I Am A Bearish Bull On Zynex; It's Complicated

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About: Zynex, Inc. (ZYXI)
by: Kevin Mackie
Summary

Zynex is one of the only major players in a small niche, the electro-therapy market.

After a dizzy history, the last three years have shown indications of a turnaround.

Precise plans for growth, improving financial metrics, and several potential catalysts make for an intriguing investment.

Risk factors are plentiful. This is a high risk, high reward situation. Though I am invested, there is a spirit of gambling in this one.

Early this month, I stayed away from one of my key investing tenets; only commit capital to a company that has a long history of solid operating performance. Zynex (ZYXI), whose primary line of business is the sale of electro-therapy devices and supplies for use in pain management, has had a hard time finding their identity in the last decade. Their injured past has included several launched and then quickly discontinued lines of business and subsidiaries, flunked acquisitions, regular turnover in the CFO position, liquidity issues, a lengthy loan default, resultant consecutive years of negative earnings, having to re-issue financial statements and a subsequent lawsuit, and several "going concern" inclusions by the firms that audited their financial statements. It made me nervous to become part owner in such a company, but I realized that A) I am young and can stomach the risk of investing in a potential turnaround situation and B) I have done extensive due diligence (to include having a phone conversation with the CFO, exchanged emails with the CEO, and have read every annual report since 2005). I understand the business and the risks, and I think the potential reward outweighs the potential downside.

Business Line

Zynex' primary revenue source is from the sale/lease of its NexWave device, and associated supplies (batteries and electrodes).

*Image from Zynex.com

This device brings about the beneficial, pain-relieving effects by sending various electrical signals into muscle tissue from surface electrodes:

Opioid epidemic

*Image from zynex.com

The soothing and regenerative effects of this therapy have been well documented. A huge advantage that it has is zero side-effects. A main marketing thrust for the company has been presenting their product as a solution to the opioid epidemic in the United States. Opioids mask the pain, they do nothing to treat issues. They are also remarkably addictive, and opioid abuse is rampant and dangerous. According to thetruth.com:

Taking opioids at too high of a dose, or for too long a period of time, increases the risk of addiction, overdose, and death. The likelihood of using opioid painkillers long-term spikes after just five days of use. Five. And because of this, a lot of people are dying. In 2017, more than 47,600 people died of opioid overdoses in America--more than 130 people every day. And that's 130 too many.

Electro-therapy is non-addictive, treats pain, and has therapeutic/regenerative applications. NexWave is the dominant player in the market. Their main competitors went out of business a few years ago and comparable products sold over the counter are, according to the CFO, not as good or are being produced by businesses who are burning through cash as fast as they can make it. These other electro-therapy devices are easily available, no prescription required. Go to Amazon and type in "electro-therapy" and you will find devices for $25. This means that no barriers to entry exist and competition is plentiful. The question to answer is are Zynex' devices better than these OTC machines? Perhaps. But of the many devices that come up on Amazon, all of them have a 4.5-star rating. People are clearly pleased with these 'lower end' models. Some of them have more than 7,000 reviews. One unit has over 9,000 reviews, 71% of which were five stars and 14% with four stars. It sounds to me like Zynex is trying to push their product as superior and "prescription strength" when, in my opinion, there isn't enough distinguishable difference between their device and the OTC products that warrant a tremendous mark-up. You can bet Zynex is charging more. The MSRP on a Zynex NexWave device is $1,995. The main price range on Amazon for devices is between $40 and $60. It is a hard sell to claim that Zynex' devices are 33 times better, as the price would suggest. It may not take long for patients, doctors, and insurance companies to catch on. An interesting comment from Seeking Alpha contributor Western Edge on a recent Zynex headline is worth posting here:

I talked to an acquaintance at one of the largest US based physical therapy companies, and when I asked about EMSIs (Electronic Muscle Stimulators) he suggested going to Amazon. ZYXI is dependent on rent seeking and making sure insurance/government covers their marked up product via sales relationships. If major physical therapy companies don't see the added value of their product, I would be cautious. Not saying revenues don't continue to grow, but the stock is expensive and the likelihood of being the much hyped exclusive savior from the scourge of opiates seems limited.

And I agree. Without using the product myself, it is hard to prove what superiority Zynex has to offer. And if Zynex is ever forced into a position where people realize they don't actually have legitimate pricing power, their margins will be destroyed. That being said, our economy is filled with examples of performance equivalent products being sold for higher prices. Let's not forget how Payless duped people into paying way more for cheap shoes. So while this is a risk factor, it doesn't necessarily spell doom for the company.

The Way Things Were...

Zynex does not have a pretty past. Both internal and external factors have slapped them around. Understanding these matters is important in order to contextualize the business as they stand today.

1) For many years, Zynex put the cart several lengths in front of the horse in terms of reimbursement for claims and commissions paid to sales reps. In short, Zynex was providing products to customers first, and thereafter seeking insurance reimbursement, which in some cases it did not fully receive.

See, patients need a prescription from a doctor in order to receive a Zynex device. After that prescription is made, the patient's insurance is billed for reimbursement, which payment processing can take from 30 days to many months. In the past, Zynex did virtually no due diligence into each specific persons insurance coverage before recording revenue, which for years resulted in out-sized accounts receivables and fat provisions for uncollectible accounts. According to the 2008 10-K, page F - 7, "the Company recognizes revenue, both rental and sales, when products have been dispensed to the patient and the patient's having insurance has been verified." Notice that the only box that needs to be checked in order for revenue to be recognized is that the person has insurance. But simply having insurance does not mean that any given insurer will cover the product, or that the coverage will result in material reimbursement as insurers apparently have considerable power to pay less than the asked for price. Also from the 2008 10-K, page 22:

Our sales and rental revenue is reported net, after deductions for uncollectable and estimated insurance company reimbursement deductions. The deductions are known throughout the health care industry as "contractual adjustments" and describe the process whereby the healthcare insurers unilaterally reduce the amount they reimburse for our products as compared to the rental rates and sales prices charged by us. The deductions from gross revenue also take into account the estimated denials of claims for our products placed with patients and other factors which may affect collectability.

To make matters worse, commissions were paid to independent sales reps based on how many orders they submitted, which commissions were paid BEFORE the company was reimbursed by the insurer if reimbursement happened at all. So not only were they sending off a product that took money to make and ship, but they are also compensating sales reps before a dime of cash was actually received.

This situation is exacerbated in situations where insurers dispute bills retroactively. For example, on two separate occasions, Anthem Blue Cross Blue Shield disputed coverage of some devices already supplied to patients and paid for by insurance once in 2008 and again in 2010. According to the 2008 10-K, page F - 23:

Although Anthem had paid claims for the devices, including some that were individually subject to an Anthem review process and resulted in decisions favorable to the Company, Anthem claimed in a retrospective review that the devices were considered investigational or not medically necessary under a medical policy statement of its parent entity and therefore not eligible for payment.

