UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2004

OR

For the transition period from            to           

Commission File Number: 000-49765

INVERESK RESEARCH GROUP, INC.

(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 þ            No o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes þ            No o

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 

TABLE OF CONTENTS

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.

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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)

See accompanying notes to condensed consolidated financial statements.

Inveresk Research Group, Inc.

Condensed Consolidated Balance Sheets
(In thousands, except share data)

See accompanying notes to condensed consolidated financial statements.

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Inveresk Research Group, Inc.

Condensed Consolidated Statements of Cash Flows (unaudited)
(In thousands)

See accompanying notes to condensed consolidated financial statements.

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Inveresk Research Group, Inc.

Condensed Consolidated Statements of Comprehensive Income and Shareholders’ Equity
(unaudited)
(In thousands, except share data)

See accompanying notes to condensed consolidated financial statements.

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Inveresk Research Group, Inc.

Notes to Condensed Consolidated Financial Statements

1.

Description of Business and Merger Agreement

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’s client base includes major pharmaceutical companies in North America, Europe, and Japan, as well as many biotechnology and specialty pharmaceutical companies.

Merger with Charles River Laboratories International, Inc.

On June 30, 2004, the Company entered into an Agreement and Plan of Merger with Charles River Laboratories International, Inc. (“Charles River”) and Indigo Merger I Corp. and Indigo Merger II Corp., both wholly owned subsidiaries of Charles River. The merger is subject to the satisfaction of certain closing conditions, including the approval of the Company’s stockholders and receipt of regulatory approvals,

Under the terms of the merger agreement, Indigo Merger I Corp. will merge with and into the Company, whereupon the Company will become a wholly owned subsidiary of Charles River. Pursuant to and as part of a single integrated transaction the Company will then be merged with and into Indigo Merger II LLC, whereupon the separate corporate existence of the Company will cease and Indigo Merger II LLC will be the surviving corporation.

Upon the merger of Indigo Merger I Corp. and the Company, each share of the Company’s common stock will be converted into the right to receive $15.15 in cash and 0.48 shares of common stock in Charles River. In addition, each outstanding option to purchase the Company’s common stock will be converted into an option to purchase Charles River stock. Each stock option resulting from such conversion will continue to have the same terms and conditions following the merger with Indigo Merger I Corp., except that (i) each option will be exercisable for that number of whole shares of Charles River stock equal to the number of shares of Inveresk stock that were issuable upon exercise of the related Inveresk stock option multiplied by 0.8, rounded down to the nearest whole number, and (ii) the per share exercise price for the Charles River stock options will equal the exercise price per share of Inveresk stock at which the related stock option was exercisable divided by 0.8, rounded to the nearest whole cent.

During the second quarter of 2004, the Company incurred approximately $5.0 million in merger costs. These are included in the share offering and merger expenses caption in the statement of operations for the second quarter.

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 U. S. (“GAAP”) for complete financial statements.

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Inveresk Research Group, Inc.

Notes to Condensed Consolidated 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 operations 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 operations for the quarter ended and six months ended June 30, 2004 are not necessarily indicative of the results of operations 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 75,000 in respect of the quarter and six months ended June 30, 2004 and 7,500 in respect of the quarter and six months ended June 30, 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 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.

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Inveresk Research Group, Inc.

Notes to Condensed Consolidated Financial Statements

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 for the periods shown below would have reflected the pro forma amounts set forth in the table below.

The assumptions underlying the calculation of this pro forma data are described in Note 7.

New Accounting Pronouncements

On June 30/July 1, 2004, the Emerging Issues Task Force (“EITF”) reached a consensus that an investor should only apply the equity method of accounting when it has investments in either common stock (as already required by APB 18) or in-substance common stock of a corporation, provided that the investor has the ability to exercise significant influence over the operating and financial policies of the investee. The consensus in this Issue should be applied in the first reporting period beginning after September 15, 2004. For instruments that are not common stock or in-substance common stock but were accounted for under the equity method of accounting prior to the consensus, the equity method of accounting should be discontinued effective for reporting periods beginning after September 15, 2004. The Company does not expect this EITF Issue will have a material impact on its financial statements.

