ZYNEX INC - Quarter Report: 2017 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended: September 30, 2017

OR

For the transition period from                      to                     

Commission file number 33-26787-D

Zynex, Inc.

(Exact name of registrant as specified in its charter)

(303) 703-4906

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes x    No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes ¨    No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

ZYNEX, INC. AND SUBSIDIARIES

INDEX TO FORM 10-Q

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

ZYNEX, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(AMOUNTS IN THOUSANDS, EXCEPT NUMBER OF SHARES)

The accompanying notes are an integral part of these condensed consolidated financial statements.

ZYNEX, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)

(unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

ZYNEX, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(AMOUNTS IN THOUSANDS)

(unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

ZYNEX, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Organization

Zynex, Inc. (a Nevada corporation) has its headquarters in Lone Tree, Colorado. As of September 30, 2017, the Company’s only active subsidiary is Zynex Medical, Inc. (“ZMI,” a wholly-owned Colorado corporation) through which the Company conducts most of its operations. One other subsidiary, Zynex Europe, ApS (“ZEU,” a wholly-owned Denmark corporation), did not generate any revenue during the three or nine months ended September 30, 2017 and 2016 from international sales and marketing. Zynex Monitoring Solutions, Inc. (“ZMS,” a wholly-owned Colorado corporation) is developing a blood volume monitoring device, but it is not yet developed or ready for market and, as a result, ZMS has achieved no revenues to date. Its inactive subsidiaries include Zynex NeuroDiagnostics, Inc. (“ZND,” a wholly-owned Colorado corporation), Zynex Billing and Consulting, LLC (“ZBC,” an 80% owned Colorado limited liability company) and Pharmazy, Inc. (“Pharmazy”), which was incorporated in June 2015 as a wholly-owned Colorado corporation. The Company’s compound pharmacy operated as a division of ZMI dba as Pharmazy through January 2016.

The term “the Company” refers to Zynex, Inc. and its active and inactive subsidiaries.

Nature of Business

ZMI designs, manufactures and markets U.S. Food and Drug Administration (FDA) cleared medical devices that treat chronic and acute pain, as well as activate and exercise muscles for rehabilitative purposes with electrical stimulation. ZEU was formed in 2012 to conduct international sales and marketing for Company products. In addition, ZMI dba Pharmazy, which sold compound transdermal pain cream, began operations in early 2014 and was closed in January 2016.

ZMS was formed to develop and market medical devices for non-invasive cardiac monitoring, the products of which are under development. The Company is currently developing a blood volume monitoring device (Blood Volume Monitor). ZMS produced no revenues during the three or nine months ended September 30, 2017 and 2016.

During the three and nine months ended September 30, 2017 and 2016, the Company generated substantially all of its revenue (99.99%) in North America from sales and supplies of its products to patients and health care providers.

Unaudited Condensed Consolidated Financial Statements

The unaudited condensed consolidated financial statements included herein have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and accounting principles generally accepted in the United States of America (“U.S. GAAP”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures included herein are adequate to make the information presented not misleading. A description of the Company’s accounting policies and other financial information is included in the audited consolidated financial statements as filed with the SEC in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. Amounts as of December 31, 2016, are derived from those audited consolidated financial statements. These interim condensed consolidated financial statements should be read in conjunction with the annual audited financial statements, accounting policies and notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, which has previously been filed with the SEC.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments necessary to present fairly the financial position of the Company as of September 30, 2017 and the results of its operations and its cash flows for the periods presented.  The results of operations for the three and nine months ended September 30, 2017, are not necessarily indicative of the results that may be achieved for a full fiscal year and cannot be used to indicate financial performance for the entire year.

Liquidity

During 2013-2015, the Company suffered operating losses which caused a lack of liquidity and a substantial working capital deficit. This raised substantial doubt about the Company’s ability to continue as a going concern.

During 2016, the Company generated net income during Q3 and Q4 and combined with the profitability in Q1, Q2 and Q3 of 2017, the Company has recorded five consecutive profitable quarters, paid off its line of credit with Triumph Healthcare Finance, a division of TBK Bank, SSB, formerly known as Triumph Community Bank, (“Triumph”) (Note 6) and generated cash reserves and positive working capital.

As a result, in accordance with Accounting Standards Codification (“ASC”) 205-40, Presentation of Financial Statements – Going Concern, as of September 30, 2017, management evaluated whether there are conditions and events that raise doubt about the entity’s ability to continue as a going concern and concluded there is not significant doubt. The Company is currently able to meet its obligations as they become due within one year. Management’s evaluation is based only on relevant conditions and events that are known and reasonably knowable as of the date of these financial statements.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of Zynex, Inc. and its subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

Non-controlling Interest

Non-controlling interest in the equity of a subsidiary is accounted for and reported as stockholders’ (deficit) equity. Non-controlling interest represents the 20% ownership in the Company’s majority-owned (but currently inactive) subsidiary, ZBC.

Reclassifications

Certain reclassifications have been made to the 2016 financial statements to conform to the consolidated 2017 financial statement presentation. These reclassifications had no effect on net earnings or cash flows as previously reported.

Use of Estimates

Preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. The most significant management estimates used in the preparation of the accompanying consolidated financial statements are associated with the allowance for billing adjustments and uncollectible accounts receivable, the reserve for obsolete and damaged inventory, the life of its rented equipment, stock-based compensation, and valuation of long-lived assets and realizability of deferred tax assets.

