**UNITED
        STATES**
 **SECURITIES
        AND EXCHANGE COMMISSION**
 
 **Washington,
        D.C. 20549**
 
 **FORM
        40-F**
 [Check
        one]
 **[
        ]** **REGISTRATION
        STATEMENT PURSUANT TO SECTION 12 OF THE SECURITIES EXCHANGE ACT OF
        1934**
 or
 **[
        X ]** **ANNUAL
        REPORT PURSUANT TO SECTION 13(A) OR 15(D) OF THE SECURITIES EXCHANGE ACT
        OF
        1934**
  For
                  the fiscal year endedOctober
                  31, 2006
              Commission
                  File Number___01-15016
  **MDS
                  INC.**
                (Exact
                  name of Registrant as specified in its charter)**Canada
                  (Federal)**
                (Province
                  or other jurisdiction of incorporation or organization)**8099**
                (Primary
                  Standard Industrial Classification Code Number (if
                  applicable))**98-0170107**
                (I.R.S.
                  Employer Identification Number (if applicable))**Suite
                  300, West Tower**
                **2700
                  Matheson Blvd., East**
                **Mississauga,
                  Ontario Canada L4W 4V9**
                **(416)
                  213-4082**
                (Address
                  and telephone number of Registrant's principal executive
                  offices)**MDS
                  Pharma Services (US) Inc.,**
                **621
                  Rose Street, P.O. Box 80837, Lincoln, Nebraska 68501**
                **(402)
                  476-2811**
                (Name,
                  address (including zip code) and telephone number (including area
                  code)
                of
                  agent for service in the United
                  States)
 Securities
        registered or to be registered pursuant to Section 12(b) of the Act.
 
 
 Title
                  of each class
              Name
                  of each exchange on which registered**Common
                  Shares, no par value**
              **New
                  York Stock Exchange**
 Securities
        registered or to be registered pursuant to Section 12(g) of the
        Act.
 **none**
                (Title
                  of Class)
 Securities
        for which there is a reporting obligation pursuant to Section 15(d) of the
        Act.
 **none**
                (Title
                  of Class)
 For
        annual reports, indicate by check mark the information filed with this
        Form:
 
 [
                  X
                  ] Annual information form
              [
                  X
                  ] Audited annual financial
                  statements
 
 Indicate
        the number of outstanding shares of each of the issuer's classes of capital
        or
        common stock as of the close of the period covered by the annual
        report.
  **The
        Registrant had 144,319,249 Common Shares outstanding as at October 31,
        2006**
 
   Indicate
        by check mark whether the Registrant by filing the information contained
        in this
        Form is also thereby furnishing the information to the Commission pursuant
        to
        Rule 12g3-2(b) under the Securities Exchange Act of 1934 (the "Exchange Act").
        If "Yes" is marked, indicate the file number assigned to the Registrant in
        connection with such Rule.
 
 Yes
        [ ]
        No [ X ]
 
 Indicate
        by check mark whether the Registrant (1) has filed all reports required to
        be
        filed by Section 13 or 15(d) of the Exchange Act during the preceding 12
        months
        (or for such shorter period that the Registrant was required to file such
        reports) and (2) has been subject to such filing requirements for the past
        90
        days.
 
 Yes
        [ X ]
        No [ ]
 
 **Documents
        Filed Under Cover of this Form**
 
 **Document
        No. 1** :  Annual
        Information Form of MDS Inc. for the year ended October 31, 2006.
 
 **Document
        No. 2** :  Audited
        Consolidated Financial Statements for the year ended October 31, 2006, prepared
        in accordance with Canadian generally accepted accounting principles, together
        with a reconciliation to United States generally accepted accounting
        principles.
 
 **Document
        No. 3** :  Management's
        Discussion and Analysis of Financial Condition and Results of Operations
        for the
        year ended October 31, 2006.
 
 **Cautionary
        Statement Regarding Forward-Looking Statements**
 
 This
        annual report on Form 40-F (Form 40-F), including the exhibits attached hereto
        and any amendments, supplements, or modifications hereof or thereof, contains
        statements that are forward-looking statements within the meaning of certain
        securities laws, including the “safe harbour” provisions of the *Securities
        Act* (Ontario) and the *United
        States Private Securities Litigation Reform Act* of 1995.
        These forward-looking statements include, among others, statements with respect
        to our objectives for 2007, our medium-term goals, and strategies to achieve
        those objectives and goals, as well as statements with respect to our beliefs,
        plans, objectives, expectations, anticipations, estimates and intentions.
        The
        words “may”, “could”, “should”, “would”, “suspect”, “outlook”, “believe”,
“plan”, “anticipate”, “estimate”, “expect”, “intend”, “forecast”, “objective”,
        and words and expressions of similar import are intended to identify
        forward-looking statements.
 
 By
        their
        very nature, forward-looking statements involve inherent risks and
        uncertainties, both general and specific, which give rise to the possibility
        that predictions, forecasts, projections and other forward-looking statements
        will not be achieved. We caution readers not to place undue reliance on these
        statements as a number of important factors could cause our actual results
        to
        differ materially from the beliefs, plans, objectives, expectations,
        anticipations, estimates and intentions expressed in such forward-looking
        statements. These factors include, but are not limited to, management of
        operational risks; the strength of the Canadian and United States economies
        and
        the economies of other countries in which we conduct business; our ability
        to
        secure a sufficient quantity of raw materials, particularly cobalt; a reliable
        source of supply of critical nuclear isotopes; the impact of the movement
        of the
        Canadian dollar relative to other currencies, particularly the US dollar
        and the
        Euro; changes in interest rate policies of the Bank of Canada and the Board
        of
        Governors of the Federal Reserve System in the United States; the effects
        of
        competition in the markets in which we operate; the timing and technological
        advancement of new products introduced by us or by our competitors; the impact
        of changes in the laws and regulations and enforcement thereof; judicial
        judgments and legal proceedings; our ability to obtain accurate and complete
        information from, or on behalf of, our customers and counter parties; our
        ability to successfully realign our organization, resources and processes;
        our
        ability to complete strategic acquisitions and joint ventures and to integrate
        our acquisitions and joint ventures successfully; changes in accounting policies
        and methods we use to report our financial condition, including uncertainties
        associated with critical accounting assumptions and estimates; operational
        and
        infrastructure risks; other factors that may affect future results including
        changes in trade policies, timely development and introduction of new products
        and services, changes in our estimates relating to reserves and allowances,
        changes in tax laws, technological changes, natural disasters such as
        hurricanes, the possible impact on our businesses from public health
        emergencies, international conflicts and other developments including those
        relating to terrorism; and our success in anticipating and managing the
        foregoing risks.
 
 We
        caution that the foregoing list of important factors that may affect future
        results is not exhaustive. When relying on our forward-looking statements
        to
        make decisions with respect to the Company, investors and others should
        carefully consider the foregoing factors and other uncertainties and potential
        events. We do not undertake to update any forward-looking statement, whether
        written or oral, that may be made from time to time by us or on our
        behalf.
 
 In
        this
        Form 40-F, unless the context otherwise requires, references to “we”, “us”,
“our”, or similar terms, as well as references to “MDS”, the “Company”, or the
“Registrant” refer to MDS Inc.











**Document
          No. 1**
 **MDS
        INC.**
  **ANNUAL
        INFORMATION FORM**
  **FOR
        THE YEAR ENDED OCTOBER 31, 2006**
 
  
 January
        16, 2007
 Toronto,
        Canada
   MDS
        and
        design, MDS Sciex, ELAN, CellKeyTM ,
        MALDI-TOFTM, MDS Pharma Services, and “Science advancing health” are trademarks
        of MDS Inc. or its subsidiaries.
  
  **INTERPRETATION**
 **ITEMS
        AFFECTING THE COMPARABILITY OF FINANCIAL INFORMATION OF PRIOR
        YEARS**
 **DOCUMENTS
        INCORPORATED BY REFERENCE**
 **CAUTION
        REGARDING FORWARD-LOOKING INFORMATION**
 **1.** **CORPORATE
        STRUCTURE**
 1.1 Jurisdiction
        of Incorporation and Articles
 1.2 Current
        Organization
 **2.** **GENERAL
        DEVELOPMENT OF THE BUSINESSES OF MDS**
 2.1 Overview
 2.1.1 Life
        Sciences
 2.1.2 Diagnostics
 2.1.3 Customers
 2.1.4 Employees
 2.2 Recent
        Industry Developments
 2.3 Business
        Strategy of MDS
 2.4 Financial
        and Other Developments
 2.4.1 Capital
        Structure
 2.4.2 Acquisitions
 2.4.3 Divestitures
        and Discontinuances
 **3.** **NARRATIVE
        DESCRIPTION OF THE BUSINESSES OF MDS**
 3.1 Reportable
        Industry Segments
 3.2 Pharmaceutical
        Research Services (MDS Pharma Services)
 3.3 Isotopes
        and Molecular Imaging (MDS Nordion)
 3.4 Analytical
        Instruments (MDS Sciex)
 3.5 Diagnostics
 3.6 Significant
        Investees
 3.6.1 MDS
        Capital Corp
 3.6.2 Iconix
        Biosciences, Inc.
 3.7 Principal
        Facilities
 3.8 Research
        and Development
 3.9 Environmental
        Compliance
 3.10 Other
        Business Matters
 3.10.1 Risk
        Factors
 3.10.2 Legal
        Proceedings
 3.10.3 Interest
        of Management and Others in Material Transactions
 3.10.4 Transfer
        Agent and Registrar
 3.10.5 Material
        Contracts
 3.10.6 Experts
 **4.** **SELECTED
        CONSOLIDATED FINANCIAL INFORMATION**
 4.1 Summary
        Annual Information (Year to October 31)
 4.2 Dividends
 4.3 Capital
        Structure
 **5.** **MANAGEMENT’S
        DISCUSSION AND ANALYSIS** **43**
 **6.** **MARKET
        FOR SECURITIES** **43**
 **7.** **DIRECTORS
        AND OFFICERS** **44**
 7.1 Directors 44
 7.2 Executive
        Officers 44
 7.3 Additional
        Disclosure for Directors and Executive Officers 45
 **8.** **AUDIT
        COMMITTEE INFORMATION** **47**
 8.1 Composition
        of the Audit Committee 47
 8.2 Auditor
        Service Fees 48
 8.3 Pre-approval
        policies and Procedures 49
 **9.** **ADDITIONAL
        INFORMATION** **49**
 **APPENDIX
        I - MDS INC. AUDIT COMMITTEE CHARTER** **50**
 **APPENDIX
        II - DEFINITIONS** **58**
 
 
  **MDS
        INC.**
 **ANNUAL
        INFORMATION FORM**
  **INTERPRETATION**
   In
        this
        Annual Information Form (“AIF”), “we”, “us”, “our”, “MDS”, and “the Company” are
        used to refer to MDS Inc., its subsidiaries and joint ventures. In
        this
        AIF, all references to specific years are references to the fiscal year ended
        October 31. All references to “$” or “dollars” are references to Canadian
        dollars, unless otherwise specified.
  Certain
        terms and abbreviations used in this AIF are defined in Appendix II -
        Definitions.
  **ITEMS
        AFFECTING THE COMPARABILITY OF FINANCIAL INFORMATION OF PRIOR
        YEARS**
  All
        financial references in this document exclude our discontinued generic
        radiopharmaceuticals operations, our U.S., and Canadian laboratory operations,
        certain early-stage pharmaceutical research services operations, and our
        interests in Source Medical Corporation (“Source”) unless otherwise indicated.
        All financial references for the prior years have been restated to reflect
        this
        treatment. From the amounts reported in our 2005 Annual Report, revenues
        for
        2005 and 2004 have been reduced by $335million and $ 338 million, respectively,
        and income from continuing operations for 2005 and 2004 have been reduced
        by $41
        million and $40 million, respectively.
  Under
        accounting standards in effect before May 1, 2003, other businesses sold
        in the
        years covered by these consolidated financial statements did not qualify
        as
        discontinued operations and have not been presented as such herein.
  Certain
        figures for fiscal 2005 have been reclassified to conform to the fiscal 2006
        consolidated financial statement presentation.
  **DOCUMENTS
        INCORPORATED BY REFERENCE**
  The
        following sections of the MDS 2006 Annual Report (the “2006 Annual Report”) are
        incorporated by reference into this AIF:
  1.  The
        audited consolidated financial statements of MDS Inc. for the years ended
        October 31, 2006, October 31, 2005 and October 31, 2004, reported on by Ernst
        & Young LLP, Chartered Accountants (the “2006 Financial Statements”) on
        pages 27 to 62 of the 2006 Annual Financial Review; and
  2.  Management’s
        Discussion and Analysis of financial condition and results of operations
        of MDS
        Inc. (the “2006 MD&A”) contained on pages 1 to 26 of the 2006 Annual
        Financial Review.
  **CAUTION
        REGARDING FORWARD-LOOKING INFORMATION**
  From
        time
        to time, we make written or oral forward-looking statements within the meaning
        of certain securities laws, including the “safe harbour” provisions of the *Securities
        Act* (Ontario) and the *United
        States Private Securities Litigation Reform* Act *of
        1995* .
        We may
        make such statements in this document, in other filings with Canadian regulators
        or the United States Securities and Exchange Commission, in reports to
        shareholders or in other communications. These forward-looking statements
        include, among others, statements with respect to our objectives for 2007,
        our
        medium-term goal, and strategies to achieve those objectives and goals, as
        well
        as statements with respect to our beliefs, plans, objectives, expectations,
        anticipations, estimates and intentions. The words “may”, “could”, “should”,
“would”, “suspect”, “outlook”, “believe”, “plan”, “anticipate”, “estimate”,
“expect”, “intend”, “forecast”, “objective”, and words and expressions of
        similar import are intended to identify forward-looking statements.
  By
        their
        very nature, forward-looking statements involve inherent risks and
        uncertainties, both general and specific, which give rise to the possibility
        that predictions, forecasts, projections, and other forward-looking statements
        will not be achieved. We caution readers not to place undue reliance on these
        statements as a number of important factors could cause our actual results
        to
        differ materially from the beliefs, plans, objectives, expectation,
        anticipations, estimates and intentions expressed in such forward-looking
        statements. These factors include, but are not limited to, management of
        credit,
        market, liquidity and funding and operational risks; the strength of the
        Canadian and United States economies and the economies of other countries
        in
        which we conduct business; the impact of the movement of the Canadian dollar
        relative to other currencies, particularly the US dollar and the Euro; the
        effects of changes in monetary policy, including changes in interest rate
        policies of the Bank of Canada and the Board of Governors of the Federal
        Reserve
        System in the United States; the effects of competition in the markets in
        which
        we operate; the impact of changes in the laws and regulations and enforcement
        thereof; judicial judgments and legal proceedings; our ability to obtain
        accurate and complete information from or on behalf of our customers and
        counter-parties; our ability to successfully realign our organization, resources
        and processes; our ability to complete strategic acquisitions and joint ventures
        and to integrate our acquisitions and joint ventures successfully; changes
        in
        accounting policies and methods we use to report our financial condition,
        including uncertainties associated with critical accounting assumptions and
        estimates; operational and infrastructure risks; other factors that may affect
        future results including changes in trade policies, timely development and
        introduction of new products and services, changes in our estimates relating
        to
        reserves and allowances, changes in tax laws, technological changes, natural
        disasters such as hurricanes, the possible impact on our businesses from
        public
        health emergencies, international conflicts and other developments including
        those relating to the war on terrorism; and our success in anticipating and
        managing the foregoing risks.
  We
        caution that the foregoing list of important factors that may affect future
        results is not exhaustive. When relying on our forward-looking statements
        to
        make decisions with respect to the Company, investors and others should
        carefully consider the foregoing factors and other uncertainties and potential
        events. We do not undertake to update any forward-looking statement, whether
        written or oral, that may be made from time to time by us or on our
        behalf.
  **1.**
              **CORPORATE
                  STRUCTURE**
  **1.1**  **Jurisdiction
        of Incorporation and Articles**
  The
        Company was incorporated on April 17, 1969 under the laws of the Province
        of
        Ontario under the name Medical Data Sciences Limited. The Company changed
        its
        name to MDS Health Group Limited in April of 1973 and to MDS Inc. in November
        1996. The Company was continued under the *Canada
        Business Corporations Act* (the
“CBCA”) in October 1978 and remains subject to that statute.
  The
        head
        office of MDS, and its principal place of business, is located at 2700 Matheson
        Boulevard East, Suite 300, West Tower, Mississauga, Ontario, Canada, L4W
        4V9.
  **1.2**  **Current
        Organization**
  Significant
        operating subsidiaries and partnerships are defined as those
        companies/partnerships that contribute 10% or more of the consolidated revenues
        or consolidated operating income of the Company or account for 10% or more
        of
        the consolidated total assets of the Company. In addition, we consider a
        subsidiary/partnership significant if it represents MDS in a geographic market
        that we believe represents a growth opportunity for MDS. The significant
        operating subsidiaries and partnerships of the Company are set forth
        below.
  The
        following significant operating subsidiaries are wholly owned by
        MDS:
  Significant
        operating subsidiaries:
  Ø  MDS
        (Canada) Inc.; a Canadian (CBCA) corporation;
  Ø  MDS
        Pharma Services (US) Inc., a Nebraska corporation;
  Other
        significant subsidiaries:
  Ø  MDS
        Nordion Europe SA (“NESA”), a Belgian corporation;
  Ø  MDS
        Pharma Services Central Lab S.A.S., a French corporation;
  Ø  MDS
        Pharma Services S.A.S., a French corporation;
  Ø  MDS
        Pharma Services France S.A.S., a French corporation;
  Ø  MDS
        Pharma Services Espana, S.A., a Spanish corporation;
  Ø  MDS
        Pharma Services Central Lab GmbH, a German corporation;
  Ø  MDS
        Pharma Services GB Limited, a UK corporation;
  Ø  MDS
        Pharma Services Switzerland AG, a Swiss corporation;
  Ø  MDS
        Life
        Sciences (Singapore) Pte. Ltd., a Singapore corporation; and
  Ø  MDS
        Pharma Services “Taiwan”, Ltd., a Taiwanese corporation.
  In
        addition to these subsidiaries, MDS owns a 99.6% non-controlling equity interest
        in LPBP Inc., an Ontario corporation.
  As
        at
        October 31, 2005, the Company owned a 50% interest in Source, a Canadian
        corporation. On November 22, 2005 the Company sold its 50% interest in Source
        to
        its partner, Cardinal Health Inc., for $79 million.
  The
        Company also conducts business through the following significant
        partnerships:
  Ø  Applied
        Biosystems MDS Sciex Instruments (“AB/MDS Sciex”), a partnership established
        under the laws of Ontario in which MDS holds a 50% interest.
  Ø  PerkinElmer
        MDS Sciex Instruments (“Perkin Elmer/MDS Sciex”), a partnership established
        under the laws of Ontario in which MDS holds a 50% interest.
  The
        Company conducts the majority of its diagnostics business through the following
        partnerships:
  Ø  MDS
        Laboratory Services, L.P., a partnership established under the laws of Ontario
        in which MDS holds an indirect 99.6% interest.
  Ø  Metro-McNair
        Clinical Laboratories Limited Partnership (“Metro-McNair”), a limited
        partnership established under the laws of British Columbia in which MDS holds
        a
        75% interest;
  The
        entities outlined above are consolidated in the financial statements of MDS
        and
        are referred to hereafter as subsidiaries, with the exception of PerkinElmer/MDS
        Sciex, AB/MDS Sciex, each of which is accounted for on a proportionately
        consolidated basis.
  In
        addition to its subsidiaries, the Company has significant influence over
        and
        equity accounts for a number of laboratory businesses. The Company has a
        45%
        interest in MDS Capital Corp., and an 18% interest in Iconix Biosciences,
        Inc.
        (each of which is described under the heading “3.6 - Significant
        Investees”).
 
 **2.**
              **GENERAL
                  DEVELOPMENT OF THE BUSINESSES OF
                  MDS**
  **2.1**  **Overview**
 MDS
        is a
        global life sciences company that provides market-leading products and services
        that our customers need for the development of drugs and the diagnosis and
        treatment of disease. We are a leading global provider of pharmaceutical
        contract research, medical isotopes for molecular imaging, radiotherapeutics,
        and analytical instruments.
  MDS
        operates in three business segments within the Life Sciences Industry:
        Pharmaceutical Research Services; Isotopes and molecular imaging; and Analytical
        Instruments.
  In
        September 2005, we announced our strategic plan to pursue growth in the global
        life sciences market and dispose of assets that do not contribute to the
        Company’s areas of focus. The announcement also referred to our restructuring
        plan to reduce overhead and better align resources and infrastructure costs.
  During
        fiscal 2005, we discontinued certain early-stage businesses within our
        pharmaceutical research services business, a business unit of the Life Sciences
        segment, and, consistent with our strategic plan, our interests in Source
        and
        CLS were classified as discontinued operations. In November 2005, the Company
        sold its interest in Source to Cardinal Health Inc. for $79 million, and
        in
        April 2006, the Calgary Health Region exercised its option to acquire the
        Company’s partnership interest in CLS for $21 million.
  On
        October 5, 2006, MDS announced the signing of a series of agreements to sell
        its
        remaining Canadian diagnostics businesses for total proceeds of $1.3 billion.
        The Company expects net proceeds of approximately $1.1 billion after closing
        costs and payments to holders of minority interest. As a result of these
        agreements, the Company is now treating the entire diagnostics segment as
        discontinued. This transaction is expected to close by January 31, 2007 and
        is
        in line with the September 2005 announcement to reposition MDS as a global
        life
        sciences company.
  **2.1.1**  **Life
        Sciences**
  The
        Company has three Life Sciences business segments: MDS Pharma Services, which
        provides pharmaceutical contract research; MDS Nordion, which involves molecular
        imaging and radiotherapeutics; and MDS Sciex, which involves the development
        and
        manufacture of analytical instruments.
  In
        1981,
        MDS entered the analytical instruments business with the acquisition of
        Sciex  (acronym
        for “SCIentific EXport”).
  In
        1992,
        MDS acquired an initial 83% interest in Nordion International Inc. from the
        Canadian Development Investment Corporation pursuant to a privatization
        initiative by Atomic Energy of Canada Limited (“AECL”), thereby expanding its
        operations into medical isotope manufacturing and distribution. Commencing
        in
        1995, the Company increased its ownership interest in Nordion to 100%. In
        1998,
        MDS expanded into isotope-based radiation therapy with the acquisition of
        100%
        of Theratronics.
  In
        1995,
        MDS began acquiring contract pharmaceutical research organizations and expanded
        the services offered to the pharmaceutical development industry. Several
        smaller
        acquisitions led to the fiscal 2000 acquisition of Phoenix International
        Life
        Sciences Inc., a public company based in Montreal, Canada with operations
        in the
        United States and Europe. These contract research businesses have been
        integrated and now operate globally under the trade name MDS Pharma
        Services.
  **2.1.2**  **Diagnostics**
  Until
        2006, the Company also operated in the healthcare industry primarily through
        its
        Canadian clinical laboratory operations, MDS Laboratory Services. From its
        inception, clinical laboratory services have been a major business focus
        of the
        Company. As a result of a series of acquisitions and investments, MDS operates
        clinical laboratories and manages hospital laboratory systems in Canada.
        The
        Company’s largest laboratory operations are in Ontario and British Columbia.
        Other, smaller laboratory and laboratory support operations exist in Alberta,
        Quebec, and Manitoba. Prior to May 2004, MDS provided support services under
        contract for the hospital laboratory networks in Saskatchewan. Effective
        May 7,
        2004, MDS ceased to be the contract holder for this business.
  Prior
        to
        fiscal 2004, MDS was pursuing a strategy to build a US laboratory business
        based
        on managing laboratory networks for affiliated hospital groups. As a result
        of
        unsatisfactory sales and operating results and business development climate,
        in
        2004 MDS began to exit this business and as at October 31, 2005 had fully
        exited
        the remaining US operations.
  **2.1.3**  **Customers**
  Customers
        of the Company’s Life Sciences businesses include a broad range of manufacturers
        of medical products including pharmaceutical manufacturers, biotechnology
        companies, and manufacturers of medical supplies and devices. These customers
        are located in essentially all major international markets.
  Through
        its Canadian diagnostics business, the Company provides products and services
        directly to healthcare providers, including physicians and
        hospitals.
  No
        single
        customer accounted for more than 10% of the consolidated revenues of the
        Company
        for the fiscal year ended October 31, 2006.
  Revenues
        earned outside of Canada, reflecting export sales, along with revenues earned
        by
        operating units based outside of Canada, made up approximately 95% of net
        revenues for 2006.
  **2.1.4**  **Employees**
  At
        October 31, 2006, MDS had approximately 5,600 employees in 28 countries in
        its
        continuing life sciences businesses and approximately 2,700 employees in
        its
        discontinued Canadian laboratory services business.
  **2.2**  **Recent
        Industry Developments**
  MDS
        has
        benefited from the significant and rapid changes that are affecting the life
        sciences industries and the healthcare industries. These changes
        include:
  (i)
              rising
                  healthcare costs;
  (ii)
              intensifying
                  cost containment pressures;
  (iii)
              rapid
                  growth in demand for services due to aging population
                  bases;
  (iv)
              rapid
                  innovation in technology, increasing the availability of sophisticated
                  treatment options;
  (v)
              growing
                  consumer awareness of healthcare choices;
                  and
  (vi)
              growing
                  awareness within emerging and developing countries of the benefits
                  of
                  adequate healthcare systems and the improving ability to pay for
                  improved
                  healthcare solutions.
  New
        technologies have profoundly affected the life sciences and health markets.
        These new technologies, in part, have led to more focused research spending
        and
        continued corporate mergers of significant size within the pharmaceutical
        industry, as pharmaceutical companies strive to maintain or obtain a competitive
        edge by providing new and improved services or by introducing new products
        to
        market. Consolidation of this industry is expected to continue, and is likely
        expected to affect product development budgets and may lead to more focused
        research spending by the merged entities, including more concentration of
        spending budgets within therapeutics areas.
  These
        mergers are, at least in part, a response to the loss of patent protection
        on a
        significant number of large market drugs expected over the next few years.
        Off-patent drugs often lose more than half of their market share to generic
        alternatives in less than one year. To replace these lost revenues and sustain
        the levels of growth enjoyed in the past, pharmaceutical companies must either
        increase research and development spending or improve the effectiveness of
        existing spending. Major pharmaceutical companies are also acting aggressively
        to protect existing patent positions and to extend patent coverage to different
        formulations.
  A
        string
        of recent adverse events affecting a number of large market pharmaceutical
        products has placed added scrutiny on the drug approval process in the US
        There
        are increasing calls for more regulation of the approval process as a result.
        The impact of this on the rate and cost of drug innovation is
        uncertain.
  There
        is
        growing activity between pharmaceutical companies having large research budgets
        and smaller biotechnology companies that have smaller budgets but rich pipelines
        of possible new discoveries. Advances in biotechnology, genomics, and proteomics
        have created a better understanding of how diseases function both at a molecular
        level and as part of a biological system that biotechnology companies are
        seeking to exploit. Large pharmaceutical companies are increasingly providing
        funding to these smaller companies in return for rights to further develop
        and
        market products resulting from these discoveries, or buying these smaller
        companies outright.
  The
        surge
        in development activity, coupled with a drive to reduce costs and accelerate
        development time, has driven growth in outsourcing of research activities
        by
        pharmaceutical manufacturers. High throughput screening and the technologies
        that make this possible increase the number of new drug leads that can be
        investigated, enabling drug companies to identify promising candidates earlier.
        More importantly, researchers can eliminate an unpromising candidate before
        a
        large investment is made in further development.
  The
        evolving sciences of genomics and proteomics are expected to eventually lead
        to
        significant advances in diagnosis and treatment of disease. The completion
        of
        the first stage of the Human Genome Project in 2000 laid the groundwork for
        many
        of these advances. Research into proteomics is expected to further improve
        the
        information and products used in the treatment of disease. Thus far the
        conversion of these technologies into new drug discoveries has been
        disappointing; however, interest in this area remains strong. Much of this
        interest is now focused on biomarkers as a near-term application of the evolving
        science.
  It
        is
        anticipated that these technological advances may lead to more effective
        medicines. In addition, these technologies are expected to lead to more accurate
        diagnosis at an earlier disease stage, which will in turn lead to treatment
        that
        is more effective. A number of new developments also promise better disease
        prevention alternatives.
  **2.3**  **Business
        Strategy of MDS**
  The
        Company’s strategy is to focus resources and management on opportunities within
        the fast-growing global life sciences markets, which includes a focus on
        our
        pharmaceutical contract research business (served by MDS Pharma Services),
        molecular imaging and radiotherapeutics (served by MDS Nordion), and analytical
        instruments (served by MDS Sciex). Organic growth will be supplemented by
        carefully chosen acquisitions. Increasingly, technological leadership will
        be
        the main method of differentiation among participants in these markets.
  MDS
        Pharma Services (see Section 3.2) is building a global contract research
        capability across most phases of drug development. The segment is the sixth
        largest contract research organization (“CRO”) globally, and the largest CRO in
        early-stage research (Discovery through Phase IIa). The current focus of
        MDS
        Pharma Services is the profitability of this segment in all businesses and
        regions.
  MDS
        Nordion (see Section 3.3) is the largest global provider of nuclear isotopes
        used in molecular imaging and sterilization. Securing reliable sources of
        supply
        for key isotopes and building safe, dependable logistics capability are key
        strategic objectives for this core business. MDS Nordion is also focused
        on
        identifying new uses for medical isotopes and building the necessary
        manufacturing and development capabilities to be the provider of choice for
        companies that are developing new products with isotopic
        applications.
  MDS
        Sciex
        (see Section 3.4) is focused on higher end analytical instrumentation based
        on
        the principles of mass spectrometry. This segment relies heavily on leading
        edge
        research and engineering to develop instruments that have a clear advantage
        over
        competitive offerings as measured by instrument sensitivity and/or speed.
        In
        order to focus efforts in this area of expertise, MDS Sciex takes its products
        to market predominantly through partnerships with companies who take primary
        responsibility for marketing, sales, and after-sales support.
  **2.4**  **Financial
        and Other Developments**
  Factors
        affecting the comparability of the Company’s financial data for fiscal years
        2004 through 2006 include the following:
  **2.4.1**  **Capital
        Structure**
  Ø
              InDecember2002, the Company completeda
                  private placement of US$311 million of senior unsecured notes (the
“Senior
                  Unsecured Notes”). The Senior Unsecured Notes bear interest at rates
                  between 5.15% and 6.19% per annum and have maturities ranging from
                  December 2007 to December 2012.
  Ø
              In
                  2005, the Company negotiated a new $500 million, five-year committed,
                  revolving credit facility which replaced the Company’s previous $225
                  million credit facility. As at October 31, 2006, the facility remained
                  undrawn.
  **2.4.2**  **Acquisitions**
  Ø
              During
                  2004,MDSacquired
                  a 50% interest in intellectual property assets related to existing
                  Applied
                  BiosystemsInc.MALDI
                  Time-of-Flight (“TOF”) mass spectrometry systems and next-generation
                  products under development, together with a 100% interest in certain
                  MALDI-TOF product-related manufacturing and research and development
                  assets for US$40 million. In 2005, the purchase price was renegotiated
                  and
                  reduced by US$2 million.
  Ø
              During
                  2005, MDS acquiredSkeleTechInc., a therapeutically focused CROprovidingpre-clinicaldiscovery and development services in bone and central nervous
                  systems
                  biologies, for consideration of US$6 million. The purchase agreement
                  includes a provision for contingent consideration of US$2 million,
                  payable
                  to the vendors if certain profitability levels are attained in
                  fiscal
                  2006. During 2006, a payment for US$1 million was made to the vendors
                  under this agreement.
  **2.4.3**  **Divestitures
        and Discontinuances**
  Ø
              During
                  2003, MDS decided todiscontinue
                  operations and conduct an orderly exit from a generic radiopharmaceutical
                  business in Belgium. This portion of the business in Belgiumwas
                  subjectto
                  increased regulatory standards compliance that would have required
                  significant investment in plant and equipment that could not be
                  justified
                  by the returns generated by the business. This orderly exit was
                  finalized
                  during 2006.
  Ø
              During
                  2004, the Company reduced its investment in ProtanaInc.(formerly
                  MDS Proteomics Inc.) from 89% to 48.4%. In 2005, Protana Inc. filed
                  for
                  protection under the*Bankruptcy
                  and Insolvency Act*(Canada) and an interim receiver sold certain of the assets of
                  the
                  company.
  Ø
              During
                  2004, MDS sold its laboratory operations in Tennessee, New York,
                  and
                  Georgia, realizing total proceeds of $35
                  million.
  Ø
              Effective
                  May 1, 2004, MDS participated in a financial reorganization of
                  Hemosol
                  Inc., an Ontario research and development company in which MDS
                  held an 11%
                  interest. Under the terms of the reorganization, MDS transferred
                  ownership
                  of its Ontario laboratory business to Hemosol Inc. (since re-named
                  LPBP
                  Inc.) in exchange for a 99.6% equity interest (47.5% voting interest)
                  in
                  that company. As a result of this transaction, the Company has
                  benefited
                  from significant tax loss carry forwards, research and development
                  expense
                  pools, and investment tax credits, having an estimated combined
                  value at
                  the time of the transaction of $120 million. These tax assets were
                  accumulated by Hemosol Inc. from a blood products business operated
                  by
                  that company prior to the reorganization. The cost to MDS to gain
                  access
                  to these tax assets totalled $19 million, comprising a $16 million
                  cash
                  transfer to Hemosol Corp., a successor corporation to Hemosol Inc.
                  in the
                  blood products business, along with $3 million of transaction costs.
                  On
                  December 2, 2005, Hemosol Corp. filed a notice of intention to
                  make a
                  proposal to its creditors under the*Bankruptcy
                  and Insolvency Act*(Canada) and a receiver was appointed. During 2006, MDS provided
                  debtor-in-possession financing totalling $1.5 million to support
                  liquidation efforts. On November 3, 2006, MDS sold its interest
                  in the
                  secured debt and debtor-in-possession financing for $14.5
                  million.
  Ø
              In
                  2005, the Company’s management announced its commitment to a plan to
                  divest a number of business operations that were no longer part
                  of the
                  Company’s strategic plan. During 2005, the Company’s interest in Source
                  was classified as a discontinued operation, and as stated previously,
                  in
                  November, 2005, the Company disposed of its interest in Source.
                  In
                  addition, during 2006, the Company’s partner in CLS exercised its right to
                  buy out the Company’s partnership
                  interest.
  Ø
              In
                  2005, the Company approved a plan to divest of its Pharmaceutics,
                  Fermentation Biopharmaceutics/Biosafety, and*in
                  vitro*Pharmacology operations within the MDS Pharma Services segment.
                  These
                  businesses have also been classified as discontinued operations.
                  During
                  2006, these businesses were either sold or shut
                  down.
  Ø
              On
                  October 5, 2006, the Company entered into a series of agreements
                  to sell
                  its remaining Canadian diagnostics businesses, MDS Diagnostic Services
                  to
                  Borealis Infrastructure Management Inc. for net proceeds of $1.1
                  billion.
                  This transaction is expected to close by January 31,
                  2007.
  Ø
              In
                  February 2006, MDS and AECL reached a settlement on disputes related
                  to
                  the MAPLE dedicated isotope reactor, which resulted in MDS exchanging
                  its
                  interest in the reactor for a long-term isotope supply contract
                  (See
                  Section 3.3.)
  **3.**
              **NARRATIVE
                  DESCRIPTION OF THE BUSINESSES OF
                  MDS**
  **3.1**  **Reportable
        Industry Segments**
  The
        Company operates in the following business segments:
 Pharmaceutical
                  Research Services
                (MDS
                  Pharma Services)
              Operating
                  as MDS Pharma Services, this business unit provides research services
                  and
                  is the world leader in contract research from pre-clinical development
                  to
                  Phase II(a) clinical trials for innovative and generic pharmaceutical
                  companies and for biotechnology companies as well as consumer product
                  and
                  drug delivery companies.Isotopes
                  and Molecular Imaging
                (MDS
                  Nordion)
              Operating
                  as MDS Nordion, this business unit is a global leader in the production
                  of
                  isotopes used in the diagnosis and treatment of disease and isotopes
                  used
                  to sterilize medical and other products, including food. In addition,
                  this
                  business unit includes the manufacture and sale of isotope-based
                  cancer
                  therapy equipment.Analytical
                  Instruments
                (MDS
                  Sciex)
              Operating
                  as MDS Sciex, this business unit focuses on the design, development,
                  and
                  manufacture of market-leading analytical instruments based on principles
                  of mass spectrometry and related operating systems, software and
                  other
                  products. These products are sold through the AB/MDS Sciex and
                  PerkinElmer/MDS Sciex partnerships to pharmaceutical and biotechnology
                  customers as well as to academia and environmental end-use
                  markets.In
                  addition, prior to the fourth quarter of 2006, the Company’s business
                  included:Diagnostics
              Prior
                  to entering into a series of agreements, as disclosed under “2.4.3 -
                  Divestitures and Discontinuances”, the Company was, through various
                  operating business units, the leading provider of diagnostic laboratory
                  services in Canada.Medical
                  Products Distribution
              Prior
                  to the sale of Source in November 2005, as disclosed under “2.4.3 -
                  Divestitures and Discontinuances”, the Company was a partner in the
                  largest provider of distribution services for medical products
                  in Canada,
                  supplying hospitals and alternative care
                  sites.
 
  **3.2**  **Pharmaceutical
        Research Services (MDS Pharma Services)**
  MDS
        operates as a global CRO under the trade name MDS Pharma Services. MDS Pharma
        Services is one of the top global CROs and has been highly rated for customer
        service and quality by CenterWatch, a leading industry publication. The main
        focus for MDS Pharma Services is early-stage pharmaceutical research services
        (from discovery to Phase IIa) and the Company has a growing presence in
        later-stage research as well. MDS Pharma Services operates as a CRO in 26
        countries.
  Industry
        Background
  During
        the 1970’s, integrated pharmaceutical companies conducted the majority of
        research leading up to development of pharmaceutical products in-house. At
        that
        time, the only significant function that was contracted out was pre-clinical
        toxicology screening.
  The
        drug
        development process is extremely expensive due to the cost of the infrastructure
        required to support the full range of processes necessary for drug development
        and the long period of time required to achieve full regulatory approval
        of a
        new compound. On average, it takes 10 to 12 years and over US$ 800
        million to bring a new pharmaceutical from discovery through Phases I to
        III of
        clinical trials and make it available to consumers. Since patent protection
        for
        new products extends for only 17 to 20 years, the profitability of a new
        compound can be greatly enhanced by reducing the total cost of development
        and
        by shortening the elapsed period over which development occurs.
  As
        a
        result, companies began to outsource to meet the occasional surge in internal
        demand that could not be addressed with in-house capabilities. In an effort
        to
        reduce both time and costs, major drug companies began outsourcing portions
        of
        the development work to companies that provide specialized research services.
        These companies have become known as Contract Research Organizations or CROs.
        Individual CROs tend to specialize in particular stages of the drug development
        process and, therefore, develop expertise in those areas. Reliance on CRO
        expertise can enable the pharmaceutical companies to achieve cost efficiencies
        and to shorten the research time for that stage of the development process
        while
        avoiding capital investments.
  The
        decision by MDS to enter the CRO business in 1995 was influenced by a number
        of
        key trends that were beginning to affect the industry. The Company believes
        that
        these trends remain in place. In particular, corporate mergers and cost
        containment pressures at pharmaceutical companies are expected to continue
        to
        lead to downsizing of in-house research and development capabilities and
        pharmaceutical companies are anticipated to continue to focus increasingly
        on
        marketing and product distribution. Outside suppliers will increasingly be
        relied upon to provide services previously secured from in-house departments.
        Aside from reducing infrastructure costs for the pharmaceutical companies,
        outsourcing is expected to lead to reduced cycle time for development.
        Outsourcing this activity may also lead to development of drug candidates
        which
        have a small market and might have been ignored by larger pharmaceutical
        companies which require large-market drugs to cover the costs of their marketing
        and distribution channels.
  Globalization
        of pharmaceutical markets driven by ongoing mergers of major international
        pharmaceutical companies has influenced the selection of a CRO. Those with
        an
        international presence and the ability to conduct trials in multiple
        jurisdictions have greater chances of becoming preferred suppliers. The growth
        of the biotechnology industry is also significantly influencing the growth
        of
        CROs, as many smaller biotechnology companies elect not to build the
        infrastructure to conduct the various phases of the development of their
        products in-house.
  A
        general
        overview of the drug development process is provided in the diagram
        below:
  
