Attached files

file filename
EX-32.1 - EXHIBIT 32.1 - KENDLE INTERNATIONAL INCc04489exv32w1.htm
EX-31.1 - EXHIBIT 31.1 - KENDLE INTERNATIONAL INCc04489exv31w1.htm
EX-32.2 - EXHIBIT 32.2 - KENDLE INTERNATIONAL INCc04489exv32w2.htm
EX-31.2 - EXHIBIT 31.2 - KENDLE INTERNATIONAL INCc04489exv31w2.htm
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended June 30, 2010
OR
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number 000-23019
KENDLE INTERNATIONAL INC.
 
(Exact name of registrant as specified in its charter)
     
Ohio   31-1274091
 
(State or other jurisdiction   (IRS Employer Identification No.)
of incorporation or organization)    
     
441 Vine Street, Suite 500, Cincinnati, Ohio   45202
 
(Address of principal executive offices)   (Zip Code)
Registrant’s telephone number, including area code (513) 381-5550
 
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ     No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o     No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o Accelerated filer þ  Non-accelerated filer o
(Do not check if a smaller reporting company)
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o     No þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 14,905,579 shares of Common Stock, no par value, as of July 30, 2010.
 
 

 

 


 

KENDLE INTERNATIONAL INC.
Index
             
        Page  
Part I. Financial Information        
   
 
       
Item 1.
 
Financial Statements (Unaudited)
       
   
 
       
        3  
   
 
       
        4  
   
 
       
        5  
   
 
       
        6  
   
 
       
        7  
   
 
       
      18  
   
 
       
      30  
   
 
       
      30  
   
 
       
Part II. Other Information        
   
 
       
      31  
   
 
       
      31  
   
 
       
      31  
   
 
       
      31  
   
 
       
      31  
   
 
       
      31  
   
 
       
      31  
   
 
       
Signatures     32  
   
 
       
Exhibit Index     33  
   
 
       
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2

 

2


Table of Contents

KENDLE INTERNATIONAL INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
                 
    June 30,     December 31,  
(in thousands, except share data)   2010     2009  
ASSETS
               
Current assets:
               
Cash and cash equivalents
  $ 32,179     $ 52,103  
Restricted cash
    731       1,112  
Accounts receivable, net
    97,323       125,287  
Deferred tax assets — current
    7,457       8,147  
Other current assets
    22,477       20,676  
 
           
Total current assets
    160,167       207,325  
 
           
Property and equipment, net
    57,009       53,539  
Goodwill
    241,719       243,589  
Other finite-lived intangible assets, net
    13,351       15,164  
Long-term deferred tax assets
    11,646       12,716  
Other assets
    7,373       7,390  
 
           
Total assets
  $ 491,265     $ 539,723  
 
           
 
               
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
Current liabilities:
               
Current portion of obligations under capital leases
  $ 40     $ 52  
Trade payables
    11,628       14,928  
Advance billings
    67,699       76,202  
Other accrued liabilities
    41,630       59,667  
 
           
Total current liabilities
    120,997       150,849  
Obligations under capital leases, less current portion
    14       34  
Convertible notes, net
    130,271       138,308  
Deferred tax liabilities
    2,551       7,508  
Non-current income taxes payable
    1,903       1,872  
Other liabilities
    4,552       5,105  
 
           
Total liabilities
  $ 260,288     $ 303,676  
 
           
 
               
Commitments and contingencies
               
 
               
Shareholders’ equity:
               
Preferred stock — no par value; 100,000 shares authorized; none issued and outstanding
               
Common stock — no par value; 45,000,000 shares authorized; 14,924,796 and 14,912,327 shares issued and 14,901,744 and 14,889,275 outstanding at June 30, 2010 and December 31, 2009, respectively
  $ 75     $ 75  
Additional paid in capital
    181,200       180,534  
Accumulated earnings
    36,810       33,736  
Accumulated other comprehensive income:
               
Foreign currency translation adjustment
    13,384       22,194  
Less: Cost of common stock held in treasury, 23,052 shares at June 30, 2010 and December 31, 2009, respectively
    (492 )     (492 )
 
           
Total shareholders’ equity
    230,977       236,047  
 
           
Total liabilities and shareholders’ equity
  $ 491,265     $ 539,723  
 
           
The accompanying notes are an integral part of these condensed consolidated financial statements.

 

3


Table of Contents

KENDLE INTERNATIONAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
                                 
    For the Three Months Ended     For the Six Months Ended  
    June 30,     June 30,  
(in thousands, except per share data)   2010     2009     2010     2009  
 
                               
Net service revenues
  $ 82,445     $ 107,351     $ 172,672     $ 215,454  
Reimbursable out-of-pocket revenues
    28,870       34,804       55,099       71,762  
 
                       
Total revenues
    111,315       142,155       227,771       287,216  
 
                       
 
                               
Costs and expenses:
                               
Direct costs
    42,833       55,204       90,272       113,182  
Reimbursable out-of-pocket costs
    28,870       34,804       55,099       71,762  
Selling, general and administrative expenses
    34,094       35,226       68,831       73,256  
Restructuring expense
    1,153       6,006       1,153       6,006  
Depreciation and amortization
    3,701       3,937       7,486       7,895  
 
                       
 
                               
Total costs and expenses
    110,651       135,177       222,841       272,101  
 
                       
 
                               
Income from operations
    664       6,978       4,930       15,115  
 
                               
Other income (expense):
                               
Interest income
    33       133       55       363  
Interest expense
    (2,871 )     (3,728 )     (6,099 )     (7,604 )
Gain on extinguishment of debt
          3,133             3,133  
Other
    5,403       1,029       7,123       4,194  
 
                       
Total other income
    2,565       567       1,079       86  
 
                       
 
                               
Income before income taxes
    3,229       7,545       6,009       15,201  
 
                               
Income taxes
    1,366       4,352       2,935       11,121  
 
                       
 
                               
Net income
  $ 1,863     $ 3,193     $ 3,074     $ 4,080  
 
                       
 
                               
Income per share data:
                               
Basic:
                               
 
                               
Net income per share
  $ 0.13     $ 0.22     $ 0.21     $ 0.27  
 
                       
 
                               
Weighted average shares
    14,900       14,849       14,897       14,845  
 
                               
Diluted:
                               
Net income per share
  $ 0.12     $ 0.21     $ 0.20     $ 0.27  
 
                       
 
                               
Weighted average shares
    15,028       14,955       15,041       14,971  
The accompanying notes are an integral part of these condensed consolidated financial statements.

 

4


Table of Contents

KENDLE INTERNATIONAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
                                 
    For the Three Months Ended     For the Six Months Ended  
    June 30,     June 30,  
(in thousands)   2010     2009     2010     2009  
Net income
  $ 1,863     $ 3,193     $ 3,074     $ 4,080  
 
                               
Other comprehensive income (loss):
                               
 
                               
Foreign currency translation adjustment
    (8,184 )     5,387       (8,810 )     1,610  
 
                       
 
                               
Comprehensive income (loss)
  $ (6,321 )   $ 8,580     $ (5,736 )   $ 5,690  
 
                       
The accompanying notes are an integral part of these condensed consolidated financial statements.

