<PAGE>

                       SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC 20549

                                   FORM 10-Q

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

For the quarterly period ended March 31, 2001.

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

For the transition period from          to
                               --------    --------

Commission file number 0-26573

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


               Delaware                              98-0203281
   --------------------------------              ------------------
   (State or other jurisdiction                  (IRS Employer
   of incorporation or organization)             Identification No.)


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

                              (011) (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 : March 31, 2001, 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                            1
     for the three months ended March
     31, 2001 and 2000 (Unaudited)

     Consolidated Balance Sheets at March 31, 2001                    2
     and December 31, 2000 (Unaudited)

     Consolidated Statements of Cash Flows                            3
     for the three months ended March 31,
     2001 and 2000 (Unaudited)

     Notes to Consolidated Financial Statements                       4

   ITEM 2   -   MANAGEMENT'S DISCUSSION AND ANALYSIS                  11
                OR PLAN OF OPERATION


PART II  -   OTHER INFORMATION

   ITEM 1   -   LEGAL PROCEEDINGS                                     15

   ITEM 2   -   CHANGE IN SECURITIES                                  15

   ITEM 3   -   DEFAULTS UPON SENIOR SECURITIES                       15

   ITEM 4   -   SUBMISSION OF MATTERS TO A VOTE                       15
                OF SECURITY HOLDERS

   ITEM 5   -   OTHER INFORMATION                                     15

   ITEM 6   -   EXHIBITS AND REPORTS ON FORM 8-K                      15


<PAGE>

<TABLE>

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

                   UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
                   -------------------------------------------
           FOR THE THREE MONTHS FROM JANUARY 1, 2000 TO MARCH 31, 2000
                      AND JANUARY 1, 2001 TO MARCH 31, 2001
<CAPTION>
                                                  (Amounts in thousands)

                                                   Three Months Ended
                                                       March 31,
                                               2000               2001
                                           -----------  ------------------------
                                               HK$          HK$          US$
                                           (Unaudited)  (Unaudited)  (Unaudited)
<S>                                            <C>          <C>          <C>
Operating Revenues
Fitness service                                43,600       56,104        7,193
Beauty treatments                              23,777       26,975        3,458
Others                                              1            -            -
                                           -----------  -----------  -----------

Total operating revenues                       67,378       83,079       10,651
                                           -----------  -----------  -----------

Operating Expenses
Salaries and commissions                       20,138       24,649        3,161
Rent and related expenses                      16,857       20,252        2,596
Depreciation                                    9,348       12,128        1,555
Other selling and administrative expenses      14,942       24,043        3,082
                                           -----------  -----------  -----------

Total operating expenses                       61,285       81,072       10,394
                                           -----------  -----------  -----------

Income from operations                          6,093        2,007          257
                                           -----------  -----------  -----------

Non-operating (income) expenses

Other (income), net                              (154)         (45)          (6)
Interest expenses                                 972        1,047          134
                                           -----------  -----------  -----------

Total non-operating (income) expenses             818        1,002          128
                                           -----------  -----------  -----------

Income before income taxes and
minority interests                              5,275        1,005          129

Provision for income taxes                      1,059        1,051          135
                                           -----------  -----------  -----------

Income before minority interests                4,216          (46)          (6)

Minority interests                                127          137           18
                                           -----------  -----------  -----------

Net income                                      4,089         (183)         (24)
                                           ===========  ===========  ===========

Earnings per common share                        0.41        (0.02)     (0.0025)
                                           ===========  ===========  ===========

Number of shares outstanding (in thousands)    10,000       10,000       10,000
                                           ===========  ===========  ===========
</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 of
US$1.00 = HK$7.8. 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, 2001 or at any other certain rate.


                                      -1-


<PAGE>
<TABLE>
                  PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
                  --------------------------------------------
                       AUDITED CONSOLIDATED BALANCE SHEET
                       -----------------------------------
                             AS OF DECEMBER 31, 2000
                                       AND
                      UNAUDITED CONSOLIDATED BALANCE SHEET
                      ------------------------------------
                              AS OF MARCH 31, 2001
<CAPTION>
         (Amounts in thousands, except number of shares and share data)
                                                                                       As of
                                                               -------------------------------------------------------
                                                               December 31, 2000                  March 31, 2001
                                                                           HK$                HK$                US$
<S>                                                                     <C>                <C>                 <C>
ASSETS

Current assets
Cash and cash equivalents                                                1,759              2,479                318
Trade receivables                                                        4,827              4,693                602
Rental and utility deposits                                             15,137             15,286              1,960
Prepayments to vendors and suppliers and other current assets            6,427             10,611              1,360
Inventories                                                              2,070              2,069                265
Due from related companies                                                 915             (2,178)              (279)
Due from a stockholder                                                   2,108               (318)               (41)
                                                              -----------------  -----------------  -----------------

