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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2002

OR

For the transition period from                          to                         

Commission file number 0-27570

PHARMACEUTICAL PRODUCT DEVELOPMENT, INC.

(Exact name of registrant as specified in its charter)

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

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $0.10 per share

(Title of class)

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

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

The aggregate market value of the common stock held by non-affiliates of the registrant was approximately $1.25 billion as of June 30, 2002, based on the closing price of the Common Stock on that date on the Nasdaq National Market System. Shares of Common Stock held by each executive officer and director and by each person who owns 10% or more of the outstanding Common Stock have been excluded in that such person might be deemed to be affiliates. This determination of affiliate status might not be conclusive for other purposes.

As of February 3, 2003, there were 55,577,181 shares of the registrant’s common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

The Company’s definitive Proxy Statement for its 2003 Annual Meeting of Stockholders (certain parts as indicated in Part III).

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PART I

Statements in this Report that are not descriptions of historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements reflect management’s current view with respect to future events and financial performance, but are subject to risks and uncertainties. Actual results could differ materially from those currently anticipated due to a number of factors, including those set forth herein and in our other SEC filings, and including, in particular, the factors discussed in Item 1 under the heading “Factors that Might Affect our Business or Stock Price.”

Item 1. Business

Overview

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

We have been in the drug development business for more than 17 years. Our development services include preclinical programs and Phase 1 to Phase 4 clinical development. We have extensive clinical trial experience across a multitude of therapeutic areas that encompass various parts of the world, including regional, national and global studies. In addition, we also offer post-market support services for drugs that have received approval for market use, such as product launch services, patient compliance programs, and medical communications programs for consumer and healthcare providers on product use and adverse events.

With more than 5,300 professionals in 24 countries around the world, we have provided services to 41 of the top 50 pharmaceutical companies in the world as ranked by 2001 healthcare research and development spending, in addition to many leading biotechnology companies. We believe that we are one of the world’s largest providers of drug development services to pharmaceutical and biotechnology companies based on 2002 annual net revenues of contract research organizations.

Building on our outsourcing relationships with pharmaceutical and biotechnology clients, we established our discovery services business in 1997. This business focuses on early stage research to help our customers address the bottleneck at the beginning of the development process. This business primarily involves functional genomics, which is the study of gene functions to identify drug targets within the body, medicinal chemistry research and preclinical biology services, as well as preclinical evaluations of anticancer therapies.

In addition, we have developed an innovative risk-sharing research and development model to help pharmaceutical and biotechnology clients develop compounds. Through arrangements based on this model, we help our clients research and evaluate the development potential for early stage compounds, while their investment is significantly less than the amount at risk later.

We believe that our integrated drug discovery and development services offer our clients a way to identify and develop successful drugs more quickly and cost effectively. We also use our proprietary informatics technology to support our drug discovery and development services. In addition, because we are positioned globally, we are able to accommodate the multinational drug discovery and development needs of our customers. As a result of having these core areas of expertise in discovery and development, we can provide integrated services across the entire drug development spectrum, from target discovery to market and beyond.

Industry Overview

Discovering and developing new drugs is an extremely expensive and time-consuming process. The Tufts Center for the Study of Drug Development estimates that the cost to develop a new prescription drug increased from

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$231 million in 1987 to $802 million in 2001 and that it takes between 10 and 15 years to develop a new prescription drug and obtain approval to market it in the United States.

The drug development services industry provides independent product development services to the pharmaceutical and biotechnology industries. This industry has evolved from providing limited clinical trial services in the 1970s to a full-service industry today that encompasses broader relationships with customers, covering the entire drug development process, including preclinical evaluations, study design, clinical trial management, data collection, biostatistical analysis and product registration support.

Over the past 20 years, technological advances have dramatically changed the drug discovery process. New and improved technologies have evolved such as combinatorial chemistry, ultra high-throughput screening, new in vitro and in vivo preclinical profiling techniques, and the revolution in genetic-based drug research commonly referred to as genomics. The objective of these innovations is to find more drug targets and to screen against targets much more quickly with literally millions of chemical compounds. This process should produce many more molecules having the ability to affect biological activity. These molecules then need to be tested quickly and economically.

The Drug Discovery and Development Process

Drug discovery and development is the process of creating drugs for the treatment of human disease. The drug discovery process aims to generate safe and effective drug candidates, while the drug development process involves the testing of these drug candidates for safety and efficacy in animals and humans.

The Drug Discovery Process

Targets. Historically, scientists have used classical cellular and molecular biology techniques to map biological pathways in cells to provide a cellular basis for understanding disease processes. Based on this information, scientists are now using a new set of technologies called genomics to pinpoint genes responsible for cellular disease functions. Once genes are identified, they are tested in cellular assays or animals to identify which genes seem to have a causal link between cellular function and occurrence of disease. The preferred genes encode proteins that are used as drug targets in chemical screens.

Screening. After identifying a potential drug target, researchers develop tests, or assays, in which chemicals are screened for their ability to alter the functional activity of the target. Thousands of chemicals can be quickly screened when these assays are incorporated into high-throughput screening processes. Assays can produce chemicals that interact with a drug target known as “hits.” Hits that have good potency and selectivity are called “leads” and are then tested for their potential as drug candidates.

Lead Generation. Scientists now design compound libraries to provide a starting point to identify leads in the drug discovery process and to better understand the biochemistry and therapeutic relevance of targets. High quality libraries contain compounds of known purity, structure and weight, and also have diverse structural variations. Once a hit is identified in a functional assay, the compound is profiled for drug characteristics such as solubility, metabolism, stability and feasibility for commercial production.

Lead Optimization. The process of “lead optimization” involves refining the chemical structure of a lead to improve its drug characteristics, with the goal of producing a preclinical drug candidate. Lead optimization typically combines empirical and rational drug design. In empirical design procedures, large numbers of related compounds are screened for selected chemical characteristics. In rational drug design, chemicals are optimized based on the three-dimensional structure of the target. A lead that has been optimized to meet particular drug candidate criteria and is ready for toxicity testing is called a preclinical candidate.

Process Research and Development. Compounds created for screening in lead generation and lead optimization are made in relatively small, milligram quantities. Before a drug candidate can be taken into preclinical and clinical trials, larger quantities must be produced. The goal of process research is to improve the ease with which compounds can be produced in these larger quantities, typically by minimizing the number of production

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steps, and to determine how to reduce the time and cost of production. Process development refers to the production scale-up and further refinement required for clinical trials and commercial manufacturing.

The Drug Development Process

The drug development process consists of two stages: preclinical and clinical. In the preclinical stage the new drug is tested in vitro, or in a test tube, and in vivo, or in animals, generally over a one- to three-year period. The following discussion describes the role of the Food and Drug Administration, or FDA, in the drug development process in the United States. Similar regulatory processes exist in other countries.

Prior to commencing human clinical trials in the United States, a company must file with the FDA an Investigational New Drug, or IND, application containing details for at least one study protocol and outlines of other planned studies. The company must provide available manufacturing data, preclinical data, information about any use of the drug in humans for other purposes and a detailed plan for the proposed clinical trials. The design of these trials, also referred to as the study protocols, is essential to the success of the drug development effort. The protocols must correctly anticipate the nature of the data to be generated and results that the FDA will require before approving the drug. If the FDA does not comment within 30 days after an IND filing, human clinical trials may begin.

The clinical stage is the most time-consuming and expensive part of the drug development process. The drug undergoes a series of tests in humans, including healthy volunteers as well as patients with the targeted disease or condition.

Human trials usually start on a small scale to assess safety and then expand to larger trials to test efficacy. These trials are usually grouped into the following three phases, with multiple trials generally conducted within each phase:

After the successful completion of all three clinical phases, a company submits to the FDA a New Drug Application, or NDA, or a Product License Application, or PLA, requesting that the drug be approved for marketing. The NDA or PLA is a comprehensive, multi-volume filing that includes, among other things, the results of all preclinical and clinical studies. The FDA’s review can last from a few months to several years, depending on the drug and the disease state that is being treated. Drugs that successfully complete this review may be marketed in the United States. As a condition to its approval of a drug, the FDA might require additional clinical trials following receipt of approval, in order to monitor long-term risks and benefits, to study different dosage levels or to evaluate different safety and efficacy parameters in target populations. In recent years, the FDA has increased its reliance on these trials, known as Phase 3b and Phase 4 trials, which allow new drugs that show early promise to reach patients without the delay typically associated with the conventional review process.

Trends Affecting the Drug Discovery and Development Industry

The drug discovery and development services industry has been and will continue to be affected by the following trends:

Rapid Technological Change and Increased Data. Scientific and technological advancements are rapidly changing the drug discovery and development processes. The technology to understand gene function, known as

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functional genomics, is dramatically increasing the number of identified potential drug targets within the human body. All of the human therapeutic drugs on the market today are directed at approximately 500 targets. The genomics revolution is projected to expand the number of identified potential targets to between 5,000 and 10,000. This proliferation of targets increases the need for companies to use state-of-the-art technologies to validate targets effectively. Rapid methods are needed to analyze large numbers of compounds to identify and optimize promising lead drug candidates. This technology and the human expertise necessary to manage and keep up with it are costly. Companies can reduce their fixed costs by outsourcing this technology.

Increase in Potential New Drug Candidates. The increase in potential new drug candidates resulting from the genomics revolution has caused a bottleneck in the drug development industry. While the number of drug candidates is rapidly increasing, the time to develop a new drug candidate has increased in the last 30 years. Pharmaceutical and biotechnology companies do not have the internal resources to pursue development of all of these new drug candidates on their own. Consequently, these companies are looking to the drug development services industry for cost-effective and rapid means of developing new drugs.

Biotechnology Industry Growth. The United States biotechnology industry has grown rapidly over the last 10 years. This industry is generating significant numbers of new drug candidates that will require development and regulatory approval. Many of these new drug candidates are now moving into clinical development, but many biotechnology companies do not have the necessary staff, operating procedures, experience or expertise to conduct clinical trials on their own. Because of the time and fixed cost involved, these companies often do not have the inclination to develop their own staff in this area.

Need for Large Scale Global Support. More pharmaceutical and biotechnology companies currently are filing drug registration packages in several major jurisdictions simultaneously, rather than following the past practice of filing sequentially. The studies to support these registration packages frequently include a combination of multinational and domestic trials. This trend puts an emphasis on global experience and coordination throughout the development process, including the collection, analysis, integration and reporting of clinical trial data.

Cost Pressures of Introducing New Drugs. Market forces and governmental initiatives place significant pressure on pharmaceutical and biotechnology companies to reduce drug prices. Pressures on profit margins have arisen primarily from increases in the cost of the drug discovery and development process. In addition, increased competition as a result of patent expiration, market acceptance of generic drugs, and governmental and private managed care organization efforts to reduce healthcare costs have added to the pressures of introducing a new drug. The industry is responding by consolidating, downsizing operations, decentralizing the internal discovery and development process, and minimizing fixed costs. In addition, increased pressures to differentiate products and justify drug pricing are resulting in growth in healthcare economics services with respect to drugs under development and those already on the market. Consequently, pharmaceutical and biotechnology companies are attempting to increase the speed of new drug discovery and development. By identifying possible lead compounds and eliminating others from the discovery process as early as possible, companies can focus their research and development efforts more efficiently. Turning drug discovery and development processes over to third parties also minimizes these companies’ fixed costs.

The PPD Solution

We address the needs of the pharmaceutical and biotechnology industries for drug discovery and development by providing integrated services to help our clients maximize the return on their research and development investments. We believe that our application of innovative technologies, therapeutic expertise and commitment to quality throughout our integrated drug discovery and development services offers our clients a way to identify and develop successful drugs more quickly and cost effectively. We have developed significant drug development expertise from over 17 years of operation. During the past five years, we have expanded our services to include drug discovery services to help our clients identify potential new drug candidates, reduce drug discovery time and minimize unproductive compound development. We also use our proprietary informatics technology to support our drug discovery and development services. Finally, because we are positioned globally, we are able to accommodate the multinational drug discovery and development needs of our customers.

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Our Strategy

Our corporate mission is to help clients maximize the return on their research and development investments. The key parts of our strategy to accomplish this mission include the following:

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Our Services

We have been providing our core drug development services for more than 17 years. Over the past few years, we have expanded our service portfolio to include discovery and post-market support services. We provide services designed to increase efficiency, reduce timelines and save costs through our global infrastructure, integrated research and development technologies and experience, and customer-focused communications. We operate in two segments: Discovery Sciences and Development. See Consolidated Statements of Operations for segment information regarding revenues and see Note 16 of Notes to Consolidated Financial Statements for segment information regarding total assets and a measure of profit or loss.

