SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year Ended December 31, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to _______________.
Commission File No. 1-12293
NATURAL WAY TECHNOLOGIES, INC.
----------------------------------------------
(Name of small business issuer in its charter)
Nevada 87-0394313
- -------------------------------- ---------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
Rm. 2211-2215, Science and Technology Building, No. 1001
Shangbuzhong Road, Fution District Shenzhen, PRC
---------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Include Area Code: 011-07-55-369-9588
Securities Registered Pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
-------------------- -----------------------------------------
None None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
-------------------------------
(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past twelve (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 ninety (90)
days. Yes No X
Check if disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [ ]
The issuer's revenues for its most recent fiscal year were $0.
As of February 1, 2000, 3,500,000 shares of common stock of the Registrant
were outstanding. As of such date, the aggregate market value of the common
stock held by non-affiliates, based on the closing bid price on the NASD
Bulletin Board, was approximately $0.
DOCUMENTS INCORPORATED BY REFERENCE
Transitional Small Business Disclosure Format: Yes No X
-- ----
<PAGE>
TABLE OF CONTENTS
Page
------
PART I
ITEM 1. DESCRIPTION OF BUSINESS................................ 1
ITEM 2. DESCRIPTION OF PROPERTIES.............................. 2
ITEM 3. LEGAL PROCEEDINGS ..................................... 2
ITEM 4. SUBMISSION OF MATTERS TO A VOTE
OF SECURITY HOLDERS.................................... 2
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS............................. 2
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS.................... 3
ITEM 7. FINANCIAL STATEMENTS.................................... 3
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE.................. 3
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS
AND CONTROL PERSONS; COMPLIANCE WITH
SECTION 16(a) OF THE EXCHANGE ACT....................... 4
ITEM 10. EXECUTIVE COMPENSATION.................................. 5
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT................................... 5
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.......... 5
ITEM 13. EXHIBITS AND REPORTS OF FORM 8-K........................ 6
SIGNATURES.............................................. 7
FINANCIAL STATEMENTS...................................F-1
<PAGE>
PART I
ITEM 1. DESCRIPTION OF BUSINESS
General
Natural Way Technologies, Inc. was incorporated under the laws of the State
of Nevada on May 4, 1988. The Company was formed to review and make investments
or such business opportunities in any industry.
On June 30, 1996, the Company entered into an agreement with Beautimate
Group Limited ("BGL"; a company incorporated in the British Virgin Islands) and
Ongoing Limited ("OL"; a company incorporated in the British Virgin Islands) to
acquire from them 100% interest in China Medical Development Company Limited
("CMDC"; a company incorporated in the British Virgin Islands) by agreeing to
issue to (i) BGL 7,000,000 shares of common stock and (ii) 100,000 shares of
Series B supervoting preferred stock. In addition BGL received 7,000,000 shares
of Class A warrants, 7,000,000 shares of Class B warrants and 7,000,000 shares
of Class C warrants. The warrants however, were subsequently canceled.
On March 6, 1996, CMDC entered into a joint venture agreement with Dunhua
Huakang Pharmaceutical Plant ("DHPP") to establish a sino-foreign joint venture
in the People's Republic of China ("the PRC") - Dunhua Huakang Pharmaceutical
Co. Ltd. ("DHPC"). Pursuant to this joint venture agreement, CMDC was required
to contribute to DHPC cash of $4,200,000 as its capital contribution for a 70%
equity interest in DHPC, while DHPP was required to contribute to DHPC its
production plant, including buildings and machinery, with an agreed value of
$1,800,000 as its capital contribution for a 30% equity interest in DHPC. As of
June 30, 1996, CMDC had contributed $3,000,000 into DHPC as its capital
contribution while the remaining $1,200,000 was to be paid on or before March 5,
1997.
DHPC succeeded to the business of manufacturing formulated Chinese medicine
which was previously undertaken by DHPP. In connection with the establishment of
DHPC, DHPP delivered to CMDC a guarantee that the annual net income after tax
(as determined under generally accepted accounting principles in the United
States of America) of DHPC for each of its first four years of operations would
not be less than 25% of the net assets employed by DHPC. In the event that the
net income of DHPC was below the guaranteed amount, DHPP agreed to reallocate
all or a portion of its entitlement to the net income of DHPC to CMDC or make
payment to CMDC so as to cover any shortfall with respect to CMDC's share of the
net income. In addition, DHPP transferred to DHPC additional operating assets
and liabilities with an estimated value of approximately $4,288,000 for a note
receivable which bears interest at an annual rate of 5.5%. DHPP also gave a
guarantee to CMDC to transfer DHPP's accounts receivable as of December 31, 1995
back to DHPP if such accounts receivable were not realized in cash by June 30,
1997.
The other key provisions of the joint venture agreement included:
* The joint venture period is 30 years from March 1996 to March 2026;
* The profit and loss sharing ratio is the same as the respective
percentage of equity and interest; and
* The Board of Directors consists of seven members, with four designated
by CMDC and three designated by DHPP.
In addition to the foregoing, a deposit of $1,400,000 was paid by the
Company to China Food and Beverage Industrial Co. Limited ("CFBI"; a related
company which is owned and controlled by Yiu Yat Hung, a director of the
Company) to allow the Company an exclusive right to ascertain the feasibility of
acquiring not less than 50% of the share capital of CFBI. The Company was
required to make an investment decision by March 31, 1997. In the event that the
Company decided not to invest, CFBI agreed to repay the deposit in full,
together with accrued interest commencing from January 1, 1997 at 8% per annum.
During the year ended December 31, 1996, the Company issued 6,000 shares of
Series A convertible and redeemable preferred stock, par value $0.001 each, for
$6,000,000. Each share of the Series A convertible and redeemable preferred
stock is convertible into the lesser of (i) 1,000 shares or (ii) $1,000 divided
by the average closing market price of the Company's common stock for the five
days immediately preceding the date of conversion, of shares of common stock of
the Company. The outstanding convertible and redeemable preferred stock is
redeemable at the option of the Company at any time after December 31, 1997 by
giving ten days notice at a price equal to $1,000 per share plus any accrued
dividend. In 1997, 2,300 Series A convertible and redeemable preferred shares
were converted into common stock.
1
<PAGE>
On June 6, 1997, the Company executed a Termination Agreement retroactively
effective to January 1, 1997 whereby the Company divested its interest in CMDC
in exchange for the return of the 7,000,000 shares of common stock and the
100,000 shares of Series B supervoting preferred stock originally issued in the
Exchange. This transaction has been accounted for as a discontinued operation
and the results of operations have been excluded from continuing operations in
the statements of operations for calendar years 1996 and 1997.
Although the Company currently has no assets or operations, the Company
believes that it will again be able to find a suitable candidate with which to
merge or acquire.
ITEM 2. DESCRIPTION OF PROPERTIES
The Company's executive offices were located in 3,315 square feet of office
space located at One World Trade Center, Suite 7865, New York, New York. On
April 1, 1997 the Company relocated to a similar suite located on the 53rd floor
of Central Plaza, 18 Harbour Road, Wanchai, Hong Kong. The Company now operates
from an office suite at Rm. 2211 2215, Science and Technology Building, No.
1001, Shangbuzhong Road, Fution District, Shenzhen, PRC.
The Company believes that its properties are adequate to support its
current operations.
ITEM 3. LEGAL PROCEEDINGS
Management is not aware of any pending or threatened litigation against the
Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's stockholders through
the solicitation of proxies, or otherwise, during the fourth quarter of the
Company's fiscal year ended December 31, 1997.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information
The Company's Common Stock is traded in the over-the counter on the NASD
Electronic Bulletin Board. Trading in the Company's Common Stock is extremely
limited and sporadic, and there is no current market in the Company's stock. The
Company's stock trades under the symbol NWYT.
Record Holders
As of February 1, 2000, there were approximately 297 record owners of the
Common Stock of the Company.
