MDS Reports Second Quarter Fiscal 2004 Financial Results Continued
Progress in Repositioning for Growth TORONTO, June 2
/PRNewswire-FirstCall/ -- MDS Inc. (TSX: MDS; NYSE: MDZ), the
global health and life sciences company, today reported its second
quarter results and continues to deliver on commitment to deal with
under-performing businesses as part of the growth strategy. Second
Quarter Year-over-Year Highlights: - Revenues of $460 million, up
5% from $438 million - Completed the sale of two under performing
US joint venture laboratories - Reached an agreement in principal
to reorganize MDS Proteomics - Effective May 1, concluded tax
restructuring transaction with Hemosol As a result of accounting
adjustments associated with these activities, basic earnings per
share were ($0.25) compared to ($0.03) last year. Revenue growth of
5% in the quarter continued to be negatively impacted by the
continued weakness in the US dollar relative to the same quarter in
2003. Earnings per share from continuing operations before MDS
Proteomics and other items were $0.26 compared to $0.32 in the same
quarter last year. The operating performance in the quarter was
negatively impacted by a provision related to the carrying value of
MDS Proteomics and further costs related to change initiatives
begun last fall. It was positively impacted by the patent
settlement with Micromass. "Late last year we committed to dealing
with US Labs and MDS Proteomics, and we are executing on that
commitment," said John Rogers, President and CEO, MDS Inc. "I am,
however, disappointed with our operating performance in this
quarter. As we move through the remainder of the year, we will
continue to drive enhanced performance across all of MDS," he
added. Life Sciences Life Sciences segment revenues increased 5% to
$286 million up from $273 million in the prior years quarter.
Operating margin in the quarter was 20% similar to the same quarter
last year. Revenues across the segment were impacted by US currency
fluctuations. Performance in the quarter was driven by solid growth
in the isotopes business and more modest performance in the
pharmaceutical research services and analytical instruments
businesses. In the isotopes business, revenues increased 12% to $85
million, driven by increased cobalt sales in the gamma
sterilization business and strong demand in the nuclear medicine
business. The pharmaceutical research services business grew 3%
(10% when normalized for currency) over prior year to $131 million,
while growing backlog to $265 million up from $240 million in the
first quarter of 2004. The discovery/pre-clinical business has
recovered to beyond 2003 levels and the central laboratory business
continues to deliver solid performance. Revenue growth in the early
clinical research business was offset somewhat by softness in the
bioanalytical business. The analytical instruments business was
flat year-over-year at $70 million, (4% normalized for US
currency), a reflection of the strong base that was built in 2003
and the strength of the first quarter of 2004. Health Health
segment revenues grew 5% year-over-year to $174 million with growth
coming from both the diagnostics and distribution businesses.
Revenues in the Canadian laboratories business grew 4%. During the
quarter, the joint venture labs in New York and Georgia were sold
to LabCorp. Operating margins in the segment improved from 8% to
12% the result of the discontinued operations in the US, certain
one-time items and operational efficiencies achieved. Revenues in
the distribution business grew to $49 million up from $47 million
in the same period last year. Proteomics After the quarter, MDS
Proteomics announced a change to its business model and as a result
has initiated a plan to reorganize the obligations and the capital
structure of the company. The agreement in principle for this
reorganization will result in the following: - A reduction in MDS's
equity ownership in MDS Proteomics to less than 50% as well as a
further reduction in the cash burn rate at MDS Proteomics; - A
provision of $63 million to reduce the carrying value of goodwill
and other assets of MDS Proteomics; - In exchange for $15 million,
MDS Inc. will gain access to tax assets and an ongoing technology
access agreement; and - Implementation of the new revenue
generating business model to achieve cash flow breakeven operations
by the end of 2005. Once completed this reorganization will affect
the manner in which MDS Inc. accounts for its investment in MDSP in
the future and the impact that MDSP will have on its reported
earnings. Corporate On May 1 the Company completed the tax
reorganization transaction involving Hemosol. This transaction will
give the Company access to tax assets having a cash value of $120
million. We estimate that the Company will realize the benefit
provided by this transaction over the next eight years. Currency
fluctuations, related to 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 into mid-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. During the quarter, the Company
announced the creation of a new executive management role - Chief
Operating Officer. The position reflects our commitment to
strengthening and focusing our resources at every level of the
organization. An executive search firm has been retained to assist
in filling this important role. Outlook "Throughout the last
quarter we made significant progress in executing on our plan to
deal with our non-core businesses. Steps taken this quarter,
including the divestiture of two under-performing US joint ventures
and reorganizing the structure of MDS Proteomics, will minimize the
negative impact on our performance going forward. These changes, in
addition to executing on business strategies and our internal
infrastructure projects, position us to deliver stronger
performance as we move through the second half of 2004." 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 and 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 enables readers to reconcile 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. All financial
references in this document exclude the discontinued US
laboratories and generic radiopharmaceutical operations, and
therefore reflect our continuing operations, unless otherwise
noted. 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 Second
Quarter Six Months
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2004 2003 2004 2003
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Revenues $ 460 $ 438 $ 908 $ 856 Operating Income 5 41 67 94 Basic
earnings per share $ (0.25) $ (0.03) $ (0.05) $ 0.14 Revenues for
the second quarter increased 5% compared to 2003, despite the
continued weakness in the US dollar. Our isotopes business led
growth overall, rising 12% for the quarter. In the quarter, we
booked a significant provision to reduce the carrying value of our
investment in MDS Proteomics to nil. In addition, we recorded
further restructuring costs related to initiatives we began last
fall and to our exit from the Saskatchewan diagnostics market.
