WuXi PharmaTech (Cayman)'s (WX) CEO Ge Li on Q1 2014 Results - Earnings Call Transcript

May.15.14 | About: WuXi PharmaTech (WX)

WuXi PharmaTech (Cayman) (NYSE:WX)

Q1 2014 Earnings Call

May 15, 2014 8:00 am ET

Executives

Ronald Aldridge - Director of Investor Relations

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

Edward Hu - Chief Financial Officer and Chief Investment Officer

Analysts

Jordan McKinnie - JP Morgan Chase & Co, Research Division

Bryan Kipp - Janney Montgomery Scott LLC, Research Division

Bin Li - Morgan Stanley, Research Division

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

David H. Windley - Jefferies LLC, Research Division

Serena Shao - BofA Merrill Lynch, Research Division

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

Wei Du - Goldman Sachs Group Inc., Research Division

Jack Hu - Deutsche Bank AG, Research Division

Operator

Good day, everyone, and welcome to the WuXi PharmaTech First Quarter 2014 Earnings Conference Call. [Operator Instructions] I must advise you that this conference is being recorded today.

I would now like to turn the conference over to your speaker today, Mr. Ron Aldridge, Director of Investor Relations. Please go ahead, Mr. Aldridge.

Ronald Aldridge

Thank you, Kim, and good morning or good evening to everyone participating in our first quarter 2014 earnings conference call. Hosting this call today is Dr. Ge Li, Chairman and Chief Executive Officer. Joining him is Edward Hu, our Chief Financial Officer and Chief Investment 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 on which 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 non-GAAP measures, which exclude the impact of share-based compensation expenses and the amortization of acquired intangible assets and the associated deferred tax impact. We believe these non-GAAP operating measures are useful for understanding and assessing underlying business performance and operating trends. A reconciliation of our GAAP to non-GAAP first quarter 2014 results of operations is 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 2014 performance and to discuss our second quarter and full year 2014 business outlook. Dr. Li?

Ge Li

Thank you, Ron, and good evening or good morning, everyone.

Turn to Slide 4, please. WuXi's operations had a good first quarter, with solid revenue growth and a strong investment to sustain our future growth. Our revenue grew 11.3% in the first quarter to USD 146.7 million. Our revenue growth was mainly driven by small-molecule manufacturing, biologics and medicinal chemistry. We were pleased to achieve this double-digit revenue growth even with the reduction of some business from one large customer as a result of its consolidation of research programs, which we spoke to you about in March.

We expect the year-over-year revenue growth to accelerate in the coming quarters as new projects start to generate revenues across the board and as we continue to build our capabilities and offer these capabilities to our customers.

Our gross margin improved year-over-year on both GAAP and non-GAAP basis, due to the revenue ramp-up of new business and the productivity improvements, partially offset by RMB appreciation versus the U.S. dollar year-over-year.

Our good operational performance was somewhat obscured by a substantial mark-to-market loss on our foreign exchange forward contracts in the quarter as a result of the rapid depreciation -- RMB depreciation against U.S. dollar beginning in February, an issue that we highlighted for you in our fourth quarter earnings call in March. Mark-to-market loss on foreign exchange forward contracts reduced our earning -- our EPS by $0.19 per share in the quarter versus the $0.02 of gain in the last year's first quarter. If excluding mark-to-market loss, our EPS on GAAP and on non-GAAP will grow 51.3% and 46.3%, respectively. However, we did have a $1.8 million realized gain from settled foreign exchange forward contracts in the first quarter. Of course, RMB dollar exchange rate is beyond our control, and our performance is hedging -- this hedging activity is inherently variable.

Last year, you will remember that we achieved a P&L benefit from mark-to-market gains of $0.12 per share in full year 2013 versus the $0.03 per share in full year of 2012.

We have revised our full year 2014 financial guidance to reflect the impact of these mark-to-market losses. Otherwise, our financial performance this year is meeting or exceeding our expectations. We were able to offset part of our mark-to-market losses with a $0.07 per share gain on a sale of investment made by our corporate venture fund. We will have another smaller gain from a similar investment sale in the second quarter.

