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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2004

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 $1.55 billion as of June 30, 2004, 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 an affiliate. This determination of affiliate status might not be conclusive for other purposes.

As of February 15, 2005, there were 56,754,305 shares of the registrant’s common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

The Company’s definitive Proxy Statement for its 2005 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 and products to pharmaceutical, biotechnology and medical device companies. Our corporate mission is to help clients maximize the return on their research and development investments. We offer broad therapeutic expertise, advanced technologies and extensive resources for drug discovery and drug and device development. In addition to providing discovery through post-market services, we also offer our clients compound partnering opportunities.

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

With more than 6,600 professionals worldwide, we have provided services to 41 of the top 50 pharmaceutical companies in the world as ranked by 2003 healthcare research and development spending, in addition to our work with leading biotechnology and medical device companies. We believe that we are one of the world’s largest providers of drug development services to pharmaceutical, biotechnology and medical device companies based on 2004 annual net revenues generated from contract research organizations.

Building on our outsourcing relationship with pharmaceutical and biotechnology clients, we established our discovery services business in 1997. After restructuring the Discovery Sciences segment in 2003 and 2004, this business now primarily focuses on preclinical evaluations of anticancer therapies and compound partnering arrangements associated with the development and commercialization of potential drug products. We have developed a risk-sharing research and development model to help pharmaceutical and biotechnology clients develop compounds. Through collaborative arrangements based on this model, we assist our clients’ research and evaluate the development and commercial potential for compounds at various stages of development. In February 2005, we completed the acquisition of a biomarker business. The acquisition will expand our business by adding biomarker discovery and patient sample analysis capability to the collection of services offered by us.

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

Industry Overview

Discovering and developing new drugs is an extremely expensive and time-consuming process. In May 2003, the Tufts Center for the Study of Drug Development released a study that estimates the total cost to develop a new prescription drug increased from approximately $231 million in 1987 to approximately $897 million in 2000. In addition, it takes between 10 and 15 years to develop a new prescription drug and obtain approval to market it in the United States.

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The drug development services industry provides independent product development services to the pharmaceutical, biotechnology and medical device industries. This industry has evolved from providing limited clinical trial services in the 1970s to a full-service industry today characterized by broader relationships with customers and by service offerings that encompass the entire drug development process, including preclinical evaluations, study design, clinical trial management, data collection, biostatistical analysis, regulatory consulting, clinical laboratory and diagnostic services, product registration support and post-marketing support.

Over the past 20 years, technological advances, as well as the emergence of the biotechnology industry, have dramatically changed the drug discovery process. New and improved technologies have evolved such as 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 to determine their viability as potentially safe and effective drug candidates. Moreover, many industry participants, including pharmaceutical, biotechnology and contract research companies, have broadened their efforts to collaborate technically and financially to optimize their drug pipelines.

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 and to meet the FDA regulatory requirements.

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 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.

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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 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 IIIb and Phase IV trials, which allow new drugs that show early promise to reach patients without the delay typically associated with the conventional review process.

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Trends Affecting the Drug Discovery and Development Industry

The drug discovery and development services industry has been and will continue to be affected by, among others, 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 functional genomics, is dramatically increasing the number of identified potential drug targets within the human body. Pharmaceuticals on the market today target fewer than an estimated 500 human gene products. With an estimated 30,000 or so human protein-coding genes, there exists an enormous untapped pool of targets for therapeutic intervention. This proliferation of targets increases the need for companies to use state-of-the-art technologies to effectively validate and optimize promising targets and lead candidates. Industry participants are also looking to applications such as biomarker technology to save development time and costs, as well as enable more precise diagnosis and personalized treatment of disease. These technologies and the human expertise necessary to manage and keep up with them are costly.

Changes in the Regulatory Environment. The drug research and development process is heavily regulated by the FDA and its Center for Drug Evaluation and Research, or CDER. The war on terror, the AIDS epidemic and the 2004 influenza vaccine shortage in the United States have elevated the FDA’s focus on research in the areas of bio-terrorism and vaccine development. In addition, recent product safety concerns, such as the cardiovascular risks identified as being related to COX 2 inhibitors, and drug importation issues have placed the FDA and other regulatory agencies under increased scrutiny. As a result of these and other events, drug safety and related issues are under intense review by Congress, and the FDA recently announced that it will establish a new independent Drug Safety Oversight Board to oversee the management of drug safety issues within CDER and to monitor medicines once they are on the market. These events are likely to cause significant changes to the regulatory environment for the drug development process and could have a lasting and pronounced impact on the drug discovery and development industry.

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, particularly in the early stages of drug development. While research and development spending and the number of drug candidates are increasing, the time and cost required to develop a new drug candidate also has increased. Many 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 discovery and development services industry for cost-effective, innovative and rapid means of developing new drugs.

Declining Research & Development Productivity. While the total number of compounds in clinical development has increased in the last several years, thereby increasing the aggregate spending on research and development programs associated with new drug candidates, the number of novel new drugs approved for marketing has remained relatively flat or even declined. This declining productivity in part reflects efforts by pharmaceutical companies to more effectively screen compounds in early stages of development and to extend the value of existing products by pursuing new indications, over-the-counter versions and alternative delivery technologies. Pharmaceutical and biotechnology companies have responded by focusing on efforts to improve clinical success rates and to lower clinical study costs. Furthermore, many clients have also responded to the productivity challenge by increasing their focus on licensing and risk-sharing arrangements to improve new drug pipelines and gain financing for future development and marketing programs.

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 cost involved, these companies often do not have the inclination to develop their own staff in this area.

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Need for Large Scale Global Support. More pharmaceutical and biotechnology companies are filing drug registration packages simultaneously in several major jurisdictions, rather than following the traditional 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. 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 drug pricing pressures. The industry is responding by consolidating, streamlining 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, these types of companies can focus their research and development efforts more efficiently. Turning drug discovery and development processes over to third parties also minimizes fixed costs.

The PPD Solution

We address the needs of the pharmaceutical, biotechnology and medical device 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 and products offers our clients a way to identify and develop successful drugs and devices more quickly and cost effectively. We have obtained significant drug development expertise from over 19 years of operation. Starting in 1997, we expanded our services to include drug discovery services to help our clients reduce drug discovery time and minimize unproductive compound development. More recently, we have also expanded into the medical device industry. We use our proprietary informatics technology to support our discovery and development services. Finally, because we are positioned globally, we are able to accommodate the multinational discovery and development needs of our customers.

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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discovery and development services. We offer our clients a wide range of technology-based services and products using a mixture of commercially available third-party systems and internally developed software to help expedite the discovery and development processes for both drugs and devices. As new technologies develop, we equip and train our employees to make use of the innovations. We also plan to continue to leverage and build strategic technology relationships.

Our Services

We provide services designed to increase efficiency, reduce time 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 our consolidated statements of operations included elsewhere in this report for segment information regarding revenues and see Note 16 to the 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.

Preclinical Biology. Our preclinical biology group integrates pharmacology, metabolism, pharmacokinetic and toxicology expertise to provide preclinical program design and project management services. We provide a broad range of preclinical services and products including:

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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. Our experts can provide full preclinical development services and integrate other development services internally.

We offer preclinical consulting as well as a full range of preclinical efficacy, pharmacokinetic, pharmacodynamic and mechanism models for anticancer therapeutic candidates. Our experienced preclinical oncology staff design and perform the studies needed to identify, profile and optimize lead compounds.

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.

We provide non-GLP bioanalytical services in our laboratory located in Middleton, Wisconsin. Our bioanalytical laboratory analyzes biological fluid samples from preclinical animal studies and conducts in vitro discovery/early development experiments to test potential drug candidates.

Our technical writers 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.

Compound Partnering Programs. With increased capacity to screen and develop early lead compounds and candidates, pharmaceutical companies now find themselves without the capacity to develop all of these compounds and take them to market within a reasonable time. Many biotechnology companies have promising drug development candidates but lack the financial resources or the infrastructure to further develop them. These situations provide attractive opportunities for us to use our extensive experience in strategic, global drug development to selectively in-license and develop compounds or jointly develop drug candidates in collaborative arrangements. Our compound collaborative efforts have created a pipeline of products that leverage our resources, create new opportunities for growth, and share the risks and rewards of drug development.

In 1998, as part of a development collaboration with Eli Lilly & Company, we acquired an exclusive license to develop and commercialize the compound dapoxetine for genitourinary indications, including premature ejaculation, or PE. We developed the compound through Phase II proof-of-concept and, in January 2001, out-licensed it to ALZA Corporation, which was subsequently acquired by Johnson & Johnson. Under the terms of the agreement, we granted ALZA worldwide rights to develop and commercialize dapoxetine, and ALZA is responsible for all clinical, regulatory, manufacturing, sales and marketing costs associated with the compound. In exchange, we received an up-front payment and are entitled to receive further payments if regulatory milestones are achieved. In addition, we are entitled to receive royalty payments based on sales of dapoxetine, as well as milestone payments when specified sales levels are reached. In December 2003, we acquired Lilly’s patents and remaining rights to develop and commercialize dapoxetine in the field of genitourinary disorders in return for a cash payment of $65.0 million. We also agreed to pay Lilly a royalty of 5% on annual sales of dapoxetine, if any, in excess of $800 million. In December 2004, ALZA submitted a new drug application, or NDA, to the FDA for dapoxetine. The FDA accepted the NDA for filing in February 2005. If approved by the FDA, dapoxetine would be the first prescription treatment designed specifically to treat PE and will be marketed in the U.S. by Ortho-McNeil Pharmaceutical, Inc.

