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TASER International (NASDAQ:TASR)

Q3 2008 Earnings Call

October 28, 2008 10:00 am

Executives

Patrick Smith - CEO and Director

Daniel Behrendt - CFO

Analysts

Eric Wold - Merriman Curhan Ford

Mark Strauss - JP Morgan

Greg McKinley - Dougherty

Steve Dyer - Craig Hallum

Operator

Good day, ladies and gentlemen. Welcome to the Q3 2008 TASER International Incorporated earnings conference call. My name is Latrice; I will be your coordinator for today. (Operator Instructions) At this time I would like to hand the presentation over to your host for today's call, Mr. Rick Smith, CEO. Please proceed, sir.

Patrick Smith

Good morning, and welcome. Thanks for joining us this morning. Before we get started, I am going to turn over to Dan to read the Safe Harbor Statement.

Daniel Berhendt

Good morning. Certain statements contained in this presentation may be deemed to be forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995, and TASER International intends that such forward-looking statements be subject to the Safe Harbor created thereby.

Such forward-looking statements relate to expected revenue and earnings growth, estimations regarding the size of our target markets, successful penetration of law enforcement market, expansion of the product sales into the private security, military and consumer and self-defense markets, growth expectations for new and existing accounts, expansion of production capability, new product introductions, product safety and our business model.

Be cautioned that these statements are qualified by important factors that could cause actual results to differ materially from those reflected by the forward-looking statements herein. Such factors include but are not limited to market acceptance of our products, the establishment and expansion of our direct and indirect distribution channels, attract and retain the endorsement to key opinion leaders and law enforcement community, the level of product technology and price competition for our products, the degree and rate of growth in markets which we could teach, and accompanying demand for our products, potential play in international and domestic orders.

Implementation risks of manufacturing automation, risks associated with rapid technological change, execution and implementation risks of new technology, new product introduction risks, rapid manufacturing and production to meet demand, litigation resulting from alleged product-related injuries and deaths, media publicity concerning product uses and allegations of injury and deaths and the negative impact it could have on sales, product quality risks, potential fluctuations in quarterly operating results, competition, negative reports concerning TASER device uses.

Financial and budgetary constraints of prospects and customers, dependence upon sole and limited source suppliers. Fluctuations of component pricing, risk of governmental investigations regulations, TASER product tests and reports, dependent upon key employees, employee retention risks and other factors detailed in the company's filings with the Securities and Exchange Commission. And with that, I'll turn it back over to Rick.

Patrick Smith

Thanks, Dan. Okay, well I assume everybody's probably seen our press release this morning. I'm really proud of our team able to turn in the results that they did in the current economic environment. Revenues were almost $23 million dollars.

There was a $5.7 million dollar or 20% decrease over the same quarter of last year over on a sequential basis sales were up $1.8 million, driven primarily by some strong international orders this quarter.

And at the same time operations continued to demonstrate improvement, gross margins increased to 60.8%, up from 56.1%. that's almost a 5% of sales increase while the top-line dropped 20%. So Steve Mercier and his Operations team are really, really doing an outstanding job. Research and development recorded an increase by 240%, more than tripling over last year to—I'm sorry, the increase was $2.4 million.

And as we've talked about, TASER is continuing to invest heavily in R&D, new product development and building out the infrastructure of the company to support what we believe are some significant future growth opportunities.

My favorite non-GAAP number is operating income pre-R&D. That remained above 20%. We're at 21.2% operating income before R&D. year-to-date we're at 18.6 percent. And again the reason we like to talk about that is Dan and I like to have a metric to make sure that we're keeping our eye on the ball for our cost controls in our core business and make sure that the heavy spend in R&D doesn't obscure inefficiencies elsewhere in the business. So our goal's been to keep that north of the 20% where we can.

Net income and diluted earnings per share for the quarter were $800,000 and $0.01 per share respectively. Now the company generated 4.9 million in cash from operating activities and we ended the quarter with 42.5 million in cash and cash equivalent and zero debt.

I'd like to point out again another area I'm particularly proud of is the job that Dan Barin, our CFO, has done in the treasury function. There are a lot of companies who have gotten caught in the current financial meltdown and seen assets that they thought were cash turn out to be significantly impaired. Our treasury position has come through unscathed and I think that says a lot about what Dan and his team are doing.

Some other milestones for the quarter. Well, let me talk about one that was a little more challenging. Our C2 sales for the quarter were down about 50%. We attribute that to a couple of factors, lack of sell-in to new retailers.

Retailers typically don't add new products in Q3, so while we benefited from sell-in in Q1 and Q2, we didn't see any major sell-in in Q3. Also given what's happening in the economic environment, we're seeing a lot of retailers drop their inventory stock level so they're not restocking at rates we might see in a more normal economy.

Also the retail sell-through has been not as good as we would like to see, which we attribute primarily to the in store experience. Our product does require a lot of education of the end consumer, doesn't just sell itself like something more commodity well-known product. So we're putting a lot of work into the in-store experience.

