Kendle International 10Q 2007 Q3 Quarterly report

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 September 30, 2007


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 number000-23019

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 1200, Cincinnati, Ohio		45202

(Address of principal executive offices)		Zip Code

Registrant’s telephone number, including area code(513) 381-5550

(Former name or former address, 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. Yesþ Noo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filero Accelerated filerþ Non-accelerated filero

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 14,608,952 shares of Common Stock, no par value, as of October 30, 2007.

KENDLE INTERNATIONAL INC.

Index


		Page
Part I. Financial Information

Item 1. Financial Statements (Unaudited)

Condensed Consolidated Balance Sheets –September 30, 2007 and December 31, 2006		3

Condensed Consolidated Statements of Operations – Three Months Ended September 30, 2007 and 2006; Nine Months Ended September 30, 2007 and 2006		4

Condensed Consolidated Statements of Comprehensive Income – Three Months Ended September 30, 2007 and 2006; Nine Months Ended September 30, 2007 and 2006		5

Condensed Consolidated Statements of Cash Flows – Nine Months Ended September 30, 2007 and 2006		6

Notes to Condensed Consolidated Financial Statements		7

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		22

Item 3. Quantitative and Qualitative Disclosure About Market Risk		42

Item 4. Controls and Procedures		42

Part II. Other Information

Item 1. Legal Proceedings		43

Item 1A. Risk Factors		43

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		48

Item 3. Defaults upon Senior Securities		48

Item 4. Submission of Matters to a Vote of Security Holders		48

Item 5. Other Information		48

Item 6. Exhibits		48

Signatures		50

Exhibit Index		51
EX-31.1
EX-31.2
EX-32.1
EX-32.2

KENDLE INTERNATIONAL INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)


	September 30,			December 31,
(in thousands, except share data)	2007			2006
ASSETS
Current assets:
Cash and cash equivalents	$	27,907		$	19,917
Restricted cash		1,175			2,395
Accounts receivable		146,645			122,680
Other current assets		20,448			21,684

Total current assets		196,175			166,676

Property and equipment, net		27,073			23,024
Goodwill		230,280			229,598
Other finite-lived intangible assets, net		20,633			24,227
Other assets		19,394			11,547

Total assets	$	493,555		$	455,072


LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Current portion of obligations under capital leases	$	200		$	195
Current portion of amounts outstanding under credit facilities		—			2,000
Trade payables		14,323			15,150
Advance billings		82,999			62,427
Other accrued liabilities		52,569			30,500

Total current liabilities		150,091			110,272
Obligations under capital leases, less current portion		303			404
Long-term debt		—			197,500
Convertible note		200,000			—
Other noncurrent liabilities		10,139			6,784

Total liabilities		360,533			314,960


Commitments and contingencies

Shareholders’ equity:
Preferred stock — no par value; 100,000 shares authorized; no shares issued and outstanding
Common stock — no par value; 45,000,000 shares authorized; 14,602,944 and 14,445,393 shares issued and 14,579,892 and 14,422,341 outstanding at September 30, 2007 and December 31, 2006, respectively		75			75
Additional paid in capital		139,959			154,641
Accumulated deficit		(8,333	)		(16,392	)
Accumulated other comprehensive income:
Foreign currency translation adjustment		1,813			2,280
Less: Cost of common stock held in treasury, 23,052 shares at September 30, 2007 and December 31, 2006, respectively		(492	)		(492	)

Total shareholders’ equity		133,022			140,112

Total liabilities and shareholders’ equity	$	493,555		$	455,072

The accompanying notes are an integral part of these condensed consolidated financial statements.

KENDLE INTERNATIONAL INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)


	For the Three Months Ended						For the Nine Months Ended
	September 30,						September 30,
(in thousands, except per share data)	2007			2006			2007			2006
Net service revenues	$	100,070		$	75,236		$	293,311		$	197,075
Reimbursable out-of-pocket revenues		42,366			21,497			120,864			58,774

Total revenues		142,436			96,733			414,175			255,849


Costs and expenses:
Direct costs		49,119			40,941			150,062			105,721
Reimbursable out-of-pocket costs		42,366			21,497			120,864			58,774
Selling, general and administrative expenses		32,830			23,402			94,571			63,244
Depreciation and amortization		3,876			2,800			11,065			6,344

		128,191			88,640			376,562			234,083

Income from operations		14,245			8,093			37,613			21,766

Other income (expense):
Interest income		341			438			1,108			1,617
Interest expense		(3,316	)		(2,283	)		(11,988	)		(2,397	)
Write-off of deferred financing costs		(4,152	)		—			(4,152	)		—
Other		(2,076	)		(259	)		(4,388	)		(652	)

Income before income taxes		5,042			5,989			18,193			20,334
Income tax expense		1,256			1,992			5,872			7,149

Net income	$	3,786		$	3,997		$	12,321		$	13,185


Income per share data:
Basic:
Net income per share	$	0.26		$	0.28		$	0.85		$	0.92


Weighted average shares		14,534			14,371			14,483			14,294

Diluted:
Net income per share	$	0.25		$	0.27		$	0.83		$	0.89


Weighted average shares		14,895			14,789			14,864			14,756

The accompanying notes are an integral part of these condensed consolidated financial statements.

KENDLE INTERNATIONAL INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)


	For the Three Months Ended				For the Nine Months Ended
	September 30,				September 30,
(in thousands)	2007		2006		2007			2006
Net income	$	3,786	$	3,997	$	12,321		$	13,185

Other comprehensive income:

Foreign currency translation adjustment		134		19		(467	)		822

Net unrealized holding gains on available-for-sale securities arising during the period, net of tax		—		25		—			39

Net unrealized holding losses on interest rate swap agreement		—		—		—			(7	)


Comprehensive income	$	3,920	$	4,041	$	11,854		$	14,039

The accompanying notes are an integral part of these condensed consolidated financial statements.

KENDLE INTERNATIONAL INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)


	For the Nine Months Ended
	September 30,
(in thousands)	2007			2006
Net cash provided by operating activities	$	38,113		$	17,089


Cash flows from investing activities:
Proceeds from sale and maturity of available-for-sale securities		—			17,868
Purchase of available-for-sale securities		—			(7,027	)
Acquisitions of property and equipment		(10,522	)		(6,077	)
Additions to internally developed software		(250	)		(50	)
Acquisitions of businesses, less cash received		2,154			(228,772	)
Other		136			13

Net cash used in investing activities		(8,482	)		(224,045	)


Cash flows from financing activities:
Proceeds from credit facilities		—			200,000
Repayments under credit facilities		(199,500	)		(3,750	)
Issuance of long-term debt		200,000			—
Net proceeds from book overdraft		143			49
Proceeds from issuance of warrants		24,740			—
Purchase of note hedges		(42,880	)		—
Debt issue costs		(6,939	)		(5,565	)
Purchase of treasury stock		—			(99	)
Income tax benefit from stock option exercises		811			847
Proceeds from issuance of common stock		1,735			3,157
Payments on capital lease obligations		(146	)		(328	)

Net cash provided by (used in) financing activities		(22,036	)		194,311


Effects of exchange rates on cash and cash equivalents		395			465

Net increase (decrease) in cash and cash equivalents		7,990			(12,180	)
Cash and cash equivalents:
Beginning of period		19,917			37,437

End of period	$	27,907		$	25,257

The accompanying notes are an integral part of these condensed consolidated financial statements.

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 for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America 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 three and nine months ended September 30, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007. For further information, refer to the Consolidated Financial Statements and notes thereto included in the Form 10-K for the year ended December 31, 2006 filed by Kendle International Inc. (“the Company”) with the Securities and Exchange Commission.

The condensed consolidated balance sheet at December 31, 2006 has been derived from the audited financial statements at that date but does not include all of the information and notes required by accounting principles generally accepted in the United States of America 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.

The following table sets forth the computation for basic and diluted EPS (in thousands, except per share information):


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2007		2006		2007		2006
Basic earnings per share calculation:
Net income	$	3,786	$	3,997	$	12,321	$	13,185
Weighted average shares outstanding for basic computation		14,534		14,371		14,483		14,294

Earnings per share — basic	$	0.26	$	0.28	$	0.85	$	0.92

Diluted earnings per share calculation:
Net income	$	3,786	$	3,997	$	12,321	$	13,185
Weighted average shares outstanding		14,534		14,371		14,483		14,294
Dilutive effect of stock options and restricted stock		361		418		381		462

Weighted average shares outstanding for diluted EPS computation		14,895		14,789		14,864		14,756


Earnings per share — assuming dilution	$	0.25	$	0.27	$	0.83	$	0.89

Under EITF 04-8, The Effect of Contingently Convertible Instruments on Diluted Earnings Per Share, and EITF 90-19, and because of the Company’s obligation to settle the par value of its Convertible Notes (defined in Note 4) 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 stock 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 (see Note 4 for full description of Convertible Notes). These conditions have not been met as of the quarter-ended September 30, 2007. 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:


							Shares Due to the
	Convertible Notes		Warrant		Total Treasury Method		Company under Note			Incremental Shares Issued by the
Share Price	Shares		Shares		Incremental Share (1)		Hedges			Company Upon Conversion (2)

$40.00		—		—		—		—		—
$45.00		—		—		—		—		—
$50.00		191,993		—		191,993		(191,993	)	—
$55.00		555,630		—		555,630		(555,630	)	—
$60.00		858,660		—		858,660		(858,660	)	—
$65.00		1,115,070		245,070		1,360,140		(1,115,070	)		245,070
$70.00		1,334,850		526,993		1,861,843		(1,334,850	)		526,993


(1)		Represents the number of incremental shares that must be included in the calculation of fully diluted shares under U.S. Generally Accepted Accounting Principles.


(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.

Foreign Currency Hedges

In the first quarter of 2007, the Company entered into foreign currency hedging transactions to mitigate exposure in movements between the U.S dollar and British Pounds Sterling and U.S. dollar and Euro. The hedging transactions are designated to mitigate the Company’s exposure related to two intercompany notes between the Company’s U.S. subsidiary, as lender, and the Company’s subsidiaries in each of the United Kingdom and Germany. The note between the Company’s U.S. subsidiary and United Kingdom subsidiary is denominated in Pounds Sterling and had an outstanding principal amount of approximately $60.9 million at September 30, 2007. The note between the Company’s U.S. subsidiary and German subsidiary is denominated in Euro and had an outstanding principal amount of approximately $25.5 million at September 30, 2007. The hedge agreements do not qualify for hedge accounting treatment under SFAS No. 133 and all changes in the fair market value of the hedge will be recorded in the Company’s Condensed Consolidated Statements of Operations. In the third quarter and first nine months of 2007, the Company recorded losses of approximately $1.1 million and $1.9 million, respectively on the Euro hedge transaction and $910,000 and $2.1 million, respectively on the Pound Sterling hedge transaction related to the changes in the fair market value of the hedges. In the third quarter and first nine months of 2007, the losses on the fair market value of the hedge were offset by foreign exchange gains of $1.3 million and $2.1 million, respectively on the change in fair value of the Euro intercompany note, and $840,000 and $2.1 million, respectively on the change in fair value of the Pounds Sterling intercompany note.

New Accounting Pronouncements

In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 159, “Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”). Under SFAS No. 159, entities may choose to measure at fair value many financial instruments and certain other items that are not currently required to be measured at fair value. SFAS No. 159 also establishes recognition, presentation, and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 does not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value. SFAS No. 159 is effective for the Company as of January 1, 2008. At this time, the Company is currently evaluating the impact of SFAS No. 159 on its consolidated financial statements.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 provides a new, single authoritative definition of fair value and provides enhanced guidance for measuring the fair value of assets and liabilities. It requires additional disclosures related to the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value and the effect of fair value measurements on earnings. SFAS No. 157 is effective for the Company as of January 1, 2008. At this time, the Company is currently evaluating the impact of SFAS No. 157 on its consolidated financial statements.

On July 13, 2006, the FASB issued FASB Interpretation (“FIN”) No. 48 “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement 109.” FIN No. 48 establishes a single model to address accounting for uncertainty in tax positions. FIN No. 48 clarifies the accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on de-recognition, measurement,

classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN No. 48 is effective for fiscal years beginning after December 15, 2006.

On January 1, 2007, the Company adopted the provisions of FIN No. 48. The cumulative effect of adoption was a $4.3 million increase of accumulated deficit. At January 1, 2007, the total amount of unrecognized tax benefits was $6.8 million, of which $4.6 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.” The Company’s accrual for interest and penalties was $463,000 upon adoption of FIN No. 48 and an additional $144,000 was accrued in 2007.

