Soko Fitness & Spa (OTC BB:SOKF)

Third Quarter 2011 Results:

• Revenue totaled $10.3 million, an increase of 27% over $8.1 in the third quarter of fiscal 2010.
• Gross profit increased 21% to $7.0 million, compared with $5.8 million, in the same period a year ago. Gross margin was 68.2% for the third quarter of fiscal 2011, compared with 71.6 % for the third quarter of fiscal 2010, and 67.6% for the second quarter of fiscal 2011.
• Net income attributable to SOKO improved 11% year-over-year to $3.0 million, or $0.14 per diluted share based on diluted shares outstanding of 22.0 million shares, compared with $2.7 million, or $0.15 per diluted share based on diluted shares outstanding of 18.2 million shares in the same period a year ago.
• SOKO increased total fitness club members 27% year-over-year and 0.3% sequentially to approximately 23,000 and beauty salon and spa clients 28% year-over-year and 7% sequentially to approximately 27,100.
• Cash and cash equivalents was $15.7 million as of February 28, 2011, an increase of $0.7 million over November 30, 2010. The sequential increase in cash and cash equivalents was related to increased operating cash flow.
• Record deferred revenue of $18.9 million as of February 28, 2011.
• SOKO has affirmed its expected revenue range of $39-$42 million for fiscal 2011, ending May 31, 2011. This represents an increase of approximately 30–40% compared with fiscal 2010.

"This was another record quarter for SOKO as we continued to execute on our business plan, growing our top and bottom-line, expanding our geographic footprint and generating increased cash from operations," said Tong Liu, Chief Executive Officer of SOKO. "We delivered robust growth across our fitness and aesthetic businesses in each of our core geographic markets and achieved meaningful growth in our member and client base, with total spa and salon clients at the end of the third quarter exceeding our goal for the full year, supported by growth in both our newly-opened and more mature facilities. While actively signing new members and clients, we have been able to maintain high retention rates, which contributed to a record backlog of $18.9 million at the end of the third quarter."

Fiscal 2011 Guidance:

SOKO is affirming its gross revenue guidance for fiscal year 2011, ending May 31, 2011. Revenue for the fiscal year is expected to range from $39 million to $42 million, which if achieved, would represent year-over-year growth of approximately 30-40%.  SOKO expects its revenue growth to be driven by a combination of new facility openings, an increase in the number of members and clients at its existing fitness and spa facilities and an increase in average revenue per customer.

During the fourth quarter of fiscal 2011, SOKO plans to add four new facilities to its portfolio through a combination of new construction, majority acquisition and the establishment of management agreements at minority-owned facilities, bringing the total number of new facilities added in fiscal 2011 to 16.  SOKO expects that capital expenditures associated with these facilities will be fully funded from cash on hand and operating cash flow.

Mr. Liu added, "We believe we have built a strong foundation upon which to continue building our business throughout China.  Consistent with our past practice, we plan to continue our expansion focus on strategically targeted, economically stable tier-two markets in which we can build market share and quickly establish brand equity. The execution of our growth strategy is proceeding according to plan, with 12 new facilities opened during the first nine months of fiscal 2011, and another 4 under construction or engaged in pre-opening activities. In the fourth quarter and into our fiscal 2012, we will continue to target new strategic markets and identify ways to extend our demographic and geographic footprint, increase our customer base, capture market share and continue to grow our business."

HARBIN, China, March 1, 2011 /PRNewswire-Asia-FirstCall/ -- SOKO Fitness & Spa Group, Inc. today announced that it has added a total of eight new facilities to its portfolio of majority and minority owned operations during the third quarter of fiscal 2011, ending February 28, 2011.

HARBIN, China, Dec. 21, 2010 /PRNewswire-Asia-FirstCall/ -- SOKO Fitness & Spa Group, Inc.  today announced that it has expanded its presence in its core Northeast China market with three new facilities under SOKO's operations.

During its second fiscal quarter ended November 30, 2010, SOKO opened:

• its second spa facility in Shenyang,

• its first beauty salon in Dalian, Liaoning Province, and

• a fitness center in Dalian, which is operated under a management agreement.

SOKO currently operates a total of 24 facilities; 17 of these facilities are wholly-owned, six are majority owned, and one is minority owned and operated by SOKO under a management agreement.  