  Overview
        of Business
  Headquartered
        near Philadelphia, MDS Pharma Services provides contract research services
        to
        pharmaceutical manufacturers and biotechnology companies, focusing particularly
        on pre-clinical and early clinical drug development (up to Phase IIa clinical
        trials). MDS has provided services to pharmaceutical manufacturers since
        1992,
        beginning as a centralized support laboratory providing testing services
        in
        connection with Phase III clinical trials. MDS is now the largest and most
        integrated CRO in the pre-clinical and early clinical segment of the market
        and
        a developing competitor in late-stage clinical trials.
  The
        pharmaceutical research process can be broken down into three primary
        components: laboratory-based research, clinic-based testing, and out-patient
        based testing. MDS includes most laboratory-based research and clinic-based
        research in early-stage and the Company has been the leading competitor in
        this
        phase of research based on the installed base of mass spectrometers and on
        the
        number of available clinic beds. The Company’s significant capacity in each of
        these areas enables it to take on client work on very short notice and to
        develop the necessary expertise in these fields to participate in the most
        complex studies.
  Key
        lines
        of business for this division include:
  Ø
              Pharmacology,
                  in which the Company’s vast library of assays is applied to study the
                  effects of compounds on living organisms and in-vitro
                  targets.
  Ø
              Drug
                  Safety in which advanced understanding of drug safety and toxicology
                  is
                  obtained under strict Good Laboratory Practices (“GLP”) regulated
                  conditions.
  Ø
              Bioanalysis
                  in which advanced technology and analytical science is applied
                  to
                  biological fluids to gain an understanding of the drug’s absorption,
                  distribution, metabolisation and elimination.
  Ø
              Early-stage
                  clinical or first-in-man testing, in which new investigational
                  drugs are
                  tested for the first time in healthy volunteers to assess drug
                  safety and
                  to determine how the drugs are processed by the
                  body.
  Ø
              Late-stage
                  clinical or traditional clinical trials, in which investigational
                  drugs
                  are tested in volunteers exhibiting the condition the drug is intended
                  to
                  affect to determine the relative efficacy of the drug under
                  study.
  Ø
              Central
                  laboratory, a support service for late-stage trials, through which
                  samples
                  taken from study participants are run against standard assays to
                  determine
                  the safety and effectiveness of the
                  drug.
  Significant
        pre-clinical and early clinical operations are in Montreal Quebec, Lincoln
        Nebraska, Phoenix Arizona, Bothell Washington, Neptune New Jersey, Belfast
        Northern Ireland, Sittingbourne United Kingdom, Zurich Switzerland, Lyon
        France,
        and Hamburg Germany. These facilities include clinic locations and laboratories,
        as well as other development facilities.
  Management
        of late-stage clinical trials on behalf of clients is conducted globally.
        Significant clinical offices include Philadelphia Pennsylvania, Irvine
        California, Paris France, Winnersh United Kingdom, and Madrid Spain, along
        with
        smaller offices in a number of other countries. In addition, the Company
        has
        central laboratory locations in Toronto Canada, New Jersey USA, Paris France,
        Beijing China, Singapore and Hamburg Germany.
  Globally,
        approximately 4,000 employees work in MDS Pharma Services.
  Strategy
  MDS
        Pharma Services is currently one of the leading CROs in the world. Management
        expects to continue to expand its global capabilities through organic growth
        and
        through acquisition. The acquisition strategy of the Company is to focus
        on
        targets that extend leadership in key fields and leverage existing assets.
        Where
        operations do not meet the Company's expected returns, or they do not fit
        with
        the overall direction in adding value to the range of services, MDS has sought
        to divest these businesses. During 2006, MDS sold or closed a number of smaller,
        non-strategic lines of business.
  Competitors
  The
        growth of the contract research industry has been dependent on the increase
        in
        outsourcing by pharmaceutical and biotechnology companies. The market has
        experienced high growth rates and has become highly competitive. Competition
        for
        individual research contracts often includes in-house research departments
        of
        pharmaceutical and biotechnology companies, as well as universities, teaching
        hospitals, and other CROs. Industry consolidation and globalization have
        affected pharmaceutical companies as well as CROs resulting in the use of
        fewer,
        larger CROs. The Company believes that outsourcing will continue to grow
        as an
        economically attractive alternative to in-house research.
  Companies
        active in this industry, including MDS, may improve their competitive position
        by leveraging scale, which enhances the ability to service clients in their
        preferred location or in a more timely fashion, and internal operating
        efficiencies, which translates into sound and predicable execution and
        opportunity for competitive pricing/premium margins. In addition, we believe
        that our expertise and capabilities result in a unique offering that contributes
        to our competitive position. MDS Pharma Services’ strength in Pharmacology,
        Early Clinical Research and Bioanalytical Sciences and its broad configuration,
        allows it to integrate its offerings under complete Drug Development Programs
        to
        help biotech firms move their compounds through the development stages more
        rapidly.
  The
        majority of competitors have been focused primarily on later stages of the
        drug
        development process (Phase II-IV clinical research ).
        Late-stage competitors include several multinational companies such as Quintiles Transnational
        Corp. ,
        Parexel
        International, Corp., PPD, Inc., and PharmaNet Development Group, Inc.
        Early-stage (preclinical to Phase IIa) competitors include Covance, Inc.
        and
        Charles River Laboratories Inc. Several of the Company’s CRO competitors are
        significantly larger than MDS and may have greater financial and technical
        resources.
  **3.3**  **Isotopes
        and Molecular Imaging (MDS Nordion)**
  MDS
        is a
        world leader in medical isotopes for molecular imaging, development, and
        manufacturing of radiotherapeutics and sterilization. Exports of these materials
        to over 60 countries account for more than 97% of total sales by this business.
  Industry
        Background
  In
        molecular imaging, isotopes are used because of their ability to assist in
        diagnostic procedures such as single photon emission computed tomography and positron emission tomography. When formulated with chemical
        compounds that are attracted to or accumulate in particular types of tissue,
        these isotopes can aid physicians in the identification and treatment of
        certain
        diseases. . Certain other isotopes can be used to deliver direct radiation
        therapy to cancerous cells using same principles of targeted
        therapy.
  Significant
        barriers to entry exist in both the molecular imaging and sterilization
        businesses. The manufacture of raw isotopes is dependent upon the availability of capacity in acceptable types of nuclear reactors and cyclotrons.
        Processing facilities such as those operated by MDS are centralized, capital
        intensive, and expensive to operate. In addition, due to the nature of the
        materials handled by the facilities, government and environmental regulation
        are
        significant factors in the business.
  Processing
        raw isotopes into a form suitable for the intended use is highly complex.
        Many
        isotopes used for molecular imaging have a limited half-life. This imposes
        constraints on the manufacturing process and on the logistical procedures
        needed
        to deliver refined product to an end-user. Security of supply is a key customer
        concern due to the short lifespan of the products; hence, efficient and safe
        transportation systems are vital
        components of the business. The logistical system at MDS can process isotopes,
        deliver them to manufacturers and then on to hospitals or treatment centres
        in
        only a few days.
  Molecular
        imaging is a growing market. Aging populations worldwide are expected to
        increase demand for the procedures which medical isotopes make possible.
        In
        addition, considerable research is underway to identify new uses for existing
        isotopes.
  Sterilization
        of medical products is a mature industry with 4%-7% market growth. Alternative
        applications for this technology are continuously under investigation. The
        United States Food and Drug Administration (“FDA”) has approved the use of
        irradiation for microbial control of pathogens (eg: *E.coli* )
        and as
        a quarantine treatment for fruit and vegetables to eliminate agricultural
        pests.
        To date, the commercial use of irradiation has largely been limited to spices,
        some red meat, poultry and certain fresh fruits and vegetables.
  Business
        Overview
  MDS
        manufactures, processes and repackages isotopes to
        produce products that include:
  Ø
                industrial
                    isotopes for the sterilization of disposable medical products
                    and for
                    treating food;
  Ø
              medical
                  isotopes for the treatment of cancer;
                  and
  Ø
              medical
                  isotopes that are used alone or coupled to target molecules for
                  use in
                  clinical research, diagnosis of cardiac function and other diseases
                  and
                  treatment of diseases such as
                  cancer.
  In
        addition, the Company manufactures and
        sells equipment that is used for the application of its products,
        including:
  Ø
              external
                  beam therapy systems for cancer
                  treatment;
  Ø
              large
                  scale production irradiators for the sterilization of disposable
                  medical
                  products and for treating food; and
  Ø
              self-contained
                  irradiators used to treat blood for immuno-compromised patients
                  and for
                  research applications.
  MDS
        is
        the world's principal supplier of Cobalt-60 (“Co 60 ”).
        The
        majority of raw Co 60 material
        is produced under long-term supply contracts. MDS further processes the raw
        Co 60 into a
        finished form for commercial use at its Ottawa, Ontario facilities. The resulting processed material, or gamma source, is delivered
        to
        customers using approved transport containers and procedures. Customers include
        major sterilization contractors, as well as large medical product manufacturers
        who maintain their own sterilization capability. Other users include hospitals
        and private clinics that use Co 60 to
        treat
        cancer.
  MDS
        also
        markets related equipment and services, including industrial scale irradiators
        and self-contained irradiators. Delivery or construction of this
        equipment is usually accompanied by an initial shipment (“loading”) of gamma
        source. Resupply or replenishment of the gamma source is required from time
        to
        time as the radioactivity level of the initial loading declines over time
        at a
        rate of approximately 12% per year.
  Isotopes
        used for molecular imaging are handled and processed in much smaller quantities
        than those used for industrial irradiation. MDS purchases reactor-produced
        isotopes such as Molybdenum-99 (“Mo 99 ”),
        Iodine-131 ( “I 131 ”),
        Iodine-125 (“I 125 ”)
        and
        Xenon-133 (“Xe 133 ”)
        in an
        unfinished, non-purified form, and transports them to its own facilities
        in
        Ottawa for further processing. MDS manufactures cyclotron-produced isotopes
        such
        as Iodine-123 (“I 123 ”),
        Thallium-201 (“Tl 201 ”),
        Palladium-103 (“Pd 103 ”)
        and
        Yttrium-90 (“Y 90 ”)
        at its
        facilities in Vancouver, Canada and Fleurus, Belgium, and refines these
        materials in its adjacent processing facilities. MDS also has a joint venture
        with the University of Liege in Belgium to manufacture and distribute used
        in
        PET imaging.
  The
        purified forms of these isotopes are incorporated by pharmaceutical companies
        into radiopharmaceuticals used to diagnose and treat numerous serious
        disease states, such as coronary artery disease and cancer. Mo 99 decays
        into Technetium-99 (“ Tc 99 m”) ,
        which
        is the most widely used diagnostic isotope in the world. Approximately18
        million
        scans are performed each year and 80% use a Tc 99 m
        radiopharmaceutical. This number is expected to grow as the population in
        developed countries ages and as the use of molecular imaging in the management
        of coronary artery disease expands. MDS is the world’s leading supplier of
        Mo 99 .
  MAPLE
        Facility
  The
        Company’s principal source of Mo 99 is the
        existing NRU reactor located in Chalk River, Ontario which is owned and operated
        by AECL. To provide greater security for the future supply of Mo 99 and
        other reactor-produced radioisotopes commonly used in nuclear medicine, MDS
        contracted with AECL in 1996 for the construction and operation of two dedicated
        reactors and a processing facility to produce such isotopes. Pursuant to
        the
        original agreement, MDS owns the reactors and, once completed, AECL would
        operate them on a fee per service basis.
  As
        a
        result of construction deficiencies, cost overruns and other technical
        regulatory issues, completion of the facility has been delayed. The
        deficiencies, regulatory issues, significant delays, and cost overruns led
        to a
        dispute between the Company and AECL. Both MDS and AECL agreed to a mediation
        process to resolve the dispute and a mediator was appointed in February of
        2005.
  The
        mediation between the parties was successful and in early 2006 the Company
        entered into a settlement agreement with AECL related to the MAPLE
        Project .
        The
        agreement reached with AECL provides the basis for a productive ongoing
        relationship and enables AECL to move forward to successfully complete the
        project. Under the Agreement, ownership of the MAPLE Facilities was transferred
        to AECL, along with certain associated inventories, for $25 million in cash,
        a
        non-interest bearing note due over four years beginning in 2008, and a 40-year
        supply agreement containing terms that are similar to those contained in
        the
        existing supply agreement with AECL related to the NRU reactor.
  Since
        AECL has now assumed full ownership of the facility, they will be responsible
        for capital costs associated with completing the project and commissioning
        the
        reactors for future operating costs. MDS has retained a commitment to assist
        AECL to defray the costs of any material and unusual regulatory changes,
        should
        such a change occur during the life of the supply agreement. This commitment
        extends to cover any changes required by international agreements or treaties
        related to the use of highly enriched uranium in the reactors. We have also
        retained certain legal rights in the event that the facility is not operational
        by 2008.
  Final
        completion and commissioning of the reactors will entail an extended regulatory
        and quality control review process for our customers, including steps to
        determine that the products produced in the new facility meet the same quality
        standards as those produced in NRU.
  The
        new
        reactors and an integrated isotope processing facility, once operational,
        should
        enable MDS to provide its customers with a stable and secure supply of key
        medical isotopes and strengthen MDS’s competitive position in medical isotope
        supply, as they are the only reactors dedicated solely to medical isotope
        production. All other reactors engaged in medical isotope production are
        multipurpose reactors.
  In
        November 2005, AECL received approval from the CNSC for its application to
        renew
        the operating licences for its MAPLE 1 and 2 medical isotopes reactors and
        the
        New Processing Facility located at the Chalk River Laboratories. The licences
        are for a two-year period and are valid until November 30, 2007.
  In
        August
        2006 CNSC granted a new operating license for the Chalk River facilities
        that
        extends to October 31, 2011.
  Facilities
        that are able to handle and process isotopes in the manufacture of
        radiopharmaceuticals are complex and strictly regulated. MDS has added an
        80,000
        square foot manufacturing facility that is utilized on a partnership basis
        in
        the development, and later, the direct manufacture of radiotherapeutics.
        Examples include ZEVALIN® and BexxarTM. Both products
        are based on monoclonal antibodies and are used to treat non-Hodgkin’s Lymphoma
        (“NHL”). ZEVALIN uses Y 90 as the
        active agent while Bexxar uses I 131 .
        Growth
        of development and manufacturing opportunities is expected, since drug
        manufacturers may not wish to incur the capital cost or regulatory delays
        associated with building their own facilities.
  MDS
        also
        manufactures and distributes radiation therapy equipment and
        Co 60 is the
        radiation source for this equipment.
  The
        isotope business employs approximately 735 people at its Ottawa, Ontario
        head
        office and facilities in British Columbia, Quebec and Fleurus Belgium. Some
        technical and production employees of MDS belong to the Public Service Alliance
        of Canada, a collective bargaining agent representing, among others, certain
        employees of the Government of Canada. Certain other employees belong to
        the
        Energy and Paperworkers Union of Canada. Labour relations are judged to be
        good
        with both unions.
  Strategy,
        Markets, and Competition
  MDS
        has a
        leading position as an international supplier of key isotopes. Revenue growth
        for isotopes generally has historically been in line with the overall increase
        in healthcare spending and population growth, both of which have an impact
        on
        the growth in the utilization of
        diagnostic tests and the use of disposable medical products. Sales of medical
        isotopes do not follow any notable seasonal or other cycles and demand is
        relatively constant. The short half-life of the isotopes used for medical
        purposes limits the ability of any market participant to build significant
        inventories.
  Isotopes
        used for sterilization tend to be somewhat more cyclical, due primarily to
        the
        length of time required to convert Cobalt-59 (“Co 59 ”)
        into
        Co 60 and the
        limited number of facilities in which
        this can be done economically.
  Security
        of supply is a significant objective for the majority of the Company’s
        customers. The Company has developed a strong supply and logistics network
        to
        meet these demands. Current activity and investment, including the completion
        of
        the MAPLE facility, is intended to solidify the Company’s position as a reliable source of
        supply. In addition, the Company is developing new and complementary lines
        of
        business based on its expertise with isotopes. For example, the cancer treatment
        market is expected to develop rapidly over the next several years, particularly
        in emerging economies. Many of these countries are now able to afford modern
        cancer therapies and are expected to make significant investments in this
        technology as their healthcare systems develop.
  Significant
        barriers to entry limit the competition faced by the Company in the molecular
        imaging market. Since Mo 99 is the
        most significant isotope on world markets, the majority of competition faced
        by
        the Company is in this product. Major competitors are Institute National
        des
        Radioelements (IRE) of Belgium, the NTP Radioisotopes (Pty) Ltd. (a wholly
        owned
        subsidiary of Nuclear Energy Corporation of South Africa) and the Nuclear
        Research and Consultancy Group of the Netherlands.
  Competition
        in the sterilization market is different from the medical isotopes market
        due to
        the substantially different half-life of the products. Co 60 is often
        bought and sold in large quantities and can be produced by any of several
        nuclear reactors around the world. While delivery and logistics expertise
        remains an MDS advantage, the most significant competition in the sterilization
        market and Co 60 supply
        comes from Reviss (a joint venture between Mayak, Russia and GE Amersham)
        which
        acquires cobalt from Russian sources. Competition for sterilization spending
        also comes from alternative technologies, the most significant of which are
        Ethylene Oxide (EtO) and electron-beam. The Company believes that gamma-based
        sterilization technologies continue to enjoy advantages over these competitive
        technologies in some applications. In addition, there is a significant installed
        base of industrial irradiators that should ensure that gamma irradiation
        remains
        a key technology in this market.
  **3.4**  **Analytical
        Instruments (MDS Sciex)**
  Industry
        Background
  MDS
        first
        entered this industry in 1981 with the acquisition of Sciex and in 1988
        introduced the first liquid chromatography mass spectrometer for use on organic
        compounds to take advantage of the significant opportunities that exist in
        drug
        discovery and contract research outsourcing for drug development companies.
  Mass
        spectrometry has proven to be one of the most important and effective
        technologies in the drug development process, and the most significant area
        for
        growth for MDS Sciex and others in the industry for Life Sciences applications.
  Overview
        of Business
  MDS
        supplies the pharmaceutical industry with an advanced line of high-sensitivity
        analytical instruments under the MDS Sciex trade name. MDS
        manufactures ultra-trace chemical detection equipment and is Canada's leading
        manufacturer of analytical instrumentation. Marketed
        through partnerships with Applied Biosystems (a division of Applera Corporation)
        and PerkinElmer Canada, Inc. to a global customer base, export
        sales account for more than 95% of revenues from these products.
  MDS
        has
        been a major innovator of technologically sophisticated mass spectrometry
        instrumentation. In each of its product lines, MDS has been a pioneer.
        Accomplishments include the introduction of the first triple-quad mass spectrometers ,
        inductively coupled plasma mass spectrometers, and techniques for detecting
        ultra-trace amounts of small or large molecules by atmospheric pressure
        ionization (electrospray). Most of these products have evolved through multiple
        generations and continue to hold significant shares of their market
        segments.
  The
        pharmaceutical and biotechnology markets are the major users of technology
        based
        on the principles of liquid chromatography coupled with mass spectrometry (LC/MS)
        for detecting organic compounds. Early models of this equipment revolutionized
        many of the processes that were fundamental limitations in the search for
        new
        drugs or biotechnology products. Productivity and sensitivity improvements
        remain the primary basis for product differentiation for MDS
        equipment.
  Newer
        products that combine mass spectrometry with time-of-flight and ion trap
        technologies are finding markets among researchers investigating larger
        molecules such as proteins. In particular, the emerging proteomics market
        has
        become a key customer for this equipment.
  MDS
        Sciex
        and its partner Applied Biosystems are the market leader in
        high-sensitivity LC/MS equipment and have consistently delivered technological
        innovation within this industry. This innovation is a result of a high level
        of
        research and development spending each year.
  In
        2004,
        MDS and Applied
        Biosystems expanded
        their partnership to include Applied
        Biosystems’  MALDI -TOFTM
        technology and further develop the partnership as a world leader in high-end
        analytical equipment for the drug development industry.
  A
        smaller
        portion of the Company’s market is outside of the pharmaceutical industry and
        relies on similar equipment for the detection of inorganic compounds. For
        this
        group of customers, the Company produces the ELAN Inductively Coupled Plasma
        Mass Spectrometer (ICP/MS)
        that provides high sensitivity with extremely high specificity for a wide
        range
        of elements in the analysis of a single sample. The range of market areas
        that
        are addressed with the ELAN is broad and includes environmental monitoring
        (drinking and wastewater analysis), toxicology (role of trace metals in human
        disorders), semiconductors (trace impurities), and the nuclear industry
        (impurities in uranium). These machines are marketed on a worldwide basis
        through a partnership with PerkinElmer Canada, Inc.
  For
        both
        partnerships, MDS Sciex is responsible for manufacturing and has primary
        responsibility for research and development. The Company’s partners are responsible for
        marketing, sales, and service. The partnerships are structured so that each
        partner shares equally in the full profit margin generated once a piece of
        equipment is sold to an end-user.
  MDS
        Sciex’s business is dependent on a staff with highly specialized skills and
        knowledge in various branches of physics, chemistry, and biology.
        Individuals with the requisite credentials are recruited on a global basis
        and
        their knowledge is further developed by in-house training.
  Over
        500
        people work at MDS Sciex, with the majority of these employees based in the
        division’s Concord, Ontario head office.
  Strategy,
        Markets, and Competition
  The
        Company’s strategy is to be the leading global provider of top-of-line
        analytical instruments, with a particular focus on the application of this
        technology within the drug development process.
  MDS
        Sciex
        instruments are designed to outperform competitive products based on sensitivity
        and speed. The Company’s most important platform is based on LC/MS technology
        and sells under the model name API. The top end of this product range is
        the API
        5000, launched in January 2005. More recently, the Company has added to the
        LC/MS platform and introduced new instruments based on MALDI, TOF, and
        combination technologies (Q-TOF, MALDI-TOFTM).
  MDS
        Sciex
        products are sold through our partnerships with Applied Biosystems and
        PerkinElmer into global markets. The current key markets are the US, Western
        Europe, and Japan, reflecting the sophistication of the drug development
        industry in each of those areas.
  The
        Company’s principal competitors in the analytical instrumentation market include Waters Corporation, Thermo Fisher Scientific,
        Inc., Bruker Daltronics, Inc., and Agilent Technologies, Inc., all of which
        operate in the global market. Competition includes other manufacturers selling
        similar technology and also companies that sell competing but different
        technologies for certain applications.
  Since
        technological superiority is a key product differentiator, MDS Sciex, along
        with
        our partners, takes all necessary actions to defend our intellectual property .
        In 2003
        we successfully pursued Waters Corporation in a patent infringement suit
        related
        to a key LC/MS technology. Over two years, the Company received patent
        infringement settlements amounting to $53 million, pre-tax, plus a royalty
        on
        any ongoing sales of the technology. Following settlement of this patent
        infringement suit, AB/MDS Sciex launched a suit against Thermo Fisher
        Scientific, Inc. over a similar violation.
  In
        2006,
        MDS Sciex completed construction of a 10,000 square foot manufacturing facility
        in Singapore in an effort to improve the cost base of its instrumentation
        and
        materials and position the Company to take advantage of the increasing
        importance of the Asian market with respect to future sales growth. The initial
        product to be manufactured at the Singapore facility is the first analytical
        instrument focused on the cellular screening market, CellKeyTM System. This
        product was launched in late 2005. MDS Sciex is currently in the process
        of
        building an internal sales and marketing team to support the CellKeyTM system in
        North America and Europe. To supplement its direct sales and marketing
        activities, MDS Sciex will also consider strategic distribution partnerships
        in
        these and other geographic areas.
  The
        majority of MDS Sciex’s infrastructure, manufacturing and research and
        development reside in Canada. However, the Company has operations in the US
        and in Singapore. The US operation primarily provides research and development
        for our Applied Biosystems MALDI products as well as the recently launched
        CellKeyTM System.
  The
        operations of MDS Sciex to a certain degree have been and could be impacted
        by
        the cyclical nature of the semiconductor industry, the investment cycle in
        the
        biotech industry and the government regulation of environmental issues.
  **3.5**  **Diagnostics** ****
  MDS
        is
        the largest operator of private sector clinical laboratories in Canada. Services
        provided by the Company include clinical laboratory testing for physicians
        and
        non-hospital healthcare institutions, management of hospital laboratories
        under
        contract and other support services for clinical diagnostics.
  This
        segment is treated as a discontinued operation.
  Industry
        Overview
  In
        Canada, clinical laboratory testing is split roughly 66%/34% between
        hospital-based laboratories and private sector operated community laboratories.
        Hospital laboratories conduct the majority of inpatient and outpatient testing.
        In certain provinces hospital laboratories also handle community testing;
        however, in Ontario, private sector laboratories handle essentially all
        community testing. In BC, community testing is conducted in hospitals as
        well as
        in private sector laboratories.
  All
        clinical testing is conducted on samples drawn from patients and based on
        requests received from physicians. Test results are reported back to physicians.
        Fees for most testing services (other than those performed in Quebec) are
        billed
        to a government healthcare agency according to a fixed fee schedule. In Ontario,
        these billings are subject to an overall fee cap. Most jurisdictions have
        eliminated coverage for certain diagnostic procedures (“delisted”) and fees for
        these services are billed directly to patients.
  Although
        the customers of the laboratory services business are generally physicians
        and
        patients, the majority of funding for such services is provided under the
        terms
        of provincial healthcare programs. Company operations in each province are
        organized to conform to government payment programs existing in the relevant
        province.
  In
        most
        provinces, operators of clinical laboratories are required to carry licenses
        which determine the nature of tests which can be carried out at each facility
        and govern the ability of the operator to draw samples for testing purposes.
        Such licenses are for
        a limited term (generally requiring annual renewal) and their renewal is
        subject
        to government approval. In Alberta and Saskatchewan, licenses have been replaced
        by service contracts with regional health authorities.
  Business
        Overview
  The
        Company is active in all provinces west of the Maritimes, except Saskatchewan,
        either directly or through joint ventures. Approximately 59% of laboratory
        revenues originate in Ontario. A further 40% originate in British Columbia,
        and
        1% in other provinces. The
        laboratory business of MDS is carried out through the following types of
        licensed locations:
  *Patient
        Service Centre* (“PSC”)
        - a location which is licensed to draw samples from a patient, but which
        is not
        authorized to perform any testing procedures on the samples.
  *Local
        laboratory* - a
        location that serves as both a PSC
        and as a testing facility. Such laboratories do not generally carry full
        testing
        approvals and therefore conduct only limited types of tests.
  *Central
        laboratory* - a
        location to which all samples collected at PSCs are sent for testing, along
        with
        samples that cannot be tested at local laboratories .
  Laboratory
        fees are generally set provincially, following discussions between the operators
        of private laboratories and provincial ministry of health officials. In Ontario,
        the Ontario Association of Medical Laboratories represents private laboratories.
        A three-year funding agreement is currently in place covering April
        1 st ,
        2005 to
        March 31 st ,
        2008.
        In British Columbia, the British Columbia Medical Association (“BCMA”)
        negotiates fees on behalf of the laboratories. The British Columbia fee
        agreement runs until March 31, 2007
  In
        Alberta, the fee-for-service system was replaced by bulk service contracts
        in
        each of the 17 regions established by the provincial ministry of health.
        Prior
        to April 2006 MDS had operations in one of these regions. In Edmonton, the
        MDS
        Stirrat Laboratory organization, along with two competing laboratory firms,
        merged to form the Dynacare Kasper Medical Laboratories partnership, which
        has
        contracted with the Capital Health Authority to provide both hospital and
        outpatient diagnostic services in the region. MDS owns 14.5% of this
        partnership.
  MDS
        provides laboratory services in Quebec on a limited basis.
        Laboratory services in this province are generally provided by hospitals
        on an
        outpatient basis. Laboratory services provided by MDS in Quebec are billed
        directly to patients or physicians and constitute only a small portion of
        the
        testing conducted in the province.
  In
        addition to the direct provision of testing services, the Company also provides
        laboratory management services. The Company has entered into agreements to
        provide laboratory management services to a number of hospitals and to groups
        of
        hospitals, primarily in the Ontario marketplace. These agreements generally
        provide for a fee-for-service related to the management of a laboratory located
        within a hospital.
  The
        diagnostics business has approximately 2,700 employees in Canada. The majority
        of these employees are not covered by collective agreements. A number of
        employees in British Columbia, along with employees of certain of the Company’s
        hospital joint ventures, are subject to such agreements. MDS has not experienced
        a significant work stoppage due to labour activities and the Company believes
        that labour relations are good.
  Strategy,
        Markets, and Competition
  Continued
        constraints on healthcare funding are a major factor affecting the business
        in
        Canada. In Canada, the existence of fee caps or block funding prevents the
        Company from increasing its revenues in line with increases in test volumes.
        Improved efficiency is a key operating goal for the Company. Discussions
        with
        governments are focused on balancing service levels and testing volumes with
        fee
        caps.
  These
        same forces create market opportunities that the Company seeks to
        take advantage of as hospitals work to provide laboratory services more
        efficiently. Major hospitals are working to consolidate laboratory operations
        to
        bring increased efficiency to their laboratories. Hospital managers are also
        looking to bring community diagnostic work into hospitals (and away from
        community laboratory operators), to offset costs of their in-house
        laboratories.
  The
        principal competitors in the private clinical laboratory services business
        in
        Canada are Gamma Dynacare Inc. and CML Healthcare Income Fund in Ontario,
        and BC Bio Laboratories Inc. in British Columbia.
  **3.6**  **Significant
        Investees**
  **3.6.1**  **MDS
        Capital Corp.**
  MDS
        Capital Corp., in which MDS has a 45% interest, is one of the largest venture
        capital and fund management companies in Canada focused on the healthcare
        and
        life sciences industry. MDS Capital Corp. earns management fees from the
        management of investment funds, including incentive fees based on the overall
        success of the funds. In 2006, MDS Capital Corp. sold its retail funds
        management business and is in discussions concerning the sale of its remaining
        institutional funds.
  **3.6.2**  **Iconix
        Biosciences, Inc.**
  The
        Company has an 18% equity interest in and owns the majority of the long-term
        debt of privately held Iconix Biosciences, Inc., a pioneer in the new field
        of
        chemogenomics, the integration of chemistry and genomics to profile drug
        candidates. Iconix’s chemogenomic capabilities enable pharmaceutical companies
        to increase the odds of advancing the right compounds to the clinic, reducing
        attrition rates and reducing the costs of drug discovery.
  **3.7**  **Principal
        Facilities**
  The
        following were the principal operating facilities of the Company as at October
        31, 2006:
 
 Location
                  of Facility
              Type
                  of Facility
              Owned/
                Leased
              Segment
              Approximate
                  Square FootageMississauga,
                  Canada
              Corporate
                  Head Offices
              Leased
              Corporate
              13,000Toronto,
                  Canada
              Corporate
                  Offices
              Leased
              Corporate
              83,000*
                  Toronto, Canada
              Central
                  Reference Laboratory
              Owned
              Diagnostics
              84,800*
                  Burnaby, Canada
              Central
                  Reference Laboratory
              Owned
              Diagnostics
              49,000Kanata,
                  Canada
              Manufacturing
                  Plant
              Owned
              Isotopes
              483,300Fleurus,
                  Belgium
              Manufacturing
                  Plant
              Leased
              Isotopes
              36,200Belfast,
                  N. Ireland
              Clinical
                  Trials Facility
              Owned
              Pharma
                  Services
              19,500Concord,
                  Canada
              Manufacturing
                  Plant
              Owned
              Instruments
              147,500Hamburg,
                  Germany
              Clinical
                  Trials Facility
              Leased
              Pharma
                  Services
              41,500Irvine,
                  USA
              Corporate
                  Office
              Leased
              Pharma
                  Services
              39,100King
                  of Prussia, USA
              Corporate
                  Office
              Leased
              Pharma
                  Services
              47,100Lincoln,
                  USA
              Clinical
                  Trials Facility
              Owned
              Pharma
                  Services
              130,200Lyon,
                  France
              Research
                  Facility
              Owned
              Pharma
                  Services
              133,800Montreal,
                  Canada
              Research
                  Laboratory and Clinical Trials Facility
              Owned
              Pharma
                  Services
              321,500Madrid,
                  Spain
              Clinical
                  Trials Facility
              Owned
              Pharma
                  Services
              26,900Paris,
                  France
              Clinical
                  Trials Facility
              Leased
              Pharma
                  Services
              37,600Bothell,
                  USA.
              Research
                  Laboratory
              Leased
              Pharma
                  Services
              95,600Tampa,
                  USA.
              Manufacturing
                  Plant
              Owned
              Pharma
                  Services
              25,000Taipei,
                  Taiwan
              Research
                  Laboratory
              Owned
              Pharma
                  Services
              39,500Winnersh,
                  UK
              Clinical
                  Trials Facility
              Leased
              Pharma
                  Services
              12,500Mississauga,
                  Canada
              Clinical
                  Trials Facility
              Leased
              Pharma
                  Services
              63,000Phoenix,
                  USA
              Clinical
                  Trials Facility
              Owned
              Pharma
                  Services
              51,000Zurich,
                  Switzerland
              Clinical
                  Trials Facility
              Leased
              Pharma
                  Services
              40,200Neptune
              Clinical
                  Trials Facility
              Leased
              Pharma
                  Services
              39,700New
                  Orleans, USA
              Clinical
                  Trials Facility
              Leased
              Pharma
                  Services
              16,300Blainville,
                  Canada
              Clinical
                  Trials Facility
              Owned
              Pharma
                  Services
              48,000Baillet,
                  France
              Clinical
                  Trials Facility
              Leased
              Pharma
                  Services
              26,400Baillet,
                  France
              Clinical
                  Trials Facility
              Owned
              Pharma
                  Services
              23,091*Thorold,
                  Canada
              Central
                  Reference Laboratory
              Owned
              Diagnostics
              21,000*Victoria,
                  Canada
              Central
                  Reference Laboratory
              Leased
              Diagnostics
              16,600Singapore
              Manufacturing
                  Plant
              Leased
              Instruments
              10,000
 
 *
        Included in the Assets Held for Sale in the Financial Statements.
 
  **3.8**  **Research
        and Development**
  Research
        and Development costs are described in note 12 to the 2006 Financial Statements,
        which are incorporated by reference into this AIF.
 **2006**
              
              2005
              
              2004Gross
                  expenditures
              **$**
              **60**
              $
              86
              $
              100Investment
                  tax credits
              
              **(9)**
              
              (8)
              
              (20)Recoveries
                  from partners
              
              **(25)**
              
              (32)
              
              (23)Development
                  costs deferred
              
              **(7)**
              
              (15)
              
