##### Table of Contents

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SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549



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FORM 10-Q



(Mark One)

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



For the quarterly period ended September 30, 2003.



OR



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



For the transition period from
 to
.



Commission File Number 0-27570



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PHARMACEUTICAL PRODUCT DEVELOPMENT, INC.

(Exact name of registrant as specified in its charter)



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



3151 South
Seventeenth Street

Wilmington, North Carolina

(Address of principal executive offices)



28412

(Zip Code)



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



---



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



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



Indicate the number of shares outstanding of each of the issuers
classes of common stock, as of the latest practicable date: 55,975,016 shares of common stock, par value $0.10 per share, as of October 31, 2003.



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##### Table of Contents

INDEX



|                                                                                              |  |                                                                                                                             |  | Page
|--------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------- |  | ----
|Part I. FINANCIAL INFORMATION                                                                 |  |                                                                                                                            
|                                                                                              | 
|Item 1. Financial Statements                                                                  |  |                                                                                                                            
|                                                                                              |  |                                                                                                                            
|                                                                                              |  | Consolidated Condensed Statements of Operations (unaudited) for the Three and Nine Months Ended September 30, 2002 and 2003 |  | 3   
|                                                                                              |  |                                                                                                                            
|                                                                                              |  | Consolidated Condensed Balance Sheets as of December 31, 2002 and September 30, 2003 (unaudited)                            |  | 4   
|                                                                                              |  |                                                                                                                            
|                                                                                              |  | Consolidated Condensed Statements of Cash Flows (unaudited) for the Nine Months Ended September 30, 2002 and 2003           |  | 5   
|                                                                                              |  |                                                                                                                            
|                                                                                              |  | Notes to Consolidated Condensed Financial Statements                                                                        |  | 6   
|                                                                                              | 
|Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 18                                                                                                                         
|                                                                                              | 
|Item 3. Quantitative and Qualitative Disclosures about Market Risk                            |  | 29                                                                                                                         
|                                                                                              | 
|Item 4. Controls and Procedures                                                               |  | 30                                                                                                                         
|                                                                                              | 
|Part II. OTHER INFORMATION                                                                    |  |                                                                                                                            
|                                                                                              | 
|Item 6. Exhibits and Reports on Form 8-K                                                      |  | 31                                                                                                                         
|                                                                                              | 
|Signatures                                                                                    |  | 32                                                                                                                         



2



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##### Table of Contents

Part I. FINANCIAL INFORMATION



Item 1. Financial Statements



PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(unaudited)

(in thousands, except per share amounts)



|                                                      |  | Three Months Ended September 30, |         |      | Nine Months Ended September 30, |        
|----------------------------------------------------- |  | -------------------------------- | ------- | ---- | ------------------------------- | -------
|                                                      |  | 2002                             |         | 2003 |                                 |        
|Development revenues                                  |  | $                                | 142,261 |      | $                               | 164,007
|Discovery sciences revenues                           |  |                                  | 3,742   |      |                                 | 2,589  
|Reimbursed out-of-pockets                             |  |                                  | 11,281  |      |                                 | 12,919 
|                                                      |  |                                  |         |      |                                 |        
|Net revenue                                           |  |                                  | 157,284 |      |                                 | 179,515
|                                                      |  |                                  |         |      |                                 |        
|Direct costs - Development                            |  |                                  | 68,273  |      |                                 | 79,419 
|Direct costs - Discovery sciences                     |  |                                  | 1,936   |      |                                 | 1,387  
|Direct costs - Reimbursable out-of-pocket expenses    |  |                                  | 11,281  |      |                                 | 12,919 
|Research and development                              |  |                                  | 2,959   |      |                                 | 1,487  
|Selling, general and administrative expenses          |  |                                  | 38,925  |      |                                 | 42,552 
|Depreciation                                          |  |                                  | 5,968   |      |                                 | 6,479  
|Amortization                                          |  |                                  | 194     |      |                                 | 472    
|Restructuring charges                                 |  |                                  |        |      |                                 | 1,917  
|Gain on sale of assets                                |  |                                  |        |      |                                 | (5,716 
|                                                      |  |                                  |         |      |                                 |        
|                                                      |  |                                  | 129,536 |      |                                 | 140,916
|                                                      |  |                                  |         |      |                                 |        
|Operating income                                      |  |                                  | 27,748  |      |                                 | 38,599 
|Interest income, net                                  |  |                                  | 352     |      |                                 | 360    
|Impairment of investments                             |  |                                  |        |      |                                 | (773   
|Other income, net                                     |  |                                  | 466     |      |                                 | 603    
|                                                      |  |                                  |         |      |                                 |        
|Income before provision for income taxes              |  |                                  | 28,566  |      |                                 | 38,789 
|Provision for income taxes                            |  |                                  | 10,284  |      |                                 | 13,964 
|                                                      |  |                                  |         |      |                                 |        
|Income before equity in net loss of investee          |  |                                  | 18,282  |      |                                 | 24,825 
|Equity in net loss of investee, net of income taxes   |  |                                  |        |      |                                 |       
|                                                      |  |                                  |         |      |                                 |        
|Net income                                            |  | $                                | 18,282  |      | $                               | 24,825 
|                                                      |  |                                  |         |      |                                 |        
|Net income per share:                                 |  |                                  |         |      |                                 |        
|Basic                                                 |  | $                                | 0.33    |      | $                               | 0.44   
|                                                      |  |                                  |         |      |                                 |        
|Diluted                                               |  | $                                | 0.33    |      | $                               | 0.44   
|                                                      |  |                                  |         |      |                                 |        
|Weighted average number of common shares outstanding: |  |                                  |         |      |                                 |        
|Basic                                                 |  |                                  | 55,233  |      |                                 | 55,874 
|Dilutive effect of stock options and restricted stock |  |                                  | 488     |      |                                 | 460    
|                                                      |  |                                  |         |      |                                 |        
|Diluted                                               |  |                                  | 55,721  |      |                                 | 56,334 
|                                                      |  |                                  |         |      |                                 |        



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



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##### Table of Contents

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



CONSOLIDATED CONDENSED BALANCE SHEETS

(in thousands)



|                                               |  | December 31, 2002 |         |   | September 30, 2003 |  
|---------------------------------------------- |  | ----------------- | ------- | - | ------------------ | -
|                                               |  |                   |         |   | (unaudited)        |  
|Assets                                        
|Current assets                                 |  |                   |         |   |                    |  
|Cash and cash equivalents                      |  | $                 | 181,224 |   |                    | $
|Accounts receivable and unbilled services, net |  |                   | 199,936 |   |                    |  
|Investigator advances                          |  |                   | 6,300   |   |                    |  
|Prepaid expenses and other current assets      |  |                   | 13,676  |   |                    |  
|Notes receivable                               |  |                   | 500     |   |                    |  
|Deferred tax asset                             |  |                   | 13,858  |   |                    |  
|                                               |  |                   |         |   |                    |  
|Total current assets                           |  |                   | 415,494 |   |                    |  
|                                               |  |                  
|Property, plant and equipment, net             |  |                   | 107,704 |   |                    |  
|Investments                                    |  |                   | 16,934  |   |                    |  
|Goodwill                                       |  |                   | 147,408 |   |                    |  
|Intangible assets, net                         |  |                   | 3,624   |   |                    |  
|Other assets, net                              |  |                   | 956     |   |                    |  
|                                               |  |                   |         |   |                    |  
|Total assets                                   |  | $                 | 692,120 |   |                    | $
|                                               |  |                   |         |   |                    |  
|Liabilities and Shareholders Equity          
|Current liabilities                            |  |                   |         |   |                    |  
|Accounts payable                               |  | $                 | 10,645  |   |                    | $
|Payables to investigators                      |  |                   | 20,645  |   |                    |  
|Other accrued expenses                         |  |                   | 68,026  |   |                    |  
|Unearned income                                |  |                   | 114,494 |   |                    |  
|Accrued income taxes                           |  |                   | 12,231  |   |                    |  
|Current maturities of long-term debt           |  |                   | 1,757   |   |                    |  
|                                               |  |                   |         |   |                    |  
|Total current liabilities                      |  |                   | 227,798 |   |                    |  
|                                               |  |                  
|Long-term debt, less current maturities        |  |                   | 6,649   |   |                    |  
|Deferred rent and other                        |  |                   | 3,480   |   |                    |  
|Accrued additional pension liability           |  |                   | 7,905   |   |                    |  
|Deferred tax liability, net                    |  |                   | 5,951   |   |                    |  
|                                               |  |                   |         |   |                    |  
|Total liabilities                              |  |                   | 251,783 |   |                    |  
|                                               |  |                   |         |   |                    |  
|Shareholders equity                           |  |                   |         |   |                    |  
|Common stock                                   |  |                   | 5,544   |   |                    |  
|Paid-in capital                                |  |                   | 263,554 |   |                    |  
|Retained earnings                              |  |                   | 180,071 |   |                    |  
|Deferred compensation                          |  |                   | (367    | ) |                    |  
|Accumulated other comprehensive loss           |  |                   | (8,465  | ) |                    |  
|                                               |  |                   |         |   |                    |  
|Total shareholders equity                     |  |                   | 440,337 |   |                    |  
|                                               |  |                   |         |   |                    |  
|Total liabilities and shareholders equity     |  | $                 | 692,120 |   |                    | $
|                                               |  |                   |         |   |                    |  



