Document
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2018
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 of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
17800 North 85th Street
Scottsdale, Arizona
 
85255
(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)
 
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  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted 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 and post such files).    Yes  ý    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
 
ý
Accelerated filer
 
¨
 
 
 
 
Non-accelerated filer
 
¨ (Do not check if a smaller reporting company)
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  ý
The number of shares of the registrant’s common stock outstanding as of April 30, 2018 was 53,322,608.
 


Table of Contents

AXON ENTERPRISE, INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2018
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


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Table of Contents

PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
AXON ENTERPRISE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
 
March 31, 2018
 
December 31, 2017
 
(Unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
92,330

 
$
75,105

Short-term investments
4,475

 
6,862

Accounts and notes receivable, net of allowance of $880 and $754 as of March 31, 2018 and December 31, 2017, respectively
87,849

 
56,064

Contract assets, net
9,278

 

Inventory
43,104

 
45,465

Prepaid expenses and other current assets
21,934

 
21,696

Total current assets
258,970

 
205,192

Property and equipment, net of accumulated depreciation of $37,518 and $36,477 as of March 31, 2018 and December 31, 2017, respectively
31,175

 
31,172

Deferred income tax assets, net
14,200

 
15,755

Intangible assets, net
17,496

 
18,823

Goodwill
14,947

 
14,927

Long-term notes receivable, net of current portion
34,624

 
36,877

Other assets
21,573

 
15,366

Total assets
$
392,985

 
$
338,112

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
11,692

 
$
8,592

Accrued liabilities
34,869

 
23,502

Current portion of deferred revenue
76,141

 
70,401

Customer deposits
3,155

 
3,673

Current portion of business acquisition contingent consideration
2,505

 
1,693

Other current liabilities
348

 
89

Total current liabilities
128,710

 
107,950

Deferred revenue, net of current portion
58,003

 
54,881

Liability for unrecognized tax benefits
1,810

 
1,706

Long-term deferred compensation
3,998

 
3,859

Business acquisition contingent consideration, net of current portion
201

 
1,048

Other long-term liabilities
934

 
1,224

Total liabilities
193,656

 
170,668

Commitments and contingencies (Note 11)

 

Stockholders’ equity:
 
 
 
Preferred stock, $0.00001 par value; 25,000,000 shares authorized; no shares issued and outstanding as of March 31, 2018 and December 31, 2017

 

Common stock, $0.00001 par value; 200,000,000 shares authorized; 53,307,083 and 52,969,869 shares issued and outstanding as of March 31, 2018 and December 31, 2017, respectively
1

 
1

Additional paid-in capital
202,344

 
201,672

Treasury stock at cost, 20,220,227 shares as of March 31, 2018 and December 31, 2017
(155,947
)
 
(155,947
)
Retained earnings
155,105

 
123,185

Accumulated other comprehensive loss
(2,174
)
 
(1,467
)
Total stockholders’ equity
199,329

 
167,444

Total liabilities and stockholders’ equity
$
392,985

 
$
338,112

The accompanying notes are an integral part of these condensed consolidated financial statements.

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Table of Contents

AXON ENTERPRISE, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
(in thousands, except per share data)
 
 
Three Months Ended March 31,
 
2018
 
2017
Net sales from products
$
80,974

 
$
67,491

Net sales from services
20,241

 
11,751

Net sales
101,215

 
79,242

Cost of product sales
32,434

 
27,072

Cost of service sales
4,320

 
3,500

Cost of sales
36,754

 
30,572

Gross margin
64,461

 
48,670

Operating expenses:
 
 
 
Sales, general and administrative
35,759

 
30,857

Research and development
15,119

 
12,463

Total operating expenses
50,878

 
43,320

Income from operations
13,583

 
5,350

Interest and other income, net
1,263

 
206

Income before provision for income taxes
14,846

 
5,556

Provision for income taxes
1,920

 
976

Net income
$
12,926

 
$
4,580

Net income per common and common equivalent shares:
 
 
 
Basic
$
0.24

 
$
0.09

Diluted
$
0.24

 
$
0.09

Weighted average number of common and common equivalent shares outstanding:
 
 
 
Basic
53,119

 
52,418

Diluted
54,532

 
53,677

 
 
 
 
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Net income
$
12,926

 
$
4,580

Foreign currency translation adjustments
(707
)
 
165

Comprehensive income
$
12,219

 
$
4,745


The accompanying notes are an integral part of these condensed consolidated financial statements.


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Table of Contents

AXON ENTERPRISE, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
 
Three Months Ended March 31,
 
2018
 
2017
Cash flows from operating activities:
 
 
 
Net income
$
12,926

 
$
4,580

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
2,411

 
1,604

Loss on disposal of property and equipment
34

 

Bond premium amortization
22

 
218

Stock-based compensation
4,093

 
3,447

Deferred income taxes
1,514

 
(1,216
)
Unrecognized tax benefits
104

 
134

Change in assets and liabilities:
 
 
 
Accounts and notes receivable and contract assets
(17,060
)
 
(11,858
)
Inventory
2,408

 
(13,686
)
Prepaid expenses and other assets
(1,702
)
 
(2,707
)
Accounts payable, accrued and other liabilities
6,749

 
6,562

Deferred revenue
6,554

 
6,313

Net cash provided by (used in) operating activities
18,053

 
(6,609
)
Cash flows from investing activities:
 
 
 
Purchases of investments
(802
)
 

Proceeds from maturity of investments
3,167

 
18,801

Purchases of property and equipment
(1,063
)
 
(2,343
)
Purchases of intangible assets
(34
)
 
(95
)
Business acquisitions

 
(6,479
)
Net cash provided by investing activities
1,268

 
9,884

Cash flows from financing activities:
 
 
 
Proceeds from options exercised
356

 
296

Payroll tax payments for net-settled stock awards
(3,777
)
 
(2,165
)
Payments on capital lease obligation
(9
)
 
(8
)
Net cash used in financing activities
(3,430
)
 
(1,877
)
Effect of exchange rate changes on cash, cash equivalents and restricted cash
469

 
(76
)
Net increase in cash, cash equivalents and restricted cash
16,360

 
1,322

Cash, cash equivalents and restricted cash, beginning of period
78,438

 
43,969

Cash, cash equivalents and restricted cash, end of period
$
94,798

 
$
45,291

 
 
 
 
Supplemental disclosures:
 
 
 
Cash and cash equivalents
$
92,330

 
$
41,974

Restricted cash (Note 6)
2,468

 
3,317

Total cash, cash equivalents and restricted cash shown in the statements of cash flows
$
94,798

 
$
45,291

 
 
 
 
Cash paid for income taxes, net of refunds
$
63

 
$
145

 
 
 
 
Non-cash transactions
 
 
 
Property and equipment purchases in accounts payable and accrued liabilities
$
136

 
$
794

Contingent consideration related to business combinations
$

 
$
1,007

The accompanying notes are an integral part of these condensed consolidated financial statements.

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Table of Contents
AXON ENTERPRISE, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


1. Organization and Summary of Significant Accounting Policies
Axon Enterprise, Inc. (“Axon” or the “Company”) is a developer and manufacturer of advanced conducted electrical weapons (“CEWs”) designed for use by law enforcement, military, corrections, private security personnel, and by private individuals for personal defense. In addition, the Company has developed full technology solutions for the capture, secure storage and management of video/audio evidence as well as other tactical capabilities for use in law enforcement. The Company sells its products worldwide through its direct sales force, distribution partners, online store and third-party resellers. The Company was incorporated in Arizona in September 1993, and reincorporated in Delaware in January 2001. The Company’s corporate headquarters and manufacturing facilities are located in Scottsdale, Arizona. The Company’s main software development division is located in Seattle, Washington, and it develops artificial intelligence technologies through its wholly-owned subsidiary in Vietnam, Axon Public Safety Southeast Asia LLC. During 2018, the Company established Axon Public Safety Finland OY in Tampere, Finland that operates a connected hardware team focused on the development of the Company's hardware products. Axon Public Safety BV, a wholly owned subsidiary of the Company, supports the Company's international sales and marketing efforts, and is located in Amsterdam, Netherlands. Axon Public Safety BV wholly owns two subsidiaries, Axon Public Safety U.K. LTD and Axon Public Safety AU, that serve as direct sales operations in the United Kingdom ("U.K.") and Australia, respectively. The Company also sells to certain international markets through a wholly-owned subsidiary, Axon Public Safety Germany SE, and sells into the Canadian market through its wholly-owned subsidiary, Axon Public Safety Canada, Inc.
The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its 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 Securities and Exchange Commission. Certain information related to the Company’s 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 the Company’s annual consolidated financial statements for the year ended December 31, 2017, as filed on Form 10-K, with the exception of the Company's adoption of Topic 606. 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 the Company’s 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 the Company’s Form 10-K for the year ended December 31, 2017. The results of operations for the three months ended March 31, 2018 and 2017 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:
 
product warranty reserves,
inventory valuation,
revenue recognition,
valuation of goodwill, intangible and long-lived assets,
recognition, measurement and valuation of current and deferred income taxes,
fair value of stock awards issued and the estimated vesting period for performance-based stock awards, and
recognition and measurement of contingencies and accrued litigation expense.
Actual results could differ materially from those estimates.
Segment Information
The Company is comprised of two reportable segments: the manufacture and sale of CEWs, batteries, accessories, extended warranties and other products and services (the “TASER Weapons” segment); and the software and sensors business, which includes the sale of devices, wearables, applications, cloud and mobile products (collectively, the “Software and Sensors” segment). Within the Software and Sensors segment, the Company specifies sales of products and services. Revenue from the Company's “products” in the Software and Sensors segment are generally sales of sensors, including on-officer body cameras, Axon Fleet cameras, other hardware sensors, warranties on sensors,and other products, and is sometimes referred to as Sensors and Other revenue. Revenue from the Company's “services” in the Software and Sensors segment comprise sales related to the Axon Cloud, which includes Evidence.com, cloud-based evidence management software revenue, other recurring cloud-hosted software revenue and related professional services, and is sometimes referred to as Axon Cloud revenue. Within the Software and Sensors segment, the Company

