<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
[x] Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 [Fee Required]
For the fiscal year ended December 31, 1999
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 [No Fee Required]
For the transition period from ____________________ to __________________
Commission file number 0-26573
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PHYSICAL SPA & FITNESS INC.
- --------------------------------------------------------------------------------
(Exact name of small business issuer in its charter)
DELAWARE 98-0203281
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
12/F - 15/F Lee Theatre Plaza
99 Percival St., Causeway Bay
Hong Kong Not applicable
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 011 8522 572-8888
-------------------
Securities registered pursuant to Section 12(b) of the Act: None
----------------
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
------------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
YES NO X
----- -----
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B is not contained in this form, and no disclosure will
be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in part III of this Form 10-K
or any amendment to this Form 10-K. [ ]
State issuer's revenues for its most recent fiscal year: $32,525,000
The aggregate market value of the voting stock held by non-affiliates
of the registrant as of December 31, 1999 was $300,000 based upon the average of
the last available bid and asked price of the Common Stock of $0.15 as of June
18, 1999.
The number of shares outstanding of the issuer's classes of Common
Stock as of December 31, 1999: 10,000,000
Common Stock, $.001 Par Value 10,000,000 shares
DOCUMENTS INCORPORATED BY REFERENCE: NONE
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PART I
ALL FORWARD-LOOKING STATEMENTS CONTAINED HEREIN ARE DEEMED BY THE COMPANY TO BE
COVERED BY AND TO QUALIFY FOR THE SAFE HARBOR PROTECTION PROVIDED BY THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995 THE 1995 ACT SHAREHOLDERS AND
PROSPECTIVE SHAREHOLDERS SHOULD UNDERSTAND THAT SEVERAL FACTORS GOVERN WHETHER
ANY FORWARD - LOOKING STATEMENT CONTAINED HEREIN WILL BE OR CAN BE ACHIEVED. ANY
ONE OF THOSE FACTORS COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE
PROJECTED HEREIN. THESE FORWARD - LOOKING STATEMENTS INCLUDE PLANS AND
OBJECTIVES OF MANAGEMENT FOR FUTURE OPERATIONS, INCLUDING PLANS AND OBJECTIVES
RELATING TO THE PRODUCTS AND THE FUTURE ECONOMIC PERFORMANCE OF THE COMPANY.
ASSUMPTIONS RELATING TO THE FOREGOING INVOLVE JUDGMENTS WITH RESPECT TO, AMONG
OTHER THINGS, FUTURE ECONOMIC, COMPETITIVE AND MARKET CONDITIONS, FUTURE
BUSINESS DECISIONS, AND THE TIME AND MONEY REQUIRED TO SUCCESSFULLY COMPLETE
DEVELOPMENT PROJECTS, ALL OF WHICH ARE DIFFICULT OR IMPOSSIBLE TO PREDICT
ACCURATELY AND MANY OF WHICH ARE BEYOND THE CONTROL OF THE COMPANY. ALTHOUGH THE
COMPANY BELIEVES THAT THE ASSUMPTIONS UNDERLYING THE FORWARD - LOOKING
STATEMENTS CONTAINED HEREIN ARE REASONABLE, ANY OF THOSE ASSUMPTIONS COULD PROVE
INACCURATE AND, THEREFORE, THERE CAN BE NO ASSURANCE THAT THE RESULTS
CONTEMPLATED IN ANY OF THE FORWARD - LOOKING STATEMENTS CONTAINED HEREIN WILL BE
REALIZED. BASED ON ACTUAL EXPERIENCE AND BUSINESS DEVELOPMENT, THE COMPANY MAY
ALTER ITS MARKETING, CAPITAL EXPENDITURE PLANS OR OTHER BUDGETS, WHICH MAY IN
TURN AFFECT THE COMPANY'S RESULTS OF OPERATIONS. IN LIGHT OF THE SIGNIFICANT
UNCERTAINTIES INHERENT IN THE FORWARD LOOKING STATEMENTS INCLUDED THEREIN, THE
INCLUSION OF ANY SUCH STATEMENT SHOULD NOT BE REGARDED AS A REPRESENTATION BY
THE COMPANY OR ANY OTHER PERSON THAT THE OBJECTIVES OR PLANS OF THE COMPANY WILL
BE ACHIEVED.
ITEM 1. DESCRIPTION OF BUSINESS
BACKGROUND OF THE COMPANY
Physical Spa & Fitness Inc. (the "Company"), through its subsidiaries,
operates fitness and spa centers in Hong Kong and the People's Republic of China
("China" or the "PRC"). The Company currently operates eleven facilities: eight
in Hong Kong and three in China under the name "Physical Ladies' Club", with the
exception of two centers (Mei Foo and Renaissance Beauty Centre - see "Company
Organization"). All of the Company's operations, including the operating of the
fitness and spa centers, property holding, investment holding and other
corporate activities are conducted through the Company's wholly-owned or
majority-owned subsidiaries or joint ventures. See "Business of the Company
Organization". The fitness and spa centers in Hong Kong are operated by the
Company's subsidiaries. Physical Health Centre Hong Kong Limited, a Hong Kong
corporation and a majority (91.4%) owned subsidiary of the Company, operates the
following centers in Hong Kong: Causeway Bay, Tsimshatsui, Shatin, Mei Foo and
Kowloon City. Another two wholly owned subsidiaries of the Company, Physical
Health Centre (Tsuen Wan) Limited and Physical Health Center (TST) Limited,
respectively operates the Tsuen Wan center (opened in July, 1998) and the
Sheraton Hotel center (opened in July, 1999). Both are Hong Kong corporations.
The eighth center, Renaissance Beauty Centre, is operated by the Company's
majority (70%) owned subsidiary, Supreme Resources Limited, a Hong Kong
corporation.
The Company's facilities in China are operated by two joint ventures:
Shanghai Physical Ladies' Club Co., Ltd. ("Shanghai Joint Venture"), which
operates two centers in the city of Shanghai, and Dalian Physical Ladies' Club
Co., Ltd. ("Dalian Joint Venture"), which operates fitness and spa facility in
the city of Dalian. The Company, through its subsidiaries, holds a 92.5%
interest in the Shanghai Joint Venture and a 90% interest in the Dalian Joint
Venture. The minority interest in the Dalian joint ventures is held by the joint
venture's Chinese partner. China regulations of the fitness and spa facilities
encourage joint ventures with a foreign company and provide less restrictive
regulations of such form of business entities. See "Government Regulation -
China".
2
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The Company provides its customers, at each location, with access to a
wide range of U.S.- styled fitness and spa services. The Company offers to its
customers a membership for the use of its fitness facilities, which include
extensive aerobics programs, personalized training, cardiovascular conditioning
and strength training. The facilities are equipped with the latest in Western
exercise equipment, including LifeFitness, Cybex, Flex and Precor. Spa and
beauty treatment services are provided to both members and visitors, and include
skin care and facial treatments, massage, relaxation programs, weight-management
programs and personalized make-up consultations. The Company also sells at the
facilities a variety of exercise clothing and European beauty products and
cosmetics. Based on the number of the Company's facilities members, management
believes that the Company is among the top providers of fitness, exercise, and
spa/beauty treatment services in Hong Kong and China, with approximately 60,000
members.
The Company's strategy is to provide a one-stop fitness and beauty
center for women. With the exception of the Mei Foo location in Hong Kong, all
other facilities in Hong Kong and China are exclusively for women. Management
believes that the Company's strong market presence in Hong Kong and its
successful entrance into China's market is a result of its strategy of combining
fitness and beauty services in a single facility that offers state-of-the-art
exercise equipment, high quality beauty treatments and professional staff.
The Company believes that it is one of the first companies to provide
Western fitness and spa services in China. In 1994, the predecessor companies of
Physical Beauty & Fitness Holdings Limited, a British Virgin Islands corporation
("Physical Limited"), the holding company of the Company's subsidiaries, began a
process of expansion into targeted market segments in China. In 1994, the
Company through Shanghai Joint Venture opened the Company's first China
operation in Huangpu, Shanghai, with a fitness center comprising of
approximately 15,000 square feet to provide fitness and spa treatment
facilities. Since then the center has been operating profitably, and another
center of similar size was opened in Hongqiao, Shanghai in September 1995,
through Shanghai Joint Venture. A third China operation in Dalian commenced in
April 1996 and is conducted through Dalian Joint Venture. See "Business of the
Company - Organization". The Company's facilities in China are operated under
the name "Physical Ladies' Club", and the Company registered a servicemark under
that name in Chinese language, which precludes others from the use of the same
name. See "Business of the Company - Trademarks and Trade Names".
In the opinion of the Company's management, current competition in China
is, in general, comprised mainly of government operated facilities that offer
either fitness or beauty services, in small facilities that lack modern
equipment. The Company is aware of no Western quality facilities of comparable
size to that of the Company's facilities currently operating in China. The
Company expects that rising consumer incomes, increasing health awareness and
growing access to foreign goods and trends, should continue to create increased
demand for fitness and spa services in China. In 1996, the Company (through its
subsidiaries) entered into two additional joint ventures in Zhongshan (Zhongshan
Joint Venture) and Shenzhen (Shenzhen Joint Venture), China, however, such joint
ventures have not commenced any operations yet. The Company explores the
possibilities of opening the centers in Zhongshan and Shenzhen in the future,
however, there can be no assurances given that such joint ventures will start
operations or that such centers will be opened as currently contemplated by the
management. See "Business of the Company - Business Strategy".
The Company's strategy for maintaining its strong presence in Hong Kong
is to continue to provide existing and new members with high quality services at
an affordable price and by periodically upgrading the facilities as new
developments and technology emerge in the industry. The Company's objective is
to add new services and treatments to keep the Company current with market
trends and to promote and enhance the Company's reputation of providing value-
driven services to its customers. The Company places heavy emphasis on staff
training which is supported by an in-house training department and on-going
classes. The Company opened a new center in Tsuen Wan, a major district of the
Western Kowloon province of Hong Kong in July, 1998 and additional facilities in
Sheraton Hotel, Tsimshatsui, Hong Kong in July, 1999. The Company proposes to
open a new center in Tuen Mun, New Territories in Mid-2000 which is solely
offering fitness services to customers. See "Business of the Company -
Properties".
3
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The Company was incorporated on September 21, 1988 in the state of
Delaware under the name of "Foreclosed Realty Exchange, Inc", a development
stage company seeking acquisitions. Prior to acquisition of Physical Limited,
the Company had no revenue producing operations, but planned to enter into joint
ventures and/or acquisitions originally in the area of real estate to expand its
operations. In October, 1996, the Company closed a transaction with Ngai Keung
Luk (Serleo), a 100% shareholder of Physical Limited, whereby the Company
entered into a Share Exchange Agreement with Ngai Keung Luk (Serleo), pursuant
to which the Company issued 8,000,000 shares of its Common Stock to Ngai Keung
Luk (Serleo) in exchange for all of the outstanding shares of Physical Limited
(the "Closing"). Subsequently, the Company changed its name to "Physical Spa &
Fitness Inc." in November, 1996, to reflect the new business operations of the
Company. As a part of the above transaction, certain shareholders of the Company
also transferred 990,000 shares of Common Stock to Goodchild Investments
Limited, a British Virgin Islands corporation ("Goodchild"). Goodchild
subsequently disposed of its shares. See "Certain Transactions". Neither Ngai
Keung Luk (Serleo) nor Goodchild were parties affiliated with the Company prior
to or at the time of the acquisition of Physical Limited. At the Closing the
then current management of the Company resigned and was replaced by the current
management of the Company. See "Management."
The Company effected a 1.333333-for-1 reverse split of its common stock
in October 1997 and a 1-for-1.333333 forward split of its common stock in June
1998. All references in this Report to shares of Common Stock of the Company
have been adjusted for the effects of the reverse stock split and forward stock
split.
The Company maintains its executive and administrative office Hong Kong
at:
Lee Theatre Plaza 12/F - 15/F
99 Percival St., Causeway Bay, HONG KONG
The telephone number of the Company in Hong Kong is (852) 2572-8888.
Unless the context requires otherwise, as used herein, any reference to
the Company includes the Company's subsidiaries - Physical Beauty & Fitness
Holdings Limited, Physical Health Centre Hong Kong, Ltd., Regent Town Holdings
Ltd., Mighty System Ltd., Supreme Resources Ltd., Physical Health Centre (Tuen
Mun) Ltd. (formerly known as Physical Health Centre (Zhong Shan) Limited,
Zhongshan Physical Ladies' Club, Ltd., Ever Growth Ltd., Proline Holdings Ltd.,
Shanghai Physical Ladies' Club Company Ltd., Shanghai Physical Ladies' Club Co.,
Ltd., Jade Regal Holdings Ltd., Physical Health Centre( Dalian) Ltd., Dalian
Physical Ladies' Club Co. Ltd., Star Perfection Holdings Ltd., Physical Health
Centre (Shenzhen) Ltd., Shenzhen Physical Ladies' Club Company Ltd., Physical
Health Centre (Tsuen Wan) Limited, Physical Health Centre (Macau) Limited,
Physical Health Centre (TST) Limited, and Global Resources Limited. See also
"Business - Organization".
THE COMPANY'S BUSINESS
General
- -------
The Company's fitness and spa centers are located in or near urban areas
in highly populated areas of Hong Kong and major metropolitan cities in China
and most of them are operated under long-term leases. With the exception of Mei
Foo center, a portion of which is owned by the Company (see "Business -
Properties"), the Company does not own the real property on which the centers
are located, but owns the leasehold improvements and equipment with respect to
each center. Generally, the Company's centers average 20,000 square feet and
include a workout area including a broad range of fitness equipment, changing
room, sauna and steam facilities and a separate area devoted exclusively to
professional spa and beauty treatment programs. Each center typically includes a
laser TV room with lounge, health drink bar and sells a range of exercise
clothing, European beauty products and cosmetics.
The Company's strategy is to grow through expansion of its fitness and
spa facilities in Hong Kong and China, as well as to explore the opportunities
for its fitness and spa services in other countries of Far East. The Company
intends to build on its continuous operating presence (over 10 years) in Hong
Kong, the relationships in China established by the Company's executives and
senior staff and the Company's policy of offering what it believes are the
state-of-the-art exercise and spa facilities and beauty treatments at affordable
prices in their respective markets. In addition, the Company is closely
monitoring potential opportunities in the Philippines, Taiwan, Malaysia and
Indonesia.
Organization
- ------------
The Company's operations are conducted through its subsidiaries in Hong
Kong and Sino-foreign joint ventures in China. A number of the Company's
subsidiaries have been incorporated in the British Virgin Islands, primarily for
tax reasons. Such structure provides greater flexibility for the Company in
obtaining tax benefits, especially in case of corporate accounts. Set forth
below is the description of the Company's subsidiaries and their respective
roles in the organizational structure of the Company.
4
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<TABLE>
<CAPTION>
Date of Equity interest
acquisition/ Place of owned by the
Name of Company formation incorporation Company Principal activities
- --------------- ---------- -------------- --------------- --------------------
Direct Indirect
------ --------
<S> <C> <C> <C> <C> <C>
Physical Beauty & Fitness Holdings March 8, 1996 BVI 100% - Investment holding
Limited ("Physical Limited")
Physical Health Centre Hong Kong March 2, 1990 Hong Kong - 91.4% Operating 5 Fitness
Limited ("Hong Kong Limited") Centres in Hong Kong
Regent Town Holdings Limited September 20, 1993 BVI - 92.5% Investment holding
("Regent")
Supreme Resources Limited ("Supreme") September 29, 1994 Hong Kong - 70% Operating a beauty
treatment center
in Hong Kong
Physical Health Centre (Tuen Mun) Limited September 29, 1994 Hong Kong - 100% Investment holding
(formerly known as
Physical Health Centre
(Zhong Shan) Limited)*
Zhongshan Physical Ladies' Club Ltd. October 29, 1996 The PRC - 95% Operating a Fitness
(owned by Zhongshan Physical)* (1) Center in Zhong
Shan, the PRC
Ever Growth Limited ("Ever Growth") September 29, 1994 Hong Kong - 100% Property holding
Proline Holdings Limited ("Proline") September 28, 1994 BVI - 92.5% Investment holding
(wholly owned by Regent)
Shanghai Physical Ladies' Club Company September 28, 1994 Hong Kong - 92.5% Investment holding
Limited ("Shanghai Physical")
(wholly owned by Proline)
Shanghai Physical Ladies' Club Co., Ltd. September 28, 1994 The PRC - 92.5% Operating two
(owned by Shanghai Physical)(1) Fitness Centers
in Shanghai,
the PRC
Mighty System Limited ("Mighty") December 15, 1994 BVI - 100% Provision of
marketing service for
cosmetic sales
Jade Regal Holdings Limited ("Jade March 15, 1994 BVI - 100% Investment holding
Regal")
Physical Health Centre (Dalian) Limited March 15, 1996 Hong Kong - 100% Investment holding
(Dalian Physical") (wholly
owned by "Jade Regal")
Dalian Physical Ladies' Club Co., Ltd. March 15, 1996 The PRC - 90% Operating a Fitness
(90% owned by Dalian Physical) (1) Centre in Dalian,
the PRC
Star Perfection Holdings April 15, 1996 BVI - 100% Investment holding
Limited ("Star Perfection")
Physical Health Centre (Shenzhen) April 15. 1996 Hong Kong - 100% Investment holding
Limited ("Shenzhen Physical")
(wholly owned by Star
Perfection)
Shenzhen Physical Ladies' Club Co. Ltd. August 16, 1996 The PRC - 90% Operating a Fitness
(owned by "Shenzhen Physical")* (1) Centre in
Shenzhen, the PRC
Physical Health Centre March 21, 1997 Hong Kong - 100% Investment holding,
(Macau) Limited* ** Operating a
Macau Centre
Physical Health Centre ** September 8, 1997 Hong Kong - 100% Operating a Fitness
(Tsuen Wan) Limited Centre in Hong Kong
Physical Health Centre ** December 1, 1998 Hong Kong - 100% Operating a Fitness
(TST) Limited Center in Hong Kong
Global Resoures Limited ** December 1, 1998 Hong Kong - 100% Investment holding
- -------------------
</TABLE>
(1) See Notes to the Financial Statements * Proposed new center; not opened yet.
** Not shown on the organizational chart.
The Company opened new centers in Tsuen Wan in July, 1998 and Sheraton Hotel,
Tsimshatsui,Hong Kong in July, 1999.
See also "Company - Properties". The Company's
organizational chart is set forth below on the next page.
5
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<TABLE>
<CAPTION>
ORGANIZATION CHART OF PHYSICAL SPA & FITNESS INC.
--------------------------------------------------
Physical Spa & Fitness Inc.
US
|
| 100%
|
Physical Beauty & Fitness
Holdings Limited
BVI
|
|
<S> <C> <C> <C> <C> <C> <C> <C>
- ---------------------------------------------|----------------------------------------------------
|92.5% |100% |100% |91.40% |70% |100%* |100%* |100%
- ----------- --------- ---------- -------------- ---------- ---------- ------------ -----------
Regent Town Mighty Jade Regal Physical Health Supreme Star Physical Ever Growth
Holdings System Holdings Centre Resources Perfection Health Limited
Limited Limited Limited Hong Kong Limited Holdings Centre
Limited Limited (Tuen Mun)
Limited
BVI BVI BVI HK HK BVI HK HK
- ----------- --------- ---------- -------------- ---------- ---------- ------------ -----------
| | | | | | |
|100% |100%* |100% |100% |100%* |95% |100%
Proline Holdings Physical Health | | Physical Health | |
Limited Centre (Dalian) | | Centre (Shenzhen) | |
Limited | | Limited | |
BVI HK | | HK | |
- ----------- ---------- | | ----------- | |
| | | | | | |
|100%* |90% | | |90% | |
Shanghai | | | | | |
Physical | | | | | |
Ladies' Club | | | | | |
Company | | | | | |
Limited | | | | | |
HK | | | | | |
|100% | Causeway Bay | | | |
| | Tsimshatsui | | | |
Shanghai Dalian Shatin Renaissance Shenzhen Zhongshan Property in
Joint Joint Mei Foo Beauty Joint Joint Mei Foo
Venture Venture Kowloon City Centre Venture Venture
(Central Branch)
Operation
* 50% held by one nominee shareholder. Since the Companies Ordinance of Hong
Kong requires a minimum of 2 shareholders for each limited company, Mr. Luk
holds the remaining shares on behalf of Physical Beauty & Fitness Holdings Ltd.
