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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[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, 2001
[ ] 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 026573
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PHYSICAL SPA & FITNESS INC.
- --------------------------------------------------------------------------------
(Exact name of 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)
40/F., NatWest Tower, Times Square,
No. 1 Matheson Street, Causeway Bay
Hong Kong Not applicable
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 852 2917-0000
-------------
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 [X] NO [ ]
Indicate by check mark if there is no disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not contained herein, and will not 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: $50,269,000
The aggregate market value of the voting stock held by non-affiliates
of the registrant as of December 31, 2001 was $140,000 based upon the average of
the last available bid and asked price of the Common Stock of $0.07 as of
December, 2001.
The number of shares outstanding of the registrant's classes of common
stock as of December 31, 2001: Common Stock, $.001 Par Value, 10,000,000 shares
DOCUMENTS INCORPORATED BY REFERENCE: NONE
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. 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. 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 sixteen facilities:
twelve in Hong Kong and four in China (including one in Macau) under the name
"PHYSICAL", with the exception of 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 five wholly owned subsidiaries of the Company, Physical
Health Centre (Tsuen Wan) Limited, Physical Health Center (TST) Limited,
Physical Health Centre (Tuen Mun) Limited, Physical Health Centre (E House)
Limited (formerly known as Global Resources Limited), and Physical Beauty Centre
(Central) Limited respectively operates the Tsuen Wan Centre (opened in July,
1998), the Sheraton Hotel center (opened in July, 1999), the Tuen Mun Centre
(opened in July, 2000), the Elizabeth House Centre (opened in April, 2001), and
the Wing On Centre (opened in April, 2002). All of these companies are Hong Kong
corporations. Renaissance Beauty Centre is operated by Supreme Resources
Limited, which was previously a majority (70%) owned subsidiary of the Company
and became a wholly-owned subsidiary in 2000. Supreme Resources Limited is also
a Hong Kong corporation.
1
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 100% (increased
from 92.5% in 2000) 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".
The Company's facility in Macau is operated by a wholly-owned
subsidiary of the Company, Su Sec Pou Physical Health Centre (Macau) Limited,
which is a Macau corporation.
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 the fitness cards 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 Western
exercise equipment, including Life Fitness, Cybex, Flex and Precor. Spa and
beauty treatment services are provided to both customers and visitors, and
include skin care and facial treatments, massage, spa relaxation programs and
weight-management programs. The Company also sells at the facilities a variety
of exercise clothing and European beauty products. Based on the number of the
Company's customers, 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 80,000 customers.
The Company's strategy is to provide a one-stop fitness and beauty
center for its customers. With the exception of the Mei Foo and Elizabeth House
locations in Hong Kong and Xu Hui in Shanghai location, 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. Another center of similar size was opened in Hongqiao, Shanghai in
September 1995, through Shanghai Joint Venture. The Hongqiao outlet was
relocated to Xu Hui with enhanced facilities in early March, 2001. 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 trade name "Physical", 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 becoming keen as the fitness and spa industry has attained its growth stage
with increased new entrants from both domestic and global market. 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".
2
The Company's strategy for maintaining its strong presence in Hong Kong
is to continue to provide existing and new customers 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. In April, 2001, the Company opened a new center in Elizabeth House,
Causeway Bay, Hong Kong which is offering fitness services to both male and
female customers. In early April, 2002, the Company also opened a new beauty
center in Wing On Central Building, Central, Hong Kong which provides spa/beauty
services to both male and female customers. See "Business of the Company -
Properties".
The Company was incorporated on September 21, 1988 in the state of
Delaware under the name of "Foreclosed Realty Exchange, Inc", a development
stage company seeking acquisitions. Prior to acquisition of Physical Limited,
the Company had no revenue producing operations, but planned to enter into joint
ventures and/or acquisitions originally in the area of real estate to expand its
operations. In October, 1996, the Company closed a transaction with Ngai Keung
Luk (Serleo), a 100% shareholder of Physical Limited, whereby the Company
entered into a Share Exchange Agreement with Ngai Keung Luk (Serleo), pursuant
to which the Company issued 8,000,000 shares of its Common Stock to Ngai Keung
Luk (Serleo) in exchange for all of the outstanding shares of Physical Limited
(the "Closing"). Subsequently, the Company changed its name to "Physical Spa &
Fitness Inc." in November, 1996, to reflect the new business operations of the
Company. 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.
Since December 20, 2001, the Company has changed its executive and
administrative office in Hong Kong at:
40/F., NatWest Tower, Times Square,
No. 1 Matheson Street, Causeway Bay, HONG KONG
The telephone number of the Company in Hong Kong is (852) 2917-0000.
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., 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., Physical Health
Centre (Shanghai) Limited (formerly known as 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, Su Sec Pou Physical Health
Centre (Macau) Limited, Physical Health Centre (TST) Limited, Physical
Health Centre (E House) Limited (formerly known as Global Resources Limited),
Physical Beauty Centre (Central) Limited, Physical Health Centre (PM) Limited,
and Physical Health Centre (Kornhill) Limited.
See also "Business - Organization".
3
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 fitness 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, health drink bar and sells a range of European beauty products.
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 (since 1986) 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.
EQUITY INTEREST
DATE OF ACQUISITION / PLACE OF OWNED BY THE PRINCIPAL
NAME OF COMPANY FORMATION INCORPORATION COMPANY ACTIVITIES
Direct Indirect
------ --------
Physical Beauty and March 8, 1996 BVI 100% - Investment
Fitness Holdings holding
Limited ("Physical
Limited")
Ever Growth Limited September 29, 1994 HK - 100% Property
("Ever Growth") holding
Physical Health Centre December 1, 1998 HK - 100% Operate a
(E House) Limited fitness
(formerly known as center
Global Resources in
Limited) Hong Kong
Jade Regal Holdings March 15, 1996 BVI - 100% Investment
Limited ("Jade Regal") holding
Physical Beauty Centre September 14, 2001 HK - 100% Operating a
(Central) Limited** beauty
center
in
Hong Kong
4
Organization (Continued)
- ------------
EQUITY INTEREST
DATE OF ACQUISITION PLACE OF OWNED BY THE PRINCIPAL
NAME OF COMPANY / FORMATION INCORPORATION COMPANY ACTIVITIES
Direct Indirect
------ --------
Physical Health Centre March 15, 1996 HK - 100% Investment
(Dalian) Limited holding
("Dailan Physical")
Physical Health Centre December 31, 2001 HK - 100% Will operate a
(Kornhill) Limited** fitness and
beauty center in
Hong Kong
Physical Health Centre March 21, 1997 HK - 100% Investment
(Macau) Limited holding
Physical Health Centre May 30, 2001 HK - 100% Will operate a
(PM) Limited** fitness and
beauty center in
Hong Kong
Physical Health Centre April 15, 1996 HK - 100% Investment
(Shenzhen) Limied holding
("Shenzhen Physical")
Physical Health Centre November 18, 1998 HK - 100% Operating a
(TST) Limited fitness and
("Physical TST") beauty center in
Hong Kong
Physical Health Centre September 8, 1997 HK - 100% Operating a
(Tsuen Wan) Limited fitness and
("Physical Tsuen Wan") beauty center in
Hong Kong
Physical Health Centre September 29, 1994 HK - 100% Operating a
(Tuen Mun) Limited fitness
center in
Hong Kong
Physical Health Centre March 2, 1990 HK - 91.4% Operating 3
Hong Kong Limited fitness and
("Hong Kong Limited") beauty centers,
1 fitness center
and 2 beauty
centers in
Hong Kong
Proline Holdings Limited September 28, 1994 BVI - 100% Investment
("Proline") holding
Regent Town Holdings September 20, 1993 BVI - 100% Investment
Limited ("Regent") holding
Physical Health Centre September 28, 1994 HK - 100% Investment
(Shanghai) Limited holding
(formerly known as
Shanghai Physical Ladies'
Club Company Limited)
("Shanghai Physical")
Star Perfection Holdings April 15, 1996 BVI - 100% Investment
Limited ("Star holding
Perfection")
Supreme Resources Limited September 29, 1994 HK - 100% Operating a
("Supreme") beauty
center in
Hong Kong
Su Sec Pou Physical Health August 18, 1997 Macau - 100% Operating a
Centre (Macau), Limited fitness
center in
Macau
See also Notes to the Financial Statements
5
See also "Company" - Properties". The Company's organizational chart is set
forth below.
ORGANIZATION CHART OF PHYSICAL SPA & FITNESS INC.
--------------------------------------------------
Physical Spa & Fitness Inc.
US
|
|100%
|
Physical Beauty & Fitness
Holdings Limited
BVI
|
|
- ---|-----------|----------|----------|----------|----------|-----------|--------------|---------------|---------|----------|-------
|100%* |100%* |100% |100% |91.40% |100%* |100% |100%* |100%* |100%* |100%*
- ----------- ---------- ---------- ---------- ---------- ----------- ----------- ----------------- ---------- --------- -----------
Supreme Physical Regent Jade Physical Physical Star Physical Physical Ever Physical
Resources Health Town Regal Health Health Perfection Health Health Growth Health
Limited Centre Holdings Holdings Centre Centre Holdings Centre Centre Limited Centre
(E House) Limited Limited Hong Kong (Tsuen Wan) Limited (Tuen Mun) (TST) (Macau)
Limited Limited Limited Limited Limited Limited
HK HK BVI BVI HK HK BVI HK HK HK HK
- ----------- ---------- ---------- ---------- ---------- ----------- ----------- ----------------- ---------- --------- -----------
| | | | | | | | | | |
|100% |100% |100% |100%* |100% |100% |100%* 100%---|---95% |100% |100% |100%
Renaissance Causeway Proline Physical | Tsuen Wan Physical Tuen Mun| Zhongshan Tsim- Property Su Sec Pou
Beauty Bay Holdings Health | Health Centre Health | Joint shatsui in Physical
Center -E House Limited Centre | Centre | Venture -Sheraton Mei Foo Health
(Central (Dalian) | (Shenzhen) Centre
Branch Limited | Limited (Macau),
Operation) | Limited
HK HK BVI HK | HK HK HK HK Macau
- ----------- ---------- ---------- --------- | ----------- ----------- --------- ---------- ---------
| | | |
|100%* |90% | |90%
Physical | | |
Health | | |
Centre | | |
(Shanghai) | | |
Limited | | |
HK | Causeway Bay |
---------- | Tsimshatsui |
| | Shatin |
|100% | Mei Foo (Fitness) |
| | Mei Foo (Beauty) |
Shanghai Dalian Kowloon City Shenzhen
Joint Joint Joint
Venture Venture HK Venture
----------
*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.
** Physical Beauty Centre (Central) Limited, Physical Health Centre (Kornhill)
Limited and Physical Health Centre (PM) Limited are not shown in the above
chart.
6
OWNERSHIP STRUCTURES IN CHINA
The organizational structure of the Company's operations in China is set
forth below.
INTEREST TERM REGISTERED
TYPE OF OWNED BY OF THE CAPITAL
NAME OF THE JOINT THE JOINT (AMOUNT IN
JOINT VENTURE LOCATION VENTURE COMPANY VENTURE THOUSAND) PROFIT SHARING
ARRANGEMENT
- ----------------- ------------ ---------- ---------- -------- ---------------- ------------------------------------
Shanghai Huangpu Co-operative 100% 10 Originally None. Joint venturer receives
Physical and Xu Hui years US$1,000 in rent for locations and will
Ladies' Club (formerly cash and receive equipment when the
Joint known as increased to venture is dissolved.