In the third quarter of 2007, approximately $833,000 of tax liabilities, including $221,000 of accrued interest, were reversed as required by FIN No. 48. The liabilities were established as of January 1, 2007 as part of the initial adoption of FIN 48; however, during third quarter 2007, the time period for assessing tax on these items expired, necessitating the reversal.

The Company has approximately $1.5 million in unrecognized tax benefits for which the statute of limitations is expected to expire within the next 12 months. Expiration of the statute of limitations on some or all of these unrecognized tax benefits may cause a material impact on the Company’s effective tax rate in a particular period.

The tax years that remain subject to examination for the Company’s major tax jurisdictions are shown below:


Jurisdiction		Open Years
United States		2002, 2004 - 2006
Germany		2003 - 2006
United Kingdom		2005 - 2006
Netherlands		2004 - 2006

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.

2. Acquisitions:

Acquisition of International Clinical Research Limited and related companies:

In April 2006, the Company completed its acquisition of Latin America CRO International Clinical Research Limited and its related companies (“IC-Research”). At the time of acquisition, IC-Research was a CRO in Latin America with operations in Argentina, Brazil, Chile and Colombia. The acquisition supports the Company’s goal of strategic business expansion and diversification in high-growth regions to deliver global clinical trials for its customers. IC-Research was integrated as part of the Company’s Late Stage segment.

The acquisition closed in April 2006. The aggregate purchase price was approximately $971,000 in cash, including acquisition costs. In addition, there is an earnout provision, with a maximum additional amount to be paid of $260,000 as well as an additional contingent payment of $100,000. To date, the Company

has paid out approximately $70,000 of the earnout and contingency provisions. In the first nine months of 2007, the Company accrued approximately $74,000 to record the additional contingency provision amount earned. The additional goodwill amounts were recorded in the financial statements in the first nine months of 2007.

The following table summarizes the fair values of the assets acquired and liabilities assumed at the date of acquisition. Contingent payments discussed above are not included in the purchase price allocation table below. A third party was used to assist the Company in valuing the intangible assets.

Purchase Price Allocation:


(in thousands at the prevailing exchange rate at April 25, 2006):
Current assets	$	94
Property, plant and equipment		9
Intangible assets		500
Goodwill		418

Total assets acquired		1,021
Current liabilities		(50	)

Net assets acquired	$	971

Acquisition of Phase II-IV Clinical Services Business of Charles River Laboratories International, Inc.:

In August 2006, the Company acquired the Phase II-IV Clinical Services business of Charles River Laboratories International, Inc (“CRL Clinical Services”). The acquisition was expected to strengthen the Company’s position as one of the leading global players in the clinical development industry, adding therapeutic expertise, diversifying its customer base and expanding its capacity to deliver large global trials. The total purchase price, including acquisition costs and the working capital adjustment, in which the Company paid for any working capital in excess of $2.0 million, was approximately $236 million. The Company financed the purchase with $200 million in term debt as well as its existing cash and proceeds from the sale of available-for-sale securities.

The following table summarizes the fair values of the assets acquired and liabilities assumed at the date of acquisition. A third party was used to assist the Company in valuing the intangible assets.

Purchase Price Allocation:


(in thousands at the prevailing exchange rate at August 16, 2006):
Accounts receivable	$	23,221
Other current assets		16,463
Property, plant and equipment		4,427
Other long-term assets		2,851
Intangible assets		19,100
Goodwill		204,190

Total assets acquired		270,252
Advance billings		(10,264	)
Other current liabilities		(10,803	)
Other long-term liabilities		(12,920	)

Total liabilities assumed		(33,987	)

Net assets acquired	$	236,265

For the acquisitions discussed above, results of operations are included in the Company’s Condensed Consolidated Statements of Operations from the date of acquisition.

The following unaudited pro forma results of operations assume the acquisitions of ICR and CRL Clinical Services occurred at the beginning of 2006:


	Nine Months Ended
(in thousands, except per share data)	September 30, 2006
Net service revenues	$	264,385
Net income		5,456
Net income per diluted share	$	0.37
Weighted average shares		14,756

The pro forma financial information is not necessarily indicative of the operating results that would have occurred had the acquisition been consummated as of January 1, 2006, nor is it necessarily indicative of future operating results.

3. Goodwill and Other Intangible Assets:

Goodwill at September 30, 2007 and December 31, 2006 is comprised of:

(in thousands)


Balance at December 31, 2006	$	229,598
Additional adjustments		(50	)
Foreign currency fluctuations		985
Tax benefit to reduce goodwill		(253	)

Balance at September 30, 2007	$	230,280

The additional goodwill acquired in the first nine months of 2007 relates to a decrease in liabilities assumed of approximately $825,000 partially offset by a decrease in assets acquired of $357,000 as well as additional acquisition costs of approximately $245,000 in conjunction with the acquisition of CRL Clinical Services acquisition. Also, additional goodwill of $173,000 was recorded related to a working capital adjustment and earn-out provisions in the IC-Research acquisition.

Amortizable intangible assets consisted of the following:


	As of September 30,			As of December 31,
(in thousands)	2007			2006
Amortizable intangible assets:
Carrying amount:
Customer relationships		18,000			18,000
Non-compete agreements		460			460
Completed technology		2,600			2,600
Backlog		6,200			6,200
Internally developed software (a)		16,032			16,039

Total carrying amount	$	43,292		$	43,299
Accumulated Amortization:
Customer relationships		(1,652	)		(682	)
Non-compete agreements		(460	)		(374	)
Completed technology		(603	)		(205	)
Backlog		(3,912	)		(1,772	)
Internally developed software		(14,776	)		(14,228	)

Total accumulated amortization	$	(21,403	)	$	(17,261	)

Net amortizable intangible assets	$	21,889		$	26,038


(a)		Internally developed software is included in Other Assets in the Company’s Condensed Consolidated Balance Sheets.

Amortizable intangible assets at September 30, 2007 and December 31, 2006 are comprised of:

(in thousands)


													Internally
	Customer			Non-Compete			Completed						Developed
	Relationships			Agreements			Technology			Backlog			Software
Balance at December 31, 2006	$	17,318		$	86		$	2,395		$	4,428		$	1,811
Additional amounts acquired		—			—			—			—			250
2007 amortization		(970	)		(86	)		(398	)		(2,140	)		(805	)

Balance at September 30, 2007	$	16,348		$	—		$	1,997		$	2,288		$	1,256

Completed technology represents proprietary technology acquired in the Company’s August 2006 acquisition of CRL Clinical Services. Value was assigned to the completed technology based on the technology directly related to revenue generation or profit enhancement. The value was calculated using

an income approach, which assumes that the value of the technology is equivalent to the present value of the future stream of economic benefits that can be derived from its ownership. The useful life of five years for the intangible asset was determined by estimating the remaining useful life of the technology acquired.

Backlog represents backlog acquired in the Company’s August 2006 acquisition of CRL Clinical Services. Value was assigned to backlog by evaluating the expected future economic operating income generated by the backlog. The useful life of the backlog was determined by evaluating the remaining life of the contracts that compose the backlog acquired.

Internally-developed software is included in other assets within the condensed consolidated financial statements. The Company typically amortizes internally-developed software over a 5 year useful life.

Amortization expense for the next five years relating to these amortizable intangible assets is estimated to be as follows:


	(in thousands)
Remainder of 2007:	$	1,348
2008:		4,121
2009:		3,172
2010:		2,480
2011:		2,311
Thereafter:		8,457

Total	$	21,889

4. Debt:

In August 2006, in conjunction with its acquisition of CRL Clinical Services, the Company entered into a new credit agreement (including all amendments, the “Facility”). The Facility is comprised of a $200 million term loan that matures in August 2012 and a revolving loan commitment that expires in August 2011. The balance of the $200 million term loan was paid off in the third quarter of 2007 with proceeds from the convertible debt issuance discussed below. The original revolving loan commitment was $25 million and was increased to $53.5 million under an amendment to the Facility and an Increase Joinder Agreement, which was entered into on June 27, 2007 and shortly thereafter permitted the Company to increase the revolving loan commitment. The Facility contains various affirmative and negative covenants including financial covenants regarding maximum leverage ratio, minimum interest coverage ratio and limitations on capital expenditures.

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.

On July 10, 2007, the Company entered into a Purchase Agreement with UBS Securities LLC (the “Underwriter”) for the issuance and sale by the Company of $175 million in aggregate principal amount of the Company’s 3.375% Senior Convertible Notes due July 15, 2012 (the “Convertible Notes”), pursuant to the Company’s effective Registration Statement on Form S-3. On July 11, 2007, the Underwriter exercised an over-allotment option and purchased an additional $25 million in aggregate principal amount of Convertible Notes. On July 16, 2007, $200 million in aggregate principal amount of the 5-year Convertible Notes with a maturity date of July 15, 2012 were sold to the

Underwriters at a price of $1,000 per Convertible Note, less an underwriting discount of 3% per Convertible Note.

The Convertible Notes bear interest at an annual rate of 3.375%, payable semi-annually in arrears on January 15 and July 15 of each year, with the first interest payment being made on January 15, 2008. The Convertible Notes are convertible at the option of the holder into cash and, if applicable, shares of the Company’s common stock at an initial conversion price of $47.71 per share (approximating 20.9585 shares per $1,000 principal amount of the Convertible Notes), upon the occurrence of certain events, including (1) any calendar quarter ending after September 30, 2007 in which the closing price of the Company’s common stock is greater than 130% of the conversion price for at least 20 trading days during the period of 30 consecutive trading days ending on the last trading day of the preceding calendar quarter (establishing a contingent conversion price of $47.71 per share); (2) any five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of Convertible Notes for each day of that period is equal to or less than 97% of the product of the closing sale price of the Company’s common stock and the applicable conversion rate; (3) upon specified corporate transactions including consolidation or merger; and (4) any time during the period beginning on January 1, 2012 until the close of business on the second business day immediately preceding July 15, 2012. In addition, upon events defined as a “fundamental change” under the Convertible Note Indenture, holders of the Convertible Notes may require the Company to repurchase the Convertible Notes. If upon the occurrence of such events in which the holders of the Convertible Notes exercise the conversion provisions of the Convertible Notes, the Company will need to remit the principal balance of the Convertible Notes to the holders in cash. As such, the Company would be required to classify the entire amount outstanding of the Convertible Notes as a current liability in the following quarter. The evaluation of the classification of amounts outstanding associated with the Convertible Notes will occur every quarter. As of September 30, 2007, the Convertible Notes are classified as long-term in the accompanying Condensed Consolidated Balance Sheet.

Upon conversion, holders will receive cash up to the principal amount of the notes to be converted, and any excess conversion value will be delivered in shares of the Company’s common stock. If conversion occurs in connection with a “fundamental change” as defined in the Convertible Notes Indenture, the Company may be required to repurchase the Convertible Notes for cash at a price equal to the principal amount plus accrued but unpaid interest. In addition, if conversion occurs in connection with a change in control, the Company may be required to deliver additional shares of the Company’s common stock (a “make whole” premium) by increasing the conversion rate with respect to such notes. The maximum aggregate number of shares that the Company would be obligated to issue upon conversion of the Convertible Notes is 5.6 million shares, but under most conditions, the Company would be obligated to issue 4.2 million shares upon conversion of the Convertible Notes.

Pursuant to Emerging Issues Task Force (“EITF”) 90-19,Convertible Bonds with Issuer Option to Settle for Cash upon Conversion, EITF 00-19,Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock(“EITF 00-19”), and EITF 01-6,The Meaning of Indexed to a Company’s Own Stock(“EITF 01-6”), the Convertible Notes are accounted for as convertible debt in the accompanying condensed consolidated balance sheet and the embedded conversion option in the Convertible Notes has not been accounted for as a separate derivative. For a discussion of the effects of the Convertible Notes and the bond hedges and warrants discussed below on earnings per share, see Note 1.

Concurrent with the sale of the Convertible Notes, the Company purchased bond hedges from UBS and JP Morgan (“the counterparties”), which are designed to mitigate potential dilution from the conversion of the Convertible Notes in the event that the market value per share of the Company’s common stock at the time of exercise is greater than approximately $47.71. Under the bond hedges that cover

approximately 4.2 million shares of the Company’s common stock, the counterparties are required to deliver either shares of the Company’s common stock or cash in the amount that the Company is obligated to deliver to the holders of the Convertible Notes with respect to the conversion, calculated exclusive of shares deliverable by the Company by reason of any additional premium relating to the Convertible Notes or by reason of any election by the Company to unilaterally increase the conversion rate pursuant to the indenture governing the Convertible Notes. The bond hedges expire at the close of trading on July 15, 2012, which is also the maturity date of the Convertible Notes, although the counterparties will have ongoing obligations with respect to Convertible Notes properly converted on or prior to that date of which the counterparties have been timely notified.

