Spine Revenues Up 11.1% New Trend?

Spine industry suppliers sold $2.27 billion of products in the second quarter (2Q09), exceeding our forecast by $54 million, or 2.4%.  We have, therefore, increased our forecast for the Spine Industry by .5% to $8.860 billion for the remainder of 2009.  We have also increased our forecast for 2010 from $9.821 billion to $9.841 billion.  Suppliers of spine surgery products, like all other sectors in the Orthopedics industry, had been reporting slowing rates of sales growth since fourth quarter, 2008.  Specifically, industry growth rates were 8.0%, 9.7% and 12.7%, respectively, for the quarters ended March, 2009, December, 2008 and September, 2008.  Three reasons, we believe, caused the surprisingly strong sales growth in the just ended quarter:

• First, DePuy, Inc., Orthofix International, and Biomet, Inc. all returned to high growth rates with revenue growth of 11%, 13%, and 16%, respectively. Revenues at Medtronic, which we estimate as having 40% market share, also grew 6.5%, beating analyst estimates.
• Next, procedure volumes in spine treatment have remained higher than that of other areas of orthopedics such as large joint repair. 
• Finally, companies continued to focus on entering niche markets that have the potential for growth. NuVasive, Inc. and TranS1, Inc. are now looking at MIS technologies to treat deformity while Alphatec Spine Inc. leads the development of products to treat aging spines. The success of these companies helped push the overall industry sales higher.

The spine product industry also continues to move novel technologies through the approval process. During 2Q09, Medtronic received FDA approval for its Bryan Cervical Disc and Orthofix received the CE (European conformance) mark for the Advent cervical disc. Perhaps the most exciting development was the FDA clearance of Orthovita’s Cortoss, which presents an alternative to PMMA (Poly methyl methacrylate) in the treatment of vertebral compression fractures. These new technologies could help sustain the high sales growth rate in the long term.

The Centers for Medicare and Medicaid Services (CMS) also issued the final 2010 IPPS (inpatient prospective payment system) ruling regarding reimbursement. Spine procedures fared well with fusion reimbursement and vertebral augmentation procedure reimbursement increasing 5.3% and 3.2%, respectively.

Larger Companies Return to High Growth Rates

Over the past few quarters, smaller spine product companies have been growing at faster rates than the larger companies. However, these larger companies finally reached improved growth rates in 2Q09. Revenue growth at larger spine companies grew at slower rates than their smaller competitors, but it did return to the overall market growth rates. Some smaller spine companies are facing a cash crunch given the tight credit markets and hesitation on the part of investors, which may be allowing larger companies to regain market share.

In Table 1 we list and rank the quarterly sales for each major spinal implant company with our estimates for all of 2009 and 2010. As the table illustrates, sales of spinal implants and their related biologic products rose 11.1% in 2Q09. Although this is a lower growth rate than the 14% growth in 2Q08, it still represents a significant increase over the 8.0% growth in 1Q09. For all of 2009, we estimate that spine revenues will rise nearly 10% to $8.86 billion.

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

Revenue ($ millions)	2008	1Q09	2Q09	3Q09E	4Q09E	2009E	2010E
Medtronic	$3, 389	$881	$915	$874	$870	$3, 540	$3, 717
DePuy	913	250	270	240	238	998	1, 078
Synthes	867	234	239	236	247	956	1, 061
Stryker	507	129	140	133	153	555	613
NuVasive	250	80	89	93	104	366	490
Orthofix / Blackstone	252	66	71	68	72	277	304
Zimmer	230	65	64	62	70	260	300
Globus	178	54	64	62	69	249	343
Biomet	210	54	62	57	61	233	251
Alphatec	101	31	32	32	35	129	155
Pioneer Surgical	92	27	28	28	29	112	134
Orthovita	77	22	24	23	25	94	117
K2M	60	20	21	20	22	83	107
SeaSpine	45	14	15	15	16	60	75
Scient’x	52	14	14	14	15	58	63
Osteotech	52	12	12	12	12	48	50
ArthroCare	55	11	12	13	14	50	52
RTI Biologics	42	10	11	11	11	43	45
Integra Spine	19	10	10	10	11	41	47
US Spine	29	10	10	10	10	39	50
LDR	21	8	9	9	9	35	53
TranS1	25	9	8	8	9	33	44
Spinal Elements	18	6	6	6	7	25	33
Exactech (Altiva)	7	2	2	2	2	8	9
Other	495	137	142	141	148	568	653
Total Revenues	$8, 073	$2, 154	$2, 270	$2, 177	$2, 259	$8, 860	$9, 841
Total Growth	12.9%	8.0%	11.1%	9.7%	10.2%	9.8%	11.1%