Co., Ltd. Hongqiao), US$2,000 in
("Shanghai Shanghai cash in 1995
Joint Venture")
Dalian Physical Dalian Equity 90% 12 Originally Pro-rata to equity interests
Ladies' Club years Rmb10,000 in
Co., Ltd. cash and
("Dalian Joint changed to
Venture") Rmb1,000 in
cash and
Rmb9,000
in form of
fixed assets
and renovation
materials in
1996
Shenzhen Shenzhen Co-operative 90% 10 HK$4,600 in Pro-rata to equity interests
Physical years form of cash
Ladies' Club and fixed
Co. Ltd. assets
("Shenzhen
Joint
Venture")
Zhongshan Zhongshan Co-operative 95% 10 US$500 in form Pro-rata to equity interests
Physical years of cash and
Ladies' Club fixed assets
Co. Ltd.
("Zhongshan
Joint Venture")
See also Notes to the Financial Statements
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). Physical Health Centre (Shanghai) Limited (formerly
known as 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
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. Prior
to the date of this report, however, the Company has verbally agreed with the
Chinese enterprise to terminate the joint venture contract.
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. Prior to the date of this report,
however, the Company has verbally agreed with the Chinese partner to terminate
the joint venture contract.
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.
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.
8
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 since late `80S.
See also "Competition".
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 since
early `90S, 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 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.
In recent years, several fitness centers have entered into the market.
They are well-equipped with the latest brands of Western-styled exercise
machines and help enhance the popularity of the fitness industry.
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.
9
In mid-90'S, several Hong Kong and Japanese companies set up spa/beauty
centers of varieties of facilities. More and more internationally recognized
skin care lines have also 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 skin care products, 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 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. At the
Closing the then current management of the Company resigned and was replaced by
the current management of the Company. See "Management."
In 1986, the founder and principal shareholder of the Company, Ngai
Keung Luk (Serleo), set up the first fitness center under the trade name of
"Physical" 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 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 four
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.
10
HONG KONG
The first facility was opened in the Mei Foo Sun Chuen area of Hong Kong
to provide fitness training and spa treatment services at a price thought to be
affordable by its target middle-class customers. The Mei Foo center opens its
fitness facilities to both male and female customers while the spa/beauty
treatment service is solely provided to female patrons. It proved profitable and
within a year, more than 700 fitness customers and 1,000 clients for spa
treatments were enrolled. 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 separated from the
fitness facility for expansion purpose. The two facilities currently occupy an
aggregate floor area of 12,000 square feet.
The second fitness and spa center 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. (subsequently 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.
In March 1990, the business of the two centers 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. Since opening, the Causeway Bay Center
experienced an ongoing strong demand for its fitness and spa services, and the
Company relocated the center to the existing location of 30,000 sq. ft in June
1997.
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 was
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
customers 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
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.
From Mid-1998 to April, 2002, the Company opened five additional centers
in Hong Kong through its wholly owned subsidiaries, Physical Health Centre
(Tsuen Wan) Limited, Physical Health Centre (TST) Limited, Physical Health
Centre (Tuen Mun) Limited, Physical Health Centre (E House) Limited and Physical
Beauty Centre (Central) Limited respectively. These collectively make up a total
of twelve centers (where the fitness facility and spa facility in Mei Foo are
counted as two centers) in Hong Kong.
See also "Description of Property".
11
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 customers 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
March, 2001, the Hong Qiao Center was relocated to Metro City, Xu Hui District
which is one of the busiest shopping districts in Shanghai with enhanced
facilities of approximately 24,000 sq. ft. The Xu Hui Center was further
expanded to approximately 41,000 sq. ft. in February, 2002 to provide fitness
service to both female and male customers.
In April, 1996, the Company opened its third fitness/spa center in the
city of Dalian, China. Dalian, 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 customers and
nearly one thousand spa clients.
In October, 2000, the Company opened its first fitness center in Macau.
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.
See also "Description of Properties".
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.
12
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 customer
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.
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 centers in Tsuen Wan, Hong Kong (July, 1998), Sheraton Hotel,
Tsimatshui, Hong Kong (July, 1999), Tuen Mun, Hong Kong (July, 2000), Macau
(October, 2000), and Elizabeth House, Causeway Bay, Hong Kong (April, 2001). In
early April, 2002, the Company opened a new beauty center in Central, Hong Kong
and expanded its Tsuen Wan fitness center to locate male customers. The Company
also expects to establish two more centers which are respectively located in
Hong Kong and Shanghai, and additional 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 Company is the first entrant into the market and has
secured a more established position than its competitors in the opinion of the
Management.
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 system, allowing customers 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.
13
- - MAINTAINING A STRONG PRESENCE IN HONG KONG
The Company has well-established customer base and pre-dominant market
share 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. 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 customers 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 international workshops 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 also closely monitoring the market opportunities in other South East
Asian countries such as Taiwan, 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 experienced
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 customers. Since 1995, the Company has recruited fully
qualified and experienced aerobic instructors from Australia.
The Company believes, based on customer 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
customers as well as comfortable usage by present customers.
14
SPA SERVICES
Spa services are open to both customers and walk-in guests. However,
customers of the centers have priority for such service facilities. Over 80
types of spa treatments are offered including facial treatments, various skin
care treatments, spa relaxation programs, massage, and weight-management
programs.
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 fitness customers 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 treatments. These treatments 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 selected centers such as
leotards, shorts, T-shirts, training shoes, socks and training suits, including
Nike, Reebock and several U.S. and Australian brand products. The Company also
sells European skin care products manufactured in France and Spain by Guinot,
Sothys and Anubis, respectively. The fitness and beauty related products are
available in the centers to facilitate the needs of their customers.
SERVICES
The Company currently offers prospective customers a fitness 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 population in the 18 to 45 years old range.
15
Under the plans, new customers are charged a registration fee upon
admission and a monthly fee each month to maintain their privileges. The initial
registration fees are non-refundable and range from approximately HK$800
(US$103) to HK$1,500 (US$192), depending on the diversity of facilities and
services available at the enrolling center, the local competitive environment,
as well as the effects of seasonal price strategies. The Hong Kong centers from
times to times are launching promotion at a special fee of HK$500 (US$64). Each
customer will also be charged a monthly due of HK$299 (US$38) for the usage of
the fitness centers. In order to fully utilize the facilities, the Company
grants a special offer of admission fees to off-peak customers. Prepayment of
the monthly fee is encouraged by offering a discount for customers who prepay
for twelve or more months. Customers are also provided on a monthly basis 10
aerobic coupons on free-of-charge basis at Hong Kong locations. Any customer 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 customers, the Company
operates a network system where customers may use the facilities in any fitness
centers of the Company in Hong Kong 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 customers. Generally, they are open
from 7:00 a.m. to 11:00 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 the Customer Services Department as
well as each of the centers regularly invite comments from customers 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 customers 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", 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 and (ii) newspapers, magazines, leaflets,
light box, and other promotional activities, which were accounted for
approximately 10%, and 90%, respectively, of the Company's total advertising
expenses in 2001.
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 fitness training and beauty treatments to
prospective customers. The Company believes that these presentations are
enhanced by its well-equipped, attractive centers and its "value pricing"
programs. The Company also conducts a variety of marketing efforts. The
Company's executives and sales personnel attend trade shows and exhibitions, and
sponsor seminars and TV programs throughout Hong Kong and China. The Company has
introduced on-site aerobics shows, gymnasium instruction, and beauty
consultation in the course of these activities.
16
Since 1993, the Company has begun marketing, on a retail basis products
to its customers including apparel manufactured by leading U.S. and Australian
fitness apparel brands. These products are intended to add value to the services
and increase the Company's revenues. The Company's marketing focus also includes
corporate customers and clients from the reputable banks in Hong Kong. In
addition to its advertising, personal sales presentations and targeted marketing
efforts, the Company is increasingly utilizing in-door marketing programs. Open
days are organized to introduce the centers to prospective customers and
referral incentive programs involve current customers in the process of new
customer enrollments that effectively help foster customer loyalty.
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 one to two 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$12,000 (US$1,500) and beauty treatments are charged separately upon usage.
These facilities use expensive, name-brand equipment, luxurious decoration,
large areas of space averaging 30,000 sq ft, and offer a wide range of services
to attract customers. The primary club in this category is Phillip Wain with
three locations. There are certain upscale market establishments which provide
fitness services only, most are for both male and female, and are concentrated
in one area of Hong Kong. The joining fees range from HK$2,000 (US$260) to
HK$4,000 (US$510) with monthly membership fees ranging from HK$488 (US$63) to
HK$699 (US$90). These establishments range in size from 10,000 sq ft to 30,000
sq ft. Examples are California's Fitness with five outlets, New York Fitness
with one outlet, and Fitness First Health Clubs with three outlets. 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.
17
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 in the same category is Modern Beauty Salon with seventeen locations
of average size of approximately 20,000 sq. ft. A monthly subscription of HK$180
(US$23) is required to become a member of the above center for a continuous
period of one year. The operators of spa/beauty services only which are in
direct competition with the Company's beauty centers include Caesar Beauty
Centre, with three locations, Sau San Tong Healthy Trim Institute, with two
locations, Angel Face Beauty Creations (International) Ltd., with nine
locations, Marie France Bodyline, with six locations, Oasis Spa, with two
locations, and Royal Bodyperfect, with five 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. Representative of the
low-end market include Mid-City. Joining fee to these facilities vary from
HK$600 (US$77) to HK$2,000 (US$256), and monthly fees average approximately
HK$400 (US$51). 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.
18
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 investors such as Decleor
Health & Beauty Institute, in both Shanghai and Dalian. Services in these
facilities are more up to date and develop in fast pace to cater to the China
market.
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 Total Fitness Club and Megafit in Shanghai, and New Mart Fitness in
Dalian. These facilities usually offer aerobic, exercise, drinking bars and
occasionally beauty treatments.
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 expatriate 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
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 also opened in Dalian,
however, in the management's opinion, seldom 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. The closest
competitors in this market include Gold's Gym and Fitness First Health Club in
Shanghai, and Qiulin Fitness and Shaping in Dalian.
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" thereby
eliminating the prior practice of using a different trade names for each center.
The Company registered a servicemark under its trade name "Physical" 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" 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, 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
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 1,000 employees, including approximately
30 commission based sales executives. Approximately 550 employees are involved
in fitness operations, including sales personnel, instructors, and supervisory
personnel. Approximately 350 employees are involved in beauty and spa
operations. Approximately 100 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.
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 sales and purchase
contracts, allowing the customer 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
sales and purchase contracts and limitations on the term of contracts. In
addition, the Company is subject to several other types of regulations 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
Under typical regulations, customers of fitness centers have the right
to cancel any un-used services 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 customer 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 customer agreements provide that a customer's one-time registration
fee is non-refundable in case of cancellation.
The Consumer Council of Hong Kong protects the rights of consumers. The
customers 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 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 beauty
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 in Beijing, 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
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 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.
The Police Department has strict regulations in China regarding massage
services and requires 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 beauty 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 of 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
ITEM 2. PROPERTIES
The Company relocated its headquarters which include the Company's
executive and administrative offices to a new location of approximately 17,300
square feet in Causeway Bay, Hong Kong in December, 2001.
Aggregate rental expense was approximately HK$47.2 million (US$6.1
million), HK$56.5 million (US$7.2 million) and HK$70.4 million (US$9 million)
for the year ended December 31, 1999, 2000 and 2001, 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 and 2,000 sq. ft. in the neighborhood 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.
