Back to GetFilings.com
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, 2003
[ ] 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
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
40/F., RBS 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: $56,348,000
The aggregate market value of the voting stock held by non-affiliates
of the registrant as of December 31, 2003 was $400,000 based upon the average of
the last available bid and asked price of the Common Stock of $0.20 as of
December, 2003.
The number of shares outstanding of the registrant's classes of common
stock as of December 31, 2003: 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 (to be
consolidated with the Citylink, Shatin Center in April, 2004), Mei Foo (two
centers) and Kowloon City. Another seven 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, Physical Health
Centre (Kornhill) Limited, and Physical Health Centre (Shatin) 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), the Kornhill Center (opened in June, 2002), and the Citylink,
Shatin Center (opened in November, 2003). All of these companies are Hong Kong
corporations. Renaissance Beauty Centre is operated by Supreme Resources
Limited, a Hong Kong corporation, which is a wholly-owned subsidiary of the
Company.
1
The Company's facilities in China are operated by two joint ventures:
Shanghai Physical Fitness & Beauty Centre 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 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 health food
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. 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".
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.
2
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., RBS Tower (formerly known as 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., Zhongshan
Physical Ladies' Club, Ltd., Ever Growth Ltd., Proline Holdings Ltd., Physical
Health Centre (Shanghai) Limited, Shanghai Physical Fitness & Beauty Centre 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, Physical Beauty Centre
(Central) Limited, Physical Health Centre (Shatin) Limited, Physical Health
Centre (Kornhill) Limited, and Physical Health Centre (Central) Limited.
See also "Business - Organization".
THE COMPANY'S BUSINESS
General
- -------
The Company's fitness and spa centers are located in or near urban
areas in highly populated areas of Hong Kong and major metropolitan cities in
China and most of them are operated under long-term leases. With the exception
of Mei Foo 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, shower 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 and health food.
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.
3
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
center
in
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")
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% Operating a
(Shatin) Limited** fitness and
beauty center
in Hong Kong
Physical Health Centre April 15, 1996 HK - 100% Investment
(Shenzhen) Limied holding
("Shenzhen Physical")
Physical Health Centre November 18, 1998 HK - 100% Operating a
(TST) Limited fitness and
("Physical TST") beauty center
in Hong Kong
Physical Health Centre September 8, 1997 HK - 100% Operating a
(Tsuen Wan) Limited fitness and
("Physical Tsuen Wan") beauty center
in Hong Kong
Physical Health Centre September 29, 1994 HK - 100% Operating a
(Tuen Mun) Limited fitness
center in
Hong Kong
Physical Health Centre March 2, 1990 HK - 91.4% Operating 3
Hong Kong Limited fitness and
("Hong Kong Limited") beauty centers,
1 fitness center
and 2 beauty
centers in
Hong Kong
4
EQUITY INTEREST
DATE OF ACQUISITION / PLACE OF OWNED BY THE PRINCIPAL
NAME OF COMPANY FORMATION INCORPORATION COMPANY ACTIVITIES
--------------- --------- ------------- ------- ----------
Direct Indirect
------ --------
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
("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
(Dalian) | (Shenzhen) Centre
Limited | Limited (Macau),
| 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
required a minimum of 2 shareholders for each limited company prior to February
13, 2004, 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, 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 99% 15 US$2,000 Pro-rata to equity interests
Physical and Xu Hui, years
Fitness Shanghai
& Beauty
Centre
Co, Ltd.
("Shanghai
Joint Venture")
Dalian Physical Dalian Equity 90% 12 Rmb1,000 in Pro-rata to equity interests
Ladies' Club years cash and
Co., Ltd. Rmb9,000
("Dalian Joint in form of
Venture") fixed assets
and renovation
materials
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, 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. On December 12,
2003, Shanghai Physical signed an agreement with SHTYG to acquire 1% of the
registered capital held by them at a consideration of US$20,000. The transfer
was approved by the PRC government on January 15, 2004 and since then, the
Shanghai JV has changed its status into a foreign-invested enterprise which is
wholly owned by Physical Shanghai.
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.
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".
8
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.
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."
9
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.
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, it was relocated to a brand
new shopping mall nearby, Grand Central Plaza. At the expiration of its tenancy
in April, 2004, the Shatin Center was further relocated to the Citylink Plaza in
the same district with an expanded area of 66,000 square feet.
In March 1993, Hong Kong Limited opened a beauty/spa center of
approximately 3,000 square feet in Kowloon City to provide facilities to
customers residing in the south-eastern area of Kowloon.
10
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 June, 2002, 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".
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".
11
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.
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 by
way of direct investment or franchise, 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). 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.
12
- - 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 is
regularly updated 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.
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.
13
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 so as to keep them informed of the
latest international developments in spa treatments, applications, technology
and equipment.
RETAIL
The Company sells a range of fitness related products such as
sun-tanning lotion and health food at selected fitness centers, and European
skin care products at all of its beauty 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.
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$200
(US$26) 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. Customers are also provided on a monthly basis 10 aerobic coupons on
complementary 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 2003.
14
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.
Since 2003, the Company has begun marketing, on a retail basis health
food products to its customers. 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 six outlets, and Fitness First
Health Clubs with four outlets. The Company's fitness/spa facilities compete
directly primarily with the middle markets (see below).
15
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 fourteen 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 four
locations, Angel Face Beauty Creations (International) Ltd., with fifteen
locations, Marie France Bodyline, with eight 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.
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.
16
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.
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 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.
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.
17
Employees
The Company has approximately 1,500 employees, including approximately
30 commission based sales executives. Approximately 770 employees are involved
in fitness operations, including sales personnel, instructors, and supervisory
personnel. Approximately 550 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. 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.
Certain regulations allow customers of fitness centers to cancel any
un-used services. 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.
18
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.
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.
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$70.4 million (US$9
million), HK$103.6 million (US$13 million) and HK$119.7 million (US$15 million)
for the year ended December 31, 2001, 2002 and 2003, 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.
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.
19
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 Company's fiscal
year ended December 31, 2003.
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, 2004, the 52-week trading
range was between $0.20 to $0.45 per share. The last reported sale was in April,
2004 at $0.45 per share. The reported sporadic sales in the fiscal year 2003,
are set forth below*.
Date Open High Low Close
Jan-03 0.16 0.25 0.16 0.25
Feb-03 0.25 0.51 0.20 0.20
- ---------------------
* Historical quotes provided by Commodity Systems, Inc.
As of December 31, 2003, there were approximately 619 record holders of
the Company's Common Stock. The Company effected a 1.333333-for-1 reverse split
of its Common Stock in October 1997 and a 1-for-1.333333 forward stock split in
June 1998.
DIVIDEND POLICY
- ---------------
The Company has never paid any cash dividends on its Common Stock and
does not anticipate paying any cash dividends in the future. The Company
currently intends to retain future earnings, if any, to fund the development and
growth of its business.
20
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data are qualified by reference to, and should
be read in conjunction with, the Consolidated Financial Statements, related
Notes to Consolidated Financial Statements and Report of Independent Public
Accountants, and Management's Discussion and Analysis of Financial Condition and
Results of Operations contained elsewhere herein. The following table summarizes
certain selected financial data of the Company for the fiscal years ended
December 31, 1999 through December 31, 2003. The data has been derived from
Consolidated Financial Statements (audited) included in Item 8 of this Report.
