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Executives

Patty Frank – Director, IR

Candace Kendle – Chairman and CEO

Buzz Brenkert – SVP, CFO and Secretary

Analysts

Todd Van Fleet – First Analysis

Dave Windley – Jefferies & Co.

Sandy Draper – Raymond James

Douglas Tsao – Lehman Brothers

Steven Shankman – Natixis

Kendle International Inc. (KNDL) Q2 2008 Earnings Call Transcript August 6, 2008 9:30 AM ET

Operator

Welcome to Kendle's second quarter 2008 earnings conference call and webcast. As a reminder, this call is being recorded. At this time, I will now turn the call over to Patty Frank, Kendle's Director of Investor Relations Please go ahead.

Patty Frank

Thank you. Good morning everyone and welcome to our conference call. With us today are Dr. Candace Kendle, Kendle's Chairman and CEO; Chris Bergen, Kendle's Chief Operating Officer; and Buzz Brenkert, Kendle's' Chief Financial Officer. By now you should have all received a copy of our earnings release. This release also is posted on our corporate Web site at www.kendle.com or via PR Newswire at www.prnewswire.com. If you're interested in listening to a replay of this call, a telephone version is available through September 5th by dialing 706-645-9291 and entering access code 55347808 or you may access the webcast of the archived call at www.kendle.com.

All participants are currently in a listen-only mode. A question-and-answer session will be conducted following management's formal remarks. If you would like to ask a question, please press the star key followed by the number one on your telephone keypad. Please note webcast participants do not have the capability to ask questions. Before I turn the call over to Dr. Kendle I would like to remind everyone that statements made during today's call that are not historical might be considered forward looking. Today we will be talking about our expectations regarding a number of activities in which Kendle is engaged. Reliance should not be placed on such forward-looking statements because they involve risks and uncertainties that may cause our actual results to differ materially from those which we are going to discuss or which we may imply. Those risks and uncertainties are outlined in our Securities and Exchange Commission filings.

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

Candace Kendle

Thank you Patty and good day to everyone. Buzz, would you like to start us off?

Buzz Brenkert

Certainly. Good morning, everyone. We are pleased to report record operating results for the second quarter. Net service revenues for the quarter totaled $127 million that's another quarterly record and a 30% increase over last year's second quarter. Operating income for the quarter totaled just over $16 million, a 48% increase over prior year. Operating margin was 12.7% compared to 11.1% in Q2, 2007. For the quarter, the company is reporting earnings per share of $0.52, which represents a 79% increase over last year's second quarter. Diluted earnings per share in Q2 of last year totaled $0.29.

Focusing on revenue, as I mentioned earlier, $127 million of net service revenue for this quarter represents 30% growth over last year and more than 11% growth over the first quarter of this year. The growth in revenue was primarily due to an increase in billable hours as headcount grew over 5% from the first quarter of 2008. Our acquisition of DecisionLine at the beginning of June added just over $2 million to revenue this quarter. Excluding revenue from the former DecisionLine operations, organic growth was 28% over last year and 9% over the previous quarter this year. Fluctuations in foreign exchange rates accounted for about 7% of year-over-year growth and 2% of growth over Q1. Excluding the impact of currency fluctuations, the organic growth rate was 21% year over year and 7% sequentially. Revenue in our early stage business at $8.6 million was 55% ahead of last year's second quarter and represented a 53% increase from last quarter. Two-thirds of the increase reflects revenue from the DecisionLine operations with the remainder due to strong results from our Morgantown operations. Revenue in our late stage operation was strong at over $116 million, growing 29% over last year's Q2 revenue of $90 million and a sequential 11% increase from Q1. As indicated previously, the majority of the increase in revenue was due to an increase in billable hours.

