In April 2008, the FASB issued Financial Statement Position SFAS 142-3, "Determination of the Useful Life of Intangible Assets" ("FSP 142-3"). FSP 142-3 provides guidance with respect to estimating the useful lives of recognized intangible assets acquired on or after the effective date and requires additional disclosure related to the renewal or extension of the terms of recognized intangible assets. FSP 142-3 is effective for fiscal years and interim periods beginning after December 15, 2008. The adoption is not expected to have a material impact on the consolidated results of operations and financial position. International Financial Reporting Standards We have been monitoring the deliberations and progress being made by accounting standard setting bodies and securities regulators both in Canada and the United States with respect to their plans regarding convergence to International Financial Reporting Standards (IFRS). The Accounting Standards Board in Canada and the Canadian Securities Administrators (CSA) have recently confirmed that domestic issuers will be required to transition to IFRS for fiscal years beginning on or after January 1, 2011. The CSA in a Concept Paper released on February 13, 2008, provided a tentative conclusion that allows domestic issuers who are also Securities and Exchange Commission (SEC) registrants, like MDS, to continue to report under US GAAP for a further two years from the transition date for domestic issuers. Separately, the SEC in late 2007 also eliminated the requirement of reconciling financial statements to US GAAP for foreign private issuers that file under IFRS, effective November 15, 2007. We adopted US GAAP as our primary reporting standard for our consolidated financial statements in fiscal 2007. We commenced reporting under US GAAP to improve the comparability of our financial information with that of our competitors, the majority of whom are US-based multinational companies that report under US GAAP. If current proposals by the CSA are approved without changes, the earliest we will be required to adopt IFRS as our primary reporting standard will be in fiscal 2014. We may adopt IFRS as our primary reporting standard earlier if the SEC either requires domestic registrants in the US to transition to IFRS prior to fiscal 2014 or if it permits domestic registrants to voluntarily adopt IFRS prior to fiscal 2014 and the majority of our competitors commence to report under IFRS. Internal Control over Financial Reporting As a result of our internal controls review during the preparation of our 2007 annual financial statements, we concluded that effective internal control over financial reporting was not maintained with respect to accounting for and disclosure of the fair value of compensation expense and period-end liabilities for certain stock-based incentive compensation plans. As this error resulted in a material audit adjustment to our statements for fiscal 2007 and a restatement of the 2007 interim financial statements to correct the Canadian to US GAAP reconciliation tables in the notes to the financial statements, we concluded that this constituted a material weakness in the Company's internal control over financial reporting and that the Company's internal control over financial reporting was not effective as at October 31, 2007. Although we believe that the reported material weakness is narrow in scope and that it does not have a pervasive impact on internal control over financial reporting at MDS, we will continue to evaluate our internal control over financial reporting on an ongoing basis and will upgrade and enhance internal control over financial reporting as needed. To address the identified material weakness, management implemented measures in the first quarter of 2008 to remediate the control deficiency, including review of certain stock-based incentive compensation plans with third-party compensation experts, the calculation of fair value for these plans using a Monte Carlo simulation, and a review of accounting regulations for stock-based compensation plans with third-party accounting experts. These measures have strengthened internal control associated with the calculation and reporting of the fair value of stock-based incentive compensation plan liability and expense. These measures were implemented prior to the preparation of the financial statements for the quarter ended January 31, 2008 and will be subject to the Company's assessment of internal controls in fiscal 2008. Consolidated Statements of Financial Position (unaudited) 2008 2007 As at April 30 with comparatives at October 31 Restated (millions of US dollars) (Note 2) ------------------------------------------------------------------------- ASSETS Current Assets Cash and cash equivalents $ 139 $ 235 Short-term investments - 102 Accounts receivable, net 260 287 Note receivable 73 - Unbilled revenue 111 99 Inventories, net 117 128 Income taxes recoverable 56 54 Current portion of deferred tax assets 47 45 Prepaid expenses and other 32 22 Assets held for sale 27 1 ------------------------------------------------------------------------- Total Current Assets 862 973 Property, plant and equipment, net 364 386 Deferred tax assets 31 4 Long-term investments and other 178 290 Goodwill 799 782 Intangible assets, net 510 583 ------------------------------------------------------------------------- Total Assets $ 2,744 $ 3,018 ------------------------------------------------------------------------- ------------------------------------------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Accounts payable and accrued liabilities $ 288 $ 384 Current portion of deferred revenue 75 71 Income taxes payable 16 57 Current portion of long-term debt 20 94 Current portion of deferred tax liabilities 33 10 Liabilities related to assets held for sale 12 - ------------------------------------------------------------------------- Total Current Liabilities 444 616 Long-term debt 280 290 Deferred revenue 14 17 Other long-term obligations 30 30 Deferred tax liabilities 139 168 ------------------------------------------------------------------------- Total Liabilities 907 1,121 ------------------------------------------------------------------------- Shareholders' Equity Common shares, at par - Authorized shares: unlimited; Issued and outstanding shares: 122,036,150 and 122,578,331 for April 30, 2008 and October 31, 2007, respectively. 494 493 Additional paid-in capital 75 72 Retained earnings 858 842 Accumulated other comprehensive income 410 490 ------------------------------------------------------------------------- Total shareholders' equity 1,837 1,897 ------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 2,744 $ 3,018 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Incorporated Under The Canada Business Corporations Act See accompanying notes. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) ------------------------------------------------------------------------- Three months Six months ended April 30 ended April 30 ------------------------------------------------------------------------- 2008 2007 2008 2007 (millions of US dollars, Restated Restated except per share amounts) (Note 2) (Note 2) ------------------------------------------------------------------------- Revenues Products $ 169 $ 129 $ 320 $ 234 Services 157 134 302 270 Reimbursement revenues 24 23 50 46 ------------------------------------------------------------------------- Total revenues 350 286 672 550 ------------------------------------------------------------------------- Costs and expenses Direct cost of products (106) (83) (201) (154) Direct cost of services (101) (82) (193) (172) Reimbursed expenses (24) (23) (50) (46) Selling, general and administration (75) (61) (139) (115) Research and development (22) (16) (42) (28) Depreciation and amortization (23) (18) (50) (32) Restructuring charges - net (1) (25) (1) (38) Other income (expenses) - net 10 (74) 6 (70) ------------------------------------------------------------------------- Total costs and expenses (342) (382) (670) (655) ------------------------------------------------------------------------- Operating income (loss) from continuing operations 8 (96) 2 (105) Interest expense (6) (8) (12) (14) Interest income 4 10 10 14 Mark-to-market on interest rate swaps - 1 2 1 Equity earnings 10 11 24 25 ------------------------------------------------------------------------- Income (loss) from continuing operations before income taxes 16 (82) 26 (79) Income tax (expense) recovery - current (3) 31 (25) 29 - deferred (2) (4) 27 (5) ------------------------------------------------------------------------- Income (loss) from continuing operations 11 (55) 28 (55) Income from discontinued operations - net of income tax - 792 - 808 ------------------------------------------------------------------------- Net income $ 11 $ 737 $ 28 $ 753 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Basic earnings (loss) per share - from continuing operations $ 0.09 $ (0.40) $ 0.23 $ (0.39) - from discontinued operations - 5.77 - 5.73 ------------------------------------------------------------------------- Basic earnings per share $ 0.09 $ 5.37 $ 0.23 $ 5.34 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Diluted earnings (loss) per share - from continuing operations $ 0.09 $ (0.40) $ 0.23 $ (0.39) - from discontinued operations - 5.75 - 5.72 ------------------------------------------------------------------------- Diluted earnings per share $ 0.09 $ 5.35 $ 0.23 $ 5.33 ------------------------------------------------------------------------- ------------------------------------------------------------------------- See accompanying notes CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) Three months Six months ended April 30 ended April 30 2008 2007 2008 2007 Restated Restated (Note 2) (Note 2) ------------------------------------------------------------------------- Net income $ 11 $ 737 $ 28 $ 753 ------------------------------------------------------------------------- Foreign currency translation (1) 41 (75) 28 Unrealized gain (loss) on available-for-sale assets - - 1 (3) Unrealized gain (loss) on derivatives designated as cash flow hedges, net of tax - 5 (4) 5 Reclassification of realized losses - (2) - (2) Repurchase and cancellation of Common shares (1) (33) (2) (33) ------------------------------------------------------------------------- Other comprehensive income (loss) $ (2) $ 11 $ (80) $ (5) ------------------------------------------------------------------------- Comprehensive income (loss) $ 9 $ 748 $ (52) $ 748 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Consolidated Statements of Cash Flows (UNAUDITED) Three months Six months ended April 30 ended April 30 2008 2007 2008 2007 Restated Restated (millions of US dollars) (Note 2) (Note 2) ------------------------------------------------------------------------- Operating activities Net income $ 11 $ 737 $ 28 $ 753 Less: Income from discontinued operations - net of tax - 792 - 808 ------------------------------------------------------------------------- Income (loss) from continuing operations 11 (55) 28 (55) Adjustments to reconcile net income to cash provided (used in) operating activities relating to continuing operations: Items not affecting current cash flow (1) 132 29 160 Changes in non-cash operating assets and liabilities balances relating to operations (24) 34 (128) 1 ------------------------------------------------------------------------- Cash provided by (used in) operating activities of continuing operations (14) 111 (71) 106 Cash used in operating activities of discontinued operations - (69) - (53) ------------------------------------------------------------------------- (14) 42 (71) 53 ------------------------------------------------------------------------- Investing activities Acquisitions (2) (603) (2) (603) Purchase of property, plant and equipment (15) (7) (28) (16) Proceeds on sale of property, plant and equipment 2 - 3 - Proceeds on sale of short-term investments - 25 101 151 Purchases of short-term investments - (15) - (37) Proceeds on sale of long-term investment 4 2 7 13 Other (2) (1) (2) - ------------------------------------------------------------------------- Cash provided by (used in) investing activities of continuing operations (13) (599) 79 (492) ------------------------------------------------------------------------- Cash provided by investing activities of discontinued operations - 929 - 929 ------------------------------------------------------------------------- (13) 330 79 437 ------------------------------------------------------------------------- Financing activities Repayment of long-term debt (1) (1) (81) (7) Decrease in deferred revenue and other long-term obligations (1) (1) - - Payment of cash dividends - - - (3) Issuance of shares 4 6 5 10 Repurchase of shares (12) (441) (17) (441) ------------------------------------------------------------------------- Cash used in financing activities of continuing operations (10) (437) (93) (441) ------------------------------------------------------------------------- Cash used in financing activities of discontinued operations - - - (2) ------------------------------------------------------------------------- (10) (437) (93) (443) ------------------------------------------------------------------------- Effect of foreign exchange rate changes on cash and cash equivalents 32 28 (11) 4 ------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents during the period (5) (37) (96) 51 Cash and cash equivalents, beginning of period 144 335 235 247 ------------------------------------------------------------------------- Cash and cash equivalents, end of period $ 139 $ 298 $ 139 $ 298 ------------------------------------------------------------------------- ------------------------------------------------------------------------- See accompanying notes NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (All tabular amounts in millions of US dollars, except where noted) 1. Basis of Presentation The accompanying unaudited consolidated financial statements have been prepared by the Company in United States (US) dollars and in accordance with US generally accepted accounting principles (US GAAP) for interim financial reporting, which do not conform in all respects to the requirements of US GAAP for annual financial statements. Accordingly, these condensed notes to the unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto prepared in accordance with US GAAP that are contained in the Company's amended Annual Report for the fiscal year ended October 31, 2007, filed on January 29, 2008 with the US Securities and Exchange Commission, the Ontario Securities Commission, and other securities regulatory authorities in Canada. These interim consolidated financial statements have been prepared using accounting policies that are consistent with the policies used in preparing the Company's audited consolidated financial statements for the year ended October 31, 2007. There have been no material changes to the Company's significant accounting policies since October 31, 2007, except as described below under "Recently Adopted Accounting Pronouncements". These policies are consistent with accounting principles generally accepted in Canada (Canadian GAAP) in all material respects except as described in Note 19. Use of Estimates In preparing the Company's consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the dates of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from these estimates and the operating results for the interim periods presented are not necessarily indicative of the results expected for the full year. On an ongoing basis, management reviews its estimates to ensure that these estimates appropriately reflect changes in the Company's business and new information as it becomes available. If historical experience and other factors used by management to make these estimates do not reasonably reflect future activity, the Company's results of operations and financial position could be materially impacted. 2. Changes Affecting Fiscal 2008 Consolidated Financial Statements a. Restatement of 2007 Interim Financial Statements During the preparation of the 2007 annual financial statements, an error was identified in the US GAAP reconciliation provided as part of the fiscal 2007 interim financial statements with respect to certain stock-based incentive compensation plans for which an incorrect valuation methodology was utilized. The Company has corrected this error by restating selling, general and administration expenses for the three months ended April 30, 2007 with a reduction of $1 million in the accompanying quarterly consolidated financial statements and reducing the value of accrued liabilities by a similar amount. The Canadian GAAP financial statements previously reported were not impacted by the change, except for the reconciliation to US GAAP (see Note 19). b. Recently adopted accounting pronouncements On November 1, 2007, the Company adopted the provisions of the US Financial Accounting Standards Board (FASB) interpretation # 48 (FIN 48), "Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement # 109". FIN 48 clarifies accounting for uncertainty in income taxes recognized in an enterprise's financial statements and prescribes a recognition threshold of more likely than not to be sustained upon audit examination. As a result of the implementation an adjustment to the liability for unrecognized tax benefits was not required; accordingly, no adjustment was made to opening retained earnings at November 1, 2007. At February 1, 2008, the total amount of unrecognized tax benefits, including interest and penalties, was $28 million. Of these unrecognized tax benefits, $21 million, if recognized, would favourably affect the effective income tax rate in the future. The amount of unrecognized tax benefits at April 30, 2008, including interest and penalties, is $29 million. The Company accrues interest and penalties relating to unrecognized tax benefits in its provision for income taxes. As of February 1, 2008, the balance of accrued interest and penalties was $5 million. During the quarter there was an increase to the liability for interest and penalties by approximately $1 million. MDS is subject to taxation in Canada and the US, its principal jurisdictions, and in numerous other countries around the world. With few exceptions, MDS is no longer subject to examination by Canadian tax authorities for tax years before 2002, while most tax returns for 2002 and beyond remain open for examination. Tax returns filed in the US generally are not subject to examination for years before 2003, while 2003 and subsequent US tax filings generally remain open for audit by tax authorities. In certain circumstances, selective returns in earlier years are also open for examination. 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 on November 1, 2008. The Company is currently evaluating the effects 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 fiscal 2009 and is currently evaluating the effects of the adoption of SFAS 159. The adoption is not expected to have a material impact on the consolidated results of operations and financial condition. 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 after October 31, 2009. The Company is currently evaluating the effects that the adoption of SFAS 141R will have on its consolidated results of operations and financial condition and is not yet in a position to determine such effects. d. In December 2007, the FASB issued SFAS # 160, "Non-controlling Interests in Consolidated Financial Statements- an Amendment of ARB # 51". SFAS 160 is effective for fiscal years beginning after December 15, 2008. 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 the Company's consolidated results of operations and financial condition. e. In March 2008, the FASB issued SFAS # 161, "Disclosures about Derivative Instruments and Hedging Activities - An Amendment of FASB Statement 133 (SFAS 133) SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008. MDS plans to adopt the provisions of SFAS 161 on February 1, 2009. f. In April 2008, the FASB issued Financial Statement Position SFAS 142-3, "Determination of the Useful Life of Intangible Assets" (FSP 142-3). FSP 142-3 provides guidance with respect to estimating the useful lives of recognized intangible assets acquired on or after the effective date and requires additional disclosure related to the renewal or extension of the terms of recognized intangible assets. FSP 142-3 is effective for fiscal years and interim periods beginning after December 15, 2008. The adoption is not expected to have a material impact on the Company's consolidated results of operations and financial condition. g. MDS has been monitoring the deliberations and progress being made by accounting standard setting bodies and securities regulators both in Canada and the United States with respect to their plans regarding convergence to International Financial Reporting Standards (IFRS). The Accounting Standards Board in Canada and the Canadian Securities Administrators (CSA) have recently confirmed that domestic issuers will be required to transition to IFRS for fiscal years beginning on or after January 1, 2011. The CSA in a Concept Paper released on February 13, 2008, provided