<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
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 700, 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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 10,951,276 shares of common
stock, no par value, as of October 31, 1998.
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KENDLE INTERNATIONAL INC.
<TABLE>
<CAPTION>
INDEX
Page
----
<S> <C> <C>
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets - September 30, 1998
and December 31, 1997 3
Condensed Consolidated Statements of Operations - Three
Months Ended September 30, 1998 and 1997; Nine Months
Ended September 30, 1998 and 1997 4
Condensed Consolidated Statements of Comprehensive
Income - Three Months Ended September 30, 1998 and 1997;
Nine Months Ended September 30, 1998 and 1997 5
Condensed Consolidated Statements of Cash Flows - Nine
Months Ended September 30, 1998 and 1997 6
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12
Part II. Other Information 19
Item 6. Exhibits and Reports on Form 8-K 19
Signatures 20
Exhibit Index 21
</TABLE>
2
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KENDLE INTERNATIONAL INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------ ------------
(Unaudited)
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 56,104,181 $ 15,766,963
Available for sale securities 50,041 8,438,650
Accounts receivable 26,587,785 15,027,791
Unreimbursed investigator and project costs 5,186,448 5,174,967
Other current assets 2,879,018 1,845,297
------------ ------------
Total current assets 90,807,473 46,253,668
------------ ------------
Property and equipment, net 9,785,780 6,194,692
Excess of purchase price over net assets acquired, net 48,355,410 25,929,433
Other assets 2,429,026 1,246,815
------------ ------------
Total assets $151,377,689 $ 79,624,608
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of obligations under capital leases $ 923,625 $ 627,836
Trade payables 5,978,284 9,837,358
Advances against investigator and project costs 4,083,670 1,303,310
Advance billings 8,834,820 8,066,286
Other accrued liabilities 6,721,411 5,708,505
------------ ------------
Total current liabilities 26,541,810 25,543,295
------------ ------------
Obligations under capital leases, less current portion 1,658,652 1,617,256
Note payable -- escrow agreement 1,590,000 1,470,000
Other noncurrent liabilities 1,312,023 645,248
------------ ------------
Total liabilities 31,102,485 29,275,799
------------ ------------
Shareholders' equity:
Preferred stock -- no par value; 100,000 shares authorized; no shares
issued and outstanding
Common stock -- no par value; 15,000,000 shares authorized;
10,950,756 shares issued and outstanding at September 30, 1998,
7,582,367 shares issued and outstanding at December 31, 1997 75,000 75,000
Additional paid in capital 114,294,069 50,186,639
Retained earnings 5,364,427 351,970
Accumulated other comprehensive income 541,708 (264,800)
------------ ------------
Total shareholders' equity 120,275,204 50,348,809
------------ ------------
Total liabilities and shareholders' equity $151,377,689 $ 79,624,608
============ ============
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
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KENDLE INTERNATIONAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
----------------------------- -----------------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net revenues $22,869,484 $12,517,782 $65,168,642 $25,689,492
----------- ----------- ----------- -----------
Costs and expenses:
Direct costs 11,550,007 7,115,974 34,726,388 14,463,060
Selling, general and administrative
expenses 7,303,677 3,360,414 19,456,674 7,360,761
Depreciation and amortization 1,261,657 513,741 3,321,001 804,946
----------- ----------- ----------- -----------
20,115,341 10,990,129 57,504,063 22,628,767
----------- ----------- ----------- -----------
Income from operations 2,754,143 1,527,653 7,664,579 3,060,725
Other income (expense):
Interest income 766,239 94,837 1,063,607 108,092
Interest expense (69,512) (284,470) (211,686) (355,694)
Other expense (92,736) (12,648) (38,650) (21,426)
----------- ----------- ----------- -----------
Income before income taxes
and extraordinary item 3,358,134 1,325,372 8,477,850 2,791,697
Income tax expense 1,348,708 372,808 3,465,394 372,808
----------- ----------- ----------- -----------
Income before extraordinary item 2,009,426 952,564 5,012,456 2,418,889
Extraordinary loss, net of tax benefit (1,139,823) (1,139,823)
----------- ----------- ----------- -----------
Net income (loss) $ 2,009,426 ($187,259) $ 5,012,456 $ 1,279,066
=========== =========== =========== ===========
Pro forma income (loss) data:
Income before extraordinary item $952,564 $ 2,418,889
Pro forma adjustment for income taxes (196,435) (756,626)
----------- -----------
Pro forma income before
extraordinary item 756,129 1,662,263
Extraordinary loss, net of tax benefit (1,139,823) (1,139,823)
----------- -----------
Pro forma net income (loss) ($383,694) $522,440