Dividends
The Company has never declared or paid any cash dividend on its Common
Stock and does not expect to declare or pay any such dividend in the foreseeable
future.
2
<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Material Changes in Results of Operations
Because the Termination Agreement was effective retroactive to January 1,
1997, the Company had no operations other than the search for a business to
acquire or with which to combine for the year ended December 31, 1997. Since all
operations were discontinued, comparison with the prior fiscal year is not
relevant.
Material Changes in Financial Condition, Liquidity and Capital Resources
A deposit of $1,400,000 was paid to China Food and Beverage Industrial Co.
Limited ("CFBI"; a related company which is owned and controlled by Yiu Yat
Hung, a director of the Company) to allow the Company an exclusive right to the
ascertain feasibility of acquiring not less than a 50% interest in the share
capital of CFBI. The Company had to make an investment decision by March 31,
1997. In the event that the Company decided not to invest, CFBI has agreed to
repay the deposit in full together with accrued interest commencing from January
1, 1997 at 8% per annum.
During the year ended December 31, 1996, the Company issued 6,000 shares of
Series A convertible and redeemable preferred stock, par value $0.001 each, for
$6,000,000. Each share of the Series A convertible and redeemable preferred
stock is convertible into the lesser of (i) 1,000 shares or (ii) $1,000 divided
by the average closing market price of the Company's common stock for the five
days immediately preceding the date of conversion, of shares of common stock of
the Company. The outstanding convertible and redeemable preferred stock is
redeemable at the option of the Company at any time after December 31, 1997 by
giving ten days notice at a price equal to $1,000 per share plus any accrued
dividend. During 1997, 2,300 Series A convertible and redeemable preferred stock
was converted into common stock.
On June 6, 1997, the Company executed a Termination Agreement retroactively
effective to January 1, 1997 whereby the Company divested its interest in CMDC
in exchange for the return of the 7,000,000 shares of common stock and the
100,000 shares of Series B supervoting preferred stock originally issued in the
Exchange. This transaction has been accounted for as a discontinued operation
and the results of operations have been excluded from continuing operations in
the statements of operations for calendar years 1996 and 1997.
Although the Company has no assets or operations, the Company believes that
it will be able to find a suitable candidate with which to merge or acquire.
ITEM 7. FINANCIAL STATEMENTS
The consolidated financial statements of the Company, together with the
independent auditors' report thereon of Blackman Kallick Bartelstein LLP appears
on pages F-2 through F-25 of this report. See Index to Financial Statements on
page F-1 of this report.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Following the acquisition of CMDC by the Company on July 31, 1996, the
Company's Board of Directors selected Arthur Andersen & Co. to serve as its new
independent accountants and dismissed D. Brian Macbeth, Certified Public
Accountant, of Spring, Texas who previously served as the independent accountant
for the Company.
3
<PAGE>
D. Brian Macbeth's reports on the financial statements of the Company for
the fiscal years ended December 31, 1994 and 1995 contained no adverse opinion
or disclaimer of opinion and were not qualified or modified as to uncertainty,
audit scope, or accounting principles. In connection with his audits for fiscal
years 1994 and 1995 and through July 31, 1996, there were no disagreements with
D. Brian Macbeth on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure, which disagreements if not
resolved to the satisfaction of D. Brian Macbeth, would have caused him to make
reference thereto in his reports on the financial statements for such years.
Arthur Andersen & Co. served as the principal accounting firm for DHPP with
respect to the financial statements of such company for fiscal years 1994 and
1995.
The information described above regarding the Company's decision to dismiss
D. Brian Macbeth as its independent accountant and select Arthur Andersen & Co.
as its new independent accountants, along with a letter from D. Brian Macbeth
stating that he agrees with the above information regarding the Company's change
of accountants, was fully disclosed in a Form 8-K filed with the SEC.
Following the execution of the Termination Agreement, Arthur Andersen
resigned as independent accountants and the Company's Board of Directors
selected Blackman Kallick Bartelstein LLP as its new independent accountant.
Arthur Andersen & Co. reports on the financial statements of the Company
for the fiscal years ended December 31, 1995 and 1996 contain no adverse opinion
or disclaimer of opinion and were not qualified or modified as to uncertainty,
audit scope, or accounting principles. In connection with its audits for fiscal
years 1995 and 1996 there were no disagreements with Arthur Andersen & Co. on
any matter of accounting principles or practices, financial statement
disclosure, or auditing scope or procedure, which disagreements if not resolved
to the satisfaction of Arthur Andersen & Co. would have caused it to make
reference thereto in its reports on the financial statements for such years.
The information described above regarding the resignation of Arthur
Andersen & Co. as its independent accountant and select Blackman Kallick &
Bartelstein LLC as its new independent accountants, along with a letter from
Arthur Andersen & Co. stating that it agrees with the above information
regarding the Company's change of accountants, was fully disclosed in a Form 8-K
filed with the SEC.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(a) OF THE EXCHANGE ACT
Information Regarding Present Directors and Executive Officers
The following table sets forth the names and ages of the present executive
officers and directors of the Company and the positions held by each.
Name Age Title
- -------- ----- -------
Yao Yi On 43 Chairman, Chief Executive Officer and Director
Ma Ding Jie 62 Chief Financial Officer and Director
Jin Hui Juan 41 Director
Each of the directors has been elected to serve until the next annual
meeting of the directors by the shareholders or until their respective
successors have been duly elected and shall have qualified.
Yiu Yat On is a co-founder of Guang Hui Highway Project Company Limited and
has served as Vice President, Treasurer and a Director of the Company since the
acquisition of Guang Hui by the Company in December of 1996. Since June of 1997,
Mr. Yiu has served as the Company's Chief Executive Officer and Chairman. Mr.
Yiu is also a co-founder of China Medical Development Company Ltd., and has
served as Vice-Chairman and Vice President of Natural Way since the exchange in
June of 1996. For over twenty years, Mr. Yiu has served as a management
consultant to various companies in the PRC and has operated various companies in
the PRC. Mr. Yiu has a graduate degree in business administration.
4
<PAGE>
Ma Ding Jie has many years experience in production management and
warehousing operations. Mr. Ma is presently the assistant general manager of
HongHua Building Material Company in Shenzhen.
Jin Hui Juan is a chemical engineer with the Shanghai Chemistry Research
Institute and is the assistant general manager of HongHui Printing and Dyeing
Company. He has also served as general manager of Hong Kong Hongda Company.
Information Regarding Nominees for Election as Directors
All of the present directors have been nominated for re-election as
directors at the Company's next annual shareholders' meeting.
ITEM 10. EXECUTIVE COMPENSATION
No compensation has been paid to any officer, director or control person
during the prior three years.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table is furnished as of February 1, 2000, to indicate
beneficial ownership by the Company's common stock by (1) each shareholder of
the Company who is known by the Company to be a beneficial owner of more than 5%
of the Company's common stock (2) each director, nominee and named officer of
the Company, individually, and (3) all officers and directors of the Company as
a group. The information set out in the following table was supplied by such
persons.
Name and address of Number of Shares
Beneficial Owner (1) Beneficially Owned (2) Percent
- -------------------- ---------------------- -------
Yiu Yat On (2) 6,900,000 67.6%
Ma Ding Jie 0 0
jin Hui Juan 0 0
All officers and directors
as a group (3 persons) 6,900,000 67.6%
Beautimate Group Limited (2) 6,900,000 67.6%
Suite 5301, Central Plaza
18 Harbour Road, Wanchai, Hong Kong
1. Unless otherwise noted, each person or group identified possesses sole
voting and investment power with respect to the shares shown opposite the
name of such person or group.
