Executives
Kim Lee - Director, Investor Relations
Stephen P. DeFalco - President and Chief Executive Officer
Douglas S. Prince - Executive Vice-President Finance and Chief Financial Office
Analysts
Lennox Gibbs - TD Newcrest
Maher Yaghi - Desjardins Securities
John Maletic - Scotia Capital
David Martin - Dundee Securities Corporation
Randall Stanicky - Goldman Sachs
Maxime Paris - CIBC World Markets
David Windley - Jefferies & Co.
Douglas Miehm - RBC Capital Markets
MDS Inc. (MDZ) F3Q08 Earnings Call September 4, 2008 9:30 AM ET
Operator
Welcome to the MDS third quarter results conference call. (Operator Instructions) I would now like to turn the meeting over to Kim Lee, Director of Investor Relations.
Kim Lee
Our third quarter results were issued this morning, along with our MD&A and financial statement. If you have not received a copy of these documents, they are posted on our website at MDSInc.com. We are also webcasting this event live on our website, where you will find a PowerPoint presentation highlighting the details of the call. The archived version will remain on our website after the call today.
Joining me this morning are Stephen DeFalco, President and CEO of MDS and Doug Prince, Executive Vice President of Finance and CFO. Stephen will begin the call with his perspective on the quarter and Doug will follow with his comments on Q3. Prior to our Q&A session we will turn it back to Stephen for a few closing comments.
During the call we will be making forward-looking statements about MDS's businesses. These statements are not a guarantee of future performance and are subject to risks and uncertainty that could cause actual results to differ materially. Some of these risks are disclosed in the reports and other documents filed with the relevant Canadian and U.S. securities regulators and are available on our website.
Let me remind everyone that all financial data today is shown on a U.S. GAAP basis and in U.S. dollars unless otherwise stated. In addition to standard GAAP measures we also make reference to selected non-GAAP financial measures that we believe provide meaningful information to investors. Both GAAP and non-GAAP measures referenced here are used by management to assess the performance of the business and as a basis for management compensation.
To help our investors gain a clear understanding of our non-GAAP measures, such as net revenue, adjusted EBITDA and adjusted earnings per share, we provide detailed reconciliation between GAAP and non-GAAP measures in the MD&A of our July 31, 2008 interim financial report and our 2007 annual report, which are available on our website.
With that, I'll turn it over to Stephen DeFalco.
Stephen DeFalco
Q3 was stronger than Q2 with adjusted EBITDA of 21%, although overall performance was mixed and a decline versus a strong quarter in 2007. MDS Nordion delivered solid, steady pro forma and MDS Analytical Technologies showed sequential improvement despite a difficult environment. MDS Pharma Services continues to see strong new business wins which have resulted in a record backlog, however the conversion to revenue and earnings growth is taking longer than expected, which is not where we want to be. We are driving efficiencies in our business and continue to make investments to better serve our customers.
For the quarter MDS reported net revenues of $298 million versus $308 million last year, adjusted EBITDA of $41 million, down 16% from last year and up 21% versus Q2.
Now looking across our businesses, MDS Nordion delivered solid performance in the quarter and we are making progress with our innovation agenda. Nordion continues to partner with pharmaceutical and biotech companies to develop new and exciting technologies for molecular imaging. We also took action to address the long-term isotope supply issue by commencing arbitration with AECL and filing a $1.6 billion claim against AECL and the government of Canada.
MDS Analytical Technologies showed sequential improvement in what is still a somewhat soft North American pharma market. We continue to see great opportunities in our implied markets and strength in Asia.
During the quarter we launched seven leading-edge software solutions at the American Society for Mass Spectrometry to further our position in the fast-growing applied markets. They included Analyst 1.5 software, an updated version of our core operating system for mass spectrometry systems that increases customer productivity - Analyst is capable of identifying more than 600 contaminants in a single analysis of food or water, more than double the amount that can be detected by alternative testing solutions - and iMethods, which provides customers with customizable turnkey solutions for routine food and beverage testing.
LightSight software is an application package that contains automated method creation from metabolite indication with our triple quadrupole and QTRAP mass spectrometry systems. We expect these software offerings to revolutionize the user experience and provide us better access to the growing applied market and further our penetration of the life sciences market.
Our acquisition of Blueshift Biotechnologies this quarter allowed us to expand the breadth of our cellular imaging portfolio with a high throughput offering. IsoCyte, a benchtop laser scanning cytometer, expands our capabilities in cellular analysis and further strengths our global sales and service offerings. We are seeing market enthusiasm for this new product and received additional orders during the quarter.
$19 million in R&D was invested in the quarter, which continues to fuel a robust product pipeline. We're now preparing to launch new and exciting hardware. Combined with our leading edge suite of software solution, we will have a full array of new solutions in the market for our customers.
Moving to Pharma Services, as I stated earlier, the business continues to see strong new business wins and a growing backlog, however conversion to revenue in late stage is taking longer than anticipated. In Q3 we announced new restructuring actions as process improvements have led to productivity gains at a number of our sites.
Highlights from our plan include [top rating] of business development team and improving business development activities and processes, launching our quality on-time brand, utilizing our lean sigma process improvement methodology, implementing customer service systems such as Apollo, Clean Quick and SAS, and expanding in high-growth areas such as our Beijing central lab facility and state of the art Phase I facility in Phoenix, Arizona.
