<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-QSB
(X) QUARTERLY REPORT PURSUANT SECTION 13 OF 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 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 three months ended March
31, 1997 and 1996 (Unaudited) 1
Consolidated Balance Sheets at March 31, 1997
and December 31,1996 (Unaudited) 2
Consolidated Statements of Cash Flows
for the three months ended March 31, 1997
and 1996 (Unaudited) 3
Notes to Consolidated Financial Statements 4 - 14
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OR PLAN OF OPERATION 15 - 18
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS 19
ITEM 2 - CHANGE IN SECURITIES 19
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES 19
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE
OF SECURITY HOLDERS 19
ITEM 5 - OTHER INFORMATION 19
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K 19
<PAGE>
<TABLE>
PHYSICAL SPA & FITNESS, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF INCOME (UNAUDITED)
THREE MONTHS ENDED March 31, 1997 AND 1996
(Amounts in thousands, except number of shares and per share data)
<CAPTION>
Three Months Ended March 31,
--------------------------------------------------
1997 1996
------------------------ ------------------------
HK$ US$ HK$ US$
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Operating Revenues
Fitness service 9,843 1,270 6,809 879
Beauty treatments 14,075 1,816 15,051 1,942
Others 22 3 1,151 148
----------- ----------- ----------- -----------
Total operating revenues 23,940 3,089 23,011 2,969
----------- ----------- ----------- -----------
Operating Expenses
Salaries and commissions 7,549 974 5,485 708
Rent and related expenses 6,214 802 4,895 632
Depreciation 2,889 373 2,592 334
Other selling and administrative expenses 6,533 842 5,571 719
----------- ----------- ----------- -----------
Total operating expenses 23,185 2,991 18,543 2,393
----------- ----------- ----------- -----------
Income from operations 755 98 4,468 576
----------- ----------- ----------- -----------
Non-operating (income) expenses
Other (income), net (202) (26) (189) (24)
Interest expenses 426 55 393 50
----------- ----------- ----------- -----------
Total non-operating (income) expenses 224 29 204 26
----------- ----------- ----------- -----------
Income before income taxes and
minority interests 531 69 4,264 550
Provision for income taxes 423 55 1,382 178
----------- ----------- ----------- -----------
Income before minority interests 108 14 2,882 372
Minority interests 80 10 256 33
----------- ----------- ----------- -----------
Net income 28 4 2,626 339
=========== =========== =========== ===========
Earnings per common share 0.00 0.00 0.26 0.03
=========== =========== =========== ===========
Number of shares outstanding (in
thousands) 10,000 10,000 10,000 10,000
=========== =========== =========== ===========
Translations 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 South China Morning Post on March 31, 1997 of US$1.00=HK$7.75. No
representation is made that the Hong Kong Dollar amounts could have been, or
could be, converted into United States Dollars at that rate on March 31, 1996 or
at any other certain rate.
1
</TABLE>
<PAGE>
<TABLE>
PHYSICAL SPA & FITNESS, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
AS OF DECEMBER 31, 1996 (AUDITED) AND
AS OF MARCH 31, 1997 (UNAUDITED)
(Amounts in thousands, except number of shares and per share data)
<CAPTION>
March 31, December 31, 1996
1997
-------------------------- --------------------------
HK$ US$ HK$ US$
ASSETS (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Current assets
Cash and cash equivalents 2,270 293 2,509 324
Trade receivables 12,544 1,619 14,820 1,912
Rental and utility deposits 4,822 622 4,735 611
Prepayments to vendors and suppliers and other
current assets 8,354 1,078 11,808 1,524
Inventories 6,449 832 6,456 833
Due from related companies 1,659 214 1,986 256
Due from a shareholder - current portion 14,087 1,817 5,566 718
------------ ------------ ------------ ------------
Total current assets 50,185 6,475 47,880 6,178
------------ ------------ ------------ ------------
Due from a shareholder - non-current portion 8,820 1,139 10,885 1,404
Prepayments for construction-in-progress 29,050 3,748 12,011 1,550
Property, plant and equipment, net 46,237 5,966 46,917 6,054
------------ ------------ ------------ ------------
Total assets 134,292 17,328 117,693 15,186
============ ============ ============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Short-term bank loans 5,241 676 5,627 726
Long-term bank loans - current portion 7,573 977 1,827 236
