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Orthopedics Sector Feels Bumps, Bruises

Posted on: Monday, 17 April 2006, 21:00 CDT

By Daniel Lee, The Indianapolis Star

Apr. 16--Just about everyone sees a bright future for the orthopedics industry.

It's just that at the moment things aren't looking so hot. The industry -- facing increased pressures from both Wall Street and the surgical suite -- finds itself in a bit of a rut.

And that could mean changes ahead for an industry that has created jobs and wealth in Indiana for decades.

The Northern Indiana city of Warsaw is home to major players Zimmer Holdings Inc., Biomet Inc., DePuy Orthopedics Inc. and Symmetry Medical Inc., as well as a host of related businesses.

Warsaw even refers to itself as the "Orthopedic Manufacturing Capital of the World."

But the industry is facing a raft of challenges, from revenue slowdowns and falling stock prices to customer pressures and management changes.

Last month's surprise resignation of Biomet founder and chief executive Dane Miller and confirmation that the company hired investment bank Morgan Stanley to explore "strategic alternatives" prompted speculation over whether Biomet, a homegrown Indiana company, was putting itself up for sale.

Biomet is not alone in facing mounting challenges.

Hospitals, faced with profit pressures of their own, have been pressuring orthopedic companies to hold the line on price after years of steady increases for the cost of the implants used in knee and hip replacements and other procedures.

Medicare, a major source of reimbursement for orthopedic procedures, has not kept pace with the rising costs of these procedures, surgeons say. In addition, analysts say, after years of stellar growth the companies are finding it harder to hit the targets that investors have gotten used to quarter after quarter.

The industry also faces an investigation, with several major orthopedics manufacturers including DePuy, Biomet and Zimmer receiving subpoenas from the U.S. Justice Department last year concerning their consulting and service contracts with surgeons.

"It's a very interesting transition point for the industry. It kind of signals the end of an era," said Robin Young, editor and publisher of industry newsletter Orthopedics This Week. "It's an industry moving into a new phase. It's a little more professional, a little more influenced by Wall Street."

Industry experts still are bullish on the future, though. They call advancements in hip and knee joint replacements and other surgeries a historic medical breakthrough. People with crippling pain can regain their active lifestyles. The market should only grow as baby boomers age.

"I think the future for Biomet, Warsaw and in the orthopedic community as a whole looks extremely bright," said Daniel Hann, Biomet's interim president and chief executive. "This is a very strong and vibrant industry that is blessed with incredible demographics."

Hann, previously Biomet's general counsel, dived into his new job by seeking to quell any worries among Biomet's work force. The interim CEO last week spent almost 24 straight hours meeting with workers in groups of about 100 over three shifts to answer questions.

Zimmer, DePuy and Symmetry each declined to comment for this article.

Right now Wall Street doesn't seem too thrilled.

Zimmer's stock price, for instance, is down 22 percent from its 52-week high in September. Michigan-based Stryker Corp., another device maker, has seen its price fall 24 percent since a September high. Symmetry Medical, which supplies the orthopedics manufacturers, has seen its shares slide 27 percent since September. Biomet shares are flat from a year ago, despite a spike on news of Miller's resignation.

"These companies are going to be haunted by the memory of their own growth. There's going to be pressure from the investment community to find new ways to do that," said Stephen Simpson, analyst for the financial Web site Motley Fool. "The bigger you get, the harder it is to grow by 20 percent."

For instance, Biomet has increased revenue by about 16 percent each of the last several years, but analysts are forecasting that rate to slow to around 8 percent to 9 percent over the next couple of years.

Analysts say Biomet remains a viable standalone company and that a sale is far from a sure thing.

But at least one industry expert sees the resignation of Miller, a respected veteran engineer and industry leader, as representative of bigger changes on the way.

Young said that orthopedics manufacturing, despite being a big-time business, still has a small-town feel with its biggest players based in Midwestern locales such as Warsaw and Kalamazoo, Mich. "Grandfathers and fathers and kids grew up in the business, and they know how to make hips and knees," he said. "Once it got started there, it just grew up there."

However, Young added, as profit pressures mount, these companies increasingly could be led by professional outside managers rather than by industry insiders.

But industry experts see Warsaw remaining a key center for orthopedics for years to come.