=========== ===========
Income (loss) per share data (pro forma for 1997):
Basic:
Income per share before extraordinary
item $0.19 $0.14 $0.55 $0.40
Extraordinary loss per share (0.21) (0.28)
----------- ----------- ----------- -----------
Net income (loss) per share $0.19 ($0.07) $0.55 $0.12
=========== =========== =========== ===========
Weighted average shares outstanding 10,750,343 5,250,963 9,187,371 4,206,362
Diluted:
Income per share before extraordinary
item $0.18 $0.13 $0.51 $0.34
Extraordinary loss per share (0.19) (0.23)
----------- ----------- ----------- -----------
Net income (loss) per share $0.18 ($0.06) $0.51 $0.11
=========== =========== =========== ===========
Weighted average shares and potential
shares outstanding 11,410,455 6,038,441 9,821,955 4,880,722
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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KENDLE INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
For the Three Months Ended For the Nine Months Ended
Sept. 30, Sept. 30,
--------------------------- ----------------------------
1998 1997 1998 1997
---------- --------- ----------- ----------
<S> <C> <C> <C> <C>
Net income (loss) $2,009,426 $(187,259) $5,012,456 $1,279,066
---------- --------- ----------- ----------
Other comprehensive income, net of tax:
Foreign currency translation adjustments 973,237 5,608 805,708 5,608
Net unrealized holdings gains (losses)
on available for sale securities arising
during the period, net of tax 174 3,953 65,273 3,953
Reclassification adjustment for holdings
gains included in net income, net of tax (64,473)
---------- --------- ----------- ----------
Net change in unrealized holdings gains
(losses) on available for sale securities 174 3,953 800 3,953
---------- --------- ----------- ----------
Comprehensive income $2,982,837 $(177,698) $ 5,818,964 $1,288,627
========== ========= =========== ==========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
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KENDLE INTERNATIONAL INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
For the Nine Months Ended
September 30,
--------------------------------
1998 1997
---- ----
<S> <C> <C>
Net cash used in operating activities $ (3,650,597) $ (486,590)
------------ ------------
Cash flows from investing activities:
Proceeds from sale of available for sale securities 10,337,102
Purchase of available for sale securities (9,804,750)
Acquisitions of property and equipment (3,410,346) (1,111,613)
Additions to software costs (1,103,390) (284,894)
Other investments (250,000)
Acquisition of business, less cash acquired (12,675,466) (22,842,235)
------------ ------------
Net cash used in investing activities (7,102,100) (34,043,492)
------------ ------------
Cash flows from financing activities:
Borrowings under line of credit 3,100,000
Repayments under line of credit (3,100,000)
Borrowings under senior credit facility 10,745,439
Repayments of senior credit facility (10,745,439)
Proceeds from subordinated debt borrowings 3,500,000
Proceeds from issuance and conversion of stock purchase warrants 1,501,537
Repayments of subordinated debt borrowings (5,000,000)
Net proceeds from sale of common stock 51,474,635 45,251,554
Proceeds from exercise of stock options 90,605 15,948
Debt issue costs (54,322) (538,698)
Payments on capital lease obligations (611,249) (330,110)
Distributions to shareholders (2,557,819)
------------ ------------
Net cash provided by financing activities 50,899,669 41,842,412
------------ ------------
Effects of exchange rates on cash and cash equivalents 190,246 5,608
Net increase in cash and cash equivalents 40,337,218 7,317,938
Cash and cash equivalents:
Beginning of period 15,766,963 2,047,476
------------ ------------
End of period $ 56,104,181 $ 9,365,414
============ ============
Supplemental schedule of noncash investing and financing activities:
- --------------------------------------------------------------------
Acquisition of equipment under capital lease obligations $ 1,637,056
============
Issuance of note payable under escrow agreement for acquisition of U-Gene $ 1,530,000
============
Equipment acquired for note payable $ 739,684
============
Acquisition of Businesses (Note 4):
Fair value of assets acquired $ 30,193,345 $ 34,072,671
Fair value of liabilities assumed (4,975,689) (8,552,180)
Stock issued (12,542,190) (2,678,256)
------------ ------------
Net cash payments $ 12,675,466 $ 22,842,235
============ ============
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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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 nine months ended
September 30, 1998 are not necessarily indicative of the results that may
be expected for the year ending December 31, 1998. For further information,
refer to the consolidated financial statements and notes thereto included
in the Form 10-K filed by Kendle International Inc. ("the Company") on
March 31, 1998 with the Securities and Exchange Commission.
