##### Table of Contents

---

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549



---

FORM 10-Q



---

(Mark One)

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

For the quarterly period ended September 30, 2006.

OR



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

For the transition period from  to
.

Commission File Number 0-27570



---

PHARMACEUTICAL PRODUCT
DEVELOPMENT, INC.

(Exact name of registrant as specified in its charter)



---



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

3151 South Seventeenth Street

Wilmington, North Carolina

(Address of principal executive
offices)

28412

(Zip Code)

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



---

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

Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.

Large accelerated filer  x    Accelerated filer ̈Non-accelerated filer ̈

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

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



---



---

##### 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, 2005 and 2006 (unaudited) |  | 3   
|                                                                                                                            | 
|Consolidated Condensed Balance Sheets as of December 31, 2005 and September 30, 2006 (unaudited)                            |  | 4   
|                                                                                                                            | 
|Consolidated Condensed Statements of Cash Flows for the Nine Months Ended September 30, 2005 and 2006 (unaudited)           |  | 5   
|                                                                                                                            | 
|Notes to Consolidated Condensed Financial Statements (unaudited)                                                            |  | 6   
|                                                                                                                            | 
|Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations                               |  | 25  
|                                                                                                                            | 
|Item 3. Quantitative and Qualitative Disclosures about Market Risk                                                          |  | 41  
|                                                                                                                            | 
|Item 4. Controls and Procedures                                                                                             |  | 42  
|                                                                                                                            | 
|Part II. OTHER INFORMATION                                                                                                  |  |     
|                                                                                                                            | 
|Item 6. Exhibits                                                                                                            |  | 43  
|                                                                                                                            |  |     
|Signatures                                                                                                                  |  |      |  | 44



2



---

##### 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 data)



|                                                      |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |        
|----------------------------------------------------- |  | -------------------------------- | ------- | - | ------------------------------- | - | ------- | ---- |  | - | ------- | - |  | - | -------
|                                                      |  | Three Months Ended September 30, |         |   | Nine Months Ended September 30,
|                                                      |  | 2005                             |         |   | 2006                            |   |         | 2005 |  |   | 2006   
|Net Revenue:                                          |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |        
|Development                                           |  | $                                | 235,148 |   |                                 | $ | 285,348 |      |  | $ | 672,931 |   |  | $ | 821,987
|Discovery Sciences                                    |  |                                  | 19,458  |   |                                 |   | 4,456   |      |  |   | 35,954  |   |  |   | 27,955 
|Reimbursed out-of-pockets                             |  |                                  | 18,674  |   |                                 |   | 23,344  |      |  |   | 53,591  |   |  |   | 71,528 
|                                                      |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |        
|Total net revenue                                     |  |                                  | 273,280 |   |                                 |   | 313,148 |      |  |   | 762,476 |   |  |   | 921,470
|                                                      |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |        
|Direct Costs:                                         |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |        
|Development                                           |  |                                  | 118,910 |   |                                 |   | 144,121 |      |  |   | 342,891 |   |  |   | 412,560
|Discovery Sciences                                    |  |                                  | 2,178   |   |                                 |   | 2,416   |      |  |   | 6,212   |   |  |   | 6,893  
|Reimbursable out-of-pocket expenses                   |  |                                  | 18,674  |   |                                 |   | 23,344  |      |  |   | 53,591  |   |  |   | 71,528 
|                                                      |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |        
|Total direct costs                                    |  |                                  | 139,762 |   |                                 |   | 169,881 |      |  |   | 402,694 |   |  |   | 490,981
|                                                      |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |        
|Research and development expenses                     |  |                                  | 1,967   |   |                                 |   | 1,887   |      |  |   | 22,233  |   |  |   | 3,829  
|Selling, general and administrative expenses          |  |                                  | 64,417  |   |                                 |   | 77,247  |      |  |   | 184,049 |   |  |   | 228,478
|Depreciation                                          |  |                                  | 10,135  |   |                                 |   | 12,008  |      |  |   | 28,006  |   |  |   | 34,317 
|Amortization                                          |  |                                  | 279     |   |                                 |   | 84      |      |  |   | 846     |   |  |   | 481    
|Loss on impairment and disposal of assets             |  |                                  | 25      |   |                                 |   | 42      |      |  |   | 275     |   |  |   | 1,428  
|Gain on exchange of assets                            |  |                                  |        |   |                                 |   |        |      |  |   | (5,144  | ) |  |   |       
|                                                      |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |        
|Total operating expenses                              |  |                                  | 216,585 |   |                                 |   | 261,149 |      |  |   | 632,959 |   |  |   | 759,514
|                                                      |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |        
|Income from operations                                |  |                                  | 56,695  |   |                                 |   | 51,999  |      |  |   | 129,517 |   |  |   | 161,956
|Interest income, net                                  |  |                                  | 2,400   |   |                                 |   | 3,831   |      |  |   | 5,615   |   |  |   | 10,133 
|Impairment of equity investment                       |  |                                  | (3,797  | ) |                                 |   |        |      |  |   | (3,797  | ) |  |   |       
|Other income (expense), net                           |  |                                  | 403     |   |                                 |   | (53     | )    |  |   | 1,260   |   |  |   | 1,125  
|                                                      |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |        
|Income before provision for income taxes              |  |                                  | 55,701  |   |                                 |   | 55,777  |      |  |   | 132,595 |   |  |   | 173,214
|Provision for income taxes                            |  |                                  | 19,941  |   |                                 |   | 18,964  |      |  |   | 43,155  |   |  |   | 58,141 
|                                                      |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |        
|Net income                                            |  | $                                | 35,760  |   |                                 | $ | 36,813  |      |  | $ | 89,440  |   |  | $ | 115,073
|                                                      |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |        
|Net income per common share:                          |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |        
|Basic                                                 |  | $                                | 0.31    |   |                                 | $ | 0.31    |      |  | $ | 0.78    |   |  | $ | 0.99   
|                                                      |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |        
|Diluted                                               |  | $                                | 0.31    |   |                                 | $ | 0.31    |      |  | $ | 0.77    |   |  | $ | 0.97   
|                                                      |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |        
|Dividends declared per common share                   |  | $                                |        |   |                                 | $ | 0.025   |      |  | $ |        |   |  | $ | 0.075  
|                                                      |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |        
|Weighted average number of common shares outstanding: |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |        
|Basic                                                 |  |                                  | 115,286 |   |                                 |   | 116,971 |      |  |   | 114,312 |   |  |   | 116,608
|Dilutive effect of stock options and restricted stock |  |                                  | 1,854   |   |                                 |   | 1,820   |      |  |   | 1,754   |   |  |   | 1,791  
|                                                      |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |        
|Diluted                                               |  |                                  | 117,140 |   |                                 |   | 118,791 |      |  |   | 116,066 |   |  |   | 118,399
|                                                      |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |        

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



3



---

##### Table of Contents

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED BALANCE SHEETS

(in thousands)



