MDS Reports Third Quarter Fiscal 2004 Financial Results Growth In
Revenues Over Prior Year TORONTO, Sept. 9 /PRNewswire-FirstCall/ --
MDS Inc. (TSX: MDS; NYSE: MDZ), the global health and life sciences
company, today reported its third quarter results. Third Quarter
Year-over-Year and Operational Highlights: - Revenues of $465
million, up 5% from $444 million. - Operating income from
continuing operations before MDS Proteomics and other items
declined 11% from $74 million to $66 million. - Earnings from
continuing operations before MDS Proteomics and other items
declined from $0.32 to $0.29. - Completed the re-organization of
MDS Proteomics, which has been renamed Protana Inc. - Subsequent to
the quarter announced the expansion of the Applied Biosytems/MDS
Sciex joint venture. - Declared a 30% increase in the dividend from
$0.10 to $0.13 per share on an annualized basis. Revenue growth in
the quarter continued to be negatively impacted by the continued
weakness in the US dollar relative to the same quarter in 2003. "In
the third quarter, three of our businesses performed at or above
plan, lead by continued strength in our analytical instruments
business. This performance was partially offset by weakness in the
bioanalytical segment of our pharmaceutical services business and
the ongoing cost of change across the organization. Our isotopes
business performed as expected, although the timing of cobalt
deliveries late in the quarter pushed the revenues related to that
supply into the fourth quarter." said John Rogers, President and
CEO, MDS Inc. Life Sciences Life Sciences segment revenues
increased 6% to $292 million up from $275 million in the prior
year's quarter. Revenues across the life sciences segment continued
to be impacted by US currency fluctuations. Operating income in the
quarter declined from $57 million to $47 million, as a result of
revenue shortfalls in the bioanalytical segment of the
pharmaceutical services business and timing issues related to
cobalt sales. Analytical instrument sales of the API 4000(TM) and
the Q TRAP 4000(TM) continued to drive performance in the quarter
along with growth in the remaining segments of our isotopes and
pharmaceutical research services businesses. In the isotopes
business, revenues decreased 4% to $80 million, driven by the
timing of cobalt shipments in the gamma sterilization business and
modest growth in the nuclear medicine business. The pharmaceutical
research services business grew 7% (10% when normalized for
currency) over the prior year from $125 million to $134 million. In
the quarter, backlog continued to grow to $285 million up from $265
million in the second quarter of 2004. The analytical instruments
business grew 16% over the prior year (36% when expressed as
end-user sales in US currency), the result of continued strength in
the demand for Sciex instruments. Health Health segment revenues
increased 2% year-over-year to $173 million. Revenues in the
Canadian laboratories business grew 5% from $102 million to $107
million, while revenues in the US declined by 5% from $19 million
to $18 million. MDS is continuing to review its options with
respect to the remaining US laboratory businesses. Revenues in the
distribution business were level at $48 million year over year.
Proteomics During the quarter, the reorganization of Protana Inc.
(formerly MDS Proteomics) was completed. The per share loss of
$0.01 in the quarter associated with MDS Proteomics reflects the
net impact of operating losses prior to the date of closing the
reorganization partially offset by gains resulting from the
reorganization. Having concluded this reorganization, our operating
results will no longer be impacted by any operating losses
generated by Protana. Corporate Currency fluctuations, including
the weakness of the US dollar, continue to be an important risk
factor for our Life Sciences business. While our current portfolio
of hedges extends to the end of 2005, the average realized
conversion rate on US dollar exports is expected to decline further
as we move through the balance of 2004. We continue to monitor the
forward markets and hedge when appropriate, however should rates
remain at their current levels, we do not expect to be able to
fully mitigate the impact of US dollar fluctuations on our results
in 2005 and beyond. After the quarter, the Company announced the
signing of a definitive agreement to expand the scope of the
Applied Biosytems/MDS Sciex joint venture in life science mass
spectrometry. Under the terms of the agreement, MDS has agreed to
pay US $40 million for a 50% interest in current Applied Biosystems
MALDI Time-of-Flight (TOF) mass spectrometry systems and
next-generation products under development. The transaction is
expected to increase MDS Sciex revenues by $25-30 million dollars
in fiscal year 2005. The transaction is expected to close in
October 2004, following approvals by the requisite regulatory
bodies. After the quarter, the Board of Directors approved a new
dividend policy for MDS. The new policy is designed to maintain
stable and consistent dividends, with a targeted payout ratio of
approximately 10-15% of the previous year's normalized, sustainable
earnings per share after consideration of the Company's cash and
liquidity position and future cash requirements. The Board of
Directors declared a quarterly cash dividend of $0.0325 per Common
share, an increase of 30% on an annualized basis, to all
shareholders of record as of September 17, 2004. The dividend is
payable on October 1, 2004. Outlook "We will continue to focus on
driving operating performance across all of our businesses at MDS
and anticipate that these efforts should will be reflected in
improved operating performance as we move into 2005," said John
Rogers, President and CEO, MDS Inc. MDS will be holding a
conference call today at 11:00 am. This call will be webcast live
at, http://www.mdsintl.com/, and will also be available in archived
format at http://www.mdsintl.com/news_present.asp after the call.
At MDS Inc., our more than 10,000 highly skilled people provide
enabling products and services for the development of drugs and the
diagnosis and management of disease. We focus on helping to
discover new drugs, assisting doctors to diagnose and treat
patients and preventing the spread of disease. Find out more about
MDS Inc. at http://www.mdsintl.com/ or by calling 1-888-MDS-7222,
24 hours a day. This document contains forward-looking statements.
Some forward looking statements may be identified by words like
"expects", "anticipates", "plans", "intends", "indicates" or
similar expressions. The statements are not a guarantee of future
performance and are inherently subject to risks and uncertainties.
