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 (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, Mei Foo (two centers) and Kowloon City. Another seven wholly owned subsidiaries of the Company, Physical Health Centre (Tsuen Wan) Limited, Physical Health Center (TST) Limited, Physical Health Centre (Tuen Mun) Limited, Physical Health Centre (E House) Limited, Physical Beauty Centre (Central) Limited, Physical Health Centre (Kornhill) Limited, and Physical Health Centre (Shatin) Limited respectively operates the Tsuen Wan Center, the Sheraton Center, the Tuen Mun Center, the Elizabeth House Center, the Wing On Centre, the Kornhill Center, and the Shatin Center. All of these companies are Hong Kong corporations. Renaissance Beauty Centre is operated by Supreme Resources Limited, a Hong Kong corporation, which is a wholly-owned subsidiary of the Company.
The Company's facilities in Shanghai, China are operated by a wholly owned foreign enterprise, Shanghai Physical Fitness & Beauty Centre Co., Ltd. ("Shanghai PRC"), which operates three centers in the city of Shanghai.
During the year, the Company ceased its existing operation in Dalian and commenced a licence agreement with an independent investor for operating a new fitness and spa center (opened in October, 2005) in the city of Dalian.
In September, 2003, the Company signed a trademark licence agreement with a third party for operating a fitness and spa center in Hangzhou, China which opened in April, 2004. Since May, 2005, the Company has agreed to grant the use of the trade name to the other party by receiving a lump sum licence fee in lieu of a management fee. See Notes to Financial Statements (Note 14 "Other Supplemental Information").
The Company's facility in Macau is operated by a wholly-owned subsidiary of the Company, Su Sec Pou Physical Health Centre (Macau) Limited, which is a Macau corporation.
The Company provides its customers, at each location, with access to a wide range of U.S.-styled fitness and spa services. The Company offers to its customers the fitness cards for the use of its fitness facilities, which include extensive aerobics programs, personalized training, cardiovascular conditioning and strength training. The facilities are equipped with the latest Western exercise equipment, including Life Fitness, Cybex, Flex and Precor. Spa and beauty treatment services are provided to both customers and visitors, and include skin care and facial treatments, massage, spa relaxation programs and weight-management programs. The Company also sells at the facilities health food and European beauty products. Based on the number of the Company's customers, management believes that the Company is among the top providers of fitness, exercise, and spa/beauty treatment services in Hong Kong and China, with approximately 110,000 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 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. The Huangpu and Hongqiao centers were respectively relocated to Lu Wan (October, 2002) and Xu Hui (March, 2001) with enhanced facilities. In February, 2005, a third center Was opened in Huangpu, Shanghai. See "Business of the Company - Organization". The Company's facilities in China are operated under the trade name "Physical", and the Company registered a servicemark under that name in Chinese language, which precludes others from the use of the same name. See "Business of the Company - Trademarks and Trade Names".
In the opinion of the Company's management, current competition in China is becoming keen as the fitness and spa industry has attained its growth stage with increased new entrants from both domestic and global market. The Company expects that rising consumer incomes, increasing health awareness and growing access to foreign goods and trends, should continue to create increased demand for fitness and spa services in China. The Company explores the possibilities of opening these centers in the future, however, there can be no assurances given that such centers will start operations or be opened as currently contemplated by the management. See "Business of the Company - Business Strategy".
The Company's strategy for maintaining its strong presence in Hong Kong is to continue to provide existing and new customers with high quality services at an affordable price and by periodically upgrading the facilities as new developments and technology emerge in the industry. The Company's objective is to add new services and treatments to keep the Company current with market trends and to promote and enhance the Company's reputation of providing value- driven services to its customers. The Company places heavy emphasis on staff training which is supported by an in-house training department and on-going classes.
Unless the context requires otherwise, as used herein, any reference to the Company includes the Company's subsidiaries - Physical Beauty & Fitness Holdings Limited, Physical Health Centre Hong Kong Ltd., Regent Town Holdings Ltd., Supreme Resources Ltd., Physical Health Centre (Tuen Mun) Ltd., Zhongshan Physical Ladies' Club Co., Ltd., Ever Growth Ltd., Proline Holdings Ltd., Physical Health Centre (Shanghai) Limited, Shanghai Physical Fitness & Beauty Centre Co., Ltd., Jade Regal Holdings Ltd., Physical Health Centre( Dalian) Ltd., Dalian Physical Ladies' Club Co., Ltd., Star Perfection Holdings Ltd., Physical Health Centre (Shenzhen) Ltd., Shenzhen Physical Ladies' Club Co., Ltd., Physical Health Centre (Tsuen Wan) Limited, Physical Health Centre (Macau) Limited, Su Sec Pou Physical Health Centre (Macau) Limited, Physical Health Centre (TST) Limited, Physical Health Centre (E House) Limited, Physical Beauty Centre (Central) Limited, Physical Health Centre (Shatin) Limited, Physical Health Centre (Kornhill) Limited, and Global Fitness Management Limited (formerly known as Physical Health Centre (Central) Limited).
See also "Business - Organization".
THE COMPANY'S BUSINESS
General - -------
The Company's fitness and spa centers are located in or near urban areas in highly populated areas of Hong Kong and major metropolitan cities in China and most of them are operated under long-term leases. With the exception of Mei Foo fitness center, a portion of which is owned by the Company (see "Business - Properties"), the Company does not own the real property on which the centers are located, but owns the leasehold improvements and equipment with respect to each center. Generally, the Company's centers average 30,000 square feet and include a workout area for aerobic classes, a broad range of fitness equipment, changing room, shower room, sauna and steam facilities and a separate area devoted exclusively to professional spa and beauty treatment programs. Each center typically includes a laser TV room, health drink bar and sells a range of European beauty products and health food.
Organization - ------------
The Company's operations are conducted through its subsidiaries. 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.
See also Notes to the Financial Statements
See also "Company" - Properties". The Company's organizational chart is set forth below.
*50% held by one nominee shareholder. Since the Companies Ordinance of Hong Kong required a minimum of 2 shareholders for each limited company prior to February 13, 2004, Mr. Luk holds the remaining shares on behalf of Physical Beauty & Fitness Holdings Ltd.
** Physical Beauty Centre (Central) Limited, Physical Health Centre (Kornhill) Limited, Physical Health Centre (Shatin) Limited, and Global Fitness Management Limited(formerly known as Physical Health Centre (Central) Limited) are not shown in the above chart.
OWNERSHIP STRUCTURES IN CHINA
The organizational structure of the Company's operations in China is set forth below.
See also Notes to the Financial Statements
SHANGHAI PRC. The Shanghai PRC was formerly a Sino-foreign cooperative joint venture established on September 7, 1993 in Shanghai, China. On May 28, 2004, the Company was approved to register as a wholly owned foreign enterprise which is owned by Physical Shanghai.
DALIAN JOINT VENTURE. On April 11, 1995, Physical Health Centre (Dalian) Limited, a Hong Kong corporation ("Dalian Physical") formed a Sino-foreign equity joint venture with a Chinese enterprise to operate a fitness/ spa center in Dalian, China. The joint venture period is 12 years from the issue of the business license on April 11, 1995. The equity interest of Dalian Physical is 90% and the Chinese joint venture partner's equity interest is 10%. The joint venture has maintained effective operations from April 1996 to September 2005.
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 PRC and Dalian Joint Venture operate in China, they are subject to special considerations and significant risks not typically associated with investments in equity securities of the United States or Western European countries.
OVERVIEW OF THE COMPANY'S MARKETS
HONG KONG - ---------
FITNESS - -------
The concept of preventive health care and physical fitness, which became popular in Hong Kong in the early 1980's, was introduced from the United States and Europe. With the growing affluence of the local population and improvement in their standard of living, people began to immerse in physical exercise to maintain a fit and healthy body. The fitness trend grew in Hong Kong and gained popularity within the high income group initially.
To cater to this new industry, a number of fitness centers were established in Hong Kong which provided a variety of exercise equipment as well as aerobic dance classes. Private clubs (dining clubs, marina clubs, entertainment clubs) targeted towards the upper income group also began to provide similar services to their members or expanded their existing facilities.
The majority of these fitness centers targeted the high income group, were very exclusive, and entrance fees or membership fees were generally high. Under this marketing strategy, these fitness centers were restricted to a comparatively small number of potential customers. Additionally, some of these fitness centers were affected by the migration boom of Hong Kong in the mid 1980's. At that time, a large number of professionals migrated from Hong Kong to other countries to pursue educational and economic opportunities. This migration boom affected the customer base of these fitness centers and thus decreased the viability of their business. As a result, fitness centers targeting the high income group in Hong Kong were vulnerable and underwent a period of consolidation. Later on, as the market developed, a market niche emerged for fitness centers catering to the middle income group.
SPA - ---
The spa industry in Hong Kong, which includes the skin care or beauty industry, is rather fragmented with a large number of small operations. It is common that certain spa and beauty treatments are provided by a wide range of establishments including beauty salons, hair salons, and even cosmetic counters situated in department stores. The standard of services for beauty treatments varies widely. Normally, the customer base of these operations is confined to a relatively limited number of frequent customers. Exclusive private clubs that cater to a small percentage of wealthy Hong Kong women and the inconsistent quality and skill level of small operations have increased the demand for middle market skin care treatments since late 80'S.
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 90'S, but offer, in the Management's opinion, a limited selection of locally made, out-of-date equipment (as compared to the equipment used in the Company's centers). Such facilities are frequented by more men than women, as they tend to be equipped with barbells and weights.
The Company believes that aerobics is gaining popularity with the influx of follow-along television programs. The Management observed that the overall improved lifestyle; availability of fast food and convenience foods, increased spending power, and increasingly sedentary lifestyles of Chinese people, has led to a widespread concern for weight control. The Management believes that aerobics especially appeals to women in China, as large percentages of women seem to be concerned with losing weight.
In recent years, several fitness centers have entered into the market. They are well-equipped with the latest brands of Western-styled exercise machines and help enhance the popularity of the fitness industry.
SPA - ---
The Company noted that Western-styled spa and beauty treatments has become increasingly common and popular in China. Home-treatments, using cosmetics purchased in department stores, have also become very common. However, in the Management's opinion standards of skill and hygiene tend to be poor, as is the quality of products used, as compared to those provided by the Company's centers.
In mid-90'S, several Hong Kong and Japanese companies set up spa/beauty centers of varieties of facilities. More and more internationally recognized skin care lines have also become available in department stores. Those department stores often hold in-house promotions to demonstrate their products and educate potential customers. It appears that the desire to own anything imported, including skin care products, is considered prestigious and is therefore highly desired by Chinese women. The Management noticed that the demand for "foreign" spa treatments and beauty salons, and imported products is high. The local and international media is introducing fitness and skin care news to a growing receptive audience. The Company believes that the demand for affordable, value-driven beauty and skin care has increased.
