Neuro Companies Causing Headaches

Ever since President Bush (the First) declared the 1990s to be the Decade of the Brain, hopes have been high for device innovations to treat a variety of neurological conditions ranging from stroke to migraines to depression.

For all the promise these therapeutic areas hold, neurological device applications have proven to be among the most inscrutable for entrepreneurs and investors, replete with technological and clinical challenges, not the least of which is the difficulty of conducting neuro trials, e.g., the inherent problems in enrolling acute patients for stroke studies.

Several recent announcements have done nothing but confirm how challenging the neuro space is. In fact, this year is starting out to be one that neuro investors would just as soon forget. Highlighting the bad news cascade was Northstar Neuroscience Inc.'s announcement that its EVEREST pivotal trial failed to meet its primary efficacy endpoint. This caused Northstar's stock to immediately plummet by nearly 90%, hovering today at just above $1 per share. Coming off what many investors called the most successful device IPO of 2006 (raising more than $100mm), Northstar's stock took an unexplained hit not long after going public, but there is no doubt about the reason behind this most recent crash.

Hopes surrounding Northstar were high. The EVEREST trial was designed to determine whether cortical neurostimulation, together with rehab therapy, would improve hand and arm function in stroke survivors better than rehab alone. Not only did the initial four-week data fail to show any meaningful difference between the investigational and control groups, but a preliminary review of the longer-term (24-week data) appears to show similar results. John Bowers, Northstar's president and CEO, during a conference call discussing the trial results, noted, "To put it mildly, we are extremely surprised and disappointed" by the study's outcome, and couldn't explain why EVEREST failed to reflect the positive results demonstrated by the company's two previous feasibility trials.

Northstar remains well-financed--the company reported having more than $80mm in cash and investment on hand as of year-end 2007. While feasibility studies are still being explored for possible applications of Northstar's Renova technology to treat tinnitus, aphasia and depression, Bowers acknowledged that it is unlikely the company will make sufficient progress in any of those areas to launch a new pivotal trial this year.

Northstar is not the first high-profile failure in the hot neurostim/neuromodulation space. Cyberonics' decision to no longer focus on treatment-resistant depression with its vagus-nerve stimulation technology--concentrating instead on epilepsy--has been well documented. Northstar's fall may, however, cause investors to pause and assess what progress other players in this area are making before committing additional funds.

Other recent examples of bad neuro news come from one particular therapeutic area: PFO closure (a hole in the heart that fails to close after birth) thought to possibly cause both migraines and stroke. NMT Medical Inc. just announced that it was shutting down its MIST II PFO/migraine trial, primarily due to patient enrollment difficulties, to concentrate on its CLOSURE I pivotal PFO/stroke trial. Investors didn't take the news well, driving the company's stock price down as much as 35%, although it has regained about half of that lost value in the last couple of days.

Indeed, one whole area of PFO closure technology--so-called energy-based approaches that use sources including RF-energy to seal the PFO--has apparently proven unworkable. Cierra Inc., a company out of The Foundry incubator, is in the process of winding up its operations, and, according to executives familiar with this space, CoAptus Medical Corp., the other player in this space using an energy-based approach, may soon follow suit.

Lest we leave you with a completely negative take on the prospects for device-based neurological therapies, here's one recent positive development: earlier this month, the FDA cleared Penumbra Inc.'s system, which is a tool-set designed to treat ischemic stroke by removing occlusions from the brain's larger vessels. Penumbra's approach is designed to provide neuro-interventionalists with an approach that can be used beyond the narrow, three-hour window during which the drug tPA is indicated, as the company's system can be employed within eight hours of an ischemic event.

"Human Brain" by Flickr user Gaetan Lee used under a creative commons license.

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Cardiovascular Systems Antes Up

IN VIVO Blog heard some muted, but optimistic tones about this year's device IPO market at the JP Morgan conference. But Cardiovascular Systems Inc. must have heard a ear-splitting rendition of "Happy Days Are Here Again" that convinced it to file for an $86.25 million offering.

Don't get us wrong. The filing pleased as well as surprised us. We’re pleased because we identified Cardiovascular Systems as one of our notable Series A deals of the year in 2006. Imagine the sound of us tooting our own horn here.

But we’re surprised because, well the company just started selling its Diamondback 360° Orbital Atherectomy System, a minimally invasive catheter system for the treatment of peripheral arterial disease. That's because the FDA just granted Cardiovascular Systems 510(k) clearance in September.

In fact, the company says it “commenced a limited commercial introduction of the Diamondback 360° in the United States in September 2007.” By the end of the year the company shipped more than 1,700 single-use catheters to 57 hospitals and generated revenues of approximately $4.6 million, according to the S-1.

That’s a nice start, no doubt. But is it enough to go public on?

IN VIVO Blog says yes. Here's why.

