WuXi PharmaTech (Cayman) Management Discusses Q1 2013 Results - Earnings Call Transcript

May.14.13 | About: WuXi PharmaTech (WX)

WuXi PharmaTech (Cayman) (NYSE:WX)

Q1 2013 Earnings Call

May 14, 2013 8:00 am ET

Executives

Ronald Aldridge - Director of Investor Relations

Ge Li - Co-Founder, Chairman, Chief Executive Officer, Member of Compensation Committee and Member of Strategy & Finance Committee

Edward Hu - Chief Financial Officer and Chief Operating Officer

Analysts

Bryan Kipp

Ingrid Yin - Oppenheimer & Co. Inc., Research Division

Timothy C. Evans - Wells Fargo Securities, LLC, Research Division

Bin Li - Morgan Stanley, Research Division

John Kreger - William Blair & Company L.L.C., Research Division

David H. Windley - Jefferies & Company, Inc., Research Division

Wei Du - Goldman Sachs Group Inc., Research Division

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

Jack Hu - Deutsche Bank AG, Research Division

Paul R. Knight - Credit Agricole Securities (NYSE:USA) Inc., Research Division

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the WuXi PharmaTech First Quarter 2013 Earnings Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today, Tuesday, the 14th of May 2013. I would now like to hand the conference over to your first speaker today, Mr. Ron Aldridge. Thank you, sir. Please go ahead.

Ronald Aldridge

Thank you, Edwin, and good morning or good evening to everyone participating in our first quarter 2013 earnings conference call. Hosting this call today is Dr. Ge Li, Chairman and Chief Executive Officer. Joining him is Edward Hu, our Chief Operating Officer and Chief Financial Officer.

During today's presentation and question-and-answer session, we will make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not historical facts but instead are predictions about future events. Although we believe that our predictions are reasonable, future events are inherently uncertain, and our forward-looking statements may turn out to be incorrect. Information on many of the risks relating to our forward-looking statements can be found in our filings with the SEC. Our forward-looking statements speak only as of the date that they are made, and we assume no obligation to update any forward-looking statements, except as required by law.

Also in discussing our financials, we will use certain not non-GAAP measures, which exclude share-based compensation expenses and amortization and the deferred tax impact of acquired intangible assets. We believe these non-GAAP operating measures are useful for understanding and assessing underlying business performance and operating trends. Reconciliations of our GAAP to non-GAAP first quarter 2013 results of operations are found in today's earnings release, which has been posted to our website and in the appendix to this presentation. [Operator Instructions]

And now it's my pleasure to introduce Dr. Ge Li to review our first quarter 2013 performance and to discuss our second quarter and full year 2013 business outlook. Dr. Li?

Ge Li

Thank you, Ron, and good evening or good morning, everyone. Slide 3 please. I'm pleased to report that WuXi had a good first quarter. We achieved double-digit, broad-based revenue growth led by China-based Laboratory Service and research manufacturing.

In commercial manufacturing, we're in the process of transitioning from dependence on single products by building a pipeline of products to accelerate growth in 2014 and beyond. In addition to achieving strong revenue growth, we are effectively controlling our costs with strategies such as moving chemistry to our Wuhan campus and our Lean Sigma program. One of the issues we have been facing at WuXi over the past few years is the declining margins. This year, through effective cost control and operating efficiency improvement, we expect to maintain flat year-over-year gross margins and operating margins in 2013. As a result of our expectation for continued double-digit revenue growth and the relatively stable margins, we are reconfirming our full year 2013 revenue and EPS guidance.

Slide 4, please. WuXi generated solid revenue and earning growth. We continue to invest in new capabilities and capacity, particularly in biologics, to sustain the future growth. We are achieving strong and growing free cash flow, and we are returning much of it to shareholders through share buyback programs. In order to leverage our partners' knowledge and experience, we are entering into strategic partnerships to create a more long-term value with our capabilities, such as our JVs with MedImmune to develop a novel biologics to treat rheumatoid arthritis in China and with PRA for clinical trial service in China.

