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VOL. 127 | NO. 201 | Monday, October 15, 2012

Excise Tax Looms for Local Device Companies

MICHAEL WADDELL | Special to The Daily News

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A new excise tax will be levied on medical devices beginning Jan. 1, and the impact will be significant for medical device companies with a Memphis presence.

Large players like Wright Medical Technology Inc. and fledgling outfits like Arrowhead Medical Device Technologies Inc. are preparing for the 2.3 percent pinch on each device sold in the U.S., including pacemakers and stents, defibrillators, artificial joints, chemotherapy delivery systems, surgical tools and X-ray machines.

The Supreme Court ruled to uphold the Affordable Care Act on June 26, leaving the new excise tax in place on medical devices. The tax, which is estimated to raise $29 billion over the next 10 years, is one of many taxes and fees imposed by Congress to help offset the cost of subsidizing insurance coverage for more than 30 million people.

The effect of the tax will be especially painful for younger startup companies working toward profitability.

“It’s another burden on small companies like ours,” said Tom Twardzik, vice president of sales and marketing for Arrowhead, which produces an innovative toe implant surgical repair device. “The tax takes away money that could contribute to our growth, and it takes away money from other young companies that are trying to hire people and advance the economy. We already have taxes levied for regulatory clearance, quality compliance, intellectual property registration – all expenses beyond just the making of the product.”

Some experts believe increased doctor visits for the influx of new patients could lead to an increase in procedures and thus an increase in device usage, but those thoughts could be misguided considering the many restrictions that will be in place under the reform.

Investors seem relatively unfazed by the potential negative impact of the tax. Stock values of some of the large local manufacturers of medical devices dipped in the weeks following the Supreme Court’s decision in June, with Wright Medical’s share value taking the hardest tumble. But since then, shares for Wright Medical, Smith & Nephew and Medtronic Inc. have recovered and risen to values surpassing late June’s figures, according to analysis from Summit Asset Management Group.

“I think what happened in late June after the Supreme Court decision and what has happened since has been a little unexpected,” said Lance Hollingsworth, a principal at Summit. “Stock values for the three medical device companies initially reacted positively to the decision, then sold off a little bit, but then fully recovered and moved on to yearly highs. It doesn’t appear that the market was all that worried, that there was much of a negative reaction or that trouble ahead is imminent.”

The new tax means layoffs for some medical device companies or cuts in areas like research and development budgets or domestic expansion plans. Earlier this year, Stryker Corp. of Kalamazoo, Mich., cited the upcoming tax as a factor in plans to reduce its global work force by about 5 percent. A story published in mid-September in MassDevice cites more than 2,000 job cuts in the medical device industry in the previous two-month span.

Larger local manufacturers of medical devices like Wright Medical are also bracing for the hit.

“We do not have any specific plans at this time to offset the tax,” said Julie Tracy, Wright Medical senior vice president and chief communications officer. “Nobody likes to pay a tax, and it will certainly impact the bottom line.”

Arlington-based Wright Medical’s taxable product offerings include large joint implants for the hip and knee; extremity implants for the hand, elbow, shoulder, foot and ankle; and both synthetic and tissue-based bone graft substitute materials.

Representatives from Smith & Nephew and Medtronic could not be reached for comment.

For very young companies that might not have reached profitability yet, the new tax is similar to a punch to the gut. For a company that has $1 million in revenues but no profitability yet, it equals $23,000 in additional out-of-pocket taxes.

Twardzik explains the ripple effect spreads to other parts of the business.

“We will have to cut expenses, so it will eliminate our investing in capital purchases, hiring, business expenses, and utilizing other local professionals in areas like advertising, design, engineering, manufacturing and quality compliance,” he said.

The tax will also apply to unsold inventory on hand on Dec. 31, which means some companies could decide to throw out excess inventory before the end of the year to avoid a hefty tax.

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