Axon Enterprise - Earnings Call - Q1 2012
April 26, 2012
Transcript
Speaker 1
As a reminder, this call is being recorded for replay purposes. I'd now like to hand the call over to Mr. Rick Smith, CEO. Please go ahead, sir.
Speaker 3
Great, thank you. Welcome everyone. Thanks for spending part of your morning with us. Before we get started, I'm going to have Dan Barrett, our CFO, read the safe harbor.
Speaker 0
Thank you, Rick. Our safe harbor statement: Certain statements contained in this presentation may be deemed to be forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Axon Enterprise intends that such forward-looking statements be subject to the safe harbor created thereby. Such forward-looking statements relate to expected revenue and earnings growth, estimations regarding the size of our target markets, successful penetration of the law enforcement market, expansion of product sales to the private security, military, and consumer self-defense markets, growth expectations for new and existing accounts, expansion of production capability, new product introductions, product safety, and our business model. We caution that these statements are qualified by important factors that could cause actual results to differ materially from those reflected by the forward-looking statements herein.
Such factors include, but are not limited to, market acceptance of our products, establishment and expansion of our direct and indirect distribution channels, attracting and retaining the endorsement of key opinion leaders in the law enforcement community, the level of product technology and price competition for our products, the degree and rate of growth in the markets for which we compete, and accompanying demand for our products, potential delays in international and domestic orders, implementation risk of manufacturing automation, risks associated with rapid technological change, execution and implementation risks of new technology, new product introduction risks, ramping manufacturing production to meet demand, litigation resulting from alleged product-related injuries and deaths, media publicity concerning product uses and allegations of injury and deaths, and the negative impact this could have on sales, product quality concerns, potential fluctuations in quarterly operating results, competition, negative reports concerning TASER device uses, financial and budgetary constraints and prospects and customers, dependence on sole limited source suppliers, fluctuations in component pricing, risk of government investigations and regulations, TASER product tests and reports, dependence upon key employees, employee retention risk, and other factors detailed in the company's filings with the Securities and Exchange Commission.
With that, I'll turn it back over to Rick Smith.
Speaker 3
Thanks, Dan. I think we're all proud to be having a call like the one we're having today. I think the results reflect a lot of hard work by a lot of great people. As you all are probably aware, first quarter revenues came in at $25.6 million, an increase of $2.5 million or 10.9% over the first quarter a year ago. Sequentially, revenues grew by about 20%. This increase was driven primarily by our third consecutive quarter of growth in North American law enforcement, which grew by over 25%, as well as by a large order from the U.S. Army. These increases were partially offset by a 51% decrease in international sales from the year-ago period, although we did see a slight sequential increase over the fourth quarter.
There were two particularly bright spots I'd like to highlight in the first quarter revenues, and then I'll hand over to Dan to go through the details. Gross margin across the business grew from 52.8% in the year-ago period to 59.4%. Even more impressive, if you look at gross margins in our core ECD segment, they were at 65.2%. Operating income of $6.4 million, $6.456 million, I guess round that to $6.5 million, came in over 25% of revenues, driven by a combination of strong operating results and a partial reversal of the Turner verdict, which caused us to reduce our litigation reserve by $2.2 million. Now, with that, I will hand over to Dan to go into more detail through the results.
Speaker 0
Thanks, Rick. As Rick said, revenue for Q1 was $25.6 million, which is up approximately $2.5 million or 10.9% from the prior year first quarter amount. The increase in sales versus prior year were driven by the continued adoption of the X2 electronic control device, as well as a significant order from the U.S. Army for 3,500 X26 Electronic Control Devices following the Department of Defense's type classification of the X26. Gross margin for the first quarter was $15.2 million or 59.4% of revenue, which is 6.6% as percent of sales, better than the 52.8% in the prior year. The improvements in margin were mostly driven by the increased leverage of indirect manufacturing costs due to the higher sales and a favorable product mix. When we look at the core ECD segment gross margin, it was 65.2% in Q1 of 2012 versus 59.3% in Q1 of 2011.
We're encouraged by the gross margin performance. We'll likely see a slight degradation in gross margin as we increase the sale of video products, as these carry a lower gross margin than the ECD products, but that should be partially offset over time with the profitable recurring revenue from Evidence.com as the video business scales up. The SG&A expenses for the quarter were $8.9 million versus $9.3 million in the prior year. SG&A was 34.5% of net sales in Q1 of 2012, compared to 40.4% of net sales in 2011. The improvement was mostly driven by lower consulting and lobbying fees, about $240,000. We continue to be encouraged by the lower SG&A levels, although some of the improvements in the quarter are really driven by some timing difference. We expect the ongoing SG&A rates to be closer to the sort of the 2011 SG&A levels on a go-forward basis.
