SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                             -----------------------

                                   FORM 10-KSB

(Mark One)
/X/      ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT
         OF 1934 (Fee Required)

         For the fiscal year ended December 31, 1996.

/ /      TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE
         ACT OF 1934 (No Fee Required)

For the transition period from __________ to _________

                         Commission File Number: 0-25334

                     THE GREAT AMERICAN BACKRUB STORE, INC.
--------------------------------------------------------------------------------
                 (Name of small business issuer in its charter)

                           NEW YORK                       13-3729043
--------------------------------------------------------------------------------
      (State or other jurisdiction of                (I.R.S. Employer
      incorporation or organization)                 Identification No.)

425 MADISON AVENUE SUITE 605 NEW YORK, NEW YORK             10017
--------------------------------------------------------------------------------
     (Address of principal executive offices)            (Zip Code)

Issuer's telephone number (212) 750-7046

Securities registered under Section 12(b) of the Act:

                                                   Name of each exchange
          Title of each class                       on which registered
          -------------------                       -------------------

       Common Stock, $.001 par value               Nasdaq SmallCap Market
       -----------------------------               ----------------------


Check  whether the issuer (1) filed all reports  required to be filed by Section
13 or 15(d) of the  Exchange  Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports),  and (2) has been
subject to the filing requirements for the past 90 days. Yes /X/. No / /.

Check if disclosure  of delinquent  filers in response to Item 405 of Regulation
S-B is not contained in this form, and no disclosure  will be contained,  to the
best of registrant's  knowledge,  in definitive proxy or information  statements
incorporated  by reference  in Part III of this Form 10-KSB or any  amendment to
this Form 10-KSB. / /

State issuer's revenues for its most recent fiscal year:  $3,045,937

State the  aggregate  market  value of the voting  stock held by  non-affiliates
computed by reference  to the price at which the stock was sold,  or the average
bid and asked prices of such stock,  as of February 12, 1997. (See definition of
affiliate in Rule 12b-2 of the Exchange Act) $11,368,432

NOTE:  If  determining  whether  a  person  is  an  affiliate  with  involve  an
unreasonable  effort and expense,  the issuer may calculate the aggregate market
value of the  common  equity  held by  non-affiliates  on a basis of  reasonable
assumptions, if the assumptions are stated.

The number of shares of Common  Stock of the issuer  outstanding  as of February
28, 1997 is 2,416,841.

Transition Small Business Disclosure Format (check one):  Yes / /    No  /X/


<PAGE>
                                     PART I

                  ITEM 1.  DESCRIPTION OF BUSINESS

OVERVIEW

         The Company is a development stage company engaged in the creation of a
national  chain of stores  under the name "The Great  American  BackRub  Store,"
which offer  reasonably-priced  back rubs to customers while they are seated and
fully  clothed in a clean,  open,  non-threatening  environment.  The  Company's
stores  will also  offer  back rub  services  off-site,  to  corporate  offices,
convention  centers and tourist  attractions.  The  Company  currently  owns and
operates 11 retail stores in New York City, one in The Westchester mall in White
Plains,  New York,  and one at the  Woodfield  Mall in the Chicago  metropolitan
area. In addition,  the Company recently  entered into franchise  agreements for
two locations,  one at the Roosevelt Field Mall on Long Island, New York and the
other at the Cherry Creek Mall in Denver,  Colorado, and granted an option for a
third franchise in the Los Angeles, California metropolitan area.

         The  Company's  growth  strategy  is to  be  implemented  primarily  by
Terrance Murray, the Company's Chief Executive Officer, who previously served as
the executive vice president, operations of Supercuts, Inc. Supercuts, Inc. is a
hair care chain with in excess of 1,000  company-owned  and franchised stores in
43 states and Puerto Rico. The Company  believes that the  substantial  national
retail and franchise experience of Mr. Murray are an asset to the Company.

INDUSTRY BACKGROUND

         With  the  increasing   awareness  that  health  is  a  key  factor  in
determining  worker  productivity,  a number of businesses  have emerged to help
promote physical and mental well-being.  This health consciousness  movement has
led to the rapid  expansion  of  businesses  such as health  clubs,  spas,  diet
centers/alternative  education schools,  health and fitness magazines and health
equipment manufacturers.

         Back pain and stress have become  increasingly  serious health concerns
in modern society.  The effects of poor posture,  long hours at desks/keyboards,
and increased  stress and work related  pressures have all resulted in a society
that suffers  from chronic  backaches  and muscular  tension.  The July 14, 1994
issue of THE NEW ENGLAND JOURNAL OF MEDICINE reported that backaches rank second
only to respiratory infections as the leading cause of work absences and are the
number one basis for  worker's  compensation  claims and that over 80 percent of
the American adult population suffers from back pain on an occasional basis.

         In recent years,  preventive health care has taken on new meaning, both
for the consumer and many employers. The December 25, 1994 issue of THE NEW YORK
TIMES  reported that a small but growing  number of  corporations  are including
massage in their employee health programs.

         Although the number is increasing, only a small percentage of Americans
utilize massage on a regular basis.  Management believes that this is so because
of the  consumer's  perception  that the typical  back rub is high  priced,  not
convenient  to schedule or travel to, and requires the customer to be undressed.
The Company  believes that The Great American  BackRub Store is sensitive to and
addresses all of these concerns.  The pricing structure ($8.95,  $16.95, $28.95,
$38.95 and $49.95,  respectively  for 5, 10, 20, 30, and 45 minute back rubs) is
perceived by customers to be very  reasonable.  Stores are located in convenient
locations and no appointments  are required.  The customer remains fully clothed
during the entire back rub sequence  and,  because of the openness of the entire
location, is confident of the "safeness" of the experience.

         Results  from the  Company's  computerized  point-of-sale  (POS) system
indicate  that repeat  customers  account for an average of 60% of the Company's
daily customers.  A majority (60%) of the customers are women,  with the typical
customer being between the ages of 25 and 50.

                                       -2-
<PAGE>

CONCEPT

         By design, The Great American BackRub Store is a specialty  interactive
retailer  offering a wide range of massage  and stress  reduction  products.  In
addition to experiencing the hands-on interaction of the back rub, customers are
able to view the entire process from both the street and inside the store.  Once
inside, customers are encouraged to sample and test the products on display. The
Company therefore believes that the combination of the boutique retailer concept
with back rub services makes The Great American  BackRub Store a unique shopping
experience.

         The  Company's  concept  is to provide a clean,  open,  non-threatening
environment  where  people  can enjoy the  benefits  of a back rub as a daily or
weekly  stress  relaxation  technique  without  having to  undress  and  without
incurring  the time and  expense  of a  conventional  massage.  Integral  to the
Company's  strategy is the sale of massage and stress reduction products in each
of its stores,  including  oils,  bath salts,  back supports and  electronic and
mechanical stress reduction devices.

         The focus of the  Company's  service  business is a 5, 10, 20, 30 or 45
minute back rub that consists of an 18-step massage  sequence of the back, neck,
shoulders, arms and hands conducted on the Company's specially designed back rub
chair.  These areas  represent  eighty percent of the areas  normally  worked on
during a full body massage, without the space-consuming tables or necessity that
the customer undress. In the 20, 30 and 45 minute sequences,  additional time is
spent on  particular  areas where either the customer or the  therapist  detects
stress or tension.  The  percentage  of customers  purchasing  the 20, 30 and 45
minute  sequences  has  increased  to almost 50% of services.  In addition,  the
Company  offers  scalp  massages  and has  designed  a foot rub  sequence  which
involves the customer wearing a disposable sock during a reflexology treatment.

STORE DESIGN, OPERATIONS AND CONTROLS

         The  typical  Great  American   BackRub  Store  location   consists  of
approximately  600 to 1,200  square  feet,  including  300 to 600 square feet of
retail space. Customers are seated on a specially-designed  chair which provides
cushioned  support  for the  chest,  arms and head.  The  Company's  stores  are
designed to permit people both inside and outside the store to view the back rub
process and at the same time maintain the privacy of the back rub customer.

         Each of the Company's  stores will typically be staffed with a manager,
an  assistant  manager,  and  between  eight and  twelve  part-time  therapists,
depending upon the size of the store.

         The Company's stores, as well as intended  franchisee-operated  stores,
will be located in leased  facilities  with high pedestrian  traffic,  including
metropolitan  areas,  shopping malls,  popular tourist attractions and specialty
locations  such  as  airports,  casinos  and  convention  centers.  Stores  will
generally be open seven days a week from early morning to late evening.

         The back rub services  are  provided by licensed or  certified  massage
therapists  who, as  employees,  earn  between  $10.00 and $16.00 per hour.  All
therapists are required to wear the Company's  standard uniform:  Company shirt,
white pants and white athletic shoes. See "Employees; Employee Training."

         Management has installed  certain  store-level  internal controls which
minimize  incidents of employee  theft and  maximize the flow of pertinent  data
from the store to the Company's accounting department.  When a customer enters a
store, the receptionist greets the customer,  answers any questions the customer
may have, and then prepares a pre-numbered "ticket" on which the customer's name
and requested  service(s) are printed.  The next available  therapist then takes
the ticket from the  receptionist,  leads the  customer to the back rub area and
performs one of three back rub  sequences.  At the end of the back rub sequence,
the therapist verifies the ticket,  escorts the customer to the receptionist and
returns  the  ticket.  The  receptionist  collects  the payment due and issues a
receipt to the customer. At no time does the therapist collect any payments from
the customer.  At the end of the day, all pre-numbered tickets must be accounted
for, and cash  deposits  must balance with reports  generated by the store's POS
system.

                                       -3-

<PAGE>

         The POS system  currently being used by management is that used in over
800 Supercuts stores. In addition to normal cash register functions,  the system
generates  a  sophisticated  array of reports  and cross  checks  which  provide
management  with immediate  access to sales data,  labor  scheduling,  inventory
changes,   cash  shortages  and  employee   productivity.   The  information  is
automatically  downloaded every night to the Company's office in New York and is
available for management's review and use the following day.

INTENDED EXPANSION

         Although no assurance can be given, the Company plans to open a minimum
of 40  Company-owned  and/or  franchised  stores  during  the  next  two  years.
Management  believes an important  element of  "marketing"  is the  selection of
prime  locations with heavy traffic  patterns.  During the initial  expansion of
both Company and  franchised  stores,  sites will be  generally  limited to high
traffic locations such as malls, popular tourist attractions, and busy specialty
locations (e.g. airports, casinos and convention centers).

         Management   estimates  that  its  current   average  cost  to  open  a
Company-owned store location is approximately  $100,000,  including  pre-opening
costs,  leasehold  improvements,  fixtures,  equipment and store inventory.  The
Company,  in  its  franchise  offering  circular,  estimates  that  the  initial
investment  required by a franchisee,  including the initial  franchise  fee, is
approximately  $70,000  to  $135,000,  depending  upon a  number  of  variables,
including  leasehold  related  costs  and  improvements,  inventory,  equipment,
training fees and staffing.

         The Company  supplements its retail  operations with corporate or other
off-site service and intends to actively  increase this portion of its business.
This service  involves  having one or more therapists  taking  portable  massage
chairs to a place of business,  convention center or tourist  attraction.  Since
the  only  operating   costs   associated   with  this  service  are  labor  and
transportation,  the profit margins on such corporate and other offsite work are
significant.

         To encourage  repeat  business,  the Company has  developed a "Frequent
Rub"  program  which  rewards  repeat  customers  with a free back rub after the
purchase of nine back rubs. The Company also actively  promotes the sale of gift
certificates by giving a similar discount on the purchase of nine  certificates.
As  an  extension  of  the  gift  certificate  program,  the  Company  tested  a
Valentine's  Day card  which  included  a gift  certificate.  As a result of the
success of this program, the Company has expanded such program to include a line
of gift and holiday certificates.

         The Company may also seek to acquire,  where feasible,  companies whose
business is compatible with that of the Company.  The Company does not currently
have any agreements,  commitments or  arrangements  with respect to any proposed
acquisitions,  and no assurance  can be given that any  acquisition  opportunity
will  be  consummated  in the  future.  The  Company  is  also  considering  the
development or  acquisition of a mail order catalog to sell products  related to
its retail operations under The Great American BackRub name.

FRANCHISE DEVELOPMENT

         The Company  anticipates  that a  significant  portion of the Company's
growth will be through  franchising.  Management  has  developed  a  franchising
program which is based largely on management's  prior experience with Supercuts,
Inc. The  franchise  plan calls for the sale of  individual  unit  franchises as
opposed to territorial  sales, to control the respective  sites and to limit the
impact  of  a  franchisee  whose  operating  standards  are  not  acceptable  to
management. Although sold as individual units, the intention is to sell multiple
units within a market area to one  franchisee  in order to achieve  economies of
scale.

         Under the  terms of the  Company's  current  franchise  agreement,  the
franchise fee generally is $12,500 per unit. In all cases, the royalty fee is 6%
of gross  revenues  (both  services and products) and 3% of gross revenues (both
services and products) which must be paid to a cooperative advertising fund. The
initial  term of the  franchise  agreement  is five years,  with  options  (upon
payment of a fee) to extend the term for an additional five years. The franchise
agreement  places  strict  limitations  on the  operations  of the  business and
requires the  franchisee to conform to all operations  standards  established by
the Company.  The  franchise  agreement  also requires that all employees of the
franchisee attend and complete a training course conducted or approved by the

                                       -4-

<PAGE>
Company. In the event the Company conducts the training class, the franchisee is
required to pay the Company a fee for each employee trained.

         The Company's first  franchised store (the "Las Vegas Store") opened in
July 1994 in Las Vegas,  Nevada. The Company entered into a franchise  agreement
(the "Franchise  Agreement") with its Las Vegas franchisee (the "Franchisee") on
June 1, 1994.  Pursuant to the  Franchise  Agreement,  the  Franchisee  paid the
Company an initial,  non-recurring,  non-refundable franchise fee of $10,000. In
addition,  the Franchisee  paid the Company a monthly royalty fee equal to 8% of
the  Franchisee's  gross  monthly  revenues  (as  such  term is  defined  in the
Franchise Agreement). The Franchisee also paid to the Company an advertising and
sales  promotion  fee which is equal to the  greater  of 3% of the  Franchisee's
gross  monthly  revenues  or  $1,000.  On May  30,  1995,  the  Company  and the
Franchisee  entered  into a  franchise  termination  agreement  whereby  (i) the
Franchise  Agreement  and related  sublease  were  terminated,  (ii) the Company
purchased  certain  assets  from the  Franchisee  and (iii) the  Company and the
Franchisee  provided for the mutual  release of any  obligations  of each to the
other whether arising out of the Franchise Agreement, the sublease or otherwise.
The purchase price for the assets  conveyed by the Franchisee to the Company was
$25,000 and 18,185  shares of Common  Stock.  Simultaneously  with the Franchise
Termination Agreement, the Company closed the Las Vegas Store.