In 2002, we licensed from Bayer AG the worldwide rights to undertake additional Phase II clinical studies on the compound implitapide for treatment of arteriosclerosis, elevated triglycerides, pancreatitis and hyperlipidemia. In connection with our studies, we have access to Bayer’s existing information from previously conducted preclinical studies and Phase II clinical trials, as well as regulatory filings to conduct clinical trials in the United States, Europe and South Africa. We have initiated Phase II proof-of-concept clinical trials for different kinds of elevated cholesterol and triglyceride indications. Following completion of the Phase II proof-of-concept

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study, Bayer has the right to terminate its license with us and assume further development of the compound. If Bayer elects to assume development, then Bayer must reimburse our Phase II costs and pay us milestone payments and royalties to be agreed upon by the parties.

In 2003, we made an equity investment in Chemokine Therapeutics Corp., then a privately held biotechnology company, to continue development of a proprietary peptide that might be useful as a blood recovery therapeutic agent. We worked closely with Chemokine to scale up the product under good manufacturing practice, or GMP, and to conduct the GLP toxicology studies necessary to advance the program to the clinic. In the second half of 2004, Chemokine initiated a study in healthy volunteers that we understand will be completed in the first half of 2005. Chemokine also granted PPD an exclusive option to license the peptide and the right to first negotiate a license to other Chemokine peptides. In December 2004, Chemokine completed an initial public offering of its common stock in Canada.

In November 2003, we made an equity investment in Syrrx, Inc., a privately held drug discovery company, and entered into a collaboration agreement to develop Syrrx’s orally active dipeptidyl peptidase IV, or DPP IV, inhibitors to treat type 2 diabetes and other major human diseases. Syrrx has multiple lead candidates for preclinical developments, three of which were investigated in GLP toxicology programs. In October 2004, we filed an IND for the first DPP IV inhibitor. We initiated the Phase I study in the end of October and this inhibitor is now in Phase Ib, which is when the drug is first administered to subjects suffering from the indication. We currently anticipate starting Phase II trials in April 2005. We filed an IND for a second DPP IV inhibitor in late December 2004 and a Phase I study for this second DPP IV inhibitor is scheduled to begin in April 2005. In February 2005, Takeda Pharmaceutical Company Limited announced that it entered into an agreement to acquire 100% of the equity of Syrrx. At this time, we do not know what impact, if any, this acquisition will have on the DPP IV collaboration with Syrrx.

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 development process. We provide a broad range of development services, either individually or as an integrated package, to meet clients’ needs.

Phase I Clinical Testing. We are one of the industry’s largest Phase I trial providers, with clinical testing services currently conducted in a 220-bed unit in Austin, Texas. To accommodate the growing demand for our Phase I services, we leased new facilities in Austin and are constructing a new 300-bed Phase I unit. We anticipate moving our Phase I operations to the new unit in April 2005. Our professional physician and nursing staff administers general Phase I 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 operations also include a dental research clinic to evaluate the safety and effectiveness of new analgesic compounds in molar extraction models. We manage our Phase I services to maximize scheduling flexibility and efficiency. These services can also be integrated with our other services that we provide, such as bioanalytical, data management, pharmacokinetic and biostatistical services.

Laboratory Services. We offer the following laboratory services to the pharmaceutical and device industries:

Austin Central Lab: Austin central lab is located in our Phase I unit and supports the Phase I 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. The laboratory will be relocating with our Phase I unit in April 2005. Having our laboratory in the same facility as the volunteers speeds our response time to assess unexpected outcomes. This laboratory also serves as a central laboratory for small to medium size Phase II through IV multicenter studies.

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MRL International: We provide global specialty central laboratory services for large clinical trials through our MRL 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 Institutes of Health) funded clinical trials. We are one of the largest specialty central laboratory providers for Phase I through IV global studies involving agents used in cholesterol, endocrine, metabolic and cardiovascular clinical research.

Bioanalytical Lab: We provide bioanalytical services through GLP-compliant laboratories in Richmond, Virginia and Middleton, Wisconsin. Our bioanalytical laboratories analyze biological fluid samples from animal and human clinical studies. The latter studies include those conducted by our Phase I unit as well as those conducted on behalf of our clients from Phase I through Phase IV 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. 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.

GMP Lab: We provide product analysis laboratory services through our GMP-compliant laboratory in Middleton, Wisconsin. Our product analysis services include inhalation, biopharmaceutics, dissolution and stability studies. These studies are necessary to characterize dosage form release patterns and stability under various environmental conditions in the intended package for marketing. These evaluations must be carried out from preclinical testing through Phase IV and the resulting data maintained over the commercial life of a product. 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.

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 I clinical testing.

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

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We conduct 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. Within this project-oriented structure, we can manage every aspect of the clinical trial in Phases II through IV 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 practices, 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 approval. We provide consulting on the conduct of clinical trials for simultaneous regulatory submissions to multiple countries.

We provide our clients with one or more of the following Phase II through IV 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 with us 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 Institutes of Health, begun in 1990, which has had approximately 60 protocols open at any given time. This project has involved approximately 1,000 investigational sites and greater than 110,000 enrolled patients and has generated greater than 400 protocols and more than 6,000 pharmacy, regulatory and operational audits at the sites.

Clinical Data Management and Biostatistical Analysis. We provide clients with assistance in areas such as 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, monitoring board summaries and presentations, NDA preparation, electronic production and presentations and defense services to regulatory authorities.

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

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Market-Development Support. We provide custom-designed market development programs for pharmaceutical, biotechnology and medical device clients. Developed with pharmaceutical and biotechnology client feedback, in 2003 we created a dedicated team of clinical, marketing and health outcomes experts to help companies with pre-launch (Phase II through III) and post-market (Phase IIIb through IV) programs to develop markets for new products and extend market value of existing products. The portfolio of services we offer in this area includes health outcomes, large-volume late stage trials, medical communications, consumer health and online marketing and education.

Applying advanced technologies and experience, we combine health outcomes, such as epidemiology, psychometrics and economics, with clinical research to measure and compare risks, benefits and economic and quality-of-life impacts of drug therapies. The resulting data is used to help demonstrate the value of the product and provide insight on needs to optimize user acceptance upon product launch. We also provide late stage trials, such as Phase IIIb through IV studies, which can produce valuable safety and efficacy data analysis and provide information for the product marketing promotion. Our medical communications services include post-market observational studies, registries and compliance and persistency programs, which can optimize real-world outcomes and indicate ways to help enhance proper use of the drug by the physician and patient. We also provide consumer health programs, which can provide product life extension through over-the-counter programs. Our online marketing and education services provide our clients with proprietary Web sites for disseminating medical information, online market research and product marketing services for a variety of clinical specialties.

Device Testing. Through our acquisition of Eminent Research Systems in 2003, we expanded our service offerings to support clinical trials for the medical device industry, especially in the cardiovascular area. Our device services include study design, regulatory consulting, global trial management, data management, biostatistics and documentation development. Using PPD GlobalView, a Web-based proprietary software product Eminent developed, we have a leading position for long-term registries of permanent implantable cardiovascular devices.

eClinical Initiatives. Our eClinical initiatives offer efficiencies, enhanced quality and improved communications with our clients. In 2004, we piloted a customized project progression and resource management tool, which helps project managers provide efficient and cost-effective study management with quality deliverables. We also implemented a new clinical trial management system, providing Web-based, real-time access to study data from anywhere in the world. We plan to expand use of this system into our Phase IV studies in 2005. We also continue to expand PPD DirectConnect^™ Web portals, which are now supporting over 250 client studies with over 3,350 users across 72 pharmaceutical, biotechnology, clinical laboratory and government clients. We continue to expand our Oracle^® clinical data management system, including introduction of Oracle clinical’s remote data capture, or RDC, system and a core electronic data capture, or EDC, team to leverage our EDC experience across project teams. In 2004, we expanded our use of a Web-based document management system supporting our data management, safety and clinical operations businesses. This system enables us to flexibly resource project teams worldwide.

Informatics. Our informatics division, known as CSS Informatics, 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:

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A primary focus of our informatics division is to provide consulting services to help pharmaceutical, biotechnology and medical device 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. We provide expertise on the Oracle Pharmaceutical Application suite and the PhaseForward suite of products with a full range of support services including installation, training, validation, technical support and custom development.

Clients and Marketing

We provide a broad range of discovery and development services and products to help pharmaceutical, biotechnology and medical device companies develop compounds, drugs and devices, as well as the markets in which they plan to sell products that gain approval.

Client Identification and Mix

Our Development Group provides Phase I to Phase IV clinical development and market support services. We market these services in the Americas, Asia, Europe, Africa, the Middle East and the Pacific Rim. We believe that the key differentiators that help us win development business from pharmaceutical and biotechnology companies include our global infrastructure, quality-driven execution based on ongoing training, quality assurance and control practices, and cross-functional groups with dedicated therapeutic expertise. Through our medical device development group, we offer clinical trial services and regulatory expertise to device companies, including a number of the leading cardiovascular device manufacturers and pharmaceutical companies developing adjunct therapies. In addition, our market development services combine clinical, marketing and health outcomes expertise to help pharmaceutical, biotechnology and device companies develop markets for new products and extend market value for existing products. We believe that these services help our clients maximize the life cycle of their products.

For the year ended December 31, 2004, 82.9% of our Development Group’s net revenues were attributable to clinical services and 17.1% to laboratory services. From a geographic perspective, 72.5% of our Development Group’s net revenues in 2004 were derived from the United States with the remaining amount coming primarily from Europe. For additional information on our geographic distribution, see Note 17 to the Notes to Consolidated Financial Statements included elsewhere in this report.

Our Discovery Sciences Group offers services and technologies to select drug candidates for clinical evaluation. This preclinical-focused group primarily provides services to clients in the pharmaceutical and biotechnology industries. In addition, we perform research on compounds that we own or license and through our compound risk-sharing collaborative relationships. Our Discovery Sciences Group revenues have all been generated in the United States.

