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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549



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FORM 10-Q



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(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, 2004.



OR



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



For the transition period from  to
.



Commission File Number 0-27570



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PHARMACEUTICAL PRODUCT DEVELOPMENT, INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                        
|-------------------------------------------------------------- |  | ---------------------------------------
|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



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



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



Indicate the number of shares outstanding of each of the issuers
classes of common stock, as of the latest practicable date: 56,533,046 shares of common stock, par value $0.10 per share, as of October 29, 2004.



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##### Table of Contents

INDEX



|                                                                                                                            |  |     
|--------------------------------------------------------------------------------------------------------------------------- |  | ----
|                                                                                                                            |  | Page
|Part I. FINANCIAL INFORMATION                                                                                               |  |     
|                                                                                                                            | 
|Item 1. Financial Statements                                                                                                |  |     
|                                                                                                                            | 
|Consolidated Condensed Statements of Operations for the Three and Nine Months Ended September 30, 2003 and 2004 (unaudited) |  | 3   
|                                                                                                                            | 
|Consolidated Condensed Balance Sheets as of December 31, 2003 and September 30, 2004 (unaudited)                            |  | 4   
|                                                                                                                            | 
|Consolidated Condensed Statements of Cash Flows for the Nine Months Ended September 30, 2003 and 2004 (unaudited)           |  | 5   
|                                                                                                                            | 
|Notes to Consolidated Condensed Financial Statements                                                                        |  | 6   
|                                                                                                                            | 
|Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations                               |  | 16  
|                                                                                                                            | 
|Item 3. Quantitative and Qualitative Disclosures about Market Risk                                                          |  | 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 EndedSeptember 30, |         |   | Nine Months EndedSeptember 30, |  
|                                                      |  | 2003                            |         |   | 2004                           |   |         | 2003 |  |   | 2004    |  
|Net revenue:                                          |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Development revenues                                  |  | $                               | 164,007 |   |                                | $ | 193,233 |      |  | $ | 481,493 |   |  | $ | 551,125 |  
|Discovery sciences revenues                           |  |                                 | 2,589   |   |                                |   | 2,289   |      |  |   | 12,808  |   |  |   | 11,870  |  
|Reimbursed out-of-pockets                             |  |                                 | 12,919  |   |                                |   | 20,302  |      |  |   | 40,061  |   |  |   | 48,645  |  
|                                                      |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Total net revenue                                     |  |                                 | 179,515 |   |                                |   | 215,824 |      |  |   | 534,362 |   |  |   | 611,640 |  
|                                                      |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Direct costs:                                         |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Development                                           |  |                                 | 79,419  |   |                                |   | 95,038  |      |  |   | 232,422 |   |  |   | 274,082 |  
|Discovery sciences                                    |  |                                 | 1,387   |   |                                |   | 1,367   |      |  |   | 6,395   |   |  |   | 4,215   |  
|Reimbursable out-of-pocket expenses                   |  |                                 | 12,919  |   |                                |   | 20,302  |      |  |   | 40,061  |   |  |   | 48,645  |  
|                                                      |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Total direct costs                                    |  |                                 | 93,725  |   |                                |   | 116,707 |      |  |   | 278,878 |   |  |   | 326,942 |  
|                                                      |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Research and development expenses                     |  |                                 | 1,487   |   |                                |   | 4,138   |      |  |   | 8,573   |   |  |   | 9,062   |  
|Selling, general and administrative expenses          |  |                                 | 42,552  |   |                                |   | 49,361  |      |  |   | 124,119 |   |  |   | 142,336 |  
|Depreciation                                          |  |                                 | 6,479   |   |                                |   | 7,392   |      |  |   | 20,233  |   |  |   | 20,992  |  
|Amortization                                          |  |                                 | 472     |   |                                |   | 231     |      |  |   | 1,191   |   |  |   | 973     |  
|Gain on sale of assets                                |  |                                 | (5,716  | ) |                                |   | (58     | )    |  |   | (5,738  | ) |  |   | (65     | )
|Restructuring charges                                 |  |                                 | 1,917   |   |                                |   |        |      |  |   | 1,917   |   |  |   | 2,619   |  
|                                                      |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|                                                      |  |                                 | 140,916 |   |                                |   | 177,771 |      |  |   | 429,173 |   |  |   | 502,859 |  
|                                                      |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Income from operations                                |  |                                 | 38,599  |   |                                |   | 38,053  |      |  |   | 105,189 |   |  |   | 108,781 |  
|Interest income, net                                  |  |                                 | 360     |   |                                |   | 499     |      |  |   | 1,181   |   |  |   | 949     |  
|Impairment of investments                             |  |                                 | (773    | ) |                                |   |        |      |  |   | (9,373  | ) |  |   | (2,000  | )
|Other income, net                                     |  |                                 | 603     |   |                                |   | 495     |      |  |   | 1,281   |   |  |   | 1,750   |  
|                                                      |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Income before provision for income taxes              |  |                                 | 38,789  |   |                                |   | 39,047  |      |  |   | 98,278  |   |  |   | 109,480 |  
|Provision for income taxes                            |  |                                 | 13,964  |   |                                |   | 14,057  |      |  |   | 35,446  |   |  |   | 36,412  |  
|                                                      |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Net income                                            |  | $                               | 24,825  |   |                                | $ | 24,990  |      |  | $ | 62,832  |   |  | $ | 73,068  |  
|                                                      |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Net income per share:                                 |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Basic                                                 |  | $                               | 0.44    |   |                                | $ | 0.44    |      |  | $ | 1.13    |   |  | $ | 1.30    |  
|                                                      |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Diluted                                               |  | $                               | 0.44    |   |                                | $ | 0.44    |      |  | $ | 1.12    |   |  | $ | 1.29    |  
|                                                      |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Weighted average number of common shares outstanding: |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Basic                                                 |  |                                 | 55,874  |   |                                |   | 56,447  |      |  |   | 55,712  |   |  |   | 56,275  |  
|Dilutive effect of stock options and restricted stock |  |                                 | 460     |   |                                |   | 563     |      |  |   | 524     |   |  |   | 490     |  
|                                                      |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Diluted                                               |  |                                 | 56,334  |   |                                |   | 57,010  |      |  |   | 56,236  |   |  |   | 56,765  |  
|                                                      |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  



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



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PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



CONSOLIDATED CONDENSED BALANCE SHEETS



(in thousands)



|                                                                      |  |                  |         |                   |   |        
|--------------------------------------------------------------------- |  | ---------------- | ------- | ----------------- | - | -------
|                                                                      |  | December 31,2003 |         | September 30,2004
|                                                                      |  |                  |         | (unaudited)      
|Assets                                                                |  |                  |         |                   |   |        
|Current assets                                                        |  |                  |         |                   |   |        
|Cash and cash equivalents                                             |  | $                | 110,102 |                   | $ | 194,547
|Accounts receivable and unbilled services, net                        |  |                  | 243,494 |                   |   | 246,619
|Investigator advances                                                 |  |                  | 12,792  |                   |   | 10,912 
|Prepaid expenses and other current assets                             |  |                  | 19,192  |                   |   | 22,483 
|Deferred income taxes, net                                            |  |                  | 12,366  |                   |   | 19,132 
|                                                                      |  |                  |         |                   |   |        
|Total current assets                                                  |  |                  | 397,946 |                   |   | 493,693
|                                                                      |  |                 
|Property, plant and equipment, net                                    |  |                  | 112,143 |                   |   | 125,008
|Investments                                                           |  |                  | 61,371  |                   |   | 65,246 
|Intangible assets                                                     |  |                  | 2,007   |                   |   | 4,167  
|Goodwill                                                              |  |                  | 178,076 |                   |   | 177,151
|Other assets                                                          |  |                  | 841     |                   |   | 730    
|Long-term deferred income taxes, net                                  |  |                  | 23,083  |                   |   | 22,527 
|                                                                      |  |                  |         |                   |   |        
|Total assets                                                          |  | $                | 775,467 |                   | $ | 888,522
|                                                                      |  |                  |         |                   |   |        
|Liabilities and Shareholders Equity                                  |  |                  |         |                   |   |        
|Current liabilities                                                   |  |                  |         |                   |   |        
|Accounts payable                                                      |  | $                | 15,243  |                   | $ | 11,383 
|Payables to investigators                                             |  |                  | 23,735  |                   |   | 30,317 
|Other accrued expenses                                                |  |                  | 63,749  |                   |   | 85,158 
|Unearned income                                                       |  |                  | 129,818 |                   |   | 125,649
|Accrued income taxes                                                  |  |                  | 7,419   |                   |   | 17,597 
|Current maturities of long-term debt and capital lease obligations    |  |                  | 1,381   |                   |   | 667    
|                                                                      |  |                  |         |                   |   |        
|Total current liabilities                                             |  |                  | 241,345 |                   |   | 270,771
|                                                                      |  |                 
|Long-term debt and capital lease obligations, less current maturities |  |                  | 6,281   |                   |   | 5,934  
|Accrued additional pension liability                                  |  |                  | 9,859   |                   |   | 10,004 
|Deferred rent and other                                               |  |                  | 5,461   |                   |   | 5,527  
|                                                                      |  |                  |         |                   |   |        
|Total liabilities                                                     |  |                  | 262,946 |                   |   | 292,236
|                                                                      |  |                  |         |                   |   |        
|Shareholders equity                                                  |  |                  |         |                   |   |        
|Common stock                                                          |  |                  | 5,605   |                   |   | 5,649  
|Paid-in capital                                                       |  |                  | 278,057 |                   |   | 288,994
|Retained earnings                                                     |  |                  | 226,381 |                   |   | 299,449
|Accumulated other comprehensive income, net of deferred taxes         |  |                  | 2,478   |                   |   | 2,194  
|                                                                      |  |                  |         |                   |   |        
|Total shareholders equity                                            |  |                  | 512,521 |                   |   | 596,286
|                                                                      |  |                  |         |                   |   |        
|Total liabilities and shareholders equity                            |  | $                | 775,467 |                   | $ | 888,522
|                                                                      |  |                  |         |                   |   |        