2. Beautimate Group Limited is controlled by Yiu Yat On, an officer and
director of the Company. Such individuals may be deemed to be the
beneficial owners of the shares held by Beautimate Group Limited. However,
such individual disclaims beneficial ownership of the shares indicated as
held by Beautimate Group Limited.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On June 28, 1996, the Company entered into a Conditional Acquisition
Agreement with China Food and Beverage Industrial Company Limited ("China Food
and Beverage") and its shareholders pursuant to which the Company would have the
right to acquire not less than 50% of the shares of China Food and Beverage for
a price not to exceed eight times earnings. Pursuant to such agreement, as
amended, the Company had until June 30, 1997 to conduct due diligence with
respect to the potential acquisition of China Food and Beverage. The Company
deposited $1,400,000 with China Food and Beverage which was refundable in full
with interest at 8% commencing on January 1, 1997 if the Company elected not to
consummate such acquisition. If the Company elected to pursue the acquisition of
China Food and Beverage the deposit was to be applied toward the purchase price.
5
<PAGE>
China Food and Beverage was involved in efforts to form a sino-foreign
joint venture which owned and operated an almond juice manufacturing business
presently operated by a PRC government controlled entity. China Food and
Beverage is owned and controlled by Yiu Yat Hung, a former director of the
Company.
The Company has, from time to time, borrowed funds from New Silver Eagle
Holdings Limited, a company controlled by Yiu Yat Hung and family a former
director of thee Company.
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
Number Description of Exhibit
2.1 Acquisition Agreement dated June 3, 1996 between Energy Systems, Inc.
and China Medical Development Co. Ltd. (1)
3.1 Amended and Restated Articles of Incorporation (2)
3.2 Bylaws, as amended to date (2)
4.1 Certificate of Designation for Series A Convertible Preferred Shares (2)
4.2 Certificate of Designation for Series B Convertible Preferred Shares (2)
4.3 Certificate of Designation for Series C Convertible Preferred Shares (2)
10.1 Conditional Acquisition Agreement between Natural Way Technologies, Inc.
and China Food and Beverage Industrial Company Limited (2)
10.2 Letter of Intent dated May 15, 1996 between Natural Way Technologies,
Inc. and Simple Win Investment Ltd.
10.3 Termination Agreement dated June 6, 1997 between Natural Way
Technologies, Inc. and China Medical Development Company (3)
16.1 Letter from D. Brian Macbeth relating to change of independent
accountants (1)
21.1 Subsidiaries of Registrant
27.1* Financial Data Schedules
- --------
* Filed herewith
(1) Incorporated by reference to the respective exhibits filed with the
Company's Current Report on Form 8-K/A dated June 30, 1996.
(2) Incorporated by reference to the respective exhibits filed with the
Company's Quarterly Report on Form 10-QSB for the quarter ended September
30, 1996.
(3) Incorporated by reference to the respective exhibits filed with the
Company's Quarterly Reports on Form 10-QSB for the quarter ended June 30,
1997.
(b) Reports on Form 8-K
1. Resignation of Arthur Andersen & Co. as the Company's independent
accountant and the selection of Blackman Kallick & Bartelstein LLP as
its new accountant.
6
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
NATURAL WAY TECHNOLOGIES, INC.
By: /s/ Yiu Yat Hung
-------------------------
Yiu Yat Hung
Chief Executive Officer
Dated: February 9, 2000
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
Signature Title Date
----------- ------- ------
/s/ Yat On President and Director February 9, 2000
- -----------------
Yiu Yat On
/s/ Jin Hui Juan Secretary and Director February 9, 2000
- -----------------
Jin Hui Juan
/s/ Yao Su Zhen Director February 9, 2000
- -----------------
Yao Su Zhen
/s/ Ma Ding Jie Chief Financial Officer and Director February 9, 2000
- ----------------- (Principal Financial and Accounting Officer)
Ma Ding Jie
7
<PAGE>
NATURAL WAY TECHNOLOGIES, INC. AND SUBSIDIARIES
Index to Consolidated Financial Statements
Page
----
Report of Independent Public Accountants F-2
Consolidated Balance Sheets as of December 31, 1996 and 1995 F-3-F-4
Consolidated Statements of Operations for the Years Ended
December 31, 1996, 1995 and 1994 F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1996, 1995 and 1994 F-6-F-7
Statements of Changes in Shareholders' Equity for the Years
Ended December 31, 1996, 1995 and 1994 F-8
Notes to Financial Statements F-9-F-25
F-1
<PAGE>
INDEPENDENT AUDITOR'S REPORT
Stockholders and the Board of Directors
Natural Way Technologies, Inc.
We have audited the accompanying balance sheet of Natural Way Technologies, Inc.
("the Company") as of December 31, 1997, and the related statements of
operations, cash flows and changes in stockholders' equity for the year then
ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit. The financial statements of the Company for the
years ended December 31, 1995 and 1996, were audited by other auditors whose
report, dated April 11, 1997, expressed an unqualified opinion on those
financial statements.
We conducted our audit in accordance with generally accepted auditing standards
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Natural Way Technologies, Inc.
as of December 31, 1997, and the results of its operations and its cash flows
for the year ended December 31, 1997, in conformity with generally accepted
accounting principles in the United States of America.
The accompanying financial statements have been prepared assuming Natural Way
Technologies, Inc. will continue as a going concern. As more fully described in
Note 2, the Company ceased operations in 1996. The lack of operations raises
substantial doubt about the Company's ability to continue as a going concern.
Appropriate disclosures have been made and our opinion is not qualified in this
respect.
Also, as discussed in Notes 1, 17 and 19, the Company has recorded deemed
dividends in 1997 primarily in conjunction with the termination of a joint
venture interest and the misappropriations of a deposit.
Chicago, Illinois
October 15, 1999 Blackman Kallick Bartelstein, LLP
F-2
<PAGE>
NATURAL WAY TECHNOLOGIES, INC.
BALANCE SHEETS
AS OF DECEMBER 31, 1996 AND 1997
ASSETS
1996 1997
------ ------
Rmb'000 Rmb'000 US$'000
Current assets:
Cash 10,017 - -
Accounts receivable, net 73,533 - -
Due from a related company 4,159 - -
Due from a director 75 - -
Prepayments and deposits 2,607 - -
Inventories, net 5,618 - -
-------- ----- -----
Total current assets 96,009 - -
-------- ----- -----
Investment deposits 31,548 - -
Deferred value added tax recoverable 1,011 - -
Property, plant and equipment, net 23,526 - -
-------- ------- ------
Total assets 152,094 - -
======== ======= ======
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
LIABILITIES AND STOCKHOLDERS' EQUITY
1996 1997
------ ------
Rmb'000 Rmb'000 US$'000
Current liabilities:
Accounts payable 9,016 - -
Accrued expenses and other payables 7,762 - -
Due to a related company 3,412 - -
Taxation payable 13,648 - -
-------- ------ -------
Total current liabilities 33,838 - -
Payable to a joint venture partner 35,450 - -
-------- ------ -------
Total liabilities 69,288 - -
-------- ------ -------
Minority interest 22,450 - -
-------- ------ -------
Stockholders' equity (deficit):
Preferred stock, Series A convertible
and redeemable, par value US$0.001;
issued and outstanding - 6,000 shares
as of December 31, 1996 and 3,700 shares
as of December 31, 1997 - - -
Preferred stock, Series B supervoting,
par value US$0.001; issued and outstanding
- - 100,000 shares as of December 31, 1996 and
nil as of December 31, 1997
Preferred stock, Series C convertible and
redeemable, par value US $0.001; issued and
outstanding - nil as of December 31, 1996 and 1997 - - -
Common stock, par value US$0.001; issued and
outstanding - 8,200,000 shares as of December 31,
1996 and 3,500,000 shares as of December 31, 1997 68 29 3
Additional paid-in capital 43,611 49,214 5,929
Dedicated capital 1,752 - -
Retained earnings (accumulated deficit) 14,901 (49,243) (5,932)
Cumulative translation adjustment 24 - -
-------- ------ -------
Total stockholders' equity 60,356 - -
-------- ------ -------
Total liabilities, minority interest
and stockholders' equity 152,094 - -
======== ====== =======
F-4
<PAGE>
NATURAL WAY TECHNOLOGIES, INC.