While all regions experienced significant revenue growth, we continued to see proportionately higher growth in regions outside of North America. For instance, North American based service revenues grew over 19% from Q2 last year and were 45% of total company revenues down from 50% of total revenues in Q2 of last year and European revenues grew over 33% to 44% of total, up from 42% of total revenue last year. Latin American revenues more than doubled, increasing from 5% of total last year to 8% this year and Asia-Pacific revenues grew 33%, remaining at 3% of total revenue for both Q2 of 2008 and 2007. Customer concentration as measured by our top five and top ten customers in terms of revenues remained fairly steady, versus the second quarter of last year. Our top five customers accounted for 28% of revenue for both the second quarter 2008 and 2007. Our ten largest customers accounted for 41% of revenue this year versus 42% in the second quarter last year. No customer accounted for as much as 10% of revenue.

Turning to income, income from operations for the quarter was slightly over $16 million or 12.7% of net revenue, compared to $10.9 million in Q2 of 2007 or 11.1% of revenue. Included in income from operations for the quarter is intangible amortization expense related to the Charles River and DecisionLine acquisitions totaling $802,000 and $131,000, respectively. Pretax income for the quarter totaled $12.4 million, nearly doubling last year's $6.6 million and the tax rate for the quarter was 36.7% compared to just over 34% in the same quarter last year. Net income of $7.8 million compares to income of $4.3 million for Q2 of the prior year an 81% increase. As I mentioned earlier, the diluted earnings per share was $0.52 versus $0.29 last year, a 79% year-over-year increase. As expected, the DecisionLine acquisition had a negligible effect on earnings adding less than $0.01 a share. Cash flow from operations for the quarter was $6.1 million reflecting significant growth in net accounts receivable and $6.3 million of capital expenditures. The bulk of capital expenditures were IT related. Year-to-date net service revenues were over $241 million, an increase of 25% versus last year, 24% on an organic basis. Foreign exchange rate differences between years account for 7% 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 46% of net service revenue, down from 50% last year. Latin America's contribution grew to 7% this year, up from 4% in 2007, while Europe's contribution remained consistent with last year at 43% and Asia-Pacific grew from 3% last year to 4% this year. For the full year, our top five customers accounted for 29% of net revenues, up from 27% last year. And our top ten customers represented just over 41%, versus 40% last year. Again, no customer contributed as much as 10% of revenue.

Full year operating income of $30 million compares very favorably to the 2007 operating income of just over $23 million for the first six months. Included in income from operations for the six months ended June 30, 2008 is intangible amortization expense of $1.6 million, related to the CRL acquisition and 131,000 related to the recent DecisionLine acquisition. Year to date net income totaled $13.5 million or $0.90 per diluted share compared to $8.5 million last year or $0.57 per share, both increasing by 58%. The effective tax rate year to date was 36% up from 35% last year. The increase in the tax rate is a function of geographic distribution of income between tax in jurisdictions.

Turning to the balance sheet, we ended the quarter with cash and marketable securities totaling over $25 million, down from $32 million at the start of the quarter. Accounts receivable at the end of the quarter totaled over $200 million including $84 million of unbilled receivables and over $116 million of billed receivables. Advanced billings totaled over $108 million resulting in net receivables of almost $92 million and DSO of 47 days up from 42 days period last year. The change in DSOs is related to timing of collections. In the first 11 days subsequent to the end of the quarter, we collected almost $36 million of receivables, 40% of the net balance outstanding at June 30. Working capital aggregated almost $61 million. On the liability side, borrowings include $200 million of convertible notes as well as $11 million outstanding on the revolver related to the purchase of DecisionLine. Interest expense related to the credit facility borrowings was approximately $50,000 for the quarter. The $11 million revolver balance was paid off in full with collections in early July.

With that, I'll turn it over to you, Candace, to discuss business development.

Candace Kendle

Thank you. Gross sales for the quarter were a record $204 million, representing a 24% increase over the second quarter last year and a 13% sequential increase from the first quarter. Cancellations were $27 million or 13% of gross sales. Net sales were $177 million compared to net sales of $152 million in the same quarter last year. This represents a 16% increase and a net book to bill of 1.4. Net sales increased 4% sequentially from Q1. With regard to our pipeline, our total business authorizations totaled $979 million for the quarter compared to $758 million for the same quarter last year representing a 29% increase and sequentially a 7% increase from the end of last quarter's backlog of $917 million.