For the year ended December 31, 2004, total net revenue for all of our services were 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. We refer to the Standard Industry Classification, or SIC, codes for publicly traded companies to determine their classification.

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Concentration of business among large customers is not uncommon in our industry. We believe that our diverse client mix, in which no single client in 2004 accounted for more than 10% of our net revenues, limits our exposure to significant risks associated with industry consolidation and major product cancellations. However, we have experienced higher concentration in the past and might experience it in the future. Approximately 36% of our 2004 net revenues were derived from clients headquartered outside the United States, in particular in Europe and Japan. Approximately 27.6% of our 2004 net revenues were generated from services provided by our employees located in countries outside the United States. See Note 17 to the Notes to Consolidated Financial Statements included elsewhere in this report for the breakdown of this revenue.

Marketing Strategy

With a primary focus on large pharmaceutical companies, we promote our discovery services through a dedicated sales team, localized scientist-to-scientist communications and our centralized corporate marketing efforts. In addition, we believe that much of the preclinical oncology work we gain is derived from positive word-of-mouth communications in the industry.

For our development services and products other than informatics and specialty central lab services, we use centralized corporate marketing to support the efforts of dedicated business development staff calling on pharmaceutical, biotechnology and device 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 outsourcing across our service areas for each client. To further facilitate cross-functional sales, worldwide business development staff for development services and products across our company report to the same executive. The informatics division uses technology expert communications and localized marketing efforts, and our specialty central lab division applies core operation staff communicating with potential clients and networking.

The top 25 publicly traded pharmaceutical companies ranked by research and development expenses in 2003 accounted for 87% of research and development spending in 2003, so we concentrate on these companies. The top 50 publicly traded biotechnology companies accounted for almost 91% of the biotechnology research and development expenditures in 2003. 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. As an example, recommendations we make to a potential client with respect to a drug development study design and implementation are an integral part of our bid proposal process and an important aspect of the integrated services we 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 trial.

Our core global marketing and corporate communications activities are primarily Web-based. Our initiatives include online advertising and directory listings on predominant industry Web sources; interactive Web-based education and information programs, including Web conferences and Webcasts; direct e-mail campaigns and electronic newsletters. In late 2004, working with client, media and analyst feedback, we evolved our Web site for improved navigation and use and added new search optimization tools to help drive traffic to the site. In addition, we integrate client presentations and sales materials, global speakers’ bureau, media relations, corporate materials and marketing at professional trade shows to reinforce key messages and selling points. 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 seek to advance and promote our reputation for professional excellence.

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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 represent future revenue and exclude revenue that has been recognized previously in our statement of operations. Net revenue is defined as professional fee income, or gross revenue, less fees and associated reimbursements. Once contracted work begins, net revenue is recognized over the life of the contract. Our backlog was $1.29 billion in net revenues at December 31, 2004, compared to $1.12 billion in net revenues at December 31, 2003.

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, and the labor increases and decreases that occur at the beginning and end of each study. Additionally, contracts relating to our clinical development business generally are subject to early termination by the client, and clinical trials can be delayed or canceled for many reasons, including unexpected test results. Also, the scope of a contract can change significantly 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 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, 2004, we owned or co-owned 11 issued U.S. patents and 23 pending U.S. patent applications. Our issued U.S. patents primarily relate to our proprietary anti-tumor compounds, dapoxetine compound and methods of use, and HIV drug target gene sequences. Our pending U.S. 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 U.S. applications. As of December 31, 2004, we had eight granted and 52 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, 2004, we had exclusive license rights to seven issued U.S. patents and 54 pending U.S. 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 of 1988, a patent that claims a 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.

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Employees

At December 31, 2004, we employed approximately 6,600 professionals, of whom approximately 6,150 were in the Development Group, approximately 50 were in the Discovery Sciences Group and the remainder served in corporate operations functions. Of our staff, approximately 550 hold Ph.D., M.D., Pharm.D. or D.V.M. degrees and approximately 925 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.

Available Information

Our Web address is www.ppdi.com. We make available free of charge through our Web site 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 and medical device development outsourcing industry consists of hundreds of smaller, limited-service providers and a number of full-service global development companies. The industry continues to experience consolidation and, in recent years, a group of large, full-service competitors has emerged. In 2004, consolidation continued with the merger of PharmaNet, Inc. into SFBC International, Inc. and the merger of Inveresk Research Group, Inc. into Charles River Laboratories International, Inc. In addition, PRA International, Inc. completed an initial public offering in 2004. This trend of industry consolidation, along with other changes and the emergence of new entrants, continues to generate intense competition for clients and acquisition candidates. Additional business combinations by competitors or clients could have a significant impact on the competitive landscape of the drug development outsourcing industry.

Our Development Group and Discovery Sciences Group compete principally on the basis of reputation, scientific and technical expertise, experience and qualifications of professional staff, and the ability to deliver timely, high quality services and products to our clients. In addition to competing with a number of other global, full-service companies, our Development Group also competes against some medium-sized companies, in-house research and development departments of pharmaceutical and biotechnology companies, as well as universities and teaching hospitals. 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 could adversely affect our operating results.

Providers of outsourced drug and medical device 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 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,

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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, our Development Group competes 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.

The outsourced preclinical research industry consists of a number of large 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. Our compound risk-sharing initiatives seek to help our clients maximize the return on their research and development investments by sharing development costs and risks as well as future revenue streams from successful product launches. Many of these clients search for a collaborative partner through a competitive bidding process, which can include pharmaceutical, biotechnology and discovery platform and services companies, as well as venture capital firms and financial institutions. As such, there is significant competition for these opportunities, and our success will depend on our ability to identify and competitively bid for risk-sharing programs that are likely to be productive.

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 must file an 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 must 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 NDA. The NDA is a comprehensive, multi-volume filing that includes, among other things, the results of all preclinical 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 average review lasting 14 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 included in IND applications 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 GLP regulations. These regulations have also been adopted by the Ministry of Health in the United Kingdom and by similar regulatory

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authorities in other countries. Our product analysis lab in Middleton, Wisconsin, follows the FDA’s cGMP regulations. Both GLP and cGMP regulations require standardization procedures for all equipment, processes and analytical tests, 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 audit test data and conduct 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 and our specialty central laboratory located in Kentucky are CLIA-certified. Both of these laboratories and our specialty central clinical laboratory in Europe are accredited by the College of American Pathologists.

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 GCP, 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 several years, both the United States and foreign governments have become more concerned about the disclosure of confidential personal data. The European Union, or EU, 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, which governs 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 were required to 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 comply with the current EU and HIPAA requirements. Nevertheless, we will continue to monitor our compliance with these regulations and will take appropriate steps to ensure compliance with these and other privacy regulations.

We are also subject to regulations enforced by the following agencies:

In order to comply with these regulations, we have provided procedures, necessary equipment, and ongoing training for our employees involved in these activities. To date, we have had no citations or fines from the above agencies.

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

Risks Related to Our Discovery and Development Businesses

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

Industry trends and economic factors that affect our clients and collaboration partners, pharmaceutical, biotechnology and medical device 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 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 increases in these trends could have an 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 revenue.

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

We provide services and products to the pharmaceutical, biotechnology and medical device 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. For example, 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 and are likely to 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 for discovery and development services 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 employment agreements with Dr. Eshelman and other executives, they are generally only for one year and do not assure that Dr. Eshelman or any other executive 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, pharmaceutical and medical device industries generally and drug discovery and development more specifically are subject to increasingly rapid technological changes, such as the genomics revolution. 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 FDA 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. For example, recent product safety concerns and the creation of the Drug Safety Oversight Board could change the FDA product approval procedures. 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 or regulation governing the possession, use and dissemination of medical record information and other personal 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, including potential drug candidates that are being developed by us or with others under our risk-sharing agreements, and, as a result, our revenue. In the last several years, the United States Congress has reviewed several comprehensive health care reform proposals. The proposals are intended to expand healthcare coverage for the uninsured and reduce the growth of total healthcare expenditures. The United States 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. Any such legislation could cause our discovery and development customers to spend less on research and development. If this were to occur, we would have fewer business opportunities for our development and discovery service business, which could reduce our earnings, and the development of particular compounds might be discontinued. 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 acquisition 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. We might also spend time and money investigating and negotiating with potential acquisition or investment targets, but not complete the transaction. Any future acquisition 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.

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 2003 and 2004 we recorded impairments of equity investments, net, totaling $10.1 million and $2.0 million, respectively, to write down the carrying value of our investments for other than temporary declines in value. See Note 6 to the Notes to Consolidated Financial Statements included elsewhere in this report for a more detailed discussion of these impairments.

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

The majority of our contracts for the provision of 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 contract 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.

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

Our business involves the testing of new drugs and medical devices on human volunteers and, if marketing approval is received for any of our drug candidates, their use by patients. This 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 drug or device. Many of these volunteers and 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 and collaborative partners, 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 also not be able to get adequate insurance for these risks at reasonable rates in the future.

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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.

The clinical research studies we run in our Development Group 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 I clinic in Austin, Texas, which to date has 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 discovery and development services worldwide, our business is subject to risks associated with doing business internationally. Our revenue from our non-U.S. operations represented approximately 27.6% of our total revenues for the year ended December 31, 2004. 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:

For example, in 2004 our operating income was negatively impacted by approximately $4.9 million, net, due to the effect of the weakening of the U.S. dollar relative to the euro, British pound and Brazilian real. Although we attempt to manage this risk through provisions in our contracts with our customers and other methods, including foreign currency hedging contracts, we might not be able to eliminate or manage these risks and our operating income could be materially and adversely affected by a further decline in the value of the U.S. dollar.

Our inability to adequately protect our intellectual property rights could 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 the drug development process. In addition, one of our business strategies is to in-license and/or out-license rights to drug candidates and enter into collaborations with pharmaceutical and biotechnology companies for the development of drug candidates. Any inability to protect our intellectual property rights could materially and adversely affect our business.

