Toronto, Canada
February 22, 1999

MDS and design, Sciex, ELAN, AutoLab and "Science Advancing Health" are trademarks of MDS Inc.

COMMENT REGARDING COMPARATIVE FIGURES

In this Annual Information Form, all references to specific years are references to the fiscal year ended October 31. All references to "$" or "dollars" are references to Canadian dollars, unless otherwise specified. Amounts for years prior to 1998 have been restated to reflect the Company’s retroactive adoption of the proportionate consolidation method of accounting for its investments in joint ventures. This method of accounting was first adopted for use in 1995. In addition, all per share amounts have been restated to reflect the impact of a two-for-one share split which became effective November 15, 1996.

DOCUMENTS INCORPORATED BY REFERENCE

The following documents are incorporated by reference into this Annual Information Form (the "AIF"):

1. The audited consolidated financial statements of MDS Inc. ("MDS" or the "Company") for the years ended October 31, 1998, October 31, 1997 and October 31, 1996, reported on by Ernst & Young, Chartered Accountants (the "Financial Statements") on pages 36 to 47 of the MDS 1998 Annual Report to its shareholders (the "Annual Report"), and



2. The information contained under the heading "Management Discussion and Analysis" on pages 21 to 35 of the Annual Report.

1 - INCORPORATION

1.1 – Jurisdiction of Incorporation and Articles – Historical Perspective

The Company was incorporated on April 17, 1969 under the laws of the Province of Ontario under the name Medical Data Sciences Limited. The Company changed its name to MDS Health Group Limited in April of 1973 and completed a secondary public issue of shares on April 13, 1973. Following the public issue, the common shares of the Company were listed on the Toronto and Montreal stock exchanges. Since 1979, the Company has been listed only on the Toronto Stock Exchange.

Between 1973 and 1978, Articles of Amendment were filed by the Company, primarily to revise the terms of certain of the Company’s then authorized share capital and to effect the amalgamation of the Company with certain of its subsidiaries. The Company was continued under the Canada Business Corporations Act on October 10, 1978, and on October 31 of that year the Company was amalgamated with several of its smaller subsidiaries.

On September 17, 1980, shareholders of the Company approved certain changes to the capital structure of the Company, resulting in new authorized share capital. The new capital structure included an unlimited number of both convertible Class A Common Shares and Class B Non-voting Shares. Holders of Common shares received one Class A Common share and one Class B Non-voting share for each MDS Common share then held. These two classes of share remain the sole forms of authorized capital of MDS. All other classes of shares created at that time or subsequently have since been cancelled.

On March 6, 1990, take-over bid provisions were added to the Class B Non-Voting Shares. In the event a take-over bid (as defined under applicable legislation) is made in respect of the Class A Common Shares, and holders of more than 50% of the Class A Common Shares accept the offer, the holders of the Class B Non-Voting Shares will be allowed to participate equally with the holders of the Class A Common Shares. This will be accomplished by providing the holders of the Class B Non-Voting Shares in such circumstances with the right to convert their Shares into Class A Common Shares on a one-for-one basis. Any Class B Non-Voting Shares so converted are required to be tendered pursuant to the bid, subject to the usual rights of withdrawal. In the event of liquidation, dissolution or winding up of the Company, the Class A Common Shares rank equally with the Class B Non-Voting Shares and will receive distributions equally with Shares of other such classes on a share-for-share basis.

The Class A Common Shares and the Class B Non-Voting Shares have been split on a two-for-one basis three times, on the following dates: July 13, 1983; March 15, 1990; and, November 15, 1996. The Company changed its name to MDS Inc. on November 15, 1996.

The head office of MDS and its principal place of business is located at 100 International Boulevard, Toronto, Ontario, Canada, M9W 6J6.

1.2 – Corporate Structure

The more significant operating subsidiaries of the Company are as follows (all are 100%-owned subsidiaries of MDS and are incorporated in Canada unless noted otherwise):

• MDS Nordion Inc. ("Nordion");
• Theratronics International Limited ("Theratronics"), a company in which MDS acquired a 100% interest during 1998;
• MDS Ingram & Bell Inc. ("I&B");
• Panlabs International, Inc. ("Panlabs"), a Washington corporation ;
• Harris Laboratories, Inc. ("Harris"), a Nebraska corporation;
• Matrx Medical Inc. ("Matrx"), a Delaware corporation; and,
• Bow Valley Diagnostic Services Inc. ("Bow Valley"), an Alberta corporation;
• Pharmaceutical Development Services, Inc. operating as MDS Tricon ("Tricon"), a Florida corporation;
• Analytical Solutions, Inc. ("ASI"), a California corporation.

MDS Nordion Inc. is the sole shareholder of Nordion Europe sa ("NESA"), a company incorporated under the laws of Belgium. MDS Ingram & Bell is a 50% shareholder in Source Medical Corporation ("Source"), a Canadian company. Bow Valley owns an indirect 28% interest in Calgary Laboratory Services ("CLS"), an Alberta partnership.

In addition to the incorporated subsidiaries listed above, the Company also conducts business through the following significant partnerships:

• Metro-McNair Clinical Laboratories L.P. ("Metro"), a limited partnership established under the laws of British Columbia in which MDS holds a 75% interest;
• Perkin-Elmer Sciex Instruments ("PE/Sciex"), a partnership established under the laws of Ontario in which MDS holds a 50% interest;
• International Reference Laboratories ("IRL"), a joint venture formed under the laws of the State of Georgia in which MDS holds a 50% interest.

The entities outlined above are consolidated in the financial statements of MDS and are referred to hereafter as subsidiaries, with the exception of PE/Sciex which is accounted for on a proportionately consolidated basis. In addition, the Company’s indirect interests in CLS and Source are also proportionately consolidated.

In addition to its subsidiaries, the company has significant influence over and equity accounts for a number of laboratory businesses, the most significant of which is a 14.5% interest in Dynacare Kasper Medical Laboratories, an Alberta partnership. Finally, the Company’s 38% interest in each of MDS Capital Corp. and MDS Health Ventures Inc. (which are described in more detail later in this document) are also accounted for on an equity basis.

Throughout this document, "MDS" or "the Company" will refer to MDS Inc. together with its subsidiaries, unless the context indicates otherwise.

2 – GENERAL DEVELOPMENT OF THE BUSINESS

2.1 – Overview

MDS is the largest health and life sciences company in Canada with 1998 revenues of $1.0 billion. MDS is focused on providing technology-based solutions to its customers to help them improve the health and well-being of people. Customers include providers of health care such as hospitals, physicians, and other medical facilities, and manufacturers of health-related products such as pharmaceutical companies, biotechnology companies, and manufacturers of medical devices. The services and products of the Company are designed to assist customers to lower costs and improve the safety and efficacy of their products and services.

Health Segment

Since its inception, clinical laboratory services have been a primary business focus of the Company. Prior to 1987, MDS operated clinical laboratories in Ontario and New York State. In 1987 the Company acquired a 50% interest in Metro and in 1990 the Company acquired 100% of Bow Valley, expanding the laboratory operations to all provinces west of Quebec. In 1990, MDS acquired the Quebec, Saskatchewan, and New York State operations of Cybermedix, Inc. MDS subsequently sold its U.S. laboratory operations in 1992. More recently, the Company has re-entered the U.S. clinical laboratory market as a partner in several laboratory joint ventures, bringing laboratory management and process improvement skills to these joint ventures.

In 1986, MDS acquired a 49% interest in Ingram & Bell Inc., a medical supply manufacturing and distribution company, broadening the products and services offered to health care providers. This interest was increased to 100% in 1993. Effective October 1, 1997, I&B and Allegiance Healthcare Canada Inc., the Canadian subsidiary of Allegiance Healthcare Corporation, merged their respective Canadian health care product distribution businesses to form Source Medical Corporation. The medical product manufacturing business remains part of I&B.

Life Sciences Segment

With the acquisition of Sciex in 1981, MDS broadened its operations into analytical instruments.

In 1992, MDS acquired an initial 83% interest in Nordion International Inc. from the Canadian Development Investment Corporation pursuant to a privatization initiative by Atomic Energy of Canada Limited, thereby expanding its operations into medical isotope manufacturing and distribution. During 1995, the Company increased its ownership interest in Nordion when it purchased a minority stake then owned by Amersham International, plc. During 1998 MDS expanded into isotope-based radiation therapy with the May acquisition of 100% of Theratronics.

