UNITED STATES
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 JUNE 30, 2005
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
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(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
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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 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: 13,493,286 shares of Common
Stock, no par value, as of July 27, 2005.
1
KENDLE INTERNATIONAL INC.
INDEX
Page
----
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets - June 30,2005
and December 31, 2004 3
Condensed Consolidated Statements of Operations - Three
Months Ended June 30, 2005 and 2004; Six Months Ended
June 30, 2005 and 2004 4
Condensed Consolidated Statements of Comprehensive Income
(Loss) - Three Months Ended June 30, 2005 and 2004;
Six Months Ended June 30, 2005 and 2004 5
Condensed Consolidated Statements of Cash Flows - Six
Months Ended June 30, 2005 and 2004 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 27
Item 4. Controls and Procedures 27
Part II. Other Information 27
Item 1. Legal Proceedings 27
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 27
Item 3. Defaults upon Senior Securities 27
Item 4. Submission of Matters to a Vote of Security Holders 27
Item 5. Other Information 28
Item 6. Exhibits 28
Signatures 30
Exhibit Index 31
2
KENDLE INTERNATIONAL INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, December 31,
(in thousands, except share data) 2005 2004
--------- ---------
(unaudited) (note 1)
ASSETS
Current assets:
Cash and cash equivalents $ 19,759 $ 17,665
Restricted cash 394 971
Available-for-sale securities 9,698 10,271
Accounts receivable 52,081 56,025
Other current assets 10,695 10,243
--------- ---------
Total current assets 92,627 95,175
--------- ---------
Property and equipment, net 15,573 16,821
Goodwill 24,450 26,003
Other finite-lived intangible assets 587 663
Other indefinite-lived intangible assets 15,000 15,000
Other assets 7,810 9,018
--------- ---------
Total assets $ 156,047 $ 162,680
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of obligations under capital leases $ 503 $ 740
Current portion of amounts outstanding under credit facilities 3,166 3,000
Convertible note - 1,500
Trade payables 7,472 9,169
Advance billings 20,489 24,924
Other accrued liabilities 15,678 15,128
--------- ---------
Total current liabilities 47,308 54,461
--------- ---------
Obligations under capital leases, less current portion 597 863
Long-term debt 2,250 3,750
Other noncurrent liabilities 1,114 831
--------- ---------
Total liabilities 51,269 59,905
--------- ---------
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; 13,394,208 and
13,262,826 shares issued and 13,374,311 and 13,242,929
outstanding at June 30, 2005 and December 31, 2004, respectively 75 75
Additional paid in capital 136,997 136,111
Accumulated deficit (32,009) (35,596)
Accumulated other comprehensive:
Net unrealized holding losses on available-for-sale securities (56) (49)
Unrealized loss on interest rate swap (15) (92)
Foreign currency translation adjustment 179 2,719
--------- ---------
Total accumulated other comprehensive income 108 2,578
Less: Cost of common stock held in treasury, 19,897 shares at
June 30, 2005 and December 31, 2004, respectively (393) (393)
--------- ---------
Total shareholders' equity 104,778 102,775
--------- ---------
Total liabilities and shareholders' equity $ 156,047 $ 162,680
========= =========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
KENDLE INTERNATIONAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Three Months Ended For the Six Months Ended
(in thousands, except per share data) June 30, June 30,
--------------------------------- ---------------------------------------------
2005 2004 2005 2004
---------------- -------------- --------------------- ---------------------
Net service revenues $ 49,965 $ 41,217 $ 97,652 $ 82,003
Reimbursable out-of-pocket revenues 11,153 11,998 22,071 22,998
---------------- -------------- --------------------- ---------------------
Total revenues 61,118 53,215 119,723 105,001
---------------- -------------- --------------------- ---------------------
Costs and expenses:
Direct costs 27,152 24,221 52,878 47,482
Reimbursable out-of-pocket costs 11,153 11,998 22,071 22,998
Selling, general and
administrative expenses 17,042 14,391 33,896 28,667
Depreciation and amortization 2,119 2,270 4,377 4,569
Severance and office consolidation costs - 48 - 302
---------------- -------------- --------------------- ---------------------
57,466 52,928 113,222 104,018
---------------- -------------- --------------------- ---------------------
Income from operations 3,652 287 6,501 983
Other income (expense):
Interest income 258 84 440 164
Interest expense (141) (201) (288) (415)
Other 92 (178) 293 285
Gain on debt extinguishment - 343 300 597
---------------- -------------- --------------------- ---------------------
Income before income taxes 3,861 335 7,246 1,614
Income tax expense 2,419 124 3,659 730
---------------- -------------- --------------------- ---------------------
Net income $ 1,442 $ 211 $ 3,587 $ 884
================ ============== ===================== =====================
Income per share data:
Basic:
Net income per share $ 0.11 $ 0.02 $ 0.27 $ 0.07
================ ============== ===================== =====================
Weighted average shares 13,329 13,120 13,301 13,096
Diluted:
Net income per share $ 0.10 $ 0.02 $ 0.26 $ 0.07
================ ============== ===================== =====================
Weighted average shares 13,783 13,349 13,713 13,351
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)
For the Three Months Ended For the Six Months Ended
June 30, June 30,
(in thousands) --------------------------------- ----------------------------------
2005 2004 2005 2004
------------- ---------------- --------------- -----------------
Net income $ 1,442 $ 211 $ 3,587 $ 884
------------- ---------------- --------------- -----------------
Other comprehensive income (loss):
Foreign currency translation adjustment (1,326) (499) (2,540) (1,069)
Net unrealized holding gains (losses) on
available-for-sale securities arising
during the period, net of tax 19 (60) (7) (54)
Net unrealized holding gains on
interest rate swap agreement 15 187 77 182
------------- ---------------- --------------- -----------------
Comprehensive income (loss) $ 150 $ (161) $ 1,117 $ (57)
============= ================ =============== =================
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
KENDLE INTERNATIONAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Six Months Ended
(in thousands) June 30,
----------------------------
2005 2004
------------ ------------
Net cash provided by (used in) operating activities $ 7,244 $ (6,486)
------------ ------------
Cash flows from investing activities:
Proceeds from sales and maturities of available-for-sale securities 2,410 6,629
Purchases of available-for-sale securities (1,905) (6,691)
Acquisitions of property and equipment (2,274) (1,296)
Additions to software costs (385) (1,032)
Other 17 15
------------ ------------
Net cash used in investing activities (2,137) (2,375)
------------ ------------
Cash flows from financing activities:
Net repayments under credit facilities (1,273) (1,404)
Net proceeds / (repayments) - book overdraft (399) 75
Repayment of convertible note (1,200) (1,903)
Other (30) -
Proceeds from exercise of stock options 489 126
Payments on capital lease obligations (416) (444)
------------ ------------
Net cash used in financing activities (2,829) (3,550)
------------ ------------
Effects of exchange rates on cash and cash equivalents (184) 58
Net increase (decrease) in cash and cash equivalents 2,094 (12,353)
Cash and cash equivalents:
Beginning of period 17,665 21,750
------------ ------------
End of period $ 19,759 $ 9,397
============ ============
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 accounting principles generally accepted in the
United States of America for interim financial information and the instructions
to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include
all of the information and notes required by accounting principles generally
accepted in the United States of America for complete financial statements. In
the opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation have been included.