The Company's actual results could differ materially from those
currently anticipated due to a number of factors, including, but
not limited to, successful integration of structural changes,
including restructuring plans, acquisitions, technical or
manufacturing or distribution issues, the competitive environment
for the Company's products, the degree of market penetration of the
Company's products, and other factors set forth in reports and
other documents filed by the Company with Canadian and US
securities regulatory authorities from time to time. MANAGEMENT'S
DISCUSSION AND ANALYSIS OF OPERATING RESULTS AND FINANCIAL POSITION
This section of the quarterly report contains management's analysis
of the financial performance of the company and its financial
position. It should be read in conjunction with the consolidated
financial statements. Readers are cautioned that management's
discussion and analysis ("MD&A") contains forward-looking
statements and that actual events may vary from management's
expectations. Readers are encouraged to consult the MDS Annual
Report and Annual Information Form for fiscal 2003 for additional
details regarding risks affecting the businesses. In our MD&A
and elsewhere we refer to measures such as backlog and unusual
items that are not defined by generally accepted accounting
principles ("GAAP"). Our use of these terms may not be consistent
with the way these terms are used by others. Where possible, in
particular for earnings per share measures, we provide tables or
other information that assists readers in reconciling between such
non-GAAP measures and standard GAAP measures. While these measures
are not defined by or required by GAAP, we provide this information
to readers to help them better understand the significant events,
transactions, and trends that affect our businesses. Unless
otherwise noted, all financial references in this document exclude
the discontinued US laboratories and generic radiopharmaceutical
operations of the Company, and therefore reflect our continuing
operations. The results for prior periods have been restated to
conform to this presentation. Overview (Tabular amounts are in
millions of Canadian dollars, except where noted.) Summary Results
Third Quarter Nine Months
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2004 2003 2004 2003
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Revenues $ 465 $ 444 $ 1,373 $ 1,300 Operating Income $ 73 $ 67 $
140 $ 161 Basic earnings per share $ 0.35 $ 0.23 $ 0.30 $ 0.37
Revenues for the third quarter increased 5% compared to 2003. Our
analytical instruments business led growth overall, rising 16% for
the quarter as a result of strong sales growth in the 4000 series
of mass spectrometers. The reorganization of MDS Proteomics was
completed late in the quarter and the net impact on our operating
income is limited to a portion of the losses incurred prior to
completion of the reorganization. These losses were more than
offset by a gain we realized from the reorganization. In addition,
the completion of the reorganization has enabled us to utilize
investment tax credits earned by MDS Proteomics against income
taxes generated by our other businesses. These items, combined with
strong performance in analytical instruments and a postponement of
expected fee cuts in British Columbia (BC), helped to drive
operating income to $73 million, an increase of 9% over the prior
year. Details of operating income for the period follow: Third
Quarter Nine Months
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2004 2003 2004 2003
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Operating income from continuing operations before MDS Proteomics
and other items $ 66 $ 74 $ 206 $ 211 MDS Proteomics - Operations
(5) (9) (26) (26) - Write-down of goodwill and other assets - -
(63) - - Gain resulting from reorganization 8 - 8 -
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Operating income from continuing operations, before other items 69
65 125 185 Valuation provisions - - - (75) Restructuring charges -
(6) Investment tax credits from MDS Proteomics 3 - 3 - Patent
settlement - - 14 39 Gain on sale of businesses and other 1 2 4 12
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Operating income from continuing operations $ 73 $ 67 $ 140 $ 161
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These special items had the following impact on basic earnings per
share: Third Quarter Nine Months
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2004 2003 2004 2003
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EPS from continuing operations before MDS Proteomics and other
items $ 0.29 $ 0.32 $ 0.86 $ 0.90 MDS Proteomics (0.01) (0.06)
(0.55) (0.18)
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EPS from continuing operations before other items 0.28 0.26 0.31
0.72 Valuation provisions - - - (0.51) Restructuring charges - -
(0.02) - Recognition of MDS Proteomics tax assets 0.08 - 0.08 -
Patent settlement - - 0.06 0.18 Gain on sale of businesses and
other 0.01 - 0.03 0.06
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EPS from continuing operations 0.37 0.26 0.46 0.45 Discontinued
operations (0.02) (0.03) (0.16) (0.08)
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Basic EPS $ 0.35 $ 0.23 $ 0.30 $ 0.37
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Segment Results Third Quarter 2004 2003
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Operating Operating Income Operating Income Operating Revenues
(Loss) Margin Revenues (Loss) Margin
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Life Sciences $ 292 $ 47 16% $ 275 $ 57 21% Health 173 23 13% 169
19 11%
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465 70 15% 444 76 17% Proteomics - 3 n/m - (9) n/m
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$ 465 $ 73 16% $ 444 $ 67 15%
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n/m (equal sign) not meaningful Nine Months 2004 2003
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Operating Operating Income Operating Income Operating Revenues
(Loss) Margin Revenues (Loss) Margin
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Life Sciences $ 863 $ 161 19% $ 807 $ 160 20% Health 510 60 12% 493
26 5%
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1,373 221 16% 1,300 187 14% Proteomics - (81) n/m - (25) n/m
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$ 1,373 $ 140 10% $ 1,300 $ 161 12%
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n/m (equal sign) not meaningful Life Sciences Review of operations
- Revenues from Life Sciences businesses for the quarter were:
Third Quarter 2004 2003 Change
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Early-stage research $ 89 $ 90 (1)% Late-stage research 45 35 29%
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Pharmaceutical research services 134 125 7%
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Gamma sterilization 17 23 (26)% Nuclear medicine 53 51 4% Therapy
systems 10 9 11%
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Isotopes 80 83 (4)%
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Analytical instruments 78 67 16%
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$ 292 $ 275 6%
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Our analytical instruments business performed well this quarter as
sales of API 4000(TM) and 4000 Qtrap(TM) were very strong. Despite
competition in these markets, order levels for these high-end
machines remain solid. End-user sales of mass spectrometers were up
36% in US dollar terms, compared to the third quarter of last year.
Sales of cobalt 60 were particularly strong in the third quarter of
2003 as supply levels were high at that time. Revenues for the
third quarter this year were lower as inventory levels were
depleted in the early part of the quarter. We received new supply
too late to have much impact in the quarter; however, we expect
revenues in the fourth quarter to be up substantially.
