SHINECO, INC. - Quarter Report: 2017 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

or

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes þ   No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Sec. 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ  No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13 (a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes ¨   No þ

As of May 12, 2017, the registrant had 21,034,072 shares of common stock outstanding.

TABLE OF CONTENTS

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This document contains certain statements of a forward-looking nature. Forward-looking statements involve risks and uncertainties, such as statements about our plans, objectives, expectations, assumptions or future events. In some cases, you can identify forward-looking statements by terminology such as “anticipate,” “estimate,” “plan,” “project,” “continuing,” “ongoing,” “expect,” “we believe,” “we intend,” “may,” “should,” “will,” “could” and similar expressions denoting uncertainty or an action that may, will or is expected to occur in the future. These statements involve estimates, assumptions, known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from any future results, performances or achievements expressed or implied by the forward-looking statements.

Examples of forward-looking statements include:

The ultimate correctness of these forward-looking statements depends upon a number of known and unknown risks and events. We discuss our known material risks under the heading “Risk Factors” in our Registration Statement on Form S-1. Many factors could cause our actual results to differ materially from those expressed or implied in our forward-looking statements. Consequently, you should not place undue reliance on these forward-looking statements.

The forward-looking statements speak only as of the date on which they are made, and, except as required by law, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Nonetheless, the Company reserves the right to make such updates from time to time by press release, periodic report or other method of public disclosure without the need for specific reference to this Report. No such update shall be deemed to indicate that other statements not addressed by such update is incorrect or create an obligation to provide any other updates.

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SHINECO, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements

SHINECO, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(UNAUDITED)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements

SHINECO, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements

Shineco, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

 NOTE 1 - ORGANIZATION AND NATURE OF OPERATIONS

Shineco, Inc. (“Shineco” or the “Company”) was incorporated in the State of Delaware on August 20, 1997. The Company is a holding company whose primary purpose is to develop business opportunities in the People’s Republic of China (“PRC” or “China”).

On December 30, 2004, the Company acquired all of the issued and outstanding shares of Beijing Tenet-Jove Technological Development Corp., Ltd. (“Tenet-Jove”), a PRC company, in exchange for restricted shares of the Company’s common stock, and the sole operating business of the Company became that of its subsidiary, Tenet-Jove. Tenet-Jove was incorporated on December 15, 2003 under the laws of China. Consequently, Tenet-Jove became a 100% owned subsidiary of Shineco and was officially granted the status of a Wholly Foreign-Owned Entity (“WFOE”) by Chinese authority on July 14, 2006. This transaction was accounted for as a recapitalization. Tenet-Jove owns 90% interest of Tianjin Tenet Huatai Technological Development Co., Ltd. (“Tenet Huatai”).

On December 31, 2008, June 11, 2011 and May 24, 2012, respectively, Tenet-Jove entered into a series of contractual agreements with the owners of Ankang Longevity Pharmaceutical (Group) Co., Ltd. (“Ankang Longevity Group”), each of Yantai Zhisheng International Freight Forwarding Co., Ltd (“Zhisheng Freight”), Yantai Zhisheng International Trade Co., Ltd (“Zhisheng Trade”), Yantai Mouping District Zhisheng Agricultural Produce Cooperative (“Zhisheng Agricultural”) and Qingdao Zhihesheng Agricultural Produce Services., Ltd (“Qingdao Zhihesheng”). On February 24, 2014, Tenet-Jove also subsequently entered into the same series of contractual agreements with ShinecoZhisheng (Beijing) Bio-Technology Co., Ltd (“Zhisheng Bio-Tech”), which is a new company incorporated in 2014. Zhisheng Bio-Tech, Zhisheng Freight, Zhisheng Trade, Zhisheng Agricultural, and Qingdao Zhihesheng are collectively referred to herein as “Zhisheng Group”. These agreements include an Executive Business Cooperation Agreement; Timely Reporting Agreements; Equity Interest Pledge Agreement and Executive Option Agreement.

Pursuant to the above agreements, Tenet-Jove has the exclusive right to provide to Zhisheng Group and Ankang Longevity Group consulting services related to business operations and management. All the above contractual agreements obligate Tenet-Jove to absorb a majority of the risk of loss from Zhisheng Group and Ankang Longevity Group’s activities and entitle Tenet-Jove to receive a majority of their residual returns. In essence, Tenet-Jove has gained effective control over Zhisheng Group and Ankang Longevity Group. Therefore, the Company believes that Zhisheng Group and Ankang Longevity Group should be considered as Variable Interest Entities (“VIEs”) under the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810 “Consolidation”. Accordingly, the accounts of these entities are consolidated with those of Tenet-Jove.

Since Shineco is effectively controlled by the majority shareholders of Zhisheng Group and Ankang Longevity Group. Shineco owns 100% equity interest of Tenet-Jove. Accordingly, Shineco, Tenet-Jove, and its VIEs, Zhisheng Group and Ankang Longevity Group are effectively controlled by the same majority shareholders. Therefore, Shineco, Tenet-Jove and its VIEs are considered under common control. The consolidation of Tenet-Jove and its VIEs into Shineco has been accounted for at historical cost and prepared on the basis as if the aforementioned exclusive contractual agreements between Tenet-Jove and its VIEs had become effective as of the beginning of the first period presented in the accompanying consolidated financial statements.

The Company, its subsidiaries, its VIEs and its VIEs’ subsidiaries (collectively the “Group”) operate three main business segments: 1) Tenet-Jove is engaged in planting, manufacturing and selling of Bluish Dogbane and related products, also known in Chinese as “Luobuma”, including therapeutic clothing and textile products made from Luobuma; 2) Zhisheng Group is engaged in the business of planting, processing and distributing of green agricultural produce as well as providing domestic and international logistic services for agricultural products (“Agricultural Products”); 3) Ankang Longevity Group develops and manufactures traditional Chinese medicinal herbal products as well as other retail pharmaceutical products. These different business activities and products can potentially be integrated and benefit from one and other.

Shineco, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation and Principles of Consolidation

The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“US GAAP”) for interim financial information pursuant to the rules of the SEC and have been consistently applied. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Interim results are not necessarily indicative of results of a full year. These financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Form 10-K for the fiscal year ended June 30, 2016, which was filed on September 28, 2016.

The unaudited condensed consolidated financial statements of the Company reflect the principal activities of the Company, its subsidiaries, its VIEs and its VIEs’ subsidiaries. The non-controlling interest represents the minority shareholders’ interest in the Company’s majority owned subsidiaries. All intercompany transactions have been eliminated.

Consolidation of Variable Interest Entities

VIEs are generally entities that lack sufficient equity to finance their activities without additional financial support from other parties or whose equity holders lack adequate decision making ability. All VIEs with which the Company is involved must be evaluated to determine the primary beneficiary of the risks and rewards of the VIE. The primary beneficiary is required to consolidate the VIE for financial reporting purposes.

The carrying amount of the VIEs and their subsidiaries’ consolidated assets and liabilities are as follows:

Non-controlling Interests

US GAAP requires that non-controlling interests in subsidiaries and affiliates be reported in the equity section of a company’s balance sheet. In addition, the amounts attributable to the net income (loss) of those subsidiaries are reported separately in the unaudited condensed consolidated statements of income and comprehensive income.

Shineco, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

Risks and Uncertainties

The operations of the Company are located in the PRC. Accordingly, the Company’s business, financial condition, and results of operations may be influenced by the political, economic, and legal environments in the PRC, as well as by the general state of the PRC economy. The Company’s operations in the PRC are subject to special considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among other factors, the political, economic and legal environment and foreign currency exchange. The Company’s results may be adversely affected by changes in the political, regulatory and social conditions in the PRC, and by changes in governmental policies or interpretations with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad, and rates and methods of taxation, among other things. Although the Company has not experienced losses from these situations and believes that it is in compliance with existing laws and regulations, this may not be indicative of future results.

Members of the current management team own controlling interests in the Company and are also the owners of the VIEs in the PRC. The Company only controls the VIEs through contractual arrangements which obligate it to absorb the risk of loss and to receive the residual expected returns. As such, the controlling shareholders of the Company and the VIEs could cancel these agreements or permit them to expire at the end of the agreement terms, as a result of which the Company would not retain control of the VIEs. 

Use of Estimates

The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the unaudited condensed consolidated financial statements as well as the reported amounts of revenue and expenses during the reporting period. Significant estimates required to be made by management include, but are not limited to, useful lives of property, plant, and equipment, and intangible assets, the recoverability of long-lived assets and the valuation of accounts receivable, accrued expenses, taxes payable and inventory reserve. Actual results could differ from those estimates.

Revenue Recognition

The Company recognizes revenue from sales of bluish dogbane products, Chinese medicinal herbal products and agricultural products, as well as providing logistic service and other processing service to external customers. The Company recognizes revenue when all of the following have occurred: (i) there is persuasive evidence of an arrangement with a customer; (ii) delivery has occurred or services have been rendered; (iii) the sales price is fixed or determinable; and (iv) the Company’s collection of such fees is reasonable assured. These criteria, as related to the Company’s revenue, are considered to have been met as follows:

Sales of products: The Company recognizes revenue on sale of products when the goods are delivered and title to the goods passes to the customer provided that there are no uncertainties regarding customer acceptance; persuasive evidence of an arrangement exists; the sales price is fixed or determinable; and collectability is deemed probable.