Total current assets                                                    33,243             32,642              4,185
                                                              -----------------  -----------------  -----------------

Bank deposits, collateralized                                            3,567              3,577                459
Prepayments for construction-in-progress                                 6,954             25,623              3,285
Property, plant and equipment, net                                     169,167            163,591             20,973
                                                              -----------------  -----------------  -----------------

Total assets                                                           212,931            225,433             28,902
                                                              =================  =================  =================

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities
Short-term bank loans                                                    8,292              6,379                818
Long-term bank loans - current portion                                   7,685              7,842              1,005
Accounts payable and accrued expenses                                   23,618             25,802              3,308
Obligations under finance leases - current portion                       4,959              7,114                912
Deferred income - current portion                                       35,873             37,786              4,844
Deferred liabilities - current portion                                   4,177              4,018                515
Income taxes payable                                                       757              1,129                145
Taxes other than income                                                  3,316              3,374                433
                                                              -----------------  -----------------  -----------------

Total current liabilities                                               88,677             93,444             11,980
                                                              -----------------  -----------------  -----------------

Deferred income - non-current portion                                    1,957              5,540                710
Deferred liabilities -  non-current portion                              4,886              6,435                825
Long-term bank loans -  non-current portion                              8,104              6,110                783
Obligations under finance leases - non-current portion                   8,191             12,834              1,646
Deferred taxation                                                        6,312              6,312                809
Minority interests                                                       6,544              6,681                857

Stockholders' equity:
Common stock, par value US$0.001 each,
   100 million shares of stock authorized;
   10 million shares of stock issued and outstanding                        78                 78                 10
Cumulative translation adjustments                                         174                174                 22
Retained earnings                                                       88,008             87,825             11,260
                                                              -----------------  -----------------  -----------------

Total stockholders' equity                                              88,260             88,077             11,292
                                                              -----------------  -----------------  -----------------

Total liabilities and stockholders' equity                             212,931            225,433             28,902
                                                              =================  =================  =================
</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 of
US$1.00 = HK$7.8. 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, 2001 or at any other certain rate.

                                      -2-


<PAGE>
<TABLE>

                  PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
                  --------------------------------------------
                 UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
                 -----------------------------------------------
           FOR THE THREE MONTHS FROM JANUARY 1, 2000 TO MARCH 31, 2000
                      AND JANUARY 1, 2001 TO MARCH 31, 2001
<CAPTION>

                                                                                           Three Months Ended March 31
                                                                                  ----------------------------------------------
                                                                                         2000           2001           2001
                                                                                          HK$            HK$            US$

<S>                                                                                      <C>             <C>              <C>
Cash flows from operating activities:
Net income                                                                                4,089           (183)             (24)

Adjustments to reconcile net income to net cash provided by operating
   activities:
    Minority interests                                                                      127             137              18
    Depreciation                                                                          9,348          12,128           1,555
    Loss on disposal of property, plant and equipment                                       196              67               9
                                                                                  --------------  --------------  --------------
Changes in working capital:
    Trade receivables                                                                        87             134              17
    Deposits, prepayments and other current assets                                       (1,068)         (4,333)           (556)
    Inventories                                                                              10               -               -
    Due from related companies                                                            2,336           3,093             397
    Due from a stockholder                                                                 (620)          2,426             311
    Accounts payable and accrued expenses                                                (4,559)          2,184             280
    Deferred income                                                                       2,389           5,496             705
    Deferred liabilities                                                                    (53)          1,390             178
    Income taxes payable                                                                   (541)            372              48
    Taxes other than income                                                                  26              58               7
    Deferred taxation                                                                         -               -               -
                                                                                  --------------  --------------  --------------

Net cash provided by operating activities                                                11,767          22,969           2,945
                                                                                  --------------  --------------  --------------

Cash flows from investing activities:
    Prepayments for construction-in-progress                                             (3,184)        (18,669)          (2,393)
    Acquisition of property, plant and equipment                                         (1,906)         (8,172)          (1,048)
    Sales proceeds from disposal of property, plant and equipment                           823           1,554              199
                                                                                  --------------  --------------  --------------

Net cash used in investing activities                                                    (4,267)        (25,287)         (3,242)
                                                                                  --------------  --------------  --------------

Cash flows from financing activities:
    Increase in bank deposits                                                                 -             (10)             (1)
    Settlement of short-term bank loans                                                  (1,562)         (1,913)           (245)
    Proceeds from long-term bank loans                                                        -               -               -
    Repayment of long-term bank loans                                                      (445)         (1,837)           (236)
    Assumption of finance lease obligations                                                   -           8,074            1,035
    Capital element of finance lease rental payments                                     (1,395)         (1,276)           (164)
                                                                                  --------------  --------------  --------------

Net cash provided by (used in) financing activities                                      (3,402)          3,038             389
                                                                                  --------------  --------------  --------------

Net increase in cash and cash equivalents                                                 4,098             720              92

Cash and cash equivalents at beginning of year                                            2,896           1,759             226

Cumulative translation adjustments                                                           11               -               -
                                                                                  --------------  --------------  --------------

Cash and cash equivalents at end of year                                                  7,005           2,479             318
                                                                                  ==============  ==============  ==============
</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 of
US$1.00 = HK$7.8. 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, 2001 or at any other certain rate.


