10-Q

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934.

For the quarterly period ended June 30, 2004.

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from              to             .

Commission File Number 0-27570

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC.

(Exact name of registrant as specified in its charter)

North Carolina	56-1640186
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification Number)

3151 South Seventeenth Street

Wilmington, North Carolina

(Address of principal executive offices)

28412

(Zip Code)

Registrant’s telephone number, including area code: (910) 251-0081

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).     Yes  x    No  ¨

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 56,460,047 shares of common stock, par value $0.10 per share, as of July 30, 2004.

INDEX

	Page
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Condensed Statements of Operations (unaudited) for the Three and Six Months Ended June 30, 2003 and 2004	3
Consolidated Condensed Balance Sheets as of December 31, 2003 and June 30, 2004 (unaudited)	4
Consolidated Condensed Statements of Cash Flows (unaudited) for the Six Months Ended June 30, 2003 and 2004	5
Notes to Consolidated Condensed Financial Statements	6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3. Quantitative and Qualitative Disclosures about Market Risk	28
Item 4. Controls and Procedures	29
Part II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders	30
Item 6. Exhibits and Reports on Form 8-K	31
Signatures	32

2

Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(unaudited)

(in thousands, except per share amounts)

	Three Months Ended June 30,						Six Months Ended June 30,
	2003			2004			2003			2004
Development revenues	$	161,587		$	183,178		$	317,486		$	357,892
Discovery sciences revenues		7,124			2,033			10,219			9,581
Reimbursed out-of-pockets		16,259			15,325			27,142			28,343
Net revenue		184,970			200,536			354,847			395,816
Direct costs - Development		78,284			90,834			153,003			179,044
Direct costs - Discovery sciences		3,474			1,282			5,008			2,848
Direct costs - Reimbursable out-of-pocket expenses		16,259			15,325			27,142			28,343
Research and development expenses		3,725			3,638			7,086			4,924
Selling, general and administrative expenses		41,782			47,816			81,545			92,975
Depreciation		6,837			6,883			13,754			13,600
Amortization		429			417			719			742
Restructuring charges		—			2,114			—			2,619
		150,790			168,309			288,257			325,095
Operating income		34,180			32,227			66,590			70,721
Interest income, net		565			258			821			450
Impairment of investments		(8,600	)		(2,000	)		(8,600	)		(2,000	)
Other income, net		141			950			678			1,262
Income before provision for income taxes		26,286			31,435			59,489			70,433
Provision for income taxes		9,446			8,121			21,482			22,355
Net income	$	16,840		$	23,314		$	38,007		$	48,078
Net income per share:
Basic	$	0.30		$	0.41		$	0.68		$	0.86
Diluted	$	0.30		$	0.41		$	0.68		$	0.85
Weighted average number of common shares outstanding:
Basic		55,699			56,223			55,630			56,188
Dilutive effect of stock options and restricted stock		480			433			517			432
Diluted		56,179			56,656			56,147			56,620

The accompanying notes are an integral part of these consolidated condensed financial statements.

3

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED BALANCE SHEETS

(in thousands)

	December 31, 2003		June 30, 2004
			(unaudited)
Assets
Current assets
Cash and cash equivalents	$	110,102	$	161,896
Accounts receivable and unbilled services, net		243,494		221,322
Investigator advances		12,792		9,380
Prepaid expenses and other current assets		19,192		22,818
Deferred income taxes, net		12,366		17,315
Total current assets		397,946		432,731
Property, plant and equipment, net		112,143		121,849
Investments		61,371		65,741
Intangible assets		2,007		1,905
Goodwill		178,076		176,582
Other assets		841		780
Long-term deferred income taxes, net		23,083		23,220
Total assets	$	775,467	$	822,808
Liabilities and Shareholders’ Equity
Current liabilities
Accounts payable	$	15,243	$	8,221
Payables to investigators		23,735		29,470
Other accrued expenses		63,749		74,682
Unearned income		129,818		104,708
Accrued income taxes		7,419		19,439
Current maturities of long-term debt and capital lease obligations		1,381		914
Total current liabilities		241,345		237,434
Long-term debt and capital lease obligations, less current maturities		6,281		5,914
Accrued additional pension liability		9,859		10,044
Deferred rent and other		5,461		5,510
Total liabilities		262,946		258,902
Shareholders’ equity
Common stock		5,605		5,624
Paid-in capital		278,057		283,048
Retained earnings		226,381		274,458
Accumulated other comprehensive income, net of deferred taxes		2,478		776
Total shareholders’ equity		512,521		563,906
Total liabilities and shareholders’ equity	$	775,467	$	822,808

The accompanying notes are an integral part of these consolidated condensed financial statements.

4

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)

	Six Months Ended June 30,
	2003			2004
Cash flows from operating activities:
Net income	$	38,007		$	48,078
Adjustments to reconcile net income to net cash provided by operating activities:
Impairment of investments		8,600			2,000
Restructuring charges		—			2,619
Depreciation and amortization		14,473			14,342
Stock compensation amortization		183			—
Loss (gain) on disposition of property and equipment, net		(11	)		27
Provision for doubtful accounts		280			403
Provision (benefit) for deferred income taxes		1,246			(4,702	)
Change in operating assets and liabilities, net of effect of acquisitions		(31,789	)		13,651
Net cash provided by operating activities		30,989			76,418
Cash flows from investing activities:
Cash received from repayment of note receivable		500			—
Purchases of property and equipment		(16,001	)		(23,972	)
Proceeds from sale of property and equipment		85			183
Purchases of investments		(3,450	)		(5,900	)
Cash paid (refunded) related to businesses acquired, net of cash acquired		(1,400	)		1,450
Net cash used in investing activities		(20,266	)		(28,239	)
Cash flows from financing activities:
Principal repayments of long-term debt		(144	)		(174	)
Repayment of capital leases obligation		(916	)		(460	)
Proceeds from exercise of stock options and employee stock purchase plan		5,101			4,212
Net cash provided by financing activities		4,041			3,578
Effect of exchange rate changes on cash		2,068			37
Net increase in cash and cash equivalents		16,832			51,794
Cash and cash equivalents, beginning of the period		181,224			110,102
Cash and cash equivalents, end of the period	$	198,056		$	161,896

The accompanying notes are an integral part of these consolidated condensed financial statements.

5

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

1. SIGNIFICANT ACCOUNTING POLICIES

The significant accounting policies followed by Pharmaceutical Product Development, Inc. and its subsidiaries (collectively the “Company”) for interim financial reporting are consistent with the accounting policies followed for annual financial reporting. We prepared these unaudited consolidated condensed financial statements in accordance with Rule 10-01 of Regulation S-X, and, in management’s opinion, we have included all adjustments of a normal recurring nature necessary for a fair presentation. The accompanying consolidated condensed financial statements might not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the consolidated financial statements and notes thereto in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. The results of operations for the three-month and six-month periods ended June 30, 2004 are not necessarily indicative of the results to be expected for the full year or any other period. We derived the amounts on the December 31, 2003 consolidated condensed balance sheet from the audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

Use of Estimates in the Preparation of Financial Statements

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Principles of consolidation

The accompanying unaudited consolidated condensed financial statements include the accounts and results of operations of the Company. All intercompany balances and transactions have been eliminated in consolidation.

Earnings per share

The computation of basic income per share information is based on the weighted average number of common shares outstanding during the period. The computation of diluted income per share information is based on the weighted average number of common shares outstanding during the period plus the effects of any dilutive common stock equivalents.

Stock-Based Compensation

The Company accounts for stock-based compensation based on the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”, which states that, for fixed plans, no compensation expense is recorded for stock options or other stock-based awards to employees that are granted with an exercise price equal to or above the estimated fair value per share of the Company’s common stock on the grant date. If stock options are granted with an exercise price below the estimated fair value of the Company’s common stock at the grant date, the difference between the fair value of the Company’s common stock and the exercise price of the stock option is recorded as deferred compensation. Deferred compensation is amortized to compensation expense over the vesting period of the stock option.

6

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

1. SIGNIFICANT ACCOUNTING POLICIES (continued)

Stock-Based Compensation (continued)

The Company has adopted the disclosure requirements of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” and Statement of Financial Accounting Standards No. 148, “Accounting for Stock Based Compensation - Transition and Disclosure - an Amendment of FASB Statement No. 123”, which require compensation expense to be disclosed in the notes based on the fair value of the options granted at the date of the grant. Had compensation cost for the Company’s stock option plan been determined based on the fair value at the grant dates for awards under the plan consistent with the method required by SFAS No. 123, the Company’s net income and diluted net income per common share would have been the pro forma amounts indicated below.

	Three Months Ended June 30,				Six Months Ended June 30,
(in thousands, except per share data)	2003		2004		2003		2004
Net income, as reported	$	16,840	$	23,314	$	38,007	$	48,078
Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		1,988		1,615		3,153		2,926
Pro forma net income	$	14,852	$	21,699	$	34,854	$	45,152
Net income per share:
Basic – as reported	$	0.30	$	0.41	$	0.68	$	0.86
Basic – pro forma	$	0.27	$	0.39	$	0.63	$	0.80
Diluted – as reported	$	0.30	$	0.41	$	0.68	$	0.85
Diluted – pro forma	$	0.26	$	0.38	$	0.62	$	0.80

Recent Accounting Pronouncements

In December 2003, the FASB issued SFAS No. 132 (Revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits”. Revised Statement No. 132 requires additional disclosures about the assets, obligations cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. The Company has adopted the interim reporting requirements and does not believe the adoption of the remaining portion of this statement will have a material impact on the Company’s financial statements.

In December 2003, the FASB issued FIN 46 (revised December 2003), “Consolidation of Variable Interest Entities”. This revised interpretation is effective for all entities no later than the end of the first reporting period that ends after March 15, 2004. The Company has no investment in or contractual or other business relationship with a variable interest entity and therefore the adoption of this interpretation did not have any impact on its consolidated financial position or results of operations. However, if the Company enters into any such arrangement with a variable interest entity in the future, the Company’s consolidated financial position or results of operations might be impacted.