HISTORY
The Company was incorporated on September 21, 1988 in the state of Delaware under the name of "Foreclosed Realty Exchange, Inc", a development stage company seeking acquisitions. Prior to acquisition of Physical Beauty & Fitness Holdings Limited, a British Virgin Islands corporation ("Physical Limited"), the Company had no revenue producing operations, but planned to enter into joint ventures and/or acquisitions originally in the area of real estate, to expand its operations. In October, 1996, the Company closed a transaction with Ngai Keung Luk (Mr. Luk), a 100% shareholder of Physical Limited, whereby the Company entered into a Share Exchange Agreement with Mr. Luk. 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 Mr. Luk 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.
In 1986, the founder and principal shareholder of the Company, Mr. Luk, 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.
BUSINESS STRATEGY
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 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, and the relationships in China established by the Company's executives, management and staff over the last several years. The Company intends to continue its policy of providing what it believes are first-quality, comprehensive fitness and spa services in their respective markets at affordable prices.
The Company seeks to expand its fitness and spa business from the ground up as opposed to acquiring health and fitness clubs that are poorly managed and/or financially distressed. The Company believes that the end result of repositioning an existing center, which typically includes rebuilding a customer base, renovations, additional equipment leasing, and re-training existing staff, is less desirable than developing a new center.
The Company intends to build on its momentum, relationships and standard of quality in several ways. First, the Company intends to expand its presence in Hong Kong and China through the establishment of new fitness and spa centers in Hong Kong (see "Business-Organization-Hong Kong") and China, and through the addition of qualified personnel, including fitness instructors and spa personnel in the existing facilities. Second, in conjunction with its expansion, the Company intends to increase the variety of fitness and spa services provided and products sold on a retail basis at each location.
The Company believes that its experience in and knowledge of the fitness and spa industry in Hong Kong and China, as well as management's continuous presence in Hong Kong (since 1986) and China (since 1994), positions the Company to take advantage of perceived opportunities in this market. Further, demographic developments in Hong Kong and China, continue to create increasing demand for certain fitness and spa services. In this regard, the Company opened planned centers in Tsuen Wan, Hong Kong (July, 1998), Sheraton Hotel, Tsimatshui, Hong Kong (July, 1999), Tuen Mun, Hong Kong (July, 2000), Macau (October, 2000), and Elizabeth House, Causeway Bay, Hong Kong (April, 2001). In early April, 2002, the Company opened a beauty center in Central, Hong Kong and expanded its Tsuen Wan fitness center to locate male customers. The Company also established a fitness/spa center in Kornhill, Hong Kong in June, 2002.
- - BECOMING THE MARKET LEADER IN CHINA
In China, the Company is the first entrant into the market and has secured a more established position than its competitors in the opinion of the Management.
The planned expansion into China includes opening facilities in most major cities and economically developing urban areas throughout the country by way of direct investment or franchise, subject to then current market and other conditions. According to the State Statistic Bureau of China, the population of China exceeds 1.2 billion and there are currently thirty cities with populations in excess of 1 million. The population of China is becoming increasingly urbanized, and the tastes of the urban population is becoming increasingly sophisticated. (Source: Hong Kong Trade Development Council).
Forty percent of the population of China lives in coastal areas, where retail sales account for 60% of the country's total retail sales. Population factors and strong spending power have led the Company to target coastal areas for the spas to be developed (i.e. Dalian). Marketing programs carried out nationwide, in the management's opinion, will enable the Company to benefit from economies of scale, similar to what the Company experiences in Hong Kong.
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.
- - MAINTAINING A STRONG PRESENCE IN HONG KONG
The Company has well-established customer base and pre-dominant market share in Hong Kong. The Board of Directors estimates that over 80 percent of the Company's patrons are between the age of 20 to 40. Management believes that the strong position held in the Hong Kong market can be maintained by continuously upgrading facilities and services. The Company monitors this situation continuously, and upgrades the fitness and spa areas on a regular basis. The number of customers in each location is also carefully monitored in order to ensure adequate levels of service to individual customers, particularly during peak work-out periods. Branch Managers monitor the situation through direct observation, customer feedback and surveys.
For spa personnel, intensive training is conducted in the in-house training center and thorough on-the-job instruction. Selected employees are sent to international workshops to study the latest techniques and to learn about new products on the market. The Company seeks to satisfy its spa clients' needs with the latest technology, expertise and a high level of service.
- - EXPLORING POTENTIAL MARKETS
The Company considers its market to be the greater Asia region. The Company is also closely monitoring the market opportunities in other South East Asian countries such as Taiwan, the Philippines, Thailand, Malaysia and Indonesia.
FITNESS
The centers emphasize the benefits of health, physical fitness and exercise by providing a wide range of exercise equipment from the United States and Europe including free-weights, strength systems and cardiovascular machines from manufacturers such as Life Fitness, Cybex , Flex, and Precor. The Company places a particular emphasis on the quality of its fitness managers and instructors by providing continuous training both in Hong Kong and overseas.
The centers also conduct daily dance classes which run for approximately 45 minutes and are on a first-come, first-served basis. The Company believes that the number of dance classes conducted by the Centers per day is among the highest in Hong Kong. The variety of dance classes is regularly updated in order to appeal to the interests of customers. Since 1995, the Company has recruited fully qualified and experienced aerobic instructors from Australia.
The Company believes, based on customer survey responses, utilization rates and the existence of underutilized space in its centers, that it has sufficient excess capacity at its existing fitness centers to accommodate new customers as well as comfortable usage by present customers.
SPA SERVICES
Spa services are open to both customers and walk-in guests. However, customers of the centers have priority for such service facilities. Over 80 types of spa treatments are offered including facial treatments, various skin care treatments, spa relaxation programs, massage, and weight-management programs. Spa patrons are also entitled to free consultation by registered dietitians.
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. Since 2002, the Company has employed registered dietitians to offer free consultation to customers. The Company believes that these additional services offer 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 so as to keep them informed of the latest international developments in spa treatments, applications, technology and equipment.
RETAIL
The Company sells a range of fitness related products such as sun-tanning lotion and health food (since 2003) at selected fitness centers, and European skin care products at all of its beauty centers. These products are intended to add value to the services and increase the Company's revenues.
SERVICES
The Company currently offers prospective customers a fitness plan. Fees for services at each facility depend on the location and demand for such services at that facility. Marketing of the Company's services is targeted towards the middle income population in the 18 to 45 years old range.
Under the plans, new customers are charged a non-refundable registration fee of HK$600 (US$77) upon admission and a monthly fee of HK$299 (US$38) to maintain their privileges. The Company from times to times is launching promotion at a waiver of the registration fee as well as discounted monthly dues. Customers are also provided on a monthly basis 10 aerobic coupons on complementary basis at Hong Kong locations. Any customer who attends additional classes has to purchase coupons at HK$15 (US$2) each. China locations include aerobics classes with monthly dues.
In order to allow greater flexibility to its customers, the Company operates a network system where customers may use the facilities in any fitness centers of the Company in Hong Kong at no extra cost. The centers have long opening hours and are open all year round (except for Chinese New Year), in order to provide continuous service to its customers. Generally, they are open from 7:00 a.m. to 11:00 p.m. As with any consumer driven market, it is essential that the services provided by the Company are constantly reviewed, updated and improved. To achieve this, managers from the Customer Services Department as well as each of the centers regularly invite comments from customers in relation to the services provided. Additionally, the Company constantly seeks to introduce new products and techniques on fitness training and spa treatments in order to improve its services and thus enhance its competitive position.
SALES AND MARKETING
The Company devotes substantial resources to the marketing and promotion of its fitness and spa centers and their services because the Company believes strong marketing support is critical to attracting new customers both at existing and new fitness centers. Since July, 1988, the Company and its predecessor began to market substantially all of its fitness centers under the service name "Physical", thereby eliminating the prior practice of using different names for individual locations. See "Business - Trademarks and Trade Names".
A key component of the Company's marketing strategy is to cluster numerous fitness centers in major media markets in order to increase the efficiency and cost effectiveness of its marketing and advertising programs. Advertising consists of (i) television and (ii) newspapers, magazines, leaflets, light box, and other promotional activities, which were accounted for approximately 10%, and 90%, respectively, of the Company's total advertising expenses in 2005.
Since 1998, the Company has appointed sales agents to conduct certain promotional, marketing and sales services in public areas of the region. These agents have successfully helped enhance public awareness of the Company's fitness service and recruited thousands of new customers to use the Company's facilities.
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.
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.
COMPETITION
The Company targets primarily the 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 fifteen locations of size ranging from 1,000 sq. ft. to 37,000 sq. ft.
The operators of "fitness services only" which are in direct competition with the Company's fitness centers include California Fitness, and Fitness First.
The operators of "spa/beauty services only" which are in direct competition with the Company's beauty centers include Sau San Tong Healthy Trim Institute, Angel Face Beauty Creations, Marie France Bodyline, Sasa Beauty, Royal Bodyperfect, and Caesar Beauty Centre.
The management believes that the Company offers a more comprehensive level of both fitness and spa treatments than its competitors.
Trademarks and Trade Names
In July 1988, the Company and its predecessor began to market substantially all its fitness centers under the servicemark "Physical" thereby eliminating the prior practice of using a different trade names for each center. The Company registered a servicemark under its trade name "Physical" in Hong Kong and its Chinese equivalent name in China. In the opinion of the Company's trademark counsel in Hong Kong, the registration enables the mark to distinguish the Company's services from similar services of others. The servicemark gives the Company a priority over the use of the servicemark by others and the right to reject others from the use of the same name. In China, the Company has registered the name in Chinese language pursuant to the Chinese Trademark Law which provides the Company with protection of its name on a nation-wide basis and precludes others in China from using the same name as the Company's.
Seasonality
Historically, the Company has experienced greater sales in the third quarter of each year. In recent years, the Company has lessened this seasonal effect by the use of sales incentives and awards for its sales personnel, as well as other marketing initiatives.
Research and Development
The Company's business is service-oriented, therefore it does not have a formal Research & Development department, however, its marketing and training departments are closely following the evolution of international fitness and beauty trends.
Employees
The Company has approximately 1,200 employees. Approximately 1,130 employees are involved in fitness and beauty operations, including sales personnel, instructors, beauticians, customer service attendants and supervisory personnel. Approximately 70 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
The Company's operations and business practices of the Company are subject to regulation at the local level. General rules and regulations, including those of the local consumer protection agencies, apply to the Company's advertising, sales and other trade practices.
Statutes and regulations affecting the fitness, spa and beauty industries have been enacted or proposed in all of the areas in which the Company conducts business. Typically, these statutes and regulations prescribe certain forms and regulate the terms and provisions of sales and purchase contracts, allowing the customer the right to cancel the contract within, in most cases, 14 business days after signing. In addition, the Company is subject to several other types of regulations governing the collection of debts. These laws and regulations are subject to varying interpretations by local consumer protection agencies and the courts. The Company maintains internal review procedures in order to comply with these requirements and it believes that its activities are in substantial compliance with all applicable statutes, rules and decisions.