Revenue from the rendering of services: Revenue from international freight forwarding, domestic air and overland freight forwarding services are recognized upon the performance of services as stipulated in the underlying contract or when commodities are being released from the customer’s warehouse; the service price is fixed or determinable; and collectability is deemed probable.

Cash and Cash Equivalents

Cash and cash equivalents consist of cash on hand, cash on deposits and other highly liquid investments which are unrestricted as to withdrawal or use, and which have maturities of three months or less when purchased. The Company maintains cash with various financial institutions mainly in the PRC. Balances in banks in the PRC are uninsured. As of March 31, 2017 and June 30, 2016, the Company had no cash equivalents.

Shineco, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

Accounts Receivable

Accounts receivable are recorded at net realizable value consisting of carrying amount less an allowance for uncollectible accounts, as necessary. The Company reviews the accounts receivable on a periodic basis and makes general and specific allowance when there is doubt as to the collectability of individual balances. In evaluating the collectability of individual receivable balances, the Company considers many factors, including the age of the balance, customers’ historical payment history, their current credit-worthiness and current economic trends. As of March 31, 2017 and June 30, 2016, the allowances for doubtful accounts were $66,930 and $103,968, respectively. Accounts are written off against the allowance after efforts at collection prove unsuccessful.

Accounts receivable-unconsolidated entity represents the amount due from Shaanxi Pharmaceutical Group Pai’ang Medicine Co. Ltd. (“Shaanxi Pharmaceutical Group”). The joint-venture company established by Shaanxi Pharmaceutical and the Company are required to exclusively purchase certain raw materials and drug products from Shaanxi Pharmaceutical Group. In return, Shaanxi Pharmaceutical Group has agreed to compensate Ankang Longevity Group with a preferred distribution that equals to 7% of the total purchases made from Shaanxi Pharmaceutical Group. The accounts receivable mainly represents the preferred distribution due from Shaanxi Pharmaceutical Group.

Inventories

Inventories, which are stated at the lower of cost or current market value, consisting of raw materials, work-in-progress, finished goods related to the Company’s products. Cost is determined using the first in first out (FIFO) method. Market is the lower of replacement cost or net realizable value. Agricultural products that the Company farms are recorded at cost, which includes direct costs such as seed selection, fertilizer, labor cost and contract fee that are spent in growing agricultural products on the leased farmland, and indirect costs which include amortization of prepayment of farmland lease fee and farmland development costs. All the costs are accumulated until the time of harvest and then allocated to harvested crops costs when they are sold. The Company periodically evaluates its inventory and records inventory reserve for certain inventories that may not be saleable.

Advances to Suppliers

Advances to suppliers consist of balance paid to suppliers for materials that have not been received. Advances to suppliers are reviewed periodically to determine whether their carrying value has become impaired. As of March 31, 2017 and June 30, 2016, the Company had an allowance for uncollectible advances to suppliers in the amount of $9,756 and $10,118, respectively.

Loans to Third Parties

Loans to third parties consist of various cash advances to unrelated companies and individuals, with whom the Company has business relationships. The loans are due within one year with no interest rate. Loans to third parties are reviewed periodically as to whether their carrying values remain realizable.

Shineco, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

Property and Equipment

Property and equipment are stated at cost, less accumulated depreciation and amortization. Expenditures for additions, major renewal and betterments are capitalized, and expenditures for maintenance and repairs are charged to expense as incurred. Depreciation is provided on a straight-line basis, less estimated residual value, over an asset’s estimated useful life. Farmland leasehold improvements are amortized over the shorter of lease term or estimated useful lives of the underlying assets. Following are the estimated useful lives of the Company’s property and equipment:

Land Use Right

Under PRC law, all land in the PRC is owned by the government and cannot be sold to an individual or company. The government grants individuals and companies the rights to use parcels of land for a specified period of time. Land use rights are stated at cost less accumulated amortization. Amortization is provided over the respective useful lives, using the straight-line method. Estimated useful life is 50-years, based on the term of the land use rights.

Long-lived Assets

Finite-lived assets and intangibles are reviewed for impairment testing when circumstances require. For purposes of evaluating the recoverability of long-lived assets, when undiscounted future cash flows will not be sufficient to recover an asset’s carrying amount, the asset is written down to its fair value. The long-lived assets of the Company that are subject to evaluation consist primarily of property, plant and equipment, land use rights, investments and long-term prepaid lease. For the nine and three months ended March 31, 2017 and 2016, the Company did not recognize any impairment of its long-lived assets.

Fair Value of Financial Instruments

The Company adopted the provisions of ASC 820, “Fair Value Measurements and Disclosures.” ASC 820 clarifies the definition of fair value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify the inputs used in measuring fair value as follows:

Level 1 applies to assets or liabilities for which there are quoted prices in active markets for identical assets or liabilities.

Level 2 applies to assets or liabilities for which there are inputs other than quoted prices that are observable for the asset or liability such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical assets or liabilities in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which significant inputs are observable or can be derived principally from, or corroborated by, observable market data.

Level 3 applies to assets or liabilities for which there are unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of the assets or liabilities.

The carrying value of financial instruments included in current assets and liabilities approximate their fair values because of the short-term nature of these instruments.

Shineco, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

Income Taxes

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the unaudited condensed consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized.

The provisions of ASC 740-10-25, “Accounting for Uncertainty in Income Taxes,” prescribe a more-likely-than-not threshold for consolidated financial statement recognition and measurement of a tax position taken (or expected to be taken) in a tax return. This ASC also provides guidance on the recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, accounting for interest and penalties associated with tax positions, and related disclosures. The Company does not have any uncertain tax positions at March 31, 2017 and June 30, 2016.

The statute of limitations for the Company’s U.S. federal income tax returns and certain state income tax returns remains open for tax years 2013 and after. As of March 31, 2017, the tax years ended June 30, 2007 through June 30, 2016 for the Company’s People’s Republic of China (“PRC”) subsidiaries remain open for statutory examination by PRC tax authorities.

Value Added Tax

Sales revenue represents the invoiced value of goods, net of a Value-Added Tax (“VAT”). All of the Company’s products that are sold in the PRC are subject to a Chinese value-added tax at a rate of 17% of the gross sales price. This VAT may be offset by VAT paid by the Company on raw materials and other materials included in the cost of producing their finished product or acquiring its finished products. The Company recorded a VAT payable or VAT receivable net of payment in the accompanying unaudited condensed consolidated financial statements.

Foreign Currency Translation

The Company uses the United States dollar (“U.S. dollars” or “USD”) for financial reporting purposes. The Company’s subsidiaries and VIEs maintain their books and records in their functional currency of Renminbi (“RMB”), the currency of the PRC.

In general, for consolidation purposes, the Company translates the assets and liabilities of its subsidiaries and VIEs into U.S. dollars using the applicable exchange rates prevailing at the balance sheet date, and the statements of income and cash flows are translated at average exchange rates during the reporting period. As a result, amounts related to assets and liabilities reported on the statement of cash flows will not necessarily agree with changes in the corresponding balances on the balance sheet. Equity accounts are translated at historical rates. Adjustments resulting from the translation of the financial statements of the subsidiaries and VIEs are recorded as accumulated other comprehensive loss.

The balance sheet amounts, with the exception of equity, at March 31, 2017 and June 30, 2016 were translated at 1 RMB to $0.1451 USD and at 1 RMB to $0.1505 USD, respectively. The average translation rates applied to income and cash flow statement amounts for the nine months ended March 31, 2017 and 2016 were at 1 RMB to $0.1472 USD and at 1 RMB to $0.1563 USD, respectively. The average translation rates applied to income statement amounts for the three months ended March 31, 2017 and 2016 were at 1 RMB to $0.1451 USD and at 1 RMB to $0.1529 USD, respectively.

Shineco, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

Comprehensive Income

Comprehensive income consists of two components, net income and other comprehensive income (loss). The foreign currency translation gain or loss resulting from translation of the financial statements expressed in RMB to US$ is reported in other comprehensive loss in the unaudited condensed consolidated statements of income and comprehensive income.

Equity Investment

An investment in which the Company has the ability to exercise significant influence, but does not have a controlling interest, is accounted for using the equity method. Significant influence is generally considered to exist when the Company has an ownership interest in the voting stock between 20% and 50%, and other factors, such as representation on the Board of Directors, voting rights and the impact of commercial arrangements, are considered in determining whether the equity method of accounting is appropriate.

Earnings per Share

The Company computes earnings per share (“EPS”) in accordance with ASC 260, “Earnings per Share” (“ASC 260”). ASC 260 requires companies with complex capital structures to present basic and diluted EPS. Basic EPS is measured as net income divided by the weighted average common shares outstanding for the period. Diluted EPS is similar to basic EPS but presents the dilutive effect on a per share basis of potential common shares (e.g., convertible securities, options and warrants) as if they had been converted at the beginning of the periods presented, or issuance date, if later. Potential common shares that have an anti-dilutive effect (i.e., those that increase income per share or decrease loss per share) are excluded from the calculation of diluted EPS. There is no anti-dilutive effect for the nine months and three months ended March 31, 2017 and 2016.

