Recon Revenue Growth Rates Drop
Large joint industry suppliers sold $2.7 billion of products in the third quarter of 2010 (3Q10), missing our forecast of $2.9 billion. We have, therefore, lowered our forecast for the large joint reconstruction industry to $3.1 billion from 3.3 billion for the 4Q10. We have decreased our forecast for the year from $12.0 billion to $11.6 billion as a result of both the third quarter results and our new fourth quarter estimate.
Before this past quarter’s report, large joint implant suppliers were stating that sales growth rates in 2Q were, in fact, slowing after what had appeared to be six months of rebounding sales growth rates. At the end of March 2010, large joint reconstruction revenues had grown 8.9% year-over-year (YOY). But as suppliers added up the numbers for the June quarter, they found that growth rates had slipped to 4.5%. The double whammy of slower procedure volume growth and pricing pressure really hit in the September quarter.
For the three months ended September 30, 2010, sales of large joint reconstruction products grew 0.8% on a YOY basis. Both knee and hip revenues increased at the same rate, growing at 0.8% YOY excluding the impacts of foreign currency.
Chart 1: Large Joint Reconstruction Market Revenue Growth (YOY)
Source: Company reports
The First Drop
As Chart 1 illustrates, industry sales rebounded significantly during the fourth quarter of 2009 and continuing into the first quarter of 2010. During the second quarter, growth, while lower, was still respectable. Then came the third quarter. Looking at this chart, the first thought is that the large joint industry is on a growth rate roller coaster—UP and DOWN, with stomach churning g-forces.
Of course, the down turn from 3Q08 to 2Q09 was the First Drop on the Large Joint roller coaster ride. That was a 9.3% plummet which makes this year’s 3.7% dip in 3Q10 seem much more benign.
Much of the differences in the magnitude of growth rate change can be attributed to different macro factors. In late ’08, for example, Zimmer reported that its revenues had declined by 4.8% on a YOY basis. Wright Medical reported that overall large joint reconstruction implant sales had increased 16.1%, while Biomet reported that its large joint implant sales were higher by 8.3%. So, while the overall numbers during ’08 First Drop were negative in the aggregate, the impact on specific suppliers was much more varied and lumpy.
This time, however, the pressure on sales growth appears to be more universal. This time, for example, the fastest grower among all large joint implant suppliers was Biomet with a (still modest) 2.3% rate of growth. Similarly, the greatest decline was reported by (again) Zimmer and that was 2.1% (of manufacturers with market shares of 2% or greater). So, unlike the period from 3Q08 – 2Q09, market pressures were more evenly distributed and seemed to affect a broader swath of the industry. Finally, we would note that all of these changes are occurring in the seasonally slow third quarter.
David Dvorak, President and CEO of Zimmer, probably summarized the macro environment for large joints well when he pointed to “High unemployment has resulted in expiring health insurance and COBRA subsidies in the U.S., as well as a decline in enrollment in private health plans” as the principal reasons for slower procedural growth and more difficult pricing. Dvorak continued; “Demographic analysis suggests that these trends have had a particularly notable impact on the non-Medicare potential patient base for joint replacement procedures, those between 45 and 65 years of age.”
Dominic Caruso, Chief Financial Officer of Johnson & Johnson, also cited many of these same factors but went a little further when he said; “we did see a slowdown overall in hospital admissions and also in elective procedures.”
In our view, high unemployment rates will continue to depress procedure growth rates. Specifically, the respected economic forecasting firm, Financial Forecasts Center LLC., is stating that unemployment rates in the U.S. are likely to remain between 9.5% and 9.6% during the remainder of 2010.
Louise Mehrotra, Vice President of Investor Relations at Johnson & Johnson, commented that U.S. pricing in hips and knees had declined 1% to 2% from levels reached in Q210 versus the previous quarter while international pricing was down 1%. Zimmer’s management stated that their average selling prices declined 1.4% and Biomet’s management reported that they also experienced pricing decreases in both the U.S. and abroad.
Pricing pressures and flattening procedure growth combined to create the flat revenue growth rates in 3Q10. The following list ranks all major large joint implant suppliers according to their 3Q10 sales growth rate.
Biomet + 2.3%
DePuy + 2.5%
Smith & Nephew + 3.2%
Stryker + 0.9%
These manufacturers combined accounted for 0.9% YOY revenue growth in overall large joint reconstruction, 0.8% in hips, and 1.1% in knees. Looking at specific companies, while Zimmer remains the leader in large joint reconstruction by market share, this position has continued to erode. Two years ago, Zimmer held 26.2% of the large joint reconstruction market. This percentage had fallen to 24.8% as of 3Q09, and now sits at 24.5% as shown in Chart 2.
