The information discussed below is derived from the Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for the three and nine months ended September 30, 2009 and should be read in conjunction therewith. The Company's results of operations for a particular quarter may not be indicative of results expected during subsequent quarters or for the entire year.
Company Overview
Kendle International Inc. (the Company 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 services, 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 IV clinical trials, regulatory affairs and biometrics and statistics offerings. The Company has, in the past, aggregated its clinical development operating unit, regulatory affairs operating unit, and biometrics operating unit into the Late Stage segment under the aggregation criteria in accounting guidance related to disclosures about segments of an enterprise and related information. The aggregation criteria met include 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 unallocated corporate expenses, information technology, marketing and communications, human resources, finance and legal 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 is in the process of completing of an organizational realignment intended to drive innovation, improve productivity and gain efficiencies. The realignment primarily affects business units within the Late Stage reportable segment and is not expected to significantly affect the Company's reporting under accounting guidance related to disclosures about segments. It is anticipated that the Late Stage operating units will continue to be aggregated as they still are expected to meet the aggregation criteria in the guidance. Additionally, the Company has implemented cost savings measures to reduce labor and facilities related costs. The expected outcome of the above efforts is a more streamlined, focused organization better positioned to provide services to our customers.
The Company primarily earns net service revenues through performance under Late Stage segment "full-service" contracts. The Company also recognizes revenues through limited service contracts, consulting contracts, and Early Stage segment contracts. For a detailed discussion regarding the Company's Late Stage segment contracts, Early Stage segment contracts, revenue recognition process and other Critical Accounting Policies and Estimates, please see "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in the Annual Report on Form 10-K for the year ended December 31, 2008.

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.
New Business Authorizations and Backlog
New business authorizations, representing new sales of our services, are added to backlog when the Company enters into a contract, letter of intent or other forms of commitments. Authorizations can vary significantly from quarter to quarter and contracts generally have terms ranging from several months to several years. The Company's new business authorizations for the three months ended September 30, 2009 and 2008 were approximately $137 million and $212 million, respectively. New business authorizations for the nine months ended September 30, 2009 and 2008 were approximately $350 million and $597 million, respectively.
In 2009, new business authorizations declined significantly due to continued delays in and lengthening of the selling cycle. Mergers and acquisitions by and between the Company's customers in the biopharmaceutical industry are resulting in delays in signed contracts, as well as extending the time in which our customers make final project decisions, as our customers are re-evaluating their research and development spending priorities in an effort to control costs. We believe that biopharmaceutical research and development spending has slowed from the historical levels and that growth rates may be relatively flat over the next few years. However, we also believe that outsourcing penetration is likely to increase, as outsourcing is an effective means for our customers to reduce their costs. In addition, smaller customers without large partners have experienced difficulty obtaining financing. In general, in the first nine months of 2009, the Company experienced cancellations at a higher level than its historical norms and in this current environment could continue to experience higher than its normal cancellations.
Backlog consists of new business authorizations for which the work has not started but is anticipated to begin in the future as well as contracts in process that have not been completed. 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. Backlog at September 30, 2009 was approximately $846 million. The net book-to-bill ratio was .8 to 1 and 1.4 to 1, respectively, for the three months ended September 30, 2009 and 2008 and .6 to 1 and 1.4 to 1 for the nine months ended September 30, 2009 and 2008, respectively.
As discussed in "Item 1 - Backlog" in the Company's Annual Report on Form 10-K for the year ended December 31, 2008, the Company's backlog might never be recognized as revenue and is not necessarily a meaningful predictor of future performance.

Results of Operations
The Company's results of operations are subject to volatility due to a variety of factors. The cancellation or delay of contracts and cost overruns could have adverse effects on the Condensed Consolidated Financial Statements. Fluctuations in the Company's sales cycle and the ability to maintain large customer contracts or to enter into new contracts could negatively affect the Company's long-term growth. In addition, the Company's aggregate backlog, consisting of signed contracts and letters of intent as well as awarded projects for which the contract is actively being negotiated, is not necessarily a meaningful indicator of future results. Accordingly, no assurance can be given that the Company will be able to realize the net service revenues included in the backlog. For a more detailed discussion regarding the risk factors associated with the Company's results of operations, among other things, see Item 1A-Risk Factors, included in the Company's Annual Report on Form 10-K for the year ended December 31, 2008.