New Accounting Pronouncements 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued an update ("ASU 2014-09") establishing Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers (“ASC 606”).  ASU 2014-09 establishes a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most of the existing revenue recognition guidance.  ASU 2014-09 requires an entity to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services and also requires certain additional disclosures.  In August 2015, the FASB issued an update (“ASU 2015-14”) to ASC 606, Deferral of the Effective Date, which defers the adoption of ASU 2014-09 to interim and annual reporting periods in fiscal years that begin after December 15, 2017.  In March 2016, the FASB issued an update (“ASU 2016-08”) to ASC 606, Principal versus Agent Considerations (Reporting Revenue Gross versus Net), which clarifies the implementation guidance on principal versus agent considerations in the new revenue recognition standard pursuant to ASU 2014-09.  In April 2016, the FASB issued an update (“ASU 2016-10”) to ASC 606, Identifying Performance Obligations and Licensing, which clarifies guidance related to identifying performance obligations and licensing implementation guidance contained in ASU 2014-09.  In May 2016, the FASB issued an update (“ASU 2016-12”) to ASC 606, Narrow-Scope Improvements and Practical Expedients, which amends certain aspects of the new revenue recognition standard pursuant to ASU 2014-09. The Company is permitted to use either the retrospective or the modified retrospective method when adopting these standards. The Company is continuing to evaluate the impact of the adoption of these standards on its consolidated financial statements, and have not yet concluded on the method of adoption.

In January 2017, the FASB issued ASU 2017-01, which clarifies the definition of a business to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The standard will be effective for us until the first quarter of our fiscal 2019. The Company expects that the adoption of this ASU would not have a material impact on the Company’s unaudited condensed consolidated financial statements.

Shineco, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

In January 2017, the FASB issued ASU No. 2017-03, Accounting Changes and Error Corrections (Topic 250) and Investments—Equity Method and Joint Ventures (Topic 323). The amendments amended Accounting Changes and Error Corrections (Topic 250) to state that registrants should consider additional qualitative disclosures if the impact of an issued but not yet adopted ASU is unknown or cannot be reasonably estimated and to include a description of the effect of the accounting policies that the registrant expects to apply, if determined. Transition guidance included in certain issued but not yet adopted ASUs was also updated to reflect this amendment. The Company does not expect that the adoption of this guidance will have a material impact on its consolidated financial statements.

NOTE 3- INVENTORIES

The inventories consist of the following:

Work-in-process includes direct costs such as seed selection, fertilizer, labor cost and subcontractor fee that are spent in growing agricultural products on the leased farmland, and indirect costs which include amortization of prepayment of farmland lease fee and farmland development cost. All the costs are accumulated until the time of harvest and then allocated to harvested crops costs when they are sold.

 NOTE 4- PROPERTY AND EQUIPMENT, NET

Property and equipment consist of the following:

Depreciation and amortization expense charged to operations were $415,163 and $567,806 for the nine months ended March 31, 2017 and 2016, respectively. Depreciation and amortization expense charged to operations were $133,239 and $185,403 for the three months ended March 31, 2017 and 2016, respectively.

Shineco, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

Farmland leasehold improvements consist of following:

NOTE 5- LAND USE RIGHTS, NET

The Company states land use right at cost less accumulated amortization. All land in the People’s Republic of China is government owned and cannot be sold to any individual or company. However, the government grants the user a “land use right” (the “Right”) to use the land. The Company has the Right to use the land for 50 years and amortizes the Right on a straight-line basis over the period of 50 years.

For the nine months ended March 31, 2017 and 2016, the Company incurred amortization expense of $29,874 and $30,133, respectively. For the three months ended March 31, 2017 and 2016, the Company incurred amortization expense of $14,829 and $12,559, respectively.

The estimated future amortization expenses are as follows:

Shineco, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

NOTE 6 - INVESTMENTS

Ankang Longevity Group entered into two equity investment agreements with a third party, Shaanxi Pharmaceutical Group Pai’ang Medicine Co. Ltd., a Chinese state-owned pharmaceutical enterprise to invest a total of RMB 6.8 million (approximately $1.0 million) to form a joint venture pharmacy retail company called Shaanxi Pharmaceutical Sunsimiao Drugstores Ankang Retail Chain Co., Ltd. (“Sunsimiao Drugstores”), and a joint venture pharmaceutical wholesale distribution company named Shaanxi Pharmaceutical Holding Group Longevity Pharmacy Co., Ltd. (“Shaanxi Longevity Pharmacy”). Ankang Longevity Group obtained 49% interest in each of these two new joint venture companies. These two joint ventures are formed as new business entities to collaborate with Shaanxi Pharmaceutical Group to expand sales to regional hospitals and clinics and to establish the presence of retail pharmacies under the Brand name “Sunsimiao”. The investments are accounted for using the equity method because Ankang Longevity Group has significant influence, but no control of these two entities. Ankang Longevity Group recorded income of $588,994 and $479,965 for the nine months ended March 31, 2017 and 2016, respectively and recorded income of $187,226 and $120,300 for the three months ended March 31, 2017 and 2016, respectively, from the investment, which was included in “Income from equity method investments” in the unaudited condensed consolidated statements of income and comprehensive income.

Ankang Longevity Group entered into a supplemental agreement with Shaanxi Pharmaceutical Group Pai’ang Medicine Co. Ltd. (“Shaanxi Pharmaceutical Group”). According to the supplemental agreement, the new joint-venture companies established by Shaanxi Pharmaceutical and Ankang Longevity Group are required to exclusively purchase certain raw materials and drug products from Shaanxi Pharmaceutical Group. In return, Shaanxi Pharmaceutical Group has agreed to compensate Ankang Longevity Group with a preferred distribution equal to 7% of the total purchases made from Shaanxi Pharmaceutical Group. For the nine months ended March 31, 2017 and 2016, a total of $846,297 and $883,095 were recognized by Ankang Longevity Group from this supplemental agreement in addition to its 49% share of the income from the joint ventures, respectively. For the three months ended March 31, 2017, total income of $253,669 was recognized by Ankang Longevity Group from this supplemental agreement, compared to $306,395 in the same period in 2016.

On October 21, 2013, the Company, through its controlled subsidiaries, Zhisheng Freight and Zhisheng Agricultural, entered into an agreement with an unrelated third party, Zhejiang Zhen’Ai Network Warehousing Services Co., Ltd. (“Zhen’Ai Network”), and invested RMB 14.5 million (approximately $2.2 million) into Tiancang Systematic Warehousing project (“Tiancang Project”) operated by Zhen’Ai Network. Tiancang Project is an online platform established to provide comprehensive warehousing and logistic solutions to companies involved in E-commerce. The Company is entitled to a profit sharing of 29% of Tiancang Project’s after-tax net income annually, less 30% statutory reserve and 10% employee welfare fund. When the amount of the accumulated statutory reserve reaches 30% of the total investment for the Tiancang Project, no additional appropriation of the statutory reserve is required. For the nine months ended March 31, 2017 and 2016, Zhisheng Freight received investment income distributions of $110,387 and $140,670 from Zhen’Ai Network, respectively. For the three months ended March 31, 2017 and 2016, Zhisheng Freight received investment income distributions of $110,387 and $140,670 from Zhen’Ai Network, respectively.

On November 21, 2016, the Company (the “Investor”) entered into an agreement with Original Lab Inc., a California corporation (the “Investee”), that the investor makes a payment of $200,000 to in exchange for the right to acquire certain shares of the investee’s common stock and preferred stock. For the nine and three months ended March 31, 2017, the Company did not record investment income from this investment.

The Company’s investments in unconsolidated entities consist of the following:

Shineco, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

Summarized financial information of unconsolidated entities is as follows:

NOTE 7 - DEPOSIT FOR BUSINESS ACQUISITION

On December 12, 2016, Tenet-Jove entered into a purchase agreement with Tianjin Tajite E-Commerce Co., Ltd. (“Tianjin Tajite”), an online e-commerce company based on Tianjian, China, specializing in distributing Luobuma related products and Japanese elderly health products, pursuant to which Tenet-Jove intends to acquire 51% of the equity interests of Tianjin Tajite for a cash consideration of Chinese RMB 14,000,000 (approximately $2 million). On December 25, 2016, the Company paid the full amount as the deposit to secure the deal. The Company expects to formally close the transaction by June 30, 2017.

NOTE 8 - PREPAID LEASES

One of the Company’s controlled subsidiaries, Zhisheng Group entered into several farmland lease contracts with farmer cooperatives to lease farmland in order to plant and grow organic vegetable, fruit and Chinese yew trees. The lease term varies from 5 years to 24 years. The aggregate lease payments on these leases amount to RMB 36.8 million (approximately $5.3 million). Zhisheng Group paid off the entire required lease amount plus transfer fees at the beginning of the lease.

These leases are accounted for as operating leases and will be amortized each year on a straight-line basis over the lease terms. The amortization expense is initially recorded as work in process under inventory account during the growing period and then transferred to harvested crops costs at the time of harvest and then allocated to cost of sales when they are sold.

Shineco, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

The prepaid leases consist of the following:

Further amortization expense is as follows:

NOTE 9 - SHORT-TERM LOANS

Short-term loans consist of the following:

The loans outstanding were guaranteed by the following properties, entities or individuals: 

a. Not collateralized or guaranteed.

Shineco, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

b. Collateralized by the building owned by Xiaoyan Chen and Jing Chen, who are both the related parties of the company. Xiaoyan Chen is one of the shareholders of Ankang Longevity Pharmaceutical (Group) Co., Ltd. Jing Chen is the sister of the Xiaoyan Chen but not a shareholder of Ankang Longevity Group.

c. Guaranteed by commercial credit guaranty companies unrelated to the Company.

d. Guaranteed by a commercial credit guaranty company, unrelated to the Company and also by Jiping Chen, a shareholder of the Company.

e. Guaranteed by a third-party company and also by Jiping Chen, a shareholder of the Company.

* The Company repaid the loans in full on maturity date.