In November 2003, during discussions on EITF Issue 03-01, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”, the EITF reached a consensus which requires quantitative

7

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

1. SIGNIFICANT ACCOUNTING POLICIES (continued)

Recent Accounting Pronouncements (continued)

and qualitative disclosures for debt and marketable equity securities classified as available-for-sale or held-to-maturity under Statements 115 and 124 that are impaired at the balance sheet date but for which an other-than-temporary impairment has not been recognized. The consensus on quantitative and qualitative disclosures is effective for fiscal years ending after December 15, 2003 and comparative information for earlier periods presented is not required. The Company did not have any investments with unrealized losses since December 31, 2003 and thus the adoption of this consensus did not have a material impact on the Company’s financial statements. At the March 2004 EITF meeting, the Task Force reached a consensus on a three-step impairment model. Except for disclosure requirements already in place, the Issue 03-01 consensus will be effective prospectively for all relevant current and future investments in reporting periods beginning after June 15, 2004. The Company already does quarterly evaluations of its investments and thus does not expect the adoption of this consensus to have a material impact on its financial statements.

2. GOODWILL AND INTANGIBLE ASSETS

Changes in the carrying amount of goodwill for the twelve months ended December 31, 2003 and the six months ended June 30, 2004, by operating segment, were as follows:

(in thousands)	Development			Discovery		Total
Balance as of January 1, 2003	$	126,936		$	20,472	$	147,408
Changes in goodwill recorded during the period for prior year acquisitions		1,550			143		1,693
Changes in goodwill recorded during the period for current year acquisitions		24,282			—		24,282
Translation adjustments		4,693			—		4,693
Balance as of December 31, 2003		157,461			20,615		178,076
Changes in goodwill recorded during the period for prior year acquisitions (finalization of purchase price adjustments)		(699	)		—		(699	)
Translation adjustments		(795	)		—		(795	)
Balance as of June 30, 2004	$	155,967		$	20,615	$	176,582

Information regarding the Company’s other intangible assets follows:

	As of December 31, 2003						As of June 30, 2004
(in thousands)	Carrying Amount		Accumulated Amortization		Net		Carrying Amount		Accumulated Amortization		Net
Backlog and customer relationship	$	2,100	$	1,969	$	131	$	2,733		2,323		410
Patents		280		236		44		280		259		21
License agreements		2,500		668		1,832		2,500		1,026		1,474
Total	$	4,880	$	2,873	$	2,007	$	5,513	$	3,608	$	1,905

The Company amortizes all intangible assets on a straight-line basis, based on estimated useful lives of two to five years for backlog and customer relationship, five years for patents and three to ten years for license agreements. The weighted average amortization period for backlog and customer relationship is 2.1 years, patents is 5.0 years, license agreements is approximately 3.4 years and all intangibles collectively is approximately 2.6 years.

8

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

2. GOODWILL AND INTANGIBLE ASSETS (continued)

Amortization expense for the three months ended June 30, 2003 and 2004 was $0.43 million and $0.42 million, respectively. Estimated amortization expense for the next five years is as follows:

(in thousands)
2004 (remaining 6 months)	$	439
2005		862
2006		356
2007		112
2008		80
2009 and thereafter		56

3. ACQUISITIONS

In July 2003, the Company acquired Eminent Research Systems, Inc., a clinical research organization specializing in medical device development, and Clinsights, Inc., a company affiliated with Eminent through common ownership that provides a range of post-market services to medical device and related pharmaceutical companies and operates proprietary web sites for the dissemination of medical information, online research and product marketing. Eminent and Clinsights are part of the Development segment of the Company. The results of operations are included in the Company’s consolidated condensed results of operations as of and since July 18, 2003, the effective date of the acquisitions. The Company acquired Eminent and Clinsights for total consideration of $23.6 million in cash. Under the terms of the merger agreement, the original aggregate purchase price of $25.0 million was reduced by $1.4 million in the first quarter of 2004 as a result of an adjustment to the purchase price based on Eminent’s closing balance sheet.

These acquisitions were accounted for using the purchase method of accounting, utilizing appropriate fair value techniques to allocate the purchase price based on the estimated fair values of the assets and liabilities. Accordingly, the estimated fair value of assets acquired and liabilities assumed were included in the Company’s consolidated condensed balance sheet as of the effective date of the acquisitions.

The total purchase price for the acquisitions was allocated to the estimated fair value of assets acquired and liabilities assumed as set forth in the following table:

(in thousands)	Eminent			Clinsights			Total
Condensed balance sheet:
Current assets	$	677		$	1,346		$	2,023
Property and equipment, net		436			226			662
Non-current assets		32			25			57
Deferred income taxes		1,184			1,093			2,277
Current liabilities		(4,946	)		(731	)		(5,677	)
Value of identifiable intangible assets:
Backlog and customer relationship		383			250			633
Goodwill		14,541			9,041			23,582
Total	$	12,307		$	11,250		$	23,557

Initially, the Company bases the purchase price allocations for the acquisitions on preliminary estimates, using available information and making assumptions management believes are reasonable. As more information becomes available, the purchase price allocations are refined and finalized. Purchase price allocations have been finalized for these acquisitions. Goodwill is evaluated annually as required by SFAS 142. Goodwill related to Eminent and Clinsights is not expected to be deductible for tax purposes.

9

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

4. COMPREHENSIVE INCOME

Comprehensive income consisted of the following:

	Three Months Ended June 30,					Six Months Ended June 30,
(in thousands)	2003		2004			2003		2004
Net income, as reported	$	16,840	$	23,314		$	38,007	$	48,078
Cumulative translation adjustment		3,193		(881	)		4,659		(1,321	)
Change in fair value of hedging transaction		—		(102	)		—		(1,974	)
Reclassification adjustment for hedging results included in income		—		643			—		1,123
Unrealized gain (loss) on investment		1,056		(193	)		1,546		469
	$	21,089	$	22,781		$	44,212	$	46,375

Accumulated other comprehensive income, net of tax, consisted of the following:

(in thousands)	December 31, 2003			June 30, 2004
Translation adjustment	$	8,698		$	7,378
Minimum pension liability, net of tax		(6,220	)		(6,220	)
Fair value on hedging transaction, net of tax		—			(851	)
Unrealized gain on investment		—			469
	$	2,478		$	776

5. ACCOUNTS RECEIVABLE AND UNBILLED SERVICES

Accounts receivable and unbilled services consisted of the following:

(in thousands)	December 31, 2003			June 30, 2004
Billed	$	151,525		$	131,838
Unbilled		94,928			93,036
Provision for doubtful accounts		(2,959	)		(3,552	)
	$	243,494		$	221,322

6. INVESTMENTS

The Company has investments in publicly traded and privately held entities. Investments in publicly traded entities are classified as available-for-sale securities and are measured at market value. The Company records net unrealized gains or losses associated with investments in publicly traded entities as a component of shareholders’ equity until they are realized or an other-than-temporary decline has occurred. The market value of the Company’s investments in publicly traded entities is based on the closing price as quoted by the applicable stock exchange or association as of June 30, 2004.

10

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

6. INVESTMENTS (continued)

In addition to the Company’s investments in publicly traded entities, the Company has equity and convertible debt instruments in private entities for which fair values are not readily determinable. The Company records all of its investments in private entities under the cost method of accounting. The Company assesses the market value of these entities on a quarterly basis to determine whether declines in the market value of these investments are other than temporary. This quarterly review includes an evaluation of, among other things, the market condition of the overall industry, historical and projected financial performance, expected cash needs and recent funding events. As a result of these evaluations, the Company recorded impairments for other than temporary declines in the fair market value of its investments in SLIL Biomedical Corp. of $4.7 million, Spotlight Health, Inc. of $3.7 million and Signature Bioscience, Inc. of $0.2 million for the three months ended June 30, 2003, and in Chemokine Therapeutics Corp. of $2.0 million for the three months ended June 30, 2004. SLIL and Signature Bioscience were deemed to be impaired primarily as a result of the market condition of the overall industry and their individual historical and projected performance and expected cash needs. The write-downs of Spotlight Health and Chemokine were recorded based primarily on their individual historical and projected financial performance and completed or anticipated issuances of shares to new investors at lower valuations than the Company’s recorded value.

Investments consisted of the following:

(in thousands)	December 31, 2003		June 30, 2004
Investment in Surromed, Inc.	$	29,007	$	29,007
Investment in Syrrx, Inc.		25,000		25,000
Investment in Chemokine Therapeutics Corp.		2,700		700
Investment in BioDelivery Sciences International, Inc.*		2,284		2,754
Investment in Spotlight Health, Inc.		1,230		1,230
Investment in Oriel Therapeutics, Inc		900		1,800
Investment in CancerConsultants		250		250
Investment in Accentia, Inc.		—		5,000
	$	61,371	$	65,741

* Publicly traded security

7. INCOME TAXES

During the second quarter of 2004, we recorded a tax benefit of $3.7 million as a result of the utilization of capital loss carryforwards that previously had a valuation allowance recorded against them. We also recorded a $0.8 million valuation allowance due to the uncertainty of realizing the future tax benefit associated with the equity impairment recorded in the second quarter of 2004.

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PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

8. ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

The Company uses derivative financial instruments to manage its exposures to foreign exchange rates. The derivative instruments are accounted for pursuant to SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended by SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities”. As amended, SFAS No. 133 requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet, measure those instruments at fair value and recognize changes in the fair value of derivatives in earnings in the period of change unless the derivative qualifies as an effective hedge that offsets certain exposures. Such contracts are designated at inception to the related foreign currency exposures being hedged.

Hedged transactions are denominated in U.S. dollars on behalf of subsidiaries with pound sterling and euro functional currencies. To achieve hedge accounting, contracts must reduce the foreign currency exchange rate risk otherwise inherent in the amount and duration of the hedged exposures and comply with established risk management policies. Pursuant to its foreign exchange hedging policy, the Company may hedge anticipated transactions and the related receivables and payables denominated in foreign currencies using forward foreign currency exchange rate contracts. Foreign currency derivatives are used only to meet the Company’s objective of minimizing variability in the Company’s operating results arising from foreign exchange rate movements. The Company does not enter into foreign exchange contracts for speculative purposes. Hedging contracts are measured at fair value using dealer quotes and mature within twelve months from their inception.

At June 30, 2004, the face amounts of the Company’s foreign exchange contracts designated as cash flow hedges totaled approximately $65.0 million. For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative instrument is initially recorded in accumulated other comprehensive income (“OCI”) as a separate component of shareholders’ equity and subsequently reclassified into earnings in the period during which the hedged transaction is recognized in earnings.

At June 30, 2004, the Company recorded the fair value of the derivative instruments in the consolidated condensed balance sheet as a component of other accrued expenses.