We continue to see growth in large trials in both the absolute number as well as percentage of our backlog dollars. With regard to RFPs, we're seeing growth in the number of RFPs as well as growth in dollar value. The number of RFPs increased more than 22% from last quarter. We saw an increase of more than 100% in the average dollar value of RFPs received in this quarter as compared with Q2 of 2007. Our top five customers represented 38% and 44% of total growth and net sales respectively. This is down from 50% and 55% from Q2 2007.

Moving to our strategic outlook, the market opportunity for our service remains very strong with outsourcing penetration projected to reach an estimated 25% to 35% by 2011. We believe we are well positioned in early and late stage clinical development to capitalize on this opportunity. We continue to see an increasing shift by our customers toward strategic outsourcing to maximize R&D efficiencies, targeting reduction of costs and shortened development of timelines. A sensor for this process is global understanding of patient recruitment and retention. During the quarter, Kendle was recognized by Thomson CenterWatch in its 2008 survey of European investigated sites as one of the top CROs in Europe. This is after being named the Top CRO to Work With in 2007, a survey of US sites at the end of the last year. The results not only suggest our unique approach to site relationships is effective on a global scale but reaffirm Kendle's belief that strategic relationships with investigators are critical to our success in delivering results to our customers.

With regard to our business expansion, early stage development remains a significant expansion opportunity for Kendle with Phase I growth projected to outsource the broader outsourcing market at about 15% annually. This coupled with the expected growth in discovery and pre clinical pipelines will translate to better demand for early stage services. During the quarter we made significant progress related to the expansion of our Phase I business. On June 2 we announced the acquisition of DecisionLine Clinical Research, a Phase I CRO based in Toronto, Canada. In future communication we'll refer to this as Kendle Phase I facility, Toronto. Our new unit is an industry leader in the evaluation of early stage innovative CNS drugs and is recognized worldwide for its work in the conduct of human abuse liability studies and assessment of abuse potential and risk mitigation. In addition, the new operation provides geographical expansion, additional scientific expertise, high medical competencies for first in man studies, including biologics and strong project execution. The integration is proceeding on schedule with the financial contribution of the Toronto unit exceeding our expectations at the time of acquisition. We already are recognizing the benefit of the new unit in terms of the additional capability, capacity and synergy for us in our Phase II-IV programs, particularly in the CNS consulting arena.

Looking to our other early Phase operations, our focus continues to be on performance enhancement and customer diversification to deliver improved profitability to our shareholders. Our clinical pharmacology unit in the Netherlands is improving and is expected to show further improvement later in the year. Our bioequivalents unit in Morgantown, West Virginia had a strong second quarter and is stabilizing its business. We continue to focus on diversifying our customer base to maximize and execute capacity provided by this operation.

Moving to our leadership, the executive leadership realignment and the senior leadership appointments announced earlier this year have provided Kendle with a strengthened leadership team to drive our global growth strategies and deliver sustainable performance across all areas of the business. The additions to our finance leadership team and the newly created role in commercial operations provide us with more comprehensive and timely operations reporting and improved forecasting capabilities. Our operational leadership in the areas targeted for business expansion, most notably early Phase and Asia-Pacific, has provided key scientific and technical leadership to guide our growth.

Finally our enhanced expertise in systems infrastructure and ERP will help us to drive global connectivity and leverage in support of business needs. While we do not expect to see significant benefit from this system during the next 12 months, we are focusing on reviewing processes both at Kendle and with our customers that will drive down overall costs.

With regard to our global resources, continuing to attract and retain the industry's top talent is key to our future growth and success in a competitive labor market. We continue to move forward against our hiring objectives in support of our growth plans and are pleased to report that our attrition rates remain below the industry average, dropping another 2.2% in the second quarter. Alignment and orientation of our global leadership team and work force to the Kendle vision and strategy remains a top priority.

