1996 Ortho Overview

I N STITUTIONAL RESEARCH
The Skinny on The Skeleton
1997
HAMBRECHT & QUIST LLC
An In-Depth Assessment of Trends

and Investment Opportunity
in the Orthopaedic Industry
Growth
Pricing
Consolidation
New Technologies
Investment Strategies
In collaboration with
KNOWLEDGE ENTERPRISES, INC.
H&Q Orthopaedic Industry Coverage

New Coverage Existing Coverage
Biomet OrthoLogic
DePuy Sofamor Danek
Stryker Spine-Tech
Industry Report Robert C. Faulkner

December 30, 1996 Daniyal Shoaib
H&Q Orthopaedic Industry Snapshot
INDUSTRY INVESTMENT STRATEGY

• In core reconstructive markets, invest in industry leadership — the consolidators.
• In niche markets, invest in acquirable unique technology at sane valuations.
• Core market outlook is improving for pricing and growth; risks are discounted.
STOCK RECOMMENDATIONS
Stryker (Nasdaq/STRY - $30 1/8) — STRONG BUY
• EPS growth of 20% is intact and OP-1 is a potential kicker.
• Excellent risk/reward profile; 12-month target price $39.
DePuy (NYSE/DPU - $20 1/4) — BUY
• Industry leadership on sale; strong geographic and product diversity.
• Consistent share gainer and a proven consolidator with upside.
• Excellent risk/reward profile; 12-month target price $24.
Sofamor Danek (NYSE/SDG - $30 1/2) — BUY
• Spinal implant liability now quantifiable; key events to occur in January.
• Undervalued and the best takeover candidate long term.
• Relatively high-risk/high-reward profile; takeover value $60 minus liability.
Spine-Tech (Nasdaq/SPYN - $24 1/8) — BUY
• The hot play in fusion cages; the biggest near-term opportunity in orthopaedics.
• Positive 12- to 24-month outlook, but 1997 expectations look too aggressive.
• Fairly valued now; buy on dips or with outperformance.
Biomet (Nasdaq/BMET - ($15 1/8) — HOLD
• Low geographic and product diversity reduces growth potential.
• Moderate size impedes growth through acquisition.
• Without acquisitions, EPS risk is likely on the downside.
OrthoLogic (Nasdaq/OLGC - $5 3/4) — HOLD
• Transition to direct sales for bone growth stimulators put brakes on growth.
• Regrouping may require one or two more quarters; wait for bottom.
Product is the best, and long-term outlook is good.
Table of Contents
Investment Theme. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Out of Adversity Comes Opportunity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Waiting for Consolidation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Potential Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
A Brief History . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Industry Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
The Reconstructive Device Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Long-Term Developments: Goals and Technologies to Watch. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Mix Shift and Pricing in the U.S. Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Pricing Forecast: Partly Sunny. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Winning in the Future: To Contract or Not to Contract?. . . Contract!. . . . . . . . . . . . . . . . . . . . . . . 14
The Ex-United States Reconstructive Device Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
The Players . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
The Trauma Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Long-term Developments: Goals and Technologies to Watch . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
The Spinal Implant Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Long-term Developments: Goals and Technologies to Watch . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
Lumbar Spinal Implant Market Outlook Discussion. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Fusion Cages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
The U.S. Lumbar Instrumentation Market. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
The Players . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Osteobiologics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Soft Tissue Repair/Sports Medicine Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
Arthroscopy/Sports Medicine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
Bone Substitutes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Company Profiles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
Stryker Corp. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
DePuy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
Biomet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75
List of Exhibits
Exhibit 1: Estimated Worldwide Reconstructive Market Dollar Growth: 1993A to 2000E . . . . . . . . . . . 5

Exhibit 2: Market Segment Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Exhibit 3: Market Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Exhibit 4: Porous/Cemented Mix Shift Trends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Exhibit 5: Impact of Mix Shift on Sales for Industry and Major Players . . . . . . . . . . . . . . . . . . . . . . . . 11
Exhibit 6: Financial Indicators in U.S. Reconstructive Joint Procedures: 1995 . . . . . . . . . . . . . . . . . . . 12
Exhibit 7: U.S. Hip and Knee Unit Share Trends: 1990-1995 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Exhibit 8: Estimated 1995 Reconstructive Market Shares for Major Players ($) . . . . . . . . . . . . . . . . . . 17
Exhibit 9: Spinal Implant Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Exhibit 10: Fusion Market Segments by Procedure and Dollar Volume . . . . . . . . . . . . . . . . . . . . . . . . . 21
Exhibit 11: Fusion Cage Implantation in Lumbar Spine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
Exhibit 12: Comparison of Fusion Cages with Today’s Modalities on Key Outcome Parameters . . . . . 24
Exhibit 13: U.S. Markets and Maximum Potential for OP-1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
Exhibit 14: Sales and Growth by Reported Category: 1995A to 1998E . . . . . . . . . . . . . . . . . . . . . . . . . 36
Exhibit 15: Sources of Revenue Growth: 1995A to 1998E . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
Exhibit 16: Stryker’s Cash Flow Provides Opportunity for Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
Exhibit 17: DePuy's Cash Flow Enables Continued Growth Through Acquisition . . . . . . . . . . . . . . . . . 52
Exhibit 18: Sources of Total Sales Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52
Exhibit 19: Key Product Segments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
Exhibit 20: Hip Market Share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
Exhibit 21: DePuy Mix Shift Trends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56
Exhibit 22: Sources of DePuy Reconstructive Device Sales Growth: 1996E to 2000E . . . . . . . . . . . . . 56
Exhibit 23: Spinal Implant Sales by Product Segment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
Exhibit 24: Sales By Reported Category: Fiscal 1994A to 1997E . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64
Exhibit 25: Sources of Total Biomet Sales Growth: Fiscal 1994 to Q1-97 . . . . . . . . . . . . . . . . . . . . . . . 66
Exhibit 26: Biomet’s Cash Flow Provides Opportunity for Growth Through
Internal Product Development and Acquisition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66
Exhibit 27: Implant Sales Growth: Fiscal 1996A to 2000E . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
Exhibit 28: Sources of Biomet Reconstructive Device Sales Growth: Fiscal 1996 to 2000E . . . . . . . . . 68
The Skinny on the Skeleton
December 30, 1996* Robert C. Faulkner (212) 207-1497
rfaulkner@hamquist.com
Dow 30: 6560.91 Dan Shoaib (212) 207-1409
S&P 500: 1291.38 dshoaib@hamquist.com
*Report priced after market close December 27.
INVESTMENT THEME
Out of Adversity Comes Opportunity

The orthopaedic industry is largely an out-of-favor industry in the investment world
at present. The purpose of this report is to assess whether the trends leading to this out-
of-favor status are complete and how far they have to go, as well as to determine where
and whether bargains may be found. The maturation and pricing pressure of the core hip
and knee segments of the industry are well documented. In the United States, procedure
growth is in single digits, mix has shifted from high end to less expensive units, big
buyers have forced bids for business, perceived product differentiation has diminished,
and Medicare Diagnosis Related Groups (DRGs) have squeezed providers, who pass
pressure along to suppliers. No doubt, the reconstructive business is caught in the cross
fire of change in healthcare. The spinal implant business is in the midst of technological
and competitive change and players rank high on acquirers’ wish lists, generating a
diversity of opportunities.
Despite the difficult industry environment, we are here to say that this industry offers We are bullish on
investors opportunity. We are bullish on investment in orthopaedics, particularly investment in
investment in those companies which will benefit from ongoing change. The list of orthopaedics.
industry ills represents past history and even a bit of the present, but the future looks
brighter. At a basic level, unit volume growth is solid and no effort is underway to reduce
procedure growth. Orthopaedic reconstructive surgery remains one of the most
successful in healthcare in terms of outcomes because it restores function, often fully.
We also believe that mix-driven price declines accounting for most of the price pressure
to date are moderating at present. Furthermore, we believe that the worst increases in
discounting are behind us, as most big buyers now have contracts and the rest of the
buyers are not big. (These issues are covered fully in the body of this report.)
The orthopaedic market is a maturing market with a few unique twists. So, who wins The winners will be
in a maturing market? The winners will be leaders, those with market power, which leaders, those with
comes in the form of market share and reach in selling and distribution. In the context market power, which
of this rather expensive market, we believe that select orthopaedic companies offer now offer inexpensive
inexpensive quality and growth. quality and growth.
Our best stock pick is Stryker (STRONG BUY), and we also favor DePuy (BUY). Our best stock pick is
In both cases, investors buy market leadership and proven management teams. Stryker Stryker (STRONG
is our favorite stock because it has higher projected earnings per share (EPS) growth BUY), and we also
than DePuy, a cheaper P/E-to-growth rate ratio, and impending news on OP-1, the favor DePuy (BUY).
revolutionary bone growth protein, all driving potentially greater upside in the next year.
DePuy, however, is the pit bull of the industry, with the best track record of growth in the
core orthopaedic markets. We have confidence that the company can take advantage of
change to grow internally and be an industry consolidator. As DePuy makes further
acquisitions, which are not included in EPS estimates, rising estimates may drive
appreciation even further. It is also the best takeover candidate for an even bigger player
who wants to buy critical mass in the industry. We rate Biomet a HOLD despite its
impressive record of growth because of its less developed critical mass, including share
in the core U.S. markets and more limited scope in geography and product lines. We
expect the risk to be on the upside for DePuy and on the downside for Biomet.
Among spinal implant Among spinal implant companies, we believe Spine-Tech (BUY) has a great future
companies, we believe but we are concerned that near-term expectations are aggressive. Any significant break
Spine-Tech (BUY) has in the stock price should provide a buying opportunity, as would outperformance on
a great future, and we numbers. We recently moved to a BUY on Sofamor Danek (SDG) because of increasing
recently moved to a clarity on its liability situation. We view Sofamor Danek and Spine-Tech as excellent
BUY on Sofamor takeover targets in general, and Sofamor Danek at these valuation levels if liability risk
Danek. is quantified. We believe Spine-Tech is a bit richly valued for a near-term acquisition.
We are recommending acquirers, not targets, especially in the core reconstructive
markets. We have selected the acquirers for two reasons: (1) if acquirors are valued
appropriately for their present business, acquisitions should provide upside, as in the
drug industry a few years ago; and (2) we think valuations could become worse for the
acquirees in the core businesses as the competitive scenario evolves.
Leadership is For the large cap companies, our definition of quality includes leadership positions
inexpensive today. in key markets, a history of taking market share, and a strong platform for consolidation.
These companies have the critical mass and technology base necessary to both grow
internally and maximize new technologies and consolidation opportunities, and the
capability to capitalize on change. Indeed, change is what we see ahead for the
orthopaedic industry. Aggressive direct sales is essential, as companies that can leverage
acquired product lines through strong distribution channels are likely to register
sustained growth.
There are also opportunities among the small companies with internal growth
potential that may be tomorrow’s takeout candidates. For the small capitalization
companies, the key to success is product differentiation, defining differentiation as
uniquely superior clinical outcomes for patients, not merely features. We prefer
companies that are developing or marketing products that meet a significant unmet need,
possess superior FDA labeling claims, and are highly proprietary. These are the
companies that can enter a competitive marketplace and be valuable enough to be
acquired with high returns to public investors.
Waiting for Consolidation. . .

What about consolidation among these many players with 10% to 23% market share
in the core reconstructive business? Many have predicted it before now and rumors are
rampant, but the industry says everything is too expensive. Four factors seem to support
the inactivity: (1) universal optimism among industry participants; (2) recent failures in
acquisitions; (3) two unique structural attributes of the industry (surgeon champions and
independent distributors); and (4) valuations.
Everyone still believes First, everyone still believes they can win. Biomet’s growth has been sustained;
they can win. Howmedica and Zimmer have installed new managements to staunch the market share
losses. Over time, someone will lose faith in their ability to grow the business, at which
point a business will be sold because valuations will reach the level at which there are
2 HAMBRECHT & QUIST LLC

buyers. We believe that this process is now beginning to gain momentum as contracting
for market share takes hold. Once again, we expect a big transaction this year. . . but we
have said it before.
Valuations are crucial because of the recent disappointments in acquisitions. The
Kirchner acquisition by Biomet, in particular, showed that it is difficult to integrate
historical competitors and retain all the business. Kirchner was a $72 million entity as
an independent business, but now retains only $60 million in revenue. If an acquirer
expects to lose a piece of the acquired business, it is exceedingly difficult to justify
acquisitions at current valuations.
Two structural elements can make these acquisitions difficult. The first is the Industry structure can
surgeon-driven nature of promotion of these product lines. Surgeon champions design, make these acquisitions
promote, and are paid royalties on products for specific companies. Loyalty to and of difficult.
specific surgeons is hard to maintain through these transitions. Other companies may
lure them away or they may become disgruntled due to rival surgeons already under the
tent of the acquirer. If these surgeons are not retained, significant business can be lost.
The second element is that many implant companies have used stocking or independent
distributors who may carry other product lines as well. As a result, the company often
does not have the relationship with the customer, and cannot carry the business with it if
it is sold. These distributors may be lured away by competitors in the transition, resulting
in lost business.
Finally, the fact that much of the industry is buried in large corporations means that
these businesses serve a multitude of strategic purposes. For Bristol-Myers-Squibb, the
sale of Zimmer, the largest orthopaedic company, would be counter to a stated objective
of internal and acquired growth. Pfizer’s intentions with Howmedica remain unclear, as
efforts to achieve growth continue.
We do not need mergers of major public entities, however, to generate real earnings The more lucrative
growth from consolidation. The more lucrative (if smaller) opportunity is to consolidate opportunity is to
the many highly fragmented segments in orthopaedics. These can be purchased for three consolidate fragmented
to six times cash flow, be immediately accretive, and be grown substantially by a larger segments in
organization. This type of consolidation is ongoing, and benefits the acquirers. orthopaedics.
We believe that the best targets today are in non-core businesses, such as trauma, We believe that the best
spine, etc., that can be leveraged by a larger company. The prime targets in non- targets today are in
reconstructive businesses are Sofamor Danek, Acromed, Advanced Spine, Spine-Tech, non-core businesses,
OrthoFix, Arthrex, OrthoLogic, and Arthrocare. The most likely buyers of such as trauma, spine,
reconstructive companies are Johnson & Johnson, and Sulzer, a European concern. A etc.
Sulzer/Biomet fit would give geographic complementarity. We would expect Johnson &
Johnson to be more interested in buying critical mass, indicating companies like Smith
& Nephew, Howmedica, Zimmer, or DePuy. The most likely targets or sellers, willing
or otherwise, include Biomet, Howmedica (Pfizer), Smith & Nephew, and DePuy. All of
the larger players are likely to be buyers of peripheral businesses. Please refer to a
complete grid of companies and activity by business segment in the Appendices.
Potential Risks
We feel that most risks are at least adequately discounted. A key risk for the
orthopaedic industry could be the impact of potential Medicare reform in 1997. It
appears clear that the Republican Congress has little enthusiasm for grabbing this hot
potato, but there are likely to be some cuts to "reduce the rate of growth." The
Institutional Research: The Skinny on the Skeleton 3

orthopaedic industry is particularly susceptible to Medicare-targeted reform since the
large majority of orthopaedic procedures are performed on the elderly. Hospitals would
try to pass this pressure onto manufacturers. We have no evidence that hip and knee
surgery is to be targeted.
A BRIEF HISTORY
History is important For those new to the metal-bending industry of healthcare, a brief chronicle of the
because it is being orthopaedic industry may give context to our analysis and predictions. The history is
undone. important because much of it is being undone or rewritten with current trends.
Just 30 years ago, the industry was in its proverbial swaddling clothes. Previously,
joints were fused and functionality was not reestablished. The predominant therapy was
painkillers and a cane. Replacements for the hip came first, followed closely by the knee.
The roster of industry players grew largely through the defection of disgruntled
engineers and sales managers from successive generations of companies.
The benefit of the new hips and knees was enormous, relieving pain and restoring
function with low risk. As procedures grew from just a few hundred thousand in the mid-
1980s to almost 1,000,000 for hips and knees worldwide today, the companies
introduced more and more features and benefits. Porous coatings were used to enhance
bone ingrowth and reduce side effects from cement. The cost-plus environment allowed
prices to escalate 10% to 20% per year.
Three factors conspired to put the brakes on growth. First, the introduction of DRGs
by Medicare in the 1980s turned implants from profit generators in a cost-plus system
into costs in a flat-procedure-fee system. Hip replacements were targeted for especially
low reimbursement rates. This was the first domino in a chain effect leading to large
buying groups and the cost pressures experienced by hospitals today. The knee and hip
businesses were especially hard hit because volumes were big, exposure to Medicare
was large (90%), and the implant itself made up a large proportion of the procedure cost.
Medicare has kept increases in reimbursement well below inflation for several years, as
well, and many hospitals still lose money on the procedure.
Second, procedure growth slowed as nearly full penetration was reached at about
70% of all eligible patients. Third, and most important today, the much-touted high
technology premium products proved to be of little clinical value for less active patients
relative to the cemented products. The financial result of this trend has been steadily
declining share for high-priced units, and an overall decline in average selling prices
(ASPs) due to the mix shift. We believe this trend is largely over, contributing to our
comfort with investment in the industry.
With the rise of contract buyers in the United States, territory representatives
became less important, and with declining ASPs, distributor profits were crushed, often
decreasing the quality of coverage. At present, the core industry is restructuring in a shift
from independent to direct sales people. The shift allows companies to control the
customer contact and capture distributor margins, and, in some cases, ensure adequate
sales coverage. This shift is perhaps 65% complete, and some companies may never
shift to direct forces.
Cost reduction has kept pace with price reductions thus far. Manufacturing is a job
shop process. Costs are reduced with better processes and work flow and elimination of
non clinical-value-added elements, such as high-polish finishes and less expensive

instruments. Some players expect to reduce costs by 25% over a four-year period to
offset price erosion, and they are confident that this can be accomplished. There is
minimal economy of scale in the manufacturing process.
INDUSTRY OVERVIEW
This overview covers key industry segments and statistics and places particular Key issues include
focus on issues and segments relevant to growth and investment value. The key issues pricing in
highlighted include pricing in reconstructive devices, with new analysis showing the reconstructive devices,
dominant and diminishing impact of product mix on this trend, indicating a near-term and the trend toward
uptick in growth. Quantification of the trends driving pure pricing declines points to contracts.
moderating, but continuing minor price pressure. Discussion of the trend toward
contracts in the reconstructive segment highlights existing market share as the key
competitive advantage. The key segments highlighted are reconstructive devices, spinal
implants, and osteobiologics, while others are covered in less detail.
The orthopaedic products market generated estimated worldwide sales of
$7.2 billion in 1995. It is characterized by a high degree of fragmentation and consists
of both high growth and low growth segments. By far, the largest segment of the
orthopaedic products market is reconstructive devices, mainly hip and knee prostheses,
with estimated worldwide sales of $3.6 billion in 1995, nearly 50% of the market. The
reconstructive device market is mature in the developed world, with approximately 6%
unit growth and 3% dollar growth in the United States in 1995, and 3% unit growth and
4% dollar growth ex-United States, for worldwide dollar growth of 3.3%.
Exhibit 1
Estimated Worldwide Reconstructive Market Dollar Growth: 1993A to 2000E
1993 1994 1995 1996 1997E 1998E 1999E 2000E
U.S. Market
Procedures 3.2% 5.4% 6.4% 5.3% 5.1% 5.2% 5.2% 5.2%
Mix (2.9) (2.6) (2.1) (2.1) (1.1) (0.6) (0.4) 0
Price 2.0 (0.1) (1.7) (1.9) (2.4) (2.0) (1.8) (1.3)
Total 2.3 2.7 2.6 1.4 1.6 2.5 3.0 3.9
Ex-U.S. Market 6.0 5.0 4.0 4.0 3.0 4.0 5.0 5.0
Worldwide 4.2% 3.9% 3.3% 2.7% 2.3% 3.3% 4.0% 4.4%
Source: Industry Data Sources, H&Q estimates, Knowledge Enterprises, Inc.
In a quest for growth, many major orthopaedic companies are diversifying into high In a quest for growth,
growth segments of the orthopaedic market such as trauma, spinal implants, many companies are
osteobiologics, and sports medicine. This diversification has leveraged the larger diversifying into high
companies’ market power into the smaller markets, resulting in significant consolidation growth segments.
of the industry as a whole.

The trauma market includes devices that promote the healing of fractured bones and
had 1995 estimated worldwide sales of $1.0 billion, or 14% of the orthopaedic products
market. We include internal and external fixation and bone growth stimulators in this
market. Trauma procedures and products are remarkably effective at repairing the
skeleton. We expect the trauma market to sustain double digit growth over the next
several years as new technologically advanced devices that reduce the costs associated
with fracture treatment and provide added clinical benefit come to market. As a market
less reliant on Medicare reimbursement, the cost pressures are often less severe than for
reconstructive segments. While we do not include it for discussion in the trauma
segment, OP-1, Stryker’s bone growth protein, will have its first application in trauma.
The product promises to have a significant impact on recovery and healing rates in
difficult trauma cases, and is the first significant new technology in the segment in many
years.
The spinal implant market includes instrumentation designed to increase the success
rates of vertebral fusion procedures and had 1995 estimated worldwide sales of
$450 million at the end-user level, or about 6% of the orthopaedic products market. We
expect strong growth in the U.S. spinal implant market through the turn of the century
with the recent introduction of fusion cages, a novel technology providing improved
clinical benefit that could expand the number of implant procedures performed. The
baby boomer demographics of increased back problems should help fuel growth as well.
Arthroscopy includes instruments and visualization technologies for minimally
invasive diagnosis and surgery on joints and sports medicine. The worldwide market is
$715 million, with $450 million in the United States and $265 million ex-United States.
The core arthroscopy business was recently a fast-growing market, but growth has
slowed to under 5%. New products that save surgeon time and/or improve outcomes can
be rapidly adopted.
Osteobiologics are genetically engineered molecules (drugs) that directly stimulate
bone and soft tissue formation. The market for these products does not exist today, as
these molecules are currently in clinical development, but these products offer the
highest growth potential of any segment of the orthopaedic products market. Stryker is
likely to be first, with a product scheduled for launch in late 1998 or 1999. We project
revenue potential well in excess of $200 million in the United States alone within several
years. Most major orthopaedic players are attempting to develop similar products, either
independently or in collaboration with a development stage company.
The markets for bone replacements and cartilage repair are in their infancy and, in
our view, have great long-term growth potential. Both are fertile ground for many
developing companies with novel products.

Exhibit 2
Market Segment Shares
Other
10%
Spine
6%
Soft Goods
10% Reconstructive
Devices
50%
Arthroscopy/SM
10%
Trauma
14%
Source: H&Q estimates
THE RECONSTRUCTIVE DEVICE MARKET

The reconstructive device market, defined as implants for hips, knees, and
extremities, registered 1995 estimated sales of $1.8 billion in the United States and
$1.7 billion ex-United States. Geographic concentration of the market is typical, with
the U.S. representing around 50%, and Western Europe and Japan representing 30% of
the worldwide market. Worldwide hip sales are estimated at $1.7 billion in 1995, with
$800 million in the United States growing at negative 2% and $900 million ex-United
States growing in the mid single digits. Worldwide knee sales were estimated at
$1.75 billion, with $950 million in the United States growing at 4% and $800 million
ex-United States growing in the high single digits. Worldwide sales of implants for the
extremities, mainly the shoulder, were estimated at $110 million, with $70 million in the
United States and $40 million ex-United States, with shoulders growing over 20%.
The two critical issues surrounding investment in this industry are identifying the The two critical
nature and extent of pricing trends in the United States, and determining which investment issues are
companies will capitalize on change to emerge winners in the United States and pricing trends and
globally. As outlined in detail below, we believe that most of the price decline in the determining the
United States has come from mix shift, a trend we believe is just about over. Present winners.
(1996) average unit price declines are on the order of 6.3%, of which mix shift is 3.3%,
indicating real price declines in the United States of 3%. The absolute price decline has
resulted as large buyers have driven bidding processes. However, we believe that the

structure and dynamics of the market will suppress this trend to a 1% to 2% annual price
decline, at most. We posit also that larger companies are likely to benefit from the trend,
and that smaller ones will suffer. Our projection for the impact of mix shift and price
declines in the United States is 5% total in 1997 and 3.5% in 1998, improving thereafter.
Pricing in Europe has been relatively benign with annual increases of 2% to 3%, but is
subject to large sudden changes, such as when France instituted its “TIPS” pricing
system, reducing hip and knee prices substantially. It is rumored that France will
institute a further 10% to 12% price cut in February 1997.
Exhibit 3
Market Growth
US Reconstructive Market Growth - Hips
1992 1993 1994 1995 1996 1997 1998 1999 2000
Procedures 2.6% (1.3%) 4.5% 4.5% 4.5% 4.0% 4.0% 4.0% 4.0%
Mix Impact (3.4%) (3.2%) (3.0%) (3.3%) (2.0%) (1.5%) (1.0%) 0.0%
Price 3.9% (0.8%) (1.4%) (2.5%) (3.0%) (3.0%) (2.0%) (1.5%) (1.0%)
Total Growth (5.5%) (0.1%) (1.0%) (1.8%) (1.0%) 0.5% 1.5% 3.0%
US Reconstructive Market Growth - Knees

1992 1993 1994 1995 1996 1997 1998 1999 2000
Procedures 4.4% 7.8% 6.2% 8.0% 6.0% 6.0% 6.0% 6.0% 6.0%
Mix Impact (2.4%) (2.0%) (1.4%) (1.1%) (0.5%) 0.0% 0.0% 0.0%
Price 7.0% 5.0% 1.0% (1.0%) (1.0%) (2.0%) (2.0%) (2.0%) (1.5%)
Total Growth 10.4% 5.2% 5.6% 3.9% 3.5% 4.0% 4.0% 4.5%
Reconstructive Market
1992 1993 1994 1995 1996 1997 1998 1999 2000
Procedures 3.5% 3.2% 5.4% 6.4% 5.3% 5.1% 5.2% 5.2% 5.2%
Mix Impact 0.0% (2.9%) (2.6%) (2.1%) (2.1%) (1.1%) (0.6%) (0.4%) 0.0%
Price 5.5% 2.0% (0.1%) (1.7%) (1.9%) (2.4%) (2.0%) (1.8%) (1.3%)
Total Growth 0.0% 2.3% 2.7% 2.6% 1.4% 1.6% 2.5% 3.0% 3.9%
Ex-US Market 6.0% 5.0% 4.0% 4.0% 3.0% 4.0% 5.0% 5.0%
Worldwide Growth 4.2% 3.9% 3.3% 2.7% 2.3% 3.3% 4.0% 4.4%
Source: Industry Data Sources; Knowledge Enterprises, and H&Q estimates
Growth in the core geographic markets — the United States, Western Europe, and
Japan — is expected to come mainly from the growing populations of elderly persons,
and greater demand resulting from an increasingly fitness-oriented population,
reduction in procedure risks, improvement in implant technology, increased use of
implants in younger patients, and development of orthopaedic procedures for other body
parts. In the emerging markets, particularly Asia, growth should come from greater
demand resulting from increasing economic prosperity, an aging population, and low
current penetration rates for orthopaedic implant procedures.
Background
A hip or knee replacement is clinically indicated for a patient with osteoarthritis,
rheumatoid arthritis, aseptic necrosis, or fracture leading to severe joint pain and/or
limited range of joint motion. It can be categorized as either primary or revision. A
revision replacement is clinically indicated when infection of the joint occurs or when

the implant loosens because the supporting bone of the primary implant becomes
compromised. The lifetime of an implant is sufficient to see 97% of patients to the grave,
but can last anywhere between 5 to 25 years post-procedure, with most lasting at least
15 years.
A primary or revision replacement can be categorized as either a total or partial
replacement procedure. The vast majority of reconstructive device procedures consist
of total joint arthroplasty. In total hip arthroplasty, the upper bone in the leg (femoral
head) is removed and discarded. Then the socket into which the femoral head fits
(acetabulum) is enlarged and a layer of (usually) plastic, ultra high molecular weight
polyethylene (UHMWPe) is implanted, usually in a metal hemisphere. Finally, the
femoral head is replaced by a smaller metal sphere attached to a stem which is
inserted into the medullary canal of the femur (thigh bone). In a partial hip
replacement, only the femoral head and neck are replaced. In total knee arthroplasty,
a more complex but similar procedure in nature, the articulating surfaces (surfaces at
which bones meet) of the femur and tibia (lower leg bone) are replaced and the patella
(knee cap) is generally resurfaced.
Fixing the components of an implant to the skeleton is accomplished by either bone
cement (polymethylmethacrylate) or bony ingrowth into a porous coated implant. In a
cemented implant procedure, the bone cement is packed into the excised area before the
implant is inserted. Then, after implant insertion, the implant is held in place until the
cement hardens. In a porous coated implant procedure, bony ingrowth through the pores
in the implant’s coated surface achieves fixation. Porous coated implants are typically
more expensive than cemented implants, but take less operating room time and do not
incur the cost of cement and cement-related accessories. There is an ongoing debate in
the clinical and managed care communities about exactly when and for whom a porous
coated implant is clinically indicated and what the relative economic merits are of each.
Long-Term Developments: Goals and Technologies to Watch

Hip and knee replacement procedures constitute some of the most successful
procedures in history. They eliminate pain, restore function, and require minimal
monitoring or maintenance. For over 90% of patients, it is a permanent fix. This fact
contributes to the industry’s present ills by making differentiation of implants
exceedingly difficult. While remaining progress to be made in improving these
procedures may be minor, the focus is on improving the wear characteristics of the self-
lubricating plastics used in the implants. Wear particles tend to trigger an immune
reaction, which can result in osteolysis, the destruction of the bone around the implant.
Other efforts focus on enhancing implant-to-bone contact upon implantation in order
to avoid growth of fibrous tissue which provides less purchase for the implant.
Improved instrumentation is the major focus, while bone growth proteins may be a
longer-term solution.
Mix Shift and Pricing in the U.S. Market

The two most significant recent trends in the U.S. reconstructive device market are
a mix shift from more expensive porous coated implants to less expensive cemented
implants, and pricing pressure.
From January 1993 to September 1996, the percentage of unit sales coming from Mix shift was an
porous coated hips has declined from 48% to 25% and for porous coated knees from independent factor
47% to 20%, as indicated in Exhibit 4. It is important to note that the mix shift issue was from cost containment.
an independent factor from cost containment, but was clearly accelerated by it.