FITNESS/SPA CENTERS - HONG KONG AND CHINA
-----------------------------------------
HONG KONG Size Own / Lease Term Expiration Renewal Option Monthly Rent(1)(2)
---- ----------- --------------- -------------- ------------------
40/F, NatWest Tower, 17,300 sq. ft. Lease 10/15/2004 None HK$515,033
Times Square,
No.1 Matheson Street,
Causeway Bay,
Hong Kong
Shop A on 11/F, 30,000 sq. ft. Lease 2/28/2003 None HK$1,122,236
12/F-15/F.,
Lee Theatre Plaza
99 Percival Street
Causeway Bay,
Hong Kong
701B, 7/F 1,500 sq. ft. Lease 9/10/2003 None HK$28,119
One Hysan Avenue
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 11,000 sq. ft. Lease 5/19/2003 None HK$504,009
131-133, Level 1,
Grand Central Plaza
Shatin, Hong Kong
6/F, 30,000 sq. ft. Lease 12/31/2004 3 Years HK$578,220
City Landmark
No. 68 Chung On Street
Tsuen Wan, Hong Kong
18/F - 21/F 50,000 sq. ft. Lease 3/31/2004 5 Years HK$1,156,637
City Landmark
No. 68 Chung On Street
Tsuen Wan, Hong Kong
P/F., Stage 8 8,000 sq. ft. Own/lease 4/30/2004 3 Years HK$105,211
122B Broadway Street
Mei Foo Sun Chuen,
Hong Kong
24
HONG KONG (Continued) Size Own / Lease Term Expiration Renewal Option Monthly Rent(1)(2)
---- ----------- --------------- -------------- ------------------
Fourth Podium Floor 2,000 sq. ft. Lease 4/17/2003 3 Years HK$35,214
Stage 8, 114 & 118
Broadway Street
Mei Foo Sun Chuen,
Hong Kong
Shop 66, P/F, Stage 3 2,000 sq. ft. Lease 9/1/2002 5 Years HK$93,751
26-50 Broadway
Mei Foo Sun Chuen
Hong Kong
14/F., Coda Plaza 5,000 sq. ft. Lease 6/30/2003 None HK$131,762
51 Garden Road
Central, Hong Kong
G/F., 5 Junction Road 3,000 sq. ft. Lease 6/30/2003 None HK$55,000
Kowloon City,Hong Kong
Shops 108,109,G08,S17 & B08, 44,000 sq. ft. Lease 3/5/2005 2 Years HK$2,366,973
The Elegance at Sheraton,
Tsimshatsui, Hong Kong
Whole Wet Market on Ground 20,000 sq. ft. Lease 5/31/2003 5 Years HK$515,339
Floor, Tuen Mun Town Plaza
Phase I, Tuen Mun, N.T.
3/F of Podium 34,000 sq. ft. Lease 11/30/2003 3 Years HK$944,660
Elizabeth House
250-254 Gloucester Road
Hong Kong
Basement, G/F-4/F, 18,000 sq. ft. Lease 12/16/2004 3 Years HK$786,410
Wing On Central Building,
26 Des Voeux Central,
Hong Kong
Shops 6-50, 4/F, 27,500 sq. ft. Lease 3/31/2005 3 Years HK$1,019,800
Kornhill Plaza (South),
Kornhill, Hong Kong
- ---------------------
(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.
25
CHINA Size Own / Lease Term Expiration Renewal Option Monthly Rent(1)
- ----- ---- ----------- --------------- -------------- ---------------
5/F-7/F., Huangpu Gymnasium 23,000 sq. ft. Lease 9/30/2003(5) None HK$131,000 (2)
No. 311 Shandong Road
(Mid) Shanghai
4/F., China Wanda Bldg 15,000 sq. ft. Lease 2/28/2008 None HK$106,000 (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$196,000 (4)
808 Hong Qiao Road
Shanghai
5/F-6/F., Metro City 24,000 sq. ft. Lease 10/31/2011(6) None HK$236,000
No. 1111 Zhao Jia Bang Road
Shanghai
4/F., Metro City 16,900 sq. ft. Lease 10/31/2011 None HK$163,830
No. 1111 Zhao Jia Bang Road
Shanghai
S101-4 & S201-2 on South Tower, 58,700 sq. ft. Lease 5/14/2014 None HK$583,894
3/F & 4/F on North Tower,
Hong Kong Plaza
Shanghai
2/F, Macau Landmark 40,000 sq. ft. Lease 8/14/2009 None HK$535,000
555 Avenida da Amizade
ZAPE, Macau
- --------------
(1) Monthly rent is paid in Rmb except for the Macau Center which rent is
paid in HK$.
(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. The premises was
surrendered earlier in March 2001.
(5) Lease for 6/F & 7/F expires on September 6, 2003.
(6) Lease extends by one year and one month on September 28, 2001.
26
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, 2001.
27
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, 2002, the 52-week trading
range was between $0.02 to $0.37 per share. The last reported sale was in March,
2002 at $0.16 per share. The reported sporadic sales in the fiscal year 2001,
are set forth below*.
Date Open High Low Close
Nov-01 0.15 0.37 0.15 0.15
Jun-01 0.15 0.25 0.15 0.24
- ---------------------
* Historical quotes provided by Commodity Systems, Inc.
As of December 31, 2001, there were approximately 624 record holders of
the Company's Common Stock. The Company effected a 1.333333-for-1 reverse split
of its Common Stock in October 1997 and a 1-for-1.333333 forward stock split in
June 1998.
DIVIDEND POLICY
- ---------------
The Company has never paid any cash dividends on its Common Stock and
does not anticipate paying any cash dividends in the future. Physical Health
Centre Hong Kong Limited, the subsidiary of the company acquired by the Company
in October, 1996, paid dividends out in 1995. The Company currently intends to
retain future earnings, if any, to fund the development and growth of its
business.
28
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data are qualified by reference to, and should
be read in conjunction with, the Consolidated Financial Statements, related
Notes to Consolidated Financial Statements and Report of Independent Public
Accountants, and Management's Discussion and Analysis of Financial Condition and
Results of Operations contained elsewhere herein. The following table summarizes
certain selected financial data of the Company for the fiscal years ended
December 31, 1997 through December 31, 2001. The data has been derived from
Consolidated Financial Statements (audited) included in Item 8 of this Report.
(In thousands, except share and per share data)
YEAR ENDED DECEMBER 31
---------------------------------------------------------------------
1997 1998 1999 2000 2001 2001
HK$ HK$ HK$ HK$ HK$ US$
--------- --------- --------- --------- --------- ---------
Consolidated Statements of Operations Data
OPERATING REVENUES 148,954 210,209 253,172 303,312 392,097 50,269
--------- --------- --------- --------- --------- ---------
OPERATING EXPENSES
Salaries and commissions (34,459) (56,415) (70,729) (88,999) (113,239) (14,518)
Rent and related expenses (36,222) (46,527) (63,931) (74,685) (95,413) (12,232)
Depreciation (18,274) (25,781) (33,187) (41,335) (56,545) (7,249)
Other selling and administrative expenses (34,849) (60,572) (57,520) (80,634) (108,298) (13,885)
--------- --------- --------- --------- --------- ---------
Total operating expenses (123,804) (189,295) (225,367) (285,653) (373,495) (47,884)
--------- --------- --------- --------- --------- ---------
INCOME FROM OPERATIONS 25,150 20,914 27,805 17,659 18,602 2,385
--------- --------- --------- --------- --------- ---------
NON-OPERATING INCOME (EXPENSES)
Other income, net 2,186 645 452 853 778 99
Interest expenses (4,151) (3,933) (4,245) (3,379) (3,638) (466)
Goodwill write-off -- -- -- (1,113) -- --
--------- --------- --------- --------- --------- ---------
Total non-operating income (expenses) (1,965) (3,288) (3,793) (3,639) (2,860) (367)
--------- --------- --------- --------- --------- ---------
INCOME BEFORE INCOME TAXES AND MINORITY
INTERESTS 23,185 17,626 24,012 14,020 15,742 2,018
(Provision) Credit for income taxes (6,969) 108 (4,933) (3,312) (6,785) (870)
--------- --------- --------- --------- --------- ---------
INCOME BEFORE MINORITY INTERESTS 16,216 17,734 19,079 10,708 8,957 1,148
Minority interests (1,460) (1,198) (577) (1,010) (535) (69)
--------- --------- --------- --------- --------- ---------
NET INCOME 14,756 16,536 18,502 9,698 8,422 1,079
========= ========= ========= ========= ========= =========
Net income per share 1.48 1.65 1.85 0.97 0.84 0.11
========= ========= ========= ========= ========= =========
Number of shares of stock outstanding
(in thousands) 10,000 10,000 10,000 10,000 10,000 10,000
========= ========= ========= ========= ========= =========
Balance Sheet Data
Current assets 46,964 39,467 41,206 31,135 51,841 6,646
Total assets 168,170 169,641 186,131 212,931 258,075 33,087
Current liabilities 92,439 81,976 67,809 88,677 122,856 15,751
Long-term obligations other than finance leases 15,479 13,592 16,319 15,789 15,243 1,955
Working capital (45,475) (42,509) (26,603) (57,542) (71,015) (9,105)
Obligations under finance leases-non current 8,252 4,215 12,114 8,191 9,342 1,198
Deferred taxation 4,574 4,712 5,661 6,312 7,434 953
Minority interests 3,945 5,144 5,721 6,544 7,079 908
Shareholders' equity 43,481 60,002 78,507 88,260 96,681 12,395
29
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
The following discussion should be read in conjunction with "Selected
Income Data" and the Consolidated Financial Statements and Notes thereto
appearing elsewhere in this report.
Overview
- --------
The Company, through its predecessor companies and its subsidiaries, has
been an established commercial operator of fitness and spa centers in Hong Kong
and China since 1986 (see "Company - History"). The Company currently operates
sixteen facilities: twelve in Hong Kong and four in China (including one in
Macau). Based on the number of the customers 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 80,000 customers. 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."
RESULTS OF OPERATIONS
The Company's revenues are derived from its two main lines of business
of fitness and spa services in the following principal ways: admission fees and
monthly subscription fees from the fitness customers, and the sale of beauty
treatments and skin care products to the beauty patrons.
In respect to fitness services, customers are invited to purchase a
standard fitness card at a fee currently set at HK$800 (US$103) for one person.
The Hong Kong centers from times to times are launching promotion at a special
fee of HK$500 (US$64). Each customer will also be charged a monthly due of
HK$299 (US$38) for the usage of the fitness centers. In order to fully utilize
the facilities, the Company grants a special offer of admission fees at HK$200
(US$26) to off-peak customers.
In respect to beauty services, the customers may purchase single
treatment, 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.
Years Ended December 31,
--------------------------
1999 2000 2001
---- ---- ----
Operating Revenues 100.00% 100.00% 100.00%
Total operating expenses 89.02% 94.18% 95.26%
Operating income 10.98% 5.82% 4.74%
Income before income taxes and minority
Interests 9.48% 4.62% 4.01%
Provision for income and deferred taxes 1.95% 1.09% 1.73%
Minority interests 0.23% 0.33% 0.14%
Net income 7.31% 3.20% 2.15%
======== ======== ========
30
FISCAL YEAR ENDED DECEMBER 31, 2001 COMPARED TO FISCAL YEAR ENDED DECEMBER 31,
- ------------------------------------------------------------------------------
2000
- ----
OPERATING REVENUES. The Company's operating revenues showed the
continuous growth in the fiscal year ended December 31, 2001 as compared to the
fiscal year ended December 31, 2000. Operating revenues for the fiscal year
ended 2001 totaled HK$392,097,000 (US$50,269,000) compared to HK$303,312,000
(US$38,887,000) in the fiscal year ended December 31, 2000, representing an
increase of 29%.
