Opinions abound when it comes to the 2.3% medical device tax. Most of them negative. But often times, many of these opinions are NOT backed by facts and data.
For example, most medtech professionals would agree that even though more Americans will be insured through the Affordable Care Act (ACA), this will not equate to a windfall for medical device companies. Solid opinion, right? But where’s the data to back this up?
The average age of a patient that receives a heart valve, cardiac stent, and knee implant is 70, 62, and 64, respectively. However, if you compare these ages to the group of uninsured that will become insured under ACA, a stark contrast exists. Eighty percent of uninsured patients are under 45 years old and 88% are under 55, well below the average device user. Only 2% of the uninsured are over 65 years old.
In this interview, Matt Dolan provides us with interesting facts as to why the premise of the medical device tax may not be justified.
Scott Nelson: Hello, hello everyone. It’s Scott Nelson, and welcome to another edition of Medsider, the program where you can learn from experience and proven medical device/med tech experts on your own terms without going to school. And on today’s call we have Matt Dolan, who is a senior research analyst for Roth Capital Partners. Matt’s been involved in covering the medical device industry for about 10 years. He’s been with Roth Capital for about six years. His investment news has been cited in Barron’s, Investor’s Business Daily, Wall Street Transcript, Forbes, and Business Week in addition to a few others. So without further ado, welcome to the call Matt. Really appreciate you coming on the program.
Matt Dolan: Thanks, Scott.
Scott Nelson: Alright. So, on today’s call we’re going to cover the medical device tax. In particular, we’re going to focus on a really, really good report, which I’ll link to in the show notes, that Matt helped put together covering the medical device tax and its potential implications. So the three main kind of umbrella subjects that we’re going to talk about is, first and foremost, the impact of the med tech industry on the economy as well as the healthcare system overall, and then we’ll probably spend a little bit more time even talking about the other two points. Is the 2.3% medical device tax justifiable? And then third, what are the potential negative ramifications of the medical device tax? But before we dig into those three points, Matt, we’re coming off the election this past Tuesday, with Obama being reelected, in your opinion, is there still a chance that the device tax can be repealed?
Matt Dolan: I think there’s always a chance. Probability is certainly down since Tuesday night. There’s talk of a possible delay simply because the guidelines needed to implement the tax haven’t been released yet. Those are anticipated in the very near term. It sounds like the IRS was sitting on a number of these different types of guidelines until the election in an effort to not make this a political issue or something that would become a discussion within the election cycle. So now that that’s behind us, I do think we’ll the guidelines shortly. I think there is a possibility of a delay. I think repeal is less probable, but I think a delay does give us the chance to have a continued discussion on what you mentioned earlier, the premise of the tax and the possibility at least of a repeal. So it’s not the best-case scenario for the industry, but I think continues the discussion and keeps that door open.
Scott Nelson: Gotcha. And through my understanding, it looks like there’s House support for the repeal but in the Senate it would be a little bit more challenging and there may be some needed senators on the Democratic side that would need to reach across the aisle and agree to maybe either change the device tax or repeal it altogether. Is that correct?
Matt Dolan: Yeah, absolutely. Actually, the repeal concept has passed the House a number of times but hits a roadblock in the Senate. There are some Senate Democrats that have expressed potential support for the repeal of the tax. You can guess who they might be given some of the constituencies in certain key states to the medical device industry. So it’s not going to take a vast majority of the Democrats to come over, but certainly there has been some bipartisan support to potentially repeal the tax, so I do think the discussion is still alive despite the presidential results and we’ll see how things play out here. There are a number of tax reform bills that need to get pushed through Congress here in this lame duck session, and it seems that that would be an appropriate piece of legislation to possibly tie something around the medical device tax too.