(In thousands, except share and per share data)
YEAR ENDED DECEMBER 31
---------------------------------------------------------------------
1999 2000 2001 2002 2003 2003
HK$ HK$ HK$ HK$ HK$ US$
--------- --------- --------- --------- --------- ---------
Consolidated Statements of Operations Data
OPERATING REVENUES 253,172 303,312 392,097 413,744 439,511 56,348
--------- --------- --------- --------- --------- ---------
OPERATING EXPENSES
Salaries and commissions (70,729) (88,999) (113,239) (139,740) (156,181) (20,023)
Rent and related expenses (63,931) (74,685) (95,413) (132,929) (155,844) (19,980)
Depreciation (33,187) (41,335) (51,494) (63,412) (62,618) (8,028)
Other selling and administrative expenses (57,520) (80,634) (108,298) (95,844) (103,629) (13,286)
--------- --------- --------- --------- --------- ---------
Total operating expenses (225,367) (285,653) (368,444) (431,925) (478,272) (61,317)
--------- --------- --------- --------- --------- ---------
INCOME (LOSS) FROM OPERATIONS 27,805 17,659 23,653 (18,181) (38,761) (4,969)
--------- --------- --------- --------- --------- ---------
NON-OPERATING INCOME (EXPENSES)
Other income, net 452 853 778 418 553 70
Interest expenses (4,245) (3,379) (3,638) (5,645) (7,329) (940)
Goodwill write-off -- (1,113) -- -- -- --
--------- --------- --------- --------- --------- ---------
Total non-operating expenses (3,793) (3,639) (2,860) (5,227) (6,776) (870)
--------- --------- --------- --------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAXES AND
MINORITY INTERESTS AND THE CUMULATIVE
EFFECT OF A CHANGE IN ACCOUNTING
PRINCIPLE 24,012 14,020 20,793 (23,408) (45,537) (5,839)
(Provision) Credit for income taxes (4,933) (3,312) (6,785) (834) 359 47
--------- --------- --------- --------- --------- ---------
INCOME (LOSS) BEFORE MINORITY INTERESTS
AND THE CUMULATIVE EFFECT OF A CHANGE
IN ACCOUNTING PRINCIPLE 19,079 10,708 14,008 (24,242) (45,178) (5,792)
Minority interests (577) (1,010) (761) 147 210 27
--------- --------- --------- --------- --------- ---------
NET INCOME (LOSS) BOFORE CUMULATIVE EFFECT
OF A CHANGE IN ACCOUNTING PRINCIPLE 18,502 9,698 13,247 (24,095) (44,968) (5,765)
Cumulative effect on prior year of deferral
of sales rebates, net of income taxes
and minority interests -- -- -- 3,857 -- --
--------- --------- --------- --------- --------- ---------
NET INCOME (LOSS) 18,502 9,698 13,247 (20,238) (44,968) (5,765)
========= ========= ========= ========= ========= =========
Net income per share 1.85 0.97 1.32 (2.02) (4.50) (0.58)
========= ========= ========= ========= ========= =========
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 41,206 31,135 51,841 55,597 64,225 8,235
Total assets 186,131 212,931 263,126 324,890 314,886 40,370
Current liabilities 67,809 88,677 122,856 209,239 250,694 32,140
Long-term obligations other than finance
leases 16,319 15,789 15,243 22,252 11,772 1,509
Working capital (26,603) (57,542) (71,015) (153,642) (186,469) (23,905)
Obligations under finance leases-non current 12,114 8,191 9,342 5,032 716 92
Deferred taxation 5,661 6,312 7,434 4,593 2,746 352
Minority interests 5,721 6,544 7,305 7,285 7,230 927
Shareholders' equity 78,507 88,260 101,506 81,256 36,289 4,653
21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
The following discussion should be read in conjunction with "Selected
Financial 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.
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$15,000 (US$1,923).
The following table sets forth selected income data as a percentage of
total operating revenue for the periods indicated.
Years Ended December 31,
--------------------------
2001 2002 2003
---- ---- ----
Operating Revenues 100.00% 100.00% 100.00%
Total operating expenses 93.97% 104.39% 108.82%
Operating income (loss) 6.03% (4.39%) (8.82%)
Income (Loss) before income taxes and
minority interests 5.30% (5.66%) (10.36%)
Provision for income and deferred taxes 1.73% 0.20% (0.08%)
Minority interests 0.19% (0.04%) (0.05%)
Net income (loss) 3.38% (4.89%) (10.23%)
======== ======== ========
22
FISCAL YEAR ENDED DECEMBER 31, 2003 COMPARED TO FISCAL YEAR ENDED DECEMBER 31,
- ------------------------------------------------------------------------------
2002
- ----
OPERATING REVENUES. The Company's operating revenues increased 6% to
HK$439,511,000 (US$56,348,000) in the fiscal year ended December 31, 2003 as
compared to HK$413,744,000 (US$53,044,000) of last year.
Operating revenues derived by the Company's fitness services decreased
7% to HK$258,015,000 (US$33,079,000) compared to HK$278,212,000 (US$35,668,000)
of last year. Fitness revenues as a percentage of total revenues were 59% in
2003 as compared to 67% in 2002.
Operating revenues for the Company's beauty treatments in 2003 totaled
HK$181,093,000 (US$23,217,000) compared to HK$135,532,000 (US$17,376,000) in
2002, representing an increase of 34%. Beauty revenues as a percentage of total
revenues increased from 33% to 41% in 2003 as compared to 2002.
Operating revenues derived from the Company's Hong Kong locations
remain an important contributor to the Company's business, generating
HK$385,966,000 (US$49,483,000), or 88% of total operating revenues in the fiscal
year ended December 31, 2003 as compared to HK$374,102,000 (US$47,962,000) or
90% of total operating revenues in the fiscal year ended December 31, 2002.
Operating revenues derived from the Company's China locations generated
HK$53,545,000 (US$6,865,000), or 12% of total operating revenues in the fiscal
year ended December 31, 2003 as compared to HK$39,642,000 (US$5,082,000) or 10%
of total operating revenues in the fiscal year ended December 31, 2002.
OPERATING EXPENSES. The Company's operating expenses for the fiscal
year ended December 31, 2003 totaled HK$478,272,000 (US$61,317,000) compared to
HK$431,925,000 (US$55,375,000) in the fiscal year ended December 31, 2002,
representing an increase of 11%. Total operating expenses, after taking into
account all corporate expenses, were 109% of total operating revenue as compared
to 104% 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$416,732,000 (US$53,427,000) in the fiscal year ended December 31, 2003,
representing an increase of HK$40,865,000 (US$5,239,000) or 11% as compared to
HK$375,867,000 (US$48,188,000) in 2002. 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 full
operation in 2002. Moreover, additional expenses were also incurred by the
Citylink, Shatin Center which commenced its fitness operation in November, 2003.
Hong Kong operating expenses represented 87% of total operating expenses in
2003, same as last year.
Operating expenses associated with the Company's China locations were
HK$61,540,000 (US$7,890,000) in the fiscal year ended December 31, 2003,
representing an increase of 10% as compared to HK$56,058,000 (US$7,187,000) in
2002 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 years ended December 31, 2003 and 2002.
TOTAL NON-OPERATING EXPENSES. Total non-operating expenses for the
fiscal year ended December 31, 2003 totaled HK$6,776,000 (US$870,000) compared
to HK$5,227,000 (US$670,000) in the fiscal year ended December 31, 2002,
representing an increase of 30% mainly due to higher interest expenses.
PROVISION FOR INCOME TAXES. Provision for income taxes for the fiscal
year ended December 31, 2003 totaled HK$(359,000) (US$(47,000)) compared to
HK$834,000 (US$107,000) in 2002, representing a decrease of 143%. The decrease
is mainly due to losses incurred in the year.
NET LOSS. The Company suffered a net loss of HK$44,968,000
(US$5,765,000) for the fiscal year ended December 31, 2003, compared to a net
loss of HK$20,238,000 (US$2,595,000) for the fiscal year ended December 31,
2002, representing an increase of 122%. The loss substantially reflects the
adverse impact of an outbreak of the Severe Acute Respiratory Syndrome (SARS)
during the year.
23
In Mid-March, 2003, SARS occurred in areas such as Vietnam, Toronto,
Southern China, Hong Kong, and Singapore. Consumers avoided from contacting the
SARS virus by staying at home that led to weak demand in the Company's fitness
and beauty service. The revenues and results of the Company, like most
retailers, were badly hit by the disease. In view of the uncertainty in the
economic situation, the Company has postponed the renovation work of the
Citylink, Shatin center thus incurring additional opportunity costs.
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.
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.
24
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.
25
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.
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 6 "Short-Term Bank Loans"; Note 7 "Long-Term Bank Loans"; and Note 10
"Obligations under Finance Leases").
