Axon Enterprise, Inc. (AXON) Earnings Call Transcript & Summary

Hello, everyone, and thank you for joining us for our first ever virtual Growth Stock conference. My name is Jonathan Ho, and I'm the research analyst here at William Blair & Company that covers Axon. I'm required to inform you that a complete list of research disclosures or potential conflicts of interest is available at our website at www.williamblair.com. With us today are Jawad Ahsan, the Chief Financial Officer of Axon; Andrea James, who's the Vice President of Investor Relations; and Angel Ambrosio, who is also with the Investor Relations team. Just wanted to start this off with maybe, Jawad, having you spend a little bit of time walking us through the high level story for Axon, just in case a few folks that are less familiar with the story would like to get a little bit of a level set. So Jawad, I'll hand it over to you.

Sure. Thanks, Jonathan. So the company started as TASER International in 1993. Actually started in the consumer market and ended up pivoting to law enforcement. And over the better part of 3 decades now, we've been building that channel with law enforcement. First, with TASER; and then around 2008 or so, we got into the body camera space. It wasn't until 2014 after the incident in Ferguson, body cameras really started to be embraced. What brought Axon to the forefront to a market-leading position in body cameras was not so much the device, but the actual back-end software, the evidence management, which we call Evidence.com. And it was that cloud-first architecture, the sort of consumer face -- the consumer type of UI/UX from the companies that we acquired that had really consumer software type of developers that got us the success -- that brought us the success we had with Evidence.com and really, I think, gave us the idea to expand beyond evidence management into now records, software, dispatch as well. And the company has really pivoted over the last few years from being primarily TASER and body camera to more of an enterprise software company that's bringing these cloud-based solutions to law enforcement, but also increasingly federal corrections enterprise and enterprise markets. So we're really diversifying beyond law enforcement and we're -- so we're an enterprise software company that also happens to sell devices. The way that I think about the company today, we've got four strategic growth areas. The first one is de-escalation. So that's not only TASER, but it's also all the training that we've developed around the idea that an officer should be de-escalating a situation versus, like, running in, shouting, drawing their firearm and this is actually pretty relevant for the situation today. The second pillar we call sensors and digital evidence management, which is not only the body camera, but also the in-car camera, any video collected from a drone and the evidence management platform that goes along with it. The third pillar is productivity. And that's a suite of software that helps make officers more productive in their paperwork, such as records. And then finally, communications, which is not only acts on dispatch, but also our live streaming suite of software.

Great. Thanks, Jawad, for that introduction and overview. I think it's top of mind for a lot of investors to try and understand, number one, when we look at some of the recent events regarding law enforcement protests and some of the incidents out there, can you talk a little bit about what the implications are for Axon? And maybe what role you can play -- the technologies that you have and the solutions that you have to maybe prevent these incidents from happening again?

Yes. Like I said, the whole idea of de-escalation, it's very topical right now. Look, I think we're a very adaptable, flexible company. We have had a history of being innovators in public safety. We pivoted, like I said, from just TASER only to also expanding into body cameras and then now we're pivoting again to being a software-driven company. Our -- the number one thing, I think, to keep in mind is that we're very much a mission-driven company, and our mission is to protect life. We want to make the bullet obsolete. We want to enable a fairer justice system. We want to increase transparency in law enforcement through the use of body cameras. And all those things today, I think, are very relevant. And I think, frankly, it's exactly what society needs right now in order to find a path forward. So I talked about our 4 pillars that really tie in nicely to the current sort of, I think, how we can start to find a path forward. An example of those, I'll give you two examples. One is our live streaming functionality that's new on our Axon Body 3 body-worn camera. We made an investment in live streaming, building out a partnership in a network with Verizon and AT&T and the AB3 camera has the ability to effectively live stream video, either via mobile app or through a browser. And I would say that initially, folks were interested in it, and were doing some trials. Some people were skeptical if it was really something that they needed, live streaming video. What we're seeing now is a lot of interest in signing up for Axon Aware. In situations where you have your officers that are out with protesters or a situation escalates beyond that, one of the most valuable things for a law enforcement officer arriving on a scene is situational awareness and also real-time resourcing decisions. And you can radio in your description of an incident, but there's nothing better than seeing what's going on over a live-feed video. And that's exactly what Axon Aware provides. We've seen an uptick in some trials there. Axon Citizen is another software product that we've developed that enables agencies to collect evidence. It's an evidence submission platform where you can basically call for evidence. I know it sounds fairly straightforward, but what our technology does is it filters out the noise, and we're able to prevent an agency from getting spammed. So if you're an agency that's looking for people to submit photos or video, we have the ability to, through geotagging and some other technology, to filter out what we would consider to be a valid submission versus -- there was actually an anecdote that Andrea likes to share of an agency that tried something like this without Axon Citizen, and they ended up getting spammed with bunch of K-Pop videos. So our technology, we think, is really the software that we've developed. We're seeing an uptick in the trial -- in trials for those use cases.