Scott Nelson: Gotcha. Okay, so with that said, let’s dig into the first point and quickly discuss the impact of the med tech industry on the economy overall as well as the healthcare system. I thought it was interesting that you started off the report talking a little bit about some of the stats. Well, let’s just talk through some of these stats in that the US med tech industry—I’m looking at your report now—ships 136 billion dollars in product, 8.5 billion dollars in salaries and employs well over 400,000 individuals in looking at its impact on the economy overall. And in reading some of the pieces recently that have come out post election, it seems like the response amongst politicians is that if we could position the repeal of the device tax not necessarily from ObamaCare but more so as its impact on the economy and from a job loss perspective, we may have a better chance of possibly repealing that. But it’s interesting that you started off the report that way. And when you did your research, what were some of the things that stood out in regard to the med tech industry’s impact on the economy and healthcare system overall?
Matt Dolan: Sure. Maybe it’ll be helpful to give a little background on why this report came together. We only had a few weeks really to do a number of the analyses that you see throughout the report in advance of our presentation in Washington.
Scott Nelson: Sure.
Matt Dolan: And in that process we had the chance to speak with many medical device executives throughout the industry who had also spent some time on Capitol Hill having these discussions with their representatives. So we had the chance to kind of hear how those discussions had proceeded, what they had learned, what some of the positives and negatives were, and a lot of the perceptions, what those perceptions were in DC as well. So in this report we tried to really answer a lot of those questions without having them be required to be asked, and the first premise was, what’s the state of the med tech space today prior to looking forward to the Affordable Care Act and the effect of the medical device tax.
And obviously some of the things you mentioned, those are stats that have been thrown around a lot in the last year in this discussion, but we really wanted to show that the med tech industry is not a part of the cost problem. There’s a study that shows on a percentage basis the spend on medical devices has not really changed over the last couple of decades. We feel that disability is down by 25%, and obviously, death rates and life expectancy have been improved from the patient’s perspective because of these devices as well. And then using some of the more political buzzwords, certainly medical device companies are responsible for a lot of innovation, a lot of job creation. At above average rates they add to local, state and federal economies and those types of things.
So it’s really a very positive industry that is facing a very tough time here going into 2013. As managers evaluate the impact of the tax, certainly jobs are either being cut or certainly new hires are not coming into the fray, and other projects more on the R and D side of things are being either evaluated or cut altogether as well. So yeah, the innovation concept and the employment concept are both right in the crosshairs of this medical device tax.
Scott Nelson: Gotcha. And some of those stats that you’ve mentioned in the report, death rates down 16%, life expectancy increased by over 3 years, disability down 25%, etc., those are some interesting stats when you consider, from a devil’s advocate perspective, someone might say, “Well, medical device companies just want to make money. They want to innovate new products. Obviously, there’s an increased cost of goods with those new products, higher cost of the healthcare system, and that burden then falls on the taxpayer.” But I think some of those stats in the report kind of speak to the fallacies in that argument.
Matt Dolan: Yeah, there’s certainly a need for more cost effectiveness going forward now than ever before, but medical device spending relative to the overall spend on healthcare is a very small number. It’s 5 or 6% of expenditures within the US. So what we wanted to show is that it’s not becoming a bigger proportion. But I do think things have changed. You can’t just come with a better mousetrap or a product that’s only safe and efficacious. I do think you need to be able to add that cost effectiveness argument to the equation as we look at the future of the medical device industry.
Scott Nelson: Right. Without a doubt. So with that said, let’s move into kind of the second bullet point in regard to trying to answer the question. Is the 2.3% device tax justifiable? Does it make sense? And in the report you outlined a nice analysis or a nice argument in regard to the fact that more patients in theory will be covered by ObamaCare, but what percentage of those patients will actually benefit from medical device? Can you speak to that?
Matt Dolan: Sure. So one of the arguments we heard coming from the Hill prior to us spending time in DC was that one of the premises behind the medical device tax was that medical device companies would benefit from a higher number of patients being ensured, effectively, and we tried to slice and dice that concept in a couple of different ways. One is the one you mentioned, and we looked at just a handful of medical device products, heart valves, ICDs, stents, some orthopedic implants, some of the more common devices that are used out there today, and we looked at the average age of a patient receiving that device, and that was well into the 60s or even 70s for certain products. In comparison, when we took a look at some statistics around the uninsured, you see that almost 90% of them are under 55 and another I think about 80% are under 45 years old. So we’re really talking about two primarily different groups here that are coming into the insurance system as opposed to those that typically use a medical device, and we thought that was a pretty striking comparison as one example.
