Extremities 3Q Revenues Up 15%?

Extremities may be small parts of the human body, but their repair and replacement are generating high sales growth rates. Furthermore, the number of extremity repair procedures remains the largest in all of orthopedics with over 3.5 million surgical procedures performed annually in the U.S. (more than 40 million physician visits annually in the United States for extremity related complaints). Therefore, the overall market share of extremities (as a percent of global orthopedic revenues) has been growing faster than hips, knees, and even spine. According to our estimates, the extremities sector of orthopedics will grow more than 16% for the calendar year 2008 and that rate will be the highest growth rate reported of any orthopedic sector.

DePuy

For the third quarter, ending September 30, 2008, almost all extremity companies reported double-digit annual growth rates ranging from 10% to more than 50%. Johnson & Johnson’s DePuy, the leading extremity company worldwide, reported a 12% year-over-year growth for the third quarter to $50 million in quarterly product shipments. This growth rate was less than we’d been expecting and reflects, we think, increasing competition from other extremity companies with strong offerings in the faster growth shoulder segment. DePuy’s 3Q2008 extremity sales growth rate was also less than our estimate of the U.S. extremity shipment growth rate for the third quarter—namely 20%. For 3Q2007, DePuy reported an extremities product sales growth rate of more than 50% as a result of both product sales and acquisitions.

DePuy’s share of the extremities market, we estimate, is now 23.2% as of 3Q08—down slightly from the prior year’s 24%. Originally, we’d estimated that DePuy’s extremity revenue growth rate for the third quarter would be a relatively conservative 19% growth rate (the industry, we expected, would grow 20%). Since actual revenue growth fell short of our estimate by almost 5% we are reducing our fourth quarter sales growth rate estimate from 15% to 12%.

With no major acquisitions in 2008, we believe it is highly likely that DePuy extremities sales growth rate for 2008 will be in line with 12%. The company’s two product bright spots are the Agility Ankle System and the Delta Shoulder System, which contributed significantly to DePuy’s extremity sales.

Zimmer Holdings

Zimmer Holdings extremity sales growth rates were similar to, but still higher than DePuy’s. Third quarter extremity sales rose 15% compared to the same period last year. Zimmer’s 3Q extremities revenue contributed $28 million to overall Zimmer sales. Sales of extremity products now account for 3% of Zimmer’s total revenues. Last year, extremity sales comprised 2.6% of Zimmer’s total orthopedic product sales. For the nine months ended September 30, 2008, Zimmer’s extremity product sales have risen 21% on a year-over-year basis and bring the firm’s nine month extremity sales to more than $90 million. Zimmer’s extremity sales in North America grew 19% in the third quarter. Zimmer’s extremity sales in Europe increased 9% and, surprisingly, Zimmer reported that Asian extremity sales declined 11%.

One of the key strengths of Zimmer’s extremity product line is the platform of shoulder products. Leading the way is Zimmer’s Bigliani/Flatow Shoulder Solution and the Zimmer Trabecular Metal Reverse Shoulder System which led extremities sales growth in the American division. Zimmer’s Anatomical Shoulder System and the Coonrad/Morrey Total Elbow led extremities sales in the European bazaar followed by the Coonrad/Morrey Total Elbow which led the Asian market.

PearlDiver estimated that Zimmer’s 2008 third quarter sales would be around 18%, which was 3% higher than the company’s actual growth of 15%. The fourth quarter of 2007 had produced revenues of $30 million, a solid 36% annual growth. Then, for 1Q08 Zimmer reported that extremity sales had increased 31% year-over-year. Not bad at all, but still below the prior year. For the second and third quarters of 2008, Zimmer reported that its extremity sales growth rate had slowed to 18% (2Q) year-over-year and then 15% (3Q) year-over-year.

The trend of slower year-over-year sales growth for this year is, we think, clear and we are, therefore, lowering our revenue growth estimate for the fourth quarter of 2008 from 20% to 16%. A key factor, we believe, is that Zimmer’s shoulder division is experiencing more competition. Looking ahead to 2009, we are forecasting slower but steady double-digit revenue growth for Zimmer in the 10% to 12%  range—barring, of course, any M&A activity in the extremity sector.

Wright Medical Technologies

Wright Medical Technologies, a small orthopedic company based in Arlington, Tennessee, is one of those companies gaining market share in the extremity market. This year’s acquisition of A & M Surgical’s foot and ankle products, INbone Technologies and its own product line of Charlotte-related extremity products has made Wright Medical Technologies one of the fastest growing extremity (indeed, orthopedic) companies in the industry. It is clear that Wright Medical is closing the market share gap with DePuy, Tornier, and Zimmer.

For the third quarter, Wright Medical reported a very strong sales growth rate of 38.5%—bringing reported quarterly revenues in at $21.7 million. Due to an acquisition in the foot and ankle sector, we now estimate that Wright’s 2008 extremity product sales growth rate will be close to 37% on a year-over-year basis. The total growth of the three quarters combined is nearly 48% year-over-year. Sales of extremity products now represent 19% of all of Wright Medical’s product sales. Wright’s U.S. extremity business grew on the strength of rising shipments of the DARCO and CHARLOTTE product lines and product sales from its April 2008 acquisition of INbone Technologies, Inc. International sales were driven primarily by Wright’s DARCO plating systems.

