The following discussion should be read in conjunction with our financial statements and the notes thereto which appear elsewhere in this report. The results shown herein are not necessarily indicative of the results to be expected in any future periods. This discussion contains forward-looking statements based on current expectations, which involve uncertainties. In some cases, you can identify forward-looking statements by terminology such as "anticipate," "estimate," "plan," "project," "predict," "potential," "continue," "ongoing," "expect," "believe," "intend," "may," "will," "should," "could," or the negative of these terms or other comparable terminology. All forward-looking statements included in this document are based on information available to the management on the date hereof.
Actual results and the timing of events could differ materially from the forward-looking statements as a result of a number of factors. Readers should also carefully review factors set forth in other reports or documents that we file from time to time with the Securities and Exchange Commission.
You should read the following discussion and analysis in conjunction with our unaudited financial statements contained in this report as well as the audited financial statements, “Management’s Discussion and Analysis of Financial Condition and Results of Operation’s and Risk Factors” contained in our Annual Report on Form 10-K, as amended to date, for the fiscal year ended December 31, 2013. We undertake no obligation and do not intend to update, revise or otherwise publicly release any revisions to our forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of any unanticipated events.
Overview
Biostar Pharmaceuticals, Inc. (“we”, the “Company” or “Biostar”) was incorporated on March 27, 2007 in the State of Maryland. Our business operation is conducted in China primarily through our variable interest entity (“VIE”), Shaanxi Aoxing Pharmaceutical Co., Ltd. (“Aoxing Pharmaceutical”), which we control through contractual arrangements between Aoxing Pharmaceutical and our wholly owned subsidiary, Shaanxi Biostar Biotech Ltd. (“Shaanxi Biostar”).
On March 28, 2010, we, through Shaanxi Biostar, entered into an agreement to acquire the assets of Xi’an Meipude Bio-Technology Co., Ltd., a Xi’an-based medical equipment manufacturer (“Meipude”), for RMB7.85 million ($1.2 million), including certain assets registered to a family member of an original Meipude shareholder. We took control over the assets of Meipude on March 29, 2010. To facilitate the transfer of some of the assets, however, we were required to acquire all of the outstanding equity interests of Meipude, which we subsequently applied for deregistration on January 18, 2011.
In October 2011, Aoxing Pharmaceutical entered into a Share Transfer Agreement to acquire Shaanxi Weinan Huaren Pharmaceuticals, Ltd. (“Shaanxi Weinan”) from the holders of 100% of equity interests in Shaanxi Weinan. The aggregate purchase price is RMB 61 million (approximately $9.55 million), in cash and payable in several tranches.
Shaanxi Weinan owns drug approvals and permits for a portfolio of 86 drugs and one health product, all of which, were added to the Company’s current drug portfolio following the completion of this acquisition. The Company completed this acquisition on October 25, 2011, and the name of the acquired company changed to Shaanxi Weinan Aoxing Pharmaceuticals, LLC. We are in the process of integrating the administration, operation and sales functions of Shaanxi Weinan with those of Aoxing Pharmaceutical.
In April 2013, Aoxing Pharmaceutical executed a supplemental agreement to the Weinan Share Transfer Agreement (the “Weinan Supplemental Agreement”) with all the former equity holders of Shaanxi Weinan to acquire 13 drug approval numbers which were excluded from the Weinan Share Transfer Agreement due to incomplete re-registration. The Company acquired ownership of the 13 drug approval numbers for which re-registration has been completed in April 2013. The aggregate purchase price was approximately $10.2 million, consisting of approximately $8.8 million in cash and 1,602,564 shares of the Company’s common stock, valued at approximately $1.4 million.
We currently manufacture and sell six over-the-counter (“OTC”) medications, fourteen prescription-based pharmaceuticals, six health products, and one medical device which are sold and distributed in over 25 provinces and provincial-level cities throughout China. We also have exclusive supply contract with a hospital to supply four pharmaceutical products. Our best-selling product, Xin Ao Xing Oleanolic Acid Capsule (“Xin Aoxing Capsule”), is a state-approved OTC drug for treatment of Hepatitis B.
Agreement to co-develop new liver cancer drug
In March 2014, the Company signed a letter of intent with the Research Institute of Pharmaceuticals at Shaanxi University of Chinese Medicine to develop a new liver cancer drug based on Oleanolic Acid injection.