Our efforts have resulted in strong orders performance as customers come back to a revitalized MDS Pharma Services. Our priority is to translate those new business wins into top and bottom line growth.
Our early stage business is improving nicely. We expect late stage to take a little longer as we continue to deal with previous quarter cancellations and delays in the start of new projects. With three consecutive quarters of new business wins in excess of $160 million and a backlog that has grown more than $100 million year-to-date to $486 million - a record for Pharma Services - we are encouraged about our prospects going into 2009. We expect modest improvements for the balance of the year.
I will now turn it over to Doug Prince to provide the financial details for the quarter.
Douglas S. Prince
Before I get into the financial results I would like to remind everyone that in addition to the GAAP financial results included in the press release, we also provide commentary on items that impact the comparability of our results. For the third quarter, adjusted financial results exclude charges related to restructuring initiatives, asset impairment, a loss on the sale of a business, and integration costs. Where appropriate for year-over-year comparability, I will describe the impact of foreign exchange and acquisitions and divestitures. In addition, when I refer to revenue growth figures and margin percentages, these are based on net revenues, that is, revenue from products and services excluding reimbursement revenue.
Now for our consolidated results. In Q3 our total revenue was $321 million, including $23 million of reimbursement revenue. Net revenues were $298 million, down 3% from $308 million last year and down 5% excluding the impact of foreign exchange. Revenue declines were reported at Analytical Technologies and Nordion. The decline at Nordion was primarily related to the previously announced sale of two product lines which contributed $7 million in revenue during the third quarter last year.
Our Q3 GAAP operating loss, including restructuring and asset impairment charges, was $22 million for the quarter versus a loss of $4 million last year.
Adjusted EBITDA was $41 million compared to $49 million in 2007, down 16%. In 2008, adjusted financial results exclude $12 million in restructuring charges, an $11 million asset impairment charge for a Pharma Services facility, and a $1 million loss related to the sale of a business. In the third quarter of 2007, adjustments include $11 million Molecular Devices integration expenses and $3 million of restructuring costs. Our adjusted EBITDA margin declined to 14% from 16% in the prior year. This decrease in adjusted EBITDA was driven by declines at Pharma Services and Analytical Technologies.
Our reported gross margin, which is net revenues less associated cost of revenues, fell 3% due to a decline in gross margin at Pharma Services. SG&A for the quarter was $63 million compared to $66 million last year. As a percent of net revenues, SG&A was level at 21%.
In the third quarter we spent $19 million on R&D, 6% of revenues compared to $20 million, or 6%, spent last year.
On a reported basis, GAAP earnings per share from continuing operations was a loss of $0.08 in Q3 2008 compared to earnings of $0.06 last year. Excluding the adjusting items mentioned earlier, our adjusted earnings per share were $0.06 in 2008 compared to $0.13 last year.
Now to our business unit results, starting with Pharma Services. For the quarter, Pharma Services reported net revenues of $122 million, up 3% over the same quarter last year. These revenues reflect a favorable impact from foreign exchange of approximately $6 million. Adjusted for foreign exchange, early stage delivered revenue growth while late stage revenue declined, primarily as a result of previously reported cancellations and delays in the start of new projects.
Q3 continued to demonstrate a high level of new business wins with $169 million in new orders. Based on the strength of these new orders, our quarter-end backlog increased $55 million or 13% sequentially to $486 million.
On a GAAP basis, Pharma Services reported an operating loss of $31 million for the quarter compared to an operating loss of $5 million last year.
Excluding $8 million of restructuring expense, $11 million of asset impairment charges, adjusted EBITDA was a $2 million loss this year compared to a gain of $4 million last year. This decrease was primarily the result of lower revenues in our late stage businesses and increased investments in growth. In 2007, the late stage business also benefited from a favorable mix of higher margin services. These factors, plus inflationary pressures, offset the productivity savings achieved from our 2007 restructuring actions.
As previously announced, in addition to their ongoing productivity initiatives, Pharma Services has initiated actions to reduce headcount and close several offices. This has resulted in a restructuring charge of $8 million during the quarter, with another $6 to $8 million charge expected in the fourth quarter, in line with our previous announcement.
Next, on to Nordion. MDS Nordion reported revenue of $72 million, down 5% from $76 million last year. In the third quarter of last year we reported $7 million of revenue associated with product lines that were sold in Q3 of 2008. During the quarter, MDS Nordion's revenue increased by $2 million as a result of foreign exchange. Excluding the impact of divestitures and foreign exchange, third quarter revenues were $1 million higher compared to the same period last year, primarily driven by increased cobalt sales.
GAAP operating income was $20 million compared to $18 million last year.
Adjusted EBITDA was $23 million versus $22 million last year, primarily driven by increased sales of higher margin cobalt.
Now on to Analytical Technologies. It's been over a year since we acquired Molecular Devices. Going forward we will no longer refer to the Sciex and Molecular Devices brands. Where appropriate, we will now comment on the key product families - mass spectrometers, drug discovery and bioresearch.
MDS Analytical Technologies recorded revenue of $104 million in Q3, down from $114 million last year. Adjusted for foreign exchange, reported revenues decreased approximately 12%. The primary driver of the revenue decline was lower shipments of mass spectrometers to our joint ventures. End user revenue from mass spectrometers actually increased 5% in the third quarter, with strong demand in applied markets in Asia offset by soft demand for high-end instruments in North America.
