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Kendle International Inc. (NASDAQ:KNDL)

Q3 2008 Earnings Call Transcript

November 5, 2008, 8:30 am ET

Executives

Michael Lawson – Director, IR

Candace Kendle – Chairman and CEO

Buzz Brenkert – SVP, CFO and Secretary

Analysts

Tim Evans – Jefferies & Company

Douglas Tsao – Barclays Capital

Greg Bolan – Wachovia Capital

Todd Van Fleet – First Analysis

Adrianne [ph] – Goldman Sachs

Operator

Welcome to the Kendle third quarter 2008 earnings conference call and webcast. As a reminder, this call is being recorded. At this time for opening remarks, I would like to turn the call over to the Director of Investor Relations, Mr. Michael Lawson. Please go ahead, sir.

Michael Lawson

Thank you, Cynthia. Good morning and welcome, everyone. Before beginning the formal part of our presentation, let me tell you that what we are about to say as well as any questions we may answer could contain predictions, estimates, and other forward-looking statements. The use of words like project, estimate, forecast and other similar expressions is intended to identify those forward-looking statements.

Any forward-looking statements that we might make may represent our current judgment on what the future holds. As such, those statements are subject to a variety of risks and uncertainties, important risk factors and other considerations that could cause our actual results to be materially different are described in our securities filings including our forms 10-K and 10-Q. I encourage you to review those documents. A replay of this call can be found on our website later today at www.kendle.com.

Joining me on the call today are Dr. Candace Kendle, Chairman and CEO; Chris Bergen, Chief Operating Officer; and Buzz Brenkert, Chief Financial Officer. Following a commentary on the performance in the quarter and year-to-date, we will open up the call to take your questions.

With that, I would now like to turn the call over to Dr. Kendle.

Candace Kendle

Thank you. And good morning to all. Welcome to our call. Buzz, do you want to start us off?

Buzz Brenkert

Sure. Thanks, Kendle – thanks, Candace. Welcome to the call. Net service revenues for the third quarter totaled almost $125 million. This is a 25% increase over last year’s third quarter and is primarily due to organic growth. Our DecisionLine acquisition completed last quarter added $5.7 million to revenue this quarter. Excluding revenue from the former DecisionLine operations, organic growth was 19% over the same period last year, including 3% due to changes in foreign exchange rates.

Revenue in our Early Stage business added a little over $11 million, more than double quarter-over-quarter and was up 30% sequentially over last quarter. This increase is largely attributable to the DecisionLine acquisition. Revenue in our Late Stage business of $111 million was up almost 19% over last year’s third quarter. The majority of the increase in revenue is due to organic growth reflected in a 16% in billable hours.

While all regions experienced significant revenue growth, we continued to see proportionally higher growth in regions outside North America. Our Latin American revenues, for example, grew 107% quarter-over-quarter, growing from 5% to 9% of total revenues. Asia-Pacific revenues grew 45% in Q3 2008 versus Q3 2007 and now comprised 4% of total compared to 3%. European revenues in the third quarter were up 14% over Q3 ’07, declining from 41% to 37% of total company revenue. And finally, North American revenues grew a healthy 23% in the third quarter, making up 50% of the total down from 51% in the third quarter of 2007.

Customer concentration as measured by our top five and top ten customers in terms of revenues was virtually flat period-over-period with our five largest customers accounting for 24% in both Q3 ’08 and ’07. Our top ten customers accounted for 38% of revenue compared to 39% of revenue in the third quarter of last year.

Turning to income, income from operations for the quarter was just shy of $16 million or 12.7% of net revenue compared to a little more than $14 million or 14.2% in Q3 ’07. The decrease in operating margin is primarily due to reduced utilization of billable staff in Western Europe. Pretax income for the quarter more than tripled totaling just over $17 million and the tax rate for the quarter was 36% compared to 25% last year.

Items affecting pretax income include the other income line, representing primarily foreign exchange gains and losses, which netted to a $3.4 million gain this year, reflecting the strengthening US dollar compared to a loss of $2.1 million in Q3 of last year. Also last year’s Q3 results included $4.2 million of expense for the write-off of deferred financing fees associated with the Term B debt that was replaced with the convertible notes. The lower tax rate in Q3 ’07 is attributable to a tick-down of the Fin 48 reserves of discrete tax item in the period.

