##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549
    FORM 10-Q (Mark One) þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended March 31, 2004ORo
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934For the transition period
from 
toCommission file number
 INVERESK RESEARCH GROUP, INC.  Delaware
(State or Other Jurisdiction of
Incorporation or Organization)

    
    43-1955097
(I.R.S. Employer Identification No.)11000 Weston Parkway, Cary, NC
(Address of Principal Executive Offices)
    
    27513
(Zip Code)
 (919) 460-9005
(Registrants Telephone Number, Including Area Code) 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 o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes x No o Indicate the number of shares outstanding of each of the issuers classes
of common stock, as of the latest practicable date. Common stock, par value $0.01 per share
    
    38,025,570at April 30, 2004




---



TABLE OF CONTENTS PagePART I FINANCIAL INFORMATION
    
    
    1ITEM 1.FINANCIAL STATEMENTS (UNAUDITED)
    
    
    1Condensed Consolidated Statements of Operations
    
    
    1Condensed Consolidated Balance Sheets
    
    
    2Condensed Consolidated Statements of Cash Flows
    
    
    3Condensed Consolidated Statements of Comprehensive Income and Shareholders Equity
    
    
    4Notes to Condensed Consolidated Financial Statements
    
    
    5ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION
    
    
    15ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
    
    
    24ITEM 4. CONTROLS AND PROCEDURES
    
    
    26PART II OTHER INFORMATION
    
    
    27EX-31.1: CERTIFICATIONEX-31.2: CERTIFICATIONEX-32.1: CERTIFICATIONEX-32.2: CERTIFICATION
  Statements contained in this Form 10-Q that are forward-looking are based on
current expectations that are subject to a number of uncertainties and risks
and actual results may differ materially. Factors that might cause such a
difference include but are not limited to risks associated with: the reduction
in research and development activities by pharmaceutical and biotechnology
clients, changes in government regulations, the effect of interest rate and
foreign exchange rate fluctuations, our ability to attract and retain
employees, the loss or delay of contracts due to economic uncertainty or other
factors, our ability to efficiently manage backlog, our ability to expand our
business through strategic acquisitions, competition within the industry and
the potential adverse impact of healthcare reform. i




---



##### Table of Contents



PART I FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS (UNAUDITED) 
 Inveresk Research Group, Inc. Condensed Consolidated Statements of Operations (unaudited)
(In thousands, except per share and share data) Quarter ended
    
    Quarter endedMarch 31,
    
    March 31,2004
    
    2003Net service revenue
    
    $
    76,738
    
    
    $
    57,684Direct costs excluding depreciation
    
    
    (39,921
    )
    
    
    (29,278
    )36,817
    
    
    
    28,406Selling, general and administrative expenses:Share offering expenses
    
    
    (306
    )
    
    
    (658
    )Other selling, general and administrative expenses
    
    
    (19,853
    )
    
    
    (16,228
    )Total selling, general and administrative expenses
    
    
    (20,159
    )
    
    
    (16,886
    )Depreciation
    
    
    (3,465
    )
    
    
    (2,949
    )Amortization of intangibles
    
    
    (348
    )
    
    
    Income from operations
    
    
    12,845
    
    
    
    8,571Interest income
    
    
    101
    
    
    
    72Interest expense
    
    
    (899
    )
    
    
    (971
    )Income before income taxes
    
    
    12,047
    
    
    
    7,672Provision for income taxes
    
    
    250
    
    
    
    (295
    )Net income
    
    $
    12,297
    
    
    $
    7,377Earnings per share:Basic
    
    $
    0.32
    
    
    $
    0.20Diluted
    
    $
    0.31
    
    
    $
    0.20Weighted average number of common shares outstanding:Basic
    
    
    37,923,816
    
    
    
    36,081,610Diluted
    
    
    39,160,749
    
    
    
    37,366,463
 See accompanying notes to condensed consolidated financial statements.




---



##### Table of Contents



Inveresk Research Group, Inc. Condensed Consolidated Balance Sheets
(In thousands, except share data) March 31, 2004
    
    December 31,(unaudited)
    
    2003ASSETSCurrent assets:Cash and cash equivalents
    
    $
    24,928
    
    
    $
    24,579Accounts receivable, net
    
    
    42,459
    
    
    
    53,391Unbilled receivables, net
    
    
    32,759
    
    
    
    24,331Income taxes receivable
    
    
    5,126
    
    
    
    4,045Inventories
    
    
    1,408
    
    
    
    1,619Deferred income taxes
    
    
    2,935
    
    
    
    144Other current assets
    
    
    9,720
    
    
    
    6,902Total current assets
    
    
    119,335
    
    
    
    115,011Property, plant and equipment, net
    
    
    149,110
    
    
    
    145,364Goodwill
    
    
    172,993
    
    
    
    184,239Intangible assets
    
    
    1,855
    
    
    
    2,203Deferred income taxes
    
    
    12,619
    
    
    
    669Deferred debt issue costs
    
    
    1,506
    
    
    
    1,593$
    457,418
    
    
    $
    449,079LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    17,574
    
    
    $
    20,389Advance billings
    
    
    57,462
    
    
    
    56,745Accrued expenses
    
    
    25,012
    
    
    
    29,050Income taxes payable
    
    
    2,345
    
    
    
    2,018Deferred income taxes
    
    
    290
    
    
    
    334Current portion of long term debt
    
    
    7,634
    
    
    
    7,857Total current liabilities
    
    
    110,317
    
    
    
    116,393Deferred income taxes
    
    
    23,226
    
    
    
    22,994Long term debt
    
    
    49,220
    
    
    
    50,941Defined benefit pension plan obligation
    
    
    25,849
    
    
    
    24,576Commitments and contingenciesShareholders equity:Preferred stock, $0.01 par value 10,000,000 shares authorized, none issued
    
    
    
    
    
    
    Common stock, $0.01 par value 150,000,000 shares authorized; 37,980,837
and 37,863,498 outstanding at March 31, 2004 and December 31, 2003
    
    
    380
    
    
    
    379Additional paid-in capital
    
    
    212,369
    
    
    
    211,963Retained earnings
    
    
    16,626
    
    
    
    4,329Accumulated other comprehensive income
    
    
    19,431
    
    
    
    17,504Total shareholders equity
    
    
    248,806
    
    
    
    234,175$
    457,418
    
    
    $
    449,079
 See accompanying notes to condensed consolidated financial statements. -2-




---



##### Table of Contents



Inveresk Research Group, Inc. Condensed Consolidated Statements of Cash Flows (unaudited)
(In thousands) Quarter ended
    
    Quarter endedMarch 31, 2004
    
    March 31, 2003CASH FLOWS FROM OPERATING ACTIVITIESNet income
    
    $
    12,297
    
    
    $
    7,377Adjustments to reconcile net income to net cash provided by operating activities:Depreciation of property, plant and equipment
    
    
    3,465
    
    
    
    2,949Amortization of intangible assets
    
    
    348
    
    
    
    Deferred pension obligations
    
    
    490
    
    
    
    401Deferred income taxes
    
    
    (1,042
    )
    
    
    (278
    )Amortization of deferred loan issue costs
    
    
    92
    
    
    
    42Changes in operating assets and liabilities:Accounts receivable
    
    
    3,525
    
    
    
    (688
    )Advance billings
    
    
    (249
    )
    
    
    (790
    )Inventories
    
    
    211
    
    
    
    (36
    )Accounts payable and accrued expenses
    
    
    (4,453
    )
    
    
    (1,108
    )Income taxes
    
    
    (808
    )
    
    
    (353
    )Other assets and liabilities
    
    
    (2,760
    )
    
    
    (2,731
    )Net cash provided by operating activities
    
    
    11,116
    
    
    
    4,785CASH FLOWS FROM INVESTING ACTIVITIESPurchases of property, plant and equipment
    
    
    (8,707
    )
    
    
    (4,302
    )Net cash used in investing activities
    
    
    (8,707
    )
    
    
    (4,302
    )CASH FLOWS FROM FINANCING ACTIVITIESIssue of common stock
    
    
    407
    
    
    
    66Payment of deferred debt issue costs
    
    
    (5
    )
    
    
    (58
    )Repayments of long-term debt
    
    
    (1,938
    )
    
    
    (5,000
    )Net cash provided by (used in) financing activities
    
    
    (1,536
    )
    
    
    (4,992
    )Effect of foreign currency exchange rate changes on cash
    
    
    (524
    )
    
    
    708Increase (decrease) in cash and cash equivalents
    
    
    349
    
    
    
    (3,801
    )Cash and cash equivalents at beginning of period
    
    
    24,579
    
    
    
    19,909Cash and cash equivalents at end of period
    
    $
    24,928
    
    
    $
    16,108Supplemental cash flow information:Interest paid
    
    $
    762
    
    
    $
    18Income tax paid
    
    $
    971
    
    
    $
    463
 See accompanying notes to condensed consolidated financial statements. -3-




