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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 [Fee Required]
For the fiscal year ended December 31, 2002
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 [No Fee Required]
For the transition period from ____________________ to ____________________
Commission file number 026573
------
PHYSICAL SPA & FITNESS INC.
- --------------------------------------------------------------------------------
(Exact name of issuer in its charter)
DELAWARE 98-0203281
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
40/F., NatWest Tower, Times Square,
No. 1 Matheson Street, Causeway Bay
Hong Kong Not applicable
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 852 2917-0000
-------------
Securities registered pursuant to Section 12(b) of the Act: None
----
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
-----------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.
YES [X] NO [ ]
Indicate by check mark if there is no disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in part III of this Form 10-K
or any amendment to this Form 10-K. [ ]
State issuer's revenues for its most recent fiscal year: $50,269,000
The aggregate market value of the voting stock held by non-affiliates
of the registrant as of December 31, 2002 was $820,000 based upon the average of
the last available bid and asked price of the Common Stock of $0.41 as of
December, 2002.
The number of shares outstanding of the registrant's classes of common
stock as of December 31, 2002: Common Stock, $.001 Par Value, 10,000,000 shares
DOCUMENTS INCORPORATED BY REFERENCE: NONE
PART I
ALL FORWARD-LOOKING STATEMENTS CONTAINED HEREIN ARE DEEMED BY THE COMPANY TO BE
COVERED BY AND TO QUALIFY FOR THE SAFE HARBOR PROTECTION PROVIDED BY THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995. SHAREHOLDERS AND PROSPECTIVE
SHAREHOLDERS SHOULD UNDERSTAND THAT SEVERAL FACTORS GOVERN WHETHER ANY
FORWARD-LOOKING STATEMENT CONTAINED HEREIN WILL BE OR CAN BE ACHIEVED. ANY ONE
OF THOSE FACTORS COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE
PROJECTED HEREIN. THESE FORWARD-LOOKING STATEMENTS INCLUDE PLANS AND OBJECTIVES
OF MANAGEMENT FOR FUTURE OPERATIONS, INCLUDING PLANS AND OBJECTIVES RELATING TO
THE PRODUCTS AND THE FUTURE ECONOMIC PERFORMANCE OF THE COMPANY. ASSUMPTIONS
RELATING TO THE FOREGOING INVOLVE JUDGMENTS WITH RESPECT TO, AMONG OTHER THINGS,
FUTURE ECONOMIC, COMPETITIVE AND MARKET CONDITIONS, FUTURE BUSINESS DECISIONS,
AND THE TIME AND MONEY REQUIRED TO SUCCESSFULLY COMPLETE DEVELOPMENT PROJECTS,
ALL OF WHICH ARE DIFFICULT OR IMPOSSIBLE TO PREDICT ACCURATELY AND MANY OF WHICH
ARE BEYOND THE CONTROL OF THE COMPANY. ALTHOUGH THE COMPANY BELIEVES THAT THE
ASSUMPTIONS UNDERLYING THE FORWARD-LOOKING STATEMENTS CONTAINED HEREIN ARE
REASONABLE, ANY OF THOSE ASSUMPTIONS COULD PROVE INACCURATE AND, THEREFORE,
THERE CAN BE NO ASSURANCE THAT THE RESULTS CONTEMPLATED IN ANY OF THE
FORWARD-LOOKING STATEMENTS CONTAINED HEREIN WILL BE REALIZED. BASED ON ACTUAL
EXPERIENCE AND BUSINESS DEVELOPMENT, THE COMPANY MAY ALTER ITS MARKETING,
CAPITAL EXPENDITURE PLANS OR OTHER BUDGETS, WHICH MAY IN TURN AFFECT THE
COMPANY'S RESULTS OF OPERATIONS. IN LIGHT OF THE SIGNIFICANT UNCERTAINTIES
INHERENT IN THE FORWARD LOOKING STATEMENTS INCLUDED THEREIN, THE INCLUSION OF
ANY SUCH STATEMENT SHOULD NOT BE REGARDED AS A REPRESENTATION BY THE COMPANY OR
ANY OTHER PERSON THAT THE OBJECTIVES OR PLANS OF THE COMPANY WILL BE ACHIEVED.
ITEM 1. BUSINESS
BACKGROUND OF THE COMPANY
Physical Spa & Fitness Inc. (the "Company"), through its subsidiaries,
operates fitness and spa centers in Hong Kong and the People's Republic of China
("China" or the "PRC"). The Company currently operates seventeen facilities:
thirteen in Hong Kong and four in China (including one in Macau) under the name
"PHYSICAL", with the exception of Renaissance Beauty Centre (see "Company
Organization"). All of the Company's operations, including the operating of the
fitness and spa centers, property holding, investment holding and other
corporate activities are conducted through the Company's wholly-owned or
majority-owned subsidiaries or joint ventures (see "Business of the Company
Organization"). The fitness and spa centers in Hong Kong are operated by the
Company's subsidiaries. Physical Health Centre Hong Kong Limited, a Hong Kong
corporation and a majority (91.4%) owned subsidiary of the Company, operates the
following centers in Hong Kong: Causeway Bay, Tsimshatsui, Shatin, Mei Foo (two
centers) and Kowloon City. Another six wholly owned subsidiaries of the Company,
Physical Health Centre (Tsuen Wan) Limited, Physical Health Center (TST)
Limited, Physical Health Centre (Tuen Mun) Limited, Physical Health Centre (E
House) Limited, Physical Beauty Centre (Central) Limited and Physical Health
Centre (Kornhill) Limited respectively operates the Tsuen Wan Center (opened in
July, 1998), the Sheraton Hotel Center (opened in July, 1999), the Tuen Mun
Center (opened in July, 2000), the Elizabeth House Center (opened in April,
2001), the Wing On Centre (opened in April, 2002), and the Kornhill Center
(opened in June, 2002). All of these companies are Hong Kong corporations.
Renaissance Beauty Centre is operated by Supreme Resources Limited, which was
previously a majority (70%) owned subsidiary of the Company and became a
wholly-owned subsidiary in 2000. Supreme Resources Limited is also a Hong Kong
corporation.
1
The Company's facilities in China are operated by two joint ventures:
Shanghai Physical Fitness & Beauty Centre Co, Ltd. (formerly known as Shanghai
Physical Ladies' Club Co., Ltd.) ("Shanghai Joint Venture"), which operates two
centers in the city of Shanghai, and Dalian Physical Ladies' Club Co., Ltd.
("Dalian Joint Venture"), which operates fitness and spa facility in the city of
Dalian. The Company, through its subsidiaries, holds a 99% interest (changed
from 100% in 2002) in the Shanghai Joint Venture and a 90% interest in the
Dalian Joint Venture. The minority interests in the two joint ventures are held
by the joint ventures' Chinese partners. China regulations of the fitness and
spa facilities encourage joint ventures with a foreign company and provide less
restrictive regulations of such form of business entities. See "Government
Regulation - China".
The Company's facility in Macau is operated by a wholly-owned
subsidiary of the Company, Su Sec Pou Physical Health Centre (Macau) Limited,
which is a Macau corporation.
The Company provides its customers, at each location, with access to a
wide range of U.S.-styled fitness and spa services. The Company offers to its
customers the fitness cards for the use of its fitness facilities, which include
extensive aerobics programs, personalized training, cardiovascular conditioning
and strength training. The facilities are equipped with the latest Western
exercise equipment, including Life Fitness, Cybex, Flex and Precor. Spa and
beauty treatment services are provided to both customers and visitors, and
include skin care and facial treatments, massage, spa relaxation programs and
weight-management programs. The Company also sells at the facilities a variety
of exercise clothing and European beauty products. Based on the number of the
Company's customers, management believes that the Company is among the top
providers of fitness, exercise, and spa/beauty treatment services in Hong Kong
and China, with approximately 100,000 customers.
The Company's strategy is to provide a one-stop fitness and beauty
center for its customers. Management believes that the Company's strong market
presence in Hong Kong and its successful entrance into China's market is a
result of its strategy of offering state-of-the-art exercise equipment, high
quality beauty treatments and professional staff.
The Company believes that it is one of the first companies to provide
Western fitness and spa services in China. In 1994, the predecessor companies of
Physical Beauty & Fitness Holdings Limited, a British Virgin Islands corporation
("Physical Limited"), the holding company of the Company's subsidiaries, began a
process of expansion into targeted market segments in China. In 1994, the
Company through Shanghai Joint Venture opened the Company's first China
operation in Huangpu, Shanghai, with a fitness center to provide fitness and spa
treatment facilities. Another center of similar size was opened in Hongqiao,
Shanghai in September 1995, through Shanghai Joint Venture. The Huanghpu and
Hongqiao centers were respectively relocated to Lu Wan (October, 2002) and Xu
Hui (March, 2001) with enhanced facilities. A third China operation in Dalian
commenced in April 1996 and is conducted through Dalian Joint Venture. See
"Business of the Company - Organization". The Company's facilities in China are
operated under the trade name "Physical", and the Company registered a
servicemark under that name in Chinese language, which precludes others from the
use of the same name. See "Business of the Company - Trademarks and Trade
Names".
In the opinion of the Company's management, current competition in
China is becoming keen as the fitness and spa industry has attained its growth
stage with increased new entrants from both domestic and global market. The
Company expects that rising consumer incomes, increasing health awareness and
growing access to foreign goods and trends, should continue to create increased
demand for fitness and spa services in China. In 1996, the Company (through its
subsidiaries) entered into two additional joint ventures in Zhongshan (Zhongshan
Joint Venture) and Shenzhen (Shenzhen Joint Venture), China, however, such joint
ventures have not commenced any operations yet. The Company explores the
possibilities of opening these centers in the future, however, there can be no
assurances given that such joint ventures will start operations or that such
centers will be opened as currently contemplated by the management. See
"Business of the Company - Business Strategy".
2
The Company's strategy for maintaining its strong presence in Hong Kong
is to continue to provide existing and new customers with high quality services
at an affordable price and by periodically upgrading the facilities as new
developments and technology emerge in the industry. The Company's objective is
to add new services and treatments to keep the Company current with market
trends and to promote and enhance the Company's reputation of providing value-
driven services to its customers. The Company places heavy emphasis on staff
training which is supported by an in-house training department and on-going
classes.
The Company was incorporated on September 21, 1988 in the state of
Delaware under the name of "Foreclosed Realty Exchange, Inc", a development
stage company seeking acquisitions. Prior to acquisition of Physical Limited,
the Company had no revenue producing operations, but planned to enter into joint
ventures and/or acquisitions originally in the area of real estate to expand its
operations. In October, 1996, the Company closed a transaction with Ngai Keung
Luk (Serleo), a 100% shareholder of Physical Limited, whereby the Company
entered into a Share Exchange Agreement with Ngai Keung Luk (Serleo), pursuant
to which the Company issued 8,000,000 shares of its Common Stock to Ngai Keung
Luk (Serleo) in exchange for all of the outstanding shares of Physical Limited
(the "Closing"). Subsequently, the Company changed its name to "Physical Spa &
Fitness Inc." in November, 1996, to reflect the new business operations of the
Company. At the Closing the then current management of the Company resigned and
was replaced by the current management of the Company. See "Management."
