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Hip Net Revenue Growth Rate Slows During 2Q:04, But Knees Accelerate BY JOHN CHOPACK, SEPTEMBER 20, 2004

After the dust cleared from the 2Q:04 earnings season and we had time to analyze the large joint reconstruction market, it was clear that a cursory glance at the market showed a declining revenue growth rate in the hip market especially when examining 'as reported numbers' which included foreign currency effects. However, we feel it is not accurate to base any conclusions regarding the large joint reconstruction market on 'as reported numbers.' Therefore, in Table 1 we have compiled large joint reconstruction revenues of the five leading hip and knee manufacturers based on growth rates which have eliminated the effects of currency.

Knee Growth Remains Strong. Knee revenues increased to $906 million during the 2Q:04 which was a 16% increase over the 2Q:03. The year-over-year growth rate for the 2Q:04 was 1% higher than it was during the 1Q:04. We believe that growth drivers include increased penetration of unicompartmental knees and acceptance of premium priced alternate bearing prosthesis.

Hip Growth Rate is Slowing. Hip revenues totaled $811 million during the 2Q:04 which represent a year-over-year growth rate of 10% which is 2% lower than the 12% growth rate experienced during the 1Q:04. The key driver of the overall market slowdown is the slowdown of Stryker's growth rate for hip revenues which dropped from 17% to 9%. We believe that the slowdown is occurring as a consequence of ceramic-on-ceramic fully penetrating existing accounts and that the higher revenue growth rate as a consequence of converting existing customers has slowed. We anticipate that as additional manufacturers, including Smith & Nephew and Exactech, introduce ceramic-on-ceramic hips shortly, the overall growth in hip revenues will accelerate.

Future Drivers

• Mobile Bearing Knees - With the recent FDA panel approval to down classify both the unicompartmental and total mobile bearing knees, we expect a full FDA approval shortly. The down classification will spawn every major manufacturer to launch US versions of the mobile bearing knees they have been marketing in Europe for years. The mobile bearing prosthesis will likely be priced at a premium to traditional fixed knees and will target a younger more active patient population. Expect DePuy to see added pressure from competition which has been lacking for over 20 years.
  
• Alternate Bearing Knee Prosthesis - The mechanism of failure for a majority of large joint reconstruction implants remains the articulating surface which is typically Ultra High Molecular Weight Polyethylene (UHMWPE). Although most manufacturers have addressed the problem for hips by either cross-linking the polyethylene or by introducing metal or ceramic articulations to reduce wear, the knee market has seen little transition from traditional polyethylene. While the mechanism of polyethylene wear for hips, which is usually volumetric, differs from knees, which results in delamination, pitting and cracking in large proportions, there remain alternate materials which could reduce catastrophic failure in knee components. To date, Zimmer has launched a highly cross-linked tibial knee prosthesis in a cruciate retaining version, which has penetrated approximately 50% of all of its cruciate retaining tibial inserts. Smith & Nephew launched its Oxinium oxidized zirconium femoral component. Both companies have addressed polyethylene problems in knee implants on a grand scale. We expect more innovation from various manufacturers in an attempt to address the problems with polyethylene failure in knee arthroplasty.
  
• Total Hip Resurfacing Devices - While total hip resurfacing devices have been available in Europe for years, manufacturers have been slow to introduce these devices within the US. One reason is the clinical pathway for total hip resurfacing devices requires a full IDE clinical pathway rather than a 510(k) regulatory approval. Second, hemi resurfacing devices, introduced nearly two decades ago, demonstrated limited clinical success. However, we believe that a total hip resurfacing device will address the problems of early failure of hemi-hip resurfacing devices as a consequence of large scale cartilage wear. Wright Medical which is nearing a clinical approval for their CONSERVE PLUS device is expected to be the first to market in the US at the beginning of next year.
  
• More Manufacturers offering Ceramic-on-Ceramic Hips - As more manufactures gain FDA approval to market ceramic-on-ceramic hips in the US we expect to see an increase in growth for both these manufactures as well as the overall market. We believe the growth will primarily result from a product mix shift from less expensive polyethylene components to more expensive ceramic implants within a manufacturer's current customer base rather than large market share shifts. Smith & Nephew and Exactech, which are each utilizing CeramTec's PMA to speed FDA approval significantly, are likely to be the next two manufacturers on the market in US.