3. Recent US Accounting Pronouncements a. In September 2006, the FASB issued Statement of Financial Accounting Standards (SFAS) # 157, "Fair Value Measurements". SFAS 157 provides guidance for using fair value to measure assets and liabilities. It also responds to investors' requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. SFAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value, and does not expand the use of fair value in any new circumstances. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and is required to be adopted by the Company in the first quarter of fiscal 2009. The Company is currently evaluating the effect that the adoption of SFAS 157 will have on its consolidated results of operations and financial condition and is not yet in a position to determine such effects. b. In February 2007, the FASB issued SFAS # 159, "The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of FASB Statement # 115". This Statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The Company is required to adopt the provisions of SFAS 159 effective for its 2009 fiscal year and is currently evaluating the effect that the adoption of SFAS 159 will have on its consolidated results of operations and financial condition and is not yet in a position to determine such effects. c. In December 2007, the FASB issued SFAS # 141R, "Business Combinations" a substantial amendment to SFAS 141. The objective of this Statement is to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial reports about a business combination and its effects. To accomplish that, this statement establishes principles and requirements for how the acquirer: a) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree; b) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and c) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The Company is required to adopt the provisions of SFAS 141R effective for acquisitions occurring after October 31, 2009. d. In December 2007, the FASB issued SFAS # 160, "Non-controlling Interests in Consolidated Financial Statements- an Amendment of ARB # 51". The objective of this Statement is to improve the relevance, comparability, and transparency of the financial information that a reporting entity provides in its consolidated financial statements related to the non-controlling interest held by others in entities that are consolidated by the reporting entity. MDS does not consolidate entities with material non-controlling interests and the provisions of SFAS 160 are not expected to have a material impact on its consolidated results of operations and financial condition. 4. Acquisitions a. Acquisition of Molecular Devices Corporation On March 20, 2007, MDS completed a tender offer which resulted in the Company acquiring all of the outstanding shares of Molecular Devices Corporation (MD), a leading provider of high-performance measurement tools for high content screening, cellular analysis and biochemical testing. MD is principally involved in the design, development, manufacture, sale and service of bioanalytical measurement systems that accelerate and improve drug discovery and other life sciences research. The Company acquired MD primarily to add their leading-edge products to those of MDS Sciex and to strengthen the Company's position as one of the top global providers of analytical instrumentation and related products marketed to life sciences customers. The operations for this acquisition are reported within the results of the Company's MDS Analytical Technologies segment (which combines MD with the previous analytical instruments segment) in the consolidated financial statements from the date of acquisition. The aggregate purchase consideration (net of cash acquired of $21 million) was approximately $600 million, paid in cash from existing cash on hand. Included in the consideration is $27 million cash cost to buy back outstanding in-the-money options of MD at the closing date of acquisition. Direct and incremental third party acquisition costs associated with the acquisition and included in the aggregate purchase consideration were approximately $7 million. The acquisition has been accounted for as a purchase in accordance with SFAS # 141, and the Company has accordingly allocated the purchase price of the acquisition based upon the preliminary estimate of the fair values of the assets acquired and liabilities assumed, pending completion of a comprehensive valuation with mainly the valuation of brands to be finalized. The purchase price and related allocations will be finalized in the second quarter of fiscal 2008. b. Other acquisition In December 2007, MDS acquired 100% of the stock of a small company that is in the process of developing a complimentary product to our MDS Analytical Technologies product portfolio. Consideration for the transaction was $2 million net of cash acquired, plus an additional $2 million in cash payments expected in 2008 which have been placed in escrow according to the agreement. The additional $2 million payment included in prepaid expenses and other is contingent on the retention of certain key employees and the completed validation of the functionality and technical specification of prototypes of the product acquired. The purchase price and related allocations have not been finalized and may be revised as a result of adjustments made to the purchase price, additional information regarding liabilities assumed, and revisions of preliminary estimates of fair values made at the date of purchase. In connection with the fair valuing of the assets acquired and liabilities assumed, MDS, assisted by a valuation consultant firm, performed assessments of intangible assets using customary valuation procedures and techniques. A preliminary value of $1 million was assigned to in-process research and development which has been expensed accordingly. c. Pro forma information (unaudited) The following unaudited pro forma information is provided for MDS assuming the acquisition of MDC occurred on November 1, 2006. Three months ending January 31 ------------------------------------------------------------------------- 2008 2007 ------------------------------------------------------------------------- Net revenues $ 322 $ 315 ------------------------------------------------------------------------- Income from continuing operations, net of income taxes 17 (3) Income from discontinued operations, net of income taxes - 16 ------------------------------------------------------------------------- Net income 17 13 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Earnings per share Basic $ 0.14 $ 0.09 Diluted $ 0.14 $ 0.09 ------------------------------------------------------------------------- ------------------------------------------------------------------------- The information presented above is for illustrative purposes only and is not indicative of the results that would have been achieved had the acquisition taken place as of the beginning of the earliest period presented. The unaudited pro forma information reflects interest on the purchase price calculated at the Company's short-term investments rates for the period prior to the acquisition date for the respective periods. 