With the opening of the Macau center and the Elizabeth House center in
October, 2000 and April, 2001 respectively (both of which are solely providing
fitness services), operating revenues derived by the Company's fitness services
increased 34% to HK$272,756,000 (US$34,969,000) compared to HK$203,759,000
(US$26,123,000) in the fiscal year ended December 31, 2000. Fitness revenues as
a percentage of total revenues were 70% in the fiscal year ended December 31,
2001 as compared to 67% in the fiscal year ended December 31, 2000.
Operating revenues for the Company's beauty treatments totaled
HK$119,341,000 (US$15,300,000) compared to HK$99,553,000 (US$12,764,000) in the
fiscal year ended December 31, 2000, representing an increase of 20%. Beauty
revenues as a percentage of total revenues were 30% in the fiscal year ended
December 31, 2001 as compared to 33% in the fiscal year ended December 31, 2000.
Operating revenues derived from the Company's Hong Kong locations remain
an important contributor to the Company's business, generating HK$360,388,000
(US$46,204,000), or 92% of total operating revenues in the fiscal year ended
December 31, 2001 as compared to HK$284,007,000 (US$36,412,000) or 94% of total
operating revenues in the fiscal year ended December 31, 2000.
Operating revenues derived from the Company's China locations generated
HK$31,709,000 (US$4,065,000), or 8% of total operating revenues in the fiscal
year ended December 31, 2001 as compared to HK$19,305,000 (US$2,475,000) or 6%
of total operating revenues in the fiscal year ended December 31, 2000.
OPERATING EXPENSES. The Company's operating expenses for the fiscal year
ended December 31, 2001 totaled HK$373,495,000 (US$47,884,000) compared to
HK$285,653,000 (US$36,623,000) in the fiscal year ended December 31, 2000,
representing an increase of 31%. The increase in the operating expenses was
primarily due to higher overheads incurred by the Company in following its
expansion plan. Total operating expenses, after taking into account all
corporate expenses, were 95% of total operating revenue as compared to 94% of
last year.
Operating expenses associated with the Company's Hong Kong locations
were HK$329,155,000 (US$42,199,000) in the fiscal year ended December 31, 2001,
representing an increase of HK$71,050,000 (US$9,109,000) or 28% as compared to
HK$258,105,000 (US$33,091,000) in 2000. Hong Kong operating expenses represented
88% of total operating expenses in the fiscal year ended December 31, 2001 as
compared to 90% in 2000. The increase in operating expenses was primarily due to
additional expense of HK$40,011,000 (US$5,130,000) incurred by the Elizabeth
House center which has not yet commenced operation in 2000. Moreover, additional
marketing expenses of HK$7,700,000 (US$987,000) was incurred in association with
a new installment program initiating in April, 2001.
Operating expenses associated with the Company's China locations were
HK$44,340,000 (US$5,685,000) in the fiscal year ended December 31, 2001,
representing an increase of 61% as compared to HK$27,548,000 (US$3,532,000) in
2000 primarily due to an additional expense of HK$11,713,000 (US$1,502,000)
incurred by the Macau center which opened in October 2000. Operating expenses in
China represented 12% of total operating expenses in the fiscal year ended
December 31, 2001 as compared to 10% in 2000.
31
TOTAL NON-OPERATING EXPENSES (INCOME). Total non-operating expenses for
the fiscal year ended December 31, 2001 totaled HK$2,860,000 (US$367,000)
compared to HK$3,639,000 (US$467,000) in the fiscal year ended December 31,
2000, representing a decrease of 21% mainly due to a goodwill of HK$1,113,000
(US$143,000) being written off in 2000 but there is no expenses of similar
nature recorded in 2001.
PROVISION FOR INCOME TAXES. Provision for income taxes for the fiscal
year ended December 31, 2001 totaled HK$6,785,000 (US$870,000) compared to
HK$3,312,000 (US$424,000) in 2000, representing an increase of 105%. The
effective tax rate of the year was 43.1% as compared with 23.6% of last year,
representing an increase of 83%. The increase is mainly due to a write-back of
overprovision for taxation of 13.4% in 2000 whereas no such case happened in
2001.
NET INCOME. The Company's net income for the fiscal year ended December
31, 2001 totaled HK$8,422,000 (US$1,079,000) compared to HK$9,698,000
(US$1,244,000) for the fiscal year ended December 31, 2000, representing a
decrease of 13%. The decrease in the net income was mainly due to the narrowing
profit margin in the adverse economic condition in the fiscal year ended
December 31, 2001.
FISCAL YEAR ENDED DECEMBER 31, 2000 COMPARED TO FISCAL YEAR ENDED DECEMBER 31,
- ------------------------------------------------------------------------------
1999
- ----
OPERATING REVENUES. The Company's operating revenues showed the
continuous growth in the fiscal year ended December 31, 2000 as compared to the
fiscal year ended December 31, 1999. Operating revenues for the fiscal year
ended 2000 totaled HK$303,312,000 (US$38,887,000) compared to HK$253,172,000
(US$32,458,000) in the fiscal year ended December 31, 1999, representing an
increase of 20%.
Operating revenues derived by the Company's fitness services increased
22% to HK$203,759,000 (US$26,123,000) compared to HK$166,917,000 (US$21,400,000)
in the fiscal year ended December 31, 1999. Fitness revenues as a percentage of
total revenues were 67% in the fiscal year ended December 31, 2000 as compared
to 66% in the fiscal year ended December 31, 1999.
Operating revenues for the Company's beauty treatments totaled
HK$99,553,000 (US$12,764,000) compared to HK$86,225,000 (US$11,054,000) in the
fiscal year ended December 31, 1999, representing an increase of 15%. Beauty
revenues as a percentage of total revenues were 33% in the fiscal year ended
December 31, 2000 as compared to 34% in the fiscal year ended December 31, 1999.
Operating revenues derived from the Company's Hong Kong locations remain
an important contributor to the Company's business, generating HK$284,007,000
(US$36,412,000), or 94% of total operating revenues in the fiscal year ended
December 31, 2000 as compared to HK$238,096,000 (US$30,525,000) or 94% of total
operating revenues in the fiscal year ended December 31, 1999.
Operating revenues derived from the Company's China locations generated
HK$19,305,000 (US$2,475,000), or 6% of total operating revenues in the fiscal
year ended December 31, 2000 as compared to HK$15,076,000 (US$1,933,000) or 6%
of total operating revenues in the fiscal year ended December 31, 1999.
OPERATING EXPENSES. The Company's operating expenses for the fiscal year
ended December 31, 2000 totaled HK$285,653,000 (US$36,623,000) compared to
HK$225,367,000 (US$28,893,000) in the fiscal year ended December 31, 1999,
representing an increase of 27%. 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 Sheraton
Hotel center, Tuen Mun center and Macau center which opened in July 1999, July
2000 and October 2000 respectively. Total operating expenses, after taking into
account all corporate expenses, were 94% of total operating revenue as compared
to 89% of last year.
Operating expenses associated with the Company's Hong Kong locations
were HK$258,105,000 (US$33,091,000) in the fiscal year ended December 31, 2000,
representing an increase of HK$51,283,000 (US$6,576,000) or 25% as compared to
HK$206,822,000 (US$26,515,000) in 1999. Hong Kong operating expenses represented
90% of total operating expenses in the fiscal year ended December 31, 2000 as
compared to 92% in 1999. The increase in operating expenses was primarily
incurred by the new branch in Tuen Mun, Hong Kong which has not yet been opened
in 1999. The operating expenses for the Tuen Mun center amounted to
HK$13,651,000 (US$1,750,000) in 2000. In addition, the Sheraton Hotel center
incurred operating expenses of HK$59,738,000 (US$7,659,000), representing an
increase of HK$28,901,000 (US$3,705,000) over last year which reflected the
6-month operation since July 1999.
32
Operating expenses associated with the Company's China locations were
HK$27,548,000 (US$3,532,000) in the fiscal year ended December 31, 2000,
representing an increase of 49% as compared to HK$18,545,000 (US$2,378,000) in
1999. Operating expenses in China represented 10% of total operating expenses in
the fiscal year ended December 31, 2000 as compared to 8% in 1999. The increase
in operating expenses was primarily incurred by the new branch in Macau which
has not yet been opened in 1999. The operating expenses for the new branch
totaled HK$6,543,000 (US$839,000) in 2000.
TOTAL NON-OPERATING EXPENSES (INCOME). Total non-operating expenses for
the fiscal year ended December 31, 2000 totaled HK$3,639,000 (US$467,000)
compared to HK$3,793,000 (US$486,000) in the fiscal year ended December 31,
1999, representing a decrease of 4% due to lower interest expenses.
PROVISION FOR INCOME TAXES. Provision for income taxes for the fiscal
year ended December 31, 2000 totaled HK$3,312,000 (US$424,000). The effective
tax rate of the year was 23.6% as compared with 20.5% of last year, representing
an increase of 15%. The increase is mainly due to a profits tax rate of 16%
being charged on the Company's Hong Kong locations whereas the income of these
profits contributors was partially offset by the losses incurred by the
Company's China locations.
NET INCOME. The Company's net income for the fiscal year ended December
31, 2000 totaled HK$9,698,000 (US$1,244,000) compared to HK$18,502,000
(US$2,372,000) for the fiscal year ended December 31, 1999, representing a
decrease of 48%. 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, 2000, however, the revenues derived in association with such expansion were
not fully recognized in the same time period in accordance with the Company's
accounting policy.
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$32,458,000) compared to HK$210,209,000
(US$26,950,000) 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$21,400,000)compared to HK$139,829,000 (US$17,927,000)
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$11,054,000)compared to HK$70,317,000 (US$9,015,000) 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$30,525,000), or 94% of total operating revenues in the fiscal year ended
December 31, 1999 as compared to HK$192,692,000 (US$24,704,000) 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$1,933,000), or 6% of total operating revenues in the fiscal
year ended December 31, 1999 as compared to HK$17,517,000 (US$2,246,000) or 8%
of total operating revenues in the fiscal year ended December 31, 1998.
33
OPERATING EXPENSES. The Company's operating expenses for the fiscal year
ended December 31, 1999 totaled HK$225,367,000 (US$28,893,000)compared to
HK$189,295,000 (US$24,269,000)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$26,516,000) in the fiscal year ended December 31, 1999,
representing an increase of HK$39,716,000 (US$5,092,000) or 24% as compared to
HK$167,106,000 (US$21,424,000) 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$3,953,000) in 1999. In addition, the Tsuen Wan center incurred
operating expenses of HK$45,059,000 (US$5,777,000), representing an increase of
HK$18,738,000 (US$2,402,000) 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$2,378,000) in the fiscal year ended December 31, 1999,
representing a decrease of 16% as compared to HK$22,189,000 (US$2,845,000) 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.
TOTAL NON-OPERATING EXPENSES (INCOME). Total non-operating expenses for
the fiscal year ended December 31, 1999 totaled HK$3,793,000 (US$486,000)
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$632,000). 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$562,000) 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$576,000). 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$2,372,000)compared to HK$16,536,000
(US$2,120,000) 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.
34
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations primarily through cash generated
from operations, short-term bank credit, long-term bank loans, advances from
customers relating to prepaid fitness and spa income, and leasing arrangements
with financial institutions. See Notes to Financial Statements (Note 5
"Short-Term Bank Loans"; Note 6 "Long-Term Bank Loans"; and Note 8 "Obligations
under Finance Leases").
Cash and cash equivalent balances for the fiscal years ended December
31, 2001 and December 31, 2000 were HK$4,787,000 (US$614,000) and HK$1,759,000
(US$226,000) respectively.