Accounts payable and accrued expenses 5,111 659 8,317 1,073
Obligations under finance leases- current portion 2,761 356 2,257 291
Deferred income 28,850 3,723 22,042 2,844
Income taxes payable 12,965 1,673 14,752 1,904
Taxes other than income 9,165 1,183 9,257 1,194
------------ ------------ ------------ ------------
Total current liabilities 71,666 9,247 64,079 8,268
------------ ------------ ------------ ------------
Long-term bank loans 4,210 543 240 31
Long-term loans from third parties 13,916 1,796 13,916 1,796
Loans from minority shareholders of subsidiaries 5,160 666 5,160 666
Obligations under finance leases - non current 6,602 852 1,698 219
portion
Deferred taxation 1,451 187 1,451 187
Minority interests 4,940 637 4,857 627
Shareholders' equity:
Common stock, par value US$ 0.001 each, 100
million shares authorized; 10 million shares 78 10 78 10
outstanding
Cumulative translation adjustment 99 13 72 9
Retained earnings 26,170 3,377 26,142 3,373
------------ ------------ ------------ ------------
Total shareholders' equity 26,347 3,400 26,292 3,392
------------ ------------ ------------ ------------
Total liabilities and shareholders' equity 134,292 17,328 117,693 15,186
============ ============ ============ ============
</TABLE>
Translations 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 South China Morning Post on March 31, 1997 of US$1.00=HK$7.75. No
representation is made that the Hong Kong Dollar amounts could have been, or
could be, converted into United States Dollars at that rate on March 31, 1996 or
at any other certain rate.
2
<PAGE>
<TABLE>
PHYSICAL SPA & FITNESS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 1997 AND 1996
(Amounts in thousands)
<CAPTION>
March 31, 1997 March 31, 1996
------------------------ ------------------------
HK$ US$ HK$ US$
Cash flows from operating activities: (Unaudited) (Unaudited) (Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Net income 28 4 2,626 339
Adjustments to reconcile net income to net cash
provided by operating activities:
Minority interests 80 10 256 33
Depreciation 2,889 373 2,592 334
Loss on disposal of fixed assets - - - -
(Increase) Decrease in assets:
Trade receivables 2,276 293 359 46
Deposits, prepayments and other current assets 3,367 435 1,193 154
Inventories 7 1 (1,198) (155)
Due from related companies 327 42 - -
Increase (Decrease) in liabilities:
Accounts payable and accrued expenses (3,206) (414) 17 2
Deferred income 6,808 879 823 106
Deferred liabilities - - - -
Income taxes payable (1,787) (231) 1,368 176
Taxes other than income (92) (11) 235 30
Deferred taxation - - 381 49
----------- ----------- ----------- -----------
Net cash provided by operating activities 10,697 1,381 8,652 1,114
----------- ----------- ----------- -----------
Cash flows from investing activities:
Prepayments for construction-in-progress (17,039) (2,199) (12,431) (1,603)
Acquisition of property, plant and equipment (2,206) (285) (682) (87)
Sales proceeds from disposal of property,
plant and equipment - - - -
----------- ----------- ----------- -----------
Net cash used in investing activities (19,245) (2,484) (13,113) (1,690)
----------- ----------- ----------- -----------
Cash flows from financing activities
(Settlement) Proceeds of short-term bank loans (386) (50) 3,316 428
Decrease (Increase) in due from a shareholder (6,456) (833) 4,099 529
Proceeds from long-term bank loans 10,000 1,290 - -
Repayment of long-term bank loans (284) (37) (3,410) (440)
Proceeds from (Settlement of) long-term
loans from third parties - - 1,159 150
Assumption of finance lease obligations 8,432 1,088 (23) (3)
Capital element of finance lease rental
payments (3,024) (390) - -
Capital contribution of the Chinese joint
venture partner into a joint venture - - 907 117
----------- ----------- ----------- -----------
Net cash provided by (used in) financing
activities 8,282 1,068 6,048 781
----------- ----------- ----------- -----------
Net increase (decrease) in cash and cash
equivalents (266) (35) 1,587 205
Cash and cash equivalents, at beginning of year 2,509 324 901 116
Cumulative translation adjustments 27 4 96 13
----------- ----------- ----------- -----------
Cash and cash equivalents, at end of year 2,270 293 2,584 334
=========== =========== =========== ============
</TABLE>
Translations 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 South China Morning Post on March 31, 1997 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, 1996 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. 10 million common shares
were issued and outstanding as of March 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.