March 2014 Registered Offering
On March 10, 2014, Biostar Pharmaceuticals, Inc. (“Biostar” or the “Company”) and certain institutional investors entered into a securities purchase agreement (the “Purchase Agreement”) in connection with an offering (“Offering”) pursuant to which the Company agreed to sell, and the investors agreed to purchase 1,650,000 shares of the Company’s common stock and warrants to purchase up to 660,000 shares of the Company’s common stock, for aggregate gross proceeds, before deducting fees to the placement agents and other estimated offering expenses payable by the Company, of approximately $4.1 million. The warrants will be immediately exercisable upon issuance and will remain exercisable for three years thereafter at an exercise price of $3.23 per share. The exercise price and number of shares underlying the warrants are subject to adjustment in the case of stock splits, stock dividends, combinations of shares and similar recapitalization transactions. The net proceeds from the offering will be used for working capital and other general corporate purposes. Moody Capital Solutions, Inc. and Axiom Capital Management, Inc. served as the placement agents for the offering. The Offering was effected as a takedown off the Company’s shelf registration statement on Form S-3 (File No. 333-192963), which became effective on January 3, 2014, pursuant to a prospectus supplement to be filed with the Securities and Exchange Commission.
Results of Operations
Net Sales
|
|
Three Months Ended March 31,
|
|
|
%
|
|
|
|
2014
|
|
|
2013
|
|
|
change
|
|
Aoxing Pharmaceutical Products
|
|
|
|
|
%
|
|
|
|
|
|
%
|
|
|
|
|
Xin Aoxing Oleanolic Acid Capsule
|
|
$
|
5,077,309
|
|
|
|
38.6
|
%
|
|
$
|
5,443,928
|
|
|
|
45.0
|
%
|
|
|
(6.7
|
) %
|
Other Aoxing Pharmaceutical products
|
|
|
2,971,494
|
|
|
|
22.6
|
%
|
|
|
2,502,174
|
|
|
|
20.6
|
%
|
|
|
18.8
|
%
|
Sub-total
|
|
|
8,048,803
|
|
|
|
61.2
|
%
|
|
|
7,946,102
|
|
|
|
65.6
|
%
|
|
|
1.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shannxi Weinan Products
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shaanxi Weinan products
|
|
|
2,727,745
|
|
|
|
20.7
|
%
|
|
|
2,083,214
|
|
|
|
17.4
|
%
|
|
|
30.9
|
%
|
Shaanxi Weinan products (new)
|
|
|
230,949
|
|
|
|
1.7
|
%
|
|
|
-
|
|
|
|
0.0
|
%
|
|
|
n/a
|
|
Sub-total
|
|
|
2,958,694
|
|
|
|
22.4
|
%
|
|
|
2,083,214
|
|
|
|
17.4
|
%
|
|
|
42.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Hospital products
|
|
|
2,173,667
|
|
|
|
16.4
|
%
|
|
|
2,062,593
|
|
|
|
17.0
|
%
|
|
|
5.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total sales
|
|
$
|
13,181,164
|
|
|
|
100.0
|
%
|
|
$
|
12,091,909
|
|
|
|
100.0
|
%
|
|
|
9.0
|
%
|
For the three months ended March 31, 2014, total net sales increased by approximately $1.1 million or 9.0% compared to the same period in 2013. The increase is mainly attributable to the increase in sales volume of other Aoxing products and Weinan products and the addition of 4 new products at Shaanxi Weinan. The increase in sales volume is mainly due to the positive image spread by the hospital using our products. Our sales prices didn’t change much in the first quarter of 2014.