Net income was a record $11 million compared to $3.8 million for Q3 of the prior year, representing a 190% improvement that’s driving record earnings per share on a diluted basis of $0.73 versus $0.25 per diluted share in the third quarter of 2007. Excluding the write-off of deferred financing fees, EPS for Q3 last year was $0.43.

Cash flow from operations for the quarter was $6.7 million, and capital expenditures totaled $6.1 million. Most of the CapEx relates to information technology, including our ongoing ERP development. We also reduced the outstanding balance on our revolver by $9 million during the quarter.

Year-to-date net service revenues were almost $366 million, a 25% improvement over the same period last year and 22% on an organic basis. Foreign exchange rate differences between years account for 5% of this growth. Year-to-date revenue contribution by region reflects significant changes in North America and Latin America versus last year. North America contributed 47% of net service revenues for the first nine months of this year, down from 50% last year. Latin America’s contribution grew to 8% this year, up from 5% in 2007. Europe’s contribution was down slightly to 41% from 42% of last year, and Asia Pacific grew from 3% to 4% this year.

For the first nine months, our top five customers accounted for 27% of net revenues compared to 25% last year and our top ten customers represented just over 39%, the same as last year. No customer accounted for as much as 10% of revenue. First nine-month operating income of $45.9 million compared to very favorably to 2007 nine-month operating income of $37.6 million, with operating margin of 12.5% somewhat below last year’s 12.8%.

Year-to-date net income nearly doubled totaling $24.4 million or $1.63 per diluted share compared to $12.3 million or $0.83 per share for the same period last year. Excluding the write-off of deferred financing fees, last year’s EPS was $1.01.

Turning to the balance sheet, we ended the quarter with cash and marketable securities totaling almost $18.4 million, down from $25.3 million at the start of the quarter. Accounts receivable at the end of the quarter totaled over $190 million, including $81 million of unbilled receivables and $109 million of billed receivables. Advance billings totaled $98 million, resulting in net receivables of almost $92 million and DSO of 46 days, down from 47 days in June.

Working capital aggregated just over $68 million. On the liability side, borrowings include $200 million of convertible notes outstanding at the end of the quarter and $2 million outstanding on the revolver. The revolver balance was paid off in October.

Finally, with regard to the current situation in the financial markets and what it may mean to Kendle, let me say that we’ve been very careful in selecting our key financial partners. We’ve undertaken an analysis of our financial counterparty risk in the areas of credit instruments, investments, insurance and well-earned benefit plans. And we feel very positive about the limited counterparty risks that currently exist at Kendle.

With that, I’ll turn the call back over to Candace.

Candace Kendle

Thanks, Buzz. I will begin by comments with new business development and pipeline performance followed by comments on our outlook. Gross sales for the quarter were a record $212 million, representing a 21% increase over the third quarter of last year and a 4% increase sequentially from the second quarter of 2008. Cancellations were $38 million or 18% of gross sales compared to cancellations of $27 million in the second quarter of 2008. As a percent of total, cancellations are up slightly, but in our opinion, not indicative of a trend and well within historical industry average. As we have noted in the past, we would expect our cancellation rates to fall more in line with our peers as our business mix shifts.

Net sales were $174 million compared to net sales of $168 million in the same quarter last year. This represents a 4% increase and a net book-to-bill of 1.4. Our total business authorizations totaled just over $1 billion for the quarter compared to $831 million for the same quarter last year, representing a 22% increase. Sequentially, our new business authorizations increased 3% from the end of last quarter’s backlog of $979 million.

We saw a modest decline in the number of RFPs quarter-over-quarter, but a significant increase in the total dollar value. The number of RFPs decreased a little over 8% from the same quarter last year. However, the aggregate total dollar volume of RFPs increased 43% and the average RFP value increased 54% in Q3 ’08 versus Q3 ’07.

Moving on to a few brief comments with regard to our outlook. I did want to talk about customer risk. Over the last several weeks, a lot had been written about the biopharm outsourcing environment. I would like to add my thoughts on how we see the picture emerging and specifically how we see it affecting Kendle. I will talk specifically about the broad customer base and then in particular how (inaudible) might affect a largely late stage CRO.

Let’s start with the large multi-national biopharmaceutical customer, so the major pharmaceutical companies and the large biotechs, those companies having greater than $1 billion in revenues. These customers make up 65% of our backlog and currently represent 50% of fourth quarter awards and proposals pending. The significant difference between our backlog at 65% and the fourth quarter awards and proposals outstanding 50% is the FSP new opportunities and renewals not tracked in proposals. We believe the numbers are at or above – that is the fourth quarter award and proposal number are at or above the backlog 65% number, so very consistent both in our backlog fourth quarter awards and proposals outstanding.