Pharmaceutical research services revenue increased by 7% in the
third quarter compared to the same period last year, and were up
10% when adjusted for the impact of currency fluctuations. In our
early-stage businesses, pharmacology and drug safety have remained
strong; however, we saw continued weakness in our bioanalytical
business, where revenues remained below those of 2003. These
shortfalls in the bioanalytical business have offset otherwise
solid revenue growth in early clinical research, where revenues are
up in line with industry average growth rates. Revenues in our
late-stage businesses were up significantly compared to last year
and strength in our European late-stage clinical development was a
major factor in this improvement. We have experienced continued
growth in backlog as sales momentum in pharmaceutical research
services remains healthy. As the majority of our revenues in this
division originate in the United States, we track our backlog in US
currency. Our backlog has grown over the past seven quarters as
shown in the table below: Average Backlog (millions of US dollars)
---------------------------------------------------------- Fiscal
2003 - Quarter 1 $200 Quarter 2 220 Quarter 3 240 Quarter 4 230
Fiscal 2004 - Quarter 1 240 Quarter 2 265 Quarter 3 285 Measurement
of backlog is not defined by GAAP and our measurement of backlog
may vary from that used by others. While we believe that long-term
backlog trends serve as a useful metric for assessing the growth
prospects for our business, backlog is not a guarantee of future
revenues and provides no information about the timing on which
future revenue may be recorded. Operating income in the Life
Sciences segment was affected by slower than expected sales in our
higher margin bioanalytical business. Profit margins in this
business are tied to the utilization of capacity in our
bioanalytical laboratories. During this fiscal year, we experienced
a business mix characterized by lower value studies compared with
2003, particularly from our pharma customers. This has resulted in
lower revenues and higher production costs, which has impacted
operating margins. Changes in mix do occur from time to time,
depending on the products that are in the development pipelines of
our customers. We continue to do good business with all of our
major clients but, on average, revenues are lower than the previous
year. In May 2004, we received an untitled letter from the Food and
Drug Administration (FDA) expressing concerns related to certain
procedures performed in a bioanalytical study in 2001 at our
Montreal facility. During much of the third quarter, significant
resources were dedicated to working with the FDA to address their
concerns. We have formally responded to and met with the FDA and
believe that the processes put in place fully address their
concerns. Although the financial implications of this regulatory
issue are difficult to quantify, we believe that this situation did
have a negative impact on revenues and operating income in the
third quarter. Capital expenditures - Purchases of capital assets
in Life Sciences amounted to $23 million for the quarter compared
to $24 million last year. Segment outlook - We are entering the
final quarter of 2004 well positioned in two of our Life Sciences
businesses. With the substantial increase in our cobalt
inventories, we expect strong revenue growth from our isotopes
businesses in our fourth quarter. We are also continuing to see
good order levels in our key analytical instrument lines. These two
businesses contribute substantially to the overall operating margin
of this segment, so this revenue strength is encouraging. It should
be noted though that the level of quarter-over-quarter revenue
growth experienced in the third quarter in analytical instruments
is unlikely to be repeated for the fourth quarter, reflecting the
higher than expected growth for the third quarter of this year. Our
pharmaceutical research services business is expected to show
improved revenue growth and improved margins in the fourth quarter.
While we expect bioanalytical revenues to build, we anticipate that
this will happen gradually over the next several quarters. Maple
Project- During the third quarter, we were advised by Atomic Energy
Canada Limited (AECL) that a technical problem was experienced
during a recent operating test and the shut-off rod safety system,
which forms a central part of the emergency shutdown system of the
MAPLE reactor, failed to function within its specifications. AECL
is currently conducting an investigation into the cause of this
event. AECL has advised us that they will be unable to present
their findings on this and other matters to the Canadian Nuclear
Safety Commission (CNSC) prior to their November 2004 meeting. We
continue to be disappointed by AECL's performance in resolving
technical and regulatory issues on this project. AECL has advised
us that they remain confident that, in time, all technical issues
will be resolved and the reactors and associated processing
facility will receive the requisite regulatory approvals. At this
time, we do not have sufficient, reliable information from AECL to
predict with any reasonable degree of accuracy when commercial
production will commence in the new facilities. AECL's existing NRU
reactor is able to satisfy all customer requirements for
reactor-based isotopes. The current operating license issued by
CNSC for the NRU reactor expires in December 2005. We are advised
by AECL, the owner and operator of the reactor, that they expect an
extension to the existing license will be obtained, which will
ensure uninterrupted supply of the critical products we supply to
the global medical community. In the third quarter, $11 million of
costs were capitalized with respect to the MAPLE reactor project
including $9 million of design, construction and installation
costs, and $2 million of interest. At quarter-end, the total amount
capitalized on this project was $330 million, an amount that
significantly exceeds original cost estimates developed by AECL.
This amount is net of cost-sharing payments which we have received
to date from AECL, and which are significantly less than the amount
to which we believe we are entitled. We expect to continue our
current accounting practices for this project until construction is
completed, following which we will cease capitalizing costs and
will commence recording amortization expense. The change from
capitalization to amortization is expected to take place gradually
over a period of several months as production volumes from the
older NRU reactor are transitioned to the new facility. Financial
responsibility for decommissioning costs of both the NRU and the
MAPLE facilities and liabilities related to any nuclear incidents
are now and will remain the responsibility of AECL. Construction
costs for this project, as well as AECL's current estimates of
operating costs, both significantly exceed initial estimates.
Financial responsibility for construction cost over-runs and
portions of pre- and post- commissioning operating costs are the
subject of a dispute with AECL. We intend to vigorously pursue our
interests in this dispute. Given current uncertainties, it is not
possible, at this time, to predict the final construction costs or
operating costs that will be borne by MDS. Accordingly, it is also
not possible to predict the overall impact on our operating
profitability following the transition from the current operating
environment to the new facility. Health Review of operations -
Revenues from Health businesses in the quarter were: Third Quarter
2004 2003 Change
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Canadian laboratories $ 107 $ 102 5% US laboratories 18 19 (5)%
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Diagnostics 125 121 3% Distribution 48 48 -
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$ 173 $ 169 2%
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Our Canadian diagnostic business was up slightly compared to the
same quarter last year. In the key British Colombia market, the
government and the BC Medical Association resolved the on-going
dispute over unilateral fee cuts announced by the government last
year. The settlement resulted in the deferral of all fee cuts to
July 1, 2004, at which time a 20% fee reduction came into affect.
