Axon Enterprise - Earnings Call - Q2 2011
July 28, 2011
Transcript
Speaker 4
Ladies and gentlemen, welcome to the second quarter 2011 Axon Enterprise Earnings Conference call. My name is Latasha, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question and answer session towards the end of this conference. If at any time during the call you require audio assistance, simply press star followed by zero, and a coordinator will be happy to assist you. I would now like to turn the call over to Mr. Rick Smith, CEO. Please proceed.
Speaker 3
Thank you. Okay, welcome everybody. Before we get started, I'm going to pass to our CFO, Dan Behrendt, for the Safe Harbor statement.
Speaker 0
Yeah, good morning. 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 in 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 capabilities, new product introductions, product safety, and our business model. We caution that these statements are qualified by important factors that could cause the 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 of the markets in which we compete and the accompanying demand for our products, potential delays in international and domestic orders, implementation risks of manufacturing automation, risks associated with rapid technological change, execution and implementation risks of new technology, new product introduction risks, ramping manufacturing production and need demands, litigation resulting from alleged product-related injuries and deaths, media publicity concerning the product uses and allegations of injury and deaths, and the negative impact this could have on sales, product quality risks, potential fluctuations in quarterly operating results, competition, negative reports concerning TASER device uses, financial and budgetary constraints to prospects and customers, dependence upon sole limited source suppliers, fluctuations in component pricing, risk of government investigations and regulations, TASER product tests and reports, dependence on key employees, employee retention risks, and other factors detailed in the company's filings with the U.S.
Securities and Exchange Commission. With that, I'll turn it back over to Rick Smith, our CEO.
Speaker 3
Thanks, Dan. Okay, I think the interesting story this quarter, particularly, is about cash. We generated almost $5 million in cash, and we've announced, in addition to the $12.5 million stock buyback we just completed, that we are beginning another up to $20 million cash buyback. Revenues for the quarter were $21.2 million, up 11% over last year. We saw our TASER X2, that we announced this quarter and we just began shipping in the last two weeks, generated $1.4 million of sales in the quarter. Gross margins improved to 57.7%, but the real impressive figure here in my mind, and a lot of credit goes to Doug Quinn and his team that run our hardware operations, the margins in our core electronic control device business were 63.8% before you take on the data center operations and software maintenance. Operational costs have dropped down to 57.7%.
A lot of the operational focus on tuning our business unit by unit, I think, is paying off as we see these operational efficiencies. SG&A down about 10% over last year. Again, a lot of focus on cost controls. R&D down 8.6% over the same period last year. Anytime I talk about R&D, I also like to point out we are getting more out of R&D now than we ever have, even though our spend level is down. The TASER new product development process has really been refined over the past 12 months. The X2 was developed, frankly, for a fraction of the cost that it took for us to develop the X3 a few years ago. The variable cost of goods of that product is dramatically lower than the X3. The quality and reliability is higher than anything we've ever built.
The process changes we've made, I cannot overstate how important they are. I think as we moved from 2003 to the present, we went from a small company to a very small entrepreneurial engineering team. As we've scaled, we've had hiccups and some missteps along the way, but I think we've now really hit our stride where I would say we've got a world-class engineering team and process that's able to take the voice of the customer, ingest it, convert it into products, make sure we go through a world-class validation, quality testing, and design verification program, and bring those products to market. That is going to be one of the key core competencies of this business that allows us to create shareholder value over the long term. Adjusted operating income, which basically takes out a lot of the noise and non-cash items, such as amortization, asset impairment, etc.
If you look at just sort of the core operations of the business, let's see, we generated $4.2 million this quarter in this adjusted operating income, up over 450% over the same period last year. Now, on a GAAP basis, loss for the quarter was $5.1 million. That included, obviously, reserves for some different items that I'll talk about as we move forward here. One of those reserves was related to the Protector concept and product. We recorded a $1.4 million asset impairment charge. We've abandoned that business. Last year, when we went into it, we approached Protector as sort of an option on a potentially very large market in terms of cellular and mobile safety products.