Until recently, these large customers contracted with us almost exclusively in our late stage business. This is changing with the acquisition of DecisionLine. They have looked to us for full service, multi-national program project services in phases III, IIIb and IV, for selective functional services such as pharmacovigilance and pharmacoepidemiology, or for volume-based services through functional service provider contracts over multiple years in the areas of biometrics, state D [ph] medical writings.

As we’ve grown, particularly filing the acquisition of CRO clinical services, we have been able to offer broader scope of services such as in therapeutic expertise and depth in geography. We are considered an equal provider of late stage services when compared to larger CROs because of the size of our uniquely Late Stage business. Even in the most recent large Hooley [ph] deal, for example, all of the providers are within their core competency.

While there is uncertainty with regard to how the recent global financial crisis as well as the change in the US administration will specifically affect the outsourcing practices long-term, we do have experience with some of the variables historically. And I’d like to comment on those and how we think they will affect the CRO market. First of all, sponsors believe that outsourcing is a more cost-effective way in which to develop new compounds, and this in part has resulted in yet another increase in recent workforce reductions. For example, those at Pfizer and at Merck. The reduced workforces within our customer will continue to drive upward the percentage of business outsourced. The question then becomes how big is the base of business from these sponsors.

During the consolidation of the pharmaceutical industry in early 2000, companies underwent major reprioritization of pipelines. This retrenchment that took place seriously interrupted product to clinical development and slowed the growth of CRO pipeline. Since that time, regular and ongoing prioritization practices have been put in place at all companies. It is now an established business practice to evaluate every compound and its place in the pipeline as it passes through each phase of development. While this does not mean there will not be some forced cancellation or delays, it does seem unlikely that there will be a retrenchment to the extent that we saw in the early 2000.

Finally, customers have become far more open to CRO innovation with regard to technology solutions, process change, and geographic shift in order to achieve cost savings and shorten development times. Sponsors are actively seeking out senior leadership in CROs to help identify opportunities for improving the way in which clinical development is conducted. This has continued to progress through the most recent weeks.

Let’s talk about mid-sized and smaller biopharmaceutical companies. That’s the pharma and biotech companies with less than $1 billion in revenues. Remember, Kendle’s business is predominantly a late stage clinical development business, and thus we are less likely to have small companies in our customer mix. The small biopharms are more likely to be conducting early stage, that is preclinical, bioanalytical and Phase 1 activities exclusively. In this way, we are very different from Covance, for example, where there is a predominance of early stage business. Though to a lesser extent, we are also different from ICON, PharmaNet, and PPDI who have higher early stage business concentration than Kendle. They may or may not have more risk from small biotechs.

When thinking of risk, we think of mid-sized and small biopharms in two ways; revenue versus non-revenue generating companies, and companies with and without large multi-national partners for clinical development. That would be our large biopharm customer base. The risk profile in general becomes higher as you move from companies with partners with or without revenues to companies with revenue but no partner, to companies without revenue and without a multi-national partner.

With regard to Kendle, mid-size to small biopharms who have large multi-national clinical development partners make up 25% of Kendle’s backlog and 33% of fourth quarter awards and pending proposals. Mid-size to small biopharms that have revenue make up another 3% of backlog and 10% of fourth quarter awards and pending proposals. The remaining 7% of companies without revenue, coincidently both backlog and proposals, have strong cash positions – had strong cash positions at the time of contract signing. A very few have seen deterioration and we are closely monitoring them for matching contract executions and payments.

In summary, while we feel that there is risk in this environment, there is also opportunities. These opportunities are best managed through staying close to the customer, understanding the opportunities for partnership, and the need for mitigating risks for program execution and contract payments. I hope these comments help you understand our thinking about the industry as well as the customer risk at Kendle.

In closing this part of the call, I want you to know that we recognize we are now building a business, growing a business while in western world recessions. The team understands the differences with regard to the customer, capital and M&A in this new environment. We feel that some of the key elements to managing the business is our ability to squeeze our costs and tighten our focus on working capital, enhance our forecasting and planning, monitor counterparty exposure and plan for increased cost of capital. We must also be able to take advantage of M&A opportunity, being mindful of the need for more aggressive due diligence. However, having said all this, we feel that probably most important of all is our need to stay close to our customers.