In 1995, MDS began acquiring contract pharmaceutical research organizations and expanded the services offered to the pharmaceutical development industry. Acquisitions included the purchase of Panlabs in 1995, and Harris and Neo-pharm in 1996. Further expansion in this field occurred in 1998 and the Company acquired and began operation of a formulations facility in Florida operating under the name MDS Tricon. Also, on October 30, 1998, MDS acquired 100% of ASI to increase the size and scope of its bioanalytical laboratory services.

Customers

The Company’s Life Sciences segment customers include a broad range of manufacturers of medical products including pharmaceutical manufacturers, biotechnology companies, and manufacturers of medical supplies and devices. These customers are located in essentially all major international markets. In the Health segment in Canada, the Company provides products and services directly to health care providers including physicians and hospitals. In the United States the Company operates through a series of joint venture agreements with individual hospitals and hospital networks to provide laboratory management services to local hospitals. No single customer accounts for more than 10% of revenues. The Ontario Ministry of Health, in its capacity as the funding body for the Ontario public health insurance programme, funds approximately 15% of total revenues.

Over the past three years, exports from Canada have comprised approximately 27% of total revenues and for 1998 accounted for $271 million in revenues. Export revenues, combined with revenues earned by operating units based outside of Canada, made up 50% of net revenues for the year.

Employees

As at October 31, 1998, MDS had approximately 7,100 employees in nine countries around the world.

2.2 – Recent Industry Developments

MDS has benefited from the significant and rapid changes which are affecting the health care and life sciences industry in Canada and elsewhere. These changes include:

1. rising health care costs;
2. intensifying cost containment pressures within the health care envelope;
3. rapid growth in demand for services due to ageing population bases;
4. rapid innovation in technology, increasing the availability of sophisticated treatment options;
5. growing consumer awareness of health care choices;
6. changing funding responsibilities as governments drive more of the costs of health care to consumers and their health insurance companies;
7. growing awareness within emerging and developing countries of the benefits of adequate health care systems.

As a result of these changes, the balance of power within the health care and life sciences industry has shifted. The resulting competition for market dominance and control of the industry has played out differently in different jurisdictions. In Canada, the reduced level of federal government funding has left increased responsibility for policy development in the hands of provincial governments. Health care funding provided by provincial governments has generally not kept pace with the rising cost structure and growing demand for services. This has led to increased emphasis on the cost effective of services and caused service providers to pursue more cost efficiency in their operations. In addition, the delisting of some health care services under provincial health care plans has, in turn, shifted increased responsibility in certain areas back to consumers and direct providers.

In the United States, the role of government has been increasing and, government now accounts for nearly one-half of the nation’s health care expenditures. Focus on government spending in the U.S. is having much the same effect as it did in Canada and health care providers are becoming far more focused on cost efficiency and cost effectiveness. At the same time, health management organizations are playing an increasingly important role in treatment decisions and the cost and effectiveness of a treatment now play an important role in determining a treatment strategy. The industry has seen continued consolidation of payers and providers, including hospital groups and others, and economic power within the health care market is becoming further concentrated.

This is resulting in new roles for market participants in both countries. The increased importance of productivity improvements and efficiencies has created new opportunities for value creation and has opened new business opportunities for those suppliers who are able to adapt quickly to the changing needs of their customers.

The explosion of new technologies has profoundly affected the life sciences and health markets. In recent years, the pharmaceutical industry has seen a wave of corporate mergers, and consolidation of this industry is expected to continue. Simultaneously, advances in biotechnology and genomics have created new opportunities in pharmacology. Smaller biotechnology companies are also seeking new leads from the results of the research in these fields. The explosion in development activity, coupled with a drive to reduce costs and accelerate development time, is driving a boom in outsourcing of research activities by pharmaceutical manufacturers. The advent of high throughput screening, accompanied by the technologies which make this possible, increases the number of new drug leads that can be investigated, enabling drug companies to identify promising candidates earlier. More importantly, researchers can eliminate unpromising candidates before large investment is made in further development.

These new technologies, and others which appear to be nearing fruition, are expected to lead to significant advances in diagnosis and treatment of disease. Better drugs, delivered more quickly and at a lower cost, will be one outcome of these advances. In addition, these technologies are expected to lead to better diagnosis at an earlier disease stage, which will in turn lead to more effective treatment. A number of new developments also promise better disease prevention alternatives. Improved patient outcomes at a lower overall cost continue to be the goal.

2.3 – Business Strategy of MDS

MDS’s business strategy is to be positioned to take advantage of emerging opportunities in markets where the Company has either an established base of involvement or strong scientific and technical capabilities which are consistent with the needs of our customers.

The goal of the Company is to be a leading provider of products and services in selected markets, including:

• drug discovery and development products and services such as analytical instruments and contract research;
• diagnostic services including automation and management of clinical laboratories and development of emerging diagnostic methods and tools;
• isotope products and services including sterilization, radioisotopic production and distribution radiopharmaceuticals, and radioisotope-based cancer therapies;

Increasingly, technological leadership will be the main method of differentiation amongst participants in these markets. MDS invests significantly in research and development and in capital equipment to ensure its competitive edge. In 1998, the Company invested $33 million in research, product development, and innovative business initiatives. The Company invested a further $94 million in capital assets.

MDS also believes that business alliances, such as joint ventures and similar entities, are becoming increasing accepted as an effective and responsive organizational form for pursuing business objectives. Alliances that bring together the complementary capabilities of two or more companies may provide the best solutions to customers of the future. The ability of market participants to develop such alliances and to manage them successfully will be a key success factor for future growth. MDS is building on the success of its well-established partnerships such as Metro-McNair and joint ventures with The Perkin-Elmer Corporation and at MDS Hudson Valley Laboratories and establishing new partnerships in areas of its business not traditionally managed in this way. These include Source Medical Corporation, Toronto Medical Laboratories, and U.S.-based hospital joint ventures such as those with Columbia/HCA.

2.4 – Financial and Other Developments

Factors affecting the comparability of financial data for the years 1994 through 1998 (in addition to those factors disclosed in the Notes to the Selected Consolidated Financial Information) include the following:

Capital Structure

• In March 1996, the Company raised $44 million (net of share issue costs) from the sale of 4 million Class B Non-Voting Shares.
• On October 30, 1996, the shareholders of the Company approved a two-for-one share split of the Class A Common Shares and Class B Non-Voting Shares, which became effective on November 15, 1996.

Acquisitions

• During 1994, the Company purchased several environmental testing businesses, increased its ownership in an existing environmental subsidiary and acquired an interest in a small medical laboratory for total cash consideration of $4.9 million.
• During 1995, the Company acquired the 14% interest in Nordion formerly held by Amersham International plc for $17.6 million cash. The purchase price was equal to the net tangible assets acquired.
• During 1995, the Company acquired a medical laboratory and Panlabs International, Inc. for $37.3 million, including cash consideration of $35.7 million and a promissory note for $1.6 million. The above acquisitions resulted in $6.5 million of goodwill.
• During 1996, the Company acquired Harris Laboratories, Inc., Neo-pharm Laboratories Inc., a laboratory operation, a supplier of specialty medical equipment and the 20% of the shares of Matrx Medical Inc. which it did not already own. In addition, the Company exercised an early settlement option on its earn-out obligation under the 1995 purchase agreement for Panlabs. Total consideration for these acquisitions was $82.2 million, comprising long-term debt of $12.4 million and cash of $69.8 million. Goodwill of $49.5 million was recorded on these transactions. Under the terms of certain of the purchase agreements, amounts up to $24 million may be paid based on future earnings of the companies, as defined, for the period October 1, 1996 to October 31, 1999. The amount and timing of the contingent consideration are not readily determinable at this time and have not, therefore, been reflected in the accounts.
• During 1997, the Company acquired the 65% of the shares of AutoMed Corporation which it did not already own and 100% of Neurotech sa for total consideration of $7.2 million, comprising cash and long-term debt.
• During 1998, the Company acquired 100% of Theratronics and 100% of Analytical Solutions, Inc., in addition to a small, Ontario-based clinical laboratory. The total cost of these acquisitions was $26.2 million, comprising cash and the assumption of certain existing long-term debt.

