SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _________ TO ___________
Commission file number 000-23019
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KENDLE INTERNATIONAL INC.
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(Exact name of registrant as specified in its charter)
Ohio 31-1274091
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(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
441 Vine Street, Suite 1200, Cincinnati, Ohio 45202
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(Address of principal executive offices) Zip Code
Registrant's telephone number, including area code (513) 381-5550
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(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. Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 12,733,743 shares of Common
Stock, no par value, as of April 30, 2002.
1
KENDLE INTERNATIONAL INC.
INDEX
PAGE
----
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets - March 31, 2002
and December 31, 2001 3
Condensed Consolidated Statements of Income - Three
Months Ended March 31, 2002 and 2001 4
Condensed Consolidated Statements of Comprehensive Income (Loss) -
Three Months Ended March 31, 2002 and 2001 5
Condensed Consolidated Statements of Cash Flows - Three
Months Ended March 31, 2002 and 2001 6
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosure About Market Risk 21
Part II. Other Information 22
Item 2. Changes in Securities and Use of Proceeds 22
Item 4. Submission of Matters to a Vote of Security Holders 22
Item 6. Exhibits and Reports on Form 8-K 22
Signatures 23
Exhibit Index 24
2
KENDLE INTERNATIONAL INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data) March 31, December 31,
2002 2001
--------- ---------
(unaudited) (note 1)
ASSETS
Current assets:
Cash and cash equivalents $ 5,523 $ 6,016
Available for sale securities 21,444 19,508
Accounts receivable 57,384 59,611
Other current assets 5,912 5,305
--------- ---------
Total current assets 90,263 90,440
--------- ---------
Property and equipment, net 16,328 16,407
Goodwill, net 88,776 86,094
Other intangible assets 15,000 --
Other assets 11,265 11,110
--------- ---------
Total assets $ 221,632 $ 204,051
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of obligations under capital leases $ 678 $ 660
Amounts outstanding under credit facilities 20,608 14,195
Trade payables 6,785 6,502
Advance billings 16,761 18,951
Other accrued liabilities 14,073 13,468
--------- ---------
Total current liabilities 58,905 53,776
--------- ---------
Obligations under capital leases, less current portion 1,461 1,362
Convertible note 6,000 --
Other noncurrent liabilities 6,888 6,606
--------- ---------
Total liabilities 73,254 61,744
--------- ---------
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; 12,732,419 and
12,399,406 shares issued and 12,715,139 and 12,382,126
outstanding at March 31, 2002 and December 31, 2001, respectively 75 75
Additional paid in capital 133,257 128,986
Retained earnings 19,439 17,322
Accumulated other comprehensive loss:
Net unrealized holding gains (losses) on available for sale securities (1) 35
Foreign currency translation adjustment (4,042) (3,761)
--------- ---------
Total accumulated other comprehensive loss (4,043) (3,726)
Less: Cost of common stock held in treasury, 17,280 shares at
March 31, 2002 and December 31, 2001, respectively (350) (350)
--------- ---------
Total shareholders' equity 148,378 142,307
--------- ---------
Total liabilities and shareholders' equity $ 221,632 $ 204,051
========= =========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
KENDLE INTERNATIONAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(in thousands, except per share data) For the Three Months Ended
March 31,
---------------------------------
2002 2001
---- ----
Net service revenues $ 43,921 $ 32,253
Reimbursable out-of-pocket revenues 10,029 8,106
-------- --------
Total revenues 53,950 40,359
-------- --------
Costs and expenses:
Direct costs 26,032 19,748
Reimbursable out-of-pocket costs 10,029 8,106
Selling, general and
administrative expenses 12,283 9,936
Depreciation and amortization 1,974 2,312
-------- --------
50,318 40,102
-------- --------
Income from operations 3,632 257
Other income (expense):
Interest income 153 241
Interest expense (265) (118)
Other (34) 80
-------- --------
Income before income taxes 3,486 460
Income tax expense 1,369 198
-------- --------
Net income $ 2,117 $ 262
======== ========
Income per share data:
Basic:
Net income per share $ 0.17 $ 0.02
======== ========
Weighted average shares 12,686 12,008
Diluted:
Net income per share $ 0.16 $ 0.02
======== ========
Weighted average shares 13,470 12,519
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
KENDLE INTERNATIONAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
(in thousands) For the Three Months Ended
March 31,
------------------------------
2002 2001
---- ----
Net income $ 2,117 $ 262
------- -------
Other comprehensive income:
Foreign currency translation adjustment (281) (1,096)
Net unrealized holding gains (losses) on
available for sale securities arising
during the period, net of tax (36) 112
Reclassification adjustment for holding
losses included in net income, net of tax -- 26
------- -------
Net change in unrealized holding gains
(losses) on available for sale securities (36) 138
------- -------
Comprehensive income (loss) $ 1,800 $ (696)
======= =======
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