Slide 5, please. Our small-molecule manufacturing business has continued to achieve strong growth in Process Chemistry and research manufacturing, and we are also seeing a resurgence in our commercial manufacturing business. 3 years ago, we had only one commercial manufacturing product. Today, we have 8, plus 11 more products in Phase III that have good potential to become commercial manufacturing products for us. 4 of these 19 products have been designated by the FDA as breakthrough or faster-track compounds, indicating the high quality of the molecules that we are working on for our customers.

Manufacturing of commercial pharmaceuticals can provide stable long-term revenue growth from our patent-protected life of 10 years or more. So while our manufacturing revenue in the past has been lumpy, we now have a broad diverse -- diversified portfolio of manufacturing products that we expect to bring strong sustained growth in 2014 and beyond.

We are also addressing growing demand. There's a 2-year $100 million project to build a new small-molecule research manufacturing and commercial manufacturing facility in Changzhou City, which is about 110 miles away from Shanghai. Phase I of this expansion will double our current manufacturing capacity, and it shall be completed by the fourth quarter of 2015.

Our biologics business is also ramping up rapidly. As one of example for our progress, we recently shipped drug substance and drug product for TaiMed Biologics' HIV product ibalizumab to the U.S., and it was approved by the FDA for expanded access program, the first such approval for a biologic drug manufactured in China. We are very proud of this accomplishment.

Also, our cGMP biologics production facility in Wuxi city won an award from the International Society for Pharmaceutical Engineering, the only research facility in China to be so honored.

Our medicinal chemistry business also grew well, driven by increasing demand from biotech and the domestic customers.

We also continue to strengthen our management team in the quarter. I'm very pleased that Dr. Steve Yang has joined WuXi as our Chief Operating Officer. Steve comes to us from AstraZeneca, where he was Vice President and Head of Asia and the Emerging Market iMed. Previously, he was the Vice President and Head of Asia R&D at Pfizer and Head of Pfizer's Global R&D strategic management group. Steve's knowledge and experience will surely help to lead -- help WuXi to the next level.

During the quarter, we also invited Dr. Mu Hua to join us as our Head of Product Development Service and Partnership Business Unit. Hua has nearly 2 decades of product development and a regulatory experience with FDA, EMEA and the CFDA. His experience will help our partners to develop innovative drugs for both Chinese and the global market.

And Ed Hu, who many of you know very well, has been named as our Chief Investment Officer, responsible for all of our investment, including strategic investments in new business, corporate venture investments, merger and acquisitions and joint ventures. He will also continue to be our Chief Financial Officer. As many of you know, Ed has led efforts to build many of WuXi's new business in past several years, including biologics, toxicology, genomics, clinical trials service in China. He has also created and managed joint ventures with MedImmune and PRA.

An important investment that we made in the quarter, with ordering Illumina X Ten sequencing system, which will allow WuXi to offer our customers whole genome sequencing with much more affordable price.

In other news, our analytical and stability testing facility and the clinical trial materials and manufacturing facility passed FDA GMP inspection. This will bring regulatory advantage and the potential approval to clients who use WuXi's service for their NDA and ANDA filings and a commercial, analytical and stability testing.

We are also investing in several new facilities. We recently completed the construction of a new high-potency API manufacturing lab in Shanghai to meet our customers' growing needs for these molecules, particularly for oncology drugs. We leveraged our Philadelphia site's decade-long experience in biosafety testing capability and completed construction of a new biosafety testing lab in Suzhou, China, where we see growing demand for biosafety testing as the strong growth of the biologics industry in China. This new lab will offer the same biosafety testing service for Chinese and Asian customers as those in our Philadelphia site for U.S. customers.

We also completed an expansion of our materials characterization laboratory in St. Paul, which means increasing customer demand for this service driven by increasing regulatory requirements for medical devices.

And then last month, we broke ground to expand the cell therapy manufacturing facility in our Philadelphia campus, which we expect to be completed by the second quarter of 2015. This investment reflects our high level of confidence in our business future.

Slide 6, please. Because of our strong operational performance, we exceeded our first quarter guidance. We achieved a revenue of $146.7 million compared to the guidance of $143 million to $145 million. Because of the volatility in currency market in the past few months, we give our first quarter guidance excluding mark-to-market gains or losses on foreign exchange forward contracts. On that basis, we achieved a GAAP diluted EPS of $0.43 versus the guidance of $0.31 to $0.33 and a non-GAAP diluted EPS of $0.49 versus the guidance of $0.36 to $0.38.