Slide 5, please. We exceeded our revenue guidance for the quarter mainly due to a better-than-expected performance by Manufacturing Services. We're happy to exceed our EPS guidance for the quarter as a result of better-than-expected revenues, improvement in operating efficiency and cost savings and the foreign exchange gains.

For now, Ed will discuss our first quarter results in more detail. Ed, please.

Edward Hu

Thank you, Dr. Li. Turn to Slide 6, please. So here in the slide, you can see our revenue performance for the quarter. We achieved 11.7% total year-over-year revenue growth. China-based Laboratory Services grew 15.5% and will continue to grow integrated drug discovery and development services. Manufacturing Services revenue achieved 9.6% growth driven by strong research manufacturing. U.S.-based Lab Services grew 3.8%.

Turn to Slide 7, please. This slide shows quarterly trend in revenue by business segment. Overall, the company achieved a record quarterly revenue and double-digits year-over-year revenue growth in the first quarter. China-based Laboratory Services had a strong year-over-year growth as has occurred over the past several years. Our first quarter revenue was slightly down compared to previous fourth quarter. This is normal trend as many of our pharmaceutical customers have just recently completed their full year budget and have not yet made some of their specific spending decisions early in the year.

U.S.-based Laboratory Services achieved a steady but a modest growth. The margin in this business competes is more mature than our China-based business. We expect relatively light first half compared to the same period in 2012 due to one large then [ph] recurring project in the first half of 2012. We expect stronger revenue growth from this business in the second half of 2013.

Manufacturing Services benefited from strong sequential growth, particularly in research and manufacturing and growth from manufacturing of new commercial products. We now manufacture advanced intermediate for 6 commercial products for our customers.

Slide 6 -- Slide 8, please. Our double-digit revenue growth and effective cost control results in comparable double-digits GAAP gross profit and operating income growth and stable year-over-year growth and operating margins. The higher effective tax rate was caused by the timing of tax benefits in both 2012 and 2013. The 2012 effective tax rate was reduced by the reversal of our FIN 48 tax provision for uncertain tax positions related to the earlier AppTec acquisition. This is a onetime event in the fourth quarter of 2012. In 2013, we expect to receive a tax benefit in Q2 and Q3 from additional R&D expense deductions and a separate tax refund for one of our Chinese subsidiaries. As a result, for the full year 2013, we expect an effective tax rate of about 18.5%.

Our EPS grew faster than net income growth due to our share buyback programs last year. Because we announced our new share buyback programs later in the first quarter, we made very little share repurchase during the first quarter.

Turn to Slide 9, please. This shows the quarterly progression of our GAAP profit and margins. Gross profit and operating income in the first quarter was solid and were comparable to the first quarter of 2012. Aside from onetime benefits in the fourth quarter of 2012 from a VAT tax refund and government subsidy. First quarter 2013 gross and operating margins were generally in line with those of prior quarters. We expect this margin trend to continue with flat year-over-year GAAP gross margin and operating margin in 2013.

Turn to Slide 10, please. Our non-GAAP P&L performance was similar to our GAAP performance with double-digit year-over-year revenue growth, gross profit and operating income growth, stable gross margin and operating margin, a higher effective tax, our lower share count from share repurchases and good EPS growth.

Turn to Slide 11, please. Our sequential non-GAAP performance was also similar to our GAAP performance with good gross profit and operating income growth and margins generally in line with prior quarters.

Slide 12. This slide shows the factors impact our year-over-year growth in first quarter 2013 diluted EPS. Business growth added about $0.06, labor inflation, investment reduced EPS by $0.02 each and RMB appreciation against the U.S. dollar by $0.01. Last year, share purchases increased our EPS by about $0.01. We expect similar effects from these factors during the remaining quarters of 2013.

Turn to Slide 13, please. Our business generates good cash flow from operations. We have $265.7 million cash and $67.9 million bank loans by the end of first quarter. We had operating cash flow of $39.4 million and capital expenditures of $6 million in the quarter. Our cap expenditures will increase throughout the remaining of the year, and we still expect to invest about $60 million in capital expenditures in 2013.