Analytical Technologies reported a GAAP operating loss of $9 million in Q3 compared to an $11 million loss last year. In addition to equity earnings, major adjusting items include $4 million of restructuring charges in 2008 and $11 million of integration expense in 2007.
Adjusted EBITDA was $21 million in Q2 compared to $27 million last year. This $6 million decrease was primarily driven by lower sales of high-end high-margin instruments plus increased manufacturing costs related to our shift to Asia manufacturing.
While we continue to see soft demand for high-end instruments, sequential growth in end user revenue and effective cost controls resulted in margin improvement compared to the second quarter. Analytical Technologies implemented a number of productivity in Q3, including headcount reductions in North America, which resulted in a $4 million restructuring charge this quarter.
Turning next to cash flow and the balance sheet, in Q3 we generated $5 million of cash, resulting in an ending cash balance of $130 million. During the quarter we generated $23 million of operating cash flow and incurred $14 million of capital expenditures. We received $15 million from the sale of two product lines at Nordion and spent $14 million on the acquisition of Blueshift for Analytical Technologies.
We repurchased 1 million common shares for $15 million under our normal course issuer bid and borrowed $15 million under our revolver over quarter end. That draw has since been repaid and as of today there are no borrowings on that $500 million facility.
For the remainder of fiscal 2008 we expect to have net operating cash inflows. We believe that cash on hand, cash from operations, and cash from existing financing sources will provide sufficient liquidity to fund ongoing operations, capital expenditures, R&D expenses, customer FDA settlements and restructuring costs.
Now to our 2008 guidance. We are updating our guidance today to reflect our expectations for the balance of the year. Primarily as a result of the slower than expected revenue ramp at Pharma Services, we now expect net revenues for 2008 to be in the range of $1.23 to $1.25 billion. Our adjusted EBITDA and adjusted earnings per share guidance has remained unchanged at $160 to $170 million and $0.27 to $0.33, respectively, as the cost reduction actions that we have implemented are expected to offset the lower revenues.
As a result of the restructuring and asset impairment charges announced in the quarter and certain other adjusting items, income from continuing operations is expected to be in the $18 to $28 million range, with basic earnings per share between $0.15 and $0.23. We have also deferred several investment projects to 2009 and capital expenditures are now expected to be in the range of $50 to $60 million. Our effective tax rate for 2008 remains unchanged.
And finally, our outlook. We took tough actions in Q3 to deliver improved EBITDA following a disappointing Q2. AT has executed cost reduction actions to improve profitability while also driving innovation through R&D and acquisitions. Nordion has sharpened their portfolio via the divestiture of slower-growth product lines and is more focused than ever on their mission as a premier provider of molecular imaging technologies. At Pharma Services, our investments in business development have resulted in their highest backlog ever. Coupled with the cost reduction actions currently under way, the record backlog is expected to drive increased revenue and adjusted EBITDA in Q4 and 2009.
That concludes my financial comments for the quarter and, with that, I will turn it back to Stephen for closing remarks.
Stephen DeFalco
We made continued progress in executing our strategy in the third quarter, which improved performance over Q2. Rolling into Q4, we see strengthening across all of our businesses. We continue to take actions to drive EBITDA expansion and position ourselves well for 2009 and beyond.
I'll now turn it back to Kim.
Kim Lee
We will open the line for questions.
Question-and-Answer Session
Operator
(Operator Instructions) Your first question comes from Lennox Gibbs - TD Newcrest.
Lennox Gibbs - TD Newcrest
I'm going to start just a little off topic on Nordion. Recently, Covidien announced another molybdenum supply interruption out of their facility in Petten in the Netherlands, and recall back in '05-'06, there was a similar event that created a pretty tight [even fall] for MDS. Can you comment on your ability to meet market demand caused by this shortfall and whether or not we should expect to see an uptick in your moly business as a result?
Stephen DeFalco
Yes, we're watching that situation very closely. All of the reactor suppliers and industry participants are talking to each other, a little different than last time. What happened last time was Covidien's generator line went down. This is a little different in that the reactor, the Petten reactor in Holland, is down. And the news keeps changing how long it'll be out, but it's going to be out for a little while. We're working with our customers and ramping up our production but, as you know, the precision and accuracy of the news gets better over time because everybody knows more. And so it's a situation we're watching closely.
Lennox Gibbs - TD Newcrest
And then just secondly, in terms of the recovery in the early development segment, it doesn't look to be a very compelling top line trend. Earlier you previously commented that 70% of the top 10 customers were back. It sounds like a pretty dramatic reversal. Why has this not translated to a more robust top line recovery? Maybe if you could just comment on competitive issues, if there are any, and on your penetration of those top customers?
Stephen DeFalco
As I said, Lennox, I think this has taken longer than we had expected and we're not really happy with where we are. I would say early stage is recovering quite nicely. Customers are coming back, revenue is ramping, it's more profitable, and we're seeing the trend lines. We're a little bit here in Q3 dealing with some issues in late stage which, given our scale, one cancellation or one or two project start delays will wreak some havoc on us here.
So I think on early stage we have a good bead on it. It's moving nicely. I think late stage is going to take us another couple of quarters here to really be able to see that trend line.
Lennox Gibbs - TD Newcrest
But just back to early stage for a second, are you where you thought you might have been at this point. Given that so many customers have come back relatively quickly, shouldn't one have expected sort of a more steep trajectory here?