Divestitures

• During 1995 and 1996, Nordion sold its European in-vivo distribution and in-vitro manufacturer operations to allow management to focus on its continuing European radiochemical and radiopharmaceutical manufacturing and distribution operations.
• Effective May 13, 1997, the Company disposed of its environmental testing business for total consideration of $7.4 million, including cash of $4.4 million and a long-term note receivable.
• During 1998, the Company completed the disposition of two non-strategic operating units in transactions which produced $9.8 million of proceeds. No significant gain or loss was realized as a result of these disposals.

Other Matters

• During the third quarter of 1996, the Government of Canada, Atomic Energy of Canada limited and the Company, and its subsidiary Nordion, reached an agreement to build two specialized reactors to ensure a stable long-term supply of medical isotopes. The agreement culminated several years of negotiation and protects Nordion’s worldwide leadership position in nuclear medicine. Construction of these new reactors commenced during the second quarter of 1997. The Government of Canada is providing MDS with a $100 million non-interest-bearing loan to fund a portion of the construction costs. Since 1997, the Company has received $36 million under the terms of this loan. Repayment of the loan over a fifteen-year period will commence during the year 2000. To satisfy its future repayment obligation, the Company has pledged a financial instrument having a value at October 31, 1998 of $46 million as security for the loan.
• During 1996, the Company began operating a laboratory partnership with The Toronto Hospital. A number of contracts with other Toronto area hospitals are being negotiated by this new partnership. In addition, the Company has signed laboratory operating agreements with major hospitals in the Niagara region and in other areas of Ontario.
• During 1997, the Company established a partnership with the Calgary Regional Health Authority to manage all laboratory services in the region.
• During 1997, the Company established a joint venture with Columbia/HCA Healthcare Corporation, the largest private hospital network in the united States. The joint venture will initially provide consolidated laboratory services utilizing the Company’s MDS AutoLab technology to Columbia operations in the state of Georgia. Shortly after the year-end, agreement in principle was reached to establish a new site covering Columbia/HCA’s South Florida region.
• During 1998, an agreement was reached with the Ontario Ministry of Health which established new fee schedules for the policy years ended March 31, 1999 and 2000. The new rate schedule includes a 1.5% increase in the basic fees charged for laboratory tests for the two years.
• A second agreement was reached in the year that settled on-going negotiations related to fee adjustments for years up to March 31, 1998. Laboratory operators in Ontario have been faced with increases in testing volumes approaching 10% to 12%. The most significant impact of this increase in testing volumes began in late 1997 and may reflect initiatives launched by Ontario hospitals to curtail laboratory services for non- patients (i.e.: community based referral work). The agreement covering the fee settlement resulted in a retroactive revenue inclusion of $9.1 million for the Company in the second quarter and compensated MDS for testing costs from the incremental volumes seen in late 1997 and early 1998. Management also believes that satisfactory agreements will be reached governing future periods.

3-NARRATIVE DESCRIPTION OF THE BUSINESSES OF MDS

3.1 – Reportable Industry Segments

MDS operates in two business segments: Life Sciences, which includes the development, manufacture, and provision of products and services to manufacturers of medical products; and, Health, which focuses on the provision of services and products to health care providers. Each of these business segments contains a number of separate operating business units which are grouped according to business sectors:

The following table provides information about the relative size and importance of the Company’s business segments:

3.2 – Life Sciences Segment

Life Sciences businesses are those whose primary business is the direct manufacture of medical products or which supply technology, products or services to other companies for use in the manufacture of medical products. Customers of MDS’s Life Sciences businesses include companies involved in the development of pharmaceuticals and biotechnological products, as well as manufacturers of medical products and devices. In all cases, the products or services include a high level of technological sophistication or require significant technical or scientific expertise.

3.2.1 – Drug Discovery and Development Sector

MDS entered the analytical instrumentation business in 1988 with the acquisition of Sciex. In 1995, MDS created its Pharmaceutical Services division to take advantage of the significant opportunities which are believed to exist in drug discovery and contract research outsourcing for drug development companies. These two main lines of business make up the Drug Discovery and Development Sector.

Industry background

During the 1970’s, the majority of research leading up to development of pharmaceutical products was conducted in-house by integrated pharmaceutical companies. At that time, the only significant function which was contracted out was preclinical toxicology screening. The drug development process is extremely expensive due to the cost of infrastructure required to support the full range of processes necessary for drug development and the long period of time required to achieve full regulatory approval of a new compound. On average, it takes 10 to 12 years and over US$500 million to bring a new pharmaceutical from discovery through Phases I to IV of clinical trials and make it available to consumers. Since patent protection for new products extends for only 17 to 20 years, the profitability of a new compound can be greatly enhanced by reducing the total cost of development and by shortening the elapsed period over which development occurs. In an effort to reduce both time and costs, major drug companies began outsourcing portions of the development work to companies that provide research services. These companies have become known as Contract Research Organizations or CRO’s. Individual CROs tend to specialize in particular stages of the drug development process and, therefore, develop expertise in those areas. Reliance on CRO expertise can enable the pharmaceutical companies to achieve cost efficiencies and to shorten the research time for that stage.

The decision by MDS to enter the CRO business was influenced by a number of key trends that affect the industry. The Company believes that cost containment pressures at pharmaceutical companies will continue to lead to downsizing of in-house research and development capabilities and that pharmaceutical companies will focus increasingly on marketing and product distribution. Outside suppliers will increasingly be relied upon to provide services previously secured from in-house departments. Aside from reducing infrastructure costs for the pharmaceutical companies, this initiative is expected to lead to reduced cycle time for development. Outsourcing this activity may also lead to development of drug candidates which have a small market and might have been ignored by larger pharmaceutical companies which require large-market drugs to cover the costs of their marketing and distribution channels.

Globalization of pharmaceutical markets driven by recent mergers of major international pharmaceutical companies, can be expected to influence the selection of a CRO. Those with an international presence and the ability to conduct trials in multiple jurisdictions are expected to be the preferred suppliers. The growth of the biotechnology industry is also influencing the growth of CRO’s, as many biotechnology companies do not have the capability to conduct trials for their products.

A general overview of the drug development process is provided below:

Sector Overview Operating under the name MDS Pharmaceutical Services, MDS provides contract research services to pharmaceutical manufacturers and biotechnology companies, focusing particularly on drug discovery and early-stage drug development (up to phase IIa clinical trials). MDS has provided services to pharmaceutical manufacturers since 1992, beginning as a centralized support laboratory providing testing services in connection with phase III clinical trials. In 1995, MDS identified pharmaceutical development as a major growth area and, through its acquisition of Panlabs International, Inc., established a platform for a new division. The acquisitions of Harris Laboratories, Inc. and Laboratoires Neo-pharm Inc. in 1996 broadened the range of research services offered to customers in the drug development field. In 1998 the services offered by MDS expanded to include formulation and small quantity manufacturing services with the establishment of the MDS Tricon facility in Florida. In addition, the Company’s network of bioanalytical laboratories was increased when Analytical Solutions, Inc. was acquired at year-end. In addition to contract research, MDS also supplies the pharmaceutical industry with an advanced line of high-sensitivity analytical instruments based on the principles of mass spectrometry. under the PE/Sciex brand name, MDS manufactures ultra-trace chemical detection equipment and is Canada's leading manufacturer of analytical instrumentation. Export sales account for more than 95% of revenues from these products. Through a joint venture with The Perkin-Elmer Corporation, one of the world's largest distributors of life sciences products, including analytical equipment, MDS products reach a global market. Within the joint venture relationship, MDS is primarily responsible for the design, development, and manufacture of instrumentation targeted towards the detection of trace chemicals or elements in a variety of application areas, most notably in the pharmaceutical, biotechnology, environmental and semiconductor industries. MDS has been a major innovator of technologically sophisticated mass spectrometry instrumentation. In each of its product lines, MDS has been a pioneer. Accomplishments include the introduction of the first triple-quad mass spectrometers, inductively coupled plasma mass spectrometers, and techniques for detecting ultra-trace amounts of small or large molecules by atmospheric pressure ionization (electrospray). Most of these products are in the third generation and continue to hold a major share of their market segments. The pharmaceutical and biotechnology markets are the major users of technology based on the principles of liquid chromatography coupled with mass spectrometry (LC/MS) for detecting organic compounds. Early models of this equipment revolutionized many of the processes which were fundamental limitations in the search for new drugs or biotechnology products. productivity improvements continue with the introduction of two new models in 1998. Additional design features include enhanced computer control functions, improved sensitivities and speed. In 1997, Sciex introduced a smaller, lower cost version of these instruments and brought the benefits of the technology to new classes of users. A portion of the Company’s market is outside of the pharmaceutical industry and relies on similar equipment for the detection of inorganic compounds. For this group of customers the Company produces the ELAN Inductively Coupled plasma Mass Spectrometry (ICP/MS) which provides high sensitivity with extremely high specificity for a wide range of elements in the analysis of a single sample. The range of market areas that are addressed with the ELAN is very broad and includes environmental monitoring (drinking and wastewater analysis), toxicology (role of trace metals in human disorders), semiconductors (trace impurities), and the nuclear industry (impurities in uranium). The Company’s Drug Discovery and Development Sector operates facilities in Canada, the United States, Europe, and Asia. Over 1,600 employees work in Drug Discovery and Development at these locations.