This concludes my part – this part of the comments and I’d like to return to Buzz to make our comments on guidance shift.

Buzz Brenkert

Thanks, Kendle – Candace. Excuse me. We have revisited our forecast for the full year as we seasonally do throughout the year and compared it to our current guidance. As you know, our current revenue guidance for 2008 is a revenue range of $490 million to $500 million. On a constant currency basis, that is if the Q3 average foreign exchange rates were to be applicable to our operations in Q4, we believe we would be in the upper half of our current revenue guidance at the end of the year. That is above $495 million. However, through October the dollar has continued to strengthen and add an accelerating pace. Where we’ll end the year is unknown, but it is all but certain that the Q4 average exchange rates will reflect a stronger dollar than the Q3 average.

Consequently we feel it is appropriate for us to broaden the revenue guidance range a bit to $485 million to $500 million. Of course, foreign exchange rates affects all aspects of the operating results, including operating income and other income, with reductions in operating income offset to some extent by gains in other income and vice versa. We are therefore reducing our guidance range on operating margin by 50 basis points to a range of 12.5% to 13.5%, and increasing our EPS guidance range by $0.10 to a range of $2.10 to $2.00 in the quarter.

Candace Kendle

Thank you, Buzz. At this point, we’d like to open for questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Tim Evans with Jefferies & Company.

Tim Evans – Jefferies & Company

Hi, thanks. This is on behalf of Dave Windley. Just wondering how the average duration is changing with the wins over the last quarter or two?

Candace Kendle

Average duration of contract?

Tim Evans – Jefferies & Company

Yes.

Candace Kendle

We don’t have exclusive information, but we have not noticed a change, but we have not done the analysis.

Tim Evans – Jefferies & Company

Okay. What about hiring piece?

Candace Kendle

Quarter-over-quarter from the – in the third quarter we added an additional headcount of 343 individuals or 292 FTEs.

Tim Evans – Jefferies & Company

Okay. And could you talk a little bit about the other income line and break out the offsetting effects in that line?

Buzz Brenkert

Certainly. There are two major items that make up the other income line. One is the interest effect on the mark-to-market for our cross currency hedge. That’s affected by the changes in the yield curves between the US, the UK, and the European community. That recorded a loss of about $1.7 million during the quarter, offsetting the rest of the balance, which was all but due to foreign exchange rates.

Tim Evans – Jefferies & Company

Okay. What about – are you currently in discussions in anyone about longer term commitments? And if you can provide any color on that?

Candace Kendle

Yes. And it has probably has some seasonality at the – during – the fourth quarter is the usual time to execute FSPs, for example, with our longer term relationships. And certainly there has been an escalation in larger partnership interests either initiated by ourselves or by our customers. So, the answer is, probably more than ever. But it is also seasonal.

Tim Evans – Jefferies & Company

Okay. And one last one, if you could talk maybe about the balance of functional opportunities versus project program opportunities and if that’s changing at all?

Candace Kendle

I don’t really know what the – I can’t give you the percentage. There are certainly more of them, but I can’t tell you whether the percentage has increased. But certainly there are more FSP and partnership opportunities for Kendle today than a year ago, but as a percentage of business, I don’t have the statistics. I’d be happy to get them.

Tim Evans – Jefferies & Company

Okay, great. Thanks so much.

Operator

Your next question comes from the line of Douglas Tsao with Barclays Capital.

Douglas Tsao – Barclays Capital

Hi, good morning. So – I’m just trying to get my arms around a little bit, but – so, largely the non-operating income gain this quarter was related to the interest rate – or the foreign exchange hedge is related [ph] within your company notes. Is that correct, Buzz?

Buzz Brenkert

No. The hedge offsets the foreign exchange impact on the notes, but it does have a component that is – because it really is a swap of future cash flows, it does have a component that is affected by the change in the yield curves. That was a loss during the quarter, Doug. So it offsets somewhat the foreign exchange gains. And there are two parts for those foreign exchange gains. One part is a gain on translation of balance sheet accounts and the other is billings for changes in the exchange rate or customer contracts where the exchange rate has changed significantly from the time of the contract.

Douglas Tsao – Barclays Capital

Okay. And so do you have a rough estimate of what that non-operating income line should like in the fourth quarter?