Turn to Slide 14, please. With this growth in our net cash and free cash flow, we have used and will continue to use a sizable portion of that cash to buy back shares to return value to our shareholders. Last year, our share repurchase program exceeded our free cash flow, and we have now a new share buyback programs announced in March to purchase $100 million of our shares over the 18- to 24-month period. So we are deploying our cash effectively both to build our business and accelerate our EPS growth through share purchases.

Turn to Slide 15, please. Because of a good start to the year, we are reconfirming all of our previous 2013 financial guidance. In addition, we have new guidance that we expect flat year-over-year gross margin and operating margin.

Turn to slide 16, please. For the second quarter, we expect total revenues of $138 million to $140 million, GAAP diluted EPS of $0.34 to $0.35 and non-GAAP diluted EPS of $0.39 to $0.40. Both our Manufacturing Services and U.S. Lab Services business have difficult comps in the second quarter, as both of these business had their record quarters in the second quarter of 2012. Now we expect quarter revenue growth to accelerate in the second half of 2013 across several business units.

Turn to Slide 17, please. Here, you see the distribution of revenues across 5 business groups. All 5 business units are growing year-over-year. The fastest-growing area is our development services, which increased their share of total revenue by more than 4 percentage points in the past year.

And now Dr. Li will discuss the performance and prospects of each of our businesses. Dr. Li?

Ge Li

Thank you, Ed. Let's turn to Slide 18, please. I will begin by discussing our synthetic chemistry. This business, we started 12 years ago when we founded WuXi, used to be 100% of our company revenue. Now it's only about 17%. The service is becoming somewhat commoditized. We are facing competition primarily from Chinese and Indian CROs with a moderate pricing pressure. However, synthetic chemistry is one of WuXi's core competence. We have accumulated a lot of knowledge and experience and knowhows during the past years. Our skill and experience will allow us to achieve single-digit revenue growth despite price declines. We have implemented Lean Sigma programs in this business that have shown significant operating efficiency improvement and cost savings. And we also have moved some of our synthetic chemistry business to our Wuhan campus, which has relatively lower operating cost and offers our customers more price choice.

Slide 19, please. Discovery service include medicinal chemistry, biology, DMPK, analytical and the bio analytical services. These serviced are growing rapidly so that today, they represent more than 1/4 of our total revenues. We expect mid-teen revenue growth and a stable profitability here in 2013 driven by volume growth and the improving productivity. While most of our clients in this business today are multinationals, we begin to see new opportunities in serving our Chinese customers. One of our fastest-growing functions is biology where we expect to achieve substantial revenue and profit growth this year, as we build a leading technology platform in oncology, infectious disease, CNS and other areas in China.

Slide 20, please. In 2008 to 2009, we began to invest to enter the toxicology services, and now we are the largest toxicology CRO in China with the highest quality services. While there has been a severe slump in the worldwide toxicology business for about 5 years now, our toxicology business is growing well. We more than doubled our annual cost of revenues in 2012 and are targeting a greater than 40% increase in cost of revenues in 2013 this year.

We have developed a very diverse client list now, and nearly 1/3 of our revenues are coming from Chinese customers who look for high-quality studies for both domestic and international IND filings In the first quarter of -- in the fourth quarter of 2012, this business broke even, and today, it is slightly profitable. The facility is currently running at about 60% of our capacity. We expect to reach capacity utilization of about 80% to 85% by year end when we will consider building out the remaining shell space of the facility next year.

Slide 21, please. We expect broad-based growth throughout our company over the next several years, but one of the areas we feel most excited about is biologics. We feel we have several competitive advantage in this business. First is eliminate the competition. WuXi is the partner of choice for biologics service in China, as fewer CROs or pharmaceutical companies have biologic facilities in China which meet international standards.

Second is regulatory. Chinese regulations require that biologics used in clinical trials either be approved in other markets, which takes several years of clinical testing and regulatory review, or be manufactured in China. We're in a unique position to help our multi-national customers to parallel developed biologics products in China and globally, as our facility will produce clinical trial material that meet Chinese and the international GMP standards. Our product portfolio is mostly novel molecules with some biosimilars from both multinational and the Chinese customers.