</TABLE>
6
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<TABLE>
OWNERSHIP STRUCTURES IN CHINA
The organizational structure of the Company's operations in China is set
forth below.
<CAPTION>
TYPE OF INTERESTS PROFIT
NAME OF THE JOINT OWNED BY THE TERM OF THE REGISTERED SHARING
JOINT VENTURE LOCATION VENTURE COMPANY JOINT VENTURE CAPITAL* ARRANGEMENT
Foreign Chinese
partner partner
------- -------
<S> <C> <C> <C> <C> <C> <C>
Shanghai Physical Huangpu and Co-operative 92.5%(1) 10 years Originally See Shanghai Joint Ladies' Club
Co., Hongqiao, (exp. 2003) US$1,000 in Venture below
Ltd. ("Shanghai Shanghai cash and
Joint Venture") increased to
US$2,000 in
cash in 1995
Dalian Physical Dalian Equity Originally 12 years Originally Pro-rata to equity Ladies' Club
Co., 55% and (exp. 2007) Rmb10,000 in interests
Ltd. ("Dalian changed to cash and
Joint Venture") 90% in 1996 changed to
Rmb1,000 in
cash and
Rmb9,000
in form of
fixed assets
and renovation
materials
in 1996.
Shenzhen Physical Shenzhen Co-Operative 90% 10 years HK$4,600 in Pro-rata to equity Ladies' Club
Co., (exp. 2006) form of cash interest
Ltd. ("Shenzhen and fixed
Joint Venture")** assets
Zhongshan Physical Zhongsan Equity 95% 10 years US$500 in Pro-rata to equity Ladies Club
Co., Ltd. (exp. 2006) form of cash interest
("Zhongshan and fixed
Joint Venture")** assets
</TABLE>
- -------------------------------------------------------
(1) See Notes to the Financial Statements.
* In thousands
** Those joint ventures have not commenced operations yet. See below.
SHANGHAI JOINT VENTURE. The Shanghai Joint Venture is a Sino-foreign
cooperative joint venture established on September 7, 1993 in Shanghai, China.
The Chinese joint venture partner is a state-owned enterprise in the PRC,
Shanghai Ti Yu Guan (SHTYG). Shanghai Physical Ladies' Club Company Limited, a
Hong Kong corporation ("Shanghai Physical") authorized Physical Health Centre
Hong Kong Limited, a Hong Kong corporation, to enter into a joint venture
contract with SHTYG. The joint venture period is 10 years from the date of issue
of the business license on September 7, 1993. SHTYG is paid rent of RMB950,000
for the first 3 years of the joint venture. Rent for the fourth to tenth years
will be 110% of the preceding year, except where the inflation rate in the PRC
exceeds 16% in which case, the rental increase would be indexed to the inflation
rate.
DALIAN JOINT VENTURE. On April 11, 1995, Physical Health Centre
(Dalian) Limited, a Hong Kong corporation ("Dalian Physical") formed a
Sino-foreign equity joint venture with a Chinese enterprise to operate a
fitness/ spa center in Dalian, China. The joint venture period is 12 years from
the issue of the business license on April 11, 1995. The equity interest of
Dalian Physical is 90% and the Chinese joint venture partner's equity interest
is 10%. The joint venture commenced effective operations in April 1996.
7
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ZHONGSHAN JOINT VENTURE. In June 1996, Physical Health Center (Zhong
Shan) Ltd. ("Zhongshan Physical", now known as Physical Health Centre (Tuen Mun)
Limited), entered into a joint venture contract, as supplemented in August,
1996, with a Chinese enterprise in Zhongshan, China to establish a Sino-foreign
cooperative joint venture for the provision of fitness and spa services. The
joint venture period is 10 years from issue date of the business license on
October 29, 1996. The Chinese joint venture partner will be entitled to
HK$30,000 per annum in the form of a technology introduction fee. The Chinese
joint venture partner will not be entitled to share in profits after receipt of
the technology introduction fee. All the benefits and liabilities of the joint
venture will be assumed by Zhongshan Physical. The agreement is subject to
approval by relevant PRC authorities in Zhongshan. As of the date of this
report, however, both joint venture partners have not contributed the required
capital according to the requirements of the contract. Such default in the
funding obligations will require renegotiations between the two partners and may
also trigger default remedies as specified in the joint venture contract.
Further, a failure to meet regulatory time limits set by the State
Administration of Industry and Commerce for capital contributions could result
in the cancellation of the approval of the joint venture's business license. The
joint venture has not yet commenced operations as of this date. The Company is
negotiating with the Chinese enterprise to terminate the joint venture contract
and it believes that the default remedies are unlikely to be imposed on either
parties.
SHENZHEN JOINT VENTURE. In 1996, Shenzhen Physical Ladies' Club Co.,
Ltd., entered into a joint venture contract with a Chinese enterprise in
Shenzhen, China to establish a Sino-foreign cooperative joint venture for the
provision of fitness and spa services. According to the laws in the PRC and the
terms of the joint venture contract, both joint venture partners are obliged to
fulfill their capital contribution requirements into the joint venture within a
specified period of time after the issue of the business license. As of the date
of this Report, however, both joint venture partners have not contributed the
required capital according to the requirements of the contract. Such default in
the funding obligations will require renegotiations between the two partners and
may also trigger default remedies as specified in the joint venture contract.
Further, a failure to meet regulatory time limits set by the State
Administration of Industry and Commerce for capital contributions could result
in the cancellation of the approval of the joint venture's business license.
The joint venture has not yet
commenced operations as of this date. The Company is negotiating with the
Chinese enterprise to terminate the joint venture contract and it believes that
the default remedies are unlikely to be imposed on either parties.
Since Shanghai Joint Venture and Dalian Joint Venture operate in China,
they are subject to special considerations and significant risks not typically
associated with investments in equity securities of the United States or Western
European countries.
OVERVIEW OF THE COMPANY'S MARKETS
HONG KONG
- ---------
FITNESS
- -------
The concept of preventive health care and physical fitness, which
became popular in Hong Kong in the early 1980's, was introduced from the United
States and Europe. With the growing affluence of the local population and
improvement in their standard of living, people began to immerse in physical
exercise to maintain a fit and healthy body. The fitness trend grew in Hong Kong
and gained popularity within the high income group initially.
To cater to this new industry, a number of fitness centers were
established in Hong Kong which provided a variety of exercise equipment as well
as aerobic dance classes. Private clubs (dining clubs, marina clubs,
entertainment clubs) targeted towards the upper income group also began to
provide similar services to their members or expanded their existing facilities.
8
<PAGE>
The majority of these fitness centers targeted the high income group,
were very exclusive, and entrance fees or membership fees were generally high.
Under this marketing strategy, these fitness centers were restricted to a
comparatively small number of potential customers. Additionally, some of these
fitness centers were affected by the migration boom of Hong Kong in the mid
1980's. At that time, a large number of professionals migrated from Hong Kong to
other countries to pursue educational and economic opportunities. This migration
boom affected the customer base of these fitness centers and thus decreased the
viability of their business. As a result, fitness centers targeting the high
income group in Hong Kong were vulnerable and underwent a period of
consolidation. Later on, as the market developed, a market niche emerged for
fitness centers catering to the middle income group.
SPA
- ---
The spa industry in Hong Kong, which includes the skin care or beauty
industry, is rather fragmented with a large number of small operations. It is
common that certain spa and beauty treatments are provided by a wide range of
establishments including beauty salons, hair salons, and even cosmetic counters
situated in department stores. The standard of services for beauty treatments
varies widely. Normally, the customer base of these operations is confined to a
relatively limited number of frequent customers. Exclusive private clubs that
cater to a small percentage of wealthy Hong Kong women and the inconsistent
quality and skill level of small operations have increased the demand for middle
market skin care treatments in the recent years.
CHINA
- -----
FITNESS
- -------
In China, the concept of physical fitness has a long history, but it was
not widely practiced, except by the 50+ generation. Even China's famous Tai' Chi
is seldom practiced by young people. Organized sports for recreation are more
popular, though sports centers are in the Management's opinion generally ill
equipped and out of date. It appears that intensive training in a particular
sport is only available to a minority of people. Physical fitness centers are
usually in the form of gymnasiums run by state-owned sports authorities.
A handful of small clubs with standard facilities have opened in recent
years, but offer, in the Management's opinion, a limited selection of locally
made, out- of-date equipment (as compared to the equipment used in the Company's
centers). Such facilities are frequented by more men than women, as they tend to
be equipped with barbells and weights.
The Company believes that aerobics is gaining popularity with the recent
influx of follow-along television programs. The Management observed that the
overall improved lifestyle; availability of fast food and convenience foods,
increased spending power, and increasingly sedentary lifestyles of Chinese
people, has led to a widespread concern for weight control. The Management
believes that aerobics especially appeals to women in China, as large
percentages of women seem to be concerned with losing weight.
A number of five-star hotels in China have luxury spas and fitness
centers, well-equipped with the latest brands of Western-styled exercise
machines (as compared to the Company's facilities). However, the Management
believes that the exorbitant fees (in the Company's opinion) prevent any
significant competitive impact on the industry. Private dining clubs have become
increasingly popular throughout China in the recent years, and usually include
small fitness and beauty centers. However, the Company believes that as the
focus of these clubs is usually dining, drinking, karaoke and entertainment,
they have contributed insignificantly to the industry. (See "Competition")
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SPA
- ---
The Company noted that Western-styled spa and beauty treatments has
become increasingly common and popular in China. Home-treatments, using
cosmetics purchased in department stores, have also become very common. However,
in the Management's opinion standards of skill and hygiene tend to be poor, as
is the quality of products used, as compared to those provided by the Company's
centers.
In recent years, several Hong Kong and Japanese companies have entered
the market with small, limited service salons. Several internationally
recognized skin care lines, such as Dior, Channel and Elizabeth Arden have
recently become available in department stores. Those department stores often
hold in-house promotions to demonstrate their products and educate potential
customers. It appears that the desire to own anything imported, including
cosmetics, is considered prestigious and is therefore highly desired by Chinese
women. The Management noticed that the demand for "foreign" spa treatments and
beauty salons, and imported products is high. The local and international media
is introducing fitness and skin care news to a growing receptive audience. The
Company believes that the demand for affordable, value-driven beauty and skin
care has increased.
HISTORY
The Company was incorporated on September 21, 1988 in the state of
Delaware under the name of "Foreclosed Realty Exchange, Inc", a development
stage company seeking acquisitions. Prior to acquisition of Physical Beauty &
Fitness Holdings Limited, a British Virgin Islands corporation ("Physical
Limited"), the Company had no revenue producing operations, but planned to enter
into joint ventures and/or acquisitions originally in the area of real estate,
to expand its operations. In early 1991, the Company was planning to become a
public company and issued 750,000 shares of common stock with certain
registration rights to an unrelated corporation for services in connection with
the Company's efforts to become a public company. That corporation, in turn
distributed the 750,000 shares as dividends to its shareholders. The Company has
not filed a registration statement as originally planned and the shares became
free trading pursuant to Rule 144, after the expiration of the applicable
restrictive period. In October, 1996, the Company closed a transaction with Ngai
Keung Luk (Serleo), a 100% shareholder of Physical Limited, whereby the Company
entered into a Share Exchange Agreement with Ngai Keung Luk (Serleo). Physical
Limited was incorporated on March 8, 1996 under the laws of British Virgin
Islands and has interests in various companies operating fitness and beauty
centers and other related businesses in Hong Kong and China (see "Company-
Organization"). Pursuant to the Share Exchange Agreement, the Company issued
8,000,000 shares of its Common Stock to Ngai Keung Luk (Serleo) in exchange for
all of the outstanding shares of Physical Limited (the "Closing"). Subsequently,
the Company changed its name to "Physical Spa & Fitness Inc." in November, 1996,
to reflect the new business operations of the Company. As a part of the above
transaction, certain shareholders of the Company also transferred 990,000 shares
of Common Stock to Goodchild Investments Limited, a British Virgin Islands
corporation ("Goodchild"). Goodchild subsequently disposed of its shares. See
"Certain transactions". Neither Ngai Keung Luk (Serleo) nor Goodchild were
parties affiliated with the Company prior to or at the time of the acquisition
of Physical Limited. At the Closing the then current management of the Company
resigned and was replaced by the current management of the Company. See
"Management."
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In 1986, the founder and principal shareholder of the Company, Ngai
Keung Luk (Serleo), set up the first fitness center under the name of "Physical
Health Club" with the objective of providing physical fitness and spa treatment
services at prices which could be afforded by a rapidly growing middle class
population in Hong Kong. Two years later in 1988, another center was founded
under the name of "Physical Ladies' Club" in Hong Kong. The businesses of these
centers were operated in a form of a sole proprietorship and were subsequently
transferred to Physical Health Centre Hong Kong Limited, a Hong Kong corporation
established on March 2, 1990 ("Hong Kong Limited"). During the period from 1990
to 1996, Hong Kong Limited and Physical Limited expanded their scope of
operations by acquiring and establishing several subsidiaries and by forming
Sino- foreign joint ventures in China to operate six additional fitness/spa
centers in Hong Kong, three in China and other related businesses (see "Company
- - Organization"). The subsidiary companies were all formerly owned by Mr. Luk
and other principal shareholders, or solely by Mr. Luk. The respective equity
interests were transferred by Mr. Luk and other principal shareholders to Hong
Kong Limited or Physical Limited throughout 1993 to 1996 at the original cost of
the respective investments. In October, 1996, 91.4% of the equity interests of
Hong Kong Limited was transferred by the principal and other shareholders
(including Mr. Luk) to Physical Limited at the par value of the shares
transferred. In addition, all the equity interests of Hong Kong Limited in
various subsidiaries and Sino-foreign joint-ventures were also transferred to
Physical Limited at the recorded cost of these investments.
HONG KONG
The first facility was opened in the Mei Foo Sun Chuen area of Hong
Kong, which has a population of approximately 680,000. The Company's first
center offered fitness training and spa treatment facilities at a price thought
to be affordable by its target middle-class customers. The Mei Foo Center
operates under a membership basis and is open to both male and female customers
and is the Company's only center that has male members. The Mei Foo Center
proved profitable and within a year, it had enrolled more than 700 members and
1,000 clients for spa treatments. In 1990 the Mei Foo Center was expanded by
acquiring by the Company's subsidiary an additional 700 square feet, immediately
above the existing facility. In December 1999, the spa facility was further
expanded by approximately 2,000 square feet, resulting in a total of 10,000
square feet. The Mei Foo center operates under the name "Physical Health Club".
The second fitness and spa center under the name "Physical Ladies' Club"
was opened in July 1988 on Nathan Road, Tsimshatsui, Kowloon, which is one of
the busiest commercial and entertainment areas in the Kowloon area of Hong Kong.
The Tsimshatsui Center, consisting at that time of 12,000 sq. ft. (currently
expanded to 25,000 sq. ft) is, to the best of the Management's knowledge, to be
the first fitness and spa center to provide high quality, Western-styled
professional services for fitness training and spa treatment for middle income
women customers in Hong Kong. Tsimshatsui Center within a year of its opening,
had approximately 2,000 fitness members and 2,000 patrons for spa treatments.
In March 1990, the business of Physical Health Club and Physical Ladies'
Club was transferred to, and consolidated under, Hong Kong Limited (see above).
To broaden its geographical diversification, Hong Kong Limited opened
its third fitness and spa center in Causeway Bay Plaza, Causeway Bay in August,
1990. Located in one of the most popular entertainment areas on Hong Kong
Island, the Causeway Bay Center initially occupied a floor space of
approximately 18,000 square feet. In the first year of operation, the Causeway
Bay Center had approximately 5,000 members and 2,000 patrons for spa services.
The Causeway Bay Center experienced an ongoing strong demand for its fitness and
spa services, and the Company relocated the Causeway Bay Center to a new 30,000
sq. ft center in June, 1997.
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In order to cater to the market demand in the New Territories area of
Hong Kong, Hong Kong Limited opened its fourth fitness and spa center in New
Town Tower, Shatin, in September 1992. The Shatin Center is located in a
commercial complex in the heart of the densely populated residential and popular
entertainment areas in the New Territories. It occupies a floor space of
approximately 15,000 square feet. In October 1998, the Shatin Center is
relocated to a brand new shopping mall nearby, Grand Central Plaza, at the
expiration of the original tenancy.
In March 1993, Hong Kong Limited opened another fitness and spa center
of approximately 3,000 square feet in Kowloon City to provide facilities to
members residing in the south-eastern area of Kowloon.
As a result of a growing demand for upscale facilities and amenities for
spa services in the upper middle market, the Company opened through a newly
formed subsidiary, Supreme Resources Limited (see "Company - Organization"), its
first upscale market spa treatment center; "Renaissance Beauty Centre". The
Renaissance center is situated in an upper income residential area in Central,
Hong Kong and provides spa treatment services.
In Mid-1998 and 1999, the Company opened two additional centers in Hong
Kong through its wholly owned subsidiaries, Physical Health Centre (Tsuen Wan)
Limited and Physical Health Centre (TST) Limited respectively. One is located at
Tsuen Wan with approximately 50,000 square feet and the other one at the
Sheraton Hotel, Tsimshatsui with approximately 40,000 square feet. These
collectively make up a total of eight centers in Hong Kong.
The Company proposes to open its ninth center in Tuen Mun, New
Terrritories in Mid-2000. (See "Description of Property")
CHINA
Commencing in the mid-1980's, China commenced market-oriented reforms
that were designed to open up and improve the economy and the Chinese standard
of living. As economic reforms became successful in China and a large,
middle-class market developed, China was targeted as an expansion market where
the success in Hong Kong could be duplicated.
Shanghai, with a booming economy, an influx of foreign investment, and a
population of 14 million, was the logical choice for the Company to start its
first China location. In January of 1994, the Huang Pu branch was opened in one
of Shanghai's busiest shopping districts, through a joint venture company formed
between a Chinese enterprise and a newly formed subsidiary of the Company. The
center has an area of 15,000 sq. ft. (which was expanded to 23,000 sq. ft. in
1998), and within the first year there were over 2,000 fitness members and spa
clients. Based upon the positive response to the first facility in Shanghai, the
decision was made to open a second Shanghai branch.
September, 1995 marked the opening of the second center in Shanghai-Hong
Qiao branch in Shanghai, situated in the fashionable Hong Qiao Special Economic
Development Zone. This center contains approximately 12,000 sq. ft. and is
easily accessible to a large residential area and busy commercial district.
In April, 1996, the Company opened its third fitness/spa center in China
in the city of Dalian. Dalian, China, located on the northern peninsula near
Korea, is the third largest seaport in China and has a population of
approximately 5,600,000. Dalian is the fashion capital of China, hosting the
world renowned International Fashion Festival annually, and is also a major
tourist destination. Dalian has seen an influx of foreign investment in the past
several years, and the purchasing power of these citizens ranks high in the
nation. The Company's market research showed a strong existing interest in
fitness and spa services, with few choices available to potential customers.
Within the first six months of opening, Dalian center had over one thousand
fitness members and nearly one thousand spa clients.
BUSINESS STRATEGY
The Company believes that it has a strong reputation in the Hong Kong
and China markets in which it presently operates. This belief is based on
several factors, including continuous operating presence of the Company in Hong
Kong for the past years (since 1986), and the relationships in China established
by the Company's executives, management and staff over the last several years.
The Company intends to continue its policy of providing what it believes are
first-quality, comprehensive fitness and spa services in their respective
markets at affordable prices.
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The Company seeks to expand its fitness and spa business from the ground
up as opposed to acquiring health and fitness clubs that are poorly managed
and/or financially distressed. The Company believes that the end result of
repositioning an existing center, which typically includes rebuilding a
membership base, renovations, additional equipment leasing, and re-training
existing staff, is less desirable than developing a new center.
The Company intends to build on its momentum, relationships and standard
of quality in several ways. First, the Company intends to expand its presence in
Hong Kong and China through the establishment of new fitness and spa centers in
Hong Kong (see "Business-Organization-Hong Kong") and China, and through the
addition of qualified personnel, including fitness instructors and spa personnel
in the existing facilities. Second, in conjunction with its expansion, the
Company intends to increase the variety of fitness and spa services provided and
products sold on a retail basis at each location. For example, the Company
currently is developing plans to develop corporate and personal fitness training
services in China.