Our Discovery Sciences Group

Our Discovery Sciences Group focuses on the discovery research segment of the pharmaceutical research and development outsourcing market. We have acquired or developed proprietary genetic and chemical technologies to improve the productivity of biopharmaceutical research and development. These technologies cover a number of discovery techniques, including:

Functional Genomics. Genomics is revolutionizing the process of drug discovery through the sequencing of the human genome and the identification of genes associated with disease. It is estimated that there are approximately 35,000-40,000 genes in the human genome. Genes are comprised of chemical structures called nucleotides. It is the order of these nucleotides that make up a gene sequence. Through a complex sequence of events, genes specify, or encode, proteins that have specific functions in cells. Neither a gene sequence nor gene disease association data alone provide sufficient information to identify cellular proteins that make effective drug targets. Our proprietary functional genomics technology provides the means to link gene sequences with cellular mechanisms known or believed to be involved in disease to develop effective screens for drug discovery.

The basis for and the advantage of our proprietary GSX system are that it identifies essential genes in a disease pathway based on function. A change in biological function observed by our scientists enables them to identify a gene that has a causal link to a particular disease. In the GSX system, we start with a set of genes that we want to test as potential drug targets. These genes are then broken up to generate a collection of small, random strings of nucleotides, referred to as gene fragments. These gene fragments are then put into test cells where the fragments will be converted into protein, or “expressed.” Our scientists observe the test cells to detect any change in a particular function. We expect that some of the gene fragments will alter the activity of a component of the test cells causing a desired change in a cellular property, or “phenotype.” Thus, it is essential to have cells that display a desired biological property that is known or believed to be part of a disease pathway. For example, a malignant cell is useful for identifying a gene fragment that alters the growth pattern of the cell and therefore potentially has anti-tumor activity.

Our scientists look for cells in which a particular function, such as malignant growth, has been inhibited by the gene fragment introduced into the cell. The functional inhibition results from expression of gene fragments in the cells that can effectively inhibit the function of the whole, or full-length, gene corresponding to the fragment. In general terms, the gene fragments are said to be acting on targets that are essential to the cellular function that is inhibited. Each inhibitory gene fragment is called a genetic suppressor element, or GSE. After our scientists identify

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cells with altered phenotypes, they isolate the cells that display the desired phenotype and recover the inserted GSE from these cells. Our scientists then determine the nucleotide sequence of each GSE. Upon searching large databases containing gene sequences of the human genome using a GSE sequence, we can frequently find the gene from which that GSE came.

Because of their inhibitory nature, GSEs can themselves be used as therapeutic compounds, or they can be used as drug discovery tools. Typically, GSEs are used to identify and validate drug discovery targets based on the premise that if a GSE causes a desired effect on a target, then a drug acting on the same target as the GSE should produce the same outcome. Once we identify a target using our GSX system, a scientist can easily test the ability of a chemical compound to inhibit the activity of the target using any one of a variety of conventional biological assays, preferably in a high-throughput screening format to expedite the process.

Our GSX system can be applied to finding treatment for such diseases as cancer, heart disease, viral infections and others. In principle, the technology permits identification of all necessary components of any disease pathway as long as the component is involved in an observable phenotype. We offer our GSX system as part of our services to collaborators throughout the drug discovery process.

Target Validation. Our scientists utilize state-of-the-art systems to determine the relevance of newly identified target genes to a particular disease state. These systems include blocking target expression of a target gene using GSEs or inhibitory RNA molecules to interfere with the activity of that target gene and determine the effect on disease progression. Our biologists perform tumor model experiments that link target activity with tumor development. As an adjunct to our core validation techniques, we offer systems to determine gene expression patterns to better understand the biological activity of a target in a disease state.

Chemistry. Our chemistry group assists our customers from lead generation through lead optimization. These services include providing chemicals with selected structures for screening, computational chemistry and synthesis expertise to help determine which hits and leads have drug-like characteristics that make them worthy of additional study or optimization. We provide a broad range of chemistry services, including:

Custom-designed libraries. We design and produce custom libraries of compounds for our clients. These libraries are generally focused toward specific target families or our customer specifications. We also produce custom-designed libraries for internal research and development programs.

Lead Generation. The availability of high quality compound libraries with structures relevant for screening specifically against important targets and that are designed for rapid lead optimization is a rate-limiting step in the drug discovery process. We have developed synthesis protocols to produce small molecule libraries so that any leads generated require less optimization and have a greater likelihood of success of becoming drug candidates. Our chemists can create chemical structures according to customer specifications or directed toward specific targets. We can also provide library synthesis for a customer’s in-house or previously purchased compound libraries. The chemical synthesis strategy we employ typically yields between one to 10,000 different chemicals. We use all available components to input a range of diversity for production of customer-unique libraries. We invest significant effort in the process and synthesis of each library to ensure that the compounds generated are of known purity, structure, diversity and amount. We analyze the library during each stage of its development to ensure the identity of each compound and to maintain quality.

We have developed proprietary software that uses various parameters to define diversity in a library. Our SAR System^™ software analyzes how changes in chemical structure correlate with physical and chemical parameters of compounds in a virtual library. The SAR System software can be used prior to library synthesis to construct a virtual library based on customer specifications. We can then minimize the components of the virtual library to identify compounds that potentially interact with a particular target to be screened as leads.

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Lead Optimization. Our medicinal chemists can optimize structures to improve the profile of a compound or lead series generated from multiple starting points, including leads provided by our customers, leads generated internally from our custom libraries, and leads from internally generated libraries designed and synthesized to customer specifications. Regardless of the lead’s source, we emphasize simultaneous improvement of multiple parameters of lead compounds. Our experts are able to evaluate and re-engineer compounds to improve compound solubility, absorption, half-life, inherent toxicity, delivery or pro-drug generation.

Our chemistry group also offers chemistry services, including:

Preclinical Biology. Our preclinical biology group integrates pharmacology, metabolism, pharmacokinetic and toxicology expertise to provide preclinical program design and project management services. These services assist in the identification and prioritization of portfolio compounds that have the best chance of success in clinical development. We provide a broad range of preclinical services and products including:

Lead Profiling and Prioritization Resources. Our lead profiling and prioritization services facilitate the early screening process and enable our customers to choose compounds that have the best chance of success in the preclinical and clinical arenas. We can also perform computational analysis to predict absorption, toxicity or metabolite characteristics of a lead compound. We can employ a variety of assays to profile lead compounds including assays that use Pharmazyme^™ isozymes, our patented recombinant human cytochrome P450 enzymes. Cytochrome P450s are enzymes primarily responsible for metabolizing many drug substances. We can identify metabolizing enzymes and identify metabolites. Using these in vivo assays, we can also determine pre-formulation, solubility and stability characteristics. We also employ a process known as cassette dosing, which allows us to simultaneously evaluate a number of compounds in screening pharmacokinetic studies.

Preclinical Program Design and Proprietary Preclinical Project Management Software. Once a potential drug candidate is identified, we offer services and products that enable our customers to decide whether to advance the drug candidate into a preclinical program both faster and with a greater probability of success. We offer our customers access to our proprietary Web-based interactive tool called First Pass^™, a software program that helps the user prepare an efficient preclinical development plan based on a variety of parameters. The program estimates costs, amount of material required and study timelines. The program also helps identify studies critical for development. Our experts can then provide full preclinical development services and can integrate other development services internally.

Specialized Oncology Preclinical Cancer Research Models. We offer preclinical consulting as well as a full range of preclinical efficacy, pharmacokinetic, pharmacodynamic and mechanism models for anticancer

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therapeutic candidates. Our experienced oncology staff design and perform the studies needed to identify, profile and optimize lead compounds.

Toxicology Consulting and Laboratory Support. Supported by our board-certified toxicologists, we develop and implement preclinical toxicology programs. To support the clinical development program, we write the toxicology study protocols, identify qualified good laboratory practice, or GLP, testing facilities, manage the placement and conduct of studies and prepare and review pharmacology, toxicology, absorption and metabolism data for regulatory submissions. Our biologists offer a range of growth inhibition assays and cytotoxicity assays in mouse and human cell lines to test toxicity characteristics of candidate compounds.

Technical Writing and Regulatory Submissions. Our technical writers can prepare pharmacology and toxicology summaries for regulatory submissions and work with regulatory authorities to develop preclinical plans. We offer a full range of regulatory support services, including document submission, preparation and review of all preclinical regulatory submissions required by regulatory agencies, and facilitation of meetings with regulatory agencies to ensure successful outcomes.

Laboratory Support. Our preclinical biology group supports extensive laboratory services. The FDA’s 1997 Drug Metabolism Drug Interaction Guidance suggests that in vitro metabolism studies be used to screen for potential drug-drug interactions in the clinic. Data from in vitro studies demonstrating the lack of interaction can be used to rationalize and streamline the clinical drug-drug interaction program. Our scientists perform assays to identify the metabolizing human cytochrome P450 enzymes and resulting metabolites of a new chemical entity, predict its metabolic profile and assess its drug-drug interaction potential. Our metabolism group performs a variety of drug metabolism services including inhibition assays, induction studies, metabolic stability studies to assess potential for first possible effect, metabolite identification, metabolite profiling, drug-drug interaction studies, serum stability assays, protein binding studies and absorption assays.

Our pharmacokinetics experts help customers evaluate the toxicity of their drug candidates using both GLP and non-GLP pharmacokinetic and bioanalytical analyses. Specialized toxicologists develop screening protocols based on the nature of drug candidates and therapeutic targets. Our expertise includes preformulation and compound preparation, single- and cassette-compound dosing, drug administration via different routes, sample collection based on defined protocols, method development to demonstrate a viable extraction procedure, solution preparation with reference standards, quality control, sample preparation with a variety of techniques, and data analysis. Our pharmacokinetisists are experienced in generating large-scale GLP-compliant analyses and reports that can be integrated into the final toxicology study report.

Drug Development Collaborations. Some biotechnology and pharmaceutical companies have not progressed to the development of previously discovered therapeutic compounds for several reasons, including the fact that these compounds may have efficacy outside of the core therapeutic expertise of the company, the potential market for a particular compound may fall below the company’s minimum threshold, or the company may not have the financial resources to further develop the compound. We believe there are attractive opportunities to selectively in-license these compounds, jointly develop them with a third party and license them out again in collaborative arrangements that combine our global development resources with these compounds. We offer contract clinical research services as part of joint development agreements with owners of chemical compounds in need of development.

For example, in January 2001 we granted ALZA Corporation, which was subsequently acquired by Johnson & Johnson, an exclusive license to our compound dapoxetine for genitourinary indications, including premature ejaculation. We received these rights in 1998 as part of a development collaboration with Eli Lilly and Company. Under the terms of the agreement, ALZA received worldwide rights to develop and commercialize dapoxetine and is responsible for clinical, regulatory, manufacturing, sales and marketing costs resulting from the license. In exchange, we received an up-front payment and will receive royalties on net sales and milestone payments based on product approval and meeting certain sales levels.

In addition, in 2002, we acquired worldwide rights from Bayer AG to undertake additional Phase 1 and 2 clinical studies on implitapide in the areas of arteriosclerosis, elevated triglycerides, pancreatitis and hyperlipidemia.

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In connection with our studies, we will have access to Bayer AG’s existing information from preclinical studies and previously conducted Phase 1 and 2 clinical trials, as well as regulatory filings to conduct clinical trials in the United States, Europe and South Africa.

We expect to continue to use our development expertise in risk-sharing arrangements. We generally structure these risk-sharing arrangements to provide us with up-front fees, milestone payments and royalties as a compound is developed.

Our Development Group

We have designed our various global services to be flexible and integrated in order to assist our clients in optimizing their research and development spending through the clinical stages of the drug development process. We provide a broad range of development services, either individually or as an integrated package, to meet clients’ needs. We provide systems integration services and software development services, and create data links between discovery and development.

Phase 1 Clinical Testing. We are one of the industry’s largest Phase 1 trial providers, with clinical testing services conducted in a 220-bed unit in Austin, Texas, and a 50-bed unit in Leicester, England. Our professional nursing and physician staff administers general Phase 1 safety tests, special population studies, and bioavailability and bioequivalence testing. Bioavailability and bioequivalence testing involves administration of test compounds and obtaining biological fluids sequentially over time to measure absorption, distribution, metabolism and excretion of the drug. Special population studies might involve the elderly, women or patients with specific diagnoses, such as renal failure or asymptomatic HIV. Our Austin, Texas site also has a dental research clinic to evaluate the safety and effectiveness of new analgesic compounds in molar extraction models.

Our in-house clinical laboratory supports the Phase 1 operations in Austin. This laboratory performs clinical chemistry assays on volunteer specimens to ensure that each subject qualifies for the study and is not adversely affected by a drug. Having our laboratory in the same facility as the volunteers speeds our response time to unexpected outcomes. This laboratory also provides services to function as a central laboratory for small Phases 2 through 4 studies. We manage our Phase 1 services to maximize scheduling flexibility and efficiency. These services also can be integrated with our other services, such as bioanalytical, data management, pharmacokinetic and biostatistical services.

Laboratory Services. We provide bioanalytical services through good laboratory practice, or GLP, compliant laboratories in Richmond, Virginia and Middleton, Wisconsin. Our bioanalytical laboratories analyze biological fluid samples from animal and human clinical studies. The latter includes those conducted by our Phase 1 units as well as those conducted on behalf of our clients from Phase 1 through Phase 4 for drug and metabolite content and concentration. We currently have over 1,500 validated assays available for our clients’ use in conducting laboratory analyses, qualifying us for a wide range of assignments. Our laboratories also process fluid samples for preclinical studies.