9. PENSION PLAN

Pension costs are determined under the provisions of Statement of Financial Accounting Standards No. 87, “Employers’ Accounting for Pensions”, and related disclosures are determined under the provisions of Statement of Financial Accounting Standards No. 132 (Revised 2003), “Employers’ Disclosures about Pensions and other Postretirement Benefits”.

The Company has a separate contributory defined benefit plan (the “U.K. Plan”) for its qualifying United Kingdom employees employed by the Company’s U.K. subsidiaries. This pension plan was closed to new participants as of December 31, 2002. The benefits for the U.K. Plan are based primarily on years of service and average pay at retirement. Plan assets consist principally of investments managed in a mixed fund.

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PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

9. PENSION PLAN (continued)

Pension costs for the U.K. Plan included the following components:

	Three Months Ended June 30,						Six Months Ended June 30,
(in thousands)	2003			2004			2003			2004
Service cost	$	214		$	307		$	426		$	620
Interest cost		308			432			613			871
Expected return on plan assets		(258	)		(361	)		(513	)		(729	)
Amortization of transition asset amount		(3	)		(4	)		(6	)		(8	)
Amortization of net loss		107			155			213			313
Net periodic pension cost	$	368		$	529		$	733		$	1,067

For the six months ended June 30, 2004, the Company made contributions of $1.0 million and anticipates contributing an additional $1.0 million to fund its pension plan during the remainder of 2004.

10. RESTRUCTURING CHARGES

In the first six months of 2004, PPD recorded a $2.6 million restructuring charge associated with exiting our chemistry facility in Research Triangle Park, North Carolina. These charges include lease termination costs (net of sublease rentals) of approximately $2.1 million and a loss on sale of assets used in the Company’s chemistry services of approximately $0.5 million. The lease termination liability will be paid over the remaining life of the lease which will end in 2015. At June 30, 2004, the Company recorded the restructuring liability of $2.1 million in the consolidated condensed balance sheet as a component of other accrued expenses.

11. COMMITMENTS AND CONTIGENCIES

The Company currently maintains insurance for risks associated with the operation of its business, provision of professional services, and ownership of property. These policies provide coverage for a variety of potential losses, including, without limitation, loss or damage to property, bodily injury, general commercial liability, professional errors and omissions, and medical malpractice. The Company’s retentions and deductibles associated with these insurance policies range from $0.25 million to $0.5 million.

The Company is self-insured for health insurance for employees located within the United States. The Company maintains stop-loss insurance on a “claims made” basis for expenses in excess of $0.225 million per member per year. As of December 31, 2003 and June 30, 2004, the Company maintained a reserve of approximately $3.7 million and $4.3 million, respectively, included in other accrued expenses on the consolidated condensed balance sheets, to cover open claims and estimated claims incurred but not reported.

In September 2003, the Company entered into agreements with SurroMed, Inc. pursuant to which the Company committed to purchase biomarker discovery services from SurroMed of at least $2.0 million, $2.0 million, $1.0 million and $1.0 million during the years ended December 31, 2004, 2005, 2006 and 2007, respectively.

The Company signed an agreement to jointly develop and commercialize Syrrx-designed human dipeptidyl peptidase IV, or DP4, inhibitors as drug products for the treatment of type 2 diabetes and other major human diseases. The Company will provide preclinical and clinical development resources and expertise for the collaboration, and will fund the majority of preclinical and clinical studies through Phase IIb development of selected DP4 inhibitors. The Company and Syrrx have agreed to share equally the costs of Phase III development.

13

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

11. COMMITMENTS AND CONTIGENCIES (continued)

In addition, the Company will make milestone payments to Syrrx upon the occurrence of certain clinical and regulatory events. In the event of approval to market a drug product, the Company and Syrrx will share equally the profits from drug sales.

In April 2003, the Company made an equity investment in Chemokine Therapeutics. In connection with this investment, Chemokine granted PPD an exclusive option to license the peptide for a one-time license fee of $1.5 million. If the Company chooses to exercise this option, it will be obligated to pay the license fee plus the costs for future development work on the peptide. Chemokine also granted PPD the right to first negotiate a license to other peptides.

In November 2003, the Company became a limited partner in A. M. Pappas Life Science Ventures III, LP, a venture capital fund. The Pappas Fund was established for the purpose of making investments in equity securities of privately held companies in the life sciences, healthcare and technology industries. Under the terms of the limited partnership agreement, the Company committed to invest up to an aggregate of $4.75 million in the Pappas Fund. No capital call can exceed 10% of the Company’s aggregate capital commitment, and no more than one-third of the Company’s commitment could be called prior to May 2004 and no more than two-thirds prior to May 2005. As such, the Company anticipates that its aggregate investment will be made through a series of future capital calls over the next several years. No capital calls have been made through June 30, 2004, and the Company’s capital commitment will expire in May 2009.

In the fourth quarter of 2003, the Company acquired from Eli Lilly & Company the patents for the compound dapoxetine for development in the field of genitourinary disorders. This compound is currently licensed to ALZA Corporation and is in Phase III development for premature ejaculation. Under the terms of the agreement with Lilly, the Company paid Lilly $65.0 million in cash and agreed to pay Lilly a royalty of 5% on annual net sales of dapoxetine in excess of $800 million. Dapoxetine is currently in Phase III clinical trials and has not been approved for sale in the United States or any foreign country.

Under most of the agreements for Development Group services, we agree to indemnify and defend the sponsor against third-party claims based on the Company’s negligence or willful misconduct. Any successful claims could have a material adverse effect on the Company’s financial condition, results of operations and future prospects.

In the normal course of business, the Company is a party to various claims and legal proceedings. For example, we are in litigation with a client that is claiming we breached our contract and were negligent in conducting a clinical trial, and is claiming that it does not owe us the remaining amounts due under the contract and is seeking other damages from our alleged breach and negligent acts. The Company records a reserve for these matters when an adverse outcome is probable and the amount of the potential liability is reasonably estimable. Although the ultimate outcome of these matters is currently not determinable, management of the Company, after consultation with legal counsel, does not believe that the resolution of these matters will have a material effect upon the Company’s financial condition, results of operations or cash flows for an interim or annual period.

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PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

12. BUSINESS SEGMENT DATA

Revenues by principal business segment are separately stated in the consolidated condensed financial statements. Income from operations and identifiable assets by principal business segment were as follows:

	Three months Ended June 30,						Six Months Ended June 30,
(in thousands)	2003			2004			2003			2004
Income (loss) from operations:
Development	$	36,680		$	37,955		$	73,493		$	73,437
Discovery sciences		(2,500	)		(5,728	)		(6,903	)		(2,716	)
Total	$	34,180		$	32,227		$	66,590		$	70,721

	December 31, 2003		June 30, 2004
Identifiable assets:
Development	$	684,890	$	731,669
Discovery sciences		90,577		91,139
Total	$	775,467	$	822,808

13. SUBSEQUENT EVENTS

In July 2004, we renewed our $50.0 million revolving credit facility with Bank of America, N. A. Indebtedness under the facility is unsecured and subject to traditional covenants relating to financial ratios and restrictions on certain types of transactions. Borrowings under this credit facility are available to provide working capital and for general corporate purposes. As of June 30, 2004, there was no amount outstanding under this credit facility. However, the aggregate amount we are able to borrow has been reduced by $0.80 million due to outstanding letters of credit issued under this facility. This credit facility is currently scheduled to expire in June 2005, at which time any outstanding balance would be due.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis is provided to increase understanding of, and should be read in conjunction with, the consolidated condensed financial statements and accompanying notes. In this discussion, the words “PPD”, “we”, “our” and “us” refer to Pharmaceutical Product Development, Inc., together with its subsidiaries where appropriate.

Forward-looking Statements

This Form 10-Q contains forward-looking statements within the meaning of the federal securities laws. These statements relate to future events or our future financial performance. Forward-looking statements include statements concerning plans, objectives, goals, strategies, future events or performance, expectations, predictions, assumptions and other statements that are not statements of historical facts. In some cases, you can identify forward-looking statements by words such as “might”, “will”, “should”, “expect”, “plan”, “anticipate”, “believe”, “estimate”, “predict”, “intend”, “potential” or “continue”, or the negative of these terms, or other comparable terminology. These statements are only predictions. These statements rely on a number of assumptions and estimates that could be inaccurate and that are subject to risks and uncertainties. Actual events or results might differ materially due to a number of factors, including those listed in “Potential Volatility of Quarterly Operating Results and Stock Price” below. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.

Company Overview

We are a leading global provider of drug discovery and development services to pharmaceutical, biotechnology and medical device companies. Our corporate mission is to help clients maximize the return on their research and development investments. We offer therapeutic expertise, advanced technologies and extensive resources for drug discovery and drug and device development.

We have been in the drug development business for more than 19 years. Our development services include preclinical programs and Phase I to Phase IV clinical development services. We have extensive clinical trial experience across a multitude of therapeutic areas and various parts of the world, including regional, national and global studies. In addition, for drugs that have received approval for market use, we also offer post-market support services such as product launch services, patient compliance programs, and medical communications programs for consumer and healthcare providers on product use and adverse events.

With more than 6,000 professionals worldwide, we have provided services to 43 of the top 50 pharmaceutical companies in the world as ranked by 2002 healthcare research and development spending, in addition to our work with leading biotechnology and medical device companies. We believe that we are one of the world’s largest providers of drug development services to pharmaceutical, biotechnology and medical device companies based on 2003 annual net revenues generated from contract research organizations.

Building on our outsourcing relationship with pharmaceutical and biotechnology clients, we established our discovery services business in 1997. This business focuses on early stage research to help our customers address the bottleneck at the beginning of the development process. Currently, this business primarily involves preclinical evaluations of anticancer therapies, preclinical biology services and compound partnering arrangements associated with the development and commercialization of potential drug products. We have developed an innovative risk-sharing research and development model to help pharmaceutical and biotechnology clients develop compounds. Through collaborative arrangements based on this model, we help our clients research and evaluate the development potential for compounds at various stages of development. We previously provided functional genomics services, which is the study of gene functions to identify drug targets within the body, but ceased providing those services in the third quarter of 2003. In addition, in the first quarter of 2004, we ceased providing lead optimization services, which is the process of refining the chemical structure of a compound to improve its drug characteristics, as well as medicinal chemistry research, in order to focus on our other discovery sciences operations.

