Form 10-Q

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 a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 117,221,219 shares of common stock, par value $0.05 per share, as of October 27, 2006.

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

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. The Company prepared these unaudited consolidated condensed financial statements in accordance with Rule 10-01 of Regulation S-X and, in management’s opinion, has included all adjustments of a normal recurring nature necessary for a fair presentation. The accompanying consolidated condensed financial statements 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, 2005. The results of operations for the three-month and nine-month periods ended September 30, 2006 are not necessarily indicative of the results to be expected for the full year or any other period. The amounts in the December 31, 2005 consolidated condensed balance sheet are derived from the audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

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.

On December 30, 2005, the Company’s Board of Directors approved a two-for-one stock split. The record date for the stock split was February 17, 2006. The distribution of shares was completed on February 28, 2006. All share and per share amounts for all periods presented in the accompanying consolidated financial statements have been adjusted to reflect the effect of this stock split.

In December 2004, the Financial Accounting Standards Board, or FASB, issued SFAS No. 123 (revised), “Share-Based Payment”, that requires compensation costs related to share-based payment transactions to be recognized in the financial statements. With limited exceptions, the amount of compensation cost is measured based on the fair value on the date of grant of the equity or liability instruments issued. In addition, the fair value of liability instruments is remeasured each reporting period. Compensation cost is recognized over the period that an employee provides service in exchange for the award. In March 2005, the SEC issued Staff Accounting Bulletin 107 which describes the SEC staff’s expectations in determining the assumptions that underlie the fair value estimates and discusses the interaction of SFAS No. 123 (revised) with existing SEC guidance. SFAS No. 123 (revised) became effective for fiscal years that began after June 15, 2005, so on January 1, 2006, the Company adopted the modified retrospective transition method permitted by the statement using the Black-Scholes option pricing method, previously used in footnote disclosure. In accordance with the modified retrospective application method prescribed by SFAS No. 123 (revised), the Company has adjusted its financial statements for all periods prior to January 1, 2006 to give effect to the fair-value based method of accounting for all awards granted in fiscal years beginning after December 15, 1994. Amounts previously disclosed as pro forma adjustments have been reflected in earnings for all prior periods. See Note 9 for further details.

In March 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligation”, or FIN 47, to clarify that the term “conditional asset retirement obligation” as used in SFAS No. 143 refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. An entity must recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. FIN 47 also defines when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. FIN 47 is effective as of the end of fiscal years ending after December 15, 2005. The adoption of this statement did not have a material impact on the Company’s financial condition or results of operations.

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections”, which changes the requirements for the accounting and reporting of a change in accounting principle. SFAS No. 154 applies to all voluntary changes in accounting principle as well as to changes required by an accounting pronouncement that does not include specific transition provisions. SFAS No. 154 requires that changes in accounting principle be retrospectively applied. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company will apply SFAS No. 154 for changes occurring after January 1, 2006, as appropriate.

In June 2005, the Emerging Issues Task Force, or EITF, reached a consensus on EITF Issue 05-6, “Determining the Amortization Period for Leasehold Improvements Purchased after Lease Inception or Acquired in a Business Combination”. EITF 05-6 requires leasehold improvements purchased after the beginning of the initial lease term or that are acquired in a business combination to be amortized over the lesser of the useful life of the assets or a term that includes the original lease term plus any renewals that are reasonably assured at the date the leasehold improvements are purchased or acquired. In September 2005, the EITF clarified that this issue does not apply to preexisting leasehold improvements. This guidance was effective for leasehold improvements purchased or acquired in reporting periods beginning after June 29, 2005. The adoption of this statement did not have a material impact on the Company’s financial condition or results of operations.

In October 2005, the FASB issued Staff Position FAS 13-1, “Accounting for Rental Costs Incurred During a Construction Period”, or FSP 13-1. FSP 13-1 states that rental costs associated with ground or building operating leases incurred during a construction period shall be recognized as rental expense and not capitalized. FSP 13-1 is effective for the first reporting period beginning after December 15, 2005. The adoption of this statement did not have a material impact on the Company’s financial condition or results of operations.

In November 2005, the FASB issued Staff Position FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments”. This statement addresses the determination as to when an investment is considered impaired, whether the impairment is other-than-temporary and the measurement of an impairment loss. The statement is effective for reporting periods beginning after December 15, 2005. The adoption of this statement did not have any impact on the Company’s financial condition or results of operations.

In June 2006, the EITF reached a consensus on EITF Issue 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation)”, which addresses the income statement disclosure on taxes assessed by a governmental authority that are directly imposed on a revenue-producing transaction between a seller and a customer. Taxes within the scope of EITF 06-3 include sales taxes, use taxes, value-added taxes, and some types of excise taxes. For any such taxes that are reported on a gross basis, a company should disclose the amounts of those taxes in interim and annual financial statements for each period for which an income statement is presented if those amounts are significant. EITF Issue No. 06-3 will be effective for interim and annual reporting periods beginning after December 15, 2006. The Company currently accounts for taxes on a net basis. Therefore, EITF 06-3 should not have any significant impact on the Company’s financial condition or results of operations.

In June 2006, the FASB issued Staff Position FIN 46(R)-6, “Determining the Variability to Be Considered in Applying FASB Interpretation No. 46(R)”, or FSP FIN 46(R)-6, which introduces a “by-design” approach in determining variability. FSP FIN 46(R)-6 provides a two-step approach: 1) analyze the nature of the risk in the entity; and 2) determine the purpose(s) for which the entity was created and determine the variability. This standard is applicable for all entities (including newly created entities) with which an enterprise first becomes involved, and for all entities previously required to be analyzed under FIN 46(R) when a reconsideration event has occurred beginning the first day of the reporting period beginning after June 15, 2006. The Company adopted the provisions of FSP FIN 46(R)-

6 on July 1, 2006 and the statement did not have any impact on the Company’s financial condition or results of operations.

In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109”, or FIN 48, which clarifies the accounting for uncertainty in tax positions. FIN 48 requires that the Company recognize in its financial statements the impact of a tax position, if that position will more likely than not be sustained on audit, based on the technical merits of the position. The provisions of FIN 48 also provide a measurement attribute for the financial statement recognition of the tax position. FIN 48 will be effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact of the adoption of FIN 48 on its financial condition and results of operations.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”, or SFAS No. 157, which defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In addition, the statement establishes a framework for measuring fair value and expands disclosure about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 and interim periods within those years. The Company is currently evaluating the impact of the adoption of SFAS No. 157 on its financial condition and results of operations.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106, and 132(R)”, or SFAS No. 158. This standard requires employers to recognize the underfunded or overfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in the funded status in the year in which the changes occur through accumulated other comprehensive income. Additionally, SFAS No. 158 requires employers to measure the funded status of a plan as of the date of its year-end statement of financial position. The recognition of an asset and liability related to the funded status of a plan and the new disclosure provisions of SFAS No. 158 will be effective for fiscal years ending after December 15, 2006. The change in the measurement date requirement will be effective for fiscal years ending after December 15, 2008. The Company is currently evaluating the impact of the adoption of SFAS No. 158 on its financial condition and results of operations.

In September 2006, the SEC staff issued Staff Accounting Bulletin 108 “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”, or SAB 108, which requires that companies utilize a “dual-approach” when quantifying and evaluating the materiality of financial misstatements. This dual approach includes both an income statement focused assessment and a balance sheet focused assessment. The guidance in SAB 108 must be applied to annual financial statements for fiscal years ending after November 15, 2006. The Company is currently evaluating the impact of adopting SAB 108, but does not expect that it will have a material effect on its financial condition or results of operations.

Inventories, which consist principally of laboratory supplies, are valued at the lower of cost (first-in, first-out method) or market. Inventories totaling $2.3 million and $2.6 million as of December 31, 2005 and September 30, 2006, respectively, were included in prepaid expenses and other current assets.

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

The Company has reclassified certain 2005 financial statement amounts to conform to the 2006 financial statement presentation.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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.

In February 2005, the Company completed its acquisition of substantially all of the assets of SurroMed, Inc.’s biomarker business. This biomarker business is part of the Discovery Sciences segment of the Company. In exchange for the assets, the Company surrendered to SurroMed all shares of preferred stock of SurroMed it held. As additional consideration for the acquisition, the Company assumed approximately $3.4 million of SurroMed liabilities under capital leases and additional operating liabilities, and agreed to guarantee repayment of up to $1.5 million under a SurroMed bank loan. In February 2006, this amount was reduced to $0.8 million and SurroMed pledged a $0.5 million certificate of deposit to secure payment of the bank loan. In accordance with the requirements of SFAS No. 5, “Accounting for Contingencies”, as clarified by FASB Interpretation No. 45, the Company has recorded a liability in the amount of $25,000 for the estimated fair value of the net obligation it has assumed under this guarantee. In connection with this transaction, the Company recognized a pre-tax gain on exchange of assets of $5.1 million, primarily related to the $4.9 million gain on the termination of a preexisting facility lease arrangement with SurroMed in accordance with EITF 04-01, “Accounting for Preexisting Relationships between the Parties to a Business Combination”. The fair value of the leasing arrangement was determined based on the discounted cash flows of the difference between the future required rental payments under the lease agreement and the current market rate for similar facilities.

This acquisition was 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 acquisition.

The total purchase price for the SurroMed acquisition in 2005 was allocated to the estimated fair value of assets acquired and liabilities assumed as set forth in the following table:

The results of operations from the biomarker assets acquired are included in the Company’s consolidated condensed statements of operations as of and since February 1, 2005, the effective date of the acquisition. Pro forma results of operations for the three months and nine months ended September 30, 2005 have not been presented because the financial results related to the biomarker assets for the one-month period ended January 31, 2005 are not material to the consolidated condensed statements of operations.

Accounts receivable and unbilled services consisted of the following amounts on the dates set forth below:

Property and equipment, stated at cost, consisted of the following amounts on the dates set forth below:

Capitalized costs for the new corporate headquarters facility in Wilmington, North Carolina included in construction in progress as of December 31, 2005 and September 30, 2006 were $19.7 million and $76.3 million, respectively. In February 2006, the Company entered into an $80.0 million construction loan facility with Bank of America, N.A. Borrowings under this credit facility are available to finance the construction of the Company’s new corporate headquarters building and related parking facility. As of September 30, 2006, the Company had borrowed $56.1 million under this credit facility. During the three months and nine months ended September 30, 2006, the Company capitalized interest of approximately $0.7 million and $1.4 million, respectively, relating to the construction of the new corporate headquarters facility.

The Company had a note payable related to a laboratory building in Brussels, Belgium. In May 2006, the Company paid the $5.9 million unpaid balance and retired the note.

Property and equipment under capital leases, stated at cost, consisted of the following amounts on the dates set forth below:

Changes in the carrying amount of goodwill for the twelve months ended December 31, 2005 and the nine months ended September 30, 2006, by operating segment, were as follows:

The Company evaluates goodwill for impairment annually at the reporting unit level as required by SFAS No. 142.

The Company amortizes all intangible assets on a straight-line basis, based on estimated useful lives of three to five years for backlog and customer relationships and three to ten years for license and royalty agreements. The weighted average amortization period is 4.1 years for backlog and customer relationships, approximately 6.2 years for license and royalty agreements and approximately 5.9 years for all intangibles collectively.

Amortization expense for the three months ended September 30, 2005 and 2006 was $0.3 million and $0.1 million, respectively. Amortization expense for the nine months ended September 30, 2005 and 2006 was $0.8 million and $0.5 million, respectively. Estimated amortization expense for the period October 1, 2006 to December 31, 2006 and the next five years is as follows:

Short-term investments, which are composed of available-for-sale securities, and investments consisted of the following amounts on the dates set forth below:

As of December 31, 2005, the Company’s short-term investments consisted of Auction Rate Securities, or ARS. ARS generally have stated maturities of 20 to 30 years. However, these securities have economic characteristics of short-term investments due to a rate-setting mechanism and the ability for holders to liquidate them through a Dutch auction process that occurs on pre-determined intervals of less than 90 days. As such and because of management’s intent regarding these securities, the Company classifies these investments as short-term investments. Since the fair market value equaled the adjusted cost, there were no unrealized gains or losses associated with these investments as of December 31, 2005.

