SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-QSB
(X) QUARTERLY REPORT PURSUANT SECTION 13 OF 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997.
( ) TRANSITION REPORT PURSUANT SECTION 13 OF 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________ TO ________
COMMISSION FILE NUMBER 333-38697
PHYSICAL SPA & FITNESS, INC.
(EXACT NAME OF SMALL BUSINESS AS SPECIFIED IN ITS CHARTER)
DELAWARE 13-1026995
---------------------- ----------------
(STATE OR OTHER JURISDICTION (IRS EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
12/F - 15/F LEE THEATRE PLAZA
99 PERCIVAL ST., CAUSEWAY BAY
HONG KONG
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(852) (852) 2572-8888
(ISSUER'S TELEPHONE NUMBER)
CHECK WHETHER THE ISSUER (1) FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION
13 OR 15(d) OF THE SECURITIES EXCHANGE ACT DURING THE PAST 12 MONTHS (OR FOR
SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS) AND
(2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS.
YES NO X
---- ----
STATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES OF COMMON
EQUITY, AS OF THE LATEST PRACTICABLE DATED : JUNE 1, 1999, 10,000,000 SHARES.
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT (CHECK ONE) :
YES NO X
---- ----
<PAGE>
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION PAGE
----
ITEM 1 - FINANCIAL STATEMENTS
Consolidated Statements of Operations
for the nine months and three months ended September
30, 1997 and September 30, 1996 (Unaudited) 1
Consolidated Balance Sheets at September 30, 1997
and December 31,1996 (Unaudited) 2
Consolidated Statements of Cash Flows
for the nine months ended September 30, 1997
and September 30, 1996 (Unaudited) 3
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 4 - 14
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS 27 - 31
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS 32
ITEM 2 - CHANGE IN SECURITIES 32
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES 32
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE
OF SECURITY HOLDERS 32
ITEM 5 - OTHER INFORMATION 32
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K 32
<PAGE>
<TABLE>
PHYSICAL SPA & FITNESS, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF INCOME (UNAUDITED)
NINE MONTHS AND THREE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
(Amounts in thousands, except number of shares and per share data)
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30 NINE MONTHS ENDED SEPTEMBER 30
1996 1997 1997 1996 1997 1997
------------ ------------ ------------ ------------ ------------ ------------
HK$ HK$ US$ HK$ HK$ US$
<S> <C> <C> <C> <C> <C> <C>
Operating Revenues
Fitness service 13,309 24,312 3,137 30,126 55,161 7,118
Beauty treatments 17,392 15,829 2,043 52,943 50,862 6,563
Others 38 47 6 1,846 110 14
------------ ------------ ------------ ------------ ------------ ------------
Total operating revenues 30,739 40,188 5,186 84,915 106,133 13,695
------------ ------------ ------------ ------------ ------------ ------------
Operating Expenses
Salaries and commissions 5,955 10,118 1,306 16,869 26,201 3,381
Rent and related expenses 5,327 9,551 1,232 15,640 22,659 2,924
Depreciation 2,700 4,883 630 8,199 10,974 1,416
Other selling and administrative 4,688 9,224 1,191 18,516 23,542 3,038
expenses
------------ ------------ ------------ ------------ ------------ ------------
Total operating expenses 18,670 33,776 4,359 59,224 83,376 10,759
------------ ------------ ------------ ------------ ------------ ------------
Income from operations 12,069 6,412 827 25,691 22,757 2,936
------------ ------------ ------------ ------------ ------------ ------------
Non-operating (income) expenses
Other (income), net (224) (399) (51) (613) (1,653) (213)
Interest expenses 206 1,211 156 583 2,460 317
------------ ------------ ------------ ------------ ------------ ------------
Total non-operating (income) expenses (18) 812 105 (30) 807 104
------------ ------------ ------------ ------------ ------------ ------------
Income before income taxes and
minority interests 12,087 5,600 722 25,721 21,950 2,832
Provision for income taxes 3,764 1,423 183 7,907 4,769 616
------------ ------------ ------------ ------------ ------------ ------------
Income before minority interests 8,323 4,177 539 17,814 17,181 2,217
Minority interests 1,132 475 61 1,897 1,689 218
------------ ------------ ------------ ------------ ------------ ------------
Net income 7,191 3,702 478 15,917 15,492 1,999
============ ============ ============ ============ ============ ============
Earnings per common share 0.72 0.37 0.05 1.59 1.55 0.20
============ ============ ============ ============ ============ ============
Number of shares outstanding (in
thousands) 10,000 10,000 10,000 10,000 10,000 10,000
============ ============ ============ ============ ============ ============
</TABLE>
Translation of amounts from Hong Kong Dollars ("HK$") into United States Dollars
("US$") for the convenience of the reader has been made at the exchange rate
quoted by the Asian Wall Street Journal on March 31, 1998 of US$1.00 = HK$7.75.
No representation is made that the Hong Kong Dollar amounts could have been, or
could be, converted into United States Dollars, at that rate on March 31, 1998
or at any other certain rate.
1
<PAGE>
<TABLE>
PHYSICAL SPA & FITNESS, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
AS OF DECEMBER 31, 1996 (AUDITED) AND
AS OF SEPTEMBER 30, 1997 (UNAUDITED)
(Amounts in thousands, except number of shares and per share data)
<CAPTION>
December 31,
1996 September 30, 1997
------------ --------------------------
HK$ HK$ US$
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets
Cash and cash equivalents 2,509 1,752 226
Trade receivables 14,820 11,172 1,441
Rental and utility deposits 4,735 7,673 990
Prepayments to vendors and suppliers and other 11,808 11,329 1,462
current assets
Inventories 6,456 5,941 767
Due from related companies 1,986 843 109
Due from a shareholder - current portion 5,566 10,278 1,326
------------ ------------ ------------
Total current assets 47,880 48,988 6,321
------------ ------------ ------------
Due from a shareholder - non-current portion 10,885 4,561 588
Prepayments for construction-in-progress 12,011 12,111 1,563
Property, plant and equipment, net 46,917 97,338 12,560
------------ ------------ ------------
Total assets 117,693 162,998 21,032
============ ============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Short-term bank loans 5,627 7,882 1,017
Long-term bank loans - current portion 1,827 7,327 945
Accounts payable and accrued expenses 8,317 12,303 1,587
Loans from third parties - 13,916 1,796
Obligations under finance leases- current portion 2,257 4,794 619
Deferred income 22,042 25,291 3,263
Income taxes payable 14,752 13,234 1,708
Taxes other than income 9,257 9,338 1,205
------------ ------------ ------------
Total current liabilities 64,079 94,085 12,140
------------ ------------ ------------
Long-term bank loans 240 3,670 474
Long-term loans from third parties 13,916 - -
Loans from minority shareholders of subsidiaries 5,160 5,160 666
Obligations under finance leases - non current 1,698 9,212 1,189
portion
Deferred taxation 1,451 2,498 322
Minority interests 4,857 6,550 845
Shareholders' equity:
Common stock, par value US$ 0.001 each, 100
million shares authorized; 10 million shares 78 78 10
outstanding
Cumulative translation adjustment 72 111 14
Retained earnings 26,142 41,634 5,372
------------ ------------ ------------
Total shareholders' equity 26,292 41,823 5,396
------------ ------------ ------------
Total liabilities and shareholders' equity 117,693 162,998 21,032
============ ============ ============
</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, 1998 of US$1.00 = HK$7.75.
No representation is made that the Hong Kong Dollar amounts could have been, or
could be, converted into United States Dollars, at that rate on March 31, 1998
or at any other certain rate.