We provide product analysis laboratory services through our good manufacturing practice, or cGMP, compliant laboratory in Middleton, Wisconsin. Our product analysis services include dissolution and stability studies, which are necessary to characterize dosage form release patterns and stability under various environmental conditions in the intended package for marketing. These studies must be carried out from preclinical testing through Phase 4 and maintained over the commercial life of products. New formulations as well as generics and prescription products going to over-the counter status, such that they no longer require physician prescription for consumer use, all require the same set of studies as the original dosage form.

Our bioanalytical methods include gas chromatography/mass spectrometry (GC/MS), liquid chromatography/mass spectrometry (LC/MS), high performance liquid chromatography (HPLC), gas chromatography (GC), radioimmunoassay (RIA) and enzyme linked immunosorbent assay (ELISA). Support services include facilities for handling HIV-positive samples, data management for pharmacokinetic studies from multi-center trials and sample/data archiving.

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We provide global specialty central laboratory services for large clinical trials through our laboratories in Highland Heights, Kentucky and Brussels, Belgium. Our specialty central laboratories provide highly standardized efficacy and safety testing services for pharmaceutical companies engaged in clinical drug development as well as U.S. government (National Institute of Health) funded clinical trials. We are one of the largest specialty central laboratory providers for Phase 1 through 4 global studies involving agents used in cholesterol, endocrine, metabolic and cardiovascular clinical research.

We are one of a few full service companies able to offer our clients the advantages of bioanalytical, product analysis and specialty central laboratory services, as well as Phase 1 clinical testing.

Phases 2 through 4 Clinical Trial Management. The core of our development business is a comprehensive package of services for the conduct of Phases 2 through 4 clinical trials, which in concert with our other services allow us to offer our clients an integrated package of clinical management services. We have significant clinical trials experience in the areas of:

We serve our clients’ needs by conducting clinical trials through a project team. A project manager supervises all aspects of the conduct of the clinical trial, while our clinical research associates are in the field monitoring the trial at the various investigational sites where it is being conducted. Within this project-oriented structure, we can manage every aspect of the clinical trial in Phases 2 through 4 of the drug development process. The services that we offer to initiate clinical trials include protocol development, case report form design, feasibility studies, investigator selection, recruitment and training, site initiation and monitoring, accelerated patient enrollment, development of training materials for investigators and training of clients’ staff.

We monitor our clinical trials in compliance with government regulations and guidelines. We have adopted global standard operating procedures intended to satisfy regulatory requirements in the United States and in many foreign countries and serve as a tool for controlling and enhancing the quality of our clinical trials. All of our standard operating procedures are in compliance with good clinical practice, or GCP, requirements and the International Conference on Harmonization, or ICH, standards. The FDA has adopted these standards in their guidance documents and more recently the members of the European community and Japan have codified these standards into their Clinical Research Regulations. We compile, analyze, interpret and submit data generated during clinical trials in report form to the FDA or other relevant regulatory agencies for purposes of obtaining regulatory

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approval. We provide consulting on conducting clinical trials for simultaneous regulatory submissions to multiple countries.

We provide our clients with one or more of the following Phases 2 through 4 clinical trial management services using parallel processing to accelerate the development process:

Study Design. We serve our clients in the critical area of study design by applying our experience in the preparation of study protocols and case report forms.

Investigator Recruitment. During clinical trials, physicians, who are also referred to as investigators, at hospitals, clinics or other locations, supervise administration of the drug to patients. We recruit investigators who contract either with us or with our clients to participate in clinical trials. We are continually looking for new investigator sites, particularly those that complement our primary therapeutic areas.

Study Monitoring. We provide study-monitoring services, which include investigative site initiation, patient enrollment assistance and data collection through subsequent site visits. We have monitored many clinical trials, including a number of very large studies. For example, we are engaged in a project with the National Institute of Health, begun in 1990, which has approximately 50 protocols open at any given time. Through December 31, 2002, this project had involved approximately 1,000 investigational sites and approximately 110,000 enrolled patients, had generated 400 protocols and more than 4,200 pharmacy, regulatory and operational audits at the sites.

Clinical Data Management and Biostatistical Analysis. We provide clients with assistance in areas such as study design, sample size determination, case report form design and production, database design and construction, fax-based monitoring, and electronic data capture. We also provide statistical analysis and summaries, including: interim and final analyses, data safety and monitoring board summaries and presentations, new drug application preparation and electronic production and presentations and defense to regulatory authorities.

Medical Writing and Regulatory Services. We provide planning services for product development, including preclinical review, chemistry, manufacturing and controls, or CMC; consulting, and clinical protocol development. These activities are complemented by report writing, program management and regulatory services designed to reduce overall development time.

Post-Development Support. We provide custom-designed pharmaceutical and medical information programs in support of marketed pharmaceutical products. Other services include clinical consultations with pharmacists, nurses, veterinarians and other customer assistance specialists.

Healthcare Economics, Outcomes and Marketing Research. We offer a number of services in healthcare economics, outcomes and market research to pharmaceutical and biotechnology companies, as well as managed care payors and providers. These services include prospective health economic and outcomes studies incorporated into Phases 2 through 4 clinical trials; retrospective studies including database evaluations and medical chart reviews to analyze use patterns; mathematical modeling of health economics and outcomes information to real world settings; epidemiological study design and implementation; and development and implementation of publication strategies for health outcomes and marketing research results.

eClinical initiative. Our eClinical initiatives offer efficiencies, enhanced quality and improved communications with our clients. Launched in 2001, PPD DirectConnect^™ Web portals have grown to support over 750 users across 26 pharmaceutical and biotechnology companies. Also in 2001, we re-engineered our data management processes to Oracle Clinical data management system. We are further expanding our capabilities by introducing a Web-based document imaging system in 2003. We are also moving to a Web-based safety system offering expanded functionality and integration with our clinical data management information.

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Informatics. Our informatics division delivers specialized software products and technical consulting services to support many aspects of the pharmaceutical research and development process, including drug discovery, clinical trials, regulatory review and pharmacovigilance. Our informatics clients include international and domestic pharmaceutical and biotechnology companies and government agencies, including the FDA. Our current informatics software products include:

A primary focus of our informatics division is to provide consulting services to help pharmaceutical and biotechnology companies assess and resolve clinical data management and safety system challenges, such as integrating and customizing systems, migrating clinical and safety data, providing computer systems validation services that include compliance evaluation, and updating or replacing legacy systems to meet regulatory guidance.

The informatics group was expanded to extend its services in the training, validation and software development areas with the acquisition in June 2002 of Complete Software Solutions, Inc., or CSS. CSS, now a division of our informatics group, is a leading supplier of services to the companies that use the Oracle Pharmaceutical Applications Suite. CSS also provides companies with validation and regulatory consulting expertise across a broad range of data management and safety systems. CSS has its main office in San Francisco, California and serves clients in North America, Europe and Japan.

Clients and Marketing

We provide a broad range of research and development and consulting services in the Development and Discovery Sciences Groups to help pharmaceutical and biotechnology companies from target discovery through development to post-market approval.

Our Development Group provides Phase 1 to Phase 4 clinical development and post-market support services. We believe that the key differentiators that help us win development business include our global infrastructure, quality performance and execution based on ongoing training and quality assurance and control practices, dedicated project teams, and cross-functional therapeutic units with dedicated expertise. Our key assets in this regard include Phase 1 trial clinics in the United States and Europe, a broad range of analytical lab services from in vivo analysis through Phase 4 with our GLP bioanalytical, cGMP product analysis laboratories and our specialty central laboratory, as well as integrated technologies and expertise to provide simultaneous, multinational Phase 2 through Phase 4 submissions. In addition, we offer medical and drug information services and market development services for product launch through post-market approval support, integrating services from our medical communications division and our drug development subsidiary. We also offer consulting and technology for clinical management, validation, training, coding and drug safety from our informatics expertise. We market our development services in the Americas, Europe, Africa, the Middle East and the Pacific Rim and expanded our capabilities in Asia with the June 2002 acquisition of ProPharma Pte Ltd, a contract research organization based in Singapore with offices in Hong Kong, Taiwan, Australia and Thailand.

For the year ended December 31, 2002, approximately 79.5% of our Development Group’s net revenue was attributable to clinical services and 20.5% to laboratory services. In regards to geographic alignment, approximately 20.9% of our Development Group’s net revenues in 2002 were derived from outside the United States, primarily in the United Kingdom.

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Our Discovery Sciences Group offers services and technologies to identify and validate novel drug targets, create compounds, and optimize and profile drug candidates for clinical evaluation. This group provides services to clients in the pharmaceutical and biotechnology industries as well as in general chemical, agrochemical, and other industries. In addition, we conduct research on compounds for which we hold licenses. Our Discovery Sciences Group revenues have all been generated in the United States to date.

For the year ended December 31, 2002, total net revenue for all of our services was derived from various industries approximately as follows:

For the purposes of classifying net revenue, we define Pharmaceutical to include companies with the majority of their research and development related to chemical entities and Biotechnology to include companies with the majority of their research and development related to biologically engineered compounds. Other includes companies primarily focused upon medical devices, diagnostics and generic formulations. In addition, we refer to the Standard Industry Classification, or SIC, codes for publicly traded companies to determine their classification.

We believe that concentration of business among certain large customers is not uncommon in our industry. We have experienced this kind of concentration in the past and might experience it in the future. In 2002, no single client accounted for more than 10% of our net revenue. Approximately 36.6% of our total 2002 net revenue was derived from clients headquartered outside the United States, in particular in Europe and Japan. Approximately 20% of our 2002 net revenue was generated from services provided by our employees located in countries outside the United States. See Note 17 of Notes to Consolidated Financial Statements included elsewhere in this report for the breakdown of this revenue.

With a primary focus on large pharmaceutical companies, we promote our functional genomics discovery technology through a dedicated sales team, localized scientist-to-scientist communications and centralized marketing efforts.

For all of our development, medical communications and informatics services and products, we use centralized corporate marketing to support the efforts of dedicated business development staff calling on pharmaceutical and biotechnology companies. Our sales teams focus on client segments and service areas. In addition, while the service area representatives call on particular buying groups within a given pharmaceutical client, sales account managers are responsible for coordinating all outsourcing across our service areas from that client. To further facilitate cross-functional sales, all business development staff for development services and products across the company worldwide report up to the same executive.

The top 20 publicly traded pharmaceutical companies accounted for 83% of research and development spending in 2001, as ranked by Med Ad News, so we concentrate on these companies. The top 50 publicly traded biotechnology companies accounted for 91% of the biotechnology research and development expenditures in 2001, according to Med Ad News. To appropriately focus our sales and marketing efforts among biotechnology companies, we consider additional factors such as the stage of a drug’s development and the financial stability of a company’s business.

Our business development personnel consult with potential pharmaceutical and biotechnology clients early in the project consideration stage in order to determine their requirements. Along with the appropriate operational, technical or scientific personnel, our business development representatives invest significant time to determine the optimal means to design and execute the potential client’s program requirements. For example, for our drug development services, recommendations we make to the potential client with respect to study design and implementation are an integral part of our bid proposal process and an important aspect of the integrated services we

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offer. We believe our preliminary efforts relating to the evaluation of a proposed clinical protocol and implementation plan enhance the opportunity for accelerated initiation and overall success of the clinical trial.

Our core global marketing and corporate communications activities include online advertising and directory listings on predominant industry Web sources; interactive Web education and information programs, including Web conferences and Webcasts; direct e-mail campaigns; client presentations and detailing materials; global speakers’ bureau; media relations; corporate materials; and marketing at professional trade shows. In addition, we encourage and sponsor the participation of our personnel in a variety of professional endeavors, including the presentation of papers at national and international professional trade meetings and the publication of scientific articles in medical and pharmaceutical journals. Through these presentations, publications and additional promotion via our corporate Web site, we believe these activities advance and promote our reputation for professional excellence.

Backlog

Our backlog consists of anticipated net revenue from letters of intent, verbal commitments and contracts that either have not started but are anticipated to begin in the near future or are in process and have not been completed. Amounts included in backlog have not already been recognized as revenues in our statement of operation. Net revenue is defined as professional fee income, or gross revenue, less fees and associated reimbursements that we receive as an agent, consisting principally of investigator fees. Once contracted work begins, net revenue is recognized over the life of the contract. Our backlog was $974.4 million in net revenue at December 31, 2002, compared to $674.2 million in net revenue at December 31, 2001.

We believe that our backlog as of any date is not necessarily a meaningful predictor of future results, because backlog can be affected by a number of factors, including the size and duration of contracts, many of which are performed over several years. Additionally, contracts relating to our clinical development business generally are subject to early termination by the client or delay for many reasons, including unexpected test results. Also, the scope of a contract can change during the course of a study. If the scope of a contract is revised, the adjustment to backlog occurs when the revised scope is finalized. For these reasons, we might not be able to fully realize our entire backlog as net revenue.

