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

Thank you everyone for joining us today. I'm Sami Badri with Credit Suisse Equity Research. And we have someone from Axon Enterprise. We have Josh Isner, the Chief Operating Officer. So Josh, thank you very much for joining us.

Of course, thanks for having me.

So maybe to kick off with a very high level question. I was hoping if you could kind of give us the download on Axon high level and maybe just the state of the company in 2022?

Yes, absolutely. So Axon is a company that really has 2 very distinct businesses, one of which is our TASER business, which is what we call it our de-escalation pillar. And there, our mission is to obsolete the bullet and policing. We think over time, we are going to be able to build and deploy a conducted energy device that outperforms a police firearm. And every kind of year we get a little closer to that and it's certainly a long journey to convince a police officer to not have a firearm on their belt. You got to have something that works 100% of the time regardless of what the clothing the person is wearing and how far away they are. So we're moving down that path and we do think we'll get there eventually. But certainly a very nice business on that side, high gross margin subscription business where we deploy anytime you see cop carrying one of those yellow Tasers, that's one of our products. And so we're very excited about that business. It continues to grow both domestically and internationally and across the Federal government as well. And then the other side of our business is our Software and Sensors segment. There, we kind of broke into the market as the premier body camera vendor in public safety. And since, we've really grown out all the software around those body cameras and added some new sensors as well. There, our vision is to be the operating system of public safety. So all the major police workflows from reporting to dispatching officers to managing digital evidence to working with prosecutors in the courts, our goal is to be kind of that central software that makes all that happen, think like an ERP for public safety. And right now, we're the market leader in digital evidence management in policing. We manage about 22x the size of the Netflix library. We're Microsoft Azure's biggest customer and certainly can do some interesting things over time with the dataset that large and very excited for what the future holds in that business. And as I said, we sell to a few different markets, both public safety, state and local law enforcement in the United States, the Federal government in the United States, international customers. Then we have a growing commercial enterprise segment, which is kind of body cams and digital evidence management software for retailers or construction workers or last-mile delivery drivers. So kind of a growing team within Axon where we've had a lot of success there. And I think that will be an interesting business for the years to come.

And before we get into a little bit more of the business dynamics, at least what's been going on, could we talk a little bit about the moonshot goal? And it's -- I think the target is to reduce death by 50% in the next 10 years.

Absolutely.

And then what are some of the challenges that you guys are considering that's going to stand between you and achieving this goal over the next 10 years?

So right now, it's a pretty consistent number year-in and year-out in terms of how many people between police officers and civilians who are killed in police encounters every year. And our goal in the next 10 years is to cut that number by 50%, as you said. And I think there's a couple of different things there. The biggest one is continuing to improve the TASER device to where it can take the place of the gun in at least some of those encounters. And how we do that is more shots for the officer, better accuracy, better clothing penetration and a longer distance. You can keep a further distance from the suspect. And so that's one big kind of pillar of the technology that's got to improve. And then the second one is giving police more situational awareness tools that might change the way they approach a subject or think drone footage ahead of time where you can see exactly what's happening before an officer arrives at the scene. So we think between kind of the better use of force option and some of the situational awareness tools, we can impact that number. And that one is a really important one for us. Our mission is to protect life. And Rick founded the company; Rick Smith, our CEO founded the company in 1993. We've made a lot of progress. Hundreds of thousands of lives saved where lethal alternative could have been used. But the next step is kind of really starting to drive that number down in terms of shooting deaths between the police and the public.

Now we can kind of get into more a little bit of the business-specific questions. And I think one of the key dynamics that a lot of people, not only in public safety, but also in overall tech is testing to understand pricing, right? So how does pricing translate into Axon's product subscriptions? How do you guys make those decisions? And how are those generally being integrated into price points customers are paying every year?

So in general, we view ourselves as a premium product at a premium price point. We've invested hundreds of millions of dollars into the segments of our business over the last 10 years. And we're proud of that because what's come out of it is a very user-friendly organic business where there's really tightly integrated hardware and software. And so I think we're really well positioned for the future. But certainly, as we invest more in R&D, making sure that there's an ROI for the company on those investments is critical. And so we tend to price, like I said, on the premium side of the curve. Going into next year, of course, with the environment we're in now, we expect that to be reflected in pricing. But it's important to remember, in a market as small as public safety and especially because our strategy relies on happy customers buying more products from us in the future, we certainly don't want to create any kind of friction there that would cause customers to rethink buying future products from us. So we're walking a bit of a tight road there. But every year, our pricing changes a little bit. And this year, it might change slightly more than in past years, but we'll come out with that in January, and hopefully, we'll be met with some understanding based on the supply chain environment we're in, the inflationary wage environment we're in and so forth.