Stephen DeFalco
No, I think we're where about we want to be. I mean, understand when a customer comes back they might give us a project but that project might be scheduled, for their reasons, in calendar Q1, right? And that's because that's when their molecule will pass its other milestones and be ready. And so you see that more in the backlog building. Most of them would have their business already booked out for, call it, the next six to eight weeks, right? They've already made commitments and whatnot. So they place business, but the business is a little further out. It's sort of their next available molecule, when it's ready. I think we're doing a good job winning that, as you're seeing in the backlog numbers.
Operator
Your next question comes from Maher Yaghi - Desjardins Securities.
Maher Yaghi - Desjardins Securities
I want to ask you a question on Nordion. You mention in the press release that you're uncomfortable with the current situation in which even if the NRU reactor would have been given approval to continue operating beyond 2011 that the situation is not suitable for MDS. Can you maybe elaborate a little bit about why you feel that even if the NRU continued to operate beyond 2011 that would not be appropriate for you guys?
Stephen DeFalco
Yes. I think, Maher, nothing has changed on that at all, and I'll kind of go back to what we've stated before, right? MDS has always been concerned and has been making investments to ensure long-term supply. I think we're fine in the short to medium term. I think NRU operates every day. It's the world's most reliable reactor. We'll see that reconfirmed here over the next couple of weeks, given things that are kind of going on in that industry. And we would expect that to get re-licensed in the midterm, and I think people are speculating that'll be a five-year license that would take us up to 2016. That's not for certain.
So I think in the short to medium term, we're fine. Nordion's a good leader in that business. That's a very profitable business for us. What's not satisfactory to us is the less than solution, and that's why we're taking the actions that we're taking. And we're very consistent on that.
Maher Yaghi - Desjardins Securities
So even if the NRU reactor would continue to operate even long term, you are not looking to continue to get your supply from the NRU, even if it's available?
Stephen DeFalco
Oh, no. We will absolutely get our supply from the NRU as long as the NRU operates, which looks like it'll be short to medium term. That doesn't solve what we think are longer-term issues. Quite frankly, they're industry issues. Every one of the reactors in the industry is 50-ish years old, right? And so what's not acceptable to us is not having a solution past the NRU. But as long as the NRU operates, we'll be working with the NRU in supplying our customers around the world.
Maher Yaghi - Desjardins Securities
And just a follow up question on Analytical Technologies. Can you split up the sales number for Sciex and MD like you did in the past?
Stephen DeFalco
No, we don't intend to do that going forward. It's MDS Analytical Technologies.
Maher Yaghi - Desjardins Securities
Okay, so if I may, I wanted to ask you about the revenue line at Analytical Technologies. If I look at industry numbers, they're still quite in the top teens level growth on the top line. Beyond the mass spectrometry decline in revenues - not shipments, like you said, but revenues - was there weakness also at MD like we saw last quarter or that situation has reasserted itself?
Stephen DeFalco
We don't think right now the industry's growing at 14%, and so I think if you get an organic number on that, it won't nearly be at that rate. And certainly we follow all our competition and their press releases, so I don't know that I agree with your assertion there. Our end user revenues on mass spec are growing at 5%, which we actually think is pretty close to mid top of the pack there.
Molecular Devices I think is tracking with its segment. And I think everybody in the industry's feeling a little softness in North America and, quite frankly, good strong growth in Asia. Those products participate less in the applied markets, which are good markets for us that have been on fire. And so those continue to really, really ramp strongly. I think every time you see a food testing issue or an environmental issue hit the newspaper, that's good for mass spec sales and participating in those applied markets.
And Molecular Devices is a little bit more driven straight by the core life sciences markets.
Maher Yaghi - Desjardins Securities
So product mix was negatively impacting MD this quarter like last quarter or you're back to maybe Q4 or Q3 type of product mix?
Stephen DeFalco
No, we're certainly having a little bit of a shift away from our high-end boxes to our low-end boxes just because the high-end boxes get caught up in capital expense approvals and so that's a little more sluggish. But, no, generally I think this is the mix we're going to have for a little while here, probably until we see some broader good news in the economy and pharma in North America.
Operator
Your next question comes from John Maletic - Scotia Capital.
John Maletic - Scotia Capital
Just a follow up question on Pharma Services. Has there been any change in the level of cancellations in this quarter or are you still talking about the lingering effects of past quarter cancellations?
Stephen DeFalco
Our cancellations have been running pretty low. As you know, we don't really control cancellations that much. They mostly have to do with customers identifying that that molecule isn't acceptable to take forward, and that's partly because we do good testing for them. So it's not something in our control. But cancellations are relatively low. It's just in late stage we had some previous cancellations which are affecting where we are right now, where we were anticipating those would all be running projects and revenue in this quarter. And we have seen some pushouts as I think pharmaceutical and biotech clients either don't meet the milestones that they were heading for in the previous phase or rejuggle their portfolios.
But I think the issue for us is in our late-stage business. Given our size, one or two of those can really wreak havoc for us.
John Maletic - Scotia Capital
So then it is a handful of delays. It's just one or two that are causing this and it's not a broader increase in the duration of your backlog?
Stephen DeFalco
No. And then we did not have any big cancellations this quarter.
John Maletic - Scotia Capital
And then secondly, on the currency, given the weakness in the Canadian dollar over the near term, has there been any change to how you're viewing it as far as your guidance? Are you still baking in parity for the remainder of the year? What kind of impact, positive impact, do you expect to see if we can see continuation of these trends?