KENDLE INTERNATIONAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands) For the Three Months Ended
March 31,
--------------------------------
2002 2001
---- ----
Net cash provided by operating activities $ 2,758 $ 4,685
-------- --------
Cash flows from investing activities:
Proceeds from sales and maturities of available for sale securities 5,397 14,883
Purchases of available for sale securities (7,428) (8,360)
Acquisitions of property and equipment (1,037) (1,164)
Additions to software costs (594) (930)
Other -- (5)
Acquisition of business, less cash acquired (7,931) (10,697)
-------- --------
Net cash used in investing activities (11,593) (6,273)
-------- --------
Cash flows from financing activities:
Net proceeds under credit facilities 6,500 12,854
Net proceeds (repayments) - book overdraft 1,900 (46)
Proceeds from exercise of stock options 128 65
Payments on capital lease obligations (187) (206)
Other 58 (13)
-------- --------
Net cash provided by financing activities 8,399 12,654
-------- --------
Effects of exchange rates on cash and cash equivalents (57) (215)
Net increase (decrease) in cash and cash equivalents (493) 10,851
Cash and cash equivalents:
Beginning of period 6,016 6,709
-------- --------
End of period $ 5,523 $ 17,560
======== ========
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Acquisition of Businesses:
Fair value of assets acquired (net of cash acquired) $ 19,154 $ 16,429
Fair value of liabilities assumed (1,131) (1,859)
Common stock issued (4,092) (3,873)
Convertible debt issued (6,000) --
-------- --------
Net cash payments $ 7,931 $ 10,697
======== ========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
6
KENDLE INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION:
The accompanying unaudited condensed consolidated financial
statements have been prepared in accordance with generally accepted
accounting principles 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 generally
accepted accounting principles 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 months ended March 31, 2002 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 2002. For further information, refer to the
consolidated financial statements and notes thereto included in the Form
10-K for the year ended December 31, 2001 filed by Kendle International
Inc. ("the Company") with the Securities and Exchange Commission.
The condensed consolidated balance sheet at December 31, 2001 has
been derived from the audited financial statements at that date but does
not include all of the information and notes required by generally accepted
accounting principles for complete financial statements.
2. 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 net income used in computing net income per diluted share has
been calculated as follows:
(in thousands) Three Months Ended Three Months Ended
March 31, 2002 March 31, 2001
------------------ ------------------
Net income per statement of income $2,117 $262
Add: After-tax interest expense on
convertible note 24 --
------ ----
Net income for diluted EPS calculation $2,141 $262
The weighted average shares used in computing net income per
diluted share have been calculated as follows:
7
(in thousands) Three Months Ended Three Months Ended
March 31, 2002 March 31, 2001
------------------ ------------------
Weighted average common shares
outstanding 12,686 12,008
Stock options 568 511
Convertible note 216 --
------ ------
Weighted average shares 13,470 12,519
Options to purchase approximately 790,000 and 434,000 shares of
common stock were outstanding during the three months ended March 31, 2002
and 2001 respectively, but were not included in the computation of earnings
per diluted share because the options' exercise price was greater than the
average market price of the common shares and, therefore, the effect would
be antidilutive.
3. ACQUISITIONS:
Details of the Company's acquisitions in 2002 and 2001 are listed
below. The acquisitions have been accounted for using the purchase method
of accounting. The escrow account referred to have been established at
acquisition date to provide indemnification of sellers' representations and
warranties.
Valuation of Common Stock issued in the acquisitions was based on
an appraisal obtained by the Company which provided for a discount of the
shares due to lock-up restrictions and the lack of registration of the
shares.
On January 29 2002, the Company acquired substantially all of the
assets of Clinical and Pharmacologic Research, Inc. (CPR) located in
Morgantown, West Virginia. CPR specializes in Phase I studies for the
generic drug industry, enabling the Company to expand into the generic drug
market.
Results of CPR are included in the Company's consolidated results
from the date of acquisition.
The aggregate purchase price was approximately $18.2 million,
including approximately $8.1 million in cash (including acquisition costs),
314,243 shares of Common Stock valued at $4.1 million and a $6.0 million
convertible subordinated note. The value of the shares issued was based on
the average closing price of the Company's shares over the three-day period
before the terms of the acquisition were agreed to. The note is convertible
at the holders option into 314,243 shares of the Company's Common Stock at
any time before January 29, 2005, the Maturity Date.
The following summarizes the estimated fair values of the assets
acquired and liabilities assumed at the date of acquisition. The intangible
asset is based on a third-party valuation of a customer contract acquired.