The Company effected a 1.333333-for-1 reverse split of its common stock
in October 1997 and a 1-for-1.333333 forward split of its common stock in June
1998. All references in this Report to shares of Common Stock of the Company
have been adjusted for the effects of the reverse stock split and forward stock
split.
Since December 20, 2001, the Company has changed its executive and
administrative office in Hong Kong at:
40/F., NatWest Tower, Times Square,
No. 1 Matheson Street, Causeway Bay, HONG KONG
The telephone number of the Company in Hong Kong is (852) 2917-0000.
Unless the context requires otherwise, as used herein, any reference to
the Company includes the Company's subsidiaries - Physical Beauty & Fitness
Holdings Limited, Physical Health Centre Hong Kong Ltd., Regent Town Holdings
Ltd., Supreme Resources Ltd., Physical Health Centre (Tuen Mun) Ltd. (formerly
known as Physical Health Centre (Zhong Shan) Limited), Zhongshan Physical
Ladies' Club, Ltd., Ever Growth Ltd., Proline Holdings Ltd., Physical Health
Centre (Shanghai) Limited (formerly known as Shanghai Physical Ladies' Club
Company Ltd.), Shanghai Physical Fitness & Beauty Centre Co, Ltd. (formerly
Known as Shanghai Physical Ladies' Club Co., Ltd.), Jade Regal Holdings Ltd.,
Physical Health Centre( Dalian) Ltd., Dalian Physical Ladies' Club Co. Ltd.,
Star Perfection Holdings Ltd., Physical Health Centre (Shenzhen) Ltd., Shenzhen
Physical Ladies' Club Company Ltd., Physical Health Centre (Tsuen Wan) Limited,
Physical Health Centre (Macau) Limited, Su Sec Pou Physical Health Centre
(Macau) Limited, Physical Health Centre (TST) Limited, Physical Health Centre (E
House) Limited (formerly known as Global Resources Limited), Physical Beauty
Centre (Central) Limited, Physical Health Centre (Shatin) Limited (formerly
known as Physical Health Centre (PM) Limited), Physical Health Centre (Kornhill)
Limited, and Physical Health Centre (Central) Limited.
See also "Business - Organization".
3
THE COMPANY'S BUSINESS
General
- -------
The Company's fitness and spa centers are located in or near urban
areas in highly populated areas of Hong Kong and major metropolitan cities in
China and most of them are operated under long-term leases. With the exception
of Mei Foo fitness center, a portion of which is owned by the Company (see
"Business - Properties"), the Company does not own the real property on which
the centers are located, but owns the leasehold improvements and equipment with
respect to each center. Generally, the Company's centers average 30,000 square
feet and include a workout area including a broad range of fitness equipment,
changing room, sauna and steam facilities and a separate area devoted
exclusively to professional spa and beauty treatment programs. Each center
typically includes a laser TV room, health drink bar and sells a range of
European beauty products.
The Company's strategy is to grow through expansion of its fitness and
spa facilities in Hong Kong and China, as well as to explore the opportunities
for its fitness and spa services in other countries of Far East. The Company
intends to build on its continuous operating presence (since 1986) in Hong Kong,
the relationships in China established by the Company's executives and senior
staff and the Company's policy of offering what it believes are the
state-of-the-art exercise and spa facilities and beauty treatments at affordable
prices in their respective markets. In addition, the Company is closely
monitoring potential opportunities in the Philippines, Taiwan, Malaysia and
Indonesia.
Organization
- ------------
The Company's operations are conducted through its subsidiaries in Hong
Kong and Sino-foreign joint ventures in China. A number of the Company's
subsidiaries have been incorporated in the British Virgin Islands, primarily for
tax reasons. Such structure provides greater flexibility for the Company in
obtaining tax benefits, especially in case of corporate accounts. Set forth
below is the description of the Company's subsidiaries and their respective
roles in the organizational structure of the Company.
EQUITY INTEREST
DATE OF ACQUISITION / PLACE OF OWNED BY THE PRINCIPAL
NAME OF COMPANY FORMATION INCORPORATION COMPANY ACTIVITIES
--------------- --------- ------------- ------- ----------
Direct Indirect
------ --------
Physical Beauty and March 8, 1996 BVI 100% - Investment
Fitness Holdings holding
Limited ("Physical
Limited")
Ever Growth Limited September 29, 1994 HK - 100% Property
("Ever Growth") holding
Physical Health Centre December 1, 1998 HK - 100% Operate a
(E House) Limited fitness
(formerly known as center
Global Resources in
Limited) Hong Kong
Jade Regal Holdings March 15, 1996 BVI - 100% Investment
Limited ("Jade Regal") holding
Physical Beauty Centre September 14, 2001 HK - 100% Operating
(Central) Limited** a beauty
center in
Hong Kong
Physical Health Centre March 15, 1996 HK - 100% Investment
(Dalian) Limited holding
("Dailan Physical")
4
Organization (Continued)
- ------------
EQUITY INTEREST
DATE OF ACQUISITION / PLACE OF OWNED BY THE PRINCIPAL
NAME OF COMPANY FORMATION INCORPORATION COMPANY ACTIVITIES
--------------- --------- ------------- ------- ----------
Direct Indirect
------ --------
Physical Health Centre December 31, 2001 HK - 100% Operating a
(Kornhill) Limited** fitness and
beauty center
in Hong Kong
Physical Health Centre March 21, 1997 HK - 100% Investment
(Macau) Limited holding
Physical Health Centre May 30, 2001 HK - 100% Will operate a
(Shatin) Limited** fitness and
(formerly known as beauty center
Physical Health in Hong Kong
Centre (PM) Limited)
Physical Health Centre April 15, 1996 HK - 100% Investment
(Shenzhen) Limied holding
("Shenzhen Physical")
Physical Health Centre November 18, 1998 HK - 100% Operating a
(TST) Limited fitness and
("Physical TST") beauty center
in Hong Kong
Physical Health Centre September 8, 1997 HK - 100% Operating a
(Tsuen Wan) Limited fitness and
("Physical Tsuen Wan") beauty center
in Hong Kong
Physical Health Centre September 29, 1994 HK - 100% Operating a
(Tuen Mun) Limited fitness
center in
Hong Kong
Physical Health Centre March 2, 1990 HK - 91.4% Operating 3
Hong Kong Limited fitness and
("Hong Kong Limited") beauty centers,
1 fitness center
and 2 beauty
centers in
Hong Kong
Proline Holdings Limited September 28, 1994 BVI - 100% Investment
("Proline") holding
Regent Town Holdings September 20, 1993 BVI - 100% Investment
Limited ("Regent") holding
Physical Health Centre September 28, 1994 HK - 100% Investment
(Shanghai) Limited holding
(formerly known as
Shanghai Physical Ladies'
Club Company Limited)
("Shanghai Physical")
Star Perfection Holdings April 15, 1996 BVI - 100% Investment
Limited ("Star holding
Perfection")
Supreme Resources Limited September 29, 1994 HK - 100% Operating a
("Supreme") beauty
center in
Hong Kong
Su Sec Pou Physical Health August 18, 1997 Macau - 100% Operating a
Centre (Macau), Limited fitness
center in
Macau
Physical Health Centre August 9, 2002 HK - 100% Inactive
(Central) Limited**
See also Notes to the Financial Statements
5
See also "Company" - Properties". The Company's organizational chart is set
forth below.
ORGANIZATION CHART OF PHYSICAL SPA & FITNESS INC.
--------------------------------------------------
Physical Spa & Fitness Inc.
US
|
|100%
|
Physical Beauty & Fitness
Holdings Limited
BVI
|
|
- ---|-----------|----------|----------|----------|----------|-----------|--------------|---------------|---------|----------|-------
|100%* |100%* |100% |100% |91.40% |100%* |100% |100%* |100%* |100%* |100%*
- ----------- ---------- ---------- ---------- ---------- ----------- ----------- ----------------- ---------- --------- -----------
Supreme Physical Regent Jade Physical Physical Star Physical Physical Ever Physical
Resources Health Town Regal Health Health Perfection Health Health Growth Health
Limited Centre Holdings Holdings Centre Centre Holdings Centre Centre Limited Centre
(E House) Limited Limited Hong Kong (Tsuen Wan) Limited (Tuen Mun) (TST) (Macau)
Limited Limited Limited Limited Limited Limited
HK HK BVI BVI HK HK BVI HK HK HK HK
- ----------- ---------- ---------- ---------- ---------- ----------- ----------- ----------------- ---------- --------- -----------
| | | | | | | | | | |
|100% |100% |100% |100%* |100% |100% |100%* 100%---|---95% |100% |100% |100%
Renaissance Causeway Proline Physical | Tsuen Wan Physical Tuen Mun| Zhongshan Tsim- Property Su Sec Pou
Beauty Bay Holdings Health | Health Centre Health | Joint shatsui in Physical
Center -E House Limited Centre | Centre | Venture -Sheraton Mei Foo Health
(Central (Dalian) | (Shenzhen) Centre
Branch Limited | Limited (Macau),
Operation) | Limited
HK HK BVI HK | HK HK HK HK Macau
- ----------- ---------- ---------- --------- | ----------- ----------- --------- ---------- ---------
| | | |
|100%* |90% | |90%
Physical | | |
Health | | |
Centre | | |
(Shanghai) | | |
Limited | | |
HK | Causeway Bay |
---------- | Tsimshatsui |
| | Shatin |
|99% | Mei Foo (Fitness) |
| | Mei Foo (Beauty) |
Shanghai Dalian Kowloon City Shenzhen
Joint Joint Joint
Venture Venture HK Venture
----------
*50% held by one nominee shareholder. Since the Companies Ordinance of Hong Kong
requires a minimum of 2 shareholders for each limited company, Mr. Luk holds the
remaining shares on behalf of Physical Beauty & Fitness Holdings Ltd.
** Physical Beauty Centre (Central) Limited, Physical Health Centre (Kornhill)
Limited, Physical Health Centre (Shatin) Limited (Formerly knowna as Physical
Health Centre (PM) Limited), and Physical Health Centre (Central) Limited are
not shown in the above chart.
6
OWNERSHIP STRUCTURES IN CHINA
The organizational structure of the Company's operations in China is set
forth below.
INTEREST TERM REGISTERED
TYPE OF OWNED BY OF THE CAPITAL
NAME OF THE JOINT THE JOINT (AMOUNT IN
JOINT VENTURE LOCATION VENTURE COMPANY VENTURE THOUSAND) PROFIT SHARING
ARRANGEMENT
- ----------------- ------------ ---------- ---------- -------- ---------------- ------------------------------------
Shanghai Lu Wan Co-operative Originally Originally Originally Originally none(joint venturer receives
Physical and Xu Hui 100% and 10 years US$1,000 in rent for locations and will
Fitness (formerly changed and cash and receive equipment when the
& Beauty known as to 99% extended increased to joint venture is dissolved)
Centre Huangpu & in 2002 to 15 US$2,000 in and changed to pro-rata to
Co, Ltd. Hongqiao), years cash in 1995 equity interests in 2002
(formerly Shanghai in 2002
known as
Shanghai
Physical
Ladies' Club
Co., Ltd.)
