AXON ENTERPRISE, INC. annual report, FY2014

Business Context and Reporting Period

TASER International, Inc. (now associated with AXON Enterprise, Inc.) filed this Form 10-K for the fiscal year ended December 31, 2014. The business comprised two reportable segments: TASER Weapons, consisting of conducted electrical weapons, cartridges, accessories and related services; and AXON, consisting of body-worn cameras, TASER Cam, cloud-based EVIDENCE.com and related mobile products.

The filing reports annual results and unaudited quarterly information. Fourth-quarter 2014 net sales were $46.8 million, gross margin was $27.4 million and net income was $5.1 million.

Financial Metrics

Metric	2014	2013	Change
Net sales	$164.5 million	$137.8 million	+19.4%
Gross margin	$101.5 million	$85.8 million	+18.3%
Gross margin percentage	61.7%	62.3%	Down 60 basis points
Income from operations	$32.5 million	$27.9 million	+16.3%
Net income	$19.9 million	$18.2 million	+9.2%
Diluted EPS	$0.37	$0.34	+8.8%
Cash flow from operations	$35.4 million	$32.4 million	+9.3%

• TASER Weapons revenue increased 14.2% to $145.6 million and represented 88.5% of total sales. AXON revenue increased 82.6% to $18.9 million, representing 11.5% of sales.
• AXON bookings for AXON products and EVIDENCE.com increased to $57.1 million from $14.5 million. Bookings are orders rather than invoiced sales, and some future amounts are subject to government appropriations or cancellation clauses.
• Key product revenue included X26P of $43.5 million, X2 of $28.8 million, X26 of $18.7 million, cartridges of $38.5 million, AXON solutions of $9.0 million and EVIDENCE.com of $4.0 million.
• Research and development expense rose 50.5% to $14.9 million, primarily due to increased AXON development spending. SG&A increased 16.3% to $54.2 million.
• AXON remained loss-making at the segment operating level, with an operating loss of $18.6 million, compared with a $9.6 million loss in 2013. TASER Weapons generated $51.1 million of operating income.
• At December 31, 2014, cash and cash equivalents were $48.4 million, short-term investments were $32.8 million and long-term investments were $9.3 million. Working capital was $107.9 million.
• Total liabilities were $56.3 million and stockholders’ equity was $129.1 million. Long-term debt and capital lease obligations were minimal; the filing reports approximately $0.1 million of total long-term debt and capital lease obligations.
• The company had a $10.0 million secured revolving credit facility, no borrowings, $0.4 million of letters of credit and $9.6 million of remaining availability. It was in compliance with its financial covenants.
• Investing activities used $24.6 million, primarily for net investment purchases of $21.9 million and $2.7 million of property, equipment and intangible expenditures. Financing activities used $4.8 million, including $22.4 million of share repurchases.

Material Changes Versus the Prior Comparable Period

• Growth was driven by customer upgrades to the X26P and X2 smart weapons and continued adoption of AXON cameras and EVIDENCE.com.
• X26P revenue nearly doubled to $43.5 million, while X26 revenue declined 39.4% to $18.7 million. North American X26 sales were discontinued as of December 31, 2014.
• AXON unit volumes expanded substantially: AXON flex units increased 104.7% and AXON body units increased from 1,888 to 13,219.
• International sales increased to $32.3 million from $22.2 million and rose to 19.6% of total sales from 16.1%. The company established an international headquarters in Amsterdam.
• Overall gross margin declined modestly because AXON carried lower margins than TASER Weapons. TASER Weapons gross margin was 67.3%, versus 19.1% for AXON.
• Fourth-quarter inventory charges included a reserve for discontinued X26 inventory and approximately $1.1 million of potential losses on products that may not be usable in certain AXON camera products.
• Deferred revenue increased to $35.7 million from $20.2 million, reflecting extended warranties, AXON services and hardware-related deferrals. EVIDENCE.com revenue is generally recognized ratably over one- to five-year service periods.

Guidance, Outlook, Risks and Unusual Items

• Management expected additional investment in 2015 in AXON product development, EVIDENCE.com functionality, sales and marketing, international expansion and customer-facing personnel. SG&A and R&D were expected to increase.
• Management anticipated additional AXON and EVIDENCE.com trials in 2015 and believed that trials, technology summits, trade shows and an expanded sales force would support future bookings and sales.
• Management expected AXON to grow but cautioned that AXON gross margins would remain lower in the near term and that a larger AXON mix could reduce consolidated margins.
• Material risks include dependence on law-enforcement budgets and procurement cycles, reliance on X26P and X2 sales, uncertain adoption of the SaaS model, government contract appropriation clauses, product liability litigation, regulatory restrictions, cybersecurity and cloud-service interruptions, foreign exchange exposure, supplier concentration and rapid technological change.
• The company was a defendant in 12 product-liability lawsuits and had two additional product matters on appeal. Management concluded that the matters were not reasonably expected to materially affect results, but acknowledged that litigation outcomes are inherently uncertain and insurance may not cover all losses.
• The company recorded no operating litigation judgment in 2014, compared with a $1.45 million charge in 2013. A distributor matter was resolved in 2014 after an approximately $1.2 million attorneys’ fee award.
• The company maintained $3.3 million of unrecognized tax benefits and was under IRS examination for tax year 2012. No adjustments had been proposed as of the filing.
• The company did not pay dividends and did not intend to pay dividends in the foreseeable future. The credit facility also restricted cash dividends.
• Grant Thornton issued unqualified opinions on the financial statements and internal control over financial reporting. Management reported effective disclosure controls and internal control over financial reporting.

Important Facts for Investors to Verify

• Whether AXON bookings convert into recognized revenue, particularly amounts subject to municipal appropriations or cancellation provisions.
• The pace of AXON and EVIDENCE.com adoption, subscription renewals, deferred-revenue recognition and progress toward segment profitability.
• The sustainability of consolidated margins as AXON becomes a larger percentage of revenue.
• Customer upgrade demand for X26P and X2 following the discontinuation of North American X26 sales.
• Potential inventory write-downs, warranty costs and product-transition effects related to discontinued or redesigned products.
• Developments in product-liability lawsuits, appeals, insurance coverage and any related reserves or settlements.
• The outcome of the IRS examination and realization of deferred tax assets and research-and-development tax credits.
• Exposure to cybersecurity, data loss, third-party cloud outages, government budget constraints, regulatory restrictions and foreign currency changes.