Hedge Fund Maverick Capital, with 15% of the company, is among its biggest investors. Maverick is increasingly well regarded as a patient investor in start-ups, but when a company pursues a public offering the firm--with a reported $9 billion or more under management--can bring its considerable public market-oriented resources to bear. If Maverick isn't investing in the IPO itself, it already has a pretty good idea about who will.

Easton Capital is another large investor. A few years ago, Maverick and Easton seemingly brought another cardiovascular company to the public markets way too soon.

That company, Conor Medsystem Inc., also didn't have revenue or FDA-approval for its drug-eluting stent technology, giving an opening to critics who thought the company was unwisely testing the IPO market in 2004. Conor did spectacularly well in the IPO and post-IPO performance, well enough on the public markets to be acquired by Johnson & Johnson acquired the company for $1.4 billion, admittedly with disappointing results but also some new hope.

Some may see Cardiovascular Systems filing as an unwise move or the issuance of a 25-page "For Sale" sign. IN VIVO Blog, however, will be betting on an IPO.

Photo 'A Roll of the Dice' by Flickr user Darwin Bell used under a Creative Commons license.

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REVA's a Keeper

Perhaps the most interesting part of Reva Medical Inc.'s announcement that it raised $42 million isn't who joined the company as an investor. Rather it's who has remained an investor--Boston Scientific.

The struggling company has been busy divesting itself of most of its portfolio--up to 100 public and private companies--as part of its restructuring. (See the upcoming issue of IN VIVO magazine for a small report on Boston Scientific's weight loss program.)

New CFO Sam Leon told investors at one conference that the company's portfolio looked more like a venture capital firm's portfolio than a business development important so it's shedding those investment that aren't in line with its core focus and "building a wall" around those that are.

It appears that REVA hasn't been kicked off the Natick, Mass. compound. No reason to wonder why, the company is working a bioresorbable stent, and Boston Scientific has the exclusive option for global distribution for both the corornary and periperal products.

Think Boston Scientific would be interested in one of those? Yeah, IN VIVO Blog thinks so too.

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Emergent Emerges

A $60 million Series D for any device company is interesting, but perhaps one of the more eye-catching elements of Evalve Inc.’s new round is the participation of Emergent Medical Ventures, the new firm founded by serial entrepreneurs and investors Tom Fogarty and Allan May.

In a phone call from Piper Jaffray’s health care conference, May confirmed our belief that this is Emergent’s very first investment, and it’s an atypical one at that.

As we wrote back in the spring, Fogarty and May hope Emergent Medical will redefine early stage medical device investing or at least--as Fogarty states--return the practice to its roots when the VC's focus wasn't on investing per se, but on "actually starting companies—to take them through the process of innovation and value creation."

In the phone call, May says the firm will make a handful of “one off” investment in later-stage companies intimately familiar to Fogarty. Evalve is the first. Fogarty invested in the company while he was with Three Arch and had remained a board member, although he is stepping down as part of this round.

Cyberheart will be the second. That round should close later this week, May says. (Check out our profile on the company here.) May asked that the third not be identified yet, but IN VIVO magazine readers will recognize the name.

Emergent—as the name suggests—will spend the bulk of its time and capital on starting medical device companies the ole fashioned way. May said he hopes to close on the first $100 million fund by the end of this year. (They’ve already secured two-thirds of it.) Emergent also added to its team bringing aboard general surgeon Ken Baker as an associate, May said.

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Quite A Set of Lung (Companies)

Are the public markets ready for TWO interventional pulmonology companies?

With Tuesday's filing for an $86.25 million IPO yesterday, Broncus Technologies Inc. became the second company with a device that could treat serious emphysema to seek support from public investors. We reported on the first way back in September when Emphasys Medical Inc. filed for a near identical amounts. (Seriously, $86.25 million vs. $86.3 million? Who is cheating off of whom here?)

Technologically and clinically, this is exciting stuff. According to Broncus’ S-1, 3.8 million adults in the United States have reported that they had been diagnosed. The company suggests—as they should—that many people go undiagnosed. The filing cites a 2005 survey by the National Center for Health Statistics that states the “prevalence of emphysema in the U.S. increased at an average annual growth rate of 2.4% from 1997 to 2005, with approximately 675,000 new diagnoses between 2003 and 2005, the most recent years for which this data is available. We estimate that emphysema is responsible for approximately $5 billion in direct healthcare costs in the United States each year, comprised primarily of hospital and physician costs and oxygen use.”

Although their approaches are quite different, Broncus and Emphasys hope to treat people with the most serious—and most expensive—cases of emphysema. Today, severely sick people have very few options. Drugs and supplemental oxygen can help. Other than that you’re looking at highly invasive transplants or lung volume reduction surgery. The two companies developed products that can be delivered through the airways so no opening of the chest is required.

