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

Hey, good afternoon, everyone. I'm Brian Gesuale, Senior Analyst for Raymond James, covering industrial technology and public safety technology. I'm delighted to have Axon here to present their story. It's been a terrific transformation story over the last 6 or 7 years, as well as just a phenomenal stock this year on some really strong execution. We have the company's Chief Financial Officer, Jawad Ahsan, here to answer a bunch of questions in a fireside chat format. And Jawad, so thank you so much for joining us today.

My pleasure. Thanks for having us, Brian.

I'm just going to jump right into questions, and we can certainly take questions from the audience as well. You're welcome to e-mail those to me at [email protected]. But maybe we start off just level setting the story. Would you take us through this evolution of Axon from what was an episodic hardware business to a recurring revenue model that's largely in place today? But as part of that, maybe think about Axon 4 years ago versus the present versus 4 or 5 years out and how the different stages of the evolution will be?

Sure, yes, it has been an evolution. And the way that I'd like to think about it is really in terms of stages or phases. And the first phase really was getting the TASER business established and building up that channel. So the first 15 years of the company was building the channel, getting the company up off the ground, and that took us to about $1 billion in market cap. The second phase was when we started making investments in body cameras. It really started in 2008. It didn't -- that business didn't really take off until Ferguson and the Black Lives Matter Movement was really gaining steam in 2014. And the solutions that we had built were exactly right for that moment. And so over the last 6 years or so, body cameras have really been taking off and getting established, and we've established ourselves as a market leader there on the strength of our software and our cloud-first approach. And I'd say the next phase of growth for the company is taking -- and this actually speaks to, Brian, your question about 4 years ago. Four years ago, I joined the company in 2017, and we had really silos of products. We had TASER, we had body camera, we had the in-car camera, and to a large degree, they were siloed. Today, it's all integrated, right? Today, we sell a platform, we sell an ecosystem with Evidence.com as the backbone. And then you can add on TASERs, body cameras, the in-car camera, you can add on records and dispatch the software features like transcription and AI. All of that comes together on the platform. And the more of our products we have, the more effective they become with each other and the more effective your agency is. And this is really the foundation for the next part of our growth.

Great. Yes, and I think it's been a fascinating story the way you really built that ecosystem out and the multiplier effect. And so we've been really impressed with that. Let's maybe zoom in a little bit to some of the current events in the funding environment, which is so important, given there's this real push and pull of social inequity and yet this domestic political backdrop has changed here. It's clear that your nonlethal technology and ecosystem of sensors that promote transparency are a major part of the solution to bridge some of these inequality gaps with law enforcement. At the same time, there's been a lot of discussion on defunding movements and we certainly have state budgets, which are in pretty large shortfalls given the macro economy. Over the long term, it's clear that technology has momentum, but should there be any apprehension in the near term? And really, should we think about any lumpiness or orders? Or how do you take this long-term trend in the short-term budget issue?

Yes. I guess I'll start with first talking about how the company is organized. We've got 4 main pillars, or I guess strategic areas of growth. The first one is de-escalation. So that's TASER, that's the training, the set of training products that we have. So VR empathy training. All of that falls under the umbrella of de-escalation. Then we have the body cameras and evidence management. All that goes under what we think is really trying to drive more transparency with law enforcement. Records and all that suite of software that goes along with that is what we call productivity. And then the dispatch software, live streaming, real-time operations, situational awareness, that all falls under communications. So when you think, Brian, about those 4 categories, de-escalation, transparency, productivity, communications, these are exactly the things that our society is calling for as far as reform in policing. And all of our products are geared towards exactly that. That's why when you hear us talk about Axon is really built for this moment, we believe that -- this idea of defunding the police, that was a knee-jerk reaction to some really unfortunate things that have happened. And thankfully, that's now transforming into something more level-headed and mature which is reforming the police, and that's exactly what our products are geared towards. And so that's where we -- when we look at our pipeline, we're still seeing a lot of strength in our pipeline for that reason because our products are built to solve the problem that many law enforcement agencies in this country is trying to solve as far as reform.

Yes, that makes a lot of sense to me. Maybe if we just follow up on that question, one of the things I don't think people appreciate enough about your product suite is that third area that you talked about where productivity comes into play in Axon Records. As you start to think about so many on-premise solutions that differ from your cloud-based solution are some of the budget dollars actually pushing people to make that change towards records? And are you seeing kind of an increase of what that pipeline may look like just because our funding issues are really driving them away from these expensive long-term on-premise solutions?

