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  • 10-K (Mar 16, 2007)

 
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Kendle International 10-K 2009
FORM 10-K
Table of Contents

 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
     
  þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
    For the Fiscal Year Ended December 31, 2008
or
  o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission File Number 000-23019
 
 
     
Ohio
(State or other jurisdiction
of incorporation or organization)
  31-1274091
IRS Employer
ID No.
 
441 Vine Street, 500 Carew Tower
Cincinnati, Ohio 45202
513-381-5550
 
Securities Registered Pursuant to Section 12(b) of the Act:
 
     
Title of Each Class
 
Name of Each Exchange on Which Registered
Common Stock, no par value   The NASDAQ Stock Market LLC
    (NASDAQ Global Select Market)
 
Securities Registered Pursuant to Section 12(g) of the Act:
None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o  No þ
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o  No þ
 
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 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 þ  No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  [o]
 
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer o Accelerated filer þ Non-accelerated filer o Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No þ
 
The aggregate market value of the Registrant’s Common Stock at June 30, 2008, held by non-affiliates was $501,679,662 (based on the $36.33 closing price of the Company’s Common Stock on The NASDAQ Global Select Market LLC on June 30, 2008). Shares of Common Stock held by each Executive Officer and Director and by any person who owns 10% or more of the outstanding Common Stock have been excluded in that such person might be deemed to be an affiliate.
 
As of March 2, 2009, 14,865,025 shares of no par value Common Stock were issued and 14,841,973 shares of no par value Common Stock were outstanding.
 
 
Portions of the Registrant’s Proxy Statement to be filed with the Commission for its 2009 Annual Meeting of Shareholders to be held May 14, 2009, are incorporated by reference into Part III.
 
See Exhibit Index on page 44.
 


 

 
Kendle International Inc.
 
Form 10-K Annual Report
For the Fiscal Year Ended December 31, 2008
 
 
                 
        Page
 
        Item 1 — Business     3  
        Item 1A — Risk Factors     6  
        Item 1B — Unresolved Staff Comments     13  
        Item 2 — Properties     13  
        Item 3 — Legal Proceedings     13  
        Item 4 — Submission of Matters to a Vote of Security Holders     13  
 
PART II
            14  
        Item 6 — Selected Financial Data     16  
        Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations     17  
        Item 7A — Quantitative and Qualitative Disclosures about Market Risk     35  
        Item 8 — Financial Statements and Supplementary Data     38  
        Item 9 — Changes in and Disagreements with Accountants on Accounting and Financial Disclosure     38  
        Item 9A — Controls and Procedures     38  
        Item 9B — Other Information     41  
 
PART III
        Item 10 — Directors and Executive Officers of the Registrant     41  
        Item 11 — Executive Compensation     42  
            42  
        Item 13 — Certain Relationships and Related Transactions, and Director Independence     43  
        Item 14 — Principal Accountant Fees and Services     43  
 
PART IV
        Item 15 — Exhibits and Financial Statement Schedules     44  
             
        Signatures        
 EX-12.1
 EX-21
 EX-23.1
 EX-24
 EX-31.1
 EX-31.2
 EX-32.1
 EX-32.2


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This Annual Report on Form 10-K contains certain statements that are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to a number of assumptions, risks and uncertainties, many of which are beyond the control of Kendle International Inc. (the Company or Kendle). See “Item 1A — Risk Factors” for further information.
 
The forward-looking statements speak as of the date made and are not guarantees of future performance. Actual results or developments may differ materially from the expectations expressed or implied in the forward-looking statements, and the Company undertakes no obligation to update any such statements.
 
 
ITEM 1.   BUSINESS
 
General
 
Kendle International Inc., an Ohio corporation established in 1989, is a global clinical research organization (CRO) that provides a broad range of Phase I-IV global clinical development services to the biopharmaceutical industry. The Company augments the research and development activities of biopharmaceutical companies by offering high-quality, value-added clinical research services and proprietary information technology designed to reduce drug development time and expense. The Company is managed in two reportable segments, Early Stage and Late Stage. The Early Stage business currently focuses on the Company’s Phase I operations, while Late Stage is comprised of clinical development services related to Phases II through IV.
 
 
The Early Stage reportable segment is focused on the high-end scientific exploratory medicine area, from First-in-Human studies through proof-of-concept stages, in the Company’s Toronto, Canada and Utrecht, The Netherlands locations. The Company also provides full support for Phase I studies in established compounds, including bioequivalence and pharmacokinetics studies, at its Morgantown, West Virginia location.
 
Late Stage
 
The Late Stage reportable segment currently includes four reporting units: Global Clinical Development, Late Phase, Regulatory Affairs and Quality, and Biometrics. This segment has a global reach that enables the Company to meet its customers’ needs by accessing specific patient populations in large urban areas as well as emerging areas all over the world.
 
The Global Clinical Development (GCD) unit conducts Phase II and III clinical trials worldwide. GCD provides a wide range of services including project management, clinical monitoring, investigator recruitment, patient recruitment, data management and study reports to assist customers with their drug development efforts.
 
The Late Phase unit designs and conducts Phase IIIB and IV studies worldwide. In addition, the Late Phase unit also focuses on health economics and outcomes research, observational studies, scientific events and medical education services.
 
The Regulatory Affairs and Quality unit provides regulatory expertise and consulting services at every stage of drug and device development, from early development to market and post market. This unit designs clinical programs and clinical trial protocols, reviews programs and provides gap analysis to assist sponsors in achieving their clinical development strategies. The unit also provides consulting services for nonclinical development for small molecules, biologicals, vaccines and devices. This unit has Chemistry, Manufacturing and Controls experts that assist with the U.S. Food and Drug Administration application process. Additionally, this unit has safety experts that assist customers with the collection, analysis and reporting of accurate drug safety data.
 
The Biometrics unit offers customized clinical data management with the ability to connect into and utilize a customer’s own data systems. The unit has biostatisticians that can supply comprehensive statistical analysis plans on a turnkey basis or on a consultant basis. The Company has data management operations in the U.S., Europe, Australia and Mexico with other low cost locations planned in the future.


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The Company believes that the outsourcing of drug development activities by biopharmaceutical companies has been increasing and will continue to increase as these companies strive to grow revenues through an accelerated drug development cycle while responding to cost containment pressures. The CRO industry, by specializing in clinical trial management, often performs the needed services with a higher level of expertise or specialization at a faster pace and at a lower cost than a biopharmaceutical company could perform such services internally.
 
Acquisition Activity
 
In June 2008, the Company completed its acquisition of DecisionLine Clinical Research Corporation (DecisionLine) and its related company. DecisionLine is a clinical research organization located in Toronto, Ontario specializing in the conduct of early phase studies. The acquisition supports the overall goal of strategic business expansion, and, in particular, expansion of Phase I studies. Please see Note 11 to the Consolidated Financial Statements for further detail regarding this acquisition.
 
In August 2006, the Company acquired the Phase II-IV Clinical Services business of Charles River Laboratories International, Inc. (“CRL Clinical Services”). The acquisition strengthened the Company’s position as one of the leading global players in the clinical development industry, adding therapeutic expertise, diversifying its customer base and expanding its capacity to deliver large global trials.
 
In April 2006, the Company completed its acquisition of a Latin America CRO, International Clinical Research Limited (“IC-Research”) and related companies. IC-Research is a leading CRO in Latin America with operations in Argentina, Brazil, Chile and Colombia. This acquisition supports the Company’s goal of strategic business expansion and diversification in high-growth regions to deliver global clinical trials for its customers.
 
Business Strategy
 
The Company’s strategy is to continue to enhance its reputation as a high-quality, global provider of a full range of CRO services. The Company’s strategy consists of the following strategic initiatives:
 
  •  Driving growth in the Company’s core competency in Phases I through IV clinical trials.
 
  •  Meeting the specific development pipeline needs for the Company’s targeted customers.
 
  •  Gaining share in the CRO market through further penetration in the large (greater than $10 million in contract value) trial sector as well as continued expansion in mid-sized trials.
 
  •  Expanding the Company’s geographic footprint with a focus on high-growth regions such as Africa and Asia/Pacific.
 
  •  Setting the stage for business mix expansion, such as expansion in support of Early Stage.
 
  •  Building infrastructure to support the continued expansion and growth of the Company.
 
Customers and Marketing
 
Net service revenues from the top five customers accounted for approximately 27% of the Company’s total net service revenues for the year ended December 31, 2008 compared to 25% for the year ended December 31, 2007. No customer accounted for more than 10% of the Company’s net service revenues for 2008 or 2007.
 
Segment and geographic information for the Company is contained in Note 14 to the Consolidated Financial Statements.
 
Backlog
 
Backlog consists of anticipated net service revenue from contracts, letters of intent and other forms of commitments (collectively defined as backlog) that either have not started but are anticipated to begin in the near future, or are in process and have not been completed. Amounts included in backlog represent anticipated future net service revenue and exclude net service revenue that has been recognized previously in the Consolidated Statements of Operations. Once contracted work begins, net service revenue is recognized in the Consolidated Statements of


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Operations. Backlog at December 31, 2008, was approximately $1.02 billion compared to approximately $869 million at December 31, 2007. The majority of the Company’s backlog is from large established biopharmaceutical firms with annual revenues greater than $1 billion. Backlog arising from contracts with small biotech firms with no revenues or large partner are not material to the Company, generally comprising less than 10%. In the first quarter of 2009, the Company experienced a large cancellation from one customer in this small biotech segment of the business. The average duration of the contracts in backlog fluctuates from quarter to quarter based on the contracts constituting backlog at any given time. The Company generally experiences a longer period of time between contract award and revenue recognition with respect to large contracts covering global services. As the Company increasingly competes for and enters into large contracts that are global in nature, the Company expects the average duration of the contracts in backlog to increase and may be affected by changes in foreign exchange rates. Fluctuations in foreign exchange rates caused backlog to decrease by $27 million as of December 31, 2008. The Company estimates that approximately 45% of its backlog at December 31, 2008 will be recognized as net service revenue in fiscal year 2009.
 
No assurance can be given that the Company will be able to realize the net service revenues that are included in the backlog. Backlog is not necessarily a meaningful indicator of future results for a variety of reasons, including, but not limited to, the following: (i) contracts vary in size and duration, with revenue from some studies realized over a number of years; (ii) the scope of contracts may change, either increasing or decreasing the value of the contract; and (iii) studies may be terminated or delayed by the study’s sponsor or by regulatory authorities.
 
Competition
 
The Company competes primarily against in-house research and development departments of biopharmaceutical companies, universities, teaching hospitals and other full-service CROs, some of which possess substantially greater capital, technical expertise and other resources than the Company. CROs generally compete on the basis of past performance for a customer, medical and scientific expertise in specific therapeutic areas, the quality of services provided, the ability to manage large-scale trials on a global basis, medical database management capabilities, the ability to provide statistical and regulatory services, the ability to recruit investigators, the ability to recruit patients into studies, the ability to integrate information technology with systems to improve the efficiency of clinical research, an international presence with strategically located facilities and financial viability and price.
 
The CRO industry is highly fragmented with hundreds of CROs ranging from small, limited-service providers to full-service, global drug development corporations. Some of the full-service CROs competing with the Company include Covance, Inc., PAREXEL International Corporation, Pharmaceutical Product Development, Inc., ICON plc, PRA International, PharmaNet Development Group, Inc. and Quintiles Transnational Corporation.
 
Government Regulation
 
The Company’s clinical services are subject to industry standards for the conduct of clinical research and development studies that are contained in regulations for Good Clinical Practice (GCP). The Food and Drug Administration (FDA) in the United States and the European Agency for the Evaluation of Medicinal Products in Europe (EMEA), along with other regulatory bodies, require that clinical trial test results submitted to the regulatory bodies be based on studies conducted in accordance with GCP.
 
In addition, the International Conference on Harmonization — Good Clinical Practice Guidelines provides guidance on GCP. The Company implements and revises its standard operating procedures to facilitate GCP compliance.
 
Employees
 
As of December 31, 2008, the Company employed approximately 4,275 associates, about 58% of whom were employed outside the United States. None of the Company’s employees are covered by a collective bargaining agreement and the Company believes its overall relations with its associates are good. Employees in certain of the Company’s non-U.S. locations are represented by workers’ councils as required by local laws.


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Available Information
 
The Company maintains a web site at the address www.kendle.com. The Company is not including the information contained on its web site as a part of, or incorporating it by reference into, this Annual Report on Form 10-K. The Company makes available free of charge through its web site its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after it electronically files such material with, or furnishes such material to, the Securities and Exchange Commission (SEC).
 
Required filings by the Company’s officers and directors with respect to the Company furnished in electronic form are also made available on its web site as is the Company’s Proxy Statement for its annual meeting of shareholders. These filings also may be read or copied at the SEC’s Public Reference Room located in Washington, D.C. The SEC also maintains an Internet site (http://www.SEC.gov) that contains reports, proxy statements and other information regarding issuers that file electronically with the SEC.
 
ITEM 1A.   RISK FACTORS
 
Certain statements contained in this Annual Report on Form 10-K 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 that may cause actual results, performance or achievements to differ materially from those expressed or implied. Forward-looking statements generally contain the words “believe”, “expect,” “may,” “anticipate,” “intend,” “estimate,” “project,” “plan,” “assume,” “seek to” or other similar expressions, although not all forward-looking statements contain these identifying words. 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. The risk factors listed below are those deemed to be material by the Company. Additional risks and uncertainties not currently known may materially adversely affect the Company’s business, financial condition and/or results of operations.
 
Risks Related to Our Business
 
 
The Company’s revenues depend on the outsourcing trends, size of the drug-development pipeline and research and development expenditures of the biopharmaceutical industry. Economic factors and industry trends that affect companies in those industries affect its business. A slowdown in research and development spending or a reprioritization of the drug development pipelines in the biopharmaceutical industry could negatively affect its net service revenues and results of operations. Mergers and acquisitions in the biopharmaceutical industry and the related rationalization of the drug-development pipelines could result in delay or cancellation of certain existing projects.
 
 
The CRO industry is comprised of a wide range of competitors as was previously mentioned, including small, niche providers as well as full-service global clinical research organizations. These companies compete based on a variety of factors, including reputation for quality, performance, price, scope of service offerings and geographic presence. Some of the Company’s competitors have greater financial resources and a wider range of service offerings over a greater geographic area. Additionally, the Company’s customers have in-house capabilities to perform services that are provided by CROs. These factors potentially could have a negative impact on the Company’s ability to win business awards.


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Many of the Company’s contracts provide for services on a fixed-price basis and may be terminated or reduced in scope with little or no notice. Cancellations may occur for a variety of reasons, including the failure of the product to satisfy safety requirements, the Customer’s inability to manufacture sufficient quantities of the drug, unexpected results of the product or the client’s decision to terminate the development of a product.
 
The loss, reduction in scope or delay of a large contract or the delay of multiple contracts could have a material adverse effect on the Company’s results of operations; although its contracts entitle it to receive payments for work performed in the event of a cancellation. Cancellation or delay of a large contract or multiple contracts could leave the Company with under-utilized resources and thereby negatively affect its net service revenues and results of operations. The Company believes its aggregate backlog is not necessarily a meaningful indicator of future net service revenues and financial results.
 
 
Because many of the Company’s contracts are structured as fixed price, it is at financial risk if it initially underbids the contract or overruns the initial cost estimates. Such under-bidding or significant cost overruns could have a material adverse effect on the Company’s business, results of operations, financial condition and cash flows.
 
The Company’s backlog is composed of contracts varying in terms of amounts, global nature and type. To the extent this mix of contracts continues to shift toward larger (in excess of $10 million) contracts with a more global component, this may cause the rate at which the backlog converts into revenue to lengthen when compared with historical trends and the amount recognized as revenue could be affected by fluctuations in applicable foreign currencies.
 
As the Company increasingly competes for and enters into large contracts that are more global in nature, the Company expects the rate at which this backlog converts into revenue, referred to as the “conversion rate”, to increase (or lengthen). An increase in this conversion rate means that the rate of revenue recognized on these large contract awards may be slower than what the Company has experienced in the past, which could impact the Company’s net service revenues and results of operations on a quarterly and annual basis. The revenue recognition on larger, more global in nature projects could be slower than on smaller, less global in nature projects for a variety of reasons, including but not limited to an extended period of negotiation between the time the project is awarded to the Company and the actual signature of the contract as well as an increased timeframe for obtaining the necessary regulatory approvals. In addition, the portion of backlog that may be performed in non-U.S. subsidiaries is exposed to fluctuations in the applicable foreign currencies which could affect the amount of revenue ultimately recognized. Fluctuations in foreign exchange rates caused backlog to decrease by approximately $27 million at December 31, 2008.
 
 
The Company’s success depends to a significant extent upon the skills, experience and efforts of its senior management team and its ability to hire qualified personnel in the geographic regions and therapeutic areas in which it operates. The loss of any of the Company’s executive officers or other key employees, without a properly executed transition plan, could have an adverse effect on it. In addition, there is substantial competition among both CROs and biopharmaceutical companies for qualified personnel. Difficulty recruiting or retaining qualified personnel and/or unexpected recruiting costs could affect the Company’s ability to meet financial and operational goals.
 
 
The clinical research studies we operate rely upon the accessibility and willing participation of physician investigators and volunteer subjects. Investigators supervise the administration of study drugs to patients during the course of a clinical trial. Volunteer subjects generally include people from the communities in which the studies are


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conducted. The Company’s clinical research business could be adversely affected if we are unable to attract suitable investigators or clinical study volunteers on a consistent basis.
 
 
The Company has grown rapidly. Some of this growth has come as a result of acquisitions, and the Company continues to evaluate new acquisition opportunities. Businesses that grow rapidly often have difficulty managing their growth. The Company’s rapid growth has placed, and is expected to continue to place, significant demands on its management, its business and on its financial, accounting, information and other systems. The Company needs to continue recruiting and employing experienced executives and key employees capable of providing the necessary support. In addition, the Company will need to continue to improve its financial, accounting, information and other systems in order to effectively manage the Company’s growth. The Company’s ability to grow successfully through acquisitions could be affected by expenses incurred in integrating an acquired company, losses of key employees from an acquired company and unforeseen risks in acquiring companies in certain geographies. The Company cannot assure you that its management will be able to manage the Company’s growth and integrate acquired businesses effectively or successfully, or that its financial, accounting, information or other systems will be able to successfully accommodate the Company’s external and internal growth. A failure to meet these challenges could materially impair the Company’s ability to operate its business. Additionally, depending upon the nature of the consideration in an acquisition, an acquisition could result in dilution to existing shareholders.
 
 
The Company had goodwill and other acquisition-related intangible assets of approximately $255.4 million and $249.6 million as of December 31, 2008 and December 31, 2007, respectively, which constituted approximately 46% and 50%, respectively, of its total assets at these periods. The Company periodically (at least annually), evaluates goodwill and other acquired intangible assets for impairment. Any future determination requiring the write off of a significant portion of the Company’s goodwill or other acquired intangible assets could adversely affect its results of operations and financial condition. See Note 5 to the Consolidated Financial Statements for further detail on goodwill or other intangible assets.
 
 
As of December 31, 2008, the Company had $200.0 million in convertible debt outstanding and an additional $53.5 million of borrowing capacity under a revolving line of credit as well as approximately $311,000 of obligations outstanding under capital leases. The Company also maintains a $5.0 million multicurrency facility that is renewable annually and used in connection with its European operations. For a description of the Company’s indebtedness and that of its subsidiaries, see Liquidity and Capital Resources section of Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
The Company’s level of indebtedness will have several important effects on its future operations. For example, the Company will be required to use a portion of its cash flow from operations for the payment of principal and interest due on its outstanding indebtedness. In addition, the Company’s outstanding indebtedness and leverage could increase the impact of negative changes in general economic and industry conditions, as well as competitive pressures. Finally, the level of the Company’s outstanding indebtedness may affect its ability to obtain additional financing for working capital, capital expenditures or general corporate purposes.
 
General economic conditions as well as conditions affecting the Company’s operations specifically, including, but not limited to, financial and business conditions, many of which are beyond its control, may affect its future performance. As a result, these and other factors may affect the Company’s ability to make principal and interest payments on its indebtedness. The Company’s business might not continue to generate cash flow at or above current levels. Moreover, if the Company is required to repatriate foreign earnings in order to pay its debt service, it may not be able to accomplish this in a “tax efficient” manner and may, therefore, incur additional income taxes. If the


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Company cannot generate sufficient cash flow from operations in the future to service its indebtedness, it may, among other things:
 
  •  Seek additional financing in the debt or equity markets;
 
  •  Seek to refinance or restructure all or a portion of its indebtedness;
 
  •  Sell selected assets;
 
  •  Reduce or delay planned capital expenditures
 
These measures might not be sufficient to enable the Company to service its indebtedness. In addition, any financing, refinancing or sale of assets might not be available on economically favorable terms, if at all.
 
Furthermore, the Company’s credit facility contains certain restrictive covenants which will affect, and in many respects significantly limit, management’s choices in responding to business, economic, regulatory and other competitive conditions.
 
 
The Company draws on its money market fund holdings or uses its revolving credit facility to provide liquidity to fund its operating needs. The balances fluctuate depending on the Company’s needs and cash flows. If a party to the Facility or the sponsors of the money market funds becomes insolvent or unable to honor its commitments, the Company could have insufficient cash to meet its obligations and may be required to seek alternative forms of capital at rates and with terms and conditions not as favorable as those under its current Facility.
 
 
The current global economy has shown signs of weakening and continues to show these signs; its impact may be far reaching. As a result, the Company may be exposed to risks related to defaults from its suppliers, customers, as well as, from the counterparties to its purchased call options, sold warrants and cross currency swap arrangements that are beyond the Company’s control. Key suppliers could fail to deliver agreed upon goods or services. Customers may not be able to obtain financing for their clinical trials with the Company, which may result in the delay or cancellation of these trials. Additionally, customers may not be able to pay or may pay receivables more slowly than in the past resulting in bad debt expenses or poor cash flows. The purchasers of the call options, sold warrants and cross currency swaps could become insolvent resulting in an inability to honor their commitments or in unanticipated dilution should the target conversion price terms be met.
 
 
Government agencies regulate the drug development process utilized by the Company in its work with biopharmaceutical companies. Changes in regulations that simplify the drug approval process or increases in regulatory requirements that lessen the research and development efforts of the Company’s customers could negatively affect it. In addition, any failure on the Company’s part to comply with existing regulations or in the adoption of new regulations could impair the value of its services and result in the termination of or additional costs under its contracts with customers. Comprehensive healthcare reform could reduce the demand for services which could reduce revenues. Legislation creating downward pressure on the prices for drugs that pharmaceutical and biotechnology companies can charge could reduce the amount of revenue the Company could earn from projects outsourced to it. Healthcare reform outside the U.S. could also adversely impact the Company’s revenues and profitability.
 
