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Please see page 16 for rating definitions, important disclosures and required analyst certifications All estimates/forecasts are as of 04/01/13 unless otherwise stated.

Wells Fargo Securities, LLC 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.

April 1, 2013

Equity Research

Healthcare Coverage Expansion A Shot In The Arm For MedTech • Summary. Based on feedback we received, we are updating our 1/15/13 analysis

to better reflect the likely device utilization rate of the newly insured under the ACA. We now model the utilization rate based on the overall insured population vs. our previous analysis that used the Medicaid population, which we believe underestimated the incremental volume benefit. Based on our new analysis, we estimate increased healthcare coverage represents a 1.5% tailwind to U.S. volume across 10 key device categories in 2014 vs. our previous estimate of 0.6%. For our covered companies (excluding AGN), we estimate median upside potential of 0.8% in worldwide sales and 2.2% in EPS in 2014. Our analysis suggests THOR, NUVA and HTWR are likely to see the most upside potential in 2014.

• What's changed in our new analysis? We now assume that the utilization rate of the newly insured will be comparable to that of the overall insured population (including private and public payors). Our prior analysis used the utilization rate of the Medicaid population, which we believe underestimated the procedure volume benefit from the expanded healthcare coverage as children account for over 50% of the Medicaid population. We see the overall insured population as a better model because: 1) its age-distribution is more similar to that of the newly insured; and 2) Medicaid is already included in this population.

• Increased coverage represents a 1.5% tailwind to U.S. volume for 10 key device categories in 2014 with orthopedic expected to benefit more than cardiovascular procedures. Given that the largest annual increase in coverage for the uninsured is in 2014, it is not surprising that we see the greatest impact on procedures in that year of 150bps (range of -0.1% to 0.7% for the other years). Our analysis also showed that in general, the incremental utilization benefit in 2014 is greater for orthopedic procedures at 1.8% vs. cardiovascular procedures at 1.0%, perhaps not surprising based on the elective nature of many of the orthopedic procedures. Based on cumulative benefit to U.S. volume of 3.6% from 2012-22, we believe this will be sufficient to offset the 2.3% medtech tax. We also expect the procedure volume benefit to offset at least some of the potential incremental pricing pressure from implementation of Accountable Care Organizations and bundled payments.

• We estimate median upside potential of 0.8% to WW sales and 2.2% to EPS in 2014. For our covered companies, we estimate median 2014 sales upside potential of $23MM or 0.8% and EPS upside potential of $0.05 or 2.2%. The incremental sales growth rate is 0.8%, which represents a 16% increase over the median current estimated 2014 sales growth rate of 5.2%. The incremental EPS growth rate is 2.4%, which represents a 23% increase over the median current estimated 2014 EPS growth rate of 10.6%.

• THOR, NUVA and HTWR expected to see most upside potential in 2014. Our analysis suggests that THOR, NUVA, and HTWR are likely the biggest beneficiaries in 2014. For NUVA, we estimate upside potential of 2.9% in sales and 19% in EPS. For THOR, we estimate upside potential of 3.5% in sales and 8% in EPS. For HTWR, we estimate upside potential of 2.1% in sales.

• Incremental procedure volume supports premium valuation. With the incremental procedure volume expected in 2014, which is not reflected in our estimates or that of the Street in our view, we believe the large-cap medtech group's 10% premium valuation to S&P 500 is warranted.

Medical Technology

Larry Biegelsen, Senior Analyst(212) 214-8015 /

[email protected] Huang, Associate Analyst

(212) 214-8039 / lei [email protected]

Kevin Strange, Associate Analyst(212) 214-8042 /

[email protected] W. Bijou, Associate Analyst

(212) 214-8038 / [email protected]

WELLS FARGO SECURITIES, LLC Medical Technology EQUITY RESEARCH DEPARTMENT

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Discussion UPDATING OUR JANUARY 2013 ANALYSIS OF IMPACT FROM INCREASED HEALTHCARE COVERAGE – WHAT’S CHANGED? Based on feedback we received, we are updating our January 2013 analysis of the potential impact from increased healthcare coverage under the Affordable Care Act (ACA). Our prior analysis assumed the utilization rate of the newly insured under the ACA will reflect that of the Medicaid population (see “ACA Impact on MedTech Utilization Likely Small” dated 1/15/13). However, a further analysis indicates that there are differences in the demographics of the uninsured and Medicaid populations which very likely depressed the previous estimated increase in utilization. The most notable difference is that the Medicaid population tends to be much younger than the uninsured population (Figure 1). As such, we have updated our analysis by looking at key device utilization rates by age groups and assuming utilization of the newly insured will reflect that of the overall insured population (public and private insurance, including Medicaid). Based on the new analysis, we estimate that increased healthcare coverage under the ACA could add 150bps of incremental volume in the U.S. in 2014 across 10 key orthopedic and cardiovascular surgical procedures. This compares to only 60bps incremental procedure volume based on our January analysis using Medicaid utilization rates. We detail this analysis and estimated financial impact on our covered companies in the rest of this note. Figure 1: Age Distribution of Insured by Payor Type vs. Uninsured

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Nonelderly Private Medicaid Uninsured

Age 55-64

Age 45-54

Age 35-44

Age 26-34

Age 19-25

Children (Total)

Source: US Census Bureau; Wells Fargo Securities, LLC Overall Insured Population Represents A Better Utilization Model For The Newly Insured Under The ACA. As noted above, a key reason for updating our analysis is to better reflect the difference in age profile of the uninsured vs. the Medicaid population vs. the overall insured population. This is summarized in Figure 1, which shows that children (18 years and younger) represent over half of the Medicaid population. In contrast, children account for only 16% of the uninsured population. As such, we believe that modeling utilization of the newly insured after that of the Medicaid population underestimates the potential increase in utilization. We believe a better model for newly insured utilization is the overall insured, a population that includes 32% children. Based on figures provided by the Congressional Budget Office (CBO), we estimate that Medicaid could account for about 30% of healthcare coverage for the newly insured while the remaining approximately 70% will likely be enrolled in exchanges (see Figure 2).