Anthem went on to demand refunds that cost Zynex hundreds of thousands of dollars and a write off of inventory and accounts receivable.

All these factors come together to show up in several years' worth of financial statements. Poor billing practices, silly commission standards, and no vetting of insurers lead to wild accounts receivable and uncollectibility.

The numbers tell it all:

2004 2005 2006 2007 2008
Accounts Receivable % rev. 15 30 52 55 47
Provisions for uncollectible accounts % receivables 149 102 82 131 14

*Table compiled by author from company filings

2007 was a case in point for how bad things were at their peak. More than half of revenue was still in someone else's bank account. Furthermore, in that particular year, the amount that they were hoping to receive in the future was dwarfed by the amount of money they were going to have to write off due to bad debt. Things got so bad that the board of directors concluded that three quarters worth of financial statements "should be revised to reflect adjustments to the allowance for provider discounts, accounts receivable and net revenue for such periods" (2008 10-K, page 27). Doing so resulted in 2008 revenues being reduced by $5.1 million, which was nearly a third of total revenues for that year.

Fortunately, things are different now. They started adjusting things in 2013, after years of basing compensation off of orders:

2010 10-K, page 10: "Our field sales representatives are compensated based on the number of valid orders obtained."

2013 10-K, page 11: "Our field sales representatives are compensated based on an amount of cash collected from products sold."

2018 10-K, page 5: "...compensated based on fixed amounts depending on the type of product sold and insurance carrier of the patient."

While I prefer the 2013 version, due to the inherently long collection periods from working with insurance agencies, it doesn't make sense to expect representatives to not get paid for what may amount to several months while the company waits to see how much cash they end up collecting off an order. The 2018 version is the happy medium. As Zynex has become more familiar with various insurance companies and how they each handle reimbursement, they can pay commissions to reps based on how much money they can in good faith expect to receive. This is coupled with commissions being tied to the type of product involved.

2) Changes in government regulation resulted in a huge drop in demand for Zynex products and reimbursability. Here is a list of changes that occurred with the health care reform laws that came about in 2010, along with subsequent measures:

  • Timeline to submit Medicare claims was shortened.
  • Starting in mid-year 2012, Medicare and Medicaid no longer cover electro-therapy units for low back pain. This change "eliminated reimbursement for approximately 50% of the Medicare patients we normally serve. A number of commercial insurance plans have adopted the Medicare coverage guidelines into their plans." 2013 10-K, page 12.
  • The Center for Medicare and Medicaid services "mandated additional documentation requirements, including a physician 'face to face' for TENS devices." 2013 10-K, page 12.
  • The Center for Medicare and Medicaid services added electro-therapy devices to their competitive bidding program, and Zynex was unable to compete in the bidding. This resulted in them losing access to Medicare patients in 9 major metropolitan areas. In light of all the heavy legislative changes, Zynex chose to no longer accept Medicare patients in 2013, as stated in the 2013 10-K on page 12 but were still required to service existing accounts.
  • Procedures for medical reimbursement coding of insurance claims become increasingly complicated, which resulted in greater difficulty collecting money from third-party payors.

In several consecutive 10-Ks, Zynex blamed their dire problems on health-care reform. As will be seen later, however, the troubles with health-care law forced Zynex into a situation where they tightened down on costs and controls and made fantastic improvements to their billing procedures. In my opinion, the challenging period from 2010-2013 was the best thing that ever happened to Zynex.

3) Poor internal controls over financial reporting led to lawsuits, mismanagement of inventory, and general lack of structured corporate leadership. 2005-2008, 2013, and 2015-16 were all years in which Zynex admitted to poor internal controls in several aspects:

- Material weakness due to a lack of segregation of duties (read no CFO or audit committee).

- ...the design and operating effectiveness of the Company's controls over the financial statement close process related to the timely account reconciliation, analysis and assessment of key accounting estimates and financial reporting and disclosure was not in place." 2016 10-K, page 18

- Lack of documentation and review of financial information by our accounting personnel with direct oversight responsibility, and lack of analysis and reconciliation of certain accounts on a periodic basis." 2007 10-K, page 26

- Lack of timely reconciliation of inventory quantities and inventory location and lack of timely calculation and review of unit costs applied to the valuation of our inventory." 2007 10-K, page 26

- Lack of timely write off of uncollectible and duplicate billings that result in an overstatement of our accounts receivable." 2007 10-K, page 26

As previously mentioned, the 2008 period was so bad that they had to restate three quarters worth of reports, which led to several parties bringing lawsuits against them:

The lawsuits purport to be a class action on behalf of purchasers of the Company securities between May 21, 2008 and March 31, 2009. The lawsuits allege, among other things, that the defendants violated Section 10 and Rule 10b-5 of the Securities Exchange Act of 1934 by making intentionally or recklessly untrue statements of material fact and/or failing to disclose material facts regarding the financial results and operating conditions for the first three quarters of 2008. (2008 10-K, page 19)

The lawsuit was settled in 2011 for $2.5 million, which amount was covered by insurance.

Internal controls have tightened now, thanks in large part due to an audit committee finally formed again in 2017.

4) Zynex acquired a company in 2012 whose product line they were unable to successfully integrate and then promote. It was NeuroDyne, "an 18-year-old manufacturer of advanced medical devices for non-invasive measurement of surface electromyography (recording the electric activity of muscle tissue) and autonomic nervous systems. The devices can be used for evaluation and treatment of neurological and neuromuscular disorders as well as education and research." Zynex paid $400,000 in stock and cash for the company, along with a contingent consideration wherein more money, up to $190,000, was to be paid over the next seven years based on a declining percentage of NeuroDyne products sales over the same time frame. Zynex was anticipating annual revenues from NeuroDyne products of between $210,000 and $3.5 million per year. Zynex recorded $251,000 worth of goodwill for the transaction. By the end of 2013, after recording two years' worth of no significant sales of NeuroDyne products, Zynex wrote off the goodwill and intangibles associated with the acquisition. This is embarrassing. How do you acquire a company that had been in business 18 years, with worldwide sales distribution, and generate no revenue from them and ultimately have to give up on them just two years later? I view this as an attempt to buy growth in light of horrible issues elsewhere in the business. Needless to say, the attempt fell flat on its face.

Seeing the clear failures of all product lines but the NexWave, management has finally realized that they will be more profitable if they narrow their focus. The 2018 10-K, page 4 states: "We are currently focused on expanding our sales force to address what we believe is an untapped market for electro-therapy products."

