand for certain fitness and spa services. In this regard, the
Company opened planned seventh center in Tsuen Wan, Hong Kong in July, 1998 and
another new center in Sheraton Hotel, Tsimatshui, Hong Kong in mid-1999. The
Company also expects to establish additional fitness and spa centers in other
major metropolitan centers in China over the next several years. There is no
assurance that such centers will be opened as currently planned, since they are
subject to changing political and economic conditions, as well as the Company's
evaluation of the applicable market conditions.
- - BECOMING THE MARKET LEADER IN CHINA
In China, the fitness and spa industry is in its formative stage. In
addition there is an image associated with Western luxury consumer goods. The
Company is not aware of any Western-style facilities of comparable size or
competitors in the fitness and spa industry whose market position is more
established than the Company's. Management plans to take advantage of those
circumstances and in doing so, become the first entrant into China market.
The planned expansion into China includes opening facilities in most
major cities and economically developing urban areas throughout the country,
subject to then current market and other conditions. According to the State
Statistic Bureau of China, the population of China is 1.2 billion and there are
currently thirty cities with populations in excess of 1 million. The population
of China is becoming increasingly urbanized, and the tastes of the urban
population is becoming increasingly sophisticated. (Source: Hong Kong Trade
Development Council).
Forty percent of the population of China lives in coastal areas, where
retail sales account for 60% of the country's total retail sales. Population
factors and strong spending power have led the Company to target coastal areas
for the spas to be developed (i.e. Dalian). Facilities can be linked by a
reciprocal membership system, allowing members to use another facility when
traveling to other parts of the country. Marketing programs carried out
nationwide, in the management's opinion, will enable the Company to benefit from
economies of scale, similar to what the Company experiences in Hong Kong.
<PAGE>
- - MAINTAINING A STRONG PRESENCE IN HONG KONG
The Company has well-established customer base and pre-dominant market
share in Hong Kong and opened two new locations in 1998 and 1999 in Hong Kong.
The Board of Directors estimates that over 80 percent of the Company's patrons
are between the age of 20 to 40. Based on the reports of the Hong Kong Census
and Statistics Department, the number of women within the age group of 25 to 45
rose from 850,000 to 1,200,000 between 1986 and mid-1996, representing an
increase of 41%. Management believes that the strong position held in the Hong
Kong market can be maintained by continuously upgrading facilities and services.
The Company monitors this situation continuously, and upgrades the fitness and
spa areas on a regular basis. The number of members in each location is also
carefully monitored in order to ensure adequate levels of service to individual
customers, particularly during peak work-out periods. Branch Managers monitor
the situation through direct observation, customer feedback and surveys.
For spa personnel, intensive training is conducted in the in-house
training center and thorough on-the-job instruction. Selected employees are sent
to France and Italy to study the latest techniques and to learn about new
products on the market. The Company seeks to satisfy its spa clients' needs with
the latest technology, expertise and a high level of service.
- - EXPLORING POTENTIAL MARKETS
The Company considers its market to be the greater Asia region. The
Company is exploring the possibility of opening a new fitness/spa center in
Macau in 1999. Macau is a Portuguese colony strategically located at the mouth
of the Pearl River on the border of China. Macau is easily accessible by Hong
Kong residents via a 45 minute jet foil ride and is a popular vacation
destination for both Hong Kong and Chinese residents. Macau has a population of
approximately 500,000 of which 50% is female (Hong Kong Trade Development
Council). The Company plans to target primarily Macau's local residents.
The Company is also closely monitoring the market opportunities in other
South East Asian countries such as the Philippines, Thailand, Malaysia and
Indonesia.
FITNESS
The Centers emphasize the benefits of health, physical fitness and
exercise by providing a wide range of exercise equipment from the United States
and Europe including free-weights, strength systems and cardiovascular machines
from manufacturers such as Life Fitness, Cybex , Flex, and Reebok Skywalker. The
Company places a particular emphasis on the quality of its fitness managers and
instructors by providing continuous training both in Hong Kong and overseas.
The centers also conduct daily dance classes which run for approximately
45 minutes and are on a first-come, first-served basis. The Company believes
that the number of dance classes conducted by the Centers per day is among the
highest in Hong Kong. The variety of dance classes include aerobic dance, step ,
arms and thighs workout, funk and jazz and are taught by experience instructors.
The dance classes are reviewed on a monthly basis and new dance classes are
introduced approximately every three months in order to appeal to the interests
of members. Since 1995, the Company has recruited fully qualified and
experienced aerobic instructors from Australia.
The Company believes, based on member survey responses, utilization
rates and the existence of underutilized space in its centers, that it has
sufficient excess capacity at its existing fitness centers to accommodate new
membership growth as well as comfortable usage by present members.
<PAGE>
SPA SERVICES
Spa services are open to both members and non-members. However, members
of the centers have priority for such service facilities. Over 80 types of spa
treatments are offered including facial treatments, various skin care
treatments, relaxation programs, personalized make-up application and
instruction, and weight-management and massage.
All of the centers have designated rooms for spa treatments in order to
ensure privacy. In view of the popularity of the spa treatments, the centers
have a booking system whereby sessions for such treatment are reserved in
advance. The centers offer special discounts to patrons for beauty treatments
during off-peak hours in order to maintain an even level of customers during the
day. In promoting the fitness training services provided by the centers, patrons
for spa treatments, who are not members of the centers, are eligible to use all
facilities of the centers including fitness training, on the day of their visits
for a spa treatment. The Company believes that this additional service offers an
advantage over its competitors who engage only in beauty treatments.
The Company has a broad scale of fees for its spa services and believes
that these fees are both affordable and competitive in terms of the quality and
variety of services provided at the centers. The centers typically charge the
normal fee on spa treatment per session. However, discounts are given to those
patrons who purchase prepaid coupons. These coupons are valid without time limit
but are usually used within a short time period.
The Company employs professional spa personnel who hold recognized
qualifications and adequate experience. Each center retains a specific manager
for spa treatments that supervises the spa personnel and other staff members of
the center. Each spa employee serves only one patron during the entire session
of spa treatment. The Company places great emphasis on providing continuous
training programs for its spa personnel. In order to remain informed of the
latest international developments in spa treatments, applications, technology
and equipment, the Company arranges both local and overseas training.
RETAIL
The Company sells a range of products at each center such as leotards,
shorts, T-shirts, training shoes, socks and training suits, including Nike and
several U.S. and Australian brand products. The Company also sells European skin
care products manufactured in Italy and Spain by Frais Monde and Anibus,
respectively. In addition, cosmetics from Frais Monde are offered. The fitness
and beauty related products are available in the centers to facilitate the needs
of their members.
MEMBERSHIP
The Company currently offers prospective members a membership plan. Fees
for services at each facility depend on the location and demand for such
services at that facility. Marketing of the Company's services is targeted
towards the middle income female population in the 18 to 34 years old range.
<PAGE>
Under the plans, new members are charged a membership fee upon admission
and a monthly fee each month to maintain their membership privileges. The
initial membership fees are non-refundable and range from approximately HK$1,400
(US$180) to HK$1,500 (US$194), depending on the diversity of facilities and
services available at the club of enrollment, the local competitive environment,
as well as the effects of seasonal price strategies. Monthly dues for
memberships generally range from HK$168 (US$22) to HK$299 (US$39) during the
typical membership period. Prepayment of the monthly fee is encouraged by
offering a discount for members who prepay for six or twelve months. Members are
also provided on a monthly basis 10 aerobic coupons on free-of-charge basis at
Hong Kong locations. Any member who attends additional classes has to purchase
coupons at HK$15 (US$2) each. China locations include aerobics classes with
monthly dues.
In order to allow greater flexibility to its members, the Company
operates a network system where members may use the facilities provided at the
largest centers of the Company at no extra cost. The Centers have long opening
hours and are open all year round (except for Chinese New Year), in order to
provide continuous service to its members and customers. Generally, they are
open from 7:00 a.m. to 10:30 p.m. As with any consumer driven market, it is
essential that the services provided by the Company are constantly reviewed,
updated and improved. To achieve this, managers from each of the Centers
regularly invite comments from members in relation to the services provided.
Additionally, the Company constantly seeks to introduce new products and
techniques on fitness training and spa treatments in order to improve its
services and thus enhance its competitive position.
SALES AND MARKETING
The Company devotes substantial resources to the marketing and promotion
of its fitness and spa centers and their services because the Company believes
strong marketing support is critical to attracting new members both at existing
and new fitness centers. Since July, 1988, the Company and its predecessor began
to market substantially all of its fitness centers under the service name
"Physical Ladies' Club", thereby eliminating the prior practice of using
different names for individual locations. See "Business - Trademarks and Trade
Names".
A key component of the Company's marketing strategy is to cluster
numerous fitness centers in major media markets in order to increase the
efficiency and cost effectiveness of its marketing and advertising programs.
Advertising consists of (I) television, (ii) newspapers,telephone directories
and other promotional activities and (iii) radio, which were accounted for
approximately 10%, 80%, and 10%, respectively, of the Company's total
advertising expenses in 1998.
The Company's sales and marketing programs emphasize the benefits of
health, physical fitness and exercise by appealing to the public's desire to
look and feel better. The success of the Company's marketing efforts are
dependent upon the ability of its sales personnel to make effective personal
presentations of the benefits of membership to prospective members. The Company
believes that these presentations are enhanced by its well-equipped, attractive
centers and its "value pricing" membership programs. The Company conducts a
variety of marketing efforts. The Company's executives and sales personnel
attend trade shows and exhibitions throughout Hong Kong and China. At these
trade shows, the Company usually operates a separate promotional exhibit. The
Company's executives and marketing personnel also attend and sponsor seminars
given to individual end-user organizations or industry groups.
<PAGE>
RETAIL
CORPORATE SPONSORSHIP
Since 1993, Nike has sponsored the Company's fitness instructors in
China under an annual contract that is renewable each year. Nike supplies each
fitness instructor with several different shoes, track suits, T-shirts and caps
four times a year. In return, the Company sells only Nike footwear in its China
locations. Commencing in 1993, the Company has participated with Evian Water of
France in a variety of promotional activities, both China and Hong Kong.
Typically, Evian will invite the Company to participate in a variety of
promotional events held at trade shows, shopping centers and entertainment
venues. In return, the Company sells only Evian bottled water in its China
locations.
The Company has begun marketing, on a retail basis products to its
members including apparel manufactured by Nike and leading U.S. and Australian
fitness apparel brands . These products are intended to add value to the
memberships and increase the Company's revenues. The Company's marketing focus
also includes corporate membership sales which are designed to improve
productivity. The Company has introduced programs such as corporate on-site
aerobics classes to expand the market for its services. In addition to its
advertising, personal sales presentations and targeted marketing efforts, the
Company is increasingly utilizing in-club marketing programs, open houses and
contests for members and their guests foster member loyalty and introduce
fitness centers to prospective members and referral incentive programs involve
current members in the process of new member enrollments.
ACCOUNT COLLECTION
All collections of past-due accounts are handled internally by the
Company. Customers who have outstanding unpaid balances are not provided further
services until such balances are paid in full. Corporate accounts are handled
pursuant to the applicable terms of credit agreements. Local corporate accounts
are normally not allowed any special credit. International corporate accounts,
which are much larger than the local accounts, can be allowed three to six
months credit, with a possibility of extending such period, depending on the
account's size and record.
COMPETITION
HONG KONG
The competition of the Company consists of the following.
Upscale Market
- --------------
The Hong Kong upscale market consists of exclusive private clubs which
usually provide both fitness services and spa treatments at very high prices.
These private clubs are typically oriented towards women and offer a great deal
of variety to their customers. Annual membership fees average approximately
HK$19,000 (US$2,500) and beauty treatments are charged separately upon usage.
These facilities use expensive, name-brand equipment, luxurious decoration,
large areas of space up to 30,000 sq ft, and offer a wide range of services to
attract customers. The two primary clubs in this category are Philip-Wain and
Body by Deborah International Health Spa. There are certain upscale market
establishments which provide fitness services only, most are for both male and
<PAGE>
female, and are concentrated in one area of Hong Kong. The joining fees range
from HK$2,000 (US$258) to HK$7,000 (US$903) with monthly membership fees ranging
from HK$350 (US$45) to HK$800 (US$103). These establishments range in size from
10,000 sq ft to 30,000 sq ft. Examples are Ray Wilson s California Gym and New
York Fitness. Another fitness only company, Tom Turk, was the earliest entrant
into the Hong Kong Market, with the first outlet opening in the early 1980's.