a tentative conclusion that allows domestic issuers who are also Securities and Exchange Commission (SEC) registrants, like MDS, to continue to report under US GAAP for a further two years from the transition date. Separately, the SEC in late 2007 also eliminated the requirement of reconciling financial statements to US GAAP for foreign private issuers that file under IFRS effective November 15, 2007. MDS adopted US GAAP as the primary reporting standard for the Company's consolidated financial statements in fiscal 2007. MDS commenced reporting under US GAAP to improve the comparability of the financial information with that of its competitors, the majority of whom are US-based multinational companies that report under US GAAP. If current proposals by the CSA are approved without changes, the earliest the company will be required to adopt IFRS as the primary reporting standard will be in fiscal 2014. MDS may adopt IFRS as the primary reporting standard earlier if the SEC either requires domestic registrants in the US to transition to IFRS prior to fiscal 2014 or if it permits domestic registrants to voluntarily adopt IFRS prior to fiscal 2014 and the majority of the Company's competitors commence to report under IFRS. 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 $600 million, paid in cash from existing cash on hand. Included in the consideration was $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 $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 estimated fair values of the assets acquired and liabilities assumed. The purchase price and related allocations were finalized in the second quarter of 2008 as follows: ------------------------------------------------------------------------- April 30, October 31, 2008 2007 ------------------------------------------------------------------------- Net tangible assets $ 21 $ 15 Developed technologies (five-year weighted average useful life) 161 161 Brands 30 60 Goodwill 388 364 ------------------------------------------------------------------------- Total purchase price $ 600 $ 600 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Since October 31, 2007, the principal change in the purchase price allocation relates to a lower value placed upon acquired brands of $30 million. The following table summarizes the components of the net tangible assets acquired at fair value: ------------------------------------------------------------------------- April 30, October 31, 2008 2007 ------------------------------------------------------------------------- Inventories $ 40 $ 40 Property, plant and equipment 12 12 Other assets and liabilities, net (31) (37) ------------------------------------------------------------------------- Net tangible assets acquired $ 21 $ 15 ------------------------------------------------------------------------- ------------------------------------------------------------------------- The value of brands decreased due to shortened estimates of useful lives as the final valuation of intangibles was completed in the second quarter. Net tangible assets increased as a result of the final valuation of deferred revenue being completed in the second quarter and there was a decrease in the deferred tax liability recorded following a decrease in the brand value. The changes in fair values were reflected in the adjustment of the goodwill balance. Pro forma information The following unaudited pro forma information is provided for MDS assuming the acquisition of MD occurred on November 1, 2006. Three months Six months ended April 30 ended April 30 ------------------------------------------------------------------------- 2008 2007 2008 2007 ------------------------------------------------------------------------- Revenues $ 350 $ 308 $ 672 623 ------------------------------------------------------------------------- Income (loss) from continuing operations, net of income taxes 11 (75) 28 (78) Income from discontinued operations, net of income taxes - 792 - 808 ------------------------------------------------------------------------- Net income $ 11 $ 717 $ 28 $ 730 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Earnings per share Basic $ 0.09 $ 5.08 $ 0.23 $ 5.17 Diluted $ 0.09 $ 5.07 $ 0.23 $ 5.16 ------------------------------------------------------------------------- ------------------------------------------------------------------------- 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. 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 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. 5. Discontinued Operations and Assets Held for Sale a. In November 2007, the Company signed an agreement to sell its external beam therapy and self-contained irradiator product lines. The sale closed effective May 1, 2008 and a purchase price adjustment and closing costs will be finalized in the third quarter. Under the terms of this agreement, Best Medical International Inc., a provider of radiotherapy and oncology products, purchased MDS Nordion's external beam therapy and self-contained irradiator product lines for $15 million in cash. Best Medical International Inc. acquired these two product lines, which have combined annualized revenues of approximately $32 million and approximately 150 employees. Once the Company made the decision to dispose of the product lines, 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 in the first quarter of 2008. Related to the disposal, $1 million of the loss was allocated to the impairment of goodwill. In accordance with SFAS # 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits", a pension curtailment gain of approximately $1 million was recorded as a result of the transfer of employees to Best Medical International Inc. The related assets have been reclassified as assets held for sale as of the second quarter of 2008. Assets held for sale and liabilities related to assets held for sale comprised: As at As at April 30 October 31 ------------------------------------------------------------------------- 2008 2007 ------------------------------------------------------------------------- Assets held for sale Accounts receivable, net $ 5 $ - Inventories, net 20 - Property, plant and equipment, net 2 - Long-term investments and other - 1 ------------------------------------------------------------------------- Total assets held for sale $ 27 $ 1 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Liabilities related to assets held for sale Accounts payable and accrued liabilities $ 9 $ - Deferred revenue 3 - ------------------------------------------------------------------------- Total liabilities related to assets held for sale $ 12 $ - ------------------------------------------------------------------------- ------------------------------------------------------------------------- b. 