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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT SECTION 13 OF 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002.
( ) TRANSITION REPORT PURSUANT SECTION 13 OF 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-26573
PHYSICAL SPA & FITNESS INC.
(Exact name of small business as specified in its charter)
Delaware 98-0203281
-------------------------------- ------------------
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
40/F NatWest Tower, Times Square
No. 1 Matheson Street, Causeway Bay
Hong Kong
(Address of principal executive offices)
(011) (852) 2917-0000
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act during the past 12 months (or for
such shorter period that the registrant was required to file such reports) and
(2) has been subject to such filing requirements for the past 90 days.
Yes X No
---- ----
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: September 30, 2002, 10,000,000
shares.
Transitional Small Business Disclosure Format (check one) :
Yes No X
---- ----
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION PAGE
----
ITEM 1 - FINANCIAL STATEMENTS
Consolidated Statements of Operations 1
for the three-month and nine-month period
ended September 30, 2002 and 2001 (Unaudited)
Consolidated Balance Sheets at September 30, 2002 (Unaudited) 2
and December 31, 2001
Consolidated Statements of Cash Flows 3
for the nine-month periods ended
September 30, 2002 and 2001 (Unaudited)
Notes to Financial Statements 4
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF 8
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 3 - CONTROLS AND PROCEDURES 13
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS 14
ITEM 2 - CHANGE IN SECURITIES 14
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES 14
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE 14
OF SECURITY HOLDERS
ITEM 5 - OTHER INFORMATION 14
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K 14
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
--------------------------------------------
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
-----------------------------------------------
(In thousands, except share and per share data)
Three months ended September 30 Nine months ended September 30
2001 2002 2002 2001 2002 2002
---------- ---------- ---------- ---------- ---------- ----------
HK$ HK$ US$ HK$ HK$ US$
Operating Revenues
Fitness service 77,973 80,201 10,282 203,127 217,892 27,935
Beauty treatments 28,941 33,593 4,307 92,591 97,099 12,449
---------- ---------- ---------- ---------- ---------- -----------
Total operating revenues 106,914 113,794 14,589 295,718 314,991 40,384
---------- ---------- ---------- ---------- ---------- -----------
Operating Expenses
Salaries and commissions 32,121 37,698 4,833 84,960 101,993 13,076
Rent and related expenses 23,732 35,011 4,488 69,710 97,456 12,494
Depreciation 14,923 13,487 1,729 41,639 47,863 6,136
Other selling and administrative expenses 25,754 27,597 3,538 78,324 76,262 9,777
---------- ---------- ---------- ---------- ---------- -----------
Total operating expenses 96,530 113,793 14,588 274,633 323,574 41,483
---------- ---------- ---------- ---------- ---------- -----------
Income (Loss) from operations 10,384 1 1 21,085 (8,583) (1,099)
---------- ---------- ---------- ---------- ---------- -----------
Non-operating (income) expenses
Other (income), net (171) (82) (11) (601) (279) (36)
Interest expenses 944 1,554 199 3,416 3,511 450
---------- ---------- ---------- ---------- ---------- -----------
Total non-operating (income) expenses,
net 773 1,472 188 2,815 3,232 414
---------- ---------- ---------- ---------- ---------- -----------
Income (Loss) before income taxes and
minority interests 9,611 (1,471) (187) 18,270 (11,815) (1,513)
Provision for income taxes 1,756 1,145 147 5,243 1,882 242
---------- ---------- ---------- ---------- ---------- -----------
Income (Loss) before minority interests 7,855 (2,616) (334) 13,027 (13,697) (1,755)
Minority interests 466 (347) (45) 1,444 (436) (56)
---------- ---------- ---------- ---------- ---------- -----------
Income (Loss) before cumulative effect of
a change in an accounting principle 7,389 (2,963) (379) 11,583 (14,133) (1,811)
Cumulative effect on prior years (to December
31, 2001) of deferral of sales rebates, net
of income taxes and minority interests - (840) (108) - 260 33
---------- ---------- ---------- ---------- ---------- -----------
Net income (loss) 7,389 (3,803) (487) 11,583 (13,873) (1,778)
Other comprehensive loss
- - Foreign currency translation adjustments - - - - (11) (1)
---------- ---------- ---------- ---------- ---------- -----------
Comprehensive income (loss) 7,389 (3,803) (487) 11,583 (13,884) (1,779)
========== ========== ========== ========== ========== ===========
Income (Loss) per share before cumulative
effect of a change in accounting principle 0.74 (0.30) (0.04) 1.16 (1.41) (0.18)
Cumulative effect on prior years (to December
31, 2001) of deferral of sales rebates - (0.08) (0.01) - 0.02 -
---------- ---------- ---------- ---------- ---------- -----------
Income (Loss) per common share 0.74 (0.38) (0.05) 1.16 (1.39) (0.18)
========== ========== ========== ========== ========== ===========
Number of shares outstanding (in
thousands) 10,000 10,000 10,000 10,000 10,000 10,000
========== ========== ========== ========== ========== ===========
Pro forma portion
Net income (loss), assuming accounting
change is applied retroactively 8,929 (2,963) (379) 14,930 (14,133) (1,811)
========== ========== ========== ========== ========== ===========
Income (Loss) per common share 0.90 (0.30) (0.04) 1.50 (1.41) (0.18)
========== ========== ========== ========== ========== ===========
Translation of amounts from Hong Kong Dollars ("HK$") into United States Dollars
("US$") for the convenience of the reader has been made at the exchange rate of
US$1.00 = HK$7.8. No representation is made that the Hong Kong Dollar amounts
could have been, or could be, converted into United States Dollars, at that rate
on September 30, 2002 or at any other certain rate.
