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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, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION
PERIOD FROM _________ TO ___________
Commission file number _000-23019____
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
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(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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 12,778,654 shares of Common
Stock, no par value, as of July 31, 2002.
1
KENDLE INTERNATIONAL INC.
INDEX
Page
----
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets -June 30, 2002
and December 31, 2001 3
Condensed Consolidated Statements of Operations - Three
Months Ended June 30, 2002 and 2001; Six Months
Ended June 30, 2002 and 2001 4
Condensed Consolidated Statements of Comprehensive Income (Loss) -
Three Months Ended June 30, 2002 and 2001; Six Months
Ended June 30, 2002 and 2001 5
Condensed Consolidated Statements of Cash Flows - Six
Months Ended June 30, 2002 and 2001 6
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 14
Item 3. Quantitative and Qualitative Disclosure About Market Risk 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 28
2
KENDLE INTERNATIONAL INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data) June 30, December 31,
2002 2001
-------------------- ---------------------
(unaudited) (note 1)
ASSETS
Current assets:
Cash and cash equivalents $ 5,613 $ 6,016
Available for sale securities 22,187 19,508
Accounts receivable 57,713 59,611
Other current assets 7,599 5,305
-------------------- ---------------------
Total current assets 93,112 90,440
-------------------- ---------------------
Property and equipment, net 17,098 16,407
Goodwill 89,718 86,094
Other indefinite-lived intangible assets 15,000 -
Other assets 9,482 11,110
-------------------- ---------------------
Total assets $ 224,410 $ 204,051
==================== =====================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of obligations under capital leases $ 773 $ 660
Amounts outstanding under credit facilities 7,548 14,195
Trade payables 7,639 6,502
Advance billings 19,649 18,951
Other accrued liabilities 11,634 13,468
-------------------- ---------------------
Total current liabilities 47,243 53,776
-------------------- ---------------------
Obligations under capital leases, less current portion 1,710 1,362
Convertible note 6,000 -
Long-term debt 12,000 -
Other noncurrent liabilities 7,515 6,606
-------------------- ---------------------
Total liabilities 74,468 61,744
-------------------- ---------------------
Commitments and contingencies
Shareholders' equity:
Preferred stock -- no par value; 100,000 shares authorized; no shares
issued and outstanding
Common stock -- no par value; 45,000,000 shares authorized; 12,753,863
and 12,399,406 shares issued and 12,733,966 and 12,382,126
outstanding at June 30, 2002 and December 31, 2001, respectively 75 75
Additional paid in capital 133,465 128,986
Retained earnings 19,072 17,322
Accumulated other comprehensive loss:
Net unrealized holding gains on available for sale securities 10 35
Foreign currency translation adjustment (2,287) (3,761)
-------------------- ---------------------
Total accumulated other comprehensive loss (2,277) (3,726)
Less: Cost of common stock held in treasury, 19,897 and 17,280 shares at
June 30, 2002 and December 31, 2001, respectively (393) (350)
-------------------- ---------------------
Total shareholders' equity 149,942 142,307
-------------------- ---------------------
Total liabilities and shareholders' equity $ 224,410 $ 204,051
==================== =====================
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 For the Six Months Ended
June 30, June 30,
----------------------------- --------------------------------
2002 2001 2002 2001
-------- -------- -------- --------
Net service revenues $ 43,694 $ 38,661 $ 87,615 $ 70,914
Reimbursable out-of-pocket revenues 14,500 12,368 24,529 20,474
-------- -------- -------- --------
Total revenues 58,194 51,029 112,144 91,388
-------- -------- -------- --------
Costs and expenses:
Direct costs 26,506 23,895 52,538 43,643
Reimbursable out-of-pocket costs 14,500 12,368 24,529 20,474
Selling, general and
administrative expenses 12,428 10,722 24,711 20,658
Depreciation and amortization 2,081 2,488 4,055 4,800
-------- -------- -------- --------
55,515 49,473 105,833 89,575
-------- -------- -------- --------
Income from operations 2,679 1,556 6,311 1,813
Other income (expense):
Interest income 148 263 301 504
Interest expense (281) (261) (546) (379)
Other 92 (42) 58 38
Investment impairment (1,938) - (1,938) -
-------- -------- -------- --------
Income before income taxes 700 1,516 4,186 1,976
Income tax expense 1,067 638 2,436 836
-------- -------- -------- --------
Net income (loss) $ (367) $ 878 $ 1,750 $ 1,140
======== ======== ======== ========
Income per share data:
Basic:
Net income (loss) per share $ (0.03) $ 0.07 $ 0.14 $ 0.09
======== ======== ======== ========
Weighted average shares 12,731 12,267 12,671 12,138
Diluted:
Net income (loss) per share $ (0.03) $ 0.07 $ 0.13 $ 0.09
======== ======== ======== ========
Weighted average shares 12,731 12,855 13,455 12,682
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 For the Six Months Ended
June 30, June 30,
-------------------------- ------------------------
2002 2001 2002 2001
---- ---- ---- ----
Net income (loss) $ (367) $ 878 $ 1,750 $ 1,140
------ ----- ------- -------
Other comprehensive income:
Foreign currency translation adjustment 1,755 (402) 1,474 (1,498)
Net unrealized holding gains (losses) on
available for sale securities arising
during the period, net of tax 11 8 (25) 120
Reclassification adjustment for holding
losses included in net income, net of tax - - 26
------ ----- ------- -------
Net change in unrealized holding gains
(losses) on available for sale securities 11 8 (25) 146
------ ----- ------- -------
Comprehensive income (loss) $ 1,399 $ 484 $ 3,199 $ (212)
======= ===== ======= ======
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 Six Months Ended
June 30,
----------------------------
2002 2001
---- ----
Net cash provided by operating activities $ 9,419 $ 4,278
------- -------
Cash flows from investing activities:
Proceeds from sales and maturities of available for sale securities 13,957 23,472
Purchases of available for sale securities (16,849) (16,949)
Acquisitions of property and equipment (2,387) (2,017)
Additions to software costs (1,245) (1,636)
Acquisition of businesses, less cash acquired (7,942) (10,789)
Contingent purchase price paid in connection with prior acquisition - (2,144)
Other - (5)
------- -------
Net cash used in investing activities (14,466) (10,068)
------- -------
Cash flows from financing activities:
Net proceeds under credit facilities 5,000 13,606
Net proceeds (repayments) - book overdraft (451) 380
Proceeds from exercise of stock options 279 235
Payments on capital lease obligations (393) (450)
Other (15) (15)
------- -------
Net cash provided by financing activities 4,420 13,756
------- -------
Effects of exchange rates on cash and cash equivalents 224 (307)
Net increase (decrease) in cash and cash equivalents (403) 7,659
Cash and cash equivalents:
Beginning of period 6,016 6,709
------- -------
End of period $ 5,613 $14,368
======= =======
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Acquisition of Businesses:
Fair value of assets acquired (net of cash acquired) $19,165 $16,474
Fair value of liabilities assumed (1,131) (1,812)
Common stock issued (4,092) (3,873)
Convertible debt issued (6,000) -
-------- -------
Net cash payments $ 7,942 $10,789
======== =======
The accompanying notes are an integral part of these condensed consolidated
financial statements.