Management

The CEO is Thomas Sandgaard, who serves as both CEO and Chairman of the Board. He founded the company in 1996 and has had significant ownership in the common stock of the company, aligning his interests with that of shareholders. His biography is interesting in totality, but key to his success has been an entrepreneurial spirit informed by a MBA and undergraduate degree in electrical engineering.

The reviews of Zynex on glassdoor.com are interesting in that they are filled with references to the good character of the CEO, who according to the same site has a decent 77% approval rating. Here is a sampling:

"I have worked for many companies in many different fields - never have I met a CEO that cares so much about his staff."

"The CEO really cares about his employees and it shows in numerous ways."

"Zynex has superior products that truly help people improve their lives. Management is always available to talk with along with team leads and supervisors. There are a ton of great people working here and the culture has changed from the past!"

"Officers of the company are down to earth and easy to talk to regarding concern on any sort."

"...management makes every effort to grow and support the reps."

"The owner is very personable and friendly. The company seems like it is growing each week."

"Management acknowledges when a job is, even small tasks are, done well."

But these positive reports are from relatively recently. Going back to reviews during Zynex' trouble period in 2014 and 2015 there were comments such as:

"CEO is delusional and narcissistic."

"no end of horrible leadership."

"While working there, I heard so many complaints about the CEO."

"The way the company was run is ludicrous. I was terminated because I kept telling the people that would call in that they needed to pay their bill instead of what the CEO directly said I should have done which was "If they didn't want to pay their bills they don't have to, we can let it go."

Given that the majority of recent reviews are positive and that the negative remarks came during a time when things were incredibly stressful for the CEO, I want to give him the benefit of the doubt. But in my personal interaction with Mr. Sandgaard, I can't say I have been meaningfully impressed. He seemed initially pleased to be working with me, but quickly soured once I started asking hard questions. He also seems to be unaware of what is going on in his own company in a few regards. He quickly accepted my invitation to be connected on LinkedIn, but when I told him that I was in Denver (where their corporate headquarters are) and wanted to have a tour of their facilities and have a conversation with him and the CFO, I got no response. I understand if the head of a company doesn't want to take time out his day to sit down with a freelance analyst, but to receive no response whatsoever rubbed me the wrong way. I then chose to email him the questions I would have asked in person and was quite displeased with his response. I have decided to include in this report the exact emails we exchanged so that you can see my questions and his responses.

My email:

Dear Zynex management,

My name is Kevin Mackie. I have had a brief discussion with a few of you previously, and I appreciate the time you have given me thus far. I am preparing a lengthy and in depth research report about Zynex, to be published online and read by investment professionals around the world. I am a shareholder and have enjoyed remarkable returns in a short time frame. I congratulate you all on recent successes reaching new all time highs for the common stock. I have read every annual report since 2005, and have had many questions come up that I would love to have addressed. Sorry if many of my questions seem forward or pointed, but I would love to have some clarity around these items. Please forward this email to others who may be able to add insight. In particular, I could not find the email addresses for Ms. Lucsok, Mr. Brown, or the board of directors. Again, as a shareholder, I appreciate your time. I am excited about Zynex' future.

Questions:

- In earlier years, number of orders were reported. Recently that stopped. Why? What constitutes an order? Is it only when a Zynex device is ordered, or do supply shipments count as an order? Has the definition of "order" ever changed?

- When did Zynex start accepting medicare and medicaid? According to 10-Ks, Zynex stopped accepting around 2013. But now medicaid and medicare reportedly make up 12% of 1st quarter 2019 orders.

- Can any Zynex products be plugged in instead of battery powered? In any past generations of Zynex products, could any be plugged in?

- Does a separate bill get sent every time a consumable shipment is sent?

- Can you breakdown of how much of revenue comes from each consumable? What percent is batteries, electrodes, lumbar support, JetStream therapy, cervical traction, etc?

- Zynex has a long history of awarding equity as a form of compensation. Will that stop? October 2017 was the latest instance.

- Why does Zynex no longer talk about the potential of the stroke rehab market (stopped mentioned in the 2010 10-K)? What roadblocks are there that have prevented expanded use of the NeuroMove product, and what is the plan going forward to drive sales there? For years sales have been negligible from NeuroMove. Why is the market not accepting the product, or is Zynex having a problem with marketing?

- Why did Mr. Sandgaard ask the entire board to resign in 2013?

- What roadblocks have there been that have prevented any international expansion? What is the plan for international, to finally break into overseas markets?

- Is there any intent for Mr. Sandgaard to relinquish majority control so as to attract institutional investments?

- Why has the CFO role turned over so many times? There have been four since 2005.

- Why was it such a struggle to generate meaningful sales from NeuroDyne when that company had been in business for 18 years prior to being acquired? Zynex gave up on the NeuroDyne product line in 2013 due to cash constraints. Now that Zynex is healthier, can Zynex resume the NeuroDyne agenda?

- Why has the process be slow to capture EMPI market share of $250,000,000? They closed down in 2015, but according to the most recent conference call Zynex has not captured much, only a few tens of millions.

- There was a COO role created and then eliminated after only 4 months in 2016. What were the dynamics there that led to the sudden departure of the COO and the elimination of the position?

- Why did Zynex stop reporting a number for uncollectible accounts starting in 2017?

-Leased devices are no longer given to lessees after sufficient payments. How long is the actual useful life of a device? How does that life span contrast with how long it is depreciated for? After a device has been completely depreciated, is it still put into use, effectively generating a 100% gross margin?

- What is are the details of the marketing officer role? What specific plans is Zynex pursuing there?

Again, thank you for your time. What is the process for me to be involved in the Q&A queue for the next conference call?

Kevin Mackie

His response:

Dear Mr. Mackie, here are some answers to your questions:

· Yes, we do report order numbers. Let me know if you need information locating those numbers.

· An order is a prescription. Does not include supplies.

· Zynex has always accepted Medicare orders. Let me know if you need more detail.

· Yes, most of our products offer an AC adapter option.

· Generally we bill for all devices and supplies we send.

· Please read our filings as well as earnings call transcripts for revenue distribution.

· We often award stock options to our employees.

· Our current focus is the pain management market. Therefore products like the NeuroMove is not promoted as heavily at this point in time.

· In 2013 the company was under financial stress and reducing the cost of the board members was an obvious initiative.

· Our current focus is the US pain management market. International expansion may well come at some point.

· Correct. The CFO position has had some turnover. The most recent a little over two years ago.

· Our focus has been on the pain management market. As a result revenue from the products acquired from NeuroDyne has been low.

· We have been growing 30% year over year recently. As you point out there is still a huge untapped potential for further growth.

Please let me know if I can be of further help.

