Axon Enterprise, Inc. — Q1 2019 Form 10-Q Summary
Business Context and Reporting Period
Axon provides law-enforcement technology solutions through two reportable segments: TASER conducted electrical weapons and related products, and Software and Sensors, including cameras, devices, cloud evidence management, applications and related services. This unaudited report covers the three months ended March 31, 2019, compared with the three months ended March 31, 2018.
Financial Performance and Key Metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Net sales | $115.8 million | $101.2 million | 14.4% increase |
| Product revenue | $88.1 million | $81.0 million | 8.8% increase |
| Service revenue | $27.7 million | $20.2 million | 37.0% increase |
| Gross margin | $68.9 million; 59.5% | $64.5 million; 63.7% | Margin down 420 basis points |
| Income from operations | $2.7 million; 2.3% | $13.6 million; 13.5% | Declined $10.9 million |
| Net income | $6.4 million; 5.5% | $12.9 million; 12.8% | Declined $6.5 million |
| Diluted EPS | $0.11 | $0.24 | Declined $0.13 |
| Adjusted EBITDA | $13.7 million | $21.3 million | Declined $7.6 million |
| Operating cash flow | $(14.0) million | $18.0 million | Declined $32.0 million |
Software and Sensors revenue increased 33.8% to $50.4 million, led by a 36.4% increase in Axon Evidence and cloud services revenue. TASER segment revenue increased 2.9% to $65.4 million, primarily due to higher cartridge revenue and initial TASER 7 sales.
Gross margin was pressured by initial TASER 7 production costs, higher depreciation on production equipment, trade-in credits, freight and customs costs, increased third-party cloud costs and post-acquisition professional services. Sales, general and administrative expense increased 19.9% to $42.9 million, while research and development expense increased 54.5% to $23.4 million.
Cash and cash equivalents were $223.6 million at March 31, 2019, supplemented by $105.3 million of short-term investments. Total cash, cash equivalents and restricted cash was $225.2 million, down $125.8 million from year-end, primarily because the company purchased $105.3 million of investments. Accounts and notes receivable plus contract assets totaled approximately $167.0 million, while deferred revenue totaled $184.8 million.
Axon had no borrowings under its $50.0 million revolving credit facility and approximately $46.9 million of availability after outstanding letters of credit. The company reported no long-term debt and a funded debt-to-EBITDA ratio of 0.001 to 1.00. Total liabilities were $258.7 million and stockholders’ equity was $480.5 million.
Material Changes Versus the Prior Comparable Period
- Revenue grew 14.4%, with services growing substantially faster than product revenue.
- Software and Sensors revenue grew 33.8%, while TASER revenue grew 2.9%.
- Cloud and evidence services revenue increased $7.4 million to $27.7 million.
- TASER 7 generated $10.0 million of revenue and 8,835 units, while legacy TASER X2 unit sales declined 51.9%.
- Gross margin declined from 63.7% to 59.5%, and operating margin declined from 13.5% to 2.3%.
- Operating expenses increased $15.4 million, including higher headcount, sales and marketing costs, research and development investment and stock-based compensation.
- Operating cash flow turned negative, primarily due to a $22.0 million increase in accounts receivable and contract assets, a $7.3 million decrease in accounts payable and other liabilities, and a $3.9 million increase in inventory.
- The company adopted lease accounting standard Topic 842 on January 1, 2019, recognizing $11.7 million of operating lease assets and $12.8 million of operating lease liabilities at March 31, 2019.
Guidance, Outlook, Risks and Unusual Items
Management expects 2019 revenue of $485 million to $495 million, full-year stock-based compensation expense of approximately $35 million and a normalized income tax rate of 20% to 25%. Management stated that funding sources should satisfy anticipated cash requirements for at least the next 12 months, although future cash generation and access to financing are not assured.
Management expects the subscription model to expand, particularly through TASER 7, which is primarily sold through subscription offerings. Remaining performance obligations were approximately $930 million at March 31, 2019; the company expects to recognize 15% to 20% over the next 12 months and the remainder over five to seven years, subject to deployment delays, budget appropriations and cancellation clauses.
Software and Sensors bookings were $76.4 million, down 21.7% from Q1 2018. Management attributed the comparison partly to an unusually large international order in Q1 2018 and expects bookings growth to improve when Axon Body 3 begins shipping in Q3 2019.
The company recorded $7.9 million of stock-based compensation in the quarter. Approximately 12.0 million performance-based awards remained outstanding, and future expense depends on the probability and timing of achieving operational and market capitalization targets. A $2.7 million discrete tax benefit related primarily to stock-based compensation materially reduced the reported tax rate, producing a 28.8% benefit rate for the quarter compared with management’s 21.1% estimated underlying full-year rate.
Material contingencies include seven product-liability lawsuits, Digital Ally patent litigation, a potential consumer class action concerning TASER safety switches and a Federal Trade Commission investigation into the VIEVU acquisition. Management does not currently believe these matters will materially affect financial position, results or cash flows, but litigation outcomes remain uncertain. The company also had $24.6 million of surety bonds and $3.1 million of letters of credit outstanding.
Key operating risks include subscription-related collection delays and credit losses, government contract cancellations or non-appropriation, product defects, supply-chain interruptions, higher component, freight and tariff costs, cybersecurity or cloud-service outages, privacy regulation, international operations, intellectual-property litigation and dependence on key personnel and suppliers.
Important Facts for Investors to Verify
- Whether TASER 7 adoption and the subscription transition improve recurring revenue and unit growth without further compressing gross margins.
- Whether Axon Body 3 shipments in Q3 2019 improve Software and Sensors bookings and hardware growth.
- Conversion of the $930 million remaining performance obligation balance into revenue and cash, including the effect of government appropriation and cancellation provisions.
- Accounts receivable collections, contract-asset growth and operating cash flow under the subscription model.
- The sustainability of the 2019 revenue guidance and the expected $35 million stock-based compensation expense.
- Potential dilution from approximately 12.0 million outstanding performance-based awards, including CEO performance awards and XSUs.
- Developments in the FTC investigation, product litigation, Digital Ally patent case and consumer class-action matter.
- The effect of tariffs, freight, customs costs, supplier availability and new-product production costs on gross margin.
- Future share repurchases; no shares were repurchased in Q1 2019, and $16.3 million remained available under the authorization.