Revenue Recognition, Allowance for Billing Adjustments and Collectability

The Company recognizes revenue when each of the following four conditions are met: 1) a contract or sales arrangement exists, 2) products have been shipped and title has transferred, or rental services have been rendered, 3) the price of the products or services is fixed or determinable, and 4) collectability is reasonably assured. The Company recognizes revenue when medical units and supplies are shipped or, for medical units sold from consigned inventory, when it receives notice that the product has been prescribed and delivered to the patient. The Company, prior to recognizing revenue verifies the patient’s insurance coverage or obtains the insurance company preauthorization, when required. Revenue from supplies is recognized upon shipment. Revenue from the rental of products is normally on a month-to-month basis and is recognized ratably over the products’ rental period. Revenue from sales to distributors is recognized when the Company ships its products. Revenue is reported net, after adjustments for estimated insurance company or governmental agency (collectively “Third-party Payors”) reimbursement deductions and, for wholesale customers and patient billings, an allowance for uncollectible accounts. The Third-party Payor reimbursement deductions are known throughout the health care industry as “billing adjustments” whereby the Third-party Payors unilaterally reduce the amount they reimburse for the Company’s products.

A significant portion of the Company’s revenues are derived, and the related receivables are due, from Third-party Payors. The nature of these receivables within the medical industry has typically resulted in long collection cycles. The process of determining what products will be reimbursed by Third-party Payors and the amounts that they will reimburse is complex and depends on conditions and procedures that vary among providers and may change from time to time. The Company maintains an allowance for billing adjustments and an allowance for doubtful accounts. Billing adjustments result from reimbursements from Third-party Payors that are less than amounts claimed and from where the amount claimed by the Company exceeds the Third-party Payors usual, customary and reasonable reimbursement rate. The Company determines the amount of the allowance and adjusts it at the end of each reporting period, based on a number of factors, including historical rates of collection, the aging of the receivables, trends in the historical rates of collection and current relationships and experience with the Third-party Payors. If the rates of collection of past-due receivables recorded for previous fiscal periods changes, or if there is a trend in the rates of collection on those receivables, the Company may be required to change the rate at which it provides for additions to the allowance. A change in the rates of the Company’s collections can result from a number of factors, including experience and training of billing personnel, changes in the reimbursement policies or practices of Third-party Payors, or changes in industry rates of reimbursement. We believe we have a sufficient history of collection experience to estimate the net collectible amounts by payor. However, changes to the allowance for billing adjustments and uncollectible accounts, which are recorded in the income statement as a reduction of revenue, have historically fluctuated and may continue to fluctuate significantly from quarter to quarter and year to year.

Due to the nature of the medical industry and the reimbursement environment in which the Company operates, estimates are required to record net revenues and accounts receivable at their net realizable values (also known as net collectible value). Inherent in these estimates is the risk that they will have to be revised or updated as additional information becomes available. Specifically, the complexity of third-party billing arrangements and the uncertainty of reimbursement amounts for certain products or services from payors or unanticipated requirements to refund payments previously received may result in adjustments to amounts originally recorded. Due to continuing changes in the health care industry and third-party reimbursement, as well as changes in our billing practices to increase cash collections, it is possible that management’s estimates could change in the near term, which could have an impact on our results of operations and cash flows. Any differences between estimated settlements and final determinations are reflected as an increase or a reduction to revenue in the period when such final determinations are known.

The Company frequently receives refund requests from insurance providers relating to specific patients and dates of service. Billing and reimbursement disputes are very common in the Company’s industry. These requests are sometimes related to a limited number of patients or products; at other times, they include a significant number of refund claims in a single request. The Company reviews and evaluates these requests and determines if any refund request is appropriate. The Company also reviews these refund claims when it is rebilling or pursuing reimbursement from insurance providers. The Company frequently has significant offsets against such refund requests, and sometimes amounts are due to the Company in excess of the amounts of refunds requested by the insurance providers. Therefore, at the time of receipt of such refund requests, the Company is generally unable to determine if a refund request is valid and should be accrued. Such refunds are accrued when the amount is fixed and determinable.

However, no assurances can be given with respect to such estimates of reimbursements and offsets or the ultimate outcome of any refund requests. In addition to the allowance for billing adjustments, the Company records an allowance for uncollectible accounts receivable for wholesale (sales to distributors) sales and certain patient billings. Uncollectible accounts receivable are primarily a result of non-payment from patients who have been direct billed for co-payments or deductibles, lack of appropriate insurance coverage and disallowances of charges by Third-party Payors. If there is a change to a material insurance provider contract or policy, application by a provider, a decline in the economic condition of providers or a significant turnover of Company billing personnel resulting in diminished collection effectiveness, the estimate of the allowance for uncollectible accounts receivable may not be adequate and may result in an increase in the future.

Fair Value of Financial Instruments

The Company’s financial instruments include cash, accounts receivable, accounts payable and income taxes, for which current carrying amounts approximate fair value due to their short-term nature. Financial instruments also include the line of credit and capitalized leases, the carrying value of which approximates fair value because the interest rates on the outstanding borrowings are at rates that approximate market rates for borrowings with similar terms and average maturities.

Inventory

Inventory, which primarily represents finished goods, are valued at the lower of cost (average) or market.

The Company monitors inventory for turnover and obsolescence and records losses for excess and obsolete inventory, as appropriate. The Company provides reserves for estimated excess and obsolete inventories equal to the difference between the costs of inventories on hand and the estimated market value based upon assumptions about future demand. If future demand is less favorable than currently projected by management, additional inventory write-downs may be required.

Segment Information

We define operating segments as components of our enterprise for which separate financial information is reviewed regularly by the chief operating decision-makers to evaluate performance and to make operating decisions. We have identified our Chief Executive Officer and Chief Financial Officer as our chief operating decision-makers (“CODM”).