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Any patents that we own or license might not provide valuable protection in the future for the covered technology or products. Our patent applications might never result in the issuance of a patent. Competitors might develop similar products or methods that are not covered by our issued patent claims. In addition, an issued patent might be narrowed or invalidated by a court upon challenge. The value of an issued patent could also be diminished if a patent is issued to a competitor that blocks our ability to use our patented technology. If blocked, we might be forced to stop using some or all of the technology or to license technology from third parties on unfavorable terms.

In addition to patent protection, we also rely on copyright, trademark and trade secret protection. 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. These agreements and other procedures, however, might not provide us with adequate protection against improper use or disclosure of confidential information. Also, 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 relationships. Although we require our employees and consultants to maintain the confidentiality of all confidential information of previous employers, both the company and these individuals 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 compounds, 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 addition to the possibility of having to defend an infringement claim asserted against us, 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 could 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 on unfavorable terms.

We have only limited experience in the drug discovery business, and our prospects for success in this business remain uncertain and are dependent on third parties with whom we collaborate.

It takes many years for a drug discovery business like ours to generate revenue and income. 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. Generating revenue and income from our drug discovery business will depend on our ability to:

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Since 1997, we have entered into collaborative agreements to develop and commercialize drugs with others. Our ability to succeed in our drug discovery business will depend on successfully executing existing and any new arrangements we enter into for the development and commercialization of a drug candidate. The third parties that we collaborate with might not perform their obligations as expected or they 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 the product candidates or not to devote sufficient resources to the development, manufacture, marketing or sale of these product candidates. If the parties to our collaborative agreements do not fulfill their obligations, elect not to develop a candidate or fail to devote sufficient resources to it, we could be materially and adversely affected.

We are dependent on third parties for certain essential business functions for our risk-sharing arrangements, and failures of these third party providers could materially adversely affect our business, financial condition and results of operations.

We and some of our collaborative partners are dependent on third parties for certain functions associated with the development and commercialization of our potential drug candidates, including manufacturing and marketing and sales. Our dependence on third parties for these services might adversely affect us and our ability to develop and commercialize a drug candidate on a timely and competitive basis. If we or our collaborative partners are unable to retain or replace third-party providers of required services on commercially acceptable terms, our potential drug candidates might not be developed and commercialized as planned, if at all. If we encounter delays or failures by these third parties to perform, we might have to seek alternative sources of supply, lose sales or abandon a drug candidate, and our business, financial condition and results of operations could be materially and adversely affected.

We might not be able to obtain government approval for our product candidates.

The development and commercialization of pharmaceutical products are subject to extensive governmental regulation in the United States and foreign countries. Government approvals are required to develop, market and sell the potential drug candidates we are developing alone or with others under our risk-sharing arrangements. Obtaining government approval to develop, market and sell drug candidates is time-consuming and expensive, and the clinical trial results for a particular drug candidate might not satisfy required government approvals. In addition, governmental approvals might not be received in a timely manner, if at all, and we and our collaborative partners might not be able to meet other regulatory requirements for our products. Even if we are successful in obtaining all required approvals to market and sell a drug candidate, post-marketing requirements and the failure to comply with other regulations could result in suspension or limitation of government approvals.

In connection with drug discovery activities outside the United States, we and our collaborators will be subject to foreign regulatory requirements governing the testing, approval, manufacture, labeling, marketing and sale of pharmaceutical products. These requirements vary from country to country. Even if approval has been obtained for a product in the United States, approvals in foreign countries must be obtained prior to marketing the product in those countries. The approval process in foreign countries may be more or less rigorous from country to country and the time required for approval may be longer or shorter than that required in the United States. Clinical studies conducted outside of any particular country may not be accepted by that country and the approval of a pharmaceutical product in one country does not assure that the product will be approved in another country.

We might incur substantial expense to develop products that are never successfully developed and commercialized.

We have incurred and expect to continue to incur substantial research and development and other expenses in connection with our compound partnering agreements. We anticipate that these expenses will exceed our prior research and development expenses, with the possible exception of our $65.0 million payment to Eli Lilly and Company in 2003. The potential drug candidates to which we devote resources might never be successfully developed or commercialized by us or our collaborative partners for numerous reasons, including:

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Incurring significant expenses for a potential drug candidate that is not successfully developed and/or commercialized, could have a material adverse effect on our business, financial condition, results of operations and prospects, because we would not receive the anticipated milestone, royalty or other payments and rights.

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

We depend on our customers, investigators, collaboration partners, our own 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, investigators and collaboration partners, 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 affecting us or our customers, investigators or collaboration partners could have a significant negative impact on our operations.

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

Our specialty central laboratories and some of our other discovery and development services rely heavily on air travel for transport of clinical trial kits and other materials and people and disruption to the air travel system could have a material adverse effect on our development 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 stock market, and in particular pharmaceutical and biotechnology companies, has also experienced significant decreases in value in the past. This volatility and 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 February 15, 2005, we had 61 offices located in 28 countries on six continents. All locations relate to our Development Group, and the Morrisville, North Carolina and Menlo Park, California locations also house our Discovery Sciences Group. Our principal executive offices are located in Wilmington, North Carolina. We own and operate four facilities, including a building 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 also own land in Wilmington, North Carolina where we plan to construct a new corporate headquarters facility we intend to occupy in late 2006. 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 February 15, 2005 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, 2004.

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Executive Officers

The following table contains information concerning our executive officers as of February 15, 2005:

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 us 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 was promoted from Senior Vice President to his current position in January 2002. 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 us in December 1995. Ms. Baddour was promoted to Chief Accounting Officer in 1997 and to Chief Financial Officer in 2002. Prior to her employment by us, Ms. Baddour was the Controller for Cooperative Bank from 1980 to 1995. Ms. Baddour is a Certified Public Accountant.

Colin Shannon is our Executive Vice President – Global Clinical Operations. Mr. Shannon joined us in 1995. He has served in numerous management positions, including Chief Operating Officer, Europe and Chief Financial and Administration Officer, Europe. Prior to his employment by us, Mr. Shannon spent more than 15 years in a variety of financial and accounting positions in the utility and multimedia industries.

Francis J. Casieri is our Senior Vice President – Global Business Development. Mr. Casieri has served as our Senior Vice President – Global Business Development since August 2004. Mr. Casieri also served in this same role from January 2000 to April 2002. Mr. Casieri rejoined us in September 2003 as General Manager – Account Management following a year and a half sabbatical.

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PART II

Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common stock is traded under the symbol “PPDI” 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 15, 2005, there were approximately 30,600 holders of our common stock.

We have never declared or paid any cash dividends as a public company. Furthermore, we have no 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 Financial Data

The following table represents selected historical consolidated financial data. The statement of operations data for the years ended December 31, 2002, 2003 and 2004 and balance sheet data at December 31, 2003 and 2004 are derived from our audited consolidated financial statements included elsewhere in this report. The statement of operations data for the year ended December 31, 2000 and 2001, and the balance sheet data at December 31, 2000, 2001 and 2002 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 consolidated financial statements and notes to the financial statements included elsewhere in this report.

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Consolidated Statement of Operations Data (in thousands, except per share data):

Consolidated Balance Sheet Data (in thousands):

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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 performance, expectations, predictions, assumptions and other statements that are not statements of historical facts. In some cases, you can identify forward-looking statements by terminology such as “might”, “will”, “should”, “expect”, “plan”, “anticipate”, “believe”, “estimate”, “predict”, “intend”, “potential” or “continue”, or the negative of these terms, or other comparable terminology. These statements are only predictions. These statements rely on a number of assumptions and estimates that could be inaccurate and that are subject to risks and uncertainties. Actual events or results might differ materially due to a number of factors, including those listed in “Potential Volatility of Quarterly Operating Results and Stock Price” 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.

Executive Overview

Because our revenues are dependent on a relatively small number of industries and clients, we closely monitor the market for our services. For a discussion of the trends affecting our market, see “Item 1. Business—Trends Affecting the Drug Discovery and Development Industry”. Our new business authorizations for the first two quarters of 2003 were lower than we expected. In response, we refocused our business development and operational efforts to increase new business authorizations. We believe that those efforts, together with a stronger market for CRO services in the second half of 2003 and in 2004, resulted in increased new authorizations for those periods.

While we cannot predict the demand for CRO services in 2005, we believe the overall historical market drivers for our industry are intact. To grow authorizations in 2005, we plan to focus on our business development efforts, including increasing the percentage of successful proposals, and the delivery of timely, high quality services to our clients. We continue to believe there are several specific opportunities for growth in 2005. We currently conduct a significant amount of government-sponsored research and plan to continue our efforts to win new opportunities in this market. Our Latin American and European Phase II through IV units had an excellent year in 2004 and we believe there are opportunities for continued growth in these areas. We have also experienced an increase in the demand for our Phase I services and are expanding our Phase I clinic in Austin, Texas to 300 beds to enhance our ability to service large, complex studies. This expansion should be completed in April 2005. In 2004, the demand for our bioanalytical and GMP services increased and we have expanded our GMP laboratory facilities and invested in new equipment to meet this increased demand. Finally, we also believe the demand for our post-marketing development services will continue to grow and we will also seek to expand our medical device services.

