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DANEK SPINAL INFUSION IMPLANT FRANCHISE BACKS 58% STOCK PRICE INCREASE IN 1992 AS O-T-C DEVICE ISSUES SLUMP; NICHE PLAYERS ADAC, NELLCOR RESIST BEAR MARKET

This article was originally published in The Gray Sheet

Executive Summary

Danek's established spinal implants franchise and the prospects for expansion in a fast-growing orthopedic surgery subspecialty made the company a favorite among over-the-counter traded medical technology stocks in 1992. In its first full year as a publicly traded firm, Danek soared 58% to 43-1/4, a gain of 15-7/8. Danek's stock has been on a nearly uniform rise since it debuted in May 1991 at 15. By the end of January 1992, the stock had risen to 56-3/4, before undergoing a two-for-one split in February. During the year, the company added $272.7 mil. to its market valuation, which climbed from $466.5 mil. to $739.1 mil. Danek was the largest point gainer in 1992 among the 40 NASDAQ-traded medical device and diagnostic stocks tracked on a monthly basis by "The Gray Sheet." Overall, the composite over- the-counter Index was off 22.1% (see box, p. 15). Declines outnumbered advances for the year as 22 stocks fell and 17 moved ahead. Year-to-year comparisons were not available for one issue -- SpaceLabs Medical -- which was added to the Index in July after the firm was spun off from former parent Westmark, now called Advanced Technology Laboratories. The O-T-C device sector firms fared worse than New York and American Stock Exchange device firms followed by "The Gray Sheet"; that Index of 32 stocks posted a loss of 16.5% for the year ("The Gray Sheet" Jan. 11, p. 25). The O-T-C Index also had disappointing results compared to the NASDAQ composite, which accelerated 15.5% for the year. The Index' performance in 1992, which contrasts sharply with its exuberant surge of 105.4% in 1991, underscores the intertwining nature of health care stocks with wider political and economic trends. Last year, investors took refuge in health care stocks as an antidote to the recession blues. In 1992, anxiety over a promised comprehensive health care reform plan by the Clinton Administration dampened investment in the health care field as prospects in other sectors began to brighten late in the year. The market continued to respond, however, to medical technology stocks that appear to be well-positioned in small niche areas with the potential for growth. That description applies to Danek and two other firms that defied the bear market environment in 1992, Nellcor and ADAC. Pure-play issue Danek has a dominant position in a new and burgeoning segment of the orthopedic field: spinal implants, which are used to facilitate the fusion of two or more vertebrae during surgical treatment of spinal degenerative diseases, deformities and traumas. The market for the devices began emerging in the late 1980s in response to the broader social trends of an aging and increasingly active population. The market is estimated to have grown 37% in 1991 to $104 mil. and around 44% to $150 mil. in 1992. Danek believes it held the largest stake (36%) of the U.S. spinal implant market in 1991. The company estimates that its share of the market grew to 42% by the end of the first six months of 1992. The growth has translated into a gushing revenue and profit stream for Danek. For the first nine months of 1992, Danek's profit surged 103% to $8.9 mil. on sales of $52.8 mil., up 82%. Danek's aggressive strategy of introducing new-generation spinal devices was exemplified last February, when it launched its TSRH II devices. The products enhance Danek's core TSRH line, a series of hooks that attach to spinal support rods through eyebolt-locking mechanisms and are used to treat spinal conditions arising from degenerative diseases, deformities and trauma. In 1993, the firm plans to launch TSRH III, third-generation versions of the product line. Danek also is preparing to introduce by the end of January the Dyna-Lok product line, which received FDA clearance in December. A series of bone plates, bolts and screws, Dyna-Lok is deemed to be "more versatile" than Danek's current bone plate and screw line. Danek expects that it will experience further growth during 1993 from its first set of metal plates, rods and hooks designed specifically for use in cervical fixation procedures. The products, which already have received FDA clearance, are scheduled for a February release. To date, the firm's only cervical fixation device has been the Songer cable system, an alternative to conventional single-strand wire that is used to provide stability during the healing of cervical fixations. Other new products expected to come to market