We currently operate our business as one operating segment which includes two revenue types:  Product devices and Product supplies. 

Recent Accounting Pronouncements

In August 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities (“ASU 2017-12”), which amends and simplifies existing guidance in order to allow companies to more accurately present the economic effects of risk management activities in the financial statements. ASU 2017-12 is effective for us in the first quarter of fiscal 2020, and earlier adoption is permitted. We are currently evaluating the impact of our pending adoption of ASU 2017-12 on our consolidated financial statements.

In June 2016, FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326) ("ASU 2016-13"), Measurement of Credit Losses on Financial Instruments. The standard significantly changes how entities will measure credit losses for most financial assets and certain other instruments that aren't measured at fair value through net income. The standard will replace today's "incurred loss" approach with an "expected loss" model for instruments measured at amortized cost. For available-for-sale debt securities, entities will be required to record allowances rather than reduce the carrying amount, as they do today under the other-than-temporary impairment model. It also simplifies the accounting model for purchased credit-impaired debt securities and loans. This ASU is effective for annual periods beginning after December 15, 2019, and interim periods therein. Early adoption is permitted for annual periods beginning after December 15, 2018, and interim periods therein. We are currently evaluating the impact that the adoption of ASU 2016-13 will have on our financial condition, results of operations and cash flows.

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)” (“ASU 2016-02”). These amendments require the recognition of lease assets and lease liabilities on the balance sheet by lessees for those leases currently classified as operating leases under ASC 840 “Leases”. These amendments also require qualitative disclosures along with specific quantitative disclosures. These amendments are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted. Entities are required to apply the amendments at the beginning of the earliest period presented using a modified retrospective approach. We are currently evaluating the impact that the adoption of ASU 2016-02 will have on our financial condition, results of operations and cash flows.

In May 2014, the FASB issued ASU No. 2014-09—“Revenue from Contracts with Customers” (Topic 606) which amended revenue recognition guidance to clarify the principles for recognizing revenue from contracts with customers. The guidance requires an entity to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. The guidance also requires expanded disclosures relating to the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Additionally, qualitative and quantitative disclosures are required about customer contracts, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract.  This accounting guidance is effective for the Company beginning in the first quarter of fiscal year 2018, using one of two prescribed retrospective methods. The Company is evaluating the impact of the amended revenue recognition guidance on the Company’s consolidated financial statements.

Management has evaluated other recently issued accounting pronouncements and does not believe that any of these pronouncements will have a material impact on the Company’s consolidated financial statements.

Recent Adopted Accounting Pronouncements

In March 2016, the FASB issued ASU No. 2016-09, Stock Compensation (Topic 718), which includes provisions intended to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements. The standard is effective for annual periods beginning after December 15, 2016. We adopted this ASU during the first quarter 2017.  The key effects of the adoption on our financial statements include that the Company will now recognize windfall tax benefits as deferred tax assets instead of tracking the windfall pool and recording such benefits in equity. Additionally, we have elected to recognize forfeitures as they occur rather than estimating them at the time of grant. The adoption of this ASU did not have a material impact on our consolidated financial statements.

(2) PROPERTY AND EQUIPMENT

Property and equipment as of September 30, 2017 and December 31, 2016, consist of the following (in thousands):

Total depreciation expense related to our property and equipment was $0.1 million for the three months ended September 30, 2017 and 2016.

Total depreciation expense related to our property and equipment was $0.2 million and $0.3 million for the nine months ended September 30, 2017 and 2016, respectively.

(3) EARNING (LOSS) PER SHARE

Basic earnings (loss) per share are computed by dividing net income (loss) by the weighted-average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net loss by the weighted-average number of common shares outstanding and the number of dilutive potential common share equivalents during the period, calculated using the treasury-stock method for outstanding stock options.

The calculation of basic and diluted earnings (loss) per share for the three and nine months ended September 30, 2017 and 2016 is as follows:

For the three and nine months ended September 30, 2017, 0.1 million and 0.8 million shares, respectively, of common stock were excluded from the dilutive stock calculation because their exercise prices were greater than the average fair value of our common stock for the period.

For the three months ended September 30, 2016, 1.6 million shares of common stock were excluded from the dilutive stock calculation because their exercise prices were greater than the average fair value of our common stock for the period. For the nine months ended September 30, 2016, 2.2 million shares of common stock were excluded from the dilutive stock calculation due to the net loss for the period.

Prior to their issuance on August 28, 2017, the dilutive securities calculation included 776,250 shares of common stock issuable related to the private placement which was completed on February 28, 2017. The common shares were issuable six months from the closing of the shareholder notes.

(4) STOCK-BASED COMPENSATION PLANS

In June 2017, our stockholders approved the 2017 Stock Incentive Plan (the “2017 Stock Plan”) with a maximum of 5,000,000 shares reserved for issuance.  Awards permitted under the 2017 Stock Plan include:  Stock Options and Restricted Stock.  Awards issued under the 2017 Stock Plan are at the discretion of the Board of Directors.  As applicable, awards are granted with an exercise price equal to the closing price of our common stock on the date of grant and generally vest over four years.  During the three and nine months ended September 30, 2017, 76,000 and 286,000 options have been granted under the 2017 Stock Plan.