We'll see some of that hit on an experimental basis in Q4, but as we roll into the 2009 retail season, the first quarter when a lot of retailers are making their plans for the year, I think we'll have a much more developed retail program given some of the talent that we've added to focus in that space.

So some of the action plans we're doing on the C2, first of all our new senior or executive VP of sales and marketing have met with every major retailer that we've got and the good news is they're actually all quite happy with how the C2 is performing.

Although it's not up to the levels we'd like to see, good news is they've all reported they view it as a successful program. They'll continue to work with us on developing the in-store experience and promotions. So again that's an area where we are investing right now in different test markets for different types of fixtures to sell the product in the store.

So some milestones for the quarter, but first I'd like to talk about is really some of the rounding-out of our management team. This last quarter we announced Jas Dhillon coming on board as our Chief Strategy Officer and the General Manager for our new TASER Virtual Systems division. Before coming here, Jas was responsible for the team that led business development strategy and product innovation and MNA for Microsoft Office Live.

For those of you who keep track of these things, Office Live is one of Microsoft's major strategic initiatives as they port their core Microsoft product offering from in-the-box delivery to an online delivery mode. That's a major initiative and needless to say, we're pretty excited to have somebody with his background joining our team here at TASER.

As well as Mark Fidelman, our new Executive VP of Sales. Mark actually was with Jas Dhillon at his first startup, Blueline Online, now CT Space. And since that time Mark is working consulting where he's worked across a variety of different company from the Fortune 500 to the Fortune 100 on down. So Mark brings a lot of experience both in from start-ups all the way up through the growth chain to very large companies and he's doing a great job building out the right infrastructure to take our sales to the next level.

We've also added Irene Blomgren, a prominent recruiter out of Silicone Valley whose been helping us make these other significant adds. She's helping out as our Human Capital Executive Vice President.

And as you know this builds on some significant adds earlier in the year with Nick Pappas out of Gateway, where he was responsibility for Gateway.com, the start-up operations, Best Buy, Circuit City and (inaudible) eyewear, where it's a strong marketing and consumer background with Nick, and Steve Mercier, running our operations.

Steve is out of Intel, 20-some years at Intelligence, and I think again our shareholders can certainly see the footprint in the snow for where he's been in terms of our operating results.

International sales this quarter represented 16% total net sales. That was up from 12% last year. Oh, I'm sorry, up from 12% sequentially. Significant shipments included the first order, for about 1,250 TASER X26 devices from the Queensland Australia police services, which has more than 9,000 law enforcement officers. And it's adapting our TASER technology after conducting extensive trials and studies.

We see Australia as a significant growth opportunity of products that are being very well-accepted there. We also had a follow-on order for 1,000 TASER X26s from the Korean National Police, which is expanding its program.

In France we saw the Interior Minister issue an official decree in September that permits local French law enforcement agencies to deploy TASER ECDs. There is more than 20,000 of these local agencies that are now open market for TASER. We are very much focused on the French opportunity. We've continued to see the right policy and infrastructure moves, although we haven't seen the significant orders yet.

The good news is we're continuing to see all the progress that's indicating that we're going to see expanding pager deployment. In fact, I believe this last quarter there was a statistic that came out of France at the ministerial level where they reported although tasers are deployed by approximately 1% of their police officers, they've seen a 30% decrease in police shootings. So again, those are the types of results that are very good for long-term growth of the taser programs.

Domestic orders, we didn't announce a lot of big orders this quarter. One of the more interesting ones was 400 TASER devices with 400 TASER cams from Palm Beach County Sheriff's office in Florida.

But the good news is we've continued to see some stabilization in our core market for the small-to-mid-size agencies, which really carried the business though the quarter to some pretty solid results given the operating environment.

We also saw four more human studies published on TASER devices, including the new Actrap (ph), that's currently in field study on field trials and getting ready for commercial roll-out. These studies continue to build on the scientific compendium of information that's out there that supports the overall safety devices. We had three more product liability suits dismissed during the quarter for a total of 74 wrongful death or injury suits that have been dismissed or judgment entered in favor of the company.

And of course you all probably saw yesterday that we found out Friday that the U.S. District Court in Northern California eliminated the $5.2 million in punitive damages awarded in the Heston case. It's obviously a significant win for our legal department. It reduces the estimated total damages in that case by over 97% to we now have 150, by our calculation 153,000 in compensatory damages.

We're continuing to look at the appropriate legal angles, obviously, we feel that even there are issues with any damages in this case where the jury found that Mr. Heston was 85% responsible and assigned 15% to TASER in sort of the straw that broke the camel's back theory.

While our hearts go out to Mr. Heston's family, who have certainly been through a lot, we think the judge came to the right conclusion, certainly on the punitive damages. At this point I'm going to hand over to Dan, and then I'll be back to talk about our future initiatives.