                                      -3-


<PAGE>
                  PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES
                  --------------------------------------------

              NOTES TO UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
              ----------------------------------------------------
           FOR THE THREE MONTHS FROM JANUARY 1, 2000 TO MARCH 31, 2000
                      AND JANUARY 1, 2001 TO MARCH 31, 2001


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 shares of common stock
         with par value of US$0.001 each. The Company is a U.S. public company
         listed on the National Association of Securities Dealers
         Over-the-Counter Bulletin Board.

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

         Pursuant to a Share Exchange Agreement entered into between the Company
         and Physical Holdings on August 8, 1996, the Principal Stockholder
         transferred his controlling interest in the outstanding stock of
         Physical Holdings in exchange for 80% of the outstanding common stocks
         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.


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

         The transfer of the Principal Stockholder'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 Principal Stockholder 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>
                                                                                  EQUITY INTEREST
                                   DATE OF ACQUISITION /    PLACE OF                OWNED BY THE        PRINCIPAL
        NAME OF COMPANY            FORMATION                INCORPORATION             COMPANY           ACTIVITIES
                                                                                 Direct     Indirect
                                                                                 ------     --------
<S>                                <C>                            <C>             <C>         <C>       <C>
        Physical Holdings          March 8, 1996                  BVI             100%          -       Investment
                                                                                                        holding

        Ever Growth Limited        September 29, 1994             HK                -         100%      Property
          ("Ever Growth")                                                                               holding

        Physical Health Centre     December 1, 1998               HK                -         100%      Will operate a
          (E House) Limited                                                                             Fitness Centre
          (formerly known as                                                                            in Hong Kong
          Global Resources
          Limited)

        Jade Regal Holdings        March 15, 1996                 BVI               -         100%      Investment
          Limited                                                                                       holding
</TABLE>
--------------------------------------------------------------------------------
                                       -4-




<PAGE>
<TABLE>

PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
====================================================================================================================
(Amounts in thousands, except share and per share data)

1.      ORGANIZATION AND PRINCIPAL ACTIVITIES (CONTINUED)

<CAPTION>
                                                                                    EQUITY INTEREST
                                      DATE OF ACQUISITION     PLACE OF                OWNED BY THE        PRINCIPAL
        NAME OF COMPANY               / FORMATION             INCORPORATION             COMPANY           ACTIVITIES
                                                                                  Direct      Indirect
                                                                                  ------      --------
<S>                                   <C>                           <C>              <C>        <C>       <C>
        Physical Health Centre        March 15, 1996                 HK              -          100%      Investment
          (Dalian) Limited                                                                                holding
          ("Physical Dailan")

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

        Physical Health Centre        April 15, 1996                 HK              -          100%      Investment
          (Shenzhen) Limied                                                                               holding
          ("Physical Shenzhen")

        Physical Health Centre        November 18, 1998              HK              -          100%      Operating a
          (TST) Limited ("Physical                                                                        Fitness
          TST")                                                                                           Centre in
                                                                                                          Hong Kong

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

        Physical Health Centre        September 29, 1994             HK              -          100%      Operating a
          (Tuen Mun) Limited                                                                              Fitness
          ("Physical Tuen Mun")                                                                           Centre in
                                                                                                          Hong Kong

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

        Proline Holdings Limited      September 28, 1994             BVI             -          100%      Investment
                                                                                                          holding

        Regent Town Holdings          September 20, 1993             BVI             -          100%      Investment
          Limited ("Regent Town")                                                                         holding

        Shanghai Physical Ladies'     September 28, 1994             HK              -          100%      Investment
          Club Company Limited                                                                            holding
          ("Physical Shanghai")

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

        Supreme Resources Limited     September 29, 1994             HK              -          100%      Operating a
          ("Supreme")                                                                                     beauty
                                                                                                          treatment
                                                                                                          centre in
                                                                                                          Hong Kong

        Su Sec Pou Physical Health    August 18, 1997               Macau            -          100%      Operating a
          Centre (Macau), Limited                                                                         Fitness
                                                                                                          Centre in
                                                                                                          Macau

---------------------------------------------------------------------------------------------------------------------
</TABLE>

                                                         -5-




<PAGE>

PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
================================================================================
(Amounts in thousands, except share and per share data)

1.       ORGANIZATION AND PRINCIPAL ACTIVITIES (CONTINUED)

         The Group also operates Fitness Centres in the PRC through some of its
         Operating Subsidiaries which are Sino-foreign joint ventures ("JV")
         established in the PRC. In the opinion of the directors, the Group is
         able to govern and control the financial and operating policies and the
         board of directors of the JV. Therefore, the JV have been accounted for
         as subsidiaries. Detailed information in connection with these JV is as
         follows:

a)       Shanghai Physical Ladies' Club Co., Ltd., a Sino-foreign co-operative
         JV (the "Shanghai JV"), was established on September 7, 1993 in
         Shanghai, the PRC. The original total investment and registered capital
         of the Shanghai JV was US$1 million each and was increased to US$2
         million each in 1995. The capital contributions were to be made in
         cash. The JV period is for 10 years starting from the date of the
         business licence issued on September 7, 1993.