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



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##### Table of Contents

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)



|                                                                                  |  | Nine Months Ended September 30, |        
|--------------------------------------------------------------------------------- |  | ------------------------------- | -------
|                                                                                  |  | 2002                            |        
|Cash flows from operating activities:                                             |  |                                 |        
|Net income                                                                        |  | $                               | 19,925 
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                                 |        
|Impairment of investments                                                         |  |                                 | 32,006 
|Depreciation and amortization                                                     |  |                                 | 17,694 
|Stock compensation amortization                                                   |  |                                 | 158    
|Gain on disposition of property and equipment                                     |  |                                 | (34    
|Loss on disposition of property and equipment                                     |  |                                 | 109    
|Change in provision for doubtful accounts                                         |  |                                 | (361   
|Gain on sale of investment                                                        |  |                                 | (173   
|Equity in net loss of investee                                                    |  |                                 | 119    
|Change in deferred income taxes                                                   |  |                                 | (2,458 
|Change in operating assets and liabilities, net of effect of acquisitions         |  |                                 | (1,478 
|                                                                                  |  |                                 |        
|Net cash provided by operating activities                                         |  |                                 | 65,507 
|                                                                                  |  |                                 |        
|Cash flows from investing activities:                                             |  |                                 |        
|Cash received from repayment of note receivable                                   |  |                                 | 17,000 
|Purchases of property and equipment                                               |  |                                 | (26,580
|Proceeds from sale of property and equipment                                      |  |                                 | 100    
|Purchases of investments                                                          |  |                                 | (8,642 
|Net cash paid for acquisitions                                                    |  |                                 | (50,674
|                                                                                  |  |                                 |        
|Net cash used in investing activities                                             |  |                                 | (68,796
|                                                                                  |  |                                 |        
|Cash flows from financing activities:                                             |  |                                 |        
|Principal repayments of long-term debt                                            |  |                                 |       
|Repayment of capital leases obligation                                            |  |                                 | (2,280 
|Proceeds from long-term debt                                                      |  |                                 | 1,464  
|Proceeds from exercise of stock options and employee stock purchase plan          |  |                                 | 5,878  
|                                                                                  |  |                                 |        
|Net cash provided by financing activities                                         |  |                                 | 5,062  
|                                                                                  |  |                                 |        
|Effect of exchange rate changes on cash                                           |  |                                 | 2,044  
|                                                                                  |  |                                 |        
|Net increase (decrease) in cash and cash equivalents                              |  |                                 | 3,817  
|Cash and cash equivalents, beginning of the period                                |  |                                 | 143,173
|                                                                                  |  |                                 |        
|Cash and cash equivalents, end of the period                                      |  | $                               | 146,990
|                                                                                  |  |                                 |        



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



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##### Table of Contents

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

(in thousands, except per share data)



1. SIGNIFICANT ACCOUNTING POLICIES



The significant accounting policies followed by Pharmaceutical Product Development, Inc. and its subsidiaries (collectively PPD or the
Company) for interim financial reporting are consistent with the accounting policies followed for annual financial reporting. We prepared these unaudited consolidated condensed financial statements in accordance with Rule 10-01 of
Regulation S-X, and, in managements opinion, we have included all adjustments of a normal recurring nature necessary for a fair presentation. The accompanying consolidated condensed financial statements might not include all of the information
and footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the consolidated financial statements and notes thereto in PPDs Annual Report on Form 10-K for the year
ended December 31, 2002. The results of operations for the three-month and nine-month periods ended September 30, 2003 are not necessarily indicative of the results to be expected for the full year or any other period. We derived the amounts on the
December 31, 2002 consolidated condensed balance sheet from the audited financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2002.



Use of Estimates in the Preparation of Financial Statements



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



Principles of consolidation



The accompanying unaudited consolidated condensed financial statements include the accounts and operations of PPD. We have eliminated all intercompany
balances and transactions in consolidation.



Earnings per
share



We compute basic net income (loss) per share
information using the weighted average number of shares of common stock outstanding during the period. We compute diluted net income (loss) per common share using the weighted average number of shares of common and dilutive potential common shares
outstanding during the period.



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PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

(in thousands, except
per share data)



1. SIGNIFICANT ACCOUNTING POLICIES (continued)



Stock-Based Compensation



The Company accounts for stock-based compensation based on the provisions of
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, which states that, for fixed plans, no compensation expense is recorded for stock options or other stock-based awards to employees that are granted
with an exercise price equal to or above the estimated fair value per share of the Companys common stock on the grant date. If stock options are granted with an exercise price below the estimated fair value of the Companys common stock
at the grant date, the difference between the fair value of the Companys common stock and the exercise price of the stock option is recorded as deferred compensation. Deferred compensation is amortized to compensation expense over the vesting
period of the stock option. The Company has adopted the disclosure requirements of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation and Statement of Financial Accounting Standards No. 148,
Accounting for Stock Based Compensation - Transition and Disclosure - an Amendment of FASB Statement No. 123, which require compensation expense to be disclosed based on the fair value of the options calculated on the date of the grant.



Had compensation cost for the Companys stock option plan
been determined based on the fair value at the grant dates for awards under the plan consistent with the method required by SFAS No. 123, the Companys net income and net income per common share would have been the pro forma amounts indicated
below.



|                                                                                                                                          |  | Three Months Ended September 30, |        | Nine Months Ended September 30,
|----------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------- | ------ | -------------------------------
|                                                                                                                                          |  | 2002                             |        | 2003                           
|Net income, as reported                                                                                                                   |  | $                                | 18,282 |                                
|                                                                                                                                          |  |                                  |        |                                
|Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax
effects |  |                                  | 1,267  |                                
|                                                                                                                                          |  |                                  |        |                                
|Pro forma net income                                                                                                                      |  | $                                | 17,015 |                                
|                                                                                                                                          |  |                                  |        |                                
|Net income per share:                                                                                                                     |  |                                  |        |                                
|Basic  as reported                                                                                                                       |  | $                                | 0.33   |                                
|Basic  pro forma                                                                                                                         |  | $                                | 0.31   |                                
|                                                                                                                                          |  |                                  |        |                                
|Diluted  as reported                                                                                                                     |  | $                                | 0.33   |                                
|Diluted  pro forma                                                                                                                       |  | $                                | 0.31   |                                



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PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

(in thousands, except
per share data)



1. SIGNIFICANT ACCOUNTING POLICIES (continued)



Recent Accounting Pronouncements



In June 2001, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations, or SFAS No. 143, which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The
associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. SFAS No. 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002. The adoption of this statement did
not have a material impact on the Companys financial statements.



In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146, Accounting for Costs Associated with Exit or Disposal Activities, or SFAS No. 146. SFAS No. 146 addresses accounting and reporting for costs
associated with exit or disposal activities. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value when the liability is incurred. SFAS No. 146 is effective
for exit or disposal activities that are initiated after December 31, 2002. The Company recorded the restructuring charges in the third quarter of 2003 in accordance with SFAS No. 146.



In November 2002, the Emerging Issues Task Force, or EITF, of the FASB finalized its tentative consensus on EITF Issue
00-21, Revenue Arrangements with Multiple Deliverables, which provides guidance on the timing and method of revenue recognition for sales arrangements that include the delivery of more than one product or service. EITF 00-21 is effective
prospectively for arrangements entered into in fiscal periods beginning after June 15, 2003. Although the Company has many contracts with multiple deliverables, the deliverables do no represent separate units of accounting. As such, the adoption of
this statement did not have a material impact on the Companys financial statements.



In November 2002, the FASB issued Financial Accounting Standards Board Interpretation No. 45, or FIN 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others, an interpretation of FASB Statement Nos. 5, 57, and 107 and Rescission of FASB Interpretation No. 34. FIN 45 clarifies the requirements of FASB Statement No. 5, Accounting for Contingencies, relating to the
guarantors accounting for, and disclosure of, the issuance of certain types of guarantees. FIN 45 requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation it assumes under that
guarantee. The disclosure provisions of FIN 45 are effective for financial statements of interim or annual periods that end after December 15, 2002. FIN 45s provisions for initial recognition and measurement should be applied on a prospective
basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantors fiscal year-end. The guarantors previous accounting for guarantees that were issued before the date of FIN 45s initial application may
not be revised or restated to reflect the effect of the recognition and measurement provisions of FIN 45. The adoption of this statement did not have an impact on the Companys financial statements, other than the guarantee discussed in Note 6
to the Consolidated Condensed Financial Statements.



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##### Table of Contents

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

(in thousands, except
per share data)



1. SIGNIFICANT ACCOUNTING POLICIES (continued)



Recent Accounting Pronouncements (continued)



In December 2002, the FASB issued SFAS No. 148,
Accounting for Stock-Based Compensation  Transition and Disclosure  an Amendment of FASB Statement No. 123. This Statement amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative
methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. This statement requires that companies having a year-end after December 15, 2002
follow the prescribed format and provide the additional disclosures in their annual reports. The adoption of this statement did not have a material impact on the Companys financial statements.



In January 2003, the FASB issued Interpretation No. 46 or FIN 46,
Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51, Consolidated Financial Statements. FIN 46 establishes accounting guidance for consolidation of variable interest entities
that function to support the activities of the primary beneficiary. In October 2003, the FASB issued FASB Staff Position FIN 46-6, Effective Date of FASB Interpretation No. 46, Consolidation of Variable Interest Entities deferring the
effective date for applying the provisions of FIN 46 for public entities interests in variable interest entities or potential variable interest entities created before February 1, 2003 until financial statements of interim or annual periods
that end after December 15, 2003. The Company has no investment in or contractual relationship or other business relationship with a variable interest entity and therefore the adoption of this interpretation will not have any impact on its
consolidated financial position or results of operations. However, if the Company enters into any such arrangement with a variable interest entity in the future or an entity with which we have a relationship is reconsidered based on guidance in FIN
46 to be a variable interest entity, the Companys consolidated financial position or results of operations might be impacted.



Reclassifications



We have reclassified certain 2002 financial statement amounts to conform to the 2003 financial statement presentation.



2. GOODWILL AND INTANGIBLE ASSETS



In June 2001, the FASB issued Statement of Financial Accounting Standards
No. 141, Business Combinations, which eliminated the pooling of interests method of accounting for business combinations and addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business
combination. In June 2001, the FASB issued Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, or SFAS No. 142. PPD adopted SFAS No. 142 as of January 1, 2002. SFAS No. 142 addresses the financial
accounting and reporting standards for the acquisition of intangible assets outside of a business combination, and for goodwill and other intangible assets subsequent to their acquisition. This accounting standard requires that goodwill be
separately disclosed from other intangible assets in the statement of financial position, and no longer be amortized but tested for impairment on a periodic basis. The provisions of this accounting standard also require the completion of a
transitional impairment test within six months of adoption. PPD completed the transitional impairment test as of January 1, 2002 and the annual impairment test as of October 1, 2002 and did not identify any impairments of goodwill. These tests
involved determining the fair market value of each of the reporting units with which the goodwill was associated and comparing the estimated fair market value of each of the reporting units with its carrying amount.



