Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2020
or
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 001-16391
Axon Enterprise, Inc.
(Exact name of registrant as specified in its charter)
Delaware
86-0741227
(State or other jurisdiction ofincorporation or organization)
(I.R.S. EmployerIdentification No.)
17800 North 85th Street
85255
Scottsdale, Arizona
(Address of principal executive offices)
(Zip Code)
(480) 991-0797
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, $0.00001 Par Value
AAXN
The Nasdaq Global Select Market
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated Filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
The number of shares of the registrant’s common stock outstanding as of April 30, 2020 was 59,825,208.
AXON ENTERPRISE, INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2020
Page
Special Note Regarding Forward-Looking Statements
ii
PART I - FINANCIAL INFORMATION
1
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of March 31, 2020 (Unaudited) and December 31, 2019
Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income for the Three Months Ended March 31, 2020 and 2019
2
Unaudited Condensed Consolidated Statements of Stockholders’ Equity for the Three Months Ended March 31, 2020 and 2019
3
Unaudited Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2020 and 2019
4
Notes to Unaudited Condensed Consolidated Financial Statements
5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
26
Item 3. Quantitative and Qualitative Disclosures About Market Risk
37
Item 4. Controls and Procedures
38
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
39
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
40
SIGNATURES
41
This Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), including statements regarding our expectations, beliefs, intentions and strategies regarding the future. We intend that such forward-looking statements be subject to the safe-harbor provided by the Private Securities Litigation Reform Act of 1995. From time to time, we also provide forward-looking statements in other materials we release to the public as well as verbal forward-looking statements. These forward-looking statements include, without limitation, statements regarding: the impact of the COVID-19 pandemic; proposed products and services and related development efforts and activities; expectations about the market for our current and future products and services; the impact of pending litigation; our outlook for 2020 with respect to revenue, legal expenses relating to the FTC litigation, stock compensation expense, and income tax rate; trends relating to subscription plan programs and revenues; our anticipation that contracts with governmental customers will be fulfilled; expected trends, including the benefits of, research and development investments; the sufficiency of our liquidity and financial resources; that we may repurchase our common stock; expectations about customer behavior; the impact on our investment portfolio of changes in interest rates; trends in the percentage of our revenues denominated in foreign currencies; our potential use of foreign currency forward and option contracts; statements concerning projections, predictions, expectations, estimates or forecasts as to our business, financial and operational results and future economic performance; statements of management’s strategies, goals and objectives and other similar expressions; as well as the ultimate resolution of financial statement items requiring critical accounting estimates, including those set forth in our Form 10-K for the year ended December 31, 2019. Such statements give our current expectations or forecasts of future events; they do not relate strictly to historical or current facts. Words such as “may,” “will,” “should,” “could,” “would,” “predict,” “potential,” “continue,” “expect,” “anticipate,” “future,” “intend,” “plan,” “believe,” “estimate,” and similar expressions, as well as statements in future tense, identify forward-looking statements. However, not all forward-looking statements contain these identifying words.
We cannot guarantee that any forward-looking statement will be realized, although we believe we have been prudent in our plans and assumptions. Achievement of future results is subject to risks, uncertainties and potentially inaccurate assumptions. The following important factors could cause actual results to differ materially from those in the forward-looking statements: the potential global impacts of the COVID-19 pandemic; our exposure to cancellations of government contracts due to appropriation clauses, exercise of a cancellation clause, or non-exercise of contractually optional periods; our ability to design, introduce and sell new products or features; our ability to defend against litigation and protect our intellectual property, and the resulting costs of this activity; our ability to manage our supply chain and avoid production delays, shortages, and impacts to expected gross margins; the impact of stock compensation expense, impairment expense, and income tax expense on our financial results; customer purchase behavior, including adoption of our software as a service delivery model; negative media publicity regarding our products; the impact of product mix on projected gross margins; defects in our products; changes in the costs of product components and labor; loss of customer data, a breach of security, or an extended outage, including our reliance on third party cloud-based storage providers; exposure to international operational risks; delayed cash collections and possible credit losses due to our subscription model; changes in government regulations in the U.S. and in foreign markets, especially related to the classification of our product by the United States Bureau of Alcohol, Tobacco, Firearms and Explosives and to evolving regulations surrounding privacy and data protection; our ability to integrate acquired businesses; our ability to attract and retain key personnel; and counter-party risks relating to cash balances held in excess of FDIC insurance limits. Many events beyond our control may determine whether results we anticipate will be achieved. Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could differ materially from past results and those anticipated, estimated or projected. You should bear this in mind as you consider forward-looking statements. The Annual Report on Form 10-K that we filed with the Securities and Exchange Commission ("SEC") on February 28, 2020 and this Quarterly Report on Form 10-Q list various important factors that could cause actual results to differ materially from expected and historical results. These factors are intended as cautionary statements for investors within the meaning of Section 21E of the Exchange Act and Section 27A of the Securities Act. Readers can find them under the heading “Risk Factors” in the Report on Form 10-K and in this Report on Form 10-Q, and investors should refer to them. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider any such list to be a complete set of all potential risks or uncertainties.
Except as required by law, we undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosures we make on related subjects in our Form 10-Q, 8-K and 10-K reports to the SEC. Our filings with the SEC may be accessed at the SEC’s web site at www.sec.gov.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
March 31,
December 31,
2020
2019
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents
$
156,540
172,250
Short-term investments
188,673
178,534
Accounts and notes receivable, net of allowance of $1,827 and $1,567 as of March 31, 2020 and December 31, 2019, respectively
147,945
146,878
Contract assets, net
43,959
38,102
Inventory
46,922
38,845
Prepaid expenses and other current assets
34,702
34,866
Total current assets
618,741
609,475
Property and equipment, net
43,065
43,770
Deferred tax assets, net
29,433
27,688
Intangible assets, net
11,929
12,771
Goodwill
24,752
25,013
Long-term investments
50,225
45,499
Long-term notes receivable, net of current portion
27,556
31,598
Long-term contract assets, net
12,293
9,644
Other assets
59,457
40,181
Total assets
877,451
845,639
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable
31,568
25,874
Accrued liabilities
36,404
45,001
Current portion of deferred revenue
119,827
117,864
Customer deposits
3,325
2,974
Other current liabilities
3,891
3,853
Total current liabilities
195,015
195,566
Deferred revenue, net of current portion
91,886
87,936
Liability for unrecognized tax benefits
4,173
3,832
Long-term deferred compensation
3,430
3,936
Deferred tax liability, net
342
354
Other long-term liabilities
23,015
10,520
Total liabilities
317,861
302,144
Commitments and contingencies (Note 12)
Stockholders’ equity:
Preferred stock, $0.00001 par value; 25,000,000 shares authorized; no shares issued and outstanding as of March 31, 2020 and December 31, 2019, respectively
-
—
Common stock, $0.00001 par value; 200,000,000 shares authorized; 59,813,163 and 59,497,759 shares issued and outstanding as of March 31, 2020 and December 31, 2019, respectively
Additional paid-in capital
543,305
528,272
Treasury stock at cost, 20,220,227 shares as of March 31, 2020 and December 31, 2019
(155,947)
Retained earnings
175,699
172,265
Accumulated other comprehensive loss
(3,468)
(1,096)
Total stockholders’ equity
559,590
543,495
Total liabilities and stockholders’ equity
The accompanying notes are an integral part of these condensed consolidated financial statements.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
(in thousands, except per share data)
Three Months Ended March 31,
Net sales from products
107,288
88,089
Net sales from services
39,874
27,721
Net sales
147,162
115,810
Cost of product sales
48,884
39,600
Cost of service sales
9,670
7,293
Cost of sales
58,554
46,893
Gross margin
88,608
68,917
Operating expenses:
Sales, general and administrative
63,027
42,892
Research and development
26,381
23,354
Total operating expenses
89,408
66,246
Income (loss) from operations
(800)
2,671
Interest and other income, net
941
2,313
Income before provision for income taxes
141
4,984
Benefit from income taxes
(3,933)
(1,435)
Net income
4,074
6,419
Net income per common and common equivalent shares:
Basic
0.07
0.11
Diluted
Weighted average number of common and common equivalent shares outstanding:
59,609
58,914
60,394
59,751
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Foreign currency translation adjustments
(2,372)
50
Comprehensive income
1,702
6,469
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Accumulated
Additional
Other
Total
Common Stock
Paid-in
Treasury Stock
Retained
Comprehensive
Stockholders’
Shares
Amount
Capital
Earnings
Loss
Equity
Balance, December 31, 2019
59,497,759
20,220,227
Cumulative effect of applying a change in accounting principle, net of tax
(640)
Issuance of common stock under employee plans, net
315,404
(5,162)
Stock-based compensation
20,195
Balance, March 31, 2020
59,813,163
Balance, December 31, 2018
58,810,637
453,400
171,383
(1,513)
467,324
298,649
(1,159)
7,905
Balance, March 31, 2019
59,109,286
460,146
177,802
(1,463)
480,539
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
2,881
2,800
Loss on disposal and abandonment of intangible assets
13
18
Loss on disposal and impairment of property and equipment, net
517
242
Deferred income taxes
(1,548)
577
Unrecognized tax benefits
341
307
Other noncash, net
1,156
896
Provision for expected credit losses
902
Change in assets and liabilities:
Accounts and notes receivable and contract assets
(9,700)
(21,994)
(8,630)
(3,936)
Prepaid expenses and other assets
2,277
(3,152)
Accounts payable, accrued and other liabilities
(3,562)
(7,284)
Deferred revenue
4,499
3,232
Net cash provided by (used in) operating activities
13,415
(13,970)
Cash flows from investing activities:
Purchases of investments
(99,512)
(105,322)
Proceeds from call / maturity of investments
84,315
Purchases of property and equipment
(2,209)
(5,271)
Proceeds from disposal of property and equipment
78
Purchases of intangible assets
(45)
(162)
Investment in unconsolidated affiliate
(4,700)
Net cash used in investing activities
(22,073)
(110,755)
Cash flows from financing activities:
Proceeds from options exercised
28
100
Income and payroll tax payments for net-settled stock awards
(5,190)
(1,259)
Net cash used in financing activities
Effect of exchange rate changes on cash and cash equivalents
(1,890)
67
Net decrease in cash and cash equivalents
(15,710)
(125,817)
Cash and cash equivalents and restricted cash, beginning of period
172,355
351,027
Cash and cash equivalents and restricted cash, end of period
156,645
225,210
Supplemental disclosures:
223,642
Restricted cash (Note 1)
105
1,568
Total cash, cash equivalents and restricted cash shown in the statements of cash flows
Cash paid for income taxes, net of refunds
3,863
758
Non-cash transactions
Property and equipment purchases in accounts payable and accrued liabilities
617
328
Investment purchases in accounts payable
13,451
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Summary of Significant Accounting Policies
Axon Enterprise, Inc. (“Axon,” the “Company,” "we," or "us") is a market-leading provider of law enforcement technology solutions. Our core mission is to protect life. We fulfill that mission through developing hardware and software products that advance the long term objectives of a) obsoleting the bullet, b) reducing social conflict, and c) enabling a fair and effective justice system.