         The Company  entered into two option  agreements  (the "Bay Area Option
Agreements")  with  Bay Area  Backs I, a  California  limited  partnership  (the
"Optionee"),  on June 20, 1994 and June 21, 1994, respectively,  for the opening
of two  franchised  stores in the San Francisco  area.  Pursuant to the Bay Area
Option  Agreements,  the  Optionee  paid to the  Company  $5,000 for each of two
options (the "Bay Area  Options") to require the Company to enter into franchise
agreements  with the  Optionee.  On May 30,  1995,  the Company and the Optionee
entered  into an option  termination  agreement  whereby (i) the Bay Area Option
Agreements were terminated,  (ii) the Company  purchased certain assets from the
Optionee and (iii) the Company and the Optionee  provided for the mutual release
of any  obligations  of each to the other  whether  arising  out of the Bay Area
Option  Agreements or otherwise.  The purchase price for the assets  conveyed by
the  Optionee  to the Company and the  termination  of the Bay Area  Options was
$27,300.

         Upon  termination  of the franchise and the options  referred to above,
the Company  suspended  its  franchise  program and  focused on  developing  its
Company-owned  stores.  Starting in  September  1996,  the  Company  resumed the
marketing of its franchise  program.  In November 1996, the Company entered into
two  franchise  agreements,  one for a location at  Roosevelt  Field Mall,  Long
Island,  New York, and the second for the Cherry Creek Mall,  Denver,  Colorado.
Certain executive  officers and directors of the Company have an interest in the
Roosevelt  Mall  franchisee.  See Item 12  (Certain  Relationships  and  Related
Transactions). In addition, in November 1996, the Company entered into an option
agreement (the "Franchise Option Agreement") for a franchise location in the Los
Angeles,  California  metropolitan  area.  Under  the  terms  of both  franchise
agreements,   the   franchisee   has  paid  the   Company  a  $12,500   initial,
non-recurring,  non-refundable,  franchise  fee and has  agreed to pay a monthly
royalty equal to 6% of the franchise's  gross monthly  revenues (as such term is
defined in the franchise  agreements).  Under the terms of the Franchise  Option
Agreement,  the optionee has paid to the Company a non- refundable fee of $5,000
(to be applied to the $12,500  franchise  fee in the event the optionee  signs a
franchise  agreement  within  120  days  of the  date  of the  Franchise  Option
Agreement)  and the Company has given the optionee an exclusive  right to open a
Great  American  BackRub  franchise  within Los  Angeles  and  Orange  Counties,
California  for a period of 120 days.  In the event that the optionee  locates a
site  within  said  counties  that is  acceptable  to both the  Company  and the
optionee,  the Company and the franchisee will enter into a franchise  agreement
with terms identical to those described above.

COMPETITION

         Management  does  not  know of any  other  multi-unit  retailer  in the
business  in which the  Company  operates.  Competition  currently  consists  of
numerous independent massage therapists, spas, salons and health clubs providing
full body massage,  and a limited number of massage therapists  providing seated
massage  in  non-retail   "off-site"   environments.   As  competition   may  be
anticipated,  however,  due to the  relatively  low cost of entry and absence of
substantial  barriers  into such  business,  no assurance  can be given that the
Company will successfully  compete with any such  competitors,  some of whom may
have substantially greater financial and other resources than the Company.

                                       -5-

<PAGE>

REGULATION

         The sales of  franchises  in the  United  States is  subject to certain
requirements  established by the FTC. These requirements generally relate to the
disclosure of information  regarding the  franchisor and the rights,  duties and
obligations of the prospective  franchisee.  These  disclosures and explanations
are set forth in a document called a Uniform Franchise  Offering Circular (which
is commonly  referred to as a "UFOC").  Effective  in 1995,  the FTC revised the
disclosure  requirements  for a UFOC to  require,  among  other  things,  "plain
English  language"  disclosures.  The Company  believes it is in compliance with
these changes.

         In addition to the requirements of the FTC, certain states require that
franchisors register in the state and submit a modified UFOC for approval before
offering  franchises  in such  state.  These  state  UFOCs must  comply with the
applicable  state laws, which vary from state to state. The Company is currently
registered in New York, California and Illinois.

         Certain states in which the Company  intends to operate,  including the
States of  Illinois  and New York,  in which the Company  currently  operates 13
Company-owned stores,  require the licensing of massage therapists.  The Company
and its massage  therapist  employees  will also be subject to various state and
local laws and ordinances.

         The Company  believes that it is in compliance with all applicable laws
and regulations and has all required licenses to conduct its business.  However,
no assurances  can be given that current laws or  regulations  applicable to the
Company's  business  will not change.  Any such new laws or  regulations  or the
Company's  expansion  into new  geographic  areas  could  subject the Company to
substantial  costs in order to comply with such  applicable laws or regulations.
Any  failure  by the  Company  to  comply  with  any  new or  existing  laws  or
regulations could subject the Company to substantial penalties.

EMPLOYEES; EMPLOYEE TRAINING

         As of December 31, 1996, the Company had 132  employees,  consisting of
three full-time members of management,  two full-time administrative  employees,
10 full-time  managers,  and 60 full-time and 57 part-time  in-store  employees.
Other than  members of  management  and the stores'  managers  who are  salaried
employees, all full and part-time personnel are hourly employees.

         The Company requires each new therapist to participate in the Company's
three to five day  training  program as a condition to  employment.  The program
includes  extensive  training  relating  to the  Company's  5, 10, 20, 30 and 45
minute massage sequences,  product knowledge and customer service.  All back rub
services are  provided by  therapists  who are either  licensed (in states where
such licensing is required) or have completed  training at a school certified by
a recognized trade association.

         It is estimated by the American  Massage  Therapists  Association  that
there are over 120,000 licensed/certified massage therapists in the country. The
Company's  experience has shown that most therapists are  under-employed and are
seeking  part-time  employment to supplement their existing  private  clientele.
This need for part-time employment allows the Company to use flexible scheduling
and minimizes payroll and benefit costs associated with full-time employment.

         Currently,  the  Company  requires  all of its  employee/therapists  to
obtain  professional  liability  insurance in the minimum  amount of  $1,000,000
through one of two professional massage organizations. In some cases the Company
is permitted under the applicable  policy to be named as an additional  insured.
In addition,  the Company has obtained a  professional  liability  policy for an
additional $1,000,000 covering all of its employees.

         All of the Company's employees are non-union. The Company considers its
relationship with its employees to be satisfactory.

                                       -6-

<PAGE>

TRADEMARK PROTECTION

         The mark THE GREAT  AMERICAN  BACKRUB is the subject of U.S.  Trademark
Registration No. 1,922,629, issued September 26, 1995. The registration includes
the  statement  that the Company does not claim  exclusive  rights to use of the
term  "BACKRUB"  alone,  apart  from  the  trademark  as  shown.  The  trademark
registration  will  remain in full force and effect for a term of ten years from
the date of issue.  However, a declaration of continued use must be filed in the
Trademark  Office no earlier  than the fifth  anniversary  and no later than the
sixth  anniversary of the  registration  in order to avoid  cancellation  of the
registration.   The  registration  gives  the  company  prima  facie  nationwide
exclusivity  to the mark THE GREAT  AMERICAN  BACKRUB as against any third party
adopting a confusingly similar mark after the date of issue.

RECENT AND PROPOSED FINANCING TRANSACTIONS

         On December 27, 1996, the Company  consummated a bridge  financing (the
net  proceeds  of which were  approximately  $175,000),  consisting  of five and
one-third  investment  units, each such unit comprising a promissory note in the
principal amount of $49,250 and 750,000 warrants (the "Bridge  Warrants").  Each
such note bears  interest  at the rate of 10% per annum and is payable  one year
from the date of issue or upon an earlier public  offering of equity  securities
of the Company.  Each Bridge Warrant entitles the holder thereof to purchase one
share of the  Company's  Series A  Convertible  Preferred  Stock (the  "Series A
Preferred  Stock")  for a price of  $5.00,  subject  to  adjustment  in  certain
circumstances,  at any time during the three-year period commencing on the first
anniversary of the date of issuance of the Bridge Warrants. Each share of Series
A  Preferred  Stock  pays  a  cumulative  dividend  of  $.35  per  annum,  has a
liquidation preference of $5.00 and is convertible on or after December 27, 1997
into the  greater  of (i) two  shares of Common  Stock of the  Company or (ii) a
number of shares of Common  Stock  equal to $8.00  divided by the average of the
closing  prices of the Common Stock for the ten trading days ending on the third
trading day preceding the date of conversion  (the "Closing  Price")  subject to
further adjustment under certain circumstances. In the bridge financing, William
Zanker, President of the Company, Terrance C. Murray, Chief Executive Officer of
the Company, and Keith R. Dee, Chief Financial Officer of the Company, purchased
an aggregate of one and one-third of the investment  units. On January 27, 1997,
Mr.  Zanker  and the  Company  entered  into an  agreement  whereby  Mr.  Zanker
rescinded  his  investment  in  the  Bridge  Financing,   consisting  of  .73387
investment  units,  and an equal  number of units  were sold by the  Company  to
another investor.

         On February 5, 1997, the Company filed with the Securities and Exchange
Commission  (the  "Commission")  a  registration  statement  on Form  SB-2  (the
"Registration  Statement") for the sale in an  underwritten  offering of 270,000
shares of Series B  Convertible  Preferred  Stock of the Company  (the "Series B
Preferred  Stock") at an anticipated  public offering price of $10.00 per share.
The terms of the  proposed  offering  and of the  Series B  Preferred  Stock are
currently  under  discussion  between the Company  and the  underwriter  but are
expected  to  provide  that each share of Series B  Preferred  Stock will have a
cumulative dividend of $.70 per annum and a liquidation preference of $10.00 and
will be convertible on and after the first  anniversary of the effective date of
the  Registration  Statement into the greater of (i) four shares of Common Stock
or (ii) a number  of  shares of Common  Stock  equal to  $16.00  divided  by the
Closing Price,  up to a maximum number of shares which has yet to be determined,
subject to further adjustment in certain circumstances.

         Under the terms of the Bridge Warrants,  upon the  effectiveness of the
Registration  Statement  described  above,  each Warrant shall be  automatically
converted  into one-half of a warrant (a "Series B Warrant")  each of which will
entitle  the  holder  thereof  to  purchase  one share of  Series B  Convertible
Preferred  Stock for an initial price of $8.00 per share,  subject to adjustment
in certain circumstances, at any time during the three-year period commencing on
the first anniversary of the effective date of such Registration Statement,  and
the holders of the Series B Warrants are entitled to have such  Warrants and the
Preferred Stock and Common Stock underlying such Warrants  registered for public
sale.  On February 7, 1997,  the Company filed a second  registration  statement
with the  Commission  with  respect  to the sale by the  holders  thereof of the
Series B Warrants  and the  Preferred  Stock and Common  Stock  underlying  such
Warrants.

                                       -7-

<PAGE>

ITEM 2.  DESCRIPTION OF PROPERTY

         The Company currently has 11 New York City Great American BackRub Store
locations,  one location in The Westchester  mall in White Plains,  New York and
one  location  in the  Woodfield  Mall in  Schaumberg,  Illinois  near  Chicago.
Together,  these stores employ a total of  approximately  127 full and part-time
employees. See Item 1 (Description of Business--Employees; Employee Training).

         The location and lease  expiration date of each of the Company's stores
are summarized below:

     LOCATION                                       LEASE EXPIRATION DATE
     --------                                       ---------------------

958 Third Avenue                                      August 31, 2003
New York, New York

323-5 Bleecker Street                                 May 31, 2005
New York, New York

527 Third Avenue                                      January 31, 2002
New York, New York

160 Spring Street                                     February 28, 2005
New York, New York

1573 Second Avenue                                    July 31, 2005
New York, New York

514 Columbus Avenue                                   December 31, 2004
New York, New York

2265 Broadway                                         October 31, 2005
New York, New York

Westchester-Store Mall                                July 14, 2005
White Plains, New York

138 7th Avenue                                        May 11, 2003
Brooklyn, New York

171 West 71st Street                                  June 30, 2006
New York, New York

250 West 91st Street                                  October 31, 2006
New York, New York

2195 Broadway                                         October 31, 2006
New York, New York

Woodfield Mall                                        December 30, 2004
Schaumberg, Illinois


         The Company's  corporate office is leased and is located at 425 Madison
Avenue,  New York, New York.  The Company  believes that this office is adequate
for its current and presently  foreseeable  needs or that  adequate  replacement
space is available.

                                       -8-

<PAGE>
         ITEM 3.  LEGAL PROCEEDINGS

         The  Company  is not a party  to any  material  threatened  or  pending
litigation.

         ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         None.

                                       -9-

<PAGE>

                                     PART II

         ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

         On February  28,  1995,  the Common  Stock was listed for  quotation on
Nasdaq under the symbol "RUBB." Prior to such listing, the Common Stock had been
traded on the OTC Bulletin  Board since October 18, 1993.  The  following  table
sets forth, for the periods indicated, the high and low bid for the Common Stock
as  reported  by the OTC  Bulletin  Board (as  adjusted  to reflect  the 1 for 8
reverse stock split effected on February 23, 1995),  as well as the high and low
bid for the Common Stock on Nasdaq.  Quotations  reflect prices between dealers,
without  retail  mark-up,  mark-down  or  commissions  and may  not  necessarily
represent actual transactions.