In addition, the Company issued warrants to the counterparties that could require the Company to issue up to approximately 4.2 million shares of the Company’s common stock on expiration dates consisting of the 100 consecutive business days beginning on and including January 15, 2013 (European style). The strike price is $61.22 per share, which represented a 70 % premium over the closing price of the Company’s shares of common stock on July 10, 2007.

The convertible bond hedge and warrant transactions generally have the effect of increasing the conversion price of the convertible notes to approximately $61.22 per share of Kendle common stock, representing approximately a 70% premium based on the closing sales price as reported on The Nasdaq Global Market on July 10, 2007, of $36.01 per share. The bond hedges and warrants are separate and legally distinct instruments that bind the Company and the counterparties and have no binding effect on the holders of the Convertible Notes. In addition, pursuant to EITF 00-19 and EITF 01-6, the bond hedges and warrants are accounted for as equity transactions. Therefore, the payment associated with the issuance of the bond hedges and the proceeds received from the issuance of the warrants were recorded as a charge and an increase, respectively, in additional paid-in capital in stockholders’ equity as separate equity transactions.

For income tax reporting purposes, the Company has elected to integrate the Convertible Notes and the bond hedges. Integration of the bond hedges with the Convertible Notes creates an original issue discount (“OID”) debt instrument for income tax reporting purposes. Therefore, the cost of the bond hedges will be accounted for as interest expense over the term of the Convertible Notes for income tax reporting purposes. The associated income tax benefits that are recognized for financial reporting purposes will be recognized as a reduction in the income tax provision in the periods that the deductions are taken for income tax reporting purposes.

The FASB has proposed FASB Staff Position No. APB 14-a, Accounting for Convertible Debt Instruments That May be Settled in Cash Upon Conversion (Including Partial Cash Settlement) (“APB 14-a”). If issued as currently contemplated, APB 14-a would require the liability and equity components of convertible debt instruments that may be settled in cash upon conversion to be separately accounted for in a manner that reflects the issuer’s nonconvertible debt borrowing rate. To allocate the proceeds from the Convertible Notes in this manner, the Company would first need to determine the carrying amount of the liability component, which would be based on the fair value of a similar liability (excluding the embedded conversion option). The resulting debt discount would be amortized over the period during which the debt is expected to be outstanding as additional non-cash interest expense. The Company is currently evaluating the potential amount of the additional interest expense. APB 14-a would be effective for financial statements for fiscal years beginning after December 15, 2007 and would be applied retrospectively for all periods presented. There can be no assurance that the proposed FSP will be issued in the form currently contemplated by the FASB, or at all.

The Company received net proceeds from the sale of the Convertible Notes of approximately $194.0 million after deducting the underwriter’s discounts and commissions. In addition, the Company used

approximately $18.1 million of the net proceeds of the offering to pay the net cost of the convertible note hedge transactions and the warrant transactions. The Company made a mandatory prepayment of $146.0 million (75% of the net proceeds of the offering) toward repayment of amounts owed under the term loan under its credit agreement and made additional voluntary prepayments during the third quarter to pay off the remaining balance of the term loan.

As of September 30, 2007, $200.0 million was outstanding under the Convertible Notes, no amounts were outstanding under the revolving credit loan and no amounts were outstanding under the Multicurrency Facility.

The weighted-average interest rate in effect on the term loan for the first nine months of 2007 was approximately 7.82%.

5. Stock Based Compensation:

In 1997, the Company established the 1997 Stock Option and Stock Incentive Plan (including amendments, the “1997 Plan”) that, as amended, provided for the issuance of up to 3,000,000 shares of the Company’s Common Stock, including both incentive and non-qualified stock options, restricted and unrestricted shares, and stock appreciation rights. The Plan expired by its terms on August 14, 2007. Participation in the 1997 Plan is at the discretion of the Board of Directors’ Management Development and Compensation Committee. Prior to August 2002, the 1997 Plan was administered by the Board of Director’s Compensation Subcommittee. The exercise price of incentive stock options granted under the 1997 Plan must be no less than the fair market value of the Common Stock, as determined under the 1997 Plan provisions, at the date the option is granted (110% of fair market value for shareholders owning more than 10% of the Company’s Common Stock). The exercise price of non-qualified stock options must be no less than 95% of the fair market value of the Common Stock at the date the option is granted. The vesting provisions of the options granted under the 1997 Plan are determined at the discretion of the Management Development and Compensation Committee. The options generally expire either 90 days after termination of employment or, if earlier, ten years after date of grant. No options under this 1997 plan could be granted after its termination date in August 2007. Restricted stock may also be granted pursuant to the 1997 Plan. Restricted shares typically vest ratably over a three year period, with shares restricted from transfer until vesting. If a participant ceases to be an eligible employee prior to the lapsing of transfer restrictions, such shares return to the Company without consideration. Unrestricted stock may also be granted to key employees under the 1997 Plan. Unrestricted shares vest immediately. The Company granted 10,700 shares of Common Stock in the first quarter of 2006. No additional shares of Common Stock were granted in the second or third quarter of 2006. The Company did not grant any restricted shares or unrestricted stock in the first nine months of 2007.

At the annual meeting of shareholders on May 10, 2007, shareholders of the Company approved the 2007 Stock Incentive Plan (the “2007 Plan”). The 2007 Plan was unanimously approved by the Board of Directors on March 9, 2007, subject to shareholder approval. Under the 2007 Plan, all employees of the Company and its subsidiaries will be eligible to receive awards. The 2007 Plan is an “omnibus” stock plan that provides a variety of equity award vehicles to maintain flexibility. The 2007 Plan will permit the grant of stock options, stock appreciation rights, restricted stock awards, restricted stock units and stock awards. A maximum of 1,000,000 shares will be available for grants of all equity awards under the 2007 Plan.

The Company had reserved 3,000,000 shares of Common Stock for the 1997 Plan, of which approximately 1,232,435 were available for grant at August 14, 2007, the termination date of the 1997

Plan. As a result of the adoption of the 2007 Plan, the Company had reserved 1,000,000 shares of Common Stock for the 2007 Plan.

Effective January 1, 2006, the Company began accounting for stock based incentive programs under Statement of Financial Accounting Standards (SFAS) 123(R), “Share-Based Payment.” SFAS 123(R) superseded Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, be recognized as compensation expense in the income statement at fair value. The Company adopted the provisions of SFAS 123(R) for all share-based payments granted after January 1, 2006 and for all awards granted to employees prior to January 1, 2006 that remain unvested on January 1, 2006. The Company adopted SFAS 123(R) using a modified prospective application. The Company uses the straight-line method of recording compensation expense relative to share-based payment.

In addition, SFAS 123(R) requires the benefits of tax deductions in excess of recognized compensation expense to be reported as a financing cash flow, rather than as an operating cash flow. This requirement reduced net operating cash flows and increased net financing cash flows by approximately $811,000 during the first nine months of 2007 and $847,000 in the first nine months of 2006.

The following is a summary of stock based compensation expense recorded by the Company:

Compensation Expense (in thousands)


	Three Months Ended September 30				Nine Months Ended September 30
	2007		2006		2007		2006
Stock options	$	141		195	$	769		1,438
Restricted stock		1		12		19		37
Unrestricted stock		0		0		0		336

Total stock based compensation	$	142	$	207	$	788	$	1,811

At September 30, 2007, there was approximately $718,000 of total unrecognized compensation cost, $717,000 relating to options and $1,000 relating to restricted stock related non-vested share-based payment plans. The cost is expected to be recognized over a weighted-average period of 2.1 years for options and 3 months for restricted stock.

Stock Options:

The following table summarizes information regarding stock option activity in 2007:


						Weighted		Aggregate
				Weighted		Average		Intrinsic
				Average		Remaining		Value
	Shares			Exercise Price		Contractual Life		($ in thousands)
Options outstanding at 12/31/06		797,597		$	11.55
Granted		40,000			32.50
Canceled		(48,480	)		10.52
Exercised		(155,680	)		11.18

Options outstanding at 09/30/07		633,437			13.05		5.75	$	8,173
Exercisable at 09/30/07		483,717			13.38		5.39	$	6,474

The per-share weighted-average fair value of options and awards granted is as follows:


	Three Months Ended September 30				Nine Months Ended September 30
	2007		2006		2007		2006
Stock options		N/A		N/A	$	12.79	$	24.60
Unrestricted stock		N/A		N/A		N/A	$	31.39

Under the provisions of SFAS 123(R), 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 September 30				Nine Months Ended September 30
	2007		2006		2007			2006
Dividend yield		N/A		N/A		0	%		0	%
Expected volatility		N/A		N/A		41.9	%		56.0	%
Risk-free interest rate		N/A		N/A		4.7	%		5.0	%
Expected term		N/A		N/A		4.5			6.2

The expected volatility is based on the Corporation’s stock price over a historical period which approximates the expected term as well as 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. The expected term is calculated as the historic weighted average life of similar awards.

The total intrinsic value of stock options exercised was approximately $2.1 million and $800,000 during the third quarter of 2007 and 2006, respectively, and $4.0 million and $5.5 million for the nine months ended September 30, 2007 and 2006, respectively.

Restricted Stock:

A summary of restricted stock activity during the first nine months of 2007 is as follows:


Outstanding at 12/31/06	6,250
Granted	—
Vested	(6,125	)
Canceled	—

Outstanding at 09/30/07	125

No restricted shares vested during the third quarter of 2007. The weighted-average fair value of restricted shares vested was $8.63 per share during the first nine months of 2007.

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.


	Early		Late		Support
(in thousands)	Stage		Stage		& Other			Total
*Three months ended September 30, 2007*
Net service revenues	$	4,687	$	93,381	$	2,002		$	100,070
Reimbursable out-of-pocket revenues	$	—	$	42,366	$	—		$	42,366

Total revenues	$	4,687	$	135,747	$	2,002		$	142,436
Operating income (loss)	$	281	$	24,623	$	(10,659	)	$	14,245
Total assets	$	31,173	$	397,227	$	65,155	(a)	$	493,555

*Three months ended September 30, 2006*
Net service revenues	$	5,985	$	67,926	$	1,325		$	75,236
Reimbursable out-of-pocket revenues	$	—	$	21,497	$	—		$	21,497

Total revenues	$	5,985	$	89,423	$	1,325		$	96,733
Operating income (loss)	$	1,181	$	15,865	$	(8,953	)	$	8,093
Total assets	$	43,251	$	360,613	$	69,696	(a)	$	473,560


(a)		Primarily comprised of cash, marketable securities and tax-related assets.


	Early		Late		Support
(in thousands)	Stage		Stage		& Other			Total
*Nine months ended September 30, 2007*
Net service revenues	$	15,660	$	271,769	$	5,882		$	293,311
Reimbursable out-of-pocket revenues	$	—	$	120,864	$	—		$	120,864

Total revenues	$	15,660	$	392,633	$	5,882		$	414,175
Operating income (loss)	$	1,950	$	63,297	$	(27,634	)	$	37,613
Total assets	$	31,173	$	397,227	$	65,155	(a)	$	493,555

*Nine months ended September 30, 2006*
Net service revenues	$	16,834	$	176,404	$	3,837		$	197,075
Reimbursable out-of-pocket revenues	$	—	$	58,774	$	—		$	58,774

Total revenues	$	16,834	$	235,178	$	3,837		$	255,849
Operating income (loss)	$	3,938	$	44,694	$	(26,866	)	$	21,766
Total assets	$	43,251	$	360,613	$	69,696	(a)	$	473,560


(a)		Primarily comprised of cash, marketable securities and tax-related assets.

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 Form 10-Q for the three and nine months ended September 30, 2007 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) is a global contract research organization (CRO) that delivers integrated clinical research services, including clinical trial management, clinical data management, statistical analysis, medical writing, regulatory consulting and organizational meeting management and publications services on a contract basis to the biopharmaceutical industry. 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. The Company primarily earns net service revenues through performance under Late Stage segment “full-service” contracts. The Company also recognizes revenues through limited service contracts, consulting contracts, and Early Stage segment contracts. The Company’s revenue recognition process is described under “Critical Accounting Policies and Estimates”.