The intangible asset has been determined to have an indefinite life and
will not be amortized, but will instead be reviewed for impairment at least
annually.
8
At January 29, 2002
(in thousands)
Current assets $1,241
Fixed assets 213
Goodwill 2,927
Intangible asset 15,000
-------
Total assets acquired 19,381
Liabilities assumed 1,131
-------
Net assets acquired $18,250
In February 2001, the Company acquired AAC Consulting Group, Inc.,
a full service regulatory consulting firm with offices in Rockville,
Maryland. Total acquisition costs consisted of approximately $10.9 million
in cash and 374,665 shares of the Company's Common Stock. Of the total
shares, 124,888 shares were placed in an escrow account and have
subsequently been released.
The following unaudited pro forma results of operations assume the
acquisitions occurred at the beginning of 2001:
(in thousands) Three Months Ended Three Months Ended
March 31, 2002 March 31, 2001
------------------ ------------------
Net revenues $44,722 $35,906
Net income $2,255 $722
Net income per diluted share $0.17 $0.06
Weighted average shares 13,666 13,388
Pro-forma net income per above $2,255 $722
Add: After-tax interest expense on
convertible note 34 34
Pro-forma net income for diluted EPS $2,289 $ 756
The pro forma financial information is not necessarily indicative of
the operating results that would have occurred had the acquisitions been
consummated as of January 1, 2001, nor are they necessarily indicative of
future operating results.
4. GOODWILL AND OTHER INTANGIBLE ASSETS:
9
In accordance with Statement of Financial Accounting Standards (SFAS)
No. 142, effective January 1, 2002 the Company discontinued the
amortization of goodwill and other identifiable intangible assets that
have indefinite useful lives. Intangible assets that have finite
useful lives will continue to be amortized over their useful lives.
The impact of discontinuing amortization of goodwill with indefinite
lived intangible assets on net income, basic and diluted earnings per share
for the quarter ended March 31, 2001 is approximately $563,000, or $0.05
per share on a basic and fully diluted basis. Adjusted net income, basic
and diluted earnings per share for the three months ended March 31, 2001
was approximately $825,000, or $0.07 per share on a basic and fully
diluted basis.
Identifiable intangible assets as of March 31, 2002 are composed of:
(in thousands)
Gross Accumulated
Carrying Amount Amortization
--------------- -------------
Non-amortizable intangible assets $ 113,124 $ 9,348
Amortizable intangible assets -- --
---------- ------
Total $ 113,124 $ 9,348
5. DEBT:
The Company has two Senior Credit Facilities (the Credit Facilities).
The Credit Facilities are composed of a $35.0 million revolving credit loan
and a $5.0 million Multicurrency Facility that is renewable annually and is
used in connection with the Company's European operations. The $35.0
million facility bears interest at a rate equal to either (a) LIBOR plus
the Applicable Percentage (as defined) or (b) the higher of the Federal
Fund's Rate plus 0.5%, plus the Applicable Margin or the Bank's prime rate.
The $5.0 million facility is composed of a euro overdraft facility up to
the equivalent of $3.0 million and a sterling overdraft facility up to the
equivalent of $2.0 million. This Multicurrency Facility bears interest at a
rate equal to either (a) the rate published by the European Central Bank
plus a margin (as defined) or (b) the bank's Base Rate (as determined by
the bank having regard to prevailing market rates) plus a margin (as
defined). The facilities contain various restrictive financial covenants,
including the maintenance of certain fixed coverage and leverage ratios and
minimum net worth levels. At March 31, 2002, $16.5 million was outstanding
under the Company's $35 million revolving credit loan and $4.1 million was
outstanding under the $5.0 million Multicurrency Facility. Interest is
payable on the $16.5 million outstanding at a weighted average rate of 3.7%
and on the $4.1 million at a weighted average rate of 4.7%.
With the acquisition of Clinical and Pharmacologic Research, Inc.
("CPR"), on January 29, 2002 the Company entered into a $6,000,000
convertible note payable to the shareholders of CPR. The principal balance
is convertible into 314,243 shares of the Company's Common Stock at any
time through January 29, 2005 (the Maturity Date). If the note has not been
converted at the Maturity Date, the Company has the option to extend the
Maturity Date of the note for another three years. The note bears interest
at an annual rate of 3.80% from January 29, 2002 through the Maturity Date.
Interest is payable semi-annually.
10
If the Maturity Date is extended, the interest rate will be reset on
January 29, 2005 at an annual rate of interest equal to the yield of a
United States Treasury Note.
6. SEGMENT INFORMATION
Effective January 1, 2002, the Company integrated the medical
communications group into its Phase IV product and services offering. As a
result, the Company is now managed under a single reportable segment
referred to as contract research services, which encompasses Phase I
through IV services.