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



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PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS



(unaudited)

(in thousands)



|                                                                                  |  |                                |         |   |      |   |         |  
|--------------------------------------------------------------------------------- |  | ------------------------------ | ------- | - | ---- | - | ------- | -
|                                                                                  |  | Nine Months EndedSeptember 30, |        
|                                                                                  |  | 2003                           |         |   | 2004 |  
|Cash flows from operating activities:                                             |  |                                |         |   |      |   |         |  
|Net income                                                                        |  | $                              | 62,832  |   |      | $ | 73,068  |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                                |         |   |      |   |         |  
|Impairment of investments                                                         |  |                                | 9,373   |   |      |   | 2,000   |  
|Depreciation and amortization                                                     |  |                                | 21,424  |   |      |   | 21,965  |  
|Restructuring charges                                                             |  |                                | 1,917   |   |      |   | 2,619   |  
|Stock compensation amortization                                                   |  |                                | 275     |   |      |   |        |  
|Gain on sale of assets                                                            |  |                                | (5,738  | ) |      |   | (65     | )
|Loss on disposition of property and equipment                                     |  |                                | 299     |   |      |   | 139     |  
|Provision for doubtful accounts                                                   |  |                                | 280     |   |      |   | 651     |  
|Provision (benefit) for deferred income taxes                                     |  |                                | 3,569   |   |      |   | (6,101  | )
|Change in operating assets and liabilities, net of effect of acquisitions         |  |                                | (47,403 | ) |      |   | 19,800  |  
|                                                                                  |  |                                |         |   |      |   |         |  
|Net cash provided by operating activities                                         |  |                                | 46,828  |   |      |   | 114,076 |  
|                                                                                  |  |                                |         |   |      |   |         |  
|Cash flows from investing activities:                                             |  |                                |         |   |      |   |         |  
|Cash received from repayment of note receivable                                   |  |                                | 500     |   |      |   |        |  
|Purchases of property and equipment                                               |  |                                | (22,940 | ) |      |   | (34,337 | )
|Proceeds from sale of property and equipment                                      |  |                                | 261     |   |      |   | 241     |  
|Purchases of investments                                                          |  |                                | (15,450 | ) |      |   | (5,833  | )
|Cash (paid) refunded related to businesses acquired, net of cash acquired         |  |                                | (25,866 | ) |      |   | 1,450   |  
|                                                                                  |  |                                |         |   |      |   |         |  
|Net cash used in investing activities                                             |  |                                | (63,495 | ) |      |   | (38,479 | )
|                                                                                  |  |                                |         |   |      |   |         |  
|Cash flows from financing activities:                                             |  |                                |         |   |      |   |         |  
|Principal repayments of long-term debt                                            |  |                                | (883    | ) |      |   | (259    | )
|Repayment of capital leases obligation                                            |  |                                | (1,394  | ) |      |   | (724    | )
|Proceeds from exercise of stock options and employee stock purchase plan          |  |                                | 7,993   |   |      |   | 9,259   |  
|                                                                                  |  |                                |         |   |      |   |         |  
|Net cash provided by financing activities                                         |  |                                | 5,716   |   |      |   | 8,276   |  
|                                                                                  |  |                                |         |   |      |   |         |  
|Effect of exchange rate changes on cash                                           |  |                                | 4,529   |   |      |   | 572     |  
|                                                                                  |  |                                |         |   |      |   |         |  
|Net increase (decrease) in cash and cash equivalents                              |  |                                | (6,422  | ) |      |   | 84,445  |  
|Cash and cash equivalents, beginning of the period                                |  |                                | 181,224 |   |      |   | 110,102 |  
|                                                                                  |  |                                |         |   |      |   |         |  
|Cash and cash equivalents, end of the period                                      |  | $                              | 174,802 |   |      | $ | 194,547 |  
|                                                                                  |  |                                |         |   |      |   |         |  



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)



|1. | SIGNIFICANT ACCOUNTING POLICIES
|-- | -------------------------------



The significant accounting policies followed by Pharmaceutical Product Development, Inc. and its subsidiaries (collectively the Company) for
interim financial reporting are consistent with the accounting policies followed for annual financial reporting. We prepared these unaudited consolidated condensed financial statements in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Article 10 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 should be read in conjunction with the consolidated financial statements and notes thereto in the Companys Annual Report on Form 10-K for the year ended December 31, 2003. The results of
operations for the three-month and nine-month periods ended September 30, 2004 are not necessarily indicative of the results to be expected for the full year or any other period. We derived the amounts on the December 31, 2003 consolidated condensed
balance sheet from the audited financial statements included in the Companys Annual Report on Form 10-K for the year ended December 31, 2003.



Use of Estimates in the Preparation of Financial Statements



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



Principles of consolidation



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



Earnings per share



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



Stock-Based Compensation



The Company accounts for stock-based compensation based
on the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, which states that, for fixed plans, no compensation expense is recorded for stock options or other stock-based awards 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.



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PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS



(unaudited)



|1. | SIGNIFICANT ACCOUNTING POLICIES (continued)
|-- | -------------------------------------------



Stock-Based Compensation (continued)



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



|                                                                                                                                          |  |                                 |        |                                |   |        |  |      |        |  |   |       
|----------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | ------------------------------ | - | ------ |  | ---- | ------ |  | - | ------
|(in thousands, except per share data)                                                                                                     |  | Three Months EndedSeptember 30, |        | Nine Months EndedSeptember 30,
|                                                                                                                                          |  | 2003                            |        | 2004                           |   | 2003   |  | 2004
|Net income, as reported                                                                                                                   |  | $                               | 24,825 |                                | $ | 24,990 |  | $    | 62,832 |  | $ | 73,068
|Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax
effects |  |                                 | 1,402  |                                |   | 1,469  |  |      | 4,555  |  |   | 4,395 
|                                                                                                                                          |  |                                 |        |                                |   |        |  |      |        |  |   |       
|Pro forma net income                                                                                                                      |  | $                               | 23,423 |                                | $ | 23,521 |  | $    | 58,277 |  | $ | 68,673
|                                                                                                                                          |  |                                 |        |                                |   |        |  |      |        |  |   |       
|Net income per share:                                                                                                                     |  |                                 |        |                                |   |        |  |      |        |  |   |       
|Basic  as reported                                                                                                                       |  | $                               | 0.44   |                                | $ | 0.44   |  | $    | 1.13   |  | $ | 1.30  
|Basic  pro forma                                                                                                                         |  | $                               | 0.42   |                                | $ | 0.42   |  | $    | 1.05   |  | $ | 1.22  
|                                                                                                                                          |  |                                 |        |                               
|Diluted  as reported                                                                                                                     |  | $                               | 0.44   |                                | $ | 0.44   |  | $    | 1.12   |  | $ | 1.29  
|Diluted  pro forma                                                                                                                       |  | $                               | 0.42   |                                | $ | 0.41   |  | $    | 1.04   |  | $ | 1.21  



Recent Accounting
Pronouncements



In December 2003, the FASB issued SFAS No.
132 (Revised 2003), Employers Disclosures about Pensions and Other Postretirement Benefits. Revised Statement No. 132 requires additional disclosures about the assets, obligations, cash flows and net periodic benefit cost of
defined benefit pension plans and other defined benefit postretirement plans. The Company has adopted the interim disclosure requirements of this statement (see Note 9).



In December 2003, the FASB issued revised FIN 46, Consolidation of Variable Interest Entities. This revised
interpretation is effective for all entities as of the first reporting period that ends after March 15, 2004. The Company has no investment in or contractual or other business relationship with a variable interest entity and, therefore, the adoption
of this interpretation did not have any impact on its consolidated financial position or results of operations.



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



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##### Table of Contents

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS



(unaudited)



|1. | SIGNIFICANT ACCOUNTING POLICIES (continued)
|-- | -------------------------------------------



Recent Accounting Pronouncements (continued)



and qualitative disclosures for debt and marketable equity securities classified as available-for-sale or held-to-maturity under SFAS No. 115 and SFAS No. 124 that are
impaired at the balance sheet date but for which an other-than-temporary impairment has not been recognized. In September 2004, FASB Staff Position (FSP) EITF Issue 03-1-1 was issued to delay the effective date for the measurement and
recognition guidance contained in paragraphs 10 through 20 of Issue 03-1. Application of those paragraphs is deferred pending issuance of a final FSP relating to the draft FSP EITF Issue 03-1-a, Implementation Guidance for the Application of
Paragraph 16 of EITF Issue 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, which the Board may issue as early as November. This delay does not suspend the requirement to recognize
other-than-temporary impairments as required by existing authoritative literature. The guidance in paragraph 6 through 9 of Issue 03-1 (step 1 of the impairment model  determining whether an investment is impaired), as well as the disclosure
requirements in paragraphs 21 and 22, have not been deferred and should be applied based on the transition provisions provided in Issue 03-1. The Company adopted the guidance in paragraphs 6 through 9 of Issue 03-1 and the disclosure requirements in
paragraphs 21 and 22. Such adoption did not have a material impact on the Companys financial position or results of operations.