Absolutely. Absolutely. It seems like you guys have a bigger role to play, particularly as society adjusts through a lot of these challenges. Yes, maybe another area of interest is around the COVID-19 crisis and trying to understand how this is impacting both the buying behaviors of some of your customers that maybe are facing fiscal pressure not only from COVID, but also from the recent events now and also maybe some potential strain that's going to come from both of these situations. What are you seeing out there? How are folks reacting? And again, how can that -- how do you look about -- look at that as an impact on your business?

Yes. The refrain -- and this is something we've talked about internally a lot and I keep a pulse very closely with our sales team. The general refrain I keep hearing is that from a buying cycle standpoint, it's largely business as usual. And that's because a lot of our customers are on budget cycles that either started January 1, October 1 or July 1, and so they're still working their way through those budgets. We've heard about some uncertainty around how their budgets are going to look next year or maybe the year after. There's a lot of grant money out there that's available. The CARES Act was recently approved. That's going to put funding in the hands of law enforcement. In some cases, already hit their bank accounts. There's the Heroes Act that's out there that's not yet written in the new law but is being circulated. Where we have heard just anecdotally incidences of agencies potentially being impacted is more like, "Hey, we think our agency may -- or our budget, rather, may be cut. Would you be willing to work with us on some type of a payment plan, where historically, our contracts are 5 years, and we ask for payment usually over those 5 years. And we've now looked at ways to help a customer bridge the difficult time where they could have the payments be more back-end loaded. And from our perspective, we're happy to do that because we don't see our customers as a credit risk, and we had a long-standing relationship with them. We believe that they're going to be on for a while. And also, we've got the balance sheet to do that.

Absolutely. Absolutely. I mean maybe just to clarify some misconceptions around Axon. Can you talk a little bit about what the largest sources of state and local funding are for typically your types of projects? Are these coming out of CapEx budgets, OpEx budgets? And are the taxes themselves coming from more sales taxes, use taxes or more income and property taxes?

Yes. Great question, Jon. I would say there are two misconceptions to clear up. The first one is that, as you pointed out, about 2/3 of the law enforcement budgets in this country are actually tied to property taxes. So we think that there -- while property taxes over the long term and in a prolonged economic downturn may be impacted, in the short term, we think that those are more resilient than sales and income taxes. And so we think that, that's going to have a -- the current situation is going to have immediate impact on our business. The other thing is that even in instances where budgets may be cut for law enforcement, it doesn't translate to a one-to-one cut for equipment or technology. An example of this is the LAPD, they've got a $1.9 billion budget. The majority of that $1.7 billion, $1.8 billion is on personnel. And so when you talk about any budgetary cuts, we think -- we don't know for sure, it may come in the form of fewer raises, promotions, et cetera. The budget at $1.9 billion is still, even with the $150 million cut, is still larger than what it was a year ago. And so I think that's the other thing, is that we happen to believe that our products are mission-critical, our customers are telling us they're mission-critical. And they believe that if they're going to put an officer on the field, they want them to have more technology to be able to do their job as best as they can.

Got it. Got it. Maybe digging a little bit deeper into the AB3. I know this is a product that potentially is a game changer for the company with the live streaming capability. You've given us a few examples of how it can be used by law enforcement. So I just wanted to maybe dig a little bit deeper into how that could be used. Maybe from a business process standpoint, what types of changes would be needed to fully implement it and how quickly you're seeing maybe customers start to leverage the capabilities now that they're there.