-1-
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
--------------------------------------------
AUDITED CONSOLIDATED BALANCE SHEET
-----------------------------------
AS OF DECEMBER 31, 2001
AND
UNAUDITED CONSOLIDATED BALANCE SHEET
------------------------------------
AS OF September 30, 2002
(Amounts in thousands, except number of shares and share data)
As of
-------------------------------------------------------
December 31, 2001 September 30, 2002
HK$ HK$ US$
ASSETS
Current assets
Cash and cash equivalents 4,787 2,308 296
Trade receivables 13,568 12,293 1,576
Rental and utility deposits 21,733 30,525 3,913
Prepayments to vendors and suppliers and other current assets 9,380 8,023 1,029
Inventories 2,373 2,372 304
Due from related companies - 4,848 622
----------------- ----------------- -----------------
Total current assets 51,841 60,369 7,740
----------------- ----------------- -----------------
Bank deposits and securities, collateralized 6,935 13,261 1,700
Due from a stockholder 11,695 11,318 1,451
Prepayments for construction-in-progress 11,970 18,062 2,316
Property, plant and equipment, net 175,634 223,029 28,593
----------------- ----------------- -----------------
Total assets 258,075 326,039 41,800
================= ================= =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Due to a related company 5 - -
Short-term bank loans 1,769 8,918 1,143
Long-term bank loans - current portion 12,462 24,653 3,161
Accounts payable and accrued expenses 20,644 74,717 9,579
Obligations under finance leases - current portion 5,668 9,391 1,204
Deferred income - current portion 71,000 71,904 9,218
Deferred liabilities - current portion 4,372 5,845 749
Income taxes payable 963 1,410 181
Taxes other than income 5,973 6,015 771
----------------- ----------------- -----------------
Total current liabilities 122,856 202,853 26,006
----------------- ----------------- -----------------
Deferred income - non-current portion 6,691 6,246 801
Deferred liabilities - non-current portion 5,211 8,248 1,057
Long-term bank loans - non-current portion 2,781 3,593 461
Obligations under finance leases - non-current portion 9,342 7,346 942
Deferred taxation 7,434 7,434 953
Minority interests 7,079 7,522 964
Stockholders' equity:
Common stock, par value US$0.001 each,
100 million shares of stock authorized;
10 million shares of stock issued and outstanding 78 78 10
Cumulative translation adjustments 173 162 21
Retained earnings 96,430 82,557 10,585
----------------- ----------------- -----------------
Total stockholders' equity 96,681 82,797 10,616
----------------- ----------------- -----------------
Total liabilities and stockholders' equity 258,075 326,039 41,800
================= ================= =================
Translation of amounts from Hong Kong Dollars ("HK$") into United States Dollars
("US$") for the convenience of the reader has been made at the exchange rate of
US$1.00 = HK$7.8. No representation is made that the Hong Kong Dollar amounts
could have been, or could be, converted into United States Dollars, at that rate
on September 30, 2002 or at any other certain rate.
