Axon Enterprise, Inc. — Q3 2020 Form 10-Q Summary
Business context and reporting period
Axon provides law-enforcement technology, including TASER conducted-energy devices, body cameras, sensors, cloud software, digital evidence management and related services. This unaudited Form 10-Q covers the three and nine months ended September 30, 2020, compared with the same periods in 2019. The filing reflects the continuing impact of COVID-19 and the company’s shift toward subscription-based offerings.
Key financial metrics
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Net sales | $166.4 million | $130.8 million | $454.9 million | $359.0 million |
| Revenue growth | 27.2% | — | 26.7% | — |
| Gross margin | $98.2 million; 59.0% | $80.2 million; 61.3% | $275.0 million; 60.5% | $214.6 million; 59.8% |
| Operating income (loss) | $(5.4) million | $6.6 million | $(19.9) million | $8.0 million |
| Net income (loss) | $(0.9) million | $6.1 million | $(27.6) million | $13.3 million |
| Net income (loss) per diluted share | $(0.01) | $0.10 | $(0.45) | $0.22 |
| Adjusted EBITDA | $24.9 million | $23.2 million | $70.6 million | $47.1 million |
Service revenue increased to $46.4 million in Q3 and $128.7 million for the first nine months, from $34.3 million and $94.0 million, respectively, in the comparable periods. Axon Evidence and cloud services revenue was $46.1 million in Q3 and $128.3 million year to date.
Q3 gross margin declined primarily because of product mix and several large shipments of lower- to negative-margin body-camera hardware. Nine-month gross margin improved due to a greater mix of higher-margin software revenue. Q3 operating expenses rose 41.0% to $103.7 million, including $26.1 million of stock-based compensation. Nine-month stock-based compensation was $80.1 million, compared with $30.2 million in 2019.
Net cash provided by operating activities was $4.2 million for the first nine months, compared with $19.9 million in 2019. Investing cash outflow was $300.3 million, including $229.5 million of net investment purchases, $66.0 million of capital expenditures and $4.7 million invested in an unconsolidated affiliate. Financing cash inflow was $300.2 million, primarily from a June equity offering.
Liquidity, capital structure and balance sheet
- Cash and cash equivalents were $176.0 million at September 30, 2020.
- Cash, cash equivalents and investments totaled approximately $627.5 million, up approximately $231.2 million from December 31, 2019.
- Total assets were $1.279 billion and stockholders’ equity was $895.2 million.
- The company reported no borrowings under its $50.0 million unsecured revolving credit facility. Letters of credit reduced available borrowing to $43.9 million.
- The facility matures December 31, 2021, includes an accordion feature up to $100.0 million subject to conditions, and requires a maximum funded-debt-to-EBITDA ratio of 2.50 to 1.00. The reported ratio was 0.00 to 1.00.
- Inventory increased to $97.6 million from $38.8 million at year-end 2019, reflecting safety-stock purchases and preparation for potential manufacturing disruptions.
Material changes versus the prior comparable periods
- Software and Sensors revenue increased 38.8% in Q3 and 38.9% for the first nine months, driven by Axon Body 3, Axon Dock, cloud services and growth in network users.
- TASER segment revenue increased 17.7% in Q3 and 16.7% year to date, led by cartridges and TASER 7, while legacy X26P revenue declined.
- SG&A increased 53.7% in Q3 and 55.8% year to date. Higher stock-based compensation, headcount, professional fees and FTC litigation costs were significant contributors.
- FTC-related legal expenses increased SG&A by approximately $8.6 million in Q3 and $18.5 million year to date. Management expected full-year FTC litigation costs of approximately $19.0 million to $21.0 million.
- The company completed a June 2020 public offering of 3.45 million shares at $92.00 per share, generating $306.8 million of net proceeds.
- Property and equipment increased substantially following the purchase and related capitalization of approximately $53.9 million of costs for land and infrastructure in Scottsdale, Arizona, intended for a future manufacturing and office facility.
- Remaining performance obligations were approximately $1.51 billion at September 30, 2020. Management expected to recognize 20% to 25% over the following 12 months and generally the remainder over five to seven years, subject to deployment, appropriation and cancellation risks.
Guidance, outlook, commentary and risks
Management stated that existing liquidity and other funding sources should be sufficient for anticipated capital expenditures, working capital, potential acquisitions and other requirements for at least the next 12 months. Management expects research and development expense to continue increasing as it invests in cloud-connected devices, artificial intelligence, digital evidence management, communications and real-time situational-awareness technologies.
The company reported limited operational disruption from COVID-19 through September 30, 2020, but incurred approximately $0.4 million of pandemic-related costs in Q3 and $4.1 million year to date. Risks include manufacturing and supplier interruptions, municipal budget pressure, delayed or canceled government contracts, customer credit losses, reduced freight capacity and additional facility-contamination costs.
The FTC challenged Axon’s 2018 acquisition of Vievu. Potential remedies could include divestiture of Vievu or other assets and could be material, although no liability was recorded because the outcome could not be predicted. Axon was also defending 12 product-liability lawsuits, and management did not believe the matters were likely to have a material effect based on information available at filing.
On November 3, 2020, after the quarter end, the Compensation Committee modified performance-award metrics for certain executives. The modification may increase stock-based compensation expense by approximately $3.5 million for certain PSU awards and adjusted the EBITDA metric for specified stock compensation, FTC litigation expenses and possible Vievu-disposition effects.
Performance-based awards represent a significant source of future dilution and expense. At September 30, 2020, approximately 12.1 million performance-based awards were outstanding, and substantial unrecognized stock-based compensation remained.
Important facts for investors to verify
- Whether subscription growth and the $1.51 billion performance-obligation balance convert into cash and revenue as expected, particularly given government appropriation and cancellation clauses.
- Whether body-camera hardware margins recover after the large lower-margin shipments in Q3.
- The trajectory of operating expenses, stock-based compensation and dilution from CEO Performance Award, XSPP and other performance awards.
- The ultimate cost and resolution of the FTC litigation, including any divestiture, licensing or other remedial requirements.
- Whether operating cash flow improves as inventory and receivables normalize and subscription collections mature.
- COVID-19 effects on supply chains, municipal budgets, customer collections and manufacturing continuity.
- The use of the new Scottsdale land and the timing and funding of the planned manufacturing and office facility.