 
The Company has international operations in many foreign countries, including, but not limited to, South Africa, India and countries in Eastern Europe and Latin America. These operations are subject to risks and uncertainties inherent in operating in these countries, including government regulations, currency restrictions and other restraints, burdensome taxes and political instability. These risks and uncertainties could negatively impact


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the Company’s ability to, among other things, perform large, global projects for its customers or repatriate cash. Furthermore, the Company’s ability to deal with these issues could be affected by applicable U.S. laws and the need to protect its assets in those locations.
 
 
For the year ended December 31, 2008, approximately 55% of the Company’s net service revenues were derived from operations outside the United States compared to 51% in the same period of 2007. The Company’s consolidated financial statements are denominated in U.S. dollars. As a result, changes in foreign currency exchange rates could significantly affect the Company’s results of operations, financial position and cash flows as well as its ability to finance large acquisitions outside the United States.
 
 
The Company’s operating results may vary significantly from quarter to quarter and are influenced by a variety of factors, such as:
 
  •  Exchange rate fluctuations;
 
  •  Timing of contract amendments for changes in scope that could affect the value of a contract and potentially impact the amount of net service revenues from quarter to quarter.
 
  •  Commencement, completion, execution or cancellation of large contracts;
 
  •  Collections of accounts receivable
 
  •  Progress of ongoing contracts and retention of customers;
 
  •  Timing of and charges associated with completed acquisitions or other events; and
 
  •  Changes in the mix, both in terms of geography and type of services.
 
The Company believes that operating results for any particular quarter are not necessarily a meaningful indication of future results. Although fluctuations in quarterly operating results could negatively or positively affect the market price of the Company’s common stock, these fluctuations may not be related to future overall operating performance.
 
The Company’s business depends on the continued effectiveness and availability of its information technology infrastructure, and failures of this infrastructure could harm its operations.
 
To remain competitive in the Company’s industry, it must employ information technologies that capture, manage, and analyze the large streams of data generated during the clinical trials we manage in compliance with applicable regulatory requirements. In addition, because the Company provides services on a global basis, it relies extensively on its technology to allow the concurrent conduct of studies and work sharing around the world. As with all information technology, the Company’s systems could become vulnerable to potential damage or interruptions from fires, blackouts, telecommunications failures and other unexpected events, as well as to break-ins, sabotage or intentional acts of vandalism. Given the extensive reliance of the Company’s business on this technology and the substantial investment in new technology infrastructure, any substantial disruption or resulting loss of data that is not avoided or corrected by its backup measures could harm its business and operations.
 
 
The Company has made a significant investment in an enterprise resource planning solution which is scheduled to begin deployment in the latter portion of 2009. This major initiative will integrate pricing, sales, project accounting, time reporting, trial management, human resources, billing and general ledger programs to provide management and financial reporting. The failure of this project could result in, among other things, an inability to manage our business, bill and collect accounts receivable or accurately report our financial results. This


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new technology will also rely on third parties for processing and storing of data, which exposes the Company to additional risks.
 
 
The Company’s business involves clinical trial management which includes the testing of new drugs on human volunteers. This business exposes the Company to the risk of liability for personal injury or death to patients resulting from, among other things, possible unforeseen adverse side effects or improper administration of a drug or device. Many of these volunteers and patients are already seriously ill and are at risk of further illness or death. Any claim or liability could have a material adverse effect on the Company’s financial position and its reputation if, as a result, it were required to pay damages or incur defense costs in connection with a claim and if: (i) such claim is outside the scope of indemnification agreements the Company has with clients and collaborative partners, (ii) an indemnification agreement is not performed in accordance with its terms or (iii) its liability exceeds the amount of any applicable indemnification limits or available insurance coverage. The Company might also not be able to purchase adequate insurance for these risks at reasonable rates in the future.
 
 
The nature of the Company’s business exposes it to litigation risk, and it is a party to lawsuits in the ordinary course of its business. While the Company does not believe that the resolution of any currently pending lawsuits against it will, individually or in the aggregate, have a material adverse effect on its business, financial condition or results of operations, it is possible that one or more lawsuits to which it is currently a party to or to which it subsequently becomes a party to, could adversely affect it in the future. In addition, failure to comply with applicable regulatory requirements can result in actions that could adversely affect the Company’s business and financial performance.
 
 
The Company depends on its clients, investigators, collaboration partners and other facilities for the continued operation of its business. Natural disasters or other catastrophic events, including terrorist attacks, pandemic flu, hurricanes and ice storms, could disrupt the Company’s operations or those of its clients, investigators and collaboration partners, which could also affect the Company. Even though the Company carries business interruption insurance policies and typically has provisions in its contracts that protect it in certain events, the Company might suffer losses as a result of business interruptions that exceed the coverage available under its insurance policies or for which the policies do not provide coverage. Any natural disaster or catastrophic event affecting the Company or its clients, investigators or collaboration partners could have a significant negative impact on its operations and financial performance.
 
The Company’s continued operations rely on dependable air travel.
 
The Company relies heavily on air travel for transport of its employees, and disruption to the air travel system could have a material adverse impact on the Company.
 
New standards or changes in existing accounting standards issued by the Financial Accounting Standards Board (FASB), SEC or other standard setting bodies may adversely affect the Company’s financial statements and could entail significant expenditures. The application of these standards often requires the use of estimates and assumptions which may materially differ from actual results.
 
The Company’s consolidated financial statements are currently subject to the application of U.S. Generally Accepted Accounting Principles (GAAP), which is periodically revised and/or expanded. Accordingly, the Company is required to adopt new or revised accounting standards issued by recognized authoritative bodies, including the FASB. It is possible that future changes in standards may change the current accounting treatment and


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that such changes could have a material adverse effect on the Company’s operating results and financial condition. (See Note 1, Critical Accounting Policies, New Accounting Pronouncements for known changes in standards.)
 
The preparation of the Company’s consolidated financial statements in compliance with GAAP often requires management to make estimates and assumptions based on available information at that time. These estimates and assumptions may ultimately differ from actual results and the impact could have a material adverse effect on the Company’s financial position and results of operations.
 
 
 
The market price of the Company’s common stock has historically experienced and will continue to experience some volatility. General conditions in the economy and financial markets and other developments affecting the Company or its competitors have caused the market value of the Company’s common stock to decline. This volatility and valuation decline has affected securities issued by many companies in many industries, in addition to the Company’s common stock, often for reasons unrelated to their operating performance.
 
 
In connection with the issuance of the Company’s Convertible Notes (see Note 7, Debt), the Company entered into convertible note hedge transactions with the participating Underwriter and JP Morgan Chase (collectively, the counterparties). The convertible note hedge transactions are comprised of purchased call options and sold warrants. The purchased call options are expected to reduce exposure to potential dilution upon the conversion of the Convertible Notes. The Company also entered into warrant transactions with such counterparties. The sold warrants have an exercise price that is approximately 70% higher than the closing price of the Company’s common stock on the date the Convertible Notes were priced. The warrants are expected to provide the Company with some protection against increases in our stock price over the conversion price per share. In connection with these transactions, the counterparties, or their affiliates:
 
  •  May enter into various over-the-counter derivative transactions or purchase or sell the Company’s common stock in secondary market transactions; and
 
  •  May enter into, or may unwind, various over-the-counter derivatives or purchase or sell the Company’s common stock in secondary market transactions, including during any conversion reference period with respect to a conversion of the Convertible Notes.
 
These activities may have the effect of increasing, or preventing a decline in, the market price of the Company’s common stock. In addition, any hedging transactions by the counterparties, or their affiliates, including during any conversion reference period, may have an adverse impact on the trading price of the Company’s common stock. The counterparties, or their affiliates, are likely to modify their hedge positions from time to time prior to conversion or maturity of the Convertible Notes by purchasing and selling shares of the Company’s common stock or other instruments, including over-the-counter derivative instruments, that they may wish to use in connection with such hedging. In addition, the Company intends to exercise its purchased call options whenever the Convertible Notes are converted, although not required to do so. In order to unwind any hedge positions with respect to the potential exercise of the purchased call options, the counterparties or their affiliates would expect to sell shares of common stock in secondary market transactions or unwind various over-the-counter derivative transactions with respect to the Company’s common stock during the conversion reference period for any Convertible Notes that may be converted.
 
The effect, if any, of any of these transactions and activities in connection with the Convertible Notes on the market price of the Company’s common stock will depend in part on market conditions and cannot be ascertained at this time, but any of these activities could adversely affect the trading price of the Company’s common stock and, as a result, the number of shares and value of the common stock received upon conversion of the Convertible Notes.


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Certain provisions of the Company’s Articles of Incorporation and Code of Regulations and of Ohio law make it difficult for a third party to acquire control of it without the consent of its Board of Directors (Board). These anti-takeover defenses may discourage, delay or prevent a transaction involving a change in control of the Company, and, accordingly, could limit the price that investors may be willing to pay for its common stock, including transactions in which holders of common stock might receive a premium for their shares over the market price. In cases where Board approval is not obtained, these provisions could also discourage proxy contests and make it more difficult for existing shareholders to elect directors of their choosing and cause the Company to take other corporate actions they desire. These provisions include:
 
  •  The authorization of undesignated preferred stock, the terms, rights, privileges and restrictions of which may be established and shares of which may be issued without shareholder approval;
 
  •  Limitations on persons authorized to call a special meeting of shareholders; and
 
  •  Advance notice procedures required for shareholders to nominate candidates for election as directors or to bring matters before an annual meeting of shareholders.
 
In addition, the Company has adopted a shareholder rights plan that may have anti-takeover effects which will make an acquisition of it by another company more difficult. The Company’s shareholder rights plan provides that, in the event any person or entity acquires 15% or more of its outstanding common stock, its shareholders will be entitled to purchase shares of common stock, or in certain instances, shares of the acquirer, at a discounted price. The rights are intended to discourage a significant share acquisition, merger or tender offer involving the Company’s common stock by increasing the cost of effecting any such transaction and, accordingly, could have an adverse impact on a takeover attempt that a shareholder might consider to be in the Company’s best interests.
 
ITEM 1B.   UNRESOLVED STAFF COMMENTS
 
None.
 
ITEM 2.   PROPERTIES
 
The Company leases all of its facilities with the exception of the Company-owned facility in Ely, United Kingdom. The Company’s principal executive offices are located in Cincinnati, Ohio. Early in 2008, the Company entered into a lease extension for these offices which extended the term of the lease from 2009 to 2019 and increased the amount of space leased from approximately 122,000 square feet to approximately 130,000 square feet. The lease extension also provides the Company with an opportunity to lease additional space in the future.
 
In addition, the Company leases substantial facilities in Durham, North Carolina; Toronto, Canada; Munich, Germany; Camberley, United Kingdom; Edinburgh, United Kingdom; Utrecht, The Netherlands; and Mexico City, Mexico. The Company’s Early Stage operations are located in Morgantown, West Virginia, Toronto, Canada and Utrecht, The Netherlands. The Company also maintains offices in various other North American, European and Asia-Pacific, including Australian locations, as well as in Latin America and South Africa.
 
Management believes that such offices are sufficient to meet its current needs and does not anticipate any difficulty in securing additional space, as needed, on terms acceptable to the Company.
 
ITEM 3.   LEGAL PROCEEDINGS
 
The Company is party to lawsuits and administrative proceedings incidental to the normal course of business. The Company currently is not a party to any pending material litigation, nor, to the Company’s knowledge, is any material litigation currently threatened against the Company.
 
ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
No matters were submitted to a vote of security holders during the fourth quarter of 2008.


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ITEM 5.   MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
 
Shares of the Company’s Common Stock are listed on The NASDAQ Global Select Market LLC® and are traded under the symbol “KNDL.” The following table sets forth the high and low prices for shares of the Company’s Common Stock for the periods indicated.
 
                                 
2008 Quarterly   First     Second     Third     Fourth  
 
Ranges of stock price
                               
High
  $ 51.60     $ 46.71     $ 52.00     $ 45.90  
Low
    39.07       35.35       35.42       15.86  
 
                                 
2007 Quarterly   First     Second     Third     Fourth  
 
Ranges of stock price
                               
High
  $ 39.61     $ 37.57     $ 44.51     $ 51.34  
Low
    30.02       31.22       34.70       39.02  
 
The number of holders of record of Kendle International Inc. common stock was 147 as of March 2, 2009. This total excludes shares held under beneficial ownership in nominee name or within clearinghouse positions of brokerage firms or banks. The Company has not paid dividends on its Common Stock since its initial public offering in August 1997. The Company does not currently intend to pay dividends in the foreseeable future and, in any event, is restricted from paying dividends under the terms and conditions of its credit facility.


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Performance Graph
 
The following graph compares the five-year cumulative total shareholder returns of the Company’s Common Stock with the NASDAQ Composite Index and the NASDAQ Health Services Index.
 
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Amoung Kendle International Inc., The NASDAQ Composite Index
And The NASDAQ Health Services Index
 
(COMPANY LOGO)
 
 
* $100 invested on 12/31/03 in stock & index-including reinvestment of dividends.
Fiscal year ending December 31.
 
                                                 
    Dollar Value of $100 Investment at December 31,
    2003   2004   2005   2006   2007   2008
Kendle International Inc. 
    100.00       138.80       405.99       496.06       771.61       405.68  
                                                 
NASDAQ Composite
    100.00       110.08       112.88       126.51       138.13       80.47  
                                                 
NASDAQ Health Services
    100.00       127.29       135.26       141.82       142.06       100.14  
                                                 
 
Securities Authorized Under Equity Compensation Plans:
 
The information required for Securities Authorized Under Equity Compensation Plans can be found in Part III, Item 12, Security Ownership of Certain Beneficial Owners and Management of this Annual Report on Form 10-K.


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ITEM 6.   SELECTED FINANCIAL DATA
 
 
CONSOLIDATED STATEMENTS OF OPERATIONS
 
                                         
    For the Years Ended December 31,  
    2008     2007(1)     2006(2)     2005     2004  
    (In thousands except per share data)  
 
Net service revenues
  $ 475,092     $ 397,584     $ 283,471     $ 202,032     $ 172,888  
Reimbursable out-of-pocket revenues
    203,489       171,234       90,465       48,607       42,980  
                                         
Total revenues
    678,581       568,818       373,936       250,639       215,868  
Cost and expenses:
                                       
Direct costs
    247,436       204,161       152,826       108,582       96,909  
Reimbursable out-of-pocket costs
    203,489       171,234       90,465       48,607       42,980  
Selling, general and administrative
    155,577       125,744       91,796       68,216       59,797  
Depreciation and amortization
    15,253       14,865       10,403       7,991       9,175  
Employee severance and office consolidation costs
                236             302  
Intangible impairment charge
                8,200              
                                         
Total costs and expenses
    621,755       516,004       353,926       233,396       209,163  
Income from operations
    56,826       52,814       20,010       17,243       6,705  
Other income (expense):
                                       
Interest income
    760       1,466       1,939       1,019       400  
Interest expense
    (9,637 )     (14,870 )     (6,781 )     (460 )     (776 )
Write-off of deferred financing costs
          (4,152 )                  
Other
    (2,043 )     (4,816 )     (1,795 )     (287 )     (873 )
Gain on debt extinguishment
                      300       597  
                                         
Total other income (expenses)
    (10,920 )     (22,372 )     (6,637 )     572       (652 )
Income before income taxes
    45,906       30,442       13,373       17,815       6,053  
Income taxes
    16,509       11,755       4,843       7,141       2,481  
                                         
Net income
  $ 29,397     $ 18,687     $ 8,530     $ 10,674     $ 3,572  
                                         
INCOME PER SHARE DATA
                                       
Basic:
                                       
Net income per share
  $ 1.99     $ 1.29     $ 0.60     $ 0.79     $ 0.27  
Weighted average shares
    14,751       14,520       14,323       13,572       13,166  
Diluted:
                                       
Net income per share
  $ 1.96     $ 1.26     $ 0.58     $ 0.76     $ 0.27  
Weighted average shares
    14,993       14,889       14,762       14,120       13,391  
 
 
                                         
    As of December 31,  
    2008     2007     2006     2005     2004  
 
Working capital
  $ 68,595     $ 60,084     $ 56,404     $ 63,992     $ 40,714  
Total assets
    555,559       499,723       455,072       184,759       162,680  
Total short and long-term debt, including capital leases
    200,311       200,455       200,099       4,572       9,853  
Total shareholders’ equity
    185,143       141,523       140,112       122,504       102,775  
 
 
(1) Includes the effects of the January 1, 2007 adoption of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes.
 
(2) Includes the effects of the January 1, 2006 adoption of SFAS 123R, Share-Based Payment.
 
(3) From 2004 to 2008, the Company made three acquisitions. See the Acquisitions section of Managements’ Discussion and Analysis of Financial Condition and Results of Operations.


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ITEM 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Refer to Risk Factors previously discussed in Part 1 Item 1A and the Cautionary Statement for Forward-Looking Information later in this section.
 
 
The information set forth and discussed below in Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is derived from the Company’s Consolidated Financial Statements and the related notes thereto, which are included herein, and should be read in conjunction therewith.
 
Company Overview
 
Kendle International Inc. (the Company or Kendle) is a global clinical research organization (CRO) that delivers integrated clinical development services, including clinical trial management, clinical data management, statistical analysis, medical writing, regulatory consulting and organizational meeting management and publications services, among other things, on a contract basis to the biopharmaceutical industry. The Company operates in North America, Europe, Asia/Pacific, Latin America and Africa. The Company operates its business in two reportable operating segments, Early Stage and Late Stage. The Early Stage business currently focuses on the Company’s Phase I operations while Late Stage is comprised of clinical development services related to Phase II through III clinical trials conducted worldwide, late phase clinical development services related to Phase IIIB and IV clinical trials conducted worldwide, regulatory affairs and biometrics offerings. The Company aggregates its clinical development reporting unit, regulatory affairs reporting unit, and biometrics reporting unit into the Late Stage segment under the aggregation criteria in Statement of Financial Accounting Standards (SFAS) No. 131. The aggregation criteria met includes a similar nature of services provided, a similar type of customer, similar methods used to distribute services, similar economic characteristics and a similar regulatory environment. In addition, the Company reports support functions primarily composed of Human Resources, Information Technology, Sales and Marketing and Finance under the Support and Other category for purposes of segment reporting. A portion of the costs incurred from the support units are allocated to the Early and Late Stage reportable operating segments.
 
The Company’s revenue recognition process is described later in this MD&A under “Critical Accounting Policies and Estimates.”
 
Late Stage Segment Contracts
 
The Company provides services to its customers primarily under “full-service” contracts that include a broad range of services in support of a customer’s clinical trial. These services typically include biometrics, clinical development services for Phase II through IV clinical trials and regulatory affairs. The Company from time to time provides a select number of these services under “limited-service” contracts. The Company usually competes for business awards in a competitive bidding process. In the bidding process, the Company submits a bid that includes a price based upon hourly billing rates for billable employees multiplied by task hours the Company estimates will be necessary to achieve the service assumptions. Upon receiving a business award, the Company and its customer negotiate a contract to memorialize these assumptions and the related price.
 
Service contracts usually are long-term arrangements that require Company performance over several years. A contract usually requires a portion of the contract fee to be paid at the time of contract execution, and the balance is received in specified installments or milestones over the contract’s duration. Other methods for receiving payment include units achieved and time and materials. During performance of the services, any of the following events may occur and impact the contract price:
 
  •  The customer may request a change in the assumptions;
 
  •  The customer may increase or decrease the scope of services, which requires a change to the service assumptions; and
 
  •  The Company may discover that, for a particular contract, the assumptions are incorrect or insufficient to permit completion of the contract.


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In each of the foregoing situations, the Company enters into negotiations for a contract amendment to reflect the change in scope or assumptions and the related price. Depending on the complexity of the amendment, the amendment process can take from a few weeks for a simple adjustment, such as a timeline extension, to several months for a complex amendment, such as a change in patient enrollment strategy. Under the Company’s policy, project teams are not authorized to engage in tasks outside the scope of the contract without prior management approval. In limited situations, management may authorize the project team to commence work on activities outside the contract scope while the Company and its customer negotiate and finalize the contract amendment.
 
Contract amendments are commonplace within the industry and occur on the majority of the Company’s contracts. At any point in time, the Company will be in the process of discussing numerous proposed amendments, the scope and value of which can change significantly between time of proposal and final agreement. The total value of these amendments primarily represents future work and revenues.
 
In addition to full-service and limited-service arrangements described above, the Company provides consulting services to its customers under contracts that generally are shorter-term in nature than full-service contracts. Net service revenues from these contracts represent less than 5% of the Company’s consolidated net service revenues.
 
In connection with providing services, the Company incurs pass-through costs, which include travel-related expenses for Company employees performing services and fees payable to third-party investigators or labs participating in, or supporting, the customer’s clinical trial. The customer agrees to reimburse the Company on a dollar-for-dollar basis for the costs incurred by the Company in accordance with contractually specified parameters. The revenues and costs from these pass-through and third-party costs are reflected in the Company’s Consolidated Statements of Operations under the line items titled “Reimbursable out-of-pocket revenues” and “Reimbursable out-of-pocket costs”, respectively.
 
The customer may terminate the contract at any time with little or no advance notice to the Company. Customers, in particular, may terminate a contract immediately for concerns related to the efficacy or safety of a particular drug. Upon termination, the customer is required to pay the Company for the value of work completed up to termination as well as reimburse the Company for its out-of-pocket costs incurred in accordance with the contract.
 
Although the majority of the Company’s contracts are fixed-price and net service revenues are calculated on a proportional performance or percentage of completion methodology, the Company has seen increasing demand from its customers to move toward a units-based contract methodology in new contracts. It is the Company’s intent to structure more of its contracts under a units-based methodology for calculating net service revenues so the Company expects the percentage of contracts under which net service revenues are recognized using units-based methodology to increase in future periods. Under a units-based contract methodology, amounts recognized as net service revenues are calculated based on units completed in the period multiplied by a unit value or selling price that is outlined in the contract.
 
A contract amendment, which results in revisions to net service revenues and cost estimates, is recognized in revenue calculations beginning in the period in which the parties reach written agreement to the amendment.
 