                  According to the provisions of the JV contract, Physical
                  Shanghai contributed 100% of the registered capital of the
                  Shanghai JV while the Chinese JV partner provided the premises
                  in which the Fitness Centres are located. Upon dissolution of
                  the JV, all the property, plant and equipment ("PPE") of the
                  Shanghai JV will be taken over by the Chinese JV partner while
                  Physical Shanghai will assume all the working capital, debts
                  and outstanding obligations and commitments.

                  For the first three years of the Shanghai JV, the Chinese JV
                  partner will be entitled only to a 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 JV partner has no further entitlement to the
                  profits of the Shanghai JV.

b)      Dalian Physical Ladies' Club Co., Ltd. is a Sino-foreign equity JV ("the
        Dalian JV") established on April 11, 1995 in Dalian, the PRC. The total
        registered capital of the Dalian JV was Reminbi (RMB) 10 million. The JV
        period is 12 years from the date of issue of the business license on
        April 11, 1995. Physical Dalian held a 90% equity interest in the Dalian
        JV and the profits or losses of the Dalian JV are to be shared by the
        venturers in proportion to their equity interests in the JV.

                  Physical Dalian contributed its share of the registered
                  capital in the form of PPE and renovation materials and the
                  Chinese venturer contributed in cash. Both venturers had
                  fulfilled their respective capital contributions as of
                  December 31, 1996. The JV commenced operation in 1996.

c)       Under the JV contract between Physical Shenzhen and a Chinese
         enterprise, Physical Shenzhen is required to contribute HK$4,140 in the
         form of cash and PPE as capital into Shenzhen Physical Ladies' Club Co.
         Ltd. within six months from the issuance of the business licence.

                  As of the date of this report, both JV partners have not
                  contributed the required capital according to the requirements
                  of the contract.

                  According to the directors, the Group has verbally agreed with
                  the Chinese enterprise to terminate the JV contract even
                  though no formal notice has yet been submitted to the PRC
                  authority.

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

                                      -6-

<PAGE>

PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
================================================================================
(Amounts in thousands, except share and per share data)

1.       ORGANIZATION AND PRINCIPAL ACTIVITIES (CONTINUED)

d)       Under the JV contract between Physical Health Centre (Zhong Shan)
         Limited (former name of Physical Tuen Mun) and a Chinese enterprise,
         Physical Zhongshan is required to contribute US$500 in the form of cash
         and PPE as capital into the JV within six months from the issuance of
         the business licence.

                  As of the date of this report, both JV partners have not
                  contributed the required capital according to the requirements
                  of the contract.

                  According to the directors, the Group has verbally agreed with
                  the Chinese enterprise to terminate the JV contract even
                  though no formal notice has yet been submitted to the PRC
                  authority.


2.       BASIS OF PRESENTATION

         The financial statements have been prepared in accordance with
         generally accepted accounting principles in the United States of
         America. This basis of accounting differs from that used in the
         statutory financial statements of the BVI and Hong Kong Operating
         Subsidiaries and the PRC JV, which were prepared in accordance with
         generally accepted accounting principles in Hong Kong and the
         accounting principles and the relevant financial regulations applicable
         to enterprises with foreign investments as established by the Ministry
         of Finance of China respectively.

         The financial statements are presented in Hong Kong dollars which is
         the Group's functional currency because the Group's operations are
         primarily located in Hong Kong. For illustrative purposes, the exchange
         rate adopted for the presentations of financial information has been
         made at HK$7.8 to US$1.00. No representation is made that the HK$
         amount could have been, or could be, converted into United States
         Dollars at that rate or at any other rate.


3.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

         b)       PREPARATION OF FINANCIAL STATEMENTS
                  The Principal Stockholder has undertaken to make available
                  adequate funds to the Group as and when required to maintain
                  the Group as a going concern. As a result, the financial
                  statements have been prepared in conformity with the
                  principles applicable to a going concern.

