**UNITED
      STATES**






**SECURITIES
      AND EXCHANGE COMMISSION**






**Washington,
      D.C. 20549** ****







**FORM
      10-K**




**(Mark
                One)**ý
            **ANNUAL
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
                EXCHANGE ACT OF 1934****For
                the fiscal year ended December 31, 2006****OR**o
            **TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
                EXCHANGE ACT OF 1934****For
                the transition period from
                ____________to_________________**




**Commission
      file Number: 0-24249**







**PDI,
                Inc.**(Exact
                name of registrant as specified in its charter)**Delaware**
            
            **22-2919486**(State
                or other jurisdiction of
              incorporation
                or organization)
            
            (I.R.S.
                Employer
              Identification
                No.)**Saddle
                River Executive Centre**
              **1
                Route 17 South, Saddle River, NJ 07458**(Address
                of principal executive offices and zip code)**(201)
                258-8450**(Registrant's
                telephone number, including area code)**Securities
                registered pursuant to Section 12(b) of the Act:**Common
                Stock, par value $0.01 per share
            The
                Nasdaq Stock Market LLC(Title
                of each class)
            (Name
                of each exchange on which registered)**Securities
                registered pursuant to Section 12(g) of the Act:
                None**
















Indicate
      by checkmark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act. Yes o No ý




Indicate
      by checkmark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Act. Yes o No ý




Indicate
      by checkmark 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 ý No o




Indicate
      by checkmark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K is not contained herein, and will not be contained, to the
      best of registrant's knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of this Form 10-K or any
      amendment to this Form 10-K. o




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. (check
      one):




Large
                accelerated filero
            Accelerated
                filerý
            Non-accelerated
                filero


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




The
      aggregate market value of the registrant's common stock, $0.01 par value per
      share, held by non-affiliates of the registrant on June 30, 2006, the last
      business day of the registrant's most recently completed second fiscal quarter,
      was $64,957,237 (based on the closing sales price of the registrant's common
      stock on that date). Shares of the registrant's common stock held by each
      officer and director and each person who owns 5% or more of the outstanding
      common stock of the registrant have been excluded in that such persons may
      be
      deemed to be affiliates. This determination of affiliate status is not
      necessarily a conclusive determination for other purposes. As of March 6, 2007,
      14,078,970 shares of the registrant's common stock, $0.01 par value per share,
      were issued and outstanding.




**DOCUMENTS
      INCORPORATED BY REFERENCE**




Portions
      of the Proxy Statement for the 2007 Annual Meeting of Stockholders (the Proxy
      Statement), to be filed within 120 days of the end of the fiscal year ended
      December 31, 2006, are incorporated by reference in Part III hereof. Except
      with respect to information specifically incorporated by reference in this
      Annual Report on Form 10-K (the Form 10-K), the Proxy Statement is not
      deemed to be filed as part hereof.






















**PDI,
            INC.**
 **Annual
            Report on Form 10-K**











PagePART
                IItem
                1.
            Business
            5Item
                1A.
            Risk
                Factors
            9Item
                1B.
            Unresolved
                Staff Comments
            14Item
                2.
            Properties
            14Item
                3.
            Legal
                Proceedings
            14Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            16PART
                IIItem
                5.
            Market
                for our Common Equity, Related Stockholder Matters
              and
                Issuer Purchases of Equity Securities
            17Item
                6.
            Selected
                Financial Data
            18Item
                7.
            Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations
            20Item
                7A.
            Quantitative
                and Qualitative Disclosures about Market Risk
            38Item
                8.
            Financial
                Statements and Supplementary Data
            39Item
                9.
            Changes
                in and Disagreements with Accountants on Accounting and Financial
                Disclosures
            39Item
                9A.
            Controls
                and Procedures
            39Item
                9B.
            Other
                Information
            40PART
                IIIItem
                10.
            Directors,
                Executive Officers and Corporate Governance
            41Item
                11.
            Executive
                Compensation
            41Item
                12.
            Security
                Ownership of Certain Beneficial Owners and Management and Related
                Stockholder Matters
            41Item
                13.
            Certain
                Relationships and Related Transactions, and Director
                Independence
            41Item
                14.
            Principal
                Accounting Fees and Services
            41PART
                IVItem
                15.
            Exhibits
                and Financial Statement Schedules
            42Signatures
            44


























































3
 
 **PDI,
          INC.**
 **Annual
          Report on Form 10-K**





**FORWARD
      LOOKING STATEMENT INFORMATION**







This
      Form
      10-K contains “forward-looking statements” within the meaning of Section 27A of
      the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
      1934 (the Exchange Act). Statements that are not historical facts, including
      statements about our plans, objectives, beliefs and expectations, are
      forward-looking statements. Forward-looking statements include statements
      preceded by, followed by or that include the words “believes,” “expects,”
“anticipates,” “plans,” “estimates,” “intends,” “projects,” “should,” “may,”
“will” or similar words and expressions. These forward-looking statements are
      contained throughout this Form 10-K, including, but not limited to, statements
      found in Part I - Item 1 - “Business,” Part II - Item 5 - “Market for our Common
      Equity, Related Stockholder Matters and Issuer Purchases of Securities,” Part II
      - Item 7 - “Management’s Discussion and Analysis of Financial Condition and
      Results of Operation” and “Part II - Item 7A - “Quantitative and Qualitative
      Disclosures About Market Risk”.




Forward-looking
      statements are only predictions and are not guarantees of performance. These
      statements are based on current expectations and assumptions involving judgments
      about, among other things, future economic, competitive and market conditions
      and future business decisions, all of which are difficult or impossible to
      predict accurately and many of which are beyond our control. These
      statements also involve known and unknown risks, uncertainties and other factors
      that may cause our actual results to be materially different from those
      expressed or implied by any forward-looking statement. Many of
      these factors are beyond our ability to control or predict. Such factors
      include, but are not limited to, the following:




·
            Changes
                in outsourcing trends and promotional, marketing and sales expenditures
                in
                the pharmaceutical, biotechnology and life sciences
                industries;




·
            Loss
                of one or more of our significant customers or a material reduction
                in
                service revenues from such
                customers;




·
            Senior
                management’s ability to successfully implement our updated long-term
                strategic plan;




·
            Competition
                in our industry;




·
            The
                ability to attract and retain key employees and management personnel;




·
            Product
                liability claims against us; and




·
            Our,
                or our customers’, failure to comply with applicable laws and healthcare
                regulations.




Please
      see Part I - Item 1A - “Risk Factors” of this Form 10-K, as well as other
      documents we file with the United States Securities and Exchange Commission
      (SEC) from time to time, for other important factors that could cause our actual
      results to differ materially from our current expectations and from the
      forward-looking statements discussed in this Form 10-K. Because of these and
      other risks, uncertainties and assumptions, you should not place undue reliance
      on these forward-looking statements. In addition, these statements speak only
      as
      of the date of the report in which they are set forth, and we undertake no
      obligation to revise or update publicly any forward-looking statements for
      any
      reason.





















4
 
  **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





**PART
      I**




**ITEM
      1.**  **BUSINESS**




**Summary
      of Business**




We
      are a
      diversified sales and marketing services company serving the biopharmaceutical
      and life sciences industries. In addition, we develop and execute continuing
      medical education activities to help pharmaceutical manufacturers meet their
      strategic educational goals. We commenced operations as a contract sales
      organization (CSO) in 1987 and we completed our initial public offering in
      May
      1998.




We
      create
      and execute sales and marketing programs for our customers with the goal of
      demonstrating our ability to add value to their products and maximize their
      sales performance. We have a variety of agreement types that we enter into
      with
      our customers. **** In these
      agreements, we leverage our experience in sales, peer persuasion programs,
      medical education and marketing research to help our customers meet strategic
      and financial objectives.




We
      have
      assembled our commercial capabilities through organic growth, acquisitions
      and
      internal expansion. Our portfolio of services enables us to provide a wide
      range
      of marketing and promotional options that can benefit many different products
      throughout the various stages of their life cycles.




It
      is
      important for us to form strong relationships with companies within the
      biopharmaceutical and life sciences industries. Our focus is to achieve
      operational excellence that delivers the desired product sales
      results.




We
      are
      among the leaders in outsourced sales and marketing services in the U.S. We
      have
      designed and implemented programs for many of the major pharmaceutical companies
      serving the U.S. market as well as many emerging and specialty pharmaceutical
      companies. Our relationships are built on the quality of our performance and
      program results delivered.




Our
      customers engage us on a contractual basis to design and implement promotional
      programs for both prescription and over-the-counter products. The programs
      are
      designed to increase product sales and are tailored to meet the specific needs
      of the product and the customer. These services are provided predominantly
      on a
      fee for service basis. These contracts can include incentive payments that
      can
      be earned if our activities generate results that meet or exceed performance
      targets. Contracts may be terminated with or without cause by our customers.
      Certain contracts provide that we may incur specific penalties if we fail to
      meet stated performance benchmarks.




**Corporate
      Strategy**




Our
      current service offerings include contract sales services, peer persuasion
      programs, medical education (CME) and market research. In October 2006, our
      board of directors approved an updated long-term strategic plan developed by
      senior management in consultation with a leading strategy consultant. That
      plan
      provides for us to:




·
            become
                a leading provider of commercialization services to the biopharmaceutical
                and life sciences industries; and


·
            regain
                leadership in our contract sales
                business.




**Reporting
      Segments and Operating Groups**




For
      2006,
      we reported under the following three segments: Sales Services, Marketing
      Services and PDI Products Group (PPG).




*Sales
      Services*




This
      segment includes our Performance Sales Teams and Select Access ’ Teams
      (formerly referred to as Shared Teams). This segment, which focuses on product
      detailing, represented 84.7% of consolidated revenue for the year ended December
      31, 2006.




Product
      detailing involves a representative meeting face-to-face with targeted
      physicians and other healthcare decision makers to provide a technical review
      of
      the product being promoted. Contract sales teams can be deployed on either
      a
      dedicated or shared basis.







5
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





Performance
      Sales Teams (formerly Dedicated Teams)




A
      performance contract sales team works exclusively on behalf of one customer.
      The
      sales team is customized to meet the specifications of the team’s customer with
      respect to representative profile, physician targeting, product training,
      incentive compensation plans, integration with customers’ in-house sales forces,
      call reporting platform and data integration. Without adding permanent
      personnel, the customer gets a high quality, industry-standard sales team
      comparable to its internal sales force.




Select
      Access ’




Select
      Access represents a shared sales team business model where multiple
      non-competing brands are represented for different pharmaceutical companies.
      Using these teams, we make a face-to-face selling resource available to those
      customers that want an alternative to a dedicated team. PDI Select Access is
      a
      leading provider of these detailing programs in the U.S. Since costs are shared
      among various companies, these programs may be less expensive for the customer
      than programs involving a dedicated sales force. With a shared sales team,
      the
      customer still receives targeted coverage of its physician audience within
      the
      representatives’ geographic territories.




*Marketing
      Services*




This
      segment, which includes our Pharmakon, TVG Marketing Research & Consulting
      and Vital Issues in Medicine business units, represented 15.3% of
      consolidated revenue for the year ended December 31, 2006.




Pharmakon




Pharmakon’s
      emphasis is on the creation, design and implementation of promotional
      interactive peer persuasion programs. Each marketing program can be offered
      through a number of different venues, including teleconferences, dinner
      meetings, “lunch and learns,” and web casts. Within each of our programs, we
      offer a number of services including strategic design, tactical execution,
      technology support, audience recruitment, moderator services and thought leader
      management. In the last ten years, Pharmakon has conducted over 45,000 peer
      persuasion programs with more than 550,000 participants. Pharmakon’s peer
      programs can be designed as promotional or marketing research/advisory programs.
      In addition to peer persuasion programs, Pharmakon also provides promotional
      communications activities. We acquired Pharmakon in August 2004.




TVG
      Marketing Research & Consulting




TVG
      Marketing Research & Consulting (TVG) employs leading edge, and in some
      instances proprietary, research methodologies. We provide qualitative and
      quantitative marketing research to pharmaceutical companies with respect to
      healthcare providers, patients and managed care customers in the U.S. and
      globally. We offer a full range of pharmaceutical marketing research services,
      including studies to identify the highest impact business strategy, profile,
      positioning, message, execution, implementation and post implementation for
      a
      product. Our marketing research model improves the knowledge customers obtain
      about how physicians and other healthcare professionals will likely react to
      products.




We
      utilize a systematic approach to pharmaceutical marketing research. Recognizing
      that every marketing need, and therefore every marketing research solution,
      is
      unique, we have developed our marketing model to help identify the work that
      needs to be done in order to identify critical paths to marketing goals. At
      each
      step of the marketing model, we can offer proven research techniques,
      proprietary methodologies and customized study designs to address specific
      product needs.




Vital
      Issues in Medicine




Our
      Vital
      Issues in Medicine business unit (VIM) develops and executes continuing medical
      education services funded by the biopharmaceutical and medical device and
      diagnostics industries. Using an expert-driven, customized approach, we provide
      faculty development/advocacy, continuing medical education activities in a
      wide
      variety of formats, and interactive initiatives to generate additional value
      to
      our customers' portfolios.




*PDI
      Products Group (PPG)*




The
      goal
      of the PPG segment was to source biopharmaceutical products in the U.S. through
      licensing, copromotion, acquisition or integrated commercialization services
      arrangements. This segment did not have any revenue for the years ended December
      31, 2006 and 2005.







6
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





Notwithstanding
      the fact that we have in recent years shifted our near-term strategy to
      deemphasize the PPG segment and focus on our service businesses, we may continue
      to review opportunities which may include copromotion, distribution
      arrangements, licensing and brand ownership of products. We currently do not
      expect any activity within the PPG segment in 2007.




**Contracts**




Our
      contracts are nearly all fee for service. They may contain operational
      benchmarks, such as a minimum amount of activity within a specified amount
      of
      time. These contracts may include incentive payments that can be earned if
      our
      activities generate results that meet or exceed performance targets. Contracts
      may be terminated with or without cause by our customers. Certain contracts
      provide that we may incur specific penalties if we fail to meet stated
      performance benchmarks. Occasionally, our contracts may require us to meet
      certain financial covenants, such as maintaining a specified minimum amount
      of
      working capital.




*Sales
      Services*




During
      fiscal 2006, the majority of our revenue was generated by contracts for
      dedicated sales teams. These contracts are generally for a term of one to two
      years and may be renewed or extended. The majority of these contracts, however,
      are terminable by the customer for any reason upon 30 to 90 days’ notice.
      Certain contracts provide for termination payments if the customer terminates
      the contract without cause. Typically, however, these penalties do not offset
      the revenue we could have earned under the contract or the costs we may incur
      as
      a result of its termination. The loss or termination of a large contract or
      the
      loss of multiple contracts could have a material adverse effect on our business,
      financial condition or results of operations.




*Marketing
      Services*




Our
      marketing services contracts generally take the form of either master service
      agreements with a term of one to three years or contracts specifically related
      to particular projects with terms typically lasting from two to six months.
      These contracts are generally terminable by the customer for any reason. Upon
      termination, the customer is generally responsible for payment for all work
      completed to date, plus the cost of any nonrefundable commitments made on behalf
      of the customer. There is significant customer concentration in our Pharmakon
      business, and the loss or termination of one or more of Pharmakon’s large master
      service agreements could have a material adverse effect on our business,
      financial condition or results of operations. Due to the typical size of most
      of
      TVG’s and VIM’s contracts, it is unlikely the loss or termination of any
      individual TVG or VIM contract would have a material adverse effect on our
      business, financial condition or results of operations.




**Significant
      Customers**




For
      the
      year ended December 31, 2006, our three largest customers, accounted for 28.5%,
      18.3% and 9.9%, respectively, or approximately 56.7% in the aggregate, of our
      service revenue. During 2006, we experienced the termination and/or expiration
      of several of these significant contracts. Effective as of April 30, 2006,
      AstraZeneca terminated its contract sales force arrangement with us, which
      accounted for 18.0% of our service revenue during 2006. In addition, on December
      31, 2006, our contract sales agreement with GlaxoSmithKline (GSK), which
      accounted for 28.2% of our service revenue during 2006, expired and was not
      renewed.




**Marketing**




Our
      marketing efforts target established and emerging companies in the
      biopharmaceutical and life sciences industries. Our marketing efforts are
      designed to reach the senior sales, marketing, and business development
      personnel within these companies, with the goal of informing them of the
      services we offer and the value we can bring to their products. Our tactical
      plan usually includes advertising in trade publications, direct mail campaigns,
      presence at industry seminars and conferences and a direct selling effort.
      We
      have a dedicated team of business development specialists who work within our
      business units to identify needs and opportunities within the biopharmaceutical
      and life sciences industries which we can address. We review possible business
      opportunities as identified by our business development team and develop a
      customized strategy and solution for each attractive business
      opportunity.




**Competition**




With
      respect to our sales teams, we compete with our customers’ alternative choices
      of managing their needs internally. In addition, a small number of providers
      comprise the market for outsourced pharmaceutical sales teams, and we believe
      that PDI, inVentiv Health Inc., Innovex Inc. and Publicis Groupe SA combined
      accounted for the majority of the U.S. outsourced sales team market share in
      2006. Our marketing services segment operates in a highly fragmented and
      competitive market.







7
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





There
      are
      relatively few barriers to entry into the businesses in which we operate and,
      as
      the industry continues to evolve, new competitors are likely to emerge. We
      compete on the basis of such factors as reputation, service quality, management
      experience, performance record, customer satisfaction, ability to respond to
      specific customer needs, integration skills and price. We believe we compete
      effectively with respect to each of these factors. Increased competition and/or
      a decrease in demand for our services may also lead to other forms of
      competition.




**Employees**




As
      of
      March 1, 2007, we had approximately 1,100 employees, including approximately
      700
      full-time employees. Approximately 80% of our employee population is comprised
      of field sales representatives and sales managers. We are not party to a
      collective bargaining agreement with any labor union. Relationships with our
      employees are generally positive.




**Available
      Information**




Our
      website address is www.pdi-inc.com .
      We are
      not including the information contained on our website as part of, or
      incorporating it by reference into, this Form 10-K. We make available free
      of
      charge through our website our annual reports on Form 10-K, quarterly reports
      on
      Form 10-Q, current reports on Form 8-K, and all amendments to those reports
      as
      soon as reasonably practicable after such material is electronically filed
      with
      or furnished to the SEC.




The
      public may read and copy any materials we file with the SEC at the SEC's Public
      Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may
      obtain information on the operation of the Public Reference Room by calling
      the
      SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports,
      proxy and information statements, and other information regarding registrants
      such as us that file electronically with the SEC. The website address is www.sec.gov .




**Government
      and Industry Regulation**




The
      healthcare sector is heavily regulated by both government and industry. Various
      laws, regulations and guidelines established by government, industry and
      professional bodies affect, among other matters, the approval, provision,
      licensing, labeling, marketing, promotion, price, sale and reimbursement of
      healthcare services and products, including pharmaceutical products. The federal
      government has extensive enforcement powers over the activities of
      pharmaceutical manufacturers, including authority to withdraw product approvals,
      commence actions to seize and prohibit the sale of unapproved or non-complying
      products, to halt manufacturing operations that are not in compliance with
      good
      manufacturing practices, and to impose or seek injunctions, voluntary recalls,
      and civil, monetary, and criminal penalties.




The
      Food,
      Drug and Cosmetic Act, as supplemented by various other statutes, regulates,
      among other matters, the approval, labeling, advertising, promotion, sale and
      distribution of drugs, including the practice of providing product samples
      to
      physicians. Under this statute, the Food and Drug Administration (“FDA”)
      regulates all promotional activities involving prescription drugs. The
      distribution of pharmaceutical products is also governed by the Prescription
      Drug Marketing Act (PDMA), which regulates these activities at both the federal
      and state level. The PDMA imposes extensive licensing, personnel record keeping,
      packaging, quantity, labeling, product handling and facility storage and
      security requirements intended to prevent the sale of pharmaceutical product
      samples or other diversions. Under the PDMA and its implementing regulations,
      states are permitted to require registration of manufacturers and distributors
      who provide pharmaceutical products even if such manufacturers or distributors
      have no place of business within the state. States are also permitted to adopt
      regulations limiting the distribution of product samples to licensed
      practitioners and require extensive record keeping and labeling of such samples
      for tracing purposes. The sale or distribution of pharmaceutical products is
      also governed by the Federal Trade Commission Act.




Some
      of
      the services that we currently perform or that we may provide in the future
      may
      also be affected by various guidelines established by industry and professional
      organizations. For example, ethical guidelines established by the American
      Medical Association (AMA) govern, among other matters, the receipt by physicians
      of gifts from health-related entities. These guidelines govern honoraria and
      other items of economic value which AMA member physicians may receive, directly
      or indirectly, from pharmaceutical companies. Similar guidelines and policies
      have been adopted by other professional and industry organizations, such as
      Pharmaceutical Research and Manufacturers of America, an industry trade
      group .
      In
      addition, the Office of the Inspector General has also issued guidance for
      pharmaceutical manufacturers and the Accreditation Council for Continuing
      Medical Education has issued guidelines for providers of continuing medical
      education.







8
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





There
      are
      also numerous federal and state laws pertaining to healthcare fraud and abuse
      as
      well as increased scrutiny regarding the off-label promotion and marketing
      of
      pharmaceutical products and devices. In particular, certain federal and state
      laws prohibit manufacturers, suppliers and providers from offering, giving
      or
      receiving kickbacks or other remuneration in connection with ordering or
      recommending the purchase or rental of healthcare items and services. The
      federal anti-kickback statute imposes both civil and criminal penalties for,
      among other things, offering or paying any remuneration to induce someone to
      refer patients to, or to purchase, lease or order (or arrange for or recommend
      the purchase, lease or order of) any item or service for which payment may
      be
      made by Medicare or other federally-funded state healthcare programs
      ( *e.g.* ,
      Medicaid). This statute also prohibits soliciting or receiving any remuneration
      in exchange for engaging in any of these activities. The prohibition applies
      whether the remuneration is provided directly or indirectly, overtly or
      covertly, in cash or in kind. Violations of the statute can result in numerous
      sanctions, including criminal fines, imprisonment and exclusion from
      participation in the Medicare and Medicaid programs. Several states also have
      referral, fee splitting and other similar laws that may restrict the payment
      or
      receipt of remuneration in connection with the purchase or rental of medical
      equipment and supplies. State laws vary in scope and have been infrequently
      interpreted by courts and regulatory agencies, but may apply to all healthcare
      items or services, regardless of whether Medicare or Medicaid funds are
      involved.






**ITEM
      1A.**  **RISK
      FACTORS**




In
      addition to the other information provided in this Form 10-K, you should
      carefully consider the following factors in evaluating our business, operations
      and financial condition. Additional risks and uncertainties not presently known
      to us, which we currently deem immaterial or that are similar to those faced
      by
      other companies in our industry or businesses in general, such as competitive
      conditions, may also impair our business operations. The occurrence of any
      of
      the following risks could have a material adverse effect on our business,
      financial condition or results of operations.




**Changes
      in outsourcing trends in the pharmaceutical and biotechnology industries could
      materially and adversely affect our business, financial condition and results
      of
      operations.**




Our
      business depends in large part on demand from the pharmaceutical and life
      sciences industries for outsourced marketing and sales services. The practice
      of
      many companies in these industries has been to hire outside organizations like
      us to conduct large sales and marketing projects. However, companies may elect
      to perform these services internally for a variety of reasons, including the
      rate of new product development and FDA approval of those products, the number
      of sales representatives employed internally in relation to demand for or the
      need to promote new and existing products, and competition from other suppliers.
      Recently, there has been a slow-down in the rate of approval of new products
      by
      the FDA and this trend may continue. Additionally, several large pharmaceutical
      companies have recently made changes to their commercial model by reducing
      the
      number of sales representatives employed internally and through outside
      organizations like us. If the pharmaceutical and life sciences industries reduce
      their tendency to outsource these projects, our business, financial condition
      and results of operations could be materially and adversely
      affected.




**Our
      service businesses depend on expenditures by companies in the life sciences
      industries.**




Our
      service revenues depend on promotional, marketing and sales expenditures by
      companies in the life sciences industries, including the pharmaceutical and
      biotechnology industries. Promotional, marketing and sales expenditures by
      pharmaceutical manufacturers have in the past been, and could in the future
      be,
      negatively impacted by, among other things, governmental reform or private
      market initiatives intended to reduce the cost of pharmaceutical products or
      by
      governmental, medical association or pharmaceutical industry initiatives
      designed to regulate the manner in which pharmaceutical manufacturers promote
      their products. Furthermore, the trend in the life sciences industries toward
      consolidation may result in a reduction in overall sales and marketing
      expenditures and, potentially, a reduction in the use of contract sales and
      marketing services providers.




**Our
      service contracts are generally short-term agreements and are cancelable at
      any
      time, which may result in lost revenue and additional costs and
      expenses.**




Our
      service contracts are generally for a term of one to two years (certain of
      our
      operating entities have contracts of shorter duration) and many may be
      terminated by the customer at any time for any reason. Additionally, certain
      of
      our customers have the ability to significantly reduce the number of
      representatives we deploy on their behalf. For example, as discussed above,
      AstraZeneca terminated its contract sales force arrangement with us effective
      April 30, 2006. The termination affected approximately 800 field
      representatives. The revenue impact was approximately $63.8 million in 2006.
      Additionally as discussed above, the losses of both the GSK and sanofi-aventis
      contracts for 2007 represent a loss of approximately $85.7 million in revenue
      for 2007.





9
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





The
      early
      termination or significant reduction of a contract by one of our major customers
      not only results in lost revenue, but also typically causes us to incur
      additional costs and expenses. All of our sales representatives are employees
      rather than independent contractors. Accordingly, when a contract is
      significantly reduced or terminated, unless we can immediately transfer the
      related sales force to a new program, if permitted under the contract, we must
      either continue to compensate those employees, without realizing any related
      revenue, or terminate their employment. If we terminate their employment, we
      may
      incur significant expenses relating to their termination. The loss, termination
      or significant reduction of a large contract or the loss of multiple contracts
      could have a material adverse effect on our business, financial condition or
      results of operations.




**Most
      of our service revenue is derived from a limited number of customers, the loss
      of any one of which could materially and adversely affect our business,
      financial condition or results of operations.**




Our
      revenue and profitability depend to a great extent on our relationships with
      a
      limited number of large pharmaceutical companies. For
      the
      year ended December 31, 2006, our three largest customers accounted for 28.5%,
      18.3% and 9.9%, respectively, or approximately 56.7% in the aggregate, of our
      service revenue. For the year ended December 31, 2005, our three largest
      customers, each of whom represented 10% or more of our service revenue,
      accounted for, in the aggregate, approximately 73.6% of our service revenue.
      For
      the year ended December 31, 2004, our two largest customers, each of whom
      individually represented 10% or more of our service revenue, accounted for,
      in
      the aggregate, approximately 66.4% of our service revenue. We are likely to
      continue to experience a high degree of customer concentration, particularly
      if
      there is further consolidation within the pharmaceutical industry. The loss
      or a
      significant reduction of business from any of our major customers could have
      a
      material adverse effect on our business, financial condition or results of
      operations. For example, as announced on February 28, 2006, AstraZeneca
      terminated its contract sales force arrangement with us effective April 30,
      2006. The termination affected approximately 800 field representatives, and
      the
      impact on revenue was approximately $63.8 million in 2006. Additionally, on
      September 26, 2006, we announced that GSK would not be renewing its contract
      with us when it expired on December 31, 2006. This represents a loss of revenue
      between $65 and $70 million for 2007. Furthermore, on October 25, 2006, we
      announced that we had received notification from sanofi-aventis of its intention
      to terminate its contract sales engagement with us effective December 1, 2006.
      The contract, which represented approximately $18 million to $20 million in
      revenue on an annual basis, was scheduled to expire on December 31,
      2006.




**Our
      new senior management team is seeking to implement an updated long-term
      strategic plan. There can be no assurance that we will successfully implement
      this plan.**




In
      May
      2006, Michael Marquard and Jeffrey Smith joined us as our chief executive
      officer and chief financial officer, respectively. In October 2006, our board
      of
      directors approved an updated long-term strategic plan developed by senior
      management in consultation with a leading strategy consultant. In order to
      implement our strategic plan, we may seek to do one or more of the
      following:




·
            acquire
                companies that offer prioritized complementary services that we have
                identified in order to expand our portfolio of product and service
                offerings to the biopharmaceutical and life sciences industries and
                to
                strengthen our contract sales offerings; or build these services
                in-house;
                and


·
            enter
                into risk-sharing and/or performance based arrangements on a selective
                basis.




We
      may
      expend significant funds and other resources implementing this strategy. There
      is no assurance that we will successfully implement this strategy or be able
      to
      expand our market share, increase revenues, yield a significant return on
      investment and/or improve stockholder value.




**Our
      industry is highly competitive and our failure to address competitive
      developments promptly will limit our ability to retain and increase our market
      share.**




Our
      primary competitors for sales and marketing services include in-house sales
      and
      marketing departments of pharmaceutical companies, other CSOs and medical
      education and marketing research providers. There are relatively few barriers
      to
      entry in the businesses in which we compete and, as the industry continues
      to
      evolve, new competitors are likely to emerge. Most of our current and potential
      competitors are larger than we are and have substantially greater capital,
      personnel and other resources than we have. Increased competition may lead
      to
      competitive practices that could have a material adverse effect on our market
      share, our ability to source new business opportunities, our business, financial
      condition or results of operations.







10
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





**Due
      to the expiration and/or termination of several significant contracts during
      2006 and management’s intention to implement our long-term strategic plan during
      2007 and beyond, our revenue and results of operations for the year ended
      December 31, 2006 cannot be relied upon as representative of the revenue and
      results of operations that we may achieve in 2007 and future
      periods** .




As
      noted
      above, during 2006, we experienced the termination and/or expiration of several
      significant contracts, including termination of our AstraZenaca sales contract
      force effective as of April 30, 2006, the termination of our contract sales
      agreement with sanofi-aventis effective as of December 1, 2006 and the
      expiration of our contract sales agreement with GSK on December 31, 2006. These
      three customers accounted for an aggregate of approximately $129.0 million
      of
      revenue during 2006. Unless and until we generate sufficient new business to
      offset the loss of these contracts, our 2006 financial results will not be
      duplicated in future periods and future revenue and cash flows from operations
      will decrease. In addition, our senior management intends to implement our
      long-term strategic plan during 2007 and beyond. This plan includes, in part,
      a
      focus on supplementing our current service offerings with complementary
      commercialization service offerings to the biopharmaceutical and life sciences
      industries. To the extent this element of our strategic plan is implemented
      during 2007 and in future periods, these will constitute new service offerings
      for which there were no comparable financial results during 2006.




**We
      may make acquisitions in the future which may lead to disruptions to our ongoing
      business.**




Historically,
      we have made a number of acquisitions and our strategic plan contemplates
      pursuing new acquisition opportunities. If we are unable to successfully
      integrate an acquired company, the acquisition could lead to disruptions to
      our
      business. The success of an acquisition will depend upon, among other things,
      our ability to:




·
            assimilate
                the operations and services or products of the acquired
                company;


·
            integrate
                new personnel associated with the
                acquisition;


·
            retain
                and motivate key employees;


·
            retain
                customers; and


·
            minimize
                the diversion of management’s attention from other business
                concerns.




In
      the
      event that the operations of an acquired business do not meet our performance
      expectations, we may have to restructure the acquired business or write-off
      the
      value of some or all of the assets of the acquired business, including goodwill
      and other intangible assets identified at time of acquisition.




In
      addition, the current market for acquisition targets in our industry is
      extremely competitive, and there can be no assurance that we will be able to
      successfully identify, bid for and complete acquisitions necessary or desirable
      to achieve our goals.




**If
      we do not meet performance goals set in incentive-based and revenue sharing
      arrangements, our profits could suffer.**




We
      occasionally enter into incentive-based and revenue sharing arrangements with
      pharmaceutical companies. Under incentive-based arrangements, we are typically
      paid a fixed fee and, in addition, have an opportunity to increase our earnings
      based on the market performance of the products being detailed in relation
      to
      targeted sales volumes, sales force performance metrics or a combination
      thereof. Additionally, certain of our service contracts may contain penalty
      provisions pursuant to which our fees may be significantly reduced if we do
      not
      meet certain performance metrics; for example number and timing of sales calls,
      physician reach, territory vacancies and/or sales representative turnover.
      Under
      revenue sharing arrangements, our compensation is based on the market
      performance of the products being detailed, usually expressed as a percentage
      of
      product sales. These types of arrangements transfer some market risk from our
      customers to us. In addition, these arrangements can result in variability
      in
      revenue and earnings due to seasonality of product usage, changes in market
      share, new product introductions (including the introduction of competing
      generic products into the market), overall promotional efforts and other market
      related factors.




