We want to congratulate new SA contributor Christopher Hampton who wrote a cracker of a first article on a company called Zynex (ZYXI). The stock is on fire and up 45% from when the article appeared (only 5 weeks ago).
While consolidation is always possible and nothing goes up in a straight line, we nevertheless think there are good reasons to be very bullish on the company. Here are the reasons:
- Big competitors falling away.
- $1M 'steady state' sales per sales force employee as a target.
- SaaS-like metrics: 30%+ growth, 80% recurring revenues, 80%+ gross margins, profitable and cash producing.
- Razor and blade model; 80% recurring revenues.
- Blood monitoring device offers another big opportunity.
- International expansion hasn't even really started.
- Shareholder friendly (buybacks, special dividend).
- CEO is majority owner (54% of the outstanding shares).
Zynex produces electrotherapy devices:
The most important of these is the pain management device NexWave. From the May 2019 IR presentation:
Now, the company had the good fortune that two big competitors, International Rehabilitative Sciences and Empi, didn't. The companies didn't survive an audit (by the office of the Inspector General) and went belly-up, leaving $400 in sales wide open for competitors like Zynex. They are struggling to do that, but are making good progress:
Sales have been taking off, growth in the last quarter was 34%, but as you can see, the sales are still less than a tenth of the sales of the combined former competition.
- Market growth
- Insurance coverage
- Opioid replacement
- Other products
As a result, Zynex no longer accepted Medicare and Medicaid insurance, but there are some movements to reverse this now. Here is CEO Thomas Sandgaard (PR March 19 2019):
"We continue to expand our sales force and geographic footprint across the US and have decided to reactivate our Medicare provider number. Medicare continues to approve of and pay for our prescription strength pain management technology. We believe this initiative puts us in a strong position to procure prescriptions from more prescribing physicians and therefore help accelerate order growth"
The company has a long way to go to catch that $400M sales of the former competition, but there are other opportunities besides this. One is that the market for this might significantly expand due to the opioid crisis.
The NexWave delivers pain relief without side effects, the same can't be said about the opioids that pharma companies have leashed onto an unsuspecting public with untold harm. From the Q1CC:
"The opioid epidemic continues to be a serious issue in this country and we’re increasingly working to get patients off opioids and for physicians to use our prescription-strength technology as the first line of defense when treating pain."
International sales is another opportunity which the company is only in the very first stages of exploring and there are large opportunities here (Taglich Brothers):
"In November 2018, consulting firm Transparency Market Research published a report that anticipates the global pain management device market to grow 7.6% annually reaching $6.3 billion in 2023 from nearly $3.6 billion in 2016."
Razor and blades business model
The business model is really fantastic for a company producing goods; it's almost like a SaaS platform, generating 80%+ gross margins and 80% recurring sales with 30%+ revenue growth.
The recurring sales are supplies (mainly electrodes and batteries) and they grew 37% in Q1 to $7.2M, which is 78.5% of revenue, which is huge. Basically getting an installed basis guarantees a lifelong significant revenue stream.
Much of the device revenue is from leasing, from the 10-Q:
- NeuroMove (stroke rehab)
- InWave (incontinence treatment)
- Blood Volume Monitor (patented)
- A few other products
The NeuroMove was re-introduced in February last year to their sales force (it was already sold to rehab clinics) and it's supported by a host of clinical studies (see here). It has fairly unique capabilities (website):
"NeuroMove works by detecting the attempts to move a muscle group sent from the brain. These attempts are shown in the display as significant increases in the signal over regular muscle activity. The built-in microprocessor intelligently distinguishes between regular muscle activity, muscle tone, noise and real attempts in the EMG. When a real attempt is detected, the unit “rewards” the patient with a few seconds of muscle contraction, where the visual and sensory feedback serves as an important element in relearning the movement. This is similar to the well known learning technique of “Pavlov’s Dog”.
NeuroMove also prompts the patient to relax just as often, and experience has shown that this element is significant in learning to control a muscle group. Better relaxation of a muscle group can sometimes be noticed as few as ten minutes into the first treatment session."
Their patented Blood Volume Monitor is not selling as it's still undergoing clinical studies, but when approved (both here and in the EU), there seems to be a significant market opportunity.