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Table of Contents
AXON ENTERPRISE, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


includes only revenues and costs attributable to that segment which include: costs of sales for both products and services, direct labor, selling expenses for the sales team, product management and research and development ("R&D") for products included, or to be included, within the Software and Sensors segment. All other costs are included in the TASER Weapons segment.
The Company’s Chief Executive Officer, who is the Chief Operating Decision Maker (the “CODM”), is not provided asset information by segment. Reportable segments are determined based on discrete financial information reviewed by the CODM for the Company. The Company organizes and reviews operations based on products and services. The Company performs an annual analysis of its reportable segments. Additional information related to the Company’s business segments is summarized in Note 14.
Geographic Information and Major Customers
For the three months ended March 31, 2018 and 2017, no individual country outside the U.S. represented more than 10% of 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 the Company's customers.
For the three months ended March 31, 2018 and 2017, no customer represented more than 10% of total net sales. At March 31, 2018 and December 31, 2017, no customer represented more than 10% of the aggregate accounts and notes receivable balance and contract assets.
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. Potentially dilutive securities include outstanding stock options and unvested restricted stock units ("RSUs"). The dilutive effect of potentially dilutive securities is reflected in diluted earnings per share by application of the treasury stock method. Under the treasury stock method, an increase in the fair market value of the Company’s common stock can result in a greater dilutive effect from potentially dilutive securities.
The calculation of the weighted average number of shares outstanding and earnings per share are as follows (in thousands except per share data):
 
Three Months Ended March 31,
 
2018
 
2017
Numerator for basic and diluted earnings per share:
 
 
 
Net income
$
12,926

 
$
4,580

Denominator:
 
 
 
Weighted average shares outstanding
53,119

 
52,418

Dilutive effect of stock-based awards
1,413

 
1,259

Diluted weighted average shares outstanding
54,532

 
53,677

Anti-dilutive stock-based awards excluded
404

 
676

Net income per common share:
 
 
 
Basic
$
0.24

 
$
0.09

Diluted
$
0.24

 
$
0.09


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Table of Contents
AXON ENTERPRISE, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


Standard Warranties
The Company warranties its CEWs, Axon cameras and certain related accessories from manufacturing defects on a limited basis for a period of one year after purchase and, thereafter, will 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 on a quarterly basis 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 consolidated balance sheets. 
Changes in the Company’s estimated product warranty liabilities were as follows (in thousands):
 
Three Months Ended March 31,
 
2018
 
2017
Balance, beginning of period
$
644

 
$
780

Utilization of accrual
(93
)
 
(66
)
Warranty expense (recovery)
8

 
(367
)
Balance, end of period
$
559

 
$
347

Fair Value Measurements and Financial Instruments
The Company uses 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. The Company categorizes each of its 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:
 
Level 1 – Valuation techniques in which all significant inputs are unadjusted quoted prices from active markets for assets or liabilities that are identical to the assets or liabilities being measured.
Level 2 – Valuation techniques in which significant inputs include quoted prices from active markets for assets or liabilities that are similar to the assets or liabilities being measured and/or quoted prices for assets or liabilities that are identical or similar to the assets or liabilities being measured from markets that are not active. Also, model-derived valuations in which all significant inputs and significant value drivers are observable in active markets are Level 2 valuation techniques.
Level 3 – Valuation techniques in which one or more significant inputs or significant value drivers are unobservable. Unobservable inputs are valuation technique inputs that reflect the Company's own assumptions about inputs that market participants would use in pricing an asset or liability.
The Company has cash equivalents and investments, which at March 31, 2018 and December 31, 2017 were comprised of money market funds, state and municipal obligations, corporate bonds, and certificates of deposits. See additional disclosure regarding the fair value of the Company’s cash equivalents and investments in Note 3. Included in the balance of Other assets as of March 31, 2018 and December 31, 2017 was $3.8 million related to corporate-owned life insurance policies which are used to fund the Company’s deferred compensation plan. The Company determines the fair value of its insurance contracts by obtaining the cash surrender value of the contracts from the issuer, a Level 2 valuation technique.
The Company’s financial instruments also include accounts and notes receivable, accounts payable, notes payable and accrued liabilities. Due to the short-term nature of these instruments, their fair values approximate their carrying values on the accompanying condensed consolidated balance sheets.
Valuation of Goodwill, Intangibles and Long-lived Assets
Management evaluates 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

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AXON ENTERPRISE, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


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, management estimates 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.
The Company does 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. The Company performs its goodwill and intangible asset impairment tests in the fourth quarter of each year.
Recently Issued Accounting Guidance
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”) and Accounting Standards Codification ("ASC") Subtopic 340-40, Other Assets and Deferred Costs - Contracts with Customers ("ASC 340-40"), (collectively, “Topic 606”). On January 1, 2018, the Company adopted Topic 606 by applying the modified retrospective method of adoption for all contracts that were not substantially completed as of the adoption date. ASU 2014-09 requires entities to recognize revenue through the application of a five-step model, which includes identification of the contract, identification of the performance obligations, determination of the transaction price, allocation of the transaction price to the performance obligations and recognition of revenue as the entity satisfies the performance obligations. Refer to Note 2 for further discussion.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) in order to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet for those leases classified as operating leases under previous GAAP. ASU 2016-02 requires a lessee to recognize a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term on the balance sheet. ASU 2016-02 is effective for the fiscal year beginning after December 15, 2018 (including interim periods within that year) using a modified retrospective approach and early adoption is permitted. The Company is currently in the process of evaluating the impact of adoption of this ASU on its consolidated financial statements.
 
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses, which amends ASC 326. The new guidance differs from existing GAAP wherein previous standards generally delayed recognition of credit losses until the loss was probable. ASU 2016-13 eliminates the probable initial recognition threshold and, instead, reflects an entity’s current estimate of all expected credit losses. The use of forecasted information is intended to incorporate more timely information in the estimate of expected credit loss. ASU 2016-13 is effective for the fiscal year beginning after December 15, 2019, and interim periods within that fiscal year, and early adoption is permitted. The Company is currently in the process of evaluating the impact of adoption of ASU 2016-13 on its consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 eliminates the diversity in practice related to the classification of certain cash receipts and payments. ASU 2016-15 designates the appropriate cash flow classification, including requirements to allocate certain components of these cash receipts and payments among operating, investing and financing activities. The Company adopted ASU 2016-15 effective January 1, 2018, and the adoption of this ASU did not have a material impact on its consolidated financial statements.
In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740) - Intra-Entity Transfers of Assets Other Than Inventory. ASU 2016-16 requires an entity to recognize income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. This removes the exception to postpone recognition until the asset has been sold to an outside party. The Company adopted ASU 2016-16 effective January 1, 2018, and the adoption of this ASU did not have a material impact on its consolidated financial statements.
In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows - Restricted Cash (Topic 230), which amends the existing guidance relating to the treatment of restricted cash and restricted cash equivalents on the statement of cash flows.  The Company adopted ASU 2016-18 effective January 1, 2018, and retrospectively updated the presentation of its unaudited consolidated statements of cash flows to include amounts of restricted cash with cash and cash equivalents when reconciling the beginning-of-period and end-of-period amounts. The adoption of ASU 2016-18 did not have a material impact on the Company's consolidated financial statements.

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AXON ENTERPRISE, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805) to provide a more robust framework to use in determining when a set of acquired assets and activities is a business. The Company adopted ASU 2017-01 effective January 1, 2018. The amendments in ASU 2017-01 provide a screen to determine when a set of acquired integrated assets and activities is not a business, and if the screen is not met it may result in fewer transactions that qualify as a business combination under ASC Topic 805. For the three months ended March 31, 2018, the adoption of ASU 2017-01 did not have a material impact on the Company's consolidated financial statements.
In May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718), which provides guidance on determining which changes to the terms and conditions of share-based payment awards require an entity to apply modification accounting under Topic 708. The Company adopted ASU2017-09 effective January 1, 2018, and the adoption of this ASU did not have a material impact on its consolidated financial statements.
Reclassification of Prior Year Presentation
Certain prior year amounts have been reclassified for consistency with the current year presentation. These reclassifications had no effect on the reported results of operations.
2. Revenues
Adoption of ASC Topic 606, "Revenue from Contracts with Customers"
On January 1, 2018, the Company adopted Topic 606 using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts are not adjusted, and continue to be reported in accordance with our historic accounting under ASC 605. The Company recorded a net increase in stockholders’ equity (retained earnings) of $19.0 million as of January 1, 2018 due to the cumulative impact of adopting Topic 606 on contracts that were not complete as of that date. The areas most significantly impacted were contracts with contingent hardware revenue and the treatment of incremental costs of obtaining contracts with customers. The impacts as a result of applying Topic 606 was a net increase to revenue of $1.7 million and a net decrease to selling, general and administrative expenses of approximately $0.5 million related to the costs of obtaining contracts for the three months ended March 31, 2018 as compared to what would have been recognized under ASC 605. See the impacts to reported results below for the impact of adoption of the Topic 606 on our consolidated financial statements (in thousands):
 
December 31, 2017
(As reported)
 
Impact of Adoption
of Topic 606 on
Opening Balance Sheet
 
January 1, 2018
(As adjusted)
Accounts and notes receivable, net
$
56,064

 
$
28,915

 
$
84,979

Contract assets, net

 
5,512

 
5,512

Prepaid expense and other current assets
21,696

 
2,003

 
23,699

Total impacted current assets
77,760

 
36,430

 
114,190

Deferred income tax assets, net
15,755

 
(5,158
)
 
10,597

Long-term notes receivable, net of current portion
36,877

 
(12,977
)
 
23,900

Other assets
15,366

 
5,323

 
20,689

Total impacted assets
145,758

 
23,618

 
169,376

 
 
 
 
 
 
