Business Context and Reporting Period
Axon Enterprise, Inc. develops and sells conducted electrical weapons, body-worn and in-car cameras, digital evidence management software, cloud services, and related products for law enforcement, military, corrections, security, and consumer markets. This unaudited Form 10-Q covers the three months ended March 31, 2018, compared primarily with the three months ended March 31, 2017.
The company reports two segments: TASER Weapons and Software and Sensors. Axon adopted ASC Topic 606 on January 1, 2018 using the modified retrospective method. Prior-period amounts were not adjusted.
Financial Results and Key Metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $101.2 million | $79.2 million | 27.7% increase |
| Product sales | $81.0 million | $67.5 million | 20.0% increase |
| Service sales | $20.2 million | $11.8 million | 72.2% increase |
| Gross profit | $64.5 million | $48.7 million | 32.5% increase |
| Gross margin | 63.7% | 61.4% | 230 basis-point increase |
| Operating income | $13.6 million | $5.4 million | 153.9% increase |
| Operating margin | 13.4% | 6.8% | 660 basis-point increase |
| Net income | $12.9 million | $4.6 million | 182.2% increase |
| Diluted EPS | $0.24 | $0.09 | Increase |
| Cash flow from operations | $18.1 million | $(6.6) million | $24.7 million improvement |
- TASER Weapons revenue was $63.5 million, up 10.1%. Software and Sensors revenue was $37.7 million, up 74.7%.
- Evidence.com revenue increased 72.4% to $20.2 million. Axon Body, Flex, and Dock revenue increased collectively by $3.4 million, and Axon Fleet generated $2.1 million of first-quarter revenue.
- International revenue increased 60.6% to $23.3 million and represented 23% of total sales, compared with 18% in the prior-year quarter.
- Sales and marketing, general and administrative expense increased 15.9% to $35.8 million, while research and development expense increased 21.3% to $15.1 million.
- The reported effective tax rate was 12.9%, including a $1.6 million discrete tax benefit principally related to stock-based compensation. Management identified a 23.1% estimated full-year rate before discrete items.
Financial Position, Liquidity, and Capital Resources
- Cash and cash equivalents were $92.3 million at March 31, 2018, compared with $75.1 million at December 31, 2017. Cash, cash equivalents, and restricted cash totaled $94.8 million.
- Total assets were $393.0 million and total liabilities were $193.7 million. Stockholders’ equity was $199.3 million.
- Accounts receivable and contract assets totaled $97.1 million, up from $56.1 million of accounts and notes receivable at year-end, primarily reflecting growth in customer programs and the adoption of Topic 606.
- Deferred revenue was $134.1 million, including $76.1 million current and $58.0 million long-term. Remaining performance obligations were approximately $650 million; the company expected to recognize 15% to 20% over the next twelve months and the remainder over five to seven years, subject to cancellation, appropriation, and deployment risks.
- The company had no borrowings under its $10.0 million revolving credit facility. Outstanding letters of credit reduced availability to $7.3 million. The facility matures December 31, 2018.
- Capital expenditures and intangible asset purchases totaled approximately $1.1 million. No shares were repurchased under the stock repurchase program during the quarter.
Material Changes Versus the Prior Comparable Period
- Revenue growth was led by Software and Sensors, particularly Evidence.com, camera-related products, Axon Fleet, and international sales.
- Gross margin improved primarily from greater fixed-cost leverage in cloud storage, lower non-recurring cloud migration costs, and Topic 606 revenue allocation that generally recognized more hardware revenue when delivered.
- Operating performance improved despite higher investment in sales, general and administrative activities and research and development.
- Operating cash flow shifted from a $6.6 million use in Q1 2017 to $18.1 million of cash generation in Q1 2018. The improvement reflected higher net income, increased deferred revenue, and lower inventory investment, partially offset by a $17.1 million increase in accounts receivable and contract assets.
- Topic 606 increased opening retained earnings by $19.0 million and increased Q1 2018 revenue by $1.7 million and reduced SG&A by approximately $0.5 million compared with the amounts that would have been recognized under prior revenue guidance.
Guidance, Outlook, Commentary, Risks, and Unusual Items
- No formal revenue or earnings guidance was provided in the filing. Management expects research and development expense to continue increasing as it invests in new CEW technologies, cloud-connected devices, and additional software and services. Management expects long-term operating leverage as subscription revenue scales.
- The company reported 226,900 cloud-based software licenses and annual recurring run-rate Axon Cloud and Sensors and Other revenue of $83.3 million at March 31, 2018. Approximately 55% of consolidated revenue came from contracts with multiple performance obligations.
- Key risks include municipal budget appropriations, customer cancellation or non-renewal, delayed deployments, the transition toward subscription arrangements, cybersecurity and service outages, foreign currency exposure, product liability litigation, competition, inventory obsolescence, and reliance on the X2 and X26P devices.
- Seven product liability lawsuits involving alleged wrongful death or personal injury were active at quarter-end. Management stated that it did not believe the matters were reasonably likely to materially affect results, but litigation outcomes remain uncertain and insurance may not cover all costs.
- Axon obtained a judgment exceeding $7.8 million against Phazzer in April 2018, but collectability was in doubt because Phazzer reported insolvency. The related injunction and appeals remained outstanding.
- Management concluded that disclosure controls were not effective because a material weakness involving account reconciliations and monitoring at the U.K. subsidiary had not yet been remediated and tested.
- On May 3, 2018, after quarter-end, Axon acquired VIEVU for $4.6 million in cash and 58,843 shares, with potential additional stock earn-outs of up to $6.0 million. VIEVU’s results were to be included beginning in the second quarter of 2018.
Most Important Facts for Investors to Verify
- Whether the strong Software and Sensors growth, Evidence.com adoption, bookings, and recurring revenue continue after the quarter.
- The effect of Topic 606 on reported hardware revenue, margins, deferred revenue, contract assets, and comparability with 2017.
- Conversion of the approximately $650 million remaining performance obligation balance into recognized revenue and cash, including the effect of municipal appropriations and cancellation clauses.
- Whether receivables and contract assets continue to grow faster than revenue and whether subscription sales create additional working-capital requirements.
- Progress in remediating the material weakness at the U.K. subsidiary and the effectiveness of related internal controls.
- The financial impact, purchase accounting, integration progress, and potential earn-out dilution from the VIEVU acquisition.
- Developments in product liability, Digital Ally, Phazzer, and other legal proceedings, including insurance coverage and collectability of favorable judgments.
- The sustainability of the 12.9% reported tax rate versus the 23.1% estimated rate before discrete items, including uncertain tax positions and expiring research and development credits.