Exhibit
1.3


MANAGEMENT’S
DISCUSSION AND ANALYSIS





January
25, 2010





The
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, 2009
and its financial position as of October 31, 2009. 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 also referred to the
unaudited quarterly financial statements and quarterly MD&A for fiscal 2009,
the Company’s Annual Information Form for fiscal 2009 (AIF), and the Company’s
Annual Report on Form 40-F, each of which is published separately and is
available as applicable, at www.mdsinc.com, www.sedar.com and
www.sec.gov.





Our
MD&A is intended to enable readers to gain an understanding of MDS’s current
results of operations and financial position. To do so, the Company provides
information and analysis comparing the results of operations and financial
position for the current year with 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.





Amounts
are in millions of United States (U.S.) dollars, except per share amounts and
where otherwise noted.





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 under applicable Canadian securities laws
and the “safe harbour” provisions of the United States Private Securities
Litigation Reform Act of 1995. This document contains forward-looking
statements, including statements with respect to the impact of the completion of
the sale of MDS Analytical Technologies on the Company’s operations and
financial results, the strategy of the continuing businesses, the proposed use
of proceeds from the sale of MDS Analytical Technologies, if completed, the
Company’s intention to sell MDS Pharma Services’ Early Stage operations, as well
as statements with respect to our beliefs, plans, objectives, expectations,
anticipations, estimates and intentions.  The words “may”, “could”,
“should”, “would”, “outlook”, “believe”, “plan”, “anticipate”, “estimate”,
“expect”, “intend”, “forecast”, “objective”, “optimistic”, 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 global economy, in particular the
economies of Canada, the U.S., the European Union, Asia, and the other countries
in which we conduct business; the stability of global equity markets; our
ability to complete the sale of MDS Analytical Technologies and our intended
sale of MDS Pharma Services Early Stage operations in a timely manner, or at
all; our ability to retain customers as a result of any perceived uncertainty
relating to the planned sale of MDS Analytical Technologies and the intended
sale of MDS Pharma Services Early Stage operations; the fact that our operations
will be substantially reduced as a result of the sale of MDS Analytical
Technologies and the intended sale of MDS Pharma Services Early Stage
operations; liabilities that we will retain from businesses sold; our ability to
complete other strategic transactions and to execute them successfully; our
ability to remain in compliance with our senior unsecured notes and credit
facilities covenants; our ability to negotiate future credit agreements which
may or may not be on terms favourable to us; our ability to secure a reliable
supply of raw materials, particularly cobalt and critical medical isotopes
including the return to service of the National Research Universal reactor owned
and operated by Atomic Energy of Canada Limited; the impact of the movement of
certain currencies relative to other currencies, particularly the U.S. dollar,
Canadian dollar and the Euro; changes in interest rates in Canada, the U.S., and
elsewhere; 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; our ability to manage our research and development; the impact of
changes in laws, trade policies and regulations, and enforcement thereof;
regulatory actions; judicial judgments and legal proceedings; our ability to
maintain adequate insurance; our ability to successfully realign our
organization, resources and processes; our ability to retain key personnel; our
ability to have continued and uninterrupted performance of our information
technology systems; our ability to compete effectively; the risk of
environmental liabilities; our ability to maintain effectiveness of our clinical
trials; new accounting standards that impact the policies we use to report our
financial condition and results of operations; uncertainties associated with
critical accounting assumptions and estimates; the possible impact on our
businesses from third-party special interest groups; our ability to negotiate
and maintain collective-bargaining agreements for certain of our employees;
natural disasters; public-health emergencies and pandemics; international
conflicts and other developments including those relating to terrorism; other
risk factors described in section 3.10 of our AIF; and our success in
anticipating and managing these risks.


The
foregoing list of 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, except as required by law.





Use of Non-GAAP
Measures


In
addition to measures based on U.S. Generally Accepted Accounting Principles
(GAAP) used in this MD&A, the following terms are also used: net revenues,
adjusted earnings before interest, taxes, depreciation and amortization
(adjusted EBITDA); adjusted EBITDA margin; adjusted earnings per share,
operating working capital and operating working capital days. These terms are
not defined by GAAP and our use of such terms may vary from that of other
companies. In addition, measurement of growth is not defined by GAAP and our use
of growth may vary from that of other companies. Where relevant, and
particularly for earnings-based measures, we provide tables in this document
that reconcile the non-GAAP measures used to amounts reported in accordance with
GAAP. Our executive management team assesses the performance of our businesses
based on a review of results comprising GAAP measures and these non-GAAP
measures. We also report on our performance to the Company’s Board of Directors
based on these GAAP and non-GAAP measures. In fiscal 2009, net revenue growth,
adjusted EBITDA, and operating working capital days are the primary metrics for
our annual incentive compensation plan for senior management. In fiscal 2008,
adjusted EBITDA and operating working capital days were the primary metrics for
our annual incentive compensation plan for senior management.  We
provide this non-GAAP detail so that readers have a better understanding of the
significant events and transactions that have had an impact on our results, and
so that these events and transactions can be viewed from our management’s
perspective.


Introduction


MDS
operates as a global life sciences company that provides market-leading products
and services that its customers need for the development of drugs, and for the
prevention, diagnosis and treatment of disease. We are a leading global provider
of medical isotopes, pharmaceutical contract research and analytical
instruments. We have been operating with three business segments: MDS Nordion,
which is focused on medical imaging and radiotherapeutics, and sterilization
technologies; MDS Pharma Services, which provides pharmaceutical contract
research; and MDS Analytical Technologies, which involves the development,
manufacture, and sale of analytical instruments.





Key
events of fiscal 2009


•February 2,
      2009
            -
            MDS
      forms Special Committee to continue its review of strategic
      alternatives•May 18,
    2009
            -
            MDS
      incurs medical isotope supply disruption due to the Atomic Energy of
      Canada Limited (AECL) shutdown of the National Research Universal (NRU)
      reactor•June 1,
    2009
            -
            MDS
      announces its intent to divest MDS Pharma Services Late Stage operations
      (Phase II-IV and Central Labs)•July 1,
    2009
            -
            MDS
      sells MDS Pharma Services Phase II-IV for $50 million in
    cash•September 2,
      2009
            -
            MDS
      announces strategic repositioning-
            MDS
      announces its intention to sell its remaining MDS Pharma Services Early
      Stage operations (Early Stage)-
            MDS
      announces agreement to sell MDS Analytical Technologies for $650 million
      in cash-
            MDS
      announces intent to return $400 million to $450 million of sale proceeds
      to shareholders through a substantial issuer bid•October 30,
      2009
            -
            MDS
      sells MDS Pharma Services Central Labs for $6 million in
    cash





Strategic
repositioning


During
the latter part of fiscal 2008 and fiscal 2009, the Company, under the
supervisions of a Special Committee and with the assistance of legal and
financial advisors, reviewed an extensive range of strategic alternatives for
MDS. On September 2, 2009, the Company announced a strategic repositioning
pursuant to which the Company agreed to sell MDS Analytical Technologies and
announced an intention to sell MDS Pharma Services such that, following the
repositioning, the Company would be focused primarily on its MDS Nordion
business. The Board of Directors believes that the strategic repositioning is in
the best interests of the Company and its shareholders because, among other
things, it is expected to provide the greatest opportunity to unlock the value
of MDS's businesses in the near-term and also enable a substantial portion of
the sale proceeds to be returned to shareholders. A summary of the principal
reasons for the strategic review process and the factors considered by the Board
of Directors in approving the strategic repositioning are set forth in the
Company's September 17, 2009, management information circular (Circular) for the
special meeting of the Company's shareholders that was held on October 20, 2009,
a copy of which is available at www.sedar.com.





During
fiscal 2009, as part of the strategic review process, we sold the MDS Pharma
Services Phase II-IV and Central Labs and announced our intention to sell Early
Stage. We also announced that we had entered into an agreement to sell MDS
Analytical Technologies. As a result of these transactions and announcements,
MDS has reported MDS Pharma Services and MDS Analytical Technologies as
discontinued operations for all periods presented herein. Details of the
discontinued operations are provided in the “Divestitures andDiscontinued Operations”
section of this MD&A.





Following
the sale of the MDS Analytical Technologies business, we currently intend to
retire all the outstanding senior unsecured notes and to distribute
approximately $400 million to $450 million of the sale proceeds to shareholders
pursuant to a substantial issuer bid. The actual amount used to fund the
substantial issuer bid will be determined at the time the bid is commenced and
will take into account the expected impact on the liquidity of the Common shares
subsequent to the substantial issuer bid and current estimates of future cash
requirements to fund transactions and restructuring costs, ongoing operations
and future expenditures. We currently intend to proceed with a substantial
issuer bid within 30 days following completion of the sale of MDS Analytical
Technologies.





Upon
completion of the aforementioned divestitures, we expect MDS to remain a
publicly traded entity consisting primarily of the MDS Nordion business. As part
of the strategic repositioning, we are currently planning to seek shareholder
approval at the next Annual and Special Meeting of Shareholders to change the
Company’s name to Nordion Inc. We also intend to wind-down the existing head
office operations in Toronto, Canada, which currently employs approximately 150
people, and to establish a new corporate office at MDS Nordion offices in
Ottawa, Canada. This transition is intended to result in the establishment and
hiring of approximately 50 positions in Ottawa with the remaining corporate
positions being eliminated due to the reduced scale of the ongoing operations.
The severance and benefits costs, including those for the executive officers, of
closing the Toronto office are estimated to be approximately $30 million, of
which a pre-tax restructuring charge of $9 million was recorded in the fourth
quarter of fiscal 2009 related to this initiative. On completion of the
restructuring of the corporate functions and other strategic repositioning
activities, we currently
expect to generate positive EBITDA and positive cash flow with MDS Nordion as
the main operating business even without the contributions generated from the
NRU reactor supplied medical isotopes. We will continue to focus on building MDS
Nordion’s core strengths and leadership position in providing medical isotopes
for medical imaging and radiotherapeutics, and sterilization
technologies.





Our
continuing operations, as presented in this MD&A, consist of the MDS Nordion
business as well as certain corporate functions, which we report as Corporate
and Other. Included in Corporate and Other are finance, information technology
and systems, real estate, human resources, and certain assets and liabilities
expected to be retained by the Company upon the completion of the aforementioned
strategic repositioning.





Sale
of MDS Pharma Services Phase II-IV


On July
1, 2009, we completed the sale of MDS Pharma Services Phase II-IV (Phase II-IV)
for total cash consideration of $50 million, subject to certain closing
adjustments including final working capital, cash, and indebtedness amounts. The
consideration includes $10
million in restricted cash that will be paid or released to MDS upon meeting
post-closing obligations (subject to set off for any claims for breach of
representations and warranties under the sale agreement) and $3 million to be
paid following the delivery of certain tax certifications. MDS expects the $10
million to be released to us within 15 months from the closing date of July 1,
2009. We recorded an after-tax loss of $7 million on the sale. As part of this
sale, we signed a Transition Services Agreement (TSA) to provide certain post
closing transition services to the buyer for a period of six months from the
closing date with an option by the buyer to extend for an additional six months.
The total cash consideration includes $2 million related to the TSA in which $1
million has been recorded in “(Loss) income from continuing operations” in the
consolidated statements of operations in fiscal 2009 and the remainder will be
recorded in the first quarter of fiscal 2010 when the TSA is anticipated to be
completed.





Sale
of MDS Pharma Services Central Labs


On
October 30, 2009, we completed the sale of MDS Pharma Services Central Labs
(Central Labs) for total cash consideration of $6
million, subject to certain closing adjustments. We recorded an after-tax loss
of $25 million on the sale. The loss on sale includes a $13
million preliminary closing adjustment, which is an increase in the sale
proceeds, and recognition of an unrealized foreign currency translation gain of
$4 million. We expect to finalize the loss on sale during fiscal 2010 for
post-closing adjustments. As part of this sale, we signed a TSA to provide
certain post closing transition services to the buyer for a period of six months
from the closing date with an option by the buyer to extend for an additional
six months. In addition to the total consideration of $6 million, we expect to
receive an additional $2 million in cash related to this TSA during fiscal
2010.  The purchase price may be increased by up to $4 million if
certain performance thresholds are attained by Central Labs following the
closing.





Intent
to sell MDS Pharma Services Early Stage


On
September 2, 2009, we announced our intention to sell Early Stage (Discovery
through Phase IIa), in which we are a leader in molecular screening and
profiling, and have one of the largest Phase I bed capacities in the
industry.





As a
result of this decision, MDS has reflected the total assets and total
liabilities of Early Stage at the lower of their carrying value or their fair
value less costs to sell as “Assets of discontinued operations” and “Liabilities
of discontinued operations” in the consolidated statements of financial
position, respectively. The assets included in “Assets of discontinued
operations” are not being depreciated. The results of operations of Early Stage
are included in “(Loss) income from discontinued operations, net of income
taxes” in the consolidated statements of operations. As a result of MDS’s
intention to sell Early Stage, MDS estimated the loss on sale utilizing a fair
value based on appraisals, estimated net proceeds upon sale, and discounted cash
flows. As a result, we recorded an estimated pre-tax loss on sale of $13 million
in the fourth quarter of fiscal 2009. This estimated loss on sale includes
recognition of an unrealized foreign currency translation gain of $44 million.
While management believes that the estimated loss as of October 31, 2009 was its
then best estimate and that its valuation methods were reasonable and
appropriate in the circumstances, the ultimate amount of this estimated loss may
vary significantly. During the first quarter of fiscal 2010, continued
deterioration of market conditions, the declining Early Stage customer base and
new developments in the ongoing strategic review process, including recent
discussions with interested parties, are now likely to result in lower sale
proceeds than previously expected, which could lead to an additional loss on
sale in the range of $30 million to $60 million. We also recorded non-cash
long-lived asset impairment charges of $7 million and $2 million in the third
and fourth quarters of fiscal 2009, respectively, in “(Loss) income from
discontinued operations, net of income taxes”.





In
addition to the planned shareholder distribution of $400 million to $450 million
following the sale of MDS Analytical Technologies, we previously expected to
make a secondary shareholder distribution with a portion of the net cash
proceeds from the sale of Early Stage. Subsequent to year-end, continued
deterioration of market conditions, the declining Early Stage customer base and
new developments in the ongoing strategic review process, including recent
discussions with interested parties, are now likely to result in lower sale
proceeds than previously expected, which we now believe may not be sufficient to
fund a distribution to shareholders. The amount of proceeds that are received in
cash upon the completion of the intended sale may not exceed the associated
transaction and restructuring
costs, and other obligations retained as a result of the sale of the business.
In the event that the proceeds from the intended sale of Early Stage exceed the
costs and retained obligations, the amount, timing and manner of a distribution,
if any, whether by way of return of capital, substantial issuer bid, dividend or
otherwise will be determined following the completion of the intended sale of
Early Stage. While we believe it is probable that a sale of Early Stage will
occur, in the unlikely event that a transaction does not occur, we currently
intend to retain and invest in building the business.





Sale
of MDS Analytical Technologies


On
September 2, 2009, MDS announced that we have entered into an agreement to sell
MDS Analytical Technologies to Danaher Corporation (Danaher). Total
consideration for this sale is $650 million in cash subject to certain closing
adjustments including final working capital, cash, and indebtedness amounts. The
sale remains subject to certain closing conditions and approvals, including
clearance by the U.S. Federal Trade Commission (FTC). Under the terms of the
sale, Danaher would acquire MDS Analytical Technologies, which includes
approximately 1,100 employees operating in 10 countries, and its two joint
ventures, Applied Biosystems MDS Analytical Technologies Instruments and
PerkinElmer Sciex Instruments. Under a separate arrangement, Danaher has agreed
to purchase the portion of the Applied Biosystems MDS Analytical Technologies
Instruments mass spectrometry joint venture partnership held by Life
Technologies Corporation (Life). Completion of each transaction is conditional
on the concurrent closing of the other transaction.





We
determined that the sale of MDS Analytical Technologies constituted a sale of
substantially all of the assets under the Canada Business Corporations Act,
which required approval by shareholders. On October 20, 2009, we announced that
our shareholders had approved the sale of MDS Analytical Technologies to Danaher
at a Special Meeting of Shareholders and that in excess of 99% of the Common
shares voted were in favour of the sale. On November 3, 2009, we announced that
MDS and Danaher had received a Second Request for information from the FTC
regarding the sale of MDS Analytical Technologies. The Second Request relates to
a global market segment that MDS and Danaher estimate generates less than $50
million in annual revenues for all sellers combined. The effect of the Second
Request is to extend the waiting period imposed by the Hart Scott Rodino
Antitrust Improvements Act of 1976, as amended for a period of 30 calendar days
from the date of the parties’ substantial compliance with the request, unless
the waiting period is earlier terminated. MDS and Danaher continue to cooperate
with the FTC.





On
December 11, 2009, we were served with a Notice of Application (Notice) from
PerkinElmer, Inc. (PerkinElmer) with whom MDS has a joint venture to develop,
manufacture and sell inductively coupled plasma mass spectrometers. This product
line represents less than 10% of annual revenue generated by MDS Analytical
Technologies. The Notice relates to the previously announced sale of MDS
Analytical Technologies to Danaher and has been filed with the Ontario Superior
Court of Justice. PerkinElmer seeks a range of alternative possible remedies
including: court direction with respect to the development of protocols to
enforce key provisions of the joint venture agreement between MDS and
PerkinElmer; an injunction preventing enforcement of provisions in the sale
agreement of MDS Analytical Technologies to Danaher, which provide for MDS’s
retention of the joint venture; or an interim and permanent injunction
preventing the completion of the sale of MDS Analytical Technologies to Danaher.
On January 25, 2010, the above action was dismissed.





MDS has
reflected the total assets and total liabilities of MDS Analytical Technologies
at the lower of their carrying value or fair value less costs to sell as “Assets
of discontinued operations” and “Liabilities of discontinued operations” in the
consolidated statements of financial position, respectively. The assets included
in “Assets of discontinued operations” are not being depreciated. The carrying
value of MDS Analytical Technologies’ net assets did not exceed its fair value
less costs to sell resulting in no write-down of this business as of October 31,
2009. The results of operations of MDS Analytical Technologies are included in
“(Loss) income from discontinued operations, net of income taxes” in the
consolidated statements of operations. MDS expects to finalize the sale of MDS
Analytical Technologies during the first calendar quarter of 2010 and to record
an after-tax gain on the sale in the range of $10 million to $20
million.




As
previously discussed, following the completion of the sale of MDS Analytical
Technologies, we currently intend to use the sale proceeds plus existing cash on
hand of $298 million to redeem the senior unsecured notes and to initiate the
return of $400 million to $450 million to our shareholders through a substantial
issuer bid.