Net cash provided by operating activities were HK$92,074,000
(US$11,804,000), HK$76,854,000(US$9,853,000), and HK$42,618,000 (US$5,464,000)
for fiscal years 2001, 2000, and 1999 respectively. The Company's operating
activities are historically financed by cash flows from operations. Net cash
used in investing activities were HK$70,881,000 (US$9,088,000), HK$78,127,000
(US$10,016,000), and HK$44,612,000 (US$5,719,000) for fiscal years 2001, 2000,
and 1999 respectively, primarily as a result of expenditures for property, plant
and equipment. Net cash provided (used) in financing activities, which mainly
include bank loan repayments, net of proceeds from new bank loans, were
HK$(18,164,000) (US$(2,328,000)), HK$81,000 (US$11,000), and HK$3,166,000
(US$406,000) for fiscal years 2001, 2000, and 1999 respectively.
The Company's long-term loans bear interest rates varying currently from
5.375% to 7.625% per annum. The total balance outstanding as of December 31,
2001 on such loans was HK$15,243,000 (US$1,955,000). The last repayment on the
loans is due in 2007. The Company also had various banking facilities available
from financial institutions amounting to approximately HK$18,384,000
(US$2,357,000). These facilities were secured by certain leasehold property in
Hong Kong owned by the Company's subsidiary (Ever Growth Limited) and a related
company (Silver Policy Development Limited), a fixed charge over a subsidiary's
machinery and equipment and a floating charge over its other assets (Physical
Health Centre (Macau) Limited), fixed deposits owned by the Company's
subsidiaries (Physical Health Centre Hong Kong Limited and Physical Health
Centre (TST) Limited), and personal guarantees from Mr. Luk.
Consistent with the general practice of the fitness and spa industry,
the Company receives prepaid monthly fees from fitness customers, 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 monthly fees and spa
treatment dues is characterized as deferred income, and further categorized as
current portion under current liability and non-current portion under
non-current liability, for accounting purposes.
The Company's trade receivable balance at December 31, 2001, was
HK$13,568,000 (US$1,739,000) which is mainly due by banks for the new
installment program. The program allows the holders of credit cards issued by
certain banks to purchase the Company's fitness and beauty services with the
said cards and then enjoy the 12-month interest-free payment by installment
arrangements with the banks. The Company offers credit terms varying from 7 days
to 14 days to the banks for settlement of the full purchase amounts. The Company
has never experienced any significant problems with collection of accounts
receivable from its customers. No provision for doubtful receivables is
therefore made for the period under review.
Capital expenditures for fiscal years 2001, 2000 and 1999 were
HK$65,931,000 (US$8,453,000), HK$71,934,000 (US$9,222,000) and HK$51,010,000
(US$6,540,000), 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.
35
ITEM 8. 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 Statements of Operations for the years ended
December 31, 1999, 2000 and 2001 F-4
Consolidated Balance Sheets as of December 31, 2000 and 2001 F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1999, 2000 and 2001 F-6
Consolidated Statements of Stockholders' Equity for the years
ended December 31, 1999, 2000 and 2001 F-7
Notes to Consolidated Financial Statements F-8
36
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
INDEPENDENT AUDITORS' REPORT
AUDITED FINANCIAL STATEMENTS
PHYSICAL SPA & FITNESS INC.
DECEMBER 31, 2001
F-2
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, 2000
and 2001 and the related consolidated statements of operations, stockholders'
equity and cash flows for the years 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 audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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 audits 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, 2000 and 2001 and the results of their
operations and cash flows for the years then ended in conformity with accounting
principles generally accepted in the United States of America.
MOORES ROWLAND
CHARTERED ACCOUNTANTS
CERTIFIED PUBLIC ACCOUNTANTS
Hong Kong
Date: March 1, 2002
F-3
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
==================================================================================================================
(In thousands, except share and per share data)
YEAR ENDED DECEMBER 31
----------------------------------------------------------------
1999 2000 2001 2001
NOTE HK$ HK$ HK$ US$
OPERATING REVENUES 253,172 303,312 392,097 50,269
------------- ------------- ------------- -----------
OPERATING EXPENSES
Salaries and commissions (70,729) (88,999) (113,239) (14,518)
Rent and related expenses (63,931) (74,685) (95,413) (12,232)
Depreciation (33,187) (41,335) (56,545) (7,249)
Other selling and administrative expenses (57,520) (80,634) (108,298) (13,885)
------------- ------------- ------------- -----------
Total operating expenses (225,367) (285,653) (373,495) (47,884)
------------- ------------- ------------- -----------
INCOME FROM OPERATIONS 27,805 17,659 18,602 2,385
------------- ------------- ------------- -----------
NON-OPERATING INCOME (EXPENSES)
Other income, net 452 853 778 99
Interest expenses (4,245) (3,379) (3,638) (466)
Goodwill write-off - (1,113) - -
------------- ------------- ------------- -----------
Total non-operating expenses (3,793) (3,639) (2,860) (367)
------------- ------------- ------------- -----------
INCOME BEFORE INCOME TAXES AND MINORITY
INTERESTS 24,012 14,020 15,742 2,018
Income taxes 7 (4,933) (3,312) (6,785) (870)
------------- ------------- ------------- -----------
INCOME BEFORE MINORITY INTERESTS 19,079 10,708 8,957 1,148
Minority interests (577) (1,010) (535) (69)
------------- ------------- ------------- -----------
NET INCOME 18,502 9,698 8,422 1,079
Other comprehensive income (loss)
- Foreign currency translation adjustments 3 55 (1) -
------------- ------------- ------------- -----------
COMPREHENSIVE INCOME 18,505 9,753 8,421 1,079
============= ============= ============= ===========
Earnings per share of common stock - Basic 1.85 0.98 0.84 0.11
============= ============= ============= ===========
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.
F-4
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
=========================================================================================================================
(In thousands, except share and per share data)
NOTE AS OF DECEMBER 31
----------------------------------------
2000 2001 2001
HK$ HK$ US$
ASSETS
CURRENT ASSETS
Cash and cash equivalents 1,759 4,787 614
Trade receivables 4,827 13,568 1,739
Rental and utility deposits 15,137 21,733 2,786
Prepayments to vendors and suppliers and other current assets 6,427 9,380 1,203
Inventories 3(f) 2,070 2,373 304
Due from related companies 10(d) 915 - -
---------- ---------- -----------
TOTAL CURRENT ASSETS 31,135 51,841 6,646
---------- ---------- -----------
Bank deposits, collateralized 3,567 6,935 889
Due from a stockholder 10(c) 2,108 11,695 1,500
Prepayments for construction-in-progress 6,954 11,970 1,535
Property, plant and equipment, net 4 169,167 175,634 22,517
---------- ---------- -----------
TOTAL ASSETS 212,931 258,075 33,087
========== ========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Due to a related company 10(d) - 5 1
Short-term bank loans 5 8,292 1,769 227
Long-term bank loans - current portion 6 7,685 12,462 1,598
Accounts payable and accrued expenses 23,618 20,644 2,647
Obligations under finance leases - current portion 8 4,959 5,668 727
Deferred income - current portion 35,873 71,000 9,102
Deferred liabilities - current portion 4,177 4,372 560
Income taxes payable 757 963 123
Taxes other than income 3,316 5,973 766
---------- ---------- -----------
TOTAL CURRENT LIABILITIES 88,677 122,856 15,751
---------- ---------- -----------
Deferred income - non-current portion 1,957 6,691 857
Deferred liabilities - non-current portion 4,886 5,211 668
Long-term bank loans - non-current portion 6 8,104 2,781 357
Obligations under finance leases - non-current portion 8 8,191 9,342 1,198
Deferred taxation 6,312 7,434 953
Minority interests 6,544 7,079 908
STOCKHOLDERS' EQUITY:
Common stock, par value of US$0.001 each,
100 million shares of stock authorized;
10 million shares of stock issued and outstanding 78 78 10
Cumulative translation adjustments 174 173 22
Retained earnings 88,008 96,430 12,363
---------- ---------- -----------
TOTAL STOCKHOLDERS' EQUITY 88,260 96,681 12,395
---------- ---------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY 212,931 258,075 33,087
========== ========== ===========
The financial statements should be read in conjunction with the accompanying
notes.
F-5
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
==================================================================================================================
(In thousands)
YEAR ENDED DECEMBER 31
-------------------------------------------------------
1999 2000 2001 2001
HK$ HK$ HK$ US$
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income 18,502 9,698 8,422 1,079
Adjustments to reconcile net income to net cash provided
by operating activities:
Minority interests 577 1,010 535 69
Depreciation 33,187 41,335 56,545 7,249
Loss on disposal of property, plant and equipment 196 774 2,853 366
Goodwill on acquisition of further interests in
subsidiaries written off - 1,113 - -
Changes in working capital:
Trade receivables 3,469 (932) (8,741) (1,121)
Deposits, prepayments and other current assets (4,320) (2,183) (9,549) (1,224)
Inventories (47) 481 (303) (38)
Due form related companies 40 7,458 920 118
Due from a stockholder 294 2,002 - -
Accounts payable and accrued expenses (3,062) 5,318 (2,974) (381)
Deferred income (6,271) 14,003 39,861 5,110
Deferred liabilities 2,949 1,226 520 66
Income taxes payable 1,925 (5,234) 206 26
Taxes other than income (5,770) 134 2,657 341
Deferred taxation 949 651 1,122 144
---------- ---------- ---------- -----------
NET CASH PROVIDED BY OPERATING ACTIVITIES 42,618 76,854 92,074 11,804
---------- ---------- ---------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Prepayments for construction-in-progress 6,147 (6,487) (5,016) (643)
Acquisition of property, plant and equipment (51,010) (71,934) (65,931) (8,453)
Acquisition of further interests in subsidiaries from
minority interests - (1,300) - -
Sales proceeds from disposal of property, plant and equipment 251 1,594 66 8
---------- ---------- ---------- -----------
NET CASH USED IN INVESTING ACTIVITIES (44,612) (78,127) (70,881) (9,088)
---------- ---------- ---------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in bank deposits (3,522) (45) (3,368) (432)
Due from a stockholder - - (9,587) (1,229)
Proceeds from (Settlement of) short-term bank loans 2,374 (314) (6,523) (836)
Proceeds from long-term bank loans 1,000 17,000 10,287 1,319
Repayment of long-term bank loans (4,408) (8,649) (10,833) (1,389)
Assumption of finance lease obligations 14,753 1,300 8,875 1,138
Capital element of finance lease rental payments (7,031) (5,011) (7,015) (899)
Repayment of loans from minority shareholders of subsidiaries - (4,200) - -
---------- ---------- ---------- -----------
NET CASH PROVIDED (USED IN) BY FINANCING ACTIVITIES 3,166 81 (18,164) (2,328)
---------- ---------- ---------- -----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH 3 55 (1) -
---------- ---------- ---------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1,175 (1,137) 3,028 388
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 1,721 2,896 1,759 226
---------- ---------- ---------- -----------
CASH AND CASH EQUIVALENTS AT END OF YEAR 2,896 1,759 4,787 614
========== ========== ========== ===========
The financial statements should be read in conjunction with the accompanying notes.