---



##### Table of Contents



Inveresk Research Group, Inc. Condensed Consolidated Statements of Comprehensive Income and Shareholders Equity
(unaudited)
(In thousands, except share data) Shares ofCommon
    
    
    
    
    
    Par
    
    
    
    
    
    Retained
    
    AccumulatedStock
    
    Total
    
    Value
    
    Additional
    
    Earnings
    
    Other$0.01 Par
    
    Shareholders
    
    Paid-in
    
    Paid-in
    
    (Accumulated
    
    ComprehensiveValue
    
    equity
    
    Capital
    
    Capital
    
    Deficit)
    
    Income (Loss)Balance at December 31, 2003
    
    
    37,863,498
    
    
    $
    234,175
    
    
    $
    379
    
    
    $
    211,963
    
    
    $
    4,329
    
    
    $
    17,504Issue of common stock
    
    
    117,339
    
    
    
    407
    
    
    
    1
    
    
    
    406
    
    
    
    
    
    
    
    Comprehensive income (loss):Foreign currency translation
adjustments
    
    
    
    
    
    
    1,776
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,776Tax benefit arising on
options granted on or after
June 27, 2002
    
    
    
    
    
    
    151
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    151Net income for period toMarch 31, 2004
    
    
    
    
    
    
    12,297
    
    
    
    
    
    
    
    
    
    
    
    12,297
    
    
    
    Comprehensive income
    
    
    
    
    
    
    14,224Balance at March 31, 2004
    
    
    37,980,837
    
    
    $
    248,806
    
    
    $
    380
    
    
    $
    212,369
    
    
    $
    16,626
    
    
    $
    19,431Balance at December 31, 2002
    
    
    36,004,777
    
    
    $
    152,403
    
    
    $
    360
    
    
    $
    191,618
    
    
    $
    (33,793
    )
    
    $
    (5,782
    )Issue of common stock
    
    
    260,483
    
    
    
    66
    
    
    
    3
    
    
    
    63
    
    
    
    
    
    
    
    Comprehensive income:Foreign currency translation
adjustments
    
    
    
    
    
    
    2,901
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,901Net income for period to
March 31, 2003
    
    
    
    
    
    
    7,377
    
    
    
    
    
    
    
    
    
    
    
    7,377
    
    
    
    Comprehensive income
    
    
    
    
    
    
    10,278Balance at March 31, 2003
    
    
    36,265,260
    
    
    $
    162,747
    
    
    $
    363
    
    
    $
    191,681
    
    
    $
    (26,416
    )
    
    $
    (2,881
    )
 See accompanying notes to condensed consolidated financial statements. -4-




---



##### Table of Contents



Inveresk Research Group, Inc. Notes to Condensed Consolidated Financial Statements 1. Description of Business Inveresk Research Group, Inc. and its subsidiaries (collectively the Company)
provide drug development services to companies in the pharmaceutical and
biotechnology industries. Through the Companys pre-clinical and clinical
business segments, it offers a broad range of drug development services,
including pre-clinical safety and pharmacology evaluation, laboratory sciences
services and clinical development services. The Company is one of a small
number of drug development service companies currently providing a
comprehensive range of pre-clinical and clinical development services on a
worldwide basis. The Companys client base includes major pharmaceutical
companies in North America, Europe, and Japan, as well as many biotechnology
and specialty pharmaceutical companies. 2. Basis of Presentation The accompanying condensed consolidated financial statements have been prepared
pursuant to the rules and regulations of the Securities and Exchange Commission
(SEC). In accordance with those rules and regulations, they do not include
all of the information and footnotes required by accounting principles
generally accepted in the United States (GAAP) for complete financial
statements. In the opinion of management, the accompanying unaudited condensed consolidated
financial statements contain all adjustments (consisting only of normal
recurring adjustments) considered necessary to present fairly the financial
position, results of operation and cash flows for the interim periods
presented. The December 31, 2003 balance sheet was derived from audited
financial statements, but does not include all disclosures required by GAAP.
However, the Company believes that the disclosures are adequate to make the
information presented not misleading. The financial statements should be read
in conjunction with the audited consolidated financial statements at and for
the year ended December 31, 2003 filed with the SEC on Form 10-K. The results
of operation for the quarter ended March 31, 2004 are not necessarily
indicative of the results of operation that may be expected for the year ending
December 31, 2004. 3. Summary of Significant Accounting Policies Earnings Per Share Earnings per share is computed in accordance with Statements of Financial
Accounting Standards (SFAS) 128, Earnings per Share. SFAS 128 requires
presentation of both basic earnings per share (Basic EPS) and diluted
earnings per share (Diluted EPS). Basic EPS is based on the weighted average
number of common shares outstanding during the year while Diluted EPS also
includes the dilutive effect of share options. The number of share options not
reflected in Diluted EPS because they were anti-dilutive was nil in respect of
the quarter ended March 31, 2004 and 11,000 in respect of the quarter ended
March 31, 2003. Stock-Based Compensation The Company accounts for stock-based awards to employees using the intrinsic
value method prescribed in Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees"(APB 25). Compensation cost for
stock options granted to employees is based on the excess of the quoted market
price of the Companys stock on the measurement date over the amount an
employee must pay to acquire the stock (the intrinsic value) and is
recognized over the vesting -5-




---



##### Table of Contents



Inveresk Research Group, Inc. Notes to Condensed Consolidated Financial Statements period. No compensation cost was recognized in respect of options where the
vesting of the options was conditional upon the listing of the Companys shares
on a recognized stock exchange, prior to the condition being met. Once the
condition was met, the compensation expense was recorded in full on the date
when the condition was satisfied. Had compensation expense been determined for the Companys option grants
consistent with the provisions of SFAS No. 123 Accounting for Stock Based
Compensation (SFAS 123), the Companys net income (loss) for the periods
shown below would have reflected the pro forma amounts set forth in the table
below. Quarter ended
    
    Quarter endedMarch 31, 2004
    
    March 31, 2003(Dollars in thousands, except per share data)Reported net income
    
    $
    12,297
    
    
    $
    7,377Compensation expense in respect of stock options deducted in the computation of
reported net income
    
    
    
    
    
    
    Compensation expense in respect of stock options computed on the fair value method
    
    
    (746
    )
    
    
    (313
    )Pro forma net income
    
    $
    11,551
    
    
    $
    7,064Reported basic earnings per share
    
    $
    0.32
    
    
    $
    0.20Pro forma basic earnings per share
    
    $
    0.31
    
    
    $
    0.20Reported diluted earnings per share
    
    $
    0.31
    
    
    $
    0.20Pro forma diluted earnings per share
    
    $
    0.29
    
    
    $
    0.19
 The assumptions underlying the calculation of this pro forma data are described
in Note 7. New Accounting Pronouncements On March 2004, the EITF reached a consensus on Issue 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments
(EITF 03-01). EITF 03-01 is applicable to (a) debt and equity securities
within the scope of Statement 115, (b) debt and equity securities within the
scope of Statement 124 and that are held by an investor that reports a
performance indicator, and (c) equity securities not within the scope of
Statement 115 and not accounted for under Opinion 18s equity method (e.g.,
cost method investments). EITF 03-01 provides a step model to determine whether
an investment is impaired and if an impairment is other-than-temporary. In
addition, it requires that investors provide certain disclosures for cost
method investments and, if applicable, other information related specifically
to cost method investments, such as the aggregate carrying amount of cost
method investments, the aggregate amount of cost method investments that the
investor did not evaluate for impairment because an impairment indicator was
not present, and the situations under which the fair value of a cost method
investment is not estimated. The disclosures related to cost method investments
should not be aggregated with other types of investments. The EITF 03-01
impairment model shall be applied prospectively to all current and future
investments within the scope of the Issue, effective in reporting periods
beginning after June 15, 2004. The disclosure requirements are effective for
annual periods for fiscal years ending after June 15, 2004. -6-




---



##### Table of Contents



Inveresk Research Group, Inc. Notes to Condensed Consolidated Financial Statements 4. Business Acquisitions On July 29, 2003 the Company acquired all of the outstanding capital stock of
PharmaResearch Corporation (PharmaResearch) for $43.2 million, financed
through bank borrowings. The results of operations of PharmaResearch have been
included in the consolidated financial statements since that date.
PharmaResearch was a U.S.-based drug development services group focused on the
provision of Phase II-IV clinical trials support services, principally in the
areas of respiratory and infectious diseases. PharmaResearch was based in
Morrisville and Wilmington, North Carolina, with foreign operations based in
the United Kingdom, France, Spain and China. Restructuring and integration of PharmaResearch The Company established a plan at the acquisition date, July 29, 2003, to
integrate the operations of PharmaResearch with our existing operations. The
actions covered by the integration included a reduction of 58 employees (37
employees of PharmaResearch and 21 employees of our company), the relocation of
the Morrisville, North Carolina operations of PharmaResearch to our premises in
Cary, North Carolina, integration of certain administrative functions and
operating entities between the two businesses, combination of the
PharmaResearch operations in London, Paris and Madrid with those of our company
and the closure of certain office premises. In connection with the integration plan the Company has recorded a provision of
$2.6 million that was reflected in the purchase price allocation and a
provision of $1.1 million that was reflected on our consolidated statement of
operations in restructuring and integration costs arising from business
acquisitions in 2003. The Company implemented the headcount reductions in
early September, with 37 former PharmaResearch employees and 21 former Inveresk
employees leaving the Company during September 2003. By January 2004, the
employees based at the PharmaResearch facility in Morrisville, North Carolina
were relocated to our nearby facility in Cary, North Carolina and the office in
China was closed. The following amounts have been recorded in respect of the
restructuring plan: Severance and related costs
    