The Tom Turk facilities have fees that target between the upper and middle
market customer, and their two locations are each approximately 30,000 sq. ft.
Tom Turk attracts primarily a male clientele and emphasizes their extensive line
of free weights, workout equipment and swimming pools. The Company's fitness/spa
facilities compete directly primarily with the middle markets (see below), with
the exception of Renaissance Beauty Center, which targets upscale market.
Middle Market
- -------------
There are very few establishments in this class which provide both
fitness services and spa/ beauty treatments in a single facility. The closest
competitor would be a facility called Mid-City, which provides both services for
men and women. This facility has only one location with an area of approximately
15,000 sq ft. Another competitor of the Company in the same category is Modern
Beauty Salon with six locations of various sizes up to approximately 15,000 sq.
ft. An average down payment joining fee of HK$2,000 (US$258) is required to
become a member of the above centers. Another establishment which provides only
fitness services is The Lift Club. The Lift Club has three outlets in prime
locations, with approximately 10,000 sq ft each. The joining fee is HK$1,600
(US$206) and the monthly fee is HK$550 (US$71). The operators of spa/beauty
services only which are in direct competition with the Company include
Expression, with one location, and Angel Face Beauty Creations (International)
Ltd., with nine locations. The management believes that, these facilities do not
offer as high a level of fitness equipment and instruction as the Company does
and that the Company offers a more comprehensive level of spa treatments than
these facilities. The Company targets primarily the middle market.
Low-End Market
- --------------
In this category, most establishments only provide either fitness
services or simple beauty treatments. These establishments are usually much
smaller in size and have a limited range of services. Representatives of the
low-end market include Frank & Wit, The Fitness Gym, Paradise Health Club, Tess
Beauty, and Health City. Joining fee to these facilities vary from HK$600
(US$77) to HK$2,000 (US$258), and monthly fees average approximately HK$430
(US$55). In addition, there are numerous smaller facilities operating inside the
shopping arcades, and/or associated with hair salons and department stores.
Management believes that the Company does not directly compete with this market.
In the low-end fitness market, the government operates a small number of
gymnasium facilities. These are public facilities, open to both men and women
for nominal fees.
<PAGE>
CHINA
SPA SERVICES. Certain spa services are provided by beauty salons, which
are very popular in China and have been in existence for several years. However,
most are small scale and offer only basic services in the Company's opinion and
as compared to the Company's facilities. Most salons are not modern and do not
possess certain international standards of skill and hygiene as most facilities
in Hong Kong. In the Management's view, these salons only have access to locally
manufactured skin care products, which tend to be low-tech and chemically-
based, since it is too costly for a small salon to use imported products. The
Company, as an exclusive agent for several professional European skin care
lines, maintains the leading edge in skin care. The closest competitors in the
spa industry would be several beauty salons with Hong Kong and Japanese
investors, including Carita in Shanghai, and Marco, in Dalian. Services in these
facilities are somewhat more up to date, though most do not exceed the Company's
facilities in size, nor in number of services available, in management's
opinion. Most of these salons use common department store skin care products,
which prevents them from differentiating themselves in the market. The Company
believes that no other salons offer a professional line of skin care products
for purchase, except for common, famous-name brands which are also available in
department stores.
FITNESS CENTER. There are several fitness centers in China, especially
following the opening of the Company's China facilities in Shanghai and Dalian.
The Company believes that its early entry into the market has helped it to
achieve the leading name in fitness. The Company believes that it was the first
to offer professional, up to date fitness services, up to date group exercise
(aerobics) classes, and a full range of modern exercise equipment. Though the
Company currently has only three facilities operating in China, the management
believes that its name has become already known as the Company has set the
standards for the fitness and spa industry for China. The closest competitors
are as follows:
Upscale Market
- --------------
There are many upscale recreation clubs in the major cities of China,
including Hong Kong City, Shanghai, and the Friendship Club in Dalian. These
facilities usually offer dining, bars, karaoke, massage, sauna, exercise, beauty
treatments, and occasionally bowling, tennis or golf. However, the trend for
such clubs has proven to be most successful when utilized as men's clubs. These
clubs are used primarily for entertaining business clients or for high-income
business men. Therefore, very little emphasis is placed on the level of service
and amenities within the fitness areas. Typically, most are staffed only with
receptionists as there is no demand for fitness professionals. Very few women
use such facilities. These clubs charge very high joining fees, usually upwards
of several thousand US dollars.
The majority of four and five star hotels have health clubs for outside
membership as well as for hotel guests. Usually these clubs have expensive,
brand name equipment, and often offer aerobics classes. Most also have luxury
shower and spa facilities. However, the price structure is usually comparable to
an upscale U.S. health club, and therefore is not affordable to the vast
majority of Chinese people. Such clubs cater to the ex-patriate business
community, and some are exclusive to such community. Their location, being
situated on the hotel premises, often limits size, and they tend to reach full
capacity with a low number of members. Since most hotels do not depend on the
health club as a major source of revenue, typically very little marketing or
membership incentives are used.
<PAGE>
Middle Market
- -------------
There are several middle market fitness centers in some of the larger
cities in China. Many newly built housing complexes (upscale apartment buildings
and "western" style housing villages) have recreation centers. They typically
include swimming pools, tennis courts and gyms. In the management's opinion,
such facilities are luxurious by Chinese standards, but gyms are commonly
unstaffed or only have a receptionist. More and more such centers are providing
exercise classes as well, but lack of qualified instructors, in the management's
opinion, inhibits growth in this area. Such clubs have recently been opened in
Dalian, however, in the management's opinion, none of them matches the Company
in size, nor in the range of exercise equipment available, and classes offered
and the Company does not see them as the same level competitors. Shanghai has
several recently opened middle market clubs, such as DD's Personal Club and
YMCA. DD's Personal Club caters primarily to the expatriate market and is
therefore limited in growth. YMCA is not situated in a prime location and has
not used, in the management's opinion aggressive marketing, and in the
management's view to date has not made significant impact on the fitness
industry in Shanghai.
Low-End Market
- --------------
Group exercise is an extremely popular activity in China, but mainly
done by elderly people. As more interest is created in the younger market, a
wider variety of classes are now being offered in government facilities such as
gymnasiums, parks and town squares. Such facilities usually are held on a
basketball court in a gym, or a recreation hall with large open space. Typically
there are no shower, locker, or spa facilities available. The management
believes that the popularity of these facilities is due to the nominal fees
charged.
Trademarks and Trade Names
In July 1988, the Company and its predecessor began to market
substantially all its fitness centers under the servicemark "Physical Ladies'
Club" thereby eliminating the prior practice of using a different trade names
for each Center. The Company registered a servicemark under its trade name
"Physical Ladies' Club" in Hong Kong and its Chinese equivalent name in China.
In the opinion of the Company's trademark counsel in Hong Kong, the registration
enables the mark to distinguish the Company's services from similar services of
others, although it gives the Company no right to the exclusive use of the
words. The servicemark gives the Company a priority over the use of the
servicemark by others and the right to reject others from the use of the same
name. In China, the Company was only able to register the name in Chinese
language pursuant to the Chinese Trademark Law. In the opinion of the Company's
trademark counsel, the name "Physical Ladies' Club" is considered a direct
reference to the contents and features of the services in the servicemark and as
such it cannot be registered as a trademark under the Chinese Trademark Law. The
registration of the Chinese name, however, provides the Company with protection
of its name on a nation-wide basis and precludes others in China from using the
same name as the Company's.
Seasonality
Historically, the Company has experienced greater sales in the third
quarter of each year. In recent years, the Company has lessened this seasonal
effect by the use of sales incentives and awards for its sales personnel and
members, as well as other marketing initiatives.
Insurance
The Company maintains liability insurance providing coverage to the
Company with respect to accidental bodily injury and accidental loss of or
damage to property of any customer or employee of the Company, which would occur
in connection with the business of the Company and on the premises of the
Company. The Company does not maintain product liability insurance with respect
to the beauty products used in its spa treatments.
<PAGE>
Research and Development
The Company's business is service-oriented, therefore it does not have
a formal Research & Development department, however, its marketing and training
departments are closely following the evolution of international fitness and
beauty trends.
Employees
The Company has approximately 800 employees, including approximately 70
commission based sales executives. Approximately 280 employees are involved in
fitness operations, including sales personnel, instructors, and supervisory
personnel. Approximately 300 employees are involved in beauty and spa
operations. Approximately 150 are administrative support personnel, including
accounting, marketing, training and other services.
The Company is not a party to any collective bargaining agreement with
its employees. The Company has not experienced a high turnover of non-management
personnel and also has not had difficulty in obtaining adequate replacement
personnel, except with respect to sales personnel, which the Company believes
have become somewhat more difficult to replace due, in part, to increased
competition for skilled retail sales personnel.
Government Regulation
Hong Kong
The Hong Kong operations and business practices of the Company are
subject to regulation at the local level. General rules and regulations,
including those of the local consumer protection agencies, apply to the
Company's advertising, sales and other trade practices.
Statutes and regulations affecting the fitness, spa and beauty
industries have been enacted or proposed in all of the areas in which the
Company conducts business. Typically, these statutes and regulations prescribe
certain forms and regulate the terms and provisions of membership contracts,
allowing the member the right to cancel the contract within, in most cases, 14
business days after signing, requiring an escrow for funds received from
pre-opening sales or the posting of a bond or proof of financial responsibility,
and, in some cases, establishing maximum prices and terms for membership
contracts and limitations on the term of contracts. In addition, the Company is
subject to several other types of regulations governing the sale and collection
of memberships, as well as laws governing the collection of debts. These laws
and regulations are subject to varying interpretations by local consumer
protection agencies and the courts. The Company maintains internal review
procedures in order to comply with these requirements and it believes that its
activities are in substantial compliance with all applicable statutes, rules and
decisions.
<PAGE>
Under typical regulations, members of fitness centers have the right to
cancel their un-used memberships for a period of 30 to 60 days after the date
the contract was entered into (depending on the applicable law) and are entitled
to refunds of any payment made. The specific procedures for cancellation in
these circumstances vary according to differing local laws. In each instance,
the canceling member is entitled to a refund of prepaid amounts only.
Furthermore, where permitted by law, a cancellation fee is due to the Company
upon cancellation and the Company may offset such amount against any refund
owed. The Company's membership contracts provide that a member's one-time
membership fee is non-refundable in case of cancellation.
The Consumer Council of Hong Kong protects the rights of consumers,
including memberships, such as those offered by the Company. The members have a
right to dispute the price or quality of the service, if they find it
unsatisfactory. The Council also assists consumers in cases of false claims made
by the companies with respect to a specific service offered by them. The Company
is cautious in advertising its services, and it never promotes or guarantees
unrealistic results concerning skin care or fitness services, therefore the
Company rarely faces complaints in this respect from its consumers.
The Company facilities are also subject to building, health and safety
laws. The laws require a normal building inspection at the time of renovation of
the club facilities and/or fire safety inspection. Since the Company's
facilities typically are a part of a large office building for which a license
is granted, if the Company does not comply with all the regulations, the
landlord would not be granted a license. The Board of Health carries out an
inspection of shower and restroom facilities to make sure that they comply with
the standards imposed by the Board. In order to have massage services, the law
requires a special massage license. The Board of Health and Police Department
also hold random inspections of the facilities providing massage services, since
there are strict laws requiring that massage therapists be of the same sex as
the customers. As the Company is exclusively open to women in all centers, but
one, there have been no concerns with this regulation.
China
In China, the Company's operations and business practices are subject
to regulation from the central government, which is often carried out at local
levels. There is a Consumer Council in China which is now expanded to most urban
areas and whose role is to protect consumers and enforce consumer rights in
cases of dispute regarding quality of the product or service or misleading
claims. The Consumer Council holds considerable power in China and can impose
large fines upon a company it finds in violation of consumer laws. The Consumer
Council would often publish a statement against a fined company in a local
newspaper.
