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

Okay. That makes sense. I think we've seen that happen before. We've seen gross margins kind of spring back in subsequent quarters. I want to kind of talk about one of the other things that I've received a lot of questions on, and that's kind of how to think about TASER in the immediate term. Can you maybe help investors reconcile this really substantial international growth that you're seeing, some incremental recent certifications for TASER 7 international also a little bit of what SKUs people should expect to see being bought more by customers or being demanded more, and then maybe kind of counter that with some of the views of domestic penetration and how the mix evolves, both geographically over the next couple of years or a couple of quarters?

Yes. This is a great question, Brian. I think it's one of the more misunderstood aspects of the TASER business. And I think it's because folks typically think about TASER's TAM as the 600,000 patrol officers domestically in the U.S., and they look at our annual sales and the refresh cycles and have to believe that we're running out of steam. The reality is it's more than just domestic law enforcement that are buying TASERs today. I can show you those receipts. It's federal. It's corrections. The international market has been adopting TASER at a nice clip as well, and you've seen some press releases from us on that recently. So when you look at the combination of law enforcement, federal corrections and domestic and international, really, we see the installed base or the potential installed base as being $5 million for TASER. There are about 1 million units on the field today, and we believe that we've got a lot of runway left to grow. And that's not only white space as far as selling in TASERs to locales or markets that have never bought them before, but it's also the refresh cycle because a lot of those million units are due for an upgrade.

Can you help us -- speaking of upgrade, is the demand more for TASER 7? I know it's a fantastic option, but I know there's still a lot of big fans of some of the prior versions of TASER. How do you see kind of that playing out over the next few years? And how many SKUs is it naturally for you to carry for TASER over time?

Yes. That's a great question. I would love -- I would have expected we would have maybe gravitated toward 1 or 2 SKUs. We currently have actually 4 now with the new introduction of the TASER 7 CQ, the lower cost variant of the T7. And what we're seeing is that there's actually a lot of interest in something like the X26P, which has been in the market for the better part of 2 decades now. It's our 1-shot weapon. And what we didn't anticipate was that there's actually demand. In some cases, it's price sensitivity, but, in some cases, it's really the need for a one-shot weapon. Because all of the training that you've done with your agency is around 1-shot and how to reload those cartridges, how to deploy the weapon. And moving to a 2-shot platform is actually quite a bit of work, and there's some additional retraining that needs to happen there. So there's still a need for a 1-shot weapon. I think in the near term, you're going to see us -- and then you look at something like X2, which is a 2-shot weapon. Ostensibly, the T7 is a better solution, except for the fact that in some markets, we've been working in international markets. We've been working to get the TASER approved, and we haven't even announced T7 yet. So in certain international markets, they're ready to buy. And they only have approval for TX2. So we're going to keep the X2 going for a while as well. I think over the longer term, what you're going to see is we're going to have likely a -- of versions the T7, where it's either 2-shot or maybe potentially 1-shot. It'll serve the longer tail of the market. And then T8 will be up in that I think most agencies will want to eventually drive towards.

Okay. That's helpful. I want to kind of zoom out again on the business and kind of look out. 2015 to 2020 was a period of significant investment. And at the same time, your software business was subscale. As a tech company, your need to invest is going to really continue, and your need to innovate is going to always be there. But these software units are a much bigger part of the mix today and either at scale, in some cases, or hopefully approaching it in the next year or 2. What can -- and as an enterprise software company, what can people expect from Axon from an operating profile if we go out 5 years? I mean that seems like a pretty profitable cash-generative model that you're in the early stages really of building to its full potential.

That's right. That's exactly right. The way I think about the business is what we're trying to build today is a business that's going to grow at 20% for the next few years on the top line and is going to be eventually approaching 30% adjusted EBITDA margins. And I'd say that's -- that really enforce the investments we're making today. When we think about our -- we have an opportunity now to reinvest our additional leverage back into the business. We had said a few years ago that we were going to drive 300 to 400 basis points of operating leverage on the bottom line. This is when our margins were at 11%, right? And we've come a long way since then. And what we've realized is that, look, that was a good goal for us at a certain point in time because we wanted to show that we have the ability to drive rigor and discipline within the business. And that's a muscle that we've built now. I feel really good about that. And I feel good about that because of like the nuts and bolts of how we budget and how we plan and how we make decisions on where to invest and where to focus our time. What we're doing is we're taking some of that leverage, the additional leverage we're getting from our revenue growth and reinvesting it back into our products and specifically into new markets, like federal, light correction, et cetera, that are going to keep our top line growing at 20%. Now is the time to be investing. So that 2, 3 years from now, when law enforcement, we start to get more penetrated there, that's when federal will come online in a big way or that's when enterprise may come online or corrections in a big way. And that's what's going to keep the total company growing at 20% plus. And then at some point in time, what you should expect to see from us is that we're going to allow more and more of that top line growth to fall to the bottom line as leverage, which is how we're going to get to the 30% EBITDA margins.

Yes, that makes a lot of sense. If I could just follow up briefly on that. When you -- when -- all of your businesses seem to be growing and still in adoption phase, even your most mature hardware elements. How do you think about, going out multiple years, what that software/hardware mix looks like?

So I would anticipate that the majority of our revenues, so 2/3 or more is going to be coming from software eventually. The other great thing about that is our software margins today, we're printing at 80% plus. So as a mix of our business shifts more to software, that's also going to naturally lift our margins. But there's still going to be a demand for devices, and those devices are invariably going to be lower margin than our software. But I think what you'll see is that it will shift to be more software than hardware.