                                                High Bid           Low Bid
                                                ---------          --------

1995
        1st Quarter........................       $ 9.00           $ 2.75
        2nd Quarter........................       $ 3.94           $ 1.84
        3rd Quarter........................       $ 2.94           $ 1.88
        4th Quarter........................       $ 4.00           $ 1.75

1996
        1st Quarter........................       $ 4.125          $ 3.06
        2nd Quarter........................       $ 6.63           $ 3.25
        3rd Quarter........................       $ 4.88           $ 2.50
        4th Quarter........................       $ 4.625          $ 3.25



                  The Company  has not  declared  or paid any  dividends  on the
Common  Stock and does not intend to declare or pay any  dividends on the Common
Stock in the  foreseeable  future.  The  Company  currently  intends to reinvest
earnings, if any, in development and expansion of its business.  The declaration
of dividends in the future will be at the election of the Board of Directors and
will depend upon earnings,  capital  requirements and financial  position of the
Company, general economic conditions and other relevant factors.


ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

OVERVIEW

         The  Company's  revenues  are derived  primarily  from the  services of
seated  fully  clothed  back  rubs and the sale of back  related  products.  The
Company began operations in August 1993, and opened its first store for business
in October 1993. The Company currently owns and operates 11 retail stores in New
York City, one in The Westchester mall in White Plains, New York, and one at the
Woodfield Mall in the Chicago  metropolitan  area. In addition,  the Company has
entered into franchise agreements for two locations,  one at the Roosevelt Field
Mall on Long Island,  New York and the other at the Cherry Creek Mall in Denver,
Colorado.

RESULTS OF OPERATIONS

FISCAL YEAR ENDED  DECEMBER 31, 1996 COMPARED TO FISCAL YEAR ENDED  DECEMBER 31,
1995

         For the year ended December 31, 1996, revenues from services,  products
and franchising  operations  increased to $3,045,937  compared to $1,201,941 for
the comparable  period in the prior year. The net increase of $1,843,996  (153%)
was  primarily  attributable  to  increased  traffic and the opening of five new
stores.  Operating expenses were $5,957,568 for the year ended December 31, 1996
as compared  to  $3,685,191  for the  comparable  period in the prior  year,  an
increase of $2,272,377 (62%). This increase was primarily due to the development
of a management team, operational systems, and marketing and design plans in the
implementation of the Company's expansion plans and non cash charges relating to
the issuance of options of approximately $481,000.

                                      -10-

<PAGE>

As a result of the  increased  operating  expenses,  net loss for the year ended
December  31,  1995  increased  to  $2,825,312  compared to  $2,647,255  for the
comparable  period in the prior year. No provision for income taxes was required
during  either period due to the  Company's  incurrence  of net  operating  loss
carryforwards.

         While general and administrative  expenses are expected to increase due
to the  need  for  additional  management  and  administrative  support  for the
Company's expanding operations,  these expenses as a percentage of total revenue
are expected to decline as total revenue increases. Other expense items, such as
advertising and promotion,  salaries and wages, costs of products,  however, are
related to retail operations  themselves and their relative  percentage of total
revenue are likely to remain fairly constant in the near term but should decease
as the Company streamlines its operations.


LIQUIDITY AND CAPITAL RESOURCES

         The Company had  $251,565 in working  capital as of December  31, 1996,
compared  with a working  capital of  $1,759,595  as of December 31,  1995.  The
decrease is primarily due to amounts spent on property,  equipment and leasehold
improvements to fund the Company's  expansion and amounts spent on operations in
the development of a corporate  infrastructure  in anticipation of the Company's
growth strategy.

         From  inception  to December  31,  1996,  the Company has used cash for
operating  activities of $4,535,866  and spent an additional  $1,577,724 for the
purchase of property,  equipment,  purchased leases,  leasehold improvements and
investments.  These  expenditures  have been offset by the net cash  provided by
financing  activities,  principally  from the  Company's  October  1993  private
placement of common stock,  aggregating  $870,000,  bridge notes and  short-term
financings in the principal amount of $867,667,  the Company's March 1995 public
offering of common stock resulting in net proceeds of  approximately  $5,000,000
and the issuance of common stock to warrant and option holders of  approximately
$1,000,000.  See  "Statement of Cash Flows"  included in the  Company's  audited
financial statements.

         Inasmuch as the  Company  continues  to have a high level of  operating
expenses  and will be  required to make  significant  up-front  expenditures  in
connection with its proposed expansion, the Company anticipates that losses will
continue  for at least the next 12 months and until such time,  if ever,  as the
Company  is  able  to  generate   significant  revenues  or  achieve  profitable
operations.  As a result, in their report on the Company's Financial  Statements
as of December 31, 1996, the Company's  independent certified public accountants
have  included  an  explanatory   paragraph  that  describes   factors   raising
substantial doubt about the Company's ability to continue as a going concern.

         In  accordance  with  management's  plans,  the Company has retained an
investment  banking  advisor  to  advise  it on  the  possible  sale  of  equity
securities,  as well to as introduce  and assist in the  evaluation of potential
merger and partnership opportunities. Management expects that these efforts will
result in either an  additional  equity  infusion  or an  introduction  to other
parties with  interests and resources  which may be compatible  with that of the
Company. However, no assurances can be given that the Company will be successful
in raising  additional  capital or entering into a business  alliance.  Further,
there is no assurance, assuming the Company successfully raises additional funds
or enters into a business alliance,  that the Company will achieve profitability
or positive  cash flow. On February 5, 1997,  the Company  filed a  registration
statement  to  offer  270,000  shares  of  preferred  stock  for   approximately
$2,700,000,  which, if successful, after commissions and fees, would provide the
Company with net proceeds of approximately  $2,000,000.  See Item 1 (Description
of Businesss--Recent and Proposed Financing Transactions).

                                      -11-

<PAGE>
                                    PART III

         ITEM 9. DIRECTORS,  EXECUTIVE  OFFICERS,  PROMOTERS AND CONTROL PERSON;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.

         DIRECTORS AND EXECUTIVE OFFICERS

         The directors and executive officers of the Company and their positions
with the Company are set forth below.


NAME                         AGE        POSITION WITH THE COMPANY
----                         ---        -------------------------

William Zanker               42         Chairman of the Board and President

Terrance C. Murray           48         Chief Executive Officer and Director

Keith Dee                    39         Chief Financial Officer and Secretary

Stephen Seligman             42         Director

Edward E. Faber              63         Director

Andrew L. Hyams              42         Director

Donald R. Fleischer          42         Director

Peter Hanelt                 51         Director


         All directors of the Company hold office until the next annual  meeting
of the  shareholders and until their successors have been elected and qualified.
The  officers of the Company are elected by the Board of  Directors at the first
meeting after each annual meeting of the Company's shareholders, and hold office
until  their  death,  until  they  resign or until they have been  removed  from
office.

         The following is a brief summary of the background of each director and
executive officer of the Company:

         WILLIAM  ZANKER  founded the Company in December 1992 and has served as
the Chairman of the Board of Directors and President  since that time.  Prior to
founding the Company,  Mr. Zanker was the founder and from 1980 to December 1991
the  Chairman  of the Board of  Directors  and Chief  Executive  Officer  of The
Learning Annex, Inc., a national chain offering short,  inexpensive  educational
programs in a variety of subjects.  In December 1991, an involuntary petition in
bankruptcy  was filed  against The Learning  Annex,  Inc.  (Case No.  91-B-12582
(SDNY).  From December 1991 to December 1992, Mr. Zanker was a consultant to The
Learning Annex, Inc.

         TERRANCE C. MURRAY has been a director and Chief  Executive  Officer of
the Company since December 1993.  From February 1993 through  November 1993, Mr.
Murray was a management  consultant.  From May 1991 through  January  1993,  Mr.
Murray was Executive Vice President,  Operations of Supercuts,  Inc., a national
chain of company-owned  and franchised hair care salons with headquarters in San
Francisco,  California.  From July 1985 through  April 1991,  Mr.  Murray was an
attorney  with  the  law  firm  Foley,  McIntosh  &  Foley  located  in  Albany,
California.

         KEITH R. DEE has been the Company's Chief Financial  Officer since July
1995.  From  January 1988 to June 1995,  Mr. Dee was a partner in the  certified
public accounting firm of Elwell, Cangiano, Zdon & Dee LLC. Prior to forming his
partnership,  Mr. Dee was  employed as a  Certified  Public  Accountant  at both
national and regional accounting firms.

                                      -12-

<PAGE>

         STEPHEN  SELIGMAN  has been a director  of the Company  since  February
1994.  He has been Chief  Executive  Officer of The Learning  Annex - California
from January 1991 to the present.  From October 1989 through  December 1990, Mr.
Seligman was Chief Executive Officer of The Learning Annex - New York. From 1986
through September 1989, Mr. Seligman was Chief Operating Officer of Hema Systems
Limited, a blood service management company located in New York, New York.

         EDWARD E. FABER became a director of the Company on March 7, 1995.  Mr.
Faber was the  President,  Chief  Executive  Officer and Deputy  Chairman of the
Board of  Directors  of  Supercuts,  Inc.  from June 1991 until he retired  from
active  management in December 1992.  During his tenure at Supercuts,  Mr. Faber
had primary  responsibility for franchise  development and marketing.  From 1976
through  January 1990, he held various  executive  positions with  ComputerLand,
including  President from 1976 to 1983,  President and Chief  Executive  Officer
from  1985 to 1986,  Chairman  and  Chief  Executive  Officer  from  1986  until
Computerland was sold in 1987, and Vice Chairman from 1987 to January 1990. From
February  1990 to April 1991,  he was  Chairman and Chief  Executive  Officer of
Dataphaz,   a  ComputerLand   franchisee,   which  was  sold  to   ComputerLand.
Additionally,  from  1957  to  1969,  Mr.  Faber  held  various  positions  with
International  Business  Machines.  Mr.  Faber also  served as an officer in the
United States Marine Corps.

         ANDREW L. HYAMS became a director of the Company on March 7, 1995.  Mr.
Hyams has been a  strategic  planner  for the  Boston  Department  of Health and
Hospitals  since  September  1992 and since  June 1991 has been in  private  law
practice in health law and policy in  Massachusetts.  From September 1990 to May
1991, he attended the Harvard School of Public Health. From 1985 to August 1990,
he served as  general  counsel to the  Massachusetts  Board of  Registration  in
Medicine.  Mr. Hyams has practiced law in New York and Massachusetts in both the
public and private  sectors,  specializing  in health law and regulation and has
written and lectured in this field. Mr. Hyams is also a visiting lecturer at the
Harvard School of Public  Health.  Mr. Hyams holds law and public health degrees
from Harvard Law School and Harvard School of Public Health, respectively.

         DONALD R. FLEISCHER  became a director of the Company on March 7, 1995.
In 1981, Mr. Fleischer co-founded First Moments, Inc., an advertising firm which
is a leader in the marketing and delivery of sample kits to targeted groups, and
has served as its Executive  Vice President  since then.  Mr.  Fleischer is also
President of Additions,  Inc., which specializes in direct  marketing,  contract
packaging and product fulfillment.

         PETER  HANELT  became a director of the  Company on March 7, 1995.  Mr.
Hanelt has been Chief Operating Officer and Chief Financial Officer of Esprit de
Corp., an international women's apparel manufacturer and retailer, since October
1993, and was a consultant in the  development of Esprit's  turnaround  strategy
between April and October 1993.  During his  nineteen-year  career in operations
and finance,  Mr. Hanelt has held a number of Chief Operating  Officer and Chief
Financial   Officer  positions  with  such  companies  as  Post  Tool,  Inc.,  a
multi-store,  multi-state  retail chain (from  September 1990 to December 1992);
Sam & Libby, Inc.,  retailer and wholesaler of women's shoes (from February 1990
to August 1990);  and  Manetti-Farrow,  Inc., the exclusive U.S.  wholesaler for
Gucci,  Fendi and Mark Cross accessories and leather goods (from 1983 to January
1990). In addition, Mr. Hanelt held executive financial positions at various San
Francisco hospitals,  where he was responsible for a public bond refinancing and
negotiation of a hospital affiliation. He was a certified public accountant with
Deloitte & Touche in San Francisco  from 1975 to 1979.  Mr. Hanelt  received his
undergraduate  degree from the U.S.  Military Academy at West Point in 1967, and
his M.B.A. from the University of California at Berkeley in 1975.


         SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

         Section 16(a) of the  Securities  Exchange Act of 1934, as amended (the
"Exchange Act"),  requires the Company's directors and executive  officers,  and
persons who own more than 10% of the Common Stock,  to file with the  Commission
initial  reports of beneficial  ownership  ("Forms 3") and reports of changes in
beneficial  ownership of Common Stock and other equity securities of the Company
("Forms  4").  Officers,  directors,  and greater than 10%  shareholders  of the
Company are required by Commission  regulations to furnish to the Company copies
of all Section 16(a) reports that they file. To the Company's  knowledge,  based
solely on a

                                      -13-

<PAGE>

review of the  copies of such  reports  furnished  to the  Company  and  written
representations  that no other reports were  required,  all Section 16(a) filing
requirements  applicable  to  its  officers,  directors  and  greater  than  10%
beneficial  owners were  complied  with for the fiscal year ended  December  31,
1996, other than as follows:  during fiscal 1996, William Zanker, an officer and
director of the Company,  reported one  transaction  in a late Form 4 filing and
another transaction in a second late Form 4 filing,  Terrance Murray, an officer
and director of the Company,  reported one  transaction in a late Form 4 filing,
and Keith Dee, an officer of the  Company,  reported one  transaction  in a late
Form 4 filing.

         ITEM 10. EXECUTIVE COMPENSATION

         The  following  table  sets  forth  information  concerning  the annual
compensation of the Company's  chief  executive  officer and the other executive
officers of the Company for services in all capacities to the Company during the
Company's last three fiscal years.


                           SUMMARY COMPENSATION TABLE


                                           Annual Compensation
                                   -----------------------------------


                                   YEAR                      SALARY
                                   ----                      ------

William Zanker                     1994                         *
  Chairman of the Board            1995                     $108,308
                                   1996                     $177,000

Terrance C. Murray                 1994                         *
  Chief Executive Officer          1995                     $108,308
                                   1996                     $150,000

Keith R. Dee                       1995                      $ 6,000
  Chief Financial Officer          1996                     $116,539

-------------------
*        Mr.  Zanker and Mr.  Murray did not  receive any  compensation  for the
fiscal year 1994.