And now I will ask Ed to review the financial results in the quarter in more details. Ed, please.

Edward Hu

Thank you, Dr. Li. Turn to Slide 7, please.

In this table, you can see WuXi's year-over-year revenue growth by business. Manufacturing led the way with 19.7% growth, while China-based lab services achieved 10.3% growth and U.S.-based lab services had a 1.7% growth. We expect both China-based and U.S.-based lab services growth rate to improve throughout the year and for Manufacturing Services to continue to show its strong year-over-year growth.

Slide 8, please. Our quarterly revenue follows the normal pattern. Typically, our China-based lab services had a strong revenue in each fourth quarter when many of the customers are spending their budgets and a relative weaker revenue in the fourth quarter when our customer have not yet finalized their spending plan for the next -- for the new year.

U.S.-based lab services revenue were a bit weak than expected, partly impacted by several severe winter storms on the East Coast during the first quarter. Manufacturing Services is showing strong steady growth.

Turn to Slide 9, please. Here you can see our GAAP P&L for the quarter. We achieved 11.3% revenue growth from the increasing demand for our services. This strong revenue growth and productivity improvement led to a 13.1% increase in gross profit and a 60% -- 60 basis points year-over-year improvement in our gross margin to 36.6% despite the impact of appreciation of RMB against the U.S. dollar year-over-year.

The average exchange rate of U.S. dollar to RMB was RMB 6.12 in Q1 2014 versus RMB 6.28 in Q1 of 2013.

2014 is also a year for investment at WuXi. We are making a broad range of investment in people, laboratories, sales and marketing, business development, IT infrastructure and R&D, particularly R&D spending in Biologics, genomics, biology and certain risk-sharing projects. Because of our 23.8% growth in operating expenses from these type of investments, our operating income growth was 1.8%, and operating margin was about 16% in first quarter of 2014.

As we told you during the early March earnings conference call, we expect our full year operating margin to be 1 to 2 percentage points lower than last year due to this increased investment in SG&A and R&D. We expect this investment to drive future revenue and profit growth.

A decline in net operating income, particularly the mark-to-market losses that Dr. Li referred to led to a 17.9% decrease in net income and without increasing share count, a 19.8% decrease in diluted EPS.

Turn to Slide 9 -- 10, please. So this slide shows our sequential margin performance. Gross margin was in line with prior quarters and up 60 basis points year-over-year. Operating margin declined due to our increasing level of investments in sales and marketing, G&A and R&D.

Slide 11, please. Our non-GAAP P&L is similar to our GAAP P&L, double digits year-over-year revenue growth, even better gross margin increase. Lower operating margin was due to investment in SG&A and R&D. And a decline in net income and diluted EPS was due to largely to the mark-to-market loss on foreign exchange forward contracts in the quarter.

Turn to Slide 12, please. The sequential quarter performance on a non-GAAP basis is similar to GAAP, stable gross margin and a decline in operating margin due to investments.

Slide 13, please. So this chart summarizes our realized and mark-to-market gains and losses on foreign exchange forward contracts for the first quarter of 2014 and 2013. You can see that there is a $0.21 per share swing in mark-to-market gains and losses between the first quarter of 2013 and the first quarter of 2014, turning what would have been $0.15 to $0.16 per share of diluted EPS growth into a $0.05 to $0.06 per share decline year-over-year. So I'll spend a little more time to explain in the next slide.

So Slide 14, please. As you know, about 90% of revenues from our China-based operations are recorded in U.S. dollars, and about 3/4 of our expenses are recorded in RMB because our business model is fundamentally about Chinese operation serving Western customers. When the RMB appreciates against the dollar, which is usually the case, our expenses appreciate relative to our revenues, putting pressure on our margins, which is why we hedge by purchasing foreign exchange forward contracts. We earn realized and unrealized gains on those contracts to reduce but not to fully eliminate this currency exposure. In those rare periods, like what happened in the first quarter of 2014 when the RMB depreciates rapidly against the dollar, we can incur significant mark-to-market losses on foreign exchange forward contracts as we did this quarter. But a depreciated RMB also tends to help our margins, so we have partially offsetting effects above and below this operating income line from our hedging activities regardless of how the currency moves. For the first quarter of 2014, RMB depreciation actually had a slight benefit to our operating income relative to our original forecast, which had about $0.03 positive impact on EPS.