Daniel Behrendt

Thank you very much. So I'm going to through the income statement first for the quarter. As Rick indicated, sales for the quarter are $22.9 million, which is down 5.79 million from the prior year, although sequentially our sales were up 1.8 million from Q2, mostly driven by the increase in international sales. The decrease in sales from the prior year was mostly driven by the continued lower municipal budget spending in the U.S. during -- due to the economic constraints right now in the country.

Gross margin's at 13.9 million or 60.8% of sales, or up 4.7%, that's percent to sales from the prior year, which is very significant. The increase in margin was caused by several factors, including the elimination of most of the cash and distributor discounts, lower overtime and temporary labor expenses, better productivity, lower warranty expenses and improvements in our scrap expenses.

The $950,000 decrease in indirect manufacturing expenses versus the prior year were driven again by the lower scrap and warranty reserves for the quarter. FCAA expenses were 9.1 million versus 8.1 million last year. the increase again was driven by higher salaries and benefits of $477,000 due to higher head count.

Legal expenses are up over the prior year due to an increase in outside legal and executive witness fees. Advertising costs, mostly related to the infomercial increased by $247,000 versus the prior year.

As Rick indicated, research and development expenses were 3.3 million for the quarter, which is an increase of 2.4 million over the prior year, driven mostly by the outside development costs for new programs, especially Axon, $1.3 million.

Higher salaries of $379,000 due to the increased head count, and increased supply costs of $424,000, mostly driven by costs associated with developing working prototypes for these new programs.

As we communicated last conference call, we continue to ramp the R&D spending for the rest of 2008 in order to accelerate the introduction of the new products in the pipeline and we see the higher spend actually moving into 2009 as well as we continue to move these products from the development phase into production. Income from operations was $1.5 million and pre-tax income was $1.8 million for the quarter.

The decrease in income from the prior is again driven mostly by the decrease in sales and the higher R&D spending. Net income for the quarter was $600,000 or $0.01 per share on both the basic and diluted basis.

We'll look at the year-to-date for the nine months ended September 30th. Sales were 66.5 million, which were down 4,7 million, or 3.3 million from, 4.7% or 3.3 million from the prior year. Gross margins of 40.3 million or 60.6% of sales are up 2.6% as a percent of sales for the prior year. the increase in margin was caused by several factors, including elimination of the cash and distributor discount, lower labor expenses and improvement to material costs in scrap expense.

Again indirect manufacturing expenses improved $2.1 million to 6.3 million for the year-to-date amount. Again our lower scrap, lower warranty expenses and better leverage on our fixed expenses.

SG&A expenses at 27.9 million are up 3.9 million over the prior year, drive mostly by increased salaries and benefits of $1.5 million, due to increases in head count. Higher advertising costs, due to the infomercial of 1.3 million, higher insurance costs of 211,000 and a higher 123R charges for the stock option expenses of 213,000.

R&D expenses of 8.5 million are up 5.3 million over the prior year due to increased outside development costs, mostly associated with the accent product of $2.8. Higher salaries and benefits of 55,000 and higher supply costs of 711,000 due to the prototype work we're doing right now.

Loss for operations on a year-end basis is 1.3 million, driven by the $5.2 million accrual for Heston verdict. As Rick indicated, we had some good news on that Friday. We are going to review the accrual in the fourth quarter to make a determination whether to reverse it once the judgment's entered.

Pre-tax income of $167,000, a net loss to the year-to-date is $181,000 for break-even on an EPS basis. I know as you look at the results for the year-to-date, the tax provision looks odd. Actually our tax provisions are higher than our pre-tax for the year-to-date.

This is driven by the $250,000 impairment charge we took in Q2 relating to the Arizona tax assets. So if you back that out, the tax rate is a little bit more of a normalized basis. But when you add the $250,000 up, the reasons for the tax expense looking so high for the quarter.

As I move on to the balance sheet, we did finish the quarter with $47.5 million of cash in investments. This is a decrease of $12.8 million from the prior year-end. This is really driven by the stock buy-back of $12.5 million that we announced and completed in the second quarter.

We have $42.5 million of cash in investments, and of the $47.5 million, $42.5 of that is actually cash and cash equivalent so due to the uncertainty of the market we really elected to keep our investments as liquid as possible.

So out of the 47.5 million, 42.5 are actually in cash and cash equivalent. So we're very well positioned right now. Accounts receivable 11.6 million is down roughly $100,000 from the prior year-end balance, due to lower sales in the third quarter of '08 versus the fourth quarter of '07. As you look at our day sales outstanding, we're at 45.2 days. This is acutely down a little bit from last quarter. It is about 10 days higher than what we had at year-end but that was expected.

We did eliminate the cash discounts and obviously the net result of that is our day sales outstanding is an increase a little bit, but we're pretty satisfied with the receivables given where the market is, that we're keeping our day sales outstanding pretty much inline with the prior quarter.

Inventory is $17.5 million. This is still up 4 million from the prior year, a balance of $13.5 million. But we were successful in reducing that balance from June by about $3 million and we'll continue to look at that inventory balances and make sure that we've got the appropriate amount of inventory for the business we see.