Buzz Brenkert

That’s driven an awful lot by the exchange rate and what may happen with interest rates in the three geographies. And it’s a rather significant item. Foreign exchange rates in the first month of the fourth quarter have moved towards a further strengthening of the dollar. In fact, they moved as much – almost as much in the month of October as they moved in the whole third quarter. Indications are that that’s going to moderate or perhaps even reverse in the last two months of this quarter, but it’s a great unknown. I wish I knew. To the extent that exchange rates stayed where they are, that would generate positive income in the other income line for us – rather significant positive income.

Douglas Tsao – Barclays Capital

Okay. And then in terms of – I missed kind of – you gave some detail in terms of your exposure to small biotechs. Could you just run through those again, please, quickly?

Candace Kendle

Sure. The way we divide the business in terms of characterizing our customer base is large biopharm companies, so that’s major pharma and large biotech, all companies having more than $1 billion in revenue. And then mid-size and smaller companies, so less than $1 billion in revenue. We then subset them by mid-size and smaller customers that have major partners; customers that have revenue, no partners; and customers who have no revenue and no partner. Okay? So those are the classifications. Large multi-national customers are 65% of our backlog. Okay? Do you want the –?

Douglas Tsao – Barclays Capital

I’m really just interested in the small, no partner, no revenue?

Candace Kendle

No partner, no revenue is 7%, both of backlog and of fourth quarter awards and pending proposals. It’s just coincidental 7%, I might add.

Douglas Tsao – Barclays Capital

And then just sort of given the fairly dramatic shift in terms of the capital markets, have you re-thought your sort of way of sort of approaching that kind of business? I mean, you sort of mentioned you obviously take a look at the balance sheet. And are you trying to consider sort of greater upfront payment or sort of tracking the contract in a more closer basis? Even if you decide to take on the award that somehow you are monitoring situations so that you don’t sort of get – sort of less told in the back so to speak?

Candace Kendle

I’m going to let Buzz answer, but we have always been conservative on this front. But Buzz has made even further adjustments. So maybe, Buzz, you could comment on that?

Buzz Brenkert

(inaudible) it’s the nail pretty much on the hit. We do do an extensive credit collection – credit analysis of new customers and monitor customers as far as their cash position and ability to pay. In contracts where we see risk, where there is a lack of partnership or where there cash burn rate is going to indicate that this study is going to go beyond what their cash resources are, we do insist on an advance payment that is greater than what we typically ask for. And we have tightened that up to where it is, not something that we will deviate from, and determine the timing of when that cash advance will be applied to the invoice has been changed as well. So we have from slightly tighter credit requirements and some much more aggressive collection procedures as well.

Douglas Tsao – Barclays Capital

Okay, great. Thank you very much. I’ll hop out for the questions for now.

Candace Kendle

Thank you.

Buzz Brenkert

Thanks.

Operator

Your next question comes from the line of Randall Stanicky with Goldman Sachs.

Adrianne – Goldman Sachs

Good morning. This is (inaudible).

Candace Kendle

I’m sorry. Operator, we cannot hear the caller?

Adrianne – Goldman Sachs

Can you hear me now? This is (inaudible) for Randall.

Candace Kendle

Yes. I’m sorry, we hear a squeak, but we can’t understand the question. I’m sorry, it’s very, very low. Perhaps a different line? Hello?

Operator

We’ll move to the next question. Your next question comes from the line of Greg Bolan with Wachovia Capital.

Greg Bolan – Wachovia Capital

Good morning and thanks for taking the questions. Buzz, I understand the impact of a stronger dollar revenue growth as well as below the line. But can you help me understand the impact as it relates to kind of the above the line gross margin and consolidated EBIT margin?

Buzz Brenkert

Yes. On EBIT or operating income really, the impact – the expenses get adjusted as well as revenue. But what doesn’t get adjusted really are our corporate expenses that are in the dollar. So, proportionally not as much expense gets adjusted as revenue. So it has an impact on the operating margin. It also – the impact on the margin varies from period to period depending on what geography is being – the relative volumes, if you will, of business in the different geographies.

Greg Bolan – Wachovia Capital

Okay, understood. And then just to take Doug’s question just a little bit further, since future currency movements are an unknown variable, Buzz, is it safe to say that you have zeroed out the other income line in the fourth quarter? What are you thinking in terms of your model for the fourth quarter?