in 1993 include the FDA-cleared Paragon rod and hook spinal system, which is licensed from the Japanese firm Tanaka Medical Instrument Company. The Paragon products utilize interconnecting tapered sleeves, rather than nuts and bolts, to connect the components of the system. Currently awaiting 510(k) clearance is the GDL spinal system, described as a "comprehensive" system of hooks, rods, plates and screws that is designed for use in low back and long back procedures. The company also is developing a line of minimally invasive products for endoscopic spinal surgery that could spearhead a new field within orthopedics, much as arthroscopic instruments occasioned the explosion of arthroscopic surgery in the 1980s. The firm is estimating a market potential for the products of $250 mil. by 1996. The endoscopic line is expected to allow for the first time the direct visualization of the spine for diagnostic and therapeutic applications. Scheduled for a mid-1993 release, the products were first unveiled in October at a medical education seminar ("The Gray Sheet" Nov. 9, p. 19). Among the new products, some of which already have received 510(k) clearance, are single-use, flexible steerable scopes developed by Citation Medical Corporation, in which Danek holds a minority stake ("The Gray Sheet" July 20, In Brief). The line also will include miniaturized cutting devices for use in spinal surgery. To that end, Danek has been working with American BioMed to adapt that firm's investigational OmniCath cutting device for use in percutaneous and minimally invasive surgery of the spine ("The Gray Sheet" March 23, In Brief). Also pending at FDA is a premarket approval application for use of Danek's first-generation bone plate and screw products for pedicular segmental fixation, in which screws are used in the pedicle, or bony support structure of the spine. The firm submitted the PMA in December 1991 and provided FDA with additional data this past April. Long-term, Danek anticipates a 1995-1996 launch of a porous, biodegradable polymer for use as a bone augmentation material ("The Gray Sheet" Nov. 18, I&W-8). Another product in Danek's pipeline is a "disc spacer," which is expected to begin clinical studies in late 1993 pending approval of an IDE application. Further down the road, the firm anticipates beginning clinicals for a biogenetically designed prosthetic replacement. Nellcor (up 3-5/8, or 11.8%, to 34-1/4) defied the odds in 1992 with its continuing domination in the field of pulse oximetry -- the monitoring of a patient's blood oxygen status. Nellcor boasts the largest installed base of pulse oximetry products in the U.S. Nellcor's pulse oximetry product line includes hospital monitors that incorporate its pulse oximetry sensors. For fiscal 1992 (year ended July 5), revenues from Nellcor's monitors grew 20%. The line includes Nellcor's flagship unit, the N-200, a pulse oximeter for use during surgery and in recovery rooms and intensive care units, and the N-180, a smaller,lower-priced version of the N-200 introduced at the end of 1991. Nellcor also manufactures oximetry modules on an OEM basis for third-party system suppliers. Sales of these products gained 120% in FY 1992. In addition, the firm licenses its sensors for use by other players in the monitoring field, such as Hewlett-Packard, Puritan-Bennett, Siemens, SpaceLabs and Marquette. Revenues from the sensor licensing business gained 75% in FY 1992. Nellcor broadened its monitor offerings in 1992 with the Ultra-Cap unit, designed for use in hospital critical care units. The unit combines pulse oximetry and capnography. In 1993, Nellcor will introduce monitoring products that address market opportunities outside hospital critical care units. For example, the firm expects to launch a "central alarm" unit for use by the general floor in hospitals that will include oxygen saturation as well as other parameters. For the emergency room, Nellcor plans to introduce the Stat Cap, a portable continuous carbon dioxide monitor that detects breathing and respiration. It also will offer the N-20, a hand-held, portable oxygen saturation monitor for emergency "spot checking." Both products currently await 510(k) clearances from FDA. The hottest product in Nellcor's portfolio is a pulse oximeter for the direct measurement of fetal oxygen saturation. The firm submitted a 510(k) for the product, which has been studied in over 500 patients, in September ("The Gray Sheet" Sept. 28, In Brief). The fetal oxygen saturation monitor will provide assessment for the first time of the oxygen status of a fetus during labor and delivery, potentially reducing the number of unnecessary cesarean sections performed each year, the firm