As of September 30, 2006, the Company had short-term investments in ARS and other municipal debt securities. As of September 30, 2006, unrealized gains associated with these investments were $0.2 million and

unrealized losses were $0.2 million. The gross realized (losses)/gains on these securities were $0 in each of the three months ended September 30, 2005 and 2006, and $(17,000) and $0 for the nine months ended September 30, 2005 and 2006, respectively, determined on a specific identification basis.

In May 2006, the Company sold its 2.0 million shares of Chemokine Therapeutics Corp. preferred stock for total consideration of $1.5 million and recorded a gain on sale of its investment of $0.8 million. In addition, the Company surrendered its license rights to Chemokine’s compound CTCE-0214 in exchange for $0.1 million and potential milestone payments up to $2.5 million.

The Company has equity investments in publicly traded entities. Investments in publicly traded entities are denoted as marketable equity securities in the above table and are classified as available-for-sale securities and 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 equity investments in publicly traded entities is based on the closing price as quoted by the applicable stock exchange or market on the last day of the reporting period. As of September 30, 2006, the Company’s equity investments in publicly traded companies were classified as long-term assets due to the Company’s ability to hold its investments long-term, the strategic nature of the investment and the lack of liquidity in the public markets for these securities. As of December 31, 2005 and September 30, 2006, gross unrealized gains on long-term investments in marketable securities were $8.5 million and $0, respectively, and gross unrealized losses were $0 and $4.0 million, respectively.

Of the total unrealized loss of $4.0 million as of September 30, 2006, approximately $3.7 million related to the Company’s investment in 4.3 million shares of common stock of Accentia Biopharmaceuticals, Inc. The Company owned approximately 13.5% of the outstanding capital stock of Accentia as of September 30, 2006. The remaining unrealized loss of $0.3 million related to the Company’s investment in common stock and warrants for common stock of BioDelivery Sciences International, Inc. The Company owned approximately 5.0% of BioDelivery Sciences International’s outstanding common stock as of September 30, 2006. Both of these securities have been in a loss position for less than 12 months. The Company evaluated the near-term prospects of both issuers in relation to the severity and duration of the decline in value. Based upon review of Accentia and BioDelivery Sciences International’s financial positions, and the Company’s ability and intent to hold its investments for a reasonable period of time sufficient for a forecasted recovery of fair value, the Company does not consider these investments to be other-than-temporarily impaired at September 30, 2006.

The Company also has investments in privately held entities in the form of equity and convertible debt instruments that are not publicly traded and 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 net realizable value of these entities on a quarterly basis to determine if there has been a decline in the fair value of these entities, and if so, if the decline is 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. This impairment analysis requires significant judgment.

In September 2005, the Company became a limited partner in Bay City Capital Fund IV, L.P., a venture capital fund established in July 2004 for the purpose of investing in life sciences companies. The Company has committed to invest up to a maximum of $10.0 million in the Bay City Fund IV. Capital calls during the first nine months of 2006 totaled $1.1 million, of which $0.3 million was accrued as of September 30, 2006 and subsequently paid in October 2006. Aggregate capital calls through September 30, 2006 totaled $3.0 million. Because no capital call can exceed 20% of the Company’s aggregate capital commitment, the Company anticipates its remaining capital commitment of $7.0 million will be invested through a series of future capital calls over the next several years. The Company owned

approximately 2.9% of the Bay City Fund IV as of September 30, 2006. The Company’s capital commitment will expire in June 2009.

In November 2003, the Company became a limited partner in A. M. Pappas Life Science Ventures III, L.P., a venture capital fund established for the purpose of making investments in equity securities of privately held companies in the life sciences, healthcare and technology industries. The Company has committed to invest up to a maximum of $4.75 million. Capital calls during the first nine months of 2006 totaled $0.2 million. Aggregate capital calls through September 30, 2006 totaled $0.9 million. Because no capital call can exceed 10% of the Company’s aggregate capital commitment, the Company anticipates its remaining capital commitment of $3.85 million will be invested through a series of future capital calls over the next several years. The Company owned approximately 4.7% of the Pappas Fund as of September 30, 2006. The Company’s capital commitment will expire in May 2009.

Comprehensive income consisted of the following amounts on the dates set forth below:

Accumulated other comprehensive income consisted of the following amounts on the dates set forth below:

The Company enters into foreign exchange forward and option contracts that are designated and qualify as cash flow hedges under SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities”. The Company recognizes changes in the fair value of the effective portion of these outstanding forward and option contracts in accumulated other comprehensive income, or OCI. The Company reclassifies these amounts from OCI and recognizes them in earnings when either the forecasted transaction occurs or it becomes probable that the forecasted transaction will not occur.

The Company recognizes changes in the ineffective portion of a derivative instrument in earnings in the current period. Effectiveness for forward cash flow hedge contracts is measured by comparing the fair value of the forward contract to the change in the forward value of the anticipated transaction. The fair market value of the hedged exposure is presumed to be the market value of the hedge instrument when critical terms match. The Company’s hedging portfolio had no ineffectiveness during 2005 or the first nine months of 2006.

The Company has significant international revenues and expenses, and related receivables and payables, denominated in non-functional currencies in the Company’s foreign subsidiaries. As a result, the Company purchased currency option and forward contracts as cash flow hedges to help manage certain foreign currency exposures that can be identified and quantified. Pursuant to its foreign exchange risk hedging policy, the Company may hedge anticipated and recorded transactions, and the related receivables and payables denominated in non-functional currencies, using forward foreign exchange rate contracts and foreign currency options. The Company’s policy is to only use foreign currency derivatives to minimize the variability in the Company’s operating results arising from foreign currency exchange rate movements. The Company does not enter into derivative financial instruments for speculative or trading purposes. Hedging contracts are measured at fair value using dealer quotes and mature within twelve months from their inception.

The Company’s hedging contracts are intended to protect against the impact of changes in the value of the U.S. dollar against other currencies and its impact on operating results. Accordingly, for forecasted transactions, subsidiaries incurring expenses in foreign currencies seek to hedge U.S. dollar revenue contracts. The Company reclassifies OCI associated with hedges of foreign currency revenue into direct costs upon recognition of the forecasted transaction in the statement of operations. At September 30, 2006, no such hedging contracts were outstanding.

The Company also enters into foreign currency forward contracts to hedge against changes in the fair value of monetary assets and liabilities denominated in a non-functional currency. These derivative instruments are not designated as hedging instruments; therefore, the Company recognizes changes in the fair value of these contracts immediately in other income (expense), net, as an offset to the changes in the fair value of the monetary assets or liabilities being hedged. At September 30, 2006, the face amount of these contracts was $8.7 million.

At September 30, 2006, the Company’s foreign currency derivative portfolio resulted in the Company recording a $7,000 gain as a component of prepaid expenses and other current assets and a $32,000 loss as a component of other accrued expenses.

Prior to January 1, 2006, the Company accounted for its stock-based compensation plan in accordance with the intrinsic value provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”, or APB No. 25, and provided the required pro forma disclosures of SFAS No. 123, “Accounting for Stock-Based Compensation”. Accordingly, because all stock options granted had an exercise price equal to the market value of the underlying common stock on the date of the grant, no expense related to employee stock options was recognized. Also, as the employee stock purchase plan was considered noncompensatory, no expense related to this plan was recognized. However, expense related to the grant of restricted stock was recognized in the income statement under APB No. 25.

Effective January 1, 2006, the Company adopted SFAS No. 123 (revised) using the modified retrospective application method. Accordingly, the Company measures stock-based compensation cost at grant date, based on the fair value of the award, and recognizes it as expense over the employee’s requisite service period. In accordance with the modified retrospective application method, financial statements for all periods prior to January 1, 2006 have been adjusted to give effect to the fair-value based method of accounting for all awards granted in fiscal years beginning after December 15, 1994. Amounts previously disclosed as pro forma adjustments have been reflected in earnings for all prior periods.

The following table details the impact of retrospective application of SFAS No. 123 (revised) on previously reported amounts:

The Company has an equity compensation plan (the “Plan”) under which the Company may grant stock options, restricted stock and other types of stock-based awards to its employees and directors. Total shares authorized for grant under this plan are 21.3 million. The exercise price of each option granted is equal to the market price of the Company’s common stock on the date of grant and the maximum exercise term of each option granted does not exceed ten years. Options are granted upon approval of the Compensation Committee of the Board of Directors and vest over various periods, as determined by the Compensation Committee at the date of the grant. The majority of the Company’s options vest ratably over a period of three or four years. The options expire on the earlier of ten years from the date of grant or within specified time limits following termination of employment, retirement or death. Shares are issued from the Company’s pool of authorized but unissued stock. The Company does not pay dividends on unexercised options. As of September 30, 2006, there were 6.2 million shares of common stock available for grant under the Plan.

For the three-month periods ended September 30, 2005 and 2006, stock-based compensation cost totaled $3.6 million and $4.5 million, respectively. The associated future income tax benefit recognized was $1.3 million and $1.7 million for the three-month periods ended September 30, 2005 and 2006, respectively. For the nine-month periods ended September 30, 2005 and 2006, stock-based compensation cost totaled $11.2 million and $12.7 million, respectively. The associated future income tax benefit recognized was $3.9 million and $4.8 million for the nine-month periods ended September 30, 2005 and 2006, respectively.

For the nine-month periods ended September 30, 2005 and 2006, the amount of cash received from the exercise of stock options was $17.9 million and $11.9 million, respectively. In connection with these exercises, the actual excess tax benefit realized for the tax deductions by the Company for the nine-month periods ended September 30, 2005 and 2006 were $6.8 million and $4.2 million, respectively.

A summary of the option activity under the Plan at September 30, 2006, and changes during the nine months ended September 30, 2006, is presented below:

All options granted during the nine months ended September 30, 2005 and 2006 were granted with an exercise price equal to the fair value of the Company’s common stock on the grant date. The fair value of the Company’s common stock on the grant date is equal to the Nasdaq closing price of the Company’s stock on the date of grant, except for shares granted under the U.K. Subplan where the fair value of the Company’s common stock on the grant date is equal to the average of the high and low price of the Company’s common stock on the date of grant as reported by Nasdaq. The weighted-average grant date fair value per share of options granted during the nine-month periods ended September 30, 2005 and 2006 was $11.55 and $15.93, respectively. The aggregate fair value of options granted during the nine-month periods ended September 30, 2005 and 2006 was $3.9 million and $23.6 million, respectively. The total intrinsic value of options (which is the amount by which the market value of the Company’s common stock exceeded the exercise price of the options on the date of exercise) exercised during the nine-month periods ended September 30, 2005 and 2006 was $27.9 million and $17.1 million, respectively.

A summary of the status of non-vested options as of September 30, 2006, and changes during the nine months then ended, is presented below:

The fair value of each option award is estimated on the grant date using the Black-Scholes option-pricing model. The following table indicates the assumptions used in estimating fair value for the three months and nine months ended September 30, 2005 and 2006.

The expected term represents an estimate of the period of time options are expected to remain outstanding and is based on historical exercise and termination data. The dividend yield is based on the most recent dividend payment over the market price of the stock at the beginning of the period. The risk-free interest rate is based on the rate for zero-coupon United States Treasury bonds at the date of grant with a term that approximates the expected term of the options. Expected volatilities are based on the historical volatility of the Company’s stock price over a period equal to the expected term of the options.

The Company awards shares of restricted stock to members of the senior management team and the Company’s non-employee directors. The shares awarded to members of the senior management team are subject to a three-year linear vesting schedule with one-third of the grant vesting on each of the first, second and third anniversaries of the grant date. The Company determines compensation cost based on the market value of shares on the date of grant, and records compensation expense on these shares on a straight-line basis over the three-year vesting period. The restricted stock shares granted to the Company’s non-employee directors vest over a three-year period, with ninety percent of the shares vesting on the first anniversary of the grant and five percent vesting on each of the second and third anniversary dates. The Company records compensation expense on these shares according to this vesting schedule.

In May 2006, two members of the senior management team had shares of restricted stock vest. These employees elected to surrender to the Company a portion of their vested shares to pay the income taxes due on the vested shares. As a result, 10,855 shares were forfeited to satisfy tax obligations.