 

5


Table of Contents

KENDLE INTERNATIONAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
                 
    For the Six Months Ended  
    June 30,  
(in thousands)   2010     2009  
 
               
Cash flows from operating activities:
               
Net income
  $ 3,074     $ 4,080  
Adjustments to reconcile net income to cash provided by operating activities:
               
Depreciation and amortization
    7,486       7,895  
Deferred income taxes
    (3,189 )     101  
Compensation expense on stock grants
    945       611  
Debt issue cost amortization
    3,942       4,070  
Foreign currency exchange gain
    (4,584 )     (4,599 )
(Gain) / loss on extinguishment of debt
    71       (3,133 )
Other
    334       824  
Changes in operating assets and liabilities, net of effects from acquisitions:
               
Restricted cash
    272       (2,243 )
Accounts receivable
    24,037       18,622  
Other current assets
    (2,486 )     (3,459 )
Other assets
    (111 )     (3 )
Trade payables
    (930 )     1,440  
Advance billings
    (6,725 )     (99 )
Accrued liabilities and other
    (15,736 )     15,276  
 
           
Net cash provided by operating activities
    6,400       39,383  
 
           
 
               
Cash flows from investing activities:
               
Proceeds from termination of foreign currency hedges
          17,312  
Acquisitions of property and equipment and internally developed software
    (11,014 )     (11,178 )
Acquisitions of businesses, less cash acquired
    (2,400 )     (2,875 )
Other
    (34 )     17  
 
           
Net cash provided by (used in) investing activities
    (13,448 )     3,276  
 
           
 
               
Cash flows from financing activities:
               
Repurchase of convertible notes
    (11,145 )     (18,239 )
Debt issue costs
    (413 )     (482 )
Payments on capital lease obligations
    (32 )     (124 )
Repurchase of note hedges and warrants
    (3 )     (79 )
Amounts payable — book overdraft
    656       470  
Proceeds from issuance of common stock
    66       47  
Income tax benefit from stock option exercises
    8        
 
           
Net cash used in financing activities
    (10,863 )     (18,407 )
 
           
 
               
Effects of exchange rates on cash and cash equivalents
    (2,013 )     2,354  
 
           
 
               
Net increase (decrease) in cash and cash equivalents
    (19,924 )     26,606  
Cash and cash equivalents:
               
Beginning of period
    52,103       35,169  
 
           
End of period
  $ 32,179     $ 61,775  
 
           
The accompanying notes are an integral part of these condensed consolidated financial statements.

 

6


Table of Contents

KENDLE INTERNATIONAL INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Summary of Significant Accounting Policies:
Basis of Presentation
The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim financial information and the instructions to the Quarterly Report on Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the six months ended June 30, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010. For further information, refer to the Consolidated Financial Statements and notes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2009 filed by Kendle International Inc. (“the Company”) with the Securities and Exchange Commission.
The Condensed Consolidated Balance Sheet at December 31, 2009 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and notes required by U.S. GAAP for complete financial statements.
Net Income Per Share Data
Net income per basic share is computed using the weighted average common shares outstanding. Net income per diluted share is computed using the weighted average common shares and potential common shares outstanding.

 

7


Table of Contents

The following table sets forth the computation for basic and diluted net income per share or earnings per share (in thousands, except per share information):
                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2010     2009     2010     2009  
 
                               
Basic earnings per share calculation:
                               
Net income
  $ 1,863     $ 3,193     $ 3,074     $ 4,080  
 
                       
Weighted average shares outstanding for basic EPS computation
    14,900       14,849       14,897       14,845  
 
                       
Earnings per share — basic
  $ 0.13     $ 0.22     $ 0.21     $ 0.27  
 
                       
Diluted earnings per share calculation:
                               
Net income
  $ 1,863     $ 3,193     $ 3,074     $ 4,080  
 
                       
Weighted average shares outstanding
    14,900       14,849       14,897       14,845  
Dilutive effect of stock options and restricted stock
    128       106       144       126  
 
                       
Weighted average shares outstanding for diluted EPS computation
    15,028       14,955       15,041       14,971  
 
                       
Earnings per share — assuming dilution
  $ 0.12     $ 0.21     $ 0.20     $ 0.27  
 
                       
For the six months ended June 30, 2010, approximately 128,000 of outstanding options were antidilutive compared to approximately 161,000 for the same period of 2009.
Under accounting guidance related to contingently convertible instruments on diluted earnings per share, due to the Company’s obligation to settle the par value of its Convertible Notes (defined in Note 3) in cash, the Company is not required to include any shares underlying the Convertible Notes in its weighted average shares outstanding used in calculating diluted earnings per share until the average price per share for the quarter exceeds the $47.71 conversion price and only to the extent of the additional shares that the Company may be required to issue in the event that the Company’s conversion obligation exceeds the principal amount of the Convertible Notes converted. These conditions have not been met as of the quarter ended June 30, 2010. At any such time in the future that these conditions are met, only the number of shares that would be issuable (under the “treasury” method of accounting for the share dilution) will be included, which is based upon the amount by which the average stock price exceeds the conversion price. The following table provides examples of how changes in the Company’s stock price will require the inclusion of additional shares in the denominator of the weighted average shares outstanding — assuming dilution calculation. The table also reflects the impact on the number of shares that the Company would expect to issue upon concurrent settlement of the Convertible Notes and the bond hedges and warrants mentioned below:

 

8


Table of Contents

                                         
                                    Incremental Shares  
                    Total Treasury     Shares Due to the     Issued by the  
    Convertible     Warrant     Method Incremental     Company under Note     Company Upon  
Share Price   Notes Shares     Shares     Shares (1)     Hedges     Conversion (2)  
$40.00
                             
$45.00
                             
$50.00
    136,592             136,592       (136,592 )      
$55.00
    395,683             395,683       (395,683 )      
$60.00
    611,592             611,592       (611,592 )      
$65.00
    794,284       173,820       968,104       (794,284 )     173,820  
$70.00
    950,877       374,732       1,325,609       (950,877 )     374,732  
     
(1)   Represents the number of incremental shares that must be included in the calculation of fully diluted shares.
 
(2)   Represents the number of incremental shares to be issued by the Company upon conversion of the Convertible Notes, assuming concurrent settlement of the bond hedges and warrants.
Accounting for Uncertainty in Income Taxes
At June 30, 2010, the total amount of unrecognized tax benefits was approximately $1.8 million, of which $1.7 million would impact the effective tax rate, if recognized.
Interest and penalties associated with uncertain tax positions are recognized as components of the income tax expense in the Company’s Condensed Consolidated Statements of Operations. Tax-related interest and penalties and the related recorded liability were not material at June 30, 2010.
The Company does not have a material amount of unrecognized tax benefits for which the statute of limitations is expected to expire within the next 12 months. The remaining unrecognized tax benefits primarily include potential transfer pricing exposures from allocation of income between tax jurisdictions and potential deemed foreign dividends.
The tax years that remain subject to examination for the Company’s major tax jurisdictions are shown below:
         
Jurisdiction   Open Years  
 
United States
    2006 - 2009  
Germany
    2007 - 2009  
United Kingdom
    2006 - 2009  
Netherlands
    2005 - 2009  
The Company operates in various state and local jurisdictions. Open tax years for state and local jurisdictions approximate the open years reflected above for the United States.

 

9


Table of Contents

Subsequent Events
Accounting guidance related to subsequent events requires entities to evaluate events or transactions occurring after the balance sheet date through the date of issuance of the condensed consolidated financial statements to determine whether events require recognition or nonrecognition and disclosure. Recognition is required for the effects of all subsequent events that provide additional evidence about conditions that existed at the date of the balance sheet, including estimates inherent in the process of preparing financial statements. Nonrecognized subsequent events may require disclosure. The Company has evaluated subsequent events through the issuance date of its Condensed Consolidated Financial Statements.
New Accounting Pronouncements
In October 2009, the Financial Accounting Standards Board (FASB) issued FASB Accounting Standards Update (ASU) 2009-13, Revenue Recognition (Topic 605) related to revenue recognition for multiple deliverable revenue arrangements. The guidance must be adopted no later than the beginning of the first fiscal year beginning on or after June 15, 2010 (January 1, 2011 for the Company). The Company is currently evaluating the impact, if any, of this guidance on its consolidated financial statements.
2. Goodwill and Other Intangible Assets:
Goodwill at June 30, 2010 and December 31, 2009 consisted of the following:
                         
(In thousands)   Early Stage     Late Stage     Total  
 
                       
Balance at December 31, 2009
  $ 18,313     $ 225,276     $ 243,589  
Foreign currency translation adjustments
    14       (1,884 )     (1,870 )
 
                 
Balance at June 30, 2010
  $ 18,327     $ 223,392     $ 241,719  
 
                 

 

10


Table of Contents

Amortizable intangible assets consisted of the following:
                 
    As of June 30,     As of December 31,  
(in thousands)   2010     2009  
 
               
Amortizable intangible assets:
               
Carrying amount:
               