Prior to January 1, 2002, the Company was managed through two
reportable segments, namely the contract research services group and the
medical communications group. The contract research services group includes
clinical trial management, clinical data management, statistical analysis,
medical writing, medical affairs and marketing, and regulatory
consultation. The medical communications group, which included only Health
Care Communications, Inc. (HCC) acquired in 1999, provided organizational,
meeting management and publication services to professional organizations
and pharmaceutical companies. Effective January 1, 2002, the Company
launched a new strategic initiative, Medical Affairs Medical Marketing
(MAMM). The MAMM service offering is intended to provide a more
comprehensive Phase IV product to the Company's core customers, including
post-marketing activities such as publications and symposia in support of
new product launches. As a result, the former medical communications group
was integrated into MAMM and certain of HCC's unique services have been
restructured to be in alignment with the Company's Phase IV services
strategy.
7. NEW ACCOUNTING PRONOUNCEMENTS:
In November 2001, the Financial Accounting Standards Board ("FASB")
issued EITF 01-14, "Income Statement Characterization of Reimbursements
Received for Out-of-Pocket Expenses Incurred." The EITF requires
reimbursements for out-of-pocket expenses incurred to be characterized as
revenue and expenses in the Statements of Income. The Company implemented
this rule in the first quarter of 2002 and has restated comparative
information for the first quarter of 2001. The implementation of the new
guidelines has no impact on income from operations or net income.
In July 2001, the FASB issued SFAS No. 141, "Business Combinations"
that requires all business combinations initiated after June 30, 2001 to be
accounted for using the purchase method. The Company has adopted SFAS No.
141 and the adoption did not have an impact on the Company's results of
operations or its financial position.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets" that requires that all intangible assets determined to
have an indefinite useful life no longer be amortized but instead be
reviewed at least annually for impairment. The Company adopted SFAS No. 142
as of January 1, 2002, as required. The Company analyzed goodwill for
impairment at the reporting unit level at the beginning of 2002 and found
no goodwill impairment. The Company will analyze goodwill on an annual
basis, or more frequently as circumstances warrant.
11
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 supercedes SFAS
No. 121 "Accounting for the Impairment of Long-Lived Assets to be Disposed
of" and certain provisions of APB Opinion No. 30, "Reporting the Results of
Operations - Reporting the Effects of Disposal of a Segment of a Business,
and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions." SFAS No. 144 establishes a single model for the impairment
of long-lived assets and broadens the presentation of discontinued
operations. The adoption of this statement did not have an impact on the
Company's consolidated financial statements.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS 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
months ended March 31, 2002 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 an international contract
research organization (CRO) that provides integrated clinical research services
including clinical trial management, clinical data management, statistical
analysis, medical writing, regulatory consultation and organizational, meeting
management and publications services on a contract basis to the pharmaceutical
and biotechnology industries. The Company had been managed through two
reportable segments, the Phase I through IV contract research services group,
which among other services, includes investigator meetings, pharmacoeconomics,
post-marketing surveillance, and labeling studies, and the medical
communications group. Effective January 1, 2002, the Company launched a new
strategic initiative, Medical Affairs Medical Marketing (MAMM). The MAMM service
offering is intended to provide a more comprehensive Phase IV product to the
Company's customers, including post-marketing activities such as publications
and symposia in support of new product launches. As a result, the former medical
communications group is now being managed as part of MAMM and their service
capabilities have been incorporated into the Company's overall Phase IV suite of
products. As such the medical communications group, which had principally
focused on organization, meeting management and publication services for
professional organizations and pharmaceutical companies has been restructured
and integrated with the contract research services group.
The Company's contracts are generally fixed price, with some variable
components, and range in duration from a few months to several years. A contract
typically requires a portion of the contract fee to be paid at the time the
contract is entered into and the balance is received in installments over the
contract's duration, in most cases on a milestone achievement basis. Net
revenues from contracts are generally recognized on the percentage of completion
method, measured principally by the total costs incurred as a percentage of
estimated total costs for each contract. The estimated total costs of contracts
are reviewed and revised periodically throughout the lives of the contracts with
adjustments to revenues resulting from such revisions being recorded on a
cumulative basis in the period in which the revisions are made. The Company also
performs work under time-and-materials contracts, recognizing revenue as hours
are worked based on the hourly billing rates for each contract. Additionally,
the Company recognizes revenue under units-based contracts as units are
completed multiplied by the contract per-unit price.