We believe that our integrated drug discovery and development services offer our clients a way to identify and develop successful drugs more quickly and cost effectively. We also use our proprietary informatics technology to support our development services. In addition, because we are positioned globally, we are able to accommodate the multinational drug discovery and development needs of our customers. As a result of having these core areas of expertise in discovery and development, we can provide integrated services across the entire drug development spectrum. For more detailed information on PPD, see our Annual Report on Form 10-K for the year ended December 31, 2003.

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Executive Overview

Because our revenues are dependent on a relatively small number of industries and clients, we closely monitor the market for CRO services. For a discussion of the trends affecting our market, see “Item 1. Business—Trends Affecting the Drug Discovery and Development Industry” in our Annual Report on Form 10-K for the year ended December 31, 2003. In the first half of 2003, the market for CRO services was not as robust as it was in 2002 and our new business authorizations for the first two quarters of 2003 were lower than we expected. In response, we refocused our business development and operational efforts and believe those efforts, together with a stronger market for CRO services in the second half of 2003 and the first half of 2004, resulted in improved new authorizations for those periods.

Although we cannot predict the demand for CRO services for the remainder of 2004, we believe the overall market drivers are intact. To increase authorizations for the remainder of 2004, we must continue to concentrate upon our business development efforts, including increasing the percentage of successful proposals, and the delivery of timely, high quality services to our clients. We believe there are several specific opportunities for growth in 2004. We currently conduct a significant amount of government-sponsored research, and plan to continue our efforts to win new opportunities in this market. We have also had an increase in demand for our Phase I services and are expanding our Phase I clinic in Austin, Texas to 300 beds and enhancing our capabilities to service large, complex studies. This expansion should be completed in early 2005. We also believe the demand for our post-marketing development services will continue to grow and we will also seek to expand our medical device services. Finally, we believe that we can increase the client base and service offerings for our laboratories, so we have leased an additional 20,000 square feet of space for laboratory expansion.

We review various metrics, including period-to-period growth in backlog, new authorizations, revenue, margins and earnings, to evaluate our financial performance. In the second quarter of 2004, new authorizations totaled $266.0 million. The cancellation rate for the second quarter of 2004 was 17% compared to 21% in the second quarter of 2003. Therefore, on a net basis, authorizations were up 28% for the second quarter of 2004 compared to the second quarter of 2003. Backlog grew 19% from $1,003.0 million on June 30, 2003 to $1,196.8 million on June 30, 2004. Net revenue by client type for the quarter ended June 30, 2004 was 65% pharmaceutical, 25% biotech, 3% government and 7% other. For a detailed discussion of our revenue, margins, earnings and other financial results for the second quarter of 2004, see “Results of Operations – Three Months Ended June 30, 2004 versus Three Months Ended June 30, 2003” below.

Capital expenditures for the three and six months ended June 30, 2004 totaled approximately $10.7 million and $24.0 million, respectively. The majority of the capital expenditures were for information technology enhancements, computer hardware and additional software. In addition to investing in our growing business, we are also focused on improving the efficiency of our operations by streamlining training matrices and clinical procedural documents, decreasing the number of documents needed for study initiation, centralizing regulatory document collection and rolling out a new clinical trial management system.

Our compound partnering arrangements allow us to leverage our resources and global drug development expertise to create new opportunities for growth and to share the risks and potential rewards of drug development with our collaborative partners. In 2003, in addition to furthering existing collaborations with ALZA Corporation and Bayer AG, we entered into new collaborations with Syrrx and Chemokine Therapeutics. For a discussion of these compound partnering arrangements, see “Item 1. Business – Our Services – Our Discovery Sciences Group – Compound Partnering Programs” in our Annual Report on Form 10-K for the year ended December 31, 2003. In 2004, we expect to advance the development of the potential drug candidates associated with our existing compound partnering arrangements and increase the number of candidates in various stages of human trials by the end of year. We currently anticipate filing our IND on one Syrrx compound in the third quarter of 2004 and a NDA filing on dapoxetine in early 2005. As a result of these compound partnering arrangements and the progression of our pipeline, we expect to incur significant R&D expense over the remainder of 2004 in connection with these efforts. Furthermore, in addition to progressing our existing collaborations, we will continue to evaluate other opportunities for collaborations and investments that we believe will help us achieve our mid- to long-term growth objectives.

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Acquisitions

In July 2003, PPD acquired Eminent Research Systems, a clinical research organization specializing in medical device development, and Clinsights, a company affiliated with Eminent through common ownership that provides a range of post-market services to medical device and related pharmaceutical companies and operates proprietary web sites for the dissemination of medical information, online research and product marketing. Eminent and Clinsights are part of the Development segment of PPD. The results of operations are included in our consolidated condensed results of operations as of and since July 18, 2003, the effective date of the acquisitions. PPD acquired Eminent and Clinsights for total consideration of $23.6 million in cash. Under the terms of the merger agreement, the original aggregate purchase price of $25.0 million was reduced by $1.4 million in the first quarter of 2004 as a result of a refund of the purchase price for the stock of Eminent based on Eminent’s closing balance sheet.

We accounted for these acquisitions under the purchase method of accounting, utilizing appropriate fair value techniques to allocate the purchase price based on the estimated fair values of the assets and liabilities. Accordingly, the estimated fair value of assets acquired and liabilities assumed were included in our condensed consolidated balance sheet as of the effective date of the acquisitions. For further details regarding these acquisitions, see Note 3 to the Notes to Consolidated Financial Statements.

Investments

In January 2004, we purchased 5.0 million shares of Accentia, Inc. Series E convertible preferred stock for $5.0 million. Accentia’s Series E preferred stock bears a dividend based on a percentage of net sales of certain Accentia products. We also received warrants to purchase up to an additional 10.0 million shares of Accentia’s Series E preferred stock over the 24 month period following the closing at $1.00 per share.

In March 2004, we loaned $0.9 million to Oriel Therapeutics, Inc. pursuant to a secured convertible note. In consideration for the loan, Oriel issued to us warrants to purchase 0.225 million shares of Oriel’s Series B Convertible Preferred Stock for $2.00 per share. The warrants expire in 2014.

As a result of our quarterly impairment evaluations, during the three months ended June 30, 2004, we recorded a charge to earnings for an other than temporary decline in the fair market value of our investment in Chemokine of $2.0 million. Our investment in Chemokine was deemed to be impaired primarily as a result of a recent issuance of shares to new investors at a lower valuation than our original investment.

New Business Authorizations and Backlog

We record new business authorizations, or sales of the Company’s services, when we receive a letter of intent, verbal commitment or contract. Authorizations can vary significantly from quarter to quarter, and contracts generally have terms ranging from several months to several years. We recognize revenue on these authorizations as services are performed. Our new authorizations for the three months ended June 30, 2003 and 2004 were $217.1 million and $266.0 million, respectively.

Our backlog consists of anticipated net revenues from letters of intent, verbal commitments and contracts that either have not started but are anticipated to begin in the near future or are in process and have not been completed. Amounts included in backlog represent future revenues and exclude revenues that we have previously recognized. Once work begins on a project included in backlog, net revenue is recognized over the life of the contract. Our backlog as of June 30, 2003 and 2004 was $1,003.0 million and $1,196.8 million, respectively.

Results of Operations

Revenue Recognition

We recognize revenues from fixed-price contracts on a proportional performance basis in our Development Group. To measure performance on a given date, we compare direct costs incurred through that date to estimated total contract direct costs. We believe this is the best indicator of the performance of the contractual obligations because the costs relate to the amount of labor incurred to perform the service. For time-and-materials contracts in both our Development Group and Discovery Sciences Group, we recognize revenues as hours are worked, multiplied by the applicable billable rate. For our Phase I and laboratory businesses, we recognize revenues from unitized contracts as subjects or samples are tested, multiplied by the applicable unit price.

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In connection with our management of multi-site clinical trials, we pay on behalf of our customers fees to investigators and test subjects, as well as other out-of-pocket costs for items such as travel, printing, meetings and couriers. Our clients reimburse us for these costs. As required by EITF 01-14, amounts paid by us as a principal for out-of-pocket costs are included in direct costs as reimbursable out-of-pocket expenses and the reimbursements we receive as a principal are reported as reimbursed out-of-pocket revenues. Amounts paid by us as an agent for out-of-pocket costs are combined with the corresponding reimbursements, or revenues, we receive as an agent in the statement of operations. During the three months ended June 30, 2003 and 2004, fees paid to investigators and other fees that PPD received as an agent and the associated reimbursements were approximately $47.3 and $50.3 million, respectively.

Most of the contracts for our Development Group can be terminated by our clients either immediately or after a specified period following notice by the client. These contracts typically require payment to us of expenses to wind down a study, payment to us of fees earned to date, and in some cases, a termination fee or some portion of the fees or profit that we could have earned under the contract if it had not been terminated early.

Discovery Sciences Group revenues also include non-refundable technology license fees and milestone payments. The non-refundable license fees are generally up-front payments for the initial license of and access to our technology. For non-refundable license fees received at the initiation of license agreements for which we have an ongoing research and development commitment, we defer these fees and recognize them ratably over the period of the related research and development. For non-refundable license fees received under license agreements where our continued performance of future research and development services is not required, we recognize revenue upon delivery of the technology. In addition to license fees, our Discovery Sciences Group also generates revenue from time to time in the form of milestone payments. Milestone payments are only received and recognized as revenues if the specified milestone is achieved and accepted by the customer and continued performance of future research and development services related to that milestone are not required. Although these payments are typically lower than up-front license fees, these payments can be significant because they are triggered as a result of achieving specified scientific milestones.

Recording of Expenses

We record our operating expenses among the following categories:

• direct costs;

• research and development;

• selling, general and administrative;

• depreciation;

• amortization; and

• restructuring charges.

Direct costs consist of appropriate amounts necessary to carry out the revenue and earnings process, and include direct labor and related benefit charges, other costs directly related to contracts, an allocation of facility and information technology costs, and reimbursable out-of-pocket expenses. Direct costs, as a percentage of net revenues, tend to and are expected to fluctuate from one period to another as a result of changes in labor utilization and the mix of service offerings involved in the hundreds of studies being conducted during any period of time.

Research and development, or R&D, expenses consist primarily of patent expenses, labor and related benefit charges associated with personnel performing internal research and development work, supplies associated with this work, and an allocation of facility and information technology costs.

Selling, general and administrative, or SG&A, expenses consist primarily of administrative payroll and related benefit charges, sales, advertising and promotional expenses, recruiting and relocation expenses, administrative travel, an allocation of facility and information technology costs, and costs related to operational employees performing administrative tasks.

