Beset by a flattening in procedures and great uncertainty in regulatory

matters, the orthopedic sector still sees solid future.

Jim Stommen
Contributing Writer

The winds of change that left global economic distress in their wake have been unkind to the orthopedic sector. The “no job equals no insurance, equals no surgical procedures” formula is on full display, with procedural volume growth invirtually all segments having flattened out.

But despite falling to flat, industry experts involved in a variety of ways with the usually growth-oriented sector have expectations that things will return to what they have known as normal, they said in a roundtable discussion organized byOrthopedic Design & Technology.

While not particularly optimistic about near-term improvement, they made clear that the sector’s future formula for a return to growth is underpinned by the undeniable demographics of people who need joint replacements or other repairs made necessary by an increasingly active lifestyle.

The participants in the panel discussion included:

• John Callaghan, M.D., current president of the American Academy of Orthopaedic Surgeons (AAOS), a professor of orthopedics and bioengineering at the University of Iowa College of Medicine in Iowa City, Iowa, and a practicing surgeon focusing on hip and knee replacements.

• Joseph DeVivo, president of Smith & Nephew’s Memphis, Tenn.-based Orthopaedics division.

• Bryan Hughes, a director of P&M Corporate Finance and leader of the firm’s Medical Technology team, who is located in Southfield, Mich. P&M is an investment bank providing merger and acquisition services to companies throughout North America and Europe.

• William Plovanic, Evanston, Ill.-based research analyst in the life sciences for Cannacord Genuity, whose focus is on orthopedic, diabetes, neurotechnology and general surgery.

• Anthony Viscogliosi, principal in Viscogliosi Bros. LLC, a New York, N.Y.-based venture capital/private equity/merchant banking firm that focuses on the musculoskeletal/orthopedics sector.

They addressed questions on the current state of the sector, the outlook for 2011 and beyond, which segments have been affected by procedural declines, the possible impact of healthcare reform, the fallout from regulatory uncertainty, and where research is taking the sector.

ODT: How do you assess the condition of the orthopedics sector in general as 2010 is drawing to a close, and are you optimistic or pessimistic about the sector in 2011?

Plovanic: For orthopedics as a whole, almost all the different segments—reconstructive, spine, sports medicine, trauma maybe not as much—have seen pretty significant slowdowns in the growth rate of procedures. On top of the procedural slowdowns, we have seen pricing pressures. A lot of the slowdown in 2010 really came to hit in the second quarter and has flowed through into Q3. In spine, you’re getting payor pushback on procedures in general, which is maybe hitting that a little harder than others. Then we have pricing issues on top of the procedural slowdowns. As we come to the end of 2010, the growth rates for all the orthopedics verticals are narrowing down close to the zero range, at least for reconstructive, spine and sports medicine. We can deal with pricing pressure; that’s kind of the standard course of business, but for the procedure volume to grow significantly I think is a little more challenging.

Hughes: Generally, I don’t believe 2011 will be dramatically different from 2010. Of course, the just-completed midterm elections will have an impact on the way the healthcare reform legislation evolves. However, the issues that are affecting the industry in the near term have not been resolved. There is still too much uncertainty and variability in the sector from regulatory and reimbursement issues. What is clear is that the business paradigm for OEM businesses has changed. We have already gone through one round of price consolidation in early 2010 and there is almost certainly going to be another round next year. Hospitals have made it unnecessarily difficult to bring new products. There was a meaningful slowdown on a procedure basis in the second and third quarters from insurance companies slowing their approval process. The insurance issues combined with the sunsetting of the COBRA extension had a meaningful impact this year.

However, this is a short-term disruption. The volume of patients in surgeons’ queues hasn’t changed; they are just having a more difficult time getting them approved for surgery. On a procedural basis I think that bodes well going into 2011. But surgeons and OEMs will continue to see margin pressure and will have to work harder for revenue. On a near-term basis they will be able to compensate for lower pricing with stable or increasing volumes of patients, which will give them more time to plan and modify the business model for the coming lower-margin environment. The demographics are still in their favor; the winners will be those who find a way to compete on a lower-cost basis.

DeVivo: 2011 will continue to be a challenging year. Hospitals still are struggling to align their budgets, and orthopedics seems to be on the front end of cost savings. Each company, to be successful, will have to ensure that they are able to validate that their technology improves patient outcomes and is justified based upon its costs. Until 2013, I think we’re in for some challenging times.