              (19)Research
                  and development
              **$**
              **19**
              $
              31
              $
              38
 During
        the fiscal 2006, depreciation and amortization includes $7 million (2005
        - $3
        million; 2004 - $16 million) related to equipment used for research and
        development.
   **3.9**  **Environmental
        Compliance**
  The
        Company has established a series of policies to facilitate compliance with
        applicable environmental laws and regulations. The policies require that
        business units conduct regular environmental assessments of company activities,
        establish remedial and contingency plans to deal with any incidents, and
        establish regular processes to report to senior corporate management and
        to the
        Board through the Environment, Health & Safety Committee of the Board on the
        environmental status of the Company and its subsidiaries. MDS uses an
        independent third party environmental auditing firm to conduct regulatory
        audits
        of MDS operations. MDS believes its approach to environmental compliance
        meets
        the regulated requirements and it is not expected that this policy will have
        a
        significant impact on capital expenditures, consolidated earnings, or our
        competitive position.
  **3.10**  **Other
        Business Matters**
  **3.10.1**  **Risk
        Factors**
  The
        businesses in which MDS operates are subject to a number of risks and
        uncertainties discussed below and under the heading “Risks and Uncertainties” in
        the 2006 MD&A on pages 13 to 16. Additional risks and uncertainties not
        presently known to the Company or that the Company does not currently anticipate
        will be material, may impair the Company’s business operations. If any such
        risks occur, the Company’s business, financial condition and results of
        operations could be materially adversely affected.
  **Risks
        Relating to the Business Generally**
  ***If
        we do not introduce new products in a timely manner, our products could become
        obsolete and our business, financial condition and results of operation would
        suffer.***
  We
        sell
        many of our products in industries characterized by rapid technological change,
        frequent new product and service introductions, and evolving industry standards.
        Without the timely introduction of new products and enhancements, our products
        could become technologically obsolete over time, in which case our business,
        financial condition and results of operation would suffer. The success of
        our
        new product offerings will depend upon several factors, including our ability
        to:
  Ø  accurately
        anticipate customer needs,
  Ø  innovate
        and develop new technologies and applications,
  Ø  successfully
        commercialize new technologies in a timely manner,
  Ø  price
        our
        products competitively and manufacture and deliver our products in sufficient
        volumes and on time, and
  Ø  differentiate
        our product offerings from our competitors’ product offerings.
  Many
        of
        our products are used by our customers to develop, test and manufacture their
        products. Therefore, we must anticipate industry trends and develop products
        in
        advance of the commercialization of our customers’ products. In developing new
        products, we may be required to make significant investments before we can
        determine the commercial viability of the new product. If we fail to accurately
        foresee our customers’ needs and future activities, we may invest heavily in
        research and development of products that do not lead to significant
        sales.
  In
        addition, some of our licensed technology is subject to contractual
        restrictions, which may limit our ability to develop or commercialize products
        for some applications. For example, some of our license agreements are limited
        to the field of life sciences research, and exclude clinical diagnostics
        applications.
  ***Our
        business, financial condition, and results of operation could be subject
        to
        significant fluctuation, and we may not be able to adjust our operations
        to
        effectively address changes we do not anticipate.***
  Given
        the
        nature of the markets in which we participate, we cannot reliably predict
        future
        sales and profitability. Changes in competitive, market and economic conditions
        may require us to adjust our operations, and we may not be able to make those
        adjustments or to make them quickly enough to adapt to changing conditions.
        A
        high proportion of our costs are fixed, due in part to our significant sales,
        research and development and manufacturing costs. Thus, small declines in
        sales
        could disproportionately affect business, financial condition, and results
        of
        operation in any particular quarter. Factors that may affect our quarterly
        sales
        and operating results include:
  Ø  demand
        for and market acceptance of our products,
  Ø  competitive
        pressures resulting in lower selling prices,
  Ø  adverse
        changes in the level of economic activity in regions in which we do
        business,
  Ø  adverse
        changes in industries on which we are particularly dependent, such as the
        pharmaceutical, biomedical, semiconductor and aerospace industries,
  Ø  changes
        in the portions of our sales represented by our various products and
        customers,
  Ø  delays
        or
        problems in the introduction of new products,
  Ø  our
        competitors’ announcement or introduction of new products, services or
        technological innovations,
  Ø  increased
        costs of raw materials or supplies, and
  Ø  changes
        in the volume or timing of product orders.
  ***We
        may not be able to successfully execute acquisitions or license technologies,
        integrate acquired businesses or licensed technologies into our existing
        business, or make acquired businesses or licensed technologies
        profitable.***
  We
        have
        in the past, and may in the future, supplement our internal growth by acquiring
        businesses and licensing technologies that complement or augment our existing
        product lines, such as our acquisition of the MALDI Time of Flight mass
        spectrometry systems business in October 2004. However, we may be unable
        to
        complete the acquisition of promising business acquisitions or license
        technologies for many reasons, including:
  Ø
              competition
                  among buyers and licensees,
  Ø
              the
                  need for regulatory and other
                  approvals,
  Ø
              our
                  inability to raise capital to fund these
                  acquisitions,
  Ø
              the
                  high valuations of businesses and technologies,
                  and
  Ø
              restrictions
                  in the instruments governing our indebtedness, including the indenture
                  governing our Senior Unsecured Notes and our credit
                  facility.
  In
        addition, any business we may seek to acquire or technology we may seek to
        licence may be unprofitable or marginally profitable. Accordingly, the earnings
        or losses of any such business that is acquired or technology that is licensed
        may dilute our earnings. For these businesses or technologies to achieve
        acceptable levels of profitability, we must improve their management,
        operations, products, and market penetration. We may not be successful in
        this
        regard and may encounter other difficulties in integrating acquired businesses
        or licensed technologies into our existing operations, such as incompatible
        management, information or other systems or cultural differences.
  ***We
        may not be able to successfully obtain financing to fund potential
        acquisitions***
  The
        Company’s business strategy depends on its ability to acquire existing
        profitable operations. The rate of growth of the Company may be limited by
        the
        pricing and availability of any proposed acquisition target and other factors
        not within the control of the Company. To finance our acquisitions, we may
        have
        to raise additional funds, either through public or private financings. We
        may
        be unable to obtain such funds or may be able to do so only on terms
        unacceptable to us.
  ***We
        may not be able to successfully divest businesses or business
        lines***
  We
        have
        in the past and may in the future decide to divest certain business or business
        lines either as a result of unsatisfactory performance or change in strategic
        focus. We may be unable to complete such divestitures on reasonable terms
        or at
        all.
  ***If
        we are unable to renew our licenses or otherwise lose our licensed rights,
        we
        may have to stop selling products or we may lose competitive
        advantage.***
  We
        may
        not be able to renew our existing licenses or licenses we may obtain in the
        future on terms acceptable to us, or at all. If we lose the rights to a patented
        or other proprietary technology, we may be forced to stop selling products
        incorporating that technology and possibly other products, redesign our products
        or lose a competitive advantage. Potential competitors could in-license
        technologies that we fail to license and potentially erode our market
        share.
  Our
        licenses typically subject us to various economic and commercialization
        obligations. If we fail to comply with these obligations, we could lose
        important rights under a license, such as the right to exclusivity in a market.
        In some cases, we could lose all rights under the license. In addition, rights
        granted under the license could be lost for reasons out of our control. For
        example, the licensor could lose patent protection for a number of reasons,
        including invalidity of the licensed patent, or a third party could obtain
        a
        patent that curtails our freedom to operate under one or more
        licenses.
  ***If
        we do not compete effectively, our business will be
        harmed.***
  We
        encounter aggressive competition from numerous competitors in many areas
        of our
        business. We may not be able to compete effectively with all of these
        competitors. To remain competitive, we must develop new products and
        periodically enhance our existing products. We anticipate that we may also
        have
        to adjust the prices of many of our products to stay competitive. In addition,
        new competitors, technologies, or market trends may emerge to threaten or
        reduce
        the value of entire product lines.
  ***Changes
        in governmental regulations may reduce demand for our products or services
        or
        increase our expenses.***
  We
        compete in markets in which our customers or we must comply with federal,
        state,
        local, and foreign regulations, such as environmental, health and safety,
        and
        food and drug regulations. We develop, configure, and market our products
        to
        meet customer needs created by these regulations. Any significant change
        in
        these regulations could reduce demand for our products or services or increase
        our costs of producing these products.
  ***Healthcare
        reform and changes to government policies related to healthcare spending
        may
        reduce demand for our products and services or the prices we are able to
        charge.***
  Our
        products and services are focused on enabling drug discovery and development
        and
        disease diagnosis. Government reimbursement policies can have a significant
        impact on spending decisions of certain of our customers and as a result
        our
        revenues from this business.
  ***Patent
        protection for our proprietary products, processes, and technologies may
        be
        difficult and expensive and may not result in sufficient protection for our
        technology.***
  Patent
        and trade secret protection is important to us because developing and marketing
        new technologies and products is time-consuming and expensive. We own many
        US
        and foreign patents and have applied or intend to apply for additional patents
        to cover our products. We may not obtain issued patents from any pending
        or
        future patent applications owned by or licensed to us. The claims allowed
        under
        any issued patents may not be broad enough to protect our
        technology.
  ***Third
        parties may seek to challenge, invalidate or circumvent issued patents owned
        by
        or licensed to us or claim that our products and operations infringe their
        patent or other intellectual property rights.***
  In
        addition to our patents, we possess an array of unpatented proprietary
        technology and know-how and we license intellectual property rights to and
        from
        third parties. The measures that we employ to protect this technology and
        these
        rights may not be adequate. Moreover, in some cases, the licensor can terminate
        a license or convert it to a non-exclusive arrangement if we fail to meet
        specified performance targets.
  We
        may
        incur significant expense in any legal proceedings to protect our proprietary
        rights or to defend infringement claims by third parties. In addition, claims
        of
        third parties against us could result in awards of substantial damages or
        court
        orders that could effectively prevent us from manufacturing, using, importing
        or
        selling our products in the United States or in any other country and could,
        depending on the quantum of damages awarded, have a significant adverse effect
        on our financial results.
  In
        particular, development of leading-edge technologies and protection of key
        intellectual property are important differentiators within the analytical
        instruments business. MDS aggressively defends its patent rights in this
        industry.
  ***Our
        results of operations will be adversely affected if we fail to realize the
        full
        value of our intangible assets.***
  As
        of
        October 31, 2006, our total assets included approximately $840 million of
        net
        intangible assets. Net intangible assets consist principally of goodwill
        associated with acquisitions, the value of a long-term isotope supply agreement
        (See Section 3.3), and costs associated with securing patent rights, trademark
        rights and technology licenses, net of accumulated amortization. We test
        these
        items on an annual basis for potential impairment by comparing the carrying
        value to the fair market value of the reporting unit to which they are
        assigned.
  Adverse
        changes in our business or the failure to grow our Life Sciences businesses
        may
        result in impairment of our intangible assets, which could adversely affect
        our
        results of operations.
  ***Restrictions
        in our Senior Unsecured Notes and bank credit facilities and other debt
        instruments may limit our activities.***
  The
        Senior Unsecured Notes issued by the Company in fiscal 2003 and the Company’s
        credit facility contain, and future debt instruments and bank credit facilities
        to which we may become subject may contain restrictive covenants that limit
        our
        ability to engage in activities that could otherwise benefit the Company.
        The
        credit facility is subject to substantially similar restrictive covenants,
        but
        as at the date hereof, remains undrawn.
  The
        indenture governing our Senior Unsecured Notes includes restrictions on our
        ability and the ability of our subsidiaries to:
  Ø
              pay
                  dividends on, redeem or repurchase our
                  shares,
  Ø
              sell
                  assets,
  Ø
              incur
                  obligations that restrict the ability of our subsidiaries to pay
                  dividends
                  or other amounts to us,
  Ø
              guarantee
                  or secure indebtedness,
  Ø
              enter
                  into transactions with affiliates,
                  and
  Ø
              consolidate,
                  merge, or transfer all or substantially all of our assets and the
                  assets
                  of our subsidiaries on a consolidated
                  basis.
  We
        are
        also required to meet specified financial ratios under the terms of our Senior
        Unsecured Notes. Our ability to comply with these financial restrictions
        is
        dependent on our future performance, which is subject to prevailing economic
        conditions and other factors, including factors that are beyond our control
        such
        as foreign exchange rates, interest rates, changes in technology and changes
        in
        the level of competition.
  Our
        failure to comply with the restrictions in our Senior Unsecured Notes may
        result
        in an event of default under the indenture governing our Senior Unsecured
        Notes,
        which could result in acceleration of our indebtedness under our Senior
        Unsecured Notes and require us to prepay our Senior Unsecured Notes before
        their
        scheduled due date.
  ***We
        are subject to a number of market risks.***
  We
        are
        exposed to market risks, relating to both currency exchange rates and interest
        rates. On occasion, in order to manage the volatility relating to these
        exposures, we may enter into various derivative transactions pursuant to
        our
        policies to hedge against known or forecasted market exposures. We briefly
        describe several of the market risks we face below. The following disclosure
        supplements the disclosure provided under the heading “Risks and Uncertainties”
in the 2006 MD&A.
  *Foreign
        Exchange Risk*
  As
        a
        global company, we are exposed to changes in foreign exchange
        rates:
  (a)
              Because
                  a significant portion of sales from our Canadian-based operations
                  are in
                  the United States or denominated in United States dollars, volatility
                  in
                  exchange rates can have a material impact on our financial results.
                  Sales
                  made in foreign currencies, when translated into Canadian dollars
                  for
                  financial reporting purposes, can fluctuate due to exchange rate
                  movements.
  (b)
              Our
                  foreign subsidiaries, on occasion, invoice third-party customers
                  in
                  foreign currencies other than the functional currency in which
                  they
                  primarily conduct business. Movements in the invoiced currency,
                  as
                  compared to the functional currency, result in either realized
                  and
                  unrealized transaction gains or losses that directly impact our
                  cash flows
                  and our results of operations.
  (c)
              Our
                  manufacturing and distribution organization is multinational in
                  nature.
                  Accordingly, inventories may be manufactured in one location, stored
                  in
                  another, and distributed in a third location. This can result in
                  a variety
                  of intercompany transactions that are billed and paid in many different
                  currencies. Our cash flows and our results of operations are therefore
                  directly impacted by fluctuations in these
                  currencies.
  (d)
              The
                  cash flow needs of each of our foreign subsidiaries vary over time.
                  Accordingly, there may be times when a subsidiary is on the receiving
                  side
                  or the lending side of a short-term advance from either us or another
                  of
                  our subsidiaries. These advances, being denominated in currencies
                  other
                  than a particular entity’s functional currency, can expose us to
                  fluctuations in exchange rates that can impact both our cash flows
                  and
                  results of operations.
  (e)
              In
                  order to repay debt or take advantage of tax saving opportunities,
                  we may
                  remit cash from our foreign locations to Canada. When this occurs,
                  we are
                  liquidating foreign currency net asset positions and converting
                  them into
                  Canadian or US dollars. Our cash flows and our results of operations
                  are
                  therefore also impacted by these
                  transactions.
  We
        currently have outstanding foreign exchange forward and option contracts
        to
        manage and hedge some of our exposures to foreign currencies. The principal
        currency hedged is the US dollar.
  *Foreign
        Currency Risk — Value-at-Risk Disclosure*
  We
        continue to manage foreign currency risk using foreign currency forward
        contracts, foreign currency swaps, and foreign currency option
        contracts.
  *Interest
        Rate Risk*
  Our
        Senior Unsecured Notes bear interest at fixed rates between 5.15% and 6.19%
        per
        annum and have various terms between five and twelve years. One quarter of
        our
        Senior Unsecured Notes is subject to floating rates as a result of interest
        rate
        swap agreements. Fluctuations in interest rates can therefore have a direct
        impact on both our short-term cash flows and earnings.
  ***Our
        insurance coverage may not be adequate in all circumstances and there can
        be no
        assurance that such coverage will continue to be available at rates and on
        terms
        acceptable to the Company.***
  The
        Company maintains a global liability insurance policy covering all of its
        operating units. The program provides coverage for normal operating risks
        and
        includes liability coverage to $85 million for isotope liabilities and $88
        million for liabilities in other businesses. There is no certainty that the
        amount of coverage is adequate to protect the Company in all circumstances
        or
        that the Company will be able to acquire such insurance on an ongoing basis
        at
        rates and on terms that are acceptable to the Company.
  The
        Company maintains a global policy covering property and business interruption
        risks with a total insured value of $2.1 billion and directors’ and officers’
insurance having a limit of US$120 million.
  ***We
        have exposure to natural disasters and other hazards.***
  The
        occurrence of natural disasters, pandemics, adverse weather, or other events
        may
        result in a disruption to our businesses. The consequences of such an event
        could include a loss of customers, loss of supply chain, limitations, or
        interruptions to our distribution networks (including air, road, and sea
        transportation), increased costs of raw materials, and damage or destruction
        of
        our own facilities. A significant natural disaster or similar event, including
        a
        pandemic, could have a material adverse impact on our business, financial
        condition, and results of operations.
  ***Our
        operations may be subject to review by drug approval authorities and the
        outcome
        of any such review could lead to corrective action by the
        Company.***
  MDS
        facilities devoted to pharmaceutical development are subject to regular
        inspection by both the FDA and Health Canada (see Failure to gain FDA acceptance
        of Study Review below). Customers of the Company are subject to periodic
        review
        by drug approval authorities, principally the FDA in the United States. In
        addition, the terms of a typical CRO contract provide that the Company’s
        customers can request that our facilities be subjected to the same levels
        of
        review by the authorities. The Company meets Good Laboratory Practices standards
        for its laboratories and Good Clinical Practices standards for its clinic
        facilities.
  Our
        clinical laboratories are subject to significant government regulation. In
        Canada, all laboratories are subject to periodic government inspection and
        proficiency testing by government agencies. The Company has been subject
        to such
        government inspection in all provinces in which it operates. MDS has never
        been
        subject to disciplinary or other actions as a result of a failure to meet
        standards in any area prescribed by regulation.
  ***Our
        operations might be affected if there was a disruption to air or ground
        transportation***
  Our
        businesses , particularly our Isotopes business rely heavily on both air
        and
        ground transportation and any material disruption to air or ground
        transportation systems could have a material adverse effect on our businesses
        .
        While contingency plans for a variety of events have been developed, these
        plans
        might not be effective or sufficient to avert such material adverse
        effect.
  ***Our
        business depends on the continued and uninterrupted performance of our
        information technology systems and the communication systems that support
        those
        systems, including the Internet.***
  Our
        business depends, in part, on the continued and uninterrupted performance
        of our
        information technology systems. Sustained system failures or interruptions
        could
        disrupt our ability to perform many of the functions that are critical to
        our
        businesses, including transportation of our medical isotopes, reporting clinical
        test results, processing laboratory requisitions, and timely billings. Our
        business, results of operations and financial condition could be adversely
        affected by a system failure.
  Our
        computer systems are vulnerable to damage from a variety of sources, including
        telecommunications failures, malicious human acts, and natural disasters.
        Moreover, despite network security measures, some of our servers are potentially
        vulnerable to physical or electronic break-ins, computer viruses and similar
        disruptive problems. Despite precautions taken by the Company, unanticipated
        problems affecting our systems could cause interruption in our information
        technology systems. Our insurance policies may not adequately compensate
        us for
        any losses that may occur due to any failures in our information technology
        systems.
  ***We
        are subject to a number of risks due to the fact that we carry on business
        in
        several countries.***
  The
        Company’s operations are subject to the risks of carrying on business in several
        countries in North America, Europe and Asia including, but not limited to,
        varying economic and political conditions, cultures and business practices,
        tax
        rates, possible restrictions on the transfer of funds, employee turnover,
        labour
        unrest, longer payment cycles, and the burdens and costs of compliance with
        a
        variety of foreign laws. There can be no assurance that these factors will
        not
        have an adverse effect on our business, financial condition, and results
        of
        operations.
  ***We
        are dependent upon the services of key personnel.***
  Within
        our businesses, we depend on the availability of technicians and professionals
        with knowledge in their fields, especially in our contract research services.
        Our ability to retain and motivate these staff has a direct bearing on our
        success in these businesses. The investment required to retain key staff,
        including ensuring that compensation packages are competitive, could have
        an
        impact on the profitability of this business.
  In
        addition to our own personnel, in our CRO business we depend upon the
        availability of investigators to conduct trials and volunteer participants
        for
        such trials. If we are unable to attract investigators or volunteers we will
        be
        unable to satisfy the requirements of our customers.
  ***Our
        cost of research could increase in the event certain tax credits were to
        become
        unavailable.***
  Research
        and development we conduct in Canada, both for our own account and for defined
        groups of arm’s length customers, is eligible for tax credits. Elimination or
        significant reduction of the tax credits would have a material impact on
        the
        cost of our research and development.
  ***Changes
        in the regulatory environment could adversely affect our
        business.***
  Future
        regulatory changes could impair our ability to offer the products and services
        we now provide. Such regulatory changes could make the provision of these
        services too expensive to be attractive to clients or could cause clients
        to
        reduce the amount of outsourcing they are prepared to do. We monitor carefully
        the regulatory environments in all markets in which we operate to ensure
        that we
        are prepared for and respond to proposed changes and to influence where possible
        the adoption of new regulations. There can be no assurance, however, that
        regulatory changes would not have a material adverse effect on our business,
        financial condition, or results of operation.
  ***Certain
        of our businesses are exposed to attention from special interest groups and
        are
        subject to related political risks.***
  The
        products and services that we provide are essential to the manufacture of
        numerous medical products. Among our products and services are those that
        contain or require as raw materials, nuclear materials, and drug safety
        services. From time to time, these have garnered attention from special interest
        groups and are therefore at risk of disruption as a result of such attention.
        A
        significant disruption could have a material adverse effect on our business,
        financial condition, or results of operation.
  ***Failure
        to gain FDA acceptance of Study Review could have a continuing material adverse
        effect on the financial results of MDS Pharma Services bioanalytical
        operations.***
  During
        2004 and 2006, MDS Pharma Services received written communication from the
        FDA
        related to certain generic bioequivalence studies carried out at MDS Pharma
        Services' bioanalytical laboratory facilities in Quebec.
  The
        communication resulted from inspections carried out by the FDA in 2003 and
        2004,
        a subsequent FDA audit in March 2006, and the FDA’s review of our responses to
        the audit and related communications. The communications from the FDA outlined
        concerns in certain studies about unexpected results in a limited number
        of
        study samples, the standard procedures in place at that time to investigate
        the
        root cause of the unexpected results and the policies and procedures in place
        to
        address such results. To address the FDA's concerns, and in consultation
        with
        the FDA, MDS Pharma Services developed and is implementing a comprehensive
        Quality Improvement Program which includes a review of certain generic
        bioequivalence studies carried out at the Montreal facility and remains in
        regular communication with the FDA as to the status of the review.
  Subsequent
        to the year-end, MDS Pharma Services was advised by the FDA that sponsors
        of
        affected studies were being directed by the FDA take certain steps to confirm
        the validity of data submitted as part of their previously approved or pending
        applications. Although MDS Pharma Services believes that this will result
        in a
        path forward to resolve the outstanding issues, there is no assurance at
        this
        time that steps taken by sponsors will result in confirmation of the study
        data
        to the satisfaction of the FDA. Failure to gain FDA acceptance could impact
        our
        ability to attract and retain work and have a material adverse effect on
        the
        financial results of MDS Pharma Services bioanalytical operations
  ***The
        terms of MDS Pharma Services’ contracts entitle clients to cancellation rights,
        which, if exercised, could adversely affect the business, financial condition,
        and results of operation of this business.***
  A
        majority of the revenue earned by MDS Pharma Services’ businesses is under
        contracts which typically run several months for drug discovery through Phase
        I
        clinical trials and as much as several years for Phase III/IV clinical trials.
        Terms of most contracts entered into by the Company entitle clients to
        cancellation rights that may be exercised by the client in the event of
        regulatory delays or if unexpected results are encountered at any stage of
        the
        development program. The Company’s focus on early stage contract research
        reduces its exposure to the loss of a large single contract. MDS attempts
        to
        mitigate its exposure to revenue loss from contract cancellation by maintaining
        an order backlog consisting of numerous contracts having smaller individual
        values. There can be no assurance, however, that the Company will continue
        to be
        able to mitigate this risk, in which case the cancellation of contracts could
        have a material adverse effect on the Company’s business, financial condition
        and results of operation.
  ***We
        could be subject to claims as a result of product failure in clinical trials
        testing.***
  During
        clinical trials testing, the Company will typically administer pharmaceutical
        products owned and developed by others to individuals acting as test subjects.
        Under the terms of the contracts entered into by the Company with the sponsor
        of
        the product, the sponsor retains risk related to product failure, including
        risks related to adverse reactions by test subjects; however, these terms
        vary
        among contracts and do not prevent individuals to whom the products have
        been
        administered from filing claims against MDS even though MDS may be indemnified
        in these circumstances. Furthermore, the indemnity obligations established
        under
        these contracts are not secured and it is possible that the indemnifying
        party
        may not have the financial ability to meet its obligations to MDS in the
        case of
        an adverse event.
  ***We
        could be subject to claims as a result of our administration of clinical
        trials.***
  In
        conducting the tests and other procedures that form a part of the clinical
        trials process, the Company may be subject to claims related to negligence
        or
        misconduct pertaining to the services it performs. These risks may also include
        the medical malpractice of medical personnel operating Phase I clinical
        facilities. In addition, the Company could potentially be subject to claims
        for
        negligence or misconduct on the part of third-party investigators engaged
        by the
        Company on behalf of clients. The Company maintains professional liability
        insurance coverage against these risks; however, there is no assurance that
        such
        coverage will be adequate in the event a claim is successful.
  ***Certain
        of our products depend on the availability of the supply of key
        components.***
  A
        number
        of our products include raw materials or parts for which there is a limited
        source of supply. In addition, other companies manufacture certain parts
        and
        subcomponents for us. There can be no assurance that we will be able to acquire
        the necessary materials at a price that provides us with the same economic
        return we are currently able to realize or that these suppliers will continue
        to
        supply us.
  ***Labour
        disruptions within the companies that supply our isotopes could have a material
        adverse effect on our financial results.***
  MDS
        is
        dependent upon its suppliers for its source of isotopes. The majority of
        our
        isotope suppliers are unionized. MDS has taken steps to lessen the risk that
        a
        labour disruption will cause an interruption in its source of supply of isotopes
        by establishing co-beneficial back-up arrangements with certain competitors.
        There can be no assurance, however, that labour disruptions within the Company’s
        isotopes suppliers would not have a material adverse effect on our business,
        financial condition, and results of operation.
  ***We
        are dependent upon access to nuclear reactors to install or remove cobalt
        and
        such access is dependent upon third parties.***
  MDS
        purchases Co 59 as a
        commodity. The processed Co 59 is
        inserted into nuclear reactors for periods of 18 to 24 months to convert
        it to
        Co 60 .
        Access
        to these nuclear reactors to either install or remove cobalt is determined
        based
        on the routine maintenance schedule for the reactor facility. A significant
        change in a maintenance schedule could have a material impact on the
        availability of Co 60 in any
        given year. Although the operators of the facilities establish these schedules,
        we work closely with these suppliers to optimize the timing and availability
        of
        cobalt to meet our needs. There can be no assurance, however, that any
        disruptions to the Company’s access to nuclear reactors would not have an
        adverse effect on our business, financial condition, and results of
        operation.
  ***An
        interruption in the supply of reactor-produced isotopes could have a material
        adverse effect on our financial results.***
  As
        noted
        earlier, to provide greater security for the future supply of molybdenum-99
        and
        other reactor-produced radioisotopes commonly used in nuclear medicine, MDS
        contracted with AECL for the construction and operation of two special purpose
        reactors and a processing facility to produce such isotopes.
  Completion
        of the MAPLE project is currently six years behind schedule and to date,
        AECL
        has been unable to resolve the technical and regulatory issues to the
        satisfaction of the CNSC. Although AECL has advised us that they remain
        confident that in time all technical issues will be resolved and the MAPLE
        Facilities will receive requisite regulatory approvals, at this time, we
        do not
        have sufficient reliable information from AECL to predict with any reasonable
        degree of accuracy if or when commercial production will commence from the
        MAPLE
        Facilities.
  In
        the
        absence of the MAPLE Facilities, MDS depends upon the NRU reactor operated
        by
        AECL in Chalk River for the supply of a majority of our reactor-produced
        radioisotopes. Although the NRU reactor has been a reliable source of
        radioisotopes; the NRU reactor is 48 years old and, there is no assurance
        that
        the NRU reactor will not experience a planned or unplanned shutdown. Any
        prolonged planned or unplanned shutdown, until the MAPLE Facilities are
        operational, would have a material adverse effect on our business, financial
        condition, and results of operation.
  ***Potential
        changes to the regulation of the export of medical isotopes could cause supply
        disruptions.***
  Certain
        purchased medical isotopes are produced in reactors and are by-products of
        the
        decay of the uranium fuel in the reactor. AECL obtains the majority of its
        uranium from the United States. The US Department of Energy (“DOE”) strictly
        controls exports of high-energy uranium (“HEU”). Delays in obtaining HEU could
        cause supply disruption for certain isotopes. Currently the DOE must approve
        each shipment of HEU. There is political pressure to convert to LEU and this
        is
        expected to continue; there is also political support to ensure isotope supply.
        MDS is actively working with AECL to investigate the economic and technical
        feasibility of converting from HEU to LEU. Changing to LEU would require
        additional capital investment and could impact the profitability of these
        facilities. MDS is also cognizant of any conversion process that could
        potentially disrupt reliable medical isotope supply.
  ***Operating
        licenses related to handling and storage of radioactive materials could be
        subject to cancellation by the CNSC under certain
        circumstances.***
  All
        Company facilities are government regulated and inspected. Failure to obtain
        future operating licenses could adversely affect our business, financial
        condition, or results of operation.
  ***Our
        operations are exposed to risk of material environmental
        liabilities.***
  Certain
        of the materials we handle can have a significant and pernicious impact on
        the
        environment. As a result, we are exposed to risk of costs associated with
        environmental clean-up, as well as exposure to claims from others who have
        suffered a loss as a result of an environmental spill. Because we handle
        materials that are radioactive, we have in place facilities and procedures
        designed to reduce and eliminate the risk of environmental contamination
        stemming from the processing of these materials.
  ***Our
        business, financial condition and results of operation could be harmed by
        cyclical downturns affecting certain of the industries into which we sell
        our
        analytical instruments, including downturns that are a result of funding
        decisions supporting research and development
        budgets.***
  Some
        of
        the industries and markets into which we sell our products are cyclical.
        Industry downturns are often characterized by reduced product demand, excess
        manufacturing capacity and erosion of average selling prices and profits.
        In the
        past, significant downturns in our customers’ markets and in general economic
        conditions have resulted in a reduced demand for several of our products
        and
        have hurt our business, financial condition and results of operation.
  In
        addition, demand for some of our products and services is directly related
        to
        funding of research and development budgets by our customers or to funding
        that
        is available from other sources such as governments and healthcare and academic
        institutions.
  ***A
        portion of our business in the Life Sciences industry is carried on through
        partnerships with third parties.***
  Essentially
        all sales by MDS Sciex are made through partnerships with Applied Biosystems
        and
        Perkin Elmer. The relationship between MDS and each of these partners has
        generally been good. The relationships are governed by partnership agreements
        that define the rights and responsibilities of each party. While each
        partnership is for a fixed term, both agreements extend automatically in
        the
        absence of any notice to terminate the agreements. MDS Sciex focuses primarily
        on the development and manufacturing of analytical instruments while our
        partners focus primarily on marketing, sales, and service. Failure by either
        partner to carry out its respective obligations could adversely affect our
        business, financial condition, or results of operation.
  **Additional
        Risks Relating to the diagnostics businesses (pending completion of the
        sale)**
  ***The
        Company may be unable to complete the planned sale of its diagnostics business.***
  MDS
        has
        entered into a series of agreements that will result in the sale of
        substantially all of the assets and businesses that make up the diagnostics
        segment. Completion of this deal depends on the actions of others and there
        is
        risk that the sale may not close or that the terms of the agreements could
        change.
  ***Our
        laboratories business is dependent on the continued renewal of our licenses,
        which is subject to governmental approval.***
  Licenses
        under which laboratories operate are for a limited term (generally renewing
        annually) and their renewal is subject to government approval. In addition,
        government agencies are empowered to revoke licenses in the event of a failure
        by an operator to meet regulatory or other professional standards.
        Traditionally, renewals are automatic in the absence of significant regulatory
        or disciplinary action. The Company has never lost a license due to non-renewal
        or direct revocation procedures by regulatory agencies. There can be no
        assurance, however, that the non-renewal of any licence would not have a
        material adverse effect on our business, financial condition, and results
        of
        operation.
  ***The
        Company may be subject to claims as a result of errors and omissions related
        to
        the services it performs.***
  To
        conduct diagnostic tests, patient samples must be drawn and later analyzed
        by
        employees of the Company. The Company may be subject to claims as a result
        of
        errors and omissions related to the services it performs, and the risk of
        medical malpractice by laboratory personnel and pathologists. The Company
        maintains professional liability insurance against these risks but there
        is no
        assurance that the level of insurance will be adequate to fully protect the
        Company.
  ***Change
        in government reimbursement policies may adversely affect the results of
        our
        business in this segment.***
  MDS
        expects that changes in government reimbursement policies will remain a risk
        factor for healthcare businesses for the foreseeable future. For those provinces
        that continue to utilize a fee-for-service reimbursement model, migration
        towards lump-sum funding or capitation systems may serve to limit growth
        or even
        reduce revenue levels. However, such initiatives could also be expected to
        protect the market share of existing service providers.
  To
        address these risks, MDS is continuing to invest in research and development
        focused on new, cost-saving technologies, including automation of routine,
        mechanical functions. More efficient methods of service delivery including
        improved laboratory management techniques, centralization of high volume
        testing
        currently performed in smaller on-site laboratories, and various supply chain
        management techniques are all dedicated to the reduction of cost and the
        elimination of waste within the systems.
  MDS
        remains active with industry groups and as a member of advisory panels to
        governments and other agencies. Through negotiation with healthcare authorities,
        MDS and industry organizations have been able to reach settlements and
        retroactive reimbursements for testing volumes that exceeded stated funding
        levels. While there can be no assurance that such settlements will be achieved
        in the future, management believes that negotiations with funding providers
        can
        lead to resolution of these issues. In addition, MDS is committed to ongoing
        involvement and believes that this participation in the policy-setting process
        enables the Company to be aware of proposed policy changes and to respond
        properly based on the direction in which such changes may proceed. There
        can be
        no assurance, however, that any new cost containment initiatives would not
        have
        a material adverse effect on our business, financial condition, and results
        of
        operation.
  **3.10.2**  **Legal
        Proceedings**
  From
        time
        to time during the normal course of business, the Company becomes party to
        legal
        proceedings. At the present time, the Company is not a party to proceedings
        that
        alone or in aggregate represent claims that could, in the judgment of
        management, be material to the Company and its subsidiaries on a consolidated
        basis.
  **3.10.3**  **Interest
        of Management and Others in Material Transactions**
  No
        director or executive officer of MDS nor any associate or affiliate of any
        of
        the foregoing, and, to the knowledge of the directors and executive officers
        of
        MDS, no person or company that is the direct or indirect beneficial owner
        of, or
        who exercises control or direction over, more than 10 percent of our Common
        Shares or any of such person or company’s associates or affiliates, has had an
        interest in any material transaction entered into by the Company since November
        1, 2002.
  **3.10.4**  **Transfer
        Agent and Registrar**
  The
        transfer agent of the Company is CIBC Mellon Trust Company, Toronto,
        Canada.
  **3.10.5**  **Material
        Contracts**
  The
        following are the only material contracts, other than contracts entered into
        in
        the ordinary course of business, which have been entered into by the Company
        within the most recently completed financial year, or were entered into before
        the most recently completed financial year and are still in effect:
  (a)
              The
                  Note Purchase Agreement governing our Senior Unsecured Notes issued
                  on
                  December 18, 2002. The Senior Unsecured Notes bear interest at
                  rates
                  between 5.15% and 6.19% and have various terms between five and
                  twelve
                  years.
  (b)
              A
                  $500 million, five-year committed, revolving credit facility provided
                  on
                  July 14, 2005.
  (c)
              MAPLE
                  settlement
  (d)
              Sale
                  of the Canadian diagnostics
                  business
  The
        terms
        of our Senior Unsecured Notes and credit facility are typical for debt
        instruments of this nature (see 3.8.1. “Risk Factors”).
  **3.10.6**  **Experts**
  The
        2006
        Financial Statements have been audited by Ernst & Young LLP, Box 251, 222
        Bay Street, Toronto, Ontario, M5K 1J7. During fiscal 2006, MDS’s Audit Committee
        obtained written confirmation from Ernst & Young LLP confirming that they
        are independent with respect to the Company within the meaning of the Rules
        of
        Professional Conduct of the Institute of Chartered Accountants of
        Ontario.
  **4.**
              **SELECTED
                  CONSOLIDATED FINANCIAL
                  INFORMATION**
  **4.1**  **Summary
        Annual Information (Year to October 31)**
 
 (amounts
                  in millions except per share amounts)
              **2006**
              **2005**
              **2004**(revised1)
              (revised1)**Consolidated
                  Statements of Income**Revenues
              $1,140
              $1,154
              $1,141Operating
                  income
              54
              24
              69Income
                  (loss) from continued operations
              32
              1
              23Net
                  income
              145
              31
              51Earnings
                  per share - basic and diluted
              $1.01
              $0.22
              $0.36
  
 **Consolidated
                  Statements of Financial Position**Total
                  assets
              2,678
              2,680
              2,637Long-term
                  debt
              442
              465
              485Total
                  shareholders’ equity
              1,590
              1,425
              1,421Weighted
                  average shares outstanding
              144
              142
              142Long-term
                  debt/shareholders’ equity
              28%
              33%
              34%Current
                  ratio
              2.5
              1.7
              1.9**Consolidated
                  Statements of Cash Flows**Cash
                  from continuing operating activities
              $38
              $89
              $125Capital
                  assets purchased
              61
              125
              107Cash
                  from discontinued operations, net
              188
              59
              50Net
                  issue (repayment) of long-term debt
              (8)
              (1)
              21Figures
                  for 2005 and 2004 have been revised to reflect the Diagnostics
                  segment as
                  a discontinued operation.
  **4.2**  **Dividends**
  The
        declaration of dividends is at the discretion of the board of directors.
        In
        addition, the Company is subject to certain covenants in the Senior Unsecured
        Notes and in its credit facility that could restrict its ability to declare
        and
        pay dividends.
  Prior
        to
        October 2004, dividends were declared payable in April and October. Effective
        for the October 2004 dividend, the Company adopted a policy of paying quarterly
        dividends. Pursuant to the policy, dividends, when declared, were paid in
        January, April, July, and October. In the past three years, MDS has paid
        the
        following cash dividends:
  
 
 Fiscal
                  Year
              Aggregate
                  Dividend Amount per Common Share2004
              $0.08252005
              $0.13002006
              $0.1300
  On
        October 5, 2006, the Company announced that it will discontinue its dividend
        payment following completion of the sale of the diagnostics business. The
        final
        dividend was declared on December 12, 2006 and was paid January 8, 2007 to
        shareholders of record on December 20, 2006.
  **4.3**  **Capital
        Structure**
  MDS
        uses
        a combination of equity and long-term debt to finance its business. The Company
        has one class of Common Shares authorized and outstanding. As at October
        31,
        2006, there were 144,319,249 Common Shares outstanding.
  The
        Common Shares entitle the holder thereof to receive notice of, to attend,
        and to
        vote at all meetings of holders of Common Shares. Each Common Share entitles
        the
        holder thereof to one vote per share and to share rateably in the assets
        of the
        Company on liquidation or dissolution.
  The
        Company’s share capital has been restructured or converted several times from
        Common Shares in 1973 to Class A Common and Class B Non-Voting in 1980 and
        back
        to Common in March of 2000. Under the terms of the 2000 conversion, each
        Class A
        share was converted into 1.05 Common Shares and each Class B non-voting share
        was converted into 1 Common Share.
  The
        Company’s shares have been split on a two-for-one basis four times, on the
        following dates: September 26, 1980, July 13, 1983; March 15, 1990; and,
        November 15, 1996. In addition, on September 14, 2000, the Directors of the
        Company declared a one-for-one share dividend paid on October 10, 2000 to
        shareholders of record on September 26, 2000. This share dividend had the
        same
        effect as a two-for-one stock split.
  MDS
        has a
        normal course issuer bid (NCIB) in place. During fiscal 2004, the Company
        repurchased 857,000 Common Shares for cancellation at an average price of
        $19.84
        under the terms of this bid. During fiscal 2005, the Company repurchased
        799,000
        Common Shares for cancellation at an average price of $16.67 under the terms
        of
        this bid. The Company repurchased no Common Shares for cancellation under
        the
        NCIB in 2006.
  The
        Company has issued Senior Unsecured Notes Payable totalling US$311 million,
        has
        secured financing for the MAPLE Facilities construction project in the form
        of a
        non-interest bearing government loan, and has various other forms of long-term
        credit, mostly associated with the purchase of specific assets. At October
        31,
        2006, the Canadian dollar value of all of the Company’s outstanding debt was
        $446 million. In addition, the Company has available $500 million of undrawn
        committed term credit facilities.
  **5.**
              **MANAGEMENT’S
                  DISCUSSION AND ANALYSIS**
  Please
        refer to the disclosure contained on pages 1 to 23 of the 2006 Annual Report
        under the heading “Management Discussion and Analysis” which is incorporated by
        reference into this AIF.
  **6.**
              **MARKET
                  FOR SECURITIES**
  The
        outstanding Common Shares are listed for trading on the Toronto Stock Exchange
        (symbol - MDS) and the New York Stock Exchange (symbol - MDZ). The following
        table sets forth the price ranges and volume of Common Shares traded on the
        Toronto Stock Exchange for each month of fiscal 2006.
 
 Month
              Volume
                (Total
                  Month)
              High
                  Price
              Low
                  PriceNovember
                  2005
              9,499,600
              $20.21
              $18.25December
                  2005
              8,254,400
              $20.99
              $18.55January
                  2006
              12,385,900
              $21.99
              $20.00February
                  2006
              9,000,400
              $23.20
              $21.55March
                  2006
              10,340,500
              $23.05
              $20.90April
                  2006
              5,441,000
              $22.90
              $20.90May
                  2006
              9,555,600
              $22.89
              $20.25June
                  2006
              7,712,400
              $21.19
              $19.65July
                  2006
              4,753,500
              $21.40
              $20.11August
                  2006
              6,328,600
              $22.66
              $20.08September
                  2006
              15,189,600
              $25.50
              $18.80October
                  2006
              11,964,200
              $20.30
              $18.56
 
 Other
        than the Common Shares, no other class of securities of the Company is traded
        or
        quoted on any exchange or market.
  **7.**
              **DIRECTORS
                  AND OFFICERS**
  **7.1**  **Directors**
  Each
        director of the Company is elected to serve until the next annual meeting
        of the
        Company or until his or her successor is elected or appointed. The disclosure
        under the heading “Election of Directors” in the Company’s Management Proxy
        Circular dated January 2, 2007 contains information about each director of
        the
        Company and is incorporated herein by reference.
  **7.2**  **Executive
        Officers**
  The
        Company’s Executive Management team currently comprises the following
        individuals:
 
 **Executive
                  Officer Name**
              **Position
                  with MDS**
              **Province
                  or State and Country of Residence**Andrew
                  W. Boorn
              President
                MDS
                  Sciex
              Ontario,
                  CanadaStephen
                  P. DeFalco
              President
                  and Chief Executive Officer (CEO)
              Ontario,
                  CanadaJames
                  A. H. Garner
              Executive
                  Vice-President (EVP) and Chief Financial Officer (CFO)
              Ontario,
                  CanadaThomas
                  E. Gernon
              Chief
                  Information Officer
              Ontario,
                  CanadaDavid
                  Spaight
              President
                MDS
                  Pharma Services
              Pennsylvania,
                  USA.Kenneth
                  L. Horton
              Executive
                  Vice-President, Corporate Development and General Counsel
              Massachusetts,
                  USA.James
                  M. Reid
              Executive
                  Vice-President, Organization Dynamics
              Ontario,
                  CanadaHans
                  K. Thunem
              President
                MDS
                  Diagnostics Services
              Ontario,
                  CanadaSteven
                  M. West
              President
                MDS
                  Nordion
              Ontario,
                  Canada
  Andrew
        W.
        Boorn, James M. Reid and Steven M. West have held their present positions
        or
        other senior positions with MDS Inc. or its subsidiaries during the past
        five
        years. The executive officers listed below have not reached five years with
        MDS
        and therefore their previous occupations are as follows:
  a)
              Stephen
                  DeFalco joined MDS in 2005 and was previously Chairman and CEO
                  of US
                  Genomics and prior to that role served as President of PerkinElmer
                  Instruments and Senior Vice-President of PerkinElmer
                  Inc.
  b)
              James
                  A. H. Garner joined MDS in 2003 and was previously CFO of Draxis
                  Health
                  Inc. In November 2006, the Company announced that Mr. Garner will
                  step
                  down as CFO in April, 2007.
  c)
              Thomas
                  E. Gernon joined MDS in 2005, was previously Chief Operating Officer
                  of
                  D2Hawkeye Inc., a healthcare software development company and held
                  CIO
                  positions at both PerkinElmer Inc. and J.P. Morgan
                  Invest.
  d)
              Kenneth
                  L. Horton joined MDS in December 2005 and was previously Vice President,
                  Acquisitions, Ventures and General Counsel for the Life and Analytical
                  Sciences business unit at PerkinElmer,
                  Inc.
  e)
              David
                  Spaight joined MDS in April 2006. Prior to joining MDS, Mr. Spaight
                  was
                  Senior Vice - President, Global Sales, and Marketing at Fisher
                  Scientific
                  Products, where he was responsible for the integration of the sales,
                  marketing, and research and development teams in North America,
                  Europe,
                  and Asia. Prior to joining Fisher, Mr. Spaight had an extensive
                  career at
                  PerkinElmer, Inc. where he rose up through sales, marketing, and
                  general
                  management positions to the role of Vice-President, Global Sales,
                  and
                  Marketing.
  f)
              Hans
                  K. Thunem joined MDS in 2002 and was previously Vice-President,
                  North
                  American Operations, Nortel Networks
                  Corporation.
  To
        the
        knowledge of MDS, the directors and executive officers of MDS, as a group,
        beneficially own, directly or indirectly, or exercise control or direction
        over
        an aggregate of 217,350 MDS Common Shares representing 0.15% of MDS’s issued and
        outstanding Common Shares.
  **7.3**  **Additional
        Disclosure for Directors and Executive Officers**
  To
        the
        knowledge of MDS, no director or executive officer of MDS (a) is or has been,
        in
        the last ten years, a director or executive officer of an issuer that, while
        that person was acting in that capacity, (i) was the subject of a cease trade
        order or similar order or an order that denied the issuer access to any
        exemptions under Canadian securities legislation, for a period of more than
        30
        consecutive days, (ii) was subject to an event that resulted, after that
        person
        ceased to be a director or executive officer, in the issuer being the subject
        of
        a cease trade or similar order or an order that denied the issuer access
        to any
        exemption under Canadian securities legislation, for a period of more than
        30
        consecutive days, or (iii) within a year of that period ceasing to act in
        that
        capacity, became bankrupt, made a proposal under any legislation relating
        to
        bankruptcy or insolvency or was subject to or instituted any proceedings,
        arrangement or compromise with creditors or had a receiver, receiver manager
        or
        trustee appointed to hold its assets, or (b) has, within the last ten years,
        become bankrupt, made a proposal under any bankruptcy or insolvency legislation
        or become subject to or instituted any proceedings, arrangement or compromise
        with creditors, or had a receiver, receiver or manager or trustee appointed
        to
        hold his or her assets, or (c) has been subject to any penalties or sanctions
        imposed by a court relating to securities legislation or by a securities
        regulatory authority except for the following:
  (i)
              Mr.
                  James A. H. Garner, EVP, and CFO of MDS was a****director
                  of Protana Inc. (formerly MDS Proteomics Inc.), a private company.
                  Protana
                  Inc. made an application under the*Bankruptcy
                  and Insolvency Act*(Canada) in November 2005 for the appointment of an interim receiver
                  and
                  the approval of the sale of certain assets to Transition Therapeutics
                  Inc.
                  The sale was completed and Protana Inc. is no longer carrying on
                  business.
  (ii)
              Mr.
                  Robert Luba, a director of MDS was an independent director of Safety-Kleen
                  Corp., a New York Stock Exchange listed company, which filed for
                  bankruptcy in 2000.
   **8.**
              **AUDIT
                  COMMITTEE INFORMATION**
  **8.1**  **Composition
        of the Audit Committee**
  The
        Audit
        Committee of MDS is composed of the following four members:
  Robert
        W.
        Luba (Chair), James S. A. MacDonald, Kathleen M. O’Neill, and Richard H. McCoy.
        The responsibilities and duties of the Committee are set out in the Committee’s
        charter, the text of which is set forth in Appendix I to this AIF.
  The
        Board
        of Directors believes that the composition of the Audit Committee reflects
        a
        high level of financial literacy and expertise. Each member of the Audit
        Committee has been determined by the Board to be “independent” and “financially
        literate” as such terms are defined under Canadian and United States securities
        laws and the NYSE corporate governance listing standards. In addition, the
        Board
        has determined that each of Robert W. Luba and
  Kathleen
        M. O’Neill is an “Audit Committee Financial Expert” as such term is defined
        under United States securities laws. The Board has made these determinations
        based on the education and breath and depth of experience of each member
        of the
        Committee. The following is a description of the education and experience
        of
        each member of the Committee that is relevant to the performance of his or
        her
        responsibilities as a member of the Audit Committee:
  Mr.
        Robert W. Luba holds a MBA from the University of Western Ontario and is
        a
        Fellow of the Institute of Chartered Accountants of Ontario. He is President
        of
        Luba Financial Inc., an investment company in Toronto, Ontario and was formerly
        the President and CEO of Royal Bank Investment Management Inc., President
        of
        Crown Life Insurance Company and Senior Vice-President of John Labatt Limited.
        Mr. Luba is a director of Softchoice Corporation., AIM Trimark Investments,
        ATS
        Automation Tooling Systems, Menu Foods Income Fund and KCP Income Fund.
  Mr.
        James
        S. A. MacDonald has a MBA from Northwestern University and has been the Chairman
        and Managing Partner of Enterprise Capital Management Inc. (an investment
        management company) for the last five years. Mr. MacDonald is a director
        of
        Capitol Energy Resources Ltd., Manitoba Telecom Services Inc., and Superior
        Plus
        Inc.
  Ms.
        Kathleen M. O’Neill has a
        Bachelor of Commerce from the University of Toronto, is a Fellow of the
        Institute of Chartered Accountants of Ontario, and in 2005 was accredited
        through the Institute of Corporate Directors/Rotman School of Management
        Directors Education Program.
  Ms.
        O’Neill was an Executive Vice-President with BMO Bank of Montreal and prior
        to
        that experience was a partner at PricewaterhouseCoopers, in the Corporate
        Taxation Practice.
  Ms.
        O’Neill is a member of the Board of Directors of TSX Group Inc., Hydro One
        Inc.
        Canadian Tire Bank and the Canadian Chamber of Commerce, where she chairs
        its
        Healthcare Task Force.
  Mr.
        Richard H. McCoy is a
        Corporate Director. Mr. McCoy has been in the investment banking business
        for
        over 35 years. Prior to retiring in 2003, he was Vice-Chairman, Investment
        Banking at TD Securities Inc. (one of Canada's largest investment firms located
        in Toronto, ON). Prior to joining TD Securities Inc. in May of 1997, Mr.
        McCoy
        was Deputy Chairman of CIBC Wood Gundy Securities. Mr. McCoy also serves
        as a
        director of ACE Aviation Holdings Inc., Rothmans Inc., Uranium Participation
        Corporation, Air Canada, Gerdau Ameristeel Corp., Aberdeen Asia-Pacific Income
        Investment Company Limited, Jazz Air Income Fund, and Pizza Pizza Royalty
        Income
        Fund.
  **8.2**  **Auditor
        Service Fees**
  The
        fees
        billed by MDS’s external auditors, Ernst & Young LLP, for all services
        performed by the auditors for the years ended October 31, 2006 and October
        31,
        2005 are set out below.
 
 **2006**
              
              **2005**Audit
                  fees
              $6,726,561
              
              $
                  1,984,000Audit-related
                  fees
              255,080
              
              392,000Tax
                  services
              196,120
              
              310,000Total
              $7,177,761
              
              $2,686,000
 Note:
        The
        increase in fees for audit services in 2006 is largely attributable to
        Sarbanes-Oxley compliance activities.
  Audit
        Fees - An audit engagement is one in which Ernst & Young LLP, or a foreign
        affiliate, has been hired to render an audit opinion on a set of financial
        statements or related financial information. These engagements include the
        opinion issued on the consolidated financial statements of MDS, the opinions
        issued on subsidiaries of MDS as required by statute in certain jurisdictions,
        and opinions issued on the financial statements of subsidiaries or entities
        over
        which MDS exercises management discretion. The latter category includes audit
        opinions issued on pension plans established for the benefit of MDS
        employees.
  Audit-Related
        Fees - An audit-related engagement is one in which some sort of assurance
        is
        provided that is not an audit opinion or one which supports the ability of
        Ernst
& Young LLP to render an audit opinion in an indirect manner. Such
        engagements include reviews of the interim financial statements, the reports
        of
        which are provided to the Audit Committee, accounting assistance and advice,
        systems and internal controls reviews associated with our Common Business
        Systems implementation, planning work associated with our Sarbanes-Oxley
        compliance program, and translation services related solely to our filed
        financial reports. From time to time, Ernst & Young LLP may also be engaged
        to provide audit-related services in connection with acquisitions, including
        audits of transaction date balance sheets and similar services.
  Tax
        Fees
        - A tax engagement is one in which Ernst & Young LLP has been engaged to
        provide tax services, including assistance with tax compliance and tax advice
        and planning. Tax compliance assistance is generally provided to the foreign
        subsidiaries of MDS and to certain entities that are controlled by MDS but
        in
        which there are other minority interests. Tax compliance services include
        assistance with the preparation and filing of tax returns, assistance in
        dealing
        with tax audits, and in prior years, personal tax assistance provided to
        participants in the Company’s expatriate tax program. Tax advice and planning
        services are provided to the Company and many of its subsidiaries and relate
        to
        both income taxes and sales and use taxes.
  **8.3**  **Pre-approval
        policies and Procedures**
  The
        Audit
        Committee has adopted a policy for the pre-approval of engagements for services
        of its external auditors.
  The
        Audit
        Committee’s policy requires pre-approval of all audit and non-audit services
        provided by the external auditor. The policy identifies three categories
        of
        external auditor services and the pre-approval procedures applicable to each
        category, as follows:
  (1)
              Audit
                  and audit-related services - these are identified in the annual
                  audit
                  service plan presented by the external auditor and require annual
                  approval. Changes to these fees are reported to the Audit Committee
                  at
                  least quarterly.
  (2)
              Pre-approved
                  list of non-audit services - non-audit services which are reasonably
                  likely to occur have been identified and receive general pre-approval
                  of
                  the Audit Committee, and as such, do not require specific pre-approvals.
                  The term of any general pre-approval is 12 months from approval
                  unless
                  otherwise specified. The Audit Committee annually reviews and pre-approves
                  the services on this list.
  (3)
              Other
                  proposed services - all proposed services not categorized above
                  are
                  brought forward on a case-by-case basis and specifically pre-approved
                  by
                  the Audit Committee.
  **9.**
              **ADDITIONAL
                  INFORMATION**
  Additional
        information about MDS is available on the Company’s web site at www.mdsinc.com ,
        on
        SEDAR (System for Electronic Document Analysis and Retrieval) at www.sedar.com ,
        and on
        the US Securities and Exchange web site at www.sec.gov .
  Additional
        information, including directors’ and executive officers’ remuneration and
        indebtedness, principal holders of the Company’s securities and securities
        authorized for issuance under equity compensation plans is contained in the
        Management Proxy Circular dated as of January 2, 2007 prepared in connection
        with the Company’s Annual and Special Meeting of Shareholders to be held in
        March 2007.
  Additional
        financial information is provided in the 2006 Financial Statements and the
        2006
        MD&A, each included in the 2006 Annual Report of MDS for its fiscal year
        ended October 31, 2006.
  Copies
        of
        this AIF, as well as copies of the 2006 Annual Report of MDS for the year
        ended
        October 31, 2006 and the Management Proxy Circular dated January 2, 2007
        may be
        obtained from:
 
 Peter
                  Brent
                SVP
                  Legal & Corporate Secretary, MDS Inc.
                Telephone:416-213-4082
                Fax:416-213-4222
                Email:peter.brent@mdsinc.com
              2700
                  Matheson Blvd., Suite 300, West Tower
                Mississauga,
                  Ontario, L4W 4V9
                Canada
 
  
   **APPENDIX
        I**
  MDS
        INC.
  AUDIT
        COMMITTEE CHARTER
  **Purpose**
  The
        primary function of the audit committee (the “Audit Committee”) of the board of
        directors (the “Board”) of MDS Inc. (the “Corporation”) is to assist the Board
        of Directors in fulfilling its oversight responsibilities for the financial
        reporting process, the system of internal control over financial reporting,
        the
        audit process and the processes for identifying, evaluating and managing
        the
        Company’s principal risks impacting financial reporting.
  Consistent
        with this function, the Audit Committee should encourage continuous improvement
        of, and should foster adherence to, the Corporation’s policies, procedures, and
        practices.
  **Approval
        of Charter**
  This
        Audit Committee charter requires approval by the Board.
  Future
        changes to this charter require approval by the Board based on the
        recommendation of the Audit Committee.
  **Structure
        and Composition**
  The
        Audit
        Committee shall consist of no fewer than three members from among the
        Board.
  Ø
              Each
                  member of the Audit Committee shall: (i) be free from any relationship
                  that, in the opinion of the Board, would interfere with the exercise
                  of
                  his or her independent judgment as a member of the Audit Committee;
                  and
                  (ii) meet the independence and experience requirements of all applicable
                  corporate, exchange and securities statutes, rules and regulations
                  in
                  Canada and the United States (the
                  “Regulations”).
  All
        members of the Audit Committee shall have a working familiarity with basic
        finance and accounting practices and shall be able to read and understand
        financial statements.
  At
        least
        one member of the Audit Committee shall be an “audit committee financial expert”
as such term is defined by the Regulations. The Board shall make determinations
        as to whether any particular member of the Audit Committee satisfies this
        requirement.
  The
        members of the Audit Committee shall be appointed by the Board annually on
        the
        recommendations of the Nominating and Corporate Governance Committee or until
        successors are duly appointed.
  The
        Board
        shall normally designate the Chair of the Audit Committee. In the event that
        a
        Board designation is not made, the members of the Audit Committee shall elect
        a
        Chair by majority vote of the full Audit Committee.
  In
        the
        event that the Chair of the Audit Committee does not attend a meeting of
        the
        Audit Committee, the members of the Audit Committee shall elect a temporary
        Chair for such meeting by majority vote of the members in attendance at the
        meeting.
  Once
        appointed, Audit Committee members shall cease to be a member of the Audit
        Committee only upon:
  (i)  resignation
        from the Board,
  (ii)  death,
  (iii)  disability,
        as determined by an independent physician retained by the Board; or
  (iv)  not
        being
        re-appointed pursuant to the annual appointment process described
        above.
  Except
        as
        otherwise determined by the Board in any particular circumstance, members
        of the
        Audit Committee shall not simultaneously serve on the audit committees of
        more
        than three public companies.
 
 **Meetings**
 
 The
        Audit
        Committee shall meet at least quarterly and more frequently as circumstances
        dictate.
 
 A
        majority of Audit Committee members is required for meeting quorum.
 
 The
        Audit
        Committee shall meet separately on a regular basis with management and the
        independent auditor in separate committee sessions.
 