Late Stage Segment Contracts

The Company provides services to its customers primarily under “full-service” contracts that include a broad range of services in support of a customer’s clinical trial. These services typically include biometrics, clinical development services and regulatory affairs. The Company from time to time provides a select number of these services under “limited-service” contracts. The Company usually competes for business awards in a competitive bidding process. In the bidding process, the Company submits a bid that includes a price based upon hourly billing rates for billable employees multiplied by task hours the Company estimates will be necessary to achieve the service assumptions. Upon receiving a business award, the Company and its customer negotiate a contract to memorialize these assumptions and the related price.

Service contracts usually are long-term arrangements that require Company performance over several years. A contract usually requires a portion of the contract fee to be paid at the time of contract execution, and the balance is received in installments over the contract’s duration. Other methods for receiving payment include units achieved and time and materials. During performance of the services, any of the following events may occur and impact the contract price:

	•		The customer may request a change in the assumptions;

	•		The customer may increase or decrease the scope of services, which requires a change to the service assumptions; and

	•		The Company may discover that, for a particular contract, the assumptions are incorrect or insufficient to permit completion of the contract.

In each of the foregoing situations, the Company enters into negotiations for a contract amendment to reflect the change in scope or assumptions and the related price. Depending on the complexity of the

amendment, the amendment process can take from a few weeks for a simple adjustment, such as a timeline extension, to several months for a complex amendment, such as a change in patient enrollment strategy. Under the Company’s policy, project teams are not authorized to engage in tasks outside the scope of the contract without prior management approval. In some situations, management may authorize the project team to commence work on activities outside the contract scope while the Company and its customer negotiate and finalize the contract amendment.

Contract amendments are commonplace within the industry and occur on the majority of the Company’s contracts. At any point in time, the Company will be in the process of discussing numerous proposed amendments, the scope and value of which can change significantly between time of proposal and final agreement. The total value of these amendments primarily represents future work and revenues.

In addition to full-service and limited-service arrangements described above, the Company provides consulting services to its customers under contracts that generally are shorter-term in nature than full-service contracts. Net service revenues from these contracts represent less than 5% of the Company’s net service revenues.

In connection with providing services, the Company incurs pass-through costs, which include travel-related expenses for Company employees performing services and fees payable to third-party investigators or labs participating in, or supporting, the customer’s clinical trial. The customer agrees to reimburse the Company on a dollar-for-dollar basis for the costs incurred by the Company in accordance with contractually specified parameters. The revenues and costs from these pass-through and third-party costs are reflected in the Company’s Consolidated Statements of Operations under the line items titled “Reimbursable out-of-pocket revenues” and “Reimbursable out-of-pocket costs”, respectively.

The customer may terminate the contract at any time with little or no advance notice to the Company. Customers, in particular, may terminate a contract immediately for concerns related to the efficacy or safety of a particular drug. Upon termination, the customer is required to pay the Company for the value of work completed up to termination as well as reimburse the Company for its out-of-pocket costs incurred in accordance with the contract.

Early Stage Segment Contracts

Early Stage segment business awards are subject to a competitive bidding process and, upon award, are memorialized in a contract that includes terms and conditions that are substantially similar to the Company’s contracts with its Late Stage segment customers. Because these business awards require the Company to commit beds at its Early Stage facilities, the Company attempts to require the customer to pay a cancellation fee if the customer cancels a project award. Net service revenues from these contracts generally represent less than 10% of the Company’s net service revenues.

Recent Developments and CRO Marketplace

In August 2006, the Company acquired the Phase II-IV Clinical Services business of Charles River Laboratories International, Inc (“CRL Clinical Services”). The acquisition has strengthened the Company’s position as one of the leading global players in the clinical development industry, adding therapeutic expertise, diversifying its customer base and expanding its capacity to deliver large global trials. The initial purchase price was approximately $215 million in cash plus a working capital adjustment in which the Company paid for any working capital in excess of $2.0 million. The total purchase price, including acquisition costs and the working capital adjustment, was approximately $236 million. The acquired business is part of the Company’s Late Stage segment. The Company financed the

purchase with $200 million in term debt as well as its existing cash and proceeds from available-for-sale securities.

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 Authorizations and Backlog

New business authorizations, which are sales of our services, are added to backlog when the Company enters into a contract or a letter of intent or receives a verbal commitment. Authorizations can vary significantly from quarter to quarter and contracts generally have terms ranging from several months to several years. The Company’s new business authorizations for the three months ended September 30, 2006 and 2007 were approximately $148 million and $175 million, respectively.

Backlog consists of new business authorizations 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. As the Company increasingly competes for and enters into large contracts that are global in nature, the Company expects the average duration of the contracts in backlog to increase.

For various reasons discussed in “Item 1 – Backlog” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, the Company’s backlog might never be recognized as revenue and is not necessarily a meaningful predictor of future performance.

Results of Operations

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 short-term 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 hinder the Company’s long-term growth. In addition, the Company’s aggregate backlog, consisting of signed contracts and letters of intent as well as awarded projects for which the contract is actively being negotiated, is not necessarily a meaningful indicator of future results. Accordingly, no assurance can be given that the Company will be able to realize the net service revenues included in the backlog.

Three Months Ended September 30, 2007 Compared to Three Months Ended September 30, 2006

Net Service Revenues

Net service revenues increased approximately $24.9 million, or 33%, to $100.1 million in the third quarter of 2007 from $75.2 million in the third quarter of 2006. As Kendle and CRL Clinical Services have integrated project teams and revenue is recognized on labor hours and costs, it is difficult to precisely determine the amount of the third quarter 2007 and third quarter 2006 revenue that is attributable to the acquisition of CRL Clinical Services. The Company estimates that a significant portion of the growth in net service revenues is due to the acquisition. Excluding the impact of foreign currency exchange rate variances between both periods, net service revenues increased 27% as compared to the

corresponding 2006 period. Net service revenues from the Early Stage segment decreased by approximately 22% due to a decline in Phase I revenue at the Company’s Early Stage facility in the Netherlands partially offset by an increase in Phase I revenue at the Company’s Early Stage facility in Morgantown, WV. The revenue decline at the Netherlands facility is due in part of to the cancellation of a project with a value of approximately $1.9 million that was scheduled for the third and fourth quarters of 2007. Net service revenues from the Late Stage segment grew by 37%. A significant portion of the growth in Late Stage net service revenues is attributable to the acquisition of CRL Clinical Services. Late Stage net service revenues increased in both Europe and the Americas due to an expanded customer base and larger projects awarded to the Company.

Approximately 49% of the Company’s net service revenues were derived from operations outside of North America in the third quarter of 2007 compared to 45% in the third quarter of 2006. The top five customers based on net service revenues contributed approximately 24% of net service revenues during the third quarter of 2007 compared to approximately 30% of net service revenues during the third quarter of 2006. No customer accounted for more than 10% of total third quarter 2007 net service revenues. Net services revenues from Pfizer Inc. accounted for approximately 14% of total third quarter 2006 net service revenues. The Company’s net service revenues from Pfizer Inc. are derived from numerous projects that vary in size, duration and therapeutic indication. No other customer accounted for more than 10% of the net service revenues in the third quarter of 2006.

Reimbursable Out-of-Pocket Revenues

Reimbursable out-of-pocket revenues fluctuate from period to period, primarily due to the level of investigator activity in a particular period. Reimbursable out-of-pocket revenues increased approximately 97% to $42.4 million in the third quarter of 2007 from $21.5 million in the corresponding period of 2006. The Company estimates that a significant portion of the growth in reimbursable out-of-pocket revenues is due to the acquisition of CRL Clinical Services.

Operating Expenses

Direct costs increased approximately $8.2 million, or 20%, to $49.1 million in the third quarter of 2007 from $40.9 million in the third quarter of 2006. A significant portion of the growth in direct costs is due to the acquisition of CRL Clinical Services. The portion of the increase in direct costs attributable to organic growth relates directly to the increase in net service revenues in the third quarter of 2007, primarily due to increased hiring of billable employees to support the increased contract services. Direct costs expressed as a percentage of net service revenues were 49.1% for the three months ended September 30, 2007 compared to 54.4% for the three months ended September 30, 2006. The decrease in direct costs as a percentage of net service revenues in 2007 is primarily due to increased efficiency as newly hired billable associates have become fully trained. In addition, the Company is working on larger, global trials in 2007 which result in greater opportunity for efficiencies in individual projects. Finally, in the third quarter of 2007 compared to the third quarter of 2006, the Company used less outside contractors, which are generally more costly to the Company.

Reimbursable out-of-pocket costs increased approximately 97% to $42.4 million in the third quarter of 2007 from $21.5 million in the corresponding period of 2006. The Company estimates that a significant portion of the growth in reimbursable out-of-pocket costs is due to the acquisition of CRL Clinical Services.

Selling, general and administrative expenses increased $9.4 million, or 40%, from $23.4 million in the third quarter of 2006 to $32.8 million in the same quarter of 2007. The increase is primarily due to

increases in employee-related costs from the Company’s increase in headcount. Significant headcount growth occurred with the August 2006 acquisition of CRL Clinical Services. Headcount also has increased to support increased revenue. The increase in employee-related costs is also comprised of general salary increases and corresponding payroll tax and benefit increases including increased health care costs. Selling, general and administrative expenses expressed as a percentage of net service revenues were 32.8% for the three months ended September 30, 2007 compared to 31.1% for the corresponding 2006 period.

Depreciation and amortization expense increased by $1.1 million in the third quarter of 2007 compared to the third quarter of 2006. This increase is primarily due to amortization of $1.0 million related to finite-lived intangibles acquired in the CRL Clinical Services acquisition in the third quarter of 2007 compared to approximately $705,000 in the third quarter of 2006, as well as depreciation on fixed assets acquired from CRL Clinical Services.

Income from operations increased to $14.2 million or 14.2% of net service revenues for the three months ended September 30, 2007 from $8.1 million or 10.8% of net services revenues for the corresponding 2006 period. Income from operations from Kendle’s Early Stage segment decreased approximately $900,000, or 76%, to $281,000 or 6.0% of Early Stage net service revenues for the three months ended September 30, 2007, from approximately $1.2 million, or 19.7% of Early Stage net service revenues for the corresponding period of 2006. The decrease in operating margin was driven by decreased revenue at the Company’s Early Stage facility in the Netherlands resulting in increased fixed facility and employee costs as a percentage of revenue. The operating margin decline at the Netherlands facility is due in part of to the cancellation of a project valued at approximately $1.9 million that was scheduled for the third and fourth quarter of 2007. Income from operations from the Company’s Late Stage segment increased $8.8 million, or 55%, to $24.6 million or 26.4% of Late Stage net service revenues for the three months ended September 30, 2007 from approximately $15.9 million or 23.4% of net service revenues from the corresponding period of 2006. The increase in operating margin in the third quarter of 2007 is due to increased efficiency as newly hired billable associates have become fully trained. In addition, the Company is working on larger, global trials in 2007 which result in greater opportunity for efficiencies in individual projects.

Other Income (Expense)

Other Income (Expense) was expense of approximately $9.2 million in the third quarter of 2007 compared to expense of approximately $2.1 million in the third quarter of 2006. In June 2006, the Company paid the remaining outstanding balance of approximately $3.0 million under a prior term loan and terminated the agreements related to the loan. In August 2006, the Company borrowed $200 million under a term loan agreement in connection with the closing and purchase of CRL Clinical Services. Therefore, this new term loan had outstanding principal for approximately 1.5 months in the third quarter of 2006 and for approximately one month in the third quarter of 2007 until the Company paid off this term loan with proceeds from the sale of convertible notes (discussed below).

In the third quarter of 2007, the Company issued $200.0 million in principal amount of 3.375% Convertible Senior Notes due 2012 (“Notes”). In conjunction with issuance and sale of the Notes, the Company made a mandatory prepayment on its term debt and subsequently paid off the balance of the term note in the third quarter of 2007. Consequently, in the third quarter of 2007 the Company wrote-off approximately $4.2 million in deferred financing costs related to the term note.

Interest expense increased by approximately $1.0 million in the third quarter of 2007 compared to the third quarter of 2006 due to debt outstanding for a full quarter in the third quarter of 2007 compared to

only 1.5 months of outstanding debt during the corresponding 2006 period. In the first quarter of 2007, the Company entered into an interest rate swap/collar arrangement to fix the rate on a portion of its then outstanding term debt. The derivative arrangements do not qualify for hedge accounting treatment and mark to market adjustments on these arrangements are recorded in the Company’s Condensed Consolidated Statements of Operations. In the third quarter of 2007, the Company recorded losses of approximately $658,000 related to the mark to market adjustments on the interest rate swap/collar arrangement.