Operating results for the three and six months ended June 30, 2005 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2005. For further information, refer to the Consolidated Financial
Statements and notes thereto included in the Form 10-K for the year ended
December 31, 2004 filed by Kendle International Inc. ("the Company") with the
Securities and Exchange Commission.
The condensed consolidated balance sheet at December 31, 2004 has been derived
from the audited financial statements at that date but does not include all of
the information and notes required by accounting principles generally accepted
in the United States of America for complete financial statements.
Net Income Per Share Data
Net income per basic share is computed using the weighted average common shares
outstanding. Net income per diluted share is computed using the weighted average
common shares and potential common shares outstanding.
The net income used in computing net income per diluted share has been
calculated as follows:
Three Months Ended Three Months Ended
(in thousands) June 30, 2005 June 30, 2004
------------------ ------------------
Net income per Statements of operations $ 1,442 $ 211
------------------ ------------------
Net income for diluted earnings per share $ 1,442 $ 211
calculation
7
(in thousands) Six Months Ended Six Months Ended
June 30, 2005 June 30, 2004
------------------ -----------------
Net income per Statements of operations $ 3,587 $ 884
------------------ -----------------
Net income for diluted earnings per share $ 3,587 $ 884
calculation
The weighted average shares used in computing net income per diluted share have
been calculated as follows:
Three Months Ended Three Months Ended
(in thousands) June 30, 2005 June 30, 2004
------------------ -----------------
Weighted average common shares
Outstanding 13,329 13,120
Stock options 454 229
------ ------
Weighted average shares 13,783 13,349
------ ------
Six Months Ended Six Months Ended
(in thousands) June 30, 2005 June 30, 2004
---------------- ----------------
Weighted average common shares
Outstanding 13,301 13,096
Stock options 412 255
------ ------
Weighted average shares 13,713 13,351
------ ------
Options to purchase approximately 600,000 shares of common stock were
outstanding during the three and six months ended June 30, 2005 but were not
included in the computation of earnings per diluted share because the effect
would be antidilutive.
Options to purchase approximately 1,400,000 shares of common stock were
outstanding during the three and six months ended June 30, 2004 but were not
included in the computation of earnings per diluted share because 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.
On May 12, 2005, the Compensation Committee amended the vesting schedule of a
total of approximately 140,000 options outstanding that met the following
criteria:
8
1) Outstanding/unvested as of May 12, 2005
2) Have an option price greater than $11.73 (fair market value on May 12, 2005)
3) Were granted between May 1, 2001 and May 1, 2002.
All unvested shares that met the above criteria, with the exception of options
held by any executive officer of the company, were immediately vested as of May
12, 2005. The Compensation Committee decided to accelerate the vesting schedule
of these options primarily to enhance employee appreciation of the importance of
focusing on increasing shareholder value and to avoid expensing the options upon
adoption of SFAS 123(R).
Had the Company adopted SFAS No. 123 for expense recognition purposes, the
amount of compensation expense that would have been recognized in the second
quarter of 2005 and 2004 would have been approximately $3.1 million and $1.0
million, respectively. Approximately $2.2 million of the $3.1 million in
compensation expense that would have been recognized in the second quarter of
2005 resulted from the amendment made to the vesting schedule. The amount of
compensation expense that would have been recognized in the first six months of
2005 and 2004 would have been approximately $4.0 million and $2.0 million,
respectively. The Company's pro-forma net income (loss) per diluted share would
have been adjusted to the amounts below:
Three Months Ended Three Months
(in thousands, except per share data) June 30, 2005 Ended June 30, 2004
- ---------------------------------------------- ------------------ -------------------
PRO FORMA NET INCOME (LOSS):
As reported $ 1,442 $ 211
Less: pro forma adjustment for
stock-based compensation, net of tax (2,369) (769)
------------------ --------------
Pro-forma net loss $ (927) $ (558)
PRO-FORMA NET INCOME (LOSS) PER BASIC SHARE:
As reported $ 0.11 $ 0.02
Effect of pro forma expense $ (0.18) $ (0.06)
Pro-forma $ (0.07) $ (0.04)
PRO-FORMA NET INCOME (LOSS) PER DILUTED SHARE:
As reported $ 0.10 $ 0.02
Effect of pro forma expense $ (0.17) $ (0.06)
Pro-forma $ (0.07) $ (0.04)
9
Six Months Ended Six Months Ended
June 30, June 30,
(in thousands, except per share data) 2005 2004
- ---------------------------------------------- ---------------- ----------------
PRO FORMA NET INCOME (LOSS):
As reported $ 3,587 $ 884
Less: pro forma adjustment for
stock- based compensation, net of tax (3,076) (1,542)
---------------- ----------------
Pro-forma net income (loss) $ 511 $ (658)
PRO-FORMA NET INCOME (LOSS) PER BASIC SHARE:
As reported $ 0.27 $ 0.07
Effect of pro-forma expense $ (0.23) $ (0.12)
Pro-forma $ 0.04 $ (0.05)
PRO-FORMA NET INCOME (LOSS) PER DILUTED SHARE:
As reported $ 0.26 $ 0.07
Effect of pro-forma expense $ (0.22) $ (0.12)
Pro-forma $ 0.04 $ (0.05)
New Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 123, "Share-Based Payment" (SFAS
123(R)). SFAS 123(R) requires that compensation costs relating to share-based
payment transactions be recognized in the financial statements. The cost will be
measured based on the fair value of the equity or liability instruments issued.
SFAS 123(R) covers a range of shared-based compensation arrangements, including
stock options, restricted stock plans, performance-based awards, stock
appreciation rights and employee stock purchase plans. The Company currently
uses the Black-Scholes option pricing model to value options and is currently
assessing which model may be used in the future under the new statement. In
addition to determining the fair value model to be used, the Company will also
be required to determine the transition method to be used at the date of
adoption. The allowed transition methods include prospective and retroactive
adoption options. The prospective method requires that compensation expense be
recorded for all unvested stock options at the beginning of the first quarter
following the adoption of SFAS 123(R), while the retroactive methods would
record compensation expense for all unvested stock options beginning with the
first period restated. The Company is in the process of evaluating the impact
SFAS 123(R) will have on its Consolidated Financial Statements.
In April 2005, the Securities and Exchange Commission announced the adoption of
a new rule that amends the effective date of SFAS 123(R). The effective date of
the new standard under these new rules for the Company's Consolidated Financial
Statements is January 1, 2006.
In May 2005, the FASB issued FASB Statement 154 "Accounting Changes and Error
Corrections" which replaces APB Opinion No. 20 "Accounting Changes" and FASB
Statement 3 "Reporting Accounting Changes in Interim Financial Statements." This
statement changes the requirements for the accounting for and reporting of a
change in accounting principle. This statement applies to all voluntary changes
in accounting principle. It also applies to changes required by an accounting
pronouncement in the unusual instances that the pronouncement does not include
specific transition provisions. This statement requires voluntary changes in
accounting principles be recognized retrospectively to prior periods' financial
statements, rather than recognition in the net income of the current period.