|                                                                      |  |                  |           |                   |   |          
|--------------------------------------------------------------------- |  | ---------------- | --------- | ----------------- | - | ---------
|                                                                      |  | December 31,2005 |           | September 30,2006
|                                                                      |  |                  |           | (unaudited)      
|Assets                                                                |  |                  |           |                   |   |          
|Current assets:                                                       |  |                  |           |                   |   |          
|Cash and cash equivalents                                             |  | $                | 182,000   |                   | $ | 120,858  
|Short-term investments                                                |  |                  | 137,820   |                   |   | 251,351  
|Accounts receivable and unbilled services, net                        |  |                  | 303,386   |                   |   | 388,112  
|Income tax receivable                                                 |  |                  | 14        |                   |   | 107      
|Investigator advances                                                 |  |                  | 13,578    |                   |   | 11,311   
|Prepaid expenses and other current assets                             |  |                  | 34,651    |                   |   | 54,503   
|Deferred tax assets                                                   |  |                  | 11,435    |                   |   | 12,044   
|                                                                      |  |                  |           |                   |   |          
|Total current assets                                                  |  |                  | 682,884   |                   |   | 838,286  
|                                                                      |  |                 
|Property and equipment, net                                           |  |                  | 210,020   |                   |   | 291,993  
|Goodwill                                                              |  |                  | 208,883   |                   |   | 211,109  
|Investments                                                           |  |                  | 29,171    |                   |   | 17,254   
|Intangible assets                                                     |  |                  | 2,772     |                   |   | 2,096    
|Long-term deferred tax assets                                         |  |                  | 20,080    |                   |   | 15,552   
|Other assets                                                          |  |                  | 5,790     |                   |   | 1,502    
|                                                                      |  |                  |           |                   |   |          
|Total assets                                                          |  | $                | 1,159,600 |                   | $ | 1,377,792
|                                                                      |  |                  |           |                   |   |          
|Liabilities and Shareholders Equity                                  |  |                  |           |                   |   |          
|Current liabilities:                                                  |  |                  |           |                   |   |          
|Accounts payable                                                      |  | $                | 10,363    |                   | $ | 15,678   
|Payables to investigators                                             |  |                  | 43,126    |                   |   | 39,368   
|Accrued income taxes                                                  |  |                  | 18,099    |                   |   | 28,117   
|Other accrued expenses                                                |  |                  | 119,304   |                   |   | 137,742  
|Deferred tax liabilities                                              |  |                  | 85        |                   |   | 97       
|Unearned income                                                       |  |                  | 162,662   |                   |   | 174,035  
|Current maturities of long-term debt and capital lease obligations    |  |                  | 1,607     |                   |   | 534      
|                                                                      |  |                  |           |                   |   |          
|Total current liabilities                                             |  |                  | 355,246   |                   |   | 395,571  
|                                                                      |  |                 
|Long-term debt and capital lease obligations, less current maturities |  |                  | 22,695    |                   |   | 56,118   
|Accrued pension liability                                             |  |                  | 11,151    |                   |   | 12,242   
|Deferred tax liabilities                                              |  |                  | 2,195     |                   |   | 3,452    
|Deferred rent and other                                               |  |                  | 17,637    |                   |   | 18,166   
|                                                                      |  |                  |           |                   |   |          
|Total liabilities                                                     |  |                  | 408,924   |                   |   | 485,549  
|                                                                      |  |                 
|Shareholders equity:                                                 |  |                  |           |                   |   |          
|Common stock                                                          |  |                  | 5,800     |                   |   | 5,855    
|Paid-in capital                                                       |  |                  | 395,452   |                   |   | 433,648  
|Retained earnings                                                     |  |                  | 346,417   |                   |   | 452,710  
|Accumulated other comprehensive income                                |  |                  | 3,007     |                   |   | 30       
|                                                                      |  |                  |           |                   |   |          
|Total shareholders equity                                            |  |                  | 750,676   |                   |   | 892,243  
|                                                                      |  |                  |           |                   |   |          
|Total liabilities and shareholders equity                            |  | $                | 1,159,600 |                   | $ | 1,377,792
|                                                                      |  |                  |           |                   |   |          

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



4



---

##### Table of Contents

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(unaudited)

(in
thousands)



|                                                                                          |  |                                |         |   |      |   |          |  
|----------------------------------------------------------------------------------------- |  | ------------------------------ | ------- | - | ---- | - | -------- | -
|                                                                                          |  | Nine Months EndedSeptember 30, |        
|                                                                                          |  | 2005                           |         |   | 2006 |  
|Cash flows from operating activities:                                                     |  |                                |         |   |      |   |          |  
|Net income                                                                                |  | $                              | 89,440  |   |      | $ | 115,073  |  
|Adjustments to reconcile net income to net cash provided by operating activities:         |  |                                |         |   |      |   |          |  
|Depreciation and amortization                                                             |  |                                | 28,852  |   |      |   | 34,798   |  
|Stock compensation expense                                                                |  |                                | 12,960  |   |      |   | 15,270   |  
|Gain on exchange of assets                                                                |  |                                | (5,144  | ) |      |   |         |  
|Gain on sale of investment                                                                |  |                                |        |   |      |   | (782     | )
|Impairment of investments                                                                 |  |                                | 3,797   |   |      |   |         |  
|Loss on impairment and disposal of assets                                                 |  |                                | 275     |   |      |   | 1,428    |  
|Gain on sale of assets                                                                    |  |                                | (98     | ) |      |   | (31      | )
|Provision for doubtful accounts                                                           |  |                                | 124     |   |      |   | 628      |  
|(Benefit) provision for deferred income taxes                                             |  |                                | (305    | ) |      |   | 6,287    |  
|Change in operating assets and liabilities, net of acquisitions                           |  |                                | 5,090   |   |      |   | (56,246  | )
|                                                                                          |  |                                |         |   |      |   |          |  
|Net cash provided by operating activities                                                 |  |                                | 134,991 |   |      |   | 116,425  |  
|                                                                                          |  |                                |         |   |      |   |          |  
|Cash flows from investing activities:                                                     |  |                                |         |   |      |   |          |  
|Purchases of property and equipment                                                       |  |                                | (89,083 | ) |      |   | (106,574 | )
|Proceeds from sale of property and equipment                                              |  |                                | 3,926   |   |      |   | 39       |  
|Purchases of available-for-sale investments                                               |  |                                | (24,720 | ) |      |   | (601,693 | )
|Maturities and sales of available-for-sale investments                                    |  |                                | 129,740 |   |      |   | 488,158  |  
|Purchase of note receivable                                                               |  |                                |        |   |      |   | (7,474   | )
|Proceeds from sale of investments                                                         |  |                                | 25,000  |   |      |   | 1,482    |  
|Purchases of investments                                                                  |  |                                | (11,576 | ) |      |   | (992     | )
|                                                                                          |  |                                |         |   |      |   |          |  
|Net cash provided by (used in) investing activities                                       |  |                                | 33,287  |   |      |   | (227,054 | )
|                                                                                          |  |                                |         |   |      |   |          |  
|Cash flows from financing activities:                                                     |  |                                |         |   |      |   |          |  
|Principal repayments of long-term debt                                                    |  |                                | (275    | ) |      |   | (6,005   | )
|Proceeds from construction loan                                                           |  |                                |        |   |      |   | 38,993   |  
|Repayment of capital leases obligations                                                   |  |                                | (1,301  | ) |      |   | (1,083   | )
|Proceeds from exercise of stock options and employee stock purchase plan                  |  |                                | 24,471  |   |      |   | 19,078   |  
|Income tax benefit from exercise of stock options and disqualifying dispositions of stock |  |                                | 7,025   |   |      |   | 4,265    |  
|Cash dividends paid                                                                       |  |                                |        |   |      |   | (8,774   | )
|                                                                                          |  |                                |         |   |      |   |          |  
|Net cash provided by financing activities                                                 |  |                                | 29,920  |   |      |   | 46,474   |  
|                                                                                          |  |                                |         |   |      |   |          |  
|Effect of exchange rate changes on cash and cash equivalents                              |  |                                | (6,839  | ) |      |   | 3,013    |  
|                                                                                          |  |                                |         |   |      |   |          |  
|Net increase (decrease) in cash and cash equivalents                                      |  |                                | 191,359 |   |      |   | (61,142  | )
|Cash and cash equivalents, beginning of the period                                        |  |                                | 144,348 |   |      |   | 182,000  |  
|                                                                                          |  |                                |         |   |      |   |          |  
|Cash and cash equivalents, end of the period                                              |  | $                              | 335,707 |   |      | $ | 120,858  |  
|                                                                                          |  |                                |         |   |      |   |          |  

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



5



---

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

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.

Stock Split

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

Recent accounting pronouncements

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

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



6



---

##### 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)

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

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

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

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

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

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



7



---

##### 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)

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

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

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

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

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

Inventory

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

Earnings per share

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



8



---

##### Table of Contents

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

1. SIGNIFICANT ACCOUNTING POLICIES (continued)

Reclassification

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

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.

2. ACQUISITIONS

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

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

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



|                                         |  |   |        |  
|---------------------------------------- |  | - | ------ | -
|(in thousands)                           |  |   |       
|                                         | 
|Condensed balance sheet:                 |  |   |        |  
|Current assets                           |  | $ | 186    |  
|Property and equipment, net              |  |   | 8,780  |  
|Deferred rent and other                  |  |   | (742   | )
|Current liabilities                      |  |   | (3,512 | )
|Long-term liabilities                    |  |   | (2,267 | )
|                                         | 
|Value of identifiable intangible assets: |  |   |        |  
|Goodwill                                 |  |   | 33,001 |  
|                                         |  |   |        |  
|Total                                    |  | $ | 35,446 |  
|                                         |  |   |        |  



9



---

##### Table of Contents

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

2. ACQUISITIONS (continued)

Goodwill related to SurroMed is deductible for tax purposes.