Yes. We have so many anecdotes coming in on this. And the first one I'll share with you is, as I mentioned earlier, I think I touched upon it a little bit, during the protests, where agencies are using Axon Aware, that live streaming capability for real-time situational awareness, real-time resourcing decisions and they're able to understand if you have an officer or a couple of officers at a scene and there's a protest over the radio, then sort of convey if there is a protest of a large group of people. They obviously don't know exactly how many people are in that crowd, but like that's something that is sort of tough to get a feel for. If you're able to see exactly what they're seeing, you can decide if you need to send a couple of extra officers, you need to send a dozen more. That's something that you can do with that Axon Aware. Another example that I think is unfortunately something that's fairly pertinent for today's environment in our country is we had one of our customers who got a report of someone on school grounds with a gun. And they deployed an officer. The supervisor back at the station watched the live stream through the Axon Body 3, Axon Aware and saw that the suspect had been subdued. And so it was easy to make this decision not to send additional resources such as a SWAT team, right? That would be the typical next step there, would be to send a SWAT team and send in the cavalry. And they didn't need to do that because they were able to see the live streaming. And then there are other anecdotes. Like, there was an officer who was recently in a scuffle with someone. Their body camera had fallen off and then ended up actually getting stolen. The body camera not only has the LTE chip in it -- antenna in it, it also has GPS. And so we were then able to locate the bag. It's actually so accurate, we were able to pinpoint it and find the camera in the bag of a pedestrian and recovered it.

Excellent, excellent. One of the things that I wanted to understand a little bit better about the margin potential for the body cameras is that part of the costs that are associated with the device are sort of long-term storage on -- in the cloud. I can imagine that initially, that storage is probably going to be pretty low, but then it fills up over time. Can you talk a little bit about the margin dynamics around that process?

Yes. So we contract with Azure, with Microsoft Azure, for our storage and the customer contracts with us for unlimited storage. And we have a very strong margin on that product. It carries -- actually, it's all of our software, we've talked about carries above an 80% gross margin. The storage is highest -- sorry, the margin of the storage is highest on day 1 of the contract, obviously, because they're not storing anything. I can tell you, though, that we have great -- we have a very strong pricing structure with Azure. And they've actually -- they've been a great partner because the reason we switched from AWS to Azure is that law enforcement tends to be more comfortable buying Microsoft than they do Amazon, and so we ended up making that migration. And Microsoft has been a fantastic partner with us. We've also, I think, the structure that we have in place, as I mentioned, from a pricing standpoint is really going to drive some pretty attractive economies for us the larger we get.

That makes sense. Thanks for the color there. If we switch gears a little bit to TASER 7, clearly, there's a bigger push here to subscription. In the current environment, can you talk a little bit about the OpEx models? And maybe how does that potentially make it easier to complete some sales relative to your bigger CapEx outlays?

Yes. This has been one of the biggest shifts in the business that we've made strategically. From a cash flow standpoint as well, it's one of the uses -- big uses of cash we have is transitioning our customer base over to subscription. I would also tell you, Jonathan, it's one of the things that makes Axon, frankly, more resilient today than it was during the last recession. So the last recession, we were selling primarily TASERS, primarily book and ship, primarily U.S., primarily law enforcement. We've now migrated beyond that or expanded beyond that. We sell more than just TASERS, way more than just devices, software as well, beyond the U.S., beyond law enforcement. And on a subscription model, 71% of our revenues come from recurring sources. And so we have largely made the shift to becoming a line item in a budget, and I think there are 2 things that are really powerful about that. One is, in the current environment, we're not asking agencies to go out and get a large chunk of change and go through a procurement process to spend several millions of dollars on a -- in an equipment or software purchase. It's either $179 or $229 per officer per month, depending on how many officers you sign up. And that's a model that we think is a lot easier to get through a standard deployment process in policing today. Another thing that's really powerful about that is that once you're on our network or once you're on our software, which a lot of our customers are on that type of the subscription, it's easier for us to then upsell. And it's also easier for us to deploy additional features. And a great example of this would be Records. So Records was previously included with both our OSP 7 and 7 Plus. It's now included only with the higher tier bundle 7 Plus. And if you have an OSP subscription, then a lot of our customers initially bought the OSP because they wanted either the TASER or the body camera or they wanted some of the software features like Redaction Assistant, Citizen, Axon Performance. And Records was sort of an afterthought because, frankly, it wasn't in the market yet. Well, now Records is in the market, and we're getting a lot of interest in it. And what agencies are pretty interested in it is, hey, we're already paying for this, it's part of our monthly subscription and we can get a record solution that's cloud-based and has the same look and feel, same UI/UX as evidence.com, and we're getting a lot of interest on that. And what's great about that is that we can deploy that without having -- asking the customer to go back up to procurement.