These costs were only partially offset by other gains. The second
quarter of fiscal 2003 was also affected by a number of special
items, making direct comparison of quarter-over-quarter results
difficult. The following table breaks out the impact of these
special items. Second Quarter Six Months
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2004 2003 2004 2003
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Operating income from continuing operations before MDS Proteomics
and other items $ 67 $ 74 $ 140 $ 137 MDS Proteomics - Operations
(10) (7) (21) (17) - Write-down of goodwill and other assets (63) -
(63) -
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Operating income from continuing operations, before other items (6)
67 56 120 Valuation provisions - (75) - (75) Restructuring charges
(6) - (6) - Patent settlement 14 39 14 39 Gain on sale of
businesses and other 3 10 3 10
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Operating income from continuing operations $ 5 $ 41 $ 67 $ 94
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These special items had the following impact on basic earnings per
share: Second Quarter Six Months
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2004 2003 2004 2003
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EPS from continuing operations before MDS Proteomics and other
items $ 0.26 $ 0.32 $ 0.57 $ 0.58 MDS Proteomics (0.46) (0.05)
(0.54) (0.12)
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EPS from continuing operations before other items (0.20) 0.27 0.03
0.46 Valuation provisions - (0.51) - (0.51) Restructuring charges
(0.02) - (0.02) - Patent settlement 0.06 0.18 0.06 0.18 Gain on
sale of businesses and other 0.02 0.06 0.02 0.06
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EPS from continuing operations (0.14) - 0.09 0.19 Discontinued
operations (0.11) (0.03) (0.14) (0.05)
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Basic EPS $ (0.25) $ (0.03) $ (0.05) $ 0.14
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Segment Results Second 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 $ 286 $ 57 20% $ 273 $ 57 21% Health 174 21 12% 165
(9) n/m
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460 78 17% 438 48 11% Proteomics - (73) n/m - (7) n/m
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$ 460 $ 5 1% $ 438 $ 41 9%
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n/m (equal sign) not meaningful Six 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 $ 571 $ 114 20% $ 532 $ 104 20% Health 337 37 11% 324
7 2%
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908 151 17% 856 111 13% Proteomics - (84) n/m - (17) n/m
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$ 908 $ 67 7% $ 856 $ 94 11%
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Life Sciences Review of operations - Revenues from Life Sciences
businesses for the quarter were: Second Quarter 2004 2003 Change
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Early-stage research $ 92 $ 88 5% Late-stage research 39 39 -
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Pharmaceutical research services 131 127 3%
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Gamma sterilization 21 18 17% Nuclear medicine 56 49 14% Therapy
systems 8 9 (11%)
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Isotopes 85 76 12%
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Analytical instruments 70 70 -
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$ 286 $ 273 5%
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During the second quarter, we received net proceeds of $14 million,
representing a final settlement with Micromass stemming from a
fiscal 2003 patent infringement judgment. This amount is included
in operating income for the segment and contributed 5% to the
operating margin for the quarter. The decline in operating margin
for the quarter excluding this item is attributable to lower than
expected margins in MDS Pharma Services, primarily a result of
softness in our bioanalytical business. Our isotopes business led
overall revenue growth in Life Sciences with a 12% increase in
revenue compared to the same quarter last year. The growth in
isotopes revenue was mainly due to increased revenue in our nuclear
medicine and gamma sterilization businesses. Pharmaceutical
research services revenue increased by 3% in the second 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 continued to
show strong year-over-year revenue growth, and we are pleased by
the strong turnaround in these two businesses compared to last
year. Our early clinical research business is our strongest
business and we are also pleased with the ongoing strength in this
area, although this growth was offset by softness in bioanalytical
revenues. Combined, our early-stage businesses help to drive
overall revenue growth in pharmaceutical research services.
Revenues in our late-stage businesses were flat compared to the
same period last year, primarily due to the declining value of the
US dollar, which compounded weaker than expected results in our
US-based late-stage business. This weakness was offset by strong
performance in our central laboratories business. We continue to
build our sales momentum in pharmaceutical research services and we
are encouraged that we have been able to maintain a strong backlog.
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 six quarters as shown in the table below:
Average Backlog (millions of US dollars)
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Fiscal 2003 - Quarter 1 $ 200 Quarter 2 220 Quarter 3 240 Quarter 4
230 Fiscal 2004 - Quarter 1 240 Quarter 2 265 Backlog measures are
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. Normalized for the change in the US dollar,
revenues from analytical instruments were up 4% although reported
revenues in our analytical instruments business were level with the
second quarter of 2003. The 4000 models remain strong contributors
and unit sales trended higher. Our backlog in this business remains
at a healthy level. The ELAN(R) line of inorganic analyzers also
showed solid growth compared to the second quarter of 2003, due
mainly to the recent order to supply equipment to the Centers for
Disease Control and Prevention in the United States. Capital
expenditures - Purchases of capital assets in Life Sciences
amounted to $31 million for the quarter compared to $28 million
last year. Segment outlook - We expect modest growth in isotope
revenue over the balance of this year. Atomic Energy of Canada
Limited (AECL), our contractor on the MAPLE reactor project,
notified us that the Canadian Nuclear Safety Commission (CNSC) will
hear their position on the outstanding power co-efficient issue at
their regularly scheduled meeting in mid-September. While progress
is continuing on the commissioning of the MAPLE reactors, we expect
that this will delay the commissioning timeline by approximately
four additional months. We are very disappointed at AECL's
inability to resolve this issue with the CNSC in a more timely
manner. As a result of recent concerns related to the supply of
electrical power in Ontario, we have been advised that the
maintenance schedule for Bruce Power LP's B (Bruce B) reactor may
be deferred. The timing of cobalt discharges from the Bruce B
reactor may impact the timing of shipments to customers, and we
therefore expect to see continued volatility in the
quarter-to-quarter revenue trend in this market. The Bruce
facility, along with Ontario Power Generation's Pickering reactors
and Hydro Quebec, are our primary sources of cobalt. We continue
our focus on developing new products in our analytical instruments
business. We expect these new products to drive future growth.