Reclassifications



We have reclassified certain 2003 financial statement amounts to conform to the 2004 financial statement presentation.



|2. | GOODWILL AND INTANGIBLE ASSETS
|-- | ------------------------------



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



|                                                                                                                        |  |             |         |   |           |   |        |  |   |         |  
|----------------------------------------------------------------------------------------------------------------------- |  | ----------- | ------- | - | --------- | - | ------ |  | - | ------- | -
|(in thousands)                                                                                                          |  | Development |         |   | Discovery |   | Total  | 
|Balance as of January 1, 2003                                                                                           |  | $           | 126,936 |   |           | $ | 20,472 |  | $ | 147,408 |  
|Changes in goodwill recorded during the period for prior year acquisitions                                              |  |             | 1,550   |   |           |   | 143    |  |   | 1,693   |  
|Changes in goodwill recorded during the period for current year acquisitions                                            |  |             | 24,282  |   |           |   |       |  |   | 24,282  |  
|Translation adjustments                                                                                                 |  |             | 4,693   |   |           |   |       |  |   | 4,693   |  
|                                                                                                                        |  |             |         |   |           |   |        |  |   |         |  
|Balance as of December 31, 2003                                                                                         |  |             | 157,461 |   |           |   | 20,615 |  |   | 178,076 |  
|Changes in goodwill recorded during the period for prior year acquisitions (finalization of purchase price adjustments) |  |             | (699    | ) |           |   |       |  |   | (699    | )
|Translation adjustments                                                                                                 |  |             | (226    | ) |           |   |       |  |   | (226    | )
|                                                                                                                        |  |             |         |   |           |   |        |  |   |         |  
|Balance as of September 30, 2004                                                                                        |  | $           | 156,536 |   |           | $ | 20,615 |  | $ | 177,151 |  
|                                                                                                                        |  |             |         |   |           |   |        |  |   |         |  



|                                                                     |  |                   |       |                         |   |       |  |                |       |                         |   |       |  |   |       |  |   |      
|-------------------------------------------------------------------- |  | ----------------- | ----- | ----------------------- | - | ----- |  | -------------- | ----- | ----------------------- | - | ----- |  | - | ----- |  | - | -----
|Information regarding the Companys other intangible assets follows:
|                                                                     |  |                  
|(in thousands)                                                       |  | December 31, 2003 |       | September 30, 2004     
|                                                                     |  | CarryingAmount    |       | AccumulatedAmortization |   | Net   |  | CarryingAmount |       | AccumulatedAmortization |   | Net  
|Backlog and customer relationship                                    |  | $                 | 2,100 |                         | $ | 1,969 |  | $              | 131   |                         | $ | 2,733 |  |   | 2,354 |  |   | 379  
|Patents                                                              |  |                   | 280   |                         |   | 236   |  |                | 44    |                         |   | 280   |  |   | 267   |  |   | 13   
|License and royalty agreements                                       |  |                   | 2,500 |                         |   | 668   |  |                | 1,832 |                         |   | 5,000 |  |   | 1,225 |  |   | 3,775
|                                                                     |  |                   |       |                         |   |       |  |                |       |                         |   |       |  |   |       |  |   |      
|Total                                                                |  | $                 | 4,880 |                         | $ | 2,873 |  | $              | 2,007 |                         | $ | 8,013 |  | $ | 3,846 |  | $ | 4,167
|                                                                     |  |                   |       |                         |   |       |  |                |       |                         |   |       |  |   |       |  |   |      



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PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS



(unaudited)



|2. | GOODWILL AND INTANGIBLE ASSETS (continued)
|-- | ------------------------------------------



The Company amortizes all intangible assets on a straight-line basis, based on estimated useful lives of two to five years for backlog and customer
relationship, five years for patents and three to ten years for license and royalty agreements. The weighted average amortization period for backlog and customer relationship is 2.1 years, patents is 5.0 years, license and royalty agreements is
approximately 5.1 years and all intangibles collectively is approximately 3.4 years.



Amortization expense for the nine months ended September 30, 2003 and 2004 was $1.2 million and $1.0 million, respectively. Estimated amortization expense for the next five years is as follows:



|                                  |  |                |      
|--------------------------------- |  | -------------- | -----
|                                  |  | (in thousands)
|                                  | 
|2004 (includes first nine months) |  | $              | 1,264
|2005                              |  |                | 1,112
|2006                              |  |                | 606  
|2007                              |  |                | 362  
|2008                              |  |                | 331  
|2009 and thereafter               |  |                | 1,465



|3. | ACQUISITIONS
|-- | ------------



In July 2003, the Company acquired Eminent Research Systems, Inc., a clinical research organization specializing in medical device development, and
Clinsights, Inc., a company affiliated with Eminent through common ownership that provides a range of post-market services to medical device and related pharmaceutical companies and operates proprietary web sites for the dissemination of medical
information, online research and product marketing. Eminent and Clinsights are part of the Development segment of the Company. The results of operations are included in the Companys consolidated condensed results of operations as of and since
July 18, 2003, the effective date of the acquisitions. The Company acquired Eminent and Clinsights for total consideration of $23.5 million in cash. Under the terms of the merger agreement, the original aggregate purchase price of $25.0 million was
reduced by $1.5 million in the first quarter of 2004 as a result of an adjustment to the purchase price based on Eminents closing balance sheet.



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



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



|                                         |  |         |        |   |            |   |        |       |  |   |        |  
|---------------------------------------- |  | ------- | ------ | - | ---------- | - | ------ | ----- |  | - | ------ | -
|(in thousands)                           |  | Eminent |        |   | Clinsights |   |        | Total | 
|Condensed balance sheet:                 |  |         |        |   |            |   |        |       |  |   |        |  
|Current assets                           |  | $       | 677    |   |            | $ | 1,346  |       |  | $ | 2,023  |  
|Property and equipment, net              |  |         | 436    |   |            |   | 226    |       |  |   | 662    |  
|Non-current assets                       |  |         | 32     |   |            |   | 25     |       |  |   | 57     |  
|Deferred income taxes                    |  |         | 1,184  |   |            |   | 1,093  |       |  |   | 2,277  |  
|Current liabilities                      |  |         | (4,946 | ) |            |   | (732   | )     |  |   | (5,678 | )
|                                         |  |         |       
|Value of identifiable intangible assets: |  |         |        |   |            |   |        |       |  |   |        |  
|Backlog and customer relationships       |  |         | 383    |   |            |   | 250    |       |  |   | 633    |  
|Goodwill                                 |  |         | 14,541 |   |            |   | 9,042  |       |  |   | 23,583 |  
|                                         |  |         |        |   |            |   |        |       |  |   |        |  
|Total                                    |  | $       | 12,307 |   |            | $ | 11,250 |       |  | $ | 23,557 |  
|                                         |  |         |        |   |            |   |        |       |  |   |        |  



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PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS



(unaudited)



|3. | ACQUISITIONS (continued)
|-- | ------------------------



Purchase price allocations have been finalized for these acquisitions. Goodwill related to Eminent and Clinsights is not expected to be deductible for tax
purposes.



|4. | COMPREHENSIVE INCOME
|-- | --------------------



Comprehensive income consisted of the following:



|                                                                                                                           |  |                                 |        |      |                                |        |      |  |      |        |  |   |        |  
|-------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | ---- | ------------------------------ | ------ | ---- |  | ---- | ------ |  | - | ------ | -
|(in thousands)                                                                                                             |  | Three Months EndedSeptember 30, |        |      | Nine Months EndedSeptember 30, |       
|                                                                                                                           |  | 2003                            |        | 2004 |                                |        | 2003 |  | 2004 |       
|Net income, as reported                                                                                                    |  | $                               | 24,825 |      | $                              | 24,990 |      |  | $    | 62,832 |  | $ | 73,068 |  
|Other comprehensive income (loss):                                                                                         |  |                                 |        |      |                                |        |      |  |      |        |  |   |        |  
|Cumulative translation adjustment                                                                                          |  |                                 | 782    |      |                                | 1,266  |      |  |      | 5,442  |  |   | (55    | )
|Change in fair value of hedging transaction, net of taxes of $0, $(494), $0 and $(447), respectively                       |  |                                 |       |      |                                | 1,096  |      |  |      |       |  |   | 1,030  |  
|Reclassification adjustment for hedging results included in direct costs, net of taxes of $0, $221, $0, $558, respectively |  |                                 |       |      |                                | (515   | )    |  |      |       |  |   | (1,300 | )
|Unrealized gain (loss) on investment                                                                                       |  |                                 | 393    |      |                                | (428   | )    |  |      | 1,939  |  |   | 41     |  
|                                                                                                                           |  |                                 |        |      |                                |        |      |  |      |        |  |   |        |  
|Total other comprehensive income (loss):                                                                                   |  |                                 | 1,175  |      |                                | 1,419  |      |  |      | 7,381  |  |   | (284   | )
|                                                                                                                           |  |                                 |        |      |                                |        |      |  |      |        |  |   |        |  
|Comprehensive income                                                                                                       |  | $                               | 26,000 |      | $                              | 26,409 |      |  | $    | 70,213 |  | $ | 72,784 |  
|                                                                                                                           |  |                                 |        |      |                                |        |      |  |      |        |  |   |        |  



|                                                                   |  |                  |        |   |                   |   |        |  
|------------------------------------------------------------------ |  | ---------------- | ------ | - | ----------------- | - | ------ | -
|Accumulated other comprehensive income consisted of the following: |  |                  |        |   |                  
|                                                                   |  |                 
|(in thousands)                                                     |  | December 31,2003 |        |   | September 30,2004 |  
|Translation adjustment                                             |  | $                | 8,698  |   |                   | $ | 8,643  |  
|Minimum pension liability, net of tax                              |  |                  | (6,220 | ) |                   |   | (6,220 | )
|Fair value on hedging transaction, net of tax                      |  |                  |       |   |                   |   | (270   | )
|Unrealized gain on investment                                      |  |                  |       |   |                   |   | 41     |  
|                                                                   |  |                  |        |   |                   |   |        |  
|                                                                   |  | $                | 2,478  |   |                   | $ | 2,194  |  
|                                                                   |  |                  |        |   |                   |   |        |  

|5. | ACCOUNTS RECEIVABLE AND UNBILLED SERVICES
|-- | -----------------------------------------



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



|                                |  |                  |         |   |                   |   |         |  
|------------------------------- |  | ---------------- | ------- | - | ----------------- | - | ------- | -
|(in thousands)                  |  | December 31,2003 |         |   | September 30,2004 |  
|Billed                          |  | $                | 151,525 |   |                   | $ | 162,718 |  
|Unbilled                        |  |                  | 94,928  |   |                   |   | 87,534  |  
|Provision for doubtful accounts |  |                  | (2,959  | ) |                   |   | (3,633  | )
|                                |  |                  |         |   |                   |   |         |  
|                                |  | $                | 243,494 |   |                   | $ | 246,619 |  
|                                |  |                  |         |   |                   |   |         |  



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PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS



(unaudited)



|6. | INVESTMENTS
|-- | -----------



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



The Company also has investments in privately held entities in the form of
equity and convertible debt instruments that are not publicly traded and for which fair values are not readily determinable. The Company records all of its investments in private entities under the cost method of accounting. The Company assesses the
fair value of these entities on a quarterly basis to determine if there has been a decline in the fair value of these entities, and if so, if the decline is other than temporary. This quarterly review includes an evaluation of, among other things,
the market condition of the overall industry, historical and projected financial performance, expected cash needs and recent funding events.