Medical
isotope supply disruption


On May
18, 2009, AECL announced that its NRU reactor would be out of service for more
than one month due to a heavy water leak in the reactor vessel. On May 27, 2009,
AECL announced that they believed the NRU reactor would be out of service for at
least three months. On August 12, 2009, AECL further clarified that they
expected the NRU reactor would return to service by the end of first calendar
quarter of 2010. On January 13, 2010, AECL, in its weekly update on the status
of the NRU reactor repairs, stated that the current schedule targets return to
service by the end of March 2010; however, if there are continuing challenges
with the repair process, the NRU reactor return to service schedule could extend
into April 2010. It is possible that the NRU reactor will be out
of service
for a period longer than currently announced by AECL. Since the NRU reactor has
been out of service, and as a result of the limited global supply, MDS Nordion
has been unable to secure an alternate source of the primary medical isotope
molybdenum-99 (Mo99). NRU reactor supplied isotopes have historically
contributed approximately $4 million per month of adjusted EBITDA. While
short-term alternative supply is not available, MDS continues to seek alternate
long-term supply, which will not likely generate meaningful supply for at least
five years, if at all. In relation to long-term supply, on April 28, 2009, we
announced that MDS Nordion has entered into an agreement with TRIUMF, Canada’s
national laboratory for particle and nuclear physics, to study the preliminary
stage of feasibility of producing a viable and reliable supply of photo
fission-based Mo99. Subsequently, on June 15, 2009, we announced an agreement
with the Karpov Institute of Physical Chemistry in Moscow, Russia, to study the
feasibility of the Karpov Institute providing us with a viable and reliable
reactor based supply of Mo99. Although we are also actively seeking other
sources of isotope supply, it is uncertain as to whether, and/or when, any of
these alternate sources of supply, which are all in feasibility assessment, will
become commercially viable.





MDS
Nordion has communicated its view that the Government of Canada should restart
the MAPLE Facilities project. In this regard, MDS Nordion announced on July 30,
2009, that the Company had submitted a proposal to the Government of Canada’s
Expert Review Panel on Medical Isotope and Technetium-99m Generator Production.
MDS Nordion believes, with expertise and guidance from the South African Nuclear
Energy Corporation, owner and operator of the SAFARI-1 reactor, a solution that
meets the technical and regulatory requirements needed for the provision of a
secure supply of medical isotopes could be achieved in an estimated


24
months. On December 3, 2009, the Expert Review Panel released a report, which
did not recommend or provide an assessment on specific proposals. The report
broadly assessed alternatives and while it provides for consideration of a
solution involving the MAPLE Facilities, the MAPLE Facilities were not included
in the Expert Review Panel’s technology-specific recommendations. The Government
of Canada has not responded to this report and MDS continues to focus on
arbitration proceedings with AECL, which are described below, to compel AECL to
complete the MAPLE Facilities.





As noted
above, the shortfall in medical isotopes from the AECL shutdown of the NRU
reactor is expected to decrease the adjusted EBITDA of the Company by
approximately $4 million per month. The earnings impact from an extended NRU
reactor shutdown, combined with the continued negative impact of existing market
conditions has increased the risk of breaching certain debt covenants. Following
the sale of MDS Analytical Technologies, which is expected in the first calendar
quarter of 2010, we intend to redeem the senior unsecured notes using the sale
proceeds of MDS Analytical Technologies and expect to terminate our credit
facilities, based on the terms of the respective agreements. Depending on
the timing of the sale of MDS Analytical Technologies, and based on the
reporting of compliance with the covenants with respect to our first quarter of
fiscal 2010, a breach of certain debt covenants related to the senior unsecured
notes and the revolving credit facility may occur during our second quarter of
fiscal 2010. The Company is carefully monitoring this risk and has developed
contingency plans to mitigate a potential covenant breach, which may include
requesting waivers related to our senior unsecured notes and our revolving
credit facility, which is currently undrawn. Should a breach of these covenants
occur, remediation may require repayment of all outstanding senior unsecured
notes currently valued at


$199
million ($221 million as of October 31, 2009) plus accrued interest and
associated tax-deductible make-whole payments of approximately $24 million and
may prevent us from accessing the existing revolving credit
facility.





MAPLE
Facilities


AECL and
the Government of Canada unilaterally announced in fiscal 2008 their intention
to discontinue the development work on the MAPLE Facilities. At the same
time, AECL and the Government of Canada also publicly announced that they would
continue to supply medical isotopes from the current NRU reactor, and would
pursue a license extension of the NRU reactor operations past its current expiry
date of October 31, 2011. On July 8, 2008, MDS served AECL with a notice of
arbitration proceedings seeking an order to compel AECL to fulfill its
contractual obligations and claiming C$1.6 billion (US$1.5 billion) in damages
from AECL and the Government of Canada. MDS continues to pursue these actions
with its current emphasis on arbitration proceedings. In addition to the
legal proceedings initiated by MDS against AECL and the Government of Canada, we
are currently exploring options, as described above, for both the long-term
supply of reactor-based medical isotopes and isotopes produced by other
modalities. MDS Nordion has also urged the Government of Canada and AECL to
consult with international experts and obtain their assistance toward activating
the MAPLE Facilities project.


Continuing
operations


Financial
highlights





2009
            
            2008
            
            2007Revenues
      from continuing operations
            $
            231
            $
            296
            $
            290(Loss)
      income from continuing operations
            $
            (15)
            $
            (246)
            $
            12Income
      tax expense (recovery)
            
            13
            
            (98)
            
            2Net
      interest expense (income)
            
            -
            
            (9)
            
            (22)Change
      in fair value of interest rate swaps
            
            -
            
            (2)
            
            (1)Depreciation
      and amortization
            
            24
            
            25
            
            23EBITDA
      from continuing operations
            
            22
            
            (330)
            
            14Restructuring
      charges, net
            
            9
            
            1
            
            9Write-down
      of investments and valuation provisions
            
            1
            
            10
            
            8Gain
      on sale of investments
            
            -
            
            -
            
            (7)Loss
      (gain) on sale of a business
            
            -
            
            4
            
            (1)MAPLE
      Facilities write-off
            
            -
            
            341
            
            -Adjusted
      EBITDA from continuing operations
            $
            32
            $
            26
            $
            23Adjusted
      EBITDA margin from continuing operations
            
            14%
            
            9%
            
            8%Total
      assets of continuing operations
            $
            685
            $
            591
            $
            1,551





The
continuing operations consist of MDS Nordion business, as well as certain
corporate functions, which we report as Corporate and Other. Included in
Corporate and Other are finance, information technology and systems, real
estate, human resources, and certain assets and liabilities expected to be
retained by MDS upon the completion of the aforementioned strategic
repositioning. Certain corporate employees provide services to all of MDS,
including MDS Analytical Technologies and MDS Pharma Services, which are
reported in discontinued operations, however, the full cost of these employees
is reflected in continuing operations for all reported periods.





Revenues
from continuing operations


Revenues
from continuing operations in fiscal 2009 of $231 million were $65 million lower
compared to fiscal 2008. The decrease was primarily due to lower volumes from
medical imaging driven by the unexpected and prolonged shutdown of AECL’s NRU
reactor, lower cobalt supply, the negative impact of foreign exchange and lower
revenues from the fiscal 2008 divestiture of external beam therapy and
self-contained irradiator product lines, partially offset by increased pricing
and growth in certain radiotherapeutic products. The self-contained irradiator
product lines contributed $17 million to the revenues in fiscal 2008. Excluding
the impact of foreign exchange and divestitures, revenues from continuing
operations declined by 10%.





Revenues
from continuing operations in fiscal 2008 of $296 million were $6 million higher
than in fiscal 2007 primarily due to higher revenue related to increased cobalt
shipments and a weaker U.S. dollar on average in fiscal 2008. The increase in
revenues was partially offset by lower revenues from the external beam therapy
and self-contained irradiator product lines that were sold during fiscal
2008.





Loss
from continuing operations


The loss
from continuing operations in fiscal 2009 of $15 million was significantly lower
than the $246 million loss in fiscal 2008 due to the $246 million after-tax
($341 million pre-tax) MAPLE Facilities write-off on the discontinuance of the
development work on the MAPLE Facilities by AECL in fiscal 2008. This impact was
partially offset by lower revenues due to the NRU reactor shutdown and lower
cobalt supply, lower interest income and higher interest expense recorded in
fiscal 2009 compared to fiscal 2008. The MAPLE Facilities write-off consists of
the non-cash write-off of $501 million of construction in-progress, net of $14
million of long-term financing liability, and $146 million financing
liability.





The loss
from continuing operations in fiscal 2008 was $246 million compared to income of
$12 million in fiscal 2007 primarily due to MAPLE Facilities write-off in fiscal
2008.


Income
taxes





2009
            
            2008
            
            2007(Loss)
      income from continuing operations before income taxes
            $
            (2)
            $
            (344)
            $
            14Income
      tax expense (recovery)
            $
            13
            $
            (98)
            $
            2Effective
      tax rate
            
            (650%)
            
            28%
            
            14%Statutory
      tax rate
            
            32%
            
            33%
            
            35%





In fiscal
2009, we reported an income tax expense of $13 million on a loss from continuing
operations before income taxes of $2
million.  At a 32% statutory tax rate for fiscal 2009, our expected
income tax recovery is $1 million.  Included in income tax expense of
the continuing operations of $13 million is a $12 million valuation allowance on
deferred tax assets that relate to losses that are reflected in discontinued
operations and a $3 million increase in reserves in accordance with Accounting
Standards Codification (ASC) 740-10, “Uncertainty in Income Taxes”
(formerly, FIN 48, “Accounting
for Uncertainty in Income Taxes - an interpretation of FASB Statement No.
109”).





In fiscal
2008, we reported an income tax recovery of $98 million at an effective tax rate
of 28%, which is lower than our 33% statutory tax rate. This variance was
primarily due to the tax recovery of $18 million on the $341 million MAPLE
Facilities write-off at a 28% rate, which was partially offset by a tax expense
reduction of $11 million relating to the recognition of tax credits for research
and development.





In fiscal
2007, we reported an income tax expense of $2 million at an expected tax rate of
14%, which is lower than our statutory tax rate of 35%. This variance was due to
several factors, including a $2 million income tax expense reduction relating to
enacted Canadian income tax rate declines, a $3 million reduction of income tax
expense for research and development tax credits, and a $3 million increase to
taxes for valuation allowances on losses incurred in foreign
jurisdictions.





Net
interest expense (income)


The net
interest income in fiscal 2009 of $nil was $9 million lower compared to fiscal
2008.





Interest
income in fiscal 2009 of $8 million was $4 million lower than in fiscal 2008 due
to lower interest rates in fiscal 2009 compared to fiscal 2008. Interest expense
for fiscal 2009 of $8 million was $5 million higher compared to fiscal 2008
primarily due to certain interest attributable to the MAPLE Facilities that was
capitalized until it was written off in fiscal 2008.





The net
interest income in fiscal 2008 of $9 million was $13 million lower compared to
fiscal 2007.





Interest
income in fiscal 2008 of $12 million was $11 million lower than in fiscal 2007
primarily due to lower interest rates and lower cash and short-term investment
balances that resulted from a $79 million repayment of the senior unsecured
notes, $88 million in tax payments, $13 million in capital expenditures and $44
million for share repurchases in fiscal 2008. In addition,
approximately


$3
million of incremental interest was earned in fiscal 2007 as a result of cash we
received from the sale of MDS Diagnostic Services that was subsequently used to
fund an acquisition and to repurchase shares under a substantial issuers bid.
Interest expense in fiscal 2008 of $3 million was $2 million higher than in
fiscal 2007 due to lower interest allocated on the senior unsecured notes to
discontinued operations in fiscal 2008. We have allocated the interest to the
discontinued operations based on the ratio of the net assets to be sold to the
sum of the total net assets plus the senior unsecured notes. Interest expense on
the senior unsecured notes allocated to discontinued operations in fiscal 2008
was $9 million compared to $11 million for fiscal 2007.





Adjusted
EBITDA


Adjusted
EBITDA in fiscal 2009 of $32 million was $6 million higher than in fiscal 2008.
This was primarily due to lower expenses related to the fair value of the
embedded derivatives, lower corporate and other costs and increased pricing,
partially offset by lower revenues due to the NRU reactor shutdown and lower
cobalt supply, and the foreign exchange loss resulting from the revaluation of
certain assets and liabilities. Adjusting items recorded in fiscal 2009 included
a $9 million restructuring charge related to strategic repositioning, and a $1
million write-off of investment in Entelos Inc. (Entelos). Adjusting items
recorded in fiscal 2008 included a


$1
million for lease termination costs of the head office in Toronto, Canada that
were recorded as a restructuring charge, a


$341
million non-cash MAPLE Facilities write-off and a $4 million loss on the sale of
two of the product lines within MDS Nordion. In fiscal 2008, we also recorded a
$7 million write-down of investment in Entelos and a charge for the earn-out
related to the merger between Iconix Pharmaceuticals, Inc. (Iconix) and Entelos,
and a $3 million impairment charge for an Asset Backed Commercial Paper (ABCP)
investment.


Adjusted
EBITDA in fiscal 2008 of $26 million was $3 million higher compared to fiscal
2007 primarily due to higher revenue related to cobalt shipments and lower
selling, general and administration costs. This was partially offset by higher
expenses related to the fair value of the embedded derivatives and other
indirect costs recorded in fiscal 2007 related to the Canadian laboratory
services business, MDS Diagnostic Services. The details of the disposition of
the MDS Diagnostic Services are discussed in “Divestitures and discontinued
operations” section of this MD&A. Adjusting items recorded in fiscal
2007 were a $9 million restructuring charge associated with the transition of
global information technology support services to a new provider and the
reduction of certain central support services following the sale of MDS
Diagnostic Services. We also recorded a $2 million impairment charge for the
investment in ABCP and a


$6
million write-down of investment in Lumira Capital Corp. In fiscal 2007, the
sale of investment in Hemosol Corp. (Hemosol) resulted in a gain of $2 million
and the bankruptcy proceeds resulting from the wind-down of the investment in
Protana Inc. (Protana), a successor company to MDS Proteomics resulted in a gain
of $5 million. In fiscal 2007, we also recorded a $1 million gain in MDS Nordion
for the release of the provision for indemnifications granted to the purchaser
of Therapy Systems business that we sold in 2003 on the expiry of the
indemnification period.


Operating
income (loss) from continuing operations





2009
            %
      of
              revenues
            
            2008
            %
      of
              revenues
            
            2007
            %
      of
              revenuesRevenues
            $
            231
            100%
            $
            296
            100%
            $
            290
            100%Direct
      cost of revenues
            
            (122)
            (53%)
            
            (153)
            (52%)
            
            (150)
            (52%)Selling,
      general and administration
            
            (79)
            (34%)
            
            (105)
            (36%)
            
            (122)
            (42%)Research
      and development
            
            (3)
            (1%)
            
            (3)
            (1%)
            
            (4)
            (1%)Depreciation
      and amortization
            
            (24)
            (10%)
            
            (25)
            (8%)
            
            (23)
            (8%)MAPLE
      Facilities write-off
            
            -
            -
            
            (341)
            (115%)
            
            -
            -Restructuring
      charges, net
            
            (9)
            (4%)
            
            (1)
            -
            
            (9)
            (3%)Change
      in fair value of embedded derivatives
            
            8
            3%
            
            (15)
            (5%)
            
            4
            1%Other
      (expenses) income, net
            
            (4)
            (2%)
            
            (8)
            (3%)
            
            5
            2%Operating
      loss from continuing operations
            $
            (2)
            (1%)
            $
            (355)
            (120%)
            $
            (9)
            (3%)Gross
      margin on products and services
            
            47%
            
            
            48%
            
            
            48%





Selling,
general and administration (SG&A)


SG&A
expenses in fiscal 2009 of $79 million were $26 million lower compared to fiscal
2008. The decrease is primarily due to the impact of foreign exchange on the
Canadian dollar spending, lower compensation cost from workforce reductions, and
cost control initiatives, partially offset by higher stock-based compensation
expense as compared to stock-based compensation credits recorded in fiscal
2008.





SG&A
expenses in fiscal 2008 of $105 million were $17 million lower compared to
fiscal 2007. This was primarily due to lower incentive and stock-based
compensation expense, lower pension expense, the 2008 sale of two product lines,
lower annual incentive program costs, and indirect corporate support costs
incurred in fiscal 2007 related to the divestiture of MDS Diagnostics Services.
The decrease in expenses was partially offset by fiscal 2007 costs related to
the self-insured liabilities, finance and audit costs related to U.S. GAAP
conversion and asset impairment assessments, and the impact of foreign exchange
on the Canadian dollar spending.





Research
and development (R&D)


R&D
expense in fiscal 2009 of $3 million was flat compared to fiscal 2008. R&D
expense in fiscal 2008 of $3 million was $1 million lower than in fiscal 2007.
Our R&D expenses in fiscal 2009 related primarily to the TheraSphere®
clinical program. As a percentage of revenues, R&D expenses in fiscal years
2009, 2008 and 2007 were each 1%.





Depreciation
and amortization


Depreciation
and amortization expense in fiscal 2009 of $24 million was relatively flat
compared to fiscal 2008 and fiscal 2007. As a percentage of revenues,
depreciation and amortization expense is 10% in fiscal 2009, 8% in fiscal 2008
and 2007.





Other
income (expenses), net


Other
income (expenses), net in fiscal 2009 of $4 million expense was lower by $4
million compared to fiscal 2008 due to lower valuation allowances recorded in
fiscal 2009, partially offset by the unfavorable impact of the foreign exchange
in fiscal 2009. In fiscal 2009, we recorded a $1 million for the write-down of
the investment in Entelos. In fiscal 2008, we recorded a $3 million valuation
allowance for ABCP investment, a $7 million valuation provision and charge
related to the investment in Entelos, a $4 million loss on the sale of two
product lines of MDS Nordion, and a $2 million higher costs related to
self-insured liabilities. The lower valuation provisions in fiscal 2009 were
offset by a foreign exchange loss of $5 million in fiscal 2009 compared to a
gain of $7 million in fiscal 2008.





Other
income (expenses), net in fiscal 2008 of $8 million expense was lower than Other
income of $5 million in fiscal 2007 by $13
million due to a higher gain on sale of investments and lower valuation
allowance in fiscal 2007, partially offset by the positive impact of foreign
exchange. In fiscal 2008, we recorded a $3 million valuation allowance for ABCP
investment, a $7 million valuation provision and a charge related to the
investment in Entelos, a $4 million loss on the sale of two product lines of MDS
Nordion, and a $2 million higher costs related to self-insured liabilities. In
fiscal 2007, we recorded: the sale of investment in Hemosol resulting in a gain
of $2 million; the bankruptcy proceeds from the wind-down of the investment in
Protana, a successor company to MDS Proteomics which resulted in a gain of $5
million; a $1 million gain on the sale of a MDS Nordion business; a $5 million
gain on sale of assets; a $6 million valuation provision for investment in
Lumira Capital Corp.; and a $2 million valuation allowance related to ABCP. The
impact of the foreign exchange rates resulted in a gain of $7 million in fiscal
2008 compared to a loss of $4 million in fiscal 2007.


