<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, 1999.

( )   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)

                              (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 : 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, 1999 and 1998 (Unaudited)

     Consolidated Balance Sheets at March 31, 1999
     and December 31,1998 (Unaudited)

     Consolidated Statements of Cash Flows
     for the three months ended March 31, 1999
     and 1998 (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>
<TABLE>

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

                   UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
                   -------------------------------------------
           FOR THE THREE MONTHS FROM JANUARY 1, 1998 TO MARCH 31, 1998
                     AND JANUARY 1, 1999 TO MARCH 31, 1999
<CAPTION>

                                               (Amounts in thousands)
                                         Three Months
                                             Ended
                                           March 31,     Three Months Ended
                                             1998          March 31, 1999
                                         -------------   --------------------
                                                HK$       HK$        US$
                                            (Unaudited)(Unaudited)(Unaudited)
<S>                                            <C>         <C>       <C>
Operating Revenues
Fitness service                                27,893      36,915     4,763
Beauty treatments                              13,633      17,099     2,206
Others                                             27           5         1
                                             ---------   --------- ---------

Total operating revenues                       41,553      54,019     6,970
                                             ---------   --------- ---------

Operating Expenses
Salaries and commissions                       12,416      12,849     1,658
Rent and related expenses                       9,164      12,527     1,616
Depreciation                                    5,923       6,902       891
Other selling and administrative expenses       9,468      15,323     1,977
                                             ---------   --------- ---------

Total operating expenses                       36,971      47,601     6,142
                                             ---------   --------- ---------

Income from operations                          4,582       6,418       828
                                             ---------   --------- ---------

Non-operating (income) expenses

Other (income), net                              (238)        (53)       (7)
Interest expenses                               1,131         735        94
                                             ---------   --------- ---------

Total non-operating (income) expenses             893         682        87
                                             ---------   --------- ---------

Income before income taxes and
minority interests                              3,689       5,736       741

Provision for income taxes                      1,063         997       130
                                             ---------   --------- ---------

Income before minority interests                2,626       4,739       611

Minority interests                                252         266        34
                                             ---------   --------- ---------

Net income                                      2,374       4,473       577
                                             =========   ========= =========

Earnings per common share                        0.24        0.45      0.06
                                             =========   ========= =========

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 quoted by the Asian Wall Street Journal on March 31,
1999 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, 1999 or at any other certain rate.


<PAGE>
<TABLE>

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

                      AUDITED CONSOLIDATED BALANCE SHEETS
                      -----------------------------------
                             AS OF DECEMBER 31, 1998
                                       AND
                      UNAUDITED CONSOLIDATED BALANCE SHEET
                      ------------------------------------
                              AS OF MARCH 31, 1999
<CAPTION>

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

                                                 December 31,
                                                     1998               March 31, 1999
                                                --------------      ----------------------
                                                     HK$                HK$        US$
  ASSETS                                                            (Unaudited)(Unaudited)
  ------                                                            ----------------------

<S>                                                   <C>             <C>         <C>
CURRENT ASSETS
Cash and cash equivalents                               1,721           5,872        758
Trade receivables                                       7,364           7,267        938
Rental and utility deposits                             9,829           9,895      1,277
Prepayments to vendors and suppliers and
   other current assets                                 5,232           4,550        585
Inventories                                             2,504           2,494        322
Due from related companies                              8,413           9,579      1,236
Due from a shareholder - current portion                4,404           4,937        637
                                                    ----------      ---------- ----------
TOTAL CURRENT ASSETS                                   39,467          44,594      5,753
                                                    ----------      ---------- ----------

Due from a shareholder - non-current portion                -               -          -
Prepayments for construction-in-progress                6,614          11,836      1,527
Property, plant and equipment, net                    127,774         122,290     15,779
                                                    ----------      ---------- ----------

TOTAL ASSETS                                          173,855         178,720     23,059
                                                    ==========      ========== ==========

LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------

CURRENT LIABILITIES
Short-term bank loans                                   6,232           6,196        799
Long-term bank loans - current portion                  4,327           4,156        536
Accounts payable and accrued expenses                  21,362          21,059      2,717
Obligations under finance leases- current portion       4,924           4,257        549
Deferred income                                        30,098          32,933      4,249
Deferred liabilities                                    4,269           4,083        527
Loans from third parties                                    -               -          -
Income taxes payable                                    4,066           3,594        464
Taxes other than income                                 8,952           8,961      1,156
                                                    ----------      ---------- ----------

TOTAL CURRENT LIABILITIES                              84,230          85,239     10,997
                                                    ----------      ---------- ----------

Long-term bank loans                                    6,519           6,234        804
Long-term loans from third parties                          -               -          -
Loans from minority shareholders of subsidiaries        4,200           4,200        542
Obligations under finance leases - non current
 portion                                                4,215           3,626        468
Deferred taxation                                       4,712           4,712        608
Minority interests                                      7,835           8,100      1,045

SHAREHOLDERS' EQUITY:

Common stock, par value US$ 0.001 each, 100
million shares authorized; 10 million
shares outstanding                                         78              78         10
Cumulative translation adjustment                         116             108         14
Retained earnings                                      61,950          66,423      8,571
                                                    ----------      ---------- ----------

TOTAL SHAREHOLDERS' EQUITY                             62,144          66,609      8,595
                                                    ----------      ---------- ----------

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY            173,855         178,720     23,059
                                                    ==========      ========== ==========

</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,
1999 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, 1999 or at any other certain rate.


<PAGE>
<TABLE>

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

                 UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
                 -----------------------------------------------
           FOR THE THREE MONTHS FROM JANUARY 1, 1998 TO MARCH 31, 1998
                     AND JANUARY 1, 1999 TO MARCH 31, 1999
<CAPTION>

                                                             (Amounts in thousands)
                                                       Three Months
                                                           Ended
                                                         March 31,   Three Months Ended
                                                           1998        March 31, 1999
                                                        ----------- ---------------------
                                                           HK$         HK$         US$
CASH FLOWS FROM OPERATING ACTIVITIES:                   (Unaudited) (Unaudited) (Unaudited)

<S>                                                         <C>        <C>         <C>
Net income                                                   2,374      4,473        577

Adjustments to reconcile net income to net cash
  provided by operating activities:
Minority interests                                             252        266         34
Depreciation                                                 5,923      6,902        891
Loss on disposal of fixed assets                               122         18          2

(Increase) Decrease in assets:
Trade receivables                                            2,892         97         12
Deposits, prepayments and other current assets                 202        616         79
Inventories                                                    (42)        10          2
Due from related companies                                  (1,938)    (1,166)      (150)

Increase (Decrease) in liabilities:
Accounts payable and accrued expenses                        2,837       (303)       (39)
Deferred income                                             (3,587)     2,835        365
Deferred liabilities                                          (186)      (186)       (24)
Income taxes payable                                           204       (472)       (61)
Taxes other than income                                         22          9          1
Deferred taxation                                                -          -          -
                                                         ---------- ---------- ----------

NET CASH PROVIDED BY OPERATING ACTIVITIES                    9,075     13,099      1,689
                                                         ---------- ---------- ----------

CASH FLOWS FROM INVESTING ACTIVITIES:
Prepayments for construction-in-progress                         -     (5,223)      (674)
Acquisition of property, plant and equipment                (6,961)    (1,837)      (236)
Sales proceeds from disposal of property,
  plant and equipment                                            -        401         52
                                                         ---------- ---------- ----------

NET CASH USED IN INVESTING ACTIVITIES                       (6,961)    (6,659)      (858)
                                                         ---------- ---------- ----------

CASH FLOWS FROM FINANCING ACTIVITIES
(Settlement) Proceeds of short-term bank loans                (279)       (36)        (5)
Decrease (Increase) in due from a shareholder               10,652       (533)       (69)
Payment of dividends to a shareholders                           -          -          -
Payment of dividend to minority shareholders                     -          -          -
Proceeds from long-term bank loans                           4,000          -          -
Repayment of long-term bank loans                           (5,413)      (456)       (59)
Proceeds from (Settlement of) long-term
  loans from third parties                                  (6,649)         -          -
Assumption of finance lease obligations                          -          -          -
Capital element of finance lease rental payments (1,138)    (1,256)      (161)
Capital contribution of the Chinese joint
  venture partner into a joint venture                           -          -          -
Repayment of loans from minority
  shareholders of subsidiaries                                (960)         -          -
                                                         ---------- ---------- ----------