The Company recorded interest expense of $111,500 and $133,491 for the nine months ended March 31, 2017 and 2016, respectively. The annual weighted average interest rates are 5.21% and 6.14% for the nine months ended March 31, 2017 and 2016, respectively.

The Company recorded interest expense of $39,914 and $38,429 for the three months ended March 31, 2017 and 2016, respectively. The annual weighted average interest rates are 4.71% and 5.51% for the three months ended March 31, 2017 and 2016, respectively.

NOTE 10 - RELATED PARTY TRANSACTIONS

DUE FROM RELATED PARTIES

The Company had previously made temporary advances to certain shareholders of the Company as well as several other entities that are either owned by directors or family members of those directors. Those advances are due on demand, non-interest bearing, except for the advance to Xinyang Yifangyuan Garden Technology Co., Ltd., which bears fixed monthly interest rate of 4.17%.

As of March 31, 2017 and June 30, 2016, the outstanding amounts due from related parties consist of the following:

For the nine months ended March 31, 2017 and 2016, interest income of $86,585 and $213,178 recognized on these loans was included in “Interest income, net” on the unaudited condensed consolidated statements of income and comprehensive income.

Shineco, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

For the three months ended March 31, 2017 and 2016, interest income of nil and $56,961 recognized on these loans was included in “Interest income (expense), net” on the unaudited condensed consolidated statements of income and comprehensive income.

DUE TO RELATED PARTIES

As of March 31, 2017 and June 30, 2016, the Company has related party payables of $168,129 and $244,915, respectively, mainly due to the principal shareholders or certain relatives of the shareholder of the Company who lend funds for the Company’s operations. The payables are unsecured, non-interest bearing and due on demand.

SALES TO AND PURCHASES FROM RELATED PARTIES

For the nine and three months ended March 31, 2017, the Company recorded sales to Shaanxi Pharmaceutical Group Pai’ang Medicine Co., Ltd, a related party, of $2,562,560 and $879,956, respectively. There were no purchases from related parties for the nine and three months ended March 31, 2017.

For the nine and three months ended March 31, 2016, the Company recorded sales to Shaanxi Pharmaceutical Group Pai’ang Medicine Co., Ltd, a related party, of $2,296,384 and $786,656, respectively. There were no purchases from related parties for the nine and three months ended March 31, 2016.

NOTE 11 - TAXES

The Company is subject to income taxes on an entity basis on income arising in or derived from the location in which each entity is domiciled.

Shineco is incorporated in the United States and has no operating activities. Tenet-Jove and its VIEs entities are governed by the Income Tax Laws of the PRC, and are currently subject to tax at a statutory rate of 25% on net income reported after appropriated tax adjustment. Two VIE entities receive a full income tax exemption from the local tax authority of PRC as agricultural enterprises as long as the favorable tax policy remains unchanged.

Shineco, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

Movement of valuation allowance:

(b) Value Added Tax

The Company is subject to a value added tax (“VAT”) for selling merchandise. The applicable VAT rate is 17% for products sold in the PRC. The amount of VAT liability is determined by applying the applicable tax rate to the invoiced amount of goods sold (output VAT) less VAT paid on purchases made with the relevant supporting invoices (input VAT). Under the commercial practice of the PRC, the Company pays VAT based on tax invoices issued. The tax invoices may be issued subsequent to the date on which revenue is recognized, and there may be a considerable delay between the date on which the revenue is recognized and the date on which the tax invoice is issued.

In the event that the PRC tax authorities dispute the date on which revenue is recognized for tax purposes, the PRC tax office has the right to assess a penalty based on the amount of the taxes which are determined to be late or deficient, and will be expensed in the period if and when a determination is made by the tax authorities.

(c) Taxes Payable

Taxes payable consists of the following:

Shineco, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

NOTE 12 – SHAREHOLDERS’ EQUITY

Initial Public Offering

On September 28, 2016, the Company completed its initial public offering of 1,713,190 shares of common stock at a price of $4.50 per share for gross proceeds of $7.7 million and net proceeds of approximately $5.4 million. The Company’s common shares began trading on September 28, 2016 on the NASDAQ Capital Market under the symbol “TYHT”.

Stock Incentive Plan

On September 23, 2016, the Board of Directors of the Company approved a stock incentive plan (“Plan”). Pursuant to the Plan, the Company plans to file a registration statement on Form S-8, as soon as practicable, to register up to 2,103,407 of the Company’s shares of common stock. As of the date of this report, the Company has not issued any options to purchase the Company's shares of common stock and the Company has not filed the Form S-8 registration statement.

Statutory Reserve

The Company is required to make appropriations to reserve funds, comprising the statutory surplus reserve and discretionary surplus reserve, based on after-tax net income determined in accordance with generally accepted accounting principles of the PRC (“PRC GAAP”).

Appropriations to the statutory surplus reserve is required to be at least 10% of the after tax net income determined in accordance with PRC GAAP until the reserve is equal to 50% of the entities’ registered capital. Appropriations to the discretionary surplus reserve are made at the discretion of the Board of Directors. As of March 31, 2017 and June 30, 2016, the balance of the statutory reserve was $3,410,064 and $3,242,139, respectively.

NOTE 13 - CONCENTRATION AND RISKS

The Company maintains certain bank accounts in the PRC which are not protected by Federal Deposit Insurance Corporation (“FDIC”) insurance or other insurance. The cash balance held in the PRC bank accounts was $23,489,613 and $21,986,817 as of March 31, 2017 and June 30, 2016, respectively.

During the nine months ended March 31, 2017 and 2016, almost 100% of the Company's assets were located in the PRC and 100% of the Company's revenues were derived from its subsidiaries and VIEs located in the PRC.

For the nine months ended March 31, 2017, one customer accounted for approximately 11% of the Company’s total sales. For the nine months ended March 31, 2016, one customer accounted for approximately 36% of the Company’s total sales.

For the three months ended March 31, 2017, five customers accounted for approximately 13%, 13%, 11%, 10% and 10% of the Company’s total sales, respectively. For the three months ended March 31, 2016, one customer accounted for approximately 33% of the Company’s total sales.

For the nine months ended March 31, 2017, three vendors accounted for approximately 19%, 17%, and 14% of the Company’s total purchases, respectively. For the nine months ended March 31, 2016, three vendors accounted for approximately 27%, 13% and 11% of the Company’s total purchases, respectively.

For the three months ended March 31, 2017, two vendors accounted for approximately 38% and 16% of the Company’s total purchases, respectively. For the three months ended March 31, 2016, two vendors accounted for approximately 20% and 13% of the Company’s total purchases, respectively.

Shineco, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

 NOTE 14 - COMMITMENTS AND CONTINGENCIES

Lease Commitments

The Company leases eight main office spaces under non-cancelable operating lease agreements through January 31, 2020. The Company also leases farmland under a non-cancelable operating lease agreement through April 26, 2041. Most of those operating lease payments are scheduled on a quarterly basis. The future minimum rental payments are as follows:

Rent expense totaled $491,591 and $187,335 for the nine months ended March 31, 2017 and 2016, respectively.

Rent expense totaled $167,418 and $60,745 for the three months ended March 31, 2017 and 2016, respectively.

In addition, the Company sublets the above-mentioned farmland to a third party under a non-cancelable operating lease agreement through May 31, 2020. The future minimum sublease rental income to be received is as follows:

Sublease rental income totaled $158,957 and $168,804 for the nine months ended March 31, 2017 and 2016, respectively.

Sublease rental income totaled $52,284 and $55,044 for the three months ended March 31, 2017 and 2016, respectively.

Legal Contingencies

From time to time, the Company is a party to various legal actions arising in the ordinary course of business. The Company accrues costs associated with these matters when they become probable and the amount can be reasonably estimated. Legal costs incurred in connection with loss contingencies are expensed as incurred. The Company's management does not expect any liability from the disposition of such claims and litigation individually or in the aggregate would have a material adverse impact on the Company's consolidated financial position, results of operations and cash flows. 

Shineco, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

NOTE 15 - SEGMENT REPORTING

ASC 280, “Segment Reporting”, establishes standards for reporting information about operating segments on a basis consistent with the Group's internal organizational structure as well as information about geographical areas, business segments and major customers in financial statements for details on the Group's business segments.

The Company's chief operating decision maker has been identified as the Chief Executive Officer who reviews the financial information of separate operating segments when making decisions about allocating resources and assessing performance of the Group. Based on management's assessment, the Company has determined that it has three operating segments according to the major products and locations as follows:

The operating companies of this segment, namely Tenet-Jove and Tenet Huatai, specialize in Luobuma developing and manufacturing of relevant products. With rich experience and broad channels in domestic market, the Group is leading in Luobuma textile production and other by-products.

This segment’s operations are focused in the north region of Mainland China, mostly carried out in Beijing and Tianjin City.

The operating companies of this segment, namely AnKang Longevity Group and its subsidiaries, plant and process more than 600 kinds of Chinese medicinal herbal products with an established domestic sales and distribution network.

Ankang Longevity Group is also engaged in retail pharmacy business and the operating revenue is also included in this segment due to immaterial amount. Ankang Longevity Group also started a joint-venture pharmacy retail and wholesale distribution business in the second quarter of 2013 with a large Chinese pharmaceutical company, Shaanxi Pharmaceutical Holdings Group, aiming to expand its pharmacy retail and wholesale business. The operations of this segment are mainly located in the Mid-western region of Mainland China.