("Shanghai
Joint Venture")
Dalian Physical Dalian Equity 90% 12 Originally Pro-rata to equity interests
Ladies' Club years Rmb10,000 in
Co., Ltd. cash and
("Dalian Joint changed to
Venture") Rmb1,000 in
cash and
Rmb9,000
in form of
fixed assets
and renovation
materials in
1996
Shenzhen Shenzhen Co-operative 90% 10 HK$4,600 in Pro-rata to equity interests
Physical years form of cash
Ladies' Club and fixed
Co. Ltd. assets
("Shenzhen
Joint
Venture")
Zhongshan Zhongshan Co-operative 95% 10 US$500 in form Pro-rata to equity interests
Physical years of cash and
Ladies' Club fixed assets
Co. Ltd.
("Zhongshan
Joint Venture")
See also Notes to the Financial Statements
SHANGHAI JOINT VENTURE. The Shanghai Joint Venture is a Sino-foreign
cooperative joint venture established on September 7, 1993 in Shanghai, China.
The Chinese joint venture partner is a state-owned enterprise in the PRC,
Shanghai Ti Yu Guan (SHTYG). Physical Health Centre (Shanghai) Limited (formerly
known as Shanghai Physical Ladies' Club Company Limited), a Hong Kong
corporation ("Shanghai Physical") authorized Physical Health Centre Hong Kong
Limited, a Hong Kong corporation, to enter into a joint venture contract with
SHTYG. The joint venture period is 10 years from the date of issue of the
business license on September 7, 1993 and further extended by 5 years in 2002.
By an amendment of the joint venture contract on June 1, 2002, the equity
interest of Shanghai Physical changed from 100% to 99%. The remaining 1% of the
equity interest was transferred from Shanghai Physical to SHTYG.
DALIAN JOINT VENTURE. On April 11, 1995, Physical Health Centre
(Dalian) Limited, a Hong Kong corporation ("Dalian Physical") formed a
Sino-foreign equity joint venture with a Chinese enterprise to operate a
fitness/ spa center in Dalian, China. The joint venture period is 12 years from
the issue of the business license on April 11, 1995. The equity interest of
Dalian Physical is 90% and the Chinese joint venture partner's equity interest
is 10%. The joint venture commenced effective operations in April 1996.
7
ZHONGSHAN JOINT VENTURE. In June 1996, Physical Health Center (Zhong
Shan) Ltd. ("Zhongshan Physical", now known as Physical Health Centre (Tuen Mun)
Limited), entered into a joint venture contract, as supplemented in August,
1996, with a Chinese enterprise in Zhongshan, China to establish a Sino-foreign
cooperative joint venture for the provision of fitness and spa services. Prior
to the date of this report, however, the Company has verbally agreed with the
Chinese enterprise to terminate the joint venture contract.
SHENZHEN JOINT VENTURE. In 1996, Shenzhen Physical Ladies' Club Co.,
Ltd., entered into a joint venture contract with a Chinese enterprise in
Shenzhen, China to establish a Sino-foreign cooperative joint venture for the
provision of fitness and spa services. Prior to the date of this report,
however, the Company has verbally agreed with the Chinese partner to terminate
the joint venture contract.
Since Shanghai Joint Venture and Dalian Joint Venture operate in China,
they are subject to special considerations and significant risks not typically
associated with investments in equity securities of the United States or Western
European countries.
OVERVIEW OF THE COMPANY'S MARKETS
HONG KONG
- ---------
FITNESS
- -------
The concept of preventive health care and physical fitness, which
became popular in Hong Kong in the early 1980's, was introduced from the United
States and Europe. With the growing affluence of the local population and
improvement in their standard of living, people began to immerse in physical
exercise to maintain a fit and healthy body. The fitness trend grew in Hong Kong
and gained popularity within the high income group initially.
To cater to this new industry, a number of fitness centers were
established in Hong Kong which provided a variety of exercise equipment as well
as aerobic dance classes. Private clubs (dining clubs, marina clubs,
entertainment clubs) targeted towards the upper income group also began to
provide similar services to their members or expanded their existing facilities.
The majority of these fitness centers targeted the high income group,
were very exclusive, and entrance fees or membership fees were generally high.
Under this marketing strategy, these fitness centers were restricted to a
comparatively small number of potential customers. Additionally, some of these
fitness centers were affected by the migration boom of Hong Kong in the mid
1980's. At that time, a large number of professionals migrated from Hong Kong to
other countries to pursue educational and economic opportunities. This migration
boom affected the customer base of these fitness centers and thus decreased the
viability of their business. As a result, fitness centers targeting the high
income group in Hong Kong were vulnerable and underwent a period of
consolidation. Later on, as the market developed, a market niche emerged for
fitness centers catering to the middle income group.
8
SPA
- ---
The spa industry in Hong Kong, which includes the skin care or beauty
industry, is rather fragmented with a large number of small operations. It is
common that certain spa and beauty treatments are provided by a wide range of
establishments including beauty salons, hair salons, and even cosmetic counters
situated in department stores. The standard of services for beauty treatments
varies widely. Normally, the customer base of these operations is confined to a
relatively limited number of frequent customers. Exclusive private clubs that
cater to a small percentage of wealthy Hong Kong women and the inconsistent
quality and skill level of small operations have increased the demand for middle
market skin care treatments since late `80S.
See also "Competition".
CHINA
- -----
FITNESS
- -------
In China, the concept of physical fitness has a long history, but it
was not widely practiced, except by the 50+ generation. Even China's famous Tai'
Chi is seldom practiced by young people. Organized sports for recreation are
more popular, though sports centers are in the Management's opinion generally
ill equipped and out of date. It appears that intensive training in a particular
sport is only available to a minority of people. Physical fitness centers are
usually in the form of gymnasiums run by state-owned sports authorities.
A handful of small clubs with standard facilities have opened since
early '90S, but offer, in the Management's opinion, a limited selection of
locally made, out-of-date equipment (as compared to the equipment used in the
Company's centers). Such facilities are frequented by more men than women, as
they tend to be equipped with barbells and weights.
The Company believes that aerobics is gaining popularity with the
influx of follow-along television programs. The Management observed that the
overall improved lifestyle; availability of fast food and convenience foods,
increased spending power, and increasingly sedentary lifestyles of Chinese
people, has led to a widespread concern for weight control. The Management
believes that aerobics especially appeals to women in China, as large
percentages of women seem to be concerned with losing weight.
In recent years, several fitness centers have entered into the market.
They are well-equipped with the latest brands of Western-styled exercise
machines and help enhance the popularity of the fitness industry.
SPA
- ---
The Company noted that Western-styled spa and beauty treatments has
become increasingly common and popular in China. Home-treatments, using
cosmetics purchased in department stores, have also become very common. However,
in the Management's opinion standards of skill and hygiene tend to be poor, as
is the quality of products used, as compared to those provided by the Company's
centers.
9
In mid-90'S, several Hong Kong and Japanese companies set up spa/beauty
centers of varieties of facilities. More and more internationally recognized
skin care lines have also become available in department stores. Those
department stores often hold in-house promotions to demonstrate their products
and educate potential customers. It appears that the desire to own anything
imported, including skin care products, is considered prestigious and is
therefore highly desired by Chinese women. The Management noticed that the
demand for "foreign" spa treatments and beauty salons, and imported products is
high. The local and international media is introducing fitness and skin care
news to a growing receptive audience. The Company believes that the demand for
affordable, value-driven beauty and skin care has increased.
HISTORY
The Company was incorporated on September 21, 1988 in the state of
Delaware under the name of "Foreclosed Realty Exchange, Inc", a development
stage company seeking acquisitions. Prior to acquisition of Physical Beauty &
Fitness Holdings Limited, a British Virgin Islands corporation ("Physical
Limited"), the Company had no revenue producing operations, but planned to enter
into joint ventures and/or acquisitions originally in the area of real estate,
to expand its operations. In October, 1996, the Company closed a transaction
with Ngai Keung Luk (Serleo), a 100% shareholder of Physical Limited, whereby
the Company entered into a Share Exchange Agreement with Ngai Keung Luk
(Serleo). Physical Limited was incorporated on March 8, 1996 under the laws of
British Virgin Islands and has interests in various companies operating fitness
and beauty centers and other related businesses in Hong Kong and China (see
"Company-Organization"). Pursuant to the Share Exchange Agreement, the Company
issued 8,000,000 shares of its Common Stock to Ngai Keung Luk (Serleo) in
exchange for all of the outstanding shares of Physical Limited (the "Closing").
Subsequently, the Company changed its name to "Physical Spa & Fitness Inc." in
November, 1996, to reflect the new business operations of the Company. At the
Closing the then current management of the Company resigned and was replaced by
the current management of the Company. See "Management."
In 1986, the founder and principal shareholder of the Company, Ngai
Keung Luk (Serleo), set up the first fitness center under the trade name of
"Physical" with the objective of providing physical fitness and spa treatment
services at prices which could be afforded by a rapidly growing middle class
population in Hong Kong. Two years later in 1988, another center was founded in
Hong Kong. The businesses of these centers were operated in a form of a sole
proprietorship and were subsequently transferred to Physical Health Centre Hong
Kong Limited, a Hong Kong corporation established on March 2, 1990 ("Hong Kong
Limited"). During the period from 1990 to 1996, Hong Kong Limited and Physical
Limited expanded their scope of operations by acquiring and establishing several
subsidiaries and by forming Sino-foreign joint ventures in China to operate four
additional fitness/spa centers in Hong Kong, three in China and other related
businesses (see "Company - Organization"). The subsidiary companies were all
formerly owned by Mr. Luk and other principal shareholders, or solely by Mr.
Luk. The respective equity interests were transferred by Mr. Luk and other
principal shareholders to Hong Kong Limited or Physical Limited throughout 1993
to 1996 at the original cost of the respective investments. In October, 1996,
91.4% of the equity interests of Hong Kong Limited was transferred by the
principal and other shareholders (including Mr. Luk) to Physical Limited at the
par value of the shares transferred. In addition, all the equity interests of
Hong Kong Limited in various subsidiaries and Sino-foreign joint-ventures were
also transferred to Physical Limited at the recorded cost of these investments.
10
HONG KONG
The first facility was opened in the Mei Foo Sun Chuen area of Hong
Kong to provide fitness training and spa treatment services at a price thought
to be affordable by its target middle-class customers. The Mei Foo center opens
its fitness facilities to both male and female customers while the spa/beauty
treatment service is solely provided to female patrons. It proved profitable and
within a year, more than 700 fitness customers and 1,000 clients for spa
treatments were enrolled. In 1990 the Mei Foo Center was expanded by acquiring
by the Company's subsidiary an additional 700 square feet, immediately above the
existing facility. In December 1999, the spa facility was separated from the
fitness facility for expansion purpose. The two facilities currently occupy an
aggregate floor area of 12,000 square feet.
