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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, 2002
[ ] 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
------
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, 2002 was $820,000 based upon the average of
the last available bid and asked price of the Common Stock of $0.41 as of
December, 2002.
The number of shares outstanding of the registrant's classes of common
stock as of December 31, 2002: 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 seventeen facilities:
thirteen 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 (two
centers) and Kowloon City. Another six 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, Physical Beauty Centre (Central) Limited and Physical Health
Centre (Kornhill) Limited respectively operates the Tsuen Wan Center (opened in
July, 1998), the Sheraton Hotel Center (opened in July, 1999), the Tuen Mun
Center (opened in July, 2000), the Elizabeth House Center (opened in April,
2001), the Wing On Centre (opened in April, 2002), and the Kornhill Center
(opened in June, 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 Fitness & Beauty Centre Co, Ltd. (formerly known as Shanghai
Physical Ladies' Club Co., Ltd.) ("Shanghai Joint Venture"), which operates two
centers in the city of Shanghai, and Dalian Physical Ladies' Club Co., Ltd.
("Dalian Joint Venture"), which operates fitness and spa facility in the city of
Dalian. The Company, through its subsidiaries, holds a 99% interest (changed
from 100% in 2002) in the Shanghai Joint Venture and a 90% interest in the
Dalian Joint Venture. The minority interests in the two joint ventures are held
by the joint ventures' Chinese partners. 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 100,000 customers.
The Company's strategy is to provide a one-stop fitness and beauty
center for its customers. 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 offering 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 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 Huanghpu and
Hongqiao centers were respectively relocated to Lu Wan (October, 2002) and Xu
Hui (March, 2001) with enhanced facilities. 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 these centers 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.
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 Fitness & Beauty Centre Co, Ltd. (formerly
Known as 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 (Shatin) Limited (formerly
known as Physical Health Centre (PM) Limited), Physical Health Centre (Kornhill)
Limited, and Physical Health Centre (Central) 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 30,000 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
(Central) Limited** a beauty
center in
Hong Kong
Physical Health Centre March 15, 1996 HK - 100% Investment
(Dalian) Limited holding
("Dailan Physical")
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 December 31, 2001 HK - 100% Operating 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
(Shatin) Limited** fitness and
(formerly known as beauty center
Physical Health in Hong Kong
Centre (PM) Limited)
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
Physical Health Centre August 9, 2002 HK - 100% Inactive
(Central) Limited**
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 |
|99% | 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, Physical Health Centre (Shatin) Limited (Formerly knowna as Physical
Health Centre (PM) Limited), and Physical Health Centre (Central) 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 Lu Wan Co-operative Originally Originally Originally Originally none(joint venturer receives
Physical and Xu Hui 100% and 10 years US$1,000 in rent for locations and will
Fitness (formerly changed and cash and receive equipment when the
& Beauty known as to 99% extended increased to joint venture is dissolved)
Centre Huangpu & in 2002 to 15 US$2,000 in and changed to pro-rata to
Co, Ltd. Hongqiao), years cash in 1995 equity interests in 2002
(formerly Shanghai in 2002
known as
Shanghai
Physical
Ladies' Club
Co., Ltd.)
("Shanghai
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 and further extended by 5 years in 2002.
By an amendment of the joint venture contract on June 1, 2002, the equity
interest of Shanghai Physical changed from 100% to 99%. The remaining 1% of the
equity interest was transferred from Shanghai Physical to SHTYG.
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, 2003, the Company opened six 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, Physical
Beauty Centre (Central) Limited, and Physical Health Centre (Kornhill) Limited
respectively. These collectively make up a total of thirteen 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 relocated to Lu Wan with an
expanded area of 80,000 sq. ft. in October, 2002), 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 (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 established a new fitness/spa center in Kornhill, Hong Kong in
June, 2002. The Company plans to open new centers in other major metropolitan
cities in China over the next several years. However, 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$2,000 (US$256), 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$600 (US$77). 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. 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 2002.
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$9,800 (US$1,300) 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$345 (US$44) to
HK$699 (US$90). These establishments range in size from 10,000 sq ft to 30,000
sq ft. Examples are California Fitness with five outlets, and Fitness First
Health Clubs with four outlets. The Company's fitness/spa facilities compete
directly primarily with the middle markets (see below).
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$150
(US$19) 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 fourteen
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. 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 has
registered the name in Chinese language pursuant to the Chinese Trademark Law
which 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 1,430 employees, including approximately
30 commission based sales executives. Approximately 750 employees are involved
in fitness operations, including sales personnel, instructors, and supervisory
personnel. Approximately 500 employees are involved in beauty and spa
operations. Approximately 150 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$56.5 million (US$7.2
million), HK$70.4 million (US$9 million) and HK$103.6 million (US$13 million)
for the year ended December 31, 2000, 2001 and 2002, 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.
24
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, 2002.
25
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, 2003, the 52-week trading
range was between $0.15 to $0.51 per share. The last reported sale was in March,
2003 at $0.51 per share. The reported sporadic sales in the fiscal year 2002,
are set forth below*.
Date Open High Low Close
Nov-02 0.25 0.25 0.15 0.15
Dec-02 0.15 0.41 0.15 0.41
- ---------------------
* Historical quotes provided by Commodity Systems, Inc.
As of December 31, 2002, there were approximately 619 record holders of
the Company's Common Stock. The Company effected a 1.333333-for-1 reverse split
of its Common Stock in October 1997 and a 1-for-1.333333 forward stock split in
June 1998.
DIVIDEND POLICY
- ---------------
The Company has never paid any cash dividends on its Common Stock and
does not anticipate paying any cash dividends in the future. Physical Health
Centre Hong Kong Limited, the subsidiary of the company acquired by the Company
in October, 1996, paid dividends out in 1995. The Company currently intends to
retain future earnings, if any, to fund the development and growth of its
business.
26
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data are qualified by reference to, and should
be read in conjunction with, the Consolidated Financial Statements, related
Notes to Consolidated Financial Statements and Report of Independent Public
Accountants, and Management's Discussion and Analysis of Financial Condition and
Results of Operations contained elsewhere herein. The following table summarizes
certain selected financial data of the Company for the fiscal years ended
December 31, 1998 through December 31, 2002. The data has been derived from
Consolidated Financial Statements (audited) included in Item 8 of this Report.