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

                                      -7-




<PAGE>

PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
================================================================================
(Amounts in thousands, except share and per share data)

3.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

         c)       CONTRACTUAL JOINT VENTURE
                  A contractual JV is an entity established between the Group
                  and one or more other parties with the rights and obligations
                  of the JV partners governed by a contract. In case the Group
                  owns more than 50% of the JV and is able to govern and control
                  its financial and operating policies and its board of
                  directors, such JV is considered as a de facto subsidiary and
                  is accounted for as a subsidiary.

         d)       STATEMENT OF CASH FLOWS
                  For the purposes of the statement of cash flows, the Company
                  considers all highly liquid debt instruments with an original
                  maturity within three months to be cash equivalents.

         e)       GOODWILL ON CONSOLIDATION
                  Goodwill arising on consolidation, being the excess of the
                  purchase consideration payable at the time of acquisition of
                  the subsidiaries over the fair values of the net underlying
                  assets acquired, is recognised as an expense in the period it
                  arises.

         f)       INVENTORIES
                  Inventories, mainly comprise beauty products for treatment and
                  sale, are stated at the lower of cost and net realizable
                  value. Cost, which comprises all costs of purchase and, where
                  applicable, other costs that have been incurred in bringing
                  the inventories to their present location and condition, is
                  calculated using the first-in, first-out method. Net
                  realizable value represents the estimated selling price in the
                  ordinary course of business less the estimated costs of
                  completion and the estimated costs necessary to make the sale.

         g)       PROPERTY, PLANT AND EQUIPMENT AND DEPRECIATION
                  PPE is stated at cost less accumulated depreciation.

                  The cost of an asset comprises its purchase price and any
                  directly attributable costs of bringing the asset to its
                  present working condition and location for its intended use.
                  Expenditure incurred after the assets have been put into
                  operation, such as repairs and maintenance, is normally
                  recognized as an expense in the period in which it is
                  incurred. In situations where it can be clearly demonstrated
                  that the expenditure has resulted in an increase in the future
                  economic benefits expected to be obtained from the use of the
                  assets, the expenditure is capitalized.

                  When assets are sold or retired, their costs and accumulated
                  depreciation are eliminated from the accounts and any gain or
                  loss resulting from their disposal is included in the
                  statement of operations.

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

                                      -8-

<PAGE>

PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
================================================================================
(Amounts in thousands, except share and per share data)

3.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

         g)       PROPERTY, PLANT AND EQUIPMENT AND DEPRECIATION (CONTINUED)
                  When assets are transferred between PPE and other classes of
                  assets, the cost of such an asset on transfer is deemed to be
                  the carrying amount of the asset as stated under its original
                  classification. Any previous revaluation reserve on the asset
                  is frozen upon the transfer until the retirement or disposal
                  of the asset. On the retirement or disposal of the asset, the
                  frozen revaluation reserve is transferred directly to retained
                  earnings.

                  Depreciation is provided to write off the cost of PPE over
                  their estimated useful lives from the date on which they
                  become fully operational and after taking into account their
                  estimated residual values, using the straight-line method at
                  the following rates per annum:

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

                  The Group recognizes an impairment loss on PPE 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.

         h)       REVENUE RECOGNITION
                  Revenue represents service income in connection with the
                  provision of physical fitness and beauty treatment services
                  and other related income, net of the related sales tax, if
                  any. The non-refundable admission fee is recognized as revenue
                  on a pro-rata basis over the estimated duration whereas the
                  monthly dues, service income and other related income are
                  recognized as revenue when services are rendered.

         i)       DEFERRED INCOME
                  Deferred income represents unamortized non-refundable
                  admission fees and service fees billed but for which the
                  related services, or portion of the services have not yet been
                  rendered.

         j)       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.

                  PPE 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.

                  Depreciation is provided on the cost of the assets on a
                  straight-line basis over their estimated useful lives as set
                  out in note 3(f) above. Finance charges implicit in the
                  purchase payments are charged to the statement of operations
                  over the periods of the contracts so as to produce an
                  approximately constant periodic rate of charge on the
                  remaining balances of the obligations for each accounting
                  period.

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

                                      -9-


<PAGE>

PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
================================================================================
(Amounts in thousands, except share and per share data)

3.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

         k)       OPERATING LEASES
                  Leases where substantially all the rewards and risks of
                  ownership of assets remain with the leasing company are
                  accounted for as operating leases. Rentals payable under
                  operating leases are recorded in the statement of operations
                  on a straight-line basis over the lease term.

         l)       DEFERRED LIABILITIES
                  Deferred liabilities represent the benefit arose from the
                  rent-free period of the operating leases. The deferred
                  liabilities are amortized within the lease term, and the
                  amortization is recorded in the statement of operations.

         m)       INCOME TAXES
                  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.

                  Provision for income and other related taxes have been
                  provided in accordance with the tax rates and laws in effect
                  in the various countries of operations.