WELLS FARGO SECURITIES, LLC Healthcare Coverage Expansion A Shot In The Arm For MedTech EQUITY RESEARCH DEPARTMENT

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Figure 2: Estimate of the Effects of the ACA on Healthcare Coverage

(millions) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022Medicaid* ** 1 7 9 10 10 11 11 11 11 11Exchanges 0 0 9 14 23 25 26 26 25 25 25

Employer 1 1 -1 -2 -5 -5 -5 -6 -5 -4 -4Nongroup & other*** 1 ** -1 -1 -2 -2 -3 -2 -2 -3 -3Uninsured -2 -2 -14 -20 -26 -28 -29 -29 -29 -30 -30

* includes CHIP = Children's Health Insurance Program** between 0.5M and -0.5M*** Other includes Medicare; the effects of ACA are almost entirely on nongroup coverage

Source: CBO Estimates for the Insurance Coverage Provisions of the Affordable Care Act Updated for the Recent Supreme Court Decision, July 2012, Wells Fargo Securities, LLC ANALYSIS OF RECENT DEVICE UTILIZATION RATES PROVIDES FRAMEWORK FOR INCREASED UTILIZATION FOR THE NEWLY INSURED We utilized HCUPnet to look at ten key medical devices procedures to understand: (1) the percent of procedures in nonelderly patients (<65 years old); (2) the percent of procedures by payer type (including uninsured); and (3) procedure by per million by procedure and payor type. For background, HCUPnet is part of the Healthcare Cost and Utilization Project (HCUP) of the Agency for Healthcare Research and Quality (AHRQ), which is part of the Department of Health and Human Services (HHS). HCUP includes the largest collection of longitudinal hospital care data in the U.S., encompassing all-payer, discharge-level information. Substantial Device Utilization Among The Non-Elderly. The general perception among investors is that medical device procedures are typically done in elderly patients who are insured through Medicare and therefore, an increase in coverage for nonelderly patients would have a minor impact on device utilization. We found that although the majority of medical device procedures among the categories we looked at are done in elderly patients, a substantial portion are done in non-elderly. The range for nonelderly was 25% (CRM) to 74% (lower extremities)--see Figure 3. We note that, throughout this report, our reference to procedure volume data for LVADs includes heart transplants (Diagnosis-Related Group or DRG 1, 2 and 215). Figure 3: Key Medical Device Procedures by Age Group - Insured and Uninsured (2010)

-

100,000

200,000

300,000

400,000

500,000

600,000

700,000

800,000

HeartValves

CRM* PTCA** Neuro-modulation

LVADs/HeartTransplants

SpinalFusion

Knee Hip Shoulders LowerExtremities

Procedures in Patients >65 Years Old

Procedures in Patients <65 Years Old

102,669

72% 45%

41% 25%

52%

59%

453,663

721,443

463,624

511,125

274,311

61%

55%

28%

75%

39%

48%

64,3131

254,255

33%67%4,857

26%

26%

74%

99,218 74%

* CRM: cardiovascular rhythm management (ICDs & pacemakers) ** PTCA: percutaneous transluminal coronary angioplasty (i.e., stents) Source: hcupnet.ahrq.gov, Wells Fargo Securities, LLC As Expected, Uninsured Utilization Rate Underrepresented. We also looked at procedures by payer type using the latest year available (2010). Not surprisingly, the uninsured were underrepresented among the


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procedures we looked at. Although the uninsured account for about 18% of the total non-elderly population in the U.S., among the procedures we looked at, the uninsured accounted for only 0-2% (LVADs, hips/knees, spinal fusion, shoulders) to 12-15% (PTCA, lower extremities) of procedures in the non-elderly population (see Figure 4). Figure 4: Uninsured Underrepresented in Non-Elderly Population for Procedures

6%7%

12%

6%

0%

2%1%

2% 2%

15%

0%

4%

8%

12%

16%

20%

HeartValves

CRM* PTCA** Neuro-modulation


SpinalFusion

Knee Hip Shoulders LowerExtremities

Uninsured as % procedures in non-elderlypopulation

Uninsured as % of non-elderly population

18%

* CRM: cardiovascular rhythm management (ICDs & pacemakers) ** PTCA: percutaneous transluminal coronary angioplasty (i.e., stents) Source: hcupnet.ahrq.gov, Wells Fargo Securities, LLC We also looked at procedures per million people by payer type in 2010. As expected, the number of procedures per million was lowest among the uninsured with the exception of percutaneous transluminal coronary angioplasty or PTCA which is a surrogate for stent procedures (see Figure 5). This is probably because uninsured do not receive the same preventive care that insured patients receive (e.g., drug therapy) and will often present at an emergency room with a heart attack or chest pains that require a PCI and stent. We believe it appropriate to compare the procedure rate in the newly insured population to the overall insured population for two key reasons: 1) based on conversations with experts, we understand that patient benefits provided by the exchanges, which will cover majority of the newly insured under the ACA, will resemble those of the small-group privately-insured; 2) in our analysis of procedure volume among the insured, the Medicaid population is already represented, albeit as a lower percentage of the total insured at about 9% (range 4-25%) vs. Medicaid as a percentage of the newly insured under the ACA (about 30%). One caveat to note is that our analysis assumes that procedure volume of the newly insured will mirror that of the overall insured immediately in 2014. While we believe this could happen due to pent up demand, we do note the possibility that utilization ramp among the newly insured could take some time to ramp to that of the overall insured. Figure 5: Key Medical Device Procedures per Million People (2010)