Customer relationships
  $ 22,174     $ 22,169  
Completed technology
    2,600       2,600  
Backlog
    6,200       6,200  
Internally developed software (a)
    18,115       17,963  
 
           
Total carrying amount
  $ 49,089     $ 48,932  
Accumulated Amortization:
               
Customer relationships
  $ (9,579 )   $ (8,098 )
Completed technology
    (2,031 )     (1,771 )
Backlog
    (6,013 )     (5,936 )
Internally developed software (a)
    (16,458 )     (16,187 )
 
           
Total accumulated amortization
  $ (34,081 )   $ (31,992 )
 
           
Net amortizable intangible assets
  $ 15,008     $ 16,940  
 
           
 
     
(a)   Internally developed software is included in Other Assets in the Company’s Condensed Consolidated Balance Sheets.
3. Debt:
In March 2010, the Company entered into a new credit agreement (the “Facility”). The Facility is comprised of a $35 million revolving loan commitment, with up to $10 million of such commitment available for issuance of letters of credit and up to $5 million of such commitment available for same-day swing line loans. At the Company’s request and with the consent of the current lender or additional lenders, the total commitment may be increased by, or incremental term loans be obtained for, up to an additional $15 million. At the Company’s election, loans under the Facility are available either at (i) an adjusted base rate plus an applicable margin; or (ii) an adjusted LIBOR plus an applicable margin. The applicable margin for each interest rate is calculated in accordance with the terms of the Facility.
The Facility, as amended on April 27, 2010, matures on March 31, 2015. Before this amendment, the Facility had the potential for accelerated maturity on January 15, 2012 in the event that five percent (5%) or more of the currently outstanding principal amount of the Convertible Notes discussed below had not been redeemed or repaid in full on or prior to January 15, 2012.
Borrowings under the Facility are collateralized by substantially all of the Company’s assets pursuant to the terms of a Pledge and Security Agreement. The Facility contains various affirmative and negative covenants including those regarding limitations on the Company’s ability to incur certain indebtedness, limitations on certain investments, limitations on capital expenditures and limitations on certain acquisitions and asset sales outside the ordinary course of business, as well as financial covenants regarding limitations on the Company’s total leverage ratio, senior secured leverage ratio and interest coverage ratio. As of June 30, 2010, the Company is in compliance with the covenants.

 

11


Table of Contents

The Company also maintains an existing $5.0 million Multicurrency Facility that is renewable annually and is used in connection with the Company’s European operations.
As of June 30, 2010 and December 31, 2009, there were no amounts outstanding under the revolving credit loan portion of the Old Facility, the Facility or the Multicurrency Facility.
In July 2007, the Company entered into a Purchase Agreement with UBS Securities LLC (the Underwriter) for the issuance and sale by the Company of $200 million, including a $25 million over-allotment of the Company’s Convertible Notes (Convertible Notes). The Convertible Notes have a maturity date of July 15, 2012 and were sold to the Underwriters at a price of $1,000 per Convertible Note, less an underwriting discount of 3% per Convertible Note.
In May 2010, the Company repurchased on the open market a portion of its Convertible Notes with a par value of $12 million for cash in the amount of $11.1 million, resulting in a loss of $71,000. Debt issuance costs of $154,000 were written off in conjunction with this repurchase. Consideration in the amount of $348,000 was allocated to the retirement of the equity component and was recorded as a reduction to additional paid in capital.
The carrying amounts of the equity and debt components were as follows:
                 
(in thousands)   As of June 30, 2010     As of December 31, 2009  
 
               
Equity component, carrying amount
  $ 35,860     $ 36,208  
 
           
 
               
Principal component, at par
  $ 142,500     $ 154,500  
Unamortized discount
    (12,229 )     (16,192 )
 
           
Principal component, carrying amount
  $ 130,271     $ 138,308  
 
           
The net carrying amounts of the Convertible Notes are classified as long-term in the accompanying Condensed Consolidated Balance Sheets. The debt discount and adjusted debt issuance costs are being amortized, using the effective interest rate method, over the term of the Convertible Notes which mature on July 15, 2012. Interest expense on the Convertible Notes has been recorded at an effective rate of 8.02%.
Interest expense recognized related to the Convertible Notes was as follows:
                                 
    For the three months     For the six months  
    ended June 30,     ended June 30,  
(in thousands)   2010     2009     2010     2009  
 
                               
Interest cost at coupon rate
  $ 1,265     $ 1,606     $ 2,568     $ 3,294  
Discount amortization
    1,406       1,675       2,856       3,427  
 
                       
Total interest expense recognized
  $ 2,671     $ 3,281     $ 5,424     $ 6,721  
 
                       

 

12


Table of Contents

4. Stock Based Compensation:
In the first six months of 2010, the Company issued 32,252 shares of time vested restricted share units (RSUs) under the 2007 Stock Incentive Plan. Of this award, 17,288 shares vest in their entirety after 18 months, 12,464 shares split-vest over 24 months and the remaining 2,500 shares vest in their entirety after 15 months. Of the 32,252 shares awarded, 5,971 RSUs were issued to retirement eligible associates and resulted in immediate vesting and expense recognition. The expense for the remaining RSUs will be recorded on a straight-line basis over the vesting period.
In the first six months of 2010, the Company issued 51,432 shares of performance-based restricted stock units. The vesting of these shares is dependent upon a performance condition, the Company meeting a certain EPS target for 2010, and a service condition, as 33% vest in March 2011, 33% vest in January 2012, and 33% vest in January 2013. If the performance condition is not met at least at the 90% of target level, the award does not vest. If the performance condition is met at greater than 90% of target level but below 100% of target level, the number of shares is adjusted to between 50% and 90% of the original award based upon the target tier level achieved. Of the total of 51,432 shares issued, 27,362 were issued to retirement eligible associates. Under the terms of the award, regardless of whether or not the performance condition is achieved, should an event similar to retirement occur during the first half of 2010, one-half of the RSUs granted would immediately vest. Similarly, should an event similar to retirement occur during the second half of 2010, the full amount of the RSUs granted would immediately vest. The Company has therefore recorded one-half of the expense for the retirement eligible associates in the first quarter of 2010 and would expect to record the second half of the expense in the third quarter of 2010. Expense for non retirement-eligible associates is being recorded over the vesting period (33 months).
The following is a summary of stock based compensation expense recorded by the Company for the following periods:
                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
(in thousands)   2010     2009     2010     2009  
Stock options
  $ 247     $ 236     $ 288     $ 285  
Non-vested restricted common stock
    150       18       604       326  
 
                       
Total stock based compensation
  $ 397     $ 254     $ 892     $ 611  
 
                       
As of June 30, 2010, there was approximately $1,516,000 of total unrecognized compensation cost, approximately $336,000 of which relates to options and $1,180,000 of which relates to non-vested common stock. The cost is expected to be recognized over a weighted-average period of 2.1 years for options and 1.4 years for non-vested common stock.

 

13


Table of Contents

Stock Options:
The following table summarizes information regarding stock option activity in the first six months of 2010:
                                 
                    Weighted     Aggregate  
            Weighted     Average     Intrinsic  
            Average     Remaining     Value  
    Shares     Exercise Price     Contractual Life     ($ in thousands)  
Options outstanding at December 31, 2009
    379,875     $ 16.44                  
Granted
    38,000       13.88                  
Canceled
    (20,640 )     22.72                  
Exercised
    (8,715 )     7.62                  
 
                       
Options outstanding at June 30, 2010
    388,520     $ 16.05       5.00     $ 708  
Exercisable at June 30, 2010
    353,170     $ 15.61       4.63     $ 708  
Substantially all of the outstanding options are expected to vest.
Under the provisions of accounting guidance pertaining to Stock Compensation, the Company is required to estimate on the date of grant the fair value of each option using an option-pricing model. Accordingly, the Black-Scholes pricing model is used with the following weighted-average assumptions:
                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
    2010     2009     2010     2009  
Dividend yield
    0 %     0 %     0 %     0 %
Expected volatility
    70.1 %     70.7 %     70.1 %     70.7 %
Risk-free interest rate
    2.1 %     2.1 %     2.1 %     2.1 %
Expected term
    3.2       3.2       3.2       3.2  
The expected volatility is based on the Company’s stock price over a historical period which approximates the expected term of the option as well as a comparison to volatility for other companies in the Company’s industry and expectations of future volatility. The risk free interest rate is based on the implied yield in U.S Treasury issues with a remaining term approximating the expected term of the option. The expected option term is calculated as the historic weighted average life of similar awards.
The total intrinsic value of stock options exercised was approximately $34,000 and $87,000 in the three and six months ended June 30, 2010, respectively, compared to approximately $46,000 and $98,000 in the three and six months ended June 30, 2009, respectively.

