AXON ENTERPRISE, INC. quarterly report, Q2 FY2014

AXON Enterprise, Inc. (formerly TASER International, Inc.) — Q2 2014 Form 10-Q Summary

Business context and reporting period

The filing covers the quarter and six months ended June 30, 2014. The company developed and sold conducted electrical weapons, accessories and related services, and operated an emerging EVIDENCE.com and Video segment comprising AXON cameras, TASER Cam and digital evidence-management SaaS. The company sold globally through direct sales, distributors, its online store and resellers.

Key financial metrics

Metric	Three months ended June 30	Six months ended June 30
Net sales	$37.2 million, up 15.5%	$73.4 million, up 17.2%
Gross margin	$23.2 million; 62.4%	$45.4 million; 61.9%
Income from operations	$6.2 million; 16.7% margin	$11.1 million; 15.1% margin
Net income	$3.9 million; $0.07 diluted EPS	$7.3 million; $0.13 diluted EPS
Operating cash flow	Not separately provided	$6.0 million

• Q2 sales growth was led by TASER X26P sales of $10.3 million and EVIDENCE.com & Video revenue of $4.5 million, up 136.5% from the prior-year quarter.
• Six-month TASER Weapons revenue was $65.2 million, while EVIDENCE.com & Video revenue was $8.2 million, up 89.4% year over year.
• At June 30, cash and cash equivalents were $25.9 million, short-term investments were $22.9 million and long-term investments were $10.9 million.
• Total assets were $149.4 million and total liabilities were $38.9 million. Capital lease obligations totaled approximately $0.1 million; there were no borrowings under the $10.0 million revolving credit facility.
• Deferred revenue increased to $24.1 million from $20.2 million at December 31, 2013, including $17.7 million for warranties and $4.8 million for EVIDENCE.com.
• Inventory increased to $15.1 million from $11.1 million at year-end, while accounts receivable were $23.1 million.

Material changes versus prior comparable periods

• Q2 net income declined 12.9% and six-month net income declined 6.2%, despite sales growth, because SG&A and R&D increased substantially.
• Q2 SG&A rose 23.8% to $13.5 million, and six-month SG&A rose 23.4% to $27.3 million. Q2 included approximately $2.2 million related to settlements of disputes with two former distributors.
• Q2 R&D increased 73.4% to $3.5 million, primarily from EVIDENCE.com & Video development initiatives. Management expected R&D and SG&A to continue increasing during 2014.
• Gross margin improved modestly from 61.4% to 62.4% in Q2 and from 61.0% to 61.9% for the six-month period, supported by product mix, higher average selling prices and operating leverage.
• Cash from operations fell from $12.2 million to $6.0 million for the six-month period. Cash declined $16.3 million after $17.3 million of investment purchases and $19.6 million of share repurchases.
• Customers continued shifting from the X26 and X2 platforms to the X26P. Six-month X26P revenue rose 126.5%, while X26 revenue fell 21.4% and X2 revenue fell 16.6%.
• International sales increased to $15.6 million, or 21.3% of six-month sales, from $8.1 million, or 12.9%, in the prior-year period.

Guidance, outlook, risks and unusual items

• Management believed operating cash generation and available cash would be sufficient to fund operations and strategic initiatives for the remainder of 2014. The filing does not provide a formal revenue or earnings guidance range.
• Management projected a 2014 effective tax rate of approximately 38.9% before discrete items; the six-month effective rate was 34.7% after discrete adjustments.
• Management expected near-term EVIDENCE.com & Video gross margins to remain lower because service revenue is deferred over contract terms and AXON cameras were being sold at low margins to accelerate market adoption.
• EVIDENCE.com, AXON flex and AXON body bookings increased to $11.3 million in Q2 and $17.3 million for the first six months. Some bookings were subject to future government appropriations or cancellation clauses and might not convert to revenue.
• The company had 16 active product-liability lawsuits and one additional matter on appeal involving alleged wrongful death or personal injury associated with TASER devices. Litigation outcomes could exceed insurance coverage or recorded reserves.
• The company paid approximately $4.5 million during Q2 to resolve the AA & SABA distributor litigation matter, including approximately $1.2 million of attorneys’ fees, costs and expenses.
• The company authorized $30.0 million of share repurchases, purchased approximately 1.5 million shares for $19.6 million during Q2 and had approximately $10.4 million remaining under the authorization.
• Other principal risks included product acceptance and defects, competition, cybersecurity breaches or EVIDENCE.com outages, government budget constraints and contract cancellations, international and regulatory risks, intellectual-property claims, supplier dependence, foreign-currency exposure and employee retention.
• The company carried approximately $3.2 million of unrecognized tax benefits. Recognition would favorably affect the effective tax rate, but tax positions remained subject to examination.

Important facts for investors to verify

• Whether rapid AXON and EVIDENCE.com bookings growth converts into recognized, recurring revenue given multiyear deferral and government appropriation clauses.
• Whether EVIDENCE.com & Video can improve gross margins while the company continues subsidizing or pricing AXON hardware aggressively.
• Whether rising SG&A and R&D investments generate sufficient incremental revenue and profitability.
• The sustainability of operating cash flow after inventory growth, litigation payments, investment purchases and share repurchases.
• The ultimate cost and insurance coverage of pending product-liability and other litigation.
• The recoverability of $18.4 million of net deferred tax assets and the outcome of the $3.2 million of unrecognized tax benefits.
• Compliance with the revolving credit facility’s covenants and the facility’s June 30, 2015 maturity.