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, 2003
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
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. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). 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: 12,939,366 shares of Common
Stock, no par value, as of April 30, 2003.
1
KENDLE INTERNATIONAL INC.
INDEX
Page
----
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets -March 31, 2003
and December 31, 2002 3
Condensed Consolidated Statements of Operations - Three
Months Ended March 31, 2003 and 2002 4
Condensed Consolidated Statements of Comprehensive Income (Loss) -
Three Months Ended March 31, 2003 and 2002 5
Condensed Consolidated Statements of Cash Flows - Three
Months Ended March 31, 2003 and 2002 6
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 14
Item 3. Quantitative and Qualitative Disclosure About Market Risk 25
Item 4. Controls and Procedures 25
Part II. Other Information 26
Item 1. Legal Proceedings 26
Item 2. Changes in Securities and Use of Proceeds 26
Item 3. Defaults upon Senior Securities 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 5. Other Information 26
Item 6. Exhibits and Reports on Form 8-K 26
Signatures 27
Exhibit Index 32
2
KENDLE INTERNATIONAL INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data) March 31, December 31,
2003 2002
------------ ------------
(unaudited) (note 1)
ASSETS
Current assets:
Cash and cash equivalents $ 5,811 $ 12,671
Available for sale securities 22,289 17,304
Accounts receivable 44,619 47,050
Other current assets 8,683 7,343
------------ ------------
Total current assets 81,402 84,368
------------ ------------
Property and equipment, net 18,903 19,028
Goodwill, net 22,295 22,033
Other indefinite-lived intangible assets 15,000 15,000
Other assets 14,520 14,968
------------ ------------
Total assets $ 152,120 $ 155,397
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of obligations under capital leases $ 893 $ 843
Current portion of amounts outstanding under credit facilities 3,000 3,000
Trade payables 5,678 5,883
Advance billings 19,928 22,313
Other accrued liabilities 12,382 10,878
------------ ------------
Total current liabilities 41,881 42,917
------------ ------------
Obligations under capital leases, less current portion 1,436 1,643
Convertible note 6,000 6,000
Long-term debt 9,000 9,750
Other noncurrent liabilities 738 727
------------ ------------
Total liabilities 59,055 61,037
------------ ------------
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; 12,951,453 and
12,861,510 shares issued and 12,931,556 and 12,841,613
outstanding at March 31, 2003 and December 31, 2002, respectively 75 75
Additional paid in capital 134,402 134,266
(Accumulated deficit) (39,602) (37,478)
Accumulated other comprehensive loss:
Net unrealized holding loss on available for sale securities (6) (6)
Unrealized loss on interest rate swap (551) (566)
Foreign currency translation adjustment (860) (1,538)
------------ ------------
Total accumulated other comprehensive loss (1,417) (2,110)
Less: Cost of common stock held in treasury, 19,897 shares at
March 31, 2003 and December 31, 2002, respectively (393) (393)
------------ ------------
Total shareholders' equity 93,065 94,360
------------ ------------
Total liabilities and shareholders' equity $ 152,120 $ 155,397
============ ============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
KENDLE INTERNATIONAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(in thousands, except per share data) For the Three Months Ended
March 31,
----------------------------
2003 2002
------------ ------------
Net service revenues $ 37,180 $ 43,921
Reimbursable out-of-pocket revenues 11,545 10,029
------------ ------------
Total revenues 48,725 53,950
------------ ------------
Costs and expenses:
Direct costs 22,689 26,032
Reimbursable out-of-pocket costs 11,545 10,029
Selling, general and
administrative expenses 13,142 12,283
Depreciation and amortization 2,185 1,974
Severance and office consolidation costs 682 --
------------ ------------
50,243 50,318
------------ ------------
Income (loss) from operations (1,518) 3,632
Other income (expense):
Interest income 103 153
Interest expense (272) (265)
Other (438) (34)
------------ ------------
Income (loss) before income taxes (2,125) 3,486
Income tax expense (benefit) (1) 1,369
------------ ------------
Net income (loss) $ (2,124) $ 2,117
============ ============
Income (loss) per share data:
Basic:
Net income (loss) per share $ (0.16) $ 0.17
============ ============
Weighted average shares 12,877 12,686
Diluted:
Net income (loss) per share $ (0.16) $ 0.16
============ ============
Weighted average shares 12,877 13,470
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,
----------------------------
2003 2002
------------ ------------
Net income (loss) $ (2,124) $ 2,117
Other comprehensive income (loss):
Foreign currency translation adjustment 678 (281)
Net unrealized holding losses on
available for sale securities arising
during the period, net of tax -- (36)
Net unrealized holding gains on
interest rate swap agreement 15 --
------------ ------------
Comprehensive income (loss) $ (1,431) $ 1,800
============ ============
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,
----------------------------
2003 2002
------------ ------------
Net cash provided by operating activities $ 944 $ 2,758
------------ ------------
Cash flows from investing activities:
Proceeds from sales and maturities of available for sale securities 18,500 5,397
Purchases of available for sale securities (23,488) (7,428)