Revenues from our remaining US laboratories were down slightly from
last year, reflecting the lower value of the US dollar. Revenues
from our Distribution business were level compared to the same
period last year. Our operating margin for the quarter is up
substantially due primarily to the deferral of fee reductions in
BC. Although the fee cuts were deferred until the final month of
the quarter, our mitigation strategies have been in place for the
majority of the year, resulting in better than expected results
from BC for the quarter and the year-to-date. Capital expenditures
- Health businesses purchased $4 million of capital assets during
the third quarter of 2004 compared to $3 million in the same period
in 2003. Segment outlook - We are continuing our efforts to
strengthen our operating results in this segment. Our mitigation
efforts in BC will offset a portion of the fee cut in that
province, and we are continuing to take other steps designed to
make our diagnostics operations more effective and efficient. As
these efforts will not offset the full impact of the fee cut, we do
not expect to retain this operating income level in the fourth
quarter; however, we believe that the steps taken to date to
improve operating efficiencies will result in sustainable margins
as we head into Fiscal 2005. Proteomics On July 29, 2004, MDS
Proteomics completed the reorganization that we announced in our
second quarter interim report. As a result of this reorganization,
MDS's interest in the newly renamed Protana Inc. has been reduced
to 48.4%. Also as reported in the second quarter, the carrying
value of this investment has been reduced to nil in our accounts
and we have a negative carrying value for this investment which
affords us a provision of $10 million related to our exposure under
certain guarantees. We will equity account for our interest in
Protana beginning in the fourth quarter and, because of our
negative carrying value, expect no impact on income from any
on-going Protana losses. Because MDS controlled MDS Proteomics
until it emerged from creditor protection, we continued to report
our share of the consolidated operating loss of the company for the
period up to July 29. Our share of the operating loss of the
company for that period was $5 million. Under the terms of the
reorganization, MDS was released from certain obligations that were
previously reflected as liabilities in our consolidated accounts.
As the carrying value of these liabilities exceeded the carrying
value of our net investment in MDS Proteomics, we recorded a
non-cash gain of $8 million in the third quarter. This gain offsets
the majority of our share of the consolidated net losses of MDS
Proteomics for the quarter, and consequently, the net loss we are
reporting related to the final reorganization of MDS Proteomics is
$1 million ($0.01 per share). A significant benefit of the
reorganization for MDS is the access that we gained to tax losses
carried forward and investment tax credits owned by MDS Proteomics.
Because MDS is likely to be able to benefit from these losses in
the future, we have reduced the valuation allowance that had
previously existed in our consolidated accounts related to these
assets. This resulted in a one-time earnings per share gain of
$0.08 for the quarter. As these tax assets will be used to offset
income generated by certain of our core businesses, this gain is
not included in the earnings per share related to MDS Proteomics
and is instead disclosed as a separate line in our earnings per
share reconciliation. As we do not consolidate Protana, certain
assets and liabilities belonging to that company no longer form
part of our consolidated accounts. Following are the significant
reductions in our account balances that result from this change in
accounting treatment:
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Reduction compared to October 2003 balance
-------------------------------------------------------------- Cash
$ 30 Net current liabilities $ 4 Capital assets $ 29 Goodwill $ 118
Long-term debt $ 64 Minority interest $ 43 Long-term investments $
2 Corporate Effective May 1, 2004, we completed a series of
transactions that resulted in the transfer of assets and operations
that form part of our Ontario laboratory business into MDS
Laboratory Services LP ("Labs LP"), a newly formed partnership in
which MDS now holds an indirect effective interest of 99.56%. This
interest is held through LPBP Inc (LPBP), formerly Hemosol Inc. As
a result of this transaction, the Company will be able to benefit
from significant tax losses carried forward, research and
development expense pools, and investment tax credits, having an
estimated combined value of $120 million. These tax assets were
accumulated by LPBP from the blood products business operated by
that company prior to the reorganization. The cost to us to gain
access to these assets totaled $19 million; represented by a $16
million cash transfer to Hemosol Corp., the successor corporation
to Hemosol Inc. in the blood products business, along with $3
million of transaction costs. We recorded these future tax assets
at their expected value of $120 million. In addition, and in
accordance with Canadian GAAP as set out in EIC 110 "Accounting for
Acquired Future Tax Benefits in Certain Purchase Transactions that
are not Business Combinations", we recorded a corresponding
unrealized benefit on the acquisition of these tax assets of $120
million. This benefit was reduced by the cost to us to acquire the
tax assets and the net amount of $101 million was recorded as a
deferred credit. The future tax asset will be recognized in income
based on the effective tax rate existing during each future period
as these tax assets are utilized. The unrealized benefit from the
tax assets will be amortized on a basis that is pro-rata to the
future income tax asset draw-down. This transaction resulted in tax
savings of $3 million in our third quarter and is expected to
result in similar quarterly savings over the next eight years.