Intellectual Property

We believe that patents, trademarks, copyrights and other proprietary rights are important to our business. We also rely on trade secrets, know-how, continuing technological innovations and licensing opportunities to develop and maintain our competitive position.

We actively seek patent protection both in the United States and abroad. As of December 31, 2002, we owned or co-owned five issued United States patents and 15 pending United States patent applications. Our issued United States patents primarily relate to our proprietary anti-tumor compounds, HIV drug target gene sequences and related target discovery technologies. Our pending United States patent applications primarily relate to proprietary genomic and genetic information, chemical compounds, clinical development business methods and software. We have filed or plan to file applications in other countries corresponding to most of our United States applications. As of December 31, 2002, we had 22 pending foreign filings, including eight pending Patent Cooperation Treaty, or PCT, filings.

We also have obtained licenses to other patents from academic institutions and pharmaceutical companies. As of December 31, 2002, we had exclusive license rights to 18 issued United States patents and seven pending United States patent applications, as well as corresponding foreign filings.

Pursuant to the terms of the Uruguay Round Agreements Act, patents issued from applications filed on or after June 8, 1995 have a term of 20 years from the date of filing, irrespective of how long it takes for the patent to issue. Because patent applications in the pharmaceutical industry often take a long time to issue, this method of patent term calculation can result in a shorter period of patent protection afforded to us compared to the prior method of term calculation (17 years from the date of issue). Under the Drug Price Competition and Patent Term Restoration Act of 1984 and the Generic Animal Drug and Patent Term Restoration Act, a patent that claims a

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product, use or method of manufacture covering drugs may be extended for up to five years to compensate the patent holder for a portion of the time required for FDA review. However, we might not be able to take advantage of the patent term extension provisions of this law.

In addition, we rely on trade secrets and continuing technological innovation, which we try to protect with reasonable business procedures for maintaining trade secrets, including confidentiality agreements with our collaborators, employees and consultants. We also have numerous trademark registration applications pending in the United States and other jurisdictions throughout the world.

Employees

At December 31, 2002, we employed approximately 5,300 professionals, of whom 4,850 were in the Development Group, 160 were in the Discovery Sciences Group and the remainder served in corporate operations functions. Of our staff, approximately 370 hold Ph.D., M.D., Pharm.D. or D.V.M. degrees and approximately 760 hold other masters or other postgraduate degrees. None of our employees are subject to a collective bargaining agreement. We believe that our relations with our employees are good.

We believe that our success is based on the quality and dedication of our employees. We strive to hire the best available people in terms of ability, experience, attitude and fit with our performance philosophy and standard operating procedures. We train new employees extensively, and we believe that we are an industry leader in the thoroughness of our training programs. In addition, we encourage our employees to continually grow and broaden their skills through internal and external training programs. As new technologies develop, we equip and train our employees to make use of technological innovations.

Available Information

Our website address is www.ppdi.com. We make available free of charge through our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission.

Competition

The drug development outsourcing industry consists of hundreds of smaller, limited-service providers and a number of full-service global drug development companies. The industry continues to experience consolidation and, in recent years, a group of large, full-service competitors has emerged. This trend of industry consolidation appears to have created greater competition among the larger companies for clients and acquisition candidates. In October 2002, our largest competitor, Quintiles Transnational Corp., announced that it had received an acquisition proposal from a company owned by its Chairman. In response, Quintiles formed a Special Committee of the Board of Directors to investigate strategic alternatives available to enhance shareholder value. This process and any subsequent acquisition of Quintiles could have a significant impact on the competitive landscape of the drug development industry.

In addition to competing with a number of other global, full-service companies, we also compete against some medium-sized companies, in-house research and development departments of pharmaceutical and biotechnology companies, as well as universities and teaching hospitals. In addition, the industry has few barriers to entry. Newer, smaller entities with specialty focuses, such as those aligned to a specific disease or therapeutic area, compete aggressively against larger companies for clients. Increased competition might lead to price and other forms of competition that might adversely affect our operating results.

Providers of outsourced drug development services and products compete on the basis of a number of factors, including reputation for on-time quality performance, expertise and experience in specific therapeutic areas, scope of service offerings, price, strengths in various geographic markets, technological expertise and systems, data management capabilities for time savings with data integrity, ability to acquire, process, analyze and report data in a time-saving accurate manner, ability to manage large-scale clinical trials both domestically and internationally, and

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expertise and experience in healthcare economics. Although there can be no assurance that we will continue to do so, we believe that we compete favorably in these areas.

As a general matter, the drug development services industry is not capital-intensive and the financial costs of entry into the industry are relatively low. Despite recent consolidation, this industry remains highly fragmented, with several hundred smaller, limited-service providers and a small number of full-service companies with global capabilities. Although there are few barriers to entry for smaller, limited-service providers, we believe there are significant barriers to becoming a global provider offering a broad range of services and products. These barriers include:

For specialty areas such as drug information and medical communications, informatics, analytical laboratory services and specialty central laboratory services, we compete in a market that has a myriad of niche providers. For the most part, these niche providers offer specialty services and products with a focus on a specific geographic region, a particular service or function and/or a specific stage or phase of drug development. By contrast, we provide our services on a global basis across functional areas.

Our Discovery Sciences Group competes principally on the basis of reputation, scientific and technical expertise, experience and qualifications of professional staff, quality of services, and ability to deliver quality products to the client’s specifications. The outsourced functional genomics, chemistry and preclinical research industry consists of several dominant providers and numerous smaller niche companies. Our Discovery Sciences Group faces significant competition from these companies, as well as competition from research teams funded internally by pharmaceutical and biotechnology companies. While we believe the trend to outsource research is increasing, the vast majority of research spending by these companies is for their own internal research personnel. As such, our ability to attract and retain qualified technical personnel, generate business with pharmaceutical or biotechnology companies and to continue to develop intellectual property are key components in our ability to compete successfully.

Government Regulation

Our clients are subject to extensive regulations by government agencies. Consequently, the services we provide for these clients must comply with relevant laws and regulations.

Prior to commencing human clinical trials in the United States, a company developing a new drug or biologic must file an investigational new drug application, or IND, with the FDA. The IND must include information about animal toxicity and distribution studies, manufacturing and control data, stability data and a detailed plan, or study protocol, for the proposed clinical trial of the drug or biologic in humans. If the FDA does not object within 30 days after the IND is filed, human clinical trials may begin. The study protocol will also be reviewed and approved by the institutional review board, or IRB, in each institution in which a study is conducted, and the IRB may impose additional requirements on the way in which the study is conducted in its institution.

Human trials usually start on a small scale to assess safety and then expand to larger trials to test efficacy along with safety in the target population. The trials are generally conducted in three phases, which sometimes overlap, although the FDA may require a fourth phase as a condition of approval. After the successful completion of the first three clinical phases, a company requests approval for marketing its product by submitting a new drug application, or NDA. The NDA is a comprehensive, multi-volume filing that includes, among other things, the results of all pre-clinical and clinical studies, information about how the product will be manufactured and tested, additional stability data and proposed labeling. The FDA’s review can last from six months to many years, with the

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average review lasting 18 months. Once the NDA is approved, the product may be marketed in the United States subject to any conditions imposed by the FDA.

Laboratories such as ours that provide information that is included in INDs and NDAs, must conform to regulatory requirements that are designed to ensure the quality and integrity of the testing process. For example, our bioanalytical laboratories in Richmond, Virginia and Middleton, Wisconsin follow the FDA’s good laboratory practice regulations, or GLPs. These regulations have also been adopted by the Ministry of Health in the United Kingdom and by similar regulatory authorities in other countries. Our product analysis lab in Middleton, Wisconsin follows the FDA’s good manufacturing practice, or cGMP, regulations. For both GLP and cGMP, the regulations require standardization procedures for studies, for recording and reporting data, and for retaining appropriate records. To help ensure compliance with these regulations, we have established quality assurance at our laboratory facilities to monitor ongoing compliance by auditing test data and conducting regular inspections of testing procedures and our laboratory facilities.

In addition, laboratories that analyze human blood or other biological samples for the diagnosis and treatment of study subjects must comply with the Clinical Laboratory Improvement Act, or CLIA. CLIA requires laboratories to meet staffing, proficiency and quality standards. The laboratory in our Austin, Texas facility is CLIA-certified and also has a voluntary certification given by the American Society of Clinical Pathologists. Our specialty central clinical laboratories are accredited by the College of American Pathologists and maintain Center for Disease Control – National Heart, Lung and Blood Institute, or CDC-NHLBI, part 3 Standardization for lipid analysis in both the United States and Europe.

The industry standard for the conduct of clinical research is embodied in the FDA’s regulations for IRBs, investigators and sponsor/monitors, which collectively are termed the good clinical practices, or GCPs, by industry, and the GCP guidelines issued by ICH, which have been agreed upon by industry and regulatory representatives from the United States, European Union and Japan. Our global standard operating procedures are written in accordance with all FDA and ICH requirements. This enables our work to be conducted locally, regionally and globally to standards that meet all currently applicable regulatory requirements.

In the past few years, both the United States and foreign governments have become more concerned about the disclosure of confidential personal data. The European Union, or EU, now prohibits the disclosure of personal confidential information, including medical information, to any entity that does not comply with certain security safeguards. Companies in the United States can satisfy these requirements by filing for safe harbor status according to a self-certification procedure agreed to by the EU and the United States. We have registered for and obtained safe harbor status.

The Department of Health and Human Services has promulgated final regulations under the Health Insurance Portability and Accountability Act of 1996, or HIPAA, that will govern the disclosure of confidential medical information in the United States. The Privacy Rule, which governs disclosure of confidential information, was effective beginning April 14, 2001 and all companies subject to the Privacy Rule must comply with its provisions on or before April 14, 2003. We have had a global privacy policy in place since January 2001, which includes a designated privacy officer, and we believe that we are in compliance with the current EU and HIPAA requirements. Nevertheless, we will continue to monitor our compliance with these new regulations and will take appropriate steps to ensure compliance as these and other privacy regulations come into effect.

We are also subject to the Occupational Safety and Health Administration, or OSHA, and federal, state and local regulations that govern the use or disposal of toxic substances, biological wastes and radioactive materials.

The failure on our part to comply with applicable regulations could result in the termination of ongoing research or the disqualification of data for submission to regulatory authorities. Furthermore, the issuance of a notice of finding by a governmental authority against either us or our clients, based upon a material violation by us of any applicable regulation, could materially and adversely affect our business.

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Factors that Might Affect our Business or Stock Price

Changes in trends in the pharmaceutical and biotechnology industries could adversely affect our operating results.

Industry trends and economic factors that affect our primary customers, pharmaceutical and biotechnology companies, also affect our business. For example, the practice of many companies in these industries has been to hire companies like us to conduct large drug development projects. If these industries reduce their tendency to outsource those projects, our operations, financial condition and growth rate could be materially and adversely affected. In the past several years, mergers and other factors in the pharmaceutical industry appear to have slowed decision-making by pharmaceutical companies and delayed drug development projects. Continuation or increase of these trends could have an ongoing adverse effect on our business. In addition, numerous governments have undertaken efforts to control growing healthcare costs through legislation, regulation and voluntary agreements with medical care providers and pharmaceutical companies. If future regulatory cost containment efforts limit the profits that can be derived on new drugs, our customers might reduce their drug discovery and development spending, which could reduce our business.

Our revenue depends on a small number of industries and clients.

We provide services and products to the pharmaceutical and biotechnology industries and our revenue is highly dependent on expenditures by clients in these industries. Accordingly, our operations could be materially adversely affected by the current trend toward consolidation in these industries or other factors resulting in a decrease in the number of our potential customers. If the number of our potential customers declines even further, they might be able to negotiate price discounts or other terms for our services and products that are less favorable to us than has historically been the case. We have experienced customer concentration in the past; for example, in the year ended December 31, 2001, one customer accounted for 10.3% of our net revenue. In 2002, no single client accounted for more than 10% of our net revenues. We are likely to experience continued customer concentration in the future. The loss of business from a significant client could have a material adverse effect on our results of operations.

The majority of our customers contracts can be terminated upon short notice.

Most of our contracts are terminable by the client upon 30 to 90 days’ notice. Clients terminate or delay their contracts for a variety of reasons, including, but not limited to:

The loss or delay of a large contract or multiple, smaller contracts could adversely affect our operating results.

We might not be able to recruit and retain the experienced personnel we need to compete in the drug discovery and development industry.

Our future success depends on our ability to attract, retain and motivate highly skilled personnel.

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Management

Our future success depends on the personal efforts and abilities of the principal members of our senior management and scientific staff to provide strategic direction, develop business, manage our operations and maintain a cohesive and stable environment. For example, we rely on the services of Fredric N. Eshelman, Pharm.D., our Chief Executive Officer. Although we have an employment agreement with Dr. Eshelman, as we do with other executive managers, this does not mean Dr. Eshelman or any other executive manager with whom we have an employment agreement will remain with us. We do not have employment agreements with all of our key personnel.

