Thursday, October 8, 1998

Kendle International
(Nasdaq: KNDL)
Phone: 513-381-5550
Price (10/7/98): $25


Managing clinical trials for pharmaceutical companies may sound like a chore, but Kendle parlayed its expertise in this field into top billing on Business Week's June list of "Hot Growth" companies. Triple-digit annual increases in sales and earnings and a 59% annual return on invested capital over the last three years helped Kendle attract such attention and deliver a double in the process.

Pharmaceutical companies spend $35 billion a year on R&D, about $22 billion of which relates to the type of drug development work done by contract research organizations (CROs) like Kendle. Business for these CROs has been growing -- to about $2.7 billion annually -- as large pharmaceutical companies outsource more of the specialized work that contractors can do more quickly and more cost efficiently.

By improving the quality and scope of its services and marketing itself better, Kendle has taken advantage of this trend to boost revenues from $4.4 million in FY94 to $44.2 million last year.

Since going public in August 1997, the company has also expanded via acquisitions (pro forma FY97 revenues were $67.5 million). For the first half of FY98, revenues increased 221%, with EPS up 65% to $0.33 per share from $0.20. That's impressive given higher depreciation and amortization expenses this year ($2.1 million versus $0.3 million) due to the purchase accounting used on the acquisitions. Those numbers also factor in a doubling in the number of shares outstanding due to the IPO and a June '98 follow-on offering of 2.3 million shares at $23 1/2.


Based in Cincinnati, Kendle provides integrated clinical research and drug development services on a contract basis. Services include Phase I through IV clinical trial management, clinical data management, biostatistical analysis, medical writing, and regulatory consultation for a variety of diseases.

Last year, it acquired two European-based CROs. In February 1998, it purchased New Jersey-based Acer/Excel for $14.4 million in cash plus nearly 1 million shares of stock. This deal expanded Kendle's customer base and therapeutic expertise and gave Kendle a presence in Beijing, China. In 1997, Acer/Excel participated in 65 studies involving 10,000 patients.

Kendle has done business for 60 different customers, including 19 of the 20 largest pharmaceutical companies. Yet last year, G.D. Searle accounted for 54% of its revenues, or only 35% after including the diversifying acquisitions. About 40% of 2Q '98 revenues came from Searle. Customers can terminate service contracts on 30 days notice.

Competitors include Covance (NYSE: CVD), Pharmaceutical Product Development, (Nasdaq: PPDI), Quintiles Transnational (Nasdaq: QTRN), Parexel International (Nasdaq: PRXL) and ClinTrials Research (Nasdaq: CCRO).

After the June follow-on offering, the husband and wife team of Chair/CEO Candace Kendle Bryan and President Christopher Bergan own 22% of the stock.


Income Statement*
12-month sales: $91.2 million
12-month income: $5.3 million
12-month EPS: $0.80
Profit Margin: 5.8%
Market Cap: $273.5 million (Based on 10.94 million shares)
Enterprise Value: $173.1 million
(*Pro forma results, includes acquisitions but doesn't account for the full impact of the follow-on share offering.)

Balance Sheet
Cash: $103.7 million
Current Assets: $86.6 million
Current Liabilities: $23.5 million
Long-Term Debt: $3.3 million

Price-to-earnings: 31.3
Price-to-sales: 3.0
EV-to-sales: 1.9


Any screen of companies delivering spectacular sales and earnings growth should have picked up Kendle. Some of the public CROs have experienced rough times; however, this consolidating industry (and thus Kendle) might have attracted the interest of anyone looking for outsourcing plays in a market niche promising relatively high margins.


Growing by acquisition and follow-on stock offerings presents challenges, both in managing consolidation and in squeezing out economies of scale so that the new shares don't simply dilute earnings. While Kendle has handled the growth so far, finding the personnel and the systems to scale up will become an even greater challenge now that the company has a $100 million war chest for more acquisitions.

Still, the theory is that with consolidation sweeping the CRO market, Kendle has to grow to survive. At least it is now better positioned to do that. In addition, the operating leverage is apparent.

For the first half of this year, direct costs fell from 55.8% of revenue to 54.8%, while selling, general and administrative expenses declined from 30.3% of revenues to 28.7%. Also, while net income soared 253% to $3.0 million from $0.85 million, thanks in part to interest income, earnings before interest, taxes, depreciation and amortization (EBITDA) turned in an even stronger 282% increase to $7 million from $1.8 million a year ago.

While the enterprise value to sales ratio looks a little rich for a company with 5.8% net margins, EBITDA was 16.5% of sales, up from 13.5% for the first half of FY97. So the underlying business is becoming far more profitable even if the dilution and goodwill amortization are punishing reported EPS, relatively speaking.

The Zacks consensus earnings estimates are $0.70 a share for FY98 ending in December and $0.88 a share for FY99. Those numbers appear little changed despite the fact that second quarter results announced August 6 beat estimates by 13%. (The company has come in ahead of estimates each quarter since it went public). Kendle trades at 28.4 times projected earnings six quarters out while EPS are expected to grow just 24% next year.

Unless the estimates get raised significantly, that seems a little rich, especially given Kendle's heavy dependence on one customer. So far, though, management's performance suggests that the company may merit the premium.

-- Louis Corrigan

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