Viscogliosi: We are still seeing weakness in the traditional hip, knee and spine sectors. Overall, the small bone and joint sector has been the fastest growing over the past two years—at around 15 percent annually—with revenues rising to $3.3 billion. We estimate that this relatively minor sector is ready for primetime—just like the spine market 15 years ago. So the small bone and joint opportunity—now 8 percent of the market—could gain a much bigger slice of the pie. I see this trend continuing in 2011 and beyond.

Callaghan: The amount of work that needs to be done is considerable. Hip and knee replacement surgery is one large area, and we’re just getting into the baby boomer generation, which is where more of this occurs. There’ll be more and more patients needing this operation. The spine, in addition, will affect the baby boomers, and for those boomers who are more active and for younger patients, the sports medicine issues are escalating. Another area is the obesity epidemic, because the obese tend to have more issues related to their musculoskeletal system and their joints, including the need for knee and hip replacement.

As far as next year versus this year, I’m not sure we’re going to have many new breakthroughs; I think the most important issue that will come upon us in 2011 is that we’ll start seeing entry of patients into the American Joint Replacement Registry, which is a spin-off from the Academy (AAOS). Once we get that up and running, we’ll have a better idea of how implants perform in the U.S. and if there are some winners and losers, as well as if there are some technologies that are winners and losers.

ODT: Which segments of the sector seem especially troubled, and conversely, which have been least affected by recent market conditions?

Hughes: It would be difficult to say any segment of the market has not been affected over the past two years. Clearly, vertebroplasty and kyphoplasty are coming under intense scrutiny, although this is a challenging situation. Although the recent research has shown vertebroplasty and kyphoplasty to be “ineffective,” nothing has been shown to be more effective in treating pain, even in the short term. It’s a much larger issue if the insurance companies and Medicare decide not to pay for the procedures until there is a better alternative, because it is a very emotional issue. I usually look toward Europe’s response, since their treatment patterns are a few years ahead of ours, and they are still performing these procedures. So I believe we also will be doing so until there is a better alternative.

The segments that will continue to build momentum into 2011 and beyond are those that lower the overall cost of procedures. Those areas are minimally invasive procedures across segments. Percutaneous procedures will continue to rise, as the native tissue damage from the procedure is much less and patients leave the hospital and return to work faster. Biologics and enhanced biomaterials will continue to have an expanded use as they show the ability to improve healing.

Viscogliosi: The established large bone segments—which represent more than 80 percent of the overall $41 billion orthopedics market—have slowed in the U.S., principally due to pricing issues and the uncertainty caused by healthcare reform. I don’t believe this weakness is necessarily due to the recession. The fundamental growth drivers—aging population and demand for motion/function preservation—remain strong. In addition to the small bone and joint sector, craniomaxillofacial and biomaterials are very encouraging areas of opportunity that have been largely unaffected and should maintain solid growth. And the epidemic of obesity here and increasingly around the world is generating demand for lower limb fixation systems capable of reducing the disastrous level of amputations due to the incidence of Charcot’s foot disease.

Callaghan: My understanding is that the hip and knee replacement market has been relatively flat, so fewer people are having elective surgery. I think you can put off knee replacement more than you can put off hip replacement. One thing that would attest to this is the fact that more people are opting for visco-supplementations in their knees in the past year, with the idea being that they might wait on having knee replacement surgery. Orthopedic businesses are going to have to align themselves with the doctors to make sure we’re offering procedures that have value —quality over costs. There is some data out there that by 2030, 3.6 million people will need knee replacements, whereas today it’s around 750,000 or so. Companies are going to have to realize that they’re going to make their profits from the increased procedures; they’re not going to be able to keep escalating the cost of the implant as in the past.

DeVivo: Procedures volume has been impacted in areas of elective surgeries. Where there are advanced technologies where patients have choice, we have seen that people have been concerned about losing jobs, they have been pushing off operations that they’re able to push off, and on the early intervention and advanced technology side is where it has specifically impacted the industry most.

Plovanic: It seems at this point that nothing in orthopedics has been spared. Unemployment isn’t good, the expiration of unemployment benefits and of COBRA benefits, those could be drivers of all this. A new technology solving a problem is always going to find traction in the marketplace, but it is definitely challenging right now.