On May 19, 2004, the Financial Accounting Standards Board (“FASB”) issued FSP 106-2 to provide guidance on accounting for the effects of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”), to employers that sponsor post-retirement health care plans, which provide prescription drug benefits. In addition, the FSP requires those employers to provide certain disclosures in their financial statements regarding the effect of the Act and the related subsidy on post-retirement health obligations and net periodic post-retirement benefit cost. This FSP is effective for the first interim or annual period beginning after June 15, 2004. Earlier application of the FSP is encouraged in financial statements for any period including or following enactment of the Act (December 8, 2003) that has not been issued as of the issuance date of the FSP. The Company does not expect this new FSP will have a material impact on its financial statements.

On March 17/18, 2004, the EITF reached a consensus on Issue 03-6, Participating Securities and the Two-Class Method under FASB Statement No. 128, Earnings per Share (“EITF 03-6”). This Issue includes a definition of “participating security” and clarifies some practical issues related to including participating securities in the calculation of earnings per share.

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Inveresk Research Group, Inc.

Notes to Condensed Consolidated Financial Statements

In addition, the Task Force decided that the guidance provided in EITF Topic D-95, Effect of Participating Convertible Securities on the Computation of Basic Earnings per Share, should be nullified. The consensus now requires the use of the two-class method for including participating convertible securities in the computation of basic EPS (i.e., an issuer can no longer use the if-converted method in basic EPS calculations). The consensus reached by the EITF is effective for fiscal periods beginning after March 31, 2004. Prior period earnings per share amounts presented for comparative purposes should be restated to conform to the consensus guidance. The Company does not expect this EITF consensus will have a material impact on its financial statements.

On March 17/18, 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 SFAS 115, (b) debt and equity securities within the scope of SFAS 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. The Company does not expect this EITF consensus will have a material impact on its financial statements.

New Accounting Pronouncements Adopted During the Period

Financial Accounting Standards Board Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51” as revised, requires a variable interest entity (“VIE”) to be consolidated by a company if that company absorbs a majority of the VIE’s expected losses, receives a majority of the entity’s expected residual returns, or both, as a result of ownership, contractual or other financial interest in the VIE. Prior to the adoption of FIN 46, VIEs were generally consolidated by companies owning a majority voting interest in the VIE. The consolidation requirements of FIN 46 applied immediately to VIEs created after January 31, 2003, however, the FASB deferred the effective date for VIEs created before February 1, 2003 to the quarter ended March 31, 2004 for calendar year companies. Adoption of the provisions of FIN 46 prior to the deferred effective date was permitted. The Company adopted the remaining provisions of FIN 46 in the first quarter of 2004, although the adoption of these provisions did not have an impact on its financial statements.

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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 U.K., 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 its existing operations. The actions covered by the integration included a reduction of 58 employees (37 employees of PharmaResearch and 21 employees of the 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 the Company and the closure of certain office premises.

In connection with the integration plan the Company 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 in the 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:

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 second quarter and first six months of 2004 with pro forma figures for the same

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Inveresk Research Group, Inc.

Notes to Condensed Consolidated Financial Statements

information for second quarter and first six months of 2003, computed to show the effect of the PharmaResearch acquisition as if it had been acquired on January 1, 2003.

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 entity 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 June 30, 2004 the Company’s bank credit facilities totaled $129.5 million, comprised of $54.5 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 June 30, 2004, the borrowings under the facility comprised $54.5 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 March 31, 2004, 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 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 June 30, 2004.

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Inveresk Research Group, Inc.

Notes to Condensed Consolidated Financial Statements

Derivative Instruments

The Company uses forward foreign exchange currency contracts to manage the risk of foreign exchange rate fluctuations. At June 30, 2004 the Company had one forward currency contract outstanding. This was to sell $11.6 million and buy CDN$15.6 million (in Canadian dollars) on September 30, 2004. This contract was entered into for no initial cost on June 30, 2004 and at June 30, 2004 the fair value of the contract was insignificant. This contract has not been designated as a hedge and changes in the fair value of this contract are included in selling, general and administrative expenses in the statement of operations.

