<PAGE>

                       SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC 20549

                                   FORM 10-QSB

(X)   QUARTERLY REPORT PURSUANT SECTION 13 OF 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 1998.

( )   TRANSITION REPORT PURSUANT SECTION 13 OF 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition period from ________ to ________

Commission file number 333-38697

                          PHYSICAL SPA & FITNESS, INC.
           (Exact name of small business as specified in its charter)


             Delaware                              13-1026995
      ----------------------                    ----------------
   (State or other jurisdiction                  (IRS Employer
   of incorporation or organization)             Identification No.)


                          12/F - 15/F Lee Theatre Plaza
                          99 Percival St., Causeway Bay
                                    Hong Kong
                    (Address of principal executive offices)

                              (852) (852) 2572-8888
                           (Issuer's telephone number)

Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities 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 such filing requirements for the past 90 days.

                              Yes   X      No
                                  ----        ----

State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable dated : June 1, 1999, 10,000,000 shares.

Transitional Small Business Disclosure Format (check one) :
                              Yes          No   X
                                  ----        ----


<PAGE>

                                TABLE OF CONTENTS



PART I  -  FINANCIAL INFORMATION                                    PAGE
                                                                    ----
   ITEM 1   -   FINANCIAL STATEMENTS

     Consolidated Statements of Operations
     for the three months ended March
     31, 1998 and 1997 (Unaudited)

     Consolidated Balance Sheets at March 31, 1998
     and December 31,1997 (Unaudited)

     Consolidated Statements of Cash Flows
     for the three months ended March 31, 1998
     and 1997 (Unaudited)

     Notes to Consolidated Financial Statements

   ITEM 2   -   MANAGEMENT'S DISCUSSION AND ANALYSIS
                OR PLAN OF OPERATION


PART II  -   OTHER INFORMATION

   ITEM 1   -   LEGAL PROCEEDINGS

   ITEM 2   -   CHANGE IN SECURITIES

   ITEM 3   -   DEFAULTS UPON SENIOR SECURITIES

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

   ITEM 5   -   OTHER INFORMATION

   ITEM 6   -   EXHIBITS AND REPORTS ON FORM 8-K


<PAGE>


                  PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
                  --------------------------------------------

                   UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
                   -------------------------------------------
         FOR THE THREE MONTHS FROM JANUARY 1, 1997 TO MARCH 31, 1997 AND
                       JANUARY 1, 1998 TO MARCH 31, 1998

                             (Amounts in thousands)

                                        Three Months
                                           Ended          Three Months Ended
                                       March 31, 1997       March 31, 1998
                                        ------------  --------------------------
                                             HK$           HK$          US$
                                        (Unaudited)   (Unaudited)   (Unaudited)
Operating Revenues
Fitness service                               9,843        27,893         3,599
Beauty treatments                            14,075        13,633         1,759
  Others                                         22            27             4
                                        ------------  ------------  ------------

Total operating revenues                     23,940        41,553         5,362
                                        ------------  ------------  ------------

Operating Expenses
Salaries and commissions                      7,549        12,416         1,603
Rent and related expenses                     6,214         9,164         1,182
Depreciation                                  2,889         5,923           764
Other selling and administrative
expenses                                      6,533         9,468         1,222
                                        ------------  ------------  ------------

Total operating expenses                     23,185        36,971         4,771
                                        ------------  ------------  ------------

Income from operations                          755         4,582           591
                                        ------------  ------------  ------------

Non-operating (income) expenses

Other (income), net                            (202)         (238)          (31)
Interest expenses                               426         1,131           146
                                        ------------  ------------  ------------

Total non-operating (income) expenses           224           893           115
                                        ------------  ------------  ------------

Income before income taxes and
minority interests                              531         3,689           476

Provision for income taxes                      423         1,063           137
                                        ------------  ------------  ------------

Income before minority interests                108         2,626           339

Minority interests                               80           252            33
                                        ------------  ------------  ------------

Net income                                       28         2,374           306
                                        ============  ============  ============

Earnings per common share                      0.00          0.24          0.03
                                        ============  ============  ============

Number of shares outstanding (in
thousands)                                   10,000        10,000        10,000
                                        ============  ============  ============



Translation of amounts from Hong Kong Dollars ("HK$") into United States Dollars
("US$") for the convenience of the reader has been made at the exchange rate
quoted by the Asian Wall Street Journal on March 31, 1998 of US$1.00 = HK$7.75.
No representation is made that the Hong Kong Dollar amounts could have been, or
could be, converted into United States Dollars, at that rate on March 31, 1998
or at any other certain rate.


<PAGE>

                  PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
                  --------------------------------------------

                       AUDITED CONSOLIDATED BALANCE SHEETS
                       -----------------------------------
                             AS OF DECEMBER 31, 1997
                                       AND
                      UNAUDITED CONSOLIDATED BALANCE SHEET
                      ------------------------------------
                              AS OF MARCH 31, 1998

         (Amounts in thousands, except number of shares and share data)

<TABLE>
<CAPTION>
                                                           December 31, 1997               March 31, 1998
                                                      --------------------------  --------------------------
                                                           HK$           US$           HK$           US$
ASSETS                                                                            (Unaudited)    (Unaudited)
------

<S>                                                       <C>            <C>          <C>            <C>
CURRENT ASSETS
Cash and cash equivalents                                   1,954           252         4,275           552
Trade receivables                                           9,573         1,235         6,681           862
Rental and utility deposits                                 7,243           935         7,757         1,001
Prepayments to vendors and suppliers and
   other current assets                                    10,826         1,396        10,110         1,305
Inventories                                                 4,022           519         4,064           524
Due from related companies                                  4,932           636         6,870           886
Due from a shareholder - current portion                    8,414         1,086           123            16
                                                      ------------  ------------  ------------  ------------
TOTAL CURRENT ASSETS                                       46,964         6,059        39,880         5,146
                                                      ------------  ------------  ------------  ------------

Due from a shareholder - non-current portion                2,361           305             -             -
Prepayments for construction-in-progress                   17,011         2,196        12,111         1,563
Property, plant and equipment, net                        106,846        13,787       112,666        14,537
                                                      ------------  ------------  ------------  ------------

TOTAL ASSETS                                              173,182        22,347       164,657        21,246
                                                      ============  ============  ============  ============

LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES
Short-term bank loans                                       5,596           722         5,317           686
Long-term bank loans - current portion                      6,269           809         1,454           188
Accounts payable and accrued expenses                       8,237         1,063        11,074         1,429
Obligations under finance leases- current portion           4,577           590         4,512           582
Deferred income                                            37,696         4,864        34,109         4,401
Deferred liabilities - current portion                        743            96           743            96
Loans from third parties                                    9,741         1,257         3,092           399
Income taxes payable                                        9,895         1,277        10,099         1,303
Taxes other than income                                     9,880         1,275         9,902         1,278
                                                      ------------  ------------  ------------  ------------

TOTAL CURRENT LIABILITIES                                  92,634        11,953        80,302        10,362
                                                      ------------  ------------  ------------  ------------

Long-term bank loans                                        6,786           876        10,188         1,315
Long-term loans from third parties                              -             -             -             -
Loans from minority shareholders of subsidiaries            5,160           666         4,200           542
Obligations under finance leases - non current portion      8,253         1,065         7,180           926
Deferred liabilities - non current portion                  4,269           551         4,083           527
Deferred taxation                                           4,574           590         4,574           590
Minority interests                                          6,689           863         6,945           896

SHAREHOLDERS' EQUITY:

Common stock, par value US$ 0.001 each, 100 million
shares authorized; 10 million shares outstanding               78            10            78            10
Cumulative translation adjustment                             131            17           125            16
Retained earnings                                          44,608         5,756        46,982         6,062
                                                      ------------  ------------  ------------  ------------

TOTAL SHAREHOLDERS' EQUITY                                 44,817         5,783        47,185         6,088
                                                      ------------  ------------  ------------  ------------

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY                173,182        22,347       164,657        21,246
                                                      ============  ============  ============  ============
</TABLE>

Translation of amounts from Hong Kong Dollars ("HK$") into United States Dollars
("US$") for the convenience of the reader has been made at the exchange rate
quoted by the Asian Wall Street Journal on March 31, 1998 of US$1.00 = HK$7.75.
No representation is made that the Hong Kong Dollar amounts could have been, or
could be, converted into United States Dollars, at that rate on March 31, 1998
or at any other certain rate.

<PAGE>

                  PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
                  --------------------------------------------

                 UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
                 -----------------------------------------------
         FOR THE THREE MONTHS FROM JANUARY 1, 1997 TO MARCH 31, 1997 AND
                        JANUARY 1, 1998 TO MARCH 31, 1998
                             (Amounts in thousands)

                                        Three Months
                                           Ended          Three Months Ended
                                       March 31, 1997       March 31, 1998
                                        ------------  --------------------------
                                             HK$           HK$          US$
CASH FLOWS FROM OPERATING ACTIVITIES:   (Unaudited)   (Unaudited)   (Unaudited)

Net income                                       28         2,374           306

Adjustments to reconcile net
   income to net cash provided by
   operating activities:
Minority interests                               80           252            33
Depreciation                                  2,889         5,923           764
Loss on disposal of fixed assets                  -           122            16

(Increase) Decrease in assets:
Trade receivables                             2,276         2,892           373
Deposits, prepayments and other current
   assets                                     3,367           202            25
Inventories                                       7           (42)           (5)
Due from related companies                      327        (1,938)         (250)

Increase (Decrease) in liabilities:
Accounts payable and accrued expenses        (3,206)        2,837           366
Deferred income                               6,808        (3,587)         (463)
Deferred liabilities                              -          (186)          (24)
Income taxes payable                         (1,787)          204            26
Taxes other than income                         (92)           22             3
Deferred taxation                                 -             -             -
                                        ------------  ------------  ------------

NET CASH PROVIDED BY OPERATING
   ACTIVITIES                                10,697         9,075         1,170
                                        ------------  ------------  ------------

CASH FLOWS FROM INVESTING ACTIVITIES:
Prepayments for construction-in-progress    (17,039)            -             -
Acquisition of property, plant and
   equipment                                 (2,206)       (6,961)         (897)
Sales proceeds from disposal of
   property, plant and equipment                  -             -             -
                                        ------------  ------------  ------------