(In thousands, except share and per share data)
YEAR ENDED DECEMBER 31
---------------------------------------------------------------------
1998 1999 2000 2001 2002 2002
HK$ HK$ HK$ HK$ HK$ US$
--------- --------- --------- --------- --------- ---------
Consolidated Statements of Operations Data
OPERATING REVENUES 210,209 253,172 303,312 392,097 413,744 53,044
--------- --------- --------- --------- --------- ---------
OPERATING EXPENSES
Salaries and commissions (56,415) (70,729) (88,999) (113,239) (139,740) (17,915)
Rent and related expenses (46,527) (63,931) (74,685) (95,413) (132,929) (17,042)
Depreciation (25,781) (33,187) (41,335) (51,494) (63,412) (8,130)
Other selling and administrative expenses (60,572) (57,520) (80,634) (108,298) (95,844) (12,288)
--------- --------- --------- --------- --------- ---------
Total operating expenses (189,295) (225,367) (285,653) (368,444) (431,925) (55,375)
--------- --------- --------- --------- --------- ---------
INCOME (LOSS) FROM OPERATIONS 20,914 27,805 17,659 23,653 (18,181) (2,331)
--------- --------- --------- --------- --------- ---------
NON-OPERATING INCOME (EXPENSES)
Other income, net 645 452 853 778 418 54
Interest expenses (3,933) (4,245) (3,379) (3,638) (5,645) (724)
Goodwill write-off -- -- (1,113) -- -- --
--------- --------- --------- --------- --------- ---------
Total non-operating expenses (3,288) (3,793) (3,639) (2,860) (5,227) (670)
--------- --------- --------- --------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAXES AND
MINORITY INTERESTS AND THE CUMULATIVE
EFFECT OF A CHANGE IN ACCOUNTING
PRINCIPLE 17,626 24,012 14,020 20,793 (23,408) (3,001)
(Provision) Credit for income taxes 108 (4,933) (3,312) (6,785) (834) (107)
--------- --------- --------- --------- --------- ---------
INCOME (LOSS) BEFORE MINORITY INTERESTS
AND THE CUMULATIVE EFFECT OF A CHANGE
IN ACCOUNTING PRINCIPLE 17,734 19,079 10,708 14,008 (24,242) (3,108)
Minority interests (1,198) (577) (1,010) (761) 147 19
--------- --------- --------- --------- --------- ---------
NET INCOME (LOSS) BOFORE CUMULATIVE EFFECT
OF A CHANGE IN ACCOUNTING PRINCIPLE 16,536 18,502 9,698 13,247 (24,095) (3,089)
Cumulative effect on prior year of deferral
of sales rebates, net of income taxes
and minority interests -- -- -- -- 3,857 494
--------- --------- --------- --------- --------- ---------
NET INCOME (LOSS) 16,536 18,502 9,698 13,247 (20,238) (2,595)
========= ========= ========= ========= ========= =========
Net income per share 1.65 1.85 0.97 1.32 (2.02) (0.26)
========= ========= ========= ========= ========= =========
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 39,467 41,206 31,135 51,841 55,597 7,128
Total assets 169,641 186,131 212,931 263,126 324,890 41,653
Current liabilities 81,976 67,809 88,677 122,856 209,239 26,826
Long-term obligations other than finance
leases 13,592 16,319 15,789 15,243 22,252 2,852
Working capital (42,509) (26,603) (57,542) (71,015) (153,642) (19,698)
Obligations under finance leases-non current 4,215 12,114 8,191 9,342 5,032 645
Deferred taxation 4,712 5,661 6,312 7,434 4,593 589
Minority interests 5,144 5,721 6,544 7,305 7,285 933
Shareholders' equity 60,002 78,507 88,260 101,506 81,256 10,418
27
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 seventeen facilities: thirteen 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 100,000 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$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 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,
--------------------------
2000 2001 2002
---- ---- ----
Operating Revenues 100.00% 100.00% 100.00%
Total operating expenses 94.18% 93.97% 104.39%
Operating income (loss) 5.82% 6.03% (4.39%)
Income (Loss) before income taxes and
minority interests 4.62% 5.30% (5.66%)
Provision for income and deferred taxes 1.09% 1.73% 0.20%
Minority interests 0.33% 0.19% (0.04%)
Net income (loss) 3.20% 3.38% (4.89%)
======== ======== ========
28
FISCAL YEAR ENDED DECEMBER 31, 2002 COMPARED TO FISCAL YEAR ENDED DECEMBER 31,
- ------------------------------------------------------------------------------
2001
- ----
OPERATING REVENUES. The Company's operating revenues increased 6% to
HK$413,744,000 (US$53,044,000) in the fiscal year ended December 31, 2002 as
compared to HK$392,097,000 (US$50,269,000) of last year.
Operating revenues derived by the Company's fitness services, net of
sales rebates of HK$4,743,000 (US$608,000), increased 2% to HK$278,212,000
(US$35,668,000) compared to HK$272,756,000 (US$34,969,000) of last year. Fitness
revenues as a percentage of total revenues were 67% in 2002 as compared to 70%
in 2001.
Operating revenues for the Company's beauty treatments in 2002 totaled
HK$135,532,000 (US$17,376,000) compared to HK$119,341,000 (US$15,300,000) in
2001, representing an increase of 14%. Beauty revenues as a percentage of total
revenues increased from 30% to 33% in 2002 as compared to 2001.
Operating revenues derived from the Company's Hong Kong locations
remain an important contributor to the Company's business, generating
HK$374,102,000 (US$47,962,000), or 90% of total operating revenues in the fiscal
year ended December 31, 2002 as compared to HK$360,388,000 (US$46,204,000) or
92% of total operating revenues in the fiscal year ended December 31, 2001.
Operating revenues derived from the Company's China locations generated
HK$39,642,000 (US$5,082,000), or 10% of total operating revenues in the fiscal
year ended December 31, 2002 as compared to HK$31,709,000 (US$4,065,000) or 8%
of total operating revenues in the fiscal year ended December 31, 2001.
OPERATING EXPENSES. The Company's operating expenses for the fiscal
year ended December 31, 2002 totaled HK$431,925,000 (US$55,375,000) compared to
HK$368,444,000 (US$47,236,000) in the fiscal year ended December 31, 2001,
representing an increase of 17%. Total operating expenses, after taking into
account all corporate expenses, were 104% of total operating revenue as compared
to 94% 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$375,867,000 (US$48,188,000) in the fiscal year ended December 31, 2002,
representing an increase of HK$51,763,000 (US$6,637,000) or 16% as compared to
HK$324,104,000 (US$41,551,000) in 2001. The increase was mainly due to
additional expenses incurred by the Wing On, Central Center (opened in April,
2002), the new unisex fitness center in Tsuen Wan (opened in April, 2002) and
Kornhill Center (opened in June, 2002), all of which have not yet commenced
operation in 2001. Hong Kong operating expenses represented 87% of total
operating expenses in 2002 as compared to 88% in 2001.
Operating expenses associated with the Company's China locations were
HK$56,058,000 (US$7,187,000) in the fiscal year ended December 31, 2002,
representing an increase of 26% as compared to HK$44,340,000 (US$5,685,000) in
2001 primarily due to additional expenses incurred by the enhanced facilities in
Shanghai. Operating expenses in China represented 13% of total operating
expenses in the fiscal year ended December 31, 2002 as compared to 12% in 2001.
29
TOTAL NON-OPERATING EXPENSES. Total non-operating expenses for the
fiscal year ended December 31, 2002 totaled HK$5,227,000 (US$670,000) compared
to HK$2,860,000 (US$367,000) in the fiscal year ended December 31, 2001,
representing an increase of 83% mainly due to higher interest expenses.
PROVISION FOR INCOME TAXES. Provision for income taxes for the fiscal
year ended December 31, 2002 totaled HK$834,000 (US$107,000) compared to
HK$6,785,000 (US$870,000) in 2001, representing a decrease of 88%. The decrease
is mainly due to losses incurred in the year.
NET LOSS. The Company generated a net loss of HK$20,238,000
(US$2,595,000) for the fiscal year ended December 31, 2002, compared to a net
income of HK$13,247,000 (US$1,698,000) for the fiscal year ended December 31,
2001, representing a decrease of 253%. The loss was mainly due to the narrowing
margin of the existing centers and the absorption of the pre-opening overhead
associated with four new centers.
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$368,444,000 (US$47,236,000) compared to
HK$285,653,000 (US$36,623,000) in the fiscal year ended December 31, 2000,
representing an increase of 29%. 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 94% of total operating revenue being in line with last
year.
Operating expenses associated with the Company's Hong Kong locations
were HK$324,104,000 (US$41,551,000) in the fiscal year ended December 31, 2001,
representing an increase of HK$65,999,000 (US$8,461,000) or 26% 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 expenses incurred by the Elizabeth House center which has not yet
commenced operation in 2000. Moreover, additional marketing expenses 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 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.
30
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$13,247,000 (US$1,698,000) compared to HK$9,698,000
(US$1,244,000) for the fiscal year ended December 31, 2000, representing an
increase of 37%. The increase in the net income was mainly due to a prior year
adjustment of HK$4,825,000 (US$619,000) for overprovision of depreciation 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.
31
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.
32
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 8 "Short-Term Bank Loans"; Note 9 "Long-Term Bank Loans"; and Note 12
"Obligations under Finance Leases").