 

14


Table of Contents

Non-Vested Common Stock:
A summary of non-vested common stock activity during the first six months of 2010 is as follows:
Non-Vested Stock
         
    Shares  
Shares outstanding at December 31, 2009
    52,316  
Granted
    83,684  
Vested
    (850 )
Canceled
    (6,400 )
 
     
Shares outstanding at June 30, 2010
    128,750  
The weighted-average per share fair value of non-vested shares that were granted in the first six months of 2010 was $17.38 per share.
The weighted-average per share fair value (as of grant date) of non-vested shares that vested during the first six months of 2010 was $23.84 per share.
5. Fair Value of Financial Instruments:
Accounting guidance related to fair value measurements enables the reader of the financial statements to assess the inputs used to develop those measurements by establishing a hierarchy for ranking the quality and reliability of the information used to determine fair values. This guidance requires that assets and liabilities carried at fair value be classified and disclosed in one of the following three categories:
  Level 1:   Quoted market prices in active markets for identical assets or liabilities.
 
  Level 2:   Observable market based inputs or unobservable inputs that are corroborated by market data.
 
  Level 3:    Unobservable inputs that are not corroborated by market data.
The Company generally applies fair value techniques on a non-recurring basis associated with, (1) valuing potential impairment loss related to goodwill pursuant to accounting guidance related to goodwill and other intangible assets and, (2) valuing potential impairment loss related to long-lived assets accounted for pursuant to accounting guidance related to impairment or disposal of long-lived assets.
The following table summarizes the carrying amounts and fair values of certain financial assets and liabilities at June 30, 2010:
                                 
            Quoted Prices in              
            Active Markets for     Significant Other     Significant  
    Carrying     Identical Assets     Observable Inputs     Unobservable Inputs  
(in thousands)   Amount     (Level 1)     (Level 2)     (Level 3)  
 
                               
Money Market Accounts
  $ 5,706     $ 5,706     $     $  

 

15


Table of Contents

The following table summarizes the carrying amounts and fair values of certain financial assets and liabilities at December 31, 2009:
                                 
            Quoted Prices in              
            Active Markets for     Significant Other     Significant  
    Carrying     Identical Assets     Observable Inputs     Unobservable Inputs  
(in thousands)   Amount     (Level 1)     (Level 2)     (Level 3)  
 
                               
Money Market Accounts
  $ 16,627     $ 16,627     $     $  
The carrying amounts of cash, accounts receivable, and accounts payable approximate fair value. The fair value of the Company’s Convertible Notes was approximately 91% and 89% of the par value at June 30, 2010 and December 31, 2009, respectively.
6. Segment Information:
The Company operates its business in two reportable segments, Early Stage and Late Stage. The Early Stage business currently focuses on the Company’s Phase I operations, while Late Stage is comprised of contract services related to Phase II through IV clinical trials, regulatory affairs and biometrics offerings. Support and Other consists of unallocated corporate expenses, primarily information technology, marketing and communications, human resources, finance and legal.

 

16


Table of Contents

Segment information for the three and six months ended June 30, 2010 and 2009 is as follows:
                                 
    Early     Late     Support        
(in thousands)   Stage     Stage     & Other     Total  
 
                               
Three months ended June 30, 2010
                               
Net service revenues
  $ 5,932     $ 75,967     $ 546     $ 82,445  
Reimbursable out-of-pocket revenues
  $ 574     $ 28,296     $     $ 28,870  
 
                       
Total revenues
  $ 6,506     $ 104,263     $ 546     $ 111,315  
Operating income (loss)
  $ (488 )   $ 13,896     $ (12,744 )   $ 664  
 
                               
Three months ended June 30, 2009
                               
Net service revenues
  $ 7,381     $ 96,557     $ 3,413     $ 107,351  
Reimbursable out-of-pocket revenues
  $     $ 34,804     $     $ 34,804  
 
                       
Total revenues
  $ 7,381     $ 131,361     $ 3,413     $ 142,155  
Operating income (loss)
  $ (106 )   $ 18,946     $ (11,862 )   $ 6,978  
                                 
    Early     Late     Support        
(in thousands)   Stage     Stage     & Other     Total  
 
                               
Six months ended June 30, 2010
                               
Net service revenues
  $ 13,303     $ 158,071     $ 1,298     $ 172,672  
Reimbursable out-of-pocket revenues
  $ 1,164     $ 53,935     $     $ 55,099  
 
                       
Total revenues
  $ 14,467     $ 212,006     $ 1,298     $ 227,771  
Operating income (loss)
  $ (430 )   $ 30,883     $ (25,523 )   $ 4,930  
 
                               
Six months ended June 30, 2009
                               
Net service revenues
  $ 16,463     $ 193,195     $ 5,796     $ 215,454  
Reimbursable out-of-pocket revenues
  $     $ 71,762     $     $ 71,762  
 
                       
Total revenues
  $ 16,463     $ 264,957     $ 5,796     $ 287,216  
Operating income (loss)
  $ 914     $ 40,132     $ (25,931 )   $ 15,115  
Identifiable assets by segment as of June 30, 2010 and December 31, 2009 are as follows:
                 
(in thousands)   June 30, 2010     December 31, 2009  
Identifiable assets:
               
 
               
Early Stage
  $ 44,529     $ 48,070  
Late Stage
  $ 380,757     $ 406,832  
Support & Other (a)
  $ 65,979     $ 84,821  
 
           
Total assets
  $ 491,265     $ 539,723  
 
           
 
     
(a)   Primarily comprised of cash and tax-related assets.

 

17


Table of Contents

7. Restructuring Expenses:
In an effort to manage costs, the Company continues to evaluate measures to more appropriately match its workforce size to anticipated customer demand and workload and match facilities to anticipated workforce needs. As a result, the Company committed to consolidate certain of its U.K. offices and to an additional workforce action to reduce headcount, primarily in the Late Stage and Support and Other segments in the U.S. and Western Europe, in the amount of $1.2 million. Approximately half of this amount relates to the U.K. office consolidation. During the second quarter of 2010, $1.2 million was added to the accrual, $1.0 million was paid and $1.5 million remains accrued as of June 30, 2010.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The information discussed below is derived from the Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for the three and six months ended June 30, 2010 and should be read in conjunction therewith. The Company’s results of operations for a particular quarter may not be indicative of results expected during subsequent quarters or for the entire year.
Company Overview
Kendle International Inc. (the Company or Kendle) is a global clinical research organization (CRO) that delivers integrated clinical development services, including clinical trial management, clinical data management, statistical analysis, medical writing, regulatory consulting and organizational meeting management and publications services, among other services, on a contract basis to the biopharmaceutical industry. The Company operates in North America, Europe, Asia/Pacific, Latin America and Africa. The Company operates its business in two reportable operating segments, Early Stage and Late Stage. The Early Stage business currently focuses on the Company’s Phase I operations while Late Stage is comprised of clinical development services related to Phase II through IV clinical trials, regulatory affairs and biometrics and statistics offerings. The Company has aggregated its Clinical and Data Monitoring operating unit, Regulatory, Site and Medical affairs operating unit, Biostatistics and Statistical Programming operating unit and its Project Management and Late Phase operating unit into the Late Stage segment under the aggregation criteria in accounting guidance related to disclosures about segments of an enterprise and related information. The aggregation criteria met include a similar nature of services provided, a similar type of customer, similar methods used to distribute services, similar economic characteristics and a similar regulatory environment. In addition, the Company reports support functions primarily composed of unallocated corporate expenses for information technology, marketing and communications, human resources, finance and legal under the Support and Other category for purposes of segment reporting. A portion of the costs incurred by the support units are allocated to the Early and Late Stage reportable operating segments.
The Company primarily earns net service revenues through performance under Late Stage segment “full-service” contracts. The Company also recognizes revenues through limited or functional service contracts, consulting contracts, and Early Stage segment contracts. For a detailed discussion regarding the Company’s Late Stage segment contracts, Early Stage segment contracts, revenue recognition process and other Critical Accounting Policies and Estimates, please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in the Annual Report on Form 10-K for the year ended December 31, 2009.