Early Stage Segment Contracts
 
Early Stage segment business awards are subject to a competitive bidding process and, upon award, are memorialized in a contract that includes terms and conditions that are substantially similar to the Company’s contracts with its Late Stage segment customers. The Early Stage segment contract duration is usually substantially less than the Late Stage segment. Because these business awards require the Company to commit beds at its Early Stage facilities, the Company attempts to require the customer to pay a cancellation fee if the customer cancels a project award. Net service revenues from these contracts generally represent less than 10% of the Company’s consolidated net service revenues.


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Acquisitions
 
In June 2008, the Company completed its acquisition of DecisionLine Clinical Research Corporation (DecisionLine) and its related company. DecisionLine is a clinical research organization located in Toronto, Ontario specializing in the conduct of early phase studies. The acquisition supports the overall goal of strategic business expansion, and, in particular, expansion of Phase I studies. Please see Note 11 to the Consolidated Financial Statements for further detail regarding this acquisition.
 
In August 2006, the Company acquired CRL Clinical Services. The acquisition strengthened the Company’s position as one of the leading global players in the clinical development industry, adding therapeutic expertise, diversifying its customer base and expanding its capacity to deliver large global trials. The total purchase price, including acquisition costs and the working capital adjustment, in which the Company paid for any working capital in excess of $2.0 million, was approximately $236 million. The Company financed the purchase with $200 million in term debt as well as its existing cash and proceeds from the sale of available-for-sale securities.
 
In April 2006, the Company completed its acquisition of IC-Research. At the time of acquisition, IC-Research was a CRO in Latin America with operations in Argentina, Brazil, Chile and Colombia. This acquisition supports the Company’s goal of strategic business expansion and diversification in high-growth regions to deliver global clinical trials for its customers. IC-Research was integrated as part of the Company’s Late Stage segment.
 
The results of operations for these acquisitions are included in the Company’s Consolidated Statements of Operations from the dates of acquisition. For further discussions of these acquisitions, see Notes to the Consolidated Financial Statements.
 
Recent Developments and CRO Marketplace
 
The CRO industry in general continues to be dependent on the research and development efforts of the principal pharmaceutical and biotechnology companies as major customers, and the Company believes this dependence will continue. The loss of business from any of its major customers could have a material adverse effect on the Company. The current uncertain economic conditions have caused customers to re-evaluate priorities resulting in increases in contracts for the more promising projects, scaling back and/or canceling other projects. The biopharmaceutical industry is reducing costs and, often, their workforce. The Company may benefit from increased outsourcing on the part of its customers or it may be harmed by a reduction in spending. The Company views the current conditions as an opportunity to attract well qualified candidates to strengthen and improve its operations. Another trend noted by the industry is the decline in prescription drug sales caused by cost conscious patients opting for less expensive generic drugs or none at all. This is both an opportunity and a challenge for the Company, as its customers will need to find less costly, more efficient research options often through the establishment of strategic alliances or partnerships. The Company believes it is well positioned for this development. The current conditions have also impacted the credit environment, making the obtaining of financing difficult for some customers. The Company is proactively monitoring outstanding accounts receivable and strives to remain in a cash positive position on its riskier customers.
 
In addition, the volatility of currency exchange rate fluctuations has a significant impact on the Company as more of its business is earned outside the United States. Fluctuations in exchange rates are not predictable with any degree of accuracy or foreseeable.
 
In January 2009, the Company eliminated a substantial portion of the note payable between the U.S. subsidiary and the U.K. subsidiary. In connection with this transaction, the Company also terminated its Pound Sterling foreign currency hedge arrangement. Please see Item 7A Quantitative and Qualitative Disclosures About Market Risk, Foreign Currency Hedges section for more information. At December 31, 2008, the value of the hedge arrangement related to the U.S. dollar and Pound sterling was approximately $18.3 million. At the time of termination of the hedge in January, the Company received approximately $17.1 million in cash proceeds resulting from this termination.


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Information to be discussed regarding segments is outlined in the below table:
 
                                 
    Early
    Late
    Support
       
    Stage(b)     Stage(c)     & Other(d)     Total  
    (In thousands)  
 
Year ended December 31, 2008
                               
Net service revenues
  $ 35,199     $ 430,317     $ 9,576     $ 475,092  
Income from operations
  $ 6,177     $ 105,140     $ (54,491 )   $ 56,826  
Operating Margin %(a)
    17.5 %     24.4 %           12.0 %
Year ended December 31, 2007
                               
Net service revenues
  $ 21,373     $ 366,379     $ 9,832     $ 397,584  
Income from operations
  $ 2,941     $ 85,971     $ (36,098 )   $ 52,814  
Operating Margin %(a)
    13.8 %     23.5 %           13.3 %
Year ended December 31, 2006
                               
Net service revenues
  $ 23,328     $ 254,954     $ 5,189     $ 283,471  
Income from operations
  $ (2,855 )   $ 66,631     $ (43,766 )   $ 20,010  
Operating Margin %(a)
    (12.2 )%     26.1 %           7.1 %
 
 
(a) Expressed as a percentage of net service revenues.
 
(b) The Early Stage segment results for the twelve months ended December 31, 2008 include the June (acquisition date) through December operating results of DecisionLine.
 
(c) The Late Stage segment results for the twelve months ended December 31, 2006 include the April (acquisition date) through December operating results of IC-Research and the August (acquisition date) through December operating results of CRL Clinical Services.
 
(d) Support and Other consists of unallocated corporate expenses, primarily information technology, marketing and communications, human resources, finance and legal.
 
Year Ended December 31, 2008 (2008) Compared with Year Ended December 31, 2007 (2007)
 
 
Net service revenues increased 19% to $475.1 million for 2008 from $397.6 million in 2007. Exchange rate fluctuations had a minimal impact on net service revenues for the full year.
 
Net service revenues in the Early Stage segment increased approximately $13.8 million to approximately $35.2 million in 2008 compared to $21.4 million in 2007. The majority of this increase is attributable to the DecisionLine acquisition as net service revenues from DecisionLine were approximately $12.8 million for the period from June 2008, date of acquisition, through the end of the year. Net service revenues at the Company’s Phase I unit in Morgantown, West Virginia decreased by approximately $0.1 million in 2008 compared to 2007 while net service revenues at the Phase I unit in the Netherlands increased by approximately $1.1 million in 2008 compared to 2007. The decline in net service revenue at the Company’s Early Stage unit in Morgantown was due partially to a third quarter of 2008 contract delay of two studies. The majority of the work on these contracts is expected to be completed in the first quarter of 2009.
 
Net service revenues in the Late Stage segment increased approximately 17% to $430.3 million in 2008 compared to $366.4 million in 2007.
 
Net service revenues in North America and Europe increased by approximately 16% and 15%, respectively, in 2008 compared to 2007 primarily due to larger projects awarded to the Company. Net service revenues in Latin America increased 88% to $39.0 million as the Company’s customers continue to look toward Latin America, Asia-Pacific and other lower cost emerging regions to conduct clinical trials. Net service revenues in Asia-Pacific increased by approximately 29% in 2008 compared to 2007. Although the Company continues to expect strong


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demand for clinical trial services in Latin America and Asia-Pacific to continue in the future, the Company does not expect the rate of net service revenue increase to continue at the levels experienced in 2008.
 
A summary of net service revenues by geographic region for 2008 and 2007 is presented below:
 
                                         
    For the Year Ended December 31,        
    2008     2007        
    Net Service
          Net Service
             
    Revenues     % of Revenue     Revenues     % of Revenue     % of Growth  
    (In thousands)  
 
North America
  $ 229,346       48 %   $ 198,242       50 %     16 %
Latin America
    38,996       8 %     20,784       5 %     88 %
Europe
    189,528       40 %     165,195       42 %     15 %
Asia-Pacific
    17,222       4 %     13,363       3 %     29 %
                                         
Total
  $ 475,092             $ 397,584               19 %
                                         
 
Net service revenues from the Company’s top five customers accounted for approximately 27% and 25% of net service revenues in 2008 and 2007, respectively. No customer accounted for more than 10% of total net service revenues for 2008 or 2007.
 
 
Reimbursable out-of-pocket revenues and expenses fluctuate from period to period due primarily to the level of investigator activity in a particular period. Reimbursable out-of-pocket revenues and expenses increased 19% to $203.5 million in 2008 from $171.2 million in 2007. The increase is due primarily to an increase in the number of studies in which the Company is procuring investigator services as well as to an increase in size of those studies.
 
 
Direct costs increased by 21% from $204.2 million in 2007 to $247.4 million in 2008. The increase in direct costs is attributable to the increased hiring of billable employees to support the growth in the overall business. Direct costs expressed as a percentage of net service revenues were 52.1% in 2008 compared to 51.4% in 2007. The slight increase in direct costs as a percentage of net service revenues in 2008 is due in part to additional direct costs of approximately $4.9 million recorded in the fourth quarter of 2008 due to a programming issue unique to one study and one customer. As a result of the programming issue, the Company will need to rework the project, resulting in additional direct costs accrued at December 31, 2008. The Company is in the process of working with its insurance provider to recover direct cost amounts that might be covered under the terms of the Company’s insurance coverage. However, under the provisions of SFAS No. 5, any such recovery would be considered a gain contingency. Accordingly, no receivable has been recorded at December 31, 2008 related to potential insurance recovery. Any insurance proceeds received would serve to reduce direct costs in future periods.
 
Selling, general and administrative expenses increased $29.9 million, or 24%, from $125.7 million in 2007 to $155.6 million in 2008. The increase is primarily due to increases in employee-related costs from the Company’s increase in headcount. Average headcount, which includes both billable and nonbillable associates, for 2008 increased by 20% when compared with 2007; which is in line with the Company’s efforts to build infrastructure to support the Company’s growth. The increase in employee-related costs is comprised of general salary increases and corresponding payroll tax and benefit increases including increased health care costs. Selling, general and administrative expenses expressed as a percentage of net service revenues were 32.7% in 2008 compared to 31.6% in 2007.
 
Depreciation and amortization expense increased by $0.4 million, from $14.9 million in 2007 to $15.3 million in 2008. The increase is primarily due to increased amortization expense of approximately $952,000 related to amortization of a customer relationship asset acquired in the June 2008 acquisition of DecisionLine offset partially by a decline in amortization expense on certain finite-lived intangible assets acquired in the 2006 acquisition of the Phase II-IV Clinical Services business of Charles River Laboratories International, Inc.. Finite-lived intangibles are amortized in a manner consistent with the underlying expected future cash flows from the customers, resulting in


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higher amortization expense in the initial year of acquisition. In addition, depreciation expense increased as a result of new asset purchases in 2008 and the related depreciation thereon.
 
Income from operations in 2008 increased to $56.8 million, or 12.0% of net service revenues, compared to $52.8 million, or 13.3% of net service revenues in 2007. The overall decline in operating income as a percentage of net service revenues was due in part to a revenue reduction of $2.3 million and additional direct costs of $4.9 million due to the programming issue on one project and the related rework discussed above as well as an overall decline in the utilization of billable associates in 2008 compared to 2007. The revenue reduction and additional direct costs due to the programming issue is included in the Company’s Support and Other category for purposes of segment reporting.
 
Income from operations from Kendle’s Early Stage segment in 2008 was $6.2 million, or 17.5% of net service revenues compared to Early Stage income from operations of $2.9 million, or 13.8% of net service revenues in 2007. The primary reason for the increase in operating margin in Early Stage in 2008 was due to operating income from DecisionLine of approximately $2.2 million and an increase in operating income at the Company’s Phase I unit in the Netherlands.
 
Income from operations from Kendle’s Late Stage segment in 2008 was $105.1 million or 24.4% of net service revenues compared to Late Stage income from operations of $86.0 million, or 23.5% of net service revenues in 2007. The increase in income from operations as a percentage of net services revenues for the Late Stage segment for the year ended December 31, 2008 compared to the same period in 2007 is primarily due to the growth in the Company’s Late Stage operations in lower-cost, emerging markets in Latin America and Asia-Pacific.
 
 
Total other income (expense) was expense of $10.9 million in 2008 compared to expense of $22.4 million in 2007.
 
The components of Other Income/Expense were as follows for the periods presented:
 
                 
    For the Year Ended December 31,  
    2008     2007  
    (In thousands)  
 
Interest expense
  $ (9,637 )   $ (14,870 )
Interest income
    760       1,466  
Write-off of deferred financing costs
          (4,152 )
Foreign currency gains/(losses)
    (1,006 )     (4,513 )
Other
    (1,037 )     (303 )
                 
Total
  $ (10,920 )   $ (22,372 )
                 
 
In 2008, the Company incurred interest expense of approximately $9.6 million compared to interest expense of approximately $14.9 million in 2007. Interest expense decreased due to a lower interest rate on the Convertible Notes outstanding in 2008 compared to the interest rate on the term loan outstanding during 2007 prior to its payoff in the third quarter of 2007. See Note 1, New Accounting Pronouncements for a discussion of the impact of a recently issued accounting pronouncement affecting these Convertible Notes.
 
In the first quarter of 2007, the Company entered into interest rate swap and collar arrangements to fix the rate on a portion of its then outstanding term debt. The derivative arrangements were not designed for hedge accounting treatment and mark to market adjustments on these arrangements are recorded in the Company’s Consolidated Statements of Operations. In the fourth quarter of 2007, the Company terminated the interest rate swap and paid $881,000 to reflect the amounts due upon termination of the swap. Total 2007 losses related to the interest rate swap/collar arrangements, including the $881,000 paid upon termination of the swap arrangement, were approximately $1.3 million. Losses related to the interest rate swap/collar arrangements are reflected in interest expense in the Company’s Consolidated Statements of Operations.


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Interest income decreased by approximately $706,000 in 2008 due to smaller cash and investment balances, as well as a decline in interest rates, in 2008 compared to 2007. In addition, the Company used available cash to finance its June 2008 acquisition of DecisionLine.
 
In the third quarter of 2007, the Company issued $200.0 million in 3.375% Convertible Notes. In conjunction with issuance and sale of the Convertible Notes, the Company made a mandatory prepayment on its term debt and subsequently paid off the balance of the term note in the third quarter of 2007. Consequently, in the third quarter of 2007 the Company wrote-off approximately $4.2 million in deferred financing costs related to the term note.
 
In the first quarter of 2007, the Company entered into foreign currency hedge arrangements to hedge foreign currency exposure related to intercompany notes outstanding. The derivative arrangements were not designated for hedge accounting treatment and mark to market adjustments on these arrangements are recorded in the Company’s Consolidated Statements of Operations. In 2008, the Company recorded gains of approximately $2.4 million related to exchange rate fluctuations on these intercompany notes and the related derivative instruments compared to gains of approximately $1.4 million related to the intercompany notes and derivative instruments in 2007.
 
In addition to the gains on the intercompany notes and foreign currency hedge arrangements discussed above, the Company recorded foreign exchange rate losses of approximately $3.4 million in 2008 compared to losses of approximately $5.9 million in 2007. The foreign exchange losses in 2008 were due primarily to the weakening of the British pound against the Euro as the Company has a large amount of euro denominated payables in countries that have a functional currency of the British pound. The foreign exchange loss in 2007 was due to the weakening of the British pound against the Euro and the weakening of the U.S. dollar against both the British pound and the Euro. As the Company increases its global contracts, it is increasingly exposed to fluctuations in exchange rates.
 
The exchange rate transaction gains and losses typically occur when the Company holds assets and/or liabilities in a currency other than the functional currency of the reporting location. With the exception of the hedge arrangements on intercompany notes referred to above, the Company does not currently have hedges in place to mitigate exposure due to foreign exchange rate fluctuations. Due to uncertainties regarding the timing of and currencies involved in the majority of the Company’s foreign exchange rate transactions, it is impracticable to implement hedging instruments to match the Company’s foreign currency inflows and outflows. The Company is evaluating ways to mitigate the impact of foreign currency exchange rates in the future. For example, the Company is putting in place an intercompany procedure to allow for regular settlement of global intercompany balances.
 
 
The Company recorded tax expense at an effective rate of approximately 36.0% in 2008 compared to approximately 38.6% in 2007. The decrease in the effective income tax rate in 2008 is primarily due to the distribution of income among the Company’s non-U.S. subsidiaries. In addition, in 2008 the Company recorded an additional tax benefit of approximately $3.3 million related to the recognition of tax benefits that were previously unrecognized in accordance with FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement 109”. In 2007 the Company had recorded additional tax expense of approximately $416,000 related to that same pronouncement.
 
 
The net income for 2008 was approximately $29.4 million or $1.96 per diluted share and $1.99 per basic share.
 
The net income for 2007 was approximately $18.7 million, or $1.26 per diluted share and $1.29 per basic share.
 
Year Ended December 31, 2007 Compared with Year Ended December 31, 2006 (2006)
 
 
Net service revenues increased 40% to $397.6 million for 2007 from $283.5 million in 2006. The 40% increase includes a 6% increase due to the impact of foreign currency exchange rate fluctuations. As Kendle and CRL Clinical Services have integrated project teams and net service revenue is recognized on integrated labor hours and costs, it is difficult to precisely determine the amount of 2007 and third and fourth quarter 2006 revenue that is


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attributable to the acquisition of CRL Clinical Services. The Company estimates that a significant portion of the growth in net service revenues is due to this acquisition.
 
Net service revenues in the Early Stage segment declined approximately $1.9 million to approximately $21.4 million in 2007 compared to $23.3 million in 2006. Net service revenues at the Company’s Phase I unit in Morgantown, West Virginia increased by approximately $1.1 million in 2007 compared to 2006 while net service revenues at the Phase I unit in the Netherlands declined by approximately $3.0 million in 2007 compared to 2006. The decline in net service revenue at the Company’s Early Stage unit in the Netherlands was due partially to a third quarter of 2007 contract cancellation of approximately $1.9 million. The majority of the work on this contract would have been completed in the third and fourth quarters of 2007.
 
Net service revenues in the Late Stage segment increased approximately 44% to $366.4 million in 2007 compared to $255.0 million in 2006. A significant portion of the increase is due to including a full-year of net service revenue in 2007 from the acquisition of CRL Clinical Services compared to 4.5 months of net service revenue in 2006.
 
Net service revenues in North America and Europe increased by approximately 28% and 50%, respectively, in 2007 compared to 2006 primarily due to the impact of the CRL Clinical Services acquisition, strong demand for Phase II-IV services and larger projects awarded to the Company. Net service revenues in Latin America increased by more than 100% to $20.8 million, due to increased customer demand for clinical trials in the region. Net service revenues in Asia-Pacific increased by approximately 68% in 2007 compared to 2006 due to increased customer demand for clinical trials in the Asia-Pacific region.
 
A summary of net service revenues by geographic region for 2007 and 2006 is presented below:
 
                                         
    For the Year Ended December 31,        
    2007     2006        
    Net Service
          Net Service
             
    Revenues     % of Revenue     Revenues     % of Revenue     % of Growth  
    (In thousands)  
 
North America
  $ 198,242       50 %   $ 155,469       55 %     28 %
Latin America
    20,784       5 %     10,240       3 %     103 %
Europe
    165,195       42 %     109,808       39 %     50 %
Asia-Pacific
    13,363       3 %     7,954       3 %     68 %
                                         
Total
  $ 397,584             $ 283,471               40 %
                                         
 
Net service revenues from the Company’s top five customers accounted for approximately 25% and 28% of net service revenues in 2007 and 2006, respectively. No customer accounted for more than 10% of total net service revenues for 2007. Net service revenues from Pfizer Inc. accounted for approximately 12% of the total 2006 net service revenues. No other customer accounted for more than 10% of 2006 net service revenues. A primary reason for the shifts in the above referenced revenue metrics was the CRL Clinical Services acquisition, which strengthened the Company’s role in global clinical trials and assisted in diversifying the customer base.
 
 
Reimbursable out-of-pocket revenues and expenses fluctuate from period to period due primarily to the level of investigator activity in a particular period. Reimbursable out-of-pocket revenues and expenses increased 89% to $171.2 million in 2007 from $90.5 million in 2006. A significant portion of the increase in reimbursable out-of-pocket revenues and costs is due to the CRL Clinical Services acquisition. The remainder of the change is due primarily to an increase in the number of studies in which the Company is procuring investigator services as well as to an increase in size of those studies.
 
 
Direct costs increased by 34% from $152.8 million in 2006 to $204.2 million in 2007. A significant portion of the increase in costs is related to the acquisition of CRL Clinical Services. The remaining portion of the increase in


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direct costs is attributable to the increased hiring of billable employees to support the growth in the overall business. Direct costs expressed as a percentage of net service revenues were 51.4% in 2007 compared to 53.9% in 2006. The decrease in direct costs as a percentage of net service revenues in 2007 is due to the Company’s work on larger, global trials in 2007 which result in greater opportunities for efficiencies in individual projects as well as opportunities to increase work in lower cost geographic regions.
 
Selling, general and administrative expenses increased $33.9 million, or 36.9%, from $91.8 million in 2006 to $125.7 million in 2007. The increase is primarily due to increases in employee-related costs from the Company’s increase in headcount. Significant headcount growth occurred with the August 2006 acquisition of CRL Clinical Services. Headcount increased to build the Company’s infrastructure to support the growth in revenue. The increase in employee-related costs is comprised of general salary increases and corresponding payroll tax and benefit increases including increased health care costs. Selling, general and administrative expenses expressed as a percentage of net service revenues were 31.6% in 2007 compared to 32.4% in 2006.
 
Depreciation and amortization expense increased by $4.5 million, from $10.4 million in 2006 to $14.9 million in 2007. A portion of the increase is related to the increased amortization expense of finite-lived intangible assets acquired in the CRL Clinical Services acquisition. For 2007 this amount was $4.2 million compared to $2.4 million in 2006. The remaining portion of the change is the result of an increase in depreciation expense attributable to an increase in depreciable assets originating from the CRL Clinical Services acquisition and 2007 purchases.
 
In 2006, the Company recorded an $8.2 million impairment charge on a $15.0 million customer relationship intangible asset that was acquired in the Company’s 2002 acquisition of Clinical and Pharmacologic Research, Inc. (CPR) in Morgantown, West Virginia. The intangible asset represents one customer relationship which due to its characteristics was considered to have an indefinite life and was subject to annual impairment testing. The fair value of the intangible at December 31, 2006, was calculated by using a discounted cash flow model. Due to declining net service revenue in 2006 from this customer at the Morgantown facility as well as budgeted net service revenue for 2007 and future projected net service revenues that are at lesser levels than historically experienced from this customer, the Company determined that the customer relationship was impaired. As a result of this impairment charge, the Company has assigned a 23-year useful life to the customer relationship and began amortizing this asset in 2007. The 2007 amortization expense on this asset was approximately $300,000.
 