What we learned along the way, frankly, was that for all of the public attention around the issue of distracted driving, and there have been a number of startups and a number of other companies that have entered the space, we are not seeing that in a market that is actually turning into a revenue market where there's a sufficient demand to justify the focus of our team. As part of our efforts to really, again, focus on tuning and running the business for profitability, we made the determination, and we did, obviously, engage for a period of time in looking for various partnerships or ways to monetize some of our investment in Protector. We came to the conclusion that those efforts were not bearing sufficient fruit. It was better to get management at all levels truly focused, and so we've abandoned the Protector business.
Next item, we did have a setback this quarter in the Turner case in North Carolina. We got hit with what we consider to be a runaway jury verdict of $10 million, of which our insurance will cover the majority if it is paid. Because it went over our remaining insurance balance, we've recorded a $3.3 million charge in the second quarter. The last time this happened to us was the Heston case back in 2008. In Heston, we were originally hit with around $7 million in total damages. We succeeded in post-trial motions, including an aggressive appeals process. Literally, just in May of 2011, just two months ago, we prevailed in vacating three of the four monetary awards, and the Heston damages were dropped from $7 million to around $200,000. That was a significant victory for us on the legal front.
In the Turner case, we believe, number one, it was truly a tragic and sad incident that occurred. Our hearts do go out to the family. We understand that they've been through a very painful experience. That does not change our assessment that we believe, in this case, a motion overruled the science. I should caution that we shouldn't just assume that because we lost, that we won on the last round with Heston in terms of post-trial motions and appeals. Those are generally considered long shots in the general sense from a legal perspective. However, our level of confidence is pretty high in our post-trial proceedings in Heston, I'm sorry, in Turner.
Anyone who's interested in reading why we would have some confidence that we have some very strong legal arguments that that $10 million should either be overturned or dramatically reduced or a new trial ordered, you can go to taser.com/rule50. That's taser.com/rule, R-U-L-E, 50. There you can download our Rule 50 motion that will lay out in detail the legal and scientific arguments about that case. Okay, moving on. This quarter, as I talked about, we generated almost $5 million in cash from operations. We did complete the $12.5 million stock repurchase. Cash and equivalents and investments at the end of the quarter were around $38.5 million. We had no debt recorded on its balance sheet.
We approached our board on, I believe it was just this week, to we believe our business is hitting a level, again, where we're really tuning in our operations and we're seeing a little bit more predictability in the business. We've determined that we don't need as much cash as we have on the balance sheet in order to run the business. That's a disciplined thing to do, to return more of our cash to shareholders. Accordingly, we have approved an additional $20 million buyback that will begin when the window opens in a few days. With that, let me turn over to Dan. Just to add it up so there's no confusion, we completed the $12.5, and we have approval on another $20. We've received and announced what could be a total of $32.5 million of share buyback this year.
Of course, that depends on market conditions and our ability to buy subject to some of the trading restrictions. Obviously, we're turning a lot of cash to shareholders. That's something that we're proud of, and we're proud of the cash generation capability of the business. Dan, over to you.
Speaker 0
Thanks, Rick. I'm going to go through the results for the second quarter, maybe just a little bit more detail. As Rick indicated, revenues for Q2 were $21.2 million. These are up approximately $2.1 million or 10.9% from the prior year. The increase was driven mostly by the introduction of the TASER X2, which generated about $1.4 million of sales during the second quarter. As a result, North American sales for the second quarter are up approximately 8% over the prior year results. Their international sales are also up sharply over the prior year due to sizable follow-on orders that we announced during the quarter. The gross margins of $12.2 million, or 57.7% of revenues, are up 7.3% as percent of sales over the 50.4% for the prior year.
Following the commercial launch of Evidence.com during the second quarter of 2010, we are recognizing the cost of service up in gross margins. The impact of that was $1.3 million this quarter, or 6% of sales. Excluding those costs for the cost of service delivered, the actual hardware part of the business had gross margins of 63.8%. The margins were very strong for the quarter, actually favorably impacted by the product mix, including the introduction of the TASER X2, which enjoys a very strong gross margin as well with some of the other ECD products. We also had better absorption of our fixed overhead and lower scrap and obsolete inventory expenses. The SG&A expenses for the quarter of $9.1 million are down from the $10 million in the prior year. SG&A as percent of sales are 42.8% compared to 52.2% for the same quarter last year.