Our headquarters in Scottsdale, Arizona houses our executive management, sales, marketing, certain engineering, manufacturing, and other administrative support functions. We also have a software engineering development center located in Seattle, Washington, and subsidiaries located in Australia, Canada, Finland, Hong Kong, Germany, India, Italy, the Netherlands, the United Kingdom, and Vietnam.
The accompanying unaudited condensed consolidated financial statements include the accounts of Axon Enterprise, Inc. and our wholly owned subsidiaries. All material intercompany accounts, transactions, and profits have been eliminated.
Basis of Presentation and Use of Estimates
These unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the SEC. Certain information related to our organization, significant accounting policies and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) has been condensed or omitted. The accounting policies followed in the preparation of these unaudited condensed consolidated financial statements are consistent with those followed in our annual consolidated financial statements for the year ended December 31, 2019, as filed on Form 10-K, with the exception of our adoption of certain accounting pronouncements which we describe below. In the opinion of management, these unaudited condensed consolidated financial statements contain all material adjustments, consisting only of normal recurring adjustments, necessary to fairly state our financial position, results of operations and cash flows for the periods presented and the presentations and disclosures herein are adequate when read in conjunction with our Form 10-K for the year ended December 31, 2019. The results of operations for the three months ended March 31, 2020 and 2019 are not necessarily indicative of the results to be expected for the full year (or any other period). Significant estimates and assumptions in these unaudited condensed consolidated financial statements include:
Actual results could differ materially from those estimates.
Segment Information
Our operations are comprised of two reportable segments: the manufacture and sale of conducted electrical devices ("CEDs"), batteries, accessories, extended warranties and other products and services (the “TASER” segment);
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
and the development, manufacture, and sale of software and sensors, which includes the sale of devices, wearables, applications, cloud and mobile products, and services (collectively, the “Software and Sensors” segment). In both segments, we report sales of products and services. Service revenue in both segments includes sales related to Axon Evidence. In the Software and Sensors segment, service revenue also includes other recurring cloud-hosted software revenue and related professional services. Collectively, this revenue is sometimes referred to as "Axon Cloud revenue."
Reportable segments are determined based on discrete financial information reviewed by our Chief Executive Officer who is our chief operating decision maker ("CODM"). We organize and review operations based on products and services, and currently there are no operating segments that are aggregated. We perform an analysis of our reportable segments at least annually. Additional information related to our business segments is summarized in Note 14.
Geographic Information and Major Customers / Suppliers
For the three months ended March 31, 2020 and 2019, no individual country outside the U.S. represented more than 10% of total net sales. Individual sales transactions in the international market are generally larger and occur more intermittently than in the domestic market due to the profile of our customers. For the three months ended March 31, 2020 and 2019, no customer represented more than 10% of total net sales. At March 31, 2020 and December 31, 2019, no customer represented more than 10% of the aggregate balance of accounts and notes receivable and contract assets.
We currently purchase both off the shelf and custom components, including, but not limited to, finished circuit boards, injection-molded plastic components, small machined parts, custom cartridge components, electronic components, and off the shelf sub-assemblies from suppliers located in the U.S., Canada, China, Israel, Mexico, Republic of Korea, and Taiwan. Although we currently obtain many of these components from single source suppliers, we own the injection molded component tooling, most of the designs, and the test fixtures used in their production for all custom components. As a result, we believe we could obtain alternative suppliers in most cases without incurring significant production delays. We also strategically hold safety stock levels on custom components to further reduce this risk. For off the shelf components, we believe that in most cases there are readily available alternative suppliers who can consistently meet our needs for these components. We acquire most of our components on a purchase order basis and do not have any significant long-term contracts with component suppliers.
Income per Common Share
Basic income per common share is computed by dividing net income by the weighted average number of common shares outstanding during the periods presented. Diluted income per share reflects the potential dilution from outstanding stock options and unvested restricted stock units. The calculation of the weighted average number of shares outstanding and earnings per share are as follows (in thousands except per share data):
Numerator for basic and diluted earnings per share:
Denominator:
Weighted average shares outstanding
Dilutive effect of stock-based awards
785
837
Diluted weighted average shares outstanding
Anti-dilutive stock-based awards excluded
12,161
12,125
Net income per common share:
6
Standard Warranties
We warranty our CEDs, Axon cameras and certain related accessories from manufacturing defects on a limited basis for a period of one year after purchase and, thereafter, will repair or replace any defective unit for a fee. Estimated costs for the standard warranty are charged to cost of products sold when revenue is recorded for the related product. Future warranty costs are estimated based on historical data related to warranty claims and this rate is applied to current product sales. Historically, reserve amounts have been increased if management becomes aware of a component failure or other issue that could result in larger than anticipated warranty claims from customers. The warranty reserve is reviewed quarterly to verify that it sufficiently reflects the remaining warranty obligations based on the anticipated expenditures over the balance of the warranty obligation period, and adjustments are made when actual warranty claim experience differs from estimates. The warranty reserve is included in accrued liabilities on the accompanying condensed consolidated balance sheets.
Changes in our estimated product warranty liabilities were as follows (in thousands):
Balance, beginning of period
1,476
898
Utilization of reserve
(171)
(123)
Warranty expense (benefit)
(85)
252
Balance, end of period
1,220
1,027
Fair Value Measurements and Financial Instruments
We use the fair value framework that prioritizes the inputs to valuation techniques for measuring financial assets and liabilities measured on a recurring basis and for non-financial assets and liabilities when these items are re-measured. Fair value is considered to be the exchange price in an orderly transaction between market participants, to sell an asset or transfer a liability at the measurement date. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are:
We have cash equivalents and investments, which at March 31, 2020 and December 31, 2019 were comprised of money market funds, certificates of deposit, commercial paper, corporate bonds, corporate notes, municipal bonds, U.S. Government agency bonds, U.S. Treasury bills, U.S. Treasury inflation-protected securities, and U.S. Treasury repurchase agreements. See additional disclosure regarding the fair value of our cash equivalents and investments in Note 3. Included in the balance of other assets as of March 31, 2020 and December 31, 2019 was $3.5 million and $4.2 million, respectively, related to corporate-owned life insurance policies which are used to fund our deferred compensation plan. We determine
7
the fair value of insurance contracts by obtaining the cash surrender value of the contracts from the issuer, a Level 2 valuation technique. During the three months ended March 31, 2020, we made an investment of $4.7 million in preferred stock and recorded preferred stock warrants at a fair value of $2.6 million, which is also included in the balance of other assets as of March 31, 2020. The estimated fair value of the investments was determined based on Level 3 inputs. As of March 31, 2020, management estimated that the fair value of the investment equaled its carrying value.
Our financial instruments also include accounts and notes receivable, accounts payable and accrued liabilities. Due to the short-term nature of these instruments, their fair values approximate their carrying values on the balance sheet.
Restricted Cash
Restricted cash balances as of March 31, 2020 and December 31, 2019 included $0.1 million primarily related to funds held in an international bank account for a country in which we are required to maintain a minimum balance to operate. Approximately half of the balance was included in prepaid expenses and other current assets on our condensed consolidated balance sheets, with the remainder included in other assets.
Valuation of Goodwill, Intangibles and Long-lived Assets
We evaluate whether events and circumstances have occurred that indicate the remaining estimated useful life of long-lived assets and identifiable intangible assets, excluding goodwill and intangible assets with indefinite useful lives, may warrant revision or that the remaining balance of these assets may not be recoverable. Such circumstances could include, but are not limited to, a change in the product mix, a change in the way products are created, produced or delivered, or a significant change in the way products are branded and marketed. In performing the review for recoverability, we estimate the future undiscounted cash flows expected to result from the use of the assets and their eventual disposition. The amount of the impairment loss, if impairment exists, is calculated based on the excess of the carrying amounts of the assets over their estimated fair value computed using discounted cash flows.
We do not amortize goodwill and intangible assets with indefinite useful lives; rather such assets are required to be tested for impairment at least annually or sooner whenever events or changes in circumstances indicate that the assets may be impaired. We perform our annual goodwill and intangible asset impairment tests in the fourth quarter of each year.
Recently Issued Accounting Guidance
Recently Adopted Accounting Pronouncements
In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 includes an impairment model (known as the current expected credit loss model) on financial instruments and other commitments that is based on expected losses rather than incurred losses. Under the new guidance, an entity recognizes as an allowance its estimate of expected credit losses, which the FASB believes will result in more timely recognition of such losses. The use of forecasted information is intended to incorporate more timely information in the estimate of expected credit loss. This ASU also requires enhanced disclosures relating to significant estimates and judgments used in estimating credit losses, as well as credit quality. Upon adoption, we recorded a noncash cumulative effect adjustment to retained earnings of $0.6 million, net of $0.2 million of income taxes, on the opening consolidated balance sheet as of January 1, 2020, reflecting an overall increase to the allowance for expected credit losses. See Notes 3 and 4 for further disclosures related to Topic 326.
In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement. ASU 2018-13 eliminates, adds and modifies certain disclosure requirements for fair value measurements. The amendments apply to the disclosures of changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value
8
measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. Adoption of this ASU on January 1, 2020 did not have a material impact on our consolidated financial statements.
Effective the first quarter of 2021:
In December 2019, the FASB issued ASU 2019-12, Simplifying the Accounting for Income Taxes. The amendments in the ASU are effective for fiscal years beginning after December 15, 2020, including interim periods therein. Early adoption of the standard is permitted, including adoption in interim or annual periods for which financial statements have not yet been issued. Adoption of this ASU is not expected to have a material impact on our consolidated financial statements.
In January 2020, the FASB issued ASU No. 2020-01, Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) – Clarifying the Interactions Between Topic 321, Topic 323, and Topic 815 (a Consensus of the Emerging Issues Task Force). The guidance clarifies the interaction between ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities and the ASU on equity method investments. ASU 2016-01 provides companies with an alternative to measure certain equity securities without a readily determinable fair value at cost, minus impairment, if any, unless an observable transaction for an identical or similar security occurs. ASU 2020-01 clarifies that for purposes of applying the Topic 321 measurement alternative, an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting under Topic 323, immediately before applying or upon discontinuing the equity method. In addition, the new ASU provides direction that a company should not consider whether the underlying securities would be accounted for under the equity method or the fair value option when it is determining the accounting for certain forward contracts and purchased options, upon either settlement or exercise. The amendments in this update become effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted, and the amendments are to be applied prospectively. Adoption of this ASU is not expected to have a material impact on our consolidated financial statements.