says. Nellcor is estimating that the annual market potential for the monitor component of the unit will be about $75 mil.; the sensors used with the product are expected to have an annual market potential in the $50-$100 mil. range. Medical imaging products manufacturer ADAC was the largest percentage gainer on the Index, soaring 196.3% to 5, up 3-3/8. During the year, the firm climbed to the number one position in the U.S. in its core business, nuclear medicine. At a Jan. 11 presentation to investors at the Hambrecht & Quist conference in San Francisco, ADAC President and COO David Lowe noted that 1992 bookings for ADAC's nuclear medicine products grew 52%, from $58 mil. in 1991 to $88 mil. In 1992, ADAC's products accounted for the largest share (19% or $76 mil.) of the $400 mil. U.S. nuclear medicine market, Lowe said. Among ADAC's offerings are the Genesys dual-head gamma camera, which competes in the fastest growing segment of the nuclear medicine market. Since shipping of the product began in March 1991, ADAC has installed over 100 Genesys units, giving it the largest installed base in the U.S. of dual-head gamma cameras. This past year, ADAC expanded its gamma camera offerings with five new products, including the TransCam, a mobile gamma camera, and Polaris, a low-cost gamma camera. TransCam and Polaris were acquired via the purchase of Danish gamma camera firm Provivo in February 1992. ADAC also introduced Cirrus, a gamma camera with a circular field of view for use in the cardiology segment of the nuclear medicine market. Another new introduction is Argus, a gamma camera with a rectangular field of view that has propelled ADAC "to about a $32 mil. run rate in terms of bookings," Lowe told investors at H&Q. The firm believes Argus will allow it to capture the number one position in the rectangular field-of-view camera segment of the nuclear medicine market in 1993. In December, ADAC launched the Vertex camera, a dual-head, variable angle detector system for use both in bone and cardiac imaging. ADAC also took measures in 1992 to shore up its digital angiography business, which had consisted of digital imaging computer systems used in the diagnosis and treatment of arterial vascular blockages. Revenues from the business had been sliding since 1989 due to customer preference for a single system that integrates computer and x-ray components. To address this problem, ADAC announced in October the planned introduction of Cygnus, a system that combines ADAC's computer system with Fischer Imaging's x-ray system ("The Gray Sheet" Oct. 12, I&W-3). Puritan-Bennett, which edged up only 4.3% in the banner year of 1991, jumped 39.6% in 1992, rising 9-1/2 to 33-1/2. During the year, the firm became the first major player in the real-time blood gas monitoring field with its PB-3300 intra-arterial blood gas monitor, the product of six years of development ("The Gray Sheet" June 1, p. 24). The PB-3300 system, which began shipping in September, provides continuous and direct measurement of a patient's arterial blood gas values, which are used to assess the status of critically ill patients. Previous methods to measure these values required blood to be drawn and involved a time delay in the reporting of blood analysis results. Applied Biosystems (up 9-1/2, or 71.7%, to 22-3/4) registered the second largest percentage gain for the year after ADAC. The stock, which had been trading in the middle teens throughout the year, closed October at 20 on the announcement of a definitive merger agreement with analytical instrument manufacturer Perkin- Elmer ("The Gray Sheet" Oct. 12, p. 3). The stock moved up another 2-3/4 by the year's end. A registration statement for the merger, which calls for Perkin-Elmer to exchange .678 shares of its stock for every Applied Biosystems share, became effective with the Securities and Exchange Commission on Jan. 13. Shareholders of both companies are set to vote on the merger at separate meetings scheduled for Feb. 18. Among the hardest hit stocks on the Index were Healthdyne (off 64.9%, or 16-7/8, to 9-1/8) and Tokos Medical (plummeting 62.8%, or 28-1/4, to 16-3/4). Healthdyne, which soared 134% in 1991, suffered from decreased earnings at its 68%-owned home infusion therapy subsidiary Home Nutritional Services during the April-September period. HNS' earnings fell 17.9% to $2.3 mil. in the three months ended June 30 and 48.3% to $1.5 mil. in the quarter ended Sept. 30. The deterioration in earnings at HNS stems from its acceptance of several national and regional managed care contracts at lower prices than usual. Healthdyne says the strategy was undertaken in response to increasing price competition in the home infusion therapy