Cash and cash equivalent balances for the fiscal years ended December
31, 2003 and December 31, 2002 were HK$1,806,000 (US$231,000) and HK$1,336,000
(US$171,000) respectively.
Net cash provided by operating activities were HK$58,288,000
(US$7,472,000), HK$105,334,000 (US$13,503,000), and HK$92,074,000
(US$11,804,000) for fiscal years 2003, 2002, and 2001 respectively. The
Company's operating activities are historically financed by cash flows from
operations. Net cash used in investing activities were HK$42,731,000
(US$5,478,000), HK$120,362,000 (US$15,430,000), and HK$70,881,000 (US$9,087,000)
for fiscal years 2003, 2002, and 2001 respectively, primarily as a result of
expenditures for property, plant and equipment. Net cash provided (used) in
financing activities, which mainly include bank loan repayments, net of proceeds
from new bank loans, were HK$(15,088,000) (US$(1,934,000)), HK$11,589,000
(US$1,486,000), and HK$(18,164,000) (US$(2,328,000)) for fiscal years 2003,
2002, and 2001 respectively.
During the fiscal year ended December 31, 2003, 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 3.66% to 8% per annum. The
total balance outstanding as of December 31, 2003 on such loans was
HK$11,772,000 (US$1,509,000). The last repayment on the loans is due in 2007.
The Company had total banking facilities available from financial institutions
amounting to approximately HK$42,976,000 (US$5,510,000). 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, Physical Health center (TST) Limited)
and personal guarantees from Mr. Luk, respectively.
Consistent with the general practice of the fitness and spa industry,
the Company receives prepaid monthly fees from fitness customers, which are
non-refundable, and spa treatment dues from 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.
26
The Company's trade receivable balance at December 31, 2003, was
HK$8,938,000 (US$1,146,000) which is mainly due by banks for the 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
year under review.
Capital expenditures for fiscal years 2003, 2002 and 2001 were
HK$46,159,000 (US$5,918,000), HK$126,364,000 (US$16,199,000) and HK$65,931,000
(US$8,453,000), respectively.
And as mentioned in note 3 to the financial statements, the Company has
a negative working capital of HK$186,469,000 (US$23,906,000) and HK$153,642,000
(US$19,698,000) as of December 31, 2003 and 2002 respectively. Besides, it has a
net loss of HK$44,968,000 (US$5,765,000) and HK$20,238,000 (US$2,595,000) for
the years ended December 31, 2003 and 2002 respectively. These conditions raise
substantial doubt about the Company's ability to continue as a going concern. In
order to maintain it as a going concern, the management is seeking to procure
additional funding from various sources. In addition, the Principal Stockholder
has also undertaken to make available adequate funds to the Company as and when
required to maintain the Company as a going concern. In this connection, the
Company has worked out a funding schedule with the Principal Stockholder whereby
he agrees to inject funds of not less than HK$500,000 (US$64,000) each time and
realize his net worth assets to support the Company as and when required.
Accordingly, the Company believes that cash flow generated from its operations,
the tight cost and cash flow control measures and its existing and additional
credit facilities to be sought should be sufficient to satisfy its working
capital and capital expenditure requirements for at least the next 12 months.
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.
27
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.
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 Moores Rowland F-2
Consolidated Statements of Operations for the years ended
December 31, 2001, 2002 and 2003 F-3
Consolidated Balance Sheets as of December 31, 2002 and 2003 F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 2001, 2002 and 2003 F-6
Consolidated Statements of Stockholders' Equity for the years
ended December 31, 2001, 2002 and 2003 F-7
Notes to Financial Statements F-8
28
INDEPENDENT AUDITORS' REPORT
AUDITED FINANCIAL STATEMENTS
PHYSICAL SPA & FITNESS INC.
DECEMBER 31, 2003
F-1
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, 2003
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, 2003. 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, 2003 and 2002 and the results
of their operations and cash flows for each of the three years in the period
ended December 31, 2003 in conformity with accounting principles generally
accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 3 (b) to the
financial statements, the Company has suffered losses from operations during the
year 2003 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 (s) to the financial statements, the Company changed its
method of accounting for sales rebates in the year 2002.
/s/ MOORES ROWLAND MAZARS
MOORES ROWLAND MAZARS
CHARTERED ACCOUNTANTS
CERTIFIED PUBLIC ACCOUNTANTS
Hong Kong
Date: April 14, 2004
F-2
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
- -------------------------------------------------------------------------------------------------------------------------
(In thousands, except share and per share data)
YEAR ENDED DECEMBER 31
-----------------------------------------------------------------
2003 2003 2002 2001
NOTE US$ HK$ HK$ HK$
OPERATING REVENUES 56,348 439,511 413,744 392,097
-------------- -------------- ------------- -------------
OPERATING EXPENSES
Salaries and commissions (20,023) (156,181) (139,740) (113,239)
Rent and related expenses (19,980) (155,844) (132,929) (95,413)
Depreciation (8,028) (62,618) (63,412) (51,494)
Other selling and administrative expenses (13,286) (103,629) (95,844) (108,298)
-------------- -------------- ------------- -------------
Total operating expenses (61,317) (478,272) (431,925) (368,444)
-------------- -------------- ------------- -------------
(LOSS) INCOME FROM OPERATIONS (4,969) (38,761) (18,181) 23,653
-------------- -------------- ------------- -------------
NON-OPERATING INCOME (EXPENSES)
Other income, net 70 553 418 778
Interest expenses (940) (7,329) (5,645) (3,638)
-------------- -------------- ------------- -------------
Total non-operating expenses (870) (6,776) (5,227) (2,860)
-------------- -------------- ------------- -------------
(LOSS) INCOME BEFORE INCOME TAXES AND MINORITY
INTERESTS AND THE CUMULATIVE EFFECT OF A
CHANGE IN ACCOUNTING PRINCIPLE (5,839) (45,537) (23,408) 20,793
Benefit (Provision) for income taxes 8 47 359 (834) (6,785)
-------------- -------------- ------------- -------------
(LOSS) INCOME BEFORE MINORITY INTERESTS AND
THE CUMULATIVE EFFECT OF A CHANGE IN
ACCOUNTING PRINCIPLE (5,792) (45,178) (24,242) 14,008
Minority interests 27 210 147 (761)
-------------- -------------- ------------- -------------
NET (LOSS) INCOME BEFORE CUMULATIVE EFFECT OF
A CHANGE IN ACCOUNTING PRINCIPLE (5,765) (44,968) (24,095) 13,247
Cumulative effect on prior year of deferral of
sales rebates, net of income taxes and
minority interests 3(s) - - 3,857 -
-------------- -------------- ------------- -------------
NET (LOSS) INCOME (5,765) (44,968) (20,238) 13,247
Other comprehensive income (loss)
- - Foreign currency translation adjustments - 1 (12) (1)
-------------- -------------- ------------- -------------
COMPREHENSIVE (LOSS) INCOME (5,765) (44,967) (20,250) 13,246
============== ============== ============= =============
The financial statements should be read in conjunction with the accompanying notes.
F-3
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
- -------------------------------------------------------------------------------------------------------------------------
(In thousands, except share and per share data)
YEAR ENDED DECEMBER 31
-----------------------------------------------------------------
2003 2003 2002 2001
US$ HK$ HK$ HK$
(Loss) Earnings per share of common stock
before cumulative effect of change in
accounting principle (0.58) (4.50) (2.41) 1.32
Cumulative effect on prior year of deferral of
sales rebates - - 0.39 -
-------------- -------------- ------------- -------------
(Loss) Earnings per share of common stock - Basic (0.58) (4.50) (2.02) 1.32
============== ============== ============= =============
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
Net (loss) income (5,765) (44,968) (20,238) 17,104
============== ============== ============= =============
(Loss) Earnings per share of common stock
- - Basic (0.58) (4.50) (2.02) 1.71
============== ============== ============= =============
The financial statements should be read in conjunction with the accompanying notes.