Interest income decreased by approximately $97,000 in the third quarter of 2007 due to smaller cash and investment balances in the third quarter of 2007 compared to the corresponding period of 2006, as in addition to the term debt, the Company used cash and proceeds from the sale of investments to finance the CRL Clinical Services acquisition.

In the first quarter of 2007, the Company entered into foreign currency hedge arrangements to hedge foreign currency exposure related to intercompany notes outstanding. The derivative arrangements do not qualify for hedge accounting treatment and mark to market adjustments on these arrangements are recorded in the Company’s Consolidated Statements of Operations. In the third quarter of 2007, the Company recorded gains of approximately $155,000 related to these derivative instruments. In addition to the gains on derivative instruments, the Company recorded foreign exchange rate losses of approximately $2.2 million in the third quarter of 2007 compared to losses of $205,000 in the third quarter of 2006. The increased foreign exchange loss is due to the weakening of the US dollar against the British pound and the euro as well as an increase in global contracts in 2007, leading to increased exchange rate exposure. With the exception of the hedge arrangements on intercompany notes referred to above, 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.

Income Taxes

The Company reported tax expense at an effective rate of 24.9% in the quarter ended September 30, 2007, compared to tax expense at an effective rate of 33.3% in the quarter ended September 30, 2006. In the third quarter of 2007, the Company reversed approximately $833,000 of tax liabilities established due to the adoption of FIN 48. The liabilities were reversed as the time period for assessing tax on these items expired.

The Company continues to maintain full valuation allowances against the net operating losses incurred in some of its subsidiaries. Because Kendle operates on a global basis, the effective tax rate varies from quarter to quarter based on the mix of locations that generate the pre-tax earnings or losses.

Net Income

The net income for the quarter ended September 30, 2007 was approximately $3.8 million, or $0.26 per basic and $0.25 per diluted share compared to net income of $4.0 million for the quarter ended September 30, 2006, or $0.28 per basic and $0.27 per diluted share.

Nine Months Ended September 30, 2007 Compared to Nine Months Ended September 30, 2006

Net Service Revenues

Net service revenues increased approximately $96.2 million, or 49%, to $293.3 million in the first nine months of 2007 from $197.1 million in the first nine months of 2006. As Kendle and CRL Clinical Services have integrated project teams and revenue is recognized on labor hours and costs, it is difficult to precisely determine the amount of the 2007 and 2006 revenue that is attributable to the acquisition of CRL Clinical Services. The Company estimates that a significant portion of the growth in net service revenues is due to the acquisition. Excluding the impact of foreign currency exchange rate variances between both periods, net service revenues increased 42% as compared to the corresponding 2006 period. Net service revenues from the Early Stage segment decreased by approximately 7% due to decline in Phase I revenue at the Company’s Early Stage facility in the Netherlands partially offset by an increase in Early Stage revenue at the Company’s Early Stage facility in Morgantown, WV. The decline in Phase I revenue at the Netherlands facility is due in part to a project cancellation. Net service revenues from the Late Stage segment grew by 54%. A significant portion of the growth in Late Stage net service revenues is attributable to the acquisition of CRL Clinical Services. Late Stage net service revenues increased in both Europe and the Americas due to an expanded customer base and larger projects awarded to the Company.

Approximately 50% of the Company’s net service revenues were derived from operations outside of North America in the first nine months of 2007 compared to 44% in the first nine months of 2006. The top five customers based on net service revenues contributed approximately 25% of net service revenues during the first nine months of 2007 compared to approximately 29% of net service revenues during the first nine months of 2006. No customer accounted for more than 10% of total net service revenues for the first nine months of 2007. Net service revenues from Pfizer Inc. accounted for approximately 12% of total net service revenues for the nine months ended September 30, 2006. The Company’s net service revenues from Pfizer Inc. are derived from numerous projects that vary in size, duration and therapeutic indication. No other customer accounted for more than 10% of the net service revenues in the first nine months of 2006.

Reimbursable Out-of-Pocket Revenues

Reimbursable out-of-pocket revenues fluctuate from period to period, primarily due to the level of investigator activity in a particular period. Reimbursable out-of-pocket revenues increased approximately 106% to $120.9 million in the first nine months of 2007 from $58.8 million in the corresponding period of 2006. The Company estimates that a significant portion of the growth in reimbursable out-of-pocket revenues is due to the acquisition of CRL Clinical Services.

Operating Expenses

Direct costs increased approximately $44.4 million, or 42%, to $150.1 million in the first nine months of 2007 from $105.7 million in the first half of 2006. A significant portion of the growth in direct costs is due to the acquisition of CRL Clinical Services. The portion of the increase in direct costs attributable to organic growth relates directly to the increase in net service revenues in the first nine months of 2007, primarily due to increased hiring of billable employees to support the increased contract services. Direct costs expressed as a percentage of net service revenues were 51.2% for the nine months ended September 30, 2007 compared to 53.6% for the nine months ended September, 2006. The decrease in direct costs as a percentage of net service revenues in 2007 is partially due to a charge in the second quarter of 2006 of approximately $700,000 in direct costs to provide additional study services to resolve non-medical customer concerns over one study. In addition, the Company is working on larger, global trials in 2007 which result in greater opportunity for efficiencies in individual projects.

Reimbursable out-of-pocket costs increased approximately 106% to $120.9 million in the first nine months of 2007 from $58.8 million in the corresponding period of 2006. The Company estimates that a significant portion of the growth in reimbursable out-of-pocket costs is due to the acquisition of CRL Clinical Services.

Selling, general and administrative expenses increased $31.4 million, or 50%, from $63.2 million in the first nine months of 2006 to $94.6 million in the same period of 2007. The increase is primarily due to increases in employee-related costs from the Company’s increase in headcount. Significant headcount growth occurred with the August 2006 acquisition of CRL Clinical Services. Headcount also has increased to support increased revenue. The increase in employee-related costs is also comprised of general salary increases and corresponding payroll tax and benefit increases including increased health care costs. Selling, general and administrative expenses expressed as a percentage of net service revenues were 32.2% for the nine months ended September 30, 2007 compared to 32.1% for the corresponding 2006 period.

Depreciation and amortization expense increased by $4.7 million in the first nine months of 2007 compared to the first nine months of 2006. This increase is primarily due to 2007 amortization of $3.1 million compared to 2006 amortization of $705,000 related to finite-lived intangibles acquired in the CRL Clinical Services acquisition. Additionally, depreciation increased due to depreciation on fixed assets acquired from CRL Clinical Services and capital purchases in 2007.

Income from operations increased to $37.6 million or 12.8% of net service revenues for the nine months ended September 30, 2007 from $21.8 million or 11.0% of net services revenues for the corresponding 2006 period. Income from operations from Kendle’s Early Stage segment decreased $2.0 million, or 50%, to $1.9 million or 12.5% of Early Stage net service revenues for the nine months ended September 30, 2007, from approximately $3.9 million, or 23.4% of Early Stage net service revenues for the corresponding period of 2006. The decrease in operating margin was driven by decreased revenue, due in part to a project cancellation discussed previously, at the Company’s Early Stage facility in the Netherlands resulting in increased fixed facility and employee costs as a percentage of revenue. In addition, in the first quarter of 2007 the Company incurred approximately $130,000 of severance costs at the Company’s Morgantown, West Virginia location. Income from operations from the Company’s Late Stage segment increased $18.6 million, or 42%, to $63.3 million or 23.3% of Late Stage net service revenues for the nine months ended September 30, 2007 from approximately $44.7 million or 25.3% of net service revenues from the corresponding period of 2006. Growth in the Late Stage segment was driven by strong performance in both Europe and the Americas as well as the acquisition of CRL Clinical Services.

Other Income (Expense)

Other Income (Expense) was expense of approximately $19.4 million in the first nine months of 2007 compared to expense of approximately $1.4 million in the first nine months of 2006. In June 2006, the Company paid the remaining outstanding balance of $3.044 million under a prior term loan and terminated the agreements related to the loan. In August 2006, the Company borrowed $200 million under a term loan agreement in connection with the closing and purchase of CRL Clinical Services.

In the third quarter of 2007, the Company issued $200.0 million in principal amount of 3.375% Convertible Senior Notes due 2012 (“Convertible Notes”). In conjunction with issuance and sale of the Convertible Notes, the Company made a mandatory prepayment on its term debt and subsequently paid off the balance of the term note in the third quarter of 2007. Consequently, in the third quarter of 2007 the Company wrote-off approximately $4.2 million in deferred financing costs related to the term note.

Interest expense increased by approximately $9.6 million in the first nine months of 2007 compared to the first nine months of 2006 due to the outstanding principal under the Company’s term debt during the 2007 period. The term debt was paid off during the third quarter of 2007 with proceeds from the sale of the Notes.

In the first quarter of 2007, the Company entered into an interest rate swap/collar arrangement to fix the rate on a portion of its then outstanding term debt. The derivative arrangements do not qualify for hedge accounting treatment and mark to market adjustments on these arrangements are recorded in the Company’s Condensed Consolidated Statements of Operations. In the first nine months of 2007, the Company recorded losses of approximately $480,000 related to the mark to market adjustments on the interest rate swap/collar arrangement.

Interest income decreased by approximately $509,000 in 2007 due to smaller cash and investment balances in the nine months ended September 30, 2007 compared to the corresponding period of 2006, as in addition to the term debt, the Company used cash and proceeds from the sale of investments to finance the CRL Clinical Services acquisition.

In the first quarter of 2007, the Company entered into foreign currency hedge arrangements to hedge foreign currency exposure related to intercompany notes outstanding. The derivative arrangements do not qualify for hedge accounting treatment and mark to market adjustments on these arrangements are recorded in the Company’s Condensed Consolidated Statements of Operations. In the first nine months of 2007, the Company recorded gains of approximately $180,000 related to these foreign currency derivative instruments. In addition to the gains on derivative instruments, the Company recorded foreign exchange rate losses of approximately $4.5 million in the first nine months of 2007 compared to losses of $512,000 in the first nine months of 2006. The increased foreign exchange loss is due to the weakening of the US dollar against the Pound Sterling and the Euro as well as an increase in global contracts in 2007, leading to increased exchange rate exposure. With the exception of the hedge arrangements on intercompany notes referred to above, 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.

Income Taxes

The Company reported tax expense at an effective rate of 32.2% in the nine months ended September 30, 2007, compared to tax expense at an effective rate of 35.2% in the nine months ended September 30, 2006. In the third quarter of 2007, the Company reversed approximately $833,000 million of tax liabilities established due to the adoption of FIN 48. The liabilities were reversed as the time period for assessing tax on these items expired.

Net Income

Net income for the nine months ended September 30, 2007 was approximately $12.3 million or $0.83 per diluted share and $0.85 per basic share compared to net income for the nine months ended September 30, 2006 of $13.2 million or $0.89 per diluted share and $0.92 per basic share.

Liquidity and Capital Resources

Cash and cash equivalents increased by $8.0 million for the nine months ended September 30, 2007 as a result of cash provided by operating activities of $38.1 million offset by cash used in financing activities of approximately $22.0 million and by cash used in investing activities of approximately $8.5 million. At September 30, 2007, cash and cash equivalents were $27.9 million. In addition, the Company has approximately $1.2 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 non-cash items. The change in net operating assets generated approximately $7.8 million in cash during the nine months ended September 30, 2007, primarily due to an increase in accrued liabilities and trade payables partially offset by an increase in net accounts receivable. 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 $63.6 million at September 30, 2007, and $60.3 million at December 31, 2006.

Investing activities for the nine months ended September 30, 2007 consisted primarily of cash of $3.1 million received by the Company related to settlement of the final working capital amount in the purchase of CRL Clinical Services offset by additional acquisition costs of approximately $979,000 and capital expenditures of approximately $10.8 million, mostly relating to computer equipment and software purchases, including internally developed software.

Financing activities for the nine months ended September 30, 2007, consisted primarily of proceeds from the sale and issuance of the Convertible Notes of $200.0 million offset by payments of $199.5 million on the Company’s term note, debt issuance costs of approximately $6.9 million, of which $6.6 million was associated with the issuance of the Convertible Notes, and net payments of $18.1 million related to the purchase of bond hedges and proceeds from the issuance of warrants also related to the sale and issuance of the Convertible Notes.

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.