Procedures per Million People Heart Valves CRM* PTCA**

Neuro-modulation

LVADs/ Heart Transplants

Spinal Fusion Knee Hip Shoulders

LowerExtremities

Medicare 1,243 4,265 5,296 1,487 43 3,276 8,196 5,700 894 1,519Medicaid 169 308 750 85 11 667 485 351 41 712Other Public Insurance 312 532 2,023 221 0 6,033 3,082 1,294 373 2,873Private insurance 189 303 1,080 134 15 1,366 1,746 945 104 613

Average Non-elderly Insured 189 312 1,042 126 13 1,381 1,522 830 100 715Uninsured 59 118 699 37 0 150 69 89 13 539

* CRM: cardiovascular rhythm management (ICDs & pacemakers) ** PTCA: percutaneous transluminal coronary angioplasty (i.e., stents) Source: hcupnet.ahrq.gov, Wells Fargo Securities, LLC estimates NEW ANALYSIS POINTS TO MORE MEANINGFUL UTILIZATION IMPACT FOR MEDTECH COMPANIES Based on the estimated number of uninsured expected to receive healthcare coverage under the ACA and using the previously discussed utilization rates as a framework, we assessed the potential impact of an increase in the number of people with healthcare coverage in the U.S. for 10 major medical device categories. Our analysis assumed that the number of procedures per million people would increase due to healthcare coverage and that


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the utilization rate of the newly insured would be comparable to that of the overall insured population by age group. Recall our January analysis assumed that the utilization rate of the newly insured will follow that of the Medicaid population, which we now believe underestimates the opportunity. Our new analysis estimates incremental procedure volume of 1.5% in the U.S. across the 10 medical device groups in 2014 (see Figure 6), as compared to 60bps incremental utilization based on our prior analysis. Additionally, with a cumulative benefit in procedure volume of 3.6% from 2012-22, we expect the incremental volume to effectively offset the 2.3% medical device tax. Note that our analysis assumes that utilization rate of the newly insured will increase immediately to that of the overall insured level in 2014 due to pent up demand. However, we acknowledge the possibility that actual utilization ramp among the newly insured could take some time. Increased Coverage Should Be A Tailwind For Key Device Categories. In our analysis, we evaluated the incremental annual benefit for 2012-22 and the cumulative benefit in 2022. Given that the largest annual increase in coverage for the uninsured occurs in 2014, it is not surprising that we see the greatest impact on procedures in that year. The median incremental volume benefit in the U.S. in 2014 for the 10 categories we looked was 150bps, with a range of 70-410 bps (see Figure 6), while the median incremental volume benefit in the other years range from -0.1% in 2019 to 0.7% in 2016 (see Figure 7). Using 2011 as the baseline, the median overall cumulative benefit through 2022 was 360bps. Figure 6. Estimated Incremental And Cumulative Benefit in U.S. Procedure Volume from Coverage Expansion

Median

Hips KneesSpinal Fusion Shoulders

Lower Extrem ity

Heart Valves PT CA* CRM**

Neuro-m odulation

T ransplants/LVADs Ortho Cardio Overall

2012 0.3% 0.4% 0.6% 0.3% 0.1% 0.3% 0.1% 0.2% 0.2% 0.7 % 0.3% 0.2% 0.3%

2013 0.2% 0.2% 0.3% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.4% 0.2% 0.1% 0.1%

2014 1.8% 2.0% 3.4% 1.5% 0.7 % 1.4% 0.8% 0.9% 0.9% 4.1% 1.8% 0.9% 1.5%

2015 0.7 % 0.8% 1.4% 0.6% 0.3% 0.6% 0.3% 0.3% 0.4% 1.7 % 0.7 % 0.4% 0.6%

2016 0.8% 1.0% 1.6% 0.7 % 0.3% 0.7 % 0.4% 0.4% 0.4% 2.0% 0.8% 0.4% 0.7 %

2017 0.3% 0.3% 0.5% 0.2% 0.1% 0.2% 0.1% 0.1% 0.1% 0.6% 0.3% 0.1% 0.2%

2018 0.1% 0.2% 0.2% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.3% 0.1% 0.1% 0.1%

2019 -0.1% -0.1% -0.2% -0.1% -0.1% -0.1% -0.1% -0.1% -0.1% -0.3% -0.1% -0.1% -0.1%

2020 0.2% 0.3% 0.5% 0.2% 0.1% 0.2% 0.1% 0.1% 0.1% 0.6% 0.2% 0.1% 0.2%

2021 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

2022 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

Cum ulative benefit in 2022 4.3% 5.0% 8.2% 3.7 % 1.8% 3.5% 1.9% 2.1% 2.3% 10.1% 4.3% 2.3% 3.6% Ortho includes hips, knees, spinal fusion, shoulders, lower extremities. Cardio includes heart valves, PTCA* (i.e. stents), CRM** (ICDs/pacemakers), neuromodulation, LVADs. Source: Wells Fargo Securities, LLC estimates FOR DETAILS ABOUT OUR METHODOLOGY IN CALCULATING VOLUME BENEFIT SUMARIZED IN FIGURE 6, PLEASE SEE APPENDIX STARTING ON PAGE 15. Figure 7: Estimated Median* Incremental U.S. Volume Benefit by Year

0.3%0.1%

1.5%

0.6%0.7%

0.2%0.1%

-0.1%

0.2%

0.0% 0.0%

-0.2%

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%

1.6%

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

* Median based on all ten previously mentioned orthopedic and cardiovascular procedures Source: Wells Fargo Securities, LLC estimates