The Company incurs costs, in excess of contract amounts, in
subcontracting with third-party investigators as well as other out-of-pocket
costs. These out-of-pocket costs are reimbursable by its customers. Effective
January 1, 2002 in connection with the implementation of EITF 01-14, the Company
includes amounts paid to investigators and other out-of-pocket costs as
reimbursable out-of-pocket revenues and reimbursable out-of-pocket expenses in
the Consolidated Statements of Income. In certain contracts, these costs are
fixed by the contract terms so the Company recognizes these costs as part of net
service revenues and direct costs.
Direct costs consist of compensation and related fringe benefits for
project-related associates, unreimbursed project-related costs and indirect
costs including facilities, information systems and other costs. Selling,
general and administrative expenses consist of compensation
13
and related fringe benefits for sales and administrative associates and
professional services, as well as unallocated costs related to facilities,
information systems and other costs.
The Company's results are subject to volatility due to a variety of
factors. The cancellation or delay of contracts and cost overruns could have
immediate adverse effects on the 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 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 revenues included in the backlog.
ACQUISITIONS
In January 2002, the Company acquired the assets of Clinical and
Pharmacologic Research, Inc., located in Morgantown, West Virginia. CPR
specializes in Phase I studies for the generic drug industry. Total acquisition
costs consisted of approximately $8.1 million cash, 314,243 shares of the
Company's common stock valued at $4.1 million and a $6.0 million convertible
subordinated note. The note is convertible to 314,243 shares of the Company's
common stock at any time before January 29, 2005, the Maturity Date. If the note
has not been converted at the Maturity Date, the Company has the option to
extend the Maturity Date of the note for another three years.
The estimated fair value of the assets acquired and liabilities assumed
at the date of acquisition is as follows:
At January 29, 2002
(in thousands)
Current assets $1,241
Fixed assets 213
Goodwill 2,927
Intangible asset 15,000
-------
Total assets acquired 19,381
Liabilities assumed 1,131
-------
Net assets acquired $18,250
The intangible asset is based on a third-party valuation of a customer
contract acquired and has been determined to have an indefinite useful life and
will not be amortized, but will instead be reviewed for impairment at least
annually.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2002 COMPARED TO THREE MONTHS ENDED MARCH 31, 2001
14
Net service revenues increased 36% to $43.9 million in the first
quarter of 2002 from $32.3 million in the first quarter of 2001. Excluding the
negative impact of foreign currency exchange rates, net service revenues
increased 38% in the first quarter of 2002. The 36% increase in net service
revenues was composed of growth from acquisitions of 9% and organic growth in
revenues of 27%. The growth in organic service revenues is primarily
attributable to the increased level of clinical development activity in 2002.
Approximately 28% of the Company's net service revenues were derived from
operations outside the United States in the first quarter of 2002 compared to
34% in the corresponding period in 2001. The top five customers based on net
service revenues contributed approximately 47% of net revenues during the
quarter. Net service revenues from Pharmacia Inc. and Helsinn Healthcare SA
accounted for approximately 17% and 11%, respectively, of total first quarter
2002 net service revenues.
Direct costs increased by 32% from $19.7 million in the first quarter
2001 to $26.0 million in the first quarter 2002. The 32% increase in direct
costs is composed of a 23% increase in organic direct costs and a 9% increase in
direct costs due to the impact of acquisitions. The increase in organic direct
costs is primarily a result of an increase in employee and contractor costs to
support the increased revenue base. Direct costs expressed as a percentage of
net service revenues were 59.3% for the three months ended March 31, 2002
compared to 61.2% for the three months ended March 31, 2001. The decrease in
these costs as a percentage of net revenues is due to a higher level of revenue
per billable employee resulting from increased utilization of billable
employees.
Selling, general and administrative expenses increased by 24% or $2.4
million, to $12.3 million in first quarter 2002 compared to $9.9 million in
first quarter 2001. The 24% increase in selling, general and administrative
expenses is composed of a 17% increase in organic SG&A costs and a 7% increase
in SG&A costs due to the impact of acquisitions. The increase in organic SG&A
costs is primarily due to increased employee-related costs such as salaries,
training costs and other employee costs incurred to support the larger revenue
base. Selling, general and administrative expenses expressed as a percentage of
net service revenues were 28.0% for the three months ended March 31, 2002
compared to 30.8% for the corresponding 2001 period. The decrease in these costs
as a percentage of revenue is a result of the Company's ability to leverage
these costs over a higher revenue base.
Depreciation and amortization expense decreased by 15% in the first
quarter of 2002 compared to the first quarter of 2001. The decrease is due to
the implementation of SFAS No. 142 in the first quarter of 2002, which has
eliminated the amortization of goodwill and other indefinite lived intangible
assets. See the discussion on SFAS No. 142 in the New Accounting Pronouncements
section of Management's Discussion and Analysis.