The Convertible Notes bear interest at an annual rate of 3.375%, payable semi-annually in arrears on January 15 and July 15 of each year, with the first interest payment being made on January 15, 2008. The Convertible Notes are convertible at the option of the holder into cash and, if applicable, shares of the Company’s common stock at an initial conversion price of $47.71 per share (approximating 20.9585 shares per $1,000 principal amount of the Convertible Notes), upon the occurrence of certain events, including (1) any calendar quarter ending after September 30, 2007 in which the closing price of the Company’s common stock is greater than 130% of the conversion price for at least 20 trading days during the period of 30 consecutive trading days ending on the last trading day of the preceding calendar quarter (establishing a contingent conversion price of $47.71per share); (2) any five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of Convertible Notes for each day of that period is equal to or less than 97% of the product of the closing sale price of the Company’s common stock and the applicable conversion rate; (3) upon specified corporate transactions including consolidation or merger; and (4) any time during the period beginning on January 1, 2012 until the close of business on the second business day immediately preceding July 15, 2012. In addition, upon events defined as a “fundamental change” under the Convertible Note Indenture, holders of the Convertible Notes may require the Company to repurchase the Convertible Notes. If upon the occurrence of such events in which the holders of the Convertible Notes exercise the conversion provisions of the Convertible Notes, the Company will need to remit the principal balance of the Convertible Notes to the holders in cash. As such, the Company would be required to classify the entire amount outstanding of the Convertible Notes as a current liability in the following quarter. The evaluation of the classification of amounts outstanding associated with the Convertible Notes will occur every quarter. As of September 30, 2007 the Convertible Notes are classified as long-term in the accompanying Condensed Consolidated Balance Sheet.

Pursuant to Emerging Issues Task Force (“EITF”) 90-19,Convertible Bonds with Issuer Option to Settle for Cash upon Conversion, EITF 00-19,Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock(“EITF 00-19”), and EITF 01-6,The Meaning of Indexed to a Company’s Own Stock(“EITF 01-6”), the Convertible Notes are accounted for as convertible debt in the accompanying consolidated balance sheet and the embedded conversion option in the Convertible Notes has not been accounted for as a separate derivative. For a discussion of the

effects of the Convertible Notes and the bond hedges and warrants discussed below on earnings per share, see Note 1 to the Condensed Consolidated Financial Statements (Unaudited).

Concurrent with the sale of the Convertible Notes, the Company purchased convertible note hedges from UBS and JP Morgan (“the counterparties”), which are designed to mitigate potential dilution from the conversion of the Convertible Notes in the event that the market value per share of the Company’s common stock at the time of exercise is greater than approximately $47.71. Under the bond hedges that cover approximately 4.2 million shares of the Company’s common stock, the counterparties are required to deliver either shares of the Company’s common stock or cash in the amount that the Company is obligated to deliver to the holders of the Convertible Notes with respect to the conversion, calculated exclusive of shares deliverable by the Company by reason of any additional premium relating to the Convertible Notes or by reason of any election by the Company to unilaterally increase the conversion rate pursuant to the indenture governing the Convertible Notes. The bond hedges expire at the close of trading on July 15, 2012, which is also the maturity date of the Convertible Notes, although the counterparties will have ongoing obligations with respect to Convertible Notes properly converted on or prior to that date of which the counterparties have been timely notified.

The convertible note hedge and warrant transactions generally have the effect of increasing the conversion price of the convertible notes to approximately $61.22 per share of Kendle common stock, representing approximately a 70% premium based on the closing sales price as reported on The Nasdaq Global Market on July 10, 2007, of $36.01 per share.

The bond hedges and warrants are separate and legally distinct instruments that bind the Company and the counterparties and have no binding effect on the holders of the Convertible Notes. In addition, pursuant to EITF 00-19 and EITF 01-6, the bond hedges and warrants are accounted for as equity transactions. Therefore, the payment associated with the issuance of the bond hedges and the proceeds received from the issuance of the warrants were recorded as a charge and an increase, respectively, in additional paid-in capital in stockholders’ equity as separate equity transactions.

The FASB has proposed FASB Staff Position (“FSP”) No. APB 14-a, Accounting for Convertible Debt Instruments That May be Settled in Cash Upon Conversion (Including Partial Cash Settlement) (“APB 14-a”). If issued as currently contemplated, APB 14-a would require the liability and equity components of convertible debt instruments that may be settled in cash upon conversion to be separately accounted for in a manner that reflects the issuer’s nonconvertible debt borrowing rate. To allocate the proceeds from the Convertible Notes in this manner, the Company would first need to determine the carrying amount of the liability component, which would be based on the fair value of a similar liability

(excluding the embedded conversion option). The resulting debt discount would be amortized over the period during which the debt is expected to be outstanding as additional non-cash interest expense. The Company is currently evaluating the potential amount of the additional interest expense. APB 14-a would be effective for financial statements for fiscal years beginning after December 15, 2007 and would be applied retrospectively for all periods presented. There can be no assurance that the proposed FSP will be issued in the form currently contemplated by the FASB, or at all.

The Company received net proceeds from the sale of the Convertible Notes of approximately $194.0 million after deducting the underwriter’s discounts and commissions. In addition, the Company used approximately $18.1 million of the net proceeds of the offering to pay the net cost of the convertible note hedge transactions and the warrant transactions. The Company made a mandatory prepayment of $146.0 million (75% of the net proceeds of the offering) toward repayment of amounts owed under the term loan under its credit agreement and made additional voluntary prepayments during the third quarter to pay off the remaining balance of the term loan.

The weighted-average interest rate in effect on the term loan for the first nine months of 2007 was approximately 7.82%.

Market Risk and Derivative Instruments

Interest Rates

The Company is exposed to changes in interest rates on its amounts outstanding under the Facility and Multicurrency Facility. At September 30, 2007, no amounts were outstanding under either the Facility or the Multicurrency Facility.

In February 2007, the Company entered into an interest rate swap/collar to fix the interest rate on a portion of its debt. The Company fixed the interest rate on the total outstanding balance of the term loan through April 30, 2007 at a fixed rate of 5.079% plus the 2.50% margin. Beginning May 1, 2007, the Company fixed the interest rate on $40.0 million of the outstanding term loan at the rate of 5.079% plus the 2.5% margin with an additional $51.0 million covered under the interest rate collar. The collar provides for interest rate protection at a cap of 6.25% and a floor of 3.21%. This agreement does not qualify for hedge accounting treatment under SFAS No. 133 and all changes in the fair market value of the hedge will be recorded in the Company’s Condensed Consolidated Statements of Operations. In the first nine months of 2007, the Company recorded a loss of approximately $480,000 related to changes in the fair market value of the interest rate swap/collar arrangement.

Foreign Currency

The Company operates on a global basis and is therefore exposed to various types of currency risks. Two specific transaction risks 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.

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.

During the first nine months of 2007, the Company recorded total foreign exchange losses of approximately $4.5 million related to the risks described above. As described below, in the first quarter of 2007 the Company entered into foreign currency hedge transactions to hedge exposure related to intercompany notes between the Company’s U.S. subsidiary, as lender, and the Company’s subsidiaries in each of the United Kingdom and Germany.

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 $1.8 million at September 30, 2007 and $2.3 million at December 31, 2006.

Foreign Currency Hedges

Kingdom and Germany. The note between the Company’s U.S. subsidiary and United Kingdom subsidiary is denominated in Pounds Sterling and had an outstanding principal amount of approximately $60.9 million at September 30, 2007. The note between the Company’s U.S. subsidiary and German subsidiary is denominated in Euro and had an outstanding principal amount of approximately $25.5 million at September 30, 2007. The hedge agreements do not qualify for hedge accounting treatment under SFAS No. 133 and all changes in the fair market value of the hedge will be recorded in the Company’s Consolidated Statements of Operations. In the first nine months of 2007, the Company recorded losses of approximately $1.9 million on the Euro hedge transaction and $2.2 million on the Pound Sterling transaction related to the changes in the fair market value of the hedge. The losses on the fair market value of the hedge were offset by foreign exchange gains of $2.1 million on the change in value of the Euro intercompany note and $2.1 million on the change in value of the Pound Sterling intercompany note.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make significant estimates and assumptions that affect the reported Condensed Consolidated Financial Statements for a particular period. Actual results could differ from those estimates.

Revenue Recognition

The majority of the Company’s net service revenues are based on fixed-price contracts calculated on a proportional performance basis (also referred to herein as “percentage-of-completion”) based upon assumptions regarding the estimated total costs for each contract. Additionally, work is performed under time-and-materials contracts, recognizing revenue as hours are worked based on the hourly billing rate for each contract. The Company also recognizes revenue under units-based contracts by multiplying units completed by the applicable contract per-unit price. Finally, at one of the Company’s Early Stage subsidiaries, the contracts are of a short-term nature and revenue is recognized under the completed contract method of accounting.

With respect to fixed price contracts, a percentage of completion is multiplied by the contract value to determine the amount of revenue recognized. Costs are incurred for performance of each contract and compared to the estimated budgeted costs for that contract to determine a percentage of completion on the contract. The contract value equals the value of the services to be performed under the contract as determined by aggregating the labor hours estimated to be incurred to perform the tasks in the contract at the agreed rates. Contract value excludes the value of third-party and other pass-through costs. As the work progresses, original estimates might be changed as a result of management’s regular contract review process.

Management regularly reviews the budget on each contract to determine if the budgeted costs accurately reflect the costs that the Company will incur for contract performance. The Company reviews each contract’s performance to date, current cost trends and circumstances specific to each contract. The Company estimates its remaining costs to complete the contract based on a variety of factors, including:

	•		Actual costs incurred to date and the work completed in incurring the actual costs;

	•		The remaining work to be completed based on the timeline of the contract as well as the number of units remaining for certain tasks in the contract; and

	•		Factors that could change the rate of progress of future contract performance.

Examples of factors included in the review process include patient enrollment rate, changes in the composition of staff on the project or other customer requirements.

Based on these contract reviews, the Company adjusts cost estimates. Adjustments to revenues resulting from changes in cost estimates are recorded on a cumulative basis in the period in which the revisions are made. When estimates indicate a loss, such loss is provided in the current period in its entirety. While the Company routinely adjusts cost estimates on individual contracts, the Company’s estimates and assumptions historically have been accurate in all material respects in the aggregate. The Company expects the estimates and assumptions to remain accurate in all material respects in the aggregate in future periods.

A contract amendment, which results in revisions to revenues and cost estimates, is recognized in the percentage-of-completion calculations beginning in the period in which the parties agree to the amendment. (See also Company Overview section of MD&A for a description of the contract amendment process.) Historically the aggregate value of contract amendments signed in any year represents 15% to 20% of annual sales, and, like sales, represents future revenues. Although the majority of the Company’s contract amendments relate to future services, the Company and its customers may execute contract amendments for services that the Company already has performed. In these circumstances, revenue from these services is recognized in the current period. Historically, the impact of such amendments on results of operations has not been material.

Under the Company’s policy, project teams are not authorized to engage in tasks outside the scope of the contract without prior management approval. In some situations, management may authorize the project team to commence work on activities outside the contract scope while the Company and its customer negotiate and finalize the contract amendment. When work progresses on unsigned, unprocessed contract amendments, the Company reviews the direct costs incurred, and, where material defers such costs on the balance sheet. In addition, the impact of such costs on the estimates to complete is considered and, where material, the estimates are adjusted. Historically, neither the deferred costs nor the impact on estimates have been material.

The Company believes that total costs constitute the most appropriate indicator of the performance of fixed price contracts because the costs relate primarily to the amount of labor hours incurred to perform the contract. The customer receives the benefit of the work performed throughout the contract term and is obligated to pay for services once performed. Accordingly, the Company believes that an input measure of cost is a reasonable surrogate for an output measure under the proportional performance model and is consistent with the revenue recognition concepts of SAB 101.

As the Company provides services on projects, it also incurs third-party and other pass-through costs, which are reimbursable by its customers pursuant to the contract. The revenues and costs from these third-party and other pass-through costs are reflected in the Company’s Consolidated Statements of Operations under the line items titled “Reimbursable out-of-pocket revenues” and “Reimbursable out-of-pocket costs”, respectively.

Direct Costs

Direct costs consist of compensation and related fringe benefits for project-related associates, unreimbursed project-related costs and an allocated portion of indirect costs, which primarily include facilities-related costs and information systems costs. Labor costs represent over 80% of total direct costs with the allocated portion of indirect costs representing less than 10% of total. To determine the allocated portion of indirect costs, the Company calculates an allocation percentage based on the relationship between billable associate salaries and total salaries. The remaining indirect costs are allocated to SG&A.