Other aspects of this transaction were completed in a manner
consistent with our second quarter disclosures. The tax rate
applicable to our core business was 37% compared to 36% reported in
the same quarter last year. From time to time, we are subject to
audit by tax authorities. While such audits typically raise
adjustments, these adjustments are usually not material. Over the
course of the past year, we have been subject to a routine tax
audit by Canadian tax authorities. During the course of this audit,
the Canadian Revenue Agency (the CRA) questioned the deductibility
of certain costs paid by one of our joint ventures to our joint
venture partner. These costs are in the nature of marketing and
selling expenses. Although we have yet to be reassessed based on
the position put forward by the CRA, the expenses in question total
$80 million and disallowance would result in a tax liability
estimated at $10 million to $15 million. Based on our own knowledge
of the nature of these payments and on discussions with our legal
counsel, we believe that these costs are deductible and entirely
appropriate. We believe that we have adequate tax reserves on our
books for all reasonable tax audit exposures. No additional
provision was made in the accounts this quarter for this possible
reassessment. Research and development spending in the quarter of
$7 million is net of investment tax credits including those from
MDS Proteomics. The slight decrease from last year reflects lower
spending by MDS Proteomics in the period leading up to the
reorganization. Our hedging strategy continued to protect us from
the impact of the decline in the value of the US dollar. US dollar
hedges that matured in the quarter resulted in gains of $8 million
compared to $6 million for the same period last year. For the year
to date, we have realized gains from matured hedges totalling $27
million (2003 - $11 million). As at the end of the quarter, our
remaining portfolio of hedges has an unrealized gain of $31
million. If the US dollar retains its currently level, we expect to
realize this gain on a declining basis over the course of the next
five quarters. Investment in change Last year, we announced the
launch of major initiatives across MDS that included the
implementation of a common business system based on an Oracle
platform, improvements to our information technology
infrastructure, and the adoption of a shared services approach to
the provision of certain support services. We have made a
significant investment of resources in these initiatives and we
have made considerable progress. MDS Enterprise Services was
launched on June 1, 2004, and our human resource, facilities
management, and information technology support groups moved to this
new organization. Our Oracle implementation is proceeding and we
expect the first conversion to the new platform to be effective
November 1, 2004. Other business units will follow, with the
majority of the conversions being completed over the balance of
fiscal 2005. Our current expectation is that we will have invested
up to $135 million in these change initiatives by the time they are
complete. While some of this investment will be in capital, a
significant portion will be expensed as incurred. In addition to
these initiatives, in October 2003 we outsourced certain of our IT
infrastructure and IT support services to IBM. The incremental cost
of transitioning to outsourced IT support services will be incurred
over the course of 2004 through 2006 as the other initiatives are
completed and we are able to reduce our rate of spending on
internal IT support. To date in fiscal 2004, we have invested $48
million in these combined initiatives, of which, $34 million has
been expensed. These expenses account for the majority of the
incremental selling, general, and administrative expense for the
year-to-date. Through the remainder of fiscal 2004 and 2005, we
expect to continue to experience elevated levels of general and
administrative expense as a result of these initiatives, as well as
other corporate projects such as compliance with Sarbanes-Oxley
legislation. Discontinued operations Combined revenues for
discontinued operations for the quarter were $4 million compared to
$19 million last year. The closure of the generic
radiopharmaceutical facility is expected to occur before the end of
December 2004. Liquidity and capital resources Our net cash
position at July 31, 2004 was $270 million, compared to $297
million at April 30, 2004, reflecting the combined effect of the
Hemosol and Protana reorganizations. Operating working capital was
$136 million, an increase of $18 million from April. Events
subsequent to the end of quarter After the quarter, the Company
announced the signing of a definitive agreement to expand the scope
of the Applied Biosytems/MDS Sciex joint venture in life science
mass spectrometry. Under the terms of the agreement, MDS has agreed
to pay US $40 million for a 50% interest in current Applied
Biosystems MALDI Time-of-Flight (TOF) mass spectrometry systems and
next-generation products under development. This new business is
expected to increase MDS Sciex revenues by $25-30 million in fiscal
year 2005. The transaction is expected to close in October of 2004,
following approvals by the requisite regulatory bodies. Outlook A
number of initiatives previously discussed were completed in the
third quarter that continue the strategic repositioning of MDS. As
noted, we are pleased with the progress we are making on our change
initiatives. Continued vigilance will be required to ensure that we
exercise strong financial controls over our investments in this
area and then implement the change required to realize the full
benefits of these investments. To this purpose we remain committed.
The third quarter was strong for our isotopes, analytical
instruments, and diagnostics businesses but we faced significant
challenges in the bioanalytical component of our pharmaceutical
services division. This business is not delivering the returns that
it is capable of and we remain focused on facing these challenges
head-on. During the quarter, we made significant progress preparing
for compliance with the US Sarbanes-Oxley legislation and Bill 198
in Ontario. We expect to be compliant with these new regulations,
as required, for our fiscal 2005 year-end. CONSOLIDATED STATEMENTS
OF FINANCIAL POSITION As at July 31 with comparatives at October 31
(millions of Canadian dollars) 2004 2003
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ASSETS Current Cash and cash equivalents $ 273 $ 263 Accounts
receivable 341 274 Inventories 175 199 Income taxes recoverable 8 9
Current portion of future tax assets 14 - Prepaid expenses 30 30
-------------------------------------------------------------------------
841 775 Capital assets 800 776 Future tax assets 131 23 Long-term
investments and other (note 3) 226 217 Goodwill (note 3) 652 774
-------------------------------------------------------------------------
Total assets $ 2,650 $ 2,565
-------------------------------------------------------------------------
-------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY Current Bank indebtedness $ 3
$ 3 Accounts payable and accrued liabilities 346 355 Deferred
revenue 34 35 Income taxes payable 38 14 Current portion of
unrealized benefit of future tax asset (note 2) 13 - Current
portion of long-term debt 6 9
-------------------------------------------------------------------------
440 416 Long-term debt (note 3) 486 533 Deferred revenue 38 34
Unrealized benefit of future tax asset (note 2) 85 - Other
long-term obligations (note 3) 31 23 Future tax liabilities 74 70
Minority interest (note 2 & 3) 22 63
-------------------------------------------------------------------------
$ 1,176 $ 1,139
-------------------------------------------------------------------------
Shareholders' equity Share capital 828 816 Retained earnings 607
572 Currency translation adjustment 39 38
-------------------------------------------------------------------------
1,474 1,426
-------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 2,650 $ 2,565
-------------------------------------------------------------------------
-------------------------------------------------------------------------
See accompanying notes CONSOLIDATED STATEMENTS OF INCOME (Restated
- note 5) Three months to Nine Months to July 31 July 31
-------------------------------------------------------------------------
(millions of Canadian dollars, except per share amounts) 2004 2003
2004 2003
-------------------------------------------------------------------------
Net revenues $ 465 $ 444 $ 1,373 $ 1,300 Cost of revenues (278)
(268) (817) (788) Selling, general and administration (95) (81)
(287) (238) Research and development (7) (11) (29) (34)
Depreciation and amortization (21) (20) (55) (58) Restructuring
charges (note 4) - - (6) - Other income (expense) - net (note 5) 9
2 (39) (24) Equity earnings - 1 - 3
-------------------------------------------------------------------------
Operating income 73 67 140 161 Interest expense (6) (5) (20) (20)
Dividend and interest income 3 1 7 6
-------------------------------------------------------------------------
Income from continuing operations before income taxes and minority
interest 70 63 127 147 Income taxes (note 6) (11) (23) (61) (78)
