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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This annual report on Form 10-K (the “Report”) and other reports (collectively the “Filings”) filed by the registrant from time to time with the Securities and Exchange Commission (the “SEC”) contain or may contain forward looking statements and information that are based upon beliefs of, and information currently available to, the registrant’s management as well as estimates and assumptions made by the registrant’s management. When used in the filings the words “anticipate,” “believe,” “estimate,” “expect,” “future,” “intend,” “plan” or the negative of these terms and similar expressions as they relate to the registrant or the registrant’s management identify forward looking statements. Such statements reflect the current view of the registrant with respect to future events and are subject to risks, uncertainties, assumptions and other factors (including the risks contained in the section of this Report entitled “Risk Factors”) relating to the registrant’s industry, the registrant’s operations and results of operations and any businesses that may be acquired by the registrant. Should one or more of these risks or uncertainties materialize, or should the underlying assumptions prove incorrect, actual results may differ significantly from those anticipated, believed, estimated, expected, intended or planned.
Although the registrant believes that the expectations reflected in the forward looking statements are reasonable, the registrant cannot guarantee future results, levels of activity, performance or achievements. Except as required by applicable law, including the securities laws of the United States, the registrant does not intend to update any of the forward-looking statements to conform these statements to actual results. The following discussion should be read in conjunction with the registrant’s financial statements and the related notes thereto included in this Report.
In this Report, the terms “we,” “us,” “our company,” “our” and “Shineco” refer to Shineco, Inc. (“TYHT” when referring solely to our Delaware company), including its consolidated subsidiaries and variable interest entities (“VIEs”), unless the context otherwise requires;
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Part I
General Overview
We are a Delaware holding company that uses our subsidiaries’ and variable interest entities’ vertically- and horizontally-integrated production, distribution and sales channels to provide health and well-being focused plant-based products. Our products are only sold domestically in China. We utilize modern engineering technologies and biotechnologies to produce, among other products, Chinese herbal medicines, organic agricultural produce and specialized textiles. Our health and well-being focused plant-based products business is divided into three major segments:
1. Processing and distributing traditional Chinese herbal medicine products as well as other pharmaceutical products. The companies of this segment, Ankang Longevity Group, operate 66 cooperative retail pharmacies throughout Ankang, a city in southern Shaanxi province, China, through which we sell directly to individual customers traditional Chinese medicinal products produced by us as well as by third parties. Ankang Longevity Group also owns a factory specializing in decoction, which is the process by which solid materials are heated or boiled in order to extract liquids, and distributes decoction products to wholesalers and pharmaceutical companies around China. This segment accounted for approximately 40% of our revenues for the fiscal year ending June 30, 2016.
2. Planting, processing and distributing green and organic agricultural produce as well as growing and cultivating yew trees (taxus media). We currently cultivate and sell yew mainly to large group and corporate customers, but do not currently process yew into Chinese or Western medicines. This segment is conducted through the Company’s variable interest entities: the Zhisheng Group, which comprises the following Chinese companies participating in our yew tree business: Shineco Zhisheng (Beijing) Bio-Technology Co. (“Zhisheng Bio-Tech”), 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”). This segment accounted for approximately 48% of our revenues for the fiscal year ending June 30, 2016.
3. Developing and distributing specialized fabrics, textiles and other byproducts derived from an indigenous Chinese plant Apocynum Venetum, grown in the Xinjiang region of China, and known in Chinese as “Luobuma” or “bluish dogbane”. Our Luobuma products are specialized textile and health supplement products designed to incorporate traditional Eastern medicines with modern scientific methods. These products are predicated on centuries-old traditions of Eastern herbal remedies derived from the Luobuma raw material. This segment is channeled through the Company’s directly-owned subsidiary, Beijing Tenet-Jove Technological Development Co., Ltd. (“Tenet-Jove”). This segment accounted for approximately 12% of our revenues for the fiscal year ending June 30, 2016.