Retrospective application requires restatements of prior period financial
statements as if that accounting principle had always been used. This statement
carries forward without change the guidance contained in the Opinion 20
10
for reporting the correction of an error in previously issued financial
statements and a change in accounting estimate. The provisions of FASB Statement
154 are effective for accounting changes and corrections of error made in fiscal
years beginning after December 15, 2005.
Statement No. 153, "Exchanges of Non-monetary Assets", an amendment of APB
Opinion No. 29, "Accounting for Non-monetary Transactions" is based on the
principle that exchanges of non-monetary assets should be measured based on the
fair value of the assets exchanged. Further, the amendments eliminate the narrow
exception for non-monetary exchanges of similar productive assets and replace it
with a broader exception for exchanges of non-monetary assets that do not have
commercial substance. The Statement is effective for non-monetary asset
exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier
application is permitted for non-monetary asset exchanges occurring in fiscal
periods beginning after the date of issuance. The application of FAS-153 is not
expected to have any impact on earnings and financial position.
In December 2004, the FASB issued FASB Staff Position (FSP) No. 109-2,
"Accounting and Disclosure Guidance for the Foreign Earnings Repatriation
Provision within the American Jobs Creation Act of 2004." The FSP provides
guidance under FAS No. 109, "Accounting for Income Taxes," with respect to
recording the potential impact of the repatriation provision of the American
Jobs Creation Act of 2004 (the "Jobs Act") on enterprises' income tax expense
and deferred tax liability. The Jobs Act, enacted on October 22, 2004, creates a
temporary incentive for U.S. corporations to repatriate undistributed income
earned abroad by providing an 85 percent dividends received deduction for
certain dividends from controlled foreign corporations. FSP No. 109-2 states
that companies are allowed time beyond the financial reporting period of
enactment to evaluate the effect of the Jobs Act on its plan for reinvestment or
repatriation of foreign earnings for purposes of applying FAS No. 109. The
Company has evaluated the effects of the repatriation provision and does not
plan to repatriate undistributed income earned abroad. Therefore, the provisions
of FSP 109-2 have no material effect on the Company's Consolidated Financial
Statements.
2. OFFICE CONSOLIDATION AND EMPLOYEE SEVERANCE:
In the first quarter of 2004, in order to align its resources to meet customer
need and demand projections, the Company implemented a workforce realignment
plan which resulted in a pre-tax charge of approximately $254,000 for severance
and outplacement benefits. An additional $48,000 in net costs (composed of
approximately $80,000 in additional costs offset by a reduction to the liability
of approximately $32,000) was incurred in the second quarter of 2004 relating to
this plan. The workforce realignment plan impacted approximately 3 percent of
the Company's North American workforce. Payments in 2004 totaled $302,000 and no
amounts remain accrued at June 30, 2005.
In August 2003, the Company initiated a workforce realignment plan which
immediately eliminated approximately 65 positions from its global workforce. In
the third quarter of 2003, the Company recorded a pre-tax charge of
approximately $897,000 for severance and outplacement benefits relating to this
workforce realignment. Approximately $15,000 remains accrued and is reflected in
Other Accrued Liabilities on the Company's Condensed Consolidated Balance Sheet.
11
The amounts accrued for the workforce reduction and office consolidation costs
are detailed as follows:
Employee
(in thousands) Severance
- ------------------------------ ---------
Liability at December 31, 2004 $ 15
Amounts accrued --
Amounts paid --
Adjustment to liability --
Liability at June 30, 2005 $ 15
3. GOODWILL AND OTHER INTANGIBLE ASSETS:
Non-amortizable intangible assets at June 30, 2005 and December 31, 2004 are
composed of:
(in thousands)
Indefinite-lived
Goodwill Intangible
-------- ----------------
Balance at 12/31/04 $ 26,003 $ 15,000
Foreign currency fluctuations (1,359) --
Tax benefit to reduce goodwill (194) --
-------- ----------------
Balance at 6/30/05 $ 24,450 $ 15,000
======== ================
Amortizable intangible assets at June 30, 2005 and December 31, 2004 are
composed of:
(in thousands)
Customer Non-Compete Internally-Developed
Relationships Agreements Software
------------- ----------- --------------------
Balance at 12/31/04 $ 346 $ 317 $ 5,097
Additional amounts acquired -- -- 385
Dispositions -- -- (12)
2005 amortization (19) (57) (1,288)
------------- ----------- --------------------
Balance at 6/30/05 $ 327 $ 260 $ 4,182
============= =========== ====================
Internally-developed software is included in other assets within the condensed
consolidated financial statements.
Amortization expense for the next five years relating to these amortizable
intangible assets is estimated to be as follows:
(in thousands)
Remainder of 2005: $ 936
2006: $1,558
2007: $1,124
2008: $ 570
2009: $ 302
12
4. DEBT:
In May 2005, the Company entered into the Second Amended and Restated Credit
Agreement (the "Facility") that replaced the previous credit agreement. 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 Facility is composed of a $20.0 million revolving credit loan that expires
in May of 2008. The existing term loan is carried over from the previous
agreement and matures in March of 2007.
The revolving credit loan bears interest at a rate equal to either (a) The LIBOR
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 existing 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 new five year
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. The Company is in compliance with the
financial covenants contained in the Facility as of June 30, 2005.
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 June 30, 2005 no amounts were outstanding under the Company's revolving
credit loan, $5.3 million was outstanding under the term loan, and approximately
$165,000 was outstanding under the $5.0 million Multicurrency Facility. Interest
is payable on the term loan at a rate of 5.8% and on the Multicurrency Facility
at a rate of 6.75%. Principal payments of $750,000 are due on the term loan on
the last business day of each quarter through March 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 Statement of Financial Accounting
Standards (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 the applicable margin (currently 1.50%). The swap is in
place through the life of the term loan, ending on March 31, 2007. Changes in
fair value of the swap are recorded in Accumulated Other Comprehensive Loss on
the Condensed Consolidated Balance Sheet. At June 30, 2005, approximately
$15,000 has been recorded in Accumulated Other Comprehensive Income to reflect
the unrealized loss of the swap compared to the unrealized loss of approximately
$92,000 at December 31, 2004.
13
With the acquisition of Clinical and Pharmacologic Research, Inc. (CPR), the
Company entered into a $6.0 million convertible note payable to the shareholders
of CPR. The principal balance was 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 had not been converted at the Maturity
Date, the Company had the option to extend the Maturity Date of the note for
another three years. The note bore interest at an annual rate of 3.80% from
January 29, 2002 through the Maturity Date. Interest was payable semi-annually.
In June of 2003, the Company and the shareholders of CPR entered into Note
Prepayment Agreements. Under the Note Prepayment Agreements, the Company agreed
to satisfy its payment obligations under the $6.0 million convertible note by
making a series of four payments between June 30, 2003 and January 10, 2005. The
four payments were initiated either by the Company through the exercise of a
"call" option or by the CPR shareholders through the exercise of a "put" option.