Reclassification of Prior Year Presentation
Certain prior year amounts, including the long-term portion of contract assets, have been reclassified for consistency with the current year presentation. These reclassifications are not material and had no effect on the reported results of operations.
9
2. Revenues
Nature of Products and Services
The following tables present our revenues by primary product and service offering (in thousands):
Three Months Ended March 31, 2020
Three Months Ended March 31, 2019
Software and
TASER
Sensors
TASER 7
15,326
9,954
TASER X26P
11,061
15,872
TASER X2
14,075
13,085
TASER Pulse and Bolt
1,200
670
Single cartridges
26,625
19,160
Axon Body
12,823
6,445
Axon Flex
1,183
1,224
Axon Fleet
4,775
3,516
Axon Dock
4,951
3,312
Axon Evidence and cloud services
498
39,154
39,652
36
27,618
27,654
TASER Cam
927
903
Extended warranties
4,977
5,458
10,435
4,316
4,930
9,246
2,133
1,996
4,129
2,298
2,471
4,769
75,895
71,267
65,391
50,419
The following table presents our revenues disaggregated by geography (in thousands):
United States
117,463
80
%
94,333
81
Other countries
29,699
20
21,477
19
Contract Balances
The following table presents our contract assets, contract liabilities and certain information related to these balances as of and for the three months ended March 31, 2020 (in thousands):
March 31, 2020
56,252
Contract liabilities (deferred revenue)
211,713
Revenue recognized in the period from:
Amounts included in contract liabilities at the beginning of the period
48,465
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Contract liabilities (deferred revenue) consisted of the following (in thousands):
December 31, 2019
Current
Long-Term
Warranty:
12,963
15,469
28,432
12,716
16,378
29,094
Software and Sensors
10,886
4,447
15,333
9,852
5,156
15,008
23,849
19,916
43,765
22,568
21,534
44,102
Hardware:
14,097
15,901
29,998
9,569
15,468
25,037
17,142
36,062
53,204
22,235
33,759
55,994
31,239
51,963
83,202
31,804
49,227
81,031
Services:
588
1,293
1,881
293
765
1,058
64,151
18,714
82,865
63,199
16,410
79,609
64,739
20,007
84,746
63,492
17,175
80,667
205,800
27,648
32,663
60,311
22,578
32,611
55,189
92,179
59,223
151,402
95,286
55,325
150,611
Remaining Performance Obligations
As of March 31, 2020, we had approximately $1.27 billion of remaining performance obligations, which included both recognized contract liabilities as well as amounts that will be invoiced and recognized in future periods. The remaining performance obligations are limited only to arrangements that meet the definition of a contract under Topic 606 as of March 31, 2020. We expect to recognize between 20% - 25% of this balance over the next twelve months, and generally expect the remainder to be recognized over the following five to seven years, subject to risks related to delayed deployments, budget appropriation or other contract cancellation clauses.
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3. Cash, Cash Equivalents and Investments
The following tables summarize our cash, cash equivalents, and held-to-maturity investments at March 31, 2020 and December 31, 2019 (in thousands):
As of March 31, 2020
Gross
Cash and
Amortized
Unrealized
Cash
Short-Term
Cost
Gains
Losses
Fair Value
Equivalents
Investments
73,560
Level 1:
Money market funds
3,536
Agency bonds
40,340
91
(2)
40,429
2,000
12,738
25,602
Treasury bills
17,983
15
17,998
10,995
6,988
Subtotal
61,859
106
61,963
16,531
19,726
Level 2:
State and municipal obligations
32,185
34
(27)
32,192
1,991
29,687
507
Certificates of deposit
1,900
1,400
500
Corporate bonds
145,022
79
(959)
144,142
4,987
119,654
20,381
U.S. Treasury repurchase agreements
49,400
Treasury inflation-protected securities
3,247
(47)
3,200
Commercial paper
28,364
10,072
18,292
260,118
113
(1,033)
259,198
66,450
169,033
24,635
395,537
219
(1,035)
394,721
156,541
188,759
50,237
As of March 31, 2020, the balances reflected above were offset by a payable of $13.5 million related to unsettled investment purchases, which was settled in early April. We believe unrealized losses on our investments are due to interest rate fluctuations.
We adopted Topic 326 on January 1, 2020, and applied the credit loss guidance related to held-to-maturity securities prospectively. Because we do not have any history of losses for our held-to-maturity investments, our expected loss allowance methodology for held-to-maturity investments is developed using published or estimated credit default rates for similar investments and current and future economic and market conditions. At both January 1 and March 31, 2020, our credit loss reserve for held-to-maturity investments was approximately $0.1 million. During the three months ended March 31, 2020, we increased the frequency of review for our investment portfolio in order to more closely monitor potential impacts of the COVID-19 pandemic.
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As of December 31, 2019
103,319
8,845
32,869
14
(4)
32,879
15,131
17,738
41,714
41,724
25,038
25,046
21,560
3,478
135,175
71
(30)
135,216
886
113,241
21,048
57,200
3,235
3,249
29,202
27,202
251,250
93
251,313
60,086
163,403
27,761
396,283
107
(34)
396,356
4. Expected Credit Losses
We are exposed to credit losses primarily through sales of products and services. Our expected loss allowance methodology for accounts receivable, notes receivable, and contract assets is developed using historical collection experience, published or estimated credit default rates for entities that represent our customer base, current and future economic and market conditions and a review of the current status of customers' trade accounts receivables. Additionally, specific allowance amounts are established to record the appropriate provision for customers that have a higher probability of default. Our monitoring activities include account reconciliation, dispute resolution, payment confirmation, consideration of customers' financial condition and macroeconomic conditions. Balances are written off when determined to be uncollectible.
We considered the current and expected future economic and market conditions surrounding the novel coronavirus ("COVID-19") pandemic and recorded additional credit loss expense of approximately $0.9 million during the three months ended March 31, 2020.
We review receivables for U.S. and international customers separately to better reflect different published credit default rates and economic and market conditions.
The following table provides a roll-forward of the allowance for expected credit losses that is deducted from the amortized cost basis of accounts receivable, notes receivable, and contract assets to present the net amount expected to be collected (in thousands):
1,395
172
1,567
Adoption of Topic 326, cumulative-effect adjustment to retained earnings
767
768
722
164
Amounts written off charged against the allowance
Other, including dispositions and foreign currency translation
2,882
333
3,215
As of March 31, 2020, the allowance for expected credit losses for each type of customer receivable was as follows:
Accounts receivable and notes receivable, current
1,827
429
959
Total allowance for expected credit losses on customer receivables
5. Inventory
Inventories are stated at the lower of cost and net realizable value. Cost is determined using the weighted average cost of raw materials, which approximates the first-in, first-out (“FIFO”) method and includes allocations of manufacturing labor and overhead. Included in finished goods at March 31, 2020 and December 31, 2019 was $1.5 million and $1.4 million, respectively, of trial and evaluation hardware units. Provisions are made to reduce excess, obsolete or slow-moving inventories to their net realizable value. Inventory consisted of the following at March 31, 2020 and December 31, 2019 (in thousands):
Raw materials
21,808
20,789
Finished goods
25,114
18,056
Total inventory
6. Goodwill and Intangible Assets
The changes in the carrying amount of goodwill for the three months ended March 31, 2020 were as follows (in thousands):
1,354
23,659
(130)
(131)
(261)
23,528
Intangible assets (other than goodwill) consisted of the following (in thousands):
Net
Useful
Carrying
Life
Amortization
Amortizable (definite-lived) intangible assets:
Domain names
5‑10 years
3,161
(1,111)
2,050
2,126
Issued patents
5‑25 years
3,175
(1,397)
1,778
3,271
(1,339)
1,932
Issued trademarks
3‑15 years
1,164
(553)
611
1,166
(678)
488
Customer relationships
4‑8 years
3,636
(1,497)
2,139
3,721
(1,416)
2,305
Non-compete agreements
3‑4 years
439
(398)
450
(404)
46
Developed technology
3‑5 years
10,660
(7,074)
3,586
(6,528)
4,132
Re-acquired distribution rights
2 years
1,765
(1,765)
2,009
(2,009)
Total amortizable
24,000
(13,795)
10,205
24,438
(13,409)
11,029
Non-amortizable (indefinite-lived) intangible assets:
TASER trademark
900
Patents and trademarks pending
824
842
Total non-amortizable
1,724
1,742
Total intangible assets
25,724
26,180
Amortization expense of intangible assets for the three months ended March 31, 2020 and 2019 was $0.8 million and $1.0 million, respectively. Estimated amortization for intangible assets with definite lives for the remaining nine months of 2020, the next five years ended December 31, and thereafter, is as follows (in thousands):
2,476
2021
2,854
2022
1,258
2023
971
2024
890
2025
623
Thereafter
1,133
7. Other Long-Term Assets
Other long-term assets consisted of the following at March 31, 2020 and December 31, 2019 (in thousands):
Cash surrender value of corporate-owned life insurance policies
3,523
4,214
Deferred commissions (1)
21,826
22,068
Restricted cash
55
56
Operating lease assets
21,944
9,653
Investment in unconsolidated affiliate (2)
4,700
Warrants for unconsolidated affiliate (3)
2,588
Prepaid expenses, deposits and other
4,821
4,190
Total other long-term assets
8. Accrued Liabilities
Accrued liabilities consisted of the following at March 31, 2020 and December 31, 2019 (in thousands):
Accrued salaries, benefits and bonus
13,378
24,737
Accrued professional, consulting and lobbying fees
8,993
Accrued warranty expense
Accrued income and other taxes
2,093
3,362
Other accrued expenses
10,720
12,191
9. Income Taxes
On March 27, 2020, the U.S federal government enacted the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). The CARES Act is an emergency economic stimulus package in response to the coronavirus outbreak which, among other things, contains numerous income tax provisions. Some of these tax provisions are expected to be effective retroactively for years ending before the date of enactment. We are currently evaluating the implications of the CARES Act, but its impact on the financial statements and related disclosures is not expected to be material.
We file income tax returns for federal purposes and in many states, as well as in multiple foreign jurisdictions. Our tax filings remain subject to examination by applicable tax authorities for a certain length of time, generally three to four years, following the tax year to which these filings relate. Our U.S. federal income tax return for fiscal year 2016 is currently under audit by the Internal Revenue Service and we have been notified our 2016 and 2017 state tax returns will be audited by the state of California. Additionally, we were notified that an audit will commence for Axon Public Safety Southeast Asia LLC, our entity in Vietnam. The tax period has not yet been defined.
In April 2020, recent interpretations of a German law relating to withholding taxes on intellectual property rights have emerged. We are currently evaluating this law and any related impact to our financial position or results of operations.
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Deferred Tax Assets
Net deferred income tax assets at March 31, 2020, primarily include R&D tax credits, stock-based compensation expense, deferred revenue, accruals and reserves, and net operating losses, partially offset by accelerated depreciation expense and valuation allowance reserve. Our total net deferred tax assets at March 31, 2020 were $29.1 million.