The Company recorded impairments for other than temporary declines in the fair value of its investments in SLIL Biomedical Corp. of $4.7 million,
Spotlight Health, Inc. of $3.7 million, Signature Bioscience, Inc. of $0.2 million and BioDelivery Sciences International, Inc. of $0.8 million for the nine months ended September 30, 2003, and in Chemokine Therapeutics Corp. of $2.0 million for the
nine months ended September 30, 2004. SLIL and Signature Bioscience were deemed to be impaired primarily as a result of the market condition of the overall industry and their individual historical and projected performance and expected cash needs.
BioDelivery Sciences is a publicly traded company and 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 believed the
decline in value as of September 30, 2003 was other than temporary and thus recorded a charge to earnings. The write-downs of Spotlight Health and Chemokine were recorded based primarily on their individual historical and projected financial
performance and completed or anticipated issuances of shares to new investors at lower valuations than the Companys recorded value.



Investments consisted of the following at the dates set forth below:



|                                                        |  |                  |        |                   |   |       
|------------------------------------------------------- |  | ---------------- | ------ | ----------------- | - | ------
|(in thousands)                                          |  | December 31,2003 |        | September 30,2004
|Investment in Surromed, Inc.                            |  | $                | 29,007 |                   | $ | 29,007
|Investment in Syrrx, Inc.                               |  |                  | 25,000 |                   |   | 25,000
|Investment in Accentia, Inc.                            |  |                  |       |                   |   | 4,933 
|Investment in BioDelivery Sciences International, Inc.* |  |                  | 2,284  |                   |   | 2,325 
|Investment in Chemokine Therapeutics Corp.              |  |                  | 2,700  |                   |   | 700   
|Other investments **                                    |  |                  | 2,380  |                   |   | 3,281 
|                                                        |  |                  |        |                   |   |       
|                                                        |  | $                | 61,371 |                   | $ | 65,246
|                                                        |  |                  |        |                   |   |       

---



|* | Publicly traded security
|- | ------------------------

|** | Other investments include several investments in private entities individually valued at less than $2.0 million in both periods presented.
|-- | ------------------------------------------------------------------------------------------------------------------------------------------



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PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS



(unaudited)



|7. | INCOME TAXES
|-- | ------------



During the second quarter of 2004, we recorded a tax benefit of $3.7 million for a decrease in a valuation allowance for capital loss carryforwards
utilized during the period. Additionally, we established a $0.8 million valuation allowance related to the future tax benefit associated with the equity impairment recorded in the second quarter of 2004 that is not more likely than not to be
realized.



|8. | ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
|-- | ------------------------------------------------------------



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



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



At September 30, 2004, the face amounts of the Companys foreign exchange contracts designated as cash flow hedges totaled approximately $46.7
million. For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative instrument is initially recorded in accumulated other comprehensive income as a separate component
of shareholders equity and subsequently reclassified into earnings in the period during which the hedged transaction is recognized in earnings.



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



|9. | PENSION PLAN
|-- | ------------



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



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



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PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS



(unaudited)



|9. | PENSION PLAN (continued)
|-- | ------------------------



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



|                                        |  |                                 |      |   |                                |   |      |      |  |   |       |   |  |   |        |  
|--------------------------------------- |  | ------------------------------- | ---- | - | ------------------------------ | - | ---- | ---- |  | - | ----- | - |  | - | ------ | -
|(in thousands)                          |  | Three Months EndedSeptember 30, |      |   | Nine Months EndedSeptember 30, |  
|                                        |  | 2003                            |      |   | 2004                           |   |      | 2003 |  |   | 2004  |  
|Service cost                            |  | $                               | 213  |   |                                | $ | 305  |      |  | $ | 639   |   |  | $ | 925    |  
|Interest cost                           |  |                                 | 307  |   |                                |   | 429  |      |  |   | 920   |   |  |   | 1,300  |  
|Expected return on plan assets          |  |                                 | (257 | ) |                                |   | (359 | )    |  |   | (770  | ) |  |   | (1,088 | )
|Amortization of transition asset amount |  |                                 | (3   | ) |                                |   | (3   | )    |  |   | (9    | ) |  |   | (11    | )
|Amortization of net loss                |  |                                 | 106  |   |                                |   | 154  |      |  |   | 319   |   |  |   | 467    |  
|                                        |  |                                 |      |   |                                |   |      |      |  |   |       |   |  |   |        |  
|Net periodic pension cost               |  | $                               | 366  |   |                                | $ | 526  |      |  | $ | 1,099 |   |  | $ | 1,593  |  
|                                        |  |                                 |      |   |                                |   |      |      |  |   |       |   |  |   |        |  



For the nine months
ended September 30, 2004, the Company made contributions of $1.4 million and anticipates contributing an additional $0.5 million to fund its pension plan during the remainder of 2004.



|10. | RESTRUCTURING CHARGES AND GAIN ON SALE OF ASSETS
|--- | ------------------------------------------------



In the first nine months of 2004, the Company recorded a $2.6 million restructuring charge associated with exiting the Companys chemistry facility
in Research Triangle Park, North Carolina. These charges include lease payments and termination costs (net of sublease rentals) of approximately $2.1 million and a loss on sale of assets used in chemistry services of approximately $0.5 million. The
lease termination liability will be paid over the remaining life of the lease which will end in 2015. At September 30, 2004, the Company recorded the restructuring liability of $1.5 million in the consolidated condensed balance sheet as a component
of other accrued expenses.



In July 2003, the Company announced
the restructuring of its Discovery Sciences segment. In connection with this restructuring, the Company consolidated its Discovery Sciences operations into its Morrisville, North Carolina and Middleton, Wisconsin facilities, and discontinued
offering functional genomics services in Menlo Park, California. The Company 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, the Company 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 the Companys Menlo Park operations. The value of the tangible assets and intellectual property was based on an independent
appraisal. The Company 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. The Company 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.



|11. | COMMITMENTS AND CONTINGENCIES
|--- | -----------------------------



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



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PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS



(unaudited)



|11. | COMMITMENTS AND CONTINGENCIES (continued)
|--- | -----------------------------------------



The Company is self-insured for health insurance for employees located within the United States. The Company maintains stop-loss insurance on a
claims made basis for expenses in excess of $0.225 million per member per year. As of December 31, 2003 and September 30, 2004, the Company maintained a reserve of approximately $3.7 million and $4.5 million, respectively, included in
other accrued expenses on the consolidated condensed balance sheets, to cover open claims and estimated claims incurred but not reported.



In September 2003, the Company entered into agreements with SurroMed, Inc. pursuant to which the Company committed to pay for 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. As of September 30, 2004, the Company had paid SurroMed $1.0 million for biomarker discovery
services.



The Company signed an agreement to jointly develop
and commercialize Syrrx-designed human dipeptidyl peptidase IV, or DP4, inhibitors as drug products for the treatment of type 2 diabetes and other major human diseases. The Company will provide preclinical and clinical development resources and
expertise for the collaboration, and will fund the majority of preclinical and clinical studies through Phase IIb development of selected DP4 inhibitors. The Company and Syrrx have agreed to share equally the costs of Phase III development. In
addition, the Company will make milestone payments to Syrrx upon the occurrence of certain clinical and regulatory events. In September 2004, we filed an investigational new drug application for one Syrrx DP4 inhibitor and the Phase I clinical study
for that inhibitor commenced in late October 2004. We will make a milestone payment to Syrrx as a result of the commencement of the Phase I studies in the fourth quarter of 2004. In the event we are successful in obtaining approval to market a drug
product under the collaboration with Syrrx, the Company and Syrrx will share equally the profits from drug sales.



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



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



In the fourth quarter of 2003, the Company acquired from Eli Lilly &
Company the patents for the compound dapoxetine for development in the field of genitourinary disorders. This compound is currently licensed to ALZA Corporation, a subsidiary of Johnson & Johnson, and is being developed for premature
ejaculation. Under the terms of the agreement with Lilly, the Company paid Lilly $65.0 million in cash and agreed to pay Lilly a royalty of 5% on annual net sales of dapoxetine in excess of $800 million. The Company anticipates that ALZA Corporation
will submit a new drug application for dapoxetine with the FDA in the first quarter of 2005. Dapoxetine has not been approved for sale in the United States or any foreign country.



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PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS



(unaudited)



|11. | COMMITMENTS AND CONTINGENCIES (continued)
|--- | -----------------------------------------



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



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



|12. | BUSINESS SEGMENT DATA
|--- | ---------------------



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



|                               |  |                                 |        |      |                                |        |      |  |   |         |   |  |   |         |  
|------------------------------ |  | ------------------------------- | ------ | ---- | ------------------------------ | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|(in thousands)                 |  | Three months EndedSeptember 30, |        |      | Nine Months EndedSeptember 30, |       
|                               |  | 2003                            |        | 2004 |                                |        | 2003 |  |   | 2004    |  
|Income (loss) from operations: |  |                                 |        |      |                                |        |      |  |   |         |   |  |   |         |  
|Development                    |  | $                               | 36,808 |      | $                              | 41,650 |      |  | $ | 110,301 |   |  | $ | 115,094 |  
|Discovery sciences             |  |                                 | 1,791  |      |                                | (3,597 | )    |  |   | (5,112  | ) |  |   | (6,313  | )
|                               |  |                                 |        |      |                                |        |      |  |   |         |   |  |   |         |  
|Total                          |  | $                               | 38,599 |      | $                              | 38,053 |      |  | $ | 105,189 |   |  | $ | 108,781 |  
|                               |  |                                 |        |      |                                |        |      |  |   |         |   |  |   |         |  



|                     |  |                  |         |                   |   |        
|-------------------- |  | ---------------- | ------- | ----------------- | - | -------
|                     |  | December 31,2003 |         | September 30,2004
|Identifiable assets: |  |                  |         |                   |   |        
|Development          |  | $                | 684,890 |                   | $ | 798,152
|Discovery sciences   |  |                  | 90,577  |                   |   | 90,370 
|                     |  |                  |         |                   |   |        
|Total                |  | $                | 775,467 |                   | $ | 888,522
|                     |  |                  |         |                   |   |        



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



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



Forward-looking Statements



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



Company Overview



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



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



With more than 6,400 professionals worldwide, we have provided services to 41 of the top 50 pharmaceutical companies in the
world as ranked by 2003 healthcare research and development spending, in addition to our work with leading biotechnology and medical device companies. We believe that we are one of the worlds largest providers of drug development services to
pharmaceutical, biotechnology and medical device companies based on 2003 annual net revenues generated from contract research organizations.