F-6
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
==================================================================================================================
(In thousands)
CUMULATIVE
RETAINED TRANSLATION
COMMON STOCK EARNINGS ADJUSTMENTS TOTAL
---------------------------- ------------ ----------------- -----------
NOTE NUMBER HK$ HK$ HK$ HK$
Balance as of January 1, 1999 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
Net income - - 9,698 - 9,698
Translation adjustment - - - 55 55
-------------- ------------ ------------- ---------------- -----------
Balance as of December 31,
2000 10,000,000 78 88,008 174 88,260
Net income - - 8,422 - 8,422
Translation adjustment - - - (1) (1)
-------------- ------------ ------------- ---------------- -----------
BALANCE AS OF DECEMBER 31,
2001 10,000,000 78 96,430 173 96,681
============== ============ ============= ================ ===========
F-7
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 Principal 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 Principal 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 Principal 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 Principal 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 Principal 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:
EQUITY INTEREST
DATE OF ACQUISITION/ PLACE OF OWNED BY THE PRINCIPAL
NAME OF COMPANY FORMATION INCORPORATION COMPANY ACTIVITIES
Direct Indirect
Physical Holdings March 8, 1996 BVI 100% - Investment
holding
Ever Growth Limited September 29, 1994 HK - 100% Property
("Ever Growth") holding
Jade Regal Holdings March 15, 1996 BVI - 100% Investment
Limited holding
F-8
1. ORGANIZATION AND PRINCIPAL ACTIVITIES (CONTINUED)
EQUITY INTEREST
DATE OF ACQUISITION/ PLACE OF OWNED BY THE PRINCIPAL
NAME OF COMPANY FORMATION INCORPORATION COMPANY ACTIVITIES
Direct Indirect
Physical Beauty Centre September 14, 2001 HK - 100% Will operate
(Central) Limited a beauty
centre in HK
Physical Health Centre March 15, 1996 HK - 100% Investment
(Dalian) Limited holding
("Physical Dailan")
Physical Health Centre December 1, 1998 HK - 100% Operating a
(E House) Limited fitness
centre in HK
Physical Health Centre December 31, 2001 HK - 100% Will operate
(Kornhill) Limited a Fitness
Centre in HK
Physical Health Centre March 21, 1997 HK - 100% Investment
(Macau) Limited holding
Physical Health Centre May 30, 2001 HK - 100% Will operate
(PM) Limited a Fitness
Centre in HK
Physical Health Centre April 15, 1996 HK - 100% Investment
(Shenzhen) Limied holding
("Physical Shenzhen")
Physical Health Centre November 18, 1998 HK - 100% Operating a
(TST) Limited ("Physical Fitness
TST") Centre in HK
Physical Health Centre September 8, 1997 HK - 100% Operating a
(Tsuen Wan) Limited Fitness
("Physical Tsuen Wan") Centre in HK
Physical Health Centre September 29, 1994 HK - 100% Operating a
(Tuen Mun) Limited fitness
("Physical Tuen Mun") centre in HK
F-9
1. ORGANIZATION AND PRINCIPAL ACTIVITIES (CONTINUED)
EQUITY INTEREST
DATE OF ACQUISITION/ PLACE OF OWNED BY THE PRINCIPAL
NAME OF COMPANY FORMATION INCORPORATION COMPANY ACTIVITIES
Direct Indirect
Physical Health Centre March 2, 1990 HK - 91.4% Operating 3
Hong Kong Limited Fitness
Centres, 1
fitness
centre and
2 beauty
centres in HK
Proline Holdings Limited September 28, 1994 BVI - 100% Investment
holding
Regent Town Holdings September 20, 1993 BVI - 100% Investment
Limited ("Regent Town") holding
Physical Health Centre September 28, 1994 HK - 100% Investment
(Shanghai) Limited holding
(Formerly known as
Shanghai Physical
Ladies' Club Company
Limited)
Star Perfection Holdings April 15, 1996 BVI - 100% Investment
Limited holding
Supreme Resources September 29, 1994 HK - 100% Operating a
Limited ("Supreme") beauty
centre in HK
Su Sec Pou Physical August 18, 1997 Macau - 100% Operating a
Health Centre (Macau), fitness
Limited ("Physical centre in
Macau") Macau
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:
F-10
1. ORGANIZATION AND PRINCIPAL ACTIVITIES (CONTINUED)
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 Shanghai 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 the Shanghai JV will be taken over by the Chinese
JV partner while Physical Shanghai 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 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 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.
According to the directors, the Group has verbally agreed with the
Chinese enterprise to terminate the JV contract even though no formal
notice has yet been submitted to the PRC authority. The directors also
consider that the Group will not suffer penalties nor financial losses
upon the termination of the JV.
F-11
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 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.
According to the directors, the Group has verbally agreed with the
Chinese enterprise to terminate the JV contract even though no formal
notice has yet been submitted to the PRC authority. The directors also
consider that the Group will not suffer penalties nor financial losses
upon the termination of the JV.
2. BASIS OF PRESENTATION
The financial statements 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.
The financial statements are presented in Hong Kong dollars which is
the Group's functional currency because the Group's operations are
primarily located in Hong Kong. For illustrative purposes, the exchange
rate adopted for the presentations of financial information as of and
for the year ended December 31, 2001 has been made at HK$7.8 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, 2001 or at any other rate.
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) PREPARATION OF FINANCIAL STATEMENTS
The Group has a negative working capital of HK$57,542 and
HK$71,015 as of December 31, 2000 and 2001 respectively. These
conditions raise doubt about the Group's ability to continue
as a going concern.
Continuation of the Group as a going concern is dependent upon
obtaining additional working capital in the future. The
Principal Stockholder has undertaken to make available
adequate funds to the Group as and when required to maintain
the Group as a going concern. As a result, the financial
statements have been prepared in conformity with the
principles applicable to a going concern.
F-12
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
c) 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.
d) 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.
e) GOODWILL ON CONSOLIDATION
Goodwill arising on consolidation, being the excess of the
purchase consideration payable at the time of acquisition of
the subsidiaries over the fair values of the net underlying
assets acquired, is recognised as an expense in the period it
arises. However, see Note 3(s) below.
f) INVENTORIES
Inventories, mainly comprise beauty products for treatment and
sale, are stated at the lower of cost and net realizable
value. Cost, which comprises all costs of purchase and, where
applicable, 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
---------------------------------
2000 2001 2001
HK$ HK$ US$
Beauty products for
treatment 1,300 1,392 178
Beauty products for sale 770 981 126
-------- --------- --------
2,070 2,373 304
======== ========= ========
g) PROPERTY, PLANT AND EQUIPMENT AND DEPRECIATION
PPE is stated at cost less accumulated depreciation.
The cost of an asset comprises 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 normally
recognized as an expense 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 and accumulated
depreciation are eliminated from the accounts and any gain or
loss resulting from their disposal is included in the
statement of operations.
F-13
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
g) PROPERTY, PLANT AND EQUIPMENT AND DEPRECIATION (CONTINUED)
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 provided to write off the cost of PPE over
their estimated useful lives from the date on which they
become fully operational and after taking into account their
estimated residual values, using the straight-line method at
the following rates per annum:
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.
h) REVENUE RECOGNITION
Revenue represents 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 duration whereas the
monthly dues, service income and other related income are
recognized as revenue when services are rendered.
i) DEFERRED INCOME
Deferred income represents unamortized non-refundable
admission fees and service fees billed but for which the
related services, or portion of the services have not yet been
rendered.
j) 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(g) 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.
F-14
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
k) 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.
l) 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.
m) INCOME TAXES
No provision for withholding or U.S. federal income taxes or
tax benefits on the undistributed earnings and / or losses of
the Company and its Operating Subsidiaries has been provided
as the earnings of the Operating Subsidiaries, in the opinion
of the management, will be reinvested indefinitely.
Provision for income and other related taxes have been
provided in accordance with the tax rates and laws in effect
in the various countries of operations.
The Group provides for deferred income taxes using the
liability method, by which deferred income taxes are
recognized for all significant temporary differences between
the tax and financial statement bases of assets and
liabilities. The tax consequences of those differences are
classified as current or non-current based upon the
classification of the related assets or liabilities in the
financial statements.
n) FOREIGN CURRENCY TRANSLATION
The Company and its subsidiaries maintain their accounting
books and records in Hong Kong Dollars ("HK$"), except for the
PRC JV and Macau subsidiary which maintain their accounting
books and records in RMB and MOP respectively. Foreign
currency transactions during the year are translated to HK$ 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 and
Macau subsidiary are translated into HK$ using the closing
rate method, whereby the balance sheet items are translated
into HK$ using the exchange rates at the respective balance
sheet dates. The share capital and retained earnings are
translated at exchange rates prevailing at the time of the
transactions while income and expenses items are translated at
the average 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.
F-15
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
o) 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.
p) EARNINGS PER SHARE
Basic earnings per share excludes dilution and is computed by
dividing earnings available to common shareholders by the
weighted average number of common shares outstanding for the
periods.
Diluted earnings per share is computed by dividing earnings
available to common shareholders by the weighted average
number of common shares outstanding adjusted to reflect
potentially dilutive securities. There were no potentially
dilutive securities outstanding during any of the years and,
accordingly, basic and diluted earnings per share are the
same.
q) USES OF ESTIMATES
The preparation of the consolidated financial statements in
conformity with generally accepted accounting principles
requires the Group'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.
r) ADVERTISING AND MARKETING COSTS
All advertising and marketing costs are to be expensed off in
the periods in which those costs are incurred or the first
time the advertising takes place.
F-16
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
s) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In March 2001, the Financial Accounting Standards Board issued
FIN No. 44, "Accounting for certain transactions involving
stock compensation". FIN No. 44 provides guidance for applying
APB Opinion No. 25, "Accounting for stock issued to
employees". With certain exceptions, FIN No. 44 applies
prospectively to new awards, exchange of awards in a business
combination, after July 1, 2001. The implementation of FIN No.
44 did not have a material effect on the Group's results of
operations as no stock options were granted to employees up to
the balance sheet date.
In July 2001, the Financial Accounting Standards Board issued
SFAS No. 141, Business combinations" and SFAS No. 142,
"Goodwill and other intangible assets". SFAS No. 141 requires
that the purchase method of accounting be used for all
business combinations initiated after June 30, 2001. SFAS No.
141 also specifies the criteria that intangible assets
acquired in a purchase method business combination must meet
to be recognized and reported apart from goodwill. SFAS No.
142 requires that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead be
tested for impairment, at least annually, in accordance with
the provisions of SFAS No. 142. SFAS No. 142 will also require
that intangible assets with definite useful lives be amortized
over their respective estimated useful lives to their
estimated residual values, and be reviewed for impairment in
accordance with SFAS No. 121, "Accounting for the impairment
of long-lived assets and long-lived assets to be disposed of".
The provisions of SFAS No. 141 are effective immediately,
except with regard to business combinations initiated prior to
July 1, 2001. SFAS No. 142 will be effective as of January 1,
2002. Goodwill and other intangible assets acquired in
business combinations completed before July 1, 2001, will
continue to be amortized prior to the adoption of SFAS No.
142. At this time, the management believe that the adoption of
either of these statements will not have a material effect on
on the Group's consolidated financial position, results of
operations and cash flows.
In June 2001, the Financial Accounting Standards Board issued
SFAS No. 143, "Asset Retirement Obligations". SFAS No. 143
establishes accounting requirements for retirement obligations
associated with tangible long-lived assets, it requires that
an asset retirement cost should be capitalized as part of the
cost of the related long-lived asset and subsequently
allocated to expense using a systematic and rational method.
The implementation of SFAS No. 143 did not have a material
effect on the Group's consolidated financial position, results
of operations and cash flows.
In August 2001, the FASB issued SFAS No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets". SFAS No. 144
replaces SFAS 121. SFAS No. 144 requires that those long-lived
assets be measured at the lower of carrying amount or fair
value less cost to sell, whether reported in continuing
operations or in discontinued operations. SFAS No. 144 are
effective for financial statements issued for fiscal years
beginning after December 15, 2001 and are applied
prospectively. At this time, the management believe that the
adoption of this statement will not have a material effect on
on the Group's consolidated financial position, results of
operations and cash flows.
