Axon Enterprise, Inc.
AXON ENTERPRISE, INC. (Form: 10-Q, Received: 11/09/2017 16:55:42)
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 September 30, 2017
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 October 31, 2017 was 52,912,769 .
 


Table of Contents

AXON ENTERPRISE, INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2017
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2

Table of Contents

PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
AXON ENTERPRISE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
 
September 30, 2017
 
December 31, 2016
 
(Unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
43,471

 
$
40,651

Short-term investments
18,372

 
48,415

Accounts and notes receivable, net of allowance of $801 and $443 as of September 30, 2017 and December 31, 2016, respectively
51,204

 
39,466

Inventory
52,692

 
34,841

Prepaid expenses and other current assets
23,002

 
13,858

Total current assets
188,741

 
177,231

Property and equipment, net of accumulated depreciation of $35,484 and $37,799 as of September 30, 2017 and December 31, 2016, respectively
31,263

 
24,004

Deferred income tax assets, net
22,845

 
19,515

Intangible assets, net
20,758

 
15,218

Goodwill
14,923

 
10,442

Long-term investments

 
234

Long-term accounts and notes receivable, net of current portion
32,543

 
17,602

Other assets
16,534

 
13,917

Total assets
$
327,607

 
$
278,163

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
12,354

 
$
10,736

Accrued liabilities
22,431

 
18,248

Current portion of deferred revenue
60,453

 
45,137

Customer deposits
2,648

 
2,148

Current portion of business acquisition contingent consideration
1,735

 
1,690

Other current liabilities
470

 
80

Total current liabilities
100,091

 
78,039

Deferred revenue, net of current portion
51,574

 
40,054

Liability for unrecognized tax benefits
1,763

 
1,896

Long-term deferred compensation
3,533

 
3,362

Business acquisition contingent consideration, net of current portion
2,715

 
1,635

Other long-term liabilities
1,851

 
2,289

Total liabilities
161,527

 
127,275

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 September 30, 2017 and December 31, 2016

 

Common stock, $0.00001 par value; 200,000,000 shares authorized; 52,853,920 and 52,325,251 shares issued and outstanding as of September 30, 2017 and December 31, 2016, respectively
1

 
1

Additional paid-in capital
197,978

 
187,656

Treasury stock at cost, 20,220,227 shares as of September 30, 2017 and December 31, 2016
(155,947
)
 
(155,947
)
Retained earnings
125,256

 
118,275

Accumulated other comprehensive income
(1,208
)
 
903

Total stockholders’ equity
166,080

 
150,888

Total liabilities and stockholders’ equity
$
327,607

 
$
278,163

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

3

Table of Contents

AXON ENTERPRISE, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
(in thousands, except per share data)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Net sales from products
$
73,985

 
$
63,204

 
$
208,351

 
$
167,745

Net sales from services
16,277

 
8,678

 
40,796

 
18,423

Net sales
90,262

 
71,882

 
249,147

 
186,168

Cost of product sales
34,573

 
23,664

 
91,817

 
61,172

Cost of service sales
5,924

 
1,653

 
13,258

 
4,230

Cost of sales
40,497

 
25,317

 
105,075

 
65,402

Gross margin
49,765

 
46,565

 
144,072

 
120,766

Operating expenses:
 
 
 
 
 
 
 
Sales, general and administrative
36,398

 
28,121

 
99,079

 
77,333

Research and development
14,166

 
7,358

 
39,618

 
20,995

Total operating expenses
50,564

 
35,479

 
138,697

 
98,328

Income (loss) from operations
(799
)
 
11,086

 
5,375

 
22,438

Interest and other income (expense), net
1,430

 
(455
)
 
3,320

 
(460
)
Income before provision for income taxes
631

 
10,631

 
8,695

 
21,978

Provision for income taxes
209

 
6,788

 
1,417

 
11,022

Net income
$
422

 
$
3,843

 
$
7,278

 
$
10,956

Net income per common and common equivalent shares:
 
 
 
 
 
 
 
Basic
$
0.01

 
$
0.07

 
$
0.14

 
$
0.21

Diluted
$
0.01

 
$
0.07

 
$
0.14

 
$
0.20

Weighted average number of common and common equivalent shares outstanding:
 
 
 
 
 
 
 
Basic
52,831

 
52,206

 
52,663

 
52,791

Diluted
53,843

 
53,141

 
53,762

 
53,656

 
 
 
 
 
 
 
 
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Net income
$
422

 
$
3,843

 
$
7,278

 
$
10,956

Foreign currency translation adjustments
(1,560
)
 
61

 
(2,111
)
 
320

Comprehensive income (loss)
$
(1,138
)
 
$
3,904

 
$
5,167

 
$
11,276


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


4

Table of Contents

AXON ENTERPRISE, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
 
Nine Months Ended September 30,
 
2017
 
2016
Cash flows from operating activities:
 
 
 
Net income
$
7,278

 
$
10,956

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
5,677

 
2,744

Purchase accounting adjustments to goodwill
(23
)
 
520

Loss on inventory nonmonetary exchanges

 
147

Loss on disposal of property and equipment, net

 
40

Loss on disposal of intangible assets

 
21

Bond premium amortization
594

 
980

Stock-based compensation
11,423

 
6,742

Deferred income taxes
(4,155
)
 
(2,672
)
Unrecognized tax benefits
(134
)
 
17

Tax benefit from stock-based compensation

 
(919
)
Change in assets and liabilities:
 
 
 
Accounts and notes receivable
(26,027
)
 
(14,409
)
Inventory
(19,074
)
 
(10,804
)
Prepaid expenses and other assets
(11,261
)
 
(10,441
)
Accounts payable, accrued and other liabilities
2,906

 
12,566

Deferred revenue
26,460

 
26,331

Customer deposits
501

 
140

Net cash provided by (used in) operating activities
(5,835
)
 
21,959

Cash flows from investing activities:
 
 
 
Purchases of investments
(19,950
)
 
(49,316
)
Proceeds from call / maturity of investments
49,633

 
55,235

Purchases of property and equipment
(9,072
)
 
(3,335
)
Proceeds from disposal of property and equipment

 
40

Purchases of intangible assets
(431
)
 