Third is our people. We have built a highly capable team of about 350 staff members, including about 30 returnees with industry experience in the U.S. and the European Union.

Fourth is our facility. We have invest about USD 30 million in capital expenditures in biologics throughout the year -- through year end of 2012, including construction of discovery and the development laboratories in Shanghai and a cGMP drug substance manufacturing facility in WuXi city. The drug substance facility was designed to meet international GMP standards with state-of-the-art disposable technology, and it is the first of its kind in China. We plan to invest another $18 million more capital expenditures in 2013, including installation of 2,000 liters bioreactors that will enable us to produce Phase III clinical trial materials and completing the -- and also completing the build-out of a fill/finish facility.

We continue to ramp up revenue gradually with an increasing number of projects. Our backlog has grown to about $40 million, and we have about 50 customers now.

Slide 22, please. Our business has been a classic CRO model, earning revenues on FTE and fee-for-service basis. We will selectively enter into strategic partnerships with different forms of compensation, particularly to help our partners to commercialize their products in China. Here are some examples of what we're doing. Some of our medicinal chemistry product -- projects are now structured to charge lower FTE rates while receiving bonus payment on compound year under preclinical studies of Phase I clinical trials. Our joint venture with MedImmune to develop and commercialize MEDI5117 for rheumatoid arthritis in China give us both an ownership interest in the product and then revenue for work we perform at the service company for the joint venture.

Our joint venture with PRA to offer a broad platform of Phase I to IV clinical trial services in China, Hong Kong and Macau give us access to the expertise and the customers of a global clinical CRO where we provide an established organization expertise in Chinese regulatory affairs and the drug discovery and development capabilities.

Some of our biologics contracts also include milestone payments and/or single-digit royalties. Some other programs on this slide will earn near-term revenue, while others will build a revenue stream later in this decade and beyond. They're all a reflection of our confidence in our ability to work with the partners to create valuable medicines.

Slide 23. The first half of revenue growth in our U.S. Lab Service business will be slower due to lower demand in biologic testing and also different comparisons caused by 17% year-over-year revenue growth in the first half of 2012. Performance in the second half of 2013 will be stronger. We continue to see the improvement of profitability of this business, and we expect broad-based, high single-digit revenue growth, with stable margins in U.S. Lab Service in the long term.

Slide 24, please. Manufacturing Service revenue will continue to be variable quarter-to-quarter but with a strong underlying growing trend. Overall, small molecule manufacturing revenue is expected to grow at a mid-teen rate in 2013, driven by strong growth in research manufacturing. We believe that commercial manufacturing revenue will be relatively flat year-over-year in 2013. Two years ago, we had only 1 large commercial products to manufacture. Today, we are manufacturing advanced intermediates for 6 commercial products. And behind the 6, we also supply 7 other products currently in Phase III, including some with large commercial revenue potential for WuXi.

Slide 25, please. So to include -- to conclude, we expect our drivers to fulfill revenue growth to be China-based Laboratory Service driven by our ability to deliver high-quality services and drug candidates for our customers and increasing utilization of our integrated drug development services. Manufacturing Service will continue to grow driven by research and manufacturing and beginning in 2014, a growing commercial manufacturing pipeline.

Biologics drug discovery, development and manufacturing service will grow rapidly, and our clinical development platform with the WuXi-PRA joint venture will help our partners to bring their innovative medicines to China.

Thank you for your attention, and now we would be happy to answer your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Paul Knight from CLSA.

Bryan Kipp

This is actually Bryan Kipp on behalf of Paul. Just to start it off, a question on the operating margin. Obviously, you guys, there's year-over-year 40 bp decline. You expect full year to be around that 21.2% that you saw last year. I just kind of want to hear what you're thinking. The second quarter, you see some acceleration. You still see some headwinds. Does that mean a lot of the incremental expansion is going to come, in your mind, from the second half? Or do you think it's going to ramp up Q-o-Q?