 

18


Table of Contents

The CRO industry in general continues to be dependent on the research and development efforts of the principal pharmaceutical and biotechnology companies as major customers, and the Company believes this dependence will continue. The loss of business from any of its major customers could have a material adverse effect on the Company.
New Business Awards and Backlog
New business awards, representing new sales of our services and additional services provided on existing contracts, are added to backlog when the Company enters into a contract, letter of intent or other forms of commitments. Awards can vary significantly from quarter to quarter and contracts generally have terms ranging from several months to several years. The Company’s new business awards for the three months ended June 30, 2010 and 2009 were approximately $132 million for both periods.
In 2009 and continuing into 2010, new business awards declined significantly from historical levels due to a variety of reasons, some of which are the continued delays in and lengthening of the selling cycle. Mergers and acquisitions by and between the Company’s customers in the biopharmaceutical industry are resulting in delays in signed contracts, as well as extending the time in which our customers make final project decisions, as our customers are re-evaluating their research and development spending priorities in an effort to control costs. We believe that biopharmaceutical research and development spending has slowed from the historical levels and that growth rates in the next few years may not return to historical levels. In addition, smaller customers without large partners have experienced difficulty obtaining financing. However, we also believe that outsourcing penetration is likely to increase, as outsourcing is an effective means for our customers to reduce their costs.
In general, in 2009 and continuing into 2010, the Company experienced cancellations at a higher level than its historical norms. Cancellations have largely been outside of the Company’s control and substantially attributable to development pipeline reprioritization, lack of drug efficacy and safety and sponsor funding issues. Recent experience indicates that cancellations are beginning to moderate, however the Company remains uncertain as to whether the current level of cancellation experience will continue.
Backlog consists of new business awards for which the work has not started but is anticipated to begin in the future, as well as contracts in process that have not been completed. The average duration of the contracts in backlog fluctuates from quarter to quarter based on the contracts constituting backlog at any given time. The Company generally experiences a longer period of time between contract award and revenue recognition with respect to large contracts covering global services. Backlog at June 30, 2010 was approximately $778 million. The net book-to-bill ratio was 1.2 to 1 and .7 to 1, respectively, for the three months ended June 30, 2010 and 2009.
As discussed in “Item 1 — Backlog” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009, the Company’s backlog might never be recognized as revenue and is not necessarily a meaningful predictor of future performance.

 

19


Table of Contents

Results of Operations
Revenues
                                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
(in thousands)   2010     2009     % Decrease     2010     2009     % Decrease  
 
                                               
Net service revenues
                                               
Late stage
  $ 75,967     $ 96,557       -21.3 %   $ 158,071     $ 193,195       -18.2 %
Early stage
    5,932       7,381       -19.6 %     13,303       16,463       -19.2 %
Support & other
    546       3,413       -84.0 %     1,298       5,796       -77.6 %
 
                                   
Total net service revenues
    82,445       107,351       -23.2 %     172,672       215,454       -19.9 %
Reimbursable out-of-pocket revenues*
    28,870       34,804       -17.0 %     55,099       71,762       -23.2 %
 
                                   
Total revenues
  $ 111,315     $ 142,155       -21.7 %   $ 227,771     $ 287,216       -20.7 %
 
                                   
     
*   Reimbursable out-of-pocket revenues and expenses fluctuate from period to period, primarily due to the level of investigator activity in a particular period.
Net service revenues declined approximately $24.9 million and $42.8 million for the three and six month periods ended June 30, 2010, respectively, as a result of reduced volume of services provided, partially offset in the year to date period by benefits from foreign currency exchange rates.
Net service revenues in the Late Stage segment for the three and six month periods in 2010 decreased from the same periods of the prior year by approximately $20.6 million and $35.1 million, respectively. The declines are the result of the lower sales volume in 2009 and continuing into 2010 arising out of continued delays in the selling cycle, more specifically, advancing contracts from the awarded status to the signed contract status. The Company also experienced a significantly higher than normal cancellation rate on previously awarded studies in 2009 and continuing into 2010. In the second quarter, the Company has begun to see this rate moderate, however it is still not yet at historical or normal levels experienced by the Company or industry average. The Company believes this situation is the result of weakness in the current global economy and its customers’ cost control efforts. Additionally, pharmaceutical company mergers, as well as slowed prescription drug sales and uncertainty in the global economy, delayed customer decisions on previously awarded contracts and a slowdown in the contract signature process as pharmaceutical companies continue to re-evaluate their pipelines have contributed to reduced revenues.
Net service revenues from the Early Stage segment decreased from the same periods of the prior year by approximately $1.4 million in the current quarter and $3.2 million for the year to date, primarily due to lower sales volumes and continued project delays, similar to those discussed for the Late Stage segment.

 

20


Table of Contents

A summary of net service revenues by geographic region for the three and six months ended June 30, 2010 and 2009 is presented below.
                                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
(in thousands)   2010     2009     % Decrease     2010     2009     % Decrease  
 
                                               
North America
  $ 37,281     $ 51,707       -27.9 %   $ 79,379     $ 108,911       -27.1 %
Europe
    33,078       40,174       -17.7 %     69,703       75,658       -7.9 %
Latin America
    8,867       10,948       -19.0 %     17,212       22,987       -25.1 %
Asia-Pacific
    3,219       4,522       -28.8 %     6,378       7,898       -19.2 %
 
                                   
Total net service revenues
  $ 82,445     $ 107,351       -23.2 %   $ 172,672     $ 215,454       -19.9 %
 
                                   
As mentioned above, as a result of lower sales or new business awards in 2009, revenues in all regions decreased from the same periods of the previous year. In the second quarter of 2010, the European region’s revenues were particularly affected by the recent unfavorable exchange rate fluctuations, however this was offset by benefits in the other regions. Additionally, the decline in revenues in the Latin American region is due to the winding down and completion of several large customer projects.
The top five customers based on net service revenues contributed approximately 25% of net service revenues during both the three month and six month periods ended June 30, 2010 and 28% of net service revenues for both of the same periods of 2009. No customer accounted for more than 10% of total net service revenues in any period presented.
The Company’s results of operations are subject to volatility due to a variety of factors. The cancellation or delay of contracts and cost overruns could have adverse effects on the Condensed Consolidated Financial Statements. Fluctuations in the Company’s sales cycle and the ability to maintain large customer contracts or to enter into new contracts could negatively affect the Company’s long-term growth. For a more detailed discussion regarding the risk factors associated with the Company’s results of operations, among other things, see Item 1A-Risk Factors, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.
Operating Expenses
                                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
(in thousands)   2010     2009     % Decrease     2010     2009     % Decrease  
 
                                               
Direct costs
  $ 42,833     $ 55,204       -22.4 %   $ 90,272     $ 113,182       -20.2 %
Reimbursable out-of-pocket costs*
    28,870       34,804       -17.0 %     55,099       71,762       -23.2 %
SG&A expenses
    34,094       35,226       -3.2 %     68,831       73,256       -6.0 %
Restructuring expenses
    1,153       6,006       -80.8 %     1,153       6,006       -80.8 %
Depreciation and amortization
    3,701       3,937       -6.0 %     7,486       7,895       -5.2 %
 
                                   
Total operating expenses
  $ 110,651     $ 135,177       -18.1 %   $ 222,841     $ 272,101       -18.1 %
 
                                   
     
*   Reimbursable out-of-pocket revenues and expenses fluctuate from period to period, primarily due to the level of investigator activity in a particular period.

