Business Context and Reporting Period
Company: TASER International, Inc. (now Axon Enterprise, Inc.), a developer and manufacturer of conducted electrical weapons, on-officer cameras, digital evidence management software, and related services. The company reports two segments: TASER Weapons and Axon.
Period: Form 10-Q for the quarter and six months ended June 30, 2016; comparative periods are the three and six months ended June 30, 2015. Financial statements are unaudited.
Key Financial Metrics
| Metric | Q2 2016 | Q2 2015 | Six Months 2016 | Six Months 2015 |
|---|---|---|---|---|
| Net sales | $58.8 million | $46.7 million | $114.3 million | $91.5 million |
| Gross margin | $37.3 million; 63.5% | $30.7 million; 65.8% | $74.2 million; 64.9% | $60.6 million; 66.2% |
| Income from operations | $6.2 million; 10.6% | $9.4 million; 20.1% | $11.4 million; 9.9% | $20.1 million; 22.0% |
| Net income | $3.7 million | $6.1 million | $7.1 million | $13.3 million |
| Diluted EPS | $0.07 | $0.11 | $0.13 | $0.24 |
| Cash flow from operations | Not separately provided | Not separately provided | $10.3 million | $11.0 million |
Q2 sales increased 25.8% year over year, while six-month sales increased 24.9%. Axon segment sales grew 48.7% in Q2 and 49.7% for the six-month period, led by Evidence.com and on-officer camera adoption. TASER Weapons sales grew 20.4% in Q2 and 20.0% for the six-month period.
Operating expenses increased substantially, particularly sales, general and administrative expense, which rose 57.9% in Q2 and 64.0% for the six-month period. Research and development expense increased 13.6% in Q2 and 30.3% for the six-month period, primarily due to Axon headcount and product development. Axon generated an operating loss of $8.9 million in Q2 and $19.1 million for the six-month period, compared with losses of $5.3 million and $9.9 million, respectively, in the prior-year periods.
Balance Sheet, Cash Flow, Debt and Liquidity
- Cash and cash equivalents were $37.3 million at June 30, 2016, compared with $59.5 million at December 31, 2015.
- Total cash, cash equivalents and investments were $91.6 million, down $26.7 million from year-end 2015.
- Total assets were $228.7 million and total liabilities were $94.3 million.
- Deferred revenue increased to $66.8 million from $51.0 million at year-end, reflecting growth in prepaid hardware, warranties, Axon services and Evidence.com subscriptions.
- Operating cash flow was $10.3 million. Investing activities provided $1.6 million, primarily because investment maturities exceeded purchases.
- Financing activities used $34.5 million, including $33.7 million for common-stock repurchases and $1.0 million for payroll taxes on net-settled stock awards.
- The company had approximately $0.1 million of long-term debt and capital lease obligations and no borrowings under its $10.0 million revolving credit facility. Approximately $3.0 million of letters of credit reduced available borrowing to approximately $7.0 million.
- The company reported compliance with its credit covenants: a 0.80:1 leverage ratio versus a maximum of 1.00:1 and a 2.24:1 fixed-charge coverage ratio versus a minimum of 1.25:1.
Material Changes Versus Prior Comparable Period
- Revenue growth was strong, but profitability declined: Q2 net income fell 40.2% and six-month net income fell 46.6% year over year.
- Gross margin declined 230 basis points in Q2 and 130 basis points for the six-month period, largely due to discounting associated with upgrade programs and installment plans. Axon segment margins improved for the six-month period to 49.7% from 44.3%.
- Evidence.com revenue increased 82.9% in Q2 to $4.9 million and 106.4% for the six-month period to $9.5 million.
- Axon bookings were $72.0 million in Q2, up 135.2% from $30.6 million. Future bookings remain subject to municipal appropriations and potential contract cancellation clauses.
- The company repurchased approximately 1.8 million shares for $33.8 million during the first six months. Approximately $16.2 million remained authorized for future repurchases at June 30.
- Inventory increased to $21.9 million from $15.8 million at year-end, while prepaid expenses and other assets increased to $14.3 million from $8.2 million.
- The company recorded a $0.8 million out-of-period adjustment in the first quarter for liabilities that should have been recorded in the fourth quarter of 2015. Management concluded the error was not material to previously reported periods or expected full-year 2016 results.
Guidance, Outlook, Commentary and Risks
- Management estimated a full-year 2016 effective tax rate of approximately 37.8% before discrete adjustments. The six-month effective rate was 37.3%.
- Management stated that expected operating cash flow, cash and investments, and available credit should be sufficient to fund operations and strategic initiatives for the remainder of 2016 and the foreseeable future.
- Management expects Axon fixed costs to become more leveraged as sales grow and expects service-delivery costs as a percentage of service revenue to decline over time, but no quantitative margin guidance was provided.
- The company identified a material weakness in internal control over financial reporting involving liability identification and recording, revenue recognition, deferred revenue, account reconciliations and monitoring. Disclosure controls were therefore deemed ineffective as of June 30, 2016. Remediation efforts included additional accounting staff, enhanced reviews, system controls and documentation; management expected completion before year-end 2016, subject to testing.
- Product-liability litigation consisted of nine active lawsuits alleging wrongful death or personal injury associated with TASER devices. Management did not believe the matters were reasonably likely to have a material aggregate effect, but acknowledged that outcomes are inherently uncertain and insurance coverage may be insufficient.
- The company faced patent and other litigation from Digital Ally, a patent and trademark action against Phazzer, and an approximately $0.6 million arbitration claim from a former French distributor.
- Brexit was identified as a new risk that could increase regulatory complexity, costs and restrictions in the United Kingdom and adversely affect operations.
- Tax assets and uncertain tax positions require significant judgment. The company reported approximately $3.6 million of unrecognized tax benefits and estimated that approximately $44.0 million of future U.S. pretax book income would be needed to realize the relevant net deferred tax assets.
- Other key risks include government budget and appropriation constraints, product defects and warranty costs, data-security breaches or Evidence.com outages, competition, intellectual-property claims, foreign-exchange exposure, supplier dependence and the ability to scale Axon operations.
Important Facts for Investors to Verify
- Whether Axon revenue growth and bookings convert into recognized revenue and cash, particularly where contracts contain future appropriations or cancellation clauses.
- Whether Axon can achieve sustained profitability as sales, marketing, research and development, and infrastructure spending continue to rise.
- Progress and independent testing of remediation efforts for the material weakness in internal controls.
- The adequacy of warranty reserves, especially for the newly launched Axon Body 2, and the impact of product returns on margins and cash flow.
- The ultimate exposure from product-liability, patent, commercial and arbitration proceedings and the sufficiency of insurance coverage.
- Utilization and expiration of federal, state and foreign tax attributes, including Arizona research and development credits.
- The effect of Brexit, foreign-currency movements and international sales volatility on results.
- Whether continued share repurchases are consistent with funding requirements for inventory, deferred-revenue obligations, product development and Axon expansion.