**If
      we are unable to attract key employees, we may be unable to support the
      implementation of our strategic plan and growth of our
      business.**




Successful
      execution of our business strategy depends, in large part, on our ability to
      attract and retain qualified management, marketing and other personnel with
      the
      skills and qualifications necessary to fully execute our programs and strategy.
      Competition for talent among companies in the pharmaceutical and life sciences
      industries is intense and we cannot assure you that we will be able to continue
      to attract or retain the talent necessary to support the growth of our business.







11
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





**If
      we pursue a strategy that includes co-promotion and exclusive distribution
      arrangements, and/or licensing and brand ownership of products, we cannot assure
      you that we can successfully develop this business.**




We
      may in
      the future pursue a strategy which includes co-promotion, distribution
      arrangements, and/or licensing and brand ownership of products. These types
      of
      arrangements can significantly increase our operating expenditures in the
      short-term. Typically, these agreements require significant “upfront” payments,
      minimum purchase requirements, minimum royalty payments, payments to third
      parties for production, inventory maintenance and control, distribution services
      and accounts receivable administration, as well as sales and marketing
      expenditures. In addition, particularly where we license or acquire products
      before they are approved for commercial use, we may be required to incur
      significant expense to gain and maintain the required regulatory approvals
      and
      there can be no assurance that we would be able to obtain any necessary
      regulatory approvals for those products. In addition, regulatory approval does
      not ensure commercial success. As a result, our working capital balance and
      cash
      flow position could be materially and adversely affected until the products
      in
      question become commercially viable, if ever. The risks that we face in
      developing this segment of our business, if we choose to pursue it, may increase
      in proportion with:




·
            the
                number and types of products covered by these types of
                agreements;


·
            the
                applicable stage of the drug regulatory process of the products at
                the
                time we enter into these agreements;


·
            the
                incidence of adverse patent and other intellectual property developments
                relating to our product portfolio;
                and


·
            our
                control over the manufacturing, distribution and marketing
                processes.




In
      the
      event that we pursue a strategy which includes the co-promotion, distribution,
      and/or licensing and brand ownership of products, there is no assurance that
      we
      will be able to successfully implement this strategy .




**We
      may require additional funds in order to implement our strategic plan and
      evolving business model.**




Pursuant
      to our strategic plan, we may require additional funds in order to pursue
      other business opportunities or meet future operating requirements; develop
      incremental marketing and sales capabilities; and/or acquire other services
      businesses. We
      may
      seek additional funding through public or private equity or debt financing
      or
      other arrangements with collaborative partners. If we raise additional funds
      by
      issuing equity securities, further dilution to existing stockholders may result.
      In addition, as a condition to providing us with additional funds, future
      investors may demand, and may be granted, rights superior to those of existing
      stockholders. We cannot be sure, however, that additional financing will be
      available from any of these sources or, if available, will be available on
      acceptable or affordable terms. If adequate additional funds are not available,
      we may be required to delay, reduce the scope of, or eliminate one or more
      of
      our strategic initiatives.




**Product
      liability claims could harm our business.**




We
      could
      face substantial product liability claims in the event any of the pharmaceutical
      or other products we have previously marketed or market now or may in the future
      market are alleged to cause negative reactions or adverse side effects or in
      the
      event any of these products causes injury, is alleged to be unsuitable for
      its
      intended purpose or is alleged to be otherwise defective. For example, we have
      been named as a defendant in numerous lawsuits as a result of our detailing
      of
      Baycol â on
      behalf of Bayer Corporation (Bayer). Product liability claims, regardless of
      their merits, could be costly and divert management's attention, or adversely
      affect our reputation and the demand for our services or products. We rely
      on
      contractual indemnification provisions with our customers to protect us against
      certain product liability related claims. There is no assurance that these
      provisions will be fully enforceable or that they will provide adequate
      protection against claims intended to be covered. We currently have product
      liability insurance in the aggregate amount of $5.0 million but we cannot assure
      you that our insurance will be sufficient to cover fully all potential claims.
      Also, adequate insurance coverage might not be available in the future at
      acceptable costs, if at all.




**Our
      business will suffer if we are unable to hire and retain key management
      personnel.**




The
      success of our business also depends on our ability to attract and retain
      qualified senior management and experienced financial executives who are in
      high
      demand and who often have competitive employment options. Our failure to attract
      and retain qualified individuals could have a material adverse effect on our
      business, financial condition or results of operations **.**







12
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





**Our
      business may suffer if we fail to attract and retain qualified sales
      representatives.**




The
      success and growth of our business depends on our ability to attract and retain
      qualified pharmaceutical sales representatives. During 2006, we experienced
      an
      unusually high turnover rate among our sales representatives due to the early
      termination of a number of significant contract sales force arrangements. There
      is intense competition for pharmaceutical sales representatives from CSOs and
      pharmaceutical companies. On occasion, our customers have hired the sales
      representatives that we trained to detail their products. We cannot be certain
      that we can continue to attract and retain qualified personnel. If we cannot
      attract and retain qualified sales personnel, we will not be able to expand
      our
      teams business and our ability to perform under our existing contracts will
      be
      impaired.




**Our
      failure, or that of our customers, to comply with applicable healthcare
      regulations could limit, prohibit or otherwise adversely impact our business
      activities.**




Various
      laws, regulations and guidelines established by government, industry and
      professional bodies affect, among other matters, the provision of, licensing,
      labeling, marketing, promotion, sale and distribution of healthcare services
      and
      products, including pharmaceutical products. In particular, the healthcare
      industry is governed by various federal and state laws pertaining to healthcare
      fraud and abuse, including prohibitions on the payment or acceptance of
      kickbacks or other remuneration in return for the purchase or lease of products
      that are paid for by Medicare or Medicaid. Sanctions for violating these laws
      include civil and criminal fines and penalties and possible exclusion from
      Medicare, Medicaid and other federal or state healthcare programs. Although
      we
      believe our current business arrangements do not violate these federal and
      state
      fraud and abuse laws, we cannot be certain that our business practices will
      not
      be challenged under these laws in the future or that a challenge would not
      have
      a material adverse effect on our business, financial condition or results of
      operations. Our failure, or the failure of our customers, to comply with these
      laws, regulations and guidelines, or any change in these laws, regulations
      and
      guidelines may, among other things, limit or prohibit our business activities
      or
      those of our customers, subject us or our customers to adverse publicity,
      increase the cost of regulatory compliance and insurance coverage or subject
      us
      or our customers to monetary fines or other penalties.




**Our
      stock price is volatile and could be further affected by events not within
      our
      control. In 2006, our stock traded at a low of $9.37 and a high of $15.69.
      In
      2005, our stock traded at a low of $11.12 and a high of $22.26.**




The
      market for our common stock is volatile. The trading price of our common stock
      has been and will continue to be subject to:




·
            volatility
                in the trading markets generally;


·
            significant
                fluctuations in our quarterly operating
                results;


·
            announcements
                regarding our business or the business of our
                competitors;


·
            industry
                and/or regulatory developments;


·
            changes
                in revenue mix;


·
            changes
                in revenue and revenue growth rates for us and for our industry as
                a
                whole; and


·
            statements
                or changes in opinions, ratings or earnings estimates made by brokerage
                firms or industry analysts relating to the markets in which we operate
                or
                expect to operate.




**Our
      quarterly revenues and operating results may vary, which may cause the price
      of
      our common stock to fluctuate.**




Our
      quarterly operating results may vary as a result of a number of factors,
      including:




·
            commencement,
                delay, cancellation or completion of sales and marketing programs;


·
            regulatory
                developments;


·
            uncertainty
                related to compensation based on achieving performance benchmarks;


·
            mix
                of services provided and/or mix of programs, i.e., contract sales,
                peer
                persuasion programs, medical education, marketing research;


·
            timing
                and amount of expenses for implementing new programs and accuracy
                of
                estimates of resources required for ongoing programs;


·
            timing
                and integration of acquisitions;


·
            changes
                in regulations related to pharmaceutical companies; and


·
            general
                economic conditions.







13
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





In
      addition, in the case of revenue related to service contracts, we recognize
      revenue as services are performed, while program costs, other than training
      costs, are expensed as incurred. As a result, during the first two to three
      months of a new contract, we may incur substantial expenses associated with
      implementing that new program without recognizing any revenue under that
      contract. This could have a material adverse impact on our operating results
      and
      the price of our common stock for the quarters in which these expenses are
      incurred. For these and other reasons, we believe that quarterly comparisons
      of
      our financial results are not necessarily meaningful and should not be relied
      upon as an indication of future performance. Fluctuations in quarterly results
      could materially and adversely affect the market price of our common stock
      in a
      manner unrelated to our long-term operating performance.




**Our
      controlling stockholder continues to have effective control of us, which could
      delay or prevent a change in corporate control that may otherwise be beneficial
      to our stockholders.**




John
      P.
      Dugan, our chairman, beneficially owns approximately 35% of our outstanding
      common stock. As a result, Mr. Dugan is able to exercise substantial control
      over the election of all of our directors and to determine the outcome of most
      corporate actions requiring stockholder approval, including a merger with or
      into another company, the sale of all or substantially all of our assets and
      amendments to our certificate of incorporation.




**We
      have anti-takeover defenses that could delay or prevent an acquisition and
      could
      adversely affect the price of our common stock.**




Our
      certificate of incorporation and bylaws include provisions, such as providing
      for three classes of directors, which are intended to enhance the likelihood
      of
      continuity and stability in the composition of our board of directors. These
      provisions may make it more difficult to remove our directors and management
      and
      may adversely affect the price of our common stock. In addition, our certificate
      of incorporation authorizes the issuance of "blank check" preferred stock.
      This
      provision could have the effect of delaying, deterring or preventing a future
      takeover or a change in control, unless the takeover or change in control is
      approved by our board of directors, even though the transaction might offer
      our
      stockholders an opportunity to sell their shares at a price above the current
      market price.






**ITEM
      1B.**  **UNRESOLVED
      STAFF COMMENTS**




None.






**ITEM
      2.**  **PROPERTIES**




Our
      corporate headquarters are located in Saddle River, New Jersey where we lease
      approximately 84,000 square feet. The lease runs for a term of approximately
      twelve years, which began in July 2004. We entered into a sublease for
      approximately 16,000 square feet of space in the Saddle River facility for
      a
      term of five years which began in July 2005. The sublease allows the subtenant
      a
      renewal option for an additional term of two years. TVG operates out of a 37,000
      square foot facility in Dresher, Pennsylvania under a lease that runs for a
      term
      of approximately twelve years which began in January 2005. Pharmakon operates
      out of a 6,700 square foot facility in Schaumburg, Illinois, under a lease
      that
      expires in February 2010. We believe that our current facilities are adequate
      for our current and foreseeable operations and that suitable additional space
      will be available if needed.




In
      2006,
      we had net charges of approximately $657,000 related to unused office space
      capacity at our Saddle River, New Jersey and Dresher, Pennsylvania locations
      and
      $1.3 million in asset impairment charges for leasehold improvements and
      furniture and fixtures associated with the unused office space at those
      facilities. In the fourth quarter of 2005, we recorded charges of approximately
      $2.4 million related to unused office space capacity at our Saddle River and
      Dresher locations. There are approximately 19,400 and 11,000 square feet of
      unused office space at Saddle River and Dresher, respectively, which we are
      seeking to sublease in 2007.




**ITEM
      3.**  **LEGAL
      PROCEEDINGS**




**Securities
      Litigation**




In
      January and February 2002, we, our former chief executive officer and our former
      chief financial officer were served with three complaints that were filed in
      the
      U.S. District Court for the District of New Jersey (the Court) alleging
      violations of the Exchange Act. These complaints were brought as purported
      shareholder class actions under Sections 10(b) and 20(a) of the Exchange Act
      and
      Rule 10b-5 established thereunder. On May 23, 2002, the Court consolidated
      all
      three lawsuits into a single action entitled In re PDI Securities Litigation,
      Master File No. 02-CV-0211, and appointed lead plaintiffs (Lead Plaintiffs)
      and
      Lead Plaintiffs’ counsel. On or about December 13, 2002, Lead Plaintiffs filed a
      second consolidated and amended complaint (Second Consolidated and Amended
      Complaint), which superseded their earlier complaints.







14
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





In
      February 2003, we filed a motion to dismiss the Second Consolidated and Amended
      Complaint. On or about August 22, 2005, the Court dismissed the Second
      Consolidated and Amended Complaint without prejudice to plaintiffs.




On
      October 21, 2005, Lead Plaintiffs filed a third consolidated and amended
      complaint (Third Consolidated and Amended Complaint). Like its predecessor,
      the
      Third Consolidated and Amended Complaint named us, our former chief executive
      officer and our former chief financial officer as defendants; purported to
      state
      claims against us on behalf of all persons who purchased our common stock
      between May 22, 2001 and August 12, 2002; and sought money damages in
      unspecified amounts and litigation expenses including attorneys’ and experts’
fees. The essence of the allegations in the Third Consolidated and Amended
      Complaint was that we intentionally or recklessly made false or misleading
      public statements and omissions concerning our prospects with respect to our
      marketing of Ceftin in connection with the October 2000 distribution agreement
      with GSK, our marketing of Lotensin in connection with the May 2001 distribution
      agreement with Novartis Pharmaceuticals Corporation, as well as our marketing
      of
      Evista in connection with the October 2001 distribution agreement with Eli
      Lilly
      and Company.




On
      December 21, 2005, we filed a motion to dismiss the Third Consolidated and
      Amended Complaint under the Private Securities Litigation Reform Act of 1995
      and
      Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure. On November
      2,
      2006, the Court issued an Opinion and Order dismissing with prejudice all claims
      asserted in the Third Consolidated and Amended Complaint against all defendants
      and denied Lead Plaintiffs’ request to amend the complaint.




**Bayer-Baycol
      Litigation**




We
      have
      been named as a defendant in numerous lawsuits, including two class action
      matters, alleging claims arising from the use of Baycol, a prescription
      cholesterol-lowering medication. Baycol was distributed, promoted and sold
      by
      Bayer in the U.S. through early August 2001, at which time Bayer voluntarily
      withdrew Baycol from the U.S. market. Bayer had retained certain companies,
      such
      as us, to provide detailing services on its behalf pursuant to contract sales
      force agreements. We may be named in additional similar lawsuits. To date,
      we
      have defended these actions vigorously and have asserted a contractual right
      of
      defense and indemnification against Bayer for all costs and expenses we incur
      relating to these proceedings. In February 2003, we entered into a joint defense
      and indemnification agreement with Bayer, pursuant to which Bayer has agreed
      to
      assume substantially all of our defense costs in pending and prospective
      proceedings and to indemnify us in these lawsuits, subject to certain limited
      exceptions. Further, Bayer agreed to reimburse us for all reasonable costs
      and
      expenses incurred through such date in defending these proceedings. As of
      December 31, 2006, Bayer has reimbursed us for approximately $1.6 million in
      legal expenses, the majority of which was received in 2003 and was reflected
      as
      a credit within selling, general and administrative expense. We did not incur
      any costs or expenses relating to these matters during 2006, 2005 or 2004.




**Cellegy
      Litigation**




On
      April
      11, 2005, we settled a lawsuit which was pending in the U.S. District Court
      for
      the Northern District of California against Cellegy Pharmaceuticals, Inc.
      (Cellegy), which was set to go to trial in May 2005 (PDI, Inc. v. Cellegy
      Pharmaceuticals, Inc., Case No. C 03-05602 (SC)). We had claimed (i) that we
      were fraudulently induced to enter into a December 31, 2002 license agreement
      with Cellegy (the License Agreement) to market the product Fortigel and (ii)
      that Cellegy had otherwise breached the License Agreement by failing, inter
      alia, to provide us with full information about Fortigel or to take all
      necessary steps to obtain expeditious FDA approval of Fortigel. We sought return
      of our $15 million upfront payment, other damages and an order rescinding the
      License Agreement. Under the terms of the settlement, in exchange for our
      executing a stipulation of dismissal with prejudice of the lawsuit, Cellegy
      agreed to and did deliver to us: (i) a cash payment in the amount of $2.0
      million; (ii) a Secured Promissory Note in the principal amount of $3.0 million,
      with a maturity date of October 11, 2006; (iii) a Security Agreement, granting
      us a security interest in certain collateral; and (iv) a Nonnegotiable
      Convertible Senior Note, with a face value of $3.5 million, with a maturity
      date
      of April 11, 2008.




In
      addition to the initial $2.0 million we received on April 11, 2005, Cellegy
      had
      paid us $200,000 in 2005 and $458,500 through June 30, 2006 towards the
      outstanding principal balance of the Secured Promissory Note. These payments
      were recorded as a credit to litigation expense in the periods in which they
      were received.







15
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





On
      December 1, 2005, we commenced a breach of contract action against Cellegy
      in
      the U.S. District Court for the Southern District of New York (PDI, Inc. v.
      Cellegy Pharmaceuticals, Inc., 05 Civ. 10137 (PKL)). We alleged that Cellegy
      breached the terms of the Security Agreement and Secured Promissory Note we
      received in connection with the settlement. We further alleged that to secure
      its debt to us, Cellegy granted us a security interest in certain "Pledged
      Collateral," which was broadly defined in the Security Agreement to include,
      among other things, 50% of licensing fees, royalties or "other payments in
      the
      nature thereof" received by Cellegy in connection with then-existing or future
      agreements for Cellegy's drugs Rectogesic® and Tostrex® outside of the U.S.,
      Mexico, and Canada. Upon receipt of such payments, Cellegy agreed to make prompt
      payment to us. We alleged that we were owed 50% of a $2.0 million payment
      received by Cellegy in connection with the renegotiation of its license and
      distribution agreement for Rectogesic® in Europe, and that Cellegy's failure to
      pay us constituted an event of default under the Security Agreement and the
      related Secured Promissory Note. For Cellegy's breach of contract, we sought
      damages in the total amount of $6.4 million plus default interest from Cellegy.




On
      December 27, 2005, Cellegy filed an answer to our complaint, denying the
      allegations contained therein, and asserting affirmative defenses. Discovery
      subsequently commenced and pursuant to a scheduling order entered by the court,
      was to be completed by November 21, 2006. On June 22, 2006, the parties appeared
      before the court for a status conference and agreed to a dismissal of the
      lawsuit without prejudice because, among other reasons, discovery would not
      be
      complete before October 11, 2006, the maturity date of the Secured Promissory
      Note, at which time Cellegy would owe us the entire unpaid principal balance
      and
      interest on the Second Promissory Note. On July 13, 2006, the court dismissed
      the December 1, 2005 breach of contract lawsuit without prejudice. This had
      no
      effect on the original settlement.




On
      September 27, 2006, Cellegy announced that it had entered into an asset purchase
      agreement to sell
      its intellectual property rights and other assets relating to certain of its
      products and product candidates to Strakan International Limited (the Sale).
      Pursuant to a letter agreement between Cellegy and us, Cellegy agreed to pay
      us
      $3.0 million (the Payoff Amount) in full satisfaction of Cellegy’s obligations
      to us under the Secured Promissory Note, which had an outstanding principal
      amount of approximately $2.34 million, and the $3.5 million Nonnegotiable
      Convertible Senior Note (collectively, the Notes). Pursuant to the letter
      agreement, $500,000 of the Payoff Amount was paid to us in September 2006,
      and
      the remaining $2.5 million was paid to us in December 2006 upon consummation
      of
      the Sale. We
      had
      previously established an allowance for doubtful notes for the outstanding
      balance of the Notes; therefore, the Agreement did not result in the recognition
      of a loss. The $3.0 million received was recorded as a credit to litigation
      expense.




**California
      Class Action Litigation**




On
      September 26, 2005, we were served with a complaint in a purported class action
      lawsuit that was commenced against us in the Superior Court of the State of
      California for the County of San Francisco on behalf of certain of our current
      and former employees, alleging violations of certain sections of the California
      Labor Code. During the quarter ended September 30, 2005, we accrued
      approximately $3.3 million for potential penalties and other settlement costs
      relating to both asserted and unasserted claims relating to this matter. In
      October 2005, we filed an answer generally denying the allegations set forth
      in
      the complaint. In December 2005, we reached a tentative settlement of this
      action, subject to court approval. As a result, we reduced our accrual relating
      to asserted and unasserted claims relating to this matter to $600,000 during
      the
      quarter ended December 31, 2005. In October 2006, we received preliminary
      settlement approval from the court and the final approval hearing was held
      in
      January 2007. Pursuant to the settlement, we are currently in the process of
      distributing payments to the class members, their counsel and the California
      Labor and Workforce Development Agency in an aggregate amount of approximately
      $50,000.




**Other
      Legal Proceedings**




We
      are
      currently a party to other legal proceedings incidental to our business. As
      required, we have accrued our estimate of the probable costs for the resolution
      of these claims. While management currently believes that the ultimate outcome
      of these proceedings, individually and in the aggregate, will not have a
      material adverse effect on our business, financial condition or results of
      operations, litigation is subject to inherent uncertainties. Were we to settle
      a
      proceeding for a material amount or were an unfavorable ruling to occur, there
      exists the possibility of a material adverse impact on our business, financial
      condition or results of operations. Legal fees are expensed as
      incurred.






**ITEM
      4.**  **SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDERS**




None.







16
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





**PART
      II**




**ITEM
      5.**  **MARKET
      FOR OUR COMMON EQUITY, RELATED STOCKHOLDER MATTERS**




**AND
      ISSUER PURCHASES OF EQUITY** **SECURITIES**




**Market
      Information**




Our
      common stock is traded on the Nasdaq Global Market under the symbol “PDII.” The
      price range per share of common stock presented below represents the highest
      and
      lowest closing price for our common stock on the Nasdaq Global Market for the
      last two years by quarter:







2006
            
            2005HIGH
            
            LOW
            
            HIGH
            
            LOWFirst
                quarter
            
            $
            15.00
            
            $
            9.70
            
            $
            21.45
            
            $
            19.00Second
                quarter
            
            $
            14.59
            
            $
            10.14
            
            $
            20.77
            
            $
            11.27Third
                quarter
            
            $
            15.50
            
            $
            11.01
            
            $
            15.99
            
            $
            12.36Fourth
                quarter
            
            $
            11.57
            
            $
            9.53
            
            $
            15.24
            
            $
            12.38






**Holders**




We
      had
      336 stockholders of record as of March 8, 2007. Not reflected in the number
      of
      record holders are persons who beneficially own shares of common stock held
      in
      nominee or street name.




**Dividend** **s**




We
      have
      not declared any cash dividends and do not intend to declare or pay any cash
      dividends in the foreseeable future. Future earnings, if any, will be used
      to
      finance the future operation and growth of our business.




**Securities** **Authorized
      For Issuance Under Equity Compensation Plans**




We
      have
      in effect a number of stock-based incentive and benefit programs designed to
      attract and retain qualified directors, executives and management personnel.
      All
      equity compensation plans have been approved by security holders. The following
      table sets forth certain information with respect to our equity compensation
      plans as of December 31, 2006:




Number
                  of securitiesremaining
                  available forNumber
                  of securities to
              
              Weighted-average
              
              future
                  issuancebe
                  issued upon exercise
              
              exercise
                  price of
              
              (excluding
                  securitiesPlan
                  Category
              
              of
                  outstanding options (a)(1)
              
              outstanding
                  options (b)
              
              reflected
                  in column (a))(1)Equity
                  compensation plansapproved
                  by security holders(2004
                  Stock Award andIncentive
                  Plan, 2000 OmnibusIncentive
                  Compensation Plan,and
                  1998 Stock Option Plan)
              
              
              807,238
              
              $
              26.03
              
              
              1,028,453Equity
                  compensation plans notapproved
                  by security holders
              
              
              -
              
              
              -
              
              
              -Total
              
              
              807,238
              
              $
              26.03
              
              
              1,028,453(1)
                  Excludes restricted stock and stock-settled stock appreciation
                  rights.









17
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**







**Issuer
      Purchases Of Equity Securities**




From
      time
      to time, we repurchase our common stock on the open market or in privately
      negotiated transactions or both. We did not repurchase any shares of our common
      stock during 2006. On November 7, 2006 we announced that our Board of Directors
      authorized us to repurchase up to one million shares of our common stock. We
      have not repurchased any shares of our common stock during 2007 as of the date
      of this Form 10-K. Purchases, if any, will be made from available
      cash.




**Comparative
      Stock Performance Graph**




The
      graph
      below compares the yearly percentage change in the cumulative total stockholder
      return on our common stock, based on the market price of our common stock,
      with
      the total return of companies included within the Nasdaq Composite Index for
      the
      period commencing December 31, 2001 and ending December 31, 2006. The
      calculation of total cumulative return assumes a $100 investment in the
      Company’s common stock and the Nasdaq Composite Index on December 31, 2001, and
      the reinvestment of all dividends.












**ITEM
      6.**  **SELECTED
      FINANCIAL DATA**




The
      selected financial data set forth below should be read in conjunction with
      "Management's Discussion and Analysis of Financial Condition and Results of
      Operations" and our consolidated financial statements and related notes
      appearing elsewhere in this Form 10-K. The operations data for the years ended
      December 31, 2006, 2005, and 2004 and the balance sheet data at December 31,
      2006 and 2005 are derived from our audited consolidated financial statements
      appearing elsewhere in this Form 10-K. The operations data for the years ended
      December 31, 2003 and 2002 and the balance sheet data at December 31, 2004,
      2003
      and 2002 are derived from our audited consolidated financial statements that
      are
      not included in this Form 10-K. The historical results are not necessarily
      indicative of the results to be expected in any future period. Operations data
      for the year ended December 31, 2006 include the effect of adopting of SFAS
      No.
      123, “(Revised 2004): Share-Based Payment” (FAS 123R) as of January 1, 2006.
      Operations data for the years ended December 31, 2005, 2004, 2003, and 2002
      do
      not include any effect from FAS 123R.







18
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**







(in
                    thousands, except per share data)
                
                **2006**
                
                
                
                **2005**
                
                
                
                **2004**
                
                
                
                **2003**
                
                
                
                **2002**Continuing
                      operations data:Total
                    revenues, net
                
                $
                239,242
                
                
                
                $
                305,205
                
                
                
                $
                345,797
                
                (4
                )
                $
                330,547
                
                (5
                )
                $
                295,199
                
                (5
                )Gross
                    profit
                
                
                55,844
                
                
                
                
                52,402
                
                
                
                
                92,633
                
                
                
                
                84,960
                
                
                
                
                25,070Operating
                    expenses
                
                
                49,931
                
                (1
                )
                
                65,064
                
                (2
                )
                
                58,554
                
                
                
                
                65,897
                
                
                
                
                73,251
                
                (6
                )Asset
                    impairment
                
                
                -
                
                
                
                
                6,178
                
                (3
                )
                
                -
                
                
                
                
                -
                
                
                
                
                -Total
                    operating expenses
                
                
                49,931
                
                
                
                
                71,242
                
                
                
                
                58,554
                
                
                
                
                65,897
                
                
                
                
                73,251Income
                    (loss) fromcontinuing
                    operations
                
                $
                11,375
                
                
                
                $
                (11,407
                )
                
                
                $
                20,435
                
                
                
                $
                11,931
                
                
                
                $
                (29,540
                )Per
                    share data from continuing operations:Income
                    (loss) per share of common stockBasic
                
                $
                0.82
                
                
                
                $
                (0.80
                )
                
                
                $
                1.40
                
                
                
                $
                0.84
                
                
                
                $
                (2.11
                )Diluted
                
                $
                0.81
                
                
                
                $
                (0.80
                )
                
                
                $
                1.37
                
                
                
                $
                0.83
                
                
                
                $
                (2.11
                )Weighted
                    average number of shares outstanding:Basic
                
                
                13,859
                
                
                
                
                14,232
                
                
                
                
                14,564
                
                
                
                
                14,231
                
                
                
                
                14,033Diluted
                
                
                13,994
                
                
                
                
                14,232
                
                
                
                
                14,893
                
                
                
                
                14,431
                
                
                
                
                14,033Balance
                    sheet data:Cash
                    and short-term investments
                
                $
                114,684
                
                
                
                $
                97,634
                
                
                
                $
                109,498
                
                
                
                $
                114,632
                
                
                
                $
                72,661Working
                    capital
                
                
                112,186
                
                
                
                
                92,264
                
                
                
                
                96,156
                
                
                
                
                100,009
                
                
                
                
                81,854Total
                    assets
                
                
                201,636
                
                
                
                
                200,159
                
                
                
                
                224,705
                
                
                
                
                219,623
                
                
                
                
                190,939Total
                    long-term debt
                
                
                -
                
                
                
                
                -
                
                
                
                
                -
                
                
                
                
                -
                
                
                
                
                -Stockholders'
                    equity
                
                
                149,197
                
                
                
                
                135,610
                
                
                
                
                165,425
                
                
                
                
                138,488
                
                
                
                
                123,211


(1)
            Includes
                $4.0 million in credits to legal expense related to settlements in
                the
                Cellegy litigation matter and the California class action lawsuit
                and $2.0
                million in charges for facilities realignment costs. See Note 9 and
                Note
                17 to the consolidated financial statements for more details.




(2)
            Includes
                $5.7 million for executive severance costs and $2.4 million for facilities
                realignment costs. See Notes 16 and 17 to the consolidated financial
                statements for more details.




(3)
            Asset
                impairment charges include a $3.3 million non-cash charge for the
                impairment of the goodwill associated with the Select Access reporting
                unit; and a $2.8 million non-cash charge for the impairment of the
                Siebel
                sales force automation platform. See Notes 4 and 5 to the consolidated
                financial statements for more
                details.




(4)
            Includes
                revenue of $4.9 million associated with the acquisition of Pharmakon
                on
                August 31, 2004.




(5)
            Includes
                product revenue of negative $11.6 million in 2003 for the Ceftin
                returns
                reserve, which we began selling in the fourth quarter of 2000. For
                2002,
                it includes product revenue of $6.4 million that related to Ceftin.
                See
                Note 15 to the consolidated financial statements for more details.




(6)
            Includes
                $15.0 million for the initial licensing fee associated with the Cellegy
                License Agreement, and $3.2 million associated with our 2002
                restructuring.







19
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**







**ITEM
      7.**  **MANAGEMENT'S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS**




We
      make
      forward-looking statements that involve risks, uncertainties and assumptions
      in
      this Form 10-K. Actual results may differ materially from those anticipated
      by
      these forward-looking statements as a result of various factors, including,
      but
      not limited to, those presented under the captions “Forward-Looking Statement
      Information” and “Risk Factors” contained elsewhere in this Form
      10-K.




The
      following Management’s Discussion and Analysis of Financial Condition and
      Results of Operations should be read in conjunction with our consolidated
      financial statements and the related notes appearing elsewhere in this Form
      10-K.




**OVERVIEW**




We
      are a
      diversified sales and marketing services company serving the biopharmaceutical
      and life sciences industries. We create and execute sales and marketing
      programs. We do this by working with companies who own the intellectual property
      rights to these products and recognize our ability to add value to these
      products and maximize their sales performance. We have a variety of agreement
      types that we enter into with our customers, from fee for service arrangements
      to arrangements which involve risk-sharing and incentive based
      provisions.




**DESCRIPTION
      OF REPORTING SEGMENTS AND NATURE OF CONTRACTS**




In
      the
      fourth quarter of 2005, we announced that we would be discontinuing our medical
      devices and diagnostics (MD&D) business unit. Beginning in the second
      quarter of 2006, the MD&D business unit was reported as discontinued
      operations. At December 31, 2006, our reporting segments are as
      follows:





 ̈  Sales
      Services:


·
            Performance
                Sales Teams; and


·
            Select
                Access.





 ̈
            Marketing
                Services:


·
            Vital
                Issues in Medicine (VIM)®;


·
            Pharmakon;
                and


·
            TVG
                Marketing Research and Consulting
                (TVG).




 ̈  PDI
      Products Group (PPG).




An
      analysis of these reporting segments and their results of operations is
      contained in Note 21 to our consolidated financial statements and in the *Consolidated
      Results of Operations* discussion below.




*Description
      of Businesses*




**Sales
      Services**




This
      segment includes our Performance Sales Teams and Select Access ’ Teams
      (formerly referred to as Shared Teams). This segment, which focuses on product
      detailing, represented 84.7% of consolidated revenue for the year ended December
      31, 2006.




Product
      detailing involves a representative meeting face-to-face with targeted
      physicians and other healthcare decision makers to provide a technical review
      of
      the product being promoted. Contract sales teams can be deployed on either
      a
      dedicated or shared basis.




Performance
      Sales Teams (formerly Dedicated Teams)




A
      performance contract sales team works exclusively on behalf of one customer.
      The
      sales team is customized to meet the specifications of the team’s customer with
      respect to representative profile, physician targeting, product training,
      incentive compensation plans, integration with customers’ in-house sales forces,
      call reporting platform and data integration. Without adding permanent
      personnel, the customer gets a high quality, industry-standard sales team
      comparable to its internal sales force.





20
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





Select
      Access ’




Select
      Access represents a shared sales team business model where multiple
      non-competing brands are represented for different pharmaceutical companies.
      Using these teams, we make a face-to-face selling resource available to those
      customers that want an alternative to a dedicated team. PDI Select Access is
      a
      leading provider of these detailing programs in the U.S. Since costs are shared
      among various companies, these programs may be less expensive for the customer
      than programs involving a dedicated sales force. With a shared sales team,
      the
      customer still receives targeted coverage of its physician audience within
      the
      representatives’ geographic territories.