Certain regulations allow customers of fitness centers to cancel any un-used services. In each instance, the canceling customer is entitled to a refund of prepaid amounts only. Furthermore, where permitted by law, a cancellation fee is due to the Company upon cancellation and the Company may offset such amount against any refund owed. The Company's customer agreements provide that all fees paid shall under no circumstances be refundable.
The Consumer Council 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, 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.
ITEM 2.
ITEM 2. PROPERTIES
Since December 20, 2001, the Company has maintained its executive and administrative office in Hong Kong at:
40/F., RBS Tower, Times Square, No. 1 Matheson Street, Causeway Bay, HONG KONG The telephone number of the Company in Hong Kong is (852) 2917-0000.
Aggregate rental expense was approximately HK$119.7 million (US$15 million), HK$125.7 million (US$16 million) and HK$123.3 million (US$16 million) for the year ended December 31, 2003, 2004 and 2005, respectively. The Company leases a number of properties under operating leases. Most of the leases runs for an initial period with an option to renew upon the expiry of the original term. Lease payments are fixed for the initial period but will be adjusted to reflect the market rental for the renewal period.
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 fitness 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.
Management believes that the existing facilities of the Company are adequate to meet its current needs and that suitable additional or alternative space will be available in the future on commercially reasonable terms, although there is no assurance that future terms would be as favorable as the current terms.
The Company has not invested in any real property at this time nor does the Company intend to do so. The Company has no formal policy with respect to investments in real estate or investments with persons primarily engaged in real estate activities.
ITEM 3.
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's stockholders through the solicitation of proxies, or otherwise, during the Company's fiscal year ended December 31, 2005.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDE MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company's Common Stock has been listed on the Bulletin Board of the NASDAQ's over-the-counter market under the symbol PFIT, since December 1996, but has been traded only sporadically. As of March 31, 2006, the 52-week trading range was between $0.07 to $0.9 per share. The last reported sale was in March, 2006 at $0.25 per share. The reported sporadic sales in the fiscal year 2005, are set forth below. Quotations reflect inter-dealer prices, without retail mark-up, markdown, or commission and may not represent actual transactions.
Date Open High Low Close
Apr 2005 0.51 0.55 0.45 0.45 May 2005 0.40 0.40 0.40 0.40 Jul 2005 0.40 0.50 0.40 0.50 Aug 2005 0.50 0.50 0.30 0.30 Sep 2005 0.30 0.30 0.20 0.20 Oct 2005 0.20 0.40 0.20 0.20 Dec 2005 0.20 0.20 0.07 0.07
- --------------------- [SOURCE: Reuters]
As of December 31, 2005, there were approximately 618 record holders of the Company's Common Stock.
DIVIDEND POLICY - ---------------
The Company has never paid any cash dividends on its Common Stock and does not anticipate paying any cash dividends in the future. The Company currently intends to retain future earnings, if any, to fund the development and growth of its business.
RECENT SALES OF UNREGISTERED SECURITIES; USE OF PROCEEDS FROM REGISTERED SECURITIES.
NONE.
PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS.
NONE.
ITEM 6.
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 Registered Public Accounting Firm, 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, 2001 through December 31, 2005. The data has been derived from Consolidated Financial Statements (audited) included in Item 8 of this Report.
(Amounts in thousands, except share and per share data)
ITEM 7.
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 110,000 customers. The Company offers to its customers, at each location, access to a wide range of U.S.-styled fitness and spa services.
RESULTS OF OPERATIONS
The Company's revenues are derived from its two main lines of business of fitness and spa services in the following principal ways: admission fees and monthly subscription fees from the fitness customers, and the sale of beauty treatments and skin care products to the beauty patrons.
In respect to fitness services, each customer will be charged a monthly due of HK$299 (US$38) for the usage of the fitness centers. During promotional period, discounts on the monthly dues will be offered to customers.
In respect to beauty services, the customers may purchase single treatment, or in packages of ten or more treatments, with quantity discounts available. There is a wide range of beauty treatments available at prices ranging from HK$400 (US$51) to HK$15,000 (US$1,923).
The following table sets forth selected income data as a percentage of total operating revenue for the periods indicated.
Years Ended December 31, -------------------------- 2003 2004 2005 ---- ---- ----
Operating revenues 100.00% 100.00% 100.00%
Total operating expenses 108.82% 98.53% 112.61%
(Loss) Income from operations (8.82%) 1.47% (12.61%)
(Loss) Income before income taxes and minority interests (10.36%) 0.38% (13.28%)
Benefit (Provision) for income taxes 0.08% (0.11%) 0.50%
Minority interests 0.05% 0.01% 0.19%
Net (loss) income (10.23%) 0.28% (12.59%) ======== ======== ========
FISCAL YEAR ENDED DECEMBER 31, 2005 COMPARED TO FISCAL YEAR ENDED DECEMBER 31, - ------------------------------------------------------------------------------ - ----
OPERATING REVENUES. Operating revenues for the fiscal year ended December 31, 2005 totaled HK$444,416,000 (US$56,976,000) compared to HK$503,564,000 (US$64,559,000) of last year. This represented a decrease of 12%, mainly due to keen competition especially in the fitness market.
Fitness services which constituted 55% of total operating revenues, dropped by 18% to HK$245,995,000 (US$31,538,000) in 2005. Since April, 2005, the Company has promoted a new life fitness plan at an average monthly fee of HK$83 (US$11). The Company expects to attract some of its existing customers to enroll the new plan upon renewal, therefore initially lowering the revenues generated from other plans with higher monthly fees. Moreover, this year also saw increasing competition in the fitness market with close competitor (California Fitness) opening a new center (Jackie Chan Sport Club) in the same building of one of the Company's existing center.
Beauty services, being 44% of total operating revenues, dropped slightly by 3% to HK$196,304,000 (US$25,167,000) in 2005 due to the keen competition in the market that not only hinders price increment but also distracts customers to other service providers offering lower price than the Company.
Operating revenues derived from the Company's Hong Kong locations represented 86% of the Company's business, generating HK$383,119,000 (US$49,118,000) in the fiscal year ended December 31, 2005 as compared to HK$442,755,000 (US$56,763,000) or 88% of the Company's business in the fiscal year ended December 31, 2004. This represented a decrease of 13%.
Operating revenues derived from the Company's China locations generated HK$61,297,000 (US$7,858,000) in the fiscal year ended December 31, 2005, representing an increase of 1%, as compared to HK$60,809,000 (US$7,796,000). The China operation represented 14% of total operating revenues in the fiscal year ended December 31, 2005 as compared to 12% of last year.
OPERATING EXPENSES. The Company's operating expenses for the fiscal year ended December 31, 2005 totaled HK$500,450,000 (US$64,160,000) compared to HK$496,155,000 (US$63,610,000) in the fiscal year ended December 31, 2004. This represented an increase of HK$4,295,000 (US$551,000). Although there has been a decrease of HK$3,029,000 (US$388,000) in the leasehold improvement of a center which had been fully depreciated by March, 2005, operating expenses remained high. In particular, the Shanghai subsidiary has incurred an additional cost of HK$7,172,000 (US$919,000) following the grand opening of its third center in early February, 2005. This is partially offset by variable costs decreasing as a result of lower revenues.
Operating expenses associated with the Company's Hong Kong locations were HK$421,040,000 (US$53,979,000) or 84% of total operating expenses in the fiscal year ended December 31, 2005, as compared to HK$425,718,000 (US$54,580,000) or 86% of total operating expenses in 2004. This represented a decrease of 1% from a small portion of variable costs decreasing as a result of lower revenues and therefore allowed room for tighter cost control over staff headcount, usage of public utilities, and efficiency in marketing and promotional activities.
Operating expenses associated with the Company's China locations were HK$79,410,000 (US$10,181,000) in the fiscal year ended December 31, 2005, representing an increase of 13% as compared to HK$70,437,000 (US$9,030,000) in 2004 primarily due to additional expenses incurred by the enhanced facilities in Shanghai. Operating expenses in China represented 16% of total operating expenses in the fiscal year ended December 31, 2005, as compared to 14% of 2004.
TOTAL NON-OPERATING EXPENSES. Total non-operating expenses for the fiscal year ended December 31, 2005 totaled HK$2,968,000 (US$380,000) compared to HK$5,512,000 (US$707,000) in the fiscal year ended December 31, 2004. This represented a decrease of 46% primarily due to lower interest expenses.
PROVISION FOR INCOME TAXES. No income taxes were provided for the year of 2005 because of losses incurred.
NET LOSS. The Company had incurred a net loss of HK$55,946,000 (US$7,173,000) for the fiscal year ended December 31, 2005, compared to a net profit of HK$1,394,000 (US$179,000) of last year. The keen competition has impacted adversely over the business of the Company; however, Management believes the industry as a whole will get momentum of growth in the light of economic rebound. In 2006, the Company will focus on strategies in how to maximize sales turnover in the medium to long run.
FISCAL YEAR ENDED DECEMBER 31, 2004 COMPARED TO FISCAL YEAR ENDED DECEMBER 31, - ------------------------------------------------------------------------------ - ----
OPERATING REVENUES. The Company's operating revenues increased 15% to HK$503,564,000 (US$64,559,000) in the fiscal year ended December 31, 2004 as compared to HK$439,511,000 (US$56,348,000) of last year.
Operating revenues derived by the Company's fitness services increased 16% to HK$298,596,000 (US$38,282,000) compared to HK$258,015,000 (US$33,079,000) of last year. Fitness revenues as a percentage of total revenues were 59% in 2004 and 2003.
Operating revenues for the Company's beauty treatments in 2004 totaled HK$203,000,000 (US$26,026,000) compared to HK$181,093,000 (US$23,217,000) in 2003, representing an increase of 12%. Beauty revenues as a percentage of total revenues were 40% in 2004 as compared to 41% in 2003.
Operating revenues derived from the Company's Hong Kong locations remain at 88% of the Company's business, generating HK$442,755,000 (US$56,763,000) in the fiscal year ended December 31, 2004 as compared to HK$385,966,000 (US$49,483,000) in the fiscal year ended December 31, 2003. This represented an increase of 15%.
Operating revenues derived from the Company's China locations generated HK$60,809,000 (US$7,796,000) in the fiscal year ended December 31, 2004, representing an increase of 14%, as compared to HK$53,545,000 (US$6,865,000). This included a management service income of HK$1,758,000 (US$225,000) recognized during the year. The China operation represented 12% of total operating revenues in the fiscal years ended December 31, 2003 and 2004.
OPERATING EXPENSES. The Company's operating expenses for the fiscal year ended December 31, 2004 totaled HK$496,155,000 (US$63,610,000) compared to HK$478,272,000 (US$61,317,000) in the fiscal year ended December 31, 2003, representing an increase of 4%. Total operating expenses, after taking into account all corporate expenses, were 99% of total operating revenue as compared to 109% of last year. The ratio remained high reflecting steep running costs in a competitive environment.