ODT: Where does healthcare reform fit into your assessment of where the sector is headed? Does the larger number of insureds coming down the pike mean much, since they largely will be younger and healthier, or might the need for repairs to maintain an active lifestyle win out?

Hughes: I think there will be significant modification to the current healthcare legislation in the new congress. There has been talk of repealing the device tax, which would give a boost to the industry. I don’t think that the larger number of insured currently contemplated will be a huge driver—generally these are younger patients who are not candidates for surgery. They may have more procedures if they were covered by insurance, although this premise doesn’t impact all market segments. The industry doesn’t need those younger patients in order to grow significantly over the next decade. Doctors will have a difficult enough time serving the baby boomer population; there are not enough surgeons today to care for all of them, let alone 30 million morepotential patients.

DeVivo: It’s a jump ball to see whether healthcare reform is going to improve the number of orthopedic procedures. My view is that it will have a negligible impact. What will drive procedures over the next decade will be improving demographics. When it does, orthopedics will be one of the hottest growth industries in medical devices, albeit most certainly with a different pricing structure. I believe, though, that the next two years are going to be rough for the industry.

Viscogliosi: I don’t believe that having millions more people with some form of health insurance necessarily leads to a bonanza for the industry. The principal issue in healthcare reform is not a drop in demand for orthopedic devices and treatment. It will, however, affect levels of reimbursement, which already is driving down prices. To an extent, joint replacement can be postponed and patients can always receive pain medication, but it’s hard to imagine a wholesale shift in market dynamics. Don’t forget that demand for product is growing quite sharply in overseas and developing markets as healthcare options in those populations become more accessible.

Plovanic: My thought is, will healthcare reform really addincremental patients to the bucket? I don’t know if it really does, so for the device companies I don’t know if there is anincremental benefit.

Callaghan: There might be a little boom in the number of sports medicine procedures, but in terms of joint replacement procedures, you won’t see much of an increase.

ODT: Regulatory uncertainty has become a topic of much conversation within the medtech industry, in particular the U.S. Food and Drug Administration’s (FDA) push to make significant changes to the 510(k) program. How do you view the direction the agency seems to be taking?

DeVivo: The agency has been under a lot of political pressure to tighten things as they analyze product submissions. I believe the process isn’t as broken as everyone thinks it is, and I think the medical device industry through AdvaMed (the Washington, D.C.-based Advanced Medical Technology Association) has done a good job of communicating with the FDA that we are not too far off from a good regulatory environment. There is concern, of course, with a Class IIb category that would be very broad in requiring clinical data for Class II devices, and that’s really the area of biggest concern. Today, 8 percent to 10 percent of Class II applications require clinicals, and if it goes up to 50 percent or 60 percent, that would be very disruptive. But, in general, I think the FDA is realizing that there are a lot of moderate improvements that can be made. We’ll see what the future political environment forces them to do, and also when the Institute of Medicine study comes out next summer, we’ll see what that study says.

We stand with the FDA to make sure that the process ensures patient safety, but also is rational to the marketplace. The hysteria that has occurred has been based upon politics and the press; if you look at the data, it’s not as bad as a couple of reporters have made it out to be. Over time, as the executives at the FDA review the data, it will be clear that there are areas for improvement, but I doubt there is going to be a huge revolution.

Plovanic: I’m here at the Cleveland Clinic Innovation Summit, and these are the topics that are being discussed in some of the panels. Somebody on a panel said it very eloquently that you had a new head of the FDA going in, and their job was a turnaround person, so the first thing you had to do was upend the whole system before you can give it a new footing and a basis upon which to move forward. I think we definitely felt that in the last 12 months, and now they’re trying to find the basis upon which to move forward. Over the next 12 months we will likely gain more clarity into the process and expectations will be more clearly defined, and as uncertainty is removed, the process will become at least bearable. The regulatory barriers have definitely gone up and it is going to be more challenging to get new technologies to market.

Viscogliosi: The FDA is under immense pressure from Congress to be more aggressive and circumspect in its dealings with industry. The short-term result is a deadlock—with too few administrators, no clear mandate and ever more costly and complex clinical trial programs. The longer-term outlook is for a real squeeze on the development of innovative technology. For us and particularly for patients, this is not promising nor does it make sense. We need to bring efficient and effective technologies quickly to patients. For example, it took almost 10 years for the STAR ankle to reach U.S. patients when it had been in common use in Europe for many years as a clinically proven solution for disabling ankle arthritis. (Editor’s note: The STAR ankle is manufactured by Viscogliosi’s Small BoneInnovation firm.)