The second fitness and spa center was opened in July 1988 on Nathan
Road, Tsimshatsui, Kowloon, which is one of the busiest commercial and
entertainment areas in the Kowloon area of Hong Kong. The Tsimshatsui Center,
consisting at that time of 12,000 sq. ft. (subsequently expanded to 25,000 sq.
ft) is, to the best of the Management's knowledge, to be the first fitness and
spa center to provide high quality, Western-styled professional services for
fitness training and spa treatment for middle income women customers in Hong
Kong.
In March 1990, the business of the two centers was transferred to, and
consolidated under, Hong Kong Limited (see above).
To broaden its geographical diversification, Hong Kong Limited opened
its third fitness and spa center in Causeway Bay Plaza, Causeway Bay in August,
1990. Located in one of the most popular entertainment areas on Hong Kong
Island, the Causeway Bay Center initially occupied a floor space of
approximately 18,000 square feet. Since opening, the Causeway Bay Center
experienced an ongoing strong demand for its fitness and spa services, and the
Company relocated the center to the existing location of 30,000 sq. ft in June
1997.
In order to cater to the market demand in the New Territories area of
Hong Kong, Hong Kong Limited opened its fourth fitness and spa center in New
Town Tower, Shatin, in September 1992. The Shatin Center is located in a
commercial complex in the heart of the densely populated residential and popular
entertainment areas in the New Territories. It occupies a floor space of
approximately 15,000 square feet. In October 1998, the Shatin Center was
relocated to a brand new shopping mall nearby, Grand Central Plaza, at the
expiration of the original tenancy.
In March 1993, Hong Kong Limited opened another fitness and spa center
of approximately 3,000 square feet in Kowloon City to provide facilities to
customers residing in the south-eastern area of Kowloon.
As a result of a growing demand for upscale facilities and amenities
for spa services in the upper middle market, the Company opened through a
subsidiary, Supreme Resources Limited (see "Company - Organization"), its first
upscale market spa treatment center; "Renaissance Beauty Centre". The
Renaissance center is situated in an upper income residential area in Central,
Hong Kong and provides spa treatment services.
From Mid-1998 to April, 2003, the Company opened six additional centers
in Hong Kong through its wholly owned subsidiaries, Physical Health Centre
(Tsuen Wan) Limited, Physical Health Centre (TST) Limited, Physical Health
Centre (Tuen Mun) Limited, Physical Health Centre (E House) Limited, Physical
Beauty Centre (Central) Limited, and Physical Health Centre (Kornhill) Limited
respectively. These collectively make up a total of thirteen centers (where the
fitness facility and spa facility in Mei Foo are counted as two centers) in Hong
Kong.
See also "Description of Property".
11
CHINA
Commencing in the mid-1980's, China commenced market-oriented reforms
that were designed to open up and improve the economy and the Chinese standard
of living. As economic reforms became successful in China and a large,
middle-class market developed, China was targeted as an expansion market where
the success in Hong Kong could be duplicated.
Shanghai, with a booming economy, an influx of foreign investment, and
a population of 14 million, was the logical choice for the Company to start its
first China location. In January of 1994, the Huang Pu branch was opened in one
of Shanghai's busiest shopping districts, through a joint venture company formed
between a Chinese enterprise and a newly formed subsidiary of the Company. The
center has an area of 15,000 sq. ft. (which was relocated to Lu Wan with an
expanded area of 80,000 sq. ft. in October, 2002), and within the first year
there were over 2,000 fitness customers and spa clients. Based upon the positive
response to the first facility in Shanghai, the decision was made to open a
second Shanghai branch.
September, 1995 marked the opening of the second center in
Shanghai-Hong Qiao branch in Shanghai, situated in the fashionable Hong Qiao
Special Economic Development Zone. This center contains approximately 12,000 sq.
ft. and is easily accessible to a large residential area and busy commercial
district. In March, 2001, the Hong Qiao Center was relocated to Metro City, Xu
Hui District which is one of the busiest shopping districts in Shanghai with
enhanced facilities of approximately 24,000 sq. ft. The Xu Hui Center was
further expanded to approximately 41,000 sq. ft. in February, 2002 to provide
fitness service to both female and male customers.
In April, 1996, the Company opened its third fitness/spa center in the
city of Dalian, China. Dalian, located on the northern peninsula near Korea, is
the third largest seaport in China and has a population of approximately
5,600,000. Dalian is the fashion capital of China, hosting the world renowned
International Fashion Festival annually, and is also a major tourist
destination. Dalian has seen an influx of foreign investment in the past several
years, and the purchasing power of these citizens ranks high in the nation. The
Company's market research showed a strong existing interest in fitness and spa
services, with few choices available to potential customers. Within the first
six months of opening, Dalian center had over one thousand fitness customers and
nearly one thousand spa clients.
In October, 2000, the Company opened its first fitness center in Macau.
Macau has been a Portuguese colony (until December 20, 1999) strategically
located at the mouth of the Pearl River on the border of China. Macau is easily
accessible by Hong Kong residents via a 45-minute jet foil ride and is a popular
vacation destination for both Hong Kong and Chinese residents. Macau has a
population of approximately 500,000 (Hong Kong Trade Development Council). The
Company plans to target primarily Macau's local residents.
See also "Description of Properties".
BUSINESS STRATEGY
The Company believes that it has a strong reputation in the Hong Kong
and China markets in which it presently operates. This belief is based on
several factors, including continuous operating presence of the Company in Hong
Kong for the past years (since 1986), and the relationships in China established
by the Company's executives, management and staff over the last several years.
The Company intends to continue its policy of providing what it believes are
first-quality, comprehensive fitness and spa services in their respective
markets at affordable prices.
12
The Company seeks to expand its fitness and spa business from the
ground up as opposed to acquiring health and fitness clubs that are poorly
managed and/or financially distressed. The Company believes that the end result
of repositioning an existing center, which typically includes rebuilding a
customer base, renovations, additional equipment leasing, and re-training
existing staff, is less desirable than developing a new center.
The Company intends to build on its momentum, relationships and
standard of quality in several ways. First, the Company intends to expand its
presence in Hong Kong and China through the establishment of new fitness and spa
centers in Hong Kong (see "Business-Organization-Hong Kong") and China, and
through the addition of qualified personnel, including fitness instructors and
spa personnel in the existing facilities. Second, in conjunction with its
expansion, the Company intends to increase the variety of fitness and spa
services provided and products sold on a retail basis at each location.
The Company believes that its experience in and knowledge of the
fitness and spa industry in Hong Kong and China, as well as management's
continuous presence in Hong Kong (since 1986) and China (since 1994), positions
the Company to take advantage of perceived opportunities in this market.
Further, demographic developments in Hong Kong and China, continue to create
increasing demand for certain fitness and spa services. In this regard, the
Company opened planned centers in Tsuen Wan, Hong Kong (July, 1998), Sheraton
Hotel, Tsimatshui, Hong Kong (July, 1999), Tuen Mun, Hong Kong (July, 2000),
Macau (October, 2000), and Elizabeth House, Causeway Bay, Hong Kong (April,
2001). In early April, 2002, the Company opened a new beauty center in Central,
Hong Kong and expanded its Tsuen Wan fitness center to locate male customers.
The Company also established a new fitness/spa center in Kornhill, Hong Kong in
June, 2002. The Company plans to open new centers in other major metropolitan
cities in China over the next several years. However, there is no assurance that
such centers will be opened as currently planned since they are subject to
changing political and economic conditions, as well as the Company's evaluation
of the applicable market conditions.
- - BECOMING THE MARKET LEADER IN CHINA
In China, the Company is the first entrant into the market and has
secured a more established position than its competitors in the opinion of the
Management.
The planned expansion into China includes opening facilities in most
major cities and economically developing urban areas throughout the country,
subject to then current market and other conditions. According to the State
Statistic Bureau of China, the population of China is 1.2 billion and there are
currently thirty cities with populations in excess of 1 million. The population
of China is becoming increasingly urbanized, and the tastes of the urban
population is becoming increasingly sophisticated. (Source: Hong Kong Trade
Development Council).
Forty percent of the population of China lives in coastal areas, where
retail sales account for 60% of the country's total retail sales. Population
factors and strong spending power have led the Company to target coastal areas
for the spas to be developed (i.e. Dalian). Facilities can be linked by a
reciprocal system, allowing customers to use another facility when traveling to
other parts of the country. Marketing programs carried out nationwide, in the
management's opinion, will enable the Company to benefit from economies of
scale, similar to what the Company experiences in Hong Kong.
13
- - MAINTAINING A STRONG PRESENCE IN HONG KONG
The Company has well-established customer base and pre-dominant market
share in Hong Kong. The Board of Directors estimates that over 80 percent of the
Company's patrons are between the age of 20 to 40. Management believes that the
strong position held in the Hong Kong market can be maintained by continuously
upgrading facilities and services. The Company monitors this situation
continuously, and upgrades the fitness and spa areas on a regular basis. The
number of customers in each location is also carefully monitored in order to
ensure adequate levels of service to individual customers, particularly during
peak work-out periods. Branch Managers monitor the situation through direct
observation, customer feedback and surveys.
For spa personnel, intensive training is conducted in the in-house
training center and thorough on-the-job instruction. Selected employees are sent
to international workshops to study the latest techniques and to learn about new
products on the market. The Company seeks to satisfy its spa clients' needs with
the latest technology, expertise and a high level of service.
- - EXPLORING POTENTIAL MARKETS
The Company considers its market to be the greater Asia region. The
Company is also closely monitoring the market opportunities in other South East
Asian countries such as Taiwan, the Philippines, Thailand, Malaysia and
Indonesia.
FITNESS
The centers emphasize the benefits of health, physical fitness and
exercise by providing a wide range of exercise equipment from the United States
and Europe including free-weights, strength systems and cardiovascular machines
from manufacturers such as Life Fitness, Cybex , Flex, and Precor. The Company
places a particular emphasis on the quality of its fitness managers and
instructors by providing continuous training both in Hong Kong and overseas.
The centers also conduct daily dance classes which run for
approximately 45 minutes and are on a first-come, first-served basis. The
Company believes that the number of dance classes conducted by the Centers per
day is among the highest in Hong Kong. The variety of dance classes include
aerobic dance, step, arms and thighs workout, funk and jazz and are taught by
experienced instructors. The dance classes are reviewed on a monthly basis and
new dance classes are introduced approximately every three months in order to
appeal to the interests of customers. Since 1995, the Company has recruited
fully qualified and experienced aerobic instructors from Australia.
The Company believes, based on customer survey responses, utilization
rates and the existence of underutilized space in its centers, that it has
sufficient excess capacity at its existing fitness centers to accommodate new
customers as well as comfortable usage by present customers.
14
SPA SERVICES
Spa services are open to both customers and walk-in guests. However,
customers of the centers have priority for such service facilities. Over 80
types of spa treatments are offered including facial treatments, various skin
care treatments, spa relaxation programs, massage, and weight-management
programs.
All of the centers have designated rooms for spa treatments in order to
ensure privacy. In view of the popularity of the spa treatments, the centers
have a booking system whereby sessions for such treatment are reserved in
advance. The centers offer special discounts to patrons for beauty treatments
during off-peak hours in order to maintain an even level of customers during the
day. In promoting the fitness training services provided by the centers, patrons
for spa treatments, who are not fitness customers of the centers, are eligible
to use all facilities of the centers including fitness training, on the day of
their visits for a spa treatment. The Company believes that this additional
service offers an advantage over its competitors who engage only in beauty
treatments.