Edward Hu

I think the operating margin for the full year, we said, is going to be relatively flat compared to last year, but the quarter-over-quarter fluctuation probably is still going to happen. One particular trend is in, typically in third quarter, we hire a lot of new graduate students from college recruiting, so that will have seasonal impact. But other than that, we expect the full year operating margin will be comparable to last year.

Bryan Kipp

Okay. And just a follow-up on the U.S.-based Laboratory Services, you said it in here, the high single-digit revenue growth expectation for the long term. Obviously, there were some headwinds in the first quarter, a 3.8% growth. Do you expect that high single digit in this year? Do you think that the first quarter drag could bring those down a little bit because of those pull-throughs in the -- those onetime items in 2012?

Edward Hu

Yes. So the U.S. Lab Service business had difficult comp compared to last year. The last year, first half is actually very strong growth with a onetime project. So we expect the second half will grow into high single-digit range, so the growth will be higher in second half. For the full year, it will still be a high single-digit growth.

Operator

The next question comes from the line of Ingrid Yin from Oppenheimer.

Ingrid Yin - Oppenheimer & Co. Inc., Research Division

So you guided 2013 margin will be comparable with last year. This is better margin guidance than you guided before. Can you explain what made you change the guidance? And what is your view on margins for WuXi's business in the long term, I mean, more than just this year, looking out a few years, and if the operating margin is stable? And what items between operating income and net income made you give top line growth of 13% to 15%, but EPS growth of 6% to 9%, I understand there will be less shares and higher tax. Are you still very conservative on the EPS growth rate guidance?

Edward Hu

So Ingrid, let me try to answer your question. The confidence we have in terms of operating margin year-over-year relatively flat is as we really now see the fruits of our operating efficiency improvement programs, including Lean Sigma across the company, that's certainly one of the major factors. The second is also our newer business that we have been investing, have an impact, started turning into a breakeven or start making profit like toxicology. So that helps kind of maintain our margins. In the longer term, obviously, we're working very hard to try to maintain or even improve margins. Regarding the top line growth of 13% to 15% but bottom line EPS growth, 6% to 9%, I think that some of those because we have investment losses from the joint venture with MedImmune and probably, you'll see also we're going to incur losses from the joint venture with PRA as well, building [ph] up with a capability, and also, there's uncertain foreign exchange gain or losses in the remaining quarters, which we cannot predict.

Ingrid Yin - Oppenheimer & Co. Inc., Research Division

Okay. Great. I just want to follow up on the tox business. You mentioned that, overall, globally, this business is not doing well, but you're obviously gaining shares by growing the segment by 40%. Can you explain how you gain market share from competitors who might have more experience? And how much cost saving can you provide to customers?

Edward Hu

I think our cost business is actually quite unique because we have upstream, which is integrated with our manufacturing business. Our research and manufacturing business, they're actually also generating a compound that we do testing in our own facility. And so this is a very unique in our business. The other is actually, we see an increasing demand from high-quality domestic pharmaceutical companies, they come to WuXi to do high-quality GLP tox studies, they intend to file IND both in the U.S. and in China. So that's another trend. The other thing is also biologics grow in China very rapidly, and we are going to capture the toxicology market for the growing biologics markets.

Ge Li

Also, Ingrid, there are many international capable standard facilities in China. So -- and overcapacity globally essentially has no relevance to China.

Operator

Your next question comes from the line of Tim Evans from Wells Fargo.

Timothy C. Evans - Wells Fargo Securities, LLC, Research Division

Ed, could you tell us what is embedded in 2013 guidance for other income?

Edward Hu

The other income is mainly government subsidies and gain/loss from foreign exchange forward contracts. So I think our guidance for this category is probably comparable to last year overall. We expect and continue to receive some government subsidies, and then given RMB appreciation, we also still continue to expect we'll probably going to see some foreign exchange gains from forward contracts.

Timothy C. Evans - Wells Fargo Securities, LLC, Research Division

And if you had to quantify the amount of revenue that you get that has some sort of this -- I guess you would call it risk-sharing element to it where you're getting a lower rate in return for bonuses. How much -- how big is that component of your revenue right now and how big do you see it being in the future?

