Feltl and Company Research Department 2100 LaSalle Plaza 800 LaSalle Avenue Minneapolis, MN 55402 1.866.655.3431 Ben C. Haynor, CFA [email protected] | 612.492.8872 Novadaq Technologies, Inc. Healthcare- Dia g nostic Ima g in g June 22, 2012 Company Description: Novadaq Technologies, Inc. develops, manufactures and markets real-time fluorescence imaging products used by surgeons in open, minimally invasive and interventional surgical procedures to visualize blood flow and assess the quality of blood perfusion. The company was founded in 2000 and is based in Mississauga, Ontario, Canada. SPY no longer a secret, initiating with STRONG BUY, $8.50 PT (NVDQ - $5.57) STRONG BUY Key Points Financial Summary Novadaq’s proprietary SPY imaging technology revolutionizes blood flow and perfusion assessment. SPY imaging has broad applicability and a potential US consumable revenue opportunity of ~$1.8 billion. Rev(mil) 2011A 2012E 2013E Mar $2.6A $4.8A $8.2E Partnerships with industry leaders validate the strength June $3.6A $4.7E $9.6E of the company’s FDA-approved technology, while Sept $4.3A $5.7E $11.1E Novadaq retains a highly attractive market for itself. Dec $5.0A $7.8E $13.0E Potential “arms race” developing. FY $15.3A $23.0E $41.8E Initiating with STRONG BUY rating and $8.50 price P/Sales 14.5x 9.6x 5.3x target (7.0x 2013 EV/Sales). Novadaq’s proprietary SPY imaging technology revolutionizes blood flow and perfusion assessment. Their unique technology allows surgeons to visualize blood flow and perfusion in real-time, which greatly enhances the ability to make proper clinical decisions during surgeries. For example, in breast reconstruction surgery and EPS 2011A 2012E 2013E gastrointestinal surgery, which typically register complication rates of over 12%, SPY imaging has been shown to reduce complication rates to 4% or less. The cost of Mar ($0.09)A ($0.14)A ($0.02)E complications that occur in these types of complex surgeries can run well into the six- June ($0.13)A ($0.00)E ($0.02)E figures and be devastating to patient outcomes. Over 50 peer-reviewed publications Sept ($0.04)A ($0.03)E ($0.00)E Dec ($0.06)A ($0.02)E $0.02E support the use of SPY imaging. The company’s SPY imaging technology has broad applicability, with current and FY ($0.32)A ($0.17)E ($0.02)E potential applications in plastic and reconstructive, gastrointestinal, cardiac, P/E NM NM NM cancer, and vascular surgeries (including wound care). We estimate the theoretical addressable market in the US to comprise well over one million procedures per year totaling roughly $1.8 billion in potential consumable sales. Novadaq has partnered with industry leaders, validating the strength of its technology platform, while reserving a highly attractive market for itself. The Price: $5.57 company has formed partnerships with Intuitive Surgical (ISRG – not rated), KCI, 52-Week Range: $7.98-$3.53 LifeCell, and MAQUET Cardiovascular for sales, marketing, and distribution. Each Target: $8.50 company they have partnered with is the market leader in the respective area covered Rating: STRONG BUY by the partnership, yet Novadaq has retained the endoscopic fluorescence imaging market for itself with its FDA-approved PINPOINT system, which will launch in the Shares Outstanding: 39.8 mil second half of this year. We believe the potential recurring revenue for PINPOINT in the Mkt. Capitalization: $222mil US market is ~$400 million per annum. Ave. Volume: 50,000 Instit. Ownership: 24% Due to the fact that SPY imaging is mainly used in complex surgeries (generally BV / Share: $0.8 costing more than $25,000), which are often the most profitable for hospitals, Debt / Tot. Cap.: 12% there is the potential for an “arms race” to develop amongst hospitals in a given Est. LT EPS Growth: 40% locale, whereby one hospital acquires a SPY imaging device causing the complex surgeries in the area to relocate to that hospital and forcing the other hospitals in the locale to purchase the technology as well. This is a similar situation to that which occurred with Intuitive Surgical’s da Vinci surgical robot. Our channel checks suggest this happened early this year in the Twin Cities market, and management has noted that they have seen the same occurrence elsewhere. Initiating coverage of Novadaq with a STRONG BUY rating and $8.50 price target, which represents 7.0x 2013 EV/Sales. Please see important disclosures on pages 20 to 22. June 22, 2012 rops Strong, Pricing Weak, Farm Profits Could Suffer INVESTMENT THESIS Novadaq offers a unique technology with its SPY imaging; no other technology on the market captures real-time blood flow and perfusion. The company’s technology show incredible promise in improving outcomes and lowering costs and has over 50 clinical publications supporting its use. At present, their solutions are most often used in complex surgical procedures, such as breast reconstruction, that are both expensive and suffer from high complication rates. Complications that develop in these types of procedures generally result in long and expensive hospital stays, which Novadaq’s