PRO MEDICUS LIMITED — Capital/Financing Update 2004

Oct 17, 2004

Attention ASX Company Announcements Platform Lodgement of Open Briefing

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Pro Medicus Limited 450 Swan Street Richmond, Victoria 3121

Date of lodgement: 18-Oct-2004

Title: Open Briefing. Pro Medicus. CEO on North American Deal

Record of interview:

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Pro Medicus Limited today announced it has signed a three-year agreement with Agfa HealthCare under which Agfa will exclusively license Pro Medicus's full suite of practice management and digital integration software in the North American private radiology market. What's your rationale for entering the North American market in partnership with another company, specifically Agfa?

CEO Sam Hupert

The North American market's by far the largest medical IT market in the world and there are many similarities to our market here. There's a large and very rapidly growing private sector that's looking for a fully integrated solution, with a focus on the financial and productivity aspects of a practice. We believe we have that solution and we specialise in the private radiology side so our product set's ideal for that market.

But, the market's huge; it's over 20 times the size of ours. We do roughly 14 million x-ray exams in Australia a year - they do over 400 million in the US alone! The size and breadth of the territory, the competition and the local knowledge you'd have to have would make setting up by ourselves too big an ask. It could consume enormous amounts of resources and funding without any guaranteed return.

So we looked for a partner, and Agfa was an obvious first port of call. We'd established a very strong and positive relationship with it here in Australia, and we'd already done the R&D and integration development, which is the same worldwide, so we could integrate with Agfa everywhere straight out of the box.

Agfa's one of the biggest players in the US radiology market with huge links into the private/imaging centre space, both from an analogue perspective $-$ it supplies film to over 40 percent of the market – and in digital where it's also one of the biggest players. It therefore made perfect sense for us.

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The agreement relates to the diagnostic imaging centre market. Why was this particular segment of the market chosen as the target and what's the risk this approach could limit acceptance of the products by other sectors of the radiology market?

CEO Sam Hupert

Firstly, in the US, the imaging centre segment is the fastest growing – at something like 30 percent per annum. There are over 5,000 imaging centres in the US, and the number's growing at around 15 percent a year, with the volume of work done per centre also growing at approximately that rate. There's been a huge move away from in-patient radiology by the large institutions to more freestanding out-patient clinics like we have here.

The second thing is the imaging centre segment's now on the cusp of going digital. following the lead of the hospital/institutional segment, where the penetration of digital's over 80 percent. It's the segment that's least well addressed by integrated digital solutions and it's now chasing the productivity and clinical benefits digital offers.

While the agreement with Agfa focuses on imaging centres, it also covers the radiology departments in community hospitals with around 300 beds or less, which number about 3,000. So in effect it's a huge chunk of the private market that Agfa will address exclusively with our technology. And although this will be our prime focus, we still have the right to deal outside the imaging centre/small community hospital market – with Agfa, direct to the end user, or through other third parties.

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Under the agreement, Agfa will "exclusively" license your products for three years. What are the specific terms of this exclusivity and what will happen after the three years?

CEO Sam Hupert

Agfa won't promote or distribute a competing product in the territory covered by the agreement, which is the US and Canada, and we can't look to sell our products into the imaging centre market through other channels.

Agfa's putting very significant resources into this project, which is great for us as the exclusivity will ensure the resources will be focused on our products and not divided across a range of alternate offerings.

Conversely, we felt it was best to deal with one partner and make sure that partner had a leading position in the market we were looking to address. Distributing through multiple channels not only places a significant overhead on a company of our size, it also runs the risk of delivering a confusing message to the market.

So, we think the way our deal is structured serves to focus the efforts of both companies on the same goal – the success of our products in the market space.

As to what happens after three years, it's fair to say this deal will bring our two organisations closer together. Whilst nothing is set in concrete at this stage, we envisage that the three years will be just the beginning.

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You've said the deal will generate revenue of a minimum of $10 million over its three-year term. How will this revenue be structured and what will be the impact on earnings? What's the potential upside?

CEO Sam Hupert

There's very significant upside for us. The general structure of the deal is that we'll "localise" our practice management system for the US and Canadian markets, and that process is well underway, then Agfa will market, implement and provide first-line support for our licensed technology.

We'll receive a significant percentage of every sale as licence revenue, so the upside's there for both companies and that's very important. We'll also get a significant percentage of ongoing maintenance fees, so every licence we sell will roll out into a maintenance agreement within three or six months depending on the product, which will give us a growing recurring revenue stream from these markets.

We anticipate revenue will commence early in the second half of the current financial year and ramp up incrementally throughout the three-year period in line with increased market penetration.

The other thing is the deal is largely underwritten by minimum payments that are staged so they're less in year one, greater in year two and greatest in year three to reflect what we believe will be a realistic market penetration. So, whilst $10 million's the anticipated minimum revenue over the three years, there's a strong likelihood it'll be significantly greater.

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Another listed Australian health IT company, IBA Health, recently signed a global licensing and product development deal with Eastman Kodak that's expected to generate $50 million of revenue over its five-year term. Given the North American healthcare market's by far the largest in the world, why are your revenue estimates so much lower than IBA's?

CEO Sam Hupert

From what we know of the IBA deal, we believe the deals are fundamentally very different and therefore the numbers aren't comparable.

Firstly, the private/imaging centre market is a core market for Agfa. It's already a dominant supplier to this segment so we'll have a strong presence and customer base for our products right from the start.