Broncus’ Exhale emphysema product line includes needles and stents that are used, respectively, to create new airways and prop them open, allowing trapped oxygen to escape. The company says as the air escapes, the diaphragm regains some of its normal range of motion, enabling the patient to breathe more easily. Broncus’ procedure takes one or two hours under general anesthesia or conscious sedation.

Emphasys Bronchial Valve is a one-way valve that, once inserted in airways, allows trapped air and fluids to escape during exhalation but prevents any air from entering the airway inhalation. The device provides the benefits of lung volume reduction surgery without the risk of open surgery. With airways leading to disease portions of the lung blocked off a patient is able to breathe more effectively. The entire procedure lasts between 20 and 40 minutes, according to the company’s S-1.

At this point, Emphasys would seem to have one distinct advantage. It’s further along in clinical testing than Broncus. As we noted in September, Emphasys has submitted the results of its pivotal trial to the FDA. It hopes to have market approval next year.

Broncus, meanwhile, has a longer road to hoe. According to the S-1, the company has enrolled more than 100 subjects worldwide in our studies and clinical trials, “including approximately 40 subjects treated in our pivotal Exhale Airway Stents for Emphysema, or EASE, Trial for the treatment of severe homogeneous emphysema.” The company hopes to complete enrollment by the end of next year and file for its PMA in 2009, with an eye on having a product on the market in 2010.

That might be too long a time horizon to interest IPO buyers, but stranger things have happened.

One of those stranger things happens to have happened to Broncus’ off-spring, Asthmatx Inc. That company, a spin off from Broncus, had filed to go public in 2005 only to withdraw the offering. CEO Glen French says the company, which is developing a device to treat severe asthma, was ready to go public at the price it wanted, but instead opted to sign a $50 million financing deal with Olympus Medical Systems Corp. French says Asthmatx got the money it wanted and sold a smaller stake than it would have during the IPO.

So perhaps Broncus will be able to tap into the thin vein of IPO buyers willing to gamble on unproven—albeit ingenious—devices. There can be huge upside there. But by filing an IPO the company also could be positioning itself to draw interest from significant corporate investors or, perhaps, even a potential acquirer.

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Where's the Love?

Medical device VCs, when asked what sectors and technologies intrigue them the most, often cite aesthetics and neurostimulation among the two more fascinating and game-changing opportunities.

But IPO buyers don't appear to be as fascinated by the potential, at least not yet.

Over the past day, we heard of the EnteroMedics Inc. disappointing IPO and Reliant Technologies Inc. reluctance in trying to go public at all.

EnteroMedics is developing an implantable device to stimulate (or modulate) the vagus nerve to suppress a person's appetite. The technology has other gastrointestinal applications as well, but the combination of obesity AND neurostimulation convinced VCs to invest $45 million in the company just last year.

The proceeds of the IPO--now only $46 million--will go toward funding clinical trials to prove the device works. So public investors might be pardoned for backing off an early-stage company without a product to sell.

But Reliant Technologies is selling its Fraxel laser systems. It's got FDA clearance to treat several skin conditions from lesions to wrinkle reductions. The company reported total net revenue of $57.5 million in 2006, albeit with a net loss of $20.9 million. In 2005, the company reported a net loss of $18.2 million on total net revenue of $33.8 million. The company had hoped to raise $62 million through the sale of 4.7 million shares.

It's always difficult to understand the appetites of IPO buyers, but these aren't the only disappointing stock stories in these sectors. Shares in Thermage Inc., another aesthetics company, still hover below the $7 price tag buyers paid in its own IPO last November. Thermage shares did spend a few winter months in the double-digit neighborhood earlier this year before sinking back down.

Meanwhile, shares in Northstar Neuroscience Inc., one of the more ballyhooed neurostimulation companies, sunk back into the single digits, partly due to some disappointing communications with the FDA over its cortical stimulation device that might someday help people recover from stroke.

Northstar shares did go out at $15 in its May 2006 IPO, but they haven't been able to hold onto that value. The news that the company will have to delay its PMA filing by a couple of quarters isn't going to help things.

No doubt, VCs have to consider longer horizons than those folks buying into IPOs, and the potential in neurostimulation and aesthetics markets is huge. But it will be nice when (and we suppose if) public markets could give just a little of validation to their belief in these two promising sectors.

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Disappearing Act

As we noted yesterday, the scientific opinion pendulum may be swinging back in the direction of drug-eluting stents, but venture capitalists continue to look for a better way.

Witness the €5.5 million ($7.8 million) second round raised by Arterial Remodeling Technologies. Founded in 2002, the French company intends to use the capital to pursue CE Mark clearance for its experimental biosresorbable stents. No doubt, this field is crowded. Heck, we’ve profiled a number of companies in this area here, here and here, and all will be seeking funding at one point or another.

Oh and the profile for ART can be found here.