During the nine months ended September 30, 2005 and 2006, the Company awarded 117,280 and 16,512 shares of restricted stock, respectively, with a fair value of $2.7 million and $0.5 million, respectively. The weighted average fair value of each share was $23.09 and $31.47 for the nine months ended September 30, 2005 and 2006, respectively. Total compensation expense recorded during the three months ended September 30, 2005 and 2006 for restricted stock shares granted was $0.3 million and $0.4 million, respectively. The associated future income tax benefit recognized was $0.1 million and $0.2 million for the three months ended September 30, 2005 and 2006, respectively. Total compensation expense recorded during the nine months ended September 30, 2005 and 2006 for restricted stock shares granted was $0.6 million and $1.3 million, respectively. The associated future income tax benefit recognized was $0.2 million and $0.5 million for the nine months ended September 30, 2005 and 2006, respectively. As of September 30, 2006, the total unrecognized compensation cost related to 125,374 shares of non-vested restricted stock was approximately $2.4 million. This cost is expected to be recognized over a weighted-average period of 1.89 years in accordance with the vesting periods of the restricted stock.

The Board of Directors and shareholders have reserved 4.5 million shares of the Company’s common stock for issuance under the Employee Stock Purchase Plan (the “ESPP”). The ESPP has two six-month offering periods (each an “Offering Period”) each year, beginning January 1 and July 1, respectively. Eligible employees can elect to make payroll deductions from 1% to 15% of their base pay during each payroll period of an Offering Period. Special limitations apply to eligible employees who own 5% or more of the outstanding common stock of the Company. In addition, in accordance with the ESPP and beginning with the first six-month Offering Period in 2006, the Board of Directors set a limit on the total payroll deductions for each year of $8.0 million. None of the contributions made by eligible employees to purchase the Company’s common stock under the ESPP are tax-deductible to the employees. During 2005, the purchase price was 85%, and beginning January 1, 2006 it is 90%, of the lesser of (a) the reported closing price of the Company’s common stock for the first day of the Offering Period or (b) the reported closing price of the common stock for the last day of the Offering Period. As of September 30, 2006, there were 2.4 million shares of common stock available for purchase by ESPP participants.

The fair value of each ESPP share is estimated using the Black-Scholes option-pricing model. The following table indicates the assumptions used in estimating fair value for the three months and nine months ended September 30, 2005 and 2006.

The compensation costs for the ESPP as determined based on the fair value of the discount and option feature of the underlying ESPP grant, consistent with the method of SFAS No. 123, were $0.5 million for each of the three- month periods ended September 30, 2005 and 2006. The income tax benefit recognized was $0.2 million and $0.1 million for the three-month periods ended September 30, 2005 and 2006, respectively. The compensation costs for the ESPP were $1.5 million and $1.3 million for the nine months ended September 30, 2005 and 2006, respectively. The income tax benefit recognized was $0.5 million and $0.2 million for the nine-month periods ended September 30, 2005 and 2006, respectively. As of September 30, 2006, the total unrecognized compensation cost related to ESPP shares for the current Offering Period was approximately $0.5 million. This cost is expected to be recognized over the remaining three months of the Offering Period.

For the nine-month periods ended September 30, 2005 and 2006, the value of stock issued for ESPP purchases was $6.6 million and $7.2 million, respectively. In connection with disqualifying dispositions, the tax benefits realized by the Company for the nine-month periods ended September 30, 2005 and 2006 were $0.2 million and $0.1 million, respectively.

During the nine months ended September 30, 2005 and 2006, employees contributed $5.7 million and $5.8 million, respectively, to the ESPP for the purchase of shares under that plan.

The effective tax rate for the third quarter of 2006 and 2005 was 34.0% and 35.8%, respectively. The effective tax rate for the first nine months of 2006 and 2005 was 33.6% and 32.5%, respectively. The effective tax rate for the first nine months of 2006 was positively impacted by 1.6% by the recognition of benefit for state economic development tax credits as well as a decrease in liabilities for tax contingencies and a decrease in valuation allowance due to the closing of certain state tax statutes and audits. The effective tax rate for the first nine months of 2005 was positively impacted by a $6.3 million reduction in the valuation allowance provided for the deferred tax asset relating to capital loss carryforwards. The reduction was a result of the utilization of capital loss carryforwards that previously had a valuation allowance recorded against them as well as the recognition of capital gains for the SurroMed transaction, the dapoxetine new drug application milestone payment from ALZA Corporation received in March 2005 and the $15.0 million up-front payment from Takeda San Diego, Inc. received during the third quarter of 2005 with respect to the dipeptidyl peptidase IV, or DPP4 program. The reduction in the valuation allowance decreased the effective tax rate by 4.4%.

The Company records current and deferred income tax expense related to its foreign operations to the extent those earnings are taxable in a foreign jurisdiction. The American Jobs Creation Act of 2004 introduced a special one-time dividends received deduction on the repatriation of foreign earnings to a U.S. taxpayer. The Company had not previously recorded a U.S. tax liability on these revenues because it intended to permanently reinvest them in its foreign operations. During the three months and nine months ended September 30, 2005, the Company recorded tax expense of $1.2 million and $1.9 million, respectively, related to the then projected repatriation of foreign earnings of $53.0 million.

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

The Company has a separate contributory defined benefit 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.

For the nine months ended September 30, 2006, the Company made contributions of $2.6 million and anticipates contributing an additional $0.2 million to fund this plan during the remainder of 2006.

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 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 $2.5 million.

The Company is self-insured for health insurance for the majority of its employees located within the United States, but maintains stop-loss insurance on a “claims made” basis for expenses in excess of $0.25 million per member per year. As of December 31, 2005 and September 30, 2006, the Company maintained a reserve of approximately $5.0 million and $8.4 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 2005, the Company became a limited partner in Bay City Capital Fund IV, L.P., a venture capital fund. The Company has committed to invest up to a maximum of $10.0 million in the Bay City Fund IV. Aggregate capital calls through September 30, 2006 totaled $3.0 million. Because no capital call can exceed 20% of the Company’s aggregate capital commitment, the Company anticipates its remaining capital commitment of $7.0 million will be made through a series of future capital calls over the next several years. The Company’s capital commitment will expire in June 2009. For further details, see Note 6.

In November 2003, the Company became a limited partner in A. M. Pappas Life Science Ventures III, L.P., a venture capital fund. The Company has committed to invest up to a maximum of $4.75 million. Aggregate capital calls through September 30, 2006 totaled $0.9 million. Because no capital call can exceed 10% of the Company’s aggregate capital commitment, the Company anticipates its remaining capital commitment of $3.85 million will be made through a series of future capital calls over the next several years. The Company’s capital commitment will expire in May 2009. For further details, see Note 6.

In March 2005, the Company entered into a lease for additional space in Austin, Texas for its Phase II through IV operations. The additional space is adjacent to the Company’s new Phase I clinic. To induce the Company to enter into the lease for additional space, the landlord deposited $5.5 million into an escrow account to be used to reimburse the Company for the rent and other expenses paid by the Company under the lease for the existing facilities after July 1, 2005 and the costs and expenses to sublease those facilities. The Company accounted for the amount to be received from the escrow account as a lease incentive that would be recognized in income over the life of the ten-year term of the lease. In April 2006, the Company and the landlord agreed to settle a dispute relating to this escrow account. Under the terms of the settlement, the Company received $4.3 million in full and final settlement of all claims.

In February 2005, the Company acquired substantially all of SurroMed’s assets related to its biomarker business. As part of this acquisition, the Company agreed to guarantee repayment of up to $1.5 million under a SurroMed bank loan with a maturity date of December 31, 2006. In February 2006, this amount was reduced to $0.8 million and SurroMed pledged a $0.5 million certificate of deposit to secure payment of the bank loan. In accordance with the requirements of FASB Statement No. 5, “Accounting for Contingencies”, as clarified by FASB Interpretation No. 45, the Company has recorded a liability in the amount of $25,000 as of September 30, 2006 for the estimated fair value of the net obligation it has assumed under this guarantee.

In January 2005, the Company acquired approximately 7.5 acres of property located in downtown Wilmington, North Carolina, on which the Company is constructing a new headquarters building. The total purchase price for the land was approximately $2.8 million. In connection with the sale of the 7.5-acre tract, the seller, Almont Shipping Company, refinanced existing liens on the property with the proceeds of an $8.0 million loan from Bank of America. This loan was secured by a lien on substantially all of Almont’s assets, including a 28-acre tract of land adjacent to the tract the Company acquired. This loan was also secured by a guarantee from the Company. In March 2006, the loan matured and Almont filed a petition for relief under Chapter 11 of the United States Bankruptcy Code. In early April

2006, Bank of America demanded payment of the loan under the Company’s guarantee. The Company subsequently purchased the secured note and all related loan documents for approximately $7.5 million. This amount is included in prepaid expenses and other current assets on the September 30, 2006 consolidated condensed balance sheet. The note bears interest at a fluctuating rate equal to the one-month London Interbank Offered Rate, or LIBOR, plus a margin of 1.50% and is secured by a first lien deed of trust on the 28-acre tract of land. The land is currently under a contract for sale for a purchase price in excess of the loan amount. The Company has agreed in principle to accept a note from the buyers of the land in the amount of $6.5 million in refinance of the note currently held by the Company. The closing is subject to satisfaction of certain conditions precedent, including the approval by the Bankruptcy Court of amendments to the sale contract and other matters. If the closing occurs, the note from the buyers will be secured by a first lien on a 17-acre portion of the 28-acre tract, a second lien on the remainder of that tract and personal guarantees of the principals of the buyers.

As of September 30, 2006, the Company had liabilities of $7.3 million for certain unsettled matters in connection with tax positions taken on the Company’s tax returns, including interpretations of applicable income tax laws and regulations. The Company establishes a reserve when, despite management’s belief that the Company’s tax returns reflect the proper treatment of all matters, the treatment of certain tax matters is likely to be challenged. Significant judgment is required to evaluate and adjust the reserves in light of changing facts and circumstances. Further, a number of years may lapse before a particular matter for which the Company has established a reserve is audited and finally resolved. While it is difficult to predict the final outcome or the timing of resolution of any particular tax matter, management believes that the reserves of $7.3 million reflect the probable outcome of known tax contingencies. The Company believes it is unlikely that the resolution of these matters will have a material adverse effect on the Company’s financial position or results of operations, as presented.

In August 2005, the Company amended its September 2004 royalty stream purchase agreement with Accentia. Under the terms of the amended agreement, the Company agreed to provide specified clinical development services to Accentia in connection with two pivotal Phase III trials for SinuNase® for the treatment of chronic sinusitis. In exchange for providing these services, Accentia agreed to pay the Company a royalty equal to 14% of the net sales of specified SinuNase products if approved for sale by the FDA. The Company’s obligation to provide Phase III clinical development services expired on December 31, 2005. Accentia continued the development of SinuNase and in April 2006, the FDA granted SinuNase fast-track status. In October 2006, the Company amended the August 2005 amended royalty stream purchase agreement and renewed its commitment to provide specified clinical development services to Accentia in connection with a Phase III trial for SinuNase up to a specified dollar limitation. In exchange for providing these services, Acccentia renewed its agreement to pay the Company a royalty of 14% of net sales of specified SinuNase products if approved for sale. Under the amended agreement, either party has the option to terminate the agreement at any time on or before December 31, 2006, in which case Accentia is obligated to pay the Company in cash for its services rendered through that date. Accentia anticipates that the Phase III trial for SinuNase will start in the fourth quarter of 2006.

The Company has been involved in compound development and commercialization collaborations since 1997. The Company developed a risk-sharing research and development model to help pharmaceutical and biotechnology clients develop compounds. Through collaborative arrangements based on this model, the Company assists its clients by sharing the risks and potential rewards associated with the development and commercialization of drugs at various stages of development. Including the collaboration with Accentia discussed above, the Company currently has four such arrangements that involve the potential future receipt of one or more of the following: payments upon the achievement of specified development and regulatory milestones; royalty payments if the compound is approved for sale; sales-based milestone payments; and a share of net sales up to a specified dollar limit. The compounds that are the subject of these collaborations are still in development and have not been approved for sale in any country. The Company’s collaboration with ALZA Corporation, a subsidiary of Johnson & Johnson, or J&J, for dapoxetine requires the Company to pay a royalty of 5% on annual net sales of the compound in excess of $800 million. In addition, J&J received a not-

approvable letter from the FDA in October 2005, but has continued the global development program and stated that it anticipates resubmitting the NDA with the FDA in 2007. As a result of the risks associated with drug development, including obtaining regulatory approval to sell in any country, the receipt of any further milestone payments, royalties or other payments is uncertain.