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Orthopedics Expected To Realize Greater Incremental Benefit Vs. Cardiovascular. In addition to assessing the potential overall impact of increased healthcare coverage across 10 key device categories, we also evaluated the potential impact by therapeutic category of orthopedics vs. cardiovascular groups. Our analysis shows that in general, the incremental utilization benefit is greater for orthopedic procedures as compared to that of cardiovascular procedures. This difference is particularly noticeable through 2016. Across the five orthopedic procedure categories--hips, knees, spine, shoulders and lower extremities--that we evaluated, the median incremental utilization impact was 1.8% in 2014 and 0.7% in 2015 (see Figure 8). By comparison, across the five cardiovascular categories--valves, PTCA (stents), CRM (ICDs/pacemakers), neuromodulation, LVADs, the median incremental utilization impact was 0.9% in 2014 and 0.4% in 2015 (see Figure 9). We believe one possible explanation for this difference in incremental volume is that more of the orthopedic procedures may be considered elective in nature and thus may not be affordable to those without insurance. As such, once the uninsured receive coverage under the ACA, we should expect to see a step up in the procedure volume for the elective cases among the newly insured. In contrast, some of the cardiovascular procedures are non-elective and performed in emergent situations regardless of healthcare coverage. This suggests less upside potential in procedure volume when the uninsured receives healthcare coverage. Figure 8: Estimated Median Incremental Benefit in U.S. Orthopedic* Procedure Volume

0.3%0.2%

1.8%

0.7%0.8%

0.3%0.1%

-0.1%

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0.0% 0.0%

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0.6%

0.9%

1.2%

1.5%

1.8%

2.1%

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

* Includes procedures for hips, knees, spine, shoulders and lower extremities Source: Wells Fargo Securities, LLC estimates Figure 9: Estimated Median Incremental Benefit in U.S. Cardiovascular* Procedure Volume

0.2%0.1%

0.9%

0.4%0.4%

0.1%0.1%

-0.1%

0.1%

0.0% 0.0%

-0.2%

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

* Includes procedures for valves, PTCA (stents), CRM (ICDs/pacemakers), neuromodulation and LVADs Source: Wells Fargo Securities, LLC estimates


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A Closer Look At 2014 Impact--LVADs And Spine Procedures Expected To See The Most Impact. With the largest number of uninsured (12 million) expected to gain healthcare coverage in 2014, we took a closer look at the medical device categories that could be most impacted by the coverage expansion (see Figure 10). In particular, we note that LVADs and spine procedures are estimated to see the greatest incremental volume benefit at 4.1% and 3.4%, respectively. We should note that LVADs include DRG 1, 2 and 215, which includes both LVADs and heart transplants. The data suggests that companies with above-average U.S. exposure to these device categories should see a disproportionately higher benefit in 2014. Device categories that are expected to see the least volume benefit from the expanded coverage in 2014 include PTCA (0.8%), CRM (0.9%), neuromodulation (0.8%), and lower extremities (0.7%). Figure 10. Estimated Incremental Benefit in U.S. Volume in 2014 by Procedure Type

1.8%

2.0%

3.4%

1.5%

0.7%

1.4%

0.8% 0.9%0.9%

4.1%

0.0%

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1.0%

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2.0%

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3.0%

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4.5%

Hips Knees Spinal Fusion Shoulders LowerExtremity

Heart Valves PTCA* CRM** Neuro-modulation


Overall Median = 1.5%

* PTCA: percutaneous transluminal coronary angioplasty (i.e., stents) ** CRM: cardiovascular rhythm management (ICDs & pacemakers) Source: Wells Fargo Securities, LLC estimates Cumulative Utilization Upside Potentially Sufficient To Offset 2.3% Medical Device Tax. We estimate the median cumulative volume benefit in the U.S. from the increase in coverage due to the ACA between 2012 and 2022 will be 3.6%. Based on average gross margin of 60-70%, we believe that the benefit from increased healthcare coverage should be largely sufficient to outweigh the cost of the 2.3% excise tax in most major device categories (see Figure 11). We should reiterate that the incremental benefit appears to be greater for most of the orthopedic categories vs. the cardiovascular categories. It’s also important to note that our analysis focuses on the U.S. only, which accounts for about 55% of worldwide sales among our 15 covered companies. Therefore, the impact of the ACA on worldwide sales would be almost half of the impact in the U.S.


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Figure 11. Estimated Cumulative Benefit in U.S. Procedure Volume from Newly Insured Under the ACA

4.3%

5.0%

8.2%

3.7%

1.8%

3.5%

1.9% 2.1% 2.3%

10.1%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

Hips Knees Spinal Fusion Shoulders LowerExtremity

Heart Valves PTCA* CRM** Neuro-modulation


Overall Median = 3.6%

Ortho median = 4.3%

Cardio median = 2.3%

Source: Wells Fargo Securities, LLC estimates WE ESTIMATE 0.8% INCREMENTAL SALES GROWTH AND 2.2% EPS UPSIDE POTENTIAL IN 2014 FOR COVERED COMPANIES--THOR, NUVA AND HTWR LIKELY TO BENEFIT THE MOST. We calculated the potential impact on sales, sales growth, EPS and EPS growth for our covered companies based on the estimated incremental volume in 2014 (Figures 12-13). As discussed in previous sections of this report, we believe that medical benefits received by the newly insured under the ACA will more closely mirror those of the overall insured population. As such, our company-specific analysis uses the median incremental utilization, which is calculated based on the device utilization rate of the overall insured population. For each company, we tried to match the medtech sales mix to one of the 10 orthopedic or cardiovascular categories or the median of all the categories. Increased Device Utilization Expected To Drive Incremental Sales Growth And EPS Upside Potential In 2014. Among our covered companies, the median dollar sales upside potential in 2014 is $23MM or 0.8% (range 0.1% to 3.5%) while the median EPS upside potential is $0.05 or 2.2% (range 0.3% to 32.3%). In terms of incremental sales growth rate, the median increase for the overall group was 0.8% in 2014, or a 16% increase over current median 2014 sales growth of 5.2%. In terms of incremental EPS growth rate, the median increase for the group was 2.4%, or a nearly 23% increase over the current median 2014 EPS growth of 10.6%. For the large-cap medtech pure-play companies, we estimate median incremental sales growth of 0.8% in 2014, which represents an 18% increase over our current 4.5% estimate. Stand-outs among the large-caps in terms of incremental sales growth rate include BSX, MDT and ZMH, each with the potential to increase its current low-to-mid single digit top-line growth rate by over 20% in 2014 as a result of the increased device utilization. In terms of incremental EPS growth in 2014, we estimate median increase of 2.2%, a 24% increase over the current estimate of 8.9% for the large-cap companies. Stand-outs include BSX, MDT, SYK and ZMH.


