OUS Troubles Sink Hip/Knee Growth Rates

The economic tsunami continues in the large joint reconstruction market, and total revenues remained under sea level for the second consecutive quarter. Sales reports confirm that over the previous three months, large joint reconstruction market revenue declined, dipping even further into the red led by declines in sales outside the U.S. Zimmer, Inc. again saw the biggest declines after suffering the same honor in the first quarter of 2009.

Chart 1: Global Reconstruction Market Revenue Growth (Year-Over-Year)

Source: Company Reports

Chart 1 displays global, year-over-year (YOY) revenue growth rates for the hip, knee, and overall large joint reconstruction markets. The results confirm that we have now seen our second consecutive quarter of declining sales. From April 1st through June 30th, we estimate the overall market for hips and knee reconstruction decreased 4.2%, with hip reconstruction decreasing more dramatically (by 5.2%) than knee reconstruction revenues which declined 3.5%.

Two ships still fighting to remain above the 0% YOY growth water line were Biomet, Inc. and Exactech Inc. Biomet was the only manufacturer to see an increase in revenue in both areas of large joints: 1.3% increase in hip reconstruction and 3.5% in knee reconstruction. Although Exactech did not have positive numbers in both areas of the market, the company did report stellar YOY growth within their hip reconstruction revenues of 17.5%.

Second Quarter Breakdown

Biomet, Inc. reported large joint reconstruction product sales of $328.7 million in its 4Q09 (which ends May 31, 2009), an overall YOY increase of 2.6%. Hip repair product sales increased 1.3% YOY on the continued success of their press-fit stems. Knee repair product sales increased 3.5% on strong sales of the Vanguard Complete Knee System and E-Poly Tibial Bearings.

DePuy, Inc. reported large joint reconstruction sales of $631 million, a 4% decrease from the second quarter of 2008. The company’s hip division reported sales of $274 million, below Wall Street consensus expectations of $287 million and our PearlDiver expectations of $289 million. This represents a YOY revenue growth rate decrease of 4.5%. DePuy reported knee repair product sales at $357 million, a decrease in revenue growth of 3.5% from 2Q08, in line with Wall Street and PearlDiver expectations.

Exactech, Inc. reported large joint reconstruction product sales of $25.6 million, a YOY decrease of 2.3%. Despite this decrease in large joint reconstruction overall, hip repair product sales experienced an exceptional quarter increasing YOY 17.5% to $6.7 million. The company attributes these gains to their Novation product line which has attracted new customers. This exceeded PearlDiver expectations of $6.0 million, but was overshadowed by a larger-than-expected decrease in knee repair sales which account for 44% of total revenue. Knee repair product sales were reported at $18.9 million, a decrease of 7.8% YOY, which  accounts for the company’s total revenues coming in at $2 million below our forecast.

Smith & Nephew, Inc. reported large joint reconstruction product sales of $357.0 million, a YOY decrease of 7.0% from 2Q08. Hip repair product sales decreased YOY 8.2% to $168.0 million, falling well below PearlDiver estimates. Knee repair product sales decreased YOY 6.0% to $189 million, also falling below PearlDiver estimates.

Stryker, Inc. reported revenue declines in both the hip and knee reconstruction markets. Overall, large joint repair product sales were reported to be $582.4 million, a decreaseof 1.7% over the previous year. Stryker hip repair product sales declined YOY for the third consecutive quarter, decreasing 1.8% in 2Q09 to $277.1 million.

Despite declining sales, revenue for hip repair products exceeded Wall Street expectations of $273 million and PearlDiver expectations $271 million. Knee repair product revenues declined 1.5% to $305.3 million, but were also not as bad as we expected, beating Wall Street expectations of $302 million and PearlDiver expectations of $301 million.

Wright Medical, Inc. reported that large joint reconstruction product sales declined YOY 1.9% to $71.3 million due to lower procedure volumes. Hip repair product sales decreased YOY by 0.8% to $41.1 million, well below PearlDiver and Wall Street estimates. Knee repair product sales decreased by 3.3% YOY, falling to $30.2 million. This decline was slightly below PearlDiver and Wall Street estimates. Pricing in both the hip and knee divisions through the quarter remained flat domestically and decreased slightly in Europe.

