INTERPACE BIOSCIENCES, INC. - Quarter Report: 2005 June (Form 10-Q)

$643,000 in Lotensin royalties and the remaining amount consisted primarily of approximately $58,000 in product revenue related to the sale of the Xylos product.

     Cost of goods and services for the quarter ended June 30, 2005 was $64.3 million, 7.5% less than cost of goods and services of $69.6 million for the quarter ended June 30, 2004. As a percentage of total net revenue, cost of goods and services increased to 80.8% for the quarter ended June 30, 2005 from 76.1% in the comparable prior year period. Program expenses (i.e., cost of services) associated with the sales services segment for the quarter ended June 30, 2005 were $58.4 million, 10.4% less than program expenses of $65.2 million for the prior year period. As a percentage of sales services segment revenue, program expenses for the quarters ended June 30, 2005 and 2004 were 83.3% and 77.1%, respectively, a reduction of year-over-year gross profit margin of 6.2% . This reduction in gross profit percentage partially resulted from market conditions that lead to increases in field compensation and other field costs. These increases were at higher rates than specified in our contracts, requiring us to absorb the excess, lowering our gross profits. Additionally, cost reduction efforts by our major clients have led to more stringent contract terms resulting in lower gross profit margins. Cost of goods and services associated with the marketing services segment were $5.9 million, a $1.6 million increase over the comparable prior year period. This increase can be attributable to the acquisition of Pharmakon in August of 2004. Excluding Pharmakon, the cost of goods and services decreased in this segment by approximately 6.9% . This decrease can be attributed to fewer projects in the second quarter of 2005 versus the comparable prior year period. Additionally, the gross profit margin has declined compared to the prior year period as a result of the change in the mix of services provided for the quarter ended June 30, 2005. Cost of goods and services associated with the PPG segment were zero and approximately $53,000 for the quarters ended June 30, 2005 and 2004, respectively.

      Compensation expense for the quarter ended June 30, 2005 was $6.5 million, 17.6% less than $7.9 million for the comparable prior year period. This decrease was primarily due to reduced amounts of incentive compensation and reduction in support services headcount. In 2005, we affected these headcount reductions in an attempt to reduce our fixed overhead; we plan to utilize outsourced services to perform these functions so that these components of overhead will be more flexible. As a percentage of total net revenue, compensation expense decreased to 8.2% for the quarter ended June 30, 2005 as compared to 8.7% in the comparable prior year period. Compensation expense for the quarter ended June 30, 2005 attributable to the sales services segment was $4.9 million compared to $5.8 million for the quarter ended June 30, 2004; as a percentage of revenue it increased to 7.0% from 6.8% in the comparable prior year period. Compensation expense for the quarter ended June 30, 2005 attributable to the marketing services segment was $1.7 million, approximately 4.4% or $70,000 more than the comparable prior year period. This increase can be attributed to additional compensation expense associated with our Pharmakon business unit offset by a reduction in the bonus accrual for the current three month period. As a percentage of revenue, compensation expense for the ended of the quarter ended June 30, 2005, decreased to 17.3% from 21.9% in the comparable prior year period, mostly attributable to the reduction in incentive compensation accrual. Compensation expense associated with the PPG segment was zero for the quarter ended June 30, 2005 as compared to $576,000 for the quarter ended June 30, 2004. In the second quarter of 2004, the compensation expense attributed to PPG was primarily related to allocated costs and to employees involved with the deemphasizing of that segment in 2004.