Strategy and Competition

MDS is currently one of the top ten CROs in the world. The Company believes it is the only CRO of significant size that is focused on early stage drug development. Management expects to continue to develop its international capabilities as a contract research organization while remaining focused on early stage development activities. The Company is also focused on the leading-edge technologies which are utilized during the development process. Although significant effort and investment will go into integrating and growing existing operating units, selective acquisitions will also be pursued. The acquisition strategy of the Company is to focus on those targets which provide a good fit with the existing continuum of service and technology offerings and a reasonable economic return.

The growth of the contract research industry has been dependent on the increase in outsourcing by major pharmaceutical companies. Competition for individual research contracts often includes in-house service departments of the pharmaceutical company as well as other CROs. Management believes that outsourcing will continue and grow as an economically attractive alternative to in-house research; however, competition from research departments will remain a factor in the industry. The majority of CRO competitors of the Company have been focused primarily on later stages of the drug development process (Phase III to IV). These competitors comprise several multinational companies and include ClinTrials Research, Inc., Quintiles Transnational Corp., Covance, Inc., Parexel International, Corp., IBAH Inc., Phoenix International life Sciences Inc., and Pharmaceutical Product Development, Inc.

The Company’s principal competitors in the analytical instrumentation market include Micromass limited in the United Kingdom (now owned by U.S.-based Watters Corporation), Thermo Instruments Inc. and Hewlett Packard Company in the United States.

Risks

A portion of the revenue earned by the Drug Discovery and Development Sector is under contracts which typically run several months for drug discovery through phase I clinical trials and as much as several years for phase III clinical trials. Terms of most contracts entered into by the Company entitle clients to cancellation rights. Such rights are common to these contracts and may be exercised by the client in the event of regulatory delays or if unexpected results are encountered in an earlier stage of the development programme. Although it is not possible for the Company to predict the occurrence of such delays or cancellations, the Company’s strategy is to mitigate the impact of any such delays by maintaining a broad portfolio of on-going contracts.

During clinical trials testing, the Company will typically administer products owned and developed by others into test subjects. The pharmaceutical customer retains risk related to product failure, including risks related to adverse reactions by test subjects.

Although MDS facilities devoted to pharmaceutical development are not directly subject to significant unusual government regulation, customers of the Company are subject to periodic review by drug approval authorities, principally the Food and Drug Administration in the United States. under the terms of typical CRO contracts, the Company’s customers can request that Company facilities be subjected to the same levels of review by the authorities. The Company meets Good Laboratory Practices ("GLP") standards for its laboratories and Good Clinical Practices ("GCP") standards for its clinic facilities. The Company has never experienced a contract cancellation for failure to meet such standards.

3.2.2 – Isotopes Sector

MDS is a leading manufacturer, marketer and distributor of radioisotope products, supplying a major segment of world demand for its main product categories. The primary uses for radioisotopes processed by MDS are in nuclear medicine (including the production of radiopharmaceuticals and cancer treatment) and in industrial irradiation for microbial control. Exports of these materials to more than 70 countries account for more than 95% of total sales by this sector.

Industry background

Radioisotopes are forms of chemical elements that are radioactive and are not naturally occurring. These elements are produced as byproducts within specially equipped nuclear reactors and within specially designed equipment known as cyclotrons.

In nuclear medical usage these products are desirable because of their ability to show up on x-ray or similar diagnostic procedures. When formulated with chemical compounds that are attracted to or accumulate in particular types of tissue, these isotopes can aid physicians in the identification and treatment of diseases, principally cancers. Certain other radioisotopes can be used to deliver direct radiation therapy to cancerous cells using the same principles.

The principal radioisotopes in use worldwide are:

Molybdenum-99 and iodine-131/125 are produced in reactors. The following isotopes are produced in cyclotrons:

Significant barriers to entry exist in both the medical isotopes and sterilization businesses. The manufacture of raw isotopes is dependent upon the availability of capacity in acceptable types of nuclear reactors and cyclotron time. processing facilities such as those operated by MDS are centralized, capital intensive, and expensive to operate. In addition, due to the nature of the materials handled by the facilities, government and environmental regulation is a significant factor in the business. In addition, processing of raw isotopes into a form which is suitable for the intended use is highly complex. Many isotopes used for nuclear medicine have a limited half-life (the period of time over which the potency of the radioactivity declines by 50%). This imposes constraints on the manufacturing process and on the logistical procedures needed to deliver refined product to an end user. Efficient and safe transportation and logistical systems are vital components of the business. Security of supply is a key customer concern, due to the short life span of the products. Nuclear decay renders some of the products processed by MDS useless in a matter of days and isotopes are processed, delivered to manufacturers and then on to hospitals or treatment centres in only a few days.

Nuclear medicine is a growing market. Ageing populations worldwide are expected to result in increased demand for the procedures which nuclear medicine make possible. In addition, considerable research is underway to identify new uses for existing radioisotopes. These forces are expected to propel the growth of this industry in future.

Industrial irradiation and cobalt-60 marketing are fairly mature industries. Alternative uses for this technology are under investigation. This has led to the development of industrial irradiation of food products. To date, irradiation of food products has largely been limited to certain dry goods such as spices, certain fruits and vegetables, and to poultry. During 1998, the U.S. Food and Drug Administration ("FDA") approved the use of irradiation for microbial control of pathogens (principally e. coli) in red meat. At present there is limited application of these procedures for red meat, however, significant effort is being devoted to promoting this alternative.

Sector Overview

MDS processes and repackages radioisotopes and uses the refined materials to produce products that include:

• radioactive sources for use in sterilization;
• immunochemical reagents and kits for clinical diagnosis and research investigation;
• radioisotopes for use in nuclear medicine; and,
• radioactive sources for the treatment of cancer.

In addition, the Company manufacturers and sells equipment that is used for the application of its radioactive products, including:

• cancer therapy and treatment equipment;
• treatment planning software for cancer therapy;
• sterilization systems and supplies to ensure that disposable medical products are contaminant-free;
• sterilization systems and supplies for use on a wide variety of food products; and
• small-scale irradiators used for research purposes and to treat blood for immuno-compromised patients.

In its industrial irradiation operations, MDS is the world's principal supplier of cobalt-60. Raw cobalt-60 material is produced under long-term supply contracts in nuclear reactors operated by Ontario Hydro and by Hydro Quebec. MDS further processes the raw cobalt-60 (also referred to as a gamma source) for commercial use at its Kanata, Ontario facilities. The resulting processed material is delivered to customers using approved transport containers and procedures. Customers of the industrial division include major sterilization contractors, as well as large medical product manufacturers who maintain their own sterilization capability. Other users include hospitals and alternative sites which use cobalt-60 in cancer treatment applications.

MDS also markets related processing equipment and technology, including industrial scale irradiators and smaller research irradiators. Delivery or construction of this equipment is usually accompanied by an initial shipment (‘loading") of gamma source. Resupply or replenishment of the gamma source is required from time to time as the radioactivity level of the initial loading declines over its half-life.