I would like to move at this time, before we go to Q&A, to comment on our guidance and expectations. For the full year, Kendle is now projecting net service revenues in the range of $490 million to $500 million and earnings per share on a diluted basis of $2 to $2.15. Kendle previously had rejected net service revenues in the range of 450 million to $460 million and earnings per share on a diluted basis of $1.90 to $2.07. As previously reported, operating margin is still projected to be within 13% to 14%. Within our calculations we continue to expect the net book to bill of 1.4 to 1.5 going forward. Amortization of the CRLCS acquisition intangible will be about $3.2 million or about $0.14 per share in 2008 and the DecisionLine intangible amortization is expected to be around $1 million about $0.04 a share. This revenue guidance does include our recent acquisition of DecisionLine.

With that, I would like to move to Q&A. Operator?

Question-and-Answer Session

Operator

(Operator instructions) your first question is from Todd Van Fleet with First Analysis.

Todd Van Fleet – First Analysis

Good morning, guys, nice quarter. I wanted to ask about the sizable sequential step up on SG&A, about five million bucks and I think unless I get it wrong that a good portion of that showed up in the corporate line, Buzz, maybe you can clarify? But I was just kind of curious as to what was the reason for the step up and then what is more permanent and what is just kind of temporary?

Buzz Brenkert

Sure Todd. Most of that increase is related to compensation. As you know, the company's merit increases are all effective as of April 1, so the second quarter is the first quarter that has that increase in it. We also had a significant increase in incentive compensation as a result of the results for the quarter and those two items make up the bulk of it. Now there are a number of things like the DecisionLine acquisition added some SG&A to what we had, there were director stock grants that fall into the second quarter every year, there were some higher IT support costs but the real driving items are compensation related.

Todd Van Fleet – First Analysis

Okay. So the incentive comp accrual then, Buzz, if you can help us understand, the amount of the accrual during the quarter, you said it was based on the quarter performance. So just help us understand how we should expect perhaps additional accruals for the remainder of the year? Help us understand kind of your accrual methodology. Do you kind of accrual as you go, so if Q3 comes in line we should expect a similar expense from your point of view or did you accrue quite a bit in Q2?

Buzz Brenkert

The accrual is made based on what the expectations are for the entire year and based on the quarter and what their contribution is during the quarter. So frankly there is a bit of excess accrual, if you will, in the second quarter that is catch up from the lower level of accrual in Q1.

Todd Van Fleet – First Analysis

Okay.

Buzz Brenkert

So I would say what you really for your model ought to be looking at is really the year-to-date accrual if you will.

Todd Van Fleet – First Analysis

Okay and then let me ask a below line question now, what is your expectation regarding the Forex charges below the operating line? Previously it was $4 million to $5 million, are we still on track for that or is it something higher?

Buzz Brenkert

You mean in our guidance, our full year guidance?

Todd Van Fleet – First Analysis

Yes.

Buzz Brenkert

The revised guidance anticipates about the same level.

Todd Van Fleet – First Analysis

About the same level and we saw how much in Q2 then of that $1.6 million below the line?

Buzz Brenkert

Just a little over $1 million.

Todd Van Fleet – First Analysis

Just a little over $1 million. And for Q1 it was, if you can refresh me, was it about $2 million?

Buzz Brenkert

It was about $2 million, yes, a little over $2 million.

Todd Van Fleet – First Analysis

Okay, thank you.

Operator

Your next question is from Dave Windley from Jefferies & Co.

Dave Windley – Jefferies & Co.

Hi, my congratulations on the quarter as well. Candace your comments regarding RFP flows, I wanted to clarify those a little bit. It sounds like your remote is difficult to understand. Did you say 22% growth in the volume of RFPs and I think you said last quarter, is that 1Q of '08 or 2Q of '07?

Candace Kendle

It is 22% growth over Q1 of '08. The 100% comparison in terms of average dollar size was to Q2 '07.

Dave Windley – Jefferies & Co.

Okay, alright and that's average dollar size. And so if you look then at year-over-year total dollar value of RFPs, how much did that grow? I'm assuming that would be even more than 100%.

Candace Kendle

It's grown significantly.