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PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

(in thousands, except
per share data)



2. GOODWILL AND INTANGIBLE ASSETS
(continued)



Changes in the carrying amount
of goodwill for the twelve months ended December 31, 2002 and the nine months ended September 30, 2003, by operating segment, were as follows:



|                                                                  |  | Development |         | Discovery |   | Total 
|----------------------------------------------------------------- |  | ----------- | ------- | --------- | - | ------
|Balance as of January 1, 2002                                     |  | $           | 6,839   |           | $ | 751   
|Goodwill recorded during the period                               |  |             | 116,814 |           |   | 19,721
|Translation adjustments                                           |  |             | 3,283   |           |   |      
|                                                                  |  |             |         |           |   |       
|Balance as of December 31, 2002                                   |  | $           | 126,936 |           | $ | 20,472
|                                                                  |  |             |         |           |   |       
|                                                                  |  |             |        
|                                                                  |  | Development |         | Discovery |   | Total 
|Balance as of January 1, 2003                                     |  | $           | 126,936 |           | $ | 20,472
|Goodwill recorded during the period for prior year acquisitions   |  |             | 1,550   |           |   | 143   
|Goodwill recorded during the period for current year acquisitions |  |             | 23,760  |           |   |      
|Translation adjustments                                           |  |             | 2,555   |           |   |      
|                                                                  |  |             |         |           |   |       
|Balance as of September 30, 2003                                  |  | $           | 154,801 |           | $ | 20,615
|                                                                  |  |             |         |           |   |       



Information regarding
PPDs other intangible assets follows:



|                                |  | As of December 31, 2002 |       | As of September 30, 2003
|------------------------------- |  | ----------------------- | ----- | ------------------------
|                                |  | Carrying Amount         |       | Accumulated Amortization
|Backlog                         |  | $                       | 2,100 |                         
|Patents                         |  |                         | 280   |                         
|License agreements              |  |                         | 2,500 |                         
|Miscellaneous intangible assets |  |                         | 915   |                         
|                                |  |                         |       |                         
|Total                           |  | $                       | 5,795 |                         
|                                |  |                         |       |                         



All intangible assets
are amortized on a straight-line basis, based on estimated useful lives of two years for backlog, five years for patents, three to ten years for license agreements and two to ten years for miscellaneous intangible assets. The weighted average
amortization period for all intangibles is approximately 2.5 years.



Amortization expense for the three months ended September 30, 2002 and 2003 was $194 and $472, respectively. Amortization expense for the nine months ended September 30, 2002 and 2003 was $630 and $1,191, respectively. Estimated
amortization expense for the next five years is as follows:



|2003 (remaining 3 months) |  | $ | 426
|------------------------- |  | - | ---
|2004                      |  |   | 882
|2005                      |  |   | 726
|2006                      |  |   | 244
|2007                      |  |   | 50 



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PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

(in thousands, except
per share data)



3. ACQUISITIONS



In February 2002, PPD acquired 100% of the outstanding common stock of
Medical Research Laboratories International, Inc., or MRL U.S., and Medical Research Laboratories International, BVBA, or MRL Belgium, collectively, MRL. MRL is now part of the Development segment of PPD. MRL U.S. operates a central
laboratory in Highland Heights, Kentucky, near Cincinnati, Ohio, and MRL Belgium operates a central laboratory in Brussels, Belgium. MRL provides highly standardized efficacy and safety testing services for pharmaceutical companies engaged in
clinical drug development and is one of the largest central laboratory providers for Phase I-IV global studies involving agents used in cholesterol, endocrine, metabolic and cardiovascular clinical research. The results of operations are included in
PPDs consolidated condensed results of operations as of and since February 19, 2002, the effective date of the acquisition. PPD acquired MRL for total consideration of $113.1 million, including $39.0 million in cash, $73.5 million in
PPDs common stock (approximately 2.6 million unregistered shares) and direct acquisition costs of $0.6 million for legal, appraisal and accounting fees.



In April 2002, PPD acquired Piedmont Research Center II, Inc, or PRC, a research laboratory based in Morrisville, North Carolina that performs
preclinical evaluations of anti-cancer therapies for national and international pharmaceutical and biotechnology companies. PRC is now part of the Discovery segment of PPD. The results of operations are included in PPDs consolidated condensed
results of operations as of and since April 1, 2002, the effective date of the acquisition. PPD acquired PRC for total consideration of $19.6 million, including $2.4 million in cash, $17.1 million in PPDs common stock (0.5 million unregistered
shares) and direct acquisition costs of $0.1 million for legal and accounting fees.



In June 2002, PPD acquired Complete Software Solutions, Inc., or CSS, a technical consulting firm offering implementation, validation and training services as well as specialized software for pharmaceutical and
biotechnology industries. CSS is now part of the Development segment of PPD. The results of operations are included in PPDs consolidated condensed results of operations as of and since June 12, 2002, the effective date of the acquisition. PPD
acquired CSS for total consideration of $16.8 million in cash.



In June 2002, PPD acquired ProPharma Pte Ltd, or ProPharma, an Asian-based clinical research organization with experience in managing pan-Asian clinical trials. ProPharma is now part of the Development segment of PPD. The results of
operations are included in PPDs consolidated condensed results of operations as of and since June 27, 2002, the effective date of the acquisition. PPD acquired ProPharma for total consideration of $3.0 million in cash. In addition, PPD paid
$1.4 million as additional purchase price in the second quarter of 2003. This was a contingency payment which depended upon the financial performance of ProPharma for a specified period following the acquisition.



In July 2003, PPD acquired Eminent Research Systems, Inc., or Eminent, a
clinical research organization specializing in medical device development, and Clinsights, Inc., or Clinsights, which provides a range of post-market services to medical device and related pharmaceutical companies and operates proprietary web sites
for the dissemination of medical information, online research and product marketing. Eminent and Clinsights are now part of the Development segment of PPD. The results of operations are included in PPDs consolidated condensed results of
operations as of and since July 18, 2003, the effective date of the acquisitions. PPD acquired Eminent and Clinsights for total consideration of $25.0 million in cash.



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



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PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

(in thousands, except
per share data)



3. ACQUISITIONS (continued)



The total purchase price for the 2002 acquisitions was allocated to the
estimated fair value of assets acquired and liabilities assumed as set forth in the following table:



|                                         |  | MRL |         |   | PRC |   |        | CSS |  |   | ProPharma |   |  | Total |      
|---------------------------------------- |  | --- | ------- | - | --- | - | ------ | --- |  | - | --------- | - |  | ----- | -----
|Condensed balance sheet:                 |  |     |         |   |     |   |        |     |  |   |           |   |  |       |      
|Current assets                           |  | $   | 16,020  |   |     | $ | 803    |     |  | $ | 945       |   |  | $     | 1,023
|Property and equipment, net              |  |     | 8,308   |   |     |   | 822    |     |  |   | 34        |   |  |       | 116  
|Current liabilities                      |  |     | (7,814  | ) |     |   | (1,367 | )   |  |   | (899      | ) |  |       | (252 
|Long-term capital lease obligation       |  |     | (1,107  | ) |     |   | (457   | )   |  |   |          |   |  |       |     
|Deferred tax liability                   |  |     | (2,553  | ) |     |   | (4     | )   |  |   |          |   |  |       |     
|Value of identifiable intangible assets: |  |     |         |   |     |   |        |     |  |   |           |   |  |       |      
|Backlog                                  |  |     | 2,100   |   |     |   |       |     |  |   |          |   |  |       |     
|Goodwill                                 |  |     | 98,165  |   |     |   | 19,864 |     |  |   | 16,686    |   |  |       | 3,513
|                                         |  |     |         |   |     |   |        |     |  |   |           |   |  |       |      
|Total                                    |  | $   | 113,119 |   |     | $ | 19,661 |     |  | $ | 16,766    |   |  | $     | 4,400
|                                         |  |     |         |   |     |   |        |     |  |   |           |   |  |       |      



The total purchase
price for the 2003 acquisitions was allocated to the estimated fair value of assets acquired and liabilities assumed as set forth in the following table:



|                                         |  | Eminent |        |   | Clinsights |   |        | Total | 
|---------------------------------------- |  | ------- | ------ | - | ---------- | - | ------ | ----- | 
|Condensed balance sheet:                 |  |         |        |   |            |   |        |       | 
|Current assets                           |  | $       | 679    |   |            | $ | 1,577  |       | 
|Property and equipment, net              |  |         | 436    |   |            |   | 226    |       | 
|Non-current assets                       |  |         | 32     |   |            |   | 25     |       | 
|Deferred tax asset                       |  |         | 1,184  |   |            |   | 1,093  |       | 
|Current liabilities                      |  |         | (3,292 | ) |            |   | (720   | )     | 
|                                         |  |         |       
|Value of identifiable intangible assets: |  |         |        |   |            |   |        |       | 
|Goodwill                                 |  |         | 14,711 |   |            |   | 9,049  |       | 
|                                         |  |         |        |   |            |   |        |       | 
|Total                                    |  | $       | 13,750 |   |            | $ | 11,250 |       | 
|                                         |  |         |        |   |            |   |        |       | 



Initially, the
purchase price allocations for the acquisitions are based on preliminary estimates, using available information and making assumptions management believes are reasonable. Purchase price allocations are subject to finalization within one year of the
acquisition. The purchase price allocations for all 2002 acquisitions were finalized by June 30, 2003. Goodwill will be evaluated annually for impairment as required by SFAS 142.



Goodwill related to MRL, PRC, ProPharma, Eminent and Clinsights is not expected to be deductible for tax purposes. Goodwill
related to CSS is expected to be deductible for tax purposes.



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PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

(in thousands, except
per share data)



3. ACQUISITIONS (continued)



The unaudited pro forma results from operations for PPD assuming all
acquisitions were consummated as of January 1, 2002 were as follows:



|                      |  | Three Months EndedSeptember 30, |         | Nine Months EndedSeptember 30,
|--------------------- |  | ------------------------------- | ------- | ------------------------------
|                      |  | 2002                            |         | 2003                          
|Total revenue         |  | $                               | 159,130 |                               
|Net income            |  | $                               | 18,413  |                               
|                      |  |                                 |         |                               
|Net income per share: |  |                                 |         |                               
|Basic                 |  | $                               | 0.33    |                               
|Diluted               |  | $                               | 0.33    |                               



The above amounts are
based upon certain assumptions and estimates. PPD believes these assumptions and estimates are reasonable, but they do not reflect any benefit from economies that might be achieved from combined operations. Pro forma adjustments were made to
interest income and income tax totaling $(167) and $92 for the three-month periods ended September 30, 2002 and 2003, respectively. Pro forma adjustments were made to interest income and income tax decreasing net income by $491 and $339 for the
nine-month periods ended September 30, 2002 and 2003, respectively. These adjustments are reflected in the above table. The pro forma financial information presented above is not necessarily indicative of either the results of operations that would
have occurred had the acquisitions taken place at the beginning of the period indicated or of future results of operations of the combined companies.