6
KENDLE INTERNATIONAL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION:
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
for interim financial information and the instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and notes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation
have been included. Operating results for the three months and six months ended
June 30, 2002 are not necessarily indicative of the results that may be expected
for the year ending December 31, 2002. For further information, refer to the
consolidated financial statements and notes thereto included in the Form 10-K
for the year ended December 31, 2001 filed by Kendle International Inc. ("the
Company") with the Securities and Exchange Commission.
The condensed consolidated balance sheet at December 31, 2001 has been
derived from the audited financial statements at that date but does not include
all of the information and notes required by generally accepted accounting
principles for complete financial statements.
2. NET INCOME (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 weighted average shares used in computing net income (loss) per
diluted share have been calculated as follows:
(in thousands) Three Months Ended Three Months Ended
June 30, 2002 June 30, 2001
------------------ ------------------
Weighted average common shares
outstanding 12,731 12,267
Stock options -- 588
------ ------
Weighted average shares 12,731 12,855
Options to purchase approximately 1,970,000 shares of common stock
(approximately 465,000 shares of common stock equivalents) were outstanding
during the three months ended June 30, 2002 but were not included in the
computation of earnings (loss) per diluted share because the effect would be
antidilutive. Options to purchase approximately 280,000 shares of common stock
were outstanding during the three months ended June 30, 2001 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.
7
KENDLE INTERNATIONAL INC.
The net income used in computing net income per diluted share has been
calculated as follows:
(in thousands) Six Months Ended Six Months Ended
June 30, 2002 June 30, 2001
---------------- ----------------
Net income per statement of operations $1,750 $1,140
Add: After-tax interest expense on
convertible note 58 --
------ ------
Net income for diluted EPS calculation $1,808 $1,140
The weighted average shares used in computing net income per diluted
share have been calculated as follows:
(in thousands) Six Months Ended Six Months Ended
June 30, 2002 June 30, 2001
---------------- ----------------
Weighted average common shares
outstanding 12,671 12,138
Stock options 518 544
Convertible note 266 --
------ ------
Weighted average shares 13,455 12,682
Options to purchase approximately 871,000 and 410,000 shares of common
stock were outstanding during the six months ended June 30, 2002 and 2001
respectively, but were not included in the computation of earnings per diluted
share because the options' exercise price was greater than the average market
price of the common shares and, therefore, the effect would be antidilutive.
3. ACQUISITIONS:
Details of the Company's acquisitions in 2002 and 2001 are listed
below. The acquisitions have been accounted for using the purchase method of
accounting.
Valuation of Common Stock issued in the acquisitions was based on an
appraisal obtained by the Company which provided for a discount of the shares
due to lock-up restrictions and the lack of registration of the shares.
On January 29, 2002, the Company acquired substantially all of the
assets of Clinical and Pharmacologic Research, Inc. (CPR) located in Morgantown,
West Virginia. CPR specializes in Phase I studies for the generic drug industry,
enabling the Company to expand into the generic drug market.
Results of CPR are included in the Company's consolidated results from
the date of acquisition.
The aggregate purchase price was approximately $18.2 million, including
approximately $8.1 million in cash (including acquisition costs), 314,243 shares
of Common Stock valued at $4.1 million and a $6.0 million convertible
subordinated note. The value of the shares issued
8
was based on the average closing price of the Company's shares over the
three-day period prior to the closing of the acquisition. The note is
convertible at the holders' option into 314,243 shares of the Company's Common
Stock at any time before January 29, 2005, the Maturity Date.
The following summarizes the fair values of the assets acquired and
liabilities assumed at the date of acquisition. The intangible asset represents
one customer contract, the fair value of which was determined by a third party
valuation. The intangible asset has been determined to have an indefinite life
and will not be amortized, but instead will be reviewed for impairment at least
annually. The contract was determined to have an indefinite useful life based on
the unique nature of the services provided by CPR, the limited likelihood that a
competitor would attempt to gain some of the business provided under this
contract due to the barriers to entry and the historical relationship between
CPR and the customer.
At January 29,
2002
(in thousands)
--------------
Current assets $ 1,241
Fixed assets 213
Goodwill 2,927
Intangible asset 15,000
-----------------
Total assets acquired 19,381
Liabilities assumed 1,131
-----------------
Net assets acquired $ 18,250
The former majority shareholder of CPR is no longer employed by CPR
and never was employed by Kendle, but he does provide consulting services to
Kendle. He is currently employed by the customer that accounts for the majority
of CPR's current business as provided for in the contract discussed above.
In February 2001, the Company acquired AAC Consulting Group, Inc., a
full service regulatory consulting firm with offices in Rockville, Maryland.
Aggregate purchase price including acquisition costs consisted of approximately
$10.9 million in cash and 374,665 shares of the Company's Common Stock.