2
<PAGE>
<TABLE>
PHYSICAL SPA & FITNESS, INC., AND SUBSIDIARIES
----------------------------------------------
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
-----------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1997
(Amounts in thousands)
<CAPTION>
1996 1997
------------ --------------------------
HK$ HK$ US$
<S> <C> <C> <C>
Cash flows from operating activities:
Net income 15,917 15,492 1,999
Adjustments to reconcile net income to net cash
provided by operating activities:
Minority interests 1,897 1,689 218
Depreciation 8,199 10,974 1,416
Loss (Gain) on disposal of fixed assets 18 135 17
(Increase) Decrease in assets:
Trade receivables (4,788) 3,648 471
Deposits, prepayments and other current assets (13,099) (2,459) (317)
Inventories (2,290) 515 66
Due from related companies (525) 1,143 147
Increase (Decrease) in liabilities:
Accounts payable and accrued expenses (196) 3,986 514
Deferred income 5,488 3,249 419
Income taxes payable 5,432 (1,518) (196)
Taxes other than income 711 81 10
Deferred taxation 1,315 1,047 135
------------ ------------ ------------
Net cash provided by operating activities 18,079 37,982 4,899
------------ ------------ ------------
Cash flows from investing activities:
Prepayments for construction-in-progress - (100) (13)
Acquisition of property, plant and equipment (15,814) (61,529) (7,938)
Sales proceeds from disposal of property, plant
and equipment 627 3 1
------------ ------------ ------------
Net cash used in investing activities (15,187) (61,626) (7,950)
------------ ------------ ------------
Cash flows from financing activities
(Settlement) Proceeds of short-term bank loans 3,776 2,255 291
Decrease (Increase) in due from a shareholder (5,302) 1,612 208
Payment of dividends to a shareholders - - -
Payment of dividend to minority shareholders - - -
Proceeds from long-term bank loans - 10,000 1,290
Repayment of long-term bank loans (3,816) (1,070) (138)
Proceeds from (Settlement of) long-term
loans from third parties 1,159 - -
Assumption of finance lease obligations 4,927 16,174 2,087
Capital element of finance lease rental payments (588) (6,123) (790)
Capital contribution of the Chinese joint
venture partner into a joint venture 911 - -
Repayment of loans from minority
shareholders of subsidiaries (9) - -
------------ ------------ ------------
Net cash provided by (used in) financing 1,058 22,848 2,948
activities
------------ ------------ ------------
Net increase (decrease) in cash and cash 3,950 (796) (103)
equivalents
Cash and cash equivalents, at beginning of year 901 2,509 324
Cumulative translation adjustments 102 39 5
------------ ------------ ------------
Cash and cash equivalents, at end of year 4,953 1,752 226
============ ============ ============
</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, 1998 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, 1998
or at any other certain rate.
3
<PAGE>
PHYSICAL SPA $ FITNESS, INC., INC. AND SUBSIDIARIES
------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
(UNAUDITED)
----------
1. ORGANIZATION AND PRINCIPAL ACTIVITIES
- ------------------------------------------
Physical Spa & Fitness Inc. ("the Company") was incorporated on September 21,
1988 under the laws of the United States of America under the name of Foreclosed
Realty Exchange Inc. The Company was incorporated with a share capital of 100
million common shares with par value of US$0.001 each. 7.5 million common shares
were issued and outstanding as of December 31, 1997. The Company is a U.S.
public company listed on the National Association of Securities Dealers Bulletin
Board.
Physical Beauty & Fitness Holdings Limited ("Physical Holdings") was
incorporated (in March 8, 1996 under the laws of the British Virgin Islands
("BVI") with a capital of one common share being held by a shareholder ("the
Shareholder"), Physical Holdings has interests in various companies ("Operating
Subsidiaries") operating fitness and beauty centers ("Fitness Centres") and
other related businesses Hong Kong and the People's Republic of China ("the
PRC").
Pursuant to a Share Exchange Agreement entered into between the Company and
Physical Holdings on August 8, 1996, the Shareholder transferred his controlling
interest, in the outstanding stock, of Physical Holdings in exchange for 80% of
the outstanding stock of the Company. The transaction was completed on October
21, 1996 when the Company became the ultimate holding company of Physical
Holdings and the Operating Subsidiaries. As part of the above transaction,
certain shareholders of the Company also transferred 990,000 pre-split (742,500
post-split) 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 of its shares of common stock of
the Company.
On November 27, 1996, the Company changed its name to Physical Spa & Fitness,
Inc.
The Shareholder's interests in the fitness and beauty centers in Hong Kong and
the PRC and other related businesses were originally conducted through Physical
Health Centre Hong Kong Limited ("Physical HK"), a Hong Kong, corporation
established on March 2, 1990 by two principal shareholders ("the Principal
Shareholders"), one of which is the Shareholder. In 1994, the share capital was
increased and additional shares were issued to the Principal Shareholders as
well as other shareholders.
Physical HK was established to succeed to and continue the operation of two
Fitness Centres and other related businesses previously operated by the
Principal Shareholders in Hong Kong in the form of a sole proprietorship.
4
<PAGE>
1. ORGANIZATION AND PRINCIPAL ACTIVITIES (Cont'd)
- ---------------------------------------------------
During the period from 1990 to 1996, Physical HK and Physical Holdings expanded
their scope of operations by acquiring and establishing, several subsidiary,
companies and by forming Sino-foreign joint ventures in the PRC to operate six
additional Fitness Centres in Hong Kong, two in Shanghai and one in Dalian, the
PRC and other related businesses. These subsidiary companies were all formerly
jointly owned by the Principal Shareholders or solely by the Shareholder. The
respective equity interests were transferred by the Principal Shareholders to
Physical HK or Physical Holdings throughout 1993 to 1996 at the original cost of
the respective investments.
On October 19, 1996, 91.4% of the equity interests of Physical HK was
transferred by the Principal Shareholders and other shareholders of Physical HK
to Physical Holdings at the par value of the shares transferred. In addition,
all the equity interests of Physical HK in various subsidiaries and a
Sino-foreign joint venture were also transferred to Physical Holdings at the
recorded cost of these investments. The Company, Physical Holdings and the
Operating Subsidiaries are collectively known as the Group. They are all
distinct legal entities with limited liability.
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.
5
<PAGE>
1. ORGANIZATION AND PRINCIPAL ACTIVITIES (Cont'd)
- ---------------------------------------------------
<TABLE>
The details of Physical Holdings and Operating Subsidiaries and their principal
activities as of the date of this report are summarized below:
<CAPTION>
Date of Equity interest
acquisition/ Place of owned by the
Name of Company formation incorporation Company Principal activities
- --------------- --------- ------------- ------- --------------------
Direct Indirect
------ --------
<S> <C> <C> <C> <C> <C>
Physical Beauty & Fitness Holdings March 8, 1996 BVI 100% - Investment holding
Limited ("Physical Holdings:)
Physical Health Centre Hong Kong March 2, 1990 Hong Kong 91.4% - Operating 5 Fitness Centres
Limited ("Physical HK") in Hong Kong
Regent Town Holdings Limited September 20, BVI 88.5% - Investment holding
("Regent") 1993
Supreme Resources Limited ("Supreme") September 29, Hong Kong 70% - Operating a beauty
1994 treatment centre in Hong
Kong
Physical Health Centre (Zhong Shan) September 29, Hong Kong 100% - Investment holding
Limited ("Zhongshan Physical") 1994 (formerly operating a
(formerly known as Famerich beauty treatment centre
Development Limited ("Famerich") in Hong Kong)
Zhongshan Physical Ladies' Club Ltd. October 29, 1996 The PRC - 95% Operating a Fitness Centre
(Owned by Zhongshan Physical) in Zhongshan, the PRC
Ever Growth limited ("Ever Growth") September 29, Hong Kong 100% - Property holding
1994
Proline Holdings Limited ("Proline") September 28, BVI - 88.5% Investment holding
(wholly owned by Regent) 1994
Shanghai Physical Ladies' Club Company September 28, Hong Kong - 88.5% Investment holding
Limited ("Shanghai Physical") 1994
(wholly owned by Proline)
Shanghai Physical Ladies' Club Co., Ltd. September 28, The PRC - 88.5% Operating two Fitness
(owned by Shanghai Physical) 1994 Centres in Shanghai, the
PRC
Mighty System Limited ("Mighty") December 15, BVI 100% - Provision of marketing
1994 services for cosmetics
sales
Jade Regal Holdings Limited ("Jade March 15, 1996 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
(90% owned by Dalian Physical) in Dalian, the PRC
Star Perfection Holdings Limited ("Star April 15, 1996 BVI 100% - Investment holding
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 The PRC - 90% Operating a Fitness Centre
(owned by "Shenzhen Physical") in Shenzhen, the PRC
Physical Health Centre (Macau) Limited March 21, 1997 Hong Kong 100% - Investment holding
("Macau Physical")
Physical Health Centre (Tsuen Wan) Limited September 8, 1997 Hong Kong 100% - Operating a Fitness Centre
("Tsuen Wan Physical") in Hong Kong
</TABLE>
6
<PAGE>
1. ORGANIZATION AND PRINCIPAL ACTIVITIES (Cont'd)
- ---------------------------------------------------
Regent Town Holdings Limited ("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 interests of Regent owned by a minority
shareholder was acquired by the Shareholder (see Note 6(d)). All the shares
owned by Physical HK and the Shareholder were then transferred to Physical
Holdings at the original cost of investments to the Physical HK and the
Shareholder.
