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Executives

Rick Smith - Chief Executive Officer and Cofounder

Daniel M. Behrendt - Chief Financial Officer

Analysts

Paul Coster - JPMorgan

Eric Wold - Merriman Curhan Ford & Co.

Gregory McKinley - Dougherty and Company

TASER International, Inc. (TASR) Q4 2008 Earnings Call February 24, 2009 10:00 AM ET

Operator

Good day ladies and gentlemen and welcome to the Fourth Quarter 2008 TASER International Earnings Conference Call. My name is Frances and I'll be your coordinator for today. At this time, all participants are in a listen-only mode. [Operators Instructions]. As a reminder, this conference is being recorded for replay purposes.

I'd like to turn the call over to Mr. Rick Smith, CEO of TASER International. Please proceed.

Rick Smith

Thank you. Before we start this call this morning, I'd like start out by remembering TASER Investor Jack Cover who passed away this month after a long fight with Alzheimer's disease. Tom and I founded this company with Jack back in 1993 and I spent the first months learning inventorship in a garage in Tucson from a man who is at one point the chief scientist and the private subcontractor of the Apollo moon landing project. I'll never forget that incredible experience, or the amazing human being that Jack was.

Unfortunately, it seems our society never recognized his greatness until he's gone. I know that future generations will look back to Jack Cover's invention as a turning point in history, when we stopped focusing on finding ever more deadly ways to kill each other and instead began a search for more humane ways to end our conflicts without taking human life in the process.

I'm going to turn it over to Dan, to get the process started for our call this morning with our Safe Harbor statement.

Daniel M. Behrendt

Thanks Rick. 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 products and accounts expansion of production capabilities, 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 retaining 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 of the markets in which we compete, and accompanying demand for our products, potential delays in the 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 that 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 in component pricing, risk of government investigation 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.

With that, I'll turn it back over to Rick Smith, our CEO.

Rick Smith

Thanks, Dan. For the fourth quarter of 2008, revenues were $26.4 million, a $4.6 million or 15% decrease over the same quarter in the prior year. However, on a sequential basis, sales increased $3.5 million, driven primarily by huge incremental growth in international orders, despite a weakening global economy.

Operations continued to demonstrate real improvement, as our gross margin increased to 63.4% in the fourth quarter compared to 55.2% in the fourth quarter of 2007.

Consistent with our strategy announced last year, R&D increased by $3.2 million, or 268%, in the fourth quarter of 2008 compared to same period in 2007; reflecting our ongoing commitment to invest in new technology and product diversification.

Net income for the quarter was $6.6 million compared to the $7.2 million for the same period a year ago; net income in diluted earnings per share for the fourth quarter was $3.6 million and $0.06 respectively.

Revenue for the year was $92.8 million compared with revenue of a $100.7 million in 2007, a decrease of 8%. And despite the decline in revenues, gross margin for the year was 61.4% compared to the 57.1% driven by our focus on a lean operating environment. Net income and diluted earnings per share were $3.4 million and $0.05 respectively. The company generated $8.1 million in cash from operations during 2008, ending with cash and equivalents of $46.9 million and zero debt.

The company also repurchased 1.8 million shares of our stock worth $12.5 million during the second quarter of 2008. Needless to say, it feels pretty good to be in the strong financial condition that we are, given what's happening in the global economy. A lot of companies are struggling for their survival and we are in a position to be able to execute on new opportunities in these times, which we believe of course really will position us for a lot of growth as we come out of the global recession.

Our operating income before research, development and extraordinary expenses was 22% for the quarter. If you look at the impact of the... reversing the charges related to the Heston case would have been 41.7%. Of course we consider that an extraordinary event. While it's not GAAP, but Dan and I would like to keep our eye on operating income excluding R&D and extraordinary expenses, because that's the way for us to look at how efficiently we're running the business, excluding things outside of our control like litigation as well as the R&D expenses. So of course, what we're trying to do is make sure that while we're investing in R&D, that those expenses don't take our eye off the ball in running an efficient business. For the year, our operating income before R&D was 19.5% in 2007, that number was 24.6%.