The Legend Spa Wanda is SOKO's second spa facility in Shenyang, and its fourth facility overall in this market. It occupies 7,000 square feet in Shenyang Wanda Plaza, an integrated business, leisure and entertainment complex located in the city's downtown area. The facility includes 11 treatment rooms and is staffed by expert practitioners performing a wide variety of high-end aesthetic procedures.

The Dalian Beiliang Fitness Center and Dalian Beiliang Queen Beauty are the first two facilities in the northeast city of Dalian, an international trade and finance center with a population of approximately 6.1 million and a high concentration of upper- and middle-class citizens. The spa facility in Dalian, occupies 3,700 square feet in the Beiliang business center, and features five treatment rooms, offering a full range of luxury beauty and aesthetic treatments, consistent with SOKO's existing spa and salon facilities in Harbin, Shenyang and Beijing. The fitness center is the first facility operated by SOKO under a management agreement. Under terms of the agreement, SOKO will receive 6% of the fitness center's gross cash sales net of sales tax as its management service fee. SOKO expects to enter into an agreement with the facility's other shareholders, through which SOKO would have an option to acquire the remaining equity interest in this facility within the next two years.

"We believe this presents new opportunities for us to expand into new markets without significant initial capital costs but consistent with our core strategy of maintaining total control of all our facilities," said Tong Liu, Chief Executive Officer of SOKO.  ,

SOKO plans to open a total of 16 new facilities during its fiscal year ending May 31, 2011 and has already begun operating four new facilities since the beginning of the fiscal year. SOKO currently has nine additional facilities under construction or engaged in pre-opening sales activities, including:

• one new spa and one new fitness center in its headquarters city of Harbin,

• three spa facilities in Shenyang, and accompany

• SOKO's first two spa facilities and two fitness centers in Hangzhou, the capital city of Eastern China's Zhejiang Province, a fast growing business and tourist destination.  These facilities will mark SOKO's initial expansion into Hangzhou.

One of these facilities is expected to be run under management agreements, similar to the management agreement it has signed for The Dalian Beiliang Fitness Center.

As previously announced, based primarily on the newly opened facilities and projected new facility openings, an increase in the number of members and clients at its existing fitness and spa facilities and an increase in average revenue per customer, SOKO expects its gross revenue for fiscal 2011 to be between $38 million and $42 million, which would represent year-over-year growth of approximately 27-40%.

IDG-Accel China Investors II L.P. makes significant investment in SOKF.

Form 4

Form 4

 First Quarter Financial Highlights:

• Revenue totaled $9.1 million, an increase of 42% over $6.4 million in
  the same period a year ago.

• Gross profit increased 42% to $6.0 million, compared with $4.2 million,
  in the same period a year ago. Gross margin was 66% for the first
  quarter of both fiscal 2011 and 2010.

• Operating income improved by 25% year-over-year to $2.9 million,
  compared with operating income of $2.3 million in the same period a
  year ago.

• Net income (after including other income and expense) improved by 35%
  year-over-year to $3.1 million, or $0.14 per diluted share, compared
  with $2.3 million, or $0.13 per diluted share in the same period a year
  ago.

• Increased total fitness club members 40% year-over-year and 13%
         sequentially to approximately 20,500, and beauty salon and spa clients
         16% year-over-year and 7% sequentially to approximately 22,700.

• Cash and cash equivalents of $24.5 million as of August 31, 2010, an
  increase of $6.4 million over May 31, 2010.

• Introduces preliminary guidance for fiscal 2011 ending May 31, 2011.
  Company expects revenue of $38-$42 million, an increase of
  approximately 27-40% over fiscal 2010.

"We achieved strong results during the first quarter of fiscal 2011, with record top and bottom line growth reflecting the ongoing implementation of our expansion strategy," said Tong Liu, Chief Executive Officer of SOKO. "While our focus remains on our core markets in Northeastern China, positive results from our initial expansion efforts in Beijing have given us confidence that we can effectively replicate our business model in new markets in China. Another area that we believe presents significant growth potential is the luxury hotel market, and in an effort to capitalize on this opportunity, we opened our second hotel-based facility and first yoga center in Beijing, located in Westin's Chaoyang Hotel. Initial customer reaction to Yoga Wave Westin has been positive and we look forward to ramping up this facility in a manner consistent with our other fitness and yoga centers."

