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Industry Report Healthcare June 20, 2007 Opportunities In Orthopaedics Recommendations: ORTHOsoft Inc. Buy (S) BioSyntech Inc. Buy (S) Catherine Bouchard, MSc, MBA Healthcare Analyst (514) 350-2938 [email protected] Industry Report – Healthcare Opportunities In Orthopaedics Investment Summary ............................................................................................................................ 2 ORTHOsoft Inc. (OSH-V) ......................................................................................................................... 3 Investment Thesis .................................................................................................................................. 4 Company Profile..................................................................................................................................... 4 Objectives & Strategy ............................................................................................................................ 6 Competitive Analysis.............................................................................................................................. 7 Management Profile ............................................................................................................................... 9 Recent Results..................................................................................................................................... 10 Financial Forecast................................................................................................................................ 11 Valuation .............................................................................................................................................. 13 Sources of Risk .................................................................................................................................... 13 Financial Statements ........................................................................................................................... 16 BioSyntech Inc. (BSY-T) ................................................................................................................... 19 Investment Thesis ................................................................................................................................ 20 Company Profile................................................................................................................................... 20 Objectives & Strategy .......................................................................................................................... 22 Competitive Analysis............................................................................................................................ 23 Management Profile ............................................................................................................................. 24 Recent Results..................................................................................................................................... 25 Financial Forecast................................................................................................................................ 26 Valuation .............................................................................................................................................. 28 Sources of Risk .................................................................................................................................... 28 Financial Statements ........................................................................................................................... 30 Appendix I – Orthopaedic Backgrounder............................................................................................ 33 Appendix II – Computer Assisted Surgery ......................................................................................... 35 Appendix III – Cartilage Regeneration Market .................................................................................... 40 Appendix IV- Chronic Wound Care Market ......................................................................................... 44 Appendix V – Important Disclosures................................................................................................... 45 Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 1 June 20, 2007 Opportunities In Orthopaedics Investment Summary We believe the global orthopaedic industry offers attractive opportunities. Musculoskeletal conditions represent the most frequent cause of disability, and every segment of the orthopaedic market, which neared US$26 billion in 2005, is experiencing solid growth. Key drivers behind this growth include an aging, more active and longer-lived population, an increasing prevalence of obesity, and the introduction of new technologies that expand application of orthopaedic procedures to younger age groups or that allow minimally invasive surgery. We are initiating coverage on the following two companies in this report: • ORTHOsoft Inc., rated a Speculative Buy with a one-year share price target of $1.50, implying a total return of 150%. ORTHOsoft develops and markets computer assisted orthopaedic surgery (CAOS) navigation systems, which help surgeons to track instruments and implants in real time during surgical procedures. CAOS navigation systems optimize the positioning of the devices used during the operations, therefore improving the surgeon’s precision and the patient’s outcome. ORTHOsoft is well positioned to benefit from the opportunities in the orthopaedic market. It offers a line of products with multiple competitive advantages through an expanding distribution network based on a direct sales force and strategic partnerships. We believe the company should experience strong revenue growth in 2007. • BioSyntech Inc., rated a Speculative Buy with a one-year share price target of $1.00, implying a total return of 89%. BioSyntech develops advanced biotherapeutic thermogels designed for tissue repair and delivery of therapeutic agents. The company’s products are all based on BST-Gel, a unique technology platform. BioSyntech is well positioned to benefit from the opportunities in the cartilage regeneration, the chronic wound care and the chronic heel pain markets. The company is developing safe, groundbreaking products targeting unmet medical needs. Its lead products, BST-CarGel and BST-DermOn, should get marketing approval in 2009. Moreover, BioSyntech continues to seek additional alliances worldwide to benefit from existing sales and distribution channels. The company has already signed two agreements with pharmaceutical companies in Asia. Exhibit 1 - Company Ratings And Recommendations Company Ticker Rating* Last 6/20/2007 1-Yr Target Dividend ROR ORTHOsoft Inc. BioSyntech Inc. OSH-V BSY-T B (S) B (S) $0.60 $0.53 $1.50 $1.00 $0.00 $0.00 150% 89% * B (S) = Buy (Speculative) Source: Bloomberg; Laurentian Bank Securities (LBS) estimates. Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 2 June 20, 2007 ORTHOsoft Inc. (OSH-V) Buy (S) – Target Price: $1.50 Company Profile ORTHOsoft is a leader in the computer assisted orthopaedic surgery (CAOS) navigation systems market. The company develops and distributes medical software, instruments and computerized systems to assist orthopaedic surgeons in knee, hip, and spine surgery. We are initiating coverage on ORTHOsoft with a Speculative Buy rating and a one-year share price target of $1.50. This implies a total return of 150%. Our target is based on a DCF using a WACC of 11.5%. We have a share risk rating of High. We highlight the following: Source: BigCharts.com Ticker Rating Risk Price 1-Yr Target Dividend 1-Yr ROR 52-Wk High-Low Next Reporting Valuation Market Data OSH-V Shares O/S (M) Buy (S) Market Cap (M) High Float O/S (M) $0.60 Float Value (M) $1.50 Avg Daily Volume (K) $0.00 Control Blocks 150% Voting $0.84-$0.34 Equity Management August 31, 2007 DCF; WACC 11.5% Fully Diluted EPS (December 31 Year End) Q1 Q2 Q3 Q4 F2006 ($0.02) A ($0.03) A ($0.01) A ($0.03) A F2007 ($0.04) A ($0.03) ($0.02) ($0.01) F2008 F2009 51.1 $30.6 51.1 $30.6 33.5 21.5% 22.6% Annual ($0.09) ($0.09) ($0.02) $0.05 1. Opportunities in the orthopaedic navigation market: Due to demographic changes and increasing popularity of minimally invasive surgeries (MIS), the market is expected to grow at a CAGR of 50% from 2006 to 2010. 2. Competitive advantages: ORTHOsoft is the only company to specialize exclusively in CAOS navigation systems. Thus, it is well positioned to develop a strong relationship with orthopaedic surgeons. ORTHOsoft offers cost-effective, userfriendly solutions with the most accurate optical trackers on the market, the new NavitrackER. 3. Product mix change: ORTHOsoft has stopped offering development services and now focuses on increasing its installed base and recurring revenues. The latter, which include pay per use and disposable components of the systems, should provide higher margins, economies of scale, more predictable and less cyclical revenues, and surgeon loyalty. 4. Two-pronged sales and distribution strategy: ORTHOsoft has nine strategic partners, including Zimmer and Smith & Nephew. The company is also building its own sales force, with 26 sales representatives targeting key regions where orthopaedic procedures are expected to increase. 5. Strong management team: The CEO, who owns 21.5% of the company, has a solid technological and medical background, which allows him to really understand the needs in the orthopaedic market. The new COO has more than 25 years of experience in building distribution networks and sales forces. 6. Less than 8 months of cash: As of March 31, 2007, ORTHOsoft had only 7.7 months of cash. However, the cash burn rate is expected to decrease in the upcoming quarters. EBITDA (millions) F2006 ($0.5) A ($1.0) A ($0.4) A ($1.1) A F2007 ($1.9) A ($1.2) ($0.6) ($0.2) F2008 F2009 Source: Company reports; Thomson One; LBS estimates. Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] ($3.0) ($3.8) $0.1 $3.7 3 June 20, 2007 Opportunities In Orthopaedics ORTHOsoft Inc. Buy (S), Target $1.50 We are initiating coverage on ORTHOsoft with a Speculative Buy rating and a one-year share price target of $1.50. This target implies a 150% return from current levels and is based on a discounted cash flow model. We have a share risk rating of High. Investment Thesis Strong Growth In 2007 ORTHOsoft should experience strong revenue growth in 2007. The company is well positioned to benefit from the opportunities in the orthopaedic market. It offers CAOS navigation products with multiple competitive advantages through an expanding distribution network based on a direct sales force and strategic partnerships. Company Profile Leading Provider Of CAOS Navigation Systems Founded in 1995, ORTHOsoft develops and markets CAOS navigation systems with knee, hip and spine applications. CAOS navigation systems help surgeons to track instruments and implants in real time during surgical procedures. They optimize the positioning of the devices used during the surgery therefore improving the surgeon’s precision and the patient’s outcome. The ORTHOsoft line of products include (Exhibit 2): Exhibit 2 - ORTHOsoft's CAOS Navigation System Sesamoid NavitrackER Universal Knee Interface Source: Company reports. Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 1. Navitrack TotalKnee: ORTHOsoft’s knee navigation system assists surgeons in determining the mechanical and rotational axis of the patient’s leg during total knee replacement surgery. This system is imageless (it does not require any CT images prior to surgery) and compatible with most types of knee implants. 2. Navitrack TotalHip: ORTHOsoft’s hip application guides surgeons in positioning implants during total hip replacement. The Navitrack TotalHip is imageless and can be used in supine and lateral patient position. 4 June 20, 2007 Opportunities In Orthopaedics 3. Navitrack FluoroSpine: ORTHOsoft’s FluoroSpine imageless system assists surgeons in positioning pedicle screws to help reduce spinal implant misplacement. 4. MIS Hip Navigation System: This application provides information on cup positioning in the radiologic reference system routinely used by surgeons. MIS Hip is compatible with a number of hip implants. 5. CAS Platform and instruments: Every Navitrack product comes with a Navitrack medical cart system (including an optical tracking device). This CAOS platform was designed to be ergonomic, user-friendly and to reflect today’s operating room needs. ORTHOsoft has recently launched the next generation Navitrack Sesamoid, a streamlined, small and highly transportable platform. Navitrack software applications and surgical instruments can be used on platforms other than ORTHOsoft’s system. The company also offers specialized instruments and tracking arrays for CAOS. ORTHOsoft is the third largest CAOS navigation system provider in North America and Europe. The company has currently 250 working sites in the world and employs over 80 people. Since 1996, more than 60,000 orthopaedic procedures were performed with the company’s navigation systems. ORTHOsoft generated $12.7 million in revenues in 2006. The revenue mix by category has changed significantly over the last quarters (Exhibit 3). Development services revenues have continuously decreased since Q2/2005 and reached zero during Q1/2007. This was partly offset by a 75% increase in recurring revenues (payper-use and disposable components) year over year (YOY). During Q1/2007, the company sold 53% of its products in Europe, and 45% in US. Exhibit 3 - Revenue Mix By Category 100% 36.0% 80% 60% 40% 49.6% 20% 14.4% 0% Q1/2006 Source: Company reports. Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] Q2/2006 Q3/2006 Q4/2006 Development Services Hardware Q1/2007 Software Applications Recurring Revenues 5 June 20, 2007 Opportunities In Orthopaedics Objectives & Strategy Specialized, Innovative, And Focus On Aggressive Distribution ORTHOsoft’s objective is to become a global leader in providing easy to use, safe and cost-effective computer assisted surgery (CAS) solutions to orthopaedic surgeons. The company’s goal is to establish CAS as the standard of care in orthopaedic procedures. Management’s strategies include: • Focus on orthopaedic procedures: ORTHOsoft is the only company in the world to specialize exclusively in CAOS navigation systems. The management believes that focusing solely on orthopaedics allows the company to better address the needs of orthopaedic surgeons and differentiates them from their competitors. ORTHOsoft’s sales representatives are CAOS experts and can therefore give rapid and accurate answers to surgeons, whereas a general CAS vendor would often need to ask a technician before answering a customer. • Innovation: ORTHOsoft invests in R&D in order to offer cutting edge, easy to use and affordable solutions that improve clinical accuracy and patient outcomes. To respond to the precise needs of orthopaedic surgeons, ORTHOsoft’s R&D team works closely with surgeons and is lead by Dr. Amiot, ORTHOsoft’s CEO, who is also a practicing surgeon. Furthermore, sales representatives gather feedback from leading orthopaedic surgeons regarding ORTHOsoft’s products. According to management, working with surgeons allows ORTHOsoft to offer first-in-class solutions, to build credibility, to increase market penetration, and to successfully compete against existing and future CAS technologies. • Recurring revenues: ORTHOsoft encourages pay-per-use as the mode of payment since public hospitals usually prefer this method to large capital expenditures. Pay-per-use also allows the surgeons to try the product before the hospital makes the commitment to buy the installed base. ORTHOsoft’s strategy is also to increase the disposable components of its Navitrack systems to increase recurring revenues (Exhibit 4). The benefits of such strategy include higher margins, economies of scale, more predictable and less cyclical revenues, as well as development of surgeon loyalty. Recurring Revenues ($M) Exhibit 4 - Recurring Revenues (Q3/2005 to Q1/2007) 1.0 Compound Quarter Growth Rate = 23% 0.8 0.6 0.4 0.2 0.0 Q3/2005 Q4/2005 Q1/2006 Q2/2006 Q3/2006 Q4/2006 Q1/2007 Source: Company reports. • Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] Aggressive distribution strategy: ORTHOsoft is pursuing a two pronged distribution strategy to maximize its potential earnings. First, the company has 6 June 20, 2007 Opportunities In Orthopaedics established a network of partnerships with leading orthopaedic implant manufacturers, including Zimmer, Smith & Nephew, and small to medium sized orthopaedic distributors. The company expects to add three more partners in the near future. The major benefits of such alliances are access to distribution channels and co-marketing. ORTHOsoft is also building a direct sales force. Twenty-six sales representatives now work exclusively for ORTHOsoft and target five key regions (California, Florida, New York, Texas, and the North-Eastern area) where demographics imply an increasing prevalence of orthopaedic procedures. Furthermore, ORTHOsoft focuses on key hospitals and orthopaedic opinion leaders. The advantages of this strategy are to develop a long-term relationship with surgeons (key decision makers in the buying process), to expand the number of specialists using CAOS in each hospital, and to generate recurring revenues. Competitive Analysis The CAOS Navigation Systems Market: Growing And Concentrated The CAOS navigation systems market is expected to grow at a rapid rate in the upcoming years (Appendix II). This is mainly due to demographic changes, increasing prevalence of obesity, younger patients considering orthopaedic procedures, increasing popularity of minimally invasive surgery (MIS), and introduction of new technologies and applications. However, the market is highly concentrated (Exhibit 5). The five largest players hold an aggregate market share of 95%, with ORTHOsoft being the third largest CAOS navigation systems provider. Competition between these companies is based on product characteristics (accuracy, ease of use, functionality), customer support, price, scope and effectiveness of sales and marketing efforts. Exhibit 5 - CAOS Navigation Systems US Market Share In Units Sold (2006) Praxim 2.6% Kinamed Plus Ortho. 1.0% 1.3% BrainLAB 37.1% Aesculap 10.0% Medtronic 10.6% ORTHOsoft 18.1% Stryker 19.4% Source: Millennium Research Group. ORTHOsoft’s Value Proposition ORTHOsoft’s competitive advantages include: 1. Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] Easy to use navigation systems: The Navitrack Sesamoid has a touch screen and a laser aiming device that reduces the surgeon’s movements between the computer and the patient. ORTHOsoft’s systems also include an user-friendly, step-driven interface with images and short animations that demonstrate key tasks to be performed at each step. In addition, ORTHOsoft has recently 7 June 20, 2007 Opportunities In Orthopaedics developed the On-Site, a palm-pilot that controls the computer from a distance (patent pending). This device further reduces the surgeon’s movements in the operating room and stores operative data. Other Key Benefits Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 2. Accurate optical trackers: ORTHOsoft uses optical tracking devices, which are considered more accurate and easier to use than electromagnetic devices. Recently, the company launched an improved version of these trackers, the NavitrackER, including nine optical surfaces instead of three spheres (patent pending). This unique product offers advanced resistance to loss of sight from tissue or liquid stains, has the smallest relative distance error, and thus significantly increases visibility and accuracy compared to other technologies. 3. Compact and highly transportable platform: The Navitrack Sesamoid is the smallest CAS platform available on the market. This characteristic is important for surgeons and hospital administrators since operating rooms are usually numerous and cramped. 4. High-quality service and technical support: ORTHOsoft is the only company in the world to specialize exclusively in CAOS navigation systems. The company is building a direct sales force of highly specialized vendors to give an excellent service and develop a strong, long-term relationship with orthopaedic surgeons, a key factor for success in the market. On the other hand, surgeons usually prefer to limit the number of additional technicians present in the operating room during the procedure. Since ORTHOsoft’s sales representatives are CAOS experts, the presence of an additional technician or the implant vendor is not necessary during the procedure. Furthermore, because the Navitrack solution is user-friendly, surgeons do not usually require further assistance after the initial 10 cases. Other navigation systems (ex. BrainLAB’s VectorVision) are often complicated, and may require a longer training process. 5. Partnerships: ORTHOsoft has currently nine partners. Alliances are a key factor for success in the CAOS navigation systems market since companies gain access to large distribution channels, and potential co-marketing agreements. ORTHOsoft’s products have other characteristics that are essential in the CAOS navigation systems market and common to the major players: 1. Imageless solution: ORTHOsoft’s major products do not require pre- or intraoperative imaging and therefore reduces radiation exposure, operation time, and cost. However, imageless systems are considered slightly less accurate than image guided surgery systems. 2. Universal platform: ORTHOsoft offers a universal platform that is designed to work with any orthopaedic implants. Universal systems are preferred to closed systems by hospitals since they can satisfy several surgeons’ preferences for different implants and are therefore more economic. 3. Affordability: The cost of ORTHOsoft’s installed base ($200,000-250,000) is comparable to the cost of other navigation systems. In addition, ORTHOsoft encourages pay-per-use as the mode of payment since public hospitals usually prefer this method to large capital expenditures. We note that, on either a payper-use or an asset purchase basis, the average cost is $1,000 per procedure. 8 June 20, 2007 Opportunities In Orthopaedics Management Profile Experienced Management Team ORTHOsoft’s CEO owns 21.5% of the company and thus, we feel his interests are aligned with those of the shareholders (Exhibit 6). Key executives include: • Louis-Philippe Amiot, MD, FRCSC, MSc (Eng) - Chairman and CEO: Dr. Amiot founded ORTHOsoft in 1995. He also acts as the R&D Director and performs about two operations per month. Dr. Amiot completed orthopaedic surgery training in 2000 and pursued a Fellowship in Spine Surgery at the Johns Hopkins University Hospital from July 2000 to July 2001. In 2004, Dr. Amiot was honoured by the Young Chamber of Commerce as Quebec's Entrepreneur of the year. Dr. Amiot received his degree in Electronic Engineering in 1988, and worked for Bell Northern Research from 1988-1991 as a software developer and also in video-teleconferencing codecs hardware development. • Peggy Katsiroumbas, CA - CFO: Ms. Katsiroumbas’ professional experience was acquired at Deloitte & Touche where she worked in the technology, telecommunications and manufacturing sectors. Ms. Katsiroumbas was responsible for managing various audits, due diligence and special engagements. • Yvan Beaudoin, BSc, MBA - COO: Mr. Beaudoin started with ORTHOsoft in March 2003. He has been VP Sales & Marketing from January 2004 to January 2007, Interim COO from January to March 2007, and COO since March 2007. Mr. Beaudoin has over 25 years of experience in the biomedical industry, building distribution networks and sales forces. He worked as a senior executive for Ansell and American Cyanamid. The shares of ORTHOsoft are widely held (Exhibit 6). As of April 24, 2007, only the CEO, SGF Santé and Centerpulse AG, a division of Zimmer, owned or controlled more than 10% of the common share outstanding. Other institutions include AGF Management Limited, Mavrix, Sprott Assett Management, and Fonds de Solidarité FTQ. Exhibit 6 - ORTHOsoft Ownership (As of April 24, 2007) Retail 25.0% CEO 21.5% Other Directors 1.1% Centerpulse 12.4% SGF Santé 19.0% Other Institutions 21.0% Source: Company reports. Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 9 June 20, 2007 Opportunities In Orthopaedics Recent Results A Difficult But Predictable First Quarter On March 31, 2007, ORTHOsoft reported disappointing Q1/2007 results. Highlights include the following: • Revenues were $2.5 million in Q1/2007 compared to $2.4 million in Q1/2006. This modest growth (6.2% YOY) is due to the increase in hardware and recurring revenues (9.1% and 75.2% YOY respectively) offset by the decrease in software applications and development services revenues (-30.7% and -100% YOY respectively). CAOS systems revenues were down mainly because of postponed sales to a strategic partner, which committed to $2.5 million in minimum purchases for 2007. We note also that the first quarter is usually the weakest of the year since it is the budget period in hospitals. Development services revenues were null as part of ORTHOsoft’s business strategy. • EBITDA has declined to –$1.9 million in Q1/2007, from -$0.5 million in Q1/2006. This reduction is partly attributable to a smaller gross profit margin caused by the higher cost of production overhead as the company is preparing for the scaling of activities in the next months. In addition, R&D expenditures were up by 83.9% YOY due to the development of the NavitrackER and other strategic technologies. Finally, the development of the direct sales force resulted in a significant increase in sales and marketing expenses (103.8% YOY). • Net earnings were -$2.0 million in Q1/2007 (-$0.04 per share) compared to -$0.7 million in Q1/2006 (-$0.02 per share). Since it went public in 2004, ORTHOsoft has not generated positive net earnings. Nevertheless, the company’s shares have outperformed the Canadian healthcare sector since October 2006 (Exhibit 7). ORTHOsoft also outperformed the Canadian medical device sub-sector from September 2006 to April 2007. However, since the beginning of May, ORTHOsoft has underperfomed the MD Index. • As of March 31, 2007, ORTHOsoft had 7.7 months of cash. During Q1/2007, the company had a burn rate of about $0.81 million per month. Working capital for the quarter was $7.9 million. ORTHOsoft did not issue any common shares during the quarter. Exhibit 7 - Relative Stock Price Performance (June 2005-Present) 2.0 1.5 1.0 0.5 0.0 Jun-05 Oct-05 S&P/TSX Feb-06 Jun-06 S&P/TSX Health Care Oct-06 OSH Feb-07 Jun-07 MD* *MD is a market-weighted index of the major Canadian medical devices companies. Source: Bloomberg; LBS. Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 10 June 20, 2007 Opportunities In Orthopaedics Financial Forecast Poised For Revenue Growth We believe ORTHOsoft will experience a significant increase in sales during the next four years. Indeed, we forecast revenue growth of 34% in 2007E, 89% in 2008E, 62% in 2009E, and 44% in 2010E (Exhibit 8). This is mainly due to: • Growing new hardware/software sales. ORTHOsoft has currently 250 working sites and we believe this number should significantly increase as a result of the aggressive distribution strategy and the improved credibility of the company. ORTHOsoft has nine distribution and co-marketing partners, and expects to establish three new alliances in the near term future. It is also worth noticing that one of ORTHOsoft’s partners committed to purchase $2.5 million of products during 2007 ($0 in Q1/2007). In addition, ORTHOsoft is building its direct sales force. The company has hired 26 sales representatives and this number should reached 30 before year-end. We should see the effect of this strategy on revenues during the second half of the 2007. • Significant growth in recurring revenues. We believe ORTHOsoft will successfully implement its strategy to increase its recurring revenues from its installed base. The CAOS navigation systems market having a lengthy sale cycle (typically one every five years), recurring revenues should smooth the results. They should also develop the surgeon’s loyalty. Furthermore, ORTHOsoft should generate important revenues with its NavitrackER, a groundbreaking tracker that surgeons might require no matter what navigation system they use. • Opportunities in the CAOS navigation systems market. Because of its numerous competitive advantages, we believe that ORTHOsoft is well positioned to benefit from the increasing popularity of CAOS. The orthopaedic navigation market is the least developed segment of the CAS market and is expected to grow at a compound annual rate (CAGR) of 50% from 2006 to 2010 (Appendix II). This major growth supports our revenue forecasts for ORTHOsoft. The major barrier to adoption that we see is the lack of reimbursement for orthopaedic navigation. However, this problem could be resolved in 2008 as health care plans might start to fully reimburse orthopaedic navigation. Exhibit 8 - ORTHOsoft Revenue Outlook ($M) Hardware Software Recurring Services Total 2006 6.7 2.9 2.5 0.6 12.7 2007E 8.7 3.4 4.8 0.0 16.9 2008E 15.6 7.6 8.9 0.0 32.0 2009E 25.8 12.4 13.6 0.0 51.7 2010E 41.2 16.5 16.9 0.0 74.6 Source: Company reports; LBS estimates. Break-even by 2008E Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] ORTHOsoft has never generated positive EBITDA (Exhibit 9). According to our estimates, EBITDA should improve over the next years. Major drivers behind this include: 11 June 20, 2007 Opportunities In Orthopaedics • Higher margins due to product mix change: ORTHOsoft has stopped offering development services to its partners, which generated low gross margins. The pay-per-use and the disposable products (including the NavitrackER) should generate higher gross margins and economies of scale. In the upcoming years, we believe the company will be able to maintain a 65% gross margin. • R&D as part of the business strategy: ORTHOsoft invests in R&D in order to offer first-in-class and cost effective products. We forecast modest growth YOY in R&D expenses. • Boost in sales and marketing expenses: We believe sales and marketing expenses will grow at a rapid pace, particularly in 2007, as a result of ORTHOsoft strategy to build a direct sales force. On an annual basis, we forecast approximately 30% of revenues will be spent in sales and marketing efforts during the next four years. • Stable general and administrative expenses: We do not believe that general and administrative expenses will experience significant growth in the next few years. They should remain at about 15% of revenues. ($ million) Exhibit 9 - ORTHOsoft EBITDA Outlook 10 8 6 4 2 0 -2 -4 -6 2004 2005 2006 2007E 2008E 2009E 2010E Source: Company reports; LBS estimates. We believe ORTHOsoft will be profitable by 2008E year-end. The company should not have income taxes payable in the next four years. As of December 31, 2006, ORTHOsoft had losses carried forward of about $6.1 million and R&D expenditures carried forward of about $17.4 million, which can be used to reduce future taxable income. The company also had investment tax credits of about $2.2 million, which can be applied against future federal income taxes payable. ORTHOsoft should also be free cash flow positive by 2009E. As the company develops new products and manufactures them in house, we expect regular capital expenditures (about $1.2M per year). Low Liquidity Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] As of March 31, 2007, ORTHOsoft had only 7.7 months of cash. However, we expect a significant a reduction of the cash burn rate in the upcoming quarters. Therefore, the company may be able to sustain its activities for more than eight months. We note that ORTHOsoft has no debt on its balance sheet. 12 June 20, 2007 Opportunities In Orthopaedics Valuation Target of $1.50, Total Return of 150% We rate the shares of ORTHOsoft a Speculative Buy with a one-year share price target of $1.50, implying a total return of 150%. This is based on a discounted cash flow using a weighted average cost of capital (WACC) of 11.5% (Exhibit 10). Since the company has no debt, we based our calculation on the cost of equity, which is 9.5% (according to Thomson One, ORTHOsoft has a beta of 0.89). We then added a premium of 2% to take into account the additional risks associated with a small Canadian capitalization with low liquidity and low trading volume. Exhibit 10 - Valuation $ (Million) EBIT(1-Tax Rate) + Depreciation + Deferred Taxes - Capex - Additions to W/C = FCFF = / = Terminal Value PV of Equity BV Net Debt BV Prefs PV of Equity Share O/S Equity Value Per Share 76.6 = 0.0 0.0 76.6 51.1 1.50 2007E (4.8) 0.9 0.0 1.6 (0.2) (5.3) Term. 2008E 2009E 2010E Year (1.0) 2.6 6.8 12.9 1.1 1.1 1.2 1.2 0.0 0.0 0.0 0.0 1.7 1.8 1.8 1.8 0.5 0.8 1.1 1.9 (2.2) 1.1 5.1 10.4 (4.8) 125.4 79.0 (1.7) 0.8 3.3 Source: LBS estimates. Sources of Risk Absence Of Profitability Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] Since inception, ORTHOsoft has not realized any profit. Future profitability depends on: • Revenues will vary based on the speed at which new technology is accepted by the medical community and patients. There are numerous barriers to adoption in the CAS navigation systems market including the lack of long-term data, long preoperative planning process, and lack of additional reimbursement (Appendix II). Lack of adoption could adversely impact ORTHOsoft’s revenues. • The market is characterized by frequent new technology introductions and by lengthy and unpredictable sales cycles. One of the risks is that the company will be unable to develop innovative, useful technologies, and strong relationships with orthopaedic surgeons. However, we note that the process is successful at this time. 13 June 20, 2007 Opportunities In Orthopaedics • New sales and distribution strategy. ORTHOsoft made the transition from a business that was essentially based on guaranteed revenues with an exclusive partner to selling applications through multiple partners and a direct sales force. This change in strategy reduces the risk of being dependant upon a small number of customers. ORTHOsoft currently has nine distribution and co-marketing partners. However, there is no assurance that these partners will be successful in growing sales or that they will not change their strategies and make alliances with ORTHOsoft’s competitors. ORTHOsoft is also building a direct sales force. The company has little experience in establishing a sales force and evaluating the costs associated to it. However, we note that the new COO has more than 25 years of experience in building distribution networks and sales forces. • Performance of key executives. ORTHOsoft’s success depends on the management’s capacity to create value to the stakeholders, and their ability to attract and retain highly skilled personnel. Furthermore, we believe the CEO plays a very important role in the company and his departure could negatively impact ORTHOsoft’s future profitability. Competition ORTHOsoft operates in a single market. The CAOS navigation systems market is growing and becoming increasingly competitive. Some of ORTHOsoft’s current and future competitors have greater resources, wider customer base, and more extensive sales channels. They may develop and market products that would reduce ORTHOsoft’s competitive advantages and market share. Increasing competition could also result in a price war, which would negatively impact ORTHOsoft’s revenues. Dependence On Single Source Suppliers ORTHOsoft is dependent on small number of suppliers for certain products and components. The loss of any of these suppliers or their inability to adequately supply ORTHOsoft could negatively impact the company’s business. In addition, this dependency limits ORTHOsoft’s control over price, availability, quality and delivery schedules. International Operations ORTHOsoft’s derives a significant portion (99% in Q1/2007) of its revenues from USA and Europe. The major risks of having business operations outside Canada include: • A large portion of ORTHOsoft’s revenues may be affected by changes in exchange rates. Since ORTHOsoft’s cost are usually payable in Canadian dollars, the company’s net earnings are therefore subject to foreign currency risk. • Trade barriers imposed by foreign countries. • Limited or unfavourable intellectual property protection. • Potential adverse tax consequences. • Seasonal reductions in business activity during the summer months in Europe. • Recessionary environments in foreign economies. Ability To Raise Funds As of March 31, 2007, ORTHOsoft had only 7.7 months of cash. The company may be forced to seek additional financing in order to support its activities or take advantage of unanticipated opportunities. However, there is no assurance that the company will successfully raise additional funds. Conflict of Interests Centerpulse (Zimmer) holds more than 10% of ORTHOsoft’s common share outstanding and is also a major customer of the company. We note Mr. Paul Hickey, a senior officer of Zimmer, is also a director of ORTHOsoft. Situations may arise where the interests of Zimmer will be in direct conflict with the interests of ORTHOsoft. Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 14 June 20, 2007 Opportunities In Orthopaedics Intellectual Property ORTHOsoft relies on patents, trademarks, and other laws to protect its intellectual property. However, there can be no assurance that these laws will adequately protect the company’s property technology from misappropriation by another company. There is also a risk that ORTHOsoft’s current or future products may unintentionally infringe upon third-party proprietary technology. Regulatory Issues ORTHOsoft’s products are subject to regulation as medical devices. Failure to comply with applicable regulatory requirements could have a material adverse effect on ORTHOsoft’s results. Product Liability and Insurance ORTHOsoft is subject to the risk that it will incur product liability claims. No assurances can be given that the insurance coverage limits of ORTHOsoft are adequate to protect it against product liability claims that may arise. Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 15 June 20, 2007 Opportunities In Orthopaedics Financial Statements Exhibit 11 - ORTHOsoft Inc. Income Statement (F2004-2010E) Fiscal Year Ending December 31 ($Millions, except per share amounts) 2004 2005 2006 Revenue Cost Of Sales General & Administrative Expenses Sales & Marketing Expenses Research & Development Expenses Foreign Exchange Loss (Gain) EBITDA 9.5 3.5 3.2 2.6 4.4 0.2 (4.5) 10.2 3.5 2.7 2.8 3.8 (0.0) (2.6) 12.7 4.1 3.1 4.2 4.3 (0.1) (3.0) 2.5 1.0 0.3 1.5 1.5 0.0 (1.9) 3.5 1.2 0.5 1.5 1.4 0.0 (1.2) 5.1 1.8 0.8 1.8 1.4 (0.0) (0.6) Amortization Interest Expense (Income) Special Items EBT 0.7 0.6 0.0 (5.7) 0.7 (0.1) 0.0 (3.2) 0.9 (0.1) 0.0 (3.8) 0.2 (0.1) 0.0 (2.0) 0.2 (0.0) 0.0 (1.4) Current Tax Future Tax Net Earnings (1.5) (0.0) (4.2) 0.0 0.0 (3.2) 0.0 0.0 (3.8) 0.0 0.0 (2.0) After-Tax (Addback) Of Special Items Net Earnings B. Special Items 0.0 (4.2) 0.0 (3.2) 0.0 (3.8) 0.0 (2.0) Dil. EPS From Cont Ops B. Sp. Items Diluted EPS Weighted Average S/O - Basic (M) Weighted Average S/O - Diluted (M) Q1/07 Q2/07E Q3/07E Q4/07E 2007E 2008E 2009E 2010E 5.9 2.0 0.9 1.8 1.5 (0.1) (0.2) 16.9 6.0 2.5 6.5 5.7 (0.0) (3.8) 32.0 11.2 4.8 9.6 6.3 (0.0) 0.1 51.7 18.1 7.8 15.5 6.6 (0.0) 3.7 74.6 26.1 11.2 22.4 7.0 (0.0) 8.0 0.3 0.0 0.0 (0.9) 0.3 0.0 0.0 (0.5) 0.9 (0.1) 0.0 (4.7) 1.1 0.1 0.0 (1.1) 1.1 0.1 0.0 2.5 1.2 0.0 0.0 6.8 0.0 0.0 (1.4) 0.0 0.0 (0.9) 0.0 0.0 (0.5) 0.0 0.0 (4.7) 0.0 0.0 (1.1) 0.0 0.0 2.5 0.0 0.0 6.8 0.0 (1.4) 0.0 (0.9) 0.0 (0.5) 0.0 (4.7) 0.0 (1.1) 0.0 2.5 0.0 6.8 ($0.14) ($0.08) ($0.09) ($0.04) ($0.03) ($0.02) ($0.01) ($0.09) ($0.02) ($0.14) ($0.08) ($0.09) ($0.04) ($0.03) ($0.02) ($0.01) ($0.09) ($0.02) $0.05 $0.05 $0.12 $0.12 41.4 30.8 41.4 41.4 41.7 41.7 51.1 51.1 51.1 51.1 51.1 51.1 51.1 51.1 51.1 51.1 51.1 51.1 51.1 54.8 51.1 54.8 94% 1241% 1326% 1056% 8% -42% -25% -44% 24% 15% 18% 17% 6% 255% 184% 130% 10% 24% 24% 1% 34% 67% 53% 24% 74% -83% -66% -72% 34% 30% 26% 3% 89% nm nm nm 62% nm nm nm 44% 114% 171% 171% Gross Margin (Includes D&A) EBITDA Margin EBT Margin Before Special Items Net Margin From Cont Ops B. Sp. Items 63% -47% -60% -45% 66% -25% -31% -31% 68% -23% -30% -30% 61% -74% -79% -79% 65% -35% -42% -42% 65% -12% -17% -17% 65% -3% -8% -8% 64% -23% -28% -28% 65% 0% -3% -3% 65% 7% 5% 5% 65% 11% 9% 9% Tax Rate 26% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% Income Statement Statistics Revenue Growth EBITDA Growth Net Earn. From Cont Ops B. Sp. Items Growth Dil. EPS From Cont Ops B. Sp. Items Growth Source: Company reports; LBS estimates. Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 16 June 20, 2007 Opportunities In Orthopaedics Financial Statements (continued) Exhibit 12 - ORTHOsoft Inc. Balance Sheet (F2004-F2010E) Fiscal Year Ending December 31 ($Millions, except per share amounts) 2004 2005 2006 Assets Cash & Cash Equivalents Accounts Receivable Inventories Other Total Current Assets 4.4 4.0 0.9 3.4 12.6 4.3 2.4 1.0 1.2 8.9 8.2 3.0 1.0 2.4 14.6 1.2 2.6 1.1 7.3 12.1 0.6 3.0 1.1 6.2 10.9 0.0 3.9 1.5 6.3 11.7 1.2 0.8 0.4 2.5 1.3 0.9 0.4 2.5 1.3 1.1 0.2 2.5 1.5 1.1 0.2 2.7 1.5 1.2 0.2 2.9 15.1 11.5 17.1 14.9 Liabilities & Shareholders' Equity Bank Indebtedness Accounts Payable & Accrued Liabilities Long-term Debt Due Within One Year Other Total Current Liabilities 0.0 2.4 0.0 1.0 3.3 0.0 2.0 0.0 0.1 2.1 0.0 3.4 0.0 0.6 4.0 Long-Term Debt Other Total Non-Current Liabilities 0.0 0.3 0.3 0.0 0.3 0.3 Total Liabilities 3.6 Shareholders' Equity Capital Stock Contributed Surplus Retained Earnings (Deficit) Total Shareholders' Equity 2007E 2008E 2009E 2010E 0.0 4.5 1.7 6.5 12.7 0.0 4.5 1.7 6.5 12.7 0.0 8.4 2.9 6.3 17.6 0.0 12.8 4.5 6.1 23.4 3.1 18.0 6.3 6.1 33.5 1.6 1.2 0.2 2.9 1.6 1.3 0.2 3.0 1.6 1.3 0.2 3.0 1.7 1.5 0.2 3.4 1.8 1.7 0.2 3.6 1.8 1.9 0.2 3.8 13.8 14.7 15.7 15.7 21.0 27.0 37.4 0.0 3.3 0.0 0.9 4.2 0.0 3.7 0.0 0.9 4.5 1.0 4.4 0.0 0.9 6.3 1.9 5.1 0.0 0.9 7.8 1.9 5.1 0.0 0.9 7.8 3.8 9.4 0.0 0.9 14.1 2.4 14.4 0.0 0.9 17.6 0.0 20.3 0.0 0.9 21.2 0.0 0.1 0.1 0.0 0.1 0.1 0.0 0.1 0.1 0.0 0.1 0.1 0.0 0.1 0.1 0.0 0.1 0.1 0.0 0.1 0.1 0.0 0.1 0.1 0.0 0.1 0.1 2.4 4.1 4.3 4.6 6.4 7.9 7.9 14.2 17.7 21.2 18.7 0.8 (8.0) 11.5 18.7 1.6 (11.2) 9.1 25.7 2.4 (15.0) 13.0 25.7 1.9 (17.0) 10.6 25.7 1.9 (18.5) 9.2 25.7 1.9 (19.3) 8.3 25.7 1.9 (19.8) 7.8 25.7 1.9 (19.8) 7.8 25.7 1.9 (20.8) 6.8 25.7 1.9 (18.3) 9.3 25.7 1.9 (11.5) 16.1 Total Liabilities & Shareholders' Equity 15.1 11.5 17.1 14.9 13.8 14.7 15.7 15.7 21.0 27.0 37.4 Balance Sheet Statistics Net Total Debt/Equity Net Total Debt/Capital Net Total Debt/LTM EBITDA EBIT Coverage -38% -38% 0.0x (9.4x) -48% -48% 1.3x 44.9x -63% -63% 1.2x 49.8x -11% -6% 12% 24% -11% -6% 11% 19% 0.6x 0.3x 0.1x 0.8x 34.9x 199.9x (544.3x) (38.9x) 24% 56% 19% 36% 0.8x 25.8x 90.7x (11.3x) 25% -19% 20% -19% 0.8x (0.0x) 31.4x 3,652x -142% -139% -148% $0.26 -67% $0.21 -59% $0.15 29% $0.18 Property, Plant & Equipment Patents & Other Intangible Assets Other Total Non-Current Assets Total Assets ROE (Annualized) Book Value Q1/07 Q2/07E Q3/07E Q4/07E -52% $0.18 -36% $0.16 -21% $0.15 -16% $0.13 46% $0.32 Source: Company reports; LBS estimates. Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 17 June 20, 2007 Opportunities In Orthopaedics Financial Statements (continued) Exhibit 13 - ORTHOsoft Inc. Statement Of Cash Flows (F2004-F2010E) Fiscal Year Ending December 31 ($Millions, except per share amounts) 2004 2005 2006 Q1/07 Q2/07E Q3/07E Q4/07E 2007E 2008E 2009E 2010E Operating Activities Net Income (Loss) For The Year Non-Cash Items: Depreciation & Amortization Future Income Taxes Special Items Other Operating Cash Flow (4.2) 0.0 0.7 (0.0) 1.1 0.0 (2.4) (3.2) 0.0 0.7 0.0 1.0 0.0 (1.5) (3.8) 0.0 0.9 0.0 1.0 0.0 (1.9) (2.0) 0.0 0.2 0.0 (0.5) 0.0 (2.3) (1.4) 0.0 0.2 0.0 0.0 0.0 (1.2) (0.9) 0.0 0.3 0.0 0.0 0.0 (0.6) (0.5) 0.0 0.3 0.0 0.0 0.0 (0.2) (4.7) 0.0 0.9 0.0 (0.5) 0.0 (4.3) (1.1) 0.0 1.1 0.0 0.0 0.0 0.0 2.5 0.0 1.1 0.0 0.0 0.0 3.7 6.8 0.0 1.2 0.0 0.0 0.0 8.0 Decrease (Increase) In Non-Cash WC Net Cash Provided By Operating Activities (2.5) (4.9) 2.4 0.9 0.4 (1.5) 0.2 (2.1) 0.9 (0.3) (0.6) (1.2) (0.3) (0.5) 0.2 (4.1) (0.5) (0.5) (0.8) 2.8 (1.1) 6.9 Investing Activities Acquisitions Capital Expenditures Acquisition Of Intangible Assets Other Net Cash Provided By Investing Activities 0.0 (0.5) (0.3) (0.0) (0.8) 0.0 (0.7) (0.2) 0.0 (0.9) 0.0 (0.9) (0.2) (0.5) (1.6) 0.0 (0.4) (0.0) (4.5) (4.9) 0.0 (0.3) (0.1) 0.0 (0.4) 0.0 (0.3) (0.1) 0.0 (0.4) 0.0 (0.3) (0.1) 0.0 (0.4) 0.0 (1.3) (0.2) (4.5) (6.0) 0.0 (1.2) (0.2) 0.0 (1.4) 0.0 (1.2) (0.2) 0.0 (1.4) 0.0 (1.2) (0.2) 0.0 (1.4) Financing Activities Proceeds of Long-Term Debt Total Repayment Of Long-Term Debt Issuance Of Common Stock Other Net Cash Provided By Financing Activities 0.0 (4.9) 12.7 1.4 9.2 0.0 0.0 0.0 0.0 0.0 0.0 0.0 6.9 0.0 6.9 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Cash From Discontinued Operations 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Increase (Decrease) In Net Cash Net Cash At Beginning Of Period Net Cash At End Of Period 3.5 0.9 4.4 (0.0) 4.4 4.3 3.8 4.3 8.2 (7.0) 8.2 1.2 (0.6) 1.2 0.6 (1.6) 0.6 (1.0) (0.9) (1.0) (1.9) (10.0) 8.2 (1.9) (1.9) (1.9) (3.8) 1.4 (3.8) (2.4) 5.5 (2.4) 3.1 Free Cash Flow Operating Cash Flow Change In Working Capital Capital Expenditures Free Cash Flow (2.4) (2.5) (0.5) (5.4) (1.5) 2.4 (0.7) 0.2 (1.9) 0.4 (0.9) (2.4) (2.3) 0.2 (0.4) (2.4) (1.2) 0.9 (0.3) (0.6) (0.6) (0.6) (0.3) (1.5) (0.2) (0.3) (0.3) (0.8) (4.3) 0.2 (1.3) (5.3) 0.0 (0.5) (1.2) (1.7) 3.7 (0.8) (1.2) 1.6 8.0 (1.1) (1.2) 5.7 ($0.17) 30.8 $0.00 41.4 ($0.06) ($0.05) ($0.01) ($0.03) ($0.02) ($0.10) ($0.03) 41.7 51.1 51.1 51.1 51.1 51.1 51.1 $0.03 54.8 $0.10 54.8 Free Cash Flow Per Share Diluted Shares Outstanding Source: Company reports; LBS estimates. Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 18 June 20, 2007 Opportunities In Orthopaedics BioSyntech Inc. (BSY-T) Buy (S) – Target Price: $1.00 Company Profile BioSyntech develops advanced biotherapeutics designed for regenerative medicine and delivery of therapeutic agents. The company’s products are all based on its patented technology platform, BST-Gel, a family of hydrogels liquid at room temperatures but solid at human body temperature. We are initiating coverage on BioSyntech with a Speculative Buy rating and a one-year share price target of $1.00. This implies a total return of 89%. Our target is based on a DCF using a WACC of 15%. We have a share risk rating of High. We highlight the following: 1. Opportunities in the cartilage regeneration and chronic wound care markets: Despite the large number of treatments available for cartilage regeneration and chronic wounds, there is still a clear high unmet medical need in both markets. Furthermore, these markets are expected to grow because of demographic changes and increasing prevalence of obesity. 2. Innovative products targeting unmet medical needs: BioSyntech has a pipeline full of products based on its unique BST-Gel platform. Its lead products, BST-CarGel and BST-DermOn, should get marketing approval in 2009. 3. Strategic sales and distribution partnerships: The company has already signed two agreements with leading pharmaceutical companies in Asia. Additional distribution agreements are under discussion for the US, Europe, and other countries. 4. Solid management team: We believe BioSyntech is led by an experienced management team given their strong scientific and marketing experience. Founding directors and management currently own over 11% of the common share outstanding, and two institutions each currently control more than 10%. 5. More than 12 months of cash: On December 31, 2006, BioSyntech had 15 months of cash. However, the cash burn rate should increase as the company goes forward with its clinical trials. Therefore, BioSyntech may be forced to seek additional financing in 2008 to sustain its activities. Source: BigCharts.com Ticker Rating Risk Price 1-Yr Target Dividend 1-Yr ROR 52-Wk High-Low Next Reporting Valuation Market Data BSY-T Shares O/S (M) Buy (S) Market Cap (M) High Float O/S (M) $0.53 Float Value (M) $1.00 Avg Daily Volume (K) $0.00 Control Blocks 89% Voting $0.76-$0.25 Equity June 30, 2007 Management DCF; WACC 15% Fully Diluted EPS (December 31 Year End) Q1 Q2 Q3 Q4 F2007 ($0.02) A ($0.02) A ($0.02) A ($0.02) F2008 ($0.02) ($0.03) ($0.03) ($0.03) F2009 F2010 95.4 $50.6 95.4 $50.6 72.4 11.3% Annual ($0.08) ($0.12) ($0.14) ($0.14) EBITDA (millions) F2007 ($1.4) A ($2.0) A ($2.1) A ($1.6) F2008 ($2.1) ($2.5) ($2.8) ($2.3) F2009 F2010 Source: BioSyntech Reports; Thomson One; LBS Estimates. Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] ($7.1) ($9.7) ($11.3) ($11.0) 19 June 20, 2007 Opportunities In Orthopaedics BioSyntech Inc. Buy (S), Target $1.00 We are initiating coverage on BioSyntech with a Speculative Buy rating and a one-year share price target of $1.00. This target implies a 89% return from current levels and is based on a discounted cash flow model. We have a share risk rating of High. Investment Thesis Innovating Products For Large Unsatisfied Markets BioSyntech is well positioned to benefit from the growth opportunities in the cartilage regeneration, the chronic wound care and the chronic heel pain markets (Appendices III and IV). The company is developing safe, groundbreaking products targeting unmet medical needs. Moreover, BioSyntech has established two strategic alliances to benefit from existing sales and distribution channels. Company Profile A Unique Platform With Multiple Applications BioSyntech develops advanced biotherapeutic thermogels designed for tissue repair and delivery of therapeutic agents. The company’s products are all based on BST-Gel, a patented technology platform with the following characteristics: • BST-Gel is a family of hydrogels based on chitosan, a natural biopolymer derived from crustacean shells. Chitosan has been shown in scientific literature to have antimicrobial and antifungal properties, to promote tissue growth in tissue repair, to accelerate wound healing, to be beneficial for drug delivery systems, and to be hemostatic. BioSyntech manufactures and uses Ultrasan, which is known as the market’s purest available form of chitosan. • BST-Gel is liquid at room temperatures but solid at human body temperature, an advantageous characteristic for tissue repair and injectable drug delivery systems. • BST-Gel is biocompatible since chitosan is a non-toxic linear disaccharide that does not trigger any immune response when injected in the body. BST-Gel is also muco-adhesive and safely biodegradable. • BST-Gel has controllable residence times that allow degradation periods to be adapted to specific applications. Therefore, the therapeutic effect can be targeted to last a few days to several years. • BST-Gel is a porous scaffold, an important property for tissue repair (Appendix III). It allows an easy flow of blood, nutrients, cells, and fluids. Established in 1995, BioSyntech has three products in clinical development for cartilage repair, chronic wound healing and chronic heel pain relief. These products could permit innovative, cost-effective and minimally invasive treatments for millions of patients worldwide. BioSyntech’s pipeline include: Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 20 June 20, 2007 Opportunities In Orthopaedics A Pipeline Filled With Products 1. BST-CarGel: This product was developed for cartilage regeneration. BSTCarGel is mixed with the patient’s own blood and applied during minimally invasive surgery (MIS) to the cartilage lesion, that was first debrided and microfractured (Exhibit 14). The product fills and sticks to the lesion where it solidifies. Because the cartilage regeneration occurs within the body, it is termed In Situ ChondroInduction (ICI). The BST-CarGel is degraded as the neocartilage is generated. BST-CarGel has shown excellent results in pre-clinical studies. It is now the subject of a randomized Canadian pivotal trial, in which BST-CarGel is compared to microfracture alone. In June 2007, BioSyntech announced it has completed the enrolment of the first 20 patients. The data collected from these patients should be submitted to the FDA as pilot data in support of an IDE. Exhibit 14 - Animal study showing cartilage regeneration with BST-CarGel Defect Debridement & marrow stimulation Treatment BST-CarGel & autologous Blood Regeneration After 6 months Source: Company reports. 2. BST-DermOn: This product was developed to treat chronic wounds. BSTDermOn maintains a moist environment that allows gas exchange and accelerates wound healing via biological effect on inflammatory cells. Scientific literature and BioSyntech’s pre-clinical studies support that chitosan and BSTDermOn stimulate wound healing, respectively. On February 8, 2007, BioSyntech announced the start of recruitment into a Canadian pivotal clinical trial for BSTDermOn to evaluate its capacity to cure chronic diabetes foot ulcers. 3. BST-InPod: This product was developed for chronic heel pain associated with fat pad atrophy. The fat pad is the foot’s natural cushion that acts as shock absorbers. BST-InPod is a mix of hydrogels and natural fatty acids, which is injected in the heel to regenerate the fat pad. The procedure is safe and minimally invasive. BST-InPod should enter a Canadian pilot clinical trial in 2007. 4. Other tissue repair products are being developed for applications such as bone reconstruction (BST-Ossifil and BST-Ossifix) and intervertebral disc restoration (BST-Disc). BioSyntech is also developing injectable biomaterials for the delivery of biotherapeutics and instrumentation products (Arthro-BST and Mach-1). BioSyntech has had limited revenues to date, generated almost entirely by sales of instrumentation products and Ultrasan. As of June 2007, 74 patents were granted and 40 were still pending, covering technology platform, products and applications. The common shares of BioSyntech, which traded on the TSX Venture Exchange for two years, have traded on the TSX since October 30, 2006. Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 21 June 20, 2007 Opportunities In Orthopaedics Objectives & Strategy R&D Driven Company With Partners BioSyntech’s objective is to develop and market therapies based on its technology platform, targeting large unmet medical needs. The strategy of management includes: 1. Medical device classification: Health Canada, the FDA, and European authorities have classified BioSyntech’s leading products as medical devices. According to the management, it represents a significant advantage to the company over its competitors because of the accelerated regulatory approval process compared to drugs and biological products. 