During the three and nine months ended September 30, 2017, 0 and 10,000 shares of restricted stock were issued to management, respectively.  During the three and nine months ended September 30, 2017 no shares of restricted stock vested. No shares of restricted stock were forfeited during the three and nine months ended September 30, 2017.  The fair market value of restricted shares for share-based compensation expensing is equal to the closing price of our common stock on the date of grant. The restrictions on the stock awards are released annually over four years

The Company previously reserved 3,000,000 shares of common stock for issuance under its 2005 Stock Option Plan (the “Option Plan”). The Option Plan expired as of December 31, 2014. Vesting provisions of the expired plan were to be determined by the Board of Directors. All stock options under the Option Plan expire no later than ten years from the date of grant. Options granted in 2016 and through May 2017 prior to the approval of the 2017 Stock Incentive Plan were approved by and certified by the board of directors on September 6, 2017 under the existing 2005 stock option plan.

The following summarizes stock-based compensation expenses recorded in the condensed consolidated statement of operations:

In the three and nine months ended September 30, 2017, the Company recorded compensation expense related to stock options of $9,000 and $46,000, respectively, all of which was recorded in selling, general and administrative expense on the accompanying condensed consolidated statement of operations.

In the three and nine months ended September 30, 2016, the Company recorded compensation expense related to stock options of $12,000 and $171,000, respectively, all of which was recorded in selling, general and administrative expense on the accompanying condensed consolidated statement of operations.

During the three and nine months ended September 30, 2017, the Company granted options to purchase up to 76,000 and 511,000 shares of common stock to employees at a weighted average exercise price of $0.92 and $0.41 per share, respectively. The weighted-average grant date fair value of options granted during the three and nine months ended September 30, 2017 were $0.90 and $0.39 respectively.

During the three and nine months ended September 30, 2016, the Company granted options to purchase up to 100,000 and 854,000 shares of common stock to employees at a weighted average exercise price of $0.22 and $0.27 per share, respectively. The weighted-average grant date fair value of options granted during the three and nine months ended September 30, 2016 were $0.19 and $0.33, respectively.

No options were exercised during the three or nine months ended September 30, 2017. 1,000 shares were exercised during the three and nine months ended September 30, 2016.

The Company used the Black Scholes option pricing model to determine the fair value of stock option grants, using the following assumptions:

A summary of stock option activity under all equity compensation plans for the nine months ended September 30, 2017, is presented below:

As of September 30, 2017, the Company had approximately $0.2 million of unrecognized compensation expense related to stock options that will be recognized over a weighted average period of approximately 3.40 years.

(5) INCOME TAXES

The provision for income taxes is recorded at the end of each interim period based on the Company’s best estimate of its effective income tax rate expected to be applicable for the full fiscal year. The Company’s effective income tax rate was 2% for the three and nine months ended September 30, 2017, and resulted in income tax expense of $44,000 and $89,000 respectively, due to alternative minimum taxes. There was no income tax expense during the three or nine months ended September 30, 2016.

The Company has generated a net operating loss carryforward (NOL) for federal income tax purposes of approximately $5.3 million as of September 30, 2017, which is available to offset taxable income in the future at various dates through 2035. The Company also has available NOL carryforwards of approximately $14.7 million for state purposes, which begin to expire at various dates ranging from five to seven years.

As of September 30, 2017 and December 31, 2016, the Company has a valuation allowance on all deferred tax assets. The Company has generated taxable income in 2017 and projects income in future periods. Based on these factors, the Company is currently evaluating the realization of its deferred tax assets and may have an adjustment to its valuation allowance in the future.

The Company paid no income taxes during the three or nine months ended September 30, 2017 or 2016.

(6) LINE OF CREDIT

The Company had an asset-backed revolving credit facility under a Loan and Security Agreement as amended, (the “Triumph Agreement”) with Triumph Healthcare Finance. This credit facility was paid in full on June 30, 2017.

The Triumph Agreement contained certain customary restrictive and financial covenants for asset-backed credit facilities. The Company had not been in compliance with the financial covenants under the Triumph Agreement since July 2014.

On July 14, 2014, the Company received notice from the Lender of an event of default under the Triumph Agreement. The notice relates to the Company’s default under the minimum debt service coverage ratio requirement for the quarter ended March 31, 2014 and certain other alleged defaults. The Lender notified the Company that it was exercising its default remedies under the Triumph Agreement, including, among others, accelerating the repayment of all outstanding obligations under the Triumph Agreement (outstanding principal and accrued interest) and collecting the Company’s bank deposits to apply towards the outstanding obligations.

As of September 30, 2017, $0 was outstanding under the Triumph Agreement as compared to $2.8 million at December 31, 2016. Subsequent to the default and prior to the pay off, the effective interest rate under the Triumph Agreement was approximately 11.0% (6.75% interest rate plus 3% additional default interest rate and 1.25% fees). The Triumph Agreement required monthly interest payments in arrears on the first day of each month. The Triumph Agreement originally matured on December 19, 2014. Triumph had agreed to forbear from the exercise of its rights and remedies under the terms of the Triumph Agreement through June 30, 2017, pursuant to the terms of the March 31, 2017 forbearance agreement. In connection with the agreement entered into on March 28, 2016, the Lender suspended this monthly payment requirement for February, March and April of 2016 up to an aggregate cap of $250,000, in exchange for the issuance of a warrant to purchase 50,000 shares of the Company’s common stock.

The Company used the Black Scholes option pricing model to determine the fair value of the stock warrant, using the following assumptions:

During the three months ended March 31, 2016, the Company recorded bank fee expense related to this stock warrant of $15,000.

(7) PRIVATE PLACEMENT MEMORANDUM

Commencing in November of 2016, the Company conducted a private placement on a “best efforts, minimum-maximum” basis of 12% unsecured subordinated promissory notes, for a minimum of $1,000,000 and a maximum of $1,500,000 pursuant to Sections 4(a)(2) and 4(a)(5) of the Securities Act of 1933, as amended (the “1933 Act”) and Rule 506(b) of the 1933 Act (the “Offering”). The Offering was conducted through a FINRA registered broker, Newbridge Securities Corporation (“Newbridge”). On February 28, 2017, the Company conducted a closing under the Offering and issued promissory notes totaling $1,035,000, with a maturity date of June 28, 2018, with the remaining unpaid principal balance due. The Offering requires the Company to make monthly repayment commencing on July 1, 2017, until the Senior Lender has been paid in full, the private placement memorandum limits the funds available for repayment to the note holders to an amount equal to 5% of the Company’s collections received by the Senior Lender during that month. Newbridge was compensated in connection with sales made in the Offering consisting of (i) a cash amount equaling 10% commissions, a 3% non-accountable expense allowance, and related expenses totaling $155,000 (ii) 776,250 shares of our Common Stock were issued to the placement agent as additional commission and fees totaling $255,000, and (iii) the Company had an obligation to issue 776,250 shares of the common stock, six months after issuance of the notes to the noteholders which had initially been recorded as a liability totaling $255,000. The shares were issued on August 28, 2017. In connection with the Offering, we also paid our Lender $342,000 as repayment of principal and interest on the outstanding obligations. The common stock issued to the note holders represents additional interest expense and was initially recorded as a liability and was adjusted each reporting period based upon the fair value of the underlying stock until issued on August 28, 2017. During the three and nine months ended September 30, 2017, the Company recognized $143,000 and $292,000 in debt issuance costs and debt discount amortization expense included in interest expense, respectively. Also, included in interest expense is the increase in value of the common shares issued to the private placement noteholders from the date of issue of approximately $529,000 and $740,000 for the three and nine month periods ended September 30, 2017, respectively.

The table below summarizes the cash and non-cash components of the private placement memorandum (in thousands):

(8) DEFERRED INSURANCE REIMBURSEMENT

During the first quarter of 2016, the Company collected $880,000 from a single insurance company for accounts receivable. The accounts receivable had been previously reduced to zero by the allowance for billing adjustments. Subsequent to March 31, 2016, the insurance company verbally communicated to the Company that this payment was made in error and requested it be refunded to the insurance company. The Company recorded this $880,000 insurance reimbursement as a deferred insurance liability. However, the Company is disputing the refund request and has initiated an internal audit of the reimbursement to determine that the original sales arrangement was properly executed, the products had been shipped and title was transferred (or rental services were rendered), the price of the products or services and the reimbursement rate is fixed and determinable, and the Company’s ultimate claim to the reimbursement is reasonably assured. The Company will record the appropriate amount as net revenue when such internal audit is complete and any refund obligation is deemed remote.

(9) CAPITAL LEASES AND OTHER OBLIGATIONS

The Company had previously entered into a Lease Termination Agreement (“LTA”) and new Lease Agreement (“LA”) with its landlord relating to the Company’s headquarters location in Lone Tree, Colorado, under which the Company reduced the amount of space leased at its headquarters. Subsequently, on August 12, 2016, the Company entered into an amended Lease Agreement to extend and amend the terms and conditions of the LA.

The following is a summary of the key terms of the LA, as amended:

Also see Note 13 below regarding the Company’s office lease commitments.

The Company also leases certain equipment under capital leases which expire on various dates through 2018. Imputed interest rates on the leases range from approximately 2% to 10%. At September 30, 2017, the total recorded cost of assets under capital leases was approximately $461,000. Accumulated depreciation related to these assets totals approximately $356,000.

(10) CONCENTRATIONS

For the three months ended September 30, 2017, the Company sourced approximately 52% of the components for its electrotherapy products from three significant vendors (defined as supplying at least 10%). For the nine months ended September 30, 2017, the Company sourced approximately 47% of components from two vendors.

For the three months ended September 30, 2016, three significant vendors sourced 79% of our electrotherapy products. For the nine months ended September 30, 2016 two vendors sourced 52% of our components. Management believes that its relationships with suppliers are good; however, if the relationships were to be replaced, there may be a short-term disruption to operations, a period of time in which products may not be available and additional expenses may be incurred.

The Company had receivables from a private health insurance carrier at September 30, 2017 and December 31, 2016, that made up approximately19% and 10%, respectively, of the net accounts receivable balance.

(11) LITIGATION

From time to time, the Company may become party to litigation and other claims in the ordinary course of business. To the extent that such claims and litigation arise, management would provide for them if losses are determined to be both probable and estimable.

The Company is currently not a party to any material pending legal proceedings.

(12) RELATED PARTY TRANSACTIONS

The Company employs Mr. Martin Sandgaard and Mr. Joachim Sandgaard, both sons of Thomas Sandgaard. Compensation was $43,000 and $40,000 for the three months ended September 30, 2017 and 2016, respectively and $129,000 and $101,000 for the nine months ended September 30, 2017 and 2016, respectively. To meet Mr. Sandgaard’s obligation to his former wife under a settlement agreement, the Company, during the fourth quarter of 2015, entered into 3 year employment arrangement totaling $100,000 per year with Mr. Joachim Sandgaard.

Related party payables primarily consist of advances made to the Company and inventory purchases made on behalf of the Company. Accrued liabilities as of September 30, 2017 and December 31, 2016 include a net payable to Thomas Sandgaard of $0 and $75,000 respectively, and a net payable to an employee of $0 and $112,000 respectively. During the three months ended September 30, 2017 the company made repayments to Thomas Sandgaard and an employee of $0 and $93,000 respectively. During the nine months ended September 30, 2017 the Company made a repayment to Thomas Sandgaard and an employee of $75,000 and $112,000 respectively.