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Figure 12: Estimated Impact on Sales Growth of Covered Companies Therapeutic Incremental

Company % of Total Sales Sales ($M) Category Utilization $M Upside Potential % Upside Current Incremental PotentialABT 15% 3,484 MedTech* 1.5% $52 0.2% 4.7% 0.2%BSX 50% 3,709 MedTech* 1.5% $55 0.8% 2.6% 0.8%COO2 10% 164 MedTech* 1.5% $2.4 0.1% 8.1% 0.1%EW 43% 1,022 Valves 1.4% $15 0.6% 13.1% 0.7%HTWR 50% 113 LVADs 4.1% $5 2.1% 27.4% 2.6%JNJ 19% 13,714 MedTech* 1.5% $204 0.3% 3.6% 0.3%MAKO 100% 150 Hips/knees* 1.9% $3 1.9% 19.4% 2.3%MDT3 55% 9,576 MedTech* 1.5% $142 0.8% 2.7% 0.8%NUVA 87% 599 Spine 3.4% $20 2.9% 5.3% 3.0%STJ 47% 2,715 Cardio* 0.9% $26 0.4% 4.5% 0.5%SYK 66% 6,233 MedTech* 1.5% $93 1.0% 5.1% 1.0%THOR 85% 464 LVADs 4.1% $19 3.5% 9.8% 3.9%TRNX 60% 206 Upper/lower e 1.1% $2 0.7% 8.3% 0.7%ZMH 56% 2,703 Ortho* 1.8% $47 1.0% 4.5% 1.0%Mean 53% 2.0% $49 1.2% 8.5% 1.3%Median 53% 1.5% $23 0.8% 5.2% 0.8%

Large-cap4 53% 1.5% $51 0.8% 4.5% 0.8%1. Data for calendar year 2014 except FY14 for COO and FY15 for MDT.

2. Assumes impact on CSI sales only. For fiscal year ending October 2014.3. For fiscal year ending April 2015.4. Median of large-cap pure-play companies BSX, EW, MDT, STJ, SYK, ZMH.* Uses group median for incremental upside potentialSource: Company reports; Wells Fargo Securities, LLC estimates

2014E US MedTech Sales1 Incremental 2014E Sales 2014E Sales Growth Rate

Figure 13: Estimated Impact on Sales, EPS and EPS Growth of Covered Companies

PriceCompany Rating (3/28/13) $M Upside Potential % Upside Current $ Upside Potential1 % Upside Current IncrementalABT Outperform $35.32 $52 0.2% $2.24 $0.01 0.5% 10.9% 0.6%BSX Market Perform $7.81 $55 0.8% $0.75 $0.02 2.5% 11.0% 2.8%COO2 Outperform $107.88 $2 0.1% $6.71 $0.02 0.3% 10.4% 0.3%EW Outperform $82.16 $15 0.6% $4.11 $0.06 1.5% 26.5% 1.9%HTWR Market Perform $88.41 $5 2.1% ($1.42) $0.13 8.8% 49.6% 103.7%

JNJ Outperform $81.53 $204 0.3% $5.66 $0.03 0.6% 4.9% 0.6%MAKO Market Perform $11.15 $3 1.9% ($0.09) $0.03 32.3% 79.1% 165.0%MDT3 Outperform $46.96 $142 0.8% $4.18 $0.07 1.7% 8.4% 1.9%NUVA Market Perform $21.31 $20 2.9% $1.11 $0.21 18.7% 8.2% 20.3%STJ Market Perform $40.44 $26 0.4% $3.95 $0.04 1.1% 6.2% 1.1%SYK Outperform $65.24 $93 1.0% $4.72 $0.11 2.3% 9.0% 2.7%THOR Outperform $37.50 $19 3.5% $2.06 $0.16 7.6% 15.9% 8.8%TRNX Market Perform $18.85 $2 0.7% ($0.08) $0.03 30.7% 78.2% 163.1%ZMH Outperform $75.22 $47 1.0% $6.27 $0.14 2.2% 8.7% 2.4%

Mean $49 1.2% $0.08 7.9% 23.4% 33.9%Median $23 0.8% $0.05 2.2% 10.6% 2.5%

Large-cap4 $51 0.8% $0.07 2.0% 8.9% 2.2%1. EPS upside potential based on 2014E sales x 2014E gross margin x (1-35% tax rate) divided by 2014E share count.2. Assumes impact on CSI sales only. For fiscal year ending October 2014.3. For fiscal year ending April 2015.4. Median of large-cap pure-play companies BSX, EW, MDT, STJ, SYK, ZMH.Source: Company reports; Factset; Wells Fargo Securities, LLC estimates

Incremental 2014E Sales 2014E EPS Impact 2014E EPS Growth Rate


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Analysis Suggests NUVA, THOR And HTWR Likely To See The Most Benefit In 2014. Among our covered companies, three stood as most likely to benefit from the increased utilization: NUVA, THOR and HTWR (Figure 14-15).

• For NUVA, based on its business mix, we applied 3.3% utilization rate for spinal fusion as potential upside, yielding upside potential of $20MM or 2.9% in sales and $0.20 or 18.5% in EPS. We expect increased utilization to add 3.0% to NUVA’s 2014 sales growth rate, or a 57% increase to our current estimate of 5.3% growth.