Earnings per
share


As of
October 31, 2009, we had 120 million Common shares outstanding. We did not
repurchase any shares in fiscal 2009. We repurchased 2.9 million shares in
fiscal 2008 for $44 million as part of normal course issuer bid. In fiscal 2007,
we repurchased 22.8 million shares for $441 million as part of a substantial
issuer bid.





The
reported loss per share from continuing operations in fiscal 2009 of $0.12
improved from the loss of $2.02 in fiscal 2008. This was primarily due to a
$2.02 write-off for the MAPLE Facilities and $0.08 for valuation provisions
recorded against investments in fiscal 2008, partially offset by lower revenues
due to the NRU reactor shutdown and higher restructuring charges in fiscal
2009.





Adjusted
earnings per share from continuing operations in fiscal 2009 was $0.02 compared
to $nil in fiscal 2008. This was due to an increase in the change in the fair
value of the embedded derivatives, lower compensation costs due to a smaller
work force and cost control initiatives, increased pricing, the positive impact
of the foreign exchange partially offset by lower revenues due to the NRU
reactor shutdown and lower cobalt supply. The adjusting items used in
calculating adjusted EPS reflect the after-tax adjusting items used in
calculating adjusted EBITDA. In fiscal 2009, the adjusted EPS includes $0.08 for
the write-down of certain tax assets,


$0.05 for
restructuring charges and $0.01 for the valuation provision for write-off of the
investment in Entelos. In fiscal 2008, the adjusted EPS includes adjusting items
of $2.02 for the MAPLE Facilities write-off, $0.09 for a reduction in the
deferred tax liabilities due to the enactment of income tax rate reductions in
Canada, $0.08 for valuation provisions recorded against
investments,


$0.01 for
restructuring charges and $0.02 for the mark-to-market gain on interest rate
swaps.





Loss per
share from continuing operations in fiscal 2008 was $2.02 compared to earnings
per share of $0.09 in fiscal 2007 primarily due to the MAPLE Facilities
write-off in fiscal 2008. Adjusted earnings per share from continuing operations
in fiscal 2008 was $nil compared to $0.14 in fiscal 2007. In fiscal 2007, the
adjusted EPS includes $0.05 for the restructuring charges, $0.06 for the
valuation provisions for Entelos and ABCP investments, $0.04 for the gain on the
sale of the investments and $0.01 for mark-to-market gain on interest rate
swaps.





Details
of adjusted (loss) earnings per share from continuing operations and adjusted
net income from continuing operations for fiscal years 2009, 2008 and 2007 are
as follows:





2009
            
            2008
            
            2007Basic
      (loss) earnings per share from continuing operations - as
      reported
            $
            (0.12)
            $
            (2.02)
            $
            0.09Adjusted
      for:Restructuring
      charges, net
            
            0.05
            
            0.01
            
            0.05Write-down
      of investments and valuation provisions
            
            0.01
            
            0.08
            
            0.06Loss
      (gain) on sale of business
            
            -
            
            0.02
            
            (0.01)Gain
      on sale of investments
            
            -
            
            -
            
            (0.04)Gain
      on interest rate swaps
            
            -
            
            (0.02)
            
            (0.01)MAPLE
      Facilities write-off
            
            -
            
            2.02
            
            -Write-down
      of tax assets
            
            0.08
            
            -
            
            -Tax
      rate changes
            
            -
            
            (0.09)
            
            -Adjusted
      earnings per share from continuing operations
            $
            0.02
            $
            -
            $
            0.14







2009
            
            2008
            
            2007(Loss)
      earnings from continuing operations - as reported
            $
            (15)
            $
            (246)
            $
            12Adjusted
      for income taxes (after tax):Restructuring
      charges, net
            
            6
            
            1
            
            6Write-down
      of investments and valuation provisions
            
            1
            
            10
            
            8Loss
      (gain) on sale of business
            
            -
            
            2
            
            (1)Gain
      on sale of investments
            
            -
            
            -
            
            (6)Gain
      on interest rate swaps
            
            -
            
            (2)
            
            (1)Write-down
      of tax assets
            
            9
            
            -
            
            -MAPLE
      Facilities write-off
            
            -
            
            246
            
            -Tax
      rate changes
            
            -
            
            (11)
            
            -Adjusted
      net income from continuing operations
            $
            1
            $
            -
            $
            18


MDS
Nordion


Financial
Highlights





2009
            %
      of
              revenues
            2008
            %
      of
              revenues
            2007
            %
      of
              revenuesRevenues
            $
      231
            100%
            $           296
            100%
            $           290
            100%Direct
      cost of revenues
            (122)
            (53%)
            (153)
            (52%)
            (150)
            (52%)Selling,
      general and administration
            (40)
            (17%)
            (48)
            (16%)
            (60)
            (21%)Research
      and development
            (3)
            (1%)
            (3)
            (1%)
            (4)
            (1%)Depreciation
      and amortization
            (14)
            (6%)
            (13)
            (4%)
            (13)
            (4%)Change
      in fair value of embedded derivatives
            8
            3%
            (15)
            (5%)
            4
            1%MAPLE
      Facilities write-off
            -
            -
            (341)
            (115%)
            -
            -Other
      (expenses) income, net
            (1)
            -
            (2)
            (1%)
            5
            2%Operating
      income (loss)
            59
            26%
            (279)
            (94%)
            72
            25%Depreciation
      and amortization
            14
            6%
            13
            4%
            13
            4%EBITDA
            73
            32%
            (266)
            (90%)
            85
            29%MAPLE
      Facilities write-off
            -
            -
            341
            115%
            -
            -Loss
      (gain) on sale of a business
            -
            -
            4
            2%
            (1)
            -Adjusted
      EBITDA
            $73
            32%
            $             79
            27%
            $            84
            29%Margins:Gross
      margin
            47%
            
            48%
            
            48%Adjusted
      EBITDA margin
            32%
            
            27%
            
            29%





Revenues


Revenues
in fiscal 2009 of $231 million were lower by $65 million than in fiscal 2008.
This was due to lower revenues from medical imaging driven by the NRU reactor
shutdown, lower cobalt supply, the negative impact of the foreign exchange and
the 2008 divestiture of the external beam therapy and self-contained irradiator
product lines, partially offset by increased pricing and growth in certain
radiotherapeutic products. Our external beam therapy and self-contained
irradiator product lines contributed $17 million to the revenues in fiscal 2008.
Excluding the impact of foreign exchange and divestitures, fiscal 2009 revenues
were down 10% compared to fiscal 2008.





The NRU
reactor supplies substantially all of the reactor-based medical isotopes. On May
18, 2009, we received information from AECL, our primary supplier of reactor
based medical isotopes, regarding an interruption in the supply of medical
isotopes. On January 13, 2010, AECL, in its weekly update on the status of the
NRU reactor repairs, stated that the current schedule targets return to service
by the end of March 2010; however, if there are continuing challenges with the
repair process, the NRU reactor return to service schedule could extend into
April 2010. The details of the NRU reactor shutdown were discussed earlier in
the “Medical Isotope Supply
Disruption” section of this MD&A.





Revenues
in fiscal 2008 of $296 million were slightly higher than in fiscal 2007
primarily due to higher cobalt revenues. The 2008 divestiture of the external
beam therapy and self-contained irradiator product lines substantially offset
the impact of foreign exchange. The impact of the weakness in the U.S. dollar
compared to the Canadian dollar in 2008 increased the fiscal 2008 revenues by $14
million. On May 1, 2008, we completed the sale of external beam therapy and
self-contained irradiator product lines, and as a result, revenues were $15
million lower in fiscal 2008 than in fiscal 2007. Excluding the impact of
foreign exchange and divestiture, revenues were up 3% in fiscal 2008 compared to
fiscal 2007.





Revenues
from medical imaging and radiotherapeutics in fiscal 2009 declined approximately
16% versus fiscal 2008 mainly due to the impact of the NRU reactor shutdown. We
did experience growth in radiotherapeutics led by TheraSphere®, which
experienced growth of over 25%, with $20 million in annual revenue, and became
our third largest product, based on revenue as this treatment continues to gain
acceptance for cancer treatment.





Revenue
from sterilization technologies in fiscal 2009 were down approximately 30%
versus fiscal 2008 primarily due to lower cobalt supply and the impact of the
2008 sale of the previously mentioned product lines. Our supply of cobalt
decreased in fiscal 2009 compared to fiscal 2008 due to the timing of the
discharges, which are typically on 18- to 24-month cycles, from the reactors
that supply us. We took steps in 2007 to increase the supply of cobalt, signing
an extension to the 2005 long-term contract with Energoatom, the utility
operator responsible for Russia’s nuclear power plants. This 17-year extension
resulted in the commitment to increase in MDS Nordion’s cobalt-60 (Co60). In
June 2009, as a result of a change in the Russian government’s policy on nuclear
products, an amendment was signed to this contract for the supply of Co60 with
Energoatom. This amendment, which did not amend


the
pricing and other terms, reduced the overall future purchase commitment by
approximately $35 million to $82 million as of October 31, 2009.





Selling,
general and administration (SG&A)


SG&A
expense in fiscal 2009 of $40 million was $8 million lower than in fiscal 2008
primarily due to the impact of foreign exchange on spending resulting from the
weakness of the U.S. dollar compared with the Canadian dollar and lower annual
incentive payouts.





SG&A
expense in fiscal 2008 of $48 million was $12 million lower than in fiscal 2007,
primarily due to lower stock-based compensation expense, lower annual incentive
payouts, sale of the previously mentioned product lines in 2008, partially
offset by the negative impact of foreign exchange on spending.





Research
and development (R&D)


R&D
expense as a percent of revenues was 1% for all of the fiscal years 2009, 2008
and 2007. R&D investment in fiscal 2009 remained flat at $3 million compared
with fiscal 2008. Our R&D expenses in fiscal 2009 primarily related to
spending for the TheraSphere® clinical programs. R&D investment in fiscal
2008 was $1 million lower compared with fiscal 2007, which was primarily due to
the TheraSphere® program for which the initial phase of development was
completed in fiscal 2007. In addition to the R&D, we collaborate with a
number of companies and government agencies to develop new radiotherapeutics and
imaging products. During fiscal 2009, MDS Nordion continued to develop and
manufacture products under its customer collaboration agreements and established
a Molecular Imaging Centre of Excellence at the University of Ottawa Heart
Institute, Canada’s largest cardiovascular health centre, to advance cardiology
research.





Change
in fair value of embedded derivatives


In fiscal
2009, we recorded a gain for the change in fair value of embedded derivatives of
$8 million compared to loss of $15 million in fiscal 2008, primarily relating to
the Russian cobalt supply contract. The Russian cobalt supply contract is
denominated in U.S. dollars, which creates an embedded derivative as MDS
Nordion’s Canadian operations has Canadian dollars as its functional currency.
We mark-to-market any changes in the fair value of the embedded derivative and
record these increases and decreases as gains and losses within operating income
(loss). As the contracts have durations up to 17 years and represent large
purchase commitments, movements in the U.S. to Canadian dollar exchange drive
significant unrealized gains or losses. The result of lower volumes associated
with the Energoatom amendment in June 2009 reduced the embedded derivative
liability associated with this supply contract and resulted in a gain of $5
million for the third quarter of fiscal 2009. The change in fair value of
embedded derivatives in fiscal 2008 resulted in a loss of $15 million, compared
to gain of $4 million in fiscal 2007.





Other
income (expenses), net


Other
income (expenses), net in fiscal 2009 of $1 million expense relates to a foreign
exchange loss on the revaluation of certain assets and liabilities.





Other
income (expenses), net for fiscal 2008 of $2 million expense included a $4
million loss on the sale of two product lines, offset by a $2 million foreign
exchange gain from the revaluation of certain assets and liabilities resulting
from the strengthening of the U.S. dollar during 2008. Other income (expenses),
net for fiscal 2007 of $5 million income included a $1 million gain for the
release of the provision for indemnifications granted to the purchaser of the
Therapy Systems business that we sold in 2003 on the expiry of the
indemnification period.





During
the fourth quarter of fiscal 2009, we reviewed the timing of incurring future
site remediation costs of the facility located in Kanata, Ontario, due to the
NRU reactor shutdown. Accordingly, we recorded $5 million as the present value
of the future site remediation costs in “Property, plant and equipment, net” and
“Other long-term obligations” in the consolidated financial statements. The
capitalized future site remediation costs will be depreciated and the retirement
obligation will be accreted over the life of the asset effective the first
quarter of fiscal 2010. We determined the fair value of the retirement
obligation based on third party estimates. Considerable management judgment is
required in estimating this obligation and the key assumptions include the
credit-adjusted risk-free interest rate, timing and the estimate of the
remediation activities. Changes in these assumptions based on future information
may result in an adjustment to the estimated obligation over time. We maintain a
$14 million (2008 - $13 million) letter of credit to support the future site
remediation costs for this facility.





Operating
income (loss)


Operating
income in fiscal 2009 of $59 million was $338 million higher than in fiscal 2008
primarily due to the $341 million MAPLE Facilities write-off in fiscal 2008 and
a $23 million year-over-year reduction in expense related to the change in the
fair value of the embedded derivative. This increase was partially offset by the
net impact of the lower revenues resulting from the NRU reactor shutdown and
lower cobalt supply.


Operating
loss in fiscal 2008 of $279 million compared to operating income of $72 million
in fiscal 2007. This significant loss in fiscal 2008 was due to the MAPLE
Facilities write-off and a $4 million loss on the sale of external beam therapy
and self-contained irradiator product lines.





Adjusted
EBITDA


Adjusted
EBITDA in fiscal 2009 of $73 million was $6 million lower than in fiscal 2008.
The decrease was primarily due to lower volumes from the NRU reactor shutdown
and lower cobalt supply, a $3 million reduction from the revaluation of certain
assets and liabilities and a $2 million reduction due to the 2008 sale of two
product lines. This decrease was partially offset by the reduction of expense
related to the fair value of the embedded derivatives and increased pricing. We
had previously announced an approximate


$4
million reduction in adjusted EBITDA for every month the reactor was out of
service. Prior to the shutdown of the NRU reactor in May 2009, NRU reactor
supplied products contributed approximately $30 million of EBITDA in the current
fiscal year, which included $6 million of incremental EDITDA that resulted from
higher sales during a competitor’s supply disruption. Excluding the increase in
adjusted EBITDA related to embedded derivatives, adjusted EBITDA decreased by
$29 million primarily due to lower revenues from NRU reactor shutdown and lower
cobalt supply. In fiscal 2009, we did not have any adjusting items. In fiscal
2008, the adjusting items were the $341 million non-cash write-down related to
the MAPLE facilities and a $4 million loss on the divestiture of two of the
product lines.





Adjusted
EBITDA in fiscal 2008 of $79 million was $5 million lower than in fiscal 2007
primarily due to $19 million of increased embedded derivatives expense
associated with the Russian cobalt supply contracts. Excluding the change in the
fair value of embedded derivatives, adjusted EBITDA increased by $14 million due
to lower SG&A, higher revenue, and the impact of foreign exchange primarily
due to the revaluation of certain assets and liabilities. In fiscal 2007, the
adjusting item relates to a gain of $1 million for the release of provision for
indemnifications granted to the purchaser of the Therapy Systems business that
was sold in 2003 due to the expiry of the indemnification
period.


Corporate
and Other


Financial
Highlights





2009
            
            2008
            
            2007Selling,
      general and administration
            $
            (39)
            $
            (57)
            $
            (62)Depreciation
      and amortization
            
            (10)
            
            (12)
            
            (10)Restructuring
      charges, net
            
            (9)
            
            (1)
            
            (9)Other
      expenses, net
            
            (3)
            
            (6)
            
            -Operating
      loss
            
            (61)
            
            (76)
            
            (81)Depreciation
      and amortization
            
            10
            
            12
            
            10EBITDA
            
            (51)
            
            (64)
            
            (71)Restructuring
      charges, net
            
            9
            
            1
            
            9Write-down
      of investments and valuation provisions
            
            1
            
            10
            
            8Gain
      on sale of investments
            
            -
            
            -
            
            (7)Adjusted
      EBITDA
            $
            (41)
            $
            (53)
            $
            (61)





Selling,
general and administration (SG&A)


SG&A
expense in fiscal 2009 of $39 million were $18 million lower compared fiscal
2008 due to lower compensation cost from a smaller workforce and cost control
initiatives, and the foreign exchange impact on the Canadian dollar spending,
partially offset by higher stock-based compensation expense compared to
stock-based compensation credits recorded in 2008.





SG&A
expense in fiscal 2008 of $57 million was $5 million lower than fiscal 2007 due
to lower incentive and stock-based compensation expense and certain costs
incurred in 2007 related to the indirect costs for the divestiture of the MDS
Diagnostics Services. The decrease in the costs were partially offset by higher
costs related to self-insured liabilities and audit costs related to U.S. GAAP
conversion and asset impairment assessments, and the impact of foreign exchange
on the Canadian dollar spending. The details of the disposition of the MDS
Diagnostic Services are discussed in the “Divestitures and discontinued
operations” section of this MD&A.





Restructuring
charges


Restructuring
charges for fiscal 2009 of $9 million were $8 million higher compared to fiscal
2008 due to planned workforce reductions related to our intended move of the
corporate head office from Toronto to Ottawa, Canada. This restructuring amount
includes severance and benefits costs. We may also incur a variety of other
costs related to the planned divestitures and strategic repositioning as
discussed in the “Outlook” section of the
MD&A. We recorded these restructuring charges in the fourth quarter of
fiscal years 2009 and 2008, respectively.





Restructuring
charges for fiscal 2008 of $1 million were $8 million lower compared to fiscal
2007 due to $9 million of restructuring charges recorded in 2007 associated
primarily with the transition of the global IT support services to a new
provider and for the reduction of certain central support services following the
sale of MDS Diagnostics Services.





Other
income (expenses), net


Other
income (expenses), net in fiscal 2009 of $3 million expense was lower by $3
million than in fiscal 2008 due to lower valuation allowances recorded in fiscal
2009 partially offset by the negative impact of foreign exchange rates. In
fiscal 2009, we recorded


$1
million for the write-down of the investment in Entelos. In fiscal 2008, we also
recorded a $3 million valuation allowance for ABCP investment and a $7 million
valuation provision and charge related to the investment in Entelos. The changes
in the foreign exchange rates resulted in a loss of $3 million in fiscal 2009
and a gain of $5 million in fiscal 2008.





Other
income in fiscal 2009 also includes income that we are entitled to receive in
accordance with a TSA for certain transition services that we provide to a buyer
of a business that we sold. As part of the sale of Phase II-IV, we signed a TSA
to provide certain post closing transition services to the buyer for a period of
six months from the closing date. The total cash consideration
includes


$2
million related to this TSA in which $1 million was recorded in fiscal 2009 and
the remaining $1 million is expected to be recorded in the first quarter of
fiscal 2010 when the TSA is expected to be completed. As part of the sale of
Central Labs, we signed a TSA to provide certain post closing transition
services to the buyer for a period of six months from the closing date with an
option by the buyer to extend for an additional six months. We expect to receive
an additional $2 million related to this TSA, of which no amount has been
received during fiscal 2009.