Ge Li

Tim, it's still small. It's still small, and I think as we indicated in the script, we'll selectively to enter a strategic partnership, selectively under deals, to do risk sharing.

Operator

The next question comes from the line of Bin Li from Morgan Stanley.

Bin Li - Morgan Stanley, Research Division

And my first question is on the PRA joint venture, and obviously, this is one of the new initiatives that you're doing. And I wonder whether, Dr. Li or Ed, whether you can spend a little more time to talk about what's your expansion plan as you mentioned in your prepared remarks? And what their action -- and where are we at in terms of the expansion of this joint venture? And how does that work with our internal clinical trial capability, which we have obtained through acquisition previously?

Ge Li

Bin, we're still at the early stage of this joint venture, established joint venture and setting up the foundation to have good growth in future because as both WuXi and PRA believe, China will become a future development hub for new medicines for the global. So -- and like -- it's already in the press release. We actually reported our -- WuXi as a clinical unit, which we acquired a couple of years ago into this WuXi-PRA JV.

Bin Li - Morgan Stanley, Research Division

So I have a follow-up question on the stock purchase program that you just implemented in March. I mean, your stock is hitting historical high at least for the last 3, 4 years. How should we think about the pace of stock purchase as the new program just started?

Ge Li

I think, as we indicated, we're going to continue to return cash from our operating to shareholders. We're going to continue to buy, but of course, it depends on the stock price.

Operator

The next question comes from the line of John Kreger from William Blair.

John Kreger - William Blair & Company L.L.C., Research Division

A couple of questions on margin. I think you guys called out 4 sources of headwind that have been an issue, I know, over the last year. So can you just give us a sense about whether or not they're getting tougher or a bit easier, such as the wage pressures and the pricing pressures within synthetic chemistry?

Ge Li

Well, actually, we -- I think it's comparable to last year, I don't think that's getting tougher or getting worse. But certainly, we hope, through our, like operating improvement efficiency programs, it will be easier for us down the road.

John Kreger - William Blair & Company L.L.C., Research Division

And a follow-up to that, back on, I think that was Slide 17 where you showed the revenue pie charts. Looks like you're getting substantial growth in what you're calling development. What mix impact, if any, do you think that'll have on your margins as that business continues to get -- become bigger relative to the more traditional chemistry work?

Ge Li

Well, it definitely improve margin.

Edward Hu

Yes. The development service area still some of the business [ph] led by biologics currently still are losing money, and the genomics probably also losing money at the moment. As we scale those business up, it's going to contribute to the margin expansion.

John Kreger - William Blair & Company L.L.C., Research Division

And then one quick follow-up, the clinical JV with PRA, when do you expect that to break even?

Ge Li

Well, it's too early to tell now, John. It's a tough question to answer. But we feel this is certainly a future growth area, and we're going to invest very aggressively in that area. And hopefully, like -- and the other business we invested in previous years will pay back pretty quickly.

Operator

Your next question comes from the line of Dave Windley from Jefferies.

David H. Windley - Jefferies & Company, Inc., Research Division

So John kind of asked my question, I want to ask it in a slightly different way. So you've had margin pressures for the variety of reasons that you point to for some period of time, and you've been driving efficiencies to offset those margin pressures, and I guess I just wanted to understand if with Lean Sigma, if you're seeing those efficiencies accelerate or is your ability to maintain margin year-over-year, kind of keep it flat, is that mostly a function of the more muted move in the RMB?

Ge Li

Well, actually, David, I think the efficiency way actually is accelerating, so as we [indiscernible] I think [indiscernible] I think I showed you at -- you asked whether it's accelerating amount, right, because -- in terms of efficiency [ph] in gain. I think, it is accelerating as we gain more experience. Yes. And, David, another thing, as I mentioned, is also our development services actually are growing much faster [indiscernible] , and those business will start contributing to the profit. That will help our margins.