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
<TABLE>
1995 1996 1997
------ ------ --------
Rmb '000 Rmb '000 Rmb '000 US$ '000
<S> <C> <C> <C> <C>
Net sales - - - -
Cost of goods sold - - - -
-------- ------- ------ -------
Gross profit - - - -
General and administrative
expenses (66) (181) - -
Interest expense - (5) - -
Bad debt expense - (947) - -
Foreign exchange gain - - 24 3
-------- ------- ------ -------
(Loss) income from
continuing operations (66) (1,133) 24 3
Discontinued operations
Income from operations before
minority interest - 25,352 - -
-------- ------- ------ -------
Net (loss) income before
minority interest (66) 24,219 24 3
Minority interest - (7,510) - -
-------- ------- ------ -------
Net (loss) income (66) 16,709 24 3
======== ======= ====== =======
Earnings (loss) per common share-
Basic
Continuing operations - (.14) .02
Discontinued operations
Income from operations before
minority interest - 3.09 -
Minority interest - (.91) -
-------- ------- ------
Total-Basic - 2.04 .02
======== ======= ======
Diluted
Continuing operations - (.08) .02
Discontinued operations
Income from operations before
minority interest - 1.85 -
Minority interest - (.55) -
-------- ------- ------
Total-Diluted - 1.22 .02
======== ======= ======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
NATURAL WAY TECHNOLOGIES, INC.
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
<TABLE>
1995 1996 1997
------ ------ ------
Rmb '000 Rmb '000 Rmb '000 US$ '000
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net (loss) income (66) 16,709 24 3
Adjustments to reconcile net
(loss) income to net cash
provided by operating activities
Provision for doubtful debts - 947 - -
Write-back of allowance for
obsolete and slow-moving inventory - (527) - -
Depreciation of property, plant
and equipment - 965 - -
Minority interest - 7,510 - -
(Increase) decrease in operating
assets-
Accounts receivable, net - (18,293) - -
Due from a related company - 4,593 - -
Due from stockholders - 84 - -
Due from a director - (75) - -
Prepayments and deposits - 930 - -
Inventories, net - 399 - -
Deferred value added tax
recoverable - 338 - -
Increase (decrease) in operating
liabilities-
Accounts payable - 2,240 - -
Accrued expenses and other
payables 66 (17,241) (18) (2)
Due to related company - 3,032 - -
Taxation payable - 1,432 - -
-------- ------- ------ ------
Net cash provided by operating
activities - 3,043 6 1
-------- ------- ------ ------
</TABLE>
F-6 (To be continued)
<PAGE>
NATURAL WAY TECHNOLOGIES, INC.
STATEMENTS OF CASH FLOWS (CONT'D)
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
<TABLE>
1995 1996 1997
----- ------ --------
Rmb '000 Rmb '000 Rmb '000 US$ '000
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Cash flows from investing activities:
Investment deposits (31,548) - -
Acquisition of property, plant and
equipment - (8,218) - -
Establishment of joint venture - 3,111 - -
Effect of translation adjustments - 24 (24) (3)
-------- -------- ------ -------
Net cash used in investing activities - (36,631) (24) (3)
-------- -------- ------ -------
Cash flows from financing activities:
Issuance of common stock - 2 - -
Loan, subsequently capitalized by
issuance of preferred stock - 49,920 - -
Cost of issuance of stock - (8,131) - -
Diminution of cash due to
disposal of subsidiary - (9,999) (1,205)
Forgiveness of interest by a joint
venture partner - 1,814 - -
-------- -------- ------ -------
Net cash provided by (used in)
financing activities - 43,605 (9,999) (1,205)
-------- -------- ------ -------
Net increase (decrease) in cash - 10,017 (10,017) (1,207)
Cash as of beginning of year - - 10,017 1,207
-------- -------- ------ -------
Cash as of end of year - 10,017 - -
======== ======== ====== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-7
<PAGE>
NATURAL WAY TECHNOLOGIES, INC.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
<TABLE>
Series A
Convertible Series B
and Redeemable Supervoting (Accumulated
Preferred Stock Preferred Stock Common Stock Additional Deficit) Cumulative
Number of Number of Number of Paid-in Dedicated Retained Translation
Shares Amount Shares Amount Shares Amount Capital Capital Earnings Adjustments
-------- ------ -------- ------- -------- ------ -------- --------- ---------- -----------
Rmb Rmb Rmb Rmb '000 Rmb '000 Rmb '000 Rmb '000
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance as of December 31,
1994 - - 100,000 832 8,000,000 66,560 8 - 10 -
Net loss - - - - - - - - (66) -
Balance as of December 31,
1995 - - 100,000 832 8,000,000 66,560 8 - (56) -
Issuance of Series A
preferred stock 6,000 50 - - - - 49,920 - - -
Issuance of common stock - - - - 200,000 1,664 - - - -
Issuance costs - - - - - - (8,131) - - -
Forgiveness of interest by
a joint venture partner - - - - - - 1,814 - - -
Net income - - - - - - - - 16,709 -
Transfer from retained
earnings to dedicated capital - - - - - - - 1,752 (1,752) -
Translation adjustments - - - - - - - - - 24
Balance as of December 31,
1996 6,000 50 100,000 832 8,200,000 68,224 43,611 1,752 14,901 24
Conversion of Series A
preferred stock to common
stock (2,300) (19) - - 2,300,000 19,136 (19) - - -
Redemption and cancellation
of Series B preferred stock - - (100,000) (832) - - 1 - - -
Assumption of liabilities and
contribution to capital - - - - - - 5,563 - - -
Redemption and cancellation
of common stock - - - - (7,000,000) (58,240) 58 - - -
Transfer back to retained
earnings from dedicated
capital - - - - - - - (1,752) 1,752 -
Deemed dividend-terminated
joint venture interest - - - - - - - - (54,198) -
Deemed dividend -
misappropriated funds - - - - - - - - (11,648) -
Deemed dividend - forgiveness
of accounts receivable - - - - - - - - (74) -
Net income - - - - - - - - 24 -
Translation adjustments - - - - - - - - - (24)
Balance as of December
31, 1997 3,700 31 - - 3,500,000 29,120 49,214 - (49,243) -
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-8
<PAGE>
NATURAL WAY TECHNOLOGIES, INC.
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION AND PRINCIPAL ACTIVITIES
Natural Way Technologies, Inc. ("the Company") was incorporated in the State of
Nevada, United States of America on May 4, 1988 under the name of Energy
Systems, Inc. On June 26, 1996, the Company changed its name to Natural Way
Technologies, Inc.
a. Acquisition of subsidiary
On June 30, 1996, the Company entered into an agreement with Beautimate
Group Limited ("BGL"; a company incorporated in the British Virgin Islands)
and Ongoing Limited ("OL"; a company incorporated in the British Virgin
Islands) to acquire from them a 100% interest in China Medical Development
Company Limited ("CMDC"; a company incorporated in the British Virgin
Islands) by issuing to (i) BGL 6,900,000 shares of common stock, 100,000
shares of Series B supervoting preferred stock, 7,000,000 Class A warrants,
7,000,000 Class B warrants and 7,000,000 Class C warrants, and (ii) OL
100,000 shares of common stock. BGL is owned by New Silver Eagle Holdings
Limited (a company incorporated in the British Virgin Islands), which is
beneficially owned by Yat-hung Yiu, former director and CEO and Yat-on Yiu,
current CEO and director of the Company and brother of Yat-hung Yiu, and
certain family members of Yat-hung and Yat-on Yiu. OL is owned by Wu Guan,
a director of CMDC.
b. CMDC and its joint venture
On March 6, 1996, CMDC entered into a joint venture agreement with Dunhua
Huakang Pharmaceutical Plant ("DHPP"; a PRC state-owned company under the
Dunhua Municipal Government) to establish a sino-foreign joint venture in
Dunhua, Jilin Province, the People's Republic of China ("the PRC") - Dunhua
Huakang Pharmaceutical Co. Ltd. ("DHPC"). Pursuant to this joint venture
agreement, CMDC was required to contribute into DHPC cash of US$4,200,000
(equivalent to approximately Rmb34,860,000, determined at an exchange rate
of US$1 for Rmb8.30) as its capital contribution for a 70% equity interest
in DHPC, while DHPP was required to contribute into DHPC the production
plant, including buildings and machinery, with a valuation of US$1,800,000
(equivalent to approximately Rmb14,940,000, determined at an exchange rate
of US$1 for Rmb8.30) as its capital contribution for a 30% equity interest
in DHPC. As of December 31, 1996, CMDC and DHPP had fully paid up all of
their capital contributions - CMDC's contribution in cash of US$4,200,000
was verified by a certified public accountant in the PRC according to PRC
regulations whereas DHPP's contribution was yet to be subject to such a
verification. CMDC's contribution primarily came via the Company's initial
cash investment in CMDC of US$4,207,100.