The following unaudited pro forma results of operations assume the
acquisitions occurred at the beginning of 2001:
(in thousands) Six Months Ended June Six Months Ended June
30, 2002 30, 2001
-------------------------- ------------------------
Net service revenues $88,416 $76,341
Net income $1,888 $1,672
Net income per diluted share $0.14 $0.13
Weighted average shares 13,553 13,551
Pro-forma net income per above $1,888 $1,672
9
Add: After-tax interest expense on
convertible note 68 68
Pro-forma net income for diluted EPS $1,956 $1,740
The pro forma financial information is not necessarily indicative of
the operating results that would have occurred had the acquisitions been
consummated as of January 1, 2001, nor are they necessarily indicative of future
operating results.
4. GOODWILL AND OTHER INTANGIBLE ASSETS:
In accordance with Statement of Financial Accounting Standards (SFAS)
No. 142, "Goodwill and Other Intangible Assets", effective January 1, 2002 the
Company discontinued the amortization of goodwill and other identifiable
intangible assets that have indefinite useful lives. Intangible assets that have
finite useful lives will continue to be amortized over their useful lives.
The impact of discontinuing amortization of goodwill with indefinite
lived intangible assets on net income, basic and diluted earnings per share for
the quarter ended June 30, 2001 is approximately $637,000, or $0.05 per share on
a basic and fully diluted basis. The impact of discontinuing amortization of
goodwill with indefinite lived intangible assets on net income, basic and
diluted earnings per share for the six months ended June 30, 2001 is
approximately $1.2 million or $0.10 per basic share and $0.09 per fully diluted
share. Adjusted net income, basic and diluted earnings per share for the three
months ended June 30, 2001 was approximately $1.5 million or $0.12 per share on
a basic and fully diluted basis. Adjusted net income, basic and diluted earnings
per share for the six months ended June 30, 2001 was approximately $2.3 million
or $0.19 per share on a basic and $0.18 per share on a fully diluted basis.
Identifiable intangible assets as of June 30, 2002 are composed of:
(in thousands)
Carrying
Amount
Non-amortizable intangible assets:
Goodwill $ 89,718
Customer contract 15,000
Amortizable intangible assets --
----------
Total $ 104,718
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 $23.0 million
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 $23.0 million facility
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 (as defined).
10
The $5.0 million facility is composed of a euro overdraft facility up
to the equivalent of $3.0 million and a sterling overdraft facility up to the
equivalent of $2.0 million. This Multicurrency Facility bears interest at a rate
equal to either (a) the rate published by the European Central Bank plus a
margin (as defined) or (b) the Bank's Base Rate (as determined by the bank
having regard to prevailing market rates) plus a margin (as defined). Under
terms of the credit agreement, revolving loans are convertible into term loans
within the facility if used for acquisitions. The facilities contain various
restrictive financial covenants, including the maintenance of certain fixed
coverage and leverage ratios and minimum net worth levels. At June 30, 2002, no
amounts were outstanding under the Company's $23 million revolving credit loan
and $4.5 million was outstanding under the $5.0 million Multicurrency Facility.
Interest is payable on the $15.0 million term loan at a rate of 3.3% and on the
$4.5 million outstanding under the Multicurrency Facility at a weighted average
rate of 4.6%. Principal payments of $750,000 are due on the last business day of
each quarter through March of 2007.
Effective July 1, 2002 the Company entered into an interest rate swap
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, 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 will be recorded in Other Comprehensive Income on
the Balance Sheet.
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.
6. INVESTMENT
In January 1999, the Company acquired a minority interest in Digineer,
Inc. (Digineer), formerly known as Component Software International, Inc.), a
healthcare consulting and software development company, for approximately $1.6
million in cash and 19,995 shares of the Company's common stock. This investment
has been accounted for under the cost method.
During the second quarter of 2002, Digineer adopted a plan to cease
operations. As a result of this action, the Company has determined that its
investment in Digineer is impaired. In the second quarter of 2002, the Company
recorded a $1.9 million non-cash charge in "Other Income/(Expense)" to reflect
the write-off of this investment. The write-off is a capital loss for income tax
purposes and is deductible only to the extent the Company generates capital
gains in the future to offset this loss. The Company has recorded a valuation
allowance against the deferred tax asset relating to the Digineer write-off and
no income tax benefit has been recorded.
7. SEGMENT INFORMATION
Effective January 1, 2002, the Company integrated the medical
communications group into its Phase IV product and services offering. As a
result, the Company is now managed under
11
a single reportable segment referred to as contract research services, which
encompasses Phase I through IV services.
Prior to January 1, 2002, the Company was managed through two
reportable segments, namely the contract research services group and the medical
communications group. The contract research services group includes clinical
trial management, clinical data management, statistical analysis, medical
writing, medical affairs and marketing, and regulatory consultation. The medical
communications group, which included only Health Care Communications, Inc. (HCC)
acquired in 1999, provided organizational, meeting management and publication
services to professional organizations and pharmaceutical companies. Effective
January 1, 2002, the Company launched a new strategic initiative, Medical
Affairs Medical Marketing (MAMM). The MAMM service offering is intended to
provide a more comprehensive Phase IV product to the Company's core customers,
including post-marketing activities such as publications and symposia in support
of new product launches. As a result, the former medical communications group
was integrated into MAMM and certain of HCC's unique services have been
restructured to be in alignment with the Company's Phase IV services strategy.
8. NEW ACCOUNTING PRONOUNCEMENTS:
In July 2002, the Financial Accounting Standards Board ("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 will be required for exit or
disposal activities of the Company initiated after December 31, 2002, with
earlier adoption encouraged.
In November 2001, the FASB issued EITF 01-14, "Income Statement
Characterization of Reimbursements Received for Out-of-Pocket Expenses
Incurred." The EITF requires reimbursements for out-of-pocket expenses incurred
to be characterized as revenue and expenses in the Statements of Operations. The
Company implemented this rule beginning in the first quarter of 2002 and has
restated comparative information for 2001. The implementation of the new
guidelines has no impact on income from operations or net income.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 supercedes SFAS No.
