3. Changes in Accounting Policies The Company adopted the Canadian Institute of Chartered Accountants (CICA) Handbook Sections 1530, “Comprehensive Income"; 3855, “Financial Instruments - Recognition and Measurement"; 3861, Financial Instruments - Disclosure and Presentation” and 3865, “Hedges” on November 1, 2006. The adoption of these new standards resulted in changes in the accounting for financial instruments and hedges, as well as the recognition of certain transition adjustments, that have been recorded in opening accumulated comprehensive income as described below. The comparative interim consolidated financial statements have not been restated. With the adoption of these standards, the Company’s accounting for financial instruments is now largely harmonized with US GAAP for this area. The principal changes in the accounting for financial instruments and hedges due to the adoption of these accounting standards are described below. (a) Comprehensive Income Comprehensive income is composed of the Company’s net income and other comprehensive income. Other comprehensive income includes unrealized exchange gains and losses on translation of self-sustaining foreign operations, translation gains and losses resulting from the application of US dollar reporting, unrealized gains and losses on translation of debt designated as a hedge, and changes in the fair market value of derivative instruments designated as cash flow hedges, net of applicable income taxes. The components of comprehensive income are disclosed in the consolidated statement of comprehensive income. (b) Financial Assets and Financial Liabilities Under the new standards, all financial instruments are classified into one of the following five categories: held-for-trading, held-to-maturity investments, loans and receivables, available-for-sale financial assets or other financial liabilities. All financial instruments, including derivatives, are included on the consolidated statement of financial position and are measured at fair value except for loans and receivables, held-to-maturity investments and other financial liabilities which are measured at amortized cost. Held for trading financial investments are recorded at cost as they are initiated and are subsequently measured at fair value and all gains and losses are included in net income in the period in which they arise. Available-for-sale financial instruments are also initially recorded at cost and are subsequently measured at fair value with revaluation gains and losses included in other comprehensive income until the instrument is disposed, derecognized, or impaired. As a result of the adoption of these standards, the Company has classified its cash and cash equivalents as held-for-trading. Short-term investments are classified as available-for-sale investments. Accounts receivable, and long-term note receivables are classified as loans and receivables. The financial instrument pledged as security on long-term debt is classified as a held-to-maturity investment. Accounts payable, long-term debt and capital lease obligations have been classified as other financial liabilities, all of which are measured at amortized cost. (c) Derivatives and Hedge Accounting Derivatives ----------- All derivative instruments, including embedded derivatives, are recorded in the statement of financial position at fair value unless exempted from derivative treatment as a normal purchase and sale. All changes in their fair value are recorded in income unless cash flow hedge accounting is used, in which case the changes in fair value associated with the effective portions of the hedge is recorded in other comprehensive income. The Company has elected to apply this accounting treatment for all embedded derivatives in host contracts entered into on or after November 1, 2003. The impact of the change in the accounting policy related to embedded derivatives was not material. Hedge Accounting ---------------- At the inception of a hedging relationship, the Company documents the relationship between the hedging instrument and the hedged item, as well as the risk management objectives and strategy for undertaking various hedge transactions. This process includes linking all derivatives to specific assets and liabilities on the consolidated statement of financial position or to specific firm commitments or forecasted transactions. The Company also assesses, both at the inception of the hedge and on an ongoing basis, whether the derivatives that are used are effective in offsetting changes in fair values or cash flows of hedged items. Under the previous standards, derivatives that met the requirements for hedge accounting were generally accounted for on an accrual basis. Under the new standards, all derivatives are recorded at fair value. All gains and losses from changes in the fair value of derivatives not designated as a part of a hedging relationship are recognized in the statement of income. These gains and losses are reported in other income (expense). When derivatives are designated as hedges, the Company classifies them either as: (i) hedges of the change in fair value of recognized assets or liabilities or firm commitments (fair value hedges); (ii) hedges of the variability in highly probable future cash flows attributable to a recognized asset or liability, or a forecasted transaction (cash flow hedges); or (iii) hedges of net investments in a foreign operation (net investment hedges). Cash flow hedge --------------- The Company operates globally, which gives rise to risks that its earnings and cash flows may be adversely impacted by fluctuations in foreign exchange rates. The Company enters into foreign currency forward contracts and foreign currency option contracts to hedge foreign exchange exposures on anticipated sales. The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges is recognized in other comprehensive income. Any gain or loss in fair value relating to the ineffective portion is recognized immediately in the statement of income in other income (expense). Amounts accumulated in other comprehensive income are reclassified to the statement of income in the period in which the hedged item affects