                  The 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.

         n)       FOREIGN CURRENCY TRANSLATION
                  The Company and its subsidiaries maintain their accounting
                  books and records in Hong Kong Dollars ("HK$"), except for the
                  PRC JV and Macau subsidiary which maintain their accounting
                  books and records in RMB and MOP respectively. Foreign
                  currency transactions during the year are translated to HK$ at
                  the approximate rates of exchange on the dates of
                  transactions. Monetary assets and liabilities denominated in
                  foreign currencies at year end and translated at the
                  approximate rates of exchange ruling at the balance sheet
                  date. Non-monetary assets and liabilities are translated at
                  the rates of exchange prevailing at the time the asset or
                  liability was acquired. Exchange gains or losses are recorded
                  in the statements of operations.

                  On consolidation, the financial statements of the PRC JV and
                  Macau subsidiary are translated into HK$ using the closing
                  rate method, whereby the balance sheet items are translated
                  into HK$ using the exchange rates at the respective balance
                  sheet dates. The share capital and retained earnings are
                  translated at exchange rates prevailing at the time of the
                  transactions while income and expenses items are translated at
                  the average exchange rate for the year.

                  All exchange differences arising on the consolidation are
                  recorded within equity. Historically, foreign exchange
                  transactions have not been material to the financial
                  statements.

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

                                      -10-


<PAGE>

PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
================================================================================
(Amounts in thousands, except share and per share data)

3.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

         o)       RELATED PARTIES
                  Parties are considered to be related if one party has the
                  ability, directly or indirectly, to control the other party or
                  exercise significant influence over the other party in making
                  financial and operating decisions. Parties are also considered
                  to be related if they are subject to common control or common
                  significant influence.

         p)       EARNINGS PER SHARE
                  Basic earnings per share excludes dilution and is computed by
                  dividing earnings available to common shareholders by the
                  weighted average number of common shares outstanding for the
                  periods.

                  Diluted earnings per share is computed by dividing earnings
                  available to common shareholders by the weighted average
                  number of common shares outstanding adjusted to reflect
                  potentially dilutive securities. There were no potentially
                  dilutive securities outstanding during any of the years and,
                  accordingly, basic and diluted earnings per share are the
                  same.

         q)       USES OF ESTIMATES
                  The preparation of the consolidated financial statements in
                  conformity with generally accepted accounting principles
                  requires the Group's management to make estimates and
                  assumptions that affect the amounts reported in these
                  financial statements and accompanying notes. Actual amounts
                  could differ from those estimates.

         r)       ADVERTISING AND MARKETING COSTS
                  All advertising and marketing costs are to be expensed off in
                  the periods in which those costs are incurred or the first
                  time the advertising takes place.

         s)       RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
                  In December 1999, the Securities and Exchange Commission
                  issued Staff Accounting Bulletin ("SAB") 101, "Revenue
                  recognition in financial statements", which provides guidance
                  on applying generally accepted accounting principles for
                  recognizing revenue. SAB 101 is effective for fiscal years
                  beginning after December 15, 1999. The adoption of SAB 101 has
                  no material impact on the Group's consolidated financial
                  position, results of operations and cash flows.

                  In June 1999, the Financial Accounting Standards Board issued
                  SFAS No. 137, "Accounting for derivative instruments and
                  hedging activities" which delayed the effective date of SFAS
                  No. 133 "Accounting for derivative instruments and hedging
                  activities" for one year. SFAS No. 133 provides guidance for
                  the recognition and measurement of derivatives and hedging
                  activities. It requires an entity to record, at fair value,
                  all derivatives as either assets or liabilities in the balance
                  sheet, and it establishes specific accounting rules for
                  certain types of hedges. SFAS No. 133 is now effective for
                  fiscal years beginning after June 15, 2000 and will be adopted
                  by the Group when required, if not earlier. The impact, if
                  any, of adopting SFAS No. 133 on the Group's consolidated
                  financial position, results of operations and cash flows, has
                  not been finalized.

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

                                      -11-

<PAGE>

PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
================================================================================
(Amounts in thousands, except share and per share data)

3.       SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

         s)       RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS (CONTINUED)
                  In March 2000, the Financial Accounting Standards Board issued
                  FIN No. 44, "Accounting for certain transactions involving
                  stock compensation". FIN No. 44 provides guidance for applying
                  APB Opinion No. 25, "Accounting for stock issued to
                  employees". With certain exceptions, FIN No. 44 applies
                  prospectively to new awards, exchange of awards in a business
                  combination, after July 1, 2000. The implementation of FIN No.
                  44 did not have a material effect on the Company's results of
                  operations.

4.       SHORT-TERM BANK LOANS

         The short-term bank loans are collateralized and repayable within one
         year.

5.       LONG-TERM BANK LOANS

         The Group obtained various lines of credit under banking facilities
         from creditworthy commercial banks in HK to finance its operations.
         These loans were collateralized by certain of the assets of the Group
         and its stockholders.

         The collateral of the loans include:

         (i)      leasehold property in Hong Kong owned by Ever Growth;

         (ii)     fixed deposits owned by Physical Tsuen Wan and Physical TST;

         (iii)    leasehold property in Hong Kong owned by relatives of the
                  Principal Stockholder;

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

         (v)      personal guarantees from the Principal Stockholder.