Famerich was incorporated to operate a beauty treatment centre in Hong Kong. The
business was closed down in late 1994 and the company became dormant thereafter.
The loss of HK$1,332 resulting from the shut down has been included in the
consolidated statement of income for the three-month period from October 1 to
December 31, 1994. In June, 1996, Famerich changed its name to Zhongshan
Physical and it then entered into a joint venture contract to establish a
Sino-foreign co-operative joint venture for the provision of physical fitness
and beauty treatment services through a Fitness Centre in the PRC. (see details
below)
7
<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>
INTERESTS TERM OF
TYPE OF OWNED BY THE PROFIT SHARING ARRANGEMENT
NAME OF THE JOINT THE JOINT REGISTERED FOREIGN CHINESE
JOINT VENTURE LOCATION VENTURE GROUP VENTURE CAPITAL PARTNER PARTNER
<S> <C> <C> <C> <C> <C> <C>
Shanghai Huangpu Co- 88.5% 10 years Originally See next page
Physical Ladies' and operating US$1,000 in
Club Co., ltd. Hongqiao, cash and
("Shanghai JV") Shanghai increased
to US$2,000
in cash in 1995
Dalian Physical Dalian Equity originally 12 years Originally Pro-rata to equity
Ladies' Club at 55% Rmb10,000 interests
Co., Ltd. and in cash and
("Dalian JV") changed changed to
to 90% in Rmb1,000
1996 in cash and
Rmb9,000
in form of
fixed assets
and
renovation
materials in
1996
Shenzhen Shenzhen Co- 90% 10 years HK$4,600 Pro-rata to equity interests
Physical operative in form of
Ladies' Club cash and
Co. Ltd. fixed assets
("Shenzhen
JV")
Zhongshan Zhongshan Equity 95% 10 years US$500 in Pro-rata to equity interests
Physical Ladies form of
Club Co. Ltd. cash and
("Zhongshan fixed assets
JV")
</TABLE>
8
<PAGE>
1. ORGANIZATION AND PRINCIPAL ACTIVITIES (Cont'd)
- ---------------------------------------------------
Other special provisions of these joint ventures are summarized as follows:
Shanghai JV
- -----------
Pursuant to an agreement between Physical HK and Shanghai Physical dated July
20, 1993, Shanghai Physical authorized Physical HK to enter into a joint venture
contract ("the Contract") on its behalf with the Chinese joint venture partner.
Under this agreement, benefits, rights and obligations arising from the Contract
belong to Shanghai Physical. Physical HK contributed the required capital on
behalf of Shanghai Physical.
According to the provisions of the Contract, Shanghai Physical contributed 100%
of the registered capital of the joint venture while the Chinese joint venture
partner provided the premises in which the Fitness Centres are located. Upon
dissolution of the joint venture, all fixed assets of the joint venture will be
assumed by the Chinese joint venture partner while Shanghai Physical will assume
all the working capital, debts and outstanding obligations and commitments. For
the first three years of the joint venture, the Chinese joint venture partner
will be entitled only to rent of Rmb950 per annum. Thereafter, the rental
payment will be increased by 10% per annum unless the inflation rate in the PRC
is higher than 16%. The Chinese joint venture partner has no further entitlement
to the profits of the joint venture.
Shenzhen JV
- -----------
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.
The joint venture has not yet commenced operations as of the date of this
report.
9
<PAGE>
1. ORGANIZATION AND PRINCIPAL ACTIVITIES (Cont'd)
- ---------------------------------------------------
Zhongshan JV
- ------------
Similar to the Shenzhen JV, both joint venture partners have not yet fulfilled
their required capital contribution obligations within the specified time limit.
The joint venture partners are in the process of applying for extension of such
time limits from the relevant authorities.
On August 2, 1996, a supplementary agreement was signed between the joint
venture partners to amend the provisions of the contract to the extent that all
the benefits and liabilities of the joint venture will be assumed by Zhongshan
Physical. In return, the Chinese joint venture partner will be entitled to HK$30
per annum in the form of a technology introduction fee. The Chinese joint
venture partner will not be entitled to share in the profits of the joint
venture after receipt of the technology introduction fee. The supplementary
agreement is subject to the approval of the relevant PRC authorities.
The joint venture has not yet commenced operations as of the date of this
report.
Since the Shanghai JV and the Dalian JV operate in the PRC, they are subject to
special considerations and significant risks not typically associated with
investments in equity securities of United States and Western European
companies. These include risks associated with, among others, the political,
economic and legal environments and foreign currency exchange. These are
described further in the following paragraphs:
POLITICAL ENVIRONMENT
The value of the Company's interests in the Shanghai and Dalian JVs may be
adversely affected by significant political, economic and social uncertainties
in the PRC. A change in policies by the Chinese government could adversely
affect the Company's interests in the Shanghai and Dalian JVs by, among other
factors: changes in laws, regulations or the interpretation thereof;
confiscatory taxation; restrictions on foreign currency conversion, imports or
sources of suppliers; or the expropriation or nationalization of private
enterprises.
10
<PAGE>
1. ORGANIZATION AND PRINCIPAL ACTIVITIES (Cont'd)
- ---------------------------------------------------
ECONOMIC ENVIRONMENT
The economy of the PRC differs significantly from the economies of the United
States and Western Europe in such respects as structure, level of development,
gross national product, growth rate, capital reinvestment, resource allocation,
self-sufficiency, rate of inflation and balance of payments position, among
others. Only recently has the Chinese government encouraged substantial private
economic activities.
The Chinese economy has experienced significant growth in the past five years,
but such growth has been uneven among various sectors of the economy and
geographic regions. Actions by the Chinese central government to control
inflation have significantly restrained economic expansion recently. Similar
actions by the central government of the PRC in the future could have a
significant adverse effect on economic conditions in the PRC and the economic
prospects for the Group.
FOREIGN CURRENCY EXCHANGE
The Chinese central government imposes control over its foreign currency
reserves through control over imports and through direct regulation of the
conversion of its national currency into foreign currencies. As a result, the
Renminbi is not freely convertible into foreign currencies.
The Shanghai and Dalian JVs conduct substantially all of their business in the
PRC, and their financial performance and condition are measured in terms of
Renminbi. The revenues and profits of the Shanghai and Dalian JVs are
predominantly denominated in Renminbi, and will have to be converted to pay
dividends to the Company in United States Dollars or Hong Kong Dollars. Should
the Renminbi devalue against these currencies, such devaluation would have a
material adverse effect on the Company's profits and the foreign currency
equivalent of such profits repatriated by the Shanghai and Dalian JVs to the
Company. The Company currently is not able to hedge its exchange rate exposure
in the PRC because neither the banks in the PRC nor any other financial
institution authorized to engage in foreign exchange transactions offer forward
exchange contracts.
LEGAL ENVIRONMENT
Since 1979, many laws and regulations dealing with economic matters in general
and foreign investment in particular have been enacted in the PRC. However, the
PRC still does not have a comprehensive system of laws and enforcement of
existing laws may be uncertain and sporadic.
11
<PAGE>
2. BASIS OF PRESENTATION
- --------------------------
The financial year end date of Physical HK and the Operating Subsidiaries
incorporated in Hong Kong and the BVI was September 30 up to September 30, 1994
while the PRC joint ventures' financial year end is December 31. Pursuant to
members' resolutions passed by Physical HK and the Operating Subsidiaries
incorporated in Hong Kong and the BVI, their financial year end dates were all
changed to December 31 in 1995. For presentation purposes, the consolidated
financial statements of the Group for the fifteen month period from October 1,
1994 to December 31, 1995 have been segregated to report the results of
operations and cash flows for the three-month period from October 1, 1994 to
December 31, 1994 separately from those for the twelve-month period from January
1, 1995 to December 31, 1995.
Unaudited stub period consolidated income statements of the Group for the
three-month period from October 1, 1993 to December 31, 1993 are presented for
comparison purposes.
The accompanying consolidated financial statements were prepared in accordance
with generally accepted accounting principles in the United States of America
("US GAAP"). 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 ("HK GAAP") and the accounting principles and
the relevant financial regulations applicable to enterprises with foreign
investments as established by the Ministry of Finance of China ("PRC GAAP")
respectively.
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.
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
in full as revenue upon membership being granted while the monthly dues are
recognized as revenue on a monthly basis.