2. Pipeline: BioSyntech has a pipeline full of products based on its BST-Gel platform. BST-CarGel should get marketing approval by H1/2009 in Canada and Europe, and H2/2010 in USA. BST-DermOn should get marketing approval by Q4/2008 in Canada and Europe. The other products should reach the market by 2012. 3. Partnerships: To benefit from existing distribution and sales channels, BioSyntech continues to seek additional strategic alliances worldwide. The company has already signed two licensing and equity-investment agreements with leading pharmaceutical companies in Asia (Exhibit 15). Additional distribution agreements are under discussion for the US, Europe, and other countries. Exhibit 15 - BioSyntech's Partnerships Licensee Nicholas Piramal India Ltd (Headquarters in India) EquityProducts Investment $6.0M Current and ($0.80 per future products share) Kuhnil Pharma Co. (Headquarters in Korea) BST-CarGel BST-InPod $1.2M ($0.80 per share) Exclusive rights India, Pakistan, Sri Lanka, Bangladesh, Philippines, Laos, Cambodia, Vietnam Korea Source: Company reports. 4. Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] Manufacturing: BioSyntech currently has the manufacturing capacity to supply Canadian and European clinical testing and early commercial needs. The company has chosen to manufacture its products in house to control quality, a key factor to success in the industry. BioSyntech is planning the construction of a larger scale cGMP (“Current Good Manufacturing Practices”) manufacturing facility for 2007. 22 June 20, 2007 Opportunities In Orthopaedics Competitive Analysis Three Unsatisfied And Growing Markets BST-CarGel targets the growing but increasingly competitive cartilage regeneration market (Appendix III). The market is expanding at a double-digit rate because of the aging population and the increase prevalence of obesity, in addition to the fact that current therapies are suboptimal. Many new products and instruments have been developed and commercialized to overcome the weaknesses of the actual treatments. With Carticel, an autologous chondrocyte implantation (ACI) therapy, Genzyme is the market leader at present. BST-CarGel has the following competitive advantages (Exhibit 16): • Quality: BST-CarGel is a porous, biocompatible, and muco-adhesive scaffold. It integrates well with native cartilage and degrades as the new cartilage is formed. Convenient for small and large lesions, the procedure using BST-CarGel leads to a high quality of neocartilage (well-organized hyaline cartilage rather than fibrocartilage). Consequently, neocartilage’s long-term viability can be expected when BST-CarGel is used. • Clinical validation: Pre-clinical studies showed cartilage regeneration with BSTCarGel. A Health Canada’s Special Access Program (SAP) with 33 patients found that BST-CarGel is safe and reduces pain. We believe the Canadian pivotal trial is well designed, evaluating BST-CarGel by comparing it to microfracture. • Ease of use and affordability: Cartilage repair with BST-CarGel is a minimally invasive procedure, requiring only one surgery. BST-CarGel is also cost efficient, as it should be priced significantly less than the ACI procedures (about $15,000). Exhibit 16 - BST-CarGel Competitive Analysis Size of lesions Quality of cartilage Number of operations Total time of surgery Time of cell culture Cost Microfracture < 2 cm2 + 1 15 min $ ACI 3-12 cm2 .+ + + 2 2.5 hrs 1 month $$$$ Mosaicplasty BST-CarGel 2-4 cm2 0-10 cm2 .+ + + + 1 1 45 min 30 min $$ $$ Source: Company reports; LBS estimates. BST-DermOn is a therapy for deep chronic wounds, an unmet medical need (Appendix IV). While this market is highly competitive, current treatments are expensive and ineffective in many cases. BST-DermOn is a novel topical therapy that BioSyntech believes could be adopted as an affordable, first-line therapy for chronic wounds. BSTDermOn’s key benefit over other hydrogels includes bacteriostatic properties. BST-InPod could be the first long-term therapy for chronic heel pain. Heel pain is experienced by about 14% of adults and often occurs because of atrophy of the fat pad. This pad deteriorates with use (age, excessive weight, high impact sports, and inadequate shoes) but also with diabetes and rheumatoid arthritis. Existing treatments include in-sole cushions, heelpieces, anti-inflammatory medications and orthotics. There is currently no reliable surgical treatment for this problem. BST-InPod could permanently restore the pad’s thickness and cushioning properties. Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 23 June 20, 2007 Opportunities In Orthopaedics Management Profile Experienced Management Team Founding directors and management currently owns over 11% of the common share outstanding (Exhibit 17). A share ownership plan is in place to encourage management to increase their stake in the company. As a result, we feel managers’ and directors’ interests are aligned with those of the shareholders. Furthermore, we believe BioSyntech is led by a solid management team given their strong background and experience. As of April 25, 2007, only ProQuest Investments and Fonds de Solidarité FTQ held more than 10% of the common share outstanding. Exhibit 17 - BioSyntech Ownership (As of April 25, 2007) Founding Directors and Management ProQuest 11% Investments Retail and other 15% institutions Fonds de 49% Solidarité FTQ Nicholas 10% BDC Piramal Pappas Venture 3% 8% 4% Source: Bloomberg; Company reports. Key executives include: Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] • Claude LeDuc - CEO, President and Director: Mr. LeDuc has been President and CEO of BioSyntech since March 2004. Before this, he was employed by Genzyme Biosurgery as Director for International Markets. Before that, he worked nine years at Biomatrix where he was responsible with various marketing, sales and business development roles in Canada and Europe. Mr. LeDuc started his career in the health industry in 1986 with Syntex Laboratories and he joined Serono Laboratories in 1991. • Francois Michaud, CA, CMA - CFO: Mr. Michaud has been CFO of BioSyntech since August 2006. Mr. Michaud has over 18 years of experience in accounting, investment banking, working with KPMG, JP Morgan, Quebecor, DS Smith Plc and Ekco Group. Before joining BioSyntech, Mr. Michaud served as CFO for Hemera Technologies. • Richard Lacombe, PhD, MBA - VP, Clinical Affairs: Dr. Lacombe joined BioSyntech in July 2006. He has more than 30 years of experience in pharmaceutical /Biotech /Contract Research Organization (CRO) companies. Dr. Lacombe was President and CEO for Virocell and General Manager for Covance Canada, Asia Pacific, and Latin America. He also worked at Phoenix International Life Sciences, Hoechst-Roussel Canada and Cyanamid of Canada. • Matthew Shive, PhD - VP, Product Development: Dr. Shive has been VP product development since 2000. He received a PhD in Biomedical Engineering. His strong scientific expertise lies in the interactions between implanted biomaterials and biological systems, and he has published over 50 scientific articles and conference proceedings in this area. 24 June 20, 2007 Opportunities In Orthopaedics • Eric DesRosiers, PhD, MBA - VP New Technology and Operations: Dr. DesRosiers has been a key executive for BioSyntech since May 2000 and VP of R&D since October 2003. From 1994 to 2000, Dr. DesRosiers worked at Apotex Research. Dr. DesRosiers has a PhD degree in biomedical engineering. Recent Results Two Pivotal Clinical Trials Causing Lower EBITDA On December 31, 2006, BioSyntech reported Q3/2007 results, showing growing sales but a deteriorating net loss over last year. Highlights include the following: • 337% YOY increase in revenues to $0.15 million. BioSyntech is an R&D driven company and has therefore not made significant sales of its products in the past years. The growth observed this quarter is mainly due to the sale of instrumentation products. • EBITDA has declined to -$2.08 million in Q3/2007 from -$1.66 million in Q3/2006. This reduction is partly due to higher R&D spending (33% increase YOY) related to the significant increase in expenses incurred for the BST-CarGel and BST-DermOn clinical trials. SG&A was also up during the quarter (44% YOY) mainly due to the hiring of new employees related to clinical development activities and by additional investor relations’ expenses. • Net loss has increased to -$2.18 million in Q3/2007 ($0.02 per share) from -$1.92 million in Q3/2006 ($0.04 per share). Since the beginning of its operations in 1995, BioSyntech has not generated any earnings. The company shares have underperformed the Canadian healthcare sector since inception (Exhibit 18). BioSyntech has also underperformed the MD Index since February 2007. Exhibit 18 - Relative Stock Performance (June 2005-Present) 2.0 1.5 1.0 0.5 0.0 2005 2006 BSY S&P/TSX Health Care 2007 S&P/TSX MD* *MD is a market-weighted index of the major Canadian medical devices companies. Source: Bloomberg; LBS. • Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] More than 12 months of cash. On December 31, 2006, BioSyntech had more than $14 million of liquidity and its burn rate was about $0.78 million per month. The company is not highly levered. 25 June 20, 2007 Opportunities In Orthopaedics Financial Forecast BST-CarGel Driving Revenue Growth BST-CarGel should get marketing approval by H1/2009 in Canada and Europe, and H2/2010 in the US. Thus, we do not anticipate any significant revenues before 2010E. We forecast revenues of $2.8 million in 2010E, $20 million in 2011E, $52 million in 2012E, and 72 in 2013E. This growth is mainly due to: • The potential market of BST-CarGel is about 600,000 units per year. The orthopaedic surgeons perform more than 1.6 million arthroscopic knee procedures each year in the US and 3 million worldwide (Appendix III). Cartilage lesions are observed in approximately 63% of all knee arthroscopies, which correspond to 1 million chondral lesions in the US. BioSyntech targets the grade III and IV lesions, which represent about 60% of the chondral lesions. Given its comparative advantages, we believe BioSyntech should attain a market share of 20% in 2013E (Exhibit 19). • BST-CarGel should be priced at approximately $3,000. Genzyme’s Carticel, the market leader at present, costs about $15,000 and is covered by most health care plans, the majority of which routinely reimburse up to US$3,098.65 for this treatment option. BST-CarGel should be entitled to receive the same reimbursement and thus, be priced at about $3,000. However, this price could vary significantly depending on the results of the clinical trials. We expect BioSyntech to receive 20% of the total revenues generated by BST-CarGel, the remainder being for its sales and distribution partners. More pessimistic and optimistic scenarios are presented in Exhibit 19. • No value was attributed to either the BST-DermOn or the BST-InPod in our financial forecasts. While we think those two products could generate substantial revenues to the company, more clinical results are needed to get a better idea of the potential price and market penetration for those products. Exhibit 19- BST-CarGel Estimated Revenue In 2013 Market BST-CarGel Penetration Units 15% 20% 30% 90,000 120,000 180,000 Revenues ($M) 15% $270 $360 $540 $41 $54 $81 Transfer to BSY ($M) 20% 25% $54 $72 $108 $68 $90 $135 Source: LBS Estimates. We believe EBITDA will deteriorate in 2008E (Exhibit 20). However, it should improve in 2010E and become positive in 2011E as BioSyntech begins to generate substantial revenues: • Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] Higher gross margins from 2009E. Between 2004 and 2006, BioSyntech’s gross margins varied from 50% to 65%. In 2007E, the company should increase its gross margins to about 70% based on the first three quarters. We believe gross margins in 2008E and 2009E will remain at 70%, since no significant change in revenues or product mix is predicted. However, as of 2010E, we anticipate a significant increase in gross margins. We believe BST-CarGel does not cost much to produce and could generate gross margins of up to 90%. 26 June 20, 2007 Opportunities In Orthopaedics • Significant R&D expenses in 2008E. In Q1/2007, BioSyntech started a pivotal clinical trial with BST-DermOn and completed the enrolment of a 20 patient subset of its ongoing BST-CarGel pivotal trial. Furthermore, the company expects to enter into a pilot trial with BST-InPod in 2007 and other products are moving towards more advanced clinical development. Therefore, we believe BioSyntech will incur substantial additional R&D expenses in 2008E. ($ million) Exhibit 20 - BioSyntech EBITDA Outlook 40 30 20 10 0 -10 -20 2005 2006 2007E 2008E 2009E 2010E 2011E 2012E 2013E Source: LBS Estimates. BioSyntech should not have income taxes payable in the next 4 years. As of March 31, 2006, the company had future tax assets of $8.5 million. The company also had some $2.51 million in research tax credits that can be applied against future federal income taxes payable. Free Cash Flow Positive In 2011E We believe BioSyntech will be free cash flow positive by 2011E. As part of its business strategy, the company is planning the construction of a larger scale cGMP manufacturing facility for 2007. We therefore anticipate substantial capital expenditures in the next four quarters (about $6 million in total). In the absence of marketed products and with the increase of R&D expenditures, BioSyntech’s cash burn rate should peak in 2008E. As of December 31, 2006, BioSyntech had more than 12 months of cash and was not highly levered. However, we believe that BioSyntech will be forced to seek additional financing to fund its operations in 2008E, through proceeds from equity, longterm debt, licenses, product development and co-marketing agreements, research tax credits, and/or grants. Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 27 June 20, 2007 Opportunities In Orthopaedics Valuation Target of $1.00, Total Return of 89% We rate the shares of BioSyntech a Speculative Buy with a one-year share target price of $1.00. This target implies a total return of 89%. It is based on a discounted cash flow using a WACC of 15% (Exhibit 21). BioSyntech’s cost of equity is 12% (according to Bloomberg, BioSyntech has a beta of 1.35 against the S&P/TSX index), and its cost of debt is 10%. A premium of 3.5% was added to the WACC to take into account the risks associated with a small Canadian capitalization with two products in late-stage development and low trading volume. Exhibit 21 - Valuation $ (Million) EBIT(1-Tax Rate) + Depreciation + Deferred Taxes - Capex - Additions to W/C = FCFF = / = Terminal Value PV of Equity BV Net Debt BV Prefs PV of Equity Share O/S Equity Value Per Share 85.1 = (10.3) 0.0 95.4 95.4 1.00 2008E 2009E 2010E 2011E 2012E 2013E (11.0) (12.8) (12.4) 1.2 22.5 35.0 1.3 1.5 1.4 1.3 1.3 1.2 0.0 0.0 0.0 0.0 1.9 2.8 8.3 7.8 7.4 7.1 6.8 6.6 0.3 1.1 0.7 3.6 4.1 1.1 (18.3) (20.2) (19.1) (8.2) 14.7 31.4 Term. Year 35.8 1.2 2.9 6.4 0.5 33.0 (16.0) 316.7 133.8 (15.4) (12.7) (4.7) 7.4 13.8 Source: LBS estimates. Sources of Risk Absence Of Profitability Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] Since inception, BioSyntech has not realized any profit and there is no assurance that the company will achieve profitability in the future. Its future profitability depends on: • Results of clinical trials: There is no assurance that the company will achieve important product development milestones and obtain regulatory approval for its products. Furthermore, we note that the company has strictly defined the type of patient that can be recruited in its pivotal trials. This might cause delays before completion of enrolment and regulatory approval. • Market penetration: There is no assurance that medical practitioners will adopt BioSyntech’s products or that BioSyntech will develop the capacity to manufacture and market products. It will greatly depend on the company’s ability to obtain additional financing or to enter into agreements with others, and to develop a strategic distribution and sales channel. Another uncertainty arises from the availability of government and insurance reimbursements for BioSyntech’s products. • Performance of key executives: Future profitability also greatly depends upon the capacity of BioSyntech’s key executives to create value for stakeholders. 28 June 20, 2007 Opportunities In Orthopaedics Ability To Raise Funds BioSyntech expects to incur substantial R&D and SG&A expenses in the near future, without generating significant revenues from the sale of products. Until the company is in its commercialization phase, its financial health will depend on its ability to sustain operations with proceeds from additional financing, revenues from collaborative agreements, licenses, research tax credits and grants. Competition BioSyntech operates in an increasingly competitive environment. Competitors are expected to enter into market sectors competing with them. Some of these competitors have greater resources than BioSyntech. They may develop and market new products or services that render BioSyntech products and services less easy to market or less competitive. Intellectual Property BioSyntech relies on patents and other laws to protect its intellectual property. However, there can be no assurance that these laws will be adequate to protect the company’s property technology from misappropriation by another company. There is also a risk that BioSyntech’s current or future products may unintentionally infringe upon third-party proprietary technology. Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 29 June 20, 2007 Opportunities In Orthopaedics Financial Statements Exhibit 22 - Biosyntech Inc. Income Statement (F2006-2013E) Fiscal Year Ending March 31 ($Millions, except per share amounts) 2006 2007E 2008E 2009E 2010E 2011E 2012E 2013E 72.2 Revenue 0.1 0.3 0.2 0.2 2.8 20.2 52.2 Cost Of Sales 0.0 0.1 0.1 0.1 0.6 2.0 5.2 7.2 Gross Profit 0.0 0.2 0.2 0.1 2.2 18.2 47.0 65.0 11.5 Research & Development Expenses 3.2 4.4 6.2 7.8 9.0 9.9 10.9 Investment Tax Credits (0.3) (0.7) (0.7) (0.8) (0.8) (0.8) (0.8) (0.8) General & Administrative Expenses 2.9 3.6 4.4 4.4 5.0 6.5 13.1 18.1 Foreign Exchange Loss (Gain) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 EBITDA (5.8) (7.1) (9.7) (11.3) (11.0) 2.5 23.8 36.2 Amortization & Depreciation 0.6 0.5 1.3 1.5 1.4 1.3 1.3 1.2 Interest Expense (Income) 0.5 (0.2) 0.1 0.4 0.8 1.0 0.9 0.5 Special Items 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 EBT (6.9) (7.4) (11.1) (13.2) (13.2) 0.2 21.6 34.5 Current Tax 0.0 0.0 0.0 0.0 0.0 0.0 7.6 12.1 Future Tax 0.0 0.0 0.0 0.0 0.0 0.0 1.9 2.8 Net Earnings (6.9) (7.4) (11.1) (13.2) (13.2) 0.2 14.0 22.4 After-Tax (Addback) Of Special Items 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Net Earnings Before Special Items (6.9) (7.4) (11.1) (13.2) (13.2) 0.2 14.0 22.4 Diluted EPS From Cont Ops Before Special Items ($0.17) ($0.08) ($0.12) ($0.14) ($0.14) $0.00 $0.11 $0.17 Diluted EPS ($0.17) ($0.08) ($0.12) ($0.14) ($0.14) $0.00 $0.11 $0.17 Weighted Average Shares Outstanding - Basic (M) 40.9 94.2 95.4 95.4 95.4 95.4 95.4 95.4 Weighted Average Shares Outstanding - Diluted (M) 40.9 94.2 95.4 95.4 95.4 128.7 128.7 128.7 Revenue Growth -65% 349% -13% -17% 1300% 621% 158% 38% EBITDA Growth 36% 23% 37% nm nm nm 833% 52% Income Statement Statistics Net Earnings From Cont Ops Before Spec Items Growth 33% 8% 50% nm nm nm 6619% 60% Diluted EPS From Cont Ops Before Spec Items Growth 18% -53% 48% nm nm nm 6619% 60% 90% Gross Margin (Includes D&A) 65% 71% 70% 70% 80% 90% 90% -9366% -2561% -4042% -5669% -394% 13% 46% 50% EBT Margin Before Special Items -11146% -2676% -4605% -6616% -471% 1% 41% 48% Net Margin From Cont Ops Before Spec Items -11146% -2676% -4605% -6616% -471% 1% 27% 31% 0% 0% 0% 0% 0% 0% 35% 35% EBITDA Margin Tax Rate Source: Company reports; LBS estimates Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 30 June 20, 2007 Opportunities In Orthopaedics Financial Statements (continued) Exhibit 23 -Biosyntech Inc. Balance Sheet (F2006-F2013E) Fiscal Year Ending March 31 ($Millions, except per share amounts) 2006 2007E 2008E 2009E 2010E 2011E 2012E 2013E Assets Cash & Cash Equivalents 4.6 5.0 0.0 0.0 0.0 0.0 0.0 0.0 Short-Term Investments 6.2 6.0 0.0 0.0 0.0 0.0 0.0 0.0 Accounts Receivable 0.1 0.4 0.3 0.0 0.9 4.4 8.8 9.9 Inventories 0.0 0.1 0.0 0.0 0.2 0.4 0.9 1.0 0.5 0.8 0.9 1.1 1.3 1.4 1.6 1.7 11.4 12.2 1.2 1.2 2.3 6.3 11.3 12.6 Other Total Current Assets Property, Plant & Equipment 2.6 4.1 8.3 7.8 7.4 7.1 6.8 6.6 Patents & Other Intangible Assets 0.5 0.7 1.5 2.3 3.1 3.9 4.7 5.5 Other 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2 Total Non-Current Assets 3.3 5.0 10.1 10.4 10.8 11.2 11.8 12.3 14.7 17.2 11.3 11.5 13.1 17.5 23.1 24.9 Total Assets Liabilities & Shareholders' Equity Bank Indebtness 2.5 0.0 5.9 21.0 35.8 40.2 29.4 6.3 Accounts Payable & Accrued Liabilities 1.2 1.5 1.2 0.0 0.5 0.9 1.8 2.0 0.0 Long-term Debt Due Within One Year 0.5 0.0 0.0 0.0 0.0 0.0 0.0 Other 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 Total Current Liabilities 4.3 1.5 7.2 21.2 36.4 41.1 31.2 8.4 1.0 Long-Term Debt 1.9 4.0 3.5 3.0 2.5 2.0 1.5 Other 0.0 0.0 0.0 0.0 0.0 0.0 1.9 4.7 Total Non-Current Liabilities 1.9 4.0 3.5 3.0 2.5 2.0 3.4 5.7 Total Liabilities 6.1 5.5 10.7 24.2 38.9 43.1 34.6 14.1 39.9 49.8 49.8 49.8 49.8 49.8 49.8 49.8 4.5 5.1 5.1 5.1 5.1 5.1 5.1 5.1 Retained Earnings (Deficit) (35.9) (43.2) (54.3) (67.5) (80.7) (80.5) (66.5) (44.0) Total Shareholders' Equity 8.6 11.7 0.6 (12.6) (25.8) (25.6) (11.6) 10.9 14.7 17.2 11.3 11.5 13.1 17.5 23.1 24.9 Shareholders' Equity Capital Stock Contributed Surplus Total Liabilities & Shareholders' Equity Balance Sheet Statistics Net Total Debt/Equity 3% -8% 1573% -190% -148% -165% -267% 67% Net Total Debt/Capital 2% -6% 94% 211% 307% 255% 160% 40% Net Total Debt/LTM EBITDA EBIT Coverage ROE (Annualized) Book Value (0.2x) 0.1x (0.4x) (1.5x) (2.8x) 15.8x 1.5x 0.5x (11.8x) 45.8x (115.7x) (31.3x) (16.5x) 1.2x 24.7x 73.2x 0% 0% 0% 0% 0% 0% 0% 0% $0.12 $0.12 $0.01 ($0.13) ($0.27) ($0.27) ($0.12) $0.11 Source: Company reports; LBS estimates Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 31 June 20, 2007 Opportunities In Orthopaedics Financial Statements (continued) Exhibit 24 - Biosyntech Inc. Statement Of Cash Flows (F2006-F2013E) Fiscal Year Ending March 31 ($Millions, except per share amounts) 2006 2007E 2008E 2009E 2010E 2011E 2012E 2013E Net Income (Loss) For The Year (6.9) (7.4) (11.1) (13.2) Non-Cash Items: 0.0 0.0 0.0 0.0 (13.2) 0.2 14.0 22.4 0.0 0.0 0.0 Depreciation & Amortization 0.6 0.5 1.3 0.0 1.5 1.4 1.3 1.3 Options Granted 0.7 0.0 1.2 0.0 0.0 0.0 0.0 0.0 0.0 Future Income Taxes 0.0 Special Items 0.0 0.0 0.0 0.0 0.0 0.0 1.9 2.8 0.0 0.0 0.0 0.0 0.0 0.0 Other 0.0 0.3 (0.0) 0.0 0.0 0.0 0.0 0.0 0.0 Operating Cash Flow (5.3) (6.9) (9.8) (11.7) (11.8) 1.5 17.2 26.5 Decrease (Increase) In Non-Cash Working Capital (0.9) (0.3) (0.3) (1.1) (0.7) (3.6) (4.1) (1.1) Net Cash Provided By Operating Activities (6.2) (7.2) (10.1) (12.8) (12.4) (2.1) 13.1 25.4 Acquisitions (0.2) (0.1) 0.0 0.0 0.0 0.0 0.0 0.0 Capital Expenditures 0.0 (1.8) (5.5) (1.0) (1.0) (1.0) (1.0) (1.0) Acquisition Of Intangible Assets (0.1) (0.3) (0.8) (0.8) (0.8) (0.8) (0.8) (0.8) Other (6.2) 0.2 6.0 0.0 0.0 0.0 0.0 0.0 Net Cash Provided By (Used In) Investing Activities (6.5) (1.9) (0.3) (1.8) (1.8) (1.8) (1.8) (1.8) Proceeds of Long-Term Debt 16.6 10.0 0.0 0.0 0.0 0.0 0.0 0.0 Total Repayment Of Long-Term Debt (0.8) (0.0) 0.0 0.0 0.0 0.0 0.0 0.0 Issuance Of Common Stock 16.4 11.6 (0.5) (0.5) (0.5) (0.5) (0.5) (0.5) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 16.4 11.6 (0.5) (0.5) (0.5) (0.5) (0.5) (0.5) Operating Activities Investing Activities Financing Activities Other Net Cash (Used In) Provided By Financing Activities Cash From Discontinued Operations 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Effect Of Exchange Rate On Cash And Cash Equivalents 0.0 (0.0) (0.0) 0.0 0.0 0.0 0.0 0.0 Increase (Decrease) In Net Cash 3.7 2.5 (10.9) (15.1) (14.7) (4.4) 10.8 23.1 Net Cash At Beginning Of Period 0.1 3.8 6.3 (4.6) (19.7) (34.4) (38.8) (28.0) Net Cash At End Of Period 3.8 6.3 (4.6) (19.7) (34.4) (38.8) (28.0) (5.0) Operating Cash Flow (5.3) (6.9) (9.8) (11.7) (11.8) 1.5 17.2 26.5 Change In Working Capital (0.9) (0.3) (0.3) (1.1) (0.7) (3.6) (4.1) (1.1) Capital Expenditures 0.0 (1.8) (5.5) (1.0) (1.0) (1.0) (1.0) (1.0) Free Cash Flow (6.2) (9.0) (15.6) (13.8) (13.4) (3.1) 12.1 24.4 Free Cash Flow Per Share ($0.15) ($0.10) ($0.16) ($0.14) ($0.14) ($0.02) $0.09 $0.19 Diluted Shares Outstanding 40.9 94.2 95.4 95.4 95.4 128.7 128.7 128.7 Free Cash Flow Source: Company reports; LBS estimates Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 32 June 20, 2007 Opportunities In Orthopaedics Appendix I – Orthopaedic Backgrounder A Large And Growing Market From fractures to arthritis to osteoporosis, musculoskeletal conditions represent the most frequent cause of disability. In 2005, the global orthopaedic market neared US$26 billion (an increase of 13% over 2004). Every segment of the market is experiencing solid growth, with the largest segment being reconstructive implants (Exhibit 25). Exhibit 25 - Global Orthopaedic Market By Product Segment, In US$ (2005) Other 26.5% Fracture Repair 18.5% Arthroscopy 13.6% Orthobiologics 14.8% Spinal 26.5% Source: Knowledge Enterprises. Key drivers behind this growth include: Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] • Demographic changes: Today, bone and joint diseases account for half of all chronic conditions in people over 50 years old in developed countries. This age group, which could double in size by 2020, is expected to be more active and to live longer than previous generations. • Increasing prevalence of obesity: Obesity has been identified as a risk factor for osteoarthritis and other musculoskeletal disorders. The prevalence of obesity has increased significantly for both adults and children in the past years. Today, over 65% of adult Americans are overweight, and over 30% are obese. Obesity is forecast to rise dramatically in most parts of the world over the next years. • Innovation: New technologies have broadened the base of orthopaedic procedures to a younger population. For example, new materials help to increase the longevity of joint replacement implants because they do not incorporate polyethylene, a component used historically but believed to cause bone death and implant failure. • Increasing demand for minimally invasive surgery (MIS): Compared to traditional surgery, MIS requires a smaller incision in the body and therefore, causes less trauma to the body, lower disruption of soft-tissue, and lower loss of blood. This in turn results in less pain, faster recovery time, and smaller surgical scars. Therefore, new technologies allowing MIS have broadened the base of orthopaedic procedures. Patients who would typically avoid traditional, painful surgeries are now willing to go through MIS. 33 June 20, 2007 Opportunities In Orthopaedics Consolidation The orthopaedic market is highly consolidated. Over 75% of global orthopaedic revenues come from seven large players: Biomet, Johnson & Johnson, Smith & Nephew, Stryker, Synthes, and Zimmer. About 25% of the market remains relatively fragmented with hundreds of companies, the vast majority of which have sales under $5 million. Orthopaedic companies continue to consolidate through acquisitions or strategic partnerships. In the case of smaller firms, these alliances allow them to overcome the high barriers to entry, to broaden their product offerings, and to benefit from existing distribution and sales channels. Key Factors For Success In the orthopaedic market, product differentiation is slight. Product innovation and the relationship between orthopaedic surgeons and vendors are key factors to success, whereas price is important to a lesser extent. Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 34 June 20, 2007 Opportunities In Orthopaedics Appendix II – Computer Assisted Surgery Understanding Surgical Navigation System Computer assisted surgery (CAS) navigation systems help surgeons to track instruments and implants in real time during surgical procedures. They optimize the positioning of the devices used during the procedure therefore improving the surgeon’s precision and the patient’s outcome. CAS systems can be based on two different technologies: 1. Image guided surgery (IGS) system uses preoperative data obtained from magnetic resonance imaging (MRI), computer tomography (CT), positron emission tomography, ultrasound, fluoroscopy or other imaging devices. During the surgical procedure, a scanner is then set up above the surgical field to precisely track the instruments, superimposing their location in the body over a 3D image displayed on a video monitor. Intraoperative imaging (C-arm navigation), a more recent innovation, does not require preoperative images, which in turn simplifies patient logistics in the hospital, provides the patient’s image in the actual position during surgery, and reduces the radiation exposure. 2. Kinematic system uses a biomechanical approach to provide a virtual reconstruction of the patient anatomy on the display. It does not require pre- or intraoperative imaging, and therefore reduces radiation exposure, operation time and cost. However, this technology has its limitations (slightly less accurate) and should not completely replace traditional IGS (for example, in severe cases where the axis of rotation is difficult to see or in surgery involving complex internal structures or soft tissues). Components of surgical navigation systems include: 1. 2. 3. 4. Registration device: To align the patient’s position to the preoperative data. Intraoperative tracking devices: To localize the instruments in the surgical field. The most common type of tracking device used by surgeons is the optical localizer (Exhibit 26). Hardware: A data-processing computer, a monitor display, a keyboard, and a mouse. Usually installed on an individual trolley, hardware components are increasingly compact, portable and versatile. Software: Most navigation software platforms are designed for Microsoft Windows or Linux/UNIX operating system. Exhibit 26 - Optical Vs Electromagnetic Tracking Devices Optical · Increased accuracy (up to 2 mm) · No distortion · Easier to set up · Only functions when the line of sight between camera and field is clear · Requires drilling of pinsites into bone to fix reference markers Electromagnetic (EM) · Less invasive · No line of sight problem · Less accurate due to EM distortion caused by ferrous metal instruments · Small markers attached to the bones · Higher capital and operating costs Source: Millennium Research Group. Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 35 June 20, 2007 Opportunities In Orthopaedics CAS navigation systems are becoming the standard of care during surgical procedures because of their numerous benefits: Expanding Market • Improve clinical accuracy: This greater accuracy in positioning and alignment results in fewer complications for the patient, shorter recovery times, lower likelihood of necessary revision surgery, and better patient outcomes. • Facilitate minimally invasive surgery (MIS): This is particularly true in orthopaedic procedures. Disadvantages of MIS are restricted vision, difficulty in handling instruments, and restricted mobility, which all increase the risk of errors. Navigation improves the surgeon’s vision during the MIS and therefore improves the implant placement and alignment. • Legal liability protection: Navigation systems provide a level of decision support and visual confirmation. It can therefore reduce the risk of malpractice or negligence litigation against healthcare professionals. • Act as a marketing tool: Particularly in orthopaedic procedures, surgeons can use navigation as a way to differentiate themselves from competitors. In 2006, the US CAS navigation systems market was valued at over US$150 million. Navigation is used in neurosurgery, ear, nose and throat (ENT), spine and orthopaedic procedures. The neurosurgery segment is the largest navigation segment, followed by spine and ENT. These procedures are more risky and therefore, surgeons benefit more from the use of navigation. Growth in the CAS navigation systems market is driven by increased adoption and procedure volumes (Exhibit 27). Technological innovations and development of new applications, purchase of second navigation systems in high-volume centers, and replacement of older systems should increase the number of unit sold in all specialities. However, because neurosurgery, spine and ENT specialities are mature markets, future growth in those segments should be moderate. Exhibit 27 - CAS Navigation Systems US Market (2006-2011) 2000 Neuro Units Sold 1500 Spine 1000 ENT Ortho 500 Total 0 2005 2006 2007 2008 2009 2010 2011 Source: Millennium Research Group. Orthopaedic is the fastest growing segment of the CAS navigation systems market. The orthopaedic speciality, including knee, hip, trauma, anterior cruciate ligament, and high tibial osteotomy procedures, is a less developed market. In 2006, approximately 3% of all orthopaedic procedures in the US were executed using Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 36 June 20, 2007 Opportunities In Orthopaedics navigation. However, sales are expected to grow at a compound annual rate of 50% between 2006 and 2010 (Exhibit 28). Adoption and procedure volumes should benefit from demographic changes, a broadening of patient base (the age at which patient consider orthopaedic procedures is declining), and increasing popularity of MIS. The orthopaedic segment should become the largest CAS navigation systems market in the US by 2011. Exhibit 28 - CAOS Navigation Systems Market In US And Europe (2006-1010) 500 Sales (US$M) 400 CAGR = 50% 300 200 100 0 2006 2007 Source: Millennium Research Group. Barriers To Adoption Competitive Analysis Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 2008 2009 2010 Factors discouraging adoption of the CAS navigation systems market include: • Lack of long-term clinical data: Particularly in the orthopaedic segment where procedures are less risky, some surgeons doubt the efficacy of navigation. They claim that clinical benefits have not been adequately demonstrated, and that the high cost and complexity of CAS navigation systems is not yet justified. They would like to see more medical leaders endorsing navigation and more demonstration of clinical benefits. • Long preoperative planning process: Computer assisted surgery requires increased preoperative planning compared to traditional surgery. In general, use of surgical navigation requires an additional 10 to 20 minutes. Some surgeons feel this is unacceptably long, particularly for routine cases. Thus, in many centers, use of surgical navigation remains limited to more difficult cases. However, some other surgeons believe it is possible to improve total procedure time after having learn how to efficiently use the system (about 50 cases). • Lack of additional reimbursement: Navigation in neurosurgery and spine are covered whereas in ENT and orthopaedics, navigation is only partially or inconsistently reimbursed. Also, because surgeons cannot perform as many procedures when using navigation, each procedure becomes less profitable. Key factors for success in the CAS navigation systems market include: 1. Product characteristics: Accuracy, functionality, and ease-of-use. Product innovation is a key factor to success in the market. 2. Service and support: Hospitals are looking to develop long-term partnerships with the smallest possible number of suppliers. A strong relationship between the 37 June 20, 2007 Opportunities In Orthopaedics orthopaedic surgeon and the vendor is imperative as surgeons are key decision makers in the buying process. 3. Price: It is particularly important for public hospitals that have financial constraints. The method of payment is a major purchase criteria as fee-per-use is generally preferred to large capital expenditures. Hospitals also ask for substantial discounts to buy a second system from the same manufacturer. Furthermore, in mature segment (neurosurgery and spine), vendors are using a low-price strategy to capture market share and attract new customers. However, additional features, applications and instruments could put some upward pressure on prices. 4. Partnerships: Many alliances have established between navigation system manufacturers and implant manufacturers, particularly in orthopaedics. The advantages of such partnerships are access to innovation and distribution channels, co-marketing, quality assurance, and compatibility of devices. In 2006, the US CAS navigation market was valued at over $150 million. During the same year, the number of installed base in the US reached 3,600, 850 new navigation systems were sold and the average selling price was $179,000. Medtronic Navigation, BrainLAB, GE Healthcare, and Stryker shared about 85% of the market in terms of revenues, units sold, and installed base (Exhibit 29). Exhibit 29 - CAS Navigation Systems US Market In Unit Sold (2006) ORTHOsoft 6.6% Aesculap 3.7% Others 4.7% Medtronic 31.8% Stryker 9.9% GE Healthcare 15.0% BrainLAB 28.3% Source: Millennium Research Group. Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] • Medtronic Navigation: In 2006, Medtronic led the CAS navigation market in terms of total installed bases. The company focuses on neurosurgery and spine systems but also has a strong installed base in ENT and orthopaedics. • BrainLAB: BrainLAB, a private company, is well positioned in all four segments. It has numerous partners including DePuy, a division of Johnson & Johnson. The company is therefore present everywhere across the country. In 2006, BrainLAB was the market leader in terms of revenues (36.5%). • GE Healthcare: Leader in the ENT segment, GE has the largest installed base after Medtronic. 38 June 20, 2007 Opportunities In Orthopaedics • Stryker Navigation: As a major orthopaedic company, Stryker is a leader in the CAOS navigation systems market. Stryker does not rely on partnerships with other vendors to penetrate the market but uses its extensive sales force. • Other competitors focus on individual navigation segments, in most cases the fast-growing orthopaedic market (Exhibit 30). Exhibit 30 - Leading Competitors In The CAS Navigation Systems Company Aesculap BrainLAB Compass GE Healthcare (GE) Kinamed Medtronic (MDT) ORTHOsoft (OSH) Plus Ortho. Praxim Radionics (IART) Stryker (SYK) System(s) OrthoPilot VectorVision, Ci, Kolibri Cygnus InstaTrak, ENTradk, Fluoro-Track NaviPro StealthStation, LandmarX Navitrack PiGalileo Surgetics OmniSight Stryker Navigation Segment(s)* O N, S, E, O N, E N, S, E O N, S, E, O S, O O S, E, O N, S, E N, S, E, O * N = neurological, S = spine, E = ENT, O = orthopaedic Source: Millennium Research Group. Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 39 June 20, 2007 Opportunities In Orthopaedics Appendix III – Cartilage Regeneration Market Cartilage Is A Complex Tissue Cartilage is a highly organized and specialized tissue (Exhibit 31). Unlike bone, cartilage is not vascularized and has limited capacity for self-renewal. Articular cartilage is composed of hyaline cartilage (a sub-type of cartilage). Covering the bone extremities, it provides a smooth and slippery surface allowing the bones to slide over each other without friction. The cartilage ability to bear large loads is attributed to the extracellular matrix (ECM), a surrounding substance secreted and organized by the chondrocytes. ECM contains water and three classes of proteins: collagens, proteoglycans, and other noncollagenous proteins. Exhibit 31 - Main Zones Of Articular Cartilage Organization Chondrocytes are elongated in the superficial zone and parallel to the surface. They gradually become rounded, repeatedly arranged in columns, and completely surrounded by the ECM in deeper zones. Source: Sports Medicine and Arthroscopy Review. Causes Of Cartilage Defects Osteoarthritis (OA) is a common degenerative joint disease wherein the cartilage that connects and protects weight-bearing joints deteriorates. OA is the major cause of joint pain requiring reconstruction. It usually starts after age 45, but can occur anytime. Primary OA is mostly related to aging and heredity. Secondary OA is caused by another disease or condition, including excess weight, joint injury, complications of another type of arthritis, diabetes, and hormone disorders. OA affects about 190 million people globally, 12% of Americans age 25 and older, and 10% of Canadian adults. The prevalence is expected to increase as the population ages and obesity prevalence rises. Cartilage lesions also often result from a sports injury or accident. Trauma induced lesions are typically detected during arthroscopic procedures and classified according to their gravity (Exhibit 32). Orthopaedic surgeons perform more than 1.6 million arthroscopic knee procedures each year in the US and 3 million worldwide. Cartilage lesions are observed in approximately 63% of all knee arthroscopies, with each patient having an average of 2.7 lesions. Trauma induced cartilage lesions can also occur in the knee, hip, ankle, and shoulder. Like OA, it usually results in chronic pain, loss of function, and reduced quality of life. Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 40 June 20, 2007 Opportunities In Orthopaedics Exhibit 32 - Chondral Lesions Grades Grade I II III IV Description Softening of the articular cartilage Fibrillation or superficial fissures of the cartilage Deep fissuring of the cartilage without exposed bone Exposed bone Incidence 9.7% 28.1% 41.0% 19.2% Source: Arthroscopy. Limited Treatment Options Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] Once damaged, cartilage is unable to self-repair. Because of its complex organization, it is very difficult to duplicate or regenerate hyaline cartilage. Most symptoms of joint degeneration are managed with nonsurgical treatments, including life style modifications, analgesics, nonsteroidal anti-inflammatory drugs, corticosteroid injections, and hyaluronic acid viscosupplementation. Surgical treatments are also available and the most commonly used include: • Debridement: During this arthroscopic procedure, loose and unstable fragments of articular cartilage are removed. Debridement is usually viewed as a short-term solution, but it is often successful in relieving symptoms for a few years. • Bone marrow stimulation: This surgical procedure is used for the treatment of small articular cartilage defects. For most patients, joint function improves for several years after the surgery but full recovery is hardly ever attained. During the procedure, drilling, abrasion arthroplasty, or microfracture are used to create a conduit to connect the vascularized subchondral bone marrow with the debrided cartilage lesion. These techniques lead to the formation of a blood clot and an inflammatory response that stimulates the migration of potential repair cells into the cartilage lesion. They proliferate and form a granulation tissue, which is gradually replaced by scar-like fibrocartilage. Unfortunately, the fibrous tissue is biomechanically inferior to hyaline cartilage and is not integrated into the adjacent native cartilage. Thus, it is subject to rapid degeneration. Consequently, some patients are forced to undergo additional surgical treatment. Repair by microfracture is the most commonly used procedure for cartilage defects. There are approximately 50,000 microfractures per year. • Autologous chondrocytes implantation (ACI): This method requires two operations. The first operation takes a few chondrocytes from inside the cartilage, which are grown in a laboratory. Approximately one month later, a second operation is required to implant the grown cartilage into the lesion, which is then covered with a patch of tissue. This cover holds the cells in place while they attach themselves to the surrounding cartilage. ACI is an expensive ($15,000 or $30,000-$45,000 including the surgery) and lengthy procedure. However, it improves joint function in more than 80% of the patients. According to some orthopaedic surgeons, ACI is more effective than microfracture to improve symptoms and function in the long run, and to rebuild hyaline cartilage instead of fibrous tissue. However, strong scientific evidence is lacking to prove their belief. Furthermore, ACI is not recommended for people suffering from OA. About 2,000 ACI are performed each year. 41 June 20, 2007 Opportunities In Orthopaedics • Osteochondral autograft (mosaicplasty) or allograft: These infrequent procedures involve transplantation of hyaline cartilage (osteochondral plugs). It is effective only for cartilage defects of limited size. Challenges of this surgical treatment include availability of tissue graft material, donor site morbidity, and risks of rejection and disease transmission with allograft. There are about 2,000 mosaicplasty per year. • Total joint replacement: This drastic procedure, which is expensive, risky, and has a finite life expectancy, remains the treatment of choice for extensive lesions or joint reconstruction. Approximately 300,000 patients per year require total knee replacement. Despite the large number of treatments available, there is still a clear high unmet medical need for cartilage injuries. Opinions as to which procedure is the best vary among surgeons, and therefore, better-designed clinical trials are required to compare existing treatments. Furthermore, existing treatments are costly and invasive, or limited in their effectiveness. Thus, new products and instruments are needed to overcome the weaknesses of the actual treatments for cartilage regeneration. Competitive Analysis In 2005, worldwide sales of orthobiologics reached $2.4 billion (an increase of 13.6% from 2004). Orthobiologics are used to repair, replace, or regenerate musculoskeletal structures including tissue and bone. The segment of this market dedicated to cartilage regeneration is on the rise because of demographic change and obesity, but also because current therapies are suboptimal. The cartilage regeneration market is also increasingly competitive as many companies have products commercialized or in development (Exhibit 33). Genzyme is the market leader at present. Key factors for success in the cartilage repair market include: Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 1. Scaffold characteristics: Pore size, porosity, biocompatibility, muco-adhesive properties, integration with native cartilage, and biodegradability (which must be tailored to rate of neocartilage formation) are important factors to consider when developing scaffolds. 2. New cartilage characteristics: Composition (high concentration of type II collagen and hyaluronic acid) and organization of the neocartilage are crucial to cartilage regeneration. Long-term viability is also essential. 3. Clinical validation: Well-designed and rigorous pre-clinical and clinical trials are necessary to convince the medical community and the regulators. Demonstration of long-term efficacy is also important. 4. Ease-of-use and price: The procedure must be minimally invasive, timeefficiency and cost efficiency. 5. Partnerships: Many alliances have established in the cartilage repair market. The advantages of such partnerships are access to innovation and distribution and sales channels. 42 June 20, 2007 Opportunities In Orthopaedics Exhibit 33 - Major Competitors In The Cartilage Repair Market Company Approach* Product Status** Cell-based therapies Aesculap Arthro Kinetics BioTissue Co.don/ Ormed Fidia Genzyme Orthogen/ Arthrex Tigenix ACI ACI MACI ACI MACI ACI; MACI MACI ACI Novocart CaReS BioSeed-C Chondrosphere (Artrocell) Hyalograft C Carticel; Carticel II Chondrokin (ArthroMatrix) ChondroCelect M M M M; C M M; C M C Polymeric Implants Advanced Biosurfaces BioSyntech Salumedica/ Arthrex Smith & Nephew CR SGCR CR CaSO4 Plug Injectable polyurethane BST-CarGel Salucartilage TruFit C C M M Neocartilage Histogenics Isto/ Zimmer JNJ/ Regenerative Neocartilage Neocart Neocartilage IstoCyte Autograft CAIS C C C *ACI = Autologous chondrocytes implantation, MACI = ACI with matrix, CR = Cartilage resurfacing, SGCR = Scaffold-Guided Cartilage Regeneration. **M = Marketed, C = In clinical trial Source: Knowledge Enterprises; Company reports. Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 43 June 20, 2007 Opportunities In Orthopaedics Appendix IV- Chronic Wound Care Market The global wound care market was estimated to US$7.2 billion in 2006. It comprises two sectors: 1. Traditional wound care products: This segment is mature and consists mainly of low technology gauze-based dressings. 2. Advanced wound care products: This US$4.1 billion segment is growing at 10% per year, driven by an ageing population, the increase prevalence of diabetes and product innovations. The advanced wound care segment includes moist wound dressings (hydrogels, hydrocolloids, alginates, foams, and transparent films), antimicrobial dressings that deliver substances to the wound, and biological products such as skin substitutes, tissue-engineered products and growth factors. The market also includes other treatments such as negative pressure wound therapy, oxygen therapy, laser therapy, electrical stimulation, and ultrasound therapy. Over 6.8 million Americans suffer from chronic wounds each year. Chronic wounds occur when the body is unable to repair injured tissue, which may lead to amputation. Elderly, diabetic, obese, immunosuppressed, and immobilized individuals are more susceptible to develop chronic wounds associated with diseases such as diabetic ulcers, pressure ulcers, and venous stasis ulcers. The chronic wound market segment accounts for the largest portion of revenues in the advanced wound care market (about 42% in 2003). The chronic wound care market is highly competitive. A few global players such as Smith & Nephew and Johnson & Johnson, account for more than 80% of market share by revenue. Kinetics Concepts is the current leader in the advanced wound care market with its V.A.C negative pressure wound therapy system. Smith & Nephew is also a major player, being the worldwide leader in the wound dressing segment. Several types of products are available in the market, but unfortunately, they are often expensive and ineffective. Key factors for success in the chronic wound care market include: Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] • Innovation: New products introduced to the market must offer a more efficient and painless solution, in a shorter time period. • Price: New products must be cost efficient. Access to reimbursement is also a major issue. 44 June 20, 2007 Opportunities In Orthopaedics Appendix V – Important Disclosures Company Ticker ORTHOsoft Inc. BioSyntech Inc. Disclosures* OSH-V BSY-T V V The analyst(s) certify that (1) the views expressed in this report in connection with securities or issuers they analyze accurately reflect their personal views and (2) no part of their compensation was, is, or will be directly or indirectly, related to the specific recommendations or views expressed by them in this report. The Research Analyst’s compensation is based on various performance and market criteria and is charged as an expense to certain departments of Laurentian Bank Securities (LBS), including investment banking. * Legend A The Analyst, in his/her own account or in a related account, owns securities of this issuer. L LBS collectively beneficially owns in excess of 1% of one or more classes of the issued and outstanding equity securities of this issuer. O The Director of Equity Research/Co-Director, in his/her own account or in a related account, owns securities of this issuer. U Within the last 24 months, LBS has undertaken an underwriting liability with respect to equity securities of, or has provided advice for a fee with respect to, this issuer. V The Analyst has visited material operations of this issuer. P This issuer paid a portion of the travel-related expenses incurred by the Analyst to visit material operations of this issuer Laurentian Bank Securities Equity Research Ratings Distribution 40% 30% 38% 20% 31% 13% 10% 6% 6% 6% 0% Top Pick Buy Spec Buy Hold Reduce Tender Percentage of companies covered by Laurentian Bank Securities Equity Research within each rating category. Catherine Bouchard, MSc, MBA Healthcare Analyst 514.350.2938 [email protected] 45 June 20, 2007 Opportunities In Orthopaedics Recommendation Terminology LBS (Laurentian Bank Securities) recommendation terminology is as follows: Top Pick Buy Hold Reduce Our best investment idea, the greatest potential value appreciation. The stock is expected to generate significant risk-adjusted returns over the next 12 months. The stock is expected to generate modest risk-adjusted returns over the next 12 months. The stock is expected to generate negative risk-adjusted returns over the next 12 months. Our ratings may be followed by “(S)” which denotes that the investment is speculative and has a higher degree of risk associated with it. Additionally, our target prices are based on a 12-month investment horizon. The information contained in this document is based on what we deem to be reliable sources, but no guarantee or promise, explicit or implicit, is given as to the accuracy and exhaustiveness of these sources. This report shall under no circumstances be considered an offer to buy or sell, or a request to buy and/or sell the stocks mentioned. Laurentian Bank Securities Inc. and its employees may not be held liable for any monetary losses stemming from the implementation of the recommendations contained in this document. Laurentian Bank Securities Inc. and/or its officers, directors, representatives, traders, analysts and members of their families may hold positions in the stocks mentioned in this document and may buy and/or sell these stocks on the market or otherwise. Stocks in foreign currency may be adversely affected by exchange rate fluctuations. Laurentian Bank Securities Inc. is a wholly-owned subsidiary of Laurentian Bank of Canada. The opinions, projections and estimates are those of the Economic and Financial Research department of Laurentian Bank Securities Inc. as at the date appearing on the cover page, and are subject to change without prior notice. Laurentian Bank Securities Inc. may, in exchange for remuneration, act as a financial advisor or tax consultant for, or participate in the financing of companies mentioned in this document. This study may not be reproduced, in whole or in part, without the consent of Laurentian Bank Securities Inc. 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