- Order growth, and with it revenue growth, will accelerate again after already raking up a 140% growth in Q1.
- Salesforce productivity has a lot of upside; with hiring slowing down and even halting in H1 2020, profitability will recover.
- Lowering inventories and other cost and a $10M buyback program are additional positives.
- New devices are getting ready to sell as well, although it remains to be seen how fast they can ramp.
- Stock valuation has come down significantly, and the shares can be bought under $15 with a favorable risk/reward situation.
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Zynex (NASDAQ:ZYXI) is one of a few troubled shares in our SHU Growth Portfolio but we fully expect this to turn around. At first sight, this is really quite curious, given the order growth in the just-published Q1 figures of a whopping 140%. Below is a little table that clarifies things:
|Q2 20||Q3||Q4||Q1 21|
Source: company filings
Order growth is a leading indicator
Source: Earnings Deck
There are contradicting forces at work here. The leading indicator is order growth, from the Q1CC:
the order growth we're seeing right now is directly correlated to the amount of revenue we're going to see in the third and fourth quarter of next year and into the following year.
There are several lags:
- From orders to sales
- From sales to reimbursement
- From sales to supply sales (batteries, electrodes)
And there is another lag that is important here, which is the ramp-up of productivity from newly hired salespeople. This takes time, and some have to be let go (which is indeed what the company did in Q1).
Then it takes time for them to increase their installed base to ramp up demand for supplies, which is like 75%-80% of revenue, and perhaps more importantly, it is recurring revenue.
We'll get to that in a minute, but if you think order growth of 140% is exceptional and are jumping for joy because it's a leading indicator, you ain't seen nothing yet (Q1CC):
But you'll probably see something like 300% order growth in April, 300% in May, and maybe 200% order growth in June. That’s the kind of numbers we're looking at right now.
In part, this is easy comps because in Q2 last year the pandemic started to bite, but there will still be a considerable acceleration, which bodes very well for revenue growth in 2022.
Higher profit coming
So that's order growth sorted, it's accelerating and it will lead to significant revenue growth in H2 and next year. But will this be profitable growth? Adjusted EBITDA came in soft in Q1, so it looks like the company is simply buying growth, by hiring a lot of new salespeople.
Indeed that's what they did in H2 last year, which is exactly why order growth is accelerating. Since, with a few exceptions, the productivity of new reps is below average, this comes at a short-term cost.
But this year things will be different, the hiring is going to slow down significantly, and in fact, it already has. The number of sales reps declined slightly, to a little below 500 in Q1 as management let go of those that didn't meet the standard.
They will only start hiring again in H2 of this year, but at a pace that's about a third of what they did last year when they hired no less than 300 new sales reps.
So, in H2 2021 the company will be adding just 100 sales reps, and that will be it for the year; no hiring in H1. This is why we believe a significant profitability recovery is already baked in the figures, here are all the reasons:
- Huge order increase in Q2
- Q1 seasonally low
- Slower hiring until H2 so higher productivity
- Decreasing inventory, better prices on components, cost prices decreasing in general. They have more suppliers
- New headquarters should increase efficiency
- G&A will trickle down from 23% in Q1 to about 20% year-end
Q1 is always seasonally the lowest quarter as reimbursements suffer from deductibles at the start of the year. The company will also gradually reduce inventory levels which is about $3M higher than normal and this will be back to normal in H2, improving profitability (and cash flow).
The company has been able to reduce costs by engaging with additional suppliers, which also reduces their dependency in crisis. The new, significantly bigger headquarters has come online and initially, that's a cost factor, but these lap out (Q1CC):
we transitioned our production and warehouse to a new facility in Q1. This will greatly enhance our efficiency, but in the short term will put some pressure on gross margins.
So gross margin, a little below par at 75.6% in Q1 for the company, will recover.
The fall in operational margin is much more pronounced, no wonder as S&M increased 148% y/y, and the sales force grew by 121% y/y, both much more pronounced than revenue growth (58%).
But revenue growth will accelerate. In Q2, sales of $31M-$32.5M will already be much higher than in Q1 ($24.1M) and S&M cost will stay roughly constant in dollar terms in H1, so that will sort itself out in short order.
G&A expense grew just 45% y/y, slower than revenue growth but they're still like 23% of revenues. This will decline to roughly 20% by the end of the year, so there is operational leverage from overhead as well.