4. COMPREHENSIVE INCOME



Comprehensive income consisted of the following:



|                                     |  | Three Months Ended September 30, |        | Nine Months Ended September 30,
|------------------------------------ |  | -------------------------------- | ------ | -------------------------------
|                                     |  | 2002                             |        |                                
|Net income, as reported              |  | $                                | 18,282 |                                
|Cumulative translation adjustment    |  |                                  | (866   | )                              
|Unrealized (loss) gain on investment |  |                                  | (2,087 | )                              
|                                     |  |                                  |        |                                
|                                     |  | $                                | 15,329 |                                
|                                     |  |                                  |        |                                



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PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

(in thousands, except
per share data)



5. ACCOUNTS RECEIVABLE AND UNBILLED SERVICES



Accounts receivable and unbilled services consisted of
the following:



|                              |  | December 31, 2002 |         |   | September 30, 2003 |  
|----------------------------- |  | ----------------- | ------- | - | ------------------ | -
|                              |  |                   |         |   | (unaudited)        |  
|Billed                        |  | $                 | 130,865 |   |                    | $
|Unbilled                      |  |                   | 72,692  |   |                    |  
|Reserve for doubtful accounts |  |                   | (3,621  | ) |                    |  
|                              |  |                   |         |   |                    |  
|                              |  | $                 | 199,936 |   |                    | $
|                              |  |                   |         |   |                    |  



6. INVESTMENTS



Investments in publicly traded entities are classified as available-for-sale
securities and are measured at market value. Net unrealized gains or losses are recorded as a component of shareholders equity until realized or other than temporary decline has occurred. The market value is based on the closing price as
quoted by the respective stock exchanges.



Additionally,
investments consist of equity instruments in private entities for which fair values are not readily determinable. All of the Companys investments in private entities are recorded under the cost or equity method of accounting. The Company
assesses the market value of these entities on a quarterly basis to determine whether declines in the market value of these securities are other than temporary. This quarterly review includes an evaluation of, among other things, the market
condition of the overall industry, historical and projected financial performance, expected cash needs and recent funding events.



PPD assesses its investment portfolio on a quarterly basis to determine whether declines in the market value of these securities are other than temporary.
This quarterly review includes an evaluation of, among other things, the market condition of the overall industry, historical and projected financial performance, expected cash needs and recent funding events. As a result of managements
quarterly evaluations, during the three months ended September 30, 2003, the Company recorded a charge to earnings for an other than temporary decline in the fair market value of its investment in BioDelivery Sciences International, Inc. of $0.8
million. BioDelivery Sciences is a publicly traded company, so this write-down was based on the closing price of its stock as of September 30, 2003. Although the stock had traded above cost for short periods of time throughout 2003, management
believes the decline in value as of September 30, 2003 was other than temporary and thus recorded the charge to earnings. Prior to this quarter, market fluctuations were recorded through our equity accounts. During the three months ended June 30,
2003, the Company recorded charges to earnings for other than temporary declines in the fair market value of its investments in SLIL Biomedical Corp. of $4.7 million, Spotlight Health, Inc. of $3.7 million and Signature Bioscience, Inc. (formerly
Primecyte, Inc.) of $0.2 million. SLIL and Primecyte were deemed to be impaired primarily as a result of the market condition of the overall industry, historical and projected performance and expected cash needs of the individual companies. The
write-down of Spotlight Health was recorded based primarily on its historical and projected financial performance and the expectation of an issuance of shares to a new investor at a lower valuation. During the nine months ended September 30, 2002,
PPD recorded a charge to earnings for an other than temporary decline in the fair market value of its investment in DNA Sciences of approximately $32.0 million. The investment in DNA Sciences was deemed to be impaired as a result of adverse events
experienced by DNA Sciences during the first quarter of 2002.



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PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

(in thousands, except
per share data)



6. INVESTMENTS (continued)



In September 2003, PPD purchased 4.4 million shares of SurroMed, Inc. Series
F convertible preferred stock in exchange for $12.0 million in cash and $12.0 million in tangible assets and intellectual property from PPDs Menlo Park, California operation. Including the 1.0 million shares of SurroMeds Series E
convertible preferred stock that were purchased in April 2002 for $5.0 million, PPD owns approximately 15.7% of SurroMeds outstanding capital stock as of September 12, 2003. SurroMed is a privately held company that provides biomarker
solutions to pharmaceutical and biotechnology companies using proprietary, integrated bioanalysis technologies that detect biological markers and compounds to enable precise diagnosis and personalized treatment of disease.



In April 2000, the Company purchased 1.0 million shares of Spotlight Health
Series C convertible preferred stock for $5.0 million. As of September 30, 2003, the Company owned approximately 6.4% of Spotlights outstanding capital stock. In January 2001, the Company entered into an agreement with Spotlight Health and
Wachovia, to guarantee a $2.0 million revolving line of credit provided to Spotlight Health by Wachovia. In July 2003, Spotlight Health replaced this credit facility with a new $2.0 million revolving line of credit from Bank of America, N.A. We
continue to guarantee Spotlights obligations under the new credit facility. As of September 30, 2003, Spotlight Health had $2.0 million outstanding under this credit facility. In accordance with the requirements of FASB Statement No. 5,
Accounting for Contingencies, and as clarified by FASB Interpretation No. 45, we have recorded a liability in the amount of $0.2 million for the fair value of the obligation we have assumed under this guarantee. We review the financial
statements of Spotlight Health on a quarterly basis to determine if they have sufficient financial resources to continue operations. Future events and circumstances might adversely affect Spotlight Healths financial condition and Spotlight
Health might not be in the position to repay the facility, in which case Bank of America might attempt to collect on our guaranty of this facility.



In April 2002, Apothogen, Inc., an equity method investment of PPD, was acquired by IntraBiotics Pharmaceuticals, Inc. As a result of the acquisition, PPD
received shares of IntraBiotics common stock representing less than a 1.0% ownership interest in IntraBiotics outstanding common stock. In connection with the acquisition, the contracts and commitments between Apothogen and its stockholders related
to the initial investment were terminated. Following the acquisition, IntraBiotics continued to rent facility space from PPD and PPD provided Intrabiotics with specified drug development and administrative services. During the fourth quarter of
2002, the Company recorded a charge to earnings for an other than temporary decline in the fair market value of its investment in IntraBiotics of approximately $0.3 million. PPD no longer leases facility space to IntraBiotics and has ceased
providing IntraBiotics with drug development and administrative services.



In June 2002, PPD purchased approximately 0.7 million units of BioDelivery Sciences International, Inc. for $3.6 million. Each unit consisted of one share of common stock and one warrant for common stock. PPDs
common stock in BioDelivery Sciences International represented an ownership interest of approximately 9.9% in BioDelivery Sciences Internationals outstanding common stock as of September 30, 2003. BioDelivery Sciences International is a
publicly traded company that is developing and seeking to commercialize a drug delivery technology designed for a potentially broad base of pharmaceuticals, vaccines and over-the-counter drugs.



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PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

(in thousands, except
per share data)



6. INVESTMENTS (continued)



In December 2002, the Company purchased 150 thousand shares of Oriel
Therapeutics, Inc. Series A convertible preferred stock for $0.15 million. The Company also received, as part of the purchase, a warrant to purchase an equal number of shares of stock offered by Oriel Therapeutics in its next round of financing at a
discount. In April 2003, the Company exercised these warrants to purchase 150 thousand shares of Oriel Therapeutics Series B convertible preferred stock for $0.2 million. At the same time, the Company also purchased an additional 255 thousand shares
of Oriels Series B convertible preferred stock for $0.5 million. PPDs common stock in Oriel Therapeutics represented an ownership interest of approximately 13.5% in Oriel Therapeutics outstanding common stock as of September 30,
2003. Oriel Therapeutics Corp. is a privately held company pursuing the development of technology to improve drug delivery in the treatment of respiratory and pulmonary diseases.



In April 2003, PPD purchased 2.0 million shares of Chemokine Therapeutics Corp. Series A convertible preferred stock for
$2.7 million, which represented approximately a 17.0% interest in the outstanding stock of Chemokine as of September 2003. Chemokine is a privately held company focusing on the development of peptide and small molecule therapeutics that are agonists
or antagonists of chemokine activity. Chemokines are small proteins that recruit cells to local sites of infection and might be useful as either blood recovery or anti-metastasis agents.



7. COMMITMENTS AND CONTIGENCIES



In the normal course of business, the Company is a party to various claims and legal proceedings. The Company records a reserve for these matters when an
adverse outcome is probable and the amount of the potential liability is reasonably estimable. Although the ultimate outcome of these matters is currently not determinable and actual results could vary materially, management of the Company, after
consultation with legal counsel, does not believe that the resolution of these matters will have a material effect upon the Companys financial condition, results of operations or cash flows for an interim or annual period.



In September 2003, PPD entered into agreements with SurroMed, Inc. to
purchase biomarker discovery services from SurroMed for $2.0 million, $2.0 million, $1.0 million and $1.0 million during the years ended December 31, 2004, 2005, 2006 and 2007, respectively.



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



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PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

(in thousands, except
per share data)



8. BUSINESS SEGMENT DATA



Revenues by principal business segment are separately stated in the
consolidated condensed financial statements. PPD uses income (loss) from operations as its measurement of segment profitability. Income from operations and identifiable assets by principal business segment were as follows:



|                               |  | Three months EndedSeptember 30, |        | Nine Months EndedSeptember 30, |     
|------------------------------ |  | ------------------------------- | ------ | ------------------------------ | ----
|                               |  | 2002                            |        |                                | 2003
|Income (loss) from operations: |  |                                 |        |                                |     
|Development                    |  | $                               | 30,890 |                                |     
|Discovery sciences             |  |                                 | (3,142 | )                              |     
|                               |  |                                 |        |                                |     
|Total                          |  | $                               | 27,748 |                                |     
|                               |  |                                 |        |                                |     



|                     |  | December 31, 2002 |         | September 30, 2003
|-------------------- |  | ----------------- | ------- | ------------------
|Identifiable assets: |  |                   |         |                   
|Development          |  | $                 | 635,660 |                   
|Discovery sciences   |  |                   | 56,460  |                   
|                     |  |                   |         |                   
|Total                |  | $                 | 692,120 |                   
|                     |  |                   |         |                   



9. RESTRUCTURING CHARGES AND GAIN
ON SALE OF ASSETS



In July 2003, PPD announced the
restructuring of its discovery sciences segment to focus on lead optimization, which is the process of refining the chemical structure of a compound to improve its drug characteristics. In connection with this restructuring, PPD consolidated its
discovery sciences operations into its Morrisville, North Carolina and Middleton, Wisconsin facilities, and discontinued offering functional genomics services in Menlo Park, California. PPD recorded a charge to earnings in the third quarter of 2003
of $1.9 million for this restructuring. Restructuring charges included $0.9 million for one-time termination benefits, $0.7 million for facility charges and $0.3 million for other related charges. All restructuring charges were incurred and paid
during the third quarter of 2003.