A lot of significant events in the fourth quarter; international sales increased to 28% of total net sales compared to 16% in the third quarter. We sold 5000 TASER X26 ECDs following the announcement of the UK government intends to fund 10,000 unit for police offices in England and Wales as they continue to rollout TASER devices beyond just firearm officers.

550 TASER X26s from the Korean National Police as they expand their program, a 1000 TASER ECDs to the Brazilian National Guard as they begin to spin out the TASER program. And we are investing to build our international success. We've gotten new hires with the European sales manager in Q4 and a new Middle-Eastern sales manager in the first quarter. And some of our increases in SG&A that you'll see are related to investments both in international sales infrastructure as well as additional sales and marketing support for the new business initiatives, I'll talk about more at the end of the call. Domestically, we saw LAPD purchase 1275 TASER X26s, Jacksonville Sheriffs Office 480, and Orange County Sheriff's Office with a 101 TASERs in Northern California.

C2 sales grew in our consumer market from 4 million in 2007 to 6.1 million in 2008. Overall the C2 product lines generated 6.8% of sales, probably to offset some of the decreased municipal spending in our domestic LE sector. We also added this year significant new hire of Nick Pappas, our VP of Strategic Communications, which includes marketing, to help focus on further developing the consumer segment. You may recall, Nick has a very strong background coming from Gateway Computers, where he led the team that developed Gateway.com, that he was one of the twelve program leaders to do BestBuy.com at Best Buy, moving on to Circuit City and Luxottica Eyewear. His intensive... he's leading an extensive effort to develop the lightweight retail displays messaging (ph) and packaging to further refine our C2 products for expanded retail success. You've seen a number of mainstream retailers come on this year, are now turning to C2.

We've also demonstrated a number of innovated new products and concepts at the International Association of Chiefs of Police Conference in San Diego including the TASER AXON, the new Controlled Digital Power Magazine for the X26, the TASER Shockwave and the TASER XREP.

We have at this point made a decision that the XREP, which is previously target for our first quarter launch is going to slip to second quarter. The reason is that last year when we were in field trials, we made a determination to do some significant design enhancements on the XREP based on what we are learning in our validation process. Those design enhancements have been very successful. We've received that part of production tooling and we've done preliminary builds. We believe we have cut the touch time in manufacturing in terms of labor by over 50%, enhanced the robustness of the round both from an electrical standpoint as well as mechanical standpoint. We got to second battery to increase cold weather performance.

But when this was to happen, when we put the whole round back together, we actually learnt that it significantly changed the aerodynamic performance of the round actually in a good way. We're seeing significantly better aerodynamic performance, but what that's meant is the sense that we design to stabilize around through spin stabilization are in fact too large now for the rounded spinning it too fast. So we've got to go back and we're now redesigning those spins for this better aerodynamic profile. What this will mean at the end of the day is we'll actually get, we believe longer range with less drop and less loss of velocities, we can decrease the profile of those spins. It just means it is going to mean retuning the device and some retooling on the spins, which will flip this into probably late in the second quarter till our truck goes to market.

But we do continued to get fantastic input from law enforcement, a lot of interest in this round and it is a significant round. This will be by far the most sophisticated, effectively it's a missile system launched from the 12 gauge shotgun. So that you can understand the complexity of bringing that system reliably to market.

Also this year, there were a number of new studies published. In fact, 36 company funded medical studies and safety studies republished in 2008 and then also 236 medical safety studies published on TASER devices, making it the most studied of any less-lethal weapon system despite some of the sounds likes that get repeated in the public media sometimes, there is no system with more published studies in law enforcement trends today.

Our three more product liability suits were dismissed in the fourth quarter, representing at the end of total of 77 wrongful death or injuries suits that have been dismissed or judgment entered in favor of the company. We also saw a significant victory on October 28th when the District Court in the Northern District to California eliminated the $5.2 million in punitive damages in the Heston case. It's a significant legal finding in the company's favor and it reduces the estimated total damages by over 97% to 153,150 in compensatory damages, which amount is fully covered by our insurance. As a result, the company has reversed the related $5.2 million litigation judgment expense in the fourth quarter of 2008.