    Other costs
    
    LeaseterminationPharma
    
    
    
    
    
    Pharma
    
    
    
    
    
    and abandonmentResearch
    
    Inveresk
    
    Research
    
    Inveresk
    
    costs(Dollars in thousands)Amount established at acquisition
    
    $
    1,190
    
    
    $
    676
    
    
    $
    348
    
    
    $
    412
    
    
    $
    1,137Utilized from July 29, 2003 to December 31, 2003
    
    
    (877
    )
    
    
    (676
    )
    
    
    (242
    )
    
    
    (344
    )
    
    
    Balance at December 31, 2003
    
    
    313
    
    
    
    
    
    
    
    106
    
    
    
    68
    
    
    
    1,137Reclassification
    
    
    
    
    
    
    
    
    
    
    331
    
    
    
    
    
    
    
    (331
    )Utilized in the first quarter of 2004
    
    
    (266
    )
    
    
    
    
    
    
    (82
    )
    
    
    (35
    )
    
    
    (237
    )Released to reduce goodwill in the first
quarter of 2004
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (136
    )Translation adjustment
    
    
    
    
    
    
    
    
    
    
    3
    
    
    
    
    
    
    
    27Balance at March 31, 2004
    
    $
    47
    
    
    $
    
    
    
    $
    358
    
    
    $
    33
    
    
    $
    460
 The Company expects the remaining provisions for severance costs to be utilized
in 2004. The lease termination and abandonment costs will be utilized over the
periods of the leases of the properties concerned. The following table compares the Companys net service revenues, net income and
earnings per share data for the first quarter of 2004 with pro forma figures
for the same information for the first quarter -7-




---



##### Table of Contents



Inveresk Research Group, Inc. Notes to Condensed Consolidated Financial Statements of 2003, computed to show the effect of the PharmaResearch acquisition as if
had been acquired on January 1, 2003. Quarter
    
    Quarter endedended March
    
    March31, 2004
    
    31, 2003(Dollars in thousands, except per share data)Net service revenue
    
    $
    76,738
    
    
    $
    68,369Net income (loss)
    
    $
    12,297
    
    
    $
    7,042Earnings (loss) per shareBasic
    
    $
    0.32
    
    
    $
    0.20Diluted
    
    $
    0.31
    
    
    $
    0.19Number of shares used in calculating earnings (loss) per shareBasic
    
    
    37,923,816
    
    
    
    36,081,610Diluted
    
    
    39,160,749
    
    
    
    37,366,463
 This unaudited pro forma
financial information has been prepared for comparative purposes only and does not purport to be indicative of the results
of operations which would actually have occurred had the companies operated as
one during the period. No effect has been included for synergies, if any, that
might have been realized through the acquisition. 5. Credit Facilities and Debt At March 31, 2004 the Companys bank credit facilities totaled $131.4 million
comprised of $56.4 million of term loans in U.S. dollars and up to $75 million
of loans available in multiple currencies under a revolving credit arrangement. At March 31, 2004, the borrowings under the facility comprised $56.4 million
drawn down as a five year term loan with repayments due quarterly until
December 31, 2007. Such borrowings bear interest at rates between LIBOR plus
1.25% and LIBOR plus 2.00% depending on the ratio of Earnings before Interest,
Taxes, Depreciation and Amortization (EBITDA) to borrowings. Based on the
financial position of the company at December 31, 2003 the borrowings currently
bear interest at LIBOR plus 1.25%. The exposure to interest rate fluctuations
on the loans drawn under this facility has been limited by retaining, with
minor amendments, the interest rate swaps entered into previously in connection
with the previous bank credit facility. The bank credit facility subjects the
Company to significant affirmative, negative and financial covenants, is
guaranteed by the Company and its significant subsidiaries and is secured by
liens on substantially all of the assets and pledges of the shares of the
subsidiaries. The covenants include, but are not limited to, a maximum leverage
ratio, a minimum net worth amount and a minimum amount for the ratio of
consolidated EBITDA to consolidated financial charges. The Company was in
compliance with these covenants at March 31, 2004. -8-




---



##### Table of Contents



Inveresk Research Group, Inc. Notes to Condensed Consolidated Financial Statements 6. Income Taxes Significant components of the Companys deferred tax assets and liabilities are
as follows: March 31,
    
    December 31,2004
    
    2003(Dollars in thousands)Deferred tax assets:Defined benefit pension obligations
    
    $
    7,746
    
    
    $
    7,364Federal and state net operating losses
    
    
    13,261
    
    
    
    13,652Foreign net operating losses
    
    
    438
    
    
    
    425Interest rate swaps
    
    
    344
    
    
    
    296U.K. share option deductions
    
    
    539
    
    
    
    555Other deferred tax assets
    
    
    2,972
    
    
    
    3,583Total deferred tax assets
    
    
    25,300
    
    
    
    25,875Valuation allowance for deferred tax assets
    
    
    (539
    )
    
    
    (15,789
    )Net deferred tax assets
    
    $
    24,761
    
    
    $
    10,086Deferred tax liabilitiesProperty, plant and equipment
    
    
    (31,508
    )
    
    
    (31,569
    )Intangible assets
    
    
    (715
    )
    
    
    (532
    )Other deferred tax liabilities
    
    
    (500
    )
    
    
    (500
    )Net deferred tax liabilities
    
    $
    (7,962
    )
    
    $
    (22,515
    )
 Following the completion of the integration of PharmaResearch Corporation into
the clinical operations in the USA, in the first quarter of 2004, the Company
has reassessed the valuation allowance previously established to reduce the
value of the deferred tax assets (mainly arising on net operating losses) in
the USA. As a consequence, the valuation allowance has been reduced by $15.4
million during the current period. A portion of the tax benefit, $13.7
million, was recorded as a reduction of goodwill as these deferred tax assets
were acquired in 2001 and at that time a valuation allowance was established.
The remaining $1.7 million was recognized as a tax benefit in the statement of
operations in the first quarter of 2004. The balance sheet classification of net deferred tax liabilities is as follows: March 31,
    
    December 31,2004
    
    2003(Dollars in thousands)Net current deferred tax assets
    
    $
    2,935
    
    
    $
    144Net non-current deferred tax assets
    
    
    12,619
    
    
    
    669Net current deferred tax liabilities
    
    
    (290
    )
    
    
    (334
    )Net non current deferred tax liabilities
    
    
    (23,226
    )
    
    
    (22,994
    )Net deferred tax liabilities
    
    $
    (7,962
    )
    
    $
    (22,515
    )
 The provision for income taxes is affected by various factors. The Company
receives research and development tax credits in Canada and the United Kingdom.
The level of such credits is dependent upon the amount of qualifying costs in
these jurisdictions and therefore the tax credits are not a constant percentage
of income before income taxes. -9-




---



##### Table of Contents



Inveresk Research Group, Inc. Notes to Condensed Consolidated Financial Statements As a consequence of these factors, the Companys provision for income taxes
expressed as a percentage of income before income taxes may fluctuate from
period to period. The Companys consolidated effective tax rate differed from the federal
statutory rate as set forth below: Quarter ended
    
    Quarter endedMarch 31, 2004
    
    March 31, 2003(Dollars in thousands)U.S. Federal statutory rate
    
    $
    4096
    
    
    $
    2,686U.K. and Canadian Research and Development tax credits
    
    
    (1,908
    )
    
    
    (1,761
    )Difference between foreign income taxed at U.S. Federal Statutory rates and
foreign income tax expense
    
    
    (394
    )
    
    
    (276
    )Increase(reduction) in federal valuation allowance
    
    
    (1,714
    )
    
    
    196Increase (reduction) in valuation allowance against losses of foreign subsidiaries
    
    
    
    
    
    
    (53
    )Share option deductions
    
    
    (155
    )
    
    
    (554
    )Other
    
    
    (175
    )
    
    
    57$
    (250
    )
    
    $
    295
 7. Stock Options and Other Equity-Based Compensation Plans The Company has issued options to employees pursuant to the Inveresk Research
Group, Inc. 2002 Stock Option Plan and to non-executive directors pursuant to
the Inveresk Research Group, Inc 2002 Non-employee Directors Stock Option Plan.
The objectives of these plans include attracting and retaining personnel and
promoting the success of the Company by providing employees and non-executive
directors with the opportunity to acquire shares. All options issued prior to June 27, 2002 were issued by Inveresk Research
Group Limited. Those options subsequently were exchanged for stock options
issued by Inveresk Research Group, Inc. (the replacement options) under its
2002 Stock Option Plan on June 28, 2002. The replacement options had exercise
prices, exercise periods and other terms substantially the same as those that
were replaced. The replacement options became fully vested (immediately exercisable in full)
upon completion of the Companys initial public offering and such options will
expire 10 years after the original date of grant. At March 31, 2004 the number
of replacement options remaining outstanding was 535,318. The Company has also
issued options that vest in equal annual installments over the three years
following the date of grant. At March 31, 2004 the number of shares issuable
on exercise of these options outstanding was 1,713,174. -10-