Because the Company’s business is labor intensive, direct costs historically have increased with an increase in net service revenues. The Company, however, has not experienced any material variations in the relationship between direct costs and net service revenues for the fiscal years ended 2004, 2005 and 2006. The following factors will cause direct costs to decrease as a percentage of net service revenues:

	•		Higher utilization rates for billable employees; and

	•		The ability to complete contracted work more efficiently than estimated by the Company.

The following factors will cause direct costs to increase as a percentage of net service revenues:

	•		The occurrence of cost overruns from increased time to complete contract performance;

	•		Increased costs due to higher-paid employees or contractors performing contract services; and

	•		Pricing pressure from increased competition.

The Company does not expect that the foregoing factors will have a material impact on the historical relationship between direct costs and net service revenues.

Other Costs

Selling, general and administrative expenses consist of compensation and related fringe benefits for sales and administrative employees and professional services, as well as unallocated costs related to facilities, information systems and other costs.

Depreciation and amortization expenses consist of depreciation and amortization costs recorded on a straight-line method over the estimated useful life of the property or equipment and internally developed software. Finite-lived intangible assets are generally amortized on an accelerated basis based on the discounted cash flow calculations used in the valuation of the asset.

Accounts Receivable/Allowance for Doubtful Accounts

Billed accounts receivable represent amounts for which invoices have been sent to customers. Unbilled accounts receivable are amounts recognized as revenue for which invoices have not yet been sent to customers. Advance billings represent amounts billed or payment received for which revenues have not yet been earned. The Company maintains an allowance for doubtful accounts receivable based on historical evidence of accounts receivable collections and specific identification of accounts receivable that might pose collection problems. The bad debt provision is monitored on a regular basis and adjusted as circumstances warrant. With the exception of a $1.7 million write-off in 2005 of receivables due from one customer, the Company’s allowance for doubtful accounts has been sufficient to cover any bad debt write-offs. If the Company is unable to collect all or part of its outstanding receivables, there could be a material impact to the Company’s Consolidated Results of Operations or financial position.

Long-Lived Assets

The Company analyzes goodwill and other indefinite-lived intangible assets to determine any potential impairment loss on an annual basis, unless conditions exist that require an updated analysis on an interim basis. Certain factors that may occur and indicate an impairment include the following: significant underperformance relative to historical or projected operating results; significant changes in the manner of the Company’s use of the underlying assets; and significant adverse industry or market economic trends.

A fair value approach is used to test goodwill for impairment. The fair value approach compares estimates related to the fair value of the reporting unit with the unit’s carrying amount, including goodwill. If the carrying amount of the reporting unit exceeds the fair value, the amount of the impairment loss must be measured. At December 31, 2006, the fair value of the reporting units exceeded the carrying value, resulting in no goodwill impairment charge.

In addition, the Company has an intangible asset representing one customer relationship acquired in the Company’s acquisition of Clinical and Pharmacologic Research, Inc (CPR). The fair value of this customer relationship had been $15 million prior to the fourth quarter of 2006 and the useful life had been designated as indefinite. Due to declining revenue from this customer in 2006 and declining revenue projected for 2007 and future years, the Company determined that the asset was impaired and recorded an $8.2 million impairment charge in 2006. Effective January 1, 2007, the Company has assigned a 23-year useful life to the customer relationship and in the first quarter of 2007 the Company began amortizing the customer relationship basis over the 23 years on a straight-line basis.

The estimate of fair value of long-lived assets is inherently subjective and requires the Company to make a number of assumptions and projections. These assumptions and projections relate to future revenues, earnings and the probability of certain outcomes and scenarios. If factors change and the Company employs different assumptions in estimating fair value of its long-lived assets, the estimated fair value of these assets could change and result in impairment charges.

Internally Developed Software

The Company capitalizes costs incurred to internally develop software used primarily in the Company’s proprietary clinical trial and data management systems, and amortizes these costs over the useful life of the product, not to exceed five years. Internally developed software represents software in the application development stage, and there is no assurance that the software development process will produce a final product for which the fair value exceeds its carrying value. Internally developed software is an intangible asset subject to impairment write-downs whenever events indicate that the carrying value of the software may not be recoverable. As with other long-lived assets, this asset is reviewed at least annually to determine the appropriateness of the carrying value of the asset. Assessing the fair value of the internally developed software requires estimates and judgment on the part of management.

Tax Valuation Allowance

The Company estimates its tax liability based on current tax laws in the statutory jurisdictions in which it operates. Because the Company conducts business on a global basis, its effective tax rate has and will continue to depend upon the geographic distribution of its pre-tax earnings (losses) among jurisdictions with varying tax rates. These estimates include judgments about deferred tax assets and liabilities resulting from temporary differences between assets and liabilities recognized for financial reporting purposes and such amounts recognized for tax purposes. The Company has assessed the realization of deferred tax assets and a valuation allowance has been established based on an assessment that it is more likely than not that realization cannot be assured. The ultimate realization of this tax benefit is dependent

upon the generation of sufficient operating income in the respective tax jurisdictions. If estimates prove inaccurate or if the tax laws change unfavorably, significant revisions in the valuation allowance may be required in the future.

Stock-based Compensation

Effective January 1, 2006, the Company began accounting for stock-based incentive programs under Statement of Financial Accounting Standards (SFAS) 123(R), “Share-Based Payment.” SFAS 123(R) superseded Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, be recognized as compensation expense in the income statement at fair value. The Company adopted the provisions of SFAS 123(R) for all share-based payments granted after January 1, 2006, and for all awards granted to employees prior to January 1, 2006, that remain unvested on January 1, 2006. The Company adopted SFAS 123(R) using a modified prospective application. The Company uses the straight-line method of recording compensation expense relative to share-based payment.

The weighted average fair value of the options granted was estimated on the date of grant using the Black-Scholes option-pricing model. The use of a Black-Scholes model requires the use of extensive historical employee exercise data and the use of a number of complex assumptions including assumptions regarding expected volatility of the stock, the risk free interest rate, expected dividends and expected term of the grant. The Company calculated expected volatility of its stock based on the volatility of its stock over a period approximating the expected term of the grants. The risk-free interest rate assumption is based upon observed interest rates appropriate for the term of the Company’s employee stock options. The Company assumed a dividend yield of zero because the Company has not paid dividends in the past and does not expect to do so in the future. Because stock-based compensation expense is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based on historical experience. The expected term of the option is based upon the contractual term and expected employee exercise and expected post-vesting employment termination behavior.

The adoption of SFAS 123(R) resulted in additional stock-based compensation expense of approximately $141,000 and $769,000 in the third quarter and first nine months of 2007, respectively, compared to additional stock-based compensation expense of approximately $195,000 and $1.4 million in the third quarter and first nine months of 2006, respectively. The incremental stock-based compensation expense caused net income to decrease by approximately $126,000 and $599,000 and basic and diluted earnings per share to decrease by $0.01 and $0.04 per share in the three and nine months ended September 30, 2007, respectively. The incremental stock-based compensation expense caused net income to decrease by approximately $163,000 and $1.1 million and basic and diluted earnings per share to decrease by $0.01 and $0.07 per share in the three and nine months ended September 30, 2006, respectively. Stock-based compensation expense is recorded primarily in general and administrative expenses in the Company’s Consolidated Statements of Income as the majority of the stock option expense related to options granted to executives.

If factors change and the Company employs different assumptions in the application of SFAS 123(R) in future periods, the compensation expense that the Company records may differ significantly from the expense recorded in the current period.

New Accounting Pronouncements

On July 13, 2006, the FASB issued FASB Interpretation (“FIN”) No. 48 “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement 109.” FIN No. 48 establishes a single model to address accounting for uncertainty in tax positions. FIN No. 48 clarifies the accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN No. 48 also provides guidance on de-recognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN No. 48 is effective for fiscal years beginning after December 15, 2006.

The tax years that remain subject to examination for the Company’s major tax jurisdictions are shown below:


Jurisdiction		Open Years
United States		2002, 2004 - 2006
Germany		2003 - 2006
United Kingdom		2005 - 2006
Netherlands		2004 - 2006

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.

Cautionary Statement for Forward-Looking Information

Certain statements contained in this 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.

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, 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.

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. Management’s assessment of and conclusion on the effectiveness of internal controls over financial reporting did not include an assessment of certain elements of the internal control over financial reporting of the Phase II-IV Clinical Services business of Charles River Laboratories International, Inc., acquired in August of 2006, which is included in the financial statements of the Company for the quarter ended September 30, 2007 and as of December 31, 2006. The excluded element constitutes

approximately $283 million of the Company’s total assets as of September 30, 2007, approximately $204 million of which is goodwill.

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, these internal controls over financial reporting during the period covered by this report.


Part II.		Other Information


Item 1.		Legal Proceedings — The Company is not party to any material proceedings under Item 103 of Regulation S-K.


Item 1A.		Risk Factors

Factors that could cause actual performance to differ materially from these forward-looking statements include, without limitation, the following:

The Company depends on the biopharmaceutical industry for most of its revenue.

The Company’s revenues depend on the outsourcing trends and research and development expenditures of the biopharmaceutical industry. Economic factors and industry trends that affect companies in those industries affect its business. A slowdown in research and development spending in the biopharmaceutical industry could negatively affect its net service revenues and results of operations. Mergers and acquisitions in the biopharmaceutical industry could result in delay or cancellation of certain projects.

The Company’s contracts may be delayed, terminated or reduced in scope with little or no notice.

Many of the Company’s contracts provide for services on a fixed-price basis and may be terminated or reduced in scope with little or no notice. Cancellations may occur for a variety of reasons, including the failure of the product to satisfy safety requirements, unexpected results of the product or the client’s decision to terminate the development of a product.

The loss, reduction in scope or delay of a large contract or the delay of multiple contracts could have a material adverse effect on the Company’s results of operations, although its contracts entitle it to receive payments for work performed in the event of a cancellation. Cancellation or delay of a large contract or multiple contracts could leave the Company with under-utilized resources and thereby negatively affect its net service revenues and results of operations. The Company believes its aggregate backlog and verbal awards are not necessarily meaningful indicators of future net service revenues and financial results.

The fixed price nature of many of the Company’s contracts could result in financial losses.

Because many of the Company’s contracts are structured as fixed price, it is at financial risk if it initially underbids the contract or overruns the initial cost estimates. Such under-bidding or significant cost overruns could have a material adverse effect on the Company’s business, results of operations, financial condition and cash flows.

If the Company fails to hire, retain and integrate qualified personnel, it will be difficult for it to achieve its goals.

The Company’s success depends to a significant extent upon the skills, experience and efforts of its senior management team and its ability to hire qualified personnel in the regions in which it operates. The loss of any of the Company’s executive officers or other key employees, without a properly executed transition plan, could have an adverse effect on it. In addition, there is substantial competition among both CROs and biopharmaceutical companies for qualified

personnel. Difficulty recruiting or retaining qualified personnel and/or unexpected recruiting costs will affect the Company’s ability to meet financial and operational goals.

If the Company is required to write off goodwill or other intangible assets, its financial position and results of operations would be adversely affected.

For the year ended December 31, 2006, the Company incurred a non-cash goodwill impairment charge of $8.2 million relating to a customer relationship intangible asset acquired in 2002. The Company had goodwill and other acquisition-related intangible assets of approximately $40 million and $254 million (after deducting the impairment charge) as of December 31, 2005 and December 31, 2006, respectively, which constituted approximately 21% and 56%, respectively, of its total assets. At September 30, 2007, the Company had goodwill and other acquisition-related intangible assets of approximately $251 million which constituted approximately 51% of its total assets. The Company periodically evaluates goodwill and other intangible assets for impairment. Any future determination requiring the write off of a significant portion of the Company’s goodwill or other intangible assets could adversely affect its results of operations and financial condition.

The CRO industry is highly competitive.

The CRO industry is comprised of a wide range of competitors, including small, niche providers as well as full-service global clinical research organizations. These companies compete based on a variety of factors, including reputation for quality performance, price, scope of service offerings and geographic presence. Some of the Company’s competitors have greater financial resources and a wider range of service offerings over a greater geographic area. Additionally, the Company’s customers have in-house capabilities to perform services that are provided by CROs. These factors potentially could have a negative impact on the Company’s ability to win business awards.

The Company has grown rapidly and its growth has placed, and is expected to continue to place, significant demands on it.