NET CASH USED IN INVESTING ACTIVITIES       (19,245)       (6,961)         (897)
                                        ------------  ------------  ------------

CASH FLOWS FROM FINANCING ACTIVITIES
(Settlement) Proceeds of short-term bank
   loans                                       (386)         (279)          (36)
Decrease (Increase) in due from a
   shareholder                               (6,456)       10,652         1,375
Payment of dividends to a shareholders            -             -             -
Payment of dividend to minority shareholders      -             -             -
Proceeds from long-term bank loans           10,000         4,000           516
Repayment of long-term bank loans              (284)       (5,413)         (698)
Proceeds from (Settlement of) long-term
   loans from third parties                       -        (6,649)         (858)
Assumption of finance lease obligations       8,432             -             -
Capital element of finance lease rental
   payments                                  (3,024)       (1,138)         (147)
Capital contribution of the Chinese
   joint venture partner into a
   joint venture                                  -             -             -
Repayment of loans from minority
   shareholders of subsidiaries                   -          (960)         (124)
                                        ------------  ------------  ------------
NET CASH PROVIDED BY FINANCING
   ACTIVITIES                                 8,282           213            28
                                        ------------  ------------  ------------


<PAGE>

                  PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
                  --------------------------------------------

                 UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
                 -----------------------------------------------
         FOR THE THREE MONTHS FROM JANUARY 1, 1997 TO MARCH 31, 1997 AND
                        JANUARY 1, 1998 TO MARCH 31, 1998
                             (Amounts in thousands)

                                        Three Months
                                           Ended          Three Months Ended
                                       March 31, 1997       March 31, 1998
                                        ------------  --------------------------
                                             HK$           HK$          US$
                                        (Unaudited)   (Unaudited)   (Unaudited)


NET INCREASE (DECREASE) IN CASH AND CASH
   EQUIVALENTS                                 (266)        2,327           301

Cash and cash equivalents, at
   beginning of year                          2,509         1,954           252

Cumulative translation adjustments               27            (6)           (1)
                                        ------------  ------------  ------------

Cash and cash equivalents, at
   end of year                                2,270         4,275           552
                                        ============  ============  ============



Translation of amounts from Hong Kong Dollars ("HK$") into United States Dollars
("US$") for the convenience of the reader has been made at the exchange rate
quoted by the Asian Wall Street Journal on March 31, 1998 of US$1.00 = HK$7.75.
No representation is made that the Hong Kong Dollar amounts could have been, or
could be, converted into United States Dollars, at that rate on March 31, 1998
or at any other certain rate.


<PAGE>

                  PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
                  --------------------------------------------


                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                   ------------------------------------------

                 (Amounts in thousands, except number of shares,
                   per share data and unless otherwise stated)



1.       ORGANIZATION AND PRINCIPAL ACTIVITIES
----------------------------------------------

Physical Spa & Fitness Inc. ("the Company") was incorporated on September 21,
1988 under the laws of the United States of America under the name of Foreclosed
Realty Exchange Inc. The Company was incorporated with a share capital of 100
million common shares with par value of US$0.001 each. 10 million common shares
were issued and outstanding as of March 31, 1998 as adjusted for a forward split
in June 1998. The Company is a U.S. public company listed on the National
Association of Securities Dealers Automated Quotations.

Physical Beauty & Fitness Holdings Limited ("Physical Holdings") was
incorporated on March 8, 1996 under the laws of the British Virgin Islands
("BVI") with a capital of one common share being held by a shareholder ("the
Shareholder"). Physical Holdings has interests in various companies ("Operating
Subsidiaries") operating fitness and beauty centres ("Fitness Centres") and
other related businesses in Hong Kong and the People's Republic of China ("the
PRC").

Pursuant to a Share Exchange Agreement entered into between the Company and
Physical Holdings on August 8, 1996, the Shareholder transferred his controlling
interest in the outstanding stock of Physical Holdings in exchange for 80% of
the outstanding common shares of the Company. The transaction was completed on
October 21, 1996 when the Company became the ultimate holding company of
Physical Holdings and the Operating Subsidiaries. As part of the above
transaction, certain shareholders of the Company also transferred 990,000 common
shares to Goodchild Investments Limited ("Goodchild"). Accordingly, the
Shareholder and Goodchild became the major shareholders of the Company. In
February, 1998, Goodchild sold all its common shares of the Company in a public
transaction to a Japanese institutional investor.

On November 27, 1996, the Company changed its name to Physical Spa & Fitness,
Inc.

The Shareholder's interests in the fitness and beauty centres in Hong Kong and
the PRC and other related businesses were originally conducted through Physical
Health Centre Hong Kong Limited ("Physical HK"), a Hong Kong corporation
established on March 2, 1990 by two principal shareholders ("the Principal
Shareholders"), one of which is the Shareholder. In 1994, the share capital was
increased and additional shares were issued to the Principal Shareholders as
well as other shareholders.

Physical HK was established to succeed and continue the operation of two Fitness
Centres and other related businesses previously operated by the Principal
Shareholders in Hong Kong in the form of a sole proprietorship.


<PAGE>

1.       ORGANIZATION AND PRINCIPAL ACTIVITIES  (Cont'd)
----------------------------------------------

During the period from 1990 to 1997, Physical HK and Physical Holdings expanded
their scope of operations by acquiring and establishing several subsidiary
companies and by forming Sino-foreign joint ventures in the PRC to operate seven
additional Fitness Centres in Hong Kong, two in Shanghai and one in Dalian, the
PRC, and other related businesses. These subsidiary companies were all formerly
jointly-owned by the Principal Shareholders or solely by the Shareholder. The
respective equity interests were transferred by the Principal Shareholders to
Physical HK or Physical Holdings throughout 1993 to 1996 at the original cost of
the respective investments.

On October 19, 1996, 91.4% of the equity interests of Physical HK was
transferred by the Principal Shareholders and other shareholders of Physical HK
to Physical Holdings at the par value of the shares transferred. In addition,
all the equity interests of Physical HK in various subsidiaries and a
Sino-foreign joint venture were also transferred to Physical Holdings at the
recorded cost of these investments. The Company, Physical Holdings and the
Operating Subsidiaries are collectively known as the Group. They are all
distinct legal entities with limited liability.

The transfer of the Shareholder's interests in Physical Holdings and the
Operating Subsidiaries was a reorganization of companies under common control
and has been accounted for effectively as a pooling of interests, and the
consolidated financial statements of the Company have been presented as if the
Operating Subsidiaries had been owned by the Company since their date of
incorporation or acquisition by the Shareholder whichever is later.

The details of Physical Holdings and the Operating Subsidiaries and their
principal activities as of the date of this report are summarized below:

<TABLE>
<CAPTION>
                                                    Date of
                                                  acquisition/      Place of     Equity interest
            Name of Company                        formation      incorporation   owned by the      Principal activities
                                                                                     Company
--------------------------------------------- ------------------- ------------- ------------------ ---------------------------------
                                                                                 Direct  Indirect
                                                                                 ------  --------

<S>                                           <C>                 <C>            <C>       <C>     <C>
Physical Beauty & Fitness Holdings Limited    March 8, 1996       BVI             100%      -      Investment holding
   ("Physical Holdings")

Physical Health Centre Hong Kong Limited      March 2,  1990      Hong Kong      91.4%      -      Operating 5 Fitness Centres
   ("Physical HK")                                                                                    in Hong Kong

Regent Town Holdings Limited ("Regent")       September 20, 1993  BVI            92.5%      -      Investment holding

Supreme Resources Limited ("Supreme")         September 29, 1994  Hong Kong       70%       -      Operating a beauty
                                                                                                      treatment centre in Hong
                                                                                                      Kong

Physical Health Centre (Zhong Shan) Limited   September 29, 1994  Hong Kong       100%      -      Investment holding
   ("Zhongshan Physical")(formerly known as                                                           (formerly operating a
   Famerich Development Limited ("Famerich"))                                                         beauty treatment centre
                                                                                                      in Hong Kong)

Zhongshan Physical Ladies' Club Ltd. (owned   October 29, 1996    The PRC          -       95%     Operating a Fitness Centre
    by Zhongshan Physical)                                                                            in Zhongshan, the PRC

</TABLE>


<PAGE>

1.       ORGANIZATION AND PRINCIPAL ACTIVITIES  (Cont'd)
----------------------------------------------


<TABLE>
<CAPTION>
                                                    Date of
                                                  acquisition/      Place of     Equity interest
            Name of Company                        formation      incorporation   owned by the      Principal activities
                                                                                     Company
--------------------------------------------- ------------------- ------------- ------------------ ---------------------------------
                                                                                 Direct  Indirect
                                                                                 ------  --------

<S>                                           <C>                 <C>            <C>     <C>       <C>
Ever Growth Limited ("Ever Growth")           September 29, 1994  Hong Kong      100%      -       Property holding

Proline Holdings Limited ("Proline")          September 28, 1994  BVI              -     92.5%     Investment holding
   (wholly owned by Regent)

Shanghai Physical Ladies' Club Company        September 28, 1994  Hong Kong        -     92.5%     Investment holding
   Limited ("Shanghai Physical")
   (wholly owned by Proline)

Shanghai Physical Ladies' Club Co., Ltd.      September 28, 1994  The PRC          -     92.5%     Operating two Fitness
   (owned by Shanghai Physical)                                                                       Centres in Shanghai, the PRC

Mighty System Limited ("Mighty")              December 15, 1994   BVI            100%      -       Provision of marketing
                                                                                                      services for cosmetics sales

Jade Regal Holdings Limited ("Jade Regal")    March 15, 1996      BVI            100%      -       Investment holding

Physical Health Centre (Dalian) Limited       March 15, 1996      Hong Kong        -      100%     Investment holding
   ("Dalian Physical") (wholly owned
   by Jade Regal)

Dalian Physical Ladies' Club Co., Ltd.        March 15, 1996      The PRC          -      90%      Operating a Fitness
   (90% owned by Dalian Physical)                                                                     Centre in Dalian, the PRC

Star Perfection Holdings Limited              April 15, 1996      BVI            100%      -       Investment holding
   ("Star Perfection")

Physical Health Centre (Shenzhen) Limited     April 15, 1996      Hong Kong        -      100%     Investment holding
   ("Shenzhen Physical")
   (wholly-owned by Star Perfection)

Shenzhen Physical Ladies' Club Co. Ltd.       August 16, 1996     The PRC          -      90%      Operating a Fitness Centre
   Ltd. (owned by "Shenzhen Physical")                                                                in Shenzhen, the PRC

Physical Health Centre (Macau) Limited        March 21, 1997      Hong Kong      100%      -      Investment holding
   ("Macau Physical")

Physical Health Centre (Tsuen Wan) Limited    September 8, 1997   Hong Kong      100%      -       Operating a Fitness Centre
   ("Tsuen Wan Physical")                                                                             in Hong Kong

</TABLE>

Regent was originally 67% owned by Physical HK upon its incorporation. In June,
1995, Physical HK increased its equity interest to 83.5% by acquiring additional
shares issued by Regent at the par value of the shares. In June, 1996, 5% of the
equity interest of Regent owned by a minority shareholder was acquired by the
Shareholder (see Note 6(c)). All the shares owned by Physical HK and the
Shareholder were then transferred to Physical Holdings at the original cost of
their investment to Physical HK and the Shareholder.