The Company has a broad scale of fees for its spa services and believes
that these fees are both affordable and competitive in terms of the quality and
variety of services provided at the centers. The centers typically charge the
normal fee on spa treatment per session. However, discounts are given to those
patrons who purchase prepaid treatments. These treatments are valid within a
specified period of time.
The Company employs professional spa personnel who hold recognized
qualifications and adequate experience. Each center retains a specific manager
for spa treatments that supervises the spa personnel and other staff members of
the center. Each spa employee serves only one patron during the entire session
of spa treatment. The Company places great emphasis on providing continuous
training programs for its spa personnel. In order to remain informed of the
latest international developments in spa treatments, applications, technology
and equipment, the Company arranges both local and overseas training.
RETAIL
The Company sells a range of products at selected centers such as
leotards, shorts, T-shirts, training shoes, socks and training suits, including
Nike, Reebock and several U.S. and Australian brand products. The Company also
sells European skin care products manufactured in France and Spain by Guinot,
Sothys and Anubis, respectively. The fitness and beauty related products are
available in the centers to facilitate the needs of their customers.
SERVICES
The Company currently offers prospective customers a fitness plan. Fees
for services at each facility depend on the location and demand for such
services at that facility. Marketing of the Company's services is targeted
towards the middle income population in the 18 to 45 years old range.
15
Under the plans, new customers are charged a registration fee upon
admission and a monthly fee each month to maintain their privileges. The initial
registration fees are non-refundable and range from approximately HK$800
(US$103) to HK$2,000 (US$256), depending on the diversity of facilities and
services available at the enrolling center, the local competitive environment,
as well as the effects of seasonal price strategies. The Hong Kong centers from
times to times are launching promotion at a special fee of HK$600 (US$77). Each
customer will also be charged a monthly due of HK$299 (US$38) for the usage of
the fitness centers. In order to fully utilize the facilities, the Company
grants a special offer of admission fees at HK$200 (US$26) to off-peak
customers. Prepayment of the monthly fee is encouraged by offering a discount
for customers who prepay for twelve or more months. Customers are also provided
on a monthly basis 10 aerobic coupons on free-of-charge basis at Hong Kong
locations. Any customer who attends additional classes has to purchase coupons
at HK$15 (US$2) each. China locations include aerobics classes with monthly
dues.
In order to allow greater flexibility to its customers, the Company
operates a network system where customers may use the facilities in any fitness
centers of the Company in Hong Kong at no extra cost. The centers have long
opening hours and are open all year round (except for Chinese New Year), in
order to provide continuous service to its customers. Generally, they are open
from 7:00 a.m. to 11:00 p.m. As with any consumer driven market, it is essential
that the services provided by the Company are constantly reviewed, updated and
improved. To achieve this, managers from the Customer Services Department as
well as each of the centers regularly invite comments from customers in relation
to the services provided. Additionally, the Company constantly seeks to
introduce new products and techniques on fitness training and spa treatments in
order to improve its services and thus enhance its competitive position.
SALES AND MARKETING
The Company devotes substantial resources to the marketing and
promotion of its fitness and spa centers and their services because the Company
believes strong marketing support is critical to attracting new customers both
at existing and new fitness centers. Since July, 1988, the Company and its
predecessor began to market substantially all of its fitness centers under the
service name "Physical", thereby eliminating the prior practice of using
different names for individual locations. See "Business - Trademarks and Trade
Names".
A key component of the Company's marketing strategy is to cluster
numerous fitness centers in major media markets in order to increase the
efficiency and cost effectiveness of its marketing and advertising programs.
Advertising consists of (i) television and (ii) newspapers, magazines, leaflets,
light box, and other promotional activities, which were accounted for
approximately 10%, and 90%, respectively, of the Company's total advertising
expenses in 2002.
The Company's sales and marketing programs emphasize the benefits of
health, physical fitness and exercise by appealing to the public's desire to
look and feel better. The success of the Company's marketing efforts are
dependent upon the ability of its sales personnel to make effective personal
presentations of the benefits of fitness training and beauty treatments to
prospective customers. The Company believes that these presentations are
enhanced by its well-equipped, attractive centers and its "value pricing"
programs. The Company also conducts a variety of marketing efforts. The
Company's executives and sales personnel attend trade shows and exhibitions, and
sponsor seminars and TV programs throughout Hong Kong and China. The Company has
introduced on-site aerobics shows, gymnasium instruction, and beauty
consultation in the course of these activities.
16
Since 1993, the Company has begun marketing, on a retail basis products
to its customers including apparel manufactured by leading U.S. and Australian
fitness apparel brands. These products are intended to add value to the services
and increase the Company's revenues. The Company's marketing focus also includes
corporate customers and clients from the reputable banks in Hong Kong. In
addition to its advertising, personal sales presentations and targeted marketing
efforts, the Company is increasingly utilizing in-door marketing programs. Open
days are organized to introduce the centers to prospective customers and
referral incentive programs involve current customers in the process of new
customer enrollments that effectively help foster customer loyalty.
ACCOUNT COLLECTION
All collections of past-due accounts are handled internally by the
Company. Customers who have outstanding unpaid balances are not provided further
services until such balances are paid in full. Corporate accounts are handled
pursuant to the applicable terms of credit agreements. Local corporate accounts
are normally not allowed any special credit. International corporate accounts,
which are much larger than the local accounts, can be allowed one to two months'
credit, with a possibility of extending such period, depending on the account's
size and record.
COMPETITION
HONG KONG
The competition of the Company consists of the following.
Upscale Market
- --------------
The Hong Kong upscale market consists of exclusive private clubs which
usually provide both fitness services and spa treatments at very high prices.
These private clubs are typically oriented towards women and offer a great deal
of variety to their customers. Annual membership fees average approximately
HK$9,800 (US$1,300) and beauty treatments are charged separately upon usage.
These facilities use expensive, name-brand equipment, luxurious decoration,
large areas of space averaging 30,000 sq ft, and offer a wide range of services
to attract customers. The primary club in this category is Phillip Wain with
three locations. There are certain upscale market establishments which provide
fitness services only, most are for both male and female, and are concentrated
in one area of Hong Kong. The joining fees range from HK$2,000 (US$260) to
HK$4,000 (US$510) with monthly membership fees ranging from HK$345 (US$44) to
HK$699 (US$90). These establishments range in size from 10,000 sq ft to 30,000
sq ft. Examples are California Fitness with five outlets, and Fitness First
Health Clubs with four outlets. The Company's fitness/spa facilities compete
directly primarily with the middle markets (see below).
17
Middle Market
- -------------
There are very few establishments in this class which provide both
fitness services and spa/ beauty treatments in a single facility. The closest
competitor in the same category is Modern Beauty Salon with seventeen locations
of average size of approximately 20,000 sq. ft. A monthly subscription of HK$150
(US$19) is required to become a member of the above center for a continuous
period of one year. The operators of spa/beauty services only which are in
direct competition with the Company's beauty centers include Caesar Beauty
Centre, with three locations, Sau San Tong Healthy Trim Institute, with two
locations, Angel Face Beauty Creations (International) Ltd., with fourteen
locations, Marie France Bodyline, with six locations, Oasis Spa, with two
locations, and Royal Bodyperfect, with five locations. The management believes
that, these facilities do not offer as high a level of fitness equipment and
instruction as the Company does and that the Company offers a more comprehensive
level of spa treatments than these facilities. The Company targets primarily the
middle market.
Low-End Market
- --------------
In this category, most establishments only provide either fitness
services or simple beauty treatments. These establishments are usually much
smaller in size and have a limited range of services. Representative of the
low-end market include Mid-City. Joining fee to these facilities vary from
HK$600 (US$77) to HK$2,000 (US$256), and monthly fees average approximately
HK$400 (US$51). In addition, there are numerous smaller facilities operating
inside the shopping arcades, and/or associated with hair salons and department
stores. Management believes that the Company does not directly compete with this
market.
In the low-end fitness market, the government operates a small number
of gymnasium facilities. These are public facilities, open to both men and women
for nominal fees.
18
CHINA
SPA SERVICES. Certain spa services are provided by beauty salons, which
are very popular in China and have been in existence for several years. However,
most are small scale and offer only basic services in the Company's opinion and
as compared to the Company's facilities. Most salons are not modern and do not
possess certain international standards of skill and hygiene as most facilities
in Hong Kong. In the Management's view, these salons only have access to locally
manufactured skin care products, which tend to be low-tech and chemically-based,
since it is too costly for a small salon to use imported products. The Company,
as an exclusive agent for several professional European skin care lines,
maintains the leading edge in skin care. The closest competitors in the spa
industry would be several beauty salons with Hong Kong investors such as Decleor
Health & Beauty Institute, in both Shanghai and Dalian. Services in these
facilities are more up to date and develop in fast pace to cater to the China
market.
FITNESS CENTER. There are several fitness centers in China, especially
following the opening of the Company's China facilities in Shanghai and Dalian.
The Company believes that its early entry into the market has helped it to
achieve the leading name in fitness. The Company believes that it was the first
to offer professional, up to date fitness services, up to date group exercise
(aerobics) classes, and a full range of modern exercise equipment. Though the
Company currently has only three facilities operating in China, the management
believes that its name has become already known as the Company has set the
standards for the fitness and spa industry for China. The closest competitors
are as follows:
Upscale Market
- --------------
There are many upscale recreation clubs in the major cities of China,
including Total Fitness Club and Megafit in Shanghai, and New Mart Fitness in
Dalian. These facilities usually offer aerobic, exercise, drinking bars and
occasionally beauty treatments.
The majority of four and five star hotels have health clubs for outside
membership as well as for hotel guests. Usually these clubs have expensive,
brand name equipment, and often offer aerobics classes. Most also have luxury
shower and spa facilities. However, the price structure is usually comparable to
an upscale U.S. health club, and therefore is not affordable to the vast
majority of Chinese people. Such clubs cater to the expatriate business
community, and some are exclusive to such community. Their location, being
situated on the hotel premises, often limits size, and they tend to reach full
capacity with a low number of members. Since most hotels do not depend on the
health club as a major source of revenue, typically very little marketing or
membership incentives are used.
19
Middle Market
- -------------
There are several middle market fitness centers in some of the larger
cities in China. Many newly built housing complexes (upscale apartment buildings
and "western" style housing villages) have recreation centers. They typically
include swimming pools, tennis courts and gyms. In the management's opinion,
such facilities are luxurious by Chinese standards, but gyms are commonly
unstaffed or only have a receptionist. More and more such centers are providing
exercise classes as well, but lack of qualified instructors, in the management's
opinion, inhibits growth in this area. Such clubs also opened in Dalian,
however, in the management's opinion, seldom of them matches the Company in
size, nor in the range of exercise equipment available, and classes offered and
the Company does not see them as the same level competitors. The closest
competitors in this market include Gold's Gym and Fitness First Health Club in
Shanghai, and Qiulin Fitness and Shaping in Dalian.