-2-
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
--------------------------------------------
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
-----------------------------------------------
FOR THE NINE MONTHS FROM JANUARY 1, 2001 TO SEPTEMBER 30, 2001
AND JANUARY 1, 2002 TO SEPTEMBER 30, 2002
(in thousands)
Nine Months Ended September 30
----------------------------------------------
2001 2002 2002
HK$ HK$ US$
Cash flows from operating activities:
Net income (loss) 11,583 (13,873) (1,778)
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Minority interests 1,444 442 56
Depreciation 41,639 47,863 6,136
Loss on disposal of property, plant and equipment 910 312 40
Changes in working capital:
Trade receivables (5,290) 1,275 163
Deposits, prepayments and other current assets (4,205) (7,435) (953)
Inventories 2 1 -
Due from related companies 915 (4,853) (622)
Due from a stockholder (9,308) - -
Accounts payable and accrued expenses (8,193) 54,073 6,932
Deferred income 35,443 459 59
Deferred liabilities 70 4,510 578
Income taxes payable 4,162 447 57
Taxes other than income 41 42 5
-------------- -------------- --------------
Net cash provided by operating activities 69,213 83,263 10,673
-------------- -------------- --------------
Cash flows from investing activities:
Prepayments for construction-in-progress 5,553 (6,092) (781)
Acquisition of property, plant and equipment (54,448) (95,973) (12,303)
Sales proceeds from disposal of property, plant and equipment 62 403 52
-------------- -------------- --------------
Net cash used in investing activities (48,833) (101,662) (13,032)
-------------- -------------- --------------
Cash flows from financing activities:
Increase in bank deposits and securities (1,373) (6,326) (811)
Due from a stockholder - 377 48
(Settlement of) proceeds from short-term bank loans (5,627) 7,149 917
Proceeds from long-term bank loans 5,000 26,170 3,355
Repayment of long-term bank loans (6,759) (13,167) (1,688)
Assumption of finance lease obligations 8,074 7,982 1,023
Capital element of finance lease rental payments (5,111) (6,254) (802)
-------------- -------------- --------------
Net cash provided by financing activities (5,796) 15,931 2,042
-------------- -------------- --------------
Net increase (decrease) in cash and cash equivalents 14,584 (2,468) (317)
Cash and cash equivalents at beginning of period 1,759 4,787 614
Cumulative translation adjustments - (11) (1)
-------------- -------------- --------------
Cash and cash equivalents at end of period 16,343 2,308 296
============== ============== ==============
Translation of amounts from Hong Kong Dollars ("HK$") into United States Dollars
("US$") for the convenience of the reader has been made at the exchange rate of
US$1.00 = HK$7.8. No representation is made that the Hong Kong Dollar amounts
could have been, or could be, converted into United States Dollars, at that rate
on September 30, 2002 or at any other certain rate.
-3-
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
--------------------------------------------
NOTES TO FINANCIAL STATEMENTS
-----------------------------------------------------
(Amounts in thousands, except share and per share data)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements include
the accounts of Physical Spa & Fitness Inc. ("the Company") and the
subsidiaries that it controls. The Company, through its subsidiaries,
operates fitness and spa/beauty centers in Hong Kong and China. Unless
otherwise specified in the text, references to the Company include the
Company and its subsidiaries. These financial statements should be read
in conjunction with the consolidated financial statements included in
the Company's Annual Report on Form 10-K for the year ended December
31, 2001.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles
for interim financial information and with the instructions to Form
10-Q and Article 10 of Regulation S-X. Accordingly, they do not include
all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion
of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been
included. Operating results for the nine-month period ended September
30, 2002 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2002.
The balance sheet at December 31, 2001 has been derived from the
audited financial statements at that date but does not include all of
the information and footnotes required by generally accepted accounting
principles for complete financial statements.
2. PREPARATION OF FINANCIAL STATEMENTS
The Group has a negative working capital of HK$71,015 and HK$142,484 as
of December 31, 2001 and September 30, 2002. Besides, the Group has a
net income of HK$11,583 and a net loss of HK$13,873 for the nine-month
periods ended September 30, 2001 and 2002. These conditions raise
substantial doubt about the Group's ability to continue as a going
concern.
Continuation of the group as a going concern is dependent upon
attaining profitable operations in the future, exercising tight cost
and cash flow controls measures, and seeking additional banking
facilities. In addition, 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.
3. NEW ACCOUNTING PRONOUNCEMENTS
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. Since January 1, 2002, the
consolidated financial statements have been prepared in conformity with
EITF 01-9. Upon adoption by the Group since January 1, 2002, sales
rebates incurred were accounted for as a reduction in the corresponding
revenues instead of being included in other selling and administrative
expenses. In addition, the sales rebates incurred have been deferred in
synchronization with the deferral of revenue in accordance with the
Group's accounting policy. As a result, deferred income for the current
quarter have been increased by HK$2,213 while expenses have been
reduced by HK$1,030 and revenues have been increased by HK$2,323. In
addition, revenues and deferred income have been increased by HK$5,276
and HK$4,637 respectively while expenses have been reduced by HK$9,595
for the nine-month period ended September 30, 2002.