Gains resulting from this early extinguishment of debt were recorded when paid
as a gain in the Company's Condensed Consolidated Statements of Operations. In
the first quarter of 2005, the Company paid approximately $1.2 million to settle
the remaining $1.5 million of the convertible note that was outstanding at
December 31, 2004. A gain of $300,000 has been recorded in the first quarter of
2005 in the Company's Condensed Consolidated Statements of Operations. No
amounts remain outstanding under this convertible note at June 30, 2005. Total
gains resulting from early extinguishment of debt under the Note Prepayment
Agreement were approximately $1.5 million.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information discussed below is derived from the Condensed Consolidated
Financial Statements included in this Form 10-Q for the three and six months
ended June 30, 2005 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 consulting and organizational meeting
management and publications services on a contract basis to biopharmaceutical
companies. The Company is managed in one reportable segment encompassing
contract services related to Phase I through IV clinical trials.
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 service
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. When
14
estimates indicate a loss, such loss is provided in the current period in its
entirety. 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.
Finally, at one of the Company's subsidiaries, the contracts are of a short-term
nature and revenue is recognized under the completed contract method of
accounting.
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 expenses in
the Condensed 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 an allocation
of 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.
Depreciation and amortization expenses consist of depreciation and amortization
costs recorded on a straight-line method over the estimated useful life of the
property or equipment and internally developed software.
The CRO industry in general continues to be dependent on the research and
development efforts of the principal pharmaceutical and biotechnology companies
as major customers, and the Company believes this dependence will continue. The
loss of business from any of its major customers could have a material adverse
effect on the Company.
The Company's results of operations are subject to volatility due to a variety
of factors. The cancellation or delay of contracts and cost overruns could have
short-term adverse affects on the Condensed Consolidated Financial Statements.
Fluctuations in the Company's sales cycle and the ability to maintain large
customer contracts or to enter into new contracts could hinder the Company's
long-term growth. In addition, the Company's aggregate backlog, consisting of
signed contracts and letters of intent, 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 JUNE 30, 2005 COMPARED TO THREE MONTHS ENDED JUNE 30, 2004
Net Service Revenues
Net service revenues increased approximately $8.8 million, or 21%, to $50.0
million in the second quarter of 2005 from $41.2 million in the second quarter
of 2004. The 21% increase in net service revenues was due entirely to organic
revenue growth. Foreign currency exchange rate fluctuations accounted for a 2%
increase in net service revenues in the second quarter of 2005 compared to 2004.
In the second quarter of 2005, net service revenues in the North American
15
and European regions increased by approximately $3.5 million or 14% and $5.1
million or 34%, respectively, from the same period of the prior year. The growth
in net service revenues is primarily due to the Company's expanding customer
base in both North America and Europe.
Approximately 44% of the Company's net service revenues were derived from
operations outside of North America in the second quarter of 2005 compared to
41% in the corresponding period in 2004. The top five customers based on net
service revenues contributed approximately 34% of net service revenues during
the second quarter of 2005 compared to approximately 39% of net service revenues
during the second quarter of 2004. Net service revenues from Pfizer Inc.
accounted for approximately 16% of total second quarter 2005 net service
revenues compared to approximately 19% of total second quarter 2004 net service
revenues. The Company's net service revenues from Pfizer Inc. are derived from
numerous projects that vary in size, duration and therapeutic indication. No
other customer accounted for more than 10% of the net service revenues for the
quarter in either period presented.
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 decreased 7% to $11.2 million in the second quarter of
2005 from $12.0 million in the corresponding period of 2005.
Operating Expenses
Direct costs increased approximately $3.0 million, or 12%, to $27.2 million in
the second quarter of 2005 from $24.2 million in the second quarter of 2004.
Foreign currency exchange rate fluctuations accounted for a 3% increase in
direct costs in the second quarter of 2005 compared to 2004. The growth in
direct costs relates directly to the increase in net service revenues in the
second quarter of 2005. Direct costs expressed as a percentage of net service
revenues were 54.3% for the three months ended June 30, 2005 compared to 58.8%
for the three months ended June 30, 2004. The decrease in direct costs as a
percentage of net service revenues is attributable to increased utilization of
billable associates during the second quarter of 2005 as well as a larger
revenue base to absorb fixed costs.
Reimbursable out-of-pocket costs decreased 7% to $11.2 million in the second
quarter of 2005 from $12.0 million in the corresponding period of 2004.
Selling, general and administrative expenses increased $2.6 million, or 18%,
from $14.4 million in the second quarter of 2004 to $17.0 million in the same
quarter of 2005. Foreign currency exchange rate fluctuations accounted for a 1%
increase in selling, general and administrative expenses in the second quarter
of 2005 compared to the comparable period of 2004. The increase is primarily due
to costs associated with the Company's marketing efforts in the second quarter
of 2005 and increases in employee-related costs. The increase in
employee-related costs is composed of general salary increases and corresponding
payroll tax increases as well as an increase in sales commissions and
profit-sharing accrual. Selling, general and administrative expenses expressed
as a percentage of net service revenues were 34.1% for the three months ended
June 30, 2005 compared to 35.0% for the corresponding 2004 period.
16
Depreciation and amortization expense decreased by $151,000 in the second
quarter of 2005 compared to the second quarter of 2004. This decrease was due to
a reduction in depreciation expense as fixed assets come to the end of their
depreciable life and as well as a slowdown in additions to fixed assets as
compared to prior periods.
In the first quarter of 2004, in order to align its resources to meet customer
need and demand projections, the Company implemented a workforce realignment
plan which resulted in a pre-tax charge of approximately $254,000 for severance
and outplacement benefits. In the second quarter of 2004, the Company incurred
an additional $48,000 in costs related to this workforce realignment plan. This
workforce realignment plan impacted approximately 3 percent of the Company's
North American workforce. No amounts related to this plan remain accrued at June
30, 2005.
Other Income (Expense)
Other Income (Expense) was income of approximately $209,000 in the second
quarter of 2005 compared to income of approximately $48,000 in the second
quarter of 2004. Interest expense decreased by approximately $60,000 in the
second quarter of 2005 compared to the second quarter of 2004 due to decreased
debt outstanding in the second quarter of 2005. Interest income increased by
approximately $174,000 in the second quarter of 2005 due to larger cash and
investment balances in the quarter as well as a general increase in interest
rates in the second quarter of 2005 compared to the second quarter of 2004. The
available-for-sale securities balance averaged $9.8 million in the second
quarter of 2005 compared to $8.9 million in the second quarter of 2004. Foreign
exchange rate gains and losses were a loss of approximately $35,000 in the
second quarter of 2004 compared to a gain of $207,000 in the second quarter of
2005. In the second quarter of 2004, the Company recorded a gain of $343,000 on
the partial early retirement of the Company's convertible debt. The convertible
note was fully paid as of March 31, 2005 so no such gain occurred in the second
quarter of 2005.