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 in the quarter and the six months ended April 30, 2007 were as follows: ------------------------------------------------------------------------- Second Quarter Year-to-date ------------------------------------------------------------------------- 2007 2007 ------------------------------------------------------------------------- Net revenues $ 20 $ 95 Cost of revenues (12) (58) Selling, general and administration (6) (15) ------------------------------------------------------------------------- Operating income 2 22 Gain on sale of discontinued operations 905 905 Interest income - 1 Income taxes (114) (117) Minority interest (1) (4) Equity earnings - 1 ------------------------------------------------------------------------- Income from discontinued operations $ 792 $ 808 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Basic earnings per share from discontinued operations $ 5.77 $ 5.73 ------------------------------------------------------------------------- ------------------------------------------------------------------------- 6. Inventories As at As at April 30 October 31 ------------------------------------------------------------------------- 2008 2007 ------------------------------------------------------------------------- Raw materials and supplies $ 78 $ 83 Work-in process 23 34 Finished goods 30 26 ------------------------------------------------------------------------- 131 143 Allowance for excess and obsolete inventory (14) (15) ------------------------------------------------------------------------- Inventories net $ 117 $ 128 ------------------------------------------------------------------------- ------------------------------------------------------------------------- 7. Long-Term Investments and Other As at As at April 30, October 31, ------------------------------------------------------------------------- 2008 2007 ------------------------------------------------------------------------- Financial instrument pledged as security on long-term debt (note a) $ 42 $ 46 Long-term notes receivable (note c) 40 125 Equity investments (note d) 6 10 Equity investments in joint ventures (note d) 23 38 Available for sale investments (note b) 16 24 Deferred pension assets 40 39 Other long-term investments 11 4 Venture capital investments - 4 ------------------------------------------------------------------------- Long-term investments and other $ 178 $ 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. b. Asset Backed Commercial Paper Included with available for sale investments is an investment in non-bank sponsored asset backed commercial paper (ABCP) issued by two trusts with an original cost of $17 million. These investments matured in September 2007 but as a result of liquidity issues in the ABCP market, did not settle at maturity. In September 2007, a Pan-Canadian Investors Committee for Third Party Asset Backed Commercial Paper (the Committee) was formed to propose a solution to the liquidity problem in the ABCP market. Whilst no adjustment was recorded in the first quarter of 2008, an impairment loss of $2 million was recognized in the fourth quarter of fiscal 2007. In March 2008, the Committee filed with the Ontario Superior Court of Justice a restructuring arrangement. The holders of ABCP voted in favour of the Committee's restructuring plan. The Company has estimated the fair value of its investments in ABCP using all currently available information and assumptions that market participants would use in pricing such investments. The Company reviewed information provided by the Committee, JP Morgan, DBRS, current investment ratings, valuation estimates of the underlying assets and general economic conditions. Accordingly, the Company used a scenario-based probability-weighted discounted cash flow approach to value its investment at April 30, 2008 and recognized an impairment loss of $3 million in the second quarter of 2008 representing a 20% reduction of the face value of the investments and for a total write-down of $5 million representing a 30% reduction in the fair value of the investment. A change in the estimate of the composition of the underlying assets may affect the face value of the investments in the future. c. 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 Atomic Energy of Canada Limited related to the MAPLE reactor project, a long-term note receivable for $38 million after discounting 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 value as at April 30, 2008 is $48 million, of which $8 million is included in prepaid expenses and other. The note receivable will be accreted up to its face amount of C$53 million over a period of four years. A $73 million note receivable relating to the sale of the diagnostics business referred to in Note 5 was reclassified from long-term investments and other to note receivable as it is now due within one year. d. Equity investments As at As at April 30 October 31 ------------------------------------------------------------------------- 2008 2007 ------------------------------------------------------------------------- Lumira Capital Corp $ 6 $ 10 MDS Sciex joint ventures 23 38 ------------------------------------------------------------------------- Equity investments $ 29 $ 48 ------------------------------------------------------------------------- ------------------------------------------------------------------------- The Company accounts for its investments in significantly influenced companies and joint ventures using the equity method of accounting. 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 expenses. In February 2008, the Company received $4 million in cash from Lumira as a distribution and reduction in stated capital. The Company reduced its investment in Lumira accordingly. 8. Restructuring Charges An analysis of the activity in the provision through April 30, 2008 is as follows: Provision Cumulative drawdowns Balance at Restructuring ----------------------- April 30, Charge Cash Non-cash 2008 ------------------------------------------------------------------------- 2005: Workforce reductions $ 34 $ (33) $ (1) $ - Equipment and other asset write-downs - adjustment 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 $ (13) $ (2) $ 2 Equipment and other asset write-downs 2 (1) 2 3 Contract cancellation charges 5 (6) 1 - Other 14 (11) (3) - ------------------------------------------------------------------------- $ 38 $ (31) $ (2) $ 5 ------------------------------------------------------------------------- $ 5 ------------------------------------------------------------------------- ------------------------------------------------------------------------- In the second quarter of 2008 there was a restructuring charge of $1 million, and cash utilization of $2 million. The remaining balance primarily relates to the MDS Pharma Services segment. The restructuring activities will be completed by the end of 2009. 