Income from operations in 2007 increased to $52.8 million, or 13.3% of net service revenues, compared to $20.0 million, or 7.1% of net service revenues in 2006.
 
Income from operations from Kendle’s Early Stage segment in 2007 was $2.9 million, or 13.8% of net service revenues compared to Early Stage loss from operations of $2.9 million in 2006. The Early Stage loss from operations in 2006 was due to the $8.2 million impairment charge discussed above.
 
Income from operations from Kendle’s Late Stage segment in 2007 was $86.0 million or 23.5% of net service revenues compared to Late Stage income from operations of $66.6 million, or 26.1% of net service revenues in 2006. The decrease in income from operations as a percentage of net services revenues for the year ended December 31, 2007 compared to the same period of 2006 is primarily due to two factors. First, during 2007, the Company increased its support infrastructure to support the increase in Late Stage net service revenue. This growth in infrastructure resulted in an increase in support type costs allocated to the Late Stage segment. In addition, amortization expense related to finite-lived intangible assets acquired in the CRL Clinical Services acquisition increased from $2.4 million in 2006 to $4.2 million in 2007.
 
 
Total other income (expense) was expense of $22.4 million in 2007 compared to expense of $6.6 million in 2006.


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The components of Other Income/Expense were as follows for the periods presented:
 
                 
    For the Year Ended December 31,  
    2007     2006  
    (In thousands)  
 
Interest expense
  $ (14,870 )   $ (6,781 )
Interest income
    1,466       1,939  
Write-off of deferred financing costs
    (4,152 )      
Foreign currency gains/(losses)
    (4,513 )     (1,562 )
Other
    (303 )     (233 )
                 
Total
  $ (22,372 )   $ (6,637 )
                 
 
Interest income decreased by approximately $473,000 in 2007 due to smaller cash and investment balances in 2007 compared to 2006. In addition to term debt used to finance the acquisition of CRL Clinical Services, the Company used available cash and proceeds from the sale of investments to finance the acquisition.
 
In 2007 the Company incurred interest expense of approximately $14.9 million compared to interest expense of approximately $6.8 million in 2006. The increase in interest expense is primarily due to acquisition-related debt outstanding for the entire year of 2007 compared to approximately 4.5 months of 2006, as discussed below.
 
In June 2006, the Company paid the remaining outstanding balance of approximately $3.0 million under a prior term loan and terminated the agreements related to the loan. In August 2006, the Company borrowed $200 million under a term loan agreement in connection with the closing and purchase of CRL Clinical Services. Therefore, this new term loan had outstanding principal for approximately 4.5 months in 2006 and for approximately seven months of 2007 until the Company paid off this term loan with proceeds from the sale of Convertible Notes discussed below.
 
In the third quarter of 2007, the Company issued $200.0 million in 3.375% Convertible Notes. In conjunction with issuance and sale of the Convertible Notes, the Company made a mandatory prepayment on its term debt and subsequently paid off the balance of the term note in the third quarter of 2007. Consequently, in the third quarter of 2007 the Company wrote-off approximately $4.2 million in deferred financing costs related to the term note.
 
In the first quarter of 2007, the Company entered into interest rate swap and collar arrangements to fix the rate on a portion of its then outstanding term debt. The derivative arrangements were not designed for hedge accounting treatment and mark to market adjustments on these arrangements are recorded in the Company’s Consolidated Statements of Operations. In the fourth quarter of 2007, the Company terminated the interest rate swap and paid $881,000 to reflect the amounts due upon termination of the swap. Total 2007 losses related to the interest rate swap/collar arrangements, including the $881,000 paid upon termination of the swap arrangement, were approximately $1.3 million.
 
In the first quarter of 2007, the Company entered into foreign currency hedge arrangements to hedge foreign currency exposure related to intercompany notes outstanding. These derivative arrangements were not designed for hedge accounting treatment and mark to market adjustments on these arrangements are recorded in the Company’s Consolidated Statements of Operations. In 2007, the Company recorded gains of approximately $1.4 million related to exchange rate fluctuations on these intercompany notes and the related derivative instruments.
 
In addition to the gains on the foreign currency hedge arrangements, discussed above, the Company recorded foreign exchange rate losses of approximately $5.9 million in 2007 compared to losses of approximately $1.6 million in 2006. The increased foreign exchange rate loss was due to the continued weakening of the U.S. dollar against the British pound and the Euro as well as an increase in the number of global contracts the Company entered into in 2007, leading to increased exchange rate exposure. The exchange rate transaction losses typically occur when the Company holds assets and/or liabilities in a currency other than the functional currency of the reporting location. With the exception of the hedge arrangements on intercompany notes referred to above, the Company did not have hedges in place to mitigate exposure due to foreign exchange rate fluctuations. Due to uncertainties regarding the timing of and currencies involved in the majority of the Company’s foreign exchange


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rate transactions it is impracticable to implement hedging instruments to match the Company’s foreign currency inflows and outflows.
 
 
The Company recorded tax expense at an effective rate of approximately 38.6% in 2007 compared to approximately 36.2% in 2006. The increase in the effective income tax rate in 2007 is primarily due to the distribution of income among the Company’s non-U.S. subsidiaries. In addition, in 2007 the Company recorded additional expense of approximately $416,000 related to FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement 109”. In the fourth quarter of 2006, the Company recorded a tax charge of approximately $921,000 related to the tax effect of a dividend declared in the course of setting up an intercompany note between the Company’s German and U.S. entities. In 2006, the Company also recorded a valuation allowance of approximately $230,000 related to state and local net operating loss carryforwards. Because Kendle operates on a global basis, the effective tax rate may vary from year to year based on the locations that generate the pre-tax earnings.
 
 
The net income for 2007, including the effects of amortization of 2006 acquired intangibles and the write-off of deferred financing costs (items totaling approximately $5.3 million or $0.35 per diluted share) was approximately $18.7 million or $1.26 per diluted share and $1.29 per basic share.
 
The net income for 2006, including the effects of amortization of 2006 acquired intangibles, acquisition-related expenses and the intangible impairment charge (items totaling approximately $7.4 million, net of tax or $0.50 per diluted share) was approximately $8.5 million, or $0.58 per diluted share and $0.60 per basic share.
 
Liquidity and Capital Resources
 
The Company had cash and cash equivalents of approximately $35.2 million at December 31, 2008 compared to approximately $45.5 million at December 31, 2007. In 2008, cash and cash equivalents decreased by $10.3 million as a result of cash provided by operating activities of $37.1 million offset by cash used in investing activities of $46.3 million and cash provided by financing activities of $2.6 million. The negative effect of foreign exchange rates on cash and cash equivalents was approximately $3.8 million. In addition, the Company has restricted cash of approximately $884,000 at December 31, 2008 compared with $844,000 at December 31, 2007, which represents cash received from customers that is segregated in a separate Company bank account and available for use only for specific project-related expenses, primarily investigator fees, upon authorization from the customer.
 
Net cash provided by operating activities consisted primarily of net income increased by non-cash adjustments (primarily depreciation and amortization). The change in net operating assets used $6.0 million in cash in 2008 primarily driven by an increase in accounts receivable partially offset by an increase in advanced billings. The change in net operating assets provided $22.6 million in cash in 2007 primarily due to increases in advance billings and accrued liabilities partially offset by an increase 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. Accounts receivable, net of advance billings, increased from $57.1 million at December 31, 2007, to $63.4 million at December 31, 2008.
 
Cash flows used for investing activities for the year ended December 31, 2008 consisted primarily of capital expenditures of $27.1 million, the acquisition of DecisionLine for $18.1 million and a $1.1 million payment to terminate the interest rate collar. Cash flows from investing activities for the year ended December 31, 2007 consisted primarily of capital expenditures of $15.3 million and additional acquisition expenses of approximately $1.0 million offset by cash of $3.1 million received by the Company related to the settlement of the final working capital amount in the purchase of CRL Clinical Services.
 
Cash flows provided by financing activities for the year ended December 31, 2008 excluding the offsetting effects of drawdowns and repayments of the revolving credit facility consisted primarily of $2.2 million in proceeds


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from stock option activity. Cash flows from financing activities for the year ended December 31, 2007 consisted primarily of proceeds from the sale and issuance of the Convertible Notes of $200.0 million offset by payments of $199.5 million on the Company’s term note, debt issuance costs of $6.9 million, of which $6.6 million was associated with the issuance of the Convertible Notes, and net payments of $18.1 million related to the purchase of bond hedges and proceeds from the issuance of warrants, also related to the sale and issuance of the Convertible Notes.
 
Cash used for capital expenditures was $27.1 million, $15.3 million and $8.8 million in 2008, 2007 and 2006, respectively.
 
In August 2006, in conjunction with its acquisition of CRL Clinical Services, the Company entered into a new credit agreement (including all amendments, the “Facility”). The Facility is comprised of a $200 million term loan that matures in August 2012 and a revolving loan commitment that expires in August 2011. The balance of the $200 million term loan was paid off in the third quarter of 2007 with proceeds from the Convertible Notes discussed below. The original revolving loan commitment was $25 million and was increased to $53.5 million under an amendment to the Facility and an Increase Joinder Agreement, which was entered into on June 27, 2007 and shortly thereafter permitted the Company to increase the revolving loan commitment. The Facility contains various affirmative and negative covenants including financial covenants regarding maximum leverage ratio, minimum interest coverage ratio and limitations on capital expenditures. The Company is in compliance with the covenants at December 31, 2008. The Company is in the process of seeking an amendment to the Facility to adjust certain of its financial covenants. There can be no assurances that the Company will be successful in obtaining this amendment. Management does not believe it is essential to its operations to obtain this amendment, however, it may limit our ability to pursue future opportunities.
 
The Company also maintains an existing $5.0 million Multicurrency Facility that is renewable annually and is used in connection with the Company’s European operations.
 
On July 10, 2007, the Company entered into a Purchase Agreement with the Underwriter for the issuance and sale by the Company of $175 million in aggregate principal amount of the Company’s Convertible Notes pursuant to the Company’s effective Registration Statement on Form S-3. On July 11, 2007, the Underwriter exercised an over-allotment option and purchased an additional $25 million in aggregate principal amount of Convertible Notes. On July 16, 2007, $200 million in aggregate principal amount of the 5-year Convertible Notes with a maturity date of July 15, 2012 were sold to the Underwriters at a price of $1,000 per Convertible Note, less an underwriting discount of 3% per Convertible Note.
 
The Convertible Notes bear interest at an annual rate of 3.375%, payable semi-annually in arrears on January 15 and July 15 of each year, with the first interest payment having been made on January 15, 2008. The Convertible Notes are convertible at the option of the holder into cash and, if applicable, shares of the Company’s common stock at an initial conversion price of $47.71 per share (approximating 20.9585 shares per $1,000 principal amount of the Convertible Notes), upon the occurrence of certain events, including (1) any calendar quarter ending after September 30, 2007 in which the closing price of the Company’s common stock is greater than 130% of the conversion price for at least 20 trading days during the period of 30 consecutive trading days ending on the last trading day of the preceding calendar quarter (establishing a contingent conversion price of $47.71 per share); (2) any five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of Convertible Notes for each day of that period is equal to or less than 97% of the product of the closing sale price of the Company’s common stock and the applicable conversion rate; (3) upon specified corporate transactions including consolidation or merger; and (4) any time during the period beginning on January 1, 2012 until the close of business on the second business day immediately preceding July 15, 2012. In addition, upon events defined as a “fundamental change” under the Convertible Note Indenture, holders of the Convertible Notes may require the Company to repurchase the Convertible Notes. If upon the occurrence of such events in which the holders of the Convertible Notes exercise the conversion provisions of the Convertible Notes, the Company will need to remit the principal balance of the Convertible Notes to the holders in cash. As such, the Company would be required to classify the entire amount outstanding of the Convertible Notes as a current liability in the following quarter. The evaluation of the classification of amounts outstanding associated with the Convertible Notes will


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occur every quarter. As of December 31, 2008, the Convertible Notes are classified as long-term in the accompanying Consolidated Balance Sheets.
 
Upon conversion, holders will receive cash up to the principal amount of the Convertible Notes to be converted, and any excess conversion value will be delivered in shares of the Company’s common stock. If conversion occurs in connection with a “fundamental change” as defined in the Convertible Notes Indenture, the Company may be required to repurchase the Convertible Notes for cash at a price equal to the principal amount plus accrued but unpaid interest. In addition, if conversion occurs in connection with a change in control, the Company may be required to deliver additional shares of the Company’s common stock (a “make whole” premium) by increasing the conversion rate with respect to such notes. The maximum aggregate number of shares that the Company would be obligated to issue upon conversion of the Convertible Notes is 5.6 million shares, but under most conditions, the Company would be obligated to issue 4.2 million shares upon conversion of the Convertible Notes.
 
Pursuant to Emerging Issues Task Force (EITF) 90-19, Convertible Bonds with Issuer Option to Settle for Cash upon Conversion, EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock (“EITF 00-19”), and EITF 01-6, The Meaning of Indexed to a Company’s Own Stock (EITF 01-6), the Convertible Notes are accounted for as convertible debt in the accompanying Consolidated Balance Sheets and the embedded conversion option in the Convertible Notes has not been accounted for as a separate derivative. For a discussion of the effects of the Convertible Notes and the bond hedges and warrants discussed below on earnings per share, see Note 1 to the Consolidated Financial Statements.
 
The accounting for the above mentioned Convertible Notes in future periods will be affected by the issuance of APB 14-1. Please see Note 1, New Accounting Pronouncements.
 
Concurrent with the sale of the Convertible Notes, the Company purchased convertible bond hedges from the Underwriter and JP Morgan Chase (collectively, the counterparties), which are designed to mitigate potential dilution from the conversion of the Convertible Notes in the event that the market value per share of the Company’s common stock at the time of exercise is greater than approximately $47.71. Under the bond hedges that cover approximately 4.2 million shares of the Company’s common stock, the counterparties are required to deliver shares of the Company’s common stock in the amount that the Company is obligated to deliver to the holders of the Convertible Notes with respect to the conversion, calculated exclusive of shares deliverable by the Company by reason of any additional premium relating to the Convertible Notes or by reason of any election by the Company to unilaterally increase the conversion rate pursuant to the indenture governing the Convertible Notes. The bond hedges expire at the close of trading on July 15, 2012, which is also the maturity date of the Convertible Notes although the counterparties will have ongoing obligations with respect to Convertible Notes properly converted on or prior to that date of which the counterparties have been timely notified.
 
In addition, the Company issued warrants to the counterparties that could require the Company to issue up to approximately 4.2 million shares of the Company’s common stock on expiration dates consisting of the 100 consecutive business days beginning on and including January 15, 2013 (European style). The strike price is $61.22 per share, which represented a 70% premium over the closing price of the Company’s shares of common stock on July 10, 2007.
 
The Convertible Note hedge and warrant transactions generally have the effect of increasing the conversion price of the Convertible Notes to approximately $61.22 per share of Kendle common stock, representing approximately a 70% premium based on the closing sale price as reported on The NASDAQ Global Market on July 10, 2007, of $36.01 per share.
 
The bond hedges and warrants are separate and legally distinct instruments that bind the Company and the counterparties and have no binding effect on the holders of the Convertible Notes. In addition, pursuant to EITF 00-19 and EITF 01-6, the bond hedges and warrants are accounted for as equity transactions. Therefore, the payment associated with the issuance of the bond hedges and the proceeds received from the issuance of the warrants were recorded as a charge and an increase, respectively, in Additional Paid-in Capital in Stockholders’ Equity as separate equity transactions.


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For income tax reporting purposes, the Company has elected to integrate the Convertible Notes and the bond hedges. Integration of the bond hedges with the Convertible Notes creates an original issue discount (OID) debt instrument for income tax reporting purposes. Therefore, the cost of the bond hedges will be accounted for as interest expense over the term of the Convertible Notes for income tax reporting purposes. The associated income tax benefits that are recognized for financial reporting purposes will be recognized as a reduction in the income tax provision in the periods that the deductions are taken for income tax reporting purposes.
 
The Company received net proceeds from the sale of the Convertible Notes of approximately $194.0 million after deducting the underwriter’s discounts and commissions. In addition, the Company used approximately $18.1 million of the net proceeds of the offering to pay the net cost of the Convertible Note hedge transactions and the warrant transactions. The Company made a mandatory prepayment of $146.0 million (75% of the net proceeds of the offering) toward repayment of amounts owed under the term loan under its credit agreement and made additional voluntary prepayments during the third quarter of 2007 to pay off the remaining balance of the term loan.
 
As of December 31, 2008, $200.0 million was outstanding under the Convertible Notes, no amounts were outstanding under the revolving credit loan and no amounts were outstanding under the Multicurrency Facility.
 
The weighted-average interest rate in effect on the term loan for the first seven months of 2007 was approximately 7.82%.
 
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 the Facility and the Multicurrency Facility, will be sufficient to meet its foreseeable cash needs. The Company has not historically experienced regular liquidity or collections issues with the large majority of its customers. However, the Company does have contracts with biotechnology and small pharmaceutical companies, some of which are dependent upon external financing to fund their contractual commitments. The Company is continuing to monitor the financial status of its customers. In the future, the Company will continue to consider the acquisition of businesses to enhance its service 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.
 
 
Future minimum payments for all contractual obligations for years subsequent to December 31, 2008, are as follows:
 
                                         
    Year
    Years
    Years
    Years
       
    2009     2010-2011     2012-2013     After 2013     Total  
    (In thousands)  
 
Capital lease obligations (including interest)
  $ 197     $ 127     $     $     $ 324  
Operating Leases
    17,653       27,337       17,531       27,505       90,026  
Debt payments(1)
                200,000             200,000  
Interest on debt(2)
    6,750       13,500       3,656             23,906  
Foreign currency hedge arrangements(3)
                17,853             17,853  
FIN 48 obligation, including interest and penalties(4)
                             
                                         
Total
  $ 24,600     $ 40,964     $ 239,040     $ 27,505     $ 332,109  
                                         
 
Short-term obligations arising in the ordinary course of business are excluded from the above table.
 
 
(1) Under the terms of the Convertible Notes, the Convertible Notes are convertible into shares of the Common Stock upon the occurrence of various factors described in the Liquidity and Capital Resources section of Management’s Discussion and Analysis. The above table assumes no conversion with the principal amount of the Convertible Notes paid at the maturity date of July 15, 2012.
 
(2) The interest rate used in the calculation of interest was 3.375% which represents the cash coupon obligation.


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(3) Based on December 31, 2008 fair value of foreign currency hedge arrangements maturing in 2012. See MD&A Recent Developments and CRO Activity for recent activity related to this hedge.
 
(4) FIN 48 obligations of $1.8 million have not been reflected in the above table due to the inherent uncertainty as to the amount and timing of settlement, which is contingent upon the occurrence of possible future events, such as examinations and determinations by various tax authorities.
 
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 net service revenues are based on fixed-price contracts calculated on a proportional performance basis (also referred to herein as “percentage-of-completion”) based upon assumptions regarding the estimated total costs for each contract. The Company also recognizes revenue under units-based contracts by multiplying units completed by the applicable contract per-unit price. Additionally, work is performed under time-and-materials contracts, recognizing revenue as hours are worked based on the hourly billing rate for each contract. Finally, at one of the Company’s Early Stage operations, the contracts are of a short-term nature and revenue is recognized under the completed contract method of accounting.
 
 
With respect to certain fixed price contracts, costs are incurred for performance of each contract and compared to the estimated budgeted costs for that contract to determine a percentage of completion on the contract. The percentage of completion is then multiplied by the contract value to determine the amount of revenue recognized. The contract value equals the value of the services to be performed under the contract as determined by aggregating the labor hours estimated to be incurred to perform the tasks in the contract at the agreed rates. Contract value excludes the value of third-party and other pass-through costs. As the work progresses, original estimates might be changed as a result of management’s regular contract review process.
 
Management regularly reviews the budget on each contract to determine if the budgeted costs accurately reflect the costs that the Company will incur for contract performance. The Company reviews each contract’s performance to date, current cost trends and circumstances specific to each contract. The Company estimates its remaining costs to complete the contract based on a variety of factors, including:
 
  •  Actual costs incurred to date and the work completed as a result of incurring the actual costs;
 
  •  The remaining work to be completed based on the timeline of the contract as well as the number of incomplete tasks in the contract; and
 
  •  Factors that could change the rate of progress of future contract performance.
 
Examples of factors included in the review process that could change the rate of progress of future contract performance are: patient enrollment rate, changes in the composition of staff on the project or other customer requirements, among other things.
 
Based on these contract reviews, the Company adjusts its cost estimates. Adjustments to net service revenue resulting from changes in cost estimates are recorded on a cumulative basis in the period in which the revisions are made. When estimates indicate a loss, such loss is provided in the current period in its entirety. While the Company routinely adjusts cost estimates on individual contracts, the Company’s estimates and assumptions historically have been accurate in all material respects in the aggregate. The Company expects the estimates and assumptions to remain accurate in all material respects in the aggregate in future periods.
 
A contract amendment, which results in revisions to net service revenues and cost estimates, is recognized in the percentage-of-completion calculations beginning in the period in which the parties reach written agreement to the amendment. (See also Company Overview section of MD&A for a description of the contract amendment


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process.) Historically, the aggregate value of contract amendments signed in any year represents 15% to 20% of annual sales. Although the majority of the Company’s contract amendments relate to future services, the Company and its customers may execute contract amendments for services that the Company already has performed. In these circumstances, net service revenue from past services performed is recognized in the current period. Historically, the impact of such amendments on results of operations has not been material.
 
Under the Company’s policy, project teams are not authorized to engage in tasks outside the scope of the contract without prior management approval. In limited situations, management may authorize the project team to commence work on activities outside the contract scope while the Company and its customer negotiate and finalize the contract amendment. When work progresses on unsigned, unprocessed contract amendments, the Company reviews the direct costs incurred, and, where material defers such costs on the balance sheet. In addition, the impact of such costs on the estimates to complete is considered and, where material, the estimates are adjusted. Historically, neither the deferred costs nor the impact on estimates have been material.
 
The Company believes that total costs constitute the most appropriate indicator of the performance of fixed price contracts because the costs relate primarily to the amount of labor hours incurred to perform the contract. The customer receives the benefit of the work performed throughout the contract term and is obligated to pay for services once performed. Accordingly, the Company believes that an input measure of cost is a reasonable surrogate for an output measure under the proportional performance model and is consistent with the revenue recognition concepts of Staff Accounting Bulletin (SAB) 104, Revenue Recognition.
 