Exhibit 4
Porous/Cemented Mix Shift Trends

(% Porous)
50.0%
45.0%
40.0%
35.0%
30.0%
Hips
25.0%
Knees
20.0%
15.0%
10.0%
5.0%
0.0%
Q1 93
Q2 93
Q3 93
Q4 93
Q1 94
Q2 94
Q3 94
Q4 94
Q1 95
Q2 95
Q3 95
Q4 95
Q1 96
Q2 96
Q3 96
Source: IMS America; H&Q estimates
Two factors converged to drive this mix shift. First, clinical data were generated
showing little benefit to porous implants for less active patients. Specifically, outcomes
for older and less active patients were as good with cemented hips. The second factor
was the meager annual increases of 0% to 2% in reimbursement under the Medicare
DRG code 209, which covers over 90% of hip and knee procedures. Until 1995, hip
procedures lost money for the average hospital, bringing significant pressure on implant
suppliers. Implants had risen to near 30% of costs of a total hip procedure by 1995 as
other costs were reduced.
With the rise of cost pressures, a new phenomenon arose, known as “patient demand
matching.” With patient demand matching, orthopaedic surgeons choose porous coated
implants for younger, more active patients with longer life spans and greater need for
mobility, and cemented implants for elderly or less active patients who are likely to be
outlived by their implants. The consequence has been the shift away from use of porous
coated implants since 1993.
Clearly, there is a place for porous coated implants in the reconstructive device
market and, in fact, it appears that the shift from porous coated to cemented implants has
largely run its course, as porous coated implants appear to have reached their clinically
justified level of usage. Moreover, some porous coated implant manufacturers
(particularly Biomet) have demonstrated that the fully costed economics of porous coated
and cemented implants are comparable. This calculation includes the additional
procedure time (15 to 20 minutes) and the cost of the cement and cement-related
accessories. Biomet has largely avoided the mix shift hit to sales as a result of this strategy.

Exhibit 5
Impact of Mix Shift on Sales for Industry and Major Players
1994 1995 Q3-96
Industry
Hips -3.2% -3.0% -2.2%
Knees -2.0% -1.4% -1.2%
Zimmer
Hips -3.9% -0.5% -3.3%
Knees -0.9% -1.0% -0.5%
DePuy
Hips -3.5% -5.9% -5.4%
Knees -5.1% -3.2% 2.7%
Howmedica
Hips -4.2% -7.5% -6.2%
Knees -2.8% -2.7% -2.7%
Biomet
Hips -2.7% -1.6% 2.0%
Knees -1.6% -0.3% -1.2%
We estimate that the shift from porous coated to cemented implants negatively
impacted U.S. knee implant revenue from -1% to -2% per year and U.S. hip implant
revenue around -3% per year from 1994 to 1996 Stabilization of this trend definitively
brightens the outlook for the reconstructive device market.
Pricing Forecast: Partly Sunny

Pure pricing pressure from hospitals remains, though it is more minor than is widely Pure pricing pressure
perceived. It appears to us that price declines accelerated in the first half of 1996. We is more minor than is
estimate that the change in ASP for reconstructive devices overall was about -3% at the widely perceived.
end of the second quarter of 1996. Importantly, according to most industry players, the
ASP declines appear to have decelerated in the second half of 1996, which could bode
well for reconstructive device manufacturers. ASP declines appear to be more severe in
hips than in knees and in porous coated implants than in cemented ones.
Price erosion has been driven by the consolidation of providers and the resulting
increase in power of administrative buyers, made more acute by Medicare cuts. Hospital
administrators have a fairly simple goal: to make money on the $10,900 reimbursement
for DRG 209 (see Exhibit 6). To make the procedure profitable, costs were reduced
primarily by reducing average length of hospital stay from 19 days in 1982 to 7 days in
1994. Many now have a length of stay of 5 days. Hospitals and surgeons also reduced
procedure OR (operating room) time from 2.5 hours to as little as 45 minutes, at a
savings of $40 per minute fully costed.

Exhibit 6
Financial Indicators in U.S. Reconstructive Joint Procedures: 1995
Total Hip Partial Revision Total Revision

Hip Hip Knee Knee
Charges $21,306 $19,342 $24,880 $21,155 $20,805

Costs* $10,477 $9,782 $12,239 $10,278 $10,193
% Markup 103.4% 97.7% 103.3% 105.8% 104.1%

Reimbursement $10,727 $10,826 $11,263 $10,947 $10,903
Gain/(Loss) $250 $1,044 ($976) $669 $710
Implant Cost $3,056.03 $515.10 $4,446.00 $3,783.58 $4,778.76

% of total cost 29.2% 5.3% 36.3% 36.8% 46.9%
Length of stay (days) 6.50 8.52 7.46 5.92 5.98
*Captures costs for: routine/special care nursing, operating room, laboratory, radiology, pharmacy, medical
supplies and other ancillary services
Source: CHIPS, company price lists
To gain negotiating leverage, administrators urged surgeons to standardize on a

single implant to allow volume purchasing, a tactic that has met with mixed success thus
far. However, with implants constituting a significant percentage of DRG
reimbursement, it appears likely that they will continue to be a primary area of focus for
cost-conscious hospitals.
Buyers appear to be This story bring us to the present time, wherein buyers appear to be losing some of
losing some of their their leverage. We are calculatedly optimistic that the worst of the price declines is over,
leverage. based on three observations.
First, surgeons have been recalcitrant, to date, in complying with implant
standardization, and administrators are not fond of changing surgeon behavior.
Orthopaedics as a practice is highly profitable, and for most hospitals, hips and knees
are a relatively small part of the orthopaedic business associated with a surgeon. Instead
of enforcing compliance system-wide for a buying group, some local administrators
allow surgeons to use any product, often at the old price, and sometimes only if the
contract price is matched. The industry has wised up a bit recently and revised these
contracts to tie discounts more closely to volume.
The result of surgeon recalcitrance is a standoff between surgeons and
administrators. We expect this standoff to significantly slow price erosion from here
because it does not allow rapid switching, or even any switching in many cases, among
brands. Second, the renewed profitability of the procedure is also a positive sign for near-
term pricing trends. A customer’s profitability should reduce his urgency in negotiations.
The third observation is that the Columbia/HCA contract, won by DePuy and
Howmedica, may mark a floor for pricing near term. We draw analogies with the drug
industry, which had similar large buyer experiences. In the drug industry, price declines

appeared to halt partially in response to the Medicaid “best price” policy, in which
HCFA paid the “best price” given to any other volume buyer, less 15%. This policy made
significant increases in discounts to any one account highly onerous, likely spurring
pricing discipline.
Initially, DePuy and Howmedica felt beaten up by the contract, having given up
more than they received, and rumors were circulating that the contracts would be
terminated by both sides. The widely quoted figure of 40% discounts likely stimulated
price concessions throughout the market and certainly stimulated price cuts to hospitals
in the Columbia/HCA system by companies not in the contract.
A few statistics and laborious calculations may support our optimism for better The hip and knee
pricing near term. Today, as much as 75% of all hips and knees are sold at list price to business is a minor
small-volume and/or surgeon-driven hospitals. Price pressure is likely minor for this piece of a hospital’s
segment. If a single hospital seeks to reduce implant costs, it can more easily drive profitable orthopaedic
compliance than a system of hospitals, but the low potential volumes limit discounts to business.
5%, if any. If all hospitals entered contracts and drove compliance over five years, the
price decline would be 5% on 75% of units, or 0.75% per year on the whole business.
Of course, most hospitals are not in contracts and the spread of contracts in this
segment of hospitals is likely to be slow. For a low-volume center, the hip and knee
business is likely a minor piece of the orthopaedic business, which remains highly
profitable. The payoff from the painful process of gaining compliance diminishes in
these circumstances.
For the other 25% of implant volume, the oft-quoted figure of 40% discounts for Our calculations give a
Columbia/HCA strikes fear into everyone. However, virtually 100% of implants used in hypothetical price
a system the size of Columbia/HCA would have to be of a single manufacturer in order pressure of 1% to 2%.
to achieve a 40% discount. Such a level of volume clearly cannot be met by Columbia/
HCA or any other account. Through October 1996, DePuy gave a 19% discount to
Columbia/HCA. Using a 19% discount as the maximum likely for the largest accounts,
we can hypothesize that typical discounts will be under 15%. To acheive these discounts,
accounts must drive share, a slow and painful process, making “discount creep” a slow
process over a period of years. If we assume five years for the change, and a present
discount of 5% for these accounts (the minimum), the industry will lose 10% price over
this time, or 2% per year, on 25% of the business, or 0.5% per year on the whole
business. We believe that the large group purchasers that can drive compliance (the key
attribute) have already signed contracts, indicating a moderation of this particular
pressure. In sum, these calculations give a hypothetical price pressure of 1.25% per year,
or 1% to 2% in general terms.
Another concern is that high-volume centers will increase their share significantly,
driving down implant prices through their expansion. We have been waiting for this
trend, but it is glacially slow, if it exists at all. Because over 90% of procedures are paid
by Medicare, price competition among providers is not a factor because price is set.
Surgeon choice remains up to the individual. Not least, in the long term, it may be
difficult for high-volume centers to demonstrate better quality because the success rate
is so high. We do not expect significant volume concentration until centers can compete
on outcomes quality, which appears a long way off.
A final factor against wild price erosion is that large orthopaedic companies are not
terribly profitable, at 10% to 15% net income margins, indicating that they should not
be far from prices below which they will not go. We believe that the Columbia/HCA
experience delineated this point. Costs can continue to be squeezed, but there is not an

obvious expense line on the P&L that can be eliminated, such as SG&A. These products
remain high-service items, a factor which is unlikely to change drastically, although
service levels are certain to be reduced selectively.
Overall, we expect reported average unit prices to decline 3% to 4% for 1997,
including 1% for mix and 2% to 3% for price alone. These numbers are slightly higher
than the hypothetical example because they include a comparison against the first half
of 1996, during which mix and prices declined rapidly. In 1998, we expect average unit
prices to decline 2% to 3%, including 1% mix and 2% price. This decline should be more
than offset by unit growth of 5% per year in the U.S. market.
Winning in the Future: To Contract or Not to Contract?. . . Contract!

Market share is We believe that the reconstructive market is undergoing a profound change in its
becoming a more competitive landscape, and that the impact has not yet been felt. Simply, market share is
important competitive becoming a much more important competitive advantage because compliance is now the
advantage. key to cost savings for hospitals, and the path of least resistance to achieving compliance
is to choose an implant that is widely used. Furthermore, once compliance on an implant
brand is accomplished, it strikes us as highly unlikely that these accounts can
realistically switch brands regularly without infuriating their surgeons, since surgeon
switching is clearly a sticking point. Upon contract expiration, a new company would
have to beat existing prices but expect significantly lower volumes at first than the
established player, who has had time to grow share and volume to justify the discount.
So why would a manufacturer not pursue contracts? There are two views about
contracting by competitors: it is too risky not to play, and it is too risky to play. A
significant percentage of reconstructive device procedures (as high as 60%) are
performed by low volume orthopaedic surgeons who require high service levels from
manufacturers. As a result, manufacturers not part of contracts can sell into hospitals
with contracts by continuing to provide attentive service to orthopaedic surgeons who
may prefer a specific implant system or guidance from a particular sales representative.
If a surgeon performs only 20 procedures per year, and has an active practice in other
procedures at the hospital, a hospital is unlikely to go to the mat to enforce compliance
on implant choice. It is widely assumed that significant legal issues prevent hospitals
from forcing compliance against the will of a surgeon.
Non-contracting manufacturers, Biomet primary among them, continue to
emphasize surgeon relationships as the mainstay of their business and product
differentiation as communicated by surgeon champions to maintain volume and price
levels. They point to success, so far, in their own firm prices, the apparent deceleration
of pricing pressure, and the pain the rest of the industry inflicted on itself by agreeing to
draconian reductions.
In our view, contracts The key question is whether the balance of power will continue to swing towards the
are here to stay. administrator as buyer or back towards the surgeon. In our view, hospital administrators
and group purchasing contracts are here to stay. In five years, the percentage of contract-
based reconstructive device sales has increased from 0% to about 25%. We expect that
this percentage, along with compliance rates, will continue to increase because both
parties, buyers and sellers, stand to gain.
In the near term (one to two years), manufacturers may be able to maintain price
effectively by avoiding group purchasing contracts, emphasizing product
differentiation, and catering effectively to the orthopaedic surgeon, but it will be at the
expense of market share and, possibly, viability in the longer term (two-plus years).

A good example of this dynamic may be the Columbia/HCA contract granted to
DePuy and Howmedica. The actual outcome is hotly debated, but DePuy claims to have
achieved unit increases of 36% and dollar increases of 17% through Columbia through
October 1996 versus 1995, an apparently clear payoff. However, other manufacturers
continued to sell into Columbia/HCA hospitals. Biomet’s sales in the Columbia/HCA
network have grown 5% to 6% in 1996, for example. The important statistic, however, is
that Biomet growth in Columbia/HCA is at less than half the rate of 10% to 15% in 1995.
Osteonics also acknowledges losing share in these accounts. It appears that surgeons are
at the beginning of the “compliance curve” in this account. As compliance increases, we
find it difficult to imagine that non-contract participants will grow in these accounts.
The ultimate answer to the question of which companies will win is likely to lie at
the middle of this standoff between administrator and surgeon. This middle ground is
market share, because the larger the market share a company has, the easier it is for a
purchasing system to gain compliance around that product. If prices at a given volume
are relatively constant across manufacturers, and if discount is a function of absolute or
increased volume, then starting market share is a key competitive advantage.
The Ex-United States Reconstructive Device Market

Outside the United States, the two key markets for reconstructive devices are Europe
and Japan. Europe is highly fragmented, with each country demonstrating its own trends
with regard to growth and pricing. Most European sales strategies incorporate a country-
specific approach, with a direct presence in the major European markets, including the
United Kingdom, Germany, and France. Many companies have established a direct
presence by creating distribution subsidiaries, often by buying out former independent
distributors. These purchases are increasingly common in part because distributors are
finding it difficult to carry the vast inventory required to compete. The establishment of
distribution subsidiaries in major European markets has become even more important
with the “Americanization” of the European regulatory climate, which has increasingly
required manufacturers to possess critical mass on location for coping with legal and
regulatory issues. Distribution subsidiaries provide a parent company with the hands-on
expertise and level of communication necessary to navigate these regulatory hurdles.
In Japan, where legal and regulatory hurdles have also been rising, “going direct”
appears essential. Almost all companies have a direct presence in Japan, except Biomet
and Wright Medical. In Japan, there is a strong belief in the quality and clinical results
of U.S. products, which control 80% of the market. Importantly, perhaps more so in
Japan than in any other part of the world, relationships drive orthopaedics sales,
indicating that consolidation of market share in any given product segment is unlikely,
once distribution capacity has been maximized.
The Players
The reconstructive device market is highly fragmented and intensely competitive.
The major players include DePuy, Biomet, Osteonics, a division of Stryker, Zimmer, a
subsidiary of Bristol-Myers Squibb, Howmedica, a subsidiary of Pfizer, Smith &
Nephew, Johnson & Johnson Professional Inc., a division of Johnson & Johnson, and
Intermedics, a division of Sulzer Orthopaedics. Market shares are clustered very tightly,
with DePuy and Zimmer neck and neck with about 22% to 23% share in the hip implant
market, and Zimmer leading the knee implant market with about 22% share, with several
other manufacturers posting double digit market shares.

Exhibit 7
U.S. Hip and Knee Unit Share Trends: 1990-1995
Hip Market Share

50%
45%
40%
35%
30% Biomet
DePuy
25% Howmedica
Osteonics
20%
Richards
Zimmer
15%
10%
5%
0%
1990 1991 1992 1993 1994 1995
Knee Market Share

35%
30%
25%
Biomet
20% Depuy
Howmedica
Intermedics
15%
J&J
Osteonics
10% Richards
Wright
Zimmer
5%
0%
1990 1991 1992 1993 1994 1995

Exhibit 8
Estimated 1995 Reconstructive Market Shares for Major Players ($)
Worldwide United States Ex-U.S.
Zimmer 18.6% 20.4% 16.6%

Howmedica 13.7% 13.2% 14.2%
Sulzermedica 13.3% 7.3% 19.6%
DePuy 12.4% 14.6% 10.0%
Johnson & Johnson 8.9% 9.8% 8.0%
Biomet 7.8% 12.0% 3.3%
Stryker 7.6% 8.0% 7.2%
Smith & Nephew 6.0% 7.0% 5.0%
Others 11.7% 7.7% 16.0%
Source: Knowledge Enterprises, Inc.
THE TRAUMA MARKET

The worldwide trauma market had 1995 estimated sales of $1.0 billion, with
$500 million in the United States growing at 14% and $500 million ex-United States
growing at 11%. The objective of trauma devices is to achieve complete bone healing or
union and restoration of alignment and full range of motion in patients who have
sustained fractures for whom casting alone is insufficient. Trauma devices include
internal fixation devices, external fixation devices, and bone growth stimulators.
The worldwide internal fixation device market had 1995 estimated sales of
$675 million, with $350 million in the United States growing at 12% and $325 million
ex-United States. Internal fixation devices include mainly plates and screws used to
achieve fracture reduction. Surgical intervention is required to fasten the plates and
screws to the surface of the bone at the fracture site and again to remove them after the
fracture has healed. The surgical implantation procedure is often lengthy and carries the
risk of infection of the fracture site.
Intramedullary fixation, involving the insertion of a metal rod into the bone canal to
achieve reduction, has become increasingly popular for treatment of long bone fractures,
as this procedure carries a lower risk of fracture site infection. However, intramedullary
fixation also generally requires a second surgery for removal of the metal rod after the
fracture has healed.
The U.S. internal fixation device market is dominated by one company, Synthes.
Other players include Zimmer, Smith & Nephew, and Howmedica. It appears that
Synthes and Zimmer are gaining market share.
The worldwide external fixation device market had 1995 estimated sales of
$180 million, with $80 million in the United States growing at 9% and $100 million ex-
United States growing at 9%. External fixation devices seek to achieve fracture
reduction from the outside of a limb, without extensive open surgery. They can offer
some important clinical and cost advantages over internal fixation devices for certain
indications. First, external fixation devices allow patients to bear full weight on the

affected limb at an earlier stage than internal fixation devices, and require less time to
attach. They also do not require an extensive second surgical intervention for device
removal.
Synthes is the market share leader with 31% share, followed by EBI, a division of
Biomet, with 20% share, Smith & Nephew with 12% share, Howmedica with 11%
share, and Orthofix with 11% share. It appears that Synthes and EBI are gaining market
share. We estimate market growth of 10% over the next few years.
We believe that bone The U.S. bone growth stimulation device market had estimated 1995 sales of
growth stimulators $122 million, growing at 10%, with negligible sales ex-United States. Bone growth
could become first-line stimulators are prescribed for treatment of non-healing fractures and as adjuncts for
therapy for treatment of spinal fusion procedures to increase the success rates for vertebral fusions. Currently, the
non-healing fractures. gold standard for treatment of non-healing fractures is surgical intervention involving
the harvesting of bone from the patient’s iliac crest for implantation at the fracture site,
a procedure associated with high rates of morbidity. Although bone growth stimulators
have been around since the late 1970s, an increasing body of scientific evidence
demonstrating efficacy and new technology has resulted in the resurgence of the market.
We believe that bone growth stimulators could become first-line therapy for treatment
of non-healing fractures if orthopaedic physicians gain greater comfort with clinical
results. We estimate that the market potential for bone growth stimulators could be as
great as $400 million at peak.
The major players in the bone growth stimulation market include EBI, the market
share leader with 60% share, OrthoLogic with 9% share, and Orthofix with 10% share.
OrthoLogic has rapidly gained market share since the introduction of its bone growth
stimulator for treatment of non-healing fractures in March 1994, up to 21% as of the
third quarter of 1996. Its product requires only 30 minutes of treatment time per day
versus 10 hours per day for EBI’s bone growth stimulator.
Long-term Developments: Goals and Technologies to Watch

Unmet clinical needs in trauma revolve around reducing procedure risks and
improving healing rates. Reducing surgeon and operating room time remains a potent
driver for new products as well. Bone growth proteins, bone graft substitutes, and
resorbable fixation products are the top identified needs. Bone growth proteins promise
higher healing rates, leading to fewer repeat surgeries and faster patient function. The
impact could be large, with changing needs for fixation implants. Bone graft substitutes
may offer equivalent healing to autologous bone while avoiding the painful graft
procedure, exposure to infection, or poorer healing rates with many present substitutes.
Finally, the ideal resorbable technology would promise better load-bearing attributes
than metal and would obviate the need to remove implants after bones are healed, as is
currently recommended.
THE SPINAL IMPLANT MARKET

We believe that devices used in spinal fusions comprise one of the orthopaedic
markets with the greatest near-term growth potential due to fusion cages in the United
States and the high remaining unmet need in these procedures, especially in the lumbar
spine. The market is only now beginning to benefit from new technologies and
techniques which will improve outcomes, reduce risks, and increase the population of
patients who can benefit from the procedure. Other products, such as bone graft
substitutes and bone growth proteins, stand to grow this market further in meeting the
still-high unmet need.

We estimate a worldwide spinal implant market at end-user prices (not all We look for strong
companies have their own direct sales forces) of $450 million in 1995, with U.S. sales growth in the U.S.
of $250 million, growing at 8% in 1995, and ex-United States sales of $200 million, market due to the
growing at approximately 10%. Growth comes from procedures, price, and increased introduction of fusion
implant usage. We look for strong growth going forward in the U.S. market, near 20%, cages.
due to the introduction of fusion cages, and continuing ex-United States growth at 10%
through 2000 due to growing usage of implants. It is the opportunity to make devices
first-line therapy for close to 100% of fusions, the unequivocal standard of care, that
represents the growth opportunity in both cervical and lumbar fusions.
Exhibit 9
Spinal Implant Market

Geographic Distribution
Europe
Europe24%
24%
U.S.
U.S
56%
56%
Asia/Other
Asia/Other
20%20%
In the United States, cervical (upper spine) fusions appear to be growing at over
10%, and penetration of implants is rising rapidly. The cervical market is primarily a
U.S. business, with $45 million in the United States and $65 million worldwide. Growth
has been driven by the increase in cervical fusions due to increasingly good results with
the procedure, and through penetration of implants into the procedures. Synthes has
dominated this business in the United States, but Sofamor Danek has made substantial
inroads. Growth in this segment likely has a couple more years before the procedures are
fully penetrated.
Lumbar fusions appear to be almost flat, at 78,000 in 1995, and the rate of implant We expect growth in
usage is rising slightly. The lack of growth is driven by payers who object increasingly lumbar procedures to
to the poorly proven benefit of fusion surgeries. Overall, procedure growth appears to be increase to 10% with
around 4% in the United States. We expect growth in lumbar procedures to increase to the introduction of
10% with the introduction of fusion cages due to the well-documented benefits of the fusion cages.
product. We expect procedures to grow at 7% in Europe, with remaining growth coming
from increased penetration of implants into procedures performed. We include complete
projections and segmentation of the lumbar spinal implant market in the Appendix.

We differ from an apparent consensus on the outlook for the lumbar spinal segment
on a number of details. First, we suspect that lumbar fusion procedures and implant sales
would be single-digit in the near future without fusion cages. Second, we believe that
the number of lumbar procedures for 1997 is 82,000, less than many figures quoted. This
figure is corroborated by most procedure data sources (HCIA, IMS, NCHS). We also
fear that some expectations for first-year sales (1997) for fusion cages are aggressive, at
as high as $90 million. We believe the opportunity is real and of the same magnitude as
others in the longer term. We believe that our 1997 estimate of $37 million is acheivable,
but still optimistic. Our numbers show a one-year slower ramp to peak versus others.
Even at our lower numbers, the product would be the most successful first-year launch
in orthopaedic industry history.
To hit $90 million in U.S. sales of the fusion cage in the first year, we must assume
penetration of 28% of all lumbar procedures with implants, regardless of the indication
for the procedure. Or we must assume penetration of 22% of all lumbar procedures,
with or without implants. These surgeons are conservative, still smarting from liability
suits with pedicle screws, and not all surgeons are yet convinced of the fusion cage’s
benefits for a wide segment of their patients. And, in 1997, not all of them will be
trained until later in the year. The fusion cage companies also face well-entrenched
competitors such as Sofamor Danek, DePuy, and AcroMed, who are likely to play
heavily on surgeons’ conservatism.
Background
There are three primary surgical procedures on the spine: laminectomy, discectomy,
and fusion. Laminectomy is a decompression procedure in which part of the spine is
removed to relieve pressure on the surrounding nerves. A discectomy is the removal of
all or a portion of a herniated disc. Neither discectomy nor laminectomy generally
involves device implantation.
Spinal fusions are performed to eliminate the pain caused by a number of factors.
The three primary ones are: pain due to degeneration of disks between vertebrae and the
occasional associated malalignment (70% of patients); trauma, including auto accidents
and removal of tumors (20% combined); and spinal deformities such as scoliosis, the
severe lateral curvature of the spine (10%). In trauma and degenerative disc disease, pain
and reduced function occur as the deformation of the spine causes contact between the
bony spine and the nerves emanating from the spinal column. The common fusion
procedures are: fusion with bone graft without instrumentation, and fusion with bone
graft with plates, screws, hooks, or rods.
The spinal fusion market has anatomic and severity segments which drive product
selection. The spine has three sections: upper, or cervical spine, the middle, or thoracic
spine, and the lower, or lumbar spine.
Cervical fusions have Cervical fusions have been the fastest growing segment as surgeons increase their
been the fastest growing usage of implants. Upper vertebrae bear less load and are much smaller than the lower
segment. vertebrae, requiring minimal support. Until recently, instrumentation was not often used
in cervical fusions. The implants used are simple plates and screws similar to trauma
products. In Europe, fusion cages are available for cervical procedures but are in early-
stage development in the United States (Spine-Tech). Although constituting almost half
of spinal fusion procedures, cervical fusions generate on the order of $500 per
instrumented procedure versus $2,000 for lumbar procedures. Almost all surgeries for
deformities or trauma are instrumented with hooks, rods, screws, or plates.

The lumbar spinal fusion segment is the largest segment in dollar terms and a close
second to cervical fusions in procedure terms. Implants, including screws, plates, hooks,
or rods, have become the standard of care, although bone alone is still commonly used.
The fusion cage is the
most exciting "new"
Exhibit 10 technology.
Fusion Market Segments by Procedure and Dollar Volume
100%
90% 18%
80% Cervical
47%
47%
70%
32%
60%
Cerv
50% Thoracic
16% Thor
16%
40% Lum
30%
50%
20% Lumbar
38%
38%
10%
0%
Procedures Dollars
Source: Industry Sources; H&Q estimates
The interbody fusion cage (fusion cage, or cage, shown in Exhibit 11 on the
following page) is the most exciting "new" technology for spinal surgeons, particularly
in view of the potential for laparoscopic implantation. Fusion cages have been marketed
in Europe for years to a modest reception. Fusion cages are generally cylindrical, around
0.5 inches in diameter, hollow, and with holes in the sides (like rolled swiss cheese). Two
fusion cages are inserted in the disc space side by side, protruding into the top and
bottom vertebrae, and filled with bone fragments harvested from the patient to enhance
possibility of fusion. The fusion cages reestablish disc height, and thereby restore the
proper anatomy (likely relieving pressure on nerves), and bone grows through the holes
and around the fusion cages for a fusion. They provide proper physiological support,
through the vertebral bodies of the spine. Threads on the exterior of the cage prevent the
cage from slipping out of the hole into which it was implanted or protruding through the
other side. The devices can be implanted in an open procedure or with laparoscopic
techniques.
The FDA approved two fusion cages, Spine-Tech’s BAK/L and U.S. Surgical’s Ray
Threaded Fusion Cage, in the fall of 1996. Fusion cages are entering a highly receptive
market. In a quirk of fate, fusion cages are the first products approved by the FDA for
general lumbar fusion. Pedicle screw and plate constructs, the present standard of care,
have not been approved for this use
Severity segments are based on the number of levels to be fusioned, the degree of
stabilization required, and the activity level of the patient. Where disc degeneration or
trauma afflicts multiple levels of the spine, implants are almost always used. Older or
less active patients are less likely to receive an implant.

Exhibit 11
Fusion Cage Implantation in Lumbar Spine

Fusion Cage Implants
L4 L4
Healthy L4
Disc
L5 L5
L5
S1
Diseased
Disc
Pre-Operation Post-Operation
Source: Spine-Tech
In the United States, we estimate implant usage in around 77% of total lumbar
fusion procedures. An estimated 60% of fusions of a single level of the lumbar spine
used an implant in 1995. We believe that fusion cages will increase the rate of implant
usage. Instrumentation would undoubtedly be above the present penetration level in the
United States were it not for the pedicle screw lawsuits, catalyzed by a December 17,
1993, "20/20" episode highlighting the off-label usage of pedicle screws and supposed
harm done to patients. Since then, the growth of lumbar fusion procedures has not fully
recovered, with negative growth rates for 1993/94 and 1994/95. Most spinal implant
companies selling pedicle screws have now been granted approval for limited
applications in the lumbar spine. A process is underway to downclassify pedicle screw
constructs from Class III (requiring clinical trials) to Class II (510 (k)). This process is
moving at a glacial pace.
Long-term Developments: Goals and Technologies to Watch

Spinal fusion, by whichever means, remains a rather crude solution to spinal
problems; it may reduce pain, but it does not restore function. Frequently, the fusion at
one disk level increases the burden on adjacent sections, leading to further deterioration.
There will almost certainly be other approaches to fusion. Ultimately, the goal is to
restore function to the affected area of the spine, perhaps through an implantable disc.
Such a development would bring spine surgery to the level at which hip and knee surgery
is today, allowing restoration of function.
Other materials and shapes placed in the disc space may be able to achieve the same
objectives as fusion cages, but would require a regulatory process of five to seven years for
U.S. approval. Sofamor Danek has obtained the rights to and patented the use in the spine
of Hedrocel, an ultra-strong material likely to withstand the spine’s compression forces,
yet retaining a rigidity similar to that of bone. We are not aware of progress with this
material in clinical trials. Sofamor Danek is also experimenting with a fusion cage that
conforms to the “lordotic curve,” the natural curve of the spine. The advantages or
disadvantages of such a device are unproven and are unlikely to be significant, in our view.