Net income for the first quarter of 2002 was $2.1 million compared to
net income of $262,000 for the corresponding period of 2001. On a pro-forma
basis, eliminating goodwill amortization in 2001, net income in the first
quarter of 2001 was approximately $825,000.
In the first quarter of 2002, the Company was impacted by lower results
from its medical communications activities as a result of the transition to a
broader Medical Affairs/Medical Marketing service offering. Future quarters in
2002 may experience results similar to the first quarter of 2002 as the Company
continues the implementation of its broader Phase IV service offerings.
15
The Company's effective tax rate was 39.3% for the three months ended
March 31, 2002 as compared to 43.0% for the three months ended March 31, 2002.
The decrease in the effective tax rate is primarily due to the impact of
non-deductible goodwill amortization on the effective tax rate in 2001 that was
eliminated in 2002.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents decreased by $0.5 million for the three
months ended March 31, 2002 primarily as a result of cash provided by operating
and financing activities of $2.8 million and $8.4 million, respectively, offset
by cash used in investing activities of $11.6 million. Net cash provided by
operating activities primarily resulted from net income and a decrease in
accounts receivable offset by a decrease in advance billings. 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 decreased to $40.6
million at March 31, 2002 from $40.7 million at December 31, 2001.
Investing activities for the three months ended March 31, 2002
consisted primarily of $7.9 million in costs incurred related to the Company's
acquisition, net of cash acquired, and capital expenditures of approximately
$1.6 million.
Financing activities for the three months ended March 31, 2002
consisted primarily of net borrowings of $6.5 million under the Company's credit
facilities that were used to finance the acquisition.
The Company had available for sale securities totaling $21.4 million at
March 31, 2002.
The Company has two Senior Credit Facilities (the Credit Facilities).
The Credit Facilities are composed of a $35.0 million revolving credit loan and
a $5.0 million Multicurrency Facility that is renewable annually and is used in
connection with the Company's European operations. The $35.0 million facility
bears interest at a rate equal to either (a) LIBOR plus the Applicable
Percentage (as defined) or (b) the higher of the Federal Fund's Rate plus 0.5%,
plus the Applicable Margin or the Bank's prime rate. The $5.0 million facility
is composed of a euro overdraft facility up to the equivalent of $3.0 million
and a sterling overdraft facility up to the equivalent of $2.0 million. This
Multicurrency Facility bears interest at a rate equal to either (a) the rate
published by the European Central Bank plus a margin (as defined) or (b) the
bank's Base Rate (as determined by the bank having regard to prevailing market
rates) plus a margin (as defined). The facilities contain various restrictive
financial covenants, including the maintenance of certain fixed coverage and
leverage ratios and minimum net worth levels. At March 31, 2002, $16.5 million
was outstanding under the Company's $35 million revolving credit loan and $4.1
million was outstanding under the $5.0 million Multicurrency Facility. Interest
is payable on the $16.5 million outstanding at a weighted average rate of 3.7%
and on the $4.1 million at a weighted average rate of 4.7%.
With the acquisition of Clinical and Pharamcologic Research, Inc.
("CPR"), on January 29, 2002 the Company entered into a $6,000,000 convertible
note payable to the shareholders of CPR. The principal balance is convertible
into 314,243 shares of the Company's Common Stock at any time through January
29, 2005 (the Maturity Date). If the note has not been converted at the Maturity
Date, the Company has the option to extend the Maturity Date of the note for
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another three years. The note bears interest at an annual rate of 3.80% from
January 29, 2002 through the Maturity Date. Interest is payable semi-annually.
If the Maturity Date is extended, the interest rate will be reset on January 29,
2005 at an annual rate of interest equal to the yield of a United States
Treasury Note.
The Company's primary cash needs on both a short-term and long-term
basis are for the payment of salaries and fringe benefits, hiring and recruiting
expenses, business development costs, capital expenditures, acquisitions, and
facility related expenses. The Company believes that its existing capital
resources, together with cash flows from operations and borrowing capacity under
its Credit Facilities, will be sufficient to meet its foreseeable cash needs. In
the future, the Company will continue to consider acquiring businesses to
enhance its service offerings, therapeutic base and global presence. Any such
acquisitions may require additional external financing and the Company may from
time to time seek to obtain funds from public or private issuance of equity or
debt securities. There can be no assurance that such financing will be available
on terms acceptable to the Company.
MARKET RISK
Interest Rates
The Company is exposed to changes in interest rates on its available
for sale securities and amounts outstanding under its Credit Facilities.
Available-for-sale securities are recorded at fair value in the financial
statements. These securities are exposed to market price risk, which also takes
into account interest rate risk. At March 31, 2002, the potential loss in fair
value resulting from a hypothetical decrease of 10% in quoted market price would
be approximately $2.1 million. The Company is also exposed to interest rate
changes on its variable rate borrowings. Based on the Company's March 31, 2002
amounts outstanding under Credit Facilities, a one percent change in the
weighted average interest rate would change the Company's annual interest
expense by approximately $206,000.