5. Discontinued Operations and Assets Held for Sale In November 2007, the Company signed an agreement to sell its external beam therapy and self-contained irradiator product lines. Under the terms of this agreement, Best Medical International Inc., a provider of radiotherapy and oncology products, will purchase MDS Nordion's external beam therapy and self-contained irradiator product lines for $15 million cash. Best Medical International Inc. will acquire these two product lines, which have combined annualized revenues of approximately $32 million and approximately 150 employees. The transaction, which is subject to the usual closing conditions, is expected to close in the second quarter of 2008. Once the Company made the decision, the Company followed the guidance of SFAS # 144 "Accounting for the Impairment or Disposal of Long-lived Assets" and recorded a loss on sale of this business in the amount of $4 million. The related assets have been reclassified as assets held for sale as of the first quarter of 2008. In October 2006, the Company signed an agreement to sell its Canadian laboratory services business, MDS Diagnostic Services in a C$1.325 billion transaction. The sale of MDS Diagnostic Services closed in February 2007. This strategic sale was designed to shift the Company's business focus to the global life sciences market. The results of discontinued MDS Diagnostic Services operations in the first quarter were as follows (no activity in 2008): Three months ended January 31 ------------------------------------------------------------------------- 2007 ------------------------------------------------------------------------- Net revenues $ 75 Cost of revenues (46) Selling, general and administration (8) ------------------------------------------------------------------------- Operating income 21 Income taxes (3) Minority interest (3) Equity earnings 1 ------------------------------------------------------------------------- Income from discontinued operations 16 ------------------------------------------------------------------------- Basic EPS from discontinued operations $ 0.11 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Assets held for sale and liabilities related to assets held for sale comprised: As at As at January 31 October 31 ------------------------------------------------------------------------- 2008 2007 ------------------------------------------------------------------------- Assets held for sale Accounts receivable, net $ 4 $ - Inventories, net 19 - Property, plant and equipment, net 4 - Long-term investments and other 1 1 Goodwill 1 - ------------------------------------------------------------------------- Total assets held for sale $ 29 $ 1 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Liabilities related to assets held for sale Accounts payable and accrued liabilities $ 11 $ - Deferred revenue 3 - ------------------------------------------------------------------------- Total liabilities related to assets held for sale $ 14 $ - ------------------------------------------------------------------------- ------------------------------------------------------------------------- 6. Inventories As at As at January 31 October 31 ------------------------------------------------------------------------- 2008 2007 ------------------------------------------------------------------------- Raw materials and supplies $ 68 $ 83 Work-in process 27 34 Finished goods 27 26 ------------------------------------------------------------------------- 122 143 Allowance for excess and obsolete inventory (14) (15) ------------------------------------------------------------------------- Inventory, net $ 108 $ 128 ------------------------------------------------------------------------- ------------------------------------------------------------------------- 7. Long-Term Investments and Other As at As at January 31 October 31 ------------------------------------------------------------------------- 2008 2007 ------------------------------------------------------------------------- Financial instrument pledged as security on long-term debt $ 44 $ 46 Long-term notes receivable 119 125 Equity investments 10 10 Equity investments in joint ventures 25 38 Available for sale investments 18 24 Deferred pension assets 40 39 Other long-term investments 9 4 Venture capital investments 2 4 ------------------------------------------------------------------------- Long-term investments and other $ 267 $ 290 ------------------------------------------------------------------------- ------------------------------------------------------------------------- a. Fair value The financial instrument pledged as security on long-term debt, which is classified as held to maturity, and the long-term notes receivable, have fair values that approximate their carrying value. Other long-term investments, excluding those classified as available for sale, are recorded at cost. Included with available for sale investments is an investment in asset backed commercial paper (ABCP) of $15 million net of a $2 million provision. MDS provided $2 million against the investment in 2007 to reflect the conditions in the ABCP market. As there have been no significant developments with regard to this investment, MDS believes the current provision is adequate. b. Long-term notes receivable In 2006, as a result of a comprehensive mediation process that resulted in an exchange of assets between the Company and AECL related to the MAPLE reactor project, a long-term note receivable for $38 million was received by the Company. This non-interest bearing note receivable is repayable over four years commencing in 2008. The note receivable is net of an unamortized discount based on an imputed interest rate of 4.5%. The note receivable will be accreted up to its face amount of C$53 million over a period of four years. Long-term notes receivable also include amounts due related to the sale of MDS Diagnostic Services. c. Equity investments As at As at January 31 October 31 ------------------------------------------------------------------------- 2008 2007 ------------------------------------------------------------------------- Lumira Capital Corp 10 10 MDS Sciex joint ventures 25 38 ------------------------------------------------------------------------- Equity investments $ 35 $ 48 ------------------------------------------------------------------------- ------------------------------------------------------------------------- The Company owns 45.7% of the outstanding share capital of Lumira Capital Corp. (Lumira - formerly MDS Capital Corp.). Lumira is an investment fund management company that also has long-term investments in development- stage enterprises that have not yet earned significant revenues from their intended business activities or established their commercial viability. The recovery of invested amounts and the realization of investment returns is dependent upon the successful resolution of scientific, regulatory, competitive, political and other risk factors, as well as the eventual commercial success of these enterprises. These investments are subject to measurement uncertainty, and adverse developments could result in further write-downs of the carrying values. In 2007, the Company wrote down this investment to its estimated fair value and recorded a provision of $6 million in other expense. 