The Company believes that its experience in and knowledge of the fitness
and spa industry in Hong Kong and China, as well as management's continuous
presence in Hong Kong (since 1986) and China (since 1994), positions the Company
to take advantage of perceived opportunities in this market. Further,
demographic developments in Hong Kong and China, continue to create increasing
demand for certain fitness and spa services. In this regard, the Company opened
planned seventh center in Tsuen Wan, Hong Kong in July, 1998 and another new
center in Sheraton Hotel, Tsimatshui, Hong Kong in July, 1999. The Company also
expects to establish additional fitness and spa centers in other major
metropolitan centers in China over the next several years. There is no assurance
that such centers will be opened as currently planned, since they are subject to
changing political and economic conditions, as well as the Company's evaluation
of the applicable market conditions.
- - BECOMING THE MARKET LEADER IN CHINA
In China, the fitness and spa industry is in its formative stage. In
addition there is an image associated with Western luxury consumer goods. The
Company is not aware of any Western-style facilities of comparable size or
competitors in the fitness and spa industry whose market position is more
established than the Company's. Management plans to take advantage of those
circumstances and in doing so, become the first entrant into China market.
The planned expansion into China includes opening facilities in most
major cities and economically developing urban areas throughout the country,
subject to then current market and other conditions. According to the State
Statistic Bureau of China, the population of China is 1.2 billion and there are
currently thirty cities with populations in excess of 1 million. The population
of China is becoming increasingly urbanized, and the tastes of the urban
population is becoming increasingly sophisticated. (Source: Hong Kong Trade
Development Council).
Forty percent of the population of China lives in coastal areas, where
retail sales account for 60% of the country's total retail sales. Population
factors and strong spending power have led the Company to target coastal areas
for the spas to be developed (i.e. Dalian). Facilities can be linked by a
reciprocal membership system, allowing members to use another facility when
traveling to other parts of the country. Marketing programs carried out
nationwide, in the management's opinion, will enable the Company to benefit from
economies of scale, similar to what the Company experiences in Hong Kong.
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- - MAINTAINING A STRONG PRESENCE IN HONG KONG
The Company has well-established customer base and pre-dominant market
share in Hong Kong and opened two new locations in 1998 and 1999 in Hong Kong.
The Board of Directors estimates that over 80 percent of the Company's patrons
are between the age of 20 to 40. Based on the reports of the Hong Kong Census
and Statistics Department, the number of women within the age group of 25 to 45
rose from 850,000 to 1,200,000 between 1986 and mid-1996, representing an
increase of 41%. Management believes that the strong position held in the Hong
Kong market can be maintained by continuously upgrading facilities and services.
The Company monitors this situation continuously, and upgrades the fitness and
spa areas on a regular basis. The number of members in each location is also
carefully monitored in order to ensure adequate levels of service to individual
customers, particularly during peak work-out periods. Branch Managers monitor
the situation through direct observation, customer feedback and surveys.
For spa personnel, intensive training is conducted in the in-house
training center and thorough on-the-job instruction. Selected employees are sent
to France and Italy to study the latest techniques and to learn about new
products on the market. The Company seeks to satisfy its spa clients' needs with
the latest technology, expertise and a high level of service.
- - EXPLORING POTENTIAL MARKETS
The Company considers its market to be the greater Asia region. The
Company is exploring the possibility of opening a new fitness/spa center in
Macau in the next couple of years. Macau has been a Portuguese colony (until
December 20, 1999) strategically located at the mouth of the Pearl River on the
border of China. Macau is easily accessible by Hong Kong residents via a 45
minute jet foil ride and is a popular vacation destination for both Hong Kong
and Chinese residents. Macau has a population of approximately 500,000 of which
50% is female (Hong Kong Trade Development Council). The Company plans to target
primarily Macau's local residents.
The Company is also closely monitoring the market opportunities in other
South East Asian countries such as the Philippines, Thailand, Malaysia and
Indonesia.
FITNESS
The Centers emphasize the benefits of health, physical fitness and
exercise by providing a wide range of exercise equipment from the United States
and Europe including free-weights, strength systems and cardiovascular machines
from manufacturers such as Life Fitness, Cybex , Flex, and Precor. The Company
places a particular emphasis on the quality of its fitness managers and
instructors by providing continuous training both in Hong Kong and overseas.
The centers also conduct daily dance classes which run for approximately
45 minutes and are on a first-come, first-served basis. The Company believes
that the number of dance classes conducted by the Centers per day is among the
highest in Hong Kong. The variety of dance classes include aerobic dance, step ,
arms and thighs workout, funk and jazz and are taught by experience instructors.
The dance classes are reviewed on a monthly basis and new dance classes are
introduced approximately every three months in order to appeal to the interests
of members. Since 1995, the Company has recruited fully qualified and
experienced aerobic instructors from Australia.
The Company believes, based on member survey responses, utilization
rates and the existence of underutilized space in its centers, that it has
sufficient excess capacity at its existing fitness centers to accommodate new
membership growth as well as comfortable usage by present members.
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SPA SERVICES
Spa services are open to both members and non-members. However, members
of the centers have priority for such service facilities. Over 80 types of spa
treatments are offered including facial treatments, various skin care
treatments, relaxation programs, personalized make-up application and
instruction, and weight-management and massage.
All of the centers have designated rooms for spa treatments in order to
ensure privacy. In view of the popularity of the spa treatments, the centers
have a booking system whereby sessions for such treatment are reserved in
advance. The centers offer special discounts to patrons for beauty treatments
during off-peak hours in order to maintain an even level of customers during the
day. In promoting the fitness training services provided by the centers, patrons
for spa treatments, who are not members of the centers, are eligible to use all
facilities of the centers including fitness training, on the day of their visits
for a spa treatment. The Company believes that this additional service offers an
advantage over its competitors who engage only in beauty treatments.
The Company has a broad scale of fees for its spa services and believes
that these fees are both affordable and competitive in terms of the quality and
variety of services provided at the centers. The centers typically charge the
normal fee on spa treatment per session. However, discounts are given to those
patrons who purchase prepaid coupons. These coupons are valid within a specified
period of time.
The Company employs professional spa personnel who hold recognized
qualifications and adequate experience. Each center retains a specific manager
for spa treatments that supervises the spa personnel and other staff members of
the center. Each spa employee serves only one patron during the entire session
of spa treatment. The Company places great emphasis on providing continuous
training programs for its spa personnel. In order to remain informed of the
latest international developments in spa treatments, applications, technology
and equipment, the Company arranges both local and overseas training.
RETAIL
The Company sells a range of products at each center such as leotards,
shorts, T-shirts, training shoes, socks and training suits, including Nike and
several U.S. and Australian brand products. The Company also sells European skin
care products manufactured in Italy and Spain by Frais Monde and Anibus,
respectively. In addition, cosmetics from Frais Monde are offered. The fitness
and beauty related products are available in the centers to facilitate the needs
of their members.
MEMBERSHIP
The Company currently offers prospective members a membership plan. Fees
for services at each facility depend on the location and demand for such
services at that facility. Marketing of the Company's services is targeted
towards the middle income female population in the 18 to 34 years old range.
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Under the plans, new members are charged a membership fee upon admission
and a monthly fee each month to maintain their membership privileges. The
initial membership fees are non-refundable and range from approximately HK$800
(US$103) to HK$1,500 (US$193), depending on the diversity of facilities and
services available at the club of enrollment, the local competitive environment,
as well as the effects of seasonal price strategies. Monthly dues for
memberships generally range from HK$168 (US$22) to HK$299 (US$38) during the
typical membership period. Prepayment of the monthly fee is encouraged by
offering a discount for members who prepay for six or twelve months. Members are
also provided on a monthly basis 10 aerobic coupons on free-of-charge basis at
Hong Kong locations. Any member who attends additional classes has to purchase
coupons at HK$15 (US$2) each. China locations include aerobics classes with
monthly dues.
In order to allow greater flexibility to its members, the Company
operates a network system where members may use the facilities provided at the
largest centers of the Company at no extra cost. The Centers have long opening
hours and are open all year round (except for Chinese New Year), in order to
provide continuous service to its members and customers. Generally, they are
open from 7:00 a.m. to 10:30 p.m. As with any consumer driven market, it is
essential that the services provided by the Company are constantly reviewed,
updated and improved. To achieve this, managers from each of the Centers
regularly invite comments from members in relation to the services provided.
Additionally, the Company constantly seeks to introduce new products and
techniques on fitness training and spa treatments in order to improve its
services and thus enhance its competitive position.
SALES AND MARKETING
The Company devotes substantial resources to the marketing and promotion
of its fitness and spa centers and their services because the Company believes
strong marketing support is critical to attracting new members both at existing
and new fitness centers. Since July, 1988, the Company and its predecessor began
to market substantially all of its fitness centers under the service name
"Physical Ladies' Club", thereby eliminating the prior practice of using
different names for individual locations. See "Business - Trademarks and Trade
Names".
A key component of the Company's marketing strategy is to cluster
numerous fitness centers in major media markets in order to increase the
efficiency and cost effectiveness of its marketing and advertising programs.
Advertising consists of (i) television, (ii) newspapers,telephone directories
and other promotional activities and (iii) radio, which were accounted for
approximately 10%, 80%, and 10%, respectively, of the Company's total
advertising expenses in 1999.
The Company's sales and marketing programs emphasize the benefits of
health, physical fitness and exercise by appealing to the public's desire to
look and feel better. The success of the Company's marketing efforts are
dependent upon the ability of its sales personnel to make effective personal
presentations of the benefits of membership to prospective members. The Company
believes that these presentations are enhanced by its well-equipped, attractive
centers and its "value pricing" membership programs. The Company conducts a
variety of marketing efforts. The Company's executives and sales personnel
attend trade shows and exhibitions throughout Hong Kong and China. At these
trade shows, the Company usually operates a separate promotional exhibit. The
Company's executives and marketing personnel also attend and sponsor seminars
given to individual end-user organizations or industry groups.
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RETAIL
CORPORATE SPONSORSHIP
Since 1993, Nike has sponsored the Company's fitness instructors in
China under an annual contract that is renewable each year. Nike supplies each
fitness instructor with several different shoes, track suits, T-shirts and caps
four times a year. In return, the Company sells only Nike footwear in its China
locations. Commencing in 1993, the Company has participated with Evian Water of
France in a variety of promotional activities, both China and Hong Kong.
Typically, Evian will invite the Company to participate in a variety of
promotional events held at trade shows, shopping centers and entertainment
venues. In return, the Company sells only Evian bottled water in its China
locations.
The Company has begun marketing, on a retail basis products to its
members including apparel manufactured by Nike and leading U.S. and Australian
fitness apparel brands . These products are intended to add value to the
memberships and increase the Company's revenues. The Company's marketing focus
also includes corporate membership sales which are designed to improve
productivity. The Company has introduced programs such as corporate on-site
aerobics classes to expand the market for its services. In addition to its
advertising, personal sales presentations and targeted marketing efforts, the
Company is increasingly utilizing in-club marketing programs, open houses and
contests for members and their guests foster member loyalty and introduce
fitness centers to prospective members and referral incentive programs involve
current members in the process of new member enrollments.
ACCOUNT COLLECTION
All collections of past-due accounts are handled internally by the
Company. Customers who have outstanding unpaid balances are not provided further
services until such balances are paid in full. Corporate accounts are handled
pursuant to the applicable terms of credit agreements. Local corporate accounts
are normally not allowed any special credit. International corporate accounts,
which are much larger than the local accounts, can be allowed three to six
months credit, with a possibility of extending such period, depending on the
account's size and record.
COMPETITION
HONG KONG
The competition of the Company consists of the following.
Upscale Market
- --------------
The Hong Kong upscale market consists of exclusive private clubs which
usually provide both fitness services and spa treatments at very high prices.
These private clubs are typically oriented towards women and offer a great deal
of variety to their customers. Annual membership fees average approximately
HK$19,000 (US$2,500) and beauty treatments are charged separately upon usage.
These facilities use expensive, name-brand equipment, luxurious decoration,
large areas of space up to 30,000 sq ft, and offer a wide range of services to
attract customers. The two primary clubs in this category are Philip-Wain and
Body by Deborah International Health Spa. There are certain upscale market
establishments which provide fitness services only, most are for both male and
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female, and are concentrated in one area of Hong Kong. The joining fees range
from HK$2,000 (US$257) to HK$7,000 (US$899) with monthly membership fees ranging
from HK$350 (US$45) to HK$800 (US$103). These establishments range in size from
10,000 sq ft to 30,000 sq ft. Examples are Ray Wilson s California Gym and New
York Fitness. Another fitness only company, Tom Turk, was the earliest entrant
into the Hong Kong Market, with the first outlet opening in the early 1980's.
The Tom Turk facilities have fees that target between the upper and middle
market customer, and their two locations are each approximately 30,000 sq. ft.
Tom Turk attracts primarily a male clientele and emphasizes their extensive line
of free weights, workout equipment and swimming pools. The Company's fitness/spa
facilities compete directly primarily with the middle markets (see below), with
the exception of Renaissance Beauty Center, which targets upscale market.
Middle Market
- -------------
There are very few establishments in this class which provide both
fitness services and spa/ beauty treatments in a single facility. The closest
competitor would be a facility called Mid-City, which provides both services for
men and women. This facility has only one location with an area of approximately
15,000 sq ft. Another competitor of the Company in the same category is Modern
Beauty Salon with six locations of various sizes up to approximately 15,000 sq.
ft. An average down payment joining fee of HK$2,000 (US$257) is required to
become a member of the above centers. Another establishment which provides only
fitness services is The Lift Club. The Lift Club has three outlets in prime
locations, with approximately 10,000 sq ft each. The joining fee is HK$1,600
(US$206) and the monthly fee is HK$550 (US$71). The operators of spa/beauty
services only which are in direct competition with the Company include
Expression, with one location, and Angel Face Beauty Creations (International)
Ltd., with nine locations. The management believes that, these facilities do not
offer as high a level of fitness equipment and instruction as the Company does
and that the Company offers a more comprehensive level of spa treatments than
these facilities. The Company targets primarily the middle market.
Low-End Market
- --------------
In this category, most establishments only provide either fitness
services or simple beauty treatments. These establishments are usually much
smaller in size and have a limited range of services. Representatives of the
low-end market include Frank & Wit, The Fitness Gym, Paradise Health Club, Tess
Beauty, and Health City. Joining fee to these facilities vary from HK$600
(US$77) to HK$2,000 (US$257), and monthly fees average approximately HK$430
(US$55). In addition, there are numerous smaller facilities operating inside the
shopping arcades, and/or associated with hair salons and department stores.
Management believes that the Company does not directly compete with this market.
In the low-end fitness market, the government operates a small number of
gymnasium facilities. These are public facilities, open to both men and women
for nominal fees.
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CHINA
SPA SERVICES. Certain spa services are provided by beauty salons, which
are very popular in China and have been in existence for several years. However,
most are small scale and offer only basic services in the Company's opinion and
as compared to the Company's facilities. Most salons are not modern and do not
possess certain international standards of skill and hygiene as most facilities
in Hong Kong. In the Management's view, these salons only have access to locally
manufactured skin care products, which tend to be low-tech and chemically-
based, since it is too costly for a small salon to use imported products. The
Company, as an exclusive agent for several professional European skin care
lines, maintains the leading edge in skin care. The closest competitors in the
spa industry would be several beauty salons with Hong Kong and Japanese
investors, including Carita in Shanghai, and Marco, in Dalian. Services in these
facilities are somewhat more up to date, though most do not exceed the Company's
facilities in size, nor in number of services available, in management's
opinion. Most of these salons use common department store skin care products,
which prevents them from differentiating themselves in the market. The Company
believes that no other salons offer a professional line of skin care products
for purchase, except for common, famous-name brands which are also available in
department stores.
FITNESS CENTER. There are several fitness centers in China, especially
following the opening of the Company's China facilities in Shanghai and Dalian.
The Company believes that its early entry into the market has helped it to
achieve the leading name in fitness. The Company believes that it was the first
to offer professional, up to date fitness services, up to date group exercise
(aerobics) classes, and a full range of modern exercise equipment. Though the
Company currently has only three facilities operating in China, the management
believes that its name has become already known as the Company has set the
standards for the fitness and spa industry for China. The closest competitors
are as follows:
Upscale Market
- --------------
There are many upscale recreation clubs in the major cities of China,
including Hong Kong City, Shanghai, and the Friendship Club in Dalian. These
facilities usually offer dining, bars, karaoke, massage, sauna, exercise, beauty
treatments, and occasionally bowling, tennis or golf. However, the trend for
such clubs has proven to be most successful when utilized as men's clubs. These
clubs are used primarily for entertaining business clients or for high-income
business men. Therefore, very little emphasis is placed on the level of service
and amenities within the fitness areas. Typically, most are staffed only with
receptionists as there is no demand for fitness professionals. Very few women
use such facilities. These clubs charge very high joining fees, usually upwards
of several thousand US dollars.
The majority of four and five star hotels have health clubs for outside
membership as well as for hotel guests. Usually these clubs have expensive,
brand name equipment, and often offer aerobics classes. Most also have luxury
shower and spa facilities. However, the price structure is usually comparable to
an upscale U.S. health club, and therefore is not affordable to the vast
majority of Chinese people. Such clubs cater to the ex-patriate business
community, and some are exclusive to such community. Their location, being
situated on the hotel premises, often limits size, and they tend to reach full
capacity with a low number of members. Since most hotels do not depend on the
health club as a major source of revenue, typically very little marketing or
membership incentives are used.
19
<PAGE>
Middle Market
- -------------
There are several middle market fitness centers in some of the larger
cities in China. Many newly built housing complexes (upscale apartment buildings
and "western" style housing villages) have recreation centers. They typically
include swimming pools, tennis courts and gyms. In the management's opinion,
such facilities are luxurious by Chinese standards, but gyms are commonly
unstaffed or only have a receptionist. More and more such centers are providing
exercise classes as well, but lack of qualified instructors, in the management's
opinion, inhibits growth in this area. Such clubs have recently been opened in
Dalian, however, in the management's opinion, none of them matches the Company
in size, nor in the range of exercise equipment available, and classes offered
and the Company does not see them as the same level competitors. Shanghai has
several recently opened middle market clubs, such as DD's Personal Club and
YMCA. DD's Personal Club caters primarily to the expatriate market and is
therefore limited in growth. YMCA is not situated in a prime location and has
not used, in the management's opinion aggressive marketing, and in the
management's view to date has not made significant impact on the fitness
industry in Shanghai.
Low-End Market
- --------------
Group exercise is an extremely popular activity in China, but mainly
done by elderly people. As more interest is created in the younger market, a
wider variety of classes are now being offered in government facilities such as
gymnasiums, parks and town squares. Such facilities usually are held on a
basketball court in a gym, or a recreation hall with large open space. Typically
there are no shower, locker, or spa facilities available. The management
believes that the popularity of these facilities is due to the nominal fees
charged.
Trademarks and Trade Names
In July 1988, the Company and its predecessor began to market
substantially all its fitness centers under the servicemark "Physical Ladies'
Club" thereby eliminating the prior practice of using a different trade names
for each Center. The Company registered a servicemark under its trade name
"Physical Ladies' Club" in Hong Kong and its Chinese equivalent name in China.
In the opinion of the Company's trademark counsel in Hong Kong, the registration
enables the mark to distinguish the Company's services from similar services of
others, although it gives the Company no right to the exclusive use of the
words. The servicemark gives the Company a priority over the use of the
servicemark by others and the right to reject others from the use of the same
name. In China, the Company was only able to register the name in Chinese
language pursuant to the Chinese Trademark Law. In the opinion of the Company's
trademark counsel, the name "Physical Ladies' Club" is considered a direct
reference to the contents and features of the services in the servicemark and as
such it cannot be registered as a trademark under the Chinese Trademark Law. The
registration of the Chinese name, however, provides the Company with protection
of its name on a nation-wide basis and precludes others in China from using the
same name as the Company's.
Seasonality
Historically, the Company has experienced greater sales in the third
quarter of each year. In recent years, the Company has lessened this seasonal
effect by the use of sales incentives and awards for its sales personnel and
members, as well as other marketing initiatives.
Insurance
The Company maintains liability insurance providing coverage to the
Company with respect to accidental bodily injury and accidental loss of or
damage to property of any customer or employee of the Company, which would occur
in connection with the business of the Company and on the premises of the
Company. The Company does not maintain product liability insurance with respect
to the beauty products used in its spa treatments.
20
<PAGE>
Research and Development
The Company's business is service-oriented, therefore it does not have
a formal Research & Development department, however, its marketing and training
departments are closely following the evolution of international fitness and
beauty trends.