Scott Nelson: Right, right. I’m looking at the stats here in the report. Eighty percent of uninsured patients are under 45 years old and 88% are under 55, so well below the average device user, which you just mentioned. I think cardiac stents, the average age is 62, ICDs 60, heart valves 70, etc. So that’s a really powerful statistic.
Matt Dolan: Yeah, and I’d also add that a lot of these patients, if we’re talking about clinically necessary treatments, a lot of these uninsured patients are getting treated either way. If you come into the ER, the product is still being used whether the patient’s insured or not, especially in more of an emergent situation. So knowing a number of physicians in my family, I think that’s a big argument from the doctor’s side of things, is that even though they’re not insured there are a lot of treatments that take place on someone else’s docket, so to speak.
Scott Nelson: Right, right. And another very valid point too that you outlined in this report is the fact that hospital purchasing or procurement departments, that environment is only going to get worse. When you look at the average customer of a device company, especially as more hospitals acquire physician practices, it’s a hospital, and just because of ObamaCare it’s not like they’re going to open up the books and begin to accept higher prices. In fact, likely they’ll try to begin to continue to ask for lower pricing from device companies in return for their reduced margins.
Matt Dolan: Yeah, absolutely, and one of the thoughts that we had heard, again leading into this analysis, was that more insured patients means that hospitals should be getting paid on every patient. Then the question becomes, at what reimbursement rate? And I think that’s something that is going to constrain their purchasing power as opposed to improve it as we go into next year. We did a survey of medical device companies indicating what they were hearing from the field. Over three quarters of those companies expect hospital purchasing to be worse. We’ve anecdotally spoken with GPOs and other hospital systems and the feedback again has been consistent that they’re looking to cut their purchasing behavior in the next year and beyond as a result of the evolving healthcare environment. So this is just a small piece of the argument saying, “Look, if medical device companies are going to benefit from this apparent windfall,” and that’s kind of the term that’s been thrown around consistently in this discussion, “this windfall of patients coming into the system that are now insured, wouldn’t hospital spending potentially be looking more favorable as a result?” And in fact, in this analysis, we found that the opposite was true.
Scott Nelson: Sure. Yeah. And I think you kind of used it as a case study when looking at the State of Massachusetts and kind of their universal healthcare program dating back to, I can’t remember it exactly, maybe early 2000 or mid-2000, I can’t remember. But I thought that was a really interesting example of looking at a state that kind of has instituted something similar to ObamaCare as it is today and the impact, have medical devices really seen a windfall in a state that has introduced something similar to ObamaCare? And based on your analysis, it looks like the answer is no.
Matt Dolan: Yeah, exactly. And again, leading into this report, we found there’s just a lot of talk back and forth about, “We think there will be a benefit or windfall,” “We think there won’t be,” but there wasn’t a lot of data around it. And we got some feedback from a couple of the medical device advocacy groups, including MDMA, which is one of the groups based in DC, and they had just begun starting this discussion coincidentally at the time when we were doing our research, and Massachusetts as you said legislated their universal healthcare program in 2006, and then it was slowly implemented through 2011. So we thought it’d be interesting to say, “Although it’s not exactly the same as the Affordable Care Act, how did medical device businesses fare in Massachusetts relative to the rest of the country, again, under that same premise? Hey, if there’s going to be a windfall associated with universal healthcare, that’s something we should see in this particular state, and then use the rest of the country as a comparison.” We only had a few weeks to put this together but we still had almost 5 billion dollars of revenue represented in our analysis, and eight of nine companies had negative comparison. So then the listeners can go in and see our report, but we continue on and show the actual growth rates for each of those companies in Massachusetts versus the rest of the US and you can see the discrepancy is not only just neutral but actually quite negative.