Deferred income represents membership fees and service fees billed but the
related services, or portion of the services, have not yet been rendered.
12
<PAGE>
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont'd)
- --------------------------------------------------------
c. Cash and Cash Equivalents
-----------------------------
Cash and cash equivalents include cash on hand, demand deposits with banks
and liquid investments with an original maturity of three months or less.
d. 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
e. 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 Operating Subsidiaries
has been provided as the earnings of the Operating Subsidiaries, in the
opinion of the management, will be reinvested indefinitely.
Physical HK, Supreme, Zhongshan Physical, Ever Growth, Shanghai Physical,
Dalian Physical and Shenzhen Physical, Macau Physical and Tsuen Wan
Physical were incorporated under the laws of Hong Kong. They provide for
Hong Kong profits tax at a rate of 16.5% on the basis of their income for
financial reporting purposes, adjusted for income and expense items which
are not assessable or deductible for income tax purposes.
Physical Holdings, Regent, Mighty, Proline, Jade Regal and Star Perfection
were incorporated under the laws of BVI and under these laws, they are not
subject to tax on income or on capital gains.
The Shanghai and Dalian JVs, which were incorporated under the laws of the
PRC, provide for enterprise income tax on their assessable income in
accordance with the relevant regulations of the PRC, after considering all
available tax benefits and allowances. They are subject to Chinese
enterprise income taxes at he applicable tax rate of 33%.
13
<PAGE>
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont'd)
- --------------------------------------------------------
e. Taxation: Income Taxes
--------------------------
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.
f. Taxation: Sales Taxes
-------------------------
According to the tax regulations promulgated by the PRC government which
came into effect on January 1, 1994, the Shanghai and Dalian JVs are
subject to Business Tax ("BT") calculated at 5% on the gross service income
received by the joint venture.
BT is recognized on the accrual basis. Sales revenue is recorded in the
financial statements net of BT.
g. Foreign Currency Translation
--------------------------------
The Company, Physical Holdings and the Hong Kong and BVI Operating
Subsidiaries maintain their accounting books and records in Hong Kong
dollars ("HK$"). Foreign currency transactions during the year are
translated into 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.
The PRC Operating Subsidiaries maintain their books and records in
Renminbi. Foreign currency transactions are translated into Renminbi at the
applicable exchange rate quoted by the People's Bank of China ("the unified
exchange rate"), prevailing at the dates of the transactions. Monetary
assets and liabilities denominated in foreign currencies are translated
into Renminbi using the applicable unified exchange rates at the balance
sheet date. The resulting exchange differences are included in the
determination of income.
14
<PAGE>
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont'd)
- --------------------------------------------------------
g. Foreign Currency Translation (Cont'd)
-----------------------------------------
Renminbi is not freely convertible into foreign currencies. All foreign
exchange transactions involving Renminbi must take place either through the
Bank of China or other institutions authorized to buy and sell foreign
currencies, or at a swap centre. Before January 1, 1994, the exchange rates
used for transactions through the Bank of China and other authorized
institutions were set by the government (the "official exchange rate") from
time to time whereas the exchange rates available at the swap centres (the
"swap centre rates") were determined largely by supply and demand. The
Chinese government announced the unification of the two-tier exchange rate
systems in December 1993 effective January 1, 1994. The unification brought
the official exchange rate of the Renminbi in line with the swap centre
rate. The unification did not have a major impact on the consolidated
financial statements of the Company under US GAAP.
On consolidation, the financial statements of the PRC Operating
Subsidiaries are translated into Hong Kong Dollars using the closing rate
method, whereby the balance sheet items are translated into Hong Kong
Dollars 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/period. 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.
h. 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.
15
<PAGE>
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont'd)
- --------------------------------------------------------
i. 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.
j. 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.
4. PROPERTY, PLANT AND EQUIPMENT
- ----------------------------------
<TABLE>
<CAPTION>
Year Ended Nine Months Ended
December 31, September 30,
-------------------------- --------------------------
1995 1996 1996 1997
------------ ------------ ------------ ------------
HK$ HK$ HK$ HK$
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Land and buildings 2,550 3,137 3,137 3,137
Leasehold improvements 32,282 40,143 40,084 62,075
Machinery and equipment 29,511 37,995 36,166 61,995
Furniture and fixtures 6,421 6,368 6,368 5,558
Computers 1,456 1,586 1,550 2,219
Motor vehicles 725 728 728 729
Less: Accumulated depreciation (31,814) (43,040) (39,933) (38,375)
------------ ------------ ------------ ------------
Net book value 41,131 46,917 48,100 97,338
============ ============ ============ ============
</TABLE>
As of December 31, 1996, the cost and accumulated depreciation of fixed assets
held under finance leases amounted to approximately HK$4,927 and HK$132
respectively. As of September 30, 1997, the cost and accumulated depreciation of
fixed assets held under financed leases amounted to approximately HK$21,199 and
HK$2,192 respectively.
16
<PAGE>
5. TRADE RECEIVABLES
- ----------------------
<TABLE>
Trade receivables comprised the following items:
<CAPTION>
Year Ended Nine Months Ended
December 31, September 30,
-------------------------- --------------------------
1995 1996 1996 1997
------------ ------------ ------------ ------------
HK$ HK$ HK$ HK$
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Balances with a beauty product vendor 7,691 9,641 5,314 8,197
Corporate beauty package receivables - 4,854 6,210 2,854
Others 937 325 496 774
------------ ------------ ------------ ------------
8,628 14,820 12,020 11,825
============ ============ ============ ============
</TABLE>
(a) Balance with a beauty product vendor:
Pursuant to a marketing agreement between an Operating Subsidiary, Mighty, and a
beauty product vendor ("the Vendor"), the Vendor agreed to pay marketing fees
calculated at HK$500 per month from June 1994 to November 1994 and HK$250 per
month thereafter to Mighty for marketing services rendered for cosmetic sales up
to May, 1996. In addition, the Group also purchases beauty products from the
Vendor. On September 30, 1996, Mighty entered into an agreement with the Vendor
for the settlement of the outstanding balances of HK$4,965 by three installments
beginning December 31, 1996 to June 30, 1997. The first installment of HK$2,800
due on December 31, 1996 was settled by offsetting the cost of beauty products
purchased by the Group from the Vendor during the 3 months from October 1 to
December 31, 1996. The second installment of HK$1,000 was due on March 3l, 1997
and was settled in cash by the Vendor. The outstanding balances with the Vendor
are interest-free and unsecured. As of September 30, 1997, the final installment
was satisfied by offsetting the cost of beauty products purchased by the Group
from the Vendor.
The Vendor has also agreed to bear all custom duty and sales taxes in connection
with beauty products sold to the Group and imported into and sold in the PRC by
the Group which were estimated to be approximately HK$1,396 and HK$7,544 and
HK$8,197 as of December 31, 1995, 1996 and September 30, 1997 respectively. The
estimated custom duty and sales tax liabilities have been included in "Taxes
other than income" with a corresponding Receivable from the Vendor being
recorded in "Trade Receivable" in the accompanying balance sheet. The Vender
agreed to settle the balances when the corresponding custom duty and sales taxes
are paid by the Group.
17
<PAGE>
5. TRADE RECEIVABLE (Cont'd)
- ------------------------------
(b) Corporate beauty packages receivables:
During 1996, two Operating Subsidiaries, Regent and Jade Regal, entered into
several agreements with a third party company ("the Package Subscriber") for
sales of corporate beauty packages ("the Packages") at a consideration of
approximately HK$6,900. The Packages were given away or resold by the Package
Subscriber to its customers ("the ultimate users") for beauty treatments
performed at the Fitness Centres of the Shanghai and Dalian JVs. Pursuant to the
agreements, non-refundable redemption letters for each beauty treatment with
prescribed expiry dates within one year of the date of the letters were issued
by Regent and Jade Regal to the Package Subscriber which allowed the ultimate
users to redeem the Packages at the Centres. As of December 31, 1996,
approximately HK$6,800 of the Packages had either been redeemed by the ultimate
customers or had expired without being redeemed. This amount has been included
as Beauty Treatment revenue in the consolidated income statement of the Group
for the year ended December 3l, 1996.
Similar arrangements have been made between Physical HK and the Vendor mentioned
in (a) above. Please refer to Note 6(a) for details.
