Spine Market Shows Stability in 3Q

Spine industry suppliers sold $2.172 billion of products in the third quarter (3Q09), falling just short of our forecast of $2.177 by $5 million. We have therefore decreased our forecast slightly for the year from $8.860 billion to $8.833 billion. Even though the total sales figure fell just short of our estimates, the market has still reached a point of stability. Last year, spine industry suppliers reported a decline in revenue growth. That trend bottomed in 1Q09—when spinal implant shipments reportedly grew 8.1% YOY. Since then the industry revenue growth rate increased to 11.1% and 10%, respectively, for 2Q09 and 3Q09. Spine product companies, in our opinion, have laid the foundation for sustained, low double-digit revenue growth in the coming quarters. Three major trends, we believe, will impact future trends in the top line:

• New Product Cycle—The high growth biologics area is at the beginning of a new spine product cycle, with allograft-based stem cell products such as Trinity Evolution and Osteocel for spine fusion, and new bone void fill materials such as Cortoss for vertebral compression fracture treatment are taking center stage.

• Capital Crunch—Companies that control large shares of the market may be benefitting from the capital crunch facing smaller, start-up companies. Smaller companies may have problems executing their marketing or sales force expansion plans without adequate capital, or be forced to sell differentiated technologies at a discount.

• Consolidation—Larger companies are acquiring smaller competitors. For example, even though Archus Orthopedics Inc. raised over $63 million in venture capital since inception, the company shut down operations in September. Facet Solutions, Inc. then acquired Archus. Cardo Medical Inc. acquired the assets of Vertebron Inc. on October 7 for $1.3 million in cash. On September 14, 2009, Integra LifeSciences Corp. acquired the assets of Innovative Spinal Technologies Inc. (IST) for $9.25 million in cash.

Revenues at Larger Companies Growing at Market Rates

Revenue growth at larger companies has returned to that of the overall spine market, excluding Medtronic. For example, Orthofix International Spine revenue growth was flat one year ago (3Q08), but grew 11.1% this quarter. Revenues at DePuy Spine, Inc. grew 7% in 3Q08 and 11% this quarter. Some smaller spine product companies are facing a cash crunch given the tight credit markets, which may be allowing larger companies to regain market share or acquire these competitors cheaply. Also, growth leader Trans1 Inc. is facing reimbursement difficulties. Based on the reimbursement issue and slowing domestic procedure volumes, we are lowering estimates for 4Q09 to $6.7 million, an 11.6% YOY decrease in revenue.

In Table 1 we list and rank the quarterly sales for each major spinal implant company with our estimates for 2010 and 2011. As the table illustrates, sales of spinal implants and their related biologic products rose 9.9% in 3Q09. Although this is a lower growth rate than the 11.1% growth in 2Q09, it still represents a significant increase over the 8.0% growth in 1Q09. We would also note that the third quarter is seasonally weak for the spine industry, as some procedures are postponed during the summer months until the fourth quarter when some patients’ insurance deductibles have been met. From 2005-2008, on average, spine companies realized 24.6% of their revenues in the third quarter and 26% in the fourth quarter.  This ratio tends to be more pronounced in smaller, faster growing companies. For example, Trans1, Inc. and NuVasive, Inc. recorded 29.1% and 29.8%, respectively, of their revenues in the fourth quarter of 2008. For all of 2009, we estimate that spine revenues will rise nearly 10% to $8.83 billion.

Table 1: Quarterly and Annual Sales Revenue for Spine Product Companies

Source: PearlDiver Technologies estimates, Wall Street reports, SEC filings; Synthes, Globus, and DePuy are estimated revenues; Osteotech spine-related revenue assumes 70% DBM revenue is spine related; and Abbott Spine revenues reported as part of Zimmer 4Q08

Table 2 displays market share gains and losses for the quarter. We estimate that NuVasive and Globus gained 1% and .7%, respectively, in the quarter due to strong revenue growth. Medtronic continued to lag market growth rates and does not anticipate returning to market growth until 2010.

Table 2: Market Share Changes

Source: PearlDiver Technologies estimates, Wall Street reports, SEC filings

Individual Company Commentary

Globus Medical, Inc.

Globus Medical is gaining market share and revenue. Third quarter revenues rocketed up 45% to $66.2 million (versus $45 million in 3Q08). In the past several years Globus has become a force to be reckoned with in the spine product industry, with revenues doubling from $123 million in 2007 to an estimated $255 million in 2009. This company has plenty of innovative ideas and Globus manages to move these ideas quickly to market. The company will launch 17 new products in 2009 and has launched 26 in the last four years. Moving forward, Globus plans to leverage its minimally invasive platform known as MILDER (minimally invasive, less disruptive, earlier recovery) Spine Care. The focus is to develop and launch technologies that treat spine disorders in a minimally invasive fashion to facilitate faster and pain free recoveries. Product launches should continue to drive extremely strong growth at Globus. We estimate 4Q revenues will be $71.5 million, representing a 43% year-over-year (YOY) growth, and we estimate full-year revenue to be $255.7 million (43.4% YOY growth).