As a part of this
restructuring, PPD purchased 4.4 million shares of SurroMed, Inc. Series F convertible preferred stock in exchange for $12.0 million in cash and $12.0 million in tangible assets and intellectual property from PPDs Menlo Park operations. The
value of the tangible assets and intellectual property was based on an independent appraisal. PPD recorded a gain on sale of assets of $5.7 million as a result of this transaction. The majority of the remaining tangible assets were transferred to
the CRO Phase II through IV division and the remaining discovery sciences operations. PPD also entered into agreements with SurroMed to purchase biomarker discovery services from SurroMed for $6.0 million over a period of four years and to serve as
a non-exclusive representative to market and sell additional biomarker discovery services.



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##### Table of Contents

|Item 2. |  | Managements Discussion and Analysis of Financial Condition and Results of Operations
|------- |  | -------------------------------------------------------------------------------------



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



Forward-looking Statements



This Form 10-Q contains forward-looking statements within the meaning of the
federal securities laws. These statements relate to future events or our future financial performance. Forward-looking statements include statements concerning plans, objectives, goals, strategies, future events or performances, expectations,
predictions, assumptions and other statements that are not statements of historical facts. In some cases, you can identify forward-looking statements by words such as might, will, should, expect,
plan, anticipate, believe, estimate, predict, intend, potential or continue, or the negative of these terms, or other comparable terminology. These
statements are only predictions. These statements rely on a number of assumptions and estimates which could be inaccurate and which are subject to risks and uncertainties. Actual events or results might differ materially due to a number of factors,
including those listed in Potential Volatility of Quarterly Operating Results and Stock Price. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results,
levels of activity, performance or achievements. We generally undertake no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.



Company Overview



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



We have been in the drug development business for more than 17
years. Our development services include preclinical programs and Phase I through Phase IV clinical development services. We have extensive clinical trial experience across a multitude of therapeutic areas and parts of the world, including regional,
national and global studies. In addition, we also offer post-market support services for drugs that have received approval for market use, such as product launch services, patient compliance programs, and medical communications programs for consumer
and healthcare providers on product use and adverse events.



With more than 5,600 professionals worldwide, we have provided services to 43 of the top 50 pharmaceutical companies in the world as ranked by 2002 healthcare research and development spending, in addition to our work with leading
biotechnology and medical device companies. We believe that we are one of the worlds largest providers of drug development services to pharmaceutical, biotechnology and medical device companies based on 2002 annual net revenues generated from
contract research organizations.



Building on our outsourcing
relationship with pharmaceutical and biotechnology clients, we established our discovery sciences group in 1997. This business focuses on early stage research to help our customers address the bottleneck at the beginning of the development process.
This business primarily involves lead optimization, which is the process of refining the chemical structure of a compound to improve its drug characteristics, as well as medicinal chemistry research, preclinical biology services and preclinical
evaluations of anticancer therapies. In the third quarter of 2003, we discontinued providing functional genomics services, which is the study of gene functions to identify drug targets within the body, in order to focus on our other discovery
sciences operations.



In addition, we have developed an
innovative risk-sharing research and development model to help pharmaceutical and biotechnology clients develop compounds. Through arrangements based on this model, we help our clients research and evaluate the development potential for compounds at
various stages of development.



We believe that our integrated
drug discovery and development services offer our clients a way to identify and develop successful drugs more quickly and cost effectively. We also use our proprietary informatics technology to support our drug discovery and development services. In
addition, because we are positioned globally, we are



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##### Table of Contents

able to accommodate the multinational drug discovery and development needs of our customers. As a result of having these core areas of expertise in discovery
and development, we can provide integrated services across the entire drug development spectrum, from target discovery to market and beyond. For more detailed information on PPD, see our Annual Report on Form 10-K for the year ended December 31,
2002.



Results of Operations



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



In connection with the management of multi-site clinical trials, we pay on behalf of our customers fees to investigators and
test subjects, and other out-of-pocket costs, such as travel, printing, meetings, and couriers, for which we are reimbursed at cost. As required by EITF 01-14, amounts paid by us as a principal for out-of-pocket costs are included in direct costs as
reimbursable out-of-pocket expenses and the reimbursements we receive as a principal are reported as reimbursed out-of-pocket revenues. Amounts paid by us as an agent for out-of-pocket costs are combined with the corresponding reimbursements, or
revenues, we receive as an agent in the statement of operations. During the three months ended September 30, 2002 and 2003, fees paid to investigators and other fees that PPD received as an agent and the associated reimbursements were approximately
$39.3 million and $38.8 million, respectively. During the nine months ended September 30, 2002 and 2003, fees paid to investigators and other fees in which PPD acts as an agent and the associated reimbursements were approximately $113.6 million and
$130.8 million, respectively.



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



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



We record our recurring operating expenses among five categories:



| |  | direct costs;
| | - | -------------



| |  | research and development;
| | - | -------------------------



| |  | selling, general and administrative;
| | - | ------------------------------------



| |  | depreciation; and
| | - | -----------------



| |  | amortization.
| | - | -------------



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



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



Selling, general and administrative, or SG&A, expenses consist primarily of administrative payroll and related benefit
charges, sales, advertising and promotional expenses, recruiting and relocation expenses, administrative travel, an allocation of facility and information technology costs and costs related to professionals working in an indirect capacity.



Depreciation expenses consist of depreciation costs recorded
on a straight-line method, based on estimated useful lives of 40 to 50 years for buildings, five years for laboratory equipment, three years for computers and related equipment and four to 10 years for furniture and equipment, except for our
airplane, which we are depreciating over 30 years. Leasehold improvements are depreciated over the shorter of the respective lives of the leases or the useful lives of the improvements. Property under capital leases is depreciated over the life of
the lease or the service life, whichever is shorter.



Amortization expenses consist of amortization costs recorded on intangible assets on a straight-line method over the life of the intangible assets. The excess of the purchase price of a business acquired over the fair value of net tangible
assets, identifiable intangible assets and acquired in-process research and development costs at the date of the acquisition has been assigned to goodwill. Goodwill was being amortized over periods of 10 to 25 years prior to January 1, 2002. In June
2001, the FASB issued Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, or SFAS No. 142. We adopted SFAS No. 142 as of January 1, 2002 and no longer amortize goodwill. The provisions of this
accounting standard required us to complete a transitional impairment test within six months of adoption. We are also required to complete annual impairment tests going forward. These impairment tests involve determining the fair market value of
each of the reporting units with which the goodwill was associated and comparing the estimated fair market value of each of the reporting units with its carrying amount. We completed the transitional impairment test as of January 1, 2002 and the
annual impairment test as of October 1, 2002. Neither test identified any impairments of goodwill.



Acquisitions



In
February 2002, PPD acquired 100% of the outstanding common stock of Medical Research Laboratories International, Inc., or MRL U.S., and Medical Research Laboratories International, BVBA, or MRL Belgium, collectively, MRL. MRL is now part
of the Development segment of PPD. MRL U.S. operates a central laboratory near Cincinnati, Ohio, and MRL Belgium operates a central laboratory in Brussels, Belgium. MRL provides highly standardized efficacy and safety testing services for
pharmaceutical companies engaged in clinical drug development. PPD acquired MRL for total consideration of $113.1 million, including $39.0 million in cash, $73.5 million in PPDs common stock (approximately 2.6 million unregistered shares) and
direct acquisition costs of $0.6 million for legal, appraisal and accounting fees.



In April 2002, PPD acquired Piedmont Research Center II, Inc, or PRC, a research laboratory based in Morrisville, North Carolina that performs preclinical evaluations of anti-cancer therapies for national and
international pharmaceutical and biotechnology companies. PRC is now part of the Discovery segment of PPD. PPD acquired PRC for total consideration of $19.6 million, including $2.4 million in cash, $17.1 million in PPDs common stock (0.5
million unregistered shares) and direct acquisition costs of $0.1 million for legal and accounting fees.



In June 2002, PPD acquired Complete Software Solutions, Inc., or CSS, a technical consulting firm offering a full range of implementation, validation and
training services as well as specialized software for pharmaceutical and biotechnology industries. CSS is now part of the Development segment of PPD. PPD acquired CSS for total consideration of $16.8 million in cash.



In June 2002, PPD acquired ProPharma Pte Ltd, an Asian-based clinical
research organization with extensive experience in managing pan-Asian clinical trials. ProPharma is now part of the Development segment of PPD. PPD acquired ProPharma for total consideration of $3.0 million in cash. In addition, PPD paid $1.4
million as additional purchase price in the second quarter of 2003. This was a contingency payment which depended upon the financial performance of ProPharma for a specified period following the acquisition.



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In July 2003, PPD acquired Eminent Research Systems, Inc., a clinical research organization specializing
in medical device development, and Clinsights, Inc., which provides a range of post-market services to medical device and related pharmaceutical companies and operates proprietary web sites for the dissemination of medical information, online
research and product marketing. Eminent and Clinsights are now part of the Development segment of PPD. The results of operations are included in PPDs consolidated condensed results of operations as of and since July 18, 2003, the effective
date of the acquisitions. PPD acquired Eminent and Clinsights for total consideration of $25.0 million in cash.



These acquisitions were accounted for using the purchase method, utilizing appropriate fair value techniques to allocate the purchase price based on the
estimated fair values of the assets and liabilities. Accordingly, the estimated fair value of assets acquired and liabilities assumed were included in PPDs condensed consolidated balance sheet as of the effective dates of the acquisitions. The
results of operations are included in PPDs condensed consolidated results of operations as of and since the effective dates of the acquisitions. For further details regarding these acquisitions, see Note 3 to Consolidated Condensed Financial
Statements.



Restructuring Charges and Gain on Sale of Assets



In July 2003, PPD announced the restructuring of its
Discovery Sciences segment to focus on lead optimization, which is the process of refining the chemical structure of a compound to improve its drug characteristics. In connection with this restructuring, PPD consolidated its Discovery Sciences
operations into its Morrisville, North Carolina and Middleton, Wisconsin facilities, and discontinued offering functional genomics services in Menlo Park, California. PPD recorded a charge to earnings in the third quarter of 2003 of $1.9 million for
this restructuring. Restructuring charges included $0.9 million for one-time termination benefits, $0.7 million for facility charges and $0.3 million for other related charges. All restructuring charges were incurred and paid during the third
quarter of 2003.