<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.
<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
not yet open
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
not yet open
Physical Health Centre (Macau) Limited March 21, 1997 Hong Kong 100% - Investment holding
("Macau Physical")
</TABLE>
<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)
<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
NAME OF THE TYPE OF OWNED BY THE
JOINT VENTURE JOINT THE JOINT REGISTERED
LOCATION VENTURE GROUP VENTURE CAPITAL PROFIT SHARING ARRANGEMENT
FOREIGN CHINESE
PARTNER PARTNER
<S> <C> <C> <C> <C> <C> <C>
Shanghai Huangpu Co- 88.5% 10 years Originally None. Joint venture receives
Physical Ladies' and operating US$1,000 in rent for location and will
Club Co., ltd. Hongqiao, cash and receive equipment when joint
("Shanghai JV") Shanghai increased venture is dissolved.
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>
<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.
<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 bligations 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.
<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.
<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.
<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%.
<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.
<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.
<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
- ----------------------------------
Year Ended Three Months Ended
December 31, March 31,
---------------------- ---------------------
1995 1996 1996 1997
---------- ----------- ---------- ----------
HK$ HK$ HK$ HK$
(UNAUDITED)(UNAUDITED)
Land and buildings 2,550 3,137 2,550 3,137
Leasehold improvements 32,282 40,143 32,379 40,184
Machinery and equipment 29,511 37,995 30,112 40,170
Furniture and fixtures 6,421 6,368 6,421 6,368
Computers 1,456 1,586 1,456 1,586
Motor vehicles 725 728 727 729
Less: Accumulated depreciation (31,814) (43,040) (34,410) (45,937)
---------- ----------- --------- -----------
Net book value 41,131 46,917 39,235 46,237
========== =========== ========= ===========
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$132
respectively.
<PAGE>
5. TRADE RECEIVABLES
- ----------------------
<TABLE>
Trade receivables comprised the following items:
<CAPTION>
Year Ended Three Months Ended
December 31, March 31,
------------------------ ------------------------
1995 1996 1996 1997
----------- ----------- ----------- -----------
HK$ HK$ HK$ HK$
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Balances with a beauty product vendor 7,691 9,641 6,178 8,300
Corporate beauty package receivables - 4,854 - 2,854
Others 937 325 695 1,390
----------- ----------- ----------- -----------
8,628 14,820 6,873 12,544
=========== =========== =========== ===========
</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 as of
December 31, 1995 and 1996 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.
<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$2,854 due on June 30, 1997
was also settled in cash in November, 1997.
6. RELATED PARTY TRANSACTIONS
- -------------------------------
<TABLE>
The Group had the following transactions with related companies:
<CAPTION>
----------------------------------
Three months ended
----------------------------------
December March March
31, 31, 31,
1996 1996 1997
----------------------------------
HK$ HK$ HK$
(unaudited)(unaudited)
<S> <C> <C> <C>
Rental of a director's 636 151 156
quarters
Purchase of cosmetics and
beauty products - - -
Purchase of beauty and
fitness equipment - - -
Sales of beauty and fitness
equipment 793 - -
Purchase rebate received - - -
Management fee received 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.
<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.
The Group made certain advances to the Shareholder during the years. The balance
due the Group at December 31, 1996 was HK$16,451 including interest. 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.
7. 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
December 31, December 31,
-------------------- --------------------
1995 1996
<S> <C> <C>
Maximum amount outstanding during the
period/year/year HK$5,156 HK$5,626
Average amount outstanding during the
period/year/year HK$3,911 HK$4,517
Weighted average interest rate at the end of
the period/year/year 11% 11%
Weighted average interest rate during the
period/year/ year 11% 9%
</TABLE>
8. LONG-TERM BANK LOANS
- -----------------------------
Long-term bank loans bear interest at 11% p.a. on the outstanding balances. As
of December 31, 1996, the loans are repayable HK$1,827 in 1997 and HK$240 in
1998.