Depreciation expenses consist of depreciation costs recorded on a straight-line method, based on estimated useful lives of 40 to 50 years for buildings, five years for laboratory equipment, two to three years for software, three to five years for computers and related equipment, and five to ten years for furniture and equipment, except for our airplane, which we are depreciating over 30 years. We depreciate leasehold improvements over the shorter of the life of the relevant lease or the useful life of the improvement. We depreciate property under capital leases over the life of the lease or the service life, whichever is shorter.

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Amortization expenses consist of amortization costs recorded on intangible assets on a straight-line method over the life of the intangible assets.

In the first six months of 2004, PPD recorded a $2.6 million restructuring charge associated with exiting our chemistry facility in Research Triangle Park, North Carolina. These charges include lease termination costs (net of sublease rentals) of approximately $2.1 million and a loss on sale of assets used in our chemistry services of approximately $0.5 million. The lease termination liability will be paid over the remaining life of the lease which will end in 2015. At June 30, 2004, the Company recorded the restructuring liability of $2.1 million in the consolidated condensed balance sheet as a component of other accrued expenses.

Three Months Ended June 30, 2004 Versus Three Months Ended June 30, 2003

The following table sets forth amounts from our consolidated condensed financial statements along with the dollar and percentage change for the three months ended June 30, 2004 compared to the three months ended June 30, 2003.

	Three Months Ended June 30, (unaudited)
(in thousands, except per share data)	2004			2003			$ Inc (Dec)			% Inc (Dec)
Net revenue:
Development revenues	$	183,178		$	161,587		$	21,591		13.4	%
Discovery sciences revenues		2,033			7,124			(5,091	)	(71.5	)
Reimbursed out-of-pockets		15,325			16,259			(934	)	(5.7	)
Total net revenue		200,536			184,970			15,566		8.4
Direct costs:
Development		90,834			78,284			12,550		16.0
Discovery sciences		1,282			3,474			(2,192	)	(63.1	)
Reimbursable out-of-pocket expenses		15,325			16,259			(934	)	(5.7	)
Total direct costs		107,441			98,017			9,424		9.6
Research and development expenses		3,638			3,725			(87	)	(2.3	)
Selling, general and administrative expenses		47,816			41,782			6,034		14.4
Depreciation		6,883			6,837			46		0.7
Amortization		417			429			(12	)	(2.8	)
Restructuring charges		2,114			—			2,114
Income from operations		32,227			34,180			(1,953	)	(5.7	)
Impairment of investments		(2,000	)		(8,600	)		6,600		(76.7	)
Interest and other income (expense), net		1,208			706			502		71.1
Income before taxes		31,435			26,286			5,149		19.6
Provision for income taxes		8,121			9,446			(1,325	)	(14.0	)
Net income	$	23,314		$	16,840		$	6,474		38.4
Net income per diluted share	$	0.41		$	0.30		$	0.11		36.7

Total net revenue increased to $200.5 million in the second quarter of 2004. The increase in total net revenue resulted from an increase in our Development Group revenues. The Development Group’s operations generated net revenue of $183.2 million, which accounted for 91.3% of total net revenue for the second quarter of 2004. The 13.4% increase in the Development Group’s net revenue was primarily attributable to an increase in the amount of global CRO Phase II through IV services we provided in the second quarter of 2004 as compared to the second quarter of 2003. Net revenue for the Development Group also increased by approximately $0.8 million due to the effect of the weakening of the U.S. dollar relative to the euro and the British pound in the second quarter of 2004.

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The Discovery Sciences Group generated net revenue of $2.0 million in the second quarter of 2004, a decrease of $5.1 million from the same period in 2003. The higher 2003 Discovery Sciences net revenue was mainly attributable to a $5.0 million milestone payment earned by us in the second quarter of 2003 as a result of the initiation of Phase III clinical trials for dapoxetine.

Total direct costs increased to $107.4 million in the second quarter of 2004 primarily as the result of an increase in the Development Group direct costs. Development Group direct costs increased $12.6 million from the second quarter of 2003 to the second quarter of 2004. The primary reason for this increase was an increase in personnel costs of $8.3 million. Personnel costs increased due to hiring additional employees in our global CRO Phase II through IV division, increased incentive compensation accruals and increased costs in our foreign operations due to the weakening of the U.S. dollar. In the second quarter of 2003, incentive compensation accruals were lower than our normal accrual levels as a result of our financial and operating performance in that period. The remaining $4.3 million of this increase in Development direct costs included increased facility costs related to the increase in personnel and increased subcontractor costs.

Gross margin from the Development segment was 50.4% for the second quarter of 2004 compared to 51.6% for the second quarter of 2003. Of this 1.2% decline in gross margin, 0.9% relates to expected fluctuations from one period to another as a result of changes in labor utilization and the mix of service offerings involved in the hundreds of studies conducted during any period of time. The remaining variance of 0.3% was attributable to the increased incentive compensation accruals and the increased costs in our foreign operations due to the weakening of the U.S. dollar mentioned earlier.

R&D expenses decreased $0.1 million from $3.7 million in the second quarter of 2003 to $3.6 million in the second quarter of 2004. The decline was due to the cessation of our functional genomics services in the third quarter of 2003 and chemistry services operations in the first quarter of 2004, and was almost completely offset by the increase in R&D spending on our compound partnering arrangements. We expect to incur significant R&D expenses during the remainder of 2004 in connection with our existing compound partnering arrangements.

SG&A expenses increased $6.0 million to $47.8 million in the second quarter of 2004. The increase includes additional personnel costs of $5.5 million. Of this increase, $4.1 million were related to increased incentive compensation accruals and foreign currency translation effect mentioned above. The remaining $1.4 million increase in personnel costs related to increased infrastructure to manage direct personnel and insure quality delivery of projects. As a percentage of total net revenue, SG&A expenses increased from 22.6% in the second quarter of 2003 to 23.8% in the second quarter of 2004.

In the second quarter of 2004, PPD recorded a $2.1 million restructuring charge associated with exiting our chemistry facility in Research Triangle Park, North Carolina. These charges include lease termination costs (net of sublease rentals) of approximately $2.1 million. The lease termination liability will be paid over the remaining life of the lease which will end in 2015.

Income from operations decreased $2.0 million to $32.2 million in second quarter of 2004. As a percentage of net revenue, income from operations decreased to 16.1% of net revenue in the second quarter of 2004 from 18.5% in the second quarter of 2003. Income from operations was negatively impacted by approximately $0.8 million due to the effect of the U.S. dollar weakening relative to the euro, the British pound and the Brazilian real, netted against the foreign currency hedging gain of $0.6 million during the second quarter of 2004. Although these currency movements increased net revenue in the aggregate, the negative impact on income from operations is attributable to dollar-denominated contracts for services rendered in countries other than the United States. In these cases, revenue is not impacted by the weakening of the U.S. dollar, but the costs associated with performing these contracts, which are paid in the local currency, are negatively impacted when translated to U.S. dollars.

During the three months ended June 30, 2003 and 2004, the Company recorded charges to earnings for other than temporary declines in the fair market value of its investments in SLIL Biomedical Corp. of $4.7 million, Spotlight Health, Inc. of $3.7 million and Signature Bioscience, Inc. of $0.2 million in the 2003 period, and in Chemokine Therapeutics Corp. of $2.0 million in the 2004 period. SLIL and Signature Bioscience were deemed to be impaired primarily as a result of the market condition of the overall industry and their individual historical and projected performance and expected cash needs. The write-downs of Spotlight Health and Chemokine were recorded based primarily on their individual historical and projected financial performance and completed or expected issuances of shares to new investors at a lower valuations than the Company’s recorded value.

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Our provision for income taxes decreased to $8.1 million in the second quarter of 2004. Our effective income tax rate for the second quarter of 2004 was 25.8% compared to 35.9% for the second quarter of 2003. During the second quarter of 2004, our effective tax rate was positively impacted by the $3.7 million tax benefit which we recorded as a result of the utilization of capital loss carryforwards that previously had a valuation allowance recorded against them. We expect our effective tax rate for the remainder of 2004 to be approximately 36%.

Net income of $23.3 million in the second quarter of 2004 represents an increase of $6.5 million from $16.8 million in the second quarter of 2003. Net income per diluted share of $0.41 in the second quarter of 2004 represents an increase from $0.30 net income per diluted share in the second quarter of 2003.

Six Months Ended June 30, 2004 Versus Six Months Ended June 30, 2003

The following table sets forth amounts from our consolidated condensed financial statements along with the dollar and percentage change for the six months ended June 30, 2004 compared to the six months ended June 30, 2003.

	Six Months Ended June 30, (unaudited)
(in thousands, except per share data)	2004			2003			$ Inc (Dec)			% Inc (Dec)
Net revenue:
Development revenues	$	357,892		$	317,486		$	40,406		12.7	%
Discovery sciences revenues		9,581			10,219			(638	)	(6.2	)
Reimbursed out-of-pockets		28,343			27,142			1,201		4.4
Total net revenue		395,816			354,847			40,969		11.6
Direct costs:
Development		179,044			153,003			26,041		17.0
Discovery sciences		2,848			5,008			(2,160	)	(43.1	)
Reimbursable out-of-pocket expenses		28,343			27,142			1,201		4.4
Total direct costs		210,235			185,153			25,082		13.6
Research and development expenses		4,924			7,086			(2,162	)	(30.5	)
Selling, general and administrative expenses		92,975			81,545			11,430		14.0
Depreciation		13,600			13,754			(154	)	(1.1	)
Amortization		742			719			23		3.2
Restructuring charges		2,619			—			2,619
Income from operations		70,721			66,590			4,131		6.2
Impairment of investments		(2,000	)		(8,600	)		6,600		(76.7	)
Interest and other income (expense), net		1,712			1,499			213		14.2
Income before taxes		70,433			59,489			10,944		18.4
Provision for income taxes		22,355			21,482			873		4.1
Net income	$	48,078		$	38,007		$	10,071		26.5
Net income per diluted share	$	0.85		$	0.68		$	0.17		25.0

Total net revenue increased to $395.8 million in the first six months of 2004. The increase in total net revenue resulted primarily from an increase in our Development Group revenues. The Development Group’s operations generated net revenue of $357.9 million, which accounted for 90.4% of total net revenue for the first six

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months of 2004. The 12.7% increase in the Development Group’s net revenue was primarily attributable to an increase in the amount of global CRO Phase II through IV services we provided in the first six months of 2004 as compared to the first six months of 2003. Net revenue for the Development Group also increased by approximately $2.3 million due to the effect of the U.S. dollar weakening relative to the euro and the British pound in the first six months of 2004.