Employees
The Company has approximately 800 employees, including approximately 40
commission based sales executives. Approximately 380 employees are involved in
fitness operations, including sales personnel, instructors, and supervisory
personnel. Approximately 290 employees are involved in beauty and spa
operations. Approximately 90 are administrative support personnel, including
accounting, marketing, training and other services.
The Company is not a party to any collective bargaining agreement with
its employees. The Company has not experienced a high turnover of non-management
personnel and also has not had difficulty in obtaining adequate replacement
personnel, except with respect to sales personnel, which the Company believes
have become somewhat more difficult to replace due, in part, to increased
competition for skilled retail sales personnel.
Government Regulation
Hong Kong
The Hong Kong operations and business practices of the Company are
subject to regulation at the local level. General rules and regulations,
including those of the local consumer protection agencies, apply to the
Company's advertising, sales and other trade practices.
Statutes and regulations affecting the fitness, spa and beauty
industries have been enacted or proposed in all of the areas in which the
Company conducts business. Typically, these statutes and regulations prescribe
certain forms and regulate the terms and provisions of membership contracts,
allowing the member the right to cancel the contract within, in most cases, 14
business days after signing, requiring an escrow for funds received from
pre-opening sales or the posting of a bond or proof of financial responsibility,
and, in some cases, establishing maximum prices and terms for membership
contracts and limitations on the term of contracts. In addition, the Company is
subject to several other types of regulations governing the sale and collection
of memberships, as well as laws governing the collection of debts. These laws
and regulations are subject to varying interpretations by local consumer
protection agencies and the courts. The Company maintains internal review
procedures in order to comply with these requirements and it believes that its
activities are in substantial compliance with all applicable statutes, rules and
decisions.
21
<PAGE>
Under typical regulations, members of fitness centers have the right to
cancel their un-used memberships for a period of 30 to 60 days after the date
the contract was entered into (depending on the applicable law) and are entitled
to refunds of any payment made. The specific procedures for cancellation in
these circumstances vary according to differing local laws. In each instance,
the canceling member is entitled to a refund of prepaid amounts only.
Furthermore, where permitted by law, a cancellation fee is due to the Company
upon cancellation and the Company may offset such amount against any refund
owed. The Company's membership contracts provide that a member's one-time
membership fee is non-refundable in case of cancellation.
The Consumer Council of Hong Kong protects the rights of consumers,
including memberships, such as those offered by the Company. The members have a
right to dispute the price or quality of the service, if they find it
unsatisfactory. The Council also assists consumers in cases of false claims made
by the companies with respect to a specific service offered by them. The Company
is cautious in advertising its services, and it never promotes or guarantees
unrealistic results concerning skin care or fitness services, therefore the
Company rarely faces complaints in this respect from its consumers.
The Company's facilities are also subject to building, health and
safety laws. The laws require a normal building inspection at the time of
renovation of the club facilities and/or fire safety inspection. Since the
Company's facilities typically are a part of a large office building for which a
license is granted, if the Company does not comply with all the regulations, the
landlord would not be granted a license. The Board of Health carries out an
inspection of shower and restroom facilities to make sure that they comply with
the standards imposed by the Board. In order to have massage services, the law
requires a special massage license. The Board of Health and Police Department
also hold random inspections of the facilities providing massage services, since
there are strict laws requiring that massage therapists be of the same sex as
the customers. As the Company is exclusively open to women in all centers, but
one, there have been no concerns with this regulation.
China
In China, the Company's operations and business practices are subject
to regulation from the central government, which is often carried out at local
levels. There is a Consumer Council in China which is now expanded to most urban
areas and whose role is to protect consumers and enforce consumer rights in
cases of dispute regarding quality of the product or service or misleading
claims. The Consumer Council holds considerable power in China and can impose
large fines upon a company it finds in violation of consumer laws. The Consumer
Council would often publish a statement against a fined company in a local
newspaper.
China requires a fire safety inspection and license before completion
of renovation of the facility. The safety department performs unannounced
inspections every year to ensure proper compliance with the regulations, such as
maintenance of clear fire exits, extinguishers, smoke detectors and other safety
equipment.
The Board of Health has strict regulations regarding spa facilities and
fitness/beauty equipment that is used by many people per day. The Board requires
an initial license before opening of the facilities and requires installation of
certain anti-bacterial and hygiene equipment. For example, the beauty treatment
area is required to have ultra-violet ("UV") disinfection lamps installed within
every 5 feet of public space. The law also requires UV disinfection every night
for the air, beds and chairs in the area. The Board also requires "hot cabinet"
disinfection units for small beauty tools and equipment. In the Company's
experience, random inspections of those areas of the spa are often done by the
Board of Health.
22
<PAGE>
The Board of Health also requires an inspection and license for each
imported cosmetic or skin care product. The license must be obtained from the
Central Government in Beijing and a substantial fee is charged for the testing
of each imported product.
In China, the Board of Health is responsible for monitoring the
operation of the Company's spas, however, their strict regulations fall in line
with the standards of the Company and therefore, to date, there has been no fine
or restriction of the operation of any fitness or spa facility.
There is a Council for Fair Pricing in China, and every business that
sells products or provides services must register their fees with this
department. The Council has a right to dispute fees if it deems them
unreasonable, however to date, the Council's directives are just a formality
which is limited to collecting a registration fee from each business and rarely
questions the pricing.
The Police Department has strict regulations in China regarding massage
services and requires (although in the management's experience, it seldom checks
for compliance) the Company to ensure that the massage therapist is of the same
sex as the customer. A special license is required for massage services, which
is in the management's opinion, difficult to obtain. The massage therapist must
be certified and licensed by a government affiliation, and must have an annual
health examination. Since all the Company's centers in China are exclusively for
women and include only female staff, the Company has not been impacted by those
regulations.
China has also regulations which are so restricting, that, in fact,
amount to not allowing independently owned fitness and beauty spas by foreign
companies. Instead, the regulations encourage joint ventures with a foreign
company. Fitness and beauty spas fall under the category of "Entertainment and
Recreation", which to date have always been business entities in a form of joint
ventures.
23
<PAGE>
ITEM 2. DESCRIPTION OF PROPERTY
The Company's headquarters which include the Company's executive and
administrative offices are located at a 30,000 square feet facility in Hong Kong
pursuant to a lease expiring February 28, 2003. The Company relocated its
headquarters and its Causeway Bay location to this location in Mid-1997 in order
to accommodate additional customers, and more extensive lines of fitness and spa
treatment equipment.
Aggregate rental expense was approximately HK$29.4 million (US$3.8
million), HK$36.0 million (US$4.6 million) and HK$47.2 million (US$6.1
million)for the year ended December 31, 1997, 1998 and 1999, respectively.
Mei Foo is the only location indirectly partially owned by the Company.
The Company ( through its subsidiary, Ever Growth Limited), directly owns 700
sq. ft. of the property where the Mei Foo center is located. There are 7,300 sq.
ft. located in the same building for fitness facility and an additional 2,000
sq. ft. for the spa facility located in the same district.
Set forth below is the information regarding the Company's centers in
Hong Kong and China.
<TABLE>
FITNESS/SPA CENTERS - HONG KONG AND CHINA
-----------------------------------------
<CAPTION>
Current Monthly
HONG KONG Size Own/Lease Term Expiration Renewal Option Rent(1)(2)
- --------------- ---- --------- --------------- -------------- ---------------
<S> <C> <C> <C> <C> <C>
Shop A on 11-F, 12/F-15/F., 30,000 sq. ft. Lease 2/28/2003 None HK$1,122,236
Lee Theatre Plaza
99 Percival Street
Causeway Bay, Hong Kong
10/F-12/F., Storeroom on 25,000 sq. ft. Lease 1/31/2003 (3) None HK$564,905
5/F, Room 701A,
Prestige Tower
23-25 Nathan Road
Tsimshatsui, Hong Kong
Shop Nos. 125, 126 and 131-133 10,200 sq. ft. Lease 5/19/2001 (4) 2 Years HK$423,667
Level 1,
Grand Central Plaza
Shatin, Hong Kong
18/F - 21/F City Landmark 50,000 sq. ft. Lease 3/31/2001 5 Years HK$1,048,287
No. 68 Chung On Street
Tsuen Wan, Hong Kong
Unit 605-609, Level 6 3,200 sq. ft. Lease 7/4/1999 (4) None HK$111,915
NewTown Tower, 10-18
Pak Hok Ting Street
Shatin, Hong Kong
</TABLE>
24
<PAGE>
<TABLE>
<CAPTION>
Current Monthly
HONG KONG (Continued) Size Own/Lease Term Expiration Renewal Option Rent(1)(2)
- --------------------- ---- --------- --------------- -------------- ---------------
<S> <C> <C> <C> <C> <C>
P/F., Stage 8 8,000 sq. ft. Own/lease 4/30/2001 None HK$102,343
122B Broadway Street
Mei Foo Sun Chuen,
Hong Kong
Shop 66, P/F 2,000 sq. ft. Lease 9/1/2002 None HK$92,658
Stage 3
26-50 Broadway
Mei Foo Sun Chuen
Hong Kong
14/F., Coda Plaza 5,000 sq. ft. Lease 6/30/2000 None HK$140,062
51 Garden Road
Central, Hong Kong
G/F., 3,000 sq. ft. Lease 6/30/2001 None HK$51,000
5 Junction Road
Kowloon City, Hong Kong
Shops 108, G08, S17 & B08, 43,464 sq. ft. Lease 3/5/2005 2 years HK$1,881,994
The Elegance at Sheraton,
Tsimshatsui, Hong Kong
- ---------------------
</TABLE>
(1) Monthly rent is paid in HK Dollars
(2) Monthly rent also includes the management fee for property management.
Excludes utilities and rates.
(3) Lease for Room 701A expires on July 31, 2002.
(4) Lease for Unit 605-609, New Town Tower, 10-18 Pak Hok Ting Street, Shatin,
Hong Kong was granted an early surrender on October 15, 1998.
<TABLE>
<CAPTION>
Current Monthly
CHINA Size Own/Lease Term Expiration Renewal Option Rent(1)
- ----- ---- --------- --------------- -------------- ---------------
<S> <C> <C> <C> <C> <C>
5/F-7/F., Huangpu Gymnasium 23,000 sq. ft. Lease 9/2003 None HK$130,105 (2)
No. 311 Shandong Road
(Mid) Shanghai
4/F., China Wanda Bldg 15,000 sq. ft. Lease 2/28/2008 None HK$128,975 (3)
No. 18 Hongda Road
Zhongshan District, Dalian
2/F, 3/F, 4/F, Block B No. 12,000 sq. ft. Lease 12/14/2004 None HK$179,312 (4)
808 Hong Qiao Road
Shanghai
- -----------------------
</TABLE>
(1) Monthly rent is paid in Rmb, with the exception of Dalian property, for
which the rent is paid in HK Dollars.
(2) Lease agreement was revised in August 1999 to fix the annual rental for the
remaining tenancy period.
(3) Rental was reduced from March 1, 1999 and agreed to increase by 5% from
March 1, 2002.
(4) Combined monthly rent includes management fee. The monthly rent will
increase by the inflation rate (1999 - 2.24%) beginning May 1, 1999 for 2/F
space and June 30, 1999 for 3/F and 4/F space.
25
<PAGE>
In November, 1999, the company signed an offer letter for space of
15,000 sq. ft. to be used for fitness services at Tuen Mun, New Territories. The
lease has a term of 3 years with a first option to renew for a further term of 3
years and a second option to renew for another term of 2 years. The term include
a lease payment of HK$394,289 (US$50,654) per month for the first 3 years and
HK$473,147 (US$60,785) per month for the fourth to sixth year. The rent will be
at the then open market rent afterwards. The lease also includes a management
fee of HK$117,527 (US$15,098) per month.
The Company believes that current facilities will be sufficient to
satisfy the Company's existing requirements. In its strategy to expand
operations, however, the Company may open new locations in Macau or China.
Although the Company believes that such locations will be available at
affordable prices, no assurance can be given. The Company believes that, in the
event any of the existing leases that expire within five years are not renewed,
adequate alternative space is available in the same areas at comparable rates.
In the Company's experience, most premises used for fitness/spa services have an
optimum life span of about five years, after which time they need to be improved
and/or renovated. The Management believes that the costs of such renovation are
not lesser than the cost of acquiring new premises, and therefore the Company is
not concerned with the fact that most of its leases do not have renewal options.
ITEM 3. LEGAL PROCEEDINGS
There are no pending material legal proceedings to which the Company or
any of its properties is subject, nor to the knowledge of the Company, are any
such legal proceedings threatened.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's stockholders
through the solicitation of proxies, or otherwise, during the fourth quarter of
the Company's fiscal year ended December 31, 1999.
26
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock has been listed on the Bulletin Board of the
NASD's over-the-counter market under the symbol PFIT, since December 1996, but
has been traded only sporadically. As of March 31, 1999, the 52-week trading
range was between $6.00 to $0.15 per share.
The last reported closing bid price of Common Stock reported by NASD was
on June 18, 1999 at $0.156 per share of Common Stock. Since that time there were
no reported sales of the Company's Common Stock. As of December 31, 1999, there
were approximately 624 record holders of the Company's Common Stock. The Company
effected a 1.333333-for-1 reverse split of its Common Stock in October 1997 and
a 1-for-1.333333 forward stock split in June 1998.
DIVIDEND POLICY
- ---------------
The Company has never paid any cash dividends on its Common Stock and
does not anticipate paying any cash dividends in the future. Physical Health
Centre Hong Kong Limited, the subsidiary of the company acquired by the Company
in October, 1996, paid dividends out in 1995. The Company currently intends to
retain future earnings, if any, to fund the development and growth of its
business.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS
The following discussion should be read in conjunction with "Selected
Consolidated Financial Data" and the Consolidated Financial Statements and Notes
thereto appearing elsewhere in this report.
Overview
- --------
General
The following discussion should be read in conjunction with "Selected
Consolidated Financial Data" and the Consolidated Financial Statements and Notes
thereto appearing elsewhere in this Report.
Company's Overview
- ------------------
The Company, through its predecessor companies and its subsidiaries, has
been an established commercial operator of fitness and spa centers in Hong Kong
and China since 1986 (see "Company - History"). The Company currently operates
eleven facilities: eight in Hong Kong and three in China. Based on the number of
the members of the Company's facilities, management believes that the Company is
one of the top providers of fitness facilities and spa and beauty treatment
services in Hong Kong and China, with approximately 60,000 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$2,000(US$257) for one person. (A current promotion allows a special fee of
HK$500 (US$64) at a particular booth). A monthly subscription fee of HK$299
(US$38) 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$400 (US$51) to HK$13,000 (US$1,670).
The following table sets forth selected income data as a percentage of
total operating revenue for the periods indicated.
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1997 1998 1999
---- ---- ----
<S> <C> <C> <C>
Operating Revenues 100.00% 100.00% 100.00%
Total operating expenses 83.12% 90.05% 89.02%
Operating income 16.88% 9.95% 10.98%
Income before income taxes and minority
interests 15.57% 8.38% 9.48%
Provision for income and deferred taxes 4.68% (0.05%) 1.95%
Minority interests 0.98% 0.57% 0.23%
Net income 9.91% 7.87% 7.31%
======== ======== =======
</TABLE>
28
<PAGE>
FISCAL YEAR ENDED DECEMBER 31, 1999 COMPARED TO FISCAL YEAR ENDED DECEMBER 31,
1998
- --------------------------------------------------------------------------------
OPERATING REVENUES. The Company's operating revenues showed the
continuous growth in the fiscal year ended December 31, 1999 as compared to the
fiscal year ended December 31, 1998. Operating revenues for the fiscal year
ended 1999 totaled HK$253,172,000 (US$32,525,000) compared to HK$210,209,000
(US$27,005,000) in the fiscal year ended December 31, 1998, representing an
increase of 20%. Operating revenues derived by the Company's fitness services
increased 19% to HK$166,917,000 (US$21,444,000)compared to HK$139,829,000
(US$17,964,000) in the fiscal year ended December 31, 1998. Fitness revenues as
a percentage of total revenues were 66% in the fiscal year ended December 31,
1999 as compared to 67% in the fiscal year ended December 31, 1998.
Operating revenues for the Company's beauty treatments totaled
HK$86,225,000 (US$11,077,000)compared to HK$70,317,000 (US$9,034,000) in the
fiscal year ended December 31, 1998, representing an increase of 23%. Beauty
revenues as a percentage of total revenues were 34% in the fiscal year ended
December 31, 1999 as compared to 33% in the fiscal year ended December 31, 1998.
Operating revenues derived from the Company's Hong Kong locations remain
an important contributor to the Company's business, generating HK$238,096,000
(US$30,588,000), or 94% of total operating revenues in the fiscal year ended
December 31, 1999 as compared to HK$192,692,000 (US$24,755,000) or 92% of total
operating revenues in the fiscal year ended December 31, 1998.
Operating revenues derived from the Company's China locations generated
HK$15,076,000 (US$1,937,000), or 6% of total operating revenues in the fiscal
year ended December 31, 1999 as compared to HK$17,517,000 (US$2,250,000) or 8%
of total operating revenues in the fiscal year ended December 31, 1998.
OPERATING EXPENSES. The Company's operating expenses for the fiscal year
ended December 31, 1999 totaled HK$225,367,000 (US$28,953,000)compared to
HK$189,295,000 (US$24,318,000)in the fiscal year ended December 31, 1998,
representing an increase of 19%. The increase in the operating expenses was
primarily due to higher salaries and commissions as a result of increased
revenues and additional rent and related expenses incurred by the new Tsuen Wan
branch and Sheraton branch which opened in July 1998 and July 1999 respectively.
Total operating expenses, after taking into account all corporate expenses, were
89% of total operating revenue as compared to 90% of last year.
Operating expenses associated with the Company's Hong Kong locations
were HK$206,822,000 (US$26,570,000) in the fiscal year ended December 31, 1999,
representing an increase of HK$39,716,000 (US$5,102,000) or 24% as compared to
HK$167,106,000 (US$21,468,000) in 1998. Hong Kong operating expenses represented
92% of total operating expenses in the fiscal year ended December 31, 1999 as
compared to 88% in 1998. The increase in operating expenses was primarily
incurred by a new branch in Sheraton Hotel, Hong Kong which has not yet been
opened in 1998. The operating expenses for the Sheraton Hotel center amounted to
HK$30,837,000 (US$3,962,000) in 1999. In addition, the Tsuen Wan center incurred
operating expenses of HK$45,059,000 (US$5,789,000), representing an increase of
HK$18,738,000 (US$2,407,000) over last year which reflected the 6-month
operation since July 1998.
Operating expenses associated with the Company's China locations were
HK$18,545,000 (US$2,382,000) in the fiscal year ended December 31, 1999,
representing a decrease of 16% as compared to HK$22,189,000 (US$2,851,000) in
1998. Operating expenses in China represented 8% of total operating expenses in
the fiscal year ended December 31, 1999 as compared to 12% in 1998. The decrease
in operating expenses was primarily due to less selling and administrative
expenses incurred in the year.
29
<PAGE>
TOTAL NON-OPERATING EXPENSES (INCOME). Total non-operating expenses for
the fiscal year ended December 31, 1999 totaled HK$3,793,000 (US$487,000)
compared to HK$3,288,000 (US$422,000) in the fiscal year ended December 31,
1998, representing an increase of 15% due to higher interest expenses.
PROVISION FOR INCOME TAXES. Provision for income taxes for the fiscal
year ended December 31, 1999 totaled HK$4,933,000 (US$634,000). The effective
tax rate of the year was 20.5%. For the fiscal year ended December 31, 1998, the
Company provided income taxes of HK$4,382,000 (US$563,000) against which the
Company settled prior years taxes and recorded the amount over provided in prior
years in the amount of HK$4,490,000 (US$577,000). This resulted in a negative
provision of HK$108,000 (US$14,000) in the fiscal year ended December 31, 1998.
NET INCOME. The Company's net income for the fiscal year ended December
31, 1999 totaled HK$18,502,000 (US$2,377,000)compared to HK$16,536,000
(US$2,124,000) for the fiscal year ended December 31, 1998, representing an
increase of 12%. The increase in the net income was mainly due to the additional
contribution of the Sheraton Hotel center and Tsuen Wan center.