(339
)
Business acquisitions
(10,629
)
 

Net cash provided by investing activities
9,551

 
2,285

Cash flows from financing activities:
 
 
 
Repurchase of common stock

 
(33,746
)
Proceeds from options exercised
1,255

 
431

Payroll tax payments for net-settled stock awards
(2,830
)
 
(1,299
)
Payments on capital lease obligation
(25
)
 
(29
)
Payments on notes payable

 
(77
)
Tax benefit from stock-based compensation

 
919

Net cash used in financing activities
(1,600
)
 
(33,801
)
Effect of exchange rate changes on cash and cash equivalents
704

 
631

Net increase (decrease) in cash and cash equivalents
2,820

 
(8,926
)
Cash and cash equivalents, beginning of period
40,651

 
59,526

Cash and cash equivalents, end of period
$
43,471

 
$
50,600

Supplemental disclosure:
 
 
 
Cash paid for income taxes, net of refunds
$
12,206

 
$
11,308

Non-cash transactions
 
 
 
Property and equipment purchases in accounts payable and accrued liabilities
$
556

 
$
145

Contingent consideration related to business combinations
$
1,007

 
$

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

5

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 software development division is located in Seattle, Washington. 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. In 2015, the Company formed Axon Public Safety Canada, Inc., a wholly owned subsidiary, to facilitate transactions for its products and services with new and existing customers located in Canada.
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.
a. 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 (“US 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, 2016 , as filed on Form 10-K. 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, 2016 . The results of operations for the nine months ended September 30, 2017 and 2016 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 allocated in multiple-deliverable contracts or arrangements,
valuation of goodwill, intangibles 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.
b. Segment Information
The Company is comprised of two reportable segments: the manufacture and sale of CEWs, accessories and other products and services (the “TASER Weapons” segment); and the software and sensors business, which includes the TASER Cam, Axon cameras and related accessories, Evidence.com, and the Axon Artificial Intelligence team ("Axon AI") (collectively, the “Software and Sensors” segment). Reportable segments are determined based on discrete financial information reviewed by the Company’s Chief Executive Officer who is the Chief Operating Decision Maker (the “CODM”) for the Company. The Company organizes and reviews operations based on products and services, and currently there are no operating segments that are aggregated. The Company performs an annual analysis of its reportable segments. Additional information related to the Company’s business segments is summarized in Note 14.

6

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


c. Geographic Information and Major Customers

For the three and nine months ended September 30, 2017 and 2016 , net sales by geographic area were as follows (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
United States
$
73,203

 
81.1
%
 
$
60,558

 
84.2
%
 
$
204,155

 
81.9
%
 
$
155,245

 
83.4
%
Other Countries
17,059

 
18.9

 
11,324

 
15.8

 
44,992

 
18.1

 
30,923

 
16.6

Total
$
90,262

 
100.0
%
 
$
71,882

 
100.0
%
 
$
249,147

 
100.0
%
 
$
186,168

 
100.0
%
Sales to customers outside of the U.S. are typically denominated in U.S. dollars, and are attributed to each country based on the shipping address of the distributor or customer. For the three months ended September 30, 2017, one country, the U.K. represented more than 10% of the Company's net sales at 10.5% . For the nine months ended September 30, 2017 and the three and nine months ended September 30, 2016 , 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 and nine months ended September 30, 2017 and 2016 , no customer represented more than 10% of total net sales. At September 30, 2017 , the Company had a trade receivable from one customer comprising 10.3% of the aggregate accounts receivable balance. At December 31, 2016 , the Company had a trade receivable from one customer comprising 14.5% of the aggregate accounts receivable balance.
d. 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. 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 September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Numerator for basic and diluted earnings per share:
 
 
 
 
 
 
 
Net income
$
422

 
$
3,843

 
$
7,278

 
$
10,956

Denominator:
 
 
 
 
 
 
 
Weighted average shares outstanding - basic
52,831

 
52,206

 
52,663

 
52,791

Dilutive effect of stock-based awards
1,012

 
935

 
1,099

 
865

Diluted weighted average shares outstanding
53,843

 
53,141

 
53,762

 
53,656

Anti-dilutive stock-based awards excluded
575

 
227

 
506

 
304

Net income per common share:
 
 
 
 
 
 
 
Basic
$
0.01

 
$
0.07

 
$
0.14

 
$
0.21

Diluted
$
0.01

 
$
0.07

 
$
0.14

 
$
0.20

e. Revenue Recognition, Deferred Revenue and Accounts and Notes Receivable
The Company derives revenue from two primary sources: (1) the sale of physical products, including CEWs, Axon cameras, 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 software as a service ("SaaS") (including data storage fees and other ancillary services), which includes varying levels of support. To a lesser extent, the Company also recognizes training and other professional services revenue. Revenue is recognized when persuasive evidence of an arrangement exists,