Units-Based
 
Although the majority of the Company’s contracts are fixed-price and net service revenues are calculated on a percentage of completion methodology as discussed above, the Company has seen increasing demand from its customers to move toward a units-based contract methodology in new contracts. It is the Company’s intent to structure more of its contracts under a units-based methodology for calculating net service revenues so the Company expects the percentage of contracts under which net service revenues are recognized using units-based methodology to increase in future periods. Under a units-based contract methodology, amounts recognized as net service revenues are calculated based on units completed in the period multiplied by a unit value or selling price that is outlined in the contract.
 
For a units-based contract, a typical unit could include such things as completion of a monitoring visit, monthly site management units or case report form pages entered. The Company tracks the units completed for each unit category included in the contract. Net service revenue is recognized monthly based on the units actually completed in the period at the agreed upon unit value or selling price. Net service revenue is recognized only up to the number of units contained in each contract. If the Company completes or expects to complete units over and above the number of units initially estimated and contained in the contract, a contract amendment is generated to reflect the additional units needed.
 
A contract amendment, which results in revisions to net service revenues and expected units or unit values, is recognized in the unit-based net service revenue calculations beginning in the period in which the parties agree to the amendment. (See also Company Overview section of MD&A for a description of the contract amendment process.)
 
The Company believes that under certain types of contracts the value of the work performed is best captured by calculating net service revenues using the value of units completed. The Company believes that units-based revenue recognition is consistent with the revenue recognition concepts of SAB 104.
 
As the Company provides services on projects, it also incurs third-party and other pass-through costs, which are reimbursable by its customers pursuant to the contract. The revenues and costs from these third-party and other pass-through costs are reflected in the Company’s Consolidated Statements of Operations under the line items titled “Reimbursable out-of-pocket revenues” and “Reimbursable out-of-pocket costs”, respectively.


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Direct costs consist of compensation and related fringe benefits for project-related associates, unreimbursed project-related costs and an allocated portion of indirect costs, which primarily includes facilities-related costs and information systems costs. Labor costs represent over 80% of total direct costs with the allocated portion of indirect costs representing less than 10% of total. To determine the allocated portion of indirect costs, the Company calculates an allocation percentage based on the relationship between billable associate salaries and total salaries. The remaining indirect costs are allocated to SG&A.
 
Because the Company’s business is labor intensive, direct costs historically have increased with an increase in net service revenues. The Company, however, has not experienced any material variations in the relationship between direct costs and net service revenues for the fiscal years ended 2008, 2007 and 2006. The following factors, among others, will cause direct costs to decrease as a percentage of net service revenues:
 
  •  Higher utilization rates for billable employees; and
 
  •  The ability to complete contracted work more efficiently than estimated by the Company.
 
The following factors, among others, will cause direct costs to increase as a percentage of net service revenues:
 
  •  The occurrence of cost overruns from increased time to complete contract performance;
 
  •  Lower utilization rates for billable employees;
 
  •  Increased costs due to higher-paid employees or contractors performing contract services; and
 
  •  Pricing pressure from increased competition.
 
The Company does not expect that the foregoing factors will have a material impact on the historical relationship between direct costs and net service revenues.
 
 
Selling, general and administrative expenses consist of compensation and related fringe benefits for sales and administrative employees and professional services, as well as unallocated costs related to facilities, information systems and other costs.
 
Depreciation and amortization expenses consist of depreciation and amortization costs recorded on a straight-line method over the estimated useful life of the property or equipment and internally developed software. Finite-lived intangible assets are generally amortized on an accelerated basis based on the discounted cash flow calculations used in the valuation of the asset.
 
 
Billed accounts receivable represent amounts for which invoices have been issued to customers. Unbilled accounts receivable are amounts recognized as revenue for which invoices have not yet been issued to customers. Advance billings represent amounts billed or payment received for which revenues have not yet been earned. The Company maintains an allowance for doubtful accounts receivable based on historical evidence of accounts receivable collections and specific identification of accounts receivable that might pose collection problems. The bad debt provision is monitored on a regular basis and adjusted as circumstances warrant. With the exception of a $1.7 million write-off in 2006 of receivables due from one customer, the Company’s allowance for doubtful accounts has been sufficient to cover any bad debt write-offs. Due to the economic climate in the second-half of 2008 and the tightening of the credit markets, the Company increased its bad debt reserve, primarily to cover exposure from a limited number of customers that rely on outside sources to fund their operations. The Company will continue to monitor its bad debt exposure and adjust bad debt reserves as necessary.
 
If the Company is unable to collect all or part of its outstanding receivables, there could be a material impact to the Company’s Consolidated Statements of Operations or financial position.


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The Company analyzes goodwill and other finite-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. Certain factors that may occur and indicate an impairment include the following: significant underperformance relative to historical or projected operating results; significant changes in the manner of the Company’s use of the underlying assets; and significant adverse industry or market economic trends.
 
A fair value approach is used to test goodwill for impairment. The fair value approach compares estimates related to the fair value of the reporting unit with the unit’s carrying amount, including goodwill. The fair value is determined using both the market approach and the income approach using projected discounted cash flows. If the carrying amount of the reporting unit exceeds the fair value, the amount of the impairment loss must be measured. The Company has five reporting units that were tested for impairment: Early Stage, Global Clinical Development, Late Phase, Regulatory Affairs and Biometrics. The Company determined its reporting units using criteria established in SFAS 142. SFAS 142 defines a reporting unit as the components of operating segments for which discrete financial information is available and regularly reviewed by management. At December 31, 2008 and 2007, the fair value of the reporting units exceeded the carrying value, resulting in no goodwill impairment charge.
 
The estimate of fair value of long-lived assets is inherently subjective and requires the Company to make a number of assumptions and projections. These assumptions and projections relate to future net service revenue, earnings and the probability of certain outcomes and scenarios. If factors change and the Company employs different assumptions in estimating fair value of its long-lived assets, the estimated fair value of these assets could change and result in impairment charges. Please see Item 1A, Risk Factors for discussion of risks and potential risks that may impact future net service revenues, among other things, of the Company.
 
 
Pursuant to the guidance included in Statement of Position 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use”, the Company capitalizes costs incurred to internally develop software used primarily in the Company’s proprietary clinical trial and data management systems, and amortizes these costs over the useful life of the product, not to exceed five years. Internally developed software represents software in the application development stage, and there is no assurance that the software development process will produce a final product for which the fair value exceeds its carrying value. Internally developed software is an intangible asset subject to impairment write-downs whenever events indicate that the carrying value of the software may not be recoverable. As with other long-lived assets, this asset is reviewed at least annually to determine the appropriateness of the carrying value of the asset and the estimated useful lives. Assessing the fair value of the internally developed software requires estimates and judgment on the part of management. As discussed in Note 1 to the Consolidated Financial Statements, internally developed software is amortized over its estimated useful life of five years. The Company believes the useful life established remains reasonable.
 
 
The Company adopted FIN 48 as of January 1, 2007. FIN 48 requires significant judgment in determining what constitutes an individual tax position as well as assessing the outcome of each tax position. Changes in judgments as to recognition or measurement of tax positions can materially affect the estimate of the effective tax rate, and, consequently, the Company’s operating results. The Company considers many factors when evaluating and estimating tax positions and tax benefits, which may require periodic adjustments and which may not accurately anticipate actual outcomes. In addition, the calculation of tax liabilities involves dealing with uncertainties in the application of complex tax regulations in a multitude of jurisdictions. The Company determines its liability for uncertain tax positions globally under the provisions in FIN 48. At December 31, 2008, the Company has recorded a gross FIN 48 liability of $1.8 million. If events occur and the payment of these amounts ultimately proves to be unnecessary, the reversal of liabilities would result in tax benefits being recognized in the period when it is determined the liabilities are no longer necessary. If the calculation of liability related to uncertain tax positions proves to be more or less than the ultimate assessment, a tax expense or benefit to expense, respectively, would result.


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The Company provides for income taxes on all transactions that have been recognized in the Consolidated Financial Statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” Specifically, the Company estimates its tax liability based on current tax laws in the statutory jurisdictions in which it operates. Because the Company conducts business on a global basis, its effective tax rate has and will continue to depend upon the geographic distribution of its pre-tax earnings (losses) among jurisdictions with varying tax rates. These estimates include judgments about deferred tax assets and liabilities resulting from temporary differences between assets and liabilities recognized for financial reporting purposes and such amounts recognized for tax purposes. The Company has assessed the realization of deferred tax assets and a valuation allowance has been established based on an assessment that it is more likely than not that realization cannot be assured. The ultimate realization of this tax benefit is dependent upon the generation of sufficient operating income in the respective tax jurisdictions. If estimates prove inaccurate or if the tax laws change unfavorably, significant revisions in the valuation allowance may be required in the future.
 
 
The Company adopted the provisions of SFAS 123(R) for all share-based payments granted after January 1, 2006, and for all awards granted to employees prior to January 1, 2006, that remain unvested on January 1, 2006. The Company adopted SFAS 123(R) using a modified prospective application. The Company uses the straight-line method of recording compensation expense relative to share-based payment. Stock-based compensation expense is recorded primarily in general and administrative expenses in the Company’s Consolidated Statements of Operations as the majority of the stock option expense related to options granted to executives.
 
If factors change and the Company employs different assumptions in the application of SFAS 123(R) in future periods, the compensation expense that the Company records may differ significantly from the expense recorded in the current period.
 
 
For a discussion of New Accounting Pronouncements, see Note 1 to the Company’s Consolidated Financial Statements.
 
 
Certain statements contained in this Annual Report on Form 10-K 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 that 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 that could cause actual performance to differ materially from these forward-looking statements include those Risk Factors set forth in Item 1A of this Annual Report on Form 10-K.
 
ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
 
The Company is exposed to changes in interest rates on its amounts outstanding under the Facility and Multicurrency Facility. At December 31, 2008, no amounts were outstanding under either the Facility or the Multicurrency Facility.


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In February 2007, the Company entered into an interest rate swap arrangement and an interest rate collar arrangement to fix the interest rate on a portion of its debt. The Company fixed the interest rate on the total outstanding balance of the term loan through April 30, 2007 at a fixed rate of 5.079% plus the 2.5% margin. Beginning May 1, 2007, the Company fixed the interest rate on $40.0 million of the outstanding term loan at the rate of 5.079% plus the 2.5% margin with an additional $51.0 million covered under the interest rate collar. The collar provided for interest rate protection at a cap of 6.25% and a floor of 3.21%. These agreements were not designated for hedge accounting treatment under SFAS No. 133 and all changes in the fair market value of the hedge will be recorded in the Company’s Consolidated Statements of Operations. In December 2007, the Company terminated the swap transaction and paid $881,000 to reflect the amounts due upon termination of the swap. Total 2007 losses related to changes in the fair market value of the interest rate swap and collar arrangements, including the $881,000 paid out upon termination of the swap arrangement were approximately $1.3 million. In the first quarter of 2008, the Company terminated the interest rate collar arrangement and paid approximately $1.1 million, of which approximately $382,000 was accrued at December 31, 2007, to reflect the amounts due upon termination of the collar. In the first quarter of 2008, the Company recorded approximately $700,000 in losses related to changes in the fair market value of the interest rate collar arrangement.
 
Foreign Currency
 
The Company operates on a global basis and is therefore exposed to various types of currency risks. Two specific transaction risks arise from the nature of the contracts the Company executes with its customers. From time to time contracts are denominated in a currency different than the particular local currency. This contract currency denomination issue is applicable only to a portion of the contracts executed by the Company. The first risk occurs as revenue recognized for services rendered is denominated in a currency different from the currency in which the subsidiary’s expenses are incurred. As a result, the subsidiary’s net service revenues and resultant net income or loss can be affected by fluctuations in exchange rates.
 
The second risk results from the passage of time between the invoicing of customers under these contracts and the ultimate collection of customer payments against such invoices. Because the contract is denominated in a currency other than the subsidiary’s local currency, the Company recognizes a receivable at the time of invoicing at the local currency equivalent of the foreign currency invoice amount. Changes in exchange rates from the time the invoice is prepared until the payment from the customer is received will result in the Company receiving either more or less in local currency than the local currency equivalent of the invoice amount at the time the invoice was prepared and the receivable established. This difference is recognized by the Company as a foreign currency transaction gain or loss, as applicable, and is reported in Other Income (Expense) in the Consolidated Statements of Operations.
 
A third type of transaction risk arises from transactions denominated in multiple currencies between any two of the Company’s various subsidiary locations. For each subsidiary, the Company maintains an intercompany receivable and payable, which is denominated in multiple currencies. Changes in exchange rates from the time the intercompany receivable/payable balance arises until the balance is settled or measured for reporting purposes, results in exchange rate gains and losses. This intercompany receivable/payable arises when work is performed by a Kendle location in one country on behalf of a Kendle location in a different country under contract with the customer. Additionally, there are occasions when funds are transferred between subsidiaries for working capital purposes. The foreign currency transaction gain or loss is reported in Other Income (Expense) in the Consolidated Statements of Operations.
 
In 2008, the Company recorded total foreign exchange losses of approximately $3.4 million compared to $5.9 million in 2007 related to the risks described above. As described below, in the first quarter of 2007 the Company entered into foreign currency hedge transactions to hedge exposure related to intercompany notes between the Company’s U.S. subsidiary, as lender, and the Company’s subsidiaries in each of the United Kingdom and Germany.
 
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 the Consolidated Financial Statements. The


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Company’s foreign subsidiaries translate their financial results from local currency into U.S. dollars as follows: income statement accounts are translated at average exchange rates for the period; balance sheet asset and liability accounts are translated at end of period exchange rates; and equity accounts are translated at historical exchange rates. Translation of the balance sheet in this manner affects the shareholders’ equity account referred to as the foreign currency translation adjustment account. This account exists only in the foreign subsidiaries’ U.S. dollar balance sheet and is necessary to keep the foreign subsidiaries’ balance sheet stated in U.S. dollars in balance. Cumulative foreign currency translation adjustments, which are reported as a separate component of Shareholders’ Equity, were approximately $14.5 million at December 31, 2008 and $3.8 million at December 31, 2007.
 
Foreign Currency Hedges
 
In the first quarter of 2007, the Company entered into foreign currency hedging transactions to mitigate exposure in movements between the U.S. dollar and British Pounds Sterling and U.S. dollar and Euro. The hedging transactions are designed to mitigate the Company’s exposure related to two intercompany notes between the Company’s U.S. subsidiary, as lender, and the Company’s subsidiaries in each of the United Kingdom and Germany. The note between the Company’s U.S. subsidiary and United Kingdom subsidiary is denominated in Pounds Sterling and had an outstanding principal amount of approximately $41.4 million at December 31, 2008 compared to $58.8 million at December 31, 2007. The note between the Company’s U.S. subsidiary and German subsidiary is denominated in Euros and had an outstanding principal amount of approximately $22.8 million at December 31, 2008 compared to $25.7 million at December 31, 2007. The hedge agreements were not designated for hedge accounting treatment under SFAS No. 133 and all changes in the fair market value of the hedge are recorded in the Company’s Consolidated Statements of Operations. In 2008, the Company recorded gains of approximately $1.4 million on the Euro hedge transactions and gains of approximately $18.0 million on the Pound Sterling transaction related to the changes in the fair market value of the hedge. The gains on the fair market value of the hedge were offset by foreign exchange losses of approximately $1.3 million on the change in value of the Euro intercompany note and $15.7 million on the change in value of the Pound Sterling intercompany note. In 2007, the Company recorded losses of approximately $1.9 million on the Euro hedge transaction and gains of approximately $300,000 on the Pound Sterling transaction related to the changes in the fair market value of the hedge. The losses on the fair market value of the hedge were offset by foreign exchange gains of approximately $2.6 million on the change in value of the Euro intercompany note and approximately $366,000 on the change in value of the Pound Sterling intercompany note. As it relates specifically to the foreign currency hedges discussed above, a 10% change in the U.S. dollar to Euro and U.S. dollar to Pound Sterling exchange rates would impact pre-tax income by approximately $1.1 million in 2008.
 
In January 2009, the Company eliminated a substantial portion of the note payable between the US subsidiary and the UK subsidiary, referenced above. In connection with this transaction, the Company also terminated its Pound Sterling foreign currency hedge arrangement referenced above. At December 31, 2008, the value of the hedge arrangement related to the US dollar and Pound sterling was approximately $18.3 million. At the time of termination of the hedge in January, the Company received approximately $17.1 million in cash proceeds resulting from this termination.
 
Fair Value of Derivative Transactions
 
The notional amounts and fair values of the Company’s interest rate collar and foreign currency hedges at December 31, 2008 and 2007 are shown below (in thousands).
 
                                 
    As of December 31, 2008     As of December 31, 2007  
    Notional
    Fair
    Notional
    Fair
 
    Amount     Value     Amount     Value  
 
Interest rate collar
  $     $     $ 52,000     $ (382 )
Foreign currency hedges
    77,955       17,853       81,098       (1,617 )
                                 
            $ 17,853             $ (1,999 )
                                 


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ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
The Financial Statements and Supplementary Data called for by this Item are set forth in pages F-1 to F-36, which are incorporated herein by reference.
 
ITEM 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
 
None to report.
 
ITEM 9A.   CONTROLS AND PROCEDURES
 
Management’s Evaluation of Disclosure Controls and Procedures
 
Based on the Company’s most recent evaluation, which was completed as of the end of the period covered by this Annual Report on Form 10-K, our CEO/Chairman (principal executive officer) and Chief Financial Officer (principal financial and accounting officer) concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) are effective.
 
(a) Management’s Report on Internal Control over Financial Reporting
 
The Company’s management is responsible for establishing and maintaining adequate internal controls designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The Company’s internal control over financial reporting includes those policies and procedures that:
 
1. pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets of the Company;
 
2. provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with GAAP and that receipts and expenditures of the Company are being made only in accordance with the authorizations of management and the Directors of the Company; and
 
3. provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the Consolidated Financial Statements.
 
All internal control systems, no matter how well designed, have inherent limitations, including the possibility of human error, collusion and the improper overriding of controls by management. Accordingly, even those systems determined to be effective can provide only reasonable, but not absolute assurance with respect to financial statement preparation and presentation. Further, because of changes in conditions, the effectiveness of internal control may vary over time.
 
As required by Section 404 of the Sarbanes Oxley Act of 2002, management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2008. Management’s assessment is based on the criteria established in the Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based upon our assessment, management concludes that the Company maintained effective internal control over financial reporting as of December 31, 2008.
 
Deloitte and Touche LLP, the Company’s independent registered public accounting firm, has issued an attestation report on the Company’s internal control over financial reporting and as of December 31, 2008. This report appears below.


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(b) Changes in Internal Control Over Financial Reporting
 
There have been no changes in the Company’s internal control over financial reporting during the most recently completed fiscal quarter ended December 31, 2008 that have materially affected, or are reasonably likely to materially affect the Company’s internal control over financial reporting.
 
             
         
/s/  Candace Kendle

Candace Kendle, PharmD
  Chairman of the Board of Directors, Chief Executive Officer and Principal Executive Officer   March 16, 2009
         
/s/  Karl Brenkert III

Karl Brenkert III
  Senior Vice President, Chief Financial Officer and Principal Financial Accounting Officer   March 16, 2009


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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Shareholders of
Kendle International Inc.
Cincinnati, Ohio
 
We have audited the internal control over financial reporting of Kendle International Inc. and subsidiaries (the “Company”) as of December 31, 2008, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
 
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
 
A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
 
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
 
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2008 of the Company and our report dated March 16, 2009 expressed an unqualified opinion on those financial statements.
 
/s/  DELOITTE & TOUCHE LLP
 
Cincinnati, Ohio
March 16, 2009


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ITEM 9B   OTHER INFORMATION
 
Nothing to report.
 
PART III
 
ITEM 10.   DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
 
The name, age and background information for each of the Company’s Directors is set forth in the section entitled “Election of Directors” contained in the Company’s definitive Proxy Statement to be filed with the SEC and is incorporated herein by reference.
 
 
Information regarding the members of the audit committee and the audit committee financial expert is set forth in the sections entitled “Board of Directors” and “Audit Committee” under the heading “Governance of the Company” in the Company’s definitive Proxy Statement to be filed with the SEC. The information in these sections is incorporated herein by reference.
 
 
The Executive Officers of the Company at March 2, 2009, were as follows:
 
             
            Executive
Name
  Age   Position   Officer Since
 
Candace Kendle, PharmD
  62   Chief Executive Officer and Chairman of the Board of Directors   1989
Christopher C. Bergen
  58   Chief Operating Officer and Director   1989
Karl Brenkert III
  61   Senior Vice President, Chief Financial Officer and Secretary   2002
Simon S. Higginbotham
  48   President   2004
 
Background information regarding Dr. Kendle and Mr. Bergen is set forth in the section entitled “Election of Directors” in the Company’s definitive Proxy Statement to be filed with the SEC. Background information regarding Mr. Brenkert and Mr. Higginbotham is set forth in the notes to the table within the section entitled “Securities Ownership of Management” contained in the Company’s definitive Proxy Statement to be filed with the SEC. This information is incorporated herein by reference.
 
 
Information on compliance with Section 16(a) of the Exchange Act is set forth in the section entitled “Section 16(a) Beneficial Ownership Reporting Compliance” under the heading entitled “Securities Ownership” in the Company’s definitive Proxy Statement to be filed with the SEC and is incorporated herein by reference.
 
 
The Company has adopted a Code of Ethics and Conduct, which applies to the Company’s employees, including its Chief Executive Officer and its principal financial and accounting officer. The Code of Ethics and Conduct is available on the Company’s web site at www.kendle.com. Amendments to the Code of Ethics and Conduct will be posted to the Company’s web site. In addition, the Company will make available, free of charge, to any person, a copy of its Code of Ethics and Conduct upon written request submitted to the Company. This written request should be addressed to the Company’s Secretary at the Company’s principal executive offices.


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ITEM 11.   EXECUTIVE COMPENSATION
 
Information required by this report is set forth in the following sections under the heading entitled “Governance of the Company” in the Company’s definitive Proxy Statement to be filed with the SEC, which information is incorporated herein by reference:
 
  •  “Compensation Committee Interlocks and Insider Participation”; and
 
  •  “Compensation of Directors”.
 
Information required by this report is set forth in the “Executive Compensation” section in the Company’s definitive Proxy Statement to be filed with the SEC. The “Executive Compensation” section includes information under the following headings, which information is incorporated herein by reference.
 