Cost of sales
|
|
Three Months Ended March 31,
|
|
|
%
|
|
|
|
2014
|
|
|
2013
|
|
|
change
|
|
Aoxing Pharmaceutical Products
|
|
|
|
|
%
|
|
|
|
|
|
%
|
|
|
|
|
Xin Aoxing Oleanolic Acid Capsule
|
|
$
|
824,112
|
|
|
|
13.9
|
%
|
|
$
|
1,367,670
|
|
|
|
25.3
|
%
|
|
|
(39.7
|
) %
|
Other Aoxing Pharmaceutical products
|
|
|
2,104,038
|
|
|
|
35.5
|
%
|
|
|
1,745,882
|
|
|
|
32.3
|
%
|
|
|
20.5
|
%
|
Sub-total
|
|
|
2,928,150
|
|
|
|
49.4
|
%
|
|
|
3,113,552
|
|
|
|
57.6
|
%
|
|
|
(6.0
|
) %
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shannxi Weinan Products
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shaanxi Weinan products
|
|
|
1,239,245
|
|
|
|
20.9
|
%
|
|
|
895,723
|
|
|
|
16.6
|
%
|
|
|
38.4
|
%
|
Shaanxi Weinan products (new)
|
|
|
188,223
|
|
|
|
3.2
|
%
|
|
|
-
|
|
|
|
-
|
|
|
|
n/a
|
|
Sub-total
|
|
|
1,427,468
|
|
|
|
24.1
|
%
|
|
|
895,723
|
|
|
|
16.6
|
%
|
|
|
59.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Hospital products
|
|
|
1,572,458
|
|
|
|
26.5
|
%
|
|
|
1,393,744
|
|
|
|
25.8
|
%
|
|
|
12.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of sales
|
|
$
|
5,928,076
|
|
|
|
100.0
|
%
|
|
$
|
5,403,019
|
|
|
|
100.0
|
%
|
|
|
9.7
|
%
|
For the three months ended March 31, 2014, cost of sales increased by approximately $0.5 million or 9.7%, compared to the same period in 2013. This increase is mainly due to the increase in sales volume of other Aoxing products and Weinan existing products and the addition of 4 new products at Shaanxi Weinan. The increase in the production workers’ salary also contributed to the increase in the cost of sales.
The % change in cost of sales of Xin Aoxing decreased in more extent than that of net sales because in 2013, as a promotion, Xin Aoxing was sold in bundle with some gift products which cost was also included in Xin Aoxing’s cost of sales.
The % change in cost of sales of hospital products increased in more extent than that of net sales was mainly due to the higher labor costs.
Gross Profit
|
|
Three Months Ended March 31,
|
|
|
|
2014
|
|
|
2013
|
|
|
|
Gross Profit
|
|
|
Product Gross Margin %
|
|
|
Gross Profit
|
|
|
Product Gross Margin %
|
|
Aoxing Pharmaceutical Products
|
|
|
|
|
|
|
|
|
|
|
|
|
Xin Aoxing Oleanolic Acid Capsule
|
|
$
|
4,253,197
|
|
|
|
83.8
|
%
|
|
$
|
4,076,258
|
|
|
|
74.9
|
%
|
Other Aoxing Pharmaceutical products
|
|
|
867,456
|
|
|
|
29.2
|
%
|
|
|
756,292
|
|
|
|
30.2
|
%
|
Sub-total
|
|
|
5,120,653
|
|
|
|
63.6
|
%
|
|
|
4,832,550
|
|
|
|
60.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shaanxi Weinan Products
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shaanxi Weinan products
|
|
|
1,488,500
|
|
|
|
54.6
|
%
|
|
|
1,187,491
|
|
|
|
57.0
|
%
|
New Product
|
|
|
42,726
|
|
|
|
18.5
|
%
|
|
|
-
|
|
|
|
n/a
|
|
Sub-total
|
|
|
1,531,226
|
|
|
|
51.8
|
%
|
|
|
1,187,491
|
|
|
|
57.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Hospital products
|
|
|
601,209
|
|
|
|
27.7
|
%
|
|
|
668,849
|
|
|
|
32.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total gross profit
|
|
$
|
7,253,088
|
|
|
|
55.0
|
%
|
|
$
|
6,688,890
|
|
|
|
55.3
|
%
|
Gross profit increased by approximately $0.6 million or 8.4% for the three months ended March 31, 2014, as compared to the same period in 2013. The increase in gross profit was due primarily to the increase in sales volume of Other Aoxing Pharmaceutical products and Weinan existing products. The addition of 4 new products at Weinan also contributed to the increase in gross profit.
The overall gross profit margin was largely unchanged in the first quarter of 2014 compared to the same period of last year mainly because the increase in labor cost was offset by the decrease in the cost of sales of Xin Aoxing as mentioned above.