David H. Windley - Jefferies & Company, Inc., Research Division

Right. Okay. Just to clarify, on Slide 19, where you talk about an additional chemistry and other drug discovery services, and you talk about stable profitability, I just want to make sure that by that you meant profit margin. Is that right? I mean, you say mid-teens revenue growth and stable profitability. Is that -- are we to interpret that as stable profit dollars year-over-year or stable profit margin?

Edward Hu

No, no, profit margin.

Ge Li

Margin, yes.

David H. Windley - Jefferies & Company, Inc., Research Division

And then finally, you talked about in tox that 30% of your revenue is coming from domestic Chinese clients. We've heard in a variety or I've heard, at least, in a variety of venues that there is some upsurge in domestic activity from Chinese clients for numerous business or at least, more than just toxicology, and I wondered if you could comment on how much demand you're seeing from Chinese clients for other services or perhaps tell us what your percentage of revenue from Chinese clients is in total.

Ge Li

Well, actually, the growth is pretty significant, but it's coming from a small base. So I will say right now still in the range of 5% to 10% from domestic companies. The majority of our business are still from multinationals.

David H. Windley - Jefferies & Company, Inc., Research Division

Okay. If I could sneak in one more, so you say you might get your point of building out Suzhou. Can you talk about what that would do to your CapEx requirements in 2014 if you decided to build out Suzhou? Sorry [indiscernible] ...

Edward Hu

It's actually -- we actually -- the facility is pretty large. We have a shell space already exist. We just need to build out additional rooms, install equipment. So the incremental CapEx to getting the next 46-room build-out is probably in the neighborhood of $6 million or so in 2014.

Operator

The next question comes from the line of Wei Du from Goldman Sachs.

Wei Du - Goldman Sachs Group Inc., Research Division

I guess, I just want to clarify, when you talk about the risk-sharing business, I know it's kind of small. I guess, one thing I want to know given the change in business mix, if the margin from that segment is higher, and also I want to know about the payment. I guess, you are expanding your customer base, I guess, especially you're doing this risk sharing. What will be the, I guess, the payment terms? And I think most importantly, does this have any conflict with your own original strategy? Because I thought WuXi has always been positioned itself by providing service to other clients and now you have the risk sharing, and obviously, there's going to be some proprietary issue involved. So I guess, how did you actually explain to your existing clients? Would that be an issue?

Ge Li

Well, first, there's no issue with our clients because we don't compromise IP's protection and the service quality. And a way you just look at this risk sharing as a different way to collect payments based on our capabilities. So you asked about margin and for short term, near term, actually, we sacrifice margin, but for mid -- long term, we believe we will gain margin. So again, that reflects our confidence on our service because we believe it is more than risk sharing. We believe actually it's more reward sharing.

Wei Du - Goldman Sachs Group Inc., Research Division

So obviously because the margin's lower, so you basically share the payment over there. But about the payment term, do you worry about any defaults since this is risk sharing? Maybe this question is a bit naïve. I guess do you worry about the other party [indiscernible] ...

Ge Li

No, naïve questions. As we mentioned earlier, we selectively enter into this type of agreement. I don't see any default of payment because -- as we select our partners pretty carefully.

Operator

Your next question comes from the line of Tycho Peterson from JPMorgan.

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

I want to maybe just follow up in the last question. Have you seen any kind of change in the -- just in general from payment timelines from some of your China-based customers? We've heard from some other companies that the timelines of getting paid are being extended. Can you talk to that dynamic?

Edward Hu

Yes. Tycho, actually our payment term to Chinese clients is not materially different from international clients. So we typically have a upfront down payment, and then as service progresses, we collect payment. So we haven't seen any significant difference between the Chinese clients and international clients.

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

Okay. And then on the topic of toxicology, you've talked about trying to get to 80% to 85% utilization and then potentially opening new capacity. Can you maybe just touch on what you think the ideal utilization level is for that business? I mean, I guess, in general, we think about north of 80%, you can start to extract price, but how do we think about the potential for you to open new capacity and what that can do, utilization maybe a year from now?