NuVasive, Inc.

NuVasive attributed its outstanding revenue growth in 3Q09 to continued market share gains driven by its minimally invasive product platform, which, in the words of CEO Alex Lukianov, gives the company an “unparalleled advantage.” Third quarter revenues grew 41.8% to $94.9 million (versus $66.9 million in 2Q08), and the company was profitable for the quarter. NuVasive management anticipates $45 million to $50 million in biologics sales in 2009. NuVasive sees the spine product market as strong, and reiterated that he expects 10% annual growth. Management raised full-year revenue guidance to $365 million–$367 million from the previous guidance of $360 million–$365 million. NuVasive expects 30%–35% revenue growth in 2010. Product pricing was essentially flat for the quarter, and strong procedure volumes drove growth.

NuVasive also introduced several new products at the annual NASS (North American Spine Society) conference. These include the continued development of XLIF (extreme lateral interbody fusion)in the thoracic region, a new scoliosis and adult deformity system, an expandable vertebral body replacement system, the helix translational anterior cervical plate and the next generation XLP lateral plate.

NuVasive is laying the foundation for growth by investing in clinical trials to bring new products to market.

• XL TDR (total disc replacement) clinical IDE (investigational device exemption) study began enrollment during the third quarter and the company expects to complete enrollment in late 2010.

• Studies for Osteocel Plus in both the lumbar and cervical spine are underway with data expected to come in late 2010 through 2011.

• The company plans to file for a PMA (Pre Market Approval) for the PCM cervical disc replacement device in early 2010 as planned.

We estimate 4Q09 revenues will be $102.5 million (37.4% YOY growth). We expect that the strong growth will continue at NuVasive, and we estimate full-year revenue to be $365.9 million, which is a 46.3% YOY growth.

TranS1, Inc.

Reimbursement challenges continue to weigh on TranS1, negatively impacting the company’s revenue and procedure volume growth. On October 6, TranS1 pre-announced that third quarter revenues fell short of management’s prior guidance of $7.4 million–$7.9 million. Third quarter 2009 revenues grew 14.8% to $6.9 million (up from $6 million in 3Q08). The company reported that surgeons performed 729 Axial Lumbar Interbody Fusion (AxiaLIF) procedures worldwide (606 domestic) in the quarter (up from 555 in 3Q08). AxiaLIF procedure growth, a key driver of revenues, increased 8.6% YOY in the first quarter.

The primary reason for the shortfall in the third quarter was confusion over the category III CPT (Current Procedural Terminology) code that physicians use for reimbursement. Beginning January 1, 2009, the access code that physicians use to be reimbursed for AxiaLIF became a category III CPT code, as opposed to the ALIF (anterior lumbar interbody fusion) code. There remains significant uncertainty as to when this issue will be resolved and when the procedure could receive a category I code, which would allow for more straight forward reimbursement. Management noted that AxiaLif 360° procedures in particular are being affected, which raises concerns for us given the higher selling price for this procedure. Also of concern is the fact that the salesforce must spend time educating and retraining existing customers on reimbursement, as opposed to seeking new business.

The average selling price (ASP) of AxiaLIF was $10, 400, up 12.6% from 3Q08; 22% (138 cases) of the procedures were 2-level (fusing two vertebral levels in the lumbar spine) and 28% (199 cases) of the procedures were 360° fusions, which command higher ASPs. The company’s direct salesforce stood at 66 at the end of the quarter and the company will be slowing sales force expansion.

Based on the reimbursement issue and slowing domestic procedure volumes, we are lowering estimates for 4Q09 to $6.7 million, an 11.6% YOY decrease in revenue. For the full-year 2009, we estimate revenues to be $30 million.

Biomet, Inc.

Revenue growth at Biomet Spine continues to exceed expectations. This marked Biomet’s seventh consecutive quarter of domestic revenue growth in spine. Biomet’s third quarter spinal repair and implant revenues (fiscal 1Q10) increased 15.4% YOY (16.6% constant currency) to $59.3 million, surpassing PearlDiver estimates of $57 million. Sales in the U.S. rose 15%. The company cited balanced growth in the cervical thoracolumbar and strong spacer product lines during the quarter. The Solitaire Anterior Spine System drove growth in the spacers and the Polaris Deformity System helped drive the thoracolumbar product line. In Europe the Synergy and Array Spinal Systems led growth.

During the conference call held on October 9, 2009, the company attributed the strong growth to new product launches, an increase in inventory being released to the field, surgeon and salesforce education events, and the focus on a dedicated spinal product salesforce. We estimate 4Q09 (Biomet’s 2Q10) revenues to be $61 million (10.3% YOY revenue growth) and calendar year 2009 revenues to be $235 million (12.3% YOY revenue growth).