Source: PearlDiver estimates, Wall Street reports, SEC filings. Synthes, Globus, and DePuy are estimated revenues. Osteotech spine-related revenue assumes 70% DBM revenue is spine related. Abbott Spine revenues reported as part of Zimmer 4Q08. ArthroCare Spine has been delisted from the NASDAQ and has not reported revenues

Companies attributed revenue growth in the quarter to higher procedure volumes and healthy procedure mixes. Overall, pricing was almost flat (we estimate a modest 1.5% increase), and companies reported that budget-constrained hospitals continue to apply pressure for lowering costs. This underscores the importance of new product introductions and regulatory approvals in the spine sector.

Table 2 illustrates market share changes for individual companies this quarter. Strong revenue growth allowed NuVasive, Globus, and Alphatec to gain market share. Zimmer’s gain was attributable to the Abbott acquisition. Biomet, Trans1, and Orthofix also saw modest share gains. Medtronic lost share, but at a slower rate than previous quarters.

Table 2: Market Share Changes

Company	2Q08	2Q09	Est. Market Share Δ
NuVasive	2.8%	3.9%	1.1%
Globus	2.1%	2.8%	0.7%
Alphatec	1.2%	1.4%	0.2%
Zimmer*	2.7%	2.8%	0.1%
Biomet	2.6%	2.7%	0.1%
TranS1	0.3%	0.3%	0.0%
Orthofix	3.1%	3.1%	0.0%
Synthes*	10.6%	10.5%	-0.1%
DePuy	12.0%	11.9%	-0.1%
Stryker	6.3%	6.2%	-0.1%
Medtronic	42.0%	40.3%	-1.7%

Synthes, DePuy, and Globus revenues are estimated. Zimmer revenue growth includes Abbott acquisition.

Individual Company Commentary

Privately Held Spinal implant Companies

Globus Medical has been a sales growth superstar and is now the largest privately held spinal implant company in the world. We estimate that revenues at Globus exceeded $60 million in 2Q09, and we estimate that full year revenues will exceed $245 million. We are tracking several other firms, including LDR Spine, SeaSpine, Pioneer Surgical Technology Inc., K2M Inc., Scient’x, and Spinal Elements Inc., which are posting strong sales growth rates ranging from 20% to 35%.

NuVasive, Inc.

NuVasive continued to capture additional market share in 2Q09 in its march to claim the fourth largest share of the market in the world. By beating previous revenue forecasts, this company helped the new trend of high revenue increases in the overall market. Second quarter revenues grew 54.2% to $88.5 million (a significant increase from $57.4 million in 2Q08) and the company was profitable for the quarter. Sales of Osteocel Plus, the stem cell-based biologic, reached $8 million (9.0% of sales) for the quarter. CEO Alex Lukianov sees the spine product market as strong, and reiterated that he expects 10% annual growth. Management raised full-year revenue guidance to $360 million –$365 million from the previous guidance of $350 million–$360 million. Beyond this, NuVasive expects 30%–35% revenue growth in 2010. International sales, which so far comprise 2.5% of revenues in 2009, should grow to 13% in the long term. The company is also on track to opening an office in Japan in 2010.

In addition to making smart technology acquisitions such as the PCM cervical disc, NuVasive is broadening the application of its MIS technology to new markets in the spine sector. The company is working on applications in adult degenerative scoliosis and an intervertebral body device for tumor treatment. By the end of 2010, NuVasive plans to have a major presence in the thoracic/deformity treatment market, while also building on its cervical treatment portfolio. The worldwide sales force will rise to 275–300 reps globally by the end of the year, and they will have a broadening product line to offer to buyers.

We expect that the strong growth will continue at NuVasive, and we are raising our full-year revenue estimates to $365.5 million, which is a 46.2% year-over-year (YOY) growth.

Stryker Corporation

Stryker’s spine division was the best performing orthopedic division in the company. In 2Q09, Stryker’s spinal repair and implant revenues grew 9% (13% constant currency) to $140.2 million (up from $128.1 million in 2Q08), exceeding our estimates of $138.3 million. The domestic spine product business grew 14% YOY. Revenues were driven by inter-body and lumbar products. The company reported that overall international spine product revenues declined 1% during the quarter (+10% constant currency) even though revenues in Asia-Pacific and Japan saw low double-digit growth.

Management noted that they continue to view the spine product market positively and they believe Stryker has gained share over time. We estimate Stryker has about 6.3% market share in the spine sector. There were modest increases in pricing during the quarter, however, high procedure volumes and, to a lesser extent, a strong procedure mix were the primary drivers of growth. We estimate that the 2009 full-year revenue will be $554.9 million (9.3% YOY growth) and 3Q09 revenues to $133 million (9.8% YOY growth).