And we looked at another group of Northeastern states to control for any geographical differences, and again that was true. So this is a fairly small sample, but I do think the industry is going to continue to dig into this. And this is probably the most compelling piece of the report or probably the freshest data that was available in the report that we put out, again, this past September for our time in DC.
Scott Nelson: Right, right. And like you said, even though it’s a relatively small sample size, I just think it’s really interesting because prior to reading to this report, as you mentioned, there’s a lot of opinion going on back and forth, I mean there’s a lot of that in the report that you put together [00:17:08] and I thought the kind of the case study and when looking at Massachusetts was fascinating. And even to that point, the PCI procedure [00:17:17] or the percutaneous coronary interventions, a heart cath, coronary stents or a coronary angioplasty procedure, I thought that was really interesting when you compare the State of Massachusetts versus the rest of the United States. You’d think there’d be more patients available for heart caths in Massachusetts, but in reality they were down I think 4% looking at 2004 through 2010, where the rest of the US was down 1%. Does that sound familiar?
Matt Dolan: Yeah.
Scott Nelson: Yeah.
Matt Dolan: No, that’s exactly right. I think that’s a nice example because it looks at volume as opposed to revenue, so it takes out any effect that pricing may have within a particular product category. Yeah, and I think PCIs are certainly a medically necessary procedure, and I think it speaks to some of the points we made earlier about these patients are getting treated whether you like it or not, and why would there be a benefit especially within the medically necessary side of the industry?
Scott Nelson: Gotcha. Gotcha. Great stuff. And then let’s now transition to kind of the third point and discuss kind of the potential negative ramifications should this device tax continue on without any sort of repeal or adjustments to it, first and foremost being the top line nature of the tax. And can you discuss briefly kind of the average earning decline, the small caps versus large caps that you…?
Matt Dolan: Sure, yeah. Yeah, so a lot of people here, 2.3% of revenue, and it seems like a fairly small number, but you have to imagine that a lot of these companies, their operating margins are in the maybe 10% range, 10 to 20% for the industry for those companies that are profitable, and frankly, the smaller entities out there often aren’t profitable. They’re trying to develop some new innovative device to help treatments be safer and more cost-effective, so there’s a lot of investment associated with that. Most companies don’t get profitable until their revenues exceed a hundred million dollars, and I think under the basis of this tax the small companies take the biggest hit. And you can see in our report, the large companies, the average hit to their profits was about 4%. The small companies, the average hit to their profits was about 34%. So it’s a huge difference.
Now, granted there are some companies in that small group that aren’t making a ton of money, so the percentage might be a little bit misleading, but I think the concept is still the same that a 230-basis-point hit to your profits is a very big deal to the viability of a company, and that’s why we’ve seen so many companies proactively go out and already cut jobs in advance of this or we’ve seen hiring freezes in a number of companies as well.
Scott Nelson: Sure. Absolutely. And I struggle, even researching this, I’ve done other interviews, one with Steve Ferguson, for example, the Chairman of Cook, in regard to the device tax, and Cook have been very vocal about it, but I still struggle to figure out why was this implemented as a top line tax on profits? I don’t quite see how there’s any justification. Have you been able to figure out any rationale as to why it was implemented this way?
Matt Dolan: I’ve heard a number of rationales, I mean, even through our process there were five or six opinions thrown out there. The obvious one is this windfall concept. Frankly, I think that there was a need to pay for the Affordable Care Act on an aggregate basis, and I think the legislators came together and said, “How are we going to pay for this? Let’s look at the different industries that are options.” They came up with some dollar amounts. And as you remember, the device tax was actually supposed to be higher and it was trimmed back to a degree.
I certainly don’t think this was a scientific decision where they said, “Look, you guys are going to benefit by X amount, and therefore, we’re going to tax you by Y.” But this was more of something where, “Hey, we have to pay for the bill. Let’s find a way to do it,” and the justification would be, “Hey, there’s a windfall of patients coming through the door now that these medical device companies are going to benefit from.” I think that premise was really derived within the pharmaceutical industry, which makes a lot more sense. You have more insured that can be on some sort of drug therapy that maybe previously weren’t. And reflecting on the conversation you and I have already had, I think that may be a little bit flawed in terms of applying that same logic to the medical industry.