In preparing our condensed consolidated financial statements, management assesses the likelihood that its deferred tax assets will be realized from future taxable income. In evaluating our ability to recover our deferred income tax assets, management considers all available positive and negative evidence, including our operating results, ongoing tax planning and forecasts of future taxable income on a jurisdiction by jurisdiction basis. A valuation allowance is established if it is determined that it is more likely than not that some portion or all of the net deferred tax assets will not be realized. Management exercises significant judgment in determining our provisions for income taxes, our deferred tax assets and liabilities, and our future taxable income for purposes of assessing our ability to utilize any future tax benefit from our deferred tax assets.
As of March 31, 2020, we continue to demonstrate three-year cumulative pre-tax income in the U.S. federal and state tax jurisdictions; however, we have Arizona R&D Tax Credits expiring unutilized each year. Therefore, management has concluded that it is more likely than not that our Arizona R&D deferred tax asset will not be realized.
As of March 31, 2020, we have cumulative pre-tax losses in the U.K. and Canada, which limits the ability to consider other subjective evidence, such as projections for future growth. On the basis of this evaluation, a full valuation allowance has been recorded for these jurisdictions. The amount of the deferred tax asset considered realizable, however, could be adjusted in future periods if objective negative evidence in the form of cumulative losses is no longer present and additional weight is given to subjective evidence such as projections for growth. Although we also have cumulative pre-tax losses in Australia, we have determined that sufficient deferred tax liabilities will reverse in order to realize all assets except one long-lived intangible where there is not an expectation that the asset may be realized. Therefore, we have recorded a partial valuation allowance for Australia.
We complete R&D tax credit studies for each year that an R&D tax credit is claimed for federal, Arizona, and California income tax purposes. Management has made the determination that it is more likely than not that the full benefit of the R&D tax credit will not be sustained on examination and recorded a liability for unrecognized tax benefits of $6.5 million as of March 31, 2020. In addition, management accrued $0.1 million of interest for estimated uncertain tax positions related to certain federal income tax liabilities. Should the unrecognized benefit of $6.6 million be recognized, our effective tax rate would be favorably impacted. Approximately $2.6 million of the unrecognized tax benefit associated with R&D credits has been netted against the R&D deferred tax asset.
Effective Tax Rate
Our overall effective tax rate for the three months ended March 31, 2020, after discrete period adjustments, was (2,789.4%). Before discrete adjustments, the tax rate was 90%, which is more than the federal statutory rate, primarily due to state taxes and non-deductible expenses for items such as meals and entertainment, executive compensation limitation under Internal Revenue Code ("IRC") Section 162(m), and income inclusion from global intangible low-taxed income ("GILTI"), offset by a reduction for foreign-derived intangible income ("FDII") and R&D tax credits. The effective tax rate was favorably impacted by a $4.1 million discrete tax benefit primarily associated with windfalls related to stock-based compensation for restricted stock units (“RSUs”) that vested or stock options that were exercised during the three months ended March 31, 2020.
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10. Stockholders’ Equity
Performance-based stock awards
We have issued performance-based stock options and performance-based RSUs, the vesting of which is generally contingent upon the achievement of certain performance criteria related to our operating performance, as well as successful and timely development and market acceptance of future product introductions. In addition, certain of the performance RSUs have additional service requirements subsequent to the achievement of the performance criteria. Compensation expense is recognized over the requisite service period, which is defined as the longest explicit, implicit or derived service period based on management’s estimate of the probability of the performance criteria being satisfied, adjusted at each balance sheet date. For both service-based and performance-based RSUs, we account for forfeitures as they occur as a reduction to stock-based compensation expense and additional paid-in-capital.
For performance-based options with a vesting schedule based entirely on the attainment of both performance and market conditions, stock-based compensation expense is recognized for each pair of performance and market conditions over the longer of the expected achievement period of the performance and market conditions, beginning at the point in time that the relevant performance condition is considered probable of achievement. The fair value of such awards is estimated on the grant date using Monte Carlo simulations.
CEO Performance Award
On May 24, 2018, our stockholders approved the Board of Directors’ grant of 6,365,856 stock option awards to Patrick W. Smith, our CEO (the “CEO Performance Award”). The CEO Performance Award consists of 12 vesting tranches with a vesting schedule based entirely on the attainment of both operational goals (performance conditions) and market capitalization goals (market conditions), assuming continued employment either as the CEO or as both Executive Chairman and Chief Product Officer and service through each vesting date. Each of the 12 vesting tranches of the CEO Performance Award have a 10-year contractual term and will vest upon certification by the Board of Directors that both (i) the market capitalization goal for such tranche, which begins at $2.5 billion for the first tranche and increases by increments of $1.0 billion thereafter, and (ii) any one of the following eight operational goals focused on revenue or eight operational goals focused on Adjusted EBITDA have been met for the previous four consecutive fiscal quarters. Adjusted EBITDA for purposes of the CEO Performance Award ("Adjusted EBITDA (CEO Performance Award)") is defined as net income (loss) attributable to common stockholders before interest expense, investment interest income, provision (benefit) for income taxes, depreciation and amortization, and stock-based compensation expense.
Eight Separate Adjusted EBITDA (CEO
Eight Separate Revenue Goals (1)
Performance Award) Goals
Goal #1, $710,058
Goal #9, $125,000
Goal #2, $860,058
Goal #10, $155,000
Goal #3, $1,010,058
Goal #11, $175,000
Goal #4, $1,210,058
Goal #12, $190,000
Goal #5, $1,410,058
Goal #13, $200,000
Goal #6, $1,610,058
Goal #14, $210,000
Goal #7, $1,810,058
Goal #15, $220,000
Goal #8, $2,010,058
Goal #16, $230,000
As of March 31, 2020, the following operational goals were considered probable of achievement:
The first two market capitalization goals have been achieved as of March 31, 2020. However, none of the stock options granted under the CEO Performance Award have vested thus far as the operational goals have not yet been achieved as of March 31, 2020. As there are nine operational goals considered probable of achievement, we recorded stock-based compensation expense of $44.3 million related to the CEO Performance Award from the Grant Date through March 31, 2020. The number of stock options that would vest related to the nine tranches is approximately 4.8 million shares.
As of March 31, 2020, we had $147.3 million of total unrecognized stock-based compensation expense for the performance goals that were considered probable of achievement, which will be recognized over a weighted-average period of 5.79 years. As of March 31, 2020, we had unrecognized stock-based compensation expense of $54.4 million for the performance goals that were considered not probable of achievement.
eXponential Stock Performance Plan
On February 12, 2019, our shareholders approved the 2019 Stock Incentive Plan (the “2019 Plan”), which was adopted by the Board of Directors to reserve a sufficient number of shares to facilitate our eXponential Stock Performance Plan (“XSPP”) and grants of eXponential Stock Units (“XSUs”) under the plan. Initial awards under the plan were granted in January 2019, with additional employee awards granted since that date. During the three months ended March 31, 2020, we granted an additional 43 thousand XSUs.
The XSUs are grants of RSUs, each with a term of approximately nine years, that vest in 12 equal tranches. Each of the 12 tranches will vest upon certification by the Compensation Committee of the Board of Directors that both (i) the market capitalization goal for such tranche, which begins at $2.5 billion for the first tranche and increases by increments of $1.0 billion thereafter, and (ii) any one of eight operational goals focused on revenue or eight operational goals focused on Adjusted EBITDA (CEO Performance Award) have been met for the previous four consecutive fiscal quarters.
The first two market capitalization goals have been achieved as of March 31, 2020. However, none of the XSU tranches have vested thus far as the operational goals have not yet been achieved as of March 31, 2020. As there are nine operational goals considered probable of achievement, we recorded stock-based compensation expense of $23.2 million related to the XSU awards from their respective grant dates through March 31, 2020. The number of XSU awards that would vest related to the nine tranches is approximately 4.1 million shares.
As of March 31, 2020, we had $131.8 million of total unrecognized stock-based compensation expense for the performance goals that were considered probable of achievement, which will be recognized over a weighted-average period of 5.65 years. As of March 31, 2020, we had unrecognized stock-based compensation expense of $35.5 million for the performance goals that were considered not probable of achievement.
Restricted Stock Units
The following table summarizes RSU activity for the three months ended March 31, 2020 (number of units and aggregate intrinsic value in thousands):
Number of
Weighted Average
Aggregate
Units
Grant-Date Fair Value
Intrinsic Value
Units outstanding, beginning of year
1,249
45.47
Granted
69.19
Released
(219)
35.49
Forfeited
50.82
Units outstanding, end of period
1,074
49.05
75,985
Aggregate intrinsic value represents our closing stock price on the last trading day of the period, which was $70.77 per share, multiplied by the number of RSUs outstanding. As of March 31, 2020, there was $41.4 million in unrecognized compensation costs related to RSUs under our stock plans for shares that are expected to vest. We expect to recognize the cost related to the RSUs over a weighted average period of 2.09 years. RSUs are released when vesting requirements are met.
During the three months ended March 31, 2020, we granted 0.1 million service-based RSUs. Certain RSUs that vested in the three months ended March 31, 2020 were net-share settled such that we withheld shares to cover the employees’ tax obligation for the applicable income and other employment taxes, and remitted the cash to the appropriate taxing authorities. Total shares withheld related to RSUs were approximately 53 thousand and had a value of $4.0 million on their respective vesting dates as determined by the closing stock price on such dates. Payments for the employees’ tax obligations are reflected as a financing activity within the condensed consolidated statements of cash flows. We record a liability for the tax withholding to be paid by us as a reduction to additional paid-in capital.
Performance Stock Units
The following table summarizes Performance Stock Units (“PSUs“) activity for the three months ended March 31, 2020 (number of units and aggregate intrinsic value in thousands):
6,033
34.47
102
42.41
(158)
24.88
(188)
34.97
5,789
34.86
409,657
Aggregate intrinsic value represents our closing stock price on the last trading day of the period, which was $70.77 per share, multiplied by the number of PSUs outstanding. As of March 31, 2020, there was $137.1 million in unrecognized compensation costs related to PSUs under our stock plans for shares that are expected to vest. We expect to recognize the cost related to the PSUs over a weighted average period of 5.52 years. PSUs are released when vesting requirements are met.
During the three months ended March 31, 2020, we granted 0.1 million PSUs, including approximately 43 thousand XSUs. As of March 31, 2020, the performance criteria had been met for approximately 0.1 million of the 5.8 million PSUs outstanding. Certain of the PSUs outstanding as of March 31, 2020 can vest with a range of shares earned being between 0% and 200% of the targeted shares granted, depending on the final achievement of pre-determined performance criteria as of the vesting date. The amount of PSUs included in the table above related to such grants is the
target level. The maximum additional number of PSUs that could be earned is 0.2 million, which are not included in the table above.