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 since from time
to time contracts are denominated in a currency different than the particular
subsidiary's local currency. This contract currency denomination issue is
applicable only to a portion of the contracts executed by the Company's foreign
subsidiaries. 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 revenues
and resultant net income can be affected by fluctuations in exchange rates.
Historically, fluctuations in exchange rates from those in effect at the time
contracts were executed have not had a material effect upon the Company's
consolidated financial results.
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
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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 consolidated statements of income.
The Company's 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
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 subsidiary's U.S. dollar balance sheet
and is necessary to keep the foreign balance sheet stated in U.S. dollars in
balance. Foreign currency translation adjustments, reported as a separate
component of shareholders' equity were $(4.0) million at March 31, 2002 compared
to $(3.8) million at December 31, 2001.
KEY ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make significant estimates
and assumptions that affect the reported Consolidated Financial Statements for a
particular period. Actual results could differ from those estimates.
The majority of the Company's revenues are based on fixed-price
contracts calculated on a percentage-of-completion basis based on assumptions
regarding the estimated total costs for each contract. Costs are incurred for
each project and compared to the estimated budgeted costs for each contract to
determine a percentage of completion on the project. The percentage of
completion is multiplied by the total contract value to determine the amount of
revenue recognized. Management reviews the budget on each contract to determine
if the budgeted amounts are correct, and budgets are adjusted as needed.
Historically, the majority of the Company's estimates have been materially
correct, but there can be no guarantee that these estimates will continue to be
accurate. As the work progresses, original estimates might be changed due to
changes in the scope of the work. The Company attempts to negotiate contract
amendments with the sponsor to cover these services provided outside the terms
of the original contract. Historically, the Company has been successful in
negotiating amendments in the majority of these instances. However, there can be
no guarantee that the sponsor will agree to proposed amendments, and the Company
ultimately bears the risk of cost overruns. In the past, the Company has had to
commit additional resources to existing projects, resulting in lower gross
margins. Similar situations may occur in the future.
As the Company works on projects, the Company incurs costs, in excess
of contract amounts, which are normally reimbursable by its customers. In
certain contracts, however, these costs are fixed by the contract terms. In
these contracts, the Company is at risk for costs incurred in excess of the
amounts fixed by the contract terms. Excess costs incurred above the contract
terms would negatively affect the Company's gross margin.
The Company's primary customers are concentrated in the pharmaceutical
and biotechnology industries. The Company derives a significant portion of its
revenue from a small
18
number of large pharmaceutical companies. The Company's revenue could be
negatively impacted by changes in the financial condition of these companies,
including potential mergers and acquisitions involving any of these companies.
Additionally, customers may generally terminate a study at any time, which might
cause unplanned periods of excess capacity and reduced revenue and earnings.
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.
The Company has an investment in a private company, Digineer, for which
the fair value is not readily determinable. The Company accounts for this
investment under the cost method. Digineer is a software consulting and
development company that does not have established marketable products and is
highly dependent on its ability to raise additional capital to fund its
operations until such time as it generates sufficient revenues and operating
cash flows to meet its obligations. There is no guarantee Digineer will be
successful in raising additional capital necessary in the short-term, or be
successful in establishing marketable products in the long-term. The investment
in Digineer is subject to impairment write-downs if events indicate that the
carrying value of this investment may not be recoverable. Management reviews all
of its investments for declines in value on a quarterly basis or more
frequently, if circumstances warrant. Assessing the value of this investment
requires significant judgement. The carrying value of this investment is $1.9
million at March 31, 2002.
The Company has a 50% owned joint-venture investment with KendleWits, a
company located in China. This investment is accounted for under the equity
method. To date, the Company has contributed approximately $750,000 for the
capitalization of KendleWits and the carrying value at March 31, 2002 is
approximately $500,000. Future capitalization needs will be dependent upon the
on-going capitalization needs of KendleWits. Results of KendleWits may vary, and
are dependent upon the demand for clinical research services in China and the
ability of KendleWits to generate additional business.
The Company capitalizes costs incurred to internally develop software
used primarily in providing proprietary clinical trial and data management
services, 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. Assessing the fair value of the
internally developed software requires estimates and judgement on the part of
management.
The Company estimates its tax liability based on current tax laws in
the statutory jurisdictions in which it operates. Because we conduct business on
a global basis, our effective tax rate has, and will continue to depend upon the
geographic distribution of our pre-tax earnings among jurisdictions with varying
tax rates. These estimates include judgements 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 based
on estimates of future taxable profits and losses in the various jurisdictions.
