Business Context and Reporting Period
Axon Enterprise, Inc. develops and sells conducted electrical weapons, cameras, sensors, digital evidence management, cloud software and related services for public safety, military, corrections, security and personal-defense markets. The report covers the unaudited three and nine months ended September 30, 2018, compared primarily with the corresponding 2017 periods.
Axon reports two segments: TASER Weapons and Software and Sensors. The company is transitioning from hardware sales toward multi-element, multi-year subscription and recurring-payment arrangements. It adopted ASC Topic 606 on January 1, 2018 using the modified retrospective method, increasing opening retained earnings by $19.0 million.
Financial Performance and Position
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Net sales | $104.8 million | $90.3 million | $305.3 million | $249.1 million |
| Revenue growth | 16.1% | — | 22.5% | — |
| Gross margin | $65.6 million; 62.6% | $49.8 million; 55.1% | $193.2 million; 63.3% | $144.1 million; 57.8% |
| Income from operations | $4.0 million | $(0.8) million | $22.8 million | $5.4 million |
| Net income | $5.7 million | $0.4 million | $27.1 million | $7.3 million |
| Diluted EPS | $0.10 | $0.01 | $0.47 | $0.14 |
| Adjusted EBITDA | $13.3 million | $6.8 million | $46.7 million | $25.3 million |
- Q3 product revenue was $80.9 million and service revenue was $23.9 million. Nine-month product revenue was $238.6 million and service revenue was $66.7 million.
- Q3 TASER Weapons revenue increased 7.2% to $63.7 million; Software and Sensors revenue increased 33.5% to $41.2 million. Nine-month growth was 10.4% and 48.6%, respectively.
- Axon Evidence and cloud-services revenue increased 47.6% year over year in Q3 to $23.9 million and 58.5% for the nine months to $64.5 million.
- Q3 operating expenses were $61.7 million, including $39.7 million of SG&A and $22.0 million of R&D. Nine-month operating expenses were $170.4 million.
- Net cash provided by operating activities was $32.6 million for the nine months, compared with $5.9 million of cash used in the 2017 period. Operating cash flow benefited from $31.7 million of deferred-revenue growth but was reduced by a $51.2 million increase in accounts receivable and contract assets.
- Cash, cash equivalents and restricted cash totaled $326.8 million at September 30, 2018, including $324.4 million of cash and cash equivalents. The increase largely reflected $234.0 million of net proceeds from the May equity offering.
- Axon had no borrowings under its $10.0 million revolving credit facility; $6.9 million remained available after $3.1 million of letters of credit. The facility matured on December 31, 2018. The reported funded-debt-to-EBITDA ratio was 0.001 to 1.00.
- Total assets were $681.7 million and stockholders’ equity was $459.7 million at September 30, 2018. Deferred revenue totaled $159.0 million, including $69.4 million classified as long term.
Material Changes Versus the Prior Comparable Period
- Revenue growth was driven by continued adoption of body cameras, Axon Evidence, Axon Fleet and recurring customer programs. Software and Sensors increased to 39.3% of Q3 revenue from 34.1% in Q3 2017.
- Gross margin expanded by 750 basis points in Q3 and 550 basis points for the nine months. Management attributed the improvement to cloud-storage scale benefits and ASC 606 revenue matching, which generally recognizes hardware consideration when hardware is delivered.
- R&D increased 55.2% in Q3 and 40.3% for the nine months as Axon invested in new conducted-electrical-weapon technologies, cloud products and personnel.
- The company acquired VIEVU on May 3, 2018 for estimated consideration of $17.6 million, including cash, common stock, contingent consideration and a Safariland supply agreement. VIEVU contributed $5.4 million of revenue and $2.6 million of operating losses from acquisition through September 30.
- Axon recorded a $2.0 million impairment charge for abandoned developed technology acquired in a business combination and $0.5 million of expense for VIEVU purchase commitments exceeding estimated demand.
- The May follow-on offering issued 4.645 million shares at $53.00 per share and generated $234.0 million of net proceeds, increasing shares outstanding and liquidity.
- Stock-based compensation increased to $15.3 million for the nine months from $11.4 million. The CEO Performance Award generated $1.8 million of expense through September 30, although no options had vested.
Guidance, Outlook, Risks and Unusual Items
- Management expected 2018 revenue growth of 18% to 20% versus 2017, a normalized tax rate of 20% to 25%, and capital expenditures of $10 million to $12 million.
- Management anticipated lower TASER Weapons sales in the quarter ending December 31, 2018 because of expected 2019 shipment timing for TASER 7.
- Axon reported approximately $820 million of remaining performance obligations at September 30, 2018. It expected 15% to 20% to be recognized over the following 12 months and the remainder over five to seven years, subject to deployment delays, budget appropriations and cancellation clauses.
- Annual recurring run-rate Axon Cloud and Sensors and Other revenue was $101.6 million, with 325,200 cloud-based software licenses booked. Approximately 53% of Q3 revenue came from contracts with multiple performance obligations.
- Material risks include government budget appropriations and cancellations, adoption of subscription offerings, product defects and warranty claims, supply-chain constraints, component and labor costs, cybersecurity or cloud outages, litigation and intellectual-property claims, regulatory changes, foreign-exchange exposure, acquisition integration and reliance on key personnel.
- Seven product-liability lawsuits were disclosed, involving alleged wrongful death or personal injury associated with TASER CEWs. Management stated that losses were not reasonably expected to be material, but litigation outcomes remain uncertain and insurance may not cover all exposure.
- The FTC requested information regarding the VIEVU acquisition; Axon was cooperating with the non-public investigation.
- An October 2018 VIEVU camera overheating incident may affect purchase-commitment liabilities or inventory reserves in the fourth quarter, but the company could not estimate a possible loss range.
- Axon terminated a September 2018 agreement to purchase a 69-year leasehold for a planned headquarters on November 2, 2018 and expected return of its approximately $0.2 million escrow deposit.
- Disclosure controls were not effective as of September 30, 2018 because remediation testing for a material weakness involving the U.K. subsidiary was incomplete. The company also disclosed late Section 16(a) Forms 4 by multiple officers and directors.
Important Facts for Investors to Verify
- Whether the 18% to 20% 2018 revenue-growth outlook and 20% to 25% normalized tax-rate expectation were achieved.
- The sustainability of gross-margin expansion, particularly the effects of ASC 606, hardware revenue allocation and cloud-storage scale benefits.
- Conversion of bookings and the $820 million performance-obligation balance into invoiced revenue and cash, considering government appropriation and cancellation provisions.
- Cash conversion and working-capital requirements as subscription programs increase receivables and require upfront hardware spending.
- VIEVU integration, camera overheating exposure, purchase commitments, inventory reserves and the FTC investigation.
- Progress in remediating the U.K. internal-control material weakness and improving insider-reporting compliance.
- Potential dilution from the CEO Performance Award, other equity awards and contingent consideration related to VIEVU.
- Developments in product-liability, patent, arbitration and other legal proceedings, including collectability of the $7.8 million-plus Phazzer judgment.