7

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


delivery has occurred or services have been rendered, title has transferred, the price is fixed and collectability is reasonably assured. Contractual arrangements may contain explicit customer acceptance provisions, and under such arrangements, the Company defers recognition of revenue until formal customer acceptance is received. Extended warranty revenue, SaaS revenue and related data storage revenue are recognized ratably over the term of the contract commencing on a pre-determined date subsequent to the delivery of the hardware. Training and professional service revenues are generally recorded once the services are completed.
Revenue arrangements with multiple deliverables are divided into separate units and revenue is allocated using the relative selling price method based upon vendor-specific objective evidence ("VSOE") of selling price or third-party evidence of the selling prices if vendor-specific objective evidence of selling prices does not exist. If neither vendor-specific objective evidence nor third-party evidence exists, management uses its best estimate of selling price. The majority of the Company’s allocations of arrangement consideration under multiple element arrangements are performed utilizing prices charged to customers for deliverables when sold separately. The Company’s multiple element arrangements may include future CEWs and/or Axon devices to be delivered at defined points within a multi-year contract, and in those arrangements, the Company allocates total arrangement consideration over the life of the multi-year contract to future deliverables using management’s best estimate of selling price. The Company has not utilized third party evidence of selling price.
The Company offers the right to purchase extended warranties that include additional services and coverage beyond the standard limited warranty for certain products. Revenue for extended warranty purchases is deferred at the time of sale and recognized over the warranty period commencing on the date of sale. Extended warranties range from one to five years.
Evidence.com and Axon cameras and related accessories have stand-alone value to the customer and are sometimes sold separately, but in most instances are sold together. In most instances, customers generally purchase and pay for the equipment and one year of Evidence.com in advance. Additional years of service are generally billed annually over a specified service term, which has typically ranged from one to five years. Generally, the Company recognizes revenue for the Axon equipment at the time of the sale consistent with the discussion of multiple deliverable arrangements above. Revenue for Evidence.com is deferred at the time of the sale and recognized over the service period. At times the Company discounts the cost of Axon devices provided to customers to secure long-term Evidence.com service contracts. In such circumstances, revenue related to the Axon devices recognized at the time of delivery is limited to the amount allocated to the Axon device deliverable that the Company is contractually entitled to that is not contingent upon the delivery of future Evidence.com services. The Company recognizes the remaining allocated revenue related to discounted Axon devices over the remaining period it provides the contracted Evidence.com services.
In 2012, the Company introduced a program, the TASER Assurance Program (“TAP”) whereby a customer purchasing a product and joining the program will have the right to trade-in the original product for a new product of the same or like model in the future. Upon joining TAP, customers also receive an extended warranty for the initial products purchased and spare inventory. Under this program the customer generally pays additional annual installments over the contract period, generally three to five years. The Company records consideration received related to the future product purchase as deferred revenue until all revenue recognition criteria are met, which is generally when the new product is delivered. Consideration related to future product purchases is determined at the inception of the arrangement using management’s best estimate of selling price. Management’s estimate is principally based on the current selling price for such products, with due evaluation of the impact of any expected product and pricing changes, which have historically had an immaterial influence on management’s best estimate of selling price.
In 2015, The Company introduced the Officer Safety Plan (“OSP”) whereby a customer enters into a five -year Evidence.com subscription that includes all of its standard advanced features along with unlimited storage. The OSP also includes a service plan that includes upgrades of (i) the Axon devices every 2.5 years and (ii) a TASER CEW at any point within the contract period. Upon entering into the OSP, customers also receive extended warranties on the Axon and CEW devices upon delivery to cover the contract periods as well as spare inventory units. Under this program the customer generally makes an initial purchase of Axon cameras and related accessories, and CEWs at inception along with annual installments for services and future hardware deliverables over the contract period. The Company records consideration received related to the future deliverables as deferred revenue until all revenue recognition criteria are met, which is generally when the products or services are delivered.
In 2016, the Company introduced the TASER 60 Plan ("TASER 60") whereby a customer typically enters into a  five  year CEW installment purchase arrangement. TASER 60 also includes extended warranties on the CEW devices upon delivery covering the contract periods as well as on-site spares, holsters and cartridges. Generally, the Company allocates revenue to the deliverables using the relative selling price method and recognizes revenue for the amount allocated to the CEW devices at the time of sale for the amount allocated to the CEW devices, net of imputed interest, and the amount allocated to the extended warranty is recognized over five years. The Company performs an initial credit evaluation prior to execution of TASER 60 arrangements and subsequently performs quarterly credit evaluations by monitoring public municipal bond ratings, as applicable, and any subsequent credit upgrades or downgrades, to monitor for each customer's credit risk. Additionally, the Company tracks payment activity for amounts

8

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


currently due to assess the credit quality of its notes receivable portfolio. As the Company’s customers generally have investment-grade municipal bond ratings, the Company considers collectability of the contracted amounts in such installment purchase arrangements to be reasonably assured, unless other factors or payment history indicate otherwise. For customers where municipal bond information is not available, the Company considers factors such as payment history, customer-specific information and broader market and economic trends and conditions to determine whether collectability is reasonably assured. The Company considers this information when establishing its allowance for doubtful accounts. For the three and nine months ended September 30, 2017 , the Company recorded revenue of $7.5 million and $20.8 million , respectively under the Company’s TASER 60 plan, and recorded $5.0 million and $8.6 million , respectively, for the same periods in 2016.
In 2017, the Company introduced new subscription programs that allow for agencies to purchase the Company's training and duty cartridges over a five -year term whereby the customer would make five equal annual installments. The Company offers two tiers under this program: the basic and unlimited plan. The Axon Basic Cartridge Plan entitles customers to a fixed number of training and duty cartridges per year as well as a fixed number of battery replacements over the contractual term. For the Basic Cartridge Plan, the Company allocates the contractual consideration to all identified deliverables using the relative selling price method. Generally, the Company recognizes revenue for the amounts allocated to the cartridges when they are delivered to the customer. The Unlimited Cartridge Plan entitles customers to a fixed number of training cartridges per year and an unlimited amount of duty cartridges and replacement batteries. 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.
Sales tax collected on sales is netted against government remittances and thus, recorded on a net basis.
Deferred revenue consists of payments received in advance related to products and services for which the criteria for revenue recognition have not yet been met. Deferred revenue that will be recognized during the succeeding twelve month period is recorded as current deferred revenue and the remaining portion is recorded as long-term. Deferred revenue does not include future revenue from multi-year contracts for which no invoice has yet been created. Generally, customers are billed in annual installments. See Note 6 for further disclosures about the Company’s deferred revenue.
The Company records reductions to net sales for expected future product returns based on the Company’s historical experience. 
Sales are typically made on credit, and the Company generally does not require collateral. Management performs ongoing credit evaluations of its customers’ financial condition, and maintains an allowance for estimated potential losses. Uncollectible accounts are charged to expense when deemed uncollectible, and accounts and notes receivable are presented net of an allowance for doubtful accounts. This allowance represents management’s best use of estimates, and is based on judgment after considering a number of factors, including third-party credit reports, actual payment history, cash discounts, customer-specific financial information and broader market and economic trends and conditions.
f. 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 returns and warranty costs 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 returns from customers. The accrued warranty liability 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 reserve for warranty returns is included in accrued liabilities on the accompanying condensed consolidated balance sheets. 