Income Taxes
The Company reported tax expense at an effective rate of 62.7% in the quarter
ended June 30, 2005, compared to tax expense at an effective rate of 37.0% in
the quarter ended June 30, 2004. In the second quarter of 2005, the Company
recorded a one-time, non-cash charge of approximately $1.2 million, net of
federal income tax effect, to reflect the write-off of deferred state income tax
assets due to a change in Ohio state tax law enacted on June 30, 2005. The
one-time charge results from adoption of a comprehensive change in Ohio
corporate tax laws that provides for the phase-in of a Commercial Activities Tax
(CAT) on gross receipts. Concurrent with the phase-in of the CAT, the Ohio
income tax, net worth tax, and personal property tax will be phased out. The
Company anticipates that the net effect of this tax law change will benefit the
Company's earnings in future years. In addition, the Company continues to
maintain full valuation allowances against the net operating losses incurred in
some of its subsidiaries. Since Kendle operates on a global basis, the effective
tax rate varies from quarter to quarter based on the locations that generate the
pre-tax earnings or losses.
Net Income
The net income for the quarter ended June 30, 2005 was approximately $1.4
million or $0.11 per basic and $0.10 per diluted share compared to net income
for the quarter ended June 30, 2004 of $211,000, or $0.02 per basic and diluted
share.
17
SIX MONTHS ENDED JUNE 30, 2005 COMPARED TO SIX MONTHS ENDED JUNE 30, 2004
Net Service Revenues
Net service revenues increased 19% to $97.7 million in the first six months of
2005 from $82.0 million in the first six months of 2004. The 19% increase in net
service revenues was due entirely to organic growth. Foreign currency exchange
rate fluctuations accounted for a 2% increase in net service revenues in the
first six months of 2005 compared to the first six months of 2004. In the first
half of 2005, net service revenues in the North American and European regions
increased by approximately $5.9 million or 12% and $9.8 million or 34%,
respectively, from the same period of the prior year. The growth in net service
revenues is primarily due to the Company's expanding customer base in both North
America and Europe.
Approximately 44% of the Company's net service revenues were derived from
operations outside of North America in the first six months of 2005 compared to
40% in the corresponding period of 2004. The top five customers based on net
service revenues contributed approximately 36% of net service revenues during
the first six months of 2005 compared to approximately 42% of net service
revenues during the first six months of 2004. Net service revenues from Pfizer
Inc. accounted for approximately 18% of total net service revenues in the first
half of 2005 compared to approximately 21% of total net service revenues in the
first half of 2004. The Company's net service revenues from Pfizer Inc. are
derived from numerous projects that vary in size, duration and therapeutic
indication. No other customer accounted for more than 10% of the net service
revenues in either the first six months of 2005 or 2004.
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 decreased 4.0% to $22.1 million in the six months ended
June 30, 2005 from $23.0 million in the corresponding period of 2004.
Operating Expenses
Direct costs increased by 11% from $47.5 million in the first six months of 2004
to $52.9 million in the first six months of 2005. Foreign currency exchange rate
fluctuations accounted for a 2% increase in direct costs in the first six months
of 2005 compared to 2004. The remaining growth in direct costs relates directly
to the increase in net service revenues in the first half of 2005. Direct costs
expressed as a percentage of net service revenues were 54.2% for the six months
ended June 30, 2005 compared to 57.9% for the six months ended June 30, 2004.
The decrease in direct costs as a percentage of net service revenues is
attributable to increased utilization of billable associates during the second
quarter of 2005 as well as a larger revenue base to absorb fixed costs.
Reimbursable out-of-pocket costs decreased 4.0% to $22.1 million in the six
months ended June 30, 2005 from $23.0 million in the corresponding period of
2004.
Selling, general and administrative expenses increased from $28.7 million in the
first half of 2004 to $33.9 million in the first half of 2005. Foreign currency
exchange rate fluctuations accounted for a 1% increase in selling, general and
administrative expenses in the first six
18
months of 2005 compared to the comparable period of 2004. The increase is
primarily due to costs associated with the Company's marketing efforts in the
second quarter of 2005 and increases in employee-related costs. The increase in
employee-related costs is composed of general salary increases and corresponding
payroll tax increases as well as an increase in sales commissions and
profit-sharing accrual. Selling, general and administrative expenses expressed
as a percentage of net service revenues were 34.8% for the six months ended June
30, 2005 compared to 35.0% for the corresponding 2004 period.
Depreciation and amortization expense decreased by 4% in the six months ending
June 30, 2005 compared to the corresponding period of 2004.
In the first quarter of 2004, in order to align its resources to meet customer
need and demand projections, the Company implemented a workforce realignment
plan which resulted in a pre-tax charge of approximately $254,000 for severance
and outplacement benefits. In the second quarter of 2004, the Company incurred
an additional $48,000 in costs related to this workforce realignment plan. This
workforce realignment plan impacted approximately 3 percent of the Company's
North American workforce. No expenses related to workforce realignment plans
were incurred in 2005. No amounts remain accrued at June 30, 2005.
Other Income (Expense)
Other Income (Expense) was income of $745,000 for the first six months of 2005
compared to income of approximately $631,000 in the first six months of 2004.
Interest expense decreased by approximately $127,000 in the first six months of
2005 compared to the first half of 2004 due to decreased debt outstanding in the
first half of 2005. Interest income increased by approximately $276,000 in the
first half of 2005 due to larger cash and investment balances as well as a
general increase in interest rates in 2005 compared to 2004. The
available-for-sale securities balance averaged $10.1 million for the six months
ended June 30, 2005 compared to $8.8 million for the six months ended June 30,
2004. In the first half of 2004, the Company made partial early repayments on
its convertible note and recorded gains from these repayments of approximately
$597,000 compared to a gain of $300,000 on partial early repayment of debt in
the first half of 2005. The convertible note was fully paid as of March 31,
2005.
Income Taxes
The Company reported tax expense at an effective rate of 50.5% in the six months
ended June 30, 2005 compared to tax expense at an effective rate of 45.2% in the
six months ended June 30, 2004. In the second quarter of 2005, the Company
recorded a one-time, non-cash charge of approximately $1.2 million, net of
federal income tax effect, to reflect the write-off of deferred state income tax
assets due to a change in Ohio state tax law enacted on June 30, 2005. The
one-time charge results from adoption of a comprehensive change in Ohio
corporate tax laws that provides for the phase-in of a Commercial Activities Tax
(CAT) on gross receipts. Concurrent with the phase-in of the CAT, the Ohio
income tax, net worth tax, and personal property tax will be phased out. The
Company anticipates that the net effect of this tax law change will benefit the
Company's earnings in future years. The Company continues to maintain full
valuation allowances 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 quarter to quarter based on the locations that
generate the pre-tax earnings or losses.
19
Net Income
Net income for the six months ended June 30, 2005 was approximately $3.6
million, or $0.27 per diluted share and $0.26 per basic share compared to net
income of approximately $884,000 or $0.07 per basic and diluted share for the
six months ended June 30, 2004.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents increased by $2.1 million for the six months ended
June 30, 2005 as a result of cash provided by operating activities of $7.2
million offset by cash used in investing activities of $2.1, cash used in
financing activities of $2.8 million and the negative effects of exchange rates
on cash and cash equivalents of $184,000. At June 30, 2005, cash and cash
equivalents amounted to $19.8 million. In addition, the Company has
approximately $394,000 in restricted cash that represents cash received from
customers that is segregated in a separate Company bank account and available
for use only for specific project expenses. Net cash provided by operating
activities for the period consisted primarily of net income adjusted for
non-cash items and a decrease in net accounts receivable offset partially 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, was approximately $31.6 million at June 30, 2005, and $31.1 million at
December 31, 2004.