Research and development expenses were $2.1 million for the first quarter, which were favorable by $0.6 million when compared to 2011. The decrease was mostly driven by a continued decline in consulting costs, as well as implementing some headcount reductions. It's similar to SG&A. R&D expenses were favorable even to our budget. We expect ongoing R&D expenses to be closer to the run rate you saw in the flatter part of 2011. The litigation judgment expense is driven by the reversal of the part of our accrual on the Turner case. The judgment allowed us to reverse $2.2 million of the $3.3 million we had on the balance sheet. We still have that $1.1 million reserved, which is the amount of the judgment, which is in excess of our insurance limits for that year.
Adjusted operating income, which excludes the impact of stock-based compensation charges, depreciation, amortization, and losses on write-down disposal of property equipment, was $6.7 million for the first quarter of 2012. This is a $3.5 million, or 113%, increase from the adjusted operating income of $3.1 million in the first quarter of 2011. We also backed out the benefit of the partial reversal of litigation judgment on Turner out of that normalized adjusted operating income, just so people would see sort of on a go-forward basis without that one-time benefit in the results. The GAAP income from operations for the quarter was $6.5 million for the first quarter, compared to income from operations of $100,000 in the first quarter of 2011.
Net income for the first quarter was $3.8 million or $0.07 per share on both a basic and diluted basis, compared to net income of $19,000 or $0.00 per share on a basic and diluted basis in the first quarter of 2011. The tax provision for the first quarter is $2.6 million, compared to $0.1 million in the first quarter of last year. We continue to show the results of both the video and ECD segments of the business. Increased sales and reductions in the cost structure drove an increase in operating income from the ECD business in the first quarter of 2012 to $9.4 million versus $2.9 million in the first quarter of 2011. When we back out the one-time benefit, the reduction of the judgment accrual on the Turner case and normalize the result, income from operations for ECD remains at $7.2 million, or 29% of ECD sales.
Very strong results in that segment of the business. We do continue to invest heavily in the video segment. The loss from operations for the video business was $3 million in the first quarter of 2012 versus $2.9 million in the first quarter of 2011. We are beginning to see more traction in the video business with the launch of the Axon Flex product and expect to see results improve over the year. Moving on to the balance sheet, we did finish the quarter with $29.7 million worth of cash, cash equivalents and short-term investments. The increase of $3.3 million from the year-end balance was due to the $3.6 million provided from cash from operating activities. The net cash flow from operations was $3.6 million, which drove that increase in the cash balance.
Accounts receivable of $14.3 million are up $2.5 million from the prior year-end due to the increased sales in the first quarter of 2012 versus the fourth quarter of 2011. Inventory of $11.1 million is down about $400,000 from the prior year-end balance. The decrease is attributed to just general reductions in inventory balances and the increased sales figures. We do expect to see a short-term surge in the inventory balances as we ramp up the production of the Axon Flex product line. The investment of property equipment is $25.6 million, down $1.2 million compared to the prior year. The decrease is mostly a result of $1.6 million of depreciation expense, which was partially offset by investments in property equipment for TASER X2 electronic control device product line and the Axon Flex video product line. Total assets were $107.4 million at the end of the quarter.
Moving on to the liability side of the balance sheet, accounts payable of $3.8 million is down $700,000 from the prior year-end due to timing differences and AP check runs at the year-end versus the quarter-end. Accrued liabilities of $5.8 million decreased $3.5 million primarily due to the litigation judgment expense reversal of $2.2 million on the Turner case. Deferred revenue of $8.2 million at March 31st increased $225,000 from the year-end balances due to new increased sales of the X2 trade-in program, which includes an extended warranty. That extended warranty deferral went up in the first quarter. We continue to have no long-term debt and plenty of liquidity to operate the business here. As we move on to the cash flow information, the company had cash provided from operations of $3.6 million during the first quarter of 2012 versus $4.4 million in the same quarter last year.
The biggest difference versus the cash generation last year is the $2.5 million of AR. It's more of just driven by the sales growth in the first quarter. We did have cash used in investing activities for the first quarter was $0.6 million compared to $10.2 million in the same period in the prior year. The use of cash in 2011 was mostly driven by the net purchasing activity of short-term investments last year. Cash used in financing activities was only $14,000 for the three months ended March 31st, 2012, compared to $5.1 million used in the same period in 2011. The cash usage in 2011 was driven by the stock buyback. As we announced on the release here, the Board of Directors did approve another $20 million buyback for the company. You'll see that cash used in financing activities go up as we move into 2012.