Continued strong demand for current products is expected, as we
have seen no indications to date of changing customer preferences
or new competitive threats. Our Life Sciences businesses operate in
highly regulated fields. Shortly after the end of the second
quarter, we received an untitled letter from the US Food and Drug
Administration (FDA) related to a bio-equivalence study conducted
at our Montreal facility in 2001. We are currently working with the
FDA to assure them that issues raised have been addressed. Our
response has been to review our current processes and make
improvements, including the adoption of new operating procedures
governing our response to unplanned variances in studies we
conduct. While we believe that we have addressed the concerns
raised by the FDA and that, as a result, we will be a leader in
meeting new and more stringent requirements that may evolve, it is
difficult to predict what impact, if any, the publicity surrounding
this letter will have on our business development activities. We
are committed to strengthening the development of our
pharmaceutical research services business, as we seek to focus on
growth areas. Over the past year, we have executed on several
initiatives directly focused on gaining efficiencies and creating
value for our customers. We intend to continue making the necessary
changes in the pharmaceutical research services business to ensure
that we provide our customers the highest level of service and
value. During the quarter, the US dollar strengthened from the
rates in effect at the beginning of the year. We currently do not
have hedges in place to fully mitigate the impact that US dollar
fluctuations could have on our overall results in the near future;
however, we continue to monitor the forward markets and enter into
foreign exchange contracts as appropriate. Health Review of
operations - Revenues from Health businesses in the quarter were:
Second Quarter 2004 2003 Change
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Canadian laboratories $ 105 $ 101 4% US laboratories 20 17 18%
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Diagnostics 125 118 6% Distribution 49 47 4%
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$ 174 $ 165 5%
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Our Canadian diagnostic business was up modestly compared to the
same quarter last year. Revenue growth and operating margins were
affected by the reduced fee schedule in British Columbia. During
the quarter and following a court decision in our favour, we
received a retroactive repayment of the 8% fee reduction that was
implemented in September 2003. While the legality of further fee
cuts is uncertain due to this court decision, the April 1, 2004 fee
reduction of 20% has been implemented by the BC government. Second
quarter revenues include $2 million of net fee adjustments as the
retroactive payment exceeded the impact of the 20% reduction for
the period. Revenue growth and operating margins also reflect
increased patient volumes in BC and restructuring activities and
cost reduction measures that partially mitigate the impact of the
BC fee reduction. As part of our comprehensive review of our US
laboratory operations and our commitment to deal with non-core
businesses, during March we sold our laboratory operations in New
York and Georgia to Laboratory Corporation of America(R) Holdings
in an asset purchase transaction. As a result of the sale, we
incurred a loss of $10 million. The total consideration on the sale
of these operations includes proceeds of $10 million, which is
contingent upon certain conditions being maintained. Due to the
nature of the contingent consideration, we have not recorded these
proceeds in determining the loss from the sale for the quarter. We
will recognize these contingent proceeds as income if and when they
are realized. We have disclosed the impact of the sale, and the
operating results of these US laboratory businesses, as
discontinued operations for reporting purposes. In the first
quarter, we announced that we were unsuccessful in a bid for the
specimen collection, supply chain management and courier services
that support hospital laboratories in Saskatchewan. As a result, we
have booked a $3 million restructuring charge representing $2
million of severance and benefit related costs and $1 million of
goodwill write-down. Revenues from our Distribution business
continue to show modest growth compared to the same period last
year. Capital expenditures - Health businesses purchased $13
million of capital assets during the second quarter of 2004
compared to $4 million in the same period in 2003. Segment outlook
- We saw modest revenue growth during the second quarter; however,
we expect revenue contraction in BC in the third quarter as the
full effect of the fee cut is felt. We continue to execute on cost
reductions that will partially mitigate the impact of British
Columbia laboratory reform and the loss of the Saskatchewan
contract. Our focus will be on operating our laboratories
efficiently and effectively and at a standard of service and
quality for which we are known. Subsequent to the quarter end, and
as part of a series of transactions that are described in more
detail below, we transferred ownership of our Ontario laboratory
business to a public company, LPBP Inc. We will continue to manage
the Ontario laboratory business and we will report in excess of 99%
of the pre-tax income earned by this business. This transaction is
not expected to have any significant impact on our reported
operating income from our Health segment. Our exit from the two
money-losing US operations was a necessary step in repositioning
the US laboratory business and will have a positive impact on our
Diagnostics operations going forward. Proteomics Review of
operations - The operating loss for the second quarter was $73
million compared to $7 million during the same period last year.