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

3. ACCOUNTS RECEIVABLE AND UNBILLED SERVICES

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



|                                |  |                  |         |   |                   |   |         |  
|------------------------------- |  | ---------------- | ------- | - | ----------------- | - | ------- | -
|(in thousands)                  |  | December 31,2005 |         |   | September 30,2006 |  
|Billed                          |  | $                | 204,686 |   |                   | $ | 250,615 |  
|Unbilled                        |  |                  | 102,626 |   |                   |   | 141,813 |  
|Provision for doubtful accounts |  |                  | (3,926  | ) |                   |   | (4,316  | )
|                                |  |                  |         |   |                   |   |         |  
|                                |  | $                | 303,386 |   |                   | $ | 388,112 |  
|                                |  |                  |         |   |                   |   |         |  

4. PROPERTY AND EQUIPMENT

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



|                                               |  |                  |          |   |                   |   |          |  
|---------------------------------------------- |  | ---------------- | -------- | - | ----------------- | - | -------- | -
|(in thousands)                                 |  | December 31,2005 |          |   | September 30,2006 |  
|Land                                           |  | $                | 6,986    |   |                   | $ | 7,149    |  
|Buildings and leasehold improvements           |  |                  | 58,321   |   |                   |   | 72,050   |  
|Construction in progress                       |  |                  | 31,205   |   |                   |   | 94,557   |  
|Furniture and equipment                        |  |                  | 152,952  |   |                   |   | 167,617  |  
|Computer equipment and software                |  |                  | 114,331  |   |                   |   | 138,947  |  
|                                               |  |                  |          |   |                   |   |          |  
|                                               |  |                  | 363,795  |   |                   |   | 480,320  |  
|Less accumulated depreciation and amortization |  |                  | (153,775 | ) |                   |   | (188,327 | )
|                                               |  |                  |          |   |                   |   |          |  
|                                               |  | $                | 210,020  |   |                   | $ | 291,993  |  
|                                               |  |                  |          |   |                   |   |          |  

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

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



10



---

##### Table of Contents

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

4. PROPERTY AND EQUIPMENT (continued)

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



|                                               |  |                  |        |   |                   |   |        |  
|---------------------------------------------- |  | ---------------- | ------ | - | ----------------- | - | ------ | -
|(in thousands)                                 |  | December 31,2005 |        |   | September 30,2006 |  
|Leasehold improvements                         |  | $                | 824    |   |                   | $ | 824    |  
|Computer equipment and software                |  |                  | 656    |   |                   |   | 656    |  
|Furniture and equipment                        |  |                  | 2,114  |   |                   |   | 1,975  |  
|                                               |  |                  |        |   |                   |   |        |  
|                                               |  |                  | 3,594  |   |                   |   | 3,455  |  
|Less accumulated depreciation and amortization |  |                  | (1,211 | ) |                   |   | (2,125 | )
|                                               |  |                  |        |   |                   |   |        |  
|                                               |  | $                | 2,383  |   |                   | $ | 1,330  |  
|                                               |  |                  |        |   |                   |   |        |  

5. GOODWILL AND INTANGIBLE ASSETS

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



|                                                     |  |             |         |   |                   |   |        |  |   |         |  
|---------------------------------------------------- |  | ----------- | ------- | - | ----------------- | - | ------ |  | - | ------- | -
|(in thousands)                                       |  | Development |         |   | DiscoverySciences |   | Total  | 
|Balance as of January 1, 2005                        |  | $           | 159,166 |   |                   | $ | 20,615 |  | $ | 179,781 |  
|Goodwill recorded during the period for acquisitions |  |             |        |   |                   |   | 33,001 |  |   | 33,001  |  
|Translation adjustments                              |  |             | (3,899  | ) |                   |   |       |  |   | (3,899  | )
|                                                     |  |             |         |   |                   |   |        |  |   |         |  
|Balance as of December 31, 2005                      |  |             | 155,267 |   |                   |   | 53,616 |  |   | 208,883 |  
|Translation adjustments                              |  |             | 2,226   |   |                   |   |       |  |   | 2,226   |  
|                                                     |  |             |         |   |                   |   |        |  |   |         |  
|Balance as of September 30, 2006                     |  | $           | 157,493 |   |                   | $ | 53,616 |  | $ | 211,109 |  
|                                                     |  |             |         |   |                   |   |        |  |   |         |  

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

Information regarding the Companys other intangible assets follows:



|                                   |                 |                   |                          |                    |     |       |                 |   |                          |  |     |       |  |   |       |  |   |      
|---------------------------------- | --------------- | ----------------- | ------------------------ | ------------------ | --- | ----- | --------------- | - | ------------------------ |  | --- | ----- |  | - | ----- |  | - | -----
|(in thousands)                     |                 | December 31, 2005 |                          | September 30, 2006
|                                   | Carrying Amount |                   | Accumulated Amortization |                    | Net |       | Carrying Amount |   | Accumulated Amortization |  | Net
|Backlog and customer relationships |                 | $                 | 543                      |                    | $   | 338   |                 | $ | 205                      |  | $   | 543   |  | $ | 427   |  | $ | 116  
|Patents                            |                 |                   | 22                       |                    |     | 22    |                 |   |                         |  |     |      |  |   |      |  |   |     
|License and royalty agreements     |                 |                   | 5,000                    |                    |     | 2,433 |                 |   | 2,567                    |  |     | 4,500 |  |   | 2,520 |  |   | 1,980
|                                   |                 |                   |                          |                    |     |       |                 |   |                          |  |     |       |  |   |       |  |   |      
|Total                              |                 | $                 | 5,565                    |                    | $   | 2,793 |                 | $ | 2,772                    |  | $   | 5,043 |  | $ | 2,947 |  | $ | 2,096
|                                   |                 |                   |                          |                    |     |       |                 |   |                          |  |     |       |  |   |       |  |   |      

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



11



---

##### Table of Contents

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

5. GOODWILL AND INTANGIBLE ASSETS (continued)

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



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

6. SHORT-TERM INVESTMENTS AND INVESTMENTS

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



|                                            |  |                  |         |                   |   |        
|------------------------------------------- |  | ---------------- | ------- | ----------------- | - | -------
|(in thousands)                              |  | December 31,2005 |         | September 30,2006
|Short-term investments:                     |  |                  |         |                   |   |        
|Auction Rate Securities                     |  | $                | 137,820 |                   | $ | 130,144
|Other municipal debt securities             |  |                  |        |                   |   | 121,207
|                                            |  |                  |         |                   |   |        
|Total short-term investments                |  | $                | 137,820 |                   | $ | 251,351
|                                            |  |                  |         |                   |   |        
|Cost-basis investments:                     |  |                  |         |                   |   |        
|Oriel Therapeutics, Inc.                    |  | $                | 500     |                   | $ | 500    
|Bay City Capital Fund IV, L.P.              |  |                  | 1,852   |                   |   | 2,952  
|A.M. Pappas Life Science Ventures III, L.P. |  |                  | 691     |                   |   | 879    
|Other equity investments                    |  |                  | 250     |                   |   | 250    
|                                            |  |                  |         |                   |   |        
|Total cost-basis investments                |  |                  | 3,293   |                   |   | 4,581  
|                                            |  |                 
|Marketable equity securities:               |  |                  |         |                   |   |        
|BioDelivery Sciences International, Inc.    |  |                  | 1,953   |                   |   | 1,656  
|Chemokine Therapeutics Corp.                |  |                  | 2,360   |                   |   |       
|Accentia Biopharmaceuticals, Inc.           |  |                  | 21,565  |                   |   | 11,017 
|                                            |  |                  |         |                   |   |        
|Total marketable equity securities          |  |                  | 25,878  |                   |   | 12,673 
|                                            |  |                  |         |                   |   |        
|Total investments                           |  | $                | 29,171  |                   | $ | 17,254 
|                                            |  |                  |         |                   |   |        

Short-term investments

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

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



12



---

##### Table of Contents

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

6. SHORT-TERM INVESTMENTS AND INVESTMENTS (continued)

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

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

Investments

The Company has equity investments in publicly traded entities. Investments in publicly
traded entities are denoted as marketable equity securities in the above table and are classified as available-for-sale securities and measured at market value. The Company records net unrealized gains or losses associated with investments in
publicly traded entities as a component of shareholders equity until they are realized or an other-than-temporary decline has occurred. The market value of the Companys equity investments in publicly traded entities is based on the
closing price as quoted by the applicable stock exchange or market on the last day of the reporting period. As of September 30, 2006, the Companys equity investments in publicly traded companies were classified as long-term assets due to
the Companys ability to hold its investments long-term, the strategic nature of the investment and the lack of liquidity in the public markets for these securities. As of December 31, 2005 and September 30, 2006, gross unrealized
gains on long-term investments in marketable securities were $8.5 million and $0, respectively, and gross unrealized losses were $0 and $4.0 million, respectively.