Accrued liabilities
23,502

 
2,512

 
26,014

Current portion of deferred revenue
70,401

 
863

 
71,264

Total impacted current liabilities
93,903

 
3,375

 
97,278

Deferred revenue, net of current portion
54,881

 
1,249

 
56,130

Total impacted liabilities
148,784

 
4,624

 
153,408

Retained earnings
123,185

 
18,994

 
142,179

Total impacted stockholders' equity
123,185

 
18,994

 
142,179

Total impacted liabilities and stockholders' equity
271,969

 
23,618

 
295,587


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Table of Contents

Revenue Recognition
Revenues are recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. The Company enters into contracts that can include various combinations of products and services, each of which are generally distinct and accounted for as separate performance obligations. Revenue is recognized net of allowances for returns and any taxes collected from customers, which are subsequently remitted to governmental taxing authorities.
A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in Topic 606. For contracts with multiple performance obligations, the Company allocates the contract transaction price to each performance obligation using the Company's estimate of the standalone selling price ("SSP") of each distinct good or service in the contract.
Performance obligations to deliver products, including CEWs, Axon cameras and related accessories such as cartridges, batteries and docks, are generally satisfied at the point in time the Company ships the product, as this is when the customer obtains control of the asset under our standard terms and conditions. In certain contracts with non-standard terms and conditions, these performance obligations may not be satisfied until formal customer acceptance occurs. Performance obligations to fulfill service-type extended warranties and provide our Software-as-a-Service (“SaaS”) offerings are generally satisfied over time as the customer receives and consumes the benefits of these services over the stated service period.
The Company has elected to recognize shipping costs when the control of hardware products or accessories have transferred to the customer as an expense in Cost of product sales.
Nature of Products and Services
The following table presents the Company's revenues by primary product and service offering (in thousands):
 
Three Months Ended March 31, 2018
 
Three Months Ended March 31, 2017 (1)
 
TASER Weapons
 
Software and Sensors
 
Total
 
TASER Weapons
 
Software and Sensors
 
Total
TASER X26P
$
16,474

 
$

 
$
16,474

 
$
15,668

 
$

 
$
15,668

TASER X2
23,932

 

 
23,932

 
18,986

 

 
18,986

TASER Pulse and Bolt
1,346

 

 
1,346

 
1,022

 

 
1,022

Single cartridges
16,114

 

 
16,114

 
16,664

 

 
16,664

Axon Body

 
5,558

 
5,558

 

 
3,446

 
3,446

Axon Flex

 
1,669

 
1,669

 

 
1,475

 
1,475

Axon Dock

 
3,035

 
3,035

 

 
1,987

 
1,987

Axon Fleet

 
2,116

 
2,116

 

 

 

Evidence.com

 
20,241

 
20,241

 

 
11,742

 
11,742

TASER Cam

 
1,360

 
1,360

 

 
719

 
719

Extended warranties
3,706

 
2,490

 
6,196

 
2,843

 
1,418

 
4,261

Other
1,952

 
1,222

 
3,174

 
2,488

 
784

 
3,272

Total
$
63,524

 
$
37,691

 
$
101,215

 
$
57,671

 
$
21,571

 
$
79,242

(1) Amounts for the three months ended March 31, 2017 have not been adjusted under the modified retrospective method of adoption of Topic 606, and are presented consistent with the prior period amounts reported under ASC 605.

The Company derives revenue from two primary sources: (1) the sale of physical products, including CEWs, Axon cameras, Axon Signal enabled devices, corresponding hardware extended warranties, and related accessories such as Axon docks, cartridges and batteries, among others, and (2) subscription to the Company's Evidence.com digital evidence management SaaS (including secure cloud-based storage fees and other ancillary services), which includes varying levels of support. To a lesser extent, the Company also recognizes revenue from training, professional services and revenue related to other software and SaaS services.
Many of the Company's products and services are sold on a standalone basis. The Company also bundles its hardware products and services together and sells them to its customers in single transactions, where the customer can make payments over a multi-year period. These sales may include payments for upfront hardware and services, as well as payments for hardware and services to be provided by the Company at a future date. Additionally, the Company offers customers the ability to purchase CEW cartridges

11

Table of Contents

and certain services on an unlimited basis over the contractual term. Due to the unlimited nature of the arrangement whereby the Company is obligated to deliver unlimited products at the customer’s request, the Company accounts for these arrangements as stand-ready obligations, and recognizes revenue ratably over the contract period. Cost of product sales is recognized as the products are delivered to the customer.
The following table presents the Company's revenues disaggregated by geography (in thousands):
 
Three Months Ended March 31,
 
2018
 
2017 (1)
United States
$
77,950

 
77
%
 
$
64,752

 
82
%
Other countries
23,265

 
23

 
14,490

 
18

Total
$
101,215

 
100
%
 
$
79,242

 
100
%
(1) Amounts for the three months ended March 31, 2017 have not been adjusted under the modified retrospective method of adoption of Topic 606, and are presented consistent with the prior period amounts reported under ASC 605.
Contract Balances
The timing of revenue recognition may differ from the timing of invoicing to customers. The Company generally has an unconditional right to consideration when it invoices its customers and records a receivable. The Company records a contract asset when revenue is recognized prior to invoicing, or a contract liability (deferred revenue) when revenue is recognized subsequent to invoicing.
Contract assets generally result from the Company's subscription programs where the Company satisfies a hardware performance obligation upon shipment to the customer and the right to the portion of the transaction price allocated to that hardware performance obligation is conditional on the Company’s future performance of a SaaS service obligation under the contract. The Company recognizes a portion the amount allocated to hardware products shipped to the customer as accounts receivable when invoiced to the customer, and records the remaining allocated value as a contract asset as the Company has generally fulfilled its hardware performance obligation upon shipment.
Contract liabilities generally consist of deferred revenue on the Company’s subscription programs where the Company generally invoices customers at the beginning of each annual period and records a receivable at the time of invoicing when there is an unconditional right to consideration.
Deferred revenue is comprised mainly of unearned revenue related to the Company's Evidence.com SaaS platform, secure cloud-based storage, service-type extended warranties, stand-ready obligations in our cartridge programs, and rights to future CEW, camera and related accessories hardware in our subscription programs. Revenue for Evidence.com and cloud-based storage, our service-type extended warranties and stand-ready cartridge programs is generally recognized on a straight-line basis over the subscription term. Revenue for the rights to future hardware is generally recognized at the point in time the hardware products are shipped to the customer.
Payment terms and conditions vary by contract type and geography, but our standard terms are that payments are due within 30 days from the date of invoice.
The following table presents the Company's contract assets, contract liabilities and certain information related to these balances as of and for the three months ended March 31, 2018 (in thousands):
 
March 31, 2018
Contract assets
$
9,278

Contract liabilities (deferred revenue)
134,144

Revenue recognized in the period from:
 
Amounts included in contract liabilities at the beginning of the period
24,269



12

Table of Contents

Contract liabilities (deferred revenue) consisted of the following (in thousands):
 
March 31, 2018
 
December 31, 2017 (1)
 
Current
 
Long-Term
 
Total
 
Current
 
Long-Term
 
Total
Warranty:
 
 
 
 
 
 
 
 
 
 
 
TASER Weapons
$
11,601

 
$
17,058

 
$
28,659

 
$
12,501

 
$
18,619

 
$
31,120

Software and Sensors
6,941

 
5,660

 
12,601

 
6,293

 
4,195

 
10,488

 
18,542

 
22,718

 
41,260

 
18,794

 
22,814

 
41,608

Hardware:
 
 
 
 
 
 
 
 
 
 
 
TASER Weapons
4,283

 
12,440

 
16,723

 
4,164

 
11,401

 
15,565

Software and Sensors
14,152

 
15,197

 
29,349

 
16,956

 
14,781

 
31,737

 
18,435

 
27,637

 
46,072

 
21,120

 
26,182

 
47,302

Software and Sensors Services
39,164

 
7,648

 
46,812

 
30,487

 
5,885

 
36,372

Total
$
76,141

 
$
58,003

 
$
134,144

 
$
70,401

 
$
54,881

 
$
125,282


 
March 31, 2018
 
December 31, 2017 (1)
 
Current
 
Long-Term
 
Total
 
Current
 
Long-Term
 
Total
TASER Weapons
$
15,884

 
$
29,498

 
$
45,382

 
$
16,665

 
$
30,020

 
$
46,685

Software and Sensors
60,257

 
28,505

 
88,762

 
53,736

 
24,861

 
78,597

Total
$
76,141

 
$
58,003

 
$
134,144

 
$
70,401

 
$
54,881

 
$
125,282

(1) Amounts as of December 31, 2017 have not been adjusted under the modified retrospective method of adoption of Topic 606, and are presented consistent with the prior period amounts reported under ASC 605.
Remaining Performance Obligations
As of March 31, 2018, the Company had approximately $650 million 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, 2018. The Company expects to recognize between 15% - 20% of this balance over the next twelve months and expects 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.
Costs to Obtain a Contract
The Company recognizes an asset for the incremental costs of obtaining a contract with a customer, which consist primarily of sales commissions. These costs are ascribed to or allocated to the underlying performance obligations in the contract and amortized consistent with the recognition timing of the revenue for the underlying performance obligations.
For contract costs related to performance obligations with an amortization period of one year or less, the Company applies the practical expedient to expense these sales commissions when incurred. These costs are recorded as incurred within sales, general and administrative expenses on the accompanying condensed consolidated statement of operations and comprehensive income.
As of March 31, 2018, the Company's assets for costs to obtain contracts were as follows (in thousands):
 
March 31, 2018
Current deferred commissions (1)
$
5,526

Deferred commissions, net of current portion (2)
12,881

 
$
18,407

(1) Current deferred commissions are included within "Prepaid expenses and other current assets" on the accompanying condensed consolidated balance sheet.
(2) Deferred commissions, net of current portion, are included in "Other assets" on the accompanying condensed consolidated balance sheet.