Acquisitions of property and equipment (1,397) (1,037)
Additions to internally developed software (593) (594)
Other 4 --
Acquisition of business, less cash acquired -- (7,931)
------------ ------------
Net cash used in investing activities (6,974) (11,593)
------------ ------------
Cash flows from financing activities:
Net proceeds (repayments) under credit facilities (750) 6,500
Net proceeds (repayments) - book overdraft (32) 1,900
Proceeds from exercise of stock options 111 128
Payments on capital lease obligations (210) (187)
Other -- 58
------------ ------------
Net cash (used in) provided by financing activities (881) 8,399
------------ ------------
Effects of exchange rates on cash and cash equivalents 51 (57)
Net decrease in cash and cash equivalents (6,860) (493)
Cash and cash equivalents:
Beginning of period 12,671 6,016
------------ ------------
End of period $ 5,811 $ 5,523
============ ============
Supplemental schedule of noncash investing and financing activities:
Acquisition of Businesses:
Fair value of assets acquired (net of cash acquired) $ -- $ 19,154
Fair value of liabilities assumed -- (1,131)
Common stock issued -- (4,092)
Convertible debt issued -- (6,000)
------------ ------------
Net cash payments $ -- $ 7,931
============ ============
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. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
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, 2003
are not necessarily indicative of the results that may be expected for the year
ending December 31, 2003. For further information, refer to the consolidated
financial statements and notes thereto included in the Form 10-K for the year
ended December 31, 2002 filed by Kendle International Inc. ("the Company") with
the Securities and Exchange Commission.
The condensed consolidated balance sheet at December 31, 2002 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 (Loss) Per Share Data
Net income (loss) per basic share is computed using the weighted average
common shares outstanding. Net income (loss) per diluted share is computed using
the weighted average common shares and potential common shares outstanding.
The net income (loss) used in computing net income (loss) per diluted
share has been calculated as follows:
(in thousands) Three Months Ended Three Months Ended
March 31, 2003 March 31, 2002
------------------ ------------------
Net income (loss) per Statements of Operations $ (2,124) $ 2,117
Add: after-tax interest expense on
convertible note -- 24
------------------ ------------------
Net income for diluted EPS calculation $ (2,124) $ 2,141
The weighted average shares used in computing net income (loss) per
diluted share have been calculated as follows:
7
(in thousands) Three Months Ended Three Months Ended
March 31, 2003 March 31, 2002
------------------ ------------------
Weighted average common shares
Outstanding 12,877 12,686
Stock options -- 568
Convertible note -- 216
------------------ ------------------
Weighted average shares 12,877 13,470
Options to purchase approximately 2,300,000 shares of common stock were
outstanding during the three months ended March 31, 2003 but were not included
in the computation of earnings per diluted share because the effect would be
antidilutive.
Options to purchase approximately 790,000 shares of common stock were
outstanding during the three months ended March 31, 2002 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.
Stock-Based Compensation
The Company accounts for stock options issued to associates in accordance
with Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock
Issued to Employees." Under APB No. 25, the Company recognizes expense based on
the intrinsic value of the options. The Company has adopted the disclosure
requirements of Statement of Financial Accounting Standards (SFAS) No. 123,
"Accounting for Stock-Based Compensation," as amended by SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure" which
requires compensation expense to be disclosed based on the fair value of the
options granted at the date of grant.
Had the Company adopted SFAS No. 123 for expense recognition purposes, the
amount of compensation expense that would have been recognized in the first
quarter of 2003 and 2002 would have been approximately $1.3 million and
$845,000, respectively. The Company's pro-forma net income (loss) per diluted
share would have been adjusted to the amounts below:
(in thousands, except per share data) Three Months Ended Three Months Ended
March 31, 2003 March 31, 2002
------------------ ------------------
PRO FORMA NET INCOME (LOSS):
As reported $ (2,124) $ 2,117
Less: pro forma adjustment for
stock- based compensation, net of tax (1,014) (673)
------------------ ------------------
Pro-forma net income (loss) $ (3,138) $ 1,444
PRO-FORMA NET INCOME (LOSS) PER BASIC SHARE:
As reported $ (0.16) $ 0.17
Pro forma $ (0.24) $ 0.11
Effect of pro forma expense $ (0.08) $ (0.06)
8
PRO-FORMA NET INCOME (LOSS) PER DILUTED SHARE:
As reported $ (0.16) $ 0.16
Pro forma $ (0.24) $ 0.11
Effect of pro forma expense $ (0.08) $ (0.05)
New Accounting Pronouncements
In January 2003, the Emerging Issues Task Force (EITF) issued EITF Issue
00-21, "Revenue Arrangements with Multiple Deliverables," which requires
companies to determine whether an arrangement involving multiple deliverables
contains more than one unit of accounting. In applying EITF Issue 00-21, revenue
arrangements with multiple deliverables should be divided into separate units of
accounting if the deliverables in the arrangement meet certain criteria.