                       OPTIONS GRANTS IN LAST FISCAL YEAR

                                INDIVIDUAL GRANTS
                                -----------------

                                      None

               AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR
                      AND FISCAL YEAR-END OPTION/SAR VALUES

         The following  table provides  information on options/SAR  exercises in
1996 by the named executive officers and the value of such officers' unexercised
options/SARs at December 31, 1996.

                                      -14-

<PAGE>

AGGREGATED  OPTION/SAR  EXERCISES  IN  LAST  FISCAL  YEAR  AND  FISCAL  YEAR-END
OPTION/SAR VALUE TABLE
<TABLE>
<CAPTION>

                                                                          Number of Securities                  Value of
                                                                         Underlying Unexercised               Unexercised
                                                                       Options/SARs at Fiscal Year    in-the-Money Options/SARs
                        Shares Acquired on                                  End Exercisable/                 Exercisable/
Name                       Exercise (#)          Value Realized ($)           Unexercisable                 Unexercisable
----                    --------------------   ---------------------   ---------------------------  ---------------------------

<S>                           <C>                     <C>                     <C>                   <C>
William Zanker                100,000                 175,500                   120,000/0               $0/0

Terrance C. Murray            100,000                 175,500                   120,000/0               $0/0

Keith R. Dee                     0                       0                    5,000/5,000           $5,000/5,000
</TABLE>


COMPENSATION OF DIRECTORS

         Each Director who is not an employee of the Company receives $1,000 for
each Board or committee  meeting  attended.  Employees of the Company receive no
additional  compensation for service as a director. All directors are reimbursed
for their reasonable  out-of-pocket  expenses  incurred in connection with their
duties to the Company.

         The Company  granted  options to purchase 10,000 shares of Common Stock
to each of Messrs.  Seligman,  Faber,  Hyams,  Fleischer  and Hanelt on March 7,
1995.  The options have a per share  exercise  price of $5.00 and vest one-third
upon issuance, one-third on March 7, 1996 and one-third on March 7, 1997.

COMMITTEES OF THE BOARD

         The  Board of  Directors  has  authorized  three  standing  committees:
Executive Committee,  Audit Committee,  and Compensation  Committee (which shall
also function as the Stock Option  Committee).  The Audit Committee  members are
Donald Fleischer, Peter Hanelt (Chairman) and Stephen Seligman. The Compensation
Committee  members are Andrew Hyams  (Chairman) and Edward Faber.  The Executive
Committee members are William Zanker, Terrance Murray and Stephen Seligman. Only
independent   directors  will  be  appointed  to  the  Audit  and   Compensation
Committees.

1994 EMPLOYEE STOCK OPTION PLAN

         At the Company's 1994 annual meeting of  shareholders  held on July 18,
1994, the Company's  shareholders approved the Employee Plan. The purpose of the
Employee  Plan is to promote the  success of the  Company by  providing a method
whereby  eligible  employees  of the  Company and its  subsidiaries,  as defined
therein, may be awarded additional  remuneration for services rendered,  thereby
increasing  their  personal  interest in the Company.  The Employee Plan is also
intended to aid in attracting persons of suitable ability to become employees of
the Company and its subsidiaries.

         The Employee Plan provides that the maximum  number of shares of Common
Stock reserved for awards  thereunder shall be 75,000.  As of December 31, 1996,
options to purchase  8,500  shares of Common  Stock were  outstanding  under the
Employee  Plan at a weighted  average  exercise  price of $3.50 per  share.  The
Employee Plan provides for the grant of (i) options that are intended to qualify
as incentive stock options  ("Incentive  Stock  Options")  within the meaning of
Section 422A of the Internal Revenue Code of 1986, as amended,  and (ii) options
not intended to so qualify.  The  exercise  price of options  granted  under the
Employee  Plan may be more than or equal to the fair market value of such shares
on the date of grant; provided, however, that the exercise price of an Incentive
Stock Option at the time of grant  thereof  shall (i), if such  Incentive  Stock
Option  is being  granted  to a 10%  shareholder,  be at least  110% of the fair
market value on the date of grant and (ii),  if such  Incentive  Stock Option is
being granted to any other person,  be at least 100% of the fair market value on
the date of grant.  The  Company  agreed  with the  underwriters  of its initial
public  offering  not to grant or issue  options to  purchase  more than  37,500
shares of Common Stock prior to February 28, 1997. Any options granted

                                      -15-

<PAGE>

under the Employee  Plan that shall  expire,  terminate or otherwise be annulled
for any reason  without  having  been  exercised  shall again be  available  for
purposes of the Employee Plan.

         The Employee Plan is to be administered by a committee comprised of not
less than two  persons.  Each member of the  committee  shall be a member of the
Company's  Board of Directors who during the one year period prior to service on
the  committee  was not, and during such service is not,  granted or awarded any
equity securities pursuant to the Employee Plan or any other plan of the Company
if such grant or award or participation in such Employee Plan would prevent such
member from being a "disinterested person" with respect to the Employee Plan for
purposes of Rule 16b-3 under the Exchange Act. The committee will have the power
and  authority to grant to eligible  persons  options to purchase  shares of the
Company's   Common  Stock  under  the  Employee   Plan  and  to  determine   the
restrictions,  terms and  conditions  of all such options  granted as well as to
interpret the provisions of the Employee Plan, any agreements relating to awards
granted  under the Employee  Plan,  and to supervise the  administration  of the
Employee Plan.

         No Incentive  Stock  Options may be granted to any person for which the
"fair market value," as defined  within the Employee Plan,  determined as of the
time an Incentive  Stock  Option is granted to such person,  of the Common Stock
with respect to which Incentive Stock Options are exercisable for the first time
by such person  during any calendar  year under all plans of the Company and its
subsidiaries, shall exceed $100,000.

         Subject to the  provisions  of the Employee Plan with respect to death,
retirement and  termination of employment,  the term of each option shall be for
such period as the  committee  shall  determine  as set forth in the  applicable
option agreement, but not more than (i) five years from the date of grant in the
case of Incentive Stock Options held by 10% or greater shareholders and (ii) ten
years from the date of grant in the case of all other Incentive Stock Options.

         The Employee Plan is intended to comply in all respects with Rule 16b-3
under the  Exchange  Act.  Option  grants with respect to 8,500 shares of Common
Stock have been awarded under the Employee Plan as of December 31, 1996.

         It is  currently  contemplated  that  approval of an  amendment  to the
Employee  Plan  increasing  the number of shares of Common Stock  available  for
issuance  thereunder  will be sought at the Company's next annual  Shareholders'
Meeting which is expected to occur in May 1997.

NONQUALIFIED STOCK OPTIONS

         In  December  1994,  the Company  granted ten year  options to purchase
120,000  shares of Common  Stock to each of  Messrs.  Zanker,  Murray and Steven
Thompson,   then  the  Company's  Chief  Financial  Officer.  Such  options  are
exercisable  at a price of $3.75 per share.  One-third  of such  options  became
exercisable  in March 1995,  one-third  became  exercisable in December 1995 and
one-third became exercisable in December 1996. In July 1995, the Company granted
five-year  options to purchase 100,000 shares of Common Stock to each of Messrs.
Zanker and Murray,  each  exercisable  at a price of $1.875 per share.  All such
options  have been  exercised.  In July 1995,  the  Company  granted  options to
purchase  10,000 shares of Common Stock to Mr. Dee. Such options are exercisable
at a price of $2.5625 per share.  Options to purchase  5,000  shares  vested and
became  exercisable  in July 1996 and options to purchase  an  additional  5,000
shares vest and become  exercisable in July 1997. All such options expire on the
day before the 5-year anniversary of vesting. In March 1995, the Company granted
ten year options to purchase  100,000  shares of Common Stock to a consultant to
the Company.  Such options are  exercisable  at a price of $5.00 per share.  All
such  options are  currently  exercisable.  In July 1995,  the  Company  granted
five-year  options to purchase  65,000 shares of Common Stock to  consultants to
the Company.  Such options are  exercisable  at a price of $4.00 per share.  All
such options are  currently  exercisable.  In August 1995,  the Company  granted
three-year options to purchase 100,000 shares of Common Stock to a consultant to
the Company of which options to purchase 76,500 shares have been exercised. Such
options are  exercisable  at a price of $2.375 per share.  All such  options are
currently  exercisable.  In  February  1996,  the  Company  granted  warrants to
purchase 300,000 shares of Common Stock to a consultant to the Company,  100,000
of which were  exercisable at a price of $1.00 per share,  200,000 of which were
exercisable at a price of $2.50 per share, and all of which have been exercised.

                                      -16-

<PAGE>

EMPLOYMENT AGREEMENTS

         The Company has entered into an agreement  with Mr. Zanker  pursuant to
which he is employed  full-time  as the  President  of the Company for a term of
three years,  commencing as of November 1, 1994.  Mr. Zanker will be required to
devote  substantially  all of his business  time and attention to the affairs of
the Company.  Under the  agreement,  Mr. Zanker is entitled to receive an annual
base salary of $120,000 for the first two years of the  agreement and the salary
for the third year is to be set by the  Compensation  Committee of the Company's
Board of Directors.  Mr. Zanker is also entitled to receive an annual bonus, if,
when and as may be determined by the Company's Board of Directors.  In addition,
Mr.  Zanker is  entitled  to receive a bonus  ("Performance  Bonus") of $100,000
payable anytime during the initial term of the employment agreement upon (i) the
opening of an aggregate of 40 Company-owned and/or franchised stores or (ii) the
Common Stock trading at $10.00 per share for 30 consecutive  trading days at any
time after August 28, 1995, or (iii) the Company's revenues for any of the years
ended  December 31, 1995,  1996 or 1997  equalling or exceeding  $12.5  million,
exclusive of revenues from acquired companies. The employment agreement contains
a  non-compete  provision  during  the term of the  agreement  and for two years
thereafter.  In addition, Mr. Zanker is entitled to receive such benefits as are
generally  provided  from time to time by the  Company to its senior  management
employees,  as well as to participate in the Company's  stock option plan as may
from time to time be in effect.

         The Company has entered into a three-year employment agreement with Mr.
Murray similar to that of Mr. Zanker,  commencing  November 1, 1994,  containing
generally  the same  terms and  conditions  as  provided  for  above;  provided,
however,  that Mr. Murray is entitled to receive a Performance Bonus of $130,000
payable on the achievement of the same performance  criteria as described above.
Mr.  Murray's  employment  agreement  provides for Mr.  Murray to be employed as
Chief Executive Officer.

         ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

         The following table sets forth information as of February 28, 1997 with
respect to the beneficial ownership of the Common Stock by (i) each person known
by the  Company  to be the  beneficial  owner of more  than 5% of the  Company's
outstanding  Common  Stock,  (ii)  each  Director  of the  Company,  (iii)  each
executive officer of the Company,  and (iv) all Directors and executive officers
as a group.

<TABLE>
<CAPTION>

                                                                   Amount and
                                                                    Nature of
                                                                    Beneficial
                Name and Address(1)                                Ownership(2)           Percent of Class(3)
                -------------------                               --------------          -------------------

<S>                                                               <C>                            <C>
Laidlaw Holdings, Inc..............................               157,652(4)                      6.2
Laidlaw Equities, Inc..............................               149,564(4)                      5.9
Debbie Dworkin.....................................                63,562(5)                      2.6
William Zanker.....................................               183,562(6)                      7.2
Terrance C. Murray.................................               179,375(7)                      7.1
Stephen Seligman...................................                15,000(8)                       *
Andrew L. Hyams....................................                11,875(9)                       *
Edward E. Faber....................................                10,000(10)                      *
Donald R. Fleischer................................                25,625(11)                     1.0
Peter Hanelt.......................................                10,000(10)                      *
Keith Dee..........................................                26,875(12)                     1.1
Cumberland Associates..............................               130,000(13)                     5.4
All executive officers and directors as a
 group (8 persons).................................               462,312(14)                    17.0
</TABLE>

                                      -17-

<PAGE>
----------------------
*        

         Less than 1%
(1)      Unless otherwise indicated, the address of each beneficial owner is c/o
         the Company, 425 Madison Avenue, New York, New York 10017.
(2)      Beneficial  ownership has been determined in accordance with Rule 13d-3
         under the Exchange Act ("Rule 13d-3") and unless  otherwise  indicated,
         represents  shares for which the  beneficial  owner has sole voting and
         investment power.
(3)      The percentage of class is calculated in accordance with Rule 13d-3 and
         assumes that the  beneficial  owner has  exercised any options or other
         rights to subscribe  which are  exercisable  within sixty (60) days and
         that no other  options or rights to  subscribe  have been  exercised by
         anyone else.
(4)      These shares consist of (i) 8,088 shares held by Laidlaw Holdings, Inc.
         and (ii) 24,564  shares held by, and 125,000  shares  issuable upon the
         exercise of warrants held by, its subsidiary Laidlaw Equities, Inc. The
         address for each of Laidlaw Equities,  Inc. and Laidlaw Holdings,  Inc.
         is 100 Park Avenue, 28th Floor, New York, New York 10017.
(5)      Debbie Dworkin is the wife of William Zanker, the Company's Chairman of
         the Board and President.
(6)      These shares consist of (i) 63,562 shares held by Debbie  Dworkin,  Mr.
         Zanker's wife,  and (ii) 120,000  shares  issuable upon the exercise of
         options.  Mr. Zanker  disclaims any beneficial  ownership of the shares
         held by Ms. Dworkin.
(7)      Includes 120,000 shares issuable upon the exercise of options.
(8)      These shares  consist of (i) 5,000 shares held by Stephen  Seligman and
         his wife, Beth Greer,  as joint tenants with right of survivorship  and
         (ii) 10,000 shares issuable upon the exercise of options.
(9)      These  shares  consist of (i) 1,875  shares  held by Mr.  Hyams and his
         wife,  Tracey Hyams,  as joint tenants with right of  survivorship  and
         (ii) 10,000 shares issuable upon the exercise of options.
(10)     Represents 10,000 shares issuable upon the exercise of options.
(11)     These shares  consist of (i) 3,125 shares held by Mr.  Fleischer,  (ii)
         10,000  shares  issuable  upon the exercise of options and (iii) 12,500
         shares issuable upon the exercise of certain warrants  purchased by Mr.
         Fleischer.
(12)     Includes 5,000 shares issuable upon the exercise of options.
(13)     The address for  Cumberland  Associates is 1114 Avenue of the Americas,
         New York, New York 10036.
(14)     Includes  307,500  shares  issuable  upon the  exercise  of options and
         warrants.

         ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

         In June 1993,  the Company  issued to Debbie  Dworkin,  the wife of the
Company's Chairman of the Board, William Zanker,  187,500 shares of Common Stock
for nominal  consideration  upon the  founding of the Company.  Ms.  Dworkin has
transferred  an  aggregate  of  105,188 of such  shares to certain  individuals,
including 34,375 shares sold to Terrance Murray and 21,875 shares sold to Steven
Thompson.

         In  December  1994,  each of Messrs.  Zanker and  Murray  waived  their
respective salaries which had accrued since January 1994 in the aggregate amount
of $220,000 as of December  31, 1994 and worked  without  salary  until March 1,
1995.  Each has been  subsequently  compensated in accordance  with the terms of
their    respective    employment    agreements.    See   Item   10   (Executive
Compensation--Employment Agreements).

         On March 9, 1995, the Company entered into a consulting  agreement with
A. Clinton Allen (the "Consulting  Agreement"),  pursuant to which Mr. Allen was
paid $3,000 per month,  plus expenses.  In addition,  the Company granted to Mr.
Allen  options to purchase  100,000  shares of Common  Stock  exercisable  for a
period of 10 years at a price of $5.00  per share and was to grant to Mr.  Allen
an option to purchase  25,000  shares of Common  Stock at the  beginning of each
calendar year during the term of the  Consulting  Agreement.  Mr. Allen became a
director  of the Company on March 9, 1995.  On  December  18,  1995,  Mr.  Allen
resigned  from his position as a member of the Board of Directors of the Company
and the Consulting Agreement was terminated.

         On December 7, 1995, the Company entered into an option  agreement with
Laidlaw Equities,  Inc. and Laidlaw  Holdings,  Inc.  (collectively,  "Laidlaw")
pursuant to which Laidlaw granted the Company options (the

                                      -18-

<PAGE>

"Options")  to purchase an  aggregate of 475,000  shares (the "Option  Shares").
Such  options  were  exercisable  at any  time or from  time  to time  prior  to
September 7, 1996 at an exercise price of $4.00 per share.

         On April  9,  1996,  Laidlaw  granted  to  Investors  Associates,  Inc.
("IAI"),  the  underwriter  for the proposed  public  offering of the  Company's
securities  (the  "Offering")  described  in Item 1  (Description  of Business -
Recent and Proposed  Financing  Transactions),  an option to purchase 100,000 of
the Option Shares,  exercisable at any time to and including May 9, 1996, for an
exercise  price of $3.00  per  share  and the  Company  simultaneously  released
Laidlaw from the Options with respect to such shares. IAI exercised such option.

         On April 24, 1996, the Company granted certain individuals unaffiliated
with the Company (the  "Grantees")  the right (the "Right") to cause the Company
to assign the Options  with  respect to 375,000 of the Option  Shares to them at
any time prior to June 7, 1996  (subsequently  extended to  September  7, 1996);
provided,  however, that the exercise price with respect to such shares would be
$5.00  per  share.  IAI  purchased  50,000  of  such  shares  from  Laidlaw  and
simultaneously  therewith  the Company  released  Laidlaw from the Options as to
such 50,000  shares and the  Grantees  released the Company from the Right as to
such 50,000 shares.

         Except as described above, the Options expired unexercised on September
7, 1996.

         On February 1, 1996, the Company  engaged Horatio  Management  Services
Corp., an affiliate of IAI, as the Company's management  consultant for a period
of 24  months  commencing  February  1,  1996,  at a fee  of  $5,000  per  month
(exclusive  of any  accountable  out-of-pocket  expenses),  $60,000  of which is
payable on the  closing of the  Offering  and $60,000 of which is payable on the
first anniversary thereof.

         In February  1996,  the Company  entered into a Financial  Advisory and
Consulting   Agreement  (the  "Financial  Advisory  Agreement")  with  IAI.  The
Financial  Advisory  Agreement  expired on January 31, 1997. As compensation for
the services to be performed  by IAI for the Company  pursuant to the  Financial
Advisory  Agreement,  the  Company  paid to IAI a  financial  consulting  fee of
$100,000,  and issued warrants to purchase  100,000 shares of Common Stock at an
exercise  price of $1.00 per share,  exercisable  to and  including  January 31,
1997,  and  warrants to purchase  200,000  shares of Common Stock at an exercise
price of $2.50 per share,  exercisable to and including  January 31, 1998. These
warrants have been exercised.

         On November 15, 1996,  the Company  entered into a franchise  agreement
with Roosevelt Field Partners.  Certain executive  officers and directors of the
Company own,  collectively,  an  approximately  40% equity interest in Roosevelt
Field Partners.

         Certain  executive  officers  of the Company  participated  in a bridge
financing by the Company  which was  consummated  on December 27, 1996,  as more
fully  described  in Item 1  (Description  of  Business  - Recent  and  Proposed
Financing Transactions).

         All future and ongoing transactions and loans with officers,  directors
and  principal  shareholders  of the Company will be on terms no less  favorable
than could be obtained from independent  third parties and will be approved by a
majority of the disinterested directors of the Company.

                                      -19-

<PAGE>

         ITEM 13. EXHIBITS, LIST AND REPORTS ON FORM 8-K.

         (A) EXHIBITS.

EXHIBIT NO.                     DESCRIPTION
-----------                     -----------

**3.1       Certificate of Incorporation of the Company, as amended.

 *3.2       Amendment   of   Certificate   of   Incorporation   of  the  Company
            (designating Series A Convertible Preferred Stock).

**3.3       Amended and Restated By-Laws of the Company.

**4.1       Specimen Certificate of the Company's Common Stock.

**4.2       1994 Employee Stock Option Plan.

**4.3       Nonqualified Option Agreement of Mr. Zanker.

**4.4       Nonqualified Option Agreement of Mr. Murray.

**4.5       Nonqualified Option Agreement of Mr. Thompson.

**4.6       Form of  Option  Agreement  for  Options  to be  issued  to  outside
            directors upon completion of the Offering.

**10.1      Employment  Agreement dated November 1, 1994 between the Company and
            William Zanker.

**10.1.1    Amendment  dated February 1, 1995 to the Employment  Agreement dated
            November 1, 1994 between the Company and William Zanker.

**10.1.2    Amendment No. 2 dated February 27, 1995 to the Employment  Agreement
            dated November 1, 1994 between the Company and William Zanker.

**10.2      Employment  Agreement dated November 1, 1994 between the Company and
            Terrance C. Murray.

**10.2.1    Amendment  dated February 1, 1995 to the Employment  Agreement dated
            November 1, 1994 between the Company and Terrance C. Murray.

**10.2.2    Amendment No. 2 dated February 27, 1995 to the Employment  Agreement
            dated November 1, 1994 between the Company and Terrance C. Murray.

**10.3      Employment  Agreement dated November 1, 1994 between the Company and
            Steven J. Thompson.

**10.3.1    Amendment  dated February 1, 1995 to the Employment  Agreement dated
            November 1, 1994 between the Company and Steven J. Thompson.

**10.3.2    Amendment No. 2 dated February 27, 1995 to the Employment  Agreement
            dated November 1, 1994 between the Company and Steven J. Thompson.

**10.4      Franchise  Agreement  dated May 14, 1994 between  Emerald Desert Rub
            and the Company.

                                      -20-

<PAGE>



**10.5      Lease  Agreement dated August 25, 1993 between 175 East 57th Street,
            Inc. and the Company concerning the Third Avenue Store.

**10.6      Lease   Agreement   dated   February   1994   between   Town  Sports
            International,  Inc. and the Company concerning the East 86th Street
            Store.

**10.7      Notice of Town Sports International, Inc. to the Company terminating
            the East 86th Street Store lease.

**10.7.1    Lease  Extension dated February 27, 1995 relating to the 86th Street
            Store Lease.

**10.8      Lease  Agreement  dated May 15, 1994  between  Martin  Cable and the
            Company.

**10.9      Sublease  Agreement  dated May 31,  1994  between  the  Company  and
            Emerald Desert Rub.

**10.10     Commercial Lease and Deposit Receipt dated December 31, 1994 for the
            Company's San Rafael, California office.

**10.11     Promissory Note dated April 5, 1994 issued to Colonial Capital Corp.
            for $165,000.

**10.12     Substitute Promissory Note dated November 1, 1994 issued to Colonial
            Capital Corp. for $165,000.

**10.13     Letter  Agreement  dated  December  23, 1994 between the Company and
            Colonial Capital, Inc.

**10.14     Promissory  Note dated  April 5, 1994  issued to Gary D.  Lipson for
            $50,000.

**10.15     Substitute  Promissory Note dated November 1, 1994 issued to Gary D.
            Lipson for $50,000.

**10.16     Promissory Note dated April 5, 1994 issued to Kipnis Tescher Lippman
            Valinsky and Kain for $115,000.

**10.17     Substitute  Promissory  Note dated November 1, 1994 issued to Kipnis
            Tescher Lippman Valinsky & Kain for $115,000.

**10.18     Letter  Agreement  dated  December  28, 1994 between the Company and
            Kipnis Tescher Lippman Valinsky and Kain.

**10.19     Letter of Understanding  dated December 16, 1994 from the Company to
            Colonial Capital, Inc.

**10.20     Purchase  Agreement  dated June 10,  1993 by and among the  Company,
            Michael  Schub,  Linda  Amori,  Ron  Rodriguez,  Debbie  Dworkin and
            William Zanker.

**10.21     Mutual  Termination  Agreement  dated November 15, 1994 by and among
            the Company,  Michael  Schub,  Linda Amori,  Ron  Rodriguez,  Debbie
            Dworkin and William Zanker.

**10.22     Option  Agreement  dated June 20, 1994  between Bay Area Backs I and
            the Company relating to a potential franchise agreement.

**10.23     Option  Agreement  dated June 21, 1994  between Bay Area Backs I and
            the Company relating to a potential franchise agreement.

**10.24     Letter  dated  October 19, 1994 from the Company to Bay Area Backs I
            extending the term of the Option Agreements.

                                      -21-

<PAGE>

**10.24.1   Letter dated  February 13, 1995 from the Company to Bay Area Backs I
            extending the term of the Option Agreements.

**10.25     Form of Bridge  Note  relating to December  1994  private  placement
            securities offering.

**10.26     The Company's  Uniform  Franchise  Offering  Circular dated April 1,
            1994.

**10.27     Letter of Intent dated June 9, 1994 between Brookstone, Inc. and the
            Company.

**10.28     Letter of Intent dated October 6, 1994 between Brookstone,  Inc. and
            the Company.

**10.29     Assignment  of Patent  Rights  dated  December 23, 1994 from William
            Zanker to the Company.

**10.30     Consulting  Agreement dated March 9, 1995 between the Company and A.
            Clinton Allen.

**10.31     Option  Agreement  dated  March 9, 1995  between  the Company and A.
            Clinton Allen.

**10.32     Indemnification  Letter  dated  March 9, 1995 from the Company to A.
            Clinton Allen.

***10.33    Option  Agreement  dated  December  7,  1995,  by and among  Laidlaw
            Holdings, Inc., Laidlaw Equities, Inc. and the Company.

***10.34    Franchise  Termination  Agreement  dated as of May 30, 1995,  by and
            between the Company and Emerald Desert Rub.

***10.35    Option  Termination  Agreement  dated  as of May  30,  1995,  by and
            between the Company and Bay Area Backs I.

***10.36    Financial Advisory and Consulting  Agreement between the Company and
            Investors Associates, Inc.

*10.37      Consulting  agreement dated February 1, 1996 between the Company and
            Horatio Management Services Corp.

10.38       Franchise  Agreement dated November 19, 1996 between the Company and
            Roosevelt Field Partners, LLC.

10.39       Franchise  Agreement dated November 20, 1996 between the Company and
            Marion Holdings, Inc.

10.40       Option  Agreement  dated  November  21, 1996 between the Company and
            Marylou Garcia.

10.41       Agency  Agreement  dated  November  22, 1996 between the Company and
            Investors Associates, Inc., as amended December 20, 1997

10.42       Form of Note relating to December 1996 private placement.

10.43       Form of Warrant  relating to December  1996  private  placement,  as
            amended.

***11.1     Statement regarding Computation of Per Share Earnings.

**16.1      Letter  from  Elwell,  Cangiano,  Zdon & Dee  relating  to change in
            accountants.

***21.1     Subsidiaries of the Company.

                                      -22-

<PAGE>

---------------

*           Incorporated by reference to the Company's Registration Statement on
            Form SB-2 (File No. 333-21203).

**          Incorporated by reference to the Company's Registration Statement on
            Form SB-2 (File No. 33-88052).

***         Incorporated  by  reference  to the  Company's  Form  10-KSB for the
            fiscal year ended December 31, 1995 (File No. 0-25334).

            (B)  REPORTS ON FORM 8-K.  No reports  were filed on Form 8-K in the
quarter ended December 31, 1996.


                                      -23-

<PAGE>

                                   SIGNATURES

         In  accordance  with  Section  13 or 15(d) of the  requirements  of the
Exchange  Act,  the  registrant  has duly  caused the report to be signed on its
behalf by the  undersigned,  thereunto duly  authorized in the City of New York,
State of New York, on the 27th day of March, 1997.

                              THE GREAT AMERICAN BACKRUB STORE, INC.


                              By: /s/ William Zanker
                                  -----------------------------------
                                  William Zanker
                                  Chairman of the Board and President

         In accordance  with the Exchange Act, this report has been signed below
by the following  persons on behalf of the  registrant  and in the capacities on
the dates indicated.