Buzz Brenkert

We started with basically a forecast in a constant currency sort of mode and then vary the exchange rates a number of times. And given the swings that we’ve really seen, we determine that we would have a broader range for our guidance as a result of that than we would ordinarily have in the fourth quarter.

Greg Bolan – Wachovia Capital

Okay. Okay.

Buzz Brenkert

As I said, on a constant currency basis, our revenue guidance was – we would have stayed with our revenue guidance, but we dropped it at least the bottom end of the guidance down a little bit to take a sort of worst-case scenario picture at the range.

Greg Bolan – Wachovia Capital

Understood. Seems fair enough. I guess lastly, it appears as if the same-store sale – same-store sales at an early stage, that is excluding DecisionLine in both 2Q and 3Q, failed sequentially by $1 million. Can you provide a little bit more detail on the cause of this was a result of any noteworthy details or cancellations to speak of?

Buzz Brenkert

Primarily it was due to two delays due to drug availability at our Morgantown operation.

Greg Bolan – Wachovia Capital

Okay. All right. Got it. And then finally, if possible, Candace, can you comment – give any color on Early Stage activity you’re seeing so far in the fourth quarter as best as you can?

Candace Kendle

Cautiously, because it seems to be a bit of a moving target. We are confident about the fourth quarter Early Stage business.

Greg Bolan – Wachovia Capital

Okay. All right. Great results. Thanks, guys.

Candace Kendle

Thank you.

Operator

Your next question comes from Todd Van Fleet with First Analysis.

Todd Van Fleet – First Analysis

Hi, good morning guys. Nice quarter. Hopefully you can hear me through the cold here. But Buzz, I just want to ask you about the other income line again. You said that there was a $1.7 million loss related to the interest effect on the hedging component – I guess the hedging associated with the convertible note. Is that right?

Buzz Brenkert

No, it’s not the hedging associated with the convertible note. The cross currency hedge that we have relates to inter-company notes we have with our subsidiaries in Germany and the UK. Those notes were put in place to facilitate our transferring funds from Europe to the US in order to make sure that we could make the payments on the – or have the cash available on a tax-efficient basis to make the payments on our original Term B debt.

Todd Van Fleet – First Analysis

Right. And so, is that – that’s the negative $1.7 million impact then?

Buzz Brenkert

That’s correct.

Todd Van Fleet – First Analysis

Okay.

Buzz Brenkert

The hedge, we make payments in Germany and the UK in those currencies, in the euro and the pound, to the bank. The bank pays us a fixed stream in the US dollars. So the way that cross-currency hedge is valued then is by present valuing those future cash streams at the interest rates in the different geographies, offsetting those. So the changes in US yield curves if they do not match exactly the changes in European and UK yield curves are going to generate either a gain or a loss on that mark-to-market.

Todd Van Fleet – First Analysis

And this quarter it was a loss?

Buzz Brenkert

And this quarter it was a loss. Correct.

Todd Van Fleet – First Analysis

Okay. And so then there was a $5 million positive or benefit you received from ForEx related issues that are primarily balance sheet?

Buzz Brenkert

Primarily balance sheet, yes.

Todd Van Fleet – First Analysis

Okay. And so, to the extent that the ForEx kind of environment does not change from here on out, I guess maybe to ask it a little bit differently, what is the assumption that’s imbedded in your Q4 outlook regarding the other income line?

Buzz Brenkert

I’ve assumed on the other income line that foreign exchange rates will end the quarter at the same place where they were at the end of October.

Todd Van Fleet – First Analysis

At the end of October. Okay. So –

Buzz Brenkert

In my base case, yes.

Todd Van Fleet – First Analysis

All right. So the net would be a positive again on the other income line?

Buzz Brenkert

I anticipate a positive other income. That’s correct. Now that can be offset by a loss on the interest side or can be enhanced by a loss on the way the interest rates change.

Todd Van Fleet – First Analysis

Okay. All right. Thank you.

Operator

Your next question comes from the line of Randall Stanicky with Goldman Sachs.

Adrianne – Goldman Sachs

Hi, everyone. This is Adrianne [ph] for Randall. I hope you can hear me now. I just want to follow up on the other income line. Can you give us the breakdown of the – because you mentioned that’s mostly due to translations of the balance sheet offset, can you give us the breakdown by currency exposures so we can actually track the magnitude of the positive impact on the other income line in 4Q?