But ART’s approach seems fairly unique. Rather than developing a stent that is dissolved into the body after performing two functions: propping open the vessel and delivering anti-inflammatory drugs to prevent restenosis, ART’s stents—like their bare metal ancestors—won’t carry any drugs. The novel polymer from which the stents are built is both hemocompatible and biocompatible so they've caused minimal inflammation in preclinical studies involving rabbits and pigs.



“Every time you can go with a biological healing process you are in a much better position,” founder & CEO (and investor) Patrick Sabaria told us earlier this year. Sabaria, by the way, is also the former Vice President, Europe, for J&J Interventional Systems, where he introduced the world’s first approved-for-marketing coronary stent.

By our reckoning, Theracardia Inc., another start-up in this area, may be the only other start-up taking a similar approach. Find that profile here.

In this day of heightened concerns over the use of drugs and devices, ART, Theracardia and other efforts to develop stents that neither elute a drug nor leave behind a stent will be worth watching.

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Deals of the Week--the Rerun Edition

What's Happenin?

Hollywood writers are on strike and the late-night comedy shows are in reruns. To this IN VIVO blogger, it seems that same affliction has struck pharma land.

Once again, the name dominating the news flow: BiogenIdec, the Cambridge, MA-based biotech that put itself on the auction block a few weeks ago. The Financial Times reports that with opening bids dues out next week, Pfizer is still the front-runner. Merck and J&J are also interested. (Apparently, Pfizer sparked the sale by offering $80 a share for Biogen, with investor Carl Icahn quickly stepping in with a counter-off.)

And remember the Ventana/ Roche pas de deux? Roche continues its unrequited love match. The Swiss pharma announced the fourth extension of its $75-a-share hostile offer--this time until January 17, 2008. Fierce Biotech has the story. (My question for Roche: have you tried saying it with flowers?)

Thank God it's time for ...

• In addition to the $440 million pact Shire and Amicus forged to out-enzyme Genzyme, the other notable biopharma deal this week was the $477 million deal Merck inked with GTx for rights to its selective androgen receptor modulators (SARMs), including Ostarine, a Phase II compound in clinical trials for the treatment of muscle loss in cancer patients. (Devoted IN VIVO Blog readers will no doubt remember that this same class of molecules was the basis for an earlier deal this month between BMS and Pharmacopeia. Look it up with our new Transaction Tracker tool.)


• On the device side, there were several deals worth noting, including an announcement from the struggling device maker Boston Scientific. On November 5, it announced the sale of its cardiac and vascular surgery businesses to Sweden-based Gettinge AB for $750 million. The sale is part of Boston Scientific's plan, announced in August, to refocus on growth-driving businesses and reduce debt by selling off certain medical device units. (Hmm, $27,000 million - 750 million = ?) For more on the Boston Scientific saga, start with this IN VIVO piece from last year.


• Second, Arteriocyte Medical Systems, a spin-off of the Cleveland-based stem cell company Arteriocyte, inked a deal with Medtronic to acquire its Magellan Platelet Business. Deal terms were not disclosed, but the end-goal seems to be a convergence in the device/ cellular therapy space that allows improved delivery of parent company Anteriocyte's specialized adult stem cell treatments. Forbes.com has the story.


• Finally, Edwards Lifesciences announced the acquisition of Ethicon's CardioVations product line. It certainly wasn't a big deal--just $27 million--but it represents the latest chapter in the storied history of one-time med device darling HeartPort. Here's more analysis from IN VIVO's own device guru, David Cassak:

A decade ago, the hottest topic in cardiovascular medicine was minimally-invasive cardiac surgery and the hottest company, bar none, was HeartPort, which was developing an innovative system that would enable doctors to do minimally-invasive surgery while preserving cardiac-pulmonary bypass, the gold standard of cardiac surgery at the time.

The problem was, no one really wanted to preserve CPB. After a spectacular IPO, which saw the company valued at more than half a billion dollars, HeartPort struggled, and the company soon became a kind of poster child for medical device flame-outs.

HeartPort’s sale a couple of years ago to Ethicon for around $80 million was one mark of how far HeartPort’s star had fallen. Some industry executives still believe the HP technology is clinically revolutionary, and this sale to Edwards likely reflects only a portion of the assets Ethicon acquired a couple of years ago. But it does represent another chapter in the HeartPort saga.

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Cracks in Crucible of Evidence-Based Medicine Create "Climate of Calamity"

The real story emerging from this year's Transcatheter Cardiovascular Therapeutics (TCT) meeting in Washington, DC, is not the news per se regarding specific clinical trial results or new device technologies. Instead, it is the story behind the story that is making news.

Interventional cardiology has been built on the back of evidence-based medicine and, as the leading interventional cardiovascular conference, TCT--now in its 19th year--has long been the crucible for the unveiling of data from the randomized clinical trials and other studies that are the currency accounting for this specialty's historically rapid adoption of new device technology.