A bone substitute allowing the elimination of the harvesting of bone is also an
important development goal for spinal fusion development. Surgeons require bone
fragments to place in the location at which the fusion is desired. With pedicle screws it is
on the lateral processes, the bones on the back of the spine, and/or between the vertebrae.
For surgeries using a fusion cage, bone fragments are placed inside the cage. To obtain
bone fragments, surgeons must make an additional incision to harvest bone from the
pelvis (iliac crest). Some say that this procedure is more painful than the spinal procedure
itself, leaving an enduring ache, and it exposes a patient to additional trauma, recovery,
and risk of infection, and costs the surgeon time. To date, no bone graft substitute has
been accepted as standard of care for the spine. There are several on the market, including
processed cadaver bone and coral-based products. At present, such products cost around
$1,500 per spinal procedure, indicating a very large potential market. Spine-Tech
recently announced a development agreement with Orquest for such a product; the most
promising candidate, in our view.
The next quantum leap in fusion is likely to be the combination of a device and
morphogenetic proteins, a drug that stimulates bone growth (see Osteobiologics
section for further detail on other applications). Sofamor Danek and Genetics Institute
have created an alliance for the development and sale of the Genetics Institute product,
rhBMP-2, for North America. Sofamor Danek appears to have the lead in clinical
development for spinal applications for bone morphogenetic proteins. The challenge to
date has been to find a carrier for the protein that can deliver it. Sofamor-Danek is about
to start clinical trials of rhBMP-2 in conjunction with the lordotic fusion cage, the first
U.S. clinical trial of a bone growth protein in the spine. This is a pilot study leading to
a pivotal trial. Approval is not likely for five years (2002). Stryker has rights to the spine
for OP-1, a bone growth protein licensed from Creative BioMolecules. While not in the
clinic in the U.S. for the spine, Stryker has completed trials for non-union fractures,
with launch expected in 1998/1999. It is likely that some will be used in the spine on
an off-label basis for the spine. Stryker is performing exploratory studies in the spine
in Europe.
The holy grail in spinal surgery is to restore function with an implantable disc, much
as one replaces a knee joint. A number of attempts have been made and failed and many
are in development. We are not aware of any late-stage clinical work in this area. The
product is, in our view, not on the forecasting horizon.
U.S. Lumbar Spinal Implant Market Outlook Discussion

The major issues in determining market growth through 2000 are:
• Τhe impact of fusion cages on the U.S. lumbar fusion market in 1997/98
• Increased competition in the pedicle screw segment
• The evolution of views of pedicle screws in the lumbar segment.
Fusion Cages
We believe that fusion cages are likely to push U.S. growth in the lumbar spine
market, 50% of the total, to near 20% over the next few years, with traditional pedicle
screw products flat or declining in growth. Fusion cages appear to have almost every
factor in their favor for rapid and deep penetration into the spinal market. The primary
reasons why fusion cages should reach their potential are:

• Cages are likely to offer a quantum leap in the clinical risk/benefit tradeoff, and
enhanced cost effectiveness, which should establish cages over time as the first-line
implant for single-level fusions.
• Fusion cages should penetrate fusion procedures presently performed without
implants, expanding the market for implants.
• Cages should grow the number of lumbar fusions due to reduced procedure risks.
• Cages are priced at twice the price of substitutes, expanding the market dollar value
through mix upgrades, but limiting penetration somewhat.
• Cost reduction is likely, especially with laparoscopic approaches.
The quantum leap in clinical benefit is multi-factorial. On the typical primary
endpoint, percentage fused, cages are not definitively better or worse than
instrumentation. Viewed as a clinical risk/benefit tradeoff package, cages offer a clear
enough advantage. It is the combination of improvements in outcome, such as better
improvement in pain, with the reduction in risk and recovery time that makes the fusion
cage clinically valuable.
Exhibit 12
Comparison of Fusion Cages with Today’s Modalities on Key Outcome Parameters
Modality
Standard Non-Instrumented
Fusion Cage Instrumentation Procedure
Fusion % (1 level) 93% * 95% *** 70% ***
Post-Surgical Device Removal/

Problem Requiring Surgery % 2.5% * 12.5 *** 0% #
Net “Pure” Success % 91.5% 82.5% 70%
Post-Fusion Pain Meds Needed 0% ** 9% ** generally higher

Average Return to Work 11 weeks ** 23 weeks ** likely higher
Hospital Recovery Time 4 days (open) * 4-7 days ## 7 days ##

2 days (lap.) **
* Kuslich: Average ** Zdeblick; small study, *** estimated 1 level from # Yuan, et al, excluding
## Industry/NCHS significant Yuan, et al stimulators
Source: H&Q analysis
Other benefits are likely to include reduced blood loss and reduced operating time
of 60 to 90 minutes against several hours for present procedures, which increases a
surgeon’s output and income. Fusion cages are likely to save money in the procedure
alone. Our estimates show up to $3,600 savings for a single-level fusion compared to a
non-instrumented procedure, or $2,300 compared to an instrumented procedure.
Savings are less in multi-level procedures. Further savings are likely to accrue to
workers compensation insurers through the faster recovery and return to work.

The U.S. Lumbar Instrumentation Market
The core market for spinal instrumentation, the term for plates, screws, and hooks The market for spinal
and rods used in lumbar spinal fusions, is heading for profound changes, in our view. instrumentation, is
The three major issues are the entry of a new technology (fusion cages), the entry of new heading for profound
competitors, and signs of diminishing satisfaction with the surgical approach itself. We changes.
expect these issues to result in flat or declining average unit prices from 1998 onward
and in absolute declines in units.
Unit growth in the United States is likely to be flat or down as a result of the entry Unit growth in the
of fusion cages, which promise to take some volume from instrumentation. Today, 60% United States is likely to
of dollar volume comes from multiple-level procedures, procedures for which we be flat or down.
believe fusion cages are less likely to be used, although this is not yet proven. For single-
level procedures, we estimate that fusion cages will reduce instrumentation growth to -
1% between now and 1999. Overall, we expect unit volume for instrumentation to
decline 5% in 1997, and 2% to 3% in 1998.
Within the instrumentation segment, the biggest change is the entry of competition
since the approval of pedicle screw constructs for use in the lower lumbar spine, perhaps
10% of lumbar procedures. While not carte blanche for broad marketing, it gave an
opening to industry players not willing to promote entirely off-label. Stryker, Biomet,
Wright, DePuy, Cross Medical, and Synthes are seeking to turn up the heat. DePuy and
Synthes have made significant inroads, taking at least 5 share points from Sofamor
Danek in the lumbar products market in 1996, as well as share from AcroMed, Advanced
Spine, and Smith & Nephew.
The implication of these entrants is the maturation of the business and the likelihood The implication of
of a progression to bids by large buyers. The companies with large shares will stand to entrants is the
succeed best in this scenario, as compliance around a certain product is the key to likelihood of a
gaining volume and it is easiest to induce compliance around a product surgeons already progression to bids by
use. We do not expect the spine market to repeat the dramatic fate of hips and knees, large buyers.
however. To start with, there is no apparent mix issue, where a high-priced technology
from all manufacturers works no better than the standard one. Also, with Sofamor
Danek’s almost 50% share in the United States, the company has considerable leverage
on the compliance issue. Nonetheless, we suspect the days of acheiving 3% to 5% price
increases are likely to be over by 1998. The non-Medicare (20% Medicare) profile of
payers and the implant’s low proportion of procedure cost (10%) are other moderating
factors compared to hip and knee implants.
Dissatisfaction with instrumentation would exacerbate a trend to disuse spinal
instrumentation. For example, the robustness of clinical data supporting instrumentation
is unusually poor compared to most other device or drug therapies. Studies rarely have
been prospective and randomized, and the control, bone graft alone, was never
developed with clinical data. These issues were highlighted at the 1996 North American
Spine Society meeting and, as a result, we see potential for increasing dissatisfaction
with pedicle screw constructs as better studies are performed. Add this to the ongoing
legal turmoil, and sentiment could swing quite easily. Our sense of increasing skepticism
comes from the 1996 North American Spine Society (NASS) meeting in Vancouver, at
which a few above-average quality randomized studies showed little to no benefit for
pedicle screw constructs versus bone alone. It is clearly too early to sound the death knell
for the products, but momentum appears to be against them.

The Players
Currently, the two major players in the lumbar spinal implant market are Sofamor
Danek and AcroMed. Sofamor Danek leads the market with 50% share in the United
States, 40% in Europe, and around 50% in Asia. AcroMed is a distant number-two
competitor in spinal instrumentation behind Sofamor Danek, with 17% in the United
States and about 17% share worldwide. AcroMed was the pioneer in spinal
instrumentation, introducing the pedicle screw approach in the United States, and was
the first company targeted in the ongoing litigation surrounding the use of pedicle
screws. The company recently announced a settlement agreement for $112 million for
approximately 3,000 to 4,000 cases. The agreement will be submitted to the judge for
approval on January 6. The company’s U.S. business has suffered under the distraction
of litigation and the onslaught of DePuy and Synthes, but hangs on to the number-two
spot, with a solid 22% share.
DePuy now appears to be the number-three company in lumbar spinal
instrumentation, making a meteoric rise from an estimated 1% worldwide market share
in 1993, to 6% in 1994, to 10% at the end of the third quarter of 1996. In the United
States, the company has gained 14% market share in three years. However, 30% of
DePuy’s U.S. sales of approximately $15 million in 1995 were of a titanium mesh
“cage” product, which is not approved for use in the spine, but for repair of long bones.
Some of these sales may dissipate with the introduction of approved fusion cages or with
a slap on the wrist from the FDA. Synthes has also gained share rapidly in the United
States, rising from 9% in 1993 to 12% in 1994 to 17% at the end of the second quarter
of 1996.
Spine-Tech and U.S. Surgical are the key U.S. players in fusion cages. We estimate
total U.S. fusion cage sales of about $37 million in 1997, with Spine-Tech taking 78%
due to its better label and clinical presence. Sofamor Danek is in clinical trials to enter
the fusion cage market. The trial is progressing slowly and is unlikely to result in
approval before 2000. Sofamor Danek is also about to begin a trial of rhBMP, a bone
growth protein, in a fusion cage. This, too, could be approved no earlier than 2000, more
likely 2002. AcroMed expects approval of a cage with instrumentation. See the
Appendix for a complete forecast for this segment.
OSTEOBIOLOGICS
All procedures and devices under discussion to this point have focused on
mechanical reconstruction or repair of bone and cartilage. Autograft, plates, screws,
spinal fusions, and coatings on hip and knee replacements seek to harness and facilitate
bone’s regenerative properties. Osteobiologics represent products delivered locally to
actively and passively stimulate and accelerate bone’s regenerative properties. Such
products have long been imagined and held out as the next revolution in orthopaedics.
Products become imaginable for everything from injectable fixation of fractures, to
superior bonding for hip implants, to reducing reoperation rates for hard-to-repair
fractures, to injectable or minimally invasive spinal fusion products, to replenishment of
bone lost to revision arthroplasties, osteoporosis, or tumors. The ultimate market
potential is large, will be slow in coming, and well worth the effort. Perhaps the major
challenge in the development of osteobiologics has been and will continue to be the
carrier, the material which controls the release of the agents to the site of treatment.

The first osteobiologic, Stryker’s OP-1 product, developed in cooperation with The first osteobiologic,
Creative BioMolecules, may reach the U.S. market in late 1998 or 1999. It may reach Stryker’s OP-1, may
the European market sooner. Phase III clinical trials for non-union (non-healing) reach the U.S. market
fractures of the tibia started in 1992 and completed accrual of patients in January 1996. in late 1998 or 1999.
Allowing for a nine-month follow-up period, we expect results to be announced near the
end of 1996. Assuming positive results, Stryker has indicated that it expects to file the
PMA in late 1997, leading to product launch in late 1998 or 1999. We expect the first
major pieces of data to be presented at the American Academy of Orthopaedic Surgeons
meeting in mid-February. A more complete discussion of OP-1 is available in the profile
on Stryker, later in this report.
As follows, we outline the major markets in which OP-1 may be used at some time
in the future, with a maximum potential market size calculation. This is not a forecast,
but an indication that the ultimate potential can be very large. The upcoming clinical data
will be critical in determining the extent of actual penetration into these procedure
markets and their subsegments.
Exhibit 13
U.S. Markets and Maximum Potential for OP-1
Non/Delayed-Union Fractures
Number of Procedures 50,000
Cost per Patient $3,000
Market Potential Value $150,000
Spinal Fusions (Lumbar/Trauma)

Cost per Patient $3,000
Maximum Market Value $300,000
Total Bone-Graft Procedures*

Cost per Patient $2,000 - 3,000
Maximum Market Value $1.15 billion
* total bone graft procedures includes all other mentioned procedures which require bone graft.
Osteogenic Protein 1 (OP-1) is a naturally occurring protein that is produced

primarily in the kidney. The “OP-1 product” is composed of OP-1 impregnated into
collagen beads which are implanted into the bone void during surgery. OP-1 is being
regulated as a Class III medical device. In its first application, Stryker seeks to eliminate
autograft procedures and to increase the healing rate (i.e., percent healed, not speed to
healing) versus autograft alone. Stryker is also involved in a number of physician-
sponsored European trials that will be used to support CE Mark approval for three
indications, ankle fracture, fibular defect, and acute fracture with soft tissue
involvement. Further larger clinical trials are anticipated to commence in early 1997 in
additional indications, possibly including cranial and maxillofacial surgery, spinal
fusion, and prosthesis coating for implant fixation.
Because the surgeons treating the patients in the Phase III trial know who received
OP-1, we have been able to gain some anecdotal evidence on efficacy. Interviews with

doctors suggest that patients receiving OP-1 recover better without the discomfort of
harvesting bone from the hip. Based on these discussions, we are very optimistic about
the outcome of this pivotal trial.
Other major orthopaedic players are on this high-stakes band wagon, collaborating
with therapeutics companies with appropriate molecules. Genetics Institute is second on
the horizon, still far behind Stryker, developing bone morphogenetic protein II (rhBMP-
2) for orthopaedic applications, allying with Sofamor Danek for applications in the
spine. Sofamor Danek has received approvals for three IDE clinical studies of its use in
spinal indications, and is about to commence Phase I (safety) studies in humans for use
of rhBMP-2 in spinal fusion with a new design of spinal fusion cage. It is unlikely that
this device/osteobiologic combination would be on the market before 2002.
DePuy is collaborating with Genentech in the development of transforming growth
factor beta. Interpore recently announced a collaboration with Quantic Biomedical to
develop super-concentrated tissue growth factors derived from a patient’s own blood, to
be used with ProOsteon. Intermedics, a division of Sulzer, is working on a product with
Procyte, Collagen with Zimmer, and even Chiron is reported to be in the fray.
Soft Tissue Repair/Sports Medicine Market

The market for soft The market for soft tissue repair is in its infancy and has significant long-term
tissue repair is in its growth potential. The current foci of tissue engineering research are rotator cuff injury,
infancy. knee cartilage, and meniscus tear indications. Players include:
• Genzyme Tissue Repair — developing Carticel for repair of damaged cartilage and
cartilage defects in the knee.
• ReGen Biologics — entering Phase II with Collagen Meniscal Implant (CMI),
matrix for regrowth of torn menisci; also developing implants for disc and carpal/
metacarpal repair.
• Stryker, with Creative BioMolecules — have shown OP-1 has potential in
stimulating the regeneration of articular cartilage in rabbits.
• Orquest — developing mineralized collagen matrices for cartilage regrowth.
• Advanced Tissue Sciences, with Smith & Nephew — developing ex vivo human
tissue cultivation for cartilage regrowth. Results have disappointed to date.
• Biomet — developing fibrillar collagen (DFC) for tendon repair, tendon/ligament
replacement and tendon protection.
• DePuy, developing with Purdue University — small intestine submucosa (SIS) that
has demonstrated complete void filling by cartilage and bone in 12 weeks. SIS is
also in development for ACL replacement.
• Wright Medical Technology — has distribution rights to OsteoBiologics’
osteochondral implant for repair of damaged cartilage in vivo.
• OsteoBiologics, with U.S. Biomaterials Corporation — developing bioactive
materials that promote bone and cartilage repair.
• Organogenesis— evaluating preclinically a replacement for the anterior cruciate
ligament and with research on meniscal and cartilage replacements.

Problems encountered in development of tissue repair technology relate to strength,
fatigue failure and potential for immune system response and particulate debris. The
market opportunity is substantial, however, due to the size of the population at risk for
injury. This is unlikely to be a market with explosive potential, unlike, possibly,
osteobiologics, because each technology currently under development is likely to be
suitable for subsets of patients and have specific drawbacks.
Genzyme Tissue Repair is the company now delivering on a product. The product is
the Carticel cartilage-growing service which grows a patient’s cartilage ex-vivo for later
engraftment. Research conducted in Sweden revealed good to excellent results in over
87 percent of patients who underwent treatment for knee cartilage injuries (not the
meniscus) with the lab-grown cartilage cells. This research and concept has been
controversial in the U.S. orthopaedic community. The process costs $10,000, and is
targeted at younger patients and surgeons with training in the procedure.
ReGen is entering pivotal trials on its Collagen Meniscal Implant, which shows
promise for allowing the regeneration of meniscal tissue which heretofore has been
considered unsalvageable or irreparable, and therefore has been removed. By repairing
the meniscus, a physician would hope to reduce long-term complications from removal
of meniscus and the incidence of knee replacement. The trials will last at least one year,
and two-year follow-up will be required, leading to a market launch in or after 2001.
Early data indicate that osteobiologics act on cartilage cells as well, not surprisingly
since cartilage and bone cells develop from the same basic cell type. Data from a study
of OP-1 joint regeneration was presented at the American College of Surgeons meeting
in 1995, showing that an OP-1 formulation regenerated joints comprised of both bone
and cartilage. The study was conducted on 30 rabbits, in which their shoulder joints were
surgically resected to create an artificial defect. A bone graft was then inserted into this
defect, and an autologous muscle flap was threaded into the center of the bone graft to
increase the local supply of mesenchymal cells. Half of these animals were treated with
OP-1 and the other half served as controls.
Results from the range-of-motion studies showed that, as expected, both treated and
control groups declined over time. However, in the treated group, ROM was 75% at
three months, compared with 50% for the controls. The difference was even more
pronounced at six months, with ROM in the treated group at 50%, declining to 25% in
the control group. Histological examination of the joints conducted at six months
demonstrated that in the treatment group, the muscle was completely transformed into
bone marrow, with living cartilage cells present on the surface of the repair. In the
control group, in contrast, the muscle had partially degenerated into fibrous tissue and
the articular surface continued to erode.
The researchers concluded that OP-1 had caused stem cells in the host to
differentiate into normal osteocytes and chondrocytes and reconstitute the damaged
joint. The allograft provided the shape, extracellular matrix, and initial mechanical
support, while the muscle flap acted to increase the local supply of mesenchymal cells
capable of responding to the OP-1 stimulus.
Arthroscopy/Sports Medicine
Arthroscopy is closely aligned with endoscopy, involving minimally invasive
instruments and visualization technologies for diagnosis and surgery on joints. While
many of the same companies compete, the market shares are different because
arthroscopists are a different and smaller call point, the sports medicine or knee

subspecialist in orthopaedics. The $280 million U.S. market is dominated by Smith &
Nephew. Stryker is number two, with $40 million in U.S. sales, followed closely by
Linvatec, a division of Bristol-Myers, which also owns Zimmer. Arthroscopy was
recently a fast-growing market, but growth has slowed to under 5%.
New technologies can be rapidly adopted and tend to drive growth. Most of the
procedures performed include repair of joints, primarily the knee and increasingly the
shoulder. A number of exciting technologies are in various stages of progress, primarily
from the cartilage repair/sports medicine market, exciting (and covered below).
Already on the market are bone anchors, resorbables, and meniscal tacks. Bone
anchors are used to reattach soft tissue to bone, particularly in joints. J&J is the leader
in this field. Resorbables technology has been marketed for fracture fixation, in order to
eliminate the need for hardware removal following an internal fixation procedure. The
key attributes for resorbables are strength and biocompatibility. Resorbables are also
being developed for a variety of other indications, including ACL reconstruction,
meniscal repair, and general trauma and maxillofacial useses.
BONE SUBSTITUTES
Most bone substitutes seek to provide a matrix through which natural bone can
regrow. Current bone substitutes, referred to as osteoconductive agents, have
disadvantages preventing widespread adoption by physicians. They lack the structural
integrity and strength of natural bone, and migration from the site of application and
degradation over time are difficult to control. As a result, their use has been limited to
non-weight bearing clinical indications, such as treatment of wrist fractures. As more
advanced osteoconductive agents are developed, we believe the market has the potential
to expand dramatically.
The U.S. market for osteoconductive agents had 1995 estimated sales of about
$21 million, with estimated ex-U.S. sales of $104 million. We believe that the market is
in its infancy and has great long-term growth potential, as new technologically advanced
products with new indications reach the marketplace.
Currently, autograft (patient’s own bone) is considered the gold standard in
procedures requiring supplemental bone. However, the harvesting of autograft, usually
from the patient’s pelvis (iliac crest), can be painful, and this second procedure increases
the risk of infection. When autograft is not available or can not be easily obtained,
allograft bone (bone sourced from a cadaver) is an alternative. Obtained primarily from
bone and tissue banks and secondarily from companies (e.g., Osteotech, Cryolife,
Biodynamics International), allograft eliminates pain associated with the harvesting of
autograft bone, but its strength may be compromised by sterilization techniques. In
addition, infectious diseases may be transmitted from allograft donor bone, although the
risk is minimal at best, with Osteotech reporting no confirmed incidents with over
750,000 allograft units of transplant tissues. Allograft products currently available from
Osteotech include its demineralized bone matrix (DBM), in a flexible configuration that
is easily moldable and, more recently, in putty-like forms.
Another alternative to autograft is synthetic bone graft, most of which is made up of
collagen, hydroxylapatite (HA), tricalcium phosphate, or some combination of these
materials. Interpore, Zimmer (developed with Collagen Corporation), Wright Medical
Technology, and Orthofix all have FDA-approved bone graft substitutes for orthopaedic
and craniofacial applications.

Interpore’s ProOsteon 500 is a porous coralline hydroxylapatite material indicated
for use in filling metaphyseal bone defects (defects in the cancellous bone near the
joints). The product has demonstrated ingrowth of new bone and soft tissue, and has
healing times comparable to those with autograft. ProOsteon is available in granular and
block forms. Interpore has instituted clinical trial for the use of ProOsteon in cervical
spine grafting application and is also developing HA materials and a polymer-reinforced
version ProOsteon.
Collagen’s Collagraft Bone Graft Matrix, comprised of HA and calcium phosphate,
was approved by FDA for use in non-weight bearing fracture repair, while the Collagraft
Strip was approved for treatment of acute long bone fractures and traumatic osseous
defects. The Collagraft strip is freeze-dried, premixed, and does not require
refrigeration.
Although clinical trials for the use of Collagraft in spinal applications have been
discontinued, Collagen/Zimmer are investigating cross-linked collagen, collagen/
ceramic injectables, biopolymers for repair of bone and cartilage, and biopolymers for
use in implant coatings.
While demonstrating the willingness of surgeons to use a bone substitute, Collagraft
and Pro Osteon also demonstrate the need to overcome the strength, moldability, and
clinical equivalence issues. Each product generated 1995 sales under $10 million. Like
most substitutes, including autograft, both products are limited to use with internal
fixation devices.
Deficiencies in today’s products create opportunities for tomorrow’s. Many
companies have taken heed, and are developing products, including Biomet, Collagen,
Etex, Intermedics, Norian, Orquest, OrthoFix, Orthovita, Osteotech, Sofamor Danek,
and Wright Medical Technology — all of whom have products in development.
A small group of companies are developing highly similar products based on
hydroxyapatite (HA) chemistry, including Norian, Orthovita, Etex, and Orthofix. HA is
the basic mineral of bone and is therefore highly biocompatible. While initial excitement
surrounding them has been quite high, we believe that it is too early to count on
enormous markets stemming from them. We are optimistic that these products can add
value in a number of areas, but these areas will be relatively slow in developing.
The most well known is from Norian Corporation, but we suspect that all of the
products will have very similar attributes. Norian’s product, Skeletal Repair System
(SRS), is a moldable, fast-setting HA cement which can be injected into the fracture,
defect, bone void, etc., or used in an open procedure. The products can only be used in
cancellous bone, the soft porous bone near joints, and not in long bones. It appears that
these products offer compressive strength equivalent to that of bone, allowing some
weight-bearing applications, but they may lack sufficient shear strength. There is
considerable debate over whether these products are truly “remodeled,” the process of
returning an injured portion of bone or cartilage to not only its original shape, but its
original underlying structure (which implies strength). If they are remodeled, the
process appears to require years. While this makes some surgeons uneasy, it may not be
important if the strength is equivalent to bone.
SRS is in clinical trials for the treatment of distal radius (wrist) fractures, and is the
furthest in development. Patients treated with SRS returned to complete function in three
months, while non-SRS patients returned to only 80% of function within one to two
years post-operatively. Expanded indications to be sought for SRS include its use in

augmenting the stability of hardware used in fixing femoral neck, intertrochanteric, and
vertebral compression fractures; its use as a cancellous bone cement; and potentially for
primary and revision joint reconstruction, treatment of tibial plateau fractures, defect
filling, and augmentation of spinal instrumentation.
Orthovita’s Biogran product has a number of FDA-approved indications (outside
orthopaedics). The company is also developing materials for orthopaedic use, with a
range of load-bearing, resorption, and delivery characteristics. Orthofix is developing its
OsteoGenics BoneSource product for orthopaedic applications. It is already approved in
the United States for craniofacial and maxillofacial applications.
Other technologies include Wright Medical’s calcium sulfate (gypsum)
hemihydrate. The moldable bone filler drug delivery system was originally licensed
from U.S. Gypsum, but Wright recently acquired the biomaterials business from USG,
which included patents, technologies and other proprietary processes that relate to the
use of gypsum in the body. Bone infection, defect filling, cancer, and delivery of growth
factors are probable application for the gypsum product.
Orquest has, in our view, one of the more exciting stables of technologies. The
company has made extensive study of bone and cartilage regrowth, and hopes to develop
matrices that better encourage regrowth of both tissues. The company’s Healos
mineralized collagen is in European clinicals for use in spinal fusion and long bone
fracture cases. The product can be preformed in blocks or sheets, does not disintegrate
when wet, and is otherwise easy to handle.
Numerous other companies also compete in the bone substitute product market,
although most have a presence outside the United States, mostly in Europe and Japan.

Company Profiles

Stryker Corp.
STRY (Nasdaq): $ 30 1⁄8
Rating: STRONG BUY
High Quality, Growth, Low Price, High-Tech Kicker
Robert C. Faulkner (212) 207-1497

Dan Shoaib (212) 207-1409
December 27, 1996 dshoaib@hamquist.com
52-Week Last 12 Months Key Products Selected

Range Revenue Balance Sheet Items
$19 7/8-32 1/8 $890.7 mil. Reconstructive Devices Cash/Equivalents $250 mil.
FY Dec. 1995A 1996E 1997E Endoscopic Equipment Cash per Share $2.58
Stretchers and Beds Total Debt $97 mil.
FY EPS $0.90 $1.08 $1.29
Powered Surgical Instruments
FY Rev. (mil.) $872.0 $912.6 $1,021.4
FY Rev. Growth 27.9% 4.7% 11.9% Dow Jones 30 6560.91
Net Income/Loss Nasdaq Composite 1291.38
Market Shares Avg. Daily FY95A $86.9 mil. Options X/SIQ

Cap Outstanding Volume FY96E $104.2 mil. Convertibles None
$2.9 bil. 96.7 mil 100,000 FY97E $124.5 mil. Legal Disclosures a&f
STRY STRYKER CORP

High: 32.13 INVESTMENT HIGHLIGHTS
Low: 19.88
12/27/95 to 12/27/96 Close: 30.13
USD
32
• EPS growth of 20% is intact.
30
• OP-1 is a potential kicker.
28
• Excellent risk/reward profile.
26
24
• 12-month target price is $39.
22
20
Millions
3.84
1.92
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov
Source: FactSet Data Systems
SUMMARY AND RECOMMENDATION

• We rate Stryker a STRONG BUY and expect the company to maintain 20% in
earnings per share growth and 15% in sales growth through 1998.
• Stryker also offers a free option on its novel OP-1 product, the first product to stimulate
bone growth. Preliminary data are expected to be released in February 1997.
• We have set a 12-month target price of $39, which offers 33% potential upside. We
believe that STRY offers an excellent risk/reward profile.

• Current debate on growth appears to revolve around the Matsumoto acquisition and
the decline in distributed non-Stryker products. This event is behind us on the top
line, and the bottom line is likely to improve soon.
• At 23 times our 1997 earnings per share estimate, the stock promises 20%
appreciation without multiple expansion, which we expect as the bear case dies and
OP-1 gains profile.
OVERVIEW
Stryker’s core businesses include reconstructive devices, including hip, knee
trauma, spinal implants, trauma, endoscopic equipment, powered surgical instruments,
stretchers and beds, and physical therapy services. When Stryker reports its operating
results, the company includes sales of reconstructive devices, spinal implants,
endoscopic equipment; powered surgical instruments in its Surgical Products Category;
and sales of patient care and handling products and physical therapy services in its
Medical Products Category. Additionally, since acquiring a majority interest in its
Japanese distributor, Matsumoto-Medical Instruments, Inc., Stryker has reported sales
of Matsumoto distributed products, representing products sourced by Matsumoto from
other companies for sale in Japan.
Exhibit 14
Sales and Growth by Reported Category: 1995A to 1998E

($ in millions)
1995A 1996E 1997E 1998E
Total Sales $872 $912 $1,021 $1,185

% growth 28% 5% 12% 16%
Matsumoto-Distributed Products $105 $44 $33 $35
% growth 141% (58%) (25%) 6%
Total Ex-Matsumoto Distrib. $767 $868 $988 $1,150
% growth (Excludes Fx Impact) 20% 15% 14% 16%
Surgical Products $609 $670 $742 $860

% growth 12% 10% 11% 16%
Medical Products $159 $198 $246 $290
% growth 15% 25% 24% 18%
Source: Stryker financials and H&Q estimates
Many of us have shaken our head in a mixture of awe and disbelief during investor
presentations where John Brown presents his final slide, “20%,” which features a big
smiley face. After 20 years of 20% growth in earnings per share, it is mostly awe. It is
an eventuality that investors now take for granted, and has allowed the stock to trade at
a multiple premium and appreciate dramatically. The question on the minds of Stryker
watchers is whether Stryker’s business endeavors can support 20% in earnings per share
growth in the near and medium terms. For those of us investigating the Stryker story for
the first time, we want to be sure this is not the first quarter or year the company misses
the golden mark.