Famerich was incorporated to operate a beauty treatment centre in Hong Kong. The
business was closed down in late 1994 and the company became dormant thereafter.
In June, 1996, Famerich changed its name to Zhongshan Physical and it then
entered into a joint venture contract to establish a Sino-foreign co-operative
joint venture for the provision of physical fitness and beauty treatment
services through a Fitness Centre in the PRC.


<PAGE>

1.       ORGANIZATION AND PRINCIPAL ACTIVITIES  (Cont'd)
----------------------------------------------

The Group operates Fitness Centres in the PRC through some of its Operating
Subsidiaries which are Sino-foreign joint ventures established in the PRC.
Detailed information in connection with these joint ventures is as follows:


<TABLE>
<CAPTION>
                                                              Term
                                    Type of      Interest     of the
   Name of the                       joint       owned by     joint    Registered
  Joint Venture      Location       venture      the Group    venture    capital     Profit sharing arrangement
----------------- -------------- -------------  -----------  --------  ------------  ---------------------------

<S>               <C>            <C>              <C>        <C>       <C>           <C>
Shanghai          Huangpu and    Co-operative     92.5%      10 years  Originally    See arrangement on p.11
Physical Ladies'  Hongqiao,                                            US$1,000 in
Club Co., Ltd.    Shanghai                                             cash and
("Shanghai JV")                                                        increased
                                                                       to US$2,000
                                                                       in cash in
                                                                       1995

Dalian Physical   Dalian         Equity            90%       12 years  Originally    Pro-rata to equity interests
Ladies' Club                                                           Rmb10,000
Co., Ltd.                                                              in cash and
("Dalian JV")                                                          changed to
                                                                       Rmb1,000
                                                                       in cash and
                                                                       Rmb9,000
                                                                       in form of
                                                                       fixed assets
                                                                       and
                                                                       renovation
                                                                       materials in
                                                                       1996

Shenzhen          Shenzhen       Co-operative      90%       10 years  HK$4,600      Pro-rata to equity interests
Physical                                                               in form of
Ladies' Club                                                           cash and
Co. Ltd.                                                               fixed assets
("Shenzhen JV")


Zhongshan         Zhongshan      Co-operative      95%       10 years  US$500 in     Pro-rata to equity interests
Physical                                                               form of
Ladies' Club                                                           cash and
Co. Ltd.                                                               fixed assets
("Zhongshan JV")

</TABLE>


<PAGE>

1.       ORGANIZATION AND PRINCIPAL ACTIVITIES  (Cont'd)
----------------------------------------------

Other special provisions of these joint ventures are summarized as follows:

Shanghai JV
-----------

Pursuant to an agreement between Physical HK and Shanghai Physical dated July
20, 1993, Shanghai Physical authorized Physical HK to enter into a joint venture
contract ("the Contract") on its behalf with the Chinese joint venture partner.
Under this agreement, benefits, rights and obligations arising from the Contract
belong to Shanghai Physical. Physical HK contributed the required capital on
behalf of Shanghai Physical.

According to the provisions of the Contract, Shanghai Physical contributed 100%
of the registered capital of the joint venture while the Chinese joint venture
partner provided the premises in which the Fitness Centres are located. Upon
dissolution of the joint venture, all fixed assets of the joint venture will be
assumed by the Chinese joint venture partner while Shanghai Physical will assume
all the working capital, debts and outstanding obligations and commitments. For
the first three years of the joint venture, the Chinese joint venture partner
will be entitled only to rent of Rmb950 per annum. Thereafter, the rental
payment will be increased by 10% per annum unless the inflation rate in the PRC
is higher than 16%. The Chinese joint venture partner has no further entitlement
to the profits of the joint venture.

Shenzhen JV
-----------

According to the laws in the PRC and the terms of the joint venture contract,
both joint venture partners are obliged to fulfill their capital contribution
requirements to the joint venture within a specified period of time after the
issue of the business license. As of the date of this report, however, both
joint venture partners have not contributed the required capital according to
the requirements of the contract. Such default in the funding obligations will
require renegotiations between the two partners and may also trigger default
remedies as specified in the joint venture contract. Further, a failure to meet
regulatory time limits set by the State Administration of Industry and Commerce
for capital contributions could result in the cancellation of the approval of
the joint venture's business license. Both joint venture partners are in the
process of applying to the relevant authorities for an extension of such time
limits.

The joint venture has not yet commenced operations as of the date of this
report.



<PAGE>

1.       ORGANIZATION AND PRINCIPAL ACTIVITIES  (Cont'd)
----------------------------------------------

Zhongshan JV
------------

Similar to the Shenzhen JV, both joint venture partners have not contributed the
required capital within the specified time limit according to the requirements
of the contract as of the date of this report. The joint venture partners are in
the process of applying for extension of such time limit from the relevant
authorities.

On August 2, 1996, a supplementary agreement was signed between the joint
venture partners to amend the provisions of the contract to the extent that all
the benefits and liabilities of the joint venture will be assumed by Zhongshan
Physical. In return, the Chinese joint venture partner will be entitled to HK$30
per annum in the form of a technology introduction fee. The Chinese joint
venture partner will not be entitled to share in the profits of the joint
venture after receipt of the technology introduction fee. The supplementary
agreement is subject to the approval of the relevant PRC authorities.

The joint venture has not yet commenced operations as of the date of this
report.

Since the Shanghai JV and the Dalian JV operate in the PRC, they are subject to
special considerations and significant risks not typically associated with
investments in equity securities of United States and Western European
companies. These include risks associated with, among others, the political,
economic and legal environments and foreign currency exchange. These are
described further in the following paragraphs:

POLITICAL ENVIRONMENT

The value of the Company's investments in the Shanghai and Dalian JVs may be
adversely affected by changes in policies by the Chinese government including,
among others, changes in laws, regulations or the interpretation thereof;
confiscatory taxation; restrictions on foreign currency conversion, imports or
sources of suppliers; or the expropriation or nationalization of private
enterprises.

ECONOMIC ENVIRONMENT

The economy of the PRC differs significantly from the economies of the United
States and Western Europe in such respects as structure, level of development,
gross national product, growth rate, capital reinvestment, resource allocation,
self-sufficiency, rate of inflation and balance of payments position, among
others. Only recently has the PRC government encouraged substantial private
economic activities.

The Chinese economy has experienced significant growth in the past five years,
but such growth has been uneven among various sectors of the economy and
geographic regions. Actions by the PRC central government to control inflation
have significantly restrained economic expansion recently. Similar actions by
the central government of the PRC in the future could have a significant adverse
effect on the economic conditions in the PRC and the economic prospects for the
Company, its subsidiaries and the China joint ventures in which the Company has
invested.


<PAGE>

1.       ORGANIZATION AND PRINCIPAL ACTIVITIES  (Cont'd)
----------------------------------------------

ECONOMIC ENVIRONMENT (CONT'D)

In recent years, the PRC economy has experienced periods of rapid economic
expansion and high rates of inflation. More recently, it has been exposed to the
economic crisis in Asia. The central government has from time to time adopted
various measures designed to stabilize the economy, regulate growth and contain
inflation. All such economic events and measures could adversely affect the
Group's results of operations and expansion plans.

FOREIGN CURRENCY EXCHANGE

The Chinese central government imposes control over its foreign currency
reserves through control over imports and through direct regulation of the
conversion of its Renminbi currency into foreign currencies. As a result, the
Renminbi was not freely convertible into foreign currencies in the past. While
recent changes in foreign exchange regulations permit the Renminbi to be
convertible under the "current account", which includes trade and service
related foreign exchange transactions, it is still not freely convertible under
the "capital account" which includes foreign direct investment.

All foreign exchange transactions involving the Renminbi must take place either
through the People's Bank of China or other institutions authorized to buy and
sell foreign currencies, or at a swap centre. Before January 1, 1994, the
exchange rates used for transactions through the People's Bank of China and
other authorized institutions were set by the government (the "official exchange
rate") from time to time whereas the exchange rates available at the swap
centres (the "swap centre rates") were determined largely by supply and demand.
The Chinese government announced the unification of the two-tier exchange rate
systems in December 1993 effective January 1, 1994. The unification brought the
official exchange rate of the Renminbi in line with the swap centre rate.

Payment for imported materials and remittance of earnings outside of the PRC are
subject to the availability of foreign currency which is dependent on the
foreign currency denominated earnings of the entity or must be arranged through
a swap centre or designated foreign exchange bank. Approval for exchange at a
swap centre is granted to joint venture enterprises for valid reasons such as
the purchase of imported materials and remittance of earnings. However, there
can be no assurance that current authorizations for foreign invested enterprises
("FIE") to retain their foreign exchange to satisfy foreign exchange liabilities
or to pay dividends will not be limited or eliminated or that FIEs such as the
Shanghai and Dalian JVs will be able to obtain sufficient foreign exchange to
pay dividends or satisfy their foreign exchange requirements. Foreign exchange
transactions under the capital account continue to require approvals from the
State Administration of Foreign Exchange, which could limit the ability of the
Shanghai and Dalian JVs to obtain foreign exchange through foreign currency
denominated debt or equity financing.