Based on these projections and the time period for the realization of these loss
carryforwards, a valuation allowance has not been recorded. If
19
estimates prove inaccurate or if the tax laws change unfavorably, a valuation
allowance could be required in the future.
NEW ACCOUNTING PRONOUNCEMENTS
In November 2001, the Financial Accounting Standards Board ("FASB")
issued EITF 01-14, "Income Statement Characterization of Reimbursements Received
for Out-of-Pocket Expenses Incurred." The EITF requires reimbursements for
out-of-pocket expenses incurred to be characterized as revenue and expenses in
the Statements of Operations. The Company implemented this rule in the first
quarter of 2002 and has restated comparative information for the first quarter
of 2001. The implementation of the new guidelines has no impact on income from
operations or net income.
In July 2001, the FASB issued SFAS No. 141, "Business Combinations" that
requires all business combinations initiated after June 30, 2001 to be accounted
for using the purchase method. The Company has adopted SFAS No. 141 and the
adoption did not have an impact on the Company's results of operations or its
financial position.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets" that requires that all intangible assets determined to have
an indefinite useful life no longer be amortized but instead be reviewed at
least annually for impairment. The Company adopted SFAS No. 142 as of January 1,
2002, as required. The Company analyzed goodwill for impairment at the reporting
unit level at the beginning of 2002 and has found no goodwill impairment. The
Company will analyze goodwill on an annual basis, or more frequently as
circumstances warrant.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 supercedes SFAS No.
121 "Accounting for the Impairment of Long-Lived Assets to be Disposed of" and
certain provisions of APB Opinion No. 30, "Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions." SFAS No. 144
establishes a single model for the impairment of long-lived assets and broadens
the presentation of discontinued operations. The adoption of this statement did
not have an impact on the Company's consolidated financial statements.
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 which 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
21
of such financial performance are each subject to numerous conditions,
uncertainties and risk factors. Factors which could cause actual performance to
differ materially from these forward-looking statements include, without
limitation, factors discussed in conjunction with a forward-looking statement,
changes in general economic conditions, competitive factors, outsourcing trends
in the pharmaceutical industry, the Company's ability to manage growth and to
continue to attract and retain qualified personnel, the Company's ability to
complete additional acquisitions and to integrate newly acquired businesses, the
Company's ability to penetrate new markets, competition and consolidation within
the industry, the ability of joint venture businesses to be integrated with the
Company's operations, the fixed price nature of contracts or the loss of large
contracts, cancellation or delay of contracts, the progress of ongoing projects,
cost overruns, fluctuations in the Company's sales cycle, the ability to
maintain large customer contracts or to enter into new contracts, the effects of
exchange rate fluctuations, and the other risk factors set forth in the
Company's SEC filings, copies of which are available upon request from the
Company's investor relations department. No assurance can be given that the
Company will be able to realize the net revenues included in backlog and verbal
awards. The Company believes that its aggregate backlog and verbal awards are
not necessarily meaningful indicators of future results.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
See Management's Discussion and Analysis of Financial Conditions and Results of
Operations.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings - None
Item 2. Changes in Securities and Use of Proceeds -
In January 2002, the Company issued 314,243 shares of Common Stock to
the former shareholders of Clinical and Pharmacologic Research, Inc.
Item 3. Defaults upon Senior Securities - Not applicable
Item 4. Submission of Matters to a Vote of Security Holders - None
Item 5. Other Information - Not applicable
Item 6. Exhibits and Reports on Form 8-K --
(a) Exhibits
The below exhibits were filed on February 13, 2002 on Form 8-K:
2(a) Asset Purchase Agreement made and entered into on January 29,
2002 among Kendle International Inc., Clinical and Pharmacologic
Research, Inc., Thomas S. Clark, M.D., Charles T. Clark, and E. Stuart
Clark.
2(b) Convertible Subordinated Note, dated January 29, 2002 issued by
Kendle International Inc. to Clinical and Pharmacologic Research, Inc.
(b) Reports filed on Form 8-K during the quarter:
The Company filed Form 8-K on February 13, 2002 to disclose the
acquisition of substantially all the assets of Clinical and
Pharmacologic Research, Inc.
The Company filed Form 8-K/A on March 29, 2002 to file the financial
statements of Clinical and Pharmacologic Research, Inc.
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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 hereunto duly authorized.
KENDLE INTERNATIONAL INC.
By: /s/ Candace Kendle
-------------------------------
Date: May 15, 2002 Candace Kendle
Chairman of the Board and
Chief Executive Officer
By: /s/ Timothy M. Mooney
-------------------------------
Date: May 15, 2002 Timothy M. Mooney
Executive Vice President -
Chief Financial Officer
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