Maybe we could also unpack or the composition at least of what drives the price increase. For example, I think I recall you mentioning a 2022 price increase is largely reflected expedite costs, logistic costs, other or even component costs that has required a lot of increased costs, therefore, you increased pricing. But then, when we get into 2023, that pricing should be more reflective of CPI and actual inflation. Is that about the right?

To some extent, yes. We're still -- the logistics costs have -- they're starting to ease, but we still have -- there's still some headwinds there. And same on supply. I think we were saying earlier, I think the first good sign is we're seeing more availability, but the pricing hasn't quite caught up to the availability yet. And so we're hoping to see some of those costs trend down next year. But look, we build -- we have 6 to 12 month lead time. So a lot of the products we're going to sell next year are already -- we already have the raw materials in-house to start building. So we're going to be fair, for sure, but CPI is a big part of it and as are those other considerations.

And then you kind of mentioned the supply chain dynamics already, but is the second half of 2022 or 2022 largely the worst of supply chain constraints and dynamics or could this get worse before it gets better? And like, how would you kind of characterize where we are at least?

Well, the one big variable is what happens between China and Taiwan. Certainly, that could change a lot overnight, and we're mindful of that and have -- and that's weighing into our thinking about how much inventory we carry and so forth. But in general, assuming it doesn't turn into a catastrophe, I think things are easing. And I think we are starting to see the signs just in terms of, like I said, availability of many of our components is starting to increase. We're able to bring more in-house, whereas it was a little tighter, probably the last, I'd call it, 6 or 8 quarters. So certainly encouraged there. And our operations team has done a fantastic job of making sure we can meet demand. And we've had really exciting revenue growth this year. Revenue is up about 33%, which is given some of the constraints on supply, it's not easy to do and our operations team deserves a lot of credit for that.

Got it. Got it. So I wanted to pivot gears and really talk about the demand environment and also the federal budgetary environment in general. We're probably in a very unprecedented time where all these, I want to say, categories or buckets of funds are becoming readily available to states, municipalities and law enforcement and public safety in general. So how have all these funding sources began or begun impacting Axon?

I'd say, whenever -- it's always nice when there's grant money out there or money that unexpected that hits police and public safety budgets that can be spent on our products or other vendors' products. But for us, we really don't pay a ton of attention to that versus like our goal is get into the operational budget every year in the police department. So we try to capture a line as OpEx that is a recurring subscription and it kind of represents all of our products in a bundled form in that line item. And that way, we're kind of a little more insulated from some of the ebbs and flows of the federal grant process. And I think it's been nice that some of that money has been out there, but I don't think it's been a major contributor to our results. I think our team has just done a really nice job of demonstrating an ROI with our products. I think it's widely yelled that our products save municipal government's money year-in and year-out at this point. And so that's we feel really confident in what the future holds regardless of what the funding environment is.

I mean, in general, like when you guys look at the kind of composition of demand and what's being coming in through the salespeople, there hasn't necessarily been something directly indexed towards ARPA funds?

No, no. There's -- once in a while, you'll get a small customer. The way that manifests itself is, we see customers say, hey, I'd like to pay all 5 years upfront of this deal. And that happens very, very rarely with us, which I take as a good sign, like agencies are planning on paying year-to-year in their budgets for this. And I'd much rather have that environment than one where it's like, hey, we have some money lying around, so we'll do a 5 year deal with you guys, paid upfront, because you just don't know what that means in the long-term. So for us, it's been -- we've luckily and as a result of a lot of the hard work that our sales teams have done been much more in that former case, which is exciting for the future.

Well, talking about also just demand in general, but I guess, the U.S. picture and the international picture is much different. Could you spend a little bit of time talking about international demand?