For the short term, there are two issues: the true rate of growth in the base business,
a topic of heated debate at present, and the sources of growth for the next 12 months. In
the medium term, of 12 months to 24 months, the key issue is understanding how the
Stryker machine operates, and why its record of 20% growth should remain intact.
Looking a bit further out, investors have a free option on a revolutionary orthopaedic
product, OP-1, the first bone growth stimulating protein available. The product should
be available as early as late 1998 or in 1999, and will be increasingly visible in 1997,
when data are presented and the PMA is filed for approval. This product alone could
drive sales and profit growth for several years under a best-case scenario.
In our view, Stryker is well-positioned to meet the promise inherent in its track Stryker is well-
record. For 1996, it is fairly evident that the company will make the fourth quarter EPS positioned to meet the
expectations and deliver 20% growth. Because the acquisition of the Japanese promise inherent in its
subsidiary, Matsumoto, led to a significant drop in sales of products distributed by track record.
Matsumoto, but not produced by Stryker, the top line in 1996 has been, in fact, abysmal
and exaggerated by the yen’s fluctuation, estimated at 5%. Because the decline in these
sales is over, we have looked at the business ex-Matsumoto distributed sales in order to
determine the health of the remaining business. Ex-Matsumoto distributed products, we
estimate the sources of sales growth as: 10% from “same-store sales,” 2% from acquired
operations, and 3% from acquisition of distributors for a total top-line growth rate of
15% or 13% including the impact of foreign exchange fluctuations. Renewed
profitability in the stretcher/bed business and cost reduction should close the gap to 20%
in EPS growth.
For 1997, we estimate total growth at 12% and ex-Matsumoto growth at 14%,
including: “same-store sales” at 9%, acquired product growth at 4% (assuming no new
acquisitions), and acquisition of distributors at 1%. Again, recovery in profitability in
the stretcher and bed business should add around 5% to 6% to earnings per share, and
ongoing company-wide cost reductions should make up whatever gap there is to 20%
in EPS growth. Japan may contribute to profit growth if costs are reduced or sales
growth is regained.
In 1998 and 1999, the new trauma, spinal, and/or OP-1 businesses should be
generating growth, as should the Japanese subsidiary. The other businesses appear
poised to, at least, continue market growth, and the U.S. Osteonics hip and knee market
looks like pricing is improving, while unit growth remains positive. We see no threat to
the momentum that Stryker has behind it. Its businesses are solid, if not spectacular.
Clear threats to profitability are absent, and the company has a number of future growers
in the greenhouse. In our view, the bear case is not there.
Exhibit 15
Sources of Revenue Growth: 1995A to 1998E
Total Matsu. Acquired Fx Base

Growth Impact Sales Impact Businesses
1995A1 28% 13% 14%3 1% 13%
1996E 5% (8%) 5% (2%) 10%
1997E2 12% (2%) 4% (0%) 9%
1998E2 16% 0% 2% 0% 14%
1 Full year with Matsumoto Medical
2 Assumes no further acquisitions
3 Includes Matsumoto

FUTURE GROWTH: WHY TO BELIEVE
This is a stock for those Clearly, this is a stock for those who invest in management — in companies that can
who invest in weather all seasons — companies for the long haul. Stryker is a study in incrementalism,
management. a business run according to a basic formula which reads like “business 101.”
• Hire smart, ambitious people who get along with others.
• Align individual incentives with the company’s, with clear performance goals and
stock, then stay out of the way.
• Emphasize sales forces selling on straight commission and no caps.
• Make every new version of a product at a lower cost than the previous one.
• Compete in existing businesses, and be a little better at every function.
• Never bet the company.
As with most good advice, its value is a function of its execution, and Stryker’s
formula is executed with strict discipline. The senior managers have many years with the
company, are young and aggressive, and have a deep understanding of the expectations
of the company’s leaders John Brown and Dave Simpson (chief executive officer and
chief financial officer, respectively). The way this system appears to work consistently
is through decentralization of the businesses (autonomy) and frank communication
between the Brown/Simpson team and the subsidiary management. A premium is placed
on dealing with reality, not self-denial.
Part of the execution appears to be planning ahead, keeping contingencies in place,
and focusing on growth. Sifting through the past and the present numbers, it becomes
apparent that Brown and Simpson are planting seeds for multiple growth opportunities
which are maturing at different rates.
Management’s long- The strategic astuteness of Stryker’s management is an important element to the
term view is responsible company’s long-term success which is, perhaps, overshadowed by the prowess in
for Stryker’s major execution. Examples include consistently being early to high-growth opportunities,
growth opportunities. including hips and knees in the 1980s, endoscopy in the early 1990s, Japan in the early
1980s, and others. The more recent examples with potential future payoffs include the
acquisition of Matsumoto, the investment in bone growth factors through Creative
BioMolecules, and the establishment of a stand-alone sales force for spinal products.
Stryker is not afraid to take significant but calculated risks to gain important competitive
positions, including the Matsumoto acquisition, converting the entire sales force to
straight commission, or taking on Hillenbrand (90%+ share) in the hospital bed market.
Importantly for future growth, Stryker’s ability to make acquisitions is ample.
Always an acquirer, Stryker has $250 million in cash and rapidly increasing cash flow
to complete them. Stryker shies away from large acquisitions which may be difficult to
integrate and tend to offer a much lower return than smaller ones, but prefers "ideas" and
using the Stryker resources to leverage them. Stryker is entering a period in which
acquisitions can be more easily leveraged by its geographic breadth and a broad product
line for bundling and contracts in the United States. Osteo Holdings, for example,
provides incremental critical mass in Europe (where Stryker is weaker), a good product
line in trauma (which Stryker can expand), a new product for the U.S. sales force, and a
replacement for Mathys products for the sales force in Japan.

Exhibit 16
Stryker’s Cash Flow Provides Opportunity for Growth
FY 1994 FY 1995
EBITDA 144.1 182.6
Y/Y% 28% 27%
Free cash flow (a) 120.6 150.0
Y/Y % 23% 26%
(a) EBITDA - Cap Ex

Source: Company financial statements and H&Q estimates
One goal that is oddly lacking in the Stryker ethos is a stated desire for leadership
in the markets in which it competes. Of course, by being “better” and gaining share, the
end result should be leadership. However, we would not expect the company to make a
dramatic move, such as a large acquisition, to achieve it in the short term. In the United
States, the company is number two in Powered Instruments, number three in
arthroscopy, number two in endoscopy, and number five in reconstructive orthopaedics
(hips/knee units). It is number two in reconstructive implants in Japan, and a smaller
player in Europe.
In summary, we believe that Stryker has a firm a grip on its business and growth. We believe that Stryker
This view is based on an assessment of the reported numbers, which are exceedingly has a firm a grip on its
clear in showing ongoing growth, and of the underlying business segments in which the business and growth.
company competes. If there is a point with which we agree broadly with the skeptics, it
is that Stryker’s underlying businesses are not growing as much as they once did,
especially from a U.S.-only perspective. Arthroscopy, endoscopy, and reconstruction all
drove dramatic growth at one time in the United States. We are not claiming dramatic
growth as a goal for Stryker, however, at 20% for earnings per share, and we do not
expect dramatic outperformance. In the near term, Stryker is likely to derive growth
above and beyond its markets from geographic expansion, new products in existing
segments, and continued entry into new segments, including trauma and spinal implants.
All things considered, we believe that Stryker should be able to meet our target with
relative ease.
BUSINESS SEGMENTS AND GROWTH

Three major business segments and three geographic markets can contribute
materially to performance. See the Appendix for sales models by business segment and
geography.
• Stryker Medical, selling hospital beds and physical therapy services.
• Osteonics, selling hip and knee reconstructive implants.
• The endoscopy/arthroscopy/powered instrument businesses of the Surgical unit.

• The United States, selling hip and knee implants, endoscopy/arthroscopy
products, powered surgical instruments, hospital beds and stretchers, and physical
therapy services.
• Japan, selling primarily reconstructive implants.
• Europe, selling all products (no services) plus trauma and spinal implants.
PRODUCT SEGMENTS
Stryker Surgical Products

The most exciting Stryker’s Surgical Products category includes reconstructive devices. The most
upcoming news in this exciting upcoming news in this sector may be OP-1, with major positive long-term
sector may be OP-1. growth and profitability implications for Stryker. The current segments include hip and
knee implants from the Osteonics division; spinal implants produced by the Dimso
subsidiary, a newly acquired set of trauma products; endoscopy products manufactured
and marketed by Stryker Endoscopy; and powered surgical instruments. Other adjunct
product lines, such as infection control and blood conservation are sold to the
orthopaedic and general surgeon, as well. As an entity in the United States, Stryker
Surgical Products can compete effectively at the level of the physician and administrator.
The breadth of the company’s product line and the major presence in most markets
provides competitive advantage in contract negotiations. As much as 30% of Stryker
Surgical’s business is on contract.
Trauma. In September 1996, Stryker acquired Osteo Holdings AG, (Osteo) a
trauma products company based in Selzach, Switzerland. The company had
$23.5 million in sales, all in Europe, in 1995. This is a particularly important acquisition.
In the near term, it provides product for a market that Stryker has not yet accessed.
Indeed, it has been one of the few orthopaedic companies without a trauma franchise.
Stryker will need to expand the product line and launch it in the United States and in
Japan. As discussed in the upcoming section on Japan, these products may replace the
ones lost, due to the termination of the distribution arrangement by Mathys with the
now-Stryker-owned distributor.
Without growth in Osteo, the company will provide $6 million in acquired sales
growth to Stryker in the fourth quarter of 1996, and $18 million in 1997. The growth
opportunities are quite dramatic, however. In Japan, the Mathys products were selling
around $20 million annually, at 50% or higher distributor margins, or possibly 85%
gross margins for a company selling direct. We are not looking for recapture of these
sales, but it is an important upside. The United States is likely to be slow going for a new
entrant, for the time being. The key leverage point for the trauma franchise is OP-1, a
trauma product at the outset. The surgeons buying plates, screws, intramedullary nails,
and bone graft substitutes are the same surgeons who will buy OP-1 products. OP-1 is
expected to reach the U.S. market in 1998, and Stryker will be ready if and when it does.
Since 1985, Stryker has funded Creative BioMolecules, a biotechnology company
that is developing OP-1, a recombinant human osteogenic protein that has been shown
to induce the formation of new bone. (Creative BioMolecules (Nasdaq/CBMI) is
covered by Senior Analyst A. Rachel Leheny, Ph.D., at Hambrecht & Quist.) Stryker
obtained the exclusive right to develop and market OP-1 for treatment, repair, and
replacement of bone and joint tissue, including cartilage and tendon, and recently
expanded the collaboration to periodontal and dental therapeutics. Stryker has agreed to

pay Creative BioMolecules royalty payments and will source the products from
Creative. We estimate that the payments to Creative represent approximately 13% to
14% of the total sales of the product.
Over the next few months, we expect investor and clinician awareness of OP-1 to Over the next few
increase. Specifically, we expect that three of the surgeons from the trial (who treated months, we expect
40% of the patients) will be presenting their observations at the American Academy of investor and clinician
Orthopaedic Surgeons meeting in mid-February. These surgeons have observed that the awareness of OP-1 to
OP-1 patients have equal and perhaps superior recovery to the autograft patients, with increase.
fewer side-effects.
Competition for OP-1 will come first from Genetics Institute, recently acquired by
American Home Products. Sofamor Danek is developing the product for use in the spine
in the United States, and is in Phase I clinical trials in humans. We believe that Stryker
will have a significant (two- to three-year) lead to the U.S. and European markets.
Genetics Institute and Creative BioMolecules have signed a cross-licensing agreement
to end previous disputes over intellectual property, ensuring that these two front runners
will not fight to the death in court. Several other companies are in early-stage
development of other bone growth factors.
OP-1. Osteogenic protein 1 (OP-1) is a naturally occurring morphogenic protein
that is produced primarily in the kidney and circulates systemically. It works by binding
to specific receptors on the surface of target cells, causing precursor cells to begin
making the proteins required for cell differentiation. (See details on recent data on
cartilage regeneration in the orthopaedics industry overview.) The OP-1 product is an
implantable product composed of OP-1 impregnated into collagen beads, which is
placed into the bone void during surgery. OP-1 is being regulated as a Class III medical
device and passes through the regulatory process under the IDE/PMA pathway.
Although the product is clearly acting at the molecular level, it attains device status due
to its implantable nature.
Phase III clinical trials for the first application started in 1992 and completed
adequate accrual of patients in January 1996, comparing OP-1 to autograft in surgical
treatment of non-union fractures. Accrual was continued to expand the patient group
beyond that originally intended. Assuming positive results, we expect Stryker to file the
PMA by late 1997, leading to product launch in late 1998, at the earliest (12 month FDA
review), or 1999. Stryker will not announce official trial results before submission to the
FDA, though it will apply for a CE Mark, approval for a device in Europe, with the
potential for an earlier introduction into Europe than into the United States. Phase III
trials treated non-union bone fractures. Further applications being explored include open
fracture reductions, spinal fusions, maxillofacial reconstructions, prosthetic fixations,
gap fillings, cartilage-related injuries, and dental and periodontal applications, such as
dental implants.
In the pivotal trial on treatment of non-union bone fractures, Stryker seeks to prove
equivalence for its product to autograft, the current standard of care. The autograft
procedure is a near-universal procedure in trauma surgery, whereby bone is harvested
from the pelvis (iliac crest), to replace or augment damaged or missing bone. Although
the technique is effective, it requires a second invasive procedure, which can be the most
painful part of the procedure. It is estimated that up to 25% of patients receiving
autografts experience complications resulting from the graft harvesting step. The
harvesting step also adds 20 minutes to the procedure, at $40 per minute for operating

room time and instrument costs. While not primary endpoints in the study, the ideal
results would indicate an increase in healing rate (percent healed) versus autograft alone.
Other available approaches to avoid autograft are less effective than autograft,
including allograft, which involves taking bone material from cadavers and engrafting it
into the patient. Allograft also carries a (very small) risk of infectious disease
transmission. Bone graft substitutes are also occasionally used. These include processed
coral (Interpore, Nasdaq/BONZ), processed collagen (Collagen, Nasdaq/CGEN), and a
number of liquid products that harden in the body in development from companies such
as Orquest, Norian, Etex, OrthoFix (Nasdaq/OFIXF), and Orthovita.
The Phase III trial design included two arms: one with patients treated with the OP-
1 collagen matrix and one with a control group receiving standard autograft. The
selection criteria for the trial are based on the FDA’s standard definition of a non-union
fracture — a fracture that has not healed for nine months with no evidence of
improvement for the final three months of this period. Many of the patients have failed
at least one bone graft and represent the most desperate of all patient groups. The trial is
only partially blinded, as both the patients and the surgeons performing the operation
know who receives OP-1 and who receives bone graft. The primary endpoint in the trial
is measured by x-ray analysis and rated by a panel of radiologists who are blinded to the
patient’s treatment group.
Interviews with Because the surgeons treating the patients know who received OP-1, we have been
surgeons suggested that able to obtain anecdotal insight into treatment success. Interviews with surgeons treating
the patients receiving 15 to 20 patients have suggested that the patients receiving OP-1 recover better than
OP-1 recover better those with autograft, and without the discomfort of the hip surgery. Clinically, the
than those with surgeons have been able to measure when the patient’s pain resolves and how quickly
autograft. the leg becomes weight-bearing. Based on these discussions, we are very optimistic
about the outcome of this pivotal trial.
Stryker is also involved in a number of physician-sponsored European trials that will
be used to support CE Mark approval. These trials have included a study of ankle
fracture, fibular defect, and acute fracture with soft tissue involvement, each with 20 to
25 patients. Autograft was used as a control for all of these trials. Further larger clinical
trials in three to six other indications are anticipated to commence in 1997. These will
include studies of cranial and maxillofacial surgery, spinal fusion, and prosthesis coating
for implant fixation.
Reconstructive Products: Hips, Knees, and Spine. We estimate Osteonics sales at
approximately $445 million in 1995, with a recovery to growth of 6% in 1997. With
gross margins over 70%, Osteonics is a profit engine for the company. Osteonics is the
number-four or number-five player in units in the U.S. hip implant market, with about
11% to 12% share, and likely has a slightly higher dollar share, at up to 16%, depending
on the estimate. Osteonics also has about 5% to 7% unit share and as high as 9% dollar
share in the U.S. knee implant market. In Japan, the company has 22% of the total
reconstructive market, while its presence in Europe is smaller. (See our discussion of the
markets in the industry overview.)
We expect Osteonics to We expect Osteonics to maintain market share in reconstructive devices, growing
maintain market share sales at 6% in 1997 and 1998. Osteonics recently has not been a major share gainer in
in reconstructive this business, but has a solid position and has introduced a number of creative ancillary
devices. products which are doing well. The company foresaw the pressure on service levels and
cost, and switched early to standardized instruments for its entire hip and knee product
lines to reduce training and difficulty for surgeons as well as instrument costs. Osteonics

is also an active participant in contracts for implants. According to IMS America, We do not believe that
Osteonics’ mix of porous hip stems has fallen from 40% to near 20% of the U.S. units in Osteonics’ mix change
24 months, with a significant negative impact on average selling price for the past three can progress much
quarters. We do not believe that Osteonics’ mix change can progress much further. In the further.
past four quarters, an improving trend is evident, improving from 11% of mix-related
average selling price declines in the first quarter of 1996, to 7% and under 5% in the
second and third quarters, respectively. While IMS data are far from perfect and actual
declines may be less according to Stryker, the illustrated trends are real and reflect an
improving outlook for Osteonics. We expect almost no mix-related declines in 1997.
Osteonics’ greatest strength is in Japan, with a commanding number-two spot. Osteonics’ greatest
The company’s weakness lies in its under-representation in Europe, where its share strength is in Japan.
is minor. Sales in Japan appear to be flat, while sales in Europe are up near 8%, again
with the market.
Osteonics, like competitive companies, has been gradually “going direct” in the
United States by buying the independent distributors that previously sold the product. To
Stryker, "direct" means either a Stryker employee or an independent commissioned
agent who does not take ownership of product. Distributors are typically acquired if
there is a problem, but the acquisitions can drive minor top-line growth by capturing the
distributor margin. In 1995, 1 percentage point of sales growth came from this source.
In October 1992, Stryker’s subsidiary in France acquired Dimso S.A. (pronounced
Dimzo), a European spinal implant manufacturer. Dimso’s spinal implants address
degenerative spinal diseases and deformities and spine stabilization in trauma cases.
This product line competes with Sofamor Danek, AcroMed, DePuy, and others in the
pedicle screw and plate business. The company estimates its share of the roughly
$100 million European market at 15%. We expect this product line to continue to grow
at market rates in Europe at 10%.
During 1995, after FDA approval for lower lumbar indications, Osteonics began
marketing a version of the Dimso spinal implant system in the United States. However,
with limited success to date, it has become clear to the company that it needs a specialty
sales force for spinal surgeons like others who compete in the industry. Stryker is
planning to build this force. We do not have any Dimso sales growth in the United States
in our model, as growth appears a year or two out and the sales force is not yet in place.
We point out, however, that Stryker is positioned to take its fair share, although it will
not be easy.
Surgical Instruments. Stryker also manufactures and markets a variety of surgical
instruments and operating room supplies for many types of surgeons. The primary target
is the orthopaedic surgeon, but its product are also sold to general plastic, ear, nose, and
throat, neuro, podiatric, and spinal surgeons. Stryker has the number-two place in this
$190 million business, behind Zimmer, a division of Bristol-Myers, with an
approximate 30% U.S. share for U.S. sales of approximately $60 million. U.S. market
growth for the instruments is around 5%. This business has grown consistently at rates
above its core market. The primary driver has been the addition of new product lines to
sell to the customer base, while the company also appears to have gained share. One of
the key trends driving growth and profitability has been a conversion from reusable
blades, burr, etc. to single-use devices for saws and drills. Hospitals have found the
resharpening, cleaning, and handling process cumbersome, costly, and risky with
respect to transmission of disease.

The endoscopy business Endoscopy. The endoscopy business is on a roll, and should continue to grow
is on a roll. strongly. The endoscopic business, products used for minimally invasive surgery, has
been built around avoiding the elephants of the industry, Ethicon (Johnson & Johnson)
and U.S. Surgical. The products include powered and manual instruments and
visualization products, such as cameras, rigid endoscopes, light sources, video
accessories, and other assorted products. As capital equipment required for minimally
invasive surgery, the visualization business was negatively affected by the "Hillary"
scare of 1992, depressing growth through 1994. More recently, hospitals have been
reentering the marketplace for capital equipment that makes up much of the rest of this
business. In the near term, the potential acquisition of Circon (the number-two player in
the United States) by U.S. Surgical may be the single largest threat to growth,
particularly if Ethicon enters the fray to counter U.S. Surgical. As a number-three player,
Stryker is as well-positioned as anyone, and Smith & Nephew, Wolf, and the host of
smaller players are likely to be first on the hit list. With around $55 million in U.S.
revenue for the visualization business and another $25 million in the United States for
instruments, the business does not make or break the Stryker story.
Arthroscopy. Arthroscopy is closely aligned with endoscopy, involving minimally
invasive instruments and visualization technologies. While many of the same companies
compete, the market shares are different because it is a different (smaller) call point, the
sports medicine or knee subspecialist in orthopaedics. The leader in the $280 million
U.S. market is Smith & Nephew, with almost 50% share. Stryker is number two, with
around 15% share and $40 million in U.S. sales, followed closely by Linvatec, a division
of Bristol-Myers, which also owns Zimmer. Arthroscopy was recently a fast growing
market, but growth has slowed to under 5%. We look for above-market growth for
arthroscopy products from Stryker.
Stryker Medical Products

Stryker Medical Stryker Medical Products is likely to be a major contributor to growth on the top and
Products is likely to be a bottom lines in 1997. While the top-line growth may be a surprise to some, the operating
major contributor to leverage should drive profit faster than sales. The division has two units, the Medical
growth on the top and Division, a manufacturer of specialty hospital beds and stretchers, and Physiotherapy
bottom lines in 1997. Associates, Inc., an operator of outpatient rehabilitation service centers.
We expect the bed Sales growth appears to be accelerating. In the third quarter of 1996, Stryker
business to provide Medical Products grew 33%, up from 20%, 19%, and 15% for Q2-96, Q1-96, and 1995,
1997/1996 profit respectively. We estimate that the bed business was approximately 65% of division sales
growth of 5% to 6% on in 1995, at $100 million, growing around 20%, while Physiotherapy Associates was
Stryker’s bottom line. near $50 million growing at over 30%, mainly through acquisition. We expect the bed
business to grow its profit contribution from near zero in 1995 to 7% to 8% net for 1997,
for 1997/1996 profit growth of approximately 5% to 6% on Stryker’s bottom line.
Hospital stretchers are Stryker’s original business, but have not until recently been
a driver of growth. The unit’s products include specialty beds for various departments in
the hospital, such as the ICU, emergency, maternity and recovery, and various types of
stretchers. This division has recently undertaken three major initiatives. Most recently,
the company undertook an attack on Hillenbrand, the maker of Hill-Rom hospital beds.
Hill-Rom had near 100% share and is a ferocious competitor on the sales front.
However, it appears it may have fallen prey to the monopolist’s disease, complacency,
and dated product. After over a year of a bruising selling fight, Stryker has gained 10%
of the bed business, a run rate of $30 million to $35 million, seeking to become a solid
number two in the business.

In 1994, Stryker entered the paramedic stretcher market in with the “Rugged”
stretcher, capturing around 30% of this $30 million market so far. The “Rugged”
stretcher uses mountain-bike styling, a bright yellow color, and a high-quality feel to
differentiate itself. (Take a close look on the next episode of “ER.”) Stryker established
this business at the expense of a weakened competitor, Ferno Washington. In addition,
the company has undertaken a major cost reduction/productivity enhancement effort,
which has resulted in double the output with the same number of people in the last few
years. As volume develops, operating leverage should drive profit contribution rising
faster than sales.
Physiotherapy Associates operates over 160 outpatient rehabilitation centers to Most of the growth from
patients suffering from orthopaedic or neurological injuries, with emphasis on workers’ Physiotherapy
compensation cases. The strategy is a roll-up of these service providers, providing Associates has come
economies in contracting with insurers. Most of the growth has come from acquisition. from acquisitions.
We estimate that as many as 30 centers may be acquired in 1997, providing top-line
growth of $9 million. We estimate sales per “store” at $300,000, growing at 2%.
Stryker is specifically targeting the opinion-leading therapists in order to carve out
the high-quality position in the business. Stryker was early to this roll-up strategy, and,
as such, is probably in the top five with a much lower cost basis for its clinics than the
multitude of “hot” disease management or carveout companies recently going public.
Net margins are slightly below the corporate average. Such businesses have recently
traded at far higher price-earnings (P/E) and P/E to growth-rate multiples than Stryker.
Recently, Stryker has found that prices of these practices have escalated to the point
where fewer are attractive. The present acquisition model for companies in this business
is four to five times EBIT, or one-half to one times revenue. The typical clinic in the
industry has $1 million to $1.5 million in revenue.
GEOGRAPHIC SEGMENTS
As Stryker evolves into the major player it is becoming, expanding geographic Expanding geographic
coverage becomes an effective source of growth and profitability. Like most major coverage is an effective
medical device companies, Stryker’s primary market is the United States, comprising source of growth and
55% of sales. It is also the most consistent performer. In the United States, the product profitability.
divisions are independent. Europe is relatively small, at under 14% of sales in 1995, but
is showing excellent growth. We expect Europe, growing around 20% on the top line
without acquisitions, to be a major focus for Stryker for internal and acquired growth in
the near term.
The U.S. market for most of Stryker’s products is enjoying a recovery bounce since The U.S. business has
the “Hillary” scare of 1994. The base business, combined with new products and a minor an underlying growth
lift from the acquisition of distributors gives the U.S. business an underlying growth rate rate of 20% so far in
of 20% so far in 1996, including some negative impact from mix shift in the Osteonics 1996.
division. In the short term, it appears that the stretcher and bed division will be the star
performer and contributor to profit growth. Stryker sells most of its products in the
United States through a direct sales force of about 340 representatives. The company
maintains a separate and dedicated sales force for each of its main product lines.
Uniquely, most of the Surgical division sales people are compensated on straight
commission, with no upper limit. This fact emphasizes how strongly Stryker feels about
hiring the best sales people. Reconstructive devices are sold through a combination of
direct sales representatives (or commissioned agents) and independent stocking

distributors. Stryker is in the process of converting portions of its distribution network
to direct sales in order to provide capital for inventory and to capture the distributor
margin. The company, on the surgical products side, has signed contracts covering
approximately 30% of the business, as the company actively exerts the power of its
broad product line and large positions in most of them.
We estimate sales in Stryker’s strength in Japan is the most unusual aspect of the company’s geographic
Japan at around coverage. We believe that both the size of this presence and the uncertainty around this
$170 million, making subsidiary make detailed discussion essential. We estimate sales in Japan at around
Stryker the number-two $170 million at a current run rate, or 17% of sales. The market appears flat and very
orthopaedic player. profitable. The company’s position as the number-two orthopaedic player, with 22%
share behind Zimmer’s 28%, appears virtually unassailable. Stryker is number one in
hips. The next-largest orthopaedic player has around 8% of the market. We expect no
growth from this division over the next year, but look for leverage of this asset through
new product introductions in the future. Profitability should improve in 1997 from its
present breakeven status due to cost reductions (no layoffs, some attrition, and other cost
reductions). The evolution of Matsumoto, the Japanese division, will be a key swing
element to Stryker’s growth and profitability going forward.
As mentioned earlier in this report, Stryker in 1994 acquired 31% of Matsumoto, the
distributor of Stryker’s products in Japan, and perhaps the second largest orthopaedics
distributor in Japan, bringing Stryker’s holdings to 51%. The resulting change in control
was a clear conflict of interest with most other companies for whom Matsumoto
distributed products, primarily Mathys, the leading trauma implant company, and Storz,
the endoscopy company. These companies, terminated their relationship with
Matsumoto. As a result, distributed product sales dropped from a peak of $33 million in
Q2-95 to $10.5 million in Q3-96. Profitability dropped to near zero, but the impact was
muted because the 49% minority owner helps to absorb the profit drop through Stryker’s
minority interest line. The acquisition may represent both one of the bigger risks the
company has taken, and one of the most astute strategic moves available to it. The
benefits to Stryker are primarily long term and strategic, providing a large direct
presence in orthopaedics and a platform for leverage of new products.
In Japan, the company The company is presently sorting out its tumultuous recent experience, with the
is presently sorting out evaporation of the non-Stryker sourced business of Matsumoto after the acquisition. At
its tumultuous recent present, the decline in sales appears to be largely over. We estimate that the margins on
experience. Stryker products for Matsumoto are 50%. The decline in these products has caused a
steep decline in profits to just above breakeven in Q3-96. The core Stryker business in
Japan appears up slightly in 1996 versus 1995, adjusting for exchange fluctuations,
while new products recently introduced to replace those lost should boost sales going
forward at higher margins than the distributed products. The yen compounded the
apparent decline in 1996 considerably by rising 25% to 30%.
After acquiring the company, Stryker merged the 50 to 60 people it had in Japan as
marketing and product specialists with Matsumoto, and put an American in charge, who
has since left the company. Perhaps the worst blow to the company was the departure of
Coherent Lasers, because it pulled a number of people with them. Stryker feels no loss
for the products or sales, as they were breakeven at best, but the departure of employees
came as a blow to the Japanese company’s pride.
Importantly, a new president was recently hired, Kunihiko Iwata, who joins the
company having run Alcon Japan for almost six years. Because Alcon was an effective

competitor to Matsumoto, Mr. Iwata has the respect of the Matsumoto people, an
important element to restoring momentum. Mr. Iwata has managed some of the more
aggressive sales forces in Japan, and has taken them from the traditional pure salary
compensation to the increasingly common commission-based compensation systems.
Thus far, the company has not been able to replace the lost sales with similar products
of its own. Stryker has begun to sell its own endoscopy, trauma, and spine products to
replace Storz, Mathys, and Sofamor Danek products, which the company used to
distribute, but to minor effect to date.
The structure of the acquisition has muted the impact of this massive swing in sales
on the bottom line. By acquiring 51%, not more, the company minimized its exposure
to the drop in profit from the exodus of suppliers, because the 49% owner shared in the
drop in profit through the minority interest line. In Q3-95, the company paid
$1.4 million in minority interest compared to only $25,000 in Q3-96. Furthermore,
because Japan has higher taxes than the United States, the reduced profit was in part
offset by a lower tax rate. Going forward, if the subsidiary resumes it growth, the profit
leverage will be considerable and Stryker will be able to buy additional shares of it to
reduce its minority interest payments and grow earnings. In addition, the yen should be
less onerous on growth, but still negative, in 1997.
Sales outside of the United States and Japan, mostly Europe, are only $120 million, The acquisition of
or 14% of sales for Stryker, in 1995. The acquisition of Osteo Holdings, AG, adds Osteo Holdings, AG,
$24 million in sales, all of which are in Europe, pushing Europe to a run rate of 20% of pushes Europe to a run
sales. Internationally, Stryker sells its products primarily through about 400 local dealers rate of 20% of sales.
with about 580 local sales and marketing personnel. In certain major markets, the
company sells its through direct sales forces.

DePuy, Inc.
DPU (NYSE): $ 20 1⁄4
Rating: BUY
Industry Leadership on Sale

Dan Shoaib (212) 207-1409

$16 1/2-20 1/4 $681.2 mil. Reconstructive Devices Cash/Equivalents $200 mil.
FY Dec. 1995A 1996E 1997E Spinal Implants Cash per Share $2.03
Trauma Devices Total Debt $46 mil.
FY EPS $1.05 $1.17 $1.21
Sports Medicine Products
FY Rev. mil. $636.5 $698.3 $764.5
Operating Room Supplies
Net Income/Loss Nasdaq Composite 1291.38
Market Shares Avg. Daily FY95A $94.9 mil. Options None

Cap Outstanding Volume FY96E $106.8 mil. Convertibles None
$2.0 bil. 98.6 mil 100,000 FY97E $119.6 mil. Legal Disclosures a
DPU DEPUY INC

Low: 16.50
10/31/96 to 12/27/96 Close: 20.25
USD
• Strong geographic and product diversity.
20.0
• Consistent share gainer and a proven consolidator with

19.0 upside.
• Excellent risk/reward profile.
18.0
• 12 month target price $24.

17.0
Millions
5.55
2.78
KEY INVESTMENT POINTS

• We recently initiated coverage of DePuy with a BUY recommendation, because of
its market leadership and track record of success.
• We look for earnings growth of 12% to 14% in fiscal years 1997-2000, with upside
potential from acquisitions.
• We expect DePuy’s leadership to allow the company to gain reconstructive device
market share and strongly leverage its newer businesses.

• Trading at a multiple of 16.75 times our 1997 estimate of $1.21 in earnings per share
(EPS), the stock carries low risk relative to the industry and potential for multiple
expansion.
• Our 12-month price target is $24, based on a multiple of 17 times our 1998 estimate
of $1.38 in EPS.
INVESTMENT OVERVIEW
When the going gets tough, the tough get going. DePuy is the tough guy in
orthopaedics that can gain share and leadership in its core business and leverage its
strengths into higher-growth segments. In an increasingly competitive industry with
several medium-sized players, we look for a heavyweight player like DePuy to
capitalize on the change, and DePuy already has a track record of doing so. DePuy is the
number-three player in orthopaedics, and the only major player gaining share. Besides
its core reconstructive business, the company plays in reconstructive devices, spinal
implants, trauma, sports medicine, and soft goods/operating room supplies.
The woes of the core hip and knee businesses in the orthopaedic industry are well
documented, and likely exaggerated (see attached industry overview). We believe that
DePuy’s large exposure to these businesses may lead some to avoid the investment, even
at 14.75 times 1997 in EPS. Investment in DePuy is investment in long-term industry
leadership, at a valuation that does not reflect its long-term potential.
In summary, then, we recommend DePuy stock as a long-term holding that should
offer 15% annualized returns with relatively low risk and upside potential. At 16.75
times our 1997 estimate of $1.21 in EPS with 15% earnings growth going forward, the
stock does not carry a premium to the S&P 500, although we feel it should because of
market leadership, low risk attached to projected growth, and high probability of
outperformance. Our 12-month target price is $24, based on 17 times our 1998 estimate
of $1.38 in EPS.
GROWTH DRIVERS
• DePuy’s leadership (number two in the United States and number three worldwide)
in the reconstructive device market should provide competitive advantage in
winning contracts and market share.
• DePuy’s global distribution network should drive continued strong growth outside
the United States and power the introduction of internally developed or acquired
product lines.
• DePuy’s stated acquisition-oriented growth strategy should allow the company to
achieve further geographic and product diversification.
• Management’s solid history of execution fosters confidence in its ability to grow the
business beyond the core reconstructive device franchise.
• We look for top-line growth of 10%, with 9% from base business growth and 1%
from acquisition. Operating leverage and cost reductions bring EPS growth to 12%
as the company leverages its new direct sales forces.

• We look for U.S price pressure to moderate in the core markets in 1998 and beyond.
In reconstructive devices, DePuy has consistently gained market share. DePuy’s
share in the U.S. hip implant market has increased from 20% in the first quarter of 1993
to 22% by the end of the third quarter of 1996. The company’s knee implant market
share is up from 10% to 13% over the same time span.
DePuy gains share through its aggressive direct sales force and through contracts
with large purchasing organizations. Surgeon compliance with contracts has been a
subject of heated debate in the industry over the past 12 months. For discounted
contracts to work for both buyers and sellers, sellers have tied price discounts to market
share gains. Buyers can only realize significant implant price reductions by securing a
high degree of surgeon compliance. The difficulty in achieving compliance is that, in
many instances, surgeons prefer the implants of non-contracted manufacturers and may
have close relationships with these manufacturers or their distributors. This problem has
led some manufacturers to question the contract-based approach to implant sales.
We believe that DePuy’s approach in seeking high compliance contracts should help DePuy’s approach in
the company to continue to gain share. DePuy’s most celebrated contract is with seeking contracts
Columbia/HCA, which has finally proven that compliance is achievable. In 1996, should help the
DePuy’s sales to the Columbia/HCA network increased 17% in dollars and 33% in units. company to gain share.
We expect that DePuy will increasingly benefit from contract-based sales, as buyers
recognize that compliance is easier when they contract with a market share leader whose
products are already used by a significant percentage of the orthopaedic surgeons in the
buyers’ networks. As the number-two player in the U.S. reconstructive device market,
DePuy is well-positioned to bid for contracts. We anticipate that growth in DePuy’s
reconstructive device business will be driven by (1) market share gains in the United
States coming from the base business, (2) increasing compliance in current contracts and
the signing of additional contracts in the future, (3) continued strong international
growth, and (4) moderating pricing pressure.
Through strategic acquisitions and joint ventures, DePuy has demonstrated its DePuy has
potential as a platform for growth beyond reconstructive segments, successfully entering demonstrated its
faster-growing segments of the orthopaedic products market, including spinal implants, potential as a platform
trauma, and sports medicine. Ten years ago, DePuy was primarily a hip company with for growth beyond
no international presence. Today, under the same management team, less than 70% of reconstructive
DePuy’s sales are in reconstructive devices and over 45% of sales are outside the United segments.
States. Given management’s demonstrated ability to achieve product and geographic
diversification, we expect DePuy to continue to seek growth opportunities through
acquisition and internal product development, funneling new product lines through its
global distribution network.
Finally, DePuy’s $200 million cash balance positions it well to implement its
acquisition strategy. The company seeks new products that leverage existing
distribution, new distribution platforms, or new geographies. For example, the
acquisition of Charles F. Thackray Ltd. in 1990 allowed DePuy to establish its presence
in Europe and leverage existing distribution with the Charnley Hip, the original
cemented total hip implant. The joint venture with Biedermann Motech in 1993 gave the
company a new distribution platform with spinal products. The 1994 acquisition of ACE
Medical, the trauma device manufacturer, provided DePuy with a new distribution
platform and existing distribution leverage. Finally, the acquisition of Orthopedic
Technology in March 1996 gave the company a new growth platform.

Exhibit 17
DePuy's Cash Flow Enables Continued Growth Through Acquisition

($ in millions)
1993 1994 1995 H1-96 RR-96*
EBITDA $150.5 $180.0 $200.0 $112.8 $225.5

Y/Y% 20% 11% 13%
Free Cash Flow $139.7 $165.9 $184.3 $99.6 $199.3
Y/Y % 19% 11% 8%
*Run rates as of Q2-96.
Source: Company financials; H&Q estimates
We anticipate that sales growth in DePuy’s base businesses, which now include
reconstructive devices, spinal implants, trauma, and soft goods/operating room supplies
should be around 9% to 10% going forward for two years. The acquisition of Orthopedic
Technology, in March 1996, should add another 3% to 5% to total growth through the
first quarter of 1997. Additional sales growth should come from future acquisitions. We
would expect bottom-line growth to exceed top-line growth as DePuy continues to
reduce costs and leverage its new direct distribution force. Our projections assume no
further acquisition, leaving upside potential.
Exhibit 18
Sources of Total Sales Growth
Total Growth Acquisition Fx Impact Base

Businesses
1993 11.1% 0.8%1 0.6% 9.7%5

1994 18.2% 6.3%2 0.9% 11.0%6
1995 15.3% 3.0%3 4.0% 8.3%7
H1-96 8.0% 2.0%4 -2.0% 8.0%8
1 Joint venture creates DePuy Motech, 80% owned by DePuy

2 Acquisition of ACE Medical and full year of DePuy Motech sales
3 Full year of ACE Medical sales
4 Acquisition of Orthopedic Technology
5 Reconstructive devices, soft goods/operating room supplies
6 Reconstructive devices, soft goods/operating room supplies
7 Reconstructive devices, spinal implants, soft goods/operating room supplies
8 Reconstructive devices, spinal implants, trauma, soft goods/operating room supplies

Exhibit 19
Key Product Segments

($ in millions)
1994 1995 1996 1997E 1998E 1999E 2000E
Reconstructive Devices $406 $451 $474 $505 $546 $595 $651

% of total sales 74% 71% 68% 66% 65% 64% 64%
% growth 12% 11% 5% 7% 8% 9% 9%
Spinal Implants $13 $31 $46 $61 $71 $80 $88
% of total sales 2% 5% 7% 8% 8% 9% 9%
% growth 291% 145% 50% 33% 15% 13% 10%
Trauma $39 $49 $56 $70 $86 $102 $115
% of total sales 7% 8% 8% 9% 10% 11% 11%
% growth 353% 28% 13% 26% 23% 19% 13%
Sports Medicine $28 $29 $49 $61 $69 $77 $86
% of total sales 5% 5% 7% 8% 8% 8% 8%
% growth NM 6% 66% 25% 12% 12% 12%
Other Products $67 $77 $73 $67 $71 $76 $82
% of total sales 12% 12% 11% 9% 9% 8% 8%
% growth -27% 14% -4% -8% 6% 7% 7%
Reconstructive Devices
DePuy is the leading manufacturer of hip implants in the United States and number-
three worldwide, with market shares of 22% and 16%, respectively, representing U.S.
sales of $152 million and worldwide sales of $268 million. The company is number-four
in knee implants in the United States and worldwide, with market shares of 13%,
representing U.S. sales of $100 million and worldwide sales of $182 million,
respectively. In the extremities (mainly shoulder) implant market, DePuy is a leading
manufacturer in the United States and worldwide, with market shares of 29% and 26%,
respectively, representing U.S. sales of $15 million and worldwide sales of $21 million.

Exhibit 20
Hip Market Share

50%
45%
40%
35%
30% Biomet
DePuy
25% Howmedica
Osteonics
20%
Richards
Zimmer
15%
10%
5%
0%
1990 1991 1992 1993 1994 1995
Knee Market Share

35%
30%
25%
Biomet
20% Depuy
Howmedica
Intermedics
15%
J&J
Osteonics
10% Richards
Wright
Zimmer
5%
0%
1990 1991 1992 1993 1994 1995
Source: IMS America
The reconstructive device market is considered mature in the developed world, with
2% to 3% sales growth in the United States and 4% to 5% sales growth internationally.
We estimate 1996 sales growth of -2% in the United States and 3% internationally in the
hip implant market, and 5% in the United States and 7% internationally in the knee
implant market. Worldwide sales of implants for the extremities continue to grow
rapidly, but were only $80 million in 1995 and, therefore, do not significantly impact
overall sales growth in the reconstructive device market. In 1996 to date, DePuy’s
worldwide reconstructive device sales have increased 5%, with 10% unit increases
countering 5% mix and price declines.

There are two main issues with regard to DePuy’s future growth in reconstructive DePuy’s market share
devices: market share gains (in the United States and ex-United States) and the pricing is a competitive
environment. Going forward, we expect DePuy to gain share and pricing pressure to advantage in contracts.
moderate. We also expect contracts with large purchasing organizations to become
increasingly prevalent. Reconstructive device manufacturers have conditioned discounts
on volume gains, forcing buyers to secure compliance of surgeons to the product on
contract in order to achieve cost savings. DePuy’s market share is a competitive
advantage in contracts because the easiest way for buyers to secure compliance is by
minimizing the amount of switching required of network surgeons.
To date, the best example of DePuy’s industry leadership providing competitive
advantage is the Columbia/HCA contract. In 1995, Columbia formed a panel of
surgeons from its hospital network to select a limited number of implant manufacturers
with whom it would contract. The primary basis for narrowing the vendor list from nine
to four finalists, Biomet, Intermedics, Howmedica, and DePuy, was market share within
the Columbia/HCA network. Ultimately, only Howmedica and DePuy were awarded the
contract, which began in June 1995. The first six months, when DePuy gave up pricing
without gaining compensating volume, were rocky, however, the last 10 months
(through October 1996) have seen DePuy’s sales to the Columbia network increase 17%
in dollars and 33% in units, as Columbia has increasingly driven compliance from its
member hospitals. Furthermore, once some degree of standardization has been achieved
in a particular contract, the buyer is likely to renew the contract with the same
manufacturers, so that the big grow bigger and lock in the market share already
achieved.
Thus, whether standardization continues to occur on the national level with another
Columbia, or on the local level with just one hospital, DePuy is well-positioned to
benefit because of its industry leadership and the relative ease of gaining compliance. At
the local level, compliance is generally better while discounts are not as deep. DePuy’s
strategy is to sign national contracts only with buying organizations that will drive
compliance, like Columbia/HCA.
DePuy should also gain share outside the United States because of its strong global DePuy should also gain
franchise. With the acquisition of the U.K. company, Charles F. Thackray Limited, in share outside the
1990, DePuy acquired the Charnley Hip, the original cemented total hip implant, and United States.
began to build its reputation in Europe. Today, it is the number-one U.S. orthopaedic
company in Europe and has a growing franchise in Japan, with estimated growth as high
as 20%. Outside the United States, DePuy has gone direct in every major market, a
strategy which we expect the company to extend to emerging markets in Asia and South
America. We expect continued strong growth in DePuy’s ex-U.S. reconstructive device
business.
The second main issue for DePuy’s reconstructive device sales growth is reductions
in average selling prices (ASP), which we expect to moderate. The two components of
pricing pressure are discounting and the mix shift from higher ASP porous-coated
implants to lower ASP-cemented implants. With respect to discounting, we expect it to
moderate from negative 2.0% in 1996 to -0.5% in 2000.
With respect to the mix shift, we expect an easing of pricing pressure over the next
two years as it appears that the percentage of porous-coated implants is nearing its
clinically justified level, based on the concept of patient demand matching. Furthermore,
this level is low enough so that any further declines should impact revenue less
significantly. We estimate that the mix shift impacted U.S. industry revenue by as much
as -2% to -3%, and DePuy’s U.S. reconstructive device revenue by as much as -5% in

the last 12 months, accounting for 3% of the 5% price decline in DePuy’s worldwide
reconstructive device business in 1996. Going forward, we expect DePuy’s
reconstructive device sales to get a “kick” of 1.5% in 1997, 1.0% in 1998, and 0.5% in
1999 from the ending of the mix shift.
Exhibit 21
DePuy Mix Shift Trends

80.0%
70.0%
60.0%
50.0%
Knees
40.0%
Hips
30.0%
20.0%
10.0%
0.0%
Q1 93
Q2 93
Q3 93
Q4 93
Q1 94
Q2 94
Q3 94
Q4 94
Q1 95
Q2 95
Q3 95
Q4 95
Q1 96
Q2 96
Q3 96
Source: IMS America
Exhibit 22
Sources of DePuy Reconstructive Device Sales Growth:

1996E to 2000E
Total
Fiscal Year Total Units Pricing Mix Shift Price
1996E 5.0% 10.0% -5.0% -3.0% -2.0%

1997E 6.5% 10.0% -3.5% -1.5% -2.0%
1998E 8.0% 10.0% -2.0% 0.5% -1.5%
1999E 9.0% 10.0% -1.0% 0.0% -1.0%
2000E 9.5% 10.0% -0.5% 0.0% -0.5%
Source: H&Q estimates; industry sources; IMS America

Net net we expect DePuy to achieve sales growth in reconstructive devices of 6.5% We see upside potential
in 1997, 8.0% in 1998, 9.0% in 1999, and 9.5% in 2000. We expect overall pricing for from Columbia/HCA
DePuy to be - 3.5% in 1997, with the mix shift accounting for -1.5% and discounting and international sales.
accounting for -2.0%. Projecting a 10% volume increase, which DePuy has already
achieved in 1996 and assumes additional market share gains, the improving pricing
environment should boost DePuy’s reconstructive sales growth from 5% in 1996 to 9.5%
in 2000. We see upside potential to this growth outlook from further gains in the
Columbia/HCA network and in international sales. If a greater percentage of DePuy’s
reconstructive device sales become contract-based, then we would expect that the
volume gained would merit the price discounts offered, which would make DePuy’s
reconstructive device sales growth greater than or equal to our estimates.
Product Line. In 1995, DePuy’s worldwide hip implant sales were $268 million or
about 16% of the worldwide market, with U.S. sales of $152 million or about 23% of
the U.S. market. The company’s two leading hip systems are the AML Hip and the
Charnley Hip. The AML Hip is the leading porous hip implant in the United States.
Considered the company’s flagship product, the AML Hip was the first implant to be
cleared by the FDA for use without cement and has the longest clinical history of any
porous-coated hip implant currently on the market. DePuy entered the cemented implant
market instantaneously with the 1990 acquisition of U.K-based Charles F. Thackray, the
manufacturer of the Charnley Hip. The Charnley Hip System remains one of the leading
cemented hip implants in the world in unit volume and has the longest clinical history
of any cemented implant currently on the market.
For knee implants in 1995, DePuy had sales of $182 million, or about 13% of the
worldwide market, with U.S. sales of $100 million or about 12% of the U.S. market.
DePuy markets the LCS Knee, the AMK Knee, and the Coordinate Revision Knee
System. The LCS Knee is a mobile-bearing knee system. The LCS Knee received PMA
approval after clinical trials for both cemented and cementless indications in 1985. It is
designed to simulate natural anatomic motion while also reducing stress on implant
components. It is the only mobile-bearing knee implant commercially available in the
United States, however, DePuy’s patent on mobile-bearing knee implant technology
expires in 1997 and competitors are poised to launch their own mobile-bearing knee
systems. The AMK Knee is a fixed-bearing knee system used for both primary and
revision procedures. The Coordinate Revision Knee System is indicated only for
revision procedures and uses the same instrumentation as the AMK Knee family of
products.
DePuy had 1995 worldwide extremities implant sales of $21 million or about 26%
of the worldwide market, with U.S. sales of $15 million or about 29% of the U.S.
market. The company’s Global Total Shoulder System has become a market share leader
in the United States with about 40% share four years after market launch. Sales continue
to grow at 20%.
Spinal Implants
In 1993, DePuy entered the spinal implant market through a joint venture with DePuy Motech’s sales
Biedermann Motech GmbH of Germany, with the resulting company, DePuy Motech, 80% growth has been
owned by DePuy. DePuy Motech’s sales growth has been impressive: sales have soared impressive.
from $3.2 million in 1993 to a run rate of $50 million by the end of the third quarter of 1996.
The company has risen to the number-three position in the worldwide spinal implant
market, with an estimated 10% market share at the end of the third quarter of 1996.

DePuy’s spinal implant business has benefited from the company’s creation of a
specialized sales force focused on the spine surgeon and capable of handling more products.
The sales force has marketed the use of DePuy Motech’s products in the 360 approach,
whereby the surgeon operates on the spine from both the back and front of the body,
installing instrumentation or bone graft to support the spine on both sides. This marketing
strategy has benefited from spine surgeons being pulled in opposite directions. On the one
hand, they are being wooed by proponents of posterior-only fusions with traditional
instrumentation, and on the other, by advocates of anterior-only fusions with cages. By
positioning itself in the middle, DePuy Motech appeals to both camps.
DePuy Motech’s spinal implants include the MOSS Miami system, competing in
the traditional instrumentation segment of the market, and the Titanium Surgical Mesh,
used in support of weak bony tissue. The MOSS Miami system accounts for 65% to 70%
of DePuy Motech’s sales. It utilizes anterior column support to restore and balance the
forces in the spine. DePuy Motech offers the MOSS Miami System in both stainless
steel and titanium alloy, which allows surgeons to use MRI and CT scan for post-
operative evaluation.
The Titanium Surgical Mesh accounts for the remaining 30% to 35% of DePuy
Motech’s sales. It is used for reinforcement of weak bony tissue. The Titanium Surgical
Mesh has gained acceptance outside the United States, particularly in procedures
involving the removal of a vertebral body (corpectomy). To further evaluate specific
indications, DePuy Motech is conducting clinical trials in the United States. We
anticipate that the introduction of fusion cages could result in a reduction in Titanium
Surgical Mesh sales in the United States, representing an estimated 50% of total Titanium
Surgical Mesh sales. We estimate the maximum business “at risk” from fusion cages at
20% to 25% of U.S. Titanium Surgical Mesh sales, or an estimated $1.4 million to
$1.8 million, based on estimated 1996 U.S. Mesh sales of $7 million. In addition, we
estimate Mesh sales growth of 26%, 7%, 7%, and 5% in fiscal years 1997-2000,
respectively.
We look for total spinal implant sales growth for DePuy of 33% in 1997, 16% in
1998, 13% in 1999, and 10% in 2000, although we expect slowing Mesh sales growth
and prices, which increased by 7% and 10% in 1995 and 1996, respectively, to slow total
growth. DePuy Motech initially priced its products significantly below competitors’
products to gain market acceptance, but with the past two year’s increases, its prices are
now only 5% below competitors’ prices. We see upside potential to our growth estimates
from launch of cervical spinal implants in 1997 and from acquisition.

Exhibit 23
Spinal Implant Sales by Product Segment

($ in millions)
1996E 1997E 1998E 1999E 2000E
Total Spine $46 $61 $71 $80 $88

Y/Y % 50% 33% 16% 13% 10%
MOSS Miami *$32 $44 $52 $60 $68
Y/Y % 50% 36% 19% 15% 12%
Mesh *$14 $17 $19 $20 $21
Y/Y % 51% 26% 7% 7% 5%
* Based on 70/30 split for MOSS/Mesh sales

DePuy Motech, like the rest of the spinal implant industry, is facing lawsuits
(approximately 600 lawsuits) relating to alleged conspiracy in the use of pedicle screws.
DePuy’s exposure is minimal, however, given that it was only named as a co-conspirator
and that the judge presiding over the pedicle screw litigation has made strong statements
in the past against the legitimacy of co-conspiracy claims.
Trauma
DePuy had 1995 estimated worldwide trauma sales of $49 million or about 5% of
the worldwide market, with U.S. sales of $26 million or about 6% of the U.S. market. In
1994, with the acquisition of ACE Medical, a manufacturer of titanium alloy trauma
products and external fixation devices, DePuy expanded its trauma franchise. The
company has done the easy work in growing trauma sales by picking up international
business through the introduction of trauma products in European markets and by selling
trauma products into its reconstructive device sales accounts. In Japan, DePuy ACE sells
through a distributor, but realizes excellent margins and has number-one or number-two
market share.
We believe that the best days for DePuy’s trauma business, which has not yet hit its The best days for
stride, are still ahead. The company recently established a dedicated U.S. trauma sales DePuy’s trauma
force of 50 representatives, potentially rivaling Synthes, the gorilla in the U.S. market business are still ahead.
with an estimated 35% share and a sales force of 65 to 70 sales representatives. DePuy’s
dedicated U.S. trauma sales force should help boost U.S. trauma sales, which have not
been spectacular. DePuy ACE suffered from supply constraints in 1995, however, these
have since been rectified and should no longer effect sales growth.
We expect DePuy ACE to achieve sales growth of 26% in 1997, 23% in 1998, 19%
in 1999, and 13% in 2000, as a result of market share gains in the United States and
continuing strong international growth. In the United States, we expect DePuy to gain
share from Zimmer, Howmedica, and Richards. Furthermore, the profitability of
DePuy’s trauma business should increase as DePuy ACE intends to bring all
manufacturing in-house over time, 70% of which is presently outsourced. We see a
longer-term threat in the entry of Stryker in the U.S. trauma market. With the acquisition
of Swiss-based Osteo Holdings and impending commercialization of OP-1, Stryker
could be a formidable competitor.

Sports Medicine
With the acquisition of Orthopedic Technology, Inc. (OrthoTech), in March 1996,
DePuy has the opportunity to leverage a strong sports medicine product line through an
acquired U.S. sales force of 60 representatives, and to achieve geographic
diversification. Currently, the company has no sports medicine sales outside the United
States. DePuy plans to achieve cost savings by consolidating the manufacturing of sports
medicine products into one facility. We expect business sales growth of 25% in 1997
(including growth from the acquisition of Orthopedic Technology), 12% in 1998, 12%
in 1999, and 12% in 2000 coming from market growth and market share gains
worldwide.
Growth potential from acquisition, particularly in the field of osteobiologics, which
could be easily leveraged into the sports medicine marketplace in meniscal replacement,
rotator cuff injury, and other indications, is significant. Many small companies in the
sports medicine marketplace lack clinical expertise or adequate distribution for their
novel technologies. DePuy has already acquired a minority interest in Matrix
Biotechnology, a developer of cartilage repair technology, and is developing its Small
Intestine Submucosa (SIS) for tissue repair.
DePuy Orthotech’s products include arthroscopy instruments, anterior cruciate
ligament reconstructive guide systems, tissue fixation devices, cold therapy
management systems, foot and ankle supports, and orthopaedic knee braces.
Other Products
DePuy’s other products include operating room supplies for use in reconstructive
joint surgery. This business suffered in 1996, as DePuy has focused on higher growth
product segments such as spinal implants, trauma, and sports medicine. We estimate
sales growth in other products of -4% for 1996 and -8% in 1997, with recovery to 6% in
1998, 7% in 1999, and 7% in 2000.
RESEARCH AND DEVELOPMENT

In addition to achieving growth through acquisition or joint venture. DePuy seeks to
identify future growth opportunities through strategic alliances, licensing of technology,
and in-house research. Areas of focus include tissue repair, osteoinductive agents, and
resorbables. In the area of tissue repair, DePuy has entered into an exclusive license
agreement with Purdue University to develop a tissue engineering concept using Small
Intestine Submucosa (SIS), a collagen-based naturally occurring biomaterial. SIS has
demonstrated an ability to facilitate the regeneration of a patient’s tissue at various
anatomical sites. DePuy is investigating SIS for ligament, tendon, bone, cartilage,
meniscus, and rotator cuff applications. In November 1996, DePuy also announced that
it had acquired a minority interest in Matrix Biotechnology and worldwide distribution
rights to any product commercialized by Matrix. Matrix Biotechnology is developing
cartilage repair technology.
In the area of osteoinductive agents, DePuy has entered into a license agreement
with Genentech to evaluate use of Transforming Growth Factor Beta One (TGF-ß-1) for
orthopaedic applications. TGF-ß-1 has demonstrated an ability to assist bone
regeneration and inhibit bone loss (resorption). Also, TGF-ß-1 may have
osteoconductive properties when used in combination with other biomaterials,

indicating potential as a bone graft substitute. However, work still needs to be done in
preventing TGF and other bone growth factors from stimulating bone growth
uncontrollably. We do not expect any commercial impact for DePuy in the area of
osteoinductive agents until beyond 2000. Finally, DePuy is also investigating the use of
resorbable technology in repair of cartilage damage and for bone fixation.
SALES AND MARKETING

In the United States (as of September 1996), DePuy markets its reconstructive
devices through a network of about 500 independent, commissioned sales associates
managed by 31 company-employed territory sales managers and 11 independent sales
agents. As part of a reorganization of its sales infrastructure, DePuy has been replacing
sales agents with territory sales managers who maintain higher accountability of sales
associates in their areas. Sales associates under the administration of territory sales
managers are directly compensated by DePuy, creating greater incentive to sell the
company’s products. Trauma and sports medicine products are marketed through a
combination of dedicated sales forces and the network of reconstructive device
salespeople. Spinal implants are marketed through a specialized sales force.
Internationally, DePuy has been establishing a distribution subsidiary in each
country where it markets its products, in order to better address the particular purchasing
practices, governmental regulations and reimbursement issues of each country. We
believe that this strategy has, and will continue to have, a positive impact on growth.
DePuy is one of the top U.S. orthopaedic companies in Europe, where it has a
distribution subsidiary in each major market. It is the leading orthopaedic company in
the United Kingdom, achieving double-digit growth through continued market share
gains. In Germany and France, it is the number-one or number-two U.S. orthopaedic
company and number-four or number-five overall, behind local companies that have
strong ties to hospitals. Of U.S. orthopaedic companies, it also has leading share in
Spain, Italy, and Northern Europe, although in Italy, Howmedica is stronger. In Japan,
since acquisition of its distributor in 1990, DePuy has built an estimated $65 million
business, approximately 9% to 10% share, from under $10 million in 1990. DePuy’s
Japanese distribution subsidiary has four regulatory people to handle the rising legal and
clinical hurdles associated with marketing orthopaedic products in Japan. DePuy’s
Japanese business continues to grow in double digits, perhaps as high as 20%.

Biomet, Inc.
BMET (Nasdaq): $ 15 1⁄8
Rating: HOLD
High on Core Business Execution, but
Low on Critical Mass

Dan Shoaib (212) 207-1409

$12 1/2-20 1/2 $556.1 mil. Reconstructive Devices Cash/Equivalents $128.8 mil.
FY May 1995A 1996A 1997E Trauma Devices Cash per Share $1.10
Bone Growth Stimulators Total Debt $0
FY EPS $0.69 $0.77 $0.91
Arthroscopy Products
FY Rev. (mil.) $452.3 $535.2 $580.6
Craniomaxillofacial Products
Operating Room Supplies
Nasdaq Composite 1291.38
Net Income/Loss Options C/BIQ
Market Shares Avg. Daily FY95A $79.2 mil. Convertibles None
Cap Outstanding Volume FY96E $89.1 mil. Legal Disclosures a&f
$1.75 bil. 116.0 mil 100,000 FY97E $106.0 mil.
BMET BIOMET INC

Low: 12.50
12/27/95 to 12/27/96 Close: 15.13
USD
• Low geographic and product diversity reduces growth
20.0
potential.
19.0
18.0
• Moderate size impedes growth through acquisition.
17.0
16.0 • Without acquisitions, EPS risk is likely on the down-

15.0 side.
14.0
13.0
Millions
17.1
8.6
KEY INVESTMENT POINTS

• We recently initiated coverage of Biomet with a HOLD because of its size,
geographic coverage, and strategic position in a consolidating industry leading to
uncertainty surrounding its growth.
• We estimate calendar 1997/1996 and 1998/1997 earnings per share growth of 16%
and 14%, respectively.

• We expect that the trend towards contracts will increasingly hurt Biomet’s U.S.
reconstructive device sales growth.
• We see more downside risk than upside in estimates, based on uncertainty with
respect to Biomet’s U.S. implant and EBI businesses.
• Our 12-month price target is $18, based on a multiple of 16 times our calendar 1998
estimate of $1.12 in earnings per share.
INVESTMENT OVERVIEW
Biomet’s core businesses include reconstructive devices, internal and external
fixation devices, bone growth stimulators, arthroscopy products, craniomaxillofacial
products, orthopaedic support devices, and operating room supplies. When Biomet
reports its operating results, the company breaks out sales of reconstructive devices and
its Electro-Biology, Inc. (EBI) division, which sells bone growth stimulators and external
fixation devices, and consolidates all other sales in its “Other Products” category.
Exhibit 24
Sales By Reported Category: Fiscal 1994A to 1997E
1994 1995 1996 1997E 1998E 1999E 2000E
Total Sales $373 $452 $535 $612 $671 $700 $760

% growth 11% 21% 18% 9% 11% 9% 9%
Reconstructive Devices $218 $273 $327 $357 $394 $427 $459

% of total sales 58% 60% 61% 61% 61% 61% 60%
% growth 15% 25% 20% 9% 10% 8% 8%
EBI $89 $99 $109 $117 $131 $144 $158
% of total sales 24% 22% 20% 20% 21% 21% 21%
% growth 8% 11% 10% 8% 12% 11% 10%
Other Products $66 $81 $100 $107 $118 $129 $142
% of total sales 18% 18% 19% 19% 18% 18% 19%
% growth 3% 22% 23% 8% 10% 10% 10%
There are two main In our view, there are two main investment issues for Biomet: the company’s
investment issues: strategic position in the industry and the uncertainty surrounding its EBI business. With
strategic position and regard to the former, although a highly effective company in its execution, we do not
the EBI business. believe that Biomet provides a premier platform for growth/consolidation in the
orthopaedic industry. The titans of the industry, Zimmer (NYSE/BMY), Howmedica
(NYSE/PFE), and DePuy (NYSE/DPU), have significantly greater share in
reconstructive devices, are more diversified across product lines, and have greater
capacity for acquisition. We anticipate that their market share advantage should enable
them to win purchasing contracts, particularly in reconstructive devices, at the expense
of the mid-tier and small-tier companies, a trend that we expect to accelerate going
forward. We predict that this will hurt Biomet’s reconstructive device sales growth to an
increasing degree over time.

The second investment issue relates to the uncertainty surrounding Biomet’s EBI
division, particularly the bone growth stimulation business, which is now facing flat
market growth and continuing competition from OrthoLogic. We expect that EBI will
continue to lose market share to OrthoLogic, which is marketing a more technologically
advanced bone growth stimulator through a recently beefed-up sales force.
We feel that Biomet may be caught in the middle because of its size, which could Biomet may be caught
become an increasingly important barrier to its growth in this consolidating industry. At in the middle because of
first glance, Biomet might seem like an obvious takeout play. However, there are three its size.
factors weighing against this scenario: loss of distributor relationships, departure of
surgeon champions, and price. First, the reconstructive device industry is dominated by
distributors’ relationships with surgeons. So if an acquirer tried to reduce costs by firing
Biomet’s distributors, it would lose much of Biomet’s business from those distributors’
relationships with surgeons. Second, the loss of surgeon champions who back the
acquired company’s products has historically occurred upon acquisition, resulting in a
significant loss of business. Finally, at a valuation of $1.9 million with a 20% premium
on top, we do not believe that Biomet is a likely acquisition target at the current price.
In our view, the company will more likely be an acquirer, but may be shut out of top
orthopaedic company status because of its present size. The most likely type of acquiror
could be like Sulzer, in need of a greater U.S. presence, or Johnson & Johnson, in need
of presence in hips.
In summary, then, we feel Biomet’s current businesses are unlikely to sustain over
the next four years the base business growth achieved in recent years. The stock trades
at a P/E multiple of 16 to our $0.98 in estimated calendar 1997 earnings per share. We
estimate calendar 1997 EPS growth of 16%, with risk on the downside, and estimate
calendar 1998 EPS of $1.12, amounting to 14% 1998/1997 in EPS growth. Our 12-
month target price is $18, based on 16 times our calendar 1998 earnings per share
estimate of $1.12, and we rate the stock a HOLD.
GROWTH DRIVERS
Biomet’s primary source of growth should come from continued strong ex-U.S. Biomet’s primary
sales growth. Ex-U.S. sales growth was 27.5% in fiscal 1995 and 27.7% in fiscal 1996, source of growth should
accounting for 24.0% of Biomet’s total sales in fiscal 1995 and 25.9% in fiscal 1996. come from continued
Although much of this growth came from acquisition of distributors, Biomet should be strong ex-U.S. sales
able to gain ex-U.S. share in reconstructive devices, currently at 4%, by continuing to growth.
enhance its surgeon relationships and market its clinical results with an increasingly
direct ex-U.S. presence. Going forward, however, we expect this strategy to be less
effective in the United States, and anticipate slowing progress in the U.S. device market.
We estimate Biomet reconstructive device sales growth of 9%, 10%, 8%, and 8% in
fiscal years 1997 to 2000, respectively.
EBI’s growth outlook is uncertain. We see downside risk from current businesses but EBI’s growth outlook is
upside potential from launch of a new spinal implant system, expected in February 1997. uncertain.
We expect growth in the bone growth stimulator business to remain sluggish through
fiscal 1997, as negative growth in the non-healing fractures segment largely offsets 20%
growth in the smaller spine segment. Furthermore, we expect growth in the external
fixation business to be flat in fiscal 1997 due to unfavorable comparisons with fiscal
1996, during which EBI reduced the ASPs for its Dynafix product line by close to 10%
relative to the Orthofix product line that it previously distributed.

We estimate total EBI sales growth of 8%, 12%, 11%, and 10% in fiscal years 1997
to 2000, with consolidaton of the AOA product line and new spinal implant sales adding
5% and 1% growth, respectively, in fiscal 1997 and 1% and 4% in fiscal 1998. Beyond
fiscal 1997, we look for external fixation sales growth of 9%, characteristic of the overall
market, bone growth stimulation sales growth of 7% to 8%, and AOA sales growth of 7%.
Exhibit 25
Sources of Total Biomet Sales Growth: Fiscal 1994 to Q1-97
Total Growth Acquisition Base Businesses2
1994 11% 0.0% 11%

1995 21% 11%1 10%
1996 18% 6%1 12%
Q1-97 8% 0% 8%
1 Reflects acquisition of Kirschner Medical Corporation on August 12, 1994

2 Includes impact of foreign exchange
As base business sales growth slows, Biomet will be able to use its cash flow to
make acquisitions, and to diversify into higher growth segments of the orthopaedic
products market.
Exhibit 26
Biomet’s Cash Flow Provides Opportunity for Growth

Through Internal Product Development and Acquisition
FY 1994 FY 1995 FY 1996

EBITDA $119 $143 $172
Y/Y % 20% 20%
Free cash flow $112 $114 $158
Y/Y % 1% 38%
PRODUCT SEGMENTS
Reconstructive Devices
Biomet is the number-five player in the hip implant market, with 11% share. The
company is the number-five player in the knee implant market, with 9% share. Biomet
also participates in the extremities implant market. From the beginning of 1993 to the
end of the third quarter of 1996, Biomet’s U.S. share in hips has increased from 8% to
11% and in knees from 6% to 9%.

The reconstructive device market is considered mature in the developed world, with
2% to 3% sales growth in the United States and 4% to 5% sales growth internationally.
We estimate sales growth in the hip implant market of negative 1% to 2% in the United
States and 3% internationally, and in the knee implant market of 3% to 4% in the United
States and 5% internationally. Worldwide sales of implants for the extremities, including
the shoulder, wrist, elbow, and ankle, continue to grow rapidly, but were only
$80 million in 1995 and, therefore, immaterial to overall sales growth in the
reconstructive device market.
We estimate Biomet reconstructive device sales growth of 9%, 10%, 8%, and 8% in
fiscal years 1997 to 2000. Although we expect Biomet to continue to gain ex-U.S. share
by leveraging its surgeon relationships and marketing its clinical results with a greater
direct presence, we feel that this strategy will be less effective in the United States going
forward, resulting in loss of U.S. reconstructive device market share, partially offsetting
ex-U.S. gains. In Ex-U.S. in fiscal 1996, 85% of Biomet’s sales were in reconstructive
devices; we estimate ex-U.S. reconstructive device sales growth of 18%, 13%, 11%, and
10% in fiscal 1997-2000. We estimate U.S. reconstructive device sales growth of 5%,
8%, 7%, and 6% in fiscal years 1997 to 2000.
Exhibit 27
Implant Sales Growth: Fiscal 1996A to 2000E

($ in millions)
1996 1997E 1998E 1999E 2000E

Total Implant Sales $327 $357 $394 $427 $459
Y/Y % 20% 9% 10% 8% 8%
U.S. Implant Sales $209 $221 $238 $255 $270
Y/Y % 16% 5% 8% 7% 6%
Ex-U.S. Implant Sales $118 $138 $156 $172 $189
Y/Y % 28% 18% 13% 11% 10%
Biomet’s strategy is to focus on providing superior service to the orthopaedic Biomet’s strategy is to
surgeon and to emphasize the clinical efficacy and cost-effectiveness of its implants, in focus on providing
order to justify price levels. The company has not signed any group purchasing contracts superior service to the
and has managed to achieve average annual price increases of 2% to 3% for its orthopaedic surgeon.
reconstructive devices, avoiding pricing pressure from mix shift and discounting.
However, Biomet sales growth in accounts that have contracts with other manufacturers
is only 5% to 6% versus 8% to 10% in accounts that are not part of group purchasing
contracts. The percentage of reconstructive device sales that are contract-based has
increased from 0% five years ago to about 15% in 1996.

Exhibit 28
Sources of Biomet Reconstructive Device Sales Growth:

Fiscal 1996A to 2000E
Total
Total Units Pricing Mix Shift Price
1996A 19.9% 17.4%* 2.5% 0.3% 2.2%
1997E 9% 6.5% 2.5% 0.4% 2.1%
1998E 10% 7.5% 2.5% 0.3% 2.2%
1999E 8% 5.5% 2.5% 0.2% 2.3%
2000E 8% 5.5% 2.5% 0.0% 2.5%

*Reflects acquisition of Kirschner Medical
Biomet’s view is that incremental technological improvement in reconstructive

devices and their implantation can drive cost-effectiveness. Implant costs may have
increased as a percentage of total procedure costs, but advances in implant technology
have, in fact, enabled lower procedure costs by reducing operating room time, hospital
length of stay, and improving outcomes. Biomet emphasizes that its reconstructive
devices offer superior clinical outcomes, and justifies its price levels based on patient
lifetime costs, not per-procedure costs. The company has compiled data indicating that
its implants enable significantly lower rates of revision surgery, a far more expensive
procedure than primary joint replacement surgery, and are cost-effective relative to other
manufacturers’ implants when patient lifetime costs are taken into account.
Furthermore, Biomet argues that the fully costed economics of porous-coated implants,
which comprise a high percentage of its reconstructive device sales, are comparable to
cemented implants.
Through ongoing education, training and high quality service, Biomet has marketed
this view to surgeons both in the United States and ex-U.S., forming close ties to them
in the process. Whereas other manufacturers have sought to work with both surgeons
and hospital administrators in an attempt to win contracts, Biomet has consistently
supported the surgeon alone. Approximately 90% to 95% of Biomet’s reconstructive
device sales are supported by a sales agent in the operating room with the surgeon.
Biomet views the rise of group purchasing contracts in the United States as a passing
phenomenon, and is betting that ultimate decision-making power is likely to remain with
the orthopaedic surgeon.
The company believes that a large percentage of implant procedures will continue
to be performed by low volume orthopaedic surgeons who need sales representatives in
the operating room for assistance. Today, 60% of U.S. implant procedures are performed
in low volume centers. This is changing, but very slowly, favoring Biomet. Biomet
expects that its high quality service to the orthopaedic surgeon, along with incremental
technological improvement, will continue to drive market share gains at the expense of
the top three players: Zimmer, Howmedica, and DePuy. The company perceives market
share gains in reconstructive devices as its primary source of future growth.

In our opinion, however, despite recent grumblings from the industry, group
purchasing contracts are here to stay. We believe that the percentage of contract-based
reconstructive device sales will increase over time, and that compliance will be stricter.
This trend should be driven by continuing cost-containment pressure on Medicare
spending, greater standardization of implants and instrumentation reducing the
importance of high service levels, a new generation of orthopaedic surgeons with weaker
relationships with industry, and an excess supply of orthopaedic surgeons reducing their
bargaining power. Therefore, we expect Biomet to lose U.S. reconstructive device
market share as a result of the trend towards contract-based sales.
It would be more difficult for Biomet than for some others to win contracts because
of its size even if the company chose to change its strategy. Group puchasers prefer to
sign on the heavy hitters since a higher percentage of the surgeons in their networks
already use those manufacturers’ implants, making compliance easier to achieve. Thus,
Biomet might be at a disadvantage relative to Zimmer, Howmedica, and DePuy in
contract bidding.
Product Line. Biomet’s most successful recent product has been the Maxim Total
Knee System, which has recently gained share in the worldwide knee implant market.
The Maxim Total Knee System competes in the revision segment of the knee implant
market and is clinically indicated for replacement of a knee that has compromised soft
tissue, which leads to joint instability. Biomet’s Finn Knee Replacement System, sold in
Europe, also addresses the revision segment of the knee implant market. Biomet is
especially competitive in the revision hip market for reconstructive devices with an
estimated number-two share.
The company has marketed its clinical results effectively with both its AGC Knee
and Mallory Head products. The company offers the AGC Total Knee System, which
includes all the relevant implant components and instruments for total knee
arthroplasty. AGC components are available with or without a porous coating to
enhance bone fixation. Biomet’s flagship hip implant is the Mallory-Head Total Hip
System, designed for both primary and revision implant indications and for both
cementless and cemented indications.
Biomet developed its Alliance family of hip implants to address the trend towards
patient demand matching by hospitals and purchasing groups. The Alliance family uses
a single set of instrumentation that is applicable to a wide selection of primary and
revision hip stems, allowing surgeons to match a specifically sized and shaped implant
to individual patient anatomy without facing the additional cost of instrumentation.
With the acquisition of Kirschner in August 1994, Biomet broadened its
reconstructive product line to include the Performance Knee and the Neer Shoulder
System. The acquisition of Kirschner contributed 11.2% to total sales growth in fiscal
1995 and 6.7% to total sales growth in fiscal 1996. However, Biomet lost a significant
portion of the Kirschner reconstructive device business through the distributors that it
released and the surgeon relationships that these distributors had. We estimate that loss
of Kirschner business will reduce total reconstructive device sales growth by 2% in
fiscal 1997.
EBI Division
Biomet’s EBI division manufactures and markets bone growth stimulators for
treatment of non-healing fractures and for adjunctive use in spinal fusion procedures to
increase the success rate for vertebral fusion, and also produces external fixation devices

to achieve bone fixation in troublesome fractures. EBI had sales of $109 million in fiscal
1996, with an estimated $83 million in sales of bone growth stimulators, representing
61% market share, and an estimated $26 million in sales of external fixation devices,
representing 35% market share.
There is considerable uncertainty surrounding EBI’s growth prospects, principally
due to issues relating to bone growth stimulator sales growth. We estimate total EBI
sales growth of 8%, 12%, 11%, and 10% in fiscal years 1997-2000, with bone growth
stimulator sales growth of 2%, 7%, 9%, and 8% and external fixation sales growth of
2%, 8%, 9%, and 9%, respectively. Additional growth should come from consolidation
of the AOA product line and launch of a pedicle screw system in the first quarter of 1997.
With respect to bone growth stimulator sales growth, there are four main issues for
EBI: the present flat market growth in non-healing fractures, continuing competition
from OrthoLogic, strong growth in spinal sales, and the impending commercial
availability of OP-1, to be marketed by Stryker. First, market growth appears to have
flattened out in the past couple of quarters as the two market leaders, EBI and
OrthoLogic, have lost focus on the marketplace because of internal distractions: EBI has
been devoting its time to launch of its external fixation system, while OrthoLogic has
been in the midst of a transition from an indirect to a direct sales force. As a result,
neither company has driven growth through education, training, on relationship-
building, which are the keys to success in this market. We estimate market growth of
10% going forward with downside risk.
Second, we expect EBI to continue to lose share in non-healing fractures to
OrthoLogic, which has grabbed an estimated 40% market share in non-healing fractures
since launch of its bone growth stimulator in March 1994. OrthoLogic’s product has
achieved success because the company capitalized on EBI’s vulnerability following
termination of the EBI-Orthofix agreement and also because its product requires only 30
minutes of treatment time per day versus 10 hours per day for EBI’s bone growth
stimulator.
Third, we expect strong spinal bone growth stimulator sales for EBI to accelerate
total growth. EBI has benefited in spinal sales by focusing on surgeon education and
introducing product upgrades. Also, it does not face competition in this area from
OrthoLogic, whose product is not approved for use in the spine. EBI has an estimated
47% share in the spinal bone growth stimulator market, and we are looking for continued
sales growth of 20% through fiscal 1997. The target market is mainly two-plus level
lumbar fusions. We estimate the total market for spinal stimulation at $50 million and
for non-healing fractures at $75 million.
Finally, the arrival of OP-1 on the marketplace could send a shockwave through the
bone growth stimulator industry. With possible higher healing rates than bone growth
stimulation, OP-1 would provide surgeons with an alternative to autograft in treatment
of non-healing fractures, reducing cost and patient morbidity. We estimate that in a
majority of cases, bone growth stimulators are prescribed following an unsuccessful
surgery and these would be vulnerable to replacement by OP-1.
With respect to external fixation sales growth, it appears that EBI has successfully
launched its Dynafix system and that after three more quarters of flat growth from
unfavorable year-ago pricing comparisons, growth should pick up to 9% by the end of
fiscal 1998. We believe that EBI’s Dynafix launch succeeded for two main reasons: the
division’s close relationships with surgeons and its reductions in average selling prices

(ASP) of 10% for its Dynafix product line. Apparently, EBI was able to convince
surgeons that its system was at least comparable to Orthofix’s. The price reduction
should result in flat EBI ex-fix sales growth through fiscal 1997, as the 10% ASP declines
versus year ago numbers offset unit growth. Profitability is enhanced, however. We then
expect growth to pick up to 9% by the middle of fiscal 1998 (ie., end of calendar 1997).
Net net, EBI has held onto 98% of the customers to whom it formerly sold the
Orthofix product line. Currently, 95% of EBI’s external fixation sales are from its
Dynafix product line, up from 50% six months ago. The division has substantially
increased the profitability of its external fixation sales by increasing its margins on ex-
fix sales by 25 points to 30 points. We estimate EBI’s current market share at 35%. The
division expects to add a few more product lines to compete across the board with
Orthofix. Furthermore, FDA warning letter issues relating to quality control appear to be
resolved, removing a potential impediment to growth. We look for overall market
growth of 8% to 10%, driven by product innovation expanding applications, and expect
EBI to grow its new ex-fix business at 9% beyond fiscal 1997.
Beyond base EBI growth, additional growth should come from consolidation of
AOA soft goods and launch of a pedicle screw system in the first quarter of 1997. We
expect consolidation of AOA soft goods to add 5.3% to total EBI sales growth in fiscal
1997 and 0.4% in fiscal 1998. This product line was previously included in “other
products” and, therefore, does not constitute growth for Biomet. EBI plans to launch its
new pedicle screw system at the annual meeting of the American Academy of
Orthopaedic Surgeons in February 1997. The marketing angle that EBI will focus on is
that its system provides both strength and simplicity, whereas currently available
systems offer one at the expense of the other. EBI has a well-known surgeon champion
behind its product to promote adoption, and should be nicely leveraged with its 200-
plus-representative direct sales force. We estimate that spinal implant sales will
contribute 1% to total EBI sales growth in fiscal 1997 and 4% in fiscal 1998.
A new source of growth for EBI sales should come from ex-U.S. expansion. The A new source of growth
initial Phase of ex-U.S. launch has already begun, with EBI first targeting the higher for EBI sales should
margin markets in Europe with its external fixation product line. With Biomet’s direct come from ex-U.S.
presence in major markets in Europe and similar call patterns for Biomet in Europe and expansion.
EBI in the United States, we expect ex-U.S. external fixation sales to gain momentum
during 1997 and, eventually, for EBI to use the relationships built from overseas ex-fix
sales to market its other products. The market dynamics in ex-U.S. markets are
different from country to country and from the United States, making Biomet’s direct
presence critical.
Product Line. The EBI Bone Healing System is a non-invasive device that emits
pulsed electromagnetic field signals that can induce bone growth through a non-healing
fracture. The device consists of a control unit and electrical coils. The control unit
converts household current or battery power into pulsed electromagnetic field signals
and the electrical coils conduct these signals to the fracture site. The electrical coils can
be worn over the skin, incorporated into a patient’s cast, or placed over the cast. The EBI
Bone Healing System requires 10 hours of treatment time per day, with average
treatment duration of six months.
EBI’S SPF Implantable Spinal Fusion Stimulator is a bone growth stimulator
indicated for adjunctive use in spinal fusion procedures, to increase the success rate of

fusions with bone graft. It consists of a generator that provides constant direct current to
a titanium cathode, which is placed at the fusion site.
The Dynafix external fixation system consists of fixators and accessories used to
attach the devices. AOA’s product line includes back supports, wrist and forearm splints,
shoulder immobilizers, knee braces, and a variety of casting products for use in the
application and removal of orthopaedic casts and splints.
Other Products
Biomet’s Other Products category includes devices manufactured and marketed by
subsidiaries, including Arthrotek and Walter Lorenz Surgical. These products include
internal fixation devices, operating room supplies, arthroscopy products, and
craniomaxillofacial products. Arthrotek manufactures and markets arthroscopy
products. Walter Lorenz Surgical manufactures and markets craniomaxillofacial
products. We estimate sales growth in Biomet’s Other Products category of 5% in fiscal
1997, with growth reduced by 6% due to transfer of the AOA product line to EBI.
Beyond fiscal 1997, we look for sales growth of 10%.
Biomet, through its Arthrotek subsidiary, offers a complete line of arthroscopy
products, including power instruments, manual instruments, visualization products, soft
tissue anchors, and procedure-specific instruments and implants. Arthrotek manufactures
and markets the IES 1000 system, a fully integrated arthroscopy system, the PowerPump
800, which enables compatibility with other arthroscopy shaver systems, and the One
Step ACL Guide System for use in anterior cruciate ligament reconstruction. While
Arthrotek sales growth has been flat, with increasing sales of disposables offsetting
decreasing sales of capital equipment, we expect Arthrotek sales growth to pick up as
capital equipment sales stabilize and disposables continue to grow.
Through its Walter Lorenz Surgical subsidiary, Biomet manufactures and markets a
full line of products for the craniomaxillofacial market. In February 1996, Walter Lorenz
received 510(k) and CE Mark approval to market the first resorbable plate and screw
system for craniomaxillofacial surgery in the United States and Europe. We expect
Walter Lorenz sales growth to remain in the teens, with enhanced profitability from
higher gross margins (60%, up from 45%) since the termination a supply agreement
with Leibinger. Walter Lorenz now buys instruments directly from Germany instead of
through Leibinger. Walter Lorenz may also make inroads into the dental implant market
in the future.
Biomet’s internal fixation devices include the Uniflex Nailing System, the
company’s largest selling fixation system. The Uniflex Nailing System is used for
internal fixation of femoral, tibial, and humeral fractures. It achieves intramedullary
fixation, whereby a “nail” is inserted into the central bone canal, increasing the
likelihood of fixation and reducing the probability of fracture site infection.
Biomet’s operating room supplies include surgical suction devices, filters, and
drapes. These products are less clinically differentiated, with sales growth most likely
reflecting overall market growth of about 10% in this segment of the orthopaedic
products market.

RESEARCH AND DEVELOPMENT
Current research and development efforts are directed primarily at increasing
surgeon satisfaction, the company’s traditional focus. This is accomplished in the short
term through custom-design of implant components for surgeons, and in the long term
through continual focus on incremental technological improvement. In reconstructive
devices, the greatest clinical unmet need remains the improvement of coatings to reduce
the incidence of implant loosening. Biomet is engaged in research in this area and has
developed a new method of polyethylene manufacture that may improve clinical
outcomes. Biomet is also in the process of developing a hydroxyapatite coating for its
reconstructive devices, which may improve outcomes. Clinical trials are being
conducted with three Biomet hip systems.
Also, Biomet is developing a mobile bearing knee system that should be launched
by the end of 1997, following expiration of DePuy’s patents on this technology. With
more standardized instrumentation, Biomet may be able to expand the popularity of the
mobile bearing knee, which more closely mimics the natural anatomic movement of a
knee. Biomet also sees an opportunity for product development in the revision segment
of the hip implant market, a neglected area of the reconstructive device market that is not
as price-sensitive. Additionally, Biomet is developing extremities implant technology,
including ankle, elbow, and finger prostheses.
In trauma, Biomet is developing technology applications in the shoulder. EBI is
conducting clinical trials to assess the use of its bone growth stimulation technology in
the treatment of fresh fractures, and may submit a PMA supplement during fiscal 1997.
For surgical treatment of carpal tunnel syndrome, Biomet has developed the Indiana
Tome, which combines aspects of both minimally invasive surgery and the open surgical
approach. Biomet is also conducting research in soft tissue repair, with applications in
meniscal replacement, rotator cuff injury, and ligament replacement.
Finally, in the osteobiologics arena, Biomet holds some patents relating to the use
of a combination of bone growth factors in musculoskeletal repair, which may prove
valuable in the future, depending upon which approach in the area of osteobiologics
proves most successful.
SALES AND MARKETING

The orthopaedic products market, particularly the reconstructive device segment of
the market, is dominated by industry relationships with surgeons. Biomet markets its
reconstructive products through about 330 independent commissioned sales
representatives and sales associates specializing in orthopaedic supplies in the United
States, with Biomet sales accounting for over 90% of their total sales. Biomet sets prices
for its reconstructive devices, so that its sales infrastructure is essentially direct.
EBI, through its subsidiary EBI Medical Systems, markets its products through its
170 person direct sales force in the United States and through a growing distribution
network internationally. Walter Lorenz markets its craniomaxillofacial products through
about 40 independent sales representatives and sales associates specializing in
craniomaxillofacial products in the United States, and through a network of direct
factory sales representatives and distributors internationally. AOA markets its soft goods
through a 36-representative direct sales force.

Internationally, Biomet has established a direct presence in major European markets
with distribution subsidiaries. As in the United States, the company’s sales strategy
focuses on surgeon relationships. Margins on reconstructive devices are lower, with
lower average selling prices more than offsetting lower selling expenses. Biomet’s direct
presence, however, allows the company to deliver high quality service to orthopaedic
surgeons, which is apparently as important overseas as in the United States, and has
enabled it to gain share.
Biomet’s international sales infrastructure offers the potential for considerable
leverage to EBI, Walter Lorenz, and Arthrotek products which are not currently sold
directly in international markets. Orthopaedic surgeons outside the United States tend to
be generalists, so that Biomet call patterns would not need to be adjusted for these
product sales. We expect Biomet to take advantage of this potential distribution leverage
in the future. Additionally, Biomet does not sell through a distribution subsidiary in
Japan. Possibly a result, Biomet has the smallest share of the major implant
manufacturers in Japan.

Appendix

76
Appendix A: Market Model

The Competitive Landscape in Major Segments of the Orthopaedic Industry

Hambrecht & Quist LLC 12/30/96
R. Faulkner/D. Shoaib
RECON TRAUMA SPINE ARTHROSCOPY SOFT TISSUE MAXILLOFACIAL BONE GRAFT BONE STIMULATION OSTEOBIOLOGICS
AcroMed x
Acumed x
Advanced Spine x
Aesculap x x x x x
Alphatec x x x
Arthrex x x
Avanta x
Bioelectron x
Biomet x x x x x x x
Bionix x x
Corin x x x x x
Danninger/Cross x
Encore x x x
Exactech x
Exogen x
Genesis x
Gliatech x
Implex x
Innovasive x x
Instrument Makar x x
Intermedics x x (ReGen)
Interpore x x
Johnson & Johnson x
Li Medical x
Link America x x
Norian x
Orquest x
Ortho Development x
Orthofix x x x
OrthoLogic x
Orthovita x
Osteotech x
OTI x
Raymedica x
Sofamor Danek x x x
Spine-Tech x
Synthes x x
U.S. Medical x
U.S. Surgical x
Whiteside Biomechanic x
Wright Medical x x x x x x
Source: Knowledge Enterprises, Inc.

Appendix B: Company Profiles of Other Major Players
Howmedica
• Stronger ex-U.S.
• Not full line; primarily reconstructive products
• Established education as significant selling tool in 1980s
• Significant loss of share in all areas
Intermedics
• Sulzer strength lies ex-U.S.
• Not full-line; primarily reconstructive products
• Significant loss of manpower (shift of Cindrich et al. to Encore)
• Sister company, Calcitek, could provide dental/maxillofacial entry
Johnson & Johnson
• Reportedly mandated to become number one in global orthopaedic industry by
year 2000
• JMP acquisition was excellent match for J&J
• Not full-line; likely to buy its way into every other market
• Evokes tremendous respect and fear among competitors if the company swings
into action
Smith & Nephew
• Number-two worldwide, but relatively weak in reconstructive businesses
• Diminishing presence in spine
• Significant strength in arthroscopy, bracing and trauma (wound management
ex-U.S.)
• Best positioned of all companies to become a true “musculoskeletal” franchise
(from wound management to orthopaedics to maxillofacial to ENT, etc.)
Synthes
• The trauma company
• Trains and courts more than 2,000 surgeons annually
• Intensely loyal surgeon following
• Introduced the no-frills convention exhibit booth to orthopaedics
Zimmer
• Number-one worldwide
• Full line, with expansion into non-traditional orthopaedic areas (maxillofacial)
• Strong trauma franchise
• Significant restructuring internally and in the field (movement towards
megadistributorships)
• Conspicuously absent from spinal market
• Strong presence in Japan

Appendix C
Public and Private Acquisition Candidates

Selected Specialty Orthopaedic Companies

Company Product Segment
Acromed Spine
Acumed Specialty Trauma
Advanced Spine Spine
Alphatec Specialty Trauma
Arthrex Arthroscopy/Sports Medicine
ArthroCare Arthroscopy/Sports Medicine
Avanta Small Joints
Bioelectron Trauma
Danninger/Cross Spine
Etex Osteobiologics
Genzyme Tissue Repair Specialty Trauma/Sports Medicine
Innovasive Specialty Trauma/Arthroscopy
Instrument Makar Arthroscopy/Sports Medicine
Interpore Osteobiologics
Kinetikos Medical Small Joints/Specialty Trauma
KLS Martin OMF
Medicine Lodge Sports Medicine
Norian Osteobiologics
Orquest Osteobiologics
Orthofix Trauma
OrthoLogic Trauma
Orthovita Osteobiologics
Osteomed OMF
Osteotech Osteobiologics
Raymedica Spine
Regen Arthroscopy/Sports Medicine
Sofamor Danek Spine
Spine-Tech Spine
Storz OMF/Arthroscopy
Synthes Trauma/Spine

Appendix D: Spine Market Model
U.S. Lumbar Spinal Implant Market Projections 12/12/96

Hambrecht & Quist LLC Fusions and Implant Usage by Segment, 1995-2000 R. Faulkner/D.Shoaib
1995 1Q96 2Q96 3Q96 4Q96 1996 % 1Q97 % 2Q97 % 3Q97 % 4Q97 % 1997 % 1998 % 1999 % 2000 %
Spinal Fusion Segments and Growth Rates

# Cervical 93 25 25 26 27 102 10% 27 11% 28 11% 29 11% 30 11% 114 11% 125 10% 135 8% 144 7%
# Thoracic 31 8 8 9 9 33 8% 9 8% 9 8% 9 8% 9 8% 36 8% 39 7% 41 7% 44 7%
# Lumbar 76 19 19 20 21 79 4% 20 4% 20 4% 21 4% 21 4% 82 4% 88 7% 97 10% 106 10%
Total 200 52 53 55 56 215 7% 56 8% 57 8% 59 8% 60 8% 232 8% 252 8% 273 9% 295 8%
# Fusions
3+ Level Fusions 4 1 1 1 1 4 4% 1 4% 1 4% 1 4% 1 4% 4 4% 4 7% 5 10% 5 10%
2 Level Fusions 27 7 7 7 7 28 4% 7 4% 7 4% 7 4% 7 4% 29 4% 31 7% 32 3% 34 8%
1 Level Fusions 42 10 11 11 11 43 4% 11 4% 11 4% 12 4% 12 4% 45 4% 48 7% 53 10% 59 10%
Revisions 4 1 1 1 1 4 4% 1 4% 1 4% 1 4% 1 4% 4 4% 4 7% 6 43% 8 23%
% Implant Usage
3+ Level Fusions 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%
2 Level Fusions 98% 98% 98% 98% 98% 98% 98% 98% 98% 98% 98% 98% 98% 98%
1 Level Fusions 60% 60% 60% 61% 62% 61% 62% 63% 64% 65% 64% 68% 73% 73%
Revisions 95% 95% 95% 95% 95% 95% 95% 95% 95% 95% 95% 95% 95% 95%
Total 77% 77% 77% 78% 78% 77% 78% 79% 79% 80% 79% 81% 84% 84%
# Implants
Total 59 15 15 16 16 61 5% 15 5% 16 6% 17 6% 17 6% 65 6% 72 10% 81 13% 89 10%
80
Appendix E: Spine Market Model


Hambrecht & Quist LLC Implant Type and Sales by Fusion Segment, 1995-2000 R. Faulkner/D.Shoaib
1995 1Q96 2Q96 3Q96 4Q96 1996 % 1Q97 % 2Q97 % 3Q97 % 4Q97 % 1997 % 1998 % 1999 % 2000 %
Instrumentation as % Implants
3+ Level Fusions 100% 100% 100% 100% 100% 100% 99% 98% 98% 98% 98% 98% 98% 98%
2 Level Fusions 100% 100% 100% 98% 96% 98% 95% 94% 93% 92% 93% 87% 82% 78%
1 Level Fusions 100% 100% 100% 95% 90% 96% 87% 83% 79% 75% 81% 68% 56% 50%
Revisions 100% 100% 100% 90% 85% 94% 82% 78% 75% 70% 76% 50% 40% 30%
Total 100% 100% 100% 96% 93% 97% 91% 88% 86% 83% 87% 77% 67% 62%
Fusion Cages as % Implants
3+ Level Fusions 0% 0% 0% 0% 0% 0% 1% 2% 2% 2% 2% 2% 2% 2%
2 Level Fusions 0% 0% 0% 2% 4% 2% 5% 6% 7% 8% 7% 13% 18% 22%
1 Level Fusions 0% 0% 0% 5% 10% 4% 13% 17% 21% 25% 19% 32% 44% 50%
Revisions 0% 0% 0% 10% 15% 6% 18% 22% 25% 30% 24% 50% 60% 70%
Total 0% 0% 0% 4% 7% 3% 9% 12% 14% 17% 13% 23% 33% 38%
# Instrumentation Implants
Total 59 15 15 15 15 60 14 14 14 14 57 55 54 55
# Fusion Cage Implants
Total - - - 0.6 1.1 2 1.4 1.8 2.3 2.8 8 16.6 26.4 34.0
Cages/Implant 2.5 2.5 2.5 2.5 2.5 2.4 2.5 2.4 2.4
Instrumentation Implant $
3+ Level Fusions 10 2 3 3 3 10 3 3 3 3 11 12 13 14
2 Level Fusions 60 15 16 16 16 64 16 16 17 17 66 67 65 64
1 Level Fusions 48 12 13 13 13 51 12 12 12 12 48 47 46 43
Revisions 7 2 2 2 2 7 2 2 2 1 6 4 5 4
Total 124 31 33 34 33 131 32 33 33 33 131 130 128 126
Fusion Cage $ $ 3 $ 5 $ 8 $ 6 $ 8 $ 10 $ 12 $ 37 $ 75 100% $ 116 55% $ 145 25%
US Lumbar Implant $ $ 124 $ 31 $ 33 $ 36 $ 38 $ 139 12% $ 38 $ 41 $ 44 $ 46 $ 168 21% $ 204 22% $ 244 19% $ 271 11%
Appendix F: Spine Market Model
Hambrecht & Quist LLC Market Shares by Product Category and Company, 1995-2000 R. Faulkner/D.Shoaib
1995 1Q96 2Q96 3Q96 4Q96 1996 % 1Q97 % 2Q97 % 3Q97 % 4Q97 % 1997 % 1998 % 1999 % 2000 %
Price Assumptions ($000)
$/Instrumented 3 Level 2.5 2.5 2.6 2.6 2.6 2.6 2.7 2.7 2.7 2.8 2.8 2.7
Y/Y Price Change 4% 5% 5% 5% 5% 4% 4% 4% 1% 0% -3%
$/ Cage (2/level) 1.8 1.8 1.8 1.8 1.8 1.8 1.8 1.8 1.8 1.8 1.8 1.7
U.S. Sales Projections by Product Type and Company ($mm)

$ Instrumentation $ 124 $ 31 $ 33 $ 34 $ 33 $ 131 6% $ 32 1% $ 33 -2% $ 33 -1% $ 33 0% $ 131 -1% $ 130 -1% $ 128 -1% $ 126 -2%
% SDG 50% 48% 47% 46% 45% 45% 44% 44% 43% 41% 40% 38%
% AcroMed 17% 17% 17% 17% 17% 17% 16% 15% 15% 14% 13% 12%
% Synthes 14% 15% 16% 16% 17% 17% 17% 17% 17% 17% 17% 17%
% Depuy * 8% 9% 11% 12% 13% 14% 15% 15% 15% 16% 16% 16%
% Stryker 1% 1% 1% 1% 1% 1% 1% 1% 1% 2% 3% 5%
% Biomet 0% 0% 0% 0% 0% 0% 0% 1% 1% 3% 4% 5%
% Other 10% 10% 8% 8% 7% 6% 7% 7% 8% 7% 7% 7%
$ Fusion Cages (000) $ - $ - $ - $ 3 $ 5 $ 8 $ 6 $ 8 $ 10 $ 12 $ 37 $ 75 $ 116 $ 145
% SpineTech 0% 0% 0% 0% 90% 90% 85% 75% 70% 65% 64% 61%

% US Surgical 0% 0% 0% 0% 10% 10% 15% 25% 30% 35% 36% 35%
% Sofamor Danek 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 4%
Total $ $ 124 $ 31 $ 33 $ 36 $ 38 $ 139 12% $ 38 21% $ 41 23% $ 44 21% $ 46 19% $ 168 21% $ 204 22% $ 244 19% $ 271 11%
Sofamor Danek 62 15 16 15 15 61 14 -5% 14 -8% 15 -5% 14 -5% 58 -6% 53 -8% 51 -4% 54 5% `
AcroMed 21 5 6 6 6 22 5 5 5 5 21 18 17 15
Synthes 17 5 5 5 6 21 5 6 6 6 22 22 22 21
DePuy 10 3 4 4 4 15 4 5 5 5 19 21 21 20
SpineTech - - - - 5 5 6 7 8 9 29 48 67% 74 53% 88 20%
US Surgical - - - - 0.5 0.5 0.6 1 3 4 8 26 42 60% 51 22%
Stryker 1 0 0 0 0 1 0 0 0 0 1 3 98% 4 48% 6 64%
Biomet - - - - - - - - 0 0 0.7 4 6 45% 6
* Titanium mesh cages not included as instrumentation

82
Appendix G: Spine Market Model

European Lumbar Spinal Implant Market Projections 12/12/96

Hambrecht & Quist LLC Retail Dollars 1995-2000 R. Faulkner/D.Shoaib
1995 1Q96 2Q96 3Q96 4Q96 1996 % 1Q97 % 2Q97 % 3Q97 % 4Q97 % 1997 % 1998 % 1999 % 2000 %
Lumbar Procedures 48 12 13 13 13 51 7% 13 7% 13 7% 14 7% 14 7% 55 7% 58 6% 62 6% 65 6%
% Implant Usage 50% 51% 51% 52% 52% 53% 53% 54% 54% 56% 57% 59%
Procedures w/Implant 24 6 6 7 7 26 10% 7 7 7 8 11% 29 11% 32 10% 35 9% 38 9%
Instrumentation % 98% 98% 98% 98% 98% 98% 98% 97% 97% 95% 90% 85%
Fusion Cage % 2% 2% 2% 2% 2% 2% 2% 3% 3% 5% 10% 15%
Instrumentation $ $ 54 $ 14 $ 15 $ 16 $ 16 $ 62 14% $ 16 $ 18 $ 18 $ 19 14% $ 71 15% $ 78 10% $ 80 3% $ 80 0%

Sofamor Danek % 40% 40% 40% 40% 40% 40% 40% 40% 40% 38% 37% 36%
AcroMed 25% 25% 25% 25% 25% 25% 25% 25% 25% 23% 22% 21%
Stryker 15% 15% 15% 15% 15% 15% 15% 15% 15% 18% 20% 22%
DePuy 5% 5% 5% 5% 5% 7% 7% 7% 7% 10% 12% 13%
Biomet 0% 0% 0% 0% 0% 0% 0% 0% 0% 2% 3% 3%
Other % 15% 15% 15% 15% 15% 13% 13% 13% 13% 9% 6% 5%
(Advanced Spine, Cross, Smith & Nephew)
Fusion Cage $ $ 3 $ 1 $ 1 $ 1 $ 1 $ 3 $ 1 $ 1 $ 1 $ 1 $ 4 $ 8 $ 17 112% $ 26 54%

Sofamor Danek % 30% 30% 30% 30% 30% 30% 30% 30% 30% 30% 30% 30%
AcroMed 15% 15% 15% 15% 15% 15% 15% 15% 15% 15% 15% 15%
Spine-Tech 20% 20% 20% 20% 20% 20% 20% 20% 20% 20% 20% 20%
US Surgical 20% 20% 20% 20% 20% 20% 20% 20% 20% 20% 20% 20%
Total $ (mm) $ 57 $ 15 $ 16 $ 17 $ 17 $ 64 14% $ 17 $ 18 $ 19 $ 20 $ 75 16% $ 86 15% $ 97 13% $ 106 9%

Sofamor Danek 22 6 6 7 7 25 14% 7 7 8 8 30 16% 32 8% 35 9% 37 5%
AcroMed 14 4 4 4 4 16 14% 4 5 5 5 18 16% 19 4% 20 6% 21 2%
Stryker 8 2 2 2 2 9 14% 2 3 3 3 11 15% 14 32% 16 15% 18 10%
DePuy 3 1 1 1 1 3 14% 1 1 1 1 5 61% 8 57% 10 24% 10 8%
Spine-Tech 1 0 0 0 0 1 7% 0 0 0 0 1 35% 2 111% 3 112% 5 54%
US Surgical 0 0 0 0 0 0 7% 0 0 0 0 0 35% 1 111% 2 112% 3 54%
Biomet - - - - - - - - - - - 2 2 2
Appendix H: Spine Market Model
Asia and Other Non US/Europe Lumbar Spinal Implant Market Projections 12/12/1996
Hambrecht & Quist LLC Retail Dollars 1995-2000 R. Faulkner/D. Shoaib
1995 1Q96 2Q96 3Q96 4Q96 1996 % 1Q97 % 2Q97 % 3Q97 % 4Q97 % 1997 % 1998 % 1999 % 2000 %
Total $ $ 46 $ 14 $ 14 $ 15 $ 15 $ 57 25% $ 17 0.25 $ 17 0.24 $ 18 0.24 $ 18 23% $ 71 24% $ 85 20% $ 100 18% $ 115 15%
Sofamor Danek @ 50% 23 7 7 7 7 29 9 9 9 9 35 43 50 58
AcroMed @20% 9 3 3 3 3 11 3 3 4 4 14 17 20 23
Stryker @ 5% 2 1 1 1 1 3 1 1 1 1 4 4 5 6
DePuy @5% 2 1 1 1 1 3 1 1 1 1 4 4 5 6
Other % 9 3 3 3 3 11 3 3 4 4 14 17 20 23
Worldwide Lumbar Spinal Implant Market Projections

Retail Dollars 1995-2000
1995 1Q96 2Q96 3Q96 4Q96 1996 % 1Q97 % 2Q97 % 3Q97 % 4Q97 % 1997 % 1998 % 1999 % 2000 %
Worldwide Total ($mm) $ 226 $ 60 $ 63 $ 67 $ 70 $ 261 15% $ 72 $ 76 $ 81 $ 84 $ 314 20% $ 375 20% $ 441 18% $ 492 12%
Sofamor Danek 107 28 29 29 29 115 7% 30 30 31 31 122 6% 128 4% 136 7% 148 9%
AcroMed 44 12 12 13 13 50 12% 13 13 13 14 53 7% 54 2% 57 5% 59 3%
Stryker 12 3 3 3 4 13 15% 4 4 4 4 16 16% 21 35% 25 19% 30 19%
DePuy * 15 4 5 6 6 21 39% 6 7 7 7 28 34% 33 18% 35 7% 36 3%
Synthes (US only) 17 5 5 5 6 21 21% 5 6 6 6 22 6% 22 -1% 22 -1% 21 -2%
Spine-Tech 1 0 0 0 5 5 nm 6 7 8 9 29 nm 50 71% 77 55% 94 21%
US Surgical 0 0 0 0 1 1 nm 1 1 3 4 9 nm 27 213% 44 62% 54 24%
Biomet 0 0 0 0 0 0 nm 0 0 0 0 0.7 5 8 9
Other 30 8 8 11 8 35 16% 8 8 9 9 35 -1% 40 16% 45 12% 50 11%
* DePuy figures do not include titanium mesh product

Appendix I: Stryker Sales Model
84
Stryker Corporation Sales Estimates

Sources of Growth
1995 to 1998 ($ millions)
# 1Q 95 2Q 95 3Q 95 4Q 95 1995 1Q 96 2Q 96 3Q 96 4Q 96 1996 1Q 97 2Q 97 3Q 97 4Q 97 1997 1Q 98 2Q 98 3Q 98 4Q 98 1998

Sources of Growth
Total Sales 214 229 205 224 872 218 225 224 246 912 241 254 252 273 1,021 273 291 292 329 1,185
Total Growth 44% 48% 18% 11% 28% 2% (1%) 9% 10% 5% 11% 13% 13% 11% 12% 13% 14% 16% 20% 16%
Sales Ex-Matsu 182 195 185 205 767 205 214 213 236 868 232 246 244 265 988 265 282 283 320 1,150
Growth Ex-Matsu 22% 27% 17% 17% 21% 13% 10% 15% 15% 13% 13% 15% 15% 12% 14% 14% 15% 16% 20% 16%
Fx Impact 1% 1% 1% (0%) 1% (2%) (3%) (3%) (1%) (2%) (1%) (0%) 0% 0% (0%) 0% 0% 0% 0% 0%
Growth Ex-Matsu/Fx 21% 26% 16% 17% 20% 14% 13% 18% 17% 15% 15% 15% 15% 12% 14% 14% 15% 16% 20% 16%
Acquired Sales 14 17 4 2 36 11 11 10 15 47 12 13 14 7 47 6 6 5 5 23
Acquired Growth 9% 11% 2% 1% 5% 5% 5% 5% 6% 5% 6% 6% 6% 3% 5% 3% 2% 2% 2% 2%
Base Business Growth 12% 15% 14% 16% 15% 9% 8% 13% 10% 10% 9% 9% 9% 9% 9% 11% 12% 14% 19% 14%
Appendix J: Stryker Sales Model

By Business Unit
1995 to 1998 ($ millions)
1Q 95 2Q 95 3Q 95 4Q 95 1995 1Q 96 2Q 96 3Q 96 4Q 96 1996 1Q 97 2Q 97 3Q 97 4Q 97 1997 1Q 98 2Q 98 3Q 98 4Q 98 1998

Sales
Surgical
Endoscopy 10 12 14 15 51 13 16 18 20 66 16 20 22 23 81 20 23 25 27 95
Arthroscopy 9 9 10 11 39 10 10 11 12 43 10 10 12 13 45 11 11 13 14 50
Instruments 15 15 12 18 61 18 18 14 21 71 21 21 15 23 80 24 24 17 25 91
Osteonics 108 115 108 113 444 116 118 114 116 465 120 123 120 123 487 127 131 127 131 516
Spinal Implants 3 4 3 4 14 4 4 4 5 17 4 5 4 5 18 5 6 7 8 26
Trauma 6 6 6 7 8 10 31 12 15 20 25 72
OP 1 10 10
Total Surgical 145 155 147 161 609 161 166 162 180 670 178 186 181 197 742 200 211 209 240 860
Y/Y% 22% 25% 5% (0%) 12% 11% 7% 11% 12% 10% 10% 12% 11% 9% 11% 12% 13% 16% 22% 16%
Medical
Beds 23 25 23 26 96 25 29 31 34 118 31 35 37 41 144 37 42 45 49 173

Physiotherapy 14 15 16 18 62 19 19 20 22 80 24 25 26 27 102 28 29 29 31 117
Y/Y% 26% 33% 30% 30% 23% 29% 26% 29% 29% 26% 27% 20% 17% 12% 12% 15%
Total Medical 37 40 38 43 159 44 48 51 56 198 54 60 63 68 246 65 71 74 80 290
Y/Y % 23% 34% 8% 8% 17% 19% 20% 33% 29% 25% 24% 25% 25% 22% 24% 20% 19% 17% 17% 18%
Total Sales 214 229 205 224 872 218 225 224 246 912 241 254 252 273 1,021 273 291 292 329 1,185
Y/Y % 44% 48% 18% 11% 28% 2% (1%) 9% 10% 5% 11% 13% 13% 11% 12% 13% 14% 16% 20% 16%
Matsumoto 32 33 20 19 105 13 11 11 10 44 9 8 8 8 33 8 9 9 9 35
Y/Y % 26% (29%) 141% (61%) (67%) (49%) (48%) (58%) (28%) (27%) (24%) (20%) (25%) (11%) 13% 13% 13% 6%
Total Sales Ex-Matsu 182 195 185 205 767 205 214 213 236 868 232 246 244 265 988 265 282 283 320 1,150
Y/Y % 22% 27% 17% 17% 21% 13% 10% 15% 15% 13% 13% 15% 15% 12% 14% 14% 15% 16% 20% 16%
Appendix K: Stryker Sales Model

By Geographic Unit
1995 to Date ($ millions)
1Q 95 2Q 95 3Q 95 4Q 95 1995 1Q 96 2Q 96 3Q 96
Geography
Domestic 112 118 118 129 477 134 139 143
Y/Y % 19% 20% 15% 18% 18% 19% 18% 22%
International 102 110 88 95 395 84 86 80
Y/Y % 88% 98% 22% 0% 43% (18%) (22%) (8%)
International Ex-Matsu. 70 77 67 76 290 71 75 70
Y/Y % 21% 12% 24% 2% (3%) 4%
Japan 74 80 58 64 275 51 51 43
Y/Y % 173% 176% 30% (6%) 63% (31%) (36%) (26%)
Y/Y % Ex-FX 157% 162% 31% (2%) 57% (7%) (6%) (14%)
Other International 28 31 31 31 120 33 35 37
Y/Y % 3% 14% 13% 15% 11% 19% 14% 22%
Y/Y % Ex-FX 18% 24% 19% 19% 11% 14% 7% 18%
Total 214 229 205 224 872 218 225 224
Y/Y % 44% 48% 18% 10% 28% 2% (1%) 9%

LEGAL NOTES AND DISCLOSURES
The notes applicable to the companies mentioned in this report are as follows:
American Home Products f

Biomet, Inc. a&f
Bristol-Myers Squibb, Inc. f
Chiron a&f
Collagen f
Columbia/HCA Healthcare Corp. f
Genentech f
Genzyme Tissue Repair a&b
Johnson & Johnson, Inc. f
OrthoLogic, Inc. a, b & f
Pfizer, Inc. e&f
Sofamor Danek Group, Inc. f
Spine-Tech, Inc. a
Stryker Corp. f
U.S. Surgical Corporation f
Definitions of Legal Notes

(a) Hambrecht & Quist LLC maintains a market in these stocks.
(b) Hambrecht & Quist LLC has been an underwriting manager, or co-manager, or has
privately placed securities of these companies within the last three years.
(e) The analysts covering these stocks have investment positions.
(f) Options are available on these issues.
1996 Copyright Hambrecht & Quist LLC.

All rights reserved. Additional information on any security discussed is available on request.
The information contained herein is based on sources believed to be reliable, but is neither all-inclusive nor guaranteed
by our firm. Opinions reflect our judgement at this time and are subject to change. In the course of our regular business,
we may be long or short in the securities mentioned and may make purchases and/or sales of them from time to time in
the open market or otherwise.
KNOWLEDGE ENTERPRISES, Inc., based in Chagrin Falls, Ohio, is a consulting firm specializing in the orthopaedic
industry. Its principals, John Engelhardt and Shirley Engelhardt have served in industry in marketing, product develop-
ment, and general management capacities. KNOWLEDGE ENTERPRISES, Inc. serves the needs of large and small
orthopaedic industry players for market analysis, due diligence, and business development.
KNOWLEDGE ENTERPRISES, Inc. is not a licensed investment firm and claims no responsibility for investment rec-
ommendations contained herein. Investment recommendations are the sole responsibility of Hambrecht & Quist, LLC.

http://www.hamquist.com
230 Park Avenue One Bush Street 50 Rowes Wharf
New York, NY 10169 San Francisco, CA 94104 Boston, MA 02110
(212) 207-1400 (415) 439-3000 (617) 574-0500

Notes: a, f Stryker, Inc. Hambrecht & Quist LLC
Year End: December Sales & Earnings Model December 20, 1996
Nasdaq - STRY (in millions except per share data) Robert C. Faulkner
Daniyal Shoaib
Total Y-Y Gross Oper Oper Pretax Y-Y Tax Net Y-Y Net Y-Y
Sales Chge Margin Income Margin Income Chge Taxes Rate Income Chge Margin EPS Chge Shares
$M % % $M % $M % $M % $M % % $ % M
1994
Q1 148.8 10.0% 54.6% 25.4 17% 28.0 20.0% 10.6 38.0% 17.3 20.0% 11.7% $0.18 19.8% 96.8
Q2 154.2 10.2% 54.3% 25.2 16% 27.4 21.7% 10.4 38.0% 17.0 21.5% 11.0% $0.18 21.5% 96.7
Q3 174.3 27.3% 55.4% 29.2 17% 29.7 31.7% 11.9 40.0% 16.7 19.6% 9.6% $0.17 19.7% 96.7
Q4 204.6 40.9% 58.7% 40.6 20% 42.5 53.5% 17.8 40.0% 21.3 20.0% 10.4% $0.22 20.1% 96.7
1994 681.9 22.4% 56.0% 120.5 18% 127.6 32.8% 50.8 39.8% 76.8 27.6% 11.3% $0.79 27.5% 96.7
1995
Q1 214.0 43.9% 59.0% 42.0 20% 42.8 52.9% 18.0 42.1% 20.7 19.4% 9.7% $0.21 19.4% 96.8
Q2 228.5 48.2% 57.3% 38.6 17% 40.2 46.6% 16.9 42.0% 20.4 20.0% 8.9% $0.21 19.8% 96.9
Q3 205.4 17.8% 56.8% 34.6 17% 35.9 21.0% 14.4 40.0% 20.1 20.3% 9.8% $0.21 19.9% 97.0
Q4 224.1 9.5% 57.4% 42.0 19% 44.0 3.8% 17.6 40.0% 25.7 20.4% 11.5% $0.26 20.0% 97.1
1995 872.0 27.9% 57.6% 157.2 18% 163.0 27.8% 66.9 41.0% 86.9 13.2% 10.0% $0.90 12.9% 96.9
1996
Q1 217.6 1.7% 58.9% 39.9 18% 41.8 -2.4% 15.9 38.0% 25.0 20.9% 11.5% $0.26 20.5% 97.1
Q2 225.4 -1.4% 59.0% 38.6 17% 41.1 2.1% 15.6 38.0% 24.5 20.0% 10.9% $0.25 20.2% 96.7
Q3 223.6 8.9% 57.8% 36.8 16% 39.0 8.5% 14.8 38.0% 24.2 20.0% 10.8% $0.25 20.3% 96.7
Q4 E 246.0 9.8% 59.0% 46.7 19% 49.2 11.8% 18.7 38.0% 30.5 18.9% 12.4% $0.32 19.4% 96.7
1996 E 912.6 4.7% 58.7% 162.0 18% 171.1 4.9% 65.0 38.0% 104.2 19.9% 11.4% $1.08 20.0% 96.8
1997
Q1 E 241.7 11.1% 59.0% 45.4 19% 48.2 15.4% 18.3 38.0% 29.9 19.4% 12.4% $0.31 19.9% 96.8
Q2 E 251.5 11.6% 59.0% 44.8 18% 47.3 15.1% 18.0 38.0% 29.3 19.7% 11.7% $0.30 19.6% 96.8
Q3 E 253.7 13.5% 59.0% 44.4 18% 46.7 19.8% 17.7 38.0% 29.0 19.9% 11.4% $0.30 19.7% 96.9
Q4 E 274.5 11.6% 59.5% 56.0 20% 58.7 19.2% 22.3 38.0% 36.4 19.2% 13.3% $0.38 19.0% 96.9
1997 E 1021.4 11.9% 59.1% 190.6 200.9 17.4% 76.3 38.0% 124.5 19.5% 12.2% $1.29 19.5% 96.8
1998
Q1 E 270.3 11.8% 59.2% 55.7 21% 58.2 20.7% 22.1 38.0% 36.1 20.7% 13.3% $0.37 20.5% 97.0
Q2 E 285.0 13.3% 59.2% 54.7 19% 57.3 21.3% 21.8 38.0% 35.4 20.9% 12.4% $0.37 20.7% 97.0
Q3 E 299.8 18.2% 59.0% 54.0 18% 56.7 21.3% 21.5 38.0% 34.9 20.7% 11.7% $0.36 20.4% 97.1
Q4 E 329.5 20.0% 59.7% 68.9 21% 71.5 21.8% 27.2 38.0% 44.0 20.9% 13.4% $0.45 20.7% 97.1
1998 E 1184.6 16.0% 59.3% 233.2 20% 243.6 21.3% 92.6 38.0% 150.5 20.8% 12.7% $1.55 20.6% 97.0
Balance Sheet Ratios

Sep-96 Jun-96 Mar-96 Sep-96 Jun-96 Mar-96
ASSETS
Cash & Equiv. 114.3 83.1 63.9
Marketable securities 135.9 182.9 206.6 Return on Assets 10.6% 11.3% 11.5%
Accounts receivable 168.8 169.7 164.8 Return on Equity 18.9% 20.2% 21.0%
Inventories 152.1 140.4 138.9
Deferred income taxes 51.0 47.2 46.6 Average Inventory Turns 1.5 1.6 1.6
Prepaid expenses and 13.7 13.9 19.5 Days O/S A/R 68.0 67.8 68.2
other current assets
Total current assets 635.8 637.2 640.3 Book Value $5.28 $5.02 $4.91
Net PP&E 188.5 181.3 182.7 Cash per Share $1.18 $0.86 $0.66
Other assets 86.2 47.9 48.9 Current 3.5 3.8 3.6
Total Assets 910.5 866.4 872.0 Quick 0.6 0.5 0.4
LIABILITY AND SHAREHOLDERS EQUITY

Current Liab 182.8 168.2 176.8
LT Debt 96.6 91.4 93.5
Other Liab 22.3 21.3 22.9
Minority interest 98.5 99.9 102.0
Total Equity 510.2 485.5 476.7
Tot Liab & Equity 910.5 866.4 872.0
(a) H&Q LLC maintains a market in this stock. (f) Options are available on this issue.