Arrangement consideration should be allocated among the separate units of
accounting based on their relative fair values. This issue is effective for
revenue arrangements entered into in fiscal periods beginning after June 15,
2003. The Company is currently evaluating what impact, if any, the adoption of
this issue will have on its results of operations and/or financial position.
In January 2003, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 46 (FIN 46), "Consolidation of Variable Interest Entities."
FIN 46 requires a variable interest entity to be consolidated by a company if
that company is subject to a majority of the risk of loss from the variable
interest entity's activities or entitled to receive a majority of the entity's
residual returns or both. A variable interest entity is a corporation,
partnership, trust, or any other legal structure used for business purposes that
either (a) does not have equity investors with voting rights or (b) has equity
investors that do not provide sufficient financial resources for the entity to
support its activities. A variable interest entity often holds financial assets,
including loans or receivables, real estate or other property. A variable
interest entity may be essentially passive or it may engage in research and
development or other activities on behalf of another company. The consolidation
requirements of FIN 46 apply immediately to variable interest entities created
after January 31, 2003. The consolidation requirements apply to older entities
in the first fiscal year or interim period beginning after June 15, 2003.
Certain of the disclosure requirements apply to all financial statements issued
after January 31, 2003, regardless of when the variable interest entity was
established. The Company is currently evaluating the consolidation requirements
of FIN 46.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure, an Amendment of SFAS No.
123." SFAS No. 148 provides transition guidance for those companies that elect
to voluntarily adopt the accounting provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation." SFAS No. 148 also mandates certain new disclosures
that are incremental to those required by SFAS No. 123. SFAS No. 148 is
effective for fiscal years ending after December 15, 2002. The Company has
adopted the disclosure requirements of SFAS No. 148. At this time the Company
does not plan to adopt the accounting provisions of SFAS No. 123 and will
continue to account for stock options in accordance with APB No. 25, "Accounting
for Stock Issued to Employees."
In July 2002, the FASB issued SFAS No. 146, "Accounting for Exit or
Disposal Activities." SFAS No. 146 addresses the recognition, measurement, and
reporting of costs that are associated with exit and disposal activities,
including costs related to terminating a contract
9
that is not a capital lease and termination benefits that employees who are
involuntarily terminated receive under the terms of a one-time benefit
arrangement that is not an ongoing benefit arrangement or an individual
deferred-compensation contract. SFAS No. 146 supersedes EITF No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring)" and
requires liabilities associated with exit and disposal activities to be expensed
as incurred. SFAS No. 146 is required for exit or disposal activities of the
Company initiated after December 31, 2002, with earlier adoption encouraged. The
Company has adopted SFAS No. 146.
2. ACQUISITION:
Details of the Company's acquisition in 2002 are listed below.
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 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.
Valuation of Common Stock issued in the acquisition was based on an
appraisal obtained by the Company on previously similarly structured
acquisitions, which provided for a discount of the shares due to lock-up
restrictions and the lack of registration of the shares.
The goodwill and the intangible asset acquired in the acquisition are
deductible for income tax purposes over a 15-year period.
The following unaudited pro forma results of operations assume the
acquisitions occurred at the beginning of 2002:
(in thousands) Three Months Ended
March 31,2002
------------------
Net service revenues $ 44,722
Net income $ 2,255
Net income per diluted share $ 0.17
Weighted average shares 13,666
Pro-forma net income per above $ 2,255
Add: after-tax interest expense on convertible
note 34
10
Pro-forma net income for diluted EPS $ 2,289
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, 2002, nor are they necessarily indicative of future operating
results.
3. OFFICE CONSOLIDATION AND EMPLOYEE SEVERANCE:
In order to bring its cost structure more in line with current revenue
projections, in the first quarter of 2003, the Company recorded a charge of
approximately $690,000 for severance and outplacement benefits relating to a
workforce reduction program which impacted approximately 17 employees, or 1
percent of its total workforce. Approximately $109,000 was paid during the first
quarter of 2003, and at March 31, 2003 approximately $581,000 remains accrued
and is reflected in Other Accrued Liabilities on the Company's Consolidated
Balance Sheet. The remaining $581,000 will be paid over the remaining quarters
of 2003. Additional legal and other costs of up to approximately $100,000 are
expected to be incurred over the remaining quarters of 2003 and will be expensed
as incurred. Costs relating to this program are reflected in the line item
entitled "Severance and Office Consolidation Costs" in the Company's Condensed
Consolidated Statements of Operations.