Operating Expenses
|
|
Three months ended March 31,
|
|
|
|
|
|
|
2014
|
|
|
2013
|
|
|
|
|
|
|
Operating expenses
|
|
|
% of net sales
|
|
|
Operating expenses
|
|
|
% of net sales
|
|
|
% change
|
|
Advertising expenses
|
|
$
|
1,788,541
|
|
|
|
13.6
|
%
|
|
$
|
1,886,681
|
|
|
|
15.6
|
%
|
|
|
(5.2
|
%)
|
Selling expenses
|
|
|
1,934,722
|
|
|
|
14.7
|
%
|
|
|
2,197,346
|
|
|
|
18.2
|
%
|
|
|
(12.0
|
%)
|
General and administrative expenses
|
|
|
3,597,993
|
|
|
|
27.3
|
%
|
|
|
1,077,748
|
|
|
|
8.9
|
%
|
|
|
233.8
|
%
|
Research and development expenses
|
|
|
694,944
|
|
|
|
5.3
|
%
|
|
|
796,001
|
|
|
|
6.6
|
%
|
|
|
(12.7
|
%)
|
Total operating expenses
|
|
$
|
8,016,200
|
|
|
|
60.8
|
%
|
|
$
|
5,957,776
|
|
|
|
49.3
|
%
|
|
|
34.6
|
%
|
Total operating expense increased by approximately $2.1 million or 34.5% for the three months ended March 31, 2014, as compared to the same period last year. The increase is attributable to the increase in general and administrative expenses. During the period ended March 31, 2014, the Company made provision for doubtful accounts of $2.3 million.
Advertising expenses accounted for 13.6% and 15.6% of total net sales for the three months ended March 31, 2014 and 2013, respectively. As market of our products and sales channels is becoming more established, and our brands are becoming more well-known to households, we have been reducing the amount spent on advertising campaigns.
Selling expenses consist mostly of sales salaries, commission and other selling expenses. Overall decrease was approximately $0.3 million or 12.0%. As market of our products and sales channels is becoming more established, and our brands are becoming more well-known to households, we have also been reducing the amount spent on selling activities.
General and administrative expenses consist of salaries and wages, amortization and depreciation, stock based compensation and other general and administrative expenses. During the three months ended March 31, 2014 and 2013, general and administrative expenses increased by $2.5 million or 233.8% mainly due to a provision for doubtful accounts of $2.3 million as a result of uncertainties on the collectability of accounts receivable.
We make periodical assessments as to the progress of our research and development projects, and charge to expense as appropriate, as these projects reach different stages or project milestones. We incurred approximately $0.7 million and $0.8 million in research and development expenses for the three months ended March 31, 2014 and 2013, respectively.
Provision for Income Taxes
For the three months ended March 31, 2014 and 2013, our income tax expense was approximately $0.3 million and $0.5 million, respectively. The lower income tax was the result of lower income before income taxes which was negatively affected by the higher general and administrative expenses. We are subject to the uniform corporate income tax rate of 25% in China. The calculation of effective tax rate includes the operating results of all our subsidiaries and the U.S. parent company.
Liquidity and Capital Resources
As of March 31, 2014, we had cash and cash equivalents of approximately $7.1 million and net working capital of approximately $35.8 million. On March 10, 2014, we and certain institutional investors entered into a securities purchase agreement in connection with an offering pursuant to which the Company agreed to sell, and the investors agreed to purchase 1,650,000 shares of the Company’s common stock and warrants to purchase up to 660,000 shares of the Company’s common stock, for aggregate gross proceeds, before deducting fees to the placement agents and other estimated offering expenses payable by the Company, of approximately $4.1 million. The net proceeds from the offering will be used for working capital and other general corporate purposes. At March 31, 2014, cash and cash equivalents were mainly denominated in RMB and were placed with banks in the PRC. These cash and cash equivalents may not be freely convertible into foreign currencies and the remittance of these funds out of the PRC may be subjected to exchange control restrictions imposed by the PRC government.
On an on-going basis, we take steps to identify and plan our needs for liquidity and capital resources, to fund our operations and day to day business operations. Our future capital expenditures will include, among others, expanding product lines, research and development capabilities, and making acquisitions as deemed appropriate.
Based on our current plans for the next 12 months, we anticipate that the sales of the Company’s pharmaceutical products will be the primary organic source of funds for future operating activities in 2014. However, to fund continued expansion of our operation and extend our reach to broader markets, and to acquire additional entities, as we may deem appropriate, we may rely on bank borrowing, if available, as well as capital raises. There is no assurance that we will find such funding on acceptable terms, if at all.
