Indiana device makers absorbing Obamacare excise tax

Medical-device companies in Indiana are finding that they cannot pass on the new medical-device tax created by Obamacare to their hospital customers, causing them to continue to make cuts and to look to foreign markets for more profitable growth.

But since the 2.3-percent excise tax on sales of all medical devices in the United States took effect Jan. 1, device-makers have talked more about how they’re surviving the tax, rather than railing against it.

For Warsaw-based Zimmer Holdings Inc., the tax will claim $50 million per year, starting in the second half of this year. That’s equivalent to 43 percent of total cash flow last year—although it’s lower than Zimmer’s initial estimate of $60 million per year in tax.

Bloomington-based Cook Group Inc. will pay $14 million in additional taxes this year, taking its effective tax rate from more than 30 percent now to more than 50 percent this year, said Cook spokesman John Eckberg. However, Cook’s tax hit is also lower than its earlier estimates of $20 million to $30 million.

And for companies like Nanovis LLC, a startup maker of orthopedic implants in Columbia City, the tax makes it harder to see a path to profitability.

“Usually, when we go into a hospital and say, 'Here’s our price list and here’s where we’re willing to discount to,' the hospitals say, ‘Well, that’s not enough,’" said CFO Brian More. “The tax doesn’t ever have a chance to come into it.”

The device tax is one of numerous taxes levied by the 2010 Patient Protection & Affordable Care Act, aka Obamacare, to help pay for an expansion of health insurance to millions of additional Americans.

Device makers have complained about the tax since it was proposed because it is assessed on sales—no matter if the company is making profits or not.

For Nanovis, which has only three employees and has yet to turn a profit, the tax represents a major headwind to its growth plans. The tax is due even when companies distribute free samples of new products—as Nanovis plans to do later this year.

“There’s even a chance where you end up paying the tax and you’ve got no revenue,” More said. “But, as with a lot of things in Indiana and the U.S., we will figure it out and we will survive.”

Zimmer executives talk in the same way. They reduced their profit forecast for this year as much as 19 percent—even though Zimmer figured out a way to account for only half the tax’s impact in 2013.

“We have also said all along that 2013 did not provide the same kind of opportunity for operating leverage as other years since, as you very well know, we are in a position in 2013 to have to absorb the medical-device excise tax,” James Crines, Zimmer’s chief financial officer, said during a January conference call in response to a question from Derrick Sung, a medical-device analyst at Sanford C. Bernstein & Co.

But Zimmer has a plan to cut costs to absorb the tax, as well as downward trends in pricing due to increased negotiating leverage from hospitals, which are desperate to find cost savings due to Congress’ cuts to their reimbursement rates.

Zimmer is in the middle of plans to cut $400 million in costs by 2016. It is achieving those cuts via layoffs, such as the 50 it announced last week, and by ending some product development programs.

“Obviously, we have to use those savings to absorb the medical-device excise tax,” Crines said, “but we're also using those savings to accelerate certain technology and product development programs, to cover short-term dilution from these recently completed acquisitions, and to support the continuing buildout of our emerging market businesses and to fund expansion of our global sales channels.”

For its part, Cook already backed off on plans to build five new factories in Indiana, each employing about 300 workers.

Cook and other device-makers say they are introducing new products in European or Chinese markets first, and will either bring them to the United States later or perhaps not at all.

Not every medical-device company in Indiana is affected by the tax. Officials at Micropulse Inc., a supplier to the Warsaw orthopedic makers, said they have had some compliance costs to prove the company does not owe the excise tax. The same is true at Miami Tool & Dye near Fort Wayne, which supplies gauges and fixtures to medical-device makers.

“We have not seen any effect from it,” said Vice President Joy Conley. However, she acknowledged, there could be a “trickle down” in the future, if device manufacturers have to cut corners because of the tax.