"In addition to the progress we have made with our fitness and spa businesses, we recently made progress in advancing our training and education capabilities through the formation of a cooperation agreement with Bin Xian Vocational Technology and Education Center in suburban Harbin. We believe this relationship will augment our education and training capabilities and will serve as an important tool through which to recruit new employees for our fitness and beauty centers," continued Mr. Liu.

Mr. Liu added, "We have also taken steps to strengthen our corporate governance and internal controls, which will be an important element of our continued growth. I would like to congratulate Mr. Colin Sung on his appointment as both an independent director and Audit Committee Chairman. Colin brings to us a wealth of experience in governance and accounting practices

Fiscal 2011 Guidance:

SOKO also introduced preliminary gross revenue guidance for fiscal year 2011 in the range of $38 million to $42 million, which, if achieved, would represent year-over-year growth of approximately 27-40%. SOKO expects that this revenue growth will be driven by a combination of new facility openings, an increase in the number of members and clients at its existing fitness and spa facilities and an increase in average revenue per customer.

During fiscal 2011, SOKO plans to open up to 16 new or acquired facilities (up from an estimate of 10 or more made earlier this year). These facilities will be either wholly-owned or majority controlled by SOKO but could also be minority owned or operated under a management agreement. Some of the new facilities are expected to be in SOKO's core markets of Heilongjiang and Liaoning Provinces where Harbin and Shenyang are located, respectively. SOKO expects that capital expenditures associated with these facilities will be fully funded from cash on hand and operating cash flow. By the end of fiscal 2011, SOKO expects its customer base to increase to 22,000 fitness center members and 26,500 spa and beauty clients. This compares with 18,000 fitness center members and 21,000 spa and beauty clients at the end of fiscal 2010.

Commenting on SOKO's outlook, Mr. Liu added, "Fiscal 2010 was an extremely positive year for SOKO, both strategically and operationally, and we believe we are well positioned to achieve continued strong growth in fiscal 2011. In addition to our expansion into new markets, we will continue to further establish SOKO's leadership position in our core markets of Northeastern China's second tier cities. Growth in our core markets is being driven by an expansion of China's upper and middle classes, as well as increasing affluence across the entire Chinese population. We offer a highly desirable suite of services to this important demographic and believe we can leverage our reputation, broad range of services and growing base of facilities as we continue to attract new customers and build brand equity, allowing us to capture the significant, untapped market potential that we believe exists in China for our services."

2010 Fiscal Fourth Quarter Financial Highlights:

• Fourth quarter 2010 revenue totaled $8.0 million, an increase of 40% over $5.6 million in the fourth quarter of 2009.
  
• Gross profit increased to $5.2 million, or 65% of revenue for the quarter, compared with $3.8 million, or 68% of revenue in the fourth quarter of 2009.
  
• Operating income was $2.0 million, a 5% increase over $1.9 million in the fourth quarter of 2009.
  
• Net income was $2.0 million, or $0.10 per diluted share, compared with $2.0 million, or $0.12 per diluted share in the same period a year ago.

Commenting on SOKO's plans for the upcoming year, Mr. Liu stated, "Our growth plans for fiscal 2011 remain aggressive. We believe that the cash we generate from operations, coupled with the proceeds from our April financing, will give SOKO the resources to maintain our robust expansion plans to open new facilities and acquire centers that we believe complement our existing portfolio. We achieved a great deal in fiscal 2010 and believe that the stage is set for continued advancement in fiscal 2011. With an established, well-respected brand in the beauty and fitness markets, a growing base of potential customers driven by increasing affluence in China, and a strong financial position that will enable us to achieve our growth objectives, we are excited about what the future holds for SOKO."

GeoTeam Note®:

Please note that operating income growth was lack luster. EPS was also held back by dilution from money SOKF raised earlier this year that it has still not deployed.

Added to the GeoBargain list on March 8, 2010 @ $4.00

Catalyst: Strong EPS growth; Fueled by an aggressive fitness/beauty center expansion strategy appeared to be in a position to continue its strong EPS growth.
Peak performance: Reached a high of $4.94 on March 23, 2010
Current Price: $4.01
 
Current road block: Internal control issues; Dilution could impact near-term EPS growth; No financial guidance.