On September 30, 1996, Regent and Jade Regal entered into an agreement with the
Package Subscriber for the settlement of the outstanding balances by three
installments from December 3l, 1996 to June 3O, l997. The first installment of
HK$2,000 due on December 31, 1996 was settled by a deposit paid on behalf of the
Group to a contractor for the decoration of the new premises for a Fitness
Centre in Hong Kong. The second installment of HK$2,000 due on March 31, 1997
was settled in cash and the final installment of HK$2,854 due on June 30, 1997
was also settled in cash in November, 1997.
6. RELATED PARTY TRANSACTIONS
- -------------------------------
<TABLE>
The Group had the following transactions with related companies:
<CAPTION>
------------------------------------------------
Year ended Nine months ended
---------------------- ----------------------
December December September September
31, 31, 30, 30,
1995 1996 1996 1997
---------- ---------- ---------- ----------
HK$ HK$ HK$ HK$
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Rental of a director's 540 636 453 477
quarters
Purchase of cosmetics and
beauty products 2,246 - - -
Purchase of beauty and
fitness equipment 898 - - 2,681
Sales of beauty and fitness
equipment 1,367 793 793 -
Purchase rebate received 1,208 - - -
Management fee received 10 12 12 12
</TABLE>
Certain general and administrative expenses incurred by the Group companies
during the relevant periods on behalf of the related companies were reimbursed
by the respective related companies at cost.
18
<PAGE>
6. RELATED PARTY TRANSACTIONS (Cont'd)
- ----------------------------------------
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.
During the year ended December 31, 1996, Physical HK incurred training expenses
of approximately HK$700 at no cost to other related companies.
The Group has also undertaken the following transactions with the Principal
Shareholders who were also directors of the Group companies:
(a) The Group made certain advances to the Shareholder 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 the Shareholder on behalf of the Group or by
off-setting the dividends declared by the Group and payable to the
Shareholder against the amounts owed to the Group. Dividends declared
during the year ended December 31, 1995 were off-set against amounts
owed by the Shareholder. On March 26, 1997, the Group entered into a
shareholder loan agreement ("the Agreement") with the Shareholder in
respect of the outstanding balance of approximately HK$16.5 million owed
by the Shareholder to the Group ("the Shareholder's Loan") as of
December 31, 1996. Pursuant to the Agreement, the Shareholder's Loan is
unsecured and interest-bearing at the bank prime borrowing rate
prevailing at the date of the Agreement. The Shareholder will repay the
Loan and the interest thereon in eight installments from June 30, 1997
to March 31, 1999. Accordingly, the amount from a shareholder was
classified into current and non-current portions in line with the
repayment schedule for presentation in the consolidated balance sheet as
of December 31, 1996 and September 30, 1997. On September 30, 1997, a
supplemental agreement was signed between the Company and the
Shareholder under which the Shareholder's Loan is secured by a pledge of
1,500,000 shares of common stock of the Company owned by the
Shareholder, as collateral for the Shareholder's Loan.
As of September 30, 1997, the outstanding principal amount of the
Shareholder's Loan and accrued interest is HK$14,839. The second and
third installments of HK$4,600 due on September 30 and December 31, 1997
were repaid in cash in December, 1997.
During 1996, Physical HK entered into several agreements with the beauty
product vendor ("the Vendor") mentioned in Note 5(a) for sales of
corporate beauty packages at a consideration of approximately HK$7,600.
This amount has been included as Beauty Treatment revenue in the
consolidated income statement of the Group for the year ended December
31, 1996. All payments made by the Vendor relating to these corporate
beauty packages were received by the Shareholder on behalf of Physical
HK and included in the amount due from the Shareholder. Up to December
31, 1996, approximately HK$2,500 had been repaid by the Shareholder to
Physical HK. The remaining, HK$5,100 due from the Shareholder in
relation to this arrangement was included in the Shareholder's Loan
balance as of December 31, 1996 and September 30, 1997 mentioned above.
19
<PAGE>
6. RELATED PARTY TRANSACTIONS (Cont'd)
- -------------------------------------------
(b) The Shareholder has also undertaken to indemnify the Group against any
contingent liabilities including tax liabilities and claims that may
result from the operating activities of the Group in Hong Kong, the PRC
and elsewhere occurring before September 30, 1997. Any such liabilities
will be recorded as expenses by the Group.
(c) In 1996, Physical HK made an advance to the Shareholder for the
acquisition of a 5% equity interest in Regent from a minority
shareholder ("the Minority Shareholder") at a consideration of
approximately HK$312. In addition, an advance of approximately HK$1,200
was made to the Shareholder to repay a loan from the Minority
Shareholder (see (d) below) on behalf of Regent. These advances were
included in the balance due from the Shareholder as mentioned in (a)
above. On November 13, 1996, the Shareholder transferred his equity
interests in Regent acquired from a minority shareholder to Physical
Holdings at cost and repaid the advance of approximately HK$1,200 made
from Physical HK. As a result, the Group increased its equity interest
in Regent from 83.5% to 88.5%.
(d) Pursuant to loan agreements between Regent and Supreme and their
minority shareholders, certain loans were made to Regent and Supreme by
their minority shareholders. As of December 31, 1996 and September 30,
1997, the outstanding loan balances amounted to approximately HK$5,160.
The loan balances are non-interest bearing and unsecured. The minority
shareholders have agreed that the loans are repayable when Regent and
Supreme are financially capable of doing so.
(e) During the year ended December 31, 1996, minority shareholders of
Physical HK agreed to assign the dividends declared and receivable from
Physical HK for the year ended December 31, 1995 in the amount of
approximately HK$2,821 to the Shareholder without any consideration. The
dividends so assigned were offset against the advances made by the Group
to the Shareholder as mentioned in (a) above.
(f) The Group made additional net advances to the Shareholder amounting to
approximately HD$6,000 subsequent to December 31, 1996. The amount was
repaid by the Shareholder in April, 1997.
20
<PAGE>
7. SHORT-TERM BANK LOANS
- --------------------------
The short-term bank loans are secured and repayable within one year. Please
refer to Note 8 for details of security for such facilities.
Supplemental information with respect to the short-term bank loans was as
follows:
<TABLE>
<CAPTION>
Year Ended Nine Months Ended
December 31, September 30,
-------------------------- --------------------------
1995 1996 1996 1997
------------ ------------ ------------ ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Maximum amount outstanding
during the year/period HK$5,156 HK$5,626 HK$5,229 HK$7,081
Average amount outstanding
during the year/period HK$3,911 HK$4,517 HK$4,403 HK$4,876
Weighted average interest rate
at the end of the year/period 11% 11% 9% 7%
Weighted average interest rate
during the year/period 11% 9% 9% 11%
</TABLE>
8. LONG-TERM BANK LOANS
- -------------------------
Long-term bank loans bear interest at 11.25% and 9.7% p.a. respectively on the
outstanding balances as of December 31, 1996 and September 30, 1997. The loans
are repayable as follows:
Year Nine Months
Ended Ended
December 31, September 30,
--------------------------
1996 1997
------------ ------------
(UNAUDITED)
HK$ HK$
Payable during the following period:
Within one year 1,827 7,327
Over one year but not exceeding two years 240 951
Over two years but not exceeding three years - 1,048
Over three years but not exceeding four years - 1,155
Over four years but not exceeding five years - 516
------------ ------------
Total 2,067 10,997
============ ============
As of December 31, 1996 and September 30, 1997, the Group had various banking
facilities available from financial institutions amounting to approximately
HK$8,759 and HK$19,320 respectively. These facilities were secured by:
i. leasehold property in Hong Kong owned by Evergrowth;
ii. leasehold property in Hong Kong owned by relatives of the Principal
Shareholders;
iii. leasehold property in Hong Kong owned by a related
company;
iv. personal guarantees from the Principal Shareholders and their
relatives;
v. joint and several guarantees for HK$5,248 from the Principal
Shareholders; and
vi. foreign currency fixed deposit of AUD47 from relatives of the
Principal Shareholders.
21
<PAGE>
9. PROVISION FOR INCOME TAXES
- -------------------------------
Hong Kong profits tax was provided at 16.5% on the assessable profits of
Physical HK.
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 period/years as they did not have any
assessable income.
The combined tax provision in each period was currently payable, except for the
year ended December 31, 1996 and September 30, 1997, when HK$6,946 and HK$3,722
of the provisions were currently payable and HK$1,753 and HK$1,047 were
deferred.