In November 2001, the Financial Accounting Standards Board's
Emerging Issues Task Force (EITF) reached consensus on Issue
01-9, "Accounting for consideration given by a vendor to a
customer or a reseller of the vendor's products". The issue
provides guidance on accounting for certain payments made by a
vendor of goods and services to a customer. Under certain
conditions, amount paid to customers are required to be shown
as a reduction in the corresponding revenues recorded from
those customers, rather than be shown as expenses in the
income statement. EITF 01-9 is generally effective for fiscal
years or interim periods beginning after December 15, 2001.
Management of the Company is in the process of assessing the
impact that implementing EITF 01-9 will have on the
consolidated financial statements.
F-17
4. PROPERTY, PLANT AND EQUIPMENT, NET
As of December 31
-----------------------------------------------
2000 2001 2001
HK$ HK$ US$
Land and buildings 3,137 3,137 402
Leasehold improvements 112,156 133,152 17,070
Machinery and equipment 135,551 158,874 20,368
Furniture and fixtures 35,337 44,646 5,724
Computers 4,347 4,833 620
Motor vehicles 4,992 5,972 766
Less: Accumulated depreciation (126,353) (174,980) (22,433)
------------ -------------- -----------
Net book value 169,167 175,634 22,517
============ ============== ===========
As of December 31, 2001, the cost and accumulated depreciation of PPE
held under finance leases amounted to approximately HK$23,305 (2000:
HK$22,844) and HK$11,512 (2000: HK$11,348) respectively.
5. SHORT-TERM BANK LOANS
The short-term bank loans are collateralized and repayable within one
year. Please refer to Note 6 for details of collateral for such
facilities.
Supplemental information with respect to the short-term bank loans was
as follows:
Year ended December 31
------------------------------------------------
1999 2000 2001
Maximum amount outstanding during the years HK$8,452 HK$8,292 HK$13,102
Average amount outstanding during the years HK$6,432 HK$4,973 HK$4,749
Weighted average interest rate at the end of the years 11% 8% 5%
Weighted average interest rate during the years 11% 9% 6%
F-18
6. LONG-TERM BANK LOANS
The Group obtained various lines of credit under banking facilities
which aggregated HK$34,662 as of December 31, 2001 from creditworthy
commercial banks in HK and PRC to finance its operations. These loans
were collateralized by certain of the assets of the Group and its
stockholders. As of December 31, 2001, the loans consist of the
following:
PRINCIPAL INTEREST RATE MATURITY
HK$
4,796 HK$ prime + 1.5% Within one year
3,769 6.65% Within one year
1,018 HK$ prime + 2.5% Within one year
3,610 HK$ prime + 0.25% Serially from 2002 to 2003
2,050 HK$ prime + 1.5% Serially from 2002 to 2007
------------
15,243
============
Aggregate maturities of the long-term bank loans are as follows:
PRINCIPAL PAYABLES DURING THE FOLLOWING PERIODS
HK$
12,462 2002
---------------
1,451 2003
360 2004
360 2005
360 2006
250 2007
---------------
2,781
---------------
15,243
===============
The collateral of the loans include:
(i) leasehold property in Hong Kong owned by Ever Growth;
(ii) fixed deposits owned by Physical Hong Kong and Physical TST;
(iii) leasehold property in Hong Kong owned by a related company;
(iv) personal guarantees from the Principal Stockholder; and
(v) a fixed charge over Physical Macau's machinery and equipment
and a floating charge over its other assets.
F-19
7. INCOME TAXES
Reconciliation to the expected statutory tax rate in Hong Kong of 16.0%
(2000: 16% AND 1999: 16%) is as follows:
Year ended December 31
-----------------------------------
1999 2000 2001
% % %
Weighted average statutory rate 16.0 16.0 16.0
Tax effect of net operating losses 2.6 11.7 13.2
Tax effect of timing differences - 9.8 13.9
Effect of prior year adjustments 2.3 - -
Write back of overprovision for taxation in prior years - (13.4) -
Others (0.4) (0.5) -
--------- --------- ---------
Effective rate 20.5 23.6 43.1
========= ========= =========
Income tax expense is comprised of the following:
Year ended December 31
----------------------------------------------
1999 2000 2001 2001
HK$ HK$ HK$ US$
Current taxes 3,984 2,661 5,663 726
Deferred taxes 949 651 1,122 144
--------- -------- --------- --------
Income tax expense 4,933 3,312 6,785 870
========= ======== ========= ========
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% (2000 AND 1999: 16%).
Since those PRC JV have sustained losses for the PRC income tax
purposes, 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%.
As the fitness centre operated in Macau has incurred a loss for
taxation purposes for the period, the Group has not recorded any Macau
income tax expenses. Macau profits tax is currently charged at sliding
rates with maximum rate of 15% on assessable profits.
The Group imported beauty products from suppliers in Hong Kong into the
PRC for beauty treatment and sales to its customers. Under the
prevailing PRC rules and regulations governing imports into the PRC,
the Group is required to make import declarations and to pay various
taxes including, inter alia, customs duty, consumption tax and
value-added tax, on such imports. The Group faced further penalty,
additional to the original amount of taxes payable, up to a maximum
amount equivalent to three times of the original amount of taxes
payable, had the Group been found in breach of any of such rules and
regulations.
F-20
7. INCOME TAXES (CONTINUED)
Since the Group commenced its business operation in the PRC, the Group
has not made any import declaration nor paid any of the taxes due for
such imports. The Directors have represented that the suppliers have
undertaken to the Group that they would reimburse the Group for such
payments had such payments been found necessary.
As of the balance sheet date, the Group is potentially liable to make
good in aggregate an amount of HK$11,388 (2000: HK$10,615), of which an
amount of HK$5,728 (2000: HK$3,101) has been provided for as taxes
other than income and as account receivable in the liabilities and
assets respectively. No further provision has been made for the
difference which amounted to HK$5,660 (2000: HK$7,514) and any
potential amount of penalty which might be imposed. In this respect,
the directors are of the opinion that the probability that such
potential liabilities will be crystallised would be remote.
As also stated in Note 10 to the financial statements, the Principal
Stockholder has undertaken to indemnify the Group against any
contingent liabilities including tax liabilities and claims that may
result from the operating activities of the Group in Hong Kong, the PRC
and elsewhere occurring prior to the balance sheet date. Had any
payments be found necessary, the payments made by the Principal
Stockholder will be recorded as expenses in the Group's financial
statements with a corresponding credit to contributed (paid-in) capital
in accordance with the stipulations as mentioned in the Staff
Accounting Bulletin Topic 5-T.
8. OBLIGATIONS UNDER FINANCE LEASES
Physical HK and Physical TST lease fitness equipment and motor vehicles
under several finance leases. The scheduled future minimum lease
payments were as follows:
As of December 31
---------------------------
2000 2001
HK$ HK$
Payable during the following period:
Within one year 6,679 8,079
Over one year but not exceeding two years 4,667 6,979
Over two years but not exceeding three years 3,763 4,443
Over three years but not exceeding four years 3,763 627
Over four years but not exceeding five years 627 -
Thereafter - -
------------ -----------
Total minimum lease payments 19,499 20,128
Less: Amount representing interest (6,349) (5,118)
------------ -----------
Present value of net minimum lease payments 13,150 15,010
============ ===========
9. COMMITMENTS
CAPITAL EXPENDITURE COMMITMENTS
As of December 31
---------------------------
2000 2001
HK$ HK$
Contracted but not provided net of deposit paid in the
financial statements 16,667 31,554
============ ===========
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 periods
is as follows:
As of December 31
---------------------------
2000 2001
HK$ HK$
Payable during the following periods:
Within one year 66,004 106,076
Over one year but not exceeding two years 71,023 96,038
Over two years but not exceeding three years 50,499 72,052
Over three years but not exceeding four years 33,303 27,529
Over fours years but not exceeding five years 15,859 22,041
Thereafter 44,346 102,222
------------ -----------
Total operating lease commitments 281,034 425,958
============ ===========
F-21
10. RELATED PARTY TRANSACTIONS
The Group had the following transactions with related companies:
Year ended December 31
--------------------------------
1999 2000 2001
HK$ HK$ HK$
Rental of a director's quarter 720 1,080 1,440
Purchase of beauty and fitness equipment 444 - -
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 Principal Stockholder
during the years. The balance due to the Group as at December
31, 2001 was HK$11,695. Under an agreement with the Group, the
Principal Stockholder has pledged 1,500,000 shares of the
Company's stock as collateral.
d) The Principal Stockholder has undertaken to indemnify the
Group against losses arising from any non-recoverability of
various amounts due from related companies. Any such payments
by the Principal Stockholder will be recorded as expenses by
the Group with the corresponding credit to the equity.
e) The Principal Stockholder has also undertaken to indemnify the
Group against any contingent liabilities including tax
liabilities and claims that may result from the operating
activities of the Group in Hong Kong, the PRC and elsewhere
occurring prior to the balance sheet date.
11. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Year ended December 31
-----------------------------------------
1999 2000 2001
HK$ HK$ HK$
Cash paid for:
Interest expense 4,245 3,379 3,638
Income taxes 2,059 7,895 5,457
12. OTHER SUPPLEMENTAL INFORMATION
The following items are included in the consolidated statements of
operations:
Year ended December 31
-----------------------------------------
1999 2000 2001
NOTE HK$ HK$ HK$
Foreign exchange gain a 8 47 31
Interest expense on:
Finance leases 2,346 1,961 2,176
Overdrafts and bank loans 1,846 1,351 912
Others 53 67 550
Interest income a 53 332 378
Sales taxes b 748 843 1,150
Advertising and marketing expenses c 15,323 28,534 35,321
Rental expenses under operating leases 47,249 56,484 70,382
a) Foreign exchange gain and interest income are included in
"Other income (expenses), net" in the Consolidated Statements
of Operations.
b) Sales tax is deducted from "Operating revenue" in the
Consolidated Statements of Operations.
c) Advertising and marketing expenses are included in "Other
selling and administrative expenses" in the Consolidated
Statements of Operations.
F-22
13. POST BALANCE SHEET EVENTS
Subsequent to the balance sheet date, the Group has obtained additional
banking facilities of HK$15,478 from creditworthy commercial banks in
HK to finance its expansion. These facilities are mainly collateralized
by personal guarantee from its stockholders. Up to the date of
financial statements, additional bank loans of HK$12,398 have been
drawndown under these facilities.
14. DISTRIBUTION OF PROFIT
In the opinion of management, any undistributed earnings of Physical
Holdings and the Operating Subsidiaries will be reinvested
indefinitely.
15. RETIREMENT PLAN
The Group did not operate any retirement plan before December 2000.
Following the implementation of the Mandatory Provident Fund ("MPF") in
Hong Kong with effect from December 2000, the Group operates two
Mandatory Provident Fund ("MPF") plans for its Hong Kong employees. The
assets of the MPF plans are held separately from those of the Group in
two provident funds managed by independent trustees. The Group is
required to make contributions to the MPF since January 2001 and
accordingly, no pension expenses have been incurred by the Group during
the years ended December 31, 2000.
16. 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.
17. OPERATING RISKS
a) CONCENTRATION OF SUPPLIERS
The Group purchases beauty products from a number of
suppliers. Details of individual suppliers accounting for more
than 10% of the Group's purchases are as follows:
Year ended December 31
----------------------------------------
1999 2000 2001
% % %
Hope Key Development Limited 64% 41% 39%
Kingstar International Trading Limited N/A 20% 23%
b) CONCENTRATION OF CREDIT RISK
None of the sales to the customers accounted for more than 10%
of the Group's turnover for the three year ended December 31,
1999, 2000 and 2001.
