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, 1996

[ ]  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                (I.R.S. Employer Identification No.)
of incorporation or organization)

                       One World Trade Center, Suite 7865
                            New York, New York 10048
               ---------------------------------------------------
               (Address of Principal Executive Offices) (Zip Code)

Registrant's Telephone Number, Include Area Code:  (212) 938-0574

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  X  No
         -----  -----

     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 $9,655,000.

     As of April 18, 1997,  10,200,000  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 $9,900,000.

                       DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the Registrant's  definitive annual information statement to be
filed within 120 days of the  Registrant's  fiscal year ended  December 31, 1996
are incorporated by reference into Part III.

     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.............................        8
    ITEM  3.  LEGAL PROCEEDINGS.....................................        8
    ITEM  4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...        9

PART II

    ITEM  5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER
                MATTERS.............................................        9
    ITEM  6.  MANAGEMENT'S DISCUSSION AND ANALYSIS..................        9
    ITEM  7.  FINANCIAL STATEMENTS..................................       13
    ITEM  8.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON 
                ACCOUNTING AND FINANCIAL DISCLOSURE.................       13

PART III

    ITEM  9.  DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
                PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE
                EXCHANGE ACT........................................       14
    ITEM 10.  EXECUTIVE COMPENSATION................................       14
    ITEM 11.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
                MANAGEMENT..........................................       14
    ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS........       14
    ITEM 13.  EXHIBITS AND REPORTS OF FORM 8-K......................       15

              SIGNATURES............................................       16

              FINANCIAL STATEMENTS..................................      F-1
<PAGE>
                                     PART I

     This Form 10-KSB contains forward-looking  statements within the meaning of
Section 27A of the  Securities  Act of 1933 and  Section  21E of the  Securities
Exchange Act of 1934. The Company's actual results could differ  materially from
those set forth in the  forward-looking  statements.  Certain factors that might
cause such a difference are discussed in the section  entitled  "Certain Factors
Affecting Future Operating Results" beginning on page 12 of this Form 10-KSB.

ITEM 1. DESCRIPTION OF BUSINESS

General and Development of Business

     Natural Way  Technologies,  Inc.  (the  "Company"),  a Nevada  corporation,
through its  subsidiaries  and a sino-foreign  joint venture,  is engaged in the
manufacture  of  formulated  Chinese  medicines.   The  Company's  manufacturing
facility is located in Dunhua,  Jilin Province,  the People's  Republic of China
("PRC").

     The Company's operations began in 1990 as a state-owned enterprise known as
Dunhua  Huakang  Pharmaceutical  Plant  ("DHPP") which was formed to develop and
produce a number of  medical  products.  In 1993,  DHPP  management  decided  to
concentrate  on the production of its two most  profitable  and widely  accepted
products,  Xue Shuan Xin Mai Ning ("XMN"), a medication used in the treatment of
cerebral thrombosis,  coronary  arteriosclerosis and cardiac neuralgia, and Guan
Mai Ning ("GMN"),  a medication used in the treatment of coronary heart disease,
cardiac neuralgia and blood deficiency in coronary arteries.  Management of DHPP
ultimately determined that, to fully develop its business, it would need greater
resources and larger pools of capital.  In March,  1996,  DHPP  contracted  with
China Medical Development Co., Ltd. ("China Medical"),  a British Virgin Islands
company,   to  form  a  Sino-Foreign  joint  venture  known  as  Dunhua  Huakang
Pharmaceutical Co., Ltd. (the "Pharmaceutical Joint Venture"). The joint venture
term is thirty years from March 1996 to March 2026. Under the terms of the joint
venture  agreement,  DHPP  contributed to the  Pharmaceutical  Joint Venture the
plant  and  equipment  valued  at  $1,800,000  and  China  Medical   contributed
$4,200,000 in cash for working  capital.  In addition,  DHPP  transferred to the
Pharmaceutical Joint Venture additional operating assets and liabilities with an
estimated  valuation  of  approximately  $4,261,000  in return for an  unsecured
receivable  from the  Pharmaceutical  Joint Venture which bears interest at 5.5%
per annum.  All earnings of the  Pharmaceutical  Joint Venture are to be divided
based on the parties respective capital  contributions,  or 70% to China Medical
and 30% to DHPP. DHPP has delivered a guarantee to China Medical that the annual
net income after tax of the  Pharmaceutical  Joint Venture for each of its first
four years of operations will not be less than 25% of the net assets employed by
the  Pharmaceutical  Joint  Venture.  In the  event  that the net  income of the
Pharmaceutical  Joint Venture is below the guaranteed amount, DHPP has agreed to
reallocate  to China  Medical all or a portion of its share of net income of the
Pharmaceutical Joint Venture or to make payments to China Medical so as to cover
any  shortfall  with  respect  to  China  Medical's  share  of the  net  income.
Additionally,  receivables  of  DHPP  transferred  to the  Pharmaceutical  Joint
Venture which are not collected by June 30, 1997 are subject to transfer back to
DHPP with a corresponding  reduction in the receivable  from the  Pharmaceutical
Joint Venture relating to the transferred operating assets.

     On June 30, 1996,  China  Medical  completed a "reverse  acquisition"  (the
"Exchange") of Energy Systems,  Inc. ("ESI"), a U.S. public company.  ESI had no
operations prior to the Exchange but was a publicly held shell which was seeking
an operating  business to acquire.  Pursuant to the terms of the  Exchange,  ESI
acquired  100% of the  outstanding  shares  of China  Medical  in  exchange  for
7,000,000 shares of common stock, 7,000,000 Class A Warrants,  7,000,000 Class B
Warrants,  7,000,000  Class C Warrants and 100,000  shares of Series B preferred
stock  of  ESI.  As a  condition  of the  Exchange,  ESI  agreed  to  contribute
$4,200,000  to China  Medical.  ESI  issued a total of 6,000  shares of Series A
convertible  preferred  stock for  $6,000,000  and  contributed a portion of the
proceeds  of such  offering  to China  Medical  in order  to meet  such  funding
requirements.  Following  the  Exchange,  ESI  changed  its name to Natural  Way
Technologies,  Inc.  and  management  of China  Medical  assumed  control of the
Company.  As  used  herein,  references  to  the  Company  include  Natural  Way
Technologies,  Inc.,  its  wholly-owned  subsidiary,  China  Medical,  and China
Medical's 70% interest in the Pharmaceutical Joint Venture.


                                        1
<PAGE>
Company Strategy

     Management  has  set  as  the  Company's  overriding  goal  to  become  the
recognized leader in the production and distribution of pharmaceutical  products
in the PRC. To achieve its  objectives,  the Company plans to (1) acquire and/or
develop  a line  of  leading  or  niche  market  pharmaceutical  products  aimed
specifically  at the PRC market,  and (2)  establish a  nationwide  distribution
network through the acquisition and/or construction of distribution  centers and
retail  drug  stores  throughout  the PRC.  The  Company's  plans in that regard
include  (1) the opening of drug  stores in 40 large  urban  areas,  principally
along the  Pacific  Coast,  (2) the  opening  of  stores  in the 2,860  counties
throughout  China,  and (3) the  establishment  of  dispensary  or  distribution
centers in rural areas. The pharmaceutical  industry is highly fragmented in the
PRC  because  pharmaceutical  products  cannot  be freely  distributed  from one
province to another. By setting up a nationwide  distribution system and outlets
to  operate   within  each  of  the   provinces,   cross-province   distribution
difficulties  can  be  eliminated.   Management   believes  that,   through  the
establishment  of such a distribution  network,  an  opportunity  exists for the
Company  to  capture  substantial  market  share  and to  establish  brand  name
recognition  for its products.  To facilitate its growth plans,  the Company has
signed a letter of intent to acquire a  controlling  interest in a joint venture
to be established  with Shanghai First Pharmacy Company ("SFP") to open, own and
operate  retail  drug stores  throughout  the PRC.  SFP is a PRC  company  which
presently  operates  eighteen  stores  which  sell in excess  of 10,000  medical
products and has annual  sales  exceeding  $75 million in Shanghai.  The Company
plans to execute  its  business  plan  through  this joint  venture  and through
similar acquisitions.

     In  conjunction  with its efforts to establish  its position as the leading
provider  and  distributor  of Chinese  natural  medicines  within the PRC,  the
Company is establishing  relationships with major  international  pharmaceutical
companies  whereby the Company will  distribute  western  medicines  through its
distribution network in the PRC and license and distribute the Company's Chinese
medicines outside of the PRC.

Overview of PRC Medical Products and Services Market

     The market  for  medical  services  and  products  in the PRC over the past
several  decades  has been  greatly  influenced  by the  diverse  affects of two
distinct  forces,  (1) an ancient  tradition  of  reliance  on  Chinese  natural
medicines  and  (2)  the  proliferation  and  subsequent  downsizing  of a state
controlled  health care delivery and finance system.  These  influences have had
dramatically  different  effects when viewed in rural areas of China as compared
to urban areas.

     State influence over socialized  health care,  until recent years,  was the
single  dominant force in  influencing  the delivery of health care products and
services  in  urban  areas.  Such  influence  was  largely  the  result  of  the
concentration  of hospitals and health care providers in urban areas.  Under the
state system,  state-funded  insurance plans provided free medical care for most
of the PRC's 1.2 billion  population.  Under this system,  an employee or worker
was reimbursed for medical expenses by his/her employer,  which in virtually all
instances  were state  owned.  That  system  made cost a  non-factor  in seeking
medical  services  and  created  incentives  for  frequent  hospital  visits and
physician consultations.  While PRC pharmaceutical  regulations provide that all
pharmaceuticals,  whether prescription or over-the-counter,  can be sold through
either licensed pharmacies or hospitals, given the absence of cost factors which
would  otherwise tend to deter  excessive use of medical  products and services,
the urban  dwelling  Chinese would  routinely  visit  hospitals in order to seek
medical consultations and medicine in lieu of simply visiting a retail pharmacy.