The balance sheet at December 31, 1997 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.
Certain amounts reflected in the prior periods' condensed
consolidated financial statements have been reclassified to be comparable
with the current periods.
2. SHAREHOLDER'S EQUITY:
In June, 1998, the Company completed its follow-on offering of
2,415,000 shares of common stock at a price to the public of $23.50 per
share. Of the 2,415,000 shares sold, 2,315,000 were sold by the Company and
100,000 shares were sold by selling shareholders. Proceeds to the Company
approximated $51.5 million, net of underwriting commissions and discounts
and offering expenses of $2.9 million.
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3. NET INCOME PER SHARE DATA:
In accordance with Statement of Financial Accounting Standards ("SFAS") No.
128, "Earnings Per Share," net income per basic share is computed using the
weighted average common shares outstanding for all periods presented. Net income
per diluted share is computed using the weighted average common shares and
potentially dilutive common shares outstanding for all periods presented.
The weighted average shares and potential shares outstanding used in
computing net income per diluted share have been calculated as follows:
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended
September 30, 1998 September 30, 1997
------------------- -------------------
<S> <C> <C>
Weighted average common shares
outstanding 10,750,343 5,250,963
Stock purchase warrants 135,289
Stock options 660,112 652,189
------------------- -------------------
Weighted average shares and potential
shares outstanding 11,410,455 6,038,441
<CAPTION>
Nine Months Ended Nine Months Ended
September 30, 1998 September 30, 1997
------------------- -------------------
<S> <C> <C>
Weighted average common shares
outstanding 9,187,371 4,206,362
Stock purchase warrants 130,677
Stock options 634,584 543,683
------------------- -------------------
Weighted average shares and potential
shares outstanding 9,821,955 4,880,722
</TABLE>
4. ACQUISITION:
On February 12, 1998, the Company completed its acquisition of
ACER/EXCEL Inc. ("ACER/EXCEL"), headquartered in Cranford, New Jersey.
Total acquisition costs consisted of $14.4 million in cash and 987,574
shares of the Company's Common Stock. The total purchase price included
$6.0 million placed in escrow pending resolution of an issue relating to
ACER/EXCEL's S corporation tax status. In early 1998, ACER/EXCEL determined
that, with respect to its tax status as an S corporation, certain
inadvertent terminating events occurred in 1991. On September 3, 1998,
ACER/EXCEL was granted a waiver of its inadvertent termination status
retroactive to the date of the terminating events, and $5.0 million of the
escrow was paid to the seller, with the remaining $1.0 million being
transferred to the general escrow as discussed below. As a result of the
resolution of this matter, the computation of the excess of acquisition
costs over net assets acquired was increased to include the $6.0 million as
consideration.
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<PAGE> 9
A general escrow, which was established at the acquisition date to
provide indemnification of sellers' representations and warranties and
currently consists of 186,336 shares of the Company's Common Stock, will be
released to the selling shareholders, 50% in February, 1999 and the
remainder in February, 2000. The value of the stock consideration was
determined for financial reporting purposes as of December 23, 1997, the
date the purchase price was agreed to. Valuation of the Common Stock was
based on an appraisal obtained by the Company which discounted the shares
due to lock-up restrictions and the lack of registration of the shares.
