Business Context and Reporting Period
Axon Enterprise, Inc. (formerly TASER International) develops conducted electrical weapons, body-worn cameras, digital evidence-management software, and related technology for law enforcement, military, corrections, security, and consumer markets. The filing is an unaudited Form 10-Q for the three months ended March 31, 2017, compared primarily with the first quarter of 2016.
The company reports two segments: TASER Weapons and Software and Sensors. The Software and Sensors segment includes Axon cameras, docks, Evidence.com, and Axon AI.
Key Financial Metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $79.2 million | $55.5 million | Up 42.7% |
| Gross margin | $48.7 million; 61.4% | $36.9 million; 66.5% | Margin down 5.1 points |
| Income from operations | $5.4 million; 6.8% | $5.1 million; 9.3% | Up $0.2 million |
| Net income | $4.6 million; 5.8% | $3.5 million; 6.2% | Up 32.3% |
| Diluted EPS | $0.09 | $0.06 | Up $0.03 |
| Cash flow from operations | $(6.6) million | $7.1 million | Down $13.7 million |
Revenue growth was led by Software and Sensors, which increased 122.5% to $21.6 million, including Evidence.com revenue of $11.7 million, up $7.2 million. TASER Weapons revenue increased 25.8% to $57.7 million. Bookings for Evidence.com and Axon products and services increased 15.4% to $60.1 million, although certain future bookings remain subject to government appropriations or cancellation clauses.
Gross margin declined primarily because Software and Sensors represented a larger share of sales, hardware margins declined from 30.2% to 7.9% due to higher discounting, and service margins were affected by non-recurring data-migration costs. Total operating expenses increased 36.4% to $43.3 million, including a 79.9% increase in research and development expense to $12.5 million.
Liquidity, Cash Flow, Debt, and Balance Sheet
- Cash and cash equivalents were $42.0 million at March 31, 2017; short-term investments were $29.6 million. Total cash, cash equivalents, and investments were $71.6 million, down from $89.2 million at December 31, 2016.
- Total assets were $299.5 million and total liabilities were $142.1 million at March 31, 2017.
- There were no borrowings under the $10.0 million revolving credit facility. Letters of credit of approximately $2.7 million reduced available borrowing to approximately $7.3 million.
- The revolving facility matures July 31, 2017. The company violated its maximum leverage covenant, with a reported leverage ratio of 1.14:1 versus a 1.00:1 limit; the violation was waived as of March 31, 2017. The fixed-charge coverage ratio was 2.45:1 versus a 1.25:1 minimum.
- Operating cash use reflected a $13.7 million inventory increase, primarily to support a national body-camera field trial and expected sales, a $11.0 million increase in prepaid expenses and other assets, and a $3.5 million increase in receivables.
- Investing activities provided $9.9 million, primarily from $18.8 million of investment maturities and calls, partially offset by $6.5 million for the Dextro acquisition and $2.4 million of property, equipment, and intangible purchases.
- Financing activities used $1.9 million, including $2.2 million of payroll-tax payments related to net-settled stock awards. No shares were repurchased during the quarter.
Material Changes Versus Prior Comparable Period
- Net sales increased $23.7 million, driven by substantially higher Axon camera, dock, and Evidence.com adoption and higher TASER X2 and cartridge sales.
- Software and Sensors increased to 27.2% of consolidated sales from 17.5%, while TASER Weapons declined to 72.8% from 82.5% of sales.
- Gross margin fell from 66.5% to 61.4%, and operating margin fell from 9.3% to 6.8%, despite higher operating income.
- SG&A rose 24.3% to $30.9 million, while R&D rose 79.9% to $12.5 million as the company expanded sales, support, engineering, and product-development resources.
- The company adopted ASU 2016-09 for share-based payments and ASU 2015-11 for inventory. Adoption of ASU 2016-09 increased the dilutive share count and resulted in a $0.5 million reduction to retained earnings related to forfeiture accounting; the company reported no material current-year EPS impact.
- The company acquired Dextro, Inc. for approximately $7.5 million, including contingent consideration, adding computer-vision and deep-learning technology to Axon AI. It also acquired intellectual property and personnel from Fossil-related entities, with an approximately $6.8 million purchase price.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Management estimated a full-year 2017 effective tax rate of approximately 42.9% before discrete items. Q1’s reported 17.6% rate benefited from a $1.0 million discrete tax benefit related to stock-based compensation.
- Management stated that expected operating results, cash, investments, and available financing should be sufficient to fund operations and strategic initiatives through the remainder of 2017 and the foreseeable future, while noting that additional financing may not be available on acceptable terms.
- The company expects continued investment in the Software and Sensors platform, including cloud-connected devices, Evidence.com, and Axon AI. It also expects future income to trend upward, supporting realization of a substantial portion of deferred tax assets.
- The company had eight active product-liability lawsuits involving alleged wrongful death or personal injury associated with TASER CEWs, plus other patent, antitrust, commercial, arbitration, and business litigation. Management did not believe the matters were reasonably likely to have a material aggregate effect, but acknowledged that outcomes are inherently uncertain and insurance may not cover all losses.
- Outstanding off-balance-sheet commitments included approximately $5.7 million of surety bonds and $2.7 million of letters of credit, the latter expected to expire in May 2017.
- Management identified material weaknesses in internal control over financial reporting relating to income taxes, revenue recognition, cost of goods and services, deferred revenue, account reconciliations, and monitoring processes. Disclosure controls were therefore considered ineffective as of March 31, 2017. Management expected remediation before the end of fiscal 2017, but remediation was not complete at the filing date.
- Other notable risks include government budget and appropriation clauses, customer acceptance and long-term contract cancellation risk, cybersecurity and Evidence.com service outages, product defects and warranty exposure, rapid technological change, competition, international and foreign-currency exposure, tax uncertainty, and dependence on key products and suppliers.
Facts Investors Should Verify
- Whether the company can sustain rapid Software and Sensors and Evidence.com growth while restoring segment hardware and consolidated gross margins.
- Whether inventory growth, receivables, prepaid commissions, and long-term contract investments convert into operating cash flow.
- How the July 2017 credit-facility maturity and previously waived leverage-covenant violation are resolved.
- Progress and effectiveness of remediation for the disclosed material weaknesses in financial reporting and tax accounting.
- The durability and collectability of multi-year bookings subject to government appropriations or cancellation clauses.
- The financial and operational impact of the Dextro and Axon AI acquisitions, including contingent earn-outs and integration results.
- Developments in product-liability, patent, antitrust, and other litigation, including insurance coverage and potential exposure beyond recorded amounts.
- The effect of the unusually low Q1 tax rate and the company’s estimated 42.9% full-year tax rate on future earnings.