Minority interest - net of tax (6) (3) (2) (6)
-------------------------------------------------------------------------
Income from continuing operations 53 37 64 63 Loss from
discontinued operations - net of tax (note 7) (3) (4) (22) (11)
-------------------------------------------------------------------------
Net income $ 50 $ 33 $ 42 $ 52
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Earnings per share (note 8) Basic $ 0.35 $ 0.23 $ 0.30 $ 0.37
Diluted $ 0.35 $ 0.23 $ 0.30 $ 0.37
-------------------------------------------------------------------------
-------------------------------------------------------------------------
See accompanying notes CONSOLIDATED STATEMENTS OF RETAINED EARNINGS
Three months to Nine Months to July 31 July 31
-------------------------------------------------------------------------
(millions of Canadian dollars) 2004 2003 2004 2003
-------------------------------------------------------------------------
Retained earnings, beginning of period $ 557 $ 551 $ 572 $ 543 Net
income 50 33 42 52 Repurchase of shares and options - (1) - (5)
Dividends - cash - - (5) (5) - stock - - (2) (2)
-------------------------------------------------------------------------
Retained earnings, end of period $ 607 $ 583 $ 607 $ 583
-------------------------------------------------------------------------
-------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS Three months to Nine Months
to July 31 July 31
-------------------------------------------------------------------------
(millions of Canadian dollars) 2004 2003 2004 2003
-------------------------------------------------------------------------
Operating activities Net income $ 50 $ 33 $ 42 $ 52 Items not
affecting current cash flow (note 10) (2) 24 119 149
-------------------------------------------------------------------------
48 57 161 201 Changes in non-cash working capital balances relating
to operations (note 10) (8) (10) (28) (40)
-------------------------------------------------------------------------
40 47 133 161
-------------------------------------------------------------------------
Investing activities Acquisitions - (8) (2) (8) Acquisition of tax
assets (note 2) (16) - (19) - Effect of deconsolidating MDS
Proteomics (18) - (18) - Purchase of capital assets (27) (28) (81)
(84) Purchase of technology license (note 3) (5) - (5) - Proceeds
on sale of business and investments 3 2 12 31 Other 5 (7) (9) (50)
-------------------------------------------------------------------------
(58) (41) (122) (111)
-------------------------------------------------------------------------
Financing activities Issuance of long-term debt - - - 563 Repayment
of long-term debt (2) - (3) (541) Increase (decrease) in deferred
income and other long-term obligations (3) - 11 (8) Payment of cash
dividends - - (5) (5) Issuance of shares 2 - 10 1 Repurchase of
shares and options - - - (4) Distribution to minority interest (2)
(3) (9) (10)
-------------------------------------------------------------------------
(5) (3) 4 (4)
-------------------------------------------------------------------------
Effect of foreign exchange rate changes on cash and cash
equivalents (4) (7) (5) (10)
-------------------------------------------------------------------------
Increase (decrease) in cash position during the period (27) (4) 10
36 Cash position, beginning of period 297 224 260 184
-------------------------------------------------------------------------
Cash position, end of period $ 270 $ 220 $ 270 $ 220
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Cash position comprises cash and cash equivalents less bank
indebtedness. See accompanying notes. NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (All tabular amounts in millions of Canadian
dollars, except where noted) 1. Accounting Policies These
consolidated financial statements of MDS Inc. ("MDS" or the
"Company") have been prepared on a basis consistent with the
Company's annual financial statements for the year ended October
31, 2003, with the exception that the statements for the prior
period have been restated to reflect the treatment of certain
operations as discontinued operations (note 7). These financial
statements should be read in conjunction with the accounting
policies and other disclosures in those annual financial
statements. These interim financial statements do not include all
of the disclosures contained in the annual financial statements. 2.
Reorganization of Ontario Laboratory Business Effective May 1,
2004, MDS transferred assets and operations that form part of the
Ontario laboratory business into MDS Laboratory Services LP ("Labs
LP"), a newly formed partnership in which MDS was the sole partner.
The Company then transferred a 99.99% limited partnership interest
in Labs LP to Hemosol Inc., in exchange for 100% of the Class B
non-voting shares and additional Class A voting shares of that
company. Following this transaction, MDS owns 99.56% of the equity
of Hemosol Inc., including 47.5% of the Class A voting shares.
Hemosol Inc. was subsequently renamed LPBP Inc. ("LPBP"). The
remaining 0.01% of the Ontario business is owned by a wholly owned
subsidiary of MDS Inc., MDS Laboratory Services Inc. ("MDS Labs"),
as the general partner. Through MDS Labs, MDS has retained
management control of the day-to-day and strategic operations of
the Ontario laboratories business and, consequently, the Company
continues to consolidate the results of this business. Because
other Class A shareholders of LPBP effectively now own 0.44% of the
Ontario laboratory business, the Company has recorded minority
interest expense relating to the 0.44% of LPBP owned by these other
shareholders. As a result of this transaction, the Company will be
able to benefit from significant tax losses carried forward,
research and development expense pools, and investment tax credits,
having an estimated combined value of $120 million. These tax
assets were accumulated by LPBP from a blood products business
operated by that company prior to the reorganization. The cost to
MDS to gain access to these tax assets totaled $19 million,
represented by a $16 million cash transfer to Hemosol Corporation,
a successor corporation to Hemosol Inc. in the blood products
business, along with $3 million of transaction costs. MDS has
recorded these future tax assets at an expected value of $120
million. In addition, and in accordance with Canadian GAAP as set
out in EIC 110 "Accounting for Acquired Future Tax Benefits in
Certain Purchase Transactions that are not Business Combinations",
the Company has recorded a corresponding unrealized benefit on
acquisition of tax assets of $104 million taking into account the
$16 million purchase price for the losses. This benefit has been
reduced by the transaction cost to acquire the tax assets and the
net amount of $101 million has been recorded as a long-term
deferred credit, the current portion of which has been recorded in
current liabilities. The future tax assets will be recognized in
income based on the effective tax rate existing during each future
period as these tax assets are utilized. The unrealized benefit of
these tax assets will be amortized on a basis that is pro-rata to
the future income tax asset utilization. 3. Reorganization of MDS
Proteomics On July 29, 2004, the financial reorganization of MDS
Proteomics, subsequently renamed Protana Inc. ("Protana"), was
completed. Through this reorganization, the Company reduced its
ownership in Protana from 89% to 48.4%. As the Company's share in
Protana has been reduced to less than 50%, management has
determined that MDS does not control Protana. As a result of the
loss of control, effective July 29, 2004, the Company
deconsolidated the assets and liabilities of Protana and began
accounting for the investment under the equity method. The net
investment reduction of $68 million from October 31, 2003 balances
comprised a $118 million reduction in goodwill, a $29 million
decline in fixed assets, and a $30 million decrease in cash. The
reduction in liabilities was due to the elimination of long-term
debt of $64 million, minority interest of $43 million, and net
current liabilities of $4 million. The reduction of the net
investment in MDS Proteomics began in the second quarter of 2004,
when MDS recorded a goodwill write-down in the amount of $53
million and a reduction in fixed assets for $10 million related to
its investment in Protana. These provisions reduced the carrying
value of Protana to nil. Additionally, a reserve of $10 million was
established, reflecting management's assessment of the total
exposure for MDS with respect to outstanding guarantees. The
operating losses for the third quarter were offset by the gain
realized on the dilution of MDS's share ownership of Protana. The
net impact of these transactions results in a negative net carrying
value at July 31, 2004 of $10 million. As a result of an agreement
made related to the reorganization, and for a payment of $5
million, MDS will be able to use the tax assets related to the
former MDS Proteomics business. A valuation provision related to
these assets is no longer required and was reversed in the quarter,
and these assets are now reflected at their fair value of $17
million. This resulted in an income tax recovery for $9 million,
and $3 million of investment tax credits in the quarter.