Low-End Market
- --------------
Group exercise is an extremely popular activity in China, but mainly
done by elderly people. As more interest is created in the younger market, a
wider variety of classes are now being offered in government facilities such as
gymnasiums, parks and town squares. Such facilities usually are held on a
basketball court in a gym, or a recreation hall with large open space. Typically
there are no shower, locker, or spa facilities available. The management
believes that the popularity of these facilities is due to the nominal fees
charged.
Trademarks and Trade Names
In July 1988, the Company and its predecessor began to market
substantially all its fitness centers under the servicemark "Physical" thereby
eliminating the prior practice of using a different trade names for each center.
The Company registered a servicemark under its trade name "Physical" in Hong
Kong and its Chinese equivalent name in China. In the opinion of the Company's
trademark counsel in Hong Kong, the registration enables the mark to distinguish
the Company's services from similar services of others. The servicemark gives
the Company a priority over the use of the servicemark by others and the right
to reject others from the use of the same name. In China, the Company has
registered the name in Chinese language pursuant to the Chinese Trademark Law
which provides the Company with protection of its name on a nation-wide basis
and precludes others in China from using the same name as the Company's.
Seasonality
Historically, the Company has experienced greater sales in the third
quarter of each year. In recent years, the Company has lessened this seasonal
effect by the use of sales incentives and awards for its sales personnel, as
well as other marketing initiatives.
Insurance
The Company maintains liability insurance providing coverage to the
Company with respect to accidental bodily injury and accidental loss of or
damage to property of any customer or employee of the Company, which would occur
in connection with the business of the Company and on the premises of the
Company. The Company does not maintain product liability insurance with respect
to the beauty products used in its spa treatments.
20
Research and Development
The Company's business is service-oriented, therefore it does not have
a formal Research & Development department, however, its marketing and training
departments are closely following the evolution of international fitness and
beauty trends.
Employees
The Company has approximately 1,430 employees, including approximately
30 commission based sales executives. Approximately 750 employees are involved
in fitness operations, including sales personnel, instructors, and supervisory
personnel. Approximately 500 employees are involved in beauty and spa
operations. Approximately 150 are administrative support personnel, including
accounting, marketing, training and other services.
The Company is not a party to any collective bargaining agreement with
its employees. The Company has not experienced a high turnover of non-management
personnel and also has not had difficulty in obtaining adequate replacement
personnel.
Government Regulation
Hong Kong
The Hong Kong operations and business practices of the Company are
subject to regulation at the local level. General rules and regulations,
including those of the local consumer protection agencies, apply to the
Company's advertising, sales and other trade practices.
Statutes and regulations affecting the fitness, spa and beauty
industries have been enacted or proposed in all of the areas in which the
Company conducts business. Typically, these statutes and regulations prescribe
certain forms and regulate the terms and provisions of sales and purchase
contracts, allowing the customer the right to cancel the contract within, in
most cases, 14 business days after signing, requiring an escrow for funds
received from pre-opening sales or the posting of a bond or proof of financial
responsibility, and, in some cases, establishing maximum prices and terms for
sales and purchase contracts and limitations on the term of contracts. In
addition, the Company is subject to several other types of regulations governing
the collection of debts. These laws and regulations are subject to varying
interpretations by local consumer protection agencies and the courts. The
Company maintains internal review procedures in order to comply with these
requirements and it believes that its activities are in substantial compliance
with all applicable statutes, rules and decisions.
21
Under typical regulations, customers of fitness centers have the right
to cancel any un-used services for a period of 30 to 60 days after the date the
contract was entered into (depending on the applicable law) and are entitled to
refunds of any payment made. The specific procedures for cancellation in these
circumstances vary according to differing local laws. In each instance, the
canceling customer is entitled to a refund of prepaid amounts only. Furthermore,
where permitted by law, a cancellation fee is due to the Company upon
cancellation and the Company may offset such amount against any refund owed. The
Company's customer agreements provide that a customer's one-time registration
fee is non-refundable in case of cancellation.
The Consumer Council of Hong Kong protects the rights of consumers. The
customers have a right to dispute the price or quality of the service, if they
find it unsatisfactory. The Council also assists consumers in cases of false
claims made by the companies with respect to a specific service offered by them.
The Company is cautious in advertising its services, and it never promotes or
guarantees unrealistic results concerning skin care or fitness services,
therefore the Company rarely faces complaints in this respect from its
consumers.
The Company's facilities are also subject to building, health and
safety laws. The laws require a normal building inspection at the time of
renovation of the facilities and/or fire safety inspection. Since the Company's
facilities typically are a part of a large office building for which a license
is granted, if the Company does not comply with all the regulations, the
landlord would not be granted a license. The Board of Health carries out an
inspection of shower and restroom facilities to make sure that they comply with
the standards imposed by the Board. In order to have massage services, the law
requires a special massage license. The Board of Health and Police Department
also hold random inspections of the facilities providing massage services, since
there are strict laws requiring that massage therapists be of the same sex as
the customers. As the Company is exclusively open to women in all beauty
centers, but one, there have been no concerns with this regulation.
China
In China, the Company's operations and business practices are subject
to regulation from the Central Government in Beijing, which is often carried out
at local levels. There is a Consumer Council in China which is now expanded to
most urban areas and whose role is to protect consumers and enforce consumer
rights in cases of dispute regarding quality of the product or service or
misleading claims. The Consumer Council holds considerable power in China and
can impose large fines upon a company it finds in violation of consumer laws.
The Consumer Council would often publish a statement against a fined company in
a local newspaper.
China requires a fire safety inspection and license before completion
of renovation of the facility. The safety department performs unannounced
inspections every year to ensure proper compliance with the regulations, such as
maintenance of clear fire exits, extinguishers, smoke detectors and other safety
equipment.
The Board of Health has strict regulations regarding spa facilities and
fitness/beauty equipment that is used by many people per day. The Board requires
an initial license before opening of the facilities and requires installation of
certain anti-bacterial and hygiene equipment. For example, the beauty treatment
area is required to have ultra-violet ("UV") disinfection lamps installed within
every 5 feet of public space. The law also requires UV disinfection every night
for the air, beds and chairs in the area. The Board also requires "hot cabinet"
disinfection units for small beauty tools and equipment. In the Company's
experience, random inspections of those areas of the spa are often done by the
Board of Health.
22
The Board of Health also requires an inspection and license for each
imported cosmetic or skin care product. The license must be obtained from the
Central Government and a substantial fee is charged for the testing of each
imported product.
In China, the Board of Health is responsible for monitoring the
operation of the Company's spas, however, their strict regulations fall in line
with the standards of the Company and therefore, to date, there has been no fine
or restriction of the operation of any fitness or spa facility.
There is a Council for Fair Pricing in China, and every business that
sells products or provides services must register their fees with this
department. The Council has a right to dispute fees if it deems them
unreasonable.
The Police Department has strict regulations in China regarding massage
services and requires the Company to ensure that the massage therapist is of the
same sex as the customer. A special license is required for massage services,
which is in the management's opinion, difficult to obtain. The massage therapist
must be certified and licensed by a government affiliation, and must have an
annual health examination. Since all the Company's beauty centers in China are
exclusively for women and include only female staff, the Company has not been
impacted by those regulations.
China has also regulations of not allowing independently owned fitness
and beauty spas by foreign companies. Instead, the regulations encourage joint
ventures with a foreign company. Fitness and beauty spas fall under the category
of "Entertainment and Recreation", which to date have always been business
entities in a form of joint ventures.
23
ITEM 2. PROPERTIES
The Company relocated its headquarters which include the Company's
executive and administrative offices to a new location of approximately 17,300
square feet in Causeway Bay, Hong Kong in December, 2001.
Aggregate rental expense was approximately HK$56.5 million (US$7.2
million), HK$70.4 million (US$9 million) and HK$103.6 million (US$13 million)
for the year ended December 31, 2000, 2001 and 2002, respectively.
Mei Foo is the only location indirectly partially owned by the Company.
The Company (through its subsidiary, Ever Growth Limited), directly owns 700 sq.
ft. of the property where the Mei Foo center is located. There are 7,300 sq. ft.
located in the same building and 2,000 sq. ft. in the neighborhood for fitness
facility and an additional 2,000 sq. ft. for the spa facility located in the
same district.
24
ITEM 3. LEGAL PROCEEDINGS
There are no pending material legal proceedings to which the Company or
any of its properties is subject, nor to the knowledge of the Company, are any
such legal proceedings threatened.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's stockholders
through the solicitation of proxies, or otherwise, during the fourth quarter of
the Company's fiscal year ended December 31, 2002.
25
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock has been listed on the Bulletin Board of the
NASD's over-the-counter market under the symbol PFIT, since December 1996, but
has been traded only sporadically. As of March 31, 2003, the 52-week trading
range was between $0.15 to $0.51 per share. The last reported sale was in March,
2003 at $0.51 per share. The reported sporadic sales in the fiscal year 2002,
are set forth below*.
Date Open High Low Close
Nov-02 0.25 0.25 0.15 0.15
Dec-02 0.15 0.41 0.15 0.41
- ---------------------
* Historical quotes provided by Commodity Systems, Inc.
As of December 31, 2002, there were approximately 619 record holders of
the Company's Common Stock. The Company effected a 1.333333-for-1 reverse split
of its Common Stock in October 1997 and a 1-for-1.333333 forward stock split in
June 1998.
DIVIDEND POLICY
- ---------------
The Company has never paid any cash dividends on its Common Stock and
does not anticipate paying any cash dividends in the future. Physical Health
Centre Hong Kong Limited, the subsidiary of the company acquired by the Company
in October, 1996, paid dividends out in 1995. The Company currently intends to
retain future earnings, if any, to fund the development and growth of its
business.
26
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data are qualified by reference to, and should
be read in conjunction with, the Consolidated Financial Statements, related
Notes to Consolidated Financial Statements and Report of Independent Public
Accountants, and Management's Discussion and Analysis of Financial Condition and
Results of Operations contained elsewhere herein. The following table summarizes
certain selected financial data of the Company for the fiscal years ended
December 31, 1998 through December 31, 2002. The data has been derived from
Consolidated Financial Statements (audited) included in Item 8 of this Report.