Had the change in accounting for the deferral of sales rebates been
effective for the three-month period ended September 30, 2001,
revenues, expenses and deferred income would have been reduced by
HK$966, HK$2,506 and HK$1,540 respectively. In addition, revenues,
expenses and deferred income for the six-month period ended September
30, 2001 would have been reduced by HK$1,234, HK$4,581 and HK$3,347
respectively.
-4-
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
--------------------------------------------
NOTES TO FINANCIAL STATEMENTS
-----------------------------------------------------
(Amounts in thousands, except share and per share data)
3. NEW ACCOUNTING PRONOUNCEMENTS (Continued)
In April 2002, the FASB issued SFAS No. 145: "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and
Technical Corrections". This statement made revisions to the accounting
for gains and losses from the extinguishment of debt, rescinded
Statement No. 44, and required certain lease modifications that have
economic effects similar to sale-leaseback transactions be accounted
for in the same manner as sale- leaseback transactions. At this time,
the management believe that the adoption of this statement will not
have a material effect on the Group's consolidated financial position,
results of operations and cash flows.
In June 2002, the FASB issued SFAS No. 146 "Accounting for Costs
Associated with Exit or Disposal Activities". SFAS No. 146 requires
that a liability for a cost that is associated with an exit or disposal
activity be recognized when the liability is incurred. This standard
nullifies the guidance of EITF Issue No. 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)". Under
EITF Issue No. 94-3, an entity recognized a liability for an exit cost
on the date that the entity committed itself to an exit plan. Under
SFAS No. 146, the FASB concluded that an entity's commitment to an exit
plan does not, by itself, create a present obligation to other parties
that meets the definition of a liability. SFAS No. 146 also establishes
that fair value is the objective for the initial measurement of the
liability. SFAS No. 146 will be effective for exit or disposal
activities that are initiated after December 31, 2002. The Company does
not expect that this standard will have a material effect on its
consolidated financial statements.
-5-
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
--------------------------------------------
NOTES TO FINANCIAL STATEMENTS
-----------------------------------------------------
(Amounts in thousands, except share and per share data)
4. 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
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------------------------- ------------------------------
2001 2002 2001 2002
HK$ HK$ HK$ HK$
Operating revenues
- Physical fitness 77,973 80,201 203,127 217,892
- Beauty treatments 28,941 33,593 92,591 97,099
----------- ----------- ----------- -----------
106,914 113,794 295,718 314,991
=========== =========== =========== ===========
Operating profit (loss)
- Physical fitness 7,054 2,786 8,609 (1,938)
- Beauty treatments 335 (6,589) 2,974 (11,935)
----------- ----------- ----------- -----------
7,389 (3,803) 11,583 (13,873)
=========== =========== =========== ===========
Depreciation
- Physical fitness 11,734 10,994 32,053 36,814
- Beauty treatments 3,189 2,493 9,586 11,049
----------- ----------- ----------- -----------
14,923 13,487 41,639 47,863
=========== =========== =========== ===========
Total assets
- Physical fitness 5,938 7,884 194,855 176,061
- Beauty treatments 1,578 6,716 58,204 149,978
----------- ----------- ----------- -----------
7,516 14,600 253,059 326,039
=========== =========== =========== ===========
Property, plant and equipment additions
- Physical fitness 2,491 5,508 50,808 58,704
- Beauty treatments 1,076 3,080 5,714 37,269
----------- ----------- ----------- -----------
3,567 8,588 56,522 95,973
=========== =========== =========== ===========
-6-
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
--------------------------------------------
NOTES TO FINANCIAL STATEMENTS
-----------------------------------------------------
(Amounts in thousands, except share and per share data)
4. REPORT ON SEGMENT INFORMATION (CONTINUED)
CONSOLIDATED OPERATIONS BY GEOGRAPHIC AREA
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------------------------- ------------------------------
2001 2002 2001 2002
HK$ HK$ HK$ HK$
Operating revenues
- Hong Kong 98,518 103,561 271,724 286,300
- PRC 8,396 10,233 23,994 28,691
----------- ----------- ----------- -----------
106,914 113,794 295,718 314,991
=========== =========== =========== ===========
Operating profit (loss)
- Hong Kong 11,374 1,395 21,006 (1,759)
- PRC (3,111) (3,655) (6,314) (8,653)
Interest income 71 12 307 51
Interest expenses (945) (1,555) (3,416) (3,512)
----------- ----------- ----------- -----------
Net income 7,389 (3,803) 11,583 (13,873)
=========== =========== =========== ===========
Segment assets
- Hong Kong 9,193 4,902 194,855 254,090
- PRC (1,677) 9,698 58,204 71,949
----------- ----------- ----------- -----------
7,516 14,600 253,059 326,039
=========== =========== =========== ===========
5. LONG-TERM BANK LOANS
The Group has obtained additional banking facilities of HK$5,372 and
HK$26,170 during the three-month period and nine-month period ended
September 30, 2002 from creditworthy commercial banks in Hong Kong to
finance its expansion. These facilities are collateralized by the
Group's fixed deposits and personal guarantee from its stockholder.