Under most of the agreements for Development services, the Company agrees 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, including claims for alleged breaches of contract. In one proceeding currently pending against the Company, a former client is claiming the Company breached its contract and committed tortious acts in conducting a clinical trial. That former client is claiming that it does not owe the Company the remaining amounts due under the contract and is seeking other damages from the Company’s alleged breach of contract and tortious acts. The Company records a reserve for pending and threatened litigation 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.

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

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, our 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.

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 terminology 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 and in “Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2005. 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.

We are a leading global contract research organization providing drug discovery and development services, post-approval expertise and compound partnering programs. Our clients and partners include pharmaceutical, biotechnology, medical device and government organizations. Our corporate mission is to help clients and partners maximize returns on their research and development investments and accelerate the delivery of safe and effective therapeutics to patients.

We have been in the drug development business for more than 20 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 marketed drugs, biologics and devices, we offer support services such as product launch services, medical information, patient compliance programs, patient and disease registry programs, product safety and pharmacovigilance, Phase IV monitored studies and prescription-to-over-the-counter programs.

With offices in 27 countries and more than 9,100 professionals worldwide, we have provided services to 45 of the top 50 pharmaceutical companies in the world as ranked by 2005 healthcare research and development spending. We also work with leading biotechnology and medical device companies and government organizations that sponsor clinical research. We believe that we are one of the world’s largest providers of drug development services to pharmaceutical, biotechnology and medical device companies and government organizations based on 2005 annual net revenues generated from contract research organizations.

Building on our outsourcing relationships with pharmaceutical and biotechnology clients, we established our discovery services business in 1997. This business primarily focuses on preclinical evaluations of anticancer and diabetes therapies, and on compound development and commercialization collaborations. We have developed a risk-sharing research and development model to help pharmaceutical and biotechnology clients develop compounds. Through collaborative arrangements based on this model, we assist our clients by sharing the risks and potential rewards of the development and commercialization of drugs at various stages of development. In February 2005, we completed the acquisition of a biomarker business. The acquisition expanded our discovery sciences business by adding biomarker discovery and patient sample analysis to the services we offer.

We believe that our integrated drug discovery and development services offer our clients a way to identify and develop drug candidates more quickly and cost-effectively. We use our proprietary informatics technology to support these development services. In addition, with global infrastructure, we are able to accommodate the multinational drug discovery and development needs of our customers. As a result of having core areas of expertise in discovery and

development, we provide integrated services across the drug development spectrum. For more detailed information on PPD, see our Annual Report on Form 10-K for the year ended December 31, 2005.

Our revenues are dependent on a relatively small number of industries and clients. As a result, we closely monitor the market for our 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, 2005. Although we cannot predict the demand for CRO services for the remainder of 2006, we continue to believe that the traditional market drivers for our industry are intact. In the first half of 2006, the market opportunity was robust and we experienced a new high for our global Phase II through IV business from a proposal volume standpoint. During the third quarter of 2006, proposal volume declined from the record levels in the first half of the year, but our proposal volume remains strong and ahead of the first nine months of 2005. For the remainder of the year, we plan to focus our efforts on managing our recent growth, delivering timely, high quality services to our clients and improving our business development efforts in our core markets.

We believe there are specific opportunities for continued growth in certain areas of our business. Our Latin American Phase II through IV units had strong operating and financial performance in the first nine months of 2006, and we expect to see continued revenue growth in this region for the rest of this year. Our global central laboratory also achieved strong revenue growth in the third quarter of 2006 and we are expanding our service offerings, especially in the area of infectious disease, and investing in new equipment for this business unit. In the third quarter of 2006, our Phase I clinic in Austin, Texas was affected by project delays, but these projects have been rescheduled and are expected to resume in 2007. We believe our state-of-the-art Phase I clinic and ability to service large, complex studies should allow us to continue winning business in this arena and enable us to capitalize on our expanded Phase I facilities.

We review various metrics to evaluate our financial performance, including period-to-period changes in backlog, new authorizations, cancellation rates, revenue, margins and earnings. In the third quarter of 2006, we had new authorizations of $531.0 million, a decrease of 17.7% over the third quarter of 2005. In the third quarter of 2005, we were awarded a five-year government contract for $177.3 million for direct costs which was included in our third quarter 2005 authorization total. The cancellation rate for the third quarter of 2006 was 17.8%, which is higher than the 16.8% cancellation rate for the full year of 2005, but lower than our projected cancellation rate for the full year of 2006. The cancellation rate for the first nine months of 2006 was 16.9% which is well below our average cancellation rate over the past five years. Backlog grew to $2.2 billion as of September 30, 2006, up 25.4% over September 30, 2005. The average length of our contracts increased to 35.8 months as of September 30, 2006 from 32.2 months as of September 30, 2005. Backlog by client type as of September 30, 2006 was 51% pharmaceutical, 34% biotech and 15% government/other as compared to 49% pharmaceutical, 33% biotech and 18% government/other as of September 30, 2005. Net revenue by client type for the quarter ended September 30, 2006 was 58% pharmaceutical, 30% biotech and 12% government/other compared to 64% pharmaceutical, 28% biotech and 8% government/other for the third quarter of 2005. For the three months ended September 30, 2006, net revenue contribution by service area was 78.4% for Phase II-IV services, 3.5% for Phase I clinic, 16.5% for laboratory services and 1.6% for discovery sciences compared to net revenue contribution for the twelve months ended December 31, 2005 of 76.7% for Phase II-IV services, 4.1% for Phase I clinic, 15.0% for laboratory services and 4.2% for discovery sciences. Top therapeutic areas by net revenue for the quarter ended September 30, 2006 were oncology, anti-infective/anti-viral, endocrine/metabolic, circulatory/cardiovascular and central nervous system. For a detailed discussion of our revenue, margins, earnings and other financial results for the quarter ended September 30, 2006, see “Results of Operations – Three Months Ended September 30, 2005 versus Three Months Ended September 30, 2006” below.

Capital expenditures for the three months ended September 30, 2006 totaled approximately $40.7 million. These capital expenditures were for construction costs for our new corporate headquarters building and related parking facility in Wilmington, North Carolina, computer software and hardware, scientific equipment for our laboratory units, and various building improvements in our Phase II-IV facilities. We made these investments to support our growing businesses and to improve the efficiencies of our operations. For the remainder of 2006, we expect to spend between $40 million and $45 million for capital expenditures, of which approximately $25 million will be related to the ongoing construction of our new headquarters building. The majority of the remaining forecasted capital expenditures will be related to up-fit costs for facilities, construction costs related to our new building in Scotland, information technology related expenditures and additional laboratory equipment.

As of September 30, 2006, we had $372.2 million of cash, cash equivalents and short-term investments and $56.7 million of debt primarily related to amounts borrowed to finance the construction of our new headquarters building. In the third quarter of 2006, we generated $11.6 million cash from operations. Third quarter 2006 cash flow from operations was lower than previous quarters due to an increase in accounts receivable and unbilled services. The number of days’ revenue outstanding in accounts receivable and unbilled services, net of unearned income, also known as DSO, was 42.8 and 32.8 days as of September 30, 2006 and 2005, respectively. While DSO increased in part due to the increase in accounts receivable, more than 90% of our accounts receivable balance as of September 30, 2006 was less than 60 days old. DSO also rose due to a decrease in unearned income as a percentage of accounts receivable and unbilled services at September 30, 2006 compared to September 30, 2005. We expect DSO and unbilled services will continue to fluctuate in the future depending on contract terms, the mix of contracts performed within a quarter, the levels of investigator advances and unearned income, and our success in collecting receivables.

Because of our cash position and free cash flow, in late 2005, our Board of Directors declared a special one-time cash dividend and adopted a policy to pay annual cash dividends. In October 2006, our Board of Directors amended the annual cash dividend policy to increase the annual dividend rate by 20 percent, from $0.10 to $0.12 per share, payable quarterly at a rate of $0.03 per share. We expect the new dividend rate will be effective beginning in the fourth quarter of 2006. The cash dividend policy and the payment of future cash dividends are not guaranteed and are subject to the discretion of and continuing determination by our Board of Directors that the policy remains in the best interests of our shareholders and in compliance with applicable laws and agreements.

With regards to our Discovery Sciences segment, our preclinical oncology facility had a solid performance in 2005 and the first nine months of 2006, and is now offering models to support diabetes drug development. We have added business development resources in an effort to generate additional sales of our biomarker services and improve future financial and operating performance. Our Discovery Sciences segment also includes our compound partnering arrangements. The DPP4 development program with Takeda Pharmaceuticals continues to progress. For dapoxetine, J&J has indicated an intent to re-file the NDA with the FDA in 2007. We amended our agreement with Accentia to provide clinical development services for a Phase III trial of SinuNase up to a specified dollar limitation in exchange for an increased royalty rate on certain SinuNase products. Under the amended agreement, either party can terminate the agreement by December 31, 2006, in which case we would receive a cash payment for services rendered. We are also evaluating a new compound and are funding the laboratory work for our internal evaluation, and are working on the agreement for this potential collaboration. These drug development collaborations 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 clients. For a background discussion of our 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, 2005.

We are committed to our compound partnering strategy and believe it is an innovative way to use our cash resources and drug development expertise to drive mid- to long-term shareholder value. For the remainder of 2006, we plan to continue advancing our existing collaborations and evaluate new potential opportunities in this area.

In February 2005, we completed our acquisition of substantially all of the assets of SurroMed, Inc.’s biomarker business. The biomarker business is part of the Discovery Sciences segment. In exchange for the assets, we surrendered to SurroMed for cancellation all shares of preferred stock of SurroMed we held. As additional consideration for the acquisition, we assumed approximately $3.4 million of SurroMed liabilities under capital leases and additional operating liabilities, and guaranteed repayment of up to $1.5 million under a SurroMed bank loan. We recognized a pre-tax gain on the exchange of assets of $5.1 million. For further details regarding this acquisition, see Note 2 to the Notes to Consolidated Condensed Financial Statements.

New business authorizations, which are sales of our services, are reflected in backlog when we enter into a contract or letter of intent or receive a verbal commitment. 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 September 30, 2005 and 2006 were $645.3 million and $531.0 million, respectively.

Our backlog consists of new business authorizations for which the work has not started but is anticipated to begin in the near future and contracts in process that have not been completed. As of September 30, 2006, the remaining duration of the contracts in our backlog ranged from one month to 146 months with an average duration of 35.8 months. Amounts included in backlog represent future revenue and exclude revenue that we have previously recognized. Once work begins on a project included in backlog, we recognize net revenue over the life of the contract as services are performed. Our backlog as of September 30, 2005 and 2006 was $1.7 billion and $2.2 billion, respectively. For various reasons discussed in “Item 1. Business – Backlog” in our Annual Report on Form 10-K for the year ended December 31, 2005, our backlog might never be recognized as revenue and is not necessarily a meaningful predictor of future performance.

We record revenue from contracts, other than time-and-material contracts, on a proportional performance basis in our Development segment. 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 primarily to the amount of labor incurred to perform the service. Changes to the estimated total contract direct costs result in a cumulative adjustment to the amount of revenue recognized. For time-and-material contracts in both our Development and Discovery Sciences segments, we recognize revenue as hours are worked, multiplied by the applicable hourly rate. For our Phase I and laboratory businesses, we recognize revenue from unitized contracts as subjects or samples are tested, multiplied by the applicable unit price.

In connection with the 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. In some cases, we contract directly with these third parties and are obligated to pay these costs as the principal. In other cases, our customers contract directly with these parties and ask us to pay them on their behalf as an administrative agent. Whether we pay these as principal or agent, our clients reimburse us for these costs. As required by Emerging Issues Task Force 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 revenue. In our statements of operations, we combine amounts paid by us as an agent for out-of-pocket costs with the corresponding reimbursements, or revenue, we receive as an agent. During the three months ended September 30, 2005 and 2006, fees paid to investigators and other fees we paid as an agent and the associated reimbursements were approximately $65.1 million and $71.1 million, respectively.