  •  “Compensation Discussion and Analysis:;
 
  •  “Compensation Committee Report”;
 
  •  “Summary Compensation Table”;
 
  •  “Grants of Plan-Based Awards”;
 
  •  “Outstanding Equity Awards at Fiscal Year End:;
 
  •  “Option Exercises and Stock Vested”; and
 
  •  “Potential Payments Upon Termination or Change-in-Control”.
 
ITEM 12.   SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
 
Information on the number of shares beneficially owned by each Director and by all Directors and Executive Officers as a group is set forth in the section entitled “Securities Ownership of Management” under the heading entitled “Securities Ownership” in the Company’s definitive Proxy Statement to be filed with the SEC. The information set forth in such section is incorporated herein by reference.
 
Information on the number of shares beneficially owned by any person who is known to the Company to be the beneficial owner of more than five percent of the Company’s Common Stock is set forth in the section entitled “Principal Shareholders” under the heading entitled “Securities Ownership” in the Company’s definitive Proxy Statement to be filed with the SEC. The information set forth in such section is incorporated herein by reference.


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The following table presents summary information at December 31, 2008, with respect to all of the Company’s equity compensation plans.
 
 
                         
            (c)
            Number of
            Securities
    (a)
      Remaining Available
    Number of
      for Future Issuance
    Securities to be
  (b)
  Under Equity
    Issued upon
  Weighted-Average
  Compensation Plans
    Exercise of
  Exercise Price
  (Excluding
    Outstanding
  of Outstanding
  Securities
    Options, Warrants
  Options, Warrants
  Reflected in Column
Plan Category
  and Rights(1)   and Rights(1)   (a))(2)
 
Equity compensation plans approved by security holders
    414,677     $ 17.35       912,800  
Equity compensation plans not approved by security holders
                 
Total
    414,677     $ 17.35       912,800  
 
 
(1) Excludes the 2003 Directors’ Compensation Plan under which no options, warrants or rights are granted. This plan has been approved by shareholders for up to 75,000 shares.
 
(2) Represents shares available for issuance under the 2007 Stock Incentive Plan.
 
ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
 
 
Information with respect to transactions with related persons, if any, is contained under the caption “Review and Approval of Transactions with Related Persons” under the heading entitled “Governance of the Company” in the Company’s definitive Proxy Statement to be filed with the SEC. The information set forth in such section is incorporated herein by reference.
 
 
Information with respect to the review, approval or ratification of transactions with related persons is contained under the caption “Review and Approval of Transactions with Related Persons” under the heading entitled “Governance of the Company” in the Company’s definitive Proxy Statement to be filed with the SEC. The information set forth in such section is incorporated herein by reference.
 
PROMOTERS AND CERTAIN CONTROL PERSONS
 
Not applicable.
 
 
The name of each Director that is independent is contained in the section entitled “Board of Directors” under the heading entitled “Governance of the Company” in the Company’s definitive Proxy Statement to be filed with the SEC. The information set forth in such section is incorporated herein by reference.
 
ITEM 14.   PRINCIPAL ACCOUNTANT FEES AND SERVICES
 
Information required by this Item is contained in the sections entitled “Audit Committee’s Pre-Approval Policies and Procedures” and “Fees Paid to Registered Public Accounting Firm” under the heading entitled “Ratification of Appointment of Registered Public Accounting Firm” in the Company’s definitive Proxy Statement to be filed with the SEC and is incorporated herein by reference.


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ITEM 15.   EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
 
(a) (1) and (2) — All financial statements and schedules required to be filed by Item 8 of this Annual Report on Form 10-K and included in this report are listed beginning on page F-1. No additional financial statements or schedules are being filed as the required information is not applicable or because the information is required and is included in the respective financial statements or notes thereto.
 
(3) Exhibits — Exhibits set forth below that are on file with the SEC are incorporated by reference as exhibits hereto.
 
         
Exhibit
   
Number
 
Description of Exhibit
 
  2 .1   Stock Purchase Agreement dated July 1, 1997 by and among the Company and Shareholders of U-Gene Research B.V (Incorporated by reference to the Company’s Registration Statement No. 333-30581 filed under the Securities Act of 1933)
  2 .2   Escrow Agreement dated June 27, 1997 among the Company, Keating, Muething & Klekamp, P.L.L., Bio-Medical Research Holdings, B.V., Utrechtse Particatiemaatschappij B.V., P.J. Morrison, T.S. Schwarz, I.M. Hoepelman, Ph.K. Peterson, J. Remington, M. Rozenberg-Arska and L.G.W. Sterkman (Incorporated by reference to the Company’s Registration Statement No. 333-30581 filed under the Securities Act of 1933)
  2 .3   Share Purchase Agreement dated July 2, 1997 by and among the Company and the Shareholders of GMI Gescellschaft für Angewandte Mathematick und Informatik mbH (Incorporated by reference to the Company’s Registration Statement No. 333-30581 filed under the Securities Act of 1933)
  2 .4   Stock Purchase Agreement dated February 11, 1998 by and among the Company and the Shareholders of ACER/EXCEL Inc. (Incorporated by reference to the Company’s Current Report on Form 8-K filed with the Commission on November 12, 1997)
  2 .5   Escrow Agreement dated February 11, 1998 among the Company, Tzuo-Yan Lee, Jean C. Lee, Michael Minor, Conway Lee, Steven Lee, Jean C. Lee, as Trustee under a Trust dated March 8, 1991 fbo Jennifer Lee, Citicorp Trust-South Dakota and The Fifth Third Bank (Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 1997)
  2 .6   Registration Rights Agreement dated February 11, 1998 among the Company and Tzuo-Yan Lee, Jean C. Lee, Michael Minor, Conway Lee, Steven Lee, Jean C. Lee, as Trustee under a Trust dated March 8, 1991 fbo Jennifer Lee, Citicorp Trust-South Dakota (Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 1997)
  2 .7   Share Purchase Agreement dated December 23, 1998 by and among the Company and the Shareholders of Research Consultants (International) Holdings Limited (Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 1998)
  2 .8   Escrow Agreement dated January 5, 1999 among the Company, John Glasby, Gillian Gregory, Michael Roy Broomby and Peter Nightingale (Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 1998)
  2 .9   Option Agreement dated September 9, 1998 by and between the Company and Component Software International, Inc. (Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 1998)
  2 .10   Notice of Option Exercise dated January 11, 1999 of the Option Agreement dated September 9, 1998 (Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 1998)
  2 .11   Multi-Year Strategic Services Agreement dated January 20, 1999 by and between the Company and Component Software International, Inc. (Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 1998)
  2 .12   Asset Purchase Agreement dated June 27, 1999 by and among the Company and the Shareholders of Health Care Communications, Inc. (Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1999)


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Exhibit
   
Number
 
Description of Exhibit
 
  2 .13   Stock Purchase Agreement dated June 4, 1999 by and among the Company and the Shareholders of ESCLI S.A. (Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1999)
  2 .14   Asset Purchase Agreement dated July 13, 1999 by and among the Company and the Shareholders of HCC Health Care Communications (1991), Ltd. (Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1999)
  2 .15   Share Purchase Agreement dated August 31, 1999 by and among the Company and the Shareholder of Specialist Monitoring Services Limited (Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1999)
  2 .16   Escrow Agreement dated July 13, 1999 by and among the Company, Geoffrey H. Kalish, M.D., Bradley D. Kalish, Jill Kalish, and The Fifth Third Bank, as Escrow Agent (Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 1999)
  2 .17   Escrow Agreement dated August 31, 1999 by and among the Company, Paul Martin, and The Fifth Third Bank, as Escrow Agent (Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 1999)
  2 .18   Units Purchase Agreement dated April 7, 2000 by and among the Company and the Shareholders of SYNERmedica PTY Limited and SYNERmedica Unit Trust (Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2000)
  2 .19   Stock Purchase Agreement dated February 27, 2001 by and among the Company and the Shareholders of AAC Consulting Group, Inc. (Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 2000)
  2 .20   Form of Note Prepayment Agreement (Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2003)
  2 (a)   Asset Purchase Agreement dated January 29, 2002 among Kendle International Inc., Clinical and Pharmacologic Research, Inc., Thomas S. Clark, M.D., Charles T. Clark, and E. Stuart Clark (Incorporated by reference to the Company’s Current Report on Form 8-K filed with the Commission on January 29, 2002)
  2 (b)   Convertible Subordinated Note, dated January 29, 2002 issued by Kendle International Inc. to Clinical and Pharmacologic Research, Inc. (Incorporated by reference to the Company’s Current Report on Form 8-K filed with the Commission on January 29, 2002)
  2 .21   Stock Purchase Agreement between the Company and Charles River Laboratories International, Inc. dated as of May 9, 2006 (Incorporated by reference to the Form 8-K filed with the Commission on May 12, 2006)
  3 .1   Restated and Amended Articles of Incorporation. Incorporated by reference to the Company’s Registration Statement No. 333-30581 filed under the Securities Act of 1933
  3 .2   Amended and Restated Code of Regulations (Incorporated by reference to the Company’s Registration Statement No. 333-30581 filed under the Securities Act of 1933)
  3 .3   Amendment of the Restated and Amended Articles of Incorporation to Increase the Authorized Shares (Incorporated by reference to the Company’s definitive Proxy Statement on Schedule 14A filed with the Commission on April 14, 1999)
  4     Specimen Common Stock Certificate (Incorporated by reference to the Company’s Registration Statement No. 333-30581 filed under the Securities Act of 1933)
  4 .1   Shareholder Rights Agreement dated August 13, 1999 between the Company and The Fifth Third Bank, as Rights Agent (Incorporated by reference to the Company’s filing on Form 8-A filed with the Commission on September 7, 1999)
  4 .2   Indenture dated March 31, 2007 between the Company and LaSalle Bank National Association (Incorporated by reference to the Company’s Form S-3 filed with the Commission on April 9, 2007)
  4 .3   Supplemental Indenture No. 1 dated July 16, 2007 between the Company and LaSalle Bank National Association (Incorporated by reference to the Company’s Current Report on Form 8-K filed with the Commission on July 16, 2007)

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Exhibit
   
Number
 
Description of Exhibit
 
  10 .1   Amended and Restated Shareholders’ Agreement dated June 26, 1997 (Incorporated by reference to the Company’s Registration Statement No. 333-30581 filed under the Securities Act of 1933)
  10 .2   Master Lease Agreement dated November 27, 1996 by and between the Company and Bank One Leasing Corporation, as amended on April 18, 1997 (Incorporated by reference to the Company’s Registration Statement No. 333-30581 filed under the Securities Act of 1933)
  10 .6   Master Equipment Lease dated August 16, 1996 by and between the Company and The Fifth Third Leasing Company (Incorporated by reference to the Company’s Registration Statement No. 333-30581 filed under the Securities Act of 1933)
  10 .7   Lease Agreement dated December 9, 1991 by and between the Company and Carew Realty, Inc., as amended on December 30, 1991, March 18, 1996, October 8, 1996, January 29, 1997, and February 16, 1999 (Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 1998)
  10 .8   Indemnity Agreement dated June 21, 1996 by and between the Company and Candace Kendle Bryan (Incorporated by reference to the Company’s Registration Statement No. 333-30581 filed under the Securities Act of 1933)
  10 .9   Indemnity Agreement dated June 21, 1996 by and between the Company and Christopher C. Bergen (Incorporated by reference to the Company’s Registration Statement No. 333-30581 filed under the Securities Act of 1933)
  10 .10   Indemnity Agreement dated June 21, 1996 by and between the Company and Timothy M. Mooney (Incorporated by reference to the Company’s Registration Statement No. 333-30581 filed under the Securities Act of 1933)
  10 .11   Indemnity Agreement dated May 14, 1997 by and between the Company and Charles A. Sanders (Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 1997)
  10 .12   Indemnity Agreement dated May 14, 1997 by and between the Company and Philip E. Beekman (Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 1997)
  10 .13   Indemnity Agreement dated December 10, 1998 by and between the Company and Robert Buck (Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 1998)
  10 .14   Indemnity Agreement dated December 10, 1998 by and between the Company and Mary Beth Price (Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 1998)
  10 .15   Form of Indemnity Agreement by and between the Company and each member of the Company’s Board of Directors, except for those Indemnity Agreements noted above (Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003)
  10 .16   Credit Agreement dated as of August 16, 2006 by and among the Company, certain subsidiary Guarantors, various Lenders, UBS Securities LLC, as Sole Lead Arranger and Sole Bookrunner, UBS AG, Stamford Branch, as Issuing Bank, Administrative Agent and Collateral Agent, UBS Loan Finance LLC, as Swingline Lender, JPMorgan Chase Bank, N.A., as Syndication Agent, and KeyBank National Association, LaSalle Bank N.A. and National City Bank, as Co-Documentation Agents (Incorporated by reference to the Company’s Current Report on Form 8-K filed with the Commission on August 18, 2006)
        (a) First Amended and Restated Credit Agreement dated as of December 11, 2006 among Kendle International Inc., the several lenders from time to time party thereto and UBS AG, Stamford Branch, as administrative agent (Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2007)
  10 .17   First Amendment to the Stock Purchase Agreement dated as of August 16, 2006 between the Company and Charles River Laboratories, Inc. (Incorporated by reference to the Company’s Current Report on Form 8-K filed with the Commission on August 18, 2006)

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Exhibit
   
Number
 
Description of Exhibit
 
  10 .18   Second Amended and Restated Credit Agreement dated as of April 13, 2007 among Kendle International Inc., the several lenders from time to time party thereto and UBS AG, Stamford Branch, as administrative agent (Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2007)
  10 .19   Increase Joinder Agreement dated June 27, 2007 among the Company, certain of its subsidiaries, various Lenders, and UBS AG, Stamford Branch as administrative agent for the lenders (Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2007)
  10 .20   Confirmation of Convertible Bond Hedge Transaction, dated July 10, 2007, by and between the Company and UBS AG, London Branch (Incorporated by reference to the Company’s Current Report on Form 8-K filed with the Commission on July 10, 2007)
  10 .21   Confirmation of Convertible Bond Hedge Transaction, dated July 10, 2007, by and between the Company and JPMorgan Chase Bank, National Association, London Branch (Incorporated by reference to the Company’s Current Report on Form 8-k filed with the Commission on July 10, 2007)
  10 .22   Confirmation of Issuer Warrant Transaction, dated July 10, 2007, by and between the Company and UBS AG, London Branch (Incorporated by reference to the Company’s Current Report on Form 8-k filed with the Commission on July 10, 2007)
  10 .23   Confirmation of Issuer Warrant Transaction, dated July 10, 2007, by and between the Company and JPMorgan Chase Bank, National Association, London Branch (Incorporated by reference to the Company’s Current Report on Form 8-k filed with the Commission on July 10, 2007)
  10 .24   Third Amended and Restated Credit Agreement dated as of December 18, 2007 among Kendle International Inc., the several lenders from time to time party thereto and UBS AG, Stamford Branch, as administrative agent (Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 2007)
  10 .25   Lease Agreement dated February 27, 2008 by and between the Company and Carew Realty, Inc. (Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2008)
  10 .26   Fourth Amended and Restated Credit Agreement dated as of June 20, 2008 among the Company, the several lenders from time to time parties thereto and UBS AG, Stamford Branch, as administrative agent (Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2008)
  10 .30   MANAGEMENT CONTRACTS AND COMPENSATION PLANS
        (a) 1995 Stock Option and Stock Incentive Plan (Incorporated by reference to the Company’s Registration Statement No. 333-30581 filed under the Securities Act of 1933)
        (b) 1995 Stock Option and Stock Incentive Plan — Individual Stock Option Agreement for Incentive Stock Option (contained in Exhibit 10.20(a)) (Incorporated by reference to the Company’s Registration Statement No. 333-30581 filed under the Securities Act of 1933)
        (c) 1997 Stock Option and Stock Incentive Plan (Incorporated by reference to the Company’s Registration Statement No. 333-30581 filed under the Securities Act of 1933)
        (c)(1) Amendment No. 1 to 1997 Stock Option and Stock Incentive Plan (Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002)
        (c)(2) Amendment No. 2 to 1997 Stock Option and Stock Incentive Plan (Incorporated by reference to the Company’s definitive Proxy Statement on Schedule 14A filed with the Commission on April 12, 2000)
        (c)(3) Amendment No. 3 to 1997 Stock Option and Stock Incentive Plan (Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002)
        (c)(4) Form of Restricted Stock Award Agreement (Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004)
        (d) Form of Protective Compensation and Benefit Agreement. Incorporated by reference to the Company’s Registration Statement No. 333-30581 filed under the Securities Act of 1933)
        (e) 1998 Employee Stock Purchase Plan (Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 1998)

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Exhibit
   
Number
 
Description of Exhibit
 
        (e)(1) Amendment No. 1 to 1998 Employee Stock Purchase Plan (Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002)
        (e)(2) Amendment No. 2 to 1998 Employee Stock Purchase Plan (Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002)
        (e)(3) Amendment No. 3 to 1998 Employee Stock Purchase Plan (Incorporated by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002)
        (e)(4) Amendment No. 4 to 1998 Employee Stock Purchase Plan (Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2005)
        (e)(5) Amendment No. 5 to 1998 Employee Stock Purchase Plan (Incorporated by reference to the Company’s Current Report on Form 8-K filed with the Commission on June 3, 2005)
        (f) 2007 Stock Incentive Plan (Incorporated by reference to the Company’s definitive Proxy Statement on Schedule 14A filed with the Commission on April 9, 2007)
        (f)(1) Form of Performance based Stock Unit Agreement (Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2008)
        (g) Annual Incentive Plan (Incorporated by reference to the Company’s Current Report on From 8-K filed with the Commission on May 20, 2008)
        (h) Nonqualified Deferred Compensation Plan (Incorporated by reference to the Company’s Current Report on From 8-K filed with the Commission on May 20, 2008)
        (n) 2003 Directors Compensation Plan (Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2003)
  12 .1   Computation of Ratio of Earnings to Fixed Charges (Filed herewith)
  14     Code of Ethics (Available on the Company’s Web site at www.kendle.com)
  21     List of Subsidiaries (Filed herewith)
  23 .1   Consent of Deloitte & Touche LLP (Filed herewith)
  24     Powers of Attorney (Filed herewith)
  31 .1   Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) (Filed herewith)
  31 .2   Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) (Filed herewith)
  32 .1   Certification Pursuant to 18 U.S.C Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002- Chief Executive Office (Filed herewith)
  32 .2   Certification Pursuant to 18 U.S.C Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 — Chief Financial Officer (Filed herewith)

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Table of Contents

 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Shareholders of
Kendle International Inc.
Cincinnati, Ohio
 
We have audited the accompanying consolidated balance sheets of Kendle International Inc. and subsidiaries (the “Company”) as of December 31, 2008 and 2007, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Kendle International Inc. and subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America.
 
As discussed in Note 1, effective January 1, 2007, the Company adopted Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an Interpretation of Financial Accounting Standards Board Statement No. 109.
 
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2008, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 16, 2009 expressed an unqualified opinion on the Company’s internal control over financial reporting.
 
/s/  DELOITTE & TOUCHE LLP
Cincinnati, Ohio
March 16, 2009


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Table of Contents

 
 
                         
    For the Years Ended December 31,  
    2008     2007     2006  
    (In thousands except per share data)  
 
Net service revenues
  $ 475,092     $ 397,584     $ 283,471  
Reimbursable out-of-pocket revenues
    203,489       171,234       90,465  
                         
Total revenues
    678,581       568,818       373,936  
Costs and expenses:
                       
Direct costs
    247,436       204,161       152,826  
Reimbursable out-of-pocket costs
    203,489       171,234       90,465  
Selling, general and administrative
    155,577       125,744       91,796  
Depreciation and amortization
    15,253       14,865       10,403  
Employee severance and office consolidation costs
                236  
Intangible impairment charge
                8,200  
                         
Total costs and expenses
    621,755       516,004       353,926  
Income from operations
    56,826       52,814       20,010  
Other income (expense):
                       
Interest income
    760       1,466       1,939  
Interest expense
    (9,637 )     (14,870 )     (6,781 )
Write-off of deferred financing costs
          (4,152 )      
Other
    (2,043 )     (4,816 )     (1,795 )
                         
Total other income (expenses)
    (10,920 )     (22,372 )     (6,637 )
Income before income taxes
    45,906       30,442       13,373  
Income taxes
    16,509       11,755       4,843  
                         
Net income
  $ 29,397     $ 18,687     $ 8,530  
                         
Income per share data:
                       
Basic:
                       
Net income per share
  $ 1.99     $ 1.29     $ 0.60  
Weighted average shares
    14,751       14,520       14,323  
Diluted:
                       
Net income per share
  $ 1.96     $ 1.26     $ 0.58  
Weighted average shares
    14,993       14,889       14,762  
 
The accompanying notes are an integral part of these Consolidated Financial Statements.


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Table of Contents

 
 
                 
As of December 31,
  2008     2007  
    (In thousands except share data)  
 
ASSETS
Current assets:
               
Cash and cash equivalents
  $ 35,169     $ 45,512  
Restricted cash
    884       844  
Accounts receivable, net
    157,971       135,550  
Deferred tax asset — current
    14,077       11,403  
Other current assets
    18,439       13,476  
                 
Total current assets
    226,540       206,785  
Property and equipment, net
    44,578       32,021  
Goodwill
    236,329       230,168  
Other finite-lived intangible assets, net
    19,031       19,464  
Long-term deferred tax asset
    1,346       1,171  
Other assets
    27,735       10,114  
                 
Total assets
  $ 555,559     $ 499,723
 
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
               
Current portion of obligations under capital leases
  $ 188     $ 199  
Trade payables
    19,015       20,993  
Advance billings
    94,561       78,402  
Other accrued liabilities
    44,181       47,107  
                 
Total current liabilities
    157,945       146,701  
Obligations under capital leases, less current portion
    123       256  
Convertible notes
    200,000       200,000  
Deferred income tax liabilities
    4,424       2,322  
Non-current income taxes payable
    2,123       3,582  
Other liabilities
    5,801       5,339  
                 
Total liabilities
    370,416       358,200  
Commitments and contingencies
               
Shareholders’ equity:
               
Preferred stock — no par value; 100,000 shares authorized; none issued and outstanding
               
Common stock — no par value; 45,000,000 shares authorized; 14,861,518 and 14,681,029 shares issued and 14,838,466 and 14,657,977 outstanding at December 31, 2008 and 2007, respectively
    75       75  
Additional paid-in capital
    143,608       140,109  
Accumulated earnings (deficit)
    27,430       (1,967 )
Accumulated other comprehensive income:
               
Foreign currency translation adjustment
    14,522       3,798  
Less: Cost of common stock held in treasury, 23,052 shares at December 31, 2008 and 2007, respectively
    (492 )     (492 )
                 
Total shareholders’ equity
    185,143       141,523  
                 
Total liabilities and shareholders’ equity
  $ 555,559     $ 499,723  
                 
 
The accompanying notes are an integral part of these Consolidated Financial Statements.