**Marketing
      Services**




This
      segment, which includes our Pharmakon, TVG and VIM business units, represented
      15.3% of
      consolidated revenue for the year ended December 31, 2006.




Pharmakon




Pharmakon’s
      emphasis is on the creation, design and implementation of promotional
      interactive peer persuasion programs. Each marketing program can be offered
      through a number of different venues, including teleconferences, dinner
      meetings, “lunch and learns,” and web casts. Within each of our programs, we
      offer a number of services including strategic design, tactical execution,
      technology support, audience recruitment, moderator services and thought leader
      management. In the last ten years, Pharmakon has conducted over 45,000 peer
      persuasion programs with more than 550,000 participants. Pharmakon’s peer
      programs can be designed as promotional or marketing research/advisory programs.
      In addition to peer persuasion programs, Pharmakon also provides promotional
      communications activities. We acquired Pharmakon in August 2004.




TVG
      Marketing Research & Consulting




TVG
      employs leading edge, and in some instances proprietary, research methodologies.
      We provide qualitative and quantitative marketing research to pharmaceutical
      companies with respect to healthcare providers, patients and managed care
      customers in the U.S. and globally. We offer a full range of pharmaceutical
      marketing research services, including studies to identify the highest impact
      business strategy, profile, positioning, message, execution, implementation
      and
      post implementation for a product. Our marketing research model improves the
      knowledge customers obtain about how physicians and other healthcare
      professionals will likely react to products.




We
      utilize a systematic approach to pharmaceutical marketing research. Recognizing
      that every marketing need, and therefore every marketing research solution,
      is
      unique, we have developed our marketing model to help identify the work that
      needs to be done in order to identify critical paths to marketing goals. At
      each
      step of the marketing model, we can offer proven research techniques,
      proprietary methodologies and customized study designs to address specific
      product needs.




Vital
      Issues in Medicine




VIM
      develops and executes continuing medical education services funded by the
      biopharmaceutical and medical device and diagnostics industries. Using an
      expert-driven, customized approach, we provide faculty development/advocacy,
      continuing medical education activities in a wide variety of formats, and
      interactive initiatives to generate added-value to our customers'
      portfolios.




**PDI
      Products Group (PPG)**




The
      goal
      of the PPG segment was to source biopharmaceutical products in the U.S. through
      licensing, copromotion, acquisition or integrated commercialization services
      arrangements. This segment did not have any revenue for the years ended December
      31, 2006 and 2005.




Notwithstanding
      the fact that we have in recent years shifted our near-term strategy to
      deemphasize the PPG segment and focus on our service businesses, we may continue
      to review opportunities which may include copromotion, distribution
      arrangements, licensing and brand ownership of products. We currently do not
      expect any activity within the PPG segment in 2007.




*Discontinued
      Operations*




MD&D
      Contract Sales and Clinical Sales Teams




Our
      medical teams group provided an array of sales and marketing services to the
      MD&D industry. It provided dedicated sales teams to the MD&D industry as
      well as clinical after sales support teams.







21
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





*Nature
      of Contracts by Segment*




Our
      contracts are nearly all fee for service. They may contain operational
      benchmarks, such as a minimum amount of activity within a specified amount
      of
      time. These contracts may include incentive payments that can be earned if
      our
      activities generate results that meet or exceed performance targets. Contracts
      may be terminated with or without cause by our customers. Certain contracts
      provide that we may incur specific penalties if we fail to meet stated
      performance benchmarks. Occasionally, our contracts may require us to meet
      certain financial covenants, such as maintaining a specified minimum amount
      of
      working capital.




*Sales
      Services*




During
      fiscal 2006, the majority of our revenue was generated by contracts for
      dedicated sales teams. These contracts are generally for a term of one to two
      years and may be renewed or extended. The majority of these contracts, however,
      are terminable by the customer for any reason upon 30 to 90 days’ notice.
      Certain contracts provide for termination payments if the customer terminates
      the contract without cause. Typically, however, these penalties do not offset
      the revenue we could have earned under the contract or the costs we may incur
      as
      a result of its termination. The loss or termination of a large contract or
      the
      loss of multiple contracts could have a material adverse effect on our business,
      financial condition or results of operations.




*Marketing
      Services*




Our
      marketing services contracts generally take the form of either master service
      agreements with a term of one to three years or contracts specifically related
      to particular projects with terms typically lasting from two to six months.
      These contracts are generally terminable by the customer for any reason. Upon
      termination, the customer is generally responsible for payment for all work
      completed to date, plus the cost of any nonrefundable commitments made on behalf
      of the customer. There is significant customer concentration in our Pharmakon
      business, and the loss or termination of one or more of Pharmakon’s large master
      service agreements could have a material adverse effect on our business,
      financial condition or results of operations. Due to the typical size of most
      of
      TVG’s and VIM’s contracts, it is unlikely the loss or termination of any
      individual TVG or VIM contract would have a material adverse effect on our
      business, financial condition or results of operations.




*PPG*




The
      contracts within the products group were either performance based or fee for
      service and may have required sales, marketing and distribution of a product.
      In
      performance based contracts, we typically provided and financed a portion,
      if
      not all, of the commercial activities in support of a brand in return for a
      percentage of product sales. An important performance parameter was normally
      the
      level of sales or prescriptions attained by the product during the period of
      our
      marketing or promotional responsibility, and in some cases, for periods after
      our promotional activities have ended.






**CRITICAL
      ACCOUNTING POLICIES**




We
      prepare our financial statements in accordance with U.S. generally accepted
      accounting principles (GAAP). The preparation of financial statements and
      related disclosures in conformity with GAAP requires our management to make
      judgments, estimates and assumptions at a specific point in time that affect
      the
      amounts reported in the consolidated financial statements and disclosed in
      the
      accompanying notes. These assumptions and estimates are inherently
      uncertain.  Outlined below are accounting policies, which are important to
      our financial position and results of operations, and require the most
      significant judgments on the part of our management in their application. 
Some of those judgments can be subjective and complex. Management’s estimates
      are based on historical experience, information from third-party professionals,
      facts and circumstances available at the time and various other assumptions
      that
      are believed to be reasonable.  Actual results could differ from those
      estimates. Additionally, changes in estimates could have a material impact
      on
      our consolidated results of operations in any one period. For a summary of
      all
      of our significant accounting policies, including the accounting policies
      discussed below, see Note 1 to our consolidated financial statements.




*Goodwill,
      Intangibles and Other Long-Lived Assets*




We
      account for our purchases of acquired companies in accordance with SFAS No.
      141, *"Business
      Combinations"* (FAS
      141) and account for the related goodwill and other identifiable definite and
      indefinite-lived acquired intangible assets in accordance with SFAS No. 142, *“Goodwill
      and Other Intangible Assets”* (FAS
      142). Additionally, we review our lived-assets for recoverability in accordance
      with SFAS No. 144, “ *Accounting
      for the* *Impairment
      or Disposal of Long-Lived Assets”* (FAS
      144). **







22
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





The
      identification and valuation of these intangible assets and the determination
      of
      the estimated useful lives at the time of acquisition, as well as the completion
      of annual impairment tests require significant management judgments and
      estimates.  These estimates are made based on, among others, consultations
      with an accredited independent valuation consultant, reviews of projected future
      cash flows and statutory regulations.  In accordance with FAS 141, we
      allocate the cost of the acquired companies to the identifiable tangible and
      intangible assets and liabilities acquired, with the remaining amount being
      classified as goodwill.  Since the entities we have acquired do not have
      significant tangible assets, a significant portion of the purchase price has
      been allocated to intangible assets and goodwill.  The use of alternative
      estimates and assumptions could increase or decrease the estimated fair value
      of
      our goodwill and other intangible assets, and potentially result in a different
      impact to our results of operations.  Further, changes in business strategy
      and/or market conditions may significantly impact these judgments thereby
      impacting the fair value of these assets, which could result in an impairment
      of
      the goodwill and acquired intangible assets.




We
      have
      elected to do the annual tests for indications of goodwill impairment as of
      December 31  of
      each
      year.  We utilize a discounted cash flow model to determine fair value in
      the goodwill impairment evaluation.
      In assessing the recoverability of goodwill, projections regarding estimated
      future cash flows and other factors are made to determine the fair value of
      the
      respective reporting units.




We
      review
      the carrying value of long-lived assets for impairment whenever events or
      changes in circumstances indicate that the carrying value of such assets may
      not
      be recoverable. If the sum of the expected future undiscounted cash flows is
      less than the carrying amount of the asset, an impairment loss is recognized
      by
      reducing the recorded value of the asset to its fair value.




While
      we
      use available information to prepare our estimates and to perform impairment
      evaluations, actual results could differ significantly from these estimates
      or
      related projections, resulting in impairment and losses related to recorded
      goodwill or long-lived asse t
      balances.




*Revenue
      Recognition and Associated Costs*




Revenue
      and associated costs under pharmaceutical detailing contracts are generally
      based on the number of physician details made or the number of sales
      representatives utilized. With respect to risk-based contracts, all or a portion
      of revenues earned are based on contractually defined percentages of either
      product revenues or the market value of prescriptions written and filled in
      a
      given period. These contracts are generally for terms of one to two years and
      may be renewed or extended. The majority of these contracts, however, are
      terminable by the customer for any reason upon 30 to 90 days’ notice. Certain
      contracts provide for termination payments if the customer terminates us without
      cause. Typically, however, these penalties do not offset the revenue we could
      have earned under the contract or the costs we may incur as a result of its
      termination. The loss or termination of a large pharmaceutical detailing
      contract or the loss of multiple contracts could have a material adverse effect
      on our business, financial condition or results of operations. See Note 14
      to
      the consolidated financial statements.




Revenue
      and associated costs under marketing service contracts are generally based
      on a
      single deliverable such as a promotional program, accredited continuing medical
      education seminar or marketing research/advisory program. The contracts are
      generally terminable by the customer for any reason. Upon termination, the
      customer is generally responsible for payment for all work completed to date,
      plus the cost of any nonrefundable commitments made on behalf of the customer.
      There is significant customer concentration in our
      Pharmakon business, and the loss or termination of one or more of Pharmakon’s
      large master service agreements would have a material adverse on our business,
      financial condition or results of operations. Due to the typical size of most
      contracts of TVG and VIM, it is unlikely the loss or termination of any
      individual TVG or VIM contract.




Service
      revenue is recognized on product detailing programs and certain marketing,
      promotional and medical education contracts as services are performed and the
      right to receive payment for the services is assured. Many of the product
      detailing contracts allow for additional periodic incentive fees to be earned
      if
      certain performance benchmarks have been attained. Revenue earned from incentive
      fees is recognized in the period earned and when we are reasonably assured
      that
      payment will be made. Under performance based contracts, revenue is recognized
      when the performance based parameters are achieved. Many contracts also
      stipulate penalties if agreed upon performance benchmarks have not been met.
      Revenue is recognized net of any potential penalties until the performance
      criteria relating to the penalties have been achieved. Revenue and associated
      costs from marketing research contracts are recognize upon completion of the
      contract. These contracts are generally short-term in nature, typically lasting
      two to six months.







23
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





Cost
      of
      services consist primarily of the costs associated with executing product
      detailing programs, performance based contracts or other sales and marketing
      services identified in the contract. Cost of services include personnel costs
      and other costs associated with executing a product detailing or other marketing
      or promotional program, as well as the initial direct costs associated with
      staffing a product detailing program. Such costs include, but are not limited
      to, facility rental fees, honoraria and travel expenses, sample expenses and
      other promotional expenses.




Personnel
      costs, which constitute the largest portion of cost of services, include all
      labor related costs, such as salaries, bonuses, fringe benefits and payroll
      taxes for the sales representatives and sales managers and professional staff
      that are directly responsible for executing a particular program. Initial direct
      program costs are those costs associated with initiating a product detailing
      program, such as recruiting, hiring, and training the sales representatives
      who
      staff a particular product detailing program. All personnel costs and initial
      direct program costs, other than training costs, are expensed as incurred for
      service offerings.




Reimbursable
      out-of-pocket expenses include those relating to travel and other similar costs,
      for which we are reimbursed at cost by our customers. In accordance with the
      requirements of Emerging Issues Task Force No. 01-14, *“Income
      Statement Characterization of Reimbursements Received for Out-of-Pocket Expenses
      Incurred”* (EITF
      01-14), reimbursements received for out-of-pocket expenses incurred are
      characterized as revenue and an identical amount is included as cost of goods
      and services in the consolidated statements of operations.




Training
      costs include the costs of training the sales representatives and managers
      on a
      particular product detailing program so that they are qualified to properly
      perform the services specified in the related contract. For all contracts,
      training costs are deferred and amortized on a straight-line basis over the
      shorter of the life of the contract to which they relate or 12 months. When
      we
      receive a specific contract payment from a customer upon commencement of a
      product detailing program expressly to compensate us for recruiting, hiring
      and
      training services associated with staffing that program, such payment is
      deferred and recognized as revenue in the same period that the recruiting and
      hiring expenses are incurred and amortization of the deferred training is
      expensed. When we do not receive a specific contract payment for training,
      all
      revenue is deferred and recognized over the life of the contract.




Product
      revenue was recognized when products are shipped and title is transferred to
      the
      customer. Product revenue for the year ended December 31, 2004 was negative,
      primarily from the adjustments to the Ceftin sales returns reserve, as discussed
      in Note 15, net of the sale of the Xylos Corporation (Xylos) wound care
      products.




Cost
      of
      goods sold includes all expenses for product distribution costs, acquisition
      and
      manufacturing costs of the product sold.




*Loans
      and Investments in Privately Held Entities*




From
      time
      to time, we make investments in and/or loans to privately-held companies. We
      consider whether the fair values of any investments in privately held entities
      have declined below their carrying value whenever adverse events or changes
      in
      circumstances indicate that recorded values may not be recoverable.  If we
      considered any such decline to be other than temporary (based on various
      factors, including historical financial results, and the overall health of
      the
      investee’s industry), a write-down would be recorded to estimated fair
      value.  Additionally, on a quarterly basis, we review outstanding loans
      receivable to determine if a provision for doubtful accounts is necessary. 
Our review includes discussions with senior management of the investee, and
      evaluations of, among other things, the investee’s progress against its business
      plan, its product development activities and customer base, industry market
      conditions, historical and projected financial performance, expected cash needs
      and recent funding events.  Our assessments of value are highly subjective
      given that these companies may be at an early stage of development and rely
      regularly on their investors for cash infusions.




*Allowance
      for Doubtful Accounts*




** We
      maintain allowances for doubtful accounts for estimated losses resulting from
      the inability of our customers to make required payments.  We review a
      customer’s credit history before extending credit. We establish an allowance for
      doubtful accounts based on the aging of a customer’s accounts receivable or when
      we become aware of a customer’s inability to meet its financial obligations
      (e.g., a bankruptcy filing). We operate almost exclusively in the pharmaceutical
      industry and to a great extent our revenue is dependent on a limited number
      of
      large pharmaceutical companies. We also partner with customers in the emerging
      pharmaceutical sector, some of whom may have limited financial resources. A
      general downturn in the pharmaceutical industry or a material adverse event
      to
      one or more of our emerging pharmaceutical customers could result in higher
      than
      expected customer defaults requiring additional allowances.







24
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





*Self-Insurance
      Accruals*




We
      are
      self-insured for certain losses for claims filed and claims incurred but not
      reported relating to workers’ compensation and automobile-related losses for our
      company-leased cars. Our liability is estimated on an actuarial undiscounted
      basis using individual case-based valuations and statistical analysis supplied
      by our insurance brokers and insurers and is based upon judgment and historical
      experience; however, the final cost of many of these claims may not be known
      for
      five years or longer. We maintain stop-loss coverage with third-party insurers
      to limit our total exposure on these programs. Management reviews these accruals
      on a quarterly basis. At December 31, 2006 and 2005, self-insurance accruals
      totaled $2.5 million and $3.8 million, respectively.




*Contingencies*




In
      the
      normal course of business, we are subject to various contingencies.
 Contingencies are recorded in the consolidated financial statements when
      it is probable that a liability will be incurred and the amount of the loss
      can
      be reasonably estimated, or otherwise disclosed, in accordance with SFAS No.
      5,
“ *Accounting
      for Contingencies”* (SFAS
      5) *.* We
      are currently involved in certain legal proceedings and, as required, we have
      accrued our estimate of the probable costs for the resolution of these
      claims.  These estimates are developed in consultation with outside counsel
      and are based upon an analysis of potential results, assuming a combination
      of
      litigation and settlement strategies.  Predicting the outcome of claims and
      litigation, and estimating related costs and exposures, involves substantial
      uncertainties that could cause actual costs to vary materially from
      estimates.




*Income
      Taxes*




In
      accordance with the provisions of SFAS No. 109, “ *Accounting
      for Income Taxes,”* we
      account for income taxes using the asset and liability method. This method
      requires recognition of deferred tax assets and liabilities for expected future
      tax consequences of temporary differences that currently exist between tax
      bases
      and financial reporting bases of our assets and liabilities based on enacted
      tax
      laws and rates.




We
      operate in multiple tax jurisdictions and provide taxes in each jurisdiction
      where we conduct business and are subject to taxation.  The breadth of our
      operations and the complexity of the various tax laws require assessments of
      uncertainties and judgments in estimating the ultimate taxes we will pay. The
      final taxes paid are dependent upon many factors, including negotiations with
      taxing authorities in various jurisdictions, outcomes of tax litigation and
      resolution of proposed assessments arising from federal and state audits. We
      have established estimated liabilities for federal and state income tax
      exposures that arise and meet the criteria for accrual under SFAS 5. ** These
      accruals represent accounting estimates that are subject to inherent
      uncertainties associated with the tax audit process.  We adjust these
      accruals as facts and circumstances change, such as the progress of a tax audit.
      We believe that any potential audit adjustments will not have a material adverse
      effect on our financial condition or liquidity. However, any adjustments made
      may be material to our consolidated results of operations for a reporting
      period.




Significant
      judgment is also required in evaluating the need for and magnitude of
      appropriate valuation allowances against deferred tax assets.  Deferred tax
      assets are regularly reviewed for recoverability.  We currently have
      significant deferred tax assets resulting from net operating loss carryforwards
      and deductible temporary differences. The realization of these assets is
      dependent on generating future taxable income.  A valuation allowance is
      required when it is more likely than not that all or a portion of a deferred
      tax
      asset will not be realized.




*Restructuring,
      Facilities Realignment and Related Costs*




From
      time
      to time, in order to consolidate operations, downsize and improve operating
      efficiencies, we recognize restructuring or facilities realignment charges.
      The
      recognition of these charges requires estimates and judgments regarding employee
      termination benefits, lease termination costs and other exit costs to be
      incurred when these actions take place.  Actual results can vary from these
      estimates, which results in adjustments in the period of the change in
      estimate.

















25
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





**CONSOLIDATED
      RESULTS OF OPERATIONS**




The
      following table sets forth for the periods indicated below selected statement
      of
      continuing operations data as a percentage of revenue. The trends illustrated
      in
      this table may not be indicative of future operating results.




Years
                  Ended December 31,**Continuing
                  operations data**
              
              2006
              
              2005
              
              2004
              
              2003
              
              2002Revenues:Service,
                  net
              
              
              100.0
              %
              
              100.0
              %
              
              100.4
              %
              
              103.5
              %
              
              97.8
              %Product,
                  net
              
              
              -
              
              
              -
              
              
              (0.4
              %)
              
              (3.5
              %)
              
              2.2
              %Total
                  revenues, net
              
              
              100.0
              %
              
              100.0
              %
              
              100.0
              %
              
              100.0
              %
              
              100.0
              %Cost
                  of goods and services:Cost
                  of services
              
              
              76.7
              %
              
              82.8
              %
              
              73.1
              %
              
              73.9
              %
              
              91.5
              %Cost
                  of goods sold
              
              
              -
              
              
              -
              
              
              0.1
              %
              
              0.4
              %
              
              -Total
                  cost of goods and services
              
              
              76.7
              %
              
              82.8
              %
              
              73.2
              %
              
              74.3
              %
              
              91.5
              %Gross
                  profit
              
              
              23.3
              %
              
              17.2
              %
              
              26.8
              %
              
              25.7
              %
              
              8.5
              %Operating
                  expenses:Compensation
                  expense
              
              
              11.7
              %
              
              8.5
              %
              
              8.9
              %
              
              10.6
              %
              
              10.4
              %Other
                  selling, general and administrative
              
              
              9.5
              %
              
              9.6
              %
              
              7.2
              %
              
              8.6
              %
              
              13.3
              %Asset
                  impairment
              
              
              -
              
              
              2.0
              %
              
              -
              
              
              -
              
              
              -Executive
                  severance
              
              
              0.2
              %
              
              1.9
              %
              
              0.1
              %
              
              -
              
              
              -Legal
                  and related costs, net
              
              
              (1.4
              %)
              
              0.6
              %
              
              0.7
              %
              
              0.7
              %
              
              1.1
              %Facilities
                  realignment
              
              
              0.8
              %
              
              0.8
              %
              
              -
              
              
              -
              
              
              -Total
                  operating expenses
              
              
              20.9
              %
              
              23.3
              %
              
              16.9
              %
              
              19.9
              %
              
              24.8
              %Operating
                  income (loss)
              
              
              2.5
              %
              
              (6.2
              %)
              
              9.9
              %
              
              5.8
              %
              
              (16.3
              %)Gain
                  (loss) on investments
              
              
              -
              
              
              1.5
              %
              
              (0.3
              %)
              
              -
              
              
              -Interest
                  income, net
              
              
              2.0
              %
              
              1.0
              %
              
              0.5
              %
              
              0.3
              %
              
              0.7
              %Income
                  (loss) from continuing operationsbefore
                  income taxes
              
              
              4.5
              %
              
              (3.7
              %)
              
              10.1
              %
              
              6.1
              %
              
              (15.7
              %)Income
                  tax (benefit) expense
              
              
              (0.3
              %)
              
              0.1
              %
              
              4.2
              %
              
              2.5
              %
              
              (5.6
              %)Income
                  (loss) from continuing operations
              
              
              4.8
              %
              
              (3.7
              %)
              
              5.9
              %
              
              3.6
              %
              
              (10.0
              %)






**Comparison
      of 2006 and 2005**




*Revenue
                  (in thousands)*Change
              
              Change2006
              
              2005
              
              ($)
              
              (%)Sales
                  services
              
              $
              202,748
              
              $
              270,420
              
              $
              (67,672
              )
              
              (25.0
              %)Marketing
                  services
              
              
              36,494
              
              
              34,785
              
              
              1,709
              
              
              4.9
              %PPG
              
              
              -
              
              
              -
              
              
              -
              
              
              -**Total**
              
              **$**
              **239,242**
              
              **$**
              **305,205**
              
              **$**
              **(65,963**
              **)**
              
              **(21.6**
              **%)**


Total
      revenues for 2006 were $239.2 million, a decrease of $66.0 million or 21.6%
      from
      revenues of $305.2 million for 2005. The decrease was primarily related to
      the
      termination of the AstraZeneca sales force effective April 30, 2006 which
      consisted of approximately 800 representatives. The Astra Zeneca termination
      resulted in a decrease in revenue of approximately $63.8 million.







26
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





The
      sales
      services segment generated $202.7 million in revenue for 2006, a decrease of
      $67.7 million compared to 2005. This decrease is primarily related to the
      AstraZeneca sales force termination mentioned above.




On
      September 26, 2006, we announced that we had received verbal notification from
      GSK of its intention not to renew its contract sales engagement with us for
      2007. The contract, which represented approximately $65 million to $70 million
      in revenue on an annual basis, expired as scheduled on December 31,
      2006.




On
      October 25, 2006, we also announced that we had received notification from
      sanofi-aventis of its intention to terminate its contract sales engagement
      with
      us effective December 1, 2006. The contract, which represented approximately
      $18
      million to $20 million in revenue on an annual basis, was previously scheduled
      to expire on December 31, 2006.




The
      marketing services segment generated $36.5 million in revenue in 2006, an
      increase of $1.7 million or 4.9% from revenue of $34.8 million in 2005. This
      is
      attributable to a $4.7 million increase in Pharmakon revenue, partially offset
      by declines in revenue at both the TVG and VIM units.




The
      PPG
      segment did not have any revenue in 2006.




*Cost
                  of services (in thousands)*Change
              
              Change2006
              
              2005
              
              ($)
              
              (%)Sales
                  services
              
              $
              163,735
              
              $
              231,768
              
              $
              (68,033
              )
              
              (29.4
              %)Marketing
                  services
              
              
              19,663
              
              
              21,035
              
              
              (1,372
              )
              
              (6.5
              %)PPG
              
              
              -
              
              
              -
              
              
              -
              
              
              -**Total**
              
              **$**
              **183,398**
              
              **$**
              **252,803**
              
              **$**
              **(69,405**
              **)**
              
              **(27.5**
              **%)**




Cost
      of
      services for 2006 was $183.4 million, which was $69.4 million or 27.5% less
      than
      cost of services of $252.8 million for 2005. The sales services segment had
      a
      reduction of $68.0 million in cost of services, which is primarily attributable
      to the reduction in the size of the sales force including the AstraZeneca
      termination mentioned above. Cost of services within the marketing services
      segment decreased approximately $1.4 million, or 6.5%. The PPG segment had
      no
      costs of services expense in either 2006 or 2005.




*Gross
                  profit (in thousands)*%
                  of
              
              
              
              %
                  of
              
              Change
              
              Change2006
              
              revenue
              
              2005
              
              revenue
              
              ($)
              
              (%)Sales
                  services
              
              $
              39,013
              
              
              19.2
              %
              $
              38,652
              
              
              14.3
              %
              $
              (361
              )
              
              0.9
              %Marketing
                  services
              
              
              16,831
              
              
              46.1
              %
              
              13,750
              
              
              39.5
              %
              
              (3,081
              )
              
              22.4
              %PPG
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -**Total**
              
              **$**
              **55,844**
              
              
              **23.3**
              **%**
              **$**
              **52,402**
              
              
              **17.2**
              **%**
              **$**
              **(3,442**
              **)**
              
              **6.6**
              **%**




During
      2006 the gross profit percentage was 23.3% compared to 17.2% in the comparable
      prior year period. The primary reasons for the increase were as
      follows:




·
            an
                increase in incentive revenue earned - $3.2 million greater in 2006
                than
                2005;


·
            the
                higher margin businesses within marketing services were a greater
                portion
                of consolidated revenue than they were in the prior period (15.3%
                in 2006
                vs. 11.4% in 2005)


·
            The
                gross profit percentage from our two largest customers was higher
                in 2006
                than in 2005. The primary reasons for this improvement were: 1) greater
                incentive revenue earned; 2) fewer net contractual penalties incurred
                for
                stated performance benchmarks; and 3) more stable service costs.
                In 2005,
                the sharp increase in fuel and travel costs was greater than the
                rates
                specified in our contracts which lowered our gross profit percentages;
                whereas in 2006 there was not a large disparity in fuel and travel
                costs
                when compared to our contractual
                reimbursements.




The
      sales
      services segment had gross profit of $39.0 million in 2006, with a gross profit
      percentage of 19.2%. During 2005 this segment had gross profit of $38.7 million
      and a gross profit percentage of 14.3%. The increase in gross profit percentage
      can be attributed to the reasons listed above.







27
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





The
      marketing services segment earned gross profit of $16.8 million and $13.8
      million for 2006 and 2005, respectively. The increase in gross profit
      attributable to the marketing services segment is due to the increase in gross
      profit associated with Pharmakon which had greater revenue in 2006. The gross
      profit percentage increased to 46.1% from 39.5% in the comparable prior year
      period due primarily to the increase in gross profit at Pharmakon as well as
      an
      increase in gross profit percentage at VIM.




The
      PPG
      segment had no gross profit in 2006 or 2005.




*(Note:
      Compensation and other Selling, General and Administrative (other SG&A)
      expense amounts for each segment contain allocated corporate
      overhead.)*




*Compensation
                  expense (in thousands)*%
                  of
              
              
              
              %
                  of
              
              Change
              
              Change2006
              
              revenue
              
              2005
              
              revenue
              
              ($)
              
              (%)Sales
                  services
              
              $
              19,410
              
              
              9.6
              %
              $
              18,397
              
              
              6.8
              %
              $
              1,013
              
              
              5.5
              %Marketing
                  services
              
              
              8,665
              
              
              23.7
              %
              
              7,499
              
              
              21.6
              %
              
              1,166
              
              
              15.5
              %PPG
              
              
              -
              
              
              -
              
              
              1
              
              
              -
              
              
              (1
              )
              
              (100.0
              %)**Total**
              
              **$**
              **28,075**
              
              
              **11.7**
              **%**
              **$**
              **25,897**
              
              
              **8.5**
              **%**
              **$**
              **2,178**
              
              
              **8.4**
              **%**




Compensation
      expense for 2006 was $28.1 million, an increase of $2.2 million or 8.4% compared
      to the $25.9 million for the comparable prior year period. This increase can
      be
      primarily attributed to an increase in incentive compensation accruals in 2006
      due to the improved performance of the company as compared to the incentive
      compensation accrued in 2005. Increases in incentive accruals were partially
      offset by decreases in salaries of approximately $2.9 million and the absence
      of
      a national managers meeting which cost approximately $800,000 in 2005. As a
      percentage of total revenue, compensation expense increased to 11.7% for 2006
      from 8.5% in 2005 primarily due to the decrease in revenue.




Compensation
      expense for the sales services segment was $19.4 million, an increase of
      approximately $1.0 million or 5.5%.




Compensation
      expense for the marketing services segment was $8.7 million in 2006, a 15.5%
      increase over $7.5 million in the comparable prior year period. This increase
      is
      primarily due to the increased amount of incentives accrued within the segment
      in 2006.




The
      PPG segment
      did not have any compensation expense in 2006 or 2005.




*Other
                  SG&A (in thousands)*%
                  of
              
              
              
              %
                  of
              
              Change
              
              Change2006
              
              revenue
              
              2005
              
              revenue
              
              ($)
              
              (%)Sales
                  services
              
              $
              18,109
              
              
              8.9
              %
              $
              23,607
              
              
              8.7
              %
              $
              (5,498
              )
              
              (23.3
              %)Marketing
                  services
              
              
              4,501
              
              
              12.3
              %
              
              5,775
              
              
              16.6
              %
              
              (1,274
              )
              
              (22.1
              %)PPG
              
              
              -
              
              
              -
              
              
              10
              
              
              -
              
              
              (10
              )
              
              (100.0
              %)**Total**
              
              **$**
              **22,610**
              
              
              **9.5**
              **%**
              **$**
              **29,392**
              
              
              **9.6**
              **%**
              **$**
              **(6,782**
              **)**
              
              **(23.1**
              **%)**




Total
      other SG&A expenses were $22.6 million in 2006, versus $29.4 million in
      2005, a decrease of $6.8 million or 23.1%. This decrease is mainly attributable
      to the following: a decrease in facility costs of approximately $1.2 million;
      a
      reduction in bad debt expense of $1.8 million, $755,000 of which was recorded
      in
      2005 that pertained to the TMX loan (see Note 6 to the consolidated financial
      statements for further information); and a reduction in miscellaneous office
      operations expense of $1.9 million. Some of the main categories within office
      operations expense are business insurance, software licenses and maintenance,
      and telephone and internet charges. As a percentage of total revenue, other
      SG&A expenses decreased to 9.5% from 9.6% in 2005.




Other
      SG&A expenses associated with the sales services segment were $18.1 million,
      a decrease of $5.5 million or 23.3%. This decrease is primarily attributable
      to
      the reasons mentioned above.




Other
      SG&A expenses for the marketing services segment decreased by $1.3 million
      or 22.1%. This decrease is primarily attributable to a decrease in facility
      costs related to our Dresher, Pennsylvania facility.




Other
      SG&A expenses in the PPG segment were zero in 2006 and approximately $10,000
      in 2005.







28
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





*Asset
      impairment*




We
      recognized asset impairment charges of $6.2 million for the year ended December
      31, 2005. The charges related to Select Access goodwill impairment - $3.3
      million in the fourth quarter of 2005; and $2.8 million associated with the
      write-down of our Siebel sales force automation software in the second quarter
      of 2005. See Notes 4 and 5 to the consolidated financial statements for more
      details on these asset impairments.




*Executive
      severance*




In
      2006,
      we incurred approximately $573,000 in executive severance costs that related
      to
      the departure of one executive. In 2005 we incurred approximately $5.7 million
      in executive severance costs. These expenses were primarily attributable to
      resignations of our CEO - $2.8 million, and our CFO - $1.6 million. The
      remaining costs pertained to other executives who resigned during the year
      or
      for which settlements were reached during that period.