---



##### Table of Contents



Inveresk Research Group, Inc. Notes to Condensed Consolidated Financial Statements The following table summarizes the movements on the options outstanding in the
quarter ended March 31, 2004: Shares of CommonStock Issuable Upon
    
    
    
    
    
    Weighted AverageExercise
    
    Exercise Price
    
    Exercise PriceOutstanding at December 31, 2003
    
    
    1,819,948
    
    
    $
    0.03 - $20.14
    
    
    $
    8.72Granted
    
    
    587,200
    
    
    $
    23.64
    
    
    $
    23.64Forfeited
    
    
    (41,317
    )
    
    $
    10.60-$17.75
    
    
    $
    13.88Exercised
    
    
    (117,339
    )
    
    $
    0.03 - $13.00
    
    
    $
    3.73Outstanding at March 31, 2004
    
    
    2,248,492
    
    
    $
    0.03 - $23.64
    
    
    $
    12.79
 The following table summarizes the exercise prices of the options outstanding
at March 31, 2004: Shares ofCommon StockIssuableUponExercise
    
    Exercise Price197,891
    
    
    $0.03 per share11,736
    
    
    $0.05 per share23,473
    
    
    $0.19 per share302,218
    
    
    $0.40 per share698,390
    
    
    $10.60 per share28,334
    
    
    $13.00 per share40,000
    
    
    $14.68 per share3,500
    
    
    $16.35 per share20,000
    
    
    $17.17 per share328,250
    
    
    $17.75 per share7,500
    
    
    $20.14 per share587,200
    
    
    $23.64 per share2,248,492
 The weighted average exercise price of the Companys outstanding stock options
was $12.79 per share at March 31, 2004 and $8.72 at December 31, 2003. Pro forma information regarding net income is required by SFAS 123, which also
requires that the information be determined as if the Company has accounted for
its employee stock options under the fair value method of that statement. This
information is shown in Note 3. For purposes of this disclosure, the fair value of the fixed option grants were
estimated using the Black-Scholes optionpricing model with the following
weighted average assumptions used for option grants: Risk-free interest rate
    
    
    3.0
    %Volatility factor
    
    
    60.0
    %Weighted average expected life of options in months
    
    
    21.8
 The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective valuation assumptions including the expected -11-




---



##### Table of Contents



Inveresk Research Group, Inc. Notes to Condensed Consolidated Financial Statements stock price volatility. Because the Companys stock options have
characteristics significantly different from those of traded options, and
because changes in subjective assumptions can materially affect the fair value
estimates, in managements opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of the Companys stock
options. 8. Employee Benefits The net periodic pension costs for the Companys defined benefit pension plan
include the following components: Quarter ended
    
    Quarter endedMarch 31, 2004
    
    March 31, 2003(Dollars in thousands)Service cost
    
    $
    1,053
    
    
    $
    790Interest cost
    
    
    1,281
    
    
    
    880Return on plan assets (expected)
    
    
    (1,098
    )
    
    
    (764
    )Amortization of actuarial loss
    
    
    318
    
    
    
    199Net periodic pension cost
    
    $
    1,554
    
    
    $
    1,105
 The total employers contributions paid to the plan in the first quarter of
2004 amounted to $1.1 million and the total contributions expected to be paid
in 2004 amount to $3.7 million. 9. Segment Reporting The Company is a full-service drug development services group serving the
pharmaceutical, biotechnology and medical device industries. The Companys
drug development services comprise two operating segments  pre-clinical and
clinical. Pre-clinical services include pre-clinical safety and pharmacology
evaluation as well as laboratory sciences services. Pre-clinical services are
performed in Edinburgh, Scotland and Montreal, Canada. Clinical services
consist of designing, monitoring, and managing trials of new pharmaceutical and
biotechnology products on humans, and providing clinical data management,
biostatistical, product registration, and pharmacovigilance services. Clinical
service activities and revenues are performed and earned primarily in the
United States and Europe. The Companys European clinical operations are
performed in Maidenhead, England and Edinburgh, Scotland with its primary
satellite offices in Brussels, Belgium and Glasgow, Scotland. The operating
results of the Company in the individual European countries apart from the
United Kingdom are not material. -12-




---



##### Table of Contents



Inveresk Research Group, Inc. Notes to Condensed Consolidated Financial Statements Financial data by segment are as follows: Pre-clinical
    
    Clinical
    
    TotalQuarter Ended March 31, 2004
    
    (Dollars in thousands)Net service revenue from external customers
    
    $
    44,377
    
    
    $
    32,361
    
    
    $
    76,738Depreciation and amortization
    
    
    2,848
    
    
    
    964
    
    
    
    3,812Segment income
    
    
    11,744
    
    
    
    4,173
    
    
    
    15,917Segment assets at March 31, 2004
    
    
    384,438
    
    
    
    270,345
    
    
    
    654,783Intangible assets at March 31, 2004
    
    
    65,754
    
    
    
    109,094
    
    
    
    174,848Long-lived assets at March 31, 2004
    
    
    199,154
    
    
    
    137,346
    
    
    
    336,500Expenditures for long-lived assets in quarter ended March 31, 2004
    
    
    4,939
    
    
    
    843
    
    
    
    5,782Quarter Ended March 31, 2003Net service revenues from external customers
    
    $
    36,329
    
    
    $
    21,355
    
    
    $
    57,684Depreciation
    
    
    2,381
    
    
    
    568
    
    
    
    2,949Segment income
    
    
    8,782
    
    
    
    2,263
    
    
    
    11,045Segment assets at December 31, 2003
    
    
    375,384
    
    
    
    266,117
    
    
    
    641,501Intangible assets at December 31, 2003
    
    
    65,064
    
    
    
    121,378
    
    
    
    186,442Long-lived assets at December 31, 2003
    
    
    195,275
    
    
    
    137,143
    
    
    
    332,418Expenditures for long-lived assets in quarter ended March 31, 2003
    
    
    3,899
    
    
    
    403
    
    
    
    4,302
 The following table summarizes net service revenues and long-lived assets by
geographic area. USA
    
    Canada
    
    Europe
    
    TotalQuarter Ended March 31, 2004
    
    
    
    
    
    (Dollars in thousands)Net service revenue from external customers.
    
    $
    17,831
    
    
    $
    24,598
    
    
    $
    34,309
    
    
    $
    76,738Long-lived assets at March 31, 2004
    
    
    75,662
    
    
    
    97,392
    
    
    
    163,447
    
    
    
    336,501Quarter Ended March 31, 2003Net service revenues from external customers
    
    $
    9,362
    
    
    $
    20,377
    
    
    $
    27,945
    
    
    $
    57,684Long-lived assets at December 31, 2003
    
    
    77,510
    
    
    
    97,251
    
    
    
    157,657
    
    
    
    332,418
 The Companys operations in Europe comprise operations in a number of countries
that are co-ordinated from the United Kingdom. No European country is
significant in terms of revenues generated or assets held apart from the United
Kingdom. -13-




---



##### Table of Contents



Inveresk Research Group, Inc. Notes to Condensed Consolidated Financial Statements The following table reconciles the above totals for net service revenues,
expenditure for long-lived assets, segment income (loss), segment assets and
long-lived assets to the appropriate figures in the financial statements. Quarter ended
    
    Quarter endedMarch 31, 2004
    
    March 31, 2003(Dollars in thousands)Segment income per above segment analysis
    
    $
    15,917
    
    
    $
    11,045Corporate overhead, including share offering expenses
    
    
    (3,072
    )
    
    
    (2,474
    )Income from operations per financial statements
    
    $
    12,845
    
    
    $
    8,571Expenditures for long-lived assets per above segment analysis
    
    $
    5,782
    
    
    $
    4,302Expenditures for long-lived assets not allocated to segments
    
    
    21
    
    
    
    Expenditures for long-lived assets per financial statements
    
    $
    5,803
    
    
    $
    4,302
 March 31,
    
    December 31,2004
    
    2003(Dollars in thousands)Segment assets per above segment analysis
    
    $
    654,783
    
    
    $
    641,501Long lived assets not allocated to segments
    
    
    77
    
    
    
    57Deferred debt issue costs not allocated to segments
    
    
    1,506
    
    
    
    1,593Elimination of inter segment balances
    
    
    (198,948
    )
    
    
    (194,072
    )Assets per financial statements
    
    $
    457,418
    
    
    $
    449,079Long lived assets per above segment analysis
    
    $
    336,500
    
    
    $
    332,418Long lived assets not allocated to segments
    
    
    77
    
    
    