That methodology, however, has come under attack in the last year, creating what Martin B. Leon, MD, TCT's co-director, calls a "climate of calamity". The crisis coincides with the 30th anniversary of the procedure that has built the specialty--percutaneous coronary interventions--and is occurring in the industry's only true blockbuster product (at $5.5bn worldwide): drug-eluting stents.

The snowball that started the avalance was the release of data from a Swedish registry at last year's European Society of Cardiology meeting that raised concerns about DES safety in small numbers of cases due to problems with late-stent thrombosis. Other studies followed reporting similar problems, while still other trial results also challenged PCI's efficacy, e.g., the COURAGE study.

The result as evidenced by the tenor at this year's TCT: interventional cardiology is a specialty under attack. For the first time, both PCI procedures and DES stent usage are on the decline, in the latter's case, precipitously. According to Leon, PCI procedures have dropped by 10% in the last year, and DES penetration has fallen in the US from nearly 90% in January 2006 to around 60% in September 2007. Contributing to this crisis, in Leon's view: economic issues, the media, and regulatory challenges.

Leon and TCT co-director, Gregg W. Stone, MD, are using this year's conference as a pulpit to urge the specialty to essentially take a second look at evidence-based medicine, this time with a more critical eye. Indeed, one example they point to as indicating the need for a more balanced perspective, is that the most recent data from the same Swedish registry that caused much of the initial DES commotion, when released last month in Vienna at this year's ESC meeting, inexplicably showed improved patient outcomes with DES, not the increased risk found in the two prior years.

Nevertheless, the challenges to evidence-based medicine look to have a long-term impact on device innovation and product adoption. That was clear in a panel discussion following the release of generally positive data from the ENDEAVOR IV trial concerning Medtronic's Endeavor DES, which an FDA panel recently recommended for approval and is likely to be the next DES to hit the US market. Indeed, improved safety is seen as a potential advantage of Endeavor over the drug-eluting stents currently on the market, due in part to thinner struts and other design features. One area of concern: Endeavor showed higher late lumen loss than the Taxus DES, although that did not translate into any difference in restenosis. (Late lumen loss is used as a surrogate endpoint in clinical trials for restenosis.)

Despite Endeavor's apparent safety benefits, Mitchell Krucoff, MD, of Duke University Medical Center, one of the panelists, pointed to the higher late loss numbers as a concern, noting, "That would cause me to think twice about which drug-eluting stent to pull of the shelf when treating more complex patients."

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Forsight Scores Big

With the Red Sox and Indians facing off in the American League Championship Series, IN VIVO Blog would like nothing more than to toss in an old baseball metaphor to describe how well investors in Forsight Labs second company did with their investment, but even the ever popular grand salami falls a bit short.

So with the shameless favorite sports team plug firmly inserted, we can go on to tell you that Forsight Newco II, founded just 10 months ago, raised approximately $5 million from investors to cover costs of product development and some early clinical testing of the company’s drug-eluting ocular punctual plug, a technology that can deliver drugs through the eyes’ own tears. For a video showing the product go here.

Now, just 10 months after the company’s inception, QLT stepped forward to pay $42 million upfront for the company. But the potential returns don't stop there. QLT also agreed to pay $5 million payment upon the initiation of phase III clinical trial for the first product; $20 million for the first commercialization of a product; $20 million for the commercialization of a second product; and $15 million on first commercialization of each subsequent product.

For those keeping score at home, that’s $67 million if QLT succeeds in getting one of these products on the market; $87 million if it gets two; $102 million for three and so on. To be sure, all of these potential payments are years off. QLT will need a few years to run the plugs through clinical study and isn't likely to get a product to market until 2011 or 2012.

QLT management is being criticized for overpaying, but Bob Butchofsky, president and chief executive officer of QLT, says the company’s punctual plug, which is inserted in one of the two ducts that drains tears from the eye, will put QLT in position to challenge the $6 billion eye drop market.

Unlike standard punctual plugs, which only slow the drainage of tears from the eye as a means of treating dry eye, QLT’s new plug contains a drug core. As the tear film flows against the plug, the drug is released delivering a steady stream of drug. The Newco identified glaucoma as a first application for the device, but the plug could be used to deliver any drugs currently delivered as eye drops. “I believe this is a start of a major change on how we treat ocular disease,” Butchofsky told analysts in a conference call this morning.

Others aren’t as impressed. QLT shares hit a 52-week low today after the deal was announced. An item on the Globe and Mail web site reported:

National Bank Financial analyst Prakash Gowd calls the deal pricey, citing “very limited data supporting the theoretical benefits of [ForSight’s] punctal plug technology. Moreover, he figures the technology is likely to be a “very competitive area and patents have not yet been clarified.”