Most of the contracts for our Development segment can be terminated by our clients either immediately or after a specified period following notice. These contracts typically require payment to us of expenses to wind down a study, 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. Therefore, revenue recognized prior to cancellation does not generally require a significant adjustment upon cancellation. If we determine that a loss will result from the performance of a fixed-price contract, the entire amount of the estimated loss is charged against income in the period in which such determination is made.

The Discovery Sciences segment also generates revenue from time to time in the form of milestone payments in connection with licensing of compounds. We only recognize milestone payments as revenue 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.

Direct costs consist of 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 revenue, 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, consulting services 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 five years for software, computers and related equipment, and five to ten years for furniture and equipment, except for aircraft, which we depreciate 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.

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

Three Months Ended September 30, 2005 versus Three Months Ended September 30, 2006

The following table sets forth amounts from our consolidated condensed financial statements along with the dollar and percentage change for the three months ended September 30, 2005 compared to the three months ended September 30, 2006.

Total net revenue increased $39.9 million to $313.1 million in the third quarter of 2006. The increase in total net revenue resulted from an increase in our Development segment revenue. The Development segment generated net revenue of $285.3 million, which accounted for 91.1% of total net revenue for the third quarter of 2006. The 21.3% increase in Development net revenue was primarily attributable to an increase in the level of global Phase II through IV services we provided in the third quarter of 2006 as compared to 2005.

The Discovery Sciences segment generated net revenue of $4.5 million in the third quarter of 2006, a decrease of $15.0 million from the third quarter of 2005. The higher 2005 Discovery Sciences net revenue was attributable to the $15.0 million up-front payment we received from Takeda in connection with the DPP4 collaboration agreement during the third quarter of 2005.

Total direct costs increased $30.1 million to $169.9 million in the third quarter of 2006 primarily as the result of an increase in the Development segment direct costs. Development direct costs increased $25.2 million to $144.1 million in the third quarter of 2006. The primary reason for this was an increase in personnel costs of $21.1 million due to the hiring of additional employees in our global Phase II through IV division. The increase in personnel costs include stock compensation expense in the third quarter of 2006 of $1.9 million as compared to stock compensation expense of

$1.6 million in the third quarter of 2005 recorded in connection with the adoption of SFAS No. 123 (revised).

SG&A expenses increased $12.8 million to $77.2 million in the third quarter of 2006. As a percentage of total net revenue, SG&A expenses increased to 24.7% in the third quarter of 2006 compared to 23.6% in the third quarter of 2005. The increase in SG&A expenses includes additional personnel costs of $11.6 million. The increase in personnel costs resulted from changes in utilization levels due to an increased level of new hires, higher levels of operations infrastructure and administrative personnel and additional stock compensation costs of $0.6 million in connection with the adoption of SFAS No. 123 (revised). In addition, we recorded $0.6 million related to additional provisions for bad debt expense due to the write-off of accounts receivable from a biotechnology client that is insolvent.

Depreciation expense increased $1.9 million to $12.0 million in the third quarter of 2006. The increase was related to the depreciation of the property and equipment we acquired to accommodate our growth, a significant portion of which related to information technology system investments we made in 2005. Capital expenditures were $40.7 million in the third quarter of 2006. Capital expenditures included $18.3 million for our new corporate headquarters building and related parking facility in Wilmington, North Carolina, $6.5 million for computer software and hardware, $4.9 million for construction related to our new building in Scotland, $4.7 million related to leasehold improvements at various sites, with approximately a third of these costs related to our new facility in Austin, Texas for our Phase II-IV personnel, and $2.4 million for additional scientific equipment for our laboratory units.

Income from operations decreased $4.7 million to $52.0 million in the third quarter of 2006. As a percentage of net revenue, income from operations decreased to 16.6% in the third quarter of 2006 from 20.7% in the third quarter of 2005. Income from operations for the third quarter of 2005 included a $15.0 million up-front payment from Takeda in connection with the DPP4 collaboration.

During the third quarter of 2005, we recorded a charge to earnings of $3.8 million relating to our investment in Spotlight Health, Inc. The write-down of Spotlight Health consisted of our equity investment of $2.2 million and a liability of $1.6 million based on the outstanding balance as of September 30, 2005 of Spotlight Health’s revolving line of credit that we guaranteed.

Interest and other income increased $1.0 million to $3.8 million in the third quarter of 2006. This increase resulted primarily from higher interest income due to higher interest rates and a larger average balance of cash, cash equivalents and short-term investments.

Our provision for income taxes decreased $1.0 million to $19.0 million in the third quarter of 2006. Our effective income tax rate for the third quarter of 2006 was 34.0% compared to 35.8% for the third quarter of 2005. The difference is primarily due to the tax on the repatriation of foreign earnings in 2005 and the change in geographic distribution of our pretax earnings among locations with varying tax rates.

Net income of $36.8 million in the third quarter of 2006 represents an increase of 2.9% from $35.8 million in the third quarter of 2005. Third quarter 2005 net income included the $15.0 million up-front payment that we received from Takeda in connection with the DPP4 collaboration. Net income per diluted share remained constant at $0.31 for the third quarter of 2006.

Nine Months Ended September 30, 2005 versus Nine Months Ended September 30, 2006

The following table sets forth amounts from our consolidated condensed financial statements along with the dollar and percentage change for the nine months ended September 30, 2005 compared to the nine months ended September 30, 2006.

Total net revenue increased $159.0 million to $921.5 million in the first nine months of 2006. The increase in total net revenue resulted from an increase in our Development segment revenue. The Development segment generated net revenue of $822.0 million, which accounted for 89.2% of total net revenue for the first nine months of 2006. The 22.2% increase in Development net revenue was primarily attributable to an increase in the level of global CRO Phase II through IV services we provided in the first nine months of 2006 as compared to the first nine months of 2005.

The Discovery Sciences segment generated net revenue of $28.0 million in the first nine months of 2006, a decrease of $8.0 million from the first nine months of 2005. The higher 2005 Discovery Sciences net revenue was mainly attributable to the $10.0 million milestone payment from ALZA Corporation we received in 2005 for the filing of the dapoxetine NDA. This was partially offset by increased revenue generated by our preclinical oncology division in the first nine months of 2006 as compared to the first nine months of 2005. We received $15.0 million from Takeda in connection with the DPP4 collaboration in each of the first nine months of 2005 and 2006.

Total direct costs increased $88.3 million to $491.0 million in the first nine months of 2006 primarily as the result of an increase in Development segment direct costs. Development direct costs increased $69.7 million to $412.6

million in the first nine months of 2006. The primary reason for this was an increase in personnel costs of $62.9 million due to additional employees in our global Phase II through IV division. The increase in personnel costs include stock compensation expense of $4.8 million for the first nine months of both 2006 and 2005 recorded in connection with the adoption of SFAS No. 123 (revised). The remaining increase in the development direct costs is primarily due to increased facility costs of $7.7 million related to the increase in personnel.

R&D expenses decreased $18.4 million to $3.8 million in the first nine months of 2006. R&D expenses decreased primarily as a result of decreased spending in connection with the DPP4 program with Takeda. Under the DPP4 agreement with Takeda that we entered into in July 2005, Takeda assumed the obligation to fund future development and commercialization costs of the DPP4 inhibitor program.

SG&A expenses increased $44.4 million to $228.5 million in the first nine months of 2006. As a percentage of total net revenue, SG&A expenses increased to 24.8% in the first nine months of 2006 compared to 24.1% in the first nine months of 2005. The increase in SG&A expenses includes additional personnel costs of $34.7 million. The increase in personnel costs related mainly to changes in utilization levels due to an increased level of new hires and higher levels of operations infrastructure and administrative personnel and additional stock compensation costs of $1.3 million in connection with the adoption of SFAS No. 123 (revised). The increase in SG&A costs also includes an additional $1.6 million in recruiting costs to hire additional personnel and an increase of $2.0 million in travel costs due to training initiatives for new and existing operations personnel and increased travel related to additional personnel in administrative functions. In addition, SG&A costs include an increase of $2.0 million in accounting and legal fees.

Depreciation increased $6.3 million to $34.3 million in the first nine months of 2006. The increase was related to property and equipment we acquired to accommodate our growth, a significant portion of which related to information technology system investments we made in 2005. Capital expenditures were $106.6 million in the first nine months of 2006. Capital expenditures included $49.0 million for our new corporate headquarters building and related parking facility in Wilmington, North Carolina, $20.8 million for computer software and hardware, $12.3 million related to leasehold improvements at various sites, $8.3 million related to construction in progress and $7.3 million for additional scientific equipment for our Phase I and laboratory units.

Income from operations increased $32.4 million to $162.0 million in the first nine months of 2006. As a percentage of net revenue, income from operations increased to 17.6% of net revenue in the first nine months of 2006 from 17.0% in the first nine months of 2005. Income from operations in the first nine months of 2006 included a significant decrease in R&D expenses as discussed above and a $1.4 million loss on disposal of assets, composed of $0.8 million related to disposal of assets in our biomarker business, $0.2 million related to the disposal of an intangible asset and a $0.4 million impairment related to the value of our building in Leicester, United Kingdom. This building was the site of our former U.K. Phase I operations. Income from operations in the first nine months of 2005 included a $5.1 million gain on exchange of assets associated with the acquisition of SurroMed’s biomarker business. Income from operations for the first nine months of 2005 also included a $10.0 million milestone payment related to the filing of the dapoxetine NDA.

During the first nine months of 2005, we recorded a charge to earnings of $3.8 million relating to our investment in Spotlight Health, Inc. The write-down of Spotlight Health consisted of our investment of $2.2 million and a liability of $1.6 million based on the outstanding balance as of September 30, 2005 of Spotlight Health’s revolving line of credit that we guaranteed.

Interest and other income increased $4.4 million to $11.3 million in the first nine months of 2006. This increase resulted primarily from higher interest income due to higher interest rates and a larger average balance of cash, cash equivalents and short-term investments.

Our provision for income taxes increased $15.0 million to $58.1 million in the first nine months of 2006. Our effective income tax rate for the first nine months of 2006 was 33.6% compared to 32.5% for the first nine months of 2005. The effective tax rate for the first nine months of 2006 was positively impacted by 1.6% by the recognition of benefit for state economic development tax credits as well as a decrease in liabilities for tax contingencies and a decrease in the valuation allowance due to the closing of certain state tax statutes and audits. The effective tax rate for the first nine months of 2005 was positively impacted by a $6.3 million reduction in the valuation allowance provided for the deferred tax asset relating to capital loss carryforwards. The reduction was a result of the utilization of capital loss carryforwards that previously had a valuation allowance recorded against them as well as the recognition of capital gains for the SurroMed transaction, the dapoxetine NDA milestone payment from ALZA Corporation received in the

first quarter of 2005 and the $15.0 million up-front payment received from Takeda during the third quarter of 2005 with respect to the DPP4 program. This reduction in the valuation allowance decreased the effective tax rate by 4.4%. The remaining difference in our effective tax rates for the first nine months of 2006 compared to the first nine months of 2005 is due to the tax on the repatriation of foreign earnings in 2005 and the change in the geographic distribution of our pretax earnings among locations with varying tax rates.

Net income of $115.1 million in the first nine months of 2006 represents an increase of 28.7% from $89.4 million in the first nine months of 2005. Net income per diluted share of $0.97 in the first nine months of 2006 represents a 26.0% increase from net income per diluted share of $0.77 in the first nine months of 2005. Net income per diluted share during the first nine months of 2005 included $0.035 per share, net of tax, for the gain on exchange of assets associated with the acquisition of SurroMed’s biomarker business.

As of September 30, 2006, we had $120.9 million of cash and cash equivalents and $251.4 million of short-term investments. 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. Our expected primary cash needs on both a short- and long-term basis are for capital expenditures, including our new corporate headquarters facility, expansion of services, possible acquisitions, investments and compound partnering collaborations, geographic expansion, dividends, working capital and other general corporate purposes. We have historically funded our operations, dividends and growth, including acquisitions, primarily with cash flow from operations. In the first quarter of 2006, we entered into a construction loan to finance the construction of our new corporate headquarters building and related parking facility in Wilmington, North Carolina.