(13) SUBSEQUENT EVENT

On October 20, 2017 the Company entered into a sublease agreement with CSG Systems Inc. for approximately 42,480 square feet at 9555 Maroon Circle, Englewood CO 80112. The Term of the Sublease runs through June 30, 2023, with an option to extend for an additional two years through June 30, 2025. During the first year of the Sublease, the rent per square foot is $7.50, increasing to $19.75 during the second year of the Sublease and each year thereafter for the Initial Term increasing by an additional $1 per square foot. The Company is also obligated to pay its proportionate share of building operating expenses. The Sublandlord agreed to contribute approximately $219,000 toward tenant improvements.

The Company expects to relocate its headquarters to the subleased offices in January, 2018.

The Company issued a press release and filed a Form 8-K with the SEC announcing the transaction on October 26, 2017.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Cautionary Notice Regarding Forward-Looking Statements

This quarterly report contains statements that are forward-looking, such as statements relating to plans for future organic growth and other business development activities, as well as the impact of reimbursement trends, other capital spending and financing sources. Such forward-looking information involves important risks and uncertainties that could significantly affect anticipated results in the future and, accordingly, such results may differ from those expressed in any forward-looking statements made by or on behalf of the Company. These risks include the Company’s difficulty in paying its debts as they become due, the need for additional capital in order to grow our business, our ability to avoid insolvency and engage effective sales representatives, the need to obtain U.S. Food and Drug Administration (“FDA”) clearance and Certificate European (“CE”) marking of new products, the acceptance of new products as well as existing products by doctors and hospitals, our dependence on the reimbursement from insurance companies for products sold or rented to our customers, acceptance of our products by health insurance providers for reimbursement, larger competitors with greater financial resources, the need to keep pace with technological changes, our dependence on third-party manufacturers to produce key components of our products on time and to our specifications, implementation of our sales strategy including a strong direct sales force, and other risks described herein and in our Annual Report on Form 10-K for the year ended December 31, 2016.

These interim financial statements and the information contained in this Quarterly Report on Form 10-Q should be read in conjunction with the annual audited consolidated financial statements, and notes to consolidated financial statements, included in the Company’s 2016 Annual Report on Form 10-K and subsequently filed reports, which have previously been filed with the Securities and Exchange Commission.

General

We operate in one primary business segment, Electrotherapy and Pain Management Products. As of September 30, 2017, the Company’s only active subsidiary is Zynex Medical, Inc. (“ZMI,” a wholly-owned Colorado corporation) through which the Company conducts most of its operations. One other subsidiary, Zynex Europe, ApS (“ZEU,” a wholly-owned Denmark corporation), did not generate any revenue during the three or nine months ended September 30, 2017 and 2016 from international sales and marketing. Zynex Monitoring Solutions, Inc. (“ZMS,” a wholly-owned Colorado corporation) is developing a blood volume monitoring device, but it is not yet developed or ready for market and, as a result, ZMS has achieved no revenues to date. Its inactive subsidiaries include Zynex NeuroDiagnostics, Inc. (“ZND,” a wholly-owned Colorado corporation), Zynex Billing and Consulting, LLC (“ZBC,” an 80% owned Colorado limited liability company) and Pharmazy, Inc. (“Pharmazy”), which was incorporated in June 2015 as a wholly-owned Colorado corporation. The Company’s compound pharmacy operated as a division of ZMI dba as Pharmazy through January 2016.

RESULTS OF OPERATIONS

Summary

Net revenue was $6.8 million and $3.6 million for the three months ended September 30, 2017 and 2016, respectively, and $15.3 million and $10.4 million for the nine months ended September 30, 2017 and 2016, respectively. Net revenue increased 88% and 47% for the three and nine month periods ended September 30, 2017, respectively. Net income was $2.2 million and $0.5 million for the three months ended September 30, 2017 and 2016, respectively, a 314% increase. Net income (loss) was $4.1 million and ($0.1) million for the nine months ended September 30, 2017 and 2016, respectively, a 3003% increase. We generated cash flows from operating activities of $4.7 million during the nine months ended September 30, 2017. Increased profitability and the related cash flows allowed us to pay off our credit facility with Triumph on June 30, 2017 and produced working capital at September 30, 2017 of $1.2 million up 127% from a ($4.3 million) deficit at December 31, 2016.

Net Revenue

Net revenues are comprised of sales (purchased or rented products and consumable supplies) reduced by estimated Third-party Payors reimbursement deductions and an allowance for uncollectible amounts. The reserve for billing allowance adjustments and allowance for uncollectible accounts are adjusted on an ongoing basis in conjunction with the processing of Third-party Payor insurance claims and other customer collection history. Net revenue includes the rental of our transcutaneous electrical nerve stimulation (TENS) products, the sale of our TENS products and consumable supplies.

Our electrotherapy products may be rented on a monthly basis or purchased. Renters and purchasers are primarily patients and healthcare insurance providers on behalf of patients. Our electrotherapy products may also be purchased by dealers and distributors. If a patient is covered by health insurance, the Third-party Payor typically determines whether the patient will rent or purchase a unit depending on the anticipated time period for its use. Under certain Third-party Payor contracts, a rental continues until an amount equal to the purchase price is paid then we transfer ownership of the product to the patient and cease rental charges; while other rentals continue during the period of patient use of the equipment. For all patients using our electrotherapy products, we also sell consumable supplies, consisting primarily of surface electrodes and batteries. Revenue for the electrotherapy products is reported net, after adjustments for estimated insurance company reimbursement deductions and estimated allowance for uncollectible accounts. The deductions are known throughout the health care industry as “billing adjustments” 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, net of resubmitted billings of claims for products placed with patients which may affect collectability. See Note 1 to these Condensed Consolidated Financial Statements or Note 2 to the Consolidated Financial Statements included within our Annual Report on Form 10-K for the year ended December 31, 2016 for a more complete explanation of our revenue recognition policies.