Revenues

                                    Three Months Ended September 30,                     Nine Months ended September 30,
                                                                 % Increase                                          % Increase
                                 2009              2008          (Decrease)           2009             2008          (Decrease)

Net service revenues
Late stage                   $     91,496       $  110,879             -17.5 %    $    284,691       $ 331,793             -14.2 %
Early stage                        10,764           11,225              -4.1 %          27,227          25,500               6.8 %
Support & other                     2,328            2,724             -14.5 %           8,124           8,648              -6.1 %

Total net service
revenues                          104,588          124,828             -16.2 %         320,042         365,941             -12.5 %
Reimbursable
out-of-pocket revenues*            29,172           56,254             -48.1 %         100,934         151,346             -33.3 %

Total revenues               $    133,760       $  181,082             -26.1 %    $    420,976       $ 517,287             -18.6 %

* Reimbursable out-of-pocket revenues and expenses flutuate from period to period, primarily due to the level of investigator activity in a particular period.

Net service revenues declined approximately $20.2 million for the third quarter of 2009 and $45.9 million for the nine months as a result of changes in foreign currency exchange rates and reduced volume of services provided. The changes in currency rates reduced net service revenues by approximately 6% for the quarter and 10% for the nine month period.

Net service revenues in the Late Stage segment decreased from last year by approximately 18% in the three months ended September 30, 2009 and by approximately 14% for the nine month period. The declines were driven primarily by changes in foreign currency exchange rates and continued delays in the selling cycle, more specifically, advancing contracts from the awarded status to the signed contract status, which prevented the Company from commencing work and revenue generating activities. The Company also experienced a significantly higher than normal cancellation rate on previously awarded studies. The Company believes this situation is the result of weakness in the current global economy and reduced access to capital. Additionally, recent pharmaceutical company mergers as well as reduced prescription drug sales and uncertainty in the global economy delayed customer decisions on previously awarded contracts and slowed the contract signature process as pharmaceutical companies re-evaluate their pipelines and, in the case of newly merged customers, focus on integration efforts rather than future development of products.
Net service revenues from the Early Stage segment decreased by approximately 4% in the quarter, primarily as a result of lower net service revenues at the Company's Phase I unit in the Netherlands as a result of continued project delays and cancellations. This decline was partially offset by increased net service revenues at the Company's Phase I unit in Morgantown, West Virginia. For the nine months ended September 30, 2009, net services revenues in the Early Stage segment increased approximately 7% from the corresponding period of 2008. The increase in 2009 is primarily a result of a full nine months of Kendle Toronto (DecisionLine) net service revenue in 2009 compared to only four months of post-acquisition net service revenues in 2008. This increase was partially offset by decreased net service revenues at the Phase I unit in the Netherlands as a result of the previously mentioned project delays and cancellations. A summary of net service revenues by geographic region for the three and nine months ended September 30, 2009 and 2008 is presented below.

                                     Three Months Ended September 30,                     Nine Months ended September 30,
                                                                  % Increase                                          % Increase
                                  2009              2008          (Decrease)           2009             2008          (Decrease)

North America                 $     46,914       $   62,500             -24.9 %    $    155,825       $ 173,033              -9.9 %
Europe                              44,013           46,305              -4.9 %         119,671         149,808             -20.1 %
Latin America                        9,124           11,530             -20.9 %          32,111          29,017              10.7 %
Asia-Pacific                         4,537            4,493               1.0 %          12,435          14,083             -11.7 %

Total net service revenues    $    104,588       $  124,828             -16.2 %    $    320,042       $ 365,941             -12.5 %

The Company experienced continued strong growth in Latin America in the first nine months of 2009 as customers continued to conduct clinical trials in this region due to the region's low-cost structure and patient availability. The Company's net service revenues in Latin America increased by approximately 11% in the first nine months of 2009 compared to the same period of the prior year. The top five customers based on net service revenues contributed approximately 27% of net service revenues during the third quarter of 2009 and 24% of net service revenues during the third quarter of 2008. On a year to date basis, the top five customers accounted for approximately 28% of 2009 net services revenues and 27% of 2008 net service revenues. No customer accounted for more than 10% of total net service revenues in any period presented.

Operating Expenses

                                    Three Months Ended September 30,                     Nine Months ended September 30,
                                                                 % Increase                                          % Increase
                                 2009              2008          (Decrease)           2009             2008          (Decrease)

Direct costs                 $     48,914       $   64,070             -23.7 %    $    162,096       $ 186,763             -13.2 %
Reimbursable
out-of-pocket costs                29,172           56,254             -48.1 %         100,934         151,346             -33.3 %
SG&A expenses                      35,854           40,649             -11.8 %         109,110         122,009             -10.6 %
Restructuring expenses                380                -                               6,386               -
Depreciation and
amortization                        3,907            4,240              -7.9 %          11,802          11,245               5.0 %

Total operating expenses     $    118,227       $  165,213             -28.4 %    $    390,328       $ 471,363             -17.2 %