    SIGNATURE                         TITLE                      DATE
    ---------                         -----                      ----

/s/ William Zanker         Chairman of the Board, President   March 27, 1997
-------------------------  and Director
    William Zanker         

/s/Terrance C. Murray      Chief Executive Officer and        March 27, 1997
-------------------------  Director (principal executive
   Terrance C. Murray      officer)

/s/ Keith Dee              Chief Financial Officer and        March 27, 1997
-------------------------  Secretary (principal financial
    Keith Dee              and accounting officer)

/s/ Stephen Seligman       Director                           March 27, 1997
-------------------------
    Stephen Seligman

/s/ Edward E. Faber        Director                           March 27, 1997
-------------------------
    Edward E. Faber

/s/ Peter Hanelt           Director                           March 27, 1997
-------------------------
    Peter Hanelt

/s/ Donald R. Fleischer    Director                           March 27, 1997
-------------------------
    Donald R. Fleischer

/s/ Andrew L. Hyams        Director                           March 27, 1997
--------------------------
    Andrew L. Hyams


                                      -24-

<PAGE>

                     THE GREAT AMERICAN BACKRUB STORE, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                          INDEX TO FINANCIAL STATEMENTS



                                                                            PAGE
                                                                            ----

Report of Independent Certified Public Accountants                          F-2

Balance Sheet as of December 31, 1996                                       F-3

Statements of Operations for the years ended December 31, 1996
and 1995 and December 18, 1992 (Inception) to December 31, 1996             F-4

Statement of Changes in  Stockholders'  Equity for the years
ended  December 31, 1996 and 1995 and December 18, 1992
(Inception) to December 31, 1996                                            F-5

Statements of Cash Flows for the years ended December 31, 1996
and 1995 and December 18, 1992 (Inception) to December 31, 1996             F-6

Summary of Accounting Policies                                              F-7

Notes to Financial Statements                                              F-10

                                       F-1

<PAGE>
               REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS



Board of Directors
The Great American BackRub Store, Inc.
(A Development Stage Company)
New York, New York

We have audited the  accompanying  balance sheet of The Great  American  BackRub
Store,  Inc. as of December 31, 1996 and the related  statements of  operations,
changes in stockholders'  equity (capital  deficit) and cash flows for the years
ended  December  31, 1995 and 1996,  and for the period from  December  18, 1992
(date of inception) to December 31, 1996.  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  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatements. 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  uses and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion,  the financial  statements  referred to above present fairly, in
all material  respects,  the financial  position of The Great  American  BackRub
Store,  Inc. as of December 31, 1996,  and the results of its operations and its
cash flows for the years ended  December  31, 1995 and 1996,  and for the period
from  December 18, 1992 (date of  inception) to December 31, 1996, in conformity
with 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 1 to the
financial  statements,  the  Company has  suffered  recurring  losses  since its
inception and has an accumulated deficit of $7,001,507, which raises substantial
doubt  about its  ability to continue  as a going  concern.  Management's  plans
regarding  those matters also are described in Note 1. The financial  statements
do not  include  any  adjustments  that might  result  from the  outcome of this
uncertainty.


                                                       BDO Seidman, LLP
                                                       ----------------
                                                       BDO Seidman, LLP

New York, New York
January 31, 1997

                                       F-2

<PAGE>

                     THE GREAT AMERICAN BACKRUB STORE, INC.
                          (A DEVELOPMENT STAGE COMPANY)
                                  BALANCE SHEET

                             AS OF DECEMBER 31, 1996

                                     ASSETS

Current assets:
     Cash                                                         $ 1,188,038
     Receivables - other                                              215,060
     Prepaid expenses                                                  50,690
     Inventory                                                        329,269
                                                                 ------------
          Total current assets                                      1,783,057

Property and equipment:
     Furniture and fixtures                                           462,180
     Leasehold improvements                                           951,238
     Purchased lease                                                  120,000
     Computer equipment                                                44,306
                                                                  -----------
                                                                    1,577,724
     Less, Accumulated depreciation                              (    190,072)
                                                                  -----------
                                                                    1,387,652

Other assets:
     Deferred offering costs                                           68,800
     Note receivable                                                   50,000
     Lease and equipment deposits                                     289,152
                                                                 ------------

          Total other assets                                          407,952
                                                                 ------------
                  Total assets                                   $  3,578,661
                                                                 ============

                      LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities
     Accounts payable                                             $   576,857
     Accrued expenses                                                 421,276
     Accrued payroll and related                                      197,749
     Bridge notes                                                       7,348
     Deferred revenue                                                 328,262
                                                                 ------------
                  Total current liabilities                         1,531,492

Deferred rent                                                         240,740

Commitments and contingencies
Stockholders' equity:
     Series B convertible  preferred stock,  $.001 par value
     15,000,000 shares authorized,   none  issued
     Common stock, par value $0.001 per  share,
     20,000,000 shares authorized, 2,393,354 shares
     issued and outstanding                                             2,293
     Additional paid in capital                                     8,805,543
     Deficit accumulated during the development stage             ( 7,001,507)
                                                                  -----------
                                                                    1,806,429
                  Total liabilities and stockholders' equity      $ 3,578,661
                                                                  ===========


See  accompanying   summary  of  accounting  policies  and  notes  to  financial
statements.

                                       F-3

<PAGE>

                     THE GREAT AMERICAN BACKRUB STORE, INC.
                          (A DEVELOPMENT STAGE COMPANY)
                            STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>

                                                                         Years Ended                        December 18, 1992
                                                                         December 31,                       (Inception) to
                                                                    1996                  1995              December 31, 1996
                                                                    ----                  ----              -----------------
<S>                                                             <C>                    <C>                  <C>         
Revenues:
Services                                                         $ 2,140,304            $   874,320          $ 3,607,103
Products                                                             868,214                326,012            1,370,168
Royalties, franchise fees and other                                   37,419                  1,609               83,977
                                                                 -----------            -----------          -----------

          Total                                                    3,045,937              1,201,941            5,061,248
                                                                 -----------            -----------          -----------

Operating expenses:
Salaries and wages                                                 1,495,274              1,230,531            3,239,905
Cost of products sold, buying and occupancy                          611,919                269,261              989,483
Rental expense                                                       734,588                409,850            1,406,392
Advertising and promotion                                            210,754                158,657              506,426
Options granted as financial advisory fees                           481,250                     --              481,250
General and administrative                                         2,294,907              1,521,672            4,685,149
Depreciation                                                         128,876                 65,220              219,464
Waived salaries                                                           --                 30,000              350,000
                                                                  ----------              ---------           ----------

                  Total                                            5,957,568              3,685,191           11,877,069
                                                                  ----------              ---------           ----------

Net loss from operations                                         ( 2,911,631)           ( 2,483,250)         ( 6,815,821)
                                                                  ----------             ----------           ----------

Other income (expense):
Interest income                                                       93,667                149,691              243,358
Interest expense                                                 (     7,348)           (   313,696)         (   429,044)
                                                                  ----------             ----------           ----------

                  Total                                               86,319               (164,005)            (185,686)
                                                                  ----------             ----------           ----------

Net loss                                                         ($2,825,312)           ($2,647,255)         ($7,001,507)
                                                                  ==========             ==========           ==========
Weighted average number of shares outstanding
     during the period                                             2,005,573              1,582,250
                                                                  ==========            ===========


Net loss per common share and equivalents                         $    (1.41)            $    (1.67)
                                                                   ==========            ==========
</TABLE>


See  accompanying   summary  of  accounting  policies  and  notes  to  financial
statements

                                       F-4

<PAGE>

                     THE GREAT AMERICAN BACKRUB STORE, INC.
                          (A Development Stage Company)
                  STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>


                                                                                                                        Deficit
                                                                                                                       Accumulated
                                                                       Common Stock                   Additional        during the
                                                                                                       Paid-in         Development
                                                                 Shares              Amount            Capital           Stage
                                                                 ------              ------            -------           -----

<S>                                                            <C>                   <C>            <C>               <C>
Balance, December 18, 1992 (Inception)                                 -             $    -           $       -        $      -

Initial issuance of common stock for services,                   375,000                375               2,625               -
June 1993

Issuance of common stock in private placement,                   125,000                125             869,875               -
October 1993, for cash at $8 per share, net of
issuance costs

Net loss, year ended December 31, 1993                                 -                  -                   -        (409,965)
                                                                --------             ------           ---------        --------- 


Balance, December 31, 1993                                       500,000                500             872,500        (409,965)

Issuance of Warrants to Bridge Note Investors                          -                  -             106,000                 -

Waived salaries                                                        -                  -             320,000                 -

Net loss, year ended December 31, 1994                                 -                  -                   -        (1,118,975)
                                                               ---------             -------          ---------        -----------


Balance, December 31, 1994                                       500,000                500           1,298,500        (1,528,940)

Issuance of common stock in public offering,                   1,250,000              1,250           5,029,771                 -
March 1995, for $5 per share, net of issuance
costs

Issuance of warrants to Bridge Note Investors                          -                  -             306,500                 -

Waived salaries                                                        -                  -              30,000                 -

Issuance of common stock for additional costs in                  10,500                 11              10,489                 -
connection with the March 7, 1995 public offering

Options granted as compensation                                        -                  -             106,830                 -

Issuance of common stock to former franchisee                     24,766                 25              66,890                 -
and consultant

Net loss, year ended December 31, 1995                                 -                  -                   -        (2,647,255)
                                                              ----------             ------       -------------        -----------


Balance, December 31, 1995                                     1,785,266              1,786           6,848,980        (4,176,195)

Exercise of stock options and bridge warrants                    604,000                603           1,225,112                 -

Options granted as financial advisory fees                             -                  -             525,000                 -

Issuance of common stock to former consultants                     4,088                  4              31,527                 -

Issuance of warrants to bridge note investors, net of cost             -                  -             174,924                 -

Net loss, year ended December 31, 1996                                 -                  -                   -        (2,825,312)
                                                              ----------             -------       ------------        -----------


Balance, December 31, 1996                                     2,393,354             $2,393         $,8,805,543       ($7,001,507)
                                                               =========             ======        ============       ==============
</TABLE>

See  accompanying   summary  of  accounting  policies  and  notes  to  financial
statements

                                       F-5

<PAGE>

                     THE GREAT AMERICAN BACKRUB STORE, INC.
                          (A DEVELOPMENT STAGE COMPANY)
                            STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>

                                                                                        Years ended
                                                                                         December 31,           December 18, 1992
                                                                                                                  (Inception) to
                                                                               1996                  1995        December 31, 1996
                                                                               ----                  ----       ------------------
Cash flows from operating activities:
<S>                                                                          <C>                <C>                  <C>         
     Net loss                                                                ($2,825,312)       ($2,647,255)         ($7,001,507)
                                                                              ----------         ----------           ----------
     Adjustments to reconcile net loss to net cash used by
          operating activities:
     Depreciation and amortization                                               136,244             65,220              210,920
     Salaries waived by officers                                                      --             30,000              350,000
     Warrant financing costs                                                          --            306,500              412,500
     Options granted as financial advisory fees                                  525,000            106,830              631,830
     Common stock issued to former franchisee and consultant                      31,531             66,915               98,478
     (Increase) decrease in:
          Accounts receivable                                                   (206,006)            37,742           (  215,060)
          Prepaid expenses                                                        58,998         (  109,688)          (   50,690)
          Inventory                                                            ( 111,560)        (  204,515)          (  329,269)
          Other assets                                                        (  243,139)           191,122           (  407,952)
     Increase (decrease) in:
          Accounts payable and accrued expenses                                  454,525            244,439              998,133
          Accrued payroll and related                                            102,957            251,310              197,749
          Deferred revenues and rent                                             293,081            177,442              569,002
          Accrued officer expenses                                                    --          (  67,040)                  --
                                                                               ---------          ---------           ----------
                  Total adjustments                                            1,041,611          1,096,277            2,465,641
                                                                               ---------          ---------           ----------

Net cash used by operating activities                                         (1,783,701)        (1,550,978)          (4,535,866)
                                                                              ----------          ---------            ---------

Cash flows from investing activities:
     Purchase of certificate of deposit                                               --          1,000,000)         ( 1,000,000)
     Maturity of certificate of deposit                                        1,000,000                 --            1,000,000
     Purchased lease                                                                  --           (120,000)         (   120,000)
     Purchase of property and equipment                                          650,637)          (599,350)         ( 1,457,724)
                                                                              ----------         ----------           ----------
Net cash used in investing activities                                            349,363          1,719,350)         ( 1,557,724)
                                                                             -----------         ----------           ----------
Cash flows from financing activities:
     Net cash proceeds from the issuance of common stock                       1,225,715          5,031,021            7,126,704
     Net proceeds from the issuance of bridge warrants                             4,000                 --                4,000
     Proceeds from issuance of bridge notes and short-term debt                  262,667                 --              687,667
     Payment of bridge notes and short-term debt                                      --         (  605,000)          (  605,000)
     Bridge financing costs                                                    (  91,743)                --           (   91,743)
     Payment of officer loan payable                                                  --         (   15,000)                  --
                                                                              ----------         ----------           ----------
Net cash provided by financing activities                                      1,400,639          4,411,021            7,301,628
                                                                              ----------         ----------           ----------
Net increase (decrease) in cash and cash equivalents                           (  33,699)         1,140,693            1,188,038
Cash and cash equivalents, beginning of period                                 1,221,737             81,044                   --
                                                                              ----------         ----------           ----------
Cash and cash equivalents, end of period                                      $1,188,038         $1,221,737           $1,188,038
                                                                              ==========         ==========           ==========

Supplemental  disclosures of cash flow information:
  Cash paid during the period for:
          Interest                                                            $       --         $    7,196           $   20,892
                                                                              ==========         ==========           ==========
          Income taxes                                                        $    5,500         $    1,500           $    8,375
                                                                              ==========         ==========           ==========
</TABLE>


See  accompanying   summary  of  accounting  policies  and  notes  to  financial
statements.

                                       F-6

<PAGE>
                     THE GREAT AMERICAN BACKRUB STORE, INC.
                         ( A DEVELOPMENT STAGE COMPANY)

                         SUMMARY OF ACCOUNTING POLICIES

DESCRIPTION OF BUSINESS

The Great  American  Backrub  Store,  Inc. (the  "Company"),  formally  American
Pleasure,  Inc.,  is an  owner/operator  and  franchisor  of retail stores which
provide  seated,  fully  clothed  back  rubs and sell  back and  stress  related
products.  The Company,  incorporated on December 28, 1992,  began operations in
August,  1993 and opened its first store for  business in October,  1993.  As of
December 31, 1996,  the Company has thirteen  retail stores in operation and two
franchised store locations.

Management  believes  that  the  Company's  planned  principal  operations,  the
establishment of  company-owned  and franchised  stores  throughout the country,
have not yet  commenced.  The initial eight stores have been used to continue to
develop and modify the Company's retail concept.  Accordingly,  the accompanying
financial  statements  have been prepared as a  development  stage  company,  in
accordance with Statement of Financial Accounting Standards (SFAS) No. 7.