Building on our outsourcing relationship with pharmaceutical and biotechnology clients, we established our discovery services business in 1997. This
business focuses on early stage research to help our customers address the bottleneck at the beginning of the development process. Currently, this business primarily involves preclinical evaluations of anticancer therapies, preclinical biology
services and compound partnering arrangements associated with the development and commercialization of potential drug products. We have developed an innovative risk-sharing research and development model to help pharmaceutical and biotechnology
clients develop compounds. Through collaborative arrangements based on this model, we help our clients research and evaluate the development potential for compounds at various stages of development.



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



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Executive Overview



Because our revenues are dependent on a relatively small number of industries and clients, we closely monitor the market for CRO services. For a
discussion of the trends affecting our market, see Item 1. BusinessTrends Affecting the Drug Discovery and Development Industry in our Annual Report on Form 10-K for the year ended December 31, 2003. Our new business authorizations
for the first two quarters of 2003 were lower than we expected. In response, we refocused our business development and operational efforts and believe those efforts, together with a stronger market for CRO services in the second half of 2003 and the
first nine months of 2004, resulted in improved new authorizations for those periods.



Although we cannot predict the demand for CRO services for the remainder of 2004, we continue to believe the overall market drivers for our industry are intact. To grow authorizations for the remainder of 2004 and
into 2005, we must continue the focus on our business development efforts, including increasing the percentage of successful proposals, and the delivery of timely, high quality services to our clients. We continue to believe there are several
specific opportunities for growth in 2004 and 2005. We currently conduct a significant amount of government-sponsored research and plan to continue our efforts to win new opportunities in this market. We have also had an increase in demand for our
Phase I services and are expanding our Phase I clinic in Austin, Texas to 300 beds to enhance our ability to service large, complex studies. This expansion should be completed in March 2005. We closed our Phase I operations in Leicester, United
Kingdom due to a dramatic decline in business related to the European Clinical Trials Directive. We also believe the demand for our post-marketing development services will continue to grow and we will also seek to expand our medical device
services. Finally, the demand for our bioanalytical and GMP services has increased and we have expanded our GMP laboratory facilities and invested in new equipment to meet this new demand.



We review various metrics, including period-to-period growth in backlog, new
authorizations, revenue, margins and earnings, to evaluate our financial performance. In the third quarter of 2004, we had record new authorizations of $310.4 million. The cancellation rate for the third quarter of 2004 was 25% compared to 24% in
the third quarter of 2003. The cancellation rate for the first nine months of 2004 was 20.6%. Therefore, on a net basis, authorizations were up 6% for the third quarter of 2004 compared to the third quarter of 2003. Backlog grew 16% from $1,059.3
million on September 30, 2003 to $1,233.4 million on September 30, 2004. Backlog by client type as of September 30, 2004 was 60% pharmaceutical, 27% biotech and 13% government/other, reflecting an increase in backlog with biotech clients since
December 31, 2003. Backlog by client type as of December 31, 2003 was 64% pharmaceutical, 23% biotech and 13% government/other. Net revenue by client type for the quarter ended September 30, 2004 was 64% pharmaceutical, 26% biotech and 10%
government/other. Top therapeutic areas by net revenue for the quarter ended September 30, 2004 were oncology, anti-infective/anti-viral, central nervous system, circulatory/cardiovascular and endocrine/metabolic. For a detailed discussion of our
revenue, margins, earnings and other financial results for the third quarter of 2004, see Results of Operations  Three Months Ended September 30, 2004 versus Three Months Ended September 30, 2003 below.



Capital expenditures for the three and nine months ended September 30, 2004
totaled approximately $10.4 million and $34.3 million, respectively. The majority of the capital expenditures were for information technology enhancements, computer hardware, additional software and equipment for our bioanalytical and GMP labs. We
bought seven new liquid chromatography/mass spectrometry instruments in the third quarter of 2003, bringing our total to 48. In addition to investing in our growing business, we are also focused on improving the efficiency of our operations by
streamlining training matrices and clinical procedural documents, decreasing the number of documents needed for study initiation, centralizing regulatory document collection and rolling out a new clinical trial management system.



Our compound partnering arrangements allow us to leverage our resources and
global drug development expertise to create new opportunities for growth and to share the risks and potential rewards of drug development with our collaborative partners. In 2003, in addition to furthering existing collaborations with ALZA
Corporation and Bayer AG, we entered into new collaborations with Syrrx and Chemokine Therapeutics. For a discussion of these compound partnering arrangements, see Item 1. Business  Our Services  Our Discovery Sciences Group 
Compound Partnering Programs in our Annual Report on Form 10-K for the year ended December 31, 2003. In 2004, we have continued to advance the development of the potential drug candidates associated with our existing compound partnering
arrangements and should increase the number of candidates in various stages of human trials by the end of year. In September 2004, we filed an investigational new drug application for one Syrrx DP4 inhibitor



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and started the Phase I trial for that inhibitor in late October 2004. In addition, we anticipate that ALZA Corporation,
a subsidiary of Johnson & Johnson, will submit a new drug application for dapoxetine with the FDA in the first quarter of 2005. As a result of these compound partnering arrangements and the progression of our pipeline, we expect to incur
significant R&D expense during the remainder of 2004 in connection with these efforts. Furthermore, in addition to progressing our existing collaborations, we will continue to evaluate other opportunities for collaborations and investments that
we believe will help us achieve our mid- to long-term growth objectives.



Acquisitions



In July 2003, PPD acquired
Eminent Research Systems, a clinical research organization specializing in medical device development, and Clinsights, a company affiliated with Eminent through common ownership that provides a range of post-market services to medical device and
related pharmaceutical companies and operates proprietary web sites for the dissemination of medical information, online research and product marketing. Eminent and Clinsights are part of the Development segment of PPD. The results of operations are
included in our consolidated condensed results of operations as of and since July 18, 2003, the effective date of the acquisitions. PPD acquired Eminent and Clinsights for total consideration of $23.5 million in cash. Under the terms of the merger
agreement, the original aggregate purchase price of $25.0 million was reduced by $1.5 million in the first quarter of 2004 as a result of a refund of the purchase price for the stock of Eminent based on Eminents closing balance sheet.



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



Investments



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



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



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



Restructuring Charges and Gain on Sale of Assets



In the first nine months of 2004, we recorded a $2.6 million restructuring charge associated with exiting our chemistry
facility in Research Triangle Park, North Carolina. These charges include lease payments and termination costs (net of sublease rentals) of approximately $2.1 million and a loss on sale of assets used in our chemistry services of approximately $0.5
million. The lease termination liability will be paid over the remaining life of the lease which will end in 2015. At September 30, 2004, we recorded the restructuring liability of $1.5 million in the consolidated condensed balance sheet as a
component of other accrued expenses.



In July 2003, we
announced the restructuring of our Discovery Sciences segment. In connection with this restructuring, we consolidated our Discovery Sciences operations into our Morrisville, North Carolina and Middleton, Wisconsin facilities, and discontinued
offering functional genomics services in Menlo Park, California. We 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, we 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



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from our Menlo Park operations. The value of the tangible assets and intellectual property was based on an independent
appraisal. We 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 our CRO Phase II through IV division and the remaining discovery sciences operations.
We 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.



New Business Authorizations and Backlog



New business authorizations, which are sales of the Companys services,
are reflected in backlog when we receive a letter of intent, verbal commitment or contract. Authorizations can vary significantly from quarter to quarter, and contracts generally have terms ranging from several months to several years. We recognize
revenue on these authorizations as services are performed. Our new authorizations for the three months ended September 30, 2003 and 2004 were $288.2 million and $310.4 million, respectively.



Our backlog consists of new business authorizations for which the work has
not started but is anticipated to begin in the near future, and contracts in process that have not been completed. Amounts included in backlog represent expected future revenues and exclude revenues that we have previously recognized. Once work
begins on a project included in backlog, net revenue is recognized over the life of the contract. However, there can be no assurance that our backlog will ever be recognized as revenue. As of September 30, 2003 and 2004, our backlog was $1,059.3
million and $1,233.4 million, respectively.



Results of Operations



Revenue Recognition



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



In connection with our management of multi-site clinical trials, we pay on
behalf of our customers fees to investigators and test subjects, as well as other out-of-pocket costs for items such as travel, printing, meetings and couriers. Our clients reimburse us for these costs. As required by EITF 01-14, amounts paid by us
as a principal for out-of-pocket costs are included in direct costs as reimbursable out-of-pocket expenses and the reimbursements we receive as a principal are reported as reimbursed out-of-pocket revenues. Amounts paid by us as an agent for
out-of-pocket costs are combined with the corresponding reimbursements, or revenues, we receive as an agent in the statement of operations. During the three months ended September 30, 2003 and 2004, fees paid to investigators and other fees that PPD
received as an agent and the associated reimbursements were approximately $38.8 and $42.7 million, respectively.



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



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



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Recording of Expenses



We generally record our operating expenses among the following 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 being conducted during any period of time.