The loss includes special charges comprising a $53 million
write-down of goodwill and a $10 million dollar write-down of other
long-term assets. The remaining $10 million operating loss for the
quarter included $2 million of depreciation. During the second
quarter it became evident that MDS Proteomics would not be able to
raise new funding or to continue to operate as a going concern. It
also became evident that our investment in this company was
materially impaired. Certain debt holders in MDS Proteomics, other
parties representing minority interests in MDS Proteomics, and MDS
have agreed to support a proposal from management of MDS Proteomics
related to a reorganization of the company. If completed, the
proposed reorganization will result in substantially all of MDS
Proteomics' long-term debt being converted to equity during the
third quarter. To effect this reorganization, MDS Proteomics will
file for protection from creditors under the Companies' Creditors
Arrangements Act. Based on these factors, and as more fully
described in note 3 to the financial statements, we have reduced
the carrying value of MDS Proteomics to nil. In addition, we have
set aside a reserve of $10 million against guarantee obligations we
have related to the company. Under the terms of the proposed
reorganization, MDS will acquire tax assets valued at $20 million
owned by the company and ensure access to technology and know-how
for use in our MDS Pharma Services business for $15 million.
Segment outlook - As part of the reorganization plan, MDS
Proteomics has developed plans to launch two service-based
businesses, which will leverage existing capabilities and assets in
the rapidly growing areas of protein analysis and biomarker
development. MDS Proteomics believes these new businesses have near
term revenue generating potential that should accelerate the
transition to sustainability. In the event that the reorganization
of MDS Proteomics does not proceed as contemplated, we may be
required to record additional provisions. Corporate The tax rate
applicable to our core business was 38% compared to 36% reported in
the same quarter last year. The reported tax expense for the
quarter is reflective of the non-deductibility of the MDS
Proteomics goodwill write-down and the inability to record the tax
effect of certain of the company's operating losses. Selling,
general, and administrative expenses increased to 22% of revenues
for the quarter compared to 18% last year. This increase is
expected to be temporary and reflects the investment in various
change initiatives announced last year, including work on our
common business system and our evolution towards a shared-services
approach for support services. Research and development spending in
the quarter of $13 million has increased by $3 million from last
year, reflecting increased spending in our analytical instruments
business. Discontinued operations During the quarter, we announced
the sale of two of our US laboratory operations resulting in a $10
million loss on disposition. These businesses had operating losses
of $3 million during the quarter. The revenue from these two
businesses for the quarter was $7 million (2003 - $16). These
businesses, along with the generic radiopharmaceutical
manufacturing business in Europe, are accounted for as discontinued
operations. Combined revenues for discontinued operations for the
quarter were $10 million compared to $19 million last year.
Liquidity and capital resources Our cash position at April 30, 2004
was $297 million, up from $245 million at January 31, 2004.
Operating working capital was $118 million, a decrease of $24
million from January. An increase in accounts payable and accrued
liabilities accounts for the majority of this change. Events
subsequent to the end of the quarter On February 12, 2004 we
announced that we had concluded an agreement with Hemosol Inc. that
will enable us to gain access to tax losses, unclaimed tax
deductions and income tax credits owned by that company exceeding
$300 million, in return for a cash payment of $16 million. Under
the agreement, and through a series of transactions, on May 1, 2004
we transferred the assets and operations that form part of our
Ontario laboratory business into a partnership. We then transferred
a 99.9% limited partnership interest in this business to Hemosol in
return for non-voting and voting shares of Hemosol. Hemosol has
been renamed LPBP Inc. as a consequence of this transaction. This
transaction has been described more fully in note 10 to the
financial statements. We have retained management control of the
day-to-day operations as the general partner in the Ontario
laboratory business under this arrangement. In addition, the
operating agreements of the labs partnership will ensure that our
share of the cash generated by the business flows to us in a timely
manner. This transaction will affect our reported results and
financial position beginning in the third quarter. As a result of
the transaction, we have spent approximately $19 million, including
transaction costs, to gain access to LPBP's tax assets. As a
significant portion of our Canadian business will be sheltered from
income taxes by these tax assets, we expect to realize
approximately $14 million per year of cash tax savings over the
next 8 years. Essentially all other assets of Hemosol were
transferred to a new company called Hemosol Corp., in which we have
retained an interest that is equal to our previous interest in
Hemosol. The carrying value of our Hemosol interest was reduced to
zero in 2003 and there is no change to the carrying value as a
result of this transaction. We expect that we will dispose of this
interest over time, as market conditions permit. Outlook While this
was a very challenging quarter, we are pleased with the progress we
made on change initiatives and other cost reduction measures. These
initiatives will help us to achieve our growth and operating
targets. We will continue to focus our efforts on aligning our core
operations to meet the growing demand for our products and
services. A significant part of this effort relates to the disposal
of non-core businesses and determining how best to deal with our
significant investment in MDS Proteomics. We made good progress on
both initiatives this quarter. In the US, we sold two money-losing
laboratory locations and significantly reduced the support
structure cost associated with our US laboratories business.
Combined, these two businesses and the related support structure
produced losses of $15 million last year. With the proposed
restructuring of MDS Proteomics, we have lessened our financial
exposure to this business. Our further $15 million expenditure will
be offset by the cash value of the tax assets to which we gain
access, and has guaranteed our access to technology that has
growing importance to our MDS Pharma Services businesses. The
impact of the declining US dollar will be more significant for us
in 2005 as our current hedge position is utilized. Our cost
reduction focus is intended, in part, to address this. Despite the
apparent slowing in growth of our reported revenues, on a currency
neutral basis most of our businesses are growing at rates that
equal or exceed industry averages. From the strong base of our
exiting businesses, we continue to identify and develop
opportunities to supplement this organic growth through new
products and services. During the quarter, we made significant
progress preparing for compliance with the US Sarbanes-Oxley
legislation. We fully expect to be compliant with these new
regulations, as required, for our fiscal 2005 year-end.