Dave Windley – Jefferies & Co.

I say that because I assume your volume is up some and then average value is up 100%, is that fair?

Candace Kendle

That's fair.

Dave Windley – Jefferies & Co.

Okay, alright. As you are looking, is it possible to characterize within that flow of studies how has the volume of what you used to call elephant trials, of large trials, how has that changed?

Candace Kendle

What I will say is that on average the trials are definitely larger. Noticeably in 2008 compared to late in 2007, we haven't seen as many of the great big trials. But overall, the trials are obviously good because they are twice what it was in 2007. But the complexity of the trial is greater as the oncology trials come online, the complexity is greater because of the global footprint requirements to expedite the patient access and retention so the costs per patient is higher so all of these things drive the cost up. But we have noticed that in 2008, we haven't seen as many of the great big – one of the competitors several quarters ago referred to the $100 million trials, those have not been as prevalent in the first half of '08 as would appear to have been in latter part of '07 at least in our business mix.

Dave Windley – Jefferies & Co.

Okay. And are you continuing to see, now that you've had a couple of years of the Charles River acquisition under your belt, are you continuing to see customer expansion, adding new, totally new customers or are you now fully in a mode of driving deeper into those clients that you've established?

Candace Kendle

It is a combination of both. We are seeing more customer opportunity from mid and smaller size biotechs that meet our requirements so we are seeing new customers in that segment. Those customers are also interested in larger global trials as their drugs get into later stages so they're real viable customer base for us in our mega trial strategy. With regard to the big pharma customer, as I know you know, but just to reiterate, there's been a lot of preferred provider re-upping if you will. We go through about a three-year cycle of these kinds of things but big pharma is now circling back, looking at new provider relationships, trying to get more efficiencies. So it's an opportunity where Kendle maybe three years ago didn't meet some of the criteria for the larger trials in these big customers where Kendle has an opportunity that we didn't have at that time.

Dave Windley – Jefferies & Co.

Okay. Buzz, I believe there is a mention on the guidance that the guidance does not assume dilution from the convert, can you remind me where that trigger is, where the dilution begins?

Buzz Brenkert

$47.71.

Dave Windley – Jefferies & Co.

Okay. And am I right that it does not assume, the guidance does not assume dilution?

Buzz Brenkert

That's correct.

Dave Windley – Jefferies & Co.

Okay, alright. That's all I have now. Thanks.

Candace Kendle

Thanks Dave.

Operator

Your next question is with Sandy Draper with Raymond James.

Sandy Draper – Raymond James

Thank you very much and I also add my congratulations on the nice quarter. Buzz, maybe just circling back on the earlier expense question, maybe if we look at it a little differently, can you give us an approximation of variable cost versus the fixed cost as a way to think about, okay, if sales weren't as good or flat, what part stays the same and what part goes up? That would be very helpful.

Buzz Brenkert

Sandy, I don't have numbers along those lines. I would say that most of the direct costs are variable in nature. The SG&A costs are semi-variable, if you will. Probably the biggest variable numbers in that area are not variable with revenue, they're more variable with timing, things like advertising and insurance costs and things along those lines.

Sandy Draper – Raymond James

Okay. That's helpful. Maybe another way to look at it, if your bookings number were down sequentially, so you didn't have as strong a bookings quarter, would your SG&A number actually go down because you have lower, all things else being equal, you would have lower compensation costs or you can not envision a situation where your SG&A would actually go down?

Buzz Brenkert

I don't think the actual bookings really affect the SG&A significantly because typically those do not generate billable hours in the same quarter and compensation for things like that would ordinarily be considered variable like sales commissions and so forth are with revenue not with the actual booking.

Sandy Draper – Raymond James

Okay. That's very helpful. And then maybe a broader question for you Candace, just your thoughts on the market, the need for consolidation, the risks of consolidation, what are your thoughts about for the industry? And then for Kendle, do you feel comfortable where you are now that you've pretty much fully integrated Charles River? Do you need to get bigger, does it help you getting bigger? Just any thoughts about that in light of sort of industry trends would be helpful. Thanks Candace.