• For THOR, based on its business mix, we applied a 4.2% utilization rate for LVADs as potential upside,

yielding upside potential of $19M or 3.5% in sales and $0.16 or 7.6% in EPS. We expect increased utilization to add 3.9% to THOR’s 2014 sales growth rate, or a 40% increase over our current estimate of 9.8% growth.

• For HTWR, we also applied a 4.2% utilization rate for LVADs, yielding sales upside potential of $5MM

or 2.1% (resulting decrease in EPS loss is not meaningful). We expect increased utilization to add 2.6% to HTWR’s 2014 sales growth rate, or a 10% increase to our current estimate of 27.4% growth.

Figure 14. Estimated Incremental 2014 Sales Growth Due to Increased Utilization

3.9%

3.0%

2.6%2.3%

1.0% 1.0%0.8% 0.8% 0.7% 0.7%

0.5%0.3% 0.2% 0.1%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

THOR NUVA HTWR MAKO ZMH SYK MDT BSX TRNX EW STJ JNJ ABT COO

Incr

emen

tal 2

014

Sale

s Gro

wth

Source: Wells Fargo Securities, LLC estimates Figure 15: Upside Potential to 2014E EPS Due to Increased Utilization

32%31%

19%

9%8%

3% 2% 2% 2% 2% 1% 1% 1% 0%0%

5%

10%

15%

20%

25%

30%

35%

MAKO TRNX NUVA HTWR THOR BSX SYK ZMH MDT EW STJ JNJ ABT COO

2014

EPS

Ups

ide

Source: Wells Fargo Securities, LLC estimates Note: We estimate earnings losses for MAKO, TRNX and HTWR in 2014 even with the incremental utilization benefit.


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INCREASED UTILIZATION SUPPORTS CONTINUED MEDTECH PREMIUM VALUATION. Over the past three years, the large-cap medical device group has traded at an average of 3% premium to the S&P 500 based on forward earnings (Figure 16). The group recently traded at 14.5x next-twelve-month earnings or about 10% premium to the S&P 500. We believe that the sustainability of this relative valuation premium is supported by the potential utilization volume benefit expected in 2014 based on our analysis. Figure 16: Utilization Increase Supports Group Valuation Premium

4/08 10/08 4/09 10/09 4/10 10/10 4/11 10/11 4/12 10/1210.0

11.0

12.0

13.0

14.0

15.0

16.0

17.0

18.0

15.2x

13.3x

Source: FactSetNote: Large Cap Medtech includes ABT, AGN, BAX, BDX, BSX, COV, ISRG, JNJ, MDT, SNN, STJ, SYK, ZMH

Large Cap Medtech NTM P/E Over Last Five Years

4/10 7/10 10/10 1/11 4/11 7/11 10/11 1/12 4/12 7/12 10/12 1/130.90

0.95

1.00

1.05

1.10

1.15

1.10

1.03

Source: FactSetNote: Large Cap Medtech includes ABT, AGN, BAX, BDX, BSX, COV, ISRG, JNJ, MDT, SNN, STJ, SYK, ZMH

Large Cap Medtech NTM P/E Relative to S&P 500 Over Last Three Years

Source: FactSet BACKGROUND REVIEW OF ACA, THE UNINSURED AND CASE STUDIES ACA To Reduce Uninsured Population By Half Through 2022. The ACA of 2010 is expected to reduce the number of uninsured people by about 50% through 2022 by providing healthcare insurance coverage for millions of people by expanding Medicaid to adults with incomes at or below 138% of poverty, building on employer-based coverage and providing premium subsidies to make private insurance more affordable for many people with incomes less than 400% of poverty. Figure 17 presents the CBO’s estimated effect of the ACA on coverage for the uninsured through 2022. According to the CBO, there would have been 60 million people in the U.S. without healthcare coverage in 2022 had the ACA not been passed and the CBO estimates that the ACA will reduce the number of uninsured to 30 million by 2022. The increase in coverage for the uninsured will be phased in over a period of 10 years with the largest annual reduction in the number of people without insurance occurring in 2014 when an incremental 12 million more people (versus 2013) will likely gain healthcare insurance coverage due to the ACA (see Figure 18). In 2015 and 2016, the CBO estimates that an incremental 5 million and 6 million Americans, respectively, will gain coverage due to the ACA. Although the ACA is expected to reduce the number of uninsured by half, the absolute number of people gaining coverage (30 million) represents only about 10% of


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the total U.S. population and as mentioned above, the increase in coverage is phased in over time which limits the impact in any one year. Figure 17: Estimated Reduction in Uninsured Due to ACA

Source: Congressional Budget Office (CBO), Wells Fargo Securities, LLC Figure 18: Annual Incremental Reduction in Uninsured Due to ACA

Source: Congressional Budget Office (CBO), Wells Fargo Securities, LLC Who Are The Uninsured? Medicare provides healthcare insurance coverage for almost all Americans 65 years of age and over, therefore, the vast majority of the uninsured are below the age of 65. From an age standpoint, the uninsured are different from the overall nonelderly (<65 years old) population primarily in two ways (see Figure 19). First, children make up a relatively small portion of the uninsured (16% vs. 29% for the overall nonelderly population). Second, about 21% of the uninsured are young adults between the ages of 26-34 versus 14% for the overall nonelderly population. However, the percent of people between 35-64 years old is relatively similar among the uninsured and overall nonelderly population (45% and 46%). This is important because the consumption of most medical devices increases with age.