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During the three months ended March 31, 2018, the Company recognized $1.1 million of amortization related to deferred commissions. These costs are recorded within sales, general and administrative expenses on the accompanying condensed consolidated statement of operations and comprehensive income.
Significant Judgments
The Company’s contracts with certain municipal government customers may be subject to budget appropriation, other contract cancellation clauses or future periods which are optional. In contracts where the customer’s performance is subject to budget appropriation clauses, we generally consider the likelihood of non-appropriation to be remote when determining the contract term and transaction price. Contracts with other cancellation provisions or optional periods may require judgment in determining the contract term, including the existence of material rights, transaction price and identifying the performance obligations.
At times, customers may request changes that either amend, replace or cancel existing contracts. Judgment is required to determine whether the specific facts and circumstances within the contracts require the changes to be accounted for as a separate contract or as a modification. Generally, contract modifications containing additional goods and services that are determined to be distinct and sold at their SSP, are accounted for as a separate contract. Contract modifications where both criteria are not met, the original contract is updated and the required adjustments to revenue will be made accordingly.
The Company's contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. The Company considers CEW devices and related accessories as well as cameras and related accessories to be separately identifiable from each other as well as from extended warranties on these products and the SaaS subscriptions to Evidence.com.
In contracts where there are timing differences between when the Company transfers a promised good or service to the customer and when the customer pays for that good or service, the Company has determined that, with the exception of its TASER 60 installment purchase arrangements, its contracts generally do not include a significant financing component. For the three months ended March 31, 2018, the Company recorded revenue of $14.0 million, including $0.3 million of interest income, under the Company’s TASER 60 plan, and recorded $8.1 million, including $0.1 million of interest income, for the same period in 2017. Amounts for the three months ended March 31, 2017 have not been adjusted under the modified retrospective method of adoption of Topic 606.
Judgment is required to determine the SSP for each distinct performance obligation. The Company analyzes separate sales of its products and services as a basis for estimating the SSP of its products and services and then uses that SSP as the basis for allocating the transaction price when its products and services are sold together in a contract with multiple performance obligations. In instances where the SSP is not directly observable, such as when the Company does not sell the product or service separately, it determines the SSP using information that may include market conditions, time value of money and other observable inputs. The Company typically has more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, the Company may use information such geographic region and distribution channel in determining the SSP.
Sales are typically made on credit and we generally do not require collateral. We perform ongoing credit evaluations of our customers’ financial condition and maintain an allowance for doubtful accounts. Uncollectible accounts are written off when deemed uncollectible, and accounts and notes receivable are presented net of an allowance for doubtful accounts. This allowance represents our best estimate and is based on our judgment after considering a number of factors including third-party credit reports, actual payment history, customer-specific financial information and broader market and economic trends and conditions. In the event that actual uncollectible amounts differ from our estimates, additional expense could be necessary.

14

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AXON ENTERPRISE, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


3. Cash, Cash Equivalents and Investments
The following tables summarize the Company's cash, cash equivalents, and held-to-maturity investments at March 31, 2018 and December 31, 2017 (in thousands):
 
As of March 31, 2018
 
Amortized Cost
 
Gross Unrealized Losses
 
Fair Value
 
Cash and Cash Equivalents
 
Short-Term Investments
Cash
$
68,207

 
$

 
$
68,207

 
$
68,207

 
$

 
 
 
 
 
 
 
 
 
 
Level 1:
 
 
 
 
 
 
 
 
 
Money market funds
22,282

 

 
22,282

 
22,282

 

Corporate bonds
4,974

 
(3
)
 
4,971

 
1,300

 
3,674

Subtotal
27,256

 
(3
)
 
27,253

 
23,582

 
3,674

 
 
 
 
 
 
 
 
 
 
Level 2:
 
 
 
 
 
 
 
 
 
State and municipal obligations
1,342

 

 
1,342

 
541

 
801

Total
$
96,805

 
$
(3
)
 
$
96,802

 
$
92,330

 
$
4,475


 
As of December 31, 2017
 
Amortized Cost
 
Gross Unrealized Losses
 
Fair Value
 
Cash and Cash Equivalents
 
Short-Term Investments
Cash
$
53,459

 
$

 
$
53,459

 
$
53,459

 
$

 
 
 
 
 
 
 
 
 
 
Level 1:
 
 
 
 
 
 
 
 
 
Money market funds
20,884

 

 
20,884

 
20,884

 

Corporate bonds
6,632

 
(6
)
 
6,626

 

 
6,632

Subtotal
27,516

 
(6
)
 
27,510

 
20,884

 
6,632

 
 
 
 
 
 
 
 
 
 
Level 2:
 
 
 
 
 
 
 
 
 
State and municipal obligations
992

 

 
992

 
762

 
230

Total
$
81,967

 
$
(6
)
 
$
81,961

 
$
75,105

 
$
6,862

The Company believes the unrealized losses on its investments are due to interest rate fluctuations. As these investments are short-term in nature, are expected to be redeemed at par value, and/or because the Company has the ability and intent to hold these investments to maturity, the Company does not consider these investments to be other than temporarily impaired at March 31, 2018 or as of December 31, 2017.
4. 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, 2018 and December 31, 2017 was $1.6 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. Inventories consisted of the following at March 31, 2018 and December 31, 2017 (in thousands):
 
2018
 
2017
Raw materials
$
19,003

 
$
20,119

Finished goods
24,101

 
25,346

Total inventory
$
43,104

 
$
45,465

5. Goodwill and Intangible Assets

The changes in the carrying amount of goodwill for the three months ended March 31, 2018 were as follows (in thousands):
 
TASER
Weapons
 
Software and Sensors
 
Total
Balance, beginning of period
$
1,453

 
$
13,474

 
$
14,927

Foreign currency translation adjustment
10

 
10

 
20

Balance, end of period
$
1,463

 
$
13,484

 
$
14,947


Intangible assets (other than goodwill) consisted of the following (in thousands):
 
 
 
March 31, 2018
 
December 31, 2017
 
Useful
Life
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
Amortized:
 
 
 
 
 
 
 
 
 
 
 
 
 
Domain names
5-10 years
 
$
3,161

 
$
(504
)
 
$
2,657

 
$
3,161

 
$
(428
)
 
$
2,733

Issued patents
4-15 years
 
2,724

 
(959
)
 
1,765

 
2,697

 
(913
)
 
1,784

Issued trademarks
3-11 years
 
857

 
(416
)
 
441

 
860

 
(397
)
 
463

Customer relationships
4-8 years
 
1,396

 
(518
)
 
878

 
1,377

 
(451
)
 
926

Non-compete agreements
3-4 years
 
558

 
(376
)
 
182

 
556

 
(346
)
 
210

Developed technology
3-7 years
 
13,469

 
(4,723
)
 
8,746

 
13,469

 
(3,956
)
 
9,513

Re-acquired distribution rights
2 years
 
2,098

 
(1,049
)
 
1,049

 
2,133

 
(711
)
 
1,422

Total amortized
 
 
24,263

 
(8,545
)
 
15,718

 
24,253

 
(7,202
)
 
17,051

Not amortized:
 
 
 
 
 
 
 
 
 
 
 
 
 
TASER trademark
 
 
900

 
 
 
900

 
900

 
 
 
900

Patents and trademarks pending
 
 
878

 
 
 
878

 
872

 
 
 
872

Total not amortized
 
 
1,778

 
 
 
1,778

 
1,772

 
 
 
1,772

Total intangible assets
 
 
$
26,041

 
$
(8,545
)
 
$
17,496

 
$
26,025

 
$
(7,202
)
 
$
18,823


15

Table of Contents
AXON ENTERPRISE, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


Amortization expense of intangible assets for the three months ended March 31, 2018 and 2017 was $1.4 million and $0.9 million, respectively. Estimated amortization for intangible assets with definite lives for the remaining nine months of 2018, the next five years ended December 31, and thereafter, is as follows (in thousands):
2018
$
4,047

2019
3,871

2020
2,404

2021
2,269

2022
838

2023
568

Thereafter
1,721

Total
$
15,718

6. Other Long-Term Assets
Other long-term assets consisted of the following at March 31, 2018 and December 31, 2017 (in thousands):
 
2018
 
2017
Cash surrender value of corporate-owned life insurance policies
$
3,804

 
$
3,846

Deferred commissions (1)
12,881

 
6,803

Restricted cash (2)
2,468

 
3,333

Prepaid expenses, deposits and other
2,420

 
1,384

Total other long-term assets
$
21,573

 
$
15,366

(1) Represents assets for the incremental costs of obtaining a contract with a customer, which consist primarily of sales commissions. These costs are ascribed to or allocated to the underlying performance obligations in the contract and amortized consistent with the recognition timing of the revenue for the underlying performance obligations. The amounts as of December 31, 2017 have not been adjusted under the modified retrospective method of adoption of Topic 606, and is presented consistent with the prior period amounts. In connection with the Company's adoption of Topic 606, it recorded an adjustment of $7.3 million as of January 1, 2018, and of that amount, $5.4 million was recorded within long-term other assets. The adjusted balance of long-term deferred commissions as of January 1, 2018 was $12.2 million.
(2) As of March 31, 2018 and December 31, 2017, restricted cash primarily consisted of $1.8 million and $2.7 million, respectively, of sales proceeds related to long-term contracts with customers. As of March 31, 2018, the proceeds are held in escrow until certain billing milestones are achieved, and then specified amounts are transferred to the Company's operating accounts.
7. Accrued Liabilities
Accrued liabilities consisted of the following at March 31, 2018 and December 31, 2017 (in thousands):
 
2018
 
2017
Accrued salaries, benefits and bonus
$
10,217

 
$
8,957

Accrued professional, consulting and lobbying fees
4,046

 
3,870

Accrued warranty expense
559

 
644

Accrued income and other taxes
8,945

 
2,558

Other accrued liabilities
11,102

 
7,473

Accrued liabilities
$
34,869

 
$
23,502


16

Table of Contents
AXON ENTERPRISE, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


8. Income Taxes
ASC 740 requires a company to record the effects of a tax law change in the period of enactment; however, shortly after the enactment of the Tax Cuts and Jobs Act (the "Tax Act"), the SEC staff issued Staff Accounting Bulletin 118 ("SAB 118"), which allows a company to record a provisional amount when it does not have the necessary information available, prepared, or analyzed in reasonable detail to complete its accounting for the change in the tax law. The measurement period ends when the company has obtained, prepared and analyzed the information necessary to finalize its accounting, but cannot extend beyond one year. The Company continues to analyze the impact of the Tax Act and expects that as additional guidance from IRS Treasury is provided, further updates will be necessary.
The Tax Act imposes a U.S. entity tax on global intangible low-taxed income ("GILTI") earned by certain foreign subsidiaries. The FASB Staff Q&A, Topic 740, No. 5, Accounting for Global Intangible Low-Taxed Income, states that an entity can make an accounting policy election to either recognize deferred taxes for temporary basis differences expected to reverse as GILTI in future years or provide for the tax expense related to GILTI in the year the tax is incurred as a period expense only. Given the complexity of the GILTI provisions, we are still evaluating the effects of the GILTI provisions and have not yet determined our accounting policy. At March 31, 2018, because we are still evaluating the GILTI provisions and our analysis of future taxable income that is subject to GILTI, we have included GILTI related to current-year operations only in our EAETR (estimated annual effective tax rate) and have not provided additional GILTI on deferred items.