China requires a fire safety inspection and license before completion
of renovation of the facility. The safety department performs unannounced
inspections every year to ensure proper compliance with the regulations, such as
maintenance of clear fire exits, extinguishers, smoke detectors and other safety
equipment.
The Board of Health has strict regulations regarding spa facilities and
fitness/beauty equipment that is used by many people per day. The Board requires
an initial license before opening of the facilities and requires installation of
certain anti-bacterial and hygiene equipment. For example, the beauty treatment
area is required to have ultra-violet ("UV") disinfection lamps installed within
every 5 feet of public space. The law also requires UV disinfection every night
for the air, beds and chairs in the area. The Board also requires "hot cabinet"
disinfection units for small beauty tools and equipment. In the Company's
experience, random inspections of those areas of the spa are often done by the
Board of Health.
<PAGE>
The Board of Health also requires an inspection and license for each
imported cosmetic or skin care product. The license must be obtained from the
Central Government in Beijing and a substantial fee is charged for the testing
of each imported product.
In China, the Board of Health is responsible for monitoring the
operation of the Company's spas, however, their strict regulations fall in line
with the standards of the Company and therefore, to date, there has been no fine
or restriction of the operation of any fitness or spa facility.
There is a Council for Fair Pricing in China, and every business that
sells products or provides services must register their fees with this
department. The Council has a right to dispute fees if it deems them
unreasonable, however to date, the Council's directives are just a formality
which is limited to collecting a registration fee from each business and rarely
questions the pricing.
The Police Department has strict regulations in China regarding massage
services and requires (although in the management's experience, it seldom checks
for compliance) the Company to ensure that the massage therapist is of the same
sex as the customer. A special license is required for massage services, which
is in the management's opinion, difficult to obtain. The massage therapist must
be certified and licensed by a government affiliation, and must have an annual
health examination. Since all the Company's centers in China are exclusively for
women and include only female staff, the Company has not been impacted by those
regulations.
China has also regulations which are so restricting, that, in fact,
amount to not allowing independently owned fitness and beauty spas by foreign
companies. Instead, the regulations encourage joint ventures with a foreign
company. Fitness and beauty spas fall under the category of "Entertainment and
Recreation", which to date have always been business entities in a form of joint
ventures.
<PAGE>
ITEM 2. DESCRIPTION OF PROPERTY
The Company's headquarters which include the Company's executive and
administrative offices are located at a 30,000 square feet facility in Hong Kong
pursuant to a lease expiring February 28, 2003. The Company recently relocated
its headquarters and its Causeway Bay location to this location in order to
accommodate additional customers, and more extensive lines of fitness and spa
treatment equipment.
Aggregate rental expense was approximately HK$21.2 million (US$2.7
million), $HK$31.7 million (US$4.1 million) and HK$44.9 million (US$5.8
million)for the year ended December 31, 1996, 1997 and 1998, respectively.
Mei Foo is the only location indirectly partially owned by the Company.
The Company ( through its subsidiary, Ever Growth Limited), directly owns 700
sq. ft. of the property where the Mei Foo center is located, which space is used
for spa facility. The remaining 7,300 sq. ft., also located in the same building
where the spa is, is leased and is used for fitness facilities.
Set forth below is the information regarding the Company's centers in
Hong Kong and China.
<TABLE>
FITNESS/SPA CENTERS - HONG KONG AND CHINA
-----------------------------------------
<CAPTION>
Current Monthly
HONG KONG Size Own/Lease Term Expiration Renewal Option Rent(1)(2)
- --------------- ---- --------- --------------- -------------- ---------------
<S> <C> <C> <C> <C> <C>
Shop A on 11-F, 12/F-15/F., 30,000 sq. ft. Lease 2/28/2003 None HK$1,226,838
Lee Theatre Plaza
99 Percival Street
Causeway Bay, Hong Kong
10/F-12/F., Storeroom on 25,000 sq. ft. Lease 1/31/2000 (3) 3 Years HK$649,241
5/F, Room 701A,
Prestige Tower
23-25 Nathan Road
Tsimshatsui, Hong Kong
Shop Nos. 125 and 131-133 10,000 sq. ft. Lease 5/19/2001 (4) 2 Years HK$409,223
Level 1,
Grand Central Plaza
Shatin, Hong Kong
18/F - 21/F City Landmark 50,000 sq. ft. Lease 3/31/2001 5 Years HK$1,039,000
No. 68 Chung On Street
Tsuen Wan, Hong Kong
Unit 605-609, Level 6 3,200 sq. ft. Lease 7/4/1999 (4) None HK$111,915
NewTown Tower, 10-18
Pak Hok Ting Street
Shatin, Hong Kong
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Current Monthly
HONG KONG (Continued) Size Own/Lease Term Expiration Renewal Option Rent(1)(2)
- --------------------- ---- --------- --------------- -------------- ---------------
<S> <C> <C> <C> <C> <C>
P/F., Stage 8 8,000 sq. ft. Own/lease 4/30/1998 None HK$107,853
122B Broadway Street
Mei Foo Sun Chuen,
Hong Kong
14/F., Coda Plaza 5,000 sq. ft. Lease 6/30/2000 None HK$140,062
51 Garden Road
Central, Hong Kong
G/F., 3,000 sq. ft. Lease 6/30/2000 None HK$59,000
5 Junction Road
Kowloon City, Hong Kong
- ---------------------
</TABLE>
(1) Monthly rent is paid in HK Dollars
(2) Monthly rent also includes the management fee for property management.
Excludes utilities.
(3) Lease for Room 701A expires on July 31, 1999.
(4) Lease for Unit 901 A and 12/F, New Town Tower, 10-18 Pak Hok Ting Street,
Shatin, Hong Kong expired on April 30, 1998. The landlord extended the lease
for two additional months at HK$590,208 until June 30, 1998. The Company
simultaneously entered with the landlord into an agreement for the new lease
at Shop Nos. 125 and 131- 133, Level 1, Grand Central Plaza, Shatin, Hong
Kong.
<TABLE>
<CAPTION>
Current Monthly
CHINA Size Own/Lease Term Expiration Renewal Option Rent(1)
- ----- ---- --------- --------------- -------------- ---------------
<S> <C> <C> <C> <C> <C>
6/F., Huangpu Gymnasium 15,000 sq. ft. Lease 9/6/2003 None HK$89,835 (2)
No. 311 Shandong Road
(Mid) Shanghai
4/F., China Wanda Bldg 15,000 sq. ft. Lease 2/28/2008 None HK$143,333 (3)
No. 18 Hongda Road
Zhongshan District, Dalian
2/F, 3/F, 4/F, Block B No. 12,000 sq. ft. Lease 12/14/2004 None HK$173,965 (4)
808 Hong Qiao Road
Shanghai
- -----------------------
</TABLE>
(1) Monthly rent is paid in Rmb, with the exception of Dalian property, for
which the rent is paid in HK Dollars.
(2) The monthly rent will increase 10% per year after September 6, 1998.
(3) The monthly rent increases 5% per year after March 1, 1999.
(4) Combined monthly rent includes management fee. The monthly rent will
increase 6% per year beginning May 1, 2001 for 2/F space and commencing
December 15, 1997 for 3/F and 4/F space.
<PAGE>
In December, 1998, the Company signed an Offer to Lease for space of
43,464 sq. ft. to be used for fitness and spa services at Sheraton Hotel,
Tsimshatsui. The lease has a term of 6 years with an option to renew for a
further term of 2 years, and the terms include a lease payment of HK$1,404,000
(US$181,000) per month for the first three years and HK$1,839,000 (US$237,000)
per month for the fourth to sixth year. The lease also includes an
air-conditioning charge and management fee of HK$391,000 (US$50,000) and
promotional charges of HK$43,000 (US$5,500) per month.
The Company believes that current facilities will be sufficient to
satisfy the Company's existing requirements. In its strategy to expand
operations, however, the Company may open new locations in Macau or China.
Although the Company believes that such locations will be available at
affordable prices, no assurance can be given. The Company believes that, in the
event any of the existing leases that expire within five years are not renewed,
adequate alternative space is available in the same areas at comparable rates.
In the Company's experience, most premises used for fitness/spa services have an
optimum life span of about five years, after which time they need to be improved
and/or renovated. The Management believes that the costs of such renovation are
not lesser than the cost of acquiring new premises, and therefore the Company is
not concerned with the fact that most of its leases do not have renewal options.
ITEM 3. LEGAL PROCEEDINGS
There are no pending material legal proceedings to which the Company or
any of its properties is subject, nor to the knowledge of the Company, are any
such legal proceedings threatened.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's stockholders
through the solicitation of proxies, or otherwise, during the fourth quarter of
the Company's fiscal year ended December 31, 1998.
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock has been listed on the Bulletin Board of the
NASD's over-the-counter market under the symbol PFIT, since December 1996, but
has been traded only sporadically. As of March 31, 1999, the 52-week trading
range was between $6.00 to $0.15 per share.
The last reported closing bid price of Common Stock reported by NASD was
on June 18, 1999 at $0.156 per share of Common Stock. As of June 18, 1999, there
were approximately 624 record holders of the Company's Common Stock. The Company
effected a 1.333333-for-1 reverse split of its Common Stock in October 1997 and
a 1-for-1.333333 forward stock split in June 1998.
DIVIDEND POLICY
- ---------------
The Company has never paid any cash dividends on its Common Stock and
does not anticipate paying any cash dividends in the future. Physical Health
Centre Hong Kong Limited, the subsidiary of the company acquired by the Company
in October, 1996, paid dividends out in 1995. The Company currently intends to
retain future earnings, if any, to fund the development and growth of its
business.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
The following discussion should be read in conjunction with "Selected
Consolidated Financial Data" and the Consolidated Financial Statements and Notes
thereto appearing elsewhere in this report.
Overview
- --------
General
The following discussion should be read in conjunction with "Selected
Consolidated Financial Data" and the Consolidated Financial Statements and Notes
thereto appearing elsewhere in this Report.
Overview
- --------
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 (see "Company - History"). The Company currently operates
eleven facilities: eight in Hong Kong and three in China. Based on the number of
the members of the Company's facilities, 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. See "Management."
<PAGE>
The Company derives its revenues from two main lines of business:
fitness and spa services. The revenues derived from fitness services steadily
increased from HK$82,311,000 (US$10,621,000) in the fiscal year ended December
31, 1997 to HK$139,829 (US$18,042,000)in the fiscal year ended December 31,
1998. The revenue from beauty treatment increased slightly from HK$66,496,000
(US$8,580,000) in the fiscal year ended December 31, 1997 to HK$70,317,000
(US$9,073,000).
Since the revenues from the Company's operations in China accounted for
approximately 10% of total revenues in fiscal year 1998, the management
discussion and analysis of the results of the Cmpany's operations set forth
below, comparing the financial results of fiscal year 1998 to the previous
fiscal year, does not address separately the results of operations in China and
Hong Kong, as discussed in previous fiscal years.
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$1,500(US$194) for one person. (A current promotion allows two people for
joining fee of HK$1,000 (US$129) each). 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$388).
The following table sets forth selected income data as a percentage of
total operating revenue for the periods indicated.
<TABLE>
<CAPTION>
Years Ended December 31
--------------------------------------
1998 1997 1996
---- ---- ----
(In thousands; HK$)
<S> <C> <C> <C>
Operating Revenues 210,209 148,954 111,230
Total operating expenses 188,544 119,722 79,553
Operating income 21,665 29,232 31,677
Income before income taxes and minority interests 18,377 27,267 31,720
Provision for income and deferred taxes (108) 6,969 8,298
Minority interests 1,143 1,832 2,211
Net income 17,342 18,466 21,111
======== ======== ========
</TABLE>
<PAGE>
FISCAL YEAR ENDED DECEMBER 31, 1998 COMPARED TO FISCAL YEAR ENDED DECEMBER 31,
1997
- --------------------------------------------------------------------------------
OPERATING REVENUES. The Company's operating revenues showed the
continuous growth in the fiscal year ended December 31, 1998 as compared to the
fiscal year ended December 31, 1997. Operating revenues for the fiscal year
ended 1998 totaled HK$210,209,000 (US$27,123,000) compared to HK$148,954,000
(US$19,220,000) in the fiscal year ended December 31, 1997, representing an
increase of 41%. Operating revenues derived by the Company's fitness services
increased 70% to HK$139,829,000 (US$18,042,000)compared to HK$82,311,000
(US$10,621,000) in the fiscal year ended December 31, 1997. Fitness revenues as
a percentage of total revenues were 67% in the fiscal year ended December 31,
1998 as compared to 55% in the fiscal year ended December 31, 1997.