F-4
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
- -------------------------------------------------------------------------------------------------------------------------
(In thousands, except share and per share data)
NOTE AS OF DECEMBER 31
------------------------------------------
2003 2003 2002
ASSETS US$ HK$ HK$
CURRENT ASSETS
Cash and bank balances 231 1,806 1,336
Trade receivables 1,146 8,938 5,672
Other receivables 8 863 6,728 6,326
Rental and utility deposits 4,085 31,862 30,924
Prepayments to vendors and suppliers and other current assets 1,069 8,336 5,112
Inventories 3(d) 512 3,992 3,113
Income tax recoverable 329 2,563 -
Held-to-maturity securities, collateralised - - 3,114
------------ ---------- ----------
TOTAL CURRENT ASSETS 8,235 64,225 55,597
------------ ---------- ----------
Marketable securities, collateralised 4 422 3,290 1,540
Bank deposits, collateralised 1,680 13,103 13,340
Due from a stockholder 12(c) 1,215 9,481 10,955
Prepayments for construction-in-progress - - 1,690
Property, plant and equipment, net 5 28,818 224,787 241,768
------------ ---------- ----------
TOTAL ASSETS 40,370 314,886 324,890
============ ========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Due to a related company 12(d) - - 3,515
Short-term bank loans 6 1,855 14,473 12,634
Long-term bank loans - current portion 7 1,317 10,274 18,255
Trade payables 645 5,031 7,740
Other payables 9 11,194 87,314 65,506
Obligations under capital leases - current portion 10 707 5,516 9,358
Deferred income - current portion 14,519 113,241 76,828
Deferred liabilities - current portion 1,101 8,587 5,616
Income taxes payable 22 175 3,764
Taxes other than income 780 6,083 6,023
------------ ---------- ----------
TOTAL CURRENT LIABILITIES 32,140 250,694 209,239
------------ ---------- ----------
Deferred income - non-current portion 846 6,599 6,315
Deferred liabilities - non-current portion 1,168 9,114 7,173
Long-term bank loans - non-current portion 7 192 1,498 3,997
Obligations under capital leases - non-current portion 10 92 716 5,032
Deferred taxation 352 2,746 4,593
Minority interests 927 7,230 7,285
STOCKHOLDERS' EQUITY
Common stock, par value of US$0.001 each,
100 million shares of stock authorized;
10 million shares of stock issued and outstanding 10 78 78
Cumulative translation adjustments 21 162 161
Retained earnings 4,622 36,049 81,017
------------ ---------- ----------
TOTAL STOCKHOLDERS' EQUITY 4,653 36,289 81,256
------------ ---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY 40,370 314,886 324,890
============ ========== ==========
APPROVED AND AUTHORIZED FOR ISSUE BY THE BOARD OF DIRECTORS ON
DIRECTOR DIRECTOR
The financial statements should be read in conjunction with the accompanying notes.
F-5
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------------------------------------------------
(In thousands)
YEAR ENDED DECEMBER 31
----------------------------------------------------
2003 2003 2002 2001
US$ HK$ HK$ HK$
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income (5,765) (44,968) (20,238) 13,247
Adjustments to reconcile net (loss) income to net cash
provided
by operating activities:
Minority interests (27) (210) (20) 761
Depreciation 8,028 62,618 63,412 51,494
Loss on disposal of property, plant and equipment 19 148 1,493 2,853
Changes in working capital:
Trade receivables (419) (3,266) 1,570 (8,741)
Deposits, prepayments and other current assets (514) (4,007) (4,923) (9,549)
Inventories (113) (879) (740) (303)
Due to a related company (451) (3,515) 3,510 920
Trade and other payables 2,449 19,099 52,602 (2,974)
Deferred income 4,705 36,697 5,452 39,861
Deferred liabilities 630 4,912 3,206 520
Income taxes payable/recoverable (789) (6,152) 2,801 206
Taxes other than income (44) (342) 50 2,657
Deferred taxation (237) (1,847) (2,841) 1,122
----------- ----------- ------------ -----------
NET CASH PROVIDED BY OPERATING ACTIVITIES 7,472 58,288 105,334 92,074
----------- ----------- ------------ -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Prepayments for construction-in-progress 217 1,690 10,280 (5,016)
Acquisition of property, plant and equipment (5,918) (46,159) (126,364) (65,931)
Acquisition of marketable securities (224) (1,750) (4,654) -
Proceeds from disposal of Held to maturity securities 399 3,114 - -
Sales proceeds from disposal of property, plant and
equipment 48 374 376 66
----------- ----------- ------------ -----------
NET CASH USED IN INVESTING ACTIVITIES (5,478) (42,731) (120,362) (70,881)
----------- ----------- ------------ -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in bank deposits 30 237 (6,405) (3,368)
Due from a stockholder 189 1,474 740 (9,587)
(Settlement of) Proceeds from short-term bank loans 236 1,839 10,865 (6,523)
Proceeds from long-term bank loans 321 2,500 28,670 10,287
Repayment of long-term bank loans (1,664) (12,980) (21,661) (10,833)
Assumption of capital lease obligations 231 1,800 7,982 8,875
Capital element of capital lease rental payments (1,277) (9,958) (8,602) (7,015)
----------- ----------- ------------ -----------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (1,934) (15,088) 11,589 (18,164)
----------- ----------- ------------ -----------
EFFECT OF EXCHANGE RATE CHANGES ON CASH - 1 (12) (1)
----------- ----------- ------------ -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 60 470 (3,451) 3,028
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 171 1,336 4,787 1,759
----------- ----------- ------------ -----------
CASH AND CASH EQUIVALENTS AT END OF YEAR 231 1,806 1,336 4,787
=========== =========== ============ ===========
The financial statements should be read in conjunction with the accompanying notes.
F-6
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
- ------------------------------------------------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
- ------------------------------------------------------------------------------------------------------------------------
(In thousands, except share data)
CUMULATIVE
RETAINED TRANSLATION
COMMON STOCK EARNINGS ADJUSTMENTS TOTAL
---------------------------- -------------- --------------- --------------------------
NOTE NUMBER HK$ HK$ HK$ HK$ US$
Balance as of
January 1, 2001 10,000,000 78 88,008 174 88,260 11,315
Net income - - 13,247 - 13,247 1,699
Translation adjustment - - - (1) (1) -
------------- ------------- -------------- --------------- ------------ -----------
Balance as of
December 31, 2001 10,000,000 78 101,255 173 101,506 13,014
Net loss - - (20,238) - (20,238) (2,594)
Translation adjustment - - - (12) (12) (2)
------------- ------------- -------------- --------------- ------------ -----------
Balance as of
December 31, 2002 10,000,000 78 81,017 161 81,256 10,418
Net loss - - (44,968) - (44,968) (5,765)
Translation adjustment - - - 1 1 -
------------- ------------- -------------- --------------- ------------ -----------
BALANCE AS OF
DECEMBER 31, 2003 10,000,000 78 36,049 162 36,289 4,653
============= ============= ============== =============== ============ ===========
The financial statements should be read in conjunction with the accompanying notes.
F-7
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(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. The
Company was incorporated with authorized share capital of 100 million
common stocks with par value of US$0.001 each. 80% of the Company's
issued and outstanding common stocks were held by a stockholder (the
"Principal Stockholder"). The Company is a U.S. public company listed
on the National Association of Securities Dealers Automated 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 the
Company. Physical Holdings has interests in various companies
("Operating Subsidiaries") operating fitness and beauty centres
("Fitness Centres") and other related businesses in Hong Kong and the
People's Republic of China ("PRC").