Stephen DeFalco
John, great question. I think as a policy I try to not predict foreign exchange rates because I think it's a little outside of my expertise area, particularly when I see the best economists in the world don't do that great a job with it. I think a broad philosophy is to make sure we can make money at exchange rates and manage our business appropriately from an operations point of view.
All things being equal, a strengthening U.S. dollar is good for us, as you can well imagine. You've followed the stock for a long time, so you've seen us deliver profit improvement in an environment with a weakening U.S. dollar. You know that becomes even better with an accelerating U.S. dollar. So I think that would be good news for us, but I wouldn't hold your breath.
John Maletic - Scotia Capital
But am I right to assume that in your current guidance you're being conservative in assuming that we don't have a significant improvement?
Stephen DeFalco
Yes.
John Maletic - Scotia Capital
So there could be potential upside if we see that?
Stephen DeFalco
Yes, that's a good assumption. We are assuming the future looks like where we are.
Operator
Your next question comes from David Martin - Dundee Securities Corporation.
David Martin - Dundee Securities Corporation
A couple of questions. The first one is you indicated in the MD&A that mass spec end user sales are up but you're shipping lower volumes of units to the joint ventures. I'm wondering, are the joint ventures reducing their inventories? Do you expect this to continue? Why are they doing it?
And linked to that, have you talked to Invitrogen about their strategy for mass spec business and is it any different from ABI?
Stephen DeFalco
I think, to start your questions in order, there's no big, I would say, inventory management process going on, and you shouldn't read something in from increasing or decreasing inventories. The truth is, in mass spec we don't hold much inventory. I think it really has to do with how we do the accounting for the joint venture and the fact that the revenue we report in our reported results really has to do with our shipments out as opposed to, you know, end user acceptance criteria, if you would, so if we ship it into the joint venture.
And so this quarter we shipped a little less but end user revenues were up 5%. I think the end user revenue is what you want to key on in terms of long-term prospects and that's why we give that number.
In terms of Invitrogen, you know, just in context, MDS and ABI have worked together over the past two decades to really build the premier global mass spec franchise. It's a great business. We're working very closely with our partners to continue to build this business to make sure our new products get to market, to make sure our customers get outstanding service. We're very focused with ABI and Invitrogen on ensuring we serve those customers well.
At the same time, the change of control of our partner does give us certain rights under our agreement. We are assessing all possible options with a view to what is best for MDS shareholders. The mass spec business is a business we like a lot and MDS is very committed to that business. MDS is going to continue to focus on serving our customers in mass spec, you know, short and long term. And so I think we are working with them daytoday in making sure we get those product announcements out, those product launches done, and that their customers feel an extra special hug during this period of time.
David Martin - Dundee Securities Corporation
My follow up question is, the corporate SG&A was $2 million this quarter and that's quite a bit lower than it has been in recent quarters. I'm wondering why we're getting that lumpiness and do we expect to move forward with $2 million a quarter?
Douglas S. Prince
We see some favorability from foreign exchange and stock-based compensation in this quarter. I would say you've got to kind of look at the average that that one runs as to be a more realistic kind of view. It was a little lower than we've seen in other quarters, so I'd look back and kind of use an average.
Operator
Your next question comes from Randall Stanicky - Goldman Sachs.
Randall Stanicky - Goldman Sachs
Stephen, just a question around the profitability in Pharma Services. You've talked historically about working through some of the lower margin backlog and then you also referred today to the business mix in 2007 from a profitability perspective being pretty good. How do we think about the current profitability of the book of business that you have now as we look to the future?
Stephen DeFalco
Yes, the business that we're winning is at much better profitability than the historical backlog, and so every quarter we get a little bit ahead of that curve and feel very good about processing that business. A little bit why, you know, pushouts aren't good for us, but again that's a matter of timing.
Randall Stanicky - Goldman Sachs
Did you touch on - I may have missed it, but did you touch on the split between the early and late and, you know, what [inaudible] the last records have been pretty strong from an orders perspective.
Stephen DeFalco
Yes, we talked about that a little bit before. I think our early stage business, which has been our historical platform of strength, you know, is performing very well, good trend line, customers coming back. We'll be able to turn that into revenue and profitability.
I think late stage we've done a great job winning new business and having customers take a serious look at us in late stage and give us their business, however turning that into revenue and profitability is taking longer than we want, quite frankly, and longer than we had expected. And I think a little bit - we had some cancellations a few quarters back and, you know, we still get pushouts in that business often and one or two of those will affect it. So that one's going to take a little while longer for us to be able to see those trends clearly in the reported results. We're driving real hard on that.
Randall Stanicky - Goldman Sachs
So if we think about your comments thus far this year in that we're going to have a back half recovery, given those cancellations in Q4, Q1, clearly that's not happening from a revenue or profitability perspective, at least in this quarter. How do we think about timing going forward for some of that backlog conversion to take place? And also from the cost side, when do we see that business turn profitable? And then, you know, tying that together, we talked last quarter about exiting '09 with industry average margins. Is that something that you're still looking at or are we now thinking fiscal 2010?