Operating revenues for the Company's beauty treatments totaled
HK$70,317,000 (US$9,073,000)compared to HK$66,496,000 (US$8,580,000) in the
fiscal year ended December 31, 1997, representing an increase of 6%. Beauty
revenues as a percentage of total revenues were 33% in the fiscal year ended
December 31, 1998 as compared to 45% in the fiscal year ended December 31, 1997.
OPERATING EXPENSES. The Company's operating expenses for the fiscal year
ended December 31, 1998 totaled HK$188,544,000 (US$24,329,000)compared to
$HK119,722,000 (US$15,448,000)in the fiscal year ended December 31, 1997,
representing an increase of 57%. The increase in the operating expenses was
primarily due to the following factors: expenses incurred in connection with the
opening of new centers, a general increase in staff salaries as a result of
higher revenues generated, depreciation charges and rental expenses incurred for
enhanced facilities. Total operating expenses, after taking into account all
corporate expenses, were 89.7% of total operating revenue as compared to 80% of
last year.
TOTAL NON-OPERATING EXPENSES (INCOME). Total non-operating expenses for
the fiscal year ended December 31, 1998 totaled HK$3,288,000 (US$423,000)
compared to total non-operating income of HK$1,965,000 (US$254,000) in the
fiscal year ended December 31, 1997, representing an increase of HK$1,323,000
(US$170,000) due to less interest expenses incurred for bank loans.
PROVISION FOR INCOME TAXES. Provision for income taxes for the fiscal
year ended December 31, 1998 totaled HK$(108,000)(US$(14,000))as compared to
HK$6,969,000 (US$899,000)in the fiscal year ended December 31, 1997,representing
a decrease of 102%.
NET INCOME. The Company's net income for the fiscal year ended December
31, 1998 totaled HK$17,342,000 (US$2,238,000)compared to HK$18,466,000
(US$2,383,000) for the fiscal year ended December 31, 1997, representing a
decrease of 6%. The decrease in the net income was mainly due to a substantial
portion of expansion overhead being recognized in the fiscal year ended December
31, 1998, however, the joining fee revenues derived in association with such
expansion were not fully recognized in the same time period in accordance with
the Company's accounting policy of recognizing such revenues over the expected
membership life of the new members.
Fiscal Year Ended December 31, 1997 Compared to Fiscal year Ended
December 31, 1996
- -----------------------------------------------------------------
Operating Revenues. The Company's operating revenues showed the
continuous growth in the fiscal year ended December 31, 1997 as compared to the
fiscal year ended December 31, 1996. Operating revenues for the fiscal year
ended 1997, net of an additional provision for deferred income of HK$8,300,000
(US$1,071,000), totaled HK$148,954,000 (US$19,220,000) compared to
HK$111,230,000 (US$14,352,000) in the fiscal year ended December 31, 1996,
representing an increase of 34%. Operating revenues derived by the Company's
fitness services increased 122% to HK$82,311,000 (US$10,621,000) compared to
HK$37,069,000 (US$4,783,000) in the fiscal year ended December 31, 1996. Fitness
revenues as a percentage of total revenues were 55% in the fiscal year ended
December 31, 1997 as compared to 33% in the fiscal year ended December 31, 1996.
<PAGE>
Operating revenues for the Company's beauty treatments totaled
HK$66,496,000 (US$8,580,000) compared to HK$72,260,000 (US$9,324,000) in the
fiscal year ended December 31, 1996, representing a decrease of 8%. This was
mainly due to the Company's strategic plan to allocate more resources to promote
its fitness business which prospered significantly in 1997. Beauty revenues as a
percentage of total revenues were 45% in the fiscal year ended December 31, 1997
as compared to 65% in the fiscal year ended December 31, 1996.
Operating revenues derived from the Company's Hong Kong locations
remain an important contributor to the Company's business, generating
HK$126,939,000 (US$16,379,000) or 85% of total operating revenues in the fiscal
year ended December 31, 1997 as compared to HK$81,990,000 (US$10,580,000) or 74%
of total operating revenues in the fiscal year ended December 31, 1996.
Operating revenues derived from the Company's China locations generated
HK$22,015,000 (US$2,841,000) or 15% of total operating revenues in the fiscal
year ended December 31, 1997 as compared to HK$29,240,000 (US$3,772,000) or 26%
of total operating revenues in the fiscal year ended December 31, 1996.
Operating Expenses. The Company's operating expenses for the fiscal
year ended December 31, 1997 totaled $HK119,722,000 (US$15,448,000) compared to
HK$79,553,000 (US$10,265,000) in the fiscal year ended December 31, 1996,
representing an increase of 50%. The increase in the operating expenses was
primarily due to the following factors: a general increase in staff salaries as
a result of higher revenues generated, depreciation charges and rental expenses
incurred for enhanced facilities. Total operating expenses, after taking into
account all corporate expenses, were 80% of total operating revenue as compared
to 72% of last year.
Operating expenses associated with the Company's Hong Kong locations
were HK$100,263,000 (US$12,937,000), representing an increase of 65% as compared
to HK$60,929,000 (US$7,862,000) in the fiscal year ended December 31, 1996. Hong
Kong operating expenses represented 84% of total operating expenses in the
fiscal year ended December 31, 1997 as compared to 77% of total operating
expenses in fiscal year ended December 31, 1996. The increase in operating
expenses was primarily due to additional rent and related expenses, and
depreciation as a result of relocation of two branches in mid-1997, and
additional salary costs due to increased revenues.
Operating expenses associated with the Company's China locations were
HK$19,459,000 (US$2,511,000) representing a moderate increase of 4% due to
inflation as compared to HK$18,624,000 (US$2,403,000) in the fiscal year ended
December 31, 1996. Operating expenses in China represented 16% of total
operating expenses in the fiscal year ended December 31, 1997 as compared to 23%
of total operating expenses in the fiscal year ended December 31, 1996.
<PAGE>
Total Non-Operating Expenses (Income). Total non-operating expenses for
the fiscal year ended December 31, 1997 totaled HK$1,965,000 (US$254,000)
compared to total non-operating income of HK$43,000 (US$5,000) in the fiscal
year ended December 31, 1996, representing a decrease of HK$2,008,000
(US$260,000) due to additional interest expenses incurred for bank loans.
Provision for Income Taxes. Provision for income taxes for the fiscal
year ended December 31, 1997 totaled HK$6,969,000 (US$899,000) as compared to
HK$8,398,000 (US$1,083,000) in the fiscal year ended December 31, 1996,
representing a decrease of 17%. The effective tax rate of operating income
remained at 26%.
Net Income. The Company's net income for the fiscal year ended December
31, 1997 totaled HK$18,466,000 (US$2,383,000) compared to HK$21,111,000
(US$2,724,000) for the fiscal year ended December 31, 1996, representing a
decrease of 13%. The decrease in the net income was mainly due to a substantial
portion of expansion overhead being recognized in the fiscal year ended December
31, 1997, however, the joining fee revenues derived in association with such
expansion were not fully recognized in the same time period in accordance with
the Company's accounting policy of recognizing such revenues over the expected
membership life of the new members.
Fiscal Year Ended December 31, 1996 Compared to Fiscal Year Ended
December 31, 1995
- -----------------------------------------------------------------
Operating Revenues. The Company's operating revenues increased
significantly in the fiscal year ended December 31, 1996 as compared to the
fiscal year ended December 31, 1995. Operating revenues for the fiscal year
ended December 31, 1996 totaled HK$111,230,000 (US$14,352,000) compared to
HK$85,262,000 (US$11,002,000) in the fiscal year ended December 31, 1995,
representing an increase of 30%. Operating revenues derived by the Company's
fitness services increased 32% to HK$37,069,000 (US$4,783,000) compared to
HK$28,075,000 (US$3,623,000) in the fiscal year ended December 31, 1995. Fitness
revenues as a percentage of total revenues were 33% in the fiscal year ended
December 31, 1996, the same as in the fiscal year ended December 31, 1995. The
increased operating revenue reflects increased marketing efforts for the Hong
Kong locations and the opening of the Dalian, China center.
Operating revenues from the Company's beauty treatment business totaled
HK$72,260,000 (US$9,324,000) compared to HK$53,059,000 (US$6,846,000) in the
fiscal year ended December 31, 1995, representing an increase of 36%. Beauty
treatment revenues as a percentage of total revenues were 65% in the fiscal year
ended December 31, 1996 as compared to 62% in the fiscal year ended December 31,
1995.
Operating revenues derived from the Company's Hong Kong locations
remain an important contributor to the Company's business, generating
HK$81,990,000 (US$10,579,000), or 74% of total operating revenues in the fiscal
year ended December 31, 1996 as compared to HK$69,243,000 (US$8,935,000) or 81%
of total operating revenues in the fiscal year ended December 31, 1995.
<PAGE>
Operating revenues derived from the Company's China locations generated
HK$29,240,000 (US$3,773,000) or 26% of total operating revenues in the fiscal
year ended December 31, 1996 as compared to HK$16,019,000 (US$2,067,000) or 19%
of total operating revenues in the fiscal year ended December 31, 1995.
The number of centers increased to nine at the fiscal year ended
December 31, 1996 compared to eight centers at the fiscal year ended December
31, 1995, reflecting the opening of the Dalian, China center in April, 1996.
Operating Expenses. The Company's operating expenses for the fiscal
year ended December 31, 1996 totaled HK$79,553,000 (US$10,265,000) compared to
HK$60,827,000 (US$7,849,000) in the fiscal year ended December 31, 1995,
representing an increase of 31%. Operating expenses as a percentage of total
revenues were 72% in the fiscal year ended December 31, 1996 as compared to 71%
in the fiscal year ended December 31, 1995.
Operating expenses associated with the Company's Hong Kong locations
were HK$60,929,000 (US$7,862,000), representing an increase of 18% as compared
to HK$51,598,000 (US$6,658,000) in the fiscal year ended December 31, 1995. Hong
Kong operating expenses represented 77% of total operating expenses in the
fiscal year ended December 31, 1996 as compared to 85% of total operating
expenses in the fiscal year ended December 31, 1995.
Operating expenses associated with the Company's China locations were
HK$18,624,000 (US$2,403,000), representing an increase of 102% as compared to
HK$9,229,000 (US$1,191,000) in the fiscal year ended December 31, 1995.
Operating expenses in China represented 23% of total operating expenses in the
fiscal year ended December 31, 1996 as compared to 15% of total operating
expenses in the fiscal year ended December 31, 1995. The increase in operating
expenses was primarily due to inflation and additional marketing,
administrative, salary and rental costs incurred by the new center in Dalian,
China.
Total Non-Operating Expenses (Income). Total non-operating expenses
(income) for the fiscal year ended December 31, 1996 totaled net income of
HK$43,000 (US$5,000) compared to a net expense of HK$368,000 (US$47,000) in the
fiscal year ended December 31, 1995, representing an increase of HK$411,000
(US$53,000) or 112%.
Provision for Income Taxes. Provision for income taxes for the fiscal
year ended December 31, 1996 totaled HK$8,398,000 (US$1,083,000) compared to
HK$4,434,000 (US$572,000) in the fiscal year ended December 31, 1995,
representing an increase of 89%. The effective tax rate of operating income was
26% and 18% respectively. The increase in the effective tax rate of operating
income was due to the 33% income tax rate in China and a provision of deferred
taxation of HK$1,451,000 (US$187,000) in Hong Kong. As the contribution from
China operations increased, the higher income tax rate applicable in China
therefore made up a larger portion of the tax provision.
Net Income. The Company's net income for the fiscal year ended December
31, 1996 totaled HK$21,111,000 (US$2,724,000) compared to HK$17,533,000
(US$2,262,000) in the fiscal year ended December 31, 1995, representing an
increase of 20%. The net income margin for the fiscal year ended December 31,
1996 was 19% and was 21% for the fiscal year ended December 31, 1995. The
increased net income reflects intensified marketing efforts that resulted in an
additional contribution from existing centers in Hong Kong and China and a
contribution from the new center in Dalian, China that opened in April, 1996.