6.      OBLIGATIONS UNDER FINANCE LEASES

         Physical HK and Physical TST lease fitness equipment and motor vehicles
         under several finance leases.


7.      RETIREMENT PLAN

         The Group did not operate any retirement plan before December 2000.
         Following the implementation of the Mandatory Provident Fund ("MPF") in
         Hong Kong with effect from December 2000, the Group operates a MPF plan
         for its Hong Kong employees. The assets of the MPF are held separately
         from those of the Group in a provident fund managed by an independent
         trustee. The Group is required to make contributions to the MPF in
         January 2001 and accordingly, no pension expenses have been incurred by
         the Group during the years ended December 31, 1998, 1999 and 2000.

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

                                      -12-

<PAGE>

PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES

NOTES TO FINANCIAL STATEMENTS
================================================================================
(Amounts in thousands, except share and per share data)

8.       DISTRIBUTION OF PROFIT

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


9.       STOCK OPTION PLAN

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


                                      -13-


<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.  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. The Company currently operates eleven 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 70,000 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 (6,000,000 post-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.



                                      -14-


<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$800(US$103) for one person. (A current promotion allows a special fee of
HK$300 (US$38)). A monthly subscription fee of HK$299 (US$38) 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$400 (US$51) to HK$13,000 (US$1,670).

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


RESULTS OF OPERATIONS

<TABLE>
<CAPTION>

                                                           Three Months Ended
                                                                 March 31
                                                            2000         2001
                                                        -----------  -----------

<S>                                                         <C>         <C>
Operating Revenues                                          100.00%     100.00%

Total operating expenses                                     90.96%      97.58%

Operating income                                              9.04%       2.42%

Income before income taxes and minority
interests                                                     7.83%       1.21%

Provision for income and deferred taxes                       1.57%       1.27%

Minority interests                                            0.19%       0.16%

Net income                                                    6.07%      (0.22%)
                                                        ===========  ===========
</TABLE>


THREE MONTHS ENDED MARCH 31, 2001 (UNAUDITED) COMPARED TO THREE MONTHS ENDED
MARCH 31, 2000 (UNAUDITED).
----------------------------------------------------------------------------

         OPERATING REVENUES. The Company's operating revenues showed the
continuous growth in the first three months of 2001 as compared to the first
three months of 2000. Operating revenues for the first three months of 2001
totaled HK$83,079,000 (US$10,651,000) compared to HK$67,378,000 (US$8,638,000)
in the first three months of 2000, representing an increase of 23%. Operating
revenues derived by the Company's fitness services increased 29% to
HK$56,104,000 (US$7,193,000) compared to HK$43,600,000 (US$5,590,000) in the
first three months of 2000. Fitness revenues as a percentage of total revenues
were 68% in the first three months of 2001 as compared to 65% in the first three
months of 2000.

         Operating revenues from the Company's beauty treatment business totaled
HK$26,975,000 (US$3,458,000) compared to HK$23,777,000 (US$3,048,000) in the
first three months of 2000, representing an increase of 13%. Beauty treatment
revenues as a percentage of total revenues were 32% in the first three months of
2001 as compared to 35% in the first three months of 2000.


                                      -15-


<PAGE>

         Operating revenues derived from the Company's Hong Kong locations
remain an important contributor to the Company's business, generating
HK$75,920,000 (US$9,733,000), or 91% of total operating revenues in the three
months ended March 31, 2001 as compared to HK$63,492,000 (US$8,140,000) or 94%
of total operating revenues in the three months ended March 31, 2000.

         Operating revenues derived from the Company's China locations generated
HK$7,159,000 (US$918,000), or 9% of total operating revenues in the three months
ended March 31, 2001 as compared to HK$3,886,000 (US$498,000) or 6% of total
operating revenues in the three months ended March 31, 2000.

         OPERATING EXPENSES. The Company's operating expenses for the first
three months of 2001 totaled HK$81,072,000 (US$10,394,000) compared to
HK$61,285,000 (US$7,857,000) in the first three months of 2000, representing an
increase of 32%. Total operating expenses, after taking into account all
corporate expenses, were 98% of total operating revenue as compared to 91% of
last year. This reflects the additional costs incurred by the Company in
following its business expansion plan.

         Operating expenses associated with the Company's Hong Kong locations
were HK$71,628,000 (US$9,183,000) in the three months ended March 31, 2001,
representing an increase of 28% as compared to HK$56,057,000 (US$7,187,000) in
2000. Hong Kong operating expenses represented 88% of total operating expenses
in the three months ended March 31, 2001 as compared to 91% in 2000. The
increase was primarily due to additional expenses of HK$5,605,000 (US$719,000)
incurred by a new branch in Tuen Mun, Hong Kong which opened in July 2000, and
additional marketing expenses of HK$3,800,000 (US$487,000) in association with
the new membership referral program initiating in April 2000.