*Legal
      and related costs*




In
      2006,
      we had a net credit to legal expense of $3.3 million as compared to $1.7 million
      in expense in the comparable prior year period. The credit to legal expense
      included approximately $3.5 million in cash received in relation to the Cellegy
      litigation matter; and approximately $516,000 in credits related to the
      reversing of the California class action lawsuit accrual. For details on both
      legal matters, see Note 9 to the consolidated financial statements. ** In
      2005,
      legal expense primarily consisted of ** legal
      fees associated with the Cellegy litigation matter, net of any settlement
      payments received and $566,000 that was accrued for the California class action
      lawsuit.




*Facilities
      realignment*




In
      2006,
      we had net charges of approximately $657,000 related to unused office space
      capacity at our Saddle River, New Jersey and Dresher, Pennsylvania locations
      and
      approximately $1.3 million in expense related to the impairment of fixed assets
      associated with the unused office space at these facilities. Total charges
      in
      2006 for the sales services segment are approximately $1.3 million and
      approximately $675,000 was charged to the marketing services segment. In 2005,
      we took charges of approximately $2.4 million related to unused office space
      capacity at our Saddle River and Dresher locations. There was a charge of
      approximately $1.1 million recorded in the sales services segment and a charge
      of approximately $1.3 million recorded in the marketing services segment. There
      are approximately 19,400 and 11,000 square feet of unused office space at Saddle
      River and Dresher, respectively, which we are seeking to sublease in 2007.




*Operating
                  income (loss) (in thousands)*%
                  of
              
              
              
              %
                  of
              
              Change
              
              Change2006
              
              revenue
              
              2005
              
              revenue
              
              ($)
              
              (%)Sales
                  services
              
              $
              33
              
              
              0.0
              %
              $
              (17,386
              )
              
              (6.4
              %)
              $
              17,419
              
              
              100.2
              %Marketing
                  services
              
              
              2,798
              
              
              7.7
              %
              
              (1,186
              )
              
              (3.4
              %)
              
              3,984
              
              
              335.9
              %PPG
              
              
              3,082
              
              
              0.0
              %
              
              (268
              )
              
              0.0
              %
              
              3,350
              
              
              1,250.0
              %**Total**
              
              **$**
              **5,913**
              
              
              **2.5**
              **%**
              **$**
              **(18,840**
              **)**
              
              **(6.2**
              **%)**
              **$**
              **24,753**
              
              
              **131.4**
              **%**




There
      was
      operating income of $5.9 million in 2006 as compared to an operating loss of
      $18.8 million in 2005. This large increase can be attributed to several factors,
      including the following: a reduction in corporate overhead; an improved
      contribution from the marketing services segment; net $3.1 million in operating
      income that pertained primarily to the settling of the Cellegy litigation
      matter; asset impairments totaling $6.2 million that impacted 2005; and the
      improved performance of Select Access which showed a $4.4 million increase
      in
      gross profit which led to higher operating income. There was operating income
      for the sales services segment of approximately $33,000 as compared to an
      operating loss of $17.4 million in 2005. The asset impairments in 2005 and
      the
      improved performance of Select Access were two of the main factors for this
      increase. There was operating income in 2006 for the marketing services segment
      of $2.8 million compared to an operating loss of $1.2 million in the comparable
      prior year period. The loss in 2005 was primarily attributable to the facilities
      realignment expenses associated with this segment. There was operating income
      of
      $3.1 million in 2006 in the PPG segment which consisted entirely of settlement
      payments from Cellegy, net of legal expenses. There was an operating loss for
      the PPG segment in 2005 of $268,000 that was attributable to Cellegy litigation
      expenses, net of settlements received.




*Gain/loss
      on investment*




We
      recognized a gain on sale of our In2Focus investment of approximately $4.4
      million in the second quarter of 2005.







29
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





*Interest
      income, net*




Interest
      income, net, for 2006 and 2005 was approximately $4.7 million and $3.2 million,
      respectively. The increase is primarily attributable to an increase in interest
      rates for 2006 as well as larger available cash balances.




*Provision
      for income taxes*




We
      recorded a benefit for incomes taxes of $724,000 for the year ended December
      31,
      2006, compared to a provision for income taxes of $201,000 for the year ended
      December 31, 2005. Our overall effective tax rate was a benefit of 6.8% and
      a
      provision of 1.8% for the years ended December 31, 2006 and 2005, respectively.
       The 2006 rate includes a reduction in valuation allowance of $2.9 million
      related to deferred tax assets realized in 2006 which corresponds to a rate
      benefit of 26.9%; tax-exempt income of $1.8 million which corresponds to a
      rate
      benefit of 6.0%; and state tax benefits of $1.2 million which corresponds
      to a rate benefit of 11.3%.  Without these items, we would have had a
      37.4% effective tax rate in 2006.




*Income
      (loss) from continuing operations*




There
      was
      income from continuing operations for the year ended December 31, 2006 of
      approximately $11.4 million, compared to a loss from continuing operations
      of
      approximately $11.4 million for the year ended December 31, 2005.




*Discontinued
      operations*




Revenue
      from discontinued operations for the years ended December 31, 2006 and 2005
      was
      approximately $1.9 million and $14.2 million, respectively. There was income
      from discontinued operations before income tax for the year ended December
      31,
      2006 of $693,000 and a loss from discontinued operations before income tax
      for
      the year ended December 31, 2005 of $8.0 million. Income from discontinued
      operations, net of tax, for the year ended December 31, 2006 was approximately
      $434,000. There was a loss from discontinued operations for the year ended
      December 31, 2005 of approximately $8.0 million, primarily attributable to
      the
      write-off of MD&D goodwill.




*Net
      income (loss)*




There
      was
      net income of $11.8 million in 2006, compared to a net loss for 2005 of $19.5
      million, due to the factors discussed above.




**Comparison
      of 2005 and 2004**




*Revenue
                  (in thousands)*Change
              
              Change2005
              
              2004
              
              ($)
              
              (%)Sales
                  services
              
              $
              270,420
              
              $
              313,784
              
              $
              (43,364
              )
              
              (13.8
              %)Marketing
                  services
              
              
              34,785
              
              
              29,057
              
              
              5,728
              
              
              19.7
              %PPG
              
              
              -
              
              
              2,956
              
              
              (2,956
              )
              
              (100.0
              %)**Total**
              
              **$**
              **305,205**
              
              **$**
              **345,797**
              
              **$**
              **(40,592**
              **)**
              
              **(11.7**
              **%)**


Total
      revenue for 2005 was $305.2 million, a decrease of $40.6 million or 11.7% from
      revenue of $345.8 million for 2004. The decrease was primarily related to the
      reduction in the AstraZeneca sales force for 2005 by a monthly average of
      approximately 375 sales reps as compared to 2004. Service revenue was $305.2
      million, a decrease of $42.1 million or 12.1% from revenue of $347.3 million
      in
      2004. Product net revenue for 2004 was negative $1.5 million primarily as a
      result of a $1.7 million increase in the Ceftin reserve (See Note 15 to the
      consolidated financial statements).




The
      sales
      services segment generated $270.4 million in revenue for 2005, a decrease of
      $43.4 million compared to 2004. This decrease is primarily related to the
      AstraZeneca sales force reduction for 2005 mentioned above. Sales services
      revenue from the AstraZeneca contracts in 2005 was approximately $45.8 million
      less when compared to the comparable prior year period. While our business
      development efforts yielded several contracts that were either new or of
      increased size, those revenue increases were offset by decreases in other
      contracts that were either reduced in size or closed-out.







30
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





The
      marketing services segment generated $34.8 million in revenue in 2005, an
      increase of $5.7 million or 19.7% from revenue of $29.1 million in 2004. This
      increase was attributable to having Pharmakon results for twelve months in
      2005
      versus four months in 2004; Pharmakon was acquired on August 31, 2004. The
      additional revenue generated by Pharmakon was partially offset by declines
      in
      revenue at both the TVG and former EdComm units.




The
      PPG
      segment did not have any revenue in 2005. The PPG segment generated net revenue
      of $3.0 million in 2004, which consisted of $4.5 million in service revenue
      offset by negative product revenue of $1.5 million. The service revenue of
      $4.5
      million was generated almost entirely by revenue from Lotensin royalties; the
      negative product revenue of $1.5 million was primarily related to the increase
      in the Ceftin sales returns reserve. As our responsibility to accept product
      returns ended December 31, 2004, no further material increases to this reserve
      are likely.




*Cost
                  of goods and services (in thousands)*Change
              
              Change2005
              
              2004
              
              ($)
              
              (%)Sales
                  services
              
              $
              231,768
              
              $
              236,681
              
              $
              (4,913
              )
              
              (2.1
              %)Marketing
                  services
              
              
              21,035
              
              
              16,352
              
              
              4,683
              
              
              28.6
              %PPG
              
              
              -
              
              
              131
              
              
              (131
              )
              
              (100.0
              %)**Total**
              
              **$**
              **252,803**
              
              **$**
              **253,164**
              
              **$**
              **(361**
              **)**
              
              **(0.1**
              **%)**




Cost
      of
      goods and services for 2005 was $252.8 million, which was $361,000 less than
      cost of services of $253.2 million for 2004.




*Gross
                  profit (in thousands)*%
                  of
              
              
              
              %
                  of
              
              Change
              
              Change2005
              
              revenue
              
              2004
              
              revenue
              
              ($)
              
              (%)Sales
                  services
              
              $
              38,652
              
              
              14.3
              %
              $
              77,103
              
              
              24.6
              %
              $
              38,451
              
              
              (49.9
              %)Marketing
                  services
              
              
              13,750
              
              
              39.5
              %
              
              12,705
              
              
              43.7
              %
              
              (1,045
              )
              
              8.2
              %PPG
              
              
              -
              
              
              -
              
              
              2,825
              
              
              95.6
              %
              
              2,825
              
              
              (100.0
              %)**Total**
              
              **$**
              **52,402**
              
              
              **17.2**
              **%**
              **$**
              **92,633**
              
              
              **26.8**
              **%**
              **$**
              **40,231**
              
              
              **(43.4**
              **%)**




During
      2005 the gross profit percentage was 17.2% compared to 26.8% in the comparable
      prior year period. The primary reasons for the large percentage decrease were
      as
      follows:




·
            A
                decrease in incentive payments ($2.6 million) received in 2005 as
                compared
                to 2004;


·
            Higher
                amount of net penalties accrued in 2005 ($2.0 million) as compared
                to
                2004;


·
            Lower
                contractual margins for some of our 2005 contract
                renewals;


·
            Market
                conditions that led to increases in field compensation and other
                field
                costs (i.e. gas, travel) that were, in some cases, higher than the
                rates
                specified in our contracts; and


·
            No
                PPG revenues or gross profit earned in 2005 as compared to 2004 when
                revenue was $3.0 million and gross profit was $2.8
                million.




The
      sales
      services segment had gross profit of $38.7 million in 2005, with a gross profit
      percentage of 14.3%; during 2004 this segment had gross profit of $77.1 million
      and a gross profit percentage of 24.6%. The decrease of $38.5 million is
      primarily attributable to the reduction in the AstraZeneca sales force as well
      as the factors mentioned directly above.




The
      marketing services segment earned gross profit of $13.8 million and $12.7
      million for 2005 and 2004, respectively. The increase in gross profit
      attributable to the marketing services segment is due to the increase in gross
      profit associated with Pharmakon; this was partially offset by decreases in
      gross profit at both the TVG and former EdComm units. The gross percentage
      declined slightly from 43.7% in 2004 to 39.5% in 2005.




The
      PPG
      segment had no gross profit in 2005. The PPG segment had $2.8 million in gross
      profit for 2004 which was entirely attributable to the Lotensin royalties
      received in 2004, partially offset by the negative gross profit
      associated with the
      increase in the Ceftin reserve.







31
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





*(Note:
      Compensation and other SG&A expense amounts for each segment contain
      allocated corporate overhead.)*




*Compensation
                  expense (in thousands)*%
                  of
              
              
              
              %
                  of
              
              Change
              
              Change2005
              
              revenue
              
              2004
              
              revenue
              
              ($)
              
              (%)Sales
                  services
              
              $
              18,397
              
              
              6.8
              %
              $
              21,826
              
              
              7.0
              %
              $
              (3,429
              )
              
              (15.7
              %)Marketing
                  services
              
              
              7,499
              
              
              21.6
              %
              
              7,367
              
              
              25.4
              %
              
              132
              
              
              1.8
              %PPG
              
              
              1
              
              
              0.0
              %
              
              1,441
              
              
              48.7
              %
              
              (1,440
              )
              
              (99.9
              %)**Total**
              
              **$**
              **25,897**
              
              
              **8.5**
              **%**
              **$**
              **30,634**
              
              
              **8.9**
              **%**
              **$**
              **(4,737**
              **)**
              
              **(15.5**
              **%)**




Compensation
      expense for 2005 was $25.9 million, a decrease of $4.7 million or 15.5% less
      than the $30.6 million for the comparable prior year period. This decrease
      can
      be primarily attributed to an overall decrease in the amount of incentive
      compensation in 2005. As a percentage of total revenue, compensation expense
      decreased to 8.5% for 2005 from 8.9% in 2004.




Compensation
      expense for the sales services segment was $18.4 million, a decrease of $3.4
      million from the comparable prior year period. This decrease can be attributable
      to the reduction in incentive compensation mentioned above.




Compensation
      expense for the marketing services segment was $7.5 million in 2005, a 1.8%
      increase over $7.4 million in the comparable prior year period.




The
      PPG segment
      did not have any compensation expense in 2005. Compensation expense associated
      with the PPG segment in 2004 was $1.4 million and was primarily for severance
      related activities associated with the de-emphasis of that segment beginning
      in
      2004.




*Other
                  SG&A (in thousands)*%
                  of
              
              
              
              %
                  of
              
              Change
              
              Change2005
              
              revenue
              
              2004
              
              revenue
              
              ($)
              
              (%)Sales
                  services
              
              $
              23,607
              
              
              8.7
              %
              $
              20,097
              
              
              6.4
              %
              $
              3,510
              
              
              17.5
              %Marketing
                  services
              
              
              5,775
              
              
              16.6
              %
              
              3,686
              
              
              12.7
              %
              
              2,089
              
              
              56.7
              %PPG
              
              
              10
              
              
              0.0
              %
              
              1,244
              
              
              42.1
              %
              
              (1,234
              )
              
              (99.2
              %)**Total**
              
              **$**
              **29,392**
              
              
              **9.6**
              **%**
              **$**
              **25,027**
              
              
              **7.2**
              **%**
              **$**
              **4,365**
              
              
              **17.4**
              **%**




Total
      other SG&A expenses were $29.4 million in 2005, versus $25.0 million in
      2004, an increase of $4.4 million or 17.4%. This increase is mainly attributable
      to the following: an increase in marketing spend of $1.2 million; an increase
      in
      compliance costs of $1.0 million; and an increase in outsourcing and consulting
      costs of $1.4 million. As a percentage of total revenue, other SG&A expenses
      increased to 9.6% from 7.2% in 2004.




Other
      SG&A expenses associated with the sales services segment were $23.6 million,
      an increase of $3.5 million or 17.5%. This increase is primarily attributable
      to
      the reasons mentioned above.




Other
      SG&A expenses for the marketing services segment increased by $2.1 million
      or 56.7%. Approximately $800,000 was related to costs involved in moving to
      TVG’s new facility. Amortization expense increased by approximately $850,000 as
      result of having a full twelve months of amortization associated with Pharmakon
      as opposed to four months in 2004.




Other
      SG&A expenses in the PPG segment were approximately $10,000 for 2005, as
      compared to $1.2 million in 2004. In 2004, those
      costs were primarily related to closeout activities associated with that
      segment.




*Asset
      impairment*




We
      recognized asset impairment charges of $6.2 million for the year ended December
      31, 2005. The charges related to Select Access goodwill impairment - $3.3
      million in the fourth quarter of 2005; and $2.8 million associated with the
      write-down of our Siebel sales force automation software in the second quarter
      of 2005. See Notes 4 and 5 to the consolidated financial statements for more
      details on these asset impairments.







32
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





*Executive
      severance*




In
      2005,
      we incurred approximately $5.7 million in executive severance and related costs
      as compared to approximately $495,000 in the comparable prior year period.
      These
      expenses were primarily attributable to the announced departures of our CEO
      -
      $2.8 million in the fourth quarter of 2005, and our CFO - $1.6 million as
      disclosed and recorded in the third quarter of 2005. The remaining costs
      pertained to other executives who resigned during the year or for which
      settlements were reached during that period. In 2004, the expense pertained
      to
      the departure of one executive.




*Legal
      and related costs*




In
      2005,
      we incurred approximately $1.7 million in legal expenses as compared to $2.4
      million in the comparable prior year period. Included in 2005 is a $566,000
      litigation accrual related to the California class action lawsuit. For details
      on this lawsuit, see Note 9 to the consolidated financial
      statements. ** In
      2004,
      the legal costs of $2.4 million were primarily related to the Cellegy
      litigation.




*Facilities
      realignment*




In
      the
      fourth quarter of 2005, we took charges of approximately $2.4 million related
      to
      unused office space capacity at our Saddle River, New Jersey and Dresher,
      Pennsylvania locations. There was a charge of approximately $1.1 million
      recorded in the sales services segment and a charge of approximately $1.3
      million recorded in the marketing services segment. The charges were for
      approximately 7,300 and 11,000 square feet of unused office space at Saddle
      River and Dresher, respectively.




*Operating
                  Income (Loss) (in thousands)*%
                  of
              
              
              
              %
                  of
              
              Change
              
              Change2005
              
              revenue
              
              2004
              
              revenue
              
              ($)
              
              (%)Sales
                  services
              
              $
              (17,386
              )
              
              (6.4
              %)
              $
              32,906
              
              
              10.5
              %
              $
              (50,292
              )
              
              (152.8
              %)Marketing
                  services
              
              
              (1,186
              )
              
              (3.4
              %)
              
              1,535
              
              
              5.3
              %
              
              (2,721
              )
              
              (177.3
              %)PPG
              
              
              (268
              )
              
              0.0
              %
              
              (362
              )
              
              (12.2
              %)
              
              94
              
              
              26.0
              %**Total**
              
              **$**
              **(18,840**
              **)**
              
              **(6.2**
              **%)**
              **$**
              **34,079**
              
              
              **9.9**
              **%**
              **$**
              **(52,919**
              **)**
              
              **(155.3**
              **%)**




There
      was
      an operating loss of $18.8 million in 2005 as compared to operating income
      for
      2004 of $34.1 million. This large decrease can be attributed to several factors,
      including the reduction in the size of the dedicated contract sales force and
      lower gross profit margins (as discussed above); the asset impairments and
      executive severance costs mentioned above; and facility realignment costs.
      There
      was an operating loss for the sales services segment of $17.4 million as
      compared to operating income of $32.9 million in 2004 and was primarily due
      to
      the factors discussed above. There was an operating loss in 2005 for the
      marketing services segment of $1.2 million compared to operating income of
      $1.5
      million in the comparable prior year period. The loss in 2005 was primarily
      attributable to the facilities realignment expenses associated with this
      segment. There was an operating loss for the PPG segment in 2005 of $268,000
      that was attributable to Cellegy litigation expenses, net of settlements
      received. In 2004, PPG had an operating loss of $362,000 that primarily related
      to the closing out of that segment.




*Gain/loss
      on investment*




In
      2005,
      we recognized a gain on sale of our In2Focus investment of approximately $4.4
      million in the second quarter of 2005. **  In
      2004,
      our investment in Xylos of $1.0 million was found to be impaired and was written
      down to zero in the fourth quarter of 2004.




*Interest
      income, net*




Interest
      income, net, for 2005 and 2004 was approximately $3.2 million and $1.8 million,
      respectively. The increase is primarily attributable to an increase in interest
      rates for 2005.




*Provision
      for income taxes*




We
      recorded a provision for income taxes of $201,000 for 2005, compared to $14.4
      million for 2004. Our overall effective tax rate was 1.8% and 41.4% for 2005
      and
      2004, respectively. The 2005 rate includes a
      release
      of $1.7 million valuation allowance on capital loss carryforwards, which
      corresponds to a rate benefit of 8.8%; as well as $9.3
      million (or 48.4%) federal and state valuation allowances on net deferred tax
      assets since management believes it was more likely than not that these deferred
      tax assets would not be realized. Without
      these valuation allowance items, we would have had a 38.5% rate benefit in
      2005.







33
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





*(Loss)
      income from continuing operations*




There
      was
      a loss from continuing operations for the year ended December 31, 2005 of
      approximately $11.4 million, compared to income from continuing operations
      of
      approximately $20.4 million for the year ended December 31, 2004.




*Discontinued
      operations*




Revenue
      from discontinued operations for the years ended December 31, 2005 and 2004
      was
      approximately $14.2 million and $18.6 million, respectively. There was a loss
      from discontinued operations before income tax for the year ended December
      31,
      2005 of $8.0 million and income from discontinued operations before income
      tax
      for the year ended December 31, 2004 of $1.1 million. There was a loss from
      discontinued operations, net of tax, for the year ended December 31, 2005 of
      approximately $8.0 million and income from discontinued operations, net of
      tax,
      for the year ended December 31, 2004 of $697,000.




*Net
      (loss) income*




There
      was
      a net loss of $19.5 million in 2005, compared to net income for 2004 of $21.1
      million, due to the factors discussed above.




**LIQUIDITY
      AND CAPITAL RESOURCES**




As
      of
      December 31, 2006, we had cash and cash equivalents and short-term investments
      of approximately $114.7 million and working capital of $112.2 million, compared
      to cash and cash equivalents and short-term investments of approximately $97.6
      million and working capital of approximately $92.3 million at December 31,
      2005.




For
      the
      year ended December 31, 2006, net cash provided by operating activities was
      $19.7 million, compared to $3.1 million net cash provided by operating
      activities in 2005. The main components of cash provided by operating
      activities during
      2006 were:




·
            net
                income of $11.8 million;




·
            depreciation
                and other non-cash expense of $10.4 million which included depreciation
                expenses of $4.4 million; stock compensation expense of $1.7 million;
                decrease in the net deferred tax asset of $2.7 million and facilities’
                realignment of approximately $1.3 million offset by recoveries of
                doubtful
                accounts and notes of $1.0 million;




·
            offset
                by a net decrease in other changes in assets and liabilities of $2.6
                million which includes a $5.4 million federal tax refund received
                in the
                fourth quarter of 2006.




The
      net
      changes in the “other changes in assets and liabilities” section of the
      consolidated statement of cash flows may fluctuate depending on a number of
      factors, including the number and size of programs, contract terms and other
      timing issues. These variations may change in size and direction with each
      reporting period.




As
      of
      December 31, 2006, we had $4.2 million of unbilled costs and accrued profits
      on
      contracts in progress. When services are performed in advance of billing, the
      value of such services is recorded as unbilled costs and accrued profits on
      contracts in progress. Normally, all unbilled costs and accrued profits are
      earned and billed within 12 months from the end of the respective period. As
      of
      December 31, 2006, we had $14.3 million of unearned contract revenue. When
      we
      bill customers for services before the revenue has been earned, billed amounts
      are recorded as unearned contract revenue, and are recorded as income when
      earned.




For
      the
      year ended December 31, 2006, net cash used in investing activities was $65.4
      million. The main components consisted of the following:




·
            Approximately
                $63.9 million used in the purchase of short-term investments. Our
                investments consist of a laddered portfolio of investment grade debt
                instruments such as obligations of the U.S. Treasury and U.S. Federal
                Government agencies, municipal bonds and commercial paper. We are
                focused
                on preserving capital, maintaining liquidity, and maximizing returns,
                in
                accordance with our investment criteria.




·
            Capital
                expenditures for the year ended December 31, 2006 of $1.8 million,
                which
                consisted primarily of capital expenditures associated with IT and
                other
                computer-related expenditures. Capital expenditures for the year
                ended
                December 31, 2005 were $5.8 million, which consisted primarily of
                capital
                expenditures associated with the relocation of our offices within
                the
                marketing services group and for costs associated with the rollout
                of our
                new sales force automation software.







34
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





On
      August
      31, 2004, we acquired substantially all of the assets of Pharmakon, LLC in
      a
      transaction treated as an asset acquisition for tax purposes. The acquisition
      has been accounted for as a purchase, subject to the provisions of SFAS No.
      141.
      We made payments to the members of Pharmakon, LLC on August 31, 2004 of $27.4
      million, of which $1.5 million was deposited into an escrow account, and we
      assumed approximately $2.6 million in net liabilities. As of December 31, 2006,
      all escrow payments have been made and the escrow balance is zero. Approximately
      $1.1 million in direct costs of the acquisition were also capitalized. Based
      upon the attainment of annual profit targets agreed upon at the date of
      acquisition, the members of Pharmakon, LLC received approximately $1.4 million
      in additional payments on April 1, 2005 for the year ended December 31, 2004.




No
      additional payments were made in 2006 nor will any be made in 2007 since the
      Pharmakon business did not exceed its specified 2005 and 2006 performance
      benchmarks, respectively. In connection with this transaction, we have recorded
      $13.6 million in goodwill and $18.9 million in other identifiable intangibles
      through December 31, 2006. The identifiable intangible assets have a weighted
      average remaining amortization period of 12.6 years.




For
      the
      year ended December 31, 2006, net cash provided by financing activities
      consisted of $110,000 related to the exercise of stock options, net of related
      tax effects. For the year ended December 31, 2005, net cash used in financing
      activities was approximately $11.8 million. Approximately $13.1 million was
      used
      in the repurchasing of shares of our common stock. This was partially offset
      by
      proceeds from the exercise of stock options and the issuance of shares under
      the
      employee stock purchase plan of $1.3 million. The employee stock purchase plan
      was discontinued in 2005.




On
      April
      27, 2005, we terminated our original 2001 stock repurchase plan. On May 2,
      2005,
      we announced plans to repurchase up to a million of our outstanding shares
      of
      common stock as authorized by our Board of Directors. We repurchased 996,900
      shares in 2005 with an average purchase price of $12.90
      under that plan. The plan was terminated in 2006.




We
      did
      not repurchase any shares of our common stock during 2006. On November 7, 2006
      we announced that the Board of Directors authorized us to repurchase up to
      one
      million shares of our common stock. We have not repurchased any shares of our
      common stock during 2007 as of the date of this Form 10-K. Purchases, if any,
      will be made from our available cash.




Our
      revenue and profitability depend to a great extent on our relationships with
      a
      limited number of large pharmaceutical companies. For the year ended December
      31, 2006, we had two major customers that accounted for approximately 28.5%
      and
      18.3%, respectively, or a total of 46.8% of our service revenue. We are likely
      to continue to experience a high degree of customer concentration, particularly
      if there is further consolidation within the pharmaceutical industry. The loss
      or a significant reduction of business from any of our major customers, or
      a
      decrease in demand for our services, could have a material adverse effect on
      our
      business, financial condition or results of operations. For example, on April
      30, 2006, AstraZeneca terminated its contract sales force arrangement with
      us,
      as previously announced on February 28, 2006. The size of the AstraZeneca sales
      force was approximately 800 representatives. The revenue impact of this
      termination was $63.8 million in 2006. Additionally, on September 26, 2006,
      we
      announced that GSK would not be renewing its current contract with us when
      it
      expired on December 31, 2006. This represents a loss of revenue between $65
      and
      $70 million for 2007. Furthermore, on October 25, 2006, we announced that we
      had
      received notification from sanofi-aventis of its intention to terminate its
      contract sales engagement with us effective December 1, 2006. The contract,
      which represented approximately $18 million to $20 million in revenue on an
      annual basis, was scheduled to expire on December 31, 2006. Unless and until
      we
      generate sufficient new business to offset the loss of the aforementioned
      contracts, the current results will not be duplicated in future periods and
      future revenue and cash flows will decrease.




In
      2006,
      we had net charges of approximately $657,000 related to unused office space
      capacity at our Saddle River, New Jersey and Dresher, Pennsylvania locations
      and
      $1.3 million in asset impairment charges for leasehold improvements and
      furniture and fixtures associated with the unused office space at those
      facilities. In the fourth quarter of 2005, we took charges of approximately
      $2.4
      million related to unused office space capacity at our Saddle River, New Jersey
      and Dresher, Pennsylvania locations. There are approximately 19,400 and 11,000
      square feet of unused office space at Saddle River and Dresher, respectively,
      which we are seeking to sublease in 2007. As a result of preparing the Saddle
      River space for subletting we expect to incur approximately $200,000 in capital
      expenditures in 2007. A
      rollforward of the activity for the facility realignment plan is as
      follows:







35
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





Balance
                  as of December 31, 2004
              
              $
              -Facility
                  realignment charge
              
              
              2,354Payments
              
              
              (19
              )Balance
                  as of December 31, 2005
              
              $
              2,335Accretion
              
              
              51Payments
              
              
              (680
              )Adjustments
              
              
              606Balance
                  as of December 31, 2006
              
              $
              2,312




Cash
      flows from discontinued operations are included in the consolidated statement
      of
      cash flows. The absence of cash flows from the discontinued operation has had
      no
      material impact on cash flows. We are not expecting any material cash outlays
      with regards to this discontinued operation in the future.




Acquisitions
      are a part of our corporate strategy. We believe that our existing cash balances
      and expected cash flows generated from operations will be sufficient to meet
      our
      operating requirements for at least the next 12 months. However, we may require
      alternative forms of financing if and when we make acquisitions.




**Contractual
      Obligations**




We
      have
      committed cash outflow related to operating lease agreements, and other
      contractual obligations. Minimum payments for these long-term obligations are:




Less
                  than
              
              1
                  to 3
              
              3
                  to 5
              
              AfterTotal
              
              1
                  Year
              
              Years
              
              Years
              
              5
                  YearsContractrual
                  obligations(1)
              
              $
              6,523
              
              $
              4,496
              
              $
              2,027
              
              $
              -
              
              $
              -Operating
                  lease obligationsMinimum
                  lease payments
              
              
              30,641
              
              
              3,100
              
              
              6,516
              
              
              6,462
              
              
              14,563Less
                  minimum sublease rentals(2)
              
              
              (1,452
              )
              
              (401
              )
              
              (801
              )
              
              (250
              )
              
              -Net
                  minimum lease payments
              
              
              29,189
              
              
              2,699
              
              
              5,715
              
              
              6,212
              
              
              14,563Total
              
              $
              35,712
              
              $
              7,195
              
              $
              7,742
              
              $
              6,212
              
              $
              14,563






(1)
            Amounts
                represent contractual obligations related to software license contracts,
                IT consulting contracts and outsourcing contracts for employee benefits
                administration and software system support.




(2)
            On
                June 21, 2005, we signed an agreement to sublease approximately 16,000
                square feet of the first floor at our corporate headquarters facility
                in
                Saddle River, New Jersey. The sublease is for a five-year term commencing
                July 15, 2005, and provides for approximately $2 million in lease
                payments
                over the five-year period.






**Off-Balance
      Sheet Arrangements**




As
      of
      December 31, 2006, we had no off-balance sheet arrangements.




**Selected
      Quarterly Financial Information (unaudited)**




The
      following table set forth selected quarterly financial information for the
      years
      ended December 31, 2006 and 2005 (in thousands except per share
      data):





36
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**







For
                  the Quarters endedMarch
                  31
              
              June
                  30
              
              September
                  30
              
              December
                  312006
                  Quarters:Total
                  revenues, net
              
              $
              77,144
              
              $
              54,951
              
              $
              51,317
              
              $
              55,830Gross
                  profit
              
              
              18,704
              
              
              11,958
              
              
              12,403
              
              
              12,779Operating
                  income (loss)(1)
              
              
              7,504
              
              
              37
              
              
              (611
              )
              
              (1,017
              )Income
                  fromcontinuing
                  operations
              
              
              5,422
              
              
              707
              
              
              409
              
              
              4,837Income
                  (loss) from discontinuedoperations,
                  net of tax
              
              
              199
              
              
              188
              
              
              54
              
              
              (7
              )Net
                  income
              
              
              5,621
              
              
              895
              
              
              463
              
              
              4,830Income
                  (loss) per share:BasicContinuing
                  operations
              
              $
              0.39
              
              $
              0.05
              
              $
              0.03
              
              $
              0.35Discontinued
                  operations
              
              
              0.01
              
              
              0.01
              
              
              0.00
              
              
              (0.00
              )$
              0.41
              
              $
              0.06
              
              $
              0.03
              
              $
              0.35DilutedContinuing
                  operations
              
              $
              0.39
              
              $
              0.05
              
              $
              0.03
              
              $
              0.35Discontinued
                  operations
              
              
              0.01
              
              
              0.01
              
              
              0.00
              
              
              (0.00
              )$
              0.40
              
              $
              0.06
              
              $
              0.03
              
              $
              0.35Weighted
                  average number of shares:Basic
              
              
              13,824
              
              
              13,857
              
              
              13,871
              
              
              13,883Diluted
              
              
              13,914
              
              
              13,953
              
              
              13,987
              
              
              13,9952005
                  Quarters:Total
                  revenues, net
              
              $
              77,955
              
              $
              76,058
              
              $
              72,854
              
              $
              78,338Gross
                  profit
              
              
              16,231
              
              
              13,670
              
              
              10,041
              
              
              12,460Operating
                  loss(1)
              
              
              (925
              )
              
              (179
              )
              
              (8,333
              )
              
              (9,403
              )(Loss)
                  income fromcontinuing
                  operations
              
              
              (147
              )
              
              4,441
              
              
              (4,278
              )
              
              (11,423
              )Income
                  (loss) from discontinuedoperations,
                  net of tax
              
              
              85
              
              
              72
              
              
              94
              
              
              (8,298
              )Net
                  (loss) income
              
              
              (62
              )
              
              4,513
              
              
              (4,184
              )
              
              (19,721
              )(Loss)
                  income per share:BasicContinuing
                  operations
              
              $
              (0.01
              )
              $
              0.30
              
              $
              (0.31
              )
              $
              (0.83
              )Discontinued
                  operations
              
              
              0.01
              
              
              0.00
              
              
              0.01
              
              
              (0.60
              )$
              (0.00
              )
              $
              0.31
              
              $
              (0.30
              )
              $
              (1.43
              )DilutedContinuing
                  operations
              
              $
              (0.01
              )
              $
              0.30
              
              $
              (0.31
              )
              $
              (0.83
              )Discontinued
                  operations
              
              
              0.01
              
              
              0.00
              
              
              0.01
              
              
              (0.60
              )$
              (0.00
              )
              $
              0.31
              
              $
              (0.30
              )
              $
              (1.43
              )




Note:
      Quarterly information reflects our results of operations shown excluding the
      MD&D unit which was reported as a discontinued operation beginning in the
      second quarter of 2006. All prior periods have been restated. Quarterly and
      year-to-date computations of per share amounts are made independently;
      therefore, the sum of per share amounts for the quarters may not equal per
      share
      amounts for the year.