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 Hong Kong - 100% Property
("Ever Growth") holding
Jade Regal Holdings March 15, 1996 BVI - 100% Investment
Limited holding
Physical Beauty Centre September 14, 2001 Hong Kong - 100% Operating a
(Central) Limited beauty centre
in Hong Kong
Physical Health Centre March 15, 1996 Hong Kong - 100% Investment
(Dalian) Limited holding
("Physical Dailan")
Physical Health Centre December 1, 1998 Hong Kong - 100% Operating a
(E House) Limited fitness centre
("Physical E House") in Hong Kong
Physical Health Centre December 31, 2001 Hong Kong - 100% Operating a
(Kornhill) Limited Fitness Centre
("Physical Kornhill") in Hong Kong
F-8
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------------------------------------------
(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 21, 1997 Hong Kong - 100% Investment
(Macau) Limited holding
Physical Health Centre May 30, 2001 Hong Kong - 100% Operating a
(Shatin) Limited Fitness
Centre in
Hong Kong
Physical Health Centre April 15, 1996 Hong Kong - 100% Investment
(Shenzhen) Limied holding
("Physical Shenzhen")
Physical Health Centre November 18, 1998 Hong Kong - 100% Operating a
(TST) Limited ("Physical Fitness
TST") Centre in
Hong Kong
Physical Health Centre September 8, 1997 Hong Kong - 100% Operating a
(Tsuen Wan) Limited Fitness
("Physical Tsuen Wan") Centre in
Hong Kong
Physical Health Centre September 29, 1994 Hong Kong - 100% Operating a
(Tuen Mun) Limited fitness
("Physical Tuen Mun") centre in
Hong Kong
Physical Health Centre March 2, 1990 Hong Kong - 91.4% Operating 4
Hong Kong Limited Fitness
("Physical HK") Centres and
1 beauty
centre in
Hong Kong
Proline Holdings Limited September 28, 1994 BVI - 100% Investment
holding
Regent Town Holdings September 20, 1993 BVI - 100% Investment
Limited ("Regent Town") holding
F-9
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------------------------------------------
(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 September 28, 1994 HK - 100% Investment
(Shanghai) Limited holding
("Physical Shanghai")
Star Perfection Holdings April 15, 1996 BVI - 100% Investment
Limited holding
Supreme Resources Limited September 29, 1994 Hong Kong - 100% Operating a
("Supreme") beauty
centre in
Hong Kong
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 Hong Kong - 100% Inactive
(Central), Limited
The Company 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 Company is
able to govern and control the financial and operating policies and the
board of directors of the JV. Therefore, the JV have been accounted for
as subsidiaries. Detailed information in connection with these JV is as
follows:
a) Shanghai Physical Fitness and Beauty Centre Co., Ltd. (the
"Shanghai JV"), a Sino-foreign co-operative 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 original JV
period was for 10 years starting from the date of the business
licence issued on September 7, 1993. On April 1, 2002, the JV
period was extended from 10 years to 15 years as approved by the
PRC government.
On December 12, 2003, Physical Shanghai signed an agreement with
the Shanghai JV partner to acquire 1% of the registered capital
held by them at a consideration of US$20. The transfer was
approved by the PRC government on January 15, 2004 and since then,
the Shanghai JV has changed its status into a foreign-invested
enterprise which is wholly owned by Physical Shanghai.
F-10
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(In thousands, except share and per share data)
1. ORGANIZATION AND PRINCIPAL ACTIVITIES (CONTINUED)
b) Dalian Physical Ladies' Club Co., Ltd. ("the Dalian JV") is a
Sino-foreign equity 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 property, plant and equipment and renovation materials
and the PRC venturer contributed in cash. Both venturers had
fulfilled their respective capital contributions as of December
31, 1996. The JV commenced operation in 1996.
c) Under the JV contract between Physical Shenzhen and a PRC
enterprise, Physical Shenzhen is required to contribute HK$4,140
in the form of cash and property, plant and equipment 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 Company has verbally agreed with
the PRC 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 Company 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 PRC enterprise, Physical Zhongshan is required to contribute
US$500 in the form of cash and property, plant and equipment 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 Company has verbally agreed with
the PRC 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 Company will not suffer penalties
nor financial losses upon the termination of the JV.
F-11
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(In thousands, except share and per share data)
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 Company's functional currency because the Company'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, 2003 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, 2003 or at any other rate.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the financial
information of the Company, its majority-owned and controlled
subsidiaries and joint ventures. All material intercompany
balances and transactions have been eliminated on consolidation.
b) PREPARATION OF FINANCIAL STATEMENTS
The Company has a negative working capital of HK$186,469 and
HK$153,642 as of December 31, 2003 and 2002 respectively. Besides,
the Company has incurred losses in each of the three years ended
December 31, 2003, 2002 and 2001. These conditions raise
substantial doubt about the Company's ability to continue as a
going concern.
Continuation of the Company 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 Company as and
when required to maintain the Company 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 JV
A contractual JV is an entity established between the Company and
one or more other parties with the rights and obligations of the
JV partners governed by a contract. In case the Company 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.
F-12
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(In thousands, except share and per share data)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
d) INVENTORIES
Inventories, mainly comprise beauty products for treatment and
sale, are stated at the lower of cost and net realizable value.
Cost, which comprises all costs of purchase and, where applicable,
other costs that have been incurred in bringing the inventories to
their present location and condition, is calculated using the
first-in, first-out method. Net realizable value represents the
estimated selling price in the ordinary course of business less
the estimated costs of completion and the estimated costs
necessary to make the sale. Inventories consisted of the
following:
AS OF DECEMBER 31
-------------------------
2003 2003 2002
US$ HK$ HK$
Beauty products for treatment 316 2,469 1,941
Beauty products for sale 180 1,403 1,172
Health food for sale 16 120 --
----- ----- -----
512 3,992 3,113
===== ===== =====
e) 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.
f) PROPERTY, PLANT AND EQUIPMENT AND DEPRECIATION
Property, plant and equipment are stated at cost less accumulated
depreciation and impairment loss.
The cost of an asset comprises its purchase price and any directly
attributable costs of bringing the asset to its present working
condition and location for its intended use. Expenditure incurred
after the assets have been put into operation, such as repairs and
maintenance, is normally recognized as an expense in the period in
which it is incurred. In situations where it can be clearly
demonstrated that the expenditure has resulted in an increase in
the future economic benefits expected to be obtained from the use
of the assets, the expenditure is capitalized.
When assets are sold or retired, their costs and accumulated
depreciation are eliminated from the accounts and any gain or loss
resulting from their disposal is included in the statement of
operations.
F-13
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(In thousands, except share and per share data)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
f) PROPERTY, PLANT AND EQUIPMENT AND DEPRECIATION (CONTINUED)
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
The Company recognizes an impairment loss on property, plant and
equipment 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.
g) TRADE RECEIVABLES
Trade receivables are recorded at original invoice amount, less an
estimated allowance for uncollectible accounts. Trade credit is
generally extended on a short-term basis, thus trade receivables
do not bear interest. Trade receivables are periodically evaluated
for collectibility based on past credit history with customers and
their current financial condition. Changes in the estimated
collectibility of trade receivables are recorded in the results of
operations for the period in which the estimate is revised. Trade
receivables that are deemed uncollectible are offset against the
allowance for uncollectible accounts. The Company generally does
not require collateral for trade receivables.
h) REVENUE RECOGNITION
Revenue represents service income in connection with the provision
of physical fitness and beauty treatment services and other
related income, net of the related sales tax, if any. The
non-refundable admission fee is recognized as revenue on a
pro-rata basis over the estimated duration whereas the monthly
dues, service income and other related income are recognized as
revenue when services are rendered.
i) DEFERRED INCOME
Deferred income represents unamortized non-refundable admission
fees and service fees billed but for which the related services,
or portion of the services, have not yet been rendered.
F-14
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(In thousands, except share and per share data)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
j) CAPITAL LEASES
Leases that substantially transfer to the Company all the rewards
and risks of ownership of assets, other than legal title, are
accounted for as capital leases.
Property, plant and equipment held under capital 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(f) 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.
k) OPERATING LEASES
Leases where substantially all the rewards and risks of ownership
of assets remain with the leasing company are accounted for as
operating leases. Rentals payable under operating leases are
recorded in the statement of operations on a straight-line basis
over the lease term.
l) DEFERRED LIABILITIES
Deferred liabilities represent the benefit arose from the
rent-free period of the operating leases. The deferred liabilities
are amortized within the lease term, and the amortization is
recorded in the statement of operations.
m) INCOME TAXES
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 Company 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
statements 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-15
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(In thousands, except share and per share data)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
n) FOREIGN CURRENCY TRANSLATION
The Company and its subsidiaries maintain their accounting books
and records in Hong Kong Dollars ("HK$"), except for the PRC JV
and Physical Macau subsidiary which maintain their accounting
books and records in RMB and MOP respectively. Foreign currency
transactions during the year are translated to HK$ at the
approximate rates of exchange on the dates of transactions.