Cash and cash equivalent balances for the fiscal years ended December
31, 2002 and December 31, 2001 were HK$1,336,000 (US$171,000) and HK$4,787,000
(US$614,000) respectively.
Net cash provided by operating activities were HK$105,334,000
(US$13,503,000), HK$92,074,000(US$11,804,000), and HK$76,854,000 (US$9,853,000)
for fiscal years 2002, 2001, and 2000 respectively. The Company's operating
activities are historically financed by cash flows from operations. Net cash
used in investing activities were HK$120,362,000 (US$15,430,000), HK$70,881,000
(US$9,087,000), and HK$78,127,000 (US$10,016,000) for fiscal years 2002, 2001,
and 2000 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$11,589,000 (US$1,486,000), HK$(18,164,000) (US$(2,328,000)), and HK$81,000
(US$11,000) for fiscal years 2002, 2001, and 2000 respectively.
During the fiscal year ended December 31, 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 5.25% to 6.65% per annum. The
total balance outstanding as of December 31, 2002 on such loans was
HK$22,252,000 (US$2,852,000). The last repayment on the loans is due in 2007.
The Company had total banking facilities available from financial institutions
amounting to approximately HK$51,069,000 (US$6,547,000). 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 (E House) 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 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, 2002, was
HK$5,672,000 (US$727,000) 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 2002, 2001 and 2000 were
HK$126,364,000 (US$16,199,000), HK$65,931,000 (US$8,453,000) and HK$71,934,000
(US$9,222,000), 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.
33
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Since some operations of the Company are operated in the People's
Republic of China ("PRC"), they are subject to special considerations and
significant risks not typically associated with investments in equity securities
of United States and Western European companies. These include risks associated
with, among others, the political, economic and legal environments and foreign
currency exchange. These are described further in the following:
POLITICAL ENVIRONMENT
The value of the Company's interests in the Shanghai and Dalian joint
ventures ("JVs") may be adversely affected by significant political, economic
and social uncertainties in the PRC. A change in policies by the Chinese
government could adversely affect the Company's interests in the Shanghai and
Dalian JVs by, among other factors: changes in laws, regulations or the
interpretation thereof; confiscatory taxation; restrictions on foreign currency
conversion, imports or sources of suppliers; or the expropriation or
nationalization of private enterprises.
ECONOMIC ENVIRONMENT
The economy of the PRC differs significantly from the economies of the
United States and Western Europe in such respects as structure, level of
development, gross national product, growth rate, capital reinvestment, resource
allocation, self-sufficiency, rate of inflation and balance of payments
position, among others. Only recently has the Chinese government encouraged
substantial private economic activities.
The Chinese economy has experienced significant growth in the past five
years, but such growth has been uneven among various sectors of the economy and
geographic regions. Actions by the Chinese central government to control
inflation have significantly restrained economic expansion recently. Similar
actions by the central government of the PRC in the future could have a
significant adverse effect on economic conditions in the PRC and the economic
prospects for the Group.
FOREIGN CURRENCY EXCHANGE
The Chinese central government imposes control over its foreign
currency reserves through control over imports and through direct regulation of
the conversion of its national currency into foreign currencies. As a result,
the Renminbi is not freely convertible into foreign currencies.
The Shanghai and Dalian JVs conduct substantially all of their business
in the PRC, and their financial performance and condition are measured in terms
of Renminbi. The revenues and profits of the Shanghai and Dalian JVs are
predominantly denominated in Renminbi, and will have to be converted to pay
dividends to the Company in United States Dollars or Hong Kong Dollars. Should
the Renminbi devalue against these currencies, such devaluation would have a
material adverse effect on the Company's profits and the foreign currency
equivalent of such profits repatriated by the Shanghai and Dalian JVs to the
Company. The Company currently is not able to hedge its exchange rate exposure
in the PRC because neither the banks in the PRC nor any other financial
institution authorized to engage in foreign exchange transactions offer forward
exchange contracts.
LEGAL ENVIRONMENT
Since 1979, many laws and regulations dealing with economic matters in
general and foreign investment in particular have been enacted in the PRC.
However, the PRC still does not have a comprehensive system of laws and
enforcement of existing laws may be uncertain and sporadic.
34
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-2
Consolidated Statements of Operations for the years ended
December 31, 2000, 2001 and 2002 F-3
Consolidated Balance Sheets as of December 31, 2001 and 2002 F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 2000, 2001 and 2002 F-5
Consolidated Statements of Stockholders' Equity for the years
ended December 31, 2000, 2001 and 2002 F-6
Notes to Consolidated Financial Statements F-7
35
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, 2002
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, 2001
and 2002 and the related consolidated statements of operations, stockholders'
equity and cash flows for each of the three years in the period ended December
31, 2002. 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 Physical Spa &
Fitness Inc. and subsidiaries as of December 31, 2001 and 2002 and the results
of their operations and cash flows for each of the three years in the period
ended December 31, 2002 in conformity with accounting principles generally
accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the Group
will continue as a going concern. As discussed in Note 3 (b) to the financial
statements, the Group has suffered losses from operations during the year 2002
and has a negative working capital that raise substantial doubt about its
ability to continue as a going concern. Management's plans in regard to these
matters are also described in Note 3 (b). The financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
As discussed in Note 3 (t) to the financial statements, the Group changed its
method of accounting for sales rebates in the year 2002.
/s/ Moores Rowland
MOORES ROWLAND
CHARTERED ACCOUNTANTS
CERTIFIED PUBLIC ACCOUNTANTS
Hong Kong
Date: April 11, 2003
F-3
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
- -------------------------------------------------------------------------------------------------------------------------
(In thousands, except share and per share data)
YEAR ENDED DECEMBER 31
-----------------------------------------------------------------
2000 2001 2002 2002
NOTE HK$ HK$ HK$ US$
(Restated)
OPERATING REVENUES 303,312 392,097 413,744 53,044
-------------- -------------- --------------- ------------
OPERATING EXPENSES
Salaries and commissions (88,999) (113,239) (139,740) (17,915)
Rent and related expenses (74,685) (95,413) (132,929) (17,042)
Depreciation (41,335) (51,494) (63,412) (8,130)
Other selling and administrative expenses (80,634) (108,298) (95,844) (12,288)
-------------- -------------- --------------- ------------
Total operating expenses (285,653) (368,444) (431,925) (55,375)
-------------- -------------- --------------- ------------
INCOME (LOSS) FROM OPERATIONS 17,659 23,653 (18,181) (2,331)
-------------- -------------- --------------- ------------
NON-OPERATING INCOME (EXPENSES)
Other income, net 853 778 418 54
Interest expenses (3,379) (3,638) (5,645) (724)
Goodwill write-off (1,113) - - -
-------------- -------------- --------------- ------------
Total non-operating expenses (3,639) (2,860) (5,227) (670)
-------------- -------------- --------------- ------------
INCOME (LOSS) BEFORE INCOME TAXES AND MINORITY
INTERESTS AND THE CUMULATIVE EFFECT OF A
CHANGE IN ACCOUNTING PRINCIPLE 14,020 20,793 (23,408) (3,001)
Income taxes 10 (3,312) (6,785) (834) (107)
-------------- -------------- --------------- ------------
INCOME (LOSS) BEFORE MINORITY INTERESTS AND
THE CUMULATIVE EFFECT OF A CHANGE IN
ACCOUNTING PRINCIPLE 10,708 14,008 (24,242) (3,108)
Minority interests (1,010) (761) 147 19
-------------- -------------- --------------- ------------
NET INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF A
CHANGE IN ACCOUNTING PRINCIPLE 9,698 13,247 (24,095) (3,089)
Cumulative effect on prior year of deferral of
sales rebates, net of income taxes and
minority interests 3(t) - - 3,857 494
-------------- -------------- --------------- ------------
NET INCOME (LOSS) 9,698 13,247 (20,238) (2,595)
Other comprehensive income (loss)
- - Foreign currency translation adjustments 55 (1) (12) (2)
-------------- -------------- --------------- ------------
COMPREHENSIVE INCOME (LOSS) 9,753 13,246 (20,250) (2,597)
============== ============== =============== ============
The financial statements should be read in conjunction with the accompanying notes.