     Total other selling, general and administrative expenses were $5.9 million for the quarter ended June 30, 2005, 4.6% less than other selling, general and administrative expenses of $5.7 million for the quarter ended June 30, 2004. The expenses for the quarter were reduced by a $2.1 million payment that we received as a result of settling the Cellegy litigation matter on April 12, 2005 (See Note 12 for further details). Excluding this settlement payment, the other SG&A expenses were $8.0 million, an increase of $2.3 million compared to the $5.7 million incurred in the second quarter of 2004. A component of this $2.3 million increase was the $0.4 million of Pharmakon expenses which were not present in 2004. Another component was the allowance for credit losses of $750,000 established for the TMX loans. (See Note 5 for further details). The remaining increase was attributable to increased business development expenditures, outsourcing services related to IT support and facility and moving related costs. Outsourcing expenses have increased approximately $0.6 million for the quarter ended June 30, 2005 as compared to the comparable prior year period. Other selling, general and administrative expenses attributable to the sales services segment for the quarter ended June 30, 2005 was $6.3 million which was 8.9% of revenue, compared to other selling, general and administrative expenses for the comparable prior year period of $5.0 million, or 5.9% of revenue. This increase is primarily due to an increase in overhead costs such as facilities costs and outsourcing services. Other selling, general and administrative expenses attributable to the marketing services segment for the

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quarter ended June 30, 2005 were approximately $1.7 million compared to $676,000 for the comparable prior year period; this increase can be attributed to additional expense associated with our Pharmakon business unit, as well as the amortization costs associated with the acquisition. Other selling, general and administrative expenses associated with the PPG segment were a negative $2.1 million. This credit is attributable to the $2.1 million legal settlement we received in the second quarter of 2005 that pertained to the Cellegy litigation matter. For the quarter ended June 30, 2004 the total other selling, general and administrative expenses associated with the PPG segment were approximately $5,000.

Asset impairment

     Due to the migration of our sales force automation software to the Dendrite system, we made a determination during the second quarter of 2005 that our Siebel sales force automation software was impaired and a write-down of the asset was necessary. The amount of the write-down was approximately $2.8 million and was included in operating expense in the sales services segment.

Operating income (loss)

     Operating income for the quarter ended June 30, 2005 was approximately $4,000 compared to operating income of $8.2 million in the comparable prior year period. There was an operating loss of $2.3 million for the quarter ended June 30, 2005 for the sales services segment, $10.9 million less than operating income of $8.6 million for that segment in the comparable prior year period. The loss is attributable to the $2.8 million asset impairment charge mentioned above. The decrease can also be attributed to several factors, including the reduction in the AstraZeneca sales force and lower gross profit margins (as discussed above) in the second quarter of 2005 versus the comparable prior year period. Operating income for the marketing services segment was $228,000 for the quarter ended June 30, 2005 compared to operating income of $685,000 in that segment for the comparable prior year period. As a percentage of revenue, operating income for the marketing services segment was 2.4% for the quarter ended June 30, 2005 as compared to 9.5% for the quarter ended June 30, 2004. The PPG segment had operating income of $2.1 million for the quarter ended June 30, 2005 compared to an operating loss of $1.1 million in the comparable prior year period. The operating income for the quarter ended June 30, 2005 is attributable to the the litigation settlement of $2.1 million. The operating loss for the quarter ended June 30, 2004 was primarily attributable to the increase in the Ceftin reserve.

Other income, net

     Other income, net, for the quarters ended June 30, 2005 and 2004 was $5.1 million and $313,000, respectively. In June of 2005, we sold our ownership interest in In2Focus for approximately $4.4 million, which is the main component of other income for the three months ended June 30, 2005 (See Note 5 for more details on the transaction). The remaining $700,000 was primarily attributable to interest income, which increased over the comparable prior year period primarily due to higher interest rates. The other income for the quarter ended June 30, 2004 consisted primarily of interest income.

Provision for income taxes

     The federal and state corporate income tax expense was approximately $616,000 for the quarter ended June 30, 2005, compared to income tax expense of $3.5 million for the quarter ended June 30, 2004. The effective tax rate for the quarter ended June 30, 2005 was 12.0%, compared to an effective tax rate of 41.0 % for the quarter ended June 30, 2004. This decrease is primarily attributable to the release of a $1.7 million valuation allowance on capital loss carryforwards that we will realize in 2005 as a result of the In2Focus sale. In addition, we recorded a one-time benefit for a $585,000 state tax refund received in the second quarter, which further reduced the effective tax rate for the quarter.