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.

As of September 30, 2017, we believe we have an adequate allowance for billing adjustments relating to known insurance disputes and refund requests. However, no assurances can be given with respect to such estimates of reimbursements and offsets or the ultimate outcome of any refund requests.

Product Device Revenue

Product device revenue is related to the purchase or rental of our products. Product device revenue increased $0.1 million or 8% to $2.3 million for the three months ended September 30, 2017, from $2.2 million for the three months ended September 30, 2016. The increase in product device revenue is primarily related to improvements in our billing and collection procedures.

Product device revenue decreased $0.2 million or 3% to $6.6 million for the nine months ended September 30, 2017, from $6.8 million for the nine months ended September 30, 2016. The decrease in product device revenue is primarily related to decreased orders in 2017 partially offset by increased billings and collections as a percentage of each order.

Product Supplies Revenue

Product supplies revenue is related to the sale of supplies, typically electrodes and batteries, for our products. Product supplies revenue increased $3.0 million or 206% to $4.5 million for the three months ended September 30, 2017, from $1.5 million for the three months ended September 30, 2016. The increase in product supplies revenue is primarily related to an increased customer base from increased sales in 2016 and improvements in our billing and collection procedures.

Product supplies revenue increased $5.1 million or 144% to $8.7 million for the nine months ended September 30, 2017, from $3.6 million for the nine months ended September 30, 2016. The increase in product supplies revenue is primarily related to an increased customer base from increased sales in 2016 and improvements in our billing and collection procedures.

Operating Expenses

Cost of Revenue – Rental, Product and Supply

Cost of Revenue – rental, product and supply consist primarily of product and supply costs, operations labor and overhead, shipping and depreciation. Cost of revenue for the three months ended September 30, 2017 and 2016, increased 53% to $1.3 million from $0.9 million, respectively. The increase in cost of revenue is primarily due to the increase in product supply orders. As a percentage of revenue, cost of revenue – rental, product and supply decreased to 20% for the three months ended September 30, 2017 from 24% for the three months ended September 30, 2016. The decrease as a percentage of revenue is primarily due to the increase in revenue during the period.

Cost of revenue for the nine months ended September 30, 2017 and 2016, increased 17% to $3.3 million from $2.8 million, respectively. The increase in cost of revenue is primarily due to the increase in product supply orders. As a percentage of revenue, cost of revenue – rental, product and supply decreased to 22% for the nine months ended September 30, 2017 from 27% for the nine months ended September 30, 2016. The decrease as a percentage of revenue is primarily due to the increase in revenue during the period.

Selling, General and Administrative Expenses

Selling, general and administrative expenses primarily consist of employee related costs, including commissions and other direct costs associated with these personnel including facilities and travel expenses and professional fees, depreciation and amortization. Selling, general and administrative expense for the three months ended September 30, 2017 and 2016 increased 19% to $2.5 million from $2.1 million, respectively. The increase in selling, general and administrative expense is primarily due to increased incentive compensation. As a percentage of revenue, selling, general and administrative expense decreased to 37% for the three months ended September 30, 2017 from 59% for the three months ended September 30, 2016. The decrease as a percentage of revenue is due to the increase in revenue during the period which more than offset the aforementioned increase in expenses.

Selling, general and administrative expense for the nine months ended September 30, 2017 and 2016 decreased 13% to $6.5 million from $7.5 million, respectively. The decrease in selling, general and administrative expense is primarily due to staff reductions and decreased commission due to fewer product orders and elimination of temporary services which was partially offset by increased incentive compensation in the third quarter of 2017. As a percentage of revenue, selling, general and administrative expense decreased to 42% for the nine months ended September 30, 2017 from 72% for the nine months ended September 30, 2016. The decrease as a percentage of revenue is due to the increase in revenue during the period and the aforementioned decrease in expenses.

Other Income (Expense)

Other expense is composed primarily interest expense and debt issuance costs. For the three months ended September 30, 2017 and 2016, other expense increased to $0.7 million from $90,000 respectively. The increase during the period is related to amortization of debt issuance costs and debt discount related the private placement completed in during the first quarter of 2017 (Note 7). We amortized $0.1 million in debt costs during the three months ended September 30, 2017. Also, included in interest expense is the increase in value of the common shares related to the private placement from the inception of the note and the date the shares were issued to the noteholders of approximately $0.5 million for the three months ended September 30, 2017.

Other expense was $1.2 million and $0.3 million for the nine months ended September 30, 2017 and 2016, respectively.  The increase during the period is related to amortization of debt issuance costs and debt discount related to the private placement completed in during the first quarter of 2017. We amortized $0.3 million in debt costs during the nine months ended September 30, 2017. Also, included in interest expense is the increase in value of the common shares related to the private placement from the inception of the note and the date the shares were issued to the noteholders of approximately $0.7 million for the nine months ended September 30, 2017.

LIQUIDITY AND CAPITAL RESOURCES

We have historically financed operations through cash flows from operations, debt and equity transactions.  At September 30, 2017, our principal source of liquidity was $2.6 million in cash and $2.4 million in accounts receivables, net of allowances. The increased cash balance at September 30, 2017 was due cash flows from operations of $4.7 million during the first nine months of 2017 which was partially offset by using cash to retire our credit facility with Triumph. The credit facility had been in default since 2014 and the payoff allows the company operating flexibility going forward. Our anticipated uses of cash in the future will be to fund the expansion of our business and debt service related to the private placement with Newbridge in Q1-17. 

