AXON ENTERPRISE, INC. quarterly report, Q2 FY2019

Axon Enterprise, Inc. 2019 Q2 Form 10-Q Summary

Business context and reporting period

Axon provides connected public-safety technology, including TASER conducted electrical weapons, body cameras, sensors, cloud evidence management, and related software and services. This unaudited Form 10-Q covers the three and six months ended June 30, 2019, compared with the corresponding 2018 periods.

The company reports two segments: TASER and Software and Sensors. The filing was signed August 9, 2019; 59.3 million common shares were outstanding as of July 30, 2019.

Key financial metrics

Metric	Q2 2019	Q2 2018	Six months 2019	Six months 2018
Net sales	$112.4 million	$99.2 million	$228.2 million	$200.4 million
Gross margin	$65.6 million; 58.4%	$63.1 million; 63.6%	$134.5 million; 58.9%	$127.6 million; 63.7%
Income from operations	$(1.3) million	$5.3 million	$1.4 million	$18.9 million
Net income	$0.7 million	$8.5 million	$7.2 million	$21.4 million
Diluted EPS	$0.01	$0.15	$0.12	$0.38
Adjusted EBITDA	$10.3 million	$12.1 million	$23.9 million	$33.4 million
Operating cash flow	Not separately provided	Not separately provided	$(2.6) million	$16.1 million

Q2 product revenue was $80.4 million and services revenue was $32.0 million. Six-month product revenue was $168.5 million and services revenue was $59.7 million.

Software and Sensors revenue increased 34.2% in Q2 to $51.8 million and 34.0% for the six months to $102.2 million. TASER revenue was essentially flat in Q2 at $60.6 million and increased 1.5% for the six months to $126.0 million. Software and Sensors bookings were $142.0 million in Q2, up 59.8% year over year.

Financial position and liquidity

Cash and cash equivalents were $219.7 million at June 30, 2019, compared with $349.5 million at December 31, 2018.
Short-term investments were $116.6 million at June 30, 2019; total cash, cash equivalents and restricted cash were $221.3 million.
Total assets were $746.4 million and stockholders’ equity was $488.9 million.
The company had no borrowings under its $50.0 million revolving credit facility. Letters of credit of $4.4 million reduced available borrowing to $45.6 million.
The funded debt-to-EBITDA covenant ratio was 0.001 to 1.00 versus a maximum permitted ratio of 2.50 to 1.00.
Deferred revenue was $187.9 million, including $113.4 million current and $74.6 million long term.
Remaining performance obligations were approximately $1.05 billion. Management expected 15% to 20% to be recognized within the next 12 months, with most of the remainder recognized over five to seven years, subject to cancellation and appropriation risks.

Material changes versus prior comparable periods

Revenue grew 13.2% in Q2 and 13.8% for the six months, driven primarily by cloud services, evidence management, and Software and Sensors adoption.
Gross margin declined 520 basis points in Q2 and 480 basis points for the six months. TASER segment margin fell to 59.9% in Q2 and 62.3% for the six months, primarily from TASER 7 product mix, trade-in credits, ramp-up costs, scrap, obsolete inventory, and higher labor and depreciation costs.
Software and Sensors segment margin improved to 56.5% in Q2 from 52.3%, while service margins declined because of higher cloud storage and professional services costs.
Operating expenses increased due to higher sales and marketing costs, headcount, research and development, and stock-based compensation. Six-month R&D expense increased 39.3% to $46.8 million.
Q2 included a $1.3 million impairment charge for abandoned enterprise resource planning implementation software.
Stock-based compensation increased to $16.5 million for the six months from $9.0 million. Approximately 12.0 million performance-based awards remained outstanding at June 30, 2019.
Operating cash flow deteriorated to negative $2.6 million, largely because of increases in receivables and contract assets, inventory, prepaid assets, and lower accrued and other liabilities.
Cash decreased primarily because the company invested $116.7 million, net, in investments. The prior-year period benefited from $234.0 million of net proceeds from a public equity offering.

Guidance, outlook, risks and unusual items

Management guided to 2019 revenue of $485 million to $495 million, approximately $35 million of stock-based compensation expense, and a normalized income tax rate of 20% to 25%.
Management expects research and development spending to continue increasing as it develops Axon Records, computer-aided dispatch software, and other cloud-connected products.
TASER 7 sales were constrained by a battery-supplier quality and production issue and a cartridge design change. Management estimated that approximately $6.0 million of Q2 revenue was delayed, including about $3.0 million of TASER 7 device sales and about $3.0 million of cartridge revenue, with demand expected to be fulfilled during the remainder of 2019.
Management entered into a three-year cloud data-storage commitment totaling $50.0 million, including a $15.0 million upfront payment in July 2019.
The company had seven product-liability lawsuits involving alleged wrongful death or personal injury related to TASER use. Management did not believe the matters were reasonably likely to have a material effect, but litigation outcomes remain uncertain. The company is self-insured for the first $5.0 million of post-2014 product claims.
Digital Ally’s patent litigation resulted in summary judgment for Axon on June 17, 2019; Digital Ally appealed.
The Federal Trade Commission continued a non-public investigation of Axon’s 2018 VIEVU acquisition, including a March 2019 subpoena. Axon stated that it was cooperating.
The land lease for a proposed new headquarters remained contingent on approval by the Salt River Pima-Maricopa Indian Community. The contemplated land lease purchase price was $13.1 million, with a potential $10.9 million rent prepayment.
Key risks include government contract appropriations and cancellation clauses, adoption of subscription offerings, delayed cash collections, supply-chain disruptions, component shortages, product defects, data-security breaches or outages, cloud-provider dependence, litigation, privacy regulation, international operations, and counterparty exposure on uninsured cash balances.
The company adopted the lease accounting standard, Topic 842, on January 1, 2019, recognizing $12.5 million of additional opening assets and liabilities. The filing stated that the adoption had no other material impact.

Important facts for investors to verify

Whether TASER 7 production and cartridge supply issues were resolved and whether delayed Q2 revenue was subsequently realized.
Progress toward the $485 million to $495 million 2019 revenue outlook and the effect of product mix on gross margin.
Whether Software and Sensors bookings convert into recognized revenue, given government appropriation and cancellation provisions.
Cash conversion and working-capital trends as subscription and installment models expand.
Future stock-based compensation, dilution, and performance-award expense, including the CEO Performance Award and XSPP.
Costs and obligations under the $50.0 million cloud-storage commitment and the proposed headquarters land lease.
Developments in the FTC investigation, product-liability cases, consumer litigation, and Digital Ally’s appeal.
Potential effects of supplier concentration, tariffs, component availability, cybersecurity incidents, and privacy regulation.