The acquisition has been accounted for using the purchase method of
accounting, with goodwill as a result of the transaction being amortized
over 30 years. The results of operations are included in the Company's
results from the date of acquisition.
The following unaudited pro forma results of operations assume the
acquisition of ACER/EXCEL occurred at the beginning of each year:
<TABLE>
<CAPTION>
Nine Months Ended Nine Months Ended
September 30, 1998 September 30, 1997
------------------ ------------------
<S> <C> <C>
Net revenues $66,432,265 $35,177,922
Income before extraordinary item $4,880,893 $4,367,970
Net income $4,880,893 $3,228,147
Income before extraordinary item
(assuming the Company was taxed as a
C corporation throughout 1997) $4,880,893 $2,812,462
Net income per diluted share $0.48 $0.55
Income per diluted share before
extraordinary item (assuming the
Company was taxed as a C corporation
throughout 1997) $0.48 $0.48
Weighted average shares and
potential shares outstanding 10,139,506 5,868,296
</TABLE>
The pro forma financial information is not necessarily indicative
of the operating results that would have occurred had the ACER/EXCEL
acquisition been consummated as of January 1, 1997 and 1998, nor are they
necessarily indicative of future operating results.
9
<PAGE> 10
5. COMPREHENSIVE INCOME:
In 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive
Income." This statement requires display of comprehensive income in a set
of general purpose financial statements. Comprehensive income is defined as
changes in equity of a business enterprise during a period from
transactions and other events from non-owner sources. In accordance with
SFAS No. 130, the Company has displayed a statement of comprehensive income
for all periods presented.
Accumulated other comprehensive income was as follows:
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
------------------ -----------------
<S> <C> <C>
Net unrealized holdings gains (losses)
on available for sale securities, net
of tax $ 41 $ (759)
Cumulative foreign currency translation
adjustment 541,667 (264,041)
------------------ ------------------
Accumulated other comprehensive
income $541,708 $(264,800)
</TABLE>
6. INCOME TAXES:
The condensed consolidated financial statements of the Company for
the three and nine months ended September 30, 1997 include a provision for
income taxes only for the period since the Company's initial public
offering (IPO) on August 22, 1997 as the taxable income of the Company
prior to that date was included in the income tax returns of the individual
shareholders under the S corporation election. Pro forma income data is
presented to give effect to a tax provision on taxable income for financial
reporting purposes using statutory federal, state and local rates that
would have resulted if the Company had filed corporate tax returns during
the entire period.
7. NEW ACCOUNTING PRONOUNCEMENTS:
In June 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 131
"Disclosures about Segments of an Enterprise and Related Information." This
statement requires selected information to be reported on the Company's
operating segments. Operating segments are determined by the way management
structures the segments in making operating decisions and assessing
performance. The Company is currently reviewing what changes, if any, this
will require on the presentation of the financial statements for fiscal
periods beginning after December 15, 1997.
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<PAGE> 11
In March, 1998, the American Institute of Certified Public
Accountants issued Statement of Position ("SOP") 98-1 "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use." This
statement defines the accounting for computer software developed or
obtained (purchased) for internal use, including (1) a requirement to
capitalize specified costs as a long-lived asset, (2) amortization of such
amounts, and (3) recognition and measurement of impairment of those
amounts. The Company plans to adopt the SOP January 1, 1999. The Company
does not believe the adoption of this SOP will have a material impact on
its financial statements.
In June, 1998, the FASB issued SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." SFAS No. 133 is effective
for all fiscal quarters of all fiscal years beginning after June 15, 1999
(January 1, 2000 for the Company). SFAS No. 133 requires that all
derivative instruments be recorded on the balance sheet at their fair
value. Changes in the fair value of derivatives are recorded each period in
current earnings or other comprehensive income, depending on whether a
derivative is designated as part of a hedge transaction and, if it is, the
type of hedge transaction. Management of the Company anticipates that, due
to its limited use of derivative instruments, the adoption of SFAS No. 133
will not have a significant effect on the Company's results of operations
or its financial position.