Other
income (expenses), net in fiscal 2008 of $6 million expense was higher by $6
million than in fiscal 2007 due to lower gain on sale of investments and higher
valuation allowance partially offset by positive impact of the foreign exchange.
In fiscal 2007, the sale of investment in Hemosol resulted in a gain of $2
million and the bankruptcy proceeds resulting from the wind-down of the
investment in
Protana, a successor company to MDS Proteomics resulted in a gain of $5 million.
In fiscal 2007, we recorded a $6 million valuation provision for investment in
Lumira Capital Corp. and a $2 million valuation allowance related to ABCP. The
changes in the foreign exchange rates resulted in a gain of $5 million in fiscal
2008 compared to a loss of $3 million in fiscal 2007.





Adjusted
EBITDA


Adjusted
EBITDA in fiscal 2009 improved by $12 million compared to fiscal 2008 due to
lower compensation cost from a smaller workforce and the cost control
initiatives, foreign exchange impact on the Canadian dollar spending and lower
corporate development expenses. This was partially offset by negative impact of
the foreign exchange on the revaluation of certain of the assets and
liabilities.





The
adjusting items in fiscal 2009 include a $1 million write-off of the investment
in Entelos and a $9 million restructuring charge due to the strategic
repositioning.





Adjusted
EBITDA in fiscal 2008 improved by $8 million compared to fiscal 2007 due to
lower incentive and stock-based compensation expense and certain indirect costs
for the divestiture of the MDS Diagnostics Services. The adjusting items in
fiscal 2007 included a $6 million write-down for the investment in Lumira
Capital Corp., a $2 million impairment charge for the ABCP, and a $7 million
gain from the sale of the investments in Hemosol and Protana. In fiscal 2007, we
also recorded a $9 million restructuring charge following the sale of the
diagnostics business as an adjusting item.





The
adjusting items in fiscal 2008 include a $7 million valuation provision and
charge related to the investment in Entelos and a $3
million impairment charge for the ABCP. In fiscal 2008, we also recorded a $1
million restructuring charge for lease termination costs of the headquarter
offices in Canada.


Divestitures
and discontinued operations





MDS
Pharma Services


Revenues


Revenues
in fiscal 2009 of $442 million were lower by $140 million than in fiscal 2008.
This was primarily due to the divesture of the  Phase II-IV in the
third quarter of fiscal 2009, continuing customer concern regarding the
uncertainty created by MDS’ strategic review process, and lower overall demand
as customers continue to reprioritize their R&D pipelines due to current
economic conditions.





Revenues
in fiscal 2008 of $582 million were higher by $14 million than in fiscal 2007
primarily due to the growth in Early Stage driven by Phase I activities
including revenue from our Phoenix facility that opened in early
2008.





Costs
and other expenses


Costs and
other expenses in fiscal 2009 of $457 million were lower by $119 million than in
fiscal 2008 primarily due to the divesture of the Phase II-IV in the third
quarter of fiscal 2009 and the savings resulting from our restructuring
initiatives partially offset by higher stock compensation expense.





Costs and
other expenses in fiscal 2008 of $576 million were lower by $79 million than in
fiscal 2007 primarily due to savings resulting from restructuring initiatives
and revaluation of certain monetary assets and liabilities, partially offset by
the negative impact of foreign exchange.





Regulatory
review of Montreal, Canada bioanalytical operations


Although
the bioanalytical operations in Montreal, Canada are part of MDS Pharma
Services, the Food and Drug Administration (FDA) liability is recorded in
continuing operations as we expect to retain this potential liability following
an intended sale of that business.





In fiscal
2007, we established a $61 million FDA provision to address the U.S. FDA issues
related to the bioanalytical operations in Montreal, Canada in which we may,
where appropriate, reimburse clients who have incurred or will incur third party
audit costs or study re-run costs to complete the work required by the FDA and
other regulators. Management regularly updated its analysis of this critical
estimate based on all currently available information. During fiscal 2009 and
2008, we have continued the efforts and made substantial progress to address
regulatory issues related to the bioanalytical operations. After a detailed
review of the remaining liabilities associated with the FDA estimate and the
estimate of future expected costs that will be incurred, we reversed $10 million
in fiscal 2009 and $10 million in fiscal 2008 for the FDA related liabilities.
Based on information currently available, we believe the remaining reserve of
$19 million (2008 - $30 million) is an appropriate amount to cover any
agreements reached with clients for study audits, study reruns, and other
related costs. While management believes that its estimates and valuation
methods are reasonable and appropriate in the circumstances, the ultimate amount
of the potential liability may vary significantly if other reasonably possible
alternative assumptions were used.





During
fiscal 2009, we were served with a Statement of Claim related to repeat study
and mitigation costs of $5 million and loss of profit of $28 million. MDS has
assessed this claim and no provision has been recorded related to the claim for
lost profit. We have filed a Statement of Defence and intend to vigorously
defend this action. During fiscal 2009, we were also served with a Complaint
related to repeat study and mitigation costs of $10 million and lost profits of
$70 million. MDS has assessed this claim and no provision has been recorded
related to the claim for lost profits. We have filed an Answer and intend to
vigorously defend this action. Details of the above litigations are discussed in
the “Litigation”
section of this MD&A.





MDS
Analytical Technologies


Revenues


Revenues
in fiscal 2009 of $359 million were lower by $78 million than in fiscal 2008.
Revenue in the bioresearch and drug discovery product line was down 19% due to
lower demand and the negative impact of foreign exchange. Revenue in the mass
spectrometer product line was down 17% due to reduced shipments to our joint
ventures and the negative impact of foreign exchange. The total end-user revenue
was down 11% primarily due to reduced demand in North America and Europe
partially offset by increased demand in Asia.





Revenues
in fiscal 2008 of $437 million were higher by $85 million than in fiscal 2007
primarily due to the Molecular Devices Corporation (MDC) acquisition in the
second quarter of fiscal 2007 that increased revenues in fiscal 2008 by
approximately $83
million.


Costs
and other expenses


Costs and
other expenses in fiscal 2009 of $379 million were lower by $71 million than in
fiscal 2008 due to lower costs resulting from savings from the restructuring
activities, partially offset by the negative impact of foreign
exchange.





Costs and
other expenses in fiscal 2008 of $450 million were higher by $86 million than in
fiscal 2007 primarily due to the acquisition of MDC in the second quarter of
fiscal 2007.





Gain
(loss) on sale of discontinued operations


Sale
of Phase II-IV


On July
1, 2009, MDS completed the sale of Phase II-IV for total cash consideration of
$50 million, subject to certain closing adjustments including final working
capital, cash, and indebtedness amounts. The consideration includes $10 million
in restricted cash that will be paid or released to MDS upon meeting post
closing obligations (subject to set off for any claims for breach of
representations and warranties under the sale agreement) and $3 million to be
paid following the delivery of certain tax certifications. MDS expects the $10
million to be released to us within 15 months from the closing date of July 1,
2009.





Total
assets disposed of are $103 million (2008 - $105 million), which includes
accounts receivable of $49 million (2008 - $49 million) and unbilled revenue of
$27 million (2008 - $42 million). Total liabilities disposed of are $67 million
(2008 - $61 million), which includes accounts payable and accrued liabilities of
$26 million (2008 - $25 million) and deferred revenue of $39 million (2008 -
$33 million). During the fourth quarter of fiscal 2009, the sale of Phase II-IV
was finalized and we recorded an after-tax loss of $7 million on the sale, which
is included in “(Loss) income from discontinued operations, net of income taxes”
on the consolidated statements of operations. The loss on sale includes a $4
million closing adjustment, which is a reduction in the sale proceeds, and
recognition of an unrealized foreign currency translation gain of $8
million.





Sale
of Central Labs


On
October 30, 2009, MDS completed the sale of Central Labs for total cash
consideration of $6 million, subject to certain closing adjustments. Total
assets disposed of are $63 million (2008 - $77 million), which includes accounts
receivable of $42 million (2008 -
$40 million). Total liabilities disposed of are $18 million (2008 - $27
million), which includes accounts payable and accrued liabilities of $13 million
(2008 - $22 million). We recorded an after-tax loss of $25 million on the sale.
The loss on sale includes a $13
million preliminary closing adjustment, which is an increase in the sale
proceeds, and recognition of an unrealized foreign currency translation gain of
$4 million. We expect to finalize the loss on the sale during fiscal 2010 for
post-closing adjustments.





Intent
to sell Early Stage


On
September 2, 2009, we announced the intention to sell the remaining Early Stage,
where we are a leader in molecular screening and profiling and have one of the
largest Phase I bed capacities in the industry. As a result of this decision,
the Company has reflected the total assets and total liabilities of Early Stage
at the lower of their carrying value or their fair value less costs to sell as
“Assets of discontinued operations” and “Liabilities of discontinued operations”
in the consolidated statements of financial position, respectively. The assets
included in “Assets of discontinued operations” are not being depreciated. The
results of operations of Early Stage are included in “(Loss) income from
discontinued operations, net of income taxes” in the consolidated statements of
operations. As a result of the intention to sell Early Stage, we estimated the
loss on sale utilizing a fair value based on appraisals, estimated net proceeds
upon sale, and discounted cash flows. As a result, we recorded an estimated
pre-tax loss on sale of $13 million in the fourth quarter of fiscal 2009. This
estimated loss on sale includes recognition of an unrealized foreign currency
translation gain of $44 million. While management believes that the estimated
loss as of October 31, 2009 was its then best estimate and that its valuation
methods were reasonable and appropriate in the circumstances, the ultimate
amount of this estimated loss may vary significantly. During the first quarter
of fiscal 2010, continued deterioration of market conditions, the declining
Early Stage customer base and new developments in the ongoing strategic review
process, including recent discussions with interested parties, are now likely to
result in lower sale proceeds than previously expected, which could lead to an
additional loss on sale in the range of $30 million to $60 million. We also
recorded non-cash long-lived asset impairment charges of $7 million and $2
million in the third and fourth quarters of fiscal 2009, respectively, in
“(Loss) income from discontinued operations, net of income taxes”.





Sale
of MDS Analytical Technologies


On
September 2, 2009, we announced that we have entered into an agreement to sell
MDS Analytical Technologies to Danaher, which includes its two joint ventures,
Applied Biosystems MDS Analytical Technologies Instruments and PerkinElmer Sciex
Instruments. Total consideration for this sale is $650 million in cash subject
to certain closing adjustments including final working capital, cash, and
indebtedness amounts. The sale remains subject to certain closing conditions and
approvals, including clearance by the U.S. Federal Trade Commission. Under a
separate arrangement, Danaher has agreed to purchase the portion of Applied
Biosystems MDS Analytical Technologies Instruments mass spectrometry joint
venture partnership held by Life. Completion of each transaction is conditional
on the concurrent closing of the other transaction.


MDS has
reflected the total assets and total liabilities of MDS Analytical Technologies
at the lower of their carrying value or fair value less costs to sell as “Assets
of discontinued operations” and “Liabilities of discontinued operations” in the
consolidated statements of financial position, respectively. The assets included
in “Assets of discontinued operations” are not being depreciated. The carrying
value of MDS Analytical Technologies’ net assets did not exceed its fair value
less costs to sell resulting in no write-down of this business as of October 31,
2009. The results of operations of MDS Analytical Technologies are included in
“(Loss) income from discontinued operations, net of income taxes” in the
consolidated statements of operations.





We expect
to close the sale of MDS Analytical Technologies during the first calendar
quarter of fiscal 2010, which is currently subject to regulatory approval,
including resolution of a second request from the Federal Trade Commission in
the U.S., and other closing conditions. We expect to record an after-tax gain on
the sale in the range of $10 million to $20 million.





PerkinElmer
      Joint Venture


On
December 11, 2009, we were served with a Notice from PerkinElmer with whom MDS
has a joint venture to develop, manufacture and sell inductively coupled plasma
mass spectrometers. This product line represents less than 10% of annual revenue
generated by MDS Analytical Technologies. The Notice relates to the previously
announced sale of MDS Analytical Technologies to Danaher. The Notice has been
filed with the Ontario Superior Court of Justice and PerkinElmer seeks a range
of alternative possible remedies including court direction with respect to the
development of protocols to enforce key provisions of the joint venture
agreement between MDS and PerkinElmer, an injunction preventing enforcement of
provisions in the sale agreement of MDS Analytical Technologies to Danaher,
which provide for MDS’s retention of the joint venture; or an interim and
permanent injunction preventing the completion of the sale of MDS Analytical
Technologies to Danaher. On January 25, 2010, the above action was
dismissed.





The sale
of MDS Analytical Technologies also includes the sale of Blueshift
Biotechnologies Inc. and Molecular Devices Corporation, the two companies
previously acquired by MDS, the details of which are discussed
below.





Blueshift
      Biotechnologies Inc.


On June
26, 2008, MDS Analytical Technologies acquired 100% of the Common shares of
Blueshift Biotechnologies Inc. (Blueshift) for a total purchase price of $14
million of which $1 million was placed in escrow and has since been released. An
additional


$0.5
million was placed in escrow, which was contingent on the achievement of certain
milestones and was released to the vendors during fiscal 2009. We allocated the
purchase price to the assets acquired and the liabilities assumed and the
purchase price and related allocations were finalized in fiscal 2008. In
connection with determining the fair value of the assets acquired and the
liabilities assumed, management performed assessments of the assets and
liabilities using customary valuation procedures and techniques. The results of
operations of Blueshift are included in discontinued operations from the date of
acquisition.





Molecular
      Devices Corporation


During
fiscal 2007, we acquired 100% of the shares of MDC for a total cash purchase
price of $600 million. Included in the consideration was a $27 million cash cost
to buy back outstanding options of MDC at the closing date of the acquisition.
Of the $600
million purchase price, $26 million was allocated to net tangible assets, $161
million to developed technologies, $30 million to brands and $383 million to
goodwill. The results of operations of MDC are included in MDS Analytical
Technologies in discontinued operations from the date of
acquisition.





Other
divestitures


During
fiscal 2008, MDS Nordion sold its external beam therapy and self-contained
irradiator product lines for $15 million in cash. We recorded a loss on sale of
this business of $4 million, including a $1 million impairment of goodwill. We
also recorded a pension curtailment gain of approximately $1 million as a result
of the transfer of employees to the buyer. As these product lines did not
represent a business these were reported in continuing operations.





During
fiscal 2007, we completed the sale of MDS Diagnostic Services in a $1.2 billion
transaction. This sale was structured as an asset purchase transaction and after
provision for taxes, expenses and amounts attributable to minority interests
resulted in net proceeds of


$988
million, comprising $929 million in cash and $65 million in an unconditional
non-interest bearing note payable in March 2009. During the second quarter of
fiscal 2009, this note matured and we received $60 million in cash proceeds.
Included in income from discontinued operations is a gain of $791 million net of
income taxes on the transaction, which we recorded in fiscal
2007.


Contractual
obligations


The
following table summarizes the contractual obligations for the continuing
operations as of October 31, 2009 and the effect such obligations are expected
to have on the 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:





2010
            2011
            2012
            2013
            2014
            ThereafterLong-term
      debt
            $
            30
            $
            14
            $
            14
            $
            171
            $
            9
            $
            29Interest
      on long-term debt
            
            16
            
            15
            
            14
            
            9
            
            3
            
            1Operating
      leases
            
            19
            
            14
            
            10
            
            6
            
            4
            
            11Purchase
      obligations
            
            26
            
            25
            
            22
            
            20
            
            25
            
            113Other
      contractual commitments
            
            21
            
            9
            
            -
            
            -
            
            -
            
            -$
            112
            $
            77
            $
            60
            $
            206
            $
            41
            $
            154





Long-term
debt consisted of $221 million of senior unsecured notes issued under a private
placement during fiscal 2003 and a


$42
million, non-interest bearing, government loan; and other commitments totaling
$4 million, relating to assets purchased for the MALDI-TOF mass spectrometry
operations. Although this amount of $4 million was originally due on October 22,
2009, in accordance with an agreement with the lender, this amount was deferred
and will be forgiven upon the consummation of the planned sale of MDS Analytical
Technologies.





The
amounts for operating leases primarily relate to the rental of offices,
laboratory facilities and equipment to support the global
operations.





We have
long-term supply arrangements totaling $234 million with certain suppliers
including Energoatom and other major electricity producers that provide us with
cobalt. 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
totaling


$18
million relating to the outsourcing of certain IT infrastructure
services.





We have
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, foreign
exchange fluctuations, or, for some obligations, changes to agreed-upon
amounts.





As a
result of the strategic repositioning, we may cancel or renegotiate certain
contracts for outsourced services, including commitments related to the
outsourcing of certain IT infrastructure services. As a result of cancellations
or renegotiations, we estimate that we may incur approximately $5 million of
expense to extinguish or pay out these contracts.  We have not
terminated any material contracts to date and continue to work with the
suppliers to negotiate what we believe are appropriate modifications or
terminations of the contractual commitments for the business subsequent to the
expected sale of MDS Analytical Technologies and intended sale of Early Stage.
In addition, we have future rent payments of approximately $7 million for the
Toronto, Canada corporate offices, which we expect to vacate on the completion
of any necessary transition services related to the planned sale of MDS
Analytical Technologies and the intended sale of Early Stage. We would expect to
attempt to sublease the office space or buyout the remaining lease at a reduced
amount.





Indemnities
and
guarantees


In the
normal course of the operations, we enter into a variety of commercial
transactions such as the purchase or sale of businesses, the purchase or supply
of products or services, clinical trials, licenses and leases. These
transactions are evidenced by agreements, most of which contain standard
indemnity obligations. Our financial exposure to counterparties under these
indemnity obligations is generally based upon actual future damages, which the
counterparty may suffer as a result of the actions or inaction of the Company.
In the circumstances, we are not able to make a reasonable estimate of the
maximum potential amount we could be required to pay to counterparties under
these indemnity obligations. Historically, we have not made significant payments
under these indemnity obligations.





Upon the
completion of the expected sale of MDS Analytical Technologies and the intended
sale of Early Stage, there will be certain indemnities included in the sale
agreements that could result in obligations or payments that may be significant
in relation to the assets of the remaining businesses.


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. We do not have any off-balance sheet arrangements that have or are
reasonably likely to have a current or future affect on the financial condition,
changes in financial condition, revenues or expenses, results of operations,
liquidity or capital expenditures or capital resources that is material to
investors other than operating leases and derivative instruments.





Financial
instruments


Derivative
instruments


As of
October 31, 2009, we did not have any derivatives designated as fair value or
cash flow hedges.





The U.S.
dollar denominated senior secured notes have been designated as a hedge of net
investment in foreign operations to reduce foreign exchange fluctuations
associated with certain of the foreign currency investments of the Company, the
U.S. operations of MDS Analytical Technologies and MDS Pharma Services. As the
net investment hedge has been deemed to be effective, the U.S. dollar
denominated senior secured notes have been measured at each reporting date to
reflect changes in the spot rate since the previous measurement date and
recorded in other comprehensive income (OCI). We did not record any
ineffectiveness relating to this net investment hedge in the consolidated
statements of income for fiscal years 2009, 2008 and 2007.