The Shanghai and Dalian JVs conduct substantially all of their business in the
PRC, and their financial performance and condition are measured in terms of
Renminbi. The revenues and income of the Shanghai and Dalian JVs are

<PAGE>

1.       ORGANIZATION AND PRINCIPAL ACTIVITIES  (Cont'd)
----------------------------------------------

FOREIGN CURRENCY EXCHANGE (CONT'D)

predominantly denominated in Renminbi, and will have to be converted to pay
dividends to the Company in United States Dollars or Hong Kong Dollars. Should
the Renminbi devalue against these currencies, such devaluation would have a
material adverse effect on the Company's income and the foreign currency
equivalent of such income repatriated by the Shanghai and Dalian JVs to the
Company. The Company currently is not able to hedge its exchange rate exposure
in the PRC because neither the banks in the PRC nor any other financial
institutions authorized to engage in foreign exchange transactions offer forward
exchange contracts.

LEGAL ENVIRONMENT

Since 1979, many laws and regulations dealing with economic matters in general
and foreign investment in particular have been enacted in the PRC. However, the
PRC still does not have a comprehensive system of laws and enforcement of
existing laws may be uncertain and sporadic.



2.       BASIS OF PRESENTATION
------------------------------

The accompanying consolidated financial statements were prepared in accordance
with generally accepted accounting principles in the United States of America
("US GAAP"). This basis of accounting differs from that used in the statutory
financial statements of the BVI and Hong Kong Operating Subsidiaries and the PRC
joint ventures, which were prepared in accordance with generally accepted
accounting principles in Hong Kong ("HK GAAP") and the accounting principles and
the relevant financial regulations applicable to enterprises with foreign
investments as established by the Ministry of Finance of China ("PRC GAAP")
respectively.


3.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
---------------------------------------------------

a.       BASIS OF CONSOLIDATION
         ----------------------

         The consolidated financial statements include the financial statements
         of the Company, its majority-owned and controlled subsidiaries and
         joint ventures. All material intercompany balances and transactions
         have been eliminated on consolidation.


<PAGE>

3.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  (Cont'd)
---------------------------------------------------

b.       REVENUE & DEFERRED INCOME
         -------------------------

         Revenue represents membership fees and service income in connection
         with the provision of physical fitness and beauty treatment services
         and other related income, net of the related sales tax, if any. Annual
         membership fees and service income and other related income are
         recognized when services are rendered. During 1996, the Company changed
         its membership policy so that the annual membership fee was replaced by
         a non-refundable membership admission fee and monthly dues. The
         admission fee is recognized as revenue on a pro-rata basis over the
         estimated membership term whereas the monthly dues are recognized as
         revenue on a monthly basis.

         Deferred income represents membership fees, admission fees and service
         fees billed but for which the related services, or portion of the
         services, have not yet been rendered.

c.       CASH AND CASH EQUIVALENTS
         -------------------------

         Cash and cash equivalents include cash on hand, demand deposits with
         banks and liquid investments with an original maturity of three months
         or less.

d.       PROPERTY, PLANT AND EQUIPMENT
         -----------------------------

         Property, plant and equipment are stated at cost less accumulated
         depreciation. Depreciation of property, plant and equipment is computed
         using the straight line method over the assets' estimated useful
         lives. The estimated useful lives are as follows:

             Leasehold land held under long-term lease       Over the lease term
             Buildings                                            20 to 50 years
             Leasehold improvements                          Over the lease term
             Machinery and equipment                               5 to 10 years
             Furniture and fixtures                                      5 years
             Computers                                              4 to 5 years
             Motor vehicles                                         4 to 5 years

         The Group recognizes an impairment loss on a fixed asset when evidence,
         such as the sum of expected future cash flows (undiscounted and without
         interest charges), indicates that future operations will not produce
         sufficient revenue to cover the related future costs, including
         depreciation, and when the carrying amount of asset cannot be realized
         through sale. Measurement of the impairment loss is based on the fair
         value of the assets.


<PAGE>

3.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  (Cont'd)
---------------------------------------------------

e.       TAXATION: INCOME TAXES
         ----------------------

         No provision for withholding or U.S. federal income taxes or tax
         benefits on the undistributed earnings and/or losses of the Company and
         its Operating Subsidiaries has been provided as the earnings of the
         Operating Subsidiaries, in the opinion of the management, will be
         reinvested indefinitely.

         Physical HK, Supreme, Zhongshan Physical, Ever Growth, Shanghai
         Physical, Dalian Physical and Shenzhen Physical, Macau Physical and
         Tsuen Wan Physical were incorporated under the laws of Hong Kong. They
         provide for Hong Kong profits tax at a rate of 16% (1997 - 16.5%) on
         the basis of their income for financial reporting purposes, adjusted
         for income and expense items which are not assessable or deductible for
         income tax purposes.

         Physical Holdings, Regent, Mighty, Proline, Jade Regal and Star
         Perfection were incorporated under the laws of BVI and under these
         laws, they are not subject to tax on income or on capital gains.

         The Shanghai and Dalian JVs, which were incorporated under the laws of
         the PRC, provide for enterprise income tax on their assessable income
         in accordance with the relevant regulations of the PRC, after
         considering all available tax benefits and allowances. They are subject
         to PRC enterprise income taxes at the applicable tax rate of 33%.

         The Group provides for deferred income taxes using the liability
         method, by which deferred income taxes are recognized for all
         significant temporary differences between the tax and financial
         statement bases of assets and liabilities. The tax consequences of
         those differences are classified as current or non-current based upon
         the classification of the related assets or liabilities in the
         financial statements. A valuation allowance is provided for the portion
         of deferred tax assets that is not currently realizable, since the
         realization of these benefits depends upon the ability of the relevant
         entity to generate income in future years.

f.       TAXATION: SALES TAX
         -------------------

         According to the tax regulations promulgated by the PRC government
         which came into effect on January 1, 1994, the Shanghai and Dalian JVs
         are subject to Business Tax ("BT") calculated at 5% on the
         gross service income received by the joint ventures.

         BT is recognized on the accrual basis. Sales revenue is recorded in the
         financial statements net of BT.


<PAGE>

3.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  (Cont'd)
---------------------------------------------------

g.       FOREIGN CURRENCY TRANSLATION
         ----------------------------

         The Company, Physical Holdings and the Hong Kong and BVI Operating
         Subsidiaries maintain their accounting books and records in Hong Kong
         Dollars ("HK$"). Foreign currency transactions during the year are
         translated into HK$ at rates of exchange prevailing at the time of the
         transactions. Monetary assets and liabilities denominated in foreign
         currencies at year end are translated at the rates of exchange
         prevailing at the balance sheet date. Non-monetary assets and
         liabilities are translated at the rates of exchange prevailing at the
         time the asset or liability was acquired. Exchange gains or losses are
         recorded in the consolidated statements of income.

         The PRC Operating Subsidiaries maintain their books and records in
         Renminbi. Foreign currency transactions are translated into Renminbi at
         the applicable exchange rate quoted by the People's Bank of China ("the
         unified exchange rate"), prevailing at the dates of the transactions.
         Monetary assets and liabilities denominated in foreign currencies are
         translated into Renminbi using the applicable unified exchange rates at
         the balance sheet date. Non-monetary assets and liabilities are
         translated at the unified exchange rate prevailing at the time the
         assets or liabilities were acquired. The resulting exchange differences
         are included in the determination of income.

         On consolidation, the financial statements of the PRC Operating
         Subsidiaries are translated into HK$ using the closing rate method,
         whereby the balance sheet items are translated into HK$ using the
         unified exchange rates at the respective balance sheet dates. The share
         capital and retained earnings are translated at historical unified
         exchange rates prevailing at the time of the transactions while income
         and expense items are translated at the average unified exchange rates
         for the years. The resultant translation differences are recorded in
         the consolidated balance sheets as cumulative translation adjustments
         which are included as a separate account in shareholders' equity in the
         accompanying balance sheets.

h.       FINANCE LEASES
         --------------

         Leases that substantially transfer to the Group all the rewards and
         risks of ownership of assets, other than legal title, are accounted for
         as finance leases.

         Fixed assets held under finance leases are initially recorded at the
         present value of the minimum lease payments at the inception of the
         leases, with equivalent liabilities categorized as appropriate under
         current or non-current liabilities.

         Finance charges, which represent the difference between the minimum
         lease payments at the inception of the leases and the fair value of the
         assets acquired, are allocated to accounting periods over the period of
         the relevant leases so as to produce a constant periodic rate of charge
         on the outstanding balances.


<PAGE>

3.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  (Cont'd)
---------------------------------------------------

i.       OPERATING LEASES
         ----------------

         Leases where substantially all the rewards and risks of ownership of
         assets remain with the lessors are accounted for as operating leases.
         Rental payments under operating leases are expensed as incurred.

j.       RELATED COMPANIES
         -----------------

         A related company is a company in which one or more of the directors or
         shareholders of the Company have direct or indirect beneficial
         interests.

k.       DEFERRED LIABILITIES
         --------------------

         Deferred liabilities represent the benefit arising from the rent-free
         period granted by lessors under operating leases. Deferred liabilities
         are used to offset against operating lease rental expenses over the
         lease term.



4.       PROPERTY, PLANT AND EQUIPMENT
--------------------------------------

                                               December 31,           March 31,
                                        --------------------------  ------------
                                            1996          1997         1998
                                        ------------  ------------  ------------
                                             HK$           HK$          HK$
                                                                    (Unaudited)
Land and buildings                            3,137         3,140         3,140
Leasehold improvements                       40,143        65,101        64,977
Machinery and equipment                      37,995        68,452        64,894
Furniture and fixtures                        6,368        12,863        12,898
Computers                                     1,586         2,283         2,468
Motor vehicles                                  728         1,090         1,090
Construction-in-progress                          -             -         9,396
Less: Accumulated depreciation              (43,040)      (46,083)      (46,197)
                                        ------------  ------------  ------------

Net book value                               46,917       106,846       112,666
                                        ============  ============  ============


As of December 31, 1997, the cost and accumulated depreciation of fixed assets
held under finance leases amounted to approximately HK$17,535 (1996 - HK$4,927)
and HK$2,555 (1996 - HK$132) respectively. As of March 31, 1998, the cost and
accumulated depreciation of fixed assets held under finance leases amounted to
approximately HK$17,535 and HK$3,635 respectively.