On August 29, 2002, the Company committed to a plan that consolidated its
three New Jersey offices into one central office, located in Cranford, New
Jersey. At that time, the Company maintained separate offices in Princeton,
Cranford and Ft. Lee, New Jersey. The leases in the Ft. Lee and Princeton
offices expired during the fourth quarter of 2002 and the first quarter of 2003,
respectively. The Company vacated these offices in the fourth quarter in advance
of the expiration of each of the respective office leases. As part of this plan,
the Company eliminated approximately 22 full-time positions.
In connection with the office consolidation, the Company recorded a
pre-tax charge of $321,000 in the third quarter of 2002, consisting primarily of
facility lease costs and severance and outplacement costs. As of March 31, 2003,
$32,000 remains accrued and is reflected in Other Accrued Liabilities in the
Company's Consolidated Balance Sheet. The amounts accrued as office
consolidation costs are detailed as follows:
(in thousands) Employee Facilities Other Total
Severance
---------- ---------- ---------- ----------
Liability at December 31, 2002 $ 73 $ 44 $ 40 $ 157
Amount Paid 37 24 -- 61
Non-cash charge -- 4 -- 4
Adjustment to liability 36 4 20 60
---------- ---------- ---------- ----------
Liability at March 31, 2003 $ -- $ 12 $ 20 $ 32
11
The $60,000 adjustment to the liability was due to lower than expected
outplacement and legal costs associated with the office consolidation program.
The Company recorded an additional $53,000 in costs in the first quarter of 2003
primarily related to retention bonuses. The remaining $32,000 will be used
primarily for facility-related obligations that will be paid out in the
remaining quarters of 2003.
4. GOODWILL AND OTHER INTANGIBLE ASSETS:
Identifiable intangible assets as of December 31, 2002 and March 31, 2003
are composed of:
(in thousands)
Goodwill Indefinite-lived Amortizable
Intangible Asset intangibles
---------------- ---------------- ----------------
Balance at 12/31/02 $ 22,033 $ 15,000 $ --
Less: Tax benefit to reduce goodwill (96) -- --
Add: Exchange rate fluctuations 358 -- --
Balance at 3/31/03 $ 22,295 $ 15,000 $ --
5. DEBT:
In June 2002, the Company entered into an Amended and Restated Credit
Agreement (the "Facility") that replaced the previous credit facility that would
have expired in October 2003. The Facility is composed of a revolving credit
loan that expires in three years and a $15.0 million term loan that matures in
five years. The Facility is in addition to an existing $5.0 million
Multicurrency Facility that is renewable annually and is used in connection with
the Company's European operations. The revolving credit loan bears interest at a
rate equal to either (a) The Eurodollar Rate plus the Applicable Percentage (as
defined) or (b) the higher of the Federal Fund's Rate plus 0.5% or the Bank's
Prime Rate. The $15.0 million term loan bears interest at a rate equal to the
higher of the Federal Funds Rate plus 0.5% and the Prime Rate or an Adjusted
Eurodollar Rate.
Under terms of the Facility, revolving loans are convertible into term
loans within the Facility if used for acquisitions. The Facility contains
various restrictive financial covenants, including the maintenance of certain
fixed coverage and leverage ratios.
At March 31, 2003 the Company fell below the minimum permitted Fixed
Charge coverage ratio. The Company and the banks amended the minimum permitted
Fixed Charge coverage ratio for the first quarter of 2003 and future periods. In
addition, as part of the amendment:
- The amount available under the revolving credit loan is
reduced from $23 million to the lesser of $10 million or 50%
of the Company's Eligible Receivables, as defined.
- Until the Company's Fixed Charge Coverage Ratio returns to
levels specified in the original agreement, the applicable
percentage applied to the interest rate on the Company's
borrowing under the Facility is increased by 0.75%.
- The term loan is collateralized by a pledge of the Company's
domestic cash and cash equivalents and any amounts outstanding
under the revolving credit loan are collateralized by the
Company's Eligible Receivables, as defined, and any remaining
12
domestic cash and cash equivalents above the amounts pledged
as security under the term loan.
- The Company must maintain a ratio of cash and cash equivalents
held in the United States to principal amounts outstanding
under the Company's term loan of at least 1.1 to 1.0.
The $5.0 million Multicurrency Facility is composed of a euro overdraft
facility up to the equivalent of $3.0 million and a pound 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).
At March 31, 2003, no amounts were outstanding under the Company's
revolving credit loan, $12.0 million was outstanding under the term loan, and no
amounts were outstanding under the $5.0 million Multicurrency Facility. Interest
is payable on the term loan at a rate of 5.82%. Principal payments of $750,000
are due on the term loan on the last business day of each quarter through March
of 2007.