Candace Kendle

Sure. Deals certainly matter but Kendle has achieved global footprints that can serve all the major customers. We're focused now on the business expansion and early phase which is driving our acquisitions strategy and our business expansion in our geographies. Right now we're very focused on Asia-Pacific and continue to drive our Latin America growth although I do think there is still more opportunity in Eastern and Central Europe to build scale. Certainly there is always conversation about consolidation in the CRO industries. At this point, we're very focused on our strategy around early phase and geographic expansion that we've outlined over the last couple of quarters. Really since the integration of Charles River we're focused more on those unique opportunities.

Sandy Draper – Raymond James

Great. Thanks very much.

Operator

Your next question is from Douglas Tsao with Lehman Brothers.

Douglas Tsao – Lehman Brothers

Hi, good morning. Candace you just referred to the process of pharma companies going back and refreshing their provider agreements and that your experience is that Kendle now qualifies, could you provide some color on what exactly has changed beyond just company's revenues are bigger that has now allowed you to step up into that league?

Candace Kendle

Just to my point previously about scale mattering, it really does matter. The depth of your teams, if you're going to work with a major pharmaceutical company that has cardiovascular, oncology and CNS drugs in the pipeline, they want to know that you have depth in that level of experience, that you have available team members and that you have the geographic reach in those therapeutic areas so you can really drive the patient access and retention that I previously mentioned. So the size of the company and the depth in each of the therapeutic and geographic requirements, as well as senior management really makes the difference to companies. And you've seen our growth over the last three years both at the leadership and the geographic level and we've talked a little bit less maybe about our real growth in the medical affairs support group that is now over 100 physicians. I think it's really the size, complexity and ability to answer the multiple needs of the larger pharmaceutical companies.

Douglas Tsao – Lehman Brothers

And is this a process? How do they assess that? Do they just sort of look at – are you having interviews, are you sending CVs, is this an RFP process? I mean how –

Candace Kendle

Every company does it a slight bit different.

Douglas Tsao – Lehman Brothers

Of course.

Candace Kendle

First of all there is always the relationship component. It's very important that you build relationships within the company. The much more formal process would be outsourcing group that generally includes request for information that may follow on with a series of requests for proposals for smaller projects that grow into larger projects. But the request for information has a very extensive due diligence process beginning with the document and then presentations by the CRO to the customer and then having visits by the customer. We focus a large part on QA but also to validate what you have outlined in the RFI. So it could take a number of months and then I would be remiss if I didn't say that all of that ends up with a price negotiation around the volume of business.

Douglas Tsao – Lehman Brothers

Okay. And then also, could you walk through, just to try to get to sort of apples-to-apples comparisons, across the group, how you treat FX changes to your backlog on the quarterly reports? Are those included in gross orders?

Buzz Brenkert

No, they're not.

Douglas Tsao – Lehman Brothers

And are they taken out – how should we think about that issue then? Is it in cancellations then or is that you just have very little FX exposure on the backlog because most of your contracts are in US dollars?

Buzz Brenkert

The bulk of the contracts are in US dollars Doug. The backlog is translated if it's in other currencies, it's translated and reconciled down for the currency effect every quarter.

Douglas Tsao – Lehman Brothers

But I imagine sometimes it goes up, too, right? I mean if you have a contract in Europe –

Buzz Brenkert

Yes. You're right.

Douglas Tsao – Lehman Brothers

So was it negative this quarter or was it positive, I'm just trying to get a feel for this issue.

Buzz Brenkert

There wasn't a significant change this quarter.

Douglas Tsao – Lehman Brothers

Okay.

Buzz Brenkert

The primary pound, British pound and euros were fairly consistent through the quarter.

Douglas Tsao – Lehman Brothers

Okay. So when I think about future quarters and past quarters, where does that show up in the press release each time or what item is that reported in?

Buzz Brenkert

I don't think I understand your question.