The operating companies of this segment, the Zhisheng Group, engage in the business of growing and distributing green and organic vegetables and fruits as well as providing logistics services for distributing agricultural products. This segment has been focusing its efforts on the growing and cultivating of Chinese yew tree (formally known as “taxus media”), a small evergreen tree whose branches can be used for the production of anti-cancer medication and tree itself can be used for ornamental indoor bonsai tree, which are known to have the effect of purifying air quality.

The operations of this segment are located in the East and North regions of Mainland China, mostly carried out in Shandong Province and in Beijing where the Zhisheng Group has newly developed over 100 acres of modern greenhouses for cultivating yew trees and other plants.

Shineco, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

The following table presents summarized information by segment for the nine months ended March 31, 2017:

The following table presents summarized information by segment for nine months ended March 31, 2016:

The following table presents summarized information by segment for the three months ended March 31, 2017:

The following table presents summarized information by segment for three months ended March 31, 2016:

Total Assets as of

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS

The following discussion and analysis of the results of our operations and financial condition for the nine months and three months ended March 31, 2017 and 2016 should be read in conjunction with our unaudited condensed consolidated financial statements, and the notes to those unaudited condensed consolidated financial statements that are included elsewhere in this Report. All monetary figures are presented in U.S. dollars, unless otherwise indicated.

Forward-Looking Statements

The statements in this discussion that are not historical facts are “forward-looking statements.” The words “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “estimate,” “continue,” the negative forms thereof, or similar expressions, are intended to identify forward-looking statements, although not all forward-looking statements are identified by those words or expressions. Forward-looking statements by their nature involve substantial risks and uncertainties, certain of which are beyond our control. Actual results, performance or achievements may differ materially from those expressed or implied by forward-looking statements depending on a variety of important factors, including, but not limited to, weather, local, regional, national and global coke and coal price fluctuations, levels of coal and coke production in the region, the demand for raw materials such as iron and steel which require coke to produce, availability of financing and interest rates, competition, changes in, or failure to comply with, government regulations, costs, uncertainties and other effects of legal and other administrative proceedings, and other risks and uncertainties. We are not undertaking to update or revise any forward-looking statement, whether as a result of new information, future events or circumstances or otherwise.

Business Overview

Shineco, Inc. (the “Company”, “we”, “us” and “our”) was incorporated in the State of Delaware on August 20, 1997. On December 30, 2004, the Company acquired all of the issued and outstanding shares of Tenet-Jove, a PRC company, in exchange for our restricted shares of common stock. Consequently, Tenet-Jove became our 100% owned subsidiary and its operating business became that of the Company. Tenet-Jove was incorporated on December 16, 2003 under the laws of China and was officially granted the status of a Wholly Foreign-Owned Entity (“WFOE”) by Chinese authorities on July 14, 2006. This transaction was accounted for as a recapitalization. Tenet-Jove owns a 90% interest of Tianjin Tenet Huatai Technological Development Co., Ltd. (“Tenet Huatai”).

On December 31, 2008, June 11, 2011 and May 24, 2012, respectively, Tenet-Jove entered into a series of contractual agreements with the owner of Ankang Longevity Pharmaceutical (Group) Co., Ltd. (“Ankang Longevity Group”), each of Yantai Zhisheng International Freight Forwarding Co., Ltd (“Zhisheng Freight”), Yantai Zhisheng International Trade Co., Ltd (“Zhisheng Trade”), Yantai Mouping District Zhisheng Agricultural Produce Cooperative (“Zhisheng Agricultural”) and Qingdao Zhihesheng Agricultural Produce Services., Ltd (“Qingdao Zhihesheng”). On February 24, 2014, Tenet-Jove also subsequently entered into the same series of contractual agreements with ShinecoZhisheng (Beijing) Bio-Technology Co., Ltd (“Zhisheng Bio-Tech”), which is a new company incorporated in 2014. Zhisheng Bio-Tech, Zhisheng Freight, Zhisheng Trade, Zhisheng Agricultural, and Qingdao Zhihesheng are collectively referred to herein as “Zhisheng Group.” These agreements include an Executive Business Cooperation Agreement; Timely Reporting Agreement; Equity Interest Pledge Agreement and Executive Option Agreement.

Pursuant to these agreements, Tenet-Jove has the exclusive right to provide to Zhisheng Group and Ankang Longevity Group consulting services related to business operation and management. All these contractual agreements obligate Tenet-Jove to absorb a majority of the risk of loss from Zhisheng Group and Ankang Longevity Group’s activities and entitle Tenet-Jove to receive a majority of their residual returns. In essence, Tenet-Jove has gained effective control over Zhisheng Group and Ankang Longevity Group. Based on these contractual arrangements, we believe that Zhisheng Group and Ankang Longevity should be considered as Variable Interest Entities (“VIEs”) under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810 “Consolidation”. Accordingly, the accounts of these entities are consolidated with those of Tenet-Jove. We carry out all of our business in China through our PRC subsidiaries, our VIEs and their subsidiaries. Currently, we operate three main business segments: (i) Tenet-Jove is engaged in manufacturing and selling of Luobuma and related products, also known in Chinese as “Luobuma”, including therapeutic clothing and textile products made from Luobuma; (ii) Zhisheng Group is engaged in the business of planting, processing and distributing of green agricultural produce as well as providing domestic and international logistic services for agricultural products (“Agricultural Products”). (iii) Ankang Longevity develops and manufactures traditional Chinese medicinal herbal products as well as other retail pharmaceutical products. These different business activities and products can potentially be integrated and benefit from one and other.

Factors Affecting Financial Performance

We believe that the following factors will affect our financial performance:

Increasing demand for our products - The increasing demand for our Luobuma therapeutic products, our Chinese medicinal herbal products and our agricultural products, will have a positive impact on our financial position. We plan to develop new products and expand our distribution network as well as to grow our business through possible mergers and acquisitions of similar or synergetic businesses, all aimed at increasing awareness of our brand, developing customer loyalty, meeting customer demands in various markets and providing solid foundations for our continuous growth. We do not currently have any agreements, undertakings or understandings to acquire any such entity.

Expansion of our sources of supply, production capacity and sales network - To meet the increasing demand for our products, we need to expand our sources of supply and production capacity. We plan to make capital improvements in our existing production facilities, which would improve both their efficiency and capacity. In the short-run, we intend to increase our investment in our reliable supply network, personnel training, information technology applications and logistic system upgrades. We also participate in two non-equity investment opportunities through a VIE, both of which are expect to provide us with new network and platforms.

Maintaining effective control of our costs and expenses -Successful cost control depends upon our ability to obtain and maintain adequate material supplies as required by our operations at competitive prices. We will focus on improving our long-term cost control strategies including establishing long-term alliances with certain suppliers to ensure adequate supply is maintained. We will carry forward the economies of scale and advantages from our nationwide distribution network and diversified offerings. Moreover, we will step up our efforts in higher value added products of Luobuma by using an exclusive and patented technology, to optimize quality management, procurement processes and cost control, and give full play to the strong production capacity and trustworthy sales teams to maximize our profit and bring better long-term return for our shareholders.

Economic and Political Risks

Our operations are conducted primarily in the PRC. Accordingly, our business, financial conditions and results may be influenced by the political, economic and legal environment in the PRC, and by the general state of the PRC economy.

Our operations in the PRC are subject to special considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks with, among others, the political, economic and legal environment and foreign currency exchange. Our Company’s results may be adversely affected by changes in the political and social conditions in the PRC, and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversions, remittances abroad, and rates and methods of taxation, among other things.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”) requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the unaudited condensed consolidated financial statements as well as the reported amounts of revenue and expenses during the reporting period. Critical accounting policies are those accounting policies that may be material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change, and that have a material impact on financial condition or operating performance. While we base our estimates and judgments on our experience and on various other factors that we believe to be reasonable under the circumstances, actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies used in the preparation of our unaudited condensed consolidated financial statements require significant judgments and estimates. For additional information relating to these and other accounting policies, see Note 2 to our unaudited condensed consolidated financial statements included elsewhere in this report.

Consolidation of Variable Interest Entities

In accordance with accounting standards regarding consolidation of VIEs, VIEs are generally entities that lack sufficient equity to finance their activities without additional financial support from other parties or whose equity holders lack adequate decision-making ability. All VIEs with which the Company is involved must be evaluated to determine the primary beneficiary of the risks and rewards of the VIE. The primary beneficiary is required to consolidate the VIE for financial reporting purposes.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the unaudited condensed consolidated financial statements as well as the reported amounts of revenue and expenses during the reporting period. Significant estimates required to be made by management include, but are not limited to, useful lives of property, plant, and equipment, and intangible assets, the recoverability of long-lived assets and the valuation of accounts receivable, accrued expenses and taxes payable and inventory reserve. Actual results could differ from those estimates.

Accounts Receivable

Accounts receivable are recorded at net realizable value consisting of carrying amount less an allowance for uncollectible accounts, as necessary. The Company reviews the accounts receivable on a periodic basis and makes general and specific allowance when there is doubt as to the collectability of individual balances. In evaluating the collectability of individual receivable balances, the Company considers many factors, including the age of the balance, customers’ historical payment history, their current credit-worthiness and current economic trends. Accounts are written off against the allowance after efforts at collection prove unsuccessful.

Inventories

Inventories, which are stated at the lower of cost or current market value, consisting of raw materials, work-in-progress, finished goods related to the Company’s products. Cost is determined using the first in first out (“FIFO”) method. Market is the lower of replacement cost or net realizable value. Agricultural products that the Company farms are recorded at cost, which includes direct costs such as seed selection, fertilizer, labor cost and contract fee that are spent in growing agricultural products on the leased farmland, and indirect costs which include amortization of prepayment of farmland lease fee and farmland development cost. All the costs are accumulated until the time of harvest and then allocated to harvested crops costs when they are sold. The Company periodically evaluates its inventory and records inventory reserve for certain inventories that may not be saleable.

Revenue Recognition

The Company recognizes revenue from sales of Luobuma products, Chinese medicinal herbal products and agricultural products, as well as providing logistic service and other processing service to external customers. The Company recognizes revenue when all of the following have occurred: (i) there is persuasive evidence of an arrangement with a customer, (ii) delivery has occurred or services have been rendered, (iii) the sales price is fixed or determinable, and (iv) the Company’s collection of such fees is reasonable assured. These criteria, as related to the Company’s revenue, are considered to have been met as follows:

Sales of products: the Company recognizes revenue on sale of products when the goods are delivered and title to the goods passes to the customer provided that there are no uncertainties regarding customer acceptance; persuasive evidence of the an arrangement exists; the sales price is fixed or determinable; and collectability is deemed probable.

Revenue from the rendering of services: Revenue from international freight forwarding, domestic air and overland freight forwarding services are recognized upon the performance of services as stipulated in the underlying contract or when commodities are being released from the customer’s warehouse.

Fair Value of Financial Instruments

The Company adopted the provisions of ASC 820, “Fair Value Measurements and Disclosures.” ASC 820 clarifies the definition of fair value, prescribes methods for measuring fair value, and establishes a fair value hierarchy to classify the inputs used in measuring fair value as follows:

Level 1 applies to assets or liabilities for which there are quoted prices in active markets for identical assets or liabilities.

Level 2 applies to assets or liabilities for which there are inputs other than quoted prices that are observable for the asset or liability such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical assets or liabilities in markets with insufficient volume or infrequent transactions (less active markets); or model-derived valuations in which significant inputs are observable or can be derived principally from, or corroborated by, observable market data.

Level 3 applies to assets or liabilities for which there are unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of the assets or liabilities.

The carrying value of financial instruments included in current assets and liabilities approximate their fair values because of the short-term nature of these instruments.

Results of Operations for the Nine Months Ended March 31, 2017 and 2016

Overview

The following table summarizes our results of operations for the nine months ended March 31, 2017 and 2016:

Revenue

Currently, we have three types of revenue streams deriving from our three major business segments: First, developing, manufacturing and distributing specialized fabrics, textiles and other by-products derived from an indigenous Chinese plant Apocynum Venetum, known in Chinese as “Luobuma” or “Bluish Dogbane.” This segment is channeled through our directly owned subsidiary, Tenet-Jove. Second, processing and distributing traditional Chinese medicinal herbal products as well as other pharmaceutical products. This segment is conducted by our Ankang Longevity Group VIEs. And third, planting, processing and distributing green and organic agricultural produce as well as growing and cultivation of yew trees. This segment is conducted through our VIEs, the Zhisheng Group.

The following table sets forth the breakdown of our revenue for the nine months ended March 31, 2017 and 2016, respectively:

For the nine months ended March 31, 2017 and 2016, revenue from sales of Luobuma products was $2,769,003 and $3,537,833, respectively, which represented a decrease of $768,830 or 21.73%. The decrease of revenue from this segment was due to both the decreased sales price and decreased sales volume of our products. During the three months ended September 30, 2016, the Company focused on selling a portion of slow-moving products at cost, which resulted in less revenue recognized during that period. Moreover, the Company had promoted their products online in 2015; as a result, sales volume in the nine months ended March 31, 2016 is more than that in the same period of 2017.

For the nine months ended March 31, 2017 and 2016, revenue from sales of Chinese medicinal herbal products was $9,725,580 and $10,430,717, respectively, representing a decrease of $705,137 or 6.76%. The decrease was mainly due to the depreciation of RMB against USD. The average translation rates for the nine months ended March 31, 2017 and 2016 were at 1 RMB to $0.1472 USD and at 1 RMB to $0.1563 USD, respectively, which represented a decrease of 5.82%. Moreover, revenue from sales of Chinese medicinal herbal products decreased from RMB 66,735,232 to RMB 66,078,597, a slight decrease of 0.98%. The decrease was primarily due to decreased sales orders. During the nine months ended March 31, 2017, in order to meet the qualifications of a new standard promulgated by the local government, the Company reduced production of certain types of traditional Chinese medicinal herbal products.

For the nine months ended March 31, 2017 and 2016, revenue from sales of other agricultural products was $13,036,730 and $13,104,876, respectively, representing a decrease of $68,146 or 0.52%. The decrease was mainly due to the depreciation of RMB against USD as mentioned above. Revenue from sales of other agricultural products increased from RMB 83,844,377 to RMB 88,575,573, an increase of 5.64%, mainly due to the increase in unit price of yew trees. Unit price of yew trees with different heights from 50 to 120 centimeters, increased by approximately 8.6% to 17.7% in November 2016. In addition, in the second quarter of 2017, we developed a new business line of storage, which contributed a small amount of revenue in the nine months ended March 31, 2017 compared to the corresponding period of 2016.

Cost of Revenue

The following table sets forth the breakdown of the Company’s cost of revenue for the nine months ended March 31, 2017 and 2016, respectively:

For the nine months ended March 31, 2017 and 2016, cost of revenue from sales of our Luobuma products was $1,373,423 and $1,636,760, respectively, representing a decrease of $263,337 or 16.09%. The decrease of cost of revenue was mainly due to the reduced total production output. Moreover, the percentage of the decrease in cost of revenue was lower than the decrease in sales during this period, which resulted from higher unit fixed cost due to decreased production output.

For the nine months ended March 31, 2017 and 2016, cost of revenue from sales of Chinese medicinal herbal products was $7,196,451 and $8,014,835, respectively, representing a decrease of $818,384 or 10.21%. The decrease was mainly due to reduced production of certain types of traditional Chinese medicinal herbal products. Meanwhile, the Company changed its strategy to sell products with stronger profit margin during the three months ended March 31, 2017. As a result, the decrease in cost of revenue is higher than the decrease in revenue.

For the nine months ended March 31, 2017 and 2016, cost of revenue from sales of other agricultural products was $8,437,174 and $8,459,076, respectively, representing a slight decrease of $21,902 or 0.26%. The decrease was mainly due to the depreciation of RMB against USD as mentioned above. Cost of revenue from sales of other agricultural products increased from RMB 54,120,771 to RMB 57,324,771, an increase of 5.92%. The reason for the increase is since the second quarter of 2017, we developed a storage business line which has a relatively high cost compared with sales of our agricultural products.

Gross Profit

The following table sets forth the breakdown of the Company’s gross profit for the nine months ended March 31, 2017 and 2016, respectively:  

Gross profit from Luobuma product sales decreased by $501,402 and gross profit contribution percentage decreased by 26.61% for the nine months ended March 31, 2017 as compared to the same period of 2016. The decrease in gross profit was primarily due to a decrease in sales volume, as well as a reduction in total production output, which led to a higher unit cost and a lower gross profit.

Gross profit from sales of Chinese medicinal herbal products increased by $115,397 or 4.86% for the nine months ended March 31, 2017 as compared to the same period of 2016. The increase was mainly because the Company changed its strategy to sell products with stronger profit margin during the three months ended March 31, 2017.

Gross profit from sales of other agricultural products decreased by $46,244 for the nine months ended March 31, 2017 as compared to the same period of 2016. The decrease was mainly due to the depreciation of RMB against USD as mentioned above. Gross profit from sales of other agricultural products increased from RMB 22,686,359 to RMB 31,684,880, an increase of 8.17%. The increase was mainly due to the increase in unit prices of our yew tree products during the nine months ended March 31, 2017.

Expenses

The following table sets forth the breakdown of our operating expenses for the nine months ended March 31, 2017 and 2016, respectively:

General and Administrative Expenses

For the nine months ended March 31, 2017, our general and administrative expenses were $2,029,981, representing an increase of $489,075 or 31.74%, as compared to the same period of 2016. The increase was primarily due to the increased general and administrative expenses of our Shineco holding company, which were $684,781 and nil for the nine months ended March 31, 2017 and 2016. General and administrative expenses of Shineco were mainly composed of labor expenses and expenses related to our initial public offering, such as attorneys fees, consulting fees and auditing fees.

Selling and Distribution Expense

For the nine months ended March 31, 2017, our selling and distribution expenses were $1,186,536, representing a decrease of $177,225, or 13.00%, as compared to the same period of 2016. The decrease was primarily due to decreased advertising expenses, promotion expenses, and service fees of e-commerce websites, partially offset by increased rent expense of warehouses during the nine months ended March 31, 2017 compared to the same period of 2016.

Income from Equity Method Investments

We are 49% participants in two joint ventures: Shaanxi Pharmaceutical Sunsimiao Drugstores Ankang Retail Chain Co., Ltd. (“Sunsimiao Drugstores”), and Shaanxi Pharmaceutical Holding Group Longevity Pharmacy Co., Ltd. (“Shaanxi Longevity Pharmacy”) with Shaanxi Pharmaceutical Group. We recorded net income of $588,994 and $479,965 from these equity method investments for the nine months ended March 31, 2017 and 2016, respectively. The increase in net income was primarily due to higher net profit in the two joint ventures in the current period.

We are party to a supplemental agreement with Shaanxi Pharmaceutical Group. According to the supplemental agreement, the participants in the joint venture companies established by Shaanxi Pharmaceutical and Ankang Longevity Group are required to purchase certain raw materials and drug products exclusively from Shaanxi Pharmaceutical Group. In return, Shaanxi Pharmaceutical Group has agreed to compensate Ankang Longevity Group with a preferred distribution equal to 7% of the total purchases made from Shaanxi Pharmaceutical Group. For the nine months ended March 31, 2017, total income of $846,297 was recognized by Ankang Longevity Group from this supplemental agreement, compared to $883,095 in the same period in 2016 due to the depreciation of RMB against USD in the current period.

We invested RMB 14.5 million (approximately $2.2 million) into Tiancang Systematic Warehousing project (“Tiancang Project”) operated by Zhen’Ai Network. The Tiancang Project is currently operational. For the nine months ended March 31, 2017 and 2016, a total of $110,387 and $140,670 were recognized by Ankang Longevity Group from this supplemental agreement in addition to its 49% share of the income from the joint ventures, respectively.

On November 21, 2016, the Company (the “Investor”) entered into an agreement with Original Lab Inc., a California corporation (the “Investee”), that the investor makes a payment of $200,000 to in exchange for the right to acquire certain shares of the investee’s common stock and preferred stock. For the nine months ended March 31, 2017, the Company did not record investment income from this investment.

Interest Income, net

For the nine months ended March 31, 2017, our net interest income was $15,124 as compared to interest income of $100,336 in the same period of 2016. The significant decrease in net interest income was primarily due to decreased interest income on the loan to Xinyang Yifangyuan Garden Technology Co., Ltd. (“Xinyang Yifangyuan”). Xinyang Yifangyuan paid off the loan of RMB 3,000,000 in December, 2016. Interest income of $86,585 and $213,178 was recognized on the loans for the nine months ended March 31, 2017 and 2016. Moreover, the weighted average balances for the short-term bank loan were relatively higher for the nine months ended March 31, 2017, compared to the corresponding period in 2016.

Provision for Income Taxes

For the nine months ended March 31, 2017 and 2016, the Company’s provision for income taxes decreased by $50,179 or 5.68% from $883,840 for the nine months ended March 31, 2016 to $833,661 for the nine months ended March 31, 2017. The decrease in the Company’s provision for income taxes was primarily due to decreased taxable income of Tenet-Jove and Ankang Longevity Group for the period indicated.

Net Income

Our net income decreased by $626,343 or 9.13% for the nine months ended March 31, 2017 as compared to the same period of 2016. The decrease in net income was primarily a result of the decrease in gross profit and the increase in operating expense, partially offset by the increase in other income

Comprehensive Income (Loss)

The foreign currency translation gain or loss resulting from translation of the financial statements expressed in RMB to USD is reported in other comprehensive loss in the unaudited condensed consolidated statements of income and comprehensive income. The comprehensive income attributable to Shineco, Inc. decreased by $109,618 to comprehensive income of $4,169,203 for the nine months ended March 31, 2017 from comprehensive income of $4,278,821 for the nine months ended March 31, 2016 mainly due to decreased net income, which was offset by a decrease in the foreign currency translation loss during the current period in 2017.

Results of Operations for the Three Months Ended March 31, 2017 and 2016

Overview

The following table summarizes our results of operations for the three months ended March 31, 2017 and 2016:

Revenue 

The following table sets forth the breakdown of our revenue for the three months ended March 31, 2017 and 2016, respectively:

For the three months ended March 31, 2017 and 2016, revenue from sales of Luobuma products was $1,121,044 and $1,091,149, respectively, which represented an increase of $29,895 or 2.74%. The increase of revenue from this segment was primarily attributable to the increase in sales price of our products during the third quarter of 2017. Our vendors raised our purchase cost; therefore, we also increased the sales price of our products. However, we did not raise the price as much as the cost due to the increased competition in the Luobuma sales market.

For the three months ended March 31, 2017 and 2016, revenue from sales of Chinese medicinal herbal products was $3,049,290 and $3,165,868, respectively, representing a decrease of $116,578 or 3.68%. The decrease was primarily due to the depreciation of RMB against USD. The average translation rates for the three months ended March 31, 2017 and 2016 were at 1 RMB to $0.1451 USD and at 1 RMB to $0.1529 USD, respectively, which represented a decrease of 5.10%. Revenue from sales of Chinese medicinal herbal products increased from RMB 20,755,174 to RMB 21,016,331, a slight increase of 1.26%. Starting from the third quarter of fiscal year 2017, the Company optimized product structure and increased sales of products with relatively higher sales price and lower cost.

For the three months ended March 31, 2017 and 2016, revenue from sales of other agricultural products was $3,771,249 and $3,405,492, respectively, representing an increase of $365,757 or 10.74%. This was mainly attributable to the increase in the unit price of our yew trees as mentioned above. In addition, our storage business line contributed a small amount of extra revenue during the three months ended March 31, 2017 compared to the same period in 2016.

Cost of Revenue

The following table sets forth the breakdown of the Company’s cost of revenue for the three months ended March 31, 2017 and 2016, respectively:

For the three months ended March 31, 2017 and 2016, cost of revenue from sales of our Luobuma products was $565,085 and $490,684, respectively, representing an increase of $74,401 or 15.16%. The increase in cost of revenue was mainly due to the increased purchase cost of raw materials as mentioned above.

For the three months ended March 31, 2017 and 2016, cost of revenue from sales of Chinese medicinal herbal products was $2,281,387 and $2,531,542, respectively, representing a decrease of $250,155 or 9.88%. During the third quarter of fiscal year 2017, the Company optimized product structure and increased sales of products with relatively lower purchase costs and higher gross profit.

For the three months ended March 31, 2017 and 2016, cost of revenue from sales of other agricultural products was $2,473,270 and $2,448,331, respectively, representing an increase of $24,939 or 1.02%. The increase was mainly due to our new storage business which has a relatively high cost and low gross profit as mentioned above.

Gross Profit

The following table sets forth the breakdown of the Company’s gross profit for the three months ended March 31, 2017 and 2016, respectively:  

Gross profit from Luobuma product sales decreased by $43,371 and gross profit contribution percentage decreased by 7.28% for the three months ended March 31, 2017 as compared to the same period of 2016. As mentioned above, the increase in sales price of Luobuma products is lower than the increase in purchase cost during the three months ended March 31, 2017; as a result, gross profit decreased compared to the same period in 2016.

Gross profit from sales of Chinese medicinal herbal products had an increase of $134,081 for the three months ended March 31, 2017 as compared to the same period of 2016, primarily due to the fact that the Company changed its strategy to produce and sell products with a higher profit margin during the three months ended March 31, 2017.

Gross profit from sales of other agricultural products increased by $340,818 for the three months ended March 31, 2017 as compared to the same period of 2016. The increase was mainly due to the increased gross margin of yew tree products.

Expenses

The following table sets forth the breakdown of our operating expenses for the three months ended March 31, 2017 and 2016, respectively:

General and Administrative Expenses

For the three months ended March 31, 2017, our general and administrative expenses were $631,640, representing an increase of $168,981 or 36.52%, as compared to the same period of 2016. The increase was primarily due to the increased general and administrative expenses of our Shineco holding company, which were $356,921 and nil for the three months ended March 31, 2017 and 2016. General and administrative expenses of Shineco were mainly composed of labor expenses and expenses related to our initial public offering, such as attorneys fees, consulting fees and auditing fees.

Selling and Distribution Expense

For the three months ended March 31, 2017, our selling and distribution expenses were $304,182, representing a decrease of $57,632, or 15.93%, as compared to the same period of 2016. The decrease was primarily due to decreased services fees of e-commerce websites during the three months ended March 31, 2017, compared to the corresponding period in 2016.

Income from Equity Method Investments

We are 49% participants in two joint ventures: Shaanxi Pharmaceutical Sunsimiao Drugstores Ankang Retail Chain Co., Ltd. (“Sunsimiao Drugstores”), and Shaanxi Pharmaceutical Holding Group Longevity Pharmacy Co., Ltd. (“Shaanxi Longevity Pharmacy”) with Shaanxi Pharmaceutical Group. We recorded net income of $187,226 and $120,300 from these equity method investments for the three months ended March 31, 2017 and 2016, respectively. The increase in net income was primarily due to higher net profit in the two joint ventures in the current period.

We are party to a supplemental agreement with Shaanxi Pharmaceutical Group. According to the supplemental agreement, the participants in the joint venture companies established by Shaanxi Pharmaceutical and Ankang Longevity Group are required to purchase certain raw materials and drug products exclusively from Shaanxi Pharmaceutical Group. In return, Shaanxi Pharmaceutical Group has agreed to compensate Ankang Longevity Group with a preferred distribution equal to 7% of the total purchases made from Shaanxi Pharmaceutical Group. For the three months ended March 31, 2017, total income of $253,669 was recognized by Ankang Longevity Group from this supplemental agreement, compared to $306,395 in the same period in 2016 due to the decrease in purchases in the current period.

We invested RMB 14.5 million (approximately $2.2 million) into Tiancang Systematic Warehousing project (“Tiancang Project”) operated by Zhen’Ai Network. The Tiancang Project is currently operational. For the three months ended March 31, 2017 and 2016, Zhisheng Freight received investment income distribution of $110,387 and $140,670 from Zhen’Ai Network.