As
discussed earlier in the MD&A, with the completion of the planned sale of
MDS Analytical Technologies, MDS, among other things, expects to repay the
outstanding $221 million senior unsecured notes, resulting in the discontinuance
of the net investment hedging relationship.





As of
October 31, 2009, we have identified certain embedded derivatives primarily
relating to MDS Nordion, which had notional amount of $83 million (2008 - $130
million) with fair value of an asset of $nil (2008 - $nil) and a liability of $4
million (2008 -
$11 million). In the third quarter of fiscal 2009, we amended the Russian cobalt
supply contract that resulted in reduction of the notional amount of the
embedded derivatives by $35 million. During fiscal 2009, we recorded a gain of
$8 million (2008 -
$15 million loss and 2007 - $4 million gain) for the change in the fair value of
the embedded derivatives from continuing operations. This gain in fiscal 2009
primarily resulted from the strengthening of the Canadian dollar against the
U.S. dollar and the amendment of the Russian cobalt supply
contract.





We use
short-term foreign currency forward exchange contracts to economically hedge the
revaluations of the foreign currency balances which we did not designate as
hedges for accounting purposes. As of October 31, 2009, the notional amount of
these foreign currency forward exchange contracts was $15 million (2008 - $8
million) with fair value for an asset of $nil (2008 - $1 million) and liability
of $nil (2008 - $nil). During fiscal 2009, we recognized a realized gain on
foreign currency contracts not under hedging relationships in the amount of $1
million (2008 - $7 million loss and 2007 - $1 million gain).





Fair
value hierarchy


During
fiscal 2009, the aggregate amount of assets and liabilities measured using
significant unobservable inputs (Level 3 assets and liabilities) only related to
the ABCP investment. As of October 31, 2009, the investment in ABCP represented
less than 1% of the aggregate amount of the Company’s consolidated total
assets.





The
details of the Level 3 assets are included in Note 19 of the consolidated
financial statements.





Defined-benefit pension
plans


The
majority of the defined benefit pension assets and liabilities relate to a plan
for certain employees of MDS Nordion in Canada. Based on an actuarial report
filed with the pension regulator in Canada in 2008, with a valuation as of
January 1, 2008, we were in a surplus position on both a going-concern and
solvency basis and therefore are not currently required to provide additional
funding to the plan. As of October 31, 2009, the defined benefit pension plan
remained in a surplus position on a going concern basis; however, it was
estimated to be in a solvency deficit position. We are working to complete an
actuarial valuation for the Canadian defined benefit plan as of January 1, 2010,
which is expected to be submitted to the pension regulators by June 2010 and
form the basis for funding in fiscal 2010. Primarily as a result of the declines
in the Canadian and global equities and changes in real interest rates, we
estimate that we currently have a solvency deficit in the range of $30 million
to $35 million, which is used to determine additional funding requirements.
Based on current and proposed Canadian pension regulations, we would be required
to fund up to $5 million in 2010 and under proposed regulations we may be able
to issue a letter of credit to avoid cash funding of the solvency
deficit.


Liquidity
and capital resources





2009
            
            2008
            ChangeCash,
      cash equivalents and restricted cash
            $
            314
            $
            130
            142%Current
      ratio(1)
            
            2.9
            
            2.5
            16%


(1)Excludes total assets and total liabilities related to discontinued
operations.





Cash,
cash equivalents and restricted cash as of October 31, 2009 of $314 million was
$184 million higher compared to $130 million in 2008. The increase was due to
$60 million collected from a note receivable from Borealis related to the 2007
sale of the Diagnostics business, $45 million from the sale of the Phase II-IV,
including $10 million recorded as restricted cash, $6 million from the sale of
Central Labs, working capital performance and the positive impact of foreign
exchange. MDS expects the restricted cash to be released to us within 15 months
from the closing date of Phase II-IV of July 1, 2009.





The
current ratio has also increased to 2.9 as of October 31, 2009 compared to 2.5
as of October 31, 2008 as the current assets have increased at a faster rate
than the current liabilities. Our current assets have increased primarily due to
the collection of $35 million for the sale of the Phase II-IV and $6 million
from the sale of Central Labs, which are included in the $298 million cash
balance.





Our cash
flows from operating, investing and financing activities, as reflected in the
consolidated statements of cash flows, are summarized as follows:





2009
            
            2008
            2007Cash
      provided by (used in) continuing operating activities
            $
            81
            $
            (110)
            156Cash
      provided by (used in) continuing investing activities
            $
            (13)
            $
            113
            29Cash
      used in continuing financing activities
            $
            (6)
            $
            (116)
            (437)Cash
      provided by discontinued operations
            $
            100
            $
            26
            225Effect
      of foreign exchange rate changes on cash and cash
    equivalents
            $
            19
            $
            (18)
            10Net
      increase (decrease) in cash and cash equivalents during the
      year
            $
            181
            $
            (105)
            (17)





Continuing
operating activities


Cash
provided by operating activities for fiscal 2009 was $81 million compared to
cash of $110 million used in fiscal 2008. During fiscal 2009, we experienced
cash improvements in the operating assets and liabilities compared to fiscal
2008, primarily due to $71
million received for the notes receivable, lower accounts receivable and
inventory, and higher trade and other payables resulting from the increased
focus on working capital management. These changes in working capital generated
cash inflow of $93 million in fiscal 2009 compared to a cash outflow of $107
million in fiscal 2008. Our cash interest expense in fiscal 2009 was relatively
flat compared to fiscal 2008. In fiscal 2009, the interest income was lower by
$4 million primarily due to lower interest rates compared to fiscal
2008.





Cash used
in operating activities in fiscal 2008 of $110 million compared to cash of $156
million provided in fiscal 2007. In fiscal 2008, we paid $88 million for taxes
compared with $15 million in fiscal 2007 due to the $56 million payment
associated with the 2007 sale of the Diagnostics business. Our cash interest
expense in fiscal 2008 was relatively flat compared to fiscal
2007.  In fiscal 2008, the interest income was lower by $11 million
due to lower cash balances compared to fiscal 2007.





Continuing
investing activities


Cash used
in investing activities in fiscal 2009 was $13 million compared to cash of $113
million provided in fiscal 2008. In fiscal 2009, we incurred capital
expenditures of $10 million and had an increase in the restricted cash of $10
million resulting from to the sale of the   Phase II-IV, which
was partially offset by a decrease of $7 million for restricted cash relating to
the insurance liabilities. In fiscal 2008, we received $101 million on the
maturity of the short-term investments, $15 million from the sale of external
beam therapy and self-container irradiator product lines, and $4 million from
the investments in Lumira Capital Corp., partially offset by $13 million used to
purchase property, plant and equipment. In fiscal 2008, we used the proceeds
from the maturity of short-term investments to repay the long-term
debt.





Cash
provided by investing activities in fiscal 2008 was $113 million compared to $29
million in fiscal 2007. In fiscal 2007, we utilized $15
million to purchase property, plant, and equipment, partially offset by net
proceeds of $47 million from the sale of short-term
investments.


In fiscal
2007, we received proceeds of $929 million from the sale of the Diagnostics
business of which $600 million was used to fund the acquisition of MDC, which is
included in the planned sale of MDS Analytical Technologies. The details of the
Diagnostics business and the planned sale of MDS Analytical Technologies are
provided in the discontinued operations.





Continuing
financing activities


Cash
flows used in financing activities in fiscal 2009 of $6 million were lower
compared to $116 million in fiscal 2008. In fiscal 2009, we made debt repayments
of $6 million compared to $79 million in fiscal 2008. In fiscal 2008, we repaid
$79 million for senior unsecured notes and repurchased $44 million of shares
under the normal course issuer bid, retiring 2.9 million of the Common shares
and received proceeds of $7 million as part of the employee stock option
program.





Cash
flows used in financing activities in fiscal 2008 of $116 million were lower
compared to $437 million in fiscal 2007. In fiscal 2008, we made a $79 million
debt payment, $44 million for share repurchases, partially offset by $7 million
in proceeds received from the employee stock option program. In fiscal 2007, we
used $441 million to repurchase and cancel 22.8 million of the Common shares
under a substantial issuer bid, $8 million for the repayment of debt, and $3
million for dividend payments to the common shareholders, partially offset by
$15 million of proceeds received from the employee stock option
program.





Covenants
related to debt agreements


The
long-term senior unsecured notes contain a number of financial and other
covenants, including restrictions on asset sales, debt incurrence and the
ability to consolidate, merge or amalgamate with another corporation or transfer
all or substantially all of the assets. Based on an agreement that we entered
into with the note holders in the fourth quarter of fiscal 2009, we would be
required to repay the senior unsecured notes within three days on the closing of
the planned sale of MDS Analytical Technologies. We have provided the additional
details of this arrangement in the“Impact of divestitures, use of sale
proceeds and available cash” section of this MD&A. We also have
available a C$500 million (US$462 million), five-year, committed, revolving
credit facility that may fund the future liquidity requirements, which was
unused as of October 31, 2009, and expires in July 2010. Upon the closing of the
sale of MDS Analytical Technologies, we would not be able to access this credit
facility. As a result of losing access to the credit facility, we would also be
required to cash collateralize approximately $20 million of letters of credit.
We expect to retain sufficient cash from the sale of the businesses in absence
of having a revolving credit facility, and therefore due to the costs and
restrictions associated with a new revolving credit facility, we currently are
not in negotiations for a new credit facility, however we may enter into future
negotiations if terms become more favourable.





The terms
of the current credit facility require us to meet certain financial covenants,
which we met for the current fiscal year, and limit certain uses of funds
including significant acquisitions. These covenants require us to prepay all
amounts outstanding under the facility and provide the lenders’ the right to
discontinue further commitments under the facility before any person acquires
beneficial ownership of, or control or direction over, 50% or more of the issued
and outstanding voting shares of MDS.





Our
long-term senior unsecured notes, which mature in several tranches up to 2014,
contain a covenant that restricts the Company’s use of cash for certain purposes
if cumulative net income from the date of issuance of the notes falls below a
predefined amount. With the fiscal 2008 write-off of the MAPLE Facilities,
the cumulative net income was below the amount defined in the debt covenants for
the senior unsecured notes, which triggered some restrictive debt covenants. The
restrictions on the use of cash include the repurchase of shares, payment of
dividends and investments in businesses that we do not control. We currently
expect these restrictions to remain in place until the senior unsecured notes
are retired. In fiscal 2008 and 2007, prior to the MAPLE Facilities write-off,
we repurchased some Common shares, and in 2007, we paid $3 million in dividends.
We have not made additional investments in any non-controlled
businesses. In fiscal 2008, we repurchased 2.9 million shares for $44
million under the normal course issuer bid. In fiscal 2007, we used $441 million
to purchase 22.8 million shares under the substantial issuer bid. In fiscal
2009, we did not make any share repurchases.





If the
sale of MDS Analytical Technologies is not completed, as discussed earlier in
this MD&A, the earnings impact from an extended NRU reactor shutdown
combined with the existing market conditions, may cause a breach of the debt
covenants requiring repayment of the senior unsecured notes and preventing
access to the revolving credit facility. We are taking actions to mitigate the
risk of any debt covenant violation and are developing plans to address this
situation should it occur. This may involve negotiating waivers on existing
agreements or securing a new, smaller short-term credit facility to help fund
the ongoing liquidity requirements; however, there can be no assurance that MDS
will be successful in securing a new revolving credit facility, and if so, at
what cost.





Impact
of the strategic initiatives on future liquidity requirements


We have
received $41 million to date for the sale of the Phase II-IV and Central Labs,
which are included in the $298 million cash balance. We expect to receive an
additional $13 million, $10 million of which we recorded in restricted cash,
from the sale of the


Phase
II-IV, which will be released upon MDS meeting certain post closing obligations
and assuming that there are no breach of representations and warranties under
the sale agreement. We expect to receive these amounts by the fourth quarter of
fiscal 2010. We also expect to receive $650 million in additional cash and debt
forgiveness of $4 million on the completion of the planned sale of MDS
Analytical Technologies during the first calendar quarter of fiscal
2010.


Upon
completion of the planned sale of MDS Analytical Technologies, we currently
intend to redeem the outstanding senior unsecured notes and return between $400
million to $450 million to shareholders by way of a share buyback through a
substantial issuer bid. The actual amount will be determined at the time the bid
is commenced and will take into account the expected impact on the liquidity of
the Common shares of MDS subsequent to the intended substantial issuer bid and
current estimates of future cash requirements to fund transaction and
restructuring costs, ongoing operations and other future expenditures. The
amount of cash retained for ongoing operations would be intended to fund the
liabilities arising from the sale of MDS Analytical Technologies and the
day-to-day operations of the continuing businesses. We expect to use
approximately $20 million to collateralize certain letters of credit and we
expect to maintain sufficient cash in absence of having a committed revolving
credit facility.





We
believe that cash on hand, cash flows generated from operations, proceeds
generated from the planned sale of MDS Analytical Technologies, coupled with
available borrowings from existing financing sources or new borrowings if
needed, will be sufficient to meet the anticipated requirements for operations,
capital expenditures, R&D expenditures, contingent liabilities including FDA
settlements, potential transaction and restructuring costs, and the potential
repurchase of all outstanding senior unsecured notes. We have repaid $23 million
of the senior unsecured notes in the first fiscal quarter of 2010 upon their
maturity. The FDA liability and restructuring reserves are currently $19 million
and $8 million, respectively. At this time, we do not anticipate any issues in
collecting amounts owed to MDS in respect to the notes receivable from AECL. As
a result of a covenant in the senior unsecured notes, we have ceased paying
dividends and discontinued the share repurchase program. We currently remain in
compliance with all covenants for the senior unsecured notes and the bank credit
facility in relation to borrowings and repayments. The Company is carefully
monitoring this risk and has developed contingency plans to mitigate a potential
covenant breach, which may include requesting waivers related to our senior
unsecured notes and our revolving credit facility, which is currently undrawn.
We believe that we would be able to obtain new financing, if necessary, however,
it may be at a significantly higher cost than the existing debt and result in us
incurring additional fees.





Capitalization


2009
            
            2008
            
            ChangeLong-term
      debt
            $
            267
            $
            274
            
            (3%)Less:
      Cash and cash equivalents and restricted cash
            
            (314)
            
            (130)
            
            142%Net
      debt (cash)
            
            (47)
            
            144
            
            (133%)Shareholders’
      equity
            
            994
            
            1,090
            
            (9%)Capital
      employed(1)
            $
            947
            $
            1,234
            
            (23%)




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





Long-term
debt in fiscal 2009 decreased by $7 million compared to fiscal 2008 primarily
due to repayments of $6 million for the senior unsecured notes.





The
long-term debt include the senior unsecured notes of $221 million as of October
31, 2009, which have fixed interest between 5.52% and 6.19% per annum and mature
in several tranches up to December 2014. In December 2009, we repaid $23 million
of the senior unsecured notes that matured. In addition, based on an agreement
with the note holders, within three days following the completion of the sale of
MDS Analytical Technologies, we intend to redeem the outstanding U.S. dollar
denominated senior unsecured notes by payment of approximately $223 million to
the holders thereof. This repayment amount represents the principal outstanding
amount of the senior unsecured notes, including accrued interest and
approximately $23 million in make-whole payments that is tax deductible. With
the repayment of the senior unsecured notes, we will also not be able to access
the C$500 million


(US$462
million) revolving credit facility under the terms of the associated credit
facility agreement, which was undrawn as of October
31, 2009. Upon the close of the sale of MDS Analytical Technologies, we have an
agreement that $4 million of the debt will be forgiven. The remaining $42
million of debt as of October 31, 2009 relates to a Government of Canada loan,
which is fully defeased by a financial instrument that we purchased and that was
issued by a major Canadian bank.





Share
capital


Shares
      issued and outstanding (in
      thousands)
            
            2009
            
            2008
            
            2007Outstanding
      – beginning of the year
            
            120,137
            
            122,578
            
            144,319Issued
      during the year
            
            -
            
            462
            
            1,090Repurchased
      and cancelled
            
            -
            
            (2,903)
            
            (22,831)Outstanding
      – end of year
            
            120,137
            
            120,137
            
            122,578Dividends
      declared per share
            $
            -
            $
            -
            $
            0.03Market
      price per share:High
            $
            11.26
            $
            22.55
            $
            22.49Average
            $
            6.43
            $
            16.67
            $
            19.27Low
            $
            4.54
            $
            8.54
            $
            16.91Book
      value per share1
            $
            8.27
            $
            9.07
            $
            15.83


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





As of
October 31, 2009, we had 120.1
millionCommon shares outstanding and 4.6 million stock options to
acquire the Common shares. As of October 31, 2009, approximately 1% of the total
outstanding stock options were in the money.





During
fiscal 2009, we did not declare or pay any cash dividends as dividend payments
were discontinued as of January 2007. We do not expect to make any further
dividend payments or share repurchases until the existing senior unsecured notes
are retired.





The
completion of the planned sale of MDS Analytical Technologies would result in a
change in control, which will result in accelerated vesting of the stock options
and recognition of any unamortized expense amount in the consolidated financial
statements. The completion of the sale of MDS Analytical Technologies would also
result in the share issuer bid in which we currently intend to repurchase $400
million to $450 million worth of the outstanding Common shares of the Company.
The details of these transactions have previously been discussed in the “Strategic repositioning”and“Impact of the
strategic initiatives on future liquidity requirements”, sections of this
MD&A.





We
purchased and cancelled 2.9 million Common shares in fiscal 2008, under a
normal-course issuer bid. In fiscal 2007, we repurchased and cancelled
approximately 22.8 million Common shares under the terms of a substantial issuer
bid.





Litigation


The
Company is involved in an arbitration related to the MAPLE Facilities and an
associated litigation with AECL and the Government of Canada, the details of
which are discussed in “MAPLE
Facilities” section of this MD&A. On December 11, 2009,
PerkinElmer filed a Notice relating to the planned sale of MDS Analytical
Technologies to Danaher, the details of which are discussed in the “Sale of MDS Analytical
Technologies”and“Divestitures and discontinued operations” sections of this MD&A. On
January 25, 2010, the above action was dismissed. The Company also has the
following litigation matters relating to MDS Pharma Services.





During
fiscal 2009, we were served with a Complaint related to repeat study costs and
mitigation costs of approximately $10 million and lost profits of approximately
$70 million. This action relates to certain bioequivalence studies carried out
at the Montreal, Canada facility from January 1, 2000 to December 31, 2004. We
maintain reserves in respect of study costs as well as errors and omissions
insurance.  MDS has assessed this claim and no provision has been
recorded related to the claim for lost profits. We have filed an Answer and
intend to vigorously defend this action.