Zimmer, Inc. reported sales well below expectations in both hip and knee reconstruction markets with revenues of $308 million and $438 million, respectively. In total, large joint reconstruction product sales dropped 7.9% from 2Q08 to $746 million—the third consecutive quarter for knee and hip reconstruction revenue declines. Aside from patient deferrals, factors contributing to the decline included a decrease of average selling price for both hip and knee products of 1% and a steep decline in revenues outside the U.S. (OUS) related to both deferrals and effects of foreign currency.

Chart 2: First Quarter Large Joint Sales Growth

Source: Company Reports

Currency Impact on Reported Numbers

The market leaders of large joint reconstruction—Zimmer, Stryker, and DePuy—each suffered losses in both knee and hip divisions. Yet that is only half of the story. Domestically, each of these manufacturers did significantly better than their numbers would indicate in both categories. For DePuy and Stryker, domestic large joint revenues showed exceptional gains, and even though Zimmer’s revenues declined domestically, those losses were not even on the same scale as their reported OUS revenue declines.

Each company had their own specific troubles abroad. Currency values affected everything, but other issues also attributed to the sinking effect foreign sales had on revenues. During the quarterly call with Zimmer, Jim Crines, EVP of Finance and CFO, attributed the decrease to European patient deferrals stemming from the market slowdown. Stryker’s President and CEO, Stephen MacMillan, attributed the poor OUS sales numbers to executional issues stemming from reorganizations within key European countries as their focus shifts to key franchises.

Table 1: Domestic and International Sales of Top Manufacturers by Market Share

Source: Company Reports

Impact on Market Share

As illustrated in Chart 3, each of the top large joint repair product manufacturers (DePuy, Stryker, and Zimmer) have seen a decline in growth from 2Q08 through 2Q09 for two consecutive quarters. Meanwhile, Biomet was the only large joint recon manufacturer to maintain positive growth overall in the large joints sector.

Chart 3: Large Joint Sales Growth Trend by Company

Source: Company Reports

The result is an increased market share of the overall large joint reconstruction market for Biomet to 11.0% from 9.7% one year earlier. Conversely, over the last year, Zimmer’s market share has declined from 26.3% to 24.8%.

Table 2: Large Joint Reconstruction Market Share of Top Producers

Source: Company Reports

As the YOY winner in market share gains, Biomet has increased its share in both hip and knee divisions. In the hip division, its share has increased from 9.2% in 2Q08 to 10.4% at the end of 2Q09. In knee division, its share grew from 10.1% in 2Q08 to 11.5% at the end of 2Q09.

The biggest market share loser to report over the last year has been Zimmer, which slid from a total share in the large joint reconstruction market of 26.3% one year ago, to 25% as of the end of 2Q09. While it is still the largest market share holder in both hip and knee divisions, these declines cannot continue if the company  expects to remain in that position. The most significant of Zimmer's  market share losses thus far have been in the hip division, which declined from 24.8% to 23.2% over the last year. However, the knee division has also seen significant declines in that time frame, dropping from of 27.5% to 26.4%.

Earnings Forecast

Now with half of 2009 behind us, the declines in the large joint reconstruction market are thankfully losing momentum. However, it will be some time before the market will find its revenues above the water line again. Procedure volumes have shown no signs of increasing, and pricing is expected to remain relatively flat.

Looking forward into 2009's third and fourth quarters , we estimate a slow improvement in hip revenues, with YOY revenues declining, but to a lesser degree than we have seen in 2Q09. For the third quarter we expect a YOY market revenue decrease of 3.5%, and a decrease of 2.5% in the fourth quarter. By our estimates, this amounts to a 3.1% decline in revenues for the hip repair market.

Table 3: Forecasted Hip Repair Revenues

* adjusted to match fiscal year of January 1 to December 31
Source: Company Reports and PearlDiver Research

In the knee reconstruction market, we expect slow progress in the third and fourth quarters with revenue decreases growing smaller in the third quarter and turning again to increases in the fourth quarter. In total, we expect a 1.0% decrease for the third quarter and 0.7% growth for fourth quarter of 2009. Overall, this sales growth expectation is equivalent to 0.9% decline for the year.

Table 4: Forecasted Knee Repair Revenues

* adjusted to match fiscal year of January 1 to December 31
Source: Company Reports and PearlDiver Research

With the overall large joint reconstruction market reporting declines for the second straight quarter, we estimate the market will remain below the water line for the remaining two quarters of the year. Foreign sales have had a serious impact on the reported numbers of the market leaders during the second quarter, procedure volumes are not showing signs of dramatic improvement, and product pricing is expected to remain flat. These factors point to a tough swim back to the surface for the remainder of 2009.

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