The reconciliation of the effective income tax rate based on income before
income taxes and minority interests stated in the consolidated statements of
income to the statutory income tax rate in Hong Kong, the PRC and the BVI is as
follows:
<TABLE>
<CAPTION>
------------------------------------------------
Year ended Nine months Ended
December 31, September 30,
---------------------- ----------------------
1995 1996 1996 1997
---------- ---------- ---------- ----------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Weighted average statutory tax rate 17.0% 17.1% 20.7% 18.8%
Permanent Differences
Tax loss incurred - - - -
Loss on shut down of a beauty centre - - - -
Non-deductible expenses - - - -
Timing differences for which
no benefit has been recognized
due to establishment of
valuation allowance
- Excess of accelerated depreciation
allowances on fixed assets - - - -
- Write-off of pre-opening expenses - - - -
- Restatement of deferred income 0.9% - - -
- Restatement of purchase returns - - - -
Timing differences which give rise
to the provision of deferred taxation
- Accelerated
depreciation allowances
on fixed assets - 7.1% 8.3% 4.4%
- Restatement of deferred income - 1.6% 1.2% -
Others 0.1% - 0.5% (1.5%)
---------- ---------- ---------- ----------
Effective tax rate 18.0% 25.8% 30.7% 21.7%
========== ========== ========== ==========
</TABLE>
22
<PAGE>
9. PROVISION FOR INCOME TAXES (Cont'd)
- ----------------------------------------
The tax impact of temporary differences between financial and taxable income
that give rise to deferred tax (assets)liabilities are principally related to
the following:
<TABLE>
<CAPTION>
Year Ended Nine Months Ended
December 31, September 30,
-------------------------- --------------------------
1995 1996 1996 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Accelerated depreciation allowances
on fixed assets in Hong Kong 2,180 1,753 2,074 2,800
Restatement of deferred fitness
and beauty income (2,393) - (759) -
Valuation allowance for
deferred tax assets 213 - - -
------------ ------------ ------------ ------------
Total - 1,753 1,315 2,800
============ ============ ============ ============
</TABLE>
10. OBLIGATIONS AND COMMITMENTS
- --------------------------------
As of December 31, 1996 and September 30, 1997, 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,
1996 and September 30, 1997 amounted to HK$151,209 and HK$153,938
respectively payable as follows:
December September
31, 30,
1996 1997
------------ ------------
(UNAUDITED)
HK$ HK$
Payable during the following period:
Within one year 29,701 30,610
Over one year but not exceeding two years 24,958 34,390
Over two years but not exceeding three years 23,975 28,351
Over three years but not exceeding four years 17,747 21,143
Over four years but not exceeding five years 16,846 16,816
Thereafter 37,982 22,628
------------ ------------
Total lease commitment 151,209 153,938
============ ============
23
<PAGE>
10. OBLIGATION AND COMMITMENTS (Cont'd)
- ----------------------------------------
b. Obligations under finance leases
------------------------------------
Physical HK leases fitness equipment and motor vehicles under several
finance leases with lease terms extending from 1994 to 1999. The scheduled
future minimum lease payments as of December 31, 1996 and September 30,
1997 were as follows:
December 31, September 30,
1996 1997
------------ ------------
(UNAUDITED)
HK$ HK$
Payable during the following period:
Within one year 2,641 1,433
Over one year but not exceeding two years 1,934 5,635
Over two years but not exceeding three years 58 4,979
Over three years but not exceeding four years - 2,147
Over four years but not exceeding five years - 1,895
Thereafter - 474
------------ ------------
Total minimum lease payments 4,633 16,563
Less: amount representing interest 678 2,556
------------ ------------
Present value of net minimum lease payments 3,955 14,007
============ ============
c. Long-term loans payable and Share options to lenders
-------------------------------------------------------
Pursuant to five separate loan agreements entered into between Physical HK
and five third party lenders ("the Lenders") in 1995 and 1996, Physical HK
borrowed a sum of approximately US$1,800 (HK$13,916) ("the Loans") from the
Lenders. The Loans will be fully repayable in 1998, twenty-four months
after the drawdown dates ("the Loan Periods"). The Loans bear interest at
three percent over the prevailing prime rate after the first eighteen
months from the respective drawdown dates ("the Interest-free Period"). The
effect of the Interest-free Period was not material to net income.
According to the provisions of the same loan agreements, the Lenders were
granted share purchase options ("the Options") to purchase 0.2% to 2.4% of
the outstanding capital of Physical HK from the Shareholder at a value of
HK$l per share during the Loan Periods. The Lenders also agreed to assign
the Loans owed to them by Physical HK to the Shareholder at a value of HK$l
per share once the options are exercised. There are also provisions in the
agreements that the Lenders can sell the shares to the public or back to
the Shareholder if the Group obtains a flotation during the Loan Periods.
Up to the date of this report, the Lenders have not exercised any of the
Options.
Subsequent to September 30, 1997, Physical HK repaid the loan of US$540
(HK$4,174) to two of the five third party lenders. In addition,
supplemental loan agreements ("Supplemental Agreements") were signed
between Physical Hong Kong and another two of the remaining three third
party lenders in November 1997. According to the Supplemental Agreements,
the Lender agreed to extend the Loan Periods and abandoned their rights of
above mentioned share purchase options. In return, Physical HK will pay the
interest at three percent over the prevailing prime rate during the
extended loan period and a lump sum amount of US$60.
24
<PAGE>
10. OBLIGATION AND COMMITMENTS (Cont'd)
- ----------------------------------------
d. Capital commitments
----------------------
As of December 31, 1996, the Group had outstanding capital commitments in
relation to the purchase of fitness equipment and leasehold improvements of
new Fitness Centres of approximately HK$33,615.
Subsequent to September 30, 1997, the Group entered into an agreement with
a vendor for the leasehold improvement of Tsuen Wan Physical with a total
commitment amount of approximately HK$24,000.
11. RETIREMENT PLANS
- ---------------------
As stipulated by the regulations of the Chinese government, all of the Chinese
staff of the Shanghai and Dalian JVs are entitled to an annual pension on
retirement, which is equal to their basic salaries at their retirement dates.
The Chinese government is responsible for the pension liability to these retired
staff. The Shanghai and Dalian JVs are only required to make specified
contributions to the state-sponsored retirement plan calculated at 30% of the
basic salary of the staff.
12. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
- ------------------------------------------------------
<TABLE>
<CAPTION>
Year ended Nine months ended
December 31, September 30,
-------------------------- --------------------------
1995 1996 1996 1997
------------ ------------ ------------ ------------
HK$ HK$ HK$ HK$
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Cash paid for:
Interest expense 1,158 841 1,894 2,460
Income taxes 2,415 3,238 2,432 5,240
</TABLE>
13. OTHER SUPPLEMENTAL INFORMATION
- -----------------------------------
The following items are included in the consolidated statements of income.
<TABLE>
<CAPTION>
Nine months
Year ended ended
December 31, September 30,
-------------------------- --------------------------
1995 1996 1996 1997
------------ ------------ ------------ ------------
HK$ HK$ HK$ HK$
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Foreign exchange gain 109 1 60 20
Interest expenses on
finance leases 20 210 115 936
Interest expenses on
overdrafts and bank loans 1,138 631 468 1,095
Interest expenses on
other loans - - - 429
Interest income 1 2 2 1,214
Sales taxes 504 1,216 950 848
Rental expenses under
operating leases 18,250 21,185 15,640 22,660
</TABLE>
25
<PAGE>
14. DEDICATED CAPITAL
- ----------------------
In accordance with the relevant laws and regulations for Sino-foreign joint
venture enterprises, the Shanghai and Dalian JVs maintain discretionary
dedicated capital, which includes a general reserve fund, an enterprise
expansion fund and a staff welfare and incentive bonus fund. The Board of
Directors of the Shanghai and Dalian JVS will determine on an annual basis the
amount of the annual appropriations to dedicated capital. Since their inception,
the Shanghai and Dalian JVs have not made any such appropriations as they
incurred losses during these periods.
15. DISTRIBUTION OF PROFIT
- ---------------------------
Dividends from the Shanghai and Dalian JVs will be declared based on the profits
as reported in the statutory financial statements. Such profits will be
different from the amounts reported under US GAAP. Up to September 30, 1997, no
distribution had been made by the Shanghai and Dalian JVs as they incurred
losses during these periods.
Physical HK proposed and paid dividends of HK$32,800 for the year ended December
31, 1995 on the outstanding Common Stock. As mentioned in 6(a) and (e),
dividends payable to the Shareholder in the amount of HK$29,979 were utilized to
offset the balances owed by him to the Group. Dividends payable to the minority
shareholders of Physical HK in the amount of HKS2,821 were assigned to the
Shareholder without any consideration. They were utilized to offset the advances
made by the Group to him as noted in Note 6(a).