We review various metrics, including period-to-period growth in backlog, new authorizations, cancellation rates, revenue, margins and earnings, to evaluate our financial performance. In 2004, we had record new authorizations of $1.2 billion, an increase of 13.5% over 2003. The cancellation rate for 2004 was 22% compared to 24% in 2003. On a net basis, authorizations were up 17% in 2004 compared to 2003. Backlog grew 15% from $1.1 billion as of December 31, 2003 to $1.3 billion as of December 31, 2004. Backlog by client type as of December 31, 2004 was 58% pharmaceutical, 28% biotech and 14% government/other. Backlog by client type as of December 31, 2003 was 64% pharmaceutical, 23% biotech and 13% government/other. This change in the composition of our backlog from 2003 to 2004 reflects an increase in new authorizations from biotech clients. Net revenue by client type for the year ended December 31, 2004 was 65% pharmaceutical, 25% biotech and 10% government/other. Top therapeutic areas by net revenue for the year ended December 31, 2004 were oncology, anti-infective/anti-viral, central nervous system, circulatory/cardiovascular and endocrine/metabolic. For a detailed discussion of our revenue, margins, earnings and other financial results for the year ended December 31, 2004, see “Results of Operations – Year Ended December 31, 2004 versus Year Ended December 31, 2003” below.

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Capital expenditures for the year ended December 31, 2004 totaled approximately $48.6 million. The majority of the capital expenditures were for software, computer hardware, the expansion of our Phase I unit, and new equipment for our bioanalytical and GMP labs. We bought new liquid chromatography/mass spectrometry instruments in 2004, bringing our total to 53. In addition to investing in our growing business, we are also focused on improving the efficiency of our operations by streamlining training matrices and clinical procedural documents, decreasing the number of documents needed for study initiation, centralizing regulatory document collection and rolling out a new clinical trial management system.

With respect to our Discovery Sciences segment, our compound collaboration arrangements allow us to leverage our resources and global drug development expertise to create new opportunities for growth and to share the risks and potential rewards of drug development. In 2003, in addition to furthering existing collaborations with ALZA Corporation, a subsidiary of Johnson & Johnson, and Bayer AG, we entered into new collaborations with Syrrx and Chemokine Therapeutics. For a discussion of these compound partnering arrangements, see “Item 1. Business – Our Services – Our Discovery Sciences Group – Compound Partnering Programs” above. One of our primary goals in the discovery business at the beginning of 2004 was to end the year with four drug candidates in clinical development, and we delivered on that objective.

In September 2004, we filed an investigational new drug application for one Syrrx DPP IV inhibitor and started the Phase I trial for that inhibitor in late October 2004. This inhibitor is now in Phase Ib, which is when the drug is first administered to subjects suffering from the indication. We currently anticipate starting Phase II trials in April 2005. In December 2004, we filed an investigational new drug application for a second DPP IV inhibitor and a Phase I study for this second DPP IV inhibitor is scheduled to begin in April 2005. In February 2005, Takeda Pharmaceutical Company Limited announced that it entered into an agreement to acquire 100% of the equity of Syrrx, Inc. At this time, we do not know what impact, if any, this acquisition will have on the DPP IV collaboration with Syrrx.

In addition, ALZA Corporation submitted an NDA for dapoxetine in December 2004. The FDA accepted the dapoxetine NDA for filing in February 2005. As a result of these arrangements and the progression of our pipeline, we expect to incur significant R&D expense during 2005. Furthermore, in addition to progressing our existing collaborations, we will continue to evaluate opportunities for new collaborations and investments that we believe will help us achieve our mid- to long-term growth objectives.

In February 2005, we completed the acquisition of substantially all of the assets of SurroMed, Inc.’s biomarker business. The acquired business consists of services and technologies that support drug discovery and drug development by identifying biomarkers using biological, chemical and bioinformatics expertise and technologies. The new business is part of our Discovery Sciences segment and will expand our discovery business by adding biomarker discovery and patient sample analysis to the collection of services offered by us.

Acquisitions

In 2002, we completed four acquisitions. For details regarding these acquisitions, see Note 2 to the Notes to Consolidated Financial Statements.

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

We accounted for all of the acquisitions in 2002 and 2003 under the purchase method of accounting, utilizing appropriate fair value techniques to allocate the purchase price based on estimated fair values of the assets and liabilities. The results of operations are included in our consolidated results of operations as of and since the effective dates of the acquisitions. For further details regarding these acquisitions, see Note 2 to the Notes to Consolidated Financial Statements.

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Investments

In March 2004, PPD loaned Oriel Therapeutics $0.9 million in the form of debt that is convertible into Oriel Therapeutics’ Series B preferred stock at $2.00 per share. The loan is secured by a first lien on Oriel’s assets. In January 2004, we purchased 5.0 million shares of Accentia Biopharmaceuticals, Inc. Series E convertible preferred stock for $5.0 million. At that time, we also received a Class A and Class B warrant, each to purchase up to an additional 5.0 million shares of Series E convertible preferred stock for $1.00 per share. In September 2004, we entered into a royalty stream purchase agreement with Accentia. Under the terms of that agreement, we paid Accentia a one-time cash payment of $2.5 million for the right to receive royalties on future sales of antifungal products for the treatment of chronic sinusitis. The royalties under this agreement equal 6% of the net sales of antifungal products sold prior to FDA approval and 7% of the net sales of these products sold after FDA approval, if FDA approval is obtained. In January 2005, PPD exercised the Class A warrant of Accentia for the purchase of an additional 5.0 million shares of Series E convertible preferred stock for $5.0 million. In February 2005, Accentia filed a registration statement with the SEC for its proposed initial public offering of its common stock. Accentia proposes to sell in this public offering, in addition to shares for its own account, up to $12.0 million of common stock issuable to us upon conversion of 5.0 million shares of the Series E convertible preferred stock held by us.

As a result of management’s quarterly evaluations of our equity investments, during 2004 we recorded a charge to earnings of $2.0 million for an other than temporary decline in the fair market value of our investment in Chemokine Therapeutics Corp. See Note 6 to the Notes to Consolidated Financial Statements for a more detailed discussion of these investments.

Restructuring Charges and Gain on Sale of Assets

In 2004, we recorded a $2.6 million restructuring charge associated with exiting our chemistry facility in Research Triangle Park, North Carolina. These charges include lease payments and termination costs, net of sublease rentals, of approximately $2.1 million and a loss on sale of assets used in our chemistry services of approximately $0.5 million. The lease termination liability will be paid over the remaining life of the lease which will end in 2015.

In July 2003, we announced the restructuring of our Discovery Sciences Group. In connection with this restructuring, we consolidated our Discovery Sciences operations into our Morrisville, North Carolina and Middleton, Wisconsin facilities, and discontinued offering functional genomics services in Menlo Park, California. In the third quarter, we incurred, recorded and paid a charge to earnings of $1.9 million for this restructuring. Restructuring charges included $0.9 million for one-time termination benefits, $0.7 million for facility charges and $0.3 million for other related charges.

As a part of the 2003 restructuring, we purchased 4.4 million shares of SurroMed, Inc. Series F convertible preferred stock in exchange for $12.0 million in cash and $12.0 million in tangible assets and intellectual property from our Menlo Park operations. The value of the tangible assets and intellectual property was based on an independent appraisal. We recorded a gain on sale of assets of $5.7 million as a result of this transaction. The majority of the remaining tangible assets of the restructured operations were transferred to our CRO Phase II through IV division and the remaining Discovery Sciences operations.

New Business Authorizations and Backlog

New business authorizations, which are sales of our services, are reflected in backlog when we enter into a contract or letter of intent or receive a verbal commitment. Authorizations can vary significantly from quarter to quarter, and contracts generally have terms ranging from several months to several years. We recognize revenue on these authorizations as services are performed. Our new authorizations for the years ended December 31, 2002, 2003 and 2004 were $1,002.5 million, $1,068.2 million and $1,212.4 million, respectively.

Our backlog consists of new business authorizations for which the work has not started but is anticipated to begin in the near future, and contracts in process that have not been completed. As of December 31, 2004, the remaining duration of the contracts in our backlog ranged from one month to 114 months with an average duration of 27.6 months. Amounts included in backlog represent future revenue and exclude revenue that we have previously recognized. Once work begins on a project included in backlog, net revenue is recognized over the life of the contract. However, there can be no assurance that our backlog will ever be recognized as revenue. Our backlog as of December 31, 2002, 2003 and 2004 was $974.4 million, $1,120.2 million and $1,292.8 million, respectively.

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Results of Operations

Revenue Recognition

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

In connection with the management of multi-site clinical trials, we pay, on behalf of our customers, fees to investigators and test subjects as well as other out-of-pocket costs for items such as travel, printing, meetings and couriers. Our clients reimburse us for these costs. As required by EITF 01-14, amounts paid by us as a principal for out-of-pocket costs are included in direct costs as reimbursable out-of-pocket expenses and the reimbursements we receive as a principal are reported as reimbursed out-of-pocket revenue. In our statements of operations, we combine amounts paid by us as an agent for out-of-pocket costs with the corresponding reimbursements, or revenue, we receive as an agent. During the years ended December 31, 2002, 2003 and 2004, fees paid to investigators and other fees we paid as an agent and the associated reimbursements were approximately $157.5, $172.5 and $226.9 million, respectively.

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

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

Recording of Expenses

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

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

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

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

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

Year Ended December 31, 2004 Versus Year Ended December 31, 2003

The following table sets forth amounts from our consolidated financial statements along with the dollar and percentage change for the full year of 2004 compared to the full year of 2003.

Total net revenue increased $114.3 million to $841.3 million in 2004. The increase in total net revenue resulted primarily from an increase in our Development Group revenues. The Development Group’s operations

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generated net revenue of $759.6 million, which accounted for 90.3% of total net revenue for 2004. The 16.2% increase in the Development Group’s net revenue was primarily attributable to an increase in the level of global CRO Phase II through IV services we provided in 2004 as compared to 2003. Net revenue for the Development Group also increased by approximately $4.5 million due to the effect of the weakening of the U.S. dollar relative to the euro and the British pound based on 2004 revenue translated at the average exchange rates in 2003.