 The
        Audit
        Committee may request any officer or employee of the Corporation or the
        Corporation’s outside counsel or independent auditor to attend a meeting of the
        Audit Committee or to meet or provide consultations to the Audit Committee
        or
        any member thereof.
  The
        CEO,
        CFO, VP, Finance and Corporate Secretary of the Corporation and representatives
        of the independent auditors shall normally attend meetings of the Audit
        Committee. Others may also attend meetings as the Audit Committee may
        request.
  Notice
        of
        all meetings of the Audit Committee shall be sent to the Auditors as well
        as
        Audit Committee members.
  **Resolutions**
  Resolutions
        of the Audit Committee shall require approval by a simple majority of members
        voting on such resolution.
  **Responsibilities
        and Duties**
  ***i)***  ***Minutes
        and Reporting to the Board***
  The
        Audit
        Committee shall prepare written minutes of all of its meetings. In addition,
        the
        Chair of the Committee or designate shall report to the Board of Directors
        after
        each meeting the significant matters addressed by the Committee at such meeting
        and a copy of the minutes shall be made available to all members of the
        Board.
  ***ii)***  ***Independent
        Auditor***
  With
        respect to the Corporation’s independent auditor the Audit Committee
        shall:
  Ø
              have
                  the sole authority to recommend to the Board the appointment or
                  replacement of the independent auditor (subject, if applicable,
                  to
                  shareholder approval)
  Ø
              be
                  directly responsible for establishing the compensation of the independent
                  auditor
  Ø
              have
                  the independent auditor report directly to the Audit
                  Committee
  Ø
              determine
                  the extent of involvement of the independent auditor in reviewing
                  unaudited quarterly financial
                  results
  Ø
              meet
                  with the independent auditor prior to the annual audit to discuss
                  the
                  planning, scope and staffing of the
                  audit
  Ø
              approve
                  the selection of the senior audit partners having primary responsibility
                  for the audit
  Ø
              provide
                  for the periodic rotation of the senior audit partners having primary
                  responsibility for the audit and the audit partner responsible
                  for
                  reviewing the audit as required by
                  law
  Ø
              at
                  least on an annual basis, evaluate the qualifications, performance
                  and
                  independence of the independent auditor and the senior audit partners
                  having primary responsibility for the
                  audit
  Ø
              obtain
                  and review a report from the independent auditor at least annually
                  regarding: (i) the independent auditor’s internal quality control
                  procedures, (ii) any material issues raised by the most recent
                  internal
                  quality control review, or peer review, of the firm, or raised
                  by any
                  inquiry or investigation by governmental or professional authorities
                  within the preceding five years respecting one or more independent
                  audits
                  carried out by the firm, (iii) any steps taken to deal with any
                  issues,
                  and (iv) all relationships between the independent auditor and
                  the
                  Corporation
  Ø
              obtain
                  confirmation from management that the Corporation has not hired
                  employees
                  or former employees of the independent auditor who have participated
                  in
                  any capacity in the audit of the Corporation for the immediately
                  previous
                  12 month period
  Ø
              pre-approve
                  all auditing services and permitted non-audit services (including
                  fees and
                  terms thereof) to be performed for the Corporation by its independent
                  auditor.
  ***iii)***  ***Reporting
        to Board***
  The
        Audit
        Committee shall make regular reports to the Board, but not less frequently
        than
        quarterly.
  ***iv)***  ***Financial
        Reporting***
  With
        respect to the Corporation’s reporting of unaudited quarterly financial results,
        the Audit Committee shall:
  ­-
              Prior
                  to their public release and filing with securities regulatory agencies,
                  review and discuss with management and the independent auditor
                  the:
  ­-
              press
                  release
  ­-
              consolidated
                  financial statements and notes
                  thereto
  ­-
              management’s
                  discussion and analysis
  ­-
              results
                  of any independent auditor’s review requested/approved by the
                  committee.
  Ø
              Review
                  the Corporation’s unaudited quarterly financial results
                  including:
  ­-
              any
                  significant judgments (e.g., estimates and reserves) made in the
                  preparation of financial statements
  ­-
              any
                  significant disagreements among management and the independent
                  auditors in
                  connection with the preparation of financial
                  statements
  ­-
              the
                  extent to which changes or improvements in financial or accounting
                  practices, as approved by the Audit Committee, have been
                  implemented
  ­-
              significant
                  financial reporting issues and judgments made in connection with
                  the
                  preparation of the Corporation’s financial statements, including any
                  significant changes in the Corporation’s selection or application of
                  accounting principles, any major issues as to the adequacy if the
                  Corporation’s internal controls and any special steps adopted in light of
                  material control deficiencies
  ­-
              the
                  Corporation’s use of “pro forma” or “adjusted” non-GAAP
                  information
  ­-
              the
                  Corporation’s use of forward-looking financial
                  guidance
  ­-
              critical
                  accounting policies and practices
  ­-
              review
                  of alternative treatments of financial information in all cases,
                  ramifications of the use of such alternative disclosures and treatments,
                  and the treatment preferred by the independent
                  auditor
  ­-
              any
                  written communications between the independent auditor and management
                  (e.g. management letters, schedule of unadjusted
                  differences)
  ­-
              the
                  effect of regulatory and accounting initiatives as well as off-balance
                  sheet structures on the Corporation’s financial
                  statements
  ­-
              management
                  certifications of reports filed by the Corporation pursuant to
                  the
                  Regulations
  ­-
              integrity
                  of the Corporation’s financial reporting
                  processes
  ­-
              any
                  correspondence with regulators or governmental agencies and any
                  published
                  reports which raise material issues regarding the Corporation’s financial
                  statements or accounting policies
  Ø
              Approve
                  the unaudited quarterly financial statements of the
                  Corporation
  ***v)***  ***Year-End
        Audit***
  With
        respect to the Corporation’s annual audit, the Audit Committee
        shall:
  Ø
              Prior
                  to their public release and filing with securities regulatory agencies,
                  review and discuss with management and the independent auditor
                  the:
  ­-
              financial
                  statements and notes thereto for consolidated and separate
                  entities
  ­-
              management’s
                  discussion and analysis
  ­-
              results
                  of the independent auditor’s audit
  Ø
              The
                  review of the Corporation’s audited financial results, shall
                  include:
  ­-
              all
                  matters described above with respect to unaudited quarterly financial
                  results
  ­-
              results
                  of the independent auditor’s audit
  ­-
              discussions
                  with the independent auditors on the matters required to be discussed
                  by
                  Statement on Auditing Standards No. 61, including significant adjustments,
                  management judgments and accounting estimates, significant new
                  accounting
                  policies, any difficulties encountered in the course of the audit
                  work,
                  any restrictions on the scope of activities or access to requested
                  information, and any significant disagreements with
                  management
  ­-
              a
                  verbal and/or written report, as appropriate, from the independent
                  auditors describing (i) all critical accounting policies and practices
                  to
                  be used, (ii) all alternative treatments of financial information
                  within
                  generally accepted accounting principles that have been discussed
                  with
                  management, ramifications of the use of such alternative disclosures
                  and
                  treatments, and the treatment preferred by the independent auditors
                  and
                  (iii) other material communications between the independent auditors
                  and
                  management, such as the annual management letter or schedule of
                  unadjusted
                  differences
  Ø
              Recommend
                  to the Board whether the audited consolidated financial statements
                  of the
                  Corporation should be approved by the
                  Board
  ***vi)***  ***Annual
        Proxy Statement and Regulatory Filings***
  The
        Audit
        Committee shall:
  Ø
              issue
                  any reports required of the Audit Committee to be included in the
                  Corporation’s annual proxy
                  statement.
  Ø
              review
                  and recommend to the Board the approval of all material documents
                  filed
                  with securities regulatory agencies
                  including:
  ­-
              Consolidated
                  Year-end Financial Statements
  ­-
              Annual
                  Information Form
  ­-
              Prospectuses
  ***vii)***  ***Related
        Party Transactions and Off-Balance Sheet Structure***
  The
        Audit
        Committee shall:
  Ø
              review
                  all related-party transactions including those between the Corporation
                  and
                  its officers or directors and, if deemed appropriate, recommend
                  approval
                  of any particular transaction to the
                  Board.
  Ø
              Review
                  all material off-balance sheet structures that the Corporation
                  is a party
                  to.
  ***viii)***  ***Internal
        Controls, Risk Management and Legal Matters***
  The
        Audit
        Committee shall:
  Ø
              consider
                  the effectiveness of the Corporation’s internal controls over financial
                  reporting and related information technology security and control
                  including the process to communicate such controls and roles and
                  responsibilities.
  Ø
              discuss
                  with management the Corporation’s major financial risk exposures and the
                  steps management has taken to monitor and control such exposures,
                  including the Corporation’s risk assessment and risk management policies
                  including the use of derivative financial instruments. Areas to
                  be
                  considered in this respect include:
  ­-
                insurance
                    coverage
  ­-
              foreign
                  currency exposure
  ­-
              interest
                  rate exposure
  Ø
              review
                  with management, and if necessary, the Corporation’s counsel, any legal
                  matter which could reasonably be expected to have a material impact
                  on the
                  Corporation’s financial statements or accounting
                  policies.
  ***ix)***  ***Capital
        Structure, Investment and Cash Management Policies, Disclosure
        Policy***
  The
        Audit
        Committee shall:
  Ø
              review
                  and approve any changes to the Corporation’s capital
                  structure.
  Ø
              review
                  and approve the Corporation’s investment and cash management
                  policy.
  Ø
              review
                  and approve the Corporation’s disclosure
                  policy.
  ***x)***  ***“Whistle
        Blower” and Related Procedures***
  Ø
              The
                  Audit Committee shall establish procedures for the receipt, retention
                  and
                  treatment of complaints received by the Corporation regarding accounting,
                  internal accounting controls or auditing matters and for the confidential
                  and/or anonymous submission by employees of the Corporation of
                  concerns
                  regarding questionable accounting or auditing matters. The identity
                  of any
                  person making a submission on a confidential basis shall be revealed,
                  at a
                  minimum, to the Chair of the Audit Committee. The identity of any
                  such
                  person, however, will otherwise be treated as confidential. The
                  Committee
                  shall also be provided with such evidence as it requests to confirm
                  that
                  no disciplinary action has been taken against such
                  person.
  Ø
              Management
                  shall report to the Audit Committee on a timely basis all discovered
                  incidents of fraud within the Corporation, regardless of monetary
                  value.
  ***xi)***  ***Review
        of Charter and Self Assessment***
  The
        Audit
        Committee shall:
  Ø
              review
                  and reassess annually the adequacy of this
                  Charter.
  Ø
              review
                  annually the Audit Committee’s own
                  performance.
  ***xii)***  ***Corporate
        Knowledge and Other Activities***
  The
        Audit
        Committee shall:
  Ø
              strive
                  to expand continually its knowledge of the Corporation’s
                  activities.
  Ø
              carry
                  out such other activities consistent with this Charter, the Corporation’s
                  by-laws and governing law, that the Audit Committee or the Board
                  deem
                  necessary or appropriate.
  **Other
        Advisors**
  The
        Audit
        Committee shall have the authority to retain independent legal, accounting
        or
        other advisors including consulting with the national office of the independent
        auditor. The Corporation shall provide for appropriate funding, as determined
        by
        the Audit Committee, for payment of compensation to the independent auditor
        for
        the purpose of rendering or issuing an audit report and to any advisors employed
        by the Audit Committee.
  **Limitations
        on Committee’s Duties**
  While
        the
        Audit Committee has the responsibilities and power set forth in this Charter,
        it
        is not the duty of the Audit Committee to plan or conduct audits or to determine
        that the Corporation’s financial statements and disclosures are complete and
        accurate and are in accordance with generally accepted accounting principles
        and
        applicable rules and regulations. These are the responsibilities of either
        management and/or the independent auditor.
  In
        discharging its duties, each member of the Committee shall be obliged only
        to
        exercise the care, diligence and skill that a reasonably prudent person would
        exercise in comparable circumstances. Nothing in this Charter, including
        designating any member of the Committee as an “audit committee financial expert”
is intended, or should be determined to impose on any member of the Committee
        a
        standard of care or diligence that is in any way more onerous or extensive
        than
        the standard to which all members of the Board are subject.
  The
        essence of the Committee’s responsibilities is to monitor and review the
        activities described in this Charter to gain reasonable assurance (but not
        to
        ensure) that such activities are being conducted properly and effectively
        by the
        Corporation.
   **APPENDIX
        II**
  **DEFINITIONS**
 
 **Acronyms:**
 CRC
              A
                  Clinical Research Centre is a unit that manages patient studies
                  from
                  partnered sites within a defined investigator or patient-provider
                  location. For example, a hospital having access to a group of patients
                  having particular conditions on which trials are being conducted
                  may serve
                  as a CRC.CRO
              A
                  Contract Research Organization is a company that conducts research
                  on
                  behalf of a pharmaceutical or biotechnology company.FDA
              Food
                  and Drug Administration - The US regulatory agency charged with
                  maintaining the safety of food, drugs, and cosmetics.FDG
              Fluorodeoxyglucose
                  (F18),
                  a short-lived isotope of fluorine used predominantly in PET
                  scans.GCP
                  and GLP
              Good
                  Clinical Practices and Good Laboratory Practices are standards
                  for the
                  conduct of clinical trials (including laboratory studies) the data
                  from
                  which are expected to be submitted to a regulatory agency such
                  as the FDA.
                  In the case of GLP these practices are defined by regulation. GCP
                  have
                  arisen from general accepted clinical practices within the
                  industry.LC/MS
              A
                  form of analytical instrument that combines liquid chromatography
                  with
                  mass spectrometryMALDI
              A
                  form of mass spectrometer that uses matrix-assisted laser
                  desorption/ionization technology to give a more detailed measure
                  of the
                  molecular mass of a sample.NCE
              A
                  New Chemical Entity is a chemical compound being studied for possible
                  use
                  as a drug. Compounds are generally referred to as NCEs until a
                  NDA is
                  filed.NDA
              A
                  New Drug Application is submitted to the FDA reporting the results
                  of
                  clinical trials and must be approved by the FDA before marketing
                  can
                  begin.PET
              Positron
                  Emission Tomography - a diagnostic imaging technology that using
                  positron
                  emission to measure in detail the functioning of distinct areas
                  of the
                  human brain while the patient is comfortable, conscious and
                  alert.TOF
              A
                  form of mass spectrometry that uses differences in the transit
                  times of
                  molecules through a know distance to determine their molecular
                  weight.
  **Technical
        Terms:**
 Assay
              Analysis
                  of biological fluids or structure to determine how much or how
                  little drug
                  has been absorbed into the fluid or structure.Bioanalytical
              Methods
                  for determining the concentration of drugs in biological samples
                  such as
                  blood.Bioequivalence
              The
                  study of different formulations of the same drug to determine if
                  the
                  metabolic effects are equivalent.Biomarker
              A
                  distinctive biochemical or physiological indicator of a biological
                  process
                  or event.Biopharmaceuticals
              Pharmaceutical
                  products (drugs) developed using biotechnology instead of chemical
                  synthesis.Biotechnology
              The
                  scientific manipulation of living organisms, especially at the
                  molecular
                  genetic level, to produce useful products.Clinical
                  Trials
              Broadly,
                  the regulated process by which new drugs proceed after discovery
                  through
                  to acceptance for marketing to patients. The term most correctly
                  refers to
                  the period during which new compounds are tested in human subjects
                  and
                  encompasses the following broad phases:Phase
                  I
              Segment
                  of clinical trials research allocated to assessing the safety,
                  tolerance,
                  and pharmacokinetics of a NCE generally using otherwise healthy
                  study
                  subjects.Phase
                  II
              Segment
                  of clinical trials research allocated to assessing the safety and
                  efficacy
                  of a NCE in selected disease states using patients having the condition.Phase
                  III
              Segment
                  of clinical trials research allocated to assessing the safety and
                  efficacy
                  of a NCE often in comparison with standard therapies, conducted
                  in an
                  expanded, multi-centre manner using patients having the
                  condition.Phase
                  IV
              Follow-on
                  clinical studies completed after the FDA has approved the NCE for
                  marketing.Cobalt-60
              A
                  radioactive isotope of cobalt containing one additional neutron
                  (electrically neutral particle) compared to cobalt in its natural
                  state.Cyclotron
              A
                  form of particle accelerator that can be used to produce
                  radioisotopes.Decay
              A
                  spontaneous radioactive process by which the number of radioactive
                  atoms
                  in a material decreases over time resulting in the release of a
                  defined
                  amount of radiant energy.E.
                  coli
              A
                  member of the family of microorganisms called coliforms. Many strains
                  of
                  E. coli live peacefully in the gut; however, one strain (E. coli
                  0157:H7)
                  has been identified as the cause of a specific form of gastroenteritis
                  characterized by abdominal cramps and bloody diarrhea, leading
                  to kidney
                  failure and sometimes death.Efficacy
              Capacity
                  for producing a desired result or effect.Electron
                  (or E) Beam
              A
                  type of particle accelerator that creates a stream of high-energy
                  electrons.Gamma
                  Radiation
              Very
                  high-energy electromagnetic radiation that is released from the
                  decay of
                  radioactive sources.Genome
              The
                  entire genetic information present in a particular
                  organism.Genomics
              The
                  study of the organization, structure and function of the
                  genomeHalf-life
              The
                  time required for radioisotopes to decay to one-half the level
                  of
                  radioactivity originally present.Ionization
              The
                  process by which neutral atoms become electrically charged by the
                  loss of
                  one or more electrons (electrically negative
                  particles).Investigator
              The
                  individual from a clinic site who is ultimately in charge of a
                  study,
                  typically a physician.Irradiation
              The
                  process of exposing product to gamma radiation, or X-rays, or electrons
                  under controlled conditions.Isotope
              A
                  form of an element having the same number of protons (electrically
                  positive particles) but a different number of neutrons from its
                  ordinary
                  state. Most elements exist in more than one isotopic form and most
                  isotopes are stable (unchanging). Isotopes are typically identified
                  by an
                  element name followed by a number. (e.g., Molybdenum
                  99)Liquid
                  Chromatography
              A
                  separation technique in which the sample is injected into a liquid
                  stream
                  pumped at high pressure through a column packed with materials
                  which
                  absorb the components of the sample to varying extents, such that
                  over the
                  length of the column the components of the sample become separated
                  and are
                  detected sequentially by the mass spectrometer.Mass
                  Spectrometry
              The
                  science that measures the masses and relative concentrations of
                  atoms and
                  molecules to determine the make-up of the substance.Molybdenum
                  99
              The
                  most common isotope used for medical purposes. It is processed
                  into
                  technetium-99m for these purposes.Particle
                  Accelerator
              A
                  machine that increases the kinetic energy of electrons or protons
                  by
                  accelerating them through electric fields.Pharmacology
              The
                  study of drugs and their origins, nature, properties, and effects
                  on
                  living organisms.Pre-clinical
                  Studies
              Designates
                  those studies generally completed prior to human clinical
                  trials.Proteomics
              The
                  study of protein location, interaction, structure, and function
                  that aims
                  to identify and characterize the proteins present in normal versus
                  diseased states in biological samples.Radioisotopes
              An
                  isotope that is unstable and returns to a stable state through
                  the release
                  of energy in a process called decay. MDS processes and distributes
                  radioisotopes for use in medical applications and for sterilization
                  processing.Radiopharmaceuticals
              A
                  specially designed pharmaceutical having as part of its ingredients
                  a
                  minute amount of a radioisotope. After injection or ingestion,
                  the
                  radiopharmaceutical is designed to collect in specific organs or
                  types of
                  cells such as tumour cells.Synthesis
              The
                  process of creating a molecule through chemical
                  reaction.Target
              The
                  cells, tissues, or structures that a drug is intended to interact
                  with as
                  part of its pharmacological effect.Toxicology
                  (also called Safety Pharmacology)
              The
                  study of a chemical compound to determine the levels at which death
                  occurs.


**Document
        No. 2**
 **CONSOLIDATED
        FINANCIAL STATEMENTS**
 
 **MANAGEMENT’S
        RESPONSIBILITY FOR FINANCIAL REPORTING**
 
 The
        accompanying consolidated financial statements and management discussion
        and
        analysis (MD&A) of **MDS Inc.** (“the
        Company”) and all information in this annual report are the responsibility of
        management and have been approved by the Board of Directors.
 
 The
        consolidated financial statements have been prepared by management in conformity
        with generally accepted accounting principles in Canada and the United States
        using the best estimates and judgments of management, where appropriate.
        The
        most significant of these accounting principles are set out in notes 1 and
        27 to
        the consolidated financial statements. Management has prepared the financial
        information presented elsewhere in this annual report and has ensured that
        it is
        consistent with the consolidated financial statements.
 
 The
        MD&A has been prepared in accordance with National Instrument 51-102 of the
        Canadian Securities Administrators, taking into consideration other relevant
        guidance, including Regulation S-K of the US Securities and Exchange Commission
        (“SEC”).
 
 MDS
        Inc.
        maintains systems of internal accounting and administrative controls of high
        quality, consistent with reasonable cost. Such systems are designed to provide
        reasonable assurance that the financial information is relevant, reliable,
        accurate and disclosed in a timely manner and that the Company’s assets are
        appropriately accounted for and adequately safeguarded. During the past year,
        management has continued to improve and document the design and operating
        effectiveness of internal control over external financial reporting. The
        results
        of management’s work have been subjected to audit by the shareholders’ auditors.
        As at year end, we have determined that internal control over financial
        reporting is effective and MDS Inc. has achieved compliance with the
        requirements set by the SEC under Section 404 of the US *Sarbanes-Oxley
        Act* (“SOx”).
        In compliance with Section 302 of SOx, MDS Inc.’s Chief Executive Officer and
        Chief Financial Officer provided to the SEC a certification related to MDS
        Inc.’s annual disclosure document in the US (Form 40-F). The same certification
        was provided to the Canadian Securities Administrators.
 
 The
        Internal Auditor of the Company reviews and reports on MDS’s internal controls,
        including such testing as is deemed to be required. The Internal Auditor
        has
        full and independent access to the Audit Committee of the Board of Directors.
 
 The
        Board
        of Directors has appointed an Audit Committee consisting of four outside
        directors. The Committee meets regularly to review with management and the
        auditors any significant accounting, internal control and auditing matters,
        and
        to review and finalize the interim and annual financial statements of the
        Company along with the independent auditors’ report prior to the submission of
        the financial statements to the Board of Directors for final approval. The
        financial information throughout this annual report is consistent with the
        information presented in the consolidated financial statements.
 
 These
        consolidated financial statements have been audited by Ernst & Young LLP,
        which have been appointed as the auditors of the Company by the shareholders.
        As
        auditors, Ernst & Young LLP obtain an understanding of MDS’s internal
        controls and procedures for financial reporting to plan and conduct such
        audit
        procedures as they consider necessary to express their opinion on the
        consolidated financial statements. As auditors, Ernst & Young LLP has full
        and independent access to the Audit Committee to discuss their findings.
  
 Stephen
                  P. DeFalco
                President
                  and Chief Executive Officer
              Jim
                  A.H. Garner
                Executive
                  Vice-President and Chief Financial
                  Officer
 
  **REPORT
        OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**
 
 To
        the
        Shareholders of MDS Inc.
 
 We
        have
        audited the consolidated statements of financial position of **MDS
        Inc.** (the
        “Company”) as at October 31, 2006 and 2005 and the consolidated statements of
        income, retained earnings and cash flows for each of the three years in the
        period ended October 31, 2006. These financial statements are the responsibility
        of the Company’s management. Our responsibility is to express an opinion on
        these financial statements based on our audits.
 
 We
        conducted our audits in accordance with Canadian generally accepted auditing
        standards and the standards of the Public Company Accounting Oversight Board
        (United States). Those standards require that we plan and perform an audit
        to
        obtain reasonable assurance whether the financial statements are free of
        material misstatement. An audit includes examining, on a test basis, evidence
        supporting the amounts and disclosures in the financial statements. An audit
        also includes assessing the accounting principles used and significant estimates
        made by management, as well as evaluating the overall financial statement
        presentation. We believe that our audits provide a reasonable basis for our
        opinion.
 
 In
        our
        opinion, these consolidated financial statements present fairly, in all material
        respects, the financial position of the Company as at October 31, 2006 and
        2005
        and the results of its operations and its cash flows for each of the three
        years
        in the period ended October 31, 2006 in conformity with Canadian generally
        accepted accounting principles.
 
 We
        have
        also audited, in accordance with the standards of the Public Company Accounting
        Oversight Board (United States), the effectiveness of the Company’s internal
        control over financial reporting as of October 31, 2006, based on criteria
        established in Internal Control - Integrated Framework issued by the Committee
        of Sponsoring Organizations of the Treadway Commission and our report dated
        January 15, 2007 expressed an unqualified opinion thereon.
 
 
 Toronto,
                  Canada,
                January
                  15, 2007Chartered
                  Accountants
  
 CONSOLIDATED
        STATEMENTS OF FINANCIAL
        POSITION
 As
                  at October 31
                (millions
                  of Canadian dollars)
              
              **2006**
              2005
                (Revised
                  Notes
                2
                  and 28)**ASSETS****Current**Cash
                  and cash equivalents
              **$**
              **284**
              $
              265Short-term
                  investments*(note
                  3)*
              
              **152**
              
              -Accounts
                  receivable
              
              **256**
              
              247Unbilled
                  revenue
              
              **136**
              
              114Inventories*(note
                  4)*****
              
              **97**
              
              159Income
                  taxes recoverable
              
              **47**
              
              3Prepaid
                  expenses and other
              
              **24**
              
              21Assets
                  held for sale*(note
                  2)*
              
              **220**
              
              114**1,216**
              
              923Property,
                  plant, and equipment*(note
                  5)*
              
              **381**
              
              808Future
                  tax assets*(note
                  15)*
              
              **42**
              
              41Long-term
                  investments and other*(note
                  6)*
              
              **191**
              
              144Goodwill*(note
                  7)*
              
              **468**
              
              479Intangibles*(note
                  8)*
              
              **380**
              
              42Assets
                  held for sale*(note
                  2)*
              
              **-**
              
              243**$**
              **2,678**
              $
              2,680**LIABILITIES
                  AND SHAREHOLDERS' EQUITY****Current**Accounts
                  payable and accrued liabilities
              **$**
              **268**
              $
              319Deferred
                  revenue*(note
                  10)*
              
              **104**
              
              119Income
                  taxes payable
              
              **9**
              
              29Current
                  portion of long-term debt*(note
                  9)*
              
              **22**
              
              12Liabilities
                  related to assets held for sale*(note
                  2)*
              
              **128**
              
              50**531**
              
              529Long-term
                  debt*(note
                  9)*
              
              **420**
              
              453Deferred
                  revenue*(note
                  10)*
              
              **19**
              
              27Other
                  long-term obligations
              
              **26**
              
              35Future
                  tax liabilities*(note
                  15)*
              
              **92**
              
              68Liabilities
                  related to assets held for sale*(note
                  2)*
              
              **-**
              
              143**1,088**
              
              1,255*(Commitments,
                  contingencies, and guarantees - notes 22, 23, and 24)***Shareholders’
                  equity**Share
                  capital*(notes
                  11 and 18)*
              
              **885**
              
              847Retained
                  earnings
              
              **730**
              
              604Cumulative
                  translation adjustment*(note
                  26)*
              
              **(25)**
              
              (26)**1,590**
              
              1,425**$**
              **2,678**
              $
              2,680
 Incorporated
        under the Canada Business Corporations Act
 See
        accompanying notes
 
 On
        behalf
        of the Board:
 John
                  T. Mayberry, Director
              Robert
                  W. Luba, Director
 
  CONSOLIDATED
        STATEMENTS OF
        INCOME
 Years
                  ended October 31
                (millions
                  of Canadian dollars except per share amounts)
              
              **2006**
              2005
                (Revised
                  Notes 2
                and
                  28)
              2004
                (Revised
                  Notes 2
                and
                  28)**Net
                  revenues**
              **$**
              **1,140**
              $
              1,154
              $
              1,141Cost
                  of revenues
              
              **(743)**
              
              (709)
              
              (672)Selling,
                  general, and administration
              
              **(248)**
              
              (245)
              
              (228)Research
                  and development*(note
                  12)*
              
              **(19)**
              
              (31)
              
              (38)Depreciation
                  and amortization
              
              **(71)**
              
              (61)
              
              (58)Restructuring
                  charges - net*(note
                  13)*
              
              **8**
              
              (61)
              
              (10)Other
                  income (expense) - net*(note
                  14)*
              
              **(7)**
              
              (17)
              
              (65)Equity
                  earnings*(note
                  6)*
              
              **(6)**
              
              (6)
              
              (1)**Operating
                  income**
              
              **54**
              
              24
              
              69Interest
                  expense
              
              **(26)**
              
              (21)
              
              (23)Dividend
                  and interest income
              
              **18**
              
              10
              
              7**Income
                  from continuing operations before income taxes and minority interest**
              
              **46**
              
              13
              
              53Income
                  taxes*(note
                  15)*-
                  current
              
              **23**
              
              (16)
              
              (39)-
                  future
              
              **(37)**
              
              4
              
              -Minority
                  interest - net of tax
              
              **-**
              
              -
              
              9**Income
                  from continuing operations**
              
              **32**
              
              1
              
              23**Income
                  from discontinued operations - net of tax*****(note
                  2)***
              
              **113**
              
              30
              
              28**Net
                  income**
              **$**
              **145**
              $
              31
              $
              51Basic
                  and diluted earnings per share*(note
                  16 and 18)*
                -****from
                  continuing operations****
              **$**
              **0.22**
              $
              -
              $
              0.16-
                  from discontinued operations
              
              **0.79**
              
              0.22
              
              0.20**Basic
                  and diluted earnings per share**
              **$**
              **1.01**
              $
              0.22
              $
              0.36
 See
        accompanying notes
 
  **CONSOLIDATED
        STATEMENTS OF RETAINED EARNINGS**
  Years
                  ended October 31
                (millions
                  of Canadian dollars)
              
              **2006**
              2005
                (Revised
                  Notes
                2
                  and 28)
              2004
                (Revised
                  Notes
                2
                  and 28)**Retained
                  earnings, beginning of year**
              **$**
              **604**
              $
              600
              $
              572Net
                  income
              
              **145**
              
              31
              
              51Repurchase
                  of shares*(note
                  11)*
              
              **-**
              
              (8)
              
              (11)Dividends
              
              **(19)**
              
              (19)
              
              (12)**Retained
                  earnings, end of year**
              **$**
              **730**
              $
              604
              $
              600
 See
        accompanying notes
 
  CONSOLIDATED STATEMENTS
        OF CASH
        FLOWS
 Years
                  ended October 31
                (millions
                  of Canadian dollars)
              
              **2006**
              2005
                (Revised
                  Notes
                2
                  and 28)
              2004
                (Revised
                  Notes
                2
                  and 28)**Operating
                  activities**Net
                  income
              **$**
              **145**
              $
              31
              $
              51Income
                  from discontinued operations - net of tax
              
              **113**
              
              30
              
              28Income
                  from continuing operations
              
              **32**
              
              1
              
              23Adjustments
                  to reconcile net income to cash provided by operating activities
                  relating
                  to continuing operations*(note
                  20)*Items
                  not affecting current cash flow
              
              **110**
              
              89
              
              117Changes
                  in non-cash working capital balances relating to
                  operations
              
              **(104)**
              
              (1)
              
              (15)Cash
                  provided by operating activities of continuing operations
              
              **38**
              
              89
              
              125Cash
                  provided by operating activities of discontinued
                  operations
              
              **117**
              
              72
              
              46**155**
              
              161
              
              171**Investing
                  activities**Acquisitions*(note
                  2)*
              
              **-**
              
              (6)
              
              (10)Effect
                  of deconsolidating MDS Proteomics
              
              **-**
              
              -
              
              (18)Proceeds
                  from MAPLE settlement
              
              **27**
              
              -
              
              -Purchases
                  of property, plant and equipment
              
              **(61)**
              
              (125)
              
              (107)Purchases
                  of intangibles
              
              **-**
              
              -
              
              (5)Proceeds
                  from sale of businesses and investments
              
              **6**
              
              -
              
              3Purchases
                  of short-term investments
              
              **(152)**
              
              -
              
              -Increase
                  in deferred development charges
              
              **(11)**
              
              (18)
              
              -Other
              
              **(16)**
              
              (8)
              
              (4)Cash
                  used in investing activities of continuing operations
              
              **(207)**
              
              (157)
              
              (141)Cash
                  provided by (used in) investing activities of discontinued
                  operations
              
              **85**
              
              (2)
              
              6**Financing
                  activities**Repayment
                  of long-term debt
              
              **(8)**
              
              (1)
              
              (2)Issuance
                  of long-term debt
              
              **-**
              
              -
              
              4Increase
                  (decrease) in deferred revenue and other long-term
                  obligations
              
              **(8)**
              
              (5)
              
              14Payment
                  of cash dividends
              
              **(15)**
              
              (14)
              
              (9)Issuance
                  of shares
              
              **30**
              
              11
              
              18Repurchase
                  of shares
              
              **-**
              
              (13)
              
              (17)Cash
                  provided by (used in) financing activities of continuing
                  operations
              
              **(1)**
              
              (22)
              
              8Cash
                  used in financing activities of discontinued operations
              
              **(14)**
              
              (11)
              
              (2)Effect
                  of foreign exchange rate changes on cash and cash
                  equivalents
              
              **1**
              
              -
              
              (6)**Increase
                  (decrease) in cash and cash equivalents during the
                  year**
              
              **19**
              
              (31)
              
              36Cash
                  and cash equivalents, beginning of year
              
              **265**
              
              296
              
              260**Cash
                  and cash equivalents, end of year*****(note
                  20)***
              **$**
              **284**
              $
              265
              $
              296
 See
        accompanying notes
 
 
   **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 (All
        tabular amounts are in millions of Canadian dollars, except where
        noted)
  **1.**  **Accounting
        Policies**
 
 
 **Basis
        of presentation**
 The
        accounting policies of MDS Inc. (MDS or the Company) are in accordance with
        Canadian generally accepted accounting principles (Canadian GAAP). These
        policies are consistent with accounting principles generally accepted in
        the
        United States (US GAAP) in all material respects except as outlined in note
        27.
 
 As
        described in note 2, the Company has approved plans to discontinue certain
        businesses and to significantly restructure other operations. These plans
        require estimates to be made of the recoverability of the carrying value
        of
        certain assets based on their capacity to generate future cash flows, contract
        termination costs and other exit costs. Since restructuring activities are
        complex processes that can take several months to complete, they involve
        periodically reassessing such estimates. As a result, the Company may have
        to
        change originally reported estimates when actual payments are made or the
        activities are completed. Accordingly, actual payments may differ significantly
        from amounts recorded.
 
 Prior
        year amounts, including amounts reflected in the notes to the consolidated
        financial statements, have been revised to reflect the results of discontinued
        operations and a change in the way the Company reports segmented information.
 
 
 **Principles
        of consolidation**
 The
        financial statements of entities that are controlled by MDS, referred to
        as
        subsidiaries, or variable interest entities of which MDS is the primary
        beneficiary, are consolidated. Entities which are jointly controlled, referred
        to as joint ventures, are accounted for using the proportionate consolidation
        method. Entities which are not controlled but over which MDS has the ability
        to
        exercise significant influence, referred to as associated companies, are
        accounted for using the equity method.
 
 Significant
        accounting policies used in the preparation of these consolidated financial
        statements are as follows:
 
 
 **Use
        of estimates**
 The
        preparation of the consolidated financial statements in conformity with Canadian
        generally accepted principles requires management to make estimates and
        assumptions. These estimates and assumptions affect the reported amounts
        of
        assets and liabilities and disclosure of contingent assets and liabilities
        at
        the date of the consolidated financial statements and the reported amounts
        of
        revenue and expenses during the reporting period. Actual results could differ
        from the estimates used.
 
 
 **Cash
        and cash equivalents**
 Cash
        and
        cash equivalents include cash on hand, balances with banks, demand deposits,
        and
        investments with maturities of three months or less at the time the investment
        is made. The fair value of cash and cash equivalents approximates the amounts
        shown in the consolidated financial statements.
 
 
 **Inventories**
 Inventories
        of raw materials and supplies are valued at the lesser of cost, determined
        on a
        first-in, first-out basis, and net realizable value. Finished goods and work
        in
        process include the cost of material, labour and manufacturing overhead and
        are
        valued on a first-in, first-out basis at the lesser of cost and net realizable
        value.
 
 **Property,
        Plant, and Equipment**
 Property,
        plant and equipment, including assets under capital leases, are carried in
        the
        accounts at cost less accumulated depreciation. Gains and losses arising
        on the
        disposal of individual assets are recognized in income in the year of
        disposal.
 
 The
        costs
        associated with modifications to facilities owned by others to permit isotope
        production are deferred and recorded as facility modifications.
 
 Costs,
        including financing charges and certain design, construction and installation
        costs, related to assets that are under construction and are in the process
        of
        being readied for their intended use are recorded as construction in progress
        and are not subject to depreciation.
 
 Depreciation,
        which is recorded from the date on which each asset is placed into service,
        is
        provided for on a straight-line basis over the estimated useful lives of
        the
        property, plant and equipment as follows:
 
 Buildings  25
        - 40
        years
 Equipment  3
        - 10 years
 Furniture
        and fixtures  3
        - 10
        years
 Computer
        systems  3
        - 7
        years
 Leaseholds  Term
        of
        the lease plus renewal periods, if applicable, to a maximum of 20
        years
 Facility
        modifications  Depreciated
        over the contractual production period
 
 
 **Goodwill**
 All
        business combinations are accounted for using the purchase method. Goodwill
        represents the excess of the purchase price and related costs over the fair
        value assigned to the net tangible and intangible assets of the business
        acquired. Goodwill is not amortized and is tested for impairment on an annual
        basis.
 
 
 **Intangibles**
 Supply
        agreements and licence rights are recorded at cost and are amortized on a
        straight-line basis over their useful life, being the term of the supply
        agreement or licence right.
 
 In-process
        research and development (IPR&D) represents the value paid as a result of a
        business combination for acquired research and development (R&D) which was
        not technologically feasible as of the acquisition date and which had no
        alternative future use other than its intended use. IPR&D is recorded at
        cost and amortized on a straight-line basis over its estimated useful life,
        not
        exceeding seven years.
 
 Acquired
        technology represents the value of proprietary ‘‘know-how’’, which was
        technologically feasible as of the acquisition date, and is amortized on
        a
        straight-line basis over the estimated useful life of the technology, generally
        not exceeding three years.
 
 Maintenance
        contracts and customer relationships represent the value placed on maintaining
        products and technology previously sold to customers and the value of existing
        customer relationships. Maintenance contracts and customer relationships
        are
        recorded at cost and amortized on a straight-line basis over their estimated
        useful life, not exceeding five years.
 
 
 **Impairment
        of long-lived and intangible assets**
 MDS
        evaluates the carrying value of long-lived and intangible assets, including
        property, plant and equipment and goodwill, for potential impairment when
        events
        and circumstances warrant a review. Factors that MDS considers important
        which
        could trigger an impairment review include, but are not limited to, significant
        underperformance relative to historical or projected future operating results,
        significant changes in the manner of use of the acquired assets or the strategy
        for MDS’s overall business, significant negative industry or economic trends, a
        significant decline in MDS's stock price for a sustained period, and MDS’s
        market capitalization relative to the net book value of the
        Company.
 
 The
        carrying value of an asset is considered impaired when the anticipated net
        recoverable amount of the asset is less than its carrying value. In that
        event,
        a loss is recognized in an amount equal to the difference between the carrying
        value and fair value, and is recorded as a charge to income. The anticipated
        net
        recoverable amount for long-lived and intangible assets other than goodwill
        is
        an amount equal to the anticipated undiscounted cash flows net of directly
        attributable general and administration costs, carrying costs, and income
        taxes,
        plus the expected residual value, if any.
 
 Goodwill
        impairment is assessed at the reporting segment level at least annually.
        Potential impairment is identified when the carrying value of a reporting
        segment, including the allocated goodwill, exceeds its fair value. Goodwill
        impairment is measured as the excess of the carrying amount of the reporting
        segment’s allocated goodwill over the implied fair value of the goodwill, based
        on the fair value of the assets and liabilities of the reporting segment.
        The
        fair value of goodwill is determined in the same manner as in a business
        combination.
 
 The
        fair
        values are estimated using accepted valuation methodologies such as discounted
        future net cash flows, earnings multiples or prices for similar assets,
        whichever is most appropriate under the circumstances.
 
 
 **Short-
        and long-term investments**
 Short-term
        investments are temporary investments with original maturities of greater
        than
        three months and less than one year at the time the investment is made.
        Short-term investments are valued at the lower of cost and market.
 
 The
        Company accounts for long-term investments where it has the ability to exercise
        significant influence using the equity method of accounting. In situations
        where
        the Company does not exercise significant influence, the investments are
        recorded at cost. These investments are classified as long-term investments.
        The
        Company periodically reviews these investments for impairment. In the event
        the
        carrying value of an investment exceeds its fair value and the decline in
        fair
        value is determined to be other-than-temporary, the Company writes down the
        value of the investment to its fair value.
 
 
 **Leases**
 Leases
        entered into by the Company in which substantially all of the benefits and
        risks
        of ownership are transferred to the Company are recorded as capital leases
        and
        classified as property, plant and equipment and obligations under capital
        lease.
        Obligations under capital lease reflect the present value of future lease
        payments, discounted at an appropriate interest rate, and are reduced by
        rental
        payments net of imputed interest. Assets under capital leases are depreciated
        based on the useful life of the asset. All other leases are classified as
        operating leases and leasing costs are expensed in the period in which they
        are
        incurred.
 
 
 **Revenue
        recognition**
 Revenues
        are recorded when title to goods passes or services are provided to customers,
        the price is fixed or determinable, and collection is reasonably assured.
        For
        the majority of product revenues, title passes to the buyer at the time of
        shipment and revenue is recorded at that time. Certain services are provided
        to
        customers on a per-unit pricing basis. Revenues for such services are recognized
        when the service has been performed and a contractual right to bill exists.
        These revenues include fees-for-services that are received by our discontinued
        diagnostic laboratory testing services which are subject to future adjustment
        on
        settlement and are recorded based on management’s estimate of amounts that
        ultimately will be realized by the Company. Adjustments, if any, are recorded
        in
        the period in which negotiations are completed.
  A
        significant portion of the Company’s pharmaceutical research services revenues
        are provided under the terms of long-term contracts that can extend from
        several
        months to several years. Revenues on these contracts are recognized using
        the
        percentage-of-completion method based on a proportional performance basis
        using
        output as a measure of performance. Losses, if any, on these contracts are
        provided for in full at the time such losses are identified. Services performed
        in advance of billings are recorded as unbilled revenue pursuant to the
        contractual terms. In general, amounts become billable upon the achievement
        of
        certain milestones or in accordance with predetermined payment schedules.
        Changes in the scope of work generally result in a renegotiation of contract
        terms. Renegotiated amounts are not included in net revenues until earned
        and
        realization is assured. Billings in excess of services performed to date
        or in
        excess of costs plus estimated profits on contracts in progress are recorded
        as
        deferred revenue. Customer advances on contracts in progress are shown as
        liabilities, and reimbursable costs in excess of billings are recorded as
        unbilled revenue.
 
 Reimbursable
        costs, including investigator fees and other out-of-pocket expenses, are
        not
        reflected in total revenues or expenses where the Company acts in the capacity
        of an agent on behalf of a customer, passing through these costs without
        risk or
        reward.
 
 
 **Stock-based
        compensation plan**
 The
        fair
        value of stock options granted on and after November 1, 2003 are recognized
        as
        compensation expense on a straight-line basis over the applicable stock option
        vesting period. The expense is included in selling, general and administration
        expenses in the consolidated statements of income and as contributed surplus
        and
        grouped within share capital on the consolidated statements of financial
        position. The consideration received on the exercise of stock options is
        credited to share capital at the time of exercise.
 
 Certain
        incentive compensation plans of the Company base the determination of
        compensation to be paid in the future on the price of the Company’s publicly
        traded shares. Expenses related to these plans are charged to income over
        the
        period in which the amounts are earned based on an estimate of amounts that
        will
        be paid in the future.
 
 
 **Pension,
        post-retirement and post-employment benefit plans**
 The
        Company offers a number of benefit plans that provide pension and other
        post-employment benefits. The current service cost of benefit plans is charged
        to income annually. Cost is computed on an actuarial basis using the projected
        benefits method and based on management’s best estimates of investment yields,
        salary escalation and other factors.
 
 The
        expected costs of post-employment benefits, other than pensions, for active
        employees are accrued in the consolidated financial statements during the
        years
        in which employees provide service to MDS. Adjustments resulting from plan
        amendments, experience gains and losses, or changes in assumptions are amortized
        over the remaining average service term of active employees. Other
        post-employment benefits are recognized when the event triggering the obligation
        occurs.
 
 
 **Research
        and development (R&D)**
 The
        Company carries on various R&D programs, some of which are funded in part by
        customers and joint venture partners. Funding received is accounted for using
        the cost reduction approach. Net research costs are expensed in the periods
        in
        which they are incurred.
 
 Development
        costs that meet certain criteria, including reasonable assurance regarding
        future benefits, are deferred an d
        amortized on
        a
        straight-line basis over periods ranging from three to five years commencing
        in
        the year that the new product development is completed and commercial production
        commences.
 
 
 **Income
        taxes**
 The
        Company follows the liability method of income tax allocation. Under this
        method, future tax assets and liabilities are determined based on differences
        between the financial reporting and tax bases of assets and liabilities and
        are
        measured using substantively enacted tax rates and laws that will be in effect
        when the differences are expected to reverse.
 
 Investment
        tax credits related to the acquisition of assets are deferred and amortized
        to
        income on the same basis as the related assets, while those related to current
        expenses are included in the determination of income.
 
 
 **Earnings per
        share**
 Basic
        earnings per share is calculated by dividing the net income by the
        weighted average number of Common shares outstanding during the year.
 
 Diluted
        earnings per share has been calculated using the treasury stock method, by
        dividing net income 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 shares arising from the exercise of potentially
        dilutive stock options outstanding during the year. This method computes
        the
        number of incremental shares by assuming the outstanding stock options are
        exercised, then reduced by the number of Common shares assumed to be repurchased
        from the total of issuance proceeds plus future period compensation expense
        on
        options granted on or after November 1, 2003, using the average market price
        of
        the Company’s Common shares during the applicable period.
 
 
 **Foreign
        currency translation**
 Foreign
        operations are considered self-sustaining and are translated using the current
        rate method. Assets and liabilities are translated using the exchange rate
        in
        effect at the year-end and revenues and expenses are translated at the average
        rate for the year.
 
 Exchange
        gains or losses arising on translation of the Company's net equity investments
        in these foreign subsidiaries and those arising on translation of foreign
        currency long-term liabilities designated as hedges of these investments
        are
        recorded as cumulative translation adjustments in shareholders' equity. The
        appropriate amounts of exchange gains or losses accumulated in the cumulative
        translation adjustment are reflected in income when there is a realized
        reduction in the Company's net investment in these subsidiaries resulting
        from a
        cash distribution.
 