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Table of Contents

 
 
                                                                 
                                  Accumulated
             
    Common Stock
    Common
    Additional
          Accumulated
    Other
    Total
       
    Number of
    Stock
    Paid-in
    Treasury
    Earnings
    Comprehensive
    Shareholders’
    Comprehensive
 
    Shares     Amount     Capital     Stock     (Deficit)     Income     Equity     Income  
    (In thousands except share data)  
 
Balance at January 1, 2006
    14,085,756     $ 75     $ 147,712     $ (393 )   $ (24,922 )   $ 32     $ 122,504          
Net income
                                    8,530               8,530       8,530  
Other comprehensive income:
                                                               
Foreign currency translation adjustment
                                            2,217       2,217       2,217  
Portion of prior year unrealized loss recognized in current year, net of tax
                                            34       34       34  
Realized holding loss on available-for-sale securities, net of tax
                                            5       5       5  
Net unrealized holding gains on interest rate swap agreement
                                            (8 )     (8 )     (8 )
                                                                 
Comprehensive income
                                                            10,778  
                                                                 
Shares issued under stock plans
    336,585               4,271                               4,271          
Stock option expense
                    1,490                               1,490          
Deferred compensation — restricted stock
                    (19 )                             (19 )        
Income tax benefit from exercise of stock options
                    1,187                               1,187          
Treasury stock transaction
                            (99 )                     (99 )        
                                                                 
Balance at December 31, 2006
    14,422,341     $ 75     $ 154,641     $ (492 )   $ (16,392 )   $ 2,280     $ 140,112          
Net income
                                    18,687               18,687       18,687  
Other comprehensive income:
                                                               
Foreign currency translation adjustment
                                            1,518       1,518       1,518  
                                                                 
Comprehensive income
                                                            20,205  
                                                                 
Shares issued under stock plans
    235,636               2,560                               2,560          
Stock option expense
                    860                               860          
Income tax benefit from exercise of stock options
                    188                               188          
Note hedge transaction
                    (42,880 )                             (42,880 )        
Issuance of warrants
                    24,740                               24,740          
FIN 48 adoption
                                    (4,262 )             (4,262 )        
                                                                 
Balance at December 31, 2007
    14,657,977     $ 75     $ 140,109     $ (492 )   $ (1,967 )   $ 3,798     $ 141,523          
Net income
                                    29,397               29,397       29,397  
Other comprehensive income:
                                                               
Foreign currency translation adjustment
                                            10,724       10,724       10,724  
                                                                 
Comprehensive income
                                                            40,121  
                                                                 
Shares issued under stock plans
    180,489               2,294                               2,538          
Stock compensation expense
                    1,030                               786          
Income tax benefit from exercise of stock options
                    175                               175          
                                                                 
Balance at December 31, 2008
    14,838,466     $ 75     $ 143,608     $ (492 )   $ 27,430     $ 14,522     $ 185,143          
                                                                 
 
The accompanying notes are an integral part of these Consolidated Financial Statements.


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Table of Contents

 
 
                         
    For the Years Ended
 
    December 31,  
    2008     2007     2006  
    (In thousands)  
 
Cash flows from operating activities
                       
Net income
  $ 29,397     $ 18,687     $ 8,530  
Adjustments to reconcile net income to cash provided by operating activities:
                       
Depreciation and amortization
    15,253       14,865       10,403  
Intangible impairment charge
                8,200  
Deferred income taxes
    (6,745 )     (5,234 )     (3,967 )
Income tax benefit from stock option exercises
    (175 )     (188 )     (898 )
Compensation expense on stock grants
    1,030       879       1,879  
Debt issue cost amortization
    1,529       5,404        
Foreign currency exchange loss
    4,321       3,770       184  
Other
    (1,564 )     172       338  
Changes in operating assets and liabilities, net of effects from acquisitions:
                       
Restricted cash
    (85 )     1,587       (441 )
Accounts receivable
    (28,036 )     (16,138 )     (27,559 )
Other current assets
    (3,493 )     1,507       (1,262 )
Other assets
    (317 )     (486 )     (207 )
Trade payables
    1,010       2,632       2,806  
Advance billings
    19,613       18,814       15,895  
Accrued liabilities and other
    5,318       14,712       3,650  
                         
Net cash provided by operating activities
    37,056       60,983       17,551  
Cash flows from investing activities
                       
Purchase of available-for-sale securities
                (7,027 )
Proceeds from sale and maturity of available-for-sale securities
                17,868  
Acquisitions of property and equipment
    (25,911 )     (14,724 )     (8,725 )
Additions to internally developed software
    (1,186 )     (531 )     (91 )
Acquisitions of businesses, less cash acquired
    (18,053 )     2,154       (231,879 )
Other
    (1,143 )     (722 )     (153 )
                         
Net cash used in investing activities
    (46,293 )     (13,823 )     (230,007 )
Cash flows from financing activities
                       
Proceeds from issuance of long-term debt
    37,500       200,000       200,000  
Payments of long-term debt
    (37,500 )     (199,500 )     (4,250 )
Purchase of note hedges
          (42,880 )      
Proceeds from the issuance of warrants
          24,740        
Proceeds from issuance of common stock
    2,241       2,623       3,505  
Income tax benefit from stock option exercises
    175       188       898  
Amounts payable — book overdraft
    465       (22 )     (65 )
Payments on capital lease obligations
    (234 )     (196 )     (382 )
Purchase of treasury stock
                (99 )
Debt issue costs
          (6,946 )     (5,568 )
                         
Net cash provided by (used in) financing activities
    2,647       (21,993 )     194,039  
Effects of exchange rates on cash and cash equivalents
    (3,753 )     428       897  
Net increase (decrease) in cash and cash equivalents
    (10,343 )     25,595       (17,520 )
Cash and cash equivalents
                       
Beginning of year
    45,512       19,917       37,437  
                         
End of year
  $ 35,169     $ 45,512     $ 19,917  
                         
Supplemental disclosure of cash flow information
                       
Cash paid during the year for interest
  $ 8,087     $ 10,107     $ 6,198  
Cash paid during the year for income taxes
  $ 25,931     $ 4,870     $ 7,698  
Supplemental schedule of noncash investing and financing activities
                       
Acquisition of equipment under capital leases
  $     $ 173     $ 184  
Accrued equipment purchases
  $ (1,090 )   $ (3,574 )   $  
Acquisitions of businesses:
                       
Fair value of assets acquired via cash
  $ 25,432     $ (2,154 )   $ 266,850  
Fair value of liabilities assumed or incurred
  $ (7,379 )   $     $ (34,971 )
                         
Net cash payments / (inflows)
  $ 18,053     $ (2,154 )   $ 231,879  
                         
 
The accompanying notes are an integral part of these Consolidated Financial Statements.


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Table of Contents

 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1.   NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES:
 
 
Kendle International Inc. (the Company or Kendle), an Ohio corporation established in 1989, is a global clinical research organization (CRO) that provides a broad range of Phase I-IV global clinical development services to the biopharmaceutical industry. The Company has operations in North America, Europe, Asia/Pacific, Latin America and Africa.
 
 
The Consolidated Financial Statements include the financial information of Kendle International Inc. and its wholly-owned subsidiaries. Investments in unconsolidated companies that are at least 20% owned and in which the Company can exercise significant influence, but not control, are carried at cost plus equity in undistributed earnings since acquisition. Investments in unconsolidated companies that are less than 20% owned and in which the Company cannot exercise significant influence are carried at cost. There are no significant amounts on the Consolidated Balance Sheets related to investments in unconsolidated companies.
 
All intercompany accounts and transactions have been eliminated. The results of operations of the Company’s wholly-owned subsidiaries have been included in the Consolidated Financial Statements of the Company from the respective dates of acquisition.
 
 
Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations, requires assets acquired and liabilities assumed in a business combination to be recorded at fair value. Fair values are generally determined by using comparisons to market value transactions and present value techniques. The use of a discounted cash flow technique requires significant judgments with respect to expected cash flows to be derived from the assets, the estimated period of time the assets will produce those cash flows and the selection of an appropriate discount rate. Changes in such estimates could change the amounts allocated to individual identifiable assets, the lives over which the assigned values are amortized and the amounts allocated to goodwill. While the Company believes its assumptions are reasonable, if different assumptions were made, the purchase price allocation and the estimated useful lives of amortizable assets could differ substantially from the reported amounts.
 
Results of operations for acquired entities are included in the Company’s results of operations from the date of acquisition.
 
In December 2007, the Financial Accounting Standards Board (FASB) issued SFAS No. 141(R) (revised 2007), Business Combinations, and Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements. SFAS No. 141(R) (revised 2007) requires an acquirer to measure the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree at their fair values on the acquisition date, with goodwill being the excess value over the net identifiable assets acquired. This standard also requires the fair value measurement of certain other assets and liabilities related to the acquisition such as contingencies and research and development. SFAS No. 160 clarifies that a noncontrolling interest in a subsidiary should be reported at fair value as equity in the consolidated financial statements. Consolidated net income should include the net income for both the parent and the noncontrolling interest with disclosure of both amounts on the consolidated statement of income. The calculation of earnings per share will continue to be based on income amounts attributable to the parent. The Statements are effective for fiscal years beginning after December 15, 2008. The Company will adopt the provisions of SFAS 141(R) in connection with all of its potential acquisitions beginning in 2009. On December 31, 2008 third party costs of approximately $205,000 incurred in connection with potential acquisitions that have not closed as of year end were expensed.


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Assets and liabilities of the Company’s wholly-owned subsidiaries are translated into U.S. dollars at year-end exchange rates. Income statement accounts are translated at average exchange rates for the quarter. These translation adjustments are recorded as a separate component of Shareholders’ Equity. Foreign currency transaction gains and losses are included in the Consolidated Statements of Operations in Other Income (Expense).
 
 
Cash and cash equivalents consist of demand deposits and money market funds held with financial institutions, with an initial maturity of three months or less.
 
The Company maintains its demand deposits with certain financial institutions. The balance of one account from time-to-time exceeds the maximum U.S. federally insured amount. Additionally, there is no state insurance coverage on bank balances held in The Netherlands.
 
At December 31, 2008, the Company held cash of approximately $884,000 that is restricted as to its use as compared to approximately $844,000 at December 31, 2007. The restricted cash represents cash received from customers that is segregated in a separate Company bank account and available for use only for specific project-related expenses, primarily investigator fees, upon authorization from the customer.
 
 
The majority of the Company’s net service revenues are based on fixed-price contracts calculated on a proportional performance basis (also referred to herein as “percentage-of-completion”) based upon assumptions regarding the estimated total costs for each contract. The Company also recognizes revenue under units-based contracts by multiplying units completed by the applicable contract per-unit price. Additionally, work is performed under time-and-materials contracts, recognizing revenue as hours are worked based on the hourly billing rate for each contract. Finally, at one of the Company’s Early Stage operations, the contracts are of a short-term nature and revenue is recognized under the completed contract method of accounting.
 
 
With respect to fixed price contracts, costs are incurred for performance of each contract and compared to the estimated budgeted costs for that contract to determine a percentage of completion on the contract. The percentage of completion is then multiplied by the contract value to determine the amount of revenue recognized. The contract value equals the value of the services to be performed under the contract as determined by aggregating the labor hours estimated to be incurred to perform the tasks in the contract at the agreed rates. Contract value excludes the value of third-party and other pass-through costs. As the work progresses, original estimates might be changed as a result of management’s regular contract review process.
 
Management regularly reviews the budget on each contract to determine if the budgeted costs accurately reflect the costs that the Company will incur for contract performance. The Company reviews each contract’s performance to date, current cost trends and circumstances specific to each contract. The Company estimates its remaining costs to complete the contract based on a variety of factors, including:
 
  •  Actual costs incurred to date and the work completed as a result of incurring the actual costs;
 
  •  The remaining work to be completed based on the timeline of the contract as well as the number of incomplete tasks in the contract; and
 
  •  Factors that could change the rate of progress of future contract performance.
 
Examples of factors included in the review process that could change the rate of progress of future contract performance are; patient enrollment rate, changes in the composition of staff on the project or other customer requirements, among other things.
 
Based on these contract reviews, the Company adjusts its cost estimates. Adjustments to net service revenue resulting from changes in cost estimates are recorded on a cumulative basis in the period in which the revisions are


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made. When estimates indicate a loss, such loss is provided in the current period in its entirety. While the Company routinely adjusts cost estimates on individual contracts, the Company’s estimates and assumptions historically have been accurate in all material respects in the aggregate. The Company expects the estimates and assumptions to remain accurate in all material respects in the aggregate in future periods.
 
A contract amendment, which results in revisions to net service revenues and cost estimates, is recognized in the percentage-of-completion calculations beginning in the period in which the parties reach written agreement to the amendment. Historically the aggregate value of contract amendments signed in any year represents 15% to 20% of annual sales, and, like sales, represents future net service revenues. Although the majority of the Company’s contract amendments relate to future services, the Company and its customers may execute contract amendments for services that the Company already has performed. In these circumstances, net service revenue from these services is recognized in the current period. Historically, the impact of such amendments on results of operations has not been material.
 
Under the Company’s policy, project teams are not authorized to engage in tasks outside the scope of the contract without prior management approval. In limited situations, management may authorize the project team to commence work on activities outside the contract scope while the Company and its customer negotiate and finalize the contract amendment. When work progresses on unsigned, unprocessed contract amendments, the Company reviews the direct costs incurred, and, where material, defers such costs on the balance sheet. In addition, the impact of such costs on the estimates to complete is considered and, where material, the estimates are adjusted. Historically, neither the deferred costs nor the impact on estimates have been material.
 
The Company believes that total costs constitute the most appropriate indicator of the performance of fixed price contracts because the costs relate primarily to the amount of labor hours incurred to perform the contract. The customer receives the benefit of the work performed throughout the contract term and is obligated to pay for services once performed. Accordingly, the Company believes that an input measure of cost is a reasonable surrogate for an output measure under the proportional performance model and is consistent with the revenue recognition concepts of Staff Accounting Bulletin (SAB) 104, Revenue Recognition.
 
Units-Based
 
Although the majority of the Company’s contracts are fixed-price and net service revenues are calculated on a percentage of completion methodology as discussed above, the Company has seen increasing demand from its customers to move toward a units-based contract methodology in new contracts. It is the Company’s intent to structure more of its contracts under a units-based methodology for calculating net service revenues so the Company expects the percentage of contracts under which net service revenues are recognized using units-based methodology to increase in future periods. Under a units-based contract methodology, amounts recognized as net service revenues are calculated based on units completed in the period multiplied by a unit value or selling price that is outlined in the contract.
 
For a units-based contract, a typical unit could include such things as completion of a monitoring visit, monthly site management units or case report form pages entered. The Company tracks the units completed for each unit category included in the contract. Net service revenue is recognized monthly based on the units actually completed in the period at the agreed upon unit value or selling price. Net service revenue is recognized only up to the number of units contained in each contract. If the Company completes or expects to complete units over and above the number of units initially estimated and contained in the contract, a contract amendment is generated to reflect the additional units needed.
 
A contract amendment, which results in revisions to net service revenues and cost estimates, is recognized in the unit-based net service revenue calculations beginning in the period in which the parties agree to the amendment.
 
The Company believes that under certain types of contracts the value of the work performed is best captured by calculating net service revenues using the value of units completed. The Company believes that units-based revenue recognition is consistent with the revenue recognition concepts of SAB 104.
 
As the Company provides services on projects, it also incurs third-party and other pass-through costs, which are reimbursable by its customers pursuant to the contract. The revenues and costs from these third-party and other


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pass-through costs are reflected in the Company’s Consolidated Statements of Operations under the line items titled “Reimbursable out-of-pocket revenues” and “Reimbursable out-of-pocket costs”, respectively.
 
 
Accounts receivable represent amounts due from customers that are concentrated mainly in the biopharmaceutical industry. The concentration of credit risk is subject to the financial and industry conditions of the Company’s customers. The Company does not require collateral or other securities to support customer receivables. The Company monitors the creditworthiness of its customers. Refer to Note 14, Segment Information for additional information regarding revenue concentration.
 
 
Property and equipment are stated at cost, net of accumulated depreciation. Depreciation is computed over the estimated useful lives, ranging from five to fifty years using the straight-line method. Leasehold improvements are amortized over the lesser of the estimated useful life of the improvement or the remaining term of the underlying lease. Repairs and maintenance are charged to expense as incurred. Upon disposition, the asset and the related accumulated depreciation are relieved and any gains or losses are reflected in the Consolidated Statements of Operations.
 
Useful lives by asset category can vary based on the nature of the asset purchased. The following represents the maximum estimated useful lives for the below categories of assets:
 
     
Furniture and Fixtures
  10 years
Computer and Software
  5 years
Leasehold Improvements
  Lesser of estimated life of asset or lease term
Buildings
  50 years
Capital Lease Assets
  Lesser of estimated life of asset or lease term
 
Equipment under capital leases is recorded at the present value of future minimum lease payments and is amortized over the estimated useful lives of the assets, not to exceed the terms of the related leases. Accumulated amortization on equipment under capital leases was approximately $1.4 million at December 31, 2008 compared to $1.7 million at December 31, 2007.
 
The Company capitalizes costs incurred internally to develop software used primarily in the Company’s proprietary clinical trial and data management systems, and amortizes these costs on a straight-line basis over the estimated useful life of the product, not to exceed five years. Internally developed software costs included in the Consolidated Balance Sheets at December 31, 2008, and 2007 were $17.4 million and $16.3 million, respectively. The related accumulated amortization at December 31, 2008, and 2007 was $15.6 million and $14.9 million, respectively.
 
In accordance with the provisions of SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets,” long-lived assets such as property, plant and equipment, software and investments are reviewed for impairment whenever facts and circumstances indicate that the carrying value may not be recoverable. When required, impairment losses on assets to be held and used are recognized based on the fair value of the asset. The fair value is determined based on estimates of future cash flows, market value of similar assets, if available, or independent appraisals, if required. If the carrying amount of the long-lived asset is not recoverable from its undiscounted cash flows, an impairment loss is recognized for the difference between the carrying amount and fair value of the asset.
 
 
In accordance with the provisions of 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 estimated useful lives.


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In accordance with SFAS No. 142, goodwill is evaluated on an annual basis for impairment at the reporting unit level. The Company has five reporting units that are tested for impairment: Early Stage, Global Clinical Development, Late Phase, Regulatory Affairs and Biometrics. Such evaluation is based on a two-step test starting with a comparison of the carrying amount of the reporting unit to the fair value of the reporting unit. If the carrying amount of the reporting unit exceeds the fair value, the second phase of the test measures the impairment.
 
In 2008 and 2007, consistent with the above-referenced guidance, the Company analyzed goodwill for impairment by comparing the carrying amounts of the reporting units to the fair values of the reporting units. The fair values of the reporting units were calculated based on the income approach which uses discounted cash flows as well as public information regarding the market capitalization of the Company.
 
The Company completed the testing in the fourth quarter of 2008. The fair value of the reporting units exceeded the carrying value, resulting in no goodwill impairment for 2008. Similarly, the analysis in the fourth quarter of 2007 resulted in no goodwill impairment for 2007.
 
 
From time to time, the Company may use derivative instruments to manage exposure to interest rates and foreign currency. Derivatives meeting the hedge criteria established by SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended by SFAS No. 138, are recorded in the Consolidated Balance Sheets at fair value at each balance sheet date. When the derivative is entered into, the Company designates whether or not the derivative instrument is an effective hedge of an asset, liability or firm commitment and classifies the hedge as a cash flow hedge or a fair value hedge. If the hedge is determined to be an effective cash flow hedge, changes in the fair value of the derivative instrument are recorded as a component of other comprehensive income (loss). Changes in the value of fair value hedges are recorded in results of operations.
 
In July 2002, the Company entered into an interest rate swap agreement to fix the interest rate on its $15 million term loan which was outstanding at that time. The swap was designated as a cash flow hedge. The Company terminated the swap in the second quarter of 2006 in conjunction with paying off the term loan. In February 2007, the Company entered into a hedge agreement to fix the interest rate on a portion of its then existing term debt (see Note 7, Debt) via interest rate swap and collar arrangements. The hedge agreement was not designated for hedge accounting treatment under SFAS No. 133 and all changes in the fair market value of the hedge were recorded in the Company’s Consolidated Statements of Operations in the line item interest expense. In the fourth quarter of 2007, the Company terminated the swap agreement and in the first quarter of 2008, the Company terminated the collar agreement.
 
In the first quarter of 2007, the Company entered into foreign currency hedging transactions to mitigate exposure in movements between the U.S. dollar and British Pounds Sterling and U.S. dollar and Euro. The hedging transactions are designed to mitigate the Company’s exposure related to two intercompany notes between the Company’s U.S. subsidiary, as lender, and the Company’s subsidiaries in each of the United Kingdom and Germany. The note between the Company’s U.S. subsidiary and United Kingdom subsidiary is denominated in Pounds Sterling and had an outstanding principal amount of approximately $41.4 million at December 31, 2008. The note between the Company’s U.S. subsidiary and German subsidiary is denominated in Euro and had an outstanding principal amount of approximately $22.8 million at December 31, 2008. The hedge agreements were not designated for hedge accounting treatment under SFAS No. 133 and all changes in the fair market value of the hedge are recorded in the Company’s Consolidated Statements of Operations in the line item Other, included in the Other Income (Expense) section of this statement. In 2008, the Company recorded gains of approximately $1.4 million on the Euro hedge transaction and gains of approximately $18.0 million on the Pound Sterling transaction related to changes in the fair market value of the hedge. The gains on the fair market value of the hedge were offset by foreign exchange losses of approximately $1.3 million on the change in value of the Euro intercompany note and $15.7 million on the change in value of the Pound Sterling intercompany note. In 2007, the Company recorded losses of approximately $1.9 million on the Euro hedge transaction and gains of approximately $300,000 on the Pound Sterling transaction related to the changes in the fair market value of the hedge. The losses on the fair market value of the hedge were offset by foreign exchange gains of approximately $2.6 million on the change in value of the


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Euro intercompany note and approximately $366,000 on the change in value of the Pound Sterling intercompany note.
 
In January 2009, the Company eliminated a substantial portion of the note payable between the U.S. subsidiary and the U.K. subsidiary, referenced above. In connection with this transaction, the Company also terminated its Pound Sterling foreign currency hedge arrangement referenced above. At December 31, 2008, the value of the hedge arrangement related to the U.S. dollar and Pound sterling was approximately $18.3 million. At the time of termination of the hedge in January, the Company received approximately $17.1 million in cash proceeds resulting from this termination.
 