121 "Accounting for the Impairment of Long-Lived Assets to be Disposed of" and
certain provisions of APB Opinion No. 30, "Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions." SFAS No. 144
establishes a single model for the impairment of long-lived assets and broadens
the presentation of discontinued operations. The adoption of this statement did
not have an impact on the Company's consolidated financial statements.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets" that requires that all intangible assets determined to have
an indefinite useful life no longer be
12
amortized but instead be reviewed at least annually for impairment. The Company
adopted SFAS No. 142 as of January 1, 2002, as required. The Company analyzed
goodwill for impairment at the reporting unit level at the beginning of 2002 and
found no goodwill impairment. The Company will analyze goodwill on an annual
basis, or more frequently as circumstances warrant.
In July 2001, the FASB issued SFAS No. 141, "Business Combinations"
that requires all business combinations initiated after June 30, 2001 to be
accounted for using the purchase method. The Company has adopted SFAS No. 141
and the adoption did not have an impact on the Company's results of operations
or its financial position.
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 and
six months ended June 30, 2002 and should be read in conjunction therewith. The
Company's results of operations for a particular quarter may not be indicative
of results expected during subsequent quarters or for the entire year.
COMPANY OVERVIEW
Kendle International Inc. (the "Company") is an international contract
research organization (CRO) that provides integrated clinical research services
including clinical trial management, clinical data management, statistical
analysis, medical writing, regulatory consultation and organizational, meeting
management and publications services on a contract basis to the pharmaceutical
and biotechnology industries. The Company had been managed through two
reportable segments, the Phase I through IV contract research services group,
which among other services, includes investigator meetings, pharmacoeconomics,
post-marketing surveillance, and labeling studies, and the medical
communications group. Effective January 1, 2002, the Company launched a new
strategic initiative, Medical Affairs Medical Marketing (MAMM). The MAMM service
offering is intended to provide a more comprehensive Phase IV product to the
Company's customers, including post-marketing activities such as publications
and symposia in support of new product launches. As a result, the former medical
communications group is now being managed as part of MAMM and their service
capabilities have been incorporated into the Company's overall Phase IV suite of
products. As such the medical communications group, which had principally
focused on organizational, meeting management and publication services for
professional organizations and pharmaceutical companies has been restructured
and integrated with the contract research services group.
The Company's contracts are generally fixed price, with some variable
components, and range in duration from a few months to several years. A contract
typically requires a portion of the contract fee to be paid at the time the
contract is entered into and the balance is received in installments over the
contract's duration, in most cases on a milestone achievement basis. Net
revenues from contracts are generally recognized on the percentage of completion
method, measured principally by the total costs incurred as a percentage of
estimated total costs for each contract. The estimated total costs of contracts
are reviewed and revised periodically throughout the lives of the contracts with
adjustments to revenues resulting from such revisions being recorded on a
cumulative basis in the period in which the revisions are made. The Company also
performs work under time-and-materials contracts, recognizing revenue as hours
are worked based on the hourly billing rates for each contract. Additionally,
the Company recognizes revenue under units-based contracts as units are
completed multiplied by the contract per-unit price.
The Company incurs costs, in excess of contract amounts, in
subcontracting with third-party investigators as well as other out-of-pocket
costs. These out-of-pocket costs are reimbursable by its customers. Effective
January 1, 2002 in connection with the implementation of EITF 01-14, "Income
Statement Characterization of Reimbursements Received for Out-of-Pocket Expenses
Incurred," the Company includes amounts paid to investigators and other
out-of-pocket costs as reimbursable out-of-pocket revenues and reimbursable
out-of-pocket expenses in the Consolidated Statements of 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
14
and related fringe benefits for sales and administrative associates and
professional services, as well as unallocated costs related to facilities,
information systems and other costs.
The Company's results are subject to volatility due to a variety of
factors. The cancellation or delay of contracts and cost overruns could have
immediate adverse effects on the financial statements. Fluctuations in the
Company's sales cycle and the ability to maintain large customer contracts or to
enter into new contracts could hinder the Company's long-term growth. In
addition, the Company's aggregate backlog is not necessarily a meaningful
indicator of future results. Accordingly, no assurance can be given that the
Company will be able to realize the net revenues included in the backlog.
ACQUISITIONS
In January 2002, the Company acquired the assets of Clinical and
Pharmacologic Research, Inc. (CPR), located in Morgantown, West Virginia. CPR
specializes in Phase I studies for the generic drug industry. Total acquisition
costs consisted of approximately $8.1 million cash, 314,243 shares of the
Company's common stock valued at $4.1 million and a $6.0 million convertible
subordinated note. The note is convertible at the holders' option into 314,243
shares of the Company's common stock at any time before January 29, 2005, the
Maturity Date. If the note has not been converted at the Maturity Date, the
Company has the option to extend the Maturity Date of the note for another three
years.
The estimated fair value of the assets acquired and liabilities assumed
at the date of acquisition is as follows:
At January 29,
2002
(in thousands)
Current assets $ 1,241
Fixed assets 213
Goodwill 2,927
Intangible asset 15,000
-----------------
Total assets acquired 19,381
Liabilities assumed 1,131
-----------------
Net assets acquired $ 18,250
The intangible asset is based on a third-party valuation of a customer
contract acquired and has been determined to have an indefinite useful life and
will not be amortized, but instead will be reviewed for impairment at least
annually. The contract was determined to have an indefinite useful life based on
the unique nature of the services provided by CPR, the limited likelihood that a
competitor would attempt to gain some of the business provided under this
contract due to the barriers to entry and the historical relationship between
CPR and the customer.
The former majority shareholder of CPR is no longer employed by CPR and
never was employed by Kendle, but he does provide consulting services to Kendle.
He is currently employed by the customer that accounts for the majority of CPR's
current business as provided for in the contract discussed above.