Healthcare Providers

Our ability to maintain, expand or renew existing business with our customers and to get business from new customers, particularly in the drug development sector, depends on our ability to hire and retain healthcare providers with the skills necessary to keep pace with continuing changes in drug development technologies. Competition for experienced healthcare providers is intense. We compete with pharmaceutical and biotechnology companies, including our customers and collaborators, other contract research companies, and academic and research institutions, to recruit healthcare providers.

Scientists

Our ability to maintain, expand or renew existing business with our customers and to get business from new customers in both the drug development as well as the drug discovery areas also depends on our ability to hire and retain scientists with the skills necessary to keep pace with continuing changes in drug discovery and development technologies. We face the same risks and challenges in attracting and retaining experienced scientists as we do with healthcare providers.

Our inability to hire additional qualified personnel might also require an increase in the workload for both existing and new personnel. We might not be successful in attracting new healthcare providers, scientists or management or in retaining or motivating our existing personnel. The shortage of experienced healthcare providers and scientists, or other factors, might lead to increased recruiting, relocation and compensation costs for these professionals, which might exceed our expectations. These increased costs might reduce our profit margins or make hiring new healthcare providers or scientists impracticable. If we are unable to attract and retain any of these personnel, our ability to execute our business plan will be adversely affected.

Our future success depends on our ability to keep pace with rapid technological changes that could make our services and products less competitive or obsolete.

The biotechnology and pharmaceutical industries generally and drug discovery and development more specifically are subject to increasingly rapid technological changes. Our competitors or others might develop technologies, services or products that are more effective or commercially attractive than our current or future technologies, services or products, or that render our technologies, services or products less competitive or obsolete. If competitors introduce superior technologies, services or products and we cannot make enhancements to ours to remain competitive, our competitive position, and in turn our business, revenues and financial condition, would be materially and adversely affected.

Any failure by us to comply with existing regulations would harm our reputation and operating results.

Any failure on our part to comply with existing regulations could result in the termination of ongoing research or the disqualification of data for submission to regulatory authorities. This would harm our reputation, our prospects for future work and our operating results. For example, if we were to fail to verify that informed consent is obtained from patient participants in connection with a particular clinical trial, the data collected from that trial could be disqualified, and we might be required to redo the trial at no further cost to our customer, but at a substantial cost to us. Furthermore, the issuance of a notice from the Food and Drug Administration based on a finding of a material violation by us of good clinical practice, good laboratory practice or good manufacturing practice requirements would materially and adversely affect us.

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Proposed and future legislation or regulations might increase the cost of our business or limit our service or product offerings.

Federal or state authorities might adopt healthcare legislation or regulations that are more burdensome than existing regulations. These changes in regulation could increase our expenses or limit our ability to offer some of our services or products. For example, the confidentiality of patient-specific information and the circumstances under which it may be released for inclusion in our databases or used in other aspects of our business are subject to substantial government regulation. Additional legislation governing the possession, use and dissemination of medical record information and other personal health information has been proposed at both the state and national levels. Proposed federal regulations governing patient-specific health information might require us to implement new security measures that require substantial expenditures or limit our ability to offer some of our services and products. These regulations might also increase costs by creating new privacy requirements for our informatics business and mandating additional privacy procedures for our clinical research business.

We might lose business opportunities as a result of healthcare reform.

Numerous governments have undertaken efforts to control growing healthcare costs through legislation, regulation and voluntary agreements with healthcare providers and drug companies. Healthcare reform could reduce demand for our services and products and, as a result, our revenue. In the last few years, the United States Congress has reviewed several comprehensive health care reform proposals. The proposals intended to expand healthcare coverage for the uninsured and reduce the growth of total healthcare expenditures. Although Congress did not adopt any of the proposals, it might adopt similar proposals in the future. Congress has also considered and may adopt legislation that could have the effect of putting downward pressure on the prices that pharmaceutical and biotechnology companies can charge for prescription drugs. If Congress approves any such proposals, pharmaceutical and biotechnology companies might react by spending less on research and development. If this were to occur, we would have fewer business opportunities, which could reduce our earnings. Similarly, pending or future healthcare reform proposals outside the United States could negatively impact our revenues from our international operations.

The drug discovery and development services industry is highly competitive.

The drug discovery and development services industry is highly competitive. We often compete for business not only with other drug discovery and development companies, but also with internal discovery and development departments within our clients, who are often large pharmaceutical and biotechnology companies with greater resources than ours. We also compete with universities and teaching hospitals. If we do not compete successfully, our business will suffer. The industry is highly fragmented, with numerous smaller specialized companies and a handful of full-service companies with global capabilities. Increased competition might lead to price and other forms of competition that might adversely affect our operating results. As a result of competitive pressures, our industry has been consolidating. This trend is likely to produce more competition among the larger companies for both clients and acquisition candidates. In addition, there are few barriers to entry for smaller specialized companies considering entering the industry. Because of their size and focus, these companies might compete effectively against larger companies such as us, which could have a material adverse impact on our business.

Our business has experienced substantial expansion in the past and we must properly manage that expansion.

Our business has expanded substantially in the past. Rapid expansion could strain our operational, human and financial resources. If we fail to properly manage our expansion, our results of operations and financial condition might be hurt. In order to manage expansion, we must:

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In addition, we have numerous business groups, subsidiaries and divisions. If we cannot properly manage these groups, subsidiaries or divisions, it will disrupt our operations.

We will face additional risks in expanding our foreign operations, as we learned from past expansions including the acquisitions of companies in Belgium and Singapore in 2002. Specifically, we might find it difficult to:

Future acquisitions or investments could disrupt our ongoing business, distract our management and employees, increase our expenses and adversely affect our business.

We anticipate that a portion of any future growth of our business might be accomplished by acquiring existing businesses, products or technologies. The success of any acquisitions will depend upon, among other things, our ability to integrate acquired personnel, operations, products and technologies into our organization effectively, to retain and motivate key personnel of acquired businesses and to retain their customers. In addition, we might not be able to identify suitable acquisition opportunities or obtain any necessary financing on acceptable terms. Any future acquisitions could involve other risks, including the assumption of additional liabilities and expenses, issuances of potentially dilutive equity securities or interest-bearing debt, transaction costs, reduction in our stock price as a result of any of these or because of market reaction to a transaction, and diversion of management’s attention from other business concerns.

Acquisitions of foreign companies, such as the companies we acquired in Belgium and Singapore in 2002, also might involve the additional risks of, among others, assimilating differences in foreign business practices and overcoming language barriers.

We have made and plan to continue to make investments in other companies. In many cases, there is no public market for the securities of these companies and we might not be able to sell these securities on terms acceptable to us, if at all. In addition, if these companies encounter financial difficulties, we might lose all or part of our investment. For example, in the first quarter of 2002 we recorded an impairment of equity investment of $32.0 million to write down the carrying value of our investment in DNA Sciences, Inc. for an other than temporary decline in value.

The fixed price nature of our development contracts could hurt our operating results.

The majority of our contracts for the provision of drug development services are at fixed prices. As a result, variations in the timing and progress of large contracts can materially affect results. In addition, we bear the risk of cost overruns unless the scope of activity is revised from the original bid specifications and we are able to negotiate a contract modification with the customer shifting the cost overrun to the customer. If we fail to adequately price our contracts or if we experience significant cost overruns, our operating results could be materially adversely affected. In the past, we have had to commit unanticipated resources to complete projects, resulting in lower gross margins on those projects. We might experience similar situations in the future, which would have a material adverse impact on our operating results.

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Our drug development business exposes us to potential liability for personal injury claims that could affect our financial condition.

Our drug development business involves the testing of new drugs on human volunteers. This testing exposes us to the risk of liability for personal injury or death to patients resulting from, among other things, possible unforeseen adverse side effects or improper administration of a new drug. Many of these patients are already seriously ill and are at risk of further illness or death. We could be materially and adversely affected if we were required to pay damages or incur defense costs in connection with a claim that is outside the scope of indemnification agreements we have with clients, if any indemnification agreement is not performed in accordance with its terms or if our liability exceeds the amount of any applicable insurance. We might not be able to get adequate insurance at reasonable rates.

Our business uses biological and hazardous materials, which could injure people or violate laws, resulting in liability that could hurt our financial condition and business.

Our drug discovery and development activities involve the controlled use of potentially harmful biological materials, as well as hazardous materials, chemicals and various radioactive compounds. We cannot completely eliminate the risk of accidental contamination or injury from the use, storage, handling or disposal of these materials. In the event of contamination or injury, we could be held liable for damages that result, and any liability could exceed our ability to pay. Any contamination or injury could also damage our reputation, which is critical to getting new business. In addition, we are subject to federal, state and local laws and regulations governing the use, storage, handling and disposal of these materials and specified waste products. The cost of compliance with these laws and regulations could be significant.

If we are unable to attract suitable willing investigators and volunteers for our clinical trials, our development business might suffer.

Our clinical research studies rely upon the ready accessibility and willing participation of physician investigators and volunteer subjects. Investigators are typically located at hospitals, clinics or other sites and supervise administration of the study drug to patients during the course of a clinical trial. Volunteer subjects generally include people from the communities in which the studies are conducted, including our Phase 1 centers in Austin, Texas, and Leicester, England, which to date have provided a substantial pool of potential subjects for research studies. Our clinical research development business could be adversely affected if we were unable to attract suitable and willing investigators or volunteers on a consistent basis.

Our business is subject to international economic, currency, political and other risks that could negatively affect our revenue and results of operations.

Because we provide our drug development services worldwide, our business is subject to risks associated with doing business internationally. Our revenue from our non-U.S. operations represented approximately 20% of our total revenues for the year ended December 31, 2002. We anticipate that revenue from international operations will grow in the future. Accordingly, our future results could be harmed by a variety of factors, including:

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Because we have only limited experience in providing drug discovery services, our prospects for success in this business remain uncertain and we might be unsuccessful in our discovery business.

We established our drug discovery group in 1997 and have only limited experience with these activities and might not be successful in our drug discovery efforts. Our ability to generate revenue and income from our drug discovery business will depend on our ability to:

Our future success in our drug discovery efforts will depend on our ability to enter into and perform collaborations with other companies.

To succeed in our drug discovery business, we will need to enter into collaborative arrangements, first to obtain rights to potential drug targets, and then for the development, manufacturing and commercialization of those products when and if they are approved. We have limited or no control over the resources that a company collaborating with us devotes to our product candidates. Any entity with which we collaborate might not perform its obligations as expected. These entities also might breach or terminate their agreements with us or otherwise fail to conduct their collaborative activities successfully and in a timely manner. Further, parties collaborating with us might elect not to develop our product candidates or not to devote sufficient resources to the development, manufacture, marketing or sale of these product candidates.

Our inability to adequately protect our intellectual property rights would hurt our business.

Our success will depend in part on our ability to protect the proprietary software, compositions, processes and other technologies we develop during drug discovery and the development process. In addition, one of our business strategies is to license rights to drug candidates and enter into collaborations with pharmaceutical and biotechnology companies for the development of drug candidates. The proprietary rights associated with these drug candidates must remain protected.

Any patents that we own or license in the future might not provide valuable protection for the technology or products. Our efforts to enforce and maintain our intellectual property rights might not be successful and might result in substantial costs and diversion of management time. In addition, others might challenge patents we control and, as a result, these patents could be narrowed, invalidated, rendered unenforceable or blocked. If blocked, we might be forced to stop using some or all of the technology or to license technology from third parties. In addition, current and future patent applications on which we depend might not result in the issuance of patents. Even if our rights are valid, enforceable and broad in scope, competitors might develop products based on similar technology that is not covered by our patent claims.

In addition to patent protection, we also rely on copyright, trademark and trade secrets protection, as well as know-how, continuing technological innovation and licensing opportunities. In an effort to maintain the confidentiality and ownership of our intellectual property, we require our employees, consultants and advisors to execute confidentiality and proprietary information agreements. However, these agreements might not provide us with adequate protection against improper use or disclosure of confidential information and there might not be adequate remedies in the event of unauthorized use or disclosure. Furthermore, from time to time we hire scientific personnel formerly employed by other companies involved in one or more areas similar to the activities we conduct. In some situations, our confidentiality and proprietary information agreements might conflict with, or be subject to, the rights of third parties with whom our employees, consultants or advisors have prior employment or consulting

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relationships. Although we require our employees and consultants to maintain the confidentiality of all confidential information of previous employers, these individuals or we might be subject to allegations of trade secret misappropriation or other similar claims as a result of their prior affiliations. Finally, others might independently develop substantially equivalent proprietary information, or otherwise gain access to our trade secrets. Our failure to protect our proprietary information and techniques might inhibit or limit our ability to exclude competitors from the market and to execute our business strategies.

The drug discovery and development industry has a history of patent and other intellectual property litigation, and we might be involved in costly intellectual property lawsuits.