The Discovery Sciences Group generated net revenue of $9.6 million in the first six months of 2004, a decrease of $0.6 million from the same period in 2003. The decrease in the Discovery Sciences net revenue was mainly attributable to the reduction in net revenue from chemistry services, which we no longer offered after the first quarter of 2004, partially offset by the increase in net revenue associated with our preclinical oncology operations.

Total direct costs increased to $210.2 million in the first six months of 2004 primarily as the result of an increase in the Development Group direct costs. Development Group direct costs increased $26.0 million from the first six months of 2003 to the first six months of 2004. The primary reason for this increase was an increase in personnel costs of $18.8 million. Personnel costs increased due to hiring additional employees in our global CRO Phase II through IV division, increased incentive compensation accruals and increased costs in our foreign operations due to the weakening of the U.S. dollar. In the first six months of 2003, incentive compensation accruals were lower than our normal accrual levels as a result of our financial and operating performance in that period. The remaining $7.2 million of this increase in Development direct costs included increased facility costs related to the increase in personnel and increased subcontractor costs.

Gross margin from the Development segment was 50.0% for the first six months of 2004 compared to 51.8% for the first six months of 2003. Of this 1.8% decline in gross margin, 1.3% was attributable to the increased incentive compensation accruals and the increased costs in our foreign operations due to the weakening of the U.S. dollar mentioned earlier. The remaining variance relates to expected fluctuations from one period to another as a result of changes in labor utilization and the mix of service offerings involved in the hundreds of studies conducted during any period of time.

R&D expenses decreased $2.2 million to $4.9 million in the first six months of 2004. This decline was due to the cessation of our functional genomics services in the third quarter of 2003 and chemistry services operations in the first quarter of 2004. However, we expect to incur significant R&D expenses during the remainder of 2004 in connection with our existing compound partnering arrangements.

SG&A expenses increased $11.4 million to $93.0 million in the first six months of 2004. The increase includes additional personnel costs of $10.2 million. Of this increase, $6.5 million related to increased incentive compensation accruals and foreign currency translation effect mentioned above. The remaining $3.7 million increase in personnel costs related to increased infrastructure to manage direct personnel and insure quality delivery of projects. As a percentage of total net revenue, SG&A expenses increased to 23.5% in the first six months of 2004 from 23.0% in the first six months of 2003.

In the first six months of 2004, PPD recorded a $2.6 million restructuring charge associated with exiting our chemistry facility in Research Triangle Park, North Carolina. These charges include lease termination costs (net of sublease rentals) of approximately $2.1 million and a loss on sale of assets used in the Company’s chemistry services of approximately $0.5 million. The lease termination liability will be paid over the remaining life of the lease which will end in 2015.

Income from operations increased $4.1 million to $70.7 million in the first six months of 2004. As a percentage of net revenue, income from operations decreased to 17.9% of net revenue in the first six months of 2004 from 18.8% in the first six months of 2003. Income from operations was negatively impacted by approximately $3.2 million due to the effect of the U.S. dollar weakening relative to the euro, the British pound and the Brazilian real, netted against the foreign currency hedging gain of $1.1 million during the first six months of 2004. Although these currency movements increased net revenue in the aggregate, the negative impact on income from operations is attributable to dollar-denominated contracts for services rendered in countries other than the United States. In these cases, revenue is not impacted by the weakening of the U.S. dollar, but the costs associated with performing these contracts, which are paid in local currency, are negatively impacted when translated to the U.S. dollar.

During the six months ended June 30, 2003 and 2004, the Company recorded charges to earnings for other than temporary declines in the fair market value of its investments in SLIL Biomedical Corp. of $4.7 million, Spotlight Health, Inc. of $3.7 million and Signature Bioscience, Inc. of $0.2 million in the 2003 period and

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Chemokine Therapeutics Corp. of $2.0 million in the 2004 period. SLIL and Signature Bioscience were deemed to be impaired primarily as a result of the market condition of the overall industry and their individual historical and projected performance and expected cash needs. The write-downs of Spotlight Health and Chemokine were recorded based primarily on their individual historical and projected financial performance and completed or expected issuances of shares to new investors at a lower valuations than the Company’s recorded value.

Our provision for income taxes increased to $22.4 million in the first six months of 2004. Our effective income tax rate for the first six months of 2004 was 31.7% compared to 36.1% for the first six months of 2003. During the second quarter of 2004, our effective tax rate was positively impacted by the $3.7 million tax benefit which we recorded as a result of the utilization of capital loss carryforwards that previously had a valuation allowance recorded against them. We expect our effective tax rate for the remainder of 2004 to be approximately 36%.

Net income of $48.1 million in the first six months of 2004 represents an increase of $10.1 million from $38.0 million in the first six months of 2003. Net income per diluted share of $0.85 in the first six months of 2004 represents an increase from $0.68 net income per diluted share in the first six months of 2003.

Liquidity and Capital Resources

As of June 30, 2004, we had $161.9 million of cash and cash equivalents on hand. Our expected primary cash needs on both a short and long-term basis are for capital expenditures, expansion of services, possible acquisitions and investments, geographic expansion, working capital and other general corporate purposes. We have historically funded our operations and growth, including acquisitions, with cash flow from operations, borrowings and sales of our stock. Our cash and cash equivalents are invested in financial instruments that are rated A or better by Standard & Poor’s or Moody’s and earn interest at market rates.

In the first six months of 2004, our operating activities provided $76.4 million in cash as compared to $31.0 million for the same period last year. In the first six months of 2004, net income of $48.1 million, depreciation and amortization of $14.3 million and a net decrease in operating assets and liabilities of $15.8 million were partially offset by a benefit of $4.7 million for deferred income taxes. The net decrease in operating assets and liabilities is primarily attributable to a decrease in receivables due to increased cash collections, increase in current income taxes, a decrease in unearned income, and an increase in accrued expenses and payables to investigators.

In the first six months of 2004, our investing activities used $28.2 million in cash. Investments of $5.9 million and capital expenditures of $24.0 million were partially offset by the $1.5 million of proceeds from a refund of a portion of the purchase price associated with the acquisition of Eminent. We expect our capital expenditures to be approximately $45.0 to $50.0 million in 2004, with the majority of the anticipated spending related to continued information technology enhancement and expansion in our Phase I clinic in Austin, Texas.

In the first six months of 2004, our financing activities provided $3.6 million in cash, as net proceeds from stock option exercises and purchases under our employee stock purchase plan totaling $4.2 million were partially offset by $0.6 million in repayments of capital lease obligations and long-term debt.

Working capital as of June 30, 2004 was $195.3 million, compared to $156.6 million at December 31, 2003. The increase in working capital was due primarily to an increase in cash of $51.8 million, an increase in deferred income tax asset of $4.9 million, partially offset by the increase in payables to investigators of $5.7 million, decrease in accounts receivable and unbilled services of $22.2 million, decrease in unearned income of $25.1 million and an increase in accrued income taxes and other accruals of $23.0 million. The number of days’ revenue outstanding in accounts receivable and unbilled services, net of unearned income, also known as DSO, were 41.6 and 38.9 days for the six months ended June 30, 2004 and June 30, 2003, respectively. DSO is calculated by dividing accounts receivable and unbilled services less unearned income by average daily gross revenue for the applicable period. Our year-to-date DSO over the past several years has fluctuated between 30.8 days and 43.2 days. We expect DSO will fluctuate in the future depending on the mix of contracts performed within a quarter, the level of investigator advances and unearned income and our success in collecting receivables.

In July 2004, we renewed our $50.0 million revolving credit facility with Bank of America, N. A. Indebtedness under the facility is unsecured and subject to traditional covenants relating to financial ratios and restrictions on certain types of transactions. Borrowings under this credit facility are available to provide working capital and for general corporate purposes. As of June 30, 2004, there was no amount outstanding under this credit

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facility. However, the aggregate amount we are able to borrow has been reduced by $0.80 million due to outstanding letters of credit issued under this facility. This credit facility is currently scheduled to expire in June 2005, at which time any outstanding balance would be due.

In April 2000, we made an investment in Spotlight Health. In January 2001, we entered into an agreement with Spotlight Health and Wachovia to guarantee a $2.0 million revolving line of credit provided to Spotlight Health by Wachovia. Indebtedness under the line was unsecured and subject to traditional covenants relating to financial ratios. This credit facility expired on June 30, 2003. In July 2003, Spotlight Health replaced this credit facility with a new $2.0 million revolving line of credit from Bank of America. The new line of credit is on terms substantially similar to the prior line of credit. We continue to guarantee Spotlight’s obligations under the new credit facility, which is scheduled to expire on September 30, 2004, at which time any outstanding balance would be due. As of June 30, 2004, Spotlight Health had $2.0 million outstanding under this credit facility. In accordance with the requirements of FASB Statement No. 5, “Accounting for Contingencies”, and as clarified by FASB Interpretation No. 45, we have recorded a liability in the amount of $0.2 million for the estimated fair value of the obligation we have assumed under this guarantee. We review the financial statements of Spotlight Health on a quarterly basis to determine if it has sufficient financial resources to continue operations. Future events and circumstances might adversely affect Spotlight Health’s financial condition and Spotlight Health might not be in the position to repay the facility, in which case Bank of America may attempt to collect on our guarantee.

In September 2003, we entered into agreements with SurroMed pursuant to which we committed to purchase biomarker discovery services from SurroMed of at least $2.0 million, $2.0 million, $1.0 million and $1.0 million during the years ended December 31, 2004, 2005, 2006 and 2007, respectively, and to serve as a non-exclusive representative to market and sell additional SurroMed biomarker discovery services.

In November 2003, we entered into a collaboration agreement with Syrrx to jointly develop and commercialize Syrrx-designed human dipeptidyl peptidase IV, or DP4, inhibitors as drug products for the treatment of type 2 diabetes and other major human diseases. Under the terms of the agreement, we will provide preclinical and clinical development resources and expertise for the collaboration, and will fund the majority of preclinical and clinical studies through Phase IIb development of selected DP4 inhibitors. PPD and Syrrx have agreed to share equally the costs of Phase III development. In addition, we will make milestone payments to Syrrx upon the occurrence of certain clinical and regulatory events. In the event of approval to market a drug product, PPD and Syrrx will share equally the profits from drug sales.