Net income

     Net income for the quarters ended June 30, 2005 and 2004 was approximately $4.5 million and $5.0 million, respectively.

Six Months Ended June 30, 2005 Compared to Six Months Ended June 30, 2004

Revenue

     Revenue for the six months ended June 30, 2005 was $161.6 million, 12.2% less than revenue of $184.0 million for the six months ended June 30, 2004. Revenue from the sales services segment for the six months ended June 30, 2005 was $142.8 million, 15.8% less than revenue of $169.6 million from that segment for the comparable prior year period. This decrease is attributable to the previously announced reduction of the AstraZeneca sales force. This reduction is expected to result in a $60.0 million revenue decrease for all of 2005. The effect of this reduction for

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the six months ended June 30, 2005 was approximately $32.6 million, which was partially offset by a net increase in revenue from other clients of $5.8 million. Revenue for the marketing services segment was $18.8 million for the six months ended June 30, 2005, 51.9% more than the $12.4 million in the comparable prior year period. This increase can be attributable to the revenue generated by Pharmakon for the six month period ended June 30, 2005 (there was no contribution by Pharmakon for the six months ended June 30, 2004 since we acquired Pharmakon in August 2004). Excluding Pharmakon, revenue for the marketing services segment was $10.0 million for the six months ended June 30, 2005, a decrease of 19.2% from the comparable prior year period. This decrease can be attributed to our business development efforts yielding fewer projects in the second quarter of 2005 versus the comparable prior year period. The PPG segment did not have any revenue for the six months ended June 30, 2005 and we do not anticipate any revenue for this segment during the remainder of 2005. Revenue for the PPG segment for the six months ended June 30, 2004 was $2.1 million. This consisted primarily of Lotensin royalties, partially offset by $1.2 million increase in the Ceftin reserve.

     We will be investing in business development and marketing in order to expand and refocus our efforts to capture a greater share of the markets we serve. The full effects of this effort may not be realized until 2006.

Cost of goods and services

     Cost of goods and services for the six months ended June 30, 2005 was $128.3 million, 5.5% less than cost of goods and services of $135.7 million for the six months ended June 30, 2004. As a percentage of total net revenue, cost of goods and services increased to 79.4% for the six months ended June 30, 2005 from 73.7% in the comparable prior year period. Program expenses associated with the sales services segment for the six months ended June 30, 2005 were $116.9 million, 8.7% less than program expenses of $128.1 million for the prior year period. As a percentage of sales services segment revenue, program expenses for the six months ended June 30, 2005 and 2004 were 81.8% and 75.5%, respectively, a reduction of gross profit margin of 6.3% . A significant factor in the reduction in gross profit margin has been the decline in incentive payments from $3.2 million for the first six months of 2004 to $1.1 million for the comparable 2005 period. Another important factor in the reduction in gross profit percentage has been market conditions that lead to increases in field compensation and other field costs. These increases were at higher rates than specified in our contracts, requiring us to absorb the excess, lowering our gross profits. Additionally, cost reduction efforts by our major clients have led to more stringent contract terms resulting in lower gross profit margins. Cost of goods and services associated with the marketing services segment were $11.4 million, a $4.1 million increase over the comparable prior year period. This increase can be attributable to the acquisition of Pharmakon in August 2004. Excluding Pharmakon, the cost of goods and services decreased in this segment by approximately $680,000 or 9.3% . The gross profit margin has declined compared to the prior year period as a result of the change in the mix of services provided. Cost of goods and services associated with the PPG segment were zero and $322,000 for the six months ended June 30, 2005 and 2004, respectively. The cost of goods and services for this segment in 2004 consisted primarily of expenses associated with the selling of the Xylos wound care product which ended May 16, 2004.