Secondly, our deal with Agfa's in a defined market space within a defined geographic area but has the potential to expand to other markets both within North America and elsewhere, whereas we understand IBA's deal with Kodak is already worldwide except for Southeast Asia. The exclusive licensing of our technology outside the imaging centre market both in North America and the rest of the world is uncommitted and potentially the subject of future deals. We therefore see this as the beginning of a much larger opportunity.

Thirdly, our deal is structured to ensure we get a significant percentage of all the licence sales that are made, the percentage does not drop off significantly above a certain dollar value, so there's significant upside in each of our sales and importantly, ongoing service revenues.

Finally, our deal does not involve any intellectual property transfer; we retain 100 percent ownership of all the intellectual property, not only for our base products but also the localised and integration products.

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Given your focus on these new markets, will there be any change in your strategy within the Australian market?

CEO Sam Hupert

The Australian market's extremely important to us. We currently cover over 70 percent of Australia's private radiology practices and see very significant upside for our digital imaging products here, especially given the productivity improvements we've seen at practices using this technology.

If anything, our expansion into the US will directly benefit our clients back here. Firstly, it reinforces for them that our technology is world-class. Secondly, having sites throughout the US and Canada will provide us with a much broader installed base from which to pipe ideas into, and help fund, our development stream. This will ensure our products are always leading-edge.

Also, some of our clients may one day expand or have associations with radiology practices in North America or other parts of the world where we may operate. Being able to use the one practice management system across multiple countries may well provide them with a strategic advantage.

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What costs will be involved in modifying your digital integration products for the North American market and in continuing to service the market under the Agfa agreement?

CEO Sam Hupert

The digital integration products won't change at all from those we have in Australia because the active products are universal so these will have no new

development costs. As for the Practice Management system, the core will remain the same. The main changes will be localising the billing for the North American markets and adding a few specialised modules. We did a similar exercise back in 2002/2003, when we localised these products for the UK, which was a job of a similar order of magnitude to what we're looking to do for the US and Canada. That gives us confidence the costs will be largely contained within our normal R&D budget, which is around $750,000 to $800,000 per annum, including all our other R&D expenses.

In terms of keeping the products current, we anticipate these costs will also be contained within our normal R&D budget. We believe that, using our rapid development methodology, we can contain those costs but still get a world class product out there.

Given Agfa will be doing all of the marketing, implementation and first-line support, we don't see any other significant capital expenditure associated with this agreement and therefore anticipate our normal margins of between 60 and 70 percent on the revenue we receive from the project.

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You've described the Agfa deal, and your entry into the North American market, as potentially "company-making," yet Pro Medicus has successfully operated in the UK for 18 months without any such transformation. Why do you expect the experience in North America to be so different?

CEO Sam Hupert

The two opportunities are very different. The private market in North America's huge, unlike that of the UK, and Agfa's one of the largest players in that market. It has a sales force and support infrastructure of 700 people in the US health divisions alone! It will be exclusively licensing our technology to drive sales of a fully integrated digital offering in the private market space across the US and Canada. We therefore both expect big things from this opportunity itself, not to mention that it could potentially lead to further opportunities between our two companies.

When we went to the UK we followed a client, MIA, which under the Lodestone name has 17 sites we service and support and that we created the product for. The private market in the UK is small; the vast majority of healthcare's National Health Service (NHS) based. There are moves to privatise and MIA's looking to expand its UK and European operations. Whilst we see growth in the UK market, it will take some time to develop.

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What opportunities do you see for Pro Medicus's other products in the North American market over the medium to long term?

CEO Sam Hupert

We think there could be some great opportunities not only for our radiology products in other parts of the world but also for our other offerings in North America. For instance, Agfa as a company is becoming a lot broader based in terms of health informatics. Within the US market it has specialised products for orthopaedics, cardiology and women's health etc. Our products are well suited for these medical specialties where a lot of imaging and surgical planning is done, and we're therefore looking at opportunities in those markets. Even some of our other products, such as ProMed Clinical, the clinical desktop product we bought in March this year, have applications to these markets.

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To what extent might Pro Medicus be able to exploit such opportunities independently and to what extent would you require a partner such as Agfa?

CEO Sam Hupert

We have the flexibility to address these opportunities in our own right or look for other third party channels if we feel that these are better ways to get into those markets.

However, at this stage it makes far more sense both economically and in terms of resources to have a partner like Agfa, certainly for a company our size. But any partnering agreement has to be structured equitably. It's been very important for us as a board to make sure that, even though we were entering an alliance with a much larger company, we had enough upside in the deal so that both companies could benefit from the growth. I believe we've done this with our deal for the imaging centre market so I think we've got a good basis for further discussions.

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What opportunities are there to work with Agfa to take your digital integration products into other markets around the world?

CEO Sam Hupert

There are significant opportunities. Now that Agfa's taken us outside Australia and put us on the world stage, it makes sense to look at further opportunities. Agfa is a key player in digital imaging in virtually every major market of the world. It's just been recognised as the number one provider of healthcare digital imaging in Asia, which could present a great opportunity for leveraging our relationship.

So whilst North America is a fantastic opportunity, it's by no means the only one we'll look at.

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Thank you Sam.

For more information about Pro Medicus, visit www.promedicus.com.au or call Sam Hupert on (+61 3) 9429 8800

For previous Open Briefings by Pro Medicus, or to receive future Open Briefings by e-mail, visit www.corporatefile.com.au