equity research october 30, 2008 q4 2008 hme sleep & wound...

Please see page 11 for rating definitions, important disclosures and required analyst certifications. WCM 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 the report and investors should consider this report as only a single factor in making their investment decision.

A publication of

WACHOVIA CAPITAL MARKETS, LLC

Equity Research Q4 2008 HME Sleep & Wound Care Survey Sector Rating: Orthopedics, Overweight Sector Rating: Respiratory, Market Weight Stock Price FY EPS FY P/E

Company Name Rating 10/30/08 2008E 2009E 2008 2009

Orthopedics Kinetic Concepts, Inc. (KCI) 1 V $24.04 $3.53 $3.83 6.8x 6.3xRespiratory ResMed Inc. (RMD) 1 V 34.06 1.52 A 1.83 22.4x 18.6x

Source: Company data and WCM, LLC estimates NA = Not Available, NC = No Change, NE = No Estimate, NM = Not Meaningful1= Outperform, 2 = Market Perform, 3 = Underperform, V = Volatile

• Sleep Growth Looks Steady. We partnered with HME Business magazine to

conduct our 5th survey of home medical equipment dealers (HMEs). The survey included responses from 190 HMEs received 10/17/08-10/27/08. HMEs expect sleep revenue to grow by 10% (vs. 10% in Q2) in the next 12 months after growing at 8% (vs. 9% in Q2) in the last 12 months. This is about in line with our estimate of 10-12% growth in the U.S. market. Though expectations for growth declined in our earlier surveys, they have stabilized at 10% in our last two surveys.

• HMEs Have Begun To Manage CPAP Costs Ahead Of Medicare's 9.5% Cut. Although Medicare's competitive bidding program was delayed by 18 months, a 9.5% reimbursement cut begins on 1/1/09. A majority of HMEs (56%) have already begun to implement changes to lower CPAP costs. HMEs appear most likely to negotiate lower prices with existing suppliers and to move Medicare patients to lower cost CPAPs. And 81% of HMEs expect private insurers to cut reimbursement based on Medicare's cut; this represents potential downside to our RMD estimates.

• Respironics May Gain Some Share Though RMD Should Benefit From Its New Apria Contract. RMD's S8 II was rated 5.7 on a scale from 1 (very poor) to 7 (very good) while Respironics' M Series was rated 5.8. RMD's Swift LT was rated 5.8 while Respironics' OptiLife was rated 5.2. Respironics may gain share in both flow generators (43% expect to increase purchases, 18% to decrease) and masks (39% expect to increase purchases, 12% to decrease). This is somewhat better than RMD's flow generators (36% expect to increase purchases, 21% to decrease) and masks (36% expect to increase purchases, 16% to decrease). However, we continue to believe that RMD will gain market share within Apria (which makes up about 15% of the U.S. sleep market but was likely underrepresented in our survey).

• So Far, Impact Of Credit Crunch And Economy Appears Minimal. Most (57%) HMEs have reduced inventories to conserve cash though only a minority (20%) have seen more difficulty in borrowing money. On average, HMEs indicated that 15% of CPAP purchases are "out-of-pocket" and 12% have seen a major decline in "out-of-pocket" purchases in the past 3-6 months.

• We Remain Positive On RMD Despite Mixed Survey Results. On one hand, the sleep market appears stable with minimal economic exposure. On the other hand, Respironics appears set to gain share outside of Apria and private insurers could follow Medicare's cuts. We continue to expect upside to RMD’s EPS estimates from the Apria contract and favorable currency movements.

October 30, 2008

Medical Technology/Devices

Michael Matson, CFA, Senior Analyst (212) 214-8017 / michae l .matson@wachovia .com Vincent Ricci, Associate Analyst (212) 214-8016 / v incen t . r i cc i@wachovia .com

WACHOVIA CAPITAL MARKETS, LLC Medical Technology/Devices EQUITY RESEARCH DEPARTMENT