In the opinion of management, any undistributed earnings and/or losses of
Physical Holdings and the Operating Subsidiaries will be reinvested
indefinitely.
16. STOCK OPTION PLAN
- ----------------------
The Company has a Stock Option Plan ("the 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 375,000 shares of
Common Stock of the Company are reserved for issuance under the Plan, Stock
options ("the 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 nonqualified 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 ("the
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 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 of this report, no stock options have been
granted by the Company.
26
<PAGE>
17. SUBSEQUENT EVENTS
- ----------------------
The Group made additional net advances to the Shareholder amounting to
approximately HK$6,000 subsequent to December 31, 1996. The amount was repaid by
the Shareholder in April, 1997.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
PRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
ALL FORWARD-LOOKING STATEMENTS CONTAINED HEREIN ARE DEEMED BY THE COMPANY TO BE
COVERED BY AND TO QUALIFY FOR THE SAFE HARBOR PROTECTION PROVIDED BY THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995 THE 1995 ACT SHAREHOLDERS AND
PROSPECTIVE SHAREHOLDERS SHOULD UNDERSTAND THAT SEVERAL FACTORS GOVERN WHETHER
ANY FORWARD-LOOKING STATEMENT CONTAINED HEREIN WILL BE OR CAN BE ACHIEVED. ANY
ONE OF THOSE FACTORS COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE
PROJECTED HEREIN. THESE FORWARD-LOOKING STATEMENTS INCLUDE PLANS AND
OBJECTIVES OF MANAGEMENT FOR FUTURE OPERATIONS, INCLUDING PLANS AND OBJECTIVES
RELATING TO THE PRODUCTS AND THE FUTURE ECONOMIC PERFORMANCE OF THE COMPANY.
ASSUMPTIONS RELATING TO THE FOREGOING INVOLVE JUDGMENTS WITH RESPECT TO, AMONG
OTHER THINGS, FUTURE ECONOMIC, COMPETITIVE AND MARKET CONDITIONS, FUTURE
BUSINESS DECISIONS, AND THE TIME AND MONEY REQUIRED TO SUCCESSFULLY COMPLETE
DEVELOPMENT PROJECTS, ALL OF WHICH ARE DIFFICULT OR IMPOSSIBLE TO PREDICT
ACCURATELY AND MANY OF WHICH ARE BEYOND THE CONTROL OF THE COMPANY. ALTHOUGH THE
COMPANY BELIEVES THAT THE ASSUMPTIONS UNDERLYING THE FORWARD-LOOKING
STATEMENTS CONTAINED HEREIN ARE REASONABLE, ANY OF THOSE ASSUMPTIONS COULD PROVE
INACCURATE AND, THEREFORE, THERE CAN BE NO ASSURANCE THAT THE RESULTS
CONTEMPLATED IN ANY OF THE FORWARD-LOOKING STATEMENTS CONTAINED HEREIN WILL BE
REALIZED. BASED ON ACTUAL EXPERIENCE AND BUSINESS DEVELOPMENT, THE COMPANY MAY
ALTER ITS MARKETING, CAPITAL EXPENDITURE PLANS OR OTHER BUDGETS, WHICH MAY IN
TURN AFFECT THE COMPANY'S RESULTS OF OPERATIONS. IN LIGHT OF THE SIGNIFICANT
UNCERTAINTIES INHERENT IN THE FORWARD-LOOKING STATEMENTS INCLUDED THEREIN, THE
INCLUSION OF ANY SUCH STATEMENT SHOULD NOT BE REGARDED AS A REPRESENTATION BY
THE COMPANY OR ANY OTHER PERSON THAT THE OBJECTIVES OR PLANS OF THE COMPANY WILL
BE ACHIEVED.
OVERVIEW OF COMPANY'S BUSINESS
The Company, through its predecessor companies and its subsidiaries,
has been an established commercial operator of fitness and spa centers in Hong
Kong and China since 1986. The Company currently operates nine facilities: six
in Hong Kong and three in China. Management believes that the Company is one of
the top providers of fitness facilities and spa and beauty treatment services in
Hong Kong and China, with approximately 55,000 members. The Company offers to
its customers, at each location, access to a wide range of U.S.- styled fitness
and spa services.
The Company was incorporated on September 21, 1988 in the state of
Delaware under the name of "Foreclosed Realty Exchange, Inc", a development
stage company seeking acquisitions with no material assets or liabilities. Prior
to acquisition of Physical Beauty & Fitness Holdings Limited, a British Virgin
Islands corporation ("Physical Limited"), the Company had no revenue producing
operations, but planned to enter into joint ventures and/or acquisitions
originally in the area of real estate, to expand its operations. In October,
1996, the Company closed a transaction with Ngai Keung Luk (Serleo), a 100%
shareholder of Physical Limited, whereby the Company entered into a Share
Exchange Agreement with Ngai Keung Luk (Serleo), pursuant to which the Company
issued 8,000,000 shares of its Common Stock to Ngai Keung Luk (Serleo) in
exchange for all of the outstanding shares of Physical Limited (the "Closing").
At the Closing, the then current management of the Company resigned and was
replaced by the current management of the Company. See "Management."
27
<PAGE>
RESULTS OF OPERATIONS
The Company's revenues are derived from its two main lines of business
of fitness and spa services in three principal ways: sale of memberships to
fitness facilities, monthly membership fees and the sale of beauty treatments .
The sale of beauty products and exercise clothing also contributes an
insignificant amount to the total revenues. In respect to fitness services,
customers are invited to join as a member at a fee currently set at
HK$1,500(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.
RESULTS OF OPERATIONS
Nine Months Ended
--------------------------
September 30,
--------------------------
1996 1997
------------ ------------
Operating Revenues 100.00% 100.00%
Total operating expenses 69.75% 78.56%
Operating income 30.25% 21.44%
Income before income taxes and minority interests 30.29% 20.68%
Provision for income and deferred taxes 9.31% 4.49%
Minority interests 2.23% 1.59%
Net income 18.74% 14.60%
============ ============
NINE MONTHS ENDED SEPTEMBER 30, 1997 (UNAUDITED) COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 1996 (UNAUDITED).
- --------------------------------------------------------------------------------
OPERATING REVENUES. The Company's operating revenues enjoyed strong
growth in the first nine months of 1997 as compared to the first nine months of
1996. Operating revenues for the first nine months of 1997 totaled
HK$106,133,000 (US$13,695,000) compared to HK$84,915,000 (US$10,957,000) in the
first nine months of 1996, representing an increase of 25%. Operating revenues
derived by the Company's fitness services increased 83% to HK$55,161,000
(US$7,118,000) compared to HK$30,126,000 (US$3,887,000) in the first nine months
of 1996. Fitness revenues as a percentage of total revenues were 52% in the
first nine months of 1997 as compared to 35% in the first nine months of 1996.
28
<PAGE>
Operating revenues from the Company's beauty treatment business totaled
HK$50,862,000 (US$6,563,000) compared to HK$52,943,000 (US$6,832,000) in the
first nine months of 1996, representing a decrease of 4%. This was mainly due to
the Company's focus on the fitness business during that period of time, which
resulted from the relocation of the Company's two largest centers in Hong Kong
to larger locations and Company's advertising of such relocation and new
premises. The Company also advertised the change in its membership system, which
drew more attention to the fitness business. Beauty treatment revenues as a
percentage of total revenues were 48% in the first nine months of 1997 as
compared to 62% in the first nine months of 1996.
Operating revenues derived from the Company's Hong Kong locations remain
an important contributor to the Company's business, generating HK$89,599,000
(US$11,562,000), or 84% of total operating revenues in the first nine months of
1997 as compared to HK$62,895,000 (US$8,116,000) or 74% of total operating
revenues in the first nine months of 1996.
Operating revenues derived from the Company's China locations generated
HK$16,534,000 (US$2,133,000) or 16% of total operating revenues in the first
nine months of 1997 as compared to HK$22,020,000 (US$2,841,000) or 26% of total
operating revenues in the first nine months of 1996.
OPERATING EXPENSES. The Company's operating expenses for the first nine
months of 1997 totaled HK$83,376,000 (US$10,759,000) compared to HK$59,224,000
(US$7,642,000) in the first nine months of 1996, representing an increase of
41%. Total operating expenses, after taking into account all corporate expenses,
were 79% of total operating revenue, as compared to 70% of last year. This
reflects the additional costs incurred by the Company in following its business
expansion plan.