Alphatec Spine Inc.

On August 3, Alphatec reported outstanding first quarter revenues and again increased full-year revenue guidance to $128 million–$130 million. Alphatec’s second quarter revenues grew 35.3% to $32.3 million (vs. $23.8 million in 2Q08). U.S. revenues grew 36% in 2Q09 and 11% sequentially, exceeding overall spinal repair and implant market growth of 10%. This marked the eighth consecutive quarter of record revenues and the fifth straight quarter of YOY revenue growth exceeding 25%. Moving forward, we believe that international sales will play a role in Alphatec’s growth. In 2Q09 international sales (Europe and Asia) comprised 18.2% of revenues, or $5.9 million. Alphatec has not seen a slowdown in procedure volumes. Alphatec now has over 92 distributors in the U.S. representing over 260 sales reps with a goal of having over 85% exclusivity.

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 launched 8 new products in 2008 and is on track to launch 11 in 2009.
• The full release of GLIF (guided lumbar interbody fusion) should occur in 4Q09.
• Alphatec has secured the licensing rights to AmnioClear and plans a launch in 3Q09. AmnioClear is an in vivo wound covering derived from the amniotic membrane that delivers a defensive barrier at the site of surgery.
• The company continues to take the lead in the treatment of the aging spine, and expects to receive CE marking for Helifix in the first half of 2010 as well as a 510k for Helifuse.
• On July 7, Alphatec entered into an agreement with International Spinal Innovations, gaining worldwide licensing rights to a unique stand-alone ALIF (anterior lumbar interbody fusion) device.

We are raising full-year revenue estimates to $129.1 million from $126.5 million. For the third quarter of 2009, we estimate that sales will reach $31.5 million.

TranS1 Inc.

On July 9, TranS1 pre-announced that first quarter revenues fell short of management’s prior guidance of $8.6 million–$8.9 million. Second quarter 2009 revenues grew 32.8% to $7.9 million (up from $6 million in 2Q08). The company reported that surgeons performed 796 Axial Lumbar Interbody Fusion (AxiaLIF) procedures worldwide (671 domestic) in the quarter (up from 703 in 2Q08). AxiaLIF procedure growth, a key driver of revenues, increased 13.2% YOY in the first quarter.

The primary reason for the shortfall in the first quarter was reimbursement confusion, which resulted in what management estimates to be the loss of 100 cases, or $1 million in revenues. Confusion over CPT (Current Procedural Terminology) codes based on RVUs (relative value units) that physicians use for reimbursement was the root cause. 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. Management noted that the challenges were primarily with existing, higher volume surgeons who, due to improper coding, were encountering difficulties getting reimbursed.

The average selling price (ASP) of AxiaLIF was $10, 700, up 12.6% from 2Q08. This is partly due to the fact that 26% (175 cases) of the procedures were 2-level (fusing two vertebral levels in the lumbar spine) and 199 of the cases (29%) were 360° fusions, which command higher ASPs. The company’s direct sales force stood at 68 at the end of the quarter, and prior plans to expand it to 80 by the year’s end may prove too aggressive. Still, the company trained 70 surgeons during the quarter.

Based on the reimbursement issue and slowing domestic procedure volumes, we are lowering estimates for 3Q09 to $7.5 million (24.6% YOY growth). For the full-year 2009, we estimate revenues to be $32.6 million.

Zimmer Inc.

Zimmer Spine continued to face difficulties in the quarter. Zimmer reported that spinal implant and biologic sales in 2Q09 were $64.2 million (up from $54.3 million in 2Q08) up 18% (23% constant currency) YOY. Abbott Spine contributed $20 million to revenues, posting essentially flat revenue growth sequentially. The company’s overall growth may look high, but excluding the Abbott acquisition, spine product revenues declined 18.6%, falling from $54.3 million in 2Q08 to $44.2 million in 2Q09. The 18% revenue growth includes 20% based on procedure volume/mix, 3% based on pricing, and negative 5% based on foreign exchange.

Management cited both competitive and reimbursement pressures regarding the Dynesys Dynamic Stabilization system as primary challenges in the spine legacy business. Zimmer noted that these challenges would continue into the coming quarters if not years. We are reducing our full-year estimates from $279 million to $260 million. We estimate 3Q09 spine revenues to be $61.5 million (+22.8% YOY). This is based on revenue in the Zimmer legacy business contributing $42 million and Abbott accounting for $19.5 million.

Medtronic Inc.

