Physio-Control International Corp.

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Physio-Control International Corp.

11811 Willows Road N.E.
Redmond, Washington 98052
U.S.A.
(206) 867-4000
Fax: (206) 885-6507

Public company:
Incorporated: 1955 as Physio-Control Co.
Employees: 905
Sales: $173.16 million (1996)
Stock Exchanges: NASDAQ
SICs: 3845 Electromedical Apparatus; 7372 Prepackaged Software

Physio-Control International Corp. is the world’s leading manufacturer of external defibrillators, medical devices that apply an electrical shock to victims of sudden cardiac arrest or ventricular fibrillation, in which the heart begins to flutter or beat irregularly, to restore a normal heart rhythm.

Physio-Control defibrillators account for half of all those sold to hospitals in the United States. In addition, the company has a commanding 85 percent to 90 percent share of the advanced life support market in the United States, consisting primarily of paramedic and fire-rescue vehicles, and was an early leader in the developing “first-responder” market for automatic external defibrillators (AEDs). AEDs were designed to be used by police officers, firefighters, security guards, and others with limited medical training who often arrive first at the scene of an emergency.

Physio-Control, which went public in 1995 after being sold to an investment group by Eli Lily & Co. the year before, had sales of $173.16 million for fiscal 1996. The company, whose products are sold in 70 countries, was traded on the NASDAQ exchange under the symbol PHYS.

The 1950s–60s and Dr. Karl Edmark

Dr. Karl William Edmark (1924–94) was in his last year of residency at Lahey Clinic in Boston in 1954 when he built his first electronic monitor, a boxy-looking device with a light that flashed every time a patient’s heart beat and set off an alarm if the beat faltered during surgery. He patented the device, which he called a Heartbeat Indicator, and in 1955, set up a corporation, the Physio-Control Co., to handle any income from his invention.

Later that year, Edmark moved to Seattle, where he became one of the city’s leading cardiovascular surgeons, performing the first open-heart surgery at Swedish Hospital and, later, establishing the Cardiovascular Associates Laboratory at Providence Hospital. He also continued to experiment with electronics, developing the Pressure Pulsometer, which monitored a patient’s blood pressure during surgery.

In 1961, Edmark unveiled a defibrillator that operated on direct current. When a heart goes into fibrillation, it begins to flutter and is unable to pump blood through the body. Defibrillators administer an electrical shock, which momentarily stuns the heart and allows it to return to a regular heartbeat. Until Edmark introduced his DC Pulse Defibrillator, medical defibrillators used AC, or alternating current, which caused patients to spasm violently because of the high voltage. The DC defibrillator allowed surgeons to administer a more-controlled, low-voltage shock that restored the heartbeat without causing additional trauma.

Edmark licensed manufacturing and distribution rights to the DC Pulse Defibrillator and the Pressure Pulsometer to American Optical, one of the first big companies to enter the electronic medical-instruments industry. Over the next few years, Physio-Control, which had been bankrolled by Edmark and a few personal friends, received about $10,000 annually in royalties, which was plowed back into research.

Then in 1965, American Optical announced that it had refined Edmark’s inventions to the point where it no longer felt it needed a licensing agreement with Physio-Control to manufacture and sell the devices. Without a source of revenue, Edmark faced a decision: either he could shut down Physio-Control or begin running it as a business instead of a research laboratory. He chose the later. He also asked W. Hunter Simpson, then Northwest district manager for IBM Corp. in Seattle, if he was interested in becoming Physio-Control’s first full-time president.

Simpson had known Edmark since 1963, when he had hired the cardiologist as a consultant. At the time, IBM, which designed the first heart-lung machine for the Mayo Clinic, had been interested in further exploring the medical instruments industry. Although it meant giving up a secure position and taking a cut in pay, Simpson accepted Edmark’s offer, starting his new job in January 1966.

A graduate of the School of Business at the University of Washington, who also had studied pre-med, Simpson spent his first year at Physio-Control raising $300,000 in venture capital, attracting local investors such as Bagley Wright, whose company, Pentagram Corp., built the Space Needle for the Seattle World’s Fair. He also changed the name of the company to Physio-Control Corporation, and more narrowly defined the company’s market niche. According to Harriet and Terry King in The Team, a book published by Physio-Control detailing its first 25 years, Simpson told the company’s five employees, “Our immediate goal is to install coronary care systems in Puget Sound hospitals and smother them with love, attention and service. After that, when the time is right, we can think about marketing nationally.”