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations primarily through cash generated
from operations, short-term bank credit, long-term bank loans, loans from third
parties (outside investors ) and minority shareholders of subsidiaries, advances
from customers relating to prepaid fitness and spa income, and leasing
arrangements with financial institutions. See Notes to Financial Statements
(Note 5 "Related Party Transactions"; Note 6 "Short Term Bank Loans"; Note 7
"Long Term Bank Loans"; and Note 9(C) "Obligations and Commitments").
Cash and cash equivalent balances for the fiscal year ended December
31,1998 were HK$1,721,000 (US$222,000) and HK$1,954,000 (US$252,000)for the
fiscal year ended December 31, 1997.
Net cash provided by operating activities were HK$47,075,000
(US$6,074,000), HK$61,806,000 (US$7,975,000)and HK$$31,505,000 (US$4,065,000)
for fiscal year 1998, fiscal year 1997 and fiscal year 1996, 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$4,864,000), HK$68,307,000 (US$8,813,000) and HK$24,266,000(US$3,131,000) for
fiscal year 1998, fiscal year 1997 and fiscal year 1996, primarily as a result
of expenditures for property, plant and equipment. Net cash provided (used) in
financing activities, which mainly include bank loan repayments, net of proceeds
from new bank loans, were HK$(9,593,000) (US$(1,238,000)), HK$5,887,000
(US$759,000) and HK$(5,740,000) (US$(741,000)) in fiscal year 1998, 1997 and
fiscal year 1996,respectively.
The Company's long-term loans bear an interest rate of 10% per annum.
The total balance outstanding as of December 31, 1998 on such loans was
HK$10,846,000. The last repayment on the loans is due in 2003. The Company also
had various banking facilities available from financial institutions amounting
to approximately HK$21,400,000. These facilities were secured by certain
leasehold property in Hong Kong owned by the Company's subsidiary Evergrowth
Limited, relatives of Mr. Luk, related company and personal guarantees from Mr.
Luk and his relatives, respectively.
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.
Capital expenditures for fiscal years 1996, 1997 and 1998 HK$25,375,000
(US$3,274,000), HK$68,360,000 (US$8,820,000) and HK$38,416,000 (US$4,956,000)
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 is undergoing 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 cost of such new system is estimated to be HK$800,000 (US$103,000) and the
implementation time is expected to be within one year commencing July, 1998. The
Company has already obtained an estimate of the cost from the software service
company, and in the opinion of the Management such cost can be controlled as
proposed. The Company expects to incur the following maintenance charges for the
new system:
1998 HK$120,000 (US$15,500)
1999 HK$ 96,000 (US$12,400)
2000 and onwards HK$ 64,000 (US$8,300)
The Company believes that the estimated cost of the new system should not have a
significant impact on the cash flow of the Company.
<PAGE>
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company required to be
included in Item 7 are set forth in the Financial Statements Index.
Independent Auditors' Report of William D. Lindberg.........................F-1
Consolidated Balance Sheets as of December 31, 1996, 1997 and 1998..........F-2
Consolidated Statements of Operations for the years ended December 31,
1998, 1997 and 1996.........................................................F-4
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1998, 1997 and 1996............................................F-6
Consolidated Statements of Cash Flows for the years ended December 31,
1998, 1997 and 1996.........................................................F-8
Notes to Consolidated Financial Statements..................................F-11
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
=============================================
AUDITED CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1997 AND DECEMBER 31, 1998
AND
AUDITED CONSOLIDATED STATEMENTS OF INCOME
CASH FLOWS AND CHANGES IN SHAREHOLDER'S EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
TOGETHER WITH AUDITORS' REPORT
<PAGE>
WILLIAM D. LINDBERG
CERTIFIED PUBLIC ACCOUNTANT
1064 CLIPPER COURT
COSTA MESA, CA. 92627
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO PHYSICAL SPA & FITNESS INC.
I have audited the accompanying consolidated balance sheets of Physical Spa &
Fitness Inc. (a Delaware corporation) (the "Company") and its subsidiaries as of
December 31, 1997 and 1998, and the related consolidated statements of income,
cash flows and changes in shareholders' equity for the years ended December 31,
1996, 1997 and 1998 expressed in Hong Kong Dollars. These financial statements
are the responsibility of the Company's management. My responsibility is to
express an opinion on these financial statements based on my audit.
I conducted my audit in accordance with generally accepted auditing standards.
Those standards require that I plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
I believe that my audit provides a reasonable basis for my opinion.
In my opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Physical Spa &
Fitness Inc. and its subsidiaries as of December 31, 1997 and 1998, and the
results of their operations and their cash flows for the years ended December
31, 1996, 1997 and 1998 in conformity with generally accepted accounting
principles.
WILLIAM D. LINDBERG
Costa Mesa, California,
June 30, 1999
F-1
<PAGE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
--------------------------------------------
AUDITED CONSOLIDATED STATEMENTS OF INCOME
-----------------------------------------
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
----------------------------------------------------
(Amounts in thousands)
<TABLE>
<CAPTION>
Year ended Year ended Year Ended
December December December 31,
31, 1996 31, 1997 1998
------------ ------------ --------------------------
HK$ HK$ HK$ US$
<S> <C> <C> <C> <C>
Operating Revenues
Fitness service 37,069 82,311 139,829 18,042
Beauty treatments 72,260 66,496 70,317 9,073
Others 1,901 147 63 8
------------ ------------ ------------ ------------
Total operating revenues 111,230 148,954 210,209 27,123
------------ ------------ ------------ ------------
Operating Expenses
Salaries and commissions 23,797 34,459 56,415 7,279
Rent and related expenses 21,185 31,714 44,978 5,804
Depreciation 11,393 18,700 26,579 3,430
Other selling and administrative 23,178 34,849 60,572 7,816
expenses
------------ ------------ ------------ ------------
Total operating expenses 79,553 119,722 188,544 24,329
------------ ------------ ------------ ------------
Income from operations 31,677 29,232 21,665 2,794
------------ ------------ ------------ ------------
Non-operating (income) expenses
Other (income), net (885) (2,186) (645) (83)
Interest expenses 842 4,151 3,933 506
------------ ------------ ------------ ------------
Total non-operating (income) expenses (43) 1,965 3,288 423
------------ ------------ ------------ ------------
Income before income taxes and
minority interests 31,720 27,267 18,377 2,371
Provision for income taxes 8,398 6,969 (108) (14)
------------ ------------ ------------ ------------
Income before minority interests 23,322 20,298 18,485 2,385
Minority interests 2,211 1,832 1,143 147
------------ ------------ ------------ ------------
Net income 21,111 18,466 17,342 2,238
============ ============ ============ ============
Earnings per common share 2.11 1.85 1.73 0.22
============ ============ ============ ============
Number of shares outstanding 10,000 10,000 10,000 10,000
(in thousands)
============ ============ ============ ============
</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 the Asian Wall Street Journal on March 31, 1999 of US$1.00 = HK$7.75.
No representation is made that the Hong Kong Dollar amounts could have been, or
could be, converted into United States Dollars, at that rate on March 31, 1999
or at any other certain rate.
F-2
<PAGE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
--------------------------------------------
AUDITED CONSOLIDATED BALANCE SHEETS
-----------------------------------
AS OF DECEMBER 31, 1997 AND 1998
--------------------------------
(Amounts in thousands, except number of shares and share data)
<TABLE>
<CAPTION>
December 31, December 31,
1997 1998
------------ --------------------------
HK$ HK$ US$
<S> <C> <C> <C>
ASSETS
Current assets
Cash 1,954 1,721 222
Trade receivables 9,573 7,364 950
Rental and utility deposits 7,243 9,829 1,268
Prepayments to vendors and suppliers & other current assets 10,826 5,232 675
Inventories 4,022 2,504 323
Due from related companies 4,932 8,413 1,087
Due from a shareholder - current portion 8,414 4,404 568
------------ ------------ ------------
Total current assets 46,964 39,467 5,093
------------ ------------ ------------
Due from a shareholder - non-current portion 2,361 - -
Prepayments for construction-in-progress 17,011 6,614 853
Property, plant and equipment, net 106,846 127,774 16,487
------------ ------------ ------------
Total assets 173,182 173,855 22,433
============ ============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Short-term bank loans 5,596 6,232 804
Long-term bank loans - current portion 6,269 4,327 558
Accounts payable and accrued expenses 8,237 21,362 2,756
Obligations under finance leases- current portion 4,577 4,924 635
Deferred income 37,696 30,098 3,884
Deferred liabilities 5,012 4,269 551
Loans from third parties 9,741 - -
Income taxes payable 9,895 4,066 525
Taxes other than income 9,880 8,952 1,155
------------ ------------ ------------
Total current liabilities 96,903 84,230 10,868
------------ ------------ ------------
Long-term bank loans 6,786 6,519 841
Loans from minority shareholders of subsidiaries 5,160 4,200 542
Obligations under finance leases - non current portion 8,253 4,215 544
Deferred taxation 4,574 4,712 608
Minority interests 6,689 7,835 1,011
Shareholders' equity:
Common stock, par value US$ 0.001 each,
100 million shares authorized;
10 million shares outstanding 78 78 10
Cumulative translation adjustment 131 116 15
Retained earnings 44,608 61,950 7,994
------------ ------------ ------------
Total shareholders' equity 44,817 62,144 8,019
------------ ------------ ------------
Total liabilities and shareholders' equity 173,182 173,855 22,433
============ ============ ============
</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 the Asian Wall Street Journal on March 31, 1999 of US$1.00 = HK$7.75.
No representation is made that the Hong Kong Dollar amounts could have been, or
could be, converted into United States Dollars, at that rate on March 31, 1999
or at any other certain rate.
F-3
<PAGE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
--------------------------------------------
AUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
----------------------------------------------
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
----------------------------------------------------
(Amounts in thousands)
<TABLE>
<CAPTION>
Year ended Year ended Year Ended
December 31, December 31, December 31,
1996 1997 1998
------------ ------------ --------------------------
HK$ HK$ HK$ US$
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net income 21,111 18,466 17,342 2,238
Adjustments to reconcile net income to
net cash provided by operating activities:
Minority interests 2,211 1,832 1,143 147
Depreciation 11,393 18,700 26,579 3,430
Loss (gain) on disposal of fixed assets 18 124 592 76
(Increase) Decrease in assets:
Trade receivables (6,192) 5247 2,209 285
Deposits, prepayments and other current (9,232) (1,526) 3,008 388
assets
Inventories (4,761) 2,434 1,518 196
Due from related companies (1,986) (2,946) (3,481) (449)
Increase (Decrease) in liabilities:
Accounts payable and accrued expenses 3,281 (80) 13,125 1,694
Deferred income 2,322 15,654 (7,598) (981)
Deferred liabilities - 5,012 (743) (96)
Income taxes payable 4,980 (4,857) (5,829) (752)
Taxes other than income 6,909 623 (928) (120)
Deferred taxation 1,451 3,123 138 18
------------ ------------ ------------ ------------
Net cash provided by operating activities 31,505 61,806 47,075 6,074
------------ ------------ ------------ ------------
Cash flows from investing activities:
Prepayments for construction-in-progress (7,084) (5,000) 10,397 1,342
Acquisition of property, plant and equipment (18,291) (63,360) (48,813) (6,298)
Sales proceeds from disposal of
property, plant and equipment 1,109 53 716 92
------------ ------------ ------------ ------------
Net cash used in investing activities (24,266) (68,307) (37,700) (4,864)
------------ ------------ ------------ ------------
Cash flows from financing activities
(Settlement) Proceeds of short-term bank loans 3,577 (31) 636 82
Decrease (Increase) in due from a (3,187) 5,676 6,371 822
shareholder
Payment of dividend to minority (2,821) -
shareholders
Proceeds from long-term bank loans 1,000 14,500 4,000 516
Repayment of long-term bank loans (4,027) (3,512) (6,208) (801)
Proceeds from (Settlement of) long-term
loans from third parties 1,159 (4,175) (9,741) (1,257)
Assumption of finance lease obligations - - 847 109
Capital element of finance lease rental (1,152) (6,571) (4,538) (585)
payments
Capital contribution of the Chinese joint
venture partner into a joint venture 911 - -
Repayment of loans from minority
shareholders of subsidiaries (1,200) - (960) (124)
------------ ------------ ------------ ------------
Net cash (used in) provided by financing (5,740) 5,887 (9,593) (1,238)
activities
------------ ------------ ------------ ------------
</TABLE>
F-4
<PAGE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
--------------------------------------------
AUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS (Cont'd)
------------------------------------------------------
THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
------------------------------------------------
(Amounts in thousands)
<TABLE>
<CAPTION>
Year ended Year ended Year Ended
December 31, December 31, December 31,
1996 1997 1998
------------ ------------ --------------------------
HK$ HK$ HK$ US$
<S> <C> <C> <C> <C>
Net increase (decrease) in cash
1,499 (614) (218) (28)
Cash at beginning of year
901 2,509 1,954 252
Cumulative translation adjustments 109 59 (15) (2)
------------ ------------ ------------ ------------
Cash at end of year 2,509 1,954 1,721 222
============ ============ ============ ============
</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 the Asian Wall Street Journal on March 31, 1999 of US$1.00 = HK$7.75.