(1)
            The quarter ended June 30, 2006 includes facilities
              realignment costs of $0.3 million. The quarter ended December 31, 2006
              includes a $2.5 million credit to expense as a result of the Cellegy
              litigation settlement; $1.6 million in facilities realignment costs;
              and
              $0.6 million in executive severance
              costs.







37
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**







(2)
            The
                quarter ended March 31, 2005 includes a $1.2 million charge for employee
                severance costs and a $0.2 million charge for executive severance
                costs.
                The quarter ended June 30, 2005 includes a $2.8 million charge for
                the
                impairment of the Siebel sales force automation platform and a $0.4
                million charge for executive severance costs; the quarter ended September
                30, 2005 includes a $1.7 million charge for executive severance costs.
                The
                quarter ended December 31, 2005 includes a $3.4 million charge for
                executive severance costs; a $2.4 million charge for facilities
                realignment costs; and a $3.3 million charge for the impairment of
                the
                goodwill associated with the Select Access reporting unit.




Our
      results of operations have varied, and are expected to continue to vary, from
      quarter to quarter. These fluctuations result from a number of factors
      including, among other things, the timing of commencement, completion or
      cancellation of major contracts. In the future, our revenue may also fluctuate
      as a result of a number of additional factors, including the types of products
      we market and sell, delays or costs associated with acquisitions, government
      regulatory initiatives and conditions in the healthcare industry generally.
      Revenue, generally, is recognized as services are performed. Program costs,
      other than training costs, are expensed as incurred. As a result, we may incur
      substantial expenses associated with staffing a new detailing program during
      the
      first two to three months of a contract without recognizing any revenue under
      that contract. This could have an adverse impact on our operating results for
      the quarters in which those expenses are incurred. Revenue related to
      performance incentives is recognized in the period when the performance based
      parameters are achieved and payment is assured. A significant portion of this
      revenue could be recognized in the first and fourth quarters of a year. Costs
      of
      goods sold are expensed when products are shipped.






**EFFECT
      OF NEW ACCOUNTING PRONOUNCEMENTS**




The
      following represent recently issued accounting pronouncements that will affect
      reporting and disclosures in future periods. See Note 1 to the consolidated
      financial statements for a further discussion of each item.




In
      July
      2006, the FASB issued FASB Interpretation No. 48, “Accounting For Uncertainty In
      Income Taxes - an Interpretation of FASB Statement 109” (FIN 48). FIN 48
      clarifies that an entity’s tax benefits recognized in tax returns must be more
      likely than not of being sustained prior to recording the related tax benefit
      in
      the financial statements. As required by FIN 48, we will adopt this new
      accounting standard effective January 1, 2007. We are evaluating the potential
      effects the interpretation may have on our consolidated financial position
      or
      results of operations, but do not expect there to be a material
      consequence.




In
      September 2006, the FASB issued SFAS No. 157 (SFAS 157), “Fair Value
      Measurements.” This statement defines fair value, establishes a framework for
      measuring fair value, and expands disclosures about fair value measurements.
      This standard is to be applied when other standards require or permit the use
      of
      fair value measurement of an asset or liability. The statement is effective
      for
      financial statements issued for fiscal years beginning after November 15,
      2007, and interim periods within that fiscal year. We are in the process of
      evaluating the impact of adopting this statement.






**ITEM
      7A.**  **QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**




We
      are
      exposed to market risk for changes in the market values of some of our
      investments (investment risk) and the effect of interest rate changes (interest
      rate risk). Our financial instruments are not currently subject to foreign
      currency risk or commodity price risk. We have no financial instruments held
      for
      trading purposes and we have no interest bearing long term or short term debt.
      At December 31, 2006, 2005, and 2004, we did not hold any derivative financial
      instruments.




The
      objectives of our investment activities are: to preserve capital, maintain
      liquidity, and maximize returns without significantly increasing risk. In
      accordance with our investment policy, we attempt to achieve these objectives
      by
      investing our cash in a variety of financial instruments. These investments
      are
      principally restricted to government sponsored enterprises, high-grade bank
      obligations, high-grade corporate bonds, certain money market funds of
      investment grade debt instruments such as obligations of the U.S. Treasury
      and
      U.S. Federal Government Agencies, municipal bonds and commercial paper.







38
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





Investments
      in both fixed rate and floating rate interest earning instruments carry a degree
      of interest rate risk. Fixed rate securities may have their fair market value
      adversely impacted due to a rise in interest rates, while floating rate
      securities may produce less income than expected if interest rates fall. Due
      in
      part to these factors, our future investment income may fall short of
      expectations due to changes in interest rates or we may suffer losses in
      principal if forced to sell securities that have seen a decline in market value
      due to changes in interest rates. Our cash and cash equivalents and short term
      investments at December 31, 2006 were composed of the instruments described
      in
      the preceding paragraph. All of those investments mature by August 2007, with
      the majority maturing within the first four months of 2007 or having interest
      reset periods not greater than 35 days. If interest rates were to increase
      or
      decrease by one percent, the fair value of our investments would have an
      insignificant increase or decrease primarily due to the quality of the
      investments and the near term maturity.






**ITEM
      8.**  **FINANCIAL
      STATEMENTS AND SUPPLEMENTARY DATA**




Our
      financial statements and required financial statement schedule are included
      herein beginning on page F-1.






**ITEM
      9.**  **CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURES**




None.




**ITEM
      9A. CONTROLS AND PROCEDURES**






**(a)**  **Disclosure
      Controls and Procedures**




Our
      management, with the participation of our chief executive officer and chief
      financial officer, has evaluated the effectiveness of our disclosure controls
      and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e)
      under the Exchange Act) as of the end of the period covered by this Form 10-K.
      Based on that evaluation, our chief executive officer and chief financial
      officer have concluded that, as of the end of such period, our disclosure
      controls and procedures are effective to ensure that information required to
      be
      disclosed by us in the reports that we file or submit under the Exchange Act
      is
      (i) recorded, processed, summarized and reported, within the time periods
      specified in the SEC’s rules and forms; and (ii) accumulated and communicated to
      management, including our chief executive officer and chief financial officer,
      as appropriate to allow timely decisions regarding required
      disclosure.




Our
      management, including our chief executive officer and chief financial officer,
      does not expect that our disclosure controls and procedures or our internal
      controls will prevent all errors and all fraud. A control system, no matter
      how
      well conceived and operated, can provide only reasonable, not absolute,
      assurance that the objectives of the control system are met. Further, the design
      of a control system must reflect the fact that there are resource constraints
      and the benefits of controls must be considered relative to their costs. Because
      of the inherent limitations in all control systems, no evaluation of controls
      can provide absolute assurance that all control issues and instances of fraud,
      if any, within PDI, Inc. have been detected.






**(b)**  **Management's
      Report on Internal Control over Financial Reporting**




Our
      management is responsible for establishing and maintaining adequate internal
      control over financial reporting (as defined in Rule 13a-15(f) under the
      Exchange Act). Our management assessed the effectiveness of our internal control
      over financial reporting as of December 31, 2006. In making this assessment,
      our
      management used the criteria set forth by the Committee of Sponsoring
      Organizations of the Treadway Commission in Internal Control-Integrated
      Framework. Our management has concluded that, as of December 31, 2006, our
      internal control over financial reporting is effective based on these criteria.
      Our independent registered public accounting firm, Ernst & Young LLP, has
      issued an audit report on our assessment of our internal control over financial
      reporting, which is included herein.






**(c)**  **Changes
      in Internal Control over Financial Reporting**




There
      were no changes in our internal controls over financial reporting during the
      quarter ended December 31, 2006 that have materially affected, or are reasonably
      likely to materially affect our internal controls over financial reporting.







39
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**







**(d)**  **Report
      of Independent Registered Public Accounting Firm**




The
      Board
      of Directors and Stockholders of PDI, Inc.




We
      have
      audited management’s assessment, included in the accompanying Management's
      Annual Report on Internal Control Over Financial Reporting, that PDI, Inc.
      maintained effective internal control over financial reporting as of December
      31, 2006, based on criteria established in Internal Control—Integrated Framework
      issued by the Committee of Sponsoring Organizations of the Treadway Commission
      (the COSO criteria). PDI Inc.’s management is responsible for maintaining
      effective internal control over financial reporting and for its assessment
      of
      the effectiveness of internal control over financial reporting. Our
      responsibility is to express an opinion on management’s assessment and an
      opinion on the effectiveness of the company’s internal control over financial
      reporting based on our audit.




We
      conducted our audit in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether effective
      internal control over financial reporting was maintained in all material
      respects. Our audit included obtaining an understanding of internal control
      over
      financial reporting, evaluating management’s assessment, testing and evaluating
      the design and operating effectiveness of internal control, and performing
      such
      other procedures as we considered necessary in the circumstances. We believe
      that our audit provides a reasonable basis for our opinion.




A
      company’s internal control over financial reporting is a process designed to
      provide reasonable assurance regarding the reliability of financial reporting
      and the preparation of financial statements for external purposes in accordance
      with generally accepted accounting principles. A company’s internal control over
      financial reporting includes those policies and procedures that (1) pertain
      to
      the maintenance of records that, in reasonable detail, accurately and fairly
      reflect the transactions and dispositions of the assets of the company; (2)
      provide reasonable assurance that transactions are recorded as necessary to
      permit preparation of financial statements in accordance with generally accepted
      accounting principles, and that receipts and expenditures of the company are
      being made only in accordance with authorizations of management and directors
      of
      the company; and (3) provide reasonable assurance regarding prevention or timely
      detection of unauthorized acquisition, use, or disposition of the company’s
      assets that could have a material effect on the financial
      statements.




Because
      of its inherent limitations, internal control over financial reporting may
      not
      prevent or detect misstatements. Also, projections of any evaluation of
      effectiveness to future periods are subject to the risk that controls may become
      inadequate because of changes in conditions, or that the degree of compliance
      with the policies or procedures may deteriorate.




In
      our
      opinion, management’s assessment that PDI, Inc. maintained effective internal
      control over financial reporting as of December 31, 2006 is fairly stated,
      in
      all material respects, based on the COSO criteria. Also, in our opinion, PDI,
      Inc. maintained, in all material respects, effective internal control over
      financial reporting as of December 31, 2006, based on **** the
      COSO
      criteria **.**




We
      also
      have audited, in accordance with the standards of the Public Company Accounting
      Oversight Board (United States), the accompanying consolidated balance sheets
      of
      PDI, Inc. as of December 31, 2006 and 2005, and the related consolidated
      statements of operations, stockholders’ equity, and cash flows of PDI, Inc. for
      each of years in the period ended December 31, 2006 and our report
      dated March 15, 2007 expressed an unqualified opinion thereon.




/s/
                Ernst &Young LLPNew
                York, NYMarch
                15, 2007




**ITEM
      9B.**  **OTHER
      INFORMATION**




None.







40
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





**PART
      III**




**ITEM
      10.**  **DIRECTORS
      AND EXECUTIVE OFFICERS OF THE REGISTRANT**




Information
      relating to directors and executive officers of the registrant that is
      responsive to Item 10 of this Form 10-K will be included in our Proxy Statement
      in connection with our 2007 annual meeting of stockholders and such information
      is incorporated by reference herein.






**ITEM
      11.**  **EXECUTIVE
      COMPENSATION**




Information
      relating to executive compensation that is responsive to Item 11 of this Form
      10-K will be included in our Proxy Statement in connection with our 2007 annual
      meeting of stockholders and such information is incorporated by reference
      herein.






**ITEM
      12.**  **SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
      MATTERS**




Information
      relating to security ownership of certain beneficial owners and management
      that
      is responsive to Item 12 of this Form 10-K will be included in our Proxy
      Statement in connection with our 2007 annual meeting of stockholders and such
      information is incorporated by reference herein.






**ITEM
      13.**  **CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS**




Information
      relating to certain relationships and related transactions that is responsive
      to
      Item 13 of this Form 10-K will be included in our Proxy Statement in connection
      with our 2007 annual meeting of stockholders and such information is
      incorporated by reference herein.




**ITEM
      14.**  **PRINCIPAL
      ACCOUNTING FEES AND SERVICES**




Information
      relating to principal accounting fees and services that is responsive to Item
      14
      of this Form 10-K will be included in our Proxy Statement in connection with
      our
      2007 annual meeting of stockholders and such information is incorporated by
      reference herein.







41
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





**PART
      IV**






**ITEM
      15.**  **EXHIBITS
      AND FINANCIAL STATEMENT SCHEDULES**




(a)
            The
                following documents are filed as part of this Form
                10-K:




(1)  Financial
      Statements - See Index to Financial Statements on page F-1 of this
      report.




(2)  Financial
      Statement Schedule




Schedule
      II:  Valuation
      and Qualifying Accounts




All
      other
      schedules are omitted because they are not applicable or the required
      information is shown in the financial statements or notes thereto.




(3)  Exhibits




**Exhibit
                No.**
            
            **Description**3.1
            
            Certificate
                of Incorporation of PDI, Inc.(1)3.2
            
            By-Laws
                of PDI, Inc .(1)3.3
            
            Certificate
                of Amendment of Certificate of Incorporation of PDI, Inc.(3)4.1
            
            Specimen
                Certificate Representing the Common Stock(1)10.1*
            
            Form
                of 1998 Stock Option Plan(1)10.2*
            
            Form
                of 2000 Omnibus Incentive Compensation Plan(2)10.3*
            
            Agreement
                between the Company and John P. Dugan(1)10.4*
            
            Form
                of Employment Separation Agreement between the Company and Steven
                K. Budd,
                filed herewith10.5*
            
            Form
                of Amended and Restated Employment Agreement between the Company
                and
                Stephen Cotugno(3)10.6
            
            Saddle
                River Executive Centre Lease(5)10.7*
            
            2004
                Stock Award and Incentive Plan(4)10.8*
            
            Form
                of Agreement between the Company and Larry Ellberger(5)10.9*
            
            Form
                of Agreement between the Company and Bernard C. Boyle(5)10.10*
            
            Memorandum
                of Understanding between the Company and Bernard C. Boyle(5)10.11*
            
            Amendment
                to Memorandum of Understanding between the Company and Bernard C.
                Boyle(5)10.12
            
            Saddle
                River Executive Centre Sublease Agreement(5)10.13*
            
            Form
                of Agreement between the Company and Michael J. Marquard(6)10.14*
            
            Form
                of Agreement between the Company and Jeffrey E. Smith(6)10.15*
            
            Form
                of Agreement between the Company and Kevin Connolly, filed
                herewith21.1
            
            Subsidiaries
                of the Registrant(3)23.1
            
            Consent
                of Ernst & Young LLP filed
                herewith.





42
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**








**Exhibit
                No.**
            
            **Description**23.2
            
            Consent
                of PricewaterhouseCoopers LLP filed herewith.31.1
            
            Certification
                of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley
                Act of 2002 filed herewith.31.2
            
            Certification
                of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley
                Act of 2002 filed herewith.32.1
            
            Certification
                of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as
                adopted
                Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 filed
                herewith.32.2
            
            Certification
                of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as
                adopted
                Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 filed
                herewith.*
            Denotes
                compensatory plan, compensation arrangement or management
                contract.(1)
            Filed
                as an exhibit to our Registration Statement on Form S-1 (File No
                333-46321), and incorporated herein by reference.(2)
            Filed
                as an Exhibit to our definitive proxy statement dated May 10, 2000,
                and
                incorporated herein by reference.(3)
            Filed
                as an exhibit to our Annual Report on Form 10-K for the year ended
                December 31, 2001, and incorporated herein by
                reference.(4)
            Filed
                as an Exhibit to our definitive proxy statement dated April 28, 2004,
                and
                incorporated herein by reference.(5)
            Filed
                as an exhibit to our Form 10-K for the year ended December 31, 2005,
                and
                incorporated herein by reference.(6)
            Filed
                as an exhibit to our Form 10-Q for the quarter ended June 30, 2006,
                and
                incorporated herein by reference.







(b)
            We
                have filed, as exhibits to this Form 10-K, the exhibits required
                by Item
                601 of the Regulation S-K.






(c)
            We
                have filed, as financial statements schedules to this annual report
                on
                Form 10-K, the financial statements required by Regulation S-X, which
                are
                excluded from the annual report to stockholders by Rule
                14a-3(b).







43
 
 **PDI,
          Inc.**
 **Annual
          Report on Form 10-K (continued)**





**SIGNATURES**




Pursuant
      to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
      1934, as amended, the Registrant has duly caused this Form 10-K to be signed
      on
      its behalf by the undersigned, thereunto duly authorized, on the 16th day of
      March, 2007.




**PDI,
                INC.****/**s**/**Michael
                J. MarquardMichael
                J. MarquardChief
                Executive Officer


Pursuant
      to the requirements of the Securities Exchange Act of 1934, as amended, this
      Form 10-K has been signed by the following persons on behalf of the Registrant
      and in the capacities indicated and on the 16th day of March, 2007.




Signature
            
            Title/s/
                John P. Dugan
            
            Chairman
                of the Board of DirectorsJohn
                P. Dugan**/**s**/**Michael
                J. Marquard
            
            Chief
                Executive Officer and DirectorMichael
                J. Marquard
            
            (principal
                executive officer)/s/
                Jeffrey E. Smith
            
            Chief
                Financial Officer and TreasurerJeffrey
                E. Smith
            
            (principal
                accounting and financial officer)/s/
                John M. Pietruski
            
            DirectorJohn
                M. Pietruski/s/
                Jan Martens Vecsi
            
            DirectorJan
                Martens Vecsi/s/
                Frank Ryan
            
            DirectorFrank
                Ryan/s/
                John Federspiel
            
            DirectorJohn
                Federspiel/s/
                Dr. Joseph T. Curti
            
            DirectorDr.
                Joseph T. Curti/s/
                Stephen J. Sullivan
            
            DirectorStephen
                J. Sullivan/s/
                Jack E. Stover
            
            DirectorJack
                E. Stover





44
 
  **PDI,
          INC.**
 **Index
          to Consolidated Financial Statements**
 **and
          Financial Statement Schedules**





**Page**Report
                of Independent Registered Public Accounting Firm
            F-2Report
                of Independent Registered Public Accounting Firm
            F-3Financial
                StatementsConsolidated
                Balance Sheets at December 31, 2006 and 2005
            F-4Consolidated
                Statements of Operations for each of the three yearsin
                the period ended December 31, 2006
            F-5Consolidated
                Statements of Stockholders’ Equity for each of the three
                yearsin
                the period ended December 31, 2006
            F-6Consolidated
                Statements of Cash Flows for each of the three yearsin
                the period ended December 31, 2006
            F-7Notes
                to Consolidated Financial Statements
            F-8Schedule
                II. Valuation and Qualifying Accounts
            F-31








F-1





**Report
      of Independent Registered Public Accounting Firm**




The
      Board
      of Directors and Stockholders of PDI, Inc.:




We
      have
      audited the accompanying consolidated balance sheets of PDI, Inc. as of December
      31, 2006 and 2005, and the related consolidated statements of operations,
      stockholders’ equity, and cash flows for each of the two years in the period
      ended December 31, 2006. Our audits also included the financial statement
      schedule listed in the Index at Item 15(a) (2). These financial statements
      and
      schedule are the responsibility of the Company’s management. Our responsibility
      is to express an opinion on the financial statements and schedule based on
      our
      audits.




We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the financial
      statements. An audit also includes assessing the accounting principles used
      and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audits provide a
      reasonable basis for our opinion.




In
      our
      opinion, the financial statements referred to above present fairly, in all
      material respects, the consolidated financial position of PDI, Inc. at December
      31, 2006 and 2005, and the consolidated results of its operations and its cash
      flows for each of the two years in the period ended December 31, 2006, in
      conformity with U.S. generally accepted accounting principles. Also, in our
      opinion, the related financial statement schedule, when considered in relation
      to the basic financial statements taken as a whole, presents fairly in all
      material respects the information set forth therein.




As
      discussed in Note 1 to the financial statements, effective January 1, 2006,
      the
      Company adopted the provisions of, and accounts for stock-based compensation
      in
      accordance with, Financial Accounting Standards Board Statement of Financial
      Accounting Standards No. 123 (revised 2004), Share-Based Payment.




We
      also
      have audited, in accordance with the standards of the Public Company Accounting
      Oversight Board (United States), the effectiveness of PDI, Inc.’s internal
      control over financial reporting as of December 31, 2006, based on criteria
      established in Internal Control-Integrated Framework issued by the Committee
      of
      Sponsoring Organizations of the Treadway Commission and our report dated March
      15, 2007 expressed an unqualified opinion on management's assessment and an
      unqualified opinion thereon.







/s/
                Ernst &Young LLPNew
                York, NYMarch
                15, 2007




















F-2





**Report
      of Independent Registered Public Accounting Firm**




To
      the
      Board of Directors and




Shareholders
      of PDI, Inc.:




In
      our
      opinion, the consolidated statements of operations, cash flows and stockholders'
      equity for the year ended December 31, 2004 present fairly, in all material
      respects, the results of operations and cash flows of PDI, Inc. and
      its subsidiaries for the year ended December 31, 2004, in conformity with
      accounting principles generally accepted in the United States of America. These
      financial statements are the responsibility of the Company's management. Our
      responsibility is to express an opinion on these financial statements based
      on
      our audit. We conducted our audit of these statements in accordance with the
      standards of the Public Company Accounting Oversight Board (United States).
      Those standards require that we plan and perform the audit to obtain reasonable
      assurance about whether the financial statements are free of material
      misstatement. An audit includes examining, on a test basis, evidence supporting
      the amounts and disclosures in the financial statements, assessing the
      accounting principles used and significant estimates made by management, and
      evaluating the overall financial statement presentation. We believe that our
      audit provides a reasonable basis for our opinion.






PricewaterhouseCoopers
      LLP


Florham
      Park, NJ


March
      11,
      2005



















F-3





**PDI,
                  INC.****CONSOLIDATED
                  BALANCE SHEETS**(in
                  thousands, except share and per share data)**December
                  31,**
              
              **December
                  31,****2006**
              
              **2005****ASSETS**Current
                  assets:Cash
                  and cash equivalents
              
              $
              45,221
              
              $
              90,827Short-term
                  investments
              
              
              69,463
              
              
              6,807Accounts
                  receivable, net of allowance for doubtful accounts of$36
                  and $778, respectively
              
              
              25,416
              
              
              27,148Unbilled
                  costs and accrued profits on contracts in progress
              
              
              4,224
              
              
              5,974Income
                  tax receivable
              
              
              1,888
              
              
              6,145Other
                  current assets
              
              
              10,528
              
              
              14,078Total
                  current assets
              
              
              156,740
              
              
              150,979Property
                  and equipment, net
              
              
              12,809
              
              
              16,053Goodwill
              
              
              13,612
              
              
              13,112Other
                  intangible assets, net
              
              
              15,950
              
              
              17,305Other
                  long-term assets
              
              
              2,525
              
              
              2,710Total
                  assets
              
              $
              201,636
              
              $
              200,159**LIABILITIES
                  AND STOCKHOLDERS' EQUITY**Current
                  liabilities:Accounts
                  payable
              
              $
              3,915
              
              $
              5,693Accrued
                  income taxes
              
              
              1,761
              
              
              4,047Unearned
                  contract revenue
              
              
              14,252
              
              
              12,598Accrued
                  incentives
              
              
              9,009
              
              
              12,179Accrued
                  payroll and related benefits
              
              
              1,475
              
              
              3,709Other
                  accrued expenses
              
              
              14,142
              
              
              20,489Total
                  current liabilities
              
              
              44,554
              
              
              58,715Long-term
                  liabilities
              
              
              7,885
              
              
              5,834Total
                  liabilities
              
              
              52,439
              
              
              64,549Commitments
                  and contingencies (Note 9)Stockholders’
                  equity:Preferred
                  stock, $.01 par value; 5,000,000 shares authorized, noshares
                  issued and outstanding
              
              
              -
              
              
              -Common
                  stock, $.01 par value; 100,000,000 shares authorized;15,096,976
                  and 14,947,771 shares issued, respectively;14,078,970
                  and 13,929,765 shares outstanding, respectively
              
              
              151
              
              
              149Additional
                  paid-in capital
              
              
              119,189
              
              
              118,325Retained
                  earnings
              
              
              42,992
              
              
              31,183Accumulated
                  other comprehensive income
              
              
              79
              
              
              71Unamortized
                  compensation costs
              
              
              -
              
              
              (904
              )Treasury
                  stock, at cost (1,018,006 shares)
              
              
              (13,214
              )
              
              (13,214
              )Total
                  stockholders' equity
              
              
              149,197
              
              
              135,610Total
                  liabilities and stockholders' equity
              
              $
              201,636
              
              $
              200,159*The
                  accompanying notes are an integral part of these consolidated financial
                  statements*





F-4





**PDI,
                  INC.****CONSOLIDATED
                  STATEMENTS OF OPERATIONS**(in
                  thousands, except for per share data)**For
                  The Years Ended December 31,****2006**
              
              **2005**
              
              **2004**Revenues:Service,
                  net
              
              $
              239,242
              
              $
              305,205
              
              $
              347,318Product,
                  net
              
              
              -
              
              
              -
              
              
              (1,521
              )Total
                  revenues, net
              
              
              239,242
              
              
              305,205
              
              
              345,797Cost
                  of goods and services:Cost
                  of services (including related party expenseof
                  $180 for the period ended December 31, 2004)
              
              
              183,398
              
              
              252,803
              
              
              252,910Cost
                  of goods sold
              
              
              -
              
              
              -
              
              
              254Total
                  cost of goods and services
              
              
              183,398
              
              
              252,803
              
              
              253,164Gross
                  profit
              
              
              55,844
              
              
              52,402
              
              
              92,633Operating
                  expenses:Compensation
                  expense
              
              
              28,075
              
              
              25,897
              
              
              30,634Other
                  selling, general and administrative expenses
              
              
              22,610
              
              
              29,392
              
              
              25,027Asset
                  impairment
              
              
              -
              
              
              6,178
              
              
              -Executive
                  severance
              
              
              573
              
              
              5,730
              
              
              495Legal
                  and related costs, net
              
              
              (3,279
              )
              
              1,691
              
              
              2,398Facilities
                  realignment
              
              
              1,952
              
              
              2,354
              
              
              -Total
                  operating expenses
              
              
              49,931
              
              
              71,242
              
              
              58,554Operating
                  income (loss)
              
              
              5,913
              
              
              (18,840
              )
              
              34,079Gain
                  (loss) on investments
              
              
              -
              
              
              4,444
              
              
              (1,000
              )Interest
                  income, net
              
              
              4,738
              
              
              3,190
              
              
              1,779Income
                  (loss) before income tax
              
              
              10,651
              
              
              (11,206
              )
              
              34,858(Benefit)
                  provision for income tax
              
              
              (724
              )
              
              201
              
              
              14,423Income
                  (loss) from continuing operations
              
              
              11,375
              
              
              (11,407
              )
              
              20,435Income
                  (loss) from discontinued operations,net
                  of tax
              
              
              434
              
              
              (8,047
              )
              
              697Net
                  income (loss)
              
              $
              11,809
              
              $
              (19,454
              )
              $
              21,132Income
                  (loss) per share of common stock:Basic:Continuing
                  operations
              
              $
              0.82
              
              $
              (0.80
              )
              $
              1.40Discontinued
                  operations
              
              
              0.03
              
              
              (0.57
              )
              
              0.05$
              0.85
              
              $
              (1.37
              )
              $
              1.45Assuming
                  dilution:Continuing
                  operations
              
              $
              0.81
              
              $
              (0.80
              )
              $
              1.37Discontinued
                  operations
              
              
              0.03
              
              
              (0.57
              )
              
              0.05$
              0.84
              
              $
              (1.37
              )
              $
              1.42Weighted
                  average number of common shares andcommon
                  share equivalents outstanding:Basic
              
              
              13,859
              
              
              14,232
              
              
              14,564Assuming
                  dilution
              
              
              13,994
              
              
              14,232
              
              
              14,893*The
                  accompanying notes are an integral part of these consolidated financial
                  statements*





F-5





**PDI,
                  INC.****CONSOLIDATED
                  STATEMENTS OF STOCKHOLDERS' EQUITY**(in
                  thousands)**For
                  The Years Ended December 31,****2006**
              
              **2005**
              
              **2004****Shares**
              
              **Amount**
              
              **Shares**
              
              **Amount**
              
              **Shares**
              
              **Amount****Common
                  stock:**Balance
                  at January 1
              
              
              14,948
              
              $
              149
              
              
              14,820
              
              $
              148
              
              
              14,523
              
              $
              145Common
                  stock issued
              
              
              -
              
              
              -
              
              
              68
              
              
              1
              
              
              68
              
              
              1Restricted
                  stock issued
              
              
              155
              
              
              2
              
              
              43
              
              
              -
              
              
              98
              
              
              1Restricted
                  stock forfeited
              
              
              (23
              )
              
              -
              
              
              (24
              )
              
              -
              
              
              (14
              )
              
              -SARs
                  exercised
              
              
              1
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Stock
                  options exercised
              
              
              16
              
              
              -
              
              
              41
              
              
              -
              
              
              145
              
              
              1Balance
                  at December 31
              
              
              15,097
              
              
              151
              
              
              14,948
              
              
              149
              
              
              14,820
              
              
              148**Treasury
                  stock:**Balance
                  at January 1
              
              
              1,018
              
              
              (13,214
              )
              
              5
              
              
              (110
              )
              
              5
              
              
              (110
              )Treasury
                  stock purchased
              
              
              -
              
              
              -
              
              
              1,013
              
              
              (13,104
              )
              
              -
              
              
              -Balance
                  at December 31
              
              
              1,018
              
              
              (13,214
              )
              
              1,018
              
              
              (13,214
              )
              
              5
              
              
              (110
              )**Additional
                  paid-in capital:**Balance
                  at January 1
              
              
              
              
              
              118,325
              
              
              
              
              
              116,737
              
              
              
              
              
              109,531Common
                  stock issued
              
              
              
              
              
              -
              
              
              
              
              
              699
              
              
              
              
              
              1,511Restricted
                  stock issued
              
              
              
              
              
              (2
              )
              
              
              
              
              533
              
              
              
              
              
              2,626Restricted
                  stock forfeited
              
              
              
              
              
              (95
              )
              
              
              
              
              (494
              )
              
              
              
              
              (174
              )Stock-based
                  compensation expense
              
              
              
              
              
              1,755
              
              
              
              
              
              259
              
              
              
              
              
              -Stock
                  grants exercised
              
              
              
              
              
              87
              
              
              
              
              
              591
              
              
              
              
              
              2,369Tax
                  benefit on stock-based compensation
              
              23
              
              
              
              
              
              -
              
              
              
              
              
              641Acceleration
                  of stock option vesting
              
              
              
              
              
              -
              
              
              
              
              
              -
              
              
              
              
              
              233Reclassification
                  of unamortized compensation
              
              (904
              )
              
              
              
              
              -
              
              
              
              
              
              -Balance
                  at December 31
              
              
              
              
              
              119,189
              
              
              
              
              
              118,325
              
              
              
              
              
              116,737**Retained
                  earnings:**Balance
                  at January 1
              
              
              
              
              
              31,183
              
              
              
              
              
              50,637
              
              
              