15
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2002 COMPARED TO THREE MONTHS ENDED JUNE 30, 2001
Net service revenues increased 13% to $43.7 million in the second
quarter of 2002 from $38.7 million in the second quarter of 2001. Excluding the
impact of foreign currency exchange rates, net service revenues increased 12% in
the second quarter of 2002. The 13% increase in net service revenues was
composed of growth from acquisitions of 6% and organic growth in revenues of 7%.
The growth in organic service revenues is primarily attributable to the
increased level of clinical development activity in 2002. Approximately 25% of
the Company's net service revenues were derived from operations outside the
United States in the second quarter of 2002 compared to 32% in the corresponding
period in 2001. The top five customers based on net service revenues contributed
approximately 45% of net revenues during the quarter. Net service revenues from
Pharmacia Inc. accounted for approximately 20% of total second quarter 2002 net
service revenues. The Company's net service revenues from Pharmacia Inc. are
derived from numerous projects that vary in size, duration and therapeutic
indication.
Direct costs increased by 11% from $23.9 million in the second quarter
2001 to $26.5 million in the second quarter 2002. The 11% increase in direct
costs is composed of a 7% increase in organic direct costs and a 4% increase in
direct costs due to the impact of acquisitions. The increase in organic direct
costs is primarily a result of an increase in employee and contractor costs to
support the increased revenue base. Direct costs expressed as a percentage of
net service revenues were 60.7% for the three months ended June 30, 2002
compared to 61.8% for the three months ended June 30, 2001. The decrease in
these costs as a percentage of net service revenues is due to the mix of
contracts and services provided by the Company in the second quarter of 2002
compared to the second quarter of 2001.
Selling, general and administrative expenses increased by 16% or $1.7
million, to $12.4 million in the second quarter 2002 compared to $10.7 million
in the second quarter 2001. The 16% increase in selling, general and
administrative expenses is composed of a 14% increase in organic SG&A costs and
a 2% increase in SG&A costs due to the impact of acquisitions. The increase in
organic SG&A costs is primarily due to increased employee-related costs such as
salaries, training costs and other employee costs incurred to support the larger
revenue base. Selling, general and administrative expenses expressed as a
percentage of net service revenues were 28.4% for the three months ended June
30, 2002 compared to 27.7% for the corresponding 2001 period. The increase in
SG&A costs as a percentage of net revenues is due to the increased salaries and
employee-related costs.
Depreciation and amortization expense decreased by 16% in the second
quarter of 2002 compared to the second quarter of 2001. The decrease is due to
the implementation of Statement of Financial Accounting Standards (SFAS) No.
142, which has eliminated the amortization of goodwill and other indefinite
lived intangible assets. See the discussion on SFAS No. 142 in the New
Accounting Pronouncements section of Management's Discussion and Analysis.
Eliminating goodwill amortization in 2001, adjusted net income in the second
quarter of 2001 would have been approximately $1.5 million, or $0.12 per diluted
share
In the second quarter of 2002, the Company recorded a non-recurring
$1.9 million non-cash charge to reflect the impairment write-off of its
investment in Digineer, Inc. (Digineer), a healthcare consulting and software
development company that during the quarter adopted a plan
16
to cease operations. This charge is recorded in "Other income (expense)" in the
Company's Statements of Operations.
Including the effect of the investment impairment charge, the net loss
for the quarter was $367,000, or $0.03 per share. Excluding the effects of this
charge, net income for the quarter would have been $1.6 million, or $0.12 per
diluted share compared with $878,000, or $0.07 per diluted share during the same
period a year ago.
Net income used in calculating earnings per diluted share excluding the
impact of the Digineer write-off in the second quarter of 2002 is calculated as
follows:
Net income, excluding Digineer write-off $1,571
Add: After tax interest expense on convertible note 35
--------
Net income for diluted EPS calculation
(excluding Digineer write-off) $1,606
The weighted average shares used in computing diluted earnings per
share excluding the impact of the Digineer write-off has been calculated as
follows:
Weighted average shares outstanding: 12,731
Stock options 465
Convertible note 314
-------
Weighted average shares, excluding Digineer write-off 13,510
In the second quarter of 2002, the Company continued to be impacted by
lower results from its medical communications activities as a result of the
transition to a broader Medical Affairs/Medical Marketing service offering.
Future quarters in 2002 may experience results similar to the first and second
quarters of 2002 as the Company continues the implementation of its broader
Phase IV service offerings.
The effective tax rate for the three months ending June 30, 2002 was
152.4%. The write-off of the Digineer investment is a capital loss for income
tax purposes and is deductible only to the extent the Company generates capital
gains in the future to offset this loss. The Company has recorded a valuation
allowance against the deferred tax asset relating to the Digineer write-off and
no income tax benefit has been recorded. Excluding the impact of the investment
impairment write-off, the Company's effective tax rate would have been 40.4% for
the three months ended June 30, 2002 as compared to 42.1% for the three months
ended June 30, 2001. The decrease in the effective tax rate is primarily due to
the impact of non-deductible goodwill amortization on the effective tax rate in
2001 that was eliminated in 2002.
SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO SIX MONTHS ENDED JUNE 30, 2001
Net service revenues increased 24% to $87.6 million during the first
six months of 2002 from $70.9 million in the first six months of 2001. Excluding
the impact of foreign currency exchange rates, net service revenues increased
23% in the first half of 2002. The 24% increase
17
in net service revenues was composed of growth from acquisitions of 8% and
organic growth in revenues of 16%. The growth in organic service revenues is
primarily attributable to the increased level of clinical development activity
in 2002. Approximately 27% of the Company's net service revenues were derived
from operations outside the United States in the first six months of 2002
compared to 33% in the corresponding period in 2001. The top five customers
based on net service revenues contributed approximately 46% of net revenues
during the first half of 2002. Net service revenues from Pharmacia Inc.
accounted for approximately 18% of total six month 2002 net service revenues.
The Company's net service revenues from Pharmacia Inc. are derived from numerous
projects that vary in size, duration and therapeutic indication.