"Everybody's there," said the Motley Fool's Simpson. "These regional areas of focus just seem to persist. Once you get a critical mass of people and companies there, it gets harder to leave."

Indeed, orthopedics remains one of Indiana's signature health industries and is vital to the economic health of Warsaw and Kosciusko County. At least 20 percent of the county's labor force of 41,760 is employed by orthopedics manufacturers or related companies, according to Joy McCarthy-Sessing, president of the Warsaw/Kosciusko County Chamber of Commerce and Kosciusko Development Inc.

These days, though, those orthopedics companies find themselves in the midst of a multisided battle to control costs that includes insurers, hospitals, doctors and medical companies.

Hospitals traditionally have relied on orthopedics as a profit producer, helping to offset losses in other areas. But in many cases, reimbursement that surgeons and hospitals get for procedures have not kept pace with the rising price in the orthopedic implants and other costs associated with surgery, said Dr. Jeff Pierson, a hip and knee surgeon director of the soon-to-open St. Vincent Orthopedics Center in Indianapolis.

He said Medicare's reimbursement rate for hip and knee replacement rose just 16 percent from 1991 to 2004, far below the rate needed to keep pace with inflation and other price increases brought on by innovations in the surgical implants.

"The hospitals' primary payer has price controls on what they're going to be paid, yet the people they're purchasing these products from have no such controls," Pierson said. "It's a paradox."

Dr. Frank Kolisek, another surgeon specializing in hip and knee replacement, echoed those concerns. He said the cost of the surgical implant might have taken up 20 percent to 30 percent of the total reimbursement received for the surgery in the 1990s, but that cost would be closer to 40 percent or 50 percent today.

Individual hospitals have responded to this by trying to become more efficient to cut other costs, the surgeons said. But they also started to pressure the orthopedics companies for better prices.

"Negotiations get a little tough as profit margins are getting tighter and tighter," Kolisek said. "I think that Wall Street is not blind to the fact that there are significant price pressures in the medical industry. "

ZIMMER HOLDINGS INC.:

--Founded: 1927.

--Executive: Ray Elliott, president and chief executive.

--Employees: 6,700.

--Products: Zimmer designs and markets orthopedic products, including reconst ructive implants (knees, hips, shoulders, elbows and teeth) and fracture management devices. It also sells surgical supplies such as tourniquets and blood management systems. It has operations in more than 24 countries and sells products in more than 100 countries.

--2005 revenue: $3.3 billion.

--2005 net income: $732.5 million.

DEPUY INC. (subsidiary of Johnson & Johnson):

--Founded: 1895; acquired by Johnson & Johnson in 1998.

--Executive: Michael J. Dormer, worldwide chairman, J&J Medical Devices Group.

--Employees: 1,200.

--Products: DePuy develops and markets products under the DePuy Orthopaedics, DePuy Spine, Codman & Shurtleff and DePuy Mitek divisions. It supplies devices for reconstructing damaged and diseased joints, repairing and reconstructing traumatic skeletal injuries, and makes artificial spine discs, hydrocephalic shunt valve systems, implantable drug pumps and microsurgical instrumentation.

--2005 sales: $3.8 billion.

BIOMET INC.:

--Founded: 1977.

--Executive: Daniel P. Hann, interim president and chief executive.

--Employees: 3,620.

--Products: Reconstructive products (hips, knees and shoulders), fixation devices (bone screws and pins), orthopedic support devices, dental implants and operatingroom supplies. Subsidiaries sell electrical bone-growth stimulators and craniofacial implants. Biomet distributes products in more than 100 countries.

--2005 revenue: $1.8 billion.

--2005 net income: $351.6 million.

SYMMETRY MEDICAL INC.:

--Founded: 1976.

--Executive: Brian Moore, president and chief executive.

--Employees: 1,673.

--Products: Symmetry makes orthopedic implants (hips and knees) and the surgical instruments used to implant those devices. It also markets its products to doctors who deal with spinal injuries, dental work, cardiovascular care and ophthalmology. It has facilities in the U.S., United Kingdom and France.

--2005 revenue: $263.8 million.

--2005 net income: $31.8 million.: $31.8 million.

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ZMH, BMET,

Source: The Indianapolis Star

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