The PR describes what is patented, here is the CEO:
"I am excited to have obtained patent protection for the core principles of how we detect fluid imbalances such as excessive blood loss during surgery or internal bleeding in recovery. The algorithm which computes multiple vital signs into an easy-to-understand Index is now protected through this patent. This breakthrough technology is unique as there are no other non-invasive devices available that can detect blood loss or internal bleeding. We believe our non-invasive, easy-to-operate technology will serve a huge unmet need to manage blood volume in hospital and surgical settings, whether it is fluid loss, fluid overload or internal bleeding which is rarely detected until it becomes critical or fatal."
Management also sees opportunities for adding and/or acquiring new products, especially complementary ones.
Sales reps leverage
The limiting factor is having enough sales representatives. The company is scrambling to expand here and the tight labor market isn't helping. Management argues that an experienced sales rep can deliver roughly $1M in sales per year.
But it will be clear from the revenue figures that they are still far from that, and this is because of two reasons:
- It takes time for sales reps to get up to speed.
- It takes time for them to create an installed base of past sales from which to grow the recurring supplies sales, which are nearly 80% of revenue.
They are now adding 10 sales reps a month which would take them to approximately 250 by the end of this year. The company had a sales force of 163 at the end of last year and $31.9M in revenue.
This shows that revenue per sales rep was just $195K, basically this can grow five fold, which is a tremendous growth force.
The company is also continuously increasing their training and marketing materials, complete with a little video book marketing device. This is important, because the awareness that the NexWave is a side-effect free alternative to opioids isn't widespread.
They're also undergoing a reorganization of the sales force with appointing regional managers.
From the PR:
"The estimate range for the second quarter revenue is between $9.5 and $10.0 million with Adjusted EBITDA between $2.3 and $2.8 million as we continue to aggressively invest in growing our sales force. The revenue estimate is approximately 25% to 32% above last year's second quarter revenue of $7.6 million."
One should also note that there is a slight seasonality, producing a softer Q1. Beyond this year, the aim is to get to 400 sales reps which would give the company a shot to $400M in sales, much of it recurring. That will take time to materialize, though.
The market has plenty of opportunities, from Taglich Brothers:
"In April 2018, Market Data Forecast (a market research firm that offers business intelligence and consulting services) redicted the North America Pain Management Devices Market would generate revenue of nearly $1.4 billion in 2018. The North America Pain Management Devices Market should grow annually by 8.8% and reach nearly $2.1 billion by 2023. It is estimated that in excess of 100 million people in the US experience chronic pain.
In November 2018, consulting firm Transparency Market Research published a report that anticipates the global pain management device market to grow 7.6% annually reaching $6.3 billion in 2023 from nearly $3.6 billion in 2016."
Demographics is also helping with percentages of people over 65 rising almost everywhere in the developed world.
Insurance coverage increases also offer an opportunity. The company was hobbled back in 2012 because of a Medicare decision to eliminate coverage of industry devices prescribed for chronic lower back pain.
While two big competitors are out of business, there is competition left from companies like RS Medical, Richmar, and Mettler Electronics, all private companies. However, Taglich Brothers argues that Zynex's competitive position is good as:
"The NexWave prescription only, 3-in-1 device, is a potential advantage for Zynex. In one device, NexWave provides customers with Interferential therapy, Transcutaneous Electrical Nerve Stimulation (TENS), and NeuroMuscular Electrical Stimulation (NMES)."
How does this compare? RS Medical's RS-4i Plus is clinically supported so we assume it's FDA approved, from the website:
"The RS-4i Plus Sequential Stimulator uniquely combines true high frequency (5000 Hz) Interferential therapy for long-lasting pain relief, with neuromuscular electrical stimulation (NMES) for muscle rehabilitation."
The first combines Therapeutic Ultrasound, Electro Stimulation, Light Therapy, and Cold Laser Therapy in One Medical Device. The latter combines ultrasound and electrotherapy.
Mettler sells a lot of devices combining ultrasound, Intraferential, and TENS, but as far as we could make out, no NMES.