Operating expenses associated with the Company's Hong Kong locations were HK$425,718,000 (US$54,580,000) in the fiscal year ended December 31, 2004, representing an increase of 2% as compared to HK$416,732,000 (US$53,427,000) in 2003. The increase was mainly due to the additional expenses incurred by the Citylink, Shatin Center which commenced its fitness operation in November, 2003. Hong Kong operating expenses represented 86% of total operating expenses in 2004, as compared to 87% of last year.
Operating expenses associated with the Company's China locations were HK$70,437,000 (US$9,030,000) in the fiscal year ended December 31, 2004, representing an increase of 14% as compared to HK$61,540,000 (US$7,890,000) in 2003 primarily due to additional expenses incurred by the enhanced facilities in Shanghai. Operating expenses in China represented 14% of total operating expenses in the fiscal year ended December 31, 2004, as compared to 13% of 2003.
TOTAL NON-OPERATING EXPENSES. Total non-operating expenses for the fiscal year ended December 31, 2004 totaled HK$5,512,000 (US$707,000) compared to HK$6,776,000 (US$870,000) in the fiscal year ended December 31, 2003, representing a decrease of 19% mainly due to lower interest expenses.
PROVISION (BENEFIT) FOR INCOME TAXES. Provision for income taxes for the fiscal year ended December 31, 2004 totaled HK$568,000 (US$73,000) compared to HK$(359,000) (US$(47,000)) in 2003, representing an increase of 258% mainly due to profits generated in the year.
NET INCOME (LOSS). The Company has recorded a net income of HK$1,394,000 (US$179,000) for the fiscal year ended December 31, 2004, compared to a net loss of HK$44,968,000 (US$5,765,000) for the fiscal year ended December 31, 2003, representing an increase of 103%. The improvement in the bottom line reflects the gradual pick-up of the business from the adverse economic situation. The Company also benefits from a comparison with a relatively low base of last year which saw a disastrous Severe Acute Respiratory Syndrome (SARS) outbreak in the second quarter.
FISCAL YEAR ENDED DECEMBER 31, 2003 COMPARED TO FISCAL YEAR ENDED DECEMBER 31, - ------------------------------------------------------------------------------ - ----
OPERATING REVENUES. The Company's operating revenues increased 6% to HK$439,511,000 (US$56,348,000) in the fiscal year ended December 31, 2003 as compared to HK$413,744,000 (US$53,044,000) of last year.
Operating revenues derived by the Company's fitness services decreased 7% to HK$258,015,000 (US$33,079,000) compared to HK$278,212,000 (US$35,668,000) of last year. Fitness revenues as a percentage of total revenues were 59% in 2003 as compared to 67% in 2002.
Operating revenues for the Company's beauty treatments in 2003 totaled HK$181,093,000 (US$23,217,000) compared to HK$135,532,000 (US$17,376,000) in 2002, representing an increase of 34%. Beauty revenues as a percentage of total revenues increased from 33% to 41% in 2003 as compared to 2002.
Operating revenues derived from the Company's Hong Kong locations remain an important contributor to the Company's business, generating HK$385,966,000 (US$49,483,000), or 88% of total operating revenues in the fiscal year ended December 31, 2003 as compared to HK$374,102,000 (US$47,962,000) or 90% of total operating revenues in the fiscal year ended December 31, 2002.
Operating revenues derived from the Company's China locations generated HK$53,545,000 (US$6,865,000), or 12% of total operating revenues in the fiscal year ended December 31, 2003 as compared to HK$39,642,000 (US$5,082,000) or 10% of total operating revenues in the fiscal year ended December 31, 2002.
OPERATING EXPENSES. The Company's operating expenses for the fiscal year ended December 31, 2003 totaled HK$478,272,000 (US$61,317,000) compared to HK$431,925,000 (US$55,375,000) in the fiscal year ended December 31, 2002, representing an increase of 11%. Total operating expenses, after taking into account all corporate expenses, were 109% of total operating revenue as compared to 104% of last year. This reflects the additional costs incurred by the Company in following its business expansion plan.
Operating expenses associated with the Company's Hong Kong locations were HK$416,732,000 (US$53,427,000) in the fiscal year ended December 31, 2003, representing an increase of HK$40,865,000 (US$5,239,000) or 11% as compared to HK$375,867,000 (US$48,188,000) in 2002. The increase was mainly due to additional expenses incurred by the Wing On, Central Center (opened in April, 2002), the new unisex fitness center in Tsuen Wan (opened in April, 2002), and Kornhill Center (opened in June, 2002), all of which have not yet commenced full operation in 2002. Moreover, additional expenses were also incurred by the Citylink, Shatin Center which commenced its fitness operation in November, 2003. Hong Kong operating expenses represented 87% of total operating expenses in 2003, same as last year.
Operating expenses associated with the Company's China locations were HK$61,540,000 (US$7,890,000) in the fiscal year ended December 31, 2003, representing an increase of 10% as compared to HK$56,058,000 (US$7,187,000) in 2002 primarily due to additional expenses incurred by the enhanced facilities in Shanghai. Operating expenses in China represented 13% of total operating expenses in the fiscal years ended December 31, 2003 and 2002.
TOTAL NON-OPERATING EXPENSES. Total non-operating expenses for the fiscal year ended December 31, 2003 totaled HK$6,776,000 (US$870,000) compared to HK$5,227,000 (US$670,000) in the fiscal year ended December 31, 2002, representing an increase of 30% mainly due to higher interest expenses.
(BENEFIT) PROVISION FOR INCOME TAXES. Provision for income taxes for the fiscal year ended December 31, 2003 totaled HK$(359,000) (US$(47,000)) compared to HK$834,000 (US$107,000) in 2002, representing a decrease of 143%. The decrease is mainly due to losses incurred in the year.
NET LOSS. The Company suffered a net loss of HK$44,968,000 (US$5,765,000) for the fiscal year ended December 31, 2003, compared to a net loss of HK$20,238,000 (US$2,595,000) for the fiscal year ended December 31, 2002, representing an increase of 122%. The loss substantially reflects the adverse impact of an outbreak of the SARS during the year.
In Mid-March, 2003, SARS occurred in areas such as Vietnam, Toronto, Southern China, Hong Kong, and Singapore. Consumers avoided from contacting the SARS virus by staying at home that led to weak demand in the Company's fitness and beauty service. The revenues and results of the Company, like most retailers, were badly hit by the disease. In view of the uncertainty in the economic situation, the Company has postponed the renovation work of the Citylink, Shatin center thus incurring additional opportunity costs.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations primarily through cash generated from operations, short-term bank credit, advances from customers relating to prepaid fitness and spa income, and leasing arrangements with financial institutions. See Notes to Financial Statements. (Note 6 "Short-Term Bank Loans"; and Note 7 "Banking Facilities").
Cash and cash equivalent balances for the fiscal years ended December 31, 2005 and December 31, 2004 were HK$2,484,000 (US$318,000) and HK$1,625,000 (US$208,000) respectively.
Net cash provided by operating activities were HK$22,599,000 (US$2,897,000), HK$54,777,000 (US$7,023,000), and HK$58,288,000 (US$7,472,000) for fiscal years 2005, 2004, and 2003 respectively. The Company's operating activities are historically financed by cash flows from operations. Net cash used in investing activities were HK$14,075,000 (US$1,805,000), HK$38,307,000 (US$4,912,000), and HK$39,220,000 (US$5,028,000) for fiscal years 2005, 2004, and 2003 respectively, primarily as a result of expenditures for property, plant and equipment. Net cash used in financing activities, which mainly include bank loan repayments, net of proceeds from new bank loans, were HK$7,679,000 (US$984,000), HK$16,650,000 (US$2,135,000), and HK$18,599,000 (US$2,384,000) for fiscal years 2005, 2004, and 2003 respectively.
During the fiscal year ended December 31, 2005, 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.
Consistent with the general practice of the fitness and spa industry, the Company receives prepaid monthly fees from fitness customers, which are non-refundable, and spa treatment dues from its customers. This practice creates working capital that the Company generally utilizes for working capital purposes. However, the unused portion of the pre-paid monthly fees and spa treatment dues is characterized as deferred income, and further categorized as current portion under current liability and non-current portion under non-current liability, for accounting purposes.
The Company's trade receivable balance at December 31, 2005, was HK$12,925,000 (US$1,657,000) which is mainly due by banks for the installment program. The program allows the holders of credit cards issued by certain banks to purchase the Company's fitness and beauty services with the said cards and then enjoy the interest-free payment by installment arrangements with the banks. The Company offers credit terms varying from 7 days to 90 days to the banks for settlement of the full purchase amounts. The Company has never experienced any significant problems with collection of accounts receivable from its customers. No provision for doubtful receivables is therefore made for the year under review.
Capital expenditures for fiscal years 2005, 2004 and 2003 were HK$16,391,000 (US$2,102,000), HK$27,066,000 (US$3,470,000) and HK$44,359,000 (US$5,687,000), respectively.
As disclosed in Note 3 to the financial statements, the Company had negative working capital of HK$129,835,000 (US$16,646,000) and HK$151,385,000 (US$19,408,000) as of December 31, 2005 and 2004 and incurred losses of HK$55,946,000 (US$7,173,000) and HK$44,968,000 (US$5,765,000) for the years ended December 31, 2005 and 2003 respectively. In addition, the Company had accumulated losses and deficit in stockholders' equity of HK$18,503,000 (US$2,372,000) and HK$17,600,000 (US$2,257,000) respectively as of December 31, 2005. These conditions raised substantial doubt about the Company's ability to continue as a going concern. In order to maintain it as a going concern, the management is seeking to procure additional funding from various sources. In addition, the Principal Stockholder has also undertaken to make available adequate funds to the Company as and when required to maintain the Company as a going concern. Moreover, the negative working capital was mainly because of non-cash items including deferred income and deferred liabilities while the loss for the year was mainly attributable to the depreciation expense. Having excluded these non-cash items and taken into consideration the undertaking provided by the Principal Stockholder,Management believes that cash flow generated from the operations of the Company, the tight cost and cash flow control measures and the existing and additional credit facilities to be sought should be sufficient to satisfy the working capital and capital expenditure requirements of the Company for at least the next 12 months.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Since some operations of the Company are operated in the People's Republic of China ("PRC"), they are subject to special considerations and significant risks not typically associated with investments in equity securities of United States and Western European companies. These include risks associated with, among others, the political, economic and legal environments and foreign currency exchange. These are described further in the following:
POLITICAL ENVIRONMENT
The value of the Company's interest in the Shanghai subsidiary may be adversely affected by significant political, economic and social uncertainties in the PRC. A change in policies by the Chinese government could adversely affect the Company's interests in these companies by, among other factors: changes in laws, regulations or the interpretation thereof; confiscatory taxation; restrictions on foreign currency conversion, imports or sources of suppliers; or the expropriation or nationalization of private enterprises.