income. When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge accounting, any cumulative gain or loss existing in other comprehensive income at that time remains in other comprehensive income as long as the forecasted transaction is still probable of occurring and would be recognized in the statement of income in the period the hedged transaction impacts income. When a forecasted transaction is no longer expected to occur, the cumulative gain or loss that was reported in other comprehensive income is immediately transferred to the statement of income. Upon adoption of the new standards, the Company recorded a net increase in derivatives assets included in accounts receivables of $1 million designated as cash flow hedges and an increase of $1 million pre-tax in accumulated other comprehensive income. Net investment hedges --------------------- Hedges of net investments in foreign operations are accounted for in a manner that is similar to cash flow hedges. Any gain or loss on the hedging instrument relating to the effective portion of the hedge is recognized in other comprehensive income. The gain or loss relating to the ineffective portion is recognized immediately in the statement of income. Gains and losses accumulated in other comprehensive income are included in the statement of income upon the repatriation, reduction or disposal of the investment in the foreign operation. The adoption of the new standards resulted in the reclassification of $347 million previously recorded in the foreign currency translation adjustment account to opening accumulated comprehensive income. The carrying value, which equals the fair value of financial assets and liabilities as at July 31, 2007 is summarized as follows: ------------------------------------------------------------------------- Classification ------------------------------------------------------------------------- Held-for-trading $ 224 Held-to-maturity 42 Loans and receivables 383 Available-for-sale 90 Other liabilities $ 797 ------------------------------------------------------------------------- (d) Measurement Uncertainty To determine the assets held for sale related to those operations classified as discontinued operations, we are required to make estimates and assumptions that affect the reported amounts of these assets and liabilities and, therefore, these amounts are subject to measurement uncertainty. (e) Future Changes in Accounting Policies Capital Disclosures The CICA issued a new accounting standard, Section 1535 - Capital Disclosures, which requires the disclosure of both qualitative and quantitative information that enables users of financial statements to evaluate the entity’s objectives, policies and processes for managing capital. This new standard is effective for the Company beginning November 1, 2007. Financial Instruments The CICA issued two new accounting standards, Section 3862 - Financial Instruments - Disclosures, and Section 3863, Financial Instruments - Presentation, which apply to interim and annual financial statements relating to fiscal years beginning on or after October 1, 2007. The Company intends to adopt these new standards effective November 1, 2007. Accounting for Transaction Costs of Financial Instruments Classified Other than as Held for Trading On June 1, 2007, the EIC issued EIC-166, Accounting Policy Choice for Transaction Costs, which allows an entity the accounting policy choice of recognizing all transaction costs in net income or adding to the initial carrying cost those transaction costs that are directly attributable to the acquisition or issue of the financial instrument for all similar financial instruments other than those classified as held for trading. The guidance is effective beginning November 1, 2007. The new guidance is not expected to have a material effect on the financial position or earnings of the Company. 4. Accumulated Other Comprehensive Income The accumulated balances related to each component of other comprehensive income, net of income taxes are as follows: As at July 31, 2007 ------------------------------------------------------------------------- Accumulated other comprehensive income, net of income taxes ------------------------------------------------------------------------- Unrealized gains on derivatives designated as cash flow hedges $ 2 Unrealized gains on translation of debt designated as a hedge 129 Foreign currency translation (losses) on self-sustaining foreign operations (176) Unrealized gain on translation resulting from the application of US dollar reporting 394 ------------------------------------------------------------------------- Accumulated other comprehensive income balance as at July 31, 2007 $ 349 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Income tax liabilities related to the above components of accumulated other comprehensive income for unrealized gains on derivatives designated as cash flow hedges and unrealized gains on translation of debt designated as a hedge are $2 million and $24 million, respectively. 5. Share Capital and Stock Options The following table summarizes information on share capital and stock options and related matters as at July 31, 2007: (number of shares in thousands) Number Amount ------------------------------------------------------------------------- Common shares Balance as at October 31, 2006 144,319 $ 572 Issued during the period 1,051 18 Repurchased during the period (22,831) (91) ------------------------------------------------------------------------- Balance as at July 31, 2007 122,539 $ 499 ------------------------------------------------------------------------- ------------------------------------------------------------------------- During the second quarter, the Company repurchased and cancelled 22,831 Common shares, under the terms of a substantial issuer bid. In the financial statement for the second quarter the share capital reduction associated with the share repurchase was incorrectly reported using the average exchange rate for April instead of the weighted average historic rate applicable to share capital. Correction of this reporting error resulted in an increase in US dollar reported share capital of $32 million and a corresponding reduction in other comprehensive income translation gains resulting from the application of US dollar reporting. Average Exercise (number of shares in thousands) Number Price ------------------------------------------------------------------------- Stock options Balance as at October 31, 2006 5,850 C$ 18.76 Activity during the period: Granted 1,223 C$ 21.73 Exercised (942) C$ 16.45 Cancelled or forfeited (517) C$ 20.34 ------------------------------------------------------------------------- Balance as at July 31, 2007 5,614 C$ 19.65 ------------------------------------------------------------------------- ------------------------------------------------------------------------- There were 3,266 stock options exercisable as at July 31, 2007. 