Buzz Brenkert

I can’t give you a breakdown. I can tell you that the largest portion of it relates to European currencies, so pound and the euro. Other currencies that have some significance, but much less significance to the Mexican peso and the Australian dollar.

Adrianne – Goldman Sachs

And my second question is – I wanted to congratulate you on the strong business results you guys delivered very well this quarter. Can you give us some color on whether any larger contract that you probably signed towards the end of the quarter?

Candace Kendle

Yes. I mean, as most of you know, we were being cautious with rates during this quarter. But we did secure larger contracts at the close of the quarter, so brought it back to our expectation.

Adrianne – Goldman Sachs

So, was that contract above $20 million, $30 million range or something higher than that?

Candace Kendle

We can’t specifically, but not higher than that, but it was a larger contract.

Adrianne – Goldman Sachs

Okay. Thank you very much.

Candace Kendle

Thank you.

Operator

Your next question is a follow-up question from the line of Douglas Tsao with Barclays Capital.

Douglas Tsao – Barclays Capital

Hi, thanks for taking the follow-up questions. Buzz, just to sort of clarify Greg’s question. So, are you largely naturally hedged in terms of the Late Stage business, in terms of matching up revenues with the cost or foreign currencies?

Buzz Brenkert

Not large – I wouldn’t say largely naturally hedged. Most of our business is denominated in dollars. But what we do have is we do have a foreign currency – call it CERF language, the currency exchange rate fluctuation language in our contracts that allows us to adjust billings to reflect the changes in foreign currency. It’s a door that swings both ways and that whether the dollar strengthens or weakens, we will either have an additional billing for the change or we will issue a credit for the change.

Douglas Tsao – Barclays Capital

Okay. So, given the strengthening of the dollar, we should – further weakening of the euro and pound sterling, we should not anticipate some accretion to operating income on a percent basis because of those sort of elevators, if you will?

Buzz Brenkert

Those certainly (inaudible) significantly. Now it is – it appears those billings that are for or credits that appear for those dollar amounts bill into other income, they do not bill into revenue. So that you will see pretty fewer effect on the revenue numbers. So that’s offset by that additional billing or that credit.

Douglas Tsao – Barclays Capital

So, are you – I mean, given the where the currency rates are, why aren’t we seeing a decent amount of operating margin leverage? Just given the pretty dramatic strengthening of the US dollar amount, I would think that would have a pretty significant impact on the translation of costs from ex-US locations, which is good – very (inaudible) of your business now.

Buzz Brenkert

But it has the same cost on the revenue side.

Douglas Tsao – Barclays Capital

Right, but you said most of the contracts are denominated in dollar. So wouldn’t –

Buzz Brenkert

Most of them are denominated in dollars, that’s correct. And that’s why when the dollar strengthens, we end up with revenue. But the work that is done in the foreign country, the revenue that is shown in that foreign country is denominated in the amount there. So that’s where you would see the adjustment goes down into other income. Where is the work is done is where the revenue is recognized. And it’s the sort of inter-company contract, if you will, denominates what they are going to get in their local currencies.

Douglas Tsao – Barclays Capital

Okay. Thank you very much.

Operator

Your next question is a follow-up question from the line of Tim Evans with Jefferies & Company.

Tim Evans – Jefferies & Company

Hi, thanks for taking the follow-up. I think Doug kind of was asking what I was asking. I was just wondering if we could follow up on Greg’s question, actually quantify the FX impact on operating income, or alternatively, talk about the FX impact on the direct costs and SG&A?

Buzz Brenkert

Are you looking for the impact as compared to last year?

Tim Evans – Jefferies & Company

Yes, year-over-year.

Buzz Brenkert

Year-over-year we picked up about $1 million in operating income as a result of the foreign exchange differences.

Tim Evans – Jefferies & Company

Okay. Okay. And I also wanted to ask about therapeutic area of focus. Has that shifted at all recently?

Candace Kendle

We continue to see the growth in oncology and central nervous system disease. But I would say the growth is consistent with our market growth.

Tim Evans – Jefferies & Company

Okay, great. Thanks so much.

Operator

At this time, there are no further questions. I would like to turn the call back over to Dr. Kendle for closing remarks.

Candace Kendle

Well, I just want to thank you all for participating. And we look forward to talking to you. Thank you.

Operator

Ladies and gentlemen, this concludes today’s conference call. You may now disconnect.

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Source: Kendle International Inc. Q3 2008 Earnings Call Transcript
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