2

Survey Background Wachovia partnered with the trade magazine HME Business to conduct our latest survey of home medical equipment (HME) providers. Among the ~4,000 HME professionals that we sent the survey to, 190 responded to one or more of the survey questions for a total participation rate of about 5%. None of the questions in this survey were mandatory, therefore response rates varied from question to question (we note the response rates for questions on each of the charts). Of the 190 respondents, 162 (or 85%) completed the entire survey. The surveys replies were received between 10/17/08 and 10/27/08. Survey Says… Sleep Therapy Questions …HME Expectations For Sleep Revenue Growth Have Stabilized At 10% On average, HMEs report 8.1% growth in the past 12 months and expect 9.7% growth in the next 12 months. The retrospective growth was down 80 bps from Q2 2008 survey while the forward outlook was stable at 9.7%. Of the respondents, 15% saw a decline in their sleep revenue in the past 12 months (vs. 11% in our prior survey) and only 7% expect a decline in the next 12 months (vs. 9% in our prior survey). These growth rates compare with our estimate of low-teens (10-12%) domestic growth. HME growth expectations declined in the first three surveys we conducted falling from 15% in our Q4 2006 survey to 10% in our Q2 2008 survey. Expectations in this survey matched our prior survey, however. This is consistent with our belief that the domestic sleep market has slowed due to greater penetration (which we estimate is around 35%), slower expansion at sleep labs ahead of home testing, and a slowing mix shift towards higher-end flow generators. Figure 1: Sleep Revenue Growth Past 12 Months Figure 2: Sleep Revenue Growth Next 12 Months

2% 2%

5%6%

19% 20%

26%

9% 10%

0%

5%

10%

15%

20%

25%

30%

Declinedby 30%or more

Declinedby 20-29%

Declinedby 10-19%

Declinedby 0-9%

Nochange

Grew by0-9%

Grew by10-19%

Grew by20-29%

Grew by30% ormore

Perc

ent O

f Res

pond

ents

n = 171

Average = 8.1%

2%1%

3%1%

17%

27% 28%

14%

7%

0%

5%

10%

15%

20%

25%

30%

Declineby 30%or more

Declineby 20-29%

Declineby 10-19%

Declineby 0-9%

Nochange

Grow by0-9%

Grow by10-19%

Grow by20-29%

Grow by30% ormore

Perc

ent O

f Res

pond

ents

n = 172

Average = 9.7%

Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey

WACHOVIA CAPITAL MARKETS, LLC Q4 2008 HME Sleep & Wound Care Survey EQUITY RESEARCH DEPARTMENT

3

Figure 3: Sleep Revenue Growth (Time Series)

12%

13%

10%

9%8%

15%

12%11%

10% 10%

0%

2%

4%

6%

8%

10%

12%

14%

16%

Q4 2006 Q2 2007 Q4 2007 Q2 2008 Q4 2008

Perc

ent O

f Res

pond

ents

Last 12 Months Next 12 Months

Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey … HMEs Are Already Taking Steps To Rein In CPAP Costs Ahead Of Medicare’s 9.5% Reimbursement Cut (1/1/09) We suspected that the slowdown in the domestic sleep market may have been due in part to HMEs preparing to deal with competitive bidding and the subsequent 9.5% reimbursement cut. We asked questions to determine how the HMEs intended to deal with these pressures and whether or not they had begun to take any steps in this direction. Based on our questions, the HMEs appear more likely to stick with their existing suppliers but to negotiate lower prices and move Medicare patients to lower-end devices. The HMEs look somewhat less likely to move to lower priced suppliers or to move patients to lower-end devices from new suppliers. And the HMEs appear very unlikely to stop servicing Medicare patients. Many HMEs (57% of respondents) indicated that they have already begun to implement some of these strategies. We think that this may be driving a mix shift away from higher-end units which might be a factor in the domestic sleep market slowdown. Given that competitive bidding will be rolled out over the next few years, we think that the domestic market may remain under pressure for some time. Figure 4: Given Declining Medicare Reimbursement, How Likely Is Your Firm To Do The Following (Time Series):

Figure 5: Has Your Firm Begun To Implement Any Of These Changes Yet?

5.3

4.64.3 4.2

2.2

5.3

4.64.9

4.6

2.4

0

1

2

3

4

5

6

7

Negotiate lower priceswith existing CPAP

suppliers

Switch to lower pricedCPAP suppliers

Give Medicarepatients less featured

(lower cost)CPAPs/masks fromexisting suppliers

Give Medicarepatients less featured

(lower cost)CPAPs/masks from

new suppliers

Stop servicingMedicare sleep

patientsLike

lihoo

d, S

cale

Of 1

(Ver

y U

nlik

ely)