11
<PAGE> 12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND
RESULTS OF OPERATIONS
The information set forth and discussed below for the three and nine
months ended September 30, 1998 and 1997, is derived from the Condensed
Consolidated Financial Statements included herein 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 and drug
development services on a contract basis to the pharmaceutical and
biopharmaceutical industries. These services include Phase I through IV clinical
trial management, clinical data management, statistical analysis, medical
writing and regulatory consultation and representation.
The Company's contracts are generally fixed price, with some variable
components, and range in duration from a few months to several years. A portion
of the contract fee is typically required 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. Additionally,
the Company incurs costs, in excess of contract amounts, in subcontracting with
third-party investigators. Such costs, which are reimbursable by its customers,
are excluded from direct costs and net revenues.
Direct costs consist of compensation and related fringe benefits for
project-related employees, unreimbursed project-related costs and indirect costs
including facilities, information systems and other costs. Selling, general and
administrative expenses consist of compensation and related fringe benefits for
sales and administrative employees, professional services and advertising costs,
as well as unallocated costs related to facilities, information systems and
other costs.
The Company's results are subject to volatility due to such factors as
the commencement, completion, cancellation or delay of contracts; the progress
of ongoing projects; cost overruns; the Company's sales cycle; the ability to
maintain large customer contracts or to enter into new contracts, and other
factors. In recent months, the Company's Phase I unit has experienced a decline
in revenues and a resulting loss from operations. The Phase I unit results are
due in part to the inherent volatility in Phase I revenues due to the nature of
Phase I studies (shorter duration studies with shorter lead time and higher
potential for cancellation) combined with turnover in certain management
personnel. The Company has taken steps to mitigate this volatility with the
hiring of experienced Phase I management personnel and has increased its Phase I
new business development efforts. The Company anticipates these actions will
lead to
12
<PAGE> 13
improved Phase I unit operating results beginning in late 1998 and early
1999. However, the decline in revenues and resulting loss from operations in the
Phase I unit could continue if the Company's efforts are unsuccessful.
ACQUISITIONS
In 1997, the Company acquired U-Gene Research B.V. ("U-Gene") and GMI
Gesellschaft fur Angewandte Mathematik und Informatik mbH ("gmi") as of June
30, 1997 and September 3, 1997, respectively.
In 1998, the Company acquired ACER/EXCEL Inc. ("ACER/EXCEL")
headquartered in Cranford, New Jersey, as of February 12, 1998. ACER/EXCEL
provides customers with Phase II through IV clinical trial management, data
collection, statistical analysis and regulatory document preparation. It also
provides drug development services to the Pacific Rim, through a joint venture
which operates a CRO headquartered in Beijing, China, and through a limited
partnership in Taiwan.
The acquisitions have been accounted for using the purchase method of
accounting, with goodwill as a result of the transactions being amortized over
30 years. The results of operations are included in the Company's condensed
consolidated statements of operations from the dates of acquisition.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1997
Net revenues increased by $10.4 million, or 83%, from $12.5 million for
the three months ended September 30, 1997 to $22.9 million for the three months
ended September 30, 1998. The increase in net revenues was comprised of organic
growth of 45% and growth from acquisitions of 38%. Revenues from G.D. Searle &
Co. accounted for approximately 35% of net revenues for the three months ended
September 30, 1998 and no other customer accounted for more than 10% of the
Company's net revenues for the three months ended September 30, 1998.
Direct costs increased by $4.5 million, or 62%, from $7.1 million for
the three months ended September 30, 1997 to $11.6 million for the three months
ended September 30, 1998. This increase is primarily comprised of increases in
direct salaries and fringe benefits to support the increases in net revenues for
the period. Direct costs expressed as a percentage of net revenues decreased
from 56.8% for the three months ended September 30, 1997 to 50.5% for the three
months ended September 30, 1998. The decrease in those costs as a percentage of
net revenues is due to (a) the absorption of direct project-related costs over a
larger revenue base, (b) a refinement in the classification of indirect costs,
and (c) a favorable change in the gross profit on certain of the Company's
contracts.