We have high hopes for SOKF, but they have yet to put money from a recent raise to work, which has us moderately worried about short-term EPS growth. Although, the company should start seeing a positive contribution from facilities that are entering their prime growth cycle (starts in year two of operation).  Short-term, investors would need to gain clarity on the extent that the moderating growth from mature facilities will be mitigated by newer facilities.  We hope that SOKF completes an acquisition soon as this could be a way a to provide an immediate bump to EPS. 

Contributor Dan France brought a few more points  to our attention. He observed that the number of new clients joining SOKF centers seemed low relative to management’s business model assumptions. We posed this concern to management who said that tracking the growth in current client visits is more relevant to its business model and is within expectations. 

Additional observations Dan made:

• "I was also concerned about the average annualized revenue per fitness club member. I understand fitness center revenues only make up 20% of so of revenues but still the premium pricing model seems to be meeting resistance."  The average annualized revenue per fitness member was around $340 for the nine months ended Feb. 28 which is less than the annual membership fee of $441. Did SOKO have promotions offering discounted or even free memberships for new members or for member referrals? If so will they continue such promotions in the future?
  
• I recently heard a business report about Equinox’s plans to expand operations in China. SOKO claims to have a competitive advantage in the markets they are targeting. If global fitness industry players are also targeting China, will SOKO be able to compete with companies with far greater resources?

We are unsure of SOKF’s plan to tap the equity market:

"We have historically funded our operation primarily through bank loans and incoming cash from operations. Over the next twelve months, we intend to pursue organic and acquisitive growth in the future and increase our market share in China. We are also evaluating acquisition and consolidation opportunities in China’s fragmented fitness and beauty salon and spa industry. We believe that we have sufficient funds to operate our existing business for the next twelve months. However, in addition to funds available from our operating and short term bank loans, we may need external sources of capital for our expansion."

SOKF completed an equity raise in April 2010, after the release of its 2010 first quarter results. Investors would need to investigate whether or not the need to raise capital is now taken off the table. All and all, we were not too thrilled that SOKF raised $10 million at $3.20 in the April raise. However, upon further inspection it appears that to implement its aggressive acquisition strategy a raise was necessary:

• Cash balance only stood at only $4.8 million:
• Projected annual Free Cash flow stood at $3.8 million: (2010 annual cash flow from operations run rate of $13.6 – 2010 annual capital expenditures run rate of $9.8 million)

Our intent over the short-term is to build a check list to assess the risk position of firms in the ChinaHybrid space. For the time being this will consist of the following: (this list is likely to grow substantially)

Soko Fitness & Spa Group just announced the completion of a financing deal.  We are not too crazy about the pricing terms:

SOKO Fitness & Spa Group, Inc. announced the completion of a non-brokered private placement of 3,125,000 shares of common stock at a purchase price of $3.20 per share, yielding gross proceeds of $10 million to SOKO. 

The good news is that no warrants were issued and The shares issued to the investors will be required to be registered with the SEC for resale, but only beginning on the 14 month anniversary of the closing and under certain other circumstances.

I believe investors, including the GeoTeam would have accepted higher price terms.  Regardless, we have said that in the case of SOKF, we would welcome a capital raise.  The company can accelerate its it growth tract by acquiring operations that will be accretive EPS to supplement facilities that it will build from the ground up which generally take about 18 months to contribute to the bottom line.

Tong Liu, Chief Executive Officer of SOKO said, "We pursued this financing in order to accelerate the execution of our already aggressive growth plan. We are developing our business rapidly, but are still in the initial stages of our growth. This cash infusion, our first since going public two years ago, significantly augments our balance sheet and offers us the near-term flexibility to capitalize on strategic opportunities to develop and acquire additional facilities. We are constantly working to identify new opening and acquisition targets that fit well within our model of penetrating underserved markets, enabling us to quickly capture market share and achieve positive returns on our investments in new or acquired facilities. We expect that this transaction will allow us to accelerate our pursuit of these opportunities, helping us drive additional growth and enhancing long-term shareholder value."

As a result of the financing, SOKO now expects to open more facilities in calendar 2010 than its previous guidance of 7 to 9 new facilities planned for the calendar year.

Be prepared for a pullback where we plan to pick up additional shares.