Compensation expense

     Compensation expense for the six months ended June 30, 2005 was $15.5 million, 14.3% less than $18.1 million for the comparable prior year period. This decrease was primarily due to reduced amounts of incentive compensation and reduction in support services headcount. In 2005, we effected these headcount reductions in an attempt to reduce our fixed overhead; we plan to utilize outsourced services to perform these functions. Compensation expense for the six months ended June 30, 2005 attributable to the sales services segment was $11.4 million compared to $13.1 million for the six months ended June 30, 2004; as a percentage of revenue it increased to 8.0% for the six month period ended June 30, 2005 from 7.7% in the comparable prior year period. Compensation expense for the six months ended June 30, 2005 attributable to the marketing services segment was $4.1 million, approximately 21.8% for the six month period ended June 30, 2005 more than the comparable prior year period. This increase can be attributed to additional compensation expense associated with our Pharmakon business unit. As a percentage of revenue, compensation expense decreased to 21.8% from 27.2% in the comparable prior year period. This decrease is primarily attributable to the reduction in incentive compensation accrual for this segment. Compensation expense associated with the PPG segment was zero for the six months ended June 30, 2005 as compared to $1.7 million for the six months ended June 30, 2004. A large portion of compensation expense for the six months ended June 20, 2004 in the PPG segment was for severance related activities associated with the deemphasizing of that segment in 2004.

Other selling, general and administrative expenses

     Total other selling, general and administrative expenses were $15.7 million for the six months ended June 30, 2005, 29.5% more than other selling, general and administrative expenses of $12.1 million for the comparable prior

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year period. A component of this $3.6 million increase was the $0.9 million of Pharmakon expenses which were not present in 2004. Another component was the allowance for credit losses of $750,000 established for the TMX loans. (See Note 5 for further details). The remaining increase was attributable to outsourcing services related to IT support, facility and moving related costs, and increased business development expenditures. Outsourcing expenses have increased approximately $0.8 million for the six months ended June 30, 2005 as compared to the comparable prior year period. As a percentage of total net revenue, total other selling, general and administrative expenses increased to 9.7% for the six months ended June 30, 2005 from 6.6% in the comparable prior year period. Other selling, general and administrative expenses attributable to the sales services segment for the six months ended June 30, 2005 was $12.5 million which was 8.8% of revenue, compared to other selling, general and administrative expenses of $10.0 million, or 5.9% of revenue in the comparable prior year period. This increase is primarily due to an increase in overhead costs mentioned above. Other selling, general and administrative expenses attributable to the marketing services segment for the six month period ended June 30, 2005 was approximately $3.0 million compared to $1.4 million for the comparable prior year period; this increase can be attributed to additional expense associated with our Pharmakon business unit, as well as the amortization costs associated with the acquisition. Other selling, general and administrative expenses associated with the PPG segment were $247,000. This consists of the $2.1 million legal settlement offset by the associated legal costs in the Cellegy litigation matter. For the six months ended June 30, 2004 the total other selling, general and administrative expenses associated with the PPG segment were approximately $759,000.

Asset impairment

     Due to the migration of our sales force automation software to the Dendrite system, we made a determination during the second quarter of 2005 that our Siebel sales force automation software was impaired and a write-down of the asset was necessary. The amount of the write-down was approximately $2.8 million and was included in operating expense in the sales services segment.

Operating (loss) income

     There was an operating loss for the six months ended June 30, 2005 of approximately $0.8 million compared to operating income of $18.0 million in the comparable prior year period. This large decrease can be attributed to several factors, including the reduction in the AstraZeneca sales force and lower gross profit margins (as discussed above) in the first six months of 2005 versus the comparable prior year period. There was an operating loss for the six months ended June 30, 2005 for the sales services segment of approximately $0.9 million, $19.3 million less than the operating income of $18.4 million for that segment in the comparable prior year period. Operating income for the marketing services segment was $329,000 for the six months ended June 30, 2005 compared to operating income of $360,000 in that segment for the comparable prior year period. As a percentage of revenue, operating income for the marketing services segment was 1.7% for the six months ended June 30, 2005 as compared to 2.9% for the quarter ended June 30, 2004. The PPG segment had an operating loss of $247,000 for the six months ended June 30, 2005 attributable to Cellegy litigation costs, compared to an operating loss of $683,000 in the comparable prior year period. The operating loss for the six months ended June 30, 2004 was primarily attributable to the increase in the Ceftin reserve.