In April 2003, we made an equity investment in Chemokine Therapeutics. In connection with this investment, Chemokine granted PPD an exclusive option to license a proprietary peptide for a one-time license fee of $1.5 million. If we choose to exercise this option, we will be obligated to pay the one-time license fee plus the costs for future development work on the peptide. Chemokine also granted PPD the right to first negotiate a license to other peptides.

In November 2003, we became a limited partner in A. M. Pappas Life Science Ventures III, LP, a venture capital fund. The Pappas Fund was established for the purpose of making investments in equity securities of privately held companies in the life sciences, healthcare and technology industries. Under the terms of the limited partnership agreement, we committed to invest up to an aggregate of $4.75 million in the Pappas Fund. No capital call can exceed 10% of our aggregate capital commitment, and no more than one-third of our commitment could be called prior to May 2004 and no more than two-thirds prior to May 2005. As such, we anticipate that our aggregate investment will be made through a series of future capital calls over the next several years. No capital calls have been made through June 30, 2004, and our capital commitment will expire in May 2009.

Under most of our agreements for Development Group services, we agree to indemnify and defend the sponsor against third party claims based on our negligence or willful misconduct. Any successful claims could have a material adverse effect on our financial condition, results of operations and future prospects.

We expect to continue expanding our operations through internal growth and strategic acquisitions and investments. We expect these activities will be funded from existing cash, cash flows from operations and, if necessary or appropriate, borrowings under our existing or future credit facilities. We believe that these sources of liquidity will be sufficient to fund our operations for the foreseeable future, but offer no assurances. From time to time, we evaluate potential acquisitions, investments and other growth opportunities, which might require additional external financing, and we might seek funds from public or private issuances of equity or debt securities. In

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particular, our sources of liquidity could be affected by our dependence on a small number of industries and clients, compliance with regulations, international risks, personal injury, environmental or intellectual property claims, as well as other factors described below under “Potential Volatility of Quarterly Operating Results and Stock Price” and “Quantitative and Qualitative Disclosures about Market Risk”. In addition, see “Contractual Obligations and Commercial Commitments”, “Critical Accounting Policies and Estimates” and “Factors that Might Affect our Business or Stock Price” in our Annual Report on Form 10-K for the year ended December 31, 2003.

Critical Accounting Policies and Estimates

There were no material changes to our critical accounting policies and estimates in the first six months of 2004. For detailed information on our critical accounting policies and estimates, see our Annual Report on Form 10-K for the year ended December 31, 2003.

Recently Issued Accounting Standards

In December 2003, the FASB issued SFAS No. 132 (Revised 2003) “Employers’ Disclosures about Pensions and Other Postretirement Benefits”. Revised Statement No. 132 requires additional disclosures about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. We have adopted the interim reporting requirements and do not believe the adoption of the remaining portion of this statement will have a material impact on our financial statements.

In December 2003, the FASB issued FIN 46 (revised December 2003), “Consolidation of Variable Interest Entities”. This revised interpretation is effective for all entities no later than the end of the first reporting period that ends after March 15, 2004. We have no investment in or contractual or other business relationship with a variable interest entity and therefore the adoption of this interpretation did not have any impact on our consolidated financial position or results of operations. However, if we enter into any such arrangement with a variable interest entity in the future, our consolidated financial position or results of operations might be impacted.

In November 2003, during discussions on EITF Issue 03-01, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”, the EITF reached a consensus which requires quantitative and qualitative disclosures for debt and marketable equity securities classified as available-for-sale or held-to-maturity under Statements 115 and 124 that are impaired at the balance sheet date but for which an other-than-temporary impairment has not been recognized. The consensus on quantitative and qualitative disclosures is effective for fiscal years ending after December 15, 2003 and comparative information for earlier periods presented is not required. We have not had any investments with unrealized losses since December 31, 2003 and thus the adoption of this consensus did not have a material impact on our financial statements. At the March 2004 EITF meeting, the Task Force reached a consensus on a three-step impairment model. Except for disclosure requirements already in place, the Issue 03-01 consensus will be effective prospectively for all relevant current and future investments in reporting periods beginning after June 15, 2004. We already do quarterly evaluations of our investments and thus we do not expect the adoption of this consensus to have a material impact on our financial statements.

Taxes

We conduct operations on a global basis. As a result, our effective tax rate has and will continue to depend upon the geographic distribution of our pre-tax earnings among locations with varying tax rates. Our profits are also impacted by changes in the tax rates of the various taxing jurisdictions. In particular, as the geographic mix of our pre-tax earnings among various tax jurisdictions changes, our effective tax rate might vary from period to period. In addition, our effective tax rate might fluctuate as we record or release valuation allowances.

Inflation

Our long-term contracts, which are those in excess of one year, generally include an inflation or cost of living adjustment for the portion of the services to be performed beyond one year from the contract date. As a result, we expect that inflation generally will not have a material adverse effect on our operations or our financial condition.

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Potential Volatility of Quarterly Operating Results and Stock Price

Our quarterly and annual operating results have fluctuated in the past, and we expect that they will continue to fluctuate in the future. Factors that could cause these fluctuations to occur include:

• the timing of our Discovery Sciences Group milestone payments or other revenue;

• the timing and amount of costs associated with R&D and compound collaborations;

• exchange rate fluctuations between periods;

• our dependence on a small number of industries and clients;

• the timing of the initiation, progress or cancellation of significant projects;

• the timing and level of new business authorizations;

• the mix of products and services sold in a particular period;

• our need to recruit and retain experienced personnel;

• rapid technological change and the timing and amount of start-up costs incurred in connection with the introduction of new products and services;

• the timing and extent of new government regulations;

• intellectual property risks;

• impairment of investments or intangible assets;

• the timing of the opening of new offices;

• the timing of other internal expansion costs; and

• the timing and amount of costs associated with integrating acquisitions.

Delays and terminations of trials are often the result of actions taken by our customers or regulatory authorities, and are not typically controllable by us. Because a large percentage of our operating costs are relatively fixed while revenue is subject to fluctuation, variations in the timing and progress of large contracts can materially affect our quarterly operating results. We believe that comparisons of our quarterly financial results are not necessarily meaningful and should not be relied upon as an indication of future performance.

Fluctuations in quarterly results or other factors beyond our control could affect the market price of our common stock. These factors include changes in earnings estimates by analysts, market conditions in our industry, announcements by competitors, changes in pharmaceutical, biotechnology and medical device industries, general economic conditions, and differences in assumptions used as compared to actual results. Any effect on our common stock could be unrelated to our longer-term operating performance.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

We are exposed to foreign currency risk by virtue of our international operations. Approximately 22.5% and 27.8% of our net revenues for the three months ended June 30, 2003 and 2004, respectively, were derived from operations outside the United States. Funds generated by each subsidiary are generally reinvested in the country where they are earned. Our operations in the United Kingdom generated more than 39.6% of our net revenue from international operations during the second quarter of 2004. Accordingly, we are exposed to adverse movements in the pound sterling and other foreign currencies.

The vast majority of our contracts are entered into by our United States or United Kingdom subsidiaries. The contracts entered into by the United States subsidiaries are almost always denominated in U.S. dollars. Contracts entered into by our United Kingdom subsidiaries are generally denominated in pounds sterling, U.S. dollars or euros, but the majority of these contracts are in U. S. dollars. In 2003, with the significant weakening of the U.S. dollar relative to the euro and the pound sterling, our translation losses increased over 2002. As a result, in January 2004, we began engaging in hedging activities in an effort to manage our potential foreign exchange exposure.

We do have some currency risk resulting from the passage of time between the invoicing of customers under contracts and the ultimate collection of customer payments against those invoices. If a contract is denominated in a currency other than the subsidiary’s local currency, we recognize a receivable at the time of invoicing for the local currency equivalent of the foreign currency invoice amount. Changes in exchange rates from the time the invoice is prepared and payment from the customer is received will result in our receiving either more or less in local currency than the local currency equivalent of the invoice amount at the time the invoice was prepared and the receivable established. We recognize this difference as a foreign currency transaction gain or loss, as applicable, and report it in other income, net.

Our strategy for management of currency risk relies primarily on conducting our operations in a country’s currency, intercompany foreign currency denominated loans and may, from time to time, involve use of currency derivatives, primarily forward exchange contracts, to reduce our exposure to currency fluctuations. As of June 30, 2004, we had open foreign exchange derivative contracts with a face amount totaling $65.0 million to buy the local currencies of our foreign subsidiaries. The estimated fair value of the foreign exchange contracts based upon dealer quotes was a net liability of approximately $1.2 million. The potential loss resulting from a hypothetical weakening of the U.S. dollar relative to the pound sterling and euro of 10% would have been approximately $1.6 million for the three-month period ended June 30, 2004 based on 2004 revenues and costs related to the U.K. We do not expect that a 10% change in exchange rates in the future would have a material effect on our financial statements.

Changes in exchange rates between the applicable foreign currency and the U.S. dollar will affect the translation of foreign subsidiaries’ financial results into U.S. dollars for purposes of reporting our consolidated financial results. The process by which we translate each foreign subsidiary’s financial results to U.S. dollars is as follows:

• we translate income statement accounts at average exchange rates for the period;

• we translate balance sheet assets and liability accounts at end-of-period exchange rates; and

• we translate equity accounts at historical exchange rates.

Translation of the balance sheet in this manner affects shareholders’ equity through the cumulative translation adjustment account. This account exists only in the foreign subsidiary’s U.S. dollar balance sheet and is necessary to keep the foreign balance sheet, stated in U.S. dollars, in balance. Translation adjustments are reported with accumulated other comprehensive income (loss) as a separate component of shareholders’ equity. To date, cumulative translation adjustments have not been material to our consolidated financial position. However, future translation adjustments could materially and adversely affect our financial position.

Currently, there are no material exchange controls on the payment of dividends or otherwise prohibiting the transfer of funds out of or from within any country in which we conduct operations. Although we perform services for clients located in a number of foreign jurisdictions, we have not experienced any difficulties in receiving funds remitted from foreign countries. However, if any of these jurisdictions imposed, or modified existing, exchange control restrictions, the restrictions could have an adverse effect on our financial condition.

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We are exposed to changes in interest rates on our cash equivalents and amounts outstanding under notes payable and lines of credit. We invest our cash and cash equivalents in financial instruments with interest rates based on financial market conditions. We do not expect that a 10% change in interest rates in the future would have a material effect on our financial statements.