8. Restructuring Charges An analysis of the activity in the provision through January 31, 2008 is as follows: Cumulative drawdowns Provision Cumulative --------------------- Balance at Restructuring January 31, Charge Cash Non-cash 2008 ------------------------------------------------------------------------- 2005: Workforce reductions $ 34 $ (33) $ (1) $ - Equipment and other asset write-downs 7 - (7) - Contract cancellation charges 10 (2) (8) - ------------------------------------------------------------------------- $ 51 $ (35) $ (16) $ - ------------------------------------------------------------------------- 2006: Workforce reductions $ 1 $ (1) $ - $ - Contract cancellation charges (8) (1) 9 - ------------------------------------------------------------------------- $ (7) $ (2) $ 9 $ - ------------------------------------------------------------------------- 2007: Workforce reductions $ 17 $ (15) $ - $ 2 Equipment and other asset write-downs 2 - - 2 Contract cancellation charges 5 (5) - - Other 13 (9) (2) 2 ------------------------------------------------------------------------- $ 37 $ (29) $ (2) $ 6 ------------------------------------------------------------------------- $ 6 ------------------------------------------------------------------------- ------------------------------------------------------------------------- In the first quarter of 2008 cash drawdowns were $7 million and non-cash drawdowns were $1 million. The remaining balance primarily relates to the MDS Pharma Services segment. 9. Earnings Per Share a) Dilution Three months ended January 31 ------------------------------------------------------------------------- (number of shares in millions) 2008 2007 ------------------------------------------------------------------------- Weighted average number of Common shares outstanding - basic 123 145 Impact of shares repurchased during the period - - ------------------------------------------------------------------------- Impact of stock options assumed exercised - - ------------------------------------------------------------------------- Weighted average number of Common shares outstanding - diluted 123 145 ------------------------------------------------------------------------- ------------------------------------------------------------------------- b) Pro forma Impact of stock-based compensation Companies are required to calculate and disclose, in the notes to the consolidated financial statements, compensation expense related to the grant-date fair value of stock options for all grants of options for which no expense has been recorded in the consolidated statements of operations. For the Company, this includes those stock options issued prior to November 1, 2003. For purposes of these pro forma disclosures, the Company's net income and basic and diluted earnings per share would have been: Three months ended January 31 ------------------------------------------------------------------------- Restated See Note 2 2008 2007 ------------------------------------------------------------------------- Net income $ 17 $ 16 Compensation expense for options granted prior to November 1, 2003 - - ------------------------------------------------------------------------- Net income - pro forma $ 17 $ 16 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Pro forma basic earnings per share $ 0.14 $ 0.11 Pro forma diluted earnings per share $ 0.14 $ 0.11 ------------------------------------------------------------------------- ------------------------------------------------------------------------- 10. Share Capital At January 31, 2008, the authorized share capital of the Company consists of unlimited Common shares. The Common shares are voting and are entitled to dividends if, as and when declared by the Board of Directors. The following table summarizes information on share capital and stock options and related matters as at January 31, 2008: (number of shares in thousands) Number Amount ------------------------------------------------------------------------- Common shares Balance as at October 31, 2007 122,578 $ 493 Issued during the period 33 - Repurchased during the period (252) (1) ------------------------------------------------------------------------- Balance as at January 31, 2008 122,359 $ 492 ------------------------------------------------------------------------- ------------------------------------------------------------------------- During the quarter, the Company repurchased and cancelled 252,400 Common shares under a normal course issuer bid for a cost of $4.5 million. Of the total cost, $1 million was charged to share capital, $0.5 million was charged to other comprehensive income and $3 million was charged to retained earnings. 11. Stock-based Compensation Average C$ options Exercise (number of stock options in thousands) Number Price ------------------------------------------------------------------------- Stock options Balance as at October 31, 2007 5,555 $ 19.66 Activity during the period: Granted 9 19.58 Exercised (33) 15.77 Cancelled or forfeited (56) 21.55 ------------------------------------------------------------------------- Balance as at January 31, 2008 5,475 $ 19.67 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Average US$ options Exercise (number of stock options in thousands) Number Price ------------------------------------------------------------------------- Stock options Balance as at October 31, 2007 - $ - Activity during the period: Granted 2 18.78 Exercised - - Cancelled or forfeited - - ------------------------------------------------------------------------- Balance as at January 31, 2008 2 $ 18.78 ------------------------------------------------------------------------- ------------------------------------------------------------------------- During the quarter, the Company granted 9,000 C$ options and 2,000 US$ options (2007 - 59,000 and nil) at an average exercise price of C$19.58 and US$ 18.78 respectively (2007 - C$20.71 and US$ nil). These options have a fair value determined using the Black-Scholes model of C$4.87 and US$4.67 per share respectively (2007 - C$4.40 and US$ nil) based on the following: C$ options 2008 2007 ------------------------------------------------------------------------- Risk-free interest rate 4.0 % 4.0 % Expected dividend yield 0.0 % 0.0 % Expected volatility 0.21 0.22 Expected time to exercise (years) 4.40 3.25 ------------------------------------------------------------------------- ------------------------------------------------------------------------- US$ options 2008 2007 ------------------------------------------------------------------------- Risk-free interest rate 3.0 % - % Expected dividend yield 0.0 % - % Expected volatility 0.22 - Expected time to exercise (years) 4.40 - ------------------------------------------------------------------------- ------------------------------------------------------------------------- The stock compensation expense for the three months ended January 31, 2008 was $1 million (2007 - $1 million). Incentive