Douglas Tsao – Lehman Brothers

I mean because you're backlog usually trues up if I take your gross bookings and out your cancellations and out your revenues. So somewhere there must be an adjustment for FX, so I'm just trying to figure out how I get to it?

Buzz Brenkert

Well. There is an adjustment for FX, but I think if you do the calculation you'll find that you're off a little bit every quarter. That's the FX reconciliation.

Douglas Tsao – Lehman Brothers

Okay. Thank you.

Operator

You have a follow-up question from Todd Van Fleet with First Analysis.

Todd Van Fleet – First Analysis

I wanted to dig in a little bit more on the revenue performance in the quarter and maybe expectations for the rest of this year. First I guess on the early stage side, about $2 million was due to the DecisionLine acquisition, correct, Buzz? So we saw a little bit of a step up sequentially and over prior year on kind of the core business. Can you help us understand for the early stage business, and Candace as well, the expectation moving into the back half of this year, given all the initiatives that you put into place as well as additional contribution possibly from DecisionLine, so shouldn't I guess – we were thinking perhaps that we had seen greater contribution from DecisionLine in the quarter. But just to talk a little bit about your expectations for the balance of the year. Thanks.

Buzz Brenkert

There was about $2 million in the quarter from DecisionLine. Remember the acquisition was just made at the beginning of June so there is only a month of operations from Kendle Toronto in the second quarter. In addition to that sequentially, the Phase I business or early stage business if you will increased by almost $1 million from Q1, the revenue there. It was the bulk of the increases is related to Morgantown. Morgantown had a very strong quarter.

Todd Van Fleet – First Analysis

Candace I don't know if you care to comment on what you see for the back half of the year for early stage based on the initiatives?

Candace Kendle

I think you'll see in the existing Utrecht and Morgantown units a progressive improvement but not a big leap forward to the end of the year.

Todd Van Fleet – First Analysis

Okay. So the guidance of $490 million to $500 million for the full year, I think you could kind of read flat revenue essentially with Q2 and achieve kind of the midpoint of your guidance range for 2008. I think we understand or at least we seem to believe given the partial quarter contribution from DecisionLine in Q2 that perhaps early stage will improve in terms of revenue contribution in the back half of the year. Why would it make sense for the late stage business to see a decline in revenue relative to Q2 in the back half of the year given what seems to be nice conversion from the backlog at this stage?

Buzz Brenkert

Well, a lot of what you're looking at, when you see the increase from Q1 to Q2 on the revenue growth, about 2% of that is due to foreign exchange and who knows what is going to happen with foreign exchange going forward. There is a very similar number that is really a rather large billing and I'm hesitating to use the word pass-through because it's not a pass-through, but it's an associate CRO billing from Japan that is unusual in the quarter and is sort of re-billed to the customer with no markup. So those sorts of things are not anticipated in the figures going forward.

Todd Van Fleet – First Analysis

Okay. Two more quick ones if I could. Regarding the reversal of the accruals, Buzz, for vacation and the like, I seem to recall Q3 being the quarter for that sort of activity; is that right?

Buzz Brenkert

Q3 is one of our strongest quarters for PTO, you're correct, paid time off.

Todd Van Fleet – First Analysis

Okay. And then what is the tax rate assumed in your guidance for EPS for the year, the full year?

Buzz Brenkert

36%.

Todd Van Fleet – First Analysis

Great. Thank you.

Operator

(Operator instructions) Your next question is from Steven Shankman from Natixis.

Steven Shankman – Natixis

Thanks, good morning. A few questions here on guidance. When I look at the new EPS guidance, it's still assuming a pretty significant ramp for the second half of this year, especially to get to the middle of that range, and I hate to remind you guys but I think we heard a somewhat similar story at this time last year. So I guess what I'm getting at is what is different this year, is it the top line growth related to billable hours or Phase I expectations? Obviously some better margin expectations, what should we look at that gives us some increased confidence in hitting these new numbers in 2008?