Isotopes used for nuclear medicine are handled and processed in much smaller quantities than those used for industrial irradiation. Molybdenum-99 and iodine-125 are purchased in an unfinished, non-purified form from Atomic Energy of Canada limited ("AECL"). MDS purifies and packages these products in a form which can be used by pharmaceutical companies as a radioactive tag or identifier on their radiopharmaceutical products. MDS has and is expanding a manufacturing capacity that is utilized on a partnership basis in the development, and later, the direct manufacture of radiopharmaceuticals.

Facilities that are able to handle and process isotopes in the manufacture of radiopharmaceuticals are complex and strictly regulated. Growth of development and manufacturing opportunities is expected to occur as drug manufacturers may not wish to incur the capital cost or regulatory delays associated with building their own facilities. MDS assists developers of new radiopharmaceutical products during the development stage and as a manufacturer. This activity is expected to increase as new products and applications are identified.

Other radioisotopes are used by pharmaceutical companies in the manufacture of radiopharmaceuticals for the treatment of numerous serious disease states. MDS acquires its cyclotron-produced isotopes from facilities located in British Columbia and in belgium. The Company refines these materials at its main processing facility in Kanata and at additional facilities in Vancouver and in belgium. Medical radioisotope products are used in more than 50,000 diagnostic procedures each day such as bone scans and assessment of heart, brain, liver and kidney functions.

During 1998, MDS made a strategic decision to enter the cancer therapy and treatment market with the acquisition of Theratronics. Theratronics manufactures and distributes radiation therapy equipment and related treatment planning software. Cobalt-60 is the radiation source for this equipment.

In 1997, MDS initiated construction of two dedicated isotope reactors. The new facilities will be built by AECL and used exclusively for the production of isotopes for medical purposes. MDS will own the reactors and AECL will operate them on a contract for service basis. These Maple reactors will replace the existing NRU reactor as the principal source of molybdenum-99 and will enable MDS to provide its customers with a stable and secure supply of key medical isotopes. Maple 1 is expected to be completed in 1999, with Maple 2 following in 2000.

The Isotope Sector employs over 800 people at its Kanata, Ontario head office and facilities in British Columbia, Quebec, and Europe. Some technical and production employees of MDS belong to the public Service Alliance of Canada, a collective bargaining agent representing, among others, certain employees of the Government of Canada. Labour relations are judged to be good.

Strategy and Competition

MDS has a leading position as an international supplier of key isotopes. Security of supply is a significant objective for the majority of the Company’s customers. The Company has developed a strong supply and logistics network to meet these demands. Current activity and investment, including the construction of the Maple reactors and processing facility, is intended to solidify the Company’s position as a reliable source of supply. In addition, the Company is developing new and complementary lines of business based on its expertise with isotopes. For example, the cancer treatment market is expected to develop rapidly over the next several years, particularly in emerging economies. Many of these countries are now able to afford modern cancer therapies and are expected to make significant investments in this technology as their health care systems develop.

Partnerships for the development and manufacture of radiopharmaceuticals also represent a significant opportunity. MDS is capable of handling the complex manufacturing processes that are often required. New investment is planned in this area over the next few years.

Significant barriers to entry limit the competition faced by the Company in the medical isotopes market. Since molybdenum-99 is the most significant isotope on world markets, the majority of competition faced by the Company is in this market. Major competitors are Institut National des Radioelements (IRE) of belgium and the Atomic Energy Corporation of South Africa. Other competition, including competition in cyclotron isotopes, is not considered to be significant.

Competition in the cobalt-60 market is different from the medical radioisotopes market due to the substantially different half-life of the products. Cobalt-60 is often bought and sold in large quantities and can be produced by any of several nuclear reactors around the world. While delivery and logistics remain a key advantage which MDS possesses, the most significant competition in industrial irradiation and cobalt-60 supply comes from REVISS of Russia. Competition for sterilization spending also comes from alternative technologies, the most significant of which is e-beam. The Company believes that radiation-based sterilization technologies continue to enjoy advantages over these competitive technologies in some applications. In addition, there is a significant installed based of industrial irradiators which will ensure that industrial irradiation remains a key technology in this market.

Risks

MDS is dependent upon its suppliers (principally Ontario Hydro, Hydro Quebec, and AECL) for its source of supply. Each of these entities is a Crown Corporation and is unionized. because MDS is able to maintain an inventory of cobalt-60, a labour disruption at either Ontario Hydro or Hydro Quebec would not significantly impact the Company’s ability to meet normal customer requirements in the short-term. MDS has taken steps to lessen the risk that a labour disruption will cause an interruption in its source of supply of medical isotopes by establishing co-beneficial back-up arrangements with certain competitors.

The Company has in place facilities and procedures designed to reduce and eliminate the risk of environmental contamination stemming from the processing of raw materials. All Company facilities and government regulated and inspected. The Company also has in place a rigorous maintenance programme to ensure continued compliance with all applicable regulations.

3.3 – Health Segment

Health businesses are those which supply products or services to individuals or institutions which, in turn, provide health care services directly to patients and consumers. Generally, the customers of the Company’s health businesses consist of physicians, hospitals, and similar service providers. Services provided include routine clinical diagnostics, laboratory management, laboratory automation technology, medical product distribution, and inventory management services.

3.3.1 – Diagnostics Sector

MDS is the largest operator of private sector clinical laboratories in Canada. Services provided by the Company include clinical laboratory testing for physicians and non-hospital health care institutions, management of hospital laboratories under contract and other support services for clinical diagnostics. In addition, the Company is developing a growing presence in the united States where it is managing hospital laboratories and directing business improvement and change processes at hospitals through joint venture relationships.

Industry Overview

In Canada, clinical laboratory testing is split roughly 75%/25% between hospital based laboratories and private sector operated community laboratories. Hospital laboratories conduct the majority of in-patient and outpatient testing. In certain provinces hospital laboratories also handle community testing; however in Ontario and British Columbia private sector laboratories handle essentially all community testing. In Alberta, community and hospital testing is managed by regional health authorities and provided by both hospital and community laboratories.

All clinical testing is conducted on samples drawn from patients based on requests received from physicians. Test results are reported back to physicians and are not made available directly to patients. Fees for most testing services (other than those performed in Quebec) are billed to a government health care agency according to a fixed fee schedule, subject in most cases to an overall fee cap.

Although the customers of the laboratory services business are generally physicians and patients, the majority of funding for such services is provided under the terms of provincial health care programmes. Company operations in each province are organized to conform to government payment programmes existing in the relevant province.

In most provinces, operators of clinical laboratories are required to carry licences which determine the nature of tests which can be carried out at each facility and govern the ability of the operator to draw samples for testing purposes. Such licences are for a limited term (generally renewing annually) and their renewal is subject to government approval. In Alberta and Saskatchewan, licences have been replaced by service contracts with regional health authorities which run for various terms through 2002.

Sector Overview

The Company is active in all provinces west of the Maritimes either directly or through joint ventures with approximately 53% of laboratory revenues originating in Ontario. A further 21% originates in British Columbia, 11% in Alberta, and 4% in other provinces. Laboratory revenue from U.S. sources comprised approximately 11% of total laboratory services revenues in 1998. The laboratory business of MDS is carried out through the following types of licensed locations:

Specimen collection centres (SCC) – a location which is licenced to draw samples from a patient but which is not authorized to perform any testing procedures on the samples.

Local laboratories – a location which serves as both an SCC and as a testing facility. Such laboratories do not generally carry full testing approvals and therefore conduct only limited types of tests.

Central laboratories – a location to which all samples collected at SCC’s are sent for testing, along with samples which cannot be tested at local laboratories.

At the end of 1998, MDS operated 230 specimen collection centres, 41 local laboratories, and 5 central laboratories, located from Quebec to British Columbia.

Laboratory fees are generally set provincially, following discussions between the owners of private laboratories and provincial ministry of health officials. In Ontario, the Ontario Association of Medical Laboratories represents private laboratories. Ontario fees have been established under an agreement which runs until March 31, 2000. In British Columbia, the British Columbia Medical Association ("BCMA") negotiates fees on behalf of the laboratories. The current agreement between the BCMA and the British Columbia government runs until March 31, 2000.