Plans The Company has been utilizing mid-term incentive plans (MTIP) since 2005. The 2006 MTIP will vest in two equal tranches, based on achieving specified share price hurdles. The term of the PSUs is three years and payout will occur at the later of 24 months from the date of grant and achievement of each share price hurdle. Payout on certain PSUs will be in the form of Deferred Share Units (DSUs) and the balance will be paid in cash. During 2006, the price hurdle was met and 50% of the issued units vested. A payment of $3 million was made related to these vested units in November 2007. The 2007 MTIP will vest in two equal tranches, based on achieving specified share price hurdles of C$25.30 and C$27.50, respectively. The term of the PSUs is three years and payout will occur at the later of 24 months from the date of grant and achievement of each share price hurdle. The 2008 MTIP will vest on December 15, 2010 and the number of PSUs granted will be determined based on achieving a target rate for 2010 cash earnings per share. The final number of vested units can range from 0% to 200% of the number of PSUs granted. Payout will occur not later than 60 days following the vesting date. The Company records the cost of its mid-term incentive compensation plans at fair value based on assumptions that are consistent with those used to determine the fair value of stock compensation. The table below shows the liability and expense related to the plans: As at As at January October Liability 31, 2008 31, 2007 ------------------------------------------------------------------------- 2006 Plan $ 3 $ 11 2007 Plan 1 3 2008 Plan 1 - ------------------------------------------------------------------------- Total $ 5 $ 14 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Three months ended January 31 ------------------------------------------------------------------------- (Income)Expense 2008 2007 ------------------------------------------------------------------------- 2006 Plan $ (5) $ (1) 2007 Plan (2) - 2008 Plan 1 - ------------------------------------------------------------------------- Total $ (6) $ (1) ------------------------------------------------------------------------- ------------------------------------------------------------------------- 12. Accumulated Other Comprehensive Income As at As at January October 31, 2008 31, 2007 ------------------------------------------------------------------------- Accumulated other comprehensive income, net of income taxes, beginning of period $ 490 $ 366 Foreign currency translation (74) 112 Unrealized gain on available-for-sale assets, net of tax 1 - Unrealized (loss) gain on derivatives designated as cash flow hedges, net of tax (4) 1 Adoption of FAS 158 - 11 Repurchase and cancellation of Common shares (1) - ------------------------------------------------------------------------- Accumulated other comprehensive income, net of income taxes, end of period $ 412 $ 490 ------------------------------------------------------------------------- ------------------------------------------------------------------------- 13. Other Income (Expense) - Net Three months ended January 31 ------------------------------------------------------------------------- 2008 2007 ------------------------------------------------------------------------- Loss on sale of business $ (4) $ - Gain on sale of investment 2 2 Foreign exchange gain 4 3 Loss on embedded derivatives (4) - Other (2) (1) ------------------------------------------------------------------------- Other income (expense) - net $ (4) $ 4 ------------------------------------------------------------------------- ------------------------------------------------------------------------- 14. Employee Benefit Plan The Company sponsors various post-employment benefit plans including defined benefit and contribution pension plans, retirement compensation arrangements, and plans that provide extended health care coverage to retired employees. All defined benefit pension plans sponsored by the Company are funded plans. Other post-employment benefits are unfunded. During 2005, the Company amended the terms of certain post-employment plans such that effective January 1, 2008, and subject to certain transitional conditions, newly retired employees will no longer be entitled to extended health care benefits. The following table represents the net periodic benefit cost of defined benefit pension plans. The cost of other post-employment benefit plans was nil in the first quarter of 2008 and 2007. Three months ended January 31 ------------------------------------------------------------------------- 2008 2007 ------------------------------------------------------------------------- Service cost $ 1 $ 1 Interest cost 3 2 Expected return on plan assets (4) (3) ------------------------------------------------------------------------- Net periodic benefit cost (credit) $ - $ - ------------------------------------------------------------------------- ------------------------------------------------------------------------- 15. Supplementary Cash Flow Information Non-cash items affecting net income comprise: Three months ended January 31 ------------------------------------------------------------------------- 2008 2007 ------------------------------------------------------------------------- Depreciation and amortization $ 27 $ 14 Stock option compensation 1 1 Deferred revenue (1) (2) Deferred income taxes (12) 16 Loss on sale of business 4 - Gain on investment (2) (2) Mark-to-market on derivatives 4 - Dividend from joint ventures, net of equity earnings 12 - Other (3) 1 ------------------------------------------------------------------------- $ 30 $ 28 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Changes in non-cash working capital balances relating to operations include: Three months ended January 31 ------------------------------------------------------------------------- 2008 2007 ------------------------------------------------------------------------- Accounts receivable $ 7 $ 13 Unbilled revenue (6) (16) Inventories 1 (4) Prepaid expenses and other (12) (24) Accounts payable and deferred revenue (67) (14) Income taxes (27) 12 ------------------------------------------------------------------------- $ (104) $ (33) ------------------------------------------------------------------------- ------------------------------------------------------------------------- 16. Segment Information In accordance with SFAS No 131, "Disclosures About Segments of an Enterprise and Related Information", the Company operates within three business segments - pharmaceutical services, isotopes and analytical technologies. These segments are organized predominantly around the products and services provided to customers identified for the businesses. Three months to January 31, 2008 ------------------------------------------------------------------------- MDS MDS Analytical Pharma MDS Technol- Corporate Services Nordion ogies and Other Total ------------------------------------------------------------------------- Product revenues $ - $ 59 $ 92 $ - $ 151 Service revenues 120 1 24 - 145 Reimbursement revenues 26 - - - 26 ------------------------------------------------------------------------- Total revenues 146 60 116 - 322 Direct product cost - (34) (61) - (95) Direct service costs (88) - (4) - (92) Reimbursed expenses (26) - - - (26) Selling, general and administration (29) (11) (19) (5) (64) Research and development - - (20) - (20) Depreciation and amortization (9) (3) (15) - (27) Other income (expense) - net 5 (8) (2) 1 (4) Equity earnings - - 14 - 14 ------------------------------------------------------------------------- Segment earnings (loss) $ (1) $ 4 $ 9 $ (4) $ 8 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Total assets $ 805 $ 723 $ 854 $ 347 $ 2,729 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Capital expenditures $ 6 $ 3 $ 2 $ 2 $ 13 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Total assets for 2008 and 2007 exclude assets held for sale. Three months to January 31, 2007 ------------------------------------------------------------------------- MDS MDS Analytical Pharma MDS Techno- Corporate Services Nordion logies and Other Total ------------------------------------------------------------------------- Product revenues $ - $ 67 $ 38 $ - $ 105 Service revenues 121 0 15 - 136 Reimbursement revenues 23 - - - 23 ------------------------------------------------------------------------- Total revenues 144 67 53 - 264 Direct product cost - (34) (37) - (71) Direct service costs (89) (1) - - (90) Reimbursed expenses (23) - - - (23) Selling, general and administration (33) (11) (6) (4) (54) Research and development - (1) (11) - (12) Depreciation and amortization (8) (3) (3) - (14) Restructuring charges - net (8) - - (5) (13) Other income (expense) - net 2 - (1) 3 4 Equity earnings - - 14 - 14 ------------------------------------------------------------------------- Segment earnings (loss) $ (15) $ 17 $ 9 $ (6) $ 5 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Total assets $ 846 $ 604 $ 125 $ 491 $ 2,066 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Capital expenditures $ 2 $ 1 $ 3 $ 3 $ 9 ------------------------------------------------------------------------- ------------------------------------------------------------------------- In segment reporting, equity earnings are included in the determination of segment earnings (loss). Excluding equity earnings of $14 million results in an operating loss of $6 million in the first quarter of 2008 and a $9 million loss in 2007. Segment earnings (loss) is the same as operating income (loss) except for the MDS Analytical Technologies segment. 17. Financial Instruments The carrying amounts and fair values for all derivative financial instruments are as follows: As at January 31 As at October 31 ------------------------------------------------------------------------- 2008 2007 ------------------------------------------------------------------------- Carrying Fair Carrying Fair Amount Value Amount Value ------------------------------------------------------------------------- Asset (liability) position: Currency forward and option - assets $ 1 $ 1 $ 7 $ 7 Currency forward and option - liabilities $ (1) $ (1) $ (12) $ (12) Interest rate swap and option contracts $ - $ - $ (1) $ (1) ------------------------------------------------------------------------- ------------------------------------------------------------------------- As of January 31, 2008, the Company had outstanding foreign exchange contracts in place to sell $36 million at a weighted average exchange rate of C$1.0225 maturing over the next 12 months. In the first quarter of 2008, the Company recorded a $2 million gain on the settlement of interest rate swaps. In addition to the above derivatives, isotope supply agreements totaling $120 million include terms that result in the creation of an embedded currency derivative under SFAS 133 - "Accounting for Derivative Instruments and Hedging Activities". Under the rules contained in SFAS 133, we have determined the value of this derivative and marked it to market as at January 31, 2008. The supply contract is denominated in US dollars and due to currency movements between the US and Canadian dollar we have recorded an unrealized, mark-to- market loss of $4 million on the contract in 2008. There was no significant mark-to-market adjustment required for the first quarter of 2007. 18. Income Taxes A reconciliation of expected income taxes to reported income tax expense is provided below. Significant reconciling items include an $11 million net reduction in deferred tax liabilities due to the enactment during the quarter of reductions in Canadian federal income tax rates. Three months ended January 31 ------------------------------------------------------------------------- Restated See note 2 2008 2007 ------------------------------------------------------------------------- Expected income tax expense at MDS's 33% (2007 - 35%) statutory rate $ 3 $ 1 Increase (decrease) to tax expense as a result of: Tax credits for research and development (1) (2) Impact of tax rate changes on deferred tax balances (11) - Foreign losses that have not been recognized, net 1 4 Other 1 - ------------------------------------------------------------------------- Reported income tax expense (recovery) $ (7) $ 3 ------------------------------------------------------------------------- ------------------------------------------------------------------------- 19. Differences Between US and Canadian Generally Accepted Accounting Principles The US GAAP accounting principles used in the preparation of these consolidated financial statements conform in all material respects to Canadian GAAP, except as set out below. a) Accounting for equity interests in joint ventures - The Company owns 50% interests in two partnerships that are subject to joint control. Under US GAAP, the Company records its share of earnings of these partnerships as equity earnings. Under Canadian GAAP, the Company proportionately consolidates these businesses. Under the proportionate consolidation method of accounting, MDS recognizes its share of the results of operations, cash flows, and financial position of the partnerships on a line-by-line basis in its consolidated financial statements and eliminates its share of all material intercompany transactions with the partnerships. While there is no impact on net income from continuing operations or earnings per share from continuing operations as a result of this difference, there are numerous presentation differences affecting the disclosures in these consolidated financial statements and in certain of the supporting notes. b) Research and development - The Company expenses research and development costs as incurred. Under Canadian GAAP, the Company is required to capitalize development costs provided certain conditions are met. Such capitalized costs are referred to as deferred development costs and they are amortized over the estimated useful life of the related products, generally periods ranging from three to five years. c) Investment tax credits - The Company records non-refundable investment tax credits as a reduction in current income tax expense in the year in which the tax credits are earned. The majority of non-refundable investment tax credits earned by MDS are related