As of September 30, 2002, HK$6,982 of the loans had been repaid and the
outstanding loan balances were analysed as follows:
Principal Repayable during the following
HK$ Interest rate periods
- --------- ------------- -------
3,098 HK$ prime + 1.5% Within one year
2,817 6.65% Within one year
4,695 5.58% Within one year
939 6.65% Within two years
2,546 HK$ prime + 0.5% Serially from 2002 to 2003
5,093 HK$ prime + 0.25% Serially from 2002 to 2004
- ------
19,188
======
Aggregate maturities of the long-term bank loans are as follows:
Principal Payables during the following periods
HK$
17,016 2003
2,172 2004
- ------
19,188
======
-7-
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
PRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
ALL FORWARD-LOOKING STATEMENTS CONTAINED HEREIN ARE DEEMED BY THE COMPANY TO BE
COVERED BY AND TO QUALIFY FOR THE SAFE HARBOR PROTECTION PROVIDED BY THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995. PROSPECTIVE SHAREHOLDERS SHOULD
UNDERSTAND THAT SEVERAL FACTORS GOVERN WHETHER ANY FORWARD - LOOKING STATEMENT
CONTAINED HEREIN WILL BE OR CAN BE ACHIEVED. ANY ONE OF THOSE FACTORS COULD
CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE PROJECTED HEREIN. THESE
FORWARD - LOOKING STATEMENTS INCLUDE PLANS AND OBJECTIVES OF MANAGEMENT FOR
FUTURE OPERATIONS, INCLUDING PLANS AND OBJECTIVES RELATING TO THE PRODUCTS AND
THE FUTURE ECONOMIC PERFORMANCE OF THE COMPANY. ASSUMPTIONS RELATING TO THE
FOREGOING INVOLVE JUDGMENTS WITH RESPECT TO, AMONG OTHER THINGS, FUTURE
ECONOMIC, COMPETITIVE AND MARKET CONDITIONS, FUTURE BUSINESS DECISIONS, AND THE
TIME AND MONEY REQUIRED TO SUCCESSFULLY COMPLETE DEVELOPMENT PROJECTS, ALL OF
WHICH ARE DIFFICULT OR IMPOSSIBLE TO PREDICT ACCURATELY AND MANY OF WHICH ARE
BEYOND THE CONTROL OF THE COMPANY. ALTHOUGH THE COMPANY BELIEVES THAT THE
ASSUMPTIONS UNDERLYING THE FORWARD - LOOKING STATEMENTS CONTAINED HEREIN ARE
REASONABLE, ANY OF THOSE ASSUMPTIONS COULD PROVE INACCURATE AND, THEREFORE,
THERE CAN BE NO ASSURANCE THAT THE RESULTS CONTEMPLATED IN ANY OF THE FORWARD -
LOOKING STATEMENTS CONTAINED HEREIN WILL BE REALIZED. BASED ON ACTUAL EXPERIENCE
AND BUSINESS DEVELOPMENT, THE COMPANY MAY ALTER ITS MARKETING, CAPITAL
EXPENDITURE PLANS OR OTHER BUDGETS, WHICH MAY IN TURN AFFECT THE COMPANY'S
RESULTS OF OPERATIONS. IN LIGHT OF THE SIGNIFICANT UNCERTAINTIES INHERENT IN THE
FORWARD - LOOKING STATEMENTS INCLUDED THEREIN, THE INCLUSION OF ANY SUCH
STATEMENT SHOULD NOT BE REGARDED AS A REPRESENTATION BY THE COMPANY OR ANY OTHER
PERSON THAT THE OBJECTIVES OR PLANS OF THE COMPANY WILL BE ACHIEVED.
Overview of Company's Business:
The Company, through its predecessor companies and its subsidiaries,
has been an established commercial operator of fitness and spa centers in Hong
Kong and China since 1986. The Company currently operates sixteen facilities:
twelve in Hong Kong and four in China (including one in Macau). 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 pre-split (6,000,000 post-split) 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.
-8-
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$600(US$77) for one person.
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 treatments, the customers may purchase single
treatments, or in packages of ten or more treatments, with quantity discounts
available. There is a wide range of beauty treatments available at prices
ranging from HK$280 (US$36) 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.