    57Deferred debt issue costs not allocated to segments
    
    
    1,506
    
    
    
    1,593Long lived assets per financial statements
    
    $
    338,083
    
    
    $
    334,068
 No client accounted for more than 10% of the Companys consolidated net revenue
for any of the periods covered by these financial statements. 10. Contingencies From time to time the Company is subject to claims, suits and administrative
proceedings arising in the ordinary course of business. The Company does not
expect that any of the claims suits or proceedings of which it has been
notified will have a material adverse effect upon its operations or financial
condition. -14-




---



##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION The following discussion should be read in conjunction with the corresponding
section of our form 10-K for the year ended December 31, 2003 filed with the
Securities and Exchange Commission on February 24, 2004. The information set forth and discussed below for the quarters ended March 31,
2004 and March 31, 2003 is derived from the Condensed Consolidated Financial
Statements included under Item 1 above. The financial information set forth
and discussed below is unaudited but includes all adjustments (consisting of
normal recurring adjustments) which the Companys management considers
necessary for a fair presentation of the financial position and the operating
results and cash flows for those periods. The Companys results of operation
for a particular quarter may not be indicative of the results that may be
expected for other quarters or the entire year. Overview The discussion and analysis of our financial position which follows is intended
to give investors an understanding of our financial condition, liquidity and
capital resources and changes in financial conditions as well as our results of
operation. We are required to include much of the detail in the discussion
which follows by various regulatory requirements that we are subject to. This
introductory overview is intended to assist investors to identify the areas
that are the main focus of management. We undertake pre-clinical and clinical development services on behalf of our
clients. The scope of our services for each project is agreed with the client
and documented in a contract prior to commencement of the work. Most of the
contracts with our clients are fixed price contracts, ranging in length from up
to a few weeks to several years. As we perform the agreed services under each
of the contracts with our clients, we record revenues based on a percentage of
completion for each contract. Because we have large numbers of contracts
underway at any particular time, all of which are individually priced, we do
not analyze the results of operation based on study type or based on the
profitability of individual studies. In evaluating the underlying health of our business and its prospects, it is
important to ensure that we replace the revenues we have generated with new
signed business (i.e. future revenues), so as to maintain the growth of our
underlying businesses. Therefore, in addition to the results of our operation,
which are discussed separately below, we monitor closely new business signings
for each of our operating units on a cumulative latest twelve months basis (to
address seasonal factors). We compare this with revenues recorded over the
same period and, based upon past experience, these data provide an indication of
the future prospects of the Company. Our new business signings for the last twelve months compared with reported net
service revenues are as follows: Latest 12
    
    Latest 12Months as at
    
    Months as atMarch 31,
    
    March 31,2004
    
    2003(Dollars in thousands)New business signings (net)
    
    $
    349,871
    
    
    $
    270,868Net service revenue
    
    
    291,536
    
    
    
    226,983
 Each of our businesses operate principally under a fee for service model. We
have historically generated cash flows from operations in excess of our
requirements to fund internal growth. Because we have large numbers of
individually small contracts, no single contract has a significant effect on
our cash flow, although historically our cash flow from operations has been
stronger in the second -15-




---



##### Table of Contents



half of the year than in the first. In addition, at March 31, 2004 we had
unutilized bank credit facilities totaling $75 million. We place significant emphasis on the process of contract management and how we
recognize revenue. This is a significant area of focus for our management.
Our operational and our financial management are closely involved in the review
of progress and the analysis of expected outcomes of our studies on a regular
basis. We have no history of significant issues arising in this area. Our net
investment in accounts receivable, unbilled receivables less advance payments,
has historically approximated 30 days of net revenue and at March 31, 2004
stood at 21 days. The main area of market risk that affects our business is foreign exchange rate
fluctuations. In the first quarter of 2004, approximately 77% of our revenues
were generated outside of the U.S., principally in the United Kingdom and
Canada. We experienced considerable volatility in U.S. dollar exchange rates
in 2003, particularly against pounds sterling and against the Canadian dollar.
Whilst the depreciation of the U.S. dollar against pounds sterling positively
impacted our financial results in 2003, its depreciation against the Canadian
dollar has had an adverse impact on our profitability. This is because the
costs of our Canadian operations arise predominantly in Canadian dollars but a
significant proportion of the income of this business arises in U.S. dollars.
The impact of exchange rates on our financial results is discussed in more
detail in Item 3 below. Results of Operation We operate in two segments for financial reporting purposes: pre-clinical and
clinical. The following table shows a summary of our financial performance for
the quarter ended March 31, 2004 compared with the quarter ended March 31,
2003. -16-




---



##### Table of Contents



Quarter ended
    
    Quarter endedMarch 31,
    
    March 31,2004
    
    2003(Dollars in thousands)Net service revenue:Pre-clinical
    
    $
    44,377
    
    
    $
    36,329Clinical
    
    
    32,361
    
    
    
    21,35576,738
    
    
    
    57,684Direct costs excluding depreciation:Pre-clinical
    
    
    (21,164
    )
    
    
    (16,824
    )Clinical
    
    
    (18,757
    )
    
    
    (12,454
    )(39,921
    )
    
    
    (29,278
    )Selling, general and administrative expenses:Pre-clinical
    
    
    (8,621
    )
    
    
    (8,342
    )Clinical
    
    
    (8,467
    )
    
    
    (6,070
    )Corporate overhead:Share offering expenses
    
    
    (306
    )
    
    
    (658
    )Restructuring and integration costs arising from business acquisition
    
    
    (81
    )
    
    
    Other selling, general and administrative expenses
    
    
    (2,684
    )
    
    
    (1,816
    )(20,159
    )
    
    
    (16,886
    )Depreciation:Pre-clinical
    
    
    (2,848
    )
    
    
    (2,381
    )Clinical
    
    
    (616
    )
    
    
    (568
    )Corporate overhead
    
    
    (1
    )
    
    
    (3,465
    )
    
    
    (2,949
    )Amortization of intangibles:Clinical
    
    
    (348
    )
    
    
    (348
    )
    
    
    Income from operations:Pre-clinical
    
    
    11,744
    
    
    
    8,782Clinical
    
    
    4,173
    
    
    
    2,263Corporate overhead including share offering expenses,
restructuring and integration costs and other selling, general
and administrative expenses
    
    
    (3,072
    )
    
    
    (2,474
    )12,845
    
    
    
    8,571Interest expense, net
    
    
    (798
    )
    
    
    (899
    )Income before income taxes
    
    
    12,047
    
    
    
    7,672Provision for income taxes
    
    
    250
    
    
    
    (295
    )Net income
    
    $
    12,297
    
    
    $
    7,377
 -17-




---



##### Table of Contents



The following table summarizes the above results of operation as a percentage
of net service revenue: Quarter ended
    
    Quarter endedMarch 31,
    
    March 31,2004
    
    2003Net service revenue:Pre-clinical
    
    
    100.0
    %
    
    
    100.0
    %Clinical
    
    
    100.0
    %
    
    
    100.0
    %Total
    
    
    100.0
    %
    
    
    100.0
    %Direct costs excluding depreciation:Pre-clinical
    
    
    47.7
    %
    
    
    46.3
    %Clinical
    
    
    58.0
    %
    
    
    58.3
    %Total
    
    
    52.0
    %
    
    
    50.8
    %Selling, general and administrative expenses:Pre-clinical
    
    
    19.4
    %
    
    
    23.0
    %Clinical
    
    
    26.2
    %
    
    
    28.4
    %Total (1)
    
    
    26.3
    %
    
    
    29.3
    %Depreciation:Pre-clinical
    
    
    6.4
    %
    
    
    6.6
    %Clinical
    
    
    1.9
    %
    
    
    2.7
    %Total
    
    
    4.5
    %
    
    
    5.1
    %Amortization of intangibles:Clinical
    
    
    1.1
    %
    
    
    0.0
    %Total
    
    
    0.5
    %
    
    
    0.0
    %Income from operations:Pre-clinical
    
    
    26.5
    %
    
    
    24.2
    %Clinical
    
    
    12.9
    %
    
    
    10.6
    %Total (1)
    
    
    16.7
    %
    
    
    14.9
    %Interest expense, net
    
    
    1.0
    %
    
    
    1.6
    %Income before income taxes
    
    
    15.7
    %
    
    
    13.3
    %
   (1)
    
    Including corporate overhead. Significant Matters Affecting our Financial Condition and Results of Operation PharmaResearch On July 29, 2003 we completed our acquisition of PharmaResearch Corporation
(PharmaResearch) which was formed and began operations in 1995. We acquired
PharmaResearch for $37.1 million in cash, net of cash acquired of $6.0 million.
Its net service revenue and income from operations for the year ended December
31, 2002 were $40.6 million and $4.8 million, respectively. The acquisition of
PharmaResearch allowed us to increase significantly the scale and service of
our North American clinical development operations. Its strong presence in the
field of respiraory and other infectious diseases enables us to build
value-added clinical laboratory support services for the enlarged client base. The former PharmaResearch business operations have been functionally integrated
into our North American clinical business and accordingly, for financial
reporting purposes, we do not separately present the results of those
operations. -18-