13
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, 2003 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'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 becomes effective 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 the Company's customers. The Company
includes amounts paid to investigators and other out-of-pocket costs as
reimbursable out-of-pocket revenues and reimbursable out-of-pocket costs in the
Consolidated Statements of Operations. 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 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 CRO industry in general continues to be dependent on the research and
development activities 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 the major customers could have a
material adverse affect on the Company.
14
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 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, 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.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2003 COMPARED TO THREE MONTHS ENDED MARCH 31, 2002
Net Service Revenues
Net service revenues decreased 15% to $37.2 million in the first quarter
of 2003 from $43.9 million in the first quarter of 2002. Foreign currency
exchange rate fluctuations accounted for a 4% increase in net service revenues
in the first quarter of 2003 compared to 2002. The 15% decrease in net service
revenues was composed of growth from acquisitions of 3% and a decline in organic
net service revenues of 18%. The decline in net service revenues is due to
delays and cancellations affecting net service revenues in the first quarter of
2003 compared to the corresponding period in 2002 as well as an overall slowdown
in new business for the Company. In addition, in 2003 net service revenue
recorded on contracts where costs paid to investigators and other out-of-pocket
costs are fixed by the contract terms and recorded as direct costs and net
service revenues decreased by approximately $1.7 million. Approximately 30% of
the Company's net service revenues were derived from operations outside the
United States in the first quarter of 2003 compared to 28% in the corresponding
period in 2002. The top five customers based on net service revenues contributed
approximately 49% of net revenues during the first quarter of 2003 compared to
47% of net service revenues during the first quarter of 2002. Net service
revenues from Pharmacia Inc. and Pfizer Inc. accounted for approximately 21% and
10%, respectively, of total first quarter 2003 net service revenues compared to
approximately 17% and 10%, respectively, of total first quarter 2002 net service
revenues. The Company's net service revenues from Pharmacia Inc. and Pfizer Inc.
are derived from numerous projects that vary in size, duration and therapeutic
indication.
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 15.1% to $11.5 million in the
first quarter of 2003 from $10.0 million in the corresponding period of 2002.
Operating Expenses
Direct costs decreased by 13% from $26.0 million in the first quarter 2002
to $22.7 million in the first quarter 2003. The 13% decrease in direct costs is
composed of a 14% decrease in organic direct costs and a 1% increase in direct
costs due to the impact of acquisitions. The decline in organic direct costs is
related to the decline in net service revenues for the period. As a result of
the decrease in net service revenues, the Company has decreased the use of
outside contractors working on Company projects. In addition, the decrease in
organic direct costs is a
15
result of lower investigator and out-of-pocket costs of approximately $1.7
million on contracts where these costs are fixed by the contract terms. Direct
costs expressed as a percentage of net service revenues were 61.0% for the three
months ended March 31, 2003 compared to 59.3% for the three months ended March
31, 2002. The increase in direct costs as a percentage of net service revenue in
the first quarter of 2003 is due to lower utilization of resources in the first
quarter of 2003 resulting from temporary delays in certain projects.
Reimbursable out-of-pocket costs increased 15.1% to $11.5 million in the
first quarter of 2003 from $10.0 million in the corresponding period of 2002.
Selling, general and administrative expenses increased from $12.3 million
in the first quarter of 2002 to $13.1 million in the same quarter of 2003. The
change in selling, general and administrative expenses is composed of a 6%
increase in organic SG&A costs and a 1% increase in SG&A costs due to the impact
of acquisitions. Foreign currency exchange rate fluctuations accounted for a 5%
increase in selling, general and administrative expenses in the first quarter of
2003 compared to 2002. In addition, SG&A increased due to an increase in
employee related costs such as salary increases from the first quarter of 2002
to the first quarter of 2003. Selling, general and administrative expenses
expressed as a percentage of net service revenues were 35.3% for the three
months ended March 31, 2003 compared to 28.0% for the corresponding 2002 period.
The increase in SG&A costs as a percentage of net service revenues is due to the
decrease in net service revenues resulting from delays in certain projects.
Depreciation and amortization expense increased by 11% in the first
quarter of 2003 compared to the first quarter of 2002. The increase is primarily
due to increased depreciation and amortization relating to the Company's capital
expenditures.
In the first quarter of 2003, in order to bring its cost structure more in
line with current revenue projections, the Company recorded a charge of
approximately $690,000 for severance and outplacement benefits relating to a
workforce reduction program which impacted approximately 1 percent of its total
workforce. At March 31, 2003, approximately $581,000 remains accrued and is
reflected in Other Accrued Liabilities on the Company's Consolidated Balance
Sheet. The remaining $581,000 will be paid over the remaining quarters of 2003.
Other Income (Expense)
Other Income (Expense) was an expense of approximately $600,000 in the
first quarter of 2003 compared to an expense of approximately $150,000 in the
first quarter of 2002. In the first quarter of 2003 the Company incurred foreign
currency translation losses of approximately $345,000 primarily as a result of
the British pound weakening against the euro. Foreign currency losses in the
first quarter of 2002 were insignificant.