USE OF ESTIMATES

In  preparing  financial   statements  in  conformity  with  generally  accepted
accounting principles,  management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities and the disclosure of
contingent  assets and  liabilities at the date of the financial  statements and
revenues and expenses during the reporting  period.  Actual results could differ
from those estimates.

CASH AND CASH EQUIVALENTS

Cash and cash  equivalents  represent all amounts held in banks and money market
accounts and short term  investments  such as United States  Treasury bills with
original maturities of less than three months.

DEFERRED OFFERING COSTS

The Company has deferred offering costs related to a proposed offering (Note 8).
The deferred  offering  costs will be charged to equity upon  completion  of the
proposed  offering.  Should the proposed offering prove to be unsuccessful,  the
deferred costs, as well as additional  expenses to be incurred,  will be charged
to operations.

CONCENTRATION OF CREDIT RISK

Financial  instruments  which  potentially  subject the  Company to  significant
concentration of credit risk  consist  primarily  of $529,000 of cash in a money
market account at December 31, 1996.

INVENTORY

Inventories,  consisting of merchandise held for resale, are valued at the lower
of cost or market.  The Company uses the retail inventory method.

                                      F-7
<PAGE>
                     THE GREAT AMERICAN BACKRUB STORE, INC.
                         ( A DEVELOPMENT STAGE COMPANY)

                         SUMMARY OF ACCOUNTING POLICIES

PROPERTY AND EQUIPMENT

Property  and  equipment  are  stated at cost,  less  accumulated  depreciation.
Expenditures  from  maintenance  and repairs are charged to expense as incurred.
Depreciation  is provided  using the  straight-line  method  over the  estimated
useful life's of the assets as follows:

Leasehold improvements     The lesser of 10 years,  or the remaining life of the
                           lease
Purchased lease            The lesser of 10 years,  or the remaining life of the
                           lease
Furniture and fixtures     5 - 10 years
Computer equipment         5 years


REVENUE RECOGNITION

The  Company-owned  store revenues are recognized  when services are provided or
upon the  sale of  products.  Sales of gift  certificates  are  recognized  when
redeemed or upon expiration.  Royalties are recognized as income in the month in
which franchisee services are rendered or products are sold by franchisees.  The
Company  recognizes  franchise  revenue in accordance with SFAS No. 45. Deferred
revenues represent unredeemed and unexpired gift certificates.

PER SHARE DATA

Net loss per  common  share for the year  ended  December  31,  1996 and 1995 is
computed by dividing net loss by the weighted average common shares  outstanding
during the year.  The  assumed  exercise  of common  share  equivalents  was not
utilized since the effect was anti-dilutive.

REVERSE STOCK SPLIT

In conjunction with the Public offering, on March 7, 1995(see Note 2), the Board
of Directors declared a 1 for 8 reverse stock split effective as of the business
on February 23, 1995(see Note 2). The accompanying  financial statements and all
common shares and  equivalents  and per share data included in the  accompanying
financial  statements  and  footnotes  have been restated to reflect the reverse
stock split as if it occurred on January 1, 1995.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The  carrying  values  of  financial   instruments   including  cash,   accounts
receivable, inventory, accounts payable, accrued expenses, and deferred revenues
approximate fair value at December 31, 1996 and December 31, 1995 because of the
relative short maturities of these instruments.

LONG-LIVED ASSETS

During 1995,  Statement of Financial  Accounting  Standards No. 121, "Accounting
for the Impairment of Long-lived Assets and for Long-lived Assets to Be Disposed
Of" ("SFAS 121"), was issued. SFAS 121 requires the Company to review long-lived
assets and certain  identifiable  assets  related to those assets for impairment
whenever  circumstances  and situations  change such that there is an indication
that the carrying  amounts may not be recoverable.  If the  undiscounted  future
cash  flows of the  enterprise  are less  than  their  carrying  amounts,  their
carrying amounts are reduced to fair value and an impairment loss is recognized.
The adoption of this  pronouncement in 1996 did not have a significant impact on
the Company's financial statements.

                                      F-8
<PAGE>
                     THE GREAT AMERICAN BACKRUB STORE, INC.
                         ( A DEVELOPMENT STAGE COMPANY)

                         SUMMARY OF ACCOUNTING POLICIES

STOCK OPTIONS

In October 1995, the FASB issued Statement of Financial Accounting Standards No.
123  "Accounting  for Stock-Based  Compensation"  ("SFAS 123").  SFAS 123 allows
companies to choose whether to account for stock-based  compensation on the fair
value method or to continue to account for  stock-based  compensation  under the
current Intrinsic value method as prescribed by APB Opinion No. 25, " Accounting
for Stock Issued to Employees." The Company has adopted  disclosure  alternative
under SFAS 123 during  1996 and will  continue to follow the  provisions  of APB
Opinion No. 25.

                                      F-9
<PAGE>

                     THE GREAT AMERICAN BACKRUB STORE, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                      NOTES TO AUDITED FINANCIAL STATEMENTS

NOTE 1 - GOING CONCERN

The  accompanying  financial  statements  have been  prepared  assuming that the
Company  will  continue  as a going  concern;  they do not  include  adjustments
relating to the  recoverability of recorded asset amounts and  classification of
recorded  assets and  liabilities.  The Company has  incurred  losses  since its
inception  and has  accumulated  a deficit of  $7,001,507  at December 31, 1996.
Insomuch as the Company continues to have a high level of operating expenses and
will be required to make  significant  up-front  expenditures in connection with
its proposed expansion, the Company anticipates that losses will continue for at
least 12 months and until such time, if ever, as the Company is able to generate
sufficient  revenues  to  finance  its  operations  and the  costs of  continued
expansion.  Since inception,  the Company's  operations have generated  negative
cash flow, as its expenses have exceeded revenues,  and the Company's ability to
continue its operations is dependent upon additional  debt or equity  financing.
There can be no assurance that the Company will be able to generate  significant
revenues or achieve  profitable  operations or that its operations will generate
positive cash flow. These conditions raise substantial doubt about the Company's
ability to continue as a going concern.

In  accordance  with  management's  plans,  the Company has retained  investment
banking counsel to advise it on the possible sale of equity securities,  as well
to as introduce and assist in the evaluation of potential merger and partnership
opportunities.  Management  expects that these  efforts will result in either an
additional  equity  infusion or an  introduction to other parties with interests
and resources  which may be  compatible  with that of the Company.  However,  no
assurances  can be  given  that  the  Company  will  be  successful  in  raising
additional  capital or entering into a business alliance.  Further,  there is no
assurance,  assuming the Company  successfully raises additional funds or enters
into a  business  alliance,  that the  Company  will  achieve  profitability  or
positive  cash flow.  On February  5, 1997,  the  Company  filed a  registration
statement  to  offer  270,000  shares  of  preferred  stock  for   approximately
$2,700,000,  which, if successful, after commissions and fees, would provide the
Company with net proceeds of approximately $2,000,000.  (See Note 8 - Subsequent
Events)


If the Company is unable to obtain adequate additional financing or enter into a
business  alliance,  or  if  the  operating  stores  do  not  meet  projections,
management  will  be  required  to  sharply  curtail  its  expansion  plans  and
operations.

NOTE 2 -  INITIAL PUBLIC OFFERING

In an initial  public  offering  completed  on March 7, 1995,  the Company  sold
1,250,000  shares of common  stock for  approximately  $6,250,000  which,  after
commissions  and fees,  provided the Company with net proceeds of  approximately
$5,000,000.

On January 4, 1995,  the Board of Directors  authorized a 1 for 8 reverse  stock
split of the Company's common stock  immediately  prior to the completion of the
public offering. This action was approved at the shareholders meeting on January
31, 1995. The reverse stock split was effected on February 23, 1995.

                                      F-10
<PAGE>
                     THE GREAT AMERICAN BACKRUB STORE, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                      NOTES TO AUDITED FINANCIAL STATEMENTS

NOTE 3 - BRIDGE NOTES

As of December 31, 1996, short-term debt consisted of the following:

            Bridge notes                           $262,667
            Original issue discount                (255,319)
                                                   ---------
                     Total short-term debt         $   7,348
                                                   ==========

On December  27,  1996,  the Company  issued 10% Bridge  Notes in the  principal
amount of $262,667,  payable as to principal  and interest at the earlier of the
closing of a public offering  through the sale of equity  securities or December
27,  1997.  In  connection  with these notes,  the Company  also sold  4,000,000
warrants,  each warrant representing the right to purchase one share of Series A
preferred  stock at an exercise price of $5.00 per share.  Upon  consummation of
the offering, each bridge warrant shall automatically, without any action by the
bridge note  holders,  be  converted  into half of a  redeemable  warrant  which
entitles the holder to purchase one-half share of Series B preferred stock at an
exercise  price of $8.00 per share.  The  warrants  are  exercisable  at anytime
during the three-year  period commencing on the first anniversary of the date of
the warrant or December 27, 1997.  Original  issue discount of $262,667 has been
recorded and is being amortized over the expected term of the notes ( 3 months),
along with $91,743 of financing expenses.  Interest expense  amortization of the
original  issue discount of $7,348 for the year ended December 31, 1996 reflects
non-cash financing costs related to such warrants. Additional non-cash financing
costs of  approximately  $255,000  will be incurred  during the first quarter of
1997.

NOTE 4 - OPTIONS, STOCK PLANS AND MANAGEMENT COMPENSATION

The Company has employment  agreements with two executive officers which provide
for a minimum  aggregate  annual  compensation of $240,000 and expire on October
31, 1997.  These  agreements also provide for annual bonuses if, when and as may
be determined by the Company's Board of Directors. In addition, these agreements
provide for bonuses  aggregating  $230,000 upon  achievement of certain  Company
performance.

At the Company's 1994 annual meeting of shareholders  held on July 18, 1994, the
Company's  shareholders  approved the Employee Plan under which 75,000 shares of
common stock are authorized for issuance.  To date, 8,500 have been granted. The
purpose  of the  Employee  Plan is to  promote  the  success  of the  Company by
providing  a  method  whereby   eligible   employees  of  the  Company  and  its
subsidiaries,  as defined therein,  may be awarded  additional  remuneration for
services  rendered,  thereby  increasing their personal interest in the Company.
The  Employee  Plan is also  intended to aid in  attracting  persons of suitable
ability to become employees of the Company and its subsidiaries.

                                      F-11
<PAGE>
                     THE GREAT AMERICAN BACKRUB STORE, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                      NOTES TO AUDITED FINANCIAL STATEMENTS

NOTE 4 - OPTIONS, STOCK PLANS AND MANAGEMENT COMPENSATION(CONT'D)

In December  1994,  the Company  granted  ten year  options to purchase  360,000
shares of Common  Stock to executive  officers of the Company.  Such options are
exercisable  at a price of $3.75 per share.  One-third  of such  options  became
exercisable in March,  1995,  one-third became  exercisable in December 1995 and
one-third became exercisable in December 1996. In July 1995, the Company granted
five-year  options  to  purchase  100,000  shares of Common  Stock to  executive
officers of the Company.  Such options are  exercisable at a price of $1.875 per
share.  All such options have been exercised.  In July 1995, the Company granted
options to purchase 10,000 shares of Common Stock to an executive officer of the
Company.  Such options are exercisable at a price of $2.5625 per share.  Options
to purchase 5,000 shares vest and became exercisable in July 1996 and options to
purchase an additional  5,000 shares vest and become  exercisable  in July 1997.
All options expire on the day before the 5-year anniversary of vesting. In March
1995, the Company granted ten year options to purchase  100,000 shares of Common
Stock to a consultant to the Company. Such options are exercisable at a price of
$5.00 per share. All such options are currently  exercisable.  In July 1995, the
Company granted five year options to purchase 25,000 and 40,000 shares of Common
Stock to consultants to the Company.  Such options are exercisable at a price of
$4 per share. All options are currently exercisable. In August 1995, the Company
granted  three year  options to  purchase  100,000  shares of Common  Stock to a
consultant to the Company,  of which options to purchase 76,500 shares have been
exercised to date.  Such options are exercisable at a price of $2.375 per share.
All such options are currently exercisable.

FASB Statement 123,  "Accounting  for  Stock-Based  Compensation,"  requires the
Company to provide pro forma  information  regarding net income and earnings per
share as if  compensation  cost for the  Company's  stock  option plans had been
determined in accordance  with the fair  value-based  method  prescribed in FASB
Statement 123.

Under the accounting provisions of FASB Statement 123, the Company's, net income
and  earnings  per share  would  have  been  reduced  to the pro  forma  amounts
indicated below.

                                    1996               1995
                                    ----               ----
Net Loss
   As reported                   $ 2,825,312       $ 2,647,255
   Pro forma                       3,114,162         3,386,455

Net loss per common share
   As reported                       $ (1.41)          $ (1.67)
   Pro forma                           (1.55)            (2.14)

Net loss per share
  As reported                        $ (1.41)          $ (1.67)
  Pro forma                            (1.55)            (2.14)

                                      F-12

<PAGE>
                     THE GREAT AMERICAN BACKRUB STORE, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                      NOTES TO AUDITED FINANCIAL STATEMENTS


NOTE 4 - OPTIONS, STOCK PLANS AND MANAGEMENT COMPENSATION(CONT'D)

Non-qualified stock option transactions during the years ended December 31, 1996
and 1995 are summarized below:
<TABLE>
<CAPTION>

                                December 31, 1996                 December 31, 1995
                                -----------------                 -----------------


                                                             Weighted                                         Weighted
                                          Exercise price      average                     Exercise price      average
                                            range per         exercise                      range per         exercise
                              Shares         share             price       Shares            share             price
                              ------         -----             -----       ------            -----             -----

<S>                          <C>         <C>                  <C>         <C>           <C>                   <C>
Outstanding
options at
beginning of year            925,000     $1.875 - $5.00       $3.20       360,000                $3.75        $3.75

Options
granted                      300,000     $1.00 - $2.50        $2.00       565,000       $1.875 - $5.00        $2.85

Options
exercised                    576,500     $1.00 - $2.375       $2.01             -                    -            -

Options
forfeited                     90,000         $2.375           $2.375            -                    -            -
                              ------         ------           ------            -                    -            -

Outstanding
options at
end of year                  558,500     $2.375 - $5.00       $3.93       925,000       $1.875 - $5.00        $3.20
                             =======     =====    =====       =====       =======       =====    ====         =====

Exerciseable
options at
end of year                  553,500     $2.375 - $5.00       $3.94       345,000       $1.875 - $5.00        $3.20
                             =======      =====    ====       =====       =======       =====    ====         =====
</TABLE>

NOTE 5 - INCOME TAXES

Income taxes are provided based on the liability  method of accounting  pursuant
to Statement of Financial  Accounting  Standards (SFAS) No. 109, "Accounting for
Income  Taxes."   Deferred   income  taxes  are  recorded  to  reflect  the  tax
consequences  on future  years  differences  between the tax bases of assets and
liabilities and their financial  reporting  amounts at each year-end.  Valuation
allowances  have been  established  for all  income  tax  benefits  since  their
realizability is uncertain.