Pre-paid assets of 1.9 million are down 2.5 million from the year-end balances. This is again due to the receipt of insurance receivables we had on the books. We also had some amortization of pre-paid insurance and the expensing of our infomercial, so the driver on the pre-paid assets.

Our property planned equipment, 26.5 million is up 2.9 million from the prior year end. Big driver there is continued investment in the automation equipment. We continue to make progress payments on that, so that's been the major driver of our CapEx for the year. Total assets finished up the period at $127.1 million compared to 137.8 at the end of 2007.

Moving in to the liability, it's on the balance sheet. Accounts payable including liabilities of 12 million are up 1.9 million from the prior year end. The big driver here is that the accrual for the Heston litigation judgment of 5.2. again we're going to take a look at that in the fourth quarter once that judgment is entered to decide whether to reverse that accrual.

Current (inaudible) revenue of 2.1 million is up from the prior balance of 1.7 million, due to the sale of more extended warranties in 2008. And then we ended the period with 19.5 million of total liabilities and 107.7 of stockholder's equity.

Moving on to the statement of cash flows, we -- the company had cash provided from operations of $4.6 million for the period ended September 30th. This compares to 6.7 million of cash generation the prior year.

The cash generation of the current year is really driven by the lower pre-paid assets depreciation and the 123R non-cash charges. Net cash provided by investing activities was 7.3 million as the company realized 12.5 from maturing a culled investments,which were partially offset by the 4.8 million of new property and equipment purchases. Again the new purchases are mostly driven by the purchase of the new automated production equipment as well as purchases of new IT equipment.

The company used 12.2 million in financing activities. This is driven by the stock buyback of $12.5 million that we announced and completed in the second quarter. We were able to purchase 1.79 million shares of stock, or about 2.9% of our shares outstanding in Q2, and we ended the period with 42.5 million in cash, which is up 15.5 million from the prior-year end.

Again we just, as the markets have been in this turmoil, we've elected to keep our investments very liquid so as investments were called and matured, we've kept them in cash and cash equivalents versus reinvesting in longer-term investments. And with that I'm going to turn the call back over to Rick Smith, our CEO.

Patrick Smith

Okay, thanks Dan. There's still possible one thing I'd like to talk about a little bit is you know what doesn't kill you makes you stronger, and I think there's yet another example of that with what's happened with TASER over the last four years from a litigation perspective.

Those of you who have been with us for a long time know that in 2005 this company was really challenged when we saw a significant increase in our litigation profile. And that forced us to get very good, frankly world class at use of force defense litigation. Because we've had to sit side-by-side with our partners in law enforcement when these response to resistance or use-of-force incidents get adjudicated.

What we've learned through that process is not only that we have again built a world class capability where now that's built into our business model that we're able to perform that function, but we've come to understand something about our customers. And that is when there is an incident where police respond to physical resistance and there is use of force, if we think of that incident like a fire, it lasts for a few seconds or minutes.

And that's where TASER has typically been focused is giving tools to be able to incapacitate during those uncertain and fast-evolving moments. And we've had a huge impact for our customers. We've saved many lives; we've had major cities go for over a year without shootings for the first time in some of their histories with these devices.

What we've also learned is from that fire comes a cloud of smoke that really does the long-term damage financially to an agency. So if you think of the incident as a fire, the smoke is the years of litigation and post-incident legal reviews that happens almost universally in these cases.

And while the human cost is certainly very high or the risk to human cost is very high during the incident, from a financial perspective agencies might spend hundreds to thousands of dollars in the course of dealing with these incidents, but in the post incident aftermath they spend hundreds of thousands to millions of dollars through the litigation and the adjudication phases.

And so TASER has uniquely come to understand that that paying point for our customers, we uniquely understand that process. I as the CEO of TASER have personally sat through three trials, multiple weeks in duration start to finish.

And obviously we've built an in-house litigation team that really understands that very well and in fact I think our market views TASER now as somewhat of a far leader in this space given the record that we've been able to attain.

So what we're doing now at TASERs, we're broadening our mission a little bit. We're not just focused on the tools that police use during the incident but now we're looking at becoming more of a full-solution provider, where we're going TASER be there for our customers, not just shoulder-to-shoulder in the courtroom but we can take our unique abilities to create technology solutions to help solve these problems for our customers. So we will certainly continue to be the leader in response resistance force options.

But now with AXON we are adding new information and evidence products and services to reduce the aftermath, to reduce the uncertainty. What we’ve seen in these trials is the primary weapons against police are fear, uncertainty and doubt.

When I sat with those officers shoulder to shoulder at the defense table during the Heston trial and their honor and integrity were continually being questioned, it was all about the uncertainty of what really happened.

And when I told those officers what we’re doing with AXON and promised each one of them they’ll get one complimentary for what they’ve been through to help make sure that never happens to them again, I can’t tell you the response I got, the hugs when they said man I wish I could show that jury what I saw, because words just don’t do it justice and those words have been challenged and recast and twisted throughout the process.