services market. HNS traditionally has provided home infusion therapy services at greater operating profit margins than "most" other companies in the industry. Healthdyne's perinatal services division also experienced an earnings decrease during the three months ended Sept. 30. Healthdyne said the decline was due to "slower patient growth in the summer months," as well as costs associated with launching a new obstetrical risk management program for health management organizations and self-insured employers. Healthdyne is predicting the program has a market potential of $250 mil. per year. Tokos' stock was rocked by a series of negative publicity reports. In July, The New England Journal of Medicine published a study questioning the safety and efficacy of a drug used to delay premature labor. The drug is similar to one used by Tokos in its high-risk obstetrical management services. Tokos' stock took a further tumble in November when the firm said it expected fourth quarter results to fall below analysts' estimates ("The Gray Sheet" Nov. 23, In Brief). In part, the lower-than-anticipated results reflect the cost of an audit by an independent regulatory affairs consulting firm. Based on recommendations from the consulting firm, Tokos plans to segregate its medical device manufacturing operations from its clinical service business and operate them as separate entities. Tokos also was the target of criticism from the American Medical Association, which questioned the firm's practice of offering to pay physicians for the "clinical management" of patients receiving its obstetrical-related home care services ("The Gray Sheet" Dec. 7, I&W-1). As a result of AMA's concerns, Tokos has suspended new physician fee-for-service compensation agreements until AMA reviews the ethics of the practice ("The Gray Sheet" Dec. 14, In Brief). Controversy also continues around Tokos' Genesis home uterine monitor, which was approved by FDA in September 1990 as a means of detecting uterine contractions for women with a history of preterm labor ("The Gray Sheet" Sept. 17, 1990, p. 5). FDA currently is investigating whether the firm improperly promoted Genesis for use in the treatment of preterm labor ("The Gray Sheet" Dec. 7, 1992, I&W-2). Tokos also may have been hurt by the medical community's failure to embrace home uterine monitoring. In September, a committee of the American College of Obstetricians and Gynecologists disseminated an opinion recommending against the routine use of home uterine monitoring for preterm labor. The opinion was based on the committee's determination that to date, studies have been insufficient to determine the efficacy of home uterine monitoring in preventing preterm labor ("The Gray Sheet" Aug. 31, p. 19). Birtcher stumbled through the year, losing 55.3%, or 9-1/8, to close at 7-3/8. Like Healthdyne, the firm has been struggling with a downturn in its financial performance. Throughout the year, Birtcher was dogged by higher-than- anticipated costs for consolidating Solos Endoscopy, a manufacturer of insufflators, surgical instruments and other equipment for less-invasive surgery that it purchased in December 1991. A sales decline of 14% to $11.5 mil. for the three months ended June 30 was attributed to customer uncertainties stemming from a patent infringement suit filed by Pfizer's Valleylab subsidiary in March ("The Gray Sheet" March 23, p. 6). An August settlement of the suit, which related to Birtcher's argon gas coagulation products, resulted in Birtcher's receiving a one-time license fee payment of $2.5 mil. Birtcher also will receive a 5% royalty on worldwide sales of Valleylab's argon products through 2005 ("The Gray Sheet" Sept. 28, p. 10). On Jan. 5, Birtcher announced that continuing costs for the Solos consolidation, as well as "lower-than-anticipated industry- demand for endoscopic equipment and related surgical instrumentation in recent months," will cause Birtcher's sales to fall 22% to $11 mil. for the most recent quarter (ended Dec. 31). The firm also is predicting a loss for the period ("The Gray Sheet" Jan. 11, In Brief). Scimed, a high-flyer on the 1991 Index with a 175.4% gain, closed at 59-1/8. Although the stock tumbled 29.6%, or 24-7/8, for the year, the issue resurged during the month of December, gaining 7-5/8 from its November close of 51-1/2. Scimed currently holds approximately 40% of the U.S. coronary balloon angioplasty market, which it estimates at $360 mil. per year, President and CEO Dale Spencer said at the Hambrecht & Quist conference on Jan. 11. Scimed's share of the non-U.S. coronary balloon angioplasty market, which it values at $140 mil. per year, is about 30%, the exec said. The firm's financial