Direct costs decreased from last year by approximately $15.2 million for the quarter ended September 30, 2009 and $24.7 million for the nine month period as a result of the decline in net service revenues, cost savings activities initiated in the second quarter of 2009 and the net benefit of an insurance recovery realized in the third quarter of 2009. Direct costs expressed as a percentage of net service revenues were 46.8% for the three months ended September 30, 2009 and 51.3% in the third quarter of 2008 and 50.6% for the nine months ended September 30, 2009 and 51.0% in the corresponding period of 2008. As discussed in more detail below, in the second quarter of 2009, the Company commenced a number of cost-savings initiatives including a workforce reduction, furloughs and reductions in the standard working hours that served to reduce the level of direct costs.
In the fourth quarter of 2008, the Company identified a programming issue unique to one study and one customer that required the Company to rework a large portion of the project and additionally, to bear costs that would, under normal circumstances, be absorbed by the customer. The Company accrued $4.9 million related to these costs in the fourth quarter of 2008 and, based on revised estimates, an additional $1.0 million in the first quarter of 2009. In the third quarter of 2009, as a result of ongoing discussions with the customer and the insurance provider, the Company increased the accrual for direct costs by $1.6 million to a total of $7.5 million and recorded a receivable for the insurance claim recovery of $5.0 million. The net reduction in direct costs in the third quarter of 2009 related to this programming issue and the insurance claim recovery was approximately $3.4 million.
Selling, general and administrative (SG&A) expenses decreased approximately $4.8 million for the quarter ended September 30, 2009 compared to the corresponding period of 2008 and $12.9 million for the nine month period of 2009 compared to 2008. As a percentage of net service revenues, SG&A expenses were 34.3% for the three month period of 2009 and 34.1% for the nine month period of 2009 compared to 32.6% and 33.3% for the same periods a year ago, respectively. Approximately $1.9 million of the third quarter and $9.9 million of the nine month decrease resulted from changes in foreign currency exchange rate fluctuations (calculated using 2009 actual costs at 2008 exchange rates). The remainder of the decrease in selling, general and administrative expenses relates primarily to the cost-savings initiatives in the second quarter of 2009, as discussed in more detail below. These actions reduced SG&A expenses from last year for both the quarter and the nine months.

In the second quarter of 2009, the Company commenced several initiatives to optimize its workforce and capacity and to reduce operating expenses. These activities included a reduction of discretionary spending, limiting previously planned headcount additions, delay or elimination of merit increases, reduction or elimination of other benefits, workforce reductions or furloughs, and other potential cost savings in an attempt to reduce expenses. The Company recorded a charge in the second quarter of 2009 for severance-related and other expenses (primarily related to facility closures), of approximately $6.0 million. In the third quarter of 2009, the Company revised its estimate of severance costs and expensed an additional $380,000. These measures are expected to result in $19 million to $22 million in cost savings in 2009. As of September 30, 2009, the Company remains on track regarding its restructuring plans. Since the bulk of the Company's expenses are typically incurred in the Late Stage and Support and Other reportable segments, the majority of the costs removed from the business also affect those two segments.
Depreciation and amortization expense decreased by $0.3 million in the third quarter of 2009 compared to the third quarter of 2008. The decrease is mainly due to decreased amortization expense on finite-lived intangible assets. Finite-lived intangible assets are amortized in a manner consistent with the underlying expected future cash flows from the customers, resulting in higher amortization expense in the initial year of acquisition. For the nine months ended September 30 2009, depreciation and amortization expense increased by approximately $0.6 million over last year primarily as a result of a full nine months of amortization expense in 2009 on a customer relationship asset from the Kendle Toronto (DecisionLine) acquisition versus four months in 2008.

Income from Operations

                                    Three Months Ended September 30,                     Nine Months ended September 30,
                                                                 % Increase                                          % Increase
                               2009               2008           (Decrease)           2009             2008          (Decrease)
Operating income (loss)
Late stage                  $    23,002       $     26,674             -13.8 %    $     63,134       $  79,963             -21.0 %
Early stage                       1,784              1,208              47.7 %           2,699           3,745             -27.9 %
Support & other                  (9,253 )          (12,013 )           -23.0 %         (35,185 )       (37,784 )            -6.9 %

Total operating income      $    15,533       $     15,869              -2.1 %    $     30,648       $  45,924             -33.3 %

Income from operations declined in 2009 from 2008 for both the three and nine months primarily as a result of the decline in net service revenues. This decline was partially offset by a $3.4 million reduction in direct costs discussed above. As a percentage of net service revenues, income from operations was 14.9% for the quarter ended September 30, 2009 and 9.6% for the nine month period of 2009 compared to 12.7% and 12.5%, respectively, for the same periods a year ago.