And so AXON and all the attended systems around it, you can think of it like a taser for the legal process or in some cases we’ve used the analogy legal body armor because while cops face all sorts of physical threats in the field, the agencies face massive financial threats and officers threats to their career in the post incident world.

Now this is not entirely new to TASER. Our success, I believe, is built on a triad. And that triad includes the leg of products and technology, a second leg with training and training systems, and a third of systems and controls to make sure that our products are used appropriately and that the users have the right tools to make sure they’re used appropriately.

So let me put some meat on that. If we go back to 1993 when we launched our first consumer product, the Air TASER, we didn’t just launch a new self-defense system, we also launched AFID, our Anti Felon Identification, where we serialize and track the ammunition and disperse the ID tags printed with the serial number.

We also introduced VHS training tapes, which at the time was sort of an advanced approach where every purchaser of our product got world-class training.

In 1999 when we launched the M26 in the police market, not only did we launch the first neuromuscular incapacitation device that truly could incapacitate, we also launched Data Port, the first device that had an onboard recording that would tell you every time the trigger was pulled. And we migrated our training to CD Rom, full multi-media integration.

Well, in the years since 1999 we’ve seen more technology advancements with the X26 and Shaped Pulse technology. Our Data Port became more sophisticated with USB Plug-and-Play and advanced data capabilities.

And our systems became more comprehensive as well with the TASER CAM that now added audio and video recording. And now you’ve all seen the AXON initiative, the autonomous extended on officer network.

Basically it is a command and control device that integrates into their radio. They get not just an audio and video recording of what the taser device is pointed at, but everything that officer sees from his perspective, which is the standard by which he will be judged because the United States Supreme Court has found that an officer’s actions in these fast moving and uncertain incidents can only be judged from that officer’s perspective at the time of the incident.

With AXON we’re giving officers the tools to now record indisputably what they saw from their perspective. It is going to revolutionize post incidents proceedings the same way that our physical tools have revolutionized the way police deal with these dangerous incidents in the field.

Now as a part of the AXON initiative you’ve seen we’re building a world-class software and technology integration team with Jas Dhillon coming out of a senior position at Microsoft he’s also been CEO twice of some very successful and leading companies in the Internet space.

He was CEO and founder of Zero Degrees, which was a business networking system or product offering. They were neck and neck with Linked M. Many of you use Linked M today and Interactive Corp. bought Zero Degrees. Prior to that Jas was the founder of Blue Line Online, one of the first software as a service provider in the professional space.

They provided project management tool sets to many of the world’ leading infrastructure providers. And Jas is building around him a great team. We’ve announced some of them. There are more to come. And by the way Jas, although he’s only joined us recently, he’s been on a consulting contract for about four months before that. So this project has been ongoing for a period of time.

One of our key insights has been if we look at Apple computer, obviously a lot of eyes are on them. They’ve just performed extraordinarily well. What we see is the breakthrough that Apple achieved over the last five years or so.

They’ve broken through from being just a hardware company to being a world-class company that is able to seamlessly combine hardware and software into a seamless eco system. It creates breakthrough value for their customers, more so than any hardware company or a software company could do on their own. When you’ve got the ability to control that seamless integration, it leads to results like Apple becoming the world’s largest music retailer.

Now when we look at TASER’s capabilities, historically we’ve been very strong in the hardware and in the training space. And now as we build out our software development team, we’ve brought in a world-class team to do it.

We’re not just out hiring programmers and we’re not going to do this like the typical hardware company just adding software as an afterthought. Jas has complete control of TASER’s virtual systems as it’s general manager.

We’ve actually established a foothold in California. We’ll have an office out there in the tech community where that division will run just like we added this quarter as well a D.C. facility where we’ve added operations in our nation’s capital giving

TASER a presence near the heart of national policy making and military and federal law enforcement agencies, which, by the way, we’ve found a way to do that in a very cost effective way where we’re subletting from one of our government affairs service partners.

So the cost structure frankly is immaterial and yet we’ve got an upstanding footprint in the nation’s capital. We’re doing the same thing out on the west coast getting into the tech community. Irene Bomgardner, EBP of Human Capital, is one of the prominent recruiters in the tech space and she’s now come onboard. She’s pretty excited to see what we’re doing as well.

So I’m not going to give a whole lot more detail about specifically the programs that we’re working on. But I think you can see by the talent of the people that are jumping onboard, those folks that have seen the vision and the detail of what we’re doing are pretty excited about the opportunity.

So we’re building from a world-class hardware, engineering and training and adding a dedicated software and Internet services group that is every bit of world-class as our hardware group. And with that we believe that again these challenging times create tremendous opportunities for companies like TASER.

You know as we look back at a case study again looking at what some of the great companies have done, Apple’s transformation came really at a troubling time and with the Internet bubble bursting in the early 2000s, so as when they were stepping on the gas as far as making the investments in their transformation.

Today we’re in a unique position in that last year we had our strongest year ever and we’ve been on a great growth now. So we’re not making this investment from a position of weakness. It’s really from a position of strength building from our core and expanding our vision to diversify our products, increase our value, add to our customers, increase recurring revenue, increase customer retention. We have a vision that we believe will again revolutionize value for our customer and create breakthrough value for our shareholders.