Sure. We're really proud of our teams. Over the last 5 years, our international business has 10x in terms of total contract value. So we're on the right path. A cynic would say, hey, we started from a small base, so it's not as easy to do for the next 5 years here, but we're really kind of encouraged by what international looks like over the long-term. But much like the Federal government in the United States, those are the customers for every international market. You're not selling to the New York City or the San Francisco or the L.A., you're selling to the department, the Ministry of the Interior and like and these large national police forces. It just takes a lot of time because these are departments of hundreds of thousands of people and you got to work through multiple layers, multiple approvals to just get a trial. And then they got to study the results of that trial and then it materializes into maybe a small order and then it grows over time. So it's quite a process and it's one we've been working through market-by-market. And we're very -- we've had a lot of success in the kind of what we call the commonwealth markets, the U.K., Canada and Australia. Now the next frontier is how do we break in, especially in Europe, some of these larger PM police forces. And it takes work and takes some patience, but we're doing the right things there. And I think longer term, that will represent how we can continue to maintain this growth rate for maybe like the out years, years 5 through 10. I think our future is right in front of us for some of our markets where we've really had a lot of success like state and local. But beyond that, the things that will contribute to that continual 20% plus CAGR are things like international and the U.S. Federal government.

The one big clarification between U.S. domestic and international is the motivation to really buy your products are probably a little bit different. In the U.S., it's an alternative to a lethal weapon. Internationally, it could be the, I guess, you'd say, the strongest non-lethal weapon available in their armory.

For sure.

Is that -- and I think I vaguely remember you guys talking about some countries adopting TASER weapons as some form of a stronger kind of use of force vehicle or device. Is that kind of the way we should think about international?

Yes, absolutely. We think of the international market as a potential 500% opportunity relative to our current TASER installed base. So it's -- there's a lot of users out there and there's a lot of great use cases. We talk about the U.K. all the time. A very small percentage of their police officers carry firearms. And then there's a big gap between what does everyone else carry. And officers are getting injured at higher rates in the U.K. There's an opportunity there for TASER to be the primary use of force weapon in the U.K. And we see that across a lot of -- especially European markets. And so for us, we think there -- it's maybe the first customers that kind of abandon the firearm will probably be in Europe versus in the United States, just because like you said, it's a very different culture. It's not -- the gun culture here is very unique compared to some of these other markets and we can use that as an opportunity to introduce kind of these force-wide deployments of TASER CEWs.

I wanted to take your current revenue trajectory in 2022, which is 30% plus, and the long-term CAGR that the company has guided to, which is 20%. And then considering the international opportunity, the budgetary environment, should we think about this 20% as a North Star guidepost and even being a little bit conservative or is this kind of -- how should we be thinking about that 20% really?

Well, the first thing I'd say is we're excited to be a company that's 20-plus years old and growing at this rate. And we certainly -- we're proud of that. Of course, every year, we're going to try to maximize our revenue growth, and we've come off a couple of years where we have. And into the future, we try to make sure we don't get out over our skis on guidance, especially because we're working with sales cycles in the U.S. government that can change or that we don't yet have a ton of visibility all the way through next year. So we tend to update guidance quarter-to-quarter. But knowing what our backlog is and knowing how much subscription revenue that's coming in, we can kind of estimate at least in the base case what the revenue growth will look like. And of course, there's some upside on top of that and we'll go out and try to capture as much of that upside as we can.

I'll open it up to the audience in about 2 minutes to ask a question if there are any questions. I wanted to talk about Axon Fleet. And there have been some iterations to this product. And maybe you could tell us about the kind of aspirations of this product and how much share you guys want to take and just the relative trajectory of growth?

This is a great kind of model for how we think of product development and public safety. The first version of Axon Fleet was simply a body camera on a suction cup that went on a police windshield and that worked for some small agencies. But what it really did is it taught us a lot about that market. The second version got us to what we kind of call parity, where it's like, hey, you had the major things, a backseat camera recorder, it could record in low light, it could recognize a license plate from x amount of feet away. We kind of got to parity with the rest of the market. And at that point, we started to become the market leader. But then we came out with this third generation called, Axon Fleet, which is kind of the undisputed market leader at this point. And we built in, of course, upgrades to all the things I mentioned. But ALPR, Automated License Plate Recognition, where historically, for those of you that live in New York, you might have a few of these very expensive large systems at the tunnels and bridges where it could recognize a license plate as someone was driving by, but they were very expensive, they weren't mobile and they didn't suit kind of a wide use case. Now we can build that into the police and car video and now we can make every police car a functioning ALPR system. And that's the kind of growth we've seen in the product that's allowed us to kind of propel into this market leadership position. And of course, as we do that, we kind of look at all these different things, whether they're drones and car cameras or body cameras as sensors that feed into this ecosystem where you can manage that data, share it, redact it, transcribe it, put cases together across a number of different sensors that are producing that data. And so that's -- I think it's a really good example of how we've kind of worked through our product development cycle to kind of lead in an additional category. And hopefully, there will be a few more of those over time.