 
Marketing and advertising costs include costs incurred to promote the Company’s business. Marketing and advertising costs are expensed as incurred. Advertising expense incurred by the Company in the years ended December 31, 2008, 2007 and 2006 was $2.1 million, $2.4 million and $2.0 million, respectively.
 
 
In addition to various contract costs previously described, the Company incurs costs, in excess of contract amounts, which are reimbursable by its customers. Emerging Issues Task Force (EITF) 01-14, “Income Statement Characterization of Reimbursements Received for Out-of-Pocket Expenses Incurred,” requires the Company to include 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. Accordingly, the Company recognizes these costs as part of net service revenues and direct costs.
 
 
Net income per basic share is computed using the weighted average common shares outstanding. Net income per diluted share is computed using the weighted average common shares and potential common shares outstanding.
 
The weighted average shares used in computing net income per diluted share have been calculated as follows:
 
 
                         
    2008     2007     2006  
    (In thousands)  
 
Weighted average common shares outstanding
    14,751       14,520       14,323  
Stock options and non-vested restricted shares
    242       369       439  
                         
Weighted average shares
    14,993       14,889       14,762  
                         
 
Options to purchase approximately 30,000 shares of common stock were outstanding during 2006 but were not included in the computation of earnings per diluted share because the effect would be antidilutive. No options were antidilutive in either 2008 or 2007.
 
Under EITF 04-8, The Effect of Contingently Convertible Instruments on Diluted Earnings Per Share, and EITF 90-19, and because of the Company’s obligation to settle the par value of its Convertible Notes (defined in Note 7, Debt) in cash, the Company is not required to include any shares underlying the Convertible Notes in its weighted average shares outstanding used in calculating diluted earnings per share until the average stock price per share for the quarter exceeds the $47.71 conversion price and only to the extent of the additional shares that the Company may be required to issue in the event that the Company’s conversion obligation exceeds the principal amount of the Convertible Notes converted (see Note 7 for full description of Convertible Notes). These conditions have not been met as of December 31, 2008. At any such time in the future that these conditions are met, only the number of shares that would be issuable (under the “treasury” method of accounting for the share dilution) will be included, which is based upon the amount by which the average stock price exceeds the conversion price. The following table provides examples of how changes in the Company’s stock price will require the inclusion of


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additional shares in the denominator of the weighted average shares outstanding — assuming dilution calculation. The table also reflects the impact on the number of shares that the Company would expect to issue upon concurrent settlement of the Convertible Notes and the bond hedges and warrants mentioned below:
 
                                         
                    Incremental Shares
            Total Treasury
  Shares Due to the
  Issued by the
    Convertible Notes
      Method Incremental
  Company Under Note
  Company Upon
Share Price
  Shares   Warrant Shares   Share(1)   Hedges   Conversion(2)
 
$40.00
                             
$45.00
                             
$50.00
    191,993             191,993       (191,993 )      
$55.00
    555,630             555,630       (555,630 )      
$60.00
    858,660             858,660       (858,660 )      
$65.00
    1,115,070       245,070       1,360,140       (1,115,070 )     245,070  
$70.00
    1,334,850       526,993       1,861,843       (1,334,850 )     526,993  
 
 
(1) Represents the number of incremental shares that must be included in the calculation of fully diluted shares under U.S. Generally Accepted Accounting Principles.
 
(2) Represents the number of incremental shares to be issued by the Company upon conversion of the Convertible Notes, assuming concurrent settlement of the bond hedges and warrants.
 
 
The Company and its U.S. subsidiaries file a consolidated U.S. federal income tax return. Other subsidiaries of the Company file tax returns in their local jurisdictions.
 
The Company provides for income taxes on all transactions that have been recognized in the Consolidated Financial Statements in accordance with SFAS No. 109. Accordingly, the impact of changes in income tax laws on deferred tax assets and deferred tax liabilities are recognized in net earnings in the period during which such changes are enacted.
 
The Company records deferred tax assets and liabilities based on temporary differences between the financial statement and tax bases of assets and liabilities and for tax benefit carryforwards using enacted tax rates in effect in the year in which the differences are expected to reverse. Management provides valuation allowances against deferred tax assets for amounts that are not considered more likely than not to be realized. The valuation of the deferred tax asset is dependent on, among other things, the ability of the Company to generate a sufficient level of future taxable income. In estimating future taxable income, the Company has considered both positive and negative evidence, such as historical and forecasted results of operations, and has considered the implementation of prudent and feasible tax planning strategies.
 
The Company adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”) as of January 1, 2007. FIN 48 requires significant judgment in determining what constitutes an individual tax position as well as assessing the outcome of each tax position. Changes in judgments as to recognition or measurement of tax positions can materially affect the estimate of the effective tax rate, and, consequently, the Company’s operating results. The Company considers many factors when evaluating and estimating tax positions and tax benefits, which may require periodic adjustments and which many not accurately anticipate actual outcomes. In addition, the calculation of tax liabilities involves dealing with uncertainties in the application of complex tax regulations in a multitude of jurisdictions. The Company determines its liability for uncertain tax positions globally under the provisions in FIN 48. At December 31, 2008, the Company has recorded a gross FIN 48 liability of $1.8 million. If events occur and the payment of these amounts ultimately proves to be unnecessary, the reversal of liabilities would result in tax benefits being recognized in the period when it is determined the liabilities are no longer necessary. If the calculation of liability related to uncertain tax positions proves to be more or less than the ultimate assessment, a tax expense or benefit to expense, respectively, would result.
 
As previously referenced, in December 2007, the FASB issued SFAS No. 141(R), Business Combinations, or SFAS 141(R). The Company expects SFAS 141(R) will have an impact on its consolidated financial statements


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when effective, but will depend on the nature, terms and size of the acquisitions consummated after the effective date. One of the changes in accounting for Business Combinations contained in SFAS 141(R) is the treatment of previously unresolved or settled tax related items. Under the provisions of SFAS 141(R), these items no longer adjust goodwill, but are recorded in the current period tax expense. An immaterial portion of the $1.8 million liability for unrecognized tax benefits as of December 31, 2008 relates to tax positions of acquired entities taken prior to their acquisition by the Company. If such liabilities reverse subsequent to the adoption of SFAS 141(R,) such reversals will affect the income tax provision in the period of reversal. In addition, the Company could benefit from net operating losses incurred by CRL Clinical Services prior to the Company’s 2006 acquisition. No benefit has been recorded in the Company’s Consolidated Financial Statements for this potential deferred tax asset.
 
 
Effective January 1, 2006, the Company began accounting for stock-based incentive programs under SFAS 123(R), “Share-Based Payment.” Prior to 2006, the Company had accounted for stock options issued in accordance with Accounting Principles Board Option (APB) No. 25, “Accounting for Stock Issued to Employees.” SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, be recognized as compensation expense in the income statement at fair value. The Company adopted the provisions of SFAS 123(R) for all share-based payments granted after January 1, 2006, and for all awards granted to employees prior to January 1, 2006, that remain unvested on January 1, 2006. The Company adopted SFAS 123(R) using a modified prospective application. The Company uses the straight-line method of recording compensation expense relative to share-based payment.
 
 
Non-vested stock (referred to as “restricted stock” in the 1997 Plan) may also be granted pursuant to the 2007 Plan, which replaced the 1997 Plan (defined in Note 8). Non-vested shares typically vest ratably over a three-year period, with shares restricted from transfer until vesting. In 2008 and 2006 the Company granted 24,200 and 250 shares of restricted stock, respectively. No such shares were granted in 2007. If a participant ceases to be an eligible employee prior to the lapsing of transfer restrictions, such shares return to the Company without consideration. Unrestricted stock also may be granted to key employees under the 2007 Plan, which replaced the 1997 Plan. Unrestricted shares vest immediately. The Company granted 10,700 shares of unrestricted Common Stock in 2006. No shares of unrestricted stock were granted in 2008 or 2007.
 
 
The preparation of Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
 
 
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133”. SFAS No. 161 requires enhanced disclosure related to derivatives and hedging activities and thereby seeks to improve the transparency of financial reporting. Under SFAS No. 161, entities are required to provide enhanced disclosures relating to: (a) how and why an entity uses derivative instruments; (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and its related interpretations; and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS No. 161 must be applied prospectively to all derivative instruments and non-derivative instruments that are designated and qualify as hedging instruments and related hedged items accounted for under SFAS No. 133 for all financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. Upon adoption, the Company will provide the required disclosure as applicable.


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In April 2008, the FASB issued Staff Position (FSP) 142-3, “Determination of the Useful Life of Intangible Assets”. FSP 142-3 amends the criteria used in determining the useful life of recognized intangible assets. Under FSP 142-3, an entity shall use its own historical experience in determining the useful life of an intangible asset, or in the absence of that experience, shall use assumptions that market participants would use. The entity shall consider the period of expected cash flows, the expected use and its own historical experience in its evaluation. FSP 142-3 must be applied prospectively to the intangible assets acquired in years beginning after December 15, 2008 and early adoption is not permitted. The Company will adopt the provisions of FSP 142-3 in connection with future intangible assets acquired beginning in 2009.
 
In May 2008, the FASB issued FSP Accounting Principles Board (APB) 14-1, “Accounting for Convertible Debt Instruments That May be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (“APB 14-1”). APB 14-1 specifies that issuers of such securities should separately account for the liability and equity components in a manner that will reflect the Company’s nonconvertible debt borrowing rate. APB 14-1 is effective for fiscal years beginning after December 15, 2008 and requires retroactive application for all periods presented. The Company estimates the impact of adopting APB 14-1 will result in a reduction of its Convertible Notes of approximately $37.7 million and an increase in Additional Paid in Capital of $36.4 million. The Company expects to report an increase in interest expense of $2.7 million and $6.3 million for the periods ending December 31, 2007 and 2008, respectively. The Company also expects to report a decrease in earnings per share for the same periods of $.18 and $.42. The Company’s convertible debt was not outstanding in 2006, therefore there will be no change to previously reported 2006 results.
 
In June 2008, the FASB ratified EITF 07-5, “Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock”. EITF 07-5 addresses how an entity should evaluate whether an instrument or embedded feature is indexed to its own stock, carrying forward the guidance in EITF 01-6 and superseding EITF 01-6. Other issues addressed in EITF 07-5 include addressing situations where the currency of the linked instrument differs from the host instrument and how to account for market-based employee stock options. EITF 07-5 is effective for fiscal years beginning after December 15, 2008 and early adoption is not permitted. The Company has evaluated this statement and estimated that it is not expected to have an impact on its financial position and results of operations.
 
In June 2008, the FASB issued FSP No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities”. EITF 03-6-01 addresses whether instruments granted in share-based are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share. EITF 03-6-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and early adoption is not permitted. The Company has evaluated the impact of this statement on its financial position and results of operations and determined the impact to be immaterial.
 
2.   FAIR VALUE OF FINANCIAL INSTRUMENTS:
 
On January 1, 2008, the Company adopted the provisions of SFAS No. 157, “Fair Value Measurements,” (“SFAS 157”). SFAS 157 defines fair value and provides guidance for measuring fair value and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements, but rather applies to all other accounting pronouncements that require or permit fair value measurements. In February 2008, the FASB issued a final FSP to allow a one-year deferral of adoption of SFAS 157 for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. The Company has elected this one-year deferral and thus will not apply the provisions of SFAS 157 to nonfinancial assets and nonfinancial liabilities that are recognized at fair value in the financial statements on a nonrecurring basis until its fiscal year beginning January 1, 2009. The Company is in the process of evaluating the impact of applying FAS 157 to nonfinancial assets and liabilities measured on a nonrecurring basis. The FASB also amended SFAS 157 to exclude SFAS No. 13 and its related interpretive accounting pronouncements that address leasing transactions. SFAS 157 enables the reader of the financial statements to assess the inputs used to develop those measurements by establishing a hierarchy for ranking the quality and reliability of the information used to determine fair values.


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SFAS 157 requires that assets and liabilities carried at fair value be classified and disclosed in one of the following three categories:
 
Level 1:  Quoted market prices in active markets for identical assets or liabilities.
 
Level 2:  Observable market based inputs or unobservable inputs that are corroborated by market data.
 
Level 3:  Unobservable inputs that are not corroborated by market data.
 
The Company generally applies fair value techniques on a non-recurring basis associated with, (1) valuing potential impairment loss related to goodwill pursuant to SFAS No. 142, and (2) valuing potential impairment loss related to long-lived assets accounted for pursuant to SFAS No. 144.
 
The following table summarizes the carrying amounts and fair values of certain financial assets and liabilities at December 31, 2008:
 
                                 
        Quoted Prices in
       
        Active Markets for
  Significant Other
  Significant
    Carrying
  Identical Assets
  Observable Inputs
  Unobservable Inputs
    Amount   (Level 1)   (Level 2)   (Level 3)
    (In thousands)
 
Foreign Currency Hedges
  $ 17,853     $     $ 17,853     $  
Money Market Accounts
  $ 16,937     $ 16,937     $     $  
 
The fair values of derivative assets and liabilities traded in the over-the-counter market are determined using quantitative models that require the use of multiple inputs including interest rates, prices and indices to generate pricing and volatility factors, which are used to value the position. The predominant market inputs are actively quoted and can be validated through external sources, including brokers, market transactions and third-party pricing services.
 
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Liabilities,” (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. If the fair value option is elected, unrealized gains and losses will be recognized in earnings at each subsequent reporting date. On January 1, 2008, the Company adopted the provisions of SFAS 159 and did not elect to apply the fair value option to any eligible financial instruments. The carrying amounts of cash, accounts receivable, accounts payable and accruals approximate fair value. The fair value of the Company’s Convertible Notes was approximately 75% of the par value at December 31, 2008.
 
3.   ACCOUNTS RECEIVABLE:
 
Accounts receivable are billed when certain milestones defined in customer contracts are achieved. All unbilled accounts receivable are expected to be collected within one year.
 
                 
    December 31,  
    2008     2007  
    (In thousands)  
 
Billed (net of allowance)
  $ 94,860     $ 62,993  
Unbilled
    63,111       72,557  
                 
    $ 157,971     $ 135,550  
                 


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The Company maintains an allowance for doubtful accounts receivable based on historical evidence of accounts receivable collections and specific identification of accounts receivable that might cause collection problems. The balance in allowance for doubtful accounts receivable was as follows:
 
         
    (In thousands)  
 
Balance at December 31, 2005
  $ 2,057  
Invoice write-offs
    (1,754 )
Allowance acquired via acquisition
    199  
Additional expense
    250  
         
Balance at December 31, 2006
  $ 752  
Invoice write-offs
    (34 )
Additional expense
    236  
         
Balance at December 31, 2007
  $ 954  
Invoice write-offs
    (896 )
Additional expense
    3,150  
Foreign currency adjustments
    (141 )
         
Balance at December 31, 2008
  $ 3,067  
         
 
In the fourth quarter of 2005, the Company recorded a bad debt reserve of approximately $1.7 million associated with one study being conducted in the United Kingdom. In the third quarter of 2006, the receivable was deemed uncollectible and was written-off. Due to the economic climate in the second-half of 2008 and the tightening of the credit markets, the Company increased its bad debt reserve, primarily to cover exposure from a limited number of customers that rely on outside sources to fund their operations. The Company will continue to monitor its bad debt exposure and adjust bad debt reserves as necessary.
 
4.   PROPERTY AND EQUIPMENT:
 
Property and equipment is summarized as follows:
 
                 
    December 31,  
    2008     2007  
    (In thousands)  
 
Furnishings, equipment and other
  $ 85,628     $ 77,553  
Construction in process
    9,862       2,815  
Equipment under capital leases
    1,616       2,068  
Less: accumulated depreciation and amortization
    (52,528 )     (50,415 )
                 
Property and equipment, net
  $ 44,578     $ 32,021  
                 
 
Depreciation expense for the years ended December 31, 2008, 2007 and 2006 was $9.8 million, $8.9 million and $6.0 million, respectively.


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5.   GOODWILL AND OTHER INTANGIBLE ASSETS:
 
Non-amortizable intangible assets at December 31, 2008, and December 31, 2007, are comprised of:
 
         
    Goodwill  
    (In thousands)  
 
Balance at December 31, 2006
  $ 229,598  
Additional adjustments
    (383 )
Foreign currency fluctuations
    1,291  
Tax benefit to reduce goodwill
    (338 )
         
Balance at December 31, 2007
  $ 230,168  
Additional amounts acquired
    9,073  
Additional adjustments
    81  
Foreign currency fluctuations
    (2,655 )
Tax benefit to reduce goodwill
    (338 )
         
Balance at December 31, 2008
  $ 236,329  
         
 
In June 2008, the Company acquired approximately $9.1 million of goodwill as a result of its acquisition of DecisionLine, see Note 11, Acquisition. The goodwill and the finite-lived intangible assets acquired in the acquisition are not deductible for income tax purposes.
 
The Company has an intangible asset representing one customer relationship acquired in the Company’s acquisition of Clinical and Pharmacologic Research, Inc. (CPR). The value of this customer relationship had been $15 million prior to the fourth quarter of 2006 and the useful life had been designated as indefinite. Due to declining revenue from this customer in 2006 and the declining revenue projected for 2007 and future years, the Company determined that the asset was impaired and recorded an $8.2 million impairment charge in 2006. Effective January 1, 2007, the Company assigned a 23-year useful life to the customer relationship due to changes in a number of the conditions around the relationship, including the Company’s decision to market its services to additional customers in the future.


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Goodwill and other intangible assets consisted of the following:
 
                         
    As of December 31,
    As of December 31,
       
    2008     2007        
    (In thousands)        
 
Goodwill
  $ 236,329     $ 230,168          
                         
Amortizable intangible assets:
                       
Carrying amount:
                       
Customer relationships
  $ 22,007     $ 18,000          
Non-compete agreements
    460       460          
Completed technology
    2,600       2,600          
Backlog
    6,200       6,200          
Internally developed software(a)
    17,427       16,256          
                         
Total carrying amount
  $ 48,694     $ 43,516          
Accumulated Amortization:
                       
Customer relationships
  $ (5,003 )   $ (1,975 )        
Non-compete agreements
    (460 )     (460 )        
Completed technology
    (1,252 )     (736 )        
Backlog
    (5,521 )     (4,625 )        
Internally developed software(a)
    (15,569 )     (14,896 )        
                         
Total accumulated amortization
  $ (27,805 )   $ (22,692 )        
                         
Net amortizable intangible assets
  $ 20,889     $ 20,824          
                         
Total goodwill and intangible assets
  $ 257,218     $ 250,992          
                         
 
 
(a) Internally developed software is included in Other Assets in the Company’s Consolidated Balance Sheets.
 
Amortizable intangible assets at December 31, 2008, and December 31, 2007, are composed of:
 
                                         
                            (a)
 
                            Internally
 
    Customer
    Non-Compete
    Completed
          Developed
 
    Relationships     Agreements     Technology     Backlog     Software  
    (In thousands)  
 
Balance at December 31, 2006
  $ 17,317     $ 87     $ 2,395     $ 4,428     $ 1,811  
Additional amounts acquired
                            531  
2007 amortization
    (1,292 )     (87 )     (531 )     (2,853 )     (982 )
                                         
Balance at December 31, 2007
  $ 16,025     $     $ 1,864     $ 1,575     $ 1,360  
Additional amounts acquired
    4,930                         1,187  
Foreign currency fluctuations
    (923 )                        
2008 amortization
    (3,028 )           (516 )     (896 )     (689 )
                                         
Balance at December 31, 2008
  $ 17,004     $     $ 1,348     $ 679     $ 1,858  
                                         
 
 
(a) Internally developed software is included in Other Assets in the Company’s Consolidated Balance Sheets.
 
The weighted-average useful life of the Company’s Customer Relationship intangible assets is approximately 13 years.
 
The weighted-average useful life of the Company’s Non-Compete Agreements intangible asset is approximately 4 years.
 
Completed technology represents proprietary technology acquired in the Company’s August 2006 acquisition of CRL Clinical Services. Value was assigned to the completed technology based on the technology directly related


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to revenue generation or profit enhancement. The value was calculated using an income approach, which assumes that the value of the technology is equivalent to the present value of the future stream of economic benefits that can be derived from its ownership. A useful life of five years for the intangible asset was determined by estimating the remaining useful life of the technology acquired.
 
Backlog represents backlog acquired in the Company’s August 2006 acquisition of CRL Clinical Services. Value was assigned to backlog by evaluating the expected future economic operating income generated by the backlog. The useful life of the backlog of approximately seven years was determined by evaluating the remaining life of the contracts that compose the backlog acquired.
 
Internally-developed software is included in Other Assets within the Consolidated Financial Statements. The Company typically amortizes internally-developed software over a five year useful life.
 
Amortization expense for the next five years relating to these amortizable intangible assets is estimated to be as follows:
 
         
    (In thousands)  
 
2009:
  $ 4,741  
2010:
    3,678  
2011:
    3,146  
2012:
    2,094  
2013:
    1,318  
Thereafter:
    5,912  
         
Total
  $ 20,889  
         
 
For further detail regarding the amortizable assets acquired in 2008, see Note 11, Acquisition.
 
6.   OTHER ACCRUED LIABILITIES:
 
Other accrued liabilities at December 31, 2008 and 2007 consisted of the following:
 
                 
December 31,
  2008     2007  
    (In thousands)  
 
Accrued compensation and related payroll withholdings and taxes
  $ 16,640     $ 16,354  
Income tax payable
    2,895       9,078  
Interest payable
    3,113       3,102  
Other
    21,533       18,573  
                 
    $ 44,181     $ 47,107  
                 
 
7.   DEBT:
 
In August 2006, in conjunction with its acquisition of CRL Clinical Services, the Company entered into a new credit agreement (including all amendments, the “Facility”). The Facility was comprised of a $200 million term loan that matures in August 2012 and a revolving loan commitment that expires in August 2011. The balance of the $200 million term loan was repaid in the third quarter of 2007 with proceeds from the convertible debt issuance discussed below. On June 27, 2007 the original revolving loan commitment of $25 million was increased to $53.5 million under an amendment to the Facility and an Increase Joinder Agreement, which permitted the Company to increase the revolving loan commitment. The Facility contains various affirmative and negative covenants including financial covenants regarding maximum leverage ratio, minimum interest coverage ratio and limitations on capital expenditures.
 
No amounts were outstanding under the revolving loan at December 31, 2008 and 2007.


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