These partially offsetting effects are not equal in amount or timing. The reason why the RMB depreciation benefit to the operating income in the first quarter is only $0.03 while mark-to-market losses had $0.19 is because of 2 reasons: First, the average exchange rate in Q1 2014 was about RMB 6.12, which is the rate used to translate RMB expenses to U.S. dollars, while the March 31, 2014 exchange rate was RMB 6.22. Second, the mark-to-market gain or loss calculation takes account all the forward contracts of about $500 million notional value and reprices these contracts using the quarter end forward exchange rate curve. So this chart on Slide 14 shows the fluctuation in foreign currency market that led to our recording mark-to-market losses on foreign exchange forward contracts in the first quarter.

On the chart, the strike price of $1 to RMB forward contracts in 2014 and 2015 are compared to the forward curve as of December 31, 2013, and March 31, 2014. You can see that the forward curve moved up by approximately 1,400 basis points in the first quarter as a result of the rapid RMB depreciation against the dollar that started in mid-February. We recorded realized gain on foreign exchange forward contracts in the first quarter based on the spot exchange rate relative to the strike price on expiring contracts. We recorded mark-to-market losses in the first quarter based on the March 31, 2014, forward curve relative to the December 31, 2013, forward curve. We currently have $350 million notional value of forward contracts expiring in 2014 with an average strike price of around $6.30 and an additional $150 million forward contracts expiring in 2015 with an average strike price of around $6.20 -- sorry, RMB 6.2 to $1. If the exchange rate stays at the current level, we will continue to have realized gains from contracts expiring in 2014 and potentially realize loss for contracts expiring in 2015.

During the bulk of first quarter we could not comfortably predict the movement of the exchange rate. So when we provide our first quarter 2014 guidance in early March, we did not include potential mark-to-market gains or losses on foreign exchange forward contracts. Now we are more comfortable with the currency market now, and we are giving our present guidance for second quarter and full year 2014 assuming that RMB to U.S. dollar exchange rate will stay where it is, around $1 to RMB 6.22.

Turn to Slide 15, please. So on this slide, you can see the history of RMB appreciation and the result of WuXi's effect of hedging activities. The RMB has appreciated from about RMB 7.3 to $1 at the end of 2007 to about RMB 6.05 to $1 at the end of 2013, usually appreciates about 3% to 5% each year. During that period, WuXi purchase the foreign exchange forward contracts usually in amount totaling about 50% to 70% of annual revenue forecast and extending 12 to 18 months into the future. The amount, prices and timing of our purchase have varied. Throughout this period, the company has been successful in generating more than $28 million of realized gain to partially offset losses at the operating income level from RMB appreciation.

Starting in mid-February 2014, the RMB depreciated from about RMB 6.05 to about RMB 6.22 to $1 or about 3% as a result of a change in Chinese government practice in currency management. As a result, WuXi incurred $13.9 million of mark-to-market losses on foreign exchange forward contracts in the first quarter, partially offset by improved operating income. Whether this mark-to-market loss will become realized loss will depend on the future currency movements.

Turn to Slide 16, please. So this slide shows the distribution of our first quarter 2014 and 2013 revenue among our 5 businesses. As you can see, small-molecule manufacturing services, biologic services are growing faster than the company average.

On the right-hand side, you can see that our incremental revenue in the first quarter came mainly from small-molecule manufacturing, biologics and chemistry and discovery, in that order, with a small amount of revenue growth from U.S. lab services and relatively no growth from testing services. We're intensifying our selling effort in testing services and expect to renew growth from the second quarter onwards.

Turn to Slide 17, please. This slide shows that laboratory service achieved revenue growth of 8.3%, and this revenue growth is from the ramp-up of new services and productivity improvement more than offset the negative year-over-year impact of RMB appreciation and labor cost inflation, producing 12.6% gross margin growth.

While the RMB depreciated against the U.S. dollar started from mid-February 2014, its effect year-over-year is still an appreciation versus the dollar. The average exchange rate was RMB 6.28 in Q1 2013 and RMVB 6.12 in Q1 2014.