In Alberta, the fee-for-service system was replaced by bulk service contracts in each of the 17 regions established by the provincial ministry of health. MDS previously had operations in two of these regions. The Company’s Calgary laboratory operations have been merged with those of a competitor and the Calgary Regional Health Authority’s ("CRHA") hospital laboratory operations to form a partnership known as Calgary Laboratory Services. under an agreement with the CRHA, CLS provides all laboratory services in the Calgary region, including laboratory services provided within hospitals. MDS retains a 26.5% interest in the merged businesses and is the managing partner. In Edmonton, the MDS Stirrat Laboratory organization, along with two competing laboratory firms, merged to form the Dynacare Kasper Medical Laboratories partnership, which has contracted with the Capital Regional Health Authority to provide both hospital and outpatient diagnostic services in the region. MDS owns 14.5% of this limited partnership.

In Saskatchewan, where fee-for-service has also been replaced by a lump sum payment system, MDS has negotiated contracts to provide services to the Regional Health Authority in the delivery of health services in the province.

MDS provides laboratory services in Quebec on a limited basis. Laboratory services in this province are generally provided by hospitals on an outpatient basis. Laboratory services provided by MDS in Quebec are billed directly to patients or physicians and therefore constitute only a small portion of the testing conducted in the province.

In addition to the direct provision of testing services, the Company also provides laboratory management services and manufactures laboratory automation equipment and software. Often these related businesses operate hand in hand. In Canada, the Company has entered into agreements to provide laboratory management services to a number of hospitals and to groups of hospitals, primarily in the Ontario marketplace. These agreements generally provide for a fee-for-service related to the management of a laboratory located within a hospital.

The Company has also entered into direct partnerships with hospitals which combine management of in-house laboratories with construction of a centralized high volume laboratory serving a group of hospitals. MDS currently has three such partnerships, two of which are located in the U.S. (partner indicated in brackets): Toronto Medical Laboratories (The Toronto Hospital); Integrated Regional Laboratories (Columbia/HCA Healthcare Inc. covering hospitals located in Georgia and Florida); and MDS Hudson Valley Laboratories (three New York state hospitals).

The U.S. market is significantly different from Canada. Most hospitals in the U.S. are privately owned (although many are owned by not-for-profit entities) and health care funding is substantially less dependent on government. Nevertheless, the role of government in setting health care policy and providing funding has grown. This force, combined with the increasing role of Health Management Organizations ("HMOs") has placed more pressure on health care providers to operate efficiently. Hospital reorganizations and mergers have led to opportunities to restructure laboratory services within hospitals and MDS has applied its expertise to this task within its U.S. partnerships.

The Company’s AutoLab unit has developed expertise in laboratory automation and has a proprietary line of automation equipment and software. Laboratory automation is often a key component of the joint venture or partnership agreements entered into by MDS.

The Diagnostics Sector has approximately 4,000 employees located in Canada and the U.S. The majority of these employees are not covered by collective agreements. At October 31, 1998, employees in Alberta and Saskatchewan, along with employees of certain of the Company’s hospital joint ventures, were subject to such agreements. MDS has not experienced a significant work stoppage due to labour activities and the Company believes that labour relations are good.

Strategy and Competition

MDS has committed significant resources to the development of the hospital partnership businesses in recent years and expects to add additional partnerships in 1999 and future years. The majority of development activity is focused in the united States where laboratory consolidations and improved laboratory efficiency have only recently become primary areas of focus for health care providers.

Continued constraints on health care funding are a major factor affecting the business in both Canada and the U.S. In Canada, the existence of fee caps or block funding prevents the Company from increasing its revenues in line with increases in test volumes. Improved efficiency is a key operating goal for the Company. These same forces create market opportunities which the Company seeks to take advantage of as hospitals look to become more efficient providers of laboratory services. This is also true in the U.S. where major hospital networks are working to consolidate laboratory operations, bring increased efficiency to their laboratories and are looking to bring community diagnostic work into hospitals (and away from community laboratory operators), to increase the profitability of their in-house laboratories.

The principal competitors in the private clinical laboratory services business in Canada include Dynacare Inc., Canadian Medical Laboratories Inc., and Med-Chem Medical Laboratories limited, all in Ontario; and BC Bio Laboratories Inc. in British Columbia. In the U.S., the Company is engaged in laboratory management services rather than the direct provision of laboratory testing. The majority of the target market of the Company is large hospitals and networks of hospitals. Although the Company is offering an alternative approach to reduce laboratory costs, the major competitors remain the large clinical laboratory companies, including Smith Kline Beecham and Quest Diagnostics.

In addition to basic clinical laboratory testing, recent advances in technology have broadened the available diagnostic tools. MDS is actively pursuing new diagnostic methodologies, including the applications of mass spectrometry for diagnostic screening and proteomics (the study of protein interactions at a cellular level). It is expected that these new methodologies, and others, will enable diagnostics companies to develop new assays that can be used for routine screenings. They may also allow the creation of assays which permit the diagnosis and identification of disease state or genetic predisposition earlier than existing testing methodologies. MDS expects to invest significantly in this expanded diagnostics field in future years.

Risks

The operation of clinical laboratories is subject to significant government regulation. In Canada, all laboratories are subject to periodic government inspection and proficiency testing by government agencies. The Company has been subject to such government inspection in all provinces in which it operates. MDS has never been subject to disciplinary or other actions as a result of a failure to meet standards in any area prescribed by regulation.

In most provinces, operators of clinical laboratories are required to carry licences which determine the nature of tests which can be carried out at each facility and govern the ability of the operator to draw samples for testing purposes. Such licences are for a limited term (generally renewing annually) and their renewal is subject to government approval. In addition, government agencies are empowered to revoke licences in the event of a failure by an operator to meet regulatory or other professional standards. Traditionally, renewals are automatic in the absence of significant regulatory or disciplinary action. The Company has never lost a licence due to non-renewal or direct revocation procedures by regulatory agencies.

In Alberta and Saskatchewan, licences have been replaced by service contracts with regional health authorities that run for various terms through 2002. The Company is in the first term of such a contract in Alberta and successfully renewed its Saskatchewan contracts for a second term. There is no reason to believe that further renewals will not occur at the end of the contract periods.

MDS expects that cost containment initiatives will remain a risk factor for health care businesses for the foreseeable future. For those provinces which continue to utilize a fee-for-service reimbursement model, migration towards lump-sum funding or capitation systems may serve to limit growth or even reduce revenue levels. However, such initiatives could also be expected to protect the market share of existing service providers. Distribution businesses are similarly constrained as their ultimate customers face reduced funding from governments and other agencies at the same time as an ageing population is expected to place more demands on the health care system.

To address these risks, MDS is continuing to invest in research and development focused on new, cost-saving technologies, including automation of routine, mechanical functions. More efficient methods of service delivery including improved laboratory management techniques, centralization of high volume testing currently performed in smaller on-site laboratories, and various supply chain management techniques are all dedicated to the reduction of cost and the elimination of waste within the systems.

MDS remains active with industry groups and as a member of advisory panels to governments and other agencies. Through negotiation with health care authorities, MDS and industry organizations have been able to reach satisfactory settlements and retroactive reimbursements for testing volumes which exceeded stated funding levels. While there can be no guarantee that such settlements will be achieved in the future, management believes that negotiations within funding providers can led to satisfactory resolution of these issues. In addition, MDS is committed to on-going involvement and believes that this participation in the policy-setting process enables the Company to be aware of proposed policy changes and to respond properly based on the direction in which such changes may proceed.

3.3.2 – Distribution of Medical products

MDS conducts its distribution services business through two primary subsidiaries: MDS Ingram & Bell, which owns 50% of Source Medical Corporation; and Matrx Medical, Inc. Source is engaged in general medical product distribution in Canada. Matrx is a distributor of pre-hospital emergency supplies, as well as a manufacturer of anesthesia equipment for dental and veterinary uses.

Industry Overview

The medical products industry is dominated by a limited number of product manufacturers. Distribution of medical products in Canada is fragmented and represented by a number of different distribution channels. Many multi-national companies have subsidiaries in Canada which both manufacture and distribute their products on a direct basis. Most Canadian health care manufacturers are small in size and distribute their products through independent distribution channels. Overall, the medical devices industry (excluding pharmaceuticals) in Canada is estimated to be $3 billion.