9

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


Changes in the Company’s estimated product warranty liabilities were as follows (in thousands):
 
Nine Months Ended September 30,
 
2017
 
2016
Balance, beginning of period
$
780

 
$
314

Utilization of accrual
(178
)
 
(97
)
Warranty expense
117

 
531

Balance, end of period
$
719

 
$
748

g. Fair Value of 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 September 30, 2017 and December 31, 2016 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 2. Included in the balance of Other assets as of September 30, 2017 and December 31, 2016 was $3.7 million and $3.2 million , respectively, 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.
h. 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 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.

10

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


i. 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 (Topic 606). 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. Subsequently, the FASB issued the following accounting standard updates related to Topic 606, Revenue from Contracts with Customers:
ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net) in March 2016. ASU 2016-08 does not change the core principle of revenue recognition in Topic 606 but clarifies the implementation guidance on principal versus agent considerations.
ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing in April 2016. ASU 2016-10 does not change the core principle of revenue recognition in Topic 606 but clarifies the implementation guidance on identifying performance obligations and its licensing.
ASUs 2016-12 and 2016-20, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, and Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers, respectively, issued in May and December 2016, respectively. These ASUs do not change the core principle of revenue recognition in Topic 606 but clarify the implementation guidance on a few narrow areas and add some practical expedients to the guidance.
The amendments are effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. The Company's internal implementation team has completed the initial evaluation of the new standard, and is now working on the implementation of new technology systems and internal controls necessary to adopt the new guidance effective January 1, 2018.
The Company intends to elect the modified retrospective method of adoption for all contracts that are not completed as of the adoption date.
While the Company's assessment is not finalized, it believes the areas most significantly impacted will be contracts with contingent hardware revenue, the timing of recognition of contracts containing software licenses and post-contract customer support, and the treatment of incremental costs of obtaining contracts with customers. However, due to the complexity of certain customer contracts, the actual revenue recognition treatment required under the new standard will be dependent on contract-specific terms, and may vary in some instances from the recognition discussed below.
Currently, for bundled arrangements containing Evidence.com services where the Company has provided significantly discounted or free of charge hardware, the Company recognizes the revenue allocated to the hardware in excess of the invoiced amount over the contractual term when it is contingent on delivery of Evidence.com. Under ASU 2014-09, the Company anticipates being required to generally recognize hardware revenue upon fulfillment of the distinct hardware performance obligation when control transfers to the customer.
Currently, for sales of the Company's Axon Commander software product containing post-contract customer support ("PCS"), because the Company does not have sufficient VSOE to allocate the fee to the separate elements, the entire arrangement fee is recognized ratably over the support period term. Under the new standard, the Company expects to recognize the full amount of revenue attributable to the distinct software license predominately at the time the software is delivered to the customer, while the amount allocated to the PCS performance obligation will be recognized ratably over the support term.
Currently, the Company has an established policy to capitalize direct incremental costs of obtaining long-term customer contracts within the Software and Sensors segment as assets and recognize them as expense over the contractual term as the goods and services are delivered to the customer. The new guidance specifies that all incremental costs of obtaining customer contracts and direct costs of fulfilling our contracts with customers should be deferred and recognized when the related performance obligations are fulfilled over the contract term or expected customer life. The Company will modify its policy to defer all direct and incremental costs related to all customer contracts within both the Software and Sensors and TASER Weapons segments.

11

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


In July 2015, the FASB issued ASU 2015-11, Inventory (Topic 330). The amendments require that an entity should measure inventory at the lower of cost and net realizable value. Net realizable value is the estimated price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The Company adopted this guidance effective January 1, 2017 and it did not have a material impact on its consolidated financial statements.
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 that a lessee should 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 March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which amends Accounting Standards Codification (Topic 718), Compensation – Stock Compensation. ASU 2016-09 impacts several aspects of the accounting for share-based payment transactions. The Company adopted this guidance effective January 1, 2017, which required the following changes to the presentation of the Company's financial statements:
Excess tax benefits or deficiencies for share-based payments are now recorded as a discrete item in the period shares vest or stock options are exercised as an adjustment to income tax expense or benefit rather than additional paid-in capital. This change was applied prospectively as of January 1, 2017. The Company did not have any excess tax benefits that were not previously recognized as of January 1, 2017.
As of January 1, 2017, the calculation of diluted weighted average shares outstanding was changed prospectively to no longer include excess tax benefits as assumed proceeds. This change resulted in recording an increased number of dilutive shares, but did not have a material impact on the Company's current year diluted earnings per share;
Cash flows related to excess tax benefits or deficiencies are included in the statement of cash flows as an operating activity rather than as a financing activity. The Company adopted this change prospectively.
Cash paid to taxing authorities when withholding shares from an employee's vesting or exercise of equity-based compensation awards for tax-withholding purposes is now considered a repurchase of the Company's equity instruments and is classified as cash used in financing activities. The Company already classifies these transactions as a financing activity, and as such, there was no impact upon adoption.
The Company has made the election to account for forfeitures when they occur rather than estimating forfeitures. The Company adopted this change on a modified retrospective basis, which resulted in an increase to additional paid-in capital and decrease to retained earnings of $0.5 million as of December 31, 2016.
 
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, reflect 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. ASU 2016-15 is effective for the fiscal year beginning after December 15, 2017, and interim periods within that fiscal year, and early adoption is permitted. The retrospective transition method, requiring adjustment to all comparative periods presented, is required unless it is impracticable for some of the amendments, in which case those amendments would be prospectively as of the earliest date practicable. The Company does not expect the adoption of this ASU to 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

12

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


party. ASU 2016-16 is effective for fiscal year beginning after December 15, 2017 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 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.  ASU 2016-18 is effective for the fiscal year beginning after December 15, 2017, and interim periods within that fiscal year, and early adoption is permitted. The Company does not expect the adoption of this ASU to have a material impact on its consolidated financial statements.
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. ASU 2017-01 is effective for the fiscal year beginning after December 15, 2017, and interim periods within that year and early adoption is permitted. The Company does not expect the adoption of this ASU to have a material impact on its consolidated financial statements.
In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350) which simplifies the goodwill impairment test by eliminating Step 2 of the quantitative assessment and should reduce the cost and complexity of evaluating goodwill for impairment. Under the amended guidance, when a quantitative assessment is required, an entity will perform a goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An impairment charge will be measured as the amount by which the carrying amount exceeds the reporting unit’s fair value, not to exceed the total amount of recorded goodwill. ASU 2017-04 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's early adoption on January 1, 2017 did not have an impact on its consolidated financial statements.
In May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 708), 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. ASU 2017-09 is effective for the fiscal year beginning after December 15, 2017 using a prospective approach, and early adoption is permitted. The Company does not expect the adoption of this ASU to have a material impact on its consolidated financial statements.
j. 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.