The SG&A is down due to reductions in salaries and benefits, stock compensation, and professional services, offset by higher sales and marketing expenses in the quarter due to the TASER User Conference, which we had in the second quarter of this year. Last year, we conducted that conference in the third quarter and also the product launch expenses around the launch of the TASER X2. Research and development expenses of $2.8 million for the second quarter decreased $300,000 roughly compared to 2010. It was driven partly by moving some of the costs that were around the data center up from R&D up into cost of service delivered. We're also seeing a drop in salary due to headcount reductions, lower consulting costs, and reduced scrap expense. Those benefits were partially offset by some of the late-stage development work on the TASER X2.
As Rick indicated, we feel that the R&D department is really running operationally very well, and we feel very good about the new product introduction process here at Axon. We did have a number of unusual items that recorded in the second quarter results, including the $3.3 million charge that we've recorded in the second quarter due to the adverse jury verdict in Turner. Rick's talked about our field process there. We also recorded $1.4 million of asset impairment charges related to the decision to abandon the operations of our Protector product offering. Additionally, we recorded about an $800,000 charge to write down property and equipment that was seen to be surplus in the Evidence.com product line. There's some extra equipment there that we are no longer going to use, and we took a write down of that equipment for about $800,000 this quarter.
The adjusted operating income, which excludes the impact of stock-based compensation, depreciation, amortization, the litigation judgment expense, asset impairment, and the loss of the write down disposable property and equipment, basically a proxy of cash earnings, was $3.3 million for the quarter. This is a $4.2 million improvement over the same quarter last year where we actually lost $900,000 on that same adjusted operating income basis. GAAP loss from operations for this quarter was $5.1 million compared to a loss last year of $3.4 million. I know it's a bit of a challenge this quarter with all the unusual events, but if you peel back the onion, you actually get to normalize earnings. We actually felt very good about the results this quarter, given the sales levels that we had. The net loss for the second quarter was $2.3 million or $0.04 a share on a basic and diluted basis.
This compares to a loss of $1.4 million or $0.02 a share on a basic and diluted basis last year. Now, moving on to the balance sheet, we finished the quarter with $38.5 million of cash equivalents and short-term investments. This is down about $4.2 million from the year-end balances. That's mostly a result of the $12.5 million in cash we've used for the buyback during the first half of this year, offset by the $9.2 million of cash provided from operating activities. Accounts receivable of $10 million are actually down about $3.6 million from the prior year-end balances due to some timing of the sales and the second quarter sales versus the fourth quarter sales. Continue to actively manage the working capital here in a very active way.
Inventory at $16 million for the quarter for the period end of June 30 is also down $1.8 million from the year-end balance. Our prepaid assets of $3.5 million are actually up $1.5 million, driven mostly just by prepaid insurance premiums. The investment in property and equipment of $31.8 million is down $4.1 million. Basically, the decrease is mostly a result of the $4 million in depreciation expenses offset by the write-down of Protector and surplus Evidence.com assets and the new capital expenditures, which kind of offset each other. The PP&E is down roughly $4 million. The total assets at June 30 were $125.6 million. On the liability and equity side of the balance sheet, accounts payable of $5 million is actually up about $445,000 from the prior year, just due to timing check runs at the year-end versus the quarter-end. Our accrued liabilities, you'll see, are up sharply.
The $6.6 million is a $2.8 million increase related to the accrual of the litigation judgment expense this quarter. The deferred revenue of $6.7 million is actually down about $900,000 from the year-end balances due to the recognition of deferred revenue associated with the sale of extended warranties. Our total liabilities are $20.9 million. Our owners' equity finished the period of June 30, 2011, at $104.7 million. Continue to have no long-term debt on the balance sheet and continue to have plenty of liquidity to continue to operate the business the way we desire. As we move on to cash flow, the company did have cash provided from operations in the second quarter of $4.9 million and $9.2 million for the six months ended June 30, 2011. This compares to cash used in operations of $2.5 million for the six months ended June 30, 2010.