Chart 2: Large Joint Reconstruction Market Share as of 3Q10
Source: Company reports and PearlDiver Technologies, Inc. estimates
Individual Company Commentary
Zimmer, Inc. reported that its shipments of large joint reconstruction products resulted in $690.0 million revenue for the September quarter which was down 2.1% from prior year levels and well below our $770.2 million estimate. Sales of hip recon products fell 0.3% from prior year levels to reach $287.0 million. One bright spot in the quarter was the rising sales contribution from Zimmer’s Continuum Acetabular Cup System. Sales of knee recon products fell 3.4% from prior year levels to reach $403 million despite advances in the rollout of Patient Specific Instruments.
DePuy, Inc. (a Johnson & Johnson company)
DePuy, Inc. reported that revenues for shipments of large joint reconstruction products reached $656.2 million for the September quarter which represents a 2.5% rise over the prior year levels but also came in below PearlDiver’s $695.1 million sales estimate. Sales of hip recon products rose 2.0% to $301.9 million on the bases of rising acetabular and cementless system sales. Sales of DePuy’s knee recon products increased 3.0% to $354.3 million.
Stryker, Inc. reported that sales of large joint reconstruction products reached $597.2 million for the September quarter, up 0.9% from prior year levels. Stryker’s reported sales also fell short of PearlDiver’s estimates. Sales of hip recon products rose 2.0% YOY to $286.1 million while sales of knee recon products remained flat at $311.1 million.
Smith & Nephew, Inc.
Smith & Nephew, Inc. reported large joint reconstruction product sales of $344.6 million, a 3.2% over the third quarter of 2010 falling below PearlDiver estimates of $360.6 by 4.4%. Hip repair product sales remained flat YOY at $158.0 million with continued efforts to show differentiation of the Birmingham Hip Resurfacing System. Smith & Nephew reported knee repair product sales at $186.6 million, an increase of 6.0% YOY with contributions from the Verilast bearing technology.
Biomet, Inc. reported that sales large joint reconstruction product rose 2.3% to $350.6 million for the August quarter (Biomet’s first quarter of fiscal 2011). Sales of hip recon products remained essentially flat although both the Taperloc and Ringloc product contributed to sales in the quarter. Sales of knee recon products rose 4% on continued sales growth of the Vanguard Complete Knee System and the E1 antioxidant tibial bearings.
Clearly macroeconomic forces are and will continue to dampen procedure growth rates and pricing. As a result, we are forecasting that the fourth quarter’s revenues will be less than we’d originally forecast and that the outlook for 2011 and 2012 will also be more modest. In summary, we expect that:
The large joint reconstruction market will grow at a slower rate of 3.1% YOY
The hip reconstruction market will grow at a slower rate of 3.2% YOY
The knee reconstruction market will grow at a slower rate of 3.0% YOY
Gains on a per company basis shown in Table 1
Table 1: Forecasted Hip and Knee Repair Revenues
$ 3, 044.8
$ 3, 129.9
$ 3, 269.8
$ 1, 256.6
$ 1, 288.0
$ 1, 326.6
$ 1, 788.2
$ 1, 841.9
$ 1, 943.2
$ 2, 703.7
$ 2, 902.8
$ 3, 080.1
$ 1, 225.0
$ 1, 298.5
$ 1, 363.4
$ 1, 478.7
$ 1, 604.4
$ 1, 716.7
$ 2, 517.2
$ 2, 719.3
$ 2, 904.1
$ 1, 188.4
$ 1, 277.5
$ 1, 354.2
$ 1, 328.8
$ 1, 441.8
$ 1, 549.9
Smith & Nephew
$ 1, 495.3
$ 1, 567.7
$ 1, 664.5
$ 1, 471.6
$ 1, 569.7
$ 1, 692.6
$ 1, 040.3
$ 2, 730.3
$ 3, 097.3
$ 11, 642.0
$ 12, 319.6
$ 13, 069.5
YOY % Growth
$ 1, 222.8
$ 1, 385.2
$ 5, 167.0
$ 5, 418.4
$ 5, 670.4
$ 1, 507.5
$ 1, 712.1
$ 6, 475.0
$ 6, 901.1
$ 7, 399.1
* adjusted to match fiscal year of Jan 1 to Dec 31
Source: Company reports and PearlDiver Technologies, Inc. estimates