Medical Device Link.

Originally Published MX March/April 2005

COVER STORY

Interview by Steve Halasey

When Dennert O. Ware joined Kinetic Concepts Inc. (KCI; San Antonio, TX) in 2000 as president and CEO, the once-public company was under private management, having been taken out of the public market through a 1997 leveraged buyout. A market leader in wound-care therapies and specialty beds designed to promote patient recovery, the company was doing well on entering 2004.

It departed that year doing even better, and enjoying the support and confidence of an investing public that again owns it. KCI issued an initial public offering in February 2004, one of the first of a surge of 18 companies in the medtech sector to do so during a remarkable comeback year for the IPO market.

Dennert O. Ware, president and CEO of Kinetic Concepts Inc., on public investment as an engine of market growth. Photo by J. MICHAEL SHORT

Leading medtech's IPO class of 2004 is KCI. It was by far the largest of the 18, in terms of employees and 2003 revenues. Its public investment venture has been outstanding in terms of its success out of the box, as well. KCI is one of two medtech firms whose share price has gained around 150% in value since issue.

Ware has plans for these incoming funds. R&D will be fed generously, and sales and marketing will get what it needs to pursue a larger share of an expanding market. Growing 30% over 2004, the company nearly reached the billion-dollar revenue milestone and expects to leave it considerably in the rearview mirror in 2005.

In this interview with MX editor-in-chief Steve Halasey, Ware discusses the origins of KCI and describes the path he has charted for its future. He touches on questions of KCI's intellectual property portfolio, market position, strategies for adoption and reimbursement, and ongoing product development.

MX: Since it was founded, in 1976, KCI has been in both private and public ownership. How did the company develop in its early years, and what were the drivers for changing the financial structure of the company?

Dennert O. Ware: The company was founded by James Leininger, MD, who headed the emergency room (ER) at Baptist Hospital in San Antonio. He got frustrated losing patients after he would stabilize them from serious trauma such as broken backs and then leave them immobilized. Because of their immobility, some patients would contract nosocomial pneumonia and die.

Dr. Leininger found a bed called the RotoRest that had been designed in Florida, where the rights resided. He bought the rights and started producing beds in his apartment in San Antonio. That was the genesis of the company. Leininger was a practicing physician in the ER, so he would be on 24 hours and off 24 hours. In his off-hours, he would work on building the beds. He found out it was tougher to get into medical devices than he thought. He was spending more money than he was taking in.

Then, in the mid-1980s, the business started to grow. It grew very rapidly particularly after it moved from a for-sale model to a rental model. Because of the large number of different specialty-bed products he had, and the relatively low frequency of each hospital's need for each type of bed, Leininger found that he had a more efficient distribution system if he would rent them. He set up service centers in individual cities and was able to manage the inventories more efficiently than the hospitals could.

As a result of that, the rental model grew, the company grew, and, in the late 1980s, Dr. Leininger took the company public. It stayed public until 1997 when, with the help of two mid-cap investment houses in San Francisco, Fremont Partners and Blum Capital, the managers took the company private in a leveraged buyout. The company then remained private until we went public last year.

Was it all smooth sailing during that period?

Not quite. In 1994, the company acquired the rights to the vacuum-assisted closure (VAC) technology through a license agreement. VAC is KCI's wound-healing system, which currently makes up approximately two-thirds of the company's revenue and the bulk of our growth. It received clearance for marketing in 1995. From 1995 until 2000, the company built the market primarily in acute care and some in home care. But it did not have specific Medicare codes or a specific negative-pressure wound-therapy coverage policy. Medicare, although it had given early indications that it would pay for the therapy under miscellaneous codes, ended up not paying a substantial portion of those.

The company wrote off about $15 million in losses associated with those Medicare billings in 1999. In October 2000, it did receive Medicare reimbursement, with a specific code for negative-pressure wound therapy and specific reimbursement rates. When that occurred, the business started taking off.

You joined KCI in 2000 from Roche Diagnostics, where you were CEO. Did you find a major difference between the sales model of a clinical diagnostic company—which often involves leaseback arrangements and disposables sales—and the rental model used at KCI?

The real change wasn't between the for-sale model and the rental model. The real change was steering KCI from a relatively slow-growth company to a more-rapid-growth company. In 1998 Roche acquired Boehringer Mannheim, which had pioneered the blood glucose self-monitoring business, helping diabetics manage their disease through the guidance of physicians. That transition was really a transformation of the way diabetes is managed by physicians.