Yes, there were a couple of things, Brian, that are happening right now. One is exactly what you described, that there's more of a desire to move to cloud-based solutions. There's so much efficiency to be gained there. And as our product gains traction in the market, I think it's really showing customers a better option than the status quo. So that's part of it. Part of it is that the demographics are changing as well, right? When you look at the users of software and law enforcement agencies, we go out and visit customers all the time. And increasingly, it's a younger demographic and the folks that are used to using cloud-based software, right? They use the TurboTax, they're on social media, and they're not really seeing the value or really the -- they're not -- it's not as effective or as efficient for them to use black screens and green texts, right, or like Windows 95-based software. They want cloud-based software and they want those extra workflows. And our software talent comes from those companies we've hired from Google, from Amazon, from Facebook; we've got some world-class software talent in Seattle that has prioritized not only cloud-based and cloud-first architecture, but the same UI and UX that made Evidence.com frankly enjoy to use, right? We have heard a lot from customers that it's really -- it's a great product that they enjoy using and we brought that same design philosophy to records and to dispatch.

I'm glad you mentioned dispatch because I want to kind of look at that as well because I think people are still kind of coming up to speed on what you're doing in the communications side of things. You've been a company that's really built this software business from the ground up, kind of funded with some of your hardware profits over time. Some of those have been Home Run, Evidence.com, Records is in kind of the early stages of adoption. Can you maybe broaden out and give us a little bit of color on what you're doing with dispatch and really how when you talk about transformation this seems like one of those things transforms in real time and just give us the overall strategy there with what you're doing?

Yes. I'm very excited about our dispatch product because it's evolved from dispatch to something more, which is why we rebranded it to Axon Respond. So under the Respond umbrella, there's dispatch, the initial dispatch software that we had built. There's also -- we bundled in live streaming as well for Axon Wear. And the idea is that the combination of the software with dispatch and live streaming, it's really a real-time operations platform that's going to help deliver a better situational awareness to agencies. We introduced this at our August user conference, and we've already gotten some just really great feedback from users and from customers. It's a book of business that we're still building, okay? It's going to take some time. One of the challenges we have is that we're not only introducing a cloud-based dispatch system where it's been largely on-premise to date, but we're also trying to standardize processes. One of the challenges we've seen with the existing dispatch software that's out there is that it's so highly customized such that almost every dispatch software or solution for each agency is a one-off. And that's not really scalable, right? So when you talk about building a cloud-based dispatch business, you want that -- you want to be able to offer configuration, configurability, but you don't want to get too far down the path of like allowing everyone to customize because again, that's not going to scale. So -- but we think that's actually going to drive efficiency, right? When you look at the dispatch centers today, the law enforcement agencies, you go there and you see an operator who has like 9 monitors in front of them and 3 keyboards, multiple phones. We actually have seen foot pedals, that's like another input. It's just crazy. And the average dispatch operator in the U.S. needs to train for 18 months before they can take their first 9-1-1 call. I'm not sure I could probably [indiscernible] before I could take a 9-1-1 call. And this is exactly the kind of thing that we are trying to disrupt is to try to standardize that and simplify it so that it's not only a better outcome for that agency and for the communities they serve, but it's also -- it's more scalable.

That's very helpful. What we've seen is you've morphed into a really big software enterprise. You've introduced a bunch of new metrics that have been very helpful. Two of the very important ones that I like to watch, and many others do, are the ARR and the net retention ratio. Can you maybe walk investors through where those metrics came from over the last couple of years? Where they sit now? And then when you look at kind of the book of business, how you expect those to both kind of trend as we move forward.

Yes. So I'm going to start with ARR. ARR is something we're really proud of that business that we've built. We're now north of $200 million in ARR. Now we started -- technically we started the cloud-based business, as I said, in 2008. So we went -- it took from 2008 to 2018, about 10 years to get to $100 million in ARR. And we went from $100 million to $200 million in 2 years. We went -- it took us 2 years to go to $200 million, to double that. And that business is just continuing to gain traction. And that's one, again, where it's one of the metrics that we love to point to that shows the software -- the success of the software business that we've built. And then net retention rate, we recently introduced that because we wanted to provide even more SaaS metrics. Our churn is effectively zero, right? The reason we don't disclose that is because There's only one way to go from zero, and it's not really -- there's a lot of -- there would be noise if it fluctuates. So we wanted to focus instead on net retention rate, which has churn inherent within it. Our contracts are, on average, 5 years in length. Increasingly, they are 10 years in length. They mostly don't run the natural term of the contract because what happens as the customer renews, they add on scope or users and sometimes both. And when they do that, they're upselling and the retention rate gets a boost. That's been stable at about 120% for the last few quarters. And we think that as customers continue to walk up the value chain and they buy more of our add-on features, you'll see that retention rate number boost.