There are other competitors, but to our knowledge, there are none with the triple working TENS, NMES and Interferential therapy and one should realize that the NexWave is a prescription only device (and not an OTC or over the counter device you can buy at any pharmacy), from Electromedtech:
"OTC electrotherapy devices are usually under-powered and offer only the most basic and limited therapy settings. Although over-the-counter TENS units are often much cheaper than electrotherapy devices that require a prescription, they are generally much less effective at treating pain and do not provide users with as much treatment flexibility."
It's difficult for a non-specialist to make any claims on which of these products are better and which ones are prescription versus OTC. However, management itself argues the competitive landscape has significantly improved, even if this happened a few years back (Q1CC, our emphasis):
"My long-term goal for our electrotherapy and rehab division is to continue to grow our share of the huge market for prescription pain management and take advantage of the huge void in the market after the disappearance of our main competitors."
However, given the fact that Zynex's sales (30%+) are growing much faster than the market (7.6%-8.8%) testifies to a solid competitive position.
So does 80%+ gross margins, even if these are at least in part a result of the razor and blades model, which opens up the possibility to sell the devices below cost should competition intensify, without too much damage to financial results so competition might not be such a big threat.
We have to say, 80% gross margin, that's quite something.
And the company is already profitable with net income at $2.4M in Q1. Given the fact that revenue per sales rep can five-fold from its current basis, there is ample room for expansion here.
This will not materialize at once though because the company keeps expanding its sales force with 10 new hirings a month, but with 80%+ gross revenue and 30%+ revenue growth, it can easily afford that as that adds at least $2.2M (and rising in subsequent quarters) a quarter to gross profits.
S&M is increasing fast, though, rising 89% (y/y) to $2.5M in Q1, and rising from 19% of revenue a year ago to 26% in Q1. The sales force expanded by 53 people in Q1 (compared to Q1 2018), but again, given the revenue growth and gross margin, the company can clearly do this.
It's rare for a company trying to expand as fast as it can to have such strong and growing cash flow:
Cash from operations grew a whopping 78% in Q1. Dilution hasn't been much of a problem:
The company bought 3.8M shares in the last 18 months due to the strong cash flow and they even paid a special dividend of $2.3M, or $0.07 per share, last quarter (Q4). The company has no debt and $9.4M in cash and equivalents.
The tremendous market opportunity where products generating no side effects have little competition and compete against dangerous painkillers might very well attract competition.
All the more so considering the 80%+ gross margin and the 80% recurring revenues. However, market entry isn't so easy as these electrotherapy devices need FDA approval, which is a pretty lengthy and costly process.
Another risk would be less insurance coverage, but how likely is that given what happened with opioids?
Another thing to notice is that the shares are majority owned by the CEO (52.85%) and insiders in total hold 55% of the outstanding shares. The CEO is selling some from time to time, but not in quantities that would be cause for concern.
It's no surprise valuation metrics have risen considerably, but keep in mind this is a company growing revenues at 30%+ with 80% recurring revenues generating 80%+ gross margins whilst being profitable and cash flow positive. That's deep in SaaS territory. Analysts expect EPS this year coming in at $0.26, rising to $0.33 next year.
Medical equipment companies tend to have pretty steep valuation metrics with P/Es above 40 certainly being no exception so we don't see any hold back from a valuation point.
The shares have been in a tremendous rally, but there are strong reasons for that to continue for quite some time (even though there will be periods of consolidation):
- The company sprouts SaaS-like metrics with 30%+ growth, 80% recurring revenues and 80%+ gross margins, it's also profitable and cash flow positive.
- The company has a tremendous market opportunity with their main competitors out of commission and a large and growing market in front of it.
- The company is very well placed to benefit having FDA approval.
- The company is in a sustained effort to boost its sales force and it can easily afford this. Its existing sales force isn't anywhere near to its targeted sales per employee ratio because many are recent hirings, producing a strong and automatic ratcheting up of sales even without new hirings.
- There is significant upside in additional sales from overseas markets and additional products, especially when its blood monitoring device gets approved.
- The company has no debt and is shareholder friendly with a special dividend and substantial share buybacks.
- While valuation isn't cheap, operational margins, cash flow and earnings have the potential to rise very steeply once the company slows the torrent pace of sales force hiring and the sales of existing sales employees ratchet up to approach its $1M per employee target.
While it's undeniable that the party for shareholders is already well underway, we think it has a long way to go still.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ZYXI over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.