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

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

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



13



---

##### Table of Contents

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

6. SHORT-TERM INVESTMENTS AND INVESTMENTS (continued)

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

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

7. COMPREHENSIVE INCOME

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



|                                                                                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|------------------------------------------------------------------------------------------------------------------------------ |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                                                                               |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|(in thousands)                                                                                                                 |  | 2005                            |        |   | 2006                           |   |        | 2005 |  |   | 2006    |  
|Net income, as reported                                                                                                        |  | $                               | 35,760 |   |                                | $ | 36,813 |      |  | $ | 89,440  |   |  | $ | 115,073 |  
|Other comprehensive loss                                                                                                       |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Cumulative translation adjustment                                                                                              |  |                                 | (545   | ) |                                |   | 131    |      |  |   | (8,759  | ) |  |   | 5,171   |  
|Change in fair value of hedging transaction, net of taxes of $(244), $0, $(778) and $140, respectively                         |  |                                 | (567   | ) |                                |   |       |      |  |   | (1,785  | ) |  |   | 327     |  
|Reclassification adjustment for hedging results included in direct costs, net of taxes of $247, $0, $208 and $88, respectively |  |                                 | 574    |   |                                |   |       |      |  |   | 485     |   |  |   | 206     |  
|Unrealized gain (loss) on investments, net of taxes of $0, $(2,611), $0 and $(3,829), respectively                             |  |                                 | 71     |   |                                |   | (4,109 | )    |  |   | (733    | ) |  |   | (7,954  | )
|Reclassification adjustment for gain realized included in other income, net of taxes of $(55)                                  |  |                                 |       |   |                                |   |       |      |  |   |        |   |  |   | (727    | )
|                                                                                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total other comprehensive loss                                                                                                 |  |                                 | (467   | ) |                                |   | (3,978 | )    |  |   | (10,792 | ) |  |   | (2,977  | )
|                                                                                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Comprehensive income                                                                                                           |  | $                               | 35,293 |   |                                | $ | 32,835 |      |  | $ | 78,648  |   |  | $ | 112,096 |  
|                                                                                                                               |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  

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



|                                              |  |                  |        |   |                   |   |        |  
|--------------------------------------------- |  | ---------------- | ------ | - | ----------------- | - | ------ | -
|(in thousands)                                |  | December 31,2005 |        |   | September 30,2006 |  
|Translation adjustment                        |  | $                | 4,766  |   |                   | $ | 9,937  |  
|Minimum pension liability, net of tax         |  |                  | (7,329 | ) |                   |   | (7,329 | )
|Fair value on hedging transaction, net of tax |  |                  | (533   | ) |                   |   |       |  
|Unrealized gain on investments                |  |                  | 6,103  |   |                   |   | (2,578 | )
|                                              |  |                  |        |   |                   |   |        |  
|Total                                         |  | $                | 3,007  |   |                   | $ | 30     |  
|                                              |  |                  |        |   |                   |   |        |  



14



---

##### Table of Contents

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

8. ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

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

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

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

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

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

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



15



---

##### Table of Contents

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

9. STOCK PLANS

Adoption of Statement of Financial Accounting Standard No. 123 (R)

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

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

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



|                                             |  |                                      |         |                                     |   |                       |  |          |         |  |   |        
|-------------------------------------------- |  | ------------------------------------ | ------- | ----------------------------------- | - | --------------------- |  | -------- | ------- |  | - | -------
|                                             |  | Three Months EndedSeptember 30, 2005 |         | Nine Months EndedSeptember 30, 2005
|(in thousands, except per share data)        |  | As previouslyreported                |         | Restated                            |   | As previouslyreported |  | Restated
|Statement of Operations Items:               |  |                                      |         |                                     |   |                       |  |          |         |  |   |        
|                                             |  |                                      |         |                                    
|Total direct costs                           |  | $                                    | 138,152 |                                     | $ | 139,762               |  | $        | 397,943 |  | $ | 402,694
|Selling, general and administrative expenses |  |                                      | 61,970  |                                     |   | 64,417                |  |          | 176,389 |  |   | 184,049
|Income from operations                       |  |                                      | 60,777  |                                     |   | 56,695                |  |          | 142,203 |  |   | 129,517
|Income before provision for income taxes     |  |                                      | 59,783  |                                     |   | 55,701                |  |          | 145,281 |  |   | 132,595
|Net income                                   |  |                                      | 38,381  |                                     |   | 35,760                |  |          | 97,654  |  |   | 89,440 
|                                             |  |                                      |         |                                    
|Net income per common share:                 |  |                                      |         |                                     |   |                       |  |          |         |  |   |        
|Basic                                        |  |                                      | 0.33    |                                     |   | 0.31                  |  |          | 0.85    |  |   | 0.78   
|Diluted                                      |  |                                      | 0.33    |                                     |   | 0.31                  |  |          | 0.84    |  |   | 0.77   
|                                             |  |                                      |         |                                    
|Statement of Cash Flows Items:               |  |                                      |         |                                     |   |                       |  |          |         |  |   |        
|                                             |  |                                      |         |                                    
|Net cash provided by operating activities    |  |                                      |         |                                     |   |                       |  |          | 142,016 |  |   | 134,991
|Net cash provided by financing activities    |  |                                      |         |                                     |   |                       |  |          | 22,895  |  |   | 29,920 



|                              |  |                       |           |   |          |   |          
|----------------------------- |  | --------------------- | --------- | - | -------- | - | ---------
|                              |  | At December 31, 2005 
|                              |  | As previouslyreported |           |   | Restated
|Balance Sheet Items:          |  |                       |           |   |          |   |          
|                              |  |                      
|Long-term deferred tax assets |  | $                     | 11,628    |   |          | $ | 20,080   
|Total assets                  |  |                       | 1,151,148 |   |          |   | 1,159,600
|Paid-in capital               |  |                       | 340,451   |   |          |   | 395,452  
|Retained earnings             |  |                       | 396,068   |   |          |   | 346,417  
|Deferred compensation         |  |                       | (3,102    | ) |          |   |         
|Total shareholders equity    |  |                       | 742,224   |   |          |   | 750,676  



16



---

##### Table of Contents

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

9. STOCK PLANS (continued)

Equity Compensation Plan

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

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

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

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



|                                                    |  |        |   |  |                               |       |                                          |      |                         |   |        
|--------------------------------------------------- |  | ------ | - |  | ----------------------------- | ----- | ---------------------------------------- | ---- | ----------------------- | - | -------
|(shares and aggregate intrinsic value in thousands) |  | Shares |   |  | Weighted-AverageExercisePrice |       | Weighted-AverageRemainingContractualTerm |      | AggregateIntrinsicValue
|Outstanding at January 1, 2006                      |  | 6,487  |   |  | $                             | 18.05 |                                          |      |                         |   |        
|Granted                                             |  | 1,484  |   |  |                               | 34.69 |                                          |      |                         |   |        
|Exercised                                           |  | (817   | ) |  |                               | 14.61 |                                          |      |                         |   |        
|Forfeited                                           |  | (166   | ) |  |                               | 22.79 |                                          |      |                         |   |        
|Expired                                             |  | (13    | ) |  |                               | 16.62 |                                          |      |                         |   |        
|                                                    |  |        |   |  |                               |       |                                          |      |                         |   |        
|Outstanding at September 30, 2006                   |  | 6,975  |   |  |                               | 21.88 |                                          | 7.80 |                         | $ | 152,584
|                                                    |  |        |   |  |                               |       |                                          |      |                         |   |        
|Exercisable at September 30, 2006                   |  | 2,442  |   |  | $                             | 15.55 |                                          | 6.46 |                         | $ | 37,979 
|                                                    |  |        |   |  |                               |       |                                          |      |                         |   |        
|Vested or expected to vest at September 30, 2006    |  | 6,189  |   |  | $                             | 21.42 |                                          | 7.72 |                         | $ | 88,292 
|                                                    |  |        |   |  |                               |       |                                          |      |                         |   |        