Monetary assets and liabilities denominated in foreign currencies
at year end are 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
Physical Macau 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.
o) RELATED PARTIES
Parties are considered to be related if one party has the ability,
directly or indirectly, to control the other party or exercise
significant influence over the other party in making financial and
operating decisions. Parties are also considered to be related if
they are subject to common control or common significant
influence.
p) EARNINGS (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.
q) USES OF ESTIMATES
The preparation of the consolidated financial statements in
conformity with generally accepted accounting principles requires
the Company's management to make estimates and assumptions that
affect the amounts reported in these financial statements and
accompanying notes. Actual amounts could differ from those
estimates.
r) ADVERTISING AND MARKETING COSTS
All advertising and marketing costs are expensed off in the
periods in which those costs are incurred or the first time the
advertising takes place.
F-16
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(In thousands, except share and per share data)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
s) ACCOUNTING CHANGE
Since January 1, 2002, the consolidated financial statements have
been prepared in conformity with EITF 01-9. Upon adoption by the
Company 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 Company'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 HK$3,857 for the year ended December 31, 2001.
t) RECENTLY ISSUED ACCOUNTING STANDARDS
In November 2002, the FASB issued Interpretation No. 45 ("FIN 45")
"Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of
Others". FIN 45 elaborates on the existing disclosure requirements
for most guarantees, including loan guarantees. It 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.
However, the provisions related to recognizing a liability at
inception of the guarantee for the fair value of the guarantor's
obligations does not apply to product warranties or to guarantees
accounted for as derivatives. The initial recognition and initial
measurement provisions apply on a prospective basis to guarantees
issued or modified after December 31, 2002. The disclosure
requirements of FIN 45 are effective for financial statements of
interim or annual periods ending after December 15, 2002. The
Company does not expect the adoption of FIN 45 will have a
material impact on the Company's results of operations or
financial position.
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46")
"Consolidation of Variable Interest Entities". Until this
interpretation, a company generally included another entity in its
consolidated financial statements only if it controlled the entity
through voting interests. FIN 46 requires a variable interest
entity, as defined, to be consolidated by a company if that
company is subject to a majority of the risk of loss from the
variable interest entity's activities or is entitled to receive a
majority of the entity's residual returns. In December 2003, the
FASB issued a revised FIN 46. The revised standard, FIN 46-R,
modifies or clarifies various provisions of FIN 46 and
incorporates many FASB Staff Positions previously issued by the
FASB. This standard replaces the original FIN 46 that was issued
in January 2003. The Company does not expect the adoption of FIN
46-R will have a material impact on the Company's results of
operations or financial position.
F-17
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(In thousands, except share and per share data)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
t) RECENTLY ISSUED ACCOUNTING STANDARDS (CONTINUED)
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and
Equity". SFAS No. 150 establishes standards for how certain
financial instruments with characteristics of both liabilities and
equity shall be classified and measured. This statement is
effective for financial instruments entered into or modified after
May 31, 2003, and otherwise is effective at the beginning of the
first interim period beginning after June 15, 2003. The Company
does not expect the adoption of SFAS No. 150 will have a material
impact on the Company's result of operations or financial
position.
4. MARKETABLE SECURITIES
The balance represents "available-for-sale" unlisted capital guaranteed
funds made up of debt and equity 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 dates of the funds are
ranging from March 2006 to December 2007. These securities have been
pledged to banks to secure general banking facilities granted to the
Company.
5. PROPERTY, PLANT AND EQUIPMENT, NET
AS OF DECEMBER 31
----------------------------------------------------
2003 2003 2002
US$ HK$ HK$
Land and buildings 402 3,136 3,137
Leasehold improvements 25,239 196,871 180,832
Machinery and equipment 27,847 217,209 207,778
Furniture and fixtures 7,976 62,210 56,290
Computers 943 7,355 6,700
Motor vehicles 540 4,211 4,583
Less: Accumulated depreciation (34,129) (266,205) (217,552)
--------------- ---------------- ---------------
Net book value 28,818 224,787 241,768
=============== ================ ===============
As of December 31, 2003, the cost and accumulated depreciation of
property, plant and equipment held under capital leases amounted to
approximately HK$36,634 (2002: HK$33,716) and HK$21,394 (2002:
HK$14,478) respectively.
F-18
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(In thousands, except share and per share data)
6. SHORT-TERM BANK LOANS
The short-term bank loans are collateralized and repayable within one
year. Please refer to Note 7 for details of collateral for such
facilities.
Supplemental information with respect to the short-term bank loans was
as follows:
YEAR ENDED DECEMBER 31
--------------------------------------------------------------------
2003 2003 2002 2001
Maximum amount outstanding during the
years US$2,039 HK$15,902 HK$13,898 HK$13,102
Average amount outstanding during the
years US$1,614 HK$12,592 HK$8,305 HK$4,749
Weighted average interest rate at the
end of the years 6% 6% 8% 5%
Weighted average interest rate during
the years 7% 7% 7% 6%
7. LONG-TERM BANK LOANS
The Company obtained various lines of credit under banking facilities
which aggregated HK$42,976 as of December 31, 2003 (2002: HK$51,069)
from creditworthy commercial banks in Hong Kong and PRC to finance its
operations. These loans were collateralized by certain of the assets of
the Company and related companies, and its stockholders. As of December
31, 2003, the loans consisted of the following:
PRINCIPAL INTEREST RATE MATURITY
US$ HK$
602 4,700 5.57% Within one year
283 2,209 6.65% Serially from 2004 to 2005
79 619 HK$ prime + 0.25% Serially from 2004 to 2005
374 2,914 HK$ prime + 1.5% Serially from 2004 to 2005
171 1,330 HK$ prime + 1.5% Serially from 2004 to 2007
------- -------
1,509 11,772
======= =======
F-19
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(In thousands, except share and per share data)
7. LONG-TERM BANK LOANS (CONTINUED)
Aggregate maturities of the long-term bank loans are as follows:
PRINCIPAL PAYABLES DURING THE FOLLOWING PERIODS
US$ HK$
1,317 10,274 2004
------- -------
114 888 2005
46 360 2006
32 250 2007
------- -------
192 1,498
------- -------
1,509 11,772
======= =======
The collateral of the loans include:
(i) leasehold property in Hong Kong owned by Ever Growth;
(ii) fixed deposits owned by Physical Hong Kong, Physical E House and
Physical TST;
(iii) leasehold property in Hong Kong owned by a related company;
(iv) personal guarantees from the Principal Stockholder and his
spouse;
(v) Marketable securities as stated in Note 4; and
(vi) a fixed charge over Physical Macau's machinery and equipment and
a floating charge over its other assets.
8. INCOME TAXES
Reconciliation to the expected statutory tax rate in Hong Kong of 17.5%
(2002: 16% AND 2001: 16%) is as follows:
YEAR ENDED DECEMBER 31
-----------------------------
2003 2002 2001
% % %
her
Statutory rate 17.5 16.0 16.0
Tax effect of net operating losses (13.0) (17.9) 13.2
Tax effect of timing differences (4.0) (7.2) 13.9
Effect of change in tax rate 0.3 -- --
Others -- (0.2) --
------ ------ ------
Effective rate 0.8 (9.3) 43.1
====== ====== ======
F-20
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(In thousands, except share and per share data)
8. INCOME TAXES (CONTINUED)
Income tax benefit (expense) comprised of the following:
YEAR ENDED DECEMBER 31
---------------------------------------------------
2003 2003 2002 2001
US$ HK$ HK$ HK$
Current taxes (190) (1,488) (4,434) (5,663)
Deferred taxes 237 1,847 2,841 (1,122)
Tax effect related to deferral of sales rebates in 2001 - - 759 -
---------- ----------- ----------- -----------
Income tax benefit (expense) 47 359 (834) (6,785)
========== =========== =========== ===========
The Company 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 17.5% (2002 AND 2001: 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 Company has not recorded any
Macau income tax expense. Macau profits tax is currently charged at
sliding rates with maximum rate of 15% on assessable profits.