Certain PSUs that vested in the three months ended March 31, 2020 were net-share settled such that we withheld shares to cover the employees’ tax obligation for the applicable income and other employment taxes, and remitted the cash to the appropriate taxing authorities. Total shares withheld related to PSUs were approximately 15 thousand and had a value of $1.2 million on their respective vesting dates as determined by the closing stock price on such dates. Payments for the employees’ tax obligations are reflected as a financing activity within the condensed consolidated statements of cash flows. We record a liability for the tax withholding to be paid by us as a reduction to additional paid-in capital.
Stock Option Activity
The following table summarizes stock option activity for the three months ended March 31, 2020 (number of units and aggregate intrinsic value in thousands):
Weighted
Average
Number
Remaining
of
Exercise
Contractual
Options
Price
Life (years)
Options outstanding, beginning of year
6,431
28.34
Exercised
(6)
4.74
Expired / terminated
Options outstanding, end of period
6,425
28.36
7.84
272,512
Options exercisable, end of period
59
4.50
0.67
Aggregate intrinsic value represents the difference between the exercise price of the underlying stock option awards and the closing market price of our common stock of $70.77 on March 31, 2020. The intrinsic value of options exercised for the three months ended March 31, 2020 and 2019 was $0.3 million and $1.0 million, respectively. As of March 31, 2020, total options outstanding included 6.4 million unvested performance-based stock options. Of this total, 4.8 million options relate to tranches of the CEO Performance Award considered probable of achievement.
Stock-based Compensation Expense
The following table summarizes the composition of stock-based compensation expense for the three months ended March 31, 2020 and 2019 (in thousands):
Cost of products sold and services delivered
590
226
Sales, general and administrative expenses
14,970
4,681
Research and development expenses
4,635
2,998
Total stock-based compensation expense
Stock Incentive Plan
In February 2019, our shareholders approved the 2019 Plan authorizing an additional 6.0 million shares, plus remaining available shares under prior plans, for issuance under the new plan. Combined with the legacy stock incentive plans, there are 2.1 million shares available for grant as of March 31, 2020.
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Stock Repurchase Plan
In February 2016, our Board of Directors authorized a stock repurchase program to acquire up to $50.0 million of our outstanding common stock subject to stock market conditions and corporate considerations. During the three months ended March 31, 2020 and 2019, no common shares were purchased under the program. As of March 31, 2020, $16.3 million remains available under the plan for future purchases. Any future purchases will be discretionary.
11. Line of Credit
We have a $50.0 million unsecured revolving line of credit with a domestic bank, of which $10.0 million is available for letters of credit. The credit agreement matures on December 31, 2021 and has an accordion feature which allows for an increase in the total line of credit up to $100.0 million, subject to certain conditions, including the availability of additional bank commitments.
At March 31, 2020 and December 31, 2019, there were no borrowings under the line. Under the terms of the line of credit, available borrowings are reduced by outstanding letters of credit. As of March 31, 2020, we had letters of credit outstanding of approximately $2.7 million under the facility and available borrowing of $47.3 million, excluding amounts available under the accordion feature. Advances under the line of credit bear interest at LIBOR plus 1.0 to 1.5% per year determined in accordance with a pricing grid based on our funded debt to earnings before interest, taxes, depreciation and amortization ("EBITDA") ratio.
We are required to comply with a maximum funded debt to EBITDA ratio of no greater than 2.50 to 1.00 based upon a trailing four fiscal quarter period. At March 31, 2020, our funded debt to EBITDA ratio was 0.0003 to 1.00.
12. Commitments and Contingencies
Product Litigation
As a manufacturer of weapons and other law enforcement tools used in high-risk field environments, we are often the subject of products liability litigation concerning the use of our products. We are currently named as a defendant in eight lawsuits in which the plaintiffs allege either wrongful death or personal injury in situations in which a TASER CED was used by law enforcement officers in connection with arrests or training. While the facts vary from case to case, these product liability claims typically allege defective product design, manufacturing, and/or failure to warn. They seek compensatory and sometimes punitive damages, often in unspecified amounts.
We continue to aggressively defend all product litigation. As a general rule, it is our policy not to settle suspect injury or death cases. Exceptions are sometimes made where the settlement is strategically beneficial to us. Due to the confidential nature of our litigation strategy and the confidentiality agreements that are executed in the event of a settlement, we do not identify or comment on specific settlements by case or amount. Based on current information, we do not believe that the outcome of any such legal proceeding will have a material effect on our financial position, results of operations, or cash flows. We are self-insured for the first $5.0 million of any product claim made after 2014. No judgment or settlement has ever exceeded this amount in any products case. We continue to maintain product liability insurance coverage, including an insurance policy fronting arrangement, above our self-insured retention with various limits depending on the policy period.
Other Litigation
We are a defendant in a litigation matter filed by Digital Ally Inc. (“Digital”) in the District of Kansas alleging patent infringement regarding our Axon Signal technology. Axon was granted summary judgment of non-infringement on June 17, 2019 and judgment was entered in our favor on all of Digital’s claims. Digital’s appeal was submitted on briefs
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without oral argument. On April 22, 2020, the Federal Circuit Court of Appeals affirmed the District Court’s non-infringement ruling and entered judgment on Digital's appeal in favor of Axon.
We are also a defendant in a consumer class action lawsuit filed in the District of Nevada on April 9, 2019 by Douglas Richey (“Richey”). The case alleges the TASER Pulse, X2 and X26P CEDs have a faulty safety switch based on Richey’s Pulse allegedly discharging inside its neoprene case in a jacket pocket without injury. Any such discharge was likely due to static electricity, as disclosed in our consumer warnings. We will vigorously defend this claim and the propriety of any class certification.
The litigation information in this note is current through the date of these financial statements.
U.S. Federal Trade Commission Investigation
The U.S. Federal Trade Commission (“FTC”) filed an enforcement action on January 3, 2020 regarding Axon’s May 2018 acquisition of Vievu LLC from Safariland LLC. The FTC alleges the merger was anticompetitive and adversely affected the body worn camera ("BWC") and digital evidence management systems ("DEMS") market for “large metropolitan police departments.” The administrative proceedings are currently stayed until June 4, 2020 due to the COVID-19 pandemic and the hearing has been reset for September 9, 2020. If successful, the FTC may require us to divest Vievu and other assets, which could be material to Axon. We are vigorously defending the matter. At this time, we cannot predict the eventual scope, duration, or outcome of this request and accordingly we have not recorded any liability in the accompanying condensed consolidated financial statements.
Also on January 3, 2020, we sued the FTC in the District of Arizona for declaratory and injunctive relief alleging the FTC’s structure and administrative processes violate Article II of the U.S. Constitution and our Fifth Amendment rights to due process and equal protection. On April 8, 2020, the district court dismissed the action, without prejudice, for lack of jurisdiction, requiring Axon to first bring its constitutional claims in the administrative case. Axon has appealed that ruling to the Ninth Circuit (No. 20-15662), which has granted expedited consideration and set oral argument for July 17.
General
From time to time, we are notified that we may be a party to a lawsuit or that a claim is being made against us. It is our policy to not disclose the specifics of any claim or threatened lawsuit until the summons and complaint are actually served on us. After carefully assessing the claim, and assuming we determine that we are not at fault or we disagree with the damages or relief demanded, we vigorously defend any lawsuit filed against us. We record a liability when losses are deemed probable and reasonably estimable. When losses are deemed reasonably possible but not probable, we determine whether it is possible to provide an estimate of the amount of the loss or range of possible losses for the claim, if material for disclosure. In evaluating matters for accrual and disclosure purposes, we take into consideration factors such as our historical experience with matters of a similar nature, the specific facts and circumstances asserted, the likelihood of our prevailing, the availability of insurance, and the severity of any potential loss. We reevaluate and update accruals as matters progress over time.
Based on our assessment of outstanding litigation and claims as of March 31, 2020, we have determined that it is not reasonably possible that these lawsuits will individually, or in the aggregate, materially affect our results of operations, financial condition or cash flows. However, the outcome of any litigation is inherently uncertain and there can be no assurance that any expense, liability or damages that may ultimately result from the resolution of these matters will be covered by our insurance or will not be in excess of amounts recognized or provided by insurance coverage and will not have a material adverse effect on our operating results, financial condition or cash flows.
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Off-Balance Sheet Arrangements
Under certain circumstances, we use letters of credit and surety bonds to guarantee our performance under various contracts, principally in connection with the installation and integration of Axon cameras and related technologies. Certain of our letters of credit and surety bonds have stated expiration dates with others being released as the contractual performance terms are completed. At March 31, 2020, we had outstanding letters of credit of $2.7 million that are expected to expire in May 2020 and September 2021. Additionally, we had $24.1 million of outstanding surety bonds at March 31, 2020, with $0.5 million expiring in 2020, $2.4 million expiring in 2021, $3.2 million expiring in 2022, $7.5 million expiring in 2023 and the remaining $10.5 million expiring in 2024.
13. Employee Benefit Plans
We have a defined contribution 401(k) plan for eligible employees, which is qualified under Sections 401(a) and 401(k) of the Internal Revenue Code of 1986, as amended. Employees are entitled to make tax-deferred contributions of up to the maximum amount allowed by law of their eligible compensation.
We also have a non-qualified deferred compensation plan for certain executives, employees and non-employee directors through which participants may elect to postpone the receipt and taxation of a portion of their compensation, including stock-based compensation, received from us. The non-qualified deferred compensation plan allows eligible participants to defer up to 80% of their base salary and up to 100% of other types of compensation. The plan also allows for matching and discretionary employer contributions. Employee deferrals are deemed 100% vested upon contribution. Distributions from the plan are made upon retirement, death, separation of service, specified date or upon the occurrence of an unforeseeable emergency. Distributions can be paid in a variety of forms from lump sum to installments over a period of years. Participants in the plan are entitled to select from a wide variety of investments available under the plan and are allocated gains or losses based upon the performance of the investments selected by the participant. All gains or losses are allocated fully to plan participants and we do not guarantee a rate of return on deferred balances. Assets related to this plan consist of corporate-owned life insurance contracts and are included in other assets in the condensed consolidated balance sheets; see Note 7 for balances. Participants have no rights or claims with respect to any plan assets and any such assets are subject to the claims of our general creditors.
Contributions to the plans are made by both the employee and us. Our contributions to the 401(k) plan are based on the level of employee contributions and are immediately vested. Future matching contributions to the plans are at our sole discretion.
We also sponsor defined contribution plans in Australia, Finland, and the United Kingdom.
Our matching contributions for all defined contribution plans were $1.5 million and $1.4 million for the three months ended March 31, 2020 and 2019, respectively.