---



##### Table of Contents



Share offering expenses On February 18, 2003 we announced a proposed public offering of up to
10,350,000 shares of common stock. 3,000,000 shares were to be offered by the
Company and 7,350,000 shares were to be offered by certain selling
stockholders. On March 7, 2003, we announced the withdrawal of the
registration statement relating to this offering because market conditions at
the time made it inadvisable to proceed with the offering. The costs relating
to this offering were expensed in the first quarter of 2003 and reduced the
first quarter net income by approximately $0.7 million. We do not expect such
costs to recur in the foreseeable future. In the first quarter of 2004, our principal shareholder Candover Investments
PLC (Candover) requested that we prepare and file a registration statement to
allow Candover and a number of associated Candover entities to sell a portion
of their remaining shares. Pursuant to a registration rights agreement entered
into at the time of our initial public offering in 2002, we bore costs
associated with the registration statement amounting to $0.3 million. These
costs have been included as share offering expenses in our statement of
operations in the first quarter of 2004. Exchange rate fluctuations Our condensed consolidated financial statements are prepared in U.S. dollars.
Our principal businesses are based in the United States, United Kingdom and
Canada. Our United Kingdom and Canadian operations record their transactions
in local currencies. Accordingly, fluctuations in the pound sterling and
Canadian dollar exchange rates will impact the results of operation reported in
U.S. dollars. The results of our non-U.S. operations have been translated from pounds
sterling and Canadian dollars using the following average exchange rates: U.S. Dollars per
    
    U.S. Dollars perPound Sterling
    
    Canadian DollarQuarter ended March 31, 2004
    
    
    1.8392
    
    
    
    0.7589Quarter ended March 31, 2003
    
    
    1.6025
    
    
    
    0.6628
 The following table sets forth the percentage of our net service revenue
arising in the United Kingdom and Canada: United Kingdom
    
    CanadaQuarter ended March 31, 2004
    
    
    45
    %
    
    
    32
    %Quarter ended March 31, 2003
    
    
    48
    %
    
    
    35
    %
 Our Canadian business invoices a significant proportion of its revenues in U.S.
dollars, although its costs are largely in Canadian dollars. This can result
in transaction exchange gains or losses that are reflected in its statement of
operations. The foreign currency gains or losses recognized in the statement
of operations and included in Selling, general and administrative expenses
was a gain of $0.4 million for the quarter ended March 31, 2004 and a loss of
$1.5 million for the quarter ended March 31, 2003. First quarter 2004 compared to first quarter 2003 Net service revenue.Net service revenue in the first quarter of 2004 was
$76.7million, an increase of $19.1 million or 33% over first quarter 2003 net
service revenue of $57.7 million. Pre-clinical.Net service revenue in the first quarter of 2004 was $44.4
million, an increase of $8.1 million or 22% over revenues of $36.3 million in
the first quarter of 2002. Our pre-clinical operations -19-




---



##### Table of Contents



in Europe and North America experienced increased demand for their services
during the first quarter, both for safety evaluation services and laboratory
sciences services. Assuming constant dollar exchange rates, net service
revenues in the pre-clinical segment increased by 12% in the first quarter of
2004 compared with 2003. Clinical.Net service revenue in the first quarter of 2004 was $32.3 million,
an increase of $11.0 million or 52% over revenues of $21.4 million in the first
quarter of 2003. The principal factor behind this growth was the acquisition
of PharmaResearch which we completed in July 2003. Because we have fully
integrated this business into our clinical operations, the precise contribution
of the acquired business to first quarter 2004 net service revenue is not
available. Assuming constant dollar exchange rates, net service revenue in the
clinical segment increased by 43% in the first quarter of 2004 compared to
2003. Direct costs excluding depreciation.In the first quarter of 2004 direct costs
excluding depreciation totaled $39.9 million, an increase of $10.6 million, or
36% from $29.3 million in the first quarter of 2003. Direct costs excluding
depreciation were 52% of net service revenue in the first quarter of 2004
compared with 51% in the first quarter of 2003. Pre-clinical.Direct costs excluding depreciation in the first quarter of 2004
were $21.2 million, an increase of $4.3 million, or 26%, over costs of $16.8
million in the first quarter of 2003. In the first quarter of 2004, direct
costs excluding depreciation were 48% of net service revenue, compared with 46%
in the first quarter of 2003. The main factor behind this reduction in margin
is the weakness of the U.S. dollar against the Canadian dollar in 2004 compared
with 2003, as a significant proportion of our revenues in our Canadian
operations arise in U.S. dollars. Clinical.Direct costs excluding depreciation in the first quarter of 2004
were $18.8 million, an increase of $6.3 million, or 50% over costs of $12.5
million in the first quarter of 2003. In the first quarter of 2004 direct
costs excluding depreciation were 58% of net service revenues consistent with
the first quarter of 2003. Selling, general and administrative expenses.In the first quarter of 2004
selling, general and administrative expenses totaled $20.2 million, an increase
of $3.3 million, or 19% from $16.9 million in the first quarter of 2003. Pre-clinical.Selling, general and administrative costs in the first quarter
of 2004 were $8.6 million million, an increase of $0.3 million or 3% from $8.3
million in the first quarter of 2003. Selling, general and administrative
costs were 19% of net service revenue in the first quarter of 2004, compared
with 23% in the first quarter of 2003. Selling, general and administrative
costs were reduced in the first quarter of 2004 as a consequence of exchange
gains of $0.6 million during the period compared with exchange losses of $1.5
million in the first quarter of 2003. The remaining costs represented 21% of
net service revenue in the first quarter of 2004 compared with 19% in the
corresponding period in 2003. This increase is attributable largely adverse
U.S. dollar, Canadian dollar exchange rate movements over the past twelve
months. A significant proportion of our revenues in our Canadian operations
arise in U.S. dollars, but our costs arise predominantly in Canadian dollars. Clinical.Selling, general and administrative costs in the first quarter of
2004 were $8.5 million, an increase of $2.4 million or 39% from $6.1 million in
the first quarter of 2003. Selling, general and administrative costs were 26%
of net service revenue in the first quarter of 2004 compared with 28% in the
first quarter of 2003. The decrease in percentage terms is mainly due to the
impact of cost savings following the acquisition of PharmaResearch. Corporate overhead.Corporate overhead amounted to $3.1 million, an increase
of $0.5 million, or 24% over the first quarter of 2003. Corporate overhead in
the first quarter of 2004 included expenses of $0.3 million relating to the
costs of preparing registration statements requested by Candover and -20-




---



##### Table of Contents



$0.1 million relating to restructuring costs arising from the integration of
PharmaResearch. Selling, general and administrative expenses in the first
quarter of 2003 included an expense of $0.7 million relating to the share
offering announced and withdrawn in the quarter. Before taking account of
these costs, other corporate overhead of $2.7 million in the first quarter of
2004 or 3% of net service revenue, compared with $1.8 million in 2003 or 3% of
net service revenue. Income from operations.In the first quarter of 2004 income from operations
amounted to $12.8 million, or 17% of net service revenue. Income from
operations in the first quarter of 2003 amounted to $8.6 million, or 15% of net
service revenue. Pre-clinical.Income from operations increased to $11.8 million in the first
quarter of 2004 compared with $8.8 million in the first quarter of 2003 for the
reasons set forth above. Clinical.Income from operations was $4.2 million in the first quarter of 2004
compared with $2.3 million in the first quarter of 2003 for the reasons set
forth above. Interest expense.Interest expense in the first quarter of 2004 was $0.8
million, a reduction of $0.1 million or 11% from $0.9 million in the first
quarter of 2003. In the first quarter of 2004 interest expense included $0.4
million of net interest and amortization of deferred debt costs on our bank
facilities and cash resources and a charge of $0.4 million on the
mark-to-market revaluation of our interest rate swaps. In the first quarter of
2003 interest expense included $0.7 million of net interest and amortization of
deferred debt costs on our bank facilities and cash resources and a charge of
$0.2 million on the mark-to-market revaluation of our interest rate swaps. Provision for income taxes.Provision for income taxes was a credit of $0.2
million in the first quarter of 2004. Following the completion of the
integration of PharmaResearch Corporation into the clinical operations in the
USA, in the first quarter of 2004, the Company has reassessed the valuation
allowance previously established to reduce the value of the deferred tax assets
(mainly arising on net operating losses) in the USA. As a consequence, the
valuation allowance has been reduced by $15.4 million, of which $1.7 million
was recognized in the income statement in the first quarter of 2004. The
remaining $13.7 million was recorded as a reduction in goodwill as the
associated deferred tax assets were acquired in 2001 at which time a valuation
allowance was established. The remaining provision for income taxes
represented 12% of income before taxes in the first quarter of 2004. Provision
for income taxes was $0.3 million or 4% of income before taxes in the first
quarter of 2003. U.K. and Canadian research and development tax credits
reduced the provision for income taxes by $1.9 million or 16% of income before
taxes in 2004 and by $1.8 million or 23% of income before taxes in 2003. We
recorded a reduction in income tax expense amounting to $0.2 million or 1% of
income before taxes in the first quarter of 2004 and $0.6 million or 7% of
income before taxes in the first quarter of 2003 in respect of gains made by
our employees on exercise of stock options. Additionally, in 2004 the tax rate
applicable to our operations in Canada is approximately 2% lower than in 2003. Liquidity and capital resources Cash and cash equivalents totaled $24.9 million at March 31, 2004 compared with
$24.6 million at December 31, 2003. Our principal sources of liquidity are
cash flow from operations and borrowings under our credit facilities. At March 31, 2004 our bank credit facilities totaled $131.4 million comprised
of $56.4 million of term loans in U.S. dollars and up to $75 million of loans
available in multiple currencies under a revolving credit arrangement. At March
31, 2004, we had drawn $56.4 million in term loans under the facility, which is
repayable in quarterly instalments over the period to December 2007. This
facility bears interest at floating, LIBOR-based rates. We have limited our
exposure to interest rate fluctuations on the loans drawn under this facility
through a series of interest rate swaps. Our credit facility subjects -21-