So with order growth accelerating, which will be followed by an acceleration in revenue growth (as soon as Q2), hiring slowing down and productivity of the sales force increasing, profitability is bound to recover.
Source: Earnings Deck
By the end of the year, the company aims for 600 salespeople, but longer-term, the goal is still 800 so we're not quite done with the hiring, but it will be more measured and therefore happen at a higher level of productivity and hence a higher level of profitability.
This year, management is focused on improving sales force productivity and it has taken measures to improve sales force productivity already:
- It is slowing down the hiring (while order growth is accelerating and revenue growth will follow), even halting hiring to just the attrition rate in H1 2021.
- It has weeded out those that don't make the cut.
- It has improved recruiting and training and now has 15 regional managers holding the hands of new recruits.
- They benefited last year from being able to get more experienced recruits as a result of the pandemic.
Management believes big increases in productivity are still ahead (Q1CC):
And there's still a long way to go. The average rep can easily double or triple the orders they are producing right now. And obviously we need to hire long-term 300 more sales reps to get up to the 800 territories being filled.
Blood volume monitor
Almost all company sales come from the NexWave and related supplies.
Source: Earnings Deck
The company is seriously increasing efforts to start selling their non-invasive blood volume monitor for early detection of internal bleeding in surgical and post-recovery situations, having set up a separate division and hiring a seasoned manager.
Source: Earnings Deck
This might take some time, they are producing the first version, CM-1500, but they are already working on a prototype of an enhanced version, the CM-1600, and even a newer one, the CM-1700.
They have FDA clearance (as well as three patents) for the CM-1500 so that can be sold (and they can already make a small batch of these, like 130) but management is deliberating whether to wait for the updated versions (Q1CC):
how many of those we need to make will literally depend on how the next generation - how fast we can get them done. I have a feeling as I look at it now, we’re already looking at a CM-1700 that the CM-1600 could well be more of a stepping stone to get quickly to the CM-1700.
While they have submitted for FDA clearance for the CM-1600, they might not need FDA clearance for every new version, but they were also mentioning adding more indications and that could need FDA clearance.
The company also filed a patent application for a new device measuring early detection of blood sepsis, and the company will soon begin prototyping of this device (Q1CC):
We continue to see solid preliminary results from a clinical study at Wake Forest and are preparing to commence more studies on the device shortly.
Leveraging their sales force over more devices is another route to increase productivity, although not too much should be expected as the blood volume meter and the new sepsis device are marketed to different customers and therefore unlikely to be sold over their rehab sales force.
But one might keep in mind that the company sells quite a lot of rehab devices, and management has only really emphasized selling the NexWave (as a result of the void that competitors left in the market and it being an alternative to opioids).
All that hiring in H2 last year and the seasonal low Q1 revenue and inventory building in Q1 this year also led to a rapid decline in cash flow:
But things will improve here as well and the company still has plenty of cash at $33.4M. Running down inventories will restore their cash balance, although they also announced a $10M buyback program last month, terminating on September 8.
Last July, they did a 1.34M equity offering at $22 which counts for the jump in the number of outstanding shares, but overall, dilution has been rather moderate the last 5 years.
The sales multiple has come down a lot and given that this is backward-looking, it's likely to come down a lot more as a result of accelerating revenue.
Profitability will recover, and analysts expect $0.38 per share this year rising to $0.76 the next.
We think the stock is at a good risk/reward situation here. The main risk is reimbursement trouble, but management argues that it hasn't seen a fundamental change in 25 years on this front.
With order growth accelerating and revenue growth to follow and hiring slowed down, sales force productivity is set to increase and, with it, operational leverage and profitability.
When their sales force is complete, they can leverage it by giving more shift to some of their other rehab devices and they have new lines of businesses already lined up in the form of the blood volume meter and the early sepsis detector.
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This article was written by
Shareholders Unite is a retired academic with 30+ years of experience in the financial markets. He looks to find small companies with multi-bagger potential while mitigating risks through a portfolio approach.He runs SHU Growth Portfolio where he offers wide coverage of several small companies with high growth possibilities. He has a buy and hold approach with tranche purchases of stocks of interest. The service features an illustrative portfolio to incorporate into your portfolio, buy alerts, weekend stock and market updates, and a chat room. Learn more
Analyst’s 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.
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