Turn to Slide 18, please. Manufacturing Services segment revenue growth was 19.7%. Gross profit increased 15%, slightly less than revenue growth due to business mix, specifically the increase in our lower margin biologics manufacturing revenue because the biologics manufacturing business just began to ramp up. The gross margin in our small molecule manufacturing business was stable.

Turn to Slide 19, please. Our financial position remains very strong. We had about $427 million cash at the end of the first quarter and $88.6 million of debt, mostly bank loans. We increased our borrowing in the first quarter in the United States in part to buy back shares. This net cash balance is a result of past and continuing strong cash flow. Our operating cash flow was $53.9 million in the first quarter, capital expenditures were $9.1 million, leaving free cash flow of $44.8 million. Capital expenditures will be significantly higher in the remaining quarter of 2014.

We purchased almost 900,000 ADS for $32.8 million in the first quarter at an average share price of $36.60. And in doing so, we returned a substantial portion of first quarter free cash flow to our shareholders. The price at which we are buying our shares reflect our optimism about the company's present and future prospects.

And now I will turn the call back to Dr. Li.

Ge Li

Thank you, Ed. Slide 20, please. Despite the large mark-to-market losses in the first quarter, we believe that our underlying business performance in 2014 will continue to be strong. We are reconfirming our full year 2014 revenue guidance of $660 million to $670 million or 14% to 16% year-over-year growth. As we don't expect the depreciation of RMB to reverse during the remainder of 2014, we are assuming mark-to-market losses of $0.20 in our full year 2014 diluted EPS guidance. So we expect a full year 2014 GAAP diluted EPS of $1.53 to $1.58 including these mark-to-market losses, or $1.73 to $1.78 excluding these losses.

For full year 2014 non-GAAP diluted EPS, we expect $1.80 to $1.85 including mark-to-market losses, or $2 to $2.05 excluding these losses. So excluding mark-to-market losses, our EPS full year guidance has improved. Apart from the trends in market, our underlying business performance is meeting or exceeding our expectations.

So in the second quarter, we expect revenue of $160 million to $162 million, a GAAP diluted EPS of $0.39 to $0.41 and a non-GAAP diluted EPS of $0.46 to $0.48 and we are assuming the exchange rate stays near where it is.

Slide 21, please. While we expect to achieve strong revenue growth and a good earnings growth in 2014, we are also remaining -- investing aggressively for our future. This slide shows some of our larger current areas of investment to drive future revenue growth.

Slide 21, please. So to conclude, we achieved solid revenue growth in the first quarter. We believe that small-molecule manufacturing, biologics and other business will drive continued strong revenue growth for the next several years. In the meantime, we are making investments to build our long-term future.

Our financial guidance reflects the unusual currency movements in 2014, but our business performance is on track.

One of the reasons we are optimistic about our future is that favorable biotech funding environment in the U.S. which we expect to generate new business throughout our organization. Many small biotech companies will be looking to companies like WuXi to perform the service they will need to advance their compounds through the development. So our mission remains the same: It is to build the best open-access platform of R&D technologies, capabilities and a service to enable our customers to discover, develop and commercialize health care products more quickly and cost effectively.

So now Ed and I will be happy to answer your questions.

Question-and-Answer Session

Operator

And that first question will come from Tycho Peterson. [Operator Instructions]

Jordan McKinnie - JP Morgan Chase & Co, Research Division

This is Jordan McKinnie on for Tycho. A question on the biologics ramp. Can you just talk about where your backlog is today and how utilization is trending there?

Edward Hu

Yes. Biologics, the backlog is north of $50 million, and we also have more contract coming. Utilization is picking up. So in manufacturing side, we are just beginning to run in the manufacturing. But as the year progresses, our utilization in our biologics manufacturing capacity will be actually pretty full.

Jordan McKinnie - JP Morgan Chase & Co, Research Division

Okay, great. And then also on genomics, I mean, have you received like delivery of your X Ten? And then can you just kind of give some color on your thoughts and priorities around population sequencing?

Ge Li

Not yet, not yet. We expect to receive probably at the beginning of the third quarter or at the end of the second quarter. So our population sequencing is one of the utilization of this instrument, yes.