Best regards,

Thomas Sandgaard

Granted, I asked for a lot of detail and I asked a lot of questions. I understand that his time is limited. But he didn't answer some of my questions at all, and others he gave zero meaningful information, while still other he is demonstrably wrong about. He answered nothing about capturing market share from a closed down competitor, nothing about the failed COO role, nothing about no longer reporting uncollectible accounts, nothing about leased devices, and nothing about their new marketing officer role. And although I clearly asked why there was so much turnover at the CFO level, he didn't comment on why. Which naturally makes me suspicious. He also claimed that revenue distribution is broken down in company filings and conference calls, but not so. They only break things down between "devices" and "supplies", not down to type of devices and type of consumables like I asked. Finally, he appears to be unaware of the fact that at least one point, his company did not accept Medicare reimbursement. It's all there in the 10-K from 2014:

we stopped accepting Medicare as of November 1, 2013.

Even as recent as the 2017 10-K:

We no longer accept Medicare and Medicaid orders.

Yet in the most recent company presentation from May of this year, Medicare/Medicaid pops up as a 12% chunk of total orders.

It's one thing to be fuzzy about the exact years when the company stopped and then resumed accepting government reimbursement. It's quite another to claim that "Zynex has always accepted Medicare orders" when, at least according to official SEC filings, they haven't. Of the several things that challenge my investment thesis (no company is perfect), this is the one that gives me the jitters the most. In my opinion, he seems like a fair weather leader. If things are going well, he does a good job. But when things get challenging, he doesn't execute at a high level. He literally kept his company afloat during their hard times by loaning the corporation money. This might seem altruistic initially, but when those loans were interest bearing at 8.25%, double what treasury rates were at the time, then you have to question in whose interest he was making that loan.

Apart from the CEO, the CFO role has changed repeatedly in the last decade.

2005 CFO role created; Peter Leveton appointed
2007 Mr. Leveton terminated; Fritz G. Allison appointed
2010 Mr. Allison resigned; Anthony Scalese appointed
2014 Mr. Scalese resigned; Brian Alleman appointed
2015 Mr. Alleman's employment discontinued; CEO assumed CFO role through 2017
Feb 2016 COO role created, Michael Hartberger appointed
May 2016 COO employment discontinued
2017 CFO role re-instituted, Daniel Moorhead appointed (current)

*Data compiled by author from 10-K filings

For the fourteen years since the CFO was created, each officer has held the position for an average of 2.8 years. If you back out the period where the CEO sat in as principal of finance, each one had a tenure of only 2.2 years. And each one walked away with hundreds of thousands of shares of stock from options. And let's not forget the four-month reign of the COO in 2016. All this change in the C-suite sets of alarm bells. Why all the change? How can the organization have any sense of streamlined operations if a new guy sits in the CFO role every two years? From the emails above, Mr. Sandgaard chose not to answer those questions. Which is also concerning.

This is a huge point of concern for me personally. I included in the table the exact text used in the various 10-K reports to describe employment changes; "terminated", "resigned", and "discontinued" may have various nuances. Whether these people were fired or quit are both negative. If they were fired then one must call into question the CEO's capacity to hire someone competent. If they quit, clearly Zynex is not a good place to be employed if the chief of finance quickly gets fed up and walks out the door. This is coupled with the fact that Zynex has not had any independent board members much of company history. They had a board in 2008-2013, but for some reason, the CEO asked them all to resign in 2013 (the email above said it was to save money), and they did so. They were without a board of directors until 2017 and currently have three independent members. I intend on keeping an eye on any further turnover at the CFO or board level. For the turnaround to be truly enduring, I expect consistency in the highest seats of the organization. Mr. Moorhead just past his two-year mark as CFO. We will see if he lasts.

Addressable Market

According to the CEO, the current addressable market for their electro-therapy product (based on awareness and geographic penetration) is $400 million. This stands against a global pain management market that is predicted to be worth $6.3 billion by 2023. 20% of the global population deals with chronic pain. The opportunity is vast. The product has natural appeal for both patients and physicians given the lack of side effects and its restorative capacities. But the other side of the transaction are the insurers. When the choice is between paying for a product that is on average used for 9 months (according to the CFO) or paying for expensive drugs for perhaps years that have no healing profile, which is going to cost less? To illustrate the point, below is a chart featuring how much the NexWave device costs, on average, over a 9 month period of use, compared against the price for a 9 month supply of various opioids:

NexWave

Roxi-codone

Oxycontin Hydromorphone ER Morphabond ER (morphine)
Daily Dosage N/A 10 mg 4X 10 mg 3X 8 mg 1X 15 mg 2X
Price per pill N/A $0.52 $2.36 $7.43 $6.67
Daily Cost N/A $2.10 $7.08 $7.43 $13.33
9-month cost $1800 $565 $1911 $2007 $3600

*Source: compiled by author based on information from the GoodRx website, a discount online pharmacy. I averaged the lowest price offered on GoodRx with the average overall cash price paid according to GoodRx data. The website contains the following disclaimer: "GoodRx's cash prices are based on multiple sources, including published price lists, purchases, claims records, and data provided by pharmacies. Our discount and coupon prices are based on contracts between a pharmacy (or pharmacy purchasing group) and a Pharmacy Benefit Manager ("PBM"), who provides prices to us. The prices we show are our best estimate; while we believe our data to be generally accurate, we cannot guarantee that the price we display will exactly match the price you receive at the pharmacy."

** I obtained general dosage information from Medlineplus.gov and Mayoclinic.org. I am not a physician. I have zero medical training. Numbers cited are not recommendations, nor are they representative of averages. Dosage will differ by person.

As can be seen, some opioids have low price points, but others get expensive. A phenomenon to be aware of is "opioid tolerance", which is precisely what it sounds like. As people use opioids, their effects tend to wane over time. The body builds up a tolerance. To get the same relieving effect higher dosages and stronger drugs are prescribed. Over time, price points get higher. Opioid users get more expensive to insurers as time goes on. Naturally, insurers may have a lot of bargaining power and can get these drugs for cheaper. Nonetheless, I wager that in many instances the NexWave device will be cheaper. In nearly every case, it will be more economical given the advantages the NexWave offers beyond pain relief (non-habit forming, therapeutic, etc.).

Everyone wins with the NexWave. To include shareholders.

Plans for Growth

My very most successful investments are consistently in those companies who have a management team that has a well defined and publicized plan for growth that includes exact numbers and how those numbers will be reached. Such specificity and a goal oriented approach adds velocity to the business and provides shareholders with a measuring stick. If management isn't meeting their own goals, I know to either jump ship or stay away if I haven't invested capital yet. Mr. Sandgaard has recently said in conference calls that they are hoping to grow their sales team to 400 representatives in 5 years' time, adding 10 reps a month with a 20-30% attrition rate. With an addressable market of $400,000,000, he concluded that naturally each would be doing $1,000,000 worth of business each year once they are fully trained and are producing at a high level. While I think this is fantastically ambitious, I also think it will be extremely hard to do. But the point is now everyone will know whether or not they are meeting their own benchmarks.