QLT must be high on the technology as it made the only real bid for the company. Forsight CEO K. Angela Macfarlane says while Forsight had talks with other companies about its various programs, Newco II wasn’t being shopped around. (Curious about Forsight's first product? Go here.)

Robin Bellas, general partner at Morgenthaler Ventures, one of the investors, called the acquisition, "quite a surprise. We always expected to raise another round. It was unusual that QLT came to us and expressed strong interest in the program. We had no plans to sell it.”

For more about Forsight Labs go here.

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If Hamlet Were a VC

To tranche or not to tranche, that is the paraphrasing of a tired cliché.

Cliché or not, it’s an important question venture capitalists often ask themselves when financing a start-up that potentially could require significant capital. (We ask it here.) The obvious benefits are clear. Venture investors can commit large bits of capital to these companies—enough perhaps to carry a company to commercialization—without actually having to hand all the money over at once. (As an added benefit, they boost their IRR by shortening the time between their distribution of capital and their realized--they hope--returns.)

This morning’s panel at our In3 East conference in Boston examined two specific cases of companies running on tranched financings: atrial fibrillation company Endosense SA and spinal implant maker Innovative Spinal Technologies Inc. (IST) In the spirit of obtaining both sides of the argument, the panel included an investor perspective—delivered by Thomas Pollare investment director at 3i and lead investor in Endosense—and management—represented by Scott Schorer, president and CEO of IST.

The discussion—led by colleagues David Cassak and Stephen Levin—didn’t come to any definitive conclusion, pro or con. Pollare and Schorer obviously endorse the concept since each agreed to tranched financings in 2005. Pollare negotiated a $20 million Series A financing with Endosense, which is developing a catheter capable of delivering radiofrequency energy that scars heart tissue and disrupts the irregular electrical flow that leads to atrial fibrillation.

Schorer, meanwhile, signed a $39 million Series B with Orbimed, MPM and JPMorgan Partners taking equal parts. The company is currently selling and developing several new spinal implants.

Both suggested the tranched financing structure gives companies the capital necessary to make serious headway on a business plan. Pollare suggested the inclusion of milestones aligns the interests of management and investors as both will be rewarded by the execution of the business plan. “As an investor it’s important to have the capital working for you so it can be used efficiently,” Pollare said. “Obviously, it’s important for a second reason because if they don’t hit milestones something is wrong. You have to rethink the plan and the valuations.”

Schorer agreed but warned that the milestones could easily become a problem if management and investors don’t share the same interpretation of milestones and results. “I generally don’t like milestones and, as I was telling myself that, I looked back at the last few deals I’ve done and I realized that they all have contained milestones,” Schorer said.

IST, according to Schorer, drew down $20 million in July 2005 when it first closed on the $39 million Series B. The second $19 million came later, after the company and investors renegotiated the terms of the second tranche when the company missed some of its milestones. “We did that in reasonable terms,” Schorer says, concluding that the key to the success of tranched financings is high level of trust and respect between investors and management. The biggest risk is that investors and executives don’t share similar interpretation of results, so disagreements can arise over whether or not milestones have been met.

“There is nothing you can build into the deal structure to make it smoother,” he added. “You have to trust the people you’re working with to be fair.” IST is raising a $30 million to $35 million Series C round. It hopes to close on the financing early next year.

An audience member challenged the structure, saying it was unhealthy because it automatically put management and investors at odds. Experienced investors should be capable of judging management, evaluating performance and rewarding results without dangling the carrot and stick of a tranche investment.

Pollare, however, defended tranching, saying it gave investors an additional level of control over how their capital is used. “You can’t just give the check and say, `Call me in three years,'” he said.

“That, would be ideal,” Schorer joked.

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Ortho Settlement Doesn't Settle Everything

Yesterday’s announcement that the U.S. Attorney and four of the nation’s biggest orthopedics companies agreed to a $311 million settlement of bribery accusations would seem to put this entire matter to bed.

Under the agreement, four companies—Biomet Inc., DePuy Inc., Smith & Nephew plc and Zimmer Holdings Inc.—paid varying portions of the settlement while all agreed to adopt corporate integrity agreements and to hire outside firms that will monitor their relationships with physicians.

(It’s worth noting that Stryker Orthopedics did not take part on the settlement. CEO Steve McMillan touched on the subject before the settlement in a recent IN VIVO magazine article. Medtronic Sofamar Danek also has had prominent role in this debate.)

But once the cloud cover over the industry clears, we may find an orthopedics industry facing a whole new set of daunting questions:

What of the clean up that’s already begun? Certainly, few industry executives would deny privately that there are more than a few skeletons in the closet of most orthopedics companies—arrangements entered into around consulting agreements or royalty payments that richly reward surgeons for minimal amounts of work. But the $311 million settlement aside, our bet is that most orthopedic industry executives are applauding the settlement and—particularly given that no heavier, industry-disrupting judgments were handed down—may even have welcomed the scrutiny that the case brought.