 
 **Derivative
        financial instruments**
 The
        Company operates globally, which gives rise to risks that its earnings and
        cash
        flows may be adversely impacted by fluctuations in foreign exchange conversion
        rates and interest rates. In order to manage or hedge these risks, the Company
        enters into foreign currency forward contracts, foreign currency swaps, foreign
        currency option contracts, interest rate swaps, and interest rate option
        contracts. These are considered to be derivative financial instruments. The
        Company does not use derivative financial instruments for trading or speculation
        purposes.
 
 Foreign
        currency gains and losses on contracts used to hedge anticipated
        foreign-currency-denominated sales are recognized as an adjustment to revenues
        when the sale is recorded.
 
 Interest
        rate swap contracts are used as part of the Company’s program to manage the
        fixed and floating interest rate mix of the Company’s total debt portfolio and
        the overall cost of borrowing. Interest rate contracts involve the periodic
        exchange of payments without the exchange of the notional principal amount
        upon
        which the payments are based and are recorded as an adjustment to interest
        expense on the hedged debt instrument. The related amount payable to or
        receivable from counterparties is included as an adjustment to accrued
        interest.
  The
        Company’s policy is to document all relationships between hedging instruments
        and hedged items, as well as the risk management objectives and strategy
        for
        undertaking various hedge transactions. This process includes linking all
        derivatives to specific assets and liabilities on the consolidated statement
        of
        financial position or to specific firm commitments or forecasted transactions.
        The Company also assesses, both at the inception of the hedge and on an ongoing
        basis, whether the derivatives that are used are effective in offsetting
        changes
        in fair values or cash flows of hedged items.
 
 Realized
        and unrealized gains or losses associated with derivative instruments that
        are
        proven to be effective, but which have been terminated or which cease to
        be
        effective prior to maturity, are deferred and recognized in income in the
        period
        in which the underlying hedged transaction is recognized. In the event a
        designated hedged item is sold, extinguished or matures prior to the termination
        of the related derivative instrument, any realized or unrealized gain or
        loss on
        such derivative instrument is recognized in income immediately.
 
 Derivatives
        that do not qualify for hedge accounting are marked to market at each
        period-end, with the result that any gain or loss is charged to
        income.
 
 
 **Non-monetary
        transactions**
 All
        non-monetary transactions are measured at the fair value of the asset
        surrendered or the asset received, whichever is more reliable, unless the
        transaction lacks commercial substance. The commercial substance requirement
        is
        met when the future cash flows are expected to change significantly as a
        result
        of the transaction.
 
 
 **Recently
        enacted changes in accounting standards**
 In
        2005,
        the CICA issued various new Handbook sections. These new standards have been
        created to harmonize Canadian GAAP with US GAAP. The new standards must be
        adopted by the Company for the fiscal period beginning November 1, 2006 at
        the
        latest.
 
 (i)  CICA
        Handbook Section 1530, “Comprehensive Income” establishes standards for the
        reporting and presentation of comprehensive income and defines other
        comprehensive income to include revenues, expenses, gains and losses that
        are
        recognized in comprehensive income, but excluded from net income.
 
 (ii)  CICA
        Handbook Section 3855, “Financial Instruments - Recognition and Measurement”
establishes standards for recognizing and measuring financial assets, financial
        liabilities and non-financial derivatives.
 
 (iii)  CICA
        Handbook Section 3865, “Hedges” establishes standards for when and how hedge
        accounting may be applied.
 
 The
        Company is currently evaluating the impact of these new standards on its
        financial position and results of operations.
 
 
 **2.**  **Acquisitions,
        Divestitures and Discontinued Operations**
 
 a)  Acquisitions
 
 Effective
        August 4, 2005, the Company acquired SkeleTech, Inc., a therapeutically focused
        contract research organization providing preclinical discovery and development
        services in bone and central nervous systems biologies, for consideration
        of $8
        million (US$6 million) and an additional $2 million (US$2 million) payable
        to
        the vendors if certain profitability levels were attained in 2006. In 2006,
        an
        additional payment of $1 million (US$1 million) was made to the previous
        owners
        of SkeleTech Inc. under this provision and recorded as additional goodwill.
        This
        acquisition was accounted for using the purchase method. The purchase price
        was
        allocated to the net assets acquired based on management’s best estimate of fair
        values. Goodwill of $6 million was recorded on this transaction, reflecting
        the
        $8 million purchase price, offset by net assets acquired of $2 million, which
        included $1 million of cash.
 
 Effective
        October 22, 2004, the Company acquired a 50% interest in the assets and
        intellectual property related to the MALDI Time-of-Flight (MALDI-TOF) mass
        spectrometry business of Applied Biosystems, a division of Applera Corporation
        (Applied Biosystems). The purchase included a 100% interest in certain MALDI-TOF
        product-related manufacturing and research and development assets. The combined
        original purchase price was US$40 million. This acquisition was accounted
        for
        using the purchase method, and the purchase price was allocated to the assets
        acquired based on management’s best estimate of fair values. Goodwill of $15
        million was recorded on this transaction. In 2005, the purchase price was
        renegotiated and reduced by US$2 million with a corresponding reduction in
        goodwill (note 7).
 
 The
        Company and Applied Biosystems each contributed the MALDI-TOF business and
        related intellectual property to Applied Biosystems/MDS Sciex Instruments,
        a
        50/50 joint venture of Applied Biosystems and the MDS Sciex division of MDS.
        The
        inventory and property, plant and equipment arising from this purchase were
        retained by MDS Sciex, along with the goodwill generated on this
        transaction.
 
 The
        cost
        of the acquisitions described above has been allocated on the acquisition
        dates
        as follows:
 
 **2006**
              
              2005
              
              2004Working
                  capital
              **$**
              **-**
              $
              (1)
              $
              7Other
                  intangible assets
              
              **-**
              
              -
              
              26Software
              
              **-**
              
              -
              
              1Property,
                  plant and equipment and other
              
              **-**
              
              1
              
              -Goodwill
              
              **-**
              
              6
              
              15**-**
              
              6
              
              49Long-term
                  debt and other long-term obligations
              
              **-**
              
              -
              
              (39)Total
                  cash consideration
              **$**
              **-**
              $
              6
              $
              10
 
 
 b)  Divestitures
        and discontinued operations
 
 In
        2005,
        the Board of Directors of the Company approved a strategic plan to focus
        the
        Company on the Life Sciences businesses and to close or divest of businesses
        that were not strategic to this plan, including certain early-stage
        pharmaceutical research services businesses. As a result, the Company has
        reclassified its distribution business, its diagnostics businesses, and certain
        early-stage pharmaceutical research services businesses as discontinued
        operations.
 
 In
        addition to the businesses identified above, discontinued operations include
        the
        Company's US diagnostics business, which was classified as discontinued in
        2004,
        and a European-based generic radiopharmaceutical manufacturing business which
        was classified as discontinued in 2003.
 
 During
        2006, the Company completed the sale of its 50% interest in Source Medical
        Corporation; its 26% interest in Calgary Laboratory Services; and various
        pharmaceutical services operations. As a result of these transactions, the
        Company received proceeds from the sale of discontinued operations and other
        businesses totalling $92 million and recorded a net gain of $28 million in
        2006.
        Goodwill associated with the sale of the discontinued operations in 2006
        amounted to $27 million. On October 5, 2006, the Company announced the signing
        of a series of agreements to sell its remaining Canadian diagnostics businesses,
        MDS Diagnostic Services, to Borealis Infrastructure Management Inc. in a
        $1.325
        billion transaction (see note 29).
 
 During
        2005, the Company ceased operations in the generic radiopharmaceutical business
        and completed the sale of its sole remaining US diagnostics operation and
        achieved final settlement of outstanding issues related to the sale of some
        US
        diagnostics businesses that occurred in 2004. As a result of these events
        in
        2005, the Company received proceeds from the sale of discontinued operations
        totalling $11 million and recorded a net gain of $6 million.
 
 Proceeds
        of $26 million were realized in 2004 associated with the US diagnostics
        operations sold in that year including the laboratory operations in New York
        and
        Georgia. MDS realized a loss of $10 million on the sale which was subsequently
        reduced by the receipt of $2 million of contingent considerations based on
        the
        terms of the agreement. These gains and losses are included in the loss from
        discontinued operations as reported in the consolidated statements of
        income.
 
 Pursuant
        to CICA Handbook Section 3475, ‘‘Disposal of Long-lived Assets and Discontinued
        Operations’’ (Section 3475), the revenues and expenses of the business have been
        netted and reported as loss from discontinued operations on the consolidated
        statements of income. Figures for 2005 and 2004 have been revised to reflect
        this presentation. The results of the discontinued operations for the years
        ended October 31 were as follows:
 
 
 **2006**
              
              2005
              
              2004**Net
                  revenues**
              **$**
              **414**
              $
              675
              $
              723Cost
                  of revenues
              
              **(256)**
              
              (477)
              
              (531)Selling,
                  general and administration
              
              **(61)**
              
              (113)
              
              (98)Depreciation
                  and amortization
              
              **(10)**
              
              (14)
              
              (17)Goodwill
                  write-down
              
              **-**
              
              (15)
              
              -Gain
                  on sale of discontinued operations
              
              **28**
              
              -
              
              -Restructuring
                  charges1
              
              **(1)**
              
              (11)
              
              (4)Other
                  expenses
              
              **(3)**
              
              -
              
              (10)Equity
                  earnings
              
              **3**
              
              2
              
              2**Operating
                  income**
              
              **114**
              
              47
              
              65Interest
                  expense
              
              **-**
              
              (1)
              
              (1)Dividend
                  and interest income
              
              **2**
              
              3
              
              1Income
                  taxes
              
              **7**
              
              (9)
              
              (23)Minority
                  interest
              
              **(10)**
              
              (10)
              
              (14)**Income
                  from discontinued operations**
              **$**
              **113**
              $
              30
              $
              28
 1  Included
        in the loss from discontinued operations are net restructuring charges
        associated with workforce reductions.
 
 In
        accordance with Section 3475, long-lived assets classified as held for sale
        are
        measured at the lower of carrying value and fair value less costs to sell.
        Long-lived assets to be disposed of other than by sale are classified as
        held
        and used until disposed. MDS has classified certain operations as held for
        sale
        in accordance with this Section. The sale of these operations is expected
        to
        occur within one year and, therefore, assets and liabilities associated with
        these operations have been classified as current.
 
  The
        following table provides the assets and related liabilities held for sale
        as at
        October 31:
 
 **2006**
              
              2005**Assets
                  held for sale**Accounts
                  receivable
              **$**
              **35**
              $
              63Inventories
              
              **3**
              
              28Prepaid
                  expenses and other
              
              **3**
              
              3Property,
                  plant and equipment
              
              **32**
              
              64Future
                  tax assets
              
              **70**
              
              95Long-term
                  investments and other
              
              **15**
              
              15Goodwill
              
              **61**
              
              88Intangibles
              
              **1**
              
              1Total
                  assets held for sale
              
              **220**
              
              357Less:
                  Current assets held for sale1
              
              **(220)**
              
              (114)Long-term
                  assets held for sale
              **$**
              **-**
              $
              243**Liabilities
                  related to assets held for sale**Accounts
                  payable and accrued liabilities
              **$**
              **37**
              $
              72Long-term
                  debt
              
              **4**
              
              12Other
                  long-term obligations
              
              **7**
              
              7Future
                  tax liabilities
              
              **62**
              
              81Minority
                  interest
              
              **18**
              
              21Total
                  liabilities related to assets held for sale
              
              **128**
              
              193Less:
                  Current liabilities related to assets held for sale1
              
              **(128)**
              
              (50)Long-term
                  liabilities related to assets held for sale
              **$**
              **-**
              $
              143
 1 Assets
        held for sale and liabilities related to assets held for sale have been
        classified as current if the Company has signed agreements where such assets
        are
        expected to be disposed of within one year.
 
 To
        determine the assets held for sale related to those operations classified
        as
        discontinued operations, the Company is required to make estimates and
        assumptions that affect the reported amounts of these assets and liabilities
        and, therefore, these amounts are subject to measurement uncertainty. Actual
        amounts may differ from these estimates.
 
 
 **3.**
              **Short-term
                  Investments**
 
 As
        at
        October 31, 2006, short-term investments consisted of bankers’ acceptances and
        treasury bills amounting to $152 million with interest rates of approximately
        4.5% and maturity dates between November 2006 and May 2007. Short-term
        investments have a fair value that approximate their carrying value.
 
 
 **4.**  **Inventories**
 
 **2006**
              
              2005Raw
                  materials and supplies
              **$**
              **55**
              $
              97Work
                  in process
              
              **23**
              
              44Finished
                  goods
              
              **19**
              
              18**$**
              **97**
              $
              159
 
 During
        2006, the Company sold inventory having a net book value of $53 million to
        Atomic Energy of Canada Limited (AECL) as part of a legal settlement (see
        note
        8(i)).
  **5.**  **Property,
        Plant and Equipment**
 
 **2006**
              
              
              
              2005**Cost**
              
              **Accumulated**
                **Depreciation**
              
              Cost
              
              Accumulated
                DepreciationLand
              **$**
              **27**
              **$**
              **-**
              $
              32
              $
              -Buildings
              
              **173**
              
              **53**
              
              158
              
              49Equipment
              
              **255**
              
              **158**
              
              242
              
              145Furniture
                  and fixtures
              
              **25**
              
              **18**
              
              25
              
              17Computer
                  systems
              
              **125**
              
              **52**
              
              94
              
              36Leaseholds
              
              **50**
              
              **20**
              
              42
              
              14Facility
                  modifications
              
              **28**
              
              **11**
              
              28
              
              9Construction
                  in progress
              
              **10**
              
              -
              
              457
              
              -**$**
              **693**
              **$**
              **312**
              $
              1,078
              $
              270Accumulated
                  depreciation
              
              **(312)**
              
              
              
              (270)**$**
              **381**
              
              
              $
              808
 
 Included
        in property, plant and equipment are assets under capital leases as follows:
 
 **2006**
              
              2005Cost
              **$**
              **22**
              $
              17Accumulated
                  depreciation
              
              **(5)**
              
              (4)**$**
              **17**
              $
              13
 
 During
        the year, depreciation expense of $1 million (2005 - $1 million; 2004 - $1
        million) was recorded on assets under capital leases.
 
 Construction
        in progress includes $nil (2005 - $61 million) of capitalized financing
        costs.
 
 During
        the year, the Company transferred assets recorded in construction in progress
        and having a net book value at October 31, 2005 of $393 million to AECL as
        part
        of a legal settlement (see note 8(i)).
 
 
 **6.**  **Long-term
        Investments and Other**
 
 **2006**
              
              2005Financial
                  instruments pledged as security on long-term debt*(note
                  9)*
              **$**
              **44**
              $
              44Long-term
                  note receivable
              
              **45**
              
              -Investments
                  in significantly influenced companies
              
              **34**
              
              29Other
                  long-term investments
              
              **34**
              
              33Venture
                  capital investments
              
              **-**
              
              9Long-term
                  investments
              **$**
              **157**
              $
              115Deferred
                  development costs
              
              **34**
              
              29**$**
              **191**
              $
              144
  The
        financial instrument pledged as security on long-term debt and the long-term
        note receivable have fair values that approximates their carrying value.
        The
        estimated fair values of the remaining long-term investments are not readily
        determinable. Other long-term investments include securities in private
        companies for which reasonable estimates of fair value are not readily
        determinable.
  In 2006, as a result of a comprehensive mediation process there was an exchange
        of assets between the Company and AECL related to the MAPLE reactor project,
        a
        long-term note receivable for $43 million was received by MDS (see note 8(i)).
        This non-interest bearing note receivable is repayable over four years
        commencing in 2008. The note receivable is net of an unamortized discount
        based
        on an imputed interest rate of 4.5%. The note receivable will be accreted
        up to
        its face amount of $53 million over the period of four years.
  The
        Company accounts for its interest in Hemosol Corp. as a significantly influenced
        company using the equity method of accounting. In 2005, the Company’s share of
        the investee’s losses exceeds the carrying amount of the investment, and a $7
        million equity loss adjustment was recorded. In 2005, Hemosol Corp. filed
        for
        receivership and, as a result, the Company's guarantee of the bank debt of
        Hemosol Corp. was called by the bank and paid by MDS (see also note
        29).
 
 Certain
        long-term investments are 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.
 
 As
        at
        October 31, 2006, the Company had a secured 6% convertible promissory note
        receivable amounting to
 US$8
        million due from a significantly influenced investee which is accounted for
        by
        the equity method. This note relates to funding requirements of the investee
        for
        operations and matures on December 31, 2007. This transaction was recorded
        at an
        amount that is representative of fair value.
 
 Certain
        of the investments in significantly influenced companies and partnerships
        are
        subject to a formal valuation by other parties. The estimated fair value
        of
        these investments, as determined by these parties, amounts to
 $2
        million (2005 - $5 million) compared with a carrying value of $1 million
        (2005 -
        $3 million). Certain of the other long-term investments held by the Company
        are
        considered to be financial instruments. Among these are several investments
        in
        shares of public companies. These marketable securities had a combined market
        value of
 $16
        million (2005 - $10 million) and a combined carrying value of $13 million
        (2005
        - $1 million).
 
 
 **7.**  **Goodwill**
 
 **2006**
              2005Opening
                  balance
              **$**
              **479**
              $
              486Acquired(i)
              
              **1**
              
              6Purchase
                  price adjustment(ii)
              
              **-**
              
              (3)Foreign
                  exchange and other
              
              **(12)**
              
              (10)Closing
                  balance
              **$**
              **468**
              $
              479
  (i)
              In
                  2006, $1 million (2005 - $6 million) of the acquired goodwill relates
                  to a
                  payment under a purchase price deferral associated with the acquisition
                  of
                  SkeleTech, Inc. The acquired goodwill was recorded in the pharmaceutical
                  services segment.
 
 (ii)
              In
                  2005, the purchase price for the acquisition of a 50% interest
                  in the
                  assets and intellectual property related to the MALDI Time-of-Flight
                  (MALDI-TOF) mass spectrometry business of Applied Biosystems was
                  renegotiated and reduced by $3 million (US$2 million) with a corresponding
                  reduction in goodwill. The reduction was recorded in the instruments
                  segment.
 
 
  **8.**  **Intangibles**
 
 **2006**
              
              
              
              2005**Cost**
              
              **Accumulated**
                **Amortization**
              
              Cost
              
              Accumulated
                AmortizationSupply
                  agreements
              **$**
              **344**
              **$**
              **-**
              $
              -
              $
              -Acquired
                  technology
              
              **26**
              
              **7**
              
              26
              
              4Licenses
              
              **31**
              
              **14**
              
              30
              
              10**$**
              **401**
              **$**
              **21**
              $
              56
              $
              14Accumulated
                  amortization
              
              **(21)**
              
              
              
              (14)**$**
              **380**
              
              
              $
              42
 
 The
        change in intangibles comprised:
 
 **2006**
              2005Opening
                  balance
              **$**
              **42**
              $
              55Acquired(i)
              
              **345**
              
              -Amortized
              
              **(7)**
              
              (5)Impairment
                  charge(ii)
              
              **-**
              
              (8)Closing
                  balance
              **$**
              **380**
              $
              42
 
 (i)
              On
                  February 22, 2006, the Company announced the conclusion of a comprehensive
                  mediation process with AECL related to the MAPLE reactor project.
                  Under
                  the agreement, AECL paid MDS $25 million, net of applicable taxes,
                  and
                  AECL assumed complete ownership of the MAPLE facilities and took
                  responsibility for all costs associated with completing the project
                  and
                  the production of medical isotopes. In addition, AECL acquired
                  $53 million
                  of MAPLE-related inventories in exchange for a non-interest bearing
                  note
                  having a net present value of $43 million and which will be repaid
                  over
                  four years commencing in 2008. MDS and AECL have entered into a
                  40-year
                  supply agreement for the provision of medical isotopes in exchange
                  for a
                  fixed percentage of the selling price. In accordance with CICA
                  Handbook
                  Section 3831, “Non-monetary Transactions”, the Company exchanged the MAPLE
                  asset for a 40-year supply agreement which has been recorded as
                  an
                  intangible asset at its fair value of $344 million. This amount
                  will be
                  amortized on a straight-line basis over a 40-year period once commercial
                  production of MAPLE isotopes begins. AECL acquired $53 million
                  of
                  MAPLE-related inventories in exchange for a note payable which
                  will be
                  repaid over four years commencing in 2008. As a result of this
                  agreement,
                  a long-term note receivable for $43 million has been established
                  and a $10
                  million non-cash charge was recorded in the year (see note 14).
 
 (ii)
              In
                  2005, the Company recorded an $8 million impairment charge relating
                  to a
                  five-year licensing agreement with Protana Inc. that granted MDS
                  Pharma
                  Services access to certain Protana Inc. biomarker- related technology.
                  The
                  license agreement write-off was recorded in the pharmaceutical
                  services
                  segment.
 
 Intangibles
        acquired consist of:
 
 **2006**
              
              2005Supply
                  agreements
              **$**
              **344**
              $
              -Licenses
              
              **1**
              
              -**$**
              **345**
              $
              -
 
 
  **9.**  **Long-term
        Debt**
 
 Maturity
              
              **2006**
              
              2005Senior
                  unsecured notes
              2007
                  to 2014
              **$**
              **350**
              $
              368Other
                  debt
              2007
                  to 2015
              
              **92**
              
              97Total
                  long-term debt
              
              
              **442**
              
              465Current
                  portion
              
              
              **(22)**
              
              (12)**$**
              **420**
              $
              453
 
 The
        Company has outstanding US$311 million (C$350 million) of senior unsecured
        notes
        that bear interest at fixed rates between 5.15% and 6.19%.
 
 Other
        debt includes a non-interest-bearing government loan with a carrying value
        of
        $48 million
 (2005
        -
        $48 million) discounted at an effective interest rate of 7%. A long-term
        investment has been pledged as security for the repayment of this debt (see
        note
        6).
 
 Other
        debt also includes a US$24 million note payable (C$27 million) (2005 - C$35
        million) to Applied Biosystems relating to assets purchased for the MALDI-TOF
        mass spectrometry operations. The note bears interest at 4% and is payable
        evenly over the three remaining years of its term.
 
 The
        Company has a $500 million, four-year, committed, revolving credit facility.
        As
        at October 31, 2006, this facility was undrawn.
 
 The
        remaining debt including obligations under capital leases amounting to $14
        million (2005 - $11 million), bears interest at various fixed
        rates.
 
 Principal
        repayments of long-term debt are as follows:
 2007
              $
              222008
              
              1042009
              
              212010
              
              312011
              
              18Thereafter
              
              246$
              442
 
 
 Included
        within the future principal repayments of long-term debt are obligations
        under
        capital leases. Future minimum lease payments for obligations under capital
        leases in effect as at October 31, 2006 are as follows:
 
 2007
              $
              42008
              
              32009
              
              22010
              
              22011
              
              2Thereafter
              
              316Less:
                  portion representing interest
              
              2$
              14
 
 
 **10.
        Deferred Revenue**
 
 Deferred
        revenue includes an $18 million deferred credit (2005 - $22 million) related
        to
        the government loan associated with MAPLE reactor project, which is being
        amortized over the remaining eight years of the term of the debt using the
        sum
        of the years’ digits method (see note 9).
 
 During
        2004, the Company received $32 million from a customer as consideration for
        amending a supply agreement to eliminate certain minimum purchase commitments.
        The proceeds were recorded as deferred revenue and are being amortized over
        the
        remaining term of the contract. At October 31, 2006, the balance outstanding
        was
        $3 million (2005 - $13 million), all of which is classified as current deferred
        revenue (2005 - $10 million).
 
 
 **11.
        Share Capital**
 
 At
        October 31, 2006, 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.
  **a)**  **Summary
        of share capital**
 Common
                  Shares(number
                  of shares in thousands)
              Number
              
              AmountBalance
                  - October 31, 2003
              141,122
              $
              816Issued
              1,561
              
              25Repurchased
                  and cancelled
              (857)
              
              (8)Balance
                  - October 31, 2004
              141,826
              
              833Issued
              1,072
              
              19Repurchased
                  and cancelled
              (799)
              
              (5)Balance
                  - October 31, 2005
              **142,099**
              
              **847**Issued
              **2,220**
              
              **38**Balance
                  - October 31, 2006
              **144,319**
              **$**
              **885**
 
 During
        2006, the Company declared and paid cash dividends of $15 million on Common
        shares (2005 - $14 million; 2004 - $9 million).
 
 In
        2006,
        the Company did not repurchase or cancel Common shares. In 2005, the Company
        repurchased 799,000 (2004 - 857,000) Common shares for $13 million (2004
        - $17
        million) under the terms of a normal course issuer bid (NCIB). The excess
        of
        cost over the stated capital of the acquired shares was charged to retained
        earnings. Under the terms of its NCIB, the Company is entitled to repurchase
        up
        to 10,967,000 Common shares between June 30, 2006 and June 29, 2007. These
        repurchases of Common shares are made on the open market at prevailing market
        prices.
 
 During
        the year, the Company issued 1,859,000 (2005 - 629,000; 2004 - 1,194,000)
        Common
        shares under the stock option plan for proceeds of $27 million (2005 - $7
        million; 2004 - $14 million).
 
 **b)**  **Stock
        Dividend and Share Purchase Plan and Employee Share Ownership
        Plan**
 
 Under
        the
        Company's Stock Dividend and Share Purchase Plan, shareholders may elect
        to
        receive stock dividends in lieu of cash dividends. Stock dividends are issued
        at
        not less than 95% of the five-day average market price (the Average Market
        Price) of the shares traded on the Toronto Stock Exchange immediately prior
        to
        the dividend payment date. Plan participants may also make optional cash
        payments of up to $3,000 semi-annually to purchase additional Common shares
        at
        the Average Market Price. Participation in this plan for the year ended October
        31, 2006 resulted in the issuance of 220,000 (2005 - 264,000) Common shares
        as
        stock dividends and the issuance of 7,000 Common shares (2005 - 9,000) for
        cash.
  Subsequent
        to year-end, the Company announced that it will discontinue this plan following
        completion of the sale of the diagnostics business.
 
 Under
        the
        terms of the Company’s Employee Share Ownership Plan, eligible employees are
        able to purchase Common shares at 90% of the Average Market Price for the
        five
        days preceding the purchase. During the year, the Company issued 134,000
        Common
        shares (2005 - 177,000) under this plan for proceeds of $3 million (2005
        - $3
        million) and as at October 31, 2006, the Company has 66,000 Common shares
        that
        are reserved for future issue with this plan.
 
 
 **12.**  **Research and Development**
 
 **2006**
              
              2005
              
              2004Gross
                  expenditures
              **$**
              **60**
              $
              86
              $
              100Investment
                  tax credits
              
              **(9)**
              
              (8)
              
              (20)Recoveries
                  from partners
              
              **(25)**
              
              (32)
              
              (23)Development
                  costs deferred
              
              **(7)**
              
              (15)
              
              (19)Research
                  and development expense
              **$**
              **19**
              $
              31
              $
              38
 
 Depreciation
        and amortization expense for 2006 includes $7 million (2005 - $3 million;
        2004 -
        $16 million) related to equipment used for research and development.
 
 
 **13.
        Restructuring Charges**
 
 Restructuring
                  Charge
                (Recovery)
              Cumulative
                  Drawdowns
              **Provision
                  Balance at**
                **October
                  31, 2006**Cash
              Non-cash2004:Workforce
                  reductions
              $
              11
              $
              (10)
              $
              (1)
              **$**
              **-**Equipment
                  and other asset write-downs -
                adjustments
              
              (1)
              
              -
              1
              
              **-**10
              
              (10)
              -
              
              **-**2005:Workforce
                  reductions
              
              41
              
              (35)
              
              (1)
              
              **5**Equipment
                  and other asset write-downs -
                adjustments
              
              8
              
              -
              (8)
              
              **-**Contract
                  cancellation charges
              
              12
              
              (2)
              (10)
              
              **-**61
              
              (37)
              (19)
              
              **5**2006:Workforce
                  reductions
              
              1
              
              -
              
              -
              
              **1**Contract
                  cancellation settlement
              
              (9)
              
              -
              
              10
              
              **1**(8)
              
              -
              
              10
              
              **2****$**
              **7**
 
 Over
        the
        last three years, MDS has undertaken a number of activities designed to refocus
        the Company as a globally competitive life sciences company. In fiscal 2006,
        the
        Company completed certain of these initiatives and as a result reduced the
        balance of reserves set aside for these activities. These reserve reductions
        included the elimination of provisions made last year for expected costs
        associated with an early termination of certain information technology
        outsourcing agreements. Satisfactory resolution of the termination negotiations
        eliminated the need for this reserve. Also, during 2006, MDS completed the
        closure of the generic radiopharmaceuticals business in Europe, eliminating
        the
        need for further reserves.
  In
        2005,
        the Company recorded restructuring charges related to a reduction in its
        management, administrative, and operations workforce, a realignment of its
        information technology infrastructure, and the reorganization of certain
        pharmaceutical research services operations. In 2004, the Company recorded
        restructuring charges relating to the implementation of change initiatives
        affecting the provision of support services, systems implementation, senior
        management reductions, and certain other initiatives.
 
 
 **14.**  **Other
        Income (Expense) - Net**
 
 **2006**
              
              2005
              
              2004Impairment
                  of long-term investments*(note
                  6)*
              **$**
              **-**
              $
              (6)
              $
              (12)Impairment
                  of intangibles*(note
                  8)*
              
              **-**
              
              (8)
              
              (15)Write-down
                  of other long-term assets
              
              **(1)**
              
              -
              
              -Write-down
                  of equipment
              
              **-**
              
              -
              
              (10)Loss
                  on sale of MAPLE assets*(note
                  8)*
              
              **(10)**
              
              -
              
              -Gain
                  on patent litigation
              
              **-**
              
              -
              
              14Gain
                  on reorganization of MDS Proteomics**
              
              **-**
              
              -
              
              8Gain
                  on sale of businesses and investments
              
              **2**
              
              -
              
              3Impairment
                  of goodwill
              
              **-**
              
              -
              
              (53)Unrealized
                  loss on interest rate swaps*(note
                  25)*
              
              **-**
              
              (3)
              
              -Insurance
                  settlement
              
              **2**
              
              -
              
              -**$**
              **(7)**
              $
              (17)
              $
              (65)
 
 During
        2006, the Company recorded a $10 million non-cash charge relating to the
        agreement reached between the Company and AECL related to the MAPLE reactor
        project (see note 8). This charge relates to the isotopes segment. In addition,
        the Company recorded a $2 million gain on the sale of a business and $2 million
        received as net insurance proceeds relating to the New Orleans location,
        both
        relating to the pharmaceutical services segment and a $1 million write-down
        of
        other long-term assets in the corporate and other segment.
 
 During
        2005, the Company recorded an $8 million impairment charge relating to a
        five-year licensing agreement with an investee that granted the Company access
        to certain biomarker-related technology, and a $6 million write-down of a
        long-term investment based on the Company’s assessment of the carrying value of
        the investment and the present value of its expected future cash flows. Both
        charges related to the pharmaceutical services segment.
 
 During
        2004, the Company determined that the value of certain intangible assets
        was
        impaired. As a result, the book value of these intangible assets were reduced
        by
        $15 million to their net realizable value. In 2004, certain of the long-term
        investees of the Company experienced declines in value that were believed
        to be
        other than temporary. The Company recorded write-downs of $12 million to
        reduce
        the carrying value of these investments to an estimate of their net realizable
        value.
 
 
 **5.**  **Income
        Taxes**
 
 **a)**  **Provision**
 
 The
        Company's effective income tax rate has the following components:
 
 **2006**
              2005
              2004**%**
              %
              %Combined
                  federal and provincial tax rate
              **35.0**
              35.0
              35.7Increase
                  (decrease) in tax rate as a result of:Foreign
                  losses that have not been recognized, net
              **10.0**
              (1.6)
              8.4Impact
                  of tax rate changes on future tax balances
              **(8.9)**
              -
              5.7Research
                  and development incentives
              **(4.9)**
              (8.5)
              (5.2)Manufacturing
                  incentives
              **(0.2)**
              (3.1)
              (5.2)Impact
                  of differential foreign tax rates
              **(3.2)**
              (7.7)
              (1.7)Amortization
                  not deductible for tax
              **1.1**
              1.5
              -Investments
                  and write-downs
              **4.0**
              20.7
              42.0Restructuring
                  charge not recognized for tax
              **-**
              49.2
              -Other
              **(2.5)**
              6.8
              (6.1)Effective
                  income tax rate
              **30.4**
              92.3
              73.6
 
 **b)**  **Future
        tax assets and liabilities**
 
 Future
        tax assets and liabilities consist of the following temporary
        differences:
 
 **2006**
              
              2005**Future
                  tax assets**Tax
                  benefit of loss carryforwards
              **$**
              **115**
              $
              88Book
                  value in excess of tax basis
              
              **(15)**
              
              (4)Investment
                  tax credits
              
              **-**
              
              6Provisions
                  and reserves
              
              **2**
              
              14Future
                  tax assets before valuation allowance
              
              **102**
              
              104Valuation
                  allowance
              
              **(60)**
              
              (63)**42**
              
              41**Future
                  tax liabilities**Book
                  value in excess of tax basis
              
              **(85)**
              
              (72)Tax
                  on investment tax credits recognized for accounting purposes
              
              **(11)**
              
              (8)Provisions
                  and reserves
              
              **4**
              
              12**(92)**
              
              (68)Net
                  future tax liabilities
              **$**
              **(50)**
              $
              (27)
 
 **c)**  **Tax**  **loss
        carryforwards**
 
 As
        at
        October 31, 2006, the Company has future tax assets relating to net operating
        loss carryforwards of $146 million (2005 - $160 million) before valuation
        allowances. These assets relate to $415 million (2005 - $437 million) of
        tax
        loss carryforwards. Of the total losses, $40 million (2005 - $49 million)
        expire
        by 2011, $179 million (2005 - $132 million) expire between 2014 and 2026,
        and
        the remaining $196 million (2005 - $256 million) may be carried forward
        indefinitely.
 
 In
        addition, the Company has $85 million of capital losses available at the
        end of
        the year. In the fourth quarter of 2006, a $15 million future tax asset was
        recognized relating to these losses to reflect the expectation they will
        be
        utilized to offset a portion of the gain on the sale of MDS Diagnostic Services.
        The resulting future tax recovery was reported as a reduction of taxes otherwise
        payable related to discontinued operations.
 
  **d)**  **Investment
        tax credits**
 
 During
        the year, the Company recognized $32 million (2005 - $14 million) of investment
        tax credits relating to research performed in Canada on its own behalf and
        for
        certain customers. These investment tax credits are attributable to salaries
        and
        other research-related expenditures and were recorded as a reduction of those
        expenses, generally in research and development. Of the investment tax credits
        recognized during the year, $6 million (2005 - $nil) related to capital
        expenditures and were recorded as a reduction to the carrying values of the
        related capital assets.
 
 
 **16.**  **Earnings per share - Dilution**
 
 **2006**
              
              2005
              
              2004Weighted
                  average number of Common shares
                outstanding
                  - basic (in millions)
              
              **144**
              
              142
              
              142Impact
                  of stock options assumed exercised (in millions)
              
              **-**
              
              -
              
              1**Weighted
                  average number of Common shares outstanding - diluted (in
                  millions)**
              
              **144**
              
              142
              
              143
  Options
        to purchase 1,168,000, 4,148,000 and 1,573,000 Common shares for the years
        ended
        October 31, 2006, 2005, and 2004, respectively, were not included in the
        computation of diluted earnings per share because these options have exercise
        prices which were greater than the average market price of MDS’s shares during
        the respective years.
 
 
 **17.**  **Joint ventures**
 
 The
        Company conducts certain of its businesses through incorporated and
        unincorporated joint ventures in which it holds various percentage interests.
        Following are condensed combined statements of financial position reflecting
        the
        Company's interests in joint ventures of continuing operations:
 
 
 **2006**
              
              2005Current
                  assets
              **$**
              **29**
              $
              29Long-term
                  assets
              
              **42**
              
              39**$**
              **71**
              $
              68Current
                  liabilities
              **$**
              **18**
              $
              15Equity
              
              **53**
              
              53**$**
              **71**
              $
              68
 
  The
        following are statements of income and statements of cash flows information
        reflecting the Company's interests in joint ventures of continuing
        operations:
 
 **2006**
              
              2005
              
              2004Net
                  revenues
              **$**
              **188**
              $
              181
              $
              205Operating
                  income
              **$**
              **63**
              $
              59
              $
              102Cash
                  flow from operating activities
              **$**
              **72**
              $
              77
              $
              91Cash
                  flow from investing activities
              **$**
              **(13)**
              $
              (10)
              $
              (5)Cash
                  flow from financing activities
              **$**
              **(63)**
              $
              (62)
              $
              (100)
 
 
 **18.**  **Stock-based compensation**
 
 **a)**  **Stock
        option plan**
 
 The
        Company has a stock option plan (the Plan) primarily for senior management
        employees. Under the terms of the Plan, the Company may grant stock options
        to
        employees and certain others. The exercise price of stock options issued
        under
        the Plan equals the market price of the underlying shares on the date of
        the
        grant. All options issued under the Plan are granted and priced on the date
        on
        which approval by the Board of Directors of the Company is obtained or a
        later
        date set by the Board in its approval. All stock options granted up to October
        31, 2005 vest evenly over five years and have a term of ten years. Those
        granted
        after October 31, 2005 vest evenly over three years and have a term of seven
        years.
 
 **2006**
              2005**Number**
                **(000s)**
              
              **Weighted
                  Average Exercise**
                **Price**
              Number
                (000s)
              
              Weighted
                  Average
                Exercise
                PriceMaximum
                  available for issue
              **8,034**
              
              
              9,893Outstanding
                  November 1
              **7,672**
              **$**
              **17.76**
              7,610
              $
              17.63Granted
              **1,019**
              
              **20.10**
              1,442
              
              17.58Exercised
              **(1,859)**
              
              **14.76**
              (629)
              
              12.59Cancelled
                  or forfeited
              **(982)**
              
              **19.94**
              (751)
              
              20.44Outstanding
                  October 31
              **5,850**
              
              **18.76**
              7,672
              
              17.76Options
                  vested at year-end
              **3,612**
              **$**
              **18.42**
              4,661
              $
              16.90
 
 Options
        outstanding at October 31, 2006 comprise:
 
 **Options
                  Outstanding**
              **Options
                  Exercisable**Range
                  of Exercise Prices
              Weighted
                  Average
                Remaining
                  Contractual Life (Years)
              
              **Number**
                **(000s)**
              
              **Weighted
                  Average Exercise Price**
              **Number**
                **(000s)**
              
              **Weighted
                  Average Exercise Price**$12.14
              -
              $14.88
              2.0
              
              **764**
              **$**
              **13.78**
              **764**
              **$**
              **13.78**$15.00
              -
              $17.50
              0.7
              
              **717**
              
              **16.27**
              **444**
              
              **15.98**$17.75
              -
              $20.27
              5.8
              
              **2,909**
              
              **19.13**
              **1,233**
              
              **18.89**$20.39
              -
              $23.00
              4.7
              
              **1,448**
              
              **21.80**
              **1,160**
              
              **21.84**$24.80
              -
              $26.10
              4.7
              
              **12**
              
              **25.52**
              **11**
              
              **25.59**4.5
              
              **5,850**
              **$**
              **18.76**
              **3,612**
              **$**
              **18.42**
  Stock
        option compensation expense for 2006 was $4 million (2005 - $3 million; 2004
        -
        $1 million), which has been recorded in selling, general and administration
        expenses in the consolidated statements of income and as contributed surplus
        within share capital on the consolidated statements of financial position.
 
 The
        Company utilizes the Black-Scholes option valuation model to estimate the
        fair
        value of options granted based on the following assumptions:
 
 **2006**
              2005
              2004Risk-free
                  interest rate
              **3.9%**
              3.8%
              4.3%Expected
                  dividend yield
              **0.7%**
              0.7%
              1.0%Expected
                  volatility
              **.230**
              .334
              .317Expected
                  time until exercise
              **3.25**
              5.19
              5.25
 
 The
        weighted average fair value of options granted was estimated to be $4.14
        per
        Common share in 2006, $5.98 per Common share in 2005, and $6.83 per Common
        share
        in 2004.
 
 The
        Black-Scholes option valuation method used by the Company to determine fair
        values was developed for use in estimating the fair value of freely traded
        options that are fully transferable and have no vesting restrictions. This
        model
        requires the use of assumptions, including future stock price volatility
        and
        expected time until exercise. The Company uses historical volatility to estimate
        its future stock price volatility.
 
 **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 income. For MDS, 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:
 
 **2006**
              
              2005
              
              2004Net
                  income
              **$**
              **145**
              $
              31
              $
              51Compensation
                  expense for options granted prior to
                November
                  1, 2003
              
              **(2)**
              
              (5)
              
              (8)Net
                  income - pro forma
              **$**
              **143**
              $
              26
              $
              43Basic
                  and diluted earnings per share
              **$**
              **0.99**
              $
              0.18
              $
              0.30
 
 **c)**  **Incentive
        plans**
 *Mid-term
        Incentive Plans*
 Beginning
        in fiscal year 2004, a mid-term incentive plan was introduced based on specific
        operating margin improvement targets and achievement of defined change outcomes
        across the Company over a two-year performance cycle ending October 31, 2005.
        The plan replaced a portion of the annual stock option grants with Performance
        Share Units (PSUs). The obligations associated with this plan were charged
        to
        income in 2004 and 2005. The plan was paid out in 2006.
 
 During
        2005, the Company approved a PSU mid-term incentive plan for senior management
        (the 2006 MTIP). All PSUs under the 2006 MTIP will vest in two equal tranches,
        based on achieving specified share price hurdles of $22.00 and $26.00,
        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. Payout on certain PSUs will be in the form of Deferred Share Units
        (DSUs), the balance will be paid in cash. During 2006, the $22.00 price hurdle
        was met and 50% of the issued units have vested, subject to recipients remaining
        in the employ of MDS until 24 months from the date of grant.
  **19.**  **Employee future benefits**
 
 The
        Company sponsors various post-employment benefit plans including defined
        benefit
        and defined contribution pension plans, retirement compensation arrangements,
        and plans that provide extended health care coverage to its employees. All
        defined benefit pension plans sponsored by the Company are funded plans.
        Other
        post-employment benefit plans are unfunded. Certain benefit plans were curtailed
        effective January 1, 2008, resulting in a curtailment gain of $2 million
        (2005 -
        $2 million), which was offset by a $1 million (2005 - $1 million) unamortized
        loss.
 
 Defined
        Benefit Pension Plans - The formula for Canadian plans is based on the highest
        three or six average consecutive years’ wages and requires employee
        contributions. A non-contributory Taiwanese plan is based on an employee’s years
        of service and compensation during the last month prior to retirement. A
        plan
        available to certain US employees is based on the participants’ 60 highest
        consecutive months of compensation and their years of service.
 
 The
        Company uses an October 31 measurement date for the majority of its plans.
        The
        most recent actuarial valuations of the majority of the pension plans for
        funding purposes were as of January 1, 2004, and the next required valuations
        will be as of January 1, 2007.
 
 Defined
        Contribution Pension Plans - The Company sponsors a registered pension plan
        for
        certain senior executives. Contributions are based on 10% - 15% of each eligible
        employee’s annual earnings. In addition, the Company sponsors a contributory
        pension plan for a subsidiary where the employees’ contributions are based on a
        percentage of their pensionable earnings and the Company’s contribution is based
        on the length of pensionable services. During 2006, the Company contributed
        $2
        million (2005 - $1 million) to the defined contribution pension
        plans.
 
 Other
        Benefit Plans - These include a supplemental retirement arrangement, a
        retirement/termination allowance and post-retirement benefit plans, which
        include contributory health and dental care benefits and contributory life
        insurance coverage. Individuals must retire to be eligible.
  The
        net
        periodic benefit costs for the Company’s post-employment benefit plans comprise
        the following components:
  
 Pensions
              
              Other
                  Benefit Plans**2006**
              
              2005
              
              **2006**
              
              2005Service
                  cost
              **$**
              **5**
              $
              5
              **$**
              **1**
              $
              1Interest
                  cost
              
              **10**
              
              11
              
              **1**
              
              1Expected
                  return on plan assets
              
              **(14)**
              
              (13)
              
              **-**
              
              -Recognized
                  actuarial gain
              
              **1**
              
              1
              
              **-**
              
              -Amortization
                  of net transition asset
              
              **(3)**
              
              (3)
              
              **-**
              
              -Curtailment
                  gain
              
              **(1)**
              
              -
              
              **(1)**
              
              (1)**$**
              **(2)**
              $
              1
              **$**
              **1**
              $
              1
  
 The
        following weighted average assumptions were used in the determination of
        the net
        periodic benefit cost:
 
 Pensions
              Other
                  Benefit Plans**2006**
              2005
              **2006**
              2005Expected
                  rate of return on plan assets
              **6.21%**
              6.37%
              **n/a**
              n/aDiscount
                  rate - obligation
              **5.19%**
              6.04%
              **5.14**
              5.80%Discount
                  rate - expense
              **5.19%**
              6.04%
              **5.76**
              6.28%Rate
                  of compensation increase
              **3.96%**
              3.93%
              **4.36%**
              4.46%Health
                  care cost trend rate
              -
              first
                  five years
              n/a
              n/a
              **10.0%**
              10.0%-
              thereafter
              n/a
              n/a
              **5.0%**
              5.0%
 
 The
        assumed health care cost trend rate used in determining the benefit cost
        for
        2006 is 10% (2005 - 10%), decreasing to an ultimate level of 5% after five
        years
        (2005 - 5%). The assumed current dental trend rate used in determining the
        benefit cost for 2006 is 4.5% (2005 - 4.5%), which is expected to be maintained
        after five years.
 