FISCAL YEAR ENDED DECEMBER 31, 1998 COMPARED TO FISCAL YEAR ENDED DECEMBER 31,
1997
- --------------------------------------------------------------------------------
OPERATING REVENUES. The Company's operating revenues showed a
significant growth in the fiscal year ended December 31, 1998 as compared to the
fiscal year ended December 31, 1997. Operating revenues for the fiscal year
ended 1998 totaled HK$210,209,000 (US$27,005,000) compared to HK$148,954,000
(US$19,136,000) in the fiscal year ended December 31, 1997, representing an
increase of 41%. Operating revenues derived by the Company's fitness services
increased 70% to HK$139,829,000 (US$17,964,000)compared to HK$82,311,000
(US$10,574,000) in the fiscal year ended December 31, 1997. Fitness revenues as
a percentage of total revenues were 67% in the fiscal year ended December 31,
1998 as compared to 55% in the fiscal year ended December 31, 1997.
Operating revenues for the Company's beauty treatments totaled
HK$70,317,000 (US$9,034,000)compared to HK$66,496,000 (US$8,543,000) in the
fiscal year ended December 31, 1997, representing an increase of 6%. Beauty
revenues as a percentage of total revenues were 33% in the fiscal year ended
December 31, 1998 as compared to 45% in the fiscal year ended December 31, 1997.
Operating revenues derived from the Company's Hong Kong locations remain
an important contributor to the Company's business, generating HK$192,692,000
(US$24,755,000), or 92% of total operating revenues in the fiscal year ended
December 31, 1998 as compared to HK$126,939,000 (US$16,308,000) or 85% of total
operating revenues in the fiscal year ended December 31, 1997.
Operating revenues derived from the Company's China locations generated
HK$17,517,000 (US$2,250,000), or 8% of total operating revenues in the fiscal
year ended December 31, 1998 as compared to HK$22,015,000 (US$2,828,000) or 15%
of total operating revenues in the fiscal year ended December 31, 1997.
OPERATING EXPENSES. The Company's operating expenses for the fiscal year
ended December 31, 1998 totaled HK$189,295,000 (US$24,318,000)compared to
$HK123,804,000 (US$15,905,000)in the fiscal year ended December 31, 1997,
representing an increase of 53%. The increase in the operating expenses was
primarily due to the following factors: expenses incurred in connection with the
opening of a new center (Tsuen Wan), a general increase in staff salaries as a
result of higher revenues generated, depreciation charges and rental expenses
incurred for enhanced facilities. Total operating expenses, after taking into
account all corporate expenses, were 90% of total operating revenue as compared
to 83% of last year.
Operating expenses associated with the Company's Hong Kong locations
were HK$167,106,000 (US$21,468,000) in the fiscal year ended December 31, 1998,
representing an increase of HK$62,735,000 (US$8,059,000) or 60% as compared to
HK$104,371,000 (US$13,408,000) in 1998. Hong Kong operating expenses represented
88% of total operating expenses in the fiscal year ended December 31, 1998 as
compared to 84% in 1997. The increase was primarily due to increased marketing
expenses of HK$10,238,000 (US$1,315,000), additional salary costs of
HK$15,400,000 (US$1,978,000) as a result of higher revenues, increased
depreciation charges of HK$3,682,000 (US$473,000) for the two enhanced premises
which were relocated in Mid-1997, and additional expenses of HK$26,320,000
(US$3,381,000) incurred by a new branch in Tsuen Wan, Hong Kong which opened in
July 1998.
30
<PAGE>
Operating expenses associated with the Company's China locations were
HK$22,189,000 (US$2,851,000) in the fiscal year ended December 31, 1998,
representing an increase of 14% as compared to HK$19,433,000 (US$2,497,000) in
1997. Operating expenses in China represented 12% of total operating expenses in
the fiscal year ended December 31, 1998 as compared to 16% in 1997. The increase
in operating expenses was primarily due to inflation and increased rental for
the enhanced facility in Huang Pu, Shanghai.
TOTAL NON-OPERATING EXPENSES (INCOME). Total non-operating expenses for
the fiscal year ended December 31, 1998 totaled HK$3,288,000 (US$422,000)
compared to HK$1,965,000 (US$252,000) in the fiscal year ended December 31,
1997, representing an increase of HK$1,323,000 (US$170,000) due to less interest
income.
PROVISION FOR INCOME TAXES. Provision for income taxes for the fiscal
year ended December 31, 1998 totaled HK$(108,000)(US$(14,000))as compared to
HK$6,969,000 (US$895,000)in the fiscal year ended December 31, 1997,representing
a decrease of 102%.
NET INCOME. The Company's net income for the fiscal year ended December
31, 1998 totaled HK$16,536,000 (US$2,124,000)compared to HK$14,756,000
(US$1,896,000) for the fiscal year ended December 31, 1997, representing an
increase of 12%. The increase in the net income was mainly due to additional
contribution from the new Tsuen Wan center.
FISCAL YEAR ENDED DECEMBER 31, 1997 COMPARED TO FISCAL YEAR ENDED DECEMBER 31,
1996
- --------------------------------------------------------------------------------
OPERATING REVENUES. The Company's operating revenues showed the
continuous growth in the fiscal year ended December 31, 1997 as compared to the
fiscal year ended December 31, 1996. Operating revenues for the fiscal year
ended 1997, net of an additional provision for deferred income of HK$8,300,000
(US$1,066,000), totaled HK$148,954,000 (US$19,136,000) compared to
HK$111,230,000 (US$14,290,000) in the fiscal year ended December 31, 1996,
representing an increase of 34%. Operating revenues derived by the Company's
fitness services increased 122% to HK$82,311,000 (US$10,574,000) compared to
HK$37,069,000 (US$4,762,000) in the fiscal year ended December 31, 1996. Fitness
revenues as a percentage of total revenues were 55% in the fiscal year ended
December 31, 1997 as compared to 33% in the fiscal year ended December 31, 1996.
Operating revenues for the Company's beauty treatments totaled
HK$66,496,000 (US$8,543,000) compared to HK$72,260,000 (US$9,283,000) in the
fiscal year ended December 31, 1996, representing a decrease of 8%. This was
mainly due to the Company's strategic plan to allocate more resources to promote
its fitness business which prospered significantly in 1997. Beauty revenues as a
percentage of total revenues were 45% in the fiscal year ended December 31, 1997
as compared to 65% in the fiscal year ended December 31, 1996.
Operating revenues derived from the Company's Hong Kong locations remain
an important contributor to the Company's business, generating HK$126,939,000
(US$16,308,000) or 85% of total operating revenues in the fiscal year ended
December 31, 1997 as compared to HK$81,990,000 (US$10,533,000) or 74% of total
operating revenues in the fiscal year ended December 31, 1996.
Operating revenues derived from the Company's China locations generated
HK$22,015,000 (US$2,828,000) or 15% of total operating revenues in the fiscal
year ended December 31, 1997 as compared to HK$29,240,000 (US$3,756,000) or 26%
of total operating revenues in the fiscal year ended December 31, 1996.
OPERATING EXPENSES. The Company's operating expenses for the fiscal year
ended December 31, 1997 totaled $HK123,804,000 (US$15,905,000) compared to
HK$79,553,000 (US$10,220,000) in the fiscal year ended December 31, 1996,
representing an increase of 56%. The increase in the operating expenses was
primarily due to the following factors: a general increase in staff salaries as
a result of higher revenues generated, depreciation charges and rental expenses
incurred for enhanced facilities. Total operating expenses, after taking into
account all corporate expenses, were 83% of total operating revenue as compared
to 72% of last year.
31
<PAGE>
Operating expenses associated with the Company's Hong Kong locations
were HK$104,371,000 (US$13,408,000), representing an increase of 71% as compared
to HK$60,929,000 (US$7,827,000) in the fiscal year ended December 31, 1996. Hong
Kong operating expenses represented 84% of total operating expenses in the
fiscal year ended December 31, 1997 as compared to 77% of total operating
expenses in fiscal year ended December 31, 1996. The increase in operating
expenses was primarily due to additional rent and related expenses, and
depreciation as a result of relocation of two branches in mid-1997, and
additional salary costs due to increased revenues.
Operating expenses associated with the Company's China locations were
HK$19,433,000 (US$2,497,000) representing a moderate increase of 4% due to
inflation as compared to HK$18,624,000 (US$2,393,000) in the fiscal year ended
December 31, 1996. Operating expenses in China represented 16% of total
operating expenses in the fiscal year ended December 31, 1997 as compared to 23%
of total operating expenses in the fiscal year ended December 31, 1996.
TOTAL NON-OPERATING EXPENSES (INCOME). Total non-operating expenses for
the fiscal year ended December 31, 1997 totaled HK$1,965,000 (US$252,000)
compared to total non-operating income of HK$43,000 (US$6,000) in the fiscal
year ended December 31, 1996, representing a decrease of HK$2,008,000
(US$258,000) due to additional interest expenses incurred for bank loans.
PROVISION FOR INCOME TAXES. Provision for income taxes for the fiscal
year ended December 31, 1997 totaled HK$6,969,000 (US$895,000) as compared to
HK$8,398,000 (US$1,079,000) in the fiscal year ended December 31, 1996,
representing a decrease of 17%. The effective tax rate of operating income
remained at 26%.
NET INCOME. The Company's net income for the fiscal year ended December
31, 1997 totaled HK$14,756,000 (US$1,896,000) compared to HK$21,759,000
(US$2,795,000) for the fiscal year ended December 31, 1996, representing a
decrease of 32%. The decrease in the net income was mainly due to a substantial
portion of expansion overhead being recognized in the fiscal year ended December
31, 1997, however, the joining fee revenues derived in association with such
expansion were not fully recognized in the same time period in accordance with
the Company's accounting policy of recognizing such revenues over the expected
membership life of the new members.
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 "Short Term Bank Loans"; Note 7 "Long Term Bank Loans"; and Note 9
"Obligations under Finance Leases").
Cash and cash equivalent balances for the fiscal years ended December
31, 1999 and December 31,1998 were HK$2,896,000 (US$372,000) and HK$1,721,000
(US$221,000) respectively.
Net cash provided by operating activities were
HK$42,618,000(US$5,473,000), HK$47,075,000 (US$6,048,000), and HK$56,368
(US$7,242,000) for fiscal year 1999, fiscal year 1998, and fiscal year 1997
respectively. The Company's operating activities are historically financed by
cash flows from operations. Net cash used in investing activities were
HK$44,612,000 (US$5,731,000), HK$37,700,000 (US$4,843,000), and HK$62,869,000
(US$8,077,000) for fiscal year 1999, fiscal year 1998, and fiscal year 1997
respectively, primarily as a result of expenditures for property, plant and
equipment. Net cash provided (used) in financing activities, which mainly
include bank loan repayments, net of proceeds from new bank loans, were
HK$3,166,000(US407,000), HK$(9,593,000) (US$(1,232,000)), and HK$5,887
(US$756,000) for fiscal year 1999, fiscal year 1998, and fiscal year 1997
respectively.
The Company's long-term loans bear interest rates varying from 10% to
12% per annum. The total balance outstanding as of December 31, 1999 on such
loans was HK$7,438,000 (US$956,000). The last repayment on the loans is due in
2006. The Company also had various banking facilities available from financial
institutions amounting to approximately HK$27,200,000 (US$3,494,000). These
facilities were secured by certain leasehold property in Hong Kong owned by the
Company's subsidiary (Ever Growth Limited), fixed deposits owned by the
Company's subsidiaries (Physical Health Centre (TST) Limited and Physical Health
Centre (Tsuen Wan) Limited), relatives of Mr. Luk, related company and personal
guarantees from Mr. Luk and his relatives, respectively.
32
<PAGE>
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 December 31, 1999, was
HK$3,895,000 (US$500,000). The Company has never experienced any significant
problems with collection of accounts receivable from its customers.
Capital expenditures for fiscal years 1997, 1998 and 1999 were
HK$57,922,000 (US$7,441,000), HK$48,813,000 (US$6,271,000) and HK$51,010,000
(US$6,553,000), respectively. The Company believes that cash flow generated from
its operations and its existing credit facilities should be sufficient to
satisfy its working capital and capital expenditure requirements for at least
the next 12 months.
YEAR 2000 DISCLOSURE
The Year 2000 Issue is the result of computer programs being written
using two digits rather than four digits to define the applicable year. Computer
programs that have sensitive software may recognize a date using "00" as the
year 1900 rather than the year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar normal business activities. The Company has undergone 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 was July 1999. 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's maintenance
charges for the new system were as follows:
1998 HK$120,000 (US$15,400)
1999 HK$ 96,000 (US$12,300)
2000 and onwards HK$ 64,000 (US$8,200)
33
<PAGE>
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company required to be included in
Item 7 are set forth in the Financial Statements Index.
Independent Auditors' Report of William D. Lindberg.........................F-1
Independent Auditors' Report of Moores Rowland..............................F-3
Consolidated Balance Sheets as of December 31, 1998 and 1999................F-4
Consolidated Statements of Operations for the years ended December 31,
1997, 1998 and 1999.........................................................F-5
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1997, 1998 and 1999............................................F-6
Consolidated Statements of Cash Flows for the years ended December 31,
1997, 1998 and 1999.........................................................F-7
Notes to Consolidated Financial Statements..................................F-8
34
<PAGE>
WILLIAM D. LINDBERG
CERTIFIED PUBLIC ACCOUNTANT
1064 CLIPPER COURT
COSTA MESA, CA. 92627
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO PHYSICAL SPA & FITNESS INC.
I have audited the accompanying consolidated balance sheets of Physical Spa &
Fitness Inc. (a Delaware corporation) (the "Company") and its subsidiaries as of
December 31, 1997 and 1998, and the related consolidated statements of income,
cash flows and changes in shareholders' equity for the years ended December 31,
1996, 1997 and 1998 expressed in Hong Kong Dollars. These financial statements
are the responsibility of the Company's management. My responsibility is to
express an opinion on these financial statements based on my audit.
I conducted my audit in accordance with generally accepted auditing standards.
Those standards require that I plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
I believe that my audit provides a reasonable basis for my opinion.
In my opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Physical Spa &
Fitness Inc. and its subsidiaries as of December 31, 1997 and 1998, and the
results of their operations and their cash flows for the years ended December
31, 1996, 1997 and 1998 in conformity with generally accepted accounting
principles.
/S/ WILLIAM D. LINDBERG
Costa Mesa, California,
June 30, 1999
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
AUDITED FINANCIAL STATEMENTS
PHYSICAL SPA & FITNESS INC.
31 DECEMBER 1999
F-2
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
PHYSICAL SPA & FITNESS INC.
We have audited the accompanying consolidated balance sheets of Physical Spa &
Fitness Inc. (a Delaware Corporation) and subsidiaries as of December 31, 1999
and the related consolidated statements of operations, stockholders' equity and
cash flows for the year then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
We conducted our audit in accordance with United States generally accepted
auditing standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statements
presentation. We believe that our audit provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company and
subsidiaries as of December 31, 1999 and the results of their operations and
cash flows for the year then ended in conformity with generally accepted
accounting principles.
/S/ MOORES ROWLAND
CHARTERED ACCOUNTANTS
CERTIFIED PUBLIC ACCOUNTANTS
Hong Kong
Date: March 17, 2000
F-3
<PAGE>
<TABLE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
- ------------------------------------------------------------------------------------------------------------------------------------
(In thousands, except share and per share data)
<CAPTION>
AS OF DECEMBER 31
----------------------------------------------
1998 1999 1999
HK$ HK$ US$
ASSETS
<S> <C> <C> <C>
CURRENT ASSETS
Cash and cash equivalents 1,721 2,896 372
Trade receivables 7,364 3,895 500
Rental and utility deposits 9,829 11,654 1,497
Prepayments to vendors and suppliers and other current assets 5,232 7,727 993
Inventories 2,504 2,551 328
Due from related companies (Note 11(d)) 8,413 8,373 1,076
Due from a stockholder 4,404 4,110 528
-------------- -------------- --------------
TOTAL CURRENT ASSETS 39,467 41,206 5,294
-------------- -------------- --------------
Bank deposits, collateralized - 3,522 452
Prepayments for construction-in-progress 6,614 467 60
Property, plant and equipment, net (Note 5) 123,560 140,936 18,106
-------------- -------------- --------------
TOTAL ASSETS 169,641 186,131 23,912
============== ============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Short-term bank loans (Note 6) 6,232 8,606 1,105
Long-term bank loans - current portion (Note 7) 4,327 1,851 238
Accounts payable and accrued expenses 21,362 18,300 2,351
Obligations under finance leases - current portion (Note 9) 4,924 4,747 610
Deferred income - current portion 30,098 22,828 2,933
Deferred liabilities - current portion 2,015 2,304 296
Income taxes payable 4,066 5,991 770
Taxes other than income 8,952 3,182 409
-------------- -------------- --------------
TOTAL CURRENT LIABILITIES 81,976 67,809 8,712
-------------- -------------- --------------
Deferred income - non-current portion - 999 128
Deferred liabilities - non-current portion 2,873 5,533 710
Long-term bank loans - non-current portion (Note 7) 6,519 5,587 718
Loans from minority stockholders of subsidiaries 4,200 4,200 540
Obligations under finance leases - non-current portion (Note 9) 4,215 12,114 1,556
Deferred taxation 4,712 5,661 727
Minority interests 5,144 5,721 735
STOCKHOLDERS' EQUITY:
Common stock, par value US$0.001 each,
100 million shares of stock authorized;
10 million shares of stock issued and outstanding 78 78 10
Cumulative translation adjustments 116 119 15
Retained earnings 59,808 78,310 10,061
-------------- -------------- --------------
TOTAL STOCKHOLDERS' EQUITY 60,002 78,507 10,086
-------------- -------------- --------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY 169,641 186,131 23,912
============== ============== ==============
The financial statements should be read in conjunction with the accompanying notes.
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
F-4
<PAGE>
<TABLE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
- ------------------------------------------------------------------------------------------------------------------------------------
(In thousands, except share and per share data)
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------------------------------------------
1997 1998 1999 1999
HK$ HK$ HK$ US$
<S> <C> <C> <C> <C>
OPERATING REVENUES 148,954 210,209 253,172 32,525
-------------- -------------- -------------- --------------
OPERATING EXPENSES
Salaries and commissions (34,459) (56,415) (70,729) (9,086)
Rent and related expenses (36,222) (46,527) (63,931) (8,214)
Depreciation (18,274) (25,781) (33,187) (4,263)
Other selling and administrative expenses (34,849) (60,572) (57,520) (7,390)
-------------- -------------- -------------- --------------
Total operating expenses (123,804) (189,295) (225,367) (28,953)
-------------- -------------- -------------- --------------
INCOME FROM OPERATIONS 25,150 20,914 27,805 3,572
-------------- -------------- -------------- --------------
NON-OPERATING INCOME (EXPENSES)
Other income, net 2,186 645 452 58
Interest expenses (4,151) (3,933) (4,245) (545)
-------------- -------------- -------------- --------------
Total non-operating income (expenses) (1,965) (3,288) (3,793) (487)
-------------- -------------- -------------- --------------
INCOME BEFORE INCOME TAXES AND MINORITY INTERESTS 23,185 17,626 24,012 3,085
Provision for income taxes (Note 8) (6,969) 108 (4,933) (634)
-------------- -------------- -------------- --------------
INCOME BEFORE MINORITY INTERESTS 16,216 17,734 19,079 2,451
Minority interests (1,460) (1,198) (577) (74)
-------------- -------------- -------------- --------------
NET INCOME 14,756 16,536 18,502 2,377
Other comprehensive income (loss)
- - Foreign currency translation adjustments 59 (15) 3 1
-------------- -------------- -------------- --------------
COMPREHENSIVE INCOME 14,815 16,521 18,505 2,378
============== ============== ============== ==============
Earnings per share of common stock - Basic 1.48 1.65 1.85 0.24
============== ============== ============== ==============
Number of shares of stock outstanding
(in thousands) 10,000 10,000 10,000 10,000
============== ============== ============== ==============
The financial statements should be read in conjunction with the accompanying notes.