That's really helpful. Why don't we kind of switch gears and talk a little bit about the RMS and CAD opportunities, maybe starting with RMS, like what are some of the most important workflows that you're able to replace initially? And how much of the value proposition of a traditional RMS does that sort of constitute? So we're just trying to figure out like maybe in baseball analogies, what innings you are in, in terms of coverage. And then maybe we'll go from there.

Sure. So our product today, which I'd say has evolved beyond an MVP. The initial MVP was -- that use case was report writing, right? We wanted to nail the core report writing experience because that's, by and large, the main use case for records -- for record software. Now records mean different things to different agencies, and there are lots of different modules that you can include within a standard RMS solution. But the core report writing experience is what we wanted to nail. We've expanded beyond that to include use of force reporting, which we call Standards. There is some workflows as far as like case management. Where we are today is that the -- well, I'll tell you where we're going to be by the end of this year. The investments that we're making in addition to the modules that we brought to market by the end of 2020 is going to have -- is going to bring us to a Records product that will address 50% of the records market that's out there that's looking for a record -- cloud-based records solution. And I think for us, the -- where we go from there, how we expand beyond 50%, whether we build or buy or partner, that's really going to depend on a case-by-case basis. Right, like not every agency needs that dog catcher module, as we like to say. We're going to sort of make that determination on a case-by-case basis. What we're more interested in is driving value-added services like transcription. That's a big one that we've made an investment in. What I'm talking about is being able to use computer learning, machine learning and take -- using transcription technology, pull the audio from the video, convert it into text and pre-populate a report. And so what an officer has to do is just go in and basically edit the report versus having to convert their notes and type them in from scratch. So that's what we're really trying to head towards is really, I'd say, commoditizing the core records product, which is -- which has been around for a really long time and is, frankly, ripe for disruption and moving the market more towards paying for value-added services such as transcription.

Got it. Got it. And just recently, you announced the first full implementation of a CAD system with a launch customer. And it seems like traditional RFP systems are continuing to still age and fail. Do you think there could be an even larger window for you to be disruptive during this time frame?

Yes. There has been some skepticism around cloud-based dispatch, and we happen to believe that the cloud is a fantastic way to deliver software. It was a really good use case for evidence management, for Records. For dispatch, we understand the sensitivity because you need your dispatch system to be up all the time. We've got not only a really strong uptime, but we also have built-in redundancies and fail-safe so that if the Internet can actually -- were cut out in an agency that were deployed on Axon Dispatch, we would have the ability to augment that with an offline mode. And so we've largely, I think, retired those concerns with customers that we're talking to. And what they see is that with a cloud-based Dispatch, you get all the power of cloud software, which is you can get updates pushed out on a daily basis, on a weekly basis, versus having someone come in and install the software on-premise and having 9 different monitors, all these different inputs that you need, you have one screen, it's browser-based, you have a -- actually a product feature that I'm very proud of that the team has built is something called the command line, which is sort of like the -- it's sort of like the address bar in Google Chrome, that it's more than just typing in the address, you can do searches, you can paste in images. Our command line very quickly helps operators get to the function that they need. We have an integration with Esri, who's a large map provider. So it also pulls in addresses. There's a names database we tie it into. And so with just a few quick keystrokes, you can, in the command line, get to exactly where you need to go to and then focus on the job at hand, which is getting an officer dispatched to a scene. And then if you've got Axon Body 3 and Axon Aware, then you can also see where they are in real time on a map, share video feeds with each other. Once all that's been resolved, if there's an incident that needs to get resolved, there's now a report that needs to be written, and you can also now seamlessly pull all the video that's been reported in your [indiscernible] workflow for evidence -- I'm sorry, for records. And you can basically pre-populate your report, and then if you need to share that report or evidence with the media, with the prosecutor, you can also do that with our platform as well. So I think it's really highlighting for us Dispatch is at the front end of a really compelling value chain that starts with the initial call to 911 and goes all the way down to not only writing the report, but sharing it with whoever needs to see it.