DHPC has succeeded to certain business of manufacturing and sales of
formulated Chinese medicine in the PRC previously undertaken by DHPP. In
connection with the establishment of DHPC, DHPP delivered to CMDC a
guarantee that the annual net income after tax (as determined under
generally accepted accounting principles in the United States of America)
of DHPC for each of its first four years of operations would not be less
than 25% of the net assets employed by DHPC. In the event that the net
income of DHPC was below the guaranteed amount, DHPP agreed to reallocate
all or a portion of its entitlement to the net income of DHPC to CMDC or
make payments to CMDC so as to cover any shortfall with respect to CMDC's
share of the net income. In addition, DHPP transferred into DHPC additional
operating assets and liabilities with an estimated value of approximately
Rmb35,450,000 in return for an unsecured receivable from DHPC, which bore
interest at 5.5% per annum. DHPP also gave a guarantee to CMDC to transfer
DHPP's accounts receivable as of December 31, 1995 back to DHPP if such
accounts receivable were not realized in cash by June 30, 1997.
F-9
<PAGE>
1. ORGANIZATION AND PRINCIPAL ACTIVITIES (cont'd)
c. Discontinued operations - Disposal of subsidiary
The cooperation between DHPP and CMDC was for DHPP to research and produce
new products and to develop the local market. CMDC's part was to raise the
necessary capital in 1996 to inject into the joint venture to accomplish
these tasks. However, the Company encountered problems in raising capital
in the US stock market, which in turn contributed to the lack of new
product and local market development by DHPP. These events led to both
parties of the joint venture not contributing the agreed-upon capital into
the joint venture as originally called for by the agreement. Therefore, by
signed agreement between CMDC and DHPP both parties agreed to terminate the
joint venture as of January 1, 1997. In conjunction with the termination,
the Company terminated its ownership of CMDC and its joint venture in
exchange for the return of the 7,000,000 shares of common stock and 100,000
shares of Series B supervoting preferred stock originally issued in the
exchange. Due to the related party nature of the transaction, the Company's
net equity in the joint venture as of January 1, 1997 has been recorded as
a deemed dividend to BGL. All of the shares were cancelled by the Company
prior to December 31, 1997. In addition, all 7,000,000 Class B warrants and
7,000,000 Class C warrants were cancelled during 1997 in conjunction with
the termination agreement.
This transaction has been accounted for as a discontinued operation and the
results of operations have been excluded from continuing operations in the
statements of operations for 1996.
2. GOING CONCERN
The accompanying financial statements are prepared in accordance with generally
accepted accounting principles on a going-concern basis which contemplates that
the Company will be able to realize its assets and discharge its liabilities in
the normal course of business for the foreseeable future.
The Company ceased operations in 1996 via the termination of ownership of CMDC
and its joint venture.
The Company has the intention of acquiring other operating ventures in the near
future. Management expects that these efforts will result in maintaining the
liquidity necessary for the foreseeable future. However, no assurances can be
given that the Company will be successful in accomplishing these objectives.
Further, there can be no assurance that the Company will achieve profitability.
The Company's continuation as a going concern is dependent upon obtaining future
profitable operations and upon its ability to maintain adequate financing or
capital.
3. BASIS OF PRESENTATION
The acquisition of CMDC by the Company on June 30, 1996 was treated as a
recapitalization of CMDC with CMDC as the acquirer (reverse acquisition). On
this basis, the historical consolidated financial statements of the Company
prior to June 30, 1996 are those of CMDC and the historical stockholders' equity
amounts of CMDC prior to 1996 have been retroactively restated to reflect the
equivalent number of shares of common stock of the Company issued for this
acquisition.
F-10
<PAGE>
3. BASIS OF PRESENTATION (cont'd)
The acquisition of DHPC by CMDC on March 6, 1996 has been accounted for using
the purchase method of accounting. Accordingly, the assets acquired and
liabilities assumed have been recorded at their estimated fair values, and the
operations of DHPC are included in the financial statements of the Company from
the date of acquisition. The following is an unaudited pro forma summary of the
combined results of the Company and CMDC for the year ended December 31, 1996 as
if the acquisition had occurred as of January 1, 1996. The unaudited pro forma
summary is not necessarily indicative either of the results of operations that
would have occurred had the acquisition been made as of January 1, 1996, or of
the future results of operations of the combined companies.
Year ended December 31, 1996
----------------------------
Rmb'000 US$'000
Pro forma net sales 86,380 10,382
Pro forma net income 18,028 2,167
Pro forma basic earnings per common share 1.40 0.17
4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a. Basis of consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All material intra-group balances and transactions
have been eliminated on consolidation.
b. Inventories
Inventories are stated at the lower of cost, on a weighted average basis,
and market value. Costs of work-in-process and finished goods are composed
of direct materials, direct labor and an attributable portion of
manufacturing overheads.
c. Property, plant and equipment
Property, plant and equipment are stated at cost. Depreciation for
financial reporting purposes is provided using the straight-line method
over the estimated useful lives of the assets after taking into account the
estimated residual value. The estimated useful lives are as follows: land
use rights - 50 years, buildings - 20 years, machinery and equipment - 10
years, motor vehicles - 5 years, furniture and office equipment - 10 years.
Gains or losses on disposals are reflected in current operations. All
ordinary repair and maintenance costs are expensed as incurred.
Construction-in-progress includes the costs of construction and interest
charges arising from borrowings used to finance these assets during the
period of construction. There was no interest capitalized in 1995, 1996 or
1997.
F-11
<PAGE>
4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont'd)
d. Net sales
Net sales represent the invoiced value of goods (excluding value-added tax)
supplied to customers, net of sales returns and allowances. Sales are
recognized upon delivery of goods and passage of title to customers.
All of the Company's sales are made in the PRC and are subject to PRC
value-added tax at a rate of 17% ("output VAT"). Such output VAT is payable
after offsetting VAT paid by the Company on purchases ("input VAT").
There were no sales from continuing operations for 1995 through 1997, as
all Company sales were from its discontinued operations. See Note 1.
e. Income taxes
Income taxes are provided under the provisions of Statement of Financial
Accounting Standards No. 109.
f. Foreign currency translation
Foreign currency transactions denominated in foreign currencies are
translated into Renminbi ("Rmb") at the respective applicable rates of
exchange. Monetary assets and liabilities denominated in foreign currencies
are translated into Rmb at the applicable rate of exchange at the balance
sheet date. The resulting exchange gains or losses are credited or charged
to the statements of operations.