Investing activities for the six months ended June 30, 2005 consisted primarily
of capital expenditures of approximately $2.7 million, mostly relating to
computer equipment and software purchases, including internally developed
software.
Financing activities for the six months ended June 30, 2005, consisted primarily
of scheduled repayments relating to the Company's credit facility of $1.5
million and partial early repayment of the Company's convertible debt of
approximately $1.2 million.
The Company had available-for-sale securities totaling $9.7 million at June 30,
2005 compared to $10.3 million at December 31, 2004.
In May 2005, the Company entered into the Second Amended and Restated Credit
Agreement (the "Facility") that replaced the previous credit agreement. 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 Facility is composed of a $20.0 million revolving credit loan that expires
in May of 2008. The existing term loan is carried over from the previous
agreement and matures in March of 2007.
The revolving credit loan bears interest at a rate equal to either (a) The LIBOR
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 existing 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 new five year
term loans within the Facility if used for acquisitions. The Facility contains
various restrictive financial covenants,
20
including the maintenance of certain fixed coverage and leverage ratios. The
Company is in compliance with the financial covenants contained in the Facility
as of June 30, 2005.
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 June 30, 2005 no amounts were outstanding under the Company's revolving
credit loan, $5.3 million was outstanding under the term loan, and approximately
$165,000 was outstanding under the $5.0 million Multicurrency Facility. Interest
is payable on the term loan at a rate of 5.8% and on the Multicurrency Facility
at a rate of 6.75%. Principal payments of $750,000 are due on the term loan on
the last business day of each quarter through March 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 Statement of Financial Accounting
Standards (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 the applicable margin (currently 1.50%). The swap is in
place through the life of the term loan, ending on March 31, 2007. Changes in
fair value of the swap are recorded in Accumulated Other Comprehensive Loss on
the Condensed Consolidated Balance Sheet. At June 30, 2005, approximately
$15,000 has been recorded in Accumulated Other Comprehensive Income to reflect
the unrealized loss of the swap compared to the unrealized loss of approximately
$92,000 at December 31, 2004.
With the acquisition of CPR, the Company entered into a $6.0 million convertible
note payable to the shareholders of CPR. The principal balance was 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 had not been
converted at the Maturity Date, the Company had the option to extend the
Maturity Date of the note for another three years. The note bore interest at an
annual rate of 3.80% from January 29, 2002 through the Maturity Date. Interest
was payable semi-annually.
In June of 2003, the Company and the shareholders of CPR entered into Note
Prepayment Agreements. Under the Note Prepayment Agreements, the Company agreed
to satisfy its payment obligations under the $6.0 million convertible note by
making a series of four payments between June 30, 2003 and January 10, 2005. The
four payments were initiated either by the Company through the exercise of a
"call" option or by the CPR shareholders through the exercise of a "put" option.
Gains resulting from this early extinguishment of debt were recorded as a gain
in the Company's Condensed Consolidated Statements of Operations when payments
were made by the Company. In the first quarter of 2005, the Company paid
approximately $1.2 million to settle the remaining $1.5 million of the
convertible note that was outstanding at December 31, 2004. A gain of $300,000
has been recorded in the first quarter of 2005 in the Company's Condensed
Consolidated Statements of Operations. No amounts remain outstanding under this
convertible note at June 30, 2005. Total gains resulting from early
extinguishment of debt under the Note Prepayment Agreement were approximately
$1.5 million.
21
MARKET RISK
Interest Rates
The Company is exposed to changes in interest rates on its available-for-sale
securities and amounts outstanding under the Facility and Multicurrency
Facility. Available-for-sale securities are recorded at fair value in the
Condensed Consolidated Financial Statements. These securities are exposed to
market price risk, which also takes into account interest rate risk. At June 30,
2005, the potential loss in fair value resulting from a hypothetical decrease of
10% in quoted market price would be approximately $1.0 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 Capital Resources section of Management's Discussion and
Analysis of Financial Condition and Results of Operations.
Foreign Currency
The Company operates on a global basis and is therefore exposed to various types
of currency risks. Two specific transaction risks arise from the nature of the
contracts the Company executes with its customers. From time to time contracts
are denominated in a currency different than the particular local currency. This
contract currency denomination issue is applicable only to a portion of the
contracts executed by the Company. The first risk occurs as revenue recognized
for services rendered is denominated in a currency different from the currency
in which the subsidiary's expenses are incurred. As a result, the subsidiary's
net service revenues and resultant net income or loss can be affected by
fluctuations in exchange rates.
The second risk results from the passage of time between the invoicing of
customers under these contracts and the ultimate collection of customer payments
against such invoices. Because the contract is denominated in a currency other
than the subsidiary's local currency, the Company recognizes a receivable at the
time of invoicing at the local currency equivalent of the foreign currency
invoice amount. Changes in exchange rates from the time the invoice is prepared
until the payment from the customer is received will result in the Company
receiving either more or less in local currency than the local currency
equivalent of the invoice amount at the time the invoice was prepared and the
receivable established. This difference is recognized by the Company as a
foreign currency transaction gain or loss, as applicable, and is reported in
Other Income (Expense) in the Condensed Consolidated Statements of Operations.
A third type of transaction risk arises from transactions denominated in
multiple currencies between the Company's various subsidiary locations. The
Company maintains an intercompany receivable and payable among its various
subsidiaries, which is denominated in multiple currencies, at the end of any
given period. Changes in exchange rates from the time the intercompany
receivable/payable balance arises until the balance is settled or measured for
reporting purposes, results in exchange rate gains and losses. This intercompany
receivable/payable arises when work is performed by a Kendle location in one
country on behalf of a Kendle location in a different country that has
contracted with the customer. Additionally, there are occasions when funds are
transferred between subsidiaries for working capital purposes. The foreign
currency transaction gain or loss is reported in Other Income (Expense) in the
Condensed Consolidated Statements of Operations.
22
The Company's Condensed Consolidated Financial Statements are denominated in
U.S. dollars. Accordingly, changes in exchange rates between the applicable
foreign currency and the U.S. dollar will affect the translation of each foreign
subsidiary's financial results into U.S. dollars for purposes of reporting
Condensed Consolidated Financial Statements. The Company's foreign subsidiaries
translate their financial results from local currency into U.S. dollars as
follows: income statement accounts are translated at average exchange rates for
the period; balance sheet asset and liability accounts are translated at end of
period exchange rates; and equity accounts are translated at historical exchange
rates. Translation of the balance sheet in this manner affects the shareholders'
equity account referred to as the foreign currency translation adjustment
account. This account exists only in the foreign subsidiaries' U.S. dollar
balance sheet and is necessary to keep the foreign subsidiaries' balance sheet
stated in U.S. dollars in balance. Foreign currency translation adjustments,
which are reported as a separate component of shareholders' equity, were
approximately $178,000 June 30, 2005 compared to $2.7 million at December 31,
2004.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make significant
estimates and assumptions that affect the reported Condensed Consolidated
Financial Statements for a particular period. Actual results could differ from
those estimates.