In addition, in the second quarter of 2004, the Company purchased for a cost of $0.3 million, a series of options to sell U.S. $20 million and purchase Canadian dollars (U.S. $2.5 million on a specified date each month from May 2004 through December 2004) at a rate of U.S.$1: CDN$1.3630. The Company designated these options as cash flow hedges of the forecasted U.S. dollar denominated sales invoices arising in its Canadian operations. At June 30, 2004 the fair value of the options was $0.4 million. The Company assesses the effectiveness of the hedging arrangements at each quarter end. To the extent that the Company concludes the hedging is effective, changes in the fair value of the options are included in other comprehensive income prior to the date of exercise of each individual option and then the net gain or loss on each individual option is recognized in revenues over the collection period of the invoices being hedged. The Company expects that the total gain or losses on all the options will be recognized in revenues prior to the end of the first quarter of 2005. To the extent that the hedging is ineffective, the Company recognizes any change in the fair value of the options in selling, general and administrative expenses immediately. At June 30, 2004, the amount of existing gains and losses which have not yet been recognized in the statement of operations is insignificant.

The Company also enters into interest rate swap arrangements related to its bank borrowings to manage its exposure to variability in cash flows associated with floating interest rates. These swaps have not been designated as hedges. The details of these are described in the Company’s Form 10-K for the year ended December 31, 2003 and have not changed since that form was filed.

6.

Income Taxes

Significant components of the Company’s deferred tax assets and liabilities are as follows:

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Inveresk Research Group, Inc.

Notes to Condensed Consolidated Financial Statements

Following the completion of the integration of PharmaResearch Corporation into the clinical operations in the U.S., in the first quarter of 2004, the Company reassessed the valuation allowance previously established to reduce the value of the deferred tax assets (mainly arising on net operating losses) in the U.S. As a consequence, the valuation allowance was reduced by $15.4 million during the first quarter of 2004. 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:

The provision for income taxes is affected by various factors. The Company receives research and development tax credits in Canada and the U.K. 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.

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:

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Inveresk Research Group, Inc.

Notes to Condensed Consolidated Financial Statements

We operate in numerous countries but the tax regulations in the U.S., Canada and the U.K. 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, while 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 may possibly require significant adjustments, which cannot presently be quantified. to be made to estimates previously recorded. Our provision for income taxes is affected by various factors.

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 and Incentive Compensation Plan as Amended and Restated as of May 4, 2004 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 June 30, 2004, the number of replacement options remaining outstanding was 469,791. The Company has also issued options that vest in equal annual installments over the three years following the date of grant. At June 30, 2004, the number of shares issuable on exercise of these options outstanding was 1,776,466. During the second quarter of 2004, the Company entered into arrangements with certain members of management which, amongst other items, provide for the acceleration of the vesting of the unvested options held by the individuals concerned in the event of their employment being terminated by the Company following a change in control of the Company.

The following table summarizes the movements on the options outstanding in the six months ended June 30, 2004:

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Inveresk Research Group, Inc.

Notes to Condensed Consolidated Financial Statements

The following table summarizes the exercise prices of the options outstanding at June 30, 2004:

The weighted average exercise price of the Company’s outstanding stock options was $13.90 per share at June 30, 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 values of the fixed option grants were estimated using the Black-Scholes option-pricing model with the following weighted average assumptions used for option grants:

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 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.

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Inveresk Research Group, Inc.

Notes to Condensed Consolidated Financial Statements

8.

Employee Benefits

The net periodic pension costs for the Company’s defined benefit pension plan include the following components:

The total employer’s contributions paid to the plan in the second quarter and first six months of 2004 amounted to $0.9 and $2.0 million respectively, 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 U.S. 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 U.K. are not material.

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Inveresk Research Group, Inc.

Notes to Condensed Consolidated Financial Statements

Financial data by segment are as follows:

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Inveresk Research Group, Inc.