13

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


2 . Cash, Cash Equivalents and Investments
The following tables summarize the Company's cash, cash equivalents, and held-to-maturity investments at September 30, 2017 and December 31, 2016 (in thousands):
 
As of September 30, 2017
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
Cash and Cash Equivalents
 
Short-Term Investments
 
Long-Term Investments
Cash
$
33,825

 
$

 
$

 
$
33,825

 
$
33,825

 
$

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Level 1:
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
9,646

 

 

 
9,646

 
9,646

 

 

Corporate bonds
17,403

 

 
(10
)
 
17,393

 

 
17,403

 

Subtotal
27,049

 

 
(10
)
 
27,039

 
9,646

 
17,403

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Level 2:
 
 
 
 
 
 
 
 
 
 
 
 
 
State and municipal obligations
969

 

 

 
969

 

 
969

 

Certificates of deposit

 

 

 

 

 

 

Subtotal
969

 

 

 
969

 

 
969

 

Total
$
61,843

 
$

 
$
(10
)
 
$
61,833

 
$
43,471

 
$
18,372

 
$


 
As of December 31, 2016
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
 
Cash and Cash Equivalents
 
Short-Term Investments
 
Long-Term Investments
Cash
$
32,802

 
$

 
$

 
$
32,802

 
$
32,802

 
$

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Level 1:
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
7,849

 

 

 
7,849

 
7,849

 

 

Corporate bonds
33,379

 

 
(57
)
 
33,322

 

 
33,379

 

Subtotal
41,228

 

 
(57
)
 
41,171

 
7,849

 
33,379

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Level 2:
 
 
 
 
 
 
 
 
 
 
 
 
 
State and municipal obligations
14,477

 

 
(10
)
 
14,467

 

 
14,243

 
234

Certificates of deposit
793

 

 

 
793

 

 
793

 

Subtotal
15,270

 

 
(10
)
 
15,260

 

 
15,036

 
234

Total
$
89,300

 
$

 
$
(67
)
 
$
89,233

 
$
40,651

 
$
48,415

 
$
234

The Company believes the unrealized losses on the Company’s 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 September 30, 2017 or as of December 31, 2016.

14

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


3. 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 September 30, 2017 and December 31, 2016 was $1.3 million and $0.7 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 September 30, 2017 and December 31, 2016 (in thousands):
 
2017
 
2016
Raw materials
$
26,426

 
$
18,002

Finished goods
26,266

 
16,839

Total inventory
$
52,692

 
$
34,841

4. Goodwill and Intangible Assets

The changes in the carrying amount of goodwill for the nine months ended September 30, 2017 were as follows (in thousands):
 
TASER
Weapons
 
Software and Sensors
 
Total
Balance, beginning of period
$
562

 
$
9,880

 
$
10,442

Goodwill acquired
825

 
3,505

 
4,330

Purchase accounting adjustments

 
23

 
23

Foreign currency translation adjustment
64

 
64

 
128

Balance, end of period
$
1,451

 
$
13,472

 
$
14,923


Intangible assets (other than goodwill) consisted of the following (in thousands):
 
 
 
September 30, 2017
 
December 31, 2016
 
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

 
$
(352
)
 
$
2,809

 
$
3,161

 
$
(125
)
 
$
3,036

Issued patents
4-15 years
 
1,985

 
(874
)
 
1,111

 
1,942

 
(780
)
 
1,162

Issued trademarks
3-11 years
 
714

 
(378
)
 
336

 
655

 
(320
)
 
335

Customer relationships
4-8 years
 
1,374

 
(389
)
 
985

 
914

 
(240
)
 
674

Non-compete agreements
3-4 years
 
555

 
(317
)
 
238

 
465

 
(236
)
 
229

Developed technology
3-7 years
 
14,480

 
(3,159
)
 
11,321

 
8,661

 
(824
)
 
7,837

Re-acquired distribution rights
2 years
 
2,140

 
(357
)
 
1,783

 

 

 

Total amortized
 
 
24,409

 
(5,826
)
 
18,583

 
15,798

 
(2,525
)
 
13,273

Not amortized:
 
 
 
 
 
 
 
 
 
 
 
 
 
TASER trademark
 
 
900

 
 
 
900

 
900

 
 
 
900

Patents and trademarks pending
 
 
1,275

 
 
 
1,275

 
1,045

 
 
 
1,045

Total not amortized
 
 
2,175

 
 
 
2,175

 
1,945

 
 
 
1,945

Total intangible assets
 
 
$
26,584

 
$
(5,826
)
 
$
20,758

 
$
17,743

 
$
(2,525
)
 
$
15,218


15

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


Amortization expense of intangible assets for the three and nine months ended September 30, 2017 was $1.4 million and $3.3 million , respectively. Amortization expense of intangible assets for the three and nine months ended September 30, 2016 was $0.2 million and $0.7 million , respectively. Estimated amortization for intangible assets with definite lives for the remaining three months of 2017 , the next five years ended December 31, and thereafter, is as follows (in thousands):
2017 (remaining three months)
$
1,398

2018
5,585

2019
4,036

2020
2,568

2021
2,433

2022
782

Thereafter
1,781

Total
$
18,583

5. Other Long-Term Assets
Other long-term assets consisted of the following at September 30, 2017 and December 31, 2016 (in thousands):
 
2017
 
2016
Cash surrender value of corporate-owned life insurance policies
$
3,723

 
$
3,240

Prepaid commissions (i)
6,556

 
5,302

Restricted cash (ii)
3,326

 
3,317

Prepaid expenses, deposits and other (iii)
2,929

 
2,058

Total other long-term assets
$
16,534

 
$
13,917

(i) Prepaid commissions represent customer acquisition costs to secure long-term contracts. The Company capitalizes incremental and direct costs related to a specific contract and recognizes as expense over the term of the contract in proportion to the contract revenue.
(ii) As of September 30, 2017 and December 31, 2016, restricted cash primarily consisted of $2.7 million of sales proceeds related to a long-term contract with a specific customer. These proceeds are held in escrow until certain billing milestones are achieved, and then specified amounts are transferred to the Company's operating accounts. Restricted cash at each period end also included $0.6 million related to a performance guarantee related to an international customer sales contract.
(iii) Included in long-term assets as of September 30, 2017 and December 31, 2016 was $1.8 million of funds deposited in escrow related to contingent consideration in connection with a business combination (see Note 15). The funds will be held in escrow and released to selling shareholders if certain conditions are subsequently met. If the conditions are not met, the funds will be released back to the Company.