The Discovery Sciences Group generated net revenue of $14.3 million in 2004, a decrease of $1.2 million from 2003. The decrease in the Discovery Sciences net revenue was mainly attributable to the reduction in net revenue from chemistry services, which we stopped offering in the first quarter of 2004. In both 2003 and 2004, we received a $5.0 million dapoxetine milestone payment from ALZA. ALZA submitted an NDA for dapoxetine in December 2004. The FDA accepted this NDA for filing in February 2005. As a result, we are entitled to receive a one-time milestone payment of $10.0 million from ALZA within 30 days of the FDA’s acceptance of the NDA.

Total direct costs increased $67.1 million to $449.2 million in 2004 primarily as the result of an increase in the Development Group direct costs. Development Group direct costs increased $59.5 million to $376.4 million in 2004. The primary reason for this increase was an increase in personnel costs of $40.3 million. Personnel costs increased due to hiring additional employees in our global CRO Phase II through IV division, increased incentive compensation accruals and increased costs in our foreign operations due to the weakening of the U.S. dollar. In 2003, incentive compensation accruals were lower than our normal accrual levels as a result of our financial and operating performance in that period. The remaining $19.2 million of this increase in Development direct costs primarily consisted of increased facility costs related to the increase in personnel and increased subcontractor costs to support increased revenues.

Discovery Sciences direct costs decreased $2.2 million to $5.5 million in 2004. The higher costs in 2003 related primarily to a $2.5 million milestone payment for dapoxetine to Eli Lilly & Company that did not occur again in 2004 because we acquired the dapoxetine patents from Lilly in December 2003.

Gross margin from the Development segment was 50.4% in 2004 compared to 51.5% in 2003. The majority of this decrease was attributable to increased incentive compensation accruals and increased costs in our foreign operations due to the weakening of the U.S. dollar. The remaining variance relates to expected fluctuations from one period to another as a result of changes in labor utilization and the mix of service offerings involved in the hundreds of studies conducted during any period of time.

Research and development, or R&D, expenses decreased $59.1 million to $15.9 million in 2004. In the fourth quarter of 2003, we acquired from Eli Lilly & Company the patents for the compound dapoxetine for development in the field of genitourinary disorders. PPD paid Lilly $65.0 million in cash and agreed to pay Lilly a royalty of 5% on annual sales of dapoxetine, if any, in excess of $800 million. The $65.0 million payment to Lilly was recorded to research and development expenses because dapoxetine was still in development and had not been approved for sale in any country. Excluding that payment, R&D expenses increased $5.9 million in 2004 compared to 2003 as a result of increased spending in connection with our existing compound partnering arrangements. The increased spending on compound partnering arrangements was offset by the decrease in functional genomics and chemistry R&D expense as we ceased providing the services in the third quarter of 2003 and first quarter of 2004, respectively. In 2003, R&D expenses for our functional genomics and chemistry services operations totaled $7.0 million. We expect to incur significant R&D expenses in 2005 in connection with our existing compound partnering arrangements.

Selling, general and administrative, or SG&A, expenses increased $29.5 million to $195.8 million in 2004. As a percentage of total net revenue, SG&A expenses increased slightly to 23.3% in 2004 compared to 22.9% in 2003. The increase in SG&A expenses includes additional personnel costs of $21.6 million. Personnel costs increased by $5.7 million, due to increased incentive compensation accruals and $4.4 million related the to foreign currency translation effect of the weakening U.S. dollar mentioned previously. The remaining $11.5 million increase in personnel costs related to training costs for new personnel, higher levels of operations infrastructure to manage direct personnel and changes in utilization levels. The increase in SG&A costs also includes an increase of $2.4 million for recruiting costs due to an increase in the number of new hires in 2004 compared to 2003 and an increase of $2.3 million in accounting and auditing fees due to new regulatory requirements.

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Depreciation expense increased $1.6 million to $28.6 million in 2004. The increase was related to the depreciation of the property and equipment we acquired to accommodate our growth. Capital expenditures were $48.6 million in 2004. Capital expenditures primarily included additional spending in the Development Group on software, computer hardware, and additional scientific equipment for our Phase I and Lab units and a $5.0 million purchase of land in connection with our plans to construct a new corporate headquarters building in Wilmington, North Carolina.

Amortization expense decreased $0.4 million to $1.2 million in 2004 as a result of the decrease of $0.7 million in amortization expense for our intangible backlog related to the acquisition of MRL in 2002 becoming fully amortized in the first quarter of 2004. This was offset by an increase in amortization of $0.3 million related to the license agreement and royalty rights agreement in the Discovery Sciences Group that were placed into service during the second quarter of 2003 and the third quarter of 2004.

Operating income increased $69.2 million to $148.0 million in 2004. As a percentage of net revenue, operating income increased to 17.6% of net revenue in 2004 from 10.8% in 2003. Operating income in 2003 includes the $65.0 million payment to Lilly and a $1.9 million charge related to the restructuring of the Discovery Sciences Group offset by a $5.7 million gain on the sale of assets. The aggregate impact of these items was a $61.2 million reduction in operating income for 2003. Operating income in 2004 includes a $2.6 million restructuring charge associated with exiting our chemistry facility in Research Triangle Park, North Carolina. Operating income in 2004 was also negatively impacted by approximately $7.6 million due to the effect of the U.S. dollar weakening relative to the euro, the British pound and the Brazilian real. During 2004, we recorded a foreign currency hedging gain of $2.7 million, resulting in a net impact to operating income of $4.9 million attributable to foreign currency transactions. Although these currency movements increased net revenue in the aggregate, the negative impact on operating income is attributable to dollar-denominated contracts for services rendered in countries other than the United States. In these cases, revenue is not impacted by the weakening of the U.S. dollar, but the costs associated with performing these contracts, which are paid in local currency, are negatively impacted when translated to the U.S. dollar.

During 2004, we recorded a charge to earnings for an other than temporary decline in the fair market value of our investment in Chemokine Therapeutics Corp. of $2.0 million. We deemed our investment in Chemokine to be impaired as a result of the issuance of shares to new investors at a lower valuation than our original investment.

During 2003, we recorded charges to earnings for other than temporary declines in the fair market value of our investments in SLIL Biomedical of $4.7 million, Spotlight Health of $3.9 million, Signature Bioscience (formerly Primecyte) of $0.2 million and BioDelivery Sciences of $1.4 million. We determined that SLIL and Signature Bioscience were impaired primarily as a result of the market condition of their respective industries, historical and projected performance and expected cash needs of the individual companies. We recorded the write-down of our investment in Spotlight Health primarily based on its historical and projected financial performance and issuance of shares to a new investor at a lower valuation. BioDelivery Sciences is a publicly traded company, so we based the write-down of our investment in that company on the closing price of its securities as of December 31, 2003. Although these securities had traded above cost for short periods of time throughout 2003, we believe that due to the uncertainty of BioDelivery Sciences’ strategic direction, the decline in value was other than temporary and therefore we recorded the charge to earnings. Prior to the third quarter of 2003, we recorded market fluctuations through other comprehensive income.

Our provision for income taxes increased $26.0 million to $51.0 million in 2004. Our effective income tax rate for 2004 was 34.0% compared to 35.0% for 2003. During the second quarter of 2004, our effective tax rate was positively impacted by a $3.7 million tax benefit for a decrease in a valuation allowance for capital loss carryforwards that we expect to be able to utilize. The remaining difference in our effective rates for 2003 and 2004 is also due to the change in the geographic distribution of our pretax earnings among locations with varying tax rates.

Net income of $98.9 million in 2004 represents an increase of $52.6 million from $46.3 million in 2003. Net income per diluted share of $1.74 in 2004 represents an increase from $0.82 net income per diluted share in 2003. Net income for 2003 includes a charge of $10.1 million for impairment of equity investments. This charge, together with the payment to Lilly of $65.0 million and the restructuring charges of $1.9 million offset by the gain on sale of assets of $5.7 million, resulted in an aggregate impact of $44.8 million on 2003 net income, net of tax. Net income per diluted share of $0.82 in 2003 includes an aggregate impact of $0.80 earnings per share, net of tax, for the items mentioned above.

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Year Ended December 31, 2003 Versus Year Ended December 31, 2002

The following table sets forth amounts from our consolidated financial statements along with the dollar and percentage change for the full year of 2003 compared to the full year of 2002.

Total net revenue increased $118.3 million to $727.0 million in 2003. The increase in total net revenue resulted primarily from an increase in our Development Group revenues. The Development Group’s operations generated net revenue of $654.0 million, which accounted for 90.0% of total net revenue for 2003. The 20.0% increase in the Development Group’s net revenue was primarily attributable to an increase in the amount of global CRO Phase II through IV services we provided in 2003 as compared to 2002. Net revenue for the Development Group also increased by approximately $5.6 million due to the effect of the weakening of the U.S. dollar relative to the euro and the British pound during 2003.

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The Discovery Sciences Group generated net revenue of $15.5 million in 2003, a decrease of $2.0 million from 2002. The decrease in the Discovery Sciences net revenue was mainly attributable to a reduction in net revenue from functional genomics and chemistry services of $7.4 million and $2.0 million, respectively, due to fewer contracts for those services in 2003. We discontinued functional genomics and chemistry services in the third quarter of 2003 and the first quarter of 2004, respectively. The decreases in 2003 Discovery Sciences net revenue were partially offset by a milestone payment of $5.0 million that we earned under our sublicense agreement with ALZA as a result of the initiation of Phase III clinical trials of dapoxetine, and by an increase of $3.0 million in net revenue associated with our preclinical oncology operation. In early January 2004, we amended our sublicense agreement with ALZA. Under the terms of the amendment, ALZA made a cash payment to us of $5.0 million in the first quarter of 2004.