 The
        average remaining service period of the active employees covered by the pension
        plans for 2006 is 14 years (2005 - 14 years). The average remaining service
        period of the other retirement benefits for 2006 is 12 years (2005 - 13 years).
 
 Assumed
        health care cost trend rates have a significant effect on the amounts reported
        for the health care plans. A one-percentage-point change in assumed health
        care
        cost trend rates would have had the following impact in 2006:
 
 1%
                  Increase
              1%
                  DecreaseChange
                  in net benefit cost
              $
              -
              $
              -Change
                  in benefit obligation
              $
              3
              $
              (2)
 
 Changes
        in the benefit obligations for the plans were as follows:
 
 Pensions
              Other
                  Benefit Plans**2006**
              
              2005
              
              **2006**
              
              2005Benefit
                  obligations-beginning of year
              **$**
              **204**
              $
              186
              **$**
              **20**
              $
              18Service
                  cost - pension
              
              **(1)**
              
              6
              
              **1**
              
              1Interest
                  cost
              
              **10**
              
              11
              
              **1**
              
              1Benefits
                  paid
              
              **(7)**
              
              (6)
              
              **-**
              
              (1)Actuarial
                  losses
              
              **-**
              
              7
              
              **(1)**
              
              3Curtailments
              
              **-**
              
              -
              
              **(2)**
              
              (2)Total
                  benefit obligations - end of year
              **$**
              **206**
              $
              204
              **$**
              **19**
              $
              20
 
 Changes
        in the assets of the plans were as follows:
 
 Pensions
              Other
                  Benefit Plans**2006**
              
              2005
              
              **2006**
              
              2005Plan
                  assets at fair value - beginning of year
              **$**
              **223**
              $
              199
              **$**
              **-**
              $
              -Actual
                  return on plan assets
              
              **23**
              
              25
              
              **-**
              
              -Benefits
                  paid
              
              **(9)**
              
              (6)
              
              **(1)**
              
              (1)Company
                  contributions
              
              **3**
              
              3
              
              **1**
              
              1Participant
                  contributions
              
              **2**
              
              2
              
              **-**
              
              -Plan
                  assets at fair value - end of year
              **$**
              **242**
              $
              223
              **$**
              **-**
              $
              -
 
 Amounts
        recognized in the Company’s consolidated statements of financial position
        consist of:
 
 Pensions
              Other
                  Benefit Plans**2006**
              
              2005
              
              **2006**
              
              2005Plan
                  assets in excess of (less than) projected obligations
              **$**
              **36**
              $
              19
              **$**
              **(19)**
              $
              (20)Unrecognized
                  actuarial gains
              
              **10**
              
              21
              
              **1**
              
              4Unrecognized
                  past service costs
              
              **-**
              
              -
              
              **(1)**
              
              (1)Unrecognized
                  net transition asset
              
              **(25)**
              
              (27)
              
              **-**
              
              -**$**
              **21**
              $
              13
              **$**
              **(19)**
              $
              (17)
 
 The
        pension plan assets are included within long-term investments and other,
        and the
        other benefit plans liabilities are included within other long-term obligations
        on the consolidated statements of financial position.
 
  The
        percentage of fair value of total pension plan assets held at October 31,
        2006
        is as follows:
 
 **2006**
              2005Asset
                  category
              **Percentage
                  of Plan Assets**
              Percentage
                  of Plan AssetsCash
              **0.3%**
              0.0%Fixed
                  income
              **33.4%**
              37.1%Equities
              **66.3%**
              62.9%Total
              **100.0%**
              100.0%
 
 
 **20.**  **Cash Flow**
 
 Cash
        and
        cash equivalents comprise the following:
  **2006**
              
              2005Interest-bearing
                  balances with banks
              **$**
              **166**
              $
              122Commercial
                  paper
              
              **83**
              
              50Term
                  deposits
              
              **28**
              
              43Bankers’
                  acceptances
              
              **7**
              
              50**$**
              **284**
              $
              265
 
 
 Adjustments
        to reconcile net income to cash provided by continuing operating activities
        include:
 
 Items
        not
        affecting current cash flows:
 
 **2006**
              
              2005
              
              2004Depreciation
                  and amortization
              **$**
              **71**
              $
              61
              $
              58Deferred
                  revenue
              
              **(7)**
              
              12
              
              (17)Minority
                  interest
              
              **-**
              
              -
              
              (9)Future
                  income taxes
              
              **22**
              
              (14)
              
              (4)Equity
                  earnings - net of distribution
              
              **12**
              
              8
              
              1Impairment
                  of long-term investments*(note
                  6)*
              
              **1**
              
              6
              
              12Impairment
                  of intangible assets*(note
                  8)*
              
              **-**
              
              8
              
              15Gain
                  on sale of businesses and investments*(note
                  14)*
              
              **(2)**
              
              -
              
              (3)Write-down
                  of property, plant and equipment
              
              **-**
              
              7
              
              10Loss
                  on sale of MAPLE assets*(note
                  14)*
              
              **10**
              
              -
              
              -Stock
                  option compensation*(note
                  18)*
              
              **4**
              
              3
              
              1Net
                  gain on reorganization of MDS Proteomics
              
              **-**
              
              -
              
              (8)Impairment
                  of goodwill
              
              **-**
              
              -
              
              53Unrealized
                  loss on interest rate swaps*(notes
                  14 and 25)*
              
              **-**
              
              3
              
              -Other
              
              **(1)**
              
              (5)
              
              8**$**
              **110**
              $
              89
              $
              117
 
 Changes
        in non-cash working capital balances relating to operations:
 
 **2006**
              
              2005
              
              2004Accounts
                  receivable
              **$**
              **(9)**
              $
              (8)
              $
              (53)Unbilled
                  revenue
              
              **(22)**
              
              (26)
              
              (91)Inventories
              
              **63**
              
              (4)
              
              15Prepaid
                  expenses and other
              
              **(7)**
              
              (6)
              
              11Accounts
                  payable, accrued liabilities and deferred revenue
              
              **(66)**
              
              63
              
              73Income
                  taxes
              
              **(63)**
              
              (20)
              
              30**$**
              **(104)**
              $
              (1)
              $
              (15)
 
  Cash
        interest and income taxes paid are as follows:
 
 **2006**
              
              2005
              
              2004Interest
              **$**
              **24**
              $
              23
              $
              24Income
                  taxes
              **$**
              **10**
              $
              22
              $
              12
 
 
 **21.**  **Segmented Information**
 
 There
        have been a number of changes within the Company’s senior leadership team,
        including the appointment of a new President and Chief Executive Officer,
        which
        together with the recent global restructuring and realignment initiatives,
        necessitated a review of the way MDS reports segmented results. The strategic
        direction to focus on pharmaceutical research services, isotopes and molecular
        imaging, and analytical instruments businesses requires the Company to change
        its segment disclosure to reflect the way in which the chief operating decision
        maker evaluates the results of each segment pursuant to “CICA HB Section 1701 -
        Segment Disclosures”.
 
 The
        Company has also changed the methodology of allocating certain central expenses
        based on factors that reflect the drivers of such costs within each segment.
        Consequently, the Company is now disclosing non-allocated corporate costs
        separately, reflecting certain items that cannot be assigned to a specific
        business unit within any of the above segments.
 
 Management
        has determined that the Company operates within three dominant segments -
        pharmaceutical services, isotopes, and instruments. These segments are organized
        predominantly around the products and services provided to customers identified
        for the businesses.
 
 These
        life sciences businesses supply products and services to manufacturers of
        medical products such as pharmaceuticals, medical devices and supplies. The
        pharmaceutical services business provides pharmaceutical research services;
        the
        isotopes business manufactures medical isotopes; and the instruments business
        manufactures advanced analytical equipment.
 
 The
        accounting policies of the segments are the same as those described in the
        summary of significant accounting policies. There are no significant
        inter-segment transactions. The corporate segment results include the
        incremental cost of corporate overhead in excess of the amount allocated
        to the
        other operating segments, as well as certain other costs and income items
        that
        do not pertain to a business segment.
 
 The
        information presented below is for continuing operations. For comparability
        purposes, the Proteomics segment results for 2004 have been excluded from
        the
        tables.
 
  **Operating
        results**
 
 Year
                  ended October 31, 2006**Pharmaceutical
                  Services**
              **Isotopes**
              **Instruments**
              **Corporate**
                **and
                  Other**
              **Total****Net
                  revenues**
              **$**
              **522**
              **$**
              **338**
              **$**
              **280**
              **$**
              **-**
              **$**
              **1,140**Cost
                  of revenues
              
              **(399)**
              
              **(172)**
              
              **(172)**
              
              **-**
              
              **(743)**Selling,
                  general and administration
              
              **(137)**
              
              **(58)**
              
              **(18)**
              
              **(35)**
              
              **(248)**Research
                  and development
              
              **-**
              
              **(4)**
              
              **(15)**
              
              **-**
              
              **(19)**Depreciation
                  and amortization
              
              **(34)**
              
              **(16)**
              
              **(21)**
              
              **-**
              
              **(71)**Restructuring
                  charges - net
              
              **-**
              
              **2**
              
              **-**
              
              **6**
              
              **8**Other
                  income (expense) - net
              
              **4**
              
              **(10)**
              
              **-**
              
              **(1)**
              
              **(7)**Equity
                  earnings
              
              **(1)**
              
              **-**
              
              **-**
              
              **(5)**
              
              **(6)****Operating
                  income (loss)**
              **$**
              **(45)**
              **$**
              **80**
              **$**
              **54**
              **$**
              **(35)**
              **$**
              **54**Capital
                  expenditures
              **$**
              **41**
              **$**
              **-**
              **$**
              **8**
              **$**
              **12**
              **$**
              **61**
 
 
 Year
                  ended October 31, 2005**Pharmaceutical
                  Services**
              **Isotopes**
              **Instruments**
              **Corporate**
                **and
                  Other**
              **Total****Net
                  revenues**
              $
              543
              $
              325
              $
              286
              $
              -
              $
              1,154Cost
                  of revenues
              
              (380)
              
              (163)
              
              (166)
              
              -
              
              (709)Selling,
                  general and administration
              
              (147)
              
              (57)
              
              (19)
              
              (22)
              
              (245)Research
                  and development
              
              (2)
              
              (4)
              
              (26)
              
              1
              
              (31)Depreciation
                  and amortization
              
              (31)
              
              (17)
              
              (12)
              
              (1)
              
              (61)Restructuring
                  charges - net
              
              (24)
              
              (4)
              
              (3)
              
              (30)
              
              (61)Other
                  income (expense) - net
              
              (14)
              
              -
              
              -
              
              (3)
              
              (17)Equity
                  earnings
              
              -
              
              -
              
              1
              
              (7)
              
              (6)**Operating
                  income (loss)**
              $
              (55)
              $
              80
              $
              61
              $
              (62)
              $
              24Capital
                  expenditures
              $
              30
              $
              61
              $
              6
              $
              28
              $
              125
 
 
 Year
                  ended October 31, 2004**Pharmaceutical
                  Services**
              **Isotopes**
              **Instruments**
              **Corporate**
                **and
                  Other**
              **Total****Net
                  revenues**
              $
              509
              $
              350
              $
              282
              $
              -
              $
              1,141Cost
                  of revenues
              
              (347)
              
              (163)
              
              (150)
              
              -
              
              (660)Selling,
                  general and administration
              
              (122)
              
              (51)
              
              (11)
              
              (38)
              
              (222)Research
                  and development
              
              (1)
              
              (4)
              
              (33)
              
              -
              
              (38)Depreciation
                  and amortization
              
              (27)
              
              (15)
              
              (8)
              
              (2)
              
              (52)Restructuring
                  charges - net
              
              1
              
              (2)
              
              -
              
              (9)
              
              (10)Other
                  income (expense) - net
              
              (10)
              
              3
              
              (1)
              
              -
              
              (8)Equity
                  earnings
              
              (2)
              
              -
              
              -
              
              1
              
              (1)**Operating
                  income (loss)**
              $
              1
              $
              118
              $
              79
              $
              (48)
              $
              150Capital
                  expenditures
              $
              42
              $
              56
              $
              9
              $
              -
              $
              107
 
 Operating
        results for MDS Proteomics for 2004 included the following: cost of revenues
        -
        $12 million; selling, general and administration - $6 million; depreciation
        and
        amortization - $6 million; other income (expense) - ($57) million; and operating
        income (loss) - ($81) million.
 
 
  **Financial
        position**
 **Additions**
              **Investment
                  in Investees Subject to Significant Influence****Total
                  Assets**1************
              **Property,
                  Plant and Equipment**
              **Goodwill**Pharmaceutical
                  Services
              **2006**
              **$**
              **985**
              **$**
              **41**
              **$**
              **1**
              **$**
              **4**2005
              
              896
              
              30
              
              6
              
              4Isotopes
              **2006**
              **$**
              **697**
              **$**
              **-**
              **$**
              **-**
              **$**
              **-**2005
              
              789
              
              61
              
              -
              
              -Instruments
              **2006**
              **$**
              **186**
              **$**
              **8**
              **$**
              **-**
              **$**
              **-**2005
              
              222
              
              6
              
              -
              
              -Corporate
                  and Other
              **2006**
              **$**
              **590**
              **$**
              **12**
              **$**
              **-**
              **$**
              **30**2005
              
              416
              
              28
              
              -
              
              25Total
              **2006**
              **$**
              **2,458**
              **$**
              **61**
              **$**
              **1**
              **$**
              **34**2005
              
              2,323
              
              125
              
              6
              
              29
 1 Total
        assets exclude assets held for sale relating to discontinued operations.
 
 
 **Revenues
        by customer location**
 
 **Canada**
              
              **US**
              
              **Europe**
              
              **Asia**
              
              **Other**
              
              **Total**Pharmaceutical
                  Services
              **2006**
              **$**
              **26**
              **$**
              **267**
              **$**
              **201**
              **$**
              **8**
              **$**
              **20**
              **$**
              **522**2005
              
              29
              
              300
              
              184
              
              4
              
              26
              
              5432004
              
              36
              
              282
              
              162
              
              20
              
              9
              
              509Isotopes
              **2006**
              **$**
              **13**
              **$**
              **188**
              **$**
              **51**
              **$**
              **65**
              **$**
              **21**
              **$**
              **338**2005
              
              13
              
              171
              
              62
              
              58
              
              21
              
              3252004
              
              4
              
              185
              
              65
              
              61
              
              35
              
              350Instruments
              **2006**
              **$**
              **17**
              **$**
              **115**
              **$**
              **88**
              **$**
              **56**
              **$**
              **4**
              **$**
              **280**2005
              
              29
              
              112
              
              86
              
              54
              
              5
              
              2862004
              
              15
              
              129
              
              81
              
              -
              
              57
              
              282Total
              **2006**
              **$**
              **56**
              **$**
              **570**
              **$**
              **340**
              **$**
              **129**
              **$**
              **45**
              **$**
              **1,140**2005
              
              71
              
              583
              
              332
              
              116
              
              52
              
              1,1542004
              
              55
              
              596
              
              308
              
              81
              
              101
              
              1,141
 
 
 **Property,
        Plant, and Equipment by segment and geographical location**
 
 **Canada**
              **US**
              **Europe**
              **Asia**
              **Total**Pharmaceutical
                  Services
              **2006**
              **$**
              **50**
              **$**
              **67**
              **$**
              **54**
              **$**
              **3**
              **$**
              **174**2005
              
              51
              
              62
              
              47
              
              4
              
              164Isotopes
              **2006**
              **$**
              **119**
              **$**
              **-**
              **$**
              **5**
              **$**
              **-**
              **$**
              **124**2005
              
              533
              
              -
              
              6
              
              -
              
              539Instruments
              **2006**
              **$**
              **22**
              **$**
              **3**
              **$**
              **1**
              **$**
              **1**
              **$**
              **27**2005
              
              25
              
              1
              
              -
              
              -
              
              26Corporate
                  and Other
              **2006**
              **$**
              **56**
              **$**
              **-**
              **$**
              **-**
              **$**
              **-**
              **$**
              **56**2005
              
              79
              
              -
              
              -
              
              -
              
              79Total
              **2006**
              **$**
              **247**
              **$**
              **70**
              **$**
              **60**
              **$**
              **4**
              **$**
              **381**2005
              
              688
              
              63
              
              53
              
              4
              
              808
 
  Goodwill
        by segment and geographical location
 
 **Canada**
              **US**
              **Europe**
              **Asia**
              **Total**Pharmaceutical
                  Services
              **2006**
              **$**
              **133**
              **$**
              **292**
              **$**
              **26**
              **$**
              **-**
              **$**
              **451**2005
              
              131
              
              306
              
              25
              
              -
              
              462Isotopes
              **2006**
              **$**
              **3**
              **$**
              **-**
              **$**
              **-**
              **$**
              **-**
              **$**
              **3**2005
              
              3
              
              -
              
              -
              
              -
              
              3Instruments
              **2006**
              **$**
              **14**
              **$**
              **-**
              **$**
              **-**
              **$**
              **-**
              **$**
              **14**2005
              
              14
              
              -
              
              -
              
              -
              
              14Corporate
                  and Other
              **2006**
              **$**
              **-**
              **$**
              **-**
              **$**
              **-**
              **$**
              **-**
              **$**
              **-**2005
              
              -
              
              -
              
              -
              
              -
              
              -Total
              **2006**
              **$**
              **150**
              **$**
              **292**
              **$**
              **26**
              **$**
              **-**
              **$**
              **468**2005
              
              148
              
              306
              
              25
              
              -
              
              479
 
 
 **22.**  **Commitments and Contingencies**
 
 As
        at
        October 31, 2006, the Company is obligated under premises and equipment leases
        and other long-term contractual commitments to make minimum annual payments
        of
        approximately:
 
 **Operating**
                **Leases**
              
              **Other**
                **Contractual**
                **Commitments**2007
              $
              18
              $
              502008
              
              17
              
              382009
              
              14
              
              382010
              
              13
              
              292011
              
              11
              
              37Thereafter
              
              19
              
              125$
              92
              $
              317
 
 Rental
        expense under premises and equipment leases of continuing operations for
        the
        year ended October 31, 2006 was $24 million (2005 - $31 million; 2004 - $24
        million).
 
 Included
        in other contractual commitments above is $245 million associated with long-term
        supply arrangements and other long-term commitments with major electricity
        producers comprising the majority of the Company’s expected cobalt purchase.
 
 Other
        contractual commitments included a remaining five-year commitment totalling
        $69
        million (2005 - $211 million) relating to the outsourcing of the information
        technology infrastructure.
 
 On
        January 10, 2007, the US Food and Drug Administration (the FDA) issued letters
        to MDS and to sponsors of studies conducted by the Company at its Montreal-area
        bioanalytical laboratory facilities. In the letter, the FDA indicated that
        sponsors would be responsible for re-validation of certain data and conclusions
        related to bioanalytical studies conducted by MDS in the period 2000 to
        2004.
 
 The
        Company is currently assessing the impact of this event to determine the
        amount
        of additional costs that MDS may incur related to settlements with sponsors,
        changes to its Montreal-area facilities and processes, or other matters,
        if any.
        Insufficient information is currently available to enable the Company to
        measure
        such costs with certainty or to determine the timing of such payments, and
        therefore, no provision for these additional costs, if any, has been recorded
        in
        the statement of financial position for these matters as at October 31,
        2006.
  
 **23.**  **Guarantees**
 
 Guarantees
        for which the Company is contractually obligated to make payments in the
        event
        of a default by a third party or due to its inability to meet certain
        performance-based obligations total approximately $23 million (2005 - $11
        million).
 
 
 **24.**  **Asset Retirement Obligation**
 
 The
        Company has identified an asset retirement obligation relating to future
        site
        remediation costs of a facility located in Kanata, Ontario. The Company intends
        to use the facility for an indeterminate period of time and a liability will
        be
        recognized in the period in which sufficient information exists to estimate
        the
        range of potential settlement dates that is required to use a present value
        technique to estimate fair value.
 
 During
        2006, the Company pledged a $15 million letter of credit in support of future
        site remediation costs for the Kanata facility, which is included in the
        guarantees amount described in note 23.
 
 
 **25.**  **Financial Instruments**
 **a)**  **Foreign
        currency and interest rate contracts**
 
 The
        Company uses foreign currency forward and option contracts to manage its
        foreign
        exchange risk. Certain Canadian operations of the Company are expected to
        have
        net cash inflows in 2007 and subsequent years denominated in US dollars.
        The
        Company enters into foreign exchange contracts to hedge a substantial portion
        of
        these cash flows. The Company uses interest rate swap contracts to manage
        its
        exposure to interest rate risk on certain of its debt obligations.
 
 Included
        in revenues are gains from realized foreign exchange hedging contracts for
        the
        year of $16 million (2005 - $48 million; 2004 - $44 million). During the
        year,
        the Company realized other net foreign exchange loss of $3 million (2005
        - $1
        million loss; 2004 - $13 million loss), which was recorded within selling,
        general and administration expenses.
 
 As
        at
        October 31, 2006, the Company had outstanding foreign exchange contracts
        and
        options in place to sell up to US$64 million, and in certain circumstances
        up to
        US$82 million, at a weighted average rate of C$1.1412, maturing over the
        next
        five months. The Company also had interest rate swap contracts that economically
        convert a notional amount of US$80 million of debt from a fixed to a floating
        interest rate. The interest rate swap contracts were previously designated
        as
        hedges; however, beginning in the fourth quarter of 2005, the hedge
        effectiveness test was not met and the Company began to record the interest
        rate
        swap at fair value with changes in fair value included in income. In 2005,
        a $3
        million loss was recorded in other income (expense) (see note 14). No such
        gain
        or loss was recorded in 2006.
 
 **b)**  **Credit
        risk**
 
 Certain
        of the Company’s financial assets, including cash and cash equivalents, are
        exposed to credit risk. The Company may, from time to time, invest in debt
        obligations and commercial paper of governments and corporations. Such
        investments are limited to those issuers carrying an investment-grade credit
        rating. In addition, the Company limits the amount that is invested in issues
        of
        any one government or corporation.
 
 The
        Company is also exposed, in its normal course of business, to credit risk
        from
        its customers. No single party accounts for a significant balance of accounts
        receivable.
  **c)**  **Fair
        value**
 
 Cash
        and
        cash equivalents, accounts receivable, unbilled revenue, accounts payable
        and
        accrued liabilities, and income taxes - these assets and liabilities have
        short
        periods to maturity and the carrying values contained in the consolidated
        statements of financial position approximate their estimated fair
        value.
 
 Foreign
        exchange and interest rate swap contracts - as at October 31, 2006 and 2005,
        the
        carrying amounts and fair values for all derivative financial instruments
        are as
        follows:
 
 **2006**
              2005**Carrying
                  Amount**
              **Fair
                  Value**
              Carrying
                  Amount
              Fair
                  ValueNet
                  asset (liability) position:Currency
                  forward and option
              -
                  assets
              **$**
              **1**
              **$**
              **1**
              $
              4
              $
              7Currency
                  forward and option
              -
                  liabilities
              **$**
              **-**
              **$**
              **-**
              $
              (1)
              $
              (1)Interest
                  rate swap and option contracts
              **$**
              **(2)**
              **$**
              **(2)**
              $
              (3)
              $
              (3)
 
 Of
        the
        net $1 million (2005 - $6 million) fair value of currency forwards and options,
        the fair market value of currency options not eligible for hedge accounting
        amounted to $nil and $2 million as at October 31, 2006 and 2005 respectively.
        These contracts are included in accounts payable and accrued liabilities
        and are
        marked to market each period. The Company recorded a $4 million gain in 2006
        (2005 - $4 million gain) as a result of marking these options to market.
 
 
 **26.**  **Cumulative Translation Adjustment**
 
 Unrealized
        translation adjustments arise from the translation into Canadian dollars
        of the
        Company's net investment in self-sustaining foreign operations and the
        revaluation of certain hedged items. The Company has designated its US-dollar
        senior unsecured notes payable as a hedge of the net investment in the US
        operations. Unrealized currency-related gains or losses resulting from the
        translation of these notes into Canadian dollars are recorded in the cumulative
        translation account due to this hedging relationship. As at October 31, 2006,
        the Company had a cumulative translation adjustment loss of $25 million (2005
        -
        $26 million) largely resulting from the impact of the declining value of
        the US
        dollar on the Company's net investment in its US operations.
 
 
 **27.**  **Differences
        Between Canadian and United States Generally Accepted Accounting
        Principles**
 
 The
        consolidated financial statements have been prepared in accordance with Canadian
        GAAP. The principles adopted in these financial statements conform in all
        material respects to those of US GAAP except as summarized below. Significant
        differences between Canadian and US GAAP would have the following effect
        on net
        income of the Company:
 
 **2006**
              2005
              2004Net
                  income from continuing operations in accordance with Canadian
                GAAP
              **$**
              **32**
              $
              1
              $
              23US
                  GAAP adjustments:Unrealized
                  gains on foreign exchange contracts and interest rate
                swaps
                  (i)
              
              **(5)**
              
              (39)
              
              (10)Deferred
                  development costs (ii)
              
              **(5)**
              
              (15)
              
              -Dilution
                  gains (iii)
              
              **-**
              
              -
              
              (8)Acquired
                  in-process research and development (iv)
              
              **-**
              
              -
              
              (3)Reduction
                  in income tax expense arising from GAAP adjustments
              
              **3**
              
              17
              
              8Net
                  income (loss) from continuing operations in accordance with US
                GAAP
              
              **25**
              
              (36)
              
              10Income
                  from discontinued operations in accordance with Canadian and
                GAAP
                  - net of tax
              
              **113**
              
              30
              
              28Net
                  income (loss) in accordance with US GAAP
              
              **138**
              
              (6)
              
              38Comprehensive
                  income adjustments (v):Unrealized
                  loss on share investments - net of tax
              
              **(1)**
              
              (7)
              
              (10)Cumulative
                  translation adjustment
              
              **1**
              
              (14)
              
              4Comprehensive
                  income (loss)
              **$**
              **138**
              $
              (27)
              $
              32Basic
                  and diluted earnings (loss) per share in accordance with US
                  GAAP-
                  from continuing operations
              **$**
              **0.17**
              $
              (0.25)
              $
              0.07-
                  from discontinued operations
              
              **0.79**
              
              0.21
              
              0.20**$**
              **0.96**
              $
              (0.04)
              $
              0.27
  i)
              Foreign
                  Exchange Contracts and Interest Rate Swaps - The Company designates
                  certain foreign exchange forward contracts as hedges of future
                  revenue
                  streams and interest rate swap contracts as hedges of interest
                  obligations. Under Canadian GAAP, the resulting gains and losses
                  on the
                  contracts are recorded in operations in the period in which a contract
                  matures. Under US GAAP, these contracts would not qualify for hedge
                  accounting, and, accordingly, such contracts are carried at fair
                  value
                  with changes in fair value reflected in
                  earnings.
  ii)
              Deferred
                  Development Costs - Under Canadian GAAP, qualifying product development
                  costs are capitalized and amortized over the future periods benefited.
                  Under US GAAP, such costs are expensed as
                  incurred.
  iii)
              Dilution
                  Gains - Under Canadian GAAP, dilution gains associated with
                  development-stage subsidiaries are recorded as income. Under US
                  GAAP, such
                  gains are not recognized.
  iv)
              Acquired
                  In-Process Research and Development - Under Canadian GAAP, the
                  cost of
                  in-process research and development acquired as a result of a business
                  combination is capitalized and amortized over its estimated useful
                  life.
                  Under US GAAP, such costs are charged to income at the date of
                  acquisition.
  v)
              Comprehensive
                  Income - US GAAP requires that a statement of comprehensive income
                  be
                  displayed with the same prominence as other financial statements.
                  Comprehensive income, which incorporates net income, includes all
                  changes
                  in equity during a period except those resulting from investments
                  by
                  owners and distributions to owners.
  The
        Company has interests in certain jointly controlled entities that are
        proportionately consolidated under Canadian GAAP. Under US GAAP, such interests
        are accounted for by the equity method. Net income, earnings per share and
        shareholders’ equity under US GAAP are not impacted by the proportionate
        consolidation of these interests. Summary balance sheets and income statements,
        along with certain cash flow information, for the Company’s investments in
        jointly controlled entities are provided in note 17.
 
 The
        following table indicates the significant items in the consolidated statements
        of financial position that would have been affected had the consolidated
        financial statements been prepared under US GAAP. The revised amounts would
        have
        been as follows:
 
 **2006**
              
              2005Accounts
                  receivable and other
              **$**
              **254**
              $
              250Long-term
                  future tax assets
              
              **56**
              
              56Long-term
                  investments
              
              **106**
              
              64Goodwill
              
              **467**
              
              477Intangibles
              
              **377**
              
              39Long-term
                  future tax liabilities
              
              **93**
              
              70Accumulated
                  comprehensive loss
              
              **(63)**
              
              (76)Additional
                  paid-in capital
              
              **90**
              
              90Retained
                  earnings
              
              **599**
              
              480
 
 Under
        Staff Accounting Bulletin 74, the Company is required to disclose certain
        information related to new US GAAP standards that have not yet been adopted
        due
        to delayed effective dates.
  a)  In
        May
        2005, the Financial Accounting Standards Board (FASB) issued Statement of
        Financial Accounting Standards (SFAS) No. 154, “Accounting Changes and Error
        Corrections” (SFAS 154), which replaces “Accounting Principles Board (APB)
        Opinion No. 20, Accounting Changes”, and SFAS No. 3, “Reporting Accounting
        Changes in Interim Financial Statements - An Amendment of APB Opinion No.
        28”.
        SFAS 154 provides guidance on the accounting for and reporting of changes
        in
        accounting principles and error corrections. SFAS 154 requires retrospective
        application to prior period financial statements of voluntary changes in
        accounting principles and changes required by new accounting standards when
        the
        standard does not include specific transition provisions, unless it is
        impracticable to do so. SFAS 154 also requires certain disclosures for
        restatements due to correction of an error. SFAS 154 is effective for accounting
        changes and corrections of errors made in fiscal years beginning after December
        15, 2005, and is required to be adopted by MDS as of November 1, 2006. The
        impact that the adoption of SFAS 154 will have on MDS's consolidated results
        of
        operations and financial condition will depend on the nature of future
        accounting changes adopted by MDS and the nature of transitional guidance
        provided in future accounting pronouncements.
 
 b)  In
        June
        2006, the FASB issued FIN 48, “Accounting for Uncertainty in Income Taxes”. This
        standard prescribes a recognition and measurement model for tax positions
        taken
        or expected to be taken in a tax return, and provides guidance on derecognition,
        classification, interest and penalties, accounting in interim periods,
        disclosure and transition. This standard is effective for years ending after
        December 15, 2006.
 
 c)  In
        September 2006, the FASB issued SFAS No. 158, “Accounting for Defined Benefit
        Plans and Other Post Retirement Benefits”. This standard requires an employer to
        (i) recognize the overfunded or underfunded status of a defined benefit plan
        (other than multiemployer plans) as an asset or a liability with changes
        in that
        funded status recognized through comprehensive income; and (ii) measure the
        funded status of a plan as of the year-end date. The standard also specifies
        additional disclosures. This standard is effective for years ending after
        December 15, 2006.
 d)  In
        September 2006, the Securities and Exchange Commission (SEC) issued Staff
        Accounting Bulletin (SAB) No. 108, “Considering the Effects of Prior Year
        Misstatements when Quantifying Misstatements in Current Year Financial
        Statements”. This pronouncement addresses how the effects of the carryover or
        reversal of prior year misstatements should be considered in quantifying
        a
        current year misstatement. This statement is effective for years ending after
        November 15, 2006.
 
 
 **28.**  **Comparative
        Figures**
 
 Certain
        figures for previous years have been reclassified to conform with the current
        year's consolidated financial statement presentation. In addition, segmented
        information for previous years has been revised to reflect the discontinued
        operations reported.
 
 
 **29.**  **Subsequent Events**
 
 **a)
        Sale of MDS Diagnostic Services**
 On
        October 5, 2006, MDS announced the signing of a series of agreements to sell
        its
        remaining Canadian diagnostics businesses, MDS Diagnostic Services, to Borealis
        Infrastructure Management Inc. for gross proceeds of $1.3 billion. MDS expects
        to realize net proceeds of approximately $1.1 billion, after the provision
        for
        taxes, expenses and amounts attributable to minority interests and to report
        a
        gain on the transaction of approximately $0.9 billion. A portion of the purchase
        price may be retained for up to 18 months, contingent on the satisfaction
        of
        specific transition obligations of MDS. The transaction is subject to conditions
        and customary approvals including regulatory consents and approval from the
        shareholders of LPBP Inc., the limited partner of the entity that owns the
        majority of the assets used in the Ontario laboratory business, which approval
        has now been obtained. The transaction is expected to close by the end of
        January 2007.
 
 **b)
        Hemosol Corp. investment**
 Subsequent
        to year-end, MDS sold its $13 million investment in Hemosol Corp. for $13
        million in cash and a $1.5 million note receivable. The Company expects to
        report a gain of approximately $2 million in the first quarter of 2007.
 
 **c)
        Sale and closure of facilities**
 Subsequent
        to year-end, MDS announced the closure of its Phase I facility in New Orleans,
        which was reconstructed after it was damaged by Hurricane Katrina in 2005.
        Also,
        subsequent to year-end, MDS completed the sale of its local clinical development
        business in Madrid, Spain. The Company expects to report a loss of in the
        range
        of $7 million to $9 million in the first quarter of 2007 in connection with
        these activities.
  
 **THREE
          YEAR FINANCIAL SUMMARY**
 Years
          ended October 31
 (millions
          of Canadian dollars except per share data)


**Document
        No. 3**


**MANAGEMENT’S
      DISCUSSION AND ANALYSIS**





January
      15, 2007





Following
      is management’s discussion and analysis (MD&A) of the results of operations
      for MDS Inc. (MDS or the Company) for the year ended October 31, 2006 and its
      financial position as at October 31, 2006. This MD&A should be read in
      conjunction with the audited consolidated financial statements and notes that
      follow. For additional information and details, readers are referred to the
      unaudited quarterly financial statements and quarterly MD&A for 2006, and
      the Company’s Annual Information Form for 2006 (AIF), each of which is published
      separately and is available at www.mdsinc.com and at www.sedar.com.





Our
      MD&A is intended to enable readers to gain an understanding of MDS’s current
      results and financial position. To do so, we provide information and analysis
      comparing the results of operations and financial position for the current
      year
      to those of the preceding two fiscal years. We also provide analysis and
      commentary that we believe is required to assess the Company’s future prospects.
      Accordingly, certain sections of this report contain forward-looking statements
      that are based on current plans and expectations. These forward-looking
      statements are affected by risks and uncertainties that are discussed in this
      document, as well as in the AIF, and that could have a material impact on future
      prospects. Readers are cautioned that actual events and results will
      vary.








**Caution
      regarding forward-looking statements**


From
      time
      to time, we make written or oral forward-looking statements within the meaning
      of certain securities laws, including the “safe harbour” provisions of the *Securities
      Act* (Ontario) and the *United
      States Private Securities Litigation Reform Act* of 1995.
      This document contains such statements, and we may make such statements in
      other
      filings with Canadian regulators or the United States Securities and Exchange
      Commission, in reports to shareholders or in other communications, including
      public presentations. These forward-looking statements include, among others,
      statements with respect to our objectives for 2007, our medium-term goals,
      and
      strategies to achieve those objectives and goals, as well as statements with
      respect to our beliefs, plans, objectives, expectations, anticipations,
      estimates and intentions. The words “may”, “could”, “should”, “would”,
“suspect”, “outlook”, “believe”, “plan”, “anticipate”, “estimate”, “expect”,
“intend”, “forecast”, “objective”, and words and expressions of similar import
      are intended to identify forward-looking statements.





By
      their
      very nature, forward-looking statements involve inherent risks and
      uncertainties, both general and specific, which give rise to the possibility
      that predictions, forecasts, projections and other forward-looking statements
      will not be achieved. We caution readers not to place undue reliance on these
      statements as a number of important factors could cause our actual results
      to
      differ materially from the beliefs, plans, objectives, expectations,
      anticipations, estimates and intentions expressed in such forward-looking
      statements. These factors include, but are not limited to, management of
      operational risks; the strength of the Canadian and United States economies
      and
      the economies of other countries in which we conduct business; our ability
      to
      secure a sufficient quantity of raw materials, particularly cobalt; a reliable
      source of supply of critical nuclear isotopes; the impact of the movement of
      the
      Canadian dollar relative to other currencies, particularly the US dollar and
      the
      Euro; changes in interest rate policies of the Bank of Canada and the Board
      of
      Governors of the Federal Reserve System in the United States; the effects of
      competition in the markets in which we operate; the timing and technological
      advancement of new products introduced by us or by our competitors; the impact
      of changes in the laws and regulations and enforcement thereof; judicial
      judgments and legal proceedings; our ability to obtain accurate and complete
      information from, or on behalf of, our customers and counter parties; our
      ability to successfully realign our organization, resources and processes;
      our
      ability to complete strategic acquisitions and joint ventures and to integrate
      our acquisitions and joint ventures successfully; changes in accounting policies
      and methods we use to report our financial condition, including uncertainties
      associated with critical accounting assumptions and estimates; operational
      and
      infrastructure risks; other factors that may affect future results including
      changes in trade policies, timely development and introduction of new products
      and services, changes in our estimates relating to reserves and allowances,
      changes in tax laws, technological changes, natural disasters such as
      hurricanes, the possible impact on our businesses from public health
      emergencies, international conflicts and other developments including those
      relating to terrorism; and our success in anticipating and managing the
      foregoing risks.





We
      caution that the foregoing list of important factors that may affect future
      results is not exhaustive. When relying on our forward-looking statements to
      make decisions with respect to the Company, investors and others should
      carefully consider the foregoing factors and other uncertainties and potential
      events. We do not undertake to update any forward-looking statement, whether
      written or oral, that may be made from time to time by us or on our
      behalf.




**Use
      of non-GAAP measures**


In
      this
      MD&A, we describe certain income and expense items that are unusual or
      non-recurring. These terms are not defined by generally accepted accounting
      principles (GAAP). Our usage of these terms may vary from the usage adopted
      by
      other companies. We identify the impact of these amounts on operating income
      and
      on earnings per share (EPS). We provide this detail so that readers have a
      better understanding of the significant events and transactions that have had
      an
      impact on our results.





In
      addition, terms such as adjusted operating income; adjusted earnings before
      interest, taxes, depreciation and amortization (EBITDA); adjusted EBITDA margin;
      adjusted EPS; and backlog are not defined by GAAP, and our use of such terms
      or
      measurement of such items may vary from that of other companies. Where relevant,
      and particularly for earnings-based measures, we provide tables in this document
      that reconcile non-GAAP measures used to amounts reported on the face of the
      consolidated financial statements.





We
      also
      discuss the results of our operations for the current year versus the
      immediately preceding year, isolating variances that relate to changes in
      exchange rates and acquisitions. We use the term “organic” to describe the
      results presented in this way. To isolate the effect of currency movements,
      we
      eliminate the impact of foreign currency hedging activities in both the current
      and prior periods and recalculate the base figures for the prior period using
      the exchange rates that were in effect for the current period.





For
      our
      pharmaceutical services business, we provide information about contract backlog.
      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. We report our backlog in US
      dollars to reflect the underlying currency of the majority of such contracts
      and, therefore, reduce the volatility that would result from converting the
      measure to Canadian dollars.





Tabular
      amounts are from continuing operations in millions of Canadian dollars, except
      per share amounts and where otherwise noted.


**Introduction**


MDS
      is a
      global life sciences company that provides market-leading products and services
      that our customers need for the development of drugs and the diagnosis and
      treatment of disease. We are a leading global provider of pharmaceutical
      contract research, medical isotopes for molecular imaging, radiotherapeutics,
      and analytical instruments.








**Strategic
      initiatives**


On
      September 1, 2005, we announced our strategic plan to pursue growth in the
      global life sciences market and dispose of assets that do not contribute to
      the
      Company’s areas of focus, as well as plans to reduce overhead and better align
      resources and infrastructure costs.





Since
      that time, and in keeping with our new strategic direction, we have taken a
      number of steps, including a workforce reduction of approximately 750 positions;
      the sale of our 50% interest in Source Medical Corporation (Source) and our
      26%
      interest in Calgary Laboratory Services (CLS); and the sale or closure of
      several sites and lines of business by MDS Pharma Services that were not
      considered part of our core focus. In addition, we implemented several
      management changes that we believe have resulted in an upgrading of our
      management resources.





On
      October 5, 2006, we announced the sale of our remaining Canadian diagnostics
      businesses to Borealis Infrastructure Management Inc. for gross proceeds of
      $1.3
      billion, including amounts ultimately paid to holders of minority interests
      in
      these businesses. This sale marks the culmination of work that stretched over
      more than one year and it is the final major step in our efforts to reposition
      MDS as a global life sciences company.





We
      expect
      to close this transaction by the end of January 2007 and anticipate reporting
      a
      gain from this transaction in our first quarter of fiscal 2007 of approximately
      $0.9 billion. The transaction will yield net cash proceeds to MDS of
      approximately $1.1 billion, including an amount to be determined that will
      be
      held in escrow pending clearance of certain closing conditions. Following
      completion of the transaction, we intend to undertake a substantial issuer
      bid
      to repurchase up to $500 million of our Common shares.







**Discontinued
      operations**


We
      are
      now treating our former diagnostics segment as a discontinued operation. All
      financial references in this document exclude those businesses that we consider
      to be discontinued, unless otherwise noted. Our discontinued businesses now
      include our Canadian and US diagnostics businesses, certain non-strategic
      pharmaceutical research services businesses, and our interest in Source. All
      financial references for the prior years have been revised to reflect this
      treatment. From the amounts reported in our fiscal 2005 annual financial report,
      revenues for fiscal 2005 and fiscal 2004 have been reduced by $335 million
      and
      $338 million, respectively, and income from continuing operations have been
      decreased by $41 million and $40 million, respectively.








**Consolidated
      operating highlights**


**2006**
            2005**Net
                revenues, reported**
            **$
                1,140**
            $1,154Impact
                of foreign exchange
            **(21)**
            (109)Impact
                of acquisitions
            **(7)**
            -**Net
                revenues, organic**
            **$
                1,112**
            $
                1,045**Adjusted
                EBITDA, reported**
            **133**
            170Impact
                of foreign exchange and acquisitions
            **(20)**
            (65)**Adjusted
                EBITDA, organic**
            **$
                113**
            $
                105**Adjusted
                EBITDA margin, reported**
            **12%**
            15%**Adjusted
                EBITDA margin, organic**
            **10%**
            10%





Revenue
      for 2006 was $1,140 million, down 1% from $1,154 million in 2005. Revenues
      for
      2005 were up slightly from the $1,141 million reported in fiscal 2004. The
      declining US dollar had a significant impact in these years, offsetting organic
      growth in most of our businesses. On a consolidated basis, revenues grew by
      6%
      organically, at the
      low
      end of our 2006 guidance of 6% to 9% for our life sciences businesses. We
      attribute this to lower than market-average growth by MDS Pharma Services,
      for
      which early-stage revenue growth was negatively impacted by customer caution
      associated with the ongoing FDA review. Our pharmaceutical research services
      revenues fell 4% on a reported basis and grew 3% organically. MDS Nordion grew
      reported revenues 4% and grew revenues 14% organically, largely as a result
      of
      the strength in medical isotopes in the first half of the year, when an industry
      competitor was temporarily unable to supply the market. Reported revenues for
      MDS Sciex fell 2% and were up 5% on an organic basis.





**2006**
            %
              Change
            2005
            %
              Change
            2004**Net
                revenues**
            **$
                1,140**
            (1%)
            $
                1,154
            1%
            $
                1,141**Operating
                income**
            **54**
            125%
            24
            (65%)
            69Adjustments:Gain
                on sale of a business
            **(2)**
            
            -
            
            -MAPLE
                settlement
            **10**
            
            -
            
            -Valuation
                provisions
            **7**
            
            21
            
            25Mark-to-market
                on interest rate swaps
            **1**
            
            3
            
            -Restructuring
            **(8)**
            
            61
            
            10Other
                gains
            **-**
            
            -
            
            (17)MDS
                Proteomics
            **-**
            
            -
            
            75**62**
            
            109
            
            162Depreciation
                and amortization
            **71**
            
            61
            
            58**Adjusted
                EBITDA**
            **$
                133**
            (22%)
            $
                170
            (23%)
            $
                220**Adjusted
                EBITDA margin**
            **12%**
            
            15%
            
            19%





Operating
      income for 2006 was $54 million, more than double the $24 million we reported
      in
      2005. Operating income for 2005 was significantly affected by restructuring
      provisions booked in the final quarter of that year. Operating income in 2004
      was $69 million.





We
      also
      track adjusted EBITDA to assess the normalized cash generating potential of
      our
      businesses. Adjusted EBITDA for fiscal 2006 was $133 million, down 22% on a
      reported basis from the $170 million reported in 2005. Adjusted EBITDA for
      2005
      was down 23% from the $220 million reported in fiscal 2004. Foreign currency
      accounts for a significant portion of the drop in reported adjusted EBITDA,
      and
      adjusted EBITDA for 2006 rose 7% on an organic basis.





The
      ongoing costs of the self-review of bioequivalence studies conducted at our
      St.
      Laurent facility from 2000 through 2004 (the Retrospective Review) were
      significantly higher this year than last, totalling $31 million compared to
      $6
      million in 2005, as the review activity increased markedly over the two years.
      In addition, our investment in Sarbanes-Oxley (SOx) compliance increased
      dramatically to $14 million compared to $6 million in 2005, as fiscal 2006
      is
      our first certification year. Together, the increase in these two items cost
      360
      basis points (bps) of EBITDA margin. Spending on these two items was
      insignificant in fiscal 2004.