9. Other Income (Expenses) Three months Six months ended April 30 ended April 30 ------------------------------------------------------------------------- 2008 2007 2008 2007 ------------------------------------------------------------------------- Write-down of investments/ valuation provisions (3) (6) (3) (6) Gain on sale of investment - - 2 2 Loss on sale of Hamburg clinic - (4) - (4) Gain (loss) on sale of business - 1 (4) 1 Curtailment gain on pension 1 - 1 - Acquisition integration costs (1) (1) (1) (1) FDA provision 10 (61) 10 (61) Foreign exchange gain (loss) (1) (4) 3 (1) Gain (loss) on embedded derivatives 3 - (1) - Other 1 1 (1) - ------------------------------------------------------------------------- Other income (expense) - net $ 10 $ (74) $ 6 $ (70) ------------------------------------------------------------------------- ------------------------------------------------------------------------- During the second quarter of 2008, a write-down of investments of $3 million relating to the impairment loss on the Company's investment in asset-backed commercial paper was taken. In the second quarter of 2007, the Company recorded a provision of $61 million to reimburse clients who have incurred or will incur third- party audit costs or study re-run costs to complete the work required by the US Food and Drug Administration (FDA) or other regulators. We have utilized approximately $19 million of this reserve to date, an amount partially offset by the impact of foreign currency fluctuations on the liability. Although we believe we have substantially completed the majority of all required site audits, we still await final reimbursement requests for many of these audits. Based on information currently available, we believe that a reserve of approximately $33 million is required to cover study audits, re-runs and other related costs. Accordingly, approximately $10 million has been reversed this quarter. Management will continue to closely monitor the FDA matter and related provision. 10. Earnings Per Share a. Dilution Three months Six months ended April 30 ended April 30 ------------------------------------------------------------------------- (number of shares in millions) 2008 2007 2008 2007 ------------------------------------------------------------------------- Weighted average number of Common shares outstanding - basic 122 137 122 141 Impact of stock options assumed exercised - 1 - - ------------------------------------------------------------------------- Weighted average number of Common shares outstanding - diluted 122 138 122 141 ------------------------------------------------------------------------- ------------------------------------------------------------------------- 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 Six months ended April 30 ended April 30 ------------------------------------------------------------------------- 2008 2007 2008 2007 ------------------------------------------------------------------------- Net income $ 11 $ 737 $ 28 $ 753 Compensation expense for options granted prior to November 1, 2003 - - - (1) ------------------------------------------------------------------------- Net income - pro-forma $ 11 $ 737 $ 28 $ 752 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Pro-forma basic earnings per share $ 0.09 $ 5.37 $ 0.23 $ 5.34 Pro-forma diluted earnings per share $ 0.09 $ 5.35 $ 0.23 $ 5.33 ------------------------------------------------------------------------- ------------------------------------------------------------------------- 11. Share Capital At April 30, 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 April 30, 2008: (number of shares in thousands) Number Amount ------------------------------------------------------------------------- Common shares Balance as at October 31, 2007 122,578 $ 493 Issued during the period 330 5 Repurchased during the period (872) (4) ------------------------------------------------------------------------- Balance as at April 30, 2008 122,036 $ 494 ------------------------------------------------------------------------- ------------------------------------------------------------------------- During the second quarter, the Company repurchased and cancelled 619,700 Common shares under a normal course issuer bid for a cost of $12 million. Of the total cost, $3 million was charged to share capital, $1 million was charged to other comprehensive income and $8 million was charged to retained earnings. For the six months ended April 30, 2008, $4 million was charged to share capital, $2 million was charged to comprehensive income and $11 million was charged to retained earnings. A share repurchase of 63,200 shares was entered into on April 30, 2008 and will settle in the first week of May 2008. The total cost of this repurchase was $1 million. 12. Stock-based Compensation Average C$ 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 39 20.29 Exercised (330) 16.29 Cancelled or forfeited (184) 20.87 ------------------------------------------------------------------------- Balance as at April 30, 2008 5,080 $ 19.84 ------------------------------------------------------------------------- ------------------------------------------------------------------------- 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 12 17.91 ------------------------------------------------------------------------- Balance as at April 30, 2008 12 $ 17.91 ------------------------------------------------------------------------- ------------------------------------------------------------------------- During the quarter, the Company granted 30,000 C$ options and 10,000 US$ options (2007 - 280,500 and nil) at an average exercise price of C$20.50 and US$17.74, respectively (2007 - C$21.84 and US$ nil). These options have a fair value determined using the Black-Scholes model of C$4.40 and US$4.07 per share respectively (2007 - C$4.62 and US$ nil) based on the following: C$ options 2008 2007 ------------------------------------------------------------------------- Risk-free interest rate 3.0% 3.9% Expected dividend yield 0.0% 0.0% Expected volatility 21% 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 22% - Expected time to exercise (years) 4.40 - ------------------------------------------------- ----------- ----------- ------------------------------------------------- ----------- ----------- The stock compensation expense for the six months ended April 30, 2008 was $3 million (six months ended April 30, 2007 - $1 million), which has been recorded in selling, general and administration expenses and as additional paid in-capital within share capital. 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 of C$22.00 and C$26.00 respectively. The term of the Performance Share Units (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 of between US $1.17 and US $1.31. 