The Company has grown rapidly. Some of this growth has come as a result of acquisitions, and the Company continues to evaluate new acquisition opportunities. Businesses that grow rapidly often have difficulty managing their growth. The Company’s rapid growth has placed, and is expected to continue to place, significant demands on its management, its business and on its financial, accounting, information and other systems. The Company needs to continue recruiting and employing experienced executives and key employees capable of providing the necessary support. In addition, the Company will need to continue to improve its financial, accounting, information and other systems in order to effectively manage the Company’s growth. The Company’s ability to grow successfully through acquisitions could be affected by expenses incurred in integrating an acquired company, losses of key employees from an acquired company and unforeseen risks in acquiring companies in certain geographies. The Company cannot assure you that its management will be able to manage the Company’s growth and integrate acquired businesses effectively or successfully, or that its financial, accounting, information or other systems will be able to successfully accommodate the Company’s external and internal growth. A failure to meet these challenges could materially impair our business. Additionally, depending upon the nature of the consideration in an acquisition, an acquisition could result in dilution to existing shareholders.

The Company’s indebtedness could adversely affect its business and financial condition.

As of September 30, 2007, the Company had $200.0 million in convertible debt outstanding and an additional $53.5 million of borrowing capacity under a revolving line of credit. The Company had approximately $0.5 million of obligations outstanding under capital leases as of September 30, 2007. The Company maintains a $5.0 million multicurrency facility that is renewable annually and used in connection with its European operations. For a description of the Company’s Facility and existing indebtedness and that of its subsidiaries, see Liquidity and Capital Resources section of Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The Company’s level of indebtedness will have several important effects on its future operations. For example, the Company will be required to use a portion of its cash flow from operations for the payment of principal and interest due on its outstanding indebtedness. In addition, the Company’s outstanding indebtedness and leverage could increase the impact of negative changes in general economic and industry conditions, as well as competitive pressures. Finally, the level of the Company’s outstanding indebtedness may affect its ability to obtain additional financing for working capital, capital expenditures or general corporate purposes.

General economic conditions as well as conditions affecting the Company’s operations specifically, including, but not limited to, financial and business conditions, many of which are beyond its control, may affect its future performance. As a result, these and other factors may affect the Company’s ability to make principal and interest payments on its indebtedness. The Company’s business might not continue to generate cash flow at or above current levels. Moreover, if the Company is required to repatriate foreign earnings in order to pay its debt service, it may incur additional income taxes. If the Company cannot generate sufficient cash flow from operations in the future to service its indebtedness, it may, among other things:

	•		Seek additional financing in the debt or equity markets;

	•		Seek to refinance or restructure all or a portion of its indebtedness;

	•		Sell selected assets;

	•		Reduce or delay planned capital expenditures

These measures might not be sufficient to enable the Company to service its indebtedness. In addition, any financing, refinancing or sale of assets might not be available on economically favorable terms, if at all.

Furthermore, the Company’s credit facility contains certain restrictive covenants which will affect, and in many respects significantly limit, management’s choices in responding to business, economic, regulatory and other competitive conditions.

Change in government regulation could adversely affect the Company.

Government agencies regulate the drug development process utilized by the Company in its work with biopharmaceutical companies. Changes in regulations that simplify the drug approval process or increases in regulatory requirements that lessen the research and development efforts of the Company’s customers could negatively affect it. In addition, any failure on the Company’s part to comply with existing regulations or the adoption of new regulations could impair the value of its services and result in the termination of or additional costs under its contracts with customers.

The Company’s international operations are subject to numerous risks.

The Company has international operations in many foreign countries, including South Africa, India and countries in Eastern Europe and Latin America. These operations are subject to risks and uncertainties inherent in operating in these countries, including government regulations, currency restrictions and other restraints, burdensome taxes and political instability. These risks and uncertainties could impact negatively the Company’s ability to perform large, global projects for its customers. Furthermore, the Company’s ability to deal with these issues could be affected by applicable U.S. laws and the need to protect its assets in those locations.

The Company’s quarterly operating results may vary.

The Company’s operating results may vary significantly from quarter to quarter and are influenced by a variety of factors, such as:

Ø		Exchange rate fluctuations;

Ø		Timing of contract amendments for changes in scope that could affect the value of a contract and potentially impact the amount of net service revenues from quarter to quarter;

Ø		Commencement, completion or cancellation of large contracts;

Ø		Progress of ongoing contracts;

Ø		Timing of and charges associated with completed acquisitions or other events; and

Ø		Changes in the mix of our services.

The Company believes that operating results for any particular quarter are not necessarily a meaningful indication of future results. Although fluctuations in quarterly operating results could negatively or positively affect the market price of the Company’s common stock, these fluctuations may not be related to future overall operating performance

The Company’s financial results are exposed to exchange rate fluctuations.

For the year ended December 31, 2006, approximately 45% of the Company’s revenues were derived from operations outside the United States. For the nine months ended September 30, 2007, approximately 50% of the Company’s revenues were derived from operations outside the United States. The Company’s financial statements are denominated in U.S. dollars. As a result, changes in foreign currency exchange rates could significantly affect the Company’s results of operations, financial position and cash flows as well as its ability to finance large acquisitions outside the United States.

The Company’s business could expose it to potential liability for personal injury claims that could affect its financial condition.

The Company’s business involves clinical trial management which includes the testing of new drugs on human volunteers. This business exposes the Company to the risk of liability for personal injury or death to patients resulting from, among other things, possible unforeseen adverse side effects or improper administration of a drug or device. Many of these volunteers and patients are already seriously ill and are at risk of further illness or death. Any claim or liability could have a material adverse effect on the Company’s financial position and its reputation if, as a result, it were required to pay damages or incur defense costs in connection with a claim and if: (i) such claim is outside the scope of indemnification agreements the Company has with clients and collaborative partners, (ii) an indemnification agreement is not performed in accordance with its terms or (iii) its liability exceeds the amount of any applicable indemnification limits or available insurance coverage. The Company might also not be able to purchase adequate insurance for these risks at reasonable rates in the future.

The Company’s operations might be affected by the occurrence of a natural disaster or other catastrophic event.

The Company depends on its clients, investigators, collaboration partners and other facilities for the continued operation of its business. Natural disasters or other catastrophic events, including terrorist attacks, pandemic flu, hurricanes and ice storms, could disrupt the Company’s operations or those of its clients, investigators and collaboration partners, which could also affect the Company. Even though the Company carries business interruption insurance policies and typically has provisions in its contracts that protect it in certain events, the Company might suffer losses as a result of business interruptions that exceed the coverage available under its insurance policies or for which the policies do not provide coverage. Any natural disaster or catastrophic event affecting the Company or its clients, investigators or

collaboration partners could have a significant negative impact on its operations and financial performance.

The Company’s business depends on the continued effectiveness and availability of its information technology infrastructure, and failures of this infrastructure could harm its operations.

To remain competitive in the Company’s industry, it must employ information technologies that capture, manage, and analyze the large streams of data generated during the clinical trials we manage in compliance with applicable regulatory requirements. In addition, because the Company provides services on a global basis, it relies extensively on its technology to allow the concurrent conduct of studies and work sharing around the world. As with all information technology, the Company’s system could become vulnerable to potential damage or interruptions from fires, blackouts, telecommunications failures and other unexpected events, as well as to break-ins, sabotage or intentional acts of vandalism. Given the extensive reliance of the Company’s business on this technology, any substantial disruption or resulting loss of data that is not avoided or corrected by its backup measures could harm its business and operations.

The nature of the Company’s business exposes it to litigation and regulatory risk.

The nature of the Company’s business exposes it to litigation risk, and it is a party to lawsuits in the ordinary course of its business. While the Company does not believe that the resolution of any currently pending lawsuits against it will, individually or in the aggregate, have a material adverse effect on its business, financial condition or results of operations, it is possible that one or more lawsuits to which it’s currently a party to or to which it subsequently becomes a party to, could adversely affect it in the future. In addition, failure to comply with applicable regulatory requirements can result in actions that could adversely affect the Company’s business and financial performance.

Anti-takeover provisions in the Company’s charter documents and under Ohio law may make an acquisition of it, which may be beneficial to its stockholders, more difficult, which could depress its stock price.

Certain provisions of the Company’s Articles of Incorporation and Code of Regulations and of Ohio law make it difficult for a third party to acquire control of it without the consent of its Board of Directors. These anti-takeover defenses may discourage, delay or prevent a transaction involving a change in control of the Company, and, accordingly, could limit the price that investors may be willing to pay for its common stock, including transactions in which holders of common stock might receive a premium for their shares over the market price. In cases where Board approval is not obtained, these provisions could also discourage proxy contests and make it more difficult for existing shareholders to elect directors of their choosing and cause the Company to take other corporate actions they desire. These provisions include:

Ø		the authorization of undesignated preferred stock, the terms, rights, privileges and restrictions of which may be established and shares of which may be issued without shareholder approval;

Ø		limitations on persons authorized to call a special meeting of shareholders; and

Ø		advance notice procedures required for shareholders to nominate candidates for election as directors or to bring matters before an annual meeting of shareholders.

In addition, the Company has adopted a shareholder rights plan that may have anti-takeover effects which will make an acquisition of it by another company more difficult. The Company’s shareholder rights plan provides that, in the event any person or entity acquires 15% or more of its outstanding common stock, its shareholders will be entitled to purchase shares of common stock, or in certain instances, shares of the acquirer, at a discounted price. The rights are intended to discourage a significant share acquisition, merger or tender offer involving the Company’s common stock by increasing the cost of effecting any

such transaction and, accordingly, could have an adverse impact on a takeover attempt that a shareholder might consider to be in the Company’s best interests.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds – None

Item 3. Defaults upon Senior Securities – Not applicable

Item 4. Submission of Matters to a Vote of Security Holders – Not applicable

Item 5. Other Information – None

Item 6. Exhibits


Exhibit			Filing
Number		Description of Exhibit	Status

	4.1	Indenture dated March 31, 2007 between the Company and LaSalle Bank National Association	B

	4.2	Supplemental Indenture No. 1 dated July 16, 2007 between the Company and LaSalle Bank National Association	D

	10.1	Confirmation of Convertible Bond Hedge Transaction, dated July 10, 2007, by and between the Company and UBS AG, London Branch	C

	10.2	Confirmation of Convertible Bond Hedge Transaction, dated July 10, 2007, by and between the Company and JPMorgan Chase Bank, National Association, London Branch	C

	10.3	Confirmation of Issuer Warrant Transaction, dated July 10, 2007, by and between the Company and UBS AG, London Branch	C

	10.4	Confirmation of Issuer Warrant Transaction, dated July 10, 2007, by and between the Company and JPMorgan Chase Bank, National Association, London Branch	C

	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

B		Incorporated herein by reference to Exhibit 4.1 to the Form S-3 filed with the Commission on March 21, 2007

C		Incorporated herein by reference to Exhibits 10.1, 10.2, 10.3 and 10.4 to Current Report on Form 8-K filed with the Commission on July 10, 2007

D		Incorporated herein by reference to Exhibit 4.2 to Current Report on Form 8-K filed with the Commission on July 16, 2007

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: November 9, 2007		Candace Kendle, PharmD
		Chairman of the Board and Chief Executive Officer


	By:	/s/ Karl Brenkert III
Date: November 9, 2007		Karl Brenkert III
		Senior Vice President - Chief Financial Officer

KENDLE INTERNATIONAL INC.

Exhibit Index


Exhibits		Description

	4.1	Indenture dated March 31, 2007 between the Company and LaSalle Bank National Association*

	4.2	Supplemental Indenture No. 1 dated July 16, 2007 between the Company and LaSalle Bank National Association*

	10.1	Confirmation of Convertible Bond Hedge Transaction, dated July 10, 2007, by and between the Company and UBS AG, London Branch*

	10.2	Confirmation of Convertible Bond Hedge Transaction, dated July 10, 2007, by and between the Company and JPMorgan Chase Bank, National Association, London Branch*

	10.3	Confirmation of Issuer Warrant Transaction, dated July 10, 2007, by and between the Company and UBS AG, London Branch*

	10.4	Confirmation of Issuer Warrant Transaction, dated July 10, 2007, by and between the Company and JPMorgan Chase Bank, National Association, London Branch*

	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


*		Incorporated herein by reference as set forth in Item 6 of Part II

Positive
Negative
Uncertain
Constraining
Legalese
Litigious
Readability	H.S. freshman Avg

Kendle International (KNDL) Inactive 10-Q2007 Q3 Quarterly report

Content analysis