6. Acquisition of Molecular Devices Corporation On March 20, 2007, the Company completed a tender offer which resulted in MDS acquiring 100% of the shares of Molecular Devices Corporation (MD), a California-based company with global operations. MD designs, develops, manufactures, sells and services bioanalytical measurement systems that accelerate and improve drug discovery and other life sciences research. The Company acquired MD primarily to add their leading-edge products to those of MDS Sciex to strengthen MDS’s position as one of the top global providers of analytical instrumentation and related products marketed to life sciences customers. The operations for this acquisition are reported within the results of the Company’s newly formed MDS Analytical Technologies segment (which combines MD with the previous Instruments segment) in the consolidated financial statements from the acquisition date. The aggregate purchase consideration (net of cash acquired of $21 million) was approximately $601 million paid in cash from existing cash on hand. Included in the consideration is the cash cost of $27 million to settle all outstanding in-the-money options of MD at the closing date of the acquisition. Direct and incremental third party acquisition costs associated with the acquisition were approximately $8 million. The acquisition has been accounted for as a purchase in accordance with CICA Handbook Section 1581 “Business Combinations” and the Company has accordingly allocated the purchase price of the acquisition based upon the preliminary fair values of the assets acquired and liabilities assumed. During the quarter, the Company revised the allocation of the purchase price. The impact of the revision was to decrease net tangible assets acquired by $35 million, increase developed technology by $50 million, decrease in-process research and development by $11 million, and decrease goodwill by $6 million. The purchase price and related allocations have not been finalized and may be revised as a result of adjustments made to the purchase price as additional information becomes available regarding liabilities incurred and revisions are made to preliminary estimates of fair values made at the acquisition date. In connection with determining the fair value of the assets acquired and liabilities assumed, management performed assessments of intangible assets using customary valuation procedures and techniques. The components of the preliminary purchase price allocation for the acquisition cost of MD are as follows: ------------------------------------------------------------------------- Consideration and acquisition costs: Cash and payments, net of cash acquired $ 593 Transaction costs 8 ------------------------------------------------------------------------- Net consideration and acquisition costs $ 601 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Allocation of purchase price Net tangible assets acquired $ 15 Intangible assets acquired: Developed technologies 161 Brands 60 Goodwill (non-tax deductible) 365 ------------------------------------------------------------------------- Total purchase price $ 601 ------------------------------------------------------------------------- ------------------------------------------------------------------------- The following table summarizes the components of the net tangible assets acquired at fair value: ------------------------------------------------------------------------- Inventories $ 40 Property, plant and equipment 12 Other assets and liabilities, net (37) ------------------------------------------------------------------------- Net tangible assets acquired $ 15 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Other assets and liabilities include $26 million of net future tax liabilities. Net tangible assets acquired include a charge of $7 million to eliminate redundant positions and consolidate redundant facilities at MD over the course of the next year. The developed technologies will be amortized over their estimated lives, which are between five and seven years, while the brands have an indefinite life and are not amortized. The acquisition of MD has added $6 million of annual commitments related to operating leases and $14 million of inventory purchase commitments in 2007. 7. Sale of Canadian Diagnostics Business and Discontinued Operations In 2005, The Board of Directors of the Company approved a strategic plan to focus the Company on its life sciences businesses and to close or divest of businesses that were not strategic to this plan. As a result, the Company had reclassified its Canadian diagnostics business as discontinued operations. On February 26, 2007, the Company completed the sale of its Canadian diagnostic services business to Borealis Infrastructure Management Inc. for gross proceeds of C$1.325 billion. The 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 US$988 million comprising $929 million in cash and $65 million in an unconditional non-interest bearing note payable in March 2009. This note was recorded at an effective interest rate of 4.4% and had a book value of $59 million. Included in income from discontinued operations, the Company recorded a net gain of US$791 million on the transaction. As a result of the sale, MDS sold $84 million in net assets consisting of: ------------------------------------------------------------------------- Accounts receivable $ 31 Property, plant and equipment 27 Long-term investments and other 18 Goodwill 57 Accounts