So I’ll conclude by saying again I’m very proud of the hard work of our entire team, which despite the current economic conditions turned in sequential revenue growth, profitability, solid margins, generated almost 5 million in cash from operations.

On decreasing sales over last year Steve and his team have been working down inventory, improving margins, improving throughput and efficiency, right sizing our manufacturing team, just doing a great job.

And economic times like ones we’re in create opportunities for market leaders like TASER to extend our technology and our market leadership. I’ve been reading on the financial press, as I’m sure many of you have, that the ice age, so to speak, like this where the environment becomes very difficult, creates real opportunities for strong companies like TASER where we’re cash flow positive with a very strong balance sheet and no debt.

We’ve got a lot of options and we’re keeping our eyes open. We’re keeping our cash close to us right now to see what opportunities are out there for us because again we have the opportunity most companies don’t that comes from financial strength and technology and leadership.

So we’re able to remain profitable and cash flow positive while making significant R&D investments in our future business during a period most companies are cutting back. So as the economy comes back, we believe we’ll be a year or two ahead of the curve when everybody else starts turning on their growth engines, we’ll be running at full steam.

So I believe these investments will further extend our leadership position well into the future and again our strong balance sheet gives us the operational flexibility to optimize opportunities unavailable to many other companies in the world today.

And with that we’ll wrap up and we’ll take a few questions.

Question-and-Answer Session

Operator

(Operator instructions) And our first question comes from the line of Eric Wold with Merriman Curhan Ford. Please proceed

Eric Wold - Merriman Curhan Ford

Thank you. Good morning guys. One just numbers question then I have two quick questions after that. Can you, Dan, give the normal or breakdown with the number of units shipped of the different products?

Dan Bernhardt

Sure, sure. The number of cartridges shipped for the quarter were 284,559, so that is actually up versus the second quarter. We shipped 16,721 X26 units, 965 M26 units and 3,831 T2 units. And the TASER CAMS for the quarter are actually 2,947 TASER CAMS shipped.

Patrick Smith

One thing actually, Dan, that maybe add a little more discussion on there, the ratio of cartridges to handles and what we’ve seen there qualitatively.

Dan Bernhardt

Sure. So what we’ve been looking at is the number of cartridges sold each quarter versus the installed base. And typically we’ve seen a ratio be between four and five cartridges per handle in the field per year. And that ratio this year has been down versus the historical trend.

It’s been down around three cartridges per handle in the field. I think a lot of that’s due to the economic climate when right now I think our customers are using the cartridges they have instead of continue to purchase from us. I think you they probably built up an inventory over the years sort of in the good times so they use sort of the budget flush monies to buy cartridges.

When I looked at the sales this year and if I normalize the sales for the normal cartridge levels, our sales would actually almost $7 million higher than they’ve been. So actually instead of being down about 5%, we’d be up 5%.

So that’s obviously a trend we’re going to continue to monitor. I think that as our customers' kind of work through the current inventory, they’re eventually going to be back to us. But that certainly had an impact this year.

Eric Wold - Merriman Curhan Ford

Okay, understandable. And then I guess obviously with the potential customers looking at their budgets and looking at their tax receipts and kind of figuring out where they can spend, where can TASER fit into the budget cycle? If a budget is kind of fixed and set for the company fiscal year by municipality and TASER is not in that budget, how easy is it to get in there mid-year if things improve?

Dan Bernhardt

I think one of the things our customers have done historically to find money for the TASER programs is they use active forfeiture monies which are something that the police department has some latitude to spend as they see fit.

So obviously we’ll continue to look at that. I think we’ve got a very strong value proposition. Certainly the budgets for these municipalities are tied and not entirely helpful. But we still feel that our payback is really unreliable as far as equipment.

So that puts us in a good position, and as Rick said we’re going to continue to invest in new products and new markets to really just broaden our product offering. Obviously the economy has an impact on us but I think that as we expand our product offerings that is certainly going to help us to get into new markets. And we’re going to be looking at federal grant programs as well as a way for our municipal customers to find monies to purchase products as well.

Eric Wold - Merriman Curhan Ford

Okay and then on the gross margins side your margins were up 4 to 4.5% or so from the year ago quarter but then down almost 400 basis points from the sequential quarter Q2 on higher sales. Talk about what was the changes there from between Q2 and Q3.

Dan Bernhardt

Yes, really the two big things were we wrote off some obsolete inventory, some of the early C2 boards that we could have reworked into the product. As we really looked at the impact that would have on scrap levels and productivity for our production, we decided to write off some of those boards.

Also, the way we’re able to reduce inventory is really by cutting back on our production and the impact of that was actually less absorption of our overhead. So we scaled back our number of units produced, which affected our overhead absorption, which had a negative impact on the quarter margins.

Eric Wold - Merriman Curhan Ford

And what was the write-off on the inventory?