We have seen a significant swing from the cash usage last year for the first six months versus the cash generated this year. The cash generated this year for the first six months is driven by our adjusted operating income, also the decrease in receivables, decrease in inventory, and increase in accounts payable. The working capital has really been a big part of the cash generation this year, along with the cash earnings that we've enjoyed. Net cash used from investing activities for the six months ended June 30, 2011, was $11.6 million. This compared to $3.4 million for the same period of last year. The large use of cash and investments is mostly driven by the $10.8 million purchases of short-term investments. We're buying a lot of short-term commercial paper just to improve the yield on our investments. We also used $12.5 million in cash and finance activities.
This is purely driven by the buyback that was approved in March of this year. We've executed that completely. We did purchase just a little over 2.9 million shares at a cost of $12.5 million. As Rick indicated, the board yesterday approved an additional $20 million buyback on top of the $12.5 million buyback that was approved in March. We ended the quarter with $27.7 million in cash and $10.8 million in short-term investments for $38.5 million in cash investments. We remain confident that we've got plenty of liquidity to operate the business and feel very good about our position as we move into the second half of the year. With that, I'll turn the call back over to Rick Smith, our CEO.
Speaker 3
Great. Okay, a couple of other items I'm going to want to touch on qualitatively here. The first is, of course, the X2. Very excited about that product. More importantly, our customers are quite excited about that product. At our Master Instructor School, where we train roughly 300 officers who are the elite of training across this country, who then go forth and train the instructors around the world in Taser use. After showing them and giving them a chance to use the X2, we surveyed them as to which product they would prefer to carry, the X2 or our flagship X26. 96% of respondents said they'd prefer to carry the X2, which tells us our design efforts really hit the mark this time.
Quantitatively, we saw affirmation of that as well, in that we saw two state patrols go full deployment on the X2 right out of the gate within the first two weeks of its shipping, as well as the Newport News Sheriff's Office in Virginia, not just ordering 77 X2s, but also the new Taser Cam HD, which is our color, high-definition version of the Taser Cam, which is only available on the X2. That will be out in the second half of this year. That's still in late-stage development. I mentioned the Taser new product development process is really humming. The quality levels on the X2 are extraordinary in terms of the tests that that went through before release and the reliability that we've seen in both field trials and rigorous use in training environments.
We believe that will have a significant impact on our operating margins over the long term by significantly reducing our returns for broken units in need of repair. This quarter, also, the NIJ, National Institute of Justice, which is the research and development wing of the United States Department of Justice, released two key reports on electronic control devices. In those reports, they found several very significant findings, not the least of which was they found that Taser devices, or ECDs, carry with it a significant lower risk of injury than just about any other force option. As a result, they recommend that these devices should continue to be used lower in the force continuum because they save lives and reduce injuries. Interestingly, the report also found no evidence that Taser devices, or ECDs, cause cardiac arrhythmias in humans, even with a chest shot.
We were a bit stunned that the jury in the case in Turner seemed to ignore the findings of independent agencies like the DOJ. Instead, we believed we're swayed more by emotion. We believe over the long haul, these independent findings continue to support the hundreds of studies on TASER devices out there today. Also, we launched our new website. I believe it was in April. I'd encourage folks to go to taser.com. We have a much more agile website that our marketing and other folks are able to use. It's much more streamlined in terms of our operational management of it. We think it's better. Our search results have improved pretty dramatically on issues we care about, such as TASER safety. We've also launched this quarter, I think we already talked about it last time, Police POV, which is a TV show where we've partnered with Bates Productions.
It's on TruTV on Sunday nights. Police POV shares the police incidents from the police point of view using the Axon camera system. We're finding that show is really helping among the law enforcement community in showing the benefits of on-officer video and, frankly, building support that this is a capability officers will want to carry individually, not just that agencies see a helpful use for, but individual officers. If you go to our website as well and you click on the video section, look on the, I believe it's stories from the field or cases from the field on Axon.