ECONOMIC ENVIRONMENT
The economy of the PRC differs significantly from the economies of the United States and Western Europe in such respects as structure, level of development, gross national product, growth rate, capital reinvestment, resource allocation, self-sufficiency, rate of inflation and balance of payments position, among others. Only recently has the Chinese government encouraged substantial private economic activities.
The Chinese economy has experienced significant growth in the past ten years, but such growth has been uneven among various sectors of the economy and geographic regions. Actions by the Chinese central government to control inflation have significantly restrained economic expansion recently. Similar actions by the central government of the PRC in the future could have a significant adverse effect on economic conditions in the PRC and the economic prospects for the Group.
FOREIGN CURRENCY EXCHANGE
The Chinese central government imposes control over its foreign currency reserves through control over imports and through direct regulation of the conversion of its national currency into foreign currencies. As a result, the Renminbi is not freely convertible into foreign currencies.
The Shanghai subsidiary conducts substantially all of its business in the PRC, and its financial performance and condition is measured in terms of Renminbi. The revenues and profits of the subsidiary are predominantly denominated in Renminbi, and will have to be converted to pay dividends to the Company in United States Dollars or Hong Kong Dollars. Should the Renminbi devalue against these currencies, such devaluation would have a material adverse effect on the Company's profits and the foreign currency equivalent of such profits repatriated by the Shanghai subsidiary to the Company. The Company currently is not able to hedge its exchange rate exposure in the PRC because neither the banks in the PRC nor any other financial institution authorized to engage in foreign exchange transactions offer forward exchange contracts.
LEGAL ENVIRONMENT
Since 1979, many laws and regulations dealing with economic matters in general and foreign investment in particular have been enacted in the PRC. However, the PRC still does not have a comprehensive system of laws and enforcement of existing laws may be uncertain and sporadic.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of the Company required to be included in Item 7 are set forth in the Financial Statements Index.
Report of Independent Registered Public Accounting Firm
Consolidated Statements of Operations for the years ended December 31, 2003, 2004 and 2005
Consolidated Balance Sheets as of December 31, 2004 and 2005
Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2004 and 2005
Consolidated Statements of Stockholders' Equity (Deficit) for the years ended December 31, 2003, 2004 and 2005
Notes to Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM AUDITED FINANCIAL STATEMENTS PHYSICAL SPA & FITNESS INC. DECEMBER 31, 2005
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of PHYSICAL SPA & FITNESS INC.
We have audited the accompanying consolidated balance sheets of Physical Spa & Fitness Inc. (a Delaware Corporation) and its subsidiaries (the "Company") as of December 31, 2005 and 2004 and the related consolidated statements of operations, stockholders' (deficit) equity and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statements presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2005 and 2004 and the results of its operations and cash flows for each of the three years in the period ended December 31, 2005 in conformity with United States generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 3 (b) to the financial statements, the Company had a negative working capital and capital deficiency as of December 31, 2005 and incurred loss for the year then ended, which raised substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 3 (b). The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ MOORES ROWLAND MAZARS CHARTERED ACCOUNTANTS CERTIFIED PUBLIC ACCOUNTANTS Hong Kong
Date: April 17, 2006
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (Amounts in thousands, except share and per share data)
1. ORGANIZATION AND PRINCIPAL ACTIVITIES
Physical Spa & Fitness Inc. ("Physical") was incorporated on September 21, 1988 under the laws of the United States of America. Physical was incorporated with authorized share capital of 100 million common stocks with par value of US$0.001 each. 80% of Physical's issued and outstanding common stocks were held by a stockholder (the "Principal Stockholder"). Physical is a U.S. public company listed on the National Association of Securities Dealers Automated Quotations Over-the-Counter Bulletin Board.
Physical Beauty & Fitness Holdings Limited ("Physical Holdings") was incorporated on March 8, 1996 under the laws of the British Virgin Islands ("BVI") with a capital of one common stock being held by Physical. Physical Holdings has interests in various companies ("Operating Subsidiaries") operating fitness and beauty centres ("Fitness Centres") and other related businesses in Hong Kong, Macau and the People's Republic of China ("PRC"). During the years ended December 31, 2005, 2004 and 2003, Physical also operates Fitness Centres in the PRC through a Sino-foreign joint venture ("JV") established in the PRC. In the opinion of the directors, Physical is able to govern and control the financial and operating policies and the board of directors of the JV. Therefore, the JV has been accounted for as a subsidiary.
Detailed information in connection with the JV is as follows:
o Dalian Physical Ladies' Club Co., Ltd. ("the Dalian JV") is a Sino-foreign equity JV established on April 11, 1995 in Dalian, the PRC. The total registered capital of the Dalian JV was Renminbi ("RMB") 10 million. The JV period is 12 years from the date of issue of the business license on April 11, 1995. Physical, through its subsidiary, holds a 90% equity interest in the Dalian JV and the profits or losses of the Dalian JV are to be shared by the venturers in proportion to their equity interests in the JV.
The fitness and beauty centre operated under the Dalian JV was closed in September 2005. Since then, the Dalian JV has remained dormant.
Physical, Physical Holdings, the Operating Subsidiaries and JV are collectively referred to as the "Company".
2. BASIS OF PRESENTATION
The financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America.
The financial statements are presented in Hong Kong dollars which is the Company's functional currency because the Company's operations are primarily located in Hong Kong. For illustrative purposes, the exchange rate adopted for the presentation of financial information as of and for the year ended December 31, 2005 has been made at HK$7.8 to US$1.00. No representation is made that the HK$ amount could have been, or could be, converted into United States Dollars at that rate on December 31, 2005 or at any other date.
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (Amounts in thousands, except share and per share data)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a) PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the financial information of the Company and its subsidiaries. All intercompany balances and transactions have been eliminated on consolidation.
b) PREPARATION OF FINANCIAL STATEMENTS The Company had negative working capital of HK$129,835 and HK$151,385 as of December 31, 2005 and 2004 and incurred losses of HK$55,946 and and HK$44,968 for the years ended December 31, 2005 and 2003 respectively. In addition, the Company had accumulated losses and deficit in stockholders' equity of HK$18,503 and HK$17,600 respectively as of December 31, 2005. These conditions raised substantial doubt about the Company's ability to continue as a going concern.
Continuation of the Company as a going concern is dependent upon attaining profitable operations in the future, exercising tight cost and cash flow controls measures, and obtaining additional banking facilities and adequate finance as and when required. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
The Principal Stockholder has undertaken to make available adequate funds to the Company as and when required to maintain the Company as a going concern. In addition, the negative working capital as of December 31, 2005 was mainly because of the non-cash items including deferred income and deferred liabilities of HK$187,886 and HK$8,693 respectively while the loss for the year then ended was mainly attributable to the depreciation expense of HK$58,234. Having excluded these non-cash items and taken into consideration the undertaking provided by the Principal Stockholder, management believes that the Company will be able to settle its liabilities when they come due. As a result, the financial statements have been prepared in conformity with the principles applicable to a going concern.
c) INVENTORIES Inventories, mainly comprise beauty products for treatment and sale, are stated at the lower of cost and net realizable value. Cost, which comprises all costs of purchase and, where applicable, other costs that have been incurred in bringing the inventories to their present location and condition, is calculated using the first-in, first-out method. Net realizable value represents the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.
d) MARKETABLE DEBT AND EQUITY SECURITIES Debt securities and equity securities designated as available-for-sale, whose fair values are readily determinable, are carried at fair value with unrealized gains or losses included as a component of accumulated other comprehensive income, net of applicable taxes. Debt and equity securities classified as trading securities are carried at fair value with unrealized gains or losses included in income. Debt securities that are expected to be held-to-maturity are carried at amortized cost. Individual securities classified as either available-for-sale or held-to-maturity are reduced to net realizable value by a charge to income for other than temporary declines in fair value. Realized gains and losses are determined on the average cost method and are reflected in income.
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (Amounts in thousands, except share and per share data)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
e) PROPERTY, PLANT AND EQUIPMENT AND DEPRECIATION Property, plant and equipment are stated at cost less accumulated depreciation and accumulated impairment loss.
The cost of an asset comprises its purchase price and any directly attributable costs of bringing the asset to its present working condition and location for its intended use. Expenditure incurred after the assets have been put into operation, such as repair and maintenance expenses, is normally recognized as an expense in the period in which it is incurred. In situations where it can be clearly demonstrated that the expenditure has resulted in an increase in the future economic benefits expected to be obtained from the use of the assets, the expenditure is capitalized.
When assets are sold or retired, their costs and accumulated depreciation are eliminated from the accounts and any gain or loss resulting from their disposal is included in the statement of operations.
Depreciation is provided to write off the cost of property, plant and equipment over their estimated useful lives from the date on which they become fully operational and after taking into account their estimated residual values, using the straight-line method at the following rates per annum:
Leasehold land held under long-term lease Over the lease term Buildings 20 to 50 years Leasehold improvements Over the lease term Machinery and equipment 5 to 10 years Furniture and fixtures 5 years Computers 4 to 5 years Motor vehicles 4 to 5 years
The Company recognizes an impairment loss on property, plant and equipment when evidence, such as the sum of expected future cash flows (undiscounted and without interest charges), indicates that future operations will not produce sufficient revenue to cover the related future costs, including depreciation, and when the carrying amount of asset cannot be realized through sale. Measurement of the impairment loss is based on the fair value of the assets.
f) TRADE RECEIVABLES Trade receivables are recorded at original invoice amount. Trade credit is generally granted on a short-term basis, thus trade receivables do not bear interest. Trade receivables are periodically evaluated for collectibility based on past credit history with customers and their current financial condition. Changes in the estimated collectibility of trade receivables are recorded in the results of operations for the period in which the estimate is revised. Trade receivables that are deemed uncollectible are offset against the allowance for uncollectible amounts. No such allowance was made as of December 31, 2005 and 2004 as there was no uncollectible amounts for the two years then ended. The Company generally does not require collateral for trade receivables.
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (Amounts in thousands, except share and per share data)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
g) CASH EQUIVALENTS The Company considers all short-term, highly liquid investments with an original maturity date of three months or less to be cash equivalents.
h) REVENUE RECOGNITION Revenue represents service income in connection with the provision of physical fitness and beauty treatment services and other related income, net of the related sales tax, if any. The non-refundable admission fee is recognized as revenue over a seven-month period which is the estimated duration. Monthly dues, service income and other related income are recognized as revenue when services are rendered. Life membership fee is recognized as income over the estimated service period of twenty years.
i) DEFERRED INCOME Deferred income represents unamortized non-refundable admission fees and service fees billed but for which the related services, or portion of the services, have not yet been rendered by the balance sheet date.
j) CAPITAL LEASES Leases that substantially transfer to the Company all the rewards and risks of ownership of assets, other than legal title, are accounted for as capital leases.