They also intend to penetrate international markets. International represents a negligible source of revenue currently, but establishing a better marketing and sales presence there could unlock decent growth. They have an office in Denmark, which could help them access overseas regions.

It is also important to note that Zynex has been doing a phenomenal job of driving down overhead costs over time. According to the CFO, they have had special improvement in their billing department. They have focused on helping those employees work more efficiently while also putting better software in their hands that allows them to handle more bills in a shorter amount of time. Improvements in billings have been mentioned in both financials and conference calls. Evidence of this is the SG&A trend as a percent of revenue:

*Source: morningstar.com

Even in absolute terms, the trend is impressive:

2013 2014 2015 2016 2017 2018
SG&A ($) 21,144 11,397 9,185 9,156 9,669 15,509

*Source: compiled by author from company filings

The significant jump in 2018 is the result of 49 added sales reps during the course of the year, in line with their growth plan. Zynex is becoming very efficient.

Taking a look at recent accounts receivable trends shows clearly the improvements they have made in billings and collections, a vivid turnaround from the before described disaster years. The following chart shows that evidence, along with a variety of other metrics that reveal that Zynex is healthier now than ever before, by a long shot.

2014 2015 2016 2017 2018
Operating Margin % -51 -21 4 38 32
Accounts Receivable % revenue 28 20 22 9 8
Days Sales in Inventory 166 76 83 34 31
Days Sales Outstanding 104 83 21 20 38
Revenue per order ($) 805 837 523 1360 1393

*All data compiled by me from company 10-Ks

Better margins, smaller accounts receivable, quicker turnaround in collecting on accounts and working through inventory, and making more money per order make it clear that Zynex has made tremendous adjustments. As I mentioned before, the stiff obstacles they faced since 2010 forced them to buckle down in important ways. Those numbers I am comfortable with, but I intend to keep tracking them quarter to quarter.

Source of the Improvement

I think that the main driver behind these incredible improvements is their implementation of their EZ Rx Prescription program, launched in 2014. It is important to note that the companies financials started improving right when this program began:

  • In early 2014, ZMI slowly introduced the EZ Rx Prescription program, a new distribution model for dispensing ZMI products to patients. The program is known to prescribers, as EZ Rx Prescription and has streamlined the way physicians prescribe, patients receive our products, and how ZMI utilizes inventory. Under the program prescriptions are faxed directly to ZMI reducing the requirements on the physician or office staff to spend time with filling out device paperwork and educating patients on how to use the device. After receiving a prescription, ZMI contacts the patient directly to process the necessary paperwork and ships the device directly to the patient. Upon the patient receiving the device, they are taught how to use the device via instructional videos on the ZMI website.

  • The EZ Rx Prescription program ramped up significantly during 2015 whereas it represented over 75% of new orders by December 2015 as compared to only 15% at the start of the year. The EZ Rx Prescription program has reduced the number of units consigned to clinics for patient dispensing, thus virtually eliminating the amount of consignment inventory held by clinics. In addition, the EZ Rx Prescription program provides ZMI more control over the decision to ship a unit to a patient, whereas consigned inventory held in clinics was more difficult to control.

Other significant changes in 2015 include their billing department realizing that they actually have power to seek what is rightfully theirs. In years past, Zynex let themselves be pushed around by insurers and didn't fight for themselves or even have quality control in place to realize they weren't being reimbursed correctly in some instances. But the tone changed:

  • We continually pursue improvements to our processes of billing insurance providers. We review all claims which are initially denied or not received and rental claims not billed for the full period of use. As these situations are identified and resolved, the appropriate party is appropriately rebilled (resubmitted) or, for those claims not previously billed, billed.

  • Product Rental Revenue for 2015 increased $289 (13.2%) to $2,480 from $2,191 during 2014. The increase in Product Rental Revenue for 2015 reflects the pursuit of additional reimbursements for rental claims which had not previously been billed for the periods of use. During 2015, and principally in the third quarter of 2015, management identified a number of rental patients who were continuing to use our units, but for which rent had not yet been billed to Third-party Payors. This matter was identified during the quarter as part of our internal enhancement and upgrading of the billing department leadership and personnel. In those situations where Zynex could retroactively bill the insurance carrier, the insurance coverage was re-verified (it had also been verified originally) and the insurance carrier was billed for the appropriate dates of service. In addition, as a result of the delay in these billings, management has recorded an additional reserve in excess of our historical collection rate against these rental billings. This resulted in additional net rental income recorded during 2015 of approximately $308 which related to units that were being rented prior to 2015. Management determined that the impact to the 2014 financial statements was not significant.

2015 10-K, pages 27 and 28

Also vital was their verifying not only that any given patient was insured but also that their coverage included electro-therapy products:

  • The Company, prior to recognizing revenue verifies the patient's insurance coverage or obtained the insurance company preauthorization, when required.

- 2015 10-K, page 32

Other Products

Zynex has several products that have the potential to drive meaningful growth and could form a powerful part of the overall business strategy looking forward.

- Blood Volume Monitor

A product with zero sales as yet (still awaiting FDA approval) and that has significant potential is a patented Blood Volume Monitor. This device provides a non-invasive way to make sure patients aren't bleeding internally during and after surgery. Zynex has been awaiting word from the FDA for years about the device, so approval may not even happen. But if it does, according to Mr. Sandgaard, "Theoretically, every hospital operation room and recovery room should have one. It's hard to imagine how much we can do with it." Sales growth could be explosive if this device gets approved and marketing and sales commence. Given that this device is already patented AND no competition exists for similar devices, if this device gets FDA approval it will bring an immediate moat to the company. However, they will have to market the device successfully as well, and as will be discussed later, successful product marketing and subsequent sales have not been a strong point for Zynex.

- Stroke Rehabilitation

Another product line that represents hardly any revenue currently but has interesting potential is the NeuroMove device:

The NeuroMove™ is a neurological re-learning tool, a therapy device, which has been proven to help stroke and other patients recover lost movement. Once a stroke has occurred, the brain loses neurons which cause limb weakness or paralysis. The NeuroMove™ can train healthy neurons to assume functions lost by damaged brain cells; a concept known as Neuroplasticity. This rehabilitation tool can be used even when there is no muscle movement available. It is sophisticated enough to use in the clinic, yet simple enough for patients to use at home. Thirty minutes a day in four to five months can provide dramatic results.

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.

NeuroMove™ detects attempts even below where trace movements are visible. Several patients have found this capability to be very motivating, as they saw they could make a difference, where previously, they had no indication of their attempts.