The drug discovery and development industry has a history of patent and other intellectual property litigation, and these lawsuits will likely continue. Because we provide many different services and products in this industry and have rights to drugs, we face potential patent infringement suits by companies that have patents for similar products and methods used in business or other suits alleging infringement of their intellectual property rights. In order to protect or enforce our intellectual property rights, we might have to initiate legal proceedings against third parties. Legal proceedings relating to intellectual property would be expensive, take significant time and divert management’s attention from other business concerns, whether we win or lose. The cost of this kind of litigation could affect our profitability. Further, if we do not prevail in an infringement lawsuit brought against us, we might have to pay substantial damages, including treble damages, and we could be required to stop the infringing activity or obtain a license to use technology.

Our operations might be interrupted by the occurrence of a natural disaster or other catastrophic event.

We depend on our customers, and our laboratories and other facilities for the continued operation of our business. Although we have contingency plans in effect for natural disasters or other catastrophic events, these events, including terrorist attacks and natural disasters such as hurricanes or ice storms, could still disrupt our operations or those of our customers, which would also affect us. Even though we carry business interruption insurance policies and typically have provisions in our contracts that protect us in certain events, we might suffer losses as a result of business interruptions that exceed the coverage available under our insurance policies or for which we do not have coverage. Any natural disaster or catastrophic event in our facilities could have a significant negative impact on our operations.

Our operations might be affected if there was a disruption to the air travel system.

Our specialty central laboratories and some of our other businesses are heavily reliant on air travel for transport of clinical trial kits and other material and people, and disruption to the air travel system could have a material adverse effect on our business. While we have developed contingency plans for a variety of events that could disrupt or limit available air transportation, these plans might not be effective or sufficient to avert such a material adverse effect.

Because our stock price is volatile, our stock price could experience substantial declines.

The market price of our common stock has historically experienced and might continue to experience volatility. Our quarterly operating results, changes in general conditions in the economy or the financial markets and other developments affecting us or our competitors could cause the market price of our common stock to fluctuate substantially. In addition, in recent years, the stock market has experienced significant price and volume fluctuations. The market, and in particular pharmaceutical and biotechnology companies, has also experienced significant decreases in value. This volatility and the recent market decline have affected the market prices of securities issued by many companies, often for reasons unrelated to their operating performance, and might adversely affect the price of our common stock.

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Item 2. Properties

As of December 31, 2002, we had 54 offices located in 24 countries spanning six continents. Our principal executive offices are located in Wilmington, North Carolina. We own and operate four facilities, including a 52-bed Phase 1 facility in Leicester, England, a building in Kersewell, Scotland, a laboratory building in Brussels, Belgium and a building in Durham, North Carolina. We lease all our other facilities. We believe that our facilities are adequate for our operations and that suitable additional space will be available when needed. The locations, approximate square footage and lease expiration dates of our operating facilities comprising more than 10,000 square feet as of December 31, 2002 were as follows:

Item 3. Legal Proceedings

In the normal course of business, we are a party to various claims and legal proceedings. Although the ultimate outcome of these matters is not yet determined, after consultation with legal counsel we do not believe that the resolution of these matters will have a material effect upon our financial condition or results of operations in any interim or annual period.

Item 4. Submission of Matters to a Vote of Security Holders

No matter was submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2002.

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Executive Officers

The following table contains information concerning our executive officers as of February 3, 2003:

Fredric N. Eshelman, Pharm.D., has served as Chief Executive Officer and as a director since July 1990, and as Vice Chairman of the Board of Directors since 1993. Dr. Eshelman founded our company’s predecessor in 1985 and served as its Chief Executive Officer until 1989. Prior to rejoining us in 1990, Dr. Eshelman served as Senior Vice President, Development and as a director of Glaxo Inc., a subsidiary of Glaxo Holdings plc.

Fred B. Davenport, Jr. is our President and Assistant Secretary. Mr. Davenport joined PPD as General Counsel in December 1996. In January 2001, Mr. Davenport was promoted to Executive Vice President and to President in January 2002. Prior to his employment by us, Mr. Davenport was a partner in the Wilmington, North Carolina law firm of Murchison, Taylor, and Gibson, L.L.P., which he joined in 1977. Mr. Davenport was also a member of the faculty of the University of North Carolina at Wilmington’s Cameron School of Business Administration from 1982 to 1991.

Paul S. Covington, M.D. is our Executive Vice President – Development. Dr. Covington joined us in September 1991 as a Medical Director. He is board certified in internal medicine and licensed in North Carolina and Alabama. Prior to joining us, Dr. Covington was in private practice in Clanton, Alabama from 1985 to 1990 where he served as Chief of Staff and Director of Critical Care and Cardiopulmonary for the local hospital. From 1991 to 1992, he was Medical Director for the Birmingham site of Future Healthcare Research Centers.

Linda Baddour is our Chief Financial Officer, Treasurer, and Assistant Secretary. Ms. Baddour joined PPD in December 1995. In 1997, Ms. Baddour was promoted to Chief Accounting Officer. Prior to her employment by us, Ms. Baddour was the Controller for Cooperative Bank for Savings Inc. from 1980 to 1995. Ms. Baddour is a Certified Public Accountant and received her Master in Business Administration from the University of North Carolina at Wilmington.

W. Richard Staub is our Senior Vice President – Global Business Development. Mr. Staub joined PPD as Director, Business Development Phase 2-4, in January 1997. He has subsequently been promoted through numerous management positions in Business Development including Executive Director and Vice President, Business Development, Phase 2-4, the Americas. Prior to his employment by us, Mr. Staub spent nine years at Zeneca Pharmaceuticals, holding positions in sales, market research and product marketing.

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PART II

Item 5. Market for the Registrant’s Common Equity and Related Stockholder Matters

Our common stock is traded under the symbol “PPDI” in the over-the-counter market and is quoted on the Nasdaq National Market System. The following table sets forth the high and low prices for shares of our common stock, as reported by the National Association of Securities Dealers, Inc., for the periods indicated. These prices are based on quotations between dealers, which do not reflect retail mark-up, mark-down or commissions.

As of February 3, 2003, there were approximately 17,900 holders of our common stock.

We have never declared or paid any cash dividends as a public company. Furthermore, we have no present plans to pay cash dividends to our shareholders and, for the foreseeable future, intend to retain all of our earnings for use in continuing to develop our business. The declaration of dividends is within the discretion of our Board of Directors and is dependent upon our earnings, financial condition and capital requirements, as well as any other factors deemed relevant by the Board of Directors.

Item 6. Selected Consolidated Financial Data

The following table represents selected historical consolidated financial data. The statement of operations data for the years ended December 31, 2000, 2001 and 2002 and balance sheet data at December 31, 2001 and 2002 are derived from our audited consolidated financial statements included elsewhere in this report. The statement of operations data for each of the years ended December 31, 1998 and 1999, and the balance sheet data at December 31, 1998, 1999 and 2000 are derived from audited consolidated financial statements not included in this report. The historical results are not necessarily indicative of the operating results to be expected in the future. The selected financial data should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and notes to the financial statements.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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

Forward-looking Statements

This Form 10-K contains forward-looking statements within the meaning of the federal securities laws. These statements relate to future events or our future financial performance. Forward-looking statements include statements concerning plans, objectives, goals, strategies, future events or performances, expectations, predictions, assumptions and other statements that are not statements of historical facts. In some cases, you can identify forward-looking statements by terminology such as “might”, “will”, “should”, “expect”, “plan”, “anticipate”, “believe”, “estimate”, “predict”, “intend”, “potential” or “continue”, or the negative of these terms, or other comparable terminology. These statements are only predictions. These statements rely on a number of assumptions and estimates which could be inaccurate and which are subject to risks and uncertainties. Actual events or results might differ materially due to a number of factors, including those listed in “Potential Volatility of Quarterly Operating Results and Stock Price” and in “Part I Item 1. Business – Factors that Might Affect our Business or Stock Price”. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We generally undertake no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.

Acquisitions

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

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

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

In June 2002, PPD acquired ProPharma Pte Ltd., an Asian-based clinical research organization with extensive experience in managing pan-Asian clinical trials. ProPharma is part of the Development Group of PPD. PPD acquired ProPharma for total consideration of $3.0 million in cash. In addition, PPD agreed to pay up to $1.4 million as additional purchase price, depending upon the financial performance of ProPharma for a specified period following the acquisition.

These acquisitions were accounted for using the purchase method, utilizing appropriate fair value techniques to allocate the purchase price based on the estimated fair values of the assets and liabilities. Accordingly,

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the estimated fair value of assets acquired and liabilities assumed were included in PPD’s consolidated balance sheet as of the effective date of the acquisitions. The results of operations are included in PPD’s consolidated results of operations as of and since the effective dates of the acquisitions. There were no significant differences between the accounting policies of PPD or any of the companies acquired in these acquisitions. For further details regarding these acquisitions, see Note 2 of Notes to Consolidated Financial Statements.

Results of Operations

We recognize revenues from fixed-price contracts on a proportional performance basis in our Development Group. To measure the performance, we compare actual direct costs incurred to estimated total contract direct costs, which is the best indicator of the performance of the contract obligations as the costs relate to the labor hours incurred to perform the service. We recognize revenues from time-and-materials contracts as hours are incurred, multiplied by the billable rates for each contract in both our Development Group and Discovery Sciences Group. For our Phase 1 and laboratory businesses, we also recognize revenues from unitized contracts as subjects or samples are tested, multiplied by the price of each.

In connection with the management of multi-site clinical trials, we pay on behalf of our customers fees to investigators and test subjects, and other out-of-pocket costs, such as travel, printing, meetings, couriers, etc., for which we are reimbursed at cost. Effective January 1, 2002, in connection with the required implementation of EITF 01-14, amounts paid by us as a principal for out-of-pocket costs are now included in direct costs, while the reimbursements we receive as a principal are reported as reimbursed out-of-pocket revenues in the income statement. We plan to continue to net revenue and expense in the income statement from fees and associated reimbursements that we receive as an agent. Prior year amounts have been reclassified to conform with current year presentation.

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

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

We record our recurring operating expenses among five categories:

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

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

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

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

Amortization expenses consist of amortization costs recorded on intangible assets on a straight-line method over the life of the intangible assets. The excess of the purchase price of a business acquired over the fair value of net tangible assets, identifiable intangible assets and acquired in-process research and development costs at the date of the acquisition has been assigned to goodwill. Goodwill was being amortized over periods of 10 to 25 years prior to January 1, 2002. In July 2001, the FASB issued Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets”, or SFAS No. 142. We adopted SFAS No. 142 as of January 1, 2002 and no longer amortize goodwill. The provisions of this accounting standard also require the completion of a transitional impairment test within six months of adoption. We completed the transitional impairment test as of January 1, 2002 and the annual impairment test as of October 1, 2002 and did not identify any impairments of goodwill. These tests involved determining the fair market value of each of the reporting units with which the goodwill was associated and comparing the estimated fair market value of each of the reporting units with its carrying amount. Amortization expense related to goodwill for 2001 was $0.9 million.

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The following tables set forth amounts for certain items in our consolidated financial statements expressed as a percentage of net revenue, before reimbursed out-of-pockets, from continuing operations and the percentage changes in dollar amounts of certain items compared with the prior period. The following tables exclude revenue and costs related to reimbursable out-of-pocket expenses because they are not generated by the services we provide, do not yield any gross profit to us, and do not have any impact on our net income. Thus, we believe this information is useful to our investors because it presents the revenue and expenses that are directly attributable to the services we provide to our clients and provides a more accurate picture of our operations results and margins.

Percentage of Net Revenue, before reimbursed out-of-pockets, from continuing operations

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Year Ended December 31, 2002 Versus Year Ended December 31, 2001

Net revenue increased $148.0 million in 2002, or 32.1%, to $608.7 million from $460.6 million for 2001. Net revenue, before reimbursed out-of-pockets, increased $131.1 million in 2002, or 30.4%, to $562.6 million from net revenue, before reimbursed out-of-pockets, of $431.5 million for 2001. The Development Group’s operations accounted for 96.9% of net revenue for 2002. The Development Group generated net revenue of $545.1 million, an increase of $141.4 million, or 35.0%, from 2001. The increase in the Development Group’s net revenue was primarily attributable to an increase in the size and number of contracts in the global contract research organization, or CRO, Phase 2 through 4 services. In addition, acquisitions in the Development Group completed during 2002 contributed net revenue of $49.4 million for 2002.

The Discovery Sciences Group generated net revenue of $17.5 million in 2002, a decrease of $10.3 million, or 37.1%, from 2001. The higher 2001 Discovery Sciences’ net revenue was primarily attributable to a milestone payment generated in the first quarter of 2001 from sublicensing the compound dapoxetine to ALZA Corporation, now a part of Johnson & Johnson.