Property, plant and equipment held under capital leases are initially recorded at the present value of the minimum lease payments at the inception of the leases, with equivalent liabilities categorized as appropriate under current or non-current liabilities.
Depreciation is provided on the cost of the assets on a straight-line basis over their estimated useful lives as set out in Note 3(e) above. Finance charges implicit in the purchase payments are charged to the statement of operations over the periods of the contracts so as to produce an approximately constant periodic rate of charge on the remaining balances of the obligations for each accounting period.
k) OPERATING LEASES Leases where substantially all the rewards and risks of ownership of assets remain with the leasing company are accounted for as operating leases. Rentals payable under operating leases are recorded in the statement of operations on a straight-line basis over the lease term.
l) DEFERRED LIABILITIES Deferred liabilities represent the benefit arose from the rent-free period of the operating leases. The deferred liabilities are amortized within the lease term, and the amortization is recorded in the statement of operations.
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (Amounts in thousands, except share and per share data)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
m) INCOME TAXES Provision for income and other related taxes have been provided in accordance with the tax rates and laws in effect in the various places of operations.
The Company provides for deferred income taxes using the liability method, by which deferred income taxes are recognized for all significant temporary differences between the tax and financial statements bases of assets and liabilities. The tax consequences of those differences are classified as current or non-current based upon the classification of the related assets or liabilities in the financial statements.
n) FOREIGN CURRENCY TRANSLATION The Company maintains its accounting books and records in Hong Kong Dollars ("HK$"), except for a PRC subsidiary, the JV and a Macau subsidiary which maintain their accounting books and records in RMB and Macau Pataca respectively. Foreign currency transactions during the year are translated to HK$ at the approximate rates of exchange on the dates of transactions. Monetary assets and liabilities denominated in foreign currencies at year end are translated at the approximate rates of exchange ruling at the balance sheet date. Non-monetary assets and liabilities are translated at the rates of exchange prevailing at the time the asset or liability was acquired. Exchange gains or losses are recorded in the statements of operations.
On consolidation, the financial statements of the PRC subsidiary, the JV and the Macau subsidiary are translated into HK$ using the closing rate method, whereby the balance sheet items are translated into HK$ using the exchange rates at the respective balance sheet dates. The share capital and accumulated (losses) profits are translated at exchange rates prevailing at the time of the transactions while income and expenses items are translated at the average exchange rate for the year.
All exchange differences arising on consolidation are recorded within equity.
o) RELATED PARTIES Parties are considered to be related if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests, those parties are related parties. Another party is also a related party if it can significantly influence the management or operating policies of the transacting parties or if it has an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests. Related parties include an enterprise and its principal owners, management or members of their immediate families.
p) COMPREHENSIVE INCOME The Company reports comprehensive income in accordance with SFAS No. 130 "Reporting Comprehensive Income". Accumulated other comprehensive income (loss) represents exchange translation adjustments and is included in the stockholders' equity section of the balance sheet.
q) (LOSS) EARNINGS PER SHARE Basic (loss) earnings per share exclude dilution and are computed by dividing (loss) earnings available to common stockholders by the weighted average number of common shares outstanding for the periods.
Diluted (loss) earnings per share are computed by dividing (loss) earnings available to common stockholders by the weighted average number of common shares outstanding adjusted to reflect potentially dilutive securities. There were no potentially dilutive securities outstanding during any of the years and, accordingly, basic and diluted (loss) earnings per share are the same.
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (Amounts in thousands, except share and per share data)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
r) USES OF ESTIMATES The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires the Company's management to make estimates and assumptions that affect the amounts reported in these financial statements and accompanying notes. Actual amounts could differ from those estimates.
s) ADVERTISING AND MARKETING COSTS All advertising and marketing costs are expensed off in the period in which those costs are incurred or the first time the advertising takes place.
t) RECENTLY ISSUED ACCOUNTING STANDARDS In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based Payment" ("SFAS No. 123(R)"). This statement provides investors and other users of financial statements with more complete and neutral financial information by requiring that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. SFAS No. 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. SFAS No. 123(R) replaces SFAS No. 123, "Accounting for Stock-Based Compensation", and supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees". Public entities (other than those filing as small business issuers) will be required to apply this statement as of the first interim or annual reporting period that begins after June 15, 2005. In March 2005, the SEC have published Staff Accounting Bulletin No. 107, "Share-Based Payment," ("SAB No. 107") to give public entities guidance in applying the provisions of SFAS No. 123(R), and to users of financial statements in analyzing the information provided under SFAS No. 123(R). SAB No. 107 should be applied upon the adoption of SFAS No. 123(R). Management considers that SFAS No. 123(R) and SAB No. 107 would not have significant impact on its financial statements on adoption.
In March 2006, the EITF reached a consensus on EITF Issue No. 06-3, "How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That is, Gross versus Net Presentation)" that the entities may adopt a policy of presenting taxes in the income statement on either a gross or net basis. Gross or net presentation may be elected for each different type of tax, but similar taxes should be presented consistently. Taxes within the scope of this EITF would include taxes that are imposed on a revenue transaction between a seller and a customer, for example, sales taxes, use taxes, value-added taxes, and some types of excise taxes. If taxes are significant an entity should disclose its policy of presenting taxes and the amounts of taxes that are recognized on a gross basis. The consensus is effective for interim and annual financial periods beginning after December 15, 2006. Management considers that the adoption of this EITF would not have significant impact on its financial statements.
The FASB issued SFAS No. 154, "Accounting Changes and Error Corrections". SFAS 154 replaces APB No. 20, "Accounting Changes" and SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements" and establishes retrospective application as the required method for reporting a change in accounting principle. SFAS 154 provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and for reporting a change when retrospective application is impracticable. The reporting of a correction of an error by restating previously issued financial statements is also addressed. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005, although earlier application is permitted for changes and corrections made in fiscal years beginning after June 1, 2005. The Company will consider this SFAS in future periods for correction of error or if there is any change in accounting principle.
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (Amounts in thousands, except share and per share data)
4. MARKETABLE SECURITIES, COLLATERALIZED
The balance represents available-for-sale unlisted capital guaranteed funds made up of debt and equity securities. As of the balance sheet dates, as the cost approximated to the estimated fair value, no gain or loss was recognized. These securities have been pledged to banks to secure general banking facilities granted to the subsidiaries. Maturity information of the marketable securities is set out as below:
5. PROPERTY, PLANT AND EQUIPMENT, NET
AS OF DECEMBER 31 ---------------------------------- 2005 2005 2004 US$ HK$ HK$
Land and buildings 404 3,148 3,136 Leasehold improvements 24,913 194,320 202,857 Machinery and equipment 27,703 216,090 218,003 Furniture and fixtures 7,852 61,252 65,387 Computers 1,061 8,275 8,170 Motor vehicles 537 4,184 4,184 Less: Accumulated depreciation (42,489) (331,416) (313,845) -------- -------- --------
Net book value 19,981 155,853 187,892 ======== ======== ========
As of December 31, 2005, the cost and accumulated depreciation of property, plant and equipment held under capital leases amounted to approximately HK$716 (2004: HK$1,814) and HK$96 (2004: HK$681) respectively.
6. SHORT-TERM BANK LOANS
The short-term bank loans are collateralized and repayable within one year. Please refer to Note 7 for details of collateral for such facilities.
Supplemental information with respect to the short-term bank loans was as follows:
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (Amounts in thousands, except share and per share data)
7. BANKING FACILITIES
The Company obtained various lines of credit under banking facilities which aggregated HK$18,444 as of December 31, 2005 (2004: HK$28,173) from creditworthy commercial banks in Hong Kong to finance its operations. These banking facilities were collateralized by certain of the assets of the Company, its related companies and the Principal Stockholder and his spouse.
The collateral of the short-term bank loans include:
(i) leasehold property in Hong Kong with a net book value of HK$1,932 (2004: HK$1,999);
(ii) fixed deposits of HK$9,213 (2004: HK$11,523);
(iii) leasehold property in Hong Kong owned by Silver Policy Development Limited ("Silver Policy"), a company owned by the Principal Stockholder and his spouse;
(iv) personal guarantees from the Principal Stockholder and his spouse;
(v) marketable securities as stated in Note 4;
(vi) corporate guarantees provided by Silver Policy and Mighty System Limited, a company owned by the Principal Stockholder.
8. INCOME TAXES
The Company' subsidiaries are subject to income taxes on an entity basis on income arising in or derived from the tax jurisdiction in which they are domiciled and operates. In the opinion of management, any undistributed earnings of the Company will be reinvested indefinitely.
Income tax benefits (expenses) comprised of the following:
YEAR ENDED DECEMBER 31 ---------------------------------- 2005 2005 2004 2003 US$ HK$ HK$ HK$
Current taxes -- -- (1,112) (1,488) Deferred taxes 282 2,202 544 1,847 ------ ------ ------ ------
Income tax benefits (expenses) 282 2,202 (568) 359 ====== ====== ====== ======
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (Amounts in thousands, except share and per share data)
8. INCOME TAXES (CONTINUED)
Reconciliation to the expected statutory tax rate in Hong Kong of 17.5% (2004: 17.5% AND 2003: 17.5%) is as follows:
Note: Valuation allowance was made for deferred tax assets recognized in certain Hong Kong subsidiaries as it is more likely than not that the assets will not be realized. The net change in valuation allowance for the year ended December 31, 2005 was a decrease of HK$7,997 (US$1,025).
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (Amounts in thousands, except share and per share data)
8. INCOME TAXES (CONTINUED)
Since the Hong Kong subsidiaries have incurred losses for Hong Kong profits tax purposes, no provision for current tax has been made. For the years ended December 31, 2004 and 2003, Hong Kong profits tax has been provided on those profitable subsidiaries at the rate of 17.5%. As of December 31, 2005 and 2004, the Company has operating losses carry forward in respect of Hong Kong subsidiaries of HK$98,557 and HK$28,727 respectively. The operating losses have no expiry date under the current tax legislation.
Since the PRC subsidiary and the JV have sustained losses for PRC income tax purposes, the Company has not recorded any PRC income tax expense. PRC income tax in the future will be calculated at the applicable rate relevant to the PRC subsidiary and the JV which is currently 33%. As of December 31, 2005 and 2004, the Company has operating losses carry forward in respect of the PRC subsidiary and the JV of HK$38,070 and HK$27,582 respectively. The operating losses of the PRC subsidiary and the JV will expire five years after the losses were incurred.
As the fitness centre operated in Macau has incurred a loss for taxation purposes for the period, the Company has not recorded any Macau income tax expense. Macau profits tax is currently charged at sliding rates with a maximum rate of 12% on assessable profits. As of December 31, 2005 and 2004, the Company has operating losses carry forward in respect of the fitness centre operated in Macau of HK$13,995 and HK$16,105 respectively. The operating losses of the Macau centre will expire three years after the losses were incurred.