Stephen DeFalco
I think you gave a pretty good description here on history, and I think that describes why we're not happy with where we are here in Q3. Again, I think we have good visibility into the early stage and that's improving nicely. I need another couple of quarters here on late stage to get a better trend line, I think, in order to refresh that. You know, we're still driving very hard in that business, winning customers and trying to push the profitability, but I would say that really getting a good grasp on the timeline in late stage is probably something that'll evolve in the next quarter, too. We expect it to improve in Q4 but, you know, I don't expect any, you know, kind of a hockey stick in Q4. I expect now, you know, I think good, steady improvement going forward.
Randall Stanicky - Goldman Sachs
But profitable in Q4?
Stephen DeFalco
We do.
Operator
Your next question comes from Maxime Paris - CIBC World Markets.
Maxime Paris - CIBC World Markets
First on Analytical Technologies, what should we be expecting here in the long term? Do you see the North America market for mass spec recovering and do you see your margins going back up? Also on your new product offerings, you were talking about the launch of new software solutions. When should we be seeing new hardware solutions?
Stephen DeFalco
Let me start, I think, at the macro level, which is on the markets, you know, I've seen this cycle a number of times. Basically you can hold back on your Capex for only so long, but the truth is customers really need these instruments because they drive great productivity in their drug development pipeline. And so they can delay them for awhile but, you know, sooner or later it comes back. I think predicting when, I'm not sure. I'm not expecting, you know, quite frankly, any strengthening for the balance of calendar 2008. I think as we go into 2009, let's kind of see where we are and see when that'll turn. It'll turn in 2009; I'm just not quite sure when it will. It's usually pretty tough to predict, [provide reflections].
I think in the - we're driving hard to improve the margins in any business conditions, not waiting for them to come back. And you saw that with the restructuring that we took and you saw that with the step up in profits in that business from Q2 to Q3. And so I think we'll continue with those activities.
We're very excited about our new software. We're probably spending half our R&D budget these days on software and so, you know, sometimes - everybody gets more excited about the hardware sometimes than the software because they like the box but, you know, the software is really what's driving the penetration in the applied markets. It's taking an amazingly sophisticated - albeit, I would describe it as occasionally finicky - method and putting it in the hands of novice users who can just with turnkey capability deliver outstanding results and, quite frankly, be up and running in a day versus needing two or three weeks of training. And these instruments were only really run by Ph.D. scientists only four or five years ago.
So software very, very important, method development, speed, precision, signal analysis. And so, literally we have seven new pieces of software on the market. We basically revamped our whole suite of software, including our core offering. So we're very excited about that.
We today have what we believe and what customers usually would say in any survey the best hardware on the market. We're still the leading mass spec provider. I think as usual we will be announcing new products over the next 18 months and some of those will be some pretty exciting hardware offerings also. But, you know, quite frankly, I like where we're sitting right now because I think we have the best hardware and the best software in the market and I think we're doing quite well.
I think nothing helps in a sluggish market than a couple of exciting new offerings, but you've got to announce them when you're ready to ship them, right, because if you announce them before you're ready to ship them it doesn't do good things for your market.
So we like where we're sitting here at this point in '08 and we're very excited about '09.
Maxine Paris - CIBC World Markets
Then on your $1.6 billion claim against AECL and the Canadian government, when is the next data point here? Is there a hearing date scheduled or what shall we be expecting in the next few months?
Stephen DeFalco
I think now that this has gone into the realm of a legal case, don't expect us to be making a lot of comments here. And as anyone knows who progress through a legal case, there's a lot of hurry up and wait kind of activity, and I never like to get into the habit of predicting the courts and how the courts operate.
The next step here is really picking an arbitrator and beginning the arbitration process, and we're working through those issues. But, you know, don't expect a blow-by-blow on this.
Maxine Paris - CIBC World Markets
One follow up, if I may, on the Bioanalytical Review in Montreal. You've got a remaining reserve of $32 million. The six-month period has passed. Do you think you could see a reversal of that? You're saying on one side that you've got sufficient - the $32 million would be sufficient to cover the potential claims. On the other hand, you know, the sixmonth period has passed. Do you think you could see reversal of that?
Stephen DeFalco
We review that every quarter and we review that, obviously, with our accounting team and our auditors. And, you know, we continue to work through customers. I think that we'll continue to look at that. Right now we're very confident it's sufficient to cover anything coming down the pike, and if at some point we deem that it's more than sufficient, we would be taking a reversal on that. But we're not at that point at this point in time.
Operator
Your next question comes from David Windley - Jefferies & Co.
David Windley - Jefferies & Co.
Just to clarify on the backlog and new business, the $169 million that you're reporting, that is a net number, net of cancellations, is that correct?
Douglas S. Prince
That is our new business wins. So what we've got in the release, you can see our beginning backlog at the beginning of the quarter; you can see our new business wins. You can also subtract revenue, and then you can see what the difference is to ending backlog. And that difference would include cancellations, foreign exchange, and other adjustments.
David Windley - Jefferies & Co.
So foreign exchange was a fairly large positive adjustment in the quarter?
Douglas S. Prince
Yes, it was a bit positive there. And as Stephen commented earlier, really no cancellations to speak of within the quarter.
David Windley - Jefferies & Co.
Stephen, if I look back a year or so, your revenue base in Pharma Services was fairly similar to where it came out in this third quarter. Profitability was quite a bit different. You have taken at least one restructuring that you discussed on the call and taken some costs. You've been generally taking costs out of the business. So I guess my interest is in where have costs actually go into the business to make that same revenue base or a similar revenue base not as profitable now as it was a year ago?