The Company 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 Company 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 Company faced further penalty,
additional to the original amount of taxes payable, ranging from 50% to
500% of the original amount of taxes payable, had the Company been
found in breach of any of such rules and regulations.
Since the Company commenced its business operation in the PRC, the
Company 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 Company that they would reimburse the Company
for such payments had such payments been found necessary.
F-21
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(In thousands, except share and per share data)
8. INCOME TAXES (CONTINUED)
As of the balance sheet date, the Company is potentially liable to make
good in aggregate an amount of HK$12,388 (2002: HK$11,986), of which an
amount of HK$6,728 (2002: HK$6,326) 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 (2002: HK$5,660) and any
potential amount of penalty which might be imposed. In this respect,
the directors are of the opinion that the probability that such
potential liabilities will be crystallised would be remote.
As also stated in Note 12(e) to the financial statements, the Principal
Stockholder has undertaken to indemnify the Company against any
contingent liabilities including tax liabilities and claims that may
result from the operating activities of the Company in Hong Kong, the
PRC and elsewhere occurring prior to the balance sheet date. Had any
payments been found necessary, the payments made by the Principal
Stockholder will be recorded as expenses in the Company's financial
statements with a corresponding credit to contributed (paid-in) capital
in accordance with the stipulations as mentioned in the Staff
Accounting Bulletin Topic 5-T.
9. OTHER PAYABLES
AS OF DECEMBER 31
------------------------------------------------
2003 2003 2002
US$ HK$ HK$
Accrued rental and related expenses 4,558 35,552 22,272
Accrued salaries, commissions and related expenses 3,267 25,487 14,097
Accrued capital expenditures 1,408 10,983 19,132
Other accrued expenses and creditors 1,961 15,292 10,005
------------- ------------- ------------
11,194 87,314 65,506
============= ============= ============
F-22
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(In thousands, except share and per share data)
10. OBLIGATIONS UNDER CAPITAL LEASES
Physical HK, Physical TST, Physical Kornhill and Physical Tsuen Wan
lease fitness equipment and motor vehicles under several capital
leases. The scheduled future minimum lease payments were as follows:
AS OF DECEMBER 31
-------------------------------------------------
2003 2003 2002
US$ HK$ HK$
Payable during the following periods:
Within one year 907 7,076 11,196
Over one year but not exceeding two years 122 951 6,104
Over two years but not exceeding three years - - 627
Over three years but not exceeding four years - - -
Over four years but not exceeding five years - - -
Thereafter - - -
-------------- -------------- -------------
Total minimum lease payments 1,029 8,027 17,927
Less: Amount representing interest (230) (1,795) (3,537)
-------------- -------------- -------------
Present value of net minimum lease payments 799 6,232 14,390
============== ============== =============
11. COMMITMENTS
CAPITAL EXPENDITURE COMMITMENTS
AS OF DECEMBER 31
------------------------------------------------
2003 2003 2002
US$ HK$ HK$
Contracted but not provided net of deposit paid in the
financial statements 1,554 12,136 23,442
============= ============= ============
F-23
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(In thousands, except share and per share data)
11. COMMITMENTS (CONTINUED)
COMMITMENTS UNDER OPERATING LEASES
The Company 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
------------------------------------------------
2003 2003 2002
US$ HK$ HK$
Payable during the following periods:
Within one year 16,183 126,225 113,801
Over one year but not exceeding two years 10,706 83,503 108,756
Over two years but not exceeding three years 5,589 43,598 65,091
Over three years but not exceeding four years 3,225 25,155 30,028
Over fours years but not exceeding five years 2,653 20,690 22,482
Thereafter 8,927 69,629 90,036
------------- ------------- ------------
Total operating lease commitments 47,283 368,800 430,194
============= ============= ============
12. RELATED PARTY TRANSACTIONS
The Company had the following transactions with related parties:
YEAR ENDED DECEMBER 31
-----------------------------------------------
2003 2003 2002 2001
US$ HK$ HK$ HK$
Rental of a director's quarter 158 1,234 1,452 1,440
Purchase of beauty and fitness equipment 132 1,031 3,442 5,610
Purchase of health food 84 657 - -
a) Certain general and administrative expenses incurred by the
Company 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 Company had beneficial interests
in all the aforementioned related companies or the stockholder of
the related companies were related to the Principal Stockholder.
F-24
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(In thousands, except share and per share data)
12. RELATED PARTY TRANSACTIONS (CONTINUED)
c) The balance due from the Principal Stockholder to the Company as
at December 31, 2003 was HK$9,481 (2002: HK$10,955). Under an
agreement with the Company, the Principal Stockholder has pledged
1,500,000 shares of the Company's stock as collateral, which had a
market value of HK$2,340 as of December 31, 2003.
d) The amount due to Williluck International Limited as of December
31, 2002 was included in "Due to a Related Company" in the
accompanying balance sheet and was unsecured, interest free and
had no fixed repayment terms. The amount has been set off to the
amount due from the Principal Stockholder during the year.
e) The Principal Stockholder has undertaken to indemnify the Company
against any contingent liabilities including tax liabilities and
claims that may result from the operating activities of the
Company in Hong Kong, the PRC and elsewhere occurring prior to the
balance sheet date. He has also undertaken to indemnify the
Company against any loss arising from non-recovery of HK$2,104
(2002: HK$2,104) an amount included in "Prepayment to vendors and
suppliers and other current assets".
13. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
YEAR ENDED DECEMBER 31
------------------------------
2003 2003 2002
US$ HK$ HK$
Cash paid for:
Interest expenses 940 7,329 5,645
Income taxes 979 7,640 2,355
14. OTHER SUPPLEMENTAL INFORMATION
The following items are included in the consolidated statements of
operations:
YEAR ENDED DECEMBER 31
-----------------------------------------
2003 2003 2002
NOTE US$ HK$ HK$
Interest expenses on:
Capital leases 240 1,875 2,071
Overdrafts and bank loans 265 2,062 2,008
Others 435 3,392 1,566
Interest income a 17 135 126
Sales taxes b 174 1,354 1,026
Advertising and marketing expenses c 3,738 29,155 24,738
Rental expenses under operating leases 15,349 119,721 103,608
F-25
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(In thousands, except share and per share data)
14. OTHER SUPPLEMENTAL INFORMATION (CONTINUED)
a) Interest income is 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.
15. DISTRIBUTION OF PROFIT
In the opinion of management, any undistributed earnings of Physical
Holdings and the Operating Subsidiaries will be reinvested
indefinitely.
16. RETIREMENT PLAN
The Company 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 Company 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 Company
in two provident funds managed by independent trustees.. The pension
expenses charged to the consolidated statements of operations amounted
to HK$8,059, HK$5,707 and HK$5,021 for the years ended December 31,
2003, 2002 and 2001 respectively.
17. STOCK OPTION PLAN
The Company has a Stock Option Plan (the "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 or three years after death or
disability, whichever is later. As of the date of this report, no stock
options have been granted by the Company under the Plan.
F-26
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(In thousands, except share and per share data)
18. OPERATING RISKS
a) CONCENTRATION OF SUPPLIERS
The Company purchases beauty products from a number of suppliers.
Details of individual suppliers also accounted for more than 10%
of the Company's purchases are as follows:
YEAR ENDED DECEMBER 31
-----------------------------------------
2003 2002 2001
% % %
Hope Key Development Limited - - 39
Kaydex Trading Ltd. 39 40 -
Kingstar International Trading Limited 16 24 23
b) CONCENTRATION OF CREDIT RISK
None of the sales to the customers accounted for more than 10% of
the Company's turnover for the three years ended December 31,
2003, 2002 and 2001.