As a part of this restructuring, PPD
purchased 4.4 million shares of SurroMed, Inc. Series F convertible preferred stock in exchange for $12.0 million in cash and $12.0 million in tangible assets and intellectual property from PPDs Menlo Park operations. The value of the tangible
assets and intellectual property was based on an independent appraisal. PPD recorded a gain on sale of assets of $5.7 million as a result of this transaction. The majority of the remaining tangible assets were transferred to the CRO Phase II through
IV division and the remaining discovery sciences operations. PPD also entered into agreements with SurroMed to purchase biomarker discovery services from SurroMed for $6.0 million over a period of four years and to serve as a non-exclusive
representative to market and sell additional biomarker discovery services.



Non-GAAP Information



The following discussion
of our results of operations for the periods ended September 30, 2003 and 2002 and our financial condition as of September 30, 2003 includes non-GAAP financial measures. In the discussion, we sometimes exclude revenue and costs related to
reimbursable out-of-pocket expenses because they are not generated by services we provide, do not yield any gross profit to us, and do not have any impact on our net income. We also sometimes exclude amounts associated with the impairments of our
equity investments, gain on sale of assets and restructuring charges to more accurately reflect the results of our operations and provide similar information for period to period comparisons. We believe this information is useful to our investors
because it presents the revenue and expenses that are directly attributable to the services we provide our clients and presents a more accurate picture of our operating results and margins.



Three Months Ended September 30, 2003 Versus Three Months Ended September 30, 2002



Net revenue for the three months ended September 30, 2003
increased $22.2 million, or 14.1%, to $179.5 million from net revenue of $157.3 million in the same period in 2002. The Development Groups operations accounted for 91.4% of net revenue for the third quarter of 2003. The Development Group
generated net revenue of $164.0 million in the third quarter of 2003, an increase of $21.7 million, or 15.3%, from the 2002 third quarter. The increase in the Development Groups net revenue was primarily attributable to an increase in the size
and number of contracts in the global contract research organization, or CRO, Phase II through IV division. Net revenue for the Development Group was positively impacted by approximately $1.1 million due to the effect of the weakening of the U.S.
dollar relative to the euro and the British pound in the third quarter of 2003.



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The Discovery Sciences Group generated net revenue of $2.6 million in the third quarter of 2003, a
decrease of $1.2 million, or 30.8%, from the third quarter of 2002. The decrease in the Discovery Sciences net revenue was attributable to lower revenues within our chemistry and preclinical operations due to the expiration of contracts that were
not renewed or replaced. In addition, we experienced lower net revenue in Discovery Sciences because we discontinued offering functional genomics services in Menlo Park, California in the third quarter of 2003.



Total direct costs for the third quarter of 2003 were $93.7 million, an
increase of 15.0% from $81.5 million in the third quarter of 2002. As a percentage of net revenue, total direct costs increased to 52.2% in the third quarter of 2003 as compared to 51.8% in the third quarter of 2002. Development Groups direct
costs increased to $79.4 million in the third quarter of 2003 as compared to $68.3 million in the third quarter of 2002. This 16.3% increase resulted primarily from increased personnel costs due to the increase in the size and number of contracts in
the global CRO Phase II through IV division. Development Group direct costs as a percentage of related net revenue increased to 48.4% in the third quarter of 2003, as compared to 48.0% in the third quarter of 2002. Discovery Sciences direct costs
decreased to $1.4 million in the third quarter of 2003 as compared to $1.9 million in the third quarter of 2002. This decrease was primarily attributable to a decrease in direct costs in our chemistry and preclinical operations related to a decrease
in revenues described above and the decrease in direct costs related to the closing of our functional genomics operations in Menlo Park, California.



R&D expenses decreased 49.7% to $1.5 million in the third quarter of 2003 from $3.0 million in the third quarter of 2002. This decrease was primarily
attributable to a decrease in spending on internal R&D in the Discovery Sciences Group because of the closing of our functional genomics operations.



SG&A expenses increased 9.3% to $42.6 million in the third quarter of 2003 from $38.9 million in the third quarter of 2002. The increase was primarily
attributable to additional administrative personnel costs to support our expanding operations. As a percentage of net revenue, SG&A expenses decreased to 23.7% in the third quarter of 2003 from 24.7% in the third quarter of 2002. Excluding
reimbursed out-of-pockets for the third quarters of 2003 and 2002 of $12.9 million and $11.3 million, respectively, SG&A expenses as a percent of net revenue decreased to 25.5% in the third quarter of 2003 from 26.7% in the third quarter of
2002. These decreases in SG&A expenses as a percentage of net revenue are primarily attributable to the increase in revenue, and to a smaller extent, to increased efficiencies as our operations expanded.



Depreciation expense increased $0.5 million, or 8.6%, to $6.5 million in the
third quarter of 2003 from $6.0 million in the third quarter of 2002. The increase was primarily related to the depreciation of our increased investment in property and equipment due to our growth. Capital expenditures were $6.9 million in the third
quarter of 2003. Capital expenditures primarily included additional spending in the Development Group to enhance and expand our information technology capacity and to purchase equipment, furniture and computer hardware for new employees.



Amortization expense was approximately $0.5 million for the third quarter
of 2003 and $0.2 million for the third quarter of 2002. During the third quarter of 2002 and 2003, amortization of backlog associated with the acquisition of MRL accounted for $0.2 million and $0.3 million of the amortization expense, respectively.
Amortization of a licensing agreement in the Discovery Sciences Group accounted for $0.2 million of the amortization expense in the third quarter of 2003.



Operating income increased $10.9 million to $38.6 million in the third quarter of 2003, as compared to $27.7 million in the third quarter of 2002. As a
percentage of net revenue, operating income increased to 21.5% for the third quarter of 2003 from 17.6% in the third quarter of 2002. Excluding reimbursed out-of-pockets for the quarters ended September 30, 2003 and 2002 of $12.9 million and $11.3
million, respectively, the 2003 restructuring charges of $1.9 million and gain on sale of assets of $5.7 million, operating income increased to 20.9% of net revenue for the third quarter of 2003 from 19.0% of net revenue in the same period of 2002.
The increases in operating income and operating margin were primarily due to our revenue growth and our focus on controlling the increase in both direct and administrative costs. Operating income was negatively impacted by approximately $1.2 million
due to the effect of the weakening of the U.S. dollar relative to the euro, the British pound and the Brazilian real in the third quarter of 2003. This is attributable to contracts for services rendered in countries other than the United States
which are denominated in U.S. dollars. In these cases, revenue is not impacted by the weakening of the U.S. dollar, but costs associated with these contracts are negatively impacted when translated to the U.S. dollar.



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During the third quarter of 2003, we recorded a charge to earnings for an other than temporary decline in
the fair market value of our investment in BioDelivery Sciences International, Inc. of $0.8 million. BioDelivery Sciences is a publicly traded company, so this write-down was based on the closing price of its stock as of September 30, 2003. Although
the stock had traded above cost for short periods of time throughout 2003, management believes the decline in value as of September 30, 2003 was other than temporary and thus recorded the charge to earnings. Prior to this quarter, market
fluctuations were recorded through our equity accounts.



Our
provision for income taxes increased $3.7 million, or 35.8%, to $14.0 million in the third quarter of 2003, as compared to $10.3 million in the third quarter of 2002. Our effective income tax rate has remained at 36.0% in the 2002 and 2003 third
quarters. Our tax rate might vary from period to period due to the geographic mix of our pre-tax earnings.



Net income of $24.8 million in the third quarter of 2003 represents an increase of $6.5 million from $18.3 million in net income in the third quarter of
2002. Excluding the restructuring charges, gain on sale of assets and the impairment of equity investment and the related net tax expense, net income increased $4.6 million to $22.9 for the third quarter of 2003 as compared to $18.3 million for the
corresponding 2002 period. Net income per diluted share of $0.44 for the third quarter of 2003 represents an increase from the $0.33 in net income per diluted share in the third quarter of 2002. Excluding the restructuring charges, gain on sale of
assets and the impairment of equity investment and the related net tax expense, net income per diluted share increased to $0.41 for the third quarter of 2003 as compared to $0.33 for the third quarter of 2002.



Nine Months Ended September 30, 2003 Versus Nine Months Ended September 30, 2002



Net revenue for the nine months ended September 30, 2003
increased $95.0 million, or 21.6%, to $534.4 million from net revenue of $439.4 million in the same period in 2002. The Development Groups operations accounted for 90.1% of net revenue for the first nine months of 2003. The Development Group
generated net revenue of $481.5 million in the first nine months of 2003, an increase of $87.4 million, or 22.2%, from the first nine months of 2002. The increase in the Development Groups net revenue was primarily attributable to an increase
in the size and number of contracts in the global CRO Phase II through IV division. Net revenue for the Development Group was positively impacted by approximately $4.1 million due to the effect of the weakening of the U.S. dollar relative to the
euro and the British pound in the first nine months of 2003.



The Discovery Sciences Group generated net revenue of $12.8 million in the first nine months of 2003, a decrease of $1.4 million, or 10.1%, from the first nine months of 2002. The decrease in the Discovery Sciences net revenue was mainly
attributable to discontinuing to offer functional genomics services in Menlo Park, California in the third quarter of 2003, partially offset by a milestone payment that we earned under a sublicense agreement with ALZA Corporation as a result of the
initiation of Phase III clinical trials of dapoxetine.



Total
direct costs for the first nine months of 2003 were $278.9 million, an increase of 22.9% from $226.8 million in the first nine months of 2002. As a percentage of net revenue, total direct costs increased to 52.2% in the first nine months of 2003 as
compared to 51.6% in the first nine months of 2002. Development Group direct costs increased to $232.4 million in the first nine months of 2003 as compared to $189.5 million in the first nine months of 2002. This 22.6% increase resulted primarily
from increased personnel costs due to the increase in the size and number of contracts in the global CRO Phase II through IV division and the direct costs recorded in 2003 that were associated with the businesses acquired during 2002. Development
Group direct costs as a percentage of related net revenue increased slightly to 48.3% for the first nine months of 2003 from 48.1% in the first nine months of 2002. Discovery Sciences direct costs increased to $6.4 million in the first nine months
of 2003 as compared to $6.2 million in the first nine months of 2002. This increase was primarily attributable to the costs associated with sublicensing dapoxetine and the direct costs associated with our preclinical oncology operations, which we
acquired in April 2002, partially offset by the decrease in direct costs because of the closing of our functional genomics operations.