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION As at April 30 with
comparatives at October 31 (millions of Canadian dollars) 2004 2003
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ASSETS Current Cash and cash equivalents $ 303 $ 263 Accounts
receivable 319 274 Inventories 179 199 Income taxes recoverable 5 9
Prepaid expenses 36 30
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842 775 Capital assets 809 776 Future tax assets 17 23 Long-term
investments and other 217 217 Goodwill (note 3) 715 774
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Total Assets $ 2,600 $ 2,565
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LIABILITIES AND SHAREHOLDERS' EQUITY Current Bank indebtedness $ 6
$ 3 Accounts payable and accrued liabilities 354 355 Deferred
revenue 26 35 Income taxes payable 33 14 Current portion of
long-term debt 8 9
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427 416 Long-term debt 562 533 Deferred revenue 50 34 Other
long-term obligations (note 2) 22 23 Future tax liabilities 74 70
Minority interest 52 63
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$ 1,187 $ 1,139
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Shareholders' equity Share capital 826 816 Retained earnings 557
572 Currency translation adjustment 30 38
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1,413 1,426
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Total liabilities and shareholders' equity $ 2,600 $ 2,565
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See accompanying notes CONSOLIDATED STATEMENTS OF INCOME (Restated
- note 5) Three months Six Months to April 30 to April 30
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(millions of Canadian dollars, except per share amounts) 2004 2003
2004 2003
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Net revenues $ 460 $ 438 $ 908 $ 856 Cost of revenues (273) (263)
(538) (518) Selling, general and administration (100) (79) (188)
(157) Research and development (13) (10) (27) (24) Depreciation and
amortization (17) (18) (34) (38) Restructuring charges (note 2) (6)
- (6) - Other income (expense) - net (note 3) (46) (26) (48) (26)
Equity earnings and investment gains - (1) - 1
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Operating income 5 41 67 94 Interest expense (7) (7) (14) (15)
Dividend and interest income 2 2 4 5
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Income from continuing operations before income taxes and minority
interest - 36 57 84 Income taxes (note 4) (27) (36) (50) (55)
Minority interest - net of tax 5 (2) 4 (3)
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Income (loss) from continuing operations (22) (2) 11 26 Loss from
discontinued operations - net of tax (note 5) (14) (3) (19) (7)
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Net income (loss) $ (36) $ (5) $ (8) $ 19
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Earnings (loss) per share (note 6) Basic $ (0.25) $ (0.03) $ (0.05)
$ 0.14 Diluted $ (0.25) $ (0.03) $ (0.05) $ 0.14 CONSOLIDATED
STATEMENTS OF RETAINED EARNINGS Three months Six Months to April 30
to April 30
-------------------------------------------------------------------------
(millions of Canadian dollars) 2004 2003 2004 2003
-------------------------------------------------------------------------
Retained earnings, beginning of period $ 600 $ 566 $ 572 $ 543 Net
income (loss) (36) (5) (8) 19 Repurchase of shares and options -
(3) - (4) Dividends - cash (5) (5) (5) (5) Dividends - stock (2)
(2) (2) (2)
-------------------------------------------------------------------------
Retained earnings, end of period $ 557 $ 551 $ 557 $ 551
-------------------------------------------------------------------------
-------------------------------------------------------------------------
See accompanying notes CONSOLIDATED STATEMENTS OF CASH FLOWS Three
months Six Months to April 30 to April 30
-------------------------------------------------------------------------
(millions of Canadian dollars) 2004 2003 2004 2003
-------------------------------------------------------------------------
Operating activities Net income $ (36) $ (5) $ (8) $ 19 Items not
affecting current cash flow (note 7) 90 103 119 124
-------------------------------------------------------------------------
54 98 111 143 Changes in non-cash working capital balances relating
to operations (note 7) 37 (11) (23) (30)
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91 87 88 113
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Investing activities Acquisitions - - (2) - Purchase of capital
assets (26) (32) (54) (56) Proceeds on sale of business 9 29 9 29
Other (11) (23) (12) (42)
-------------------------------------------------------------------------
(28) (26) (59) (69)
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Financing activities Issuance of long-term debt - - - 565 Repayment
of long-term debt - (24) (1) (543) Increase (decrease) in deferred
income and other long-term obligations (9) (3) 14 (8) Payment of
cash dividends (5) (5) (5) (5) Issuance of shares 4 - 8 1
Repurchase of shares and options - (4) - (4) Distribution to
minority interest (3) (4) (7) (7)
-------------------------------------------------------------------------
(13) (40) 9 (1)
-------------------------------------------------------------------------
Effect of foreign exchange rate changes on cash and cash
equivalents 2 - (1) (3)
-------------------------------------------------------------------------
Increase in cash position during the period 52 21 37 40 Cash
position, beginning of period 245 203 260 184
-------------------------------------------------------------------------
Cash position, end of period $ 297 $ 224 $ 297 $ 224
-------------------------------------------------------------------------
-------------------------------------------------------------------------
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 discounted operations (note 5). These financial
statements should be read in conjunction with the accounting
policies and other disclosures in those annual financial
statements. These financial statements do not include all of the
disclosures required by generally accepted accounting principles
applicable to annual financial statements. 2. Restructuring Charges
In the second quarter of 2004, the Company recorded net
restructuring charges of $6 million, of which, $4 million reflects