Direct costs increased by 20% from $43.6 million in the first six
months of 2001 to $52.5 million in the first six months of 2002. The 20%
increase in direct costs is composed of a 12% increase in organic direct costs
and an 8% increase in direct costs due to the impact of acquisitions. The
increase in organic direct costs is primarily a result of an increase in
employee and contractor costs to support the increased revenue base. Direct
costs expressed as a percentage of net service revenues were 60.0% for the six
months ended June 30, 2002 compared to 61.5% for the six months ended June 30,
2001. The decrease in these costs as a percentage of net service revenues is due
to the mix of contracts and services provided by the Company in the first six
months of 2002 compared to the corresponding period of 2001.
Selling, general and administrative expenses increased by 20% or $4.0
million, to $24.7 million in the first half of 2002 compared to $20.7 million in
first half of 2001. The 20% increase in selling, general and administrative
expenses is composed of a 16% increase in organic SG&A costs and a 4% increase
in SG&A costs due to the impact of acquisitions. The increase in organic SG&A
costs is primarily due to increased employee-related costs such as salaries,
training costs and other employee costs incurred to support the larger revenue
base. Selling, general and administrative expenses expressed as a percentage of
net service revenues were 28.2% for the six months ended June 30, 2002 compared
to 29.1% for the corresponding 2001 period. The decrease in SG&A costs as a
percentage of net revenues is as a result of the Company's ability to leverage
these costs over a higher revenue base.
Depreciation and amortization expense decreased by 16% in the six
months ending June 30, 2002 compared to the corresponding period in 2001. The
decrease is due to the implementation of SFAS No. 142, which has eliminated the
amortization of goodwill and other indefinite lived intangible assets. See the
discussion of SFAS No. 142 in the New Accounting Pronouncements section of
Management's Discussion and Analysis. Eliminating goodwill amortization in 2001,
adjusted net income in the first six months of 2001 would have been
approximately $2.3 million, or $0.18 per diluted share.
In the second quarter of 2002, the Company recorded a non-recurring
$1.9 million non-cash charge to reflect the impairment write-off of its
investment in Digineer, a healthcare consulting and software development company
that during the quarter adopted a plan to cease operations. This charge is
recorded in "Other income (expense)" in the Company's Statements of Operations.
Including the effect of the investment impairment charge, net income
for the six months ended June 30, 2002 was $1.8 million or $0.13 per diluted
share. Excluding the effects of this charge, net income for the first half of
2002 would have been $3.7 million, or $0.28 per diluted share compared with $1.1
million, or $0.09 per diluted share during the same period a year ago.
18
Net income for the first half of 2002 used in calculating earnings per
diluted share excluding the impact of the Digineer write-off is calculated as
follows:
Net income, excluding Digineer write-off $3,688
Add: After tax interest expense on convertible note 58
--------
Net income for diluted EPS calculation, excluding
Digineer write-off $3,746
The pro-forma weighted average shares used in computing diluted
earnings per share excluding the impact of the Digineer write-off has been
calculated as follows:
Weighted average shares outstanding: 12,671
Stock options 518
Convertible note 266
-------
Weighted average shares, excluding Digineer write-off 13,455
In the first six months of 2002, the Company was impacted by lower
results from its medical communications activities as a result of the transition
to a broader Medical Affairs/Medical Marketing service offering. Future quarters
in 2002 may experience results similar to the first and second quarters of 2002
as the Company continues the implementation of its broader Phase IV service
offerings.
The effective tax rate for the six months ending June 30, 2002 was
58.2%. The write-off of the Digineer investment is a capital loss for income tax
purposes and is deductible only to the extent the Company generates capital
gains in the future to offset this loss. The Company has recorded a valuation
allowance against the deferred tax asset relating to the Digineer write-off and
no income tax benefit has been recorded. Excluding the impact of the investment
impairment write-off, the Company's effective tax rate would have been 39.8% for
the six months ended June 30, 2002 as compared to 42.3% for the six months ended
June 30, 2001. The decrease in the effective tax rate is primarily due to the
impact of non-deductible goodwill amortization on the effective tax rate in 2001
that was eliminated in 2002.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents decreased by $0.4 million for the six months
ended June 30, 2002 primarily as a result of cash provided by operating and
financing activities of $9.4 million and $4.4 million, respectively, offset by
cash used in investing activities of $14.5 million. Net cash provided by
operating activities primarily resulted from net income adjusted for non-cash
activity and a decrease in accounts receivable. Fluctuations in accounts
receivable and advance billings occur on a regular basis as services are
performed, milestones or other billing criteria are achieved, invoices are sent
to customers, and payments for outstanding accounts receivable are collected
from customers. Such activity varies by individual customer and contract.
Accounts receivable, net of advance billings decreased to $38.1 million at June
30, 2002 from $40.7 million at December 31, 2001.
Investing activities for the six months ended June 30, 2002 consisted
primarily of $7.9 million in costs incurred related to the Company's acquisition
of CPR, net of cash acquired, and capital expenditures of approximately $3.6
million.
19
Financing activities for the six months ended June 30, 2002 consisted
primarily of net borrowings of $5.0 million under the Company's credit
facilities that were used to finance the Company's acquisition of CPR.
The Company had available for sale securities totaling $22.2 million at
June 30, 2002.
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 $23.0 million
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 $23.0 million facility
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 (as defined).
The $5.0 million Multicurrency Facility is composed of a euro overdraft
facility up to the equivalent of $3.0 million and a sterling overdraft facility
up to the equivalent of $2.0 million. This Multicurrency Facility bears interest
at a rate equal to either (a) the rate published by the European Central Bank
plus a margin (as defined) or (b) the Bank's Base Rate (as determined by the
bank having regard to prevailing market rates) plus a margin (as defined). Under
terms of the credit agreement, revolving loans are convertible into term loans
within the facility if used for acquisitions. The facilities contain various
restrictive financial covenants, including the maintenance of certain fixed
coverage and leverage ratios and minimum net worth levels. At June 30, 2002,
there were no amounts outstanding under the Company's $23 million revolving
credit loan and $4.5 million was outstanding under the $5.0 million
Multicurrency Facility. Interest is payable on the $15.0 million term loan at a
rate of 3.3% and on the $4.5 million outstanding under the Multicurrency
Facility at a weighted average rate of 4.6%. Principal payments of $750,000 are
due on the term note on the last business day of each quarter through March of
2007.