In the first nine months of 2006, our operating activities provided $116.4 million in cash as compared to $135.0 million for the same period last year. The decrease in cash flow from operations is primarily due to a decrease in cash related to changes in operating assets and liabilities, net, of $56.2 million in the first nine months of 2006 compared to an increase of $5.1 million for the same period in 2005. This decrease was partially offset by a $25.6 million increase in net income, an increase in the provision for deferred income taxes of $6.6 million, an increase in depreciation and amortization of $5.9 million and a gain on exchange of assets of $5.1 million in 2005. The decrease related to changes in operating assets and liabilities in 2006 primarily consisted of an increase of $79.6 million in growth of receivables and unbilled services and an increase of $10.2 million in prepaids and other current assets, partially offset by an increase of $11.9 million related to accounts payable and other accrued expenses, an increase of $11.8 million in accrued income taxes and an increase of $7.8 million in unearned income. Fluctuations in receivables and unearned income occur on a regular basis as we perform services, achieve milestones or other billing criteria, send invoices to clients and collect outstanding accounts receivable. Such activity varies by individual client and contract.

In the first nine months of 2006, we used $227.1 million in cash related to investing activities. We used cash to purchase available-for-sale investments of $601.7 million, make capital expenditures of $106.6 million, purchase a note receivable for $7.5 million and purchase investments of $1.0 million. These amounts were offset by maturities and sales of available-for-sale investments of $488.2 million and proceeds from the sale of an investment of $1.5 million. We expect our capital expenditures for the remainder of 2006 to be approximately $40 million to $45 million. This projection includes updated construction cost estimates for the remainder of this year of approximately $25 million for the new corporate headquarters building and the related parking facility. The majority of the remaining forecasted capital expenditures are related to up-fit costs for facilities, information technology expenditures and additional laboratory equipment.

In the first nine months of 2006, our financing activities provided $46.5 million in cash. We received $39.0 million in borrowings under our new construction loan, $19.1 million in proceeds from stock option exercises and purchases under our employee stock purchase plan and $4.3 million in income tax benefits from the exercise of stock options and disqualifying dispositions of stock. These amounts were offset by dividend payments of $8.8 million, repayments of $6.0 million on long-term debt and repayments of capital lease obligations of $1.1 million.

The following table sets forth amounts from our consolidated balance sheet affecting our working capital, along with the dollar amount of the change from December 31, 2005 to September 30, 2006.

Working capital as of September 30, 2006 was $442.7 million, compared to $327.6 million at December 31, 2005. The increase in working capital was due primarily to the increases in short-term investments, accounts receivable and unbilled services, and prepaid expenses and other current assets. These increases were partially offset by a decrease in cash and cash equivalents, an increase in accrued income taxes due to higher pretax income, an increase in unearned income and an increase in other accrued expenses.

The number of days’ revenue outstanding in accounts receivable and unbilled services, net of unearned income, also known as DSO, was 32.8 and 42.8 days as of September 30, 2005 and 2006, respectively. We calculate DSO by dividing accounts receivable and unbilled services less unearned income by average daily gross revenue for the applicable period. Accounts receivable as of September 30, 2006 were $246.9 million, of which 92.2% was less than 60 days old. Unbilled services totaled $141.2 million at September 30, 2006 and remained flat over the unbilled services balance as of June 30, 2006. Unearned income as of September 30, 2006 was $174.0 million, which represented 44.8% of our accounts receivable and unbilled services balance. This percentage has decreased from September 30, 2005 when our unearned income of $145.6 million represented 54.1% of our accounts receivable and unbilled services balance. This decrease in unearned income as a percentage of receivables and unbilled services is one of the causes of our increase in DSO. Over the past three years, our year-to-date DSO has fluctuated between 32.2 days and 42.8 days. We expect DSO will continue to fluctuate in the future depending on contract terms, the mix of contracts performed within a quarter, the levels of investigator advances and unearned income, and our success in collecting receivables.

In July 2006, 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. This revolving credit facility does not expressly restrict or limit the payment of dividends, and we do not expect any of the covenants to affect our ability to pay dividends under our cash dividend policy for the foreseeable future. Outstanding borrowings under the facility bear interest at an annual fluctuating rate equal to the one-month London Interbank Offered Rate, or LIBOR, plus a margin of 0.60%. Borrowings under this credit facility are available to provide working capital and for general corporate purposes. As of September 30, 2006, no amounts were outstanding under this credit facility and we were in compliance with the covenants in the loan agreement. The aggregate amount we are able to borrow has been reduced by $1.25 million due to outstanding letters of credit issued

under this facility. This credit facility is currently scheduled to expire in June 2007, at which time any outstanding balance will be due.

In February 2006, we entered into an $80.0 million construction loan facility with Bank of America, N.A. This new construction loan facility is in addition to the $50.0 million revolving credit facility discussed above. Indebtedness under the construction loan facility is unsecured and is subject to the same covenants as the revolving credit facility and additional covenants commonly used in construction loan agreements. In addition, we must maintain at least $50.0 million in cash, cash equivalents and short-term investments while the loan is outstanding. Borrowings under this credit facility are available to finance the construction of our new corporate headquarters building and related parking facility in Wilmington, North Carolina and will bear interest at an annual fluctuating rate equal to the one-month LIBOR plus a margin of 0.60%. Interest on amounts borrowed under this construction loan facility is payable quarterly. This credit facility has a term of two years and will mature in February 2008, at which time the entire principal balance and all accrued and unpaid interest will be due. As of September 30, 2006, we had borrowed approximately $56.1 million under this facility.

On October 3, 2005, our Board of Directors adopted a cash dividend policy. We paid the first quarterly cash dividend under our dividend policy in the fourth quarter of 2005, and in each of the first three quarters of 2006, we paid a similar dividend of $0.025 per share. In October 2006, our Board of Directors amended the annual cash dividend policy to increase the annual dividend rate by 20 percent, from $0.10 to $0.12 per year, payable quarterly at a rate of $0.03 per share. We expect the new dividend rate will be effective beginning in the fourth quarter of 2006. The cash dividend policy and the payment of future quarterly cash dividends under that policy are not guaranteed and are subject to the discretion of and continuing determination by our Board of Directors that the policy remains in the best interests of our shareholders and in compliance with applicable laws and agreements.

In May 2006, we sold our 2.0 million shares of Chemokine Therapeutics Corp. preferred stock for total consideration of $1.5 million and recorded a gain on sale of our investment of $0.8 million. In addition, we surrendered our license rights to Chemokine’s compound CTCE-0214 in exchange for $0.1 million and potential milestone payments up to $2.5 million.

In September 2005, we became a limited partner in Bay City Capital Fund IV, L.P., a venture capital fund formed to invest in life sciences companies. We have committed to invest up to a maximum of $10.0 million in the Bay City Fund IV. Capital calls during the first nine months of 2006 totaled $1.1 million, of which we accrued $0.3 million as of September 30, 2006 and subsequently paid in October 2006. Aggregate capital calls through September 30, 2006 totaled $3.0 million. Because no capital call can exceed 20% of our aggregate capital commitment, we anticipate that our remaining capital commitment of $7.0 million will be invested through a series of future capital calls over the next several years. Our capital commitment will expire in June 2009.

In November 2003, we became a limited partner in A. M. Pappas Life Science Ventures III, L.P., a venture capital fund formed to invest in life sciences, healthcare and technology industries. We have committed to invest up to a maximum of $4.75 million in this fund. The first capital call was made in January 2005. Capital calls during the first nine months of 2006 totaled $0.2 million. Aggregate capital calls through September 30, 2006 totaled $0.9 million. Because no capital call can exceed 10% of our aggregate capital commitment, we anticipate that our remaining capital commitment of $3.85 million will be invested through a series of future capital calls over the next several years. Our capital commitment will expire in May 2009.

In March 2005, we entered into a lease for additional space in Austin, Texas for our Phase II through IV operations. The additional space is adjacent to our new Phase I clinic. To induce us to enter into the lease for additional space, the landlord deposited $5.5 million into an escrow account to be used to reimburse us for the rent and other expenses paid by us under the lease for the existing facilities after July 1, 2005 and the costs and expenses to sublease those facilities. We accounted for the amount to be received from the escrow account as a lease incentive that would be recognized in income over the life of the ten-year term of the lease. In April 2006, we agreed to settle a dispute with the landlord relating to this escrow account. Under the terms of the settlement, we received $4.3 million in full and final settlement of all claims.

In February 2005, we acquired substantially all of SurroMed’s assets related to its biomarker business. As part of this acquisition, we agreed to guarantee repayment of up to $1.5 million under a SurroMed bank loan with a maturity date of December 31, 2006. In February 2006, this amount was reduced to $0.8 million and SurroMed pledged a $0.5 million certificate of deposit to secure payment of the bank loan. In accordance with the requirements of FASB

Statement No. 5, “Accounting for Contingencies”, as clarified by FASB Interpretation No. 45, we have recorded a liability in the amount of $25,000 as of September 30, 2006 for the estimated fair value of the net obligation assumed under this guarantee.

In January 2005, we acquired approximately 7.5 acres of property located in downtown Wilmington, North Carolina, on which we are constructing a new headquarters building. The new facility will be approximately 400,000 square feet and is expected to be completed in late 2006 or early 2007. At that time, we will begin consolidating our Wilmington operations into the new building. The total cost for the construction and up-fit of the new building is expected to be approximately $100.0 million. In addition, we are constructing a parking facility on an adjacent tract of land that will serve this new building and will cost approximately $18.0 million. The purchase price of the land for the new building was approximately $2.8 million. In connection with the sale of the 7.5-acre tract, the seller, Almont Shipping Company, refinanced existing liens on the property with the proceeds of an $8.0 million loan from Bank of America, N.A. This loan was secured by a lien on substantially all of Almont’s assets, including a 28-acre tract of land adjacent to our tract. This loan was also secured by a guarantee from us. In March 2006, the loan matured and Almont filed a petition for relief under Chapter 11 of the United States Bankruptcy Code. In early April 2006, Bank of America demanded payment of the loan under our guarantee. We subsequently purchased the secured note and all related loan documents for approximately $7.5 million. The note bears interest at a fluctuating rate equal to the one-month LIBOR plus a margin of 1.50% and is secured by a first lien deed of trust on the 28-acre tract of land. The land is currently under a contract for sale for a purchase price in excess of the loan amount. We have agreed in principle to accept a note from the buyers of the land in the amount of $6.5 million in refinance of the note currently held by us. The closing is subject to satisfaction of certain conditions precedent, including the approval by the Bankruptcy Court of amendments to the sale contract and other matters. If the closing occurs, the note from the buyers will be secured by a first lien on a 17-acre portion of the 28-acre tract, a second lien on the remainder of that tract and personal guarantees of the principals of the buyers.

As of September 30, 2006, we had liabilities of $7.3 million for certain unsettled matters in connection with tax positions taken on our tax returns, including interpretations of applicable income tax laws and regulations. We establish a reserve when, despite management’s belief that our tax returns reflect the proper treatment of all matters, the treatment of certain tax matters is likely to be challenged. Significant judgment is required to evaluate and adjust the reserves in light of changing facts and circumstances. Further, a number of years may lapse before a particular matter for which we have established a reserve is audited and finally resolved. While it is difficult to predict the final outcome or the timing of resolution of any particular tax matter, management believes that the reserves of $7.3 million reflect the probable outcome of known tax contingencies. We believe it is unlikely that the resolution of these matters will have a material adverse effect on our financial position or results of operations, as presented.

In August 2005, we amended our September 2004 royalty stream purchase agreement with Accentia. Under the terms of the amended agreement, we agreed to provide specified clinical development services to Accentia in connection with two pivotal Phase III trials for SinuNase® for the treatment of chronic sinusitis. In exchange for providing these services, Accentia agreed to pay us a royalty equal to 14% of the net sales of specified SinuNase products if approved for sale by the FDA. Our obligation to provide clinical development services expired on December 31, 2005. Accentia continued the development of SinuNase and in April 2006, the FDA granted SinuNase fast-track status. In October 2006, we amended the August 2005 amended royalty stream purchase agreement and renewed our commitment to provide specified clinical development services to Accentia in connection with a Phase III trial for SinuNase up to a specified dollar limitation. In exchange for providing these services, Accentia renewed its agreement to pay us a royalty of 14% of net sales of specified SinuNase products if approved for sale. Under the amended agreement, either party has the option to terminate the agreement at any time on or before December 31, 2006, in which case Accentia is obligated to pay us in cash for our services rendered through that date. Accentia anticipates that the Phase III trial for SinuNase will start in the fourth quarter of 2006.