              
              
              29,505Net
                  income (loss)
              
              
              
              
              
              11,809
              
              
              
              
              
              (19,454
              )
              
              
              
              
              21,132Balance
                  at December 31
              
              
              
              
              
              42,992
              
              
              
              
              
              31,183
              
              
              
              
              
              50,637**Accumulated
                  other****comprehensive
                  income (loss):**Balance
                  at January 1
              
              
              
              
              
              71
              
              
              
              
              
              76
              
              
              
              
              
              25Reclassification
                  of realized (gain) loss, net of tax
              
              (33
              )
              
              
              
              
              (49
              )
              
              
              
              
              21Unrealized
                  holding gain, net of tax
              
              
              
              
              
              41
              
              
              
              
              
              44
              
              
              
              
              
              30Balance
                  at December 31
              
              
              
              
              
              79
              
              
              
              
              
              71
              
              
              
              
              
              76**Unamortized
                  compensation costs:**Balance
                  at January 1
              
              
              
              
              
              (904
              )
              
              
              
              
              (2,063
              )
              
              
              
              
              (608
              )Restricted
                  stock issued
              
              
              
              
              
              -
              
              
              
              
              
              (533
              )
              
              
              
              
              (2,627
              )Restricted
                  stock forfeited
              
              
              
              
              
              -
              
              
              
              
              
              494
              
              
              
              
              
              137Restricted
                  stock vested
              
              
              
              
              
              -
              
              
              
              
              
              1,198
              
              
              
              
              
              1,035Reclassification
                  to additional paid-in capital
              
              904
              
              
              
              
              
              -
              
              
              
              
              
              -Balance
                  at December 31
              
              
              
              
              
              -
              
              
              
              
              
              (904
              )
              
              
              
              
              (2,063
              )**Total
                  stockholders' equity**
              
              
              
              
              
              149,197
              
              
              
              
              
              135,610
              
              
              
              
              
              165,425**Comprehensive
                  income (loss):**Net
                  income (loss)
              
              
              
              
              $
              11,809
              
              
              
              
              $
              (19,454
              )
              
              
              
              $
              21,132Reclassification
                  of realized (gain) loss, net of tax
              
              (33
              )
              
              
              
              
              (49
              )
              
              
              
              
              21Unrealized
                  holding gain, net of tax
              
              
              
              
              
              41
              
              
              
              
              
              44
              
              
              
              
              
              30Total
                  comprehensive income (loss)
              
              
              
              
              $
              11,817
              
              
              
              
              $
              (19,459
              )
              
              
              
              $
              21,183*The
                  accompanying notes are an integral part of these consolidated financial
                  statements*





F-6





**PDI,
                  INC.****CONSOLIDATED
                  STATEMENTS OF CASH FLOWS**(in
                  thousands)**For
                  The Years Ended December 31,****2006**
              
              **2005**
              
              **2004****Cash
                  Flows From Operating Activities**Net
                  income (loss) from operations
              
              $
              11,809
              
              $
              (19,454
              )
              $
              21,132Adjustments
                  to reconcile net income to net cashprovided
                  by operating activities:Depreciation,
                  amortization and accretion
              
              
              5,764
              
              
              5,820
              
              
              5,916Deferred
                  income taxes, net
              
              
              2,710
              
              
              6,447
              
              
              9,199(Recovery
                  of) provision for bad debt, net
              
              
              (728
              )
              
              730
              
              
              683(Recovery
                  of) provision for doubtful notes, net
              
              
              (250
              )
              
              655
              
              
              -Stock-based
                  compensation
              
              
              1,660
              
              
              1,457
              
              
              1,232Tax
                  benefit from stock-based compensation
              
              
              (23
              )
              
              -
              
              
              -Loss
                  on disposal of assets
              
              
              -
              
              
              269
              
              
              622Asset
                  impairment
              
              
              -
              
              
              14,351
              
              
              -Non-cash
                  facilities realignment
              
              
              1,295
              
              
              -
              
              
              -(Gain)
                  loss on investment
              
              
              -
              
              
              (4,444
              )
              
              1,000Other
                  changes in assets and liabilities:Decrease
                  (increase) in accounts receivable
              
              
              2,460
              
              
              (1,229
              )
              
              15,807Decrease
                  (increase) in unbilled costs
              
              
              1,750
              
              
              (2,581
              )
              
              648Decrease
                  (increase) in income tax receivable
              
              
              4,257
              
              
              (6,145
              )
              
              -Decrease
                  in inventory
              
              
              -
              
              
              -
              
              
              43Decrease
                  (increase) in other current assets
              
              
              336
              
              
              448
              
              
              (33
              )Decrease
                  (increase) in other long-term assets
              
              
              185
              
              
              218
              
              
              (28
              )Decrease
                  in accounts payable
              
              
              (1,778
              )
              
              (41
              )
              
              (3,439
              )Decrease
                  in accrued income taxes
              
              
              (2,286
              )
              
              (1,216
              )
              
              (3,529
              )Increase
                  in unearned contract revenue
              
              
              1,654
              
              
              5,674
              
              
              507Decrease
                  in accrued incentives
              
              
              (3,170
              )
              
              (4,254
              )
              
              (4,204
              )Decrease
                  in accrued payroll and related benefits
              
              
              (2,234
              )
              
              (858
              )
              
              (617
              )(Decrease)
                  increase in accrued liabilities
              
              
              (3,969
              )
              
              2,727
              
              
              (17,250
              )Increase
                  in long-term liabilities
              
              
              243
              
              
              4,541
              
              
              1,293Net
                  cash provided by operating activities
              
              
              19,685
              
              
              3,115
              
              
              28,982**Cash
                  Flows From Investing Activities**(Purchases)
                  sales of short-term investments, net
              
              
              (63,881
              )
              
              21,686
              
              
              (27,103
              )Repayments
                  from (investments in) Xylos
              
              
              250
              
              
              100
              
              
              (1,500
              )Purchase
                  of property and equipment
              
              
              (1,770
              )
              
              (5,832
              )
              
              (8,104
              )Cash
                  paid for acquisition, including acquisition costs
              
              
              -
              
              
              (1,936
              )
              
              (28,443
              )Proceeds
                  from sale of assets and investments
              
              
              -
              
              
              4,507
              
              
              -Net
                  cash (used in) provided by investing activities
              
              
              (65,401
              )
              
              18,525
              
              
              (65,150
              )**Cash
                  Flows From Financing Activities**Net
                  proceeds from exercise of stock options
              
              
              110
              
              
              1,291
              
              
              3,880Cash
                  paid for repurchase of shares
              
              
              -
              
              
              (13,104
              )
              
              -Net
                  cash provided by (used in) financing activities
              
              
              110
              
              
              (11,813
              )
              
              3,880Net
                  (decrease) increase in cash and cash equivalents
              
              
              (45,606
              )
              
              9,827
              
              
              (32,288
              )Cash
                  and cash equivalents - beginning
              
              
              90,827
              
              
              81,000
              
              
              113,288Cash
                  and cash equivalents - ending
              
              $
              45,221
              
              $
              90,827
              
              $
              81,000Cash
                  paid for interest
              
              $
              2
              
              $
              2
              
              $
              3Cash
                  paid for taxes
              
              $
              640
              
              $
              1,513
              
              $
              7,389*The
                  accompanying notes are an integral part of these consolidated financial
                  statements*








F-7
 
 **PDI,
          Inc.**
 **Notes
          to the Consolidated Financial Statements**
 **(tabular
          information in thousands, except share and per share
          data****)**





**1.**
            **Nature
                of Business and Significant Accounting
                Policies**




*Nature
      of Business*




PDI,
      Inc.
      together with its wholly-owned subsidiaries (PDI or the Company) is a
      diversified sales and marketing services company serving the biopharmaceutical
      and life sciences industries. See
      Note
      21, Segment Information, for additional information.




*Principles
      of Consolidation*




The
      accompanying consolidated financial statements have been prepared in accordance
      with U.S. generally accepted accounting principles (GAAP). The consolidated
      financial statements include accounts of PDI and its wholly owned subsidiaries
      TVG, Inc., ProtoCall, Inc., InServe Support Solutions (InServe), and PDI
      Investment Company, Inc. All significant intercompany balances and transactions
      have been eliminated in consolidation. In the second quarter of 2006, the
      Company discontinued its Medical Device and Diagnostic (MD&D) business. The
      MD&D business was part of the Company's sales services reporting segment.
      The MD&D business is accounted for as a discontinued operation under GAAP
      and, therefore, the MD&D business results of operations have been removed
      from the Company's results of continuing operations for all periods presented.
      See Note 20, Discontinued Operations.




*Accounting
      Estimates*




The
      preparation of consolidated financial statements in conformity with GAAP
      requires management to make estimates and assumptions that affect the amounts
      of
      assets and liabilities reported 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. Significant estimates include incentives earned or
      penalties incurred on contracts, valuation allowances related to deferred income
      taxes, self-insurance loss accruals, allowances for doubtful accounts and notes,
      fair value of assets, income tax accruals, facilities realignment accruals
      and
      sales returns.




*Cash
      and Cash Equivalents*




Cash
      and
      cash equivalents consist of unrestricted cash accounts, highly liquid investment
      instruments and certificates of deposit with an original maturity of three
      months or less at the date of purchase.




*Investments
      in Marketable Securities*




The
      Company classifies its investments in marketable securities as
“available-for-sale” or “held-to-maturity” in accordance with Statement of
      Financial Accounting Standards (SFAS) No. 115, “ *Accounting
      for Certain Investments in Debt and Equity Securities.* ”
The
      Company does not have any investments classified as “trading.”
Available-for-sale investments are carried at fair market value based on quoted
      market values with the unrealized holding gain and loss, net of taxes, reported
      as a component of accumulated other comprehensive income until realized. The
      Company’s other short-term investments consist of a laddered portfolio of
      investment grade debt instruments such as obligations of the U.S. Treasury
      and
      U.S. Federal Government agencies, municipal bonds and commercial paper. These
      investments are classified as held-to-maturity because the Company has the
      intent and ability to hold these securities to maturity. Held-to-maturity
      investments are stated at amortized cost. Interest income is accrued as earned.
      Realized gains and losses are computed based upon specific identification and
      included in interest income, net in the consolidated statement of
      operations.




*Receivables
      and Allowance for Doubtful Accounts*




Trade
      accounts receivable are recorded at the invoiced amount and do not bear
      interest. Management
      reviews a customer’s credit history before extending credit. The Company has
      recorded a provision for estimated losses resulting from the inability of its
      customers to make required payments based on historical experience and
      periodically adjusts these provisions to reflect actual experience.
      Additionally, the Company will establish a specific allowance for doubtful
      accounts when the Company becomes aware of a specific customer’s inability or
      unwillingness to meet its financial obligations (e.g., bankruptcy filing).
      The
      Company operates almost exclusively in the pharmaceutical industry and to a
      great extent its revenue is dependent on a limited number of large
      pharmaceutical companies. The Company also partners with customers in the
      emerging pharmaceutical sector, some of whom may have limited financial
      resources. A general downturn in the pharmaceutical industry or adverse material
      event to one or more of the Company’s emerging pharmaceutical customers could
      result in higher than expected customer defaults and additional allowances
      may
      be required. Allowance for doubtful accounts was approximately $36,000 and
      $778,000 as of December 31, 2006 and 2005, respectively.







F-8
 
  **PDI,
          Inc.**
 **Notes
          to the Consolidated Financial Statements (Continued)**
 **(tabular
          information in thousands, except share and per share
          data****)**





*Unbilled
      Costs and Accrued Profits and Unearned Contract Revenue*




In
      general, contractual provisions, including predetermined payment schedules
      or
      submission of appropriate billing detail, establish the prerequisites for
      billings. Unbilled costs and accrued profits arise when services have been
      rendered and payment is assured but customers have not been billed. These
      amounts are classified as a current asset. Normally, in the case of detailing
      contracts, the customers agree to pay the Company a portion of the fee due
      under
      a contract in advance of performance of services because of large recruiting
      and
      employee development costs associated with the beginning of a contract. The
      excess of amounts billed over revenue recognized represents unearned contract
      revenue, which is classified as a current liability.




*Loans
      and Investments in Privately Held Entities*




From
      time
      to time, the Company makes investments in and/or loans to privately-held
      companies. The Company considers whether the fair values of any investments
      in
      privately held entities have declined below their carrying value whenever
      adverse events or changes in circumstances indicate that recorded values may
      not
      be recoverable. If the Company considers any such decline to be other than
      temporary (based on various factors, including historical financial results,
      and
      the overall health of the investee’s industry), a write-down is recorded to
      estimated fair value. For the year ended December 31, 2004, the Company recorded
      a loss on investments of $1.0 million to write-down investments to their fair
      value. Additionally, on a quarterly basis, the Company reviews outstanding
      loans
      receivable to determine if a provision for doubtful accounts is necessary.
      These
      reviews include discussions with senior management of the investee, and
      evaluations of, among other things, the investee’s progress against its business
      plan, its product development activities and customer base, industry market
      conditions, historical and projected financial performance, expected cash needs
      and recent funding events. The Company records interest income on the impaired
      loans; however, that amount is fully reserved for if the investee is not making
      their interest payments. Subsequent cash receipts on the outstanding interest
      would be applied against the outstanding interest receivable balance and the
      corresponding allowance. The Company’s assessments of value are highly
      subjective given that these companies may be at an early stage of development
      and rely regularly on their investors for cash infusions. At December 31, 2006
      and 2005, the allowance for doubtful notes was approximately $700,000 and $1.2
      million, respectively. See Note 6, Loans and Investments in Privately-Held
      Entities, for additional information.




*Property
      and Equipment*




Property
      and equipment are stated at cost less accumulated depreciation. Depreciation
      is
      computed using the straight-line method, based on estimated useful lives of
      seven to ten years for furniture and fixtures, three to five years for office
      and computer equipment, ten years for phone systems, and three to seven years
      for computer software. Leasehold improvements are amortized over the shorter
      of
      the estimated service lives or the terms of the related leases. Repairs and
      maintenance are charged to expense as incurred. Upon disposition, the asset
      and
      related accumulated depreciation are removed from the related accounts and
      any
      gains or losses are reflected in operations. As the prices of computer desktops
      and laptops continue to decline, more of these computer purchases are falling
      short of the Company’s minimum price threshold for capitalization and are being
      expensed. The Company expects that trend to continue.




*Software
      Costs*




It
      is the
      Company’s policy to capitalize certain costs incurred in connection with
      developing or obtaining internal-use software. Capitalized software costs are
      included in property and equipment on the consolidated balance sheet and
      amortized over the software's useful life. Software costs that do not meet
      capitalization criteria are expensed immediately.




*Fair
      Value of Financial Instruments*




The
      Company considers carrying amounts of cash, accounts receivable, accounts
      payable and accrued expenses to approximate fair value due to the short-term
      nature of these financial instruments. Marketable securities classified as
      “available for sale” are carried at fair value. Marketable securities classified
      as “held-to-maturity” are carried at amortized cost, which approximates fair
      value. The fair value of letters of credit is determined to be zero as
      management does not expect any material losses to result from these instruments
      because performance is not expected to be required.







F-9
 
  **PDI,
          Inc.**
 **Notes
          to the Consolidated Financial Statements (Continued)**
 **(tabular
          information in thousands, except share and per share
          data****)**





*Goodwill
      and Other Intangible Assets*




The
      Company accounts for purchases of acquired companies in accordance with SFAS
      No.
      141, *"Business
      Combinations"* (FAS
      141) and accounts for the related goodwill and other identifiable definite
      and
      indefinite-lived acquired intangible assets in accordance with SFAS No. 142, *“Goodwill
      and Other Intangible Assets”* (FAS
      142). The identification and valuation of these intangible assets and the
      determination of the estimated useful lives at the time of acquisition, as
      well
      as the completion of annual impairment tests require significant management
      judgments and estimates. These estimates are made based on, among other factors,
      consultations with an accredited independent valuation consultant, reviews
      of
      projected future cash flows and statutory regulations. In accordance with FAS
      141, the Company allocates the cost of the acquired companies to the
      identifiable tangible and intangible assets and liabilities acquired, with
      the
      remaining amount being classified as goodwill. Since the entities the Company
      has acquired do not have significant tangible assets, a significant portion
      of
      the purchase price has been allocated to intangible assets and goodwill. The
      use
      of alternative estimates and assumptions could increase or decrease the
      estimated fair value of goodwill and other intangible assets, and potentially
      result in a different impact to the Company’s results of operations. Further,
      changes in business strategy and/or market conditions may significantly impact
      these judgments thereby impacting the fair value of these assets, which could
      result in an impairment of the goodwill and acquired intangible
      assets.




The
      Company has elected to do the annual tests for indications of goodwill
      impairment as of December 31  of
      each
      year. The Company utilizes discounted cash flow models to determine fair value
      in the goodwill impairment evaluation. In assessing the recoverability of
      goodwill, projections regarding estimated future cash flows and other factors
      are made to determine that fair value of the respective reporting units. While
      the Company uses available information to prepare estimates and to perform
      impairment evaluations, actual results could differ significantly from these
      estimates or related projections, resulting in impairment related to recorded
      goodwill balances. The 2006 evaluation indicated that there was no impairment
      of
      goodwill. The 2005 evaluation indicated that goodwill recorded in the MD&D
      and Select Access reporting units was impaired and accordingly, the Company
      recognized non-cash charges of approximately $7.8 million and $3.3 million,
      respectively, in 2005. See Note 5, Goodwill and Other Intangible Assets, for
      additional information.




*Long-Lived
      Assets*




In
      accordance with SFAS No. 144, “ *Accounting
      for the Impairment or Disposal of Long-Lived Assets,”* (FAS
      144) ** the
      Company reviews the recoverability of long-lived assets and finite-lived
      intangible assets whenever events or changes in circumstances indicate that
      the
      carrying value of such assets may not be recoverable. If the sum of the expected
      future undiscounted cash flows is less than the carrying amount of the asset,
      an
      impairment loss is recognized by reducing the recorded value of the asset to
      its
      fair value measured by future discounted cash flows. This analysis requires
      estimates of the amount and timing of projected cash flows and, where
      applicable, judgments associated with, among other factors, the appropriate
      discount rate. Such estimates are critical in determining whether any impairment
      charge should be recorded and the amount of such charge if an impairment loss
      is
      deemed to be necessary. In addition, future events impacting cash flows for
      existing assets could render a write-down or write-off necessary that previously
      required no such write-down or write-off. In 2006, the Company recorded a
      non-cash charge of approximately $1.3 million for furniture and leasehold
      improvements related to the excess leased space at its Saddle River, New Jersey
      and Dresher, Pennsylvania locations. See Note 17, Facilities Realignment, for
      additional information. In 2005, the Company recorded a non-cash charge of
      approximately $2.8 million related to the impairment of its Siebel sales force
      automation software and a non-cash charge of approximately $349,000 related
      to
      the impairment of the InServe intangible assets. See Note 4, Property and
      Equipment, and Note 5, Goodwill and Other Intangible Assets, respectively,
      for
      additional information.




*Self-Insurance
      Accruals*




The
      Company is self-insured for certain losses for claims filed and claims incurred
      but not reported relating to workers’ compensation and automobile-related
      liabilities for Company-leased cars. The Company’s liability is estimated on an
      actuarial undiscounted basis supplied by its insurance brokers and insurers
      using individual case-based valuations and statistical analysis and is based
      upon judgment and historical experience, however, the final cost of many of
      these claims may not be known for five years or longer. The Company maintains
      stop-loss coverage with third-party insurers to limit its total exposure on
      these programs. Management reviews these accruals on a quarterly basis. At
      December 31, 2006 and 2005, self-insurance accruals totaled $2.5 million and
      $3.8 million, respectively, and are included in other accrued expenses on the
      balance sheet.







F-10
 
 **PDI,
          Inc.**
 **Notes
          to the Consolidated Financial Statements (Continued)**
 **(tabular
          information in thousands, except share and per share
          data****)**





*Accrued
      Sales Returns*




For
      product sales, provision is made at the time of sale for all discounts and
      estimated sales allowances. Upon approval from the Company, customers who
      purchased the Company’s Ceftin product were permitted to return unused product
      up to six months before, and one year after the expiration date for the product,
      but no later than December 31, 2004 ,
      as
      discussed in Note 15, Performance Based Contracts. There was a $1.7 million
      adjustment for changes in estimates to the Ceftin returns reserve in 2004.
      There
      were no adjustments in 2006 and 2005. These adjustments were recorded as a
      reduction to revenue consistent with the initial recognition of the returns
      allowance and resulted in the Company reporting net negative product revenue
      in
      2004.




*Treasury
      Stock*




Treasury
      stock purchases are accounted for under the cost method whereby the entire
      cost
      of the acquired stock is recorded as treasury stock. Upon reissuance of shares
      of treasury stock, the Company records any difference between the
      weighted-average cost of such shares and any proceeds received as an adjustment
      to additional paid-in capital.




*Revenue
      Recognition and Associated Costs*




Revenue
      and associated costs under pharmaceutical detailing contracts are generally
      based on the number of physician details made or the number of sales
      representatives utilized. With respect to risk-based contracts, all or a portion
      of revenues earned are based on contractually defined percentages of either
      product revenues or the market value of prescriptions written and filled in
      a
      given period. These contracts are generally for terms of one to two years and
      may be renewed or extended. The majority of these contracts, however, are
      terminable by the customer for any reason upon 30 to 90 days’ notice. Certain
      contracts provide for termination payments if the customer terminates the
      agreement without cause. Typically, however, these penalties do not offset
      the
      revenue the Company could have earned under the contract or the costs the
      Company may incur as a result of its termination. The loss or termination of
      a
      large pharmaceutical detailing contract or the loss of multiple contracts could
      have a material adverse effect on the Company’s business, financial condition or
      results of operations. See Note 14, Significant Customers.




Revenue
      and associated costs under marketing service contracts are generally based
      on a
      single deliverable such as a promotional program, accredited continuing medical
      education seminar or marketing research/advisory program. The contracts are
      generally terminable by the customer for any reason. Upon termination, the
      customer is generally responsible for payment for all work completed to date,
      plus the cost of any nonrefundable commitments made on behalf of the customer.
      There is significant customer concentration in the Company’s Pharmakon business,
      and the loss or termination of one or more of Pharmakon’s large master service
      agreements could have a material adverse on the Company’s business, financial
      condition or results of operations. Due to the typical size of most contracts
      of
      TVG Marketing Research and Consulting (TVG) and Vital Issues in Medicine (VIM)®
, it is unlikely the loss or termination of any individual TVG or VIM contract
      would have a material adverse effect on the Company’s business, financial
      condition or results of operations.




Service
      revenue is recognized on product detailing programs and certain marketing,
      promotional and medical education contracts as services are performed and the
      right to receive payment for the services is assured. Many of the product
      detailing contracts allow for additional periodic incentive fees to be earned
      if
      certain performance benchmarks have been attained. Revenue earned from incentive
      fees is recognized in the period earned and when the Company is reasonably
      assured that payment will be made. Under performance based contracts, revenue
      is
      recognized when the performance based parameters are achieved. Many contracts
      also stipulate penalties if agreed upon performance benchmarks have not been
      met. Revenue is recognized net of any potential penalties until the performance
      criteria relating to the penalties have been achieved. Revenue and associated
      costs from marketing research contracts are recognize d
      upon
      completion of the contract. These contracts are generally short-term in nature
      typically lasting two to six months.




Historically,
      the Company has derived a significant portion of its service revenue from a
      limited number of customers. Concentration of business in the pharmaceutical
      services industry is common and the industry continues to consolidate. As a
      result, the Company is likely to continue to experience significant customer
      concentration in future periods. For the years ended December 31, 2006 and
      2004,
      the Company’s two largest customers, who each individually represented 10% or
      more of its service revenue, together accounted for approximately 46.8% and
      66.4%, respectively, of its service revenue. For 2005, the Company’s three
      largest customers, who each individually represented 10% or more of its service
      revenue, together accounted for approximately 73.6% of its service revenue.







F-11
 
 **PDI,
          Inc.**
 **Notes
          to the Consolidated Financial Statements (Continued)**
 **(tabular
          information in thousands, except share and per share
          data****)**





Cost
      of
      services consist primarily of the costs associated with executing product
      detailing programs, performance based contracts or other sales and marketing
      services identified in the contract. Cost of services include personnel costs
      and other costs associated with executing a product detailing or other marketing
      or promotional program, as well as the initial direct costs associated with
      staffing a product detailing program. Such costs include, but are not limited
      to, facility rental fees, honoraria and travel expenses, sample expenses and
      other promotional expenses.




Personnel
      costs, which constitute the largest portion of cost of services, include all
      labor related costs, such as salaries, bonuses, fringe benefits and payroll
      taxes for the sales representatives and sales managers and professional staff
      that are directly responsible for executing a particular program. Initial direct
      program costs are those costs associated with initiating a product detailing
      program, such as recruiting, hiring, and training the sales representatives
      who
      staff a particular product detailing program. All personnel costs and initial
      direct program costs, other than training costs, are expensed as incurred for
      service offerings.




Reimbursable
      out-of-pocket expenses include those relating to travel and other similar costs,
      for which the Company is reimbursed at cost by its customers. In accordance
      with
      the requirements of Emerging Issues Task Force No. 01-14, *“Income
      Statement Characterization of Reimbursements Received for Out-of-Pocket Expenses
      Incurred”* (EITF
      01-14), reimbursements received for out-of-pocket expenses incurred are
      characterized as revenue and an identical amount is included as cost of goods
      and services in the consolidated statements of operations. For the years ended
      December 31, 2006, 2005 and 2004, reimbursable out-of-pocket expenses were
      $25.3
      million, $35.2 million and $22.8 million, respectively.




Training
      costs include the costs of training the sales representatives and managers
      on a
      particular product detailing program so that they are qualified to properly
      perform the services specified in the related contract. For all contracts,
      training costs are deferred and amortized on a straight-line basis over the
      shorter of the life of the contract to which they relate or 12 months. When
      the
      Company receives a specific contract payment from a customer upon commencement
      of a product detailing program expressly to compensate the Company for
      recruiting, hiring and training services associated with staffing that program,
      such payment is deferred and recognized as revenue in the same period that
      the
      recruiting and hiring expenses are incurred and amortization of the deferred
      training is expensed. When the Company does not receive a specific contract
      payment for training, all revenue is deferred and recognized over the life
      of
      the contract.




Product
      revenue is recognized when products are shipped and title is transferred to
      the
      customer. Product revenue for the year ended December 31, 2004 was negative,
      primarily from the adjustments to the Ceftin sales returns reserve, as discussed
      previously in Note 1, Nature of Business and Significant Accounting Policies,
      net of the sale of the Xylos wound care products.




Cost
      of
      goods sold includes all expenses for product distribution costs, acquisition
      and
      manufacturing costs of the product sold.




*Stock-Based
      Compensation*




On
      January 1, 2006, the Company adopted SFAS No. 123, “(Revised 2004): Share-Based
      Payment” (FAS 123R), which replaces SFAS No. 123, “Accounting for Stock-Based
      Compensation” (FAS 123) and supersedes Accounting Principles Board Opinion No.
      25, “Accounting for Stock Issued to Employees” (APB 25). FAS 123R requires all
      share-based payments to employees, including grants of employee stock options,
      to be recognized as compensation expense over the service period (generally
      the
      vesting period) in the consolidated financial statements based on their fair
      values. The Company elected to use the modified prospective transition method
      and as a result prior period results were not restated. Under the modified
      prospective transition method, awards that were granted or modified on or after
      January 1, 2006 are measured and accounted for in accordance with FAS 123R.
      The
      unearned compensation costs related to unvested stock options and restricted
      stock awards that were granted prior to January 1, 2006 will be recognized
      using
      the grant date fair value determined under FAS 123. The Company has adopted
      the
      use of the straight-line attribution method over the requisite service period
      for the entire award. The Company had no cumulative effect adjustment upon
      adoption of FAS 123R under the modified prospective method. The Company reversed
      the balance of $904,000 of unamortized compensation costs that pertained to
      restricted stock as of the January 1, 2006 balance sheet date to additional
      paid-in capital as required by FAS 123R. As a result of adopting FAS
      123R
      on January 1, 2006, net income and net income per share for the year ended
      December 31, 2006 were $290,000 and $0.02 lower, respectively, than if the
      Company had continued to account for stock-based compensation under APB
      25.







F-12
 
 **PDI,
          Inc.**
 **Notes
          to the Consolidated Financial Statements (Continued)**
 **(tabular
          information in thousands, except share and per share
          data****)**





Prior
      to
      January 1, 2006, the Company accounted for stock-based employee compensation
      using the intrinsic value method under the recognition and measurement
      principles of APB 25, and related interpretations. In accordance with APB 25,
      the Company did not recognize stock-based compensation expense with respect
      to
      options granted with an exercise price equal to the market value of the
      underlying common stock on the date of grant. As a result, prior to 2006, the
      recognition of stock-based compensation expense was generally limited to the
      expense related to restricted share awards. The following table illustrates
      the
      effect on net income and earnings per share if the Company had applied the
      fair
      value recognition provisions of FAS 123 to stock-based employee compensation
      for
      the years ended December 31, 2005 and 2004.




For
                  the Year Ended December 31,2005
              
              2004Net
                  (loss) income, as reported
              
              $
              (19,454
              )
              $
              21,132Add:
                  Stock-based employeecompensation
                  expense includedin
                  reported net (loss) income,net
                  of related tax effects
              
              
              974
              
              
              721Deduct:
                  Total stock-basedemployee
                  compensation expensedetermined
                  under fair value basedmethods
                  for all awards, net ofrelated
                  tax effects
              
              
              (6,670
              )
              
              (3,946
              )Pro
                  forma net (loss) income
              
              $
              (25,150
              )
              $
              17,907(Loss)
                  earnings per shareBasic—as
                  reported
              
              $
              (1.37
              )
              $
              1.45Basic—pro
                  forma
              
              $
              (1.77
              )
              $
              1.23Diluted—as
                  reported
              
              $
              (1.37
              )
              $
              1.42Diluted—pro
                  forma
              
              $
              (1.77
              )
              $
              1.20




Prior
      to
      adoption of FAS 123R, the Company presented all tax benefits for deductions
      resulting from the exercise of stock options and disqualifying dispositions
      as
      operating cash flows on its consolidated statements of cash flows. SFAS 123R
      requires the benefits of tax deductions in excess of recognized compensation
      expense to be reported as a component of financing cash flows, rather than
      as a
      component of operating cash flows. This requirement will reduce net operating
      cash flows and increase net financing cash flows in periods after adoption.
      Total cash flow will remain unchanged from what would have been reported under
      prior accounting rules.




FAS
      123R
      also requires that the Company recognize compensation expense for only the
      portion of stock options, stock-settled stock appreciation rights (SARs) or
      restricted shares that are expected to vest. Therefore, the Company applies
      estimated forfeiture rates that are derived from historical employee termination
      behavior. The Company applied a forfeiture rate to grants in 2006. If the actual
      number of forfeitures differs from those estimated by management, adjustments
      to
      compensation expense might be required in future periods. See Note 11,
      Stock-Based Compensation, for further information regarding the Company’s
      stock-based compensation assumptions and expenses.




*Rent
      Expense*




Minimum
      rental expenses are recognized over the term of the lease. The Company
      recognizes minimum rent starting when possession of the property is taken from
      the landlord, which normally includes a construction period prior to occupancy.
      When a lease contains a predetermined fixed escalation of the minimum rent,
      the
      Company recognizes the related rent expense on a straight-line basis and records
      the difference between the recognized rental expense and the amounts payable
      under the lease as deferred lease credits. The Company also may receive tenant
      allowances including cash or rent abatements, which are reflected in other
      accrued expenses on the consolidated balance sheet and are amortized as a
      reduction to rent expense over the term of the lease. Certain leases provide
      for
      contingent rents that are not measurable at inception. These contingent rents
      are primarily based upon use of utilities and the landlord’s operating expenses.
      These amounts are excluded from minimum rent and are included in the
      determination of total rent expense when it is probable that the expense has
      been incurred and the amount is reasonably estimable.







F-13
 
 **PDI,
          Inc.**
 **Notes
          to the Consolidated Financial Statements (Continued)**
 **(tabular
          information in thousands, except share and per share
          data****)**





*Advertising*




The
      Company recognizes advertising costs as incurred. The total amounts charged
      to
      advertising expense, which is included in other SG&A, were approximately
      $825,000, $335,000 and $230,000 for the years ended December 31, 2006, 2005
      and
      2004, respectively.




*Income
      taxes*




In
      accordance with the provisions of SFAS No. 109, “ *Accounting
      for Income Taxes,”* the
      Company accounts for income taxes using the asset and liability method. This
      method requires recognition of deferred tax assets and liabilities for expected
      future tax consequences of temporary differences that currently exist between
      tax bases and financial reporting bases of the Company’s assets and liabilities
      based on enacted tax laws and rates. A valuation allowance is established,
      when
      necessary, to reduce the deferred income tax assets when it is more likely
      than
      not that all or a portion of a deferred tax asset will not be realized.