imaging platform has been shown to drastically reduce, saving hospitals a great deal of time and money. We believe the potential US markets that can be served by Novadaq’s technology total ~$1.8 billion annually and have a compelling need for their products. In addition, it is a green-field opportunity that seldom arises so starkly. As such, we have assigned Novadaq a STRONG BUY rating and $8.50 price target. Opportunities Unique imaging modality with strong intellectual property position. Novadaq faces no direct competition from alternative fluorescent angiography systems currently and has a solid intellectual property foundation consisting of 49 patent families representing 52 granted or allowed patents and nearly 80 patent applications. Further, we are unaware of any potential competition on the horizon. Evidence of superior outcomes and cost savings. The large expenses in the healthcare system are usually generated by hospitalizations and the resulting length of stay. Novadaq’s SPY technology helps improve outcomes and save money by avoiding unnecessarily long hospital stays due to complications. The fact that the company’s products are presently used primarily in complex surgeries (read “expensive”) heightens the potential savings. Numerous studies (over 50) have validated both the superior outcomes and cost savings that result from the application of SPY imaging. Enviable partnerships with market leaders, yet Novadaq retains a highly attractive market for itself. Novadaq has formed partnerships with leading companies, including KCI, LifeCell, Intuitive Surgical (ISRG – not rated), and MAQUET Cardiovascular. Each company Novadaq has partnered with is a leader in their respective market; we believe this validates Novadaq’s technology and should serve to accelerate adoption of their products as Novadaq’s partners sell into their already well established sales channels. Importantly, Novadaq has retained the endoscopic fluorescence imaging market for itself with their FDA-approved PINPOINT system, which will launch in the second half of this year. We believe the potential recurring revenue for PINPOINT is ~$400 million per annum in the US market. Hospitals and surgeons beginning to accept Novadaq’s technology. When Novadaq first launched their SPY imaging platform with LifeCell, approximately 80% of the systems were placed in hospitals for evaluation prior to a permanent placement being agreed upon. Now, hospitals accept a permanent placement 80% to 90% of the time without requiring an evaluation. Additionally, Novadaq’s SPY imaging platform is in over 90% of the top 50 cancer surgery hospitals in the US. That said the company has installed systems in just over 400 hospitals to date, or ~12% of US hospitals with over 200 beds. This, to us, signals that leading hospitals view the technology as proven, but placements are still in the early-adopter phase with plenty of room to grow. Surgeons we have spoken to have noted that it improves on clinical judgment and SPY imaging has virtually no learning curve to using (“easier to use than an operating microscope”). Potential arms race developing. Due to the fact that SPY imaging is mainly used in complex surgeries, which are often the most profitable for hospitals (especially when complications can be successfully reduced), there is the potential for an “arms race” to develop amongst hospitals in a given locale, whereby one hospital acquires a SPY imaging device and the complex surgeries in the area relocate to that hospital, forcing the other hospitals in the locale to purchase the technology as well. This is a similar situation to that which occurred with Intuitive Surgical’s da Vinci surgical robot. Our channel checks suggest this happened early this year in the Twin Cities market, and management has noted that they have seen the same occurrence elsewhere. Broad application potential. Novadaq’s SPY technology is applicable to numerous types of procedures in open and minimally invasive surgeries. SPY imaging has been used in reconstructive, gastrointestinal (GI), cardiac, cancer and robotic surgeries. We estimate the US recurring revenue opportunity sums to ~$1.8 billion per year. Feltl and Company Research Department Novadaq Technologies, Inc. (NVDQ) Page 2 June 22, 2012 rops Strong, Pricing Weak, Farm Profits Could Suffer Risks Potential challenges of selling direct. The company plans to sell the PINPOINT product direct and has indicated that they would start out modestly with ten or so salespeople, and that they would scale up to 80-100 salespeople over time as the sales strategy is proven. Should the sales force struggle at first, Novadaq may slow down the addition of new salespeople and experience slower growth as a result. However, we believe this risk is mitigated somewhat, as Novadaq has experience building sales forces in the past; prior to partnering on SPY and their CO2 Heart Laser system, the company built sales forces dedicated to selling the products then transferred its salespeople to the partner company once the partnership agreement was in place.