(In thousands, except share and per share data)
YEAR ENDED DECEMBER 31
---------------------------------------------------------------------
1998 1999 2000 2001 2002 2002
HK$ HK$ HK$ HK$ HK$ US$
--------- --------- --------- --------- --------- ---------
Consolidated Statements of Operations Data
OPERATING REVENUES 210,209 253,172 303,312 392,097 413,744 53,044
--------- --------- --------- --------- --------- ---------
OPERATING EXPENSES
Salaries and commissions (56,415) (70,729) (88,999) (113,239) (139,740) (17,915)
Rent and related expenses (46,527) (63,931) (74,685) (95,413) (132,929) (17,042)
Depreciation (25,781) (33,187) (41,335) (51,494) (63,412) (8,130)
Other selling and administrative expenses (60,572) (57,520) (80,634) (108,298) (95,844) (12,288)
--------- --------- --------- --------- --------- ---------
Total operating expenses (189,295) (225,367) (285,653) (368,444) (431,925) (55,375)
--------- --------- --------- --------- --------- ---------
INCOME (LOSS) FROM OPERATIONS 20,914 27,805 17,659 23,653 (18,181) (2,331)
--------- --------- --------- --------- --------- ---------
NON-OPERATING INCOME (EXPENSES)
Other income, net 645 452 853 778 418 54
Interest expenses (3,933) (4,245) (3,379) (3,638) (5,645) (724)
Goodwill write-off -- -- (1,113) -- -- --
--------- --------- --------- --------- --------- ---------
Total non-operating expenses (3,288) (3,793) (3,639) (2,860) (5,227) (670)
--------- --------- --------- --------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAXES AND
MINORITY INTERESTS AND THE CUMULATIVE
EFFECT OF A CHANGE IN ACCOUNTING
PRINCIPLE 17,626 24,012 14,020 20,793 (23,408) (3,001)
(Provision) Credit for income taxes 108 (4,933) (3,312) (6,785) (834) (107)
--------- --------- --------- --------- --------- ---------
INCOME (LOSS) BEFORE MINORITY INTERESTS
AND THE CUMULATIVE EFFECT OF A CHANGE
IN ACCOUNTING PRINCIPLE 17,734 19,079 10,708 14,008 (24,242) (3,108)
Minority interests (1,198) (577) (1,010) (761) 147 19
--------- --------- --------- --------- --------- ---------
NET INCOME (LOSS) BOFORE CUMULATIVE EFFECT
OF A CHANGE IN ACCOUNTING PRINCIPLE 16,536 18,502 9,698 13,247 (24,095) (3,089)
Cumulative effect on prior year of deferral
of sales rebates, net of income taxes
and minority interests -- -- -- -- 3,857 494
--------- --------- --------- --------- --------- ---------
NET INCOME (LOSS) 16,536 18,502 9,698 13,247 (20,238) (2,595)
========= ========= ========= ========= ========= =========
Net income per share 1.65 1.85 0.97 1.32 (2.02) (0.26)
========= ========= ========= ========= ========= =========
Number of shares of stock outstanding
(in thousands) 10,000 10,000 10,000 10,000 10,000 10,000
========= ========= ========= ========= ========= =========
Balance Sheet Data
Current assets 39,467 41,206 31,135 51,841 55,597 7,128
Total assets 169,641 186,131 212,931 263,126 324,890 41,653
Current liabilities 81,976 67,809 88,677 122,856 209,239 26,826
Long-term obligations other than finance
leases 13,592 16,319 15,789 15,243 22,252 2,852
Working capital (42,509) (26,603) (57,542) (71,015) (153,642) (19,698)
Obligations under finance leases-non current 4,215 12,114 8,191 9,342 5,032 645
Deferred taxation 4,712 5,661 6,312 7,434 4,593 589
Minority interests 5,144 5,721 6,544 7,305 7,285 933
Shareholders' equity 60,002 78,507 88,260 101,506 81,256 10,418
27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
The following discussion should be read in conjunction with "Selected
Income Data" and the Consolidated Financial Statements and Notes thereto
appearing elsewhere in this report.
Overview
- --------
The Company, through its predecessor companies and its subsidiaries,
has been an established commercial operator of fitness and spa centers in Hong
Kong and China since 1986 (see "Company - History"). The Company currently
operates seventeen facilities: thirteen in Hong Kong and four in China
(including one in Macau). Based on the number of the customers of the Company's
facilities, management believes that the Company is one of the top providers of
fitness facilities and spa and beauty treatment services in Hong Kong and China,
with approximately 100,000 customers. The Company offers to its customers, at
each location, access to a wide range of U.S.-styled fitness and spa services.
The Company was incorporated on September 21, 1988 in the state of
Delaware under the name of "Foreclosed Realty Exchange, Inc", a development
stage company seeking acquisitions with no material assets or liabilities. Prior
to acquisition of Physical Beauty & Fitness Holdings Limited, a British Virgin
Islands corporation ("Physical Limited"), the Company had no revenue producing
operations, but planned to enter into joint ventures and/or acquisitions
originally in the area of real estate, to expand its operations. In October,
1996, the Company closed a transaction with Ngai Keung Luk (Serleo), a 100%
shareholder of Physical Limited, whereby the Company entered into a Share
Exchange Agreement with Ngai Keung Luk (Serleo), pursuant to which the Company
issued 8,000,000 shares of its Common Stock to Ngai Keung Luk (Serleo) in
exchange for all of the outstanding shares of Physical Limited (the "Closing").
At the Closing, the then current management of the Company resigned and was
replaced by the current management of the Company. See "Management."
RESULTS OF OPERATIONS
The Company's revenues are derived from its two main lines of business
of fitness and spa services in the following principal ways: admission fees and
monthly subscription fees from the fitness customers, and the sale of beauty
treatments and skin care products to the beauty patrons.
In respect to fitness services, customers are invited to purchase a
standard fitness card at a fee currently set at HK$600 (US$77) for one person.
Each customer will also be charged a monthly due of HK$299 (US$38) for the usage
of the fitness centers. In order to fully utilize the facilities, the Company
grants a special offer of admission fees at HK$200 (US$26) to off-peak
customers.
In respect to beauty services, the customers may purchase single
treatment, or in packages of ten or more treatments, with quantity discounts
available. There is a wide range of beauty treatments available at prices
ranging from HK$400 (US$51) to HK$13,000 (US$1,670).
The following table sets forth selected income data as a percentage of
total operating revenue for the periods indicated.
Years Ended December 31,
--------------------------
2000 2001 2002
---- ---- ----
Operating Revenues 100.00% 100.00% 100.00%
Total operating expenses 94.18% 93.97% 104.39%
Operating income (loss) 5.82% 6.03% (4.39%)
Income (Loss) before income taxes and
minority interests 4.62% 5.30% (5.66%)
Provision for income and deferred taxes 1.09% 1.73% 0.20%
Minority interests 0.33% 0.19% (0.04%)
Net income (loss) 3.20% 3.38% (4.89%)
======== ======== ========
28
FISCAL YEAR ENDED DECEMBER 31, 2002 COMPARED TO FISCAL YEAR ENDED DECEMBER 31,
- ------------------------------------------------------------------------------
2001
- ----
OPERATING REVENUES. The Company's operating revenues increased 6% to
HK$413,744,000 (US$53,044,000) in the fiscal year ended December 31, 2002 as
compared to HK$392,097,000 (US$50,269,000) of last year.
Operating revenues derived by the Company's fitness services, net of
sales rebates of HK$4,743,000 (US$608,000), increased 2% to HK$278,212,000
(US$35,668,000) compared to HK$272,756,000 (US$34,969,000) of last year. Fitness
revenues as a percentage of total revenues were 67% in 2002 as compared to 70%
in 2001.
Operating revenues for the Company's beauty treatments in 2002 totaled
HK$135,532,000 (US$17,376,000) compared to HK$119,341,000 (US$15,300,000) in
2001, representing an increase of 14%. Beauty revenues as a percentage of total
revenues increased from 30% to 33% in 2002 as compared to 2001.
Operating revenues derived from the Company's Hong Kong locations
remain an important contributor to the Company's business, generating
HK$374,102,000 (US$47,962,000), or 90% of total operating revenues in the fiscal
year ended December 31, 2002 as compared to HK$360,388,000 (US$46,204,000) or
92% of total operating revenues in the fiscal year ended December 31, 2001.
Operating revenues derived from the Company's China locations generated
HK$39,642,000 (US$5,082,000), or 10% of total operating revenues in the fiscal
year ended December 31, 2002 as compared to HK$31,709,000 (US$4,065,000) or 8%
of total operating revenues in the fiscal year ended December 31, 2001.
OPERATING EXPENSES. The Company's operating expenses for the fiscal
year ended December 31, 2002 totaled HK$431,925,000 (US$55,375,000) compared to
HK$368,444,000 (US$47,236,000) in the fiscal year ended December 31, 2001,
representing an increase of 17%. Total operating expenses, after taking into
account all corporate expenses, were 104% of total operating revenue as compared
to 94% of last year. This reflects the additional costs incurred by the Company
in following its business expansion plan.
Operating expenses associated with the Company's Hong Kong locations
were HK$375,867,000 (US$48,188,000) in the fiscal year ended December 31, 2002,
representing an increase of HK$51,763,000 (US$6,637,000) or 16% as compared to
HK$324,104,000 (US$41,551,000) in 2001. The increase was mainly due to
additional expenses incurred by the Wing On, Central Center (opened in April,
2002), the new unisex fitness center in Tsuen Wan (opened in April, 2002) and
Kornhill Center (opened in June, 2002), all of which have not yet commenced
operation in 2001. Hong Kong operating expenses represented 87% of total
operating expenses in 2002 as compared to 88% in 2001.
Operating expenses associated with the Company's China locations were
HK$56,058,000 (US$7,187,000) in the fiscal year ended December 31, 2002,
representing an increase of 26% as compared to HK$44,340,000 (US$5,685,000) in
2001 primarily due to additional expenses incurred by the enhanced facilities in
Shanghai. Operating expenses in China represented 13% of total operating
expenses in the fiscal year ended December 31, 2002 as compared to 12% in 2001.
29
TOTAL NON-OPERATING EXPENSES. Total non-operating expenses for the
fiscal year ended December 31, 2002 totaled HK$5,227,000 (US$670,000) compared
to HK$2,860,000 (US$367,000) in the fiscal year ended December 31, 2001,
representing an increase of 83% mainly due to higher interest expenses.
PROVISION FOR INCOME TAXES. Provision for income taxes for the fiscal
year ended December 31, 2002 totaled HK$834,000 (US$107,000) compared to
HK$6,785,000 (US$870,000) in 2001, representing a decrease of 88%. The decrease
is mainly due to losses incurred in the year.
NET LOSS. The Company generated a net loss of HK$20,238,000
(US$2,595,000) for the fiscal year ended December 31, 2002, compared to a net
income of HK$13,247,000 (US$1,698,000) for the fiscal year ended December 31,
2001, representing a decrease of 253%. The loss was mainly due to the narrowing
margin of the existing centers and the absorption of the pre-opening overhead
associated with four new centers.
FISCAL YEAR ENDED DECEMBER 31, 2001 COMPARED TO FISCAL YEAR ENDED DECEMBER 31,
- ------------------------------------------------------------------------------
2000
- ----
OPERATING REVENUES. The Company's operating revenues showed the
continuous growth in the fiscal year ended December 31, 2001 as compared to the
fiscal year ended December 31, 2000. Operating revenues for the fiscal year
ended 2001 totaled HK$392,097,000 (US$50,269,000) compared to HK$303,312,000
(US$38,887,000) in the fiscal year ended December 31, 2000, representing an
increase of 29%.
With the opening of the Macau center and the Elizabeth House center in
October, 2000 and April, 2001 respectively (both of which are solely providing
fitness services), operating revenues derived by the Company's fitness services
increased 34% to HK$272,756,000 (US$34,969,000) compared to HK$203,759,000
(US$26,123,000) in the fiscal year ended December 31, 2000. Fitness revenues as
a percentage of total revenues were 70% in the fiscal year ended December 31,
2001 as compared to 67% in the fiscal year ended December 31, 2000.