16

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


6. Deferred Revenue
Deferred revenue consisted of the following (in thousands):
 
September 30, 2017
 
December 31, 2016
 
Current
 
Long-Term
 
Total
 
Current
 
Long-Term
 
Total
Warranty:
 
 
 
 
 
 
 
 
 
 
 
TASER Weapons
$
10,622

 
$
17,156

 
$
27,778

 
$
9,980

 
$
17,319

 
$
27,299

Software and Sensors
6,660

 
4,811

 
11,471

 
3,979

 
2,926

 
6,905

 
17,282

 
21,967

 
39,249

 
13,959

 
20,245

 
34,204

Hardware:
 
 
 
 
 
 
 
 
 
 
 
TASER Weapons
3,181

 
10,574

 
13,755

 
1,702

 
4,390

 
6,092

Software and Sensors
13,542

 
13,349

 
26,891

 
9,850

 
11,205

 
21,055

 
16,723

 
23,923

 
40,646

 
11,552

 
15,595

 
27,147

Software and Sensors Services
26,448

 
5,684

 
32,132

 
19,626

 
4,214

 
23,840

Total
$
60,453

 
$
51,574

 
$
112,027

 
$
45,137

 
$
40,054

 
$
85,191


 
September 30, 2017
 
December 31, 2016
 
Current
 
Long-Term
 
Total
 
Current
 
Long-Term
 
Total
TASER Weapons
$
13,803

 
$
27,730

 
$
41,533

 
$
11,682

 
$
21,709

 
$
33,391

Software and Sensors
46,650

 
23,844

 
70,494

 
33,455

 
18,345

 
51,800

Total
$
60,453

 
$
51,574

 
$
112,027

 
$
45,137

 
$
40,054

 
$
85,191

7. Accrued Liabilities
Accrued liabilities consisted of the following at September 30, 2017 and December 31, 2016 (in thousands):
 
2017
 
2016
Accrued salaries, benefits and bonus
$
7,861

 
$
6,474

Accrued professional, consulting and lobbying
2,225

 
3,673

Accrued warranty expense
719

 
780

Accrued income and other taxes
5,082

 
4,581

Other accrued liabilities
6,544

 
2,740

Accrued liabilities
$
22,431

 
$
18,248

8. Income Taxes

Deferred Tax Assets
Net deferred income tax assets at September 30, 2017 , include capitalized research and development costs, research and development tax credits, non-qualified stock-based compensation expense, deferred warranty 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 September 30, 2017 were $22.8 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.

17

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


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 September 30, 2017 , 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 completed research and development (“R&D”) tax credit studies which identified approximately $17.1 million in tax credits for federal, Arizona and California income tax purposes related to the 2003 through 2017 tax years. Management has made the determination that it is more likely than not that the full benefit of the R&D tax credit will not be sustained on examination and recorded a liability for unrecognized tax benefits of $4.2 million as of September 30, 2017 . In addition, management accrued approximately $0.1 million for estimated uncertain tax positions related to certain state income tax liabilities as of September 30, 2017 . The Company does not expect a significant increase or decrease in the total amount of unrecognized tax benefits within 12 months. Should the total unrecognized tax benefit of $4.3 million be recognized, the Company’s effective tax rate would be favorably impacted. Approximately $1.8 million of the unrecognized tax benefit associated with R&D credits has been netted against the R&D credit deferred tax asset.

Effective Tax Rate
The Company’s overall effective tax rate for the nine months ended September 30, 2017 , after discrete period adjustments, was 16.3% . Before discrete adjustments, the tax rate was 32.5% , which is less than the statutory rate primarily due to income in certain foreign jurisdictions with lower tax rates, partially offset by state taxes and permanent items such as Subpart F income, meals and entertainment and lobbying fees. The effective tax rate was unfavorably impacted by foreign losses for which the Company is not expected to receive a tax benefit. This was offset by the favorable impact of a $1.5 million discrete tax benefit associated with windfalls related to stock-based compensation for restricted stock units that vested or stock options that were exercised during the nine months ended September 30, 2017 . In addition, the Company recorded a $0.7 million favorable discrete tax benefit related to the reversal of certain uncertain tax positions due to statute expiration, and a $0.4 million favorable discrete tax benefit related to tax return to provision adjustments recorded during the three months ended September 30, 2017
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 approximately 1.4 million shares available for grant as of September 30, 2017 .
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 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.

18

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


Restricted Stock Units
The following table summarizes RSU activity for the nine months ended September 30, 2017 (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
1,330

 
$
20.40

 
 
Granted
1,176

 
24.90

 
 
Released
(403
)
 
18.70

 
 
Forfeited
(87
)
 
23.34

 
 
Units outstanding, end of period
2,016

 
23.22

 
$
45,703

Aggregate intrinsic value represents the Company’s closing stock price on the last trading day of the period, which was $22.67 per share, multiplied by the number of RSUs outstanding. As of September 30, 2017 , there was $36.5 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 2.83 years . RSUs are released when vesting requirements are met.
During the nine months ended September 30, 2017 , the Company granted approximately 0.2 million performance-based RSUs, which are included in the table above. As of September 30, 2017 , the performance criteria had not been met for any of the 0.3 million performance-based RSUs outstanding.The performance-based RSUs granted in 2017 , 2016 and 2015 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 0.2 million , which are not included in the table above.
Certain RSUs that vested in the nine months ended September 30, 2017 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 approximately 0.1 million and had a value of approximately $2.8 million on their respective vesting dates as determined by the Company’s closing stock price. 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.
Stock Option Activity
The following table summarizes stock option activity for the nine months ended September 30, 2017 (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
1,008