For KCI, VAC provided a similar transformation in the way physicians managed the most complicated, most complex, hard-to-heal wounds. The kinds of things we had to think about at KCI were similar to what we had had to think about for diabetes at Roche, with respect to changing the way medicine is practiced, presenting a new technology, and then providing the mechanisms to allow that business to develop.

Intellectual Property

You alluded to KCI's early purchase of the intellectual property (IP) for the RotoRest. Where did the company acquire the IP for its VAC device?

That patent estate actually consists of multiple pieces. But the most important patents came from Wake Forest University.

Some of the VAC patents expire in 2010, while others don't expire until 2013. That gives KCI quite a head start to continue penetrating the market. How do you feel about the company's IP position going forward from those dates? Are you continuing to develop the intellectual property?

We have a very broad patent estate covering the existing products. We are continuing to develop new generations of the products, along with new technologies associated with the use of negative pressure and wound therapy. Of course, the IP part of what we are doing is important to us. We think we'll have a good IP position going forward from 2013.

Is maintaining KCI's IP position critical to maintaining its market edge?

I think it is something that certainly helps us. Another thing, of course, is that, because VAC has become recognized as the number-one brand in advanced wound care, we have developed a good market position with the product. It is respected as an outstanding therapy. For many physicians it is the therapy of choice for the most difficult wounds. The IP estate certainly is important to us in making sure that that therapy is delivered in the way we know is effective, and that both the product and the protocols we use for treating wounds with VAC are well established. When the protocols are adhered to, the product will give excellent results.

Market Size

You recently commissioned a study on the potential market for VAC and discovered that it was larger than you thought it might be.

Potentially 40% larger.

When we started in 2000, just before we got a Medicare code and established the Medicare policy, we did do a review. We hired a third-party consultant to help us size the market.

In mid-2004, we brought that same consultant back for discussion, and we worked at reassessing the market potential. We looked at a couple of hundred peer-reviewed journal articles. We looked at a lot of databases for billing data on advanced wounds, including common procedural terminology (CPT) codes and diagnostic-related group (DRG) codes. We were looking at both physician billings and hospital billings in order to understand the population of wounds.

Then we interviewed more than 200 physicians and developed specific protocols for treatment patterns covering a broad set of wounds. What came out of that was recognition that there were probably about 1.4 million wounds a year in the United States that could or should be treated with VAC. The potential is probably bigger if you include wounds of slightly lesser severity, but we think that 1.4 million is certainly a very reasonable estimate.

That study reflected only the domestic market. But KCI is also very active internationally. How big is the international marketplace potentially?

We haven't done quite the detailed work because the data for the international markets are a little harder to come by. But, looking at the demographics in Canada and the major countries of Europe, looking at the populations and the portion of the economy that goes to healthcare, we see in Canada and Europe combined a very large market potential.

When KCI issued its initial public offering (IPO) in February 2004, it was estimated that the company had penetrated about 25% of the potential market. With your revised appraisal of the market's extent, what do you think your penetration is now?

We don't disclose exactly where we think we are in terms of penetration. But our U.S. revenues last year in VAC were at $563 million. If that market were on the order of $3 billion, or just over $3 billion, based on the 1.4 million wounds that potentially could be treated by VAC, then the number for share would be slightly south of 20%—somewhere in the mid-teens, probably.

Reimbursement

Obtaining reimbursement coverage must be a major element in increasing the adoption rate for the VAC system. What did KCI do to support the effort to get reimbursement coverage approval?

We did a couple of things. First, back in 2000, in order to get Medicare Part B reimbursement, we submitted about a thousand cases to Medicare showing the efficacy of VAC on patients it covered. Also, a considerable number of physicians wrote to Medicare supporting VAC and explaining why it was an important tool for them in dealing with the most difficult wounds. We have continued to track data and report summaries of those data to Medicare. We have also established a prospective random-controlled trial program for various wound indications. Ten random-control studies are currently under way. We will continue to invest in this kind of clinical research.

How important was it that KCI was able to demonstrate not only the clinical efficacy of the VAC system but also its cost-effectiveness?

The most important thing is that we are able to care for patients and provide real patient solutions. There is a lot of concern about new medical technologies that use more money than they save, but quite a bit of evidence now shows that VAC is not only clinically effective, but reduces complications and, in some cases, reduces the length of treatment. When you look at all the different ways money is spent on dealing with complex wounds, VAC proves to be a cost-effective tool. I think that is a real plus.

How do you manage the reimbursement part of your business?

