CHINA NATURAL RESOURCES INC

China Resources Development, Inc. operates within the People's Republic of China's agricultural and retail sectors, having previously been engaged in the marketing and distribution of natural rubber and the procurement of production materials, supplies and other agricultural products. The Company's natural rubber distribution business and materials and supplies procurement business ceased effective as of January 1, 2000, and as of December 31, 2001, the Company's only active operations consisted of its supermarket business. The Company also held an 80% equity interest in Silver Moon Technologies Limited, which through its wholly-owned subsidiary Medi-China, provides online Internet healthcare content with a focus on Chinese herbal medicine and therapies, though neither Silver Moon nor Medi-China has contributed to the Company's revenues for the years ended December 31, 2000 and 2001.

The Company faces severe competition in its supermarket operations from several large chain supermarkets in Zhuhai City, all of which operate in larger quarters and offer greater product choice, as well as from convenience stores. Management believes that the competitive advantages of Zhuhai Zhongwei rest on its ability to source high quality products and provide better services, given that its supermarket is located in an upscale residential area where residents seek higher quality products and services. No single supplier accounted for more than 10% of total purchases of consumer products in 1999, 2000 and 2001, and no single customer accounted for more than 5% of total revenues from the sales of consumer products in those years.

The Company generates revenue through its supermarket operations conducted by Zhuhai Zhongwei, a wholly-owned subsidiary of HARC, which sells more than 10,000 consumer products to customers in the PRC. All sales from the supermarket operations are paid in Renminbi on a cash basis, and all purchases are made locally in Renminbi on either a cash basis or open account basis payable within 7 to 30 days. The Company also engages in trading of natural rubber occasionally depending on market conditions, and through Zhongwei Trading invests in marketable securities in the China Stock Market as short-term investments.

The Company's supermarket operations, conducted through Zhuhai Zhongwei, sell more than 10,000 consumer products including fresh meat, fruits and grocery, sanitary products, canned drink and food, snacks, frozen food, fast food, cigarettes, phone cards, wine, and other items. For the year ended December 31, 2001, supermarket operations had net sales of Rmb5,999,000 (US$725,000) ¹ and gross profit of Rmb417,000 (US$50,000) ² with a gross profit margin of 6.9% ³. The value of total purchases of consumer products was approximately Rmb4.9 million (US$592,000) ⁴ in 2001, and Zhuhai Zhongwei had approximately 130 ⁵ suppliers in that year. The top five suppliers accounted for approximately 18% ⁶ of total purchases in 2001.

The Company's natural rubber operations, though ceased as a primary business effective January 1, 2000, generated net sales of Rmb4,093,000 (US$494,000) ⁷ and a gross loss of Rmb157,000 (US$19,000) ⁸ in 2001. The processed timber operations, conducted through Hainan Weilin, were formally ceased following the disposition of HARC's 58% interest in Hainan Weilin to the Farming Bureau on April 30, 2001, for a consideration of Rmb3.8 million (US$0.46 million) ⁹. The timber processing factory had an annual production capacity of 5,000 cubic meters ¹⁰ but operated at only one third of its full capacity from early 2000 through October 2000. The Company's internet business through Silver Moon and Medi-China has not contributed to revenues, and management has adopted a cautious approach with no plan to put extra resources into the website.

On April 30, 2001, Billion Luck, through its nominees, acquired the remaining 39% equity interest in HARC from the Farming Bureau for total consideration of Rmb129.4 million (US$15.6 million) ¹¹, making HARC an indirect wholly-owned subsidiary of the Company. Concurrently, HARC disposed of its 58% interest in Hainan Weilin to the Farming Bureau for Rmb3.8 million (US$0.46 million) ¹². The Company also wrote off the balance of unamortized acquired website technology of Rmb2,936,000 (US$355,000) ¹³ as of December 31, 2001. The Company's head office in Hong Kong is shared under an office sharing agreement with Anka Consultants Limited, with rental expenses of HK$276,000 (US$35,000) ¹⁴ for the year ended December 31, 2001.

For the year ended December 31, 2001, total consolidated net sales were Rmb10,092,000 (US$1,219,000) ¹⁵, compared to Rmb5,559,000 (US$671,000) ¹⁶ in 2000. The Company reported a net loss of Rmb30,144,000 (US$3,642,000) ¹⁷ for 2001, compared to a net loss of Rmb23,200,000 (US$2,803,000) ¹⁸ in 2000. Basic and diluted loss per share from continuing operations was Rmb35.95 (US$4.35) ¹⁹ for 2001 versus Rmb30.37 (US$3.67) ²⁰ for 2000. Total consolidated assets were Rmb157,217,000 (US$18,995,000) ²¹ as of December 31, 2001, and shareholders' equity was Rmb139,581,000 (US$16,864,000) ²².

The Company's supermarket operations represent a growth vector, with net sales increasing by 14.2% from Rmb5.3 million (US$634,000) ²³ for the year ended December 31, 2000 to Rmb6.0 million (US$725,000) ²⁴ for the year ended December 31, 2001, driven by increased sales volume from successful marketing efforts. Management believes the competitive advantages of Zhuhai Zhongwei rest on its ability to source high quality products and provide better services to residents of Zhuhai City, an upscale residential area. The supermarket sells more than 10,000 consumer products and had approximately 130 ²⁵ suppliers in 2001, with no long-term purchase arrangements but no anticipated difficulties in sourcing products.