NET CASH PROVIDED BY FINANCING ACTIVITIES                      213     (2,281)      (294)
                                                         ---------- ---------- ----------

</TABLE>


<PAGE>

<TABLE>
                  PHYSICAL SPA & FITNESS INC. AND SUBSIDIARIES


                 UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
                 -----------------------------------------------
           FOR THE THREE MONTHS FROM JANUARY 1, 1998 TO MARCH 31, 1998
                     AND JANUARY 1, 1999 TO MARCH 31, 1999
<CAPTION>

                                                             (Amounts in thousands)

                                                       Three Months
                                                           Ended
                                                         March 31,   Three Months Ended
                                                           1998        March 31, 1999
                                                        ----------- ---------------------
                                                           HK$         HK$         US$
                                                        (Unaudited) (Unaudited) (Unaudited)

<S>                                                          <C>        <C>          <C>
NET INCREASE (DECREASE) IN CASH AND CASH
   EQUIVALENTS                                               2,327      4,159        537

Cash and cash equivalents, at beginning of
    year                                                     1,954      1,721        222

Cumulative translation adjustments                              (6)        (8)        (1)

Cash and cash equivalents, at end of year                    4,275      5,872        758
                                                        =========== ========== ==========

</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, 1999 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, 1999 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") a Delaware Corporation, acquired
Physical Beauty & Fitness Holdings Limited ("Physical Holdings") and Physical
Holdings' subsidiaries in October of 1996, issuing 8,000,000 shares (80% of the
Company's outstanding shares) to the shareholder of Physical Holdings ("the
Shareholder"). Physical Holdings and its subsidiaries operate fitness and beauty
centres in Hong Kong and the Peoples Republic of China ("PRC") and other related
businesses.

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
the Shareholder.

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 private transaction to a Japanese institutional
investor.

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

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                    Equity interest
                                      acquisition/    Place of       owned by the
          Name of Company              formation    incorporation      Company        Principal activities
------------------------------------ ----------------------------- ----------------- ------------------------
                                                                   Direct   Indirect
                                                                   ------   --------

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

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

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

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

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

Zhongshan Physical Ladies' Club      October 29,      The PRC        -       95%        Fitness Centre in
   Ltd. (owned by Zhongshan              1996                                           Zhongshan, the PRC
   Physical)                                                                            not yet open

</TABLE>


<PAGE>


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

<TABLE>
<CAPTION>

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


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

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

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

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


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

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

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

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

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

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

Shenzhen Physical Ladies' Club Co.   August 16,        The PRC        -      90%       Fitness Centre in
Ltd. (owned by "Shenzhen Physical")     1996                                           Shenzhen, the PRC
                                                                                       not yet open

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

                                                                                       Operating a
Physical Health  Centre (Tsuen       September 8,     Hong Kong     100%      -        Fitness Centre in
Wan) Limited (Tsuen Wan Physical)        1997                                          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. 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. In January 1998 Physical Holdings increased its
equity interest to 92.5% by acquiring additional shares owned by a minority
shareholder.


<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                    joint       owned by    joint     Registered
        Venture            Location      venture    the Group   venture     capital     Profit sharing arrangement
------------------------  ------------  ----------  ----------  --------  ------------  ---------------------------

<S>                       <C>           <C>           <C>      <C>        <C>           <C>
Shanghai Physical         Huangpu       Co-operative  92.5%    10 years   Originally    None. Joint venturer
Ladies' Club Co., Ltd.    and                                             US$1,000      receives rent for
("Shanghai JV")           Hongqiao,                                       in cash       locations and will
                          Shanghai                                        and           receive equipment when
                                                                          increased     the Joint venture is
                                                                          to            dissolved.
                                                                          US$2,000
                                                                          in cash in
                                                                          1995

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

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

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


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

The accompanying consolidated financial statements were 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 joint
ventures, 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.