19. REPORT ON SEGMENT INFORMATION
The Company'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
-------------------------------------------------------------
2002 2003 2002 2001
US$ HK$ HK$ HK$
Operating revenues
- Physical fitness 33,079 258,015 278,212 272,756
- Beauty treatments 23,217 181,093 135,532 119,341
- Others 52 403 - -
------------- ------------- ----------- ------------
56,348 439,511 413,744 392,097
============= ============= =========== ============
Operating (loss) profit
- Physical fitness (5,516) (43,026) (9,468) 9,123
- Beauty treatments (217) (1,691) (10,770) 4,124
- Others (32) (251) - -
------------- ------------- ----------- ------------
5,765 (44,968) (20,238) 13,247
============= ============= =========== ============
F-27
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(In thousands, except share and per share data)
19. REPORT ON SEGMENT INFORMATION (CONTINUED)
YEAR ENDED DECEMBER 31
-------------------------------------------------------------
2003 2003 2002 2001
US$ HK$ HK$ HK$
Depreciation
- Physical fitness 6,072 47,360 50,422 39,496
- Beauty treatments 1,956 15,258 12,990 11,998
------------- ------------- ----------- ------------
8,028 62,618 63,412 51,494
============= ============= =========== ============
Total assets
- Physical fitness 30,681 239,313 259,912 202,607
- Beauty treatments 9,689 75,573 64,978 60,519
------------- ------------- ----------- ------------
40,370 314,886 324,890 263,126
============= ============= =========== ============
Property, plant and equipment additions
- Physical fitness 4,997 38,979 88,241 56,239
- Beauty treatments 954 7,439 38,123 9,692
------------- ------------- ----------- ------------
5,951 46,418 126,364 65,931
============= ============= =========== ============
CONSOLIDATED OPERATIONS BY GEOGRAPHIC AREA
YEAR ENDED DECEMBER 31
-------------------------------------------------------------
2003 2003 2002 2001
US$ HK$ HK$ HK$
Operating revenues
- Hong Kong 49,483 385,966 374,102 360,388
- PRC 6,865 53,545 39,642 31,709
------------- -------------- ------------- ------------
56,348 439,511 413,744 392,097
============= ============== ============= ============
Operating (loss) profit
- Hong Kong (3,864) (30,140) 1,458 28,934
- PRC (978) (7,634) (16,177) (12,427)
Interest income 17 135 126 378
Interest expenses (940) (7,329) (5,645) (3,638)
------------- -------------- ------------- ------------
Net (loss) income (5,765) (44,968) (20,238) 13,247
============= ============== ============= ============
Segment assets
- Hong Kong 29,537 230,387 247,305 205,536
- PRC 10,833 84,499 77,585 57,590
------------- -------------- ------------- ------------
40,370 314,886 324,890 263,126
============= ============== ============= ============
F-28
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(In thousands, except share and per share data)
20. UNAUDITED QUARTERLY CONSOLIDATED FINANICAL DATA
2003
----
QUARTER
---------------------------------------------------------------------------
FIRST SECOND THIRD FOURTH
HK$ HK$ HK$ HK$
Operating revenues 105,765 102,463 115,082 116,201
Operating expenses (113,449) (120,151) (123,066) (121,606)
--------------- --------------- --------------- ---------------
(Loss) Income from operations (7,684) (17,688) (7,984) (5,405)
Non-operating expenses (1,492) (1,409) (1,969) (1,906)
--------------- --------------- --------------- ---------------
Income before income taxes and
minority interests (9,176) (19,097) (9,953) (7,311)
Income taxes (462) 210 201 410
Minority interests (24) 257 131 (154)
--------------- --------------- --------------- ---------------
Net loss (9,662) (18,630) (9,621) (7,055)
=============== =============== =============== ===============
Loss per share of common stock
- Basic (0.97) (1.86) (0.96) (0.71)
=============== =============== =============== ===============
F-29
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
(In thousands, except share and per share data)
20. UNAUDITED QUARTERLY CONSOLIDATED FINANICAL DATA (CONTINUED)
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 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 income (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 - - -
--------------- --------------- --------------- ---------------
Earnings (Loss) per share of
common stock
- Basic 0.03 (1.03) (0.38) (0.64)
=============== =============== =============== ===============
a) 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-30
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
NONE
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) 47 Chairman of the Board of Directors,
Chief Executive Officer
Yuk Wah Ho 48 President and Director
Robert Chui 47 Chief Financial Officer and Director
Darrie Lam 40 Executive Vice President, Secretary
and Director
Yat Ming Lam 46 Director
Allan Wah Chung Li 46 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 eighteen 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.
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 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.
29
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. Mr. Li has practiced law in Vancouver, Toronto and Hong
Kong for ten years 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 2003,
2002 and 2001 by those persons who served as Chief Executive Officer and any
Named Executive Officer who received compensation in excess of $100,000 during
such years.
30
SUMMARY COMPENSATION TABLE (US$)
Name and Principal Position Year Salary(1) Annual Awards(2)
- --------------------------- ---- --------- -----------------------------------
Bonus (3) Other compensation (4)
-------- ----------------------
Ngai Keung Luk, CEO, Chairman 2003 - - 261,800
2002 - - 186,000
2001 385,000 - 372,400
Yuk Wah Ho, President, COO 2003 77,000 - -
2002 - - -
2001 304,000 - -
(1) No officers received or will receive any bonus or other annual
compensation other than salaries during fiscal year 2003, other than
stated above. Management believes that the value of other non-cash
benefits and compensation distributed to executive officers of the
Company individually or as a group during fiscal year 2003 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 2003.
(3) Bonus awarded based on performance.
(4) Other compensation for Mr. Luk included an allowance of HK$960,000
(US$123,000) and HK$1,440,000 (US$185,000) respectively for the fiscal
years 2003 and 2002, being 100% of the fair market rent of the living
accommodation provided to Mr. Luk. In 2003, other compensation also
included amounts for personal benefits such as life insurance and
salaries tax paid on behalf of Mr. Luk. See also "Certain
Transactions".
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.
CODE OF BUSINESS CONDUCT AND ETHICS
The Company has not adopted yet the code of business conduct and ethics
to guide all directors, officers and employees, but intends to adopt one on its
next meeting of the Board of Directors.
31
CODE OF BUSINESS ETHICS FOR CEO AND SENIOR FINANCIAL OFFICERS
The Company has not adopted yet the code of ethics for its Chief
Executive Officer and all senior financial officers, but intends to adopt one on
its next meeting of the Board of Directors.
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.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of December 31, 2003, 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., RBS 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.
32
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, 2003 was
HK$9,481,000 (US$1,215,000). Under an agreement with the Company, Mr. Luk has
pledged 1,500,000 shares of the Company stock as collateral. See Note 12 to
Financial Statements.
Mr. Luk receives a monthly allowance of HK$80,000 (US$10,300) for the
fiscal year 2003 for his living accommodations. Such allowance represents the
fair market rent of the property owned by a company which is controlled by
Mr. Luk. See also "Management - Compensation".
The Company had the transactions with related companies as provided in
the Financial Statements, Note 12.
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.
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 Rowland Mazars, 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.
33
(b) Reports on Form 8-K
-------------------
NONE
ITEM 16. PRINCIPAL FEES AND SERVICES.
Set forth below are fees paid to the Company's independent accountants for the
past two years for the professional services performed for the Company.
Audit Fees: The Company paid Moores Rowland Mazars for the last two years to
audit the financial information according to the US GAAP. The amounts paid
for the audit service in each of the two most recent fiscal years are $67,000.
Audit Related Fees: None
Tax Fees: None
All Other Fees: None
34
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, 2004.
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: 4/14/04
- ------------------------ (principal executive officer)
Ngai Keung Luk
/s/ Yuk Wah Ho President and Director Date: 4/14/04
- ------------------------
Yuk Wah Ho
/s/ Robert Chui Chief Financial Officer and Director Date: 4/14/04
- ------------------------ (Principal accounting and financial officer)
Robert Chui
/s/ Darrie Lam Executive Vice President, Secretary Date: 4/14/04
- ------------------------ and Director
Darrie Lam
/s/ Yat Ming Lam Director Date: 4/14/04
- ------------------------
Yat Ming Lam
/s/ Allan Wah Chung Li Director Date: 4/14/04
- ------------------------
Allan Wah Chung Li
35