Management estimates the stroke rehab market to be worth $100 million worldwide. The device can similarly be applied to instances of loss of muscle control due to spinal cord injury ("SCI"). However, Zynex has had the NeuroMove since at least 2004, and in fact, their focus at that time was on marketing that particular device. For years the company laid out in the annual report how promising the market was for stroke rehab and the size of the SCI population:

According to information published by the American Heart Association in 2010, there is an estimated 6.4 million stroke survivors in the U.S., a population that is estimated to be growing by about 9% or 600,000 per year. Stroke is a leading cause of serious, long term disability in the United States according to a survey of the US Bureau of the Census.

... the National Spinal Cord Injury Statistical Center reports that in 2008, living U.S. victims range between 229,000 and 306,000 and the National Spinal Cord Injury Statistical Center estimates 12,000 new survivors each year.

- 2009 10-K, page 6

But suddenly in 2010, there was no mention of the addressable market in that year's 10-K. And every year in the annual report there is some mention of how the NeuroMove represents a negligible amount of sales. For whatever reason, the NeuroMove is simply not selling. The market is not being penetrated. This calls into question either the efficacy of the product or the inability of Zynex' sales/marketing force. Due to clinical research proving that the product works, it is my opinion that something is going wrong on the sales and marketing side. I asked the CEO via email about this particular issue, but I got no response. While this is certainly a concerning part of their history, it is also a potential catalyst. If Zynex can figure out how to successfully sell this product and get it to stick, then sales will advance considerably and the diversification away from only the NexWave device will be vital.

Zynex has several other products that are not yet a meaningful component of revenue, but they intend on continuing to innovate to address unique needs in the healthcare space and to market future products.

Competition

Zynex is not alone in this field. Three competitors are mentioned on the 2018 10-K, International Rehabilitative Sciences, doing business as RS Medical, EMSI, and H-Wave. I will not take the time to dig into each companies various products because they all seem quite similar but feel free to click on the linked home pages above. The one worth comparing to Zynex is the H-Wave. Of all the companies and all the products, the H-Wave seems by far the best, as they provide the most evidence towards the efficacy of their product accompanied by information regarding well known entities that use their product. Following is the most relevant information drawn from an article on the H-Wave website. It is a long read, but useful as it shows how the H-Wave sets itself apart from TENS units:

TENS is a non-invasive form of electrotherapy indicated by the FDA for the treatment of pain. While it is drug-free and has no side effects, it primarily serves as a mechanism to interfere with pain receptors and prevent pain messages from reaching the brain. Its effectiveness typically decreases in cases of intense pain and offers no benefit when it is not being worn. Additionally, it has no effect on circulation, inflammation, spasm, atrophy, range of motion, or any other clinical issue accompanied by pain. As a result, a patient being successfully treated with TENS will often require additional interventions (drugs, therapy, etc.) for underlying conditions causing the pain. Although TENS is relatively inexpensive and easy to use, its contribution to overall recovery is limited. Even under the best of circumstances, there will always be a significant portion of time when the patient is unable to wear the device and will most often resort to medications for pain management during these periods. With no rehabilitation benefit, TENS will have little to no bearing on a patient's return to full health.

A Case for H-Wave

It is imperative to understand that the effectiveness of H-Wave is not on trial. In fact, H -Wave is supported by a significant amount of evidence-based medicine and has more FDA clearances than any other form of electrical stimulation. There is extensive published research validating efficacy, and the credibility among clinicians and high profile users such as professional athletes is unparalleled in the field of e-stim. H-Wave creates physiologic changes while providing measurable and objective benefits. Consistent use of H-Wave is proven to result in significant vasodilation, increased blood flow and angiogenesis (formation of new blood vessels). These are the foundation of recovery as opposed to the masking of symptoms associated with drug use. Research additionally shows measurable and objective results such as increased range of motion, improved activities of daily living and decreased prescription drug use.

Bottom line for the payer: Faster recovery, reduced disability, accelerated return to work

H-Wave offers a unique set of benefits which are unparalleled in physical rehabilitation as it has been shown to be effective modality for treating:

• Chronic Pain • Acute Pain • Post-Operative Pain • Soft Tissue Injury/Inflammation • Muscle Spasm • Decreased Range of Motion • Muscle Atrophy • Compromised Circulation

With no known side effects, H-Wave is one of the few treatment options that is low cost, provides for pain relief, facilitates recovery and can be controlled by the patient. Unlike TENS, H-Wave utilizes technology that provides rehabilitative, cumulative and objective benefits. H-Wave is also a drug free option for patients presenting with various comorbidities that prevent them from taking pain meds and anti-inflammatory meds, which can delay physical therapy progression and a return to work.

The H-Wave's success is reflected in several studies. According to one such study, "6,774 subjects who had a previous physician-documented diagnosis of chronic soft-tissue inflammation injury or neuropathic pain in an upper or lower extremity or the spine that was unresponsive to conventional therapy, such as physical therapy, medications, TENS and other analgesic electrical stimulator modalities. After treatment with the H-Wave: 65% of study participants reported a reduced or eliminated need for pain medication, 79% reported improved functional capacity or activity, and 78% reported a 25% or greater reduction of pain."

~ The H-Wave Small Muscle Fiber Stimulator, a Nonpharmacologic Alternative for the Treatment of Chronic Soft-Tissue Injury and Neuropathic Pain: An Extended Population Observational Study. Advances in Therapy, Sep/Oct 2006. Vol:23 No: 5. p 739-749.

H-Wave also has four distinct clearances with 15 indications for use from the FDA including but not limited to pain control, maintaining or increasing range of motion, increasing circulation, relaxation of muscle spasm and anesthesia during dental procedures.

*Image from H-Wave Whitepaper

Additional Benefits of H-Wave

• Unlike medications, there are zero side effects.

• Unlike medications, H-Wave creates no work restrictions and does not cause demotivating factors such as depression or a drop in energy or endorphin levels.

• Where medication, physical therapy and surgery may have long-term cost implications, the use of H-Wave is a fixed cost: 100% of any rental cost is applied to the purchase price. After 10 months, the only cost is periodic replacement of electrode pads, and there are even fixed cost programs for that as well.

• Unlike TENS, due to the increased circulation attribute of H-Wave, patients continue to receive a physiological benefit even when the unit is not in use.

  • Unlike physical therapy, the H-Wave is available to the patient 24 hours per day, 7 days per week. H-Wave in Use Now Today, H-Wave works with thousands of physicians across the country, has active agreements with the two largest national out-patient therapy companies in the United States, and is a drug free modality of choice for the some of the most elite workers in the country. Players from over 50 professional athletic teams use H-Wave on their injured players, including…

*Image from H-Wave Whitepaper

Bear in mind, all the data about professional organizations using the H-wave device is conspicuously absent from the other manufacturers' pages. While I can't speak to their profitability as they aren't publicly traded, what matters is that the H-wave sounds like it could be better than Zynex.