You'll see, I believe we have six or eight case studies now on Axon use where you can see various police chiefs, officers, and city attorneys from agencies that are using Axon and Evidence.com talking about the significant reductions they're seeing in complaints, significant time spent on reporting, improved reporting accuracy. In fact, several of our customers have now implemented policies where if it's captured on video and there's a complaint, the video stands as the entire investigation, which saves huge resources and, frankly, yields better results because it's more accurate than an investigation that relies on trying to get a bunch of different people's perspective about what they think happened when you have it on video. We have continued to see that there's a longer sales cycle on Axon and Evidence.com than there is on our traditional ECDs.
I think if you watch those videos, you'll see why we're excited that the long-term prospects of the business remain very interesting. In fact, there was a development this year that we believe is very significant in that we've chosen a cloud-based delivery model with Evidence.com. We are, to my awareness, the first and only provider approaching the law enforcement market with a cloud-based evidence management solution for digital evidence. When we started this a few years ago, there was a fair amount of trepidation about moving data to the cloud for law enforcement. We still do certainly get questions about whether or not government agencies will really be moving their data to the cloud. There was a significant and rather seismic event in that space in that Vivek Kundra, who is the first CIO of the federal government, implemented a policy earlier this year called Cloud First.
Under that policy, the federal government is closing dozens, if not hundreds, of data centers because they had found that governments tend not to be super efficient at designing, developing, and deploying data centers. Just given the way government procurement works, it tends to take years to do these things. It's very hard to predict capacity needs years in advance and the elasticity and capability of the cloud will generate tremendous cost savings for the federal government. Just one example of that, a law enforcement agency itself, the SEC, the Securities and Exchange Commission, has moved much of its operations onto salesforce.com. If you go to YouTube and do a search on Cloud First and Kundra, K-U-N-D-R-A, you'll find some great video of the CIO talking about some of the benefits like the SEC dramatically improving their turnaround timeline cases and investigations by enabling their officers to collaborate using salesforce.com.
We believe that's a significant endorsement of the cloud strategy and cloud technology, with the federal government now leading the way. I can tell you from my personal meetings with police chiefs in state and local agencies, this dramatically increases their comfort in the cloud approach, seeing that they've got now cover from the federal level, that, in fact, it's the preferred approach. There are five trends that we believe together to strongly support that we're skating to where the puck is going, so to speak, that our business model with Axon and Evidence.com is supported by these technology trends. One is digital video. Of course, it's becoming more and more prevalent. The handling of digital video is particularly, talked about evidence, is particularly technically challenging. It's one where we're developing a real core competence. Number two is the coming of the cloud and deployed application services.
Clearly, that's a trend that is continuing to grow, and we position our business model around it. The third is the rise of mobile technology, iPads, Android tablets, smartphones, etc. Law enforcement tends to be a technology laggard in terms of adoption. Most agencies are not yet deploying this technology, although most officers carry individual smartphones. Mobile technology further supports the cloud model. When you start talking about agencies not just building data centers, but now needing to build data centers that securely interface to mobile devices over commercial networks, it again represents a significant increase in the complexity for these agencies to build and deploy their own, whereas cloud-based centralized services that interface with mobile devices, those two go hand in hand from a business model perspective. The fourth area is the rise of standards, and particularly in law enforcement.
There's what's called the National Information Exchange Model, which is promulgated by the federal government, that it is a model for information sharing between agencies. We believe the importance of sharing information between agencies is something that is much more streamlined in a cloud or centralized infrastructure sort of architecture than with every agency deploying and running their own data servers. The fifth is the movement towards green power, green document management, going paperless. We believe over the long term that digital video will move to the center of records management and will become the core record of an incident, is the recording of what happened rather than what somebody wrote on paper about what happened. We believe the move away from paper to digital assets, again, underpins our strategy.
If I have to move to wrap up here, I would say the TASER X2 and some of the things we're doing there are really making a significant impact in our core business of electronic control devices. You'll continue to see a high level of focus. We've, frankly, ejected some of the non-core activities here, like Protector, to focus in on Axon and Evidence.com, which we believe, together with our electronic control devices, provide a holistic solution to our customers around use of force in law enforcement public interaction. Excited about the balance of the year. I'm very excited to show you some of the things that we're continuing to work on in our new product development process. For that, you'll have to just stay tuned. With that, we'll wrap up the presentation portion of the call and move to questions.
