Business Context and Reporting Period
TASER International, Inc. (now Axon Enterprise, Inc.) filed its Form 10-K for the fiscal year ended December 31, 2016. The business operated through two reportable segments: TASER Weapons, comprising conducted electrical weapons, accessories and related services; and Axon, comprising body-worn and in-car cameras, cloud-based Evidence.com services, applications and mobile technologies.
The filing also reports fourth-quarter results for the three months ended December 31, 2016. The company’s strategy emphasized expanding Axon devices, Evidence.com adoption, connected product bundles, international sales and artificial-intelligence capabilities.
Key Financial Metrics
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Net sales | $268.2 million | $197.9 million | +35.6% |
| Gross margin | $170.5 million; 63.6% | $128.6 million; 65.0% | Margin down 140 bps |
| Income from operations | $31.9 million; 11.9% | $35.3 million; 17.9% | Down 9.9% |
| Net income | $17.3 million | $19.9 million | Down 13.2% |
| Diluted EPS | $0.32 | $0.36 | Down $0.04 |
| Operating cash flow | $17.9 million | $46.4 million | Down $28.5 million |
| Cash and cash equivalents | $40.7 million | $59.5 million | Down $18.9 million |
| Total investments | $48.6 million | $58.8 million | Down $10.1 million |
| Total debt and capital leases | Approximately $0.2 million | Approximately $0.1 million | Limited debt |
Fourth-quarter 2016 net sales were $82.1 million, gross margin was $49.8 million and net income was $6.3 million, compared with fourth-quarter 2015 sales of $56.0 million, gross margin of $37.0 million and net income of $5.1 million.
- TASER Weapons revenue increased 24.8% to $202.6 million, representing 75.5% of consolidated sales.
- Axon revenue increased 84.7% to $65.6 million, representing 24.5% of consolidated sales.
- Axon bookings increased 88.0% to $254.1 million. These bookings include future-period contracts that may be subject to appropriation or cancellation provisions.
- Backlog increased to $384.2 million from $183.9 million. Deferred revenue included in backlog was $85.2 million, of which $45.1 million was current.
- International sales increased 37.1% to $49.5 million, or 18.4% of total sales.
- SG&A increased 55.1% to $108.1 million, while R&D increased 29.6% to $30.6 million.
- The company repurchased approximately 1.8 million shares for $33.7 million, with $16.2 million remaining under the authorization at year-end.
Material Changes Versus the Prior Comparable Period
- Revenue growth was driven by TASER CEW upgrades, trade-in programs, installment plans, the Officer Safety Plan and TASER 60, together with continued adoption of Axon cameras and Evidence.com.
- Consolidated gross margin declined because Axon represented a larger share of sales and carried lower margins than TASER Weapons. Axon gross margin nevertheless improved to 45.5% from 42.5%, primarily due to improved Evidence.com service margins.
- Operating and net margins contracted as the company expanded its sales force, customer-facing personnel, engineering organization, international operations and corporate infrastructure.
- Operating cash flow declined materially because of increases in receivables, inventory and prepaid assets. Inventory rose to $34.8 million from $15.8 million, while long-term receivables increased to $17.6 million from $1.2 million, largely related to installment and multi-year programs.
- Deferred revenue increased to $85.2 million from $51.0 million, reflecting advance payments and multi-year warranty, hardware and Axon service arrangements.
- In December 2016, the company acquired technology and hired personnel to establish Axon AI for approximately $6.8 million, including $3.5 million paid at closing and up to $3.3 million of contingent consideration. In February 2017, it acquired Dextro for approximately $7.1 million, including earn-outs, to expand video search and machine-learning capabilities.
Guidance, Outlook, Risks and Unusual Items
Management did not provide a specific quantitative revenue or earnings forecast in the filing. It stated that SG&A and R&D expenses were expected to increase in 2017 as the company invests in sales, marketing, international expansion, customer support, product development and Axon AI. Management expected available cash, investments and operating cash generation to fund 2017 operations and strategic initiatives, although no assurance was given.
- The company depended substantially on X26P and X2 CEW sales and remained exposed to slower replacement cycles, pricing pressure and changing customer acceptance.
- Evidence.com adoption involves long sales cycles, government budget constraints, data-security requirements and multi-year revenue recognition, which may delay the effect of bookings on reported revenue.
- Government contracts may be terminated or canceled for non-appropriation. Certain future bookings therefore may not convert into recognized revenue.
- Cybersecurity breaches, cloud-provider outages, data loss or corruption could result in customer attrition, litigation, penalties and reputational damage.
- The company faced product-liability litigation, including eight active lawsuits involving alleged wrongful death or personal injury. Management stated that the matters were not reasonably expected to be material, but litigation outcomes are inherently uncertain.
- Digital Ally alleged patent infringement and other claims; the company characterized the complaint as frivolous and was defending the matter. A former French distributor also asserted an arbitration claim of approximately $0.6 million.
- The company had $46.0 million of open purchase orders, primarily cancelable orders with key vendors, and relied on certain single-source suppliers.
- The $10.0 million revolving credit facility had no borrowings, but $2.7 million of letters of credit reduced availability to $7.3 million. The facility matured July 31, 2017. The company’s leverage covenant violation at year-end was waived.
- Grant Thornton issued an unqualified opinion on the financial statements but an adverse opinion on internal control over financial reporting. Material weaknesses involved revenue recognition, cost of products and services, deferred revenue, account reconciliations and monitoring processes. Management expected remediation before the end of fiscal 2017.
- The company recorded a $14.2 million tax provision, a 45.1% effective tax rate, and approximately $4.1 million of unrecognized tax benefits, which could favorably affect the tax rate if ultimately recognized.
Important Facts for Investors to Verify
- Whether Axon bookings and backlog convert into recognized revenue and cash, particularly where contracts contain appropriation or cancellation clauses.
- The sustainability of Axon gross-margin improvement as camera, storage, professional-services and cloud costs scale.
- Progress in remediating the material weaknesses and whether subsequent filings report effective internal controls.
- Cash conversion, receivables collection, inventory levels and the effect of installment, OSP and TASER 60 programs on liquidity.
- The renewal rate and economics of Evidence.com subscriptions and the adoption of newer Axon products, including Axon Fleet and Axon AI capabilities.
- Developments in product-liability, Digital Ally, patent and distributor litigation, including insurance coverage and potential exposures.
- Refinancing or renewal of the revolving credit facility and continued compliance with its financial covenants.
- Potential effects of regulatory restrictions on CEWs, international trade and exports, foreign exchange movements, cybersecurity incidents and data-protection requirements.