Other income, net

     Other income, net, for the six months ended June 30, 2005 and 2004 was $5.8 million and $631,000, respectively. In June of 2005, we sold our ownership interest in In2Focus for approximately $4.4 million, which is the main component of other income for the six months ended June 30, 2005 (See Note 5 for more details on the transaction). The remaining $1.4 million was primarily attributable to interest income. The other income for the quarter ended June 30, 2004 consisted primarily of interest income. The increase in interest income was due primarily to the increase in interest rates.

Provision for income taxes

     The federal and state corporate income tax expense was approximately $571,000 for the six months ended June 30, 2005, compared to income tax expense of $7.7 million for the six months ended June 30, 2004. The effective tax rate for the six months ended June 30, 2005 was 11.4%, compared to an effective tax rate of 41.0 % for the six months ended June 30, 2004. This decrease is primarily attributable to the release of a $1.7 million valuation allowance on capital loss carryforwards that we will realize in 2005 as a result of the In2Focus sale. In addition, we recorded a one-time benefit for a $585,000 state tax refund received in the second quarter, which further reduced the effective tax rate for the period.

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Net income

     Net income for the six months ended June 30, 2005 was approximately $4.5 million, compared to net income of approximately $11.0 million for the quarter ended June 30, 2004.

Liquidity and Capital Resources

     As of June 30, 2005, we had cash and cash equivalents and short-term investments of approximately $107.4 million and working capital of $102.1 million, compared to cash and cash equivalents and short-term investments of approximately $109.5 million and working capital of approximately $96.2 million at December 31, 2004.

     For the six months ended June 30, 2005, net cash provided by operating activities was $7.0 million, compared to $12.6 million net cash provided by operating activities for the six months ended June 30, 2004. In addition to net income of $4.5 million for the first six months of 2005, working capital increases, including a decrease in current liabilities of $5.7 million and an increase in current assets of $2.6 million, resulted in additional cash flow from operations. The net changes in the “Other changes in assets and liabilities” section of the consolidated statement of cash flows may fluctuate depending on a number of factors, including the number and size of programs, contract terms and other timing issues; these variations may change in size and direction with each reporting period. Non-cash net charges include $2.9 million in depreciation and amortization, $3.1 million in loss on disposal of assets and $3.4 million for deferred taxes.

     As of June 30, 2005, we had $5.4 million of unbilled costs and accrued profits on contracts in progress. When services are performed in advance of billing, the value of such services is recorded as unbilled costs and accrued profits on contracts in progress. Normally all unbilled costs and accrued profits are earned and billed within 12 months from the end of the respective period. As of June 30, 2005, we had $12.8 million of unearned contract revenue. When we bill clients for services before they have been completed, billed amounts are recorded as unearned contract revenue, and are recorded as income when earned.

     For the six months ended June 30, 2005, net cash provided by investing activities was $13.7 million as compared to $48.7 million used in investing activities for the comparable period. We received approximately $17.9 million from the sale of a portion of our laddered portfolio of investment grade debt instruments as compared to the purchase of investments in the prior year period. Our portfolio is composed of the U.S. Treasury and U.S. Federal Government agencies, municipal bonds, and commercial paper. We are focused on preserving capital, maintaining liquidity, and maximizing returns in accordance with our investment criteria. We incurred approximately $4.1 million of capital expenditures of primarily associated with the relocation of our offices within the Marketing Services group. Capital expenditures for the six months ended June 30, 2004 were $5.0 million. For both periods, all capital expenditures were funded out of available cash.