payable and accrued liabilities (25) Long-term debt and other long-term obligations (24) ------------------------------------------------------------------------- Net assets $ 84 ------------------------------------------------------------------------- ------------------------------------------------------------------------- The results of discontinued operations in the quarter and the nine-months ended July 31 were as follows: Three months Nine months to July 31 to July 31 ------------------------------------------------------------------------- 2007 2006 2007 2006 ------------------------------------------------------------------------- Net revenues $ - $ 82 $ 95 $ 280 Cost of revenues - (49) (57) (180) Selling, general and administration - (11) (15) (38) Depreciation and amortization - (2) - (7) Restructuring charges - - - (1) Equity earnings - 1 1 2 ------------------------------------------------------------------------- Operating income - 21 24 56 Gain on sale of discontinued operations (1) - 904 24 Dividend and interest income - - 1 1 Income taxes - (3) (117) (9) Minority interest - net of tax - (2) (4) (7) ------------------------------------------------------------------------- Income (loss) from discontinued operations - net of tax $ (1) $ 16 $ 808 $ 65 ------------------------------------------------------------------------- Basic earnings per share $ (0.01) $ 0.11 $ 5.99 $ 0.45 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Diluted earnings per share $ (0.01) $ 0.11 $ 5.98 $ 0.45 ------------------------------------------------------------------------- ------------------------------------------------------------------------- The results from discontinued operations for 2007 reflect only the Canadian diagnostic services business. The results from discontinued operations for 2006 include results from the Canadian diagnostic services business and certain small MDS Pharma Services businesses discontinued in 2005. In accordance with Section 3475 of the CICA Handbook, long-lived assets classified as held for sale are measured at the lower of carrying value and fair value less costs to sell. Assets held for sale and liabilities related to assets held for sale comprised: As at As at July October 31 2007 31 2006 ------------------------------------------------------------------------- Assets held for sale Accounts receivable $ - $ 31 Inventories - 3 Prepaid expenses and other - 3 Property, plant and equipment - 28 Future tax asset - 63 Long-term investments and other 1 13 Goodwill - 54 Intangibles - 1 ------------------------------------------------------------------------- Total assets held for sale 1 196 Less: Current assets held for sale(1) (1) (196) ------------------------------------------------------------------------- Long-term assets held for sale $ - $ - ------------------------------------------------------------------------- ------------------------------------------------------------------------- Liabilities related to assets held for sale Accounts payable and accrued liabilities $ - $ 33 Income taxes payable - - Long-term debt - 4 Other long-term obligations - 6 Future tax liabilities - 55 Minority interest - 16 ------------------------------------------------------------------------- Total liabilities related to assets held for sale - 114 Less: Current liabilities related to assets held for sale(1) - (114) ------------------------------------------------------------------------- Long-term liabilities related to assets held for sale $ - $ - ------------------------------------------------------------------------- ------------------------------------------------------------------------- (1) Assets held for sale and liabilities related to assets held for sale have been classified as current as the Company had signed agreements where such assets were expected to be disposed of within one year. 8. Research and Development Three months Nine months to July 31 to July 31 ------------------------------------------------------------------------- 2007 2006 2007 2006 ------------------------------------------------------------------------- Gross expenditures $ 21 $ 13 $ 50 $ 38 Investment tax credits (1) (1) (3) (6) Recoveries from partners (6) (5) (17) (17) Development costs deferred (5) (2) (9) (4) ------------------------------------------------------------------------- Research and development expense $ 9 $ 5 $ 21 $ 11 ------------------------------------------------------------------------- ------------------------------------------------------------------------- For the three months ended July 31, 2007 depreciation and amortization includes $2 million (2006 - $2 million) related to equipment used for research and development, and $2 million from amortization of deferred development costs (2006 - $1 million). For the nine months ended July 31, 2007 depreciation and amortization includes $4 million (2006 - $5 million) related to equipment used for research and development and $5 million (2006 - $4 million) from amortization of deferred development costs. 9. Restructuring An analysis of the activity in the provision through July 31, 2007 is as follows: Cumulative drawdowns Provision ------------------------ Balance at Restructuring July 31, Charge Cash Non-cash 2007 ------------------------------------------------------------------------- 2005: Workforce reductions $ 34 $ (32) $ (1) $ 1 Equipment and other asset write-downs - adjustment 7 - (7) - Contract cancellation charges 10 (2) (8) - ------------------------------------------------------------------------- $ 51 $ (34) $ (16) $ 1 ------------------------------------------------------------------------- 2006: Workforce reductions $ 1 $ (1) $ - $ - Contract cancellation charges (8) (1) 9 ------------------------------------------------------------------------- $ (7) $ (2) $ 9 $ - ------------------------------------------------------------------------- 2007: Workforce reductions $ 21 $ (8) $ (1) $ 12 Equipment and other asset write-downs 5 - (3) 2 Contract cancellation charges 5 (5) - - Other 13 (6) (3) 4 ------------------------------------------------------------------------- $ 44 $ (19) $ (7) $ 18 -------------------------------------------------------------------------