During
fiscal 2009, we were served with a Statement of Claim related to repeat study
and mitigation costs of $5 million and loss of profit of $28 million. This
action relates to certain bioequivalence studies carried out at the Montreal,
Canada facility from January 1, 2000 to December 31, 2004. We maintain reserves
in respect of study costs as well as errors and omissions
insurance.  MDS has assessed this claim and no provision has been
recorded related to the claim for lost profit. We have filed a Statement of
Defence and intend to vigorously defend this action.




Risks and
uncertainties


This
section outlines certain risks and uncertainties that can have an impact on the
Company’s operating results and financial position over the course of a
year.  A more detailed discussion of risks and uncertainties and
industry trends is contained in the AIF and the Circular.





Completion
of the planned sale of MDS Analytical Technologies


The
completion of the planned sale of MDS Analytical Technologies is subject to a
number of conditions precedent, certain of which are outside the control of the
Company, including regulatory approvals and the completion of the sale by Life
to Danaher of its interest in the Applied Biosystems MDS Analytical Technologies
Instruments joint venture. There can be no certainty that these conditions will
be satisfied or, if satisfied, when they will be satisfied. Danaher is also not
required to consummate the sale of MDS Analytical Technologies in the event of a
change having a Material Adverse Effect (as defined in the sale agreement
between MDS and Danaher) prior to the consummation of the planned sale of MDS
Analytical Technologies. Although a Material Adverse Effect excludes certain
events that are beyond the control of the Company, such as changes in general
economic conditions or general conditions in any of the markets in which the MDS
Analytical Technologies operates. If the sale of MDS Analytical Technologies is
not completed, the market price of the Common shares may decline to the extent
that the market price reflects a market assumption that the sale of MDS
Analytical Technologies will be completed. If the sale of MDS Analytical
Technologies is not completed and our Board of Directors decide to seek another
merger or business combination, there can be no assurance that it will be able
to find a party willing to pay an equivalent or more attractive price than the
price to be paid pursuant to the agreement between MDS and Danaher in relation
to the sale of MDS Analytical Technologies.





Completion
of the intended sale of Early Stage


We have
announced our intention to sell Early Stage and initially stated that upon
completion of the sale of Early Stage, we intended to make a secondary
distribution to shareholders with a portion of the net cash proceeds. This
secondary distribution would be in addition to the planned shareholder
distribution of $400 million to $450 million following the sale of MDS
Analytical Technologies. There can be no assurance that MDS will complete a
transaction involving Early Stage. During the first quarter of fiscal 2010,
continued deterioration of market conditions, the declining Early Stage customer
base and new developments in the ongoing strategic review process, including
recent discussions with interested parties, are now likely to result in lower
sale proceeds than previously expected, and we now believe the sale proceeds
from Early Stage may not be sufficient to fund a second distribution to
shareholders. Shareholders may be expecting the sale and subsequent distribution
to be completed, and if we are unable to complete the sale of Early Stage and/or
make a distribution, the market price of our Common shares may
decline.





The
early-stage contract research organization market has recently seen reductions
in orders and revenue as a result of economic conditions, mergers between major
pharmaceutical companies and the reduced availability of funding for
biotechnology companies. In addition, some customers have expressed concern
regarding the uncertainty created by MDS’s Strategic Review process. The
Company’s Early Stage business has seen reduced orders and revenue, which we
believe is driven by these factors. Considering the high portion of fixed costs
within Early Stage, profitability has declined as a result of reduced revenue,
and Early Stage is currently generating an EBITDA loss. While we believe it is
probable that a sale of Early Stage will occur, in the unlikely event that MDS
does not complete the intended sale of Early Stage, in order to increase revenue
and improve profitability, MDS may have to invest additional capital and incur
restructuring costs to strengthen the business. The cost and length of time for
which MDS would have to incur cash outflows related to Early Stage is uncertain.
Those outflows may have a material adverse effect on the business, financial
condition and cash flows of the Company.





Obligations
retained after the sale of businesses


Certain
liabilities relating to the businesses, which have been sold or are expected to
be sold have been or will be retained by the Company. In particular, the Company
may remain the defendant in current lawsuits, and potentially future lawsuits,
that relate to activities, which occurred prior to the sale of the businesses,
which have been or will be sold. The Company has retained liabilities relating
to studies that were closed prior to the sale of Phase II-IV. The Company may
also retain certain pre-closing liabilities of the businesses sold, such as
environmental liabilities. As well, the Company may be required to reimburse the
purchasers of the businesses under certain circumstances, including for breaches
of representations and warranties in the applicable sale agreement. Given its
reduced size, the Company now has less of a financial base upon which to sustain
such retained liabilities, and any payments required to be made as a result of
such liabilities could have a material adverse effect on the Company and its
financial condition.





Supply
of reactor isotopes


Radioisotopes
used in nuclear medicine and sterilization technologies are manufactured in
electric-powered cyclotrons or nuclear reactors.  A continuous and
reliable supply of reactor radioisotopes, such as Mo99 and Co60, is important to
the business of the Company. Routine and/or unscheduled shutdowns of these
reactors can have a dramatic impact on the supply of radioisotopes at any
point.


AECL’s
NRU reactor is currently out of service due to leaks in the reactor
vessel.  AECL is currently completing the repair of the reactor and
expects it to return to service in the end of March of 2010, however, AECL has
reported that if there are continuing challenges with the repair process, the
NRU reactor return to service schedule could extend into April 2010. The reactor
may not return to service as planned and may be out of service permanently or
for an extended period of time or may go out of service again in the future. In
addition, due to the NRU reactor being out of service for an extended period,
the Company’s customers may have obtained alternate supply, may seek to
diversify their supply and as a result we may have lower revenue from medical
isotopes than we experienced in the past. The majority of the Company’s
reactor-based medical isotopes are currently supplied from AECL’s NRU reactor.
The NRU reactor is over 50 years old and its current license extends to 2011.
There is no assurance that the license will be extended past 2011. Refer to
“Medical isotope supply
disruption” section of this MD&A for additional discussion of the
uncertainty of the supply of reactor-based medical isotopes.





We have
taken steps to source additional long-term cobalt supply from a major supplier,
Energoatom.  By establishing new contracts or by negotiating
extensions of existing long-term supply arrangements we expect to diversify and
secure the sources of supply. Changes in maintenance schedules or the continued
operations of the reactors, which manufacture radioisotopes could impact the
availability and timing of the purchases.





Covenants
and restrictions in our senior unsecured notes and bank credit
facilities


Our
senior unsecured notes, as well as our revolving credit facility, require us to
meet specified financial ratios that are defined under the terms of the note
purchase agreement relating to our senior unsecured notes and revolving credit
facility. Failure to meet these financial ratios may result in an event of
default under the note purchase agreement, which could result in acceleration of
our indebtedness under the senior unsecured notes and require us to prepay the
senior unsecured notes before their scheduled due date. Non-compliance with
certain financial ratios could also impair our ability to draw funds on the
revolving credit facility. Future debt instruments to which we may become
subject to could also contain similar provisions.





The
earnings impact from an extended NRU reactor shutdown, combined with the
continued negative impact of existing market conditions, may cause a breach of
these debt covenants. A breach of these covenants may require repayment of the
outstanding senior unsecured notes currently valued at $199 million ($221
million as of October 31, 2009) plus accrued interest and an
associated


tax-deductible
make-whole payment of approximately $23 million that would and may prevent us
from accessing the existing revolving credit facility. As a result of losing
access to the revolving credit facility, we would also be required to cash
collateralize approximately $20 million of letters of
credit.  Depending on the timing of the sale of MDS Analytical
Technologies, and based on the reporting of compliance with the covenants with
respect to our first quarter of fiscal 2010, a breach of certain debt covenants
related to the senior unsecured notes and the revolving credit facility may
occur during our second quarter of fiscal 2010. We may, however, not violate our
covenants, or we may be able to obtain a waiver if we expect to be in violation
of the covenants.





While we
intend to redeem the senior unsecured notes using cash on hand and the sale
proceeds of MDS Analytical Technologies, if we fail to meet the financial ratios
at some point prior to the completion of the sale of MDS Analytical Technologies
we would be required to seek a wavier from the note holders or obtain new
financing at market rates.  The Company may not be able to obtain a
waiver or obtain new financing, and may not have sufficient cash on hand to
repay the senior unsecured notes, including the make-whole payment, cash
collateralize letters of credit and fund its operations.





As well,
the note purchase agreement governing the senior unsecured notes includes
restrictions on the ability of the Company and its subsidiaries to pay
dividends, repurchase Common shares, invest in businesses that the Company does
not control, sell assets, incur


obligations
that restrict the ability of the subsidiaries of the Company to pay dividends or
other amounts to us, guarantee or secure indebtedness, enter into transactions
with affiliates, consolidate, merge, or transfer all or substantially all of the
assets of the Company and its subsidiaries on a consolidated basis or initiate
refinancing of debt. Future debt instruments to which we may become subject
could also contain similar provisions.





Under a
restrictive covenant in the senior unsecured notes, we are currently unable to
pay dividends or repurchase Common shares, which may limit the access to new
capital and may negatively affect the stock price of the Company.





Declining
general economic conditions and uncertainties in the global credit and equity
markets


Our
business is sensitive to changes in general economic conditions. Worldwide
financial markets continue to experience a disruption, including, among other
things, extreme volatility in security prices, severely diminished liquidity and
credit availability, rating downgrades and declining valuations of investments.
These disruptions are likely to have an ongoing adverse effect on the world
economy.  We are unable to predict how long the economic downturn will
last.  A continuing economic downturn and capital market disruptions may
adversely impact our business resulting in: counterparties including customers,
suppliers, investment banks and commercial banks experiencing liquidity issues
and failing to fulfill contractual obligations to us, reduced demand for our
product and services, increased pressure on the prices of our products and
services, greater difficulty in collecting accounts receivable, and greater


risk of
impairment to the value, and a detriment to the liquidity of our assets and
investment portfolio.  While we intend to finance ongoing operations,
capital expenditures and restructuring projects with existing cash, cash flow
from operations and borrowing under our existing credit facilities, we may
require additional financing to support continued growth.  A declining
global economic environment may reduce access to credit markets and limit access
to capital on acceptable terms or at all.





Government
regulation and funding


The cost
of compliance with government regulation is necessary and has an impact on the
business of the Company. Changes in policies, procedures, systems and staff
training required by government regulation can have the effect of increasing the
costs we incur to provide the products and services of the Company. 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 (CNSC).





Our
pharmaceutical research facilities and the isotope manufacturing facilities are
subject to audit and approval by the FDA, CNSC and similar
agencies.  Failure to achieve approval by these agencies will impact
the ability of the Company to secure contracts to perform work.  Audit
reports issued by relevant regulatory bodies could directly impact the ability
of the Company to attract and retain work, as has been the recent experience at
the Montreal, Canada bioanalytical research facilities. We capitalize on such
experiences by formalizing the learning into our standards to improve the
quality assurance practices, customer quality and customer service of the
Company.





Regulatory
policies are designed to protect the public’s health and can affect the drug
development revenues of the Company 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.





Exposure
to foreign currencies


Approximately
97% of revenue is earned outside of Canada based on the customer’s
location.  The majority of the export product revenues and a
significant component of the foreign activities of the Company are denominated
in U.S. dollars.  We believe that continued expansion outside of
Canadian markets is essential if the Company is to achieve its growth
targets.  This expansion will subject us to volatility associated with
changes in the value of the Canadian dollar.  We manage certain
exchange rate risks primarily through the use of forward foreign exchange
contracts.





We
maintain 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.  Our policies and guidelines prohibit us from using any
derivative instrument for trading or speculative purposes.





We will
continue to monitor the current and anticipated exposure of the Company to
fluctuations in foreign currency exchange rates and enter into currency
derivative contracts to manage the exposure.





Intellectual
property


Our
business is 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 the proprietary
methods of the Company, 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.





Research
and development


MDS
carries on various research and development programs. Our business depends to
one extent or another on our ability to maintain technological competitiveness
and 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.





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 we are not aware of any
significant outstanding litigation against the Company that is not covered by
the insurance policies of the Company and that could have a material adverse
impact on the Company’s results or its financial position. We maintain a global
insurance program with liability coverage up to $100 million to protect us from
the financial risk associated with a claim made against us.  The
ability of the Company to maintain insurance coverage with adequate limits and
at a reasonable cost may be impacted by market conditions beyond our
control.


Quarterly
highlights


The
following tables provide a summary of selected financial information for each of
the eight most recently completed quarters. This financial data has been
prepared in accordance with U.S. GAAP.





Trailing
      four
              quarters
            October
      31
              2009
            July
      31
              2009
            April
      30
              2009
            January
      31
              2009Revenues
      from continuing operations
            $
            231
            $
            51
            $
            49
            $
            65
            $
            66Operating
      (loss) income from continuing operations
            $
            (2)
            $
            (12)
            $
            1
            $
            8
            $
            1(Loss)
      income from continuing operations
            $
            (15)
            $
            (19)
            $
            9
            $
            (7)
            $
            2(Loss)
      income from discontinued operations, net of income taxes
            $
            (120)
            $
            (39)
            $
            (71)
            $
            (10)
            $
            -Net
      (loss) income
            $
            (135)
            $
            (58)
            $
            (62)
            $
            (17)
            $
            2Basic
      and diluted (loss) earnings per share-
      from continuing operations
            $
            (0.12)
            $
            (0.15)
            $
            0.08
            $
            (0.07)
            $
            0.02-
      from discontinued operations
            $
            (1.00)
            $
            (0.33)
            $
            (0.59)
            $
            (0.08)
            $
            -Basic
      and diluted (loss) earnings per share
            $
            (1.12)
            $
            (0.48)
            $
            (0.51)
            $
            (0.15)
            $
            0.02





Trailing
      four
              quarters
            October
      31
              2008
            July
      31
              2008
            April
      30
              2008
            January
      31
              2008Revenues
      from continuing operations
            $
            296
            $
            84
            $
            72
            $
            80
            $
            60Operating
      (loss) income from continuing operations
            $
            (355)
            $
            (347)
            $
            7
            $
            3
            $
            (18)(Loss)
      income from continuing operations
            $
            (246)
            $
            (247)
            $
            2
            $
            1
            $
            (2)(Loss)
      income from discontinued operations, net of income taxes
            $
            (307)
            $
            (328)
            $
            (12)
            $
            12
            $
            21Net
      (loss) income
            $
            (553)
            $
            (575)
            $
            (10)
            $
            13
            $
            19Basic
      and diluted (loss) earnings per share-
      from continuing operations
            $
            (2.02)
            $
            (2.05)
            $
            0.02
            $
            0.01
            $
            (0.02)-
      from discontinued operations
            $
            (2.52)
            $
            (2.72)
            $
            (0.10)
            $
            0.10
            $
            0.18Basic
      and diluted (loss) earnings per share
            $
            (4.54)
            $
            (4.77)
            $
            (0.08)
            $
            0.11
            $
            0.16





Fourth
quarter fiscal 2009 compared to the fourth quarter fiscal 2008


Revenues
from continuing operations


Revenues
from continuing operations in the fourth quarter of fiscal 2009 of $51 million
were $33 million lower compared to the comparative fourth quarter of fiscal
2008, primarily due to lower revenues in medical imaging and radiotherapeutics,
and sterilization technologies. These lower revenues were primarily driven by
AECL’s NRU reactor shutdown and lower cobalt supply.





Selling,
general and administration (SG&A)


SG&A
expenses in the fourth quarter of fiscal 2009 of $21 million were $4 million
lower compared to the fourth quarter of fiscal 2008 primarily due to lower
compensation cost due to workforce reductions and cost control
initiatives.





Other
income (expenses), net


Other
income in the fourth quarter of fiscal 2009 of $5 million was $10 million higher
than the same quarter in fiscal 2008. This was primarily due to a $7 million
valuation provision and charge related to the investment in Entelos recorded in
the fourth quarter of fiscal 2008 and a lower foreign exchange gain on the
revaluation of certain assets and liabilities in the fourth quarter of fiscal
2009.





Operating
loss


The $12
million loss from continuing operations in the fourth quarter of fiscal 2009
improved by $335 million compared to the same quarter in fiscal 2008. This
decrease was due to a $341 million MAPLE Facilities write-off and a $7 million
valuation provision and charge related to the investment in Entelos in the
fourth quarter of fiscal 2008, and a $12 million increase in fair value of the
embedded derivatives and $4 million of lower SG&A expenses in the fourth
quarter of fiscal 2009. This was partially offset by lower MDS Nordion revenues
and a $9 million restructuring charge recorded due to the strategic
repositioning in the fourth quarter of fiscal 2009.





Adjusted
EBITDA


Adjusted
EBITDA in the fourth quarter of fiscal 2009 of $4 million was $4 million lower
compared to the same quarter of fiscal 2008.  This was primarily due
to the lower revenues from both the medical imaging and radiotherapeutics, and
lower cobalt supply and the negative impact of foreign exchange on the
revaluation of certain of the assets and liabilities, partially offset by a $12
million increase in fair value of the embedded derivatives, lower compensation
cost due to workforce reductions and other cost control
initiatives.


Adjusted
EBITDA


The
following tables provide a summary of adjusted EBITDA for continuing operations
for each of the eight most recently completed quarters:





Trailing
      four
              quarters
            October
      31
              2009
            July
      31
              2009
            April
      30
              2009
            January
      31
              2009Revenues
      from continuing operations
            $
            231
            $
            51
            $
            49
            $
            65
            $
            66Operating
      (loss) income from continuing operations
            $
            (2)
            $
            (12)
            $
            1
            $
            8
            $
            1Depreciation
      and amortization
            
            24
            
            7
            
            6
            
            6
            
            5EBITDA
            
            22
            
            (5)
            
            7
            
            14
            
            6Restructuring
      charges, net
            
            9
            
            9
            
            -
            
            -
            
            -Valuation
      provisions and investment write-downs
            
            1
            
            -
            
            -
            
            -
            
            1Adjusted
      EBITDA
            $
            32
            $
            4
            $
            7
            $
            14
            $
            7Adjusted
      EBITDA Margin (% of revenues)
            
            14%
            
            8%
            
            14%
            
            22%
            
            11%





Trailing
      four
              quarters
            October
      31
              2008
            July
      31
              2008
            April
      30
              2008
            January
      31
              2008Revenues
      from continuing operations
            $
            296
            $
            84
            $
            72
            $
            80
            $
            60Operating
      (loss) income from continuing operations
            $
            (355)
            $
            (347)
            $
            7
            $
            3
            $
            (18)Depreciation
      and amortization
            
            25
            
            6
            
            7
            
            5
            
            7EBITDA
            
            (330)
            
            (341)
            
            14
            
            8
            
            (11)Restructuring
      charges, net
            
            1
            
            1
            
            -
            
            -
            
            -Valuation
      provisions and investment write-downs
            
            10
            
            7
            
            -
            
            3
            
            -Loss
      on sale of a business
            
            4
            
            -
            
            -
            
            -
            
            4MAPLE
      Facilities write-off
            
            341
            
            341
            
            -
            
            -
            
            -Adjusted
      EBITDA
            $
            26
            $
            8
            $
            14
            $
            11
            $
            (7)Adjusted
      EBITDA Margin (% of revenues)
            
            9%
            
            10%
            
            19%
            
            14%
            
            (12%)





The
adjusting items in the fourth quarter of fiscal 2009 include a $9 million
restructuring charge due to the strategic repositioning. The adjusting item in
the first quarter of fiscal 2009 includes a $1 million for the write-off of the
investment in Entelos.