17



---

##### Table of Contents

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

9. STOCK PLANS (continued)

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

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



|                                 |  |        |   |  |                                      |      
|-------------------------------- |  | ------ | - |  | ------------------------------------ | -----
|(shares in thousands)            |  | Shares |   |  | Weighted-AverageGrant DateFair Value
|Non-vested options               |  |        |   |  |                                      |      
|Non-vested at January 1, 2006    |  | 3,744  |   |  | $                                    | 10.09
|Granted                          |  | 1,484  |   |  |                                      | 15.93
|Vested                           |  | (529   | ) |  |                                      | 8.37 
|Forfeited                        |  | (166   | ) |  |                                      | 11.21
|                                 |  |        |   |  |                                      |      
|Non-vested at September 30, 2006 |  | 4,533  |   |  | $                                    | 12.16
|                                 |  |        |   |  |                                      |      

As of September 30, 2006, the total unrecognized compensation cost related to non-vested
stock options was approximately $37.0 million. This cost is expected to be recognized over a weighted-average period of 2.14 years in accordance with the vesting periods of the options. The total fair value of shares vested during the nine months
ended September 30, 2005 and 2006 was $5.3 million and $4.5 million, respectively.

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



|                            |  |                                 |  |                                |  |             |  |            
|--------------------------- |  | ------------------------------- |  | ------------------------------ |  | ----------- |  | -----------
|                            |  | Three Months EndedSeptember 30, |  | Nine Months EndedSeptember 30,
|                            |  | 2005                            |  | 2006                           |  | 2005        |  | 2006       
|Expected term (years)       |  | 5.00                            |  | 4.50                           |  | 5.00        |  | 4.50       
|Dividend yield (%)          |  | 0.00                            |  | 0.28                           |  | 0.00        |  | 0.28-0.32  
|Risk-free interest rate (%) |  | 4.13                            |  | 5.11                           |  | 3.72-4.18   |  | 4.36-5.11  
|Expected volatility (%)     |  | 50.93                           |  | 40.58                          |  | 50.93-52.55 |  | 40.58-51.39

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



18



---

##### Table of Contents

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

9. STOCK PLANS (continued)

Restricted Stock

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

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

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

Employee Stock Purchase Plan

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



19



---

##### Table of Contents

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

9. STOCK PLANS (continued)

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



|                            |  |                                 |  |                                |  |       |  |            
|--------------------------- |  | ------------------------------- |  | ------------------------------ |  | ----- |  | -----------
|                            |  | Three Months EndedSeptember 30, |  | Nine Months EndedSeptember 30,
|                            |  | 2005                            |  | 2006                           |  | 2005  |  | 2006       
|Expected term (years)       |  | 0.50                            |  | 0.50                           |  | 0.50  |  | 0.50       
|Dividend yield (%)          |  | 0.00                            |  | 0.28                           |  | 0.00  |  | 0.28-0.32  
|Risk-free interest rate (%) |  | 4.13                            |  | 5.24                           |  | 4.13  |  | 4.37-5.24  
|Expected volatility (%)     |  | 50.93                           |  | 30.56                          |  | 50.93 |  | 30.56-40.38

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

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

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

10. INCOME TAXES

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



20



---

##### Table of Contents

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

10. INCOME TAXES (continued)

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

11. PENSION PLAN

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

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

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



|                                        |  |                                 |      |   |                                |   |      |      |  |   |        |   |  |   |        |  
|--------------------------------------- |  | ------------------------------- | ---- | - | ------------------------------ | - | ---- | ---- |  | - | ------ | - |  | - | ------ | -
|                                        |  | Three Months EndedSeptember 30, |      |   | Nine Months EndedSeptember 30, |  
|(in thousands)                          |  | 2005                            |      |   | 2006                           |   |      | 2005 |  |   | 2006   |  
|Service cost                            |  | $                               | 287  |   |                                | $ | 454  |      |  | $ | 890    |   |  | $ | 1,320  |  
|Interest cost                           |  |                                 | 496  |   |                                |   | 566  |      |  |   | 1,537  |   |  |   | 1,647  |  
|Expected return on plan assets          |  |                                 | (414 | ) |                                |   | (519 | )    |  |   | (1,283 | ) |  |   | (1,510 | )
|Amortization of transition asset amount |  |                                 | (2   | ) |                                |   |     |      |  |   | (5     | ) |  |   |       |  
|Amortization of net loss                |  |                                 | 146  |   |                                |   | 186  |      |  |   | 453    |   |  |   | 541    |  
|                                        |  |                                 |      |   |                                |   |      |      |  |   |        |   |  |   |        |  
|Net periodic pension cost               |  | $                               | 513  |   |                                | $ | 687  |      |  | $ | 1,592  |   |  | $ | 1,998  |  
|                                        |  |                                 |      |   |                                |   |      |      |  |   |        |   |  |   |        |  

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



21



---

##### Table of Contents

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

12. 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 loss or damage to property, bodily injury, general commercial liability, professional errors and omissions and medical malpractice. The Companys retentions
and deductibles associated with these insurance policies range from $0.25 million to $2.5 million.

The Company is self-insured for health
insurance for the majority of its employees located within the United States, but maintains stop-loss insurance on a claims made basis for expenses in excess of $0.25 million per member per year. As of December 31, 2005 and
September 30, 2006, the Company maintained a reserve of approximately $5.0 million and $8.4 million, respectively, included in other accrued expenses on the consolidated condensed balance sheets, to cover open claims and estimated claims
incurred but not reported.

In September 2005, the Company became a limited partner in Bay City Capital Fund IV, L.P., a venture capital
fund. The Company has committed to invest up to a maximum of $10.0 million in the Bay City Fund IV. Aggregate capital calls through September 30, 2006 totaled $3.0 million. Because no capital call can exceed 20% of the Companys aggregate
capital commitment, the Company anticipates its remaining capital commitment of $7.0 million will be made through a series of future capital calls over the next several years. The Companys capital commitment will expire in June 2009. For
further details, see Note 6.

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

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

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

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



22



---

##### Table of Contents

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

12. COMMITMENTS AND CONTINGENCIES (continued)

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

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

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

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



23



---

##### Table of Contents

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(unaudited)

12. COMMITMENTS AND CONTINGENCIES (continued)

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

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

In the normal course of business, the Company is a party to various claims and legal proceedings, including claims for alleged breaches of contract. In
one proceeding currently pending against the Company, a former client is claiming the Company breached its contract and committed tortious acts in conducting a clinical trial. That former client is claiming that it does not owe the Company the
remaining amounts due under the contract and is seeking other damages from the Companys alleged breach of contract and tortious acts. The Company records a reserve for pending and threatened litigation matters when an adverse outcome is
probable and the amount of the potential liability is reasonably estimable. Although the ultimate outcome of these matters is currently not determinable, management of the Company, after consultation with legal counsel, does not believe that the
resolution of these matters will have a material effect upon the Companys financial condition, results of operations or cash flows.