Late Stage segment income from operations declined by $3.7 million for the quarter ended September 30, 2009 and $16.9 million for the nine months ended September 30, 2009 as compared to last year. Operating margin for the Late Stage segment was 25.1% for the three month period in 2009 and 22.2% for the nine month period in 2009 compared to 24.1% for both periods in 2008. The decline in the Late Stage operating margin was due partially to a drop in net service revenues, primarily in the North American and European regions, driven by decreased utilization of billable associates and excess capacity. Additionally, for the nine month period the decline in Late Stage operating margin was due to the accrual of costs related to the workforce capacity optimization as discussed above.
Early Stage income from operations increased from 10.8% of net service revenues in the third quarter of 2008 to 16.6% of net service revenues in the third quarter of 2009 primarily because of improved utilization of the facility in Morgantown, West Virginia. For the nine months ended September 30, Early Stage segment income from operations decreased from 14.7% of net service revenues in the 2008 period to 9.9% for the corresponding period of 2009, primarily because of a decline in revenue in the first half of 2009 at the Company's Phase I unit in the Netherlands.

Other Income (Expense)

                                    Three Months Ended September 30,                     Nine Months ended September 30,
                                                                  Increase                                           Increase
                                2009              2008           (Decrease)           2009             2008         (Decrease)
Other income (expense)
Interest income              $        72       $        94      $        (22 )    $        435       $     483      $       (48 )
Interest expense                  (3,462 )          (3,832 )             370           (11,066 )       (12,079 )          1,013
Gain (loss) on
extinguishment of debt              (182 )               -              (182 )           2,951               -            2,951
Foreign currency gains /
(losses)                             139             3,777            (3,638 )           5,016             109            4,907
Other expenses                      (352 )            (413 )              61            (1,035 )          (924 )           (111 )

Total other income
(expense)                    $    (3,785 )     $      (374 )    $     (3,411 )    $     (3,699 )     $ (12,411 )    $     8,712

Interest Expense
The primary component of interest expense is related to the Company's 3.375% Convertible Notes issued in 2007. The Company adopted new accounting guidance related to convertible debt effective January 1, 2009 as it relates to this issuance and as required by the new guidance has retrospectively adjusted the prior periods for the effects of the new guidance.
Interest expense on the Convertible Notes was recorded at the effective rate of 8.02%. During the quarter ended September 30, 2009 the amount of interest expense recognized for the contractual interest rate and the discount amortization was $1.5 million for each component for a total of $3.0 million. During the quarter ended September 30, 2008, the amount of interest expense recognized for the contractual interest rate and the discount amortization was $1.7 million for each component for a total of $3.4 million.
For the nine months ended September 30, 2009 the amount of interest expense recognized for the contractual interest rate was $4.7 million and the amount recognized for discount amortization was $5.0 million for a total of $9.7 million. For the nine months ended September 30, 2008 the amount of interest expense recognized for the contractual interest rate was $5.1 million and the amount recognized for discount amortization was $4.9 million for a total of $10.0 million.

Gain (Loss) on Extinguishment of Debt
In the third quarter of 2009, the Company repurchased $15.0 million par value of its outstanding Convertible Notes for cash in the amount of $13.3 million. The carrying value of these Convertible Notes at the time of repurchase was $13.2 million and a pretax loss on extinguishment of debt of $182,000 was recorded. As part of the repurchase transaction, the proportionate share of debt issuance costs in the amount of $308,000 was written off.
For the nine months ended September 30, 2009, the Company repurchased on the open market $40 million par value of Convertible Notes for cash in the amount of $31.6 million. The carrying value of these Convertible Notes at the times of repurchase was $35.1 million and a pretax gain on extinguishment of debt of approximately $2.9 million was recorded. As part of the repurchase transactions, the proportionate share of debt issuance costs in the amount of $757,000 was written off.
See also the Liquidity and Capital Resources section. Foreign Currency
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 hedging transactions were 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 subsidiary in each of the United Kingdom and Germany. The derivative arrangements were not designated for hedge accounting treatment and mark to market adjustments on these arrangements are recorded in the Company's Condensed Consolidated Statements of Operations. In the first quarter of 2009, the Company eliminated a substantial portion of the note payable between the U.S. subsidiary and U.K. subsidiary, referenced above, and the entire amount of the note payable between the U.S. subsidiary and German subsidiary. In connection with these transactions, the Company also terminated its foreign currency hedge arrangements referenced in the preceding paragraph.
In the third quarter of 2009, the Company recorded losses of approximately $0.2 million related to exchange rate fluctuations on the remaining amount of . . .