     The state financed system of health care created a growing financial burden
for the PRC  government.  With the advent of market reform in the PRC during the
late  1970's and the  accompanying  economic  growth and  increase in the living
standard  of the Chinese  people,  the state  began to  implement  reform in the
health care system to shift a greater  portion of the  financial  responsibility
for health care to the  consumers of such  services,  the Chinese  people.  As a
result of such  shift and a growing  emphasis  on  financial  accountability  of
hospitals,  patient charges have increased.  To deal with the increased cost and
time associated with routine doctor visits, a growing  percentage of the Chinese
urban  population  has elected to forego  what were  previously  routine  doctor
visits and  instead  have  elected to  purchase  medicine  directly  from retail
pharmacies without first visiting a hospital.


                                        2
<PAGE>
     Throughout  the rise and subsequent  decline of the state  financed  health
care  system,  the health care market in rural  areas of China  continued  to be
influenced  primarily by the reliance on traditional  and local Chinese  natural
medicines.  Because of the relative scarcity of both hospitals and physicians in
the rural areas of China, the rural population has historically  relied upon the
advice of "medicine  doctors" who, though not trained or licensed as physicians,
routinely  diagnose  illness,  formulate  medicines  based  on  ancient  Chinese
formulas or  periodically  purchased  medicine from a dispensary  located in the
local county seat.

     With traditional  Chinese natural  medicine  continuing to be popular among
the Chinese people, as well as enjoying growing  popularity  outside of the PRC,
and with  continuing  growth in the PRC economy and a  continuing  shift  toward
greater  individual  responsibility  for the payment of health  care costs,  the
Company  expects  the  market  for  health  care  products  and  services,   and
particularly  pharmaceutical  products,  within  the  PRC  to  grow  at  a  rate
substantially  higher  than the U.S.  rate of  growth  in the  delivery  of such
products and services. According to published reports, it was estimated that the
market for medicines in the PRC was already in excess of $5 billion during 1996,
of which  approximately 70% was produced  domestically and approximately 30% was
imported.

     In  addition  to the  foregoing  factors,  the  Company  believes  that the
pharmaceutical market in the PRC, and the Company's position within that market,
will benefit from the following factors:  (1) the requirement that all medicines
be sold  through  either  licensed  pharmacies  or  hospitals  and  the  lack of
distinction between over-the-counter medications and prescription medications in
the PRC which  results in common  medications  (e.g.,  aspirin and cough  syrup)
being unavailable at supermarkets or other non-licensed outlets; (2) significant
regulatory  barriers  to entry  into the PRC  pharmaceutical  market by  foreign
competitors  which  is  expected  to  benefit  domestic  companies  such  as the
Company's  Pharmaceutical  Joint  Venture in  establishing  market  share and in
negotiating   joint   marketing  and   distribution   arrangements   with  large
multi-national  pharmaceutical  companies;  (3)  the  existing  position  of the
Company's proposed joint venture partner, China National  Pharmaceutical Foreign
Trade Corporation,  which has strong ties to the Ministry of Health; and (4) the
selection  of SFP which  acts as  chairman  of the  National  Medical  Retailing
Enterprises Association.

Initial Products

     The  Company's  predecessor,  DHPP,  initially  produced a broad variety of
products.  However,  because of limited capital  resources and the  difficulties
associated with managing and marketing a large number of products, DHPP, and the
Company,  emphasized  and  concentrated  on its two most  profitable  and widely
accepted  products,  XMN and GMN. XMN is a Chinese  Patent  Medicine used in the
treatment  of  cerebral  thrombosis,   coronary   arteriosclerosis  and  cardiac
neuralgia.  XMN is made from an abstract and mixture of chanxiong rhizome,  musk
kernel,  bezoar, toad venom, and leech. GMN is a Chinese Patent Medicine used in
the treatment of coronary heart disease,  cardiac neuralgia and blood deficiency
in coronary arteries. GMN is made from the extract and mixture of red sage root,
angelic root and salflower. At present, these two products constitute 99% of the
Company's production and sales.

Product Development

     Although the Company plans to gradually introduce new products, its primary
production  for the  coming  year  will be XMN and GMN.  The  Company's  initial
product development strategy involves the development and acquisition of various
medications  which address common medical concerns and have  significant  market
potential,  if properly  distributed.  The Company presently conducts no product
development activities on its own behalf, but has established relationships with
various  research  laboratories  and will attempt to acquire new  products  from
those laboratories as they are developed. As a supplement to such efforts, where
the efficacy and market potential meet the Company's criteria,  the Company will
attempt to acquire  the  exclusive  rights to  manufacture  and market  existing
products  assuming that a satisfactory  price can be agreed upon. In addition to
the  Company's  existing  practice  of  acquiring  new  products  from  research
laboratories and acquiring existing products and manufacturing  facilities,  the
Company  is  presently  engaged in  discussions  with  respect to the  potential
formation of a joint  venture  with Asia First  Pharmaceutical  Investments  Ltd
("Asia First  Pharmaceutical")  which manufactures  traditional Chinese medicine
used  in  the  treatment  of  rheumatic   arthritis.   If  such  acquisition  is
consummated, the Company will add Asia First Pharmaceutical's arthritis medicine
to its  product  line  and may  carry  on  in-house  the  research  and  product
development  activities  of Asia  First  Pharmaceutical  as well as  expand  the


                                        3
<PAGE>
funding and scope of such  research.  The  Company  may also pursue  other joint
ventures  and  acquisitions  in the future  pursuant  to which the  Company  may
acquire and carry on existing product development  activities  presently carried
conducted by prospective joint venture or acquisition candidates.

     The Company has identified nine out of eighteen new products which it hopes
to add during the next five years. Of these  products,  four are currently being
manufactured  in  the  PRC  by  other  pharmaceutical  firms,  three  are  newly
formulated  medications  which  have  not  previously  been  produced,  and  the
remaining two are derivatives of existing products.  In addition to the eighteen
new products, the Company may add up to twenty other niche products.

     The  requirements  for the addition of any new product is that it meet what
the Company has termed as its  "three/six/nine  plan". Under this plan, three of
the new products must produce annual sales of Rmb 100 million  (US$12  million),
six of the new  products  must  produce  annual  sales of Rmb 50  million  (US$6
million),  and nine of the new  products  must  produce  annual  sales of Rmb 10
million or greater (US$1.2 million).  If a new product cannot reach this minimum
sales level,  it will be  discontinued  from  production or sold.  The three new
products  which are expected to generate the highest sale are  anticipated to be
(1) an anti-blood  clotting  agent,  (2) an arthritic pain  reliever,  and (3) a
treatment  for skin fungus.  The other six products  which have been  identified
consist of or will be used in treatment of: (1) the common cold,  (2) hepatitis,
(3) urinary tract  infections,  (4) respiratory  ailments,  (5) coughs and (6) a
general  antibiotic.  All  eighteen of the new  products  are  expected to be in
production by the end of calendar year 2000. As noted above, the potential joint
venture with Asia First  Pharmaceutical  would provide the first addition to the
Company's  product  line  with  the  addition  of  Asia  First  Pharmaceutical's
rheumatic  arthritis  medicine.  No  assurance,  however,  can be given that the
Company will be  successful  in  acquiring,  developing  or marketing any of the
products presently proposed to be introduced.

Manufacturing

     The Company currently manufactures XMN and GMN at its production facilities
in Dunhua, Jilin Province, PRC. The Company's production facilities are operated
under the supervision of a team of six physicians, pharmacists and chemists. The
production  management  team sets  production  volumes  and  schedules  based on
projected  product  demand  as  determined  in  conjunction  with the  Company's
marketing staff. The production management team arranges for the purchase of raw
materials,  consisting generally of herbs, roots, bark, seeds,  fossils,  bones,
minerals,  animal  organs and other  natural  products.  The  Company  generally
maintains a thirty day supply of raw materials in inventory but has no long-term
contractual  arrangements  for the purchase of raw  materials  because these raw
materials are widely available in the PRC from numerous suppliers.

     After  securing  the  appropriate  raw  materials  for  production  of  its
products,  the Company's  production staff produces  medicinal products based on
formulas for the products  being  manufactured.  The  production  process varies
depending upon the nature and form of product being produced.  Production of dry
products  generally  involves  crushing,  mixing and compressing  ingredients to
produce powders or pills.  Production of wet products typically involves mixing,
stirring,  cooking, brewing, boiling and, in some cases, extracting ingredients.
The Company employs two separate processes, utilizing water or steam, to extract
various medical bases from raw materials. Wet products are then bottled, encased
in gel caps or hardened and cut as appropriate.

     Pharmaceutical manufacturing operations are currently conducted in a single
eight  hour shift  five days per week.  The  Company  has  adequate  facilities,
equipment and personnel to support current operations and to increase production
by approximately 50% from existing levels without adding production  shifts. The
Company can further increase  production capacity by adding production shifts or
by acquiring additional equipment and hiring additional production employees.

     In  addition  to the  Company's  production  management  team,  the Company
employs  approximately  140  persons in the  manufacturing  process.  Production
employees receive  approximately  four weeks of training upon being hired before
joining the production  line.  Employees are readily  available in the community
surrounding the Company's plant.


                                        4
<PAGE>
Marketing

     Under PRC law,  pharmaceutical  manufacturers  are not generally allowed to
export their  products.  Permitted  exports must be carried out through  certain
import/export  corporations  licensed by the PRC.  Because of the restriction on
exports and greater customer acceptance of the Company's products by the Chinese
people,  the Company's  products are marketed  almost  exclusively in the PRC at
this time.

     Senior management  oversees the marketing process and sets goals and policy
for the Company's  marketing team. The Company's sales and marketing efforts are
conducted through an in-house  marketing staff,  consisting of approximately 150
persons,  and a network of approximately 100 independent sales  representatives.
Additional  marketing  personnel  and  sales  representatives  will be  added as
management  deems  necessary to support the Company's  marketing and  production
plans. While the Company's products are sold throughout the PRC, the majority of
such sales are presently  concentrated in large  metropolitan  areas.  Among the
factors  which  have  contributed  to the  concentration  of sales in the larger
metropolitan  areas are (1) the  concentration of marketing  personnel and sales
representatives  in those  markets,  (2) the emphasis of the Company on sales to
wholesalers,  clinics  and  hospitals  which are also  primarily  located in the
larger metropolitan areas, and (3) the poor distribution system of the PRC which
makes shipment to outlying areas more difficult.