Stephen DeFalco
So, David, there's a couple of factors at play, right? I would say that we've made investments in new systems. We've made investments in new facilities in Beijing in Phoenix. We've made big investments in our business development team, which you see in terms of the orders coming in. And obviously the business has normal things like inflation and whatnot which, you know, with a service business you have a pretty big salary component against it.
And so those investments and, you know, inflationary things have more or less cancelled out, I think, the benefit that we've gotten through the productivity and the restructuring and the improvement. I think though at this point we've got a good cost structure. We've got good processes. We've got customers coming back. The key to turn that into a revenue ramp is really the next step here in this process to drive the profitability.
And as I would say, I think that we miscalculated that. I think in early stage we're seeing that. It's working nicely. I think in late stage here we're a couple of quarters behind where we wanted to be, certainly where we thought we'd be, and so that's why we're doing the things we're doing. But, you know, I think we're pretty excited about turning those new business wins into revenue, particularly at the profitability that they were won at.
David Windley - Jefferies & Co.
On your headcount reductions, just a quick question on that one and then one more on the overall business. On the headcount reductions, are those or that plus other turnover that the business may be seeing having an effect on your ability to execute on projects? And then more broadly speaking on Pharma Services, how do you think about the business and systems and management team that you have in place for that business today relative to your ability to compete? Do you need to make acquisitions or, conversely, do you need to think about putting that business in the hands of a larger player in the industry that could perhaps leverage that infrastructure more fully?
Stephen DeFalco
I think in terms of our processes and capabilities, those are improving nicely. In terms of places where we took headcount out, it was really places where our lean sigma project had led to some pretty good productivity savings. And so we don't have any, you know, we're not taking headcount out where we have profitable business that needs to be executed. So I feel good about the projects in the pipeline and our ability to service them well. And I think the new business wins, I think, really talks to - call it our competitiveness, right? We wouldn't be winning business at that rate if clients didn't view us as a competitive offering and a place they wanted to do work.
I think the other part of your question, right, I would say again, I separate early stage - we're doing fine, we're competitive, we're of sufficient scale, and I think all of that's working pretty well. I think in late stage, you know, the issue for us is we focus on a spot in the market which is small pharma, big biotech. I think there we have been very successful, winning business. We have to turn it into revenue and profit which, you know, as I stated before.
I think, though, we miscalculated our ability to do that and we're off here by a quarter or two and we're going to have to go and really get that to ramp. So that's how I look at it.
Operator
Your next question comes from Douglas Miehm - RBC Capital Markets.
Douglas Miehm - RBC Capital Markets
Two questions. Number one has to do with the salespeople in the pharmaceutical service division. I curious as to how their bonused or commissioned and when they get paid relative to when they book this backlog. Do they get paid before the business is complete or do they have to wait to be bonused until next year when this business is complete?
Stephen DeFalco
Doug, you know, I think broadly we have a new head of business development who came in, Teresa Winslow. That group is all under a single leader. I think a very coordinated set of processes and procedures. The exact nature of their commission plans is not something we want to really discuss. We view that as somewhat confidential information.
But, you know, we've thought that through pretty carefully, and quite frankly we take a little different approach in a short-cycle business than in a long-cycle business, right? And so if they're booking business that's going to be executed over multiple months it might have change order parts and stuff like that, you know, you don't pay that commission all upfront. Quite frankly, if they're in more businesses where, you know, bookings turn into revenue on a shorter cycle, then we have different programs in place.
But, you know, they're very well aligned with what we want from a business results and from a shareholder perspective.
Douglas Miehm - RBC Capital Markets
So in effect MDS isn't bearing all the risk here, it's being equally distributed between the front sales force and the company and shareholders?
Stephen DeFalco
I would say the sales force incentives are well aligned to what we're trying to achieve here from a business results and a shareholder perspective.
Douglas Miehm - RBC Capital Markets
And they're in line with industry standards?
Stephen DeFalco
Yeah. I don't know how standard the industry is but, you know, it's a relatively new industry. So I don't know how standard it is from competitor to competitor. We get pretty good data on that because, you know, we have people who have worked at other companies before, so I think we look at that. But certainly nothing that's out of the market.
Douglas Miehm - RBC Capital Markets
I guess at the end of the day the only thing I'm asking there is what's the risk to us as investors when we look at these backlog numbers, how firm are they? Or are they just bookings that are being put in place that could ultimately be cancelled?
Stephen DeFalco
On, no. If that's the heart of your question, I mean, every single order that gets into our backlog goes through a scrutiny and an assessment by our financial team. It's very well understood. We have visibility into all of the future ones. We know the margin of that business. We participated in the decision whether or not to take that business at that margin. And so, no. There's a lot of formal procedures there.
Now can items in backlog be cancelled because the client's molecule, he decides not to develop it or, for example, he booked a Phase I project and the molecule failed in animal testing, yes, that can happen. That's part of the industry. Quite frankly, we market ourselves as helping our customers bring safe molecules to market quickly, but often what we do is help them to determine that that molecule has failed and they should work on another molecule, because most of these don't make it. So for those reasons projects get cancelled, but not for order integrity issues. We've never had any of that.