The
adjusting items in the fourth quarter of fiscal 2008 include a $341 million
non-cash MAPLE Facilities write-off, $7 million valuation provision and charge
related to the investment in Entelos, and a $1 million restructuring charge for
lease termination costs of the headquarter offices in Canada. The adjusting
items in the second quarter of fiscal 2008 include $3 million for impairment
charge for the ABCP. The adjusting item in the first quarter of fiscal 2008
includes a $4 million loss on sale of the external beam therapy and
self-contained irradiator product lines.


Outlook


On
September 2, 2009, MDS announced that it entered into a $650 million agreement
to sell MDS Analytical Technologies and that it intends to sell Early
Stage.  Upon the completion of these transactions, we expect to remain
a publicly traded company focused primarily on MDS Nordion. We currently expect
to complete the sale of MDS Analytical Technologies during the first calendar
quarter of 2010. On July 1, 2009, we completed the sale of the Phase II-IV and
on October 30, 2009, we completed the sale of the Central Labs operations. The
results of MDS Analytical Technologies and MDS Pharma Services, including
Early-Stage, Phase II-IV and Central Labs are reported as discontinued
operations.





During
fiscal 2008, MDS Analytical Technologies and MDS Pharma Services generated
approximately 62% and 21%, respectively, of the Company’s consolidated adjusted
EBITDA. Accordingly, following the completion of the planned sale of MDS
Analytical Technologies, we expect that the adjusted EBITDA will be reduced
substantially. While we expect that the Company’s operating costs will be
reduced due to the smaller number of employees following the sale, we also
expect to incur restructuring costs as we resize the corporate functions to
reflect the size and nature of the remaining business.





Upon the
completion of the planned sale of MDS Analytical Technologies, the intended sale
of the remaining Early Stage and completion of associated transition services,
we intend to wind down the existing head office operations in Toronto, Canada,
which currently employs approximately 150 people, and to establish a new
corporate office in Ottawa, Canada, the current head offices of MDS Nordion.
This transition is intended to result in the establishment and hiring of
approximately 50 positions in Ottawa with the remaining 100 current corporate
positions being eliminated due to the reduced scale of the ongoing operations.
The severance cost, including those for the executive officers, of closing the
Toronto office is estimated to be approximately $30 million, of which a pre-tax
restructuring charge of $9 million was recorded in the fourth quarter of fiscal
2009 related to this initiative. In addition to a lower number of corporate
employees, we would expect to incur lower costs in certain areas, such as audit
and insurance resulting from the reduced size and nature of the remaining
business.  Upon the completion of the restructuring of the corporate
functions and certain transition activities, we expect MDS will generate
positive EBITDA and positive cash flows with MDS Nordion as the only operating
unit, with or without the contribution generated from NRU reactor supplied
product.





In fiscal
2010, we expect our corporate costs to increase due to transitional costs. We
expect to provide transition services, including separation of IT systems and
financial reporting, and provision of services such as payroll, accounts
receivable and payable, on an interim basis to each buyer of a business we sell.
While we expect to receive revenue for providing these services, the revenue may
not exceed the cost. In addition, we expect to incur costs related to items such
as recruiting and cross training of corporate staff in Ottawa, Canada,
incremental director and officer insurance to reduce future liability and costs,
reorganization of entities and records retention. Following the completion of
these activities, the transition services, and the associated restructuring
related to the Toronto, Canada corporate office, we would expect corporate
SG&A to be approximately one-third of the fiscal 2009 corporate
SG&A.





As
discussed earlier in the “Medical isotope supply
disruption” section of this MD&A, AECL has announced that its NRU
reactor is expected to return to service by the end of March 2010, however, AECL
has reported that if there are continuing challenges with the repair process,
the NRU reactor return to service schedule could extend into April of 2010. The
NRU reactor supplies substantially all of MDS Nordion’s reactor-based medical
isotopes and, as a result of this shutdown, we previously announced that
Nordion’s adjusted EBITDA would be reduced by approximately $4 million for every
month the reactor is out of service. Prior to the shutdown of the NRU reactor in
May 2009, NRU reactor supplied products contributed approximately $30 million of
EBITDA in the current fiscal year, which included $6 million of incremental
EBITDA that resulted from higher sales during a competitor’s supply disruption.
To date, we have not been able to obtain an alternate short-term supply of the
primary medical isotope Mo99.





In fiscal
2010, if the NRU reactor returns to service, we expect the revenue and
profitability from NRU reactor supplied medical isotopes may not fully return to
previous levels due to the negative impact of any alternate sources of medical
isotopes that the customers have secured during the period that the NRU reactor
was out of service and the impact of alternate procedures and methods used to
increase the utilization of medical isotopes.  These may be partially,
or completely, offset by the impact of the planned shutdown of a major European
reactor beginning in the first calendar quarter of 2010, which may disrupt
isotope supply for competitors.





In
addition to pursuing the arbitration proceeding to compel AECL to complete the
MAPLE reactors, we continue to seek other long-term sources of medical isotope
supply.  In this regard, we have announced collaborations with TRIUMF
and the Karpov Institute of Physical Chemistry and we continue to pursue
alternate long-term sources of Mo99. MDS Nordion expects to continue to fund the
costs related to its ongoing arbitration proceedings with AECL and its legal
proceedings against the Government of Canada and AECL as described earlier in
“MAPLE Facilities”
section of the MD&A.


In fiscal
2010, MDS Nordion expects the supply of cobalt will increase compared with
fiscal 2009 and that revenue associated with this product will also increase,
however, the amount shipped in each quarter is expected to continue to fluctuate
based on the timing of cobalt receipts from the suppliers. In addition, in the
third quarter of fiscal 2009, we amended the Russian Cobalt Supply Contract with
Energoatom, which was intended to increase MDS Nordion’s long-term supply of
cobalt to meet the continued growth in cobalt sterilization in the long term.
The amendment resulted in a reduction of the overall committed volumes, however,
this was primarily in the later years of this 17-year agreement.





MDS
Nordion remains encouraged by the ongoing global expansion of its TheraSphere®
product line, which grew by over 25% in fiscal 2009 compared with fiscal 2008
and with $20 million in annual revenue, it became our third largest product,
based on revenue, as this treatment continues to gain acceptance for cancer
treatment. We expect continued growth in TheraSphere® in fiscal
2010.  We also expect growth in other radiotherapeutic products,
including a new product that began commercial production in the second half of
the current fiscal year.  In fiscal 2010, we expect to increase
investment in R&D and in the selling and marketing of radiotherapeutics,
including support for the continued growth of TheraSphere®.





In the
first quarter of fiscal 2010, the operating activities of MDS Analytical
Technologies and Early Stage, which are included in discontinued operations, are
expected to generate positive cash flows.  Excluding the impact of
asset write-downs, the profitability of Early Stage improved in the fourth
quarter of fiscal 2009 compared with the third quarter of fiscal 2009. New order
wins also improved sequentially in the fourth quarter of fiscal 2009 compared
with the third quarter of fiscal 2009, however, customers continue to express
their concern over the uncertainty created by the process to sell Early Stage.
MDS Analytical Technologies continued to generate positive EBITDA in the fourth
quarter of fiscal 2009. Sequentially, adjusted EBITDA for MDS Analytical
Technologies was essentially flat.





As a
result of the planned sale of MDS Analytical Technologies and the repurchase of
the senior unsecured notes, we may generate income subject to tax in certain
jurisdictions. However, based on available tax carryovers, transaction and
restructuring costs associated with the sale, make-whole payments on the
repurchase of the senior unsecured notes, and the expected structure of the
sale, we do not expect to pay significant cash taxes on any gains arising from
the sale of MDS Analytical Technologies. As well, we expect to be able to apply
certain transaction and restructuring costs associated with the sale of MDS
Analytical Technologies to reduce any cash taxes arising on the intended future
sale of Early Stage.





In the
future the Company will significantly benefit from existing tax losses, R&D
tax credits, and other carryovers that can be applied to reduce future cash
taxes.  At year end, we reported $55 million of deferred tax assets,
all of which relate to our Canadian operations and could be used to reduce
future cash taxes in Canada.  In addition, we expect certain
transaction and restructuring costs arising from the sale of MDS Analytical
Technologies and on the intended future sale of Early Stage, to generate
additional tax carryovers for the Company.  We will also benefit from
significant reductions to the corporate tax rate in Canada.  Today our
tax rate approximates the Canadian corporate income tax rate, which is currently
32%.  However, based on both legislated and proposed income tax rate
reductions, we expect our corporate tax rate to fall to 25% by fiscal 2014. This
rate is expected to be further reduced by the amount of tax credits that MDS
Nordion generates from the R&D that it performs internally and on behalf of
certain customers.





We
currently expect to close the sale of MDS Analytical Technologies during the
first calendar quarter of fiscal 2010, which is subject to regulatory approval,
including resolution of a second request from the Federal Trade Commission in
the U.S. and other closing conditions as has previously been discussed in “Divestitures and discontinued
operations - Sale of MDS Analytical Technologies” section of this
MD&A.  We expect to receive gross proceeds of $650 million on the
completion of the sale of MDS Analytical Technologies. We currently intend to
distribute a portion of the sale of MDS Analytical Technologies proceeds,
currently estimated to be approximately $400 million to $450 million, to
shareholders pursuant to a substantial issuer bid. The balance of the gross
proceeds of the sale of MDS Analytical Technologies plus existing cash on hand
($298 million as of October 31, 2009) is expected to be used to:  (i)
redeem the senior unsecured notes; (ii) fund transaction and restructuring costs
related to the sale of MDS Analytical Technologies including the wind down of
the corporate office; and (iii) fund the future ongoing operations and
obligations.





Impact
of divestitures, use of sale proceeds and available cash


We have
received $41 million to date from the sale of the Phase II-IV and Central Labs,
which are included in the $298 million cash balance as of October 31, 2009. We
expect to receive an additional $13 million by the fourth quarter of fiscal
2010, $10 million of which is recorded in restricted cash, from the sale of the
Phase II-IV upon MDS meeting certain post closing obligations and assuming that
there are no breach of representations and warranties under the sale agreement.
In addition, we expect to receive approximately $9 million of net post close
adjustments on the Phase II-IV and Central Labs sales. We also expect to
receive


$650
million in cash and $4 million of debt forgiveness on the completion of the sale
of MDS Analytical Technologies during the first calendar quarter of
2010.


Redemption
of the senior unsecured notes


On
December 18, 2009, we repaid $23 million of the senior unsecured notes that
matured. Based on an agreement with the note holders, within three days
following the completion of the sale of MDS Analytical Technologies, we intend
to redeem the outstanding U.S. dollar denominated senior unsecured notes by
payment of approximately $223 million to the holders thereof.  This
amount includes the principal amount, including accrued interest and
approximately $23 million make-whole amount that is tax deductible. With the
sale of MDS Analytical Technologies, we will be unable to access the C$500
million (US$462 million) revolving credit facility under the terms of the
associated Credit Facility Agreement, which was undrawn as of October 31, 2009
and will be required to provide approximately $20 million of cash collateral for
the outstanding letters of credit. The $20 million of the cash collateral will
be recorded as restricted cash and we will not have access to it for our
operations, while it is held as collateral.





Distribution
to shareholders pursuant to substantial issuer bid


We
currently intend to distribute approximately $400 million to $450 million of the
sale proceeds of MDS Analytical Technologies to the shareholders pursuant to a
substantial issuer bid. The actual amount used to fund the substantial issuer
bid will be determined at the time the bid is commenced and will take into
account the expected impact on the liquidity of the Common shares subsequent to
the substantial issuer bid and current estimates for the items described below,
including the cash required for the future ongoing operations. We currently
intend to proceed with a substantial issuer bid within 30 days following
completion of the sale of MDS Analytical Technologies.





Cash
retained for the ongoing operations


On
completion of the sale of MDS Analytical Technologies and the substantial issuer
bid, we intend to initially hold a cash balance in the range of $125 million to
$175 million to support the ongoing operations and obligations related to MDS
Nordion and the Early Stage business, in addition to amounts required to fund
any unpaid transaction and restructuring costs described below. Following the
intended sale of Early Stage, we expect  our cash balance may be lower
as a result of the expected operating cash requirements of the Early Stage
business prior to the intended sale, and also the amount of proceeds that are
received in cash upon the completion of the intended sale.  These cash
proceeds may not exceed the associated transaction and restructuring costs, and
the amounts required to fund other obligations retained as a result of the sale
of the business.





Transaction
and restructuring


Corporate
restructuring


Contingent
upon the closing of the sale of MDS Analytical Technologies or a change in
accordance with the Company’s change of control (COC) policy, certain of the
executive officers, are entitled to severances, which include: (i) a sum equal
to the executive officer’s annual compensation times a prescribed multiple,
ranging from one to three, (ii) the executive officer’s average annual bonus
over the last three years, and (iii) to the extent the executive officer is
subject to certain U.S. tax requirements a tax gross-up amount in respect
thereof. In addition, other employees in the Toronto, Canada corporate office
would be entitled to severance and certain retention payments if they are
terminated by the Company. We expect to record approximately $21 million of
additional restructuring charges in fiscal 2010. Subsequent to year end, on
January 8, 2010, the Company announced the departure of Stephen P. DeFalco,
former Chief Executive Officer, and as a result $7 million of the above $21
million of severance and benefits, including a U.S. tax gross-up, became payable
in accordance with his employment contract.





Pursuant
to the Company’s strategic repositioning and COC policy, MDS may also incur the
following additional costs.





Stock-based
compensation awards


Our
stock-based compensation awards consist of stock options, performance share
units (PSUs) granted under mid-term incentive plan (MTIP) and restricted share
units (RSUs). Upon the sale of MDS Analytical Technologies, pursuant to the COC
policy all of the outstanding unvested stock-based compensation awards will
accelerate and fully vest. A change of control includes, among other things, the
sale of all or substantially all of the assets and undertaking of
MDS.





The
accelerated vesting of all of the 1 million outstanding stock options due to the
COC policy will result in a non-cash stock compensation expense of approximately
$3 million. Substantially all of the unvested stock options are out of the money
as of


October
31, 2009. We will record a non-cash expense for these stock options upon the
closing of the planned sale of MDS Analytical Technologies, which is expected to
close during the first calendar quarter of 2010.





In
addition, pursuant to the COC policy, all of the stock-based incentives granted
to employees including to the executive officers pursuant to the MTIP and RSU
plan will accelerate and fully vest at an estimated cost of approximately $15
million based on approximately 2 million PSUs and RSUs outstanding, and assuming
a share price of $8.00 per Common share. The actual payment will be based on the
average closing price of the Common shares for the five trading days up to and
including the date of vesting. We will record amounts payable under the MTIP and
the RSU plans upon the closing of the sale of MDS Analytical Technologies, which
is expected
to close in the first calendar quarter of 2010. The $2 million of RSUs that
vested and were paid out in the first fiscal quarter of 2010 are not included in
the $15 million.





Transaction
incentive plan


We
implemented a transaction incentive plan on May 20, 2009, which is designed to
motivate and retain certain executives to assist in the evaluation and
implementation of strategic alternatives available to MDS. This incentive plan
established an incentive pool based on a percentage of the enterprise value of
the businesses sold, and if two business units are sold, an amount based on the
enterprise value of the remaining business. Based on both MDS Analytical
Technologies and the intended Early Stage sales closing and a share price of
$8.00 per Common share, the payment under this incentive plan is estimated to be
$10 million of which less than


$1
million was accrued in fiscal 2009.





Contract
cancellation charges


Subsequent
to the sale of MDS Analytical Technologies and Early Stage, we will retain
certain contracts that contain minimum purchase or fixed price commitments that
are not economical for the remaining business. We expect to incur up to $5
million of expense to restructure or pay out these contracts in fiscal 2010.
Additionally, we intend to vacate all, or substantially all of the corporate
office space in Toronto, Canada, for which future rent payments and cancellation
penalties currently total approximately


$7
million. We have initiated actions to sublease the office space or negotiate a
buyout of the remaining lease at a reduced amount.





Financial
advisory services fees


As a
result of both the planned sale of MDS Analytical Technologies and the intended
sale of Early Stage, we will incur fees of approximately $21 million in
connection with financial advisory services provided by investment bankers to
MDS. Approximately


$14
million of these fees are related to the sale of MDS Analytical Technologies of
which $5 million was paid in fiscal 2009. Pursuant to agreements with the
Company’s financial advisors, if two business units are sold, they are entitled
to a fee based on the market capitalization of the remaining business which is
determined by the first sixty days average closing market price of the Common
shares following the consummation of the sale of MDS Analytical Technologies and
MDS Pharma Services. Assuming an average share price of $8.00 per Common share,
we estimate approximately $7 million of financial advisory services fee would be
incurred in relation to the sale of Early Stage should it occur following the
close of the MDS Analytical Technologies transaction.





In
addition, we expect to incur approximately $11 million in legal, accounting and
other advisory fees associated with the sale of MDS Analytical Technologies, of
which $4 million was paid in fiscal 2009. We have approximately $2 million of
unpaid advisory fees associated with the sale of MDS Phase II-IV and Central
Labs and currently expect to incur approximately $4 million of advisory fees in
relation to the sale of Early Stage.





Accounting
and Control Matters




Recent
accounting pronouncements


United
States


On July
1, 2009, the Financial Accounting Standards Board (FASB) issued ASC 105, “Generally Accepted Accounting
Principles” (ASC 105), which establishes the ASC as the authoritative
source of U.S. GAAP. The issuance of ASC 105 does not change U.S. GAAP and had
no material impact on the consolidated financial statements.





In
December 2009, FASB issued Accounting Standards Update (ASU) No. 2009-17,
“Improvements to Financial
Reporting by Enterprises Involved with Variable Interest Entities”
(formerly, SFAS No. 167, “Amendments to FASB Interpretation
No. 46(R)”) (ASU 2009-17) to improve financial reporting by enterprises
involved with variable interest entities. ASU 2009-17 shall be effective as of
the beginning of each entity’s first annual reporting period that begins after
November 15, 2009 and earlier application is not allowed. The Company will adopt
ASU 2009-17 on November 1, 2010, and it is not expected to have a material
impact on our consolidated results of operations and financial
condition.





In
August 2009, FASB issued ASU No. 2009-05, “Measuring Liabilities at Fair
Value” (ASU 2009-05). This update provides amendments to ASC 820, “Fair Value Measurements and
Disclosure” for the fair value measurement of liabilities when a quoted
price in an active market is not available. The Company will adopt ASU 2009-05
on November 1, 2009 and it is not expected to have a material impact on the
Company’s consolidated financial statements.