To

7 (V

ery

Like

ly) Q408 HME Survey

Q208 HME Survey

n = 166

Unsure7%

Yes56%

No37%

n = 167 Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey


4

…There Is A Risk That Medicare’s Cut Spills Over To Private Insurers Prior to our Q2 2008 survey, we had been operating under the assumption that the declines in Medicare CPAP reimbursement that result from competitive bidding will not be followed by private insurers. At that time, 89% of respondents felt that private pay insurers could follow Medicare’s lead in lowering reimbursement. The CPAP industry has stated that private insurance pays significantly less than Medicare and that competitive bidding dynamics already exist. Medicare only makes up 20% of the payer mix for CPAP therapy with most of the rest made up by private insurance. With the reimbursement cuts limited to Medicare, only about 10% of ResMed’s revenue is exposed. However, if there is spill over to private insurers, up to another 40% of ResMed’s revenue would potentially be exposed. We asked a question in our surveys to attempt to test this assumption. In our latest survey, 81% of respondents indicated that they expect private insurers to lower their reimbursement as a result of Medicare’s cuts under competitive bidding. These results appear to indicate that there is potential for at least some private insurers to cut reimbursement leading to greater exposure for ResMed. In the worst case scenario with all private insurers following Medicare’s cut on 1/1/09 (which is admittedly unlikely), we estimate that ResMed’s EPS could be reduced by around $0.20 in calendar 2009 (see our 6/24/08 note titled Competitive Bidding Delay Analysis). Figure 6: Do You Believe That Private Insurers Will Use CMS's 9.5% Cut To Lower Their CPAP Reimbursement?

Unsure13%

Yes81%

No6%

n = 169

Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey …There Is Also A Risk That Prolonged Pressure On The Consumer Could Impact “Out-Of-Pocket” Expenditures On CPAP, But So Far The Effect Is Minimal Prior to our current survey, we had quantified the “at risk” consumer discretionary portion of CPAP expenditure to be approximately 5-10%. We asked questions on this survey to test this hypothesis and further attempt to quantify any impact on this revenue stream due to economic pressures on consumers. Based on the responses to our survey, approximately 15% of CPAP purchases from HMEs could be classified as “out-of-pocket.” However, the HMEs indicate that at least so far, little impact has been seen on out-of-pocket expenditures on CPAP.


5

Figure 7: What Portion Of Your Firm's CPAP Supply Sales Are "Out-Of-Pocket" (Not Covered By Insurance)?

Figure 8: Has Your Firm Seen A Change In "Out-Of-Pocket" Purchases Of CPAP Supplies In The Past 3-6 Months?

43%

38%

15%

0% 0%3%

0% 0%3%

0%0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

0-10% 11-20% 21-30% 31-40% 41-50% 51-60% 61-70% 71-80% 81-90% 91-100%

Perc

ent C

lient

s Pa

ying

Out

Of P

ocke

t

n = 150

Average = 15%

We have seen a minor decline

15%

We have seen a major decline

12%Unsure

34%

We have seen a major increase

5% We have seen a minor increase

34%

n = 169 Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey Finally we asked questions intended to quantify the impact of the credit crisis on the HMEs themselves (and not just their customers) since the HMEs are the direct customers to ResMed and other CPAP manufacturers. By and large the impact on the HMEs has been minimal with the only significant trend being a decrease in inventories by the HMEs to conserve cash. The HMEs themselves have not significantly seen borrowing costs rise or had difficulty raising capital. Figure 9: Given The Recent Credit Market Turmoil, Has Your Firm:

0%

10%

20%

30%

40%

50%

60%

70%

Had increaseddifficulty borrowing

money?

Had to pay higherinterest rates?

Reduced inventoriesto conserve cash?

Delayed payments tosuppliers to conserve

cash?

Renegotiatedpayment terms with

suppliers to conservecash?

Perc

ent O

f Res

pond

ents

Yes No Unsuren = 44

Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey


6

…Price Declines On Flow Generators And Masks Are Stable HMEs report that the average prices that they pay for flow generators and masks declined by averages of 2.5% and 0.1%, respectively, over the past 12 months. These are essentially in line with the price declines seen in our prior survey (2.5% for flow generators and 0.3% for masks) indicating that average selling prices (ASPs) have continued to decline at a consistent rate in flow generators but remained flat in masks. The manufacturers cite 5-15% annual price declines, however. How do we explain this differential? We think that the manufacturers refer to pure pricing while the HMEs refer to average selling prices which account for the effect of mix shifts as well as pricing. While these mix shifts continue to be positive, we think that reimbursement pressures have slowed the mix shift and may continue to do so for the next few years. Figure 10: By What % Has The Average Price You Pay For A Flow Generator Changed In Past 12 Months?

Figure 11: By What % Has The Average Price You Pay For A Mask Changed In Past 12 Months?