     With the Company's  proposed  expansion into retail drug store  operations,
discussed below,  the Company plans to expand its marketing  efforts both within
and outside of the major  metropolitan  areas of the PRC. The Company expects to
establish retail stores in the large urban areas  principally  along the Pacific
Coast and in the various county seats throughout China.  Given the relative lack
of  medical  facilities  and  access  to  pharmaceuticals  outside  of the major
metropolitan  areas,  the Company believes that the rural areas of China will be
very receptive to the increased availability of medicines.

Planned Retail Drug Stores and Distribution Operations

     The  pharmaceutical  distribution  system  within  the PRC is  very  poorly
developed  and is  virtually  non-existent  in many rural  regions.  In order to
capitalize on the perceived need for a well established  distribution system for
pharmaceuticals  in the PRC, the Company has determined that, as a compliment to
its  manufacturing  operations,  it should be involved in the  distribution  and
retailing of both  traditional  Chinese  medicines and Western  style  medicines
throughout the PRC. In furtherance of this objective,  the Company has developed
a business  plan to  establish  3,000 drug  stores in the PRC within five years,
including the opening of stores in each of the 2,860 counties within the PRC and
stores in 40 large urban areas,  primarily along the Pacific coast.  The Company
plans to establish wholesale distribution facilities in each of the twenty-seven
provinces  of China which would  distribute  medical  products to the  Company's
retail drug stores and to various commercial establishments in each province. By
the end of 1997, a minimum of ten stores are planned to be established, provided
sufficient funds can be raised in the equity market.  Concurrent therewith,  the
Company also plans to begin acquiring existing retail outlets as well as opening
new  pharmaceutical  facilities.  All of the stores will be  designed  using the
modern Hong Kong or western  style drug store as a model,  will carry  identical
inventory  and will be staffed  by the same  number of people and work under the
same  management  concept,  including  the  use of  electronic  cash  registers,
infra-red bar code scanners and  sophisticated  inventory  control systems.  The
Company  plans to develop a program to train  management  and  employees  of the
planned  stores and  distribution  centers.  The  establishment  of the  planned
national  distribution  network is expected to  facilitate  the sale of products
manufactured  by the  Company as well as the  distribution  of products of other
pharmaceutical  manufacturers and will serve as an additional source of revenue.
It is estimated that the cost of each retail facility,  excluding  inventory and
training,  will  approximate  $30,000 for rural  stores and up to $60,000 in the
major urban  cities.  No cost has been factored in for inventory as the standard
payment terms in the PRC are net 180 days and required downpayments for imported
drugs generally range from 10% to 20%. A significant portion of the cost of this
project is expected to be  financed  by third  party  lending  sources and funds
raised in the equity  market.  Failure to  successfully  carry out the Company's
planned development of a national distribution  network,  whether through a lack
of adequate financing or otherwise,  could have a material adverse effect on the
Company's business, financial condition or results of operations.

     Initial  efforts with regard to the  establishment  of the proposed  retail
distribution  system include the proposed joint venture with SFP which presently
operates 18 retail drug  stores.  The Company has formed  Beijing  Heng Jia Long


                                        5
<PAGE>
Medical  Development  Company Ltd. ("Heng Jia Long"), a joint venture with China
National  Pharmaceutical  Foreign  Trade  Corporation  ("China  National"),   to
facilitate the transaction with SFP.  Pursuant to the terms of the Heng Jia Long
joint  venture,  the Company is  required  to inject cash and China  National is
required to contribute  certain intangible assets to Heng Jia Long. The Company,
in turn, is entitled to 92% of the net income or loss of Heng Jia Long and China
National is entitled to 8% of the net income or loss.  Pursuant to the  proposed
joint venture with SFP, Heng Jia Long is obligated to contribute $843,000 to the
capital of a newly formed joint venture to be known as "Shanghai  First Pharmacy
(Heng Jia Long) Medical  Investment  Company (the "SFP Joint Venture").  SFP, in
turn, is obligated to contribute  one retail outlet and  headquarter  facilities
with an  estimated  value of $362,000  to the SFP Joint  Venture.  The  Company,
through Heng Jia Long, is responsible for securing funding for the establishment
of the 3,000  store  retail drug store chain which is proposed to be operated by
the SFP  Joint  Venture.  Heng Jia Long will also be  responsible  for  securing
distribution rights relating to brand  pharmaceutical  products and implementing
modern management techniques. SFP will be responsible for personnel and resource
management.  Profit and loss of the SFP Joint  Venture will be allocated  70% to
Heng Jia Long and 30% to SFP.

Facilities

     The Company's  production  facilities  are located on  approximately  seven
acres in Dunhua City, Jilin Province,  and consist of eleven separate  buildings
in a campus  like  setting.  Seven  of the  buildings  are  older  single  level
structures.   These  buildings  constituted  the  DHPP  facility  prior  to  the
formulation of the Pharmaceutical  Joint Venture, but have now been converted to
storage.  In  addition  to these  facilities,  there are two  newly  constructed
buildings used for manufacturing, a new power plant and an office building which
was  acquired  from a third party and  completely  renovated.  The total  square
footage of all of the buildings is approximately 120,890 square feet.

     The two  manufacturing  buildings  were  completed  in June of 1996 and are
constructed of re-enforced concrete with a tile facade. One of the buildings has
three floors,  while the second  building has only two floors  although it is as
tall as the three storied  structure.  The three story facility has in excess of
47,000 square feet and is used for mixing, assembly and packaging. The two story
facility has  approximately  22,000  square feet and is used for  extraction  of
medical  bases  from raw  materials.  Because of the volume of water used in the
extraction and manufacturing  process and to avoid the costs of purchasing water
from the municipal  district,  the facility has its own well on the property and
draws all of its water from this source.

     The other  structure  on the  property is a newly  constructed  power plant
which contains three coal fueled generating facilities.  This one story building
has over 9,000  square feet of space and  supplies all of the steam and power to
the facility.

     The existing space is sufficient to  manufacture  and produce the Company's
existing products and those which they intend to introduce over the next several
years.

Government Regulation

     In the PRC,  the  pharmaceutical  industry is  regulated by the Ministry of
Health and the States Administration of Medicine. Before pharmaceutical products
may  be  produced  and  marketed,  a  manufacturing  license  and  qualification
certificate  must be  obtained  from each  agency.  To  obtain  any  license  or
certificate,  the product must comply with the "Testing Criteria for Issuance of
the Pharmaceutical  Manufacturer  License" promulgated by the Ministry of Health
on July  15,  1989.  This  promulgation  specifies  the  minimum  standards  for
pharmaceutical products; the qualification required of persons involved in their
production;  the equipment  standards of machinery used in  production;  and the
hygiene  requirements to be maintained  throughout the production process.  Each
license or  certificate  runs for five years.  Renewals are granted only after a
satisfactory  demonstration  that the standards set out in the promulgation have
been and are being maintained.

     The approval process of new pharmaceutical products for distribution in the
PRC generally requires  approximately  eighteen months to complete (six to eight
months for products  which have received  approval from the United States Food &
Drug Administration ("FDA")) and is applied to both domestic products and


                                        6
<PAGE>
imported  products.  The  lengthy  approval  process  has  historically  favored
domestic producers and served as an impediment to the import of products.  While
the  approval  process in the PRC is intended to serve a purpose  similar to the
FDA approval  process for drugs in the United  States and tests cases similar to
FDA standards, the process consists of less testing over a shorter time period.

     Medicines  developed  outside  of the PRC are  also  subject  to  stringent
government imposed price controls which are intended to ensure the affordability
of such products.

     In addition to  regulations  applying  specifically  to the  production and
distribution of pharmaceuticals, the Company's operations are subject to various
PRC  environmental   regulations.   Those  regulations  generally  regulate  the
discharge of hazardous materials in the manufacturing process as well as the use
of natural resources.

     The Company  believes that its  operations  comply with all  applicable PRC
regulations  governing the manufacture and distribution of  pharmaceuticals  and
governing various environmental matters.

Proprietary Rights

     The Company's  current  products are designated as Chinese Patent  medicine
and as such carry certain  proprietary rights under Chinese law in the nature of
a patent. While the PRC has implemented various laws and regulations intended to
protect the rights of owners of  proprietary  technologies  and formulas such as
those  relating  to the  production  of  the  Company's  current  pharmaceutical
products,  and signed  international  conventions relating to patent protection,
such  protections  should not be considered the equivalent of patents granted in
more developed nations.  Current patent protection for the Company's products is
five years and  consideration is being given to extending such protection to ten
years.  Because  intellectual  property protection laws in the PRC do not afford
the level of  protection  and are not as strictly  enforced  as similar  laws in
western countries, and because many of the Company's existing products are based
on ancient formulas or derivatives of such formulas,  the Company undertakes all
steps it may deem  reasonable  to  assure  that its  formulas  are kept  secret.
Accordingly,  most Chinese  natural  medicines  should be  considered to be of a
generic  nature  and it is  possible  that  other  manufacturers  could  produce
products  based on similar  formulas in which case the Company  will likely have
little recourse to prevent such manufacturing.

Competition

     There are many companies  which produce and distribute  formulated  Chinese
and western medicines.  In addition,  although the licensing approval of foreign
entities is difficult and stringent  price  controls  apply to medical  products
developed outside of the PRC, large foreign pharmaceutical corporations are also
establishing  facilities in the PRC. A number of competing  facilities may offer
greater  amenities  and broader  product  lines and may be operated by companies
having  greater  resources  than the Company.  Further,  it can be expected that
competition will intensify as large foreign  pharmaceutical  companies enter the
PRC market and other  smaller  pharmaceutical  companies  are acquired by, enter
into  joint  ventures  with or  receive  funding  from new  entrants  in the PRC
pharmaceutical market. The Company believes that it is competitive,  and will be
competitive,  with such  companies  and  facilities  based on the quality of the
Company's products, pricing and distribution channels. At present, in most areas
of the  country,  the company has no direct  competition  and none is  initially
expected in most areas where is plans to opens its retail outlets.

Employees

     At April 18, 1997, the Company  employed  approximately  374 people;  12 in
management,  38 in  administration,  173 in  production  and  151 in  sales  and
marketing.  With  the  exception  of some  of the  sales  personnel,  all of the
employees  are  located in Dunhua.  The  Company  and its  subsidiaries  are not
parties to any  traditional  labor  contracts.  The Company has not suffered any
labor stoppages and believes that it has good relations with its employees.