<PAGE>


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.

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.       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)
         ------------------------------------------

d.       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.

         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. 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.

e.       Foreign Currency Translation
         ----------------------------

         The Company and its subsidiaries maintain their accounting books and
         records in Hong Kong Dollars HK$, except for the PRC Joint Ventures
         which maintain their accounting books and records in Renminbi. Foreign
         currency transactions during the year are translated in HK$ 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 asets and liabilities are translated at the rates of
         exchange prevailing at the time the asset or liabilty ws acquired.
         Exchange gains or losses are recorded in the consolidated statements of
         income.

         On consolidation, the financial statements of the PRC Joint Ventures
         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.


<PAGE>


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

f.       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.

g.       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.

h.       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.

i.       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 income.


4.       SHORT-TERM BANK LOANS
         ---------------------
The short-term bank loans are secured and repayable within one year.


5.       LONG-TERM BANK LOANS
         --------------------

Long-term bank loans bear interest at 10% p.a. on the outstanding balances.

As of December 31, 1998, the Group had various banking facilities available from
financial institutions. 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;
       and


<PAGE>


6.       PROVISION FOR INCOME TAXES
         --------------------------

Hong Kong profits tax was provided at 16% on the assessable profits of Hong Kong
subsidiaries.

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 tax impact of temporary differences between financial and taxable income
that give rise to deferred tax (assets) liabilities are related to the
accelerated depreciation allowances on fixed assets in Hong Kong.

7.       DISTRIBUTION OF PROFIT
         ----------------------

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


8.       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 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.


<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. 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 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 (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.
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$82,311,000 (US$10,621,000) in the fiscal year ended December
31, 1997 to HK$139,829 (US$18,042,000)in the fiscal year ended December 31,
1998. The revenue from beauty treatment increased slightly from HK$66,496,000
(US$8,580,000) in the fiscal year ended December 31, 1997 to HK$70,317,000
(US$9,073,000) in fiscal year 1998.

<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>

                                                            Years Ended                        Three Months Ended
                                                            December 31,                           March 31
                                                1996           1997            1998           1998           1999
                                                ----           ----            ----           ----           ----


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

Total operating expenses                        71.52%          80.37%         89.69%         88.97%         88.12%

Operating income                                28.48%          19.62%         10.31%         11.03%         11.88%

Income before income taxes and minority
interests                                       28.52%          18.31%          8.74%          8.88%         10.62%

Provision for income and deferred taxes          7.55%           4.68%        (0.05%)          2.56%          1.85%

Minority interests                               1.99%           1.23%          0.54%          0.61%          0.49%

Net income                                      18.98%          12.40%          8.25%          5.71%          8.28%
                                              ========        ========       ========       ========       ========
</TABLE>


THREE MONTHS ENDED MARCH 31, 1999 (UNAUDITED) COMPARED TO THREE MONTHS ENDED
MARCH 31, 1998 (UNAUDITED).
----------------------------------------------------------------------------

         OPERATING REVENUES. The Company's operating revenues enjoyed strong
growth in the first three months of 1999 as compared to the first three months
of 1998. Operating revenues for the first three months of 1999 totaled
HK$54,019,000 (US$6,970,000) compared to HK$41,553,000 (US$5,362,000) in the
first three months of 1998, representing an increase of 30%. Operating revenues
derived by the Company's fitness services increased 32% to HK$36,915,000
(US$4,763,000) compared to HK$27,893,000 (US$3,599,000) in the first three
months of 1998. Fitness revenues as a percentage of total revenues were 68% in
the first three months of 1999 as compared to 67% in the first three months of
1998.

         Operating revenues from the Company's beauty treatment business totaled
HK$17,099,000 (US$2,206,000) compared to HK$13,633,000 (US$1,759,000) in the
first three months of 1999, representing an increase of 25%. Beauty treatment
revenues as a percentage of total revenues were 32% in the first three months of
1999 as compared to 33% in the first three months of 1998.