Translation of amounts from Rmb into United States dollars ("US$") for the
convenience of the reader has been made at the single rate of exchange on
December 31, 1997 of US$ 1.00 : Rmb$8.30. No representation is made that
the Rmb amounts could have been, or could be, converted into US$ at that
rate on the above dates or at any other date.
g. Earnings per common share
Effective December 31, 1997, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 128, "Earnings Per Share," which requires
the Company to change the method used to compute earnings per share ("EPS")
and to restate all prior periods presented. The presentation of primary and
fully diluted EPS has been replaced with basic and diluted EPS,
respectively. Basic EPS is computed using the weighted average number of
common shares outstanding during the period. The computation of diluted EPS
would include the dilutive effect of securities that could be exercised or
converted into common stock.
The weighted average number of shares outstanding for basic earnings (loss)
per share during the years ended December 31, 1995, 1996 and 1997 were
8,000,000, 8,200,000 and 1,200,000, respectively. The weighted average
number of shares outstanding for diluted earnings (loss) per share during
the years ended December 31, 1995, 1996 and 1997 were 8,000,000, 13,661,202
and 1,200,000, respectively.
F-12
<PAGE>
4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont'd)
h. Segment reporting
In December 1998, the Company will adopt SFAS No. 131, "Disclosures About
Segments of an Enterprise and Related Information." The adoption of this
statement requires that reportable segments are reported consistent with
how management assesses segment performance. This statement requires
disclosure of certain information by reportable segment, geographic area
and major customer. The Company's only operations consisted of the joint
venture, DHPC, in 1996. DHPC's only operating segment was the manufacture
and sale of certain formulated Chinese medicines.
i. Management estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
5. ACCOUNTS RECEIVABLE
Accounts receivable comprised:
1996 1997
---- ------
Rmb'000 Rmb'000 US$'000
Trade receivables 74,480 - -
Less: Allowance for doubtful
accounts (947) - -
-------- ------ ------
73,533 - -
6. PREPAYMENTS AND DEPOSITS
Prepayments and deposits comprised:
1996 1997
---- ------
Rmb'000 Rmb'000 US$'000
Advances to employees for
business trips 2,123 - -
Deposits for purchase of raw
materials 160
Prepayments 324 - -
------ ------ ------
2,607 - -
====== ====== ======
F-13
<PAGE>
7. INVENTORIES
Inventories comprised:
1996 1997
----- ------
Rmb'000 Rmb'000 US$'000
Raw materials 3,190 - -
Work-in-process 367 - -
Finished goods 2,356 - -
5,913 - -
Less: Allowance for obsolete
and slow-moving items (295) - -
-------- ----- ------
5,618 - -
======== ===== ======
8. INVESTMENT DEPOSITS
Investment deposits comprised:
1996 1997
Rmb'000 Rmb'000 US$'000
Deposit with China Food and
Beverage Industrial Co. Limited
(see Note 17) 11,648 - -
Deposit with Simple Win
Investment Limited (*) 19,900 - -
------- ---- -----
31,548 - -
======= ==== =====
(*) This represents a deposit paid to Simple Win Investment Limited ("SWI"; an
unrelated entity) by DHPC for acquiring 100% interest in Asia First
Pharmaceutical Investment Ltd. ("AFPI"; a company incorporated in the
British Virgin Islands), which has a 90% equity interest in Jilin Huajia
Pharmaceutical Company Limited ("JHP"; a sino-foreign joint venture
established in Meihekou, Jilin Province, the PRC). JHP is principally
engaged in the manufacturing and sales of formulated Chinese medicine in
the PRC. According to a letter of intent dated May 15, 1996 between the
Company and SWI, the Company had an option through June 30, 1997 to
determine whether it would proceed or withdraw from such an acquisition
after conducting a due diligence exercise. In the event that the Company
decided to withdraw from the acquisition, the deposit would be refunded
without interest. In accordance with the Company's termination of its
ownership of CMDC and its joint venture, DHPC, the deposit was removed
through a noncash transaction as of January 1, 1997. See Note 19.
The Company's directors consider that the Company could realize such
deposits through investments in the aforementioned companies or the Company
could recover the deposits if the Company decides to withdraw from the
acquisitions.
F-14
<PAGE>
9. DEFERRED VALUE ADDED TAX RECOVERABLE
Deferred value added tax ("VAT") recoverable arose from a change in the PRC
tax system and regulations effected January 1, 1994, and was determined at
14% of the balance of DHPP's inventories as of January 1, 1994. This is
part of the operating assets transferred by DHPP into DHPC in connection
with the establishment of DHPC (see Note 1). Pursuant to a directive issued
by the PRC State Tax Bureau, the amount of deferred VAT recoverable
outstanding at January 1, 1995 can be utilized to offset net VAT payable
over a period of five years, with the exact amount of annual utilization
varying from 15% to 20% of the balance outstanding as of January 1, 1995 as
determined by individual local tax bureaus. The amount utilized in 1996 was
approximately Rmb338,000.
10. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment comprised:
1996 1997
------ ------
Rmb'000 Rmb'000 US$'000
Land and buildings in the PRC 16,119 - -
Machinery and equipment 6,236 - -
Motor vehicles 916 - -
Furniture and office equipment 353 - -
Construction-in-progress:
Buildings in the PRC 867 - -
------- ----- -----
24,491 - -
Less: Accumulated depreciation (965) - -
------- ----- -----
23,526 - -
======= ===== =====
The Group's buildings are located on land in the PRC granted under a land
use right for a term of 50 years.
F-15
<PAGE>
1. ACCRUED EXPENSES AND OTHER PAYABLES
Accrued expenses and other payables comprised:
1996 1997
------ ------
Rmb'000 Rmb'000 US$'000
Accrual for operating expenses
Sales commissions 601 - -
Advertising and promotional
expenses 1,495 - -
Salaries and wages 865 - -
Interest expense 348 - -
Legal fees 269 - -
Stock issuance costs 1,997 - -
Other 1,477 - -
Provision for funds
Salary and welfare fund(a) 472 - -
Housing fund (b) 238 - -
------- ----- ------
7,762 - -
======= ===== ======
(a) Salary and welfare fund is provided at 2% of net income of DHPC, as
determined by DHPC's board of directors according to PRC regulations (see
Note 15). The fund is for the payment of nonrecurring bonus and welfare
expenses of employees.
(b) Housing fund is provided at Rmb98 per employee of DHPC in the PRC in
accordance with PRC regulations. The fund is for the repair and maintenance
of staff quarters.
12. PAYABLE TO A JOINT VENTURE PARTNER
This represents payable by DHPC to DHPP for the operating assets and
liabilities transferred into DHPC (see Note 1) together with accrued
interest thereon. The payable is unsecured and bears interest at 5.5% per
annum. Total interest accrued on this payable in 1996 amounted to
approximately Rmb1,814,000. DHPP has forgiven its entitlement to the 1996
interest of Rmb1,814,000, and such forgiveness is accounted for as a
capital contribution from DHPP and recorded as additional paid-in capital.
In addition, DHPP has agreed not to demand repayment until the Group is
financially capable to do so.
13. CAPITAL STOCKS AND WARRANTS
a. Common stock
The Company's authorized common stock is 50,000,000 shares with par value
of US$0.001 each. In 1996, the Company sold 200,000 shares of common stock,
par value US$0.001 each, for US$200, and issued 7,000,000 shares of common
stock, par value US$0.001 each, in connection with its acquisition of CMDC.
Effective January 1, 1997, these shares were tendered in conjunction with
the termination of ownership of CMDC and its joint venture and cancelled
prior to December 31, 1997. See Note 1. During April of 1997, 2,300 shares
of the Series A convertible and redeemable preferred stock were converted
into 2,300,000 shares of common stock.
F-16
<PAGE>
13. CAPITAL STOCKS AND WARRANTS (cont'd)
b. Preferred stock
Effective from May 13, 1996, the Company authorized the creation of
5,000,000 shares of preferred stock with par value US$0.001 each and
authorized the Company's board of directors to assign such shares to
different series and to fix the related designation, powers, preferences
and rights of the shares.
(i) Series A convertible and redeemable preferred stock
In 1996, the Company sold 6,000 shares of Series A convertible and
redeemable preferred stock, par value US$0.001 each, for US$6,000,000
(equivalent of Rmb49,920,000) by capitalizing a loan of the same amount.