That makes sense. That makes sense. I mean if we start to think about just maybe stepping back and looking at the [ task ] forward, it seems like a lot of competitors are going to face some challenges especially if there's longer procurement cycles out there for some of these complex projects. Do you think about maybe the potential to outinvest these competitors during that time frame? And a lot of these guys are going to have to mothball their development teams, lay off sales staff. How do you think about being able to maybe take advantage of the strength of your business to do that?

Yes. That is a great question, Jonathan. It's a great way to characterize that. I really do think that we're able to go on offense here because our business, I think we built a very resilient business, and we pulled our guidance for the year on our last earnings call, but we were, frankly, pretty optimistic about the outlook for the year because we really haven't seen a drop-off in demand. And I think because we take a long-term view, because we recognize that we're still in the very early innings, not only continuing to expand within law enforcement, but like I mentioned earlier, in those other markets like federal, continuing to grow in international, it's still early days, and we very much believe that we're going to win. And we're going to grow our business to $1 billion to $2 billion in revenue. I'd say that we have the ability in [indiscernible] to make those investments now. We have worked very hard over the past few years. When I joined Axon in 2017, our EBITDA margins were down around 11% and trending south. It was very difficult to not only reverse that trend, but get it to where it is today. We've worked extremely hard to drive that leverage over the past few years. And the one thing I told the team, one of my biggest sort of battles with Rick, who's just always looking to invest in and doing bigger areas, is we absolutely cannot give up the gains that we've won on margins. And so we're going to find a way to work within constraints, continue to make investments. And our R&D has been growing faster than our revenue for the past few years because we do want to make those investments and capture those markets. That will continue for some period of time, but at some point, we're going to start to drive some more leverage in the business and everyone's aligned on that goal.

Fantastic, fantastic. I mean, as we kind of look at additional areas that you can go into over time, have you looked at maybe potentially looking at jail software, ticketing, other areas that you can expand into once you have these sort of core systems in place?

Yes. So I would say within the ones that you mentioned, that really depends on what the market need is. Not only the market need, but also for us, like, if it's a high margin product, we have like our software products where our margins are 80% plus. And if we can expand in one of these categories and maintain the margin profile, and it's going to meaningfully add to top line, then we'll do that. That's something that we'll probably go address organically, maybe do an acquisition as well. But if it's not going to move the needle, then we're likely going to partner instead. And the reason I say that is because there's so many different ways that we can go and we really need to stay focused. And it's not just within law enforcement. We're getting some inbound interest from customers in other industries like construction and real estate and hospitality that are talking about other use cases for body cameras. And we're making small investments to invest in that channel. But ultimately, this has got to be something that's going to keep our business growing in the 20% to 30% range for the next few years for us to really take it seriously.

Got it. Got it. We're getting pretty close to the end of our time. So one last question for me. When we think about Axon in 5 or 10 years, what will the mix of software and subscription look like over time? Is this a case where you're just going to go completely to subscription and there just won't be hardware? How do we sort of think about that dynamic over the long run?

Yes. So as I mentioned earlier, 71% of our revenues today are tied to a recurring payment structure. Ultimately, I think that's probably going to go to 90% to 95%. It's not going to go all the way to 100%. Because of the nature of our customers and law enforcement, they have funds that they sometimes need to use to buy something, like, they do have capital expenditures that they still make and may need to make. And so there's some small portion, I think that, that will likely continue. But over the long term, this is going to transition mostly to subscription and I would say the software component of that over a 5- year window is likely going to be -- well, let me put it this way. Long term, I'd say software is going to be probably 3/4, probably [ more, ] 75% to 80% of our business.

Fantastic. Well, I want to thank you so much all for all of you joining us today at our conference, and I hope you enjoy the rest of the day. For the audience, great to connect as well, and we'll touch base again soon, hopefully, live.

Thanks, Jon. Always good to see you.

Take care. Bye-bye.

Take care. Bye.