"We are still in our initial stages of growth," said Mr. Liu. "Currently only nine of our 16 facilities have been operated under the SOKO brand for more than two years. With four new facilities already open during calendar 2010, and three facilities engaged in pre-opening activities, we are well on our way to meet our previously announced expansion goals of opening seven to nine new facilities this calendar year, all of which we believe can be funded by current operating cash flow and cash flow from organic growth.

"We will continue to seek new opportunities to construct or acquire facilities in areas where we can implement our business strategy of penetrating underserved markets to quickly capture market share and achieve a positive returns on our investment as we continue to build our brand and our business," Mr. Liu concluded.

Source: PR Newswire (April 19, 2010)

• Price = $4.15
• Trailing EPS = $0.52
• Fully-Taxed Trailing non- GAAP EPS = $0.39 ^a
• P/E based on Fully-Taxed Trailing EPS = 10.64

1. SOKF meets 8 out of 10 GeoBargain® Requirements
   
   

   	Requirement	Comments
   	Recent 52-week High(generally within 3 months)	Reached high of $4.45 on 1/15/2010
   	30% EPS Growth Rate	2nd Qtr. 2010 EPS increased 70.0%
   	10% Revenue Growth	2nd Qtr. revenue increased 40.0%.
   	Strong Cash Flow/Balance Sheet	As of 2nd Qtr. 2010
   YES	Positive Cash Flow	$7.75M
   YES	Debt to Equity Ratio less than 20%	11.09%
   NO	Current Ratio is at least 2:1	0.86:1
   	Return on Equity is at least 15%	>15.0%
   	Minimum Pre-tax Operating Margins of 8%	42.8% as of 2nd Qtr. 2010
   	Preferably Under 50 Million Shares	18.2 M shares as of 2nd Qtr.
   	High Insider Ownership (generally greater than 15%)	53.3% as of 2009 10K
   	Limited Institutional Ownership (generally less than 20%)	TBA
   	P/E Divided by Growth Rate (PEG Ratio) is Less Than 1.	0.15

   
   
2. Half of Soko's clubs are new or within the first year of operations which could lead to an acceleration of EPS growth.
   
3. The company has selectively penetrated and expanded its target markets. Historically, Soko has operated in smaller cities that attract less competition. It has recently embarked on a plan to enter larger cities where it intends to compete, using a proven business model that boasts an 81% member retention rate helping to drive practicable recurring revenue streams.
   
4. Management seems very cognizant about increasing shareholder value and intends to use equity mainly as a means to pursue acquisitions that would be immediately accretive to EPS. We actually believe an equity raise to complete some acquisitions would not be such a bad idea. It would help alleviate the short-term drain on operations from the facilities it constructs from scratch. Generally, a brand new fitness center can take up to 18 months before it contributes to the bottom line. Right now, the company can internally fund its current expansion plans to add 7 to 9 beauty and fitness centers by the end of 2010. (The company currently has 6 fitness centers)
   
   Management has also shown that they are opportunistic by entering high growth and margin markets that have tough barriers to entry, such as the non-surgical medical beauty salon market.
   
5. Soko has been more proactive on the investor relations front.

Potential Valuation Scenarios if the company can achieve its EPS growth goals

Short-Term Potential value based on fully taxed adjusted trailing EPS

P/E 20 * $0.39 = $7.80
P/E 25 * $0.39 = $9.75

^a All EPS numbers have been adjusted by the GeoTeam to reflect a Chinese tax rate of 25%.

These scenarios are not intended to be investment advice, but are scenarios based on some commonly used investment guidelines. They are provided to aid investors in making their own investment decisions

Position: Long SOKF as of date of this note.  GeoTeam generally uses disciplines when investing, and urges others to do the same.

We believe that our brand name has value. As part of our long-term growth strategy, we anticipate capitalizing on this value by establishing an upscale network of fitness centers and beauty salons and spas to expand our territory and member and client base. We believe that there is significant potential for the Company's growth going forward.

We have begun to implement some significant growth and expansion plans in existing and new facilities that, we believe, will result in higher net income in the long run. However, as we undergo these changes in our business, we believe we will incur significant increases in our operating expenses, mainly due to construction costs, increased rent expenses, salaries and benefit costs and sales commissions.