That's really helpful. I mean, I think this product cycle has proven to be powerful. And just the fact that it took a decade to $100 million, in 2 years for the next $100 million is certainly impressive. Let's talk about maybe about 18 months ago the company talked about making some investments into adjacent markets. Can you maybe help us understand and frame what those investment sizes were? And maybe what you're seeing in terms of some of those -- the fruits that are coming from those initial seeds of investment?

Yes, that's a great question, Brian, actually. I think you're the first person to ask about the size of those investments. They were fairly minimal to start with. So we've had a federal team for a number of years. We've had an enterprise team for a number of years, consumer, international. All of those teams that we consider to be outside of our core domestic law enforcement business, we seeded with law enforcement sales people first. Sales and marketing, product people as well. The thing that really shifted for us is when we hired Richard Coleman from General Dynamics. And he showed us that what we really need in these areas are people that are industry experts that -- what got us success in -- what brought us success in law enforcement isn't necessarily going to bring us success in these other verticals. And that wasn't immediately apparent to us. I know it seems like a pretty simple concept. But it wasn't apparent until Richard came on Board, and we started getting invited to meetings and we were at the table at discussions that we didn't know existed before Richard got here just because of his relationships and his brand in the federal space. And so we're rethinking enterprise, for example, were -- the federal team is now stocked with talent that comes from the federal space. Same thing with enterprise, we're hiring people that have experience building brand-new channels within those industries, whether it's hospitality or construction or real estate, all the different places where we've heard there's interest in body cameras. The same thing with consumer, we've brought on a new general manager for the consumer business that has consumer marketing strengths and a consumer marketing background. So to date, the investment has been mostly on a -- from a people standpoint, we've hired people from a sales and marketing standpoint. It's been relatively minimal from a product standpoint.

Okay, terrific. And certainly, those are big opportunities if you guys can kind of couple these elephants down. I want to maybe talk about -- we've spent a lot of time on software, which is where I think a tremendous amount of the value of the business is. But there's certainly a lot of interest in TASER, and I get a lot of questions from investors on the intermediate-term outlook for TASER as they try to reconcile what has been phenomenal international growth versus a domestic market that's fairly highly penetrated in a bit of a more measured funding environment or at least a perception of that. Also with this most recent quarter, I think you beat on just about every metric out there, but TASER 7 was going against a difficult comp and was actually down year-over-year. Is this a temporary pause? Or how do you put all of those things together to kind of explain where TASER is going?

Yes. I'm going to take the TASER 7 question first. It's not something that we're overly concerned with. We have a variety of TASER products with various price points. The T7 is obviously at the top end of the market. It's our flagship TASER product. It's gotten a lot of traction with major cities. And many of those major cities have gone through the buying cycle. I think we're going to continue to see strong sales for TASER 7 because I'm looking at the pipeline and I know there is some -- there's a lot of robust demand for T7 that's still out there. But we still sell the X2, the X26P. Some agencies are not yet ready to move to a 2-shot platform. NYPD is an example. NYPD is still a big X26P user. They love the 1-shot. So I think we have products for various price points for various market needs. And I feel very confident that the TASER 7 -- sorry, the TASER business overall is going -- that segment is going to be growing in the 10% to 12% range pretty reliably for the next few years when you look at the demand that's out there. Actually, earlier part of your question, there are probably about 1 million units or so of an install base for TASER today. And when you add up all the different areas where TASERs have a really compelling use case. So law enforcement, certainly internationally, private security, federal, corrections, you add those all up, we think that install base could be 5 million units. So there's a lot of runway. Certainly, we think domestically, there's an opportunity for us to upgrade the weapons that are out there. But then there's also a lot of runway and a lot of white space in those new verticals I had mentioned as well. So our TASER 7 -- sorry, our TASER business is -- it's still a -- it's a growth vector for us. I know that sounds a little strange because it's such a mature business. But we're -- I've historically been talking about our business shifting primarily to software and with devices becoming increasingly smaller. But the demand for a TASER is still so strong, and I think you're going to see that mix stay roughly 50/50 for the near term.

I know the CEO, Rick Smith, is so passionate about obsoleting the bullet. When we think about TASER, how do we think about the product cycles with that? Is this a 2-year thing? The 7 was quite a bit longer in its launch from the prior versions. How do you think about that when you balance all the other investments that are going on?