One thing about your body worn camera business. There have been some competitors that have emerged and some of them have been voicing opportunities for them to take share. But if you were to think about the key differentiating factor between Axon body worn cameras and the competition, what do you think is some of the -- or what do you think are some of the key differentiators between Axon and others?

Part of it is -- maybe the first thing is just this ecosystem or network where everything between hardware and software just works seamlessly together. And you can really only achieve that by building products from the ground up. It doesn't -- like an alternative method would be to acquire some big companies and try to cobble them together. And that just doesn't work in the eyes of the user. Like the user experience is never as tight or as fully integrated as it should be. And so we've really built this system from the ground up in terms of this network between hardware and software. So I think that's differentiating factor one. Everything just works really nicely together. Second one is we're really proud of our NPS score. Like as I said earlier, our strategy is to make customers happy and then they buy more products from us over time. And in a market this small, that's the only strategy that's really going to work. And so to have an NPS score in the 60s and 70s is very encouraging for us and it just -- it kind of leads to this conclusion that we don't let our customers fail. We make our customers successful. That's why our churn is so low and our NRR is so high. It's just -- it's that combination. And so, of course, it starts with the network, but then happier you keep your customer base and the more value you drive for those customers certainly over the long-term, it's a really good formula.

I'll take a pause. Does anyone in the audience have a question for Josh?

In Axon Cloud, I guess, which products or what are the main products that are most valuable to your customers? And kind of, I guess, what else could you cross-sell into the base in terms of the software?

I'd say, foundationally, we've got a product called Evidence.com that kind of is the core solution for managing digital evidence. And from there, we've layered on these additional products on top of Evidence.com that do very specific things that drive a lot of value. So I'll give you a couple of examples, transcription being one of them. So automatically transcribes all the spoken words in a video. Large agencies have dozens of people on staff to do that exact same thing manually. So by coming out with this add-on that costs $10 to $20 a user a month, you end up saving a lot of money doing that as opposed to paying 20, 30, 40 full-time employees to do that same work. And same on the redaction side, blurring faces and videos and so forth. Same dynamic where those are kind of -- those are manual jobs today and we've kind of come out with a product using AI that makes that very seamless and much more efficient. And so we try to layer on these additional products on top of just the core digital evidence management solution. And that's something that's driven by our customers. And our team does a phenomenal job taking that feedback in and then putting out products that solve those problems.

I mean, this would be a good segue for you to talk about the OSP 7+ plan. The significant -- and may be even telling us how -- what it is, how it works, why the customers want to buy that or maybe even prefer buying that. We can kind of go through that.

Our core offering is called the Officer Safety Plan and then we've got different versions of it. The one that's the most premium really rolls off the tongue, it's called the OSP 7+ premium plan. And there, it's pretty much everything we build that's on a per user basis. So you get your body camera, your TASER, your digital evidence management license, all of those add-ons like transcription, redaction, live streaming of the body camera, a product called Performance where it actually measures compliance with the agency's recording policy. And then our records management solution is also represented in that plan. And that's a product that continues to grow for us after a couple of years of development. And so we're really excited about what that plan represents, because historically, for example, the TASER devices, those were products that might have been shared across 2 to 3 users in a police agency, and then they would get beaten up and they would go out of warranty faster and the user experience wasn't very good. Well, now in this program, every user has their own body camera. And now with that license, you have your own TASER as well. So now these are standard issues, which is a win-win. Every device -- every officer has the device. And for us, we've doubled or tripled the amount of devices in each agency. And so, yes, it's been -- that's really I think the future of how we sell is figuring out what things fit well together and then selling them in a bundle that's very predictable cost-wise and deliverable-wise and agencies have been responding really well to that.

You mentioned the word costs. So I'm going to segue into gross margins. Gross margins have been a focus area for the company and probably have become increasingly focus area for the company in 2023. But you guys have been investing a lot in automation and manufacturing and essentially just your supply chain and optimizing that as much as possible. When should we expect to see really the benefits or the fruits of those investments and efforts?