Revenue Recognition
The majority of the Company's net service revenues are based on fixed-price
contracts calculated on a percentage-of-completion basis based upon 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 periodically 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. When estimates indicate a loss, such loss is
provided in the current period in its entirety. The Company attempts to
negotiate contract amendments with the customer to cover services provided
outside the terms of the original contract. However, there can be no guarantee
that the customer will agree to proposed amendments, and the Company ultimately
bears the risk of cost overruns.
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 provides services 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 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. In
these instances, the Company recognizes these costs as direct costs with
corresponding net service revenues. Excess costs incurred above the contract
terms would negatively affect the Company's gross margin.
23
Accounts Receivable/Allowance for Doubtful Accounts
Billed accounts receivable represent amounts for which invoices have been sent
to customers. Unbilled accounts receivable are amounts recognized as revenue for
which invoices have not yet been sent to customers. Advance billings represent
amounts billed or payment received for which revenues have not yet been earned.
The Company maintains an allowance for doubtful accounts receivable based on
historical evidence of accounts receivable collections and specific
identification of accounts receivable that might pose collection problems. If
the Company is unable to collect all or part of its outstanding receivables,
there could be a material impact to the Company's Condensed Consolidated Results
of Operations or financial position.
Long-Lived Assets
The Company analyzes goodwill and other indefinite-lived intangible assets to
determine any potential impairment loss on an annual basis, unless conditions
exist that require an updated analysis on an interim basis. A fair value
approach is used to test goodwill for impairment. The goodwill impairment
testing involves the use of estimates related to the fair market value of the
reporting unit and is inherently subjective. An impairment charge is recognized
for the amount, if any, by which the carrying amount of goodwill exceeds fair
value. At December 31, 2003 and 2004 the fair value of the Company exceeded the
carrying value, resulting in no goodwill impairment charge. During the first six
months of 2005, no events arose that indicated a need for an interim impairment
analysis. In addition to goodwill, the Company has a $15 million indefinite
lived intangible asset representing one customer relationship acquired in the
Company's acquisition of CPR. The intangible asset is evaluated each reporting
period to determine whether events or circumstances continue to support an
indefinite useful life. During the first six months of 2005, no event or events
have occurred which would indicate a need to adjust the indefinite useful life
of this asset.
Internally Developed Software
The Company capitalizes costs incurred to internally develop software used
primarily in the Company's proprietary clinical trial and data management
systems, and amortizes these costs over the estimated useful life of the
product, not to exceed five years. Internally developed software represents
software in the application development stage, and there is no assurance that
the software development process will produce a final product for which the fair
value exceeds its carrying value. Internally developed software is an intangible
asset subject to impairment write-downs whenever events indicate that the
carrying value of the software may not be recoverable. As with other long-lived
assets, this asset is reviewed at least annually to determine the
appropriateness of the carrying value of the asset. Assessing the fair value of
the internally developed software requires estimates and judgment on the part of
management.
Tax Valuation Allowance
The Company estimates its tax liability based on current tax laws in the
statutory jurisdictions in which it operates. Because the Company conducts
business on a global basis, its effective tax rate has and will continue to
depend upon the geographic distribution of its pre-tax earnings (losses) among
jurisdictions with varying tax rates. These estimates include judgments about
deferred tax assets and liabilities resulting from temporary differences between
assets and liabilities recognized for financial reporting purposes and such
amounts recognized for tax
24
purposes. The Company has assessed the realization of deferred tax assets and a
valuation allowance has been established based on an assessment that it is more
likely than not that realization cannot be assured. The ultimate realization of
this tax benefit is dependent upon the generation of sufficient operating income
in the respective tax jurisdictions. If estimates prove inaccurate or if the tax
laws change unfavorably, significant revisions in the valuation allowance may be
required in the future.
NEW ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 123, "Share-Based Payment" (SFAS
123(R)). SFAS 123(R) requires that compensation costs relating to share-based
payment transactions be recognized in the financial statements. The cost will be
measured based on the fair value of the equity or liability instruments issued.
SFAS 123(R) covers a range of shared-based compensation arrangements, including
stock options, restricted stock plans, performance-based awards, stock
appreciation rights and employee stock purchase plans. The Company currently
uses the Black-Scholes option pricing model to value options and is currently
assessing which model may be used in the future under the new statement. In
addition to determining the fair value model to be used, the Company will also
be required to determine the transition method to be used at the date of
adoption. The allowed transition methods include prospective and retroactive
adoption options. The prospective method requires that compensation expense be
recorded for all unvested stock options at the beginning of the first quarter
following the adoption of SFAS 123(R), while the retroactive methods would
record compensation expense for all unvested stock options beginning with the
first period restated. The Company is in the process of evaluating the impact
SFAS 123(R) will have on its Consolidated Financial Statements.
In April 2005, the Securities and Exchange Commission announced the adoption of
a new rule that amends the effective date of SFAS 123(R). The effective date of
the new standard under these new rules for the Company's Consolidated Financial
Statements is January 1, 2006.
In May 2005, the FASB issued FASB Statement No. 154 "Accounting Changes and
Error Corrections" which replaces APB Opinion No. 20 "Accounting Changes" and
FASB Statement 3 "Reporting Accounting Changes in Interim Financial Statements."
This statement changes the requirements for the accounting for and reporting of
a change in accounting principle. This statement applies to all voluntary
changes in accounting principle. It also applies to changes required by an
accounting pronouncement in the unusual instances that the pronouncement does
not include specific transition provisions. This statement requires voluntary
changes in accounting principles be recognized retrospectively to prior periods'
financial statements, rather than recognition in the net income of the current
period. Retrospective application requires restatements of prior period
financial statements as if that accounting principle had always been used. This
statement carries forward without change the guidance contained in the Opinion
20 for reporting the correction of an error in previously issued financial
statements and a change in accounting estimate. The provisions of FASB Statement
154 are effective for accounting changes and corrections of error made in fiscal
years beginning after December 15, 2005.
Statement No. 153, "Exchanges of Non-monetary Assets", an amendment of APB
Opinion No. 29, "Accounting for Non-monetary Transactions" is based on the
principle that exchanges of non-monetary assets should be measured based on the
fair value of the assets exchanged. Further, the amendments eliminate the narrow
exception for non-monetary exchanges of similar
25
productive assets and replace it with a broader exception for exchanges of
non-monetary assets that do not have commercial substance. The Statement is
effective for non-monetary asset exchanges occurring in fiscal periods beginning
after June 15, 2005. Earlier application is permitted for non-monetary asset
exchanges occurring in fiscal periods beginning after the date of issuance. The
application of FAS-153 is not expected to have any impact on earnings and
financial position.