F-4
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
- -------------------------------------------------------------------------------------------------------------------------
(In thousands, except share and per share data)
YEAR ENDED DECEMBER 31
-----------------------------------------------------------------
2000 2001 2002 2002
NOTE HK$ HK$ HK$ US$
(Restated)
Earnings (Loss) per share of common stock before
cumulative effect of change in accounting
principle 0.97 1.32 (2.41) (0.31)
Cumulative effect on prior year of deferral of
sales rebates - - 0.39 0.05
-------------- -------------- --------------- ------------
Earnings (Loss) per share of common stock - Basic 0.97 1.32 (2.02) (0.26)
============== ============== =============== ============
Number of shares of common stock outstanding (in
thousands) 10,000 10,000 10,000 10,000
============== ============== =============== ============
PROFORMA AMOUNTS ASSUMING THE CHANGE IN
ACCOUNTING FOR REBATES IS APPLIED
RETROACTIVELY 3(t)
Net income (loss) 9,698 17,104 (20,238) (2,595)
============== ============== =============== ============
Earnings (Loss) per share of common stock - Basic 0.97 1.71 (2.02) (0.26)
============== ============== =============== ============
The financial statements should be read in conjunction with the accompanying notes.
F-5
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
- -----------------------------------------------------------------------------------------------------------------------------
(In thousands, except share and per share data)
NOTE AS OF DECEMBER 31
-------------------------------------------
2001 2002 2002
ASSETS HK$ HK$ US$
(Restated)
CURRENT ASSETS
Cash and cash equivalents 4,787 1,336 171
Trade receivables 7,840 5,672 727
Other receivables 10 5,728 6,326 811
Rental and utility deposits 21,733 30,924 3,965
Prepayments to vendors and suppliers and other current assets 9,380 5,112 655
Inventories 3(f) 2,373 3,113 400
Held-to-maturity securities, collateralised 5 - 3,114 399
------------- ----------- ------------
TOTAL CURRENT ASSETS 51,841 55,597 7,128
------------- ----------- ------------
Marketable securities, collateralised 6 - 1,540 198
Bank deposits, collateralised 6,935 13,340 1,710
Due from a stockholder 14(C) 11,695 10,955 1,404
Prepayments for construction-in-progress 11,970 1,690 217
Property, plant and equipment, net 7 180,685 241,768 30,996
------------- ----------- ------------
TOTAL ASSETS 263,126 324,890 41,653
============= =========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Due to a related company 14(d) 5 3,515 451
Short-term bank loans 8 1,769 12,634 1,620
Long-term bank loans - current portion 9 12,462 18,255 2,340
Accounts payable and accrued expenses 11 20,644 73,246 9,391
Obligations under finance leases - current portion 12 5,668 9,358 1,200
Deferred income - current portion 71,000 76,828 9,850
Deferred liabilities - current portion 4,372 5,616 720
Income taxes payable 963 3,764 482
Taxes other than income 5,973 6,023 772
------------- ----------- ------------
TOTAL CURRENT LIABILITIES 122,856 209,239 26,826
------------- ----------- ------------
Deferred income - non-current portion 6,691 6,315 810
Deferred liabilities - non-current portion 5,211 7,173 920
Long-term bank loans - non-current portion 9 2,781 3,997 512
Obligations under finance leases - non-current portion 12 9,342 5,032 645
Deferred taxation 7,434 4,593 589
Minority interests 7,305 7,285 933
STOCKHOLDERS' EQUITY:
Common stock, par value of US$0.001 each,
100 million shares of stock authorized;
10 million shares of stock issued and outstanding 78 78 10
Cumulative translation adjustments 173 161 21
Retained earnings 101,255 81,017 10,387
------------- ----------- ------------
TOTAL STOCKHOLDERS' EQUITY 101,506 81,256 10,418
------------- ----------- ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY 263,126 324,890 41,653
============= =========== ============
APPROVED AND AUTHORIZED FOR ISSUE BY THE BOARD OF DIRECTORS ON
DIRECTOR DIRECTOR
The financial statements should be read in conjunction with the accompanying notes.
F-6
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
- -----------------------------------------------------------------------------------------------------------------------------
(In thousands)
YEAR ENDED DECEMBER 31
--------------------------------------------------------
2000 2001 2002 2002
HK$ HK$ HK$ US$
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) 9,698 13,247 (20,238) (2,595)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Minority interests 1,010 761 (20) (3)
Depreciation 41,335 51,494 63,412 8,130
Loss on disposal of property, plant and equipment 774 2,853 1,493 191
Goodwill on acquisition of further interests in
subsidiaries written off 1,113 - - -
Changes in working capital:
Trade and other receivables (932) (8,741) 1,570 201
Deposits, prepayments and other current assets (2,183) (9,549) (4,923) (631)
Inventories 481 (303) (740) (95)
Due from a stockholder 2,002 - - -
Due to a related company 7,458 920 3,510 450
Accounts payable and accrued expenses 5,318 (2,974) 52,602 6,744
Deferred income 14,003 39,861 5,452 699
Deferred liabilities 1,226 520 3,206 411
Income taxes payable (5,234) 206 2,801 359
Taxes other than income 134 2,657 50 6
Deferred taxation 651 1,122 (2,841) (364)
----------- ----------- -------------- ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 76,854 92,074 105,334 13,503
----------- ----------- -------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Prepayments for construction-in-progress (6,487) (5,016) 10,280 1,318
Acquisition of property, plant and equipment (71,934) (65,931) (126,364) (16,199)
Acquisition of marketable securities - - (4,654) (597)
Acquisition of further interests in subsidiaries from (1,300) - - -
minority interests
Sales proceeds from disposal of property, plant and 1,594 66 376 48
equipment
----------- ----------- -------------- ------------
NET CASH USED IN INVESTING ACTIVITIES (78,127) (70,881) (120,362) (15,430)
----------- ----------- -------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in bank deposits (45) (3,368) (6,405) (821)
Due from a stockholder - (9,587) 740 95
(Settlement of) Proceeds from short-term bank loans (314) (6,523) 10,865 1,393
Proceeds from long-term bank loans 17,000 10,287 28,670 3,676
Repayment of long-term bank loans (8,649) (10,833) (21,661) (2,777)
Assumption of finance lease obligations 1,300 8,875 7,982 1,023
Capital element of finance lease rental payments (5,011) (7,015) (8,602) (1,103)
Repayment of loans from minority shareholders of (4,200) - - -
subsidiaries
----------- ----------- -------------- ------------
NET CASH PROVIDED (USED IN) BY FINANCING ACTIVITIES 81 (18,164) 11,589 1,486
----------- ----------- -------------- ------------
EFFECT OF EXCHANGE RATE CHANGES ON CASH 55 (1) (12) (2)
----------- ----------- -------------- ------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (1,137) 3,028 (3,451) (443)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 2,896 1,759 4,787 614
----------- ----------- -------------- ------------
CASH AND CASH EQUIVALENTS AT END OF YEAR 1,759 4,787 1,336 171
=========== =========== ============== ============
The financial statements should be read in conjunction with the accompanying notes.