Additionally, MDS committed to pay $10 million to acquire access to
Protana's biomarker technology through a five-year licensing
agreement. This asset will be amortized on a straight-line basis
over the term of the agreement. The initial payment on this license
of $5 million has been recorded in Other Assets. 4. Restructuring
Charges In the fourth quarter of 2003, and subsequently in the
second quarter of 2004, the Company recorded provisions relating to
the implementation of certain change initiatives affecting the
support services, senior management reductions, and other
initiatives taking place in the business units, including system
implementations. The following is a summary of the provisions as of
July 31, 2004.
---------------------------------------------------------------------
Restructuring Provision Charge Balance at (workforce July 31,
reductions) Cumulative Drawdown 2004
---------------------------------------------------------------------
Cash Non-Cash
---------------------------------------------------------------------
Restructuring charge made October 31, 2003 $ 17 $ (11) $ (2) $ 4
April 30, 2004 6 (3) - 3
---------------------------------------------------------------------
$ 23 $ (14) $ (2) $ 7
---------------------------------------------------------------------
---------------------------------------------------------------------
5. Other Income (Expense) - Net Three months to Nine months to July
31 July 31
---------------------------------------------------------------------
2004 2003 2004 2003
---------------------------------------------------------------------
Write-down of long-term investments $ - $ - $ (2) $ (75) Write-down
of other long-term assets - - (10) - Gain on patent litigation - -
14 39 Gain on reorganization of MDS Proteomics 8 - 8 - Gain on sale
of businesses and investments 1 2 4 12 Write-down of goodwill - -
(53) -
---------------------------------------------------------------------
Other income (expense) - net $ 9 $ 2 $ (39) $ (24)
---------------------------------------------------------------------
---------------------------------------------------------------------
During the quarter, the Company sold a portion of shares it held in
investees accounted for on a cost basis. The sale resulted in a
gain of $1 million. 6. Income Taxes A reconciliation of expected
income taxes to reported income tax expense is provided below. Tax
expense for the three months ended July 31, 2004 is lower than
expected due to the completion of the Hemosol and Proteomics
reorganizations. Three months to July 31
---------------------------------------------------------------------
2004 2003
---------------------------------------------------------------------
Expected income taxes at MDS's 36% statutory rate $ 24 $ 21
Decrease to tax expense as a result of: Benefit of the tax assets
not previously recognized (5) - Other - (1)
---------------------------------------------------------------------
19 20 MDS Proteomics operating loss - 3 Recognition of MDS
Proteomics tax assets (8) -
---------------------------------------------------------------------
Reported income tax expense $ 11 $ 23
---------------------------------------------------------------------
---------------------------------------------------------------------
7. Discontinued Operations The results of the Company's
discontinued operations are as follows: Consolidated statements of
operations: Three months to Nine months to July 31 July 31
---------------------------------------------------------------------
2004 2003 2004 2003
---------------------------------------------------------------------
Revenues $ 4 $ 19 $ 31 $ 61 Loss from discontinued operations - net
of tax $ (3) $ (4) $ (22) $ (11) The $3 million loss from
discontinued operations incurred during the quarter related to $1
million of costs from its laboratory operations in New York and
Georgia, which were sold in the second quarter of 2004. The
remaining $2 million of losses was incurred by the Company's
generic radiopharmaceutical manufacturing facility in Belgium. A
$14 million provision related primarily to severance at the Belgium
facility is included in accounts payable and accrued liabilities,
and remains undrawn at July 31, 2004. The closure of this business
is proceeding, and the Company expects to begin applying severance
payments to the provision when they are made later during calendar
2004. The earnings per share impact of discontinued businesses is
as follows: Three months to Nine months to July 31 July 31
---------------------------------------------------------------------
2004 2003 2004 2003
---------------------------------------------------------------------
Earnings per share, continuing operations $ 0.37 $ 0.26 $ 0.46 $
0.45 Loss per share, discontinued operations (0.02) (0.03) (0.16)
(0.08)
---------------------------------------------------------------------
$ 0.35 $ 0.23 $ 0.30 $ 0.37
---------------------------------------------------------------------
---------------------------------------------------------------------
8. Earnings per Share a) Dilution Three months to Nine months to
July 31 July 31
---------------------------------------------------------------------
(number of shares in millions) 2004 2003 2004 2003
---------------------------------------------------------------------
Net income available to Common shareholders $ 50 $ 33 $ 42 $ 52
---------------------------------------------------------------------
---------------------------------------------------------------------
Weighted average number of Common shares outstanding - basic 142
141 142 141 Impact of stock options assumed exercised 1 1 1 1
---------------------------------------------------------------------
Weighted average number of Common shares outstanding - diluted 143
142 143 142 Basic earnings per share is calculated by dividing the
net earnings by the weighted average number of common shares
outstanding during the period. Diluted earnings per share is
calculated by dividing net earnings available to Common
shareholders by the sum of the weighted average number of Common
shares outstanding and all additional Common shares that would have
been outstanding if potentially dilutive Common shares had been
issued during the period. b) Pro Forma Impact of Stock-Based
Compensation Compensation expense related to the fair value of
stock options granted prior to November 1, 2003 is excluded from
the determination of net income and is, instead, calculated and
disclosed on a pro forma basis in the notes to the consolidated
financial statements. Compensation expense for purposes of these
pro forma disclosures is determined in accordance with a
methodology prescribed in CICA Handbook Section 3870 "Stock-Based
Compensation and Other Stock-Based Payments". The Company used the
Black-Scholes option valuation model to estimate the fair value of
options granted in prior years. For purposes of these pro forma
disclosures, the Company's net income and basic and diluted
earnings per share would have been: Three months to Nine months to
July 31 July 31
---------------------------------------------------------------------
2004 2003 2004 2003
---------------------------------------------------------------------
Pro forma net income available to Common shareholders $ 48 $ 31 $
35 $ 46 Pro forma earnings per share - basic $ 0.34 $ 0.22 $ 0.25 $
0.33 - diluted $ 0.33 $ 0.22 $ 0.25 $ 0.32 During the quarter, no
stock options were granted (2003 - 47,000). 9. Pension Benefit The
Company sponsors various post-employment benefit plans including
defined benefit pension plans, defined contribution plans and plans
that provide extended health care coverage to employees. All
defined benefit pension plans sponsored by the Company are funded
plans. Other post-employment benefits are unfunded. Pension expense
for the year-to-date was $1 million (2003 - $1 million). 10.