Net cash provided by operating activities for the three months ended March 31, 2014 was approximately $3.1 million. This was primarily due to our net income of approximately $0.3 million, adjusted by non-cash related expenses including provision for doubtful accounts of approximately $2.3 million, depreciation and amortization of approximately $0.7 million, research and development expenses of $0.7 million, stock-based compensation of approximately $0.1 million, and non-cash decrease in deferred tax assets of approximately $0.1 million and accrued interest income of approximately $0.3 million, then decreased by unfavorable changes in working capital of $0.9 million. The unfavorable changes in working capital mainly resulted from an increase in accounts receivable and loan receivable, partly offset by a decreased in deposit and other receivable, an increased in accounts payable and accrued expenses and an increase in income tax payable.
Net cash provided by operating activities for the three months ended March 31, 2013 was approximately $6.2 million. This was primarily due to our net income of approximately $0.6 million, adjusted by a non-cash increase in deferred tax assets of approximately $0.4 million, and non-cash related expenses including depreciation and amortization of approximately $0.5 million and research and development expenses of approximately $0.8 million,
offset by non-cash accrued interest income of $0.4 million
and then increased by a net increase in working capital items of approximately $4.0 million. The net increase in working capital items was mainly due to decrease in accounts receivable and increase in accounts payable and accrued expenses, offset by increase in inventories, prepaid expenses and decrease in value added taxes payable.
Net cash provided by financing activities for the three months ended March 31, 2014 was approximately $4.0 million, consisting net proceeds of $3.9 million from a public offering with warrants and $0.1 million advance from a related party.
Net cash used in financing activities for the three months ended March 31, 2013 was approximately $1.6 million, consisting repayment of an advance from a related party.
Critical Accounting Policies
We believe the following critical accounting policies, among others, affect management’s more significant judgments and estimates used in the preparation of the financial statements:
Allowance for Doubtful Accounts
We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. The allowance for doubtful accounts is based on specific identification of customer accounts and management’s best estimate of the likelihood of potential loss, taking into account such factors as the financial condition and payment history of major customers. Management evaluates the collectability of the receivables at least quarterly. If the financial condition of a customer was to deteriorate further, resulting in an impairment of their ability to make payments, additional allowances may be required. Such differences could be material and could significantly impact cash flows from operating activities.
The following are steps the Company takes in collecting accounts receivable:
Step 1: After the payment term has been exceeded, the Company stops taking orders from the delinquent customer and allows the responsible sales person three to six months to collect the accounts receivable. Most of the accounts receivable will be collected in this step because the sales person’s compensation is tied to sales receipts. The Company’s normal sales term is 90 days credit period.
Step 2: If the sales person’s collection efforts are not successful, the Company hires a collection agent and allows the agent another three to six months to collect the accounts receivable.
Step 3: If the collection agent’s efforts are not successful, the Company will commence legal action to collect the accounts receivable.
Our policies for writing off the accounts receivable are as follows:
|
1.
|
If after taking legal action, it appears that an accounts receivable is not likely to become collectible, such accounts receivable will be written off if it is more than two years old.
|
|
2.
|
If during the collection period, the customer provides bankruptcy or other insolvency documentation, the corresponding accounts receivable will be written off.
|
|
3.
|
If we are no longer able to locate a particular customer in order for us to take any collection or legal actions, the accounts receivable for such customer will be written off if it is more than two years old.
|
Inventory
We write down our inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand, future pricing and market conditions. If actual future demands, future pricing or market conditions are less favorable than those projected by management, additional inventory write-downs may be required and the differences could be material. Such differences might significantly impact cash flows from operating activities.
Property and Equipment
Property and equipment are stated at historical cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Judgment is required to determine the estimated useful lives of assets, especially for computer equipment, including determining how long existing equipment can function and when new technologies will be introduced at cost-effective price points to replace existing equipment. Changes in these estimates and assumptions could materially impact the financial position and results of operations.
Stock-Based Compensation
Our stock-based compensation expense is estimated at the grant date based on the award’s fair value as calculated by the Black-Scholes-Merton (BSM) option-pricing model and is recognized as expense over the requisite service period. The BSM model requires various highly judgmental assumptions including expected volatility and option life. Changes in these assumptions could materially impact the financial position and results of operations.