<PAGE>

5.       TRADE RECEIVABLES
--------------------------

Trade receivables comprised the following items:

                                               December 31,           March 31,
                                        --------------------------  ------------
                                            1996          1997         1998
                                        ------------  ------------  ------------
                                             HK$           HK$          HK$
                                                                    (Unaudited)

Balance with a beauty product vendor          9,641         8,380         6,231
Corporate beauty package receivables          4,854             -             -
Others                                          325         1,193           450
                                        ------------  ------------  ------------

                                             14,820         9,573         6,681
                                        ============  ============  ============




(a)      BALANCE WITH A BEAUTY PRODUCT VENDOR:
         -------------------------------------

         Pursuant to a marketing agreement between an Operating Subsidiary,
         Mighty, and a beauty product vendor ("the Vendor"), the Vendor agreed
         to pay marketing fees calculated at HK$500 per month from June 1994 to
         November 1994 and HK$250 per month thereafter to Mighty for marketing
         services rendered for cosmetic sales up to May, 1996. Marketing fees
         were recognised as revenue when the related services were rendered.

         The Group also purchases beauty products from the Vendor, and on
         September 30, 1996, Mighty entered into an agreement with the Vendor
         for the settlement of the then outstanding balances of HK$4,965 by
         three installments beginning December 31, 1996 to June 30, 1997. The
         first installment of HK$2,800 due on December 31, 1996 was settled by
         offsetting the cost of beauty products purchased by the Group from the
         Vendor during the 3 months from October 1 to December 31, 1996. Of the
         beauty products purchased from the Vendor in order to settle the
         marketing fee in 1996, approximately HK$3,700 remained as inventory as
         of December 31, 1996. Substantially all were subsequently consumed for
         beauty treatments or sold to customers in 1997. The second installment
         of HK$1,000 was due on March 31, 1997 and was settled in cash by the
         Vendor. The final installment due on June 30, 1997 was also satisfied
         by offsetting the cost of beauty products purchased by the Group from
         the Vendor. Substantially all of these beauty products were consumed
         for beauty treatments or sold to customers in 1997.

         The Vendor has also agreed to bear all custom duty and sales taxes in
         connection with beauty products sold to the Group and imported into and
         sold in the PRC by the Group which were estimated to be approximately
         HK$7,544 and HK$8,380 as of December 31, 1996 and 1997 respectively.
         The estimated related custom duty and sales tax liabilities have been
         included in "Taxes other than income" with a corresponding receivable
         from the Vendor being recorded in "Trade Receivable" in the
         accompanying balance sheets. The Vendor has agreed to settle the
         balances when the corresponding custom duty and sales tax are paid by
         the Group.


<PAGE>

5.       TRADE RECEIVABLES  (Cont'd)
--------------------------

(b)      CORPORATE BEAUTY PACKAGE RECEIVABLES:
         -------------------------------------

         During 1996, two Operating Subsidiaries, Regent and Jade Regal, entered
         into several agreements with a third party company ("the Package
         Subscriber") for sales of corporate beauty packages ("the Packages") at
         a consideration of approximately HK$6,900. The Packages were given away
         or resold by the Package Subscriber to its customers ("the ultimate
         users") for beauty treatments performed at the Fitness Centres of the
         Shanghai and Dalian JVs. Pursuant to the agreements, non-refundable
         redemption letters for each beauty treatment with prescribed expiry
         dates within one year of the date of the letters were issued by Regent
         and Jade Regal to the Package Subscriber which allowed the ultimate
         users to redeem the Packages at the Centres. As of December 31, 1996,
         approximately HK$6,800 of the Packages had either been redeemed by the
         ultimate customers or had expired without being redeemed. This amount
         has been included as Beauty Treatment revenue in the consolidated
         income statement of the Group for the year ended December 31, 1996.

         On September 30, 1996, Regent and Jade Regal entered into an agreement
         with the Package Subscriber for the settlement of the outstanding
         balances by three installments from December 31, 1996 to June 30, 1997.
         The first installment of HK$2,000 due on December 31, 1996 was settled
         by a deposit paid on behalf of the Group to a contractor for the
         decoration of the new premises for a Fitness Centre in Hong Kong. The
         second and third installments of HK$2,000 and HK$2,900 due on March 31,
         1997 and June 30, 1997, respectively were settled in cash.



6.       RELATED PARTY TRANSACTIONS
-----------------------------------

The Group had the following transactions with related companies:


<TABLE>
<CAPTION>
                                                                    Year Ended                  Three Months Ended
                                                                   December 31,                      March 31,
                                                      -------------------------------------  ------------------------
                                                         1995         1996         1997         1997         1998
                                                      -----------  -----------  -----------  -----------  -----------
                                                          HK$          HK$          HK$          HK$          HK$
                                                                                             (Unaudited)  (Unaudited)
<S>                                                        <C>          <C>          <C>          <C>          <C>
Rental of a director's quarters                              540          636          650          159          180
Purchase of cosmetics and beauty products                  2,246            -            -            -            -
Purchase of beauty and fitness equipment                     898            -        2,677            -          438
Sales of beauty and fitness equipment                      1,367          793            -            -            -
Prepayments for equipment related to                           -        3,961        3,961        3,961        3,961
construction-in-progress
Purchase rebate received                                   1,208            -            -            -            -
Management fee received                                       10           12           12            -            -
</TABLE>


<PAGE>

6.       RELATED PARTY TRANSACTIONS (Cont'd)
-----------------------------------

Certain general and administrative expenses incurred by the Group companies
during the relevant years on behalf of the related companies were reimbursed by
the respective related companies at cost.

The Principal Shareholders of the Group had beneficial interests in all the
aforementioned related companies or the shareholders of the related companies
were related to the Principal Shareholders.

The Group has also undertaken the following transactions with the Shareholder
who was also the director of the Group companies:

(a)      The Group made certain advances to the Shareholder during the years
         starting from September 1994 which were non interest-bearing, unsecured
         and repayable on demand. These advances were repaid in cash, by
         payments made by the Shareholder on behalf of the Group or by
         off-setting the dividends declared by the Group and payable to the
         Shareholder against the amounts owed to the Group. On March 26, 1997,
         the Group entered into a shareholder loan agreement ("the Agreement")
         with the Shareholder in respect of the outstanding balance of
         approximately $16,500 owed by the Shareholder to the Group ("the
         Shareholder's Loan") as of December 31, 1996. Pursuant to the
         Agreement, the Shareholder's Loan is unsecured and interest-bearing at
         the bank prime borrowing rate prevailing at the date of the Agreement.
         The Shareholder will repay the Loan and the interest thereon in eight
         quarterly installments from June 30, 1997 to March 31, 1999.
         Accordingly, the Shareholder's Loan was classified into current and
         non-current portions in line with the repayment schedule for
         presentation in the consolidated balance sheet as of December 31, 1997.

         On September 30, 1997, a supplemental agreement was signed between the
         Company and the Shareholder under which the Shareholder pledged
         1,500,000 shares of common stock of the Company owned by the
         Shareholder as collateral for the Shareholder's Loan.

         As of December 31, 1997 and March 31, 1998, the outstanding principal
         amount of the Shareholder's Loan and accrued interest is HK$10,775
         and HK$123 respectively.

(b)      The Shareholder has also undertaken to indemnify the Group against any
         contingent liabilities including tax liabilities and claims that may
         result from the operating activities of the Group in Hong Kong, the PRC
         and elsewhere occurring before March 31, 1998. Any such liabilities
         will be recorded as expenses by the Group.

(c)      Pursuant to loan agreements between Regent and Supreme and their
         minority shareholders, certain loans were made to Regent and Supreme by
         their minority shareholders. As of December 31, 1997 and March 31,
         1998, the outstanding loan balances amounted to approximately HK$5,160
         and HK$4,200 respectively. The loan balances are non-interest bearing
         and unsecured. The minority shareholders have agreed that the loans are
         repayable when Regent and Supreme are financially capable of doing so.


<PAGE>

7.       SHORT-TERM BANK LOANS
------------------------------

The short-term bank loans are secured and repayable within one year. Please
refer to Note 8 for details of security for such facilities.

Supplemental information with respect to the short-term bank loans was as
follows:

<TABLE>
<CAPTION>
                                                                                  Three Months
                                                                                     Ended
                                                  Year Ended December 31,          March 31,
                                        ----------------------------------------  ------------
                                            1995          1996          1997          1998
                                        ------------  ------------  ------------  ------------
                                                                                  (Unaudited)
<S>                                        <C>           <C>           <C>           <C>
Maximum amount outstanding during
the period/year                            HK$5,156      HK$5,626      HK$7,081      HK$5,577

Average amount outstanding during
the period/year                            HK$3,911      HK$4,517      HK$4,755      HK$4,015

Weighted average interest rate at the
end of the period/year                          11%           11%           11%           10%


Weighted average interest rate during
the period/year                                 11%            9%           10%           13%

</TABLE>

8.       LONG-TERM BANK LOANS
-----------------------------

Long-term bank loans bear interest at 11% p.a. on the outstanding balances. As
of December 31, 1997 and March 31, 1998, the loans are repayable as follows:

<TABLE>
<CAPTION>
                                                                    December 31     March 31,
                                                                    ------------  ------------
                                                                        1997          1998
                                                                    ------------  ------------
                                                                         HK$           HK$
Payable during the following period:                                              (Unaudited)
<S>                                                                      <C>           <C>
  Within one year                                                         6,269         1,454
  Over one year but not exceeding two years                               3,643         4,023
  Over two years but not exceeding three years                            1,270         1,709
  Over three years but not exceeding four years                           1,412         1,809
  Over four years but not exceeding five years                              461         2,647
                                                                    ------------  ------------

   Total                                                                 13,055        11,642
                                                                    ============  ============
</TABLE>

As of December 31, 1997 and March 31, 1998, the Group had various banking
facilities available from financial institutions amounting to approximately
HK$21,953 and HK$20,906 respectively. These facilities were secured by:

(i)     leasehold property in Hong Kong owned by Evergrowth;

(ii)    leasehold property in Hong Kong owned by relatives of  the Principal
        Shareholders;

(iii)   leasehold property in Hong Kong owned by a related company; and

(iv)    personal guarantees from the Principal Shareholders and their relatives.