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 MTIP 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 April 30, October 31, Liability 2008 2007 ------------------------------------------------------------------------- 2006 Plan $ 4 $ 11 2007 Plan 2 3 2008 Plan 2 - ------------------------------------------------------------------------- Total $ 8 $ 14 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Three months Six months Expense (Income) ended April 30 ended April 30 ------------------------------------------------------------------------- 2008 2007 2008 2007 ------------------------------------------------------------------------- 2006 Plan $ 1 $ 2 $ (4) $ 1 2007 Plan 1 - (1) - 2008 Plan 1 - 1 - ------------------------------------------------------------------------- Total $ 3 $ 2 $ (4) $ 1 ------------------------------------------------------------------------- ------------------------------------------------------------------------- 13. Accumulated Other Comprehensive Income As at As at April 30, October 31, (millions of US dollars) 2008 2007 ------------------------------------------------------------------------- Accumulated other comprehensive income, net of income taxes, beginning of period $ 490 $ 328 Foreign currency translation (75) 183 Unrealized gain on available-for-sale assets, net of tax 1 (3) Unrealized gain (loss) on derivatives designated as cash flow hedges, net of tax (4) 8 Reclassification of realized gains, net of tax - (4) Adoption of FAS 158 - 11 Repurchase and cancellation of Common shares (2) (33) ------------------------------------------------------------------------- Accumulated other comprehensive income, net of income taxes, end of period $ 410 $ 490 ------------------------------------------------------------------------- ------------------------------------------------------------------------- The foreign currency translation gain in 2007 was mainly a result of the effect of the strengthening Canadian dollar (approximately 19% for 2007) and the strengthening euro on assets and earnings. The foreign currency translation loss in 2008 was mainly a result of the effect of the weakening Canadian dollar (approximately 6% for the first two quarters of 2008) on Canadian denominated assets. 14. Employee Benefit Plans 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. Defined Benefit Pension Plans: Three months Six months ended April 30 ended April 30 ------------------------------------------------------------------------- 2008 2007 2008 2007 ------------------------------------------------------------------------- Service cost $ 1 $ 1 $ 2 $ 2 Interest cost 3 2 6 4 Expected return on plan assets (4) (3) (8) (6) Recognition of actuarial gains - (1) - (1) Curtailment gain (1) - (1) - ------------------------------------------------------------------------- $ (1) $ (1) $ (1) $ (1) ------------------------------------------------------------------------- ------------------------------------------------------------------------- Other Benefit Plans: Three months Six months ended April 30 ended April 30 ------------------------------------------------------------------------- 2008 2007 2008 2007 ------------------------------------------------------------------------- Service cost $ - $ - $ - $ - Interest cost 1 1 1 1 Expected return on plan assets - - - - ------------------------------------------------------------------------- $ 1 $ 1 $ 1 $ 1 ------------------------------------------------------------------------- ------------------------------------------------------------------------- MDS has recorded a curtailment gain of $1 million related to the transfer of staff from MDS to Best Medical International Inc. as a result of the sale of the external beam therapy and self-contained irradiator product lines, as per Note 5. 15. Supplementary Cash Flow Information Non-cash items affecting net income comprise: Three months Six months ended April 30 ended April 30 ------------------------------------------------------------------------- 2008 2007 2008 2007 ------------------------------------------------------------------------- Depreciation and amortization $ 23 $ 18 $ 50 $ 32 Stock option compensation 2 - 3 1 Deferred revenue 1 - - (2) Deferred income taxes (15) 31 (27) 47 Equity earnings - net of distribution (2) 9 10 9 Write-down of investments 3 10 3 10 Loss on disposal of equipment and other assets 2 4 4 2 Mark-to-market of derivatives (3) (1) 1 (1) FDA provision (reversal) (10) 61 (10) 61 Other (2) - (5) 1 ------------------------------------------------------------------------- $ (1) $ 132 $ 29 $ 160 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Prior year comparatives have been reclassified to conform to the current year presentation Changes in non-cash operating assets and liabilities balances relating to operations include: Three months Six months ended April 30 ended April 30 (millions of US dollars) 2008 2007 2008 2007 ------------------------------------------------------------------------- Accounts receivable $ 13 $ (5) $ 20 $ 8 Unbilled revenue (7) 27 (13) 11 Inventories (3) (3) (2) (7) Prepaid expenses and others 11 35 (1) 11 Accounts payable and accrued liabilities (25) 1 (92) (13) Income taxes (19) (21) (46) (9) Deferred income 4 - 4 - Other operating asset and liabilities 2 - 2 - ------------------------------------------------------------------------- $ (24) $ 34 $ (128) $ 1 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Prior year comparatives have been reclassified to conform to the current year presentation 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 ended April 30, 2008 ------------------------------------------------------------------------- MDS MDS Pharma MDS Analytical Corporate Services Nordion Technologies and Other Total ------------------------------------------------------------------------- Product revenues $ - $ 76 $ 93 $ $ 169 Service revenues 128 4 25 157 Reimbursement revenues 24 - - 24 ------------------------------------------------------------------------- Total revenues 152 80 118 350 Direct product cost - (42) (64) (106) Direct service cost (95) (2) (4) (101) Reimbursed expenses (24) - - (24) Selling, general and administration (33) (13) (22) (7) (75) Research and development - (2) (20) - (22) Depreciation and amortization (8) (3) (12) - (23) Restructuring charges - net (1) - - - (1) Other income (expenses) - net 9 3 - (2) 10 Equity earnings - - 10 - 10 ------------------------------------------------------------------------- Segment earnings (loss) $ - $ 21 $ 6 $ (9) $ 18 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Total assets $ 793 $ 692 $ 820 $ 412 $ 2,717 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Capital expenditures $ 9 $ 3 $ 1 $ 2 $ 15 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Total assets exclude assets held for sale. In segment reporting, equity earnings are included in the determination of segment earnings (loss). Excluding equity earnings of $10 million (2007 - $11 million) results in operating earnings of $8 million (2007 - $96 million loss). Three months ended April 30, 2007 ------------------------------------------------------------------------- MDS MDS Pharma MDS Analytical Corporate Services Nordion Technologies and Other Total ------------------------------------------------------------------------- Product revenues $ - $ 67 $ 62 $ - $ 129 Service revenues 115 4 15 - 134 Reimbursement revenues 23 - - - 23 ------------------------------------------------------------------------- Total revenues 138 71 77 - 286 Direct product cost - (35) (48) - (83) Direct service cost (80) (1) (1) - (82) Reimbursed expenses (23) - - - (23) Selling, general and administration (32) (12) (11) (6) (61) Research and development - (1) (15) - (16) Depreciation and amortization (10) (3) (4) (1) (18) Restructuring charges - net (23) - - (2) (25) Other income (expenses) - net (68) 1 (1) (6) (74) Equity