4%

12% 13%15%

38%

10%

7%

1%0%

0%

5%

10%

15%

20%

25%

30%

35%

40%

Declinedby 15% or

more

Declinedby 10-14%

Declinedby 5-9%

Declinedby 0-4%

No change Grew by 0-4%

Grew by 5-9%

Grew by10-14%

Grew by15% ormore

Perc

ent O

f Res

pond

ents

n = 141

Average = (2.5%)

3%5%

8% 8%

39%

23%

11%

2% 1%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

Declinedby 15% or

more

Declinedby 10-14%

Declinedby 5-9%

Declinedby 0-4%

No change Grew by 0-4%

Grew by 5-9%

Grew by10-14%

Grew by15% ormore

Perc

ent O

f Res

pond

ents

n = 152

Average = (0.1%)

Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey Figure 12: Change In Average Flow Generator Prices (Time Series)

Figure 13: Change In Average Mask Prices (Time Series)

(3.0%)

(1.8%)

(2.1%)

(2.5%) (2.5%)

(3.5%)

(3.0%)

(2.5%)

(2.0%)

(1.5%)

(1.0%)

(0.5%)

0.0%Q4 2006 Q2 2007 Q4 2007 Q2 2008 Q4 2008

Perc

enta

ge C

hang

e In

Ave

rage

Pric

e, P

ast Y

ear

1.5%

(1.6%)

(0.3%)(0.1%)(0.1%)

(2.0%)

(1.5%)

(1.0%)

(0.5%)

0.0%

0.5%

1.0%

1.5%

2.0%

Q4 2006 Q2 2007 Q4 2007 Q2 2008 Q4 2008

Perc

enta

ge C

hang

e In

Ave

rage

Pric

e, P

ast Y

ear

Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey


7

…Respironics’ Flow Generators Were Rated Highest And Respironics Looks Likely To Gain Some Flow Generator Market Share ResMed’s newest flow generator, the S8 II rated about in line with our Q2 2008 survey at 5.7 out of 7.0. Respironics’ M-Series received the highest rating at 5.8 which may indicate that Respironics’ product cycle remains fresh. Fisher & Paykel’s HC200/HC600 was rated 5.1, in line with our last survey, while the new Covidien Sandman lagged the group at 4.5 but showed some improvement over the prior GoodKnight series which consistently rated below 4.0. We also had the HMEs rate the newer low-end flow generators from ResMed and Respironics. The HMEs gave ResMed’s Tango a 4.4 and Respironics’ Sleep Easy a 5.4. Figure 14: Flow Generator Platform Ratings Figure 15: Flow Generator Platform Ratings (Time Series)

4.6

5.1

5.7

4.4

5.85.4

4.5

0

1

2

3

4

5

6

7

IntelliPAP(DeVilbiss)

HC200/HC600(Fisher &Paykel)

S8 Series II(ResMed)

Tango(ResMed)

M-Series(Respironics)

Sleep Easy(Respironics)

Sandman(CovidienPuritan

Bennett)

Ave

rage

Rat

ing,

Sca

le O

f 1 (W

orst

) To

7 (B

est)

n = 39

n = 87

n = 110

n = 59

n = 130

n = 85

n = 43

0

1

2

3

4

5

6

7

HC200/HC600(Fisher &Paykel)

S8/S8 II(ResMed)

Tango(ResMed)

M-Series(Respironics)

Sleep Easy(Respironics)

Sandman(CovidienPuritan

Bennett)

Ave

rage

Rat

ing,

Sca

le O

f 1 (W

orst

) To

7 (B

est)

Q4 2006 Q2 2007 Q4 2007 Q2 2008 Q4 2008

Ratings for prior platform the "GoodKnight" Series

Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey Consistent with the ratings, the HMEs indicated that they intend to increase their purchases of Respironics’ flow generators by more than any other companies’ flow generators (43% of respondents expect to increase Respironics' flow generator purchases vs. 18% that expect to decrease purchases). ResMed still appears to have a strong trajectory (36% expect to increase purchases, 21% to decrease) while Fisher & Paykel looks likely to hold flow generator market share and Covidien (COV) could continue to lose flow generator market share despite its improved product line-up. Figure 16: In Next 12 Months Will Your Flow Generator Purchases Decrease, Increase, Or Stay Unchanged…

Figure 17: Difference In % Of Respondents Increasing Vs. Decreasing Purchases (Time Series)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Fisher & Paykel Covidien PuritanBennett

ResMed Respironics

Decrease Stay Unchanged Increasen = 154

3%

10%

(5%)

29%

11%

6%

14%

6%

(27%)

13%

42%

2%

(8%)

22%

12%

(4%)

10%

15%

26%

(3%)

(40.0%)

(30.0%)

(20.0%)

(10.0%)

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%


ResMed Respironics

% In

crea

sing

Min

us %

Dec

reas

ing

Purc

hase

s, N

ext 1

2 M

onth

s

Q4 2006 Q2 2007 Q4 2007 Q2 2008 Q4 2008 Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey


8

…ResMed’s Masks Were Rated Highest But Respironics Looks Likely To Gain Some Mask Market Share ResMed continues to have the best masks according to our survey. In the nasal pillow category, ResMed’s Swift LT was the highest rated at 5.8 (out of 7.0) followed by Respironics’ OptiLife (5.2) and ComfortLite 2 (5.1) while trailed by Fisher & Paykel’s Opus (4.9). These results are largely consistent with our prior HME surveys though nearly all the masks were rated less highly in this survey. Figure 18: Nasal Pillow Mask Ratings Figure 19: Mask Ratings (Time Series)

4.1

5.8

5.1 5.24.9

0

1

2

3

4

5

6

7

Breeze (CovidienPuritan Bennett)

Mirage Swift LT(ResMed)

ComfortLite 2(Respironics)

OptiLife (Respironics) Opus (Fisher &Paykel)

Ave

rage

Rat

ing,

Sca

le O

f 1 (W

orst

) To

7 (B

est)

n = 98

n = 130 n = 128 n = 122

n = 90

0

1

2

3

4

5

6

7

Breeze (PuritanBennett)

Mirage Swift(ResMed)

ComfortLite 2(Respironics)

OptiLife(Respironics)

Opus (Fisher &Paykel)

Ave

rage

Rat

ing,

Sca

le O

f 1 (W

orst

) To

7 (B

est)

Q4 2006 Q2 2007 Q4 2007 Q2 2008 Q4 2008 Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey Figure 20: In Next 12 Months Will Your Mask Purchases Decrease, Increase, Or Stay Unchanged…

Figure 21: Difference In % Of Respondents Increasing Vs. Decreasing Purchases (Time Series)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%


ResMed Respironics

Decrease Stay Unchanged Increasen = 127

12%

3% 2%

16%15%

(16%)

6%

15%

(33%)

32%

41%

8%

(7%)

29%25%

(8%)

9%

20%

27%

10%

(40.0%)

(30.0%)

(20.0%)

(10.0%)

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

Q4 2008

% In

crea

sing

Min

us %

Dec

reas

ing

Purc

hase

s, N

ext 1

2 M

onth

s

Q4 2006 Q2 2007 Q4 2007 Q2 2008 Q4 2008 Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey …Only A Small Number Of HMEs Currently Administer Home Sleep Apnea Tests Though More Plan To Start Over Next 12 Months Only 9% of respondents currently offer patients home testing for sleep apnea. Another 16% of respondents plan to begin offering home testing over the next 12 months (down from 43% in our last survey) with the bulk starting in 6 months or more. This supports our view that home testing while home testing could be a significant driver, recent Local Coverage Determinations (LCDs) have somewhat constrained the incentives for HMEs to participate and the impact of any uptake is not likely to kick in until late 2009 at the earliest.


9

Figure 22: Does Your Firm Currently Administer Home Tests For Sleep Apnea?

Figure 23: Does Your Firm Plan To Begin Administering Home Tests For Sleep Apnea In The Next...

No90%

Yes9%

Unsure1%

n = 162

...6 months?4%

...3 months?4%

No plans to begin home testing

83%

...12 months?9%

n = 141 Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey Negative Pressure Wound Therapy (NPWT) Questions …A Minority Of HMEs Participating Offer Negative Pressure Wound Therapy (NPWT) But More Plan To Offer It In The Next 6 Months Most HMEs in our survey are not participating in the NPWT market (only 12% currently offer NPWT products) but more plan to enter in the next 6 months (14% expect to begin offering NPWT products). These numbers are consistent with our prior survey (in which 12% currently offered NPWT product and 16% expected to begin offering NPWT products). Figure 24: Do You Currently Offer NPWT? Figure 25: Do You Plan To Begin Offering NPWT In Next 6

Months?

No88%

Yes12%

n = 188

No86%

Yes14%

n = 163 Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey …Smith & Nephew, Medela, & Innovative Therapies Are Most Common NPWT Suppliers; HMEs Are Focused On Home Setting But Some Sell Into Extended & Acute Settings Most HMEs that offer or plan to offer NPWT are purchasing products from Smith & Nephew, Innovative Therapies, and Medela. Not surprisingly, the HMEs are mainly focused on offering NPWT in the home care setting (90%) but some are offering NPWT in the acute care (50%) and even extended care (45%) settings.


10

We note that while CMS data shows that HMEs have struggled to collect Medicare payments for home-based NPWT (rejection rates are >75%), payments in the other care settings are from the facilities not insurers which may make it easier to collect payments. Figure 26: From Which Supplier Do You Purchase NPWT Pumps?