The company did end the quarter with $24.3 million in cash and $5.3 million in short-term investments for a total of $29.7 million in cash, cash equivalents, and short-term investments. Again, very confident in the strong liquidity position we're in and the ability for the business to generate cash, which gives us a lot of confidence in the business. I'd also like to just cover the unit sales before I turn the call back over to Rick, just for the analysts so they can model this. For X26s, we sold 13,415 units in Q1 of 2012. We sold 3,778 X2 units, 874 M26 units, 8 of the X3 units. We sold 3,054 of the C2s. TASER cans, we actually had a quarter for TASER cans, 1,631 TASER cans sold in the quarter, and we sold 362,785 cartridges. With that, I'll turn the call back over to Rick Smith.
Speaker 3
Thanks, Dan. First, I'd like to highlight the U.S. Army order. Certainly, I'm sure folks are asking whether we should think about it as a one-time event or if this is something that can impact the future of the business. The important part there is that this purchase comes at the end of the type classification process, which the military has a fairly involved approval process for products to be type classified, which means that all the acquisition methodologies, procedures, safeguards, etc., are in place and the product is officially approved for use by the Department of Defense. This milestone does set the way to streamline future procurement by the Army. Of course, we still have selling to do for those orders to come in, but that now drastically simplifies their ability to purchase and deploy as it's now an officially approved platform. A significant milestone.
Great work to our federal and military team in completing that long process. As we initiated last quarter, we've begun to break out our P&L by business unit so that our investors will be able to see how we're doing in the electronic control device business, our historical core business, as well as the new video and cloud business unit. What you continue to see is that we have a solidly profitable, very positive cash-generating machine in our core business. The profits and cash flow from this core business have been funding the major development efforts in Axon and Evidence.com, where we believe we are mediocre, and we believe that our solution is best in class with the Flex that we'll begin shipping next month. We believe the investments we've made are the right move for Axon Enterprise.
It's been a good use of our cash and positions us to be a dominant player in a major new market. As I mentioned in our last call, in 2012, we're focused on rigorous execution. I believe that's part of what you're seeing in the numbers. Our organization is aligned towards three key goals. First is driving an upgrade cycle in our core ECD business in North America. Second is driving international sales adoption of our products globally. Third is driving adoption of Axon and Evidence.com in our cloud and video business unit. Progress on any one of these three initiatives can create significant growth and profitability for the company in 2012. Therefore, we're limiting our scope of efforts to focus like a laser on these three areas. The upgrade opportunity will represent roughly 327,000 units by the end of this year.
It'll be more than five years old, which is roughly a $350 million potential market for us to upgrade just users that have devices that are past their expected useful life. In the first quarter, upgrades only accounted for roughly 1,000 of the X2 sales. The reason for this is on December 31, our trade-in program expired. For most of the first quarter, we did not have an active trade-in program in place. We felt it was important to maintain credibility by sunsetting the program at the end state. We felt it was also important to test whether the upgrade program was making a difference, which we validated. It was making a difference. Therefore, we looked at how we could construct a new trade-in program.
After a 60-day period, we introduced our 2012 trade-in program, which we obviously had to take a hard look at how to make it consistent with what we sunsetted in 2011 and yet to meet our corporate objectives for 2012. The new program, whereas in 2011, the trade-in was a $300 credit, in 2012, the trade-in will start at $250 per unit for the first half of the year, and then it will decline to $160 per unit by year-end. We believe this program will help agencies continue to transition to the new X2 over the course of the year. As of March 30, we've only upgraded 3.3% of the ECDs that are greater than five years old. Although we do have a significant pipeline of agencies that are looking to upgrade, and obviously with 96.7% of the market available, it's an opportunity we just need to execute well on.
In our video and cloud business, the core effort has been on the dramatic product improvements with the Axon Flex. We've talked about before the primary barrier to sale with our first-generation Axon was size, wires, and comfort. It's quite interesting. I recall some amusing conversations with our General Manager of Evidence.com who related to me it's the first time he's aware of a cloud business whose growth has been somewhat throttled by something like size, wires, and comfort of the physical gear. That's what happens when you're launching a truly integrated system for our customers. We feel very confident based on customer feedback and the fact that we've been able to reduce the size and weight by 85% of that system, as well as partnering with Oakley on the sunglass integration and having multiple new mounting options.