DePuy Spine, Inc.

DePuy Spine is back on track and has reported double-digit worldwide operational growth of 13%, 11%, and 11% for the last three quarters, respectively. We estimate overall spine revenues rose to $242 million in the third quarter (vs. $221 million in 3Q08).

We believe DePuy is benefiting from several new product launches that took place in 2008 as well as continued momentum in 2009. In April 2009, DePuy launched Healos Fx Injectable Bone Graft Replacement for minimally invasive spine procedures and announced that it would be working with Advanced Technologies and Regenerative Medicine, LLC, to test a genetically engineered human protein for degenerative disc disease.

Stryker Corporation

Stryker Spine continued as the best performing orthopedic division in the company. YOY spine revenue growth has increased sequentially for the last three quarters, growing 8%, 9.4%, and 14%, respectively. In 3Q09, Stryker’s spinal repair and implant revenues grew 14% to $138.1 million (up from $128.1 million in 3Q08). The domestic spine product business grew 13% YOY. Revenues were driven by inter-body and lumbar products. The company reported that overall international spine product revenues increased 14% during the quarter (+16% constant currency) which was the highest growth seen internationally since 1Q07.

We estimate that 4Q09 revenues will grow 14% YOY, rising to $158.6 million and full-year 2009 revenue to be $565.4 million (11.4% YOY growth).

Alphatec Spine, Inc.

On November 9th, Alphatec reported record third-quarter revenues and reiterated full-year revenue guidance to $128 million – $130 million. Alphatec’s third quarter revenues grew 26.7% to $32.7 million (up from $25.8 million in 3Q08). U.S. revenues grew 21.4% in 3Q09, exceeding overall spinal repair and implant market growth of 10%. This marked the ninth consecutive quarter of record revenues and the sixth straight quarter of YOY revenue growth exceeding 25%. In 3Q09 international sales (Europe and Asia) comprised 20.3% of revenues, or $6.6 million, up from $4.4 million in 3Q08. Alphatec now has over 90 distributors in the U.S. representing 267 sales reps with a goal of having over 85% exclusivity in 2010.

In our view, the key to Alphatec’s success has been excellent execution by management, new product launches, and a focus on high-growth, niche markets such as the aging spine. The company is also focused on expanding internationally and continues to build its MIS portfolio. Highlights for the quarter are:

• U.S. market launch of the Illico SE percutaneous MIS system

• OsseoScrew submitted to the FDA for 510(k) approval

• OsseoFix patient enrollment initiated for U.S. clinical study

• Year-to-date over 300 patients treated in Europe with OsseoFix

• Year-to-date over 150 surgeons trained in Europe with OsseoFix

We are raising our full-year revenue estimates to $130.2 million from $129.1 million. For 4Q09, we estimate that sales will reach $34.7 million.

Medtronic, Inc.

Worldwide spinal implant and biologics revenues rose 4.0% to $862 million in the quarter, (which is Medtronic’s second quarter of its fiscal year) up from $829 million in same period a year earlier. Revenues in Medtronic’s core spinal product business, which now includes Kyphon, grew 1.7% in the quarter to $642 million. Sales of biologic products increased 11.1% to $220 million (up from $198 million in 3Q08). International sales were a key driver of growth, rising 9.9% YOY. However, Kyphon was primarily a drag on the core spinal business. Management noted that revenues declined YOY in the Kyphon business, driven by a decrease in physician referrals due to a negative article regarding vertebral compression fracture treatments that appeared in the New England Journal of Medicine.

In the quarterly conference call, management noted that they are working to revitalize the core product pipeline. The company is seeking to expand indications for InFuse and currently has eight clinical studies underway in an effort to achieve this with indications for posterolateral spine fusion being the most critical. Medtronic is also working on the G5 system, a new posterior pedicle screw system, but management does not expect this to impact revenues until 2011.

Growth at Medtronic spine continues to lag behind the overall spine product market growth, and management does not expect a return to this level of growth until 2011. We estimate calendar year fourth quarter spine product sales will rise 4.6% to $870 million. This would equate to calendar year 2009 spine product revenue growth of 4.1%, or $3.528 billion in revenues.

Looking Forward

The market as a whole is showing stability. Most larger companies are now posting revenue growth comparable to that of the overall market and are stemming some of the market share losses seen in the last few quarters. Smaller companies, however, face challenging capital markets and potential reimbursement issues. Chart 1 displays the current market share for spine product companies. A new product cycle is upon us, which may help to offset continued challenges with respect to pricing. Despite these challenges, we believe the spine treatment industry will continue to grow at the steady pace it has set in the past few quarters.

Chart 1: Company Market Share

Source: PearlDiver Technologies estimates

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