                                        7
<PAGE>
Potential Acquisitions

     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 China Food and Beverage for a price not to
exceed eight times earnings.  Pursuant to this agreement,  the Company has 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 shall be  refundable  in full with  interest at 8% commencing on
January 1, 1997 if the Company elects not to consummate such acquisition. If the
Company elects to pursue the  acquisition of China Food and Beverage the deposit
will be applied toward the purchase price.

     China Food and Beverage is involved in efforts to form a sino-foreign joint
venture  which  will  own and  operate  an  almond  juice  and  health  products
manufacturing business presently operated by a PRC government controlled entity.
China Food and Beverage is owned and  controlled  by Yiu Yat Hung, a director of
the Company.

     On April 2, 1997, the Company signed a Letter of Intent for the acquisition
of 70% of a proposed  joint venture with Shanghai  First  Pharmacy Co.  ("SFP").
Under  the  Letter of  Intent,  SFP  would  contribute  one  retail  outlet  and
headquarter facilities with an estimated value of $362,000 and the Company would
contribute $843,000.  The joint venture would open, own and operate the proposed
network of 3,000 retail  pharmacies  throughout  the PRC. SFP operates  eighteen
stores in the PRC,  selling over 10,000  medical  products.  Its current  annual
sales exceed $75 million.

     On May 15,  1996,  the Company  executed a letter of intent with Simple Win
Investment  Ltd.  ("Simple  Win") for the  potential  acquisition  of Asia First
Pharmaceutical  Investment Ltd. ("Asia First Pharmaceutical") and its 90% equity
interest  in  Jilin  Huajia   Pharmaceutical   Company  Limited  ("Jilin  Huajia
Pharmaceutical").  Subject to due diligence and market  conditions,  the Company
will pay the fair market value of the assets acquired,  not to exceed $5 million
for this  acquisition,  should it be consummated.  The Company  deposited $2.392
million with Simple Win which shall be  refundable  in full without  interest if
the Company elects not to consummate such acquisition.  If the Company elects to
pursue the  acquisition,  the deposit will be applied toward the purchase price.
The Company's option to acquire Asia First Pharmaceutical expires June 30, 1997.

     Jilin Huajia  Pharmaceutical  is engaged in the manufacture and sale in the
PRC of formulated Chinese medicine to treat rheumatic arthritis.

ITEM 2. DESCRIPTION OF PROPERTIES

     The Company's executive offices consist of 3,315 square feet located at One
World Trade Center,  Suite 7865, New York,  New York.  Such space is provided to
the  Company,  free of  charge,  by an entity  controlled  by Yiu Yat  Hung,  an
affiliate of the Company.

     The Company's production facilities located in Dunhua City, Jilin Province,
PRC are  owned by the  Pharmaceutical  Joint  Venture.  The  site on which  such
production facilities are located is held pursuant to a grant of land use rights
from the PRC government  expiring in 2046. See "Item 1. Description of Business.
Facilities."

     The  Company  believes  that its  properties  are  adequate  to support its
current operations.

ITEM 3. LEGAL PROCEEDINGS

     The  Company  is from  time to time a party to  litigation  arising  in the
routine course of business. Management is not aware of any pending or threatened
litigation which is material to the Company.


                                        8
<PAGE>
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, 1996.

                                     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.

     The  Company  has  applied  for  listing of its Common  Stock on the Nasdaq
Small-Cap  Market under the symbol "NWYT".  There can be no assurance,  however,
that the  Company's  Common  Stock  will in fact be  listed  on Nasdaq or that a
sustained trading market will develop.

     At April 18,  1997,  the bid price of the Common  Stock was $3.00.  For the
fourth  quarter of calendar year 1996, the price of the Common Stock ranged from
a high of $6.50 to a low of $3.75.

Record Holders

     As of April 18, 1997,  there were  approximately  293 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.

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS

     This Form 10-KSB contains forward-looking  statements within the meaning of
Section 27A of the  Securities  Act of 1933 and  Section  21E of the  Securities
Exchange Act of 1934. The Company's actual results could differ  materially from
those set forth in the  forward-looking  statements.  Certain factors that might
cause such a difference are discussed in the section  entitled  "Certain Factors
Affecting Future Operating Results" beginning on page 12 of this Form 10-KSB.

     Natural Way  Technologies,  Inc. (the "Company"),  through its subsidiaries
and a sino-foreign  joint venture,  is engaged in the  manufacture of formulated
Chinese medicines.

     The  Company  is  the  successor  to  the   operations  of  Dunhua  Huakang
Pharmaceutical Plant ("DHPP"), a state-owned enterprise,  which began in 1990 to
develop  and  produce a number of medical  products.  In 1993,  DHPP  management
decided to concentrate  on the production of its two most  profitable and widely
accepted products,  Xue Shuan Xin Mai Ning ("XMN") and Guan Mai Ning ("GMN"). In
March,  1996, DHPP contracted with China Medical  Development  Co., Ltd. ("China
Medical") a British Virgin Islands company, to form a Sino-Foreign joint venture
known as Dunhua  Huakang  Pharmaceutical  Co., Ltd. (the  "Pharmaceutical  Joint
Venture").  Under the terms of the joint venture agreement,  DHPP contributed to
the  Pharmaceutical  Joint Venture the plant and equipment  valued at $1,800,000
and China  Medical  contributed  $4,200,000  in cash for  working  capital.  All
earnings of the  Pharmaceutical  Joint  Venture  are to be divided  based on the
parties  respective  capital  contributions,  or 70% to China Medical and 30% to
DHPP. See "Description of Business General and Development of Business."


                                        9
<PAGE>
     On June 30, 1996,  China  Medical  completed a "reverse  acquisition"  (the
"Exchange") of Energy Systems,  Inc. ("ESI"), a U.S. public company.  ESI had no
operations prior to the Exchange but was a publicly held shell which was seeking
an operating  business to acquire.  Pursuant to the terms of the  Exchange,  ESI
acquired  100% of the  outstanding  shares  of China  Medical  in  exchange  for
7,000,000 shares of common stock, 7,000,000 Class A Warrants,  7,000,000 Class B
Warrants,  7,000,000  Class C Warrants and 100,000  shares of Series B preferred
stock of ESI. As a condition of the Exchange,  ESI infused $4,200,000 into China
Medical and ESI issued a total of 6,000 shares of Series A convertible preferred
stock for $6,000,000 in order to meet such funding  requirements.  Following the
Exchange, ESI changed its name to Natural Way Technologies,  Inc. and management
of China Medical assumed control of the Company.  As used herein,  references to
the Company include Natural Way Technologies, Inc., its wholly-owned subsidiary,
China  Medical,  and China  Medical's 70% interest in the  Pharmaceutical  Joint
Venture.

     As a  result  of the  reverse  acquisition  of ESI by  China  Medical,  the
Company's  operating  results  reflect China  Medical's  allocable  share of the
operations  of the  Pharmaceutical  Joint  Venture  as if the  formation  of the
Pharmaceutical  Joint  Venture and the  Exchange had occurred as of December 31,
1994.  Accordingly,   the  financial  statements  of  the  Company  reflect  the
operations  of DHPP for 1995  and for the  first  six  months  of 1996,  both as
adjusted to reflect the  Company's  70%  interest  in the  Pharmaceutical  Joint
Venture, and the operations of China Medical, which were conducted through China
Medical's 70% interest in the  Pharmaceutical  Joint Venture,  from July 1, 1996
through December 31, 1996.

Results of Operations

     The  following  table  sets  forth  certain  items  from  the  Consolidated
Statements  of Income  expressed as a percentage of net sales for the year ended
December 31, 1996 and pro forma  information  reflecting  the operations of DHPP
expressed as a percentage  of net sales of DHPP for the year ended  December 31,
1995:

                                                                     Pro Forma
                                                       1996            1995
                                                      ------          ------
Net sales....................................          100.0%          100.0%
Cost of sales................................           22.7            25.9
                                                      ------          ------
Gross profit.................................           77.3            74.1
Selling expense..............................           21.6            16.5
General and administrative expense...........           23.4            25.6
Other expenses, net..........................            2.1             0.0
                                                      ------          ------
Income before taxes and minority interest....           30.2            32.0
Provision for income taxes...................              -             1.2
                                                      ------          ------
Income before minority interest..............           30.2            30.8
Minority interest............................            9.4               -
                                                      ------          ------
Net income...................................           20.8%           30.8%
                                                      ======          ======

Fiscal Year 1996 Compared to Fiscal Year 1995

     As noted above, the Company's actual operating results for 1996 reflect the
operations of the Pharmaceutical Joint Venture from the date of its formation on
March 6, 1996 through  December 31, 1996. Pro forma  operating  results for 1995
reflect the operations of DHPP for the entire twelve month period ended December
31, 1995.  Accordingly,  comparisons of operating results during fiscal 1995 and
1996 should be made in light of the shorter  period during which  pharmaceutical
operations  were  undertaken  during  1996 and any such  comparisons  may not be
meaningful.

     Net Sales. Net sales during 1996 totaled $9.7 million compared to pro forma
net sales of $10.3 million during 1995. On a pro forma basis, assuming formation
of the  Pharmaceutical  Joint Venture on January 1, 1996, sales were up slightly
to $10.4  million  during  1996.  Growth  in pro  forma  sales  during  1996 was
restrained by increased competition in several provinces which resulted in lower
unit pricing and lower unit sales in those provinces.  Management  believes that
the  competitive  situation in those  provinces has since returned to normal and


                                       10
<PAGE>
that, with the addition of capital during June of 1996 from the formation of the
Pharmaceutical Joint Venture, the Company will be able to increase its marketing
and distribution efforts and increase sales during 1997.

     Cost of Goods Sold and Gross Profit. Cost of goods sold during 1996 totaled
$2.2 million  (22.7% of net sales)  compared to $2.7 million (25.9% of pro forma
net sales) during 1995. The decrease in cost of goods sold was  attributable  to
the  implementation  during 1996 of tighter cost controls and  re-engineering of
the production process to improve efficiency.  Gross profits during 1996 totaled
$7.5 million as compared to $7.7 million of pro forma gross profits during 1995.
On a full year basis,  gross  profit for 1996 would have been $8.0  million,  an
increase of 4%.