Income Taxes
The Company reported a tax benefit at an effective rate of 0.0% in the
quarter ended March 31, 2003 compared to tax expense at an effective rate of
39.3% in the quarter ended March 31, 2002. The Company records a full valuation
allowance against net operating losses incurred in certain European subsidiaries
of the Company. Since Kendle operates on a global basis, the effective tax rate
varies from year to year based on the locations that generate the pre-tax
earnings or losses.
16
Net Income (Loss)
Including the effect of the severance charge and office consolidation
costs (of $548,000 or $0.04 per share), the net loss for the quarter was $2.1
million, or $0.16 per share compared with net income of $2.1 million, or $0.16
per diluted share during the same period a year ago.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents decreased by $6.9 million for the three months
ended March 31, 2003 primarily as a result of cash used in investing and
financing activities of $7.0 million and $0.9 million, respectively, offset by
cash provided by operating activities of $0.9 million. Net cash provided by
operating activities primarily resulted from net loss adjusted for non-cash
activity.
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 $24.7 million at March 31, 2003 and December 31, 2002.
Financing activities for the quarter ended March 31, 2003 consisted
primarily of a payment of $750,000 relating to the Company's Facility (defined
below).
17
Investing activities for the three months ended March 31, 2003 consisted
primarily of net purchases of available for sale securities of $5.0 million and
capital expenditures of approximately $2.0 million.
The Company had available for sale securities totaling $22.3 million at
March 31, 2003.
In June 2002, the Company entered into an Amended and Restated Credit
Agreement (the "Facility") that replaced the previous credit facility that would
have expired in October 2003. The Facility is composed of a revolving credit
loan that expires in three years and a $15.0 million term loan that matures in
five years. The Facility is in addition to an existing $5.0 million
Multicurrency Facility that is renewable annually and is used in connection with
the Company's European operations. The revolving credit loan bears interest at a
rate equal to either (a) The Eurodollar Rate plus the Applicable Percentage (as
defined) or (b) the higher of the Federal Fund's Rate plus 0.5% or the Bank's
Prime Rate. The $15.0 million term loan bears interest at a rate equal to the
higher of the Federal Funds Rate plus 0.5% and the Prime Rate or an Adjusted
Eurodollar Rate.
Under terms of the Facility, revolving loans are convertible into term
loans within the Facility if used for acquisitions. The Facility contains
various restrictive financial covenants, including the maintenance of certain
fixed coverage and leverage ratios.
At March 31, 2003 the Company fell below the minimum permitted Fixed
Charge coverage ratio. The Company and the banks amended the minimum permitted
Fixed Charge coverage ratio for the first quarter of 2003 and future periods. In
addition, as part of the amendment:
- The amount available under the revolving credit loan is
reduced from $23 million to the lesser of $10 million or 50%
of the Company's Eligible Receivables, as defined.
- Until the Company's Fixed Charge Coverage Ratio returns to
levels specified in the original agreement, the applicable
percentage applied to the interest rate on the Company's
borrowing under the Facility is increased by 0.75%.
- The term loan is collateralized by a pledge of the Company's
domestic cash and cash equivalents and any amounts
outstanding under the revolving credit loan are collateralized
by the Company's Eligible Receivables, as defined, and any
remaining
18
domestic cash and cash equivalents above the amounts pledged
as security under the term loan.
- The Company must maintain a ratio of cash and cash equivalents
held in the United States to principal amounts outstanding
under the Company's term loan of at least 1.1 to 1.0.
The $5.0 million Multicurrency Facility is composed of a euro overdraft
facility up to the equivalent of $3.0 million and a pound 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).
At March 31, 2003, no amounts were outstanding under the Company's
revolving credit loan, $12.0 was million was outstanding under the term loan,
and no amounts were outstanding under the $5.0 million Multicurrency Facility.
Interest is payable on the term loan at a rate of 5.82%. Principal payments of
$750,000 are due on the term loan on the last business day of each quarter
through March of 2007.
Effective July 1, 2002 the Company entered into an interest rate swap
agreement to fix the interest rate on the $15.0 million term loan. The swap is
designated as a cash flow hedge under the guidelines of SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." Under the swap
agreement the interest rate on the term loan is fixed at 4.32% plus a margin of
1.5%. The swap is in place through the life of the term loan, ending on March
31, 2007. Changes in fair market value of the swap are recorded in Accumulated
Other Comprehensive Loss on the Consolidated Balance Sheet. At March 31, 2003
approximately $551,000 has been recorded in Accumulated Other Comprehensive Loss
to reflect a decrease in the fair market value of the swap.
With the acquisition of CPR the Company entered into a $6,000,000
convertible note payable to the shareholders of CPR. The principal balance is
convertible at the holders' option 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. 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 three-year 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
addition, 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
19
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.