A big selling point for Zynex' NexWave device is that it offers three separate modalities, interferential stimulation, electrical stimulation, and neuromuscular electrical stimulation that supposedly do three different things. This is supposed to set it apart from peers and OTC products. However, according to a report issued by Excellus Blue Cross Blue Shield:

Based upon our criteria and review of the peer-reviewed literature, TENS devices capable of delivering three separate modalities such as interferential stimulation, electrical stimulation and neuromuscular electrical stimulation (e.g., TruWave™ Plus, Zynex Medical, NexWave™, Zynex Medical, Empi Continuum™, DJO Global) are considered investigational.

This adds to the evidence that Zynex is trying to sell a simple product at marked up levels using clever marketing.

The H-Wave may not be better than Zynex according to a report from The National Center for Biotechnology. In the report, researchers conducted a study where the H-Wave, a TENS unit, and a placebo were administered to a group of men and woman to measure it's pain-relieving effects. The study concluded that "no differences were observed between the different modalities or frequencies." In other words, both TENS and H-Wave were effective, but to the same extent.

Another point worth mentioning is the fact that one competitor, EMPI, went out of business in 2015, leaving a $250 million void in the market for electrotherapy. Zynex jumped right in to fill the void and take up that lost market share by hiring several former EMPI sales reps. To quote directly from page 8 of the 2016 10-K:

In late November 2015, the electrotherapy industry experienced a significant development when our largest competitor, Empi, announced the closure of their Empi electrotherapy division. Empi previously held a large share of the electrotherapy market with approximately $250 million in annual revenue. We believe this presents a significant opportunity for our existing sales team to capture accounts previously serviced by Empi and an opportunity for recruiting former Empi representatives in new areas where we do not have representation currently. We have engaged, both as employees and contractors, 74 former Empi representatives.

However, Zynex has not done a great job in the four years since of grabbing those dollars. In the conference call from the first quarter of this year, a poignant question about this matter was asked during the Q&A:

... what percentage of the accounts that were kind of left from the competitor leaving do you think that your reps have captured to date?

Thomas Sandgaard

Not a whole lot, just maybe a few tens of millions, not hundreds of millions yet.

Again, four years after the fact and after gaining 74 reps from the competitor, Zynex has taken "not a whole lot" of the leftover market. In my opinion, Zynex really struggles on execution, particularly in regard to marketing.

As a quick aside, EMPI was shuttered because they were caught submitting false claims to TRICARE for selling electrodes to patients in quantities they did not and would never need:

The settlement resolves allegations that Empi used inappropriate techniques such as "assumptive selling" to persuade some TRICARE beneficiaries to seek and accept unjustifiably large quantities of TENS electrodes from 2010 through 2015, with a particularly steep increase in the number of beneficiaries receiving unnecessary quantities in 2014-2015. Assumptive selling consisted of Empi sales representatives contacting some TRICARE beneficiaries and inducing them to order excessive TENS electrodes by acting as though the beneficiaries had indicated a need for them, when that may not have been the case.

I only bring this up because Zynex derives 79% of their revenue from supplies. Their entire business model rests on patients re-ordering electrodes and batteries. I don't mean to accuse, but there is a risk this "assumptive selling" may happen at Zynex too.

Risk Factors

I think the most significant risk factor facing Zynex is the potential for insurers to go around them to procure supplies for the NexWave machines, and/or insurers catching on to the fact that NexWave devices aren't much better than much cheaper alternatives. The vast majority of ZYXI revenue is from supplies that patients have to order and re-order over time, not from the actual machine itself. In financial filings, they refer specifically to batteries and electrodes. The revenue split between devices and supplies was 21% vs 79% in 2018. Essentially, the company survives on people ordering supplies through them. The problem is that their price points for some supplies are way higher than that which can be found at many other retailers. For example, a single 9V battery sold on the Zynex website goes for $6.99 each if you buy 40. I can get a six pack of 9V batteries from Walmart for $8.50, or $1.42 a piece. (as a caveat, the prices I quoted from the Zynex website are from the "private pay" page. Chances are good that insurers get supplies for less, but I am skeptical that they couldn't get them for even cheaper from a mass retailer).

Zynex mentions on their company presentation that each machine placed draw in approximately $1,800 of revenue. Applying the 20/80 ratio mentioned above, that means each machine sells for $360. $1440 comes from supplies!! Their business model would be ruined if insurers, who are always trying to save a buck, went around them to get generic supplies for the machines. When 79% comes from supplies, the fat question to be asked is are they an electro-therapy device innovation company, or are they a battery and electrode distributor? My revenue breakdown, that question answers itself. There are tons of companies that make and sell batteries and electrodes. If those consumables make up the bulk of the company's revenue stream, that means they have absolutely no moat, no competitive advantage, no pricing power, no technological prowess, etc. They just sell batteries and electrodes. This topic is a HUGE challenge to the entire investment thesis.

Concentration

Zynex also has considerable concentration risk. They have consistently had nearly a quarter of their accounts receivable balance attributable to one insurer, and I have an itching feeling that it is Anthem Blue Cross Blue Shield, who have historically given them grief, as discussed previously. They also get 50% of their supply materials from one supplier, and any damaged relationship there may force them to adjust their supply chain. That will cost both time and money.

Insider Activity

The other thing to know is that there has been a lot of insider selling at Zynex in the past. This isn't necessarily something to be alarmed by since the vast majority of selling came from the CEO who until recently owned 54% of the common. It makes sense that he would shave some of his position that started out at 88.5% ownership. Many of those shares he got for literally pennies back when Zynex was struggling and before they up-listed to a major exchange. Now that the shares are trading above $7 and his money has grown exponentially and then some, taking some money off the table is no crime.

What is interesting about Mr. Sandgaards transactions are not the amount but the frequency. Since mid-March of this year, Mr. Sandgaard has sold on 18 different occasions. Recently, he sold on May 8th, 9th, 10th, 13th, 14th, 15th, 21st, and June 5, 6, and 10th. He clearly wants to reduce his holdings substantially, but doing so in large chunks less often would put a lot of downward pressure on the stock price. So he is taking bite-sized chunks out of his position. This much selling makes you question what he thinks about the future of Zynex. If he thought Zynex was sure to shoot the moon, surely he wouldn't be selling this much. Then, again, when your stock chart looks like this...

Chart

Data by YCharts

...and many of the shares owned were bought or granted at the far left, I can't blame him for selling. A >200% annualized return ain't bad.