R&D expenses increased 17.7% to $8.6 million in the first nine months of 2003 from $7.3 million in the first nine months of 2002. This increase was
primarily attributable to an increase in spending on internal R&D in the Discovery Sciences Group to develop intellectual property.



SG&A expenses increased 10.6% to $124.1 million in the first nine months of 2003 from $112.2 million in the first nine months of 2002. The increase
was primarily attributable to additional administrative personnel costs and an increase in training costs associated with new operational employees hired to support our expanding



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operations. As a percentage of net revenue, SG&A expenses decreased to 23.2% in the first nine months of 2003 from 25.5% in the first nine months of
2002. Excluding reimbursed out-of-pockets for the first nine months of 2003 and 2002 of $40.1 million and $31.1 million, respectively, SG&A expenses as a percentage of net revenue decreased to 25.1% in the first nine months of 2003 from 27.5% in
the first nine months of 2002. These decreases in SG&A expenses as a percentage of net revenue are primarily attributable to the increase in revenue, and to a smaller extent, to increased efficiencies as our operations expanded.



Depreciation expense increased $3.2 million, or 18.6%, to $20.2 million in
the first nine months of 2003 from $17.1 million in the first nine months of 2002. The increase was primarily related to the depreciation of the increased investment in property and equipment due to our growth. Capital expenditures were $22.9
million in the first nine months of 2003. Capital expenditures primarily included additional spending in the Development Group to enhance and expand our information technology capacity and to purchase equipment, furniture and computer hardware for
new employees.



Amortization expense was approximately $1.2
million for the first nine months of 2003 and $0.6 million for the first nine months of 2002. During the first nine months of 2002 and 2003, amortization of backlog associated with the acquisition of MRL accounted for $0.5 million and $0.8 million
of the amortization expense, respectively. Amortization of a licensing agreement in the Discovery Sciences Group accounted for $0.3 million of the amortization expense in the first nine months of 2003.



Operating income increased $29.8 million to $105.2 million in the first nine
months of 2003, as compared to $75.4 million in the first nine months of 2002. As a percentage of net revenue, operating income increased to 19.7% for the nine months of 2003 from 17.2% in the first nine months of 2002. Excluding reimbursed
out-of-pockets for the nine months ended September 30, 2003 and 2002 of $40.1 million and $31.1 million, respectively, 2003 restructuring charges of $1.9 million and gain on sale of assets of $5.7 million, operating income increased to 20.5% of net
revenue for the first nine months of 2003 from 18.5% of net revenue in the same period of 2002. The increases in operating income and operating margin were primarily due to our revenue growth and our focus on controlling the increase in both direct
and administrative costs. Operating income was negatively impacted by approximately $4.6 million, net, due to the effect of the weakening of the U.S. dollar relative to the euro and the British pound, partially offset by the strengthening of the
U.S. dollar relative to the Brazilian real in the first nine months of 2003. This is attributable to contracts for services rendered in countries other than the United States which are denominated in U.S. dollars. In these cases, revenue is not
impacted by the weakening of the U.S. dollar, but costs associated with these contracts are negatively impacted when translated to the U.S. dollar.



During the first nine months of 2003, we recorded charges to earnings for other than temporary declines in the fair market value of our investments in
SLIL Biomedical Corp. of $4.7 million, Spotlight Health, Inc. of $3.7 million, Signature Bioscience, Inc. (formerly Primecyte, Inc.) of $0.2 million and BioDelivery Sciences International, Inc. of $0.8 million. SLIL and Primecyte were determined to
be impaired primarily as a result of the market condition of the overall industry, historical and projected performance and expected cash needs of the individual companies. The write-down of Spotlight Health was recorded primarily based on its
historical and projected financial performance and the expectation of an issuance of shares to a new investor at a lower valuation. BioDelivery Sciences is a publicly traded company, so this write-down was based on the closing price of it stock as
of September 30, 2003. Although the stock had traded above cost for short periods of time throughout 2003, management believes the decline in value as of September 30, 2003 was other than temporary and thus recorded the charge to earnings. Prior to
this quarter, market fluctuations were recorded through our equity accounts. During the first nine months of 2002, we recorded a $32.0 million write-down of the carrying value of our investment in DNA Sciences, Inc. for an other than temporary
decline in value. Our investment in DNA Sciences was deemed to be impaired as a result of historical and projected performance, cash needs and an independent valuation of the market value of DNA Sciences.



Our provision for income taxes increased $8.6 million, or 31.9%, to $35.4
million in the first nine months of 2003, as compared to $26.9 million in the first nine months of 2002. During the first nine months of 2002, we recorded an impairment of $32.0 million in our investment in DNA Sciences. As a result of the
uncertainty of the utilization of the deduction of the impairment prior to its expiration, we recorded a valuation allowance of $10.7 million, thus providing a tax benefit of only $2.0 million in the provision for income taxes.



Net income of $62.8 million in the first nine months of 2003 represents an
increase of $42.9 million from $19.9 million in net income in the first nine months of 2002. Excluding the restructuring charges, gain on sale of



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assets and impairment of equity investments and the related net tax benefits in both periods, net income increased $16.5 million to $66.4 million for the
first nine months of 2003 as compared to $49.9 million for the corresponding 2002 period. Net income per diluted share of $1.12 for the first nine months of 2003 represents an increase from the $0.36 in net income per diluted share in the first nine
months of 2002. Excluding the restructuring charges, gain on sale of assets and impairment of equity investments and the related net tax benefits for both periods, net income per diluted share increased to $1.18 for the first nine months of 2003 as
compared to $0.91 for the first nine months of 2002.



Liquidity and Capital
Resources



As of September 30, 2003, we had $174.8 million
of cash and cash equivalents on hand. Our expected primary cash needs on both a short and long-term basis are for capital expenditures, expansion of services, possible acquisitions and investments, geographic expansion, working capital and other
general corporate purposes. We have historically funded our operations and growth, including acquisitions, with cash flow from operations, and to a lesser extent in recent years, with borrowings and stock issuances. We are exposed to changes in
interest rates on cash equivalents and amounts outstanding under notes payable, notes receivable and lines of credit. Our cash and cash equivalents are invested in financial instruments that are rated A or better by Standard & Poors or
Moodys and earn interest at market rates.



For the nine
months ended September 30, 2003, our operating activities provided $46.8 million in cash as compared to $65.5 million for the same period last year. Net income of $62.8 million, impairment of equity investments of $9.4 million, depreciation and
amortization of $21.4 million, and a $3.6 million increase in deferred income taxes were partially offset by the net decrease of $45.5 million in net operating assets and liabilities. The net decrease in net operating assets and liabilities is
primarily attributable to an increase in receivables due to increased revenues, a decrease in unearned income, and a decrease in accrued expenses.



For the nine months ended September 30, 2003, our investing activities used $63.5 million in cash. The net cash used for acquisitions of $25.9 million,
capital expenditures of $22.9 million and purchases of investments of $15.4 million was partially offset by $0.5 million received from the repayment of notes receivable.



For the nine months ended September 30, 2003, our financing activities provided $5.7 million in cash, as net proceeds from
stock option exercises and purchases under our employee stock purchase plan totaling $8.0 million were offset by $1.4 million in repayments of capital lease obligations and $0.9 million in principal repayments of long-term debt.



Working capital as of September 30, 2003 was $218.6 million, compared to
$187.7 million at December 31, 2002. The increase in working capital was due primarily to the increase in accounts receivable and unbilled services, net, of $22.9 million and the decrease in other accrued expenses of $10.0 million. The number of
days revenue outstanding in accounts receivable and unbilled services, net, less unearned income, also known as DSO, were 41.6 days for the nine months ended September 30, 2003 and 35.4 days for the twelve months ended December 31, 2002. We believe
this change in DSO reflects normal fluctuations in the rate of collections of accounts receivable and changes in temporary terms of investigator fee down payments. Over the past two years, our year-to-date DSO has fluctuated between 30.8 days and
51.1 days. We expect DSO in the future will fluctuate depending on the mix of contracts performed within a quarter and our success in collecting receivables.



In July 2003, we renewed our revolving credit facility for $50.0 million with Bank of America, N. A. Indebtedness under the facility is unsecured and
subject to traditional covenants relating to financial ratios. Borrowings under this credit facility are available to provide working capital and for general corporate purposes. As of September 30, 2003, there was no amount outstanding under this
credit facility. This credit facility is currently scheduled to expire in June 2004, at which time any outstanding balance would be due. In the past, we maintained a second revolving credit facility for $50.0 million with Wachovia Bank, N.A. on
terms and conditions substantially similar to our facility with Bank of America. However, based on our cash balance and historical ability to generate cash from operations, we elected not to renew our facility with Wachovia, and it expired on June
30, 2003.



In April 2000, we made an investment in Spotlight
Health, Inc. In January 2001, we entered into an agreement with Spotlight Health and Wachovia Bank, N.A. to guarantee a $2.0 million revolving line of credit provided to Spotlight Health by Wachovia. Indebtedness under the line was unsecured and
subject to traditional covenants relating to financial ratios. This credit facility expired on June 30, 2003. In July 2003, Spotlight Health



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replaced this credit facility with a new $2.0 million revolving line of credit from Bank of America, N.A. The new line of credit is on terms substantially
similar to the prior line of credit. We continue to guarantee Spotlights obligations under the new credit facility, which is scheduled to expire on June 30, 2004, at which time any outstanding balance would be due. As of September 30, 2003,
Spotlight Health had $2.0 million outstanding under this credit facility. In accordance with the requirements of FASB Statement No. 5, Accounting for Contingencies, and as clarified by FASB Interpretation No. 45, we have recorded a
liability in the amount of $0.2 million for the fair value of the obligation we have assumed under this guarantee. We review the financial statements of Spotlight Health on a quarterly basis to determine if they have sufficient financial resources
to continue operations. Future events and circumstances might adversely affect Spotlight Healths financial condition and Spotlight Health might not be in the position to repay the facility, in which case Bank of America might attempt to
collect on our guaranty of this facility.



In September 2003,
in connection with the purchase of 4.4 million shares of SurroMeds Series F convertible preferred stock, PPD entered into agreements with SurroMed to purchase biomarker discovery services from SurroMed for $6.0 million over a period of four
years and to serve as a non-exclusive representative to market and sell additional biomarker discovery services.