ADDITIONAL CONSIDERATIONS
On July 15, 2002 two of the Company's major customers, Pharmacia Inc. and
Pfizer Inc. announced plans to merge in a stock-for-stock transaction. The
merger closed in the second quarter of 2003. Pharmacia and Pfizer combined
represent approximately 31% of the Company's net service revenues for the three
months ended March 31, 2003 and approximately 34% of the Company's March 31,
2003 backlog. Since the merger announcement, the Company has not noticed a
change, as a result of the announced merger, in the levels of business received
from either of these companies. The Company is unable to predict what impact,
either positive or negative, if any, the merger will have on the current backlog
of business or on amount of business the Company will receive from the combined
companies in the future.
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, 2003, the potential
loss in fair value resulting from a hypothetical decrease of 10% in quoted
market price would be approximately $2.2 million.
In July 2002, the Company entered into an interest rate swap agreement
with the intent of managing the interest rate risk on its five-year term loan.
Interest rate swap agreements are contractual agreements between two parties for
the exchange of interest payment streams on a principal amount and an
agreed-upon fixed or floating rate, for a defined period of time. See discussion
of debt in the Liquidity and Resources section of the Management's Discussion
and Analysis of Financial Conditions and Results of Operations.
Foreign Currency
The Company operates on a global basis and therefore is exposed to various
types of currency risks. Two specific transaction risks arise from the nature of
the contracts the Company executes with its customers because 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. The first
risk occurs as revenue recognized for services rendered is denominated in a
currency different from the currency in which the location's expenses are
incurred. As a result, the location'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 location's local currency, the Company recognizes a receivable at the
time of invoicing at the local currency equivalent of the
20
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 Consolidated Statements of Operations.
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 approximately $(900,000) at March 31,
2003 compared to $(1.5) million at December 31, 2002.
CRITICAL 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. 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.
However, there can be no guarantee that the sponsor will agree to the proposed
amendments, and the Company ultimately bears the risk of cost overruns. In
certain instances, the Company may have to commit additional resources to
existing projects, resulting in lower gross margins. Similar situations may
occur in the future. 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.
Amendments to contracts resulting in revisions to revenues and costs are
recognized in the period in which the revisions are negotiated. Included in
accounts receivable are unbilled accounts receivable, which represent revenue
recognized in excess of amounts billed.
As the Company works on projects, the Company also incurs third-party and
other pass-through costs, which are typically reimbursable by its customers
pursuant to the contract. In
21
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 accounts for employee stock options under Accounting
Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to
Employees," and its related interpretations. Under APB 25, no compensation
expense is recognized when the exercise price is equal to the market price of
the stock on the date of the grant. If the Company accounted for stock options
under SFAS 123, the Company would have to record additional compensation expense
relating to stock option grants. If the Company had to account for stock options
under SFAS 123, the Company's financial results would be materially adversely
affected by the additional compensation expense that would have to be
recognized. The compensation expense could vary significantly from period to
period based on a number of factors, including the number of stock options
granted, the expected holding period, the share price and share price volatility
and interest rate fluctuations.
Billed accounts receivable represent amounts for which invoices have been
sent to customers. Unbilled accounts receivable are amounts recognized as
revenue for which bills 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. 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.
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. A fair value
approach is used to test goodwill for impairment. An impairment charge is
recognized for the amount, if any, by which the carrying amount of the goodwill
exceeds the fair value. In the fourth quarter of 2002, the Company recorded a
goodwill impairment charge of $67.7 million.
The Company has a 50% owned joint-venture investment in Beijing KendleWits
Medical Consulting Co., Ltd. (KendleWits), a company located in the People's
Republic of China. The Company accounts for this investment under the equity
method. To date, the Company has contributed approximately $750,000 for the
capitalization of KendleWits and the carrying value recorded as of March 31,
2003 is approximately $400,000. Future capital contributions will be dependent
upon the on-going capitalization needs of KendleWits and the Company's
willingness to provide additional capital. The Company is not obligated to make
any additional investment in KendleWits and currently has no plans to do so.
Future 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
22
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 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 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 and a valuation allowance has been established based upon an
assessment 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.
NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the Emerging Issues Task Force issued EITF Issue 00-21,
"Revenue Arrangements with Multiple Deliverables," which requires companies to
determine whether an arrangement involving multiple deliverables contains more
than one unit of accounting. In applying EITF Issue 00-21, revenue arrangements
with multiple deliverables should be divided into separate units of accounting
if the deliverables in the arrangement meet certain criteria. Arrangement
consideration should be allocated among the separate units of accounting based
on their relative fair values. This issue is effective for revenue arrangements
entered into in fiscal periods beginning after June 15, 2003. The Company is
currently evaluating what impact, if any, the adoption of this issue will have
on its results of operations and/or financial position.