     On August 31, 2004, we acquired substantially all of the assets of Pharmakon, LLC in a transaction treated as an asset acquisition for tax purposes. The acquisition has been accounted for as a purchase, subject to the provisions SFAS No. 141. We made payments to the members of Pharmakon, LLC on August 31, 2004 of $27.4 million, of which $1.5 million was deposited into an escrow account, and assumed approximately $2.6 million in net liabilities. As of June 30, 2005 we still hold $500,000 in the escrow account which is recorded in other assets on our balance sheet and will be paid out during 2006, subject to certain working capital adjustments. Approximately $1.1 million in direct costs of the acquisition were also capitalized. Based upon the attainment of annual profit targets agreed upon at the date of acquisition, the members of Pharmakon, LLC received approximately $1.4 million in additional payments on April 1, 2005 for the year ended December 31, 2004. Additionally, the members of Pharmakon, LLC can still earn up to an additional $6.7 million in cash based upon achievement of certain annual profit targets through December 2006. In connection with this transaction, we have recorded $12.6 million in goodwill and $18.9 million in other identifiable intangibles.

     For the six months ended June 30, 2005, net cash used in financing activities was approximately $5.0 million. Approximately $6.2 million was used in the repurchasing of shares on the open market. This was partially offset by proceeds from the exercise of stock options and the issuance of shares under the employee stock purchase plan of $1.2 million.

     On April 27, 2005, our Board of Directors authorized us to repurchase up to one million shares of our common stock. On July 6, we announced that our Board of Directors had authorized the repurchase of additional one million shares. As of June 30, 2005 we had repurchased approximately 580,000 shares and made cash payments of approximately $6.2 million. We intend to continue to repurchase shares on the open market or in privately negotiated transactions or both. Some or all of the repurchases will be made pursuant to a Company 10(b)5-1 Plan. All purchases will be made from our available cash. A reconciliation of the number of shares repurchased as of June 30, 2005 is as follows:

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		Average Price			Shares
Period		Per Share			Purchased
October 2001		$	22.00		5,000
May 2005		$	12.36		226,900
June 2005		$	11.92		353,330
Total		$	12.17		585,230

     Our revenue and profitability depend to a great extent on our relationships with a limited number of large pharmaceutical companies. For the six months June 30, 2005, we had three major clients that accounted for approximately 30.5%, 20.6% and 15.2%, respectively, or a total of 66.3% of our service revenue. We are likely to continue to experience a high degree of client concentration, particularly if there is further consolidation within the pharmaceutical industry. The loss or a significant reduction of business from any of our major clients, or a decrease in demand for our services, could have a material adverse effect on our business, financial condition and results of operations. For example, in December 2004, we announced a reduction in the aggregate number of representatives that we deployed for AstraZeneca. This reduction is expected to decrease revenue generated from AstraZeneca in 2005 by approximately $60.0 million versus revenues generated in 2004.

     On June 21, we signed an agreement to sublease our first floor, approximately 16,000 square feet. The sublease was for a five-year term commencing on July 15 and will provide approximately $2 million in lease payments over the five year period. The table below summarizes our lease payment obligations for the next five years. While we will receive cash payments for the sub-lease beginning in August of 2005, the cash received from the sub-lease will be entirely offset by the broker’s fee in 2005.

(in thousands)	2005			2006			2007			2008			2009			Total
Operating leases
Minimum lease payments	$	3,814		$	3,119		$	3,044		$	3,125		$	3,283		$	16,385
Less minimum sublease rentals		-			(400	)		(400	)		(400	)		(400	)		(1,600	)
Net minimum lease payments	$	3,814		$	2,719		$	2,644		$	2,725		$	2,883		$	14,785

     We believe that our existing cash balances and expected cash flows generated from operations will be sufficient to meet our operating and capital requirements for the next 12 months. We continue to evaluate and review financing opportunities and acquisition candidates in the ordinary course of business.