We have a very competent group of people who, with the assistance of a clinical advisory panel, design our clinical research program. We certainly do work with many institutions in actually doing the research, but their work is conducted according to our specifications. We appreciate very much the support we are getting from the medical community, from people sitting on the panels and helping to guide us.

The most important thing is that we are able to care for patients and provide real patient solutions. Photo by J. MICHAEL SHORT

Working with Physicians

Because of the nature of the wound-care field, does KCI work with physicians from a lot of specialties?

Absolutely. When we started out and were trying to determine who saw the most wounds, who had the most experience there and stood to benefit the most, we worked initially with reconstruction-oriented plastic surgeons and trauma-oriented orthopedists in the acute-care environment. Also, we spent a lot of time working with podiatrists in the home-care environment, who see and treat the bulk of the diabetic foot ulcers. But in the past couple of years we have expanded that. We see a lot of thoracic surgeons and general surgeons. We see some primary-care physicians who deal with pressure ulcers and diabetic foot ulcers in the home-care market.

Then there are a lot of physicians who specialize primarily in wounds; we see them at wound-care clinics around the country. So, though the number of specialties has certainly increased, there tend to be physicians within each specialty who see more of the difficult wounds because they have learned how to handle them. These are the people we try to see, regardless of their specialty.

Do you have a clinical advisory board to which doctors who you are working with actively contribute?

We do. We have a very active clinical advisory panel made up primarily of physicians. Our in-house medical director is a physician. And a small number of physicians who work with us in the field are full-time employees who tend to be available to the sales force to help educate them, particularly with respect to some of the more difficult wounds.

How important is your sales force for gathering customer feedback and contributing to future product development?

You have to think in terms of who are the people that influence the decision to use VAC. A physician writes the prescription, but it is also important for the nurses who are going to be using it to understand VAC technology.

As we developed the home-care market, we had to educate a lot of nurses associated with home health agencies. We established a very aggressive program for educating nurses there.

In the hospitals we do a lot of in-service. We are able to do that because of the structure of our sales force. A significant portion of our sales organization is made up of account executives, but another big block of them are clinical consultants. These clinical consultants are predominantly registered nurses who have wound-care or other clinical experience. They are out in the field educating nurses.

In addition, we have a speakers bureau of physicians so that we can hold meetings with physicians in groups and educate them on a peer-level basis. Educating a lot of physicians and a lot of nurses has helped make our enterprise very successful.

IPO and After

Since issuing its IPO last February, KCI has outperformed all of the analysts' projections. So how does all that revenue get spent? For instance, does the company have any debt remaining from the 1997 leveraged buyout?

Yes, we still have debt. We have done a very good job of paying it down, however. I think we paid well over $200 million against debt in 2004, about $100 million of that coming from the IPO.

We still have a long way to go. Nevertheless, we think we are certainly able to manage very well for years the debt level that we have now. We were once at much higher levels. I think that the investment community is comfortable with our financial strategy. It appears to be quite comfortable with our financial performance.

Is the company investing in its R&D pipeline the way it is in sales and marketing staff?

We do invest fairly significantly in the areas of sales force expansion, marketing, R&D, and clinical support. We spend a reasonably high amount of money on capital equipment every year. Our rental pool is capitalized such that changes to the rental pool go into capital investment. We continue to invest in information technology in order to run the business as it grows. But those capital expenses are very much in line with how we ran the business in the past. I think that we have described that quite well for the investment community.

Do you have an internal committee that sorts through and prioritizes proposals for R&D spending?

We have two ways of looking at that. First, strategically, in terms of where we see growth opportunities and in what arenas we want to play. That is part of a standard strategic planning process in which we engage on a regular basis. Then, the execution of that is managed through a separate, multifunctional committee that deals with managing priorities and scheduling projects that are approved for development.

Overall, what percentage of revenues does KCI invest in R&D?

In 2000 we were at about 1.75%. We have been moving that percentage up steadily. We expect to take it into the 4–6% range eventually. Currently, we are at about 3.5%.

How does KCI's product development pipeline look? Is it starting to fill up because of that R&D spending?

We are doing some interesting work in a bunch of areas that we never thought about investigating in the past. We are pleased to be in a position to explore these issues. Certainly, the growth that we have experienced over the past several years came because we delivered good products to people, products that work.

The challenge for us now is to maintain high growth and to make sure we continue to innovate. This company was built on three cornerstones: innovation, improvement of patient outcomes, and contributing to lower total healthcare cost. It is a foundation that has worked very well for us for the past 28 years. We hope it will work well as a basis for going forward.

Copyright ©2005 MX