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Figure 19: Age Distribution of Overall and Uninsured Nonelderly

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Overall Nonelderly US Population Uninsured Nonelderly USPopulation

55-64

45-54

35-44

26-34

19-25

0-18

Agegroups

% of people between ages 35-64 is similar among uninsured and non-elderly

Source: US Census Bureau; Wells Fargo Securities, LLC Recent Studies Show An Increase In Utilization Due To Healthcare Coverage. We have consulted with a number of healthcare policy experts to identify contemporary studies which have evaluated the impact of health insurance on healthcare utilization. Our research led us to three different studies which all indicate that health insurance leads to increased healthcare utilization. Specifically, these studies suggest that insurance can lead to an increase in hospitalization and procedure rates ranging from 30-50%. The three key studies are described below and summarized in Figure 20. 1) Study 1: Study 1: The Oregon Health Insurance Experiment: Evidence From the First Year

(Finkelstein, A. et al., Robert Wood Johnson Foundation, July 2011) – In 2008, a group of uninsured low income adults in Oregon was selected by lottery to be given the chance to apply for Medicaid. This lottery provided a unique opportunity to gauge the effects of expanding access to public health insurance on the use of health care using a randomized controlled design. About one year after enrollment, the study found that those selected by the lottery had substantial and statistically significantly higher healthcare utilization, lower out of pocket medical expenditures, and medical debt, and better self-reported health than the control group that was not given the opportunity to apply for Medicaid. Specifically, the study found that insurance coverage was associated with a 30% increase in the probability of having a hospital admission, a 15% increase in the probability of taking any prescription drug, and a 35% increase in the probability of having an outpatient visit. When looking at three common measures of utilization, the study found that insurance was associated with a 20% percent increase in hospital days, a 40% increase in total list charges, and a 45% increase in the number of hospital procedures. When looking at specific medical conditions, the study found a statistically significant increase in hospital utilization for heart disease but not for the other conditions evaluated.

2) Study 2: Medicare Spending for Previously Uninsured Adults (McWilliams, J., et al.,

Annals of Internal Medicine, October 2009) – A study published in 2009 evaluated Medicare spending and utilization for previously uninsured and insured adults by using Medicare claims data. The study used longitudinal survey data and linked Medicare claims data were used to compare Medicare spending for 4,567 beneficiaries age 65 to 74 years who were previously insured or previously uninsured before the age of 65. The study showed that adjusted annual total Medicare spending was 21% higher for previously uninsured adults than previously insured adults ($5,796 vs. $4,773; P=0.044) and that hospital stays were 30% higher. The study also showed that previously uninsured adults had a 42% and a 92% higher adjusted annual hospitalization rate than previously insured adults for complications related to cardiovascular disease or diabetes (9.1% vs. 6.4%; P = 0.002) and for joint replacements (2.5% vs. 1.3%; P = 0.006), respectively.

3) Study 3: The Effect of Health Insurance Coverage on the Demand for Hospital Care:

Evidence from a Natural Experiment in Massachusetts (Matthew Niedzwiecki, November 2012) – The paper used the Massachusetts Case Mix Database to examine the causal effect of insurance coverage on different types of hospital care utilization. The analysis found a 39-50% increase in


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emergency department (ED) use and a 50% increase in overall inpatient admissions. This increased utilization appeared to be consistent over the three-year post period.

Figure 20: Summary Findings of Studies Showing an Increase in Utilization due To Healthcare Coverage Study 1

Increase in Hospital Day s 20%

Increase in Hospital List Charges 40%

Increase in Hospital Procedures 45%

Study 2

Increase in Annual per Person Utilization of Hospital Stay s 30%

Increase in Adjusted Annual Rate of Hospitalization (%)

Complication related to cardiovascular disease or diabetes 42%

Myocardial infarction, heart failure, or stroke 37%

Joint replacement 92%

Study 3

Increase in emergency department use (any time) 39%

Increase in emergency department use (during regular doctor office hour 50%

Increase in inpatient admissions overall 50% Source: Finkelstein, A. et al., Robert Wood Johnson Foundation, July 2011; McWilliams, J., et al., Annals of Internal Medicine, October 2009; Matthew Niedzwiecki, November 2012; Wells Fargo Securities, LLC


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APPENDIX Methodology The below example uses Hip procedure data STEP 1 We calculated the number of procedures per million people in the U.S. by age range for the overall, insured and uninsured populations using HCUP data. Figure A below provides an overview of the data using hip as an example. Figure A: Procedures per Million by Coverage Status

Age Group Overall Insured Uninsured Overall Insured Uninsured Overall Insured Uninsured0-18 78 71 7.6 361 361 - 4.6 5.1 - 19-44 106 79 26.9 19,681 19,010 671 185.3 239.8 24.9 45-64 82 68 13.4 155,684 152,806 2,878 1,900.9 2,230.9 214.7 65+ 47 47 0.7 276,809 276,035 774 5,899.3 5,882.8 1,121.7 Total 313 265 48.6 452,535 448,212 4,323 1,443.9 1,692.7 88.9

Population (MM) Procedures (2010) Procedures/MM

Source: HCUPnet, Wells Fargo Securities, LLC estimates STEP 2 For 2012-2022, we estimated the number of people gaining healthcare coverage by age group by applying the current ratio of uninsured by age range to the CBO estimate of the number of people that will gain coverage each year. For example, CBO estimates that 12 million people will gain coverage in 2014. We applied the percent of uninsured by age group to the 12 million people who gain coverage in 2014 to arrive at the number of people by age group who gain coverage in 2014. Figure B below presents an overview of this. Figure B: Number of People Gaining Coverage in 2014 by Age Group

Uninsured GainingAge Group Uninsured (MM) % Composition Coverage in 20140-18 7.6 16% 1.919-44 26.9 55% 6.645-64 13.4 28% 3.365+ 0.7 1% 0.2Total 48.6 100% 12.0

Note: CBO estimates that 12MM people will gain coverage in 2014 Source: CBO, Wells Fargo Securities, LLC estimates STEP 3 Using 2014 as an example, we calculated the number of annual procedures for the uninsured who were gaining coverage BEFORE they gained coverage by multiplying the procedures per million for the uninsured times the number of people gaining coverage by age group. We then calculated the number of procedures this group of people would undergo AFTER gaining insurance by multiplying the number of procedures per million for the insured population by the number of people gaining coverage by age group in 2014. The difference in the number of procedures BEFORE and AFTER gave us the incremental number of procedures in 2014. Figure C below walks through the calculation.