No representation is made that the Hong Kong Dollar amounts could have been, or
could be, converted into United States Dollars, at that rate on March 31, 1999
or at any other certain rate.
F-5
<PAGE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
--------------------------------------------
AUDITED CONSOLIDATED STATEMENTS OF
----------------------------------
CHANGES IN SHAREHOLDERS' EQUITY
-------------------------------
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
----------------------------------------------------
(Amounts in thousands, except number of shares)
<TABLE>
<CAPTION>
Cumulative
Retained Translations
Common Stock Common Stock Earnings Adjustments TOTAL
------------ ------------ ------------ ------------ ------------
Number HK$ HK$ HK$ HK$
<S> <C> <C> <C> <C> <C>
BALANCE AT
JANUARY 1, 1995 10,000,000 78 5,031 (37) 5,072
Net income - - 21,111 - 21,111
Translation adjustment - - - 109 109
------------ ------------ ------------ ------------ ------------
BALANCE AT
DECEMBER 31, 1995 10,000,000 78 26,142 72 26,292
Net income - - 18,466 - 18,466
Translation adjustment - - - 59 59
------------ ------------ ------------ ------------ ------------
BALANCE AT
DECEMBER 31, 1996 10,000,000 78 44,608 131 44,817
Net income - - 17,342 - 17,342
Translation adjustment - - - (15) (15)
------------ ------------ ------------ ------------ ------------
BALANCE AT
DECEMBER 31, 1997 10,000,000 78 61,950 116 62,144
============ ============ ============ ============ ============
</TABLE>
F-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 Place of Equity interest
Name of Company acquisition/ incorporation owned by the Principal activities
formation Company
- ------------------------------------------- --------------------- -------------- ------------------- ------------------------
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 ("Regent") September 20, 1993 BVI 92.5% - Investment holding
Supreme Resources Limited ("Supreme") September 29, 1994 Hong Kong 70% - Operating a beauty
treatment centre in
Hong Kong
Physical Health Centre (Zhong September 29, 1994 Hong Kong 100% - Investment holding
Shan) Limited ("Zhongshan (formerly operating
Physical") (formerly known as a beauty treatment
Famerich Development Limited centre in Hong Kong)
("Famerich"))
Zhongshan Physical Ladies' Club Ltd. October 29, 1996 The PRC - 95% Fitness Centre in
(owned by Zhongshan Physical) Zhongshan, the PRC
not yet open
</TABLE>
F-7
<PAGE>
1. ORGANIZATION AND PRINCIPAL ACTIVITIES (Cont'd)
-------------------------------------
<TABLE>
<CAPTION>
Date of Place of Equity interest
Name of Company acquisition/ incorporation owned by the Principal activities
formation Company
- ------------------------------------------- --------------------- -------------- ------------------- ------------------------
Direct Indirect
------ --------
<S> <C> <C> <C> <C> <C>
Ever Growth Limited ("Ever Growth") September 29, 1994 Hong Kong 100% - Property holding
Proline Holdings Limited ("Proline") September 28, 1994 BVI - 92.5% Investment holding
(wholly owned by Regent)
Shanghai Physical Ladies' Club Company September 28, 1994 Hong Kong - 92.5% Investment holding
Limited ("Shanghai Physical")
(wholly owned by Proline)
Shanghai Physical Ladies' Club Co., Ltd. September 28, 1994 The PRC - 92.5% Operating two Fitness
(owned by Shanghai Physical) Centres in Shanghai, the PRC
Mighty System Limited ("Mighty") December 15, 1994 BVI 100% - Provision of marketing
services for cosmetics sales
Jade Regal Holdings Limited ("Jade Regal") March 15, 1996 BVI 100% - Investment holding
Physical Health Centre (Dalian) Limited March 15, 1996 Hong Kong - 100% Investment holding
("Dalian Physical")
(wholly owned by Jade Regal)
Dalian Physical Ladies' Club Co., Ltd. March 15, 1996 The PRC - 90% Operating a Fitness Centre
(90% owned by Dalian Physical ) in Dalian, the PRC
Star Perfection Holdings Limited April 15, 1996 BVI 100% - Investment holding
("Star Perfection")
Physical Health Centre (Shenzhen) Limited April 15, 1996 Hong Kong - 100% Investment holding
("Shenzhen Physical")
(wholly-owned by Star Perfection)
Shenzhen Physical Ladies' Club Co. Ltd. August 16, 1996 The PRC - 90% Fitness Centre in
(owned by "Shenzhen Physical") Shenzhen, the PRC not yet open
Physical Health Centre (Macau) Limited March 21, 1997 Hong Kong 100% - Investment holding
("Macau Physical")
Physical Health Centre (Tsuen Wan) September 8, 1997 Hong Kong 100% - Operating a Fitness Centre
Limited (Tsuen Wan Physical) in Hong Kong
</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.
F-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>
INTEREST TERM
TYPE OF OWNED BY OF THE
NAME OF THE JOINT JOINT THE JOINT REGISTERED
VENTURE LOCATION VENTURE GROUP VENTURE CAPITAL PROFIT SHARING ARRANGEMENT
- ------------------------ ------------ ---------- ---------- -------- ------------ ---------------------------
<S> <C> <C> <C> <C> <C> <C>
Shanghai Physical Huangpu Co- 92.5% 10 years Originally None. Joint venturer
Ladies' Club Co., Ltd. and operative US$1,000 in receives rent for locations
("Shanghai JV") Hongqiao, cash and and will receive
Shanghai increased equipment when the joint
to US$2,000 venture is dissolved.
in cash in
1995
Dalian Physical Dalian Equity 90% 12 years Originally Pro-rata to equity interests
Ladies' Club Co., Ltd. Rmb10,000
("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- 90% 10 years HK$4,600 Pro-rata to equity interests
Ladies' Club Co. Ltd. operative in form of
("Shenzhen JV") cash and
fixed assets
Zhongshan Physical Zhongshan Co- 95% 10 years US$500 in Pro-rata to equity interests
Ladies' Club Co. Ltd. operative form of
("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.
F-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.
F-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 liability was 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.
F-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 rent-free
period of the operating leases. The deferred liabilities are amortized
within the lease term, and the amortization is recorded in the
statement of income.
4. PROPERTY, PLANT AND EQUIPMENT
-----------------------------
Year Ended
December 31,
--------------------------
1997 1998
------------ ------------
HK$ HK$
Land and buildings 3,140 3,140
Leasehold improvements 65,101 76,379
Machinery and equipment 68,452 79,749
Furniture and fixtures 12,863 21,085
Computers 2,283 3,146
Motor vehicles 1,090 2,227
Less: Accumulated depreciation (46,083) (57,952)
------------ ------------
Net book value 106,846 127,774
============ ============
F-12
<PAGE>
As of December 31, 1998, the cost and accumulated depreciation of fixed assets
held under finance leases amounted to approximately HK$20,466 (1997-HK$17,535)
and HK$6,844 (1997-HK$2,555) respectively.
5. RELATED PARTY TRANSACTIONS
--------------------------
The Group had the following transactions with related companies:
<TABLE>
<CAPTION>
Year ended
December 31,
1996 1997 1998
------------ ------------ ------------
HK HK$ HK$
<S> <C> <C> <C>
Rental of a director's quarters 636 650 720
Purchase of beauty and
Fitness equipment - - 1,881
Sales of beauty and fitness equipment 793 2,677 -
Prepayments for equipment related to
construction-in-progress 3,961 3,961 3,961
Management fee received 12 12 12
</TABLE>
Certain general and administrative expenses incurred by the Group companies
during the relevant years on behalf of the related companies were reimbursed by
the respective related companies at cost.
The Principal Shareholders of the Group had beneficial interests in all the
aforementioned related companies or the shareholders of the related companies
were related to the Principal Shareholders.
The Group made certain advances to the Shareholder during the years. The balance
due the Group at December 31, 1998 was HK$4,404. Under an agreement with the
Group the Shareholder has pledged 1,500,000 shares of the Company stock as
collateral. The loan was segregated into current and non-current based on the
loan repayment schedule.
6. SHORT-TERM BANK LOANS
---------------------
The short-term bank loans are secured and repayable within one year. Please
refer to Note 7 for details of security for such facilities.
Supplemental information with respect to the short-term bank loans was as
follows:
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
December 31, December 31, December 31,
------------ ------------ ------------
1996 1997 1998
<S> <C> <C> <C>
Maximum amount outstanding during the
period/year/year HK$5,626 HK$7,081 HK$6,842
Average amount outstanding during the
period/year/year HK$4,517 HK$4,755 HK$5,448
Weighted average interest rate at the end of
the period/year/year 11% 11% 10%
Weighted average interest rate during the
period/year/ year 9% 10% 11%
</TABLE>
F-13
<PAGE>
7. LONG-TERM BANK LOANS
--------------------
Long-term bank loans bear interest at 10% p.a. on the outstanding balances. As
of December 31, 1998, the loans are repayable as follows:
<TABLE>
<CAPTION>
<S> <C>
HK$
1999 4,327
2000 1,685
2001 1,861
2002 952
2003 2,021
------------
10,846
============
</TABLE>
As of December 31, 1998, the Group had various banking facilities available from
financial institutions amounting to approximately HK$21,400. These facilities
were secured by:
<PAGE>
(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; and
8. 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 combined tax provision for the year ended December 31, 1997 was currently
payable.
For the year ended December 31, 1998, the Company provided income taxes of
HK$4,382 of which HK$138 was deferred. The Company settled prior years taxes and
recorded the amount over provided in prior years against the current year
provision in the amount of HK$4,490 (HK$4,382 less HK$4,490 per income statement
HK$(108)).
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.
F-14
<PAGE>
9. OBLIGATIONS AND COMMITMENTS
---------------------------
As of December 31, 1998, the Group had the following obligations and
commitments:
a. OPERATING LEASES
----------------
Physical HK and the Shanghai and Dalian JVs lease the premises of their
Fitness Centres. The total amount of lease commitments as of December
31, 1998 amounted to HK$248,644 payable as follows:
<TABLE>
<CAPTION>
Year Ended
December 31,
1998
------------
HK$
<S> <C>
Payable during the following period:
Within one year 47,429
Over one year but not exceeding two years 49,186
Over two years but not exceeding three years 40,938
Over three years but not exceeding four years 42,794
Over four years but not exceeding five years 31,530
Thereafter 36,767
------------
Total lease commitments 248,644
============
</TABLE>
b. OBLIGATIONS UNDER FINANCE LEASES
--------------------------------
Physical HK leases fitness equipment and motor vehicles under several
finance leases. The scheduled future minimum lease payments as of
December 31, 1998 were as follows:
<TABLE>
<CAPTION>
Year Ended
December
31,
------------
1998
------------
HK$
<S> <C>
Payable during the following period:
Within one year 6,008
Over one year but not exceeding two years 2,364
Over two years but not exceeding three years 2,382
Over three years but not exceeding four years & thereafter -
------------
Total minimum lease payments 10,754
(Less) : amount representing interest 1,615
------------
Present value of net minimum lease payments 9,139
============
</TABLE>
F-15
<PAGE>
10. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
-------------------------------------------------
<TABLE>
<CAPTION>
Year Ended
December 31,
----------------------------------------
1996 1997 1998
------------ ------------ ------------
HK$ HK$ HK$
<S> <C> <C> <C>
Cash paid for:
Interest expense 841 4,151 3,934
Income taxes 3,238 8,862 5,230
</TABLE>
11. OTHER SUPPLEMENTAL INFORMATION
------------------------------
The following items are included in the consolidated statements of income:
<TABLE>
<CAPTION>
Year Ended
December 31,
----------------------------------------
1996 1997 1998
------------ ------------ ------------
HK$ HK$ HK$
<S> <C> <C> <C>
Foreign exchange gain (loss) 1 (59) 36
Interest expense on finance leases 210 1,265 1,325
Interest expense on
Overdrafts and bank loans 631 1,528 1,985
Interest expense on loans from third parties - 1,358 624
Interest income 2 1,498 12
Sales taxes 1,216 1,040 (492)
Rental expenses under operating leases 21,185 31,714 44,978
</TABLE>
12. DISTRIBUTION OF PROFIT
----------------------
In the opinion of management, any undistributed earnings of Physical Holdings
and the Operating Subsidiaries will be reinvested indefinitely.