Operating
      income for 2004 includes an $81 million loss associated with our abandoned
      proteomics business, MDS Proteomics. This business generated limited revenue,
      as
      it was an early-stage research and development (R&D) company. The business
      was shut down in the third quarter of 2004. At the time of our exit from this
      business we retained a minority interest and therefore it has not been treated
      as a discontinued operation.


Early
      in
      2006, we reached an agreement that resulted in a comprehensive change in our
      relationship with Atomic Energy of Canada Limited (AECL) pertaining to the
      MAPLE
      reactor project. The details of the settlement are described in the MDS Nordion
      section, below. As a result of this settlement, we recorded a $10 million
      non-cash loss that has been reflected as an adjusting item.





Other
      adjustments recorded in the year included a $2 million gain resulting from
      the
      sale of an agronomics testing business based in Lincoln, Nebraska. This business
      contributed annual revenues of $3 million and a small profit. Also, equity
      earnings for 2006 reflect the impact of investment write-downs of $7 million
      that reduced the value of certain long-term investments held by investee
      companies to our estimate of realizable value. In 2005, we recorded valuation
      provisions and investment write-downs, including an $8 million write-off of
      purchased technology that was no longer compatible with our plans for our
      pharmaceutical research services business and an investment impairment charge
      of
      $6 million due to the uncertainty surrounding the collection of a long-term
      financial instrument. In 2005, we also recorded a $7 million write-down in
      the
      carrying value of our interest in Hemosol Corp. to reduce it to our estimate
      of
      realizable value and to allow for exposure under a guarantee of the company’s
      bank debt. This item was recorded with equity earnings. Valuation provisions
      for
      fiscal 2004 of $25 million included $10 million associated with the write-down
      of investments in an investee company and a $15 million reduction in the value
      of certain deferred development costs. A further valuation provision of $2
      million was recorded by MDS Proteomics and included in the results for that
      business.





Over
      the
      last three years, we have undertaken a number of initiatives aimed at
      restructuring MDS and, last year, launched initiatives designed to refocus
      MDS
      as a globally competitive life sciences company. These activities resulted
      in
      restructuring charges of $61 million in 2005 and $10 million in 2004. In fiscal
      2006, we completed certain of these initiatives and as a result reduced the
      balance of reserves set aside for these activities. These reserve reductions
      included the elimination of provisions made last year for expected costs
      associated with an early termination of certain information technology
      outsourcing agreements. Satisfactory conclusion to the termination negotiations
      eliminated the need for this reserve. Also, during 2006 we completed the closure
      of our generic radiopharmaceuticals business in Europe, eliminating the need
      for
      the remaining reserves.





Selling,
      general, and administration expense (SG&A) for the year totalled $248
      million, or 21.8% of revenues for our continuing businesses. This compares
      to
      $245 million and 21.2% of revenues for 2005 and $228 million and 20.0% of
      revenues for 2004. In late 2005 we took steps to reduce spending on SG&A,
      including a significant headcount reduction in corporate and central support
      services. While these efforts were successful, the reductions were more than
      offset by spending on the Retrospective Review and SOx compliance, with a $37
      million negative impact on SG&A spending in the year for these two items.
      Excluding these items, SG&A spending in 2006 was substantially lower than in
      prior years.





MDS
      Sciex
      is responsible for the majority of R&D costs we incur. Spending on R&D
      fell from $100 million in 2004 to $86 million in 2005. Excluding the impact
      of
      spending by MDS Proteomics in fiscal 2004, fiscal 2005 marked the highest level
      of R&D spending in our history as we approached launch dates for several key
      new products in the second half of 2005. R&D spending declined further to
      $60 million in 2006 as these product launches were behind us. Reflecting these
      changed spending patterns, the reported R&D expense was $19 million compared
      to $31 million in 2005.





Depreciation
      and amortization expense amounted to $71 million, a $10 million increase from
      2005, most of which can be attributed to amortization of deferred development
      costs capitalized in prior years by MDS Sciex.








**Earnings
      per share**


Adjusted
      earnings per share for the year were as follows:





**2006**
            
            2005
            
            2004Basic
                and diluted earnings per share from continuing operations - as reported
            **$**
            **0.22**
            $
            -
            $
            0.16Adjusted
                for:Gain
                on sale of a business and other
            
            **(0.01)**
            
            -
            
            (0.08)MAPLE
                settlement
            
            **0.04**
            
            -
            
            -Mark-to-market
                on interest rate swaps
            
            **-**
            
            0.01
            
            -Restructuring
            
            **(0.04)**
            
            0.30
            
            0.04Valuation
                provisions and investment write-downs
            
            **0.06**
            
            0.13
            
            0.15Tax
                rate changes
            
            **(0.03)**
            
            -
            
            -MDS
                Proteomics
            
            **-**
            
            -
            
            0.47Adjusted
                EPS
            **$**
            **0.24**
            $
            0.44
            $
            0.74





Adjustments
      made to determine adjusted EPS include all items used to derive adjusted EBITDA.
      In addition, we revalued certain future tax balances based on an enacted
      Canadian federal rate reduction and a Quebec tax rate increase. The impact
      of
      this revaluation was a $4 million reduction in net future tax liabilities,
      and
      the EPS impact of this was recorded as an adjustment.





**Fiscal
      2006 guidance report**


In
      early
      2006, we provided guidance for our year ended October 31, 2006 with respect
      to
      certain key financial measures, including expected revenue growth, expense
      reductions, profitability improvements, and capital expenditures. The following
      table reconciles the 2006 guidance to proforma results. For all measures except
      revenue growth, these pro forma results include the impact of our Canadian
      diagnostics businesses other than CLS, as these businesses were included in
      forming the original guidance.





**Measure**
            **Guidance**
            **2006
                Result**
            **Comment**Revenue
                Growth
            6%
                to 9% organic growth from continuing life sciences
                businesses
            6%
                organic growth
            Within
                guidanceSG&A
                Expenses
            100
                to 200 bps reduction in SG&A as a percentage of
                revenue
            80
                bps as reported
            200
                bps reduction, excluding Retrospective ReviewEBITDA
                Margin
            100
                to 250 bps improvement in organic adjusted EBITDA margin
            Unchanged
                as reported
            370
                bps improvement, excluding impact of Retrospective
                ReviewCapital
                Expenditures
            $55
                to $65 million
            $66
                million
            $1
                million above guidance range;
              $61
                million excluding Diagnostics
                segment








**MDS
      Pharma Services**


**Financial
      Highlights**


**2006**
            **%
                of Net revenues**
            2005
            %
                of Net revenues
            2004
            %
                of Net revenues**Net
                revenues**Early-stage
            **$
                305**
            **58%**
            $
                336
            62%
            $
                336
            66%Late-stage
            **217**
            **42%**
            207
            38%
            173
            34%**522**
            **100%**
            543
            100%
            509
            100%Cost
                of revenues
            **(399)**
            **(76%)**
            (380)
            (70%)
            (347)
            (69%)Selling,
                general and administration
            **(137)**
            **26%)**
            (147)
            (27%)
            (122)
            (24%)Research
                and development
            **-**
            **-**
            (2)
            -
            (1)
            -Depreciation
                and amortization
            **(34)**
            **(7%)**
            (31)
            (6%)
            (27)
            (5%)Restructuring
                charges
            **-**
            **-**
            (24)
            (4%)
            1
            -Other
                income (expense)
            **4**
            **1%**
            (14)
            (3%)
            (10)
            (2%)Equity
                earnings
            **(1)**
            **-**
            -
            -
            (2)
            -**Operating
                income (loss)**
            **(45)**
            **(9%)**
            (55)
            (10%)
            1
            -Adjustments:Gain
                on sale of a business
            **(2)**
            **-**
            -
            -
            -
            -Valuation
                provisions
            **-**
            **-**
            14
            3%
            10
            2%Restructuring
            **-**
            **-**
            24
            4%
            (1)
            -**(47)**
            **(9%)**
            (17)
            (3%)
            10
            2%Depreciation
                and amortization
            **34**
            **7%**
            31
            6%
            27
            5%**Adjusted
                EBITDA**
            **$
                ( 13)**
            **(2%)**
            $
                14
            3%
            $
                37
            7%**Capital
                expenditures**
            **$41**
            
            $30
            
            $42





MDS
      Pharma Services 2006 revenues fell by 4% on a consolidated basis as solid growth
      in our global clinical development and central laboratories did not offset
      weakness in certain early-stage businesses, particularly bioanalytical. On
      an
      organic basis, revenues climbed 3% for fiscal 2006 compared to 2005.





In
      our
      late-stage businesses, revenues from our central laboratory services and global
      clinical development services increased 6% and 4% respectively, compared to
      the
      prior year, as sales in this market remained strong. These businesses were
      also
      the major contributors as we grew contract backlog to US$430 million by year-end
      compared to US$340 million at the end of 2005, for a 26% increase. This followed
      a 13% increase in 2005 from the US$300 million reported at the end of fiscal
      2004.





Average
      monthly backlog by quarter was as follows:





**Average
                monthly backlog**
            
            **(millions
                of US dollars)**Fiscal
                2005 - Quarter 1
            **$**
            **315**Quarter
                2
            
            **305**Quarter
                3
            
            **315**Quarter
                4
            
            **340**Fiscal
                2006 - Quarter 1
            
            **370**Quarter
                2
              Quarter
                3
              Quarter
                4
            
            **400**
              **400**
              **430**





Our
      overall early-stage research businesses were down 9%; however, our pharmacology
      businesses experienced 11% growth this year while drug safety services revenues
      were essentially level with the prior year. The drop in early-stage revenues
      reflects the continuing impact of the ongoing Retrospective Review.





MDS
      Pharma Services has reported an operating loss this year, due in large part
      to
      the impact of the Retrospective Review, including the direct costs of the Review
      and the related impact on customers.





SG&A
      expenses for the segment were down this year, despite the impact of the
      Retrospective Review, due primarily to the restructuring undertaken at the
      end
      of fiscal 2005. Segment SG&A includes $19 million of costs associated with
      the Review and we therefore expect a further reduction in SG&A as a
      percentage of revenues for the segment in fiscal 2007 once the review work
      is
      complete.





Other
      income and expense for 2006 includes a $2 million gain from the sale of the
      agronomics business and a $2 million insurance settlement for costs related
      to
      Hurricane Katrina, which severely damaged our New Orleans Phase I facility
      in
      September 2005. The agronomics gain has been treated as an adjustment in
      arriving at adjusted EBITDA. The insurance proceeds were not treated as an
      adjustment as they represent reimbursement for costs otherwise incurred and
      expensed during the year.





During
      2005, we determined that a $6 million long-term investment was impaired based
      on
      our assessment of the likelihood of collecting this loan receivable. In
      addition, we recorded an $8 million impairment charge related to a five-year
      licensing agreement with an investee that granted us access to certain
      biomarker-related technology. This technology became redundant when we launched
      the Biomarker Alliance with a number of partners in June 2005. These items
      make
      up other income (expense) for 2005.





Adjusted
      EBITDA for the segment was a loss of $13 million compared to income of $14
      million in 2005 and $37 million in 2004. Adjusted EBITDA for 2006 reflects
      $27
      million related to the direct costs of the Retrospective Review (including
      the
      $19 million recorded in SG&A and a further $8 million recorded in cost of
      revenues) compared to $4 million in 2005.





We
      remain
      focused on taking action to position MDS Pharma Services for continued growth
      and improved operating profitability as we move forward. Recently, we have
      taken
      a number of steps designed to focus on MDS Pharma Services’ core competencies
      and strengthen the business:





§
            Appointment
                of David Spaight as President of MDS Pharma
                Services


§
            Strengthening
                our senior management team with new global leaders in Pharmacology,
                Early
                Clinical Research, Bioanalysis, Global Clinical Development, and
                Global
                Central Labs


§
            Expansion
                of our early clinical research capacity in Lincoln (50 beds), expansion
                of
                capacity in our drug safety testing business in Lyon, and beginning
                an
                expansion of our Phoenix early clinical research capacity (300 beds)


§
            Selling
                or closing of a number of our smaller, less profitable business lines
                and
                sites including, Munich (clinical pharmacology), Geneva (in vitro
                pharmacology), Taipei (fermentation); Tampa (pharmaceutics), Blainville
                (pharmaceutics), Bothell (biopharmaceutics/biosafety), and Lincoln
                (agricultural testing)


§
            Stringent
                management of hiring and discretionary
                spending


§
            Enhanced
                management review and reporting
                processes


§
            More
                selective business development activities, particularly in our late-stage
                businesses


§
            Introduction
                of LeanSigma as a primary tool to facilitate continuous
                improvement




In
      the
      fourth quarter of 2006, we took further action aimed at productivity improvement
      in our growing pharmacology and global clinical development businesses through
      the elimination of 50 positions, which resulted in a $3 million restructuring
      charge being recorded in the quarter, offsetting a reduction in certain
      restructuring reserves set aside last year.





Subsequent
      to year-end, we announced the closure of our Phase I facility in New Orleans,
      which was reconstructed after it was damaged in Hurricane Katrina in 2005.
      Unexpectedly, our experience has been that it is difficult to attract volunteers
      necessary to conduct studies and that customers have been reluctant to place
      work in this region, preferring instead to direct studies to our other
      facilities. With our recently completed expansion in Lincoln and our ongoing
      expansion in Phoenix, we will have sufficient new capacity to accommodate the
      expected continued growth in demand for our Phase I services in 2007 and beyond.





Also
      subsequent to year-end, we completed the sale of our local Spanish clinical
      development business. This operation was focused exclusively on domestic Spanish
      opportunities and was not considered to be central to our global clinical
      development business going forward. We will continue to have an operating
      presence in Madrid, which will be managed as part of our integrated global
      clinical development network.





We
      expect
      to report a loss ranging between $7 million and $9 million in the first quarter
      of 2007 in connection with these activities.





Additional
      operating improvement initiatives are currently under evaluation, and we expect
      to implement these initiatives in coming months.





Capital
      expenditures for the segment totalled $41 million and included amounts spent
      to
      increase capacity in Lincoln and Lyon and to establish our new central
      laboratory in the US. Capital expenditures were $30 million in 2005 and $42
      million in 2004.








**FDA
      review of bioanalytical operations**


The
      Company continues to work to address FDA issues related to bioequivalence
      operations in our St. Laurent and Blainville facilities. Other lines of business
      in St. Laurent and elsewhere, and other sites where bioequivalence work is
      conducted, are not the subject of the FDA letters and discussions described
      below. These other business lines and sites continue to operate in the ordinary
      course of business and are subject from time to time to routine FDA inspections.
      We have no indication that the FDA has concerns with respect to these
      operations.





The
      current regulatory issues commenced with the receipt of two letters from the
      FDA
      in May and December 2004. The first of these letters expressed concerns related
      to certain procedures performed in a bioanalytical study in 2001 at our St.
      Laurent facility. The second letter related to inspections of the St. Laurent
      bioequivalence operations during September and October 2004.





In
      response to these letters, we met with the FDA during February 2005 and agreed
      on a plan for MDS to undertake a comprehensive self-review of bioequivalence
      studies conducted at our St. Laurent facility from 2000 through 2004. This
      Review commenced in March 2005.





The
      FDA
      conducted an inspection of our bioequivalence operations in St. Laurent and
      Blainville during March 2006. At the conclusion of the inspections, we received
      observations on a Form 483 related to the effectiveness and management of the
      Retrospective Review, and to certain studies conducted at both sites. Following
      the inspection, we made changes to the review management team and specific
      changes in the Retrospective Review, and voluntarily suspended all commercial
      bioanalytical liquid chromatography/mass spectrometry operations at the St.
      Laurent facility in order to focus the site’s resources on completing the review
      in a high-quality manner.





In
      September 2006, we received a further letter from the FDA (the 2006 Letter)
      regarding the Retrospective Review and the March 2006 inspection, including
      certain of our responses to the related Form 483. The 2006 Letter was critical
      of the management and the effectiveness of the Retrospective Review and took
      issue with certain responses to the Form 483 observations and our investigation
      of certain results. While not addressing all of the actions implemented by
      the
      Company since March 2006, the letter made it clear that we had not yet been
      able
      to satisfactorily demonstrate to the FDA the effectiveness of the Retrospective
      Review or that their concerns had been fully addressed.




We
      also
      were advised during 2006 by a limited number of customers that they had received
      letters from the FDA indicating that submissions containing bioequivalence
      data
      from our St. Laurent and Blainville facilities would not be approved until
      FDA
      concerns with the data were resolved.





In
      October 2006, we met with the FDA regarding the status of the Retrospective
      Review and the 2006 Letter. At this meeting, and in correspondence with the
      FDA
      and responses to the 2006 Letter and the Form 483 observations, MDS has
      responded to the concerns raised by the FDA, highlighted upgrades and
      enhancements to the Retrospective Review and provided a comprehensive update
      of
      the findings of the Retrospective Review. While we consider the October meeting
      to have been productive and believe that we have provided information sufficient
      to address FDA concerns with the Retrospective Review, MDS has not yet received
      a response from the FDA to its submissions and there can be no assurance that
      the FDA will be satisfied with our response, that the FDA will accept the
      results of the Retrospective Review, or that the FDA will not take further
      enforcement action.





During
      fiscal 2006 we devoted substantial effort and resources to conducting the
      Retrospective Review, incurring direct costs of $31 million, of which $27
      million is included in MDS Pharma Services’ results and $4 million, is recorded
      in our corporate segment. These amounts include direct labour, consulting costs,
      and the cost of related customer accommodations.





Since
      February 2005 we have worked diligently in the conduct of the Retrospective
      Review and to address issues raised by the FDA related to our St. Laurent and
      Blainville bioequivalency operations including:





§
            Establishing
                a dedicated team in February 2005 to conduct the Retrospective Review,
                which now includes approximately 100 full-time
                employees


§
            Improving
                the leadership, project management, and control of the Retrospective
                Review in response to the March 2006
                inspection


§
            Initiating
                changes to the Company’s quality and regulatory procedures, including the
                introduction of a Quality Leadership Program to formalize the learnings
                from the Retrospective Review. This program is designed to improve
                customer quality and services through continuous improvement and
                compliance across all of our bioanalytical sites to ensure that operations
                are compliant with current FDA standards including procedures that
                automatically trigger investigational activities when data issues
                occur


§
            Engaging
                third party consultants, including Lachman Consultant Services Inc.,
                to
                assist with the review and to audit the process and results


§
            Suspending
                all commercial bioanalytical liquid chromatography/mass spectrometry
                operations in the St. Laurent facility in March 2006 to allow the
                facility
                to focus solely on the Retrospective
                Review


§
            Prioritizing
                of studies subject to letters from the FDA as described above


§
            Providing
                detailed response to FDA Form 483 observations and
                letters


§
            Submitting
                study closure reports to the FDA and sponsors upon the completion
                of the
                review and audit of studies





Since
      receipt of the first FDA letter, we have worked closely with our clients to
      keep
      them informed of our ongoing discussions with the FDA. We have worked especially
      closely with clients who have had bioanalytical data produced in our St. Laurent
      and Blainville facilities questioned by the FDA by prioritizing study reviews
      to
      correspond with their priorities.





Bioequivalence
      work for our generic customers has suffered a significant decline over the
      period in which we have been addressing the FDA issues. Our early clinical
      business has continued to experience a noticeable decline in business, generally
      attributable to reluctance by certain of our generic customers to place work
      in
      the St. Laurent clinic while the review is underway.





Resolution
      of the Retrospective Review remains a key operational focus for MDS Pharma
      Services and MDS. We have focused on maintaining open communication with clients
      and keeping them aware of the progress of our work. We remain committed to
      working cooperatively with the FDA and our customers to address all of the
      FDA’s
      concerns and to complete the Retrospective Review in a satisfactory manner.
      There can be no assurance that these studies will be acceptable to the FDA
      or
      that they will not require additional work.





On
      January 10, 2007, the US Food and Drug Administration (the FDA) issued letters
      to MDS and to sponsors of studies conducted by the Company at its Montreal-area
      bioanalytical laboratory facilities. In the letter, the FDA indicated that
      sponsors would be responsible for re-validation of certain data and conclusions
      related to bioanalytical studies conducted by MDS in the period 2000 to
      2004.





The
      Company is currently assessing the impact of this event to determine the amount
      of additional costs that MDS may incur related to settlements with sponsors,
      changes to its Montreal-area facilities and processes, or other matters, if
      any.
      Insufficient information is currently available to enable the Company to measure
      such costs with certainty or to determine the timing of such payments, and
      therefore, no provision for these additional costs, if any, has been recorded
      in
      the statement of financial position for these matters as at October 31,
      2006.





At
      the
      current time we are not able to estimate the full extent or cost of the effort
      required to fully satisfy the FDA and related client obligations. We also are
      unable to judge what further impact this situation will have on our business
      development activities, particularly for our bioanalytical and early clinical
      operations.








**MDS
      Nordion**


**Financial
      Highlights**


**2006**
            **%
                of Net revenues**
            2005
            %
                of Net revenues
            2004
            %
                of Net revenues**Net
                revenues**
            **$338**
            **100%**
            $325
            100%
            $350
            100%Cost
                of revenues
            **(172)**
            **(51%)**
            (163)
            (50%)
            (163)
            (47%)Selling,
                general and administration
            **(58)**
            **(17%)**
            (57)
            (18%)
            (51)
            (15%)Research
                and development
            **(4)**
            **(1%)**
            (4)
            (1%)
            (4)
            (1%)Depreciation
                and amortization
            **(16)**
            **(5%)**
            (17)
            (5%)
            (15)
            (4%)Restructuring
                charges
            **2**
            **1%**
            (4)
            (1%)
            (2)
            -Other
                income (expense)
            **(10)**
            **(3%)**
            -
            -
            3
            1%Equity
                earnings
            **-**
            **-**
            -
            -
            -
            -**Operating
                income**
            **80**
            **24%**
            80
            25%
            118
            34%Adjustments:MAPLE
                settlement
            **10**
            **3%**
            -
            -
            -
            -Other
                gains
            **-**
            **-**
            -
            -
            (3)
            (1%)Restructuring
            **(2)**
            **(1%)**
            4
            1%
            2
            -**88**
            **26%**
            84
            26%
            117
            33%Depreciation
                and amortization
            **16**
            **5%**
            17
            5%
            15
            4%**Adjusted
                EBITDA**
            **$104**
            **31%**
            $101
            31%
            $
                132
            38%**Capital
                expenditures**
            **$
                -**
            
            $
                61
            
            $
                56





Revenues
      from our isotopes business were up 4% compared to the prior year on a reported
      basis and 14% on an organic basis. Revenues were especially strong in the first
      half of fiscal 2006 as a major competitor announced a voluntary recall of
      technetium generators, used primarily for cardiac imaging, while they addressed
      sterility issues at their primary manufacturing facility. This facility was
      out
      of production for most of the first six months of fiscal 2006 and sales volumes
      for our isotopes business increased during this time. We estimate that up to
      $16
      million of high-margin revenues were realized in the first two quarters related
      to this. Industry supply returned to normal by the end of May.





Our
      supply of cobalt was much better this year, following a year of tight supply
      in
      fiscal 2005. Our sterilization business is heavily dependent on cobalt
      inventories, which are, in turn, impacted by maintenance schedules for the
      power
      generating reactors in which they are produced. Quarterly volumes and revenues
      for this portion of our isotopes business can fluctuate significantly based
      on
      the timing of reactor maintenance. Our inventory of cobalt was reduced by the
      fourth quarter of fiscal 2006 for this reason. Demand for cobalt remains
      healthy, and we took steps to increase our supply of cobalt, signing a new
      long-term contract in November 2005 with Rosenergoatom (the utility operator
      responsible for Russia’s nuclear power plants) and, in February 2006, renewing
      our existing contract with Bruce Power Limited Partnership to 2019.





Early
      in
      fiscal 2006, we were pleased to report the settlement of mediation with AECL
      related to the MAPLE reactor project. The agreement reached with AECL provides
      the basis for a productive ongoing relationship between us and enables AECL
      to
      move forward on the construction project. We have been relieved of any
      obligation for capital costs related to the completion of construction and
      commissioning of the reactors and the dedicated production facility, and at
      the
      same time, we have achieved a level of certainty regarding the cost of acquiring
      isotopes for sale in the future that was not possible under the earlier
      agreement.





Under
      this settlement agreement, we exchanged our interest in the project, along
      with
      certain associated inventories, for $25 million in cash, a non-interest bearing
      note due over four years beginning in 2008, and a 40-year supply agreement
      containing terms that are similar to those contained in the current supply
      agreement with AECL. Since AECL has now assumed full ownership of the facility,
      it will be responsible for capital costs associated with completing construction
      and commissioning the reactors and for future operating costs. MDS has retained
      a commitment to assist AECL to defray the costs of any material and unusual
      regulatory changes, should such a change occur during the life of the current
      or
      future supply agreement. This commitment extends to cover any changes required
      by international agreements or treaties related to the use of highly enriched
      uranium in the reactors. We have also retained certain legal rights in the
      event
      that the facility is not operational by 2008.





As
      at
      October 31, 2005, the carrying value of our interest in the project totalled
      $393 million. This carrying value included construction costs, as well as
      interest costs that were capitalized during the construction phase. As part
      of
      the settlement, AECL assumed responsibility for all costs incurred on the
      project subsequent to October 31, 2005, and a settlement was reached for certain
      earlier costs that we had capitalized prior to November 1, 2005.





Taking
      these adjustments into account, the carrying value of our interest in the
      project was $370 million at the time of the settlement. Under the settlement,
      we
      exchanged our interest in the reactor project, along with related parts and
      supply inventories having a carrying value of $53 million, for $25 million
      in
      cash, the promissory note having a discounted present value of $43 million,
      and
      the 40-year supply agreement. With the assistance of an independent valuator,
      we
      determined that the fair value of the supply agreement was $344 million and,
      accordingly, we recorded a loss of $10 million resulting from this settlement
      in
      the second quarter. This amount has been treated as an adjustment in arriving
      at
      adjusted EBITDA for the year.





The
      National Research Universal reactor will remain our primary source of reactor
      isotopes, including molybdenum, while AECL completes the MAPLE facility. In
      July
      2006, AECL announced that the operating licence for this facility was extended
      to October 31, 2011.





Late
      in
      2006 we announced plans to launch a clinical trial for our proprietary product,
      TheraSphere®. The trial, which will focus on patients suffering from secondary
      liver cancer, will proceed during fiscal 2007. Meanwhile, sales of TheraSphere
      continued under a humane devices exemption.





In
      2004,
      we concluded a $32 million (US$25 million) agreement with Biogen Idec Inc.
      to
      buy out certain minimum purchase commitments related to the supply of
      yttrium-90. The proceeds of this agreement were recorded as deferred revenue
      and
      are being recognized in income over the original five-year contract term, which
      ends in February 2007.





The
      reversal of restructuring provisions in this segment relates to reserves
      established in 2003 for the closure of our generic radiopharmaceutical
      manufacturing business in Belgium. The closure of these operations was finalized
      this year, and certain of the costs originally provided for were avoided. We
      have also adjusted EBITDA for a gain we recorded in 2004 following the sale
      of
      shares of the acquirer of our Oncology Solutions business. The shares were
      received as part of the consideration from that sale in 2003. This amount was
      included in other income in 2004.





SG&A
      expenses were up slightly for MDS Nordion at $58 million compared to $57 million
      in 2005. Depreciation and amortization was down slightly at $16 million compared
      to $17 million in the prior year.





Adjusted
      EBITDA for the segment was $104 million, up 3% from 2005 on a reported basis
      and
      up 31% organically. Currency continues to have a significant impact on the
      reported results for MDS Nordion as a large portion of revenues is denominated
      in US dollars while the majority of costs are denominated in Canadian
      dollars.





During
      fiscal 2006 we introduced a new line of equipment for cancer treatment, the
      MDS
      Nordion EquinoxTM,
      a state-of-the-art cancer therapy system, and Avanza, a patient positioning
      treatment table. Both the Equinox and the Avanza received CE Mark approval
      and
      are now commercially available in Europe and elsewhere. Sales of these products
      developed over the course of the year.





Also
      during 2006, MDS Nordion signed two new strategic customer agreements. In
      February, we signed a six-year renewable contract with Molecular Insight
      Pharmaceuticals, Inc. (MIP) to manufacture and supply ZemivaTM, a molecular
      imaging pharmaceutical being developed for cardiac ischemia, or insufficient
      blood flow to the heart. ZemivaTM, currently in clinical trials, is targeted for
      the emergency department setting. This contract will enable us to build upon
      our
      existing strong development partnership with MIP through the use of our
      significant development and manufacturing capabilities to meet the commercial
      market needs of ZemivaTM. As a result of the contract, we have expanded our Good
      Manufacturing Practice (GMP) manufacturing capabilities at our Vancouver
      facility to support the clinical program and commercial supply of ZemivaTM.





In
      April,
      we signed a three-year contract with Bradmer Pharmaceuticals Inc. (Bradmer)
      for
      the development and clinical trial supply of NeuradiabTM, a monoclonal antibody
      conjugated to an isotope and used to treat glioblastoma multiforme, the most
      common and deadly form of brain cancer. In six clinical trials reported by
      Bradmer leading up to the signing of this agreement and involving over 160
      glioblastoma multiforme cancer patients, NeuradiabTM demonstrated a significant
      survival benefit over historical controls. This new agreement with Bradmer
      further demonstrates our capabilities in the growing field of
      radiotherapeutics.





Business
      arrangements such as those with Bradmer and MIP are consistent with our
      strategic direction in this business as we focus on broadening our product
      offerings in medical imaging and radiotherapeutics. Expertise in radioisotope
      production and utilization is a key competency for MDS Nordion, and we plan
      to
      leverage this knowledge in new product areas. Neither of these contracts had
      a
      material impact on fiscal 2006 results, but both position us well in this market
      for the future.





Capital
      expenditures by MDS Nordion were negligible in 2006 as AECL assumed full
      responsibility for the construction of MAPLE. Capital costs were $61 million
      and
      $56 million in 2005 and 2004, respectively, due to the significant investment
      then being made in MAPLE. Aside from capital expenditures, MDS Nordion invests
      significantly in maintenance of its facilities, and all such costs are expensed
      as incurred.








**MDS
      Sciex**


**Financial
      Highlights**


**2006**
            **%
                of Net revenues**
            2005
            %
                of Net revenues
            2004
            %
                of Net revenues**Net
                revenues**
            **$280**
            **100%**
            $286
            100%
            $282
            100%Cost
                of revenues
            **(172)**
            **(61%)**
            (166)
            (58%)
            (150)
            (53%)Selling,
                general and administration
            **(18)**
            **(6%)**
            (19)
            (7%)
            (11)
            (4%)Research
                and development
            **(15)**
            **(5%)**
            (26)
            (9%)
            (33)
            (12%)Depreciation
                and amortization
            **(21)**
            **(8%)**
            (12)
            (4%)
            (8)
            (3%)Restructuring
                charges
            **-**
            **-**
            (3)
            (1%)
            -
            -Other
                income (expense)
            **-**
            **-**
            -
            -
            (1)
            -Equity
                earnings
            **-**
            **-**
            1
            -
            -
            -**Operating
                income**
            **54**
            **19%**
            61
            21%
            79
            28%Adjustments:Other
                gain
            **-**
            **-**
            -
            -
            (14)
            (5%)Valuation
                provisions
            **-**
            **-**
            -
            -
            15
            5%Restructuring
            **-**
            **-**
            3
            1%
            -**54**
            **19%**
            64
            22%
            80
            28%Depreciation
                and amortization
            **21**
            **8%**
            12
            4%
            8
            3%**Adjusted
                EBITDA**
            **$75**
            **27%**
            $76
            26%
            $
                88
            31%**Capital
                expenditures**
            **$
                8**
            
            $
                6
            
            $
                9




MDS
      Sciex
      revenues were down 2% as reported but up 5% on an organic basis, as the
      declining US dollar continued to have an impact on this export-based business.
      Strong sales of high-end instruments were the driver of results this year and
      demand from the small molecule markets has offset softer market conditions
      for
      proteomics. Our high-end API 5000TM and API 4000TM were also strong performers,
      joined this year by the 4800 MALDI TOF/TOFTM analyzer, a product we introduced to
      the proteomics market in 2005.





Applied
      markets continued to grow in prominence in 2006, as more and more new users
      in
      these fields adopt mass spectrometry as part of their core capabilities. These
      markets include food testing and forensics and typically make use of mid-range
      platforms. Our mid-range API 3200TM and 3200 Q TRAP® have proven popular in these
      markets.





Over
      the
      past two years we have introduced 18 new products ranging from software updates
      to a revolutionary new platform for cellular analysis. We have entered the
      HPLC
      market with a new line of equipment sold under the TempoTM name. We are happy
      with the market response to our new products this year. While many of the new
      products develop on existing technologies and markets, the CellKeyTM System is an
      entirely new product for us. The CellKey System is based on cellular dielectric
      spectroscopy (CDS) technology, an approach that removes the requirement for
      fluorescent or radiolabelled markers from the drug discovery workflow, thereby
      simplifying assay development. The sensitivity of CDS's impedance-based
      measurement system enables the measurement of endogenous receptor targets in
      whole live cells and the generation of data that is more biorelevant than in
      other cellular screening systems.





CellKey
      is an important new product for us in a number of ways. To begin, it is the
      first major product launch for us outside of our existing partnerships with
      Applied Biosystems and PerkinElmer. It is also the flagship instrument that
      will
      be manufactured in our new Singapore facility. This facility was officially
      opened in February 2006 and we have been transferring production of certain
      products to the facility throughout the year. This location will also enable
      us
      to secure a more effective supply chain with Asian suppliers and we intend
      to
      source product for both our Singapore and Concord manufacturing operations
      from
      these suppliers. We believe the cost savings afforded by reorganizing our
      operations in this way will help to offset the impact of the US
      currency.





MDS
      Sciex
      reported operating income of $54 million for the year, down 11% from 2005.
      The
      drop in the value of the US dollar was a significant factor in the reported
      results. Factoring in the impact of the movement in the US dollar, adjusted
      EBITDA was 22% higher for 2006 versus 2005 on an organic basis.





A
      modest
      reduction in SG&A in the year from $19 million to $18 million followed our
      restructuring announced at the end of 2005. SG&A in fiscal 2004 was $11
      million.





Under
      Canadian GAAP, we capitalize a substantial portion of our R&D spending and
      amortize these deferred costs once products are brought to market. Details
      of
      our R&D expenses are included in note 12 to our consolidated financial
      statements.





The
      substantial increase in depreciation and amortization in 2006 relates primarily
      to the amortization of development costs previously deferred. Amortization
      of
      such costs was low in fiscal 2005 as this was a transition year between product
      lines.





In
      2004,
      we recorded a gain of $14 million resulting from a successful US patent
      infringement suit against Micromass/Waters.





Capital
      expenditures totalled $8 million compared to $6 million in 2005 and $9 million
      in 2004. Costs associated with the construction of the Singapore facility and
      the cost of demonstration models of our new products account for the majority
      of
      spending this year.





**Corporate
      and other**


**Financial
      highlights**


**2006**
            2005
            2004Selling,
                general and administration
            **($
                35)**
            ($
                22)
            ($
                38)Research
                and development
            **-**
            1
            -Depreciation
                and amortization
            **-**
            (1)
            (2)Restructuring
                charges
            **6**
            (30)
            (9)Other
                income (expense)
            **(1)**
            (3)
            -Equity
                earnings
            **(5)**
            (7)
            1**Operating
                loss**
            **(35)**
            (62)
            (48)Adjustments:Mark-to-market
                adjustments
            **1**
            3
            -Valuation
                provisions
            **7**
            7
            -Restructuring
            **(6)**
            30
            9Depreciation
                and amortization
            **-**
            1
            2**Adjusted
                EBITDA**
            **($
                33)**
            ($
                21)
            ($
                37)





Corporate
      and other includes costs associated with our Corporate offices and executive
      management functions, along with equity earnings related to certain venture
      investments. Corporate expenses for fiscal 2006 were 3% of consolidated net
      revenues compared to 2% for fiscal 2005 and 3% for 2004. Corporate expenses
      for
      2006 include $4 million associated with the costs of the Retrospective Review
      compared to $2 million in fiscal 2005. Costs also include the corporate portion
      of our SOx compliance efforts and incremental audit costs associated with that
      certification. Fiscal 2004 was not affected in any significant way by either
      of
      these items.





To
      improve our operating results, we implemented a restructuring plan in 2005
      that
      included a reduction of our global workforce by approximately 750 employees.
      Approximately one-quarter of the headcount reduction came from our Corporate
      and
      now-disbanded Enterprise Services areas. Net restructuring charges incurred
      in
      Corporate amounted to $30 million in 2005 related to these plans.





Other
      items affecting the comparability of the corporate and other segment from year
      to year include the following:


§
            R&D
                investment tax credits earned in fiscal 2005 and related to our MDS
                Proteomics business that was shut down in 2004 were included in the
                corporate and other segment.


§
            Fiscal
                2005 includes depreciation and amortization associated with the start-up
                period of our new ERP system. In fiscal 2006 the depreciation and
                amortization associated with this system was charged to the businesses
                that utilize the system.


§
            Corporate
                and other for 2006 and 2005 include valuation provisions to reduce
                the
                value of certain investments to our estimate of their net realizable
                value.


§
            Other
                income (expense) reflects mark-to-market adjustments on a portion
                of our
                interest rate swaps that was deemed to be an ineffective hedge for
                accounting purposes.





On
      December 2, 2005, Hemosol Corp. (Hemosol, an investee in which we hold
      approximately 6.5 million shares), declared bankruptcy. As a result of the
      bankruptcy, Hemosol’s bank requested payment by MDS under the guarantee, and on
      December 8, 2005, we paid the bank $20 million. In doing so, we assumed the
      loan
      and the senior security position held by the bank. As we had previously provided
      for a $7 million exposure under this guarantee, the carrying value of this
      new
      debt interest is $13 million.





In
      conjunction with another secured lender who ranks second to us in preference,
      during the course of fiscal 2006, we provided $1.5 million of
      debtor-in-possession (DIP) financing to facilitate an orderly liquidation of
      Hemosol.





On
      November 3, 2006, we sold our secured interest in Hemosol for $13 million.
      We
      also sold our DIP financing interest to the same party for its face value.
      We
      expect to report a gain of approximately $2 million as a result of this
      transaction, as the carrying value of our DIP financing interest is nil.
      Subsequent to that transaction, a third party sponsor of a plan that will enable
      Hemosol to emerge from bankruptcy protection sought to have this transaction
      set
      aside. The outcome of this action cannot be estimated at this time.





**Discontinued
      operations**





The
      results of our discontinued businesses were as follows:


**2006**
            2005
            2004Net
                revenues
            **$
                414**
            $
                675
            $
                723Cost
                of revenues
            **(256)**
            (477)
            (531)Selling,
                general and administration
            **(61)**
            (113)
            (98)Depreciation
                and amortization
            **(10)**
            (14)
            (17)Goodwill
                write-down
            **-**
            (15)
            -Gain
                on sale of discontinued operations
            **28**
            -
            -Restructuring
                charges
            **(1)**
            (11)
            (4)Other
                expenses
            **(3)**
            -
            (10)Equity
                earnings (loss)
            **3**
            2
            2Operating
                income (loss)
            **114**
            47
            65Interest
                expense
            **-**
            (1)
            (1)Dividend
                and interest income
            **2**
            3
            1Income
                taxes recovery (expense)
            **7**
            (9)
            (23)Minority
                interest - net of tax
            **(10)**
            (10)
            (14)Income
                from discontinued operations - net of tax
            **$
                113**
            $
                30
            $
                28Basic
                earnings per share
            **$
                0.79**
            $
                0.22
            $
                0.20





Income
      taxes applicable to our discontinued operations for fiscal 2006 include a $4
      million recovery related to assets disposed of in the year and a $15 million
      tax
      recovery related to the recognition in 2006 of the tax shelter provided by
      capital losses of prior years that were not previously recognized. We expect
      to
      use these capital losses to reduce the amount of cash taxes payable resulting
      from the sale of the diagnostics business and accordingly have classified this
      recovery within discontinued operations.





The
      sale
      of Calgary Laboratory Services was finalized in early 2006. A goodwill
      impairment charge of $15 million was recorded in 2005 to reflect our anticipated
      recovery from this sale.





In
      November 2005, we completed the sale of our interest in Source to Cardinal
      Health for proceeds of $79 million and recorded a gain of $28 million. The
      gain
      on this transaction was tax sheltered due to the availability of certain capital
      losses within MDS.





Other
      expenses in discontinued operations include a $3 million non-cash valuation
      provision on long-term investments (2004 - $10 million).








**Interest**


Interest
      expense was $26 million compared to $21 million in 2005 and $23 million in
      2004.
      The increase compared to 2005 relates to non-cash interest expense on a
      government loan associated with the MAPLE project. Prior to the MAPLE
      settlement, interest on this loan was capitalized as part of the project costs.
      In 2006, we capitalized $2 million of interest costs related to the MAPLE
      project (2005 - $9 million; 2004 - $8 million) prior to completing the
      settlement.





Dividend
      and interest income was $18 million for the year, an increase of 80% over 2005.
      Higher cash balances and interest on the MAPLE inventory note receivable account
      for the increase.








**Income
      taxes**


The
      effective tax rate for 2006 was 30% (2005 - 92%; 2004 - 74%). The 2006 rate
      was
      lower than the expected rate because of the net impact of lower future Canadian
      federal income tax rates, partially offset by higher rates expected in the
      future applicable to our earnings in the province of Quebec. These items
      resulted in a $4 million net decrease in future tax liabilities, which reduced
      our tax expense for the year by the same amount.





The
      effective tax rates for 2005 and 2004 were significantly higher than the
      expected rate as we were unable to recognize future tax recoveries on investment
      write-downs and on certain elements of restructuring charges that related to
      operations in foreign jurisdictions in which we are unable to recognize tax
      assets due to persistent operating losses.








**Liquidity
      and capital resources**


**2006**
            
            2005
            ChangeCash,
                cash equivalents, and short-term investments
            **$**
            **436**
            $
            265
            65%Operating
                working capital1
            **$**
            **117**
            $
            82
            43%Cash
                from continuing operating activities
            **$**
            **38**
            $
            89
            (57%)Current
                ratio (excludes net assets held for sale)
            
            **2.5**
            
            1.7
            n/m


1 Our
      measure of operating working capital equals accounts receivable plus unbilled
      revenue and inventory less accounts payable, accrued liabilities, and current
      deferred revenue.





The
      improvement in the current ratio is mainly due to the reduction in accounts
      payable and accrued liabilities over the course of the year and the buildup
      of
      cash resulting primarily from the sale of certain businesses.





Our
      liquidity needs can be satisfied from cash generated by operations and
      short-term borrowings against our available lines of credit. During 2005, we
      negotiated a $500 million, five-year committed, revolving credit facility which
      replaced our previous $225 million credit facility. No funds were borrowed
      under
      the facility as of October 31, 2006.





Our
      primary uses of cash flow are operational expenses, investment in capital,
      dividends, interest and principal payments on our debt securities, and, in
      prior
      years, our share repurchase program. During the year, we renewed our normal
      course issuer bid (NCIB) which authorizes us to repurchase up to 10,967,277
      Common shares from time to time for a one-year period ending June 29, 2007.
      The
      repurchase of shares, if any, will be dependent upon the availability and
      alternative uses of capital, market conditions and other factors. Although
      we
      renewed our NCIB during 2006, we repurchased no shares during the year. In
      2005,
      we repurchased and cancelled 799,000 Common shares for $13 million under the
      NCIB.





Cash
      provided by operating activities was $155 million, representing a decrease
      of $6
      million compared to last year. Cash from operations included $117 million from
      our discontinued operations and $38 million from continuing operations. These
      amounts compare to $72 million and $89 million respectively for 2005 and $46
      million and $125 million respectively for 2004.





Operating
      cash flow for 2006 was significantly affected by investments in working capital,
      including liquidating restructuring liabilities and a buildup in accounts
      receivable and unbilled revenues. Implementation of our ERP system in MDS Pharma
      Services resulted in billing delays during the year. We are devoting resources
      to catching up with billings and are focused on customer
      collections.





Cash
      used
      in investing activities (excluding discontinued operations) was $207 million
      this year; however, $152 million was used to purchase short-term investments.
      Excluding this item, cash used in investing activities by continuing operations
      was $55 million compared to $157 million last year and $141 million in 2004.
      The
      significant drop compared to prior years reflects the elimination of capital
      expenditure requirements associated with the MAPLE project. In addition, the
      2006 balance reflects the $27 million cash proceeds from the MAPLE
      settlement.





Investing
      activities related to discontinued operations generated $85 million of cash
      in
      2006 compared to a usage of $2 million in 2005 and a source of $6 million in
      2004. The 2006 amount includes the substantial proceeds from the sale of Source
      and CLS.





Cash
      used
      in financing activities (excluding discontinued operations) during the year
      was
      $1 million, compared to $22 million in 2005 and an $8 million source of funds
      in
      2004. The decrease between 2005 and 2006 primarily reflects the inactivity
      on
      the NCIB compared to the last two years.





We
      believe that cash flow generated from operations, coupled with available
      borrowings from existing financing sources, will be sufficient to meet our
      anticipated capital expenditures, research and development expenditures and
      other cash requirements in 2007. At this time, we do not reasonably expect
      any
      presently known trend or uncertainty to affect our ability to access our current
      sources of cash. We remain in compliance with all covenants for our senior
      unsecured notes and our bank credit facility.