Callaghan: From the Academy standpoint, we’re very concerned about them either discontinuing the 510(k) process or markedly restricting it. The 510(k) process has really helped new technologies come to market, and that has helped a lot of patients. We want to make sure patients can get the benefit of these technologies, especially younger patients who are going to need their knee replacements to last a longer period of time. Another important point is that we’re the world leaders in producing orthopedic implants, and we would hate to see that leadership being taken over in, say, China or elsewhere in Asia. If the system makes it too burdensome, we’re going to lose the competitive advantage the U.S. has had in orthopedic implant technology for the past several decades.

Hughes: The FDA and Centers for Medicare & Medicaid Services are considering their first coordinated effort of a parallel review process for evaluating premarket approvals. This has the potential to be a positive for the industry. The evolution of the regulatory and reimbursement dynamics over the past five years has been negative for the industry and for innovation. It has been very challenging to serve two masters; hopefully this is the beginning of a resolution.

The FDA making modifications to the 510(k) process will have an unfortunate effect on innovation and competition, unless its goal is to refine guidelines and give better clarity to the process. If the outcome results in a substantial additional burden on industry in terms of testing and information, then the FDA has further set us back compared to the rest of the world. The agency needs to find a better way to work more cooperatively with industry in the right circumstances, while continuing to challenge industry in cases that are most appropriate.

Plovanic: At this point, the issue is the uncertainty. If we don’t know the path, we don’t know how long it will take, we don’t know how much it will cost and we don’t know after we have spent all that money and time if we even have the proper endpoints to gain approval. You can’t operate in a system like that, so when you gain clarity on what endpoints are needed, it gives you clarity on the pathway, it gives you clarity on how much it costs to get there, then we can make a go/no go decision on the technology. It may remove some of the “me too” technology and focus the capital on more truly innovative technology.

ODT: Where are we headed in terms of orthopedic research? What segments of the orthopedic sector seem most likely to see new technological advances in the near term as well as a little further out?

Plovanic: We continue to see innovation in the extremities space, and that’s a cross between reconstructive and trauma, but it’s just developing products for those specific indications, so it could be a procedure for which the patient doesn’t currently have an option and they’re creating a procedure-specific product set. The holy grail is soft-tissue regeneration, and there are a lot of people who have been working on that. That’s longer term. At least we do have some products on the market and we’re moving in that direction.

Hughes: There are four areas that will see considerable investment: Advanced (structural) and active (genetic and new polymers) biomaterials, nanotechnology, stem cells, diagnostics that are sensitive and accurate enough to detect early changes in physiology and biochemistry so they can be paired with earlier more minimally invasive procedures. Robotic surgery is another area where considerable advancement will happen; we haven’t scratched the surface of the human/machine interface.

Viscogliosi: Biomaterials in the form of tissue generated from stem cells and other sources are now well beyond the experimental stage and I expect them to become a major factor in treating a range of musculoskeletal conditions. Also, the latest advances in surgical instrumentation and diagnostic imaging technology will contribute to less-invasive and non-invasive forms of treatment. This will benefit everyone by reducing recovery times and achieving longer-lasting, positive outcomes—all of which will lower costs such as insurance, work loss and hospital stays.

Callaghan: The most exciting area of research is in biologics, because tissue engineering, the potential to restore injured cartilage so as to prevent arthritis, to reconstruct better ligaments when they’ve been injured—these are really exciting areas that have some promise. Those who are involved in biologics are starting to reap some of the benefits of all their research. We’re only on the tip of the iceberg for that.

DeVivo: Younger, active patients are going to demand more and are going to continue to need advanced bearing surfaces and advanced kinematics. So a lot of research will continue to go into creating a bridge between sports medicine and reconstruction. Also, a significant amount of research will continue to be funded in biologics, whether it be cartilage regeneration or growth factors or infection control. There is a significant amount of advancement still to be done in that area. That research investment is a core part of the industry.

Jim Stommen, retired editor of industry publication Medical Device Daily, is a freelance writer focusing on the medical product sector.