So I think the first thing to point out is, a couple of months ago, we welcomed our new CFO, who's sitting in the front row here, Brittany Bagley, and Brittany comes from Sonos. And one of the reasons -- one of the many reasons we're very excited to bring her on to the team is her ability to drive gross margins in the right direction. And so I think we now have kind of the leadership and the team focused on this issue. It's the easiest way to impact adjusted EBITDA. And like it's coming off a couple of years where supply chain and logistics challenges represented a little bit of a drop in that metric. I think there's some lower hanging fruit there going into next year as we kind of recover in terms of some of those costs and logistics costs. But longer term, I think the automation definitely plays into it. I think it's also a matter of, hey, how can we make sure from the beginning, from the inception phase of new products that we're designing for manufacturing that the components we're relying on are in high supply and at lower costs. This is going to be kind of a cultural shift for us as a business to really drive that number up into the mid and high 60s over time.

And then when we think about Axon, we generally think about law enforcement and public safety. But there are some new branches of government that are opening up, correctional facilities to even federal verticals like the secret service or other opportunities. Can we just talk about how those are going to be more opened up opportunities, I think initially from a body worn camera perspective, but maybe there's a path to even more consumption that those agencies would be taking on from public safety vendors?

Yes, for sure. Corrections is very exciting for us. I think that's a market historically we haven't necessarily had a team on or come out with individual products for, but that's really changed in the last couple of years and we've seen that business double 2 years in a row now and we're very excited about it. People don't realize. Department of Corrections, California Department of Corrections is the same size as the NYPD. So there's a big market out there in corrections. And it's about tailoring the products for the last-mile. So they really work for correctional agencies. And I'll give the example of the TASER, where for corrections, we actually have a lanyard that goes around your wrist and connects into the battery of the TASER. And when it's taken away, TASER becomes inoperable. So when that connection is broken, that's really important for corrections, because in some of these environments, you don't want the TASER used against the correctional officer. So it's about doing that kind of last mile work that makes a huge difference in the hands of the user and will continue to open up new markets that way. And another -- I mentioned it earlier, but in addition to some of the more public safety use cases, there's also some commercial enterprise use cases that are proving to be pretty interesting last mile delivery when people are entering your homes or assembling products in your house, making sure that there's some transparency and accountability there on what people are doing in your home. There's retail workers. In the U.K., there was a study, and this is something that's becoming prevalent, where retail workers are getting verbally or even physically abused at sometimes by customers, like there's a use case for body cameras on retail workers. Construction, things like checking things for code or being able to approve certain advancements in a project remotely. You don't have to send someone on site to do an inspection anymore. So we see a growing opportunity to really deploy these body cameras outside of public safety and in some of these more commercial use cases. And we've built this really solid workflow from kind of capture through digital evidence management. And we think that's applicable outside the public safety use cases.

And then before we wrap up, and I was going to ask you a question like, what keeps you up at night. But more topical, I think is, in a recessionary environment, say, we're going to be entering one or say, we're in one, how do you think that's going to really impact Axon? And I guess, from a lot of the investors here, that's very applicable to a lot of the companies, but for Axon and maybe some of the public safety vendors, a little bit different of a dynamic.

That is probably not the thing that keeps me up at night. What keeps me up at night is really making sure that we're maintaining a really high bar for talent at the company. As we've grown from 800 or 900 people to 3,000 people over the course of a few years. And you do get worried about like, hey, we got managers and directors hiring a lot of people and we got to make sure that we're really holding the line and not solving a problem for today, but for the next 5 years and look at every open role as an opportunity to bring someone in who can really help us scale. And so that's the thing that I think we've got to be really focused on as a business. In terms of the recession, I think we look at -- generally, when -- at times of recession, we look at those as opportunities. We think we can -- our mission rings true in terms of hiring. We can bring on some really talented people that might be leaving other jobs in tech. We have a little more predictability by our long contract lengths and the fact that we work with government customers. And so we feel like it's a time where we can double down and invest for the future, both in terms of R&D, but also in terms of just general talent that might be relocating to new companies. And so certainly, that's the time for us to really lay out the next 10 years.

Well, Josh, thank you very much for joining us. And thank you everyone else in the room for joining us as well.

Awesome. Thank you, everyone. Appreciate it.