 

21


Table of Contents

Direct costs decreased from last year by approximately $12.4 million and $22.9 million for the three and six months ended June 30, 2010 primarily as a result of the cost savings activities initiated in 2009 and reduced work volumes. Direct costs expressed as a percentage of net service revenues were 51.9% and 51.4% for the three months ended June 30, 2010 and 2009, respectively and were 52.3% and 52.5% for the respective six month periods.
Selling, general and administrative expenses (SG&A) decreased approximately $1.1 million for the quarter ended June 30, 2010 and $4.4 million for the six month period when compared to the corresponding periods of 2009. The decrease in selling, general and administrative expenses relates primarily to the cost-savings initiatives begun in the second quarter of 2009, as discussed in more detail below. As a percentage of net service revenues, SG&A expenses were 41.3% for the quarter ended June 30, 2010 compared to 32.8% for the same period a year ago. For the year to date periods of 2010 and 2009, SG&A as a percent of revenues was 39.9% and 34.0%, respectively. SG&A as a percent of revenues has increased when compared to the previous period as a significant portion of these costs are more fixed in nature and do not tend to fluctuate with net service revenues. Additionally, in the second quarter of 2010, the Company awarded annual salary merit increases to its employees for the first time since 2008, reinstated some benefits that had previously been suspended, continued on its path to implement its new ERP system and continued to invest in its new business development and global sales organization, which partially offset the benefits of our cost savings efforts.
Beginning in the second quarter of 2009, the Company commenced several initiatives to optimize its workforce and match capacity with demand and reduce operating expenses. These activities included a reduction of discretionary spending, limiting previously planned headcount additions, delay or elimination of annual salary merit increases, reduction or elimination of other benefits, workforce reductions or furloughs, and other cost savings in an attempt to reduce expenses. In the six month periods of 2009 and 2010, the Company recorded restructuring charges totaling $6.0 million ($10.2 million for the full year 2009) and $1.2 million, respectively, for severance-related and other expenses (primarily related to facility closures). These measures resulted in lower costs in 2010 as compared to 2009. Since the bulk of the Company’s expenses are typically incurred in the Late Stage and Support and Other reportable segments, the majority of the costs removed from the business also affected those two segments.
Income from Operations
                                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
                    % Increase                     % Increase  
(in thousands)   2010     2009     (Decrease)     2010     2009     (Decrease)  
Operating income (loss)
                                               
Late stage
  $ 13,896     $ 18,946       -26.7 %   $ 30,883     $ 40,132       -23.0 %
Early stage
    (488 )     (106 )     360.4 %     (430 )     914       -147.0 %
Support & other
    (12,744 )     (11,862 )     7.4 %     (25,523 )     (25,931 )     -1.6 %
 
                                   
Total operating income
  $ 664     $ 6,978       -90.5 %   $ 4,930     $ 15,115       -67.4 %
 
                                   

 

22


Table of Contents

Income from operations declined in 2010 from 2009 primarily as a result of the decline in net service revenues, partially offset by the Company’s cost reduction efforts. Total operating margins for the three and six month periods ended June 30, 2010 were approximately 1% and 3%, respectively, compared to approximately 6.5% and 7.0% for the same periods of the prior year. As mentioned in the previous section, restructuring charges were incurred in both 2009 and 2010. Excluding the impact of these restructuring charges, operating margin for the three and six month periods of 2010 were approximately 2% and 3.5%, respectively, and approximately 12% and 10% for the same periods of 2009. See Use of Non-GAAP Measures section for the reconciliation to the U.S. GAAP measure.
Late Stage segment income from operations declined by $5.0 million and $9.3 million for the quarter and year to date periods ended June 30, 2010, respectively, when compared to the same periods of the prior year. As discussed in earlier sections, lower sales or new business award volumes in 2009 have manifested in lower actual revenues in 2010. The impact of the decline in revenues exceeded the cost reduction efforts resulting in lower operating income. Operating margin for the three and six month periods ended June 30, 2010 for the Late Stage segment were approximately 18% and 19.5%, respectively, compared to approximately 20% and 21% for the same periods of the prior year.
Early Stage operating results declined significantly in 2010 from the same periods in 2009 as a result of the decline in net service revenues, partially offset by cost reduction efforts. Early Stage operations generally have higher fixed costs making a decline in revenues more difficult to absorb. Operating margins for the three and six month periods ended June 30, 2010 for the Early Stage segment were approximately (8)% and (3)%, respectively, compared to approximately (1)% and 6% for the same periods of the prior year.
Other Income (Expense)
                                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
                    Increase                     Increase  
(in thousands)   2010     2009     (Decrease)     2010     2009     (Decrease)  
Other income (expense)
                                               
Interest income
  $ 33     $ 133     $ (100 )   $ 55     $ 363     $ (308 )
Interest expense
    (2,871 )     (3,728 )     857       (6,099 )     (7,604 )     1,505  
Gain on extinguishment of debt
          3,133       (3,133 )           3,133       (3,133 )
Foreign currency gains / (losses)
    5,655       1,287       4,368       7,525       4,877       2,648  
Other expenses
    (252 )     (258 )     6       (402 )     (683 )     281  
 
                                   
Total other income (expense)
  $ 2,565     $ 567     $ 1,998     $ 1,079     $ 86     $ 993  
 
                                   
Interest Expense
The primary component of interest expense is interest on the Company’s 3.375% Convertible Notes issued in 2007. Interest expense on the Convertible Notes was recorded at an effective rate of 8.02%. During the quarter and six months ended June 30, 2010, the amount of interest expense recognized for the contractual interest rate and the discount amortization totaled $2.7 million and $5.4 million, respectively. During the quarter and six months ended June 30, 2009, the amount of interest expense recognized for the contractual interest rate and the discount amortization totaled $3.3 million and $6.7 million, respectively. The decrease in interest expense from the previous year is due to the Company’s repurchases of Convertible Notes on the open market, which reduced the principal balance outstanding. See discussion about the Company’s open market repurchase transaction completed in the second quarter of 2010 in the Liquidity and Capital Resources section below. The remainder of interest expense relates to interest on capital lease obligations and amortization of debt issuance costs, net of capitalized interest.

 

23


Table of Contents

Foreign Currency
The Company incurs foreign currency exchange gains and losses as part of the normal course of business as it has subsidiaries in many countries outside the U.S. The exchange rate transaction gains and losses typically occur when the Company holds assets in a currency other than the functional currency of the reporting location or as a result of regional cash pooling arrangements. In the three and six month periods of 2010, these foreign exchange transactions resulted in net gains of $5.7 million and $7.5 million, respectively, as compared to $1.3 million and $4.9 million, respectively, for the same periods of 2009. The foreign exchange gains are due primarily to the strengthening of most currencies against the Euro in the second quarter. The U.S. dollar strengthened against the Euro by approximately 10% when comparing June 30, 2010 to March 31, 2010 and the British Pound Sterling strengthened against the Euro by approximately 9% when comparing the same dates. The Company’s U.S. subsidiaries have a significant amount of Euro denominated payables owed to subsidiaries with a functional currency of Euro. The strengthening of the U.S. dollar resulted in a gain in the second quarter of 2010 on these intercompany balances. Additionally, one of the Company’s U.K. subsidiaries with a functional currency of British Pounds, has Euro-based liabilities with a U.S. dollar equivalent amount of $20.4 million. As a result of the British Pound strengthening against the Euro, the Company recorded significant unrealized foreign currency exchange gains in the second quarter of 2010 on this balance also.
In the first quarter of 2009, the Company terminated an intercompany loan and unwound related foreign currency hedges. As a result of these actions, $1.7 million in foreign exchange losses were recorded for the first quarter of 2009. This loss is included in the year to date gains for 2009 mentioned above.
Income Taxes
The effective income tax rate was 42.3% in the quarter ended June 30, 2010, compared to 57.7% in the quarter ended June 30, 2009. Tax expense for June 30, 2009 included approximately $1.0 million related to the gain on extinguishment of debt recorded in that period.
The effective income tax rate was 48.8% for the six months ended June 30, 2010 and 73.2% for the same period of the prior year. Included in the Company’s tax expense for 2010 of approximately $2.9 million is a charge of approximately $400,000 related to the expiration of certain tax legislation that occurred on December 31, 2009. A proposal to extend this legislation retroactively to January 1, 2010 has been included in various tax proposals considered by Congress during 2010, however such legislation has not been enacted as of June 30, 2010. Should tax legislation providing an extension be enacted in the second half of 2010, the Company will adjust its tax expense discretely in the quarter in which such legislation is passed. Such an adjustment could have a material effect on the Company’s tax expense in that quarter. Tax expense for the year to date period ended June 30, 2009 included discrete tax expense of approximately $4.4 million related to the unwinding of certain foreign currency hedge agreements and related intercompany notes, as well as $1.0 million of tax expense related to the extinguishment of debt.