The Series A convertible and redeemable preferred stock carries
preferential rights to dividends and distributions convertible and
redeemable upon liquidation. Each share of the Series A convertible and
redeemable preferred stock is convertible into common stock with the number
of shares of common stock determined by US$1,000 divided by a conversion
factor. The conversion factor equals the lesser of the average closing
market price of the Company's common stock for the five days immediately
preceding the date of notice of conversion or US$1.00. The outstanding
Series A convertible and redeemable preferred stock is redeemable at the
option of the Company at any time after December 31, 1997 by giving ten
days of notice at a price equal to US$1,000 per share plus any accrued
dividends. During April 1997, 2,300 shares of Series A convertible and
redeemable preferred stock was converted to 2,300,000 shares of common
stock.
(ii) Series B supervoting preferred stock
In 1996, the Company issued 100,000 shares of Series B supervoting
preferred stock, par value US$0.001 each, in connection with its
acquisition of CMDC. In connection with the termination of the Company's
ownership of CMDC and its joint venture, the preferred shares were tendered
and cancelled effective as of December 1, 1997. The Series B supervoting
preferred stock carried preferential rights to dividends and distributions
upon liquidation. These 100,000 shares of Series B supervoting preferred
stock also carried superior voting rights, which accounted for 30% of the
total voting rights of the Company on all corporate matters, prior to their
cancellation.
(iii) Series C convertible and redeemable preferred stock
The Company has authorized the creation of 10,000 shares of Series C
convertible and redeemable preferred stock, par value US$0.001 each. The
Series C convertible and redeemable preferred stock carries preferential
rights to dividends and distributions upon liquidation. Each share of the
Series C convertible and redeemable preferred stock is convertible into
common stock with the number of shares of common stock determined by 1,000
divided by a conversion factor. The conversion factor is equal to the
lesser of the average closing market price of the Company's common stock
for the five days immediately preceding the date of notice of conversion or
US$3.00. The outstanding Series C convertible and redeemable preferred
stock would be redeemable at the option of the Company at any time after
December 31, 1997 by giving ten days of notice at a price equal to US$1,000
per share plus any accrued dividends. No Series C convertible and
redeemable preferred stock has been issued.
F-17
<PAGE>
13. CAPITAL STOCKS AND WARRANTS (cont'd)
c. Warrants
In 1996, the Company issued 7,000,000 Class A warrants, 7,000,000 Class B
warrants and 7,000,000 Class C warrants in connection with its acquisition
of CMDC. As part of the termination of ownership of CMDC and its joint
venture, the Class B and Class C warrants were cancelled during 1997 (see
Note 1). Each of the Class A warrants was exercisable at a price of US$3.00
in exchange for one share of common stock of the Company at any time up to
June 30, 1998; each of the Class B warrants was exercisable at a price of
US$4.00 in exchange for one share of common stock of the Company at any
time up to June 30, 2000; and each of the Class C warrants was exercisable
at a price of US$5.00 in exchange for one share of common stock of the
Company at any time up to June 30, 2002. The Company's management believed
that the exercise prices of the warrants issued exceeded the fair market
value of the Company's common stock on the date of issuance of the
warrants. No warrants were ever exercised prior to their expiration or
cancellation.
14. TAXATION
The Company is subject to income taxes, on an entity basis, on income arising in
or derived from the tax jurisdiction in which it operates. The British Virgin
Islands subsidiary, CMDC, is incorporated under the International Business
Companies Act of the British Virgin Islands and, accordingly, was exempted from
payment of the British Virgin Islands income taxes. The joint venture enterprise
established in the PRC, DHPC, is subject to PRC income taxes at a rate of 33%
(30% state unified income tax and 3% local income tax). However, DHPC was
exempted from state-unified income tax and local income tax for two years
starting from the first year of profitable operations and then was subject to a
50% reduction in state unified income tax for the next three years. The first
profitable year for DHPC was the year ended December 31, 1996.
If the tax holiday for DHPC did not exist, the Company's income tax expenses
(net of minority interest) would have been increased by approximately
Rmb5,782,000 for the year ended December 31, 1996. Earnings per common share for
the year ended December 31, 1996 would have been approximately Rmb1.16.
The Company has not provided for income taxes on the undistributed earnings of
its international subsidiaries because the earnings are reinvested and, in the
opinion of management, will continue to be reinvested in the foreseeable future.
The reconciliations of the United States federal income tax rate to the
effective income tax rate based on the income (loss) before provision for income
taxes stated in the statements of operations is as follows:
Year ended December 31,
1996
-----
U.S. federal income tax rate 35%
Effect of different tax rates
in foreign jurisdictions (2)
Effect of tax exemption for DHPC (33)
-----
Effective income tax rate -%
=====
F-18
<PAGE>
14. TAXATION (cont'd)
Taxation payable comprised:
1996
--------
Rmb'000
Value added tax 13,616
Other 32
------
13,648
======
15. DISTRIBUTION OF INCOME
For 1996, substantially all of the Company's income came from its 70% owned
joint venture enterprise in the PRC, DHPC.
Income of DHPC as determined under generally accepted accounting principles in
the PRC was distributable to its joint venture partner after transfer to (i)
contributory dedicated capital as required under PRC government regulations and
the Company's articles of association, and (ii) discretionary dedicated capital
as determined by the Company's board of directors. Contributory dedicated
capital is a form of legal reserve fund. Discretionary dedicated capital
includes salary fund and staff welfare fund. Contributory and discretionary
dedicated capital is not distributable in the form of dividends. In the
Company's financial statements prepared under generally accepted accounting
principles in the United States of America, amounts designated for payments of
employee salary and welfare have been charged to income and the related
provisions are reflected as accrued liabilities in the balance sheets.
The income of DHPC available for distribution to its joint venture partner is
based on the income reported in its statutory accounts prepared under generally
accepted accounting principles in the PRC. This differs from the amount reported
under generally accepted accounting principles in the United States of America.
As of December 31, 1996, such difference was insignificant.
16. RETIREMENT PLAN
As stipulated by PRC regulations, DHPC maintains a defined contribution
retirement plan for all of its employees. All retired employees of DHPC are
entitled to an annual pension equal to their basic annual salary at retirement.
DHPC contributes to a state-sponsored retirement plan approximately 21.5% of the
basic salary of its employees, and has no further obligations for the actual
pension payments or post-retirement benefits beyond the annual contributions.
The state-sponsored retirement plan is responsible for the entire pension
obligations payable to retired employees. The contributions made in 1996
amounted to approximately Rmb282,000.
F-19
<PAGE>
17. RELATED PARTY TRANSACTIONS
Name and relationship of related parties:
Name of related party Existing relationship with the Company
- --------------------- --------------------------------------
Mr. Yat-hung Yiu Former director and CEO of the Company
Mr. Yat-on Yiu Current director and CEO of the Company and
brother of Mr. Yat-hung Yiu
China Food and Beverage A company beneficially owned and controlled by
Industrial Co. Limited (CFBI) Mr. Yat-hung Yiu
New Silver Eagle Holdings Limited Stockholder of the Company and common
directors with the Company (see Note 1)
Huakang Headquarters Common directors with the joint venture
partner, DHPP (see Note 1)
Beautimate Group Limited Stockholder (see Note 1)
Ongoing Limited Stockholder (see Note 1)
Summary of related party balances and transactions is as follows:
1995 1996 1997
------ ------ ------
Rmb'000 Rmb'000 Rmb'000 US$'000
Due from a related company
Huakang Headquarters - 4,159 - -
Due from shareholders
- -- Beautimate Group Limited 59 - - -
- -- Ongoing Limited 25 - - -
Due from a director
- --Yat-hung Yiu - 75 - -
Due to a related company
- -- New Silver Eagle Holdings
Limited - Hong Kong - 3,412 - -
Interest expense paid to
related companies
- - Huakang Headquarters - 283 - -
- - DHPP [Note 19(b)] - 1,814 - -
Deemed dividend - forgiveness of
accounts receivable from
Mr. Yat-hung Yiu - - 74 9
F-20
<PAGE>
17. RELATED PARTY TRANSACTIONS (Cont'd)
1995 1996 1997
------ ------ ------
Rmb'000 Rmb'000 Rmb'000 US$'000
Deemed dividend -
misappropriation of deposit
with CFBI(*) - - 11,648 1,403
Management fee paid to a
related company
- - Huakang Headquarters - 1,093 - -
In 1996, DHPC and Huakang Headquarters undertook a joint advertisement program
with total advertising expenses amounting to approximately Rmb17,874,000, of
which approximately Rmb7,440,000 was allocated to and absorbed by Huakang
Headquarters.