As of December 31, 1996, the Group had various banking facilities available from
financial institutions amounting to approximately HK$21,953. 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;
and
(v) joint and several guarantees for $13,248 from the Principal Shareholders.
<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 years as they did not have any
assessable income.
The combined tax provision for the year ended December 31, 1995 was currently
payable. For the years ended December 31, 1996, HK$6,946 was currently payable
and HK$1,753 was deferred.
The reconciliation of the effective income tax rate based on income before
income taxes and minority interests stated in the consolidated statements of
income to the statutory income tax rate in Hong Kong, the PRC and the BVI is as
follows:
Year Ended
December 31,
----------------------------
1995 1996
------------ ------------
Weighted average statutory tax rate 17.0% 17.1%
Permanent differences
- -Non-deductible expenses - -
Timing differences for which no benefit has
been recognized due to establishment of
valuation allowance
- -Restatement of deferred income 0.9% -
Timing differences which give rise to the
provision of deferred taxation
- -Accelerated depreciation allowances on fixed
assets - 7.1%
- -Restatement of deferred income - 1.6%
Others 0.1% -
------------ ------------
Effective tax rate 18.0% 25.8%
============ ============
<PAGE>
9. PROVISION FOR INCOME TAXES (CONT'D)
- -----------------------------------
The tax impact of temporary differences between financial and taxable income
that give rise to deferred tax (assets) liabilities are principally related to
the following:
Year Ended
December 31,
----------------------------
1995 1996
------------ ------------
HK$ HK$
Accelerated depreciation allowances
On fixed assets in Hong Kong 2,180 1,753
Restatement of deferred fitness and
Beauty income (2,393) (302)
Valuation allowance for deferred tax assets 213 -
------------ ------------
Total - 1,451
============ ============
10. OBLIGATIONS AND COMMITMENTS
- -------------------------------------
As of December 31, 1996, 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 amounted to HK$151,209 payable as follows:
Year Ended
December 31,
1996
-------------
HK$
Payable during the following period:
Within one year 29,701
Over one year but not exceeding two years 24,958
Over two years but not exceeding three years 23,975
Over three years but not exceeding four years 17,747
Over four years but not exceeding five years 16,846
Thereafter 37,982
-------------
Total lease commitments 151,209
=============
-18-
<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 were as
follows:
<TABLE>
<CAPTION>
Year Ended
December 31,
-------------
1996
------------
HK$
<S> <C>
Payable during the following period:
Within one year 2,641
Over one year but not exceeding two years 1,934
Over two years but not exceeding three years 58
Over three years but not exceeding four years & thereafter -
------------
Total minimum lease payments 4,633
(Less) : amount representing interest (678)
------------
Present value of net minimum lease payments 3,955
============
</TABLE>
c. Loans From Third Parties
------------------------
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 are fully repayable in 1997 or
1998, twenty-four months after the drawdown dates ("the Loan Periods").
d. Capital Commitments
-------------------
As of December 31, 1996, the Group had outstanding capital commitments
in relation to the purchase of fitness equipment, vehicles and
leasehold improvements of new Fitness Centres of approximately
HK$33,615.