Total direct costs increased $67.2 million to $382.2 million in 2003. Development Group direct costs increased $55.8 million to $316.9 million in 2003. This increase resulted primarily from increased personnel costs of $32.2 million due to hiring additional employees in our global CRO Phase II through IV division and to annual salary increases. Development Group direct costs increased as a percentage of related net revenue from 47.9% in 2002 to 48.5% in 2003. Direct costs, as a percentage of net revenues, have 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.

Discovery Sciences direct costs decreased $0.09 million to $7.7 million in 2003. This decrease resulted from a decline in direct costs of $3.5 million related to our functional genomics services and chemistry services due in each case to fewer contracts being performed in those areas in 2003. We will not be generating any direct costs from functional genomics or chemistry services in the future because we discontinued offering these services in the third quarter of 2003 and the first quarter of 2004, respectively. These decreases were partially offset by increases in direct costs of $2.5 million for a milestone payment to Lilly on dapoxetine and of $1.5 million associated with our preclinical oncology operations.

R&D expenses increased $64.4 million to $74.9 million in 2003. In the fourth quarter of 2003, we acquired from Eli Lilly the patents for the compound dapoxetine for development in the field of genitourinary disorders. We paid Lilly $65.0 million in cash and agreed to pay Lilly a royalty of 5% on annual sales of dapoxetine, if any, in excess of $800 million. The $65.0 million payment to Lilly was recorded to research and development expenses because dapoxetine was still in development and had not been approved for sale in any country. Excluding that payment, R&D expenses decreased $0.6 million in 2003 compared to 2002 due to discontinuing our functional genomics services.

SG&A expenses increased $15.6 million to $166.3 million in 2003. The increase was primarily attributable to additional personnel costs of $14.0 million attributable to administrative tasks that are not directly related to client projects, such as training costs. This was partially offset by a decrease in recruitment agency fees of $1.6 million. As a percentage of net revenue, SG&A expenses decreased to 22.9% in 2003 from 24.7% for 2002. This decrease is primarily attributable to the increase in net revenue and leveraging our SG&A expenses.

Depreciation expense increased $3.8 million to $27.0 million in 2003. The increase was related to the depreciation of the property and equipment we acquired to accommodate our growth. Capital expenditures were $31.7 million in 2003. Capital expenditures primarily included additional spending in the Development Group to enhance and expand our information technology capacity.

Amortization expense increased $0.6 million to $1.6 million in 2003, due to the amortization expense for a license agreement in the Discovery Sciences Group that was placed into service during 2003.

Operating income decreased to $78.8 million in 2003. As a percentage of net revenue, operating income decreased to 10.8% of net revenue in 2003 from 17.8% in 2002. Operating income in 2003 includes the $65.0 million payment to Lilly and a $1.9 million charge related to the restructuring of the Discovery Sciences Group offset by a $5.7 million gain on the sale of assets. The aggregate impact of these items was a $61.2 million reduction in operating income for 2003. Operating income was also negatively impacted by approximately $6.7 million due to the effect of the weakening of the U.S. dollar relative to the euro and the British pound, partially offset by the strengthening of the U.S. dollar relative to the Brazilian real during 2003. Although these currency movements

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increased net revenue in the aggregate, the negative impact on operating income is attributable to dollar-denominated contracts for services rendered in countries other than the United States. In these cases, revenue is not impacted by the weakening of the U.S. dollar, but the costs associated with performing these contracts, which are paid in local currency, are negatively impacted when translated to the U.S. dollar.

During 2003, we recorded charges to earnings for other than temporary declines in the fair market value of our investments in SLIL Biomedical of $4.7 million, Spotlight Health of $3.9 million, Signature Bioscience (formerly Primecyte) of $0.2 million and BioDelivery Sciences of $1.4 million. We determined that SLIL and Signature Bioscience were impaired primarily as a result of the market condition of their respective industries, historical and projected performance and expected cash needs of the individual companies. We recorded the write-down of our investment in Spotlight Health primarily based on its historical and projected financial performance and issuance of shares to a new investor at a lower valuation. BioDelivery Sciences is a publicly traded company, and we based the write-down of that investment on the closing price of its securities as of December 31, 2003. Although these securities had traded above cost for short periods of time throughout 2003, we believe that due to the uncertainty of BioDelivery Sciences’ strategic direction, the decline in value as of each of these periods was other than temporary and therefore we recorded the charges to earnings. Prior to the third quarter of 2003, we recorded market fluctuations through other comprehensive income.

In 2002, we recorded charges to earnings for other than temporary declines in the fair market value of our investment in Gallery Systems of $1.5 million and our investment in Intrabiotics Pharmaceuticals of approximately $0.3 million. We also recorded a $32.0 million write-down of the carrying value of our investment in DNA Sciences for an other than temporary decline in value in 2002. At the time of the write-down, we deemed our investment in DNA Sciences to be impaired as a result of historical and projected performance, cash needs and an independent valuation of the market value of DNA Sciences. DNA Sciences subsequently filed for bankruptcy and we no longer have any ownership interest in that entity.

Our provision for income taxes decreased $7.4 million to $24.9 million in 2003 from $38.6 million in 2002. Our effective tax rate decreased to 35.0% in 2003 compared to 49.1% in 2002. The decrease in income tax expense and rate in 2003 was due to the impact on income of acquiring the patents for the compound dapoxetine and the change in geographic distribution of pretax earnings among locations with varying tax rates. Our effective rate was higher in 2002 due to a large increase in our valuation allowance. During 2003 and 2002, we recorded impairments of equity investments of $10.1 million and $33.8 million, respectively. Because of the uncertainty about whether we could use the loss related to these impairments during the carryforward period, we recorded a valuation allowance of $1.2 million in 2003 and $11.1 million in 2002, thus providing a tax benefit of only $3.0 and $2.3 million related to the impairments in the provision for income taxes in those years.

Net income of $46.3 million in 2003 represents an increase of $6.4 million from $39.9 million in 2002. Net income for 2003 includes a charge of $10.1 million for impairment of equity investments, net. This charge, together with the payment to Lilly of $65.0 million and the restructuring charges of $1.9 million offset by the gain on sale of assets of $5.7 million, resulted in an aggregate impact of $44.8 million on net income, net of tax. Net income per diluted share of $0.82 in 2003 represents an increase from $0.72 net income per diluted share in 2002. Net income per diluted share of $0.82 in 2003 includes an aggregate impact of $0.80 earnings per share, net of tax, for the items mentioned above. Net income per diluted share of $0.72 for 2002 includes a $0.57 charge for the impairment of our equity investments and the related tax benefit.

Liquidity and Capital Resources

As of December 31, 2004, we had $144.3 million of cash and cash equivalents and $105.0 million of short-term investments. 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, leasing arrangements, borrowings and sales of our stock. Our cash and cash equivalents are invested in financial instruments that are rated A or better by Standard & Poor’s or Moody’s and earn interest at market rates.

In 2004, our operating activities provided $179.3 million in cash as compared to $13.6 million last year. The increase in cash flow from operations is primarily due to a $78.4 million increase in income before provision for

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income taxes and an increase in cash related to changes in operating assets and liabilities of $31.7 million as compared to a decrease of $43.4 million in 2003. In 2003, income from operations was negatively impacted as a result of the $65.0 million one-time payment to Lilly in 2003 to acquire the patents to the dapoxetine compound. In addition, cash flow from operations was positively impacted by a $23.0 million decrease in the net growth of receivables due to improved collections of receivables and a $23.0 million increase in unearned income due to a different mix of contract terms in 2004. In 2004, net income of $98.9 million, depreciation and amortization of $29.9 million, a decrease of $12.9 million in deferred income tax as a result primarily of a decrease in depreciation and amortization timing differences of $10.0 million, an increase of $27.8 million in accounts payable and other accrued expenses as a result of increased employee related accruals of $14.6 million, such as incentive compensation accruals and accrued salary due to the increase in employees, and an increase of $13.2 million in other accruals, such as subcontractor accruals and volume discount accruals, related to increased revenue and an increase of $24.7 million in unearned income were partially offset by an increase of $16.1 million in receivables due to increased revenue.

In 2004, we used $110.6 million in cash related to investing activities. The net cash used for net purchases of available-for-sale investments of $55.6 million, purchases of investments of $5.7 million, purchase of royalty rights agreement of $2.5 million and capital expenditures of $48.6 million were partially offset by the $1.5 million of proceeds from a refund of a portion of the purchase price associated with the acquisition of Eminent Research Systems in 2003. We expect our capital expenditures in 2005 will range from approximately $45.0 to $50.0 million, excluding our purchase of a corporate airplane for $30.5 million in February 2005 and the construction of the new corporate headquarters building in Wilmington, North Carolina. Construction of the corporate headquarters building is discussed below. The majority of these anticipated capital expenditures will relate to information technology enhancement and expansion.

In 2004, our financing activities provided $11.0 million in cash. Net proceeds from stock option exercises and purchases under our employee stock purchase plan totaling $12.1 million were partially offset by $0.4 million in repayments of long-term debt and $0.8 million in repayments of capital lease obligations.

Working capital as of December 31, 2004 was $257.1 million, compared to $156.6 million at December 31, 2003. The increase in working capital was due primarily to the increase in cash of $83.7 million, increase in short-term investments of $55.6 million and the increase in accounts receivable of $19.4 million which were partially offset by the increase in payables to investigators of $11.7 million, an increase in other accrued expenses of $38.0 million, and an increase in unearned income of $28.5 million. The number of days’ revenue outstanding in accounts receivable and unbilled services, net of unearned income, also known as DSO, were 40.0 and 42.1 days as of December 31, 2004 and December 31, 2003, respectively. DSO is calculated by dividing accounts receivable and unbilled services less unearned income by average daily gross revenue for the period presented. Over the past three years, our year-to-date DSO has fluctuated between 30.8 days and 42.2 days. We expect DSO will fluctuate in the future depending on the mix of contracts performed within a quarter, the level of investigator advances and unearned income, and our success in collecting receivables.