We have been involved in compound development and commercialization collaborations since 1997. We developed a risk-sharing research and development model to help pharmaceutical and biotechnology clients develop compounds. Through collaborative arrangements based on this model, we assist our clients by sharing the risks and potential rewards associated with the development and commercialization of drugs at various stages of development. Including the collaboration with Accentia discussed above, we currently have four such arrangements that involve the potential future receipt of one or more of the following: payments upon the achievement of specified development and regulatory milestones; royalty payments if the compound is approved for sale; sales-based milestone payments; and a share of net sales up to a specified dollar limit. The compounds that are the subject of these collaborations are still in development and have not been approved for sale in any country. Our collaboration with ALZA Corporation, a

subsidiary of Johnson & Johnson, or J&J, for dapoxetine requires us to pay a royalty of 5% on annual net sales of the compound in excess of $800 million. In addition, J&J received a not-approvable letter from the FDA in October 2005, but has continued the global development program and stated that it anticipates resubmitting the NDA with the FDA in 2007. As a result of the risks associated with drug development, including obtaining regulatory approval to sell in any country, the receipt of any further milestone payments, royalties or other payments is uncertain. During the first quarter of 2006, we earned a $15.0 million milestone payment under our DPP4 collaboration with Takeda.

Under most of our agreements for Development 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, strategic acquisitions and investments. We expect to fund these activities and the payment of future cash dividends from existing cash, cash flow 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 and dividends for the foreseeable future. From time to time, we evaluate potential acquisitions, investments and other growth opportunities that might require additional external financing, and we might seek funds from public or private issuances of equity or debt securities. While we believe we have sufficient liquidity to fund our operations for the foreseeable future, our sources of liquidity and ability to pay dividends could be affected by our dependence on a small number of industries and clients; compliance with regulations; international risks; breach of contract, personal injury or other tort claims; environmental or intellectual property claims; or other factors described below under “Critical Accounting Policies and Estimates”, “Potential Liability and Insurance”, “Potential Volatility of Quarterly Operating Results and Stock Price” and “Quantitative and Qualitative Disclosures about Market Risk”. In addition, see “Risk Factors”, “Contractual Obligations and Commercial Commitments” and “Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the year ended December 31, 2005.

Prior to January 1, 2006, we accounted for our stock-based compensation plan in accordance with the intrinsic value provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”, or APB No. 25, and provided the required pro forma disclosures of SFAS No. 123, “Accounting for Stock-Based Compensation”. Accordingly, because all stock options granted had an exercise price equal to the market value of the underlying common stock on the date of the grant, no expense related to employee stock options was recognized. Also, as the employee stock purchase plan was considered noncompensatory, no expense related to this plan was recognized. However, expense related to the grant of restricted stock was recognized in the income statement under APB No. 25.

Effective January 1, 2006, we adopted SFAS No. 123 (revised) using the modified retrospective application method. Accordingly, we measure stock-based compensation cost at grant date, based on the fair value of the award, and recognize it as expense over the employee’s requisite service period. In accordance with the modified retrospective application method, financial statements for all periods prior to January 1, 2006 have been adjusted to give effect to the fair-value based method of accounting for all awards granted in fiscal years beginning after December 15, 1994. Amounts previously disclosed as pro forma adjustments have been reflected in earnings for all prior periods. The details of the impact of the retrospective application of SFAS No. 123 (revised) on previously reported amounts in our Consolidated Condensed Statement of Operations as of September 30, 2005 and our Consolidated Balance Sheet as of December 31, 2005 are shown in Note 9 to the Notes to Consolidated Condensed Financial Statements.

As of September 30, 2006, the total unrecognized compensation cost related to non-vested stock options was approximately $37.0 million. This cost is expected to be recognized over a weighted-average period of 2.14 years in accordance with the vesting periods of the options. As of September 30, 2006, the total unrecognized compensation cost related to non-vested restricted stock was approximately $2.4 million. This cost is expected to be recognized over a weighted-average period of 1.89 years in accordance with the vesting periods of the restricted stock. Our employee stock purchase plan has two six-month offering periods (each an “Offering Period”) each year, beginning January 1 and July 1, respectively. As of September 30, 2006, the total unrecognized compensation cost related to employee stock purchase plan shares for the current Offering Period was approximately $0.5 million. This cost is expected to be recognized over the remaining three months of the Offering Period.

The fair value of each option award is estimated on the grant date using the Black-Scholes option-pricing model. See Note 9 of our Notes to Consolidated Condensed Financial Statements for details regarding the assumptions

used in estimating fair value for the quarters ended September 30, 2005 and 2006 regarding our equity compensation plan and our employee stock purchase plan.

There were no other material changes to our critical accounting policies and estimates in the first nine months of 2006. For detailed information on our other critical accounting policies and estimates, see our Annual Report on Form 10-K for the year ended December 31, 2005.

Recently issued accounting standards relevant to our financial statements, which are described in “Recent Accounting Pronouncements” in Note 1 to the Notes to Consolidated Condensed Financial Statements are:

Because we conduct operations on a global basis, our effective tax rate has and will continue to depend upon the geographic distribution of our pretax earnings among locations with varying tax rates. Our profits are also impacted by changes in the tax rates of the various tax jurisdictions. In particular, as the geographic mix of our pretax earnings among various tax jurisdictions changes, our effective tax rate might vary from period to period.

Our long-term contracts, 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. In the event that actual inflation rates are greater than our contractual inflation rates or cost of living adjustments, inflation could have a material adverse effect on our operations or financial condition.

Drug development services involve the testing of new drugs on human volunteers pursuant to a study protocol. This testing exposes us to the risk of liability for personal injury or death to patients resulting from, among other things, possible unforeseen adverse side effects or improper administration of the new drug. Many of these patients are already seriously ill and are at risk of further illness or death. We attempt to manage our risk of liability for personal injury or death to patients from administration of products under study through measures such as standard operating procedures, patient informed consent, contractual indemnification provisions with clients and insurance. We monitor clinical trials in compliance with government regulations and guidelines. We have adopted global standard operating procedures intended to satisfy regulatory requirements in the United States and in many foreign countries and to serve as a tool for controlling and enhancing the quality of drug development services. The contractual indemnifications generally do not protect us against our own actions, such as gross negligence. We currently maintain professional liability insurance coverage with limits we believe are adequate and appropriate.

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:

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. For these reasons, 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, actual or anticipated changes in our dividend policy or other factors could affect the market price of our common stock. These factors include ones beyond our control, such as changes in earnings estimates by analysts, market conditions in our industry, disclosures by product development partners and actions by regulatory authorities with respect to potential drug candidates, changes in pharmaceutical, biotechnology and medical device industries and the government sponsored clinical research sector and general economic conditions. Any effect on our common stock could be unrelated to our longer-term operating performance. For further details, see “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2005.

We are exposed to foreign currency risk by virtue of our international operations. We derived approximately 26.9% and 33.1% of our net revenues for the three months ended September 30, 2005 and 2006, respectively, from operations outside the United States. We generally reinvest funds generated by each subsidiary in the country where they are earned. However, in 2005, we repatriated $48.0 million of undistributed earnings in the form of dividends from our foreign affiliates under the American Jobs Creation Act of 2004. Our operations in the United Kingdom generated more than 35.0% of our net revenue from international operations during the three months ended September 30, 2006. Accordingly, we are exposed to adverse movements in foreign currencies, predominately in the pound sterling.

The vast majority of our contracts are entered into by our U.S. or U.K. subsidiaries. The contracts entered into by the U.S. subsidiaries are almost always denominated in U.S. dollars. Contracts entered into by our U.K. subsidiaries are generally denominated in pounds sterling, U.S. dollars or euros, with the majority in U.S. dollars. Although an increase in exchange rates for the pound sterling or euro relative to the U.S. dollar would increase net revenue from contracts denominated in these currencies, a negative impact on income from operations results from 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 into U.S. dollars. In January 2004, we began engaging in hedging activities in an effort to manage our potential foreign exchange exposure. Our last economic hedge deal expired June 30, 2006.

We also have currency risk resulting from the passage of time between the invoicing of customers under contracts and the 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 until payment from the customer will result in our receiving either more or less in local currency than the local currency equivalent of the receivable. We recognize this difference as a foreign currency transaction gain or loss, as applicable, and report it in other income, net. If the exchange rate on accounts receivable balances denominated in pounds sterling

were to change by 10%, the result to foreign currency transaction gain or loss would have been $2.0 million as of September 30, 2006.

Our strategy for managing foreign currency risk relies primarily on receiving payment in the same currency used to pay expenses and from time to time using foreign currency derivatives, such as forward exchange contracts. As of September 30, 2006, we had open foreign exchange derivative contracts with a face amount totaling $8.7 million to buy the local currencies of our foreign subsidiaries. The estimated fair value of our foreign currency derivative portfolio resulted in us recording a $7,000 gain as a component of prepaid expenses and other current assets and a $32,000 loss as a component of other accrued expenses. If the U.S. dollar had weakened an additional 10% relative to the pound sterling, euro and Brazilian real in the third quarter of 2006, net income would have been reduced by $2.6 million for the quarter.

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:

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 us.

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, new or modified exchange control restrictions could have an adverse effect on our financial condition.

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 since we currently have minimal debt and a large outstanding cash balance.

Disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) are designed only to provide reasonable assurance that information to be disclosed in our Exchange Act Reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(b). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective to provide the reasonable assurance discussed above.

There were no changes in internal control over financial reporting during the third quarter of 2006 that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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)


				Page
Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Condensed Statements of Operations for the Three and Nine Months Ended September 30, 2005 and 2006 (unaudited)				3

Consolidated Condensed Balance Sheets as of December 31, 2005 and September 30, 2006 (unaudited)				4

Consolidated Condensed Statements of Cash Flows for the Nine Months Ended September 30, 2005 and 2006 (unaudited)				5

Notes to Consolidated Condensed Financial Statements (unaudited)				6

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations				25

Item 3. Quantitative and Qualitative Disclosures about Market Risk				41

Item 4. Controls and Procedures				42

Part II. OTHER INFORMATION

Item 6. Exhibits				43

Signatures				44


	Three Months Ended September 30,						Nine Months Ended September 30,
	2005			2006			2005			2006
Net Revenue:
Development	$	235,148		$	285,348		$	672,931		$	821,987
Discovery Sciences		19,458			4,456			35,954			27,955
Reimbursed out-of-pockets		18,674			23,344			53,591			71,528

Total net revenue		273,280			313,148			762,476			921,470

Direct Costs:
Development		118,910			144,121			342,891			412,560
Discovery Sciences		2,178			2,416			6,212			6,893
Reimbursable out-of-pocket expenses		18,674			23,344			53,591			71,528

Total direct costs		139,762			169,881			402,694			490,981

Research and development expenses		1,967			1,887			22,233			3,829
Selling, general and administrative expenses		64,417			77,247			184,049			228,478
Depreciation		10,135			12,008			28,006			34,317
Amortization		279			84			846			481
Loss on impairment and disposal of assets		25			42			275			1,428
Gain on exchange of assets		—			—			(5,144	)		—

Total operating expenses		216,585			261,149			632,959			759,514

Income from operations		56,695			51,999			129,517			161,956
Interest income, net		2,400			3,831			5,615			10,133
Impairment of equity investment		(3,797	)		—			(3,797	)		—
Other income (expense), net		403			(53	)		1,260			1,125

Income before provision for income taxes		55,701			55,777			132,595			173,214
Provision for income taxes		19,941			18,964			43,155			58,141

Net income	$	35,760		$	36,813		$	89,440		$	115,073

Net income per common share:
Basic	$	0.31		$	0.31		$	0.78		$	0.99

Diluted	$	0.31		$	0.31		$	0.77		$	0.97

Dividends declared per common share	$	—		$	0.025		$	—		$	0.075

Weighted average number of common shares outstanding:
Basic		115,286			116,971			114,312			116,608
Dilutive effect of stock options and restricted stock		1,854			1,820			1,754			1,791