Douglas Miehm - RBC Capital Markets
The second one, a more general question sort of getting to the last question as well, when I think the market looks at the implied value of the various assets of this company - let's say especially the Pharma Services group when you look at it relative to other companies in the marketplace today - it honestly looks like there's a fairly significant discount between the implied value and where these things should trade if ultimately they can put up some good numbers. How over the next six to 12 months do you expect to help to close that discount to what people would see as net asset value? How would you expect to do that?
And getting back to the question around Pharma Services, at what point would you be unhappy with the late stage business that you would be willing to get rid of it?
Stephen DeFalco
Yes, I think, you know, Doug, you're asking a question in the wrong context, right, because you're asking a question about being happy and getting rid of something and that's not the context I would have, right?
I believe that we have a great opportunity to create value in businesses and that we're the right owner and we drive hard to deliver on that shareholder value. If at some point in time we determine that we are not the best to do that, we take action. You've known me for three years. You've seen us make a number of portfolio moves, both acquisitions and divestitures, which I think most shareholders would agree were very well executed and were done at very good prices. So I think that to me is kind of what determines it.
You know, I'm not happy where Pharma Services is right now, and so I think that that's pretty clear. And what we need to do is continue to drive. I'm very happy with the new business wins and, you know, I'm happy with the new systems and the customers who are using the services and turning that into repeat business. But, you know, we need to accelerate that EBITDA ramp there, and I think that we're on it.
Operator
We have a follow up question at this time from Lennox Gibbs - TD Newcrest.
Lennox Gibbs - TD Newcrest
Nordion, it's been a few months here since the fed's surprise announcement regarding the Maple reactor. I think we're pretty clear on the litigation strategy, but what can you tell us with respect to contingencies you may be considering on the operating side? And we're aware, obviously, that there are some [inaudible] in the U.S. who claim to have alternate moly technology. Is that a route that you might consider?
Stephen DeFalco
So, Lennox, absolutely we would consider it. We're in discussions with everyone in the industry, right? And so, you know, I want to make it clear we're not part of AECL. We're a separate company and what we do is take processed moly and turn it into a pharmaceutical product and then work in the distribution and logistics of it.
So yeah, any new opportunities there are in the world to source moly would be things that we would have conversations on. And, quite frankly, most of those people would come to talk to us given our position in the industry.
But, you know, I think, as I said before and I'll say again, I think in the short to medium term, we're fine. We're connected to the world's most reliable reactor. It has great capability and that's a business we've built over the years. I think what we're really trying to do is solve a longer-term issue here that's a little further out. And on that, yeah, we're looking at all possibilities because I think just the situation we're in would dictate that as the prudent course.
Operator
You have a follow up question from Maher Yaghi - Desjardins Securities.
Maher Yaghi - Desjardins Securities
I just have a follow up question also on Nordion. You mention in the press release that you're evaluating the carrying value of the Maple reactor on your balance sheet. Can you maybe just give us a bit more clarity about what determines, in your judgment, the timing, if any, that you might have to decide to write-down the $336 million in the Maple reactor on your intangible assets?
Douglas S. Prince
On that question, the intangible asset is related to the Maple supply. And as we say in the disclosure, our belief is that the contract requires a sale to complete that Maple project, hence the arbitration.
So I think we're going to have to watch how the arbitration develops over the coming months and then we'll make a call as appropriate, based on the outcomes.
Maher Yaghi - Desjardins Securities
If the arbitration goes to court and we take the next step to go to court, is that a trigger point for that test?
Stephen DeFalco
No, that would not be a hard trigger point. I mean, our perspective is we have a contract. The contract says they need to complete that facility and provide 40 years' worth of supply. And so, you know, if at some point we view that as not the position, that would then, you know, determine some other thinking about that.
But it's not arbitration to court. It's arbitration on a set of issues, court on a set of other issues.
Operator
Your last follow up question is from David Martin - Dundee Securities Corporation.
David Martin - Dundee Securities Corporation
In the late stage, obviously, you referred to some delayed projects in the central lab in the Phase II to IV business. I'm wondering, I guess that's a number of projects. If you took the three biggest of them, when do you think those projects will get started or [break in audio] lost indefinitely? And [break in audio] get started, one kind of revenue and EBITDA contribution do you expect from the top three projects collectively on a quarterly basis?
Stephen DeFalco
David, we're not going to go into that level of depth on three specific customer situations. And, quite frankly, we always are managing this number of situations. And then, you know, differences of a couple of weeks can affect a quarter, so they're very hard to estimate, the exact start date. And obviously, it's mostly tied to our clients getting regulatory approval from their last milestone in order to proceed with this project. And so we monitor that pretty closely.
David Martin - Dundee Securities Corporation
So a majority of what you're talking about here is definitely short-term delays, then?
Stephen DeFalco
As we have current information, it's short-term delays. And, quite frankly, tomorrow we could hear that we have a brand-new order that's coming in that's a rush job, they want us to start immediately, and the day after that we can hear that one of our clients got acquired and the new owner doesn't want to go forward with that molecule. And I think that's part of the industry we're in and, quite frankly, part of the value we supply to our clients is to make that a variable cost. And so it's a bit of a changing environment that we manage. I think unfortunately in Q2 and Q3 here we've had a couple of big ones that have sort of impacted us pretty hard in late stage.
Operator
Thank you. There are no further questions registered at this time, so I'd like to return the meeting back to Ms. Lee.
Kim Lee
Thanks, Joe. Thank you all for joining us this morning. If you have any additional questions, please do not hesitate to give me a call. Thanks again and have a nice day.
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