Operator

And moving on, we'll take a question from Paul Knight from Janney Capital Markets.

Bryan Kipp - Janney Montgomery Scott LLC, Research Division

This is actually Bryan Kipp on behalf of Paul. Just to kind of hone in on the Manufacturing Services side. You guys mentioned that the pipeline -- 8 commercial, 11 in phase which is an incremental one over the end of 1Q -- or at the end of last year. So I just kind of want to get additional color there. Was it -- the strong growth I think exceeded, well, my expectations. Was it broadly based on those 8 commercial products? I know you had some biologics ramp here. Can you just tease out that a little bit? Was it specific to 1 or 2 products? And just general commentary and color around that, I'd appreciate it.

Ge Li

Well, on the small-molecule manufacturing, we have quite a strong pipeline. We have 8 for commercial manufacturing and 11 for Phase III. And as you know, we created this research manufacturing like terms. And basically, we created the pipeline for our commercial manufacturing. Every year we produce essentially about 60 to 70 research APIs. Research APIs means the APIs used for preclinical and the clinical Phase I or Phase II. So we're going to continue to see strong growth for our small-molecule manufacturing.

Bryan Kipp - Janney Montgomery Scott LLC, Research Division

And I guess in addition to that, you highlighted the biologics announcement from the FDA, the TaiMed Biologics monoclonal antibody. So do you think that will be incremental through the back half of the year? I know it was just approved, and just color on that as well.

Edward Hu

Yes. It's -- the biologics manufacturing contribution in the first quarter is still insignificant, low single digits. But as the year progresses, it's going to ramp up fairly quickly.

Ge Li

Also, Bryan, I refer you to the Slide 16 where I actually categorized the business segments slightly different from last year. So actually, you can see that biologics essentially doubled from last year from like 2.3%, now to 5.6% contribution to revenue.

Bryan Kipp - Janney Montgomery Scott LLC, Research Division

Yes, sorry, just thinking about that agreement as well. Appreciate it.

Operator

We'll take a question now from Bin Li from Morgan Stanley.

Bin Li - Morgan Stanley, Research Division

So the -- my first question is on the -- on your EPS for this quarter. If we exclude the FX loss and also the onetime gain from IPO, I think you still managed to deliver $0.40, which is above your early guidance. Can you tell us why you're -- or what are the areas that are exceeding your early expectation? And along the same line, you raised the guidance by $0.05 versus your early expectation. And where is that $0.05 coming from? I mean, it's about $0.02 coming from this quarter in 1Q, but I'm just wondering what you're seeing that made you to raise the guidance. The second question is also on the biologics. Dr. Li, as you point out, your biologics is really growing at the double speed of the other business. So are you reaching capacity pretty soon? Do you have plan to expand the capacity? And if you do, what are the CapEx for that -- for the year, capacity expansion?

Edward Hu

So Bin, this is Ed. I will take the first question and Dr. Li will take the second question. So on the EPS front, excluding the MTM, the mark-to-market losses, the upside for this quarter and the full year is mainly coming from the better margin on the gross margin -- operating margin level than we originally expected. This also benefits from actually the currency depreciation that actually has benefits to the margins. And also, we have a better improvement in terms of productivity that contributes to the improvement on the margin.

Ge Li

So Bin, second question.

Bin Li - Morgan Stanley, Research Division

And for the whole year?

Edward Hu

For the whole year, same story.

Ge Li

On biologics side, our biologics team has done a really good job. So we see a strong growth for all fronts, right, because our biologics have been discovery development and the manufacturing. So discovery and development, we continue to grow our capability and the capacity. So -- and on the manufacturing, as Ed mentioned earlier, we started to like improve the utilization of the capacity. So -- well, from the end of this year and at the beginning of the next year, we probably will start to invest for the -- to increase the capacity -- or the manufacturing capacity.

Operator

[Operator Instructions] We'll move on to John Kreger from William Blair.

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

Could you give us an update on your clinical JV with PRA? How is that proceeding versus your expectations?