The Company imported beauty products from suppliers in Hong Kong into the PRC for beauty treatment and sale to its customers. Under the prevailing PRC rules and regulations governing imports into the PRC, the Company is required to make import declarations and to pay various taxes including, inter alia, customs duty, consumption tax and value-added tax, on such imports. The Company faced further penalty, additional to the original amount of taxes payable, ranging from 50% to 500% of the original amount of taxes payable, had the Company been found in breach of any of such rules and regulations.
Since the Company commenced its business operation in the PRC, the Company has not made any import declaration nor paid any of the taxes due for such imports. The directors have represented that the suppliers have undertaken to the Company that they would reimburse the Company for such payments had such payments been found necessary.
As of the balance sheet date, the Company was potentially liable to make good in aggregate an amount of HK$13,833 (2004: HK$12,994), of which an amount of HK$8,173 (2004: HK$7,334) has been provided for as "Taxes other than income" and as "Other receivables" in the liabilities and assets respectively. No further provision has been made for the difference which amounted to HK$5,660 (2004: HK$5,660) and any potential amount of penalty which might be imposed. In this respect, the directors are of the opinion that the probability that such potential liabilities will be crystallized would be remote.
As also stated in Note 12(e) to the financial statements, the Principal Stockholder has undertaken to indemnify the Company against any contingent liabilities including tax liabilities and claims that may result from the operating activities of the Company in Hong Kong, the PRC and elsewhere occurring prior to the balance sheet date. Had any payments been found necessary, the payments made by the Principal Stockholder will be recorded as expenses in the Company's financial statements with a corresponding credit to contributed (paid-in) capital in accordance with the stipulations as mentioned in the Staff Accounting Bulletin Topic 5-T.
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (Amounts in thousands, except share and per share data)
9. OTHER PAYABLES
10. OBLIGATIONS UNDER CAPITAL LEASES
The Company leases certain equipments under capital leases. The scheduled future minimum lease payments were as follows:
AS OF DECEMBER 31 ---------------------- 2005 2005 2004 US$ HK$ HK$
Payable during the following periods: Within one year 40 309 951 Over one year but not exceeding two years 15 121 -- ---- ---- ----
Total minimum lease payments 55 430 951
Less: Amount representing interest (3) (25) (235) ---- ---- ----
Present value of net minimum lease payments 52 405 716 ==== ==== ====
11. COMMITMENTS
CAPITAL EXPENDITURE COMMITMENTS
AS OF DECEMBER 31 --------------------- 2005 2005 2004 US$ HK$ HK$
Contracted but not provided for net of deposit paid 150 1,168 9,579 ===== ===== =====
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (Amounts in thousands, except share and per share data)
11. COMMITMENTS (CONTINUED)
COMMITMENTS UNDER OPERATING LEASES
The Company had outstanding commitments not provided for under non-cancelable operating leases in respect of land and buildings, the portion of these commitments payable in the following periods is as follows:
AS OF DECEMBER 31 --------------------------- 2005 2005 2004 US$ HK$ HK$
Payable during the following periods: Within one year 12,266 95,678 118,043 Over one year but not exceeding two years 8,282 64,600 81,055 Over two years but not exceeding three years 5,037 39,292 51,796 Over three years but not exceeding four years 3,230 25,197 36,724 Over fours years but not exceeding five years 2,896 22,591 25,914 Thereafter 14,183 110,631 133,222 ------- ------- -------
Total operating lease commitments 45,894 357,989 446,754 ======= ======= =======
12. RELATED PARTY TRANSACTIONS
The Company had the following transactions with related parties:
(a) The rental of a director's quarter is payable to a related company, Mighty System Limited.
(b) The purchases of beauty and fitness equipment and health food were made from a related company, Williluck International Limited.
(c) The handling fee income is received from a related company, Alpha Sun Limited, in assisting for the sale of properties owned by Alpha Sun Limited.
(d) The Principal Stockholder of the Company has beneficial interests in the aforementioned related companies or the stockholder of the related companies are close family member of the Principal Stockholder.
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (Amounts in thousands, except share and per share data)
12. RELATED PARTY TRANSACTIONS (CONTINUED)
(e) The balance due from the Principal Stockholder to the Company as of December 31, 2005 was HK$9,480 (2004: HK$9,480). Under an agreement with the Company, the Principal Stockholder has pledged 1,500,000 shares of the Company's stock as collateral, which had a market value of HK$819 as of December 31, 2005.
(f) The Principal Stockholder has undertaken to indemnify the Company against any contingent liabilities including tax liabilities and claims that may result from the operating activities of the Company in Hong Kong, the PRC and elsewhere occurring prior to the balance sheet date. He has also undertaken to indemnify the Company against any loss that may arise from non-recovery of advances made to certain unrelated parties amounted to HK$1,650 (2004: HK$890), which have been included in "Prepayment to vendors and suppliers and other current assets".
13. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (Amounts in thousands, except share and per share data)
14. OTHER SUPPLEMENTAL INFORMATION
The following items are included in the consolidated statements of operations:
(a) Interest income is included in "Other income, net" in the consolidated statements of operations.
(b) Sales taxes are deducted from "Operating revenues" in the consolidated statements of operations.
(c) Advertising and marketing expenses are included in "Other selling and administrative expenses" in the consolidated statements of operations.
(d) Management fee income is included under "Operating revenue" in the consolidated statements of operations. The fee is earned from two fitness centers operated by third parties in Hangzhou and Dalian, the PRC, under franchises of the Company.
15. RETIREMENT PLAN
The Company operates a Mandatory Provident Fund ("MPF") plan for its Hong Kong employees. The assets of the MPF plan are held separately from those of the Company in a provident fund managed by independent trustee. The pension expenses charged to the consolidated statements of operations amounted to HK$6,703, HK$6,414, and HK$8,059 for the years ended December 31, 2005, 2004 and 2003 respectively.
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (Amounts in thousands, except share and per share data)
16. STOCK OPTION PLAN
The Company has a Stock Option Plan (the "Plan") which was adopted by the Company's stockholders and its Board of Directors on April 23, 1997. Under the Plan, the Company may issue incentive stock options, non-qualified options, restricted stock grants, and stock appreciation rights to selected directors, officers, advisors and employees of the Company. A total of 500,000 shares of Common Stock of the Company are reserved for issuance under the Plan. Stock options may be granted as non-qualified or incentive options. Incentive stock options may not be granted at a price less than the fair market value of the stock as of the date of grant while non-qualified stock options may not be granted at a price less than 85% of the fair market value of the stock as of the date of grant. The plan will be administered by an option committee which is to be composed of two or more disinterested directors of the Board of Directors (the "Committee"). The option can be exercised during a period of time fixed by the Committee subject to the condition that no option may be exercised ten years after the date of grant or three years after death or disability, whichever is later. As of the date of this report, no stock options have been granted by the Company under the Plan.
17. OPERATING RISKS
a) CONCENTRATION OF SUPPLIERS
The Company purchases beauty products from a number of suppliers. Details of individual suppliers also accounted for more than 10% of the Company's purchases are as follows:
YEAR ENDED DECEMBER 31 ---------------------- 2005 2004 2003 % % %
William Pharmaceutical Agency -- 11 -- Kaydex Trading Ltd. 28 27 39 Kingstar International Trading Limited 13 13 16 The Me Group (International) Limited 11 -- --
b) CONCENTRATION OF CREDIT RISK
None of the sales to the customers accounted for more than 10% of the Company's turnover for the three years ended December 31, 2005, 2004 and 2003.
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (Amounts in thousands, except share and per share data)
18. REPORT ON SEGMENT INFORMATION
The Company's operations are classified into two reportable business segments: provision of physical fitness and beauty treatment services. Each separately managed segment offers different products requiring different marketing and distribution strategies.
Information concerning consolidated operations by business segment and geographic area is presented in the tables below and on the following pages:
CONSOLIDATED OPERATIONS BY BUSINESS SEGMENT
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (Amounts in thousands, except share and per share data)
18. REPORT ON SEGMENT INFORMATION (CONTINUED)
CONSOLIDATED OPERATIONS BY GEOGRAPHIC AREA
YEAR ENDED DECEMBER 31 -------------------------------------------- 2005 2005 2004 2003 US$ HK$ HK$ HK$
Operating revenues - Hong Kong 49,118 383,119 442,755 385,966 - PRC 7,858 61,297 60,809 53,545 -------- -------- -------- --------
56,976 444,416 503,564 439,511 ======== ======== ======== ========
Operating (loss) profit - Hong Kong (4,417) (34,454) 16,855 (30,140) - PRC (2,310) (18,017) (9,433) (7,634)
Interest income 21 171 80 135 Interest expenses (467) (3,646) (6,108) (7,329) -------- -------- -------- --------
Net (loss) income (7,173) (55,946) 1,394 (44,968) ======== ======== ======== ========
AS OF DECEMBER 31 -------------------------------------------- 2005 2005 2004 2003 US$ HK$ HK$ HK$
Segment assets - Hong Kong 21,109 164,652 190,370 230,387 - PRC 11,166 87,098 89,822 84,499 -------- -------- -------- --------
32,275 251,750 280,192 314,886 ======== ======== ======== ========
PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- (Amounts in thousands, except share and per share data)
19. UNAUDITED QUARTERLY CONSOLIDATED FINANICAL DATA
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
NONE
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
The Company's Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) as of the end of the period covered by this report (the "Evaluation Date"), have concluded that, as of the Evaluation Date, the Company's disclosure controls and procedures were adequate and effective to ensure that material information relating to the Company and its consolidated subsidiaries would be made known to them by others within those entities.
(b) Management's Report on Internal Control over Financial Reporting.
The Company's management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended). The Company's management assessed the effectiveness of its internal control over financial reporting as of December 31, 2005. The Company's management has concluded that, as of December 31, 2005, its internal control over financial reporting is effective based on these criteria.
(c) Changes in internal controls.
There were no significant changes in the Company's internal controls or in other factors that could significantly affect the Company's disclosure controls and procedures subsequent to the Evaluation Date, nor were there any significant deficiencies or material weaknesses in such disclosure controls and procedures requiring corrective actions. As a result, no corrective actions were taken.
The Company's management, including its Chief Executive Officer and Chief Financial Officer, does not expect that the Company's disclosure controls and procedures or its internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
NONE
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
DIRECTORS AND EXECUTIVE OFFICERS
The officers and directors of the Company, their ages and present positions held with the Company are as follows:
NAME AGE POSITIONS WITH THE COMPANY ---- --- --------------------------
Ngai Keung Luk 49 Chairman of the Board of Directors, Chief Executive Officer
Yuk Wah Ho 50 President and Director
Darrie Lam 42 Chief Financial Officer, Secretary and Director
Yat Ming Lam 48 Director
Allan Wah Chung Li 48 Director
The following is a brief summary of the background of each director, executive officer and key employees of the Company:
NGAI KEUNG LUK, CHIEF EXECUTIVE OFFICER, CHAIRMAN. Mr. Luk has been the Chairman of the Board of Directors and Chief Executive Officer of the Company since October, 1996. He is the founder of its predecessor companies and has over twenty years' experience in the physical health service business. Mr. Luk was previously employed as a trader on the floor of the Hong Kong gold exchange. Mr. Luk is a controlling shareholder of the Company and owns beneficially approximately 80% of the Company's Common Stock (see "Principal Shareholders").