Figure 27: In Which Care Settings Do You Offer NPWT?

18%

24%

35%

59%

6%

53%

33%

67%

47%

0%0%

10%

20%

30%

40%

50%

60%

70%

80%

Boehringer WoundSystems

Innovative Therapies Medela Smith & Nephew Talley Group

Perc

ent O

f Res

pond

ents

Currently In NPWT Market (n=17)Plan To Enter NPWT Market (n = 15)

18%

24%

35%

59%

6%

53%

33%

67%

47%

0%0%

10%

20%

30%

40%

50%

60%

70%

80%

Boehringer WoundSystems

Innovative Therapies Medela Smith & Nephew Talley Group

Perc

ent O

f Res

pond

ents

Currently In NPWT Market (n=17)Plan To Enter NPWT Market (n = 15)

Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey …Most HMEs Offer NPWT Pumps On A Rental Basis We asked HMEs about their sales model for NPWT to determine if they were renting or selling the pumps. The majority of HMEs rent the pumps although some said that the sales model depends on the care setting. While we think it makes more sense economically for HMEs to rent pumps, it is possible that more cost sensitive customers may prefer to purchase rather than rent the pumps. Figure 28: Sales Model For HMEs Offering Or Planning To Offer NPWT Products

57%

0%

43%

48%

0%

52%

0%

10%

20%

30%

40%

50%

60%

Rent Sell Depends on care setting

Perc

ent O

f Res

pond

ents

Currently In NPWT Market (n=21) Plan To Enter NPWT Market (n = 21)

Source: Wachovia Capital Markets, LLC Q4 2008 HME Survey


11

Required Disclosures

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3/13

/07

4/10

/07

5/8/

07

6/5/

077/

3/07

7/31

/07

8/28

/07

9/25

/07

10/2

3/07

11/2

0/07

12/1

8/07

1/15

/08

2/12

/08

3/11

/08

4/8/

085/

6/08

6/3/

087/

1/08

7/29

/08

8/26

/08

9/23

/08

10/2

1/08

Secu

rity

Pric

e

Kinetic Concepts, Inc. (KCI) 3-yr. Price PerformanceKinetic Concepts, Inc. (KCI) 3-yr. Price Performance

Date

Date Publication Price ($) Rating Code Val. Rng. Low Val. Rng. High Close Price ($) 8/27/2007 Matson

8/27/2007 61.48 2 62.00 65.00 61.48 9/17/2007 58.11 2 60.00 65.00 58.11 12/6/2007 56.04 2 57.00 63.00 56.04 1/11/2008 51.10 2 52.00 57.00 51.02 4/8/2008 49.57 1 58.00 62.00 48.30

10/13/2008 22.44 1 45.00 50.00 24.21 10/23/2008 20.39 1 38.00 42.00 20.61

Source: Wachovia Capital Markets, LLC estimates and Reuters data

Symbol Key Rating Code Key

Rating Downgrade Initiation, Resumption, Drop or Suspend 1 Outperform/Buy SR Suspended Rating Upgrade Analyst Change 2 Market Perform/Hold NR Not Rated Valuation Range Change Split Adjustment 3 Underperform/Sell NE No Estimate


12

$27.00

$29.00

$31.00

$33.00

$35.00

$37.00

$39.00

$41.00

$43.00

$45.00

$47.00

$49.00

$51.00

$53.00

$55.00

$57.00

$59.00

$61.00

10/2

5/05

11/2

2/05

12/2

0/05

1/17

/06

2/14

/06

3/14

/06

4/11

/06

5/9/

06

6/6/

06

7/4/

06

8/1/

06

8/29

/06

9/26

/06

10/2

4/06

11/2

1/06

12/1

9/06

1/16

/07

2/13

/07

3/13

/07

4/10

/07

5/8/

07

6/5/

07

7/3/

07

7/31

/07

8/28

/07

9/25

/07

10/2

3/07

11/2

0/07

12/1

8/07

1/15

/08

2/12

/08

3/11

/08

4/8/

08

5/6/

08

6/3/

08

7/1/

08

7/29

/08

8/26

/08

9/23

/08

10/2

1/08

Secu

rity

Pric

e

R e s M e d In c . (R M D ) 3 -y r. P ric e P e rfo rm a n c eR e s M e d In c . (R M D ) 3 -y r. P ric e P e rfo rm a n c e