Lifepak/33, 1968

It did not take long. Physio-Control manufactured its 100th patient monitor and defibrillator in the fall of 1967, and reported revenues that year of more than $500,000. Financially, Physio-Control was near the break-even point, and Simpson told stockholders at the annual meeting in the spring of 1968, “The name of the game is now marketing.” About the same time, Physio-Control learned that Zenith Corp. was developing a bulky—but portable—56-pound monitor/defibrillator. Simpson faced the challenge head-on, assigning Stanley Seiffert, Physio-Control’s manager of technical operations, the task of designing a portable monitor-defibrillator that would be more than 20 pounds lighter. Physio-Control named the yet-to-be-built device the Lifepak/33.

Physio-Control introduced the Lifepak/33—which ended up weighing 34 pounds—at the annual American Heart Association meeting in November 1968, but not without some last-minute difficulty. The night before the show opened, someone tried to smash two of the units. The devices were also left on, draining the batteries. But if a competitor was behind the vandalism, as many believed at the time, the publicity surrounding the “sabotage” made the Lifepak/33 the star of the show.

Soon afterwards, Physio-Control was able to raise another $600,000 in venture capital, and commercial production of the Lifepak/33 began in February 1969. The 15th and 45th units were sold to the U.S. Navy, which installed them aboard Air Force One and Air Force Two, the aircraft assigned to carry the president and vice president of the United States. That same year, Jacksonville, Florida, became the first city to install portable defibrillators in all 10 of its fire department emergency vehicles. Physio-Control closed out its fiscal year, at the end of September 1969, with more than $1 million in sales for the first time, although still posting a loss for the year of $35,000 because of production start-up costs.

Physio-Control went public in 1971, selling 20,000 shares of stock at $25 each. All but 7,000 shares were purchased by original investors in the company. Physio-Control also launched a national advertising program built around the success of innovative Seattle’s Medic I program, which equipped emergency vehicles with sophisticated medical equipment, including a Lifepak/33. Sales increased that year to $2.4 million, with net earnings of $266,000.

Two years later, in 1973, Physio-Control introduced the Lifepak 3, a third generation of its portable external defibrillator. The company also began construction of a $2 million headquarters and research center on 11 acres overlooking the Sammamish River in rural Redmond, Washington, later to become the home of Microsoft Corp. In 1974, Physio-Control added the Lifepak 4, which featured an electrocardiogram stripchart recorder to provide a permanent record of a patient’s heartbeat, to its growing family of portable Lifepak defibrillators. Revenues that year topped $10 million, and Physio-Control posted earnings of $1.05 million.

For several years, Physio-Control products had been distributed primarily by Minneapolis-based Medtronic, Inc. But in 1975, inventory began to accumulate in Medtronic’s warehouses. Physio-Control was worried that Medtronic eventually would be forced to slash prices on more than $5 million worth of defibrillators and dialysis machines, seriously upsetting the company’s long-term marketing plans, When Medtronic suggested that it might be interested in acquiring the much smaller Physio-Control, Simpson turned the offer around. Betting that he would be able to sell the stockpiled inventory in an orderly manner—and finance the acquisition with the proceeds—Simpson offered instead to purchase Medtronic’s instrument-sales division. The gamble paid off with Physio-Control posting records sales that year of $12.9 million, although earnings were down.

Company Perspectives:

We make lifesaving tools for lifesaving teams … unique medical devices of the highest quality, which predict or urgently intervene in life-threatening, cardiorespiratory events.

Meanwhile, the company was also facing another challenge. Physio-Control learned that a United Kingdom company was developing a defibrillator designed specifically to be used by paramedics in the fast-growing emergency medical market. The small, portable units were expected to weigh half as much as Physio-Control’s newest model, the Lifepak 4. John Gallagher, then vice president of engineering at Physio-Control, was assigned the task of pulling together a design team to rebuff the challenge with a radically different Lifepak 5.

Initially, the design team considered packing the components of the defibrillator into a bright orange belt that could be worn by the paramedics. But feedback from Seattle’s Medic 1 staff indicated that was unworkable because the bulky belt design would interfere with wearing seat belts in the emergency-response van. Physio-Control eventually settled on a more conventional design, and the Lifepak 5—weighing just 18 pounds—was introduced at the annual meeting of the American College of Cardiology in February 1976.