Deferred Tax Assets
Net deferred income tax assets at March 31, 2018, include capitalized R&D costs, research and development tax credits, stock-based compensation expense, deferred revenue, warranty and inventory reserves, accrued vacation, and other items, partially offset by accelerated depreciation expense and intangible amortization that is not tax deductible. The Company’s total net deferred tax assets at March 31, 2018 were $14.2 million.
In preparing the Company’s condensed consolidated financial statements, management assesses the likelihood that its deferred tax assets will be realized from future taxable income. In evaluating the Company’s ability to recover its deferred income tax assets, management considers all available positive and negative evidence, including its 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 its provisions for income taxes, its deferred tax assets and liabilities, and its future taxable income for purposes of assessing its ability to utilize any future tax benefit from its deferred tax assets.
Although management believes that its tax estimates are reasonable, the ultimate tax determination involves significant judgments that could become subject to audit by tax authorities in the ordinary course of business. As of each reporting date, management considers new evidence, both positive and negative, that could impact management’s view with regard to future realization of deferred tax assets. As of March 31, 2018, the Company continues to demonstrate three-year cumulative pre-tax income in the U.S. federal and Arizona tax jurisdictions; however, the Company's Arizona R&D Tax Credits start to expire in 2018 with a significant tranche with a gross value of $1.2 million expiring if not used by the end of 2019. It appears that the Company’s long term investments, which impact short term profits, will likely result in some of the R&D credits expiring before they are utilized. Therefore, management has concluded that it is more likely than not that a portion of the Company’s deferred tax assets will not be realized and has established a valuation allowance.
The Company has claimed R&D tax credits of approximately $17.0 million for federal, Arizona and California income tax purposes related to tax years 2003 to 2018. Management has made the determination that it is more likely than not that the full benefit of the R&D tax credits will not be sustained upon examination and recorded a liability for unrecognized tax benefits of $3.6 million as of March 31, 2018. In addition, management accrued $0.1 million for estimated uncertain tax positions related to certain state income tax liabilities, for a total unrecognized tax benefit as of March 31, 2018 of $3.7 million. Management expects the amount of unrecognized tax benefit liability to increase by $0.2 million within the next 12 months. Should the unrecognized benefit of $3.7 million be recognized, the Company's effective tax rate would be favorably impacted. Approximately $2.0 million of the unrecognized tax benefit associated with R&D credits has been netted against the R&D deferred tax asset.

Effective Tax Rate
The Company’s overall effective tax rate for the three months ended March 31, 2018, after discrete period adjustments, was 12.9%. Before discrete adjustments, the tax rate was 23.1%, 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 IRC section

17

Table of Contents
AXON ENTERPRISE, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


162(m), lobbying fees, an income inclusion from GILTI, offset by a reduction for foreign-derived intangible income ("FDII"). This was partially offset by R&D tax credit deductions. The effective tax rate was favorably impacted by a $1.6 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, 2018.
9. Stockholders’ Equity
In May 2016, the Company’s stockholders approved a new stock incentive plan authorizing an additional 2.0 million shares, plus remaining available shares under a prior plan, for issuance under the new plan. Combined with the legacy stock incentive plans, there are 0.8 million shares available for grant as of March 31, 2018.
Performance-based stock awards
The Company has issued performance-based stock options and performance-based restricted stock units ("RSUs"), the vesting of which is contingent upon the achievement of certain performance criteria related to the operating performance of the Company, as well as successful and timely development and market acceptance of future product introductions. In addition, certain of the performance-based RSUs have additional service-based vesting requirements subsequent to the achievement of the performance criteria. Compensation expense is recognized over the implicit service period (the longer of the period the performance condition is expected to be achieved or the required service period) based on management’s estimate of the probability of the performance criteria being satisfied, adjusted at each balance sheet date.
Restricted Stock Units
The following table summarizes RSU activity for the three months ended March 31, 2018 (number of units and aggregate intrinsic value in thousands):
 
Number
of
Units
 
Weighted
Average
Grant-Date
Fair Value
 
Aggregate
Intrinsic Value
Units outstanding, beginning of year
2,348

 
$
23.47

 
 
Granted
122

 
30.14

 
 
Released
(329
)
 
24.14

 
 
Forfeited
(114
)
 
21.79

 
 
Units outstanding, end of period
2,027

 
23.93

 
$
79,681

Aggregate intrinsic value represents the Company’s closing stock price on the last trading day of the period, which was $39.31 per share, multiplied by the number of RSUs outstanding. As of March 31, 2018, there was $39.3 million in unrecognized compensation costs related to RSUs under the Company's stock plans. The Company expects to recognize the cost related to the RSUs over a weighted average period of 2.68 years. RSUs are released when vesting requirements are met.
During the three months ended March 31, 2018, the Company granted no performance-based RSUs As of March 31, 2018, the performance criteria had not been met for any of the 0.4 million performance-based RSUs outstanding.The performance-based RSUs granted in 2017 and 2016 contain provisions whereby the amount of RSUs that ultimately vest is dependent upon the level of achievement of performance metrics. The amount of RSUs included in the table above related to such grants is the target level, which is the Company's best estimate of the amount of RSUs that will vest. The maximum additional number of performance-based RSUs that could be earned is 0.3 million, which are not included in the table above.
Certain RSUs that vested in the three months ended March 31, 2018 were net-share settled such that the Company withheld shares with value equivalent to the employees’ minimum statutory obligation for the applicable income and other employment taxes, and remitted the cash to the appropriate taxing authorities. Total shares withheld were 0.1 million and had a value of $3.6 million on their respective vesting dates as determined by the Company’s closing stock price on such dates. Payments for the employees’ tax obligations are reflected as a financing activity within the statement of cash flows. These net-share settlements had the effect of share repurchases by the Company as they reduced the amount of shares that would have otherwise been issued as a result of the vesting had they been settled on a gross basis with the employees responsible for directly remitting the applicable income and other employment taxes.

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AXON ENTERPRISE, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


Stock Option Activity
The following table summarizes stock option activity for the three months ended March 31, 2018 (number of units and aggregate intrinsic value in thousands):
 
Number
of
Options
 
Weighted
Average
Exercise
Price
 
Weighted Average Remaining Contractual Life (years)
 
Aggregate
Intrinsic Value
Options outstanding, beginning of year
804

 
$
4.99

 
 
 
 
Granted

 

 
 
 
 
Exercised
(78
)
 
4.54

 
 
 
 
Expired / terminated

 

 
 
 
 
Options outstanding, end of period
726

 
5.04

 
0.99
 
$
24,879

Options exercisable, end of period
722

 
5.04

 
1.00
 
24,729

Aggregate intrinsic value represents the difference between the exercise price of the underlying stock option awards and the closing market price of the Company's common stock of $39.31 on March 31, 2018. The intrinsic value of options exercised for the three months ended March 31, 2018 and 2017 was $2.0 million and $0.7 million, respectively. As of March 31, 2018, total options outstanding includes 0.2 million performance-based stock options, of which 4,350 were unvested and of those, none are expected to vest.
On February 26, 2018, the Company's Board of Directors approved a new stock option grant to Patrick W. Smith, the Company's Chief Executive Officer (“CEO Performance Award”), which is subject to shareholder approval.  The CEO Performance Award will consist of 12 vesting tranches, each equal to 1% of the Company's outstanding common stock as of February 23, 2018, the business day prior to the award date. The CEO Performance Award will have a per share exercise price equal to $28.58, the closing price of our common stock on February 23, 2018, and will have a vesting schedule based entirely on the attainment of both operational and market capitalization goals. Because the CEO Performance Award is still subject to shareholder approval, there was no financial statement impact as of and for the three months ended March 31, 2018.
Stock-based Compensation Expense
Stock-based compensation cost for RSUs is measured based on the closing fair market value of the Company’s common stock on the date of grant. The Company recognizes stock-based compensation cost over the requisite service period of an award on a straight-line basis for time-based RSUs and on a graded basis for RSUs that are contingent on the achievement of performance conditions. The following table summarizes the composition of stock-based compensation for the three months ended March 31, 2018 and 2017 (in thousands):
 
Three Months Ended March 31,
 
2018
 
2017
Cost of products sold and services delivered
$
141

 
$
79

Sales, general and administrative expenses
2,304

 
2,028

Research and development expenses
1,648

 
1,340

Total stock-based compensation
$
4,093

 
$
3,447

Stock Repurchase Plan
In February 2016, the Company's Board of Directors authorized a stock repurchase program to acquire up to $50.0 million of the Company’s outstanding common stock subject to stock market conditions and corporate considerations. During the three months ended March 31, 2018 and 2017, no common shares were purchased under the program. As of March 31, 2018, $16.3 million remains available under the plan for future purchases. The Company suspended its 10b5-1 plan during 2016, and any future purchases will be discretionary.

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AXON ENTERPRISE, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


10. Line of Credit
The Company has a $10.0 million revolving line of credit with a domestic bank. At both March 31, 2018 and December 31, 2017, 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, 2018, the Company had letters of credit outstanding of $2.7 million under the facility, and available borrowing of $7.3 million. The line is secured by substantially all of the assets of the Company, and bears interest at varying rates (currently LIBOR plus 1.25% or Prime less 0.50%). The line of credit matures on December 31, 2018, and requires monthly payments of interest only. The Company’s agreement with the bank requires it to comply with a maximum funded debt to earnings before interest, taxes, depreciation and amortization ("EBITDA") ratio, as defined, of no greater than 2.00 to 1.00 based upon a trailing twelve-month period. At March 31, 2018, the Company’s funded debt to EBITDA ratio was 0.002 to 1.00.
11. Commitments and Contingencies
Product Litigation
The Company is currently named as a defendant in seven lawsuits in which the plaintiffs allege either wrongful death or personal injury in situations in which a TASER CEW was used by law enforcement officers in connection with arrests. While the facts vary from case to case, the product liability claims are typically based on an alleged product defect resulting in injury or death, usually involving a failure to warn, and the plaintiffs are seeking monetary damages. The information throughout this note is current through the date of these financial statements.
As a general rule, it is the Company’s policy not to settle suspect injury or death cases. Exceptions are sometimes made where the settlement is strategically beneficial to the Company. Also, on occasion, the Company’s insurance company has settled such lawsuits over the Company’s objection where the risk is over the Company’s liability insurance deductibles. Due to the confidentiality of the Company's litigation strategy and the confidentiality agreements that are executed in the event of a settlement, the Company does not identify or comment on which specific lawsuits have been settled or the amount of any settlement.
In 2009, the Company implemented new risk management strategies, including revisions to product warnings and training to better protect both the Company and its customers from litigation based on “failure to warn” theories - which comprise the vast majority of the cases against the Company. These risk management strategies have been highly effective in reducing the rate and exposure from litigation post-2009. From the third quarter of 2011 to the first quarter of 2018, product liability cases have been reduced from 55 to seven active cases.
Management believes that pre-2009 cases have a different risk profile than cases which have occurred since the risk management procedures were introduced in 2009. Therefore, the Company necessarily treats certain pre-2009 cases as exceptions to the Company’s general no settlement policy in order to reduce caseload, legal costs and liability exposure.
The Company intends to continue its successful practice of aggressively defending and generally not settling litigation except in very limited and unusual circumstances as described above.With respect to each of the pending lawsuits, the following table lists the name of plaintiff, the date the Company was served with process, the jurisdiction in which the case is pending, the type of claim and the status of the matter.
Plaintiff
  