Of course, partnering, getting out of the business of building man-portable computers and instead leveraging the fast-moving technology of the iPhone, Apple solution, as well as the Android universe of devices. At the end of the day, we continue to get excellent feedback from customers that we've got the product right. We're taking our time and bringing it to market to make sure it's gone through full validation. In the first quarter, we did see sales bookings for Axon and Evidence.com decline slightly to $402,000 in Q1 from $537,000 in Q4. The primary driver was our decision to stop selling new orders for our first-generation hardware. In the fourth quarter of last year, we showed select customers the new Flex system, and we used an upgrade offer to drive purchases of the Gen 1 system.
However, we determined that the cost to deliver, install, and support the first-generation hardware was diverting our precious sales and engineering resources away from focusing on getting the Flex unit launched properly and expeditiously. While we were able to close several important Flex orders, including Mesa, DD, and FART, because we've been working with those agencies for an extended time period, in fact, they were able to see the product, and Mesa was involved in the early design of the product. Those agencies were able to go ahead and make purchasing decisions. Most agencies that have expressed interest are waiting to get units they can test before making a purchase decision. As Dan mentioned, we also did begin shipping the new TASER Cam HD in the first quarter, which helped drive TASER Cam product line sales over $680,000 in the quarter.
We do anticipate we'll begin commercial shipments of Flex in May. We are currently in the late stages of product validation and testing. Speaking of our product validation and development processes, we had another significant milestone this quarter. One year into the X2 sales, we have validated a return rate of less than 1%. This is dramatically lower than our historic product launches, and I believe it's solid evidence that our revised systems are performing extremely well. Accordingly, part of the profitability in Q1 resulted from a reduction in warranty reserves based on the one-year data that we now have. On the international sales front, we saw a slight increase from the $2.3 million in the fourth quarter to $2.6 million in Q1. I would say we're in the midst of a transition in our international sales strategy.
We're preparing to launch two teams from TASER International to launch into our global markets. The first team is a marketing-oriented team that will be joining our sales office that's already on the ground in Europe. We've launched a French website and have several other internationalized sites in progress that we'll be launching in the coming months. This marketing team will be providing in-market programs based on what has worked in the U.S., but of course, working with the local market and our local sales team to learn and localize our approach within the European market. We feel this immersion in the customer environment is critical to our success, and we're preparing a second team who will launch to Brazil this summer.
We believe this approach is highly cost-effective as it best leverages our talent, culture, and systems we've built to take known players from within our TASER environment and use them as elements to go out and build the international market, of course, with the long-term goal that they will be helping us to hire and develop a team of local people that really know the market. It's our way to seed the TASER culture and processes into those markets. We're very excited to bring Axon Flex to market after several years of heavy investment. We believe we have the right solution. Evidence.com is stable, ready to scale. It's ready for the content explosion that would come with scaling Axon Flex sales. We'll all be watching closely how the positive market reception to the concept translates into revenue over the coming quarters.
I will end by just reiterating that the board shares our confidence in the cash generation ability of the business. It has authorized us to use up to $20 million to buy back shares in the marketplace. With that, we will open it up and take a few questions.
Speaker 1
Thank you. Ladies and gentlemen, if you wish to ask a question, please press star, then one on your touch-tone telephone. If your question has been answered or you wish to withdraw your question, simply key star, then two. Press one to ask a question. Please stand by for your first question.
EC, your line is live. Please go ahead.
Speaker 2
Hello, guys, can you hear me?
Speaker 0
Yes, we can.
Speaker 2
I'm sorry. Just had a couple of follow-up questions. Dan, you mentioned that, or actually it might have been Rick, you mentioned that North American law enforcement sales were up in the first quarter. I didn't catch that %. I was wondering if you could give that to us again.
Speaker 3
Let me take a look at my notes here. I believe it was 25%.
Speaker 2
25%. Does that include that U.S. Army order?
Speaker 3
No.
Speaker 2
Okay. Got it. That's a pretty significant improvement and certainly exceeded my expectations. What's really driving that? Have you guys seen kind of an inflection point in municipal budgets, or has something, has the landscape changed that gives these agencies much more confidence in purchasing the product and the funding to make the purchase?
Speaker 3
I would actually tell you the interesting thing about the first quarter sales is that X2, the new product, was not the primary driver of the growth relative to the prior quarters. In the first quarter, the primary driver was, I believe, just a more rigorous execution of our sales team. We've been very focused on developing a rigorous pipeline system using Salesforce.com and really bringing best practices in to drive results. I would actually tell you the first quarter, more than market dynamics, was driven more by just operational excellence of our sales and marketing teams.