So I think that was the primary reason. There are other suspicions out there that we probably don’t need to go into in this interview, but I think that’s the way it works, is they find a way to pay for it. And in a lot of our discussions on the Hill, you couldn’t have this discussion around the premise of the medical device tax without leading into a discussion of how we’re going to pay for the bill in its entirety. So both of those questions need to be answered before we can find any type of possible resolution or repeal.
Scott Nelson: Gotcha. Very good. And coming off of that pretty significant negative impact to most companies, and even if you look at a 4% hit to large caps and, looking at your numbers in the report, roughly a 34% negative impact to small-cap companies, and a whole host of negative ramifications from cuts in R and D, job cuts, less hiring, and then even the impacts on patients, can you speak to a couple of those that really stand out when you were putting together this report and speaking about it on the Hill?
Matt Dolan: Yeah, I think one of the things we try to suggest is that you’re not only looking at just the dollars associated with a certain tax rate but also, what are the opportunity costs of this tax? And you mentioned two of the ones that we thought were most important to a political discussion, and one was the employment picture. And we did run a survey in the couple of weeks that we had leading up to this presentation to support our discussion on hiring, and we also did that on R and D spending, R and D spending being a proxy for innovation within an industry. So on the jobs side, I think the biggest takeaway was that more than 80% of companies said that they were either cutting jobs or they would hold back on hiring new employees as a result of the device tax. So in this whole unemployment discussion on a national basis, I think that has a real resonating effect in the political environment.
On the R and D side, we asked the same question and more than three quarters of companies said that they would either cut current jobs or forgo new projects as a result of the device tax. So, clearly, a heavy, heavy impact, and these were bigger surveys than the one we mentioned earlier in Massachusetts. I think aggregate revenues were well into the 40-billion-dollar-a-year-type range for the jobs survey and pretty close on the R and D side as well. So this is a very fair I think representation of where the industry stands today.
Scott Nelson: Right. So with all of that said, I think anyone that reads your report, the conclusions are pretty telling, looking at the device tax. In your opinion, is there some sort of middle ground that we can come to when looking at for the betterment of the country, the domestic United States, in helping to pay for ObamaCare? In your opinion, do you think the device industry should kind of pony up to a certain degree or do you think this device tax should be repealed altogether?
Matt Dolan: I think it should be repealed altogether, and this is not just because we follow this industry closely and are tied to it in a way. But I think if you really look at the premise behind this tax, the justification is very hard to come by, and frankly, I don’t think there’s a massive amount of discussion around some of the points that we made throughout this report. They’re very telling. So if we’re just looking at the premise of the tax, I think there’s something here that needs to be done. The next step in that question, in that discussion, is how do we pay for it?
Scott Nelson: Right.
Matt Dolan: And that’s something that’s well beyond my area of expertise and role here in this discussion. I think they do need to find a way to come up with the 30 billion or so dollars that are allotted to revenue from the device tax, but I think the key thing in justifying finding another revenue source really comes from this opportunity cost concept. If you think about the jobs lost, the innovation, the cost effectiveness within the healthcare industry, there’s a lot of benefit that is going to be sucked out of the industry as a result of the device tax, and that’s very clear based on this survey we put together.
Scott Nelson: Right.
Matt Dolan: So I think that’s something that again is hard to quantify and it takes us back to more of an anecdotal discussion, but I think that’s really the premise that needs to be used to go forward. Now, whether it’s a complete repeal or some type of balanced compromise or a tiered structure where the smaller companies are less impacted than the larger, I don’t know. Those are all things that have been thrown around. Frankly, I don’t think the probability of any of these is much above 50% at this point. I think it’s still a bit of a long shot. But the discussion I think is still ongoing. There is some bipartisan support, which I think is encouraging to some degree, and we’ll see how it plays out. We should learn more here in the coming months.