     Selling  Expense.  Selling  expense  during 1996  totalled  $2.1 million as
compared to $1.7 million for 1995. The increase was principally  attributable to
increased  advertising costs undertaken during 1996 and the hiring of additional
sales representatives.

     General and Administrative  Expense.  General and  administrative  expenses
("G&A")  during 1996 totaled  $2.3  million  (23.4% of net sales) as compared to
$2.7 million (25.6% of pro forma net sales) during 1995. The decrease in G&A was
attributable  to a  reduction  in the number of  employees  which was  partially
offset by higher per employee  salaries and wages resulting from conversion from
a state-owned enterprise to a sino-foreign joint venture

     Other Expense,  Net. Other expense,  net,  during 1996 totaled  $206,000 as
compared to $3,000 during 1995. Other expense during 1996 consisted primarily of
net interest  expense of $196,000 which was  attributable  to amounts payable to
DHPP  pursuant to the joint  venture  agreement in exchange  for certain  assets
contributed to the Pharmaceutical Joint Venture.

     Income Taxes.  The Company had no income tax provision for 1996 as compared
to $120,000  during  1995.  The  decrease in income tax  provision  for 1996 was
attributable  to a tax holiday  granted by the PRC  government for the first two
years of profitable operations of the Pharmaceutical Joint Venture.

     On a pro forma  basis,  income  tax  expense  of the  Pharmaceutical  Joint
Venture, excluding the PRC tax concession,  would have been $0.66 million during
1996.

     Minority  Interests.  Minority  interest,  totaling  $0.9  million in 1996,
represents the allocable  share of income or loss  attributable to the 30% share
of the  Pharmaceutical  Joint  Venture not owned by the Company.  On a pro forma
basis, the minority interest would have been $0.96 million for 1995.

Liquidity and Capital Resources

     At December 31,  1996,  the Company had a working  capital  balance of $7.0
million and a cash  balance of $1.2  million as  compared to working  capital of
$3.8 million and a cash balance of $0.4 million at December 31, 1995. The change
in working  capital and cash balances was  attributable  to a combination of (i)
cash flows from profitable  operations,  (ii) the receipt of $5.0 million of net
proceeds from the sale of convertible  preferred stock during 1996 and (iii) the
use of such funds for the  acquisition  of property,  plant and  equipment,  the
establishment of the  Pharmaceutical  Joint Venture and deposits on two proposed
acquisitions.

     At December 31, 1996, the primary obligations of the Company consisted of a
payable of the Pharmaceutical  Joint Venture to DHPP of $4.3 million for certain
excess  operating   assets   transferred  by  DHPP  to,  and  utilized  by,  the
Pharmaceutical  Joint Venture.  The payable  provides for interest at 5.5%. DHPP
forgave  accrued  interest on the payable in the amount of $218,000  during 1996
and has agreed not to demand  repayment at this time.  Included in the operating
assets  transferred  by DHPP to the  Pharmaceutical  Joint  Venture are accounts
receivable of DHPP,  $7.0 million of which remained  outstanding at December 31,
1996. Pursuant to the terms governing the formation of the Pharmaceutical  Joint
Venture,  if such  receivables  have not been  collected by June 30, 1997,  such
receivables  may be  transferred  back to DHPP in which  case the note  from the
Pharmaceutical  Joint  Venture  to DHPP will be  reduced  by the  amount of such
receivables actually transferred back to DHPP.


                                       11
<PAGE>
     During  1996,  the  Company  issued  6,000  shares of Series A  convertible
preferred stock raising approximately $5.0 million net of offering costs, all of
which shares remained  outstanding and convertible into Common Stock at December
31, 1996. Each share of Series A convertible preferred stock is convertible into
1,000 shares of Common Stock at any time on or prior to December 31, 1997 and is
redeemable by the Company at $1,000 per share after December 31, 1997.

     The proceeds from the sale of securities  during 1996 were used to fund the
acquisition of property,  plant and equipment  ($0.99  million) and for deposits
relating to two proposed  acquisitions ($3.8 million).  Pursuant to two separate
letters  of intent  relating  to the  proposed  acquisitions  of China  Food and
Beverage  and Asia First  Pharmaceutical,  the  Company  made  deposits  of $1.4
million and $2.4 million,  respectively.  Each of those letters of intent expire
June 30,  1997.  Pursuant to the China Food and Beverage  letter of intent,  the
purchase price for not less than 50% of China Food and Beverage will be fixed at
not more than eight  times  earnings.  The Asia First  Pharmaceutical  letter of
intent provides for a purchase price for 100% of Asia First Pharmaceutical equal
to the fair market value of the assets acquired but not more than $5 million. If
the Company  elects to pursue those  acquisitions,  the deposits will be applied
toward the  purchase  price.  Should the  Company  pursue  either or both of the
potential  acquisitions  discussed,  the  Company  will be  required  to pay the
balance of the purchase price at closing. Should the Company elect not to pursue
the  acquisitions,  the deposit with respect to China Food and Beverage shall be
refundable in full with interest at 8% from January 1, 1997 and the deposit with
respect  to Asia  First  Pharmaceutical  shall  be  refundable  in full  without
interest. See "Business - Potential Acquisitions."

     In addition to amounts which may become  payable  should the Company pursue
the acquisitions of China Food and Beverage and Asia First  Pharmaceutical,  the
Company's only other known potential material capital requirement relates to the
proposed  opening of multiple  retail  pharmacies.  Pursuant to the terms of the
proposed SFP Joint Venture, the Company,  through Heng Jai Long, is obligated to
contribute  $843,000  to the  capital  of SFP.  Additionally,  Heng  Jai Long is
obligated to secure the necessary funding for the establishment of a retail drug
store chain  throughout  the PRC. The Company,  through SFP, plans to open up to
3,000  retail  drug  stores in the PRC within  five years with not less than ten
stores  planned to open  during  1997.  The Company  has  estimated  the cost of
opening retail drug stores at $30,000 to $60,000 each.  Additionally,  over such
five year period, the Company plans to establish distribution centers in each of
the twenty-seven provinces of the PRC.

     The  Company  presently  is  actively  seeking  funding to  consummate  the
acquisitions  of China Food and  Beverage and Asia First  Pharmaceutical  and to
fund the anticipated costs, both in 1997 and for future years, of opening retail
drug stores and distribution centers.

     The Company is presently evaluating various options,  including the sale of
convertible  debt or equity  securities  to fund the Company's  acquisition  and
expansion  plans.  The Company has executed  letters of intent in that regard at
this time.

     Other than the foregoing,  the Company has no sources of available  capital
or  commitments  to provide  additional  capital.  Management  believes that the
Company has sufficient  capital resources to fund its current operations for the
foreseeable future.

Certain Factors Affecting Future Operating Results

     This Form 10-KSB contains forward-looking  statements within the meaning of
Section 27A of the  Securities  Act of 1933 and  Section  21E of the  Securities
Exchange Act of 1934. The Company's actual results could differ  materially from
those set forth in the  forward-looking  statements.  Certain factors that might
cause such a  difference  include the  following:  fluctuations  in economic and
other  conditions  within the PRC which  could  adversely  effect the demand for
pharmaceutical  products;  the entry into the PRC  pharmaceutical  market of new
domestic  or foreign  competition  or the  introduction  of new  products  which
compete with the Company's  products;  changes in government  policies which may
adversely  effect the  Company's  ability to  acquire,  produce  and  distribute
pharmaceuticals  in the PRC; the  availability and timing of, and terms on which
the Company can secure,  funding in order to carry out its proposed acquisitions
and entry into the retail drug market;  and,  inefficiencies in the distribution


                                       12
<PAGE>
system,  regulations and other conditions which generally make operations in the
PRC unpredictable when compared to operations in more developed economies.

     As the  Company's  plan of operations  revolves  around its ability to make
certain  strategic  acquisitions and to open retail drug stores and distribution
centers throughout the PRC, the Company's future revenues and profitability will
be largely dependent upon the Company's ability to secure necessary financing to
carry out such plans and its ability to manage such  operations.  If the Company
experiences delays in commencing such operations or is unable to manage the same
as planned,  the Company's  prospects and operating  results could be materially
adversely effected.

Inflation and Exchange Rates

     The Company does not believe that  inflation  has had a material  impact on
the results of its  operations.  However,  high levels of inflation and exchange
rate  fluctuations have  characterized the PRC economy in recent years.  Because
the  operations of the  Pharmaceutical  Joint Venture are conducted  exclusively
within the PRC, management believes that any price fluctuations  attributable to
inflation or changes in exchange  rates can be passed  through to its customers.
There can be no assurance,  however,  that continued inflation and exchange rate
fluctuations will not adversely impact the Company in the future. In particular,
as the  Company's  revenues are  primarily  received in Renminbi,  the Company's
ability to pay dividends and make other payments denominated in other currencies
may be adversely impacted by exchange rate fluctuations.

ITEM 7. FINANCIAL STATEMENTS

     The  consolidated  financial  statements of the Company,  together with the
independent  auditors' report thereon of Arthur Andersen & Co., appears on pages
F-2 through F-24 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 China  Medical 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.

     D. Brian Macbeth's  reports on the financial  statements of the Company for
the fiscal years ended December 31, 1994 and 1995 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 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.


                                       13
<PAGE>
                                    PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
        WITH SECTION 16(a) OF THE EXCHANGE ACT

     The  information  required by this Item will be  included  in a  definitive
proxy statement, pursuant to Regulation 14A, to be filed not later than 120 days
after the close of the Company's  fiscal year. Such  information is incorporated
herein by reference.

ITEM 10. EXECUTIVE COMPENSATION

     The  information  required by this Item will be  included  in a  definitive
proxy statement, pursuant to Regulation 14A, to be filed not later than 120 days
after the close of the Company's  fiscal year. Such  information is incorporated
herein by reference.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The  information  required by this Item will be  included  in a  definitive
proxy statement, pursuant to Regulation 14A, to be filed not later than 120 days
after the close of the Company's  fiscal year. Such  information is incorporated
herein by reference.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The  information  required by this Item will be  included  in a  definitive
proxy statement, pursuant to Regulation 14A, to be filed not later than 120 days
after the close of the Company's  fiscal year. Such  information is incorporated
herein by reference.