F-16
<PAGE>
13. 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.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
The Board of Directors of the Registrant approved the engagement of
William Lindberg, CPA in June of 1999 to serve as the Registrant's independent
public auditor and to conduct the audit of the Company's financial statements
for the fiscal years ended 1996, 1997 and 1998. The decision resulted from the
fact that on November 3, 1998, Arthur andersen withdrew its previously issued
audited reports for the years ended December 31, 1997 and December 31, 1996. The
audit reports provided by Arthur Andersen for the fiscal years ended December
31, 1996 and 1997 did not contain any adverse opinion or disclaimer of opinion
nor was any report modified as to uncertainty, audit scope or accounting
principles.
<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
The officers and directors of the Company, their ages and present
positions held with the Company are as follows:
NAME AGE POSITIONS WITH THE COMPANY
Ngai Keung Luk (Serleo) 42 Chairman of the Board of Directors, Chief Executive
Officer
Jill Bodnar 33 President and Director
Robert Chui 41 Chief Financial Officer and Director
Darrie Lam 35 Executive Vice President, Secretary and Director
Yuk Wah Ho 42 Executive Vice President and Director
Yat Ming Lam 41 Director
Allan Wah Chung Li 41 Director
The following is a brief summary of the background of each director,
executive officer and key employees of the Company:
NGAI KEUNG LUK (SERLEO), CHIEF EXECUTIVE OFFICER, CHAIRMAN. Mr. Luk has
been the Chairman of the Board of Directors and Chief Executive Officer of the
Company since October, 1996. He is the founder of Physical Spa & Fitness and has
over twelve years' experience in the physical health service business. Mr. Luk
was previously employed as a trader on the floor of the Hong Kong gold exchange.
Mr. Luk is a controlling shareholder of the Company and owns beneficially
approximately 80% of the Company's Common Stock (see "Principal Shareholders").
JILL BODNAR, PRESIDENT, DIRECTOR. Ms. Bodnar has been the Company's
President since October, 1996. She received a Bachelor Degree in Exercise
Physiology from the University of Massachusetts, USA in 1987. Prior to joining
the Company in 1993, Ms. Bodnar worked as a fitness professional in Boston
facilities, and was recruited to Asia to open a Hong Kong sports complex in
1990. On completion of the project, Ms. Bodnar joined the Company to develop the
chain in China in 1993. Ms. Bodnar was honored by IDEA Association for Fitness
Professionals in 1995 for her achievements in the industry. Ms. Bodnar is fluent
in Mandarin.
ROBERT CHUI CHI YUN, CHIEF FINANCIAL OFFICER, DIRECTOR. Mr. Chui has
been Chief Financial Officer of the Company since October, 1996. Mr. Chui
graduated from Concordia University, Canada. He is a practicing Certified Public
Accountant in Hong Kong and a fellow member of the Chartered Association of
Certified Accountants (UK). Mr. Chui has twelve years of experience with the
international accounting firm, Ernst and Young. Mr. Chui is responsible for
corporate planning and financial control.
DARRIE LAM HAU YIN, EXECUTIVE VICE PRESIDENT, SECRETARY, DIRECTOR. Ms.
Lam has been a Vice-President and Secretary of the Company since October, 1996.
Ms. Lam is a member of the Hong Kong Society of Accountants and the Chartered
Association of Certified Accountants (UK). She joined the Company in 1994 and
before that she worked with a major Hong Kong listed company, Wharf Group, as a
Financial Analyst. Ms. Lam is responsible for the Company secretarial affairs,
finance and administration functions. Ms. Lam received a MBA degree from the
University of Manchester, U.K.
<PAGE>
YUK WAH HO, EXECUTIVE VICE PRESIDENT, DIRECTOR. Ms. Ho has over eighteen
years' experience in beauty and skin care and has attended various international
beauty workshops held in Europe. Ms. Ho holds many certificates in beauty
therapy, skin care, and cosmetic applications from France, England, Taiwan and
Hong Kong, including Rene Guinot, Germain de Cappucini, and Sothy's. Ms. Ho is
responsible for the business development and staff training of the Company's
beauty treatment business. Ms. Ho is the wife of Mr. Luk.
YAT MING LAM, DIRECTOR. Mr. Lam has been a Director of the Company since
August, 1997. In the past four years, Mr. Lam has been employed as a Sales
Manager with Fitness Concept Leisure Supplies Ltd., one of the leading fitness
equipment and product suppliers. Previously, Mr. Lam was employed as a trader
with the Hong Kong gold exchange.
ALLAN WAH CHUNG LI, DIRECTOR. Mr. Li has been a director of the Company
since June, 1998. Mr. Li is a solicitor qualified to practice law in Canada,
England and Hong Kong. For the last ten years, Mr. Li practiced law in
Vancouver, Toronto and Hong Kong and had also worked for the Listing Division of
the Stock Exchange of Hong Kong. Since 1994, Mr. Li has been with Lai Sun
Development Company Limited, a company listed on the Stock Exchange of Hong
Kong, where he is currently serving as a vice-president, and is involved in
hotels and corporate transactions. Mr. Li received B.Comm. and L.L.B degrees
from the University of British Columbia, Canada.
SIU LING CHENG, MARKETING MANAGER. Ms. Cheng holds a Bachelor Degree in
Marketing at the University of Southern Queens land, Australia. Ms. Cheng joined
the Company since 1992 as a marketing executive, and was promoted to marketing
manager the following year. Ms. Cheng is responsible for the Company's
promotional and marketing activities and public relations. Ms. Cheng also
coordinates and assists the marketing teams in China branches.
GILLIAN LOUISE HOLLOWAY, SENIOR FITNESS MANAGER. Ms. Holloway is a
member of the Association for Fitness Professionals. Ms. Holloway obtained the
qualifications of Certified Aerobics Instructor and Certified Personal Trainer
issued by the American Council on Exercise. Ms. Holloway joined the Company in
1991 and is responsible for the Company's fitness training services and
membership. Ms. Holloway received a Graduate Certificate in Recreation and
Sports Management issued by the Victoria University, Australia.
ITEM 10. EXECUTIVE COMPENSATION
The following table sets forth all compensation awarded to, earned by,
or paid for all services rendered to the Company during the fiscal year ended
December 31, 1998 ("Fiscal 1998"), the fiscal year ended, 1997 ("Fiscal 1997")
and the fiscal year ended December 31, 1996 ("Fiscal 1996") by those persons who
served as Chief Executive Officer and any Named Executive Officer who received
compensation in excess of $100,000 during such years.
<PAGE>
<TABLE>
SUMMARY COMPENSATION TABLE (US$)
<CAPTION>
Annual
Name and Principal Position Year Salary(1) Awards(2)
---- --------- ---------
Bonus(3) Other compensation(4)
-------- ---------------------
<S> <C> <C> <C> <C>
Ngai Keung Luk, CEO, Chairman 1998 387,000 - 93,000
1997 166,000 - 84,000
1996 15,500 - 82,000
Jill Bodnar, President, COO 1998 75,000 3,900
1997 69,000 4,500
1996 54,700 4,500
- ------------------------------------
</TABLE>
(1) No officers received or will receive any bonus or other annual compensation
other than salaries during fiscal year 1998, other than stated above. The
table does not include any amounts for personal benefits extended to
officers of the Company, such as the cost of automobiles, life insurance and
supplemental medical insurance, because the specific dollar amounts of such
personal benefits cannot be ascertained. Management believes that the value
of non-cash benefits and compensation distributed to executive officers of
the Company individually or as a group during fiscal year 1998 did not
exceed the lesser of US$50,000 or ten percent of such officers' individual
cash compensation or, with respect to the group, US$50,000 times the number
of persons in the group or ten percent of the group's aggregate cash
compensation.
(2) No officers received or will receive any long term incentive plan (LTIP)
payouts or other payouts during fiscal year 1998.
(3) Bonus awarded based on performance.
(4) Other compensation for Mr. Luk included an allowance for Mr. Luk's living
accommodations. The yearly allowance of us$93,000 for the fiscal year 1998
and US$84,000 for the fiscal year 1997,represents, respectively, 50% of the
fair market rent of the property owned by a related company, Silver Policy
Development Limited. The remaining portion is shared by another related
company, Williluck International Limited. Mr. Luk and his wife are the
shareholders and directors of both Silver Policy Development Limited and
Williluck International Limited. The current market rent of the property,
which is exclusively used for residential purpose by Mr. Luk and his family,
is US$15,500 per month (increased from $13,700 per month) effective
November, 1997. The Company and Williluck International Limited each pay
US$6,850 per month for the first ten months and US$7,750 per month
thereafter to Silver Policy Development Limited. Yearly allowance to Mr. Luk
is recorded on the Company's books as US$93,000 in 1998. The money is paid
directly to Silver Policy Development Limited. Physical Health Centre Hong
Kong Limited is using the property as security to obtain a full line of
credit from the Kwangtung Provincial Bank. See also "Certain Transactions".
COMPENSATION OF DIRECTORS
The Company reimburses each Director for reasonable expenses (such as
travel and out-of -pocket expenses) in attending meetings of the Board of
Directors. Directors are not separately compensated for their services as
Directors.
AUDIT COMMITTEE
The Board of Directors established an Audit Committee, composed of the
two outside directors and Robert Chui, Chief Financial Officer. The principal
functions of the Audit Committee will include making recommendations to the
Board regarding the selection of independent public accountants to audit
annually the books and records of the Company , reviewing the proposed scope of
each audit and reviewing the recommendations of the independent public
accountants as a result of their audit of the Company. The Audit Committee will
also periodically review the activities of the Company's accounting staff and
the adequacy of the Company's internal controls.
<PAGE>
EMPLOYMENT AND RELATED AGREEMENTS
There are no employment agreements with the Company's key employees at
this time. The Company anticipates that such agreements will be entered into
after the Offering.
Limitation of Liability of Directors
- ------------------------------------
The laws of the State of Delaware and the Company's By-laws provide for
indemnification of the Company's directors for liabilities and expenses that
they may incur in such capacities. In general, directors and officers are
indemnified with respect to actions taken in good faith in a manner reasonably
believed to be in, or not opposed to, the best interests of the Company, and
with respect to any criminal action or proceeding, actions that the indemnitee
had no reasonable cause to believe were unlawful.
The Company has been advised that in the opinion of the Securities and
Exchange Commission, indemnification for liabilities arising under the
Securities Act is against public policy as expressed in the Securities Act and
is, therefore, unenforceable.
1997 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 as "1997 Stock Option
Plan" (the "Plan"). 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.
Under the Plan, a total of 500,000 shares of Common Stock are reserved for
issuance. The Plan provides for appropriate adjustments in the number and kind
of shares subject to the Plan and to outstanding options in the event of a stock
split, stock dividend, or certain other types of recapitalization. Stock options
may be granted as non-qualified stock options or incentive stock options, but
incentive stock options may not be granted at a price less than 100% of the fair
market value of the stock as of the date of grant (110% as to any 10%
shareholder at the time of grant); 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 shall be administered by an Option Committee which is to
be composed of two or more members of the Board of Directors who are
disinterested directors. No persons have been named to the Option Committee as
of the date of this Report. Stock options may be exercised during a period of
time fixed by the Option Committee except that no stock option may be exercised
more than ten years after the date of grant or three years after death or
disability, whichever is later. As of the date hereof, no options have been
granted by the Company.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of March 31, 1999, the stock
ownership of all persons known to own beneficially five percent or more of the
Company's Common Stock and all directors and officers of the Company,
individually and as a group. Each person has sole voting and investment power
over the shares indicated, except as noted. Unless otherwise indicated, the
address for each stockholder is 12/F - 15/F Lee Theatre Plaza, 99 Percival St.,
Causeway Bay, Hong Kong.