13. BUSINESS
SEGMENT DATA

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



|                               |  |                                 |        |      |                                |        |      |  |      |         |  |   |        
|------------------------------ |  | ------------------------------- | ------ | ---- | ------------------------------ | ------ | ---- |  | ---- | ------- |  | - | -------
|                               |  | Three Months EndedSeptember 30, |        |      | Nine Months EndedSeptember 30,
|(in thousands)                 |  | 2005                            |        | 2006 |                                |        | 2005 |  | 2006
|Income (loss) from operations: |  |                                 |        |      |                                |        |      |  |      |         |  |   |        
|Development                    |  | $                               | 43,609 |      | $                              | 53,648 |      |  | $    | 122,615 |  | $ | 151,901
|Discovery Sciences             |  |                                 | 13,086 |      |                                | (1,649 | )    |  |      | 6,902   |  |   | 10,055 
|                               |  |                                 |        |      |                                |        |      |  |      |         |  |   |        
|Total                          |  | $                               | 56,695 |      | $                              | 51,999 |      |  | $    | 129,517 |  | $ | 161,956
|                               |  |                                 |        |      |                                |        |      |  |      |         |  |   |        



|                     |  |                  |           |                   |   |          
|-------------------- |  | ---------------- | --------- | ----------------- | - | ---------
|                     |  | December 31,2005 |           | September 30,2006
|Identifiable assets: |  |                  |           |                   |   |          
|Development          |  | $                | 1,061,038 |                   | $ | 1,296,645
|Discovery Sciences   |  |                  | 98,562    |                   |   | 81,147   
|                     |  |                  |           |                   |   |          
|Total                |  | $                | 1,159,600 |                   | $ | 1,377,792
|                     |  |                  |           |                   |   |          



24



---

##### Table of Contents

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

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

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 terminology such as might, will, should, expect, plan,
anticipate, believe, estimate, predict, intend, potential or continue, or the negative of these terms, or other comparable terminology. These statements are only
predictions. These statements rely on a number of assumptions and estimates that could be inaccurate and that are subject to risks and uncertainties. Actual events or results might differ materially due to a number of factors, including those listed
in Potential Volatility of Quarterly Operating Results and Stock Price below and in Risk Factors included in our Annual Report on Form 10-K for the year ended December 31, 2005. Although we believe that the expectations
reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.

Company Overview

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

We have been in the drug
development business for more than 20 years. Our development services include preclinical programs and Phase I to Phase IV clinical development services. We have extensive clinical trial experience across a multitude of therapeutic areas and various
parts of the world, including regional, national and global studies. In addition, for marketed drugs, biologics and devices, we offer support services such as product launch services, medical information, patient compliance programs, patient and
disease registry programs, product safety and pharmacovigilance, Phase IV monitored studies and prescription-to-over-the-counter programs.

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

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

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



25



---

##### Table of Contents

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

Executive Overview

Our revenues are dependent on a relatively small number of industries and clients. As a result, we closely monitor the market for our services. For a
discussion of the trends affecting our market, see Item 1. Business  Trends Affecting the Drug Discovery and Development Industry in our Annual Report on Form 10-K for the year ended December 31, 2005. Although we cannot
predict the demand for CRO services for the remainder of 2006, we continue to believe that the traditional market drivers for our industry are intact. In the first half of 2006, the market opportunity was robust and we experienced a new high for our
global Phase II through IV business from a proposal volume standpoint. During the third quarter of 2006, proposal volume declined from the record levels in the first half of the year, but our proposal volume remains strong and ahead of the first
nine months of 2005. For the remainder of the year, we plan to focus our efforts on managing our recent growth, delivering timely, high quality services to our clients and improving our business development efforts in our core markets.

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

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

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



26



---

##### Table of Contents

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

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

With
regards to our Discovery Sciences segment, our preclinical oncology facility had a solid performance in 2005 and the first nine months of 2006, and is now offering models to support diabetes drug development. We have added business development
resources in an effort to generate additional sales of our biomarker services and improve future financial and operating performance. Our Discovery Sciences segment also includes our compound partnering arrangements. The DPP4 development program
with Takeda Pharmaceuticals continues to progress. For dapoxetine, J&J has indicated an intent to re-file the NDA with the FDA in 2007. We amended our agreement with Accentia to provide clinical development services for a Phase III trial of
SinuNase up to a specified dollar limitation in exchange for an increased royalty rate on certain SinuNase products. Under the amended agreement, either party can terminate the agreement by December 31, 2006, in which case we would receive a
cash payment for services rendered. We are also evaluating a new compound and are funding the laboratory work for our internal evaluation, and are working on the agreement for this potential collaboration. These drug development collaborations allow
us to leverage our resources and global drug development expertise to create new opportunities for growth and to share the risks and potential rewards of drug development with our clients. For a background discussion of our compound partnering
arrangements, see Item 1. Business  Our Services  Our Discovery Sciences Group  Compound Partnering Programs in our Annual Report on Form 10-K for the year ended December 31, 2005.

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

Acquisitions

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

New Business Authorizations and Backlog

New business authorizations, which are sales of our
services, are reflected in backlog when we enter into a contract or letter of intent or receive a verbal commitment. Authorizations can vary significantly from quarter to quarter and contracts generally have terms ranging from several months to
several years. We recognize revenue on these authorizations as services are performed. Our new authorizations for the three months ended September 30, 2005 and 2006 were $645.3 million and $531.0 million, respectively.



27



---

##### Table of Contents

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

Results of Operations

Revenue Recognition

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

In connection with the management of multi-site clinical trials, we pay, on behalf of our customers, fees to investigators and test subjects as well as
other out-of-pocket costs for items such as travel, printing, meetings and couriers. In some cases, we contract directly with these third parties and are obligated to pay these costs as the principal. In other cases, our customers contract directly
with these parties and ask us to pay them on their behalf as an administrative agent. Whether we pay these as principal or agent, our clients reimburse us for these costs. As required by Emerging Issues Task Force 01-14, amounts paid by us as a
principal for out-of-pocket costs are included in direct costs as reimbursable out-of-pocket expenses and the reimbursements we receive as a principal are reported as reimbursed out-of-pocket revenue. In our statements of operations, we combine
amounts paid by us as an agent for out-of-pocket costs with the corresponding reimbursements, or revenue, we receive as an agent. During the three months ended September 30, 2005 and 2006, fees paid to investigators and other fees we paid as an
agent and the associated reimbursements were approximately $65.1 million and $71.1 million, respectively.

Most of the contracts for our
Development segment can be terminated by our clients either immediately or after a specified period following notice. These contracts typically require payment to us of expenses to wind down a study, fees earned to date and, in some cases, a
termination fee or some portion of the fees or profit that we could have earned under the contract if it had not been terminated early. Therefore, revenue recognized prior to cancellation does not generally require a significant adjustment upon
cancellation. If we determine that a loss will result from the performance of a fixed-price contract, the entire amount of the estimated loss is charged against income in the period in which such determination is made.

The Discovery Sciences segment also generates revenue from time to time in the form of milestone payments in connection with licensing of compounds. We
only recognize milestone payments as revenue if the specified milestone is achieved and accepted by the customer, and continued performance of future research and development services related to that milestone are not required.