severance for 37 employees mainly associated with the
implementation of certain change initiatives announced during the
fourth quarter of 2003. The remaining $2 million of restructuring
charges recorded during the quarter was primarily associated with
the loss of a laboratory services contract in Saskatchewan, Canada
resulting in the termination of 86 employees. The Company expects
to substantially utilize the remaining provision by the end of
fiscal 2004. An analysis of activity in the provision through April
30, 2004 is as follows: (millions of Canadian dollars) Workforce
Reductions Restructuring charges recorded: For the three months
ended October 31, 2003 $ 17 For the three months ended January 31,
2004 - For the three months ended April 30, 2004 6
---------------------------------------------------------------------
Total provisions recorded: 23 Cumulative draw-downs and adjustments
in 2004: Cash payments made (9) Non cash adjustments (1)
---------------------------------------------------------------------
Provision balance at April 30, 2004 $ 13
---------------------------------------------------------------------
---------------------------------------------------------------------
3. Other Income (Expense) - Net Three months Six Months to April 30
to April 30
---------------------------------------------------------------------
2004 2003 2004 2003
---------------------------------------------------------------------
Write-down of long-term investments $ - $ (75) $ (2) $ (75)
Write-down of other long-term assets (10) - (10) - Gain on patent
litigation 14 39 14 39 Gain on sale of businesses and other 3 10 3
10 Write-down of goodwill (53) - (53) -
---------------------------------------------------------------------
Other income (expense) - net $ (46) $ (26) $ (48) $ (26)
---------------------------------------------------------------------
---------------------------------------------------------------------
MDS currently owns approximately 89% of the common shares of MDS
Proteomics. This investment is a controlled subsidiary and is
reflected in these financial statements on a fully consolidated
basis. The net carrying value of this investment is $53 million
before adjustments. On a consolidated basis, this subsidiary
accounts for $117 million of goodwill, before adjustments. MDS
Proteomics has been unable to raise financing since January 2003.
As a result of significant losses incurred by the company, MDS
Proteomics has inadequate financial resources to fund continuing
operations. In response to this situation, management of MDS
Proteomics has developed a new business plan for the company. To
implement this business plan, certain debt holders in the company,
other parties representing minority interests in MDS Proteomics and
MDS, have agreed to support a proposal from management of MDS
Proteomics related to a reorganization of the company. The proposed
reorganization will result in substantially all of MDS Proteomics'
long-term debt being converted to equity during the third quarter.
To effect this reorganization, MDS Proteomics will file for
protection from creditors under the Companies' Creditors
Arrangements Act. Under the proposed agreement, certain
debtholders, having secured interests in assets of the business and
those of a subsidiary, will have priority rights. Based on the
business plan that underlies the proposal, management of MDS
completed an assessment of the carrying value of its net investment
in MDS Proteomics. Based on this assessment, management determined
that the carrying value of the goodwill and the carrying value of
its net investment are impaired. In determining the amount of the
provision that would be required to reduce the carrying value of
these assets to net realizable value, management considered the
terms of the proposed reorganization. Management has determined
that under the proposed agreement, the priority claims of the
secured debt holders will entitle these debt holders to a claim on
all of the existing value of MDS Proteomics. As a consequence, the
value attributable to the MDS common share interest is nil. Because
MDS reports this investment on a consolidated basis, the impairment
of goodwill has resulted in a charge of $43 million, reducing the
carrying value of goodwill to $74 million. MDS has also recorded a
provision of $10 million for the Company's guarantee of certain
other long-term obligations, including capital lease obligations.
On a consolidated basis, this charge is considered to be a further
write-down of goodwill, bringing the total provision for the
impairment of goodwill to $53 million. In these consolidated
financial statements, the value of the assets of MDS Proteomics,
comprising net working capital, capital assets, and goodwill (at
its written-down value), is fully offset by the carrying value of
the secured long-term debt of the company and by the minority
interest held by other common shareholders. Under the proposed
agreement, an MDS Proteomics convertible debenture, upon which MDS
has guaranteed repayment in certain limited circumstances until
January 2005, will be converted to equity and MDS will be released
from the guarantee. For purposes of determining whether additional
provision is required in these financial statements, the proposed
conversion of the debt to equity and the release of our guarantee
are assumed to eliminate the need for any additional provision
related to this guarantee. In the event that the proposed
reorganization is not completed, or the terms change in such a way
that we are required to honour our guarantee, additional provisions
may be required. Under the terms of the proposed deal, MDS will
acquire tax assets valued at $20 million owned by the company and
ensure access to technology and know-how for use in our Pharma
Services business for $15 million. Upon completion of the
reorganization, MDS's interest in MDS Proteomics will be reduced to
less than 50% and MDS will no longer control the company. As a
result, following completion of the reorganization, MDS expects to
account for its interest in MDS Proteomics on an equity basis. It
is expected that all steps required to effect the reorganization
will be completed by the end of the third quarter. 4. Income Taxes
A reconciliation of expected income taxes to reported income tax
expense is provided below. The higher than normal taxes result