Edward Hu

John, this is Ed. So the joint venture with PRA is actually progressing pretty well. We have started signing up for the registering trial for China and also from the regional trial together with PRA. And also, we have started building up our data management and the statistical rules that we can do -- function of FFT [ph] type of services. So our backlog started building up, but turning that back into revenue will still take some time. As you know, the China's CFDA approval of R&D takes 9 to 12 months long. The current JV is still money-losing state. But as we move toward the end of the year, it will start turning around. And next year, definitely, it will start to be profitable.

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

Great. And then I believe one of the investment areas you mentioned was R&D around some of your risk-sharing deals. Can you just remind us at this point, how many of these risk-sharing deals do you have? And in general, what -- is there sort of typical terms that you can point to, to what are you actually putting up at risk and what sort of royalty possibilities do you have on the back end?

Edward Hu

Yes. We actually perform very limited number of projects that are on risk-sharing basis, which essentially we take a hit on R&D expenses and develop the product to a certain stage, and then we earn an amount of payment. And in some instance, we also receive our low single digits kind of royalty going forward.

Operator

David Windley from Jefferies has our next question.

David H. Windley - Jefferies LLC, Research Division

The question I have is around sales force. So you had mentioned that I think you're investing in sales force in one particular area where you expected to see growth resume was in testing as a result of some focus there. My interest is, first, in -- how do you turn an area like testing around so quickly? And then two, how are you positioned from a sales force standpoint to go after the smaller biotech customer base where -- I think you kind of alluded to customers have raised a lot of capital, and so I'd be curious if you've added salespeople to attack that customer base.

Ge Li

David, it's a good question. Actually, our lab testing business is growing nicely. And so we added sales force because we want to provide little service to essentially be able to reach to more customers as you mentioned, many biotech companies and laboratory companies. So the sales force has been built and hopefully, we'll soon see the benefit of the sales force.

Edward Hu

Dave, also, in the first quarter, the testing business revenue didn't grow much as -- because quite a few projects, actually, we did not finish up. Those projects are slightly delayed into second quarter. So we do have the backlog that we're actually going to cross, yes.

Ge Li

Testing business is one of the fastest growing segment in the company.

David H. Windley - Jefferies LLC, Research Division

Got it, okay. And then if I could follow up with one on more on the financial side. So you did buy back some stock in the first quarter. Would you anticipate continuing to be active there and if the stock is weak, potentially step up that activity?

Edward Hu

Yes. David, actually, we'll continue buying actually in April as well. So second quarter, we also have been buying our shares.

Operator

Moving on, we have a question from Serena Shao from Bank of America.

Serena Shao - BofA Merrill Lynch, Research Division

I actually have 2 question here regarding the outlook for the full year. So the first question is regarding the lab service business. So I know it's being a little bit weak for the first quarter. So what's your expectation or your view on the full year growth for the entire lab service business? And then my second question is about full year revenue growth. So currently, you're maintaining your, like, revenue guidance. So I want to ask here, if there's any like chances of upside surprises, where do you think it will come from, either it's from your new business like biologics or the clinical trial JV or it's from the, what, the existing manufacturing project to become commercial projects? I just want to have more understanding about that.

Ge Li

As far as I -- we can we see, we feel very confident about delivering $660 million to $670 million revenue for the 2014. So -- and again, right, because in the first quarter, we exceeded our guidance.

Serena Shao - BofA Merrill Lynch, Research Division

Yes. So my question here is if there's any potential upside surprise to your guidance, where -- which area could it be? I'm just asking your view on this because only now it's...

Ge Li

So we always look for improvement. So as far as we can say as the guidance, the top line will be $660 million to $670 million, and the bottom line on that excluding the mark-to-market loss will be $2 to $2.05, which is about $0.05 better than we guided earlier at the beginning of the year.

Serena Shao - BofA Merrill Lynch, Research Division

Okay. So how about the lab services? What's your expected growth for the full year?

Edward Hu

Lab services will continue to grow as from second quarter, third quarter on and we see a strong growth ahead.

Operator

Moving on, we'll hear from Tim Evans from Wells Fargo Securities.

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

Ed, I'm just trying to still understand some of the below-the-line moving pieces. I want to be clear, in your prior guidance, there was 0 included for mark-to-market FX gains or losses. Is that correct?

Edward Hu

In the prior guidance for the full year, we actually include a couple of cents of gain on mark-to-market.