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



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



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



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



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



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



|                                             |  |                                             |         |   |      |   |         |             |  |   |             |   |  |       |  
|-------------------------------------------- |  | ------------------------------------------- | ------- | - | ---- | - | ------- | ----------- |  | - | ----------- | - |  | ----- | -
|(in thousands, except per share data)        |  | Three Months EndedSeptember 30, (unaudited) |         |   |      |   |         |             | 
|                                             |  | 2004                                        |         |   | 2003 |   |         | $ Inc (Dec) |  |   | % Inc (Dec) |  
|Net revenue:                                 |  |                                             |         |   |      |   |         |             |  |   |             |   |  |       |  
|Development                                  |  | $                                           | 193,233 |   |      | $ | 164,007 |             |  | $ | 29,226      |   |  | 17.8  | %
|Discovery sciences                           |  |                                             | 2,289   |   |      |   | 2,589   |             |  |   | (300        | ) |  | (11.6 | )
|Reimbursed out-of-pockets                    |  |                                             | 20,302  |   |      |   | 12,919  |             |  |   | 7,383       |   |  | 57.1  |  
|                                             |  |                                             |         |   |      |   |         |             |  |   |             |   |  |       |  
|Total net revenue                            |  |                                             | 215,824 |   |      |   | 179,515 |             |  |   | 36,309      |   |  | 20.2  |  
|                                             |  |                                             |         |  
|Direct costs:                                |  |                                             |         |   |      |   |         |             |  |   |             |   |  |       |  
|Development                                  |  |                                             | 95,038  |   |      |   | 79,419  |             |  |   | 15,619      |   |  | 19.7  |  
|Discovery sciences                           |  |                                             | 1,367   |   |      |   | 1,387   |             |  |   | (20         | ) |  | (1.4  | )
|Reimbursable out-of-pocket expenses          |  |                                             | 20,302  |   |      |   | 12,919  |             |  |   | 7,383       |   |  | 57.1  |  
|                                             |  |                                             |         |   |      |   |         |             |  |   |             |   |  |       |  
|Total direct costs                           |  |                                             | 116,707 |   |      |   | 93,725  |             |  |   | 22,982      |   |  | 24.5  |  
|                                             |  |                                             |         |  
|Research and development expenses            |  |                                             | 4,138   |   |      |   | 1,487   |             |  |   | 2,651       |   |  | 178.3 |  
|Selling, general and administrative expenses |  |                                             | 49,361  |   |      |   | 42,552  |             |  |   | 6,809       |   |  | 16.0  |  
|Depreciation                                 |  |                                             | 7,392   |   |      |   | 6,479   |             |  |   | 913         |   |  | 14.1  |  
|Amortization                                 |  |                                             | 231     |   |      |   | 472     |             |  |   | (241        | ) |  | (51.1 | )
|Gain on sale of assets                       |  |                                             | (58     | ) |      |   | (5,716  | )           |  |   | 5,658       |   |  | (99.0 | )
|Restructuring charges                        |  |                                             |        |   |      |   | 1,917   |             |  |   | (1,917      | ) |  | N/A   |  
|                                             |  |                                             |         |   |      |   |         |             |  |   |             |   |  |       |  
|Income from operations                       |  |                                             | 38,053  |   |      |   | 38,599  |             |  |   | (546        | ) |  | (1.4  | )
|                                             |  |                                             |         |  
|Impairment of investments                    |  |                                             |        |   |      |   | (773    | )           |  |   | 733         |   |  |       |  
|Interest and other income (expense), net     |  |                                             | 994     |   |      |   | 963     |             |  |   | 31          |   |  | 3.2   |  
|                                             |  |                                             |         |   |      |   |         |             |  |   |             |   |  |       |  
|Income before taxes                          |  |                                             | 39,047  |   |      |   | 38,789  |             |  |   | 258         |   |  | 0.7   |  
|Provision for income taxes                   |  |                                             | 14,057  |   |      |   | 13,964  |             |  |   | 93          |   |  | 0.7   |  
|                                             |  |                                             |         |   |      |   |         |             |  |   |             |   |  |       |  
|Net income                                   |  | $                                           | 24,990  |   |      | $ | 24,825  |             |  | $ | 165         |   |  | 0.7   |  
|                                             |  |                                             |         |   |      |   |         |             |  |   |             |   |  |       |  
|Net income per diluted share                 |  | $                                           | 0.44    |   |      | $ | 0.44    |             |  | $ | 0.00        |   |  | 0.0   | %
|                                             |  |                                             |         |   |      |   |         |             |  |   |             |   |  |       |  



Total net revenue
increased to $215.8 million in the third quarter of 2004. The increase in total net revenue resulted primarily from an increase in our Development Group revenues. The Development Groups operations generated net revenue of $193.2 million, which
accounted for 89.5% of total net revenue for the third quarter of 2004. The 17.8% increase in the Development Groups net revenue was primarily attributable to an increase in the volume of global CRO Phase II through IV services we provided in
the third quarter of 2004 as compared to the third quarter of 2003. Net revenue for the Development Group also increased 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 2004 compared to the average rates for the third quarter of 2003.



Total direct costs increased to $116.7 million in the third quarter of 2004 primarily as the result of an increase in the Development Group direct costs. Development Group direct costs increased $15.6 million from the
third quarter of 2003 to the third quarter of 2004. The primary reason for this increase was an increase in personnel costs of $10.4 million. Personnel costs increased due to hiring additional employees in our global CRO Phase II through IV
division, increased incentive compensation accruals and increased costs in our foreign operations due to the weakening of the U.S. dollar. In the third quarter of 2003, incentive compensation accruals were lower than our



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normal accrual levels as a result of our financial and operating performance in that period. The remaining $5.2 million
of this increase in Development direct costs included increased subcontractor costs and increased facility costs related to the increase in personnel.



Gross margin from the Development segment was 50.8% for the third quarter of 2004 compared to 51.6% for the third quarter of 2003. Of this 0.8% decline in
gross margin, 0.36% was attributable to the increased incentive compensation accruals and the increased costs in our foreign operations due to the weakening of the U.S. dollar. The remaining variance related to expected fluctuations from one period
to another as a result of changes in labor utilization and the mix of service offerings involved in the hundreds of studies conducted during any period of time.



R&D expenses increased $2.6 million from $1.5 million in the third quarter of 2003 to $4.1 million in the third quarter of 2004. We incurred
significant R&D expenses in the third quarter of 2004 in connection with our existing compound partnering arrangements. In the third quarter of 2003, R&D expenses for our functional genomics and chemistry services operations totaled $1.0
million. We ceased performing functional genomics services in third quarter 2003 and chemistry services in first quarter 2004. We expect to incur between $7.5 million and $8.5 million in R&D expenses during the fourth quarter of 2004 in
connection with our existing compound partnering arrangements.



SG&A expenses increased $6.8 million to $49.4 million in the third quarter of 2004. As a percentage of total net revenue, SG&A expenses decreased from 23.7% in the third quarter of 2003 to 22.9% in the third quarter of 2004. The
increase in SG&A expenses includes additional personnel costs of $4.0 million related to training costs for new personnel and higher levels of operations infrastructure to manage direct personnel and insure quality delivery of projects. The
increase in SG&A costs also includes an additional $1.0 million of recruiting cost due to an increase in the number of new hires in third quarter 2004 compared to third quarter 2003.



Income from operations decreased $0.5 million to $38.1 million in third quarter of 2004. As a percentage of total net
revenue, income from operations decreased to 17.6% of net revenue in the third quarter of 2004 from 21.5% in the third quarter of 2003. Third quarter 2003 income from operations included a $5.7 million gain on sale of assets and a $1.9 million
restructuring charge. Income from operations for third quarter 2004 was negatively impacted by approximately $1.9 million due to the effect of the U.S. dollar weakening relative to the euro, the British pound and the Brazilian real. During the third
quarter of 2004, we recorded a foreign currency hedging gain of $0.7 million, resulting in a net impact to income from operations of $1.2 million. Although these currency movements increased net revenue in the aggregate, the negative impact on
income from operations is attributable to dollar-denominated contracts for services rendered in countries other than the United States. In these cases, revenue is not impacted by the weakening of the U.S. dollar, but the costs associated with
performing these contracts, which are paid in the local currency, are negatively impacted when translated to U.S. dollars.



During the third quarter of 2003, we recorded a charge to earnings for 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 and 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 believed the decline in value as of September 30, 2003 was other than temporary and thus recorded the charge to earnings. Prior to the third quarter of 2003, market fluctuations were recorded through our
equity accounts.



Our provision for income taxes increased $0.1
million to $14.1 million in the third quarter of 2004. Our effective income tax rate for the third quarter of 2004 and the third quarter of 2003 remained constant at 36.0%. We expect our effective tax rate for the remainder of 2004 to be
approximately 36.0%.



Net income of $25.0 million in the third
quarter of 2004 represents an increase of $0.2 million from $24.8 million in the third quarter of 2003. Net income per diluted share in the third quarter of 2004 and the third quarter of 2003 remained constant at approximately $0.44.