F-7
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
- ------------------------------------------------------------------------------------------------------------------------
(In thousands, except share and per share data)
CUMULATIVE
RETAINED TRANSLATION
COMMON STOCK EARNINGS ADJUSTMENTS TOTAL
---------------------------- ------------ ----------------- -----------
NOTE NUMBER HK$ HK$ HK$ HK$
Balance as of January 1, 2000 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
Prior year adjustments 4 - - 4,825 - 4,825
-------------- ------------ ------------- ---------------- -----------
Net income (Restated) - - 13,247 - 13,247
Translation adjustment - - - (1) (1)
-------------- ------------ ------------- ---------------- -----------
Balance as of December 31, 2001
(Restated) 10,000,000 78 101,255 173 101,506
Net loss - - (20,238) - (20,238)
Translation adjustment - - - (12) (12)
-------------- ------------ ------------- ---------------- -----------
BALANCE AS OF DECEMBER 31, 2002 10,000,000 78 81,017 161 81,256
============== ============ ============= ================ ===========
F-8
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 Quotations
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-9
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
1. ORGANIZATION AND PRINCIPAL ACTIVITIES (COntinued)
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% Operating a
(Central) Limited beauty
centre in HK
Physical Health Centre March 15, 1996 HK - 100% Investment
(Dalian) Limited holding
("Physical Dailan")
Physical Health Centre (E December 1, 1998 HK - 100% Operating a
House) Limited fitness
centre in HK
Physical Health Centre December 31, 2001 HK - 100% Operating a
(Kornhill) Limited 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
(Shatin) Limited a Fitness
(formerly known as Centre in HK
Physical Health
Centre (PM) Limited)
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-10
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
1. ORGANIZATION AND PRINCIPAL ACTIVITIES (Continued)
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
Star Perfection Holdings April 15, 1996 BVI - 100% Investment
Limited holding
Supreme Resources Limited September 29, 1994 HK - 100% Operating a
("Supreme") beauty
centre in HK
Su Sec Pou Physical Health August 18, 1997 Macau - 100% Operating a
Centre (Macau), Limited fitness
("Physical Macau") centre in
Macau
Physical Health Centre August 9, 2002 HK - 100% Inactive
(Central), Limited
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-11
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
1. ORGANIZATION AND PRINCIPAL ACTIVITIES (Continued)
a) Shanghai Physical Fitness and Beauty Centre Co., Ltd., (formerly
known as 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.
On 1 April 2002, the Shanghai JV has obtained approval from the
PRC government to change some of the provisions of the JV
contract. One of the major changes is that the Chinese JV partner
no longer provides the premises to the JV but would contribute
US$20, representing 1% of the registered capital of the JV. In
return, the Chinese JV partner will share 1% of the profit made by
the JV but will not bear any loss. In addition, the JV period has
been extended from 10 years to 15 years.
The Chinese JV partner has not yet made its capital contribution
up to the date of these financial statements.
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.
F-12
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
1. ORGANIZATION AND PRINCIPAL ACTIVITIES (Continued)
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.
d) Under the JV contract between Physical Health Centre (Zhong Shan)
Limited ("Physical Zhongshan") (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, 2002 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, 2002 or at any other rate.
F-13
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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$71,015 and
HK$153,642 as of December 31, 2001 and 2002 respectively. Besides,
the Group has a net income of HK$13,247 and a net loss of
HK$20,238 for the year ended December 31, 2001 and 2002
respectively. 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 obtaining 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.
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 represents the excess of the purchase consideration
payable in acquisitions of subsidiaries over the fair value of the
net assets acquired at the time of acquisition. Goodwill on
consolidation is stated at cost when it arises. As part of an
ongoing review of the valuation and amortization of goodwill,
management assesses the carrying value of the goodwill to
determine if changes in facts and circumstances suggest that they
may be impaired. If this review indicates that the goodwill is not
recoverable, as determined by a discounted cash flow analysis over
the remaining amortization period, the carrying value of the
goodwill would be reduced to its estimated fair market value.
On disposal of a subsidiary, any attributable amount of purchased
goodwill not previously amortized through the statement of
operations is included in the calculation of the gain or loss on
disposal.
F-14
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
f) 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 has 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
---------------------------------
2001 2002 2002
HK$ HK$ US$
Beauty products for treatment 1,392 1,941 249
Beauty products for sale 981 1,172 151
-------- --------- --------
2,373 3,113 400
======== ========= ========
g) MARKETABLE DEBT AND EQUITY SECURITIES
Debt securities and equity securities designated as
available-for-sale, whose fair values are readily determinable,
are carried at fair value with unrealized gains or losses included
as a component of accumulated other comprehensive income, net of
applicable taxes. Debt and equity securities classified as trading
securities are carried at fair value with unrealized gains or
losses included in income. Debt securities that are expected to be
held-to-maturity are carried at amortized cost. Individual
securities classified as either available-for-sale or
held-to-maturity are reduced to net realizable value by a charge
to income for other than temporary declines in fair value.
Realized gains and losses are determined on the average cost
method and are reflected in income.
h) PROPERTY, PLANT AND EQUIPMENT AND DEPRECIATION
Property, plant and equipment are 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-15
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
h) PROPERTY, PLANT AND EQUIPMENT AND DEPRECIATION (Continued)
When assets are transferred between property, plant and equipment
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 property, plant
and equipment 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
It is the Group's policy to periodically review the estimated
useful lives of its property, plant and equipment. This review
during the year indicated that with good effort in keeping up the
conditions of the centres, the useful lives of the leasehold
improvements could reach eight to nine years. In view of the
current economic situation in Hong Kong, the management considers
it should be prudent in future expansion and will most likely take
up not only the first option of renewal as in the past but also
the second option of renewal of the leases of various centres. As
a result, the Group has extended the depreciable period of
leasehold improvements so that it would include the original lease
terms plus the first option of renewal as well as the second
option of renewal, retroactive from January 1, 2002. The effect of
this change in estimate was to reduce depreciation charge and net
loss for 2002 by HK$3,044. Loss per share for 2002 had also been
reduced by 0.30.
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.
i) 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.
j) 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.
F-16
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
k) 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.
Property, plant and equipment 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(h) 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.
l) 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.
m) 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.
n) INCOME TAXES
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.
F-17
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
o) 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.
p) 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.
q) EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share exclude dilution and are computed
by dividing earnings (loss) available to common shareholders by
the weighted average number of common shares outstanding for the
periods.
Diluted earnings (loss) per share are 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 (loss) per share are the
same.
r) 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.
s) 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-18
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
t) ACCOUNTING CHANGE
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 in 2002 and
subsequent thereto were accounted for as a reduction in the
corresponding revenues instead of being included in 2002 and
subsequent thereto in other selling and administrative expenses.
In addition, sales rebates incurred have been deferred in
synchronization with the deferral of revenues in accordance with
the Group's accounting policy. As a result, revenues, expenses and
deferred income have been reduced by HK$7,781, HK$10,182 and
HK$2,401 respectively for the year ended December 31, 2002.
Had the change in accounting for the deferral of sales rebates
been effective for the year ended December 31, 2001, revenues,
expenses and deferred income would have been reduced by HK$2,803
and HK$7,546 and HK$4,743 respectively.
The total proforma cumulative effect of this accounting change on
prior years resulted in an after-tax and minority interests credit
to income of 3,857 for the year ended December 31, 2001.
u) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
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. The Group is required to adopt this
statement from January 1, 2003. The management believes that the
adoption of this standard 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 management does not expect that this standard will have
a material effect on its consolidated financial statements.
F-19
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
u) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS (Continued)
In November 2002, the Financial Accounting Standards Board issued
Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others". FIN 45 expands on the
accounting guidance of statements No. 5, 57 and 107 and
incorporates without change the provisions of FASB interpretation
No. 34, which is being superseded. FIN 45 elaborates on the
existing disclosure requirements for most guarantees, including
loan guarantees such as standby letters of credit. FIN 45 also
clarifies that at the time a company issues a guarantee, the
company must recognize an initial liability for the fair value, or
market value, of the obligations it assumes under that guarantee
and must disclose that information in its interim and annual
financial statements. The initial recognition and initial
measurement provisions apply on a prospective basis to guarantees
issued or modified after December 31, 2002, regardless of the
guarantor's fiscal year-end. The disclosure requirements in FIN 45
are effective for financial statements with respect to interim or
annual periods ending after December 15, 2002. The Group has
adopted the provisions of FIN 45 in the fiscal year of 2002.