Month
Served
  
Jurisdiction
  
Claim Type
  
Status
Derbyshire
  
Nov-09
  
Ontario, Canada Superior Court of Justice
  
Officer Injury
  
Discovery Phase. Trial scheduled for October 14, 2019.
Shymko
  
Dec-10
  
The Queen's Bench, Winnipeg Centre, Manitoba
  
Wrongful Death
  
Pleading Phase, currently inactive
Ramsey
  
Jan-12
  
12th Judicial Circuit Court, Broward County, FL
  
Wrongful Death
  
Discovery Phase
Bennett
 
Sep-15
 
11th Judicial Circuit Court, Miami-Dade County, FL
 
Wrongful Death
 
Discovery Phase. Trial scheduled for June 18, 2018.
Masters
 
Nov-16
 
U.S. District Court, Western District of Missouri
 
Suspect Injury
 
Discovery Phase. Trial scheduled for December 10, 2018.
Taylor
 
Mar-17
 
U.S, District Court, Southern District of Texas
 
Officer Injury
 
Discovery Phase. The Company's motion for summary judgment was filed on April 20, 2018. Docket call scheduled for August 31, 2018.
Wiggington
 
Apr-18
 
U.S, District Court, Western District Court of Missouri
 
Wrongful Death
 
Pleading Phase
No product liability cases were dismissed or judgments entered during the first quarter of 2018 and through the date of these financial statements and there are no product litigation matters in which the Company is involved that are currently on appeal.

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AXON ENTERPRISE, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


The claims, and in some instances the defense, of each of these lawsuits have been submitted to the Company’s insurance carriers that maintained insurance coverage during the applicable periods. The Company continues to maintain product liability insurance coverage with varying limits and deductibles. The following table provides information regarding the Company’s product liability insurance. Remaining insurance coverage is based on information received from the Company’s insurance provider (in millions).
Policy Year
 
Policy
Start
Date
 
Policy
End
Date
 
Insurance
Coverage
 
Deductible
Amount
 
Defense
Costs
Covered
 
Remaining
Insurance
Coverage
 
Active Cases and Cases on
Appeal
2009
 
12/15/2008
 
12/15/2009
 
$
10.0

 
$
1.0

 
N
 
$
10.0

 
Derbyshire
2010
 
12/15/2009
 
12/15/2010
 
10.0

 
1.0

 
N
 
10.0

 
Shymko
2011
 
12/15/2010
 
12/15/2011
 
10.0

 
1.0

 
N
 
10.0

 
n/a
Jan-Jun 2012
 
12/15/2011
 
6/25/2012
 
7.0

 
1.0

 
N
 
7.0

 
Ramsey
Jul-Dec 2012
 
6/25/2012
 
12/15/2012
 
12.0

 
1.0

 
N
 
12.0

 
n/a
2013
 
12/15/2012
 
12/15/2013
 
12.0

 
1.0

 
N
 
12.0

 
n/a
2014
 
12/15/2013
 
12/15/2014
 
11.0

 
4.0

 
N
 
11.0

 
n/a
2015
 
12/15/2014
 
12/15/2015
 
10.0

 
5.0

 
N
 
10.0

 
Bennett
2016
 
12/15/2015
 
12/15/2016
 
10.0

 
5.0

 
N
 
10.0

 
Masters
2017
 
12/15/2016
 
12/15/2017
 
10.0

 
5.0

 
N
 
10.0

 
Taylor
2018
 
12/15/2017
 
12/15/2018
 
10.0

 
5.0

 
N
 
10.0

 
Wiggington
Other Litigation
Phazzer Patent Infringement Litigation
In November 2015, the Company filed a complaint against Phazzer Electronics Inc. and Sang Min International Co. Ltd. for patent infringement, trademark infringement and false advertising. On July 21, 2017, the U.S. District Court for the Middle District of Florida granted the Company's Motion for Sanctions and for a Permanent Injunction against Florida-based Phazzer Electronics, Inc. The Court issued a broad permanent injunction against Phazzer banning sales of the infringing Phazzer Enforcer CEWs and dart cartridges. The injunction prohibits Phazzer and its officers, agents, employees, and anyone else acting in concert with them, from making, using, offering for sale, selling, distributing, importing or exporting Phazzer CEWs and associated cartridges. Phazzer is further enjoined from dumping its infringing inventory by “donating” CEWs to law enforcement, and from false advertising and comparison to TASER® brand products. Both Phazzer and its U.S. distributors are barred from exporting CEWs or cartridges to fill foreign orders. The injunction also makes clear that nonparties who assist Phazzer in violating the injunction, including specifically Taiwanese CEW manufacturer Sang Min International and Double Dragon Development and Trading Corporation, may be held in contempt of court. On August 10, 2017, Phazzer filed a notice of appeal which is detailed in the following section entitled cases on appeal. On April 19, 2018, the Court denied Phazzer's second motion to stay the injunction pending appeal.
On April 4, 2018, the Court entered a judgment for the Company against Phazzer in an amount exceeding $7.8 million which included an award to the Company of compensatory and treble damages for willful infringement, and also an award of reasonable attorneys’ fees and costs. The collectability of this judgment is in doubt since Phazzer has informed the Court that it is insolvent.
In imposing severe sanctions against Phazzer, the Court found that Phazzer “engaged in a pattern of bad faith conduct designed and intended to delay, stall, and increase the cost of this litigation,” and that Phazzer repeatedly disregarded Court Orders thereby exhibiting “contemptuous”, “egregious”, “flagrant” and “intentional obstructionist behavior” resulting in willful “abuse [of] the judicial process.”
The Company’s patent (U.S. No. 7,234,262) at issue in the litigation (Case No. 6:16-cv-00366-PGB-KRS) relates to the CEW’s data recording of date and time of each trigger operation and duration of the stimulus. The Court found that patent is “valid, enforceable, and infringed by Phazzer.” The injunction will remain in effect until the patent expires, and includes any CEW or device not colorably different from the Phazzer Enforcer CEW. Phazzer filed a second petition for reexamination of the Company's Patent on April 27, 2017 which resulted in a non-final office action on December 5, 2017 rejecting all old and new patent claims. The Company filed its response on February 5, 2018 and a final office action was issued by the USPTO rejecting all old and new patent claims. The Company has appealed this ruling. The injunction is still in full force and effect despite recent USPTO office action.

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AXON ENTERPRISE, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


The Company's trademark that is the subject of the injunction is Federal Registration No. 4,423,789, relating to the non-functional shape of TASER CEW cartridges used to launch the darts. The Court found the trademark “valid and enforceable, not generic, functional, or merely descriptive, and infringed by Phazzer.” The permanent injunction covers all Phazzer CEW dart cartridges that are confusingly similar to, or not more than a colorable imitation of, TASER CEW cartridges, and includes Phazzer product numbers 1-DC15, 1-DC21, 1-DC25, 1-DC21-SIDT, 1-PB30, 1-PB8F, 1-PB15943, 1-RB30, 1-PA30, and 1-LOWIMPT2015. Phazzer has filed a petition to cancel Axon’s trademark.
The Court expressly found that Phazzer cartridges currently marketed and sold as compatible with TASER brand CEWs embody the protected appearance and constitute infringing products enjoined under its Order. Phazzer was also ordered by the Court “not [to] challenge or continue to challenge the validity or enforceability of the ‘789 Registration in any manner in any forum, including the USTPO.” Accordingly, Phazzer’s pending USPTO cancellation action, which was stayed while the litigation ran its course, will be dismissed.
Digital Ally Patent Litigation
In February 2016, the Company was served with a first amended complaint filed by Digital Ally in the Federal District Court for the District of Kansas alleging patent infringement regarding the Company's Axon Signal technology, commercial bribery, antitrust, and unfair competition. In March 2016, the Company was served with a second amended complaint with similar allegations. The second amended complaint seeks a judgment of infringement, monetary damages, a permanent injunction, punitive damages and attorneys’ fees and costs.
Digital Ally’s complaint has been substantially narrowed based on (1) the district court dismissing all of Digital Ally’s antitrust claims in January 2017; (2) the USPTO granting validity review of Digital Ally’s ‘292 patent in June 2017, and Digital Ally subsequently dismissing this patent from the litigation and covenanting not to sue the Company with respect to existing and prior products; and (3) Digital Ally’s dismissal of certain inconsistent claims in the ‘452 patent, leaving only independent claim 10 for resolution by the Court. The Company believes the remaining claim of the ‘452 patent is invalid and not infringed, and is vigorously defending this litigation. Digital Ally filed an appeal on the dismissal of its antitrust claims on April 20, 2017, which is pending in the Federal Circuit Court of Appeals. The Company’s inter parte review of the ‘292 patent was heard by the PTAB on February 23, 2018, and a decision is expected by early June 2018.
The litigation stay has been lifted and the case is in the discovery phase. A third Scheduling Order was entered on December 20, 2017, and a Markman Hearing was held on March 8, 2018.
Antoine di Zazzo Arbitration
In April 2016, the Company was served with a notice of arbitration claim filed by Antoine di Zazzo, the Company’s former distributor in France, for commissions allegedly owed Mr. di Zazzo. The arbitration claim was filed with the International Court of Arbitration of the International Chamber of Commerce in Paris, France, and the amount that is claimed in controversy is $0.6 million. The Company’s records reflect that all commissions that were due Mr. di Zazzo under his contract were paid or offered to him and the Company will vigorously defend this arbitration claim.
VIEVU Commercial Litigation
In February 2017, the Company was served with a complaint filed by VieVU, LLC (“VIEVU” ) alleging tortious interference with a business expectancy. In February 2017, the Company filed complaints against VIEVU for unfair competition and false advertising in both the Superior Court of Arizona for Maricopa County as well as the California Superior Court for Santa Cruz County. VIEVU and the Company entered into mutual stipulations for dismissal of both parties’ complaints against the other. On February 21, 2018, the Federal lawsuit against VIEVU was dismissed, and on February 27, 2018 the State lawsuit against the Company was dismissed.