Source Medical is the largest full service, independent distribution company in Canada specializing in medical products. There are a number of regional and local distributors in Canada competing in this marketplace. In addition, national distributors and large manufacturers engage in direct selling and distribution of competing products. Many distributors specialize in particular product lines or types of products. Some carry a broad product range but focus on particular regions or categories of customers. A number of distributors provide only logistics services for manufacturers which do their own sales and marketing.

In recent years, growth in the overall medical products industry has been impacted by hospital cost cutting. This has resulted in pressure on margins, in particular, on some of the service aspects of the business, including distribution. Companies providing these services have responded by consolidating their operations, adopting new business processes, and moving into just-in-time delivery and supply chain management services in an attempt to bring more value-added to their offerings.

The distribution of pre-hospital emergency supplies is also highly fragmented, and no one distributor controls more than 10% of the U.S. market. Existing distributors are regionally based. In recent years, consolidation of ambulance operators (the primary customer) has occurred. This is expected to lead to consolidation of the supplies distribution industry in the near term.

Sector Overview

Prior to October 1, 1997 Canadian distribution services were carried out through I&B. Effective October 1, I&b merged its distribution business with that of Allegiance Healthcare Canada Inc., forming Source Medical Corporation. During 1998 the integration of the former businesses proceeded. by year-end, the distribution warehouses had been consolidated and significant progress had been made on integration of sales and marketing and administrative activities. The company has also invested in state-of-the-art information systems which will enable Source to better meet its customers needs.

The creation of Source Medical represented a key development for the medical supply distribution business in Canada. The combined company has annual revenues well in excess of $300 million and distributes products manufactured by the parent companies along with products of other major manufacturers. Also, Source is the Canadian distributor of products manufactured by Baxter Corporation under the terms of a five-year distribution and services agreement.

Through Source, the Company provides marketing, sales, distribution and after-sale service for products ranging from technologically sophisticated medical equipment to volume products such as syringes and patient care products. Source has established relationships with major medical product manufacturers to market and sell their products in Canada. Source also provides logistics management services and stockless inventory services to hospitals and other health care providers. Source operates distribution and dedicated warehouse facilities in all regions of the country.

In addition to its participation in Source, I&B manufactures its own lines of proprietary medical products which are distributed by Source. Manufacturing operations are located at facilities in Toronto and Montreal.

Matrx, which is based in Buffalo, New York, and serves the eastern United States and an international customer base from its head office and from a distribution warehouse located in North Carolina. In addition to a broad range of emergency medical equipment, Matrx manufactures several proprietary products which include dental vacuum pumps, air compressors and nitrous oxide delivery equipment, and veterinary anesthesia equipment. The markets in which Matrx competes are highly fragmented and Matrx is among the top companies in each of its three businesses.

The distribution businesses of MDS employ approximately 560 people, of which 410 are located in Canada. This figure includes 50% of the employees of Source, reflecting MDS’s proportionate interest in the business.

Strategy and Competition

The distribution industry in Canada is expected to continue to be constrained by the funding pressures affecting health care generally. In response, new methods and services will develop. Operating efficiencies will be a key priority and Source is investing heavily in services and technologies to meet these demands. Health care customers are expected to seek to reduce their investment in supplies inventories, leading to further demands for stockless inventory and just-in-time delivery. During 1998, Source acquired the stockless inventory programme of a key competitor in the Toronto market. Further initiatives in this area are expected.

Major competitors in distribution area include Livingston International Inc. and a number of regional and local distributors. As noted, a number of large, U.S.-based product manufacturers also self-distribute their products and can therefore be considered competitors.

Consolidation of the industries within which Matrx operates has begun, particularly the emergency medical industry. This has been driven largely by consolidation of ambulance operators under corporate banners such as Laidlaw/American Medical Response and Rural Metro. Consolidation of all three industries is expected to be a positive factor for Matrx as the larger customers are expected to look to the larger suppliers in the businesses to consolidate their purchasing needs.

Risks

The majority of the distribution agreements entered into by Source and Matrx are for a fixed term and subject to commercially reasonable cancellation provisions. It has been the experience of both I&B and Allegiance (as predecessors to Source) and of Matrx that renewal of such agreements ordinarily occurs as a routine matter. The creation of Source has not resulted in the loss of any significant distribution contracts to date.

3.4 – Other Businesses

3.4.1 – MDS Communicare

Prior to 1998, in addition to its core businesses, MDS supplied products and services to the home health care and rehabilitation markets in Canada through its Doncaster Home Health Care operating unit. Products included a wide range of goods designed to enable quality home care and to enhance lifestyle for those consumers who are being provided their health care outside of a traditional institutional setting. This unit operated through 17 company locations and two franchised locations. The majority of the unit’s revenue was earned from consumers; however, a portion of the revenue was received from various provincial home care and assistive devices programmes. As such, this portion of revenues was subject to government cost constraining initiatives, particularly reduced reimbursement ratios. Recent government policy documents in most provinces indicate increased funding and focus on home care; however, there has been little direct benefit to the home care industry to date. MDS disposed of this operating unit in 1998 and exited the home care business.

In addition, in 1998 the company disposed of its insurance paramedical business.

3.4.2 – MDS Capital Corp.

MDS Capital Corp., in which MDS has a 36% interest, is the largest venture capital and fund management company in Canada focused on the health care and life sciences industry. It is also one of the largest such firms in the world. The company manages approximately $600 million through six funds, including two funds open to public investors. MDS Capital Corp. earns management fees from these funds, including incentive fees based on the overall success of the funds.

Among the funds managed by MDS Capital Corp. is MDS Health Ventures Inc. This $27 million fund, in which MDS has a 38% direct interest, was the first venture capital fund organized by MDS.

MDS records it interests in MDS Capital Corp. and MDS Health Ventures Inc. on an equity basis. In 1998, MDS recorded equity earnings of $1.4 million from these two investments.

3.5 – Principal Facilities

Following are the principal operating facilities of the Company as at October 31, 1998:

3.6 - Research and Development

Research and Development Costs are described in Note 11 to the Financial Statements set forth on page 45 of the Annual Report which is incorporated by reference into this AIF.

3.7- Environmental Compliance

The Company has established a series of policies to facilitate compliance with all applicable environmental laws and regulations. The policies require regular environmental assessments of company activities, establishment of remedial and contingency plans to deals with any incidents, and regular reporting to the board through the Environment, Health, and Safety Committee of the board on the environmental status of the Company and its subsidiaries. MDS believes its approach to environmental compliance meets the regulated requirements and it is not expected that this policy will have a significant impact on capital expenditures.

3.8 - Other Risk Factors

3.8.1 – Insurance

The Company maintains a global insurance policy covering all of its operating units. The programme provides adequate coverage for normal operating risks and includes liability coverage to $120 million.

3.8.2 – Year 2000

MDS established a comprehensive programme during 1997 to:

• Identify areas of vulnerability for the Company with respect to Year 2000 issues;
• Assess the extent to which the Company is affected by these vulnerabilities;
• Rank the areas of vulnerability and the risk based on the extent to which the areas are critical to the Company’s continuing operations;
• Determine appropriate remedial actions; and,
• Establish timeframes that allow for completion and confirmation of remedial actions well in advance of January 1, 2000. (Collectively, "the project"), and
• Ensure full commitment of the MDS Board of Directors and the management groups from all divisions to completion of the project.

Following is a summary of the scope of activities undertaken to date, the current status of the project, the expected timing for testing and implementation, and the current and estimated costs to be incurred with respect to the project.

The project is supported at both the divisional and corporate levels. Each division president is directly responsible and accountable for Year 2000 compliance within the division. Divisional champions and project managers responsible for Year 2000 compliance have been appointed who report to senior divisional management and ensure adequate resources are allocated, appropriate priorities are established, key risk areas are identified and acted upon, and all risks and opportunities are managed effectively.