Yes, yes, great question. We're trying to bring the next-generation TASER to market sooner than we otherwise would have because it's such an exciting product. The TASER 7 was an evolution over the previous generation, which was the X2. It's still a 2-shot weapon, it's more accurate, it more consistently connects the darts. It's got a better battery life, it's got a doc, you can -- it's a smart weapon, so it's got some software-enabled features. But by and large, it was an evolutionary upgrade. TASER rate is a complete reimagining. I've actually been pushing for us to name it something different because it's such a big upgrade. Whatever we end up calling it, it's a revolutionary reimagining of the TASER platform and what a TASER should be. And this is the first product that we've looked at, that we've said, you know what, this could finally get people to start to see and believe in our vision of obsoleting the bullet. And what's really exciting about the next-generation TASER platform, Brian, is that it has application beyond law enforcement. What we're talking about is consolidating law enforcement and consumer, okay? So the next-generation platform that we're working on, we think, is going to have a lot of appeal for consumers as well. So for that reason, we are accelerating that investment ahead of what we normally would be, and it's going to be in the '22 to '23 timeframe that we release.

Okay. That's great. That sounds exciting. Let's zoom out a little bit on the business and we look at the last 5 years or so. It's been a period of significant investment. You were nurturing a bunch of software businesses that were subscale, some of them have scaled appropriately, some are still scaling. As a tech company, you're obviously going to need to invest in perpetuity, but these software units are starting to really bear some profits and good cash flow. How should investors think of a potential operating profile for Axon 5 years out? And what do you see the free cash flow conversion and just other kind of key cash metrics as you look out over a period of time?

Yes. So we've got our sight set on 2030. By the end of the decade, we want to have a TASER weapon in the market that's either made to go on our suite or is well on its way, we want to continue to drive transparency and build a fairer justice system with our body cameras and or dev software. We want to enable real-time situational awareness with dispatch. We want to become the communications platform for law enforcement. We want to obviously expand it beyond law enforcement into these other verticals where we're gaining some traction. And our long-term margin targets are 30%. Our gross margin target is 70%. So that's the operating profile that we're driving towards. I would tell you that we're so excited about the growth prospects in these new markets that we are still a little bit in an investment mode. We're trying to balance -- strike the balance between investing for growth and driving leverage. That's been a hallmark of our performance over the last few years. We're going to continue to see that. And the trick is for us to not swing the pendulum too much in one direction because certainly, like, trust me, the grid all the time wants to invest more. And I think we've got this -- the balance right, right now. We are investing for growth, right? We are investing in new products like drones and AI and transcription. But we're also driving leverage in the business. So I think you should expect to see that from us continue over the next few years. The thing that I'm most excited about is these new areas that we're expanding into could be massive in their own right, right? Federal could be on its own $1 billion business. Look at our TAM, we recently expanded our TAM. I think that may end up being conservative as well because federal could be a big business on its own. The enterprise space, there's so much interest there. It's still early days in a lot of ways, but there's enough there that we think that, that could also be a very significant business for us. Consumer is only just taking off. Like I said, we're -- and obviously that market is pretty large. So I think we're at the very beginning of something like -- I know we've had a lot of growth over the last few years. But the company is really just getting started.

Right. If I think about -- you mentioned the federal opportunity, and you threw out a pretty nice size number of $1 billion business potentially. How does that manifest? When you're engaging with customers today, are they thinking this is hardware, this is software? Is this things where the buying pattern mirrors what law enforcement is doing? Were they're on a 5-year plan? Or do they want to buy the product right up front? How do we think about just the differences of how that market evolves?

Yes. One of the things that's really interesting has been interesting to us about federal, many of those customers today are already collecting video through their own cameras, whether it's CCTV, body camera, their covert cameras. And what they're buying from us is largely evidence management, they're buying Evidence.com. And I love that because that's high margin, right, they're not buying the -- the body camera, the hardware isn't exactly the healthiest margin. And we've made that investment because we want to enable the sales of value-added services like live streaming, et cetera. And in some cases, the federal market is buying the cameras because they want to get to live streaming. But in many cases, they're just buying evidence management. And what's really unique about that for Axon is that we're FedRAMP certified, okay? And for federal agencies that want to share evidence with state and local agencies, state and local agencies are on a separate standard in -- from federal. So to enable -- basically, there's a -- it's called US 1 and US 3, those are the 2 separate standards. In order for there to be sharing between those 2 standards, that connector that flows the data back and forth also has to be FedRAMP certified. So we not only provide a FedRAMP-certified dense to federal, but we also are the only ones that are positioned to build a connector so that they can share data with multiple agencies. Today, believe it or not, that doesn't really happen. You don't really share evidence digitally. But that's a big need that we're hearing from our customers, and we're solving that. We're building that connector for them.