Dan Bernhardt

About $300,000.

Eric Wold - Merriman Curhan Ford

Okay and then the last question, in your opening remarks you mentioned that you haven’t decided on the Heston case whether or not to reverse that 5.2 that happened in Q2. What can happen there at this point forward? Can that be appealed by the Hestons and either get a new trial or could some other charge come back? Or is that 5.2 basically gone for good?

Dan Bernhardt

Basically there is an opportunity for the other side to appeal. What we’re waiting for here in the fourth quarter is really to have that judgment entered. It hasn’t been entered yet. The judge has obviously read his opinion but we need to enter it in the court record. And then we’ll see what the other side attempts to do as far as appeals. There is an opportunity to appeal.

We think obviously the same reasons why the judge felt the reverse in the punitives was appropriate, it will certainly bode well for us in the appeals process. But we’re going to consider that carefully, understand what our legal options are and make a determination in the fourth quarter of whether to take that back or not.

Eric Wold - Merriman Curhan Ford

Perfect. Thank you guys.

Dan Bernhardt

Thank you.

Operator

And our next question comes from the line of Paul Coster from JP Morgan. Please proceed sir.

Mark Strauss - JP Morgan

Hi, it’s actually Mark Strauss on behalf of Paul. First off, can you just give us an update on the timing of the new product announcements, AXON, Shockwave and XREP?

Patrick Smith

Sure. XREP and Shockwave are currently slated for first quarter. We expect to start seeing some revenue from those two. AXON you know we’re probably looking at field trials late in the first quarter in terms of significant field trials. In terms of revenue from AXON from a modeling perspective, I’d probably start modeling AXON revenue in the second half of next year, maybe third quarter with perhaps first real significant revenue impacts, late third quarter or fourth quarter.

Mark Strauss - JP Morgan

Okay, good. So no changes there. And then can you tell us how significant you think this Marine Corp directive is that just came out earlier this month?

Patrick Smith

We think philosophically that it’s very important these kinds of directives. What you were talking about there was the, I forget the acronym, basically an all Marine Corp directive that gave them the ability to buy from the operating budgets down to the unit level. So we’ve already added a few small sales associated with that.

The main thing is that many of these federal and military agencies the most important role to get over first is if they’ve got a policy that allows them to buy it and that allows us then to work directly with the operators down to the field commander level who do generally see the utility of having these types of devices for their mission.

So we don’t see that is going to necessarily open any major centralized buying in the short-term, but it gives us the ability to go down to the unit commander type level and begin to open up that market.

Mark Strauss - JP Morgan

Okay and then lastly, was there any impact from FX during the quarter?

Dan Bernhardt

No, there was not.

Mark Strauss - JP Morgan

Okay. That’s all I have. Thank you very much guys.

Dan Bernhardt

Thank you.

Operator

And our next question comes from the line of Greg McKinley with Dougherty. Please proceed, sir.

Greg McKinley - Dougherty

Yes, thank you. Dan, can you comment a little bit about how we should look at your recent additions into your R&D and sales team impacting operating expense run rate going forward? I think we’re all expecting increases in operating expenses in the third quarter, although they were maybe a little smaller increase than I might have had in mind. So can you talk a little bit about how we should think of that moving forward?

Dan Bernhardt

Yes, we’re going to obviously continue to make the investments in our infrastructure here. I think we sort of had the infrastructure support. You know $100 million business, which is sort of where we ended last year, we’re obviously making investments right now to really create a team that is capable of running a bigger business in the future.

I think we’ll continue to increase that spending. Part of why we’re flat a little bit the last quarter is we had some significant expenses in Q2 related in things like the shareholder meeting, mailing the proxies and annual reports. We had our annual tactical conference, which is our big user group meeting that has got a heavy spend associated with it. So we did have some things that were heavy spends in Q2 that didn’t repeat themselves. That certainly helped us.

As we go into Q4 we have the IACP, which is our big trade show for our police customers. So I expect to see that SG&A ramp up again in Q4. On an ongoing basis, I think as these new executives look at the skill sets we have internally and look at the team they have and see where the skills they need in order to profitably grow the business and we may have to make some additional adds, and it’s likely we will as we move forward.

Greg McKinley - Dougherty

Okay, and could you also talk about your automation equipment investments? I know the last quarter or two you’ve talked about making some progress payments into that vendor. So, where are you in the overall process of implementing that, how much have you spent, how much will you spend, and then, maybe, when do you expect to start seeing some manufacturing efficiencies come out of that?

Dan Behrendt

We’ve spent about $6 million to date. The total project is going to run, roughly, $8.5 million, so it is a significant investment. We’re working with the manufacturer right now, they’re actually working at some of the integration of the different parts of that equipment in Canada, we expect we’ll see that equipment sometime in the first quarter, and we’re going to do significant tests at the manufacturer and significant tests here. So, yeah, I think it will start having a positive impact for us probably in the second quarter of next year.

Greg McKinley - Dougherty

Okay. And all of that equipment will be centralized in your Arizona facility, or did I not understand that correctly?