 
$
5.40

 
 
 
 
Granted

 

 
 
 
 
Exercised
(171
)
 
7.35

 
 
 
 
Expired / terminated
(6
)
 
10.43

 
 
 
 
Options outstanding, end of period
831

 
4.98

 
1.66
 
$
14,706

Options exercisable, end of period
802

 
4.99

 
1.68
 
14,180

Options expected to vest, end of period
25

 
4.75

 
1.23
 
448

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 $22.67 on September 30, 2017 . The intrinsic value of options exercised for the nine months ended September 30, 2017 and 2016 was $2.6 million and $1.8 million , respectively. As of September 30,

19

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


2017 , total options outstanding includes approximately 0.2 million performance-based stock options, of which 29,350 were unvested and of those, 25,000 are expected to vest.
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 stock-based compensation for the three months ended September 30, 2017 and 2016 (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Cost of products sold and services delivered
$
134

 
$
77

 
$
368

 
$
247

Sales, general and administrative expenses
2,099

 
1,348

 
6,282

 
4,197

Research and development expenses
1,767

 
791

 
4,773

 
2,298

Total stock-based compensation
$
4,000

 
$
2,216

 
$
11,423

 
$
6,742

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 and nine months ended September 30, 2017 , no common shares were purchased under the program. During the nine months ended September 30, 2016 , the Company purchased, under a Rule 10b5-1 plan, approximately 1.8 million common shares for a total cost of approximately $33.8 million , or a weighted average cost of $18.90 per share. The weighted average cost included the average price paid per share of $18.87 , plus applicable administrative costs for the transaction. As of September 30, 2017 , $16.2 million remains available under the plan for future purchases. The Company suspended its 10b5-1 plan, and any future purchases will be discretionary.
10. Line of Credit
The Company has a $10.0 million revolving line of credit with a domestic bank. At both September 30, 2017 and December 31, 2016 , there were no borrowings under the line. As of September 30, 2017 , the Company had letters of credit outstanding of approximately $2.7 million under the facility, and available borrowing of approximately $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 1.75% or Prime less 0.50% ). The line requires monthly payments of interest only on outstanding balances. The line of credit matured on July 31, 2017 , which was subsequently extended until December 31, 2017. The Company is currently evaluating its credit needs and anticipates entering into a longer term arrangement prior to the December 31, 2017 maturity date. The Company’s agreement with the bank requires it to comply with certain financial and other covenants including maintenance of a maximum leverage ratio and minimum fixed charge coverage ratio. The leverage ratio (ratio of total liabilities to tangible net worth) can be no greater than 1 :1, and the fixed charge coverage ratio can be no less than 1.25 :1, based upon a trailing twelve -month period. At September 30, 2017 , the Company’s leverage ratio was 1.24 :1 and its fixed charge coverage ratio was 3.88 :1. The Company's violation of the leverage ratio requirement was waived by the bank as of September 30, 2017 .
11. Commitments and Contingencies
Product Litigation
The Company is currently named as a defendant in six lawsuits in which the plaintiffs allege either wrongful death or personal injury in situations in which a TASER CEW was used (or present) by law enforcement officers in connection with arrests or during training exercises. 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.

20

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


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 third quarter of 2017 , product liability cases have been reduced from 55 active to six 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
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
 
US District Court, Western District of Missouri
 
Suspect Injury
 
Discovery Phase. Trial scheduled for October 9, 2018.
Taylor
 
Mar-17
 
US District Court, Southern District of Texas
 
Officer Injury
 
Discovery Phase. Trial scheduled for August 18, 2018.

There are no product litigation matters in which the Company is involved that are currently on appeal. The judgment entered resulting from the court granting the Company’s motion for dismissal of the Digital Ally, Inc. ("Digital Ally") litigation for antitrust claims, as well as the judgment and permanent injunction in the Company's favor against Phazzer Electronics Inc. ("Phazzer"), which are on appeal as noted in the following table.
Plaintiff
  
Month
Served
  
Jurisdiction
  
Claim Type
  
Status
Digital Ally
  
Feb-17
  
US District Court, District of Kansas
  
Antitrust Claims
  
Axon's motion for dismissal of the antitrust claims was granted on January 12, 2017 with judgment entered in Axon's favor on April 14, 2017 and Plaintiff filed an appeal to the 10th Circuit Court of Appeals on April 20, 2017.
Axon
 
Feb-17
 
US District Court, Middle District of Florida
 
Judgment and Permanent Injunction
 
Axon 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.
The following case was dismissed during the third quarter of 2017. No other cases were dismissed or judgment entered into through the date of these financial statements.
Plaintiff
  
Month
Served
  
Jurisdiction
  
Claim Type
  
Status
Suarez
  
Sep-16
  
US District Court, Southern District of Florida
  
Wrongful Death
  
Dismissed

21

Table of Contents
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

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 Axon’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. The Court also issued an award to Axon of compensatory and treble damages, and also an award of reasonable attorneys’ fees and costs. 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.
In imposing severe sanctions against Phazzer, including an award of Axon’s attorneys’ fees and costs, 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.”
Axon’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 was “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.
The Axon 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.
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