We maintain a defined benefit pension plan for certain employees and former employees in the United Kingdom. This pension plan was closed to new participants as of December 31, 2002. The projected benefit obligation for the benefit plan at December 31, 2004 and December 31, 2003, as determined in accordance with SFAS No. 87, “Employers Accounting for Pensions”, was $35.7 million and $28.4 million, respectively, and the value of the plan assets was $25.4 million and $19.0 million, respectively. As a result, the plan was under-funded by $10.4 million in 2004 and by $9.4 million in 2003, net of December contributions of $0.2 million for 2004 and 2003. It is likely that the amount of our contributions to the plan could increase in future years. The amount of contributions to the plan for the years ended December 31, 2004 and 2003 were $2.0 million and $2.2 million, respectively. We expect the pension cost to be recognized in our financial statements will decrease slightly from the $2.3 million in 2004 to approximately $1.9 million in 2005. The expense to be recognized in future periods could increase depending upon the change in fair market value of the plan assets and change in the projected benefit obligation.

A decrease in the market value of plan assets and/or declines in interest rates are likely to cause the amount of the under-funded status to increase. After completion of the actuarial valuations in 2005 we could be required to record an additional reduction to shareholders’ equity. We recorded an increase to shareholders’ equity in 2004 of $0.5 million and a reduction to shareholders’ equity of $0.7 million in 2003. Given the impact that the discount rate

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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. 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.

In July 2004, we renewed our $50.0 million revolving credit facility with Bank of America, N. A. Indebtedness under the facility is unsecured and subject to traditional covenants relating to financial ratios and restrictions on certain types of transactions. Borrowings under this credit facility are available to provide working capital and for general corporate purposes. As of December 31, 2004, there was no amount outstanding under this credit facility. However, the aggregate amount we are able to borrow has been reduced by $0.8 million due to outstanding letters of credit issued under this facility. This credit facility is currently scheduled to expire in June 2005, at which time any outstanding balance would be due.

In April 2000, we made an investment in Spotlight Health, Inc. We entered into an agreement with Spotlight Health and Bank of America, N.A. to guarantee a $2.0 million revolving line of credit provided to Spotlight Health by Bank of America. Indebtedness under the line of credit is unsecured and subject to traditional covenants relating to financial ratios. This credit facility is scheduled to expire on June 30, 2005, at which time any outstanding balance would be due. As of December 31, 2004, Spotlight Health had $2.0 million outstanding under this credit facility. In accordance with the requirements of FASB Statement No. 5, “Accounting for Contingencies”, as clarified by FASB Interpretation No. 45, we have recorded a liability in the amount of $0.2 million for the estimated fair value of the obligation we have assumed under this guarantee. We review the financial statements of Spotlight Health on a quarterly basis to determine if it has sufficient financial resources to continue operations. Future events and circumstances might adversely affect Spotlight Health’s financial condition and Spotlight Health might not be in the position to repay the facility, in which case Bank of America may attempt to collect against us on our guarantee.

In September 2003, we entered into agreements with SurroMed pursuant to which we committed to pay for biomarker discovery services from SurroMed in the amounts of $2.0 million, $2.0 million, $1.0 million and $1.0 million for the years ended December 31, 2004, 2005, 2006 and 2007, respectively, and to serve as a non-exclusive representative to market and sell additional SurroMed biomarker discovery services. In February 2005, we acquired substantially all of SurroMed’s assets related to its biomarker business and terminated these agreements and the associated purchase commitments.

In November 2003, we entered into a collaboration agreement with Syrrx to jointly develop and commercialize Syrrx-designed human dipeptidyl peptidase IV, or DPP IV, inhibitors as drug products for the treatment of type 2 diabetes and other major human diseases. Under the terms of the agreement, we are obligated to provide preclinical and clinical development resources and expertise for the collaboration, and to fund the majority of preclinical and clinical studies through Phase IIb development of selected DPP IV inhibitors. PPD and Syrrx have agreed to share equally the costs of Phase III development. In addition, we agreed to make milestone payments up to an aggregate amount equal to $17.5 million to Syrrx for each collaboration product upon the occurrence of certain clinical and regulatory events. In September 2004, we filed an investigational new drug application for one Syrrx DPP IV inhibitor and the Phase I clinical study for that inhibitor commenced in late October 2004. In the fourth quarter of 2004, we paid Syrrx a milestone payment of $2.5 million as a result of the commencement of the Phase I studies. The remaining milestone payments will be expensed when the event triggering payment of the milestone occurs. In the event we are successful in obtaining approval to market a drug product under the collaboration with Syrrx, Syrrx and PPD will share equally the profits from drug sales. In February 2005, Takeda Pharmaceutical Company Limited announced that it entered into an agreement to acquire 100% of the equity of Syrrx, Inc. We own $25.0 million in preferred stock of Syrrx. If Takeda completes the acquisition of Syrrx, based on the terms of the merger agreement, we do not anticipate realizing a loss on this investment. At this time, we do not know what impact, if any, this acquisition will have on our DPP IV collaboration with Syrrx.

In April 2003, we made an equity investment in Chemokine Therapeutics Corp. In connection with this investment, Chemokine granted us an exclusive option to license a proprietary peptide for a one-time license fee of $1.5 million. If we choose to exercise this option, we will be obligated to pay the one-time license fee plus the costs for future development work on the peptide. Chemokine also granted us the right to first negotiate a license to other peptides. Chemokine completed an initial public offering of its common stock in Canada in December 2004.

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In November 2003, we became a limited partner in A. M. Pappas Life Science Ventures III, LP, a venture capital fund. The Pappas Fund was established for the purpose of making investments in equity securities of privately-held companies in the life sciences, healthcare and technology industries. Under the terms of our agreements with the Pappas Fund, we committed to invest up to an aggregate of approximately $2.5 million in the Pappas Fund. No capital call can exceed 10% of our aggregate capital commitment, and no more than two-thirds of our commitment could be called prior to May 2005. As such, we anticipate that our aggregate investment will be made through a series of future capital calls over the next several years. The first capital call was made in January 2005 at which time we invested $75,000. The second capital call is due in March 2005, at which time we will invest an additional $90,000. Our capital commitment will expire in May 2009.

In January 2005, we acquired approximately 7.5 acres of property located in downtown Wilmington, North Carolina, on which we plan to construct a new headquarters building. The new facility will be approximately 400,000 square feet and is expected to be completed in November 2006. At that time, we will begin consolidating our Wilmington operations into the new building. The total cost for the construction and up-fit of the new building is expected to be in the range of $80.0 million to $100.0 million. The total purchase price for the land was approximately $2.8 million. In connection with the sale of the property, the seller, Almont Shipping Company, refinanced existing liens on the property with the proceeds of an $8.0 million loan from Bank of America, N.A. This loan will mature in January 2006 and is secured by a lien on substantially all of Almont’s assets, including a tract of land containing approximately 30.0 acres adjacent to the 7.5 acre tract we acquired. This loan is also secured by a guarantee from us. Almont’s obligation to reimburse us in the event we are required to pay any sums to Bank of America under the guarantee is also secured by a lien on substantially all of Almont’s assets. As a part of this transaction, Almont granted us an option to purchase all or a portion of the adjacent 30-acre tract of land at an agreed upon price per acre. The option will expire on January 31, 2007.

In February 2005, we acquired a Dassault Falcon 900EX aircraft for $30.5 million. We intend to use the aircraft for corporate purposes. We financed the acquisition from available cash.

In January 2004, we purchased 5.0 million shares of Accentia Biopharmaceuticals, Inc. Series E convertible preferred stock for $5.0 million. We also received a Class A and Class B warrant, each to purchase up to an additional 5.0 million shares of Series E convertible preferred stock for $1.00 per share. In January 2005, we exercised the Class A warrant for the purchase of an additional 5.0 million shares of Series E convertible preferred stock for $5.0 million. The Class B warrant will expire on the earlier of January 7, 2006 or the effective date of a registration statement for the public sale of Accentia common stock in a qualifying initial public offering. In February 2005, Accentia filed a registration statement with the SEC for its proposed initial public offering of its common stock. Accentia proposes to sell in this public offering, in addition to shares for its own account, up to $12.0 million of common stock issuable to us upon conversion of 5.0 million shares of the Series E convertible preferred stock held by us.

The American Jobs Creation Act of 2004 introduced a special one-time dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer. We have not previously recorded a U.S. tax liability on such revenues since we intended to permanently reinvest them in our foreign operations. No provision is being made in 2004 relating to this matter because we are currently evaluating the effect of the new Act on our plan for these previously undistributed foreign earnings. We expect to complete this evaluation by the end of June 2005. The income tax effect of repatriating these earnings is not estimable at this time.

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

We expect to continue expanding our operations through internal growth and strategic acquisitions and investments. We expect these activities will be funded from existing cash, cash flow from operations and, if necessary or appropriate, borrowings under our existing or future credit facilities. We believe that these sources of liquidity will be sufficient to fund our operations for the next 12 months. From time to time, we evaluate potential acquisitions, investments and other growth opportunities that might require additional external financing, and we

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might seek funds from public or private issuances of equity or debt securities. While we believe we have sufficient liquidity to fund our operations for the next 12 months, 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 “Item 1. Business - Factors that Might Affect our Business or Stock Price”, in this Item 7 under the subheadings “Potential Volatility of Quarterly Operating Results and Stock Price” and “Critical Accounting Policies and Estimates,” and under “Item 7A - Quantitative and Qualitative Disclosures about Market Risk”.

Contractual Obligations

As of December 31, 2004, future minimum payments for all contractual obligations for years subsequent to December 31, 2004 are as follows (in thousands):