We primarily market our health and wellbeing-focused products in China. At present, we do not sell any of our products in the United States or Canada. China’s domestic pharmaceutical and healthcare product market is fast-growing but, in our opinion, underdeveloped. We believe China’s healthcare sector has the capacity to develop even further. According to China’s National Health and Family Planning Commission, China’s healthcare spending in 2013 was only 5.5% of GDP, which is far below healthcare spending of developed countries. According to the World Bank, healthcare spending for 2012 for the United States, United Kingdom, France and Germany was 17.9%, 9.4%, 11.7% and 11.3%, respectively. According to a 2015 report by Deloitte, healthcare expenditures in China are projected to grow at an average rate of 11.8% annually from 2014-2018, reaching $892 billion by 2018. From pharmaceuticals to medical products to general consumer health, China remains among the world’s most attractive markets, and by far the fastest-growing of all the large emerging ones. This growth is being driven by China’s aging population, increased incidence of chronic diseases, and a material increase in investment from both domestic and foreign corporations. The growth also reflects the Chinese government’s focus on healthcare as both a social priority (as witnessed in its late 2000s healthcare reforms) and a strategic priority (as witnessed in the 12th five-year plan’s stated focus on growing the biomedical industry in the future).
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History and Corporate Structure
Shineco, Inc. was incorporated under the laws of the State of Delaware on August 20, 1997 as Supcor, Inc. From 1997 to 2004, the Company’s only activities were organizational ones, directed at developing its business plan and raising initial capital. On December 30, 2004, the Company acquired all of the issued and outstanding shares of Tenet-Jove, a company operating in the fabrics and textile business organized under the laws of the People’s Republic of China on December 15, 2003, in exchange for shares of Shineco’s common stock. At that point, the sole operating business of Tenet-Jove then became that of the Company. On June 9, 2005, we changed our name to Shineco, Inc.
Currently, Tenet-Jove, through a series of contractual relationships, effectively controls and manages:
The Company is also a majority shareholder of Tianjin Tenet Huatai Technological Development Co., Ltd. (“Tianjin Tenet Huatai”), and it owns 49% of Shaanxi Pharmacy Holding Group Ankang Longevity Pharmaceutical Co., Ltd. and Shaanxi Pharmacy Sunsimiao Drugstores Ankang Chain Co., Ltd. through a joint venture with Shaanxi Pharmaceutical Group Pai’ang Medicine Co. Ltd., a Chinese state-owned pharmaceutical enterprise.
Contractual Arrangements with Hongli Group and its Owners
We conduct our business through a combination of contractual arrangements with PRC operating companies and equity ownership of PRC subsidiaries. In some cases we have chosen to use contractual relationships because direct investment by foreign-owned companies like our Delaware company is prohibited or restricted. In other cases we have elected to do so in spite of being permitted to own such operating company directly. Where we operate our business through such contractual relationships, we are subject to risks related to such operation. See “Risk Factors— We rely on contractual arrangements with our variable interest entities in China for our business operations, which may not be as effective in providing operational control or enabling us to derive economic benefits as through ownership of controlling equity interests.”
The principal regulation governing foreign ownership of businesses in the PRC is the Foreign Investment Industrial Guidance Catalogue, effective as of April 10, 2015 (the “Catalogue”). The Catalogue classifies various industries into three categories: encouraged, restricted and prohibited. Shineco is engaged in business in industries where direct foreign investment is expressly prohibited: the preparation of traditional Chinese medicines in small pieces ready for decoction.