Diluted		117,140			118,791			116,066			118,399


	December 31, 2005		September 30, 2006
			(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	182,000	$	120,858
Short-term investments		137,820		251,351
Accounts receivable and unbilled services, net		303,386		388,112
Income tax receivable		14		107
Investigator advances		13,578		11,311
Prepaid expenses and other current assets		34,651		54,503
Deferred tax assets		11,435		12,044

Total current assets		682,884		838,286

Property and equipment, net		210,020		291,993
Goodwill		208,883		211,109
Investments		29,171		17,254
Intangible assets		2,772		2,096
Long-term deferred tax assets		20,080		15,552
Other assets		5,790		1,502

Total assets	$	1,159,600	$	1,377,792

Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable	$	10,363	$	15,678
Payables to investigators		43,126		39,368
Accrued income taxes		18,099		28,117
Other accrued expenses		119,304		137,742
Deferred tax liabilities		85		97
Unearned income		162,662		174,035
Current maturities of long-term debt and capital lease obligations		1,607		534

Total current liabilities		355,246		395,571

Long-term debt and capital lease obligations, less current maturities		22,695		56,118
Accrued pension liability		11,151		12,242
Deferred tax liabilities		2,195		3,452
Deferred rent and other		17,637		18,166

Total liabilities		408,924		485,549

Shareholders’ equity:
Common stock		5,800		5,855
Paid-in capital		395,452		433,648
Retained earnings		346,417		452,710
Accumulated other comprehensive income		3,007		30

Total shareholders’ equity		750,676		892,243

Total liabilities and shareholders’ equity	$	1,159,600	$	1,377,792


	Nine Months Ended September 30,
	2005			2006
Cash flows from operating activities:
Net income	$	89,440		$	115,073
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		28,852			34,798
Stock compensation expense		12,960			15,270
Gain on exchange of assets		(5,144	)		—
Gain on sale of investment		—			(782	)
Impairment of investments		3,797			—
Loss on impairment and disposal of assets		275			1,428
Gain on sale of assets		(98	)		(31	)
Provision for doubtful accounts		124			628
(Benefit) provision for deferred income taxes		(305	)		6,287
Change in operating assets and liabilities, net of acquisitions		5,090			(56,246	)

Net cash provided by operating activities		134,991			116,425

Cash flows from investing activities:
Purchases of property and equipment		(89,083	)		(106,574	)
Proceeds from sale of property and equipment		3,926			39
Purchases of available-for-sale investments		(24,720	)		(601,693	)
Maturities and sales of available-for-sale investments		129,740			488,158
Purchase of note receivable		—			(7,474	)
Proceeds from sale of investments		25,000			1,482
Purchases of investments		(11,576	)		(992	)

Net cash provided by (used in) investing activities		33,287			(227,054	)

Cash flows from financing activities:
Principal repayments of long-term debt		(275	)		(6,005	)
Proceeds from construction loan		—			38,993
Repayment of capital leases obligations		(1,301	)		(1,083	)
Proceeds from exercise of stock options and employee stock purchase plan		24,471			19,078
Income tax benefit from exercise of stock options and disqualifying dispositions of stock		7,025			4,265
Cash dividends paid		—			(8,774	)

Net cash provided by financing activities		29,920			46,474

Effect of exchange rate changes on cash and cash equivalents		(6,839	)		3,013

Net increase (decrease) in cash and cash equivalents		191,359			(61,142	)
Cash and cash equivalents, beginning of the period		144,348			182,000

Cash and cash equivalents, end of the period	$	335,707		$	120,858


(in thousands)

Condensed balance sheet:
Current assets	$	186
Property and equipment, net		8,780
Deferred rent and other		(742	)
Current liabilities		(3,512	)
Long-term liabilities		(2,267	)

Value of identifiable intangible assets:
Goodwill		33,001

Total	$	35,446


(in thousands)	Development			Discovery Sciences		Total
Balance as of January 1, 2005	$	159,166		$	20,615	$	179,781
Goodwill recorded during the period for acquisitions		—			33,001		33,001
Translation adjustments		(3,899	)		—		(3,899	)

Balance as of December 31, 2005		155,267			53,616		208,883
Translation adjustments		2,226			—		2,226

Balance as of September 30, 2006	$	157,493		$	53,616	$	211,109


(in thousands)	December 31, 2005						September 30, 2006
(in thousands)	Carrying Amount		Accumulated Amortization		Net		Carrying Amount		Accumulated Amortization		Net
Backlog and customer relationships	$	543	$	338	$	205	$	543	$	427	$	116
Patents		22		22		—		—		—		—
License and royalty agreements		5,000		2,433		2,567		4,500		2,520		1,980

Total	$	5,565	$	2,793	$	2,772	$	5,043	$	2,947	$	2,096


(in thousands)

2006 (remaining 3 months)	$	83
2007		312
2008		283
2009		250
2010		250
2011		250


	Three Months Ended September 30,						Nine Months Ended September 30,
(in thousands)	2005			2006			2005			2006
Net income, as reported	$	35,760		$	36,813		$	89,440		$	115,073
Other comprehensive loss
Cumulative translation adjustment		(545	)		131			(8,759	)		5,171
Change in fair value of hedging transaction, net of taxes of $(244), $0, $(778) and $140, respectively		(567	)		—			(1,785	)		327
Reclassification adjustment for hedging results included in direct costs, net of taxes of $247, $0, $208 and $88, respectively		574			—			485			206
Unrealized gain (loss) on investments, net of taxes of $0, $(2,611), $0 and $(3,829), respectively		71			(4,109	)		(733	)		(7,954	)
Reclassification adjustment for gain realized included in other income, net of taxes of $(55)		—			—			—			(727	)

Total other comprehensive loss		(467	)		(3,978	)		(10,792	)		(2,977	)

Comprehensive income	$	35,293		$	32,835		$	78,648		$	112,096


	Three Months Ended September 30, 2005				Nine Months Ended September 30, 2005
(in thousands, except per share data)	As previously reported		Restated		As previously reported		Restated
Statement of Operations Items:

Total direct costs	$	138,152	$	139,762	$	397,943	$	402,694
Selling, general and administrative expenses		61,970		64,417		176,389		184,049
Income from operations		60,777		56,695		142,203		129,517
Income before provision for income taxes		59,783		55,701		145,281		132,595
Net income		38,381		35,760		97,654		89,440

Net income per common share:
Basic		0.33		0.31		0.85		0.78
Diluted		0.33		0.31		0.84		0.77

Statement of Cash Flows Items:

Net cash provided by operating activities						142,016		134,991
Net cash provided by financing activities						22,895		29,920


	At December 31, 2005
	As previously reported			Restated
Balance Sheet Items:

Long-term deferred tax assets	$	11,628		$	20,080
Total assets		1,151,148			1,159,600
Paid-in capital		340,451			395,452
Retained earnings		396,068			346,417
Deferred compensation		(3,102	)		—
Total shareholders’ equity		742,224			750,676


(shares and aggregate intrinsic value in thousands)	Shares		Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term	Aggregate Intrinsic Value
Outstanding at January 1, 2006	6,487		$	18.05
Granted	1,484			34.69
Exercised	(817	)		14.61
Forfeited	(166	)		22.79
Expired	(13	)		16.62

Outstanding at September 30, 2006	6,975			21.88	7.80	$	152,584

Exercisable at September 30, 2006	2,442		$	15.55	6.46	$	37,979

Vested or expected to vest at September 30, 2006	6,189		$	21.42	7.72	$	88,292


(shares in thousands)	Shares		Weighted- Average Grant Date Fair Value
Non-vested options
Non-vested at January 1, 2006	3,744		$	10.09
Granted	1,484			15.93
Vested	(529	)		8.37
Forfeited	(166	)		11.21

Non-vested at September 30, 2006	4,533		$	12.16


	December 31, 2005		September 30, 2006
Identifiable assets:
Development	$	1,061,038	$	1,296,645
Discovery Sciences		98,562		81,147

Total	$	1,159,600	$	1,377,792


	Three Months Ended September 30, (unaudited)
(in thousands, except per share data)	2005			2006		$ Inc (Dec)			% Inc (Dec)
Net revenue:
Development	$	235,148		$	285,348	$	50,200		21.3	%
Discovery Sciences		19,458			4,456		(15,002	)	(77.1	)
Reimbursed out-of-pockets		18,674			23,344		4,670		25.0

Total net revenue		273,280			313,148		39,868		14.6

Direct costs:
Development		118,910			144,121		25,211		21.2
Discovery Sciences		2,178			2,416		238		10.9
Reimbursable out-of-pocket expenses		18,674			23,344		4,670		25.0

Total direct costs		139,762			169,881		30,119		21.6

Research and development expenses		1,967			1,887		(80	)	(4.1	)
Selling, general and administrative expenses		64,417			77,247		12,830		19.9
Depreciation		10,135			12,008		1,873		18.5
Amortization		279			84		(195	)	(69.9	)
Loss on impairment and disposal of assets		25			42		17		68.0

Income from operations		56,695			51,999		(4,696	)	(8.3	)

Impairment of equity investment		(3,797	)		—		3,797		(100.0	)
Interest and other income, net		2,803			3,778		975		34.8

Income before provision for income taxes		55,701			55,777		76		0.1
Provision for income taxes		19,941			18,964		(977	)	(4.9	)

Net income	$	35,760		$	36,813	$	1,053		2.9	%

Net income per diluted share	$	0.31		$	0.31	$	0.00		0.0	%


	Nine Months Ended September 30, (unaudited)
(in thousands, except per share data)	2005			2006		$ Inc (Dec)			% Inc (Dec)
Net revenue:
Development	$	672,931		$	821,987	$	149,056		22.2	%
Discovery Sciences		35,954			27,955		(7,999	)	(22.2	)
Reimbursed out-of-pockets		53,591			71,528		17,937		33.5

Total net revenue		762,476			921,470		158,994		20.9

Direct costs:
Development		342,891			412,560		69,669		20.3
Discovery Sciences		6,212			6,893		681		11.0
Reimbursable out-of-pocket expenses		53,591			71,528		17,937		33.5

Total direct costs		402,694			490,981		88,287		21.9

Research and development expenses		22,233			3,829		(18,404	)	(82.8	)
Selling, general and administrative expenses		184,049			228,478		44,429		24.1
Depreciation		28,006			34,317		6,311		22.5
Amortization		846			481		(365	)	(43.1	)
Loss on impairment and disposal of assets		275			1,428		1,153		419.3
Gain on exchange of assets		(5,144	)		—		5,144		(100.0	)

Income from operations		129,517			161,956		32,439		25.0

Impairment of equity investment		(3,797	)		—		3,797		(100.0	)
Interest and other income, net		6,875			11,258		4,383		63.8

Income before provision for income taxes		132,595			173,214		40,619		30.6
Provision for income taxes		43,155			58,141		14,986		34.7

Net income	$	89,440		$	115,073	$	25,633		28.7	%

Net income per diluted share	$	0.77		$	0.97	$	0.20		26.0	%


Date	Title	Effective Date

December 2004	SFAS No. 123 (revised 2004), “Share-Based Payment”	First fiscal year that begins after June 15, 2005

March 2005	Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligation”	End of fiscal years ending after December 15, 2005

May 2005	SFAS No. 154, “Accounting Changes and Error Corrections”	Fiscal years beginning after December 15, 2005

June 2005	EITF Issue 05-6, “Determining the Amortization Period for Leasehold Improvements Purchased after Lease Inception or Acquired in a Business Combination”	Reporting periods beginning after June 29, 2005

October 2005	Staff Position FAS 13-1, “Accounting for Rental Costs Incurred During a Construction Period”	First reporting period beginning after December 15, 2005

November 2005	Staff Position FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments”	Reporting periods beginning after December 15, 2005

June 2006	EITF Issue 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation)”	Reporting periods beginning after December 15, 2006

June 2006	Staff Position FIN 46(R)-6, “Determining the Variability to Be Considered in Applying FASB Interpretation No. 46(R)”	First day of the reporting period beginning after June 15, 2006

July 2006	Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109”	Fiscal years beginning after December 15, 2006

September 2006	SFAS No. 157, “Fair Value Measurements”	Fiscal years beginning after November 15, 2007 and interim periods within those years


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