primarily from the inability to recognize the tax benefits
resulting from the losses incurred by MDS Proteomics and the
write-down of MDS Proteomics goodwill. Three months to April 30
---------------------------------------------------------------------
2004 2003
---------------------------------------------------------------------
Expected income taxes at MDS's 36% statutory rate $ - $ 13 Increase
(decrease) to tax expense as a result of: Gain on sale of business
(1) (4) Write-down of investments - 23 Restructuring 1 - Other 3 2
---------------------------------------------------------------------
3 34 MDS Proteomics operating loss 5 2 Write-down of MDS Proteomics
goodwill 19 -
---------------------------------------------------------------------
Reported income tax expense $ 27 $ 36
---------------------------------------------------------------------
---------------------------------------------------------------------
5. Discontinued Operations The results of the company's
discontinued operations are as follows: Consolidated statements of
operations: Three months Six Months to April 30 to April 30
---------------------------------------------------------------------
2004 2003 2004 2003
---------------------------------------------------------------------
Revenues $ 10 $ 19 $ 27 $ 42 Loss from discontinued operations -
net of tax $ (14) $ (3) $ (19) $ (7) Effective March 15, 2004, the
company sold its laboratory operations in New York, and Georgia in
an asset purchase transaction. The loss from discontinued
operations includes a $10 million loss on disposition of these
laboratories, and a $3 million (2003 - $3) operating loss for the
period in the quarter prior to the sale. Under the terms of the
asset purchase agreement, additional consideration in the amount of
$10 million may be paid in the future, depending on the outcome of
certain matters. No recognition of this contingent consideration
has been made in these financial statements. On October 24, 2003,
the Board of Directors of MDS approved a plan for an orderly exit
of the Company's generic radiopharmaceutical manufacturing facility
in Belgium. The closure of this business is proceeding. A $14
million provision related primarily to severance is included in
accounts payable and accrued liabilities. This provision was
originally recorded in the fourth quarter of 2003. This provision
remains undrawn at April 30, 2004 and the Company expects to begin
applying severance payments to this provision when they are made
later during 2004. The company has restated prior period results to
reflect the required separate disclosure of these discontinued
operations. During the second quarter, the operating loss from this
business included in discontinued operations was $1 million (2003 -
$nil). 6. Earnings per Share a) Dilution Three months Six Months to
April 30 to April 30
-----------------------------------------------------------------
(number of shares in millions) 2004 2003 2004 2003
-----------------------------------------------------------------
Net income available to Common shareholders $ (36) $ (5) $ (8) $ 19
-----------------------------------------------------------------
Weighted average number of Common shares outstanding - basic 141
141 141 141 Impact of stock options assumed exercised 2 1 2 2
-----------------------------------------------------------------
Weighted average number of Common shares outstanding - diluted 143
142 143 143 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 Six Months to
April 30 to April 30
-----------------------------------------------------------------
2004 2003 2004 2003
-----------------------------------------------------------------
Pro forma net income (loss) available to Common shareholders $ (37)
$ (7) $ (11) $ 16 Pro forma earnings (loss) per share - basic $
(0.26) $ (0.05) $ (0.08) $ 0.11 - diluted $ (0.26) $ (0.05) $
(0.08) $ 0.11 During the quarter, the Company granted 5,500 options
(2003 - 27,500) at an average exercise price of $21.95 (2003 -
$19.95). These options have a Black Scholes value of $8.14 per
share (2003 - $7.57), based on the following assumptions for the
quarter ended April 30:
-----------------------------------------------------------------
2004 2003
-----------------------------------------------------------------
Risk-free interest rate 4.4% 5.5% Expected dividend yield 1.0% 1.0%
Expected volatility 0.350 0.354 Expected time to exercise (years)
5.25 5.25 c) Discontinued Operations The earnings per share impact
of discontinued businesses is as follows: Three months Six Months
to April 30 to April 30
-----------------------------------------------------------------
2004 2003 2004 2003
-----------------------------------------------------------------
Earnings per share, continued operations $ (0.14) $ (0.01) $ 0.09 $
0.17 Loss per share, discontinued operations (0.11) (0.02) (0.14)
(0.03)
----------------------------------------------------------------- $
(0.25) $ (0.03) $ (0.05) $ 0.14
-----------------------------------------------------------------
-----------------------------------------------------------------
7. Supplementary Cash Flow Information Non-cash items affecting net
income comprise: Three months Six Months to April 30 to April 30
---------------------------------------------------------------------
2004 2003 2004 2003
---------------------------------------------------------------------
Depreciation and amortization $ 17 $ 18 $ 34 $ 38 Minority interest
(5) 2 (4) 3 Future income taxes (1) 17 9 19 Equity earnings (loss)
- net of distribution - 1 1 (1) Write-down of goodwill 63 - 63 -
Write-down of investments - 75 - 75 Equipment write-down 10 - 10 -
Gain on sale of businesses and other (3) (10) (3) (10) Loss on sale
of business 9 - 9 -
---------------------------------------------------------------------
$ 90 $ 103 $ 119 $ 124
---------------------------------------------------------------------
---------------------------------------------------------------------
Changes in non-cash working capital balances relating to operations
include: Three months Six Months to April 30 to April 30
---------------------------------------------------------------------
2004 2003 2004 2003
---------------------------------------------------------------------
Accounts receivable $ 2 $ 10 $ (46) $ 41 Inventories (13) (20) 19
(35) Accounts payable and deferred income 29 (6) (14) (42) Income