See also Notes 1, 18 and 19 for additional related party disclosures.
(*) During 1996 a deposit was paid to CFBI, an entity owned by the prior CEO of
the Company, for the exclusive right to ascertain the feasibility of
acquiring not less than a 50% equity interest in CFBI. In the event the
Company decided not to invest, CFBI was to return the deposit with
interest. In 1997 Mr.Yat-on Yiu, the brother of Mr. Yat-hung Yiu and
current CEO, discovered the deposit, which was supposedly returned by CFBI,
was never deposited into the Company's bank account. Inquiry by Mr. Yat-on
Yiu to his brother revealed that the funds had been diverted by Mr.
Yat-hung Yiu to cover professional fees, acquisition costs, rent and
payroll expenses paid personally by him on behalf of the Company. However,
no documentation was ever provided to the Company to support his claims. As
such, the Company has treated the diversion of the deposit as a
misappropriation of funds and, due to the related party nature of the
transaction, as a reduction to equity or deemed dividend during 1997.
18. SUBSEQUENT EVENT
On August 24, 1999, the Board of Directors approved the issuance of 10,530,500
shares to the Beautimate Group Limited in exchange for its capital contribution
of at least US$200,000 to pay for professional fees incurred by the Company.
F-21
<PAGE>
19. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
a. Cash paid (received) for interest comprised:
1995 1996 1997
Rmb'000 Rmb'000 Rmb'000 US$'000
Interest paid - 65 - -
====== ====== ===== =====
Interest received - (520) - -
====== ====== ===== =====
b. Supplementary disclosure of noncash investing activities:
1996
(i) In conjunction with the establishment of DHPC, the PRC joint
venture partner, DHPP, transferred the following operating assets
(liabilities) into DHPC:
Rmb'000
Cash 3,111
Accounts receivable 56,187
Due from related companies 8,752
Prepayments and deposits 3,537
Inventories 5,490
Deferred value added tax recoverable 1,349
Property, plant and equipment 18,157
Short-term borrowings (37)
Accounts payable (6,776)
Accrued expenses and other payables (24,900)
Due to related companies (380)
Taxation payable (12,216)
----------
52,274
Less: Negative goodwill adjusted against
property, plant and equipment (1,884)
----------
50,390
==========
Represented by - Capital contribution by DHPP
into DHPC (see Note 1) 14,940
Payable to DHPP (see Note 1) 35,450
----------
50,390
==========
Cash inflow resulting from the establishment
of DHPC 3,111
==========
F-22
<PAGE>
19. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (cont'd)
(ii) On June 30, 1996, the Company acquired a 100% interest in CMDC by
issuing 7,000,000 shares of common stock, 100,000 shares of
Series B supervoting preferred stock, 7,000,000 Class A warrants,
7,000,000 Class B warrants and 7,000,000 Class C warrants (see
Note 1). In addition, the Company capitalized a loan amounting to
Rmb49,920,000 by issuance of 6,000 shares of Series A convertible
and redeemable preferred stock [see Note 13 b (i)].
In 1996, interest payable of Rmb1,814,000 from DHPC to DHPP, a
joint venture partner, was forgiven by DHPP and contributed to
additional paid-in capital of the Company.
1997
- ----
In accordance with the Company's termination of its ownership of CMDC and its
joint venture (see Note 1), the following balances were removed through a
noncash transaction:
Rmb '000 US$ '000
---------- ---------
Cash 9,999 1,205
Receivables 73,533 8,859
Amounts due from related companies 4,159 501
Prepayments, deposits and other 2,607 314
Inventories 5,618 677
Investment deposits 19,900 2,398
Deferred value-added tax recoverable 1,011 122
Property, plant and equipment 23,526 2,834
Accounts payable (9,016) (1,086)
Accrued expenses and other payables (5,591) (674)
Income taxes payable (13,648) (1,644)
Payable to a joint venture partner (35,450) (4,271)
Minority interest (22,450) (2,705)
Deemed dividend - terminated joint venture interests 54,198 6,530
F-23
<PAGE>
19. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (cont'd)
In conjunction with the termination of the investment in subsidiary, the shares
originally issued for the acquisition were returned. These shares were
subsequently cancelled on December 1, 1997 (see Note 13). Rmb '000 US$'000
Redemption and cancellation of common stock (58) (7)
Redemption and cancellation of Series B
supervoting preferred stock (1) -
Additional paid-in capital 59 7
- -
On December 31, 1997, Rmb2,151,000 of accrued expenses and Rmb3,412,000 of
amounts due to related companies were assumed by the stockholder, New Silver
Eagle Holdings Limited. The stockholders then contributed the total balance of
the liabilities assumed to additional paid-in capital.
20. OPERATING RISKS
a. Dependence on strategic relationship
The Company conducted its manufacturing operations through a joint venture
with DHPP, a PRC state-owned enterprise in 1996. The termination of this
strategic relationship had an adverse effect on the operations of the
Company. See Note 1.
b. Limited product types
Substantially all of the Company's sales in 1996 were derived from two
products, via its 70% ownership in DHPC, which was terminated on January 1,
1997. No further operations existed for 1997.
c. Country risk
As substantially all of the Company's operations in 1996 were conducted in
the PRC, the Company is subject to special considerations and significant
risks not typically associated with companies operating in North America
and Western Europe. These include risks associated with, among others, the
political, economic and legal environments and foreign currency exchange.
The Company's results may be adversely affected by changes in the political
and social conditions in the PRC, and by changes in governmental policies
with respect to laws and regulations, inflationary measures, currency
conversion and remittance abroad, and rates and methods of taxation, among
other things. In addition, a significant portion of the Company's prior
revenue was denominated in Rmb which must be converted into other
currencies before remittance outside the PRC. Both the conversion of Rmb
into foreign currencies and the remittance of foreign currencies abroad
require approvals of the PRC government.
F-24
<PAGE>
21. OPERATING RISKS (cont'd)
d. The Company had transactions with customers in the PRC. The customers
may settle their debts and distribute their dividends outside the PRC.
The remittances are subject to control because Rmb is not freely
convertible into foreign currencies. Due to discontinued operations,
there were no continuing operations in 1995 through 1997. See Note 1.
On January 1, 1994, the PRC government introduced a single rate of
exchange as quoted daily by the People's Bank of China (the "Unified
Exchange Rate").
The quotation of the exchange rates does not imply free convertibility
of Rmb into Hong Kong dollars or other foreign currencies. All foreign
exchange transactions continue to take place either through the
People's Bank of China or other banks authorized to buy and sell
foreign currencies at the exchange rates quoted by the People's Bank
of China. Approval of foreign currency payments by the People's Bank
of China or other institutions requires submitting a payment
application form together with suppliers' invoices, shipping documents
and signed contracts.
22. OTHER SUPPLEMENTAL INFORMATION
1995 1996 1997
----- ----- ------
Rmb'000 Rmb'000 Rmb'000 US$'000
Provision for doubtful debts - 947 - -
Write-back of allowance for
obsolete and slow-moving
inventories - (527) -
Advertising expense - 10,434 - -
F-25
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