Speaker 4
Ladies and gentlemen, for questions, simply press star one on your touch-tone telephone. Your first question comes from the line of Erik Lapinski with Baird. Please proceed.
Speaker 2
Thank you. Good morning, guys.
Speaker 0
Morning.
Speaker 2
A couple of questions. One, just first off, Dan, housekeeping, I'm not sure if I missed it in the opening comments. If I did, I apologize. What was the $1.3 million of other income?
Speaker 0
That's partially a result of the settlement against the prime banks.
Speaker 2
Okay.
Speaker 0
It was a litigation settlement that we received.
Speaker 2
Okay. Perfect. Moving on, obviously, you know, huge gross margins in the quarter. Looks like the best gross margin you've had in about three years on the core products. Assuming we start getting a ramp back up over the coming quarters in terms of spending by law enforcement and your capacity utilization moves up, I mean, where could that core product margin go?
Speaker 0
I mean, it's certainly, you know, we've always targeted sort of a 60% margin. That's kind of the historic levels. I think it'll be, you know, certainly we had just great results this quarter. Partially, you know, there's a little bit of absorption this quarter, which helps things. We'd certainly like to see that stay north of 60%. As the unit transition from the X26 to the TASER X2, the absorption of the TASER X2 is better due to the higher price point. We do expect that that'll improve margin. Certainly, you know, we'd like to stay north of 60%, for sure.
Speaker 2
On the X2, given the demand or kind of a response to that and demand so far, is it likely that the X3 is going to be phased out, or is that something that can still just be kept in the catalog and it's pretty easy to put together if there's demand for it?
Speaker 3
No, the X3 will remain part of our product catalog. We are tailoring the X3 more towards SWAT applications. Guys do not mind carrying a slightly larger unit to get more capability. It will remain in our catalog. It is not a huge volume mover, but frankly, even from just a marketing perspective, having a three-product offering with the X26, the TASER X2, and the X3, we believe that the X3 is a preferential price point and helps in the positioning of the TASER X2 for mass adoption.
Speaker 2
Is there any way you can kind of look at all the departments that are trialing the Axon Evidence.com and give a sense that if all those departments went to full deployment, what is the current potential users of Axon on trial?
Speaker 3
I don't have that immediately available.
Speaker 0
Yeah, we're trialing a lot of places. I think the focus has been to go deep with these agencies that we're trialing with to make sure that we actually have the benefits and the product offering dialed in, the pricing right as we try to scale up that part of the business. At this point, we are trialing with agencies of different sizes, some significant major agencies along with smaller agencies because, obviously, we still are into the whole breadth of the market.
Speaker 3
We do believe that our strategy will be primarily based on agencies under 200 officers over the next couple of years. This is where we're going to see most of the growth and adoption because those smaller agencies tend to be faster at decision-making. They have less political complexities around having a large IT department. We find that the larger agencies, just the level of the sales process is more complex. It's going to take longer. We believe we can build network effects and market adoption by getting, you know, perhaps a few thousand smaller agencies over the next couple of years, and that will make it more enticing to the larger agencies.
We are in a couple of the big agencies, but I think them going to full deployment is going to be a longer road to hoe than getting more of the Aberdeens and Burnsville and the smaller agencies that see the benefit and the chief is more actively engaged. They've got a fairly small IT infrastructure in-house and are more adaptive.
Speaker 2
Perfect. Thank you, guys.
Speaker 0
Thank you.
Speaker 4
Your next question comes from the line of Paul Coaster with JPMorgan. Please proceed.
Speaker 1
Yes, thank you. Dan, I'm not sure what the most efficient way of doing this is, but can you give us the product and revenue and unit breakdown or point us to the right resource for?
Speaker 0
Yeah, I can run through the units. The unit sales for the quarter, X26, we sold 12,501. We did sell 1,512 of the TASER X2 out of the gate here and actually finished with a backlog there just due to the launch timing. M26, we sold 628 units. X3, we sold 63 units. We sold 2,007 of the C2s, 1,461 of the TASER Cams, and we sold 281,310 cartridges.
Speaker 1
Okay, the revenue breakdown, have you already provided that, or is it?