Physio-Control’s sales that year rose by more than 20 percent, to $15.7 million, although net income, still affected by the Medtronic acquisition and inventory glut, remained below $1 million. The following year, 1977, sales topped $21 million and net income almost doubled to $1.7 million. Physio-Control, which received a Presidential “E” Award from the U.S. Department of Commerce, had become the largest manufacturer of defibrillator/monitors in the world, exporting medical devices to 33 countries.

Acquisition by Eli Lilly, 1980

In 1979, Physio-Control acquired Biomega Corp., in Gainesville, Florida, which made semi-automatic blood-pressure monitors for use in emergency vehicles. The company also formed a joint venture with Valleylab Inc. in Boulder, Colorado, to develop and market pacemakers and other implantable medical devices. Revenues continued to grow, surpassing $41 million, while net income that year was more than $3.9 million. Physio-Control had also grown to more than 700 employees.

In addition, the company had begun attracting considerable interest from much larger corporations looking to expand their medical-device divisions. In early 1980, Physio-Control announced that it was being acquired by pharmaceutical giant Eli Lilly & Co. in a stock deal worth about $145 million, returning $ 170,000 for every $ 1,000 the original investors had put into the company in 1966. At Physio-Control’s annual meeting, Hunter told shareholders, “The fit is quite magnificent, almost designed, because of the attitudes and philosophies of the two companies.” In prescient fashion, Simpson also noted, “The stability of size (offered by Eli Lilly) is also important. I don’t care how good a company is in this day and age, there is always the possibility of recall (of a product). It could be disastrous for a small company.”

In 1985, Physio-Control introduced the world’s first automatic external defibrillator. The Lifepak 300, designed for use by police, firefighters, security guards, and other “first responders,” was a battery-powered defibrillator about the size of a shoe box and weighing just six pounds. The computer-controlled defibrillator automatically interpreted a victim’s heartbeat and determined if a defibrillating shock was indicated. The device also was designed not to allow a shock to be administered if it was not indicated.

The same year, Physio-Control, which had pioneered profit-sharing and the 10-hour, four-day work week for its employees, was included in an annual listing of “The 100 best companies to work for in America.” Simpson also retired at the end of 1985, ending 20 years at the helm of Physio-Control. He was succeeded as president and chief executive by Gilbert W. Anderson, then 57, Physio-Control’s executive vice president. A graduate of the University of Washington, Anderson previously had been chief executive at Stetson-Ross, a manufacturer of heavy equipment and electronics products.

Sales of the Lifepak 300—despite its innovative design—were sluggish until 1988, when researchers from the University of Washington published a report in the Journal of the American Medical Association that documented in-flight deaths of airline passengers and called for airlines to carry automatic defibrillators on board. The university study—funded by Physio-Control, the Laerdal Medical Group, a Swedish competitor, and the National Center for Health Services Research, a federal agency—found that 60 percent of nearly 600 in-flight deaths reported during the period, were related to heart attacks. The American Heart Association later endorsed the study in calling for automatic defibrillators to be carried aboard commercial passenger flights. In 1990, Virgin Atlantic Airways became the first airline to carry automatic defibrillators aboard its overseas flights, purchasing them from Physio-Control.

FDA Shutdown in 1992

In 1992, Physio-Control voluntarily shut down production of its defibrillators and patient monitors after a review by the U.S. Food and Drug Administration found the company had failed to follow “good manufacturing practices,” including inadequate failure investigations, not properly inspecting critical components of its products, and failing to adequately document manufacturing and testing procedures in writing.

Although the FDA never claimed that patients had been harmed by malfunctions of the medical equipment, and no recalls were ordered, Physio-Control signed a consent decree outlining steps it would take before resuming production. Richard O. Martin, former vice president of business development who had succeeded Anderson as president and chief executive in 1991, later told the Puget Sound Business Journal that Physio-Control “truly, fundamentally believed” that it was in compliance with all FDA requirements. He blamed the sanctions on political pressure then being brought to bear on the FDA to become more forceful in its interpretation of the rules.

In a newspaper column, Martin would later write, “Perhaps the FDA needed to flex some muscle; the agency’s reputation was besmirched due to the controversy over its generic drug scandal, the recall of the Dalkon shield IUD, and silicone gel breast implants. If that is the case, then it seems to me the FDA is guilty of shooting itself in the foot. Our government is not only crippling the medical community but maiming the entrepreneurial companies that are the backbone of American business.”