                                       14
<PAGE>
                                     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.
     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.

(b)  Reports on Form 8-K

     None


                                       15
<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:  April 23, 1997

     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/ Yiu Yat Hung         Chief Executive Officer and Chairman     April 23, 1997
-----------------------  of the Board of Directors
Yiu Yat Hung             (Principal Executive Officer)



/s/ Yat On               Vice Chairman, Vice President            April 23, 1997
-----------------------  and Director
Yiu Yat On



/s/ Yao Yi Le            Treasure, Chief Financial Officer        April 23, 1997
-----------------------  and Director (Principal Financial
Yao Yi Le                and Accounting Officer)



/s/ Yao Su Zhen          Director                                 April 23, 1997
-----------------------
Yao Su Zhen



/s/ Yao Yi Ming          Chief Operating Officer and Director     April 23, 1997
-----------------------
Yao Yi Ming


                                       16
<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

Consolidated Statements of Operations for the Years Ended
 December 31, 1996, 1995 and 1994                                        F-4

Consolidated Statements of Cash Flows for the Years Ended
 December 31, 1996, 1995 and 1994                                        F-5

Statements of Changes in Shareholders' Equity for the Years
 Ended December 31, 1996, 1995 and 1994                                  F-7

Notes to Financial Statements                                            F-8


                                       F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS


To the  Shareholders  and the Board of  Directors  of Natural Way  Technologies,
Inc.:


We have  audited the  accompanying  consolidated  balance  sheets of Natural Way
Technologies,  Inc.  (a  company  incorporated  in the  State  of  Nevada;  "the
Company") and  Subsidiaries  ("the Group") as of December 31, 1995 and 1996, and
the related  consolidated  statements of  operations,  cash flows and changes in
shareholders' equity for the years ended December 31, 1994, 1995 and 1996. 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 audits.

We conducted our audits in accordance with generally accepted auditing standards
in the  United  States of  America.  Those  standards  require  that we plan and
perform the audits 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  audits  provide  a
reasonable basis for our opinion.

In our opinion, the consolidated  financial statements referred to above present
fairly,  in all  material  respects,  the  financial  position  of  Natural  Way
Technologies,  Inc. and  Subsidiaries  as of December 31, 1995 and 1996, and the
results of their  operations  and their cash flows for the years ended  December
31, 1994,  1995 and 1996,  in  conformity  with  generally  accepted  accounting
principles in the United States of America.

As indicated in Note 8 to the accompanying consolidated financial statements, as
of  December  31,   1996,   the  Group  has  made   deposits  of   approximately
Rmb31,548,000,  including a deposit of approximately Rmb11,648,000 placed with a
related company,  in connection with the proposed  acquisition of two companies.
The  Company's  directors  consider  that the Group could  realise such deposits
either by  completing  the  acquisition  or by refund  if the Group  decides  to
withdraw from the acquisitions.



/s/ Arthur Andersen & Co.
-------------------------------
ARTHUR ANDERSEN & CO.
Certified Public Accountants
Hong Kong


Hong Kong,
April 11, 1997.


                                       F-2
<PAGE>
                 NATURAL WAY TECHNOLOGIES, INC. AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS
                        AS OF DECEMBER 31, 1995 AND 1996

                                             1995                 1996
                                            -------        -------------------
                                            Rmb'000        Rmb'000     US$'000
ASSETS

Current assets:
  Cash                                          -           10,017      1,204
  Accounts receivable, net                      -           73,533      8,838
  Due from a related company                    -            4,159        500
  Due from shareholders                        84                -          -
  Due from a director                           -               75          9
  Prepayments and deposits                      -            2,607        313
  Inventories, net                              -            5,618        675
                                              ----        --------     ------

     Total current assets                      84           96,009     11,539

Investment deposits                             -           31,548      3,792
Deferred value added tax recoverable            -            1,011        122
Property, plant and equipment, net              -           23,526      2,828
                                              ----        --------     ------

     Total assets                              84          152,094     18,281
                                              ====        ========     ======
LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
  Accounts payable                              -            9,016      1,084
  Accrued expenses and other payables          66            7,762        933
  Due to a related company                      -            3,412        410
  Taxation payable                              -           13,648      1,640
                                              ----        --------     ------
     Total current liabilities                 66           33,838      4,067

Payable to a joint venture partner              -           35,450      4,261
                                              ----        --------     ------
     Total liabilities                         66           69,288      8,328
                                              ----        --------     ------

Minority interest                               -           22,450      2,698
                                              ----        --------     ------
Shareholders' equity:
Preferred stock, Series A convertible
 and redeemable, par value US$0.001; 
 issued and  outstanding  - nil as of
 December  31, 1995 and 6,000 shares 
 as of December 31, 1996                        -                -          -

Preferred  stock,  Series  B 
 supervoting,   par  value  US$0.001;
 issued  and outstanding - 100,000 
 shares as of December 31, 1995 and 1996        -                -          -

Common stock,  par value US$0.001;  
 issued and outstanding - 8,000,000
 shares as of December 31, 1995 and 
 8,200,000 shares as of December 31, 1996      66               68          8

Additional paid-in capital                      8           43,611      5,242
Dedicated capital                               -            1,752        211
(Accumulated deficit) Retained earnings       (56)          14,901      1,791
Cumulative translation adjustments              -               24          3
                                              ----         -------     ------
     Total shareholders' equity                18           60,356      7,255
                                              ----         -------     ------
     Total liabilities, minority interest
      and shareholders' equity                 84          152,094     18,281
                                              ----         -------     ------

   The accompanying notes are an integral part of these financial statements.

------------------------  
Translation of amounts from Renminbi  ("Rmb") into United States dollars ("US$")
is for the  convenience  of the readers,  which has been made at the noon buying
rate in New York City for cable transfers in foreign currencies as certified for
customs  purposes by the Federal  Reserve  Bank of New York on March 31, 1997 of
US$1.00=Rmb8.32.  No representation is made that the Renminbi amounts could have
been, or could be,  converted  into United States dollars at that rate or at any
other rate.


                                       F-3
<PAGE>
                 NATURAL WAY TECHNOLOGIES, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF OPERATIONS
              FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996

<TABLE>
<CAPTION>

                                        1994            1995                  1996
                                     ----------      ---------     --------------------------
                                       Rmb'000         Rmb'000       Rmb'000        US$'000
                                     ----------      ---------     -----------    -----------
<S>                                  <C>             <C>           <C>            <C>
Net sales                                    -               -         80,333          9,655
Cost of goods sold                           -               -        (18,252)        (2,194)
                                     ---------       ---------     ----------     ----------

     Gross profit                            -               -         62,081          7,461

Selling expenses                             -               -        (17,350)        (2,085)
General and administrative expenses          -             (66)       (18,795)        (2,259)
Interest expenses                            -               -         (2,162)          (260)
Interest income                                            536             64
Other expenses, net                          -               -            (91)           (10)
                                     ---------       ---------     ----------     ----------

     Income (loss) before income
      taxes and minority interest            -             (66)        24,219          2,911

Provision for income taxes                   -               -              -              -
                                     ---------       ---------     ----------     ----------

Income (loss) before minority
 interest                                    -             (66)        24,219          2,911

Minority interest                            -               -         (7,510)          (903)
                                     ---------       ---------     ----------     ----------

     Net income (loss)                       -             (66)        16,709          2,008
                                     =========       =========     ==========     ==========

Primary earnings per common share
  Net income per common share                -               -           1.30     $     0.16
                                     ---------       ---------     ----------     ----------

  Weighted average number of
   shares outstanding used in
   primary calculation               8,000,000       8,000,000     12,872,848     12,872,848
                                     =========       =========     ==========     ==========

Fully dilutive earnings
 per common share
  Net income per common share                -               -           1.22     $     0.15
                                     ---------       ---------     ----------     ----------

  Weighted average number of
   shares outstanding used in
   fully dilutive calculation        8,000,000       8,000,000     13,661,202     13,661,202
                                     =========       =========     ==========     ==========

Supplementary earnings per 
 common share (see Note 4.h)
  Net income per common share                -               -           2.04     $     0.25
                                     ---------       ---------     ----------     ----------

  Weighted average number of
   common shares used in the 
   supplementary calculation        8,000,0000       8,000,000      8,200,000      8,200,000
                                    ==========       =========     ==========     ==========
</TABLE>


   The accompanying notes are an integral part of these financial statements.

------------------------
Translation of amounts from Renminbi  ("Rmb") into United States dollars ("US$")
is for the  convenience  of the readers,  which has been made at the noon buying
rate in New York City for cable transfers in foreign currencies as certified for
customs  purposes by the Federal  Reserve  Bank of New York on March 31, 1997 of
US$1.00=Rmb8.32.  No representation is made that the Renminbi amounts could have
been, or could be,  converted  into United States dollars at that rate or at any
other rate.