Adoption of FIN 45 had no impact on the Group's results of
operations or disclosures in the financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation--Transition and Disclosure--an amendment
of FASB Statement No. 123". This Statement amends SFAS No. 123,
"Accounting for Stock-Based Compensation", to provide alternative
methods of transition for a voluntary change to the fair value
based method of accounting for stock-based employee compensation.
In addition, this Statement amends the disclosure requirements of
SFAS No. 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method
used on reported results. Certain provisions of SFAS No. 148 are
effective from December 15, 2002. The management believes that
adoption of this standard does not have impact on the Group's
financial statements.
In January 2003, the FASB published interpretation No. 46,
Consolidation of Variable Interest Entities ("FIN 46") to clarify
the conditions under which assets, liabilities and activities of
another entity should be consolidated into the financial
statements of a company. FIN 46 requires the consolidation of a
variable interest entity (including a special purpose entity such
as that utilized in an accounts receivable securitization
transaction) by a company that bears the majority of the risk of
loss from the variable interest entity's activities or is entitled
to receive a majority of the variable interest entity's residual
returns or both. The provisions of FIN 46 are required to be
adopted in the fiscal year of 2003. The management does not
believe the adoption of FIN 46 will have a material impact on the
Group's financial position or results of operations.
F-20
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
u) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS (Continued)
In January 2003, the FASB's Emerging Issues Task Force, or EITF,
reached a consensus on Issue 02-16, Accounting by a Customer
(including a Reseller) for Cash Consideration Received from a
Vendor. Issue 02-16 provides guidance on how a customer should
account for cash consideration received from a vendor. The
transition provisions apply prospectively to arrangements entered
into or modified subsequent to December 31, 2002 and would require
all amounts received from vendors to be accounted for as a
reduction of the cost of the products purchased unless certain
criteria are met to allow presentation as a reduction of
advertising expense. The Group will adopt the provisions of Issue
02-16 from January 1, 2003. The management believes that adoption
of Issue 02-16 will not have a material impact on the
classification and timing of recognition of vendor consideration
in the Group's statements of operations.
4. PRIOR YEAR ADJUSTMENTS
Prior year adjustments are analysed as follows:
2000 2001 2002
HK$ HK$ HK$
(Restated)
Overprovision of depreciation in 2001 (note a) - 5,051 -
Profit arising from 2001 adjustments shared by minority
interest (note b) - (226) -
---------- --------------- ------------
- 4,825 -
========== =============== ============
a) In 2001, depreciation charge on leasehold improvements of some
centers were overstated as a result of calculation error. The
cumulative effect to the balance sheet date at December 31,
2001 is that both assets and retained earnings had been
understated by HK$5,051.
b) As a result of the restatement of the results in 2001 as
mentioned in note (a) above, the profits shared by minority
interest was increased by HK$226.
Accordingly, the earnings per share of common stock for the year ended
December 31, 2001 was revised from HK$0.84 to HK$1.32.
5. HELD-TO-MATURITY SECURITIES
These securities represent corporate bonds with maturity in June 2003
and have been pledged to a bank to secure general banking facilities
granted to the Group.
F-21
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
6. MARKETABLE SECURITIES
The balance represents unlisted capital guaranteed fund which is mainly
made up of US dollars debt securities. As at the balance sheet date, as
the cost approximated to the estimated fair value, no gain or loss was
recognized. The contractual maturity date of the fund is March 2006.
These securities have been pledged to a bank to secure general banking
facilities granted to the Group.
7. PROPERTY, PLANT AND EQUIPMENT, NET
AS OF DECEMBER 31
------------------------------------------------
2001 2002 2002
HK$ HK$ US$
Land and buildings 3,137 3,137 402
Leasehold improvements 133,152 180,832 23,183
Machinery and equipment 158,874 207,778 26,638
Furniture and fixtures 44,646 56,290 7,217
Computers 4,833 6,700 859
Motor vehicles 5,972 4,583 588
Less: Accumulated depreciation (169,929) (217,552) (27,891)
------------- ------------- ------------
Net book value 180,685 241,768 30,996
============= ============= ============
As of December 31, 2002, the cost and accumulated depreciation of
property, plant and equipment held under finance leases amounted to
approximately HK$33,716 (2001: HK$36,512) and HK$14,478 (2001:
HK$18,103) respectively.
8. SHORT-TERM BANK LOANS
The short-term bank loans are collateralized and repayable within one
year. Please refer to Note 9 for details of collateral for such
facilities.
Supplemental information with respect to the short-term bank loans was
as follows:
YEAR ENDED DECEMBER 31
-----------------------------------------------------
2000 2001 2002
Maximum amount outstanding during the years HK$8,292 HK$13,102 HK$13,898
Average amount outstanding during the years HK$4,973 HK$4,749 HK$8,305
Weighted average interest rate at the end of the years 8% 5% 8%
Weighted average interest rate during the years 9% 6% 7%
F-22
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
9. LONG-TERM BANK LOANS
The Group obtained various lines of credit under banking facilities
which aggregated HK$51,069 as of December 31, 2002 (2001: HK$34,662)
from creditworthy commercial banks in HK and PRC to finance its
operations. These loans were collateralized by certain of the assets of
the Group and its stockholders. As of December 31, 2002, the loans
consisted of the following:
PRINCIPAL INTEREST RATE MATURITY
HK$
1,090 HK$ prime + 0.25% Within one year
754 HK$ prime + 0.5% Within one year
6,439 6.65% Within one year
4,700 5.57% Within one year
940 6.65% Within two years
4,222 HK$ prime + 0.25% Serially from 2003 to 2004
2,417 HK$ prime + 1.5% Serially from 2003 to 2005
1,690 HK$ prime + 1.5% Serially from 2003 to 2007
---------------
22,252
===============
Aggregate maturities of the long-term bank loans are as follows:
PRINCIPAL PAYABLES DURING THE FOLLOWING PERIODS
HK$
18,255 2003
---------------
2,610 2004
777 2005
360 2006
250 2007
---------------
3,997
---------------
22,252
===============
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 E House;
(iii) leasehold property in Hong Kong owned by a related company;
(iv) personal guarantees from the Principal Stockholder;
(v) held-to-maturity securities and marketable securities as stated in notes
(5) and (6); and
(vi) a fixed charge over Physical Macau's machinery and equipment and a
floating charge over its other asses.
F-23
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
10. INCOME TAXES
Reconciliation to the expected statutory tax rate in Hong Kong of 16.0%
(2001: 16% AND 1999: 16%) is as follows:
YEAR ENDED DECEMBER 31
-----------------------------------
2000 2001 2002
% % %
Weighted average statutory rate 16.0 16.0 16.0
Tax effect of net operating losses 11.7 13.2 (17.9)
Tax effect of timing differences 9.8 13.9 (7.2)
Write back of overprovision for taxation in prior years (13.4) - -
Others (0.5) - (0.2)
--------- --------- ---------
Effective rate 23.6 43.1 (9.3)
========= ========= =========
Income tax expense is comprised of the following:
YEAR ENDED DECEMBER 31
---------------------------------------------------
2000 2001 2002 2002
HK$ HK$ HK$ US$
Current taxes 2,661 5,663 4,434 569
Deferred taxes 651 1,122 (2,841) (364)
Tax effect related to deferral of
sales rebates in 2001 - - (759) (98)
---------- --------- ----------- --------
Income tax expense 3,312 6,785 834 107
========== ========= =========== ========
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% (2001 AND 2000: 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-24
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
10. 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$11,986 (2001: HK$11,388), of which an
amount of HK$6,326 (2001: HK$5,728) has been provided for as taxes
other than income and as Other Receivables in the liabilities and
assets respectively. No further provision has been made for the
difference which amounted to HK$5,660 (2001: HK$5,660) and any
potential amount of penalty which might be imposed. In this respect,
the directors are of the opinion that the probability that such
potential liabilities will be crystallised would be remote.