Effective July 1, 2002 the Company entered into an interest rate swap
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, 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 will be recorded in Other Comprehensive Income on
the Balance Sheet.
With the acquisition of CPR, on January 29, 2002 the Company entered
into a $6,000,000 convertible note payable to the shareholders of CPR. The
principal balance is convertible 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.
20
The Company's primary cash needs on both a short-term and long-term
basis are for the payment of salaries and fringe benefits, hiring and recruiting
expenses, business development costs, capital expenditures, acquisitions, and
facility related expenses. The Company believes that its existing capital
resources, together with cash flows from operations and borrowing capacity under
its Credit Facilities, will be sufficient to meet its foreseeable cash needs. In
the future, the Company will continue to consider acquiring businesses to
enhance its service offerings, therapeutic base and global presence. Any such
acquisitions may require additional external financing and the Company may from
time to time seek to obtain funds from public or private issuance of equity or
debt securities. There can be no assurance that such financing will be available
on terms acceptable to the Company.
MARKET RISK
Interest Rates
The Company is exposed to changes in interest rates on its available
for sale securities and amounts outstanding under its Credit Facilities.
Available-for-sale securities are recorded at fair value in the financial
statements. These securities are exposed to market price risk, which also takes
into account interest rate risk. At June 30, 2002, the potential loss in fair
value resulting from a hypothetical decrease of 10% in quoted market price would
be approximately $2.2 million. The Company is also exposed to interest rate
changes on its variable rate borrowings. Based on the Company's June 30, 2002
amounts outstanding under Credit Facilities, a one- percent change in the
weighted-average interest rate would change the Company's annual interest
expense by approximately $195,000.
In July 2002, the Company entered into an interest rate swap 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 is therefore exposed to
various types of currency risks. Two specific transaction risks arise from the
nature of the contracts the Company executes with its customers since from time
to time contracts are denominated in a currency different than the particular
subsidiary's local currency. This contract currency denomination issue is
applicable only to a portion of the contracts executed by the Company's foreign
subsidiaries. The first risk occurs as revenue recognized for services rendered
is denominated in a currency different from the currency in which the
subsidiary's expenses are incurred. As a result, the subsidiary's net revenues
and resultant net income can be affected by fluctuations in exchange rates.
Historically, fluctuations in exchange rates from those in effect at the time
contracts were executed have not had a material effect upon the Company's
consolidated financial results.
The second risk results from the passage of time between the invoicing
of customers under these contracts and the ultimate collection of customer
payments against such invoices. Because the contract is denominated in a
currency other than the subsidiary's local currency, the Company recognizes a
receivable at the time of invoicing at the local currency equivalent of the
21
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 income.
The Company's consolidated financial statements are denominated in U.S.
dollars. Accordingly, changes in exchange rates between the applicable foreign
currency and the U.S. dollar will affect the translation of each foreign
subsidiary's financial results into U.S. dollars for purposes of reporting
consolidated financial statements. The Company's foreign subsidiaries translate
their financial results from local currency into U.S. dollars as follows: income
statement accounts are translated at average exchange rates for the period;
balance sheet asset and liability accounts are translated at end of period
exchange rates; and equity accounts are translated at historical exchange rates.
Translation of the balance sheet in this manner affects the shareholders' equity
account, referred to as the foreign currency translation adjustment account.
This account exists only in the foreign subsidiary's U.S. dollar balance sheet
and is necessary to keep the foreign balance sheet stated in U.S. dollars in
balance. Foreign currency translation adjustments, reported as a separate
component of shareholders' equity were $(2.3) million at June 30, 2002 compared
to $(3.8) million at December 31, 2001.
KEY ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make significant estimates
and assumptions that affect the reported Consolidated Financial Statements for a
particular period. Actual results could differ from those estimates.
The majority of the Company's revenues are based on fixed-price
contracts calculated on a percentage-of-completion basis based on assumptions
regarding the estimated total costs for each contract. Costs are incurred for
each project and compared to the estimated budgeted costs for each contract to
determine a percentage of completion on the project. The percentage of
completion is multiplied by the total contract value to determine the amount of
revenue recognized. Management reviews the budget on each contract to determine
if the budgeted amounts are correct, and budgets are adjusted as needed.
Historically, the majority of the Company's estimates have been materially
correct, but there can be no guarantee that these estimates will continue to be
accurate. As the work progresses, original estimates might be changed due to
changes in the scope of the work. The Company attempts to negotiate contract
amendments with the sponsor to cover these services provided outside the terms
of the original contract. However, there can be no guarantee that the sponsor
will agree to proposed amendments, and the Company ultimately bears the risk of
cost overruns. In certain instances, the Company may have to commit additional
resources to existing projects, resulting in lower gross margins.
As the Company works on projects, the Company incurs costs, in excess
of contract amounts, which are normally reimbursable by its customers. In
certain contracts, however, these costs are fixed by the contract terms. In
these contracts, the Company is at risk for costs incurred in excess of the
amounts fixed by the contract terms. Excess costs incurred above the contract
terms would negatively affect the Company's gross margin.
22
The Company's primary customers are concentrated in the pharmaceutical
and biotechnology industries. The Company derives a significant portion of its
revenue from a small number of large pharmaceutical companies. The Company's
revenue could be negatively impacted by changes in the financial condition of
these companies, including potential mergers and acquisitions involving any of
these companies. Additionally, customers may generally terminate a study at any
time, which might cause unplanned periods of excess capacity and reduced revenue
and earnings.
The Company analyzes goodwill and other indefinite-lived intangible
assets to determine any potential impairment loss on an annual basis, unless
conditions exist that require an updated analysis on an interim basis.