14. Segment Data
Our operations are comprised of two reportable segments: the manufacture and sale of CEDs, batteries, accessories, extended warranties and other products and services (the “TASER” segment); and the software and sensors business, which includes the sale of devices, wearables, applications, cloud and mobile products, and services (collectively, the “Software and Sensors” segment). In both segments, we report sales of products and services. Service revenue in both segments includes sales related to Axon Evidence. In the Software and Sensors segment, service revenue also includes other recurring cloud-hosted software revenue and related professional services. Collectively, this revenue is sometimes referred to as "Axon Cloud revenue." Our Chief Executive Officer, who is the CODM, is not provided asset information or sales, general, and administrative expense by segment.
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Information relative to our reportable segments was as follows (in thousands):
75,175
32,113
65,301
22,788
720
90
27,631
30,248
18,636
23,278
16,322
28,306
23,615
45,647
42,961
42,113
26,804
3,032
23,349
3,712
19,642
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The following discussion and analysis of our financial condition as of March 31, 2020, and results of operations for the three months ended March 31, 2020 and 2019, should be read in conjunction with the condensed consolidated financial statements and related notes included in this Report on Form 10-Q and the audited consolidated financial statements in our 2019 Annual Report on Form 10-K filed with the SEC on February 28, 2020. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in such forward-looking statements as a result of certain factors, including but not limited to those described under “Risk Factors” in our 2019 Annual Report on Form 10-K. See also "Special Note Regarding Forward-Looking Statements" on page ii of this Report on Form 10-Q.
Overview
Axon is a global network of devices, apps, training and people that helps public safety personnel become smarter and safer. Our technologies give law enforcement the confidence, focus and time they need to protect their communities. Our products impact every aspect of an officer's day-to-day experience. Our core mission is to protect life. We fulfill that mission through developing hardware and software products that advance our long term vision of a) obsoleting the bullet, b) reducing social conflict, and c) enabling a fair and effective justice system.
Our revenues for the three months ended March 31, 2020 were $147.2 million, an increase of $31.4 million, or 27.1%, from the comparable period in the prior year. We had a loss from operations of $0.8 million compared to income from operations of $2.7 million for the same period in the prior year. Gross margin improved compared to the three months ended March 31, 2019 as a result of product mix, with improvement partially offset by additional expenses related to the COVID-19 pandemic. Increased operating expenses to support continued and future growth also contributed to the decline in operating results. Expenses for the quarter ended March 31, 2020 also reflected an increase of $10.5 million in stock-based compensation expense related to the CEO Performance Award and XSPP. An increase in litigation costs also contributed to the higher selling, general and administrative expense. For the three months ended March 31, 2020, we recorded net income of $4.1 million, which reflected an income tax benefit of $3.9 million, compared to $6.4 million for the comparable period in the prior year.
COVID-19
In late 2019, COVID-19 was first detected in Wuhan, China. In March 2020 the World Health Organization declared COVID-19 a global pandemic. This contagious disease outbreak, which has continued to spread, has adversely affected workforces, economies, and financial markets globally, leading to an economic downturn. As an essential provider of products and services for law enforcement and other first responders, we remain focused on protecting the health and wellbeing of our employees while assuring the continuity of our business operations.
In response to the pandemic, Axon has taken a number of actions:
Customer support:
Employee safety and manufacturing:
Supply chain:
Shareholder engagement:
We are in a strong liquidity position, with substantial cash and investments on hand, which are discussed in more detail under Liquidity and Capital Resources. We believe that our existing liquidity and other sources of funding will be sufficient to satisfy our currently anticipated cash requirements including capital expenditures, working capital requirements, potential acquisitions and other liquidity requirements through at least the next 12 months. Our expenses for the three months ended March 31, 2020 increased by approximately $1.2 million for costs related to the pandemic, and we expect ongoing increased costs related to the mitigation of contamination risk at our facilities and donations to first responders. We expect these incremental costs will continue to be partially offset by savings on travel and events and other cost-savings measures.
Results of Operations
Three Months Ended March 31, 2020 Compared to the Three Months Ended March 31, 2019
The following table presents data from our condensed consolidated statements of operations as well as the percentage relationship to total net sales of items included in our statements of operations (dollars in thousands):
72.9
76.1
27.1
23.9
100.0
33.2
34.2
6.6
6.3
39.8
40.5
60.2
59.5
42.8
37.0
17.9
20.2
60.7
57.2
(0.5)
2.3
0.6
2.0
0.1
4.3
(2.7)
(1.2)
2.8
5.5
27
International revenue increased compared to the prior year comparable period, driven primarily by increased sales in Canada and the Asia Pacific region.
Net Sales
Net sales by product line were as follows (dollars in thousands):
Dollar
Percent
Change
TASER segment:
10.4
8.6
5,372
54.0
7.5
13.7
(4,811)
(30.3)
9.6
11.3
990
7.6
0.8
530
79.1
18.1
16.6
7,465
39.0
0.3
462
1,283.3
3.4
3.7
661
15.3
1.5
(165)
(7.2)
Total TASER segment
51.6
56.5
10,504
16.1
Software and Sensors segment:
8.7
5.6
6,378
99.0
1.1
(41)
(3.3)
3.2
3.0
1,259
35.8
2.9
1,639
49.5
26.6
23.7
11,536
41.8
2.7
528
10.7
1.4
2.1
(475)
(19.2)
Total Software and Sensors segment
48.4
43.5
20,848
41.3
Total net sales
31,352
Net unit sales for TASER segment products and Software and Sensors segment products were as follows:
Unit
11,430
8,835
2,595
29.4
11,003
14,985
(3,982)
(26.6)
10,478
9,861
3,261
1,253
2,008
160.3
Cartridges
873,364
616,517
256,847
41.7
39,864
25,848
14,016
54.2
3,074
3,591
(517)
(14.4)
2,676
1,735
5,297
4,994
303
6.1
1,514
1,741
(227)
(13.0)
Net sales for the TASER segment increased 16.1% primarily due to an increase of $7.5 million in cartridge revenue, as well as a net increase of $2.1 million in TASER device sales. As expected, we have continued to see a shift to purchases of our latest generation device, TASER 7, from legacy X2 and X26P devices. The increase in cartridge revenue was due to a combination of increased units and the higher average selling price for TASER 7 cartridges compared to legacy cartridges. Revenue was also impacted by higher average selling prices for TASER 7 units, and by lower average selling prices for X26P units.
Net sales for the Software and Sensors segment increased 41.3% during the three months ended March 31, 2020 as we continued to add users and associated devices to our network. The increase in the aggregate number of users resulted in increased Axon Evidence revenue of $11.5 million. Sales of our newest generation body camera, Axon Body 3, which began shipping in September 2019, drove the increase of $6.4 million in Axon Body revenue and the increase of $1.6 million in dock revenue.
We consider total company future contracted revenues a forward-looking performance indicator. As of March 31, 2020, we had approximately $1.27 billion of total company future contracted revenue, which included both recognized contract liabilities as well as amounts that will be invoiced and recognized in future periods. We expect to recognize between 20% - 25% of this balance over the next twelve months, and expect the remainder to be recognized over the following five to seven years, subject to risks related to delayed deployments, budget appropriation or other contract cancellation clauses.
Cost of Product and Service Sales
Within the TASER segment, cost of product sales increased to $30.2 million for the three months ended March 31, 2020 from $23.3 million for the same period in 2019. Cost as a percentage of sales increased to 40.2% from 35.6%. The increase in cost of product sales was primarily attributable to the mix of products, with higher cost per unit for TASER 7 handles and cartridges as well as higher depreciation on new production equipment for the TASER 7. Additionally, we incurred expense of approximately $0.8 million in response to COVID-19, primarily related to a two week manufacturing shutdown where we continued to pay nonworking employees.
Within the Software and Sensors segment, cost of product and service sales increased to $28.3 million for the three months ended March 31, 2020 from $23.6 million for the same period in 2019. Cost as a percentage of sales decreased to 39.7% from 46.8%. Cost of product sales increased $2.3 million, but decreased as a percentage of sales as a result of the higher average selling prices during the quarter. Cost of service sales increased $2.4 million, and decreased as a percentage of sales, driven by the mix of higher-margin software revenues. Cloud costs increased $0.7 million reflecting increased usage of Axon Evidence and new capabilities within that platform requiring LTE technology.
Gross Margin
As a percentage of net sales, gross margin for the TASER segment decreased to 60.1% from 64.4% for the three months ended March 31, 2020 and 2019, respectively. The decrease was primarily a result of the mix of higher cost TASER 7 devices and cartridges, the lower average selling price on X26P devices, and expenses related to COVID-19.
As a percentage of net sales, gross margin for the Software and Sensors segment increased to 60.3% from 53.2% for the three months ended March 31, 2020 and 2019, respectively. Within the Software and Sensors segment, hardware gross margin was 42.0% for the three months ended March 31, 2020 compared to 28.4% for the same period in 2019, while the service margins were 75.3% and 73.6% during those same periods, respectively.
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Sales, General and Administrative Expenses
Sales, general and administrative ("SG&A") expenses were comprised as follows (dollars in thousands):
Total sales, general and administrative expenses
20,135
46.9
Sales, general, and administrative as a percentage of net sales
Stock-based compensation expense increased $10.3 million in comparison to the prior year comparable period, which was primarily attributable to an increase of $5.5 million in expense related to the CEO Performance Award and an increase of $3.5 million related to our XSPP. Stock-based compensation expense also increased over the prior year comparable period due to an increase in headcount.
Professional, consulting and lobbying expenses increased $6.3 million, primarily driven by an increase of $6.1 million in expenses related to the FTC litigation. As discussed in Note 12 of the notes to our condensed consolidated financial statements within this Report on Form 10-Q, on January 3, 2020, we sued the FTC in the District of Arizona, and the FTC filed an enforcement action regarding our May 2018 acquisition of Vievu LLC. This litigation is expected to result in an increase in legal expenses during the year ending December 31, 2020. While the amount and timing of such expenses is unknown and will vary depending on the progression of litigation, we currently anticipate expenses in the range of $10.0 million to $15.0 million for the year, with a higher proportion of the expense expected during the first half of 2020.
Sales and marketing expenses increased $1.7 million, driven by a $1.2 million increase in commissions tied to higher revenues.
Salaries, benefits and bonus expense increased $0.6 million, reflecting an increase of approximately $1.5 million in salaries and benefits primarily due to an increase in headcount. The increase was partially offset by a decrease of $0.7 million related to participant losses for the Company’s non-qualified deferred compensation plan.
Credit loss expense was $0.9 million compared to bad debt expense of $0.5 million during the three months ended March 31, 2019, related to our adoption of Topic 326 and the expected impact of the COVID-19 pandemic and resulting broad economic downturn.