28



---

##### Table of Contents

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

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

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

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

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



29



---

##### Table of Contents

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

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



|                                             |  |                                            |         |   |      |   |             |  |   |             |   |  |        |  
|-------------------------------------------- |  | ------------------------------------------ | ------- | - | ---- | - | ----------- |  | - | ----------- | - |  | ------ | -
|                                             |  | Three Months EndedSeptember 30,(unaudited) |         |   |      |   |             | 
|(in thousands, except per share data)        |  | 2005                                       |         |   | 2006 |   | $ Inc (Dec) |  |   | % Inc (Dec) |  
|Net revenue:                                 |  |                                            |         |   |      |   |             |  |   |             |   |  |        |  
|Development                                  |  | $                                          | 235,148 |   |      | $ | 285,348     |  | $ | 50,200      |   |  | 21.3   | %
|Discovery Sciences                           |  |                                            | 19,458  |   |      |   | 4,456       |  |   | (15,002     | ) |  | (77.1  | )
|Reimbursed out-of-pockets                    |  |                                            | 18,674  |   |      |   | 23,344      |  |   | 4,670       |   |  | 25.0   |  
|                                             |  |                                            |         |   |      |   |             |  |   |             |   |  |        |  
|Total net revenue                            |  |                                            | 273,280 |   |      |   | 313,148     |  |   | 39,868      |   |  | 14.6   |  
|                                             |  |                                            |         |  
|Direct costs:                                |  |                                            |         |   |      |   |             |  |   |             |   |  |        |  
|Development                                  |  |                                            | 118,910 |   |      |   | 144,121     |  |   | 25,211      |   |  | 21.2   |  
|Discovery Sciences                           |  |                                            | 2,178   |   |      |   | 2,416       |  |   | 238         |   |  | 10.9   |  
|Reimbursable out-of-pocket expenses          |  |                                            | 18,674  |   |      |   | 23,344      |  |   | 4,670       |   |  | 25.0   |  
|                                             |  |                                            |         |   |      |   |             |  |   |             |   |  |        |  
|Total direct costs                           |  |                                            | 139,762 |   |      |   | 169,881     |  |   | 30,119      |   |  | 21.6   |  
|                                             |  |                                            |         |  
|Research and development expenses            |  |                                            | 1,967   |   |      |   | 1,887       |  |   | (80         | ) |  | (4.1   | )
|Selling, general and administrative expenses |  |                                            | 64,417  |   |      |   | 77,247      |  |   | 12,830      |   |  | 19.9   |  
|Depreciation                                 |  |                                            | 10,135  |   |      |   | 12,008      |  |   | 1,873       |   |  | 18.5   |  
|Amortization                                 |  |                                            | 279     |   |      |   | 84          |  |   | (195        | ) |  | (69.9  | )
|Loss on impairment and disposal of assets    |  |                                            | 25      |   |      |   | 42          |  |   | 17          |   |  | 68.0   |  
|                                             |  |                                            |         |   |      |   |             |  |   |             |   |  |        |  
|Income from operations                       |  |                                            | 56,695  |   |      |   | 51,999      |  |   | (4,696      | ) |  | (8.3   | )
|                                             |  |                                            |         |  
|Impairment of equity investment              |  |                                            | (3,797  | ) |      |   |            |  |   | 3,797       |   |  | (100.0 | )
|Interest and other income, net               |  |                                            | 2,803   |   |      |   | 3,778       |  |   | 975         |   |  | 34.8   |  
|                                             |  |                                            |         |   |      |   |             |  |   |             |   |  |        |  
|Income before provision for income taxes     |  |                                            | 55,701  |   |      |   | 55,777      |  |   | 76          |   |  | 0.1    |  
|Provision for income taxes                   |  |                                            | 19,941  |   |      |   | 18,964      |  |   | (977        | ) |  | (4.9   | )
|                                             |  |                                            |         |   |      |   |             |  |   |             |   |  |        |  
|Net income                                   |  | $                                          | 35,760  |   |      | $ | 36,813      |  | $ | 1,053       |   |  | 2.9    | %
|                                             |  |                                            |         |   |      |   |             |  |   |             |   |  |        |  
|Net income per diluted share                 |  | $                                          | 0.31    |   |      | $ | 0.31        |  | $ | 0.00        |   |  | 0.0    | %
|                                             |  |                                            |         |   |      |   |             |  |   |             |   |  |        |  

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

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

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



30



---

##### Table of Contents

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

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

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

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

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

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

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

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



31



---

##### Table of Contents

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

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



|                                             |  |                                           |         |   |      |   |             |  |   |             |   |  |        |  
|-------------------------------------------- |  | ----------------------------------------- | ------- | - | ---- | - | ----------- |  | - | ----------- | - |  | ------ | -
|                                             |  | Nine Months EndedSeptember 30,(unaudited) |         |   |      |   |             | 
|(in thousands, except per share data)        |  | 2005                                      |         |   | 2006 |   | $ Inc (Dec) |  |   | % Inc (Dec) |  
|Net revenue:                                 |  |                                           |         |   |      |   |             |  |   |             |   |  |        |  
|Development                                  |  | $                                         | 672,931 |   |      | $ | 821,987     |  | $ | 149,056     |   |  | 22.2   | %
|Discovery Sciences                           |  |                                           | 35,954  |   |      |   | 27,955      |  |   | (7,999      | ) |  | (22.2  | )
|Reimbursed out-of-pockets                    |  |                                           | 53,591  |   |      |   | 71,528      |  |   | 17,937      |   |  | 33.5   |  
|                                             |  |                                           |         |   |      |   |             |  |   |             |   |  |        |  
|Total net revenue                            |  |                                           | 762,476 |   |      |   | 921,470     |  |   | 158,994     |   |  | 20.9   |  
|                                             |  |                                           |         |  
|Direct costs:                                |  |                                           |         |   |      |   |             |  |   |             |   |  |        |  
|Development                                  |  |                                           | 342,891 |   |      |   | 412,560     |  |   | 69,669      |   |  | 20.3   |  
|Discovery Sciences                           |  |                                           | 6,212   |   |      |   | 6,893       |  |   | 681         |   |  | 11.0   |  
|Reimbursable out-of-pocket expenses          |  |                                           | 53,591  |   |      |   | 71,528      |  |   | 17,937      |   |  | 33.5   |  
|                                             |  |                                           |         |   |      |   |             |  |   |             |   |  |        |  
|Total direct costs                           |  |                                           | 402,694 |   |      |   | 490,981     |  |   | 88,287      |   |  | 21.9   |  
|                                             |  |                                           |         |  
|Research and development expenses            |  |                                           | 22,233  |   |      |   | 3,829       |  |   | (18,404     | ) |  | (82.8  | )
|Selling, general and administrative expenses |  |                                           | 184,049 |   |      |   | 228,478     |  |   | 44,429      |   |  | 24.1   |  
|Depreciation                                 |  |                                           | 28,006  |   |      |   | 34,317      |  |   | 6,311       |   |  | 22.5   |  
|Amortization                                 |  |                                           | 846     |   |      |   | 481         |  |   | (365        | ) |  | (43.1  | )
|Loss on impairment and disposal of assets    |  |                                           | 275     |   |      |   | 1,428       |  |   | 1,153       |   |  | 419.3  |  
|Gain on exchange of assets                   |  |                                           | (5,144  | ) |      |   |            |  |   | 5,144       |   |  | (100.0 | )
|                                             |  |                                           |         |   |      |   |             |  |   |             |   |  |        |  
|Income from operations                       |  |                                           | 129,517 |   |      |   | 161,956     |  |   | 32,439      |   |  | 25.0   |  
|                                             |  |                                           |         |  
|Impairment of equity investment              |  |                                           | (3,797  | ) |      |   |            |  |   | 3,797       |   |  | (100.0 | )
|Interest and other income, net               |  |                                           | 6,875   |   |      |   | 11,258      |  |   | 4,383       |   |  | 63.8   |  
|                                             |  |                                           |         |   |      |   |             |  |   |             |   |  |        |  
|Income before provision for income taxes     |  |                                           | 132,595 |   |      |   | 173,214     |  |   | 40,619      |   |  | 30.6   |  
|Provision for income taxes                   |  |                                           | 43,155  |   |      |   | 58,141      |  |   | 14,986      |   |  | 34.7   |  
|                                             |  |                                           |         |   |      |   |             |  |   |             |   |  |        |  
|Net income                                   |  | $                                         | 89,440  |   |      | $ | 115,073     |  | $ | 25,633      |   |  | 28.7   | %
|                                             |  |                                           |         |   |      |   |             |  |   |             |   |  |        |  
|Net income per diluted share                 |  | $                                         | 0.77    |   |      | $ | 0.97        |  | $ | 0.20        |   |  | 26.0   | %
|                                             |  |                                           |         |   |      |   |             |  |   |             |   |  |        |  

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

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

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



32



---

##### Table of Contents

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

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

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

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

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

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

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

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



33



---

##### Table of Contents

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

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

Liquidity and Capital Resources

As of September 30, 2006, we had $120.9 million of cash and cash equivalents and $251.4 million of short-term investments. Our cash and cash
equivalents are invested in financial instruments that are rated A or better by Standard & Poors or Moodys and earn interest at market rates. Our expected primary cash needs on both a short- and long-term basis are for capital
expenditures, including our new corporate headquarters facility, expansion of services, possible acquisitions, investments and compound partnering collaborations, geographic expansion, dividends, working capital and other general corporate purposes.
We have historically funded our operations, dividends and growth, including acquisitions, primarily with cash flow from operations. In the first quarter of 2006, we entered into a construction loan to finance the construction of our new corporate
headquarters building and related parking facility in Wilmington, North Carolina.