<PAGE>

9.       PROVISION FOR INCOME TAXES
-----------------------------------

Hong Kong profits tax was provided at 16% (1997 - 16.5%) on the assessable
profits of Physical HK.

Enterprise income tax was provided at 33% on the assessable income of the
Shanghai and Dalian JVs in accordance with the relevant tax regulations of the
PRC.

The other BVI and Hong Kong Operating Subsidiaries, except Physical HK, did not
provide for any income taxes during the years as they did not have any
assessable income.

The combined tax provision for the year ended December 31, 1995 was currently
payable. For the years ended December 31, 1996 and 1997, HK$6,947 and HK$3,846
of the provisions were currently payable and HK$1,451 and HK$3,123 were
deferred. The combined tax provision in the three months ended March 31, 1998
was currently payable.

The reconciliation of the effective income tax rate based on income before
income taxes and minority interests stated in the consolidated statements of
income to the statutory income tax rate in Hong Kong, the PRC and the BVI is as
follows:

<TABLE>
<CAPTION>
                                                                                                Three Months Ended
                                                              Year Ended December 31,                March 31,
                                                      -------------------------------------  ------------------------
                                                         1995         1996         1997         1997         1998
                                                      -----------  -----------  -----------  -----------  -----------
                                                                                             (Unaudited)  (Unaudited)
<S>                                                        <C>          <C>          <C>          <C>          <C>
Weighted average statutory tax rate                        17.0%        17.1%        20.7%        80.2%        28.4%

Permanent differences
        -Non-deductible expenses                              -            -         (0.7%)          -            -

Timing differences for which no benefit has
been recognized due to establishment of
valuation allowance
        -Restatement of deferred income                     0.9%           -            -            -            -

Timing differences which give rise to the
provision of deferred taxation
        -Accelerated depreciation allowances
         on fixed assets                                      -          7.1%         3.3%           -            -
        -Restatement of deferred income                       -          1.6%         0.4%           -            -
Others                                                      0.1%           -          1.9%        (0.5%)        0.4%
                                                      -----------  -----------  -----------  -----------  -----------

Effective tax rate                                         18.0%        25.8%        25.6%        79.7%        28.8%
                                                      ===========  ===========  ===========  ===========  ===========
</TABLE>


<PAGE>

9.       PROVISION FOR INCOME TAXES  (Cont'd)
-----------------------------------

The tax impact of temporary differences between financial and taxable income
that give rise to deferred tax (assets)liabilities are principally related to
the following:

<TABLE>
<CAPTION>
                                                              December 31,         March 31,
                                                      --------------------------  -----------
                                                          1996          1997         1998
                                                      ------------  ------------  -----------
                                                           HK$           HK$          HK$
                                                                                  (Unaudited)
<S>                                                         <C>           <C>          <C>
Accelerated depreciation allowances
on fixed assets in Hong Kong                                1,753         4,574        4,574

Deferral of fitness and beauty income                        (302)            -            -

Valuation allowance for deferred tax assets                     -             -            -
                                                      ------------  ------------  -----------
   Total                                                    1,451         4,574        4,574
                                                      ============  ============  ===========

</TABLE>

10.      OBLIGATIONS and COMMITMENTS
------------------------------------

As of December 31, 1997 and March 31, 1998, the Group had the following
obligations and commitments:

a.       OPERATING LEASES
         ----------------

         Physical HK, Tsuen Wan Physical and the Shanghai and Dalian JVs lease
         the premises of their Fitness Centres. The total amount of lease
         commitments as of December 31, 1997 and March 31, 1998 amounted to
         HK$151,810 and HK$163,223 respectively payable as follows:

<TABLE>
<CAPTION>
                                                                    December 31,    March 31,
                                                                        1997          1998
                                                                    ------------  ------------
                                                                         HK$           HK$
                                                                                  (Unaudited)
        <S>                                                             <C>           <C>
        Payable during the following period:
          Within one year                                                32,450        36,420
          Over one year but not exceeding two years                      34,370        36,791
          Over two years but not exceeding three years                   26,983        30,139
          Over three years but not exceeding four years                  19,551        21,367
          Over four years but not exceeding five years                   17,527        20,646
          Thereafter                                                     20,929        17,860
                                                                    ------------  ------------

        Total lease commitments                                         151,810       163,223
                                                                    ============  ============
</TABLE>


<PAGE>

10.      OBLIGATION AND COMMITMENTS  (Cont'd)
-----------------------------------

b.       OBLIGATIONS UNDER FINANCE LEASES
         --------------------------------

         Physical HK leases fitness equipment and motor vehicles under several
         finance leases with lease terms extending from 1994 to 1999. The
         scheduled future minimum lease payments as of December 31, 1997 and
         March 31, 1998 were as follows:

<TABLE>
<CAPTION>
                                                                    December 31,    March 31,
                                                                        1997          1998
                                                                    ------------  ------------
                                                                         HK$           HK$
        Payable during the following period:                                      (Unaudited)
        <S>                                                              <C>           <C>
          Within one year                                                 5,848         5,716
          Over one year but not exceeding two years                       5,196         4,584
          Over two years but not exceeding three years                    2,204         1,943
          Over three years but not exceeding four years & thereafter      2,440         1,943
                                                                    ------------  ------------
        Total minimum lease payments                                     15,688        14,186

        Less: amount representing interest                               (2,858)       (2,494)
                                                                    ------------  ------------

        Present value of net minimum lease payments                      12,830        11,692
                                                                    ============  ============
</TABLE>

c.       LOANS FROM THIRD PARTIES
         ------------------------

         Pursuant to five separate loan agreements entered into between Physical
         HK and five third party lenders ("the Lenders") in 1995 and 1996,
         Physical HK borrowed a sum of approximately US$1,800 (HK$13,916) ("the
         Loans") from the Lenders. The Loans were originally fully repayable in
         1997 or 1998, twenty-four months after the drawdown dates ("the Loan
         Periods").

         During 1997, Physical HK repaid the sum of US$540 (HK$4,175) to two of
         the Lenders. In addition, supplemental loan agreements ("Supplemental
         Agreements") were signed between Physical HK and two of the remaining
         Lenders in November 1997. According to the Supplemental Agreements, the
         Lenders agreed to extend the loan periods and to abandon their rights
         to certain share purchase options. In return, Physical HK will pay
         interest at three percent over the prevailing prime rate during the
         extended loan period and a lump sum amount of US$60.

         In March 1998, Physical HK repaid the sum of US$860 (HK$6,649) to two
         of the remaining Lenders.


<PAGE>

d.       CAPITAL COMMITMENTS
         -------------------

         As of December 31, 1997 and March 31, 1998, the Group had outstanding
         capital commitments in relation to the purchase of fitness equipment,
         vehicles and leasehold improvements of new Fitness Centres of
         approximately HK$14,377 and HK$18,167 respectively.

         Subsequent to March 31, 1998, the Group entered into several additional
         agreements with vendors for the purchase of machinery and equipment and
         leasehold improvements totaling approximately HK$6,467.



11.      RETIREMENT PLANS
-------------------------

As stipulated by the regulations of the Chinese government, all of the Chinese
staff of the Shanghai and Dalian JVs are entitled to an annual pension on
retirement, which is equal to their basic salaries at their retirement dates.
The Chinese government is responsible for the pension liability to these retired
staff. The Shanghai and Dalian JVs are only required to make specified
contributions to the state-sponsored retirement plan calculated at 30% of the
basic salary of the staff.



12.      SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
----------------------------------------------------------

<TABLE>
<CAPTION>
                                                                                                Three Months Ended
                                                              Year Ended December 31,                March 31,
                                                      -------------------------------------  ------------------------
                                                         1995         1996         1997         1997         1998
                                                      -----------  -----------  -----------  -----------  -----------
                                                          HK$          HK$          HK$          HK$          HK$
                                                                                             (Unaudited)  (Unaudited)

<S>                                                        <C>          <C>          <C>          <C>          <C>
Cash paid for:
Interest expense                                           1,158          842        4,151          426         1,131
Income taxes                                               2,415        3,238        8,862        2,370         1,140
</TABLE>


<PAGE>

13.      OTHER SUPPLEMENTAL INFORMATION
---------------------------------------

The following items are included in the consolidated statements of income:

<TABLE>
<CAPTION>
                                                                                                Three Months Ended
                                                              Year Ended December 31,                March 31,
                                                      -------------------------------------  ------------------------
                                                         1995         1996         1997         1997         1998
                                                      -----------  -----------  -----------  -----------  -----------
                                                          HK$          HK$          HK$          HK$          HK$
                                                                                             (Unaudited)  (Unaudited)

<S>                                                       <C>          <C>          <C>           <C>          <C>
Foreign exchange gain (loss)                                 109            1          (59)           -          (17)
Interest expense on finance leases                            20          210        1,265          181          331
Interest expense on
overdrafts and bank loans                                  1,138          632        1,528          245          490
Interest expense on loans
from third parties                                             -            -        1,358            -          310
Interest income                                                1            2        1,498            -            -
Sales taxes                                                  504        1,216        1,040          310          229
Rental expenses under operating
  leases                                                  18,250       21,185       31,714        6,214        9,164
</TABLE>


14.      DEDICATED CAPITAL
--------------------------

In accordance with the relevant laws and regulations for Sino-foreign joint
venture enterprises, the Shanghai and Dalian JVs maintain discretionary
dedicated capital, which includes a general reserve fund, an enterprise
expansion fund and a staff welfare and incentive bonus fund. The Board of
Directors of the Shanghai and Dalian JVs will determine on an annual basis the
amount of the annual appropriations to dedicated capital. Since its inception,
the Dalian JV has not made any such appropriations as it incurred losses during
these periods. As of December 31, 1997 and March 31, 1998, the Board of
Directors of the Shanghai JV has not yet determined the amount of the annual
appropriations to dedicated capital.



15.      DISTRIBUTION OF PROFIT
-------------------------------

In the opinion of management, any undistributed earnings of Physical Holdings
and the Operating Subsidiaries will be reinvested indefinitely.