A corporate management office for the project ("MO") has been established to coordinate and support divisional efforts and to otherwise direct the corporate actions. The role of the MO is to facilitate detailed planning, risk assessment, prioritization and costing. Through its coordination activities, the MO leverages common efforts to avoid duplication and ensures that project status reports are prepared by divisional teams on a timely basis. The MO consolidates divisional reports and prepares summary reports on a regular basis for Executive management and the Board of Directors. Reports prepared by divisional representatives and the MO highlight over-all status and progress, provide detailed activity reports by division and by major system, identify key risks in the project, and maintain an updated time schedule for implementation of remedial actions. The Company has developed an intranet site specifically for the project which serves to catalogue best practices, methodologies and processes. The site also facilitates communication amongst division representatives and with the MO.

The project is not limited to internal MDS systems and technology, but encompasses business partners, suppliers, and customers for which a Year 2000-related failure could have direct or indirect implications to MDS. For areas of risk not under the direct control of MDS, area specialists within the Company (e.g.: purchasing managers, sales and marketing staff) are identifying areas of external risk, communicating with external parties to determine the status of their plans, and recommending actions by MDS to limit exposure to an external Year 2000-related failure. External risks are also addressed in divisional and corporate reporting. Communication with key customers, suppliers, and business partners commenced during 1997 and will continue during 1999.

Identification of the key areas of concern where MDS is a vendor or user of technology occurred in 1997. Development of remedial action plans has begun and most major action steps have been taken. The projected completion date for remedial action on remaining risk areas is the second quarter of 1999.

The size and pervasiveness of potential system failures mean that the possibility exists that the millennium change could have a material adverse impact on the Company. Management believes that the steps taken greatly reduce the likelihood of any such impact.

The Company estimates incremental Year 2000 compliance expenditures of $6.8 million divided approximately evenly between operating and capital costs. A substantial part of the operational initiatives is expected to be undertaken by existing personnel of information technology departments within the Company. It is not expected that a significant portion of such operating costs will be incremental in nature

3.8.3 - Other

Under the terms of its operating agreement with AECL, MDS is fully indemnified by AECL for nuclear risk governed by the Nuclear liability Act relating to the operation of the NRU reactor. This indemnification will be extended to the reactors currently under construction when they become operational.

4-SELECTED CONSOLIDATED FINANCIAL INFORMATION

4.1 – Summary Annual Information (Year to October 31)

($ millions except per share amounts)	1998	1997	1996	1995	1994
Consolidated Statements of Income
Net revenues(1)	$1,001.5	$930.0	$818.9	$689.2	$652.5
Operating income before unusual items	115.9	108.3	91.6	71.9	62.2
Net income before unusual items	72.0	64.9	51.1	35.2	29.1
Net income	57.7	64.9	51.1	35.2	33.5
Earnings per share before unusual items	$1.27	$1.15	$0.93	$0.67	$0.56
Earnings per share (2,3)	$1.02	$1.15	$0.93	$0.67	$0.64
Consolidated Statements of Financial position
Capital employed(4)	$756.9	$659.9	$585.3	$511.6	$469.7
Total assets	1,048.7	905.8	865.8	729.9	724.4
Long term debt	191.2	145.7	182.9	139.1	161.6
Total Shareholders' equity	541.0	494.5	438.0	356.1	325.5
Weighted average shares outstanding	56.5	56.4	54.7	52.2	52.3
Long term debt/shareholders’ equity	35%	29%	42%	39%	50%
Current ratio	1.36	1.20	1.40	1.25	1.50
Consolidated Statements of Cash Flows
Cash from operations	$110.5	$117.4	$83.0	$74.1	$70.9
Capital assets purchased	93.9	57.7	33.5	30.4	16.0
Acquisitions	26.2	5.6	69.8	33.4	4.9
Net repayment (issues) of long-term debt	(38.9)	38.4	(32.4)	40.1	35.1

Notes

1. Figures for fiscal 1994 have been restated to reflect the proportionate consolidation method of accounting for investments in joint ventures.
2. Class B Non-Voting shareholders are entitled to an additional 1.25¢ per share per annum by means of a non-cumulative dividend in addition to any dividends paid on the Class A Common Shares. The earnings per share are calculated without the deduction of the additional dividends.
3. Earnings per share have been restated to reflect the impact of the two-for-one share split which was effective November 15, 1996.
4. Capital employed consists of total assets (excluding cash) less non-interest bearing liabilities.

4.2 – Summary Quarterly Information ($ millions except per share amounts)

Fiscal 1998	January 31	April 30	July 31	October 31
Net Revenues	$228.9	$252.1	$256.4	$264.1
Net Income	15.0	20.5	18.3	3.9
Earnings per Share	$0.27	$0.36	$0.32	$0.07
Fiscal 1997	January 31	April 30	July 31	October 31
Net Revenues	$223.2	$240.7	$230.5	$235.6
Net Income	15.2	16.9	16.3	16.5
Earnings per Share	$0.27	$0.30	$0.29	$0.29

4.3 – Dividends

The Company has paid dividends on its Class A Common and Class B Non-Voting Shares during the last five years as set out in the following table:

There are no restrictions preventing the payment of dividends. The Corporation has two classes of shares outstanding, Class A Common and Class B Non-Voting shares, both of which participate equally in dividends after the declaration of a 0.625¢ per share non-cumulative dividend on the Class B Non-Voting Shares in each fiscal half-year of the Corporation. Historically the dividends have been declared payable in April and October.

5 – MANAGEMENT'S DISCUSSION AND ANALYSIS

Please refer to the disclosure contained on pages 21 through 35 of the Annual Report under the heading "Management Discussion and Analysis" which is incorporated by reference into this AIF.

6 – MARKET FOR SECURITIES

The outstanding Class A Common and Class B Non-Voting Shares of the Company are listed for trading on The Toronto Stock Exchange (symbols MHG.A and MHG.B respectively).

7 – DIRECTORS AND SENIOR CORPORATE OFFICERS

Each director is elected to serve until the next annual meeting of the Company or until his or her successor is elected or appointed. The name, municipality of residence, position with the Company and principal occupation of the directors and officers of the Company are as follows and the year each director first became a director is in brackets after the word "Director":

NOTES: (A) Audit Committee

(C) Corporate Governance and Nominating Committee

(E) Environmental Committee

(H) Human Resources and Compensation Committee

(M) Medical Advisory Committee

All of the directors and officers have been engaged for more than five years in their present principal occupations or in other capacities with the companies or organizations with which they currently hold positions, with the exception of:

1. Wendy K. Dobson, who was appointed Director of the Company on September 13, 1995, is professor and Director of the University of Toronto, Faculty of Management, 1990 to Present.
2. Robert W. Luba, who was appointed Director of the Company on March 19, 1996, is President of Luba Financial Inc. and has held this position since 1994. He was President and Chief Executive Officer of Royal Bank Investment Management Inc. from 1991 to 1993.
3. Mary Mogford, who was appointed Director of the Company on April 1, 1998 and is a Partner with Mogford Campbell Associates Inc.
4. Ley S. Smith who was appointed Director of the Company on April 1, 1998 , and who has been retired since 1997 when he stepped down as Executive Vice-President of Pharmacia & Upjohn Inc.

As at October 31, 1998 the percentage of Class A Common Shares and Class B Non-Voting Shares beneficially owned, directly or indirectly, by all directors and senior officers of the Company as a group, was approximately 5.5% and 0.7% respectively.

8 – Additional Information

Additional information, including directors' and officers' remuneration and indebtedness, principal holders of the issuer's securities, options to purchase securities and a description of the Company's share capital, is contained in the 1998 Information Circular dated January 4, 1999. A copy of the 1998 Information Circular may be obtained upon request from the Secretary of the Company.

Additional financial information is also provided in the Financial Statements set forth in the Company's 1998 Annual Report which is incorporated by reference to this AIF. A copy of the Annual Report may be obtained upon request from the Secretary of the Company.

When the securities of the Company are in the course of a distribution pursuant to a short form prospectus or a preliminary short form prospectus, the following documents may be obtained upon request from the Secretary of the Company:

1. the Company's AIF, together with any documents incorporated by reference in the AIF,
2. the comparative financial statements for its most recently completed financial year together with the accompanying report of the auditor and any interim financial statements of the Company,
3. the Company’s information circular for its meeting of shareholders in respect of its most recent annual meeting