All this would be fine were it not for the fact that Mr. Sandgaard recently filed an S-3 stating that he has authorized himself to sell 16,661,571 shares of stock. If he sells all of them, that reduces his position from 53% to 0%. He has the option to purchase 393,821 shares of stock that vest in the next 60 days, and if he does so his ownership interest will sit at 1.2%. This has raised some concerns for me. If he had tremendous faith in the future of the company, why would he state a hypothetical intent to eliminate his ownership interest? I like companies I am invested in to have at least 10% insider ownership, and Mr. Sangaard may ruin that aspect for me if he wipes out his holdings. By my calculations, Mr. Sandgaard now holds ~45% of the common stock. Interestingly, a report from thefly.com states:

Zynex CEO and founder Thomas Sandgaard told Bloomberg in an interview that last night's shelf registration, which made 16.7M of his shares eligible for potential re-sale, was "just regular housekeeping" and that he has no plans to sell any shares in the near future. "If I sell a small block in, let's say, a year -- that shelf is live for 3 years -- I will still by far have more skin in the game than anybody else," Sandgaard said. Shares of Zynex are down 23% to $8.10 in midday trading.

I am curious what kind of "housekeeping" consists of registering every single one of his shares for sale.

The positive side of all the selling is that soon Zynex may no longer be a controlled company. Therefore, large institutions who want and expect voting power will no longer be scared of Zynex. Mr. Sandgaard had literally all the power with 53% control over the common. Majority owned means his way goes. No matter what. But if he cedes majority ownership, there will be some semblance of democracy. Mr. Sandgaard spoke to that very point earlier this year in February when Zynex uplisted to a major exchange, the NASDAQ:

We are excited to reach this important milestone for Zynex. We have made significant progress over the past several years and uplisting to Nasdaq will help us communicate our story to a broader audience. We are now better positioned to attract institutional investors, which will fundamentally enhance the value of our company.

According to the Seeking Alpha company profile page, inside ownership stands at 51%.

The second part to attracting institutional investors after uplisting to a major exchange is to relinquish majority control. The selling by Mr. Sandgaard makes sense in this light, although I wish he wouldn't unload his entire position. Furthermore, the frequent and sometimes sizeable sale of his block of stock is almost certainly keeping the stock price depressed. When he stops unloading shares, the considerable downward pressure exerted by all that will be relieved.

A positive development is Zynex' recent inclusion in the Russell 2000 index.

Rewarding Shareholders

Up until last year, Zynex shareholders could only expect returns in the form of capital appreciation, contingent of course on the value that the market saw in the company and their prospects for the future. Simply stated, Zynex wasn't financially successful enough to directly reward shareholders. All that changed in 2017 when the company started buying back stock and then in 2018 when the board declared a special dividend of $.07 a share. The actual value beyond those initiatives is one thing, but the fact that Zynex has the financial flexibility to now participate in such shareholder-friendly behaviors is what is most significant to me. I have mixed feelings about dividends and buybacks, especially for a company that is small, in growth mode, and whose stock isn't necessarily undervalued right now. That capital should go towards fortifying the core business. But nonetheless, I think the gesture is significant and symbolizes good things to come.

Valuation

If we play with their stated growth forecast a bit, and as I incorporate my own conservative estimates for their growth, we can arrive at a fair value at which shares should be bought. The best case scenario is that in 5 years and according to plan, they indeed have 400 producing sales reps. However, many of these reps will be very new, and they aren't going to be doing $1,000,000 per person of business annually.

Base Case

As of year end 2018, they had 150 sales reps. Divide annual 2018 revenue of $31,917,000 by the number of reps gives us $212,780 sales per rep in 2018. If they have 400 reps in 5 years we can multiply 400 by last year's average sales per rep for a total value of $85,112,000 in sales year 2023. Applying a 30% operating margin (conservative as last year's was 32%), a 26% tax rate (their stated average long term anticipated tax rate), and a P/E ratio of 23.75 (their current 5-year average), the calculations work out as follows:

Net Income June Shares Outstanding 2023 EPS 2023 Stock Price CAGR
$18,894,864 32,407,064 $.58 $13.77 7.71%

*Calculated by author

That is a fair return, to be sure. This is my base case.

Zynex has been incredibly volatile in the past few months. I bought in at $7.24 on May 13, so I am already looking at a nearly 30% return in less than two months. And the stocked soared as high as $11.75 on June 24. So the all-time high has already gone half-way to what my projected stock price was going to be at the end of five years if growth were slow and linear.

Everything about my inputs was conservative. For example, of the 150 reps that I used in my calculations, 49 are brand new as of last year. They are entry level. So they didn't contribute a lot to 2018 sales, and thusly lowered the average sales per rep. I also shaved 200 bps off the operating margin, just to be safe. And the P/E ratio could likely expand due to what would be an over 15% growth annually in EPS. Even in this base case, returns will respectable.

Best Case Scenario

Say the company has 400 reps in 5 years time (2023), and then we give them 5 years to ramp up (year end 2028). Each rep is doing $1,000,000 in sales every year, capturing the entire market share for $400,000,000 in revenue by 2028. Applying the 32% operating margin they were able to achieve in 2018 and charging the same tax rate, the results would be:

Net Income June Shares Outstanding EPS 2028 Stock Price CAGR
$94,720,000 32,407,064 $2.92 $69.35 22%

Most Likely Case

I think that they will have 350 producing sales reps in 5 years. I assume they will be able to be doing $300,000 per rep per year at that time. Running the calculations with a 30% operating margin, 26% tax rate, and a P/E of 20 (index average), the stock price will be $14.38 in 5 years, representing a ~11% return annualized. That is a great annualized return, better than the long term market average measured by the S&P, and just below the low end of my required rate of return of 12-15%. This valuation analysis is only considering the sale of the NexWave device.

Conclusion

With Zynex, it is a situation where even under modest growth, returns will be decent. If growth is better than modest AND/OR one of several catalysts are realized, returns could be explosive. I think the NexWave device is going to do okay in the U.S. market, and overall returns to shareholders will be fair. But if they are able to expand internationally and if one of their other products starts to gain a foot-hold (especially the blood volume monitor awaiting FDA approval), then returns could be sky-high. On the other hand, one or several risk factors could come together and result in a permanent loss of capital. Zynex has been on the brink of going under in the not so distant past. All told, I suppose you could say I am a bear-ish bull when it comes to Zynex. I do have a small position, and I would not at all be surprised to see my money double, triple, or even quadruple in the next decade. I also wouldn't be surprised for all this hype to be very short lived. It is certainly an investment that will require constant monitoring; no set it and forget it here. But the opportunity for out-sized returns could be worth the work. High risk, high reward. Make no mistake though, this is only a buy and hold if their novel products, the stroke rehabilitation device and the blood volume monitoring device, become the majority revenue and growth drivers. Otherwise, they are merely selling a marked up device and banking on recurring revenue streams from benign products, and I need to figure out the right time to jump ship with a hot return before the game is up.

Disclosure: I am/we are long ZYXI. 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.