Item 4. Controls and Procedures

(a) Disclosure Controls and Procedures: Disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) are designed only to provide reasonable assurance that they will meet their objectives. As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(b). Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are effective to provide the reasonable assurance discussed above.

(b) Internal Control Over Financial Reporting: No change in the Company’s internal control over financial reporting occurred during the Company’s last fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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Part II. OTHER INFORMATION

Item 4. Submission of Matters to a Vote of Security Holders

The 2004 Annual Meeting of Shareholders of the Company was held on May 19, 2004. At the Annual Meeting, the following directors were elected to office for the ensuing year and were approved by the following votes:

	For	Against*
Stuart Bondurant	48,856,997	1,758,563
Fredric N. Eshelman	46,639,333	3,976,227
Marye Anne Fox	49,721,127	894,433
Frederick Frank	49,553,981	1,061,579
David L. Grange	49,719,782	895,778
Catherine M. Klema	49,173,860	1,441,700
Terry Magnuson	49,513,039	1,102,521
Ernest Mario	49,513,413	1,102,147
John A. McNeill, Jr.	45,197,822	5,417,738

^* Includes abstentions.

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Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

10.205	Termination Agreement dated June 25, 2004, between PPD Development, LP and W. Richard Staub.
10.206	Second Amendment to Loan Agreement dated July 1, 2004, between Pharmaceutical Product Development, Inc. and Bank of America, N.A.
31.1	Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)
31.2	Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)
32.1	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002 – Chief Executive Officer
32.2	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002 – Chief Financial Officer

(b) Reports on Form 8-K

On April 19, 2004, we furnished a Current Report on Form 8-K under Items 9 and 12, attaching a press release announcing our operating and financial results for the quarter ended March 31, 2004. Notwithstanding its listing here, the information furnished shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liabilities of that section, nor incorporated by reference in any filing under the Securities Act of 1933, as amended, except as expressly set forth by specific reference in such a filing.

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SIGNATURES

In accordance with the requirements of the Securities Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	PHARMACEUTICAL PRODUCT DEVELOPMENT, INC.
	(Registrant)
By	/s/ Fredric N. Eshelman
	Chief Executive Officer
	(Principal Executive Officer)
By	/s/ Linda Baddour
	Chief Financial Officer
	(Principal Financial and Accounting Officer)

Date: August 3, 2004

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EX-10.205

Exhibit 10.205

TERMINATION AGREEMENT

This Termination Agreement (the “Agreement”), dated as of this 25th day of June, 2004, by and between PPD Development, LP, a Texas limited partnership (“PPD Development”), and W. Richard Staub (“Employee”).

WHEREAS, PPD Development and Employee are parties to that certain Employment Agreement dated May 1, 2002, as amended by (i) that certain Amendment No. 1 to Employment Agreement dated June 1, 2002, (ii) that certain Amendment No. 2 to Employment Agreement dated January 1, 2003, and (iii) that certain Amendment No. 3 to Employment Agreement dated January 1, 2004 (the “Employment Agreement”); and

WHEREAS, the term of the Employment Agreement is scheduled to expire on December 31, 2004; and

WHEREAS, Employee desires to terminate his employment with PPD Development prior to the expiration of the current term of the Employment Agreement and accept employment with PharmalinkFHI, Inc., a Delaware corporation (the “New Employer”), a competitor of PPD Development; and

WHEREAS, Employee has requested PPD Development to mutually terminate the Employment Agreement prior to the expiration of the current term, and PPD Development is willing to do so on the terms and conditions set forth herein.

NOW, THEREFORE, in consideration of the mutual promises, covenants and considerations contained herein, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows:

1. Termination of Employment Agreement. Subject to and upon the terms and conditions of this Agreement, the Employment Agreement shall be terminated effective August 13, 2004 (the “Termination Date”). PPD Development and Employee agree that Employee shall take paid-time-off beginning June 28, 2004 and continuing through the Termination Date, that such time off will exhaust Employee’s accrued and unused paid-time-off and that the Company shall have no further obligation to pay or otherwise compensate Employee in any manner for any accrued and unused vacation or paid-time-off.

2. Effect of Termination; Survival. From and after the Termination Date, neither party hereto shall have any rights or obligations under the Employment Agreement, except that (i) the Company shall pay Employee’s base salary set forth in Section 3 of the Employment Agreement through the Termination Date, (ii) the Company shall reimburse Employee for any unreimbursed expenses pursuant to Section 10 of the Employment Agreement, (iii) the non-compete covenant in Section 6 of the Employment Agreement shall remain in full force and effect until December 31, 2004, except with

respect to the New Employer, and (iv) the provisions of Sections 11 through 22, inclusive, of the Employment Agreement shall survive the termination thereof. Employee further acknowledges and agrees that the Proprietary Information and Inventions Agreement dated May 1, 2002 executed by Employee (the “Proprietary Agreement”) shall not be affected by the termination of the Employment Agreement, shall continue in full force and effect in accordance with the terms thereof and shall apply with respect to the New Employer.

3. Miscellaneous.

a. This Agreement constitutes the entire agreement between the parties with respect to the subject matter hereof and may not be altered or amended except by writing signed by the parties.

b. This Agreement shall be governed by the laws of State of North Carolina.

c. This Agreement shall inure to the benefit of and be binding upon the PPD Development, Employee and their respective heirs, successors, assigns and personal representatives.

d. The parties agree that any dispute under this Agreement or the Employment Agreement shall be submitted to arbitration pursuant to Section 19 of the Employment Agreement.

IN WITNESS WHEREOF, the parties have caused this agreement to be executed as of the date first hereinabove set forth.

PPD DEVELOPMENT, LP
By:	PPD GP, LLC
	Its General Partner
By:	/s/ Fredric N. Eshelman
Name:	Fredric N. Eshelman
Title:	Chief Executive Officer
	/s/ W. Richard Staub
	W. Richard Staub

EX-10.206

Exhibit 10.206

SECOND AMENDMENT TO LOAN AGREEMENT

THIS SECOND AMENDMENT TO LOAN AGREEMENT (the “Amendment”), dated as of July 1, 2004, is made by and among PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. (the “Borrower”), PPD DEVELOPMENT, LP, (the “Guarantor”) and BANK OF AMERICA, N.A. (the “Bank”).

RECITALS:

A. The Borrower, the Guarantor and the Bank entered into that certain Loan Agreement, dated as of July 25, 2002, as amended (the “Loan Agreement”).

B. The Borrower, the Guarantor and the Bank have agreed to amend the Loan Agreement as set forth herein.

NOW THEREFORE, the parties hereto agree as follows:

1. The Loan Agreement is hereby amended as follows:

(a) Section 1.01 is amended by deleting the definition of “Termination Date” and replacing it with the following definition:

“Termination Date” means June 30, 2005, or such later date as to which the Bank may agree in its sole discretion.

(b) Section 6.9(d) is amended by replacing the reference to “ADoctorInYourHouse.com” with a reference to “Spotlight Health, Inc.”

(c) Section 6.9(f) is deleted.

2. Except as hereby modified, all the terms and provisions of the Loan Agreement and exhibits thereto remain in full force and effect.

3. The Borrower and the Guarantor acknowledge and agree that there are no defenses, setoffs or counterclaims available to them with respect to the performance of their obligations under the Loan Agreement (including, without limitation, the Guarantor’s obligations under Section 3 of the Loan Agreement).

4. The Borrower and the Guarantor will execute such additional documents as are reasonably requested by the Bank to reflect the terms and conditions of this Amendment and will cause to be delivered such certificates, legal opinions and other documents as are reasonably required by the Bank. In addition, the Borrower and the Guarantor will pay all costs and

expenses in connection with the preparation, execution and delivery of the documents executed in connection with this transaction, including, without limitation, the reasonable fees and out-of-pocket expenses of special counsel to the Bank as well as any and all filing and recording fees and stamp and other taxes with respect thereto and to save the Bank harmless from any and all such costs, expenses and liabilities.

5. This Amendment may be executed in any number of counterparts, each of which when so executed and delivered shall be deemed an original, and it shall not be necessary in making proof of this Amendment to produce or account for more than one counterpart.

6. This Amendment and all other documents executed pursuant to the transactions contemplated herein shall be deemed to be contracts made under, and for all purposes shall be construed in accordance with, the internal laws and judicial decisions of the State of North Carolina. The Borrower and the Guarantor hereby submit to the jurisdiction and venue of the state and federal courts of North Carolina for the purposes of resolving disputes hereunder and thereunder or for purposes of collection.

IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed by their fully authorized officers as of the day and year first above written.

BORROWER:	PHARMACEUTICAL PRODUCT DEVELOPMENT, INC., a North Carolina corporation
	By:	/s/ Fred B. Davenport, Jr.
	Name:	Fred B. Davenport, Jr.
	Title:	President
GUARANTOR:	PPD DEVELOPMENT, LP, a Texas limited partnership
	By:	PPD GP, LLC,
		a Delaware limited liability company,
		its General Partner
	By:	/s/ Fred B. Davenport, Jr.
	Name:	Fred B. Davenport, Jr.
	Title:	President
BANK:	BANK OF AMERICA, N.A.
	By:	/s/ J. Thomas Johnson, Jr.
	Name:	J. Thomas Johnson, Jr.
	Title:	Sr. Vice President

2

EX-31.1

EXHIBIT 31.1

CERTIFICATION

I, Fredric N. Eshelman, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Pharmaceutical Product Development, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and

(c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 3, 2004	By:	/s/ Fredric N. Eshelman
		Chief Executive Officer

EX-31.2

EXHIBIT 31.2

CERTIFICATION

I, Linda Baddour, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Pharmaceutical Product Development, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and

(c) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 3, 2004	By:	/s/ Linda Baddour
		Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the quarterly report of Pharmaceutical Product Development, Inc. (“PPD”) on Form 10-Q for the period ended June 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Fredric N. Eshelman, Chief Executive Officer of PPD, hereby certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:

1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Act of 1934; and

2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of PPD as of, and for, the periods presented in the Report.

Date: August 3, 2004

/s/ Fredric N. Eshelman

Fredric N. Eshelman

Chief Executive Officer

EX-32.2

Exhibit 32.2

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the quarterly report of Pharmaceutical Product Development, Inc. (“PPD”) on Form 10-Q for the period ended June 30, 2004 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Linda Baddour, Chief Financial Officer of PPD, hereby certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:

1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Act of 1934; and

2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of PPD as of, and for, the periods presented in the Report.

Date: August 3, 2004

/s/ Linda Baddour

Linda Baddour

Chief Financial Officer