For one thing, many orthopedic companies have themselves been trying to clean up their act over the past several years, following guidelines such as those promulgated by industry trade association AdvaMed governing appropriate compensation in sales and marketing practices and consulting arrangements.

That’s good corporate citizenship, but also good business sense. Particularly as the industry has consolidated in recent years and become much more of an oligopoly, legacy consulting arrangements that don’t deliver real clinical and economic value to orthopedics companies have become both fiscally irresponsible and unnecessary. Were there times in the past when orthopedics companies set up less-than-robust consulting or royalty arrangements with surgeons just because the surgeons demanded arrangements similar to ones they believed other surgeons were getting? Sure. But as the industry has consolidated and competitive positions stabilized, the ortho giants have no longer felt the temptation to enter into these agreements. Adherence to the AdvaMed guidelines were one rationale for pushing against these kinds of practices; the federal investigation into these practices now gives ortho companies more and more plausible arguments to deny surgeons who come asking for lucrative deals.

Does this tilt or level the playing field for smaller companies? The US Attorney investigations focused on the largest orthopedics companies, a group who, in aggregate represent greater than 90% market share. What are the implications for smaller suppliers and start-up companies? Does the ban against aggressive sales training and consulting agreements eliminate questionable practices and level the playing field? Or does it do just the opposite, erecting huge barriers to entry around the market leaders and preventing others from using well-established tactics that get the attention of important customers? More to the point, particularly where things like the AdvaMed guidelines are concerned, what posture should non-market leaders take? Strict compliance with what are voluntary rules? Or an attitude of, “Let Big Ortho do what it has to; we’ll do what we have to?”

What of the historical and vital relationship with physicians?
Most of the scrutiny has focused on sales and marketing practices—product training programs at the Ritz or sales training done on championship golf courses—those kinds of things. But what rules do we want to adopt about surgeon/supplier relationships where it concerns new product development? Rigid firewalls in the area of technological innovation might cut down on some abuses but almost certainly would signal the end of meaningful new product development in a field where innovation comes largely, if not exclusively from collaborations and feedback from suppliers.

Already some surgeons are beginning to claim that rather than simply ending abuses, the current scrutiny is giving orthopedics and spine companies license to deny them fair compensation for new ideas and new product iterations. Many device industry executives argue that while the current wide-scale scrutiny (one which embraces physicians working with drug companies on clinical trials and the like) is entirely appropriate, some special consideration should be set aside for device companies when it comes to oversight on product company/surgeon relationships.

As noted, the settlement is most likely good news, particularly in that few believe it will call for fundamental changes in industry dynamics. But no one should breathe a sigh of relief until we see what impact, if any, the future oversight will have on surgeon relationships as they apply not to sales and marketing efforts, but to product development.

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Ready, set....

Globus Medical Inc. is ready to run.

Earlier this week, the company settled its lawsuit with Synthes USA, reaching an agreement that absolved Globus of allegedly stealing trade secrets and key personnel from Synthes. As part of the deal, Globus agreed to pay Synthes $13.5 million in cash and to not hire any additional Synthes employees for one year.

Freed by the drag of that lawsuit, Globus today announced it raised a $110 million Series E investment in a round assembled by Clarus Ventures, which led a syndicate of private equity investors with a commitment north of $50 million. AIG SunAmerica is the only other identified investor although several private equity firms supposedly took part.

Not that the company had exactly been standing still. Started in 2003 by CEO David Paul and other executives who left Synthes, Globus Medical last year reported more than $80 million in revenue. The size of the settlement surprised some. (Healthpoint Capital's blog has some nice before and after takes here and here. But the Philadelphia Inquirer suggested at least one juror saw some holes in Globus' case.)

Hard to say for sure why the settlement happened, but it's easy to envision Globus executives opting to settle quickly with $110 million piled atop their board room table.

The massive deal signals two developments. The first involves Globus which currently resides on the second-tier of the spinal device market. Medtronic Sofamar Danek, Depuy Spine, Synthes USA, Stryker Corp and Zimmer Spine Inc./Zimmer Holdings Inc. still lead the way. But Globus is now positioned to make a move past other mid-tier players like Blackstone Medical Inc., NuVasive Inc., Alphatec Spine Inc and others. The capital infusion enables the company to plow through with sales of its fusion products while advancing its internally developed line of non-fusion implants and spinal spacers. For more on these areas go to MedTech Insight reports here and here.

The second interesting aspect of this financing of course involves Clarus Ventures, the firm founded by five former partners of MPM Capital who left in a very public split two years ago. This financing will likely be reported as a significant “venture capital” deal, probably the biggest since CardioNet secured its $110 million (which also wasn’t really a venture capital round.) But make no mistake, this is a private equity-style investment with private equity firms involved.