The Company has a 50% owned joint-venture investment with KendleWits, a
company located in China. This investment is accounted for under the equity
method. To date, the Company has contributed approximately $750,000 for the
capitalization of KendleWits and the carrying value at June 30, 2002 is
approximately $500,000. Future capitalization needs 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. Results of
KendleWits may vary, and are dependent upon the demand for clinical research
services in China and the ability of KendleWits to generate additional business.
The Company capitalizes costs incurred to internally develop software
used primarily in providing proprietary clinical trial and data management
services, and amortizes these costs over the useful life of the product, not to
exceed five years. Internally developed software represents software in the
application development stage, and there is no assurance that the software
development process will produce a final product for which the fair value
exceeds its carrying value. Internally developed software is an intangible asset
subject to impairment write-downs whenever events indicate that the carrying
value of the software may not be recoverable. Assessing the fair value of the
internally developed software requires estimates and judgement on the part of
management.
The Company estimates its tax liability based on current tax laws in
the statutory jurisdictions in which it operates. Because we conduct business on
a global basis, our effective tax rate has, and will continue to depend upon the
geographic distribution of our pre-tax earnings among jurisdictions with varying
tax rates. These estimates include judgements about deferred tax assets and
liabilities resulting from temporary differences between assets and liabilities
recognized for financial reporting purposes and such amounts recognized for tax
purposes. The Company has assessed the realization of deferred tax assets based
on estimates of future taxable profits and losses in the various jurisdictions.
Based on these projections and the time period for the realization of these loss
carryforwards, a valuation allowance has not been recorded. If estimates prove
inaccurate or if the tax laws change unfavorably, a valuation allowance could be
required in the future.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2002, the Financial Accounting Standards Board ("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
23
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 will be
required for exit or disposal activities of the Company initiated after December
31, 2002, with early adoption encouraged.
In November 2001, the FASB issued EITF 01-14, "Income Statement
Characterization of Reimbursements Received for Out-of-Pocket Expenses
Incurred." The EITF requires reimbursements for out-of-pocket expenses incurred
to be characterized as revenue and expenses in the Statements of Operations. The
Company implemented this rule beginning in the first quarter of 2002 and has
restated comparative information for 2001. The implementation of the new
guidelines has no impact on income from operations or net income.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 supercedes SFAS No.
121 "Accounting for the Impairment of Long-Lived Assets to be Disposed of" and
certain provisions of APB Opinion No. 30, "Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions." SFAS No. 144
establishes a single model for the impairment of long-lived assets and broadens
the presentation of discontinued operations. The adoption of this statement did
not have an impact on the Company's consolidated financial statements.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets" that requires that all intangible assets determined to have
an indefinite useful life no longer be amortized but instead be reviewed at
least annually for impairment. The Company adopted SFAS No. 142 as of January 1,
2002, as required. The Company analyzed goodwill for impairment at the reporting
unit level at the beginning of 2002 and found no goodwill impairment. The
Company will analyze goodwill on an annual basis, or more frequently as
circumstances warrant.
In July 2001, the FASB issued SFAS No. 141, "Business Combinations"
that requires all business combinations initiated after June 30, 2001 to be
accounted for using the purchase method. The Company has adopted SFAS No. 141
and the adoption did not have an impact on the Company's results of operations
or its financial position.
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.
24
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 SEC filings, copies of which are available
upon request from the Company's investor relations department. No assurance can
be given that the Company will be able to realize the net revenues included in
backlog and verbal awards. The Company believes that its aggregate backlog and
verbal awards are not necessarily meaningful indicators of future results.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
See Management's Discussion and Analysis of Financial Conditions and Results of
Operations.
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 -
The Annual Meeting of Shareholders of the Company was held May 16,
2002. At such meeting, the Shareholders of the Company elected the following as
Directors of the Company: Candace Kendle, Philip E. Beekman, Christopher C.
Bergen, Robert Buck, Timothy M. Mooney, Dr. Donald C. Harrison and Robert C.
Simpson. Shares were voted as follows: Candace Kendle (FOR: 9,907,295 WITHHELD:
1,971,148), Philip E. Beekman (FOR: 11,389,808 WITHHELD: 488,635), Christopher
C. Bergen (FOR: 10,160,444 WITHHELD: 1,717,999), Robert R. Buck (FOR: 11,404,154
WITHHELD: 474,289), Timothy M. Mooney (FOR: 10,146,344 WITHHELD: 1,732,099), Dr.
Donald C. Harrison (FOR: 11,629,354 WITHHELD: 249,089) and Robert C. Simpson
(FOR: 11,404,054 WITHHELD: 474,389).
In addition, the Shareholders also ratified the appointment of
PricewaterhouseCoopers LLP as the Company's independent public accountants for
the calendar year 2002. In connection with such ratification, 11,325,249 shares
were voted for ratification, 552,290 shares cast against, and 904 shares cast to
abstain.
Item 5. Other Information - Not applicable
Item 6. Exhibits and Reports on Form 8-K --
(a) Exhibits
10.23 Amended and Restated Credit Agreement dated as of June 3, 2002
among Kendle International Inc., The Several Lenders From Time
to Time Party Hereto and Bank One, NA, as Agent
99.1 Statement of Chief Executive Officer
99.2 Statement of Chief Financial Officer
(b) Reports filed on Form 8-K during the quarter:
The Company filed Form 8-K on June 14, 2002 to disclose the $1.9
million write-off of its investment in Digineer, Inc., a healthcare
consulting and software development company that adopted a plan to
cease operations.
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: August 14, 2002 ----------------------------------------
Candace Kendle
Chairman of the Board and Chief
Executive Officer
By: /s/ Timothy M. Mooney
----------------------------------------
Date: August 14, 2002 Timothy M. Mooney
Executive Vice President - Chief
Financial Officer
27
KENDLE INTERNATIONAL INC.
EXHIBIT INDEX
Exhibits Description
-------- -----------
10.23 Amended and Restated Credit Agreement dated as of June 3, 2002 among Kendle
International Inc., The Several Lenders From Time to Time Party Hereto and Bank
One, NA, as Agent
99.1 Statement of Chief Executive Officer
99.2 Statement of Chief Financial Officer
28