That's exciting. I want to maybe talk a little bit about such a big opportunity in front of you. The balance sheet is absolutely flushed with cash. You're going to be generating more and more cash as you move forward. How do you think about capital deployment? And really along those lines, if we're at the front of kind of a transformation of public safety, are there things that are better to get to market with -- through a purchase versus a build strategy? And really, I guess, how do you evaluate all of those kind of points that come together?

Yes, I love this question. The first thing that you should know, Brian, about Axon, Rick and I would lockstep on this, the way we think about financing the business is we want to finance the business with our own profits. That's job number one, two and three. We don't want to do it through debt. We think that we've built something pretty special and very profitable. It's very, very strong cash generation, and there's no need for us to do anything other than finance our business with our own profits at this point in time, all right? There is going to come a point in time where we may need to take on debt if we see a large M&A target. We have a very strong corporate strategy team that we've built under Andrea, and we've got -- our M&A pipeline is just bursting at the seams, and we're actually looking at quite a few targets. The bar is pretty high for us to get to a point where we're actually going to be acquiring something. We've made a couple of seed investments and some companies that we're interested in. I would say the way I think about it is, yes, it would have to do what you describe. It would have to materially shorten our time to market or round up our product in, for example, with Respond or with Records. Like if there's an opportunity for us to become more competitive by picking up an acquisition, we would do that. What you're not going to see from us is, most likely, I don't want to completely close the door, but you're not going to see as an acquisition that gets us into a completely new space. We're just laser-focused right now on the product sets that we've built expanding that along 3 -- well really 2 vectors, who we sell to and where we're selling. So the markets we're selling to federal, international, et cetera -- sorry, enterprise, and then where we sell internationally, that's another area where we're investing for growth. And so I'd say from M&A standpoint, it's -- we're -- we've got the cash to remain opportunistic, and we'd like to stay opportunistic. We're planning on it, but there is a pretty high bar for us to be able to demonstrate that we're going to buy at something.

Yes. I mean there's so much opportunity in front of you, certainly going into different markets, probably doesn't make a lot of sense. It really just to accelerate that adoption and round up a portfolio, like I think would be well received. Really, my last question for you here is I want to talk a little bit about ESG. It's certainly becoming something that our investors are talking more and more about. Would you outline some of the areas that management is focused on as it pertains to ESG? I just think there's a lot of opportunities there, particularly when I think about the overall corporate mission at Axon. You're almost a poster child for what ESG should be. So could you just talk a little bit about that?

I appreciate that. Angel used to feel good about herself. Angel leads our ESG efforts, her and Andrea. So yes, I've been just super proud of our IR team. I think we've got the best in our team in the world. So first and foremost, kudos to them. And the 2 areas I feel that we're strongest. One is social. So we think that 100% all of our revenues are generated by products and solutions that really support the UN sustainable development goals, specifically the goals that are focused on gender equality, building really a resilient infrastructure and then fostering innovation. So you look at those UN goals and the idea of like promoting safe living conditions in urban areas, reducing violence and death rates, we think our products are geared towards all of that. And then the second area I would say is on governance. We have a very diverse Board. They have ownership minimums. And I think the most important thing is that they're very engaged, right? They're very actively engaged in the business. We had an employee who stated to me once that, hey, I don't get it, like what's the deal with our Board members getting all these fees and stuff, they attend 4 meetings a year, and then it's so far from the truth. We -- I talk to our Board on a regular basis. We have 4 formal board meetings a year. But there are 3 or 4 Board members that I talk to probably every other week just because they're such fantastic thought partners. And they really are -- they're -- we have a stellar Board. And it's also a diverse Board, right? Like it's probably no coincidence that those 2 are both true. So that's the other thing I'd say basically is our governance.

Yes, I mean I can tell you the enthusiasm is contagious almost when you come out to visit Axon. You can see not only from senior leadership but the employees that I've bounce into, certainly very impressive. That's going to end our script for today. Jawad, I really appreciate you taking the time to tell the story to people. And for those investors out in the digital world, thanks for listening in. You're certainly welcome to follow up with Andrea, Jawad and team and Angel, and you're also certainly welcome to contact me as well. Thanks very much, everybody.

Thanks, Brian. Good to talk to you again.

Yes, yes.