earnings - - 11 - 11 ------------------------------------------------------------------------- Segment earnings (loss) $ (98) $ 20 $ 8 $ (15) $ (85) ------------------------------------------------------------------------- ------------------------------------------------------------------------- Total assets $ 810 $ 660 $ 819 $ 435 $ 2,724 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Capital expenditures $ 5 $ 1 $ 1 $ - $ 7 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Six months ended April 30, 2008 ------------------------------------------------------------------------- MDS MDS Pharma MDS Analytical Corporate Services Nordion Technologies and Other Total ------------------------------------------------------------------------- Product revenues $ - $ 135 $ 185 $ - $ 320 Service revenues 248 5 49 - 302 Reimbursement revenues 50 - - - 50 ------------------------------------------------------------------------- Total revenues 298 140 234 - 672 Direct product cost - (76) (125) - (201) Direct service cost (183) (2) (8) - (193) Reimbursed expenses (50) - - - (50) Selling, general and administration (62) (24) (41) (12) (139) Research and development - (2) (40) - (42) Depreciation and amortization (17) (6) (27) - (50) Restructuring charges - net (1) - - - (1) Other income (expenses) - net 14 (5) (2) (1) 6 Equity earnings - - 24 - 24 ------------------------------------------------------------------------- Segment earnings (loss) $ (1) $ 25 $ 15 $ (13) $ 26 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Total assets $ 793 $ 692 $ 820 $ 412 $ 2,717 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Capital expenditures $ 15 $ 6 $ 3 $ 4 $ 28 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Total assets exclude assets held for sale. In segment reporting, equity earnings are included in the determination of segment earnings (loss). Excluding equity earnings of $24 million (2007 - $25 million) results in an operating earnings of $2 million (2007 - 105 million loss) Six months ended April 30, 2007 ------------------------------------------------------------------------- MDS MDS Pharma MDS Analytical Corporate Services Nordion Technologies and Other Total ------------------------------------------------------------------------- Product revenues $ - $ 134 $ 100 $ - $ 234 Service revenues 236 4 30 - 270 Reimbursement revenues 46 - - - 46 ------------------------------------------------------------------------- Total revenues 282 138 130 - 550 Direct product cost - (69) (85) - (154) Direct service cost (169) (2) (1) - (172) Reimbursed expenses (46) - - - (46) Selling, general and administration (65) (23) (17) (10) (115) Research and development - (2) (26) - (28) Depreciation and amortization (18) (6) (7) (1) (32) Restructuring charges - net (31) - - (7) (38) Other income (expenses) - net (66) 1 (2) (3) (70) Equity earnings - - 25 - 25 ------------------------------------------------------------------------- Segment earnings (loss) $ (113) $ 37 $ 17 $ (21) $ (80) ------------------------------------------------------------------------- ------------------------------------------------------------------------- Total assets $ 810 $ 660 $ 819 $ 435 $ 2,724 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Capital expenditures $ 7 $ 2 $ 4 $ 3 $ 16 ------------------------------------------------------------------------- ------------------------------------------------------------------------- 17. Financial Instruments The carrying amounts and fair values for all derivative financial instruments are as follows: As at April 30 As at October 31 2008 2007 ------------------------------------------------------------------------- Carrying Fair Carrying Fair Amount Value Amount Value ------------------------------------------------------------------------- Asset (liability) position: Currency forward and option - assets $ - $ - $ 7 $ 7 Currency forward and option - liabilities $ (2) $ (2) $ (12) $ (12) Interest rate swap and option contracts $ - $ - $ (1) $ (1) ------------------------------------------------------------------------- ------------------------------------------------------------------------- As of April 30, 2008, the Company had outstanding foreign exchange contracts in place to sell $54 million at a weighted average exchange rate of C$1.0143 maturing over the next twelve months. In addition to the above derivatives, isotope supply agreements totalling $123 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 April 30, 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 gain of $3 million on the contract in the second quarter of 2008 ($1 million loss year to date). There was no significant mark-to-market adjustment required for the second quarter of 2007. 18. Income Taxes The Company's effective tax rate this quarter was 31%. The tax expense was reduced by $2 million of tax credits relating to research and development that were recognized during the quarter. The tax benefit recorded this quarter on the ABCP provision reflects the fact that any tax loss arising on ABCP will be treated as a capital loss. Three months to April 30 ------------------------------------------------------------------------- 2008 2007 ------------------------------------------------------------------------- Expected income tax expense (recovery) at MDS's 33% (2007 - 35%) statutory rate $ 5 $ (28) Increase (decrease) to tax expense as a result of: Tax credits for research and development (2) (5) Valuation provisions 1 2 Foreign losses not recognized - 4 Other 1 - ------------------------------------------------------------------------- Reported income tax expense (recovery) $ 5 $ (27) ------------------------------------------------------------------------- ------------------------------------------------------------------------- 19. Differences Between Canadian and US Generally Accepted Accounting Principles 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 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 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. The amount by which plan assets exceed benefit obligations or benefit obligations exceed plan assets, on a plan- by-plan basis, is reflected as an increase in assets or liabilities, with a corresponding adjustment to accumulated other comprehensive income. 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. i. As per Note 3 (g): The Accounting Standards Board announced that Canadian Generally Accepted Accounting Principles for publicly accountable enterprises will be replaced with International Financial Reporting Standards (IFRS) for fiscal years beginning on or after January 1, 2011. While domestic issuers will be required to make the transition by 2011, the CSA in a Concept Paper provided a tentative conclusion allowing domestic issuers who are also SEC registrants, like MDS, to continue to report under US GAAP for two years from the transaction date of 2011. Early conversion to IFRS for fiscal years beginning on or after January 1, 2009 may also be permitted. DATASOURCE: MDS Inc. CONTACT: PRNewswire - - 06/05/2008

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