-19-
<PAGE>
11. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
- ----------------------------------------------------------
Year Ended
December 31,
---------------------------------
1995 1996
-------------- --------------
HK$ HK$
Cash paid for:
Interest expense 1,158 841
Income taxes 2,415 3,238
12. OTHER SUPPLEMENTAL INFORMATION
- ---------------------------------------
The following items are included in the consolidated statements of income:
Year Ended
December 31,
---------------------------------
1995 1996
-------------- --------------
HK$ HK$
Foreign exchange gain 109 1
Interest expense on finance leases 20 210
Interest expense on
Overdrafts and bank loans 1,138 631
Interest expense on loans
from third parties - -
Interest income 1 2
Sales taxes 504 1,216
Rental expenses under operating
leases 18,250 21,185
<PAGE>
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
PRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
ALL FORWARD-LOOKING STATEMENTS CONTAINED HEREIN ARE DEEMED BY THE COMPANY TO BE
COVERED BY AND TO QUALIFY FOR THE SAFE HARBOR PROTECTION PROVIDED BY THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995 THE 1995 ACT SHAREHOLDERS AND
PROSPECTIVE SHAREHOLDERS SHOULD UNDERSTAND THAT SEVERAL FACTORS GOVERN WHETHER
ANY FORWARD - LOOKING STATEMENT CONTAINED HEREIN WILL BE OR CAN BE ACHIEVED. ANY
ONE OF THOSE FACTORS COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE
PROJECTED HEREIN. THESE FORWARD - LOOKING STATEMENTS INCLUDE PLANS AND
OBJECTIVES OF MANAGEMENT FOR FUTURE OPERATIONS, INCLUDING PLANS AND OBJECTIVES
RELATING TO THE PRODUCTS AND THE FUTURE ECONOMIC PERFORMANCE OF THE COMPANY.
ASSUMPTIONS RELATING TO THE FOREGOING INVOLVE JUDGMENTS WITH RESPECT TO, AMONG
OTHER THINGS, FUTURE ECONOMIC, COMPETITIVE AND MARKET CONDITIONS, FUTURE
BUSINESS DECISIONS, AND THE TIME AND MONEY REQUIRED TO SUCCESSFULLY COMPLETE
DEVELOPMENT PROJECTS, ALL OF WHICH ARE DIFFICULT OR IMPOSSIBLE TO PREDICT
ACCURATELY AND MANY OF WHICH ARE BEYOND THE CONTROL OF THE COMPANY. ALTHOUGH THE
COMPANY BELIEVES THAT THE ASSUMPTIONS UNDERLYING THE FORWARD - LOOKING
STATEMENTS CONTAINED HEREIN ARE REASONABLE, ANY OF THOSE ASSUMPTIONS COULD PROVE
INACCURATE AND, THEREFORE, THERE CAN BE NO ASSURANCE THAT THE RESULTS
CONTEMPLATED IN ANY OF THE FORWARD - LOOKING STATEMENTS CONTAINED HEREIN WILL BE
REALIZED. BASED ON ACTUAL EXPERIENCE AND BUSINESS DEVELOPMENT, THE COMPANY MAY
ALTER ITS MARKETING, CAPITAL EXPENDITURE PLANS OR OTHER BUDGETS, WHICH MAY IN
TURN AFFECT THE COMPANY'S RESULTS OF OPERATIONS. IN LIGHT OF THE SIGNIFICANT
UNCERTAINTIES INHERENT IN THE FORWARD - LOOKING STATEMENTS INCLUDED THEREIN, THE
INCLUSION OF ANY SUCH STATEMENT SHOULD NOT BE REGARDED AS A REPRESENTATION BY
THE COMPANY OR ANY OTHER PERSON THAT THE OBJECTIVES OR PLANS OF THE COMPANY WILL
BE ACHIEVED.
Overview of Company's Business:
- -------------------------------
The Company, through its predecessor companies and its subsidiaries,
has been an established commercial operator of fitness and spa centers in Hong
Kong and China since 1986 (see "Company - History"). 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."
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$28,075,000 (US$3,623,000) in the fiscal year ended December
31, 1995 to HK$39,054,000 (US$5,039,000) in the fiscal year ended December 31,
1996. The revenue from beauty treatment also increased steadily from
HK$53,059,000 (US$6,846,000) in the year ended December 31, 1995 to
HK$72,260,000 (US$9,324,000) in the fiscal year ended December 31, 1996. The
increase in total operating revenues in fiscal 1996 amounted to 33%.
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>
RESULTS OF OPERATIONS
We should put numbers here instead of %
<CAPTION>
Three Months Ended
-----------------
March 31,
-------------
1996 1997
---- ----
<S> <C> <C>
Operating Revenues 100.00% 100.00%
Total operating expenses 80.58% 96.85%
Operating income 19.42% 3.15%
Income before income taxes and minority interests 18.53% 2.22%
Provision for income and deferred taxes 6.01% 1.77%
Minority interests 1.11% 0.33%
Net income 11.41% 0.12%
======= ========
</TABLE>
THREE MONTHS ENDED MARCH 31, 1997 (UNAUDITED) COMPARED TO THREE MONTHS ENDED
MARCH 31, 1996 (UNAUDITED).