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
F-5
<PAGE>
<TABLE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
- ------------------------------------------------------------------------------------------------------------------------------------
(In thousands, except share and per share data)
<CAPTION>
CUMULATIVE
RETAINED TRANSLATION
COMMON STOCK EARNINGS ADJUSTMENTS TOTAL
------------------------------ -------------- -------------- --------------
NUMBER HK$ HK$ HK$ HK$
<S> <C> <C> <C> <C> <C>
Balance as of January 1, 1997 10,000,000 78 26,142 72 26,292
Prior year adjustments (Note 4) - - 2,374 - 2,374
-------------- -------------- -------------- -------------- --------------
Balance as of January 1, 1997
(Restated) 10,000,000 78 28,516 72 28,666
Net income - - 18,466 - 18,466
Prior year adjustments (Note 4) - - (3,710) - (3,710)
Translation adjustment - - - 59 59
-------------- -------------- -------------- -------------- --------------
Balance as of December 31, 1997
(Restated) 10,000,000 78 43,272 131 43,481
Net income - - 17,342 - 17,342
Prior year adjustments (Note 4) - - (806) - (806)
Translation adjustment - - - (15) (15)
-------------- -------------- -------------- -------------- --------------
Balance as of December 31, 1998
(Restated) 10,000,000 78 59,808 116 60,002
Net income - - 18,502 - 18,502
Translation adjustment - - - 3 3
-------------- -------------- -------------- -------------- --------------
Balance as of December 31, 1999 10,000,000 78 78,310 119 78,507
============== ============== ============== ============== ==============
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
F-6
<PAGE>
<TABLE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
- ------------------------------------------------------------------------------------------------------------------------------------
(In thousands, except share and per share data)
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------------------------------------------
1997 1998 1999 1999
HK$ HK$ HK$ US$
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income 14,756 16,536 18,502 2,377
Adjustments to reconcile net income to net cash
provided by operating activities:
Minority interests 1,460 1,198 577 74
Depreciation 18,274 25,781 33,187 4,263
Loss on disposal of property, plant and equipment 124 592 196 25
Changes in working capital:
Trade receivables 5,247 2,209 3,469 445
Deposits, prepayments and other current assets (1,526) 3,008 (4,320) (555)
Inventories 2,434 1,518 (47) (6)
Due form related companies (2,946) (3,481) 40 5
Due from a stockholder - - 294 38
Accounts payable and accrued expenses (80) 13,125 (3,062) (394)
Deferred income 15,654 (7,598) (6,271) (806)
Deferred liabilities 4,082 806 2,949 379
Income taxes payable (4,857) (5,829) 1,925 247
Taxes other than income 623 (928) (5,770) (741)
Deferred taxation 3,123 138 949 122
-------------- -------------- -------------- --------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 56,368 47,075 42,618 5,473
-------------- -------------- -------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Prepayments for construction-in-progress (5,000) 10,397 6,147 790
Acquisition of property, plant and equipment (57,922) (48,813) (51,010) (6,553)
Sales proceeds from disposal of property, plant
and equipment 53 716 251 32
-------------- -------------- -------------- --------------
NET CASH USED IN INVESTING ACTIVITIES (62,869) (37,700) (44,612) (5,731)
-------------- -------------- -------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in bank deposits - - (3,522) (452)
(Settlement) Proceeds of short-term bank loans (31) 636 2,374 305
Decrease (Increase) in due from a stockholder 5,676 6,371 - -
Proceeds form long-term bank loans 14,500 4,000 1,000 128
Repayment of long-term bank loans (3,512) (6,208) (4,408) (566)
Proceeds form (Settlement of) long-term loans from
third parties (4,175) (9,741) - -
Assumption of finance lease obligations - 847 14,753 1,895
Capital element of finance lease rental payments (6,571) (4,538) (7,031) (903)
Repayment of loans from minority shareholders of
subsidiaries - (960) - -
-------------- -------------- -------------- --------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 5,887 (9,593) 3,166 407
-------------- -------------- -------------- --------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (614) (218) 1,172 149
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 2,509 1,954 1,721 222
CUMULATIVE TRANSLATION ADJUSTMENTS 59 (15) 3 1
-------------- -------------- -------------- --------------
CASH AND CASH EQUIVALENTS AT END OF YEAR 1,954 1,721 2,896 372
============== ============== ============== ==============
The financial statements should be read in conjunction with the accompanying notes.
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
F-7
<PAGE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
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 stocks with par
value of US$0.001 each. The Company is a U.S. public company listed on
the National Association of Securities Dealers Over-the-Counter
Bulletin Board.
Physical Beauty & Fitness Holdings Limited ("Physical Holdings") was
incorporated on March 8, 1996 under the laws of the British Virgin
Islands ("BVI") with a capital of one common stock being held by a
stockholder ("the Stockholder"). Physical Holdings has interests in
various companies ("Operating Subsidiaries") operating fitness and
beauty centres ("Fitness Centres") and other related businesses in Hong
Kong ("HK") and the People's Republic of China ("PRC").
Pursuant to a Share Exchange Agreement entered into between the Company
and Physical Holdings on August 8, 1996, the Stockholder transferred
his controlling interest in the outstanding stock of Physical Holdings
in exchange for 80% of the outstanding common stocks 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 stockholders of the Company
also transferred 990,000 common shares to Goodchild Investments Limited
("Goodchild"). Accordingly, the Stockholder and Goodchild became the
major shareholders of the Company. In February, 1998, Goodchild sold
all its common shares of the Company in a private transaction to a
Japanese institutional investor.
On November 27, 1996, the Company changed its name to Physical Spa &
Fitness Inc.
The transfer of the Stockholder'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
Stockholder whichever is later.
The details of Physical Holdings and the Operating Subsidiaries and
their principal activities as of the date of this report are summarized
below:
<TABLE>
<CAPTION>
DATE OF EQUITY INTEREST
ACQUISITION / PLACE OF OWNED BY THE PRINCIPAL
NAME OF COMPANY FORMATION INCORPORATION COMPANY ACTIVITIES
Direct Indirect
------ --------
<S> <C> <C> <C> <C> <C>
Physical Holdings March 8, 1996 BVI 100% - Investment
holding
Ever Growth Limited ("Ever September 29, 1994 HK - 100% Property holding
Growth")
Global Resources Limited December 1, 1998 HK - 100% Inactive
Jade Regal Holdings March 15, 1996 BVI - 100% Investment
Limited holding
Mighty System Limited December 15, 1994 BVI - 100% Provision of
marketing
services for
cosmetics sales
</TABLE>
- --------------------------------------------------------------------------------
F-8
<PAGE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
1. ORGANIZATION AND PRINCIPAL ACTIVITIES (CONTINUED)
<TABLE>
<CAPTION>
DATE OF EQUITY INTEREST
ACQUISITION / PLACE OF OWNED BY THE PRINCIPAL
NAME OF COMPANY FORMATION INCORPORATION COMPANY ACTIVITIES
Direct Indirect
------ --------
<S> <C> <C> <C> <C> <C>
Physical Health Centre March 15, 1996 HK - 100% Investment
(Dalian) Limited holding
("Physical Dalian")
Physical Health Centre March 21, 1997 HK - 100% Investment
(Macau) Limited holding
Physical Health Centre April 15, 1996 HK - 100% Investment
(Shenzhen) Limited holding
("Physical Shenzhen")
Physical Health Centre November 18, HK - 100% Operating a
(TST) Limited ("Physical 1998 Fitness Centre
TST") in Hong Kong
Physical Health Centre September 8, HK - 100% Operating a
(Tsuen Wan) Limited 1997 Fitness Centre
("Physical Tsuen Wan") in Hong Kong
Physical Health Centre September 29, HK - 100% Will operate a
(Tuen Mun) Limited 1994 Fitness Centre
("Physical Tuen Mun") in Hong Kong
(formerly known as
Physical Health Centre
(Zhong Shan) Limited)
Physical Health Centre March 2, 1990 HK - 91.4% Operating 5
Hong Kong Limited Fitness Centres
in Hong Kong
Proline Holdings Limited September 28, BVI - 92.5% Investment
1994 holding
Regent Town Holdings September 20, BVI - 92.5% Investment
Limited ("Regent Town") 1993 holding
Shanghai Physical Ladies' September 28, HK - 92.5% Investment
Club Company Limited 1994 holding
("Physical Shanghai")
Star Perfection Holdings April 15, 1996 BVI - 100% Investment
Limited holding
Supreme Resources Limited September 29, HK - 70% Operating a
1994 beauty treatment
centre in Hong
Kong
</TABLE>
- --------------------------------------------------------------------------------
F-9
<PAGE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
1. ORGANIZATION AND PRINCIPAL ACTIVITIES (CONTINUED)
The Group also operates Fitness Centres in the PRC through some of its
Operating Subsidiaries which are Sino-foreign joint ventures ("JV")
established in the PRC. In the opinion of the directors, the Group is
able to govern and control the financial and operating policies and the
board of directors of the JV. Therefore, the JV have been accounted for
as subsidiaries. Detailed information in connection with these JV is as
follows:
a) Shanghai Physical Ladies' Club Co., Ltd., a Sino-foreign
co-operative JV ("the Shanghai JV"), was established on
September 7, 1993 in Shanghai, the PRC. The original total
investment and registered capital of the Shanghai JV was US$1
million each and was increased to US$2 million each in 1995.
The capital contributions were to be made in cash. The JV
period is for 10 years starting from the date of the business
licence issued on September 7, 1993.
According to the provisions of the JV contract, Physical
Shanghai contributed 100% of the registered capital of the JV
while the Chinese JV partner provided the premises in which the
Fitness Centres are located. Upon dissolution of the JV, all
the property, plant and equipment ("PPE") of Shanghai JV will
be taken over by the Chinese JV partner while the Group will
assume all the working capital, debts and outstanding
obligations and commitments.
For the first three years of the Shanghai JV, the Chinese JV
partner will be entitled only to a rent of RMB950,000 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 JV partner has no further entitlement to the
profits of the Shanghai JV.
b) Dalian Physical Ladies' Club Co., Ltd. is a Sino-foreign equity
JV ("the Dalian JV") established on April 11, 1995 in Dalian,
the PRC. The total registered capital of the Dalian JV was
Reminbi (RMB) 10 million. The JV period is 12 years from the
date of issue of the business license on April 11, 1995.
Physical Dalian held a 90% equity interest in the Dalian JV and
the profits or losses of the Dalian JV are to be shared by the
venturers in proportion to their equity interests in the JV.
Physical Dalian contributed its share of the registered capital
in the form of PPE and renovation materials and the Chinese
venturer contributed in cash. Both venturers had fulfilled
their respective capital contributions as of December 31, 1996.
The JV commenced operation in 1996.
c) Under the JV contract between Physical Shenzhen and a Chinese
enterprise, Physical Shenzhen is required to contribute
HK$4,140,000 in the form of cash and PPE as capital into
Shenzhen Physical Ladies' Club Co. Ltd. within six months from
the issuance of the business licence.
As of the date of this report, both JV 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 JV 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 JV's business license.
According to the directors, the Group is negotiating with the
Chinese enterprise to terminate the JV contract and the default
remedies are unlikely to be imposed on the Group.
- --------------------------------------------------------------------------------
F-10
<PAGE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
1. ORGANIZATION AND PRINCIPAL ACTIVITIES (CONTINUED)
d) Under the JV contract between Physical Health Centre (Zhong
Shan) Limited (former name of Physical Tuen Mun) and a Chinese
enterprise, Physical Zhongshan is required to contribute
US$500,000 in the form of cash and PPE as capital into the JV
within six months from the issuance of the business licence.
As of the date of this report, both JV 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 JV 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 JV's business license.
According to the directors, the Group is negotiating with the
Chinese enterprise to terminate the joint venture contract and
the default remedies are unlikely to be imposed on the Group.
2. BASIS OF PRESENTATION
The financial statements are presented in Hong Kong dollars and have
been prepared in accordance with generally accepted accounting
principles in the United States of America. This basis of accounting
differs from that used in the statutory financial statements of the BVI
and Hong Kong Operating Subsidiaries and the PRC JV, which were
prepared in accordance with generally accepted accounting principles in
Hong Kong and the accounting principles and the relevant financial
regulations applicable to enterprises with foreign investments as
established by the Ministry of Finance of China respectively.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the financial
information of the Company, its majority-owned and controlled
subsidiaries and joint ventures. All material intercompany
balances and transactions have been eliminated on
consolidation.
b) CONTRACTUAL JOINT VENTURE
A contractual JV is an entity established between the Group
and one or more other parties with the rights and obligations
of the JV partners governed by a contract. In case the Group
owns more than 50% of the JV and is able to govern and control
its financial and operating policies and its board of
directors, such JV is considered as a de facto subsidiary and
is accounted for as a subsidiary.
c) STATEMENT OF CASH FLOWS
For the purposes of the statement of cash flows, the Company
considers all highly liquid debt instruments with an original
maturity within three months to be cash equivalents.
- --------------------------------------------------------------------------------
F-11
<PAGE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
d) INVENTORIES
Inventories are stated at the lower of cost and net realizable
value. Cost, which comprises all costs of purchase and, where
applicable, costs of conversion and other costs that have been
incurred in bringing the inventories to their present location
and condition, is calculated using the first-in, first-out
method. Net realizable value represents the estimated selling
price in the ordinary course of business less the estimated
costs of completion and the estimated costs necessary to make
the sale. Inventories consisted of the following:
AS OF DECEMBER 31
---------------------------------
1998 1999 1999
HK$ HK$ US$
Raw materials 1,402 1,907 245
Finished goods 1,102 644 83
-------- --------- --------
2,504 2,551 328
======== ========= ========
e) PROPERTY, PLANT AND EQUIPMENT AND DEPRECIATION
PPE is stated at cost less accumulated depreciation. The cost
of an asset consists of its purchase price and any directly
attributable costs of bringing the asset to its present
working condition and location for its intended use.
Expenditure incurred after the assets have been put into
operation, such as repairs and maintenance, is charged to the
statement of operations in the period in which it is incurred.
In situations where it can be clearly demonstrated that the
expenditure has resulted in an increase in the future economic
benefits expected to be obtained from the use of the assets,
the expenditure is capitalized.
When assets are sold or retired, their costs or valuation and
accumulated depreciation are removed from the accounts and any
gain or loss resulting from their disposal is included in the
statement of operations.
When assets are transferred between PPE and other classes of
assets, the cost of such an asset on transfer is deemed to be
the carrying amount of the asset as stated under its original
classification. Any previous revaluation reserve on the asset
is frozen upon the transfer until the retirement or disposal
of the asset. On the retirement or disposal of the asset, the
frozen revaluation reserve is transferred directly to retained
earnings.
Depreciation is calculated to write off the cost of PPE over
their estimated useful lives from the date on which they
become fully operational using the straight line method at the
following annual rates:
Leasehold land held under
long-term lease Over the lease term
Buildings 20 to 50 years
Leasehold improvements Over the lease term
Machinery and equipment 5 to 10 years
Furniture and fixtures 5 years
Computers 4 to 5 years
Motor vehicles 4 to 5 years
The Group recognizes an impairment loss on PPE when evidence,
such as the sum of expected future cash flows (undiscounted
and without interest charges), indicates that future
operations will not produce sufficient revenue to cover the
related future costs, including depreciation, and when the
carrying amount of asset cannot be realized through sale.
Measurement of the impairment loss is based on the fair value
of the assets.
- --------------------------------------------------------------------------------
F-12
<PAGE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
f) REVENUE RECOGNITION
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. The non-refundable admission fee is
recognized as revenue on a pro-rata basis over the estimated
membership term whereas the monthly dues, service income and
other related income are recognized as revenue when services
are rendered.
g) DEFERRED INCOME
Deferred income represents unamortized non-refundable
admission fees, membership fees, and service fees billed but
for which the related services, or portion of the services
have not yet been rendered.
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.
PPE 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.
Depreciation is provided on the cost of the assets on a
straight line basis over their estimated useful lives as set
out in note 3(e) above. Finance charges implicit in the
purchase payments are charged to the statement of operations
over the periods of the contracts so as to produce an
approximately constant periodic rate of charge on the
remaining balances of the obligations for each accounting
period.
i) OPERATING LEASES
Leases where substantially all the rewards and risks of
ownership of assets remain with the leasing company are
accounted for as operating leases. Rentals payable under
operating leases are recorded in the statement of operations
on a straight-line basis over the lease term.
j) DEFERRED LIABILITIES
Deferred liabilities represent the benefit arose from the
rent-free period of the operating leases. The deferred
liabilities are amortized within the lease term, and the
amortization is recorded in the statement of operations.
k) INCOME TAXES
No provision for withholding or U.S. federal income taxes or
tax benefits on the undistributed earnings and / or losses of
the Company and its Operating Subsidiaries has been provided
as the earnings of the Operating Subsidiaries, in the opinion
of the management, will be reinvested indefinitely.
Provision for income and other related taxes have been
provided in accordance with the tax rates and laws in effect
in the various countries of operations.
- --------------------------------------------------------------------------------
F-13
<PAGE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
k) INCOME TAXES (CONTINUED)
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.
l) FOREIGN CURRENCY TRANSLATION
The Company and its subsidiaries maintain their accounting
books and records in Hong Kong Dollars ("HK$"), except for the
PRC JV which maintain their accounting books and records in
RMB. Foreign currency transactions during the year are
translated to HK$ at the approximate rates of exchange on the
dates of transactions. Monetary assets and liabilities
denominated in foreign currencies at year end and translated
at the approximate rates of exchange ruling 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 statements of operations.
On consolidation, the financial statements of the PRC JV are
translated into HK$ using the closing rate method, whereby the
balance sheet items are translated into HK$ using the unified
exchange rates at the respective balance sheet dates. The
share capital and retained earnings are translated at
historical unified exchange rates prevailing at the time of
the transactions while income and expenses items are
translated at the average unified exchange rate for the year.
All exchange differences arising on the consolidation are
recorded within equity. Historically, foreign exchange
transactions have not been material to the financial
statements.
For the purpose of these financial statements, the exchange
rate adopted for the presentations of financial information as
of and for the year ended December 31, 1999 has been made at
HK$7.784 to US$1.00. No representation is made that the HK$
amount could have been, or could be, converted into United
States Dollars at that rate on December 31, 1999 or at any
other rates.
m) RELATED PARTIES
Parties are considered to be related if one party has the
ability, directly or indirectly, to control the other party,
or exercise significant influence over the other party in
making financial and operating decisions. Parties are also
considered to be related if they are subject to common control
or common significant influence.
- --------------------------------------------------------------------------------
F-14
<PAGE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
n) EARNINGS PER SHARE
Earnings per share is based on net income attributable to
stockholders and the weighted average number of common shares
of stock outstanding during the year.
Diluted earnings per share is not shown because the impact of
any dilution is not material.
o) USES OF ESTIMATES
The preparation of the Company's financial statements in
conformity with generally accepted accounting principles
requires the Company's management to make estimates and
assumptions that affect the amounts reported in these
financial statements and accompanying notes. Actual amounts
could differ from those estimates.
p) ACCOUNTING PRONOUNCEMENTS
COMPREHENSIVE INCOME
As of January 1, 1999, the Group adopted issued Statement of
Financial Accounting Standards ("SFAS") No. 130 ("Reporting
comprehensive income"). The adoption of this statement had no
impact on the Group's net income or stockholders' equity. SFAS
No. 130 establishes new rules for the reporting and display of
comprehensive income and its components. Comprehensive income
is comprised of net income and all changes to stockholders'
equity, except those due to investments by owners (changes in
paid-in capital) and distributions to owners (dividends).
SFAS No. 130 requires foreign currency translation adjustments
which, prior to adoption, were reported separately in
stockholders' equity, to be included in other comprehensive
income. Amounts for all periods have been presented and, where
appropriate, reclassified to conform to SFAS No. 130
requirements.
SEGMENT INFORMATION
On January 1, 1999, the Group adopted SFAS No. 131,
"Disclosures about segments of an enterprise and related
information", which supersedes SFAS No. 14, "Financial
reporting segments of a business enterprise", and establishes
standards for the way that public enterprises report
information about operating segments in financial statements.
It also establishes standards for disclosures regarding
products and services, geographic areas and major customers.
SFAS No. 131 defines operating segments as components of an
enterprise about which separate financial information is
available that is evaluated regularly by the chief operating
decision maker in deciding how to allocate resources and in
assessing performance.
COSTS OF START-UP ACTIVITIES
As of January 1, 1999, the Group adopted Statement of Position
("SOP") 98-5, "Reporting on the costs of start-up activities",
which requires costs of start-up activities to be expensed as
incurred. This statement is effective for fiscal years
beginning after December 15, 1998. The statement requires
previously capitalized costs related to start-up activities to
be expensed as a cumulative effect of a change in accounting
principle when the statement is adopted. The adoption of this
new standard did not have a significant effect on the Group's
financial position or results of operations.
- --------------------------------------------------------------------------------
F-15
<PAGE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
p) ACCOUNTING PRONOUNCEMENTS (CONTINUED)
COSTS OF COMPUTER SOFTWARE
As of January 1, 1999, the Group adopted SOP 98-1, "Accounting
for the costs of computer software developed or obtained for
internal use", which establishes new accounting and reporting
standards for the costs of computer software developed or
obtained for internal use. This statement will be applied
prospectively and is effective for fiscal years beginning
after December 15, 1998. The impact of this new standard will
not have a significant effect on the Group's financial
position or results of operations.