As also stated in Note 14(e) to the financial statements, the Principal
Stockholder has undertaken to indemnify the Group against any
contingent liabilities including tax liabilities and claims that may
result from the operating activities of the Group in Hong Kong, the PRC
and elsewhere occurring prior to the balance sheet date. Had any
payments be found necessary, the payments made by the Principal
Stockholder will be recorded as expenses in the Group's financial
statements with a corresponding credit to contributed (paid-in) capital
in accordance with the stipulations as mentioned in the Staff
Accounting Bulletin Topic 5-T.
11. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
AS OF DECEMBER 31
------------------------------------------------
2001 2002 2002
HK$ HK$ US$
TRADE PAYABLES 2,308 7,740 992
------------- ------------- ------------
OTHER PAYABLES
Accrued rental and related expenses 1,584 22,272 2,856
Accrued salaries, commissions and related expenses 8,560 14,097 1,807
Accrued expenses and other creditors 8,192 29,137 3,736
------------- ------------- ------------
18,336 65,506 8,399
------------- ------------- ------------
20,644 73,246 9,391
============= ============= ============
F-25
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
12. OBLIGATIONS UNDER FINANCE LEASES
Physical HK, Physical TST, Physical Kornhill and Physical Tsuen Wan
lease fitness equipment and motor vehicles under several finance
leases. The scheduled future minimum lease payments were as follows:
AS OF DECEMBER 31
---------------------------
2001 2002
HK$ HK$
Payable during the following periods:
Within one year 8,079 11,196
Over one year but not exceeding two years 6,979 6,104
Over two years but not exceeding three years 4,443 627
Over three years but not exceeding four years 627 -
------------ -----------
Total minimum lease payments 20,128 17,927
Less: Amount representing interest (5,118) (3,537)
------------ -----------
Present value of net minimum lease payments 15,010 14,390
============ ===========
13. COMMITMENTS
CAPITAL EXPENDITURE COMMITMENTS
AS OF DECEMBER 31
---------------------------
2001 2002
HK$ HK$
Contracted but not provided net of deposit paid in the
financial statements 31,554 23,442
============ ===========
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
---------------------------
2001 2002
HK$ HK$
Payable during the following periods:
Within one year 106,076 113,801
Over one year but not exceeding two years 96,038 108,756
Over two years but not exceeding three years 72,052 65,091
Over three years but not exceeding four years 27,529 30,028
Over fours years but not exceeding five years 22,041 22,482
Thereafter 102,222 90,036
------------ -----------
Total operating lease commitments 425,958 430,194
============ ===========
F-26
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
14. RELATED PARTY TRANSACTIONS
The Group had the following transactions with related companies:
YEAR ENDED DECEMBER 31
--------------------------------
2000 2001 2002
HK$ HK$ HK$
Rental of a director's quarter 1,080 1,440 1,452
Purchase of beauty and fitness equipment - 5,610 3,442
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 first quarter of the year. The balance due to the Group
as at December 31, 2002 was HK$10,955. Under an agreement with the
Group, the Principal Stockholder has pledged 1,500,000 shares of
the Company's stock as collateral.
d) The amount due to Williluck International Limited is included in
Due to a Related Company in the accompanying balance sheet and is
unsecured, interest free and has no fixed repayment terms.
e) The Principal Stockholder has also undertaken to indemnify the
Group against any contingent liabilities including tax liabilities
and claims that may result from the operating activities of the
Group in Hong Kong, the PRC and elsewhere occurring prior to the
balance sheet date.
15. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
YEAR ENDED DECEMBER 31
----------------------------------------
2000 2001 2002
HK$ HK$ HK$
Cash paid for:
Interest expenses 3,379 3,638 5,645
Income taxes 7,895 5,457 2,355
F-27
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
16. OTHER SUPPLEMENTAL INFORMATION
The following items are included in the consolidated statements of
operations:
YEAR ENDED DECEMBER 31
-----------------------------------------
2000 2001 2002
NOTE HK$ HK$ HK$
Foreign exchange gain a 47 31 -
Interest expenses on:
Finance leases 1,961 2,176 2,071
Overdrafts and bank loans 1,351 912 2,008
Others 67 550 1,566
Interest income a 332 378 126
Sales taxes b 843 1,150 1,026
Advertising and marketing expenses c 28,534 35,321 24,738
Rental expenses under operating leases 56,484 70,382 103,608
a) Foreign exchange gain and interest income are included in "Other
income, net" in the consolidated statements of operations.
b) Sales taxes are deducted from "Operating revenues" 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.
17. DISTRIBUTION OF PROFIT
In the opinion of management, any undistributed earnings of Physical
Holdings and the Operating Subsidiaries will be reinvested
indefinitely.
18. 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 year ended December 31, 2000. The pension expenses charged to the
statement of operations amounted to HK$5,021 and HK$5,707 for the years
ended December 31, 2001 and 2002 respectively.
F-28
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
19. 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.
20. 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
-----------------------------------------
2000 2001 2002
% % %
Hope Key Development Limited 41% 39% -
Kaydex Trading Ltd. - - 40%
Kingstar International Trading Limited 20% 23% 24%
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 years ended December 31, 2000,
2001 and 2002.