- --------------------------------------------------------------------------------
OPERATING REVENUES. The Company's operating revenues achieved a moderate
growth in the first three months of 1997 as compared to the first three months
of 1996. Operating revenues for the first three months of 1997 totaled
HK$23,940,000 (US$3,089,000) compared to HK$23,011,000 (US$2,969,000) in the
first three months of 1996, representing an increase of 4%. Operating revenues
derived by the Company's fitness services increased 45% to HK$9,843,000
(US$1,270,000) compared to HK$6,809,000 (US$879,000) in the first three months
of 1996. Fitness revenues as a percentage of total revenues were 41% in the
first three months of 1997 as compared to 30% in the first three months of 1996.
<PAGE>
Operating revenues from the Company's beauty treatment business totaled
HK$14,075,000 (US$1,816,000) compared to HK$15,051,000 (US$1,942,000) in the
first three months of 1996, representing a decrease of 6%. 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 59% in the first three months of 1997 as
compared to 65% in the first three months of 1996.
OPERATING EXPENSES. The Company's operating expenses for the first three
months of 1997 totaled HK$23,185,000 (US$2,991,000) compared to HK$18,543,000
(US$2,393,000) in the first three months of 1996, representing an increase of
25%. This reflects the additional costs incurred by the Company in following its
business expansion plan.
TOTAL NON-OPERATING EXPENSES. Total non-operating expenses for the first
three months of 1997 resulted in an increase of HK$20,000 (US$3,000) compared to
the total non-operating expenses of HK$204,000 (US$26,000) in the first three
months of 1996.
PROVISION FOR INCOME TAXES. Provision for income taxes for the first
three months of 1997 totaled HK$423,000 (US$55,000) compared to HK$1,382,000
(US$178,000) in the first three months of 1996, representing a decrease of 69%.
The effective tax rate of operating income was 80% and 32% respectively. The
increase in the effective tax rate of operating income was mainly due to a lower
income base which was offset by the tax loss companies.
NET INCOME. The Company's net income for the first three months of 1997
totaled HK$28,000 (US$4,000) compared to HK$2,626,000 (US$339,000) for the first
three months of 1996, representing a decrease of 99%. This was mainly due to an
increase in operating expenses in association with the two enhanced facilities
which would open in Mid-1997.
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").
Cash and cash equivalent balances for the respective periods ended March
31, 1997 and December 31, 1996 were HK$2,270,000 (US$293,000) and HK$2,509,000
(US$324,000), while total indebtedness at March 31, 1997 was HK$45,463,000
(US$5,866,000) and HK$30,725,000 (US$3,966,000) at December 31,
1996.
Net cash provided by operating activities were HK$8,652,000
(US$1,114,000) and HK$10,697,000 (US$1,381,000) for Fiscal Year 1996, and the
three-month period ended March 31, 1997, respectively. The Company's operating
activities are historically financed by cash flows from operations. Net cash
used in investing activities were HK$13,113,000 (US$1,690,000), and
HK$19,245,000 (US$2,484,000) for Fiscal Year 1996 and the three-month period
ended March 31, 1997, primarily as a result of expenditures for property, plant
and equipment. Net cash provided by financing activities, which mainly include
proceeds from bank loans, net interest and net repayment, were HK$6,048,000
(US$781,000), and HK$8,282,000 (US$1,068,000) in Fiscal Year 1996 and the
three-month period ended March 31, 1997.
<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 March 31, 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 March 31, 1997, was HK$12,544,000
(US$1,619,000). The Company has never experienced any significant problems with
collection of accounts receivable from its customers.
Capital expenditure for Fiscal Year 1996, and the three-month period
ended March 31, 1997, were HK$13,113,000 (US$1,690,000) and HK$19,245,000
(US$2,484,000) 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
incurr 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.
<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 March 31, 1997.
<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
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