**Contractual
      obligations**


The
      following table summarizes our contractual obligations as at October 31, 2006,
      and the effect such obligations are expected to have on our liquidity and cash
      flows in future years. The table excludes amounts already recorded on the
      consolidated balance sheet as current liabilities and certain other purchase
      obligations discussed below:





2007
            2008
            2009
            2010
            2011
            ThereafterLong-term
                debt
            $
            22
            $
            104
            $
            21
            $
            31
            $
            18
            $
            246Operating
                leases
            
            18
            
            17
            
            14
            
            13
            
            11
            
            19Other
                contractual obligations
            
            50
            
            38
            
            38
            
            29
            
            37
            
            125$
            90
            $
            159
            $
            73
            $
            73
            $
            66
            $
            390





Long-term
      debt consisted of $350 million (US$311 million) of senior unsecured notes issued
      under a private placement during 2003, a $27 million (US$24 million) note
      payable in connection with our MALDI acquisition in 2004, a $48 million
      non-interest bearing government loan and other commitments totalling $17
      million.





We
      have
      long-term supply arrangements totalling $245 million with certain suppliers
      that
      provide us with radioisotopes. This amount is included in other contractual
      obligations. These agreements provide for minimum purchase quantities, and
      certain prices are based on market rates at the time of delivery. The remaining
      balance of other contractual obligations is inclusive of commitments totalling
      $69 million relating to the outsourcing of certain information technology
      infrastructure services.





The
      Company has entered into contracts for other outsourced services; however,
      the
      obligations under these contracts are not significant and the contracts
      generally contain clauses allowing for cancellation without significant penalty.





The
      expected timing of payment of the obligations discussed above is estimated
      based
      on current information. The timing of payments and actual amounts paid may
      be
      different depending on the time of receipt of goods or services or, for some
      obligations, changes to agreed-upon amounts.








**Guarantees**


In
      the
      normal course of operations, we provide indemnifications that are often standard
      contractual terms to counterparties in transactions such as purchase and sale
      contracts, service agreements and leasing transactions. These indemnification
      agreements may require us to compensate the counterparties for costs incurred
      as
      a result of various events. The terms of these indemnification agreements will
      vary based upon the contract, the nature of which prevents us from making a
      reasonable estimate of the maximum potential amount that we could be required
      to
      pay to counterparties.








**Off-balance
      sheet arrangements**


MDS
      does
      not have any relationships with unconsolidated entities or financial
      partnerships, such as entities referred to as structured finance or special
      purpose entities, which are established for the purpose of facilitating
      off-balance sheet arrangements or other contractually narrow or limited
      purposes.








**Derivative
      instruments**


We
      use
      derivative financial instruments to manage our foreign currency and interest
      rate exposure. These instruments consisted of forward foreign exchange and
      option contracts and interest rate swap agreements entered into in accordance
      with established risk management policies and procedures. All derivative
      instrument contracts are with banks listed on Schedules I to III to the Bank
      Act
      (Canada) and we utilize financial information provided by certain of these
      banks
      to assist us in determining the fair market values of the financial
      instruments.





The
      net
      unrealized mark-to-market value of all derivative instruments at October 31,
      2006 was a gain of $1 million compared to a gain of $3 million at the end of
      2005 and income of $44 million at the end of 2004. The substantial drop from
      2004 reflects the utilization of highly advantageous hedge positions in foreign
      currency during fiscal 2005 and 2006.








**Capitalization**


**2006**
            
            2005
            
            ChangeLong-term
                debt
            **$**
            **442**
            $
            465
            
            (5%)Less:
                cash, cash equivalents, and short-term investments
            
            **(436)**
            
            (265)
            
            65%Net
                debt
            
            **6**
            
            200
            
            (97%)Shareholders’
                equity
            
            **1,590**
            
            1,425
            
            12%Capital
                employed1
            **$**
            **1,596**
            $
            1,625
            
            (2%)


1 Capital
      employed is a measure of how much of our net assets are financed by debt and
      equity.





Long-term
      debt decreased from $465 million to $442 million between October 2005 and
      October 2006. Loan payments were $8 million in 2006 compared to $1 million
      in
      2005 and $2 million in 2004. Overall, the change in long-term debt primarily
      reflects the revaluation of our senior unsecured notes to year-end exchange
      rates. The value of the US dollar relative to the Canadian dollar fell by $0.06
      during fiscal 2006, resulting in a further unrealized gain on this debt of
      $18
      million (2005 - $11 million) and bringing the total cumulative unrealized gain
      to $142 million. This unrealized gain is recorded in the cumulative translation
      adjustment account.








**Share
      capital**


Shares
                issued and outstanding
            
            **2006**
            
            2005
            
            2004Outstanding
                beginning of the year
            
            **142,099**
            
            **141,826**
            
            141,122Issued
                during the year
            
            **2,220**
            
            **1,072**
            
            1,561Repurchased
                and cancelled
            
            **-**
            
            **(799)**
            
            (857)Outstanding
                - end of year
            
            **144,319**
            
            **142,099**
            
            141,826Dividends
                declared per share
            **$**
            **0.13**
            $
            **0.13**
            $
            0.09Market
                price per share:High
            **$**
            **23.20**
            $
            **21.65**
            $
            23.20Average
            **$**
            **20.81**
            $
            **18.37**
            $
            20.30Low
            **$**
            **18.25**
            $
            **15.39**
            $
            18.17Book
                value per share1
            **$**
            **11.02**
            $
            **10.03**
            $
            10.02


1 Book
      value per share is calculated as Common shareholders’ equity divided by the
      number of Common shares outstanding.








**Risks
      and uncertainties**


This
      section outlines risks and uncertainties that can have an impact on our
      operating results and financial position over the course of a year. A more
      detailed discussion of long-term risks and uncertainties and industry trends
      is
      contained in our AIF.





*Exposure
      to foreign currencies*


Approximately
      95% of revenue is earned outside of Canada based on the customer’s location. The
      majority of our export product revenues and a significant component of our
      foreign activities are denominated in US dollars. We believe that continued
      expansion outside of Canadian markets is essential if we are to achieve our
      growth targets. This expansion will subject us to volatility associated with
      changes in the value of the Canadian dollar.





We
      manage
      exchange rate risk principally through the use of foreign exchange contracts.
      At
      October 31, 2006, we had outstanding US dollar contracts and options in place
      to
      sell up to US$64 million and, in certain circumstances, up to US$82 million,
      at
      a weighted average exchange rate of C$1.1412 maturing over the next five months.
      We treat these contracts as hedges for accounting purposes.





In
      addition to foreign operations and export sales, our senior unsecured notes
      payable are denominated in US dollars. This long-term debt is considered a
      hedge
      of our net investment in our US operations. Depending on changes in the value
      of
      the US dollar, repayment of this debt may require more cash than the value
      of
      this debt as it is currently reported.





MDS
      maintains a centralized treasury function that operates under policies and
      guidelines approved by the Audit Committee of the Board of Directors, covering
      foreign currency exchange, funding, investing, and interest rate management.
      MDS’s policies and guidelines prevent it from using any derivative instrument
      for trading or speculative purposes.





MDS
      will
      continue to monitor its current and anticipated exposure to fluctuations in
      foreign currency exchange rates and enter into currency derivatives contracts
      to
      manage the exposure.





*Government
      regulation and funding*


The
      cost
      of compliance with government regulation is necessary and impacts most of our
      businesses. Changes in policies, procedures, systems and staff training required
      by government regulation can have the effect of increasing the costs we incur
      to
      provide our products and services. We manage this risk to the degree possible
      through active participation in the review and approval process with regulatory
      bodies such as the FDA and the Canadian Nuclear Safety Commission.





Our
      pharmaceutical research facilities and our isotope manufacturing facilities
      are
      subject to audit and approval by the FDA and similar agencies. Failure to
      achieve approval by these agencies will impact our ability to secure contracts
      to perform work. Audit reports issued by relevant regulatory bodies could
      directly impact our ability to attract and retain work, as was the experience
      in
      2005 and 2006 for our Montreal-area bioanalytical research facilities. We
      capitalize on such experiences by formalizing the learning into our standards
      to
      improve our quality assurance practices and customer quality and services.





Regulatory
      policies are designed to protect the public’s health and can impact our drug
      development revenues if our customers are unable to move compounds from one
      stage to the next in a timely manner. We mitigate this risk by limiting our
      exposure to individual compounds and we maintain a balanced portfolio of
      development contracts.





Our
      diagnostics businesses in Canada are heavily dependent on both government
      licensing and government funding. The level of government funding directly
      reflects government policy related to heath care spending, and decisions can
      be
      made regarding funding that are largely beyond our control. A change in the
      level of reimbursement for diagnostic testing could have a material impact
      on
      our operating results and cash flows in a year.





*Intellectual
      property*


Our
      Life
      Sciences businesses are each dependent on intellectual property either in the
      form of patent protection of key technologies or unpatented proprietary methods
      and knowledge. We are exposed to the risk that others may gain knowledge of
      our
      proprietary methods, infringe on patents, or develop non-infringing competitive
      technologies. While we take vigorous action to defend our positions, we may
      not
      be able to control usage of this intellectual property by others to compete
      against us.





*Acquisition
      and integration*


MDS’s
      growth strategy involves our ability to acquire, successfully integrate and
      operate businesses that contribute to our overall core focus. Typically, such
      acquisitions have occurred in the Life Sciences segment. These acquisitions
      involve the commitment of capital and other resources, and large acquisitions
      will have a major financial impact in the year of acquisition and later. Our
      ability to effectively integrate, within our existing businesses, acquired
      technologies and products and services, or to retain key technical and
      managerial personnel can have a significant short-term impact on our ability
      to
      achieve our growth and profitability targets.





*Research
      and development*


During
      2006, we recorded $19 million of research and development expenses in our
      analytical instruments and isotopes business units. All of our businesses depend
      to one extent or another on our ability to maintain technological superiority
      and our ability to provide leading-edge solutions to our customers. Ongoing
      investment in R&D will be required to grow and keep pace with a changing
      technological environment. The likelihood of success for any R&D project is
      inherently difficult to predict and could require a significant investment.
      We
      manage our R&D projects independently, and together with strategic alliance
      partners, against tightly defined project outlines that prescribe expected
      deliverables for each stage of a project. Projects must deliver certain
      measurable outcomes that we believe are indicators of the likelihood of future
      success in order to proceed through these design gates and qualify for
      additional funding.





*Supply
      of reactor isotopes*


Radioisotopes
      used in nuclear medicine are manufactured in electric-powered cyclotrons or
      nuclear reactors. A continuous and reliable supply of reactor radioisotopes
      such
      as molybdenum-99 and cobalt-60 is important to certain of our
      businesses.





We
      have
      taken steps to build additional cobalt processing capacity with a major
      supplier, Rosenergoatom, and established new or negotiated extensions of
      existing long-term supply arrangements to diversify and secure our source of
      supply. Changes in maintenance schedules or the continued operations of the
      reactors manufacturing cobalt could impact the availability and timing of our
      purchases.





*Venture
      capital investments*


MDS
      has
      certain venture capital investments in biotechnology companies. We monitor
      our
      investees’ capacity to raise and spend funds and develop a commercial market for
      their products and services as well as their regulatory approval experience.
      We
      have adopted a portfolio investment approach across the sector to reduce risk,
      while retaining exposure to high-growth companies. We carry venture investments
      on our books at cost. There exists a risk that the carrying value of such
      investments could be in excess of fair value due to market conditions and this
      could result in provisions related to these investments.





*Litigation
      and insurance*


From
      time
      to time during the normal course of business, the Company and its subsidiaries
      are subject to litigation. At the present time there is no material outstanding
      litigation that is not covered by our insurance policies and that could have
      a
      material adverse impact on the Company’s results or its financial position. We
      are aware of no threatened or pending litigation which could have a material
      adverse impact. We maintain a global insurance program with liability coverage
      up to $85 million to protect us from the financial risk associated with a claim
      made against us. Our ability to maintain insurance coverage with adequate limits
      and at a reasonable cost may be impacted by market conditions beyond our
      control.








**Quarterly
      highlights**





Following
      is a summary of selected financial information derived from the Company’s
      unaudited interim period consolidated financial statements for each of the
      eight
      most recently completed quarters. Prior periods have been restated to reflect
      the discontinuance of the operations discussed above.





(millions
                of Canadian dollars, except earnings per share)**Fiscal
                2006**
            **Oct
                2006**
            **July
                2006**
            **Apr
                2006**
            **Jan
                2006**Net
                revenues
            **$**
            **1,140**
            **$**
            **291**
            **$**
            **288**
            **$**
            **279**
            **$**
            **282**Operating
                income (loss)
            **$**
            **54**
            **$**
            **20**
            **$**
            **6**
            **$**
            **2**
            **$**
            **26**Income
                (loss) from continuing operations
            **$**
            **32**
            **$**
            **16**
            **$**
            **3**
            **$**
            **(2)**
            **$**
            **15**Net
                income (loss)
            **$**
            **145**
            **$**
            **53**
            **$**
            **21**
            **$**
            **16**
            **$**
            **55****Earnings
                (loss) per share from continuing operations**Basic
                and diluted
            **$**
            **0.22**
            **$**
            **0.12**
            **$**
            **0.02**
            **$**
            **(0.02)**
            **$**
            **0.10****Earnings
                (loss) per share**Basic
                and diluted
            **$**
            **1.01**
            **$**
            **0.37**
            **$**
            **0.14**
            **$**
            **0.12**
            **$**
            **0.38**(millions
                of Canadian dollars, except earnings per share)**Fiscal
                2005**
            **Oct
                2005**
            **July
                2005**
            **Apr
                2005**
            **Jan
                2005**Net
                revenues
            $
            1,154
            $
            304
            $
            286
            $
            277
            $
            287Operating
                income (loss)
            $
            24
            $
            (45)
            $
            17
            $
            19
            $
            33Income
                (loss) from continuing operations
            $
            1
            $
            (37)
            $
            5
            $
            13
            $
            20Net
                income (loss)
            $
            31
            $
            (48)
            $
            19
            $
            29
            $
            31**Earnings
                (loss) per share from continuing operations**Basic
                and diluted
            $
            -
            $
            (0.27)
            $
            0.04
            $
            0.10
            $
            0.13**Earnings
                (loss) per share**Basic
                and diluted
            $
            0.22
            $
            (0.34)
            $
            0.14
            $
            0.21
            $
            0.21





There
      were no unusual seasonal variations in these two 12-month periods. Operating
      income for the quarter ended October 2005 was reduced by $69 million as a result
      of valuation and restructuring provisions.








**Outlook**


In
      fiscal
      2006 we generated solid organic revenue growth from our isotopes, instruments,
      and late-stage pharmaceutical services businesses. Organic growth in adjusted
      EBITDA was strong for MDS Sciex and MDS Nordion. Pharmaceutical services made
      progress in several areas but continued to face difficulties in early-stage
      businesses due to the effects of the FDA Retrospective Review.





The
      sale
      of the diagnostics business, which we expect to conclude by the end of January
      2007, will substantially change the face of MDS. It will also result in net
      proceeds of approximately $1.1 billion. We plan to use up to $500 million of
      these funds to complete a substantial issuer bid to buy back MDS Common shares
      in a Dutch auction. We intend to launch this bid as soon as practical after
      closing the sale of the diagnostics business. In order to be on par with other
      companies in the global life sciences market, we also will discontinue our
      quarterly dividend and cancel our dividend reinvestment plan when we complete
      the share buy-back. We currently expect that our January dividend will be the
      last such payment.





Both
      the
      US dollar and the Euro remained weak relative to the Canadian dollar for most
      of
      2006, which has significantly affected our results as reported in Canadian
      dollar terms. Recently, the Canadian dollar has weakened compared to both of
      these currencies. Our hedges are now providing substantially less shelter than
      has been true in the recent past. At year-end, our hedge portfolio covered
      approximately 25% of our forecasted US-dollar denominated revenues for 2007
      and
      the effective rate for the portfolio is on par with current exchange rates.
      We
      do not hedge currency exposure on currencies other than the US dollar and we
      do
      not hedge foreign currency transactions outside of Canada. We will continue
      to
      provide analysis of our results on an organic basis to help provide a clearer
      understanding of the trends affecting our businesses.





As
      reported in previous quarters, we will be shifting to reporting in US dollars
      in
      the first quarter of 2007, following the completion of the sale of our
      diagnostics business. In addition, we will adopt a quarterly US GAAP net income
      reconciliation in the first quarter of 2007, as a first step in our transition
      to US GAAP reporting.





Fiscal
      2006 has been a difficult year for MDS Pharma Services. Although revenue and
      backlog growth were strong in our late-stage businesses, the Retrospective
      Review negatively affected the early-stage businesses. The Retrospective Review
      cost $31 million in direct spending this year and the impact of the resulting
      uncertainty on revenues was significant, although the full impact cannot be
      measured with precision. We maintained our focus on this issue in the fourth
      quarter and our efforts will continue until the FDA is satisfied with our
      analysis and conclusions. Although we are devoting substantial attention to
      dealing with this issue, we have not lost sight of the fact that profitability
      from MDS Pharma Services must improve. As outlined above, we have taken some
      steps already, and we expect to announce further initiatives aimed at a
      significant improvement in the operating results of this business before the
      end
      of the first quarter.





Our
      isotopes business had a successful 2006. Results were strong in the first half
      of the year, as we stepped-up production of certain critical isotopes to meet
      an
      unexpected supply disruption experienced in the market. We have been successful
      in signing contract extensions with many of our key customers and we have
      achieved some price increases. Revenue and operating income in 2006 included
      the
      last full year of recognition of deferred revenues from the Biogen-Idec supply
      contract. Biogen-Idec has indicated that Zevalin® continues to underperform
      relative to the company’s expectations and have also indicated that it is
      reviewing its options for this product. We will monitor this situation as it
      develops next year.





While
      lower in the fourth quarter due to normal inventory and supply conditions,
      our
      cobalt business continues to be a strong performer, and we benefited from good
      cobalt availability for most of the year. We will face some volatility in cobalt
      supply in fiscal 2007, and overall cobalt revenues are expected to fall short
      of
      2006 levels. This will be only partially offset by expected increases in sales
      of our cobalt therapy equipment, following the launch of new products earlier
      this year. We have also launched a clinical trial on our TheraSphere® product
      for liver cancer. This clinical trial will evaluate the effectiveness and safety
      of TheraSphere with the goal of making this cancer therapy more widely available
      to help more patients suffering from liver cancer.





Continued
      strong sales of high-end instruments targeted at the small molecule and applied
      markets enabled us to maintain organic growth for MDS Sciex. While revenue
      growth was modest this year, organic adjusted EBITDA growth was strong. We
      see
      continued strength in the small molecule and applied markets as we enter fiscal
      2007. We also continue to work on new products and anticipate higher revenues
      from our CellKeyTM System as this new technology gains market
      acceptance.





The
      impact of currency remains an issue for this business, although one of less
      significance than in prior years. We are taking steps to address our cost
      structure in this business to address the pressure on revenues resulting from
      foreign exchange. Our new manufacturing facility in Singapore is now fully
      operational and we have been transferring production of certain units to that
      facility. We expect this move will allow us to reduce our overall cost of
      production and will provide enhanced access to an Asia supply chain that will
      provide cost savings on materials consumed in both of our plants.








**Changes
      in accounting standards and policies**


In
      2005,
      the CICA issued Handbook Sections 1530, “Comprehensive Income”, 3855, “Financial
      Instruments - Recognition and Measurement”, 3861, “Financial Instruments -
      Disclosure and Presentation”, and 3865, “Hedges”. Under the new standards, a new
      location for recognizing certain gains and losses - other comprehensive income
      -
      has been introduced, providing for certain gains and losses arising from changes
      in fair value to be temporarily recorded outside the income statement, but
      in a
      transparent manner; existing requirements for hedge accounting are extended;
      and
      all financial instruments, including derivatives, are to be included on a
      company’s balance sheet and measured initially (in most cases) at fair value.
      The Company must adopt the new standards for the fiscal year beginning November
      1, 2006.


The
      Company’s cash flow hedges and the related unrealized gain/loss will be recorded
      initially in comprehensive income and subsequently reclassified to net income
      when the offsetting gain/loss on the hedged item affects net income. As at
      October 31, 2006, there was an unrealized gain of $1 million on the Company’s
      financial instruments (2005 - $3 million). This will increase shareholders’
equity and long-term investments and other assets but will not impact net
      income.





The
      Company will also have to include its cumulative translation adjustment as
      a
      component of comprehensive income. At October 31, 2006, the accumulated
      unrealized loss from the cumulative translation adjustment was $25 million
      (2005
      - $26 million).





The
      Company plans on changing its reporting currency to US dollars effective for
      the
      first quarter of 2007 in order to enhance comparability with the Company’s
      competitors. In accordance with EIC-130, “Translation Method When the Reporting
      Currency Differs from the Measurement Currency or There Is a Change in Reporting
      Currency”, the financial statements for all years (or periods) presented should
      be translated into the reporting currency using the current rate method. Under
      this method, the income statement and the cash flow statement items for each
      year (or period) are translated into the reporting currency using the rates
      in
      effect at the date of the transactions, and assets and liabilities are
      translated using the exchange rate at the end of that year or period. All
      resulting exchange differences are reported as a separate component of
      shareholders' equity.








**Critical
      accounting policies and estimates**


Our
      discussion and analysis of our financial condition and results of operations
      is
      based upon our consolidated financial statements, which have been prepared
      in
      accordance with Canadian GAAP. These principles differ in certain significant
      respects from US GAAP, and these differences are described and quantified in
      note 27 to the consolidated financial statements.





Our
      significant accounting policies are contained in Note 1 to the consolidated
      financial statements. Certain of these policies involve critical accounting
      estimates because they require us to make particularly subjective or complex
      judgments about matters that are inherently uncertain and because of the
      likelihood that materially different amounts could be reported under different
      conditions or using different assumptions.





*Revenue
      recognition*


MDS
      sells
      a variety of products and services and we use different revenue recognition
      policies depending on the nature of the product or service sold.





The
      majority of our products, including our analytical instruments and our
      radioisotopes are sold on terms that require our customers to take ownership
      of
      goods upon either shipment or delivery. Revenue is recognized on these
      transactions at the time title passes to the buyer. Product returns, exchanges
      and warranty obligations are insignificant in our product-based
      businesses.





Certain
      products, particularly equipment related to cobalt sterilization, involve longer
      production or delivery schedules and may require formal approval or acceptance
      by our customers. Approval may not be received until some time after the product
      has been shipped; however, we recognize revenue (less the minimal holdback
      amount subject to final approval) based on shipping terms that identify when
      the
      title has passed to the customer.





Full
      revenue is recognized once we have completed all of our obligations under the
      contract, subject to a reasonable provision set by management to cover any
      identifiable future costs. Such provisions tend not to be material and
      historically we have not incurred costs significantly in excess of our
      provisions, nor have we failed to achieve customer acceptance within reasonable
      periods of time.





Services
      are provided to customers on the basis of a per-unit price for work performed
      or
      under longer-term contracts that typically define the nature of services to
      be
      provided and the terms for billing and payment.





Revenue
      for services provided on a per-unit pricing basis is recognized when we have
      completed the requested services and have the contractual right to bill our
      customer. The majority of our diagnostics revenue is recorded this way, as
      is
      our discovery and preclinical revenue and our central lab revenue.





Revenue
      for services provided under long-term contracts, such as those provided within
      our early clinical and clinical research businesses, is recognized on a
      percentage-of-completion basis, usually pro rata as costs are incurred. To
      calculate revenue, we must estimate the total revenue and total cost, including
      all costs to complete the contract, as well as the actual stage of completion.
      The amount of revenue and gross margin appropriate to the percentage of
      completion is recorded in income based on these estimates. If it becomes evident
      that a loss will be incurred on a contract, that loss is recorded
      immediately.





Revenue
      that is recognized but which cannot be billed is recorded as unbilled revenue
      on
      our consolidated statement of financial position. Management conducts a review
      of all contracts in process at least quarterly to ensure that the appropriate
      amount of revenue has been recognized and that reasonable estimates of costs
      to
      complete have been made. This review also considers the recoverability of all
      amounts recorded as unbilled revenue. If recoverability is in doubt, the value
      of unbilled revenue is reduced to the expected recoverable amount by a charge
      to
      income.





In
      a
      significant number of long-term contracts, the billing terms enable us to bill
      our customers in advance of providing services. The amount of such billings
      in
      excess of the amount that we have recognized as revenue is recorded as deferred
      revenue in the liabilities section of the consolidated statement of financial
      position.





*Valuation
      of goodwill*


Goodwill
      is not amortized, but is assessed for impairment at the reporting unit level
      annually, or sooner if events or changes in circumstances indicate that the
      carrying amount could exceed fair value. Goodwill is assessed for impairment
      using a two-step approach, with the first step being to assess whether the
      fair
      value of the reporting segment with which the goodwill is associated is less
      than its carrying value. If this is the case, a second impairment test is
      performed which requires a comparison of the fair value of goodwill to its
      carrying amount. If fair value is less than carrying value, goodwill is
      considered impaired and an impairment charge must be recognized immediately.
      Assessing the fair value of a reporting unit requires that we make numerous
      estimates, including estimating future cash flows and interest rates. Variations
      in these estimates will cause material differences in the result.





*Intangible
      assets*


Intangible
      assets include the value of acquired in-process R&D, patents, technology,
      customer relationships, licences, and long-term service contracts, which are
      recorded as intangibles on the statement of financial position. In addition
      to
      these acquired assets, intangible assets include the deferred costs of
      developing certain products and the pre-operating costs associated with new
      facilities, which are recorded in long-term investments and other assets on
      the
      statement of financial position. Intangible assets are recorded at cost and
      are
      amortized over periods that approximate their useful lives, ranging primarily
      from three to seven years. Because intangible assets are usually associated
      with
      technology that is evolving and for which obsolescence is a significant risk,
      the carrying value of intangible assets is evaluated at least once per year.
      In
      the event that management determines that it is unlikely that the Company will
      be able to fully recover the carrying value of intangible assets from the
      undiscounted cash flow that can be generated in the future from related products
      or services, the intangible assets are written down to approximate our estimate
      of their net realizable value.





*Valuation
      of long-term investments*


Long-term
      investments that are carried at cost or accounted for using the equity method
      are reviewed to determine whether their fair value is below carrying value.
      We
      maintain portfolio investments in a number of public and private companies.
      An
      investment is considered impaired if any such decline is considered other than
      temporary. Factors considered in determining whether a loss is temporary include
      the length of time and extent to which fair value has been below cost; financial
      condition and near-term prospects of the investee; and our ability and intent
      to
      hold the investment for a period of time sufficient to allow for any anticipated
      recovery. Investments are reviewed periodically to determine if there has been
      a
      decline in value that is other than temporary. In the event that impairment
      has
      occurred, the carrying value of the investment is written down to an amount
      that
      reflects management’s estimate of what could be received from a sale of the
      investment.





*Property,
      plant, and equipment*


Property,
      plant, and equipment are recorded at cost and depreciated at varying rates
      over
      their estimated useful lives. Management sets these rates based on experience
      with these or similar assets. Costs incurred on assets under construction are
      capitalized as construction in progress. Costs capitalized on these projects
      include the direct costs of construction, equipment installation and testing,
      and interest costs associated with financing large, long-term projects. No
      depreciation is recorded on such assets until they are placed in service. At
      each period-end, management reviews the total costs capitalized on all
      construction projects to determine whether or not the carrying value of the
      assets can be recovered from the undiscounted, expected, net future cash flow
      generated by the assets. If there is no reasonable expectation that the costs
      can be recovered, the carrying value of the asset is reduced to the estimated
      recoverable amount and the excess is charged to income. This process is subject
      to significant judgment and could be materially affected by variations in
      estimates of future cash flows.





*Research
      and development*


Costs
      incurred for research are expensed as incurred. If management expects that
      a new
      product has a reasonable likelihood of future commercial success and decides
      to
      proceed with product development, costs are capitalized during the remainder
      of
      the development process. These costs are identified as deferred development
      costs and are recorded within long-term investments and other assets on the
      statement of financial position. Once a product enters commercial production,
      deferred development costs are amortized over the estimated product life,
      generally three to five years.





Management
      undertakes a periodic review of each project on which deferred development
      costs
      have been recorded to determine if the carrying value of the project can be
      recovered from the undiscounted, expected, net future cash flow generated by
      sales of planned products. If there is no reasonable expectation that the costs
      can be recovered, the carrying value of the project is reduced and the excess
      is
      charged to income. This process of estimation is subject to significant
      judgment, in particular about the price and direct cost of the products, as
      well
      as expected market acceptance. Deferred development costs generally relate
      to
      products on which we have traditionally earned a high gross margin.





*Income
      taxes*


We
      operate globally and are, therefore, subject to income taxes in multiple
      jurisdictions. The income tax expense reported in the statement of income is
      based on a number of different estimates made by management. Our effective
      tax
      rate can change from year to year based on the mix of income among the different
      jurisdictions in which we operate, changes in tax laws in these jurisdictions,
      and changes in the estimated values of future tax assets and liabilities
      recorded on our consolidated statement of financial position.





The
      income tax expense reflects an estimate of cash taxes expected to be paid in
      the
      current year, as well as a provision for changes arising this year in the value
      of future tax assets and liabilities. The likelihood of recovering value from
      future tax assets requires us to determine whether it is more likely than not
      that all or a portion of the future tax assets will be realized from such items
      as loss carryforwards and the future tax depreciation of property, plant, and
      equipment. At each quarter-end we assess the valuation of future tax assets
      at
      each quarter-end and establish or adjust a valuation reserve if necessary.
      Changes in the amount of the valuation reserve required can materially increase
      or decrease the tax expense in a period. Significant judgment is applied to
      determine the appropriate amount of valuation reserve to record.





*Restructuring
      charges*


We
      have
      approved plans to restructure certain operations and, as such, we are required
      to establish critical estimates surrounding exit costs and workforce reductions.
      Because the determination of the restructuring provision is a complex process
      and the rollout of a restructuring plan could span multiple periods, we might
      be
      required to update estimates to reflect actual payments made. Any adjustments
      made will be disclosed in the notes to our consolidated financial
      statements.





*Employee
      future benefits*


Certain
      estimates and assumptions are used to actuarially determine the Company’s
      defined pension and employee future benefit obligations. The expected rate
      of
      return on plan assets, discount rate, rate of compensation increase and health
      care cost trend rate are important elements of cost and/or obligation
      measurement.





The
      discount rate, which is determined annually, allows us to reflect estimated
      future benefit payments at their present value on the measurement date, and
      is
      based on market rates for high-quality fixed income investments available for
      the period to maturity of the benefits. A lower discount rate increases the
      benefit cost and obligation.




*Stock-based
      compensation*


The
      Company uses the fair value method of accounting for stock-based compensation.
      The fair value of the options are estimated using the Black-Scholes option
      pricing model using estimated forfeiture rates, volatility, expected life of
      the
      options and the risk-free interest rate.








**Accounting
      standards and policies - Controls and procedures**


**Disclosure
      controls and procedures**


Management
      of MDS, including the Chief Executive Officer and Chief Financial Officer,
      has
      evaluated the effectiveness of the Company’s disclosure controls and procedures
      (as defined in the rules of the US Securities and Exchange Commission (SEC)
      and
      the Canadian Securities Administrator (CSA) and has concluded that such
      disclosure controls and procedures are effective.








**Management’s
      annual report on internal control over financial reporting**


The
      following report is provided by management in respect of MDS’s internal controls
      over financial reporting (as defined in the rules of the SEC and the
      CSA):





1.
            Management
                of MDS is responsible for establishing and maintaining adequate internal
                controls over financial reporting for the
                Company.


2.
            Management
                of MDS has used the Committee of Sponsoring Organizations of the
                Treadway
                Commission (COSO) framework to evaluate the effectiveness of the
                Company’s
                internal controls over financial reporting. Management believes that
                the
                COSO framework is a suitable framework for its evaluation of the
                Company’s
                internal controls over financial reporting because it is free from
                bias,
                permits reasonable consistent qualitative and quantitative measurements
                of
                MDS’s internal controls, is sufficiently complete so that those relevant
                factors that would alter a conclusion about the effectiveness of
                the
                Company’s internal controls are not omitted, and is relevant to an
                evaluation of internal controls over financial
                reporting.


3.
            Management
                of MDS has assessed the effectiveness of the Company’s internal controls
                over financial reporting, as at October 31, 2006, and has concluded
                that
                such internal controls over financial reporting are effective. There
                are
                no material weaknesses in MDS’s internal controls over financial reporting
                that have been identified by
                management.


4.
            Ernst
                & Young LLP, which has audited the consolidated financial statements
                of MDS for the year ended October 31, 2006, has also issued a report
                on
                financial statements and internal controls under Auditing Standard
                No. 2
                of the Public Company Accounting Oversight Board (United States).








**Changes
      in internal controls over financial reporting**


There
      have been no changes in MDS’s internal controls over financial reporting during
      the year ended October 31, 2006, that have materially affected or are reasonably
      likely to materially affect the Company’s internal controls over financial
      reporting.







**A.****Disclosure
        Controls and Procedures**
   The
        Company's management, with the participation of the Company's principal
        executive officer and principal financial officer, evaluated the effectiveness
        of the design and operation of the Company's disclosure controls and procedures
        (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange
        Act
        of 1934, as amended (the "Exchange Act")). Based on that evaluation, the
        Company's principal executive and principal financial officers concluded
        that
        the Company's disclosure controls and procedures as of October 31,
        2006 (the end
        of the period covered by this Report) have been designed and are functioning
        effectively to provide reasonable assurance that the information required
        to be
        disclosed by the Company in reports filed or submitted under the Exchange
        Act is
        recorded, processed, summarized and reported within the time periods specified
        in the (Securities and Exchange Commission (the "SEC") rules and forms.
   **B.**  **Management’s
        Annual Report on Internal Controls over Financial
        Reporting**
  The
        following report is provided by management in respect of MDS’s internal controls
        over financial reporting:
 
 1.
              Management
                  of MDS is responsible for establishing and maintaining adequate
                  internal
                  controls over financial reporting for the
                  Company.
 2.
              Management
                  of MDS has used the Committee of Sponsoring Organizations of the
                  Treadway
                  Commission (COSO) framework to evaluate the effectiveness of the
                  Company’s
                  internal controls over financial reporting. Management believes
                  that the
                  COSO framework is a suitable framework for its evaluation of the
                  Company’s
                  internal controls over financial reporting because it is free from
                  bias,
                  permits reasonable consistent qualitative and quantitative measurements
                  of
                  MDS’s internal controls, is sufficiently complete so that those relevant
                  factors that would alter a conclusion about the effectiveness of
                  the
                  Company’s internal controls are not omitted, and is relevant to an
                  evaluation of internal controls over financial
                  reporting.
 3.
              Management
                  of MDS has assessed the effectiveness of the Company’s internal controls
                  over financial reporting, as at October 31, 2006, and has concluded
                  that
                  such internal controls over financial reporting are effective.
                  There are
                  no material weaknesses in MDS’s internal controls over financial reporting
                  that have been identified by
                  management.
 4.
              Ernst
                  & Young LLP, which has audited the consolidated financial statements
                  of MDS for the year ended October 31, 2006, has issued an attestation
                  report on management’s assessment of the Company’s internal controls over
                  financial reporting.
 
  **C.****Attestation
        Report of the Registered Public Accounting Firm**
  
 The
        Board
        of Directors of **MDS Inc.**
 
 We
        have
        audited management’s assessment, included on page 26 of the Management’s
        Discussion and Analysis, that **MDS
        Inc** .
        maintained effective internal control over financial reporting as of October
        31,
        2006, based on criteria established in Internal Control - Integrated Framework
        issued by the Committee of Sponsoring Organizations of the Treadway Commission
        (the COSO criteria). **MDS
        Inc.’s** management is responsible for maintaining effective internal control over
        financial reporting and for its assessment of the effectiveness of internal
        control over financial reporting. Our responsibility is to express an opinion
        on
        management’s assessment and an opinion on the effectiveness of MDS Inc.’s
        internal control over financial reporting based on our audit.
 
 We
        conducted our audit in accordance with the standards of the Public Company
        Accounting Oversight Board (United States). Those standards require that
        we plan
        and perform the audit to obtain reasonable assurance about whether effective
        internal control over financial reporting was maintained in all material
        respects. Our audit included obtaining an understanding of internal control
        over
        financial reporting, evaluating management’s assessment, testing and evaluating
        the design and operating effectiveness of internal control, and performing
        such
        other procedures as we considered necessary in the circumstances. We believe
        that our audit provides a reasonable basis for our opinion.
 
 A
        company’s internal control over financial reporting is a process designed to
        provide reasonable assurance regarding the reliability of financial reporting
        and the preparation of financial statements for external purposes in accordance
        with generally accepted accounting principles. A company’s internal control over
        financial reporting includes those policies and procedures that (1) pertain
        to
        the maintenance of records that, in reasonable detail, accurately and fairly
        reflect the transactions and dispositions of the assets of the company; (2)
        provide reasonable assurance that transactions are recorded as necessary
        to
        permit preparation of financial statements in accordance with generally accepted
        accounting principles, and that receipts and expenditures of the company
        are
        being made only in accordance with authorizations of management and directors
        of
        the company; and (3) provide reasonable assurance regarding prevention or
        timely
        detection of unauthorized acquisition, use, or disposition of the company’s
        assets that could have a material effect on the financial
        statements.
 
 Because
        of its inherent limitations, internal control over financial reporting may
        not
        prevent or detect misstatements. Also, projections of any evaluation of
        effectiveness to future periods are subject to the risk that controls may
        become
        inadequate because of changes in conditions, or that the degree of compliance
        with the policies or procedures may deteriorate.
 
 In
        our
        opinion, management’s assessment that **MDS Inc.** maintained effective internal control over financial reporting as of October
        31,
        2006, is fairly stated, in all material respects, based on the COSO criteria.
        Also, in our opinion, MDS Inc. maintained, in all material respects, effective
        internal control over financial reporting as of October 31, 2006, based
        on **** the
        COSO
        criteria.
 
 We
        also
        have audited, in accordance with Canadian generally accepted auditing standards
        and the standards of the Public Company Accounting Oversight Board (United
        States), the consolidated statement of financial position of **MDS Inc.** as at
        October 31, 2006 and 2005, as well as the consolidated statements of
        income, retained earnings and cash flows for the three years in the period
        ended
        October 31, 2006 and our report dated January 15, 2007 expressed an unqualified
        opinion thereon.
 
 Toronto,
        Canada
 January
        15, 2007
  
 Chartered
        Accountants
  **D.**  **Changes
        in Internal Control over Financial Reporting**
  There
        has
        not being any significant change in the Company's internal control over
        financial reporting that occurred during the fiscal year ended October 31,
        2006
        that has materially affected, or is reasonably likely to materially affect,
        the
        Company's internal control over financial reporting.
  **E.****Notice
        of Pension Fund Blackout Period**
  The
        Company was not required by Rule 104 of Regulation BTR to send any notice
        to any
        of its directors or executive officers during the fiscal year ended October
        31,
        2006.
  **F.****Audit
        Committee Financial Expert**
  The
        Company's Board of Directors (the Board) has determined that all of the members
        of the Company's Audit Committee are "independent" within the meaning of
        applicable SEC regulations and the listing standards of the New York Stock
        Exchange (the NYSE). In addition, the Board has determined that Mr. Robert
        W.
        Luba, the Chair of the Audit Committee, Ms. Kathleen M. O’Neill, are "Audit
        Committee Financial Experts" within the meaning of General Instrument B(8)(b)
        of
        Form 40-F.
  **G.****Code
        of Ethics**
  The
        Company has a code of ethics ,
        entitled Global Business Practice Standards (GBPS), which is applicable to
        all
        MDS employees including the Company's Chief Executive Officer, Chief Financial
        Officer and other senior officers. The Company’s code of ethics can be viewed on
        its website (at www.mdsinc.com/pdf/Global_Business%20Practices.pdf ).
  **H.****Principal
        Accountant Fees and Services**
  **(** ***all
        amounts are in Canadian dollars unless otherwise
        indicated*** **)**
  ***Audit
        Fees***
  The
        aggregate fees billed by Ernst & Young LLP (the Independent Auditors) for
        professional services rendered for the audit of the Company's annual financial
        statements, including services related thereto, were $6,726,561
        for the fiscal year ended October 31, 2006 and $1,984,000 for the
        fiscal year ended October 31, 2005.
  ***Audit-Related
        Fees***
  The
        aggregate fees billed by the Independent Auditors for assurance and related
        services that are reasonably related to the performance of the audit or review
        of the Company's financial statements and are not reported as "Audit Fees,"
        including consultations concerning financial accounting and reporting matters
        not classified as audit, were $255,080  for
        the
        fiscal year ended October 31, 2006 and $392,000 for the fiscal year ended
        October 31, 2005.
  ***Tax
        Fees***
  The
        aggregate fees billed by the Independent Auditors for professional services
        rendered for tax compliance, tax advice and tax planning were $196,120
        for the fiscal year ended October 31, 2006 and $310,000 for the
        fiscal year ended October 31, 2005. The services comprising the fees reported
        as
        "Tax Fees" included tax return preparation in various foreign jurisdictions,
        consultation regarding various tax issues, support provided to management
        in
        connection with income and other tax audits.
  ***All
        Other Fees***
  The
        Independent Auditors were not engaged to provide services other than those
        reported in the preceding paragraphs during the fiscal years ended October
        31, 2006 or
        2005.
  **I.****Audit
        Committee Pre-approval Policies and Procedures******
  All
        services to be performed by the Company's Independent Auditor must be approved
        in advance by the Audit Committee. The Audit Committee has determined that
        the
        only services to be provided by the Company's Independent Auditor are audit
        and
        tax related services, which are and will be subject to the Audit Committee's
        pre-approval. MDS Corporate Finance obtains and coordinates the pre-approval
        process for audit and tax services, by receiving all requests from the various
        business units and submitting them to the Audit Committee annually, or more
        frequently, if the need arises for the Committee's pre-approval. No fees
        may be
        paid to the Company's Independent Auditor unless this pre-approval has been
        obtained.
  Pre-approval
        from the Audit Committee can be sought for planned engagements based on budgeted
        or committed fees. No further approval is required to pay pre-approved fees.
        Additional pre-approval is required for any increase in scope or in final
        fees.
  **J.****Off-Balance
        Sheet Arrangements**
  See
        information provided under the heading "Guarantees" (Note 23) contained in
        the
        Notes to Consolidated Financial Statements, included as Document No. 2 to
        this
        Annual Report on Form 40-F.
  **K.****Tabular
        Disclosure of Contractual Obligations**
  Tabular
        disclosure of long-term obligations is included on page 17 of the Management
        Discussion and Analysis filed as an exhibit to the Form 40-F.
  **L.**  **Critical
        Accounting Policies**
  See
        "Management's Discussion and Analysis of Financial Condition and Results
        of
        Operations for the year ended October 31, 2006", included as Document No.3
        to
        this Form 40-F.
  **M.****Identification
        of Audit Committee**
  The
        Company's Board of Directors has appointed an Audit Committee consisting
        of four
        outside directors - Robert W. Luba (Chair), Richard H. McCoy, James S. A.
        MacDonald, and Kathleen M. O'Neill.
  **N.**  **NYSE
        Exemptions**
  As
        required by the NYSE, the Company will post on its corporate website any
        significant differences between the corporate governance practices followed
        by
        the Company in Canada and those applicable to US companies under the NYSE's
        listing standards.
  ***Undertaking***
 
 The
        Registrant undertakes to make available, in person or by telephone,
        representatives to respond to inquiries made by the Commission Staff, and
        to
        furnish promptly, when requested to do so by the Commission Staff, information
        relating to the securities in relation to which the obligation to file an
        annual
        report on Form 40-F arises, or transactions in said securities.
 
 ***Consent
        to Service of Process***
 
 Concurrently
        with the filing of the Registrant’s Form 40-F on February 2, 2001 (File No.
        001-15016), the Registrant filed with the SEC a written irrevocable consent
        and
        power of attorney on Form F-X; an amendment to that Form F-X was filed with
        the
        SEC on May 23, 2001.
  **EXHIBITS**
 
 **The
        following exhibits are filed as part of this report:**
 
 **Exhibit****No.**
              **Description**1.
              Consent
                  of Ernst & Young LLP2.
              Certifications
                  of Chief Executive Officer (Principal Executive Officer) and Chief
                  Financial Officer (Principal Financial Officer) pursuant to Section
                  302 of
                  the Sarbanes-Oxley Act of 2002.3.
              Certification
                  of Chief Executive Officer (Principal Executive Officer) and Chief
                  Financial Officer (Principal Financial Officer) pursuant to Section
                  906 of
                  the Sarbanes-Oxley Act of 2002.
 
 
 **SIGNATURES**
 
 Pursuant
        to the requirements of the Exchange Act, the Registrant certifies that it
        meets
        all of the requirements for filing on Form 40-F and has duly caused this
        annual
        report to be signed on its behalf by the undersigned, thereto duly
        authorized.
 
 Date:
                  January 26, 2007
              **MDS
                  Inc**.
                
                By: 
                  /s/ James A.H. Garner
                James
                  A. H. Garner
                Executive
                  Vice-President Finance & Chief Financial
                  Officer
  
 **EXHIBIT
        INDEX**
   **Exhibit****No.**
              **Description**1.
              Consent
                  of Ernst & Young LLP2.
              Certifications
                  of Chief Executive Officer (Principal Executive Officer) and Chief
                  Financial Officer (Principal Financial Officer) pursuant to Section
                  302 of
                  the Sarbanes-Oxley Act of 2002.3.
              Certification
                  of Chief Executive Officer (Principal Executive Officer) and Chief
                  Financial Officer (Principal Financial Officer) pursuant to Section
                  906 of
                  the Sarbanes-Oxley Act of 2002.