Speaker 0
It'll be in the queue.
Speaker 1
Okay. Got it. Rick, you talked a little bit about more predictability in the business. What is the source of the visibility? Can you give us your best guess on how this money budget sort of issue is going to play out and when you know we should start to see re-accelerating growth?
Speaker 3
The level of predictability is more in our internal operations in terms of need for capital spending, etc. Over the last couple of years, we've made some significant investments in Axon and Evidence.com and some of these new business units. I think that's where I was primarily focused, that we don't have any major new initiatives that we believe would need a lot of cash potentially. We've got a pretty good line on what it's going to take to execute on Axon and Evidence.com. The revenue side of things, I wouldn't say is any more predictable than it has been. We've been operating in a very tough budget environment, and we've still been turning in results where we're generating ballpark $1 million a month in cash.
Unless there was some dramatic downturn in the economy with the TASER X2 coming online and many agencies having entered the role over five years, we believe that the baseline business we've been operating to feels sustainable at a minimum. That gave us comfort in terms of our cash generation and/or cash needs. In terms of the municipal environment, the main positive impact I would say is that many law enforcement agencies have made the cuts that last year they were still looking at. When agencies are looking at cutting officers, they become very focused on avoiding all expenses. They don't want to be out buying equipment when they're cutting the jobs of their comrades.
A lot of the restructuring in law enforcement has happened now, which just means it's changed our mindset to where, when we're in an agency, 18 months ago, we had situations where the union guys were pinning up our quotes on the corkboard in the locker room with a note like, "Hey, we're about to lay off 100 officers," and management's out, spending, or looking at spending a lot of money on equipment. Needless to say, that's not helpful. We're seeing that dynamic getting behind us here. A lot of the cuts have been made, so the predictability of spending, at least for our municipal customers, we think is better and that they at least have a little better idea that they've got some money to spend and that they're not in complete huge deficits that are requiring cuts.
I think there's some uncertainty about what's happening right now with the debt ceiling and all that and money from the federal level, injecting a little more uncertainty back into the state and municipal folks because they do rely on federal money as well. We don't have great predictability as to when the economy is going to turn, but at least a lot of the factors that led to the cuts are being dealt with.
Speaker 1
You previously acknowledged that, you know, it's aging inventory out there now and that a replacement cycle is probably starting soon. Given the budgetary constraints, I imagine it's postponed somewhat. Do you have a sense that there is pent-up demand, and are there any anecdotes, data points that you can share with us to substantiate that?
Speaker 0
Yep. Yep. Paul, this is Dan. Yeah, we're definitely seeing that the message of sort of the, you know, that agencies need to look to proactively replace the units, they're certainly listening to that. They're looking for the budgets to help with that. I think it's certainly very helpful to have a product that, like the X2 that we've launched, that agencies really like. That helps them to prioritize perhaps that upgrade cycle higher on their capital spend list than they might have previously. We feel very good about that. We did see last year, we had about $8 million worth of upgrades from M26 to X26 last year. I think we have seen some of that upgrade at selective agencies and remain optimistic that as we move forward, that aging installed base will certainly give us an opportunity to resell into our installed base of customers.
Speaker 3
Dan, how big is the installed base currently of units that are over five years old?
Speaker 0
It's over 175,000 units, and that'll grow by about 80,000 units a year. It's going to be, you know, we'll have well over 400,000 units in the next four years reach that over five-year mark.
Speaker 1
Okay. Great. Thanks very much.
Speaker 0
Thank you.
Speaker 4
Your next question comes from the line of Steve Dyer with Craig-Hallum. Please proceed.
Speaker 2
Thank you. Good morning, guys.
Speaker 0
Morning.
Speaker 2
The gross margin, just to kind of revisit that quickly, very good level. Was there anything sort of one time? I mean, I know you want to kind of get to 60% here over time, but is that a good level to sort of model going forward, or would you expect it to take a step back in Q3? You know.