Research and Development Expenses
Research and development ("R&D") expenses were comprised as follows (dollars in thousands):
Total research and development expenses
3,027
13.0
Research and development as a percentage of net sales
The increase in R&D expense was fully attributable to our Software and Sensors segment. Within the TASER segment, R&D expense decreased $0.7 million, due to lower headcount. R&D expense for the Software and Sensors segment increased $3.7 million, primarily due to an increase in salaries and benefits, inclusive of stock-based compensation, of $2.9 million. Contributing to the increase was an increase of $1.3 million related to our XSPP. Additionally, professional and consulting expenses increased $0.7 million for the three months ended March 31, 2020 related to development of next generation products, including the upcoming Fleet 3.
We expect R&D expense to continue to increase in absolute dollars as we focus on growing the Software and Sensors segment as we add headcount and additional resources to develop new products and services to further advance our scalable cloud-connected device platform. We believe that these investments will result in an increase in our
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subscription revenue base, which over time will result in revenue increasing faster than the increase in SG&A expenses and R&D costs, as we reach economies of scale.
Interest and Other Income (Expense), Net
Interest and other income (expense), net was $0.9 million for the three months ended March 31, 2020 compared to $2.3 million for the same period in 2019. The decrease was primarily attributable to a $0.7 million investment loss related to our non-qualified deferred compensation plan in 2020 as compared to a $0.3 million gain during the prior year comparable period. Additionally, interest income decreased $0.3 million as a result of decreased interest rates during the current period.
Provision for Income Taxes
Our overall effective tax rate for the three months ended March 31, 2020, after discrete period adjustments, was (2,789.4%). Before discrete adjustments, the tax rate was 90%, which is more than the federal statutory rate, primarily due to state taxes and non-deductible expenses for items such as meals and entertainment, executive compensation limitation under Internal Revenue Code ("IRC") Section 162(m), and income inclusion from global intangible low-taxed income ("GILTI"), offset by a reduction for foreign-derived intangible income ("FDII") and R&D tax credits. The effective tax rate was favorably impacted by a $4.1 million discrete tax benefit primarily associated with windfalls related to stock-based compensation for RSUs that vested or stock options that were exercised during the three months ended March 31, 2020.
Net Income
Our net income decreased by $2.3 million to $4.1 million for the three months ended March 31, 2020 compared to $6.4 million for the same period in 2019. Net income per basic and diluted share was $0.07 for the three months ended March 31, 2020 compared to $0.11 per basic and diluted share for the same period in 2019.
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Three Months Ended March 31, 2020 Compared to the Three Months Ended December 31, 2019
Three Months Ended
17,186
10.0
(1,860)
(10.8)
14,692
8.5
(3,631)
(24.7)
15,507
9.0
(1,432)
(9.2)
1,169
0.7
28,633
16.7
(2,008)
(7.0)
0.2
157
46.0
4,733
244
5.2
1,694
1.0
25.9
TASER segment
83,955
48.9
(8,060)
(9.6)
25,219
14.7
(12,396)
(49.2)
1,411
(228)
(16.2)
5,205
(430)
(8.3)
11,048
6.4
(6,097)
(55.2)
36,804
21.4
2,350
0.4
304
48.8
5,124
334
6.5
2,462
(466)
(18.9)
Software and Sensors segment
87,896
51.1
(16,629)
171,851
(24,689)
14,577
(3,147)
(21.6)
13,554
(2,551)
(18.8)
11,534
(1,056)
2,978
283
9.5
962,519
(89,155)
(9.3)
83,268
(43,404)
(52.1)
3,078
(0.1)
3,324
(648)
(19.5)
10,149
(4,852)
(47.8)
1,177
337
28.6
Net sales within the TASER segment decreased by approximately $8.1 million or 9.6% as compared to the prior quarter, due primarily to a net decrease of $6.9 million in TASER device sales and a decrease of $2.0 million in cartridge revenue. Unit sales of all non-consumer TASER devices declined from the prior quarter. Additionally, TASER device revenue was impacted by lower average selling prices for X26P and consumer devices during the three months ended March 31, 2020. Higher average selling prices for TASER 7 partially offset the decline.
Within the Software and Sensors segment, net sales decreased $16.6 million or 18.9% during the three months ended March 31, 2020. Revenue from Axon Body cameras decreased $12.4 million and revenue from docks decreased
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$6.1 million, primarily due to a significant number of shipments that occurred during the prior quarter following the introduction of our Axon Body 3 devices. Higher average selling prices for legacy body cameras partially offset the decline in units. Additionally, Axon Evidence revenues increased $2.4 million based on an increase in the aggregate number of users on our Axon network.
Non-GAAP Measures
To supplement our financial results presented in accordance with GAAP, we present the non-GAAP financial measures of EBITDA and Adjusted EBITDA (CEO Performance Award). Our management uses these non-GAAP financial measures in evaluating our performance in comparison to prior periods. We believe that both management and investors benefit from referring to these non-GAAP financial measures in assessing our performance, and when planning and forecasting our future periods. A reconciliation of GAAP to the non-GAAP financial measures is presented below.
Although these non-GAAP financial measures are not consistent with GAAP, management believes investors will benefit by referring to these non-GAAP financial measures when assessing our operating results, as well as when forecasting and analyzing future periods. However, management recognizes that:
EBITDA and Adjusted EBITDA (CEO Performance Award) reconciles to net income as follows (in thousands):
Net income (loss)
(12,379)
3,165
Interest expense
Investment interest income
(693)
(1,760)
(2,003)
Provision for (benefit from) income taxes
479
EBITDA
2,336
(10,476)
5,787
Adjustments:
Stock-based compensation expense
48,300
Adjusted EBITDA (CEO Performance Award)
22,531
37,824
13,692
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Liquidity and Capital Resources
Summary
As of March 31, 2020, we had $156.5 million of cash and cash equivalents, a decrease of $15.7 million as compared to December 31, 2019. Cash and cash equivalents and investments totaled $395.4 million; including a payable of $13.5 million related to unsettled investment purchases at March 31, 2020, this represented a net decrease of $14.3 million from December 31, 2019.
Our ongoing sources of cash include cash on hand, investments, and cash flows from operations. In addition, our $50.0 million revolving credit facility is available for additional working capital needs or investment opportunities. Under the terms of the line of credit, available borrowings are reduced by outstanding letters of credit. Advances under the line of credit bear interest at LIBOR plus 1.0 to 1.5% per year determined in accordance with a pricing grid based on our funded debt to earnings before interest, taxes, depreciation and amortization ("EBITDA") ratio.
As of March 31, 2020, we had letters of credit outstanding of $2.7 million, leaving the net amount available for borrowing of $47.3 million. The facility matures on December 31, 2021, and has an accordion feature which allows for an increase in the total line of credit up to $100.0 million, subject to certain conditions, including the availability of additional bank commitments. There can be no assurance that we will continue to generate cash flows at or above current levels or that we will be able to maintain our ability to borrow under our revolving credit facility. At March 31, 2020 and December 31, 2019, there were no borrowings under the line other than the outstanding letters of credit.
Our agreement with the bank requires us to comply with a maximum funded debt to EBITDA ratio, as defined, of no greater than 2.50 to 1.00 based upon a trailing four fiscal quarter period. At March 31, 2020, our funded debt to EBITDA ratio was 0.0003 to 1.00.
TASER 60 installment purchase arrangements typically involve amounts invoiced in five equal installments at the beginning of each year of the five-year term. This is in contrast to a traditional CED sale in which the entire amount being charged for the hardware is invoiced upon shipment. This impacts liquidity in a commensurate fashion, with the cash for the TASER 60 arrangement received in five annual installments rather than up front. It is our strategic intent to shift an increasing amount of our business to a subscription model, to better match the municipal budgeting process of our customers as well as to allow for multiple product offerings to be bundled into existing subscriptions. We carefully considered the cash flow impacts of this strategic shift and regularly revisit our cash flow forecast with the goal of maintaining a comfortable level of liquidity as we introduce commercial offerings in which we incur upfront cash costs to produce and fulfill hardware sales ahead of the cash inflows from our customers. We anticipate, and have prepared for, the majority of our arrangements in both reportable segments to be offered in similar subscription-type offerings over the coming years. With the launch of the TASER 7, which is primarily being sold in subscription offerings, this strategic shift continues to accelerate.
Based on our strong balance sheet and the fact that we do not have long-term debt at March 31, 2020, we believe financing will be available, both through our existing credit line and possible additional financing. However, there is no assurance that such funding will be available on terms acceptable to us, or at all. We believe that our sources of funding will be sufficient to satisfy our currently anticipated cash requirements including capital expenditures, working capital requirements, potential acquisitions and other liquidity requirements through at least the next 12 months. We and our Board of Directors may consider repurchases of our common stock from time to time pursuant to our stock repurchase plan. Further repurchases of our common stock would take place on the open market, would be financed with available cash and are subject to market and business conditions.
Cash Flows
The following table summarizes our cash flows from operating, investing and financing activities (in thousands):
Operating activities
Investing activities
Financing activities
Net increase (decrease) in cash and cash equivalents and restricted cash
Net cash provided by operating activities in the first three months of 2020 of $13.4 million reflects $4.1 million in net income, non-cash income statement items totaling $24.5 million, and a negative impact on cash of $15.1 million for the net change in operating assets and liabilities. Included in the non-cash items were $2.9 million in depreciation and amortization expense and $20.2 million in stock-based compensation expense. Cash used in operations was impacted by increased accounts and notes receivable and contract assets of $9.7 million, increased inventory of $8.6 million, decreased accounts payable, accrued liabilities and other liabilities of $3.6 million, increased deferred revenue of $4.5 million, and decreased prepaid and other assets of $2.3 million. The increase in accounts and notes receivable and contract assets was attributable to increased sales over the last several quarters, primarily sales made under subscription plans. The decrease in accounts payable, accrued liabilities and other liabilities was primarily attributable to the timing of payments, and was partially offset by a $13.5 million payable for unsettled investment purchases at March 31, 2020 which was settled in early April 2020. The increase in deferred revenue was primarily attributable to increased hardware deferred revenue from TASER subscription sales, partially offset by a decrease in prepayments for Software and Sensors services. The decrease in prepaid expenses and other assets was primarily attributable to usage of prepaid cloud storage fees, partially offset by an increase in income tax receivable.
Net cash used in operating activities in the first three months of 2019 of $14.0 million reflects $6.4 million in net income, non-cash income statement items totaling $12.7 million, and cash outflows of $33.1 million for the net change in operating assets and liabilities. Included in the non-cash items were $2.8 million in depreciation and amortization expense and $7.9 million in stock-based compensation expense. Cash used in operations was impacted by increased accounts and notes receivable and contract assets of $22.0 million, decreased accounts payable, accrued liabilities and other liabilities of $7.3 million, increased inventory of $3.9 million, and increased prepaid expenses and other assets of $3.2 million. The increase in accounts and notes receivable and contract assets was attributable to increased sales over the several prior quarters, primarily sales made under subscription plans, as well as slower customer collections. The decrease in accounts payable, accrued liabilities and other liabilities was primarily attributable to the timing of payments for our annual bonus plan. Cash used in operations was also impacted by various other operating items, including increased deferred revenue of $3.2 million.