Ge Li

Yes. Obviously, everybody would like to operate at around 80%, 85% capacity.

Edward Hu

100%. If you can schedule everything right.

But we have probably not going to pull the trigger until we see that kind of utilization and then we'll pull the trigger to expand new animal [ph] rooms in 2014.

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

Okay. And then on synthetic chemistry, I guess, just to be clear, the pricing pressure hasn't gotten worse. Is that a correct interpretation? And then I noticed in the past, in prior slides, you talked about competition in that business from competitors in China and India. You didn't mention the Indian competitors this time. So has that dynamic died down a little bit?

Ge Li

Well, actually, again, I don't think there's a pricing pressure that's getting worse. And our main competitors are still from China and India.

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

Okay. And then last one, can you just update us on the pipeline that you've got from medicinal chemistry? I mean, I think in the past you said you delivered 9 preclinical candidates in 2012. Can you just talk about what the pipeline looks like now in terms of lead optimization programs and what you could potentially deliver in medicinal chemistry this year?

Ge Li

Yes, we started the year with 40-plus programs. So hopefully, we will deliver a few more than last year in 2013.

Operator

Next question comes from the line of Jack Hu from Deutsche Bank.

Jack Hu - Deutsche Bank AG, Research Division

Can you share with us the margin structure and also the margin trend for each of the 4 service area you indicated in Slide 17, particularly the development side. What kind of gross margin should we expect on the middle to long-term basis?

Edward Hu

Jack, I think the development service segment margin probably will be in line with overall kind of China-based Lab Service margin in the long term. Currently, clearly, it's actually below that, the overall margin, as some of our businesses are still in the ramping up phases.

Operator

Your next question comes from the line of Paul Knight from CLSA.

Paul R. Knight - Credit Agricole Securities (USA) Inc., Research Division

I guess, Tim had already kind of asked the question, just a follow-up again, maybe get your thoughts on it. You guys talk about returning this free cash or much free cash to shareholders and as Tim alluded, to, the stock is at a 4-year high. At what point do you sit back and think that maybe it's a better time to institute a dividend? Or has there any been any thought put into it instead of buying back all the stock as -- if it continues to accelerate upward?

Ge Li

Well, currently, we have a $100 million buyback programs in place. So we hear you -- so we're probably down the road. We're going to consider the dividend policy but not now.

Operator

The next question comes from the line of Bin Li from Morgan Stanley.

Bin Li - Morgan Stanley, Research Division

Several questions on the backlog that you talked about, the $40 million as of the end of March. Can you give us the typical timing of the backlog -- for your backlog in specific, in average, what's the timing? And then -- and you talk about the -- you're serving about 50 customers globally. And if you can give us some kind of breakdown in terms of domestic versus international as you did with the tox business.

Edward Hu

So the typical biologics projects, they actually will last 18 to 24 months start from cellular generation all the way to in the end of GMP manufacturing. And the customer base, actually in this business, is also a mix of international and domestic. I think right now, slightly more international clients than domestic.

Bin Li - Morgan Stanley, Research Division

Oh, so it's more like -- so 50-50 then?

Edward Hu

It's probably like a 40-50 roughly. 40% domestic, 50% ...

Bin Li - Morgan Stanley, Research Division

So pretty significant is from domestic, right? Okay.

Edward Hu

Yes.

Bin Li - Morgan Stanley, Research Division

And then a follow-up question, is your guidance for the U.S. business, I think you're implying second half is going to accelerate or the growth rate will pick up for the U.S. business. Can you explain the rationale behind that?

Edward Hu

Yes. Some of those projects in the pipeline right now, we see is actually in the area like cell therapy and large bio clinical study. Those typically carries a very -- a large dollar value project and very often client is going to come into this project in the second half as they each try to meet their own milestone. So that's kind of the reason we project -- we expect the growth in second half will be much stronger than first half.

Ronald Aldridge

And with that question, we're going to conclude today's conference call. We thank everybody for participating, and we look forward to speaking with you again in August to go over our second quarter results.

Ge Li

Thank you.

Edward Hu

Thank you.

Operator

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.

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