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Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures

     An evaluation as of June 30, 2005 was carried out under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that those disclosure controls and procedures were adequate to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

Changes in internal controls

     There has been no change in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarter covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Securities Litigation

     In January and February 2002, we, our chief executive officer, and our chief financial officer, were served with three complaints that were filed in the United States District Court for the District of New Jersey alleging violations of the Exchange Act. These complaints were brought as purported shareholder class actions under Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 established thereunder. On May 23, 2002, the court consolidated all three lawsuits into a single action entitled In re PDI Securities Litigation, Master File No. 02-CV-0211, and appointed Lead Plaintiffs and Lead Plaintiffs’ counsel. On or about December 13, 2002, Lead Plaintiffs filed the Second Consolidated and Amended Complaint, which superseded their earlier complaints.

     The Second Consolidated and Amended Complaint names us, our chief executive officer and our chief financial officer as defendants; purports to state claims against us on behalf of all persons who purchased our common stock between May 22, 2001 and August 12, 2002; and seeks money damages in unspecified amounts and litigation expenses including attorneys’ and experts’ fees. The essence of the allegations in the Second Consolidated and Amended Complaint is that we intentionally or recklessly made false or misleading public statements and omissions concerning our financial condition and prospects with respect to our marketing of Ceftin in connection with the October 2000 distribution agreement with GSK, our marketing of Lotensin in connection with the May 2001 distribution agreement with Novartis, as well as our marketing of Evista in connection with the October 2001 distribution agreement with Eli Lilly and Company.

     In February 2003, we filed a motion to dismiss the Second Consolidated and Amended Complaint under the Private Securities Litigation Reform Act of 1995 and Rules 9(b) and 12(b)(6) of the Federal Rules of Civil Procedure. That motion is fully submitted to the court for its decision. We believe that the allegations in this purported securities class action are without merit and we intend to defend the action vigorously.

Bayer-Baycol Litigation

     We have been named as a defendant in numerous lawsuits, including two class action matters, alleging claims arising from the use of Baycol, a prescription cholesterol-lowering medication. Baycol was distributed, promoted and sold by Bayer in the U.S. through early August 2001, at which time Bayer voluntarily withdrew Baycol from the U.S. market. Bayer retained certain companies, such as us, to provide detailing services on its behalf pursuant to contract sales force agreements. We may be named in additional similar lawsuits. To date, we have defended these actions vigorously and have asserted a contractual right of defense and indemnification against Bayer for all costs and expenses we incur relating to these proceedings. In February 2003, we entered into a joint defense and indemnification agreement with Bayer, pursuant to which Bayer has agreed to assume substantially all of our defense costs in pending and prospective proceedings and to indemnify us in these lawsuits, subject to certain limited exceptions. Further, Bayer agreed to reimburse us for all reasonable costs and expenses incurred to date in defending these proceedings. In 2002 and 2003, Bayer reimbursed us for approximately $1.6 million in legal expenses.

Cellegy Pharmaceuticals Litigation

     On December 12, 2003, we filed a complaint against Cellegy in the U.S. District Court for the Southern District of New York. The complaint alleges that Cellegy fraudulently induced us to enter into the Cellegy License Agreement. The complaint also alleges claims for misrepresentation and breach of contract related to the Cellegy License Agreement. In the complaint, we seek, among other things, rescission of the Cellegy License Agreement and return of the $15.0 million we paid Cellegy. After we filed this lawsuit, also on December 12, 2003, Cellegy filed a complaint against us in the U.S. District Court for the Northern District of California. Cellegy’s complaint seeks a declaration that Cellegy did not fraudulently induce us to enter the Cellegy License Agreement and that Cellegy has not breached its obligations under the Cellegy License Agreement. We filed an answer to Cellegy’s complaint on June 18, 2004, in which we make the same allegations and claims for relief as we do in our New York action, and we also allege Cellegy violated California unfair competition law. By order dated April 23, 2004 our lawsuit was transferred to the Northern District of California where it may be consolidated with Cellegy’s action.