RESULTS OF OPERATIONS
Three Months Ended Nine Months Ended
September 30 September
2001 2002 2001 2002
----------- ----------- ----------- -----------
Operating Revenues 100.00% 100.00% 100.00% 100.00%
Total operating expenses 90.29% 100.00% 92.87% 102.72%
Operating income (loss) 9.71% (0.00%) 7.13% (2.72%)
Income (Loss) before income taxes and
minority interests 8.99% (1.29%) 6.18% (3.75%)
Provision for income and deferred taxes 1.64% 1.01% 1.77% 0.60%
Minority interests 0.44% 0.30% 0.49% 0.14%
Net income (loss) 6.91% (3.34%) 3.92% (4.40%)
=========== =========== =========== ==========
THREE MONTHS ENDED SEPTEMBER 30, 2002 (UNAUDITED) COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 2001 (UNAUDITED).
- ----------------------------------------------------------------------------
OPERATING REVENUES. The Company's operating revenues increased 6% to
HK$113,794,000 (US$14,589,000) in the third quarter of 2002 as compared to
HK$106,914,000 (US$13,707,000) of last year.
Operating revenues derived by the Company's fitness services, net of
sales rebates of HK$1,085,000 (US$139,000), increased 3% to HK$80,201,000
(US$10,282,000) compared to HK$77,973,000 (US$9,997,000) of the same period
last year. Fitness revenues as a percentage of total revenues were 70% in the
third quarter of 2002 as compared to 73% of last year.
Operating revenues from the Company's beauty treatment business totaled
HK$33,593,000 (US$4,307,000) compared to HK$28,941,000 (US$3,710,000) in the
third quarter of 2001, representing an increase of 16%. Beauty treatment
revenues as a percentage of total revenues increased from 27% to 30%
in the third quarter of 2002 as compared to 2001.
-9-
Operating revenues derived from the Company's Hong Kong locations
remain an important contributor to the Company's business, generating
HK$103,561,000 (US$13,277,000), or 91% of total operating revenues in the third
quarter of 2002 as compared to HK$98,518,000 (US$12,631,000) or 92% of total
operating revenues in 2001.
Operating revenues derived from the Company's China locations generated
HK$10,233,000 (US$1,312,000), or 9% of total operating revenues in the third
quarter of 2002 as compared to HK$8,396,000 (US$1,076,000) or 8% of last year.
OPERATING EXPENSES. The Company's operating expenses for the third
quarter of 2002 totaled HK$113,793,000 (US$14,588,000) compared to HK$96,530,000
(US$12,376,000) in 2001, representing an increase of 18%. Total operating
expenses, after taking into account all corporate expenses, were 100% of total
operating revenue as compared to 90% of last year. This reflects the additional
costs incurred by the Company in following its business expansion plan.
Operating expenses associated with the Company's Hong Kong locations
were HK$99,902,000 (US$12,808,000) in the third quarter of 2002, representing an
increase of 17% as compared to HK$85,111,000 (US$10,912,000) in 2001. The
increase was mainly due to additional expenses incurred by the Wing On, Central
center (opened in April, 2002) and the new unisex fitness centers in Tsuen Wan
(opened in April, 2002) and Kornhill (opened in June, 2002), all of which have
not yet commenced operation in the corresponding period of last year. Hong Kong
operating expenses represented 88% of total operating expenses in the third
quarter of 2002, same as last year.
Operating expenses associated with the Company's China locations were
HK$13,891,000 (US$1,781,000) in the third quarter of 2002, representing an
increase of 22% as compared to HK$11,419,000 (US$1,464,000) in 2001 primarily
due to the opening of an additional unisex fitness center in Xu Hui, Shanghai in
January, 2002. Operating expenses in China represented 12% of total operating
expenses in the third quarter of 2002, same as last year.
TOTAL NON-OPERATING EXPENSES. Total non-operating expenses for the
third quarter of 2002 totaled HK$1,472,000 (US$188,000) compared to HK$773,000
(US$99,000) in 2001. This represents an increase of 90% due to higher interest
expenses.
PROVISION FOR INCOME TAXES. Provision for income taxes for the third
quarter of 2002 totaled HK$1,145,000 (US$147,000) compared to HK$1,756,000
(US$225,000) in the third quarter of 2001. The decrease of 35% was mainly due to
losses incurred in the period under review.
NET LOSS. The Company has generated a net loss of HK$3,803,000
(US$487,000) for the third quarter of 2002, compared to a net income of
HK$7,389,000 (US$947,000) for 2001, representing a decrease of 151%. The
loss was mainly due to the pre-opening overhead associated with the new
centers being recorded but neither income has yet been generated nor
recognized.