Operating revenues for the Company's beauty treatments totaled
HK$119,341,000 (US$15,300,000) compared to HK$99,553,000 (US$12,764,000) in the
fiscal year ended December 31, 2000, representing an increase of 20%. Beauty
revenues as a percentage of total revenues were 30% in the fiscal year ended
December 31, 2001 as compared to 33% in the fiscal year ended December 31, 2000.
Operating revenues derived from the Company's Hong Kong locations
remain an important contributor to the Company's business, generating
HK$360,388,000 (US$46,204,000), or 92% of total operating revenues in the fiscal
year ended December 31, 2001 as compared to HK$284,007,000 (US$36,412,000) or
94% of total operating revenues in the fiscal year ended December 31, 2000.
Operating revenues derived from the Company's China locations generated
HK$31,709,000 (US$4,065,000), or 8% of total operating revenues in the fiscal
year ended December 31, 2001 as compared to HK$19,305,000 (US$2,475,000) or 6%
of total operating revenues in the fiscal year ended December 31, 2000.
OPERATING EXPENSES. The Company's operating expenses for the fiscal
year ended December 31, 2001 totaled HK$368,444,000 (US$47,236,000) compared to
HK$285,653,000 (US$36,623,000) in the fiscal year ended December 31, 2000,
representing an increase of 29%. The increase in the operating expenses was
primarily due to higher overheads incurred by the Company in following its
expansion plan. Total operating expenses, after taking into account all
corporate expenses, were 94% of total operating revenue being in line with last
year.
Operating expenses associated with the Company's Hong Kong locations
were HK$324,104,000 (US$41,551,000) in the fiscal year ended December 31, 2001,
representing an increase of HK$65,999,000 (US$8,461,000) or 26% as compared to
HK$258,105,000 (US$33,091,000) in 2000. Hong Kong operating expenses represented
88% of total operating expenses in the fiscal year ended December 31, 2001 as
compared to 90% in 2000. The increase in operating expenses was primarily due to
additional expenses incurred by the Elizabeth House center which has not yet
commenced operation in 2000. Moreover, additional marketing expenses was
incurred in association with a new installment program initiating in April,
2001.
Operating expenses associated with the Company's China locations were
HK$44,340,000 (US$5,685,000) in the fiscal year ended December 31, 2001,
representing an increase of 61% as compared to HK$27,548,000 (US$3,532,000) in
2000 primarily due to an additional expense incurred by the Macau center which
opened in October 2000. Operating expenses in China represented 12% of total
operating expenses in the fiscal year ended December 31, 2001 as compared to 10%
in 2000.
30
TOTAL NON-OPERATING EXPENSES (INCOME). Total non-operating expenses for
the fiscal year ended December 31, 2001 totaled HK$2,860,000 (US$367,000)
compared to HK$3,639,000 (US$467,000) in the fiscal year ended December 31,
2000, representing a decrease of 21% mainly due to a goodwill of HK$1,113,000
(US$143,000) being written off in 2000 but there is no expenses of similar
nature recorded in 2001.
PROVISION FOR INCOME TAXES. Provision for income taxes for the fiscal
year ended December 31, 2001 totaled HK$6,785,000 (US$870,000) compared to
HK$3,312,000 (US$424,000) in 2000, representing an increase of 105%. The
effective tax rate of the year was 43.1% as compared with 23.6% of last year,
representing an increase of 83%. The increase is mainly due to a write-back of
overprovision for taxation of 13.4% in 2000 whereas no such case happened in
2001.
NET INCOME. The Company's net income for the fiscal year ended December
31, 2001 totaled HK$13,247,000 (US$1,698,000) compared to HK$9,698,000
(US$1,244,000) for the fiscal year ended December 31, 2000, representing an
increase of 37%. The increase in the net income was mainly due to a prior year
adjustment of HK$4,825,000 (US$619,000) for overprovision of depreciation in the
fiscal year ended December 31, 2001.
FISCAL YEAR ENDED DECEMBER 31, 2000 COMPARED TO FISCAL YEAR ENDED DECEMBER 31,
- ------------------------------------------------------------------------------
1999
- ----
OPERATING REVENUES. The Company's operating revenues showed the
continuous growth in the fiscal year ended December 31, 2000 as compared to the
fiscal year ended December 31, 1999. Operating revenues for the fiscal year
ended 2000 totaled HK$303,312,000 (US$38,887,000) compared to HK$253,172,000
(US$32,458,000) in the fiscal year ended December 31, 1999, representing an
increase of 20%.
Operating revenues derived by the Company's fitness services increased
22% to HK$203,759,000 (US$26,123,000) compared to HK$166,917,000 (US$21,400,000)
in the fiscal year ended December 31, 1999. Fitness revenues as a percentage of
total revenues were 67% in the fiscal year ended December 31, 2000 as compared
to 66% in the fiscal year ended December 31, 1999.
Operating revenues for the Company's beauty treatments totaled
HK$99,553,000 (US$12,764,000) compared to HK$86,225,000 (US$11,054,000) in the
fiscal year ended December 31, 1999, representing an increase of 15%. Beauty
revenues as a percentage of total revenues were 33% in the fiscal year ended
December 31, 2000 as compared to 34% in the fiscal year ended December 31, 1999.
Operating revenues derived from the Company's Hong Kong locations
remain an important contributor to the Company's business, generating
HK$284,007,000 (US$36,412,000), or 94% of total operating revenues in the fiscal
year ended December 31, 2000 as compared to HK$238,096,000 (US$30,525,000) or
94% of total operating revenues in the fiscal year ended December 31, 1999.
Operating revenues derived from the Company's China locations generated
HK$19,305,000 (US$2,475,000), or 6% of total operating revenues in the fiscal
year ended December 31, 2000 as compared to HK$15,076,000 (US$1,933,000) or 6%
of total operating revenues in the fiscal year ended December 31, 1999.
OPERATING EXPENSES. The Company's operating expenses for the fiscal
year ended December 31, 2000 totaled HK$285,653,000 (US$36,623,000) compared to
HK$225,367,000 (US$28,893,000) in the fiscal year ended December 31, 1999,
representing an increase of 27%. The increase in the operating expenses was
primarily due to higher salaries and commissions as a result of increased
revenues and additional rent and related expenses incurred by the new Sheraton
Hotel center, Tuen Mun center and Macau center which opened in July 1999, July
2000 and October 2000 respectively. Total operating expenses, after taking into
account all corporate expenses, were 94% of total operating revenue as compared
to 89% of last year.
Operating expenses associated with the Company's Hong Kong locations
were HK$258,105,000 (US$33,091,000) in the fiscal year ended December 31, 2000,
representing an increase of HK$51,283,000 (US$6,576,000) or 25% as compared to
HK$206,822,000 (US$26,515,000) in 1999. Hong Kong operating expenses represented
90% of total operating expenses in the fiscal year ended December 31, 2000 as
compared to 92% in 1999. The increase in operating expenses was primarily
incurred by the new branch in Tuen Mun, Hong Kong which has not yet been opened
in 1999. The operating expenses for the Tuen Mun center amounted to
HK$13,651,000 (US$1,750,000) in 2000. In addition, the Sheraton Hotel center
incurred operating expenses of HK$59,738,000 (US$7,659,000), representing an
increase of HK$28,901,000 (US$3,705,000) over last year which reflected the
6-month operation since July 1999.
31
Operating expenses associated with the Company's China locations were
HK$27,548,000 (US$3,532,000) in the fiscal year ended December 31, 2000,
representing an increase of 49% as compared to HK$18,545,000 (US$2,378,000) in
1999. Operating expenses in China represented 10% of total operating expenses in
the fiscal year ended December 31, 2000 as compared to 8% in 1999. The increase
in operating expenses was primarily incurred by the new branch in Macau which
has not yet been opened in 1999. The operating expenses for the new branch
totaled HK$6,543,000 (US$839,000) in 2000.
TOTAL NON-OPERATING EXPENSES (INCOME). Total non-operating expenses for
the fiscal year ended December 31, 2000 totaled HK$3,639,000 (US$467,000)
compared to HK$3,793,000 (US$486,000) in the fiscal year ended December 31,
1999, representing a decrease of 4% due to lower interest expenses.
PROVISION FOR INCOME TAXES. Provision for income taxes for the fiscal
year ended December 31, 2000 totaled HK$3,312,000 (US$424,000). The effective
tax rate of the year was 23.6% as compared with 20.5% of last year, representing
an increase of 15%. The increase is mainly due to a profits tax rate of 16%
being charged on the Company's Hong Kong locations whereas the income of these
profits contributors was partially offset by the losses incurred by the
Company's China locations.
NET INCOME. The Company's net income for the fiscal year ended December
31, 2000 totaled HK$9,698,000 (US$1,244,000) compared to HK$18,502,000
(US$2,372,000) for the fiscal year ended December 31, 1999, representing a
decrease of 48%. The decrease in the net income was mainly due to a substantial
portion of expansion overhead being recognized in the fiscal year ended December
31, 2000, however, the revenues derived in association with such expansion were
not fully recognized in the same time period in accordance with the Company's
accounting policy.
32
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations primarily through cash
generated from operations, short-term bank credit, long-term bank loans,
advances from customers relating to prepaid fitness and spa income, and leasing
arrangements with financial institutions. See Notes to Financial Statements
(Note 8 "Short-Term Bank Loans"; Note 9 "Long-Term Bank Loans"; and Note 12
"Obligations under Finance Leases").
Cash and cash equivalent balances for the fiscal years ended December
31, 2002 and December 31, 2001 were HK$1,336,000 (US$171,000) and HK$4,787,000
(US$614,000) respectively.
Net cash provided by operating activities were HK$105,334,000
(US$13,503,000), HK$92,074,000(US$11,804,000), and HK$76,854,000 (US$9,853,000)
for fiscal years 2002, 2001, and 2000 respectively. The Company's operating
activities are historically financed by cash flows from operations. Net cash
used in investing activities were HK$120,362,000 (US$15,430,000), HK$70,881,000
(US$9,087,000), and HK$78,127,000 (US$10,016,000) for fiscal years 2002, 2001,
and 2000 respectively, primarily as a result of expenditures for property, plant
and equipment. Net cash provided (used) in financing activities, which mainly
include bank loan repayments, net of proceeds from new bank loans, were
HK$11,589,000 (US$1,486,000), HK$(18,164,000) (US$(2,328,000)), and HK$81,000
(US$11,000) for fiscal years 2002, 2001, and 2000 respectively.
During the fiscal year ended December 31, 2002, the Company has not
entered into any transactions using derivative financial instruments or
derivative commodity instruments nor held any marketable equity securities of
publicly traded companies. Accordingly, the Company believes its exposure to
market interest rate risk and price risk is not material. The Company's
long-term loans bear interest rates varying from 5.25% to 6.65% per annum. The
total balance outstanding as of December 31, 2002 on such loans was
HK$22,252,000 (US$2,852,000). The last repayment on the loans is due in 2007.
The Company had total banking facilities available from financial institutions
amounting to approximately HK$51,069,000 (US$6,547,000). These facilities were
secured by certain leasehold property in Hong Kong owned by the Company's
subsidiary (