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

Okay. And you included -- what was included for, like, the gain on the IPO that was done this quarter?

Edward Hu

Yes. We also include a few cents of gain from stocks with the sale for IPO of the companies. But our realized gain is actually much higher than we originally anticipated.

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

Okay. And then is there any additional gain or loss included for the next 3 quarters at this point?

Edward Hu

For the next 3 quarters, we assume $0.01 for mark-to-market losses. And in realized gain, obviously, we assume there will be realized gain from expiring foreign exchange forward contracts. And then probably a few more cents from IPO of the company. We will realize those gains.

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

Okay. So the entire -- maybe the better way to ask the question is, the other income line, what should we be thinking about that for the full year?

Edward Hu

The other income line actually include a bunch of things besides those foreign-exchange and gain from IPO of companies. We also have government subsidies. Those are the -- timing amount is actually -- we cannot predict precisely.

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

So is that -- does that mean that's 0?

Edward Hu

That's been something -- we always have government subsidy every year.

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

Okay. But I guess I'm just asking what's included in guidance. Because it's difficult to forecast what the operating margin is going to be not knowing what the below-the-line impact is that's included in guidance.

Edward Hu

So the below-the-line other income expense line, so other income including the government subsidies, the foreign-exchange gain and losses, gain from equity sales from IPO of the companies. Those are the pieces in the other income line. And obviously, net interest income is another line.

Operator

Next, we'll take a question from Wei Du from Goldman Sachs.

Wei Du - Goldman Sachs Group Inc., Research Division

I just want to better understand the margins. I guess I very much like to focus on the fundamental. I realize the gross margin were up, and I think Ed you explained in the early remark, talked about the currency impact to the top line and cost. And I'm just wondering whether there's any margin increase improvement due to RMB depreciation. And meanwhile, when I look at the overall, in laboratory service, because you already recategorized a lot of the item in there, I'm just wondering how much of those margin improvement due to the service mix changed. For example, the biological service, does that offer relative higher margins compared to the traditional laboratory service like medicinal chemistry? So if you can give a little bit color on that so we can better understand the margin trend.

Edward Hu

Okay. On the gross margin level, obviously, the depreciating RMB has a slight benefit in Q1. As I said, the average exchange rate is about RMB 6.12 in Q1. So we probably had about 0.8 or 0.9 percentage point margin benefit in the gross margin level because of the RMB depreciation relative to our expectation -- original forecast. But versus last year, it's still headwind. Versus last year first quarter, actually, there's probably a 1.5 percentage points of hit on the gross margin level. But we're able to actually grow -- improve gross margin year-over-year largely because we are ramping up a newer business as well as controlled costs improved productivities. So that's why the reason we can actually improve our gross margin.

Wei Du - Goldman Sachs Group Inc., Research Division

So in term of the product mix, do you see the biological service sometimes offer higher margin relative to the other?

Edward Hu

Biologics service is ramping up. So currently, it's below the company average. But it will grow to the company average or even better, particularly in development.

Operator

And our final question will come from Jack Hu from Deutsche Bank.

Jack Hu - Deutsche Bank AG, Research Division

I have 2 small questions. First, your annual report, I actually did a little math and it showed that the backlog increased by more than 70%. It is the highest in last 4 years as in previously, you recorded somewhere up between 20%, 30% growth on backlog. I just want to ask where that come from or where is it concentrated? Second question, it seems the mega-mergers are coming back. Can you comment on the impact?

Edward Hu

I will comment -- Jack, I will comment on the first question. Dr. Li will take the second question. So in our annual 20th report, the backlog end of December 2013 increased a lot, partially because of the manufacturing backlog and biologics. Those are basically -- those are long-term projects. So we significantly increased the backlog.

Ge Li

So on the merger, Jack, WuXi started to offer service in 2001. So during the last 12 years, 13 years, so we have gone through many of this type of mega-mergers. Because, again, we believe we have a very strong relationship and partnership with our customers, and we'll take these mega-merger as opportunity to continue to grow with our customers. So as history tells us, the mega-merger is not necessarily a bad thing for us.

Ronald Aldridge

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

Ge Li

Thank you.

Edward Hu

Thank you. Bye-bye.

Operator

And that does conclude our conference today. Thank you all for your participation.

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