NINE MONTHS ENDED SEPTEMBER 30, 2002 (UNAUDITED) COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 2001 (UNAUDITED).
- ----------------------------------------------------------------------------
OPERATING REVENUES. Operating revenues for the first nine months of
2002 totaled HK$314,991,000 (US$40,384,000) compared to HK$295,718,000
(US$37,913,000) of last year, representing an increase of 7%.
Operating revenues derived by the Company's fitness services, net of
sales rebates of HK$9,697,000 (US$1,243,000), increased 7% to HK$217,892,000
(US$27,935,000) compared to HK$203,127,000 (US$26,042,000) in 2001. Fitness
revenues as a percentage of total revenues were 69% in the first nine months of
2002, same as last year.
Operating revenues from the Company's beauty treatment business
increased 5% to HK$97,099,000 (US$12,449,000) in the first nine months of 2002
compared to HK$92,591,000 (US$11,871,000) of last year. Beauty treatment
revenues as a percentage of total revenues were 31% in the first nine months of
2002 and 2001.
-10-
Operating revenues derived from the Company's Hong Kong locations
remain an important contributor to the Company's business, generating
HK$286,300,000 (US$36,705,000), or 91% of total operating revenues in the nine
months ended September 30, 2002 as compared to HK$271,724,000 (US$34,836,000) or
92% of total operating revenues in the nine months ended September 30, 2001.
Operating revenues derived from the Company's China locations generated
HK$28,691,000 (US$3,678,000), or 9% of total operating revenues in the nine
months ended September 30, 2002 as compared to HK$23,994,000 (US$3,076,000) or
8% of total operating revenues in the nine months ended September 30, 2001.
OPERATING EXPENSES. The Company's operating expenses for the first nine
months of 2002 totaled HK$323,574,000 (US$41,483,000) compared to HK$274,633,000
(US$35,209,000) in the first nine months of 2001, representing an increase of
18%. Total operating expenses, after taking into account all corporate expenses,
were 103% of total operating revenue as compared to 93% of last year. This
reflects the additional costs incurred by the new centers during the period
under review.
Operating expenses associated with the Company's Hong Kong locations,
after an adjustment of the sales rebate, were HK$286,070,000 (US$36,675,000)
in the nine months ended September 30, 2002, representing an increase of 17%
as compared to HK$244,202,000 (US$31,308,000) in 2001. Hong Kong operating
expenses represented 88% of total operating expenses in the nine months ended
September 30, 2002 as compared to 89% in 2001.
Operating expenses associated with the Company's China locations were
HK$37,504,000 (US$4,808,000) in the nine months ended September 30, 2002,
representing an increase of 23% as compared to HK$30,431,000 (US$3,901,000) in
2001. Operating expenses in China represented 12% of total operating expenses
in the nine months ended September 30, 2002 as compared to 11% of last year.
TOTAL NON-OPERATING EXPENSES. Total non-operating expenses for the
first nine months of 2002 totaled HK$3,232,000 (US$414,000) compared to
HK$2,815,000 (US$361,000) in the first nine months of 2001. This represents an
increase of 15% mainly due to higher interest expenses.
PROVISION FOR INCOME TAXES. Provision for income taxes for the first
nine months of 2002 totaled HK$1,882,000 (US$242,000) compared to HK$5,243,000
(US$672,000) in the first nine months of 2001, representing a decrease of 64%
as a result of losses incurred in the period under review.
NET INCOME. The Company reported a net loss of HK$13,873,000
(US$1,778,000) for the first nine months of 2002, compared to a net income of
HK$11,583,000 (US$1,485,000) for the first nine months of 2001, representing a
decrease of 220%. The decrease reflects the additional overhead associated with
the opening of new centers not yet recovered by their additional contribution.
-11-
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.
Cash and cash equivalent balances for the respective periods ended
September 30, 2002 and December 31, 2001 were HK$2,308,000 (US$296,000) and
HK$4,787,000 (US$614,000), while total indebtedness at September 30, 2002 was
HK$53,901,000 (US$6,910,000) and HK$32,022,000 (US$4,105,000) at December 31,
2001.
Net cash provided by operating activities were HK$92,074,000
(US$11,804,000) and HK$83,263,000 (US$10,673,000) for Fiscal Year 2001, and the
nine-month period ended September 30, 2002, 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$9,087,000) and
HK$101,662,000 (US$13,032,000) for Fiscal Year 2001 and the nine-month period
ended September 30, 2002, primarily as a result of expenditures for property,
plant and equipment. Net cash (used in) provided by financing activities, which
mainly include proceeds from bank loans, net interest and repayment, were
HK$(18,164,000) (US$(2,328,000))and HK$15,931,000 (US$2,042,000) in Fiscal Year
2001 and the nine-month period ended September 30, 2002, respectively.