F-23
18. REPORT ON SEGMENT INFORMATION
The Group's operations are classified into two reportable business
segments: provision of physical fitness and beauty treatment services.
Each separately managed segment offers different products requiring
different marketing and distribution strategies.
Information concerning consolidated operations by business segment and
geographic area is presented in the tables below and on the following
pages:
CONSOLIDATED OPERATIONS BY BUSINESS SEGMENT
YEAR ENDED DECEMBER 31
-----------------------------------------------------------
1999 2000 2001 2001
HK$ HK$ HK$ US$
Operating revenues
- Physical fitness 166,917 203,758 272,756 34,969
- Beauty treatments 86,225 99,553 119,341 15,300
- Others 30 1 - -
------------ ------------ ----------- -----------
253,172 303,312 392,097 50,269
============ ============ =========== ===========
Operating profit
- Physical fitness 14,832 7,082 5,235 671
- Beauty treatments 3,670 2,616 3,187 408
------------ ------------ ----------- -----------
18,502 9,698 8,422 1,079
============ ============ =========== ===========
YEAR ENDED DECEMBER 31
-----------------------------------------------------------
1999 2000 2001 2001
HK$ HK$ HK$ US$
Depreciation
- Physical fitness 20,879 28,230 43,815 5,617
- Beauty treatments 12,308 13,105 12,730 1,632
------------ ------------ ----------- -----------
33,187 41,335 56,545 7,249
============ ============ =========== ===========
Total assets
- Physical fitness 117,263 114,983 139,363 17,867
- Beauty treatments 68,868 97,948 118,712 15,220
------------ ------------ ----------- -----------
186,131 212,931 258,075 33,087
============ ============ =========== ===========
Property, plant and equipment additions
- Physical fitness 41,656 60,410 56,239 7,210
- Beauty treatments 9,354 11,524 9,692 1,243
------------ ------------ ----------- -----------
51,010 71,934 65,931 8,453
============ ============ =========== ===========
F-24
18. REPORT ON SEGMENT INFORMATION (CONTINUED)
CONSOLIDATED OPERATIONS BY GEOGRAPHIC AREA
YEAR ENDED DECEMBER 31
-----------------------------------------------------------
1999 2000 2001 2001
HK$ HK$ HK$ US$
Operating revenues
- Hong Kong 238,096 284,007 360,388 46,204
- PRC 15,076 19,305 31,709 4,065
------------ ------------ ----------- -----------
253,172 303,312 392,097 50,269
============ ============ =========== ===========
Operating profit (loss)
- Hong Kong 25,851 19,959 24,107 3,090
- PRC (3,157) (6,101) (12,425) (1,593)
Interest income 53 332 378 48
Interest expenses (4,245) (3,379) (3,638) (466)
Goodwill write-off - (1,113) - -
------------ ------------ ----------- -----------
Net income 18,502 9,698 8,422 1,079
============ ============ =========== ===========
Segment assets
- Hong Kong 154,482 156,815 200,485 25,703
- PRC 31,649 56,116 57,590 7,384
------------ ------------ ----------- -----------
186,131 212,931 258,075 33,087
============ ============ =========== ===========
F-25
19. QUARTERLY CONSOLIDATED FINANICAL DATA (UNAUDITED)
2001
----
QUARTER
---------------------------------------------------------------------------
FIRST SECOND THIRD FOURTH
HK$ HK$ HK$ HK$
Operating revenues 83,079 105,725 106,914 96,379
Operating expenses (81,072) (97,031) (96,530) (98,862)
-------------- -------------- -------------- --------------
Income from operations 2,007 8,694 10,384 (2,483)
Non-operating expenses (1,002) (1,040) (773) (45)
-------------- -------------- -------------- --------------
Income before income taxes and
minority interests 1,005 7,654 9,611 (2,528)
Income taxes (1,051) (2,436) (1,756) (1,542)
Minority interests (137) (841) (466) 909
-------------- -------------- -------------- --------------
Net (loss) income (183) 4,377 7,389 (3,161)
============== ============== ============== ==============
(Loss) Earnings per share of
common stock
- Basic (0.02) 0.44 0.74 (0.32)
============== ============== ============== ==============
2000
Quarter
---------------------------------------------------------------------------
First Second Third Fourth
HK$ HK$ HK$ HK$
Operating revenues 67,378 72,740 83,117 80,077
Operating expenses (61,285) (64,919) (75,748) (83,701)
-------------- -------------- -------------- --------------
Income from operations 6,093 7,821 7,369 (3,624)
Non-operating expenses (818) (448) (528) (1,845)
-------------- -------------- -------------- --------------
Income before income taxes and
minority interests 5,275 7,373 6,841 (5,469)
Income taxes (1,059) (1,347) (1,756) 850
Minority interests (127) (545) 97 (435)
-------------- -------------- -------------- --------------
Net income (loss) 4,089 5,481 5,182 (5,054)
============== ============== ============== ==============
Earnings (Loss) per share of
common stock
- Basic 0.41 0.55 0.52 (0.51)
============== ============== ============== ==============
F-26
ITEM 9. 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, and December 31, 1998.
37
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
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) 45 Chairman of the Board of Directors,
Chief Executive Officer
Yuk Wah Ho 46 President and Director
Robert Chui 45 Chief Financial Officer and Director
Darrie Lam 38 Executive Vice President, Secretary
and Director
Yat Ming Lam 44 Director
Allan Wah Chung Li 44 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 its predecessor companies and
has over sixteen 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").
YUK WAH HO, PRESIDENT, DIRECTOR. Ms. Ho has over twenty 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.
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.
38
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 fellow 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's secretarial affairs, finance and administration functions. Ms. Lam
received a MBA degree from the University of Manchester, U.K.
YAT MING LAM, DIRECTOR. Mr. Lam has been a Director of the Company
since August, 1997. In the past year, Mr. Lam has run his own business in China.
Previously, Mr. Lam was employed as a Sales Manager with Fitness Concept Leisure
Supplies Ltd., one of the leading fitness equipment and product suppliers.
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.
LAM LING, GENERAL MANAGER, BEAUTY. Ms. Lam holds an ITEC Aesthetician
Diploma, Fingertip Accupuncture Certiciate - Hong Kong, Theory & Practice of
Aesthetic Diploma - Cananda and Diploma of Cosmetology - USA. Prior to joining
the Company in June, 1996, Ms. Lam was the General Manager of Golden Maple Leaf
Foundation Management Ltd. Ms. Lam is responsible for the Company's beauty
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 Queensland, 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 customer
relationship. Ms. Holloway received a Graduate Certificate in Recreation and
Sports Management issued by the Victoria University, Australia.
ITEM 11. 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 years 2001,
2000 and 1999 by those persons who served as Chief Executive Officer and any
Named Executive Officer who received compensation in excess of $100,000 during
such years.
39
SUMMARY COMPENSATION TABLE (US$)
Name and Principal Position Year Salary(1) Annual Awards(2)
- --------------------------- ---- --------- -----------------------------------
Bonus (3) Other compensation (4)
-------- ----------------------
Ngai Keung Luk, CEO, Chairman 2001 385,000 - 185,000
2000 385,000 - 138,000
1999 387,000 - 92,000
Jill Bodnar, former President (5) 2001 - - -
2000 45,000 4,900 -
1999 75,000 3,900 -
Yuk Wah Ho, President, COO 2001 304,000 - -
2000 213,000 - -
(1) No officers received or will receive any bonus or other annual
compensation other than salaries during fiscal year 2001, 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 2001 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 2001.
(3) Bonus awarded based on performance.
40
(4) Other compensation for Mr. Luk included an allowance for Mr. Luk's
living accommodations. The yearly allowance of HK$1,440,000
(US$185,000) and HK$1,080,000 (US$138,000) respectively for the fiscal
years 2001 and 2000, represents 100% (2001) and 75% (average for 2000)
of the fair market rent of the property owned by a related company,
Silver Policy Development Limited. Up to June 2000, 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. Up to June 2000, the
Company and Williluck International Limited each paid HK$60,000
(US$7,700) per month to Silver Policy Development Limited. Starting
July 2000, the Company paid the full amount of HK$120,000 (US$15,400)
per month to Silver Policy Development Limited. Yearly allowance to Mr.
Luk is recorded on the Company's books as HK$1,440,000 (US$185,000) in
2001. 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 Hongkong and Shanghai
Bank. See also "Certain Transactions".
(5) Jill Bodnar resigned from her position as the President of the
Registrant in December, 2000.
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.
41
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.
42
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of December 31, 2001, 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 40/F., NatWest Tower, Times Square, No. 1
Matheson Street, Causeway Bay, Hong Kong.
NAME AND AMOUNT AND
ADDRESS OF NATURE PERCENTAGE
BENEFICIAL OF BENEFICIAL BENEFICAILLY
OWNER OWNERSHIP (1) OWNED(2)
- ---------- ------------- ------------
DIRECTORS, OFFICERS AND 5% STOCKHOLDERS
NGAI KEUNG LUK (SERLEO)(3) 8,000,000 80.00%
YUK WAH HO, PRESIDENT (4) 8,000,000 80.00%
ROBERT CHUI, CFO 0 0.00%
DARRIE LAM, VICE PRESIDENT 0 0.00%
YAT MING LAM, DIRECTOR 0 0.00%
ALLAN WAH CHUNG LI, DIRECTOR 0 0.00%
ALL OFFICERS AND DIRECTORS 8,000,000 80.00%
AS A GROUP (6 PERSONS)(3)
- ----------
* 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
from 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. Ho overlap.
43
ITEM 13. 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, 2001 was
HK$11,695,000 (US$1,500,000). Under an agreement with the Company, Mr. Luk has
pledged 1,500,000 shares of the Company stock as collateral. See Note 10 to
Financial Statements.
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$120,000 (US$15,400) for the
fiscal year 2001 for his living accommodations. Such allowance represents 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$11,500) to
HK$106,000 (US$13,600) per month and further increased to HK$120,000 (US$15,400)
from November 1997. Hong Kong Limited and Williluck International Limited
("Williluck") each paid HK$60,000 (US$7,700) per month to Silver Policy up to
June 2000 after which Hong Kong Limited is solely responsible for the monthly
rent of HK$120,000 (US$15,400). The annual rent allowance costs as recorded by
the Company totaled HK$1,440,000 (US$185,000) in 2001. Hong Kong Limited is
using the property as security to obtain a full line of credit from the Hongkong
and Shanghai Banking Corporation. Mr. Luk is a director of Williluck. See also
"Management - Compensation".
The Company had the transactions with related companies as provided in
the Financial Statements, Note 10.
44
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Exhibits.
---------
The following exhibits of the Company are included herein.
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.
10.7 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**.
45
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. ** Filed with the Commission as
exhibit 16 to Form 8-K.
(b) Reports on Form 8-K
-------------------
NONE
46
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 April 10, 2002.
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: 4/12/02
- ------------------------ (principal executive officer)
Ngai Keung Luk
/s/ Yuk Wah Ho President and Director Date: 4/12/02
- ------------------------
Yuk Wah Ho
/s/ Robert Chui Chief Financial Officer and Director Date: 4/12/02
- ------------------------ (Principal accounting and financial officer)
Robert Chui
/s/ Darrie Lam Executive Vice President, Secretary Date: 4/12/02
- ------------------------ and Director
Darrie Lam
/s/ Yat Ming Lam Director Date: 4/12/02
- ------------------------
Yat Ming Lam
/s/ Allan Wah Chung Li Director Date: 4/12/02
- ------------------------
Allan Wah Chung Li