Selling, general and administrative expenses increased by $3.9 million,
or 117%, from $3.4 million for the three months ended September 30, 1997 to $7.3
million for the three months ended September 30, 1998. The increase is primarily
comprised of (a) an increase in salaries and benefits, which is the result of
the Company's continued efforts to increase its infrastructure in order to
support the growth in business activity, and (b) an increase in rent and other
facilities
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<PAGE> 14
expenses, training, contractual services, recruiting, marketing, advertising,
and other expenses for the three months ended September 30, 1998 as compared to
the same period in 1997. Selling, general and administrative expenses as a
percentage of net revenues increased from 26.8% for the three months ended
September 30, 1997 to 31.9% for the three months ended September 30, 1998. The
increase in those costs as a percentage of net revenues is due primarily to a
refinement in the classification of indirect costs.
Depreciation and amortization expense increased $800,000, or 145%, from
$514,000 for the three months ended September 30, 1997 to $1.3 million for the
three months ended September 30, 1998. The increase was due to capital
expenditures and amortization of goodwill as a result of the Company's
acquisitions.
Income taxes of $1.3 million, or 40.2% of income before income taxes,
were recorded for the three months ended September 30, 1998 as compared to
$373,000 for the three months ended September 30, 1997. No income taxes were
recorded with respect to periods prior to the Company's August 22, 1997 initial
public offering ("IPO") as the Company was taxed as an S corporation.
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1997
Net revenues increased by $39.5 million, or 154%, from $25.7 million
for the nine months ended September 30, 1997 to $65.2 million for the nine
months ended September 30, 1998. The increase in net revenues was comprised of
organic growth of 87% and growth from acquisitions of 67%. Revenues from G.D.
Searle & Co. accounted for approximately 39% of net revenues for the nine months
ended September 30, 1998 and no other customer accounted for more than 10% of
the Company's net revenues for the nine months ended September 30, 1998.
Direct costs increased by $20.2 million, or 140%, from $14.5 million
for the nine months ended September 30, 1997 to $34.7 million for the nine
months ended September 30, 1998. This increase is primarily comprised of
increases in direct salaries and fringe benefits to support the increases in net
revenues for the period. Direct costs expressed as a percentage of net revenues
decreased from 56.3% for the nine months ended September 30, 1997 to 53.3% for
the nine months ended September 30, 1998. The decrease in those costs as a
percentage of net revenues is due to (a) the absorption of direct
project-related costs over a larger revenue base, (b) a refinement in the
classification of indirect costs, and (c) a favorable change in the gross profit
on certain of the Company's contracts.
Selling, general and administrative expenses increased by $12.1
million, or 164%, from $7.4 million for the nine months ended September 30, 1997
to $19.5 million for the nine months ended September 30, 1998. The increase is
primarily comprised of (a) an increase in salaries and benefits, which is the
result of the Company's continued efforts to increase its infrastructure in
order to support the growth in business activity, and (b) an increase in rent
and other facilities expenses, training, contractual services, recruiting,
marketing, advertising, and other expenses for the nine months ended September
30, 1998 as compared to the same period in 1997. Selling, general and
administrative expenses as a percentage of net revenues increased from 28.7% for
the nine months ended September 30, 1997 to 29.9% for the nine months ended
September 30, 1998. The increase in those costs as a percentage of net revenues
is due primarily to a refinement in the classification of indirect costs.
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<PAGE> 15
Depreciation and amortization expense increased $2.5 million, or 313%,
from $805,000 for the nine months ended September 30, 1997 to $3.3 million for
the nine months ended September 30, 1998. The increase was due to capital
expenditures and amortization of goodwill as a result of the Company's
acquisitions.
Income taxes of $3.5 million, or 40.9% of income before income taxes,
were recorded for the nine months ended September 30, 1998 as compared to
$373,000 for the nine months ended September 30, 1997. No income taxes were
recorded with respect to periods prior to the Company's August 22, 1997 IPO as
the Company was taxed as an S corporation.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents increased by $40.3 million for the nine
months ended September 30, 1998 as a result of cash provided by financing
activities of $50.9 million offset by cash used in operating and investing
activities of $3.7 million and $7.1 million, respectively. Net cash used in
operating activities resulted primarily from net income offset by additional
working capital used to support the Company's growth.