---



##### Table of Contents



us to significant affirmative, negative and financial covenants, is guaranteed
by us and our significant subsidiaries and is secured by liens on substantially
all of our assets. Working capital balances which arise from our contracts with customers comprise
accounts receivable, unbilled receivables and advance billings. A summary of
these balances at the last five quarter ends, together with the number of
equivalent days sales they represent is set forth below. March 31, 2004
    
    December 31, 2003
    
    September 30, 2003
    
    June 30, 2003
    
    March 31, 2003No. of
    
    
    
    
    
    No. of
    
    
    
    
    
    No. of
    
    
    
    
    
    No. of
    
    
    
    
    
    No. ofBalance
    
    Days Net
    
    Balance
    
    Days Net
    
    Balance
    
    Days Net
    
    Balance
    
    Days Net
    
    Balance
    
    Days Net($'000s)
    
    Revenue
    
    ($'000s)
    
    Revenue
    
    ($'000s)
    
    Revenue
    
    ($'000s)
    
    Revenue
    
    ($'000s)
    
    RevenueAccounts receivable
    
    $
    42,459
    
    
    
    50
    
    
    $
    53,391
    
    
    
    71
    
    
    $
    45,012
    
    
    
    62
    
    
    $
    36,428
    
    
    
    53
    
    
    $
    36,289
    
    
    
    57Unbilled receivables
    
    
    32,759
    
    
    
    39
    
    
    
    24,331
    
    
    
    33
    
    
    
    26,144
    
    
    
    36
    
    
    
    25,643
    
    
    
    37
    
    
    
    24,371
    
    
    
    38Sub total
    
    
    75,218
    
    
    
    89
    
    
    
    77,722
    
    
    
    104
    
    
    
    71,156
    
    
    
    98
    
    
    
    62,071
    
    
    
    90
    
    
    
    60,660
    
    
    
    95Advance billings
    
    
    (57,462
    )
    
    
    (68
    )
    
    
    (56,745
    )
    
    
    (76
    )
    
    
    (48,266
    )
    
    
    (67
    )
    
    
    (40,840
    )
    
    
    (59
    )
    
    
    (40,625
    )
    
    
    (64
    )$
    17,756
    
    
    
    21
    
    
    $
    20,977
    
    
    
    28
    
    
    $
    22,890
    
    
    
    31
    
    
    $
    21,231
    
    
    
    31
    
    
    $
    20,035
    
    
    
    31
 The impact of the above balances on our cash flow from operations in the first
quarter of 2004 as well as in 2003, excluding translation effects, was as
follows: Quarter
    
    Quarter
    
    Quarter
    
    Quarter
    
    Quarterended
    
    ended
    
    ended
    
    ended
    
    endedMarch 31,
    
    December 31,
    
    September 30,
    
    June 30,
    
    March 31,2004
    
    2003
    
    2003
    
    2003
    
    2003(Dollars in thousands)Cash inflow (outflow)Accounts receivable including unbilled receivables
    
    $
    2,504
    
    
    $
    (6,566
    )
    
    $
    2,884
    
    
    $
    (1,411
    )
    
    $
    (688
    )Advance billings
    
    
    717
    
    
    
    8,479
    
    
    
    (2,806
    )
    
    
    215
    
    
    
    (790
    )$
    3,221
    
    
    $
    1,913
    
    
    $
    78
    
    
    $
    (1,196
    )
    
    $
    (1,478
    )
 The cash generated by operating activities was $11.1 million in the first
quarter of 2004, and $56.3 million in the year ended December 31, 2003. When
compared with operating cash flows, the cash flows relating to working capital
movements have not had a significant impact on liquidity. During the twelve months from April 1, 2004 to March 31, 2005, we are scheduled
to make repayments of $7.5 million of principal indebtedness under our bank
credit facility. We anticipate that our operating cash flow, together with
available borrowings under our bank credit facility and the net proceeds we
receive from any offerings, will be sufficient to meet our anticipated future
operating expenses, capital expenditures (including our planned expansions at
our pre-clinical facilities) and debt service obligations as they become due
over the next twelve months. Our corporate strategy of seeking continued growth
contemplates the possibility of growth through acquisitions of other
businesses, should appropriate opportunities become available. If we decide to
seek to acquire other businesses, we expect to fund these acquisitions from
existing cash resources, through additional borrowings and, possibly, with the
proceeds of sales of our capital stock. We also may pursue acquisitions in
which the consideration we pay takes the form of our capital stock. First quarter 2004 compared to First quarter 2003 Cash flow from operations in the first quarter of 2004 was $11.1 million
compared with $4.8 million in the first quarter of 2003. Cash payments for
items of capital expenditures were $8.7 million in the first quarter of 2004
compared with $4.3 million in 2003. Recent completion of an expansion at our
Edinburgh facility and the further expansion of our facilities in Montreal
accounts for most of the increase. In the first quarter of 2004 we repaid $1.9 million of our bank debt compared
with $5.0 repaid in the first quarter of 2003. Critical Accounting Policies and Estimates -22-




---



##### Table of Contents



The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities, the 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. These estimates and assumptions are
affected by the way we apply our accounting policies. An accounting estimate is
considered critical if: the estimate requires us to make assumptions about
matters that were highly uncertain at the time the estimate was made; different
estimates reasonably could have been used; or if changes in the estimate that
would have a material impact on our financial condition or results of
operations are reasonably likely to occur from period to period. We believe
that the accounting estimates employed are appropriate and resulting balances
are reasonable; however, actual results could differ from the original
estimates, requiring adjustments to these balances in future periods. The
accounting policies which we consider to be critical accounting policies
include revenue recognition, accounting for income taxes and accounting for
pension obligations. A discussion of our policies on revenue recognition and
accounting for pension obligations is included in our Form 10-K for the year
ended December 31, 2003. Income Taxes We operate in numerous countries but the tax regulations in the U.S., Canada
and the United Kingdom have the most significant effect on our income tax and
deferred tax assets and liabilities and our income tax expense. The tax
regulations are highly complex and whilst we aim to ensure the estimates of tax
assets and liabilities that we record are accurate, there may be instances
where the process of agreeing our tax liabilities with the tax authorities
could require adjustments to be made to estimates previously recorded. Our
provision for income taxes is affected by various factors. We receive research and development tax credits in Canada and the United
Kingdom. The level of such credits is dependent upon the amount of qualifying
costs in these jurisdictions. We estimate the amounts of these credits each
period based on our experience and knowledge of the relevant tax regulations.
Because the level of the credits are based on the levels of qualifying costs,
the tax credits are not directly related to income before income taxes and
therefore the level of tax credits may fluctuate from period to period when
compared to income before income taxes. Research and development tax credits
reduced our income tax expense by $1.9 million in the first quarter of 2004 and
by $1.8 million in the first quarter of 2003. We have deferred tax assets of $25.3 and $25.9 million at March 31, 2004 and
December 31, 2003. We assess the likelihood of the utilization of such assets
and based on the historical performance of the relevant operations, limitations
on the utilization of the assets and anticipated operating results, we
establish valuation allowances. In the first quarter of 2004, we reduced the
valuation allowances to $0.5 million at March 31, 2004 from $15.8 million at
December 31, 2003. As a consequence of the completion of the combination of
PharmaResearch Corporation and our existing clinical operations in the USA into
one operating legal entity in the first quarter of 2004 and based on our
assessment of the profitability of that combined entity, we believe that the
valuation allowance previously established to reduce the value of the deferred
tax assets (mainly arising on net operating losses) in the USA, is no longer
required. As a consequence, the valuation allowance has been reduced,
resulting in a reduction of $13.7 million in goodwill relating to deferred tax
assets acquired in 2001 and a tax benefit of $1.7 million which was recognized
in the statement of operations in the first quarter of 2004. We will continue to assess the allowances on the information available each
period and our assessment may change in future periods. -23-