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Figure C: Incremental Procedures For Uninsured Gaining Coverage in 2014

0-18 1.9 0 0 1.9 5 10 1019-44 6.6 25 166 6.6 240 1,594 1,42845-64 3.3 215 710 3.3 2,231 7,380 6,66965+ 0.2 1,122 191 0.2 5,883 1,002 811

Total 12.0 89 1,067 12.0 832 9,984 8,918

Uninsured Procedures/MM

Procedures in 2014 by Age Group PRIOR to Gaining Coverage

Age Group

Uninsured Gaining Coverage (MM)

Procedures Procedures

Incremental Procedures in 2014

Procedures Insured Procedures/MM

Uninsured Gaining Coverage (MM)

Procedures in 2014 by Age Group AFTER Gaining Coverage

Source: CBO, Wells Fargo Securities, LLC estimates STEP 4 We then divided the incremental number of procedures by the total number of procedures in 2014 to arrive at the percent increase in procedures due to 12 million people gaining coverage in 2014 (see Figure D). Figure D: Percent Increase in Total Hip Procedures in 2014

Total Procedures in 2014 509,332 Incremental Procedures due 8,918

to Uninsured Gaining Coverage% Incremental Benefit 1.8% Source: CBO, Wells Fargo Securities, LLC estimates STEP 5 Repeat Steps 1-4 for 2015-2022 and other procedure categories.

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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. Wells Fargo Securities, LLC maintains a market in the common stock of Medtronic, Inc., St. Jude Medical, Inc., Boston Scientific

Corporation, Edwards Lifesciences Corporation, The Cooper Companies, Inc., NuVasive, Inc., Thoratec Corp., Abbott Laboratories, Johnson & Johnson, MAKO Surgical Corp., HeartWare International, Inc., Tornier N.V.

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Wells Fargo Securities, LLC or its affiliates intends to seek or expects to receive compensation for investment banking services in the next three months from Medtronic, Inc., St. Jude Medical, Inc., Stryker Corporation, Thoratec Corp., The Cooper Companies,


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Inc., HeartWare International, Inc. Wells Fargo Securities, LLC or its affiliates received compensation for investment banking services from Zimmer Holdings, Inc.,

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Thoratec Corp., HeartWare International, Inc., Abbott Laboratories. Zimmer Holdings, Inc., Stryker Corporation, Medtronic, Inc., St. Jude Medical, Inc. currently is, or during the 12-month period

preceding the date of distribution of the research report was, a client of Wells Fargo Securities, LLC. Wells Fargo Securities, LLC provided investment banking services to Zimmer Holdings, Inc., Stryker Corporation, Medtronic, Inc., St. Jude Medical, Inc.

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Wells Fargo Securities, LLC or its affiliates has a significant financial interest in Abbott Laboratories, Johnson & Johnson, Zimmer Holdings, Inc., HeartWare International, Inc., St. Jude Medical, Inc., Medtronic, Inc., The Cooper Companies, Inc., Edwards Lifesciences Corporation, Boston Scientific Corporation, Stryker Corporation, Thoratec Corp.

Wells Fargo Securities, LLC or its affiliates intends to seek or expects to receive compensation for investment banking services in the next three months from an affiliate of Tornier N.V.

Wells Fargo Securities, LLC does not compensate its research analysts based on specific investment banking transactions. Wells Fargo Securities, LLC’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. 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.

ABT: Key risks to our valuation include slower growth in key businesses and markets, and slower-than-expected margin expansion.BSX: Key risks include product launch delays and weaker ICD and DES market growth than we forecast or share losses beyond what we model. COO: Risks include unexpected production delays, product recalls and slowdown in contact lens market. EW: Key risks include a slower uptake of Sapien, regulatory delays, and new competition. HTWR: Risks to our thesis include slower-than-expected growth of the LVAD market and/or negative HVAD clinical data. JNJ: Risks include delays to pipeline products, additional product recalls and unexpected deterioration in the industry. MAKO: Risks to our thesis include a faster uptake of MAKO's total hip application and a significant change in the hospital capital spending environment. MDT: Key risks include ICD and spine market growth and additional share losses. NUVA: Risks to our thesis include deceleration in the US spine market, share losses for NUVA, and a less favorable outcome in the MDT litigation than we assume. STJ: Key risks to our valuation are a weaker ICD market than we model, pipeline setbacks, and new safety issues with Durata. SYK: Risks to our thesis include slower procedure volume growth, increased pricing pressures, and delays in new product approvals. THOR: Risks to our thesis include better-than-expected HMII uptake and competitors gaining less share than we model. TRNX: Risks to valuation include greater competition, additional distributor changes, and delays to new product launches. ZMH: Risks to our thesis include slower procedure volume growth, unexpected pricing pressures, and delays in new product approvals and launches.


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As of: April 1, 2013

48% of companies covered by Wells Fargo Securities, LLC Equity Research are rated Outperform.

Wells Fargo Securities, LLC has provided investment banking services for 46% of its Equity Research Outperform-rated companies.

50% of companies covered by Wells Fargo Securities, LLC Equity Research are rated Market Perform.

Wells Fargo Securities, LLC has provided investment banking services for 36% of its Equity Research Market Perform-rated companies.

3% of companies covered by Wells Fargo Securities, LLC Equity Research are rated Underperform.

Wells Fargo Securities, LLC has provided investment banking services for 19% of its Equity Research Underperform-rated companies.

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


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