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

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

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



34



---

##### Table of Contents

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



|                                                                   |  |                  |         |                   |   |             |  |   |         |  
|------------------------------------------------------------------ |  | ---------------- | ------- | ----------------- | - | ----------- |  | - | ------- | -
|(in thousands)                                                     |  | December 31,2005 |         | September 30,2006 |   | $ Inc (Dec) | 
|Current assets:                                                    |  |                  |         |                   |   |             |  |   |         |  
|Cash and cash equivalents                                          |  | $                | 182,000 |                   | $ | 120,858     |  | $ | (61,142 | )
|Short-term investments                                             |  |                  | 137,820 |                   |   | 251,351     |  |   | 113,531 |  
|Accounts receivable and unbilled services, net                     |  |                  | 303,386 |                   |   | 388,112     |  |   | 84,726  |  
|Income tax receivable                                              |  |                  | 14      |                   |   | 107         |  |   | 93      |  
|Investigator advances                                              |  |                  | 13,578  |                   |   | 11,311      |  |   | (2,267  | )
|Prepaid expenses and other current assets                          |  |                  | 34,651  |                   |   | 54,503      |  |   | 19,852  |  
|Deferred tax assets                                                |  |                  | 11,435  |                   |   | 12,044      |  |   | 609     |  
|                                                                   |  |                  |         |                   |   |             |  |   |         |  
|Total current assets                                               |  | $                | 682,884 |                   | $ | 838,286     |  | $ | 155,402 |  
|                                                                   |  |                  |        
|Current liabilities:                                               |  |                  |         |                   |   |             |  |   |         |  
|Accounts payable                                                   |  | $                | 10,363  |                   | $ | 15,678      |  | $ | 5,315   |  
|Payables to investigators                                          |  |                  | 43,126  |                   |   | 39,368      |  |   | (3,758  | )
|Accrued income taxes                                               |  |                  | 18,099  |                   |   | 28,117      |  |   | 10,018  |  
|Other accrued expenses                                             |  |                  | 119,304 |                   |   | 137,742     |  |   | 18,438  |  
|Deferred tax liabilities                                           |  |                  | 85      |                   |   | 97          |  |   | 12      |  
|Unearned income                                                    |  |                  | 162,662 |                   |   | 174,035     |  |   | 11,373  |  
|Current maturities of long-term debt and capital lease obligations |  |                  | 1,607   |                   |   | 534         |  |   | (1,073  | )
|                                                                   |  |                  |         |                   |   |             |  |   |         |  
|Total current liabilities                                          |  | $                | 355,246 |                   | $ | 395,571     |  | $ | 40,325  |  
|                                                                   |  |                  |        
|Working capital                                                    |  | $                | 327,638 |                   | $ | 442,715     |  | $ | 115,077 |  

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

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

In July 2006, we renewed our $50.0 million revolving credit facility with Bank of America, N. A. Indebtedness
under the facility is unsecured and subject to traditional covenants relating to financial ratios and restrictions on certain types of transactions. This revolving credit facility does not expressly restrict or limit the payment of dividends, and we
do not expect any of the covenants to affect our ability to pay dividends under our cash dividend policy for the foreseeable future. Outstanding borrowings under the facility bear interest at an annual fluctuating rate equal to the one-month London
Interbank Offered Rate, or LIBOR, plus a margin of 0.60%. Borrowings under this credit facility are available to provide working capital and for general corporate purposes. As of September 30, 2006, no amounts were outstanding under this credit
facility and we were in compliance with the covenants in the loan agreement. The aggregate amount we are able to borrow has been reduced by $1.25 million due to outstanding letters of credit issued



35



---

##### Table of Contents

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

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

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

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

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

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

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

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



36



---

##### Table of Contents

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

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

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

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

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



37



---

##### Table of Contents

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

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

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

Critical Accounting Policies and Estimates

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

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

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

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



38



---

##### Table of Contents

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

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

Recent Accounting Pronouncements

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



|               |  |                                                                                                                                                                                     |  |                                                                                      
|-------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------
|Date           |  | Title                                                                                                                                                                               |  | Effective Date                                                                       
|               |  |                                                                                                                                                                                    
|December 2004  |  | SFAS No. 123 (revised 2004), Share-Based Payment                                                                                                                                  |  | First fiscal year that begins after June 15, 2005                                    
|               |  |                                                                                                                                                                                    
|March 2005     |  | Interpretation No. 47, Accounting for Conditional Asset Retirement Obligation                                                                                                     |  | End of fiscal years ending after December 15, 2005                                   
|               |  |                                                                                                                                                                                    
|May 2005       |  | SFAS No. 154, Accounting Changes and Error Corrections                                                                                                                            |  | Fiscal years beginning after December 15, 2005                                       
|               |  |                                                                                                                                                                                    
|June 2005      |  | EITF Issue 05-6, Determining the Amortization Period for Leasehold Improvements Purchased after Lease Inception or Acquired in a Business Combination                             |  | Reporting periods beginning after June 29, 2005                                      
|               |  |                                                                                                                                                                                    
|October 2005   |  | Staff Position FAS 13-1, Accounting for Rental Costs Incurred During a Construction Period                                                                                        |  | First reporting period beginning after December 15, 2005                             
|               |  |                                                                                                                                                                                    
|November 2005  |  | Staff Position FAS 115-1 and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments                                                 |  | Reporting periods beginning after December 15, 2005                                  
|               |  |                                                                                                                                                                                    
|June 2006      |  | EITF Issue 06-3, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net
Presentation) |  | Reporting periods beginning after December 15, 2006                                  
|               |  |                                                                                                                                                                                    
|June 2006      |  | Staff Position FIN 46(R)-6, Determining the Variability to Be Considered in Applying FASB Interpretation No. 46(R)                                                                |  | First day of the reporting period beginning after June 15, 2006                      
|               |  |                                                                                                                                                                                    
|July 2006      |  | Interpretation No. 48, Accounting for Uncertainty in Income Taxes  an interpretation of FASB Statement No. 109                                                                   |  | Fiscal years beginning after December 15, 2006                                       
|               |  |                                                                                                                                                                                    
|September 2006 |  | SFAS No. 157, Fair Value Measurements                                                                                                                                             |  | Fiscal years beginning after November 15, 2007 and interim periods within those years



39



---

##### Table of Contents

|               |  |                                                                                                                                                                |  |                                                                                                                                                                             
|-------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Date           |  | Title                                                                                                                                                          |  | Effective Date                                                                                                                                                              
|September 2006 |  | SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans  an amendment of FASB Statements No. 87, 88, 106, and
132(R) |  | Recognition of asset and liability of funded status  fiscal years ending after December 15, 2006. Measure-ment date provision  fiscal years ending after December 15,
2008
|               |  |                                                                                                                                                               
|September 2006 |  | Staff Accounting Bulletin 108 Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements        |  | Fiscal years ending after November 15, 2006                                                                                                                                 

Income Taxes

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

Inflation

Our long-term contracts, those in excess
of one year, generally include an inflation or cost of living adjustment for the portion of the services to be performed beyond one year from the contract date. In the event that actual inflation rates are greater than our contractual inflation
rates or cost of living adjustments, inflation could have a material adverse effect on our operations or financial condition.

Potential Liability and
Insurance

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

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:



| |  |  | management of growth;
| | - |  | ---------------------



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



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



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



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



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



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



40



---

##### Table of Contents

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



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



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



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



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



| |  |  | 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; 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. For these reasons, we believe that comparisons of our quarterly financial
results are not necessarily meaningful and should not be relied upon as an indication of future performance.

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

Item 3. Quantitative and Qualitative Disclosures about Market Risk

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

The vast majority of our contracts are entered into by our U.S. or U.K. subsidiaries. The contracts entered into by
the U.S. subsidiaries are almost always denominated in U.S. dollars. Contracts entered into by our U.K. subsidiaries are generally denominated in pounds sterling, U.S. dollars or euros, with the majority in U.S. dollars. Although an increase in
exchange rates for the pound sterling or euro relative to the U.S. dollar would increase net revenue from contracts denominated in these currencies, a negative impact on income from operations results from dollar-denominated contracts for services
rendered in countries other than the United States. In these cases, revenue is not impacted by the weakening of the U.S. dollar, but the costs associated with performing these contracts, which are paid in local currency, are negatively impacted when
translated into U.S. dollars. In January 2004, we began engaging in hedging activities in an effort to manage our potential foreign exchange exposure. Our last economic hedge deal expired June 30, 2006.

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



41



---

##### Table of Contents

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

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

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



| |  |  | 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 us.

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

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

Item 4. Controls and Procedures

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, we carried out an evaluation, under the
supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(b). Based upon that
evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective to provide the reasonable assurance discussed above.

Internal Control Over Financial Reporting

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



42



---

##### Table of Contents

Part II. OTHER INFORMATION

Item 6. Exhibits



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



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



43



---

##### Table of Contents

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 6, 2006



44