to research and development expenditures. Under Canadian GAAP, non-refundable investment tax credits are recorded as a reduction in the expense or the capital expenditure to which they relate. d) Embedded derivatives - Under SFAS 133 - "Accounting for derivative instruments and hedging activities", certain contractual terms are considered to behave in a similar fashion to a derivative contract and parties to the contracts are therefore required to separate the accounting for these embedded derivatives from the accounting for the host contract. Once separated, these embedded derivatives are subject to the general derivative accounting guidelines outlined in SFAS 133, particularly the requirement to mark these derivatives to market. For MDS, these terms typically relate to the currency in which the contract is denominated. Canadian GAAP is largely aligned with SFAS 133 for most embedded derivatives; however, Canadian GAAP provides exemptions for contracts that are written in a currency that is not the functional currency of one of the substantial parties to the contract but which is a currency in common usage in the economic environment of one of the contracting parties. The Company has elected to use this exemption available under Canadian GAAP in accounting for certain cobalt supply contracts entered into with a supplier located in Russia. The affected contracts are denominated in US dollars. e) Currency forward and option contracts - The Company currently designates the majority of the forward foreign exchange contracts it enters into as hedges of future anticipated cash inflows. In prior years, these contracts did not qualify for treatment as hedges according to US GAAP and, accordingly, such contracts were carried at fair value and changes in fair value were reflected in earnings. Under Canadian GAAP, all such contracts were eligible for hedge accounting, and as a result, gains and losses on these contracts were deferred and recognized in the period in which the cash flows to which they relate were incurred. f) Comprehensive income - US GAAP requires that a statement of other comprehensive income and accumulated other comprehensive income (AOCI) be displayed with the same prominence as other financial statements. Under Canadian GAAP, statements of other comprehensive income and accumulated other comprehensive income were not required for years prior to the Company's 2007 fiscal year. g) Pensions - Under US GAAP, the net funded status of pension plans sponsored by a Company are fully reflected in the consolidated assets or liabilities of the Company. FAS 158 required the Company to fully recognize the funded status of its benefit plans. Each overfunded plan is recognized as an asset and each underfunded plan is recognized as a liability. Previously unrecognized net losses and unrecognized plan changes are recognized as a component of AOCI. Under Canadian GAAP, only the net actuarial asset or liability is reflected in the consolidated financial statements. h) Stock-based compensation - Under US GAAP, certain equity-based incentive compensation plans are accounted for under the liability method using a fair value model to determine the amount of the liability at each period end. Under Canadian GAAP, these plans are accounted for under the liability method using intrinsic value to measure the liability at each period end. As mentioned in Note 2, in the fourth quarter 2007 during the preparation of our 2007 annual financial statements under US GAAP an error was identified in the prior interim financial statements with respect to certain stock based incentive compensation plans. The Company has corrected this error of $2 million in these consolidated financial statements. The previous Canadian GAAP to US GAAP reconciliation is therefore amended by the below restated reconciliation. CONSOLIDATED STATEMENTS OF FINANCIAL POSITION ------------------------------------------------------------------------- Recon- 2008 ciling As at January 31 Canadian Adjust- 2008 US (millions of US dollars) GAAP ments Reference GAAP ------------------------------------------------------------------------- Assets Current assets Cash and cash equivalents $ 150 $ (6) a $ 144 Accounts receivable, net 273 2 a,d 275 Unbilled revenue 105 - 105 Inventories, net 114 (6) a 108 Income taxes recoverable 54 - 54 Current portion of deferred tax assets 54 - 54 Prepaid expenses and other 30 2 32 Assets held for sale 29 - 29 ------------------------------------------------------------------------- Total current assets 809 (8) 801 Property, plant and equipment, net 367 (3) a 364 Deferred tax asset 3 - 3 Long-term investments and other 275 (8) a,b,g 267 Goodwill 797 (23) 774 Intangible assets, net 566 (17) a 549 ------------------------------------------------------------------------- Total assets $ 2,817 $ (59) $ 2,758 ------------------------------------------------------------------------- ------------------------------------------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities Accounts payable and accrued liabilities $ 313 $ (13) a,d,h $ 300 Deferred revenue 75 - 75 Income taxes payable 30 - 30 Current portion of long-term debt 20 - 20 Current portion of deferred tax liabilities 20 - 20 Liabilities related to assets held for sale 14 - 14 ------------------------------------------------------------------------- Total current liabilities 472 (13) 459 Long-term debt 281 - 281 Deferred revenue 16 (1) 15 Other long-term obligations 30 - 30 Deferred tax liabilities 152 (13) f,h 139 ------------------------------------------------------------------------- Total liabilities 951 (27) 924 ------------------------------------------------------------------------- Shareholders' equity Share capital 502 (10) h 492 Additional paid in capital - 74 h 74 Retained earnings 963 (107) b,d,g,h 856 Accumulated other comprehensive income 401 11 a,f,g 412 ------------------------------------------------------------------------- Total shareholders' equity 1,866 (32) 1,834 ------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 2,817 $ (59) $ 2,758 ------------------------------------------------------------------------- ------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF FINANCIAL POSITION ------------------------------------------------------------------------- Recon- 2007 ciling As at October 31 Canadian Adjust- 2007 US (millions of US dollars) GAAP ments Reference GAAP ------------------------------------------------------------------------- ASSETS Current assets Cash and cash equivalents $ 259 $ (24) a $ 235 Short-term investments 91 11 102 Accounts receivable 284 3 a,d 287 Unbilled revenue 99 - 99 Inventories, net 134 (6) a 128 Income taxes recoverable 54 - 54 Current portion of deferred tax assets 45 - 45 Prepaid expenses and other 21 1 22 Assets held for sale 1 - 1 ------------------------------------------------------------------------- Total current assets 988 (15) 973 Property, plant and equipment, net 390 (4) a 386 Deferred tax assets 4 - 4 Long-term investments and other 284 6 a,b,g 290 Goodwill 797 (15) 782 Intangible assets, net 601 (18) a 583 ------------------------------------------------------------------------- Total assets $ 3,064 $ (46) $ 3,018 ------------------------------------------------------------------------- ------------------------------------------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities Accounts payable and accrued liabilities $ 391 $ (7) a,h $ 384 Deferred revenue 71 - 71 Income taxes payable 57 - 57 Current portion of long-term debt 94 - 94 Current portion of deferred tax liabilities 10 - 10 ------------------------------------------------------------------------- Total current liabilities 623 (7) 616 Long-term debt 290 - 290 Deferred revenue 16 1 17 Other long-term obligations 29 1 30 Deferred tax liabilities 182 (14) f,h 168 Minority interest 1 (1) - ------------------------------------------------------------------------- Total liabilities 1,141 (20) 1,121 ------------------------------------------------------------------------- Shareholders' equity Share capital 502 (9) h 493 Additional paid in capital n/a 72 h 72 Retained earnings 945 (103) b,d,g,h 842 Accumulated other comprehensive income 476 14 a,f,g 490 ------------------------------------------------------------------------- Total shareholders' equity 1,923 (26) 1,897 ------------------------------------------------------------------------- Total liabilities and shareholders' Equity $ 3,064 $ (46) $ 3,018 ------------------------------------------------------------------------- ------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF OPERATIONS Three months ended January 31, 2008 ------------------------------------------------------------------------- Recon- (millions of US dollars Canadian ciling except per share amounts) GAAP Items Reference US GAAP ------------------------------------------------------------------------- Revenues Products and services $ 304 $ (8) a $ 296 Reimbursement revenues 26 - 26 ------------------------------------------------------------------------- Total revenues 330 (8) 322 ------------------------------------------------------------------------- Costs and expenses Cost of revenues (187) - a,c (187) Reimbursed expenses (26) - (26) Selling, general and administration (58) (6) a,e,h (64) Research and development (9) (11) a,b,c (20) Depreciation and amortization (30) 3 a (27) Restructuring charges - net - - - Other expense - net (3) (1) b,d (4) ------------------------------------------------------------------------- Total costs and expenses (313) (15) (328) ------------------------------------------------------------------------- Operating income (loss) from continuing operations 17 (23) (6) Interest expense (6) - (6) Interest income 6 - 6 Gain on interest rate swaps - 2 2 Equity earnings - 14 a 14 ------------------------------------------------------------------------- Income from continuing operations before income taxes 17 (7) 10 Income tax (expense) recovery - current (24) 2 (22) - deferred 28 1 29 ------------------------------------------------------------------------- Income (loss) from continuing operations 21 (4) 17 Income from discontinued operations - net of income tax - - - ------------------------------------------------------------------------- Net income $ 21 $ (4) $ 17 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Basic earnings (loss) per share - from continuing operations $ 0.17 $ 0.03 $ 0.14 - from discontinued operations - - - ------------------------------------------------------------------------- Basic earnings (loss) per share $ 0.17 $ 0.03 $ 0.14 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Diluted earnings (loss) per share - from continuing operations $ 0.17 $ 0.03 $ 0.14 - from discontinued operations - - - ------------------------------------------------------------------------- Diluted earnings(loss) per share $ 0.17 $ 0.03 $ 0.14 ------------------------------------------------------------------------- ------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF OPERATIONS Three months ended January 31, 2007 ------------------------------------------------------------------------- Recon- (millions of US dollars Canadian ciling Restated except per share amounts) GAAP Items Reference US GAAP ------------------------------------------------------------------------- Revenues Products and services $ 250 $ (9) a $ 241 Reimbursement revenues 23 - 23 ------------------------------------------------------------------------- Total revenues 273 (9) 264 ------------------------------------------------------------------------- Costs and expenses Cost of revenues (160) (1) a,c (161) Reimbursed expenses (23) - (23) Selling, general and administration (53) (1) a,e,h (54) Research and development (5) (7) a,b,c (12) Depreciation and amortization (17) 3 a,b (14) Restructuring charges - net (13) - (13) Other expense - net 1 3 b,d 4 ------------------------------------------------------------------------- Total costs and expenses (270) (3) (273) ------------------------------------------------------------------------- Operating income (loss) from continuing operations 3 (12) (9) Interest expense (6) - (6) Interest income 4 - 4 Equity earnings - 14 a 14 ------------------------------------------------------------------------- Income from continuing operations before income taxes 1 2 3 Income tax expense - current (3) 1 (2) - deferred - (1) (1) ------------------------------------------------------------------------- Income (loss) from continuing operations (2) 2 - Income from discontinued operations - net of income tax 16 - 16 ------------------------------------------------------------------------- Net income $ 14 $ 2 $ 16 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Basic earnings (loss) per share - from continuing operations $ (0.02) $ 0.02 $ - - from discontinued operations 0.12 (0.01) 0.11 ------------------------------------------------------------------------- Basic earnings (loss) per share $ 0.10 $ 0.01 $ 0.11 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Diluted earnings (loss) per share - from continuing operations $ (0.02) $ 0.02 $ - - from discontinued operations 0.12 (0.01) 0.11 ------------------------------------------------------------------------- Diluted earnings(loss) per share $ 0.10 $ 0.01 $ 0.11 ------------------------------------------------------------------------- ------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS Three months ended January 31, 2008 ------------------------------------------------------------------------- Recon- Canadian ciling (millions of US dollars) GAAP Items US GAAP ------------------------------------------------------------------------- Operating activities Net income $ 21 $ (4) $ 17 Less: Income from discontinued operations - net of tax - - - ------------------------------------------------------------------------- Income from continuing operations 21 (4) 17 Adjustments to reconcile net income to cash provided by operating activities relating to continuing operations Items not affecting current cash flow (22) 52 30 Net changes in non-cash working capital balances relating to operations (97) (7) (104) ------------------------------------------------------------------------- Cash used in operating activities of continuing operations (98) 41 (57) Cash provided by operating activities of discontinued