AXON ENTERPRISE, INC. quarterly report, Q3 FY2019

Axon Enterprise, Inc. — Form 10-Q Summary

Business context and reporting period

Axon provides connected public-safety technology, including TASER conducted electrical weapons, cameras, sensors, cloud-based evidence management, and related services. The filing covers the three and nine months ended September 30, 2019; results are unaudited and compared with the corresponding 2018 periods.

Reportable segments: TASER and Software and Sensors.
As of October 31, 2019, common shares outstanding were approximately 59.3 million.

Financial performance and position

Metric	Q3 2019	Q3 2018	9M 2019	9M 2018
Net sales	$130.8 million	$104.8 million	$359.0 million	$305.3 million
Gross margin	$80.2 million; 61.3%	$65.6 million; 62.6%	$214.6 million; 59.8%	$193.2 million; 63.3%
Income from operations	$6.6 million; 5.1%	$4.0 million; 3.8%	$8.0 million; 2.2%	$22.8 million; 7.5%
Net income	$6.1 million	$5.7 million	$13.3 million	$27.1 million
Diluted EPS	$0.10	$0.10	$0.22	$0.47
Operating cash flow	Not separately provided	Not separately provided	$19.9 million	$32.6 million

Q3 revenue increased 24.8%; nine-month revenue increased 17.6%.
Services revenue increased to $34.3 million in Q3 from $23.9 million and to $94.0 million for the first nine months from $66.7 million.
Software and Sensors revenue increased 43.5% in Q3 and 37.3% for the first nine months, driven primarily by Axon Evidence and cloud services. Q3 Software and Sensors bookings were $128.2 million, up 38.0% year over year.
TASER segment revenue increased 12.7% in Q3 and 5.3% year to date. TASER 7 adoption increased while legacy X2 and X26P unit sales declined.
Gross margin declined because of TASER 7 launch costs, product mix, trade-in credits, and higher data-storage costs. Nine-month TASER segment gross margin was 62.5%, compared with 69.4% in 2018; Software and Sensors segment gross margin was 56.4%, compared with 53.6%.
Operating expenses increased to $73.6 million in Q3 and $206.7 million year to date, reflecting higher sales and marketing, research and development, headcount, commissions, and stock-based compensation.
Stock-based compensation was $13.7 million in Q3 and $30.2 million for the first nine months, compared with $6.3 million and $15.3 million, respectively, in 2018.

Liquidity, cash flow, debt, and commitments

At September 30, 2019, cash and cash equivalents were $202.6 million; short- and long-term investments were $150.3 million; cash, cash equivalents, and restricted cash totaled $204.1 million.
Cash declined $146.9 million from year-end 2018, primarily because the company purchased $150.5 million net of investments. Capital expenditures and intangible-asset purchases totaled $12.4 million.
Operating cash flow was $19.9 million, down from $32.6 million, as receivables and contract assets increased $30.5 million and inventory increased $6.3 million. Deferred revenue provided a $28.5 million operating cash benefit.
Axon had no borrowings under its $50.0 million revolving credit facility. Approximately $46.4 million was available after $3.6 million of letters of credit. The facility matures December 31, 2021.
Funded debt to EBITDA was 0.001 to 1.00, versus a maximum covenant of 2.50 to 1.00.
Remaining performance obligations were approximately $1.13 billion at September 30, 2019. Management expects 15%–20% to be recognized over the next 12 months, with most of the remainder over five to seven years, subject to deployment, appropriation, and cancellation risks.
The company entered a three-year cloud data-storage commitment totaling $50.0 million, including a $15.0 million upfront prepayment; $46.3 million remained committed at quarter-end.

Material changes versus the prior comparable period

Revenue growth accelerated through Software and Sensors, particularly Axon Evidence and cloud services, while TASER revenue shifted from legacy devices to TASER 7.
Despite higher revenue, nine-month operating income fell 65.0% and net income fell 51.1%, primarily due to increased operating expenses, TASER 7 ramp-up costs, data-storage expenses, and higher stock-based compensation.
Nine-month gross margin contracted 350 basis points to 59.8%; Q3 gross margin contracted 130 basis points to 61.3%.
The company adopted the lease accounting standard ASC 842 on January 1, 2019, recognizing operating lease assets and liabilities. At September 30, operating lease liabilities totaled $11.6 million.
The company began selling Axon Body 3 during the quarter.
During the nine months, Axon recorded $1.3 million of impairment related to abandoned enterprise-resource-planning software. It also recorded a $0.7 million impairment charge for abandoned planning and site-development activities related to a planned headquarters.

Guidance, outlook, commentary, and risks

Management expected 2019 revenue of $500 million to $510 million.
Q4 gross margin was expected to decline from Q3 because of anticipated lower-margin Axon Body 3 and TASER 7 cartridge shipments. Management expected hardware-margin compression ahead of higher-margin cloud revenue over time.
Full-year stock-based compensation was expected to be approximately $41 million, subject to changes in the probability and timing of performance-award targets.
Management expected a normalized income tax rate of 20%–25%; the nine-month reported effective rate was 5.1%, affected by discrete tax items.
Management believes liquidity is sufficient for anticipated requirements for at least the next 12 months, but notes that future cash generation and access to financing are not assured.
Key risks include government budget appropriations and contract cancellations, subscription-related collection timing and credit losses, supply-chain interruptions and component costs, product defects and warranty claims, cybersecurity and cloud outages, privacy regulation, international operations, litigation, intellectual-property claims, and dependence on key personnel.
Axon was defending eight product-liability lawsuits involving alleged wrongful death or personal injury. Management did not consider the matters reasonably likely to be material, but litigation outcomes remain uncertain.
The company was cooperating with a non-public FTC investigation concerning its 2018 VIEVU acquisition. Digital Ally’s patent litigation judgment in Axon’s favor had been appealed.
The company terminated its planned land purchase for a new headquarters after failing to secure design approval and expected to forfeit approximately $0.2 million of escrow.

Most important facts for investors to verify

Whether Software and Sensors growth, cloud bookings, and the $1.13 billion performance-obligation balance convert into recognized revenue and cash as expected.
The pace and profitability of TASER 7 and Axon Body 3 deployments, including the effect of product mix, trade-in credits, and ramp-up costs on gross margin.
Whether operating cash flow improves as subscription-related receivables, contract assets, and inventory grow.
The future impact of performance-based equity awards, including potentially substantial stock-based compensation and dilution.
Progress and ultimate resolution of the FTC investigation, product-liability cases, Digital Ally appeal, and consumer class action.
Execution of the $50.0 million cloud-storage commitment and whether storage and compute costs moderate as management expects.
Whether the $500 million–$510 million 2019 revenue outlook and normalized tax-rate expectations are achieved.