 

24


Table of Contents

The Company continues to maintain full valuation allowances against the net operating losses incurred in some of its subsidiaries. The Company also maintains valuation allowances for portions of its foreign tax credits that are not expected to be realizable. Because Kendle operates on a global basis, the effective tax rate varies from quarter to quarter based on the relative mix of pretax earnings or losses at the various locations.
Net Income
The net income for the quarter ended June 30, 2010 was approximately $1.9 million, or $0.13 and $0.12 per basic and diluted share. Net income for the quarter ended June 30, 2009 was $3.2 million or $0.22 and $0.21 per basic and diluted share.
The net income for the six months ended June 30, 2010 was approximately $3.1 million, or $0.21 and $0.20 per basic and diluted share. Net income for the same period of the prior year was $4.1 million or $0.27 per basic and diluted share.
Liquidity and Capital Resources
Cash Flows
Cash and cash equivalents decreased by $19.9 million at June 30, 2010 when compared with December 31, 2009, primarily the result of cash provided by operating activities of $6.4 million, net of cash used in investing and financing activities of $13.4 million and $10.9 million, respectively. Foreign exchange rates had a negative impact on cash and cash equivalents in the six months of 2010 of approximately $2.0 million. At June 30, 2010, cash and cash equivalents were $32.2 million. In addition, the Company has approximately $.7 million in restricted cash that represents cash received from customers that is segregated in separate Company bank accounts and available for use only for specific project expenses.
Net cash provided by operating activities for the period consisted primarily of net income adjusted for noncash expenses such as depreciation and amortization combined with a reduction in net accounts receivable. Total noncash depreciation, amortization and debt issuance cost amortization totaled $11.4 million for the six months ended June 30, 2010. Fluctuations in accounts receivable and advance billings occur on a regular basis as services are performed, milestones or other billing criteria are achieved, invoices are sent to customers, and payments for outstanding accounts receivable are collected from customers. Such activity varies by individual customer and contract. Accounts receivable, net of advance billings, was approximately $29.6 million at June 30, 2010, and $49.1 million at December 31, 2009. The decrease in accounts receivable was primarily due to the decline in revenues. The Company has been and continues to be vigilant in monitoring and collecting its accounts receivable. The other significant change affecting operating cash flows was severance payments made as discussed in Note 7 in the Notes to the Condensed Consolidated Financial Statements and the settlement of a liability related to the customer issue discussed in the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2010.
Investing activities for the six months ended June 30, 2010 consisted primarily of $11.0 million in cash used for capital expenditures, the majority of which relates to computer equipment and software purchases, including internally developed software, and $2.4 million for the final payment related to the earnout agreement from the 2008 DecisionLine acquisition.

 

25


Table of Contents

Financing activities for the six months ended June 30, 2010 consisted primarily of $11.1 million in cash used to repurchase a portion of the Company’s Convertible Notes on the open market discussed in the next section below.
Capital Resources
On March 15, 2010, the Company terminated its existing credit agreement (including all amendments and related agreements, the “Old Facility”) and entered into a new credit agreement (the “Facility”). The Facility is comprised of a $35 million revolving loan commitment, with up to $10 million of such commitment available for issuance of letters of credit and up to $5 million of such commitment available for same-day swing line loans. At the Company’s request and with the consent of the current lender or additional lenders, the total commitment may be increased by, or incremental term loans be obtained for, up to an additional $15 million. At the Company’s election, loans under the Facility are available either at (i) an adjusted base rate plus an applicable margin; or (ii) an adjusted LIBOR plus an applicable margin. The applicable margin for each interest rate is calculated in accordance with the terms of the Facility.
The Facility, as amended on April 27, 2010, matures on March 31, 2015. Before the amendment, the Facility had the potential for accelerated maturity on January 15, 2012 in the event that five percent (5%) or more of the currently outstanding principal amount of the Convertible Notes discussed below had not been redeemed or repaid in full on or prior to January 15, 2012.
Borrowings under the Facility are collateralized by substantially all of the Company’s assets pursuant to the terms of a Pledge and Security Agreement. The Facility contains various affirmative and negative covenants including those regarding limitations on the Company’s ability to incur certain indebtedness, limitations on certain investments, limitations on capital expenditures and limitations on certain acquisitions and asset sales outside the ordinary course of business, as well as financial covenants regarding limitations on the Company’s total leverage ratio, senior secured leverage ratio and interest coverage ratio. The Company is in compliance with the covenants as of June 30, 2010.
The Company also maintains an existing $5.0 million Multicurrency Facility that is renewable annually and is used in connection with the Company’s European operations.
As of June 30, 2010 and December 31, 2009, there were no amounts outstanding under the revolving credit loan portion of the Old Facility, the Facility or the Multicurrency Facility.
In the second quarter of 2010, the Company repurchased a total of $12 million in par value of its Convertible Notes on the open market for $11.1 million. The amortized carrying value of these repurchased notes exceeded the consideration allocated to the debt component resulting in a $71,000 loss. As part of the repurchase transaction, the proportionate share of debt issuance costs of $154,000 was written off. This transaction is expected to result in reduced cash interest expense and noncash discount amortization of $600,000 in the current year and a total of $2.1 million over the remaining term of the Convertible Notes. Of the consideration paid to repurchase the Convertible Notes, $348,000 was allocated to the equity component. This is considered to be a reacquisition of a portion of the equity component of the Convertible Notes and as such is recorded as a reduction of additional paid in capital.

 

26


Table of Contents

Including the above mentioned repurchase transaction, in 2009 and 2010, the Company has repurchased a total of $57.5 million in par value of its Convertible Notes for cash totaling $47.6 million. At June 30, 2010, the remaining outstanding balance, at par value, is $142.5 million. As a result of this repurchase program, which commenced in the second quarter of 2009, the Company will reduce its interest expense by $13.0 million over the term of the Convertible Notes, $3.4 million of which has already been realized through June 30, 2010.
The Company’s primary cash needs on both a short-term and long-term basis are for the payment of salaries and fringe benefits, business development costs, capital expenditures, hiring and recruiting expenses, acquisitions and facility-related expenses. The Company believes that its existing capital resources, together with cash flows from operations and borrowing capacity under the Facility and the Multicurrency Facility, will be sufficient to meet its foreseeable cash needs for both the short and long term.
The Company has not historically experienced regular liquidity or collections issues with the large majority of its customers. However, the Company does have contracts with biotechnology and small pharmaceutical companies, some of which are dependent upon external financing to fund their contractual commitments. The Company is continuing to monitor the financial status of its customers.
As more of the Company’s revenues are generated in locations other than the U.S., repatriation of those cash flows in a tax efficient manner is increasingly challenging. The Company is continually evaluating strategies to enable it to repatriate non-U.S. cash flows in a tax efficient manner.
In the future, the Company will continue to consider the acquisition of businesses to enhance its service offerings, therapeutic base and global presence. Any such acquisitions may require additional external financings and the Company may from time to time seek to obtain funds from public or private issuances of equity or debt securities. There can be no such assurances that financings will be available on terms acceptable to the Company.
Market Risk and Derivative Instruments
Interest Rates
The Company is exposed to changes in interest rates on any amounts outstanding under the Facility and Multicurrency Facility. At June 30, 2010, no amounts were outstanding under either the Facility or the Multicurrency Facility.
Foreign Currency
The Company operates on a global basis and is therefore exposed to various types of currency risks. There are specific transaction risks which arise from the nature of the contracts the Company executes with its customers. From time to time contracts are denominated in a currency different than the particular local currency. This contract currency denomination issue is applicable only to a portion of the contracts executed by the Company.
The first risk occurs as revenue recognized for services rendered is denominated in a currency different from the currency in which the subsidiary’s expenses are incurred. As a result, the subsidiary’s net service revenues and resultant net income or loss can be affected by fluctuations in exchange rates.