taxes 15 9 23 12 Foreign exchange and other 4 (4) (5) (6)
---------------------------------------------------------------------
$ 37 $ (11) $ (23) $ (30)
---------------------------------------------------------------------
---------------------------------------------------------------------
8. Segmented Information Three months to April 30
---------------------------------------------------------------------
2004
---------------------------------------------------------------------
Life Sciences Health Proteomics Total
---------------------------------------------------------------------
Net revenues $ 286 $ 174 $ - $ 460 Operating income (loss) before
restructuring 59 25 (73) 11 Restructuring activities (2) (4) - (6)
Revenues by products and services: Medical isotopes 85 Analytical
equipment 70 Pharmaceutical research services 131 Clinical
laboratory services 125 Distribution and other 49 Proteomics -
Capital expenditures 31 13 1 45 Depreciation and amortization 12 3
2 17 Three months to April 30
---------------------------------------------------------------------
2003
---------------------------------------------------------------------
Life Sciences Health Proteomics Total
---------------------------------------------------------------------
Net revenues $ 273 $ 165 $ - $ 438 Operating income (loss) before
restructuring 57 (9) (7) 41 Restructuring activities - - - -
Revenues by products and services: Medical isotopes 76 Analytical
equipment 70 Pharmaceutical research services 127 Clinical
laboratory services 118 Distribution and other 47 Proteomics -
Capital expenditures 28 4 32 Depreciation and amortization 11 4 3
18 Six months to April 30
---------------------------------------------------------------------
2004
---------------------------------------------------------------------
Life Sciences Health Proteomics Total
---------------------------------------------------------------------
Net revenues $ 571 $ 337 $ - $ 908 Operating income (loss) before
restructuring 116 41 (84) 73 Restructuring activities (2) (4) - (6)
Revenues by products and services: Medical isotopes 171 Analytical
equipment 143 Pharmaceutical research services 257 Clinical
laboratory services 241 Distribution and other 96 Proteomics -
Capital expenditures 52 14 1 67 Depreciation and amortization 24 7
3 34 Six months to April 30
---------------------------------------------------------------------
2003
---------------------------------------------------------------------
Life Sciences Health Proteomics Total
---------------------------------------------------------------------
Net revenues $ 532 $ 324 $ - $ 856 Operating income (loss) before
restructuring 104 7 (17) 94 Restructuring activities Revenues by
products and services: Medical isotopes 150 Analytical equipment
135 Pharmaceutical research services 247 Clinical laboratory
services 234 Distribution and other 90 Proteomics - Capital
expenditures 47 9 - 56 Depreciation and amortization 24 9 5 38 9.
Financial Instruments As of April 30, 2004, the Company had
outstanding foreign exchange contracts and options in place to sell
up to US$371 million at a weighted average rate of C$1.49 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 April 30 2004
2003
---------------------------------------------------------------------
Carrying Fair Carrying Fair Amount Value Amount Value
---------------------------------------------------------------------
Net asset (liability) position: Currency forward and option
contracts $ - $ 18 $ - $ 28 Interest rate swap and option contracts
$ - $ - $ - $ (1) 10. Events subsequent to the end of the quarter
On February 12, 2004, MDS announced that the Company had concluded
an agreement with Hemosol Inc. that will enable MDS to gain access
to tax losses, unclaimed tax deductions and income tax credits
owned by that company exceeding $300 million, in return for a cash
payment of $16 million. Under the agreement, and through a series
of transactions, on May 1, 2004, MDS transferred the assets and
operations that form part of its Ontario laboratory business into a
partnership. MDS then transferred a 99.9% limited partnership
interest in this business to Hemosol in return for non-voting and
voting shares of Hemosol. Hemosol has been renamed LPBP Inc. as a
consequence of this transaction. Effective May 1, 2004 MDS owns
99.56% of the equity of the LPBP Inc. and approximately 47.5% of
the voting shares. MDS has retained management control of the
day-to-day operations as the general partner in the Ontario
laboratory business under this arrangement. In addition, the
operating agreements of the laboratory partnership will ensure that
the Company's share of the cash generated by the business flows to
it in a timely manner. This transaction will affect the reported
results and financial position of MDS beginning in the third
quarter. MDS will continue to report the Ontario laboratories on a
consolidated basis; however, the Company will report a new minority
interest representing the 0.5% of this business, which it no longer
owns. In addition, a net asset in the amount of $19 million,
representing the cost to acquire access to the tax balances of LPBP
Inc., including transaction costs will be recorded and amortized as
a component of tax expense for an expected period of 8 years. The
existing assets, liabilities, and business of Hemosol were
transferred to a new company to be called Hemosol Corp. MDS
received an interest in Hemosol Corp. equal to its previous
interest in Hemosol as a result of these transactions. Hemosol
Corp. replaced LPBP as the borrower under existing bank agreements
and was made the beneficiary of an existing MDS guarantee of this
bank debt. In addition, the assets that form the security for this
debt were transferred to the new company. As part of the
consideration paid related to the reorganization, MDS surrendered
0.5 million of the warrants that the Company currently holds in
Hemosol related to this guarantee and reduced its future
entitlement to 2 million additional warrants that will be earned if
the bank guarantee remains outstanding for specified periods. These
warrants are carried at zero cost. DATASOURCE: MDS Inc. CONTACT:
Investor Relations: Sharon Mathers, Vice-President, Investor
Relations, (416) 675-6777 x2695, ; Media Relations: Naomi Nemeth,
Director, Global External Communications, (416) 675-6777 x4692,
Copyright