Speaker 2
Got it. You'd characterize it as really just hammering the product home with these agencies and helping them cross the finish line in purchasing them.
Speaker 3
Yeah. We've actually launched a telesales initiative with a team to augment our field sales group, having a dedicated outbound team. In addition, we've had a great customer service team. I think we've had great people over the years. I think we're giving them better systems now to be able to track leads and follow up on them and make sure that we're reaching out to the market and closing every opportunity that comes our way. I'd say it's mostly rigorous execution. I would say also, feedback from the law enforcement market is the major layoffs they were going through years ago are mostly behind them. I'd say the market is somewhat stabilizing.
We do expect that in the next couple of years here, we should see a drive to replace capital equipment in law enforcement because across the board, over the last few years, they were really delaying their refresh of capital equipment in the budget environment to try to avoid the layoffs. As they come out of that now, TASERs, cars, computers, pretty much across the board, I think the market is seeing that they've not been keeping up with their capital equipment needs. We think that's obviously a good trend for us.
Speaker 2
Got it. Great. Internationally, you mentioned that sales declined 51% year over year. Can you maybe revisit some of the bigger fish that you're going after right now or you see as really reasonable opportunities? I know we've talked about some Australian opportunities, some France opportunities, and things like that. Could you maybe rehash a couple of those bigger fish you're going after?
Speaker 3
Yeah, we typically don't get into a lot of detail on their international sales from a sort of competitive space analysis. Frankly, as we mentioned historically, this can be politically sensitive for some of those agencies that may not want to, you know, it's a security issue in terms of us necessarily talking about what agencies are looking at expanding. Ones we've talked about historically that remain significant opportunities are certainly Australia, France, Brazil. Those are areas where we're putting some teams in market in Brazil and in France. We've got a very strong distributor in the United Kingdom that continues to do well. I'd say some of what we've seen is with the introduction of the X2, the international markets do tend to take a little longer cycle to evaluate new technology. We are expecting to see some more significant X2 orders begin to develop.
We're hearing from our sales pipeline that some of those evaluations are now complete. Perhaps some of the agencies that were looking at buying X26 Electronic Control Devices once the X2 came available may have taken a step back to evaluate the new technology. We remain confident that we're going to see the pipeline at least sort of return up towards the more historic levels. We believe the things that we're doing now to actually put teams in market and begin to invest in more scalable systems internationally will set the basis for long-term growth.
Speaker 2
Great. Last one from me, looking at ECD segment margins, 65.2% was just a really nice performance follow-through. Was there anything, because I mean, even looking back historically, that's probably on the higher end of what you guys have done. Was there anything in the quarter that really stood out from a margin perspective? Dan, I think you mentioned that we should probably expect it to move back towards more historical levels. Would you say more in that 60% range? Is that probably a fair way to think about it?
Speaker 0
Yeah, Peter, that's certainly a fair way to think about it. We've benefited from a number of things. As Rick said, we did see some favorable sort of news on the warranty side of things with, you know, when we launch a new product, we typically just record a higher warranty % because we don't have an actual return rate to go against. We adjust once that product's been in the market for a year. With the really rock-solid quality of the X2, we had a pretty significant reduction in the warranty reserve, which certainly helped things. The mix helped as well. We had a lot of handle sales in the quarter. Those are high, you know, that's higher margin business for us, which certainly helped. I think we feel good about the margins.
I think as the video business scales, they'll certainly contribute, but the margins on the video business aren't quite as healthy as the ECD handle profitability. You'll just see a little bit of a negative mix impact. We feel good. Certainly, the leverage on the indirect costs were solid for the quarter. When we see those higher sales, it certainly helps to bring down that indirect manufacturing cost as a % of sales, which improves the margin as well.
Speaker 2
Perfect. Great. Thanks a lot, guys.
Speaker 0
All right, thank you.
Speaker 1
Thank you. We have no more questions. I'd now like to turn the call back over to Rick Smith. Please go ahead.
Speaker 3
Great. All right. Again, thanks everyone for tuning in. We do have our shareholder meeting coming up here at Axon Enterprise headquarters May 31. We certainly invite you to come down, come see the new Axon Flex unit for yourself. You'll have an opportunity to test-fire our next two and see our latest ECDs. We will be talking to you either at the shareholder meeting or I guess our next call. Our conference call will be in July, looking at Q2 results. By then, we should hopefully have some interesting early indicators on Axon Flex market traction. Thanks for joining us today, and we'll see you all soon.