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AXON ENTERPRISE, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


Appeals
The judgment entered resulting from the Court granting the Company’s motion for dismissal of Digital Ally litigation for antitrust claims as well as the judgment and permanent injunction in the Company’s favor against Phazzer are on appeal as noted in the following table:
Plaintiff
  
Month
Served
  
Jurisdiction
  
Claim Type
  
Status
Digital Ally
  
Jan-16
  
U.S. District Court, District of Kansas
  
Antitrust Claims
  
The Company's motion for dismissal of the antitrust claims was granted on January 12, 2017 with judgment entered in its favor on April 14, 2017 and Plaintiff filed an appeal on April 20, 2017.
Axon
 
Mar-16
 
U.S. District Court, Middle District of Florida
 
Judgment and Permanent Injunction
 
The Company received judgment in its favor and a permanent injunction against Phazzer on July 21, 2017. Phazzer filed a notice of appeal on August 10, 2017.
General
From time to time, the Company is notified that it may be a party to a lawsuit or that a claim is being made against it. It is the Company’s policy to not disclose the specifics of any claim or threatened lawsuit until the summons and complaint are actually served on the Company. After carefully assessing the claim, and assuming the Company determines that it is not at fault or it disagrees with the damages or relief demanded, the Company vigorously defends any lawsuit filed against the Company. In certain legal matters, the Company records a liability when losses are deemed probable and reasonably estimable. In evaluating matters for accrual and disclosure purposes, the Company takes 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. The Company reevaluates and updates accruals as matters progress over time.
Based on the Company's assessment of outstanding litigation and claims as of March 31, 2018, the Company has determined that it is not reasonably possible that these lawsuits will individually, or in the aggregate, materially affect its 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 its 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.
Off-Balance Sheet Arrangements
Under certain circumstances, the Company uses letters of credit and surety bonds to guarantee its performance under various contracts, principally in connection with the installation and integration of its Axon cameras and related technologies. Certain of the Company's letters of credit and surety bonds have stated expiration dates with others being released as the contractual performance terms are completed. At March 31, 2018, the Company had outstanding letters of credit of $2.7 million that are expected to expire in May 2018. Additionally, the Company had $10.6 million of outstanding surety bonds at March 31, 2018, with $1.0 million expiring in 2018, $0.1 million expiring in 2020, $2.3 million expiring in 2021, $3.1 million expiring in 2022 and the remaining $4.0 million expiring in 2023.
12. Related Party Transactions
The Company subscribes to various cloud-based applications from Salesforce. Bret Taylor, a member of the Company's Board of Directors, serves as President and Chief Product Officer of Salesforce. The Company incurs costs at different times throughout the year, typically in advance of services being provided, and subsequently amortizes these costs ratably to expense as services are provided over the contractual term. The Company did not make any payments related to these services during the three months ended March 31, 2018, and made payments of $1.0 million during the three months ended March 31, 2017.
13. Employee Benefit Plans
The Company has a defined contribution profit sharing 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.
The Company also has a non-qualified deferred compensation plan for certain executives, key employees and non-employee directors through which participants may elect to postpone the receipt and taxation of a portion of their compensation, including

23

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stock-based compensation, received from the Company. 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 the Company does 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. Participants have no rights or claims with respect to any plan assets and any such assets are subject to the claims of the Company’s general creditors.
Contributions to the plans are made by both the employee and the Company. Company contributions to the 401(k) plan are based on the level of employee contributions and are immediately vested. The Company’s matching contributions to the 401(k) plan for the three months ended March 31, 2018 and 2017, were $0.8 million and $0.7 million, respectively. Future matching or profit sharing contributions to the plans are at the Company’s sole discretion.
14. Segment Data
The Company is comprised of two reportable segments: the manufacture and sale of CEWs, batteries, accessories, extended warranties and other products and services (the “TASER Weapons” segment); and the software and sensors business, which includes the sale of devices, wearables, applications, cloud and mobile products (collectively, the “Software and Sensors” segment). Within the Software and Sensors segment, the Company specifies sales of products and services. Revenue from the Company's “products” in the Software and Sensors segment are generally sales of sensors, including on-officer body cameras, Axon Fleet cameras, other hardware sensors, warranties on sensors,and other products, and is sometimes referred to as Sensors and Other revenue. Revenue from the Company's “services” in the Software and Sensors segment comprise sales related to the Axon Cloud, which includes Evidence.com, cloud-based evidence management software revenue, other recurring cloud-hosted software revenue and related professional services, and is sometimes referred to as Axon Cloud revenue. Within the Software and Sensors segment, the Company includes only revenues and costs attributable to that segment which include: costs of sales for both products and services, direct labor, selling expenses for the sales team, product management and R&D for products included, or to be included, within the Software and Sensors segment. All other costs are included in the TASER Weapons segment. The Company’s Chief Executive Officer, who is the CODM, is not provided asset information by segment, and therefore, no asset information is provided.
Information relative to the Company’s reportable segments was as follows (in thousands):
 
Three Months Ended March 31, 2018
 
Three Months Ended March 31, 2017 (1)
 
TASER
Weapons
 
Software and Sensors
 
Total
 
TASER
Weapons
 
Software and Sensors
 
Total
Net sales from products (2)
$
63,524

 
$
17,450

 
$
80,974

 
$
57,671

 
$
9,820

 
$
67,491

Net sales from services (3)

 
20,241

 
20,241

 

 
11,751

 
11,751

Net sales
63,524

 
37,691

 
101,215

 
57,671

 
21,571

 
79,242

Cost of product sales
20,543

 
11,891

 
32,434

 
18,026

 
9,046

 
27,072

Cost of service sales

 
4,320

 
4,320

 

 
3,500

 
3,500

Cost of sales
20,543

 
16,211

 
36,754

 
18,026

 
12,546

 
30,572

Gross margin
42,981

 
21,480

 
64,461

 
39,645

 
9,025

 
48,670

Sales, general and administrative
21,265

 
14,494

 
35,759

 
17,216

 
13,641

 
30,857

Research and development
2,960

 
12,159

 
15,119

 
2,212

 
10,251

 
12,463

Income (loss) from operations
$
18,756

 
$
(5,173
)
 
$
13,583

 
$
20,217

 
$
(14,867
)
 
$
5,350

(1) Amounts for the three months ended March 31, 2017 have not been adjusted under the modified retrospective method of adoption of Topic 606, and are presented consistent with the prior period amounts reported under ASC 605.
(2) Software and Sensors “products” revenue consists of sales of sensors, including on-officer body cameras, Axon Fleet cameras, other hardware sensors, warranties on sensors, and other products, and is sometimes referred to as Sensors and Other revenue.

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AXON ENTERPRISE, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)


(3) Software and Sensors “services” revenue comprises sales related to the Axon Cloud, which includes Evidence.com, cloud-based evidence management software revenue, other recurring cloud-hosted software revenue and related professional services and is sometimes referred to as Axon Cloud revenue.
15. Subsequent Event
On May 3, 2018 (the “Closing Date”), the Company acquired all of the outstanding ownership interests of VIEVU, LLC (“VIEVU”), a public safety camera and cloud-based evidence management system provider for law enforcement agencies.
The purchase price consisted of $4.6 million in cash and 58,843 shares of the Company's common stock (the “Closing Stock”) issued to VIEVU’s parent company, Safariland, LLC (“Safariland”), at closing. The number of shares of Closing Stock was determined by dividing $2.5 million in aggregate value by the volume-weighted average price of the Company’s common stock, as reported on the NASDAQ Global Select Market, for the 20-trading day period up to and including the trading day that was three trading days immediately preceding (but not including) the Closing Date (the “Closing Stock Price”). The Closing Stock Price was $42.49 per share.
Pursuant to the terms of the transaction, the Company has agreed to issue up to $6.0 million in aggregate value of its common stock (the “Earn-Out Stock Payments”), at a price per share equal to the Closing Stock Price, if certain conditions relating to retention of VIEVU’s customers are met as of the first and second anniversaries of the Closing Date. Subject to the satisfaction of those conditions, the Company may issue up to 141,226 additional shares of common stock in respect of the Earn-Out Stock Payments.
Concurrently with the closing of the VIEVU acquisition, the Company entered into a long-term Product Development and Supplier Agreement (the “Supply Agreement”) with Safariland, pursuant to which Safariland will be the Company’s preferred provider of holsters for its CEW products. The Company will include the fair value of the Supply Agreement as a component of the purchase price to be allocated to the acquired net assets of VIEVU. The acquisition will be accounted for in the second quarter of fiscal year 2018 using the acquisition method in accordance with ASC 805, Business Combinations. Accordingly, the identified assets and liabilities assumed will be measured at their acquisition-date fair value. VIEVU’s operating results will be included in the Company’s consolidated financial statements from the effective date of the acquisition (i.e., May 3, 2018).
The Closing Stock and the shares of common stock that may be issued in respect of the Earn-Out Stock Payments (if any), was and will be, as applicable, issued without registration under the Securities Act of 1933, as amended (the “Securities Act”), in reliance upon the exemption from registration set forth in Section 4(a)(2) of the Securities Act and Rule 506 of Regulation D promulgated by the SEC thereunder. Safariland represented and warranted to the Company that it is an “accredited investor” as that term is defined in Rule 501 of Regulation D, and the Company did not engage in any general solicitation in connection with the issuances of Company common stock contemplated by the terms of the transaction. All such shares of Company common stock are and will be, as applicable, “restricted securities” as that term is defined in Rule 144 promulgated by the SEC under the Securities Act.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following is a discussion of the Company’s financial condition as of March 31, 2018, and results of operations for the three months ended March 31, 2018 and 2017. The following discussion may be understood more fully by reference to the consolidated financial statements, notes to the consolidated financial statements, and Management’s Discussion and Analysis of Financial Condition and Results of Operations section contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.
Certain statements contained in this report that are not historical are “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. Such forward-looking statements relate to, among other things: our intentions about future development efforts and activities, including our intentions to invest in R&D as well as the development of new product and service lines and enhanced features for our existing product and service lines; our need that customers upgrade and replace existing conducted electrical weapons (“CEW”) units and the willingness of customers to do so; that we may have more sales denominated in foreign currencies in 2018; our intention to increase our investment in the development of sales in the international, military and law enforcement market; our plans to expand our sales force; that cloud and mobile technologies are fundamentally changing