Total direct costs increased 32.9% to $315.0 million in 2002 from $237.0 million in 2001. Total direct costs, excluding reimbursable out-of-pocket expenses, increased 29.4% to $269.0 million in 2002 from $207.9 million in 2001, and decreased slightly as a percentage of net revenue to 47.8% in 2002 from 48.2% for 2001. Development Group direct costs increased to $261.2 million in 2002 as compared to $196.1 million for 2001. This increase resulted primarily from increased personnel costs due to the increase in the size and number of contracts in the global CRO Phase 2 through 4 services and the direct costs associated with acquisitions completed during 2002. Development Group direct costs decreased as a percentage of related net revenue from 48.6% in 2001 to 47.9% in 2002. This decrease was principally due to the mix of levels of personnel involved in the contracts performed, variations in the utilization of personnel and the mix of contracts being performed during each period. Discovery Sciences direct costs decreased to $7.8 million in 2002 as compared to $11.8 million for 2001. The higher 2001 Discovery Sciences direct costs were primarily due to the costs associated with sublicensing dapoxetine to ALZA in the first quarter of 2001.

R&D expenses increased 138.4% to $10.5 million in 2002 from $4.4 million in 2001. This increase was primarily attributable to an increase in spending on R&D in the Discovery Sciences Group to develop intellectual property. As of the end of 2002, the Discovery Sciences Group had almost doubled the number of employees working on internal R&D projects as compared to the end of 2001. We expect internal R&D spending to continue to increase in both target validation and the chemistry GGTase programs.

SG&A expenses increased 19.0% to $150.4 million in 2002 from $126.4 million in 2001. The increase was primarily attributable to additional administrative personnel costs and an increase in recruiting, travel and training costs associated with new operational employees hired to support our expanding operations. As a percentage of net revenue, excluding reimbursed out-of-pockets, SG&A expenses decreased to 26.7% in 2002 from 29.3% for 2001. This decrease is primarily attributable to the increase in revenue, and to a smaller extent, to increased efficiencies as our operations expand.

Depreciation expense increased $4.0 million, or 20.8%, to $23.2 million in 2002 from $19.2 million in 2001. The increase was related to the depreciation of the increased investment in property and equipment due primarily to our growth. Capital expenditures were $36.5 million in 2002. The majority of our capital investment in 2002 was due to additional facility and equipment costs to increase laboratory capacity, costs to enhance and expand our information technology capacity and computer software and hardware for new employees.

Amortization expense was $1.1 million in 2001 and $1.0 million in 2002. During 2002, amortization of backlog associated with the acquisition of MRL accounted for $0.9 million of the amortization expense. During 2001, amortization of goodwill accounted for $0.9 million of the amortization expense. We adopted SFAS No. 142 as of January 1, 2002 and no longer amortize goodwill in our financial statements. See Note 5 of Notes to Consolidated Financial Statements for a more detailed discussion of SFAS 142.

Operating income increased $35.9 million to $108.4 million in 2002, as compared to $72.6 million in 2001. As a percentage of net revenue, excluding reimbursed out-of-pockets, operating income increased to 19.3% of net

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revenue in 2002 from 16.8% in 2001. This increase was primarily due to our revenue growth and our focus on controlling the increase in both direct and administrative costs.

During the first quarter of 2002, we recorded a $32.0 million write-down of the carrying value of our investment in DNA Sciences, Inc. for an other than temporary decline in value. Our investment in DNA Sciences was deemed to be impaired as a result of historical and projected performance, cash needs and an independent valuation of the market value of DNA Sciences. During the fourth quarter of 2002, we recorded an impairment of equity investment of $1.8 million to write down the carrying value of our investments in Gallery Systems, Inc. (formerly Digital Arts and Sciences Corporation) and IntraBiotics Pharmaceuticals, Inc. for an other than temporary decline in value.

Our provision for income taxes increased $9.9 million, or 34.4%, to $38.6 million in 2002, as compared to $28.7 million in 2001. We recorded a net tax benefit of $2.3 million and a deferred tax valuation allowance of $11.2 million associated with the $33.8 million impairment of equity investments. This valuation allowance was recorded due to the uncertainty of utilizing the capital loss benefit prior to the expiration of the loss carryforward period. Our effective income tax rate, excluding this $2.3 million tax benefit and the related impairment expense of $33.8 million, remained constant at approximately 36.5%.

Net income of $39.9 million in 2002 represents a decrease of $9.3 million from $49.2 million in 2001. This includes $33.8 million of impairment of equity investments and $2.3 million related to tax benefit. Net income per diluted share of $0.72 in 2002 represents a decrease from $0.94 in net income per diluted share in 2001. Net income per diluted share of $0.72 in 2002 includes a loss of $0.57 related to the impairment of equity investments and the tax benefit associated with this write-down.

Year Ended December 31, 2001 Versus Year Ended December 31, 2000

Net revenue increased $87.9 million in 2001, or 23.6%, to $460.6 million from $372.7 million for 2000. Net revenue, before reimbursed out-of-pockets, increased $86.2 million in 2001, or 25.0%, to $431.5 million from net revenue, before reimbursed out-of-pockets, of $345.3 million in 2000. The Development Group’s operations accounted for 93.5% of net revenue for 2001. The Development Group generated net revenue of $403.7 million, an increase of $73.2 million, or 22.1%, from 2000. The increase in the Development Group’s net revenue was primarily attributable to an increase in the size, scope and number of contracts in the global CRO Phase 2 through 4 services, as well as the increase in the number of contracts in the North America laboratory services.

The Discovery Sciences Group generated net revenue of $27.8 million in 2001, an increase of $13.0 million, or 88.1%, from 2000. The growth in the Discovery Sciences’ operations was primarily attributable to revenue generated from sublicensing the compound dapoxetine to ALZA Corporation in the first quarter of 2001 and the payments from Eli Lilly and Company in 2001 for relinquishing our rights to all compounds other than dapoxetine licensed by us in 1998.

Total direct costs increased 18.5% to $237.0 million in 2001 from $199.9 million in 2000. Total direct costs, excluding reimbursable out-of-pocket expenses, increased 20.5% to $207.9 million in 2001 from $172.6 million for 2000 and decreased as a percentage of net revenue to 48.2% in 2001 as compared to 50.0% in 2000. The Development Group’s direct costs increased to $196.1 million in 2001 as compared to $166.6 million in 2000. This increase resulted primarily from increased personnel costs due to the increase in the size and number of contracts in the global CRO Phase 2 through 4 services. The Development Group’s direct costs decreased as a percentage of related net revenue to 48.6% in 2001 from 50.4% in 2000. This decrease is principally due to the mix of levels of personnel involved in the contracts performed, variations in the utilization of personnel and the mix of contracts being performed during each period. Discovery Sciences’ direct costs increased to $11.8 million in 2001 as compared to $6.0 million in 2000. This increase was primarily due to the costs associated with sublicensing dapoxetine and the increase in the functional genomics services’ direct costs associated with its increased FTE revenue.

R&D expenses increased 58.4% to $4.4 million in 2001 from $2.8 million in 2000. This increase was primarily due to the increase in spending on R&D in the Discovery Sciences Group. As of the end of 2001, the

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Discovery Sciences Group had more than double the number of employees working on R&D as compared to the end of 2000.

SG&A expenses increased 15.8% to $126.4 million in 2001 from $109.2 million in 2000. The increase was primarily attributable to additional administrative personnel costs and an increase in recruiting and training costs associated with new hires to support our expanding operations. As a percentage of net revenue, excluding reimbursed out-of-pockets, SG&A expenses decreased to 29.3% in 2001 from 31.6% in 2000. This decrease is primarily attributable to the increase in revenue and, to a smaller extent, to increased efficiencies as our operations expand.

Depreciation expense increased $2.9 million, or 17.9%, to $19.2 million in 2001 from $16.3 million in 2000. The increase was related to the depreciation on the increased investment in property and equipment due primarily to our growth. Capital expenditures were $41.9 million in 2001 as compared to $21.5 million in 2000. The majority of our capital investment in 2001 was for the acquisition of a new airplane to replace our previous plane, which was more than 27 years old, additional facility costs related to our laboratories to increase capacity, additional software licenses related to our increase in headcount and additional scientific equipment in our laboratories.

Amortization expense remained relatively consistent at approximately $1.1 million in 2001 as compared to $0.9 million for 2000. During 2001 and 2000, amortization of goodwill accounted for $0.9 million of the amortization expense.

Operating income increased $29.1 million to $72.6 million in 2001, as compared to $43.5 million in 2000. As a percentage of net revenue, excluding reimbursed out-of-pockets, operating income increased to 16.8% of net revenue in 2001 from 12.6% in 2000. This increase was primarily due to our revenue growth and our focus on controlling the increase in both direct and administrative costs.

Our provision for income taxes increased $10.2 million, or 55.2%, to $28.7 million in 2001, as compared to $18.5 million in 2000. Our effective income tax rate increased to 36.9% in 2001 from 36.4% in 2000. Because we conduct operations on a global basis, our effective tax rate has and will continue to depend upon the geographic distribution of our pretax earnings among locations with varying tax rates. In particular, as the geographic mix of our pre-tax earnings among various tax jurisdictions changes, our effective tax rate might vary from period to period.

In October 2001, we made an investment in Apothogen, Inc. Given the involvement of the Chairman of our Board of Directors and our Chief Executive Officer in Apothogen, we were accounting for our investment in Apothogen under the equity method of accounting. Equity in net loss of investee, net of income taxes, was $0.1 million for 2001. In April 2002, Apothogen was acquired by IntraBiotics Pharmaceuticals, Inc. and we received IntraBiotics common stock in exchange for our stock in Apothogen. The investment in IntraBiotics no longer qualifies for equity method accounting.

Net income of $49.2 million in 2001 represents an increase of $16.9 million over $32.3 million in 2000. Net income per diluted share of $0.94 in 2001 represents an increase from $0.64 in net income per diluted share in 2000.

Liquidity and Capital Resources

As of December 31, 2002, we had $181.2 million of cash and cash equivalents on hand. Our expected primary cash needs on both a short and long-term basis are for capital expenditures, expansion of services, possible acquisitions, geographic expansion, working capital and other general corporate purposes. We have historically funded our operations and growth, including acquisitions, with cash flow from operations, borrowings and sales of our stock. We are exposed to changes in interest rates on cash equivalents and amounts outstanding under notes payable, notes receivable and lines of credit. Our cash and cash equivalents are invested in financial instruments that are rated A or better by Standard & Poor’s or Moody’s and earn interest at market rates.

In 2002, our operating activities provided $105.8 million in cash as compared to $101.3 million last year. The increase in cash flow from operations is primarily due to an increase in our net revenues, an increase in

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operating margins as a percentage of net revenues and our effort to control accounts receivable. In 2002, net income of $39.9 million, impairment of equity investments of $33.8 million, depreciation and amortization of $24.2 million and a net increase of $8.8 million in net operating assets and liabilities were partially offset by the $1.6 million decrease in deferred income taxes.

In 2002, our investing activities used $78.8 million in cash. The net cash used for acquisitions of $50.6 million, purchases of investments of $8.8 million and capital expenditures of $36.5 million were partially offset by $17.0 million received from the repayment of notes receivable.

In 2002, our financing activities provided $6.1 million in cash, as net proceeds from stock option exercises and purchases under our employee stock purchase plan totaling $7.5 million and proceeds from long-term debt of $1.5 million were partially offset by $2.9 million in repayments of capital lease obligations.

Working capital as of December 31, 2002 was $187.7 million, compared to $152.8 million at December 31, 2001. The increase in working capital was due primarily to the increase in accounts receivable and unbilled services, net, of $59.2 million and the increase in cash of $38.1 million which were partially offset by the increase in unearned income of $32.2 million, the increase in payables to investigators of $12.7 million and the increase in other accrued expenses of $19.1. The number of days’ revenue outstanding in accounts receivable and unbilled services, net of unearned income, also known as DSO, were 35.4 and 43.0 days as of December 31, 2002 and December 31, 2001, respectively. This improvement is a result of a focused effort by management on improving the accounts receivable collection process along with temporary improved terms regarding investigator fee down payments. We expect DSO in the future will fluctuate depending on the mix of contracts performed within a quarter and our success in collecting receivables.

We maintain a defined benefit pension plan for certain employees and former employees in the United Kingdom. The projected benefit obligation for the benefit plan at December 31, 2002 and December 31, 2001, as determined in accordance with SFAS No. 87, “Employers Accounting for Pensions”, was $19.8 million and $14.8 million, respectively, and the value of the plan assets was $13.3 million and $14.2 million, respectively. As a result, the plan was under-funded by $6.5 million at December 31, 2002 and by $0.6 million at December 31, 2001. Due to the decline in the fair market value of the plan asset, it is likely that the amount of our contributions to the plan will increase from the $1.0 million of contributions made in 2002. In addition, we expect the pension cost to be recognized in the financial statements will decrease from the $1.3 million recognized in 2002 to approximately $1.2 million in 2003.

The expense to be recognized in future periods could increase further, depending upon the amount of the change in fair market value of the plan assets and the change in the projected benefit obligation.

The decrease in the market value of plan assets is likely to cause the amount of the under-funded status to increase. Though we have not yet determined the exact amount of such under-funding, after completion of the actuarial valuations in 2003 we could be required to record an additional reduction to shareholders’ equity. We recorded a reduction to shareholders’ equity in 2002 of $5.5 million. However, we do not believe the under-funded status of the pension plan will materially affect our results of operations, financial position or cash flows. Moreover, given the impact that the discount rate and stock market performance have on the projected benefit obligation and market value of plan assets, future changes in either one of these may significantly reduce or increase the amount of our pension plan under-funding.