Private equity firms continue to survey the medical device industry, and orthopedics particularly, for opportunities. While the Globus deal clearly resides in a different neighborhood than the $10.9 billion acquisition of Biomet Inc. by Blackstone, KKR and others, it demonstrates how well-heeled venture firms--such as Clarus--can position themselves as private equity players, at least when when medical devices are involved. The $50 million-plus investment in Globus represents roughly 10% of the $500 million debut fund that Clarus closed on at the start of 2006, so it’s a big bet. It also may be the last device deal in this debut fund.

Clarus is clearly comfortable with big wagers as it demonstrated with its participation in the $80 million financing for Sientra, which is pushing for FDA approval of a silicon-based breast implant.

Check out our next issue of START-UP to hear more about the deal and Clarus.

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Which do you want first?

Hologic Inc. management presented plenty of good news last week at the Jefferies Healthcare Conference in New York.

But there's a bit of bad as well.

First, the good. CFO Glenn Muir and Jack Cummings, Chairman/CEO, laid out a very promising picture for the future of Hologic as it acquires Cytyc Inc., maker of medical devices and diagnostics for women's health.

In their view, Hologic’s digital mammography business clearly will benefit from the channels that Cytyc’s sales force already built into OB/GYN offices. But don’t take our word for it. Listen to the web cast here. The good financial stuff comes up 19 minutes into it.

The $6.2 billion price tag obviously is a big undertaking for Hologic management. In a Q&A session, Cummings only half-joked that the biggest challenge facing Hologic management is to not mess up such a well-run company as Cytyc. But another challenge will be the $2.2 billion Hologic borrowed to make the deal.

The company is keeping its eyes on interest rates. At this point, the rising rates aren't impacting the accretive qualities of the deal. But Muir says management's goal will be to "rapidly pay down that debt."

This suggests—at least to us—that the new Hologic-Cytyc will be out of the company-buying business for a while, which would be too bad. Prior to the merger, venture capitalists and the blogs that cover them saw both Cytyc and Hologic as up-and-coming companies that could be steady acquirers of venture-backed businesses as they grew from their mid-tier status.

IN VIVO Blog suggested this to Cummings after the presentation, and he disagreed. Cummings said Hologic could be in the market for smaller companies with products that would plug easily into Hologic’s increasingly impressive sales and marketing machine.

As an example, he cited the company’s recent acquisition of BioLucent Inc. The privately held company makes and sells the MammoPad, "a radiolucent foam cushion that covers the cold, hard surfaces of all commercially available mammography equipment," according to the release. (Two side notes: Tom Fogarty had a role in starting the company. BioLucen's brachytherapy business, which you can read about here, will be spun out into a separate company.)

According to Muir, BioLucent had 10% penetration of its market with each pad costing $5 and carrying 64% gross margin. Hologic sees the company initially bringing in roughly $25 million in annual revenue. Hologic paid $70 million for the company with the potential for earn outs tied to revenue.

So Hologic appears to be on a solid path toward becoming a major mover in women’s health care. That’s the good news. The bad news is the company will need time to digest the recent merger. It may still make the occasional acquisition, but any such company will need to fit neatly into the company's current business.

p.s. Muir deserves extra credit for making a lucid presentation at 8:10 in the morning. In response to a poke from Cummings, he revealed his 2 p.m. Wed. shuttle out of Boston arrived at 1:30 a.m. "Not the flight to be on." IN VIVO Blog is glad we drove down to CT and grabbed a morning MetroNorth.

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Record VC dough for device makers

The New York Times on Monday drew attention to the boatload of cash that venture capitalists are bestowing on medical device companies lately. Seed investment in the sector, according to the National Venture Capital Association, is up 60% from last year to $1.1 billion. Says the Times:

These investments in recent years have financed a range of technologies, including devices designed to unclog arteries, rebuild heart valves, monitor body functions from within, limit chronic pain and spinal problems and treat sleep dysfunction, acid reflux, epilepsy and diabetes. “The venture-capital-backed boom in medical devices has delivered extraordinary new technologies,” said David Cassak, an editor at In Vivo, a monthly publication for the medical-device field. “There’s virtually no sector of medical devices that hasn’t been given a tremendous boost.”

The emphasis there is clearly our own. But we hope to add David and his device-focused colleagues to our blog roster soon to bring you more regular medical device industry analysis.

For now, it's back to the NYT: the paper points out that investors wary of high tech as well as biopharmaceuticals, for the perceived high risks that each of those fields represents for the earliest of investors, can find a happy middle ground in medical devices.

But it remains to be seen if the boost in VC investment for device companies will last. Sure medical technologies tend to be more intuitive, ostensibly less risky investments than biotech, but they remain cyclical nonetheless.

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