Right. No, that's consistent with the way I'm thinking about it. Thinking about kind of the future, your balance sheet is loaded. How should we think about -- and your business model is going to become increasingly more cash flow rich. How do we think about capital deployment? And how do you evaluate the build versus buy and the opportunities, early days in this kind of evolution of public safety technology to really lead that and fill in any holes that you may proceed within your broad product portfolio?

Yes. You know what? I think one thing to know, Brian, is like my general style, as a CFO, is I like to be aggressive with the P&L as far as making investments and getting aftermarkets that I know we're going to generate a return, but uber-conservative with the balance sheet. And Rick feels the same way. He's also -- Rick founded the business. And he bootstrapped his way to where we are today. The only loan he ever took was a $500,000 loan from his dad, as he likes to say. And so -- and Rick and I are both generally very much aligned with like -- actually, not generally. We're very much aligned with our capital structure and the need or the desire to really continue our growth without taking on debt. I come from a -- I was a private equity-backed CFO. And once you take on debt, it just sort of changes the shape of your business. And you now have other stakeholders that you're involved into. We have a lot of operating freedom right now. There's -- we have a lot of different views as far as making investments in certain companies, looking at M&A targets. I love having that flexibility or that freedom. Another thing that our balance sheet affords us, a couple of things I'll give you. One is you saw that we had an inventory build last quarter. We're ramping up for growth internationally. And so having that inventory on hand really is, I think, a luxury for us. I never want to be in a position where we leave revenue on the table because we didn't have the inventory. We also -- you've heard us talk about getting flexible with payment plans for customers, right, where customers, to the extent that they're going to be impacted from a budgetary standpoint for the next couple of years, that's not really a concern to us because we know these agencies are serving mission-critical functions in their communities. They're going to be around for a long, long, long time. And if we can help them through the next couple of years, if they're having any budgetary concerns, we've got the balance sheet to do that. And then I'd say, also, from an M&A standpoint, we have targets in the pipeline. Andrea leads our corporate strategy function. And that muscle is -- I'd say that team is it's the strongest we've ever had. We've got a biweekly update where we look at our M&A targets. And it's actually -- it's pretty staggering in the number of targets in our pipeline. However, like we're -- generally, we've got a pretty high bar to cross for something to become an actual acquisition, and this is another thing that I'm just coming from PE. It takes a lot to integrate a company. Like we don't have a 5-year hold period. We're not just going to keep adding on these bolt-ons and then like exiting stage, right? We've got to integrate those companies. And that's a very tough thing to do. And we have such a rich opportunity with our core organic business as it is. I think you're going to see M&A in a very targeted way, if at all, from us.

Yes. No, I would agree with that strategy. Really, my final question for you is I wanted to talk about ESG. It's becoming more of a movement for institutional investors. Would you maybe outline some of the areas that management is focused on as it pertains to ESG, and maybe just talk about some of those things?

Yes. This is another one where it feels like, Brian, we were built for this with our mission. Our mission is to protect life. TASERs are deployed every day, to save lives every day. Body cameras promote transparency as well as accountability in policing. So the social good, that aspect of our company has always been there. It's always been very clear. And what we're doing now is really focusing on building relationships with communities and serving as a platform to help law enforcement better engage with their communities. We recently brought on a VP of Community impact. Regina Holloway lead those efforts, and she's already had a tremendous impact in that regard. We also have a number of diversity and inclusion initiatives. We have stood up a function within the company or the makings of a function within the company for D&I. Our Board has increasingly become more diverse over the past, I'd say, 1 year to 18 months. We have an AI ethics Board that itself is pretty diverse. So from a governance, I actually believe that we have excellent governance and a pretty diverse set of Board and ethics Board members. And then, again, our mission itself is really geared towards ESG initiatives.

Yes, I'm a big believer in what you're doing. I don't think you get the -- the ESG raters give the credit that's due yet. But I do think that, that is -- that's a temporary thing and will change over time. The final thing, I don't have an organized question to end it, but, Jawad, I'd like -- I really appreciate you spending the time with us. This is the drop-the-mic question. Is there anything that you want to make sure investors leave this fireside chat with understanding about Axon or appreciating about the company?

Yes. Drop the mic. Look, here's what I would say. What we're trying to do in the near term is to build the operating system for public safety. All right. And that's really how I think about the business. I know we tend to get asked about, "Tell me about TASER. Tell me about body camera. Now tell me about Records, and tell me about Dispatch." And that's totally understandable. I know that we'll succeed. Whether it's an investor or an analyst, Brian, like yourself, comes to me, the very first question is, "Tell me about your bundle. How's your bundle performing?" That's because really that's how we're selling, and that's what we're trying to provide to law enforcement agencies is this. The core of what we believe is that we want to build these integrated -- not only products, but integrated experiences. We want customers to be able to do everything that they need to do that's so critical to their jobs, and also to really protecting their communities in a seamless way. And they can do that. We really believe that they can do that best within Axon's network and within our suite of products, from Dispatch, to Records, to Evidence.com, back at the command center. And then when you're on the field, our actual devices as well are helping to integrate all of that. So from my perspective, that's really how I want folks to think about it, is that we're building the nervous system for public safety.

I think that's a great analogy. And we'll leave it there. Jawad, thank you very much for spending the time with us. Audience members, thank you. The company's always very accessible, as am I., should you have any follow-up questions on this very exciting story of Axon. Thank you so much.

My pleasure. Thanks for having us.