                                       F-4
<PAGE>
                 NATURAL WAY TECHNOLOGIES, INC. AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
              FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996


<TABLE>
<CAPTION>

                                            1994          1995            1996
                                           -------      -------   -------------------
                                           Rmb'000      Rmb'000   Rmb'000     US$'000
<S>                                          <C>         <C>      <C>         <C>   

Cash flows from operating activities:

Net income (loss)                            -           (66)      16,709      2,008
Adjustments to reconcile net
 income (loss) to net cash 
 provided by operating activities            -
  Provision for doubtful debts               -             -          947        114
  Write-back of allowance for
   obsolete and slow-moving inventory        -             -         (527)       (63)
  Depreciation of property, plant
   and equipment                             -             -          965        116
  Minority interest                          -             -        7,510        903
(Increase) Decrease in operating assets-
  Accounts receivable, net                   -             -      (18,293)    (2,199)
  Due from a related company                 -             -        4,593        552
  Due from shareholders                      -             -           84         10
  Due from a director                        -             -          (75)        (9)
  Prepayments and deposits                   -             -          930        112
  Inventories, net                           -             -          399         48
  Deferred value added tax recoverable       -             -          338         40
Increase (Decrease) in operating
 liabilities-
  Accounts payable                           -             -        2,240        269
  Accrued expenses and other payables        -            66      (17,241)    (2,071)
  Due to a related company                   -             -        3,032        364
  Taxation payable                           -             -        1,432        172
                                           ----         ----      -------     ------

     Net cash provided by operating
      activities                             -             -        3,043        366
                                           ----         ----      -------     ------

Cash flows from investing activities:

Investment deposits                          -             -      (31,548)    (3,792)
Acquisition of property, plant and
 equipment                                   -             -       (8,218)      (988)
Establishment of a joint venture
 (Note 19)                                   -             -        3,111        375
Effect of translation adjustments            -             -           24          3
                                           ----         ----       ------      -----

     Net cash used in investing
      activities                             -             -      (36,631)    (4,402)
                                           ----         -----      ------      -----
</TABLE>

                                                               (To be continued)


                                       F-5
<PAGE>
                 NATURAL WAY TECHNOLOGIES, INC. AND SUBSIDIARIES

                 CONSOLIDATED STATEMENTS OF CASH FLOWS (CONT'D)
              FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996


<TABLE>
<CAPTION>
                                           1994       1995             1996
                                          Rmb'000    Rmb'000    Rmb'000     US$'000

<S>                                       <C>        <C>        <C>         <C>

Cash flows from financing activities:

Issuance of common stock                  -          -               2          -
Loan, subsequently capitalized
 by issuance of preferred stock
 (Note 18)                                -          -          49,920      6,000
Cost for issuance of stock                -          -          (8,131)      (978)
Forgiveness of interest by a 
 joint venture partner                    -          -           1,814        218
                                        ----       ----         ------      -----

     Net cash provided by financing
      activities                          -          -          43,605      5,240
                                        ----       ----         ------      -----

     Net increase in cash                 -          -          10,017      1,204

Cash as of beginning of year              -          -               -          -
                                        ----       ----         ------      -----

Cash as of end of year                    -          -          10,017      1,204
                                        ====       ====         ======      =====

</TABLE>


   The accompanying notes are an integral part of these financial statements.


------------------------
Translation of amounts from Renminbi  ("Rmb") into United States dollars ("US$")
for the convenience of the readers,  which has been made at the noon buying rate
in New York City for cable  transfers in foreign  currencies  as  certified  for
customs  purposes by the Federal  Reserve  Bank of New York on March 31, 1997 of
US$1.00=Rmb8.32.  No representation is made that the Renminbi amounts could have
been, or could be,  converted  into United States dollars at that rate or at any
other rate. 


                                       F-6
<PAGE>
                NATURAL WAY TECHNOLOGIES, INC. AND SUBSIDIARIES

                  STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
              FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996

<TABLE>
<CAPTION>
                            Series A
                            convertible          Series B 
                            and redeemable      supervoting                                                      Accumu-    Cumula-
                            preferred stock    preferred stock         Common stock                               lated      tive
                            ---------------   ----------------     ------------------   Additional               deficit   transla-
                            Number of         Number of            Number of             paid-in     Dedicated   Retained  tion ad-
                             shares  Amount    shares   Amount       shares    Amount    capital     capital     earnings justments
                            -------  ------   --------  ------     ---------   ------   ----------   ---------   -------  ---------
                                        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, 1993 and 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
                              =====    ==      =======    ===      =========    ======    ======      =====       ======     ==
</TABLE>


   The accompanying notes are an integral part of these financial statements.


                                       F-7
<PAGE>
                 NATURAL WAY TECHNOLOGIES, INC. AND SUBSIDIARIES

                          NOTES TO FINANCIAL STATEMENTS



I.   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. It changed its name to Natural Way Technologies,  Inc. with effect
from June 26, 1996.

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  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 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  Eagles  Holdings  Limited (a  company  incorporated  in the
British Virgin Islands),  which is beneficially owned by Yat-hung Yiu and Yat-on
Yiu, directors of the Company, and certain family members of Yat-hung Yiu. OL is
owned by Wu Guan, a director of CMDC.

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
is  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 70% equity  interest  in DHPC,  while DHPP is
required to  contribute  into DHPC  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 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  has been verified by a certified  public
accountant in the PRC according to PRC regulations  whereas DHPC's  contribution
has yet to be subject to such a verification.


                                       F-8
<PAGE>
1.   ORGANIZATION AND PRINCIPAL ACTIVITIES (Cont'd)

CMDC and its joint venture  (Cont'd)

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 has  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  will not be less than 25% of the net  assets  employed  by
DHPC. In the event that the net income of DHPC is below the  guaranteed  amount,
DHPP has 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  has
transferred  into DHPC  additional  operating  assets  and  liabilities  with an
estimated  valuation of  approximately  Rmb35,450,000 in return for an unsecured
receivable  from DHPC,  which bears  interest  at 5.5% per annum.  DHPP has also
given a guarantee to CMDC to transfer DHPP's accounts  receivable as of December
31, 1995 back to DHPP if such  accounts  receivable  are not realized in cash by
June 30, 1997.

The other key provisions of the joint venture agreement include:

     the joint venture period is 30 years from March 1996 to March 2026; and

     the  Board of  Directors  of DHPC  consists  of seven  members,  with  four
     designated by CMDC and three designated by DHPP.

2.   SUBSIDIARIES

Details of the  Company's  subsidiaries  (which  together  with the  Company are
collectively  referred  to as "the  Group")  as of  December  31,  1996  were as
follows:

                                           Percentage of
                           Place of       equity interest
        Name            Incorporation          held         Principle activities
--------------------    ---------------   ---------------   --------------------
China Medical'
 Development Company 
 Limited ("CMDC")        The British
                         Virgin Islands        100%         Investment holding

Dunhua Huakang 
 Pharmaceutical Co. 
 Ltd. ("DHPC")           The PRC                70%         Manufacturing and 
                                                            sales of formulated
                                                            Chinese medicine in
                                                            the PRC


                                       F-9
<PAGE>
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 shareholders' equity
amounts of CMDC as of December 31, 1993,  1994 and 1995 have been  retroactively
restated  to  reflect  the  equivalent  number of shares of common  stock of the
Company issued for this acquisition.

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 consolidated  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  occured  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 primary 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.  Subsidiary

          A  subsidiary  is a company in which the  Company  holds,  directly or
          indirectly, more than 50% of its issued voting share capital.



                                      F-10
<PAGE>
4.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont'd)

     c. 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.

     d.  Property, plant and equipment

         Property,  plant and  equipment  are stated at cost.  Depreciation  for
         financial reporting purpose is provided using the straight-line  method
         over the estimated useful lives of the assets after taking into account
         of 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
         1994, 1995 and 1996.

     e.  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  Group'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 Group on purchases  ("input
         VAT").

     f.  Income taxes

         Income tax is provided  under the  provisions of Statement of Financial
         Accounting  Standards No. 109, which  requires  recognition of deferred
         tax assets and  liabilities  for expected  future tax  consequences  of
         events  that have been  included  in the  financial  statements  or tax
         returns.  Deferred  income tax is provided using the liability  method.
         Under the liability  method,  deferred income tax is recognized for all
         significant   temporary  differences  between  the  tax  and  financial
         statement bases of assets and liabilities. Income taxes are not accrued
         for unremitted earnings of international  operations that have been, or
         are intended to be, reinvested.


                                      F-11
<PAGE>
4.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont'd)

     g. Foreign currency translation

         The Company  considers  Renminbi ("Rmb") as its functional  currency as
         most of the Group's business activities are based in Renminbi.

         The  translation  of the financial  statements of group  companies into
         Renminbi is  performed  for balance  sheet  accounts  using the closing
         exchange  rate in effect at the balance  sheet date and for revenue and
         expense  accounts using an average  exchange rate during each reporting
         period.  Gains or losses  resulting  from  translation  are included in
         shareholders' equity separately as cumulative translation  adjustments.
         The net gain from foreign currency transactions included in the results
         of operations for the years ended December 31, 1994, 1995 and 1996 were
         approximately nil, nil and Rmb3,000, respectively.

     h.  Earnings per common share

         The  computation  of primary  earnings per common share is based on the
         weighted  average  number of shares of  common  stock  outstanding  and
         common  stock  equivalents   arising  from  exercise  of  warrants  and
         conversion of convertible  preferred  stock based on the average market
         price of common  stock  during  the year.  Earnings  per  common  share
         assuming  full  dilution is  determined  by dividing  net income by the
         weighted  average  number of shares of  common  stock  outstanding  and
         common  stock  equivalents   arising  from  exercise  of  warrants  and
         conversion of convertible  preferred stock based on the market price of
         common stock as of the balance sheet date.

         The supplementary  earnings per commnon share is determined by dividing
         the net income by the weighted average number of shares of common stock
         outstanding  without taking into account any common stock  equivaltents
         arising  from  exercise  of  warrants  and  conversion  of  convertible
         preferred stock.

     i.  Use of estimates

         The  preparation of financial  statements in conformity  with generally
         accepted accounting principles in the United States of America requires
         management  to make  estimates  and  assumptions  that  affect  certain
         reported  amounts and  disclosures.  Accordingly,  actual results could
         differ from those estimates.