F-29
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
21. 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
-----------------------------------------------------------
2000 2001 2002 2002
HK$ HK$ HK$ US$
(Restated)
Operating revenues
- Physical fitness 203,758 272,756 278,212 35,668
- Beauty treatments 99,553 119,341 135,532 17,376
- Others 1 - - -
----------- ------------- ----------- -----------
303,312 392,097 413,744 53,044
=========== ============= =========== ===========
Operating profit
- Physical fitness 7,082 9,123 (9,468) (1,214)
- Beauty treatments 2,616 4,124 (10,770) (1,381)
----------- ------------- ----------- -----------
9,698 13,247 (20,238) (2,595)
=========== ============= =========== ===========
F-30
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
21. REPORT ON SEGMENT INFORMATION (Continued)
YEAR ENDED DECEMBER 31
-----------------------------------------------------------
2000 2001 2002 2002
HK$ HK$ HK$ US$
(Restated)
Depreciation
- Physical fitness 28,230 39,496 50,422 6,464
- Beauty treatments 13,105 11,998 12,990 1,665
----------- ------------- ----------- -----------
41,335 51,494 63,412 8,129
=========== ============= =========== ===========
Total assets
- Physical fitness 114,983 202,607 259,912 33,322
- Beauty treatments 97,948 60,519 64,978 8,331
----------- ------------- ----------- -----------
212,931 263,126 324,890 41,653
=========== ============= =========== ===========
Property, plant and equipment additions
- Physical fitness 60,410 56,239 88,241 11,313
- Beauty treatments 11,524 9,692 38,123 4,888
----------- ------------- ----------- -----------
71,934 65,931 126,364 16,201
=========== ============= =========== ===========
CONSOLIDATED OPERATIONS BY GEOGRAPHIC AREA
YEAR ENDED DECEMBER 31
-----------------------------------------------------------
2000 2001 2002 2002
HK$ HK$ HK$ US$
(Restated)
Operating revenues
- Hong Kong 284,007 360,388 374,102 47,962
- PRC 19,305 31,709 39,642 5,082
----------- ------------- ----------- -----------
303,312 392,097 413,744 53,044
=========== ============= =========== ===========
Operating profit (loss)
- Hong Kong 19,959 28,934 1,458 187
- PRC (6,101) (12,427) (16,177) (2,074)
Interest income 332 378 126 16
Interest expenses (3,379) (3,638) (5,645) (724)
Goodwill write-off (1,113) - - -
----------- ------------- ----------- -----------
Net income 9,698 13,247 (20,238) (2,595)
=========== ============= =========== ===========
Segment assets
- Hong Kong 156,815 205,536 247,305 31,706
- PRC 56,116 57,590 77,585 9,947
----------- ------------- ----------- -----------
212,931 263,126 324,890 41,653
=========== ============= =========== ===========
F-31
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
22. UNAUDITED QUARTERLY CONSOLIDATED FINANICAL DATA
2002
QUARTER
---------------------------------------------------------------------------
FIRST SECOND THIRD FOURTH
HK$ HK$ HK$ HK$
Operating revenues 95,887 101,805 112,874 103,178
Operating expenses (98,469) (111,312) (113,793) (108,351)
--------------- --------------- --------------- ---------------
Income from operations (2,582) (9,507) (919) (5,173)
Non-operating expenses (670) (1,090) (1,472) (1,995)
--------------- --------------- --------------- ---------------
Income before income taxes and
minority interests and the
cumulative effect of a change
in an accounting principle (3,252) (10,597) (2,391) (7,168)
Income taxes (274) 186 (1,085) 340
Minority interests (61) 71 (327) 463
--------------- --------------- --------------- ---------------
Net loss before cumulative effect
of a change in an accounting
principle (3,587) (10,340) (3,803) (6,365)
Cumulative effect on prior years
of deferral of sales rebates,
net of income taxes and
minority interests (Note a) 3,857 - - -
--------------- --------------- --------------- ---------------
Net loss 270 (10,340) (3,803) (6,365)
=============== =============== =============== ===============
Loss per share before cumulative
effect of a change in
accounting principle (0.36) (1.03) (0.38) (0.64)
Cumulative effect on prior years
of deferral of sales rebates 0.39 - - -
--------------- --------------- --------------- ---------------
Loss per share of common stock
- Basic 0.03 (1.03) (0.38) (0.64)
=============== =============== =============== ===============
(a) As mentioned in note 3(t) to these financial statements, the financial statements have been prepared in conformity
with EITF 01-9 since January 1, 2002. Upon adoption on January 1, 2002, a cumulative effect on prior years of
deferral of sales rebates, net of income taxes and minority interests amounting to HK$3,857 was recognised in the
first quarter of 2002.
F-32
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(Amounts in thousands, except share and per share data)
22. UNAUDITED QUARTERLY CONSOLIDATED FINANICAL DATA (CONTINUED)
2001
QUARTER
---------------------------------------------------------------------------
FIRST SECOND THIRD FOURTH
HK$ 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)
=============== =============== =============== ===============
Net (loss) income before prior
year adjustments (183) 4,377 7,389 (3,161)
Prior year adjustments on
calculation error of
depreciation, net of minority
interests 1,206 1,206 1,206 1,207
--------------- --------------- --------------- ---------------
Net income (loss) (Restated) 1,023 5,583 8,595 (1,954)
=============== =============== =============== ===============
Earnings (Loss) per share of
common stock (Restated)
- Basic 0.10 0.56 0.86 (0.20)
=============== =============== =============== ===============
F-33
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.
36
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) 46 Chairman of the Board of Directors,
Chief Executive Officer
Yuk Wah Ho 47 President and Director
Robert Chui 46 Chief Financial Officer and Director
Darrie Lam 39 Executive Vice President, Secretary
and Director
Yat Ming Lam 45 Director
Allan Wah Chung Li 45 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, 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.
37
DARRIE LAM, 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.
WAI KEE LAM, 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.
LING LAM, 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 2002,
2001 and 2000 by those persons who served as Chief Executive Officer and any
Named Executive Officer who received compensation in excess of $100,000 during
such years.
38
SUMMARY COMPENSATION TABLE (US$)
Name and Principal Position Year Salary(1) Annual Awards(2)
- --------------------------- ---- --------- -----------------------------------
Bonus (3) Other compensation (4)
-------- ----------------------
Ngai Keung Luk, CEO, Chairman 2002 - - 186,000
2001 385,000 - 185,000
2000 385,000 - 138,000
Jill Bodnar, former President (5) 2002 - - -
2001 - - -
2000 45,000 4,900 -
Yuk Wah Ho, President, COO 2002 - - -
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 2002, 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 2002 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 2002.
(3) Bonus awarded based on performance.
39
(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) for the fiscal years 2002 and 2001, represents 100% of the
fair market rent of the property owned by a related company, Silver
Policy Development 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. Yearly allowance to Mr.
Luk is recorded on the Company's books as HK$1,440,000 (US$185,000) in
2002. 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.
40
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.
41
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of December 31, 2002, 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.
42
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, 2002 was
HK$10,955,000 (US$1,404,000). Under an agreement with the Company, Mr. Luk has
pledged 1,500,000 shares of the Company stock as collateral. See Note 14 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 2002 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 2002. 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 14.
43
Item 14. Controls and Procedures
The Company has disclosure controls and procedures (as defined in Rules 13a-14
and 15d-14 under the Securities Exchange Act of 1934, as amended) to ensure that
material information contained in its filings with the Securities and Exchange
Commission is recorded, processed, summarized and reported on a timely and
accurate basis. The Company's principal executive officer and principal
financial officer have reviewed and evaluated the Company's disclosure controls
and procedures within 90 days prior to the filing date of this report. Based on
such evaluation, the Company's principal executive officer and principal
financial officer have concluded that the Company's disclosure controls and
procedures are effective at ensuring that material information is recorded,
processed, summarized and reported on a timely and accurate basis in the
Company's filings with the Securities and Exchange Commission. Since such
evaluation there have not been any significant changes in the Company's internal
controls, or in other factors that could significantly affect these controls.
44
ITEM 15. 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**.
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
45
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 14, 2003.
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: 4/14/03
- ------------------------ (principal executive officer)
Ngai Keung Luk
/s/ Yuk Wah Ho President and Director Date: 4/14/03
- ------------------------
Yuk Wah Ho
/s/ Robert Chui Chief Financial Officer and Director Date: 4/14/03
- ------------------------ (Principal accounting and financial officer)
Robert Chui
/s/ Darrie Lam Executive Vice President, Secretary Date: 4/14/03
- ------------------------ and Director
Darrie Lam
/s/ Yat Ming Lam Director Date: 4/14/03
- ------------------------
Yat Ming Lam
/s/ Allan Wah Chung Li Director Date: 4/14/03
- ------------------------
Allan Wah Chung Li
CERTIFICATIONS
I, Ngai Keung Luk, Chairman and Chief Executive Officer of Physical Spa &
Fitness Inc., certify that:
1. I have reviewed this annual report on Form 10-K of Physical Spa & Fitness
Inc.;
2. Based on my knowledge, this annual 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 annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual report;
4. The registrant's other certifying officers and I 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 annual 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
annual report (the "Evaluation Date"); and
c) presented in this annual 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 I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the 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.
6. The registrant's other certifying officers and I have indicated in this
annual 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.
Date: April 14, 2003 /s/ Ngai Keung Luk
-----------------------------
Ngai Keung Luk, Chairman
and Chief Executive Officer
I, Robert Chui, Chief Financial Officer of Physical Spa & Fitness, Inc., certify
that:
1. I have reviewed this annual report on Form 10-K of Physical Spa & Fitness,
Inc.;
2. Based on my knowledge, this annual 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 annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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 annual report;
4. The registrant's other certifying officers and I 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 annual 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
annual report (the "Evaluation Date"); and
c) presented in this annual 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 I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the 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.
6. The registrant's other certifying officers and I have indicated in this
annual 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.
Date: April 14, 2003 /s/ Robert Chui
-----------------------------
Robert Chui
Chief Financial Officer