Whatever the reason for the FDA’s action, the shutdown contributed to the first-ever loss reported by Eli Lilly, for the third quarter of 1992. Eli Lilly did not disclose how much of its $268 million loss stemmed from the problems at Physio-Control, which kept all 1,000 employees on the payroll. But the company’s Medical Devices and Diagnostics Division, which included Physio-Control, took a pretax charge of $180 million “responding to regulatory initiatives, including actions to strengthen … good manufacturing practices and procedures.” Sales at Physio-Control fell from a high of $158 million in 1991 to less than $80 million in 1992.

The shutdown, which only affected production for domestic sales, also lasted much longer than anyone expected. Physio-Control, which predicted it would resume full production within six months, finally was allowed to resume production of the Lifepak 10, an in-field model representing about 40 percent of the company’s pre-shutdown revenues, 12 months later. The company was not allowed to resume full production of all lines until June 1994, 753 days after the shutdown began.

By then, Eli Lilly & Co. had pumped an estimated $140 million into Physio-Control to keep it going. Simpson, then retired, told the Journal American, “Physio is a precious thing, and if it hadn’t been for Lilly, it would have disappeared a year ago.” Although Eli Lilly said it was unrelated to the difficulties at Physio-Control, the pharmaceutical company also announced at the start of the year that it would sell three of the companies in its medical devices division, including Physio-Control, and spin off the others in a public offering. In July, Physio-Control was sold to Bain Capital Corp., a Boston investment group, for $23.3 million. Steve Pagliuca, managing director at Bain Capital, was named chairman of Physio-Control.

Recovery and Outlook

Despite the long shutdown, Physio-Control recovered quickly because of its strong market presence. During the shutdown, the company had developed a backlog of more than $70 million in orders from hospitals and emergency medical services. Incredibly, the company eventually filled more than 80 percent of those orders. Martin told the Puget Sound Business Journal, “That, more than anything else, speaks to what the customer thought of Physio-Control. People actually waited until they could get the Physio product.”

In December 1995, less than 18 months after buying Physio-Control, Bain Capital sold 90 percent of the company in an initial public offering for $172 million. That year, the company reported sales of $148.7 million, nearly 95 percent of its pre-shutdown sales. In 1996, sales reached a record high $173.16 million.

Capping its comeback, in 1996 Physio-Control was named one of the best manufacturing facilities in the United States by Industry Week, which noted that the company’s portable defibrillators “have to be particularly rugged to withstand the harsh treatment they are often subjected to in the field. In product demonstrations (sales representatives) have been known to pick up the instruments and heave them onto the floor as if they were bowling balls—a maneuver known as ‘the salesmen’s toss.’ As in the old Timex watch commercials, they then proceed to show that the products still work.”

In 1996, Physio-Control also received FDA approval to market the Lifepak 500, a lightweight, automatic external defibrillator (AED) designed for use by “first responders,” who often arrive first at the scene of an accident or medical emergency. The battery-operated, computer-controlled Lifepak 500, which sold for less than $4,000, automatically analyzed a victim’s heartbeat and indicated, through voice prompts and visual readouts, whether a defibrillating shock was necessary. The shock was applied by pushing a button.

One of Physio-Control’s competitors in the first-responder market was Heartstream Inc., a company formed in 1992 by five former Physio-Control employees, which also introduced a lightweight AED in 1996. Physio-Control sued Heartstream in 1995, alleging the theft of trade secrets, and Heartstream countersued, alleging unfair business practices. The lawsuits were still pending in early 1997. Other competitors in the emerging market included Zoll Medical, SurVivaLink, and Laerdal Medical.

Analysts indicated there was an enormous, potential market for AEDs, including sports stadia, high-rise office buildings, doctors’ offices, public swimming pools and beaches, health clubs, retirement homes, and community centers. An estimated half million Americans suffer sudden cardiac arrest every year and only about 5 percent survive, in part because defibrillation needs to be administered within the first 10 minutes to be most effective. In the mid-1990s, the American Heart Association, the American College of Cardiology, and the International Association of Fire Chiefs were among the organizations calling for widespread access to early defibrillation. At Physio-Control, Martin, who was elected chairman in 1997, liked to say that one day AEDs would be as common as fire extinguishers.