In
December 2008, FASB issued ASC 715-20, “Compensation - Retirement
Benefits” (formerly, FSP FAS No. 132(R)-1, “Employers’ Disclosures about
Postretirement Benefit Plan Assets”) (ASC 715-20), which requires plan
sponsors to provide new disclosures about assets in defined benefit
postretirement benefit plans as well as any concentrations of associated
risks.  These disclosures about plan assets are required for fiscal
years ending after December 15, 2009, but are not required for interim periods.
ASC 715-20 does not require disclosures for earlier periods presented for
comparative purposes at initial adoption. We will adopt ASC 715-20
on


November
1, 2009, which will only impact the disclosures of pension plan assets in the
annual consolidated financial statements.


In April
2008, FASB issued ASC 350-30, “Intangibles - Goodwill and
Other” (formerly, FSP FAS No. 142-3, “Determination of the Useful Life of
Intangible Assets”) (ASC 350-30). ASC 350-30 provides guidance with
respect to estimating the useful lives of recognized intangible assets acquired
on or after the effective date and requires additional disclosure related to the
renewal or extension of the terms of recognized intangible assets. ASC 350-30 is
effective for fiscal years beginning after December 15, 2008, and interim
periods within those fiscal years. Early adoption is prohibited. We plan to
adopt ASC 350-30 on November 1, 2009 and it is not expected to have a material
impact on the consolidated financial statements.





In
February 2008, FASB issued ASC 820-10, “Fair Value Measurements and
Disclosures” (formerly, FSP 157-2,“Effective Date of FASB Statement
No. 157”)(ASC 820-10).ASC 820-10 defers the effective date of ASC 820 for non-financial assets
and liabilities to fiscal years beginning after November 15, 2008, and
interim periods within those fiscal years. We adopted the applicable portions of
ASC 820 effective November 1, 2008 and has not yet applied the provisions of ASC
820 to the non-financial assets and liabilities within the scope of ASC 820-10.
We plan to adopt the deferred portion of ASC 820 on November 1,
2009.  We currently do not expect the adoption of the deferred
portions of ASC 820 to have a material impact on the consolidated financial
statements.





In
December 2007, FASB issued ASC 805, “Business Combinations”
(formerly FAS No. 141 (revised 2007), “Business Combinations (revised
2007)”)(ASC 805). ASC 805 requires companies to use the acquisition
method of accounting for all business combinations and the identification of an
acquirer for each business combination. ASC 805 also requires that liabilities
related to contingent consideration be measured at fair value at the acquisition
date, acquisition-related and restructuring costs be recognized separately from
the business combination and noncontrolling interest in subsidiaries be measured
at fair value and classified as a separate component of equity.  ASC
805 is effective for business combinations for which the acquisition date is on
or after the beginning of the first annual reporting period beginning on or
after December 15, 2008. We plan to adopt ASC 805 on November 1, 2009 and are
currently assessing the impact of ASC 805 retroactive tax impacts related to tax
uncertainties acquired in previous business combinations.





In
December 2007, FASB issued ASC 810, “Consolidation” (formerly,
SFAS No. 160, “Noncontrolling
Interests in Consolidated Financial Statements - an amendment of ARB No.
51”) (ASC 810), which is effective for fiscal years beginning on or after
December 15, 2008. ASC 810
requires noncontrolling interests in subsidiaries be presented as equity in the
consolidated financial statements and that all transactions between an entity
and noncontrolling interests be accounted for as equity transactions. We plan to
adopt ASC 810 on November 1, 2009 and it is not expected to have a material
impact on the consolidated results of operations and financial
condition.





International
Accounting Standards


We have
been monitoring the deliberations and progress being made by accounting standard
setting bodies and securities regulators both in the U.S. and in Canada with
respect to their plans regarding convergence to International Financial
Reporting Standards (IFRS).  We currently expect to adopt IFRS as our
primary reporting standard when the U.S. Securities and Exchange Commission
requires domestic registrants in the U.S. to transition to IFRS.





Principles
of consolidation


Our
consolidated financial statements reflect the assets, liabilities, and results
of operations of all subsidiaries and entities of which we are the primary
beneficiary. All significant intercompany accounts and transactions have been
eliminated. We use the equity method of accounting for investments in entities
for which we do not have the ability to exercise control, but have significant
influence.





Critical
accounting policies and estimates


Our
discussion and analysis of the financial condition and results of operations is
based on the consolidated financial statements, which have been prepared in
accordance with U.S. GAAP applied on a consistent basis. Beginning with its
fiscal 2007 year-end, we adopted the U.S. dollar as the Company’s reporting
currency and U.S. GAAP as its primary reporting standard for the presentation of
its consolidated financial statements.





Use
of estimates


The
preparation of the consolidated financial statements 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. Estimates
are used in accounting for, among other items, revenues from long-term
contracts, inventory valuation, residual values of leased assets, allowance for
credit losses on receivables, the amount and timing of future cash flows
expected to be received on long-term investments, projections related to
stock-based compensation plans, actuarial assumptions for the pension and other
post-employment benefit plans, future cash flows associated with goodwill and
long-lived asset valuations, and environmental and warranty reserves. Company’s
estimates are based on the facts and circumstances available at the time
estimates are made, historical experience, risk of loss, general economic
conditions and trends, and the assessments of the probable future outcomes of
these matters. Actual results could differ from those estimates. Estimates and
assumptions are reviewed periodically, and the effects of changes, if any, are
reflected in the consolidated statements of operations in the period that they
are determined.


Allowance
for doubtful accounts


We
maintain bad debt reserves based on a variety of factors, including the length
of time the receivables are past due, macroeconomic conditions, significant
one-time events, historical experience and the financial condition of customers.
We record a specific reserve for individual accounts when we become aware of a
customer’s inability to meet its financial obligations, such as in the case of
bankruptcy filings or deterioration in the customer’s operating results or
financial position. If circumstances related to a customer change, we would
further adjust estimates of the recoverability of receivables.





Inventories


Inventories
of raw materials and supplies are recorded at the lower of cost, determined on a
first-in, first-out (FIFO) basis, or market.  Finished goods and
work-in-process include the cost of material, labor and manufacturing overhead
and are recorded on a FIFO basis at the lower of cost or market.





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
period of disposal.





The costs
associated with modifications to facilities owned by others to permit isotope
production are deferred and recorded as facility modifications and amortized
over the expected contractual production.





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
is recorded from the date on which each asset is placed into service, is
generally provided for on a straight-line basis over the estimated useful lives
of the property, plant and equipment.





Asset
retirement obligations


We record
asset retirement obligation costs associated with the retirement of tangible
long-lived assets. We review legal obligations associated with the retirement of
these long-lived assets. If it is determined that a legal obligation exists and
it is probable that this liability will ultimately be realized, the fair value
of the liability for an asset  retirement obligation is recognized in
the period in which it is incurred if a reasonable estimate of fair value can be
made. The fair value of the liability is added to the carrying amount of the
associated asset and this additional carrying amount is depreciated over the
expected life of the asset. The present value of the asset retirement obligation
is accreted with the passage of time to its expected settlement fair
value.





Impairment
of long-lived assets


We
evaluate the carrying value of long-lived assets, including property, plant and
equipment, for potential impairment when events and circumstances warrant a
review. Factors that we consider important that 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 the overall business,
significant negative industry or economic trends, a significant adverse legal or
regulatory development, a significant decline in the Company’s stock price for a
sustained period, and the Company’s market capitalization relative to its net
book value.





The
carrying value of a long-lived 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 less costs of disposal by a
charge to income.  The anticipated net recoverable amount for a
long-lived asset 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.





Long-term
investments


We
account for long-term investments where the Company has the ability to exercise
significant influence using the equity method of accounting. In situations where
we do not exercise significant influence over a long-term investee that is not
publicly listed, the investments are recorded at cost. Investments in public
companies are accounted for at fair value. We periodically review 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, we write down the value of the investment to its fair
value.





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.





Stock-based
compensation


The fair
value of stock options granted on and after November 1, 2003 is recognized as
compensation expense on a straight-line basis over the applicable stock option
vesting period. The expense is included in SG&A expenses in the consolidated
statements of operations and as additional paid-in capital grouped within
shareholders’ equity 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 along with the associated amount of additional
paid-in capital.





Certain
of the Company’s incentive compensation plans base the determination of
compensation to be paid in the future on the price of the Company’s publicly
traded shares at the time of payment or time of the grant date. Expenses related
to these plans are recorded as a liability and charged to income over the period
in which the amounts are earned, based on an estimate of the current fair value
of amounts that will be paid in the future.





Stock-based
compensation expenses relating to certain employees of MDS Analytical
Technologies and MDS Pharma Services are included in the results of discontinued
operations.





Pension,
post-retirement and other post-employment benefit plans


We offer
a number of benefit plans that provide pension and other post-retirement
benefits. The current service cost of benefit plans is charged to income. 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.





We
recognize the funded status of its defined benefit plans on its balance sheet;
recognizes gains, losses, and prior service costs or credits that arise during
the period that are not recognized as components of net periodic benefit cost as
a component of accumulated other comprehensive income, net of tax; measures its
defined benefit plan assets and obligations as of the date of the Company’s
fiscal year-end balance sheet; and discloses additional information in the notes
to the consolidated financial statements about certain effects on net periodic
benefit cost for the next fiscal year that arise from delayed recognition of the
gains or losses, prior service costs or credits, and transition assets or
obligations.





The
expected costs of post-employment benefits, other than pensions, for active
employees are accrued in the years in which employees provide service to the
Company. 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.





Income
taxes


Deferred
tax assets and liabilities are recognized for future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled. We provide a valuation allowance against its deferred
tax assets when it believes that it is more likely than not that the asset will
not be realized.





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 for the
year.  All non-refundable investment tax credits recognized in income
are recorded as a reduction in income tax expense for the year. Refundable tax
credits are recorded as a reduction in the related expense.





Foreign
currency translation


Although
we report the Company’s financial results in U.S. dollars, the functional
currency of the Company’s Canadian operations is Canadian dollars. The
functional currencies of the Company’s foreign subsidiaries are their local
currencies. Monetary assets and liabilities denominated in foreign currencies
are translated into the functional currencies of operations at prevailing
year-end exchange rates. Non-monetary assets and liabilities are translated into
functional currencies at historical rates. Assets and liabilities of foreign
operations with a functional currency other than U.S. dollars are translated
into U.S. dollars at prevailing year-end exchange rates, while revenue and
expenses of these foreign operations are translated into U.S. dollars at average
monthly exchange rates. The Company’s net investments in foreign (non-Canadian)
subsidiaries are translated into U.S. dollars at historical exchange
rates.


Exchange
gains and losses on foreign currency transactions are recorded in other income
(expenses), net. Upon the sale or upon complete or substantially complete
liquidation of an investment in a foreign (a non-Canadian functional currency)
entity, the amount attributable to that entity and accumulated in the
translation adjustment component of the equity is removed from the separate
component of equity and reported as part of the gain or loss on sale or
liquidation of the investment in the period during which the sale or liquidation
occurs.





Exchange
gains or losses arising on translation of the Company’s net equity investments
in these foreign (non-Canadian) subsidiaries and those arising on translation of
foreign currency long-term liabilities designated as hedges of these investments
are recorded as OCI. Upon reduction of the Company’s investment in the foreign
(non-Canadian) subsidiary, due to a sale or complete or substantially complete
liquidation, the amount from the reporting currency translation as well as the
offsetting amount from the translation of foreign currency long-term liabilities
included in accumulated other comprehensive income are recognized in
income.





Derivative
financial instruments


In the
normal course of business, the Company uses derivative financial instruments to
manage foreign currency exchange rate risks. Derivative transactions are
governed by a uniform set of policies and procedures covering areas such as
authorization, counterparty exposure and hedging practices. Positions are
monitored based on changes in foreign currency exchange rates and their impact
on the market value of derivatives. Credit risk on derivatives arises from the
potential for counterparties to default on their contractual obligations to the
Company. The Company limits its credit risk by dealing with counterparties that
are considered to be of high credit quality. The Company does not enter into
derivative transactions for trading or speculative purposes. The Company records
derivatives at fair value either as prepaid expenses and other or as accounts
payable and accrued liabilities on the consolidated statements of financial
position. The Company determines the fair value of the derivative financial
instruments using relevant market inputs when no quoted market prices exist
for the instruments. The fair value of the derivative
financial instruments is determined by comparing the rates when the
derivatives are acquired to the market rates at period-end. The key inputs
include interest rate yield curves, foreign exchange spot and forward
rates.  The Company classifies cash flows from its derivative programs
as cash flows from operating activities in the consolidated statements of cash
flows.





The
accounting for changes in the fair value of a derivative depends on the intended
use of the derivative and the resulting designation. In order for a derivative
to qualify for hedge accounting, the derivative must be formally designated as a
fair value, cash flow or net investment hedge by documenting the relationship
between the derivative and the hedged item. The documentation includes a
description of the hedging instrument, the hedged item, the risk being hedged,
the risk management objective and strategy for undertaking the hedge, the method
for assessing the effectiveness of the hedge and the method for measuring hedge
ineffectiveness. Additionally, the hedge relationship must be expected to be
highly effective at offsetting changes in either the fair value or cash flows of
the hedged item at both inception of the hedge and on an ongoing basis. We
assess the ongoing effectiveness of the Company’s hedges on a quarterly
basis.





Controls
and procedures


Management
of MDS is responsible for the design and operation of disclosure controls and
procedures and internal control over financial reporting, and is required to
evaluate the effectiveness of these controls on an annual basis.





An
effective system of disclosure controls and procedures and internal control over
financial reporting is highly dependent upon adequate policies and procedures,
human resources and information technology. All control systems, no matter how
well designed, have inherent limitations, including the possibility of human
error and the circumvention or overriding of the controls or
procedures.  As a result, there is no certainty that our disclosure
controls and procedures or internal control over financial reporting will
prevent all errors or all fraud.





In
addition, changes in business conditions or changes in the nature of the
Company’s operations may render existing controls inadequate or affect the
degree of compliance with policies and procedures.  Accordingly, even
disclosure controls and procedures and internal control over financial reporting
determined to be effective can only provide reasonable assurance of achieving
their control objectives.





At the
end of the period covered by this report, management conducted an evaluation of
the Company’s disclosure controls and procedures and internal control over
financial reporting.  Our conclusions are set out below:





Management’s
annual report on 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 U.S. Securities and Exchange Commission and the
Canadian Securities Administrators.





Based on
that evaluation, management of MDS, including the Chief Executive Officer and
Chief Financial Officer, has concluded that as a result of the material weakness
described below in Management’s annual report on internal control over financial
reporting, the disclosure controls and procedures were not effective as of
October 31, 2009.  Management believes that the reported material
weakness is narrow in scope.





Management’s
annual report on internal control over financial reporting


Management
of MDS, including the Chief Executive Officer and Chief Financial Officer, has
evaluated the effectiveness of our internal control over financial reporting
using the Committee of Sponsoring Organizations of the Treadway Commission
(COSO) criteria.  Management believes that the COSO framework is
suitable for its evaluation of the Company’s internal control over financial
reporting because it is free from bias and it permits reasonably consistent
qualitative and quantitative measurements of MDS’s internal control. It also is
sufficiently complete in that it includes those relevant factors that would
alter a conclusion about the effectiveness of the Company’s internal control,
and because it is relevant to an evaluation of internal control over financial
reporting.





As a
result of our internal controls review, management has determined that given the
circumstances and events faced by the Company as related to the strategic
repositioning plan, the Company did not maintain effective processes and
controls over the accounting and reporting of complex and non-routine
transactions. Specifically, the design of an integrated system of controls over
the accounting and reporting for discontinued operations, including incomes
taxes, was not adequate. In addition, the technical complexity and volume of
work associated with the strategic repositioning plan placed substantial demands
on the Company’s tax resources, which in turn diminished the operating
effectiveness of our internal controls for both routine and non-routine income
tax accounting and reporting.





Based on
these findings, management of MDS, including the Chief Executive Officer and the
Chief Financial Officer, has concluded that this combination of deficiencies
constitutes a material weakness in the Company’s internal control over financial
reporting and that the Company’s internal control over financial reporting was
not effective as of October 31, 2009.





A
material weakness is a deficiency, or combination of deficiencies, in internal
control over financial reporting, such that there is a reasonable possibility
that a material misstatement of our annual or interim consolidated financial
statements will not be prevented or detected on a timely basis.





Notwithstanding
the material weakness mentioned above, management has concluded that the
consolidated financial statements included in this annual report present fairly,
in all material respects, the Company’s financial position as of October 31,
2009 and 2008, and its results of operations and cash flows for each of the
three years ended October 31, 2009, in conformity with U.S. GAAP.





Ernst
& Young LLP, a registered public accounting firm has audited the
consolidated financial statements of MDS for the fiscal year ended October 31,
2009, has also issued a report on the Company’s consolidated financial
statements and internal control over financial reporting under Auditing Standard
No. 5 of the Public Company Accounting Oversight Board (United
States).  A copy of their reports dated January 25, 2010 are included
on pages 41 and 42 of the Consolidated Financial Statements.





Changes
in internal control over financial reporting


During
fiscal 2009, our Board of Directors formed a Special Committee to review
strategic alternatives to enhance shareholder value. Based on the results of
this review, we sold Phase II-IV and Central Labs and announced our intention to
sell Early Stage. We also announced that we have entered into an agreement to
sell MDS Analytical Technologies.





The
strategic repositioning plan, combined with other demands related to the impact
of the economic downturn and the unexpected and prolonged shutdown of the AECL
NRU reactor, was expected to create substantial demands on management in terms
of workload and time constraints and increase the overall risk of being able to
maintain effective internal control over financial reporting. In anticipation of
these demands and to help mitigate these risks, we implemented a series of
actions designed to strengthen year-end disclosure controls and procedures and
to help maintain effective internal control over financial reporting. These
actions included hiring of additional resources, weekly status meetings for
finance and senior management, implementation of cross-functional project
management disciplines, expanded use of external experts to support due
diligence, carve-outs, and complex accounting and tax matters, development of
new processes related to divestiture accounting, and new oversight controls,
including enhanced analytics related to discontinued operations and continuing
operations. Despite these efforts, management of MDS has concluded that the strategic
repositioning plan and its associated technical complexities and volume of work
created a combination of deficiencies which were deemed a material weakness and
that the Company’s internal control over financial reporting was not effective
as of October
31, 2009.





To
address the material weakness identified as of October 31, 2009, management has
subsequently implemented several measures to remediate these identified control
deficiencies.  These actions include further strengthening of the
design of internal controls over complex and non-routine transactions, and the
augmentation of tax resources with additional external support. Although we
believe that the reported material weakness is narrow in scope, we intend to
continue our efforts to strengthen and enhance our disclosure controls and
procedures and internal control over financial reporting on an ongoing
basis