Date

D ate P u b lic a tio n P ric e ($ ) R atin g C o d e V a l. R n g . L o w V a l. R n g . H ig h C lo s e P ric e ($ ) 10 /25 /20 0 5 M a ts on 10 /25 /20 0 5 N A 1 3 9 .0 0 4 0 .5 0 3 8 .7 4

1 1 /3 /2 0 0 5 N A 1 4 2 .0 0 4 4 .0 0 3 7 .6 0 2 /8 /2 00 6 N A 1 4 6 .0 0 4 8 .0 0 4 0 .4 1 3 /3 0 /2 0 0 6 N A 1 4 8 .0 0 5 0 .0 0 4 3 .4 8 5 /5 /2 00 6 N A 1 4 9 .0 0 5 2 .0 0 4 8 .3 6 8 /1 8 /2 0 0 6 N A 1 5 2 .0 0 5 5 .0 0 4 3 .1 0

9 /1 1 /2 0 0 6 N A 2 4 0 .0 0 4 4 .0 0 3 9 .0 4 1 1 /9 /2 0 0 6 N A 2 4 2 .0 0 4 7 .0 0 4 6 .0 2

2 /2 /2 00 7 N A 1 6 1 .0 0 6 6 .0 0 5 4 .2 6 2 /7 /2 00 7 N A 1 6 0 .0 0 6 5 .0 0 5 0 .0 0 4 /2 3 /2 0 0 7 N A 1 5 0 .0 0 5 5 .0 0 4 8 .6 4 6 /6 /2 00 7 N A 1 5 2 .0 0 5 6 .0 0 4 4 .4 4 8 /7 /2 00 7 N A 1 5 0 .0 0 5 4 .0 0 4 5 .4 0

1 /2 /2 00 8 52 .5 3 2 5 1 .0 0 5 5 .0 0 5 1 .3 1 2 /8 /2 00 8 44 .3 3 2 4 0 .0 0 4 5 .0 0 4 3 .3 6 2 /1 2 /2 0 0 8 42 .4 9 2 3 8 .0 0 4 3 .0 0 4 2 .4 9 7 /2 1 /2 0 0 8 37 .0 0 2 3 6 .0 0 3 9 .0 0 3 7 .0 0 8 /2 5 /2 0 0 8 45 .1 7 2 4 3 .0 0 4 7 .0 0 4 5 .1 7 9 /1 6 /2 0 0 8 47 .4 0 2 4 4 .0 0 4 8 .0 0 4 7 .4 0

10 /13 /20 0 8 33 .9 0 1 4 0 .0 0 4 4 .0 0 3 6 .5 4

S ou rce : W a cho v ia C a p ita l M a rke ts , L LC e s tim a te s a n d R eu te rs d a ta

S y m b o l K e y R a tin g C o d e K ey R a tin g D ow n g ra de In itia tio n , R e su m p tio n , D ro p o r S u sp en d 1 O u tpe rfo rm /B u y S R S u sp e n de d R a tin g U pg ra d e A n a lys t C h a n g e 2 M a rke t P erfo rm /H o ld N R N o t R a ted V a lu a tio n R a n ge C h a n ge S p lit A d ju s tm e n t 3 U nd e rp erfo rm /S e ll N E N o E s tim a te

Additional Information Available Upon Request

I certify that: 1) All views expressed in this research report accurately reflect my personal views about any and all of the subject securities or issuers discussed; and 2) No part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by me in this research report. Wachovia Capital Markets, LLC or its affiliates managed or comanaged a public offering of securities for Kinetic Concepts, Inc. within the

past 12 months. Wachovia Capital Markets, LLC or its affiliates received compensation for investment banking services from Kinetic Concepts, Inc. in the

past 12 months. Kinetic Concepts, Inc. currently is, or during the 12-month period preceding the date of distribution of the research report was, a client of

Wachovia Capital Markets, LLC. Wachovia Capital Markets, LLC provided investment banking services to Kinetic Concepts, Inc. Wachovia Capital Markets, LLC does not compensate its research analysts based on specific investment banking transactions. WCM’s research analysts receive compensation that is based upon and impacted by the overall profitability and revenue of the firm, which includes, but is not limited to investment banking revenue.


13

STOCK RATING

1 = Outperform: The stock appears attractively valued, and we believe the stock's total return will exceed that of the market over the next 12 months. BUY

2 = Market Perform: The stock appears appropriately valued, and we believe the stock's total return will be in line with the market over the next 12 months. HOLD

3 = Underperform: The stock appears overvalued, and we believe the stock's total return will be below the market over the next 12 months. SELL

SECTOR RATING

O = Overweight: Industry expected to outperform the relevant broad market benchmark over the next 12 months.