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the police environment; our plan to invest in web activities and law enforcement trade shows in 2018; our intention to not pay dividends; that increases in marketing and sales activities will lead to an increase in sales; our belief that the video evidence capture and management market will grow significantly in the near future and the reasons for that belief; our intention to continue to pursue the personal security market; our intention to grow direct sales; the sufficiency of our facilities and our strategy to expand manufacturing capacity if needed; that we may lease facilities from parties that specialize in handling and manufacturing of firearm materials; that we expect to continue to depend on sales of our X2 and X26P CEW devices; our intention to apply for and prosecute our patents; that selling, general and administrative expense will increase in 2018; that research and development expenses will increase in 2018; the timing of the resolution of uncertain tax positions; our intention to hold investments to maturity; the effect of interest rate changes on our annual interest income; that we may engage in currency hedging activities; our intentions concerning, and the effectiveness of, our ongoing marketing efforts through web activities, trial programs, tech summits and law enforcement trade shows; the benefits of our CEW products compared to other lethal and less-lethal alternatives; the benefits of our Software and Sensors products compared to our competitors'; our belief that customers will honor multi-year contracts despite the existence of appropriations, termination for convenience. or similar clauses; our belief that customers will renew their Evidence.com service subscriptions at the end of the contractual term; our insulation from competition and our competitive advantage in the weapons business; estimates regarding the size of our target markets and our competitive position in existing markets; the availability of alternative materials and components suppliers; the benefits of the continued automation of our production process; the sufficiency and availability of our liquid assets and capital resources; our financing and growth strategies, including: our decision not to pay dividends, potential joint ventures, mergers and acquisitions, stock repurchases and hedging activities; the safety of our products; our litigation strategy, including the outcome of legal proceedings in which we are currently involved; our ability to maintain secure and consistent customer data access and storage, including the use of third-party data storage providers, and the impact of a loss of customer data, a breach of security or an extended outage; our ability to attract and retain the qualified professional services necessary to implement and maintain our business, both through employment and through other partnership arrangements; the effect of current and future tax strategies; the fluctuations in our effective tax rate; the impact of the U.S. Tax Cuts and Jobs Act (the “Tax Act”); the impact of recently adopted and future accounting standards; the impact of Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”) and ASC Subtopic 340-40, Other Assets and Deferred Costs - Contracts with Customers ("ASC 340-40") (collectively, “Topic 606”); and 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, 2017.

Overview
Axon Enterprise, Inc.’s (the “Company” or “Axon” or “we” or “our”) core mission is to protect life, to protect truth and to reduce social conflict through developing and selling technologies that make communities safer. We are highly focused on disrupting existing categories and bringing public safety technology into the 21st century. We are the market leader in the development, manufacture and sale of conducted electrical weapons (“CEWs”) and other electronic weapons designed for use in law enforcement, military, corrections, private security and personal defense. We have also developed a fully integrated hardware and cloud-based software solution to provide our law enforcement customers the capabilities to capture, securely store, manage, share and analyze video and other digital evidence.
Our strategic growth areas are TASER weapons, Sensors hardware including on-officer body cameras and Axon Fleet in-car video systems, our Evidence.com connected software network, and Axon Records and Computer Aided Dispatch software. These value streams exist within an estimated $7.7 billion total addressable market, comprising TASER weapons ($1.5 billion), hardware sensors ($0.7 billion), and cloud-based public safety software ($5.5 billion.)
The $1.5 billion TASER Weapons total addressable market estimates 660,000 domestic patrol officers and 1,800,000 immediately addressable international patrol officers at an average revenue of $600 per year ($50 per user per month) including the weapon, cartridges, batteries, and enhanced services currently under development.
The $5.5 billion cloud-based public safety software total addressable market estimates 1,000,000 domestic patrol officers with annual digital evidence management revenue of $750 per year ($63 per user per month, which reflects Axon current list pricing), 1,000,000 domestic police officers with annual advanced intelligence and analytics revenue of $350 per year ($29 per user per month based on estimated market pricing), 400,000 domestic patrol vehicle license evidence management annual revenue of $925 ($77 per user per month, which reflects 60% allocation to software of Axon's $129 per month listed pricing), 2,100,000 public safety employees with annual records management & computer dispatch revenue of $1,500 per year ($125 per user per month based on estimated market pricing and analysis of current existing RMS and CAD contracts), and 1,000,000 immediately addressable international officers with annual revenue of $750 per year ($63 per user per month based on Axon's current listed software pricing).

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The hardware sensors $0.7 billion total addressable market estimates 660,000 domestic patrol officers and 1,000,000 immediately addressable international officers with annual camera and dock revenue of $200 per year ($16-$19 per user per month based on Axon's listed pricing), 400,000 domestic patrol vehicles with annual hardware revenue of $600 per year ($50 per user per month based on 40% of allocation to hardware of Axon's $129 per month listed pricing), and 660,000 domestic patrol officers with annual revenue of $120 per year ($10 per user per month based on Axon's listed pricing) for the Signal Sidearm product.
Our long-term financial strategy includes shifting our revenue, contracts, and cash flows from book-and-ship hardware transactions to multi-element, multi-year, subscription or recurring payment plans. During the three months ended March 31, 2018, 55% of our consolidated revenues were recognized from contracts with multiple performance obligations, while within our TASER Weapons and Software and Sensors segments, approximately 32% and 94%, respectively, were recognized from contracts containing multiple performance obligations. Recurring revenue refers to those contracts with multiple performance obligations, which we break out in more detail in the Critical Accounting Estimates.
As of March 31, 2018, we have booked 226,900 cloud-based software licenses on the Axon Cloud network and we have annual recurring run-rate Axon Cloud and Sensors and Other revenue of $83.3 million. Annual recurring run-rate revenue is calculated by annualizing our most previous reported month's recurring license, integration, warranty and storage revenue. Our long-term goal is to transition a majority of our customers to recurring payment plan or subscription contracts.
We are also highly focused on driving operating leverage and profitability within our two reported segments, TASER Weapons and Software & Sensors.
Results of Operations

Three Months Ended March 31, 2018 Compared to the Three Months Ended March 31, 2017
The following table presents data from our statements of operations as well as the percentage relationship to total net sales of items included in our statements of operations (dollars in thousands):
 
Three Months Ended March 31,
 
2018
 
2017 (1)
Net sales from products
$
80,974

 
80.0
%
 
$
67,491

 
85.2
%
Net sales from services
20,241

 
20.0

 
11,751

 
14.8

Net sales
101,215

 
100.0

 
79,242

 
100.0

Cost of product sales
32,434

 
32.0

 
27,072

 
34.2

Cost of service sales
4,320

 
4.3

 
3,500

 
4.4

Cost of sales
36,754

 
36.3

 
30,572

 
38.6

Gross margin
64,461

 
63.7

 
48,670

 
61.4

Operating expenses:
 
 
 
 
 
 
 
Sales, general and administrative
35,759

 
35.3

 
30,857

 
38.9

Research and development
15,119

 
14.9

 
12,463

 
15.7

Total operating expenses
50,878

 
50.3

 
43,320

 
54.7

Income from operations
13,583

 
13.4

 
5,350

 
6.8

Interest and other income, net
1,263

 
1.2

 
206

 
0.3

Income before provision for income taxes
14,846

 
14.7

 
5,556

 
7.0

Provision for income taxes
1,920

 
1.9

 
976

 
1.2

Net income
$
12,926

 
12.8
%
 
$
4,580

 
5.8
%
(1) Amounts for the three months ended March 31, 2017 have not been adjusted under the modified retrospective method of adoption of Topic 606, and are presented consistent with the prior period amounts reported under ASC 605.

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The following table presents the Company's revenues disaggregated by geography (in thousands):
 
Three Months Ended March 31,
 
2018
 
2017 (1)
United States
$
77,950

 
77
%
 
$
64,752

 
82
%
Other countries
23,265

 
23

 
14,490

 
18

Total
$
101,215

 
100
%
 
$
79,242

 
100
%
(1) Amounts for the three months ended March 31, 2017 have not been adjusted under the modified retrospective method of adoption of Topic 606, and are presented consistent with the prior period amounts reported under ASC 605.
Net Sales
Net sales by product line were as follows (dollars in thousands):
 
Three Months Ended March 31,
 
Dollar
Change
 
Percent
Change
 
2018
 
2017 (1)
 
 
TASER Weapons segment:
 
 
 
 
 
 
 
 
 
 
 
TASER X26P
$
16,474

 
16.3
%
 
$
15,668

 
19.8
%
 
$
806

 
5.1
 %
TASER X2
23,932

 
23.6

 
18,986

 
24.0

 
4,946

 
26.1

TASER Pulse and Bolt
1,346

 
1.3

 
1,022

 
1.3

 
324

 
31.7

Single cartridges
16,114

 
15.9

 
16,664

 
21.0

 
(550
)
 
(3.3
)
Extended warranties
3,706

 
3.7

 
2,843

 
3.6

 
863

 
30.4

Other
1,952

 
1.9

 
2,488

 
3.1

 
(536
)
 
(21.5
)
Total TASER Weapons segment
63,524

 
62.8

 
57,671

 
72.8

 
5,853

 
10.1

Software and Sensors segment:
 
 
 
 
 
 
 
 

 


Axon Body
5,558

 
5.5

 
3,446

 
4.3

 
2,112

 
61.3

Axon Flex
1,669

 
1.6

 
1,475

 
1.9

 
194

 
13.2

Axon Fleet
2,116

 
2.1

 

 

 
2,116

 
*