NEW ACCOUNTING STANDARDS NOT YET ADOPTED
In February 1998, SFAS No. 132, "Employer's disclosures about
pensions and other postretirement benefits" amended the
disclosure requirements for pensions and other postretirement
benefits. The Group does not expect the adoption to have
significant change on the Group's financial statement
disclosures.
In June 1999, the Financial Accounting Standards Board issued
SFAS No. 137, "Accounting for derivative instruments and
hedging activities" which delayed the effective date of SFAS
No. 133 "Accounting for derivative instruments and hedging
activities" for one year. SFAS No. 133 provides guidance for
the recognition and measurement of derivatives and hedging
activities. It requires an entity to record, at fair value,
all derivatives as either assets or liabilities in the balance
sheet, and it establishes specific accounting rules for
certain types of hedges. SFAS No. 133 is now effective for
fiscal years beginning after June 15, 2000 and will be adopted
by the Group when required, if not earlier. The impact, if
any, of adopting SFAS No. 133 on the Group's consolidated
financial position, results of operations and cash flows, has
not been finalized.
In December 1999, the Securities and Exchange Commission
issued Staff Accounting Bulletin ("SAB") 101, "Revenue
recognition in financial statements", which provides guidance
on applying generally accepted accounting principles for
recognizing revenue. SAB 101 is effective for fiscal years
beginning after December 15, 1999. The impact, if any, of
adopting SAB 101 on the Group's consolidated financial
position, results of operations and cash flows, has not been
determined.
- --------------------------------------------------------------------------------
F-16
<PAGE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
4. PRIOR YEAR ADJUSTMENTS
Prior year adjustments are analysed as follows:
<TABLE>
Prior
1996 1997 1998 1999
HK$ HK$ HK$ US$
<S> <C> <C> <C> <C>
Overstatement of profits shared by
minority interest in previous years (note a) 2,374 - - -
Understatement of rental expenses in
prior years (note b) - (4,508) (1,549) -
Overprovision of depreciation in prior years
(note c) - 426 798
Loss (profit) arising from prior year
adjustments shared by minority interest
(note d) - 372 (55) -
-------------- -------------- -------------- --------------
2,374 (3,710) (806) -
============== ============== ============== ==============
</TABLE>
a) The overstatement of profits shared by minority interest was
mainly attributable to the fact that minority interest have
not been updated/reversed when the Group increased its
shareholdings in Regent Town from 67% to 92.5% progressively
since 1995.
b) In prior years, the amount of benefit arose from the rent-free
period of the operating leases capitalised as deferred
liabilities was incorrect as a result of calculation error.
The respective amortization to the statement of operations was
also affected. The cumulative effect to the balance sheet date
is that both liabilities and retained earnings had been
understated and overstated by HK$6,057.
c) In prior years, the Group recognized certain benefit arose
from the rent-free period of the operating leases as leasehold
improvements and depreciated over the lease period.
Accordingly, both assets and retained earnings had been
overstated and understated by HK$1,224.
d) As a result of the restatement of the results in prior years
as mentioned in note b and c above, the profits/loss shared by
minority interest was decreased by HK$317.
Accordingly, the earnings per share of common stock for the years ended
December 31, 1997 and 1998 were revised from HK$1.85 and HK$1.73 to
HK$1.48 and HK$1.65.
- --------------------------------------------------------------------------------
F-17
<PAGE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
5. PROPERTY, PLANT AND EQUIPMENT
<TABLE>
<CAPTION>
AS OF DECEMBER 31
----------------------------------------------
1998 1999 1999
HK$ HK$ US$
<S> <C> <C> <C>
Land and buildings 3,140 3,140 403
Leasehold improvements 70,941 89,010 11,435
Machinery and equipment 79,749 100,819 12,952
Furniture and fixtures 21,085 29,024 3,729
Computers 3,146 3,235 416
Motor vehicles 2,227 3,339 429
Less: Accumulated depreciation (56,728) (87,631) (11,258)
-------------- -------------- --------------
Net book value 123,560 140,936 18,106
============== ============== ==============
</TABLE>
As of December 31, 1999, the cost and accumulated depreciation of PPE
held under finance leases amounted to approximately HK$35,609 (1998:
HK$22,225) and HK$11,793 (1998: HK$6,844) respectively.
6. SHORT-TERM BANK LOANS
The short-term bank loans are collateralized and repayable within one
year. Please refer to Note 7 for details of collateral for such
facilities.
Supplemental information with respect to the short-term bank loans was
as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------------------------------
1997 1998 1999
<S> <C> <C> <C>
Maximum amount outstanding during the years HK$7,081 HK$6,842 HK$8,452
Average amount outstanding during the years HK$4,755 HK$5,448 HK$6,432
Weighted average interest rate at the end of the years 11% 10% 11%
Weighted average interest rate during the years 10% 11% 11%
</TABLE>
- --------------------------------------------------------------------------------
F-18
<PAGE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
7. LONG-TERM BANK LOANS
The Group obtained various lines of credit under banking facilities
which aggregated HK$27,200 as of December 31, 1999 from creditworthy
commercial banks in HK to finance its operations. These loans were
collateralized by certain of the assets of the Group and its
stockholders. As of December 31, 1999, the loans consist of the
following:
PRINCIPAL INTEREST RATE MATURITY
HK$
924 HK$ prime + 3% Serially from 1999 to 2004
3,380 HK$ prime + 2.5% Serially from 1998 to 2006
2,478 HK$ prime + 1% Serially from 1997 to 2002
656 HK$ prime + 2% Serially from 1997 to 2002
----------
7,438
==========
The collateral of the loans include:
(i) leasehold property in Hong Kong owned by Ever Growth;
(ii) fixed deposits owned by Physical TST and Physical Tsuen Wan;
(iii) leasehold property in Hong Kong owned by relatives of the
principal stockholders;
(vi) leasehold property in Hong Kong owned by a related company; and
(v) personal guarantees from the principal stockholders and their
relatives.
- --------------------------------------------------------------------------------
F-19
<PAGE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
8. INCOME TAXES
Reconciliation to the expected statutory tax rate in Hong Kong of 16.0%
(1998: 16.1% AND 1997: 19.7%) is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------------------------------
1997 1998 1999
% % %
<S> <C> <C> <C>
Weighted average statutory rate 19.7 16.1 16.0
Tax effect of net operating losses 2.6 7.4 2.6
Effect of prior year adjustments 3.5 0.7 2.3
Overprovision for taxation 4.0 - -
Write back of overprovision for taxation in prior years - (25.5) -
Others 0.2 0.7 (0.4)
-------------- -------------- --------------
Effective rate 30.0 (0.6) 20.5
============== ============== ==============
</TABLE>
Income tax expense is comprised of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------------------------------------------
1997 1998 1999 1999
HK$ HK$ HK$ US$
<S> <C> <C> <C> <C>
Current taxes 3,846 (246) 3,984 512
Deferred taxes 3,123 138 949 122
-------------- -------------- -------------- --------------
Income tax expense 6,969 (108) 4,933 634
============== ============== ============== ==============
</TABLE>
The Group is subject to income taxes on an entity basis on income
arising in or derived from the tax jurisdiction in which it is
domiciled and operates.
The Hong Kong subsidiaries are subject to Hong Kong profits tax at a
rate of 16% (1998: 16% AND 1997: 16.5%).
Since those PRC JV have sustained losses for the PRC income tax
purpose, the Company has not recorded any PRC income tax expense. PRC
income tax in the future will be calculated at the applicable rates
relevant to the PRC JV which currently are 33%.
- --------------------------------------------------------------------------------
F-20
<PAGE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
9. OBLIGATIONS UNDER FINANCE LEASES
Physical HK leases fitness equipment and motor vehicles under several
finance leases. The scheduled future minimum lease payments was as
follows:
<TABLE>
<CAPTION>
AS OF DECEMBER 31
------------------------------
1998 1999
HK$ HK$
<S> <C> <C>
Payable during the following period:
Within one year 6,008 8,947
Over one year but not exceeding two years 2,364 8,244
Over two years but not exceeding three years 2,382 6,546
Over three years but not exceeding four years - 6,072
Over four years but not exceeding five years - 6,072
Thereafter - 1,046
-------------- --------------
Total minimum lease payments 10,754 36,927
Less: Amount representing interest 1,615 8,136
-------------- --------------
Present value of net minimum lease payments 9,139 28,791
============== ==============
</TABLE>
10. COMMITMENTS
<TABLE>
CAPITAL EXPENDITURE COMMITMENTS
<CAPTION>
AS OF DECEMBER 31
------------------------------
1998 1999
HK$ HK$
<S> <C> <C>
Contracted but not provided net of deposit paid in the
financial statements 122 6,608
============== ==============
</TABLE>
<TABLE>
COMMITMENTS UNDER OPERATING LEASES
The Group had outstanding commitments not provided for under
non-cancellable operating leases in respect of land and buildings, the
portion of these commitments which are payable in the following years
is as follows:
<CAPTION>
AS OF DECEMBER 31
------------------------------
1998 1999
HK$ HK$
<S> <C> <C>
Payable during the following period:
Within one year 47,429 54,504
Over one year but not exceeding two years 49,186 48,481
Over two years but not exceeding three years 40,938 49,582
Over three years but not exceeding four years 42,794 29,716
Over fours years but not exceeding five years 31,530 23,719
Thereafter 36,767 9,890
-------------- --------------
Total operating lease commitments 248,644 215,892
============== ==============
</TABLE>
- --------------------------------------------------------------------------------
F-21
<PAGE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
11. RELATED PARTY TRANSACTIONS
The Group had the following transactions with related companies:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------------------------------
1997 1998 1999
HK$ HK$ HK$
<S> <C> <C> <C>
Rental of a director's quarter 650 720 720
Purchase of beauty and fitness equipment - 1,881 444
Sales of beauty and fitness equipment 2,677 - -
Prepayments for equipment related to construction-in-progress 3,961 3,961 -
Management fee received 12 12 -
</TABLE>
a) Certain general and administrative expenses incurred by the
Group companies during the relevant years on behalf of the
related companies were reimbursed by the respective related
companies at cost.
b) The Principal Stockholder of the Group had beneficial
interests in all the aforementioned related companies or the
Stockholder of the related companies were related to the
Principal Stockholder.
c) The Group made certain advances to the Stockholder during the
years. The balance due to the Group at December 31, 1999 was
HK$4,110. Under an agreement with the Group, the Stockholder
has pledged 1,500,000 shares of the Company's stock as
collateral.
d) The Stockholder has undertaken to indemnify the Group against
losses arising from any non-recoverability of various amounts
due from related companies. Any such payments by the
Stockholder will be recorded as expenses by the Group with the
corresponding credit to the equity.
12. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------------------------------
1997 1998 1999
HK$ HK$ HK$
<S> <C> <C> <C>
Cash paid for:
Interest expense 4,151 3,933 4,245
Income taxes 8,862 5,230 2,059
</TABLE>
- --------------------------------------------------------------------------------
F-22
<PAGE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
13. OTHER SUPPLEMENTAL INFORMATION
The following items are included in the consolidated statements of
operations:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
----------------------------------------------
1997 1998 1999
HK$ HK$ HK$
<S> <C> <C> <C>
Foreign exchange (loss) gain (59) 36 8
Interest expense on:
Finance leases 1,265 1,325 2,346
Overdrafts and bank loans 1,528 1,984 1,846
Loans from third parties 1,358 624 -
Others - - 53
Interest income 1,498 12 53
Sales taxes 1,040 (492) 748
Rental expenses under operating leases 29,430 35,985 47,249
</TABLE>
14. DISTRIBUTION OF PROFIT
In the opinion of management, any undistributed earnings of Physical
Holdings and the Operating Subsidiaries will be reinvested
indefinitely.
15. STOCK OPTION PLAN
The Company has a Stock Option Plan which was adopted by the Company's
stockholders and its Board of Directors on April 23, 1997. Under the
Plan, the Company may issue incentive stock options, non-qualified
options, restricted stock grants, and stock appreciation rights to
selected directors, officers, advisors and employees of the Company. A
total of 500,000 shares of Common Stock of the Company are reserved for
issuance under the Plan. Stock options may be granted as non-qualified
or incentive options. Incentive stock options may not be granted at a
price less than the fair market value of the stock as of the date of
grant while non-qualified stock options may not be granted at a price
less than 85% of the fair market value of the stock as of the date of
grant. The plan will be administered by an Option Committee which is to
be composed of two or more disinterested directors of the Board of
Directors. The option can be exercised during a period of time fixed by
the Committee except that no option may be exercised more than ten
years after the date of grant of three years after death or disability,
whichever is later. As of the date of this report, no stock options
have been granted by the Company under the Plan.
- --------------------------------------------------------------------------------
F-23
<PAGE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
16. REPORT ON SEGMENT INFORMATION
The Group has operations in the following geographical area:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------------------------------------------
1997 1998 1999 1999
HK$ HK$ HK$ US$
<S> <C> <C> <C> <C>
Operating revenues
Sales to customers outside the Group
- Hong Kong 126,939 192,692 238,096 30,588
- PRC 22,015 17,517 15,076 1,937
-------------- -------------- -------------- --------------
148,954 210,209 253,172 32,525
============== ============== ============== ==============
Segment profit (loss)
- Hong Kong 16,765 21,315 25,851 3,321
- PRC 644 (858) (3,157) (405)
Interest expenses, net (2,653) (3,921) (4,192) (539)
-------------- -------------- -------------- --------------
Net income 14,756 16,536 18,502 2,377
============== ============== ============== ==============
AS OF DECEMBER 31
----------------------------------------------
1998 1999 1999
HK$ HK$ US$
Segment assets
- Hong Kong 127,551 154,482 19,846
- PRC 42,090 31,649 4,066
-------------- -------------- --------------
169,641 186,131 23,912
============== ============== ==============
</TABLE>
- --------------------------------------------------------------------------------
F-24
<PAGE>
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
16. REPORT ON SEGMENT INFORMATION (CONTINUED)
The Group operates in two major segments: the provision of physical
fitness and beauty treatments services.
Information regarding these segments is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
--------------------------------------------------------------
1997 1998 1999 1999
HK$ HK$ HK$ US$
<S> <C> <C> <C> <C>
Operating revenues
- Physical fitness 82,311 139,829 166,917 21,444
- Beauty treatments 66,496 70,317 86,225 11,077
- Other 147 63 30 4
-------------- -------------- -------------- --------------
148,954 210,209 253,172 32,525
============== ============== ============== ==============
Segment profit (loss)
- Physical fitness 11,156 12,824 14,832 1,905
- Beauty treatments 3,600 3,712 3,670 472
- Other - - - -
-------------- -------------- -------------- --------------
14,756 16,536 18,502 2,377
============== ============== ============== ==============
Depreciation
- Physical fitness 8,222 14,020 20,879 2,682
- Beauty treatments 10,052 11,761 12,308 1,581
-------------- -------------- -------------- --------------
18,274 25,781 33,187 4,263
============== ============== ============== ==============
AS OF DECEMBER 31
----------------------------------------------
1998 1999 1999
HK$ HK$ US$
Total assets
- Physical fitness 91,606 117,263 15,065
- Beauty treatments 78,035 68,868 8,847
-------------- -------------- --------------
169,641 186,131 23,912
============== ============== ==============
Capital expenditure
- Physical fitness 36,411 41,656 5,351
- Beauty treatments 12,402 9,354 1,202
-------------- -------------- --------------
48,813 51,010 6,553
============== ============== ==============
</TABLE>
- --------------------------------------------------------------------------------
F-25
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
The Board of Directors of the Registrant approved the engagement of
William D. Lindberg, CPA on June 2, 1999 to serve as the Registrant's
independent public auditor and to conduct the audit of the Company's financial
statements for the fiscal years ended 1996, 1997 and 1998. The decision to
change the certifying accountant was made by the Board of Directors of the
Registrant, and resulted from the fact that on November 3, 1998, Arthur Andersen
withdrew its previously issued audited reports for the years ended December 31,
1997 and December 31, 1996. The Registrant sent a termination letter to Arthur
Andersen dated November 3, 1998, and Arthur Andersen sent a resignation letter
to the Registrant dated as of the same date.
The audit reports provided by Arthur Andersen for the fiscal years
ended December 31, 1996 and 1997 did not contain any adverse opinion or
disclaimer of opinion nor was any report modified as to uncertainty, audit scope
or accounting principles. There were discussions between Arthur Andersen and the
Registrant with respect to the related party nature of certain transactions and
related disclosures undertaken by certain subsidiaries of the Registrant in the
fiscal year ended December 31, 1996. However, Arthur Andersen has never made any
recommendations to the Registrant as to what changes in the disclosure should be
made by the Registrant. Due to the fact that the relationship between Arthur
Andersen and the Registrant ceased as of November 3, 1998, the matter regarding
the related party transaction was never resolved to their satisfaction prior to
November 3, 1998.
Upon appointment of William D. Lindberg, CPA, the Registrant authorized
the former accountant, Arthur Andersen, to respond fully to the inquiries of the
successor accountant concerning the issue of the related party transaction with
respect to the fiscal year ended December 31, 1996.
Except as disclosed above, there have been no other past disagreements
between the Registrant and Arthur Andersen on any matter of accounting
principles or practices, financial statement disclosure or auditing, scope or
procedure for the fiscal years ended December 31, 1996, December 31, 1997 and
the interim period ended November 3, 1998.
The Board of Directors of the Registrant approved the engagement of
Moores Rowland, Certified Public Accounts as of February 24, 2000 to serve as
the Registrant's independent public auditor and to conduct the audit of the
Company's financial statements for the fiscal year ended 1999. The decision to
change the certifying accountant was made by the Board of Directors of the
Registrant.
The audit reports provided by William Lindberg, CPA for the fiscal
years ended December 31, 1996, 1997 and 1998 did not contain any adverse opinion
or disclaimer of opinion nor was any report modified as to uncertainty, audit
scope or accounting principles.
Upon appointment of Moores Rowland, Certified Public Accountants, the
Registrant authorized the former accountant, William Lindberg, CPA, to respond
fully to any inquiries of the successor accountant.
There have been no other past disagreements between the Registrant and
William Lindberg, CPA on any matter of accounting principles or practices,
financial statement disclosure or auditing, scope or procedure for the fiscal
years ended December 31, 1996, December 31, 1997, December 31, 1998.
35
<PAGE>
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
DIRECTORS AND EXECUTIVE OFFICERS
The officers and directors of the Company, their ages and present
positions held with the Company are as follows:
NAME AGE POSITIONS WITH THE COMPANY
Ngai Keung Luk (Serleo) 43 Chairman of the Board of Directors, Chief Executive
Officer
Jill Bodnar 34 President and Director
Robert Chui 43 Chief Financial Officer and Director
Darrie Lam 36 Executive Vice President, Secretary and Director
Yuk Wah Ho 44 Executive Vice President and Director
Yat Ming Lam 42 Director
Allan Wah Chung Li 42 Director
The following is a brief summary of the background of each director,
executive officer and key employees of the Company:
NGAI KEUNG LUK (SERLEO), CHIEF EXECUTIVE OFFICER, CHAIRMAN. Mr. Luk has
been the Chairman of the Board of Directors and Chief Executive Officer of the
Company since October, 1996. He is the founder of Physical Spa & Fitness and has
over twelve years' experience in the physical health service business. Mr. Luk
was previously employed as a trader on the floor of the Hong Kong gold exchange.
Mr. Luk is a controlling shareholder of the Company and owns beneficially
approximately 80% of the Company's Common Stock (see "Principal Shareholders").
JILL BODNAR, PRESIDENT, DIRECTOR. Ms. Bodnar has been the Company's
President since October, 1996. She received a Bachelor Degree in Exercise
Physiology from the University of Massachusetts, USA in 1987. Prior to joining
the Company in 1993, Ms. Bodnar worked as a fitness professional in Boston
facilities, and was recruited to Asia to open a Hong Kong sports complex in
1990. On completion of the project, Ms. Bodnar joined the Company to develop the
chain in China in 1993. Ms. Bodnar was honored by IDEA Association for Fitness
Professionals in 1995 for her achievements in the industry. Ms. Bodnar is fluent
in Mandarin.