     On April 12, 2005, we announced that we had settled the lawsuit against Cellegy, which terminated the Cellegy License Agreement. We will have no further financial obligations to Cellegy and all Fortigel product rights will be returned to Cellegy. The settlement agreement provided that Cellegy pay us $2 million upon signing the settlement agreement. This payment was received on April 12, 2005.

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     Cellegy also issued to us a secured promissory note for $3 million, payable in 18 months, with mandatory earlier payments of amounts owed under this note coming from 50% of funds received by Cellegy as royalties, licensing fees and milestone payments from agreements or arrangements related to Cellegy’s Tostrex and Rectogesic products in territories outside of North America, 50% of upfront license fees and/or milestones from Fortigel licenses in North American markets, and 10% of proceeds received by Cellegy in excess of $5 million from any financings by Cellegy, except stock or option transactions for the benefit of Cellegy management, key employees or directors. These payments will be made until the amount of the note is paid in full. Cellegy’s obligations under this note are secured by a first priority security interest in favor of us in Cellegy’s interests in the payments described above and any proceeds therefrom (and certain related collateral). Amounts owed under the note may be accelerated upon an event of default, which include (but are not limited to) certain kinds of bankruptcy filings by Cellegy or certain related actions or proceedings, an uncured material breach of Cellegy’s obligations under the note, the security interest no longer being a valid, perfected, first priority security interest, and a default in indebtedness of Cellegy with an aggregate principal amount in excess of $2 million that results in the maturity of such indebtedness being accelerated before its stated maturity. Interest accrues at a rate of 12% per annum during any period that Cellegy is in default of its obligations under the secured promissory note.

     On May 18, 2005, we received a $100,000 payment from Cellegy under the secured promissory note in connection with proceeds received by Cellegy from a private placement.

     Also as part of the settlement agreement, Cellegy issued to us a senior convertible note with a principal amount of $3.5 million, which is due April 11, 2008. Cellegy may redeem this note from us at any time for $3.5 million. If Cellegy gives us notice that it is going to redeem the note, we may convert the note into shares of Cellegy common stock at a price of $1.65 per share after 18 months from the date of settlement. As long as amounts are owed under the note, Cellegy has agreed not to incur or become responsible for any indebtedness that ranks contractually senior or equal in right of payment to amounts outstanding under the note. Events of default under the senior note are generally similar to events of default under the secured note. Interest accrues at a rate of 12% per annum during any period that Cellegy is in default of its obligations under the senior convertible note.

Other Legal Proceedings

     We are currently a party to other legal proceedings incidental to our business. While management currently believes that the ultimate outcome of these proceedings, individually and in the aggregate, will not have a material adverse effect on our consolidated financial statements, litigation is subject to inherent uncertainties. Were we to settle a proceeding for a material amount or were an unfavorable ruling to occur, there exists the possibility of a material adverse effect on our business, financial condition and results of operations.

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

     On June 7, 2005, the Company held its 2005 Annual Meeting of Stockholders. At the meeting Larry Ellberger, John Federspiel, and Jan Martens Vesci were reelected as Class III Directors of the Company for three year terms with 13,402,817, 13,522,245 and 13,481,711 votes cast in favor of their election, respectively. In addition, the appointment of Ernst & Young LLP as independent auditors of the Company for fiscal 2005 was ratified with 13,626,191 votes in favor, 64,919 votes against and 1,498 votes withheld.

Item 6. Exhibits

Exhibit Index is included after signatures. New exhibits, listed as follows, are attached:

Exhibit No.		Description
31.1		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith as Exhibit 31.1.
31.2		Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith as Exhibit 31.2.
32.1		Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith as Exhibit 32.1.
32.2		Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith as Exhibit 32.2.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date: August 8, 2005		PDI, INC.
		(Registrant)
		By: /s/ Charles T. Saldarini
		Charles T. Saldarini
		Vice Chairman of the Board of Directors
		and Chief Executive Officer
		By: /s/ Bernard C. Boyle
		Bernard C. Boyle
		Chief Financial and Accounting Officer

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