Scott Nelson: Yeah. Yeah. It should definitely be interesting. I think all of us that are in the device industry, especially after reading a lot of really solid data in your report, it’s like, wow, I mean this thing makes hardly any sense at all. It’s really hard to put your hands around how this was envisioned in terms of its [00:28:22] to the device industry. But anyway, as we reach towards a conclusion, Matt, even covering kind of med tech/medical device industry for roughly 10 years—I mentioned that kind of in the intro—what keeps you up at night, if there’s something that does other than your young kids? [Laughs]
Matt Dolan: Yeah, 4-month-old at home kept me up last night.
Scott Nelson: Yeah, [laughs] that’s right. That’s right.
Matt Dolan: [Laughs]
Scott Nelson: And specific to the device industry, is there anything that keeps you up at night? And then, on the flipside, the air that we’re in right now, are there also a lot of opportunities for those device companies that can adapt and change quickly? What’s your take on that as we kind of conclude this discussion?
Matt Dolan: No, I think we’re definitely at a turning point in the industry. Our healthcare is changing, right?
Scott Nelson: Mm-hmm.
Matt Dolan: As I mentioned, my dad was a physician, my brother-in-law is an anesthesiologist, so we’ve got our hand on the pulse of the industry from a physician’s perspective who’s dealing with healthcare on a daily basis. A lot of these doctors are becoming employees of hospitals and that’s having a huge effect on how medical device companies, pharma companies, etc. are able to interact with physicians, are able to sell into hospitals and GPOs and so forth. So there’s certainly a change afoot here in the industry.
As I mentioned earlier, cost effectiveness is going to be huge. I think we’ve got a little better visibility onto the regulatory side of the equation, and now the cost side is going to become much more a piece of the discussion in the next few years. Specifically, on the reimbursement side, if we can get better clarity out of CMS as we now appear to have out of the FDA, I think that’ll help the industry move forward. But generally, I think the underlying market is not going to be as robust as it was. I still definitely think there’s room for new innovative products to come in and provide nice growth opportunities, better ways of treating patients that are less impactful and keeps them healthier and more active longer. So I think those ideas will continue to succeed, but it is in the face of a more difficult environment, so it’ll be an interesting time. And I think you just add to the number of variables required to have a successful medical device and a successful business plan around that device.
Scott Nelson: Yeah. Yeah. I couldn’t agree with you any more in regard to those kinds of concluding thoughts. So, Matt, real quick, if the audience wants to learn a little bit more about you or about Roth Capital Partners, where would you have them go?
Matt Dolan: Yeah, so the report we mentioned is on our website. There’s a link called Press Room, and if you look on September 17th there’s a link to the report on the impact of the ACA on the medical device industry, so I’d recommend checking that out. My contact information is on the website under the Research tab and feel free to reach out if anyone wants to have another discussion. This has been something that we’ve invested a fair amount of time and effort into and it’s definitely an area we’re going to remain interested in to see how it unfolds here.
Scott Nelson: Gotcha. Very good. And in the show notes, as I mentioned, I’ll link directly to the report on the Roth Capital website as well as Matt’s profile if you want to potentially read a little bit more about his work at Roth Capital Partners. So Matt, thanks a ton. I’ll have you hold on the line, but thanks again for your willingness to do this and speak about this report that you put together. And as I mentioned earlier, there have been a lot of opinions and back and forth about the device tax but not a whole lot of data, and this certainly meets that need in terms of real hard data, albeit on a relatively short notice, real hard data that speaks to the potential negative ramifications should this device tax proceed forward. So thanks again, Matt. I really appreciate it.
Matt Dolan: Alright, man. Thank you.
Scott Nelson: Alright, I’ll have you hold on the line. But again, thanks everyone for listening to the latest Medsider interview. Again, all these interviews are on iTunes. If you do an iTunes search for medical device or Medsider, podcasts will pop up. You can subscribe for free. We’re also on Stitcher Radio. That’s S-T-I-T-C-H-E-R, Stitcher Radio, as well. So a couple of different options to consume these [00:33:01] interviews [00:33:02]. Thanks for your listening attention and until the next episode of Medsider, everyone, take care.
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