During the nine-month period ended September 30, 2002, the Company has
not entered into any transactions using derivative financial instruments or
derivative commodity instruments nor held any marketable equity securities of
publicly traded companies. Accordingly, the Company believes its exposure to
market interest rate risk and price risk is not material. The Company's
long-term loans bear interest rates varying from 5.375% to 7.625% per annum. The
total balance outstanding as of September 30, 2002 on such loans was
HK$28,246,000 (US$3,621,000). 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$32,158,000 (US$4,123,000). These
facilities were secured by certain leasehold property in Hong Kong owned by the
Company's subsidiary (Ever Growth Limited) and a related company, 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 and securities
owned by the Company's subsidiaries (Physical Health Centre Hong Kong Limited
and Physical Health Centre (TST) Limited), and personal guarantees from Mr. Luk,
respectively.
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 beauty customers. This practice
creates working capital that the Company generally utilizes for working capital
purposes. However, the unused portion of the pre-paid monthly dues and spa
treatment dues is characterized as deferred income, a liability, for accounting
purposes.
The Company's trade receivable balance at September 30, 2002, was
HK$12,293,000 (US$1,576,000). The Company has never experienced any significant
problems with collection of accounts receivable from its customers.
Capital expenditure for Fiscal Year 2001, and the nine-month period
ended September 30, 2002, were HK$65,931,000 (US$8,453,000) and HK$95,973,000
(US$12,303,000) respectively. The Company also had capital expenditure
commitments of approximately HK$7,000,000 (US$897,000) as of September 30, 2002
compared with HK$31,554,000 (US$4,045,000) as of December 31, 2001, all of which
were contracted but not provided for in the financial statements. Subsequent to
the balance sheet date of September 30, 2002, the Company has not committed
significant capital expenditure. The Company believes that cash flow generated
from its operations, the tight cost and cash flow control measures and its
existing and additional credit facilities to be sought should be sufficient to
satisfy its working capital and capital expenditure requirements for at least
the next 12 months. In addition, 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.
-12-
CRITICAL ACCOUNTING POLICIES
Besides the accounting policies as described in note 3 to the financial
statements for the year ended December 31, 2001, the management consider that
its critical accounting policies include accounting for the deferral of sales
rebates as mentioned in note 3 to the financial statements as included in Item 1
above.
ITEM 3 - CONTROLS AND PROCEDURES
Within the 90-day period prior to the filing of this report, an
evaluation was carried out under the supervision and with participation of the
Company's management, including our Chief Executive Officer and Principal
Financial Officer, of the effectiveness of our disclosure controls and
procedures (as defined in Rule 13a-14(c) under the Securities Exchange Act of
1934). Based on their evaluation, our Chief Executive Officer and Principal
Financial Officer have concluded that disclosure controls and procedures are, to
the best of their knowledge, effective to ensure that information required to be
disclosed by the Company in reports that it files or submits under the Exchange
Act is recorded, processed, summarized and reported within the time periods
specified in Securities and Exchange Commission rules and forms. Subsequent to
the date of their evaluation, there were not significant changes in the
Company's internal controls or in other factors that could significantly affect
these controls, including any corrective actions with regard to significant
deficiencies and material weaknesses.
-13-
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
NONE
ITEM 2 - CHANGES IN SECURITIES
NONE
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
NONE
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS
NONE
ITEM 5 - OTHER INFORMATION
NONE
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
NONE
-14-
SIGNATURES
Pursuant to the requirements of the Exchange Act, the registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
PHYSICAL SPA & FITNESS INC.
(Registrant)
Date: November 18, 2002 /s/ Ngai Keung Luk
------------------------------------
Ngai Keung Luk,
Chairman and Chief Executive Officer
Date: November 18, 2002 /s/ Robert Chui
------------------------------------
Robert Chui,
Chief Financial Officer
-15-
CERTIFICATION
I, Ngai Keung Luk, Chairman and Chief Executive Officer and I,
Robert Chui, Chief Financial Officer, certify that:
1. We have reviewed this quarterly report on Form 10-Q of Physical
Spa & Fitness Inc. (the "registrant");
2. Based on our knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on our knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officers and we are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and we have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and we have indicated in this
quarterly report whether there were significant changes in internal controls or
in other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
11/18/02 /s/ Ngai Keung Luk
- --------------- -------------------------------------
Date Chairman and Chief Executive Officer
11/18/02 /s/ Robert Chui
- --------------- -------------------------------------
Date Chief Financial Officer