We used $22.1 million in investing activities during the first three months of 2020, which was comprised of $15.2 million for the purchase of investments, net of proceeds, $4.7 million for an equity investment in an unconsolidated affiliate, and $2.2 million for the purchase of property and equipment and intangible assets.
We used $110.8 million in investing activities during the first three months of 2019, which was comprised of $105.3 million for the purchase of investments and $5.4 million for the purchase of property and equipment and intangible assets.
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Net cash used in financing activities was $5.2 million during the first three months of 2020. During the first three months of 2020, we paid income and payroll taxes of $5.2 million on behalf of employees who net-settled stock awards during the period, which was partially offset by proceeds from options exercised of less than $0.1 million.
Net cash used in financing activities was $1.2 million during the first three months of 2019. During the first three months of 2019, we paid income and payroll taxes of $1.3 million on behalf of employees who net-settled stock awards during the period, which was partially offset by proceeds from options exercised of $0.1 million.
The discussion of off-balance sheet arrangements in Note 12 of the notes to our condensed consolidated financial statements within this Report on Form 10-Q is incorporated by reference herein.
Critical Accounting Estimates
We have identified the following accounting estimates as critical to our business operations and the understanding of our results of operations. The preparation of financial statements requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, the disclosure of contingent assets and liabilities at the date of our unaudited condensed consolidated financial statements, and the reported amounts of revenue and expenses during the reporting period. While we do not believe that a change in these estimates is reasonably likely, there can be no assurance that our actual results will not differ from these estimates. The effect of these estimates on our business operations are discussed below.
Stock-Based Compensation
We have historically granted stock-based compensation to key employees and non-employee directors as a means of attracting and retaining highly qualified personnel. Stock-based compensation awards primarily consist of service-based RSUs, performance-based RSUs, and performance-based options. Our stock-based compensation awards are classified as equity and measured at the fair market value of the underlying stock at the grant date. For service-based awards, we recognize RSU expense using the straight-line attribution method over the requisite service period. Vesting of performance-based RSUs and options is contingent upon the achievement of certain performance criteria related to our operating performance, as well as successful and timely development and market acceptance of future product introductions. For performance-based RSUs containing only performance conditions, compensation cost is recognized using the graded attribution model over the explicit or implicit service period. For awards containing multiple service, performance or market conditions, where all conditions must be satisfied prior to vesting, compensation expense is recognized over the requisite service period, which is defined as the longest explicit, implicit or derived service period, based on management’s estimate of the probability of the performance criteria being satisfied, adjusted at each balance sheet date. For both service-based and performance-based RSUs, we account for forfeitures as they occur as a reduction to stock-based compensation expense and additional paid-in-capital.
For performance-based awards, stock-based compensation expense is recognized over the expected performance achievement period of individual performance goals when the achievement of each individual performance goal becomes probable. For performance-based awards with a vesting schedule based entirely on the attainment of both performance and market conditions, stock-based compensation expense is recognized over the longer of the expected achievement period of the performance and market conditions, beginning at the point in time that the relevant performance condition is considered probable of achievement. The fair value of such awards is estimated on the grant date using Monte Carlo simulations. Refer to Note 10 of the notes to our condensed consolidated financial statements within this Report on Form 10-Q.
We have granted a total of 14.6 million performance-based awards (options and restricted stock units) of which 12.2 million are outstanding as of March 31, 2020, the vesting of which is contingent upon the achievement of certain performance criteria including the successful development and market acceptance of future product introductions, our
future sales targets and operating performance and market capitalization. Compensation expense for performance awards will be recognized based on management’s best estimate of the probability of the performance criteria being satisfied using the most currently available projections of future product adoption and operating performance, adjusted at each balance sheet date. Changes in the subjective and probability-based assumptions can materially affect the estimate of the fair value of the awards and timing of recognition of stock-based compensation and consequently, the related amount recognized in our condensed consolidated statements of operations and comprehensive income.
Allowance for Expected Credit Losses
We are exposed to the risk of credit losses primarily through sales of products and services. Our expected loss allowance for accounts receivable, notes receivable, and contract assets represents management’s best estimate and application of judgment considering a number of factors, including historical collection experience, published or estimated credit default rates for entities that represent our customer base, current and future economic and market conditions and a review of the current status of customers' trade accounts receivables. Additionally, specific allowance amounts are established to record the appropriate provision for customers that have a higher probability of default. Our monitoring activities include account reconciliation, dispute resolution, payment confirmation, consideration of customers' financial condition and macroeconomic conditions. Balances are written off when determined to be uncollectible.
A majority of our customers are governmental agencies. Due to municipal government funding rules, certain of our contracts are subject to appropriation, termination for convenience, or similar cancellation clauses, which could allow our customers to cancel or not exercise options to renew contracts in the future. Economic slowdowns that negatively affect municipal tax collections and put pressure on law enforcement may increase this risk and negatively impact the realizability of our accounts and notes receivable and contract assets. We considered the current and expected future economic and market conditions surrounding the COVID-19 pandemic and recorded additional credit loss expense of approximately $0.9 million during the three months ended March 31, 2020.
Based on the balances of our financial instruments as of March 31, 2020, a hypothetical 25 percent increase in expected credit loss rates across all pools would result in a $0.7 million increase in the allowance for expected credit losses.
Interest Rate Risk
We typically invest in a limited number of financial instruments, consisting principally of investments in money market accounts, certificates of deposit, and corporate and municipal bonds with a typical long-term debt rating of “A” or better by any nationally recognized statistical rating organization, denominated in U.S. dollars. All of our cash equivalents and investments are treated as “held-to-maturity.” Investments in fixed-rate interest-earning instruments carry a degree of interest rate risk as their market value may be adversely impacted due to a rise in interest rates. As a result, we may suffer losses in principal if we sell securities that have declined in market value due to changes in interest rates. However, because we classify our debt securities as “held-to-maturity” based on our intent and ability to hold these instruments to maturity, no gains or losses are recognized due to changes in interest rates. These securities are reported at amortized cost. Based on investment positions as of March 31, 2020, a hypothetical 100 basis point increase in interest rates across all maturities would result in a $1.1 million decline in the fair market value of the portfolio. Such losses would only be realized if we sold the investments prior to maturity.
Additionally, we have access to a $50.0 million line of credit borrowing facility which bears interest at LIBOR plus 1.0 to 1.5% per year determined in accordance with a pricing grid based on our funded debt to EBITDA ratio. Under the terms of the line of credit, available borrowings are reduced by outstanding letters of credit, which totaled $2.7 million at March 31, 2020. At March 31, 2020, there was no amount outstanding under the line of credit and the available borrowing under the line of credit was $47.3 million. We have not borrowed any funds under the line of credit since its
inception; however; should we need to do so in the future, such borrowings could be subject to adverse or favorable changes in the underlying interest rate.
Exchange Rate Risk
Our results of operations and cash flows are subject to fluctuations due to changes in foreign currency exchange rates, in each case compared to the U.S. dollar, related to transactions by our foreign subsidiaries. The majority of our sales to international customers are transacted in U.S. dollars and therefore, are not subject to exchange rate fluctuations on these transactions. However, the cost of our products to our customers increases when the U.S. dollar strengthens against their local currency, and we may have more sales and expenses denominated in foreign currencies in future years which could increase our foreign exchange rate risk. Additionally, intercompany sales to our non-U.S. dollar functional currency international subsidiaries are transacted in U.S. dollars which could increase our foreign exchange rate risk caused by foreign currency transaction gains and losses.
To date, we have not engaged in any currency hedging activities. However, we may enter into foreign currency forward and option contracts with financial institutions to protect against foreign exchange risks associated with certain existing assets and liabilities, certain firmly committed transactions, forecasted future cash flows and net investments in foreign subsidiaries. However, we may choose not to hedge certain foreign exchange exposures for a variety of reasons, including but not limited to the prohibitive economic cost of hedging particular exposures. As such, fluctuations in currency exchange rates could harm our business in the future.
Evaluation of Disclosure Controls and Procedures
Our Chief Executive Officer and Chief Financial Officer are responsible for the evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q. Our disclosure controls and procedures are designed to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of March 31, 2020.
Change in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the fiscal quarter ended March 31, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. We have not experienced any material impact to our internal controls over financial reporting despite the fact that most of our employees are working remotely due to the COVID-19 pandemic. We are continually monitoring and assessing the potential impact of COVID-19 on our internal controls to minimize the impact on their design and operating effectiveness.
The discussion under the headings Product Litigation, Other Litigation, and U.S. Federal Trade Commission Investigation in Note 12 of the notes to our condensed consolidated financial statements included in Part I, Item 1 of this Report on Form 10-Q is incorporated by reference herein.
Except as noted below, there are no material changes from the risk factors previously disclosed in Part I, Item 1A, "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2019, which could adversely affect our business, financial condition, results of operations, cash flows, and the trading price of our common stock.
The COVID-19 pandemic has significantly impacted worldwide economic conditions and could have a material adverse effect on our operations and business.
In March 2020 the World Health Organization declared coronavirus (or “COVID-19”) a global pandemic. This contagious disease outbreak, which has continued to spread, has adversely affected workforces, economies, and financial markets globally, leading to an economic downturn. As an essential provider of products and services for law enforcement and other first responders, we remain focused on protecting the health and well-being of our employees while assuring the continuity of our business operations.
COVID-19-related risks that may affect our operations and financial results include, but are not limited to:
These events have had and could continue to have an impact on our operations. If our backup and mitigation plans are not sufficient to minimize business disruption, our financial results could be adversely affected. The ultimate extent of the effects of the COVID-19 pandemic on the Company is highly uncertain and will depend on future developments that cannot be predicted. We are continuously monitoring our operations and intend to take appropriate actions to mitigate the risks arising from the COVID-19 pandemic, but there can be no assurances that we will be successful in doing so.
None.
31.1*
Principal Executive Officer Certification pursuant to Rule 13a-14(a) or Rule 15d-14(a)
31.2*
Principal Financial Officer Certification pursuant to Rule 13a-14(a) or Rule 15d-14(a)
32**
Principal Executive Officer and Principal Financial Officer Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS
Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH
Inline XBRL Taxonomy Extension Schema Document
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
Inline XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
Inline XBRL Taxonomy Extension Label Linkbase Document
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase Document
104
The cover page from the Company’s Quarterly Report for the quarter ended March 31, 2020, formatted in Inline XBRL
* Filed herewith
** Furnished herewith
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date:
May 8, 2020
By:
/s/ PATRICK W. SMITH
Chief Executive Officer
(Principal Executive Officer)
/s/ JAWAD A. AHSAN
Chief Financial Officer
(Principal Financial and
Accounting Officer)