Worldwide spinal implant and biologics revenues rose 6.5% to $915 million in the quarter, (which is Medtronic’s first quarter of its fiscal year beginning in April) up from $859 million in same period a year earlier. Sales in the July 2009 quarter (which is roughly comparable to the calendar second quarter) improved sequentially and were aided by five extra selling days in the quarter. Revenues in Medtronic’s core spinal product business, which now includes Kyphon, grew 9.1% in the July quarter to $696 million. Sales of biologic products declined 1% to $219 million (down from $221 million in 2Q08). International sales were a key driver in spine, rising 24% on a constant currency basis. Management said that a positive procedure mix drove growth while pricing remained relatively flat.

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 to be used in posterolateral spine fusion. Medtronic is also working on the G5 system, a new posterior pedicle screw system, but does not expect this to impact revenues until 2011. On June 11, Medtronic announced that it had received FDA approval for the Bryan cervical disc and is in the process of a controlled market release, which began in July. Medtronic received FDA approval for its Prestige cervical disc in 2007.

Management noted the uncertainty that surrounds Medtronic’s fiscal second quarter. We estimate calendar year third quarter spine product sales will rise 5.4% to $874 million.

Biomet Inc.

Biomet spine had an outstanding quarter, with revenue growth exceeding that of the industry. Biomet’s second quarter spinal repair and implant revenues (fiscal 4Q09) increased 16% YOY (18% constant currency) to $61.5 million lead by strong domestic growth. Sales in the U.S. rose 22%. The company cited solid growth in both spinal hardware and orthobiologics, which grew 29% in the U.S. during the quarter. The Solitaire Anterior Spine System, Polaris Deformity System, and the SpinalPak Spinal Stimulation System led domestic growth. In Europe the Synergy and Array Spinal Systems led growth. Based on the call, we believe that elective procedure volumes were stable, and pricing was relatively flat, but this was offset by positive procedure mix.

In the conference call held on July 14, 2009, the company attributed the continued turnaround in spine to the result of solid execution on new product launches, upgrades to sales management and distribution stabilization, and the focus on a dedicated spinal product sales force. Cervical and thoracolumbar implants both performed well. Biomet also believes that it is beginning to regain market share in spinal stimulation, pointing to double-digit revenue growth for the second consecutive quarter. We estimate 3Q09 (Biomet’s 1Q10) revenues to be $57 million (11.1% YOY revenue growth).

Orthofix International

Management continues to execute well at Orthofix spine and we believe that thedivision is poised for double-digit revenue growth in the coming quarters. First quarter spinal repair and implant sales rose 13% to $70.7 million (up from $62.7 million in 2Q08), exceeding our estimates of $67.5 million. Spine stimulation revenue increased 13% to $40.2 million while implant and biologic revenues increased 12% to $30.5 million. Thoracolumbar and cervical spine implants, which increased 11%, drove the strong growth rates. Orthofix continues to gain share in the spine stimulation market, with this quarter marking the seventh consecutive quarter of double-digit growth in a market growing only 6%–8%. Orthofix is estimated to have over 50% market share in spine stimulation, with Biomet and DJO as competitors.

Moving forward, we anticipate biologics will play a greater role in the company’s portfolio. In fact, demand for Trinity is such that there are currently capacity issues at MTF that Orthofix anticipates will be solved in the coming quarters. Trinity Evolution revenues were $907, 000  in total sales with spine comprising $743, 000  for the quarter. We estimate 3Q09 spine revenue to rise 11% to $68 million and full-year spine revenues to grow 10% to $277 million.

Here are four key points that should drive growth:

• On July 22, Orthofix announced an agreement with Stout Medical Group and obtained exclusive licensing rights to an expandable corpectomy implant, which is a treatment that will serve the tumor and trauma treatment markets.
• On July 1 Orthofix announced the full market release of Trinity Evolution.
• On July 15, Orthofix received CE marking for its Advent cervical disc and expects a limited market release in Europe in the fourth quarter, but the trial has currently been halted based on a recommendation from the clinical events committee.
• Orthofix continues to focus on building its distribution network and geographic expansion.

Looking Forward

Spinal product companies are happy to see improved vital signs in the market with the close of 2Q09. Larger companies are now posting revenue growth comparable to that of the overall market and stemming some of the market share losses seen in the last few quarters. A new product cycle is upon us, which may help to offset continued challenges with respect to pricing. Companies also expect to see the continuation of favorable reimbursement for traditional spine procedures. We believe the market is on a new, upward trend, and the major players have set a path for sustained growth in the second half of the year and in 2010.

Chart 1: Estimated 2009 Spine Market Share

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