M = Market Weight: Industry expected to perform in-line with the relevant broad market benchmark over the next 12 months.

U = Underweight: Industry expected to underperform the relevant broad market benchmark over the next 12 months.

VOLATILITY RATING

V = A stock is defined as volatile if the stock price has fluctuated by +/-20% or greater in at least 8 of the past 24 months or if the analyst expects significant volatility. All IPO stocks are automatically rated volatile within the first 24 months of trading.

As of: October 30, 2008

43% of companies covered by Wachovia Capital Markets, LLC Equity Research are rated Outperform.

Wachovia Capital Markets, LLC has provided investment banking services for 41% of its Equity Research Outperform-rated companies.

54% of companies covered by Wachovia Capital Markets, LLC Equity Research are rated Market Perform.

Wachovia Capital Markets, LLC has provided investment banking services for 29% of its Equity Research Market Perform-rated companies.

3% of companies covered by Wachovia Capital Markets, LLC Equity Research are rated Underperform.

Wachovia Capital Markets, LLC has provided investment banking services for 25% of its Equity Research Underperform-rated companies.

Important Disclosure for International Clients

The securities and related financial instruments described herein may not be eligible for sale in all jurisdictions or to certain categories of investors. For certain non-U.S. institutional reader (including readers in the EEA), this report is distributed by Wachovia Securities International Limited (“WSIL”). For the purposes of Section 21 of the UK Financial Services and Markets Act 2000 (“the Act”), the content of this report has been approved by WSIL a regulated person under the Act. WSIL does not deal with retail clients as defined in the Markets in Financial Instruments Directive 2007, therefore clients will automatically be deemed to be a professional or an eligible counterparty. This research is not intended for, and should not be relied upon, by retail clients.

Important Information for Australian Recipients Wachovia Capital Markets, LLC (“WCM”) is exempt from the requirements to hold an Australian financial services license in respect of the financial services it provides to wholesale clients in Australia. WCM is a registered broker-dealer registered with the U.S. Securities and Exchange Commission, and a member of the New York Stock Exchange, the Financial Industry Regulatory Authority, and the Securities Investor Protection Corp. WCM is regulated under U.S. laws which differ from Australian laws. Any offer or documentation provided to you by WCM in the course of providing the financial services will be prepared in accordance with the laws of the United States and not Australian laws.


14

Important Information for Recipients in the Hong Kong Special Administrative Region of the People's Republic of China ("Hong Kong")

For recipients resident in Hong Kong, this research is issued and distributed in Hong Kong by Wachovia Securities Asia Limited. Wachovia Securities Asia Limited is a Hong Kong incorporated investment firm licensed and regulated by the Securities and Futures Commission to carry on types 1, 4, 6 and 9 regulated activities (as defined in the Securities and Futures Ordinance [the "SFO"]). This research is not intended for, and should not be relied on by, any person other than professional investors (as defined in the SFO). The securities and related financial instruments described herein are not intended for sale nor will be sold to any person other than professional investors (as defined in the SFO). Any sale of any securities or related financial instruments described herein will be made in Hong Kong by Wachovia Securities Asia Limited. Please consult your Wachovia Securities Asia Limited sales representative or the Wachovia Securities Asia Limited office in your area for additional information.

Important Information for Japanese Recipients This material is distributed in Japan by Wachovia Securities (Japan) Co., Ltd., a foreign securities company registered with the Financial Services Agency in Japan.

Additional Disclosures WCM is a U.S. broker-dealer registered with the U.S. Securities and Exchange Commission and a member of the New York Stock Exchange, the Financial Industry Regulatory Authority and the Securities Investor Protection Corp. Wachovia Securities International Limited is a U.K. incorporated investment firm authorized and regulated by the Financial Services Authority.

This report is for your information only and is not an offer to sell, or a solicitation of an offer to buy, the securities or instruments named or described in this report. Interested parties are advised to contact the entity with which they deal, or the entity that provided this report to them, if they desire further information. The information in this report has been obtained or derived from sources believed by Wachovia Capital Markets, LLC, to be reliable, but Wachovia Capital Markets, LLC, does not represent that this information is accurate or complete. Any opinions or estimates contained in this report represent the judgment of Wachovia Capital Markets, LLC, at this time, and are subject to change without notice. For the purposes of the U.K. Financial Services Authority's rules, this report constitutes impartial investment research. Each of Wachovia Capital Markets, LLC, and Wachovia Securities International Limited is a separate legal entity and distinct from affiliated banks. Copyright © 2008 Wachovia Capital Markets, LLC.

SECURITIES: NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE

equity research october 30, 2008 q4 2008 hme sleep & wound...

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