Valuation of Intangibles
From time to time, we acquire intangible assets that are beneficial to our product development processes. Management periodically evaluates the carrying value of intangibles, including the related amortization periods. In evaluating acquired intangible assets, management determines whether there has been impairment by comparing the anticipated undiscounted cash flows from the operation and eventual disposition of the product line with its carrying value. If the undiscounted cash flows are less than the carrying value, the amount of the impairment, if any, will be determined by comparing the carrying value of each intangible asset with its fair value. Fair value is generally based on either a discounted cash flows analysis or market analysis. Future operating income is based on various assumptions, including regulatory approvals, patents being granted, and the type and nature of competing products. If regulatory approvals or patents are not obtained or are substantially delayed, or other competing technologies are developed and obtain general market acceptance or market conditions otherwise change, our intangibles may have a substantially reduced value, which could be material.
Research and Development
The remuneration of the Company’s research and development staff, materials used in internal research and development activities, and payments made to third parties in connection with collaborative research and development arrangements, are all expensed as incurred. Where the Company makes a payment to a third party to acquire the right to use a product formula which has received regulatory approval, that payment is accounted for as the acquisition of a license or patent and is capitalized as an intangible asset and amortized over the shorter of the remaining license period or patent life (See above “Intangible Assets”).
Income Taxes
We use the asset and liability method of accounting for income taxes. Under this method, income tax expense is recognized for the amount of taxes payable or refundable for the current year. In addition, deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities and for operating losses and tax credit carry-forwards. Management must make assumptions, judgments and estimates to determine the current provision for income taxes and the deferred tax assets and liabilities and any valuation allowance to be recorded against a deferred tax asset. Management’s judgments, assumptions and estimates relative to the current provision for income tax take into account current tax laws, management’s interpretation of current tax laws and possible outcomes of current and future audits conducted by foreign and domestic tax authorities. Changes in tax law or management’s interpretation of tax laws and the resolution of current and future tax audits could significantly impact the amounts provided for income taxes in the financial statements. Management’s assumptions, judgments and estimates relative to the value of a deferred tax asset take into account predictions of the amount and category of future taxable income, such as income from operations. Actual operating results and the underlying amount and category of income in future years could render management’s current assumptions, judgments and estimates of recoverable net deferred taxes inaccurate. Any of the assumptions, judgments and estimates mentioned above could cause our actual income tax obligations to differ from the estimates, thus materially impact the financial position and results of operations.
Foreign Currency
Our functional currency is the U.S. dollar, and our subsidiary and our VIE in China use their respective local currencies as their functional currencies, i.e. the RMB. An entity’s functional currency is the currency of the primary economic environment in which the entity operates. Management must use judgment in determining an entity’s functional currency, assessing economic factors including cash flow, sales price, sales market, expense, financing and inter-company transactions and arrangements. The impact from exchange rate changes related to transactions denominated in currencies other than the functional currency is recorded as a gain and loss in the statements of operations, while the impact from exchange rate changes related to translating a foreign entity’s financial statements from the functional currency to its reporting currency, the U.S. dollar, is disclosed and accumulated in a separate component under the equity section of the balance sheets. Different judgments or assumptions resulting in a change of functional currency may materially impact our financial position and results of operations.
Business Combinations
Business combinations are accounted for under the acquisition method of accounting in accordance with ASC 805, Business Combinations. Under the acquisition method the acquiring entity in a business combination recognizes 100 percent of the acquired assets and assumed liabilities, regardless of the percentage owned, at their estimated fair values as of the date of acquisition. Any excess of the purchase price over the fair value of net assets and other identifiable intangible assets acquired is recorded as goodwill. To the extent the fair value of net assets acquired, including other identifiable assets, exceed the purchase price, a bargain purchase gain is recognized. Assets acquired and liabilities assumed from contingencies must also be recognized at fair value, if the fair value can be determined during the measurement period. Results of operations of an acquired business are included in the statement of earnings from the date of acquisition. Acquisition-related costs, including conversion and restructuring charges, are expensed as incurred. We adopted this guidance as of January 1, 2010 and applied it to the Meipude and Shaanxi Weinan acquisitions.
Contractual Obligations
The following table sets forth our contractual obligations as of March 31, 2014:
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Payments due by period ($ million)
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Total
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Within 1 year
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1-3 years
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3-5 years
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>5 years
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Research and development contracts
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Purchase of a health product manufacturer
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Total contractual obligations
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Inflation
Management believes that inflation has not had a material effect on our results of operations.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements, as defined in Regulation S-K Section 303(a)(4).