The
      Company operates in multiple tax jurisdictions and provides taxes in each
      jurisdiction where it conducts business and is subject to taxation. The breadth
      of the Company’s operations and the complexity of the tax law require
      assessments of uncertainties and judgments in estimating the ultimate taxes
      the
      Company will pay. The final taxes paid are dependent upon many factors,
      including negotiations with taxing authorities in various jurisdictions,
      outcomes of tax litigation and resolution of proposed assessments arising from
      federal and state audits. The Company has established estimated liabilities
      for
      federal and state income tax exposures that arise and meet the criteria for
      accrual under SFAS No. 5, “ *Accounting
      for Contingencies”* (FAS
      5). ** These
      accruals represent accounting estimates that are subject to inherent
      uncertainties associated with the tax audit process. The Company adjusts these
      accruals as facts and circumstances change, such as the progress of a tax audit.
      The Company believes that any potential audit adjustments will not have a
      material adverse effect on its financial condition or liquidity. However, any
      adjustments made may be material to the Company’s consolidated results of
      operations or cash flows for a reporting period.




Significant
      judgment is also required in evaluating the need for and magnitude of
      appropriate valuation allowances against deferred tax assets. Deferred tax
      assets are regularly reviewed for recoverability. The Company currently has
      significant deferred tax assets resulting from net operating loss carryforwards
      and deductible temporary differences, which should reduce taxable income in
      future periods. The realization of these assets is dependent on generating
      future taxable income. A valuation allowance is required when it is more likely
      than not that all or a portion of a deferred tax asset will not be realized.




Based
      on
      the Company's assessment of its recent operating results and projections of
      future income, the Company concluded that it is more likely than not that its
      net deferred tax assets at December 31, 2006 will not be realized. Therefore,
      a
      full federal and state valuation allowance has been established. At December
      31,
      2005, based on a similar assessment, the Company established a federal and
      state
      valuation allowance for its net deferred tax assets in excess of the amount
      which was more likely than not to be realized in the form of a net operating
      loss carryback.




*Comprehensive
      Income*




Comprehensive
      income includes net income and the unrealized net gains and losses on investment
      securities. Other comprehensive income is net of reclassification adjustments
      to
      adjust for items currently included in net income, such as realized gains and
      losses on investment securities. The deferred tax expense for unrealized holding
      gains arising from investment securities during the years ended December 31,
      2006, 2005 and 2004 was $26,000, $27,000 and $19,000, respectively. The deferred
      tax expense (benefit) for reclassification adjustments for gains (losses)
      included in net income on investment securites during the years ended December
      31, 2006, 2005 and 2004 was $20,000, $30,000 and ($13,000), respectively.




*New
      Accounting Pronouncements - Standards to be Implemented*




In
      July
      2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation
      No. 48, “Accounting for Uncertainty in Income Taxes - an Interpretation of FASB
      Statement 109” (FIN 48). FIN 48 clarifies that an entity’s tax benefits
      recognized in tax returns must be more likely than not of being sustained prior
      to recording the related tax benefit in the financial statements. As required
      by
      FIN 48, the Company will adopt this new accounting standard effective January
      1,
      2007. The Company is evaluating the potential effects the interpretation may
      have on its consolidated financial position or results of operations, but does
      not expect there to be a material consequence.







F-14
 
 **PDI,
          Inc.**
 **Notes
          to the Consolidated Financial Statements (Continued)**
 **(tabular
          information in thousands, except share and per share
          data****)**





In
      September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (FAS
      157). This statement defines fair value, establishes a framework for measuring
      fair value, and expands disclosures about fair value measurements. This standard
      is to be applied when other standards require or permit the use of fair value
      measurement of an asset or liability. The statement is effective for financial
      statements issued for fiscal years beginning after November 15, 2007, and
      interim periods within that fiscal year. The Company is in the process of
      evaluating the impact of adopting this statement.




*Reclassifications*




The
      Company reclassified certain prior period financial statements balances to
      conform to the current year presentation.




**2.**
            **Acquisition**




On
      August
      31, 2004, the Company acquired substantially all of the assets of Pharmakon,
      LLC
      in a transaction treated as an asset acquisition for tax purposes. The
      acquisition has been accounted for as a purchase, subject to the provisions
      of
      SFAS No. 141. The Company made payments to the members of Pharmakon, LLC on
      August 31, 2004 of $27.4 million, of which $1.5 million was deposited into
      an
      escrow account, and the Company assumed approximately $2.6 million in net
      liabilities. Approximately $1.1 million in direct costs of the acquisition
      were
      also capitalized. As of December 31, 2006, all escrow payments had been paid
      to
      the members of Pharmakon, LLC. Based upon the attainment of annual profit
      targets agreed upon at the date of acquisition, the members of Pharmakon, LLC
      received approximately $1.4 million in additional payments on April 1, 2005
      for
      the year ended December 31, 2004. No additional payments will be made
      in
      2007, nor were any made in 2006 since the Pharmakon business did not exceed
      its
      specified 2006 and 2005 performance benchmarks. In connection with this
      transaction, the Company has recorded $13.6 million in goodwill and $18.9
      million in other identifiable intangibles through December 31, 2006. The
      identifiable intangible assets have a weighted average remaining amortization
      period of 12.6 years.




The
      following unaudited pro forma consolidated results of operations for the year
      ended December 31, 2004 assume that the Company had acquired substantially
      all
      of the assets of Pharmakon, LLC as of the beginning of the period presented.
      The
      pro forma results include estimates and assumptions which management believes
      are reasonable. However, pro forma results are not necessarily indicative of
      the
      results that would have occurred if the acquisition had been consummated as
      of
      the dates indicated, nor are they necessarily indicative of future operating
      results.




Year
                  ended December 31,2004Revenue
              
              $
              358,930Income
                  from continuing operations
              
              
              22,145Earnings
                  per share
              
              $
              1.48




**3.**
            **Investments
                in Marketable Securities**




Available-for-sale
      securities are carried at fair value and consist of auction rate securities
      (ARSs) held by the Company as well as assets in a Rabbi Trust associated with
      its deferred compensation plan. For the years ended December 31 ,
      2006
      and 2005, the carrying value of available-for-sale securities was approximately
      $33.2 million and $1.9 million, respectively and are included in short-tem
      investments. For the years ended December 31, 2006 and 2005, there was $32.6
      million and zero invested in ARSs. The ARSs are invested in high-grade municipal
      bonds that have a weighted average maturity date of 27.2 years with an average
      interest rate reset period of 33.5 days. The available-for-sale securities
      within the Company’s deferred compensation plan for the years ended December 31,
      2006 and 2005 consisted of approximately $215,000 and $1.1 million respectively,
      in money market accounts, and approximately $447,000 and $811,000, respectively,
      in mutual funds. At December 31, 2006 and 2005, included in accumulated other
      comprehensive income were gross unrealized gains of approximately $131,000
      and
      $115,000, respectively, and gross unrealized losses of approximately $3,000
      and
      $10,000, respectively. At December 31, 2006 and 2005, included in interest
      income, net were gross realized gains of approximately $65,000 and $98,000,
      respectively, and gross realized losses of approximately $12,000 and $28,000,
      respectively.







F-15
 
 **PDI,
          Inc.**
 **Notes
          to the Consolidated Financial Statements (Continued)**
 **(tabular
          information in thousands, except share and per share
          data****)**





The
      Company’s other marketable securities consist of a laddered portfolio of
      investment grade debt instruments such as obligations of U.S. Treasury and
      U.S.
      Federal Government agencies, municipal bonds and commercial paper. These
      investments are categorized as held-to-maturity because the Company’s management
      has the intent and ability to hold these securities to maturity.
      Held-to-maturity securities are carried at amortized cost, which approximates
      fair value, and have a weighted average maturity of 3.4 months. Portions of
      these held-to-maturity securities are maintained in separate accounts to support
      the Company’s standby letters of credit. The Company has standby letters of
      credit of approximately $9.7 million and $10.5 million at December 31, 2006
      and
      2005, respectively, as collateral for its existing insurance policies and its
      facility leases. At December 31, 2006 and 2005, held-to-maturity securities
      were
      included in short-term investments (approximately $36.2 million and $4.9
      million, respectively), other current assets (approximately $7.2 million and
      $7.8 million, respectively) and other long-term assets (approximately $2.5
      million and $2.7 million, respectively). For the years ended December 31, 2006
      and 2005 held-to-maturity securities included:




December
                  31,
              
              December
                  31,2006
              
              2005Cash/money
                  accounts
              
              $
              332
              
              $
              1,953Certificate
                  of deposit
              
              
              -
              
              
              2,131Municipal
                  securities
              
              
              32,843
              
              
              2,620US
                  Treasury obligations
              
              
              1,499
              
              
              987Government
                  agency obligations
              
              
              8,394
              
              
              7,742Other
                  securities
              
              
              2,879
              
              
              -Total
              
              $
              45,947
              
              $
              15,433






**4.**
            **Property
                and Equipment**




In
      2006,
      the Company recorded a non-cash charge of approximately $1.3 million for
      furniture and leasehold improvements related to the excess leased space at
      its
      Saddle River, New Jersey and Dresher, Pennsylvania
      locations. See Note 17, Facilities Realignment, for additional information.




In
      the
      second quarter of 2005, the Company had a $2.8 million write-down of its Siebel
      sales force automation software. Due to the migration of the Company’s sales
      force automation software to the Dendrite platform, it was determined that
      the
      Company’s Siebel sales force automation software was impaired and a write-down
      of the asset was necessary. The non-cash charge was included in operating
      expense in the sales services segment.




Property
      and equipment consisted of the following as of December 31, 2006 and 2005:




**December
                  31,****2006**
              
              **2005**Furniture
                  and fixtures
              
              $
              3,549
              
              $
              3,925Office
                  equipment
              
              
              1,461
              
              
              1,663Computer
                  equipment
              
              
              8,265
              
              
              7,402Computer
                  software
              
              
              9,355
              
              
              9,350Leasehold
                  improvements
              
              
              6,698
              
              
              5,73029,328
              
              
              28,070Less
                  accumulated depreciation
              
              
              (16,519
              )
              
              (12,017
              )$
              12,809
              
              $
              16,053




Depreciation
      expense was approximately $4.4 million, $3.9 million and $4.9 million, for
      the
      years ended December 31, 2006, 2005 and 2004, respectively.







F-16
 
 **PDI,
          Inc.**
 **Notes
          to the Consolidated Financial Statements (Continued)**
 **(tabular
          information in thousands, except share and per share
          data****)**







**5.**
            **Goodwill
                and Other Intangible
                Assets**




In
      December 2006 and 2005, the Company performed its annual goodwill impairment
      evaluation. Goodwill has been assigned to the reporting units to which the
      value
      of the goodwill relates. The 2006 evaluation indicated that goodwill was not
      impaired. The 2005 evaluation indicated that goodwill recorded in the MD&D
      and Select Access reporting units was impaired and accordingly, the Company
      recognized non-cash charges of approximately $7.8 million and $3.3 million,
      respectively, in 2005. On December 4, 2005 the Company announced it was
      discontinuing its MD&D business unit, which ceased operations in the second
      quarter of 2006. (See Note 20, Discontinued Operations, for additional
      information.) As a result of that decision and the expected cash flows that
      the
      unit was expected to generate in 2006, an impairment charge of $7.8 million
      was
      recorded in operating expense in the sales services segment, which represented
      all of the goodwill associated with the InServe acquisition. That charge is
      currently included in discontinued operations as MD&D is no longer part of
      the sales services segment. The loss of a key customer that historically
      represented between 25% and 35% of revenue and the lack of new business
      projected within Select Access were the main factors for the $3.3 million
      goodwill impairment charge and was recorded in the sales services segment.




Additionally,
      due to the discontinuation of the MD&D business unit, the Company evaluated
      the recoverability of MD&D long-lived assets and determined that those
      assets were impaired. The Company recorded a non-cash charge of approximately
      $349,000. This was also recorded in operating expense to discontinued
      operations.




The
      Company increased goodwill by $500,000 for the year ended December 31, 2006
      associated with the final escrow payment made to the members of Pharmakon,
      LLC,
      pursuant to the Pharmakon acquisition agreement.




Changes
      in the carrying amount of goodwill for the year ended December 31, 2006 were
      as
      follows:




MarketingServicesBalance
                  as of December 31, 2005
              
              $
              13,112Goodwill
                  additions
              
              
              500Balance
                  as of December 31, 2006
              
              $
              13,612




All
      identifiable intangible assets recorded as of December 31, 2006 are being
      amortized on a straight-line basis over the lives of the intangibles, which
      range from 5 to 15 years. The weighted average amortization period for all
      of
      the identifiable intangible assets is approximately 12.6 years. Amortization
      expense related to continuing operations for the years ended December 31, 2006,
      2005 and 2004 was approximately $1.3 million, $1.3 million, and $427,000,
      respectively. Estimated amortization expense for the next five years is as
      follows:




2007
              
              2008
              
              2009
              
              2010
              
              2011$
                  1,281
              
              $
                  1,281
              
              $
                  1,272
              
              $
                  1,253
              
              $
                  1,253




All
      intangible assets recorded as of December 31, 2006 are attributable to the
      acquisition of Pharmakon and are being amortized on a straight-line basis over
      the lives of the intangibles, which range from 5 to 15 years. As of March 31,
      2006, the intangible assets associated with the acquisition of InServe were
      fully amortized and written-off. The net carrying value of the identifiable
      intangible assets for the years ended December 31, 2006 and 2005 is as
      follows:




As
                  of December 31, 2006
              
              As
                  of December 31, 2005Carrying
              
              Accumulated
              
              
              
              Carrying
              
              AccumulatedAmount
              
              Amortization
              
              Net
              
              Amount
              
              Amortization
              
              NetCovenant
                  not to compete
              
              $
              140
              
              $
              65
              
              $
              75
              
              $
              1,634
              
              $
              1,491
              
              $
              143Customer
                  relationships
              
              
              16,300
              
              
              2,536
              
              
              13,764
              
              
              17,371
              
              
              2,491
              
              
              14,880Corporate
                  tradename
              
              
              2,500
              
              
              389
              
              
              2,111
              
              
              2,652
              
              
              370
              
              
              2,282Total
              
              $
              18,940
              
              $
              2,990
              
              $
              15,950
              
              $
              21,657
              
              $
              4,352
              
              $
              17,305







F-17
 
 **PDI,
          Inc.**
 **Notes
          to the Consolidated Financial Statements (Continued)**
 **(tabular
          information in thousands, except share and per share
          data****)**





**6.**
            **Loans
                and Investments in Privately-Held
                Entities**




In
      October 2002, the Company acquired $1.0 million of preferred stock of Xylos
      Corporation (Xylos). In addition, the Company provided Xylos with short-term
      loans totaling $500,000 in the first half of 2004. The Company determined its
      $1.0 million investment and $500,000 short-term loan to Xylos were impaired
      as
      of December 31, 2004. The Company wrote its $1.0 million investment down to
      zero
      and established an allowance for credit losses against the $500,000 short-term
      loan. Xylos made loan payments totaling $250,000 and $100,000 in 2006 and 2005,
      respectively. These payments were recorded as credits to bad debt expense in
      the
      periods in which they were received.




In
      May
      2004, the Company entered into a loan agreement with TMX Interactive, Inc.
      (TMX), a provider of sales force effectiveness technology. Pursuant to the
      loan
      agreement, the Company provided TMX with a term loan facility of $500,000 and
      a
      convertible loan facility of $500,000, both of which were due to be repaid
      on
      November 26, 2005. In 2005, due to TMX’s continued losses and uncertainty
      regarding its future prospects, the Company established an allowance for credit
      losses against the TMX loans. During 2006 and 2005, TMX provided services to
      PDI
      valued at $246,000 and $245,000 respectively. The receipt of these services
      was
      used as payment towards the loan and the balance of the loan receivable at
      December 31, 2006 is $509,000. The receipt of services in lieu of cash payment
      was recorded as a credit to bad debt expense in 2006 and credit to loan
      receivable in 2005.




In
      June
      2005, the Company sold its approximately 12% ownership share in In2Focus Sales
      Development Services Limited, (In2Focus), a United Kingdom contract sales
      company. The Company’s original investment of $1.9 million had been written down
      to zero in the fourth quarter of 2001. The Company received approximately $4.4
      million, net of deal costs, which was included in gain on investments in 2005.






**7.**
            **Retirement
                Plans**




The
      Company offers an employee 401(k) saving plan. Under the PDI, Inc. 401(k) Plan,
      employees may contribute up to 25% of their pre-tax compensation. Effective
      January 1, 2004, the Company makes a safe harbor non-elective contribution
      in an
      amount equal to 100% of the participant’s base salary contributed up to 3% plus
      50% of the participant’s base salary contributed exceeding 3% but not more than
      5%. Prior to January 1, 2004, the Company made cash contributions in an amount
      equal to 100% of the participant’s base salary contributed up to 2%.
      Participants are not allowed to invest any of their 401(k) funds in the
      Company’s common stock. The Company’s total contribution expense related to the
      Company’s 401(k) plans for 2006, 2005 and 2004 was approximately $1.3 million,
      $2.1 million, and $1.6 million, respectively.






**8.**
            **Deferred
                Compensation Arrangements**




Beginning
      in 2000, the Company established a deferred compensation arrangement whereby
      a
      portion of certain employees’ salaries is withheld and placed in a Rabbi Trust.
      The plan permits the employees to diversify these assets through a variety
      of
      investment options. Members of the Company’s Board of Directors (Board) also
      have the opportunity to defer their compensation through this arrangement.
      The
      Company adopted the provisions of EITF No. 97-14 " *Accounting
      for Deferred Compensation Arrangement Where Amounts are Earned and Held in
      a
      Rabbi Trust and Invested* ”
which
      requires the Company to consolidate into its financial statements the net assets
      of the trust. The deferred compensation obligation has been classified as a
      current liability and the net assets in the trust are classified as
      available-for-sale securities and are included in short-term investments.






**9.**
            **Commitments
                and Contingencies**




The
      Company leases facilities, automobiles and certain equipment under agreements
      classified as operating leases, which expire at various dates through 2016.
      Substantially all of the property leases provide for increases based upon use
      of
      utilities and landlord’s operating expenses. Lease and auto expense under these
      agreements for the years ended December 31, 2006, 2005 and 2004 was
      approximately $15.0 million, $22.9 million, and $24.4 million, and respectively,
      of which $12.7 million in 2006, $19.3 million in 2005, and $21.2 million in
      2004
      related to automobiles leased for use by employees for a term of one year from
      the date of delivery with yearly annual renewal options.




As
      of
      December 31, 2006, contractual obligations with terms exceeding one year and
      estimated minimum future rental payments required by non-cancelable operating
      leases with initial or remaining lease terms exceeding one year are as follows:







F-18
 
 **PDI,
          Inc.**
 **Notes
          to the Consolidated Financial Statements (Continued)**
 **(tabular
          information in thousands, except share and per share
          data****)**





Less
                    than
                
                1
                    to 3
                
                3
                    to 5
                
                AfterTotal
                
                1
                    Year
                
                Years
                
                Years
                
                5
                    YearsContractrual
                    obligations(1)
                
                $
                6,523
                
                $
                4,496
                
                $
                2,027
                
                $
                -
                
                $
                -Operating
                    lease obligationsMinimum
                    lease payments
                
                
                30,641
                
                
                3,100
                
                
                6,516
                
                
                6,462
                
                
                14,563Less
                    minimum sublease rentals(2)
                
                
                (1,452
                )
                
                (401
                )
                
                (801
                )
                
                (250
                )
                
                -Net
                    minimum lease payments
                
                
                29,189
                
                
                2,699
                
                
                5,715
                
                
                6,212
                
                
                14,563Total
                
                $
                35,712
                
                $
                7,195
                
                $
                7,742
                
                $
                6,212
                
                $
                14,563


(1)
            Amounts
                represent contractual obligations related to software license contracts,
                IT consulting contracts and outsourcing contracts for employee benefits
                administration and software system support.




(2)
            On
                June 21, 2005, the Company signed an agreement to sublease the first
                floor
                at its corporate headquarters facility in Saddle River, New Jersey.
                (approximately 16,000 square feet) The sublease is for a five-year
                term
                commencing on July 15, 2005, and provides for approximately $2 million
                in
                lease payments over the five-year period.




Due
      to
      the nature of the business in which the Company is engaged, such as product
      detailing and in the past, the distribution of products, it could be exposed
      to
      certain risks. Such risks include, among others, risk of liability for personal
      injury or death to persons using products the Company promotes or distributes.
      There can be no assurance that substantial claims or liabilities will not arise
      in the future due to the nature of the Company ’s
      business activities and recent increases in litigation related to healthcare
      products, including pharmaceuticals. The Company seeks to reduce its potential
      liability under its product detailing agreements through measures such as
      contractual indemnification provisions with customers (the scope of which may
      vary from customer to customer, and the performances of which are not secured)
      and insurance. The Company could, however, also be held liable for errors and
      omissions of its employees in connection with the services it performs that
      are
      outside the scope of any indemnity or insurance policy. The Company could be
      materially and adversely affected if it was required to pay damages or incur
      defense costs in connection with a claim that is outside the scope of an
      indemnification agreement; if the indemnity, although applicable, is not
      performed in accordance with its terms; or if the Company’s liability exceeds
      the amount of applicable insurance or indemnity.




*Securities
      Litigation*




In
      January and February 2002, the Company, its former chief executive officer
      and
      its former chief financial officer were served with three complaints that were
      filed in the U.S. District Court for the District of New Jersey (the Court)
      alleging violations of the Securities Exchange Act of 1934 (the Exchange Act).
      These complaints were brought as purported shareholder class actions under
      Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 established
      thereunder. On May 23, 2002, the Court consolidated all three lawsuits into
      a
      single action entitled In re PDI Securities Litigation, Master File No.
      02-CV-0211, and appointed lead plaintiffs (Lead Plaintiffs) and Lead Plaintiffs’
counsel. On or about December 13, 2002, Lead Plaintiffs filed a second
      consolidated and amended complaint (Second Consolidated and Amended Complaint),
      which superseded their earlier complaints. In February 2003, the Company filed
      a
      motion to dismiss the Second Consolidated and Amended Complaint. On or about
      August 22, 2005, the Court dismissed the Second Consolidated and Amended
      Complaint without prejudice to plaintiffs.




On
      October 21, 2005, Lead Plaintiffs filed a third consolidated and amended
      complaint (Third Consolidated and Amended Complaint). Like its predecessor,
      the
      Third Consolidated and Amended Complaint named the Company, its former chief
      executive officer and its former chief financial officer as defendants;
      purported to state claims against the Company on behalf of all persons who
      purchased its common stock between May 22, 2001 and August 12, 2002; and sought
      money damages in unspecified amounts and litigation expenses including
      attorneys’ and experts’ fees. The essence of the allegations in the Third
      Consolidated and Amended Complaint was that the Company intentionally or
      recklessly made false or misleading public statements and omissions concerning
      its prospects with respect to its marketing of Ceftin in connection with the
      October 2000 distribution agreement with GlaxoSmithKline (GSK), its marketing
      of
      Lotensin in connection with the May 2001 distribution agreement with Novartis
      Pharmaceuticals Corporation, as well as its marketing of Evista in connection
      with the October 2001 distribution agreement with Eli Lilly and Company.







F-19
 
 **PDI,
          Inc.**
 **Notes
          to the Consolidated Financial Statements (Continued)**
 **(tabular
          information in thousands, except share and per share
          data****)**





On
      December 21, 2005, the Company filed a motion to dismiss the Third Consolidated
      and Amended Complaint under the Private Securities Litigation Reform Act of
      1995
      and Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure. On November
      2, 2006, the Court issued an Opinion and Order dismissing with prejudice all
      claims asserted in the Third Consolidated and Amended Complaint against all
      defendants and denied Lead Plaintiffs’ request to amend the
      complaint.




*Cellegy
      Litigation*




On
      April
      11, 2005, the Company settled a lawsuit which was pending in the U.S. District
      Court for the Northern District of California against Cellegy Pharmaceuticals,
      Inc. (Cellegy), which was set to go to trial in May 2005 (PDI, Inc. v. Cellegy
      Pharmaceuticals, Inc., Case No. C 03-05602 (SC)). The Company had claimed (i)
      that it was fraudulently induced to enter into a December 31, 2002 license
      agreement with Cellegy (the License Agreement) to market the product Fortigel,
      and (ii) that Cellegy had otherwise breached the License Agreement by failing,
      inter alia, to provide it with full information about Fortigel or to take all
      necessary steps to obtain expeditious FDA approval of Fortigel. The Company
      sought return of its $15 million upfront payment, other damages and an order
      rescinding the License Agreement. Under the terms of the settlement, in exchange
      for executing a stipulation of dismissal with prejudice of the lawsuit, Cellegy
      agreed to and did deliver to the Company: (i) a cash payment in the amount
      of
      $ 2.0
      million; (ii) a Secured Promissory Note in the principal amount of $3.0 million,
      with a maturity date of October 11, 2006; (iii) a Security Agreement, granting
      the Company a security interest in certain collateral; and (iv) a Nonnegotiable
      Convertible Senior Note, with a face value of $3.5 million, with a maturity
      date
      of April, 11, 2008.




In
      addition to the initial $2.0 million received on April 11, 2005, Cellegy had
      paid $200,000 in 2005 and $458,500 through June 30, 2006 towards the outstanding
      principal balance of the Secured Promissory Note. These payments were recorded
      as a credit to litigation expense in the periods in which they were received.




On
      December 1, 2005, the Company commenced a breach of contract action against
      Cellegy in the U.S. District Court for the Southern District of New York (PDI,
      Inc. v. Cellegy Pharmaceuticals, Inc., 05 Civ. 10137 (PKL)). The Company alleged
      that Cellegy breached the terms of the Security Agreement and Secured Promissory
      Note that it received in connection with the settlement. The Company further
      alleged that to secure its debt to the Company, Cellegy granted the Company
      a
      security interest in certain "Pledged Collateral," which is broadly defined
      in
      the Security Agreement to include, among other things, 50% of licensing fees,
      royalties or "other payments in the nature thereof" received by Cellegy in
      connection with then-existing or future agreements for Cellegy's drugs
      Rectogesic® and Tostrex® outside of the U.S., Mexico, and Canada. Upon receipt
      of such payments, Cellegy agreed to make prompt payment to the Company. The
      Company alleged that it was owed 50% of a $2.0 million payment received by
      Cellegy in connection with the renegotiation of its license and distribution
      agreement for Rectogesic® in Europe, and that Cellegy's failure to pay the
      Company constituted an event of default under the Security Agreement and the
      Secured Promissory Note. For Cellegy's breach of contract, the Company sought
      damages in the total amount of $6.4 million plus default interest from Cellegy.




On
      December 27, 2005, Cellegy filed an answer to the Company’s complaint, denying
      the allegations contained therein, and asserting affirmative defenses. Discovery
      subsequently commenced and pursuant to a scheduling order entered by the court,
      was to be completed by November 21, 2006. On June 22, 2006, the parties appeared
      before the court for a status conference and agreed to a dismissal of the
      lawsuit without prejudice because, among other reasons, discovery would not
      be
      complete before October 11, 2006, the maturity date of the Secured Promissory
      Note, at which time Cellegy would owe the Company the entire unpaid principal
      balance and interest on the Secured Promissory Note. On July 13, 2006, the
      court
      dismissed the December 1, 2005 breach of contract lawsuit without prejudice.
      This had no effect on the original settlement.




On
      September 27, 2006, Cellegy announced that it had entered into an asset purchase
      agreement to sell its intellectual property rights and other assets relating
      to
      certain of its products and product candidates to Strakan International Limited
      (the Sale). Pursuant to a letter agreement between Cellegy and the Company,
      Cellegy agreed to pay the Company $3.0 million (the Payoff Amount) in full
      satisfaction of Cellegy’s obligations to the Company under the Secured
      Promissory Note, which had an outstanding principal amount of approximately
      $2.34 million, and the $3.5 million Nonnegotiable Convertible Senior Note
      (collectively, the Notes). Pursuant to the letter agreement, $500,000 of the
      Payoff Amount was paid to the Company in September 2006, and the remaining
      $2.5
      million was paid to the Company in December 2006 upon consummation of the Sale.







F-20
 
 **PDI,
          Inc.**
 **Notes
          to the Consolidated Financial Statements (Continued)**
 **(tabular
          information in thousands, except share and per share
          data****)**





The
      Company had previously established an allowance for doubtful notes for the
      outstanding balance of the Notes; therefore, the Agreement did not result in
      the
      recognition of a loss. The $3.0 million received was recorded as a credit to
      litigation expense.




*California
      Class Action Litigation*




On
      September 26, 2005, the Company was served with a complaint in a purported
      class
      action lawsuit that was commenced against the Company in the Superior Court
      of
      the State of California for the County of San Francisco on behalf of certain
      of
      its current and former employees, alleging violations of certain sections of
      the
      California Labor Code. During the quarter ended September 30, 2005, the Company
      accrued approximately $3.3 million for potential penalties and other settlement
      costs relating to both asserted and unasserted claims relating to this matter.
      In October 2005, the Company filed an answer generally denying the allegations
      set forth in the complaint. In December 2005, the Company reached a tentative
      settlement of this action, subject to court approval. As a result, the Company
      reduced its accrual relating to asserted and unasserted claims relating to
      this
      matter to $600,000 during the quarter ended December 31, 2005. In October 2006,
      the Company received preliminary settlement approval from the court and the
      final approval hearing was held in January 2007. Pursuant to the settlement,
      the
      Company is currently in the process of distributing payments to the class
      members, their counsel and the California Labor and Workforce Development Agency
      in an aggregate amount of approximately $50,000.




*Bayer-Baycol
      Litigation*




The
      Company has been named as a defendant in numerous lawsuits, including two class
      action matters, alleging claims arising from the use of Baycol, a prescription
      cholesterol-lowering medication. Baycol was distributed, promoted and sold
      by
      Bayer in the U.S. through early August 2001, at which time Bayer voluntarily
      withdrew Baycol from the U.S. market. Bayer had retained certain companies,
      such
      as the Company, to provide detailing services on its behalf pursuant to contract
      sales force agreements. The Company may be named in additional similar lawsuits.
      To date, the Company has defended these actions vigorously and has asserted
      a
      contractual right of defense and indemnification against Bayer for all costs
      and
      expenses that it incurs relating to these proceedings. In February 2003, the
      Company entered into a joint defense and indemnification agreement with Bayer,
      pursuant to which Bayer has agreed to assume substantially all of the Company’s
      defense costs in pending and prospective proceedings and to indemnify the
      Company in these lawsuits, subject to certain limited exceptions. Further,
      Bayer
      agreed to reimburse the Company for all reasonable costs and expenses incurred
      through such date in defending these proceedings. As of December 31, 2006,
      Bayer
      has reimbursed the Company for approximately $1.6 million in legal expenses,
      the
      majority of which was received in 2003 and was reflected as a credit within
      selling, general and administrative expense. The Company did not incur any
      costs
      or expenses relating to these matters during 2006, 2005 ,
      or
      2004.




*Letters
      of Credit*




As
      of
      December 31, 2006, the Company has $9.7 million in letters of credit outstanding
      as required by its existing insurance policies and its facility
      leases.






**10.**
            **Preferred
                Stock**




The
      Company's Board is authorized to issue, from time to time, up to 5,000,000
      shares of preferred stock in one or more series. The Board is authorized to
      fix
      the rights and designation of each series, including dividend rights and rates,
      conversion rights, voting rights, redemption terms and prices, liquidation
      preferences and the number of shares of each series. As of December 31, 2006
      and
      2005, there were no issued and outstanding shares of preferred stock.






**11.**
            **Stock-Based
                Compensation**




The
      Company’s stock-incentive program is a long term retention program that is
      intended to attract, retain and provide incentives for talented employees,
      officers and directors, and to align stockholder and employee interests. The
      Company considers its stock-incentive program critical to its operations and
      productivity. Currently, the Company grants options, SARs and restricted shares
      from the PDI, Inc. 2004 Stock Award and Incentive Plan (the 2004 Plan), which
      is
      described below. The Company recognizes compensation cost arising from the
      issuance of stock options, SARs, and restricted shares on a straight-line basis
      over the vesting period of the grant. Total share-based compensation expense
      recognized for the years ended December 31, 2006, 2005, and 2004 was $1.7
      million, $1.5 million, and $1.2 million, respectively.







F-21
 
 **PDI,
          Inc.**
 **Notes
          to the Consolidated Financial Statements (Continued)**
 **(tabular
          information in thousands, except share and per share
          data****)**





On
      January 1, 2006, the Company adopted FAS 123R. See Note 1, Nature of Business
      and Significant Accounting Policies, for a description of the adoption of FAS
      123R. The
      Company currently uses the Black-Scholes option pricing model to determine
      the
      fair value of stock options and SARs. The determination of the fair value of
      stock-based payment awards on the date of grant using an option-pricing model
      is
      affected by the Company’s stock price as well as assumptions regarding a number
      of complex and subjective variables. These variables include the Company’s
      expected stock price volatility over the term of the awards, actual and
      projected employee stock option exercise behaviors, risk-free interest rate
      and
      expected dividends.