---



##### Table of Contents



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are subject to market risks arising from changes in interest rates and
foreign currency exchange rates. Our primary interest rate exposure is in respect of future changes in the LIBOR
or base rates that are used to determine the amounts of interest we are
required to pay on borrowings under our bank credit facility. The outstanding
indebtedness at March 31, 2004 under our bank credit facility, bore interest at
a rate equal to LIBOR plus a margin of 1.25%. That margin is set each quarter
based on specified financial ratio tests and may vary between LIBOR plus 1.25%
and LIBOR plus 2.0%. We have entered into two interest rate swap arrangements to hedge the interest
rate exposure on our bank borrowings. The first arrangement is an interest rate
swap with a notional amount of $50 million, which expires on September 30,
2005. Under this arrangement the LIBOR rate applicable to $50 million of bank
debt is fixed at 2.9975%. The second arrangement is an interest rate swap with
a notional amount of $10 million, which expires on September 30, 2004. Under
this arrangement the LIBOR rate applicable to $10 million of bank debt is fixed
at 2.5225%. The interest rate swaps exceed our bank borrowings at March 31, 2004 by $3.6
million and this amount is exposed to fluctuations in interest rates. Our
potential loss over one year that would result from a hypothetical,
instantaneous change of 100 basis points in the interest rate is not
significant. We have not designated the interest rate swaps as hedges for financial
reporting purposes pursuant to SFAS 133. As a consequence, we record, through
the interest expense category in our statement of operations, any changes in
the fair value of the swaps. The fair value of the swaps will fluctuate, mainly
as a consequence of changes in market rates of interest. Accordingly, changes
in market rates of interest can cause fluctuations in the level of our recorded
interest expense from period to period. Our Canadian business has a significant proportion of its working capital
represented by assets and liabilities that are denominated in U.S. dollars.
Accordingly, fluctuations in the U.S. dollar / Canadian dollar exchange rate
give rise to exchange gains and losses. These gains and losses arise from the
conversion of U.S. dollars to Canadian dollars and the retranslation of cash,
accounts receivable and unbilled receivable balances and to a lesser extent
accounts payable balances. We have entered into a forward contract to sell
U.S.$12 million and buy Can$15.6 million on June 30, 2004. This contract
reduces our exposure to exchange gains and losses arising from the
retranslation of the above balances during the life of the contract. The
amounts of the U.S. dollar denominated balances held by our Canadian subsidiary
fluctuate from time to time and based on the average balances in the second
half of 2003 and the first two months of 2004 offset by the effects of the
forward contract, we estimate that a hypothetical instantaneous 10% devaluation
of the U.S. dollar against the Canadian dollar would give rise to recognition
of an exchange loss (which would be included for financial reporting purposes
in selling, general and administrative expenses) of approximately $0.2 million,
before income tax effects. On the same basis, we estimate that a hypothetical
instantaneous 10% devaluation of the Canadian dollar against the U.S. dollar
would give rise to recognition of an exchange gain (which for financial
reporting purposes would be netted against and therefore reduce selling,
general and administrative expenses) of approximately $0.2 million before
income tax effects. A significant proportion of the revenues in our Canadian operations arise in
U.S. dollars but the costs in these operations arise mainly in Canadian
dollars. To monitor this we look at the results of operation of our Canadian
business that arise in Canadian dollars. This is a net expense because it
excludes the U.S. dollar denominated revenue stream but includes most of the
costs of our Canadian operations. In 2003, we estimate that the net expense
arising in Canadian dollars in our Canadian operations amounted to
approximately $29 million. Based on this, a 10% strengthening of the Canadian
dollar against the U.S. dollar would reduce our group net income by $2.9 million
over a -24-




---



##### Table of Contents



period of a year and a 10%
weakening of the Canadian dollar against the U.S.
dollar would increase group net income by $2.9 million over a period of a year. Our European operations are less exposed to fluctuations in exchange rates than
our Canadian operations. However, the net income of our European operations is
recorded in the local currencies of the operations, pricipally pounds sterling,
and then translated into U.S. dollars. In 2003, the net income arising in
pounds sterling amounted to approximately $18 million. Based on this, a 10%
strengthening of the pound sterling against the U.S. dollar would increase our
group net income by $1.8 million over a period of a year and a 10% weakening of
the pound sterling against the U.S. dollar would decrease group net income by
$1.8 million over a period of a year. We also would potentially have exposure to foreign currency exchange rate
fluctuations in respect of the cash flows received from our foreign affiliates.
This risk is mitigated by the fact that their operations are conducted in their
respective local currencies, and it is not our intention to repatriate earnings
prospectively. We do not use financial instruments for trading or other speculative purposes. Our management does not believe that inflation in past years has had a
significant impact on our results from operation. Our management believes that,
in the event inflation affects our costs in the future, we will offset the
effect of inflation and maintain appropriate margins through increased fees. -25-




---



##### Table of Contents



ITEM 4. CONTROLS AND PROCEDURES The Chief Executive Officer and the Chief Financial Officer are responsible for
establishing and maintaining a system of disclosure controls and procedures to
ensure the accuracy and completeness of the Companys quarterly and annual
reports. They are also responsible for conducting a review of the
effectiveness of the disclosure controls and procedures as of a date within 90
days of the filing date of the quarterly or annual report and disclosing their
conclusions about the effectiveness of the disclosure controls and procedures
based on the review. Description of principal disclosure controls and procedures The system of disclosure controls and procedures cannot provide absolute
assurance on the accuracy and completeness of the Companys annual and
quarterly reports, but it has been designed to meet the Groups needs and the
risks to which it is exposed. There is a continuous process of identifying, evaluating and managing the risks
to which the Company is exposed that has been in place throughout the current
fiscal year and up to the date of this filing. The key elements of the process
are:  
    
    Formal reporting on a monthly basis to the Chief Executive Officer and Chief Financial Officer on the results of
operation and on any emerging risks and issues. The monthly results are analysed by business segment and all
significant variations from budget and the prior year are investigated. The day-to-day responsibility for each
business unit rests with experienced management and the Company has a clear organization structure that includes
appropriate delegation of authority. There is regular contact between the Chief Executive Officer and Chief Financial
Officer and the President of each business unit.
    
    Formal Board approval of the annual budget for each financial year. Annual budgets are prepared in detail for each
business unit.
    
    Review of each quarterly or annual report by the Audit Committee. The Audit Committee also meets with the Companys
external auditors on a quarterly basis to discuss the results of the external auditors review of the quarterly
financial statements and any internal control matters arising from such review.
    
    Confirmation each quarter from the President of each business unit covering the accuracy of the reported financial
results of the business and that all significant issues affecting the business have been reported to the Chief
Executive Officer and Chief Financial Officer.
    
    Confirmation from the Vice-President of Finance for each business unit that certain financial control procedures have
been completed.
    
    Consultation on significant matters with the Companys professional advisers. In addition to the above procedures, the Company has introduced an internal
audit function and a formal plan is now in place. The internal audit function
has been outsourced to one of the big four international accounting firms other
than our external independent auditors. The internal audit team reports
regularly to the Audit Committee and senior management. Evaluation of disclosure controls and procedures Based on their review of the disclosure controls and procedures as of March 31,
2004, the Chief Executive Officer and Chief Financial Officer have concluded
that the Company has effective disclosure controls and procedures. -26-




---



##### Table of Contents



Changes in internal controls There have been no significant changes in the internal controls nor in other
factors that could significantly affect these controls subsequent to March 31,
2004. 
 PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The information provided in Note 10 to the financial statements contained
in Part I of this Form 10-Q is incorporated herein by reference. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. N/A ITEM 3. DEFAULTS UPON SENIOR SECURITIES. N/A ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. N/A ITEM 5. OTHER INFORMATION. N/A ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits. 31.1
    
    
    - Certification of Walter S. Nimmo,
Chief Executive Officer,
President and Director of Inveresk Research Group, Inc. pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    
    - Certification of D. J. Paul E. Cowan, Chief Financial
Officer and Treasurer of Inveresk Research Group, Inc. pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    
    - Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
executed by Walter S. Nimmo, Chief Executive Officer, President and
Director of Inveresk Research Group, Inc.32.2
    
    
    - Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
executed by D. J. Paul E. Cowan, Chief Financial Officer and
Treasurer of Inveresk Research Group, Inc.
 -27-




---



##### Table of Contents



(b) Reports on Form 8-K.   We filed a current report on Form 8-K on March 9, 2004 including our press
release announcing the filing of a registration statement with the Securities
and Exchange Commission covering the re-sale of an aggregate of up to 8,669,714
of common stock by the selling stockholders named in the registration
statement. We filed another current report on Form 8-K on March 9, 2004 including a letter
of consent from our Independent Auditors. -28-




---



##### Table of Contents



SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. Date: May 7, 2004
    
    INVERESK RESEARCH GROUP, INC.By:
    
    /s/ D. J. Paul E. CowanD.J. Paul E. CowanChief Financial Officer and Treasurer
 -29-