22

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


forum, including the USPTO.” Accordingly, Phazzer’s pending USPTO cancellation action, which was stayed while the litigation ran its course, will be dismissed. On August 10 2017, Phazzer filed a notice of appeal.
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, commercial bribery, contracts, combinations and conspiracies in restraint of trade and unfair or anti-competitive acts and practices. 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. The Company believes the second amended complaint is frivolous and is vigorously defending this litigation. The Company’s motion to dismiss the claims involving commercial bribery, contracts, combinations and conspiracies in restraint of trade and unfair or anti-competitive acts and practices was granted on January 12, 2017 and judgment of dismissal was entered in the Company’s favor on April 14, 2017. Plaintiff filed an appeal on April 20, 2017 to the 10th Circuit Court of Appeals.
The Company has filed four inter parte reviews ("IPRs") with the USPTO to invalidate Digital Ally’s patents and also has filed a motion to stay the litigation pending resolution of the inter parte reviews which motion was granted. On June 6, 2017, the USPTO rejected one of the IPRs that Axon filed against the ‘292 patent 8,781,292 but granted the second IPR, and invalidity proceedings have been instituted against that patent regarding its auto-activation camera technology on all asserted claims. On July 7, 2017, the USPTO rejected Axon’s IPR filed against the validity of Digital Ally's ‘452 patent, claim 10; however, this patent claim is being challenged in District Court based on fraud claims, invalidity claims and non-infringement claims filed by Axon. The USPTO has not yet ruled on the second IPR filed against the validity of Digital Ally’s ‘452 patent, claim 1. This litigation is in the discovery phase but has been stayed pending the USPTO proceedings. In August, 2017 the parties filed joint IPR status statement with the court and requested to schedule a conference or briefing on the continued litigation stay. Digital Ally filed a motion (1) for leave to amend their pleading out of time, (2) to dismiss the ‘292 Patent with prejudice, and (3) to dismiss the Company’s ‘292 Patent counterclaim for lack of declaratory judgment jurisdiction. Digital Ally also filed a covenant not to sue the Company on the “292 Patent for current products only. These motions are pending.
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 approximately $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 March 2017, the Company filed a motion to dismiss which motion is pending. 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. The California complaint was served on VieVu and this litigation was voluntarily dismissed by Axon. In May 2017, the Company filed and served a complaint against VieVu in the US District Court for Arizona for violation of the Lanham Act, which litigation is pending.
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.

23

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


Based on the Company's assessment of outstanding litigation and claims as of September 30, 2017 , 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  September 30, 2017 , the Company had outstanding letters of credit of approximately  $2.7 million that are expected to expire in May 2018. Additionally, the Company had approximately  $5.7 million of outstanding surety bonds at  September 30, 2017 , with $1.0 million expiring in 2018, $2.4 million expiring in 2020, and the remaining $2.3 million expiring in 2021.
12. Related Party Transactions

The Company engages Dr. Mark Kroll, a member of the Board of Directors, to provide consulting services. The expenses related to these services were approximately $16,000 and $14,000 for the three months ended September 30, 2017 and 2016 , respectively, and $89,000 and $111,000 for the nine months ended September 30, 2017 and 2016 , respectively. At September 30, 2017 and December 31, 2016 , the Company had liabilities of approximately $4,000 and $12,000 , respectively, related to these services.
The Company subscribes to a mobile collaboration software suite co-founded and managed by Bret Taylor, a member of the Company's Board of Directors. The cost of the software-as-a-service subscription is approximately $0.2 million per year, and as of September 30, 2017 and December 31, 2016 the Company had $84,000 and $50,500 , respectively, of prepaid costs related to the subscription.
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 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 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 September 30, 2017 and 2016 , were approximately $0.6 million and $0.4 million , respectively, and $1.9 million and $1.2 million for the nine months ended September 30, 2017 and 2016 , respectively. The Company expects to make contributions to the non-qualified deferred compensation plan related to the three months ended September 30, 2017 of approximately $8,000 . Future matching or profit sharing contributions to the plans are at the Company’s sole discretion.

24

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


14. Segment Data
The Company’s operations are comprised of two reportable segments: the manufacture and sale of CEWs, accessories and other products and services (the “TASER Weapons” segment); and the software and sensors business, which includes the TASER Cam, Axon cameras and related accessories, Evidence.com, and the Axon Artificial Intelligence team ("Axon AI") (collectively, the “Software and Sensors” segment). The Company includes only revenues and costs attributable to the Software and Sensors products in that segment. Included in Software and Sensors segment costs are: costs of sales for both products and services, overhead allocation based on direct labor, selling expense for the Software and Sensors sales team, product management expenses, trade shows and related expenses, and research and development for products included in the Software and Sensors segment. All other costs are included in the TASER Weapons segment. The CODM does not review assets by segment as part of the financial information provided; therefore, only limited asset information is provided in the following tables.
Information relative to the Company’s reportable segments is as follows (in thousands):
 
Three Months Ended September 30, 2017
 
Three Months Ended September 30, 2016
 
TASER
Weapons
 
Software and Sensors
 
Total
 
TASER
Weapons
 
Software and Sensors
 
Total
Net sales from products
$
59,416

 
$
14,569

 
$
73,985

 
$
52,938

 
$
10,266

 
$
63,204

Net sales from services

 
16,277

 
16,277

 

 
8,678

 
8,678

Net sales
59,416

 
30,846

 
90,262

 
52,938

 
18,944

 
71,882

Cost of product sales
19,237

 
15,336

 
34,573

 
14,973

 
8,691

 
23,664

Cost of service sales

 
5,924

 
5,924

 

 
1,653

 
1,653

Cost of sales
19,237

 
21,260

 
40,497

 
14,973

 
10,344

 
25,317

Gross margin
40,179

 
9,586

 
49,765

 
37,965

 
8,600

 
46,565

Sales, general and administrative
20,575

 
15,823

 
36,398

 
16,439

 
11,682

 
28,121

Research and development
1,856

 
12,310

 
14,166

 
1,408

 
5,950

 
7,358

Income (loss) from operations
$
17,748

 
$
(18,547
)
 
$
(799
)
 
$
20,118

 
$
(9,032
)
 
$
11,086

Purchase of property and equipment
$
1,666

 
$
1,665

 
$
3,331

 
$
1,064

 
$
307

 
$
1,371

Purchase of intangible assets
66

 
195

 
261

 
77

 
77

 
154

Purchase of intangible assets, including goodwill, in connection with business acquisition
2,075

 
2,075

 
4,150

 

 

 

Depreciation and amortization
542

 
1,735

 
2,277

 
537

 
364

 
901



25

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


 
Nine Months Ended September 30, 2017
 
Nine Months Ended September 30, 2016
 
TASER
Weapons
 
Software and Sensors
 
Total
 
TASER
Weapons
 
Software and Sensors
 
Total
Net sales from products
$
170,103

 
$
38,248

 
$
208,351

 
$
144,307

 
$
23,438

 
$
167,745

Net sales from services

 
40,796

 
40,796

 

 
18,423

 
18,423

Net sales
170,103

 
79,044