 

27


Table of Contents

The second risk results from the passage of time between the invoicing of customers under these contracts and the ultimate collection of customer payments against such invoices. Because the contract is denominated in a currency other than the subsidiary’s local currency, the Company recognizes a receivable at the time of invoicing at the local currency equivalent of the foreign currency invoice amount. Changes in exchange rates from the time the invoice is prepared until the payment from the customer is received will result in the Company receiving either more or less in local currency than the local currency equivalent of the invoice amount at the time the invoice was prepared and the receivable established. This difference is recognized by the Company as a foreign currency transaction gain or loss, as applicable, and is reported in Other Income (Expense) in the Condensed Consolidated Statements of Operations.
A third type of transaction risk arises from transactions denominated in multiple currencies between any two of the Company’s various subsidiary locations. For each subsidiary, the Company maintains an intercompany receivable and payable, which is denominated in multiple currencies. Changes in exchange rates from the time the intercompany receivable/payable balance arises until the balance is settled or measured for reporting purposes, results in exchange rate gains and losses. This intercompany receivable/payable arises when work is performed by a Kendle location in one country on behalf of a Kendle location in a different country under contract with the customer. Additionally, there are occasions when funds are transferred between subsidiaries for working capital purposes. The foreign currency transaction gain or loss is reported in Other Income (Expense) in the Condensed Consolidated Statements of Operations.
The Company does not currently have hedges in place to mitigate exposure due to foreign exchange rate fluctuations. Due to uncertainties regarding the timing of and currencies involved in the majority of the Company’s foreign exchange rate transactions, it is impracticable to implement hedging instruments to match the Company’s foreign currency inflows and outflows. The Company has implemented procedures intended to mitigate the impact of foreign currency exchange rate fluctuations including an intercompany procedure to allow for regular settlement of intercompany balances where practical. The Company will continue to evaluate ways to mitigate the risk of this impact in the future.
The Company’s Condensed Consolidated Financial Statements are denominated in U.S. dollars. Accordingly, changes in exchange rates between the applicable foreign currency and the U.S. dollar will affect the translation of each foreign subsidiary’s financial results into U.S. dollars for purposes of reporting Condensed Consolidated Financial Statements. The Company’s foreign subsidiaries translate their financial results from local currency into U.S. dollars as follows: income statement accounts are translated at average exchange rates for the period; balance sheet asset and liability accounts are translated at end of period exchange rates; and equity accounts are translated at historical exchange rates. Translation of the balance sheet in this manner affects the shareholders’ equity account referred to as the foreign currency translation adjustment account. This account exists only in the foreign subsidiaries’ U.S. dollar balance sheet and is necessary to keep the foreign subsidiaries’ balance sheet stated in U.S. dollars in balance. Foreign currency translation adjustments, which are reported as a separate component of Shareholders’ Equity, were approximately $13.4 million at June 30, 2010 and $22.2 million at December 31, 2009.

 

28


Table of Contents

Use of Non-GAAP Financial Measures
The Results of Operations section of this Quarterly Report on Form 10-Q may, from time to time, contain adjustments to amounts calculated in accordance with generally accepted accounting principles (“GAAP”) in the United States. The Company’s management believes that investors’ understanding of the Company’s performance is enhanced by disclosing these non-GAAP financial measures as a reasonable basis for comparison of ongoing results of operations. Non-GAAP measures should not be considered a substitute for GAAP-based measures and results. The Company’s non-GAAP measures may not be comparable to non-GAAP measures of other companies.
A reconciliation between GAAP financial measures and non-GAAP financial measures is as follows:
Reconciliation of pro forma income from operations:
                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
    2010     2009     2010     2009  
 
                               
Income from operations, as reported
  $ 664     $ 6,978     $ 4,930     $ 15,115  
Restructuring expense
    1,153       6,006       1,153       6,006  
 
                       
Pro forma income from operations
  $ 1,817     $ 12,984     $ 6,083     $ 21,121  
 
                       
 
                               
Pro forma operating margin
    2.2 %     12.1 %     3.5 %     9.8 %
Restructuring Expense
Non-GAAP operating income excludes restructuring costs, primarily costs related to facility consolidations and employee severance costs. Restructuring costs have occurred in prior periods and may or may not occur in future periods. Management believes this presentation provides a reasonable basis for comparison of ongoing results of operations and is helpful for understanding the Company’s performance.
Cautionary Statement for Forward-Looking Information
Certain statements contained in this Quarterly Report on Form 10-Q that are not historical facts constitute forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, and are intended to be covered by the safe harbors created by that Act. Reliance should not be placed on forward-looking statements because they involve known and unknown risks, uncertainties and other factors that may cause actual results, performance or achievements to differ materially from those expressed or implied. Any forward-looking statement speaks only as of the date made. The Company undertakes no obligation to update any forward-looking statements to reflect events or circumstances arising after the date on which they are made.

 

29


Table of Contents

Statements concerning expected financial performance, on-going business strategies and possible future action which the Company intends to pursue to achieve strategic objectives constitute forward-looking information. Implementation of these strategies and the achievement of such financial performance are each subject to numerous conditions, uncertainties and risk factors.
Factors that could cause actual performance to differ materially from these forward-looking statements include those risk factors set forth in Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009, which risk factors may be updated from time to time by the Company’s Quarterly Reports on Form 10-Q.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
See Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this Quarterly Report on Form 10-Q and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Company’s Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in the Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Quarterly Report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are effective and designed to ensure that material information relating to the Company and the Company’s consolidated subsidiaries are made known to them by others within those entities.
Changes in Internal Control
In addition, the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, has determined that there were no changes in the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the internal controls over financial reporting during the period covered by this report.
The Company is in the process of implementing a new enterprise resource planning (ERP) system which will be implemented in phases which commenced in the second quarter of 2010. This conversion will affect key financial reporting applications such as general ledger and revenue recognition applications, among others. The Company expects the transition from legacy systems to continue throughout the year and be substantially completed by the end of 2010. The Company is evaluating, and will continue to evaluate, the impact of the implementation on its internal controls related to financial reporting. At this juncture, the Company does not anticipate any adverse impact.

 

30


Table of Contents

Part II. Other Information
Item 1.    Legal Proceedings

The Company is party to lawsuits and administrative proceedings incidental to the normal course of business. The Company currently is not a party to any pending material proceedings under Item 103 of Regulation S-K.
Item 1A.    Risk Factors

There have been no material changes from the information previously reported under Item 1A of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009.
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds

None
Item 3.    Defaults upon Senior Securities

Not applicable
Item 4.    Removed and Reserved
Item 5.    Other Information

None
Item 6.    Exhibits
         
Exhibit       Filing
Number   Description of Exhibit   Status
31.1
  Certificate of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002   A
 
31.2
  Certificate of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002   A
 
32.1
  Certificate of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002   A
 
32.2
  Certificate of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002   A
     
Filing    
Status   Description of Filing Status
 
   
A
  Filed herewith

 

31


Table of Contents

SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
         
  KENDLE INTERNATIONAL INC.
 
 
  By:   /s/ Candace Kendle    
Date: August 9, 2010    Candace Kendle, PharmD   
    Chairman of the Board and Chief Executive Officer   
 
         
     
  By:   /s/ Keith A. Cheesman    
Date: August 9, 2010    Keith A. Cheesman   
    Senior Vice President - Chief Financial Officer   

 

32


Table of Contents

         
KENDLE INTERNATIONAL INC.
Exhibit Index
     
Exhibits   Description
 
   
31.1
  Certificate of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
31.2
  Certificate of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
32.1
  Certificate of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
32.2
  Certificate of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

33