Dan Behrendt

No, it will be here in Arizona, it’s being manufactured by an automation company that is manufacturing -- they were doing it in Tucson, Oregon, and Canada. Now, they’re moving most of that equipment to Canada to complete the final optimization of that equipment.

Greg McKinley - Dougherty

Thank you.

Dan Behrendt

You’re welcome.

Operator

And our next question comes from the line of Steve Dyer with Craig Hallum, please proceed, sir.

Steve Dyer - Craig Hallum

Good morning, guys. Thanks for taking my question; most of mine have been answered. I’m curious as to your take on the recent situation in France with your representative over there, what you think that may or may not do to progress over there.

Patrick Smith

Okay, I’ll take that one. You know, actually we sent over a team of folks including our VP of Government Affairs as well as Doug Klint our general counsel, and Tom Smith, our Chairman, who's been involved in France, to work together with some local counsel in France, a public relations consulting group we’ve worked with as well to make sure that we’re getting an independent evaluation of the situation, and our read on it, short term, is, frankly that the distributor over there, it was an interesting turn of events, let’s say.

The distributor in France filed a defamation lawsuit against the French politician who’s the head of the communist party, related to defaming the TASER products by loosely reinterpreting some of the Amnesty International statements, where Amnesty talks about the people who have died after being hit with a taser. This French politician took it a step further, that the taser’s have killed 150 people.

So, our distributor called him to task. They actually had a trial that started and commenced last week, that the scientific evidence all was in support, we helped our distributor present very strong evidence and the political figure presented zero scientific evidence in the trial to support any claims that he was making.

Two days before the civil litigation began, the police arrested our distributor on charges that he had spied against the political figure. So, it’s a little bit of an interesting situation, let’s just say, but I would say this, our distributor, we looked at everything he’s done, we’ve seen no evidence of any wrongdoing.

In fact, he hired a private investigative firm specifically because that -- when you hire a PI firm, or you hire an investigative firm, so that they will handle the investigations appropriately, that’s their area of expertise, and the reason he hired that firm was to ascertain where they could serve this minister, and I think his total bill was less than €1000.

So, it wasn’t a significant campaign, and they did serve this gentleman with the papers, and our distributor’s position is that he believes it was inappropriate that influence was exerted to have him arrested days before the beginnings of the civil trial and he intends to pursue that.

So, we looked at it and we’ve also talk to various officials within the French government. In fact, the French Ministry, at the ministry level, came out and said, this is an issue purely between the distributor and this politician, and that it has nothing to do with the usefulness of the equipment.

And I believe that was in the context where they mention that although they only have 1% of their officers using it, they’ve had a 30% decrease in police shootings, and that they’re not going to get distracted by any disputes between the local business owner and the politician. So, we think it will blow over fairly quickly, and we’re continuing to monitor the situation, but we don’t see it having significant impact long-term.

Steve Dyer - Craig Hallum

Okay, great, and then secondly, I know you don’t give guidance, but how should we think about next year, just in terms of municipal budgets probably getting even tighter than they are right now, what are you hearing from your distributors, any color there?

Patrick Smith

Well, the recent decreases in oil prices we’re while watching with great interest. It’s not only the total budget, but it’s also the unexpected changes in budgeting that can impact our business. For example, last year we got hurt with a double whammy, in that budgets were decreased by lower funding and higher expenses, but it was the unexpected change in budgets, as well, that is particularly problematic, because they didn’t have time to adjust.

They budgeted for a gas price $2 a gallon and they were paying four. The optimist in me says that we might see some positive effects from unexpectedly decreasing gas prices. I don’t want to overstate that or say that we are seeing any evidence of that yet, because we’re not and I certainly would not suggest that you model that in, but there are some opportunities for some bright spots amid the gloom in the economy.

So, we’re planning for a continued tough environment, we’re seeing our business stabilizing at the levels that we’re at now, we’re looking at the new product and some new initiatives to help spur growth, and internationally as well, the weakness of the dollar we believe makes our products to little bit more attractive.

We saw an increase in our percentage of international orders last quarter. We’ll be looking at making some more investments, putting some more feet on the street internationally to grow those markets, to diversify some of our market risk here in the U.S.

Steve Dyer - Craig Hallum

Okay, great.

Patrick Smith

I wish I could give you a better answer, but it’s still clouded with uncertainty in the current environment.

Steve Dyer - Craig Hallum

No, understood. Thanks, guys.

Patrick Smith

Thank you.

Patrick Smith

Okay, well, we appreciate that. Everybody spent about an hour with us here this morning. Again, as you can tell, I’m very excited about the future. Some of the short-term turmoil, we believe gives us the opportunity to extend our lead. We’re investing heavily and we look forward to our next conference call coming up after the first of the year, and a very exciting 2009. Thanks everybody, and have a great day.

Operator

Thanks for your participation in today’s conference. This concludes the presentation, have a great day.

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Source: TASER International, Third Quarter 2008 Earnings Call Transcript
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