In December 2004, the FASB issued FASB Staff Position (FSP) No. 109-2,
"Accounting and Disclosure Guidance for the Foreign Earnings Repatriation
Provision within the American Jobs Creation Act of 2004." The FSP provides
guidance under FAS No. 109, "Accounting for Income Taxes," with respect to
recording the potential impact of the repatriation provision of the American
Jobs Creation Act of 2004 (the "Jobs Act") on enterprises' income tax expense
and deferred tax liability. The Jobs Act, enacted on October 22, 2004, creates a
temporary incentive for U.S. corporations to repatriate undistributed income
earned abroad by providing an 85 percent dividends received deduction for
certain dividends from controlled foreign corporations. FSP No. 109-2 states
that companies are allowed time beyond the financial reporting period of
enactment to evaluate the effect of the Jobs Act on its plan for reinvestment or
repatriation of foreign earnings for purposes of applying FAS No. 109. The
Company has evaluated the effects of the repatriation provision and does not
plan to repatriate undistributed income earned abroad. Therefore, the provisions
of FSP 109-2 have no material effect 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 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 and
biotechnology industries, changes in the financial conditions of the Company's
customers, potential mergers and acquisitions in the pharmaceutical and
biotechnology industries, the Company's ability to manage growth, 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 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
26
Commission, copies of which are available upon request from the Company's
investor relations department or from the SEC. The Company's growth and ability
to achieve operational and financial goals is dependent upon its ability to
attract and retain qualified personnel. If the Company fails to hire, retain and
integrate qualified personnel, it will be difficult for the Company to achieve
its financial and operational goals. No assurance can be given that the Company
will be able to realize the net service 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 Condition and Results of
Operations.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures - The Company's chief executive
officer and chief financial officer have reviewed and evaluated the
effectiveness of the Company's disclosure controls and procedures (as defined in
the Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period
covered by this quarterly report. Based on that evaluation, the chief executive
officer and the chief financial officer have concluded that the Company's
disclosure controls and procedures are effective and designed to ensure that
material information relating to the Company and the Company's consolidated
subsidiaries are made known to them by others within those entities.
Changes in Internal Controls - During the fiscal quarter ended June 30, 2005,
there were no changes in the Company's internal control over financial reporting
that have materially affected, or are reasonably likely to materially affect,
the Company's internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings - None
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds - None
Item 3. Defaults upon Senior Securities - Not applicable
Item 4. Submission of Matters to a Vote of Security Holders -
The Annual Meeting of Shareholders of the Company was held May 5, 2005. At
such meeting, the Shareholders of the Company elected the following as Directors
of the Company: Candace Kendle, Christopher C. Bergen, Robert R. Buck, G. Steven
Geis, Donald C. Harrison, Timothy E. Johnson, Frederick A. Russ and Robert C.
Simpson. Shares were voted as follows: Candace Kendle (FOR: 11,141,394 WITHHELD:
797,005), Christopher C. Bergen (FOR: 11,901,918 WITHHELD: 36,481), Robert R.
Buck (FOR: 11,900,664 WITHHELD: 37,735), G. Steven Geis (FOR: 11,902,095
WITHHELD: 36,304), Donald C. Harrison (FOR: 11,902,964 WITHHELD: 35,435),
Timothy E. Johnson (FOR: 11,903,164 WITHHELD:
27
35,235), Frederick A. Russ (FOR: 11,678,676 WITHHELD: 259,723) and Robert C.
Simpson (FOR: 11,901,964 WITHHELD: 36,435).
In addition, the Shareholders voted on the ratification of the appointment
of Deloitte & Touche LLP as the Company's independent public accountants for the
calendar year 2005. The Shareholders ratified this appointment. Voting results
on this ratification were as follows: 11,886,652 shares were voted FOR
ratification, 49,147 shares voted AGAINST, and 2,600 shares voted to ABSTAIN.
Item 5. Other Information -
(a) In a meeting on August 4, 2005, the Company's Board of Directors approved an
Amendment No. 5 (the "Amendment") to the 1998 Employee Stock Purchase Plan (the
"ESPP") pursuant to the powers granted to the Board under the terms of the ESPP.
The Amendment is filed as an exhibit hereto and is incorporated by reference
herein. The following matter is being reported in this Quarterly Report on Form
10-Q in lieu of a separate filing of a Current Report on Form 8-K.
(b) Not applicable.
Item 6. Exhibits
Exhibits - Exhibits set forth below that are on file with the Securities and
Exchange Commission are incorporated by reference as exhibits thereto.
Exhibit Filing
Number Description of Exhibit Status
- ----------- ------------------------------------------------------------------- ------
10.1 Second Amended and Restated Credit Agreement dated asof May 27, A
2005 among Kendle International Inc., the several lenders from time
to time party thereto and JPMorgan Chase Bank, N.A., as agent
10.1(a) Amended and Restated Pledge and Security Agreement dated June 3, A
2002
10.1(b) Amended and Restated Guarantee Agreement dated June 3, 2002 and A
re-affirmed as of May 27, 2005
10.1(c) Security Agreement dated May 14, 2003 and re-affirmed as of May 27, B
2005
10.20(e)(5) Amendment No. 5 to 1998 Employee Stock Purchase Plan C
31.1 Certificate of Chief Executive Officer pursuant to Section 302 of C
the Sarbanes-Oxley Act of 2002
31.2 Certificate of Chief Financial Officer pursuant to Section 302 of C
the Sarbanes-Oxley Act of 2002
32.1 Certificate of Chief Executive Officer pursuant to Section 906 of C
the Sarbanes-Oxley Act of 2002
32.2 Certificate of Chief Financial Officer pursuant to Section 906 of C
the Sarbanes-Oxley Act of 2002
28
Filing
Status Description of Filing Status
- ----------- -------------------------------------------------------------------
A Incorporated by reference to the Company's Current Report on
Form 8-K dated June 3, 2005
B Incorporated by reference to the Company's Quarterly Report on
Form 10-Q for the quarterly period ended March 31, 2003
C Filed herewith
29
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: August 9, 2005 Candace Kendle
Chairman of the Board and Chief
Executive Officer
By: /s/ Karl Brenkert III
---------------------------------
Date: August 9, 2005 Karl Brenkert III
Senior Vice President - Chief
Financial Officer
30
KENDLE INTERNATIONAL INC.
EXHIBIT INDEX
Exhibits Description
- ----------- -------------------------------------------------------------------
10.1 Second Amended and Restated Credit Agreement dated as of May 27,
2005 among Kendle International Inc., the several lenders from time
to time party thereto and JPMorgan Chase Bank, N.A., as agent
10.1(a) Amended and Restated Pledge and Security Agreement dated
June 3, 2002
10.1(b) Amended and Restated Guarantee Agreement dated June3, 2002 and
re-affirmed as of May 27, 2005
10.1(c) Security Agreement dated May 14, 2003 and re-affirmed as of
May 27, 2005
10.20(e)(5) Amendment No. 5 to 1998 Employee Stock Purchase Plan
31.1 Certificate of Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
31.2 Certificate of Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
32.1 Certificate of Chief Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
32.2 Certificate of Chief Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
31