Expected
      volatility was based on historical volatility. As there is no trading volume
      for
      the Company’s options, implied volatility was not representative of the
      Company’s current volatility so the historical volatility was determined to be
      more indicative of the Company’s expected future stock performance. The expected
      life was determined using the safe-harbor method permitted by Securities
      Exchange Commission’s Staff Accounting Bulletin No. 107 (SAB 107). The Company
      expects to use this simplified method for valuing employee SARs grants as
      permitted by the provisions of SAB 107 until more detailed information about
      exercise behavior becomes available over time. When stock options are issued,
      the Company will use an expected life commensurate with their historical
      exercise patterns. The Company bases the risk-free interest rate on U.S.
      Treasury zero-coupon issues with remaining terms similar to the expected term
      on
      the options or SARs. The Company does not anticipate paying any cash dividends
      in the foreseeable future and therefore uses an expected dividend yield of
      zero
      in the option valuation model. The Company is required to estimate forfeitures
      at the time of grant and revise those estimates in subsequent periods if actual
      forfeitures differ from those estimates. The Company uses historical data to
      estimate pre-vesting option forfeitures and records stock-based compensation
      expense only for those awards that are expected to vest.




Prior
      to
      the adoption of FAS 123R, the Company recognized the estimated compensation
      cost
      of restricted shares over the vesting term. The estimated compensation cost
      is
      based on the fair value of the Company’s common stock on the date of grant. The
      Company continues to recognize the compensation cost, net of estimated
      forfeitures, over the vesting term.




In
      accordance with FAS 123R, the Company will recognize the estimated compensation
      cost of performance contingent shares, net of estimated forfeitures, based
      on
      the probability that the performance condition will be achieved. These awards
      are earned upon attainment of identified performance goals. The fair value
      of
      the awards is based on the measurement date. The awards will be amortized over
      the performance period. Compensation cost for performance contingent shares
      is
      estimated based on the number of awards that are expected to vest and is
      adjusted for those awards that do ultimately vest.




The
      following table provides the weighted average assumptions used in determining
      the fair value of the stock-based awards granted during the years ended December
      31, 2006, 2005, and 2004 respectively:




2006
              
              2005
              
              2004Risk-free
                  interest rate
              4.81%
              
              3.79%
              
              3.63%Expected
                  life
              3.5
              
              5
                  years
              
              5
                  yearsExpected
                  volatility
              66.12%
              
              100%
              
              100%




*Stock
      Incentive Plan*




In
      June
      2004, the Board and stockholders approved the 2004 Plan. The 2004 Plan replaced
      the 1998 Stock Option Plan (the 1998 Plan) and the 2000 Omnibus Incentive
      Compensation Plan (the 2000 Plan). The 2004 Plan reserved an additional 893,916
      shares for new awards as well as combined the remaining shares available under
      the 1998 Plan and 2000 Plan. The maximum number of shares that can be granted
      under the 2004 Plan is approximately 2.9 million shares. Eligible participants
      under the 2004 Plan include officers and other employees of the Company, members
      of the Board and outside consultants, as specified under the 2004 Plan and
      designated by the Compensation and Management Development Committee of the
      Board. Unless earlier terminated by action of the Board, the 2004 Plan will
      remain in effect until such time as no stock remains available for delivery
      under the 2004 Plan and the Company has no further rights or obligations under
      the 2004 Plan with respect to outstanding awards under the 2004 plan. No
      participant may be granted more than the annual limit of 400,000 shares plus
      the
      amount of the participant's unused annual limit relating to share-based awards
      as of the close of the previous year, subject to adjustment for splits and
      other
      extraordinary corporate events.







F-22
 
 **PDI,
          Inc.**
 **Notes
          to the Consolidated Financial Statements (Continued)**
 **(tabular
          information in thousands, except share and per share
          data****)**





Stock
      options are generally granted with an exercise price equal to the market value
      of the common stock on the date of grant, expire 10 years from the date they
      are
      granted, and generally vest over a two-year period for members of the Board
      of
      Directors and three-year period for employees. Upon exercise, new shares are
      issued by the Company. SARs are generally granted with a grant price equal
      to
      the market value of the common stock on the date of grant, vest one-third each
      year on the anniversary of the date of grant and expire five years from the
      date
      of grant. The restricted shares have vesting periods that range from eighteen
      months to three years and are subject to accelerated vesting and forfeiture
      under certain circumstances.




On
      February 9, 2005, the Company accelerated the vesting of all outstanding
      unvested underwater stock options. Accelerated stock options totaled 473,334
      and
      impacted 43 employees and seven board members. There was no compensation expense
      recognized as a result of this acceleration. On December 30, 2005, prior to
      the
      adoption of FAS 123R, the Company accelerated the vesting of 97,706 SARs and
      placed a restriction on the transfer or sale of the common stock received upon
      the exercise of these SARs that matched the original vesting schedule of the
      SARs. This impacted 38 employees and resulted in $86,000 in compensation
      expense. The Company accelerated the vesting of all outstanding unvested
      underwater stock options and SARs in 2005 to avoid recognizing compensation
      expense in future periods.




At
      January 1, 2006, the Company had a total of 43,104 performance contingent shares
      of its common stock to be issued upon the attainment of all established
      performance goals by March 2008. There are three levels of performance for
      each
      business unit and at a corporate level that dictate the number of shares to
      be
      issued. Throughout 2005, the Company had recognized compensation expense related
      to this award on its expectation of the probability that the performance
      conditions would be satisfied. Based on the 2006 annual budget and future income
      projections prepared in the first quarter of 2006, the probability that the
      performance conditions, even at the marginal level, would be satisfied, was
      deemed remote and at March 31, 2006, the Company reversed approximately $60,000
      of previously recognized compensation expense and discontinued recognizing
      any
      future expense associated with this award until such time as it is considered
      probable that the performance condition will be met. The Company has and will
      continue to reassess the probability of vesting of this award at each reporting
      period.




The
      weighted average fair value of options and SARs granted during the years ended
      December 31, 2006, 2005 and 2004 was estimated to be $6.31, $9.10 and $19.26,
      respectively. For the years ended December 31, 2006, 2005 and 2004, the
      aggregate intrinsic values of options and SARs exercised under the Company’s
      stock option plans were approximately $130,000, $243,000, and $1.5 million
      respectively, determined as of the date of exercise. As of December 31, 2006,
      there was $1.6 million of total unrecognized compensation cost, net of estimated
      forfeitures, related to unvested options, SARs, and restricted stock that are
      expected to be recognized over a weighted-average period of approximately 1.9
      years. Cash received from options exercised under the Company’s stock option
      plans for the years ended December 31, 2006, 2005 and 2004 was $87,000, $591,000,
      and $2.4 million, respectively.




A
      summary
      of option and SARs activity for the year ended December 31, 2006 and changes
      during the year then ended is presented below:




Grant
              
              Contractual
              
              IntrinsicShares
              
              Price
              
              Period
                  (in years)
              
              ValueOutstanding
                  at January 1, 2006
              
              
              1,381,096
              
              $
              26.20
              
              
              6.58
              
              $
              494Granted
              
              
              146,047
              
              
              12.40
              
              
              3.71
              
              
              -Exercised
              
              
              (20,167
              )
              
              6.30Forfeited
                  or expired
              
              
              (490,358
              )
              
              28.64Outstanding
                  at December 31, 2006
              
              
              1,016,618
              
              
              23.44
              
              
              5.23
              
              
              36Exercisable
                  at December 31, 2006
              
              
              863,160
              
              $
              25.38
              
              
              5.31
              
              $
              36




A
      summary
      of the status of the Company’s nonvested options and SARs for the year ended
      December 31, 2006 and changes during the year ended December 31, 2006 is
      presented below:







F-23
 
 **PDI,
          Inc.**
 **Notes
          to the Consolidated Financial Statements (Continued)**
 **(tabular
          information in thousands, except share and per share
          data****)**





Shares
              
              Weighted-
                  Average Grant Date Fair ValueNonvested
                  at January 1, 2006
              
              
              53,501
              
              $
              8.26Granted
              
              
              146,047
              
              
              6.31Vested
              
              
              (29,999
              )
              
              7.59Forfeited
              
              
              (19,258
              )
              
              6.18Nonvested
                  at December 31, 2006
              
              
              150,291
              
              $
              6.76




A
      summary
      of the Company’s outstanding shares of restricted stock for the year ended
      December 31, 2006 and changes during the year then ended is presented
      below:


Weighted-
              
              AverageAverage
              
              Remaining
              
              AggregateGrant
              
              Vesting
              
              IntrinsicShares
              
              Price
              
              Period
                  (in years)
              
              ValueOutstanding
                  at January 1, 2006
              
              
              112,723
              
              $
              17.49
              
              
              1.08
              
              $
              1,522Granted
              
              
              155,418
              
              
              12.31
              
              
              1.73
              
              
              1,806Vested
              
              
              (48,583
              )
              
              14.23Forfeited
              
              
              (22,820
              )
              
              14.38Outstanding
                  at December 31, 2006
              
              
              196,738
              
              $
              14.57
              
              
              1.31
              
              $
              2,286






**12.**
            **Related
                Party Transactions**




The
      Company purchased certain print advertising for initial recruitment of
      representatives through a company that is wholly-owned by family members of
      the
      Company's largest stockholder. The amounts charged to the Company for these
      purchases totaled approximately $180,000 for the year ended December 31, 2004.
      The Company no longer used this vendor after December 31, 2004.






**13.**
            **Treasury
                Stock**




On
      April
      27, 2005, the Company terminated its original 2001 stock repurchase plan. On
      May
      2, 2005, the Company announced that its Board had authorized a plan to
      repurchase up to a million of its outstanding shares of common stock. The
      Company repurchased 996,900 shares in 2005 under that plan. The plan was
      terminated in 2006.




On
      November 7, 2006 the Company announced that its Board had authorized the Company
      to repurchase up to one million shares of its common stock. The Company may
      repurchase shares on the open market or in privately negotiated transactions,
      or
      both. Some or all of the repurchases, if any, may be made pursuant to a Company
      10(b)5-1 Plan that the Company intends to adopt. Purchases, if any, will be
      made
      from the Company's available cash.




The
      number of shares repurchased as of December 31, 2006 is as follows:




Average.
                  Price
              
              SharesPeriod
              
              Per
                  Share
              
              PurchasedSeptember
                  2001
              
              $
                  22.00
              
              5,000May
                  2005
              
              $
                  12.36
              
              226,900June
                  2005
              
              $
                  11.92
              
              353,330July
                  2005
              
              $
                  13.77
              
              315,570August
                  2005
              
              $
                  14.39
              
              101,100Total
              
              $
                  12.90
              
              1,001,900




An
      additional 16,106 shares were delivered back to the Company and included in
      treasury stock for the payment of taxes resulting from the vesting of restricted
      stock.







F-24
 
 **PDI,
          Inc.**
 **Notes
          to the Consolidated Financial Statements (Continued)**
 **(tabular
          information in thousands, except share and per share
          data****)**







**14.**
            **Significant
                Customers**




During
      2006, 2005 and 2004 the Company had several significant customers for which
      it
      provided services under specific contractual arrangements. The following sets
      forth the net service revenue generated by customers who accounted for more
      than
      10% of the Company's service revenue during each of the periods presented.




Years
                  Ended December 31,Customer
              
              2006
              
              2005
              
              2004A
              
              $
              68,240
              
              $
              69,452
              
              $
              76,744B
              
              
              43,603
              
              
              107,260
              
              
              153,801C
              
              
              -
              
              
              48,051
              
              
              -




For
      the
      years ended December 31, 2006, and 2004, the Company had two large customers,
      who each individually represented 10% or more of its service revenue; these
      customers accounted for in the aggregate, approximately 46.8% and 66.4%
      respectively, of its service revenue. For the year ended December 31, 2005
      the
      Company’s three largest customers, each of whom represented 10% or more of its
      service revenue, accounted for, in the aggregate, approximately 73.6% of its
      service revenue.




At
      December 31, 2006 and 2005, the Company’s two and three largest customers
      represented 11.7% and 56.6%, respectively, of the aggregate of outstanding
      service accounts receivable and unbilled services.




On
      February 28, 2006, the Company announced that it has been notified by
      AstraZeneca that its fee-for-service agreements with the Company would be
      terminated effective April 30, 2006, reducing revenue by approximately $63.8
      million in 2006.




On
      September 26, 2006, the Company announced that it had received verbal
      notification from GSK of its intention not to renew its contract sales
      engagement with the Company for 2007. The contract, which represented
      approximately $65 million to $70 million in revenue on an annual basis, expired
      as scheduled on December 31, 2006.




On
      October 25, 2006, the Company also announced that it had received notification
      from sanofi-aventis of its intention to terminate its contract sales engagement
      with the Company effective December 1, 2006. The contract, which represented
      approximately $18 million to $20 million in revenue on an annual basis, was
      previously scheduled to expire on December 31, 2006.






**15.**
            **Performance
                Based Contracts**




In
      October 2000, the Company entered into an agreement (the Ceftin Agreement)
      with
      GSK for the exclusive U.S. sales, marketing and distribution rights for
      Ceftin ® Tablets
      and Ceftin ® for Oral
      Suspension, two dosage forms of a cephalosporin antibiotic, which agreement
      was
      terminated in February 2002 by mutual agreement of the parties. From October
      2000 through February 2002, the Company marketed Ceftin to physicians and sold
      the products primarily to wholesale drug distributors, retail chains and managed
      care providers. Pursuant to the termination agreement, the Company agreed to
      perform marketing and distribution services through February 28, 2002. Customers
      who purchased the Company’s Ceftin product were permitted to return unused
      product, after approval from the Company, up to six months before and one year
      after the expiration date for the product, but no later than December 31, 2004.
      On March 31, 2004, the Company signed an agreement and waiver with a large
      wholesaler by which the Company agreed to pay that wholesaler $10.0 million,
      and
      purchase $2.5 million worth of services from that wholesaler by March 31, 2006,
      in exchange for that wholesaler waiving, to the fullest extent permitted by
      law,
      all rights with respect to any additional returns of Ceftin to the Company.
      In
      lieu of purchasing $2.5 million worth of services from the wholesaler, the
      Company entered into an agreement to provide services to affiliates of the
      wholesaler. The Company’s accrual for returns of $231,000 at December 31, 2006
      consists almost entirely of amounts owed to that wholesaler. The accrual as
      recorded by the Company is its best estimate based on its understanding of
      its
      obligations.






**16.**
            **Executive
                Severance**




On
      October 21, 2005, the Company announced the resignation of Charles T. Saldarini
      as vice chairman of the Board and chief executive officer. Mr. Saldarini also
      resigned as a member of the Company’s Board. As per the terms of his employment
      agreement, Mr. Saldarini was entitled to approximately $2.8 million in cash
      and
      stock compensation, which was recognized in the fourth quarter of 2005.







F-25
 
 **PDI,
          Inc.**
 **Notes
          to the Consolidated Financial Statements (Continued)**
 **(tabular
          information in thousands, except share and per share
          data****)**





On
      August
      10, 2005, the Company announced that Bernard C. Boyle, the Company’s Chief
      Financial Officer would resign from his position with the Company effective
      December 31, 2005. The Company recognized approximately $1.6 million in
      additional compensation expense in the third quarter of 2005 as per the terms
      of
      his employment agreement. Effective December 31, 2005, the Company entered
      into
      an amended memorandum of understanding with the Company, pursuant to which
      Mr.
      Boyle deferred his resignation until March 31, 2006.




The
      Company also announced the resignation of three other executive vice presidents
      during 2005 and one other executive vice president during 2006. The Company
      recognized charges of approximately $5.7 million and $573,000 related to
      executive resignations/settlements in 2005 and 2006, respectively. These amounts
      are shown separately within operating expenses on the consolidated statement
      of
      operations for the years ended December 31, 2005 and 2006.




**17.**
              **Facilities
                  Realignment**


The
      Company recorded facility realignment charges totaling approximately $2.0
      million and $2.4 million during 2006 and 2005, respectively. These charges
      were
      for costs related to excess leased office space the Company has at its Saddle
      River, New
      Jersey and Dresher, Pennsylvania facilities. The Company is seeking to sublease
      the excess spaces at both locations. A summary of the significant components
      of
      the facility realignment charges for the two years ended December 31, 2006
      by
      segment is as follows:




Sales
              
              MarketingServices
              
              Services
              
              Total2005:Facility
                  lease obligations
              
              $
              1,057
              
              $
              1,297
              
              $
              2,354Total
                  facility realignment charge
              
              $
              1,057
              
              $
              1,297
              
              $
              2,3542006:Facility
                  lease obligations
              
              $
              803
              
              $
              (146
              )
              $
              657Asset
                  impairments (1)
              
              
              474
              
              
              821
              
              
              1,295Total
                  facility realignment charge
              
              $
              1,277
              
              $
              675
              
              $
              1,952




(1)
      The
      asset impairments resulted in changes to the accumulated depreciation
      balance.




The
      following table presents a reconciliation of the restructuring charges in 2005
      and 2006 to the balance at December 31, 2006 and 2005, which is included in
      accrued liabilities ($1.0 million and $1.2 million, respectively) and in other
      long-term liabilities ($1.3 million and $1.1 million,
      respectively):




Balance
                    as of December 31, 2004
                
                $
                -Facility
                    realignment charge
                
                
                2,354Payments
                
                
                (19
                )Balance
                    as of December 31, 2005
                
                $
                2,335Accretion
                
                
                51Payments
                
                
                (680
                )Adjustments
                
                
                606Balance
                    as of December 31, 2006
                
                $
                2,312


Charges
      for facility lease obligations relate to real estate lease contracts where
      the
      Company has exited certain space and is required to make payments over the
      remaining lease term (January 2016 and November 2016 for the Saddle River,
      New
      Jersey facility and for the Dresher, Pennsylvania facility, respectively).
      All
      lease termination amounts are shown net of projected sublease income. The charge
      in 2006 reflect additional space exited as well as additional charges to reflect
      the softness of the real estate market in both areas as neither sublet despite
      actively marketing the spaces. Additionally, in 2006, the Company recorded
      an
      impairment charge related to leasehold improvements in both spaces as the
      Company determined it was unlikely that it will be able to recover the carrying
      value of these assets.







F-26
 
 **PDI,
          Inc.**
 **Notes
          to the Consolidated Financial Statements (Continued)**
 **(tabular
          information in thousands, except share and per share
          data****)**







**18****.**
            **Income
                Taxes**




The
      provision for income taxes from continuing operations for the years ended
      December 31, 2006, 2005 and 2004 are summarized as follows:




**2006**
              
              **2005**
              
              **2004**Current:Federal
              
              $
              (1,520
              )
              $
              (5,867
              )
              $
              3,320State
              
              
              (1,914
              )
              
              (379
              )
              
              1,904Total
                  current
              
              
              (3,434
              )
              
              (6,246
              )
              
              5,224Federal
              
              
              2,592
              
              
              3,662
              
              
              8,039State
              
              
              118
              
              
              2,785
              
              
              1,160Total
                  deferred
              
              
              2,710
              
              
              6,447
              
              
              9,199Provision
                  for income taxes
              
              $
              (724
              )
              $
              201
              
              $
              14,423




The
      deferred income taxes reflect the net tax effects of temporary differences
      between the bases of assets and liabilities for financial reporting purposes
      and
      their bases for income tax purposes. The tax effects of significant items
      comprising the Company’s deferred tax assets and (liabilities) as of December
      31, 2006 and 2005 are as follows:






**2006**
              
              **2005**Current
                  deferred tax assets (liabilities)included
                  in other current assets:Allowances
                  and reserves
              
              $
              1,580
              
              $
              2,001Contract
                  costs
              
              
              31
              
              
              2,394Compensation
              
              
              835
              
              
              717Valuation
                  allowance on deferred tax assets
              
              
              (2,446
              )
              
              (2,402
              )-
              
              
              
              
              
              2,710Noncurrent
                  deferred tax assets (liabilities)included
                  in other long-term assets:Property,
                  plant and equipment
              
              
              (1,133
              )
              
              (1,631
              )State
                  net operating loss carryforwards
              
              
              2,048
              
              
              1,955State
                  taxes
              
              
              1,016
              
              
              1,731Intangible
                  assets
              
              
              (172
              )
              
              3,088Equity
                  investment
              
              
              505
              
              
              509Self
                  insurance and other reserves
              
              
              2,703
              
              
              1,766Other
                  accruals
              
              
              (629
              )
              
              -Valuation
                  allowance on deferred tax assets
              
              
              (4,338
              )
              
              (7,418
              )-
              
              
              
              
              
              -Net
                  deferred tax asset
              
              $
              -
              
              $
              2,710







At
      December 31, 2006 and 2005, the Company had a valuation allowance of
      approximately $6.8 million and $9.8 million, respectively, related to the
      Company's net deferred tax assets that cannot be carried back.




The
      Company performs an analysis each year to determine whether the expected future
      income will more likely than not be sufficient to realize the deferred tax
      assets. The Company's recent operating results and projections of future income
      weighed heavily in the Company's overall assessment. As a result, the Company
      established a full federal and state valuation allowance for the net deferred
      tax assets at December 31, 2006 because the Company determined that it was
      more
      likely than not that these assets would not be realized. Similarly, at December
      31, 2005, the Company established a federal and state valuation allowance for
      its net deferred tax assets in excess of the benefit that could be realized
      from
      a net operating loss carryback. At December 31, 2006, the Company has
      approximately $40.8 million of state net operating loss carryforwards, which
      has
      a full valuation allowance at December 31, 2006. These state operating losses
      will begin to expire in 2010.







F-27
 
 **PDI,
          Inc.**
 **Notes
          to the Consolidated Financial Statements (Continued)**
 **(tabular
          information in thousands, except share and per share
          data****)**





A
      reconciliation of the difference between the federal statutory tax rates and
      the
      Company's effective tax rate is as follows:




**2006**
              
              **2005**
              
              **2004**Federal
                  statutory rate
              
              
              35.0
              %
              
              (35.0
              %)
              
              35.0
              %State
                  income tax rate, netof
                  Federal tax benefit
              
              
              (11.0
              %)
              
              17.9
              %
              
              5.7
              %Meals
                  and entertainment
              
              
              0.3
              %
              
              0.7
              %
              
              0.2
              %Valuation
                  allowance
              
              
              (26.9
              %)
              
              18.4
              %
              
              0.9
              %Tax
                  exempt income
              
              
              (6.0
              %)
              
              (2.9
              %)
              
              (0.4
              %)Other
              
              
              1.8
              %
              
              2.7
              %
              
              -Effective
                  tax rate
              
              
              (6.8
              %)
              
              1.80
              %
              
              41.40
              %






**19.**
            **Historical
                Basic and Diluted Net (Loss)/Income per Share**




Historical
      basic and diluted net (loss)/income per share is calculated based on the
      requirements of SFAS No. 128, *“Earnings
      Per Share.”* A
      reconciliation of the number of shares used in the calculation of basic and
      diluted earnings per share for the years ended December 31, 2006, 2005 and
      2004
      is as follows:




Years
                  Ended December 31,2006
              
              2005
              
              2004(in
                  thousands)
              
              (in
                  thousands)
              
              (in
                  thousands)Basic
                  weighted average number of common shares
              
              
              13,859
              
              
              14,232
              
              
              14,564Dilutive
                  effect of stock options, SARs, andrestricted
                  stock
              
              
              135
              
              
              -
              
              
              329Diluted
                  weighted average numberof
                  common shares
              
              
              13,994
              
              
              14,232
              
              
              14,893




Outstanding
      options at December 31, 2006 to purchase 734,404 shares of common stock with
      exercise prices of $14.16 to $93.75 were not included in the 2006 computation
      of
      historical and pro forma diluted net income per share because the exercise
      prices of the options were greater than the average market price per share
      of
      the common stock and therefore, the effect would have been antidilutive. In
      addition, there were 81,856 outstanding SARs with exercise prices $12.52 to
      $20.15 that were not included in the 2006 computation of historical and pro
      forma diluted net income per share because the exercise prices of the options
      were greater than the average market price per share of the common stock and
      therefore, the effect would have been antidilutive.




Outstanding
      options at December 31, 2005 to purchase 1,271,890 shares of common stock with
      exercise prices of $5.21 to $93.75 per share were not included in the 2005
      computation of historical and pro forma diluted net income per share because
      to
      do so would have been antidilutive, as a result of the Company’s net loss in
      2005. Additionally, 109,206 SARs were outstanding at December 31, 2005, and
      were
      not included in the computation of earnings per share as a result of the
      Company’s net loss.




Outstanding
      options at December 31, 2004 to purchase 409,182 shares of common stock with
      exercise prices of $27.00 to $93.75 were not included in the 2004 computation
      of
      historical and pro forma diluted net income per share because the exercise
      prices of the options were greater than the average market price per share
      of
      the common stock and therefore, the effect would have been antidilutive.




**20.**
              **Discontinued
                  Operations**


As
      announced in December 2005, the Company discontinued its MD&D business in
      the second quarter of 2006. The MD&D business included the Company’s
      MD&D contract sales and clinical sales teams and was previously reported in
      the sales services reporting segment. The MD&D business was abandoned
      through the run off of operations (i.e., to cease accepting new business but
      to
      continue to provide service under remaining contracts until they expire or
      terminate). In accordance with FAS No. 144, operations must be abandoned prior
      to reporting them as discontinued operations. The last active contract within
      MD&D ended in the second quarter of 2006. All prior periods have been
      restated to reflect the treatment of this unit as a discontinued operation.
      Summarized selected financial information for the discontinued operations is
      as
      follows:







F-28
 
 **PDI,
          Inc.**
 **Notes
          to the Consolidated Financial Statements (Continued)**
 **(tabular
          information in thousands, except share and per share
          data****)**





**For
                  the Year Ended December 31,****2006**
              
              **2005**
              
              **2004**Revenue,
                  net
              
              $
              1,876
              
              $
              14,210
              
              $
              18,647Income
                  (loss) from discontinuedoperations
                  before income tax
              
              $
              693
              
              $
              (8,047
              )
              $
              1,112Income
                  tax expense
              
              
              259
              
              
              -
              
              
              415Net
                  income (loss) fromdiscontinued
                  operations
              
              $
              434
              
              $
              (8,047
              )
              $
              697






**21.**
            **Segment
                Information**




The
      Company reports under the following three segments, which excludes the MD&D
      reporting unit which is now reported as a discontinued operation:




Sales
      services segment - includes the Company’s Performance and Select Access teams.
      This segment uses teams to deliver services to a wide base; they have similar
      long-term average gross margins, contract terms, types of customers and
      regulatory environments. One segment manager oversees the operations of all
      of
      these units and regularly discusses the results of operations, forecasts and
      activities of this segment with the chief operating decision maker;




Marketing
      services segment - includes the Company’s marketing research and medical
      education and communication services. This segment is project driven; the units
      comprising it have a large number of smaller contracts, share similar gross
      margins, have similar customers, and have low barriers to entry for competition.
      There are many discrete offerings within this segment, including: accredited
      continuing medical education (CME), content development for CME, promotional
      medical education, marketing research and communications. One segment manager
      oversees the operations of all of these units and regularly discusses the
      results of operations, forecasts and activities of this segment with the chief
      operating decision maker; and




PDI
      products group (PPG) - includes revenues that were earned through the Company’s
      licensing and copromotion of pharmaceutical and MD&D products. There are
      currently no ongoing operations in this segment. Any business opportunities
      are
      reviewed by the chief executive officer and other members of senior
      management.




The
      accounting policies followed by the segments are described in Note 1, Nature
      of
      Business and Significant Accounting Policies. Corporate charges are allocated
      to
      each of the operating segments on the basis of total salary costs. Corporate
      charges include corporate headquarter costs and certain depreciation expenses.
      Certain corporate capital expenditures have not been allocated from the sales
      services segment to the other operating segments since it is impracticable
      to do
      so.












F-29
 
 **PDI,
          Inc.**
 **Notes
          to the Consolidated Financial Statements (Continued)**
 **(tabular
          information in thousands, except share and per share
          data****)**





**For
                  the Year Ended December 31,****2006**
              
              **2005**
              
              **2004**Revenue:Sales
                  services
              
              $
              202,748
              
              $
              270,420
              
              $
              313,784Marketing
                  services
              
              
              36,494
              
              
              34,785
              
              
              29,057PPG
              
              
              -
              
              
              -
              
              
              2,956Total
              
              $
              239,242
              
              $
              305,205
              
              $
              345,797Operating
                  income (loss):Sales
                  services
              
              $
              33
              
              $
              (17,386
              )
              $
              32,906Marketing
                  services
              
              
              2,798
              
              
              (1,186
              )
              
              1,535PPG
              
              
              3,082
              
              
              (268
              )
              
              (362
              )Total
              
              $
              5,913
              
              $
              (18,840
              )
              $
              34,079Reconciliation
                  of income (loss) from operations toincome
                  (loss) before income taxes:Total
                  income (loss) from operationsfor
                  operating groups
              
              $
              5,913
              
              $
              (18,840
              )
              $
              34,079Gain
                  (loss) on investments
              
              
              -
              
              
              4,444
              
              
              (1,000
              )Interest
                  income, net
              
              
              4,738
              
              
              3,190
              
              
              1,779Income
                  (loss) before income taxes
              
              $
              10,651
              
              $
              (11,206
              )
              $
              34,858Capital
                  expenditures: (1)Sales
                  services
              
              $
              1,508
              
              $
              2,901
              
              $
              7,645Marketing
                  services
              
              
              262
              
              
              2,881
              
              
              433PPG
              
              
              -
              
              
              -
              
              
              -Total
              
              $
              1,770
              
              $
              5,782
              
              $
              8,078Depreciation
                  expense: (1)Sales
                  services
              
              $
              3,671
              
              $
              3,260
              
              $
              4,132Marketing
                  services
              
              
              679
              
              
              550
              
              
              627PPG
              
              
              -
              
              
              -
              
              
              27Total
              
              $
              4,350
              
              $
              3,810
              
              $
              4,786Total
                  assetsSales
                  services
              
              $
              157,750
              
              $
              148,642
              
              $
              179,754Marketing
                  services
              
              
              43,886
              
              
              51,517
              
              
              44,516PPG
              
              
              -
              
              
              -
              
              
              435Total
              
              $
              201,636
              
              $
              200,159
              
              $
              224,705(1)
                  Capital expenditures and depreciation expense do not include amounts
                  for
                  discontinued operations.















F-30





**Schedule
                  II****PDI,
                  INC.****VALUATION
                  AND QUALIFYING ACCOUNTS****YEARS
                  ENDED DECEMBER 31, 2004, 2005 AND 2006**Balance
                  at
              
              Additions
              
              (1)
              
              Balance
                  atBeginning
              
              Charged
                  to
              
              Deductions
              
              endDescription
              
              of
                  Period
              
              Operations
              
              Other
              
              of
                  Period**2004**Allowance
                  for doubtful accounts
              
              $
              749,341
              
              $
              654,903
              
              $
              (1,330,660
              )
              $
              73,584Allowance
                  for doubtful notes
              
              
              -
              
              
              500,000
              
              
              -
              
              
              500,000Tax
                  valuation allowance
              
              
              1,881,851
              
              
              322,436
              
              
              -
              
              
              2,204,287Inventory
                  valuation allowance
              
              
              817,865
              
              
              -
              
              
              (817,865
              )
              
              -Accrued
                  product rebates, salesdiscounts
                  and returns
              
              
              22,810,826
              
              
              1,676,000
              
              
              (20,171,058
              )
              
              4,315,768**2005**Allowance
                  for doubtful accounts
              
              $
              73,584
              
              $
              713,669
              
              $
              (8,847
              )
              $
              778,407Allowance
                  for doubtful notes
              
              
              500,000
              
              
              842,378
              
              
              (100,000
              )
              
              1,242,378Tax
                  valuation allowance
              
              
              2,204,287
              
              
              9,318,890
              
              
              (1,703,076
              )
              
              9,820,101Accrued
                  product rebates, salesdiscounts
                  and returns
              
              
              4,315,768
              
              
              31,551
              
              
              (4,116,460
              )
              
              230,859**2006**Allowance
                  for doubtful accounts
              
              $
              778,407
              
              $
              35,713
              
              $
              (778,407
              )
              $
              35,713Allowance
                  for doubtful notes
              
              
              1,242,378
              
              
              38,051
              
              
              (495,837
              )
              
              784,592Tax
                  valuation allowance
              
              
              9,820,101
              
              
              -
              
              
              (3,035,884
              )
              
              6,784,217Accrued
                  product rebates, salesdiscounts
                  and returns
              
              
              230,859
              
              
              -
              
              
              -
              
              
              230,859(1) 
                  Includes payments and actual write offs, as well as changes in
                  estimates
                  in the reserves andthe
                  impact of acquisitions.