Notes to Condensed Consolidated Financial Statements

The following table summarizes net service revenues and long-lived assets by geographic area.

The Company’s operations in Europe comprise operations in a number of countries that are coordinated from the U.K. No European country is significant in terms of revenues generated or assets held, other than the U.K. 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.

No client accounted for more than 10% of the Company’s consolidated net revenue for any of the periods covered by these financial statements.

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Inveresk Research Group, Inc.

Notes to Condensed Consolidated 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.

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ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 and six month periods ended June 30, 2004 and June 30, 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 operations for a particular quarter may not be indicative of the results that may be expected for other quarters or the entire year.

Overview

The following discussion and analysis of our financial position 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 operations. 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 in identifying 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 operations 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 operations, 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, this data provide an indication of the future prospects of the Company.

Approximate new business signings for the twelve months ended June 30, 2004 compared with reported net service revenues are as follows:

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

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half of the year than in the first. In addition, at June 30, 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 June 30, 2004 stood at 27 days.

The main area of market risk that affects our business is foreign exchange rate fluctuations. In the first six months of 2004, approximately 77% of our revenues were generated outside of the U.S., principally in the U.K. 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 and the six months ended June 30, 2004, compared with the quarter and six months ended June 30, 2003.

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The following table summarizes the above results of operations as a percentage of net service revenue:

Significant Matters Affecting Our Financial Condition and Results of Operations

Share offering and merger expenses

Merger with Charles River Laboratories International, Inc.

On June 30, 2004, we entered into an Agreement and Plan of Merger with Charles River and Indigo Merger I Corp. and Indigo Merger II Corp., both wholly owned subsidiaries of Charles River. The merger is subject to the satisfaction of certain closing conditions, including the approval of our stockholders and receipt of regulatory approvals.

Under the terms of the merger agreement, Indigo Merger I Corp. will merge with and into the Company, whereupon the Company will become a wholly owned subsidiary of Charles River. Pursuant to, and as part of a single integrated transaction, the Company will then be merged with and

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into Indigo Merger II LLC, whereupon the separate corporate existence of the Company will cease and Indigo Merger II LLC will be the surviving corporation.

Upon the merger of Indigo Merger I Corp. and the Company, each share of the Company’s common stock will be converted into the right to receive $15.15 in cash and 0.48 shares of common stock in Charles River. In addition, each outstanding option to purchase the Company’s common stock will be converted into an option to purchase Charles River stock. Each stock option resulting from such conversion will continue to have the same terms and conditions following the merger with Indigo Merger I Corp., except that (i) each option will be exercisable for that number of whole shares of Charles River stock equal to the number of shares of Inveresk stock that were issuable upon exercise of the related Inveresk stock option multiplied by 0.8, rounded down to the nearest whole number, and (ii) the per share exercise price for the Charles River stock options will equal the exercise price per share of Inveresk stock at which the related stock option was exercisable divided by 0.8, rounded to the nearest whole cent.

During the second quarter of 2004, we incurred approximately $5.0 million in merger costs and we expect to incur significant additional merger-related costs in the remainder of 2004. These are included in the share offering and merger expenses caption in the statement of operations for the second quarter. We expect total merger-related costs during 2004 could amount to up to $14 million, primarily due to financial advisory, legal and accounting fees. The majority of the merger-related costs expected to occur in the remainder of 2004 are contingent upon the consummation of the merger and, accordingly, are not expected to significantly impact our results of operations unless and until the merger is consummated.

If the merger agreement is terminated under certain circumstances specified in the merger agreement, we may be required to pay to or entitled to receive from Charles River, a termination fee of $38.1 million. In addition, if we fail to consummate the proposed merger, the price of our common stock may decline as the current market price may reflect an assumption that the proposed merger will be consummated and that our stockholders will become stockholders of Charles River upon closing of the merger.

Other 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 2003 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.

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

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clinical development operations. Its strong presence in the field of respiratory 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.

Exchange rate fluctuations

Our condensed consolidated financial statements are prepared in U.S. dollars. Our principal businesses are based in the U.S., U.K. and Canada. Our U.K. 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 operations 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: