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North America Equity Research

18 April 2005

Kinetic Concepts, Inc Overweight


KCI vs. BlueSky: An In-Depth Analysis $57.55
15 April 2005

• Last week we upgraded shares of KCI, adding it to JPMorgan's Medical Supplies & Devices
Focus List in light of the stock’s 2005 weakness, our comfort with Michael Weinstein
ongoing fundamentals, and our outlook for the company’s growth (1-212) 622-6635
prospects in 2005 and beyond. mike.weinstein@jpmorgan.com

• One of the concerns that has been weighing on KCI’s stock has Taylor Harris
(1-212) 622-6433
been the upcoming patent case with upstart BlueSky Medical. In a taylor.c.harris@jpmorgan.com
case brought by KCI, BlueSky is challenging the validity of KCI’s
Arjun Krishnan
V.A.C. patents; and in recent weeks we hired outside patent counsel (1-212) 622-6590
to aid us in conducting our own thorough review. arjun.krishnan@jpmorgan.com

• Today, with the help of our counsel, we provide you the results of Kimberly Weeks
that analysis, explaining why based on this work we assign a high (1-212) 622-2326
kimberly.weeks@jpmorgan.com
probability to KCI prevailing in this case and a very low probability
to BlueSky being able to completely invalidate KCI's patents.
• The outcome of this case likely awaits a court trial in September.
However, an upcoming Markman hearing should provide valuable
insights into how the judge construes key claims in the patents, and
assuming a positive outcome, could provide new lift to KCI shares.
• Our 12-month (April 2006) price target of $75/share values KCI at
just 27-28x a potentially conservative 2006 EPS estimate of $2.70.
We view this as reasonable for a company expected to grow
revenues 23-25% in 2005 and 20% in 2006 with EPS growth
projected at ~30% and 25-30%, respectively.
Kinetic Concepts, Inc
Ticker KCI EPS 2004A 2005E 2006E 2007E
Price(04/15/05) $57.55 1Q (Mar) $0.34 $0.46
52-Wk.Range $41.40-78.37 2Q (Jun) $0.39 $0.51
Mkt.Cap(MM) $4,178.1 3Q (Sep) $0.46 $0.57
Price Tgt(12 mo) $75.00 4Q (Dec) $0.47 $0.60
Fiscal Year Dec FY $1.66 $2.15 $2.70 $3.26
Shares O/S 72.60 P/E FY 34.7 26.8 21.3 17.7
Sales FY (MM) $992.6 $1,224.7 $1,467.4 $1,682.3

See page 19 for analyst certification and important disclosures, including investment banking
relationships. JPMorgan does and seeks to do business with companies covered in its research reports.
As a result, investors should be aware that the firm may have a conflict of interest that could affect the
objectivity of this report. Investors should consider this report as only a single factor in making their
investment decision. Customers of JPMorgan in the United States can receive independent, third-party
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Michael Weinstein North America Equity Research
(1-212) 622-6635 18 April 2005
mike.weinstein@jpmorgan.com

Executive Summary
The first few months of 2005 have proven bumpy ones for KCI shareholders. After
an impressive 2004 (KCI outperformed the S&P by 145%), the stock is off more than
25% to start the year amidst a series of investor concerns and the recent distribution
of KCI stock by its private investors. We touched on many of these concerns a week
ago, when we upgraded KCI to JPMorgan’s Focus List. In today’s report, we focus
on the intellectual property arena.

Our initial confidence in KCI’s IP position dates back to the company’s 1Q04
initial public offering. Our confidence at the time stemmed from: (1) the due
diligence of the company’s private investors and board members dating back several
years (well in advance of the company coming public); (2) the scope of KCI’s IP
position, including 18 issued patents in the U.S. and 12 pending; (3) the fact that in
Europe, the key patent surrounding V.A.C. technology has been substantially upheld;
and (4) the fact that the largest wound care companies in the world had looked at the
IP, specifically elected not to challenge it, and in conversations with us and others
stated that they see no way into the vacuum-assisted wound closure market except
through KCI.

Yet, the company’s patent position today finds itself under challenge, not by the
established players in wound care, but by a small upstart. BlueSky Medical, the
challenger in this story, is well below the vast majority of clinicians’ radar screens.
Moreover, their technology in our view is not really a challenge to KCI, nor for that
matter is their distribution network. The threat isn't BlueSky, but rather the
possibility that should BlueSky win its case and be able to enter the market, what that
might mean for other potential players? Specifically, would a Smith & Nephew or
J&J rethink its view on the market and its ability to participate should BlueSky
prevail? It is this fear that has, in part, weighed on the stock of late, as investors
have struggled with how to get their arms around the situation.

It was this fear that led us more than a month ago to contact outside patent
counsel with the goal of analyzing the BlueSky case. We, along with our patent
counsel, have spent the past few weeks examining the court documents and the
potential prior art references in this case. It is based on this work that we assign a
high probability to KCI prevailing in its case against BlueSky and a very low
probability of BlueSky being able to completely invalidate KCI's patents. A
brief summary of the relevant issues and our opinions, which we will expand on in
later sections, is as follows:

1. Background. The civil case Kinetic Concepts, et al v. BlueSky Medical


Corp, et al, being tried in the U.S. District Court, Western District of Texas
(San Antonio), is the first true test of the intellectual property surrounding
V.A.C. in the United States. The initial complaint was brought by KCI in
August 2003, and the case has been fully disclosed in the company’s public
filings, but we are just now nearing the actual trial, with a Markman hearing
approaching and a likely jury trial to begin in September.

2. What is KCI asserting? KCI is asserting that BlueSky Medical, through


the marketing of its “Versatile 1” pump, infringes two of the core patents
underlying V.A.C. technology. Those patents are (a) patent number
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Michael Weinstein North America Equity Research
(1-212) 622-6635 18 April 2005
mike.weinstein@jpmorgan.com

5,536,643 (the ‘643 patent), “Wound Treatment Employing Reduced


Pressure,” which is licensed from Wake Forest University; and (b) patent
number 4,969,880 (the ‘880 patent), “Wound Dressing and Treatment
Method,” licensed from David Zamierowski. Specifically, KCI is asserting
3 independent claims from the ’643 patent and 2 independent claims from
the ‘880 patent against BlueSky.

3. What are the relevant legal standards in a patent infringement/validity


suit? In patent law, the alleged infringing party, in this case BlueSky, must
prove with clear and convincing evidence either: (a) that they are not
infringing; (b) that the patent(s) in question is (are) invalid; or (c) the
patents, while maybe valid, are unenforceable. BlueSky’s defense is not that
they are not infringing, but rather that KCI’s patents are invalid. Given this
is the defense’s argument, the onus in this case is very much on BlueSky,
with deference being given to the judgment of the patent examiners who
granted KCI’s patents in the first place. Moreover, it’s important to
understand that BlueSky would need to successfully invalidate essentially
all (not just one or two) of the patent claims being asserted in this case, in
order to win this case against KCI and be able to participate in the U.S.
wound closure market using its current product offering.

4. The Central Issue. We believe the central issue in this case will come
down to whether V.A.C. truly represents a new method in the treatment of
wounds – one worthy of being patented. BlueSky is arguing that the use of
negative pressure predated KCI's patents and in this case points to several
sources of prior art, including what they call “the Kremlin papers” - a series
of papers coming out of Russia in the 1980s. KCI, on the other hand, argues
that while suction has been used for decades in operating rooms, and while
using negative pressure to remove fluid and to clean other material out of
wounds is also not a new concept, the application of negative pressure for
the actual healing of a wound WAS a new concept, and that this was the
basis of KCI’s key intellectual property.

5. So why do we think KCI will win?

a. The Kremlin Papers are only modestly relevant as prior art. For
starters, the system that they describe bears little similarity to
V.A.C. beyond the application of negative pressure – for example,
there's no dressing, nor is the system secured to the body, nor does
the system itself control the application of the therapy in
alternating intervals. Additionally, the primary application of the
vacuum pressure is for the purpose of getting excess fluid and
debris out of wounds, not the process of bringing those wounds to
closure.

b. As prior art goes, perhaps the most relevant document is a paper


by Mark Chariker and Katherine Jeter (the “Chariker-Jeter
paper”), which was known at the time of the issuance of the ‘643
patent. The Chariker-Jeter paper, which describes “closed suction
wound drainage” and dates from June 1989, was listed by the ‘643
patent examiner as one of the publications that had been taken into
consideration prior to issuance. To us, that provides the most

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Michael Weinstein North America Equity Research
(1-212) 622-6635 18 April 2005
mike.weinstein@jpmorgan.com

compelling evidence that the original patent examiner knew what


was being practiced in the wound care community and decided that
the ‘643 patent taught something that was indeed “novel” and “not
obvious” at the time. Neither the Kremlin Papers nor any other
similar document should change that, and remember that in cases
such as these, deference is given to the opinions of the original
patent examiner.

c. In KCI’s patent continuation work, the PTO has examined the


Kremlin Papers and other documents and found that they in no
way invalidate the claims of V.A.C.'s patent estate. Specifically,
we are aware of two Notices of Allowance that have been granted
by the Patent Office for continuation patent claims on V.A.C.
following notification of the existence of the Kremlin Papers. At
the time of the initial V.A.C. patent issuances, neither Wake Forest
nor KCI nor the PTO was aware of the “Kremlin” papers.
However, after KCI learned of these papers some time around
2002, it informed the Patent Office of their existence on five
pending patent applications. And for two of these, we are aware of
Notices of Allowance that have been granted, meaning that the
Patent Office has not viewed them as “blocking”, or for that matter
significant, prior art. While the claims of these continuation patents
are not identical to the claims in question from the original V.A.C.
patents (they can’t be, by definition, in order to have a distinct
patent), they should be similar enough to be meaningful to a judge
or jury.

d. Finally, we find particular strength in the components of KCI's


IP dealing with adhesion and intermittent treatment. In our mind,
the most critical patent claim being examined is Claim 13 from the
'643 patent, which teaches both the “securing” or “adhesion” step
as well as the “alternating interval” component of the therapy. In
the analysis of our patent counsel, Claim 13 is the strongest of the
ones KCI has chosen to assert, and in our opinion, this claim at a
minimum should be upheld.

6. What are the odds? While we have not found any published sources on
outcomes of similar cases, our patent counsel estimates that 75-80% of such
cases ― where the validity question boils down to the issue of “non-
obviousness” ― are resolved in favor of the plaintiff, in this case KCI. We
would take that as a baseline probability, and after having examined the
merits of the case, we believe KCI’s odds of success are indeed much
higher.

7. The next milestone – the Markman hearing. While the final result of this
case likely won’t be learned for several months, there is an upcoming
Markman hearing that could lend some insights into probabilities of success
for KCI. The Markman hearing is intended for claims construction, where
the judge will decide on the interpretation of the key disputed terms from
KCI’s patents. Should the construction of several key terms (e.g. related to
the adhesion or intermittent treatment steps) be favorable to KCI, Street
confidence in the trial’s ultimate outcome should improve.

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Michael Weinstein North America Equity Research
(1-212) 622-6635 18 April 2005
mike.weinstein@jpmorgan.com

Detailed Overview: KCI v. BlueSky Medical


Patent Law Primer
We’re not going to bore you with a 101 course on U.S. patent law. However, there
are a few items relevant to this case that are worth knowing. For starters, BlueSky’s
defense in this case is primarily one of invalidity. In patent law, the alleged
infringing party must prove with clear and convincing evidence either: (a) that they
are not infringing; (b) that the patent(s) in question is (are) invalid; or (c) as a last
resort, that the patents, while maybe valid, are unenforceable. In this case, since it
seems fairly clear that BlueSky’s product in its existing form (a) infringes KCI’s
patents, the BlueSky defense relies much more on (b) the argument that KCI’s
patents are invalid.

Given this is the defense’s argument, the onus in KCI vs. BlueSky rests much
more with BlueSky than it does KCI. The court begins with the assumption that all
allowed and issued patents are valid. Deference is given to the judgment of the patent
examiners who granted the patents in the first place. It is, therefore, the burden of the
defense in this case, as it would be in others, to prove that issued are in fact invalid.
A patent can be shown to be invalid in three distinct ways: those being (a) lack of
“utility,” (b) lack of “novelty” or (c) “obviousness.” It is rare for a defendant to put
forth lack of utility as the reason for patent invalidity, presumably because that would
imply a lack of utility for its product as well, so we will focus on the “novelty” and
“obviousness” issues.
To prove lack of “novelty”, BlueSky would have to demonstrate that a skilled artisan
could have taken a single piece of prior art (e.g. one individual paper, or patent, or
prototype) in combination with his own knowledge of the particular art and be in
possession of the claimed invention. This prior art reference must pre-date the patent
application by a year and must embody all of the critical elements of the claimed
invention. In other words, BlueSky can’t aggregate a number of different pieces
of prior art and use that combined body of evidence to say that a particular
V.A.C. claim wasn’t novel. This will become relevant for us as it relates to claims
that embody multiple elements, such as Claim 13 from the ‘643 patent, which
teaches both the adhesion and intermittent treatment components of the system. For
this claim to be struck down on the grounds of lack of novelty, BlueSky would have
to show that a single document spoke to both of these elements.

On the other hand, the “obviousness” test is that a patent can be declared invalid if
either: (a) there are two distinct prior art sources that, in combination, embody all the
elements of a patent claim, and it would have been "obvious" to a practitioner in the
field to combine these two concepts; or (b) a prior art source in combination with
“ordinary skill” would have made the invention "obvious." So then the question of
“obviousness” comes down to an interpretation of “ordinary skill.” In this case, the
question is whether wound care physicians were practicing the essence of what
KCI’s patents teach prior to the early 1990s.
Worth noting, our patent counsel estimates that 75-80% of cases that revolve around
a question of “obviousness” – as we think this one will – are ruled in favor of the
plaintiff. Moreover, we think BlueSky will need to succeed in invalidating
essentially all of the patent claims being asserted in this case (not just one or

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Michael Weinstein North America Equity Research
(1-212) 622-6635 18 April 2005
mike.weinstein@jpmorgan.com

two), in order to be able to practice in the space using their current product. So
even if some of the claims around the V.A.C. dressings from the ‘880 patent are
limited (as they were in Europe), or even if selected claims from the ‘643 patent are
struck down, BlueSky and others may still be unable to practice in the space. In
short, the hurdle to be cleared by the defendant (BlueSky) in an invalidity case is
quite high.

KCI’s Intellectual Property: What Does it Teach?


Before we get into the specifics of the patent litigation and the various claims being
asserted, let’s examine conceptually what KCI’s patents teach about the art of wound
care. As we have mentioned earlier, the medical field has for decades used suction to
remove fluid and to clean other material from wounds. So suction by itself is
certainly not a novel wound care application. The questions, therefore are (1)
whether V.A.C.'s patents describe something more than fluid/waste removal via
suction, and (2) whether there was prior art teaching those concepts in advance of the
V.A.C. patent applications.

To begin with, the abstract on the front of the ‘643 patent describes the invention
with the following language: “A method of treating tissue damage comprises
applying a negative pressure to a wound sufficient in time and magnitude to promote
tissue migration and thus facilitate closure of the wound” (italics added). So tissue
migration and wound closure – not just fluid removal – are the apparent goals
of V.A.C. therapy as described at the outset of the ‘643 patent.

Moving to the “Background of the Invention” and “Summary of the Invention”


sections of the ‘643 patent, we learn that the treatment of an open wound requires a
number of steps, including but not limited to the following:

1. “inward migration of surrounding epithelial and subcutaneous tissue;”


2. relief of “localized edema,” in order to stimulate blood flow;
3. reduction of bacteria and “formation of granulation tissue,” both of which
are accomplished through improved circulation;
4. and distribution of “a closure force evenly about the periphery of the
wound,” in contrast to the force applied by traditional suturing techniques;

In order to accomplish these goals, one needs to use a hydrophobic (i.e. “porous, not
fluid-retaining") sponge or foam, of the type described in the '880 patent. Packed
gauze or other traditional materials were intended to provide compression to the
wound and therefore tended to accentuate pressure in the surrounding tissue, whereas
an open-cell structure designed to allow for the removal of fluid via suction does
exactly the opposite, in accordance with the teachings of the ’643 patent. Following
the initial patent work on the V.A.C. system, KCI has characterized other
mechanisms of action through which V.A.C. is believed to work. For example, it is
believed that the mechanical stress applied by the sponge on the cells in the wound
bed actually stimulates a bioresponse in the form of mitosis and granulation tissue
formation. Still, the mechanism of action taught in KCI’s ‘643 and ‘880 patents
certainly seems to go beyond the simple use of suction for the purpose of fluid
removal. And in some cases, KCI's patents teach concepts that were actually
counter to standard practice at the time. The question, therefore, becomes one
of prior art and a comparison of that art to the specific claims in the V.A.C.
patents.

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Michael Weinstein North America Equity Research
(1-212) 622-6635 18 April 2005
mike.weinstein@jpmorgan.com

KCI’s Intellectual Property: Asserted Claims


Before we move into a discussion of the prior art in question, let’s briefly review
KCI is asserting 3 independent
what KCI is claiming in its suit. KCI is asserting that BlueSky Medical, through the
claims from the ’643 patent and marketing of its “Versatile 1” pump, infringes the two core patents underlying
2 independent claims from the V.A.C. technology. Those patents are (a) patent number 5,536,643 (the ‘643 patent),
‘880 patent against BlueSky. “Wound Treatment Employing Reduced Pressure,” which is licensed from Wake
Forest University; and (b) patent number 4,969,880 (the ‘880 patent), “Wound
Dressing and Treatment Method,” licensed from David Zamierowski. The
independent claims being asserted by KCI are listed below.

The ‘643 Patent: "Wound Treatment Employing Reduced Pressure”


“Reduced pressure is applied over the wound area in a controlled manner for a
period of time sufficient to promote the growth of tissue in the wound. This tissue
growth is an important stage of wound healing and may eventually lead to closure of
the wound. In addition to healing wounds, the apparatus and method can also be
used to reduce the density of bacteria in wounds, to treat burn wounds by inhibiting
progression in the depth of the burn, and to aid in preparation and attachment of
skin grafts and flaps.”

Table 1: Asserted Independent Claims from the '643 Patent


Claim Description
Claim 13 A method of treating a wound comprising the steps of:
(a) securing an appliance for applying reduced pressure to the wound; and
(b) providing reduced pressure to said appliance in alternating intervals of application and non-
application

Claim 29 A method of treating a wound comprising the steps of:


(a) applying a reduced pressure to the wound; and
(b) maintaining said reduced pressure until the wound has progressed toward a selected
stage of healing, wherein said maintaining of said reduced pressure is conducted in
alternating periods of application and non-application of the reduced pressure

Claim 32 A method of treating a wound comprising the steps of:


(a) applying a reduced pressure to the wound; and
(b) maintaining said reduced pressure until the wound has progressed toward a selected stage
of healing, wherein said selected stage of healing is a reduction in bacterial density in the
wound by at least 50%
Source: Court documents.
Note: Bolded text represents terminology to be “constructed" by the court at the upcoming Markman hearing

The ‘880 Patent: "Wound Dressing and Treatment Method”


“A wound dressing includes a cover membrane comprising a semi-permeable
material with an adhesive-coated skin contact surface. An opening is formed in an
interior portion of the membrane. An intermediate layer of material may be placed
between the wound and the membrane contact surface for either absorbing fluids
from the wound, e.g. with a hydrocolloid or hydrophilic material, or for passing such
fluids to the opening with a synthetic material, e.g. rayon. A tube includes a
proximate end fluidically communicating with the wound through the membrane
opening. A distal end of the tube is adapted for connection to a suction source for
draining the wound or fluid source for introducing liquid medication to the wound.
Both evacuation and introduction can be either active or passive. A wound treatment
method is also disclosed.”

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Michael Weinstein North America Equity Research
(1-212) 622-6635 18 April 2005
mike.weinstein@jpmorgan.com

Table 2: Asserted Independent Claims from the '880 Patent


Claim Description
Claim 1 A wound dressing, which includes:
(a) wound covering means with a skin contact surface and an outer surface;
(b) means for releaseably attaching said wound covering means to a patient in covering
relation over a wound;
(c) said wound covering means having an interior portion with an opening extending
between and open at the skin contact and outer surfaces thereof;
(d) said wound covering means comprising a semi-permeable material; and
(e) tube means having a proximate end extending through said opening and terminating
adjacent said skin contact surface and a distal end located outwardly from said outer
surface, said tube means fluidically communicating with said skin contact surface.

Claim 17 Same as Claim 1, except for element (e) listed below:


(e) tubular connector means having a proximate end extending through said opening and
terminating adjacent said skin contact surface and a distal end located outwardly from said
outer surface, said tubular connector means fluidically communicating with said skin
contact surface and comprising a flexible, collapsible material
Source: Court documents.
Note: Bolded text represents terminology to be “constructed" by the court at the upcoming Markman hearing

Prior Art? Can BlueSky Make a Case?


The Chariker-Jeter Paper.
In our view, the closest “prior art” reference to a method approaching V.A.C. therapy
is a paper by Mark Chariker and Katherine Jeter from June 19891. In fact, BlueSky
refers to the practice of negative pressure wound therapy as having been pioneered
by Chariker and Jeter and have named their disposable drainage sets in reference to
the clinicians. As such, we would expect part of the BlueSky argument to be that the
art of negative pressure wound therapy was in practice before the V.A.C. patent
applications, as evidenced by Chariker-Jeter. But the Chariker-Jeter paper was
listed on the ‘643 patent as having been reviewed by the patent examiner. So to
overturn ‘643 based on Chariker-Jeter alone, BlueSky would have to prove with clear
and convincing evidence that the patent examiner was simply wrong to allow ‘643 to
issue in light of this work . . . a prospect that is highly improbable in our view and in
the view of our patent counsel.

The first few paragraphs of Chariker-Jeter admittedly don't read too favorably for
KCI: “…we have devised a closed suction wound drainage system that 1) is effective
in collecting drainage from the most difficult sites, 2) obviates skin damage, 3)
improves wound granulation and contraction, and 4) minimizes the dressing and
nursing requirements and dramatically reduces the cost associated with wound
management and containment.” However, as the paper progresses, we learn that
what Chariker-Jeter means by “improv[ing] wound granulation,” which is a large
part of the mechanism of V.A.C. action taught in the '643 patent, is actually that they
wanted to limit the formation of granulation tissue and therefore increase the
rate of epithelialization. This is in stark contrast to what is being talked about
by Wake Forest, the source of the ‘643 patent, and KCI. As the paper continues,
it asserts that the system “…decreases the degree of fibroplasias, i.e. granulation
tissue. The result is to increase the rate of reepithelialization.”

1
Chariker, M.E. et al. “Effective Management of Incisional and Cutaneous Fistulae with
Closed Suction Wound Drainage,” Contemporary Surgery, vol. 34, June. 1989, pp. 59-63.

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Michael Weinstein North America Equity Research
(1-212) 622-6635 18 April 2005
mike.weinstein@jpmorgan.com

As we said, the Chariker-Jeter technique, as potential prior art goes, is the closest
reference to the V.A.C. technique that we have seen. And yet, there are critical
differences with V.A.C., such as the stimulation of granulation tissue mentioned
above, but also the use of an adhesive, the application of treatment in
alternating intervals, and the use of a porous dressing, as opposed to the moist
gauze used by Chariker-Jeter. Are these differences enough for V.A.C. to have
been considered a novel invention? The ‘643 patent examiner thought so, and we see
very little reason to think that a judge or jury, with the appropriate deference being
given to the original examiner, will disagree.

So if the patent examiner knew about the Chariker-Jeter method and didn’t view it as
enough to block the issuance of the primary V.A.C. method patent, then the
question becomes whether there was anything that the patent examiner didn’t
know about that would have changed his opinion? BlueSky will argue that
that’s where the “Kremlin Papers” fit in.

The “Kremlin Papers”


For background, the “Kremlin Papers” are a series of five articles appearing in the
Russian Medical Journal Vestnik Khirugii between Sept. 1986 and Feb. 1991. They
were unknown to KCI and the patent examiner at the time of the ‘643 patent,
although further dialogue with the PTO following the discovery of these papers
indicates that the PTO does not view them as changing the validity of the key V.A.C.
claims. Specifically, we are aware of two Notices of Allowance that have been
granted by the Patent Office for continuation patent claims on V.A.C. following
notification of the existence of the Kremlin Papers. After KCI learned of these
papers some time around 2002, it informed the Patent Office of their existence on
five pending patent applications. Office actions have now been taken on all five
patents and in none of these cases did the examiner raise the Kremlin Papers as
being in any way significant. Moreover, on two of these patents, we are aware of
Notices of Allowance that have been granted to Wake Forest/KCI, meaning that
the Patent Office has not viewed them as “blocking” prior art. While the claims
of these continuation patents are not identical to the claims in question from the
original V.A.C. patents (they can’t be, by definition, in order to have a distinct
patent), they should be similar enough to be meaningful to a judge or jury.

The key findings from the Kremlin Papers, along with our interpretation of the
significance in the current litigation, are detailed below.

Kremlin Paper #1 (KP#1): “The Vacuum Effect in the Surgical Treatment of


Purulent Wounds”
KP#1 describes the use of vacuum in order to clean a purulent wound (a wound with
heavy drainage) prior to surgical debridement, with the intent of lowering the
bacterial count in the wound in order to prepare the wound to be closed through
suturing. The technique described is as follows: “During the vacuum treatment, the
suction head was pressed tightly against the wound walls and, moving it along the
entire wound area, we sucked out blood clots and detritus, poorly secured areas of
tissue, foreign bodies, and microhematomas.”

So, in addition to the fact that KP#1 is really talking only about using suction for the
traditional purpose of removing debris, it actually teaches techniques that are
opposite to the claims in the ‘643 patent. For example, the system is not affixed to

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Michael Weinstein North America Equity Research
(1-212) 622-6635 18 April 2005
mike.weinstein@jpmorgan.com

the wound through an adhesive step (instead, it is moved along the wound area). And
moreover, it is intended to prepare a wound for normal suturing, whereas '643
cautions against suturing prior to the formation of underlying granulation tissue.

Kremlin Paper #2 (KP#2): “Vacuum Therapy in the Treatment of Purulent Lactation


Mastitis”
KP#2 describes the use of a glass hemisphere with an inserted tube to provide “long-
duration vacuum suction” for the purpose of treating heavily-draining breast tissue
following surgery. KP#2, along with KP#4 and KP#5, were authored by Prof. Yu. A.
Davydov and are the most relevant of the Kremlin Papers. The process is described
as follows: “Vacuum therapy was started on the operating table immediately after
surgery, as a continuation of the surgery, under anesthesia. The inserted tube was
introduced into the wound and was covered by the hemispherical chamber….The
pus, necrotic masses, and hydropic tissue fluid were evacuated from adjacent tissues
along the whole wound tract, throughout which uniform negative pressure was
created.” This vacuum therapy, we note, comes after aggressive surgical debridement
as well as making an incision in the breast tissue in order to facilitate the draining
process.

The reason that the Davydov paper is perhaps more relevant that the others is that
although it describes a process designed primarily to remove pus and dead tissue, it
does note other wound healing benefits that are part of the V.A.C. therapy. The paper
reads, “Necrolitic, antiedemic, and anti-inflammatory effects were noted when
vacuum therapy was used. The duration of the first phase of the wound process (the
hydration phase) decreased. Granulation and the beginning of the cuticularization are
observed by days 6-7.” In other words, the authors note that the technique appeared
to help relieve pressure and to speed the formation of granulation therapy, compared
to the control group in the study.

Although some of the key V.A.C. benefits are noted by Davydov, when it comes to
examining the actual claims in the ‘643 patent, the Davydov papers do not
provide direct references to key components of the V.A.C. system. For example,
no “screen means” or dressing is employed, there is no "securing" or adhesive step,
nor is the system left continuously attached to the patient with the system itself
providing “alternating intervals” of treatment. These are critical components for
Claim 13 of the ‘643 patent, in particular.

Kremlin Paper #3 (KP#3): “Active Wound Drainage”


KP#3 describes the authors’ work to determine the most appropriate level of negative
pressure to apply when draining wounds. Part of the paper deals with a study in
rabbits of the point at which tissue damage or hemorrhaging can occur due to
excessive negative pressure. The paper also compares the use in humans of passive
drainage, active drainage, and active drainage along with irrigation. As such, we
think KP#3 is irrelevant with respect to V.A.C., as it deals only with the benefits of
fluid removal.

Kremlin Paper #4 (KP#4): “The Bacteriological and Cytological Assessment of


Vacuum Therapy of Purulent Wounds” and Kremlin Paper #5 (KP#5): “Concepts
for Clinical Biological Management of the Wound Process in the Treatment of
Purulent Wounds Using Vacuum Therapy”
KP#4 and KP#5, the final two Davydov papers, describe the same apparatus as used
in KP#2. This apparatus, as we pointed out above, bears little resemblance to the

10
Michael Weinstein North America Equity Research
(1-212) 622-6635 18 April 2005
mike.weinstein@jpmorgan.com

V.A.C. system except for the fact that it involves the application of negative
pressure. The Davydov device incorporates no dressing, is not “secured” to the
patient, and relies on a nurse to apply the therapy for a set amount of time each day,
as opposed to having the device itself control the treatment intervals. These two
papers go into more detail on studies using this apparatus in heavily draining
wounds, with particular attention focused on the positive benefit of reduction of
bacterial count.

Analysis of the ‘643 Patent With Respect to the Kremlin


Papers
The summary of our analysis of the '643 patent with respect to the Kremlin
Papers is that, at a minimum, Claim 13 should be upheld. And at a minimum
that should be enough to block BlueSky and any other competitor from the
market, irrespective of the outcome of the other claims. On the risk spectrum, we
believe that Claim 29 is likely the most vulnerable, followed by Claim 32, but that
Claim 13 should be highly defensible, as we explain in more detail below.

Independent Claim 13
Claim 13 is directed to a “method of treating a wound” and includes the steps of
“securing an appliance for applying reduced pressure to [a] wound” and “providing
reduced pressure to said appliance in alternating intervals of application and non-
application.”

The Davydov papers (KP#2,4,5) do not teach a “securing” step in the sense of
using some sort of adhesive to fix the suction apparatus to the wound. And in
terms of the "alternating intervals” step, what the Davydov papers describe is a
process of having a practitioner apply the therapy periodically by placing the device
over the wound and then removing it when done (e.g. 1x/day for 2-3 hours per
session). So in our opinion the only possible way that a jury could overturn Claim 13
would be by deciding that the “alternating interval” step was taught by the Davydov
papers and that it would have been “obvious” to someone with ordinary skill to
combine that technique with the concept of securing the apparatus to the wound area.

However, in our view, it is likely that the “alternating interval” language of the
‘643 patent will be interpreted as being different from that taught in the
Davydov papers. The ‘643 patent specifically describes treatment of a wound being
“carried out by securing a negative pressure appliance to the treatment site …, and
then maintaining a substantially continuous or cyclical reduced pressure within the
appliance until the wound has reached a desired improved condition.” Col. 12, lines
42-47 (emphasis added). Similarly, the ‘643 patent states, "Supplying reduced
pressure to the appliance in an intermittent cyclic manner has also been demonstrated
to be useful for treating wounds. Intermittent or cyclic supply of reduced pressure to
an appliance may be achieved by manual or automatic control of the vacuum
system.” This cyclical reduced pressure, or treatment in alternating intervals, is
therefore to be maintained while the negative pressure appliance is secured to
the treatment site, according to the ‘643 patent, and the supply and non-supply
of reduced pressure can be controlled automatically by the V.A.C. system.

As for the “securing” step, KCI will seek to define "securing” in a rather broad
fashion, encompassing attaching a reduced pressure appliance to the skin, other than
by suction alone. We think that KCI will succeed in this definition, as we think they

11
Michael Weinstein North America Equity Research
(1-212) 622-6635 18 April 2005
mike.weinstein@jpmorgan.com

do a good job in their Markman brief of demonstrating the difference between he


terms "sealing" and “securing.”
BlueSky, on the other hand, argues that the “securing” step should further require a
certain structure of a reduced pressure apparatus, for example, a wound cover,
sealing means, a suction port, and a porous screen. However, the ‘643 patent recites
that the disclosed appliance “may include” a porous wound screen. This permissive
language is quite different from a disclosure that the appliance “includes” or “must
include” the porous screen. Moreover, the ‘643 patent includes several claims that
do not include a porous screen, for example, at least claims 6, 16, 26, 28, 33. Thus,
we believe it is not likely that a court will limit claims 13 and 14 to a device
having a porous screen as requested by BlueSky.

Table 3: Key Disputed Terms From the '643 Patent


Claim Term Party Proposed Definition
"securing an appliance for applying KCI "attaching a reduced-pressure appliance to the skin other than by suction alone"
reduced pressure"
BlueSky "Fastening an apparatus to the wound for exposing the wound to pressure that is below ambient atmospheric
pressure, where the apparatus includes as a minimum a fluid impermeable wound cover, a sealing means for
sealing the wound cover around the periphery of the wound thereby forming a fluid-tight and gas-tight
enclosure over the wound, a suction port that connects to a vacuum source for applying reduced pressure to
the enclosure and thereby to the wound, and a porous screen placed beneath the wound cover to keep the
cover off of the wound, wherein the screen is optional if the wound cover keeps itself off of the wound without
the screen."

"alternating intervals" or "alternating KCI "controlled cycles occurring while the appliance is secured to the patient"
periods"
BlueSky "Changing application for non-application reciprocally for periods of time between these two events."
Source: Markman Briefs.

We will gain more clarity on the constructions of these key terms at the upcoming
Markman hearing. A construction of the “providing” step favorable to KCI at the
Markman Hearing may go a long way in confirming the validity of Claims 13
with respect to The Kremlin Papers.

Valuation, Rating, and Price Target Analysis

Shares of KCI currently trade at 20-21x our 2006 estimates, a level we view as
highly attractive given KCI’s growth profile in comparison to mid-cap medical
technology peers and also in comparison to valuation levels for the universe of more
established medtech peers with high-teens to 20% EPS growth prospects. Over the
next year, as KCI continues to prove the sustainability of the V.A.C. opportunity, we
expect KCI to be able to support its trading multiple and to grow earnings at the high
end of our coverage universe. Our $75 price target for April 2006 values KCI at 27-
28x our current 2006E EPS estimate of $2.70 and implies over 30% upside potential
from current levels, a return that we think will allow KCI to outperform relative to
other stocks in our coverage universe. We reiterate our Overweight rating on KCI.

Risks to Our Rating and Price Target

Risks to our Overweight rating include (1) Any reductions in the reimbursement for
V.A.C. therapy. Although we have seen little evidence that a reduction is a
possibility, should Medicare or any of the third-party payors reduce payment for
V.A.C., earnings would be negatively affected. (2) Any material change in KCI’s

12
Michael Weinstein North America Equity Research
(1-212) 622-6635 18 April 2005
mike.weinstein@jpmorgan.com

intellectual property position. KCI is currently involved in patent litigation with a


privately-held medical device company named BlueSky Medical. KCI’s patent estate
is quite extensive, the company has successfully defended its key IP in Europe, and
to date, none of the major wound care players has decided to challenge KCI’s patent
position. (3) Substitute products or technology that could replace the V.A.C. in
wound healing. The V.A.C. technology is a mechanical-based vacuum technology
for healing wounds. While we are not aware of any disruptive developments in
wound closure or healing, newer, perhaps biologically based, technologies could
potentially substitute for V.A.C. in the future. Risks to our $75 price target include a
failure of KCI to meet revenue and earnings expectations over the coming quarters
and any negative developments in the litigation proceedings with BlueSky.

13
Michael Weinstein North America Equity Research
(1-212) 622-6635 18 April 2005
mike.weinstein@jpmorgan.com

Table 4: KCI Annual Income Statement and JPM Projections


Growth Rates
2001A 2002A 2003A 2004A 2005E 2006E 2007E 2008E 2003A 2004A 2005E 2006E 2007E 2008E
VAC Revenue 190.0 313.4 481.8 699.0 927.5 1,164.5 1,394.4 1,634.4 53.7% 45.1% 32.7% 25.5% 19.7% 17.2%
Surfaces Revenue 266.0 267.0 282.0 293.6 297.3 303.0 307.9 312.9 5.6% 4.1% 1.2% 1.9% 1.6% 1.6%
Total Revenue 455.9 580.4 763.8 992.6 1,224.7 1,467.4 1,702.3 1,947.3 31.6% 30.0% 23.4% 19.8% 16.0% 14.4%

Rental Revenue 361.6 453.1 582.8 726.8 875.8 1,045.0 1,199.4 1,352.4 28.6% 24.7% 20.5% 19.3% 14.8% 12.8%
Sales Revenue 94.3 126.3 181.0 265.9 349.0 422.4 497.9 579.9 43.3% 46.9% 31.3% 21.1% 17.9% 16.5%

Rental Expense 220.5 276.1 356.1 457.3 544.6 642.7 731.6 818.2 29.0% 28.4% 19.1% 18.0% 13.8% 11.8%
Cost of Goods 33.0 51.8 64.1 70.8 93.4 113.2 132.7 153.7 23.7% 10.4% 31.9% 21.2% 17.2% 15.8%
Gross Profit 202.5 252.4 343.6 464.6 586.8 711.5 838.0 975.4 36.1% 35.2% 26.3% 21.3% 17.8% 16.4%

Sales, General and Admin. 99.4 122.8 170.6 223.5 281.1 333.1 383.0 434.2 38.9% 31.0% 25.8% 18.5% 15.0% 13.4%
Research & Development 15.4 18.8 23.1 31.3 43.0 54.3 66.4 79.8 22.9% 35.5% 37.2% 26.4% 22.3% 20.3%
Operating Income 87.7 284.1 154.9 207.3 262.8 324.1 388.6 461.3 -45.5% 33.8% 26.8% 23.4% 19.9% 18.7%

Interest Income 0.3 0.5 1.1 1.1 2.4 3.1 4.6 6.8
Interest Expense (45.1) (40.9) (52.1) (32.9) (25.8) (19.4) (13.6) (5.6)
FX Currency Gain (Loss) (1.6) 4.0 7.6 5.4 2.0 - - -
Pretax Income 41.2 247.6 111.4 177.8 241.4 307.9 379.6 462.5

Tax Expense 17.3 96.0 41.8 63.2 83.5 106.2 130.9 159.6
Net Income 23.9 151.6 69.6 114.5 157.9 201.7 248.6 303.0

Preferred. Stk Conv./Div. - - 9.5 65.6 - - - -


Net Income 23.9 151.6 60.2 48.9 157.9 201.7 248.6 303.0

Earnings per Share $0.32 $1.95 $0.93 $0.69 $2.15 $2.70 $3.28 $3.94
EPS Ex-Unusuals $0.33 $0.58 $1.04 $1.66 $2.15 $2.70 $3.28 $3.94 79.5% 59.5% 29.1% 25.9% 21.5% 20.1%

Diluted Shares 74.0 77.7 64.5 71.0 73.5 74.6 75.7 76.9

MARGIN ANALYSIS
Rental Exp/Sales 61.0% 60.9% 61.1% 62.9% 62.2% 61.5% 61.0% 60.5%
COGS/Sales 34.9% 41.0% 35.4% 26.6% 26.8% 26.8% 26.7% 26.5%
Gross Margin 44.4% 43.5% 45.0% 46.8% 47.9% 48.5% 49.2% 50.1%
Sales and marketing 21.8% 21.2% 22.3% 22.5% 22.9% 22.7% 22.5% 22.3%
R&D 3.4% 3.2% 3.0% 3.2% 3.5% 3.7% 3.9% 4.1%
Operating Margin (ex charges) 19.2% 19.1% 19.7% 20.9% 21.5% 22.1% 22.8% 23.7%
Pretax Margin 9.0% 42.7% 14.6% 17.9% 19.7% 21.0% 22.3% 23.8%
Tax Rate 42.0% 38.8% 37.5% 35.6% 34.6% 34.5% 34.5% 34.5%
Net Margin 5.2% 26.1% 7.9% 4.9% 12.9% 13.7% 14.6% 15.6%

Source: JPMorgan estimates and company reports.

14
Michael Weinstein North America Equity Research
(1-212) 622-6635 18 April 2005
mike.weinstein@jpmorgan.com

Table 5: KCI Quarterly Income Statement and JPM Projections


First Quarter Second Quarter Third Quarter Fourth Quarter Full Year
2005E 2004A Change 2005E 2004A Change 2005E 2004A Change 2005E 2004A Change 2005E 2004A Change
VAC Revenue 199.3 148.3 34% 219.4 166.5 32% 243.4 185.5 31% 265.4 198.7 34% 927.5 699.0 33%
Surfaces Revenue 75.4 76.5 -2% 71.9 70.5 2% 73.1 71.6 2% 76.9 75.0 3% 297.3 293.6 1%
Total Revenue 274.6 224.8 22% 291.4 237.0 23% 316.5 257.2 23% 342.3 273.7 25% 1,224.7 992.6 23%

Rental Revenue 198.0 165.9 19% 209.0 175.6 19% 225.7 188.6 20% 243.1 196.7 24% 875.8 726.8 21%
Sales Revenue 76.6 58.9 30% 82.4 61.4 34% 90.8 68.5 32% 99.2 77.0 29% 349.0 265.9 31%

Rental Expense 125.0 105.4 19% 131.0 109.6 20% 138.1 115.1 20% 150.5 127.2 18% 544.6 457.3 19%
Cost of Goods 21.0 16.8 25% 21.7 16.6 31% 24.3 18.8 29% 26.4 18.6 42% 93.4 70.8 32%
Gross Profit 128.7 102.7 25% 138.7 110.9 25% 154.0 123.3 25% 165.4 127.8 29% 586.8 464.6 26%

Sales, General and Admin. 62.3 48.5 28% 65.8 52.9 24% 72.8 59.1 23% 80.1 62.9 27% 281.1 223.5 26%
Research & Development 9.3 7.1 31% 9.9 7.2 38% 11.4 7.5 51% 12.3 9.5 30% 43.0 31.3 37%
One-time Charges - - - 2.5 - - - - - 2.5
Operating Income 57.0 47.0 21% 62.9 48.2 30% 69.8 56.7 23% 73.0 55.4 32% 262.8 207.3 27%

Operating Income (ex-unusuals) 57.0 47.0 21% 62.9 50.8 24% 69.8 56.7 23% 73.0 55.4 32% 262.8 209.8 25%

Interest Income 0.5 0.4 35% 0.6 0.2 280% 0.6 0.2 180% 0.7 0.4 79% 2.4 1.1 112%
Interest Expense (6.9) (10.2) -32% (6.6) (8.0) -17% (6.3) (7.6) -17% (5.9) (7.2) -17% (25.8) (32.9) -22%
One-time charges - 0.0 - (3.1) - 0.0 - 0.0 - (3.1)
FX Currency Gain (Loss) 0.5 (0.5) 0.5 0.2 0.5 2.0 0.5 3.7 2.0 5.4
Pretax Income 51.1 36.7 39% 57.4 37.6 53% 64.6 51.3 26% 68.3 52.2 n/m 241.4 177.8 36%
Pretax Income (ex-unusuals) 51.1 36.7 39% 57.4 43.1 33% 64.6 51.3 68.3 52.2 241.4 183.3

Tax Expense (recurring) 17.7 13.2 34% 19.9 15.5 22.4 18.5 23.6 18.1 83.5 65.3
Tax Expense (reported) 17.7 13.2 34% 19.9 13.5 47% 22.4 18.5 21% 23.6 18.1 31% 83.5 63.2 32%
Net Income 33.4 23.5 42% 37.5 24.0 56% 42.3 32.8 29% 44.6 34.2 n/m 157.9 114.5 38%

Net Income ex-unusuals 33.4 23.5 42% 37.5 27.6 36% 42.3 32.8 29% 44.6 34.2 31% 157.9 118.1 34%

Preferred. Stk Conv./Div. - 65.6 - - 0.0 - - 0.0 - - 0.0 - 0.0 65.6 -


Net Income 33.4 (42.1) -179% 37.5 24.0 56% 42.3 32.8 29% 44.6 34.2 31% 157.9 48.9 223%

Earnings per Share $0.46 ($0.62) $0.51 $0.34 52% $0.57 $0.46 26% $0.60 $0.47 28% $2.15 $0.69 212%
EPS ex-charges $0.46 $0.34 33% $0.51 $0.39 32% $0.57 $0.46 26% $0.60 $0.47 28% $2.15 $1.66 29%

Diluted Shares 73.1 68.3 7% 73.3 71.3 3% 73.6 71.8 2% 74.1 72.6 2% 73.5 71.0 4%
Source: JPMorgan estimates and company reports.

15
Michael Weinstein North America Equity Research
(1-212) 622-6635 18 April 2005
mike.weinstein@jpmorgan.com

Table 6: KCI Quarterly Income Statement and JPM Projections (cont.)


First Quarter Second Quarter Third Quarter Fourth Quarter Full Year
2005E 2004A 2005E 2004A 2005E 2004A 2005E 2004A 2005E 2004A
Rental Exp/Sales 63.1% 63.5% 62.7% 62.4% 61.2% 61.0% 61.9% 64.7% 62.2% 62.9%
COGS/Sales 27.4% 28.5% 26.3% 27.0% 26.8% 27.5% 26.6% 24.2% 26.8% 26.6%
Gross Margin 46.9% 45.7% 47.6% 46.8% 48.7% 47.9% 48.3% 46.7% 47.9% 46.8%
Sales and marketing 22.7% 21.6% 22.6% 22.3% 23.0% 23.0% 23.4% 23.0% 22.9% 22.5%
R&D 3.4% 3.2% 3.4% 3.0% 3.6% 2.9% 3.6% 3.5% 3.5% 3.2%
Operating Margin (ex-charges) 20.8% 20.9% 21.6% 21.4% 22.1% 22.0% 21.3% 20.2% 21.5% 21.1%
Pretax Margin (ex-charges) 18.6% 16.3% 19.7% 15.8% 20.4% 19.9% 19.9% 19.1% 19.7% 17.9%
Tax Rate (recurring) 34.6% 36.0% 34.6% 36.0% 34.6% 36.0% 34.6% 34.6% 34.6% 35.6%
Net Margin (ex-charges) 12.2% 10.4% 12.9% 10.1% 13.4% 12.8% 13.0% 12.5% 12.9% 11.5%
Source: JPMorgan estimates and company reports.

16
Michael Weinstein North America Equity Research
(1-212) 622-6635 18 April 2005
mike.weinstein@jpmorgan.com

Table 7: KCI Revenue Summary and JPM Projections


2002A 2003A 1Q/04A 2Q/04A 3Q/04A 4Q/04A 2004A 1Q/05E 2Q/05E 3Q/05E 4Q/05E 2005E 2006E 2007E 2008E
U.S. Market
V.A.C.
Rental 215.7 311.6 89.9 101.4 111.3 114.3 417.0 118.0 128.8 140.1 151.2 538.1 663.0 764.3 843.6
Sales 53.4 88.2 31.7 34.6 37.4 41.9 145.6 41.5 45.3 49.2 53.1 189.1 239.0 275.6 304.2
Total V.A.C. 269.2 399.9 121.6 136.0 148.8 156.2 562.6 159.5 174.1 189.3 204.3 727.1 902.0 1,039.8 1,147.8
growth 62% 49% 48% 44% 41% 33% 41% 31% 28% 27% 31% 29% 24% 15% 10%
percent from V.A.C. Sales 20% 22% 26% 25% 25% 27% 26% 26% 26% 26% 26% 26% 27% 27% 27%

Therapeutic surfaces/other
Rental 150.8 149.5 39.8 37.4 37.2 37.8 152.2 39.4 37.4 37.9 39.3 154.0 157.9 161.0 164.2
Sales 29.2 30.6 8.6 6.2 7.1 7.7 29.5 7.5 7.1 7.2 7.5 29.3 30.1 30.7 31.3
Total Therapeutic surfaces/other 180.0 180.0 48.4 43.6 44.3 45.4 181.7 46.9 44.5 45.2 46.8 183.3 187.9 191.7 195.5
growth -4% 0% 8% 1% -2% -3% 1% -3% 2% 2% 3% 1% 3% 2% 2%

Total USA Rental 366.3 461.1 129.7 138.9 148.6 152.1 569.2 155.6 164.9 176.9 189.4 686.7 822.1 940.2 1,047.1
Total USA Sales 81.6 118.8 40.2 40.8 44.5 49.6 175.1 50.7 53.7 57.6 61.7 223.8 267.9 306.3 341.2

Total USA 449.1 579.9 169.9 179.6 193.0 201.7 744.3 206.4 218.6 234.5 251.1 910.5 1,089.9 1,246.5 1,388.3
growth 27% 29% 34% 31% 28% 23% 28% 21% 22% 21% 24% 22% 20% 14% 11%

International
V.A.C.
Rental 21.2 41.3 13.4 15.4 18.6 21.2 68.5 19.9 22.4 26.7 30.0 99.1 128.6 164.0 209.1
Sales 23.0 40.6 13.3 15.0 18.2 21.3 67.9 19.9 22.9 27.3 31.2 101.3 133.9 170.7 217.6
Total V.A.C. 44.3 81.9 26.7 30.4 36.8 42.5 136.4 39.8 45.3 54.0 61.1 200.3 262.5 334.6 426.6
growth 86% 85% 69% 60% 69% 68% 66% 49% 49% 47% 44% 47% 31% 28% 28%

Therapeutic surfaces/other
Rental 65.3 80.3 22.8 21.3 21.5 23.4 89.1 22.5 21.7 22.0 23.8 90.0 94.3 95.3 96.2
Sales 21.6 21.7 5.3 5.6 5.8 6.1 22.9 6.0 5.8 5.9 6.3 23.9 20.7 20.9 21.1
Total Therapeutic surfaces/other 87.0 102.0 28.2 26.9 27.4 29.5 112.0 28.5 27.4 27.9 30.1 113.9 115.1 116.2 117.4
growth 11% 17% 20% 4% 9% 7% 10% 1% 2% 2% 2% 2% 1% 1% 1%

Total OUS Rental 86.8 121.679 36.2 36.7 40.1 44.6 157.6 42.4 44.1 48.8 53.8 189.1 222.9 259.3 305.3
Total OUS Sales 44.8 62.275 18.7 20.6 24.0 27.4 90.8 25.9 28.7 33.1 37.5 125.2 154.6 191.6 238.7

Total International 131.2 184.0 54.9 57.3 64.1 72.0 248.3 68.3 72.8 81.9 91.3 314.3 377.5 455.8 559.0
growth 29% 40% 39% 28% 37% 36% 35% 24% 27% 28% 27% 27% 20% 21% 23%

Total Revenue 580.4 763.8 224.8 237.0 257.2 273.7 992.6 274.6 291.4 316.5 342.3 1,224.7 1,467.4 1,702.3 1,947.3
growth 27% 32% 35% 30% 30% 26% 30% 22% 23% 23% 25% 23% 20% 16% 14%
Source: JPMorgan estimates and company reports.

17
Michael Weinstein North America Equity Research
(1-212) 622-6635 18 April 2005
mike.weinstein@jpmorgan.com

18
Michael Weinstein North America Equity Research
(1-212) 622-6635 18 April 2005
mike.weinstein@jpmorgan.com

Companies Recommended in This Report


Kinetic Concepts, Inc (KCI/$57.55/Overweight)
Analyst Certification
The research analyst who is primarily responsible for this research and whose name is listed first on the front cover certifies
(or in a case where multiple analysts are primarily responsible for this research, the analyst named first in each group on the
front cover or named within the document individually certifies, with respect to each security or issuer that the analyst
covered in this research) that: (1) all of the views expressed in this research accurately reflect his or her personal views
about any and all of the subject securities or issuers; and (2) no part of any of the research analyst's compensation was, is, or
will be directly or indirectly related to the specific recommendations or views expressed by the research analyst in this
research.
Important Disclosures:

• Lead or Co-manager: JPMSI or its affiliates acted as lead or co-manager in a public offering of equity and/or
debt securities for Kinetic Concepts, Inc within the past 12 months.
• Client of the Firm: Kinetic Concepts, Inc is or was in the past 12 months a client of JPMSI; during the past 12
months, JPMSI provided to the company investment banking services, non-investment banking securities-
related service and non-securities-related services.
• Investment Banking (past 12 months): JPMSI or its affiliates received in the past 12 months compensation for
investment banking services from Kinetic Concepts, Inc.
• Investment Banking (next 3 months): JPMSI or its affiliates expect to receive, or intend to seek, compensation
for investment banking services in the next three months from Kinetic Concepts, Inc.
• Non-Investment Banking Compensation: JPMSI has received compensation in the past 12 months for products
or services other than investment banking from Kinetic Concepts, Inc. An affiliate of JPMSI has received
compensation in the past 12 months for products or services other than investment banking from Kinetic
Concepts, Inc.

Kinetic Concepts, Inc (KCI) Price Chart


135

120
105

90 OW OW $75
75
Price($)
60
45
30
15
0
Feb May Sep Dec Apr
04 04 04 04 05

Source: Reuters and JPMorgan; price data adjusted for stock splits and dividends.
Initiated coverage Apr 05, 2004. This chart shows JPMorgan's continuing coverage of this stock; the current analyst may
or may not have covered it over the entire period. As of Aug. 30, 2002, the firm discontinued price targets in all
markets where they were used. They were reinstated at JPMSI as of May 19th, 2003, for Focus List (FL) and selected Latin
stocks. For non-JPMSI covered stocks, price targets are required for regional FL stocks and may be set for other stocks
at analysts' discretion.
JPMorgan ratings: OW = Overweight, N = Neutral, UW = Underweight.
Ratings prior to Sept. 25, 2002: B = Buy, LTB = Long-Term Buy, MP = Market Performer, MU = Market Underperformer.

Explanation of Ratings: JPMorgan uses the following rating system: Overweight [Over the next six to twelve months,
we expect this stock will outperform the average total return of the stocks in the analyst’s (or the analyst’s team’s) coverage
universe.] Neutral [Over the next six to twelve months, we expect this stock will perform in line with the average total
return of the stocks in the analyst’s (or the analyst’s team’s) coverage universe.] Underweight [Over the next six to twelve
months, we expect this stock will underperform the average total return of the stocks in the analyst’s (or the analyst’s
team’s) coverage universe.] The analyst or analyst’s team’s coverage universe is the sector and/or country shown on the
cover of each publication. Each analyst’s coverage list, showing full coverage universe, is available on the analyst’s page

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Michael Weinstein North America Equity Research
(1-212) 622-6635 18 April 2005
mike.weinstein@jpmorgan.com

under the Research option on JPMorgan’s website www.morganmarkets.com, accessible to JPMorgan’s clients via
password, or in the case of hard copy research or if no access to MorganMarkets, by calling this toll free number (1-800-
477-0406).
Prior to September 25, 2002, our rating system was: Buy — we expect the stock to outperform the market by a minimum of
5% within an investment horizon of one year; Long-Term Buy — we believe the stock will outperform the market over the
long run, but we lack the visibility of a catalyst for outperformance within a one-year investment horizon; Market
Performer — the stock is expected to perform in line with the market; Market Underperformer — we expect the stock to
underperform the market by a minimum of 5% within an investment horizon of one year.

JPMorgan Equity Research Ratings Distribution, as of March 31, 2005


Overweight Neutral Underweight
(buy) (hold) (sell)
JPM Global Equity Research Coverage 39% 42% 18%
IB clients* 47% 47% 37%
JPMSI Equity Research Coverage 34% 48% 18%
IB clients* 66% 59% 45%
*Percentage of investment banking clients in each rating category.
For purposes only of NASD/NYSE ratings distribution rules, our Overweight rating falls into a buy rating category, our Neutral rating falls into a hold
rating category, and our Underweight rating falls into a sell rating category.

Valuation and Risks: Company notes and reports include a discussion of valuation methods used, including methods used
to determine a price target (if any), and a discussion of risks to the price target.

Analysts’ Compensation: The equity research analysts responsible for the preparation of this report receive compensation
based upon various factors, including the quality and accuracy of research, client feedback, competitive factors, and overall
firm revenues, which include revenues from, among other business units, Institutional Equities and Investment Banking.

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General: Information has been obtained from sources believed to be reliable but JPMorgan Chase & Co. or its affiliates and/or subsidiaries (collectively
JPMorgan) do not warrant its completeness or accuracy except with respect to any disclosures relative to JPMSI and/or its affiliates and the analyst’s
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Securities, financial instruments or strategies mentioned herein may not be suitable for all investors. The opinions and recommendations herein do not take
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issued to private clients in the U.K. is subject to the following: the investments and strategies discussed here may not be suitable for all investors; if you

20
Michael Weinstein North America Equity Research
(1-212) 622-6635 18 April 2005
mike.weinstein@jpmorgan.com

have any doubts you should consult your investment advisor. The investments discussed may fluctuate in price or value. Investors may get back less than
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Revised March 31, 2005.
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Copyright 2005 JPMorgan Chase & Co. All rights reserved. Additional information available upon request.

21
Michael Weinstein North America Equity Research
(1-212) 622-6635 18 April 2005
mike.weinstein@jpmorgan.com