ROBERT CHUI CHI YUN, CHIEF FINANCIAL OFFICER, DIRECTOR. Mr. Chui has
been Chief Financial Officer of the Company since October, 1996. Mr. Chui
graduated from Concordia University, Canada. He is a practicing Certified Public
Accountant in Hong Kong and a fellow member of the Chartered Association of
Certified Accountants (UK). Mr. Chui has twelve years of experience with the
international accounting firm, Ernst and Young. Mr. Chui is responsible for
corporate planning and financial control.
DARRIE LAM HAU YIN, EXECUTIVE VICE PRESIDENT, SECRETARY, DIRECTOR. Ms.
Lam has been a Vice-President and Secretary of the Company since October, 1996.
Ms. Lam is a member of the Hong Kong Society of Accountants and a fellow member
of the Chartered Association of Certified Accountants (UK). She joined the
Company in 1994 and before that she worked with a major Hong Kong listed
company, Wharf Group, as a Financial Analyst. Ms. Lam is responsible for the
Company secretarial affairs, finance and administration functions. Ms. Lam
received a MBA degree from the University of Manchester, U.K.
36
<PAGE>
YUK WAH HO, EXECUTIVE VICE PRESIDENT, DIRECTOR. Ms. Ho has over eighteen
years' experience in beauty and skin care and has attended various international
beauty workshops held in Europe. Ms. Ho holds many certificates in beauty
therapy, skin care, and cosmetic applications from France, England, Taiwan and
Hong Kong, including Rene Guinot, Germain de Cappucini, and Sothy's. Ms. Ho is
responsible for the business development and staff training of the Company's
beauty treatment business. Ms. Ho is the wife of Mr. Luk.
YAT MING LAM, DIRECTOR. Mr. Lam has been a Director of the Company since
August, 1997. In the past four years, Mr. Lam has been employed as a Sales
Manager with Fitness Concept Leisure Supplies Ltd., one of the leading fitness
equipment and product suppliers. Previously, Mr. Lam was employed as a trader
with the Hong Kong gold exchange.
ALLAN WAH CHUNG LI, DIRECTOR. Mr. Li has been a director of the Company
since June, 1998. Mr. Li is a solicitor qualified to practice law in Canada,
England and Hong Kong. For the last ten years, Mr. Li practiced law in
Vancouver, Toronto and Hong Kong and had also worked for the Listing Division of
the Stock Exchange of Hong Kong. Since 1994, Mr. Li has been with Lai Sun
Development Company Limited, a company listed on the Stock Exchange of Hong
Kong, where he is currently serving as a vice-president, and is involved in
hotels and corporate transactions. Mr. Li received B.Comm. and L.L.B degrees
from the University of British Columbia, Canada.
LAM WAI KEE, GENERAL MANAGER. Mr. Lam holds a Diploma in Business
Management awarded by the Hong Kong Management Association. Prior to joining the
Company in October 1997, Mr. Lam was the Director and General Manager of Fitness
Concept Leisure Supplies Ltd., one of the leading fitness equipment and product
suppliers. Mr. Lam is responsible for the Company's fitness operation in both
Hong Kong and China branches.
SIU LING CHENG, MARKETING MANAGER. Ms. Cheng holds a Bachelor Degree in
Marketing at the University of Southern Queens land, Australia. Ms. Cheng joined
the Company since 1992 as a marketing executive, and was promoted to marketing
manager the following year. Ms. Cheng is responsible for the Company's
promotional and marketing activities and public relations. Ms. Cheng also
coordinates and assists the marketing teams in China branches.
GILLIAN LOUISE HOLLOWAY, SENIOR FITNESS MANAGER. Ms. Holloway is a
member of the Association for Fitness Professionals. Ms. Holloway obtained the
qualifications of Certified Aerobics Instructor and Certified Personal Trainer
issued by the American Council on Exercise. Ms. Holloway joined the Company in
1991 and is responsible for the Company's fitness training services and
membership. Ms. Holloway received a Graduate Certificate in Recreation and
Sports Management issued by the Victoria University, Australia.
ITEM 10. EXECUTIVE COMPENSATION
The following table sets forth all compensation awarded to, earned by,
or paid for all services rendered to the Company during the fiscal year ended
December 31, 1998 ("Fiscal 1998"), the fiscal year ended, 1997 ("Fiscal 1997")
and the fiscal year ended December 31, 1996 ("Fiscal 1996") by those persons who
served as Chief Executive Officer and any Named Executive Officer who received
compensation in excess of $100,000 during such years.
37
<PAGE>
<TABLE>
SUMMARY COMPENSATION TABLE (US$)
<CAPTION>
Annual
Name and Principal Position Year Salary(1) Awards(2)
---- --------- ---------
Bonus(3) Other compensation(4)
-------- ---------------------
<S> <C> <C> <C> <C>
Ngai Keung Luk, CEO, Chairman 1999 385,000 - 92,000
1998 387,000 - 92,000
1997 166,000 - 84,000
Jill Bodnar, President, COO 1999 45,000 4,900
1998 75,000 3,900
1997 69,000 4,500
------------------------------------
</TABLE>
(1) No officers received or will receive any bonus or other annual compensation
other than salaries during fiscal year 1999, other than stated above. The
table does not include any amounts for personal benefits extended to
officers of the Company, such as the cost of automobiles, life insurance and
supplemental medical insurance, because the specific dollar amounts of such
personal benefits cannot be ascertained. Management believes that the value
of non-cash benefits and compensation distributed to executive officers of
the Company individually or as a group during fiscal year 1999 did not
exceed the lesser of US$50,000 or ten percent of such officers' individual
cash compensation or, with respect to the group, US$50,000 times the number
of persons in the group or ten percent of the group's aggregate cash
compensation.
(2) No officers received or will receive any long term incentive plan (LTIP)
payouts or other payouts during fiscal year 1999.
(3) Bonus awarded based on performance.
(4) Other compensation for Mr. Luk included an allowance for Mr. Luk's living
accommodations. The yearly allowance of HK$720,000 (US$92,000) for the
fiscal years 1999 and 1998,represents 50% of the fair market rent of the
property owned by a related company, Silver Policy Development Limited. The
remaining portion is shared by another related company, Williluck
International Limited. Mr. Luk and his wife are the shareholders and
directors of both Silver Policy Development Limited and Williluck
International Limited. The current market rent of the property, which is
exclusively used for residential purpose by Mr. Luk and his family, is
HK$120,000 (US$15,400) per month effective November, 1997. The Company and
Williluck International Limited each pay HK$60,000 (US$7,708) per month to
Silver Policy Development Limited. Yearly allowance to Mr. Luk is recorded
on the Company's books as HK$720,000 (US$92,000) in 1999. The money is paid
directly to Silver Policy Development Limited. Physical Health Centre Hong
Kong Limited is using the property as security to obtain a full line of
credit from the Kwangtung Provincial Bank. See also "Certain Transactions".
38
<PAGE>
COMPENSATION OF DIRECTORS
The Company reimburses each Director for reasonable expenses (such as
travel and out-of -pocket expenses) in attending meetings of the Board of
Directors. Directors are not separately compensated for their services as
Directors.
AUDIT COMMITTEE
The Board of Directors established an Audit Committee, composed of the
two outside directors and Robert Chui, Chief Financial Officer. The principal
functions of the Audit Committee will include making recommendations to the
Board regarding the selection of independent public accountants to audit
annually the books and records of the Company , reviewing the proposed scope of
each audit and reviewing the recommendations of the independent public
accountants as a result of their audit of the Company. The Audit Committee will
also periodically review the activities of the Company's accounting staff and
the adequacy of the Company's internal controls.
EMPLOYMENT AND RELATED AGREEMENTS
There are no employment agreements with the Company's key employees at
this time. The Company anticipates that such agreements will be entered into
after the Offering.
Limitation of Liability of Directors
- ------------------------------------
The laws of the State of Delaware and the Company's By-laws provide for
indemnification of the Company's directors for liabilities and expenses that
they may incur in such capacities. In general, directors and officers are
indemnified with respect to actions taken in good faith in a manner reasonably
believed to be in, or not opposed to, the best interests of the Company, and
with respect to any criminal action or proceeding, actions that the indemnitee
had no reasonable cause to believe were unlawful.
The Company has been advised that in the opinion of the Securities and
Exchange Commission, indemnification for liabilities arising under the
Securities Act is against public policy as expressed in the Securities Act and
is, therefore, unenforceable.
1997 STOCK OPTION PLAN
The Company has a Stock Option Plan which was adopted by the Company's
stockholders and its Board of Directors on April 23, 1997 as "1997 Stock Option
Plan" (the "Plan"). Under the Plan, the Company may issue incentive stock
options, non-qualified options, restricted stock grants, and stock appreciation
rights to selected directors, officers, advisors and employees of the Company.
Under the Plan, a total of 500,000 shares of Common Stock are reserved for
issuance. The Plan provides for appropriate adjustments in the number and kind
of shares subject to the Plan and to outstanding options in the event of a stock
split, stock dividend, or certain other types of recapitalization. Stock options
may be granted as non-qualified stock options or incentive stock options, but
incentive stock options may not be granted at a price less than 100% of the fair
market value of the stock as of the date of grant (110% as to any 10%
shareholder at the time of grant); non-qualified stock options may not be
granted at a price less than 85% of the fair market value of the stock as of the
date of grant. The Plan shall be administered by an Option Committee which is to
be composed of two or more members of the Board of Directors who are
disinterested directors. No persons have been named to the Option Committee as
of the date of this Report. Stock options may be exercised during a period of
time fixed by the Option Committee except that no stock option may be exercised
more than ten years after the date of grant or three years after death or
disability, whichever is later. As of the date hereof, no options have been
granted by the Company.
39
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of December 31, 1999, the stock
ownership of all persons known to own beneficially five percent or more of the
Company's Common Stock and all directors and officers of the Company,
individually and as a group. Each person has sole voting and investment power
over the shares indicated, except as noted. Unless otherwise indicated, the
address for each stockholder is 12/F - 15/F Lee Theatre Plaza, 99 Percival St.,
Causeway Bay, Hong Kong.
<TABLE>
<CAPTION>
NAME AND AMOUNT AND
ADDRESS OF BENEFICIAL NATURE
OWNER OF BENEFICIAL
- --------------------- OWNERSHIP (1) PERCENTAGE BENEFICIALLY OWNED(2)
------------- --------------------------------
<S> <C> <C>
DIRECTORS, OFFICERS AND 5% STOCKHOLDERS
NGAI KEUNG LUK (SERLEO)(3) 8,000,000 80.00%
JILL BODNAR, PRESIDENT 0 0.00%
YAT MING LAM, DIRECTOR 0 0.00%
ROBERT CHUI, CFO 0 0.00%
DARRIE LAM, VICE PRESIDENT 0 0.00%
YUK WAH HO, VICE PRESIDENT (4) 8,000,000 80.00%
ALLAN WAH CHUNG LI, DIRECTOR 0 0.00%
ALL OFFICERS AND DIRECTORS 8,000,000 80.00%
AS A GROUP (7 PERSONS)(3)
----------
</TABLE>
* Less than 1%
(1) Except as otherwise indicated, the Company believes that the beneficial
owners of Common Stock listed below, based on information furnished by such
owners, have sole investment and voting power with respect to such shares,
subject to community property laws where applicable. Beneficial ownership is
determined in accordance with the rules of the Securities and Exchange
Commission and generally includes voting or investment power with respect to
securities. Shares of Common Stock subject to options or warrants currently
exercisable, or exercisable within 60 days, are deemed outstanding for
purposes of computing the percentage of the person holding such options or
warrants, but are not deemed outstanding for purposes of computing the
percentage of any other person.
(2) Based upon 10,000,000 shares of Common Stock outstanding.
(3) Mr. Luk pledged 1,500,000 shares of Common Stock for the loans received the
Company under that certain Pledge Agreement dated September 30, 1997.
(4) Ms. Ho is the wife of Ngai Keung Luk (Serleo). Accordingly the number of
common stock owned by Mr. Luk and Ms. Luk overlap.
40
<PAGE>
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company made certain advances to Mr. Luk, the Company's Chief
Executive Officer and the Chairman of its Board of Directors, during the years.
The balance due to the Company and its subsidiaries at December 31, 1999 was
HK$4,110,000 (US$528,000). Under an agreement with the Company, Mr. Luk has
pledged 1,500,000 shares of the Company stock as collateral. See Note 11 to
Financial Statements.
In January 1997, the Company approved an advance to Mr. Luk in the
amount of HK$ 6 million (US$780,000), which loan was repaid in full by Mr. Luk
on April 22, 1997.
In October, 1996, the Company closed a transaction with Mr. Luk, a 100%
shareholder of Physical Beauty & Fitness Holdings Limited, a British Virgin
Islands corporation ("Physical Limited"), whereby the Company entered into a
Share Exchange Agreement with Mr. Luk, pursuant to which the Company issued
8,000,000 of its Common Stock to Mr. Luk in exchange for all of the outstanding
shares of Physical Limited (the "Closing"). As a part of the above transaction
certain shareholders of the Company transferred 990,000 shares of Common Stock
of the Company to Goodchild Investments Limited, a British Virgin Islands
corporation ("Goodchild"), whose beneficial owner is Wong Kui Tak Henry, as
consideration for Goodchild's beneficial owners' prior interest in Physical
Health Centre Hong Kong Limited, pursuant to an arrangement between Goodchild
and Mr. Luk. Neither Mr. Luk nor Goodchild were parties affiliated with the
Company prior to or at the time of the acquisition of Physical Limited. At the
Closing the then current management of the Company resigned and was replaced by
the current management of the Company.
In February, 1998, Goodchild sold all of its shares of common stock of
the Company in open market public transactions.
Mr. Luk receives a monthly allowance of HK$60,000 (US$7,708) for the
fiscal year 1999 for his living accommodations. Such allowance represents 50%
of the fair market rent of the property owned by a related company, Silver
Policy Development Limited ("Silver Policy"). Silver Policy is a limited company
incorporated in Hong Kong. Mr. Luk and Mrs. Luk respectively hold 0.01% and
99.99% shares in Silver Policy. They also act as directors of Silver Policy.
Since April 1994, Physical Health Centre Hong Kong Limited ("Hong Kong
Limited") has concluded a tenancy agreement with Silver Policy for the property
to be used exclusively for residential purpose by Mr. Luk and his family. In
April 1996, Silver Policy increased the rent from HK$90,000 (US$11,562) to
HK$106,000 (US$13,618) per month and further increased to HK$120,000 (US$15,416)
from November, 1997. Hong Kong Limited and Williluck International Limited
("Williluck") each paid HK$60,000 (US$7,708) per month for 1999 to Silver
Policy. The annual rent allowance costs as recorded by Physical totaled
HK$720,000 (US$92,497) in 1999. Pursuant to the lease agreement between Sliver
Policy and Hong Kong Limited, the premises for Mr. Luk and his family are rented
by Hong Kong Limited from Silver Policy for HK$120,000 (US$15,416) per month.
Hong Kong Limited then charges back a related company, Williluck, for a 50%
share of the rent. Mr. Luk is a director of Williluck. Hong Kong Limited is
using the property as security to obtain a full line of credit from the
Kwangtung Provincial Bank. See also "Management - Compensation".
The Company had the transactions with related companies as provided in
the Financial Statements, Note 5.
41
<PAGE>
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
---------
The following exhibits of the Company are included herein.
2. Plan of acquisition, reorganization, arrangement, liquidation or
succession
2.1 Share Exchange Agreement between Foreclosed Realty Exchange, Inc. and
Ngai Keung Luk, together with amendments*
3.1 Articles of Incorporation of Physical Spa & Fitness Inc., a Delaware
Corporation*
3.2 Certificate of Amendment of Articles of Incorporation changing the
number of directors*
3.3 Certificate of Amendment of Articles of Incorporation changing the
Company's name*
3.4 Certificate of Amendment of Articles of Incorporation changing the
authorized capital*
3.5 By-Laws of Physical Spa & Fitness Inc.*
3.6 Amended By-Laws of Physical Spa & Fitness Inc.
10.1 Lease Agreement by and between Lee Theatre Realty Limited and Physical
Health Centre Hong Kong Limited (Causeway Bay Center)*
10.2 Tenancy Agreement between Benefit Plus Company Limited and Physical
Health Centre Hong Kong Limited (Tsimshatsui Center) *
10.3 Lease Agreement between East Asia Property Agency Limited and Physical
Health Centre Hong Kong Limited (Kowloon Center)*
10.4 Lease Agreement between Broadway-Nassau Investments Limited and Ho Yuk
Wah (Mei Foo Center)*
10.5 New Town Tower, S.T.T.L.183 Confirmation of Tenancy (Shatin)*
10.6 Tenancy Agreement by and between Kamoton Investments Limited and
Supreme Resources Limited (Renaissance Beauty Centre)*
10.7 Repayment Agreement between the Company and Ngai Keung Luk*
10.8 Pledge Agreement between the Company and Ngai Keung Luk*
10.9 1997 Stock Option Plan and form of Stock Option Agreement*
16. Letter on changes in certifying accountant.
21. Subsidiaries of the Registrant*
23. Consent of Moores & Rowlands, Independent Auditors.
- ------------
* Filed with the Commission as exhibit to the Registration Statement or
amendments to the Registration Statement.
(b) Reports on Form 8-K
-------------------
Forms 8-K, Item 4. Change in Certifying Accountants.
42
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on March 31, 2000.
PHYSICAL SPA & FITNESS, INC.
By: /s/ Ngai Keung Luk
------------------------------------------
Ngai Keung Luk,
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
/s/ Ngai Keung Luk Chairman and Chief Executive Officer Date: 3/31/00
- ------------------------ (principal executive officer)
Ngai Keung Luk
/s/ Jill Bodnar President and Director Date: 3/31/00
- ------------------------ (principal executive officer)
Jill Bodnar
/s/ Robert Chui Chief Financial Officer and Director Date: 3/31/00
- ------------------------ (Principal accounting and financial
Robert Chui officer)
/s/ Darrie Lam Executive Vice President, Secretary Date: 3/31/00
- ------------------------ and Director
Darrie Lam
/s/ Yuk Wah Ho Executive Vice President and Director Date: 3/31/00
- ------------------------
Yuk Wah Ho
/s/ Yat Ming Lam Director Date: 3/31/00
- ------------------------
Yat Ming Lam
/s/ Allan Wah Chung Li Director Date: 3/31/00
- ------------------------
Allan Wah Chung Li
EXHIBIT 16
WILLIAM D. LINDBERG
CERTIFIED PUBLIC ACCOUNTANT
1064 CLIPPER COURT
COSTA MESA, CALIFORNIA 92627
TEL./FAX. (949) 548-6546
February 25, 2000
Securities and Exchange Commission
450 Fifth Street N.W.
Washington, D.C. 20549
USA
Dear Sirs:
I have read Item 4 of the Report on Form 8-K of Physical Spa &
Fitness, Inc. and I agree with statements contained therein as they relate to my
firm.
Very truly yours,
/s/ William Lindberg, CPA
EXHIBIT 21
Subsidiaries of the Registrant
* Physical Beauty & Fitness Holdings Limited
* Physical Health Centre Hong Kong, Ltd.
* Regent Town Holdings Ltd.
* Mighty System Ltd.
* Supreme Resources Ltd.
* Physical Health Centre (Tuen Mun) Ltd.
(formerly known as Physical Health Centre (Zhong Shan) Limited)
* Zhongshan Physical Ladies' Club, Ltd.
* Ever Growth Ltd.
* Proline Holdings Ltd.
* Shanghai Physical Ladies' Club Company Ltd.
* Shanghai Physical Ladies' Club Co., Ltd.
* Jade Regal Holdings Ltd.
* Physical Health Centre (Dalian) Ltd.
* Dalian Physical Ladies' Club Co. Ltd.
* Star Perfection Holdings Ltd.
* Physical Health Centre (Shenzhen) Ltd.
* Shenzhen Physical Ladies' Club Company Ltd.
* Physical Health Centre (Tsuen Wan) Limited
* Physical Health Centre (Macau) Limited
* Physical Health Centre (TST) Limited
* Global Resources Limited
EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
29 March 2000
The Board of Directors
Physical Spa & Fitness, Inc.
11/F Lee Theatre Plaza
99 Percival Street
Causeway Bay
Hong Kong
Dear Sirs
We consent to inclusion in Form 10-KSB for the fiscal year ended December
31, 1999 of our report dated March 17, 2000, relating to the consolidated
balance sheets of Physical Spa & Fitness, Inc. and subsidiaries as of December
31, 1999, and the related consolidated statements of operations, stockholders'
equity and cash flows for the year ended December 31, 1999.
Yours faithfully
/s/ Moores Rowland
Chartered Accountants
Certified Public Accountants
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