results during the year were affected by costs incurred from a 1991 patent litigation settlement agreement with Lilly. Under the settlement, Scimed paid Lilly $28 mil. in cash in January 1992 and is required to make a license payment of $10 mil. in two installments paid in January 1993 and January 1994. Scimed also is paying Lilly royalties equal to 7.5% of net sales on certain angioplasty products until April 1999. In addition, until Nov. 30, 1993, Scimed must pay Lilly 20% of net sales of Express rapid-exchange catheters sold or manufactured in the U.S. ("The Gray Sheet" Dec. 2, 1991, p. 1). For the three months ended Nov. 30, Scimed paid $28 mil. in connection with the Lilly settlement. Scimed also has incurred costs from ongoing shareholder suits and patent litigation with Pfizer subsidiary Schneider. The suit with Schneider, which covers the Express catheter as well as a second-generation rapid-exchange catheter for which FDA approval is pending, is expected to go to trial early in 1993. During 1993, Scimed's royalty payments to Lilly are likely to decrease as a result of its initiation of European manufacturing of the Express catheters. In December, Scimed announced that it began shipping to European customers "limited quantities" of Express catheters manufactured at its facility in Petit Rechain, Belgium. The facility was established under a June manufacturing and purchase agreement with the Sherwood Medical division of American Home Products ("The Gray Sheet" June 8, I&W-1). The ramp-up of the European manufacturing facility also is likely to strengthen Scimed's international revenues. Currently, international sales account for nearly 20% of the firm's total revenues and are Scimed's fastest growing business. Scimed also expects to get a boost in the three months ending Feb. 28 from its newest coronary balloon angioplasty product, the NC Shadow over-the-wire device. Introduced in November, the product is described by Scimed as having the thinnest distal shaft (2.7 French) of any over-the-wire catheter on the market. The NC Shadow's balloon is made of Triad, a "non-compliant" polyethylene terephthalate material that was designed to be "of a lower molecular weight than that of its competitors, with the intent of avoiding patent infringement problems," according to the company. Besides the second-generation rapid-exchange balloon catheter, Scimed expects to introduce other new coronary balloon angioplasty products during 1993. The firm currently has more than 20 coronary balloon angioplasty projects "in advanced development and/or pending FDA approval," Spencer said at the H&Q conference. Scimed also intends to direct approximately $10 mil., or about half of its R&D budget for the fiscal year beginning March 1, toward the development of non-balloon therapeutic and diagnostic products for the nonsurgical cardiovascular treatment field ("The Gray Sheet" Sept. 21, p. 10). Spencer told analysts at the H&Q conference that "product concepts" being considered by Scimed include devices for recannalizing diseased saphenous vein grafts; perfusion catheters to provide distal blood flow before, during, or after balloon dilatation; "debulking" devices for the treatment of certain lesions; stents; and sealing devices for the treatment of bleeding complications that occur at the vascular puncture site. Other technologies being explored include a site-specific drug delivery device and a thrombectomy device to remove intravascular thrombus. Scimed also is working with Cardiovascular Imaging Systems, Inc. to develop an ultrasound imaging guidewire ("The Gray Sheet" Sept. 28, I&W-1). The guidewire will be designed for use as a stand-alone diagnostic tool, with over-the-wire and rapid-exchange catheters, and "perhaps" with "other therapeutic catheters," Spencer said. In addition, Scimed is intent on moving into segments of the angioplasty market in which it did not previously compete. In November, the firm introduced its first coronary guidewire, Entre ("The Gray Sheet" Nov. 16, In Brief). During 1993, the firm expects to launch a line of interventional devices for the treatment of peripheral vascular disease. Besides Tokos and Scimed, another 1991 top performer that took a beating in 1992 was Datascope, which was off 11-3/8, or 30.8%, after jumping 247% in 1991. Orthopedic product manufacturers Biomet (off 14-1/2, or 47.2%, to 16-1/4) and Stryker (which fell 10-7/8, or 21.8%, to 39-1/8) reversed 1991 gains of 228% and 220%, respectively. Circon, which manufactures endoscopes and miniature video equipment for use in minimally invasive surgery, countered a 200% rise in 1991 with a slide of 11, or 33.3%, to 22.
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