Operating expenses associated with the Company's Hong Kong locations
were HK$69,767,000 (US$9,003,000), representing an increase of 52% as compared
to HK$45,916,000 (US$5,925,000) in the first nine months of 1996. Hong Kong
operating expenses represented 84% of total operating expenses in the first nine
months of 1997 as compared to 78% of total operating expenses in the first nine
months of 1996. The increase in operating expenses was primarily due to
inflation, additional marketing, administrative and salary costs as a result of
increased revenues and additional costs incurred by two branches in moving to
the new premises.
Operating expenses associated with the Company's China locations were
HK$13,609,000 (US$1,756,000), representing a moderate decrease of 2% due to
inflation as compared to HK$13,309,000 (US$1,717,000) in the first nine months
of 1996. Operating expenses in China represented 16% of total operating expenses
in the first nine months of 1997 as compared to 22% of total operating expenses
in the first nine months of 1996.
TOTAL NON-OPERATING EXPENSES (INCOME). Total non-operating expenses
(income) for the first nine months of 1997 resulted in a net expense of
HK$807,000 (US$104,000) compared to net income of HK$30,000 (US$4,000) in the
first nine months of 1996.
PROVISION FOR INCOME TAXES. Provision for income taxes for the first
nine months of 1997 totaled HK$4,769,000 (US$616,000) compared to HK$7,907,000
(US$1,020,000) in the first nine months of 1996, representing a decrease of 40%.
The effective tax rate of operating income was 22% and 31% respectively. The
decrease in the effective tax rate of operating income was due to the increasing
contribution from Hong Kong operations at the income tax rate of 16.5% compared
with the tax rate of 33% for China operations.
NET INCOME. The Company's net income for the first nine months of 1997
totaled HK$15,492,000 (US$1,999,000) compared to HK$15,917,000 (US$2,054,000)
for the first nine months of 1996, representing a moderate decrease of 3%. The
net income margin in the first nine months of 1997 was 14.6% compared to 18.7%
in the first nine months of 1996, representing an decrease of 4.1%. The
decreased net income reflects increased marketing expenses of the Company.
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 6 "Related Party Transactions"; Note 7 "Short Term Bank Loans"; Note 8
"Long Term Bank Loans"; and Note 10(c) "Obligations and Commitments").
29
<PAGE>
Cash and cash equivalent balances for the respective periods ended
September 30, 1997 and December 31, 1996 were HK$1,752,000 (US$226,000) and
HK$2,509,000 (US$324,000), while total indebtedness at September 30, 1997 was
HK$51,961,000 (US$6,706,000) and HK$30,725,000 (US$3,966,000) at December 31,
1996.
Net cash provided by operating activities were HK$18,079,000
(US$2,333,000) and HK$37,982,000 (US$4,899,000) for Fiscal Year 1996, and the
nine-month period ended September 30, 1997, respectively. The Company's
operating activities are historically financed by cash flows from operations.
Net cash used in investing activities were HK$15,187,000 (US$1,960,000)and
HK$61,626,000 (US$7,950,000) for Fiscal Year 1996 and the nine-month period
ended September 30, 1997, primarily as a result of expenditures for property,
plant and equipment. Net cash provided by financing activities were HK$1,058,000
(US$137,000) and HK$22,848,000 (US$2,948,000) for Fiscal Year 1996 and the
nine-month period ended September 30, 1997.
30
<PAGE>
The Company obtained a term loan in the amount of HK$1,000,000
(US$129,000) at an interest rate of 10.5% per annum from Shanghai Commercial
Bank Limited in Fiscal Year 1996 in connection with payment of rental deposits
for the new Causeway Bay center (relocation of an existing center). This loan is
secured by leasehold property in Hong Kong owned by relatives of Mr. Luk and is
repayable in one lump sum on November 6, 1997. No consideration has been paid by
the Company for such security. As of September 30, 1997, the outstanding
principal amount of this loan was HK$1,000,000 (US$129,000). The Company has
negotiated with the bank to replace the loan with a new loan which is to be
repaid by sixty (60) equal monthly installment payments commencing November,
1997.
The Company entered into a capital lease agreement with East Asia
Finance Company Limited in April, 1996 for the purchase of exercise equipment in
the amount of HK$1,759,200 (US$227,000) for the Dalian, China, center . The
lease is repayable in thirty six (36) monthly installments, commencing April,
1996 at an interest rate of 6.75% per annum. In addition, the Company secured a
loan of HK$3,168,000 (US$409,000) from Dao Heng Finance in August 1996 for the
equipment for a proposed new center in Zhongshan, China, however, the loan was
fully repaid in February 1997. In March, 1997 the Company entered into a capital
lease agreement with the Hongkong and Shanghai Banking Corporation Limited for
the purchase of exercise equipment in the amount of HK$7,432,320 (US$959,000)
for the centers in Hong Kong. The lease is repayable in sixty (60) monthly
installments, commencing April, 1997 at an interest rate of 10.75% per annum. In
May, 1997 the Company entered into a capital lease agreement with East Asia
Finance Company, Limited for the purchase of exercise equipment in the amount of
HK$7,742,000 (US$999,000) for the Hong Kong centers. The lease is repayable in
thirty (30) monthly installments, commencing May, 1997 at an interest rate of
6.5% per annum.
The Company has revolving lines of credit with four banks - The
Kwangtung Provincial Bank (at an interest rate of 10.75%), Dao Heng Bank (at an
interest rate of 10.75%), Shanghai Commercial Bank Limited (at interest rates of
11.5% and 12.25%) and Hongkong and Shanghai Banking Corporation Limited (at an
interest rate of 11%). As of September 30, 1997, the Company fully utilized
these revolving lines of credit. The Company draws down from the lines of credit
primarily for general working capital purposes. The lines of credit contain
covenants requiring the maintenance of minimum net worth.
Consistent with the general practice of the fitness and spa industry,
the Company receives prepaid memberships to fitness facilities, which are
non-refundable, and spa treatment dues from its customers. This practice creates
working capital that the Company generally utilizes for working capital
purposes. However, the unused portion of the pre-paid membership and spa
treatment dues is characterized as deferred income, a current liability, for
accounting purposes.
The Company's trade receivable balance at September 30, 1997, was
HK$11,172,000 (US$1,441,000). The Company has never experienced any significant
problems with collection of accounts receivable from its customers.
Capital expenditure for Fiscal Year 1996 and the nine-month period ended
September 30, 1997, were HK$15,814,000 (US$2,041,000)and HK$61,629,000
(US$7,951,000) respectively. The Company believes that cash flow generated from
its operations, the proceeds from this Offering and its existing credit
facilities should be sufficient to satisfy its working capital and capital
expenditure requirements for at least the next 18 months.
YEAR 2000 DISCLOSURE
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 early 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:
1997 HK$120,000 (US$15,500)
1998 HK$ 96,000 (US$12,400)
1999 and onwards HK$ 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.
31
<PAGE>
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
NONE
ITEM 2 - CHANGES IN SECURITIES
NONE
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
NONE
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS
NONE
ITEM 5 - OTHER INFORMATION
NONE
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
The Company did not file reports on FORM 8-K during the quarter
ending September 30, 1997.
32
<PAGE>
SIGNATURES
Pursuant to the requirements of the Exchange Act, the registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
PHYSICAL SPA & FITNESS, INC.
(Registrant)
Date: June 30, 1999 /S/ Ngai Keung Luk
----------------------------------
Ngai Keung Luk, Chairman and
Chief Executive Officer
Date: June 30, 1999 /S/ Robert Chui
----------------------------------
Robert Chui,
Chief Financial Officer
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 226
<SECURITIES> 0
<RECEIVABLES> 1441
<ALLOWANCES> 0
<INVENTORY> 767
<CURRENT-ASSETS> 6321
<PP&E> 12560
<DEPRECIATION> 0
<TOTAL-ASSETS> 21032
<CURRENT-LIABILITIES> 12140
<BONDS> 0
0
0
<COMMON> 10
<OTHER-SE> 5386
<TOTAL-LIABILITY-AND-EQUITY> 21032
<SALES> 13695
<TOTAL-REVENUES> 13695
<CGS> 0
<TOTAL-COSTS> 10759
<OTHER-EXPENSES> 10759
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 317
<INCOME-PRETAX> 2832
<INCOME-TAX> 218
<INCOME-CONTINUING> 1999
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1999
<EPS-BASIC> .20
<EPS-DILUTED> .20
</TABLE>