Buzz Brenkert

Let me take that, Steve. You're right, we anticipate some ramp up, but quite frankly, if you take a look at, we're at $0.90 year-to-date now, to get to the low end of our range, the $2 range, we need to go to $1.10, which would be $0.55 a quarter. We had $0.52 in the second quarter. I think that $0.55 is very doable, particularly when you've got the full quarter effect of the DecisionLine acquisition and the continued contribution of the new associates hired in the second quarter. We're very confident with the EPS range we've got for the year.

Steven Shankman – Natixis

Okay. And then I guess just as a little bit of a follow up, if I recall a lot of the comments from you Buzz and Candace about the prior guidance range was that it was conservative. That obviously proved to be the case here. Any further comments on how to perceive this new range or how we should think about it, is it still conservative? I get a little bit of that sense from your last comment or maybe is this one more reasonable or prudent or is it a little bit on the aggressive side, talking about the EPS range?

Buzz Brenkert

I would categorize it as conservative.

Steven Shankman – Natixis

Okay. Great. Thanks very much and a nice quarter, guys.

Candace Kendle

Thank you.

Buzz Brenkert

Thanks Steve.

Operator

Your next question is from Sandy Draper with Raymond James.

Sandy Draper – Raymond James

Thanks Buzz. Just a quick follow up on Dave's question about the converts and the strike price is $47.71 but I just want to understand the accounting because of the hedge, do you not show anything on the P&L or do you show dilution with some add back in the P&L, I'm just trying to understand those mechanics and when we would actually see reported dilution on the P&L?

Buzz Brenkert

No, we'll see reported dilution on the P&L at $47.71 if it is over that range for 20 consecutive days, the various things that are there. At termination of the convertible, we won't see dilution in the number of shares for over the $62.10 strike price that the hedge throws in there. But we do have to, for diluted shares for earnings per share calculation, we do have to start the dilution at the point in which the contractual obligation within the convertible is triggered.

Sandy Draper – Raymond James

Okay. And on that do you do the full add back of all the shares and add back the interest or just – I'm looking back at the chart you had back at the investor day last year where it shows that if at $50, it's a $191,000 or $192,000. Is that the number we should be thinking about to scale off of or is it a full add back with a full interest add back?

Buzz Brenkert

No that's the right number.

Sandy Draper – Raymond James

Okay. Then what about interest? Do you take a portion of interest or you just do not do anything with interest?

Buzz Brenkert

No. The interest isn't effective because the debt is still out there. The principal on which the interest is calculated is to be paid in cash. So there is no adjustment to the interest expense.

Sandy Draper – Raymond James

Okay. Great. Thanks a lot.

Operator

You have another follow-up from Todd Van Fleet with First Analysis.

Todd Van Fleet – First Analysis

Buzz, on this convert issue, presumably, we're going to have a different methodology in the next year because of APB 14, correct?

Buzz Brenkert

That's correct.

Todd Van Fleet – First Analysis

And so let me just ask you, what is the first point at which these bonds, if you can refresh us, they become convertible or you either you can call them or they can become converted? Is that five or ten years or –

Buzz Brenkert

The term of the bond is five years.

Todd Van Fleet – First Analysis

Okay. Alright. So five years. Have you done much work regarding kind of your expectations on – let me just ask you, what is the cost of debt that you guys have been using internally to calculate what this charge is going to be? Is it 6.5%, 7%, 7.5% in terms of your cost of debt at the time of issue?

Buzz Brenkert

That's something we're still working on with our auditors is how do you determine the appropriate cost of debt for this sort of a calculation. So it's still up in the air.

Todd Van Fleet – First Analysis

Okay. So for those of us that want to hazard a guess of what this impact is going to be next year –

Buzz Brenkert

Personally I would say that the debt that we retired with this convertible bond and the interest rate on that debt is probably a decent proxy or would put you in the neighborhood.

Todd Van Fleet – First Analysis

Okay. Great. Thank you.

Operator

At this time, there are no further questions.

Candace Kendle

Thank you all for participating and we look forward to speaking with you next quarter.

Operator

Thank you for participating in today's conference call. You may now disconnect.

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Source: Kendle International Inc. Q2 2008 Earnings Call Transcript
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