                                      F-13

<PAGE>

NOTE 5 - INCOME TAXES(CONT'D)

Reconciliation  of the  difference  between income taxes computed at the Federal
statutory tax rates and the Company's effective tax rate are as follows.

                                                    Years Ended December 31,
                                                     1996           1995
                                                     ----           ----
Income tax benefit computed at Federal
  statutory tax rates                               (34.0)%        (34.0)%
Other                                                  .1             .1
Valuation allowance of net deferred tax asset        33.9           33.9
                                                     ----           ----
Provision for income taxes                              -%             -%
                                                     =====          =====


Deferred tax assets and liabilities are comprised of the following:

                                                      December 31,
                                                        1996

Net operating loss carryforward                       $2,176,000
Other, net                                                (7,000)
                                                      -----------
Net deferred tax asset                                 2,169,000
Valuation allowance                                   (2,169,000)
                                                      -----------
                                                      $        -
                                                      ===========

For Federal tax purposes,  the Company had available,  at December 31, 1996, net
operating loss carryforwards of approximately  $6,400,000,  which expire through
2011 subject to certain annual limitations.

NOTE 6 - RELATED PARTY TRANSACTIONS

The Company reimbursed  expenses paid personally by a stockholder,  amounting to
$50,000 for the period from  December 18, 1992 (date of  inception)  to December
31, 1995.

At  December  31,  1996,  the  Company  had a  receivable  due  from  one of its
franchisee's  totaling  $151,004.  Revenue  earned from this  franchise  totaled
approximately $21,000 for the year ended December 31, 1996. Certain officers and
directors of the Company own an interest of approximately 40% in this franchise.
This receivable is due on demand and is non-interest bearing.

                                      F-14
<PAGE>
                     THE GREAT AMERICAN BACKRUB STORE, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                      NOTES TO AUDITED FINANCIAL STATEMENTS


NOTE 7 - COMMITMENTS

The Company leases retail stores and office equipment.  All of the retail stores
are leased under noncancellable agreements which expire at various dates through
the year 2006. The agreements,  which have been classified as operating  leases,
require the Company to pay insurance, taxes and other maintenance costs.

The following is a schedule of future minimum rental payments which are required
under operating leases that have initial or remaining noncancellable lease terms
in excess of one year as of December 31, 1996.

                  Year ending
                  December 31,                     Ner Minimun Rentals

                  1997                                  $1,113,000
                  1998                                   1,114,000
                  1999                                   1,107,000
                  2000                                   1,085,000
                  2001                                   1,086,000
                  Thereafter                             3,860,000
                                                        ----------

                                    Total               $9,365,000
                                                        =========

The  rental  expense,  including  deferred  rent,  under  operating  leases  was
$409,850, $734,588 and $1,406,392 for the years ended December 31, 1995 and 1996
and the period from December 18, 1992 (date of inception) to December 31, 1996.

Deferred  rent  results as the Company  recognizes  the cost of leases with free
rent periods and accelerating  lease payments on a straight-line  basis over the
term of the lease.


NOTE 8 - FINANCIAL ADVISORY AND CONSULTING AGREEMENT

In February 1996, the Company  entered into a financial  advisory and consulting
agreement  with an investment  banking firm to advise it on the possible sale of
additional  equity  securities,  as  well  as to  introduce  and  assist  in the
evaluation of potential merger and partnering opportunities.

The  agreement  is for a period of one year  commencing  on February 1, 1996 and
included a $100,000 retainer paid on the execution of the agreement and warrants
to purchase 100,000 shares of the Company's common stock at an exercise price of
$1.00 per share  exercisable  from the date of the  agreement  to and  including
January 31,  1997,  all of which have been  exercised  and  warrants to purchase
200,000  shares of common stock of the Company at an exercise price of $2.50 per
share  exercisable  from the date of the agreement to and including  January 31,
1998, of which all have been exercised.

Such  warrants  resulted  in a non-cash  charge of  $481,250  for the year ended
December 31, 1996 and will result in a non-cash charge of approximately  $50,000
for the year ended December 31, 1997.

                                      F-15


<PAGE>

                     THE GREAT AMERICAN BACKRUB STORE, INC.
                          (A DEVELOPMENT STAGE COMPANY)

                      NOTES TO AUDITED FINANCIAL STATEMENTS


NOTE 9 - SUBSEQUENT EVENTS

On February 5, 1997, the Company filed a registration statement to offer 270,000
shares of Series B convertible  Preferred  Stock for  approximately  $2,700,000,
which, if successful, after commissions and fees, would provide the Company with
net  proceeds  of  approximately  $2,000,000.  There is no  assurance  that this
offering will be successful.

Dividends  on the shares of the  Preferred  Stock  offered  would  accrue and be
cumulative from the date of original issue and would be payable semi-annually in
arrears  on April 1 and  October 1 of each  year in an amount  equal to $.70 per
share  per annum  payable  at the  Company's  option in cash or shares of Common
Stock based on the average reported closing price of the Common Stock.

Each share of Preferred  Stock would be  convertible at the option of the holder
thereof at any time from and after twelve months from the date of the closing of
this offering,  unless previously  redeemed,  into the greater of four shares of
Common  Stock or a number of shares of Common  Stock equal to $16.00  divided by
the average of the last reported sales price of the Common Stock up to a maximum
number of shares which has yet to be determined,  subject to further  adjustment
in certain circumstances.

The  Preferred  Stock  would be  redeemable  two years from the  closing of this
offering  with the  consent of the  Underwriter  or upon the closing of a public
offering  of the Company or five years from the  closing of this  offering.  The
Preferred Stock may be redeemed at the option of the Company in whole or part at
105% of the public  offering  price per share of Preferred  Stock,  plus in each
case accrued and unpaid dividends to the redemption date.

The  holders of  Preferred  Stock  would not be  entitled  to vote on any matter
except as required by law.

                                      F-16
<PAGE>
                                INDEX TO EXHIBITS

EXHIBIT NO.            DESCRIPTION
-----------            -----------

**3.1        Certificate of Incorporation of the Company, as amended.

 *3.2        Amendment  of   Certificate   of   Incorporation   of  the  Company
             (designating Series A Convertible Preferred Stock).

**3.3        Amended and Restated By-Laws of the Company.

**4.1        Specimen Certificate of the Company's Common Stock.

**4.2        1994 Employee Stock Option Plan.

**4.3        Nonqualified Option Agreement of Mr. Zanker.

**4.4        Nonqualified Option Agreement of Mr. Murray.

**4.5        Nonqualified Option Agreement of Mr. Thompson.

**4.6        Form of Option  Agreement  for  Options  to be  issued  to  outside
             directors upon completion of the Offering.

**10.1       Employment Agreement dated November 1, 1994 between the Company and
             William Zanker.

**10.1.1     Amendment dated February 1, 1995 to the Employment  Agreement dated
             November 1, 1994 between the Company and William Zanker.

**10.1.2     Amendment No. 2 dated February 27, 1995 to the Employment Agreement
             dated November 1, 1994 between the Company and William Zanker.

**10.2       Employment Agreement dated November 1, 1994 between the Company and
             Terrance C. Murray.

**10.2.1     Amendment dated February 1, 1995 to the Employment  Agreement dated
             November 1, 1994 between the Company and Terrance C. Murray.

**10.2.2     Amendment No. 2 dated February 27, 1995 to the Employment Agreement
             dated November 1, 1994 between the Company and Terrance C. Murray.

**10.3       Employment Agreement dated November 1, 1994 between the Company and
             Steven J. Thompson.

**10.3.1     Amendment dated February 1, 1995 to the Employment  Agreement dated
             November 1, 1994 between the Company and Steven J. Thompson.

**10.3.2     Amendment No. 2 dated February 27, 1995 to the Employment Agreement
             dated November 1, 1994 between the Company and Steven J. Thompson.

**10.4       Franchise  Agreement  dated May 14, 1994 between Emerald Desert Rub
             and the Company.

**10.5       Lease Agreement dated August 25, 1993 between 175 East 57th Street,
             Inc. and the Company concerning the Third Avenue Store.
<PAGE>

**10.6       Lease   Agreement   dated   February   1994   between  Town  Sports
             International, Inc. and the Company concerning the East 86th Street
             Store.

**10.7       Notice  of  Town   Sports   International,   Inc.  to  the  Company
             terminating the East 86th Street Store lease.

**10.7.1     Lease Extension dated February 27, 1995 relating to the 86th Street
             Store Lease.

**10.8       Lease  Agreement  dated May 15, 1994  between  Martin Cable and the
             Company.

**10.9       Sublease  Agreement  dated May 31,  1994  between  the  Company and
             Emerald Desert Rub.

**10.10      Commercial  Lease and Deposit  Receipt dated  December 31, 1994 for
             the Company's San Rafael, California office.

**10.11      Promissory  Note dated  April 5, 1994  issued to  Colonial  Capital
             Corp. for $165,000.

**10.12      Substitute  Promissory  Note  dated  November  1,  1994  issued  to
             Colonial Capital Corp. for $165,000.

**10.13      Letter  Agreement  dated  December 23, 1994 between the Company and
             Colonial Capital, Inc.

**10.14      Promissory  Note dated  April 5, 1994  issued to Gary D. Lipson for
             $50,000.

**10.15      Substitute Promissory Note dated November 1, 1994 issued to Gary D.
             Lipson for $50,000.

**10.16      Promissory  Note  dated  April 5, 1994  issued  to  Kipnis  Tescher
             Lippman Valinsky and Kain for $115,000.

**10.17      Substitute  Promissory Note dated November 1, 1994 issued to Kipnis
             Tescher Lippman Valinsky & Kain for $115,000.

**10.18      Letter  Agreement  dated  December 28, 1994 between the Company and
             Kipnis Tescher Lippman Valinsky and Kain.

**10.19      Letter of Understanding dated December 16, 1994 from the Company to
             Colonial Capital, Inc.

**10.20      Purchase  Agreement  dated June 10, 1993 by and among the  Company,
             Michael  Schub,  Linda Amori,  Ron  Rodriguez,  Debbie  Dworkin and
             William Zanker.

**10.21      Mutual  Termination  Agreement dated November 15, 1994 by and among
             the Company,  Michael Schub,  Linda Amori,  Ron  Rodriguez,  Debbie
             Dworkin and William Zanker.

**10.22      Option  Agreement  dated June 20, 1994 between Bay Area Backs I and
             the Company relating to a potential franchise agreement.

**10.23      Option  Agreement  dated June 21, 1994 between Bay Area Backs I and
             the Company relating to a potential franchise agreement.

**10.24      Letter dated  October 19, 1994 from the Company to Bay Area Backs I
             extending the term of the Option Agreements.

**10.24.1    Letter dated February 13, 1995 from the Company to Bay Area Backs I
             extending the term of the Option Agreements.
<PAGE>

**10.25      Form of Bridge Note  relating to December  1994  private  placement
             securities offering.

**10.26      The Company's  Uniform  Franchise  Offering Circular dated April 1,
             1994.

**10.27      Letter of Intent  dated June 9, 1994 between  Brookstone,  Inc. and
             the Company.

**10.28      Letter of Intent dated October 6, 1994 between Brookstone, Inc. and
             the Company.

**10.29      Assignment  of Patent  Rights dated  December 23, 1994 from William
             Zanker to the Company.

**10.30      Consulting Agreement dated March 9, 1995 between the Company and A.
             Clinton Allen.

**10.31      Option  Agreement  dated  March 9, 1995  between the Company and A.
             Clinton Allen.

**10.32      Indemnification  Letter  dated March 9, 1995 from the Company to A.
             Clinton Allen.

***10.33     Option  Agreement  dated  December  7, 1995,  by and among  Laidlaw
             Holdings, Inc., Laidlaw Equities, Inc. and the Company.

***10.34     Franchise  Termination  Agreement  dated as of May 30, 1995, by and
             between the Company and Emerald Desert Rub.

***10.35     Option  Termination  Agreement  dated  as of May 30,  1995,  by and
             between the Company and Bay Area Backs I.

***10.36     Financial Advisory and Consulting Agreement between the Company and
             Investors Associates, Inc.

*10.37       Consulting agreement dated February 1, 1996 between the Company and
             Horatio Management Services Corp.

10.38        Franchise Agreement dated November 19, 1996 between the Company and
             Roosevelt Field Partners, LLC.

10.39        Franchise Agreement dated November 20, 1996 between the Company and
             Marion Holdings, Inc., as amended December 20, 1996

10.40        Option  Agreement  dated  November 21, 1996 between the Company and
             Marylou Garcia.

10.41        Agency  Agreement  dated  November 22, 1996 between the Company and
             Investors Associates, Inc., as amended December 20, 1996.

10.42        Form of Note relating to December 1996 private placement.

10.43        Form of Warrant  relating to December  1996 private  placement,  as
             amended.

***11.1      Statement regarding Computation of Per Share Earnings.

**16.1       Letter  from  Elwell,  Cangiano,  Zdon & Dee  relating to change in
             accountants.

***21.1      Subsidiaries of the Company.
<PAGE>

-----------------

*            Incorporated by reference to the Company's  Registration  Statement
             on Form SB-2 (File No. 333-21203).

**           Incorporated by reference to the Company's  Registration  Statement
             on Form SB-2 (File No. 33-88052).

***          Incorporated  by  reference  to the  Company's  Form 10-KSB for the
             fiscal year ended December 31, 1995 (File No. 0-25334).