Investing activities for the nine months ended September 30, 1998
consisted primarily of the costs related to the ACER/EXCEL acquisition of $12.7
million, net of cash acquired. Financing activities for the nine months ended
September 30, 1998 consisted primarily of net proceeds of $51.5 million as a
result of the Company's follow-on offering of common stock.
Cash and cash equivalents increased by $7.3 million for the nine months
ended September 30, 1997 as a result of cash provided by financing activities of
$41.8 million offset by cash used in operating and investing activities of
$487,000 and $34.0 million, respectively. Net cash used in operating activities
resulted primarily from net income offset by additional working capital used to
support the Company's growth.
Investing activities for the nine months ended September 30, 1997
consisted primarily of the costs related to the U-Gene and gmi acquisitions of
$22.8 million, net of cash acquired. Financing activities for the nine months
ended September 30, 1997 consisted primarily of $45.3 million of net proceeds
from the Company's IPO.
The Company has a $30 million credit facility with certain banks. The
credit facility bears interest at a rate equal to either (a) LIBOR plus the
Applicable Margin (as defined) or (b) the higher of the Bank's prime rate or the
Federal Funds rate plus 0.50%, plus the Applicable Margin. All amounts
outstanding thereunder become due and payable in June, 2000. The facility
includes various restrictive covenants including the maintenance of certain
fixed coverage and leverage ratios as well as minimum net worth levels. At
September 30, 1998, there were no amounts outstanding under the credit facility.
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 facility, will be sufficient to meet its foreseeable cash needs. In
the future, the Company will continue to consider acquiring businesses to
enhance its service
15
<PAGE> 16
offerings, therapeutic base and global presence. Any such acquisitions may
require additional external financings and the Company may from time to time
seek to obtain funds from public or private issuances of equity or debt
securities. There can be no assurance that such financings will be available on
terms acceptable to the Company.
IMPACT OF THE YEAR 2000
The Year 2000 Issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Any of the
Company's computer programs that have date-sensitive software may recognize a
date using "00" as the year 1900 rather than the year 2000. This could result in
a system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices, or engage in similar normal business activities.
The Company has a detailed plan in place to address the Year 2000
Issue. The Company has formed an ongoing internal review team to address the
Year 2000 Issue that encompasses personnel from various operational and
administrative areas of the Company and an outside consultant. Progress against
the Year 2000 plan is monitored by this internal review team and reported to
senior management and the Board of Directors on a regular basis. The project
has proceeded according to plan thus far.
The Company's Year 2000 plan encompasses the following: (a) inventory
and assessment, (b) remediation, and (c) validation and implementation. To date,
the Company's key financial and operational systems have been inventoried and
detailed plans are in place for the required systems modifications or
replacements. Implementation of required changes to critical business systems,
including testing of those changes, is expected to be substantially complete by
December 31, 1998. The remainder of the plan is expected to be ongoing in 1999,
with completion by September 30, 1999.
The Company has initiated formal communications with its suppliers and
customers to determine the extent to which the Company is vulnerable to those
third parties' failure to remediate their own Year 2000 Issue. These suppliers
include utility companies, telecommunications companies and business specific
product suppliers such as software and hardware providers and Phase I unit
equipment providers. To date, responses have been received from approximately
46% of the Company's inventory of suppliers. There can be no guarantee that the
systems of other companies on which the Company's systems rely will be
converted in a timely matter, or that a failure to convert by another company,
or a conversion that is incompatible with the Company's systems, would not have
a material adverse effect on the Company.
Incremental costs, which include contractor costs to modify existing
systems and costs of internal resources involved in achieving Year 2000
compliance, are charged to expense as incurred. The Company has utilized both
internal and external resources to reprogram or replace and test the software
for Year 2000 modifications. Costs for the Year 2000 project are estimated to
total $500,000, of which approximately 50% has been spent through October 31,
1998.
The costs of the project and the date on which the Company plans to
complete the Year 2000 modifications are based on management's best estimates,
which were derived utilizing numerous assumptions of future events including the
continued availability of certain resources,
16
<PAGE> 17
third party modification plans and other factors. However, there can be no
guarantee that these estimates will be achieved and actual results could differ
materially from those plans. Specific factors that might cause such material
differences include, but are not limited to, the availability and cost of
personnel trained in this area, the ability to locate and correct all relevant
computer codes, and the ability of third parties with whom we have business
relationships to successfully address their own Year 2000 concerns.