Hambrecht & Quist LLC
Notes: none DePuy, Inc. December 20, 1996
Year End: December Sales & Earnings Model Robert C. Faulkner
NYSE: DPU (in millions except per share data) Daniyal Shoaib
Y-Y Y-Y Y-Y Y-Y

Sales Gross Oper Oper Pretax Pretax Tax Net Net Inc Net EPS
Sales Growth Margin Inc Margin Inc Growth Taxes Rate Inc Growth Margin EPS Growth Shares
$M % % $M % $M % $M % $M % % $ % M
1993 466.7 11.1% 67.5% 129.6 27.8% 126.9 30.3% 57.0 44.9% 72.2 33.5% 15.5% $0.80 33.5% 90.0
1994
Q1 129.9 NA 66.2% 35.9 27.6% 35.6 NA 15.7 44.1% 20.7 NA 15.9% $0.23 NA 90.0
Q2 137.3 NA 68.1% 39.4 28.7% 38.9 NA 17.1 44.0% 22.6 NA 16.5% $0.25 NA 90.0
Q3 136.0 NA 67.3% 34.9 25.7% 34.3 NA 15.1 44.0% 19.8 NA 14.6% $0.22 NA 90.0
Q4 148.6 NA 72.6% 41.0 27.6% 40.8 NA 17.9 43.9% 23.7 NA 15.9% $0.26 NA 90.0
1994 551.8 18.2% 68.7% 151.2 27.4% 149.6 17.9% 65.8 44.0% 86.8 20.2% 15.7% $0.96 20.2% 90.0
1995
Q1 161.1 24.0% 67.3% 45.1 28.0% 44.3 24.4% 18.8 42.4% 26.3 27.1% 16.3% $0.29 27.1% 90.0
Q2 162.1 18.1% 67.8% 44.1 27.2% 43.6 12.1% 19.2 44.0% 25.2 11.5% 15.5% $0.28 11.5% 90.0
Q3 148.4 9.1% 68.4% 36.7 24.7% 35.8 4.4% 16.1 45.0% 20.3 2.5% 13.7% $0.23 2.5% 90.0
Q4 164.9 11.0% 70.6% 44.4 26.9% 41.0 0.5% 18.6 45.4% 23.1 (2.5%) 14.0% $0.26 (2.5%) 90.0
1995 636.5 15.3% 68.6% 170.3 26.8% 164.7 10.1% 72.7 44.1% 94.9 9.3% 14.9% $1.05 9.3% 90.0
1996
Q1 173.1 7.4% 69.2% 48.3 27.9% 46.9 5.9% 20.2 43.1% 27.4 4.2% 15.8% $0.30 4.2% 90.0
Q2 175.9 8.5% 69.8% 49.4 28.1% 48.8 11.9% 21.1 43.2% 28.2 11.9% 16.0% $0.31 11.9% 90.0
Q3 167.3 12.7% 70.9% 44.0 26.3% 42.3 18.1% 18.2 43.1% 24.0 18.3% 14.4% $0.27 18.3% 90.0
Q4 E 182.0 10.4% 70.8% 48.1 26.5% 47.9 16.9% 20.7 43.1% 27.2 17.7% 14.9% $0.28 10.6% 95.7
1996 E 698.3 9.7% 70.2% 189.8 27.2% 185.9 12.9% 80.2 43.1% 106.8 12.5% 15.3% $1.17 10.8% 91.4
1997
Q1 E 188.9 9.1% 71.0% 50.9 27.0% 51.4 9.6% 22.2 43.1% 29.2 6.6% 15.5% $0.30 (2.7%) 98.6
Q2 E 193.8 10.2% 71.1% 52.5 27.1% 53.0 8.6% 22.9 43.1% 30.1 6.8% 15.5% $0.31 (2.5%) 98.6
Q3 E 182.8 9.3% 71.2% 49.9 27.3% 50.4 19.3% 21.7 43.1% 28.6 19.2% 15.7% $0.29 8.8% 98.6
Q4 E 199.0 9.3% 71.2% 55.2 27.7% 55.7 16.2% 24.0 43.1% 31.6 16.3% 15.9% $0.32 13.0% 98.6
1997 E 764.5 9.5% 71.1% 208.6 27.3% 210.6 13.3% 90.8 43.1% 119.6 12.0% 15.6% $1.21 3.8% 98.6
1998
Q1 E 206.5 9.3% 71.3% 58.0 28.1% 58.5 13.8% 25.2 43.1% 33.2 13.7% 16.1% $0.34 13.6% 98.6
Q2 E 214.9 10.9% 71.3% 60.5 28.2% 61.0 15.1% 26.3 43.1% 34.6 14.9% 16.1% $0.35 14.8% 98.6
Q3 E 201.8 10.4% 71.4% 56.8 28.2% 57.3 13.7% 24.7 43.1% 32.4 13.4% 16.1% $0.33 13.4% 98.6
Q4 E 218.8 9.9% 71.5% 62.3 28.5% 62.8 12.8% 27.1 43.1% 35.5 12.3% 16.2% $0.36 12.3% 98.6
1998 E 842.0 10.1% 71.4% 237.7 28.2% 239.7 13.8% 103.3 43.1% 135.7 13.5% 16.1% $1.38 13.5% 98.6
1999 E 929.5 10.4% 71.6% 266.5 28.7% 268.5 12.0% 115.7 43.1% 152.0 12.0% 16.4% $1.54 12.0% 98.6
2000 E 1021.5 9.9% 71.8% 297.1 29.1% 299.1 11.4% 128.9 43.1% 169.3 11.4% 16.6% $1.72 11.4% 98.6
Balance Sheet ($ in millions) Ratios

Sep-96 Jun-96 Sep-96 Jun-96
ASSETS
Cash & Equiv. 57.8 44.7 Return on Assets 14% 16%
Accounts Rec. 122.6 133.7 Return on Equity 20% 24%
Inventory 141.4 130.4
Other Current 59.5 58.6 Average Inventory Turns 1.2 1.3
Total Current 381.4 367.4 Days O/S A/R 66.0 68.4
Goodwill 220.4 222.0
Other non-current 17.4 19.5 Book Value 5.3 5.1
Net PP&E 83.9 83.7 Current 2.2 2.1
Total non-current 321.7 325.2 Quick 0.3 0.3
Total assets 703.1 692.6
LIABILITY & SHAREHOLDER'S EQUITY

Current Liab 173.5 172.0
Noncurrent Liab 45.9 56.8
Minority Interest 3.2 2.8
Total Equity 480.4 461.1
Tot Liab & Equity 703.1 692.6

Notes: f Sofamor Danek Group Hambrecht & Quist LLC
Year End: December Sales & Earnings Model July 24, 1996
NYSE - SDG (in millions except per share data) Robert C. Faulkner
Daniyal Shoaib
Y-Y Gross Oper Oper Pretax Y-Y Tax Net Y-Y Net Y-Y
Sales Growth Margin SG&A SG&A Inc Mgn Inc Growth Taxes Rate Inc Growth Mgn EPS Growth Shares
$M % % $ % $M % $M % $M % $M % % $ % M
___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___
1991 75.5 N/A 72.9% 31 40.8% 19.2 25.5% 19.9 0.0% 7.5 37.5% 12.4 0.0% 16.4% $0.53 0.0% 23.4
1992 121.0 60.2% 79.2% 56 46.5% 31.7 26.2% 32.6 64.1% 12.0 36.8% 20.6 66.0% 17.0% $0.84 58.0% 24.6
1993
Q1 34.6 N/A 78.2% 15 43.2% 9.5 27.4% 9.5 3.6 37.2% 6.0 17.3% $0.24 24.7
Q2 40.3 N/A 77.3% 18 43.9% 10.5 26.1% 10.8 3.8 35.4% 6.9 17.3% $0.28 24.7
Q3 42.6 N/A 78.3% 18 41.2% 12.7 29.9% 12.4 4.4 35.7% 8.0 18.7% $0.32 24.7
Q4 44.4 N/A 77.5% 18 39.8% 13.8 31.2% 13.5 4.5 33.2% 9.0 20.2% $0.36 24.7
1993 161.8 33.7% 77.8% 68 41.9% 46.6 28.8% 46.2 41.6% 16.3 35.2% 29.9 44.8% 18.5% $1.21 44.0% 24.7
1994
Q1 39.1 13.0% 79.5% 16 42.2% 12.1 31.0% 12.5 31.0% 4.5 35.6% 8.0 34.1% 20.6% $0.32 33.5% 24.8
Q2 38.1 (5.5%) 78.9% 17 45.3% 10.1 26.6% 10.6 (2.0%) 3.0 28.6% 7.5 7.7% 19.7% $0.30 8.4% 24.6
Q3 42.2 (0.9%) 77.2% 19 45.6% 10.4 24.7% 10.3 (17.0%) 1.2 11.4% 9.1 14.8% 21.6% $0.37 14.8% 24.7
Q4 42.4 (4.5%) 77.2% 22 51.3% 8.0 18.8% 8.3 (38.0%) 0.8 9.7% 7.5 (16.2%) 17.8% $0.31 (14.8%) 24.3
1994 161.7 (0.1%) 78.2% 75 46.2% 40.6 25.1% 41.7 (9.7%) 9.5 22.7% 32.2 7.7% 19.9% $1.31 8.2% 24.6
1995
Q1 43.9 12.4% 77.2% 20 46.5% 10.3 23.3% 10.5 (16.2%) 2.5 23.4% 8.0 (1.0%) 18.1% $0.32 (2.5%) 25.2
Q2 43.5 14.2% 78.9% 22 49.8% 9.3 21.4% 10.3 (2.1%) 2.3 21.9% 8.0 7.3% 18.5% $0.32 5.1% 25.1
Q3 47.2 11.9% 79.0% 22 47.3% 11.5 24.4% 10.9 6.2% 2.2 20.5% 8.6 (5.6%) 18.3% $0.34 (6.8%) 25.0
Q4 54.0 27.6% 79.6% 26 47.9% 13.6 25.1% 12.8 53.8% 2.6 20.2% 9.8 30.6% 18.2% $0.38 23.3% 25.7
1995 188.6 16.7% 78.7% 90 47.8% 44.7 23.7% 44.6 6.9% 9.5 21.4% 34.4 7.0% 18.3% $1.36 4.2% 25.2
1996
Q1 54.2 23.4% 80.4% 26 47.9% 14.0 25.8% 14.2 35.3% 3.6 25.3% 10.2 28.0% 18.8% $0.39 23.4% 26.1
Q2 56.8 30.7% 82.9% 27 47.1% 16.4 28.8% 15.7 51.5% 4.6 29.4% 10.6 32.4% 18.7% $0.41 28.0% 26.0
Q3 63.2 33.9% 83.6% 31 48.4% 18.0 28.4% 16.5 51.0% 5.0 30.5% 11.0 27.9% 17.4% $0.42 21.9% 26.1
Q4 E 65.5 21.2% 83.6% 32 48.5% 18.6 28.3% 17.3 34.6% 5.3 30.5% 11.6 18.0% 17.7% $0.44 15.8% 26.2
1996 E 239.7 27.1% 82.7% 115 48.0% 66.9 27.9% 63.6 42.7% 18.5 29.1% 43.4 26.2% 18.1% $1.66 22.0% 26.1
1997
Q1 67.0 23.6% 83.4% 31 47.0% 19.9 29.7% 18.5 30.5% 6.0 32.5% 12.1 18.4% 18.0% $0.46 18.5% 26.1
Q2 E 69.5 22.3% 83.4% 33 47.0% 20.6 29.7% 19.2 22.7% 6.3 32.5% 12.5 17.7% 18.0% $0.48 16.7% 26.2
Q3 E 72.0 13.9% 83.4% 33 46.0% 22.1 30.7% 20.7 25.5% 6.7 32.5% 13.5 22.2% 18.7% $0.51 22.3% 26.2
Q4 E 74.0 13.0% 83.4% 33 45.0% 23.5 31.7% 22.1 27.7% 7.2 32.5% 14.4 23.8% 19.4% $0.55 23.4% 26.3
1997 E 282.5 17.8% 83.4% 131 46.2% 86.1 30.5% 80.5 26.5% 26.2 32.5% 52.4 20.6% 18.6% $2.00 20.3% 26.2
1998 E 316.5 12.0% 81.0% 141 44.5% 94.3 29.8% 93.7 16.4% 30.0 32.0% 63.7 21.6% 20.1% $2.40 20.2% 26.5

Jun-96 Mar-96 Dec-95 Jun-96 Mar-96 Dec-95
ASSETS
Cash & Equiv. 4.8 14.1 11.3 Return on Assets 4.7% 4.6% 5.0%
Accounts Rec. 53.9 50.4 50.5 Return on Equity 7.2% 7.5% 8.0%
Inventory 27.6 25.6 25.7
Other Current 40.4 40.1 34.4 Average Inventory Turns 2.1 2.1 2.1
Tot Cur Assets 126.7 130.2 121.9 Days O/S A/R 85.4 83.7 84.1
Net PP&E 24.0 23.1 22.7
Other Assets 77.8 68.6 52.0 Book Value 5.69 5.18 4.78
--- Cash Per Share $0.18 $0.54 $0.44
Tot Assets 228.5 221.9 196.6 Current 1.9 2.3 2.7
Quick 0.9 1.1 1.4
Current Liabilities 66.6 56.8 44.8
Long-Term Debt 12.0 28.3 28.1
Other Liabilities 2.1 1.7 0.8
Total Equity 147.8 135.1 122.9
--- ---
Tot Liab & Equity 228.5 221.9 196.6
f) Options are available on this issue

Notes: a Spine-Tech, Inc. Hambrecht & Quist LLC
Nasdaq - SPYN (in millions except per share data) Robert C. Faulkner
Daniyal Shoaib
Y-Y Gross Oper Oper Pretax Pretax Tax Net Net Ongoing Fully
Sales Chge Margin SG&A Income Margin Income Growth Tax Rate Tax Inc. Margin EPS Taxed Shrs
$M % % % $M % $M % $M % % $M % $ EPS $ M
___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___
1992 0.3 N/A 88% 274% (1.4) nm (1.4) 0% 0.0 0% 0% (1.4) nm n/a n/a n/a
n/a
1993 2.0 5% 80% 82% (0.7) nm (0.0) nm 0.0 0% 0% (0.0) nm n/a n/a n/a
1994
Q1 0.9 N/A 71% 65% (0.1) nm (0.1) nm 0.0 0% 0% (0.1) nm n/a n/a n/a
1994 4.4 120% 73% 56% (0.6) nm (0.6) nm 0.0 0% 0% (0.6) nm ($0.09) n/a 6.6
1995
Q1 1.6 70% 62% 44% (0.1) nm (0.1) nm 0.0 0% 0% (0.1) (6%) ($0.01) n/a 6.6
Q2 1.7 55% 63% 48% (0.1) nm (0.1) nm 0.0 0% 0% (0.1) (6%) ($0.01) n/a 6.7
Q3 2.1 73% 76% 63% (0.2) nm 0.2 nm 0.0 0% 0% 0.2 8% $0.02 n/a 9.5
Q4 2.2 84% 74% 58% (0.1) nm 0.3 nm 0.0 0% 0% 0.3 14% $0.03 n/a 9.7
1995 7.5 71% 69% 54% (0.6) nm 0.3 nm 0.0 0% 0% 0.3 4% $0.03 n/a 8.1
1996
Q1 1.4 (7%) 61% 84% (0.8) nm (0.4) nm 0.0 0% 0% (0.4) (25%) ($0.03) n/a 9.7
Q2 1.5 (12%) 62% 99% (1.0) nm (0.6) nm 0.0 0% 0% (0.6) (39%) ($0.06) n/a 9.9
Q3 1.5 (27%) 69% 151% (1.7) nm (1.4) nm 0.0 0% 0% (1.4) (95%) ($0.15) n/a 9.9
Q4 E 6.0 176% 72% 65% (0.3) nm (0.1) nm 0.0 0% 0% (0.1) (1%) ($0.01) n/a 10.0
1996 E 10.5 39% 69% 85% (3.8) nm (2.5) nm 0.0 0% 0% (2.5) (24%) ($0.25) n/a 9.9
1997
Q1 E 7.0 384% 76% 67% (0.2) (2%) 0.2 nm 0.0 25% 25% 0.1 2% $0.01 $0.01 10.7
Q2 E 8.0 432% 78% 60% 0.5 7% 0.9 nm 0.2 25% 25% 0.7 8% $0.06 $0.05 10.9
Q3 E 9.5 524% 79% 55% 1.2 13% 1.7 nm 0.4 25% 25% 1.3 13% $0.12 $0.10 11.1
Q4 E 11.0 83% 80% 49% 2.3 21% 2.6 nm 0.7 25% 25% 2.0 18% $0.17 $0.14 11.3
1997 E 35.5 239% 78% 56% 3.9 11% 5.4 nm 1.3 25% 25% 4.0 11% $0.36 $0.30 11.0
1998
Q1 E 12.0 71% 80% 51% 2.2 18% 2.5 nm 0.8 30% 30% 1.8 15% $0.15 $0.14 11.4
Q2 E 13.2 64% 80% 50% 2.5 19% 2.8 nm 0.8 30% 30% 2.0 15% $0.17 $0.15 11.5
Q3 E 14.4 51% 81% 49% 3.0 21% 3.3 nm 1.0 30% 30% 2.3 16% $0.20 $0.18 11.6
Q4 E 15.6 41% 81% 48% 3.4 22% 3.7 nm 1.1 30% 30% 2.6 17% $0.22 $0.20 11.6
1998 E 55.0 55% 81% 49% 11.1 20% 12.3 129% 3.7 30% 30% 8.6 16% $0.75 $0.66 11.5
1999 E 85.0 55% 81% 48% 19.7 23% 20.3 65% 7.7 38% 38% 12.6 15% $1.05 $1.05 13.7
2000 E 105.0 24% 81% 45% 27.0 26% 27.8 37% 10.6 38% 38% 17.2 16% $1.35 $1.35 14.0

Sep-96 Jun-96 Mar-96 Dec-95 (run rates) Sep-96 Jun-96 Mar-96 Dec-95
ASSETS
Cash & Equiv. * 12,300 495 385 1,170 Return on Assets NM NM NM NM
Accounts Rec. 1,327 1192 972 2,186 Return on Equity NM NM NM NM
Inventory 6,540 5045 3,023 1,822
Other Current * 253 18584 20,866 22,474 Book Value 3.01 3.18 $3.26 $3.29
Tot Cur Assets 20,420 25,316 25,246 27,652 Cash Per Share $1.80 $2.35 $2.73 $2.76
Net PP&E 5,498 2379 2,126 2,058 Current 15.7 44.0 25.5 32.1
Investments * 5,251 4193 5,330 2,956 Quick 13.7 40.4 26.8 30.9
Tot Assets 31,170 31,888 32,702 32,666

Current Liabilities 1,302 576 990 862
LT Debt 0 0 0 0
Other Liabilities 0 0 0 0
Total Equity 29,868 31,312 31,712 31,804
---- ----
Tot Liab & Equity 31,170 31,888 32,702 32,666
* Total available to fund operating deficit includes virtually all of these line items.
a) Hambrecht & Quist LLC maintains a market in this stock.

Notes: a, f Biomet, Inc. Hambrecht & Quist LLC
Year End: May Sales & Earnings Model December 20, 1996
Nasdaq - BMET (in millions except per share data) Robert C. Faulkner
Daniyal Shoaib
Y-Y Y-Y Y-Y Y-Y

Total Sales Gross Oper Oper Pretax Pretax Tax Net Net Inc Net EPS
Sales Growth Margin Income Margin Income Growth Taxes Rate Income Growth Margin EPS Growth Shares
$M % % $M % $M % $M % $M % % $ % M
1995
Q1 96.2 10.7% 69.0% 26.0 27.1% 27.4 17.4% 10.3 37.6% 17.1 11.6% 17.8% $0.15 12.6% 114.4
Q2 106.9 18.3% 69.2% 29.3 27.4% 30.9 21.5% 11.5 37.2% 19.4 15.6% 18.2% $0.17 15.9% 115.0
Q3 120.7 26.2% 67.9% 31.2 25.9% 32.7 16.5% 12.2 37.2% 20.5 13.6% 17.0% $0.18 12.8% 116.1
Q4 128.5 27.9% 68.3% 32.5 25.3% 35.2 17.0% 13.1 37.2% 22.1 12.8% 17.2% $0.19 11.5% 116.3
1995 452.3 21.2% 68.6% 119.0 26.3% 126.3 18.0% 47.1 37.3% 79.2 13.4% 17.5% $0.69 13.1% 115.5
509.5 CY95 $0.73
1996
Q1 127.2 32.2% 67.6% 28.8 22.7% 30.9 12.5% 12.2 39.5% 18.6 9.0% 14.7% $0.16 8.1% 115.4
Q2 133.0 24.5% 67.3% 34.7 26.1% 36.5 18.2% 13.8 37.8% 22.7 17.1% 17.1% $0.20 16.7% 115.4
Q3 133.5 10.6% 67.1% 35.7 26.7% 37.2 13.8% 13.7 36.8% 23.5 14.4% 17.6% $0.20 15.0% 115.5
Q4 141.4 10.1% 67.7% 38.0 26.9% 40.1 13.7% 15.8 39.5% 24.2 9.5% 17.1% $0.21 10.3% 115.5
1996 535.2 18.3% 67.4% 137.3 25.7% 144.7 14.6% 55.6 38.4% 89.1 12.5% 16.7% $0.77 12.6% 115.5
556.1 CY96 $0.85
1997
Q1 137.2 7.8% 67.6% 36.3 26.5% 38.7 25.4% 14.6 37.8% 24.1 29.2% 17.6% $0.21 27.8% 116.6
Q2 144.0 8.2% 67.8% 39.4 27.4% 41.6 13.8% 15.4 37.0% 26.2 15.2% 18.2% $0.23 14.6% 116.0
Q3 E 145.2 8.8% 68.0% 40.2 27.7% 42.7 14.9% 15.8 37.0% 26.9 14.6% 18.5% $0.23 13.4% 116.7
Q4 E 154.2 9.0% 68.2% 43.2 28.0% 45.7 14.0% 16.9 37.0% 28.8 18.8% 18.7% $0.25 17.5% 116.7
1997 E 580.6 8.5% 67.9% 159.2 27.4% 168.7 16.6% 62.7 37.2% 106.0 18.9% 18.3% $0.91 17.8% 116.5
611.6 CY97 $0.98
1998
Q1 E 150.6 9.8% 68.5% 42.6 28.3% 45.1 16.6% 16.7 37.0% 28.4 18.0% 18.9% $0.24 17.8% 116.8
Q2 E 161.6 12.2% 68.8% 46.2 28.6% 48.7 17.1% 18.0 37.0% 30.7 17.2% 19.0% $0.26 16.4% 116.8
Q3 E 160.0 10.2% 69.1% 46.2 28.9% 48.7 14.1% 18.0 37.0% 30.7 14.1% 19.2% $0.26 13.9% 116.9
Q4 E 169.5 10.0% 69.5% 49.7 29.3% 52.2 14.2% 19.3 37.0% 32.9 14.2% 19.4% $0.28 14.0% 116.9
1998 E 641.7 10.5% 69.0% 184.7 28.8% 194.7 15.5% 72.1 37.0% 122.7 15.8% 19.1% $1.05 15.4% 116.8
670.8 CY98 $1.12
1999
Q1 E 164.9 9.5% 69.7% 48.7 29.5% 51.2 13.3% 18.9 37.0% 32.2 13.3% 19.5% $0.28 13.2% 117.0
Q2 E 176.4 9.2% 69.9% 52.4 29.7% 54.9 12.7% 20.3 37.0% 34.6 12.7% 19.6% $0.30 12.5% 117.0
Q3 E 174.3 9.0% 70.0% 51.9 29.8% 54.4 11.7% 20.1 37.0% 34.3 11.7% 19.7% $0.29 11.6% 117.1
Q4 E 184.6 8.9% 70.0% 55.0 29.8% 57.5 10.3% 21.3 37.0% 36.2 10.3% 19.6% $0.31 10.1% 117.1
1999 E 700.3 9.1% 69.9% 208.0 29.7% 218.0 12.0% 80.7 37.0% 137.4 12.0% 19.6% $1.17 11.8% 117.0
2000 E 759.6 8.5% 70.5% 230.2 30.3% 240.2 10.2% 88.9 37.0% 151.3 10.2% 19.9% $1.29 10.0% 117.2
Balance Sheet ($ in millions) Ratios

Aug-96 May-96 Aug-96 May-96
ASSETS
Cash & Equiv. 128.8 106.1 Return on Assets 15.2% 16.2%
Marketable securities 26.9 30.8 Return on Equity 17.3% 18.1%
Accounts Rec. 156.6 154.1
Inventory 153.8 151.5 Average Inventory Turns 0.9 0.9
Prepaid expenses 23.6 20.5 Days O/S A/R 102.8 98.0
Tot Cur Assets 489.7 462.9
Net PP&E 82.3 80.2 Book Value $4.77 $4.63
Marketable securities 32.5 31.2 Cash Per Share $1.10 $0.92
Net intangible assets 7.2 7.7 Current 6.6 7.5
Goodwill 21.2 14.9 Quick 1.7 1.7
Other Assets 1.6 1.6
Tot Assets 634.5 598.5

Current Liabilities 74.4 62.1
Deferred fed. inc. tax 3.6 1.5
Other Liabilities 0.6 0.8
Total Equity 555.9 534.1
Tot Liab & Equity 634.5 598.5
(a) H&Q LLC maintains a market in this stock. (f) Options are available on this issue.

Notes: a, b, f OrthoLogic Corp. Hambrecht & Quist LLC
Nasdaq - OLGC (in millions except per share amounts) Robert C. Faulkner
Daniyal Shoaib
Total Q-Q Y-Y Gross Oper. Oper Interest Other Pretax Y-Y Net Y-Y Net Fully Y-Y
Sales Chge Chge Margin SG&A SG&A R&D R&D Income Margin Income Expenses Income Chge Tax Tax Income Chge Margin EPS Taxed Chge Shares
$M % % % $M % $M % $M % $M $M $M % $M % $M % % $ EPS $ % M
1993 0.3 NA 51% 1.1 341% 2.8 500% (3.7) NM - - (3.3) NM 0.0 0% (3.3) NM NM (0.51) n/a NM 6.5
1994 5.0 NM 100% 5.6 113% 2.8 56% (4.8) NM - - (4.5) NM 0.0 0% (4.5) NM NM (0.65) n/a 6.9
1995
Q1 2.5 26% 383% 78% 2.3 93% 0.6 25% (1.1) NM - - (0.9) NM 0.0 0% (0.9) NM NM (0.07) n/a NM 14.3
Q2 3.1 22% 182% 79% 2.6 85% 0.5 17% (0.7) NM - - (0.6) NM 0.0 0% (0.6) NM NM (0.04) n/a NM 15.0
Q3 4.1 32% 199% 80% 3.0 74% 0.5 11% (0.2) NM - - (0.1) NM 0.0 0% (0.1) NM NM (0.01) n/a NM 15.0
Q4 5.0 24% 153% 79% 3.4 67% 0.5 10% 0.1 2% - - 0.3 NM 0.0 0% 0.3 NM 6% 0.02 0.01 NM 17.9
1995 14.7 196% 79% 11.3 77% 2.1 15% (1.9) NM - - (1.4) NM 0.0 0% (1.4) NM NM (0.09) n/a NM 15.5
1996
Q1 6.8 34% 169% 83% 4.4 65% 0.6 8% 0.7 10% 0.3 - 0.9 NM 0.02 0% 0.9 NM 14% 0.04 0.03 NM 20.8
Q2 7.9 17% 157% 84% 5.5 70% 0.5 7% 0.6 7% 0.9 - 1.5 NM 0.02 0% 1.5 NM 19% 0.06 0.04 NM 24.8
Q3 10.4 32% 157% 82% 8.5 82% 0.5 5% (0.6) -5% 1.1 - 0.5 NM 0.00 0% 0.5 NM 4% 0.02 0.01 NM 25.8
Q4 E 16.3 57% 224% 73% 11.5 70% 0.6 4% (0.2) -1% 0.7 0.7 (0.2) (164%) 0.02 0% (0.2) NM -1% (0.01) (0.00) NM 26.4
1996 E 41.4 182% 81% 29.9 72% 0.6 8% 0.4 0% 3.0 0.7 2.7 NM 0.0 0% 2.7 NM 6% 0.11 0.07 NM 24.4
1997
Q1 E 16.7 3% 148% 72% 11.3 67% 0.7 8% 0.1 -3% 0.6 0.5 0.2 (74%) 0.0 0% 0.2 (73%) 1% 0.01 0.01 -79% 26.5
Q2 E 17.1 2% 116% 72% 11.3 66% 0.7 8% 0.3 -2% 0.6 0.3 0.7 (53%) 0.0 0% 0.7 (52%) 4% 0.03 0.02 -56% 26.5
Q3 E 17.5 2% 68% 72% 11.4 65% 0.7 8% 0.6 -1% 0.6 0.3 0.9 102% 0.0 0% 0.9 102% 5% 0.03 0.02 96% 26.6
Q4 E 17.7 1% 9% 73% 11.5 65% 0.7 8% 0.7 0% 0.6 0.3 1.0 (604%) 0.0 0% 1.0 ##### 6% 0.04 0.02 -566% 26.6
1997 E 69.0 67% 72% 45.5 66% 2.7 4% 1.7 2% 2.5 1.3 2.9 8% 0.0 0% 2.9 9% 4% 0.11 0.07 -4% 26.6
1998
Q1 E 18.0 2% 8% 72% 11.5 64% 0.7 8% 0.8 1% 0.5 0.3 1.1 330% 0.0 0% 1.1 330% 6% 0.04 0.04 609% 26.8
Q2 E 18.5 2% 8% 73% 11.6 63% 0.7 8% 1.1 2% 0.6 0.3 1.4 99% 0.0 0% 1.4 99% 8% 0.05 0.05 228% 26.8
Q3 E 18.7 1% 7% 73% 11.6 62% 0.8 8% 1.3 3% 0.6 0.3 1.6 75% 0.0 0% 1.6 75% 9% 0.06 0.06 189% 26.8
Q4 E 19.0 1% 7% 73% 11.7 62% 0.8 8% 1.4 3% 0.6 0.3 1.7 66% 0.0 0% 1.7 66% 9% 0.06 0.06 175% 26.8
1998 E 74.2 8% 73% 46.5 63% 3.0 8% 4.5 2% 2.3 1.0 5.8 100% 0.0 0% 5.8 100% 8% 0.22 0.22 230% 26.8
Balance Sheet Pro Forma Ratios

Sep-96 Jun-96 Mar-96 Dec-95 Sep-96 Jun-96 Mar-96 Dec-95
ASSETS
Cash & Equiv. 53.5 85.9 91.3 18.0 Return on Assets 0.4% 1.4% 1.0% 1.1%
Accounts Rec. 25.0 11.6 9.3 6.5 Return on Equity 0.4% 1.5% 0.9% 1.3%
% of Sales 40% 49% 49% 44%
A/R Growth 13.4 2.3 2.8 NA
% of Q Sales NA 29% 41% NA
Inventory 5.6 2.9 2.2 1.8 Book Value $ 4.39 $ 4.11 $ 4.85 $ 1.37
Other Current 3.6 0.9 0.6 0.3 Cash Per Share $ 2.07 $ 3.47 $ 4.39 $ 1.01
Tot Cur Assets 87.6 101.3 103.4 26.6 Current 8.20 24.12 28.66 8.70
Net PP&E 9.1 0.9 0.8 0.7 Quick 5.00 20.45 25.30 5.89
Other Assets 16.5 3.7 0.2 0.2
Tot Assets 113.2 105.9 104.5 27.5

Current Liab 10.7 4.2 3.6 3.1
LT Debt 0.0 0.0 0.0 0.0
Other Liab 0.3 0.0 0.0 0.0
Total Equity 102.3 101.7 100.8 24.4
Tot Liab & Equity 113.2 105.9 104.5 27.5
a) Hambrecht & Quist LLC maintains a market in this stock

b) Hambrecht & Quist LLC has been an underwriting manager or co-manager, or has privately placed securities of this company within the last three years
f) Options are available on this issue.

1996 Ortho Overview

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1996 Ortho Overview

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I N STITUTIONAL RESEARCH

The Skinny on The Skeleton

An In-Depth Assessment of Trends

H&Q Orthopaedic Industry Coverage

Industry Report Robert C. Faulkner

INDUSTRY INVESTMENT STRATEGY

Exhibit 1: Estimated Worldwide Reconstructive Market Dollar Growth: 1993A to 2000E . . . . . . . . . . . 5

Out of Adversity Comes Opportunity

Waiting for Consolidation. . .

2 HAMBRECHT & QUIST LLC

Institutional Research: The Skinny on the Skeleton 3

4 HAMBRECHT & QUIST LLC

Estimated Worldwide Reconstructive Market Dollar Growth: 1993A to 2000E

1993 1994 1995 1996 1997E 1998E 1999E 2000E

Source: Industry Data Sources, H&Q estimates, Knowledge Enterprises, Inc.

Institutional Research: The Skinny on the Skeleton 5

6 HAMBRECHT & QUIST LLC

Market Segment Shares

Source: H&Q estimates

THE RECONSTRUCTIVE DEVICE MARKET

Institutional Research: The Skinny on the Skeleton 7

US Reconstructive Market Growth - Knees

Source: Industry Data Sources; Knowledge Enterprises, and H&Q estimates

8 HAMBRECHT & QUIST LLC

Long-Term Developments: Goals and Technologies to Watch

Mix Shift and Pricing in the U.S. Market

Institutional Research: The Skinny on the Skeleton 9

Porous/Cemented Mix Shift Trends

10 HAMBRECHT & QUIST LLC

Impact of Mix Shift on Sales for Industry and Major Players

1994 1995 Q3-96

Source: IMS America; H&Q estimates

Pricing Forecast: Partly Sunny

Institutional Research: The Skinny on the Skeleton 11

Financial Indicators in U.S. Reconstructive Joint Procedures: 1995

Total Hip Partial Revision Total Revision

Charges $21,306 $19,342 $24,880 $21,155 $20,805

% Markup 103.4% 97.7% 103.3% 105.8% 104.1%

Implant Cost $3,056.03 $515.10 $4,446.00 $3,783.58 $4,778.76

Length of stay (days) 6.50 8.52 7.46 5.92 5.98

To gain negotiating leverage, administrators urged surgeons to standardize on a

12 HAMBRECHT & QUIST LLC

Institutional Research: The Skinny on the Skeleton 13

Winning in the Future: To Contract or Not to Contract?. . . Contract!

14 HAMBRECHT & QUIST LLC

The Ex-United States Reconstructive Device Market

Institutional Research: The Skinny on the Skeleton 15

U.S. Hip and Knee Unit Share Trends: 1990-1995

Hip Market Share

Knee Market Share

Source: IMS America; H&Q estimates

16 HAMBRECHT & QUIST LLC

Estimated 1995 Reconstructive Market Shares for Major Players ($)

Worldwide United States Ex-U.S.

Zimmer 18.6% 20.4% 16.6%

Source: Knowledge Enterprises, Inc.

THE TRAUMA MARKET

Institutional Research: The Skinny on the Skeleton 17

Long-term Developments: Goals and Technologies to Watch

THE SPINAL IMPLANT MARKET

18 HAMBRECHT & QUIST LLC

Spinal Implant Market

Source: H&Q estimates

Fusion % (1 level) 93% * 95% * 70% *

Post-Fusion Pain Meds Needed 0% 9% generally higher