<PAGE>

16.      STOCK OPTION PLAN
--------------------------

The Company has a Stock Option Plan ("the Plan") which was adopted by the
Company's stockholders and its Board of Directors on April 23, 1997. Under the
Plan, the Company may issue incentive stock options, non-qualified options,
restricted stock grants, and stock appreciation rights to selected directors,
officers, advisors and employees of the Company. A total of 500,000 shares of
Common Stock of the Company are reserved for issuance under the Plan. Stock
options ("the Options") may be granted as non-qualified or incentive options.
Incentive stock options may not be granted at a price less than the fair market
value of the stock as of the date of grant while non-qualified stock options may
not be granted at a price less than 85% of the fair market value of the stock as
of the date of grant. The Plan will be administered by an Option Committee ("the
Committee") which is to be composed of two or more disinterested directors of
the Board of Directors. The Option can be exercised during a period of time
fixed by the Committee except that no option may be exercised more than ten
years after the date of grant or three years after death or disability,
whichever is later. As of the date of this report, no stock options have been
granted by the Company under the Plan.



17.      SUBSEQUENT EVENT
-------------------------

Subsequent to year end, Physical Holdings increased its equity interest of
Regent to 92.5% by acquiring additional 8 shares from a minority shareholder at
a consideration of approximately $960.


<PAGE>

 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS


              PRELIMINARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

ALL FORWARD-LOOKING STATEMENTS CONTAINED HEREIN ARE DEEMED BY THE COMPANY TO BE
COVERED BY AND TO QUALIFY FOR THE SAFE HARBOR PROTECTION PROVIDED BY THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995 THE 1995 ACT SHAREHOLDERS AND
PROSPECTIVE SHAREHOLDERS SHOULD UNDERSTAND THAT SEVERAL FACTORS GOVERN WHETHER
ANY FORWARD - LOOKING STATEMENT CONTAINED HEREIN WILL BE OR CAN BE ACHIEVED. ANY
ONE OF THOSE FACTORS COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE
PROJECTED HEREIN. THESE FORWARD - LOOKING STATEMENTS INCLUDE PLANS AND
OBJECTIVES OF MANAGEMENT FOR FUTURE OPERATIONS, INCLUDING PLANS AND OBJECTIVES
RELATING TO THE PRODUCTS AND THE FUTURE ECONOMIC PERFORMANCE OF THE COMPANY.
ASSUMPTIONS RELATING TO THE FOREGOING INVOLVE JUDGMENTS WITH RESPECT TO, AMONG
OTHER THINGS, FUTURE ECONOMIC, COMPETITIVE AND MARKET CONDITIONS, FUTURE
BUSINESS DECISIONS, AND THE TIME AND MONEY REQUIRED TO SUCCESSFULLY COMPLETE
DEVELOPMENT PROJECTS, ALL OF WHICH ARE DIFFICULT OR IMPOSSIBLE TO PREDICT
ACCURATELY AND MANY OF WHICH ARE BEYOND THE CONTROL OF THE COMPANY. ALTHOUGH THE
COMPANY BELIEVES THAT THE ASSUMPTIONS UNDERLYING THE FORWARD - LOOKING
STATEMENTS CONTAINED HEREIN ARE REASONABLE, ANY OF THOSE ASSUMPTIONS COULD PROVE
INACCURATE AND, THEREFORE, THERE CAN BE NO ASSURANCE THAT THE RESULTS
CONTEMPLATED IN ANY OF THE FORWARD - LOOKING STATEMENTS CONTAINED HEREIN WILL BE
REALIZED. BASED ON ACTUAL EXPERIENCE AND BUSINESS DEVELOPMENT, THE COMPANY MAY
ALTER ITS MARKETING, CAPITAL EXPENDITURE PLANS OR OTHER BUDGETS, WHICH MAY IN
TURN AFFECT THE COMPANY'S RESULTS OF OPERATIONS. IN LIGHT OF THE SIGNIFICANT
UNCERTAINTIES INHERENT IN THE FORWARD LOOKING STATEMENTS INCLUDED THEREIN, THE
INCLUSION OF ANY SUCH STATEMENT SHOULD NOT BE REGARDED AS A REPRESENTATION BY
THE COMPANY OR ANY OTHER PERSON THAT THE OBJECTIVES OR PLANS OF THE COMPANY WILL
BE ACHIEVED.


OVERVIEW OF COMPANY'S BUSINESS:
-------------------------------

         The Company, through its predecessor companies and its subsidiaries,
has been an established commercial operator of fitness and spa centers in Hong
Kong and China since 1986. As of March 31, 1998, the Company operated nine
facilities: six in Hong Kong and three in China. Management believes that the
Company is one of the top providers of fitness facilities and spa and beauty
treatment services in Hong Kong and China, with approximately 55,000 members.
The Company offers to its customers, at each location, access to a wide range of
U.S.- styled fitness and spa services.

         The Company was incorporated on September 21, 1988 in the state of
Delaware under the name of 'Foreclosed Realty Exchange, Inc', a development
stage company seeking acquisitions with no material assets or liabilities. Prior
to acquisition of Physical Beauty & Fitness Holdings Limited, a British Virgin
Islands corporation ('Physical Limited'), the Company had no revenue producing
operations, but planned to enter into joint ventures and/or acquisitions
originally in the area of real estate, to expand its operations. In October,
1996, the Company closed a transaction with Ngai Keung Luk (Serleo), a 100%
shareholder of Physical Limited, whereby the Company entered into a Share
Exchange Agreement with Ngai Keung Luk (Serleo), pursuant to which the Company
issued 8,000,000 pre-split shares of its Common Stock to Ngai Keung Luk (Serleo)
in exchange for all of the outstanding shares of Physical Limited (the
'Closing'). At the Closing, the then current management of the Company resigned
and was replaced by the current management of the Company. See 'Management.'

         The Company derives its revenues from two main lines of business:
fitness and spa services. The revenues derived from fitness services steadily
increased from HK$37,069,000 (US$4,783,000) in the fiscal year ended December
31, 1996 to HK$82,311,000 (US$10,621,000) in the fiscal year ended December 31,
1997. The revenue from beauty treatment decreased slightly from HK$72,260,000
(US$9,324,000) in the fiscal year ended December 31, 1996 to HK$66,496,000
(US$8,580,000), due to the Company's strategic plan to allocate more resources
to promote its fitness business. The increase in total operating revenues in
fiscal 1997 amounted to 34%.

<PAGE>

RESULTS OF OPERATIONS
---------------------

         The Company's revenues are derived from its two main lines of business
of fitness and spa services in three principal ways: sale of memberships to
fitness facilities, monthly membership fees and the sale of beauty treatments .
The sale of beauty products and exercise clothing also contributes an
insignificant amount to the total revenues. In respect to fitness services,
customers are invited to join as a member at a fee currently set at
HK$1,500(US$194) for one person. (A current promotion allows two people for
joining fee of HK$1,000 (US$129) each). A monthly subscription fee of HK$299
(US$39) is charged to each customer for the usage of the fitness center and spa
area.

         In respect to beauty treatments, the customers may purchase single
treatments, or in packages of ten or more treatments, with quantity discounts
available. There is a wide range of beauty treatments available at prices
ranging from HK$200 (US$26) to HK$3,000 (US$388).

         The following table sets forth selected income data as a percentage of
total operating revenue for the periods indicated.


RESULTS OF OPERATIONS


<TABLE>
<CAPTION>
                                                                   Year Ended                   Three Months Ended
                                                                  December 31,                       March 31,
                                                      -------------------------------------  ------------------------
                                                         1995         1996         1997         1997         1998
                                                      -----------  -----------  -----------  -----------  -----------

<S>                                                      <C>          <C>          <C>          <C>          <C>
Operating Revenues                                       100.00%      100.00%      100.00%      100.00%      100.00%
Total operating expenses                                  71.34%       71.52%       80.38%       96.85%       88.97%
Operating income                                          28.66%       28.48%       19.62%        3.15%       11.03%
Income before income taxes and minority interests         28.23%       28.52%       18.31%        2.22%        8.88%
Provision for income and deferred taxes                    5.20%        7.55%        4.68%        1.77%        2.56%
Minority interests                                         2.46%        1.99%        1.23%        0.33%        0.61%
Net income                                                20.56%       18.98%       12.40%        0.12%        5.71%
                                                      ===========  ===========  ===========  ===========  ===========
</TABLE>


THREE MONTHS ENDED MARCH 31, 1998 (UNAUDITED) COMPARED TO THREE MONTHS ENDED
MARCH 31, 1997 (UNAUDITED).
--------------------------------------------------------------------------------

         Operating Revenues. The Company' s operating revenues enjoyed strong
growth in the first three months of 1998 as compared to the first three months
of 1997. Operating revenues for the first three months of 1998 totaled
HK$41,553,000 (US$5,362,000) compared to HK$23,940,000 (US$3,089,000) in the
first three months of 1997, representing an increase of 74%. Operating revenues
derived by the Company' s fitness services increased 183% to HK$27,893,000
(US$3,599,000) compared to HK$9,843,000 (US$1,270,000) in the first three months
of 1997. Fitness revenues as a percentage of total revenues were 67% in the
first three months of 1998 as compared to 41% in the first three months of 1997.

         Operating revenues for the Company's beauty treatments totaled
HK$13,633,000 (US$1,759,000) compared to HK$14,075,000 (US$1,816,000) in the
first three months of 1997, representing a decrease of 3%. This was mainly due
to the Company' s adherence to its strategic plan to allocate more resources to
promote its fitness. Beauty revenues as a percentage of total revenues were 33%
in the first three months of 1998 as compared to 59% in the first three months
of 1997.

         Operating revenues derived from the Company' s Hong Kong locations
remain an important contributor to the Company's business, generating
HK$41,555,000 (US$5,362,000), or 91% of total operating revenues in the first
three months of 1998 as compared to HK$23,940,000 (US$3,089,000) or 81% of total
operating revenues in the first three months of 1997.

         Operating revenues derived from the Company's China locations generated
HK$3,601,000 (US$465,000) or 9% of total operating revenues in the first three
months of 1998 as compared to HK$4,489,000 (US$579,0000) or 19% of total
operating revenues in the first three months of 1997.