Speaker 0
I think it's, you know, product mix is a big, big determinant. The product mix is really favorable this quarter. We had, you know, more sales of sort of the higher margin ECD products, lower sales of some of the things that are maybe a little bit of a lower margin. Certainly, the mix helped us as well. That's something that's not always super predictable. As far as the one-timer, we did see some extra absorption this quarter with, you know, the component of inventory. Our actual finished goods inventory went up a little bit, reduction in raw materials. That causes a little bit more of the overhead to get capitalized on the balance sheet. That's kind of the normal ebb and flow. We certainly feel, you know, from modeling purposes, that 60% is still a good target for the ECD part of the business.
Speaker 2
Okay. I noticed this quarter, kind of the number of cartridges as a ratio of versus handles in the field is the lowest that I've ever seen it. Is there anything to read into that? Are people training less, or was it just kind of the way things ebbed and flowed in the quarter?
Speaker 0
I think it's mostly an ebb and flow. I mean, cartridges tend to do that a little bit. I think normally, what we didn't see as much this quarter is sort of that budget flush, which a lot of times is sort of cartridge-centric. That may be a little bit due to the introduction of the TASER X2, where the TASER X2 uses a different cartridge than the X26. If agencies are looking at an upgrade, they're going to want to keep their inventory of the X26 cartridges lower, not bulk up on those. That may be part of that trend you're seeing.
Speaker 3
I would add in as well, this is Rick, that we believe we saw some X26 orders push out this quarter, you know, delayed once we announced the X2. Some anecdotal information we've got about that, for example, we saw the return rates for X26s being returned for repair drop about in half the month that we announced the X2. Because we have a trade-in offer that runs through the end of the year, whether units are functional or broken, they can be traded in for a $300 trade-in credit towards a package that includes the X2 warranty, cartridges, holster, etc. Once we made that announcement, it looks like people really cut back on sending in X26 units for repair or replacement. Anecdotally as well, there were some orders we thought we expected to see a little stronger push on X26 at the end of the quarter. It didn't develop.
We believe part of that was just people are looking at the X2. A couple of them got off the dime pretty quick, like Newport News and two state patrols. You know, we know other folks are going through a little more of a rigorous field trial of it before they make a decision.
Speaker 2
Okay. I know you don't guide and there's not always a ton of visibility, but how should we think about sort of revenue in the back half of the year versus the first half?
Speaker 0
We continue to see a good pipeline of interest in the product. We remain, you know, we feel good about the business longer term. It's a tough business to forecast, as you know. We continue to see good quoting activity, and certainly, the introduction of the X2 will certainly help if it could start unlocking that upgrade cycle.
Speaker 3
There are also some very significant and large international orders that we continue to work. I know people get a little fatigued, as do we, talking about them, but the big orders we were talking about last year are still in the pipeline. They have not closed. There could be some significant upside surprises in the second half of the year. From a modeling perspective and expectation perspective, we wouldn't, you know, we wouldn't get ahead of ourselves and encourage you to model that in. We also thought we should let you know, I mean, there are still some significant opportunities internationally. Those just tend to be super lumpy and big because decisions are made at the senior level of national governments. We're hopeful that we'll start to see some of those break free for us here.
Speaker 2
Okay. Last question, just operating expenses, is this a good level to think about going forward? I mean, obviously, Axon is all of the one-time stuff this quarter.
Speaker 0
Yeah, I mean, we're continuing to really drive the OpEx down as much as possible. I think if you sort of look at the average of Q1 and Q2, I think it's still a pretty good proxy for what we need to run the business. There's always going to be a little bit of ebb and flow with the quarters based on the sort of product introductions, just some things around the business. We continue to look to drive as much efficiency as we can and really work on controlling the things we can, as far as on the operating side of the business, to be as efficient as possible and really get that break-even point in the business as well as practical.
Speaker 2
All right. Thanks, guys.
Speaker 0
Thank you.
Speaker 4
I have no further questions in the queue.
Speaker 3
Great. All right. Thanks everyone for tuning in this morning. As I mentioned, stay tuned. There's some interesting things happening in the back half of your TASER Cam HD, some other things we're working on. Thanks for your continued support. We'll be back to you all in October. Have a great balance of your summer and have a great day. Thanks.
Speaker 0
Thank you.
Speaker 4
Thank you for your participation in today's conference. This concludes the presentation, and you may all now disconnect. Good day.