The Company's risk management program includes emergency backup and
recovery procedures to be followed in the event of failure of a business
critical system. These procedures will be expanded to include specific
procedures for potential Year 2000 Issues. Contingency plans to protect the
business from Year 2000 related interruptions are being developed. These plans
will be complete by December 31, 1998 and will include, for example, development
of backup procedures and identification of alternative suppliers.
Worst-case scenarios resulting from Year 2000 problems could include
the following: loss of electrical, water and other utility services which could
result in disruption of the Company's services, software and embedded technology
failure which could disrupt the Company's equipment, systems and networks
resulting in an inability to perform existing and future studies and/or an
adverse impact on the health and well being of patients; the loss of
telecommunications capabilities (both voice and data), which could result in an
inability of the Company to internally communicate or to communicate with, among
others, its customers and investigational sites; and the inability of the
Company's third party investigational sites to become Year 2000 compliant, which
could result in the loss to the Company of their services. As previously
discussed, the Company is currently in the process of developing contingency
plans to address the consequences of these issues, should they arise. These or
other events could result in business slowdowns or suspensions and have a
material adverse effect on the Company's business, financial condition, results
of operations or cash flows.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 131 "Disclosures about
Segments of an Enterprise and Related Information." This statement requires
selected information to be reported on the Company's operating segments.
Operating segments are determined by the way management structures the segments
in making operating decisions and assessing performance. The Company is
currently reviewing what changes, if any, this will require on the presentation
of the financial statements for fiscal periods beginning after December 15,
1997.
In March, 1998, the American Institute of Certified Public Accountants
issued Statement of Position ("SOP") 98-1 "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." This statement defines the
accounting for computer software developed or obtained (purchased) for internal
use, including (1) a requirement to capitalize specified costs as a long-lived
asset, (2) amortization of such amounts, and (3) recognition and measurement of
impairment of those amounts. The Company plans to adopt the SOP January 1, 1999.
The Company does not believe the adoption of this SOP will have a material
impact on its financial statements.
In June, 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 is effective for all fiscal
quarters of all fiscal years beginning after June 15, 1999 (January 1, 2000 for
the Company). SFAS No. 133 requires that
17
<PAGE> 18
all derivative instruments be recorded on the balance sheet at their fair value.
Changes in the fair value of derivatives are recorded each period in current
earnings or other comprehensive income, depending on whether a derivative is
designated as part of a hedge transaction and, if it is, the type of hedge
transaction. Management of the Company anticipates that, due to its limited use
of derivative instruments, the adoption of SFAS No. 133 will not have a
significant effect 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.
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, the ability of the combined businesses to be integrated with the
Company's operations, the ability to penetrate new markets, the ability of joint
venture businesses to be integrated with the Company's operations, and the
ability to maintain large customer contracts or to enter into new contracts, 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.
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<PAGE> 19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings - None
Item 2. Changes in Securities - Not applicable
Item 3. Defaults upon Senior Securities - Not applicable
Item 4. Submission of Matters to a Vote of Security Holders - Not
applicable
Item 5. Other Information - Not applicable
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibits Description
-------- -----------
27.1 Financial Data Schedule For the Nine
Months Ended September 30, 1998
27.2 Financial Data Schedule For the Three
Months Ended September 30, 1998
(b) No reports on Form 8-K were filed during the quarter.
19
<PAGE> 20
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 K. BRYAN
----------------------------------------
Date: November 16, 1998 Candace K. Bryan
Chairman of the Board and Chief
Executive Officer
By: /s/ TIMOTHY M. MOONEY
----------------------------------------
Date: November 16, 1998 Timothy M. Mooney
Vice President - Chief Financial Officer
20
<PAGE> 21
KENDLE INTERNATIONAL INC.
EXHIBIT INDEX
Exhibits Description
-------- -----------
27.1 Financial Data Schedule For the Nine
Months Ended September 30, 1998
27.2 Financial Data Schedule For the Three
Months Ended September 30, 1998
21
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