<PAGE>

         OPERATING EXPENSES. The Company's operating expenses for the first
three months of 1999 totaled HK$47,601,000 (US$6,142,000) compared to
HK$36,971,000 (US$4,771,000) in the first three months of 1998, representing an
increase of 29%. Total operating expenses, after taking into account all
corporate expenses, were 88% of total operating revenue as compared to 89% of
last year. This reflects the additional costs incurred by the Company in
following its business expansion plan. The increase in operating expenses was
primarily due to additional marketing, administrative and salary costs as a
result of increased revenues and additional costs incurred by the new branch
which opened in July 1998.

         TOTAL NON-OPERATING EXPENSES (INCOME). Total non-operating expenses
(income) for the first three months of 1999 totaled a net expense of HK$682,000
(US$87,000) compared to a net expense of HK$893,000 (US$115,000) in the first
three months of 1998, representing a decrease of 24%.

         PROVISION FOR INCOME TAXES. Provision for income taxes for the first
three months of 1998 totaled HK$997,000 (US$130,000) compared to HK$1,063,000
(US$137,000) in the first three months of 1998, representing a decrease of 6%.
The effective tax rate of operating income was 17% as compared to 29% of last
year. 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 1999
totaled HK$4,473,000 (US$577,000) compared to HK$2,374,000 (US$306,000) for the
first three months of 1998, representing an increase of 88%. The net income
margin in the first three months of 1999 was 8% compared to 6% in the first
three months of 1998, representing an increase of 33%. This reflects the
additional contribution from the new branch.


LIQUIDITY AND CAPITAL RESOURCES

         The Company has financed its operations primarily through cash
generated from operations, short-term bank credit, long-term bank loans, long
term loans from third parties and minority shareholders of subsidiaries,
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, 1999 and December 31, 1998 were HK$5,872,000 (US$758,000) and
HK$1,721,000 (US$222,000), while total indebtedness at June 30, 1998 was
HK$28,669,000 (US$3,698,000) and HK$30,417,000 (US$3,924,000) at December 31,
1998.

         Net cash provided by operating activities were HK$47,075,000
(US$6,074,000) and 13,099,000 (US$1,689,000) for Fiscal Year 1998, and the
three-month period ended March 31, 1999, respectively. The Company's operating
activities are historically financed by cash flows from operations. Net cash
used in investing activities were HK$37,700,000 (US$4,864,000) and HK$6,659,000
(US$858,000) for Fiscal Year 1998 and the three-month period ended March 31,
1999, primarily as a result of expenditures for property, plant and equipment.
Net cash used in financing activities, which mainly include proceeds from bank
loans, net interest and repayment, were HK$9,593,000 (US$1,238,000) and
HK$2,281,000 (US$294,000) in Fiscal Year 1998 and the three-month period ended
March 31, 1999, respectively.

<PAGE>

         The Company obtained a term loan in the amount of HK$1,000,000
(US$129,000) 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. As of June 30, 1998, the outstanding principal amount of this loan was
HK$1,000,000 (US$129,000). The Company has negotiated with the bank to replace
the loan with a new loan which is to be repaid by sixty (60) equal monthly
installment payments commencing November, 1997.

         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 10.75% 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 (30) monthly installments, commencing May, 1997 at an interest rate of
6.5% per annum.

         The Company has revolving lines of credit with three banks - The
Kwangtung Provincial Bank, Dao Heng Bank, and Shanghai Commercial Bank Limited.
As of March 31, 1999, the Company has fully utilized these lines of credit. The
Company draws down from the lines of credit primarily for general working
capital purposes. The lines of credit contain covenants requiring the
maintenance of minimum net worth.

         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, 1999, was
HK$7,267,000 (US$938,000). The Company has never experienced any significant
problems with collection of accounts receivable from its customers.

         Capital expenditure for 1998, and the three-month period ended March
31, 1999, were HK$38,416,000 (US$4,956,000) and HK$7,060,000 (US$910,000)
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.


<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, 1999.


<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: July 6, 1999                     /S/Ngai Keung Luk
                                    ----------------------------------
                                    Ngai Keung Luk,
                                          Chairman and Chief Executive Officer

Date: July 6, 1999                     /S/ Robert Chui
                                    ----------------------------------
                                    Robert Chui,
                                    Chief Financial Officer