In June 2002, we amended our revolving credit facility for $50.0 million from Wachovia Bank, N.A., formerly known as First Union National Bank. The purpose of the amendment was to extend the expiration date. Indebtedness under the facility is unsecured and subject to traditional covenants relating to financial ratios. Borrowings under this credit facility are available to provide working capital and for general corporate purposes. As of December 31, 2002, there was no amount outstanding under this credit facility. This credit facility is currently scheduled to expire in June 2003, at which time any outstanding balance will be due.

In July 2002, we entered into a new revolving credit facility for $50.0 million with Bank of America, N. A. Indebtedness under the facility is unsecured and subject to traditional covenants relating to financial ratios. Borrowings under this credit facility are available to provide working capital and for general corporate purposes. As

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of December 31, 2002, there was no amount outstanding under this credit facility. This credit facility is currently scheduled to expire in June 2003, at which time any outstanding balance will be due.

In April 2000, we made an investment in Spotlight Health, Inc., formerly known as ADoctorInYourHouse.com. In January 2001, we entered into an agreement with Spotlight Health and Wachovia Bank, N.A. to guarantee a revolving $2.0 million line of credit provided to Spotlight Health by Wachovia. Indebtedness under the line is unsecured and subject to traditional covenants relating to financial ratios. As of December 31, 2002, Spotlight Health had $2.0 million outstanding under this credit facility. This credit facility is currently scheduled to expire in June 2003, at which time any outstanding balance will be due. We review the financial statements of Spotlight Health on a quarterly basis to determine if it has sufficient financial resources to continue operations. While we do not have current concerns regarding Spotlight Health’s ability to repay this facility, should events and circumstances in the future change Spotlight Health might not be in the position to repay the facility and Wachovia might attempt to collect on our guaranty of this facility.

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

Contractual Obligations and Commercial Commitments

Future minimum payments for all contractual obligations for years subsequent to December 31, 2002 are as follows (in thousands):

Other commercial commitments include the guarantee we provide on Spotlight Health’s $2.0 million line of credit. See full details on this arrangement in the “Liquidity and Capital Resources” section.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. We believe that the following are some of the more critical judgment areas in the application of our accounting policies that affect our financial condition and results of operations. We have discussed the application of these critical accounting policies with our Board of Directors and its Finance & Audit Committee.

The majority of our revenues are recorded from fixed-price contracts on a proportional performance basis. To measure performance, we compare actual direct costs incurred to estimated total contract direct costs, which is the best indicator of performance of the contract obligations as the costs relate to the labor hours incurred to perform the service. Direct costs are primarily comprised of labor overhead related to the delivery of services. Each month costs are accumulated on each project and compared to the budget for that particular project. This determines the percentage-of-completion on the project. This percentage is multiplied by the contract value to determine the

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amount of revenue that can be recognized. Each month management reviews the budget on each project to determine if the assumptions within the budget are still correct and budgets are adjusted accordingly. As the work progresses, original estimates might be deemed incorrect due to, among other things, revisions in the scope of work or patient enrollment rate, and a contract modification might be negotiated with the customer to cover additional costs. If not, we bear the risk of cost overruns. In the past, we have had to commit unanticipated resources to complete projects, resulting in lower gross margins on those projects. We might experience similar situations in the future. Should our estimated costs on fixed price contracts prove to be low, future margins could be reduced, absent our ability to negotiate a contract modification. We accumulate information on each project to refine our bidding process. Historically, the majority of our estimates and assumptions have been materially correct, but these estimates might not continue to be accurate. In addition, clients generally may terminate a study at any time, which might cause unplanned periods of excess capacity and reduced revenues and earnings. To offset the effects of early terminations of significant contracts, we attempt to negotiate the payment of an early termination fee as part of the original contract.

In our Discovery Science Group, we generate revenue from time to time in the form of milestone payments. Milestone payments are only received and recognized as revenues if the specified milestone is achieved and accepted by the customer and continued performance of future research and development services related to that milestone are not required. Although these payments are typically lower than up-front license fees, these payments can be significant because they are triggered as a result of achieving specified scientific milestones. Future potential milestone payments under various discovery contracts might never be received if the milestones are not achieved.

Included in “Accounts receivable and unbilled services, net” on our consolidated balance sheets is a reserve for doubtful accounts. Generally, before we do business with a new client, we have a credit check performed on that company to determine if they have a satisfactory credit rating. Senior management reviews the accounts receivable aging on a monthly basis to determine if any receivables will potentially be uncollectable. We include any accounts receivable balances that are determined to be potentially uncollectable, along with a general reserve, in our overall reserve for doubtful accounts. After all attempts to collect the receivable have failed, the receivable is written off against the reserve. Based on the information available to us, we believe our reserve for doubtful accounts as of December 31, 2002 was adequate. However, actual write-offs might exceed the recorded reserve.

Most of our investments consist of equity investments in private entities for which fair values are not readily determinable. Therefore, all of our investments are recorded under the cost method of accounting. Many of our investments are in relatively early stage life sciences or biotechnology companies that do not have established products or proven technologies and may not have any material revenue. Therefore, these investments are particularly subject to write-down for impairment whenever events or changes in circumstances indicate that the carrying amount of these investments may not be recoverable. We assess our investment portfolio on a quarterly basis to determine whether declines in the market value of these securities are other than temporary. This quarterly review includes an evaluation of, among other things, the market condition of the overall industry, historical and projected financial performance, expected cash needs and recent funding events. Given the nature of these companies, our assessments of value are subjective.

Based on estimates of future taxable profits and losses in certain foreign tax jurisdictions, management determined that a valuation allowance of $0.6 million was required for specific foreign tax loss carryforwards as of December 31, 2002. If these estimates prove inaccurate, a change in the valuation allowance, up or down, could be required in the future. We also recorded a total valuation allowance of $11,911 related to the impairment of certain equity investments, $770 of which relates to the tax effect of an item in other comprehensive income. The valuation was determined based on the uncertainty regarding our ability to utilize some of the potential capital losses generated during the loss carryforward period. A change in any of the investees’ financial health and/or stock price, or a change in our ability to utilize a potential capital loss, could require a change of valuation allowance in the future.

We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset might not be recoverable. If indicators of impairment were present, we would evaluate the carrying value of property and equipment in relation to estimates of future undiscounted cash flows. These undiscounted cash flows and fair values are based on judgment and assumptions. Additionally, goodwill is tested for

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impairment on at least an annual basis by comparing the underlying reporting units’ goodwill to their estimated fair value. We did not identify any impairment of goodwill during our transitional impairment test or annual impairment test of goodwill upon adoption of SFAS 142. These tests involved the use of estimates related to the fair market value of the reporting unit with which the goodwill was associated.

Recently Issued Accounting Standards

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

In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”, or SFAS No. 146. SFAS No. 146 addresses accounting and reporting for costs associated with exit or disposal activities. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized and measured initially at fair value when the liability is incurred. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. PPD does not expect the adoption of this statement to have a material effect on our financial statements.

In November 2001, the FASB issued Emerging Issues Task Force consensus No. 01-14, or EITF 01-14, “Income Statement Characterization of Reimbursements Received for ‘Out-of-Pocket’ Expenses Incurred”. EITF 01-14 requires that in cases where the contractor acts as a principal, reimbursements received for out-of-pocket expenses incurred be characterized as revenue and the associated costs included as operating expenses in the income statement. PPD implemented this rule as of January 1, 2002 and, as required, has reclassified comparative financial information for 2000 and 2001. The implementation of this rule resulted only in the gross-up of revenues and expenses and had no impact upon earnings.

At the October 2002 meeting of the Emerging Issues Task Force (“EITF”) of the FASB, the EITF reached a consensus on Issue 1 and Issue 2 of EITF Issue No. 02-17, “Recognition of Customer Relationship Intangible Assets Acquired in a Business Combination,” (“EITF 02-17”). On Issue 1, the EITF concluded that the contractual-legal and separability criteria do not restrict the use of certain assumptions that would be used in estimating the fair value of an intangible asset. Assumptions such as expectations of future contract renewals and other benefits related to the intangible asset must be considered in the estimates of fair value regardless of whether they meet the contractual-legal or separability criteria. On Issue 2, the EITF concluded that the contractual-legal criterion provision of SFAS 141 applies if an entity has a practice of establishing contracts with its customers. Thus, an entity would recognize a customer relationship at the date of the business combination even if there were no contracts in existence at that date since the entity has a practice of establishing contracts with its customers. The EITF also observed that this consensus addresses only the recognition of customer relationships and does not address the valuation of such customer relationships. These consensuses should be applied on a prospective basis for all business combinations consummated after October 25, 2002. We do not expect the adoption of this consensus to have a material effect on our financial statements.

In November 2002, the EITF finalized its tentative consensus on EITF Issue 00-21, “Revenue Arrangements with Multiple Deliverables”, which provides guidance on the timing and method of revenue recognition for sales arrangements that include the delivery of more than one product or service. EITF 00-21 is effective prospectively for arrangements entered into in fiscal periods beginning after June 15, 2003. We are currently evaluating the impact of the adoption of this consensus on our financial statements.

In November 2002, the FASB issued Financial Accounting Standards Board Interpretation No. 45, or FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statement Nos. 5, 57, and 107 and Rescission of FASB Interpretation No. 34.” FIN 45 clarifies the requirements of FASB Statement No. 5, “Accounting for

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Contingencies,” relating to the guarantor’s accounting for, and disclosure of, the issuance of certain types of guarantees. FIN 45 requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation it assumes under that guarantee. The disclosure provisions of FIN 45 are effective for financial statements of interim or annual periods that end after December 15, 2002. FIN 45’s provisions for initial recognition and measurement should be applied on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor’s fiscal year-end. The guarantor’s previous accounting for guarantees that were issued before the date of FIN 45’s initial application may not be revised or restated to reflect the effect of the recognition and measurement provisions of FIN 45. We do not expect the adoption of this statement to have a material effect on our financial statements.

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

Taxes

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

Inflation

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

Potential Liability and Insurance

Drug development services involve the testing of new drugs on human volunteers pursuant to a study protocol. This testing exposes us to the risk of liability for personal injury or death to patients resulting from, among other things, possible unforeseen adverse side effects or improper administration of the new drug. Many of these patients are already seriously ill and are at risk of further illness or death. We attempt to manage our risk of liability for personal injury or death to patients from administration of products under study through measures such as stringent operating procedures and contractual indemnification provisions with clients and through insurance maintained by clients. We monitor our clinical trials in compliance with government regulations and guidelines. We have adopted global standard operating procedures intended to satisfy regulatory requirements in the United States and in many foreign countries and serve as a tool for controlling and enhancing the quality of our clinical trials. The contractual indemnifications generally do not protect us against our own actions, such as negligence. We currently maintain professional liability insurance coverage of up to $15.0 million per claim, with an annual aggregate policy limit of $15.0 million.

Potential Volatility of Quarterly Operating Results and Stock Price

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

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

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

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

We are exposed to foreign currency risk by virtue of our international operations. We conduct business in several foreign countries. Approximately 12.2%, 15.0% and 20.3% of our net revenues, less reimbursed out-of-pockets, for the years ended December 31, 2000, 2001 and 2002, respectively, were derived from operations outside the United States. Funds generated by each subsidiary are generally reinvested in the country where they are earned. We have not, to date, engaged in derivative or hedging activities related to our potential foreign exchange exposures. Our operations in the United Kingdom generated more than 47% of our 2002 international net revenue, less reimbursed out-of-pockets, from international operations during 2002. Accordingly, we do have some exposure to adverse movements in the pound sterling and other foreign currencies. The United Kingdom has traditionally had a relatively stable currency compared to our functional currency, the U.S. dollar. We anticipate that those conditions will continue for at least the next 12 months, but cannot make any guarantees.

The vast majority of our contracts are entered into by our United States or United Kingdom subsidiaries. The contracts entered into by the United States subsidiaries are almost always denominated in United States dollars. Contracts entered into by our United Kingdom subsidiaries are generally denominated in pounds sterling, United States dollars or Euros. Contractual provisions either limit or reduce the economic risk in certain transactions involving multiple currencies.

We do have some currency risk resulting from the passage of time between the invoicing of customers under contracts and the ultimate collection of customer payments against those invoices. If a contract is denominated in a currency other than the subsidiary’s local currency, we recognize a receivable at the time of invoicing for the local currency equivalent of the foreign currency invoice amount. Changes in exchange rates from the time the invoice is prepared and payment from the customer is received will result in our receiving either more or less in local currency than the local currency equivalent of the invoice amount at the time the invoice was prepared and the receivable established. We recognize this difference as a foreign currency transaction gain or loss, as applicable, and report it in other income, net. If exchange rates were to change by 1% in the future, we do not expect this to have a material effect on our financial statements.

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