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Due, in part, to the regulations on foreign ownership of PRC businesses, neither we nor our subsidiaries own any equity interest in Ankang Longevity Group or the Zhisheng Group. The foregoing companies are referred to herein as the “Controlled Companies.” Instead, we control and receive the economic benefits of the Controlled Companies’ business operations through a series of contractual arrangements. Tenet-Jove, each of the Controlled Companies and its shareholders have entered into a series of contractual arrangements, also known as VIE Agreements. The VIE agreements are designed to provide Tenet-Jove with the power, rights and obligations equivalent in all material respects to those it would possess as the sole equity holder of each Controlled Company, including absolute control rights and the rights to the assets, property and revenue of each Controlled Company. Based on a legal opinion issued by Dentons LLP to Tenet-Jove, the VIE agreements constitute valid and binding obligations of the parties to such agreements and are enforceable and valid in accordance with the laws of the PRC.
Each of the types of VIE Agreements is described below and consist of, for each of Ankang Longevity Group and the Zhisheng Group, (a) exclusive business cooperation agreements, (b) timely reporting agreements, (c) equity interest pledge agreements, (d) exclusive option agreements, and (e) powers of attorney. As an overview, these agreements taken together are designed to allow our Company to manage the operations of each of the Controlled Companies and to receive all of the net income of such Controlled Companies in return therefor. To secure our interest in the Controlled Companies, the equity interest pledges and option agreements and the powers of attorney are designed to allow us to step in and convert our contractual interest into an equity interest in the event we determine that doing so is warranted. Finally, the timely reporting agreement is designed to ensure that we have timely access to the financial and other information from the Controlled Companies that we require in order to prepare regulatory and other filings.
The following is a summary of the common contractual arrangements that provide us with effective control of our VIEs and that enable us to receive substantially all of the economic benefits from their operations.
Exclusive Business Cooperation Agreements
Pursuant to substantially identical Exclusive Business Cooperation Agreements between each Controlled Company and Tenet-Jove, Tenet-Jove provides such Controlled Company with technical support, consulting services and other management services relating to its day-to-day business operations and management, on an exclusive basis, utilizing its advantages in technology, human resources, and information. Additionally, each Controlled Company has granted an irrevocable and exclusive option to Tenet-Jove to purchase from such Controlled Company, any or all of its assets, to the extent permitted under applicable PRC law. Tenet-Jove may exercise, at its sole discretion, the option to purchase from each Controlled Company any or all of such Controlled Company’s assets at the lowest purchase price permitted by PRC law. Should Tenet-Jove exercise such option, the parties shall enter into a separate asset transfer or similar agreement. Tenet-Jove shall own all intellectual property rights that are developed during the course of each Exclusive Business Cooperation Agreement. For services rendered to each Controlled Company by Tenet-Jove under the agreement to which such Controlled Company is a party, Tenet-Jove is entitled to collect a service fee calculated based on the time of services rendered multiplied by the corresponding rate, which is approximately equal to the net income of such Controlled Company.
Each Exclusive Business Cooperation Agreement shall remain in effect for ten years until it is extended or terminated by Tenet-Jove (which may be done unilaterally). Such agreements may only be terminated by the Controlled Companies upon gross negligence or fraud by Tenet-Jove. Tenet-Jove entered into an Exclusive Business Cooperation Agreement with Zhisheng Bio-Tech, Ankang Longevity Group, and Qingdao Zhihesheng on February 24, 2014, December 31, 2008, and May 24, 2012, respectively, and with each of Zhisheng Freight, Zhisheng Trade, and Zhisheng Agricultural on June 16, 2011.
Tenet-Jove is currently managing each Controlled Company pursuant to the terms of an Exclusive Business Cooperation Agreement. Pursuant to each such agreement, Tenet-Jove has absolute authority relating to the management of each Controlled Company, including but not limited to decisions with regard to expenses, salary raises and bonuses, hiring, firing and other operational functions. Although the Exclusive Business Cooperation Agreements do not prohibit related party transactions, the audit committee of Shineco will be required to review and approve in advance any related party transactions, including transactions involving Tenet-Jove or any Controlled Company.
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Timely Reporting Agreements
To ensure each Controlled Company promptly provides all of the information that Tenet-Jove and the Company need to file various reports with the SEC and other applicable regulatory authorities, a Timely Reporting Agreement was entered between each Controlled Company and Shineco on July 3, 2014.
Under the Timely Reporting Agreements, each Controlled Company agrees that it is obligated to make its officers and directors available to Shineco and promptly provide all information required by Shineco so that Shineco can file all necessary SEC and other regulatory reports as required.
Equity Interest Pledge Agreements
Under the Equity Interest Pledge Agreements among each Controlled Company (other than Zhisheng Agricultural, which is a cooperative and thus has no equity interests that can be pledged), the shareholders of each such Controlled Company and Tenet-Jove, the shareholders pledged all of their equity interests in each such Controlled Company to Tenet-Jove to guarantee the performance of such Controlled Company’s obligations under the respective Exclusive Business Cooperation Agreement. Under the terms of each agreement, in the event that the Controlled Company or its shareholders breach their respective contractual obligations under the Exclusive Business Cooperation Agreement to which they are a party, Tenet-Jove, as pledgee, will be entitled to certain rights, including, but not limited to, the right to collect dividends generated by the pledged equity interests. Each Controlled Company’s shareholders also agreed that upon occurrence of any event of default, as set forth in the applicable Equity Interest Pledge Agreement, Tenet-Jove is entitled to dispose of the pledged equity interest in accordance with applicable PRC laws. Each Controlled Company’s shareholders further agree not to dispose of the pledged equity interests or take any actions that would prejudice Tenet-Jove’s interest in the applicable Controlled Company.
Each Equity Interest Pledge Agreement shall be effective until all payments due under the related Exclusive Business Cooperation Agreement have been paid by the Controlled Company party thereto. Tenet-Jove shall cancel or terminate an Equity Interest Pledge Agreement upon a Controlled Company’s full payment of fees payable under its applicable Exclusive Business Cooperation Agreement.
Exclusive Option Agreements
Under the Exclusive Option Agreements, shareholders of each of the Controlled Companies (other than Zhisheng Agricultural, which is a cooperative and thus has no equity holders) irrevocably granted Tenet-Jove (or its designee) an exclusive option to purchase, to the extent permitted under PRC law, once or at multiple times, at any time, part or all of their equity interests in each Controlled Company. The option price is equal to the capital paid in by the applicable Controlled Company shareholders subject to any appraisal or restrictions required by applicable PRC laws and regulations. The option purchase price shall increase in case the applicable Controlled Company shareholders make additional capital contributions to such Controlled Company.
Each agreement remains effective for a term of ten years and may be unilaterally renewed at Tenet-Jove’s election.
Powers of Attorney
Under the Powers of Attorney, the shareholders of each Controlled Company authorize Tenet-Jove to act on their behalf as their exclusive agent and attorney with respect to all rights as shareholders of the respective Controlled Companies, including but not limited to: (a) attending shareholders’ meetings; (b) exercising all the shareholder’s rights, including voting, that shareholders are entitled to under the laws of China and the Articles of Association, including but not limited to the sale or transfer or pledge or disposition of shares in part or in whole; and (c) designating and appointing on behalf of shareholders the legal representative, the executive director, supervisor, the chief executive officer and other senior management members of the respective Controlled Companies.
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Guarantee Agreement
As noted above, Zhisheng Agricultural is a cooperative and has no equity interests to pledge and no equity holders to grant options. Thus, in order to secure the obligations of Zhisheng Agricultural to pay certain service fees owing to Tenet-Jove under the Exclusive Business Cooperation Agreement to which it is a party, it has entered into a Guarantee Agreement among Zhisheng Agricultural, Tenet-Jove, and Wang Qiwei, a member of the Zhisheng Agricultural cooperative dated June 16, 2011. Pursuant to the terms of the Guarantee Agreement, Wang Qiwei has agreed to guarantee the payment of service fees under the Exclusive Business Cooperation Agreement should Zhisheng Agricultural breach its obligation to do so.