         Operating Expenses. The Company's operating expenses for the first
three months of 1998 totaled HK$36,971,000 (US$4,771,000) compared to
HK$23,185,000 (US$2,991,000) in the first three months of 1997, representing an
increase of 59%. The increase in the operating expenses was mainly due to a
general increase in staff salaries as a result of higher revenue generated, and
depreciation charges as well as rental expenses incurred for enhanced
facilities. Total operating expenses, after taking into account all corporate
expenses, were effectively controlled at 89% of total operating revenue as
compared to 97% of last year.

<PAGE>

         Operating expenses associated with the Company's Hong Kong locations
were HK$32,138,000 (US$4,147,000), representing an increase of 68% as compared
to HK$19,120,000 (US$2,467,000) in the first three months of 1997. Hong Kong
operating expenses represented 87% of total operating expenses in the first
three months of 1998 as compared to 82% of total operating expenses in the first
three months of 1997. The increase in operating expenses was primarily due to
additional rent and related expenses, and depreciation as a result of relocating
two branches in Mid-1997, and additional salary costs due to increased revenues.

         Operating expenses associated with the Company's China locations were
HK$4,833,000 (US$624,000), representing an increase of 19% as compared to
HK$4,065,000 (US$524,000) in the first three months of 1997. The increase in
operating expenses was primarily due to inflation and additional depreciation
charges provided for new acquired machinery. Operating expenses in China
represented 13% of total operating expenses in the first three months of 1998 as
compared to 18% of total operating expenses in the first three months of 1997.

         Total Non-Operating Expenses. Total non-operating expenses for the
first three months of 1998 totaled HK$893,000 (US$115,000) compared to total
non-operating expenses of HK$224,000 (US$29,000) in the first three months of
1997, representing an increase of HK$669,000 (US$86,000) due to additional
interest expenses incurred for bank loans.

         Provision for Income Taxes. Provision for income taxes for the first
three months of 1998 totaled HK$1,063,000 (US$137,000) compared to HK$423,000
(US$55,000) in the first three months of 1997, representing an increase of 151%.
The effective tax rate of operating income was 29% and 80% respectively. The
decrease in the effective tax rate of operating income was due to the increasing
contribution from Hong Kong operations at the income tax rate of 16% compared
with the tax rate of 33% for China operations.

         Net Income. The Company's net income for the first three months of 1998
totaled HK$2,374,000 (US$306,000) compared to HK$28,000 (US$4,000) for the first
three months of 1997, representing an increase of HK$2,346,000 (US$302,000) or
8,379%.


LIQUIDITY AND CAPITAL RESOURCES

         The Company has financed its operations primarily through cash
generated from operations, short-term bank credit, long-term bank loans, loans
from third parties (outside investors ) and minority shareholders of
subsidiaries, advances from customers relating to prepaid fitness and spa
income, and leasing arrangements with financial institutions. See Notes to
Financial Statements.

         Cash and cash equivalent balances for the three-month period ended
March 31, 1998 and the fiscal year ended December 31,1997 were HK$4,275,000
(US$552,000) and HK$1,954,000 (US$252,000). while total indebtedness at March
31, 1998 was HK$35,943,000 (US$4,638,000) and HK$46,382,000 (US$5,985,000) at
December 31, 1997.

         Net cash provided by operating activities were HK$30,494,000
(US$3,935,000), HK$31,505,000 (US$4,065,000), HK$61,806,000 (US$7,975,000) and
HK$9,075,000 (US$1,170,000) for fiscal year 1996, fiscal year 1997 and the three
month period ended March 31,1998, respectively. The Company's operating
activities are historically financed by cash flows from operations. Net cash
used in investing activities were HK$14,274,000 (US$1,842,000), HK$24,266,000
(US$3,131,000), HK$68,307,000 (US$8,813,000) and HK$6,961,000 (US$897,000) for
fiscal year 1995, fiscal year 1996, fiscal year 1997 and the three-month period
ended March 31, 1998, primarily as a result of expenditures for property, plant
and equipment. Net cash used in financing activities, which mainly include bank
loan repayments, net of proceeds from new bank loans, were HK$15,993,000
(US$2,064,000) and HK$5,740,000 (US$741,000) in fiscal year 1995 and fiscal year
1996. Net cash provided by financing activities were HK$5,887,000 (US$759,000)
and HK$213,000 (US$28,000) in the fiscal year 1997 and the three-month period
ended March 31,1998 respectively.

         The Company obtained a term loan in the amount of HK$1,000,000
(US$129,000) at an interest rate of 10.5% per annum from Shanghai Commercial
Bank Limited in fiscal year 1996 in connection with payment of rental deposits
for the new Causeway Bay center (relocation of an existing center). This loan is
secured by leasehold property in Hong Kong owned by relatives of Mr. Luk and is
repayable in one lump sum on November 6, 1997. No consideration has been paid by
the Company for such security. The Company has negotiated with the bank to
replace the loan with a new loan of HK$1,000,000 (US$129,000), at an interest
rate of 12% per annum, which is to be repaid in sixty (60) equal monthly
installment payments commencing November, 1997 and a new term loan of
HK$2,500,000 (US$323,000), at an interest rate of 12.75% per annum, which is to
be repaid within two years from the date of advance. In January, 1997 the
Company obtained an installment loan of HK$5,000,000 (US$645,000) and a term
loan of HK$5,000,000 (US$645,000) from the Kwangtung Provincial Bank. The former
is to be repaid in sixty (60) equal monthly instalment commencing March, 1997 at
an interest rate of 10.5% per annum, and the latter is to be repaid in full in
one lump sum one year from the date of advance, at an interest rate of 10% per
annum. In January, 1998 the Company repaid HK$1,000,000 (US$129,000) and the
balance of the term loan was replaced by a new installment loan of HK$4,000,000
(US$516,000) repayable in ninety-six (96) instalments commencing March, 1998, at
an interest rate of 12.75% per annum. All of these credit facilities have been
secured by the leasehold property in Hong Kong owned by a related company,
Silver Policy Development Limited. See also Notes to the Financial Statements.

<PAGE>

         The Company entered into a capital lease agreement with East Asia
Finance Company Limited in April, 1996 for the purchase of exercise equipment in
the amount of HK$1,759,200 (US$227,000) for the Dalian, China, center . The
lease is repayable in thirty six (36) monthly installments, commencing April,
1996 at an interest rate of 6.75% per annum. In addition, the Company secured a
loan of HK$3,168,000 (US$409,000) from Dao Heng Finance in August 1996 for the
equipment for a proposed new center in Zhongshan, China, however, the loan was
fully repaid in February 1997. In March, 1997 the Company entered into a capital
lease agreement with the Hongkong and Shanghai Banking Corporation Limited for
the purchase of exercise equipment in the amount of HK$7,432,320 (US$959,000)
for the centers in Hong Kong. The lease is repayable in sixty (60) monthly
installments, commencing April, 1997 at an interest rate of 11.25% per annum. In
May, 1997 the Company entered into a capital lease agreement with East Asia
Finance Company, Limited for the purchase of exercise equipment in the amount of
HK$7,742,000 (US$999,000) for the Hong Kong centers. The lease is repayable in
thirty six (36) monthly installments, commencing May, 1997 at an interest rate
of 5.75% per annum.

         The Company has revolving lines of credit with three banks - The
Kwangtung Provincial Bank (at an interest rate of 13.0%), Dao Heng Bank (at an
interest rate of 12.75%) and Shanghai Commercial Bank Limited (at interest rate
of 12.75%). As of March 31,1998, the Company had utilized HK$5.3 million
(US$684,000) out of the total lines of HK$6.1 million (US$787,000). The Company
draws down from the lines of credit primarily for general working capital
purposes.

         Consistent with the general practice of the fitness and spa industry,
the Company receives prepaid memberships to fitness facilities, which are
non-refundable, and spa treatment dues from its customers. This practice creates
working capital that the Company generally utilizes for working capital
purposes. However, the unused portion of the pre-paid membership and spa
treatment dues is characterized as deferred income, a current liability, for
accounting purposes.

         The Company's trade receivable balance at March 31, 1998 was
HK$6,681,000 (US$862,000). The Company has never experienced any significant
problems with collection of accounts receivable from its customers.

         Capital expenditures for fiscal years 1995, 1996, 1997 and the
three-month period ended March 31, 1998, were HK$20,427,000 (US$2,636,000),
HK$25,375,000 (US$3,274,000), HK$68,360,000 (US$8,820,000) and HK$6,961,000
(US$897,000) respectively. The Company believes that cash flow generated from
its operations, the proceeds from this Offering and its existing credit
facilities should be sufficient to satisfy its working capital and capital
expenditure requirements for at least the next 18 months.


        YEAR 2000 DISCLOSURE

         The Company is undergoing a system redevelopment project to improve the
efficiency of the system with respect to changing its computer programs to
properly identify a year in the year field. The cost of such new system is
estimated to be HK$800,000 (US$103,000) and the implementation time is expected
to be within one year. The Company has already obtained an estimate of the cost
from the software service company, and in the opinion of the Management such
cost can be controlled as proposed. The Company expects to incur the following
maintenance charges for the new system:

         1998                       HK$120,000 (US$15,500)
         1999                       HK$ 96,000 (US$12,400)
         2000 and onwards           HK$ 64,000 (US$8,300)

         The Company believes that the estimated cost of the new system should
not have a significant impact on the cash flow of the Company.


<PAGE>

PART II - OTHER INFORMATION

ITEM 1   -   LEGAL PROCEEDINGS

             NONE

ITEM 2   -   CHANGES IN SECURITIES

             NONE

ITEM 3   -   DEFAULTS UPON SENIOR SECURITIES

             NONE

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

             NONE

ITEM 5   -   OTHER INFORMATION

             NONE

ITEM 6   -   EXHIBITS AND REPORTS ON FORM 8-K

             The Company did not file reports on FORM 8-K during the quarter
ending March 31, 1998.


<PAGE>






                                   SIGNATURES

Pursuant to the requirements of the Exchange Act, the registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.




                                   PHYSICAL SPA & FITNESS, INC.
                                    (Registrant)

Date: June 30, 1999                   /S/Ngai Keung Luk
                                    ----------------------------------
                                    Ngai Keung Luk, Chairman and
                                    Chief Executive Officer

Date: June 30, 1999                   /S/ Robert Chui
                                    ----------------------------------
                                    Robert Chui,
                                    Chief Financial Officer