In January 2003, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 46 (FIN 46), "Consolidation of Variable Interest Entities."
FIN 46 requires a variable interest entity to be consolidated by a company if
that company is subject to a majority of the risk of loss from the variable
interest entity's activities or entitled to receive a majority of the entity's
residual returns or both. A variable interest entity is a corporation,
partnership, trust, or any other legal structures used for business purposes
that either (a) does not have equity investors with voting rights or (b) has
equity investors that do not provide sufficient financial resources for the
entity to support its activities. A variable interest entity often holds
financial assets, including loans or receivables, real estate or other property.
A variable interest entity may be essentially passive or it may engage in
research and development or other activities on behalf of another company. The
consolidation requirements of FIN 46 apply immediately to variable interest
entities created after January 31, 2003. The consolidation requirements apply to
older entities in the first fiscal year or interim period beginning after June
15, 2003. Certain of the disclosure requirements apply to all financial
statements issued after January 31, 2003, regardless of when the variable
interest entity was established. The Company is currently evaluating the
consolidation requirements of FIN 46.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, an Amendment of SFAS No. 123. SFAS No.
148 provides transition guidance for those companies that elect to voluntarily
adopt the accounting provisions of SFAS No. 123, Accounting for Stock-Based
Compensation. SFAS No. 148 also mandates certain new disclosures that are
incremental to those required by SFAS No. 123. SFAS
23
No. 148 is effective for fiscal years ending after December 15, 2002. The
Company has adopted the disclosure requirements of SFAS No. 148. At this time
the Company does not plan to adopt the accounting provisions of SFAS No. 123 and
will continue to account for stock options in accordance with Accounting
Principles Board Opinion No. 125, "Accounting for Stock Issued to Employees."
In July 2002, the FASB issued SFAS No. 146, "Accounting for Exit or
Disposal Activities." SFAS No. 146 addresses the recognition, measurement, and
reporting of costs that are associated with exit and disposal activities,
including costs related to terminating a contract that is not a capital lease
and termination benefits that employees who are involuntarily terminated receive
under the terms of a one-time benefit arrangement that is not an ongoing benefit
arrangement or an individual deferred-compensation contract. SFAS No. 146
supersedes Emerging Issues Task Force Issue No. 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring) and requires liabilities
associated with exit and disposal activities to be expensed as incurred. SFAS
No. 146 is required for exit or disposal activities of the Company initiated
after December 31, 2002, with earlier adoption encouraged. The Company has
adopted SFAS No. 146.
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 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, changes in the financial conditions of the Company's customers,
potential mergers and acquisitions 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, the
carrying value of and impairment of the Company's investments and the other risk
factors set forth in the Company's filings with the Securities and Exchange
Commission, 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 service
24
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.
ITEM 4. CONTROLS AND PROCEDURES
(a) 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-14(c) and 15d-14(c)) as of a date within ninety days
before the filing date of 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.
(b) Changes in internal controls. There were no significant changes in the
Company's internal controls or in other factors that could significantly affect
those controls subsequent to the date of the evaluation.
25
PART II. OTHER INFORMATION
Item 1. Legal Proceedings - None
Item 2. Changes in 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 - None
Item 5. Other Information - Not applicable
Item 6. Exhibits and Reports on Form 8-K --
(a) Exhibits
10.24 Third Amendment to Amended and Restated Credit Agreement
99.1 Statement of Chief Executive Officer
99.2 Statement of Chief Financial Officer
(b) Reports filed on Form 8-K during the quarter:
On January 3, 2003 the Company filed a Form 8-K to disclose the retirement
of Timothy M. Mooney, Executive Vice President and Chief Financial Officer
and announce Karl Brenkert III as the Company's new Chief Financial
Officer and Senior Vice President.
26
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, 2003 Candace Kendle
Chairman of the Board and Chief
Executive Officer
By: /s/ Karl Brenkert III
-----------------------------------
Date: May 15, 2003 Karl Brenkert
Vice President - Chief Financial Officer
27
CERTIFICATIONS
I, Candace Kendle, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Kendle International
Inc.
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements and other financial
information included in this quarterly report, fairly present, in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
28
By: /s/ Candace Kendle
-----------------------------------
Date: May 15, 2003 Candace Kendle
Chairman of the Board and Chief
Executive Officer
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CERTIFICATIONS
I, Karl Brenkert III, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Kendle International
Inc.
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements and other financial
information included in this quarterly report, fairly present, in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
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By: /s/ Karl Brenkert III
-----------------------------------
Date: May 15, 2003 Karl Brenkert
Vice President - Chief Financial Officer
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KENDLE INTERNATIONAL INC.
EXHIBIT INDEX
Exhibits Description
-------- -----------
10.24 Third Amendment to Amended and Restated Credit
Agreement
99.1 Statement of Chief Executive Officer
99.2 Statement of Chief Financial Officer
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