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



We expect to continue expanding our operations through internal growth, strategic acquisitions and investments. We expect
these activities will be funded from existing cash, cash flow from operations and borrowings under our existing or future credit facilities. We believe that these sources of liquidity will be sufficient to fund our operations for the foreseeable
future, but offer no assurances. From time to time, we evaluate potential acquisitions, investments and other growth opportunities, which might require additional external financing, and we might seek funds from public or private issuances of equity
or debt securities. In particular, our sources of liquidity could be affected by our dependence on a small number of industries and clients, compliance with regulations, international risks, personal injury, environmental or intellectual property
claims, as well as other factors described under Potential Volatility of Quarterly Operating Results and Stock Price and Quantitative and Qualitative Disclosures about Market Risk. In addition, see Contractual
Obligations and Commercial Commitments, Critical Accounting Policies and Estimates and Factors that Might Affect our Business or Stock Price in our Annual Report on Form 10-K for the year ended December 31, 2002.



Critical Accounting Policies and Estimates



There have been no material changes to our critical accounting policies and
estimates since December 31, 2002. For detailed information on our critical accounting policies and estimates, see our Annual Report on Form 10-K for the year ended December 31, 2002.



Recently Issued Accounting Standards



In June 2001, the Financial Accounting Standards Board (the FASB) issued Statement of Financial Accounting Standards No. 143, Accounting
for Asset Retirement Obligations, or SFAS No. 143, which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS 143 requires
that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the
carrying amount of the long-lived asset. SFAS No. 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002. The adoption of this statement did not have a material impact on our financial statements.



In June 2002, the FASB issued Statement of Financial Accounting Standards
No. 146, Accounting for Costs Associated with Exit or Disposal Activities, or SFAS No. 146. SFAS No. 146 addresses accounting and reporting for costs associated with exit or disposal activities. SFAS No. 146 requires that a liability for
a cost associated with an exit or disposal activity be recognized and measured initially at fair value when the liability is incurred. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The Company
recorded the restructuring charges in the third quarter of 2003 in accordance with SFAS No. 146.



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In November 2002, the EITF finalized its tentative consensus on EITF Issue 00-21, Revenue
Arrangements with Multiple Deliverables, which provides guidance on the timing and method of revenue recognition for sales arrangements that include the delivery of more than one product or service. EITF 00-21 is effective prospectively for
arrangements entered into in fiscal periods beginning after June 15, 2003. Although the Company has many contracts with multiple deliverables, the deliverables do not represent separate units of accounting. As such, the adoption of this statement
did not have a material impact on our financial statements.



In
November 2002, the FASB issued Financial Accounting Standards Board Interpretation No. 45 (FIN 45), Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an
interpretation of FASB Statement Nos. 5, 57, and 107 and Rescission of FASB Interpretation No. 34. FIN 45 clarifies the requirements of FASB Statement No. 5, Accounting for Contingencies, relating to the guarantors accounting
for, and disclosure of, the issuance of certain types of guarantees. FIN 45 requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation it assumes under that guarantee. The disclosure
provisions of FIN 45 are effective for financial statements of interim or annual periods that end after December 15, 2002. FIN 45s provisions for initial recognition and measurement should be applied on a prospective basis to guarantees issued
or modified after December 31, 2002, irrespective of the guarantors fiscal year-end. The guarantors previous accounting for guarantees that were issued before the date of FIN 45s initial application may not be revised or restated
to reflect the effect of the recognition and measurement provisions of FIN 45. The adoption of this statement did not have an impact on our financial statements, other than the guarantee discussed in Note 6 to the Consolidated Condensed Financial
Statements.



In December 2002, the FASB issued SFAS No. 148,
Accounting for Stock-Based Compensation  Transition and Disclosure  an Amendment of FASB Statement No. 123. This Statement amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative
methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. This statement requires that companies having a year-end after December 15, 2002
follow the prescribed format and provide the additional disclosures in their annual reports. The adoption of this statement did not have a material impact on our financial statements.



In January 2003, the FASB issued Interpretation No. 46 or FIN 46, Consolidation of Variable Interest Entities,
an interpretation of Accounting Research Bulletin No. 51, Consolidated Financial Statements. FIN 46 establishes accounting guidance for consolidation of variable interest entities that function to support the activities of the primary
beneficiary. In October 2003, the FASB issued FASB Staff Position FIN 46-6, Effective Date of FASB Interpretation No. 46, Consolidation of Variable Interest Entities deferring the effective date for applying the provisions of FIN 46 for
public entities interests in variable interest entities or potential variable interest entities created before February 1, 2003 until financial statements of interim or annual periods that end after December 15, 2003. We have no investment in
or contractual relationship or other business relationship with a variable interest entity and therefore the adoption of this interpretation will not have any impact on our consolidated financial position or results of operations. However, if we
enter into any such arrangement with a variable interest entity in the future or an entity with which we have a relationship is reconsidered based on guidance in FIN 46 to be a variable interest entity, our consolidated financial position or results
of operations might be impacted.



Taxes



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



Inflation



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



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Potential Volatility of Quarterly Operating Results and Stock Price



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



| |  | our dependence on a small number of industries and clients;
| | - | -----------------------------------------------------------



| |  | the timing of the initiation, progress or cancellation of significant projects;
| | - | -------------------------------------------------------------------------------



| |  | the mix of products and services sold in a particular period;
| | - | -------------------------------------------------------------



| |  | our need to recruit and retain experienced personnel;
| | - | -----------------------------------------------------



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



| |  | intellectual property risks;
| | - | ----------------------------



| |  | impairment of investments or intangible assets;
| | - | -----------------------------------------------



| |  | the timing of our Discovery Sciences Group milestone payments or other revenue;
| | - | -------------------------------------------------------------------------------



| |  | the timing of the opening of new offices;
| | - | -----------------------------------------



| |  | the timing of other internal expansion costs;
| | - | ---------------------------------------------



| |  | the timing and amount of costs associated with integrating acquisitions;
| | - | ------------------------------------------------------------------------



| |  | the timing and amount of costs associated with internal R&D and compound partnering collaborations; and
| | - | -------------------------------------------------------------------------------------------------------



| |  | exchange rate fluctuations between periods.
| | - | -------------------------------------------



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



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



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|Item 3. |  | Quantitative and Qualitative Disclosures about Market Risk
|------- |  | ----------------------------------------------------------



We are exposed to foreign currency risk by virtue of our international operations. We conduct business in several foreign countries. Approximately 21.2%
and 23.5% of our net revenues for the three months ended September 30, 2002 and 2003, respectively, were derived from operations outside the United States. Funds generated by each subsidiary are generally reinvested in the country where they are
earned. We have not, to date, engaged in derivative or hedging activities related to our potential foreign exchange exposures. Our operations in the United Kingdom generated more than 46.6% of our net revenue from international operations during the
third quarter of 2003. Accordingly, we do have some exposure to adverse movements in the pound sterling and other foreign currencies. The United Kingdom has historically had a relatively stable currency compared to our functional currency, the U.S.
dollar. The potential loss in fair value resulting from a hypothetical weakening of the U.S. dollar relative to the British pound of 10% is approximately $0.3 million.



The vast majority of our contracts are entered into by our United States or United Kingdom subsidiaries. The contracts
entered into by the United States subsidiaries are almost always denominated in U. S. dollars. Contracts entered into by our United Kingdom subsidiaries are generally denominated in pounds sterling, U. S. dollars or euros. In the past, our mix of
contracts and currencies has mitigated the effect of foreign currency fluctuations.. This year, with a 20% change in the dollar to Euro exchange rate and a 9% exchange rate movement of the dollar to the British pound year over year, our translation
losses have been increasing. Provisions have been added to some contracts to either limit or reduce the economic risk involving multiple currencies.



We do have some currency risk resulting from the passage of time between the invoicing of customers under contracts and the ultimate collection of
customer payments against those invoices. If a contract is denominated in a currency other than the subsidiarys local currency, we recognize a receivable at the time of invoicing for the local currency equivalent of the foreign currency
invoice amount. Changes in exchange rates from the time the invoice is prepared and payment from the customer is received will result in our receiving either more or less in local currency than the local currency equivalent of the invoice amount at
the time the invoice was prepared and the receivable established. We recognize this difference as a foreign currency transaction gain or loss, as applicable, and report it in other income, net. If exchange rates were to change by 10% in the future,
we do not expect this to have a material effect on our financial statements.



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



| |  | income statement accounts are translated at average exchange rates for the period;
| | - | ----------------------------------------------------------------------------------



| |  | balance sheet asset and liability accounts are translated at end of period exchange rates; and
| | - | ----------------------------------------------------------------------------------------------



| |  | equity accounts are translated at historical exchange rates.
| | - | ------------------------------------------------------------



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



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



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



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|Item 4. |  | Controls and Procedures
|------- |  | -----------------------



(a) As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Companys
management, including the Companys Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Companys disclosure controls and procedures (as defined in Rule 13a-15(e)) pursuant to Exchange Act Rule 13a-15. Based
upon that evaluation, the Companys Chief Executive Officer and Chief Financial Officer have concluded that the Companys disclosure controls and procedures are effective.



(b) No change in the Companys internal control over financial reporting occurred during the Companys last fiscal quarter that
has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting.



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Part II. OTHER INFORMATION



|Item 6. |  | Exhibits and Reports on Form 8-K
|------- |  | --------------------------------



(a) Exhibits



|31.1 |  | Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)                                                                         
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------
|     | 
|31.2 |  | Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)                                                                         
|     | 
|32.1 |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002  Chief Executive Officer
|     | 
|32.2 |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of The Sarbanes-Oxley Act of 2002  Chief Financial Officer



(b) Reports on Form 8-K



On July 17, 2003, we furnished a Current Report on Form 8-K
under Items 9 and 12, attaching a press release announcing our operating and financial results for the quarter ended June 30, 2003. Notwithstanding its listing here, the information furnished shall not be deemed filed for purposes of
Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liabilities of that section, nor incorporated by reference in any filing under the Securities Act of 1933, as amended, except as expressly set forth by
specific reference in such a filing.



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SIGNATURES



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



PHARMACEUTICAL PRODUCT DEVELOPMENT, INC.(Registrant)By

/s/Fredric N. EshelmanChief Executive Officer(Principal Executive Officer)By

/s/Linda BaddourChief Financial Officer(Principal Financial and Accounting Officer)




Date: November 10, 2003



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