operations - - - ------------------------------------------------------------------------- (98) 41 (57) ------------------------------------------------------------------------- Investing activities Decrease in deferred development charges (5) 5 - Purchase of property, plant and equipment (13) - (13) Proceeds on sale of property, plant and equipment 1 - 1 Proceeds on sale of short-term investments 101 - 101 Proceeds on sale of long-term investments 3 - 3 Other (1) 1 - ------------------------------------------------------------------------- Cash provided by in investing activities of continuing operations 86 6 92 ------------------------------------------------------------------------- Financing activities Repayment of long-term debt (80) - (80) Increase in deferred revenue and other long-term obligations 1 - 1 Repurchase of shares (5) - (5) Issuance of shares 1 - 1 ------------------------------------------------------------------------- Cash used in financing activities of continuing operations (83) - (83) ------------------------------------------------------------------------- Effect of foreign exchange rate changes on cash and cash equivalents (3) (40) (43) ------------------------------------------------------------------------- Decrease in cash and cash equivalents during the period (98) 7 (91) Cash and cash equivalents, beginning of period 248 (13) 235 ------------------------------------------------------------------------- Cash and cash equivalents, end of period $ 150 $ (6) $ 144 ------------------------------------------------------------------------- ------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS Three months ended January 31, 2007 ------------------------------------------------------------------------- Recon- Canadian ciling Restated (millions of US dollars) GAAP Items US GAAP ------------------------------------------------------------------------- Operating activities Net income $ 14 $ 2 $ 16 Less: Income from discontinued operations - net of tax 16 - 16 ------------------------------------------------------------------------- Loss from continuing operations (2) 2 - Adjustments to reconcile net income to cash provided by operating activities relating to continuing operations Items not affecting current cash flow 13 15 28 Net changes in non-cash working capital balances relating to operations (28) (5) (33) ------------------------------------------------------------------------- Cash used in operating activities of continuing operations (17) 12 (5) Cash provided by operating activities of discontinued operations 16 - 16 ------------------------------------------------------------------------- (1) 12 11 ------------------------------------------------------------------------- Investing activities Decrease in deferred development charges (2) 2 - Purchase of property, plant and equipment (8) (1) (9) Proceeds on sale of short-term investments 126 - 126 Purchase of short-term investments (22) - (22) Proceeds on sale of long-term investments 11 - 11 Other 1 - 1 ------------------------------------------------------------------------- Cash provided by investing activities of continuing operations 106 1 107 ------------------------------------------------------------------------- Financing activities Repayment of long-term debt (6) - (6) Decrease in deferred revenue and other long-term obligations 1 - 1 Payment of cash dividends (3) - (3) Issuance of shares 4 - 4 ------------------------------------------------------------------------- Cash used in financing activities of continuing operations (4) - (4) ------------------------------------------------------------------------- Cash used in financing activities of discontinued operations (2) - (2) ------------------------------------------------------------------------- Effect of foreign exchange rate changes on cash and cash equivalents (12) (12) (24) ------------------------------------------------------------------------- Increase in cash and cash equivalents during the period 87 1 88 Cash and cash equivalents, beginning of period 253 (6) 247 Cash and cash equivalents, end of period $ 340 $ (5) $ 335 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Three months ended January 31 2008 2007 ------------------------------------------------------------------------- Net income (loss) from continuing operations in accordance with US GAAP $ 17 $ - US GAAP adjustments: Deferred development costs - net 4 - Mid term incentive plan (4) (2) Mark to market on embedded derivatives 4 - Defined benefit pension plans 1 - Reduction in income tax expense arising from GAAP adjustments (1) - ------------------------------------------------------------------------- Net income (loss) from continuing operations in accordance with Canadian GAAP 21 (2) ------------------------------------------------------------------------- Income from discontinued operations in accordance with Canadian and US GAAP - net of tax - 16 ------------------------------------------------------------------------- Net income in accordance with Canadian GAAP $ 21 $ 14 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Basic and diluted earnings per share in accordance with Canadian GAAP - from continuing operations $ 0.17 $ (0.02) - from discontinued operations - 0.12 ------------------------------------------------------------------------- $ 0.17 $ 0.10 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Recent Canadian Accounting Pronouncements a) Capital disclosures - The CICA issued Section 1535, "Capital Disclosures", which requires the disclosure of both the qualitative and quantitative information that enables users of financial statements to evaluate the entity's objectives, policies, and processes for managing capital. b) Inventories - The CICA issued Section 3031, "Inventories", which replaces existing Section 3030 and harmonizes the Canadian standards related to inventories with International Financial Reporting Standards. The new Section includes changes to the measurement of inventories, including guidance on costing, impairment testing, and disclosure requirements. c) Financial instruments - The CICA issued section 3862, "Financial Instruments - Disclosure" and Section 3863, "Financial Instruments - Presentation" to replace Section 3861, "Financial Instruments - Disclosure and Presentation". The Company has adopted Sections 1535, 3862, and 3863 effective for its fiscal year end beginning November 1, 2007 and these sections affect disclosures only. The Company is required to adopt Section 3031 effective November 1, 2008. The Company is currently evaluating the effects that the adoption of Section 3031 will have on its consolidated results of operations and financial condition and is not yet in a position to determine such effects. 20. Comparative Figures All comparative financial information has been restated to reflect the Company's results as if they had been historically reported in US dollars and in accordance with US GAAP. Certain figures for the previous year have been reclassified to conform to the current year's financial statement presentation. DATASOURCE: MDS Inc. CONTACT: PRNewswire - - 03/06/2008

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