YUK WAH HO, PRESIDENT, DIRECTOR. Ms. Ho has over twenty years' experience in beauty and skin care and has attended various international beauty workshops held in Europe. Ms. Ho holds many certificates in beauty therapy, skin care, and cosmetic applications from France, England, Taiwan and Hong Kong, including Rene Guinot, Germain de Cappucini, and Sothy's. Ms. Ho is responsible for the business development and staff training of the Company's beauty treatment business. Ms. Ho is the wife of Mr. Luk.
DARRIE LAM, CHIEF FINANCIAL OFFICER, SECRETARY, DIRECTOR. Ms. Lam has been a Vice-President and Secretary of the Company since October, 1996 and was appointed as Chief Financial Officer in July, 2005. Ms. Lam is a fellow member of the Hong Kong Institute of Certified Public Accountants and a fellow member of the Chartered Association of Certified Accountants (UK). She joined the Company in 1994 and before that she worked with a major Hong Kong listed company, Wharf Group, as a Financial Analyst. Ms. Lam is responsible for the Company's secretarial affairs, finance and administration functions. Ms. Lam received MBA degree from the University of Manchester, U.K.
YAT MING LAM, DIRECTOR. Mr. Lam has been a Director of the Company since August, 1997. In the past year, Mr. Lam has run his own business in China. Previously, Mr. Lam was employed as a Sales Manager with Fitness Concept Leisure Supplies Ltd., one of the leading fitness equipment and product suppliers.
ALLAN WAH CHUNG LI, DIRECTOR. Mr. Li has been a director of the Company since June, 1998. Mr. Li is a solicitor qualified to practice law in Canada, England and Hong Kong. Mr. Li has practiced law in Vancouver, Toronto and Hong Kong for ten years and had also worked for the Listing Division of the Stock Exchange of Hong Kong. Since 1994, Mr. Li has been with Lai Sun Development Company Limited, a company listed on the Stock Exchange of Hong Kong, where he is currently serving as a vice-president, and is involved in hotels and corporate transactions. Mr. Li received B.Comm. and L.L.B degrees from the University of British Columbia, Canada.
WAI KEE LAM, GENERAL MANAGER. Mr. Lam holds a Diploma in Business Management awarded by the Hong Kong Management Association. Prior to joining the Company in October, 1997, Mr. Lam was the Director and General Manager of Fitness Concept Leisure Supplies Ltd., one of the leading fitness equipment and product suppliers. Mr. Lam is overseeing the Company's daily operation in both Hong Kong and China centers.
SIU LING CHENG, MARKETING MANAGER. Ms. Cheng holds a Bachelor Degree in Marketing at the University of Southern Queensland, Australia. Ms. Cheng joined the Company since 1992 as a marketing executive, and was promoted to marketing manager the following year. Ms. Cheng is responsible for the Company's promotional and marketing activities and public relations. Ms. Cheng also coordinates and assists the marketing teams in China centers.
GILLIAN LOUISE HOLLOWAY, SENIOR FITNESS MANAGER. Ms. Holloway is a member of the Association for Fitness Professionals. Ms. Holloway obtained the qualifications of Certified Aerobics Instructor and Certified Personal Trainer issued by the American Council on Exercise. Ms. Holloway joined the Company in 1991 and is responsible for the Company's fitness training services and customer relationship. Ms. Holloway received a Graduate Certificate in Recreation and Sports Management issued by the Victoria University, Australia.
AUDIT COMMITTEE
The Board of Directors established an Audit Committee, composed of the two outside directors and the Chief Financial Officer. The principal functions of the Audit Committee will include making recommendations to the Board regarding the selection of independent public accountants to audit annually the books and records of the Company, reviewing the proposed scope of each audit and reviewing the recommendations of the independent public accountants as a result of their audit of the Company. The Audit Committee will also periodically review the activities of the Company's accounting staff and the adequacy of the Company's internal controls.
CODE OF BUSINESS CONDUCT AND ETHICS
The Company has not adopted yet the code of business conduct and ethics to guide all directors, officers and employees, but intends to adopt one on its next meeting of the Board of Directors.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth all compensation awarded to, earned by, or paid for all services rendered to the Company during the fiscal years 2005, 2004 and 2003 by those persons who served as Chief Executive Officer and any Named Executive Officer who received compensation in excess of $100,000 during such years.
(1) No officers received or will receive any bonus or other annual compensation other than salaries during fiscal year 2005, other than stated above. Management believes that the value of other non-cash benefits and compensation distributed to executive officers of the Company individually or as a group during fiscal year 2005 did not exceed the lesser of US$50,000 or ten percent of such officers' individual cash compensation or, with respect to the group, US$50,000 times the number of persons in the group or ten percent of the group's aggregate cash compensation.
(2) No officers received or will receive any long term incentive plan (LTIP) payouts or other payouts during fiscal year 2005.
(3) Bonus awarded based on performance.
(4) Other compensation for Mr. Luk included an allowance of HK$1,200,000 (US$154,000) for the fiscal years 2005 and HK$960,000 (US$123,000) for 2004, being fair market rent of the living accommodation provided to Mr. Luk. See also "Certain Transactions".
COMPENSATION OF DIRECTORS
The Company reimburses each Director for reasonable expenses (such as travel and out-of-pocket expenses) in attending meetings of the Board of Directors. Directors are not separately compensated for their services as Directors.
EMPLOYMENT AGREEMENTS, TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL ARRANGEMENTS
There are no employment agreements with the Company's key employees at this time.
Limitation of Liability of Directors - ------------------------------------
The laws of the State of Delaware and the Company's By-laws provide for indemnification of the Company's directors for liabilities and expenses that they may incur in such capacities. In general, directors and officers are indemnified with respect to actions taken in good faith in a manner reasonably believed to be in, or not opposed to, the best interests of the Company, and with respect to any criminal action or proceeding, actions that the indemnitee had no reasonable cause to believe were unlawful.
The Company has been advised that in the opinion of the Securities and Exchange Commission, indemnification for liabilities arising under the Securities Act is against public policy as expressed in the Securities Act and is, therefore, unenforceable.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of December 31, 2005 and April 17, 2005, the stock ownership of all persons known to own beneficially five percent or more of the Company's Common Stock and all directors and officers of the Company, individually and as a group. Each person has sole voting and investment power over the shares indicated, except as noted. Unless otherwise indicated, the address for each stockholder is 40/F., RBS Tower, Times Square, No. 1 Matheson Street, Causeway Bay, Hong Kong.
NAME AND AMOUNT AND ADDRESS OF NATURE PERCENTAGE BENEFICIAL OF BENEFICIAL BENEFICAILLY OWNER OWNERSHIP (1) OWNED(2) - ---------- ------------- ------------
DIRECTORS, OFFICERS AND 5% STOCKHOLDERS
NGAI KEUNG LUK (3) 8,000,000 80.00% YUK WAH HO, PRESIDENT (4) 8,000,000 80.00% DARRIE LAM, CHIEF FINANCIAL OFFICER 0 0.00% YAT MING LAM, DIRECTOR 0 0.00% ALLAN WAH CHUNG LI, DIRECTOR 0 0.00%
ALL OFFICERS AND DIRECTORS 8,000,000 80.00% AS A GROUP (5 PERSONS)(3) - ----------
(1) Except as otherwise indicated, the Company believes that the beneficial owners of Common Stock listed below, based on information furnished by such owners, have sole investment and voting power with respect to such shares, subject to community property laws where applicable. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting or investment power with respect to securities. Shares of Common Stock subject to options or warrants currently exercisable, or exercisable within 60 days, are deemed outstanding for purposes of computing the percentage of the person holding such options or warrants, but are not deemed outstanding for purposes of computing the percentage of any other person.
(2) Based upon 10,000,000 shares of Common Stock outstanding.
(3) Mr. Luk pledged 1,500,000 shares of Common Stock for the loans received from the Company under that certain Pledge Agreement dated September 30, 1997.
(4) Ms. Ho is the wife of Ngai Keung Luk. Accordingly the number of common stock owned by Mr. Luk and Ms. Ho overlap.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company made certain advances to Mr. Luk, the Company's Chief Executive Officer and the Chairman of its Board of Directors, during the years. The balance due to the Company and its subsidiaries at December 31, 2005 was HK$9,480,000 (US$1,215,000). Under an agreement with the Company, Mr. Luk has pledged 1,500,000 shares of the Company stock as collateral. See Note 12 to Financial Statements.
Mr. Luk receives a monthly allowance of HK$100,000 (US$12,821) for the fiscal year 2005 for his living accommodations. Such allowance represents the fair market rent of the property owned by a company which is controlled by Mr. Luk. See also "Management - Compensation".
The Company had the transactions with related companies as provided in the Financial Statements, Note 12.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Set forth below are fees paid to the Company's independent accountants for the past two years for the professional services performed for the Company.
Audit Fees: The Company paid Moores Rowland Mazars $84,615 in the year 2005 and $66,667 in the year 2004, in connection with the annual audit and to review the quarterly filings made on form 10-Q.
Audit Related Fees: NONE
Tax Fees: NONE
All Other Fees: NONE
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Exhibits. --------- The following exhibits of the Company are included herein.
2.1 Share Exchange Agreement between Foreclosed Realty Exchange, Inc. and Ngai Keung Luk, together with amendments*
3.1 Articles of Incorporation of Physical Spa & Fitness Inc., a Delaware Corporation*
3.2 Certificate of Amendment of Articles of Incorporation changing the number of directors*
3.3 Certificate of Amendment of Articles of Incorporation changing the Company's name*
3.4 Certificate of Amendment of Articles of Incorporation changing the authorized capital*
3.5 By-Laws of Physical Spa & Fitness Inc.*
3.6 Amended By-Laws of Physical Spa & Fitness Inc.
10.7 Repayment Agreement between the Company and Ngai Keung Luk*
10.8 Pledge Agreement between the Company and Ngai Keung Luk*
10.9 1997 Stock Option Plan and form of Stock Option Agreement*
16. Letter on changes in certifying accountant**.
21. Subsidiaries of the Registrant
23. Consent of Moores Rowland Mazars, Independent Auditors.
- ---------- * Filed with the Commission as exhibit to the Registration Statement or amendments to the Registration Statement. ** Filed with the Commission as exhibit 16 to Form 8-K.
(b) Reports on Form 8-K -------------------
The Form 8-K in respect of change of Chief Financial Officer has been filed on July 21, 2005.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on April 17, 2006.
PHYSICAL SPA & FITNESS INC.
By: /s/ Ngai Keung Luk ------------------------------------ Ngai Keung Luk, Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.