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Nine Months Ended September 30, 2004 Versus Nine Months Ended September 30, 2003



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



|                                             |  |                                           |         |   |      |   |         |             |  |   |             |   |  |       |  
|-------------------------------------------- |  | ----------------------------------------- | ------- | - | ---- | - | ------- | ----------- |  | - | ----------- | - |  | ----- | -
|(in thousands, except per share data)        |  | Nine Months EndedSeptember 30,(unaudited) |         |   |      |   |         |             | 
|                                             |  | 2004                                      |         |   | 2003 |   |         | $ Inc (Dec) |  |   | % Inc (Dec) |  
|Net revenue:                                 |  |                                           |         |   |      |   |         |             |  |   |             |   |  |       |  
|Development                                  |  | $                                         | 551,125 |   |      | $ | 481,493 |             |  | $ | 69,632      |   |  | 14.5  | %
|Discovery sciences                           |  |                                           | 11,870  |   |      |   | 12,808  |             |  |   | (938        | ) |  | (7.3  | )
|Reimbursed out-of-pockets                    |  |                                           | 48,645  |   |      |   | 40,061  |             |  |   | 8,584       |   |  | 21.4  |  
|                                             |  |                                           |         |   |      |   |         |             |  |   |             |   |  |       |  
|Total net revenue                            |  |                                           | 611,640 |   |      |   | 534,362 |             |  |   | 77,278      |   |  | 14.5  |  
|                                             |  |                                           |         |  
|Direct costs:                                |  |                                           |         |   |      |   |         |             |  |   |             |   |  |       |  
|Development                                  |  |                                           | 274,082 |   |      |   | 232,422 |             |  |   | 41,660      |   |  | 17.9  |  
|Discovery sciences                           |  |                                           | 4,215   |   |      |   | 6,395   |             |  |   | (2,180      | ) |  | (34.1 | )
|Reimbursable out-of-pocket expenses          |  |                                           | 48,645  |   |      |   | 40,061  |             |  |   | 8,584       |   |  | 21.4  |  
|                                             |  |                                           |         |   |      |   |         |             |  |   |             |   |  |       |  
|Total direct costs                           |  |                                           | 326,942 |   |      |   | 278,878 |             |  |   | 48,064      |   |  | 17.2  |  
|                                             |  |                                           |         |  
|Research and development expenses            |  |                                           | 9,062   |   |      |   | 8,573   |             |  |   | 489         |   |  | 5.7   |  
|Selling, general and administrative expenses |  |                                           | 142,336 |   |      |   | 124,119 |             |  |   | 18,217      |   |  | 14.7  |  
|Depreciation                                 |  |                                           | 20,992  |   |      |   | 20,233  |             |  |   | 759         |   |  | 3.8   |  
|Amortization                                 |  |                                           | 973     |   |      |   | 1,191   |             |  |   | (218        | ) |  | (18.3 | )
|Gain on sale of assets                       |  |                                           | (65     | ) |      |   | (5,738  | )           |  |   | 5,673       |   |  | (98.9 | )
|Restructuring charges                        |  |                                           | 2,619   |   |      |   | 1,917   |             |  |   | 702         |   |  | 36.6  |  
|                                             |  |                                           |         |   |      |   |         |             |  |   |             |   |  |       |  
|Income from operations                       |  |                                           | 108,781 |   |      |   | 105,189 |             |  |   | 3,592       |   |  | 3.4   |  
|                                             |  |                                           |         |  
|Impairment of investments                    |  |                                           | (2,000  | ) |      |   | (9,373  | )           |  |   | 7,373       |   |  | 78.7  |  
|Interest and other income (expense), net     |  |                                           | 2,699   |   |      |   | 2,462   |             |  |   | 237         |   |  | 9.6   |  
|                                             |  |                                           |         |   |      |   |         |             |  |   |             |   |  |       |  
|Income before taxes                          |  |                                           | 109,480 |   |      |   | 98,278  |             |  |   | 11,202      |   |  | 11.4  |  
|Provision for income taxes                   |  |                                           | 36,412  |   |      |   | 35,446  |             |  |   | 966         |   |  | 2.7   |  
|                                             |  |                                           |         |   |      |   |         |             |  |   |             |   |  |       |  
|Net income                                   |  | $                                         | 73,068  |   |      | $ | 62,832  |             |  | $ | 10,236      |   |  | 16.3  |  
|                                             |  |                                           |         |   |      |   |         |             |  |   |             |   |  |       |  
|Net income per diluted share                 |  | $                                         | 1.29    |   |      | $ | 1.12    |             |  | $ | 0.17        |   |  | 15.2  | %
|                                             |  |                                           |         |   |      |   |         |             |  |   |             |   |  |       |  



Total net revenue
increased to $611.6 million in the first nine months of 2004. The increase in total net revenue resulted primarily from an increase in our Development Group revenues. The Development Groups operations generated net revenue of $551.1 million,
which accounted for 90.1% of total net revenue for the first nine months of 2004. The 14.5% increase in the Development Groups net revenue was primarily attributable to an increase in the level of global CRO Phase II through IV services we
provided in the first nine months of 2004 as compared to the first nine months of 2003. Net revenue for the Development Group also increased by approximately $3.4 million due to the effect of the U.S. dollar weakening relative to the euro and the
British pound in the first nine months of 2004 compared to the average rates for the first nine months of 2003.



The Discovery Sciences Group generated net revenue of $11.9 million in the first nine months of 2004, a decrease of $0.9 million from the same period in
2003. The decrease in the Discovery Sciences net revenue was mainly attributable to the reduction in net revenue from chemistry services, which we stopped offering in the first quarter of 2004.



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Total direct costs increased to $326.9 million in the first nine months of 2004 primarily as the result
of an increase in the Development Group direct costs. Development Group direct costs increased $41.7 million from the first nine months of 2003 to the first nine months of 2004. The primary reason for this increase was an increase in personnel costs
of $29.2 million. Personnel costs increased due to hiring additional employees in our global CRO Phase II through IV division, increased incentive compensation accruals and increased costs in our foreign operations due to the weakening of the U.S.
dollar. In the first nine months of 2003, incentive compensation accruals were lower than our normal accrual levels as a result of our financial and operating performance in that period. The remaining $12.5 million of this increase in Development
direct costs included increased facility costs related to the increase in personnel and increased subcontractor costs.



Gross margin from the Development segment was 50.3% for the first nine months of 2004 compared to 51.7% for the first nine months of 2003. Of this 1.4%
decline in gross margin, the majority was attributable to increased incentive compensation accruals and increased costs in our foreign operations due to the weakening of the U.S. dollar mentioned earlier. The remaining variance relates to expected
fluctuations from one period to another as a result of changes in labor utilization and the mix of service offerings involved in the hundreds of studies conducted during any period of time.



R&D expenses increased $0.5 million to $9.1 million in the first nine
months of 2004 from $8.6 million in the first nine months of 2003. In the first nine months of 2004, we incurred significant R&D expenses in connection with our existing compound partnering arrangements. In the first 9 months of 2003, R&D
expenses for our functional genomics and chemistry services operations totaled $6.4 million. We ceased performing functional genomics services in third quarter 2003 and chemistry services in first quarter 2004.



SG&A expenses increased $18.2 million to $142.3 million in the first nine
months of 2004. As a percentage of total net revenue, SG&A expenses increased slightly to 23.3% in the first nine months of 2004 compared to 23.2% in the first nine months of 2003. The increase in SG&A expenses includes additional personnel
costs of $14.2 million. Of this increase, $7.8 million related to increased incentive compensation accruals and foreign currency translation effect mentioned above. The remaining $6.4 million increase in personnel costs related to training costs for
new personnel and higher levels of operations infrastructure to manage direct personnel and insure quality delivery of projects. The increase in SG&A costs also includes an additional $1.0 million of recruiting cost due to an increase in the
number of new hires in the first nine months of 2004 compared to the first nine months of 2003.



Income from operations increased $3.6 million to $108.8 million in the first nine months of 2004. As a percentage of net revenue, income from operations
decreased to 17.8% of net revenue in the first nine months of 2004 from 19.7% in the first nine months of 2003. Third quarter 2003 income from operations included a $5.7 million gain on sale of assets and a $1.9 million restructuring charge. Income
from operations in 2004 was negatively impacted by approximately $6.2 million due to the effect of the U.S. dollar weakening relative to the euro, the British pound and the Brazilian real. During the first nine months of 2004, we recorded a foreign
currency hedging gain of $1.8 million, resulting in a net impact to income from operations of $4.4 million. Although these currency movements increased net revenue in the aggregate, the negative impact on income from operations is attributable to
dollar-denominated contracts for services rendered in countries other than the United States. In these cases, revenue is not impacted by the weakening of the U.S. dollar, but the costs associated with performing these contracts, which are paid in
local currency, are negatively impacted when translated to the U.S. dollar.



During the nine months of 2004, the Company recorded charges to earnings for other than temporary declines in the fair market value of its investment in Chemokine Therapeutics Corp. of $2.0 million. Our investment in
Chemokine was deemed to be impaired as a result of a recent issuance of shares to new investors at a lower valuation than our original investment. 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 and 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.



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Our provision for income taxes increased to $36.4 million in the first nine months of 2004. Our effective
income tax rate for the first nine months of 2004 was 33.3% compared to 36.1% for the first nine months of 2003. During the second quarter of 2004, our effective tax rate was positively impacted by the $3.7 million tax benefit for a decrease in a
valuation allowance for capital loss carryforwards utilized during the period. We expect our effective tax rate for the remainder of 2004 to be approximately 36.0%.



Net income of $73.1 million in the first nine months of 2004 represents an increase of $10.2 million from $62.8 million in
the first nine months of 2003. Net income per diluted share of $1.29 in the first nine months of 2004 represents an increase from $1.12 net income per diluted share in the first nine months of 2003.



Liquidity and Capital Resources



As of September 30, 2004, we had $194.5 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, leasing arrangements, borrowings and sales of our stock. Our cash and cash equivalents are invested in financial instruments that are rated A
or better by Standard & Poors or Moodys and earn interest at market rates.



In the first nine months of 2004, our operating activities provided $114.1 million in cash as compared to $46.8 million for the same period last year. In the first nine months of 2004, net income of $73.1 million,
depreciation and amortization of $22.0 million and a decrease in net operating assets and liabilities of $19.8 million were partially offset by a benefit of $6.1 million for deferred income taxes. The decrease in net operating assets and liabilities
is primarily attributable to an increase in current income taxes, an increase in accrued expenses and payables to investigators, which were partially offset by an increase in receivables, increase in prepaid expenses and other current assets and a
decrease in unearned income.



In the first nine months of 2004,
our investing activities used $38.5 million in cash. Investments of $5.8 million and capital expenditures of $34.3 million were partially offset by the $1.5 million of proceeds from a refund of a portion of the purchase price associated with the
acquisition of Eminent Research Systems in 2003. We expect our capital expenditures to be approximately $45.0 to $50.0 million in 2004, with the majority of the anticipated spending related to continued information technology enhancement and
expansion in our Phase I clinic in Austin, Texas.