The Company's internet business through Silver Moon and Medi-China represents a potential growth vector, though management has adopted a cautious and prudent approach in light of the global economic downturn and pessimism towards the technology sector. Currently, the Company has no plan to put extra resources into the website, hoping to maintain only sufficient resources to ride through the fragile economic situation, and to be ready to grasp potential opportunities when the e-commerce industry stabilizes and demonstrates signs of revival. Neither Silver Moon nor Medi-China has contributed to the Company's revenues for the years ended December 31, 2000 and 2001.

The Company's gross profit margin for supermarket operations declined from 8.6% ²⁶ for the year ended December 31, 2000 to 6.9% ²⁷ for the year ended December 31, 2001. Selling and administrative expenses decreased by Rmb3.4 million (US$410,000) ²⁸ or 18.3% to Rmb15.2 million (US$1.8 million) ²⁹ in 2001 from Rmb18.5 million (US$2.3 million) ³⁰ in 2000, mainly due to a reduction of salary and rental expenses in HARC resulting from the relocation to a smaller office in mid-2001 and the reduction of headcounts.

The Company's supermarket operations are conducted through a structure and building owned by Zhuhai Zhongwei with a total gross area of 720 square meters ³¹. HARC maintains a branch office in Shenzhen with a total gross area of 708 square meters ³² under an 8-year rental agreement from December 1, 1999 to December 1, 2007 at an annual rental of Rmb509,540 (US$61,538) ³³. As of December 31, 2001, Zhuhai Zhongwei had a total of 31 ³⁴ employees, comprising 6 in accounting, administration and management, 16 in purchasing and supplies, 4 cashiers, and 5 in other roles.

The Company has not paid any dividends with respect to its Common Stock and has no present plan to pay any dividends in the foreseeable future, intending to retain its earnings to support the growth and expansion of its business. Since the acquisition of Billion Luck by the Company in December 1994, the Company has not received any distributions from any of its subsidiaries and has not made any distributions to its shareholders. The Company's capital expenditure for additions to long-lived assets for supermarket operations was Rmb79,000 (US$9,000) ³⁵ in 2001, compared to Rmb387,000 (US$47,000) ³⁶ in 2000.

The Company faces structural headwinds from the cessation of its two primary businesses, the marketing and distribution of natural rubber and the procurement of production materials, supplies and other agricultural products, effective January 1, 2000, which resulted in the discontinuation of substantially all of the existing operations of the Company as of December 31, 1999. The processed timber operations were also formally ceased in 2001 due to high cost of production from limited sources of supply of raw materials and generally poor market conditions. The Company's internet business faces uncertainty from the global economic downturn and pessimism towards the technology sector for Internet related products and services.

The Company faces significant regulatory and macro constraints operating in the PRC, where the legal system does not have a comprehensive system of laws, enforcement of existing laws may be uncertain and sporadic, and implementation and interpretation thereof inconsistent. The PRC judiciary is relatively inexperienced in enforcing the laws that exist, leading to a higher than usual degree of uncertainty as to the outcome of any litigation. The interpretation of PRC laws may be subject to policy changes reflecting domestic political changes, and the promulgation of new laws, changes to existing laws and the pre-emption of local regulations by national laws may adversely affect foreign investors.

The Company faces material risk from its dependence on the supermarket business as its only active operation as of December 31, 2001, which generated net sales of only Rmb5,999,000 (US$725,000) ³⁷ and a gross profit of Rmb417,000 (US$50,000) ³⁸ in 2001, with a gross profit margin of just 6.9% ³⁹, and faces severe competition from larger chain supermarkets and convenience stores in Zhuhai City. The Company's internet business through Silver Moon and Medi-China has not contributed any revenues for the years ended December 31, 2000 and 2001, and management has no plan to put extra resources into the website, creating uncertainty about the recoverability of the investment. The Company operates within the PRC legal system, which does not have a comprehensive system of laws, where enforcement may be uncertain and sporadic, and where the interpretation of laws may be subject to policy changes reflecting domestic political changes, which could adversely affect foreign investors. The Company's historical operating results are not indicative of future performance due to the cessation of its two primary businesses effective January 1, 2000 and the disposition of its timber processing operations in April 2001, leaving a limited operating history for the remaining supermarket business.

Management's message emphasizes the significant restructuring undertaken during the period, including the acquisition of the remaining 39% equity interest in HARC from the Farming Bureau for total consideration of Rmb129.4 million (US$15.6 million) ⁴⁰ on April 30, 2001, making HARC an indirect wholly-owned subsidiary, and the concurrent disposition of the 58% interest in Hainan Weilin for Rmb3.8 million (US$0.46 million) ⁴¹, formally ceasing timber processing operations. Management highlights that because of the restructuring undertaken and the acquisition and disposition of assets, operating results of prior years are not indicative of the operating results that may be expected in future years. The strategic priorities emphasized are focusing on the supermarket business as the only active operation, adopting a cautious and prudent approach to the internet business by maintaining only sufficient resources to ride through the fragile economic situation, and exploring other investment opportunities while reducing selling and administrative expenses through relocation to a smaller office and headcount reduction.