                                      F-12
<PAGE>
5.  ACCOUNTS RECEIVABLE

Accounts receivable comprised:

                                           1995                  1996
                                         -------        ---------------------
                                         Rmb'000        Rmb'000       US$'000

Trade receivables                            -           74,480        8,952

Less: Allowance for doubtful accounts        -             (947)        (114)
                                           ----          ------        -----
                                             -           73,533        8,838
                                           ====          ======        =====

6. PREPAYMENTS AND DEPOSITS

Prepayments and deposits comprised:

                                           1995                 1996
                                         -------        ---------------------
                                         Rmb'000        Rmb'000       US$'000

Advances to employees for 
 business trips                                -         2,123           255

Deposits for purchase of raw materials         -           160            19
Prepayments                                    -           324            39
                                             ----       ------           ---
                                               -         2,607           313
                                             ====       ======           ===

7.  INVENTORIES

Inventories comprised:

                                           1995                  1996
                                         -------        ---------------------
                                         Rmb'000        Rmb'000       US$'000

Raw materials                               -             3,190          383
Work-in-process                             -               367           44
Finished goods                              -             2,356          283
                                          ----            -----          ----

                                            -             5,913          710
                                          ----            -----          ---

Less: Allowance for obsolete and
 slow-moving items                          -              (295)         (35)
                                          ----            -----          ---
                                            -             5,618          675
                                          ====            =====          ===


                                      F-13
<PAGE>
8.  INVESTMENT DEPOSITS

Investment deposits comprised:

                                             1995               1996
                                            -------     ----------------------
                                            Rmb'000     Rmb'000        US$'000

Deposit with China Food and
Beverage Industrial Co. Limited (a)           -         11,648          1,400
Deposit with Simple Win Investment
 Limited (b)                                  -         19,900          2,392
                                             ---        ------          -----

                                              -         31,548          3,792
                                             ===        ======          =====

a.   This  represents a deposit paid to China Food and Beverage  Industrial  Co.
     Limited ("CFBI";  a company  beneficially  owned and controlled by Yat-hung
     Yiu, a director of the  Company) for granting the Company with an exclusive
     right to ascertain  the  feasibility  of acquiring not less than 50% equity
     interest  in CFBI.  CFBI is  negotiating  with an  unrelated  PRC  party to
     establish a joint  venture to produce  beverage  products  in the PRC.  The
     Company has to make an  investment  decision by June 30, 1997. In the event
     that the  Company  decides  not to  invest,  CFBI has  agreed  to repay the
     deposit in full  together with accrued  interest  thereon  commencing  from
     January 1, 1997 at 8% per annum.

b.   This represents a deposit paid to Simple Win Investment  Limited ("SWI"; an
     unrelated entity) 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 has an option  through June 30, 1997 to determine  whether
     it will proceed or withdraw from such an acquisition after conducting a due
     diligence exercise.  In the event that the Company decides to withdraw from
     the acquisition, the deposit will be refunded without interest.

     The Company's directors consider that the Group could realize such deposits
     through  investments  in the  aforementioned  companies  or the Group could
     recover  the   deposits  if  the  Group   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  varies  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:

                                          1995                  1996
                                        Rmb'000         Rmb'000       US$'000

Land and buildings in the PRC                -           16,119        1,938
Machinery and equipment                      -            6,236          750
Motor vehicles                               -              916          110
Furniture and office equipment               -              353           42
Construction-in-progress:
Buildings in the PRC                         -              867          104
                                           ---           ------        -----

                                             -           24,491        2,944

Less: Accumulated depreciation               -             (965)        (116)
                                           ---           ------        -----

                                             -           23,526        2,828
                                           ===           ======        =====

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>
11.  ACCRUED EXPENSES AND OTHER PAYABLES

Accrued expenses and other payables comprised:

                                       1995                 1996
                                     -------       ---------------------
                                     Rmb'000       Rmb'000       US$'000

Accrual for operating expenses       
-  Sales commissions                    -             601           72
-  Advertising and promotional
    expenses                            -           1,495          180
-  Salaries and wages                   -             865          104
-  Interest expenses                    -             348           42
-  Legal fees                           -             269           32
-  Stock issuance costs                 -           1,997          240
-  Others                              66           1,477          177

Provision for funds
-  Salary and welfare fund (a)          -             472           57
-  Housing fund (b)                     -             238           29
                                      ---           -----          ---

                                       66           7,762          933
                                      ===           =====          ===

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  non-recurring  bonus and welfare
     expenses of employees.

b.   Housingfund  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
foregiveness 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.


                                      F-16
<PAGE>
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
     (see Note 1).

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 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.  No
          Series A convertible and redeemable preferred stock has been converted
          or redeemed.

     (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 (see Note 1). The series B supervoting  preferred
          stock carries  preferential rights to dividends and distributions upon
          liquidation.  These 100,000  shares of Series B supervoting  preferred
          stock carry superior voting rights, which account for 30% of the total
          voting rights of the Company on all corporate matters.


                                      F-17
<PAGE>
13.  CAPITAL STOCK (Cont'd)

b.   Preferred stock (Cont'd)

     (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 preferred stock carries  preferential rights to dividends
          and  distributions  upon  liquidation.  Each  share  of the  Series  C
          convertible and redeemable preferred storck 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 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.  No
          Series C convertible and redeemable preferred stock has been issued.

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 (see Note 1).  Each of the Class A  warrants  is  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  is
     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 is  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  believes that the exercise prices of the warrants issued exceed
     the fair market value of the Company's common stock on the date of issuance
     of the warrants. No warrants has been exercised.

14.  TAXATION

The Company and its  subsidiaries are subject to income taxes on an entity basis
on income arising in or derived from the tax jurisdiction in which they operate.
The  British  Virgin  Islands  subsidiary,   CMDC,  is  incorporated  under  the
International  Business  Companies  Act  of  the  British  Virgin  Islands  and,
accordingly,  is 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,  it is exempted from state  unified  income tax and local
income tax for two years  starting from the first year of profitable  operations
and then is 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.


                                      F-18
<PAGE>
14.  TAXATION (Cont'd)

If the tax holiday for DHPC did not exist,  the Group'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 consolidated statements of operations is as follows:

                                              Years ended December 31,
                                          ----------------------------------
                                          1994           1995           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                   -              -              -
                                           ===            ===           =====

Taxation payable comprised:

                                                 December 31,
                                          1995                 1996
                                        Rmb'000        Rmb'000       US$'000

Value added tax                             -           13,616        1,637
Others                                      -               32            3
                                           ---          ------        -----

                                            -           13,648        1,640
                                           ===          ======        =====


                                      F-19
<PAGE>
15.  DISTRIBUTION OF INCOME

At present,  substantially  all of the Group's  income is contributed by its 70%
owned joint venture enterprise in the PRC, DHPC.

Income of DHPC as determined under generally accepted  accounting  principles in
the PRC is  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  consolidated  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 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-20
<PAGE>
17.  RELATED PARTY TRANSACTIONS

Name and relationship of related parties:

    Name of related parties            Existing relationships with the Company
----------------------------------    ------------------------------------------

Mr. Yat-hung Yiu                      Director

New Silver Eagle Holdings Limited
 - Hong Kong                          Common directors with the Company

Huakang Headquarters                  Common directors with the joint venture
                                      partner, DHPP (see Note 1)

Beautimate Group Limited              Shareholder (see Note 1)

Ongoing Limited                       Shareholder (see Note 1)

Summary of related party balances and transactions is as follows:


                                     1995                  1996
                                    -------        ----------------------
                                    Rmb'000        Rmb'000        US$'000

Due from a related company
- Huakang Headquarters                  -            4,159          500

Due from shareholders
- Beautimate Group Limited             59                -            -
- Ongoing Limited                      25                -            -

Due from a director
- Yat-hung Yiu                          -               75            9

Due to a related company
- New Silver Eagle Holdings
   Limited - Hong Kong                  -            3,412          410

Interest expense paid to
  related companies
- Huakang Headquarters                  -              283           34
- DHPP (Note12)                         -            1,814          218

Management fee paid to a related
 company
- Huakang Headquarters                  -            1,093          131
                                       ===           =====          ===


                                      F-21
<PAGE>
17.  RELATED PARTY TRANSACTIONS (Cont'd)

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.

The balances with a director, shareholders and a related company as listed above
are unsecured, non-interest bearing and without pre-determined repayment terms.

18.  SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION

a.  Cash paid (received) for interest comprised:

                         1995                       1996
                        -------           ------------------------
                        Rmb'000           Rmb'000          US$'000

Interest paid              -                 65                8
                         -----             -----             ----

Interest received          -               (520)             (63)
                         =====             =====             =====

b.  Supplementary disclosure of non-cash investing activities:

     (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
                                                   ========


                                      F-22
<PAGE>
18.  SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (Cont'd)

b.   Supplementary disclosure of non-cash investing activities : (Cont'd)

     (i) Cont'd

                                                             Rmb'000

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
                                                              ======

     (ii) On June 30,  1996,  the  Company  acquired  100%  interest  in CMDC by
          issuing  7,000,000 shares of common stock,  100,000 shares of Series B
          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)).

19.  OPERATING RISKS

a.   Dependence on strategic relationship

     The Group  conducts its  manufacturing  operations  through a joint venture
     with DHPP, a PRC state-owned  enterprise (see Note 1). The deterioration of
     this strategic relationship may have an adverse effect on the operations of
     the Group.

b.   Limited product types

     Substantially  all of the Group's  sales were  derived from two products in
     1996.

c.   Concentration of credit risk and major customers

     The Group's  concentration of credit risk with respect to trade receivables
     is limited  due to the large  number of  customers  comprising  the Group's
     customer  base.  There were no customers  which  represented  a significant
     concentration  of sales for 1996, or trade  receivables  as of December 31,
     1996. Ongoing credit evaluations of each customer's financial condition are
     performed and,  generally,  no collateral is required.  The Group maintains
     reserves for  potential  credit losses and such losses,  in the  aggregate,
     have not exceeded management's expectations.


                                      F-23
<PAGE>
19.  OPERATING RISKS (Cont'd)

d.   Concentration of suppliers

     Details  of the  suppliers  accounting  for more  than  10% of the  Group's
     purchases are as follows:

                                             Percentage of purchases for
                                              years ended December 31,
                                          ---------------------------------
                                          1994           1995          1996
                                          ----           ----          ----

China Herbal Limited(pound)(C)              -              -            20%
                                          ====           ====          ====

e.   Country risk

     As  substantially  all of the Group's  operations are conducted in the PRC,
     the Group 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 Group'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 Group's revenue is denominated in
     Renminbi  ("Rmb")  which must be  converted  into other  currencies  before
     remittance  outside the PRC.  Both the  conversion of Renminbi into foreign
     currencies  and  the  remittance  of  foreign   currencies  abroad  require
     approvals of the PRC government.

20.  OTHER SUPPLEMENTAL INFORMATION

                                     Years ended December 31,
                           -----------------------------------------------
                            1994          1995                1996
                           -------      -------      ---------------------
                           Rmb'000      Rmb'000      Rmb'000       US$'000

Provision for 
 doubtful debts               -            -            947          114

Write-back of allowance
 for obsolete and slow-
 moving inventories           -            -           (527)         (63)

Advertising expenses          -            -         10,434        1,254
                            =====        =====       ======        =====


                                      F-24