         Operating expenses associated with the Company's China locations were
HK$9,444,000 (US$1,211,000) in the three months ended March 31, 2001,
representing an increase of 81% as compared to HK$5,228,000 (US$670,000) in 2000
primarily due to an additional expense of HK$4,034,000 (US$517,000) incurred by
the Macau center which opened in October 2000. Operating expenses in China
represented 12% of total operating expenses in the three months ended March 31,
2001 as compared to 9% in 2000.

         TOTAL NON-OPERATING EXPENSES. Total non-operating expenses for the
first three months of 2001 totaled HK$1,002,000 (US$128,000) compared to
HK$818,000 (US$105,000) in the first three months of 2000. This represents an
increase of 22% mainly due to higher interest costs incurred in the period.

         PROVISION FOR INCOME TAXES. Provision for income taxes for the first
three months of 2001 totaled HK$1,051,000 (US$135,000) compared to HK$1,059,000
(US$136,000) in the first three months of 2000, representing a decrease of 0.8%.
The effective tax rate of operating income was 105% as compared to 20% of last
year.

         NET INCOME. The Company has suffered a loss of HK$183,000 (US$24,000)
for the first three months of 2001, compared to a net income of HK$4,089,000
(US$524,000) for the first three months of 2000, representing a decrease of
104%. The decrease reflects the additional overhead associated with the opening
of new centers not yet recovered by their additional contribution.

LIQUIDITY AND CAPITAL RESOURCES

         The Company has financed its operations primarily through cash
generated from operations, short-term bank credit, long-term bank loans,
advances from customers relating to prepaid fitness and spa income, and leasing
arrangements with financial institutions.

         Cash and cash equivalent balances for the respective periods ended
March 31, 2001 and December 31, 2000 were HK$2,479,000 (US$318,000) and
HK$1,759,000 (US$226,000), while total indebtedness at March 31, 2001 was
HK$40,279,000 (US$5,164,000) and HK$37,231,000 (US$4,773,000) at December 31,
2000.

         Net cash provided by operating activities were HK$76,854,000
(US$9,853,000) and 22,969,000 (US$2,945,000) for Fiscal Year 2000, and the
three-month period ended March 31, 2001, respectively. The Company's operating
activities are historically financed by cash flows from operations. Net cash
used in investing activities were HK$78,127,000 (US$10,016,000) and
HK$25,287,000 (US$3,242,000) for Fiscal Year 2000 and the three-month period
ended March 31, 2001, primarily as a result of expenditures for property, plant
and equipment. Net cash provided by financing activities, which mainly include
proceeds from bank loans, net interest and repayment, were HK$81,000 (US$11,000)
and HK$3,038,000 (US$389,000)) in Fiscal Year 2000 and the three-month period
ended March 31, 2001, respectively.

                                      -16-


<PAGE>

         The Company's long-term loans bear interest rates varying from 5.75% to
10% per annum. The total balance outstanding as of March 31, 2001 on such loans
was HK$13,952,000 (US$1,789,000). The last repayment on the loans is due in
2006. The Company also had various banking facilities available from financial
institutions amounting to approximately HK$17,000,000 (US$2,179,000). These
facilities were secured by certain leasehold property in Hong Kong owned by the
Company's subsidiary (Ever Growth Limited), fixed deposits owned by the
Company's subsidiaries (Physical Health Centre (TST) Limited and Physical Health
Centre (Tsuen Wan) Limited), relatives of Mr. Luk, related company and personal
guarantees from Mr. Luk, respectively.

         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 liability, for accounting
purposes.

         The Company's trade receivable balance at March 31, 2001, was
HK$4,693,000 (US$602,000). The Company has never experienced any significant
problems with collection of accounts receivable from its customers.

         Capital expenditure for Fiscal Year 2000, and the three-month period
ended March 31, 2001, were HK$71,934,000 (US$9,222,000) and HK$8,172,000
(US$1,048,000) respectively. The Company believes that cash flow generated from
its operations and its existing credit facilities should be sufficient to
satisfy its working capital and capital expenditure requirements for at least
the next 12 months.

        YEAR 2000 DISCLOSURE

         The Year 2000 Issue is the result of computer programs being written
using two digits rather than four digits to define the applicable year. Computer
programs that have sensitive software may recognize a date using "00" as the
year 1900 rather than the year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar normal business activities.

         The Company underwent 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 new system which is year 2000
compliant was implemented by July 1, 1999.


                                      -17-


<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

          NONE


                                      -18-


<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: May 17, 2001                  /s/Ngai Keung Luk
                                    ------------------------------------
                                    Ngai Keung Luk,
                                    Chairman and Chief Executive Officer

Date: May 17, 2001                  /s/ Robert Chui
                                    ------------------------------------
                                    Robert Chui,
                                    Chief Financial Officer