We recently increased our revenue growth estimate for Wright Medical’s fourth quarter to 34% from 31.5%. One year ago, in 4Q2007, the company reported that extremity sales (off a low base) rose 61% to almost $19 million in product sales. We now estimate that Wright’s 2008 extremity product shipments will reach $89.5 million for an annual growth rate of 43.6% versus 38% growth in prior year (2007). By the end of 2009, we are predicting Wright Medical will surpass the $100 million mark in extremity product shipments and become the fourth largest such supplier DePuy, Tornier, and Zimmer. Wright Medical has stated that they expect that 2009 revenue growth rate will be consistent and similar to 2008. Management’s guidance is that extremities sales growth will range from 23% to 28% year-over-year in 2009. We think this guidance is conservative and are incorporating in our own estimates 23% for the year 2009.

Biomet

Biomet reported that its extremity product sales increased over 16%  in the September quarter. Biomet, which became a private company in 2007, accounts for approximately 7% of the global extremity market share. Biomet’s extremity revenue growth rate is now roughly comparable to DePuy’s—in the low teens and has declined from the high twenties in 2007 and before. Among Biomet’s most prominent extremity products are the Bio Modular shoulder system and the Copeland Humeral system.

Exactech Inc.

Exactech Inc., one of the smallest extremity companies ( less than 2% of the extremity market worldwide) is reporting rapid revenue growth off an admittedly low base. For the third quarter Exactech reported that extremity product shipments reached $4.2 million which is a 73% annual year-over-year growth rate and easily surpassed our estimate of 45%. The total sales for the first three quarters amounted to $11.8 million. We estimate that extremity sales will be slightly over $16 million by the end of 2008 and around $24 million by the end of 2009. Exactech’s extremity products include the Equinoxe shoulder system, which is used for total shoulder replacement, reverse shoulder replacement and other shoulder related procedures.

The table below shows these extremity companies markets worldwide with their third quarter earnings and future estimates.

Table 1: Worldwide Extremity Product Shipments by Company (2007-2009E)
Source: SEC filings, PearlDiver estimates and press releases. Shaded lines represent estimates.
Others: Private extremity companies, Integra Life Sciences, Orthofix, Arthrex, SBi, Smith & Nephew, and Stryker.
* ArthroCare has not reported sales since 1Q07.

Tornier

Most of the remaining companies that serve the extremity markets are privately held. Tornier, the second largest extremity product supplier, was founded in France but, due to a private equity buy-out in 2006, is now based in Minneapolis, Minnesota. Two years ago, Tornier reported that annual extremity sales were approximately $100 million and were growing at a 20% average annual rate. We estimate that 2008 revenue for Tornier, with its huge overseas market, is approximately $133 million—representing a slower rate of annual growth since 2006 than management had originally forecast. (DePuy is number 1 in the extremity market worldwide closing on a $200 million or more sales by the end of 2008. Zimmer holds the number 3 rank with estimated $120 million or more in product sales by the end of 2008.) Tornier’s lead products include the Aequalis Shoulder System and the NexFix MTP Fusion System.

The following chart is our estimate for the year 2008 of the extremity companies and their market share worldwide. DePuy holds the biggest market share with 23.2%, followed by Tornier, Zimmer, and Wright Medical with 14.3%, 13.5%. and 9.6%, respectively. A special mention goes out to the Arlington, Tennessee-based Wright Medical, whose market share jumped from 7.7% market share in 2007 to 9.6% in 2008.

Chart 1: Extremity Companies Market Share (2008 E)
Source: Company’s guidance outlook and PearlDiver estimates for the year 2008
Others include Smith & Nephew, Stryker, and Orthofix, Integra LifeSciences, Small Bone Innovations, and other private companies.* ArthroCare has not reported their earnings since 1Q07.

Other Extremity Companies

Ascension Orthopedics, based in Austin, Texas, is another privately held company in the extremity sector with reported revenues in 2007 of $14 million. Small Bone Innovation (SBi), Arthrex, Integra LifeSciences, Orthofix, Smith & Nephew, Stryker, and Acumed are other companies that have established a good foundation in the extremities division. SBi reported a 56% annual growth worldwide for 2007 compared to 23% growth in 2006. Integra LifeSciences reported 20% year-over-year sales growth rate for the third quarter.

Despite an overall choppy economic environment, extremity product shipments continue to grow at exceptional rates. For the quarter ending December 31, 2008, we estimate that overall extremity product shipments will increase 16% year-over-year and within a range of 14% to 15% for 2009.

Shoulder, foot and ankle products should continue to pace the industry. Zimmer, Exactech and Biomet, we expect, will continue to perform well with their shoulder products while Wright Medical will, we think, continue to dominate the foot and ankle market and close the gap with DePuy. DePuy, Wright Medical, Tornier, Zimmer, and Biomet alone ship more than $600 million in extremity products annually. With just five companies generating over $600 million, and the tremendous growth seen in almost all the extremity companies, we predict that overall shipments of extremity products will exceed $900 million by the end of 2008 and cross the $1 billion mark by the end of 2009.