Supplementary Cash Flow Information Non-cash items affecting net
income comprise: Three months to Nine months to July 31 July 31
---------------------------------------------------------------------
2004 2003 2004 2003
---------------------------------------------------------------------
Depreciation and amortization $ 21 $ 20 $ 55 $ 58 Minority interest
6 3 2 6 Future income taxes (20) 4 (11) 23 Equity earnings (loss) -
net of distribution 1 (1) 2 (1) Write-down of goodwill - - 63 -
Write-down of investments - - (1) 75 Equipment write-down - - 10 -
(Gain) loss on sale of businesses and other (2) (2) 6 (12) Stock
option compensation - - 1 - Net-gain on dilution of share ownership
(8) - (8) -
---------------------------------------------------------------------
$ (2) $ 24 $ 119 $ 149
---------------------------------------------------------------------
---------------------------------------------------------------------
Changes in non-cash working capital balances relating to operations
include: Three months to Nine months to July 31 July 31
---------------------------------------------------------------------
2004 2003 2004 2003
---------------------------------------------------------------------
Accounts receivable $ (22) $ (12) $ (68) $ 29 Inventories 3 (1) 22
(36) Accounts payable and deferred revenue 3 4 (11) (38) Income
taxes 3 10 26 22 Foreign exchange and other 5 (11) 3 (17)
---------------------------------------------------------------------
$ (8) $ (10) $ (28) $ (40)
---------------------------------------------------------------------
---------------------------------------------------------------------
11. Segmented Information Three months to July 31
---------------------------------------------------------------------
2004
---------------------------------------------------------------------
Life Sciences Health Proteomics Total
---------------------------------------------------------------------
Net revenues $ 292 $ 173 $ - $ 465 Operating income before
restructuring 47 23 3 73 Restructuring activities - Revenues by
products and services: Medical isotopes 80 Analytical equipment 78
Pharmaceutical research services 134 Clinical laboratory services
124 Distribution and other 49 Proteomics - Capital expenditures -
net 23 4 - 27 Depreciation and amortization 14 3 4 21 Three months
to July 31
---------------------------------------------------------------------
2003
---------------------------------------------------------------------
Life Sciences Health Proteomics Total
---------------------------------------------------------------------
Net revenues $ 275 $ 169 $ - $ 444 Operating income (loss) before
restructuring 57 19 (9) 67 Restructuring activities - Revenues by
products and services: Medical isotopes 83 Analytical equipment 67
Pharmaceutical research services 125 Clinical laboratory services
121 Distribution and other 48 Proteomics - Capital expenditures -
net 24 3 1 28 Depreciation and amortization 13 4 3 20 Nine months
to July 31
---------------------------------------------------------------------
2004
---------------------------------------------------------------------
Life Sciences Health Proteomics Total
---------------------------------------------------------------------
Net revenues $ 863 $ 510 $ - $ 1,373 Operating income (loss) before
restructuring 163 64 (81) 146 Restructuring activities (2) (4) -
(6) Revenues by products and services: Medical isotopes 251
Analytical equipment 221 Pharmaceutical research services 391
Clinical laboratory services 365 Distribution and other 145
Proteomics - Capital expenditures - net 75 18 - 93 Depreciation and
amortization 38 11 6 55 Nine months to July 31
---------------------------------------------------------------------
2003
---------------------------------------------------------------------
Life Sciences Health Proteomics Total
---------------------------------------------------------------------
Net revenues $ 807 $ 493 $ - $ 1,300 Operating income (loss) before
restructuring 160 26 (25) 161 Restructuring activities Revenues by
products and services: Medical isotopes 233 Analytical equipment
202 Pharmaceutical research services 372 Clinical laboratory
services 355 Distribution and other 138 Proteomics - Capital
expenditures - net 71 12 2 84 Depreciation and amortization 37 13 8
58 12. Financial Instruments As of July 31, 2004, the Company had
outstanding foreign exchange contracts and options in place to sell
up to US$361 million at a weighted average rate of C$1.47 maturing
over the next 15 months. The Company also had interest rate swap
contracts that exchanged a notional amount of US$80 million of debt
from a fixed to a floating interest rate. Foreign exchange and
interest rate swap contracts are treated as hedges for accounting
purposes. The carrying amounts and fair values for derivative
financial instruments are as follows: Three months to July 31
---------------------------------------------------------------------
2004 2003
---------------------------------------------------------------------
Carrying Fair Carrying Fair Amount Value Amount Value
---------------------------------------------------------------------
Net asset (liability) position: Currency forward and option
contracts $ - $ 31 $ - $ 35 Interest rate swap and option contracts
$ - $ (2) $ - $ (18) 13. Subsequent event On September 1, 2004, the
Company signed a definitive agreement to acquire a 50% interest in
a mass spectrometry business for US$40 million. The transaction is
expected to close by October 31, 2004. Allocation of the purchase
price has not been determined. DATASOURCE: MDS Inc. CONTACT:
Investor Relations: Sharon Mathers, Vice-President, Investor
Relations, (416) 675-6777 x 2695, ; Media Relations: Naomi Nemeth,
Director, Global External Communications, (416) 675-6777 x 4692,
Copyright