Net cash provided by operating activities for the nine months ended September 30, 2017 and 2016 was $4.7 million and $1.2 million, respectively.  The increase in cash provided by operating activities for the nine months ended September 30, 2017 was primarily due to the significant increase in profitability in 2017. 

Net cash used in investing activities for each of the nine month periods ended September 30, 2017 and 2016 was $0.1 million.  Cash used in investing activities for the nine months ended September 30, 2017 is related to the purchase property and equipment.

Net cash used in financing activities for the nine months ended September 30, 2017 and 2016 was $2.2 million and $1.0 million, respectively.  The cash used in financing activities for the nine months ended September 30, 2017 was primarily due to the retirement of our credit facility with Triumph of $2.8 million and payments related to our promissory notes our private placement, partially offset by the cash received in the private placement. The cash used for the nine months ended September 30, 2016 was primarily related to payments on our credit facility with Triumph.

As of September 30, 2017, we had working capital of $1.2 million, compared to a deficit as of December 31, 2016 of $4.3 million. We have generated $4.7 million in positive operating cash flows during 2017 and expect to generate positive cash flows from operations going forward.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. There has been no change to critical accounting policies and estimates during the quarter.

Please refer to the “Management’s Discussion and Analysis of Financial Condition and Results of Operation” and Note 2 to the Consolidated Financial Statements located within our Annual Report on Form 10-K for the year ended December 31, 2016, filed with the Securities and Exchange Commission on April 17, 2017.

OFF BALANCE SHEET ARRANGEMENTS

The Company had no significant off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to our stockholders.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

In the ordinary course of business, we are exposed to certain market risks, including changes in interest rates. Uncertainties that are either non-financial or non-quantifiable such as political, economic, tax, other regulatory, or credit risks are not included in the following assessment of market risks.

.

ITEM 4.  CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.  Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to management, including our principal executive officer and our principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

We, under the supervision and with the participation of our management, including our President and Chief Executive Officer and our newly hired Chief Financial Officer, performed an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2017. Based on that evaluation, our President and Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of September 30, 2017, due to the material weaknesses in our internal control over financial reporting (ICFR), which are described below. We have made significant progress in addressing our ICFR weaknesses and will continue our remediating during the fourth quarter of 2017.

A material weakness is a deficiency or a combination of deficiencies in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected in a timely basis.

As a result of our assessment of ICFR as of December 31, 2016, management identified the following control deficiencies that represent material weaknesses that continue to exist as of September 30, 2017:

The following controls were fully remediated during the quarter ended September 30, 2017:

Notwithstanding the assessment that our ICFR was not effective and that there were material weaknesses as identified in this report, we believe that our consolidated financial statements contained in this Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2017, fairly present our financial position, results of our operations and cash flows for the periods covered thereby in all material respects.

We are committed to improving our ICFR. As part of this control improvement, we are currently working to (1) appoint outside independent directors to our Board of Directors and utilize an independent audit committee of the Board of Directors who will undertake oversight in the establishment and monitoring of required internal controls and procedures (when funds and/or additional resources are available to the Company), and (2) we have retained an outside independent consulting firm to assist us with assessing and testing the effectiveness of our ICFR. We will continue to monitor and evaluate the effectiveness of our internal controls and procedures and our ICFR on an ongoing basis, and are committed to taking further action and implementing additional enhancements or improvements, as necessary.

Changes in Internal Control Over Financial Reporting

During the quarter ended June 30, 2017, we hired a new Chief Financial Officer and implemented certain financial controls related to financial statement close and reporting process.

During the quarter ended September 30, 2017, our new Chief Financial Officer has assumed responsibility for all Company assets and control processes. The Company also retained an outside independent consulting firm which is updating our documentation of controls and performing testing as needed.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We are not a party to any material pending legal proceedings.

ITEM 1A. RISK FACTORS

During 2013-2015, the Company suffered operating losses which caused a lack of liquidity and a substantial working capital deficit. This raised substantial doubt about the Company’s ability to continue as a going concern.

During 2016, the Company generated net income during Q3 and Q4 and combined with the profitability in Q1, Q2 and Q3 of 2017, the Company has recorded five consecutive profitable quarters, paid off its line of credit with Triumph and generated cash reserves and positive working capital.

As a result, in accordance with Accounting Standards Codification (“ASC”) 205-40, Presentation of Financial Statements – Going Concern, as of September 30, 2017, management evaluated whether there are conditions and events that raise doubt about the entity’s ability to continue as a going concern and concluded there is not significant doubt. The Company is currently able to meet its obligations as they become due within one year. Management’s evaluation is based only on relevant conditions and events that are known and reasonably knowable as of the date of these financial statements.

Our history of operating losses could make it difficult to raise any new capital and may have an adverse impact on our relationship with third parties with whom we do business, including our customers, vendors and employees.

This Quarterly Report on Form 10-Q should be read in conjunction with the risk factors defined in our Annual Report on Form 10-K for the year ended December 31, 2016 under “Item 1A. Risk Factors.”

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

During the period covered by this Form 10-Q, there were no sales of unregistered securities except as reported above for the Company by Newbridge Securities. The following sets forth the information required by Item 701 of Regulation S-K:

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4. MINE SAFETY DISCLOSURES

None

ITEM 5. OTHER INFORMATION

None

ITEM 6.   EXHIBITS

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.