On November 21, 2016, the Company (the “Investor”) entered into an agreement with Original Lab Inc., a California corporation (the “Investee”), that the investor makes a payment of $200,000 to in exchange for the right to acquire certain shares of the investee’s common stock and preferred stock. For the three months ended March 31, 2017, the Company did not record investment income from this investment.

Interest Income (Expense), net

For the three months ended March 31, 2017, our net interest expense was $25,414 as compared to interest income of $28,423 in the same period of 2016. The significant decrease in net interest income was primarily due to decreased interest income on the loan to Xinyang Yifangyuan. Xinyang Yifangyuan paid off the loan of RMB 3,000,000 in December, 2016. Interest income of nil and $56,961 was recognized on the loans for the three months ended March 31, 2017 and 2016.

Provision for Income Taxes

For the three months ended March 31, 2017 and 2016, the Company’s provision for income taxes increased by $71,321 or 27.76% from $256,953 for the three months ended March 31, 2016 to $328,274 for the three months ended March 31, 2017. The increase in the Company’s provision for income taxes was primarily due to the deferred income tax provision of $53,214 for the three months ended March 31, 2017 compared to the deferred income tax benefit of $24,397 for the corresponding period of 2016.

Net Income

Our net income increased by $183,702 or 10.35% for the three months ended March 31, 2017 as compared to the same period of 2016. The increase in net income was primarily a result of the increase in gross profit, partially offset by the increase in operating expense and the decrease in other income.

Comprehensive Income

The foreign currency translation gain or loss resulting from translation of the financial statements expressed in RMB to US$ is reported in other comprehensive loss in the unaudited condensed consolidated statements of income and comprehensive income. The comprehensive income attributable to Shineco, Inc. increased by $351,369 to comprehensive income of $2,443,199 for the three months ended March 31, 2017 from comprehensive income of $2,091,830 for the three months ended March 31, 2016 due to increased net income and increased foreign currency translation gain due to the depreciation of RMB in terms of USD during the three months ended March 31, 2017, compared to the same period in 2016.

Liquidity and Capital Resources

We currently finance our business operations primarily through cash provided by operating activities and bank loans. Our current cash primarily consists of cash on hand and cash in bank, which is unrestricted as to withdrawal and use and is deposited with banks in China.

On September 28, 2016, we completed the initial public offering of 1,713,190 shares of the Company’s common stock at a price of $4.50 per share for gross proceeds of $7.7 million and net proceeds of approximately $5.4 million. We intend to use 54%, 16%, 25% and 5% of proceeds received through IPO in expansion of high-pressure steam degumming proceed project, development of Ziyang County, China Chinese herbal medicine farm, processing plants project and development of e-commerce platform projects and working capital, respectively.

Management believes that our current cash, cash flows provided by operating activities, and access to loans will be sufficient to meet our working capital needs for at least the next 12 months. We intend to continue to carefully execute our growth plans and manage market risk.

Treasury Policies

We have established treasury policies with the objectives of achieving effective control of treasury operations and of lowering cost of funds. Therefore, funding for all operations and foreign exchange exposure have been centrally reviewed and monitored from the top level. To manage our exposure to fluctuations in exchange rates and interest rates on specific transactions and foreign currency borrowings, currency structured instruments and other appropriate financial instruments will be used to hedge material exposure, if any.

Our policy precludes us from entering into any derivative contracts purely for speculative activities. Through our treasury policies, we aim to:

(a) Minimize interest risk

This is accomplished by loan re-financing and negotiation. We will continue to closely monitor the total loan portfolio and compare the loan margin spread under our existing agreements against the current borrowing interest rates under different currencies and new offers from banks.

(b) Minimize currency risk

In view of the current volatile currency market, we will closely monitor the foreign currency borrowings at company level. As of March 31, 2017 and June 30, 2016, we do not engage in any foreign currency borrowings or loan contracts.

Working Capital

The following table provides the information about our working capital at March 31, 2017 and June 30, 2016:

The working capital increased by $8,353,969 or 28.81% from June 30, 2016 to March 31, 2017, primarily as a result of an increase in cash due to the net proceeds from our initial public offering during the nine months ended March 31, 2017. We believe that we currently have sufficient working capital to run our business.

As of March 31, 2017 and June 30, 2016, the other major component of our working capital is accounts receivable.

The accounts receivable, including accounts receivable from unconsolidated entities, as of March 31, 2017 were $12,188,124, an increase of approximately 119.52% from $5,552,242 as of June 30, 2016, mainly due to an increase of revenue receivable from Qingdao Shipping Services Association, Qingdao Cruise and Yacht Association and Qingdao ShiMeng Cruise Industrial Development Operation Management Co., Ltd. The turnover days of trade receivables were 93.8 days for the nine months ended March 31, 2017, compared to 64.0 days in the corresponding period last period. The average turnover days of accounts receivable in our industry is approximately 40 days. The increase in turnover days of trade receivables was due to the Company given a major customer a longer credit term based on the customer’s credit history and long-term relationship with the Company. In January 2017, the Company entered into an accounts receivable repayment plan with this customer, who agreed to pay RMB 2.0 million ($290,228 as of March 31, 2017) per month starting from March 2017, and accounts receivable from them will be paid off before December 31, 2017. As of March 31, 2017, approximately 58% of our outstanding account receivables were aged within 90 days, which was in compliance with our credit terms.

Capital Commitments and Contingencies

Capital commitments refer to the allocation of funds for a possible liability in the near future arising out of capital expenditures. Contingency refers to a condition that arises from past transactions or events, the outcome of which will be confirmed only by the occurrence or non-occurrence of uncertain futures events.

As of March 31, 2017 and June 30, 2016, we had no material capital commitments or contingent liabilities.

Cash Flows

The following table provides detailed information about our net cash flows for the nine months ended March 31, 2017 and 2016.

Operating Activities

Net cash used in operating activities during the nine months ended March 31, 2017 was approximately $1.4 million, consisting of net income of $6.2 million, income from equity method investments of $1.5 million as reconciled and net changes in our operating assets and liabilities, which mainly included an increase in accounts receivable of $6.9 million, reduction in inventory of $2.6 million and repayment in other payables of $1.5 million. Net cash provided by operating activities during the nine months ended March 31, 2016 was approximately $10.1 million, consisting of net income of $6.9 million and net changes in our operating assets and liabilities, which mainly included a decrease in advances to suppliers of $1.3 million, reduction in inventory of $0.9 million and an increase in other payables of $0.6 million.

Investing Activities

For the nine months ended March 31, 2017, net cash used in investing activities amounted to $1,688,837 as compared to net cash provided by investing activities of $2,727,182 for the same period of 2016. The decrease in net cash provided by investing activities was primarily due to payments of deposit for business acquisition of approximately $2.1 million and payments of loans to third parties of $0.5 million, partially offset by collections on loans to related parties of $0.6 million and income received from investments in unconsolidated entities of $0.6 million during the nine months ended March 31, 2017. On December 10, 2016, in order to develop international market and e-commerce market for Luobuma products, the Company decided to acquire 51% of Tianjin Tajite E-Commerce Co., Ltd, a professional e-commerce company distributing Luobuma fabric commodities and Japanese elderly products.

Financing Activities

For the nine months ended March 31, 2017, net cash provided by financing activities amounted to $5.6 million, as opposed to net cash used in financing activities of $0.5 million for the same period of 2016. The increase of $6.1 million in net cash provided by financing activities was primarily due to net proceeds from our initial public offering of $5.4 million for the nine months ended March 31, 2017.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

As a small reporting company, we are not required to provide the information required by this item.

ITEM 4. CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures designed to provide reasonable assurance that material information required to be disclosed by us in the reports filed or submitted under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms, and that the information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Based on our review, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were not effective at the reasonable assurance level as of the end of the period covered by this report due to following material weaknesses:

·        Lack of full-time U.S. GAAP personnel in the accounting department to monitor the recording of the transactions;

·        Lack of segregation of duties for accounting personnel who prepared and reviewed the journal entries.

·        Failure to record properly certain expenses associated with our initial public offering, which resulted in a need to restate a previous quarterly report on Form 10-Q for the quarter ended September 30, 2016.

In order to address the above material weaknesses, our management plans to take the following steps:

·        Recruiting sufficient qualified professionals with appropriate levels of knowledge and experience to assist in reviewing and resolving accounting issues in routine or complex transactions. To mitigate the reporting risks, we engaged an outside professional consulting firm to supplement our efforts to improve our internal control over financial reporting;

·        Improving the communication between management, board of directors and the Chief Financial Officer; and

·        Obtaining proper approval for other significant and non-routine transactions from the Board of Directors.

The Company believes the foregoing measures will remediate the identified material weaknesses in future periods. The Company is committed to monitoring the effectiveness of these measures and making any changes that are necessary and appropriate.

There have been no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting during our third fiscal quarter of 2017. Because of its inherent limitations, a system of internal control over financial reporting can provide only reasonable assurance and may not prevent or detect misstatements. Further, because of changes in conditions, effectiveness of internal controls over financial reporting may vary over time. Our system contains self-monitoring mechanisms, and actions are taken to correct deficiencies as they are identified.

 PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

From time to time, we may be subject to legal proceedings and claims in the ordinary course of business. We are not currently a party to any litigation the outcome of which, if determined adversely to us, would individually or in the aggregate be reasonably expected to have a material adverse effect on our business, operating results, cash flows or financial condition.

ITEM 1A. RISK FACTORS.

As a smaller reporting company, we are not required to provide the information otherwise required by this Item. 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION.

None.

ITEM 6. EXHIBITS