In the first
nine months of 2004, our financing activities provided $8.3 million in cash, as net proceeds from stock option exercises and stock purchases under our employee stock purchase plan totaling $9.3 million were partially offset by $1.0 million in
repayments of capital lease obligations and long-term debt.



Working capital as of September 30, 2004 was $222.9 million, compared to $156.6 million at December 31, 2003. The increase in working capital was due primarily to an increase in cash of $84.4 million, an increase in deferred income tax
asset of $6.8 million, an increase in prepaid expenses and other current assets of $3.3 million, and a decrease in unearned income of $4.2 million, partially offset by the increase in payables to investigators of $6.6 million, an increase in accrued
income taxes of $10.2 million, an increase in accounts payable and other accrued expenses of $17.5 million. The number of days revenue outstanding in accounts receivable and unbilled services, net of unearned income, also known as DSO, were
41.2 and 41.6 days for the nine months ended September 30, 2004 and September 30, 2003, respectively. DSO is calculated by dividing accounts receivable and unbilled services less unearned income by average daily gross revenue for the applicable
period. Our DSO over the past several years has fluctuated between 30.8 days and 43.2 days. We expect DSO will fluctuate in the future depending on the mix of contracts performed within a quarter, the level of investigator payables and unearned
income and our success in collecting receivables.



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



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In April 2000, we made an investment in Spotlight Health. In January 2001, we entered into an agreement
with Spotlight Health and Wachovia to guarantee a $2.0 million revolving line of credit provided to Spotlight Health by Wachovia. Indebtedness under the line was unsecured and subject to traditional covenants relating to financial ratios. This
credit facility expired on June 30, 2003. In July 2003, Spotlight Health replaced this credit facility with a new $2.0 million revolving line of credit from Bank of America. The new line of credit is on terms substantially similar to the prior line
of credit. We continue to guarantee Spotlights obligations under the new credit facility, which is scheduled to expire on June 30, 2005, at which time any outstanding balance would be due. As of September 30, 2004, Spotlight Health had $2.0
million outstanding under this credit facility. In accordance with the requirements of FASB Statement No. 5, Accounting for Contingencies, and as clarified by FASB Interpretation No. 45, we have recorded a liability in the amount of $0.2
million for the estimated fair value of the obligation we have assumed under this guarantee. We review the financial statements of Spotlight Health on a quarterly basis to determine if it has sufficient financial resources to continue operations.
Future events and circumstances might adversely affect Spotlight Healths financial condition and Spotlight Health might not be in the position to repay the facility, in which case Bank of America may attempt to enforce our guarantee.



In September 2003, we entered into agreements with SurroMed
pursuant to which we committed to pay for 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, and to serve as a
non-exclusive representative to market and sell additional SurroMed biomarker discovery services. As of September 30, 2004, the Company had paid SurroMed $1.0 million for biomarker discovery services.



In November 2003, we entered into a collaboration agreement with Syrrx to
jointly develop and commercialize Syrrx-designed human dipeptidyl peptidase IV, or DP4, inhibitors as drug products for the treatment of type 2 diabetes and other major human diseases. Under the terms of the agreement, we will provide preclinical
and clinical development resources and expertise for the collaboration, and will fund the majority of preclinical and clinical studies through Phase IIb development of selected DP4 inhibitors. PPD and Syrrx have agreed to share equally the costs of
Phase III development. In addition, we will make milestone payments to Syrrx upon the occurrence of certain clinical and regulatory events. In September 2004, we filed an investigational new drug application for one Syrrx DP4 inhibitor and the Phase
I clinical study for that inhibitor commenced in late October 2004. We will make a milestone payment to Syrrx as a result of the commencement of the Phase I studies in the fourth quarter of 2004. In the event we are successful in obtaining approval
to market a drug product under the collaboration with Syrrx, PPD and Syrrx will share equally the profits from drug sales.



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



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



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



We expect to continue expanding our operations through internal growth and strategic acquisitions and investments. We expect
these activities will be funded from existing cash, cash flows from operations and, if necessary or appropriate, borrowings under our existing or future credit facilities. We believe that these sources of



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liquidity will be sufficient to fund our operations for the foreseeable future, at least the next twelve months. 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 below under Potential Volatility of Quarterly Operating Results and Stock Price and Quantitative and Qualitative Disclosures about Market Risk. In addition, see Contractual Obligations and Commercial
Commitments, Critical Accounting Policies and Estimates and Factors that Might Affect our Business or Stock Price in our Annual Report on Form 10-K for the year ended December 31, 2003.



Critical Accounting Policies and Estimates



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



Recently Issued Accounting Standards



In December 2003, the FASB issued SFAS No. 132 (Revised 2003)
Employers Disclosures about Pensions and Other Postretirement Benefits. Revised Statement No. 132 requires additional disclosures about the assets, obligations, cash flows and net periodic benefit cost of defined benefit pension
plans and other defined benefit postretirement plans. We have adopted the interim disclosure requirements of this statement (see Note 9).



In December 2003, the FASB issued revised FIN 46, Consolidation of Variable Interest Entities. This revised interpretation was effective for
all entities as of the first reporting period that ends after March 15, 2004. We have no investment in or contractual or other business relationship with a variable interest entity and, therefore, the adoption of this interpretation did not have any
impact on our consolidated financial position or results of operations.



In November 2003, during discussions on EITF Issue 03-01, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, the EITF reached a consensus which requires quantitative and qualitative
disclosures for debt and marketable equity securities classified as available-for-sale or held-to-maturity under SFAS No. 115 and SFAS No. 124 that are impaired at the balance sheet date but for which an other-than-temporary impairment has not been
recognized. In September 2004, FASB Staff Position (FSP) EITF Issue 03-1-1 was issued to delay the effective date for the measurement and recognition guidance contained in paragraphs 10 through 20 of Issue 03-1. Application of those
paragraphs is deferred pending issuance of a final FSP relating to the draft FSP EITF Issue 03-1-a, Implementation Guidance for the Application of Paragraph 16 of EITF Issue 03-1, The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments, which the Board may issue as early as November. This delay does not suspend the requirement to recognize other-than-temporary impairments as required by existing authoritative literature. The guidance in
paragraph 6 through 9 of Issue 03-1 (step 1 of the impairment model  determining whether an investment is impaired), as well as the disclosure requirements in paragraphs 21 and 22, have not been deferred and should be applied based on the
transition provisions provided in Issue 03-1. We adopted the guidance in paragraphs 6 through 9 of Issue 03-1 and the disclosure requirements in paragraphs 21 and 22. Such adoption did not have a material impact on our financial position or results
of operations.



Taxes



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



Inflation



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



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Potential Volatility of Quarterly Operating Results and Stock Price



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



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



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



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



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



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



| |  | the timing and level of new business authorizations;
| | - | ----------------------------------------------------



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



| |  | pricing pressure in the market for our services;
| | - | ------------------------------------------------



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



| |  | rapid technological change;
| | - | ---------------------------



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



| |  | the timing and extent of new government regulations;
| | - | ----------------------------------------------------



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



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



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



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



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



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



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



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Item 3. Quantitative and Qualitative Disclosures about Market Risk



We are exposed to foreign currency risk by virtue of our international operations. Approximately 23.5% and 27.2% of our net revenues for the three months
ended September 30, 2003 and 2004, respectively, were derived from operations outside the United States. Funds generated by each subsidiary are generally reinvested in the country where they are earned. Our operations in the United Kingdom generated
more than 40.9% of our net revenue from international operations during the third quarter of 2004. Accordingly, we are exposed to adverse movements in the pound sterling and other foreign currencies.



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



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



Our strategy for management of currency risk relies primarily on conducting our operations in a countrys currency, intercompany foreign currency denominated loans and may, from time to time, involve use of
currency derivatives, primarily forward exchange contracts, to reduce our exposure to currency fluctuations. As of September 30, 2004, we had open foreign exchange derivative contracts with a face amount totaling $46.7 million to buy the local
currencies of our foreign subsidiaries. The estimated fair value of the foreign exchange contracts based upon dealer quotes was a net liability of approximately $0.4 million. The potential loss resulting from a hypothetical weakening of the U.S.
dollar relative to the pound sterling and euro of 10% would have been approximately $1.5 million for the three-month period ended September 30, 2004 based on 2004 revenues and costs related to the United Kingdom. We do not expect that a 10% change
in exchange rates in the future would have a material effect on our financial statements.



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



| |  | we translate income statement accounts at average exchange rates for the period;
| | - | --------------------------------------------------------------------------------



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



| |  | we translate equity accounts at historical exchange rates.
| | - | ----------------------------------------------------------



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



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



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



Item 4. Controls and Procedures



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



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



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Part II. OTHER INFORMATION



Item 6. Exhibits and Reports on Form 8-K



|(a) | Exhibits
|--- | --------



|       |  |                                                                                                                                                                             
|------ |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.207 |  | First amendment dated July 1, 2004, to Loan Agreement by and among Spotlight Health, Inc., Pharmaceutical Product Development, Inc. and Bank of America, N.A.               
|       | 
|10.208 |  | Employment Agreement dated July 16, 2004, between Pharmaceutical Product Development, Inc. and Colin Shannon.                                                               
|       | 
|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                            
|       | 
|       |  | Exhibit 10.162 has been updated to include Colin Shannon with severance of two years salary and to delete W. Richard Staub, Patrick OConnor and Paul Ossi from the
listing.



|(b) | Reports on Form 8-K
|--- | -------------------



On July 14, 2004, we furnished a Current Report on Form 8-K under Items 9 and 12, attaching a press release announcing our operating and financial results
for the quarter and six months ended June 30, 2004. Notwithstanding its listing here, the information furnished shall not be deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject
to the liabilities of that section, nor incorporated by reference in any filing under the Securities Act of 1933, as amended, except as expressly set forth by specific reference in such a filing.



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SIGNATURES



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



PHARMACEUTICAL PRODUCT DEVELOPMENT, INC.(Registrant)By

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

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




Date: November 3, 2004



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