<PAGE>
<TABLE>
<CAPTION>
NAME AND AMOUNT AND
ADDRESS OF BENEFICIAL NATURE
OWNER OF BENEFICIAL
- --------------------- OWNERSHIP (1) PERCENTAGE BENEFICIALLY OWNED(2)
------------- --------------------------------
<S> <C> <C>
DIRECTORS, OFFICERS AND 5% STOCKHOLDERS
NGAI KEUNG LUK (SERLEO)(3) 8,000,000 80.00%
JILL BODNAR, PRESIDENT 0 0.00%
YAT MING LAM, DIRECTOR 0 0.00%
ROBERT CHUI, CFO 0 0.00%
DARRIE LAM, VICE PRESIDENT 0 0.00%
YUK WAH HO, VICE PRESIDENT (4) 8,000,000 80.00%
ALLAN WAH CHUNG LI, DIRECTOR 0 0.00%
ALL OFFICERS AND DIRECTORS 8,000,000 80.00%
AS A GROUP (7 PERSONS)(3)
----------
</TABLE>
* Less than 1%
(1) Except as otherwise indicated, the Company believes that the beneficial
owners of Common Stock listed below, based on information furnished by such
owners, have sole investment and voting power with respect to such shares,
subject to community property laws where applicable. Beneficial ownership is
determined in accordance with the rules of the Securities and Exchange
Commission and generally includes voting or investment power with respect to
securities. Shares of Common Stock subject to options or warrants currently
exercisable, or exercisable within 60 days, are deemed outstanding for
purposes of computing the percentage of the person holding such options or
warrants, but are not deemed outstanding for purposes of computing the
percentage of any other person.
(2) Based upon 10,000,000 shares of Common Stock outstanding.
(3) Mr. Luk pledged 1,500,000 shares of Common Stock for the loans received the
Company under that certain Pledge Agreement dated September 30, 1997.
(4) Ms. Ho is the wife of Ngai Keung Luk (Serleo). Accordingly the number of
common stock owned by Mr. Luk and Ms. Luk overlap.
<PAGE>
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company made certain advances to Mr. Luk, the Company's Chief
Executive Officer and the Chairman of its Board of Directors, during the years
ended September 30, 1994, December 31, 1995, December 31, 1996 and the three
months ended December 31, 1994 which were non interest-bearing, unsecured and
repayable on demand. These advances were repaid in cash, by payments made by Mr.
Luk to the Company or by off-setting the dividends declared by the Company and
payable to Mr. Luk against the amounts owed to the Company. Dividends declared
during the year ended December 31, 1995 were off-set against amounts owed by Mr.
Luk. The Company ratified and approved on November 27, 1996, certain loans to
Mr. Luk, in the amount of HK$ 16.5 million (US$2.1 million) (the "Loan"). Mr.
Luk agreed to repay the Loan in eight installments by March 31, 1999 together
with the accrued interest thereon at the prime banking rate of interest of
8.75%. Mr. Luk repaid HK$2.3 million (US$297,000) of the outstanding amount of
the Loan in the first installment. The second and the third installments in the
total of HK$4,600,000 (US$594,000) due on September 30 and December 31, 1997
were repaid in cash in December, 1997. The outstanding principal amount of the
Loan and accrued interest was HK$10,775,000 (US$1,391,000) as of December 31,
1997. The fourth installment of HK$2,300,000 (US$297,000) due on March 31, 1998
was repaid in cash in March, 1998. The remaining outstanding principal amount of
the Loan is secured by a pledge of 1,500,000 shares of common stock of the
Company by Mr. Luk, as collateral for the Loan. As of December 31, 1998, the
outstanding principal amount of the Loan was HK$4,404,000 (US$568,000).
See Note 5 to Financial Statements.
In January 1997, the Company approved an advance to Mr. Luk in the
amount of HK$ 6 million (US$780,000), which loan was repaid in full by Mr. Luk
on April 22, 1997.
In October, 1996, the Company closed a transaction with Mr. Luk, a 100%
shareholder of Physical Beauty & Fitness Holdings Limited, a British Virgin
Islands corporation ("Physical Limited"), whereby the Company entered into a
Share Exchange Agreement with Mr. Luk, pursuant to which the Company issued
8,000,000 of its Common Stock to Mr. Luk in exchange for all of the outstanding
shares of Physical Limited (the "Closing"). As a part of the above transaction
certain shareholders of the Company transferred 990,000 shares of Common Stock
of the Company to Goodchild Investments Limited, a British Virgin Islands
corporation ("Goodchild"), whose beneficial owner is Wong Kui Tak Henry, as
consideration for Goodchild's beneficial owners' prior interest in Physical
Health Centre Hong Kong Limited, pursuant to an arrangement between Goodchild
and Mr. Luk. Neither Mr. Luk nor Goodchild were parties affiliated with the
Company prior to or at the time of the acquisition of Physical Limited. At the
Closing the then current management of the Company resigned and was replaced by
the current management of the Company.
In February, 1998, Goodchild sold all of its shares of common stock of
the Company in open market public transactions.
Mr. Luk receives a monthly allowance of US$93,000 for the
fiscal year 1998 for his living accommodations. Such allowance represents 50%
of the fair market rent of the property owned by a related company, Silver
Policy Development Limited ("Silver Policy"). Silver Policy is a limited company
incorporated in Hong Kong. Mr. Luk and Mrs. Luk respectively hold 0.01% and
99.99% shares in Silver Policy. They also act as directors of Silver Policy.
<PAGE>
Since April 1994, Physical Health Centre Hong Kong Limited ("Hong Kong
Limited") has concluded a tenancy agreement with Silver Policy for the property
to be used exclusively for residential purpose by Mr. Luk and his family. In
April 1996, Silver Policy increased the rent from $11,600 to $13,700 per month
and further increased to $15,500 from November, 1997. Hong Kong Limited and
Williluck International Limited ("Williluck") each paid US$5,80 per month
thereafter. The annual rent allowance costs as recorded by Physical totaled
$84,000 in 1997 and $93,000 in 1998. Pursuant to the lease agreement between
Sliver Policy and Hong Kong Limited, the premises for Mr. Luk and his family are
rented by Hong Kong Limited from Silver Policy for HK$120,000 (US$15,500) per
month. Hong Kong Limited then charges back a related company, Williluck, for a
50% share of the rent. Mr. Luk is a director of Williluck. Hong Kong Limited is
using the property as security to obtain a full line of credit from the
Kwangtung Provincial Bank. See also "Management - Compensation".
The Company had the transactions with related companies as provided in
the Financial Statements, Note 5.
<PAGE>
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
---------
The following exhibits of the Company are included herein.
2. Plan of acquisition, reorganization, arrangement, liquidation or
succession
2.1 Share Exchange Agreement between Foreclosed Realty Exchange, Inc. and
Ngai Keung Luk, together with amendments *
3.1 Articles of Incorporation of Physical Spa & Fitness, Inc., a Delaware
Corporation*
3.2 Certificate of Amendment of Articles of Incorporation changing the
number of directors*
3.3 Certificate of Amendment of Articles of Incorporation changing the
Company's name*
3.4 Certificate of Amendment of Articles of Incorporation changing the
authorized capital*
3.5 By-Laws of Physical Spa & Fitness, Inc.*
3.6 Amended By-Laws of Physical Spa & Fitness, Inc.
10.1 Lease Agreement by and between Lee Theatre Realty Limited and Physical
Health Centre Hong Kong Limited (Causeway Bay Center)*
10.2 Tenancy Agreement between Benefit Plus Company Limited and Physical
Health Centre Hong Kong Limited (Tsimshatsui Center) *
10.3 Lease Agreement between East Asia Property Agency Limited and Physical
Health Centre Hong Kong Limited (Kowloon Center)*
10.4 Lease Agreement between Broadway-Nassau Investments Limited and Ho Yuk
Wah (Mei Foo Center)*
10.5 New Town Tower, S.T.T.L.183 Confirmation of Tenancy (Shatin)*
10.6 Tenancy Agreement by and between Kamoton Investments Limited and
Supreme Resources Limited (Renaissance Beauty Centre)*
10.7 Repayment Agreement between the Company and Ngai Keung Luk*
10.8 Pledge Agreement between the Company and Ngai Keung Luk*
10.9 1997 Stock Option Plan and form of Stock Option Agreement*
16. Letter on changes in certifying accountant.**
22 Subsidiaries of the Registrant*
- ------------
* Filed with the Commission as exhibit to the Registration Statement or
amendments to the Registration Statement..
** To be filed by amendment.
(b) Reports on Form 8-K
-------------------
Form 8-K, Item 4. Change in Certifying Accountants.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on Jume 30, 1999.
PHYSICAL SPA & FITNESS, INC.
By: /s/ Ngai Keung Luk
------------------------------------------
Ngai Keung Luk,
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
/s/ Ngai Keung Luk Chairman and Chief Executive Officer Date: 6/30/99
- ------------------------ (principal executive officer)
Ngai Keung Luk
/s/ Jill Bodnar President and Director Date: 6/30/99
- ------------------------ (principal executive officer)
Jill Bodnar
/s/ Robert Chui Chief Financial Officer and Director Date: 6/30/99
- ------------------------ (Principal accounting and financial
Robert Chui officer)
/s/ Darrie Lam Executive Vice President, Secretary Date: 6/30/99
- ------------------------ and Director
Darrie Lam
/s/ Yuk Wah Ho Executive Vice President and Director Date: 6/30/99
- ------------------------
Yuk Wah Ho
/s/ Yat Ming Lam Director Date: 6/30/99
- ------------------------
Yat Ming Lam
/s/ Allan Wah Chung Li Director Date: 6/30/99
- ------------------------
Allan Wah Chung Li
EXHIBIT 22
Subsidiaries of the Registrant
* Physical Beauty & Fitness Holdings Limited
* Physical Health Centre Hong Kong, Ltd.
* Regent Town Holdings Ltd.
* Mighty System Ltd.
* Supreme Resources Ltd.
* Physical Health Centre (Zhong Shan) Ltd.
* Zhongshan Physical Ladies' Club, Ltd.
* Ever Growth Ltd.
* Proline Holdings Ltd.
* Shanghai Physical Ladies' Club Company Ltd.
* Shanghai Physical Ladies' Club Co., Ltd.
* Jade Regal Holdings Ltd.
* Physical Health Centre (Dalian) Ltd.
* Dalian Physical Ladies' Club Co. Ltd.
* Star Perfection Holdings Ltd.
* Physical Health Centre (Shenzhen) Ltd.
* Shenzhen Physical Ladies' Club Company Ltd.
* Physical Health Centre (Tsuen Wan) Limited
* Physical Health Centre (Macau) Limited
* Physical Health Centre (TST) Limited
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 252
<SECURITIES> 0
<RECEIVABLES> 1235
<ALLOWANCES> 0
<INVENTORY> 519
<CURRENT-ASSETS> 6059
<PP&E> 13787
<DEPRECIATION> 0
<TOTAL-ASSETS> 22347
<CURRENT-LIABILITIES> 12504
<BONDS> 0
0
0
<COMMON> 10
<OTHER-SE> 5773
<TOTAL-LIABILITY-AND-EQUITY> 22347
<SALES> 19220
<TOTAL-REVENUES> 19220
<CGS> 0
<TOTAL-COSTS> 15448
<OTHER-EXPENSES> (282)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 536
<INCOME-PRETAX> 3518
<INCOME-TAX> 899
<INCOME-CONTINUING> 2619
<DISCONTINUED> 0
<EXTRAORDINARY> 236
<CHANGES> 0
<NET-INCOME> 2383
<EPS-BASIC> .24
<EPS-DILUTED> .24
</TABLE>