The company also established our new TASER Virtual Systems division headquartered in Carpinteria, California and appointed former senior Microsoft strategy leader Jas Dhillon to run that new division. This new division represents the core of our new growth strategy on transforming the company's product offering into a network and intelligent devices that creates breakthrough informational and tactful capabilities for our customers. And I will come back to that at the end of the call to provide a little more detail.

And finally from the strategic relationship with Mossberg, one of the world leaders in firearm arm manufacturing and certainly one of the world leaders in shotguns. Together with Mossberg, we co-developed a TASER X12 less-lethal platform, which has been tuned specifically to enhanced perform to the XREP and we've implemented a new patent pending radial key technology that enabled us to build a shotgun platform based off of Mossberg mill-stack approved existing platform, but we've now added a technology where this system will reject lethal rounds and will only accept less lethal rounds.

Again, tremendous feedback. For law enforcement, they really like that feature because it eliminates the risk of an officer loading a lethal round by accident in a less lethal situation. That device, the TASER X12 by Mossberg will be going to market contemporary use with the TASER XREP later this year.

So let me pass over to Dan who'll talk about financial matters and I'll then I'll be back.

Daniel M. Behrendt

Thanks Rick. I'll go through the financial results a little bit more detail. As Rick indicated, sales for Q4 were 26.4 million, which are down 4.6 million from the prior year, but up sequentially 3.5 million from Q3, mostly driven by the increased international sales which contributed to 28% of our sales for the current quarter. And some of those large international sales that we shipped in Q4 were the UK, Brazil and South Korea.

Gross margins of 16.7 million or 63.4% of sales were up 8.2% as percent of sales from the prior year. The increase in margin was caused by several factors, including elimination of most cash and distributor discounts, lower overtime and temporary labor expenses, better productivity, lower warranty expense and improvements in our scrap expense for the year.

The $450,000 decrease in the indirect manufacturing expenses again was driven by the lower scrap and supply expenses partially offset by lower absorption of planned overhead due to lower manufacturing levels in the fourth quarter of 2008, versus the fourth quarter 2007.

SG&A expenses of 10.9 million for the quarter versus 8.8 million in the prior year, the increase is driven by higher salaries and benefits of $594,000 due to higher head count. Consulting and lobby expenses are up $775,000 versus prior year due to additional marketing consulting to support C2 product line and some of the new products. We're going to be offering in 2009, as well as the IT consulting relating to the upgraded to our new version of the ERP system that we are going to put in place in the early 2009.

Legal expenses increased $382,000 due to more outside legal and expert witness fees and the 123(R) expenses for the quarter increased by $355,000 due to the auctions granted in 2008, including auctions granted mid-year which replaced the cash bonus program. Cash bonuses were down $203,000 during the fourth quarter as a result, partially offsetting that 123(R) increase.

On the research and development line, research and development expenses were $4.5 million for the quarter, which is an increase of 3.2 million over the prior year, again mostly driven by the, as in previous quarters the outside development costs of $1.5 million on the AXON products. We had higher salaries and 123(R) charges of $739,000 due to the increased head count as just both those hardware development and our new software development same headquarter in California, and increased supply cost of $625,000 mostly due to the cost associated with developing working prototypes for these new products in the pipeline. We do expect high R&D spending to continue into 2009.

Our heavy investment R&D is really driven by our strategy of product line expansion and diversification. We have several new and differentiated products in the pipeline, which will better position TASER to capture market share and address the new opportunities as the economy improves.

The company did reverse the $5.2 charge related to the punitive damages in the Heston case based on the judge granting the company's motion to throw out our punitive damages in October 2008. The original charge was taken in the second quarter of 2008 when the jury vertically joined it and before motion related to the punitive damages was ruled on.

Income from operations for the fourth quarter was $6.5 million and pre-tax income was $6.8 million for the quarter. The decrease in income from the prior year was mostly driven by the higher SG&A and R&D expenses partially offset by the reversal of the Heston punitive damages during the quarter. Net income for the quarter was 3.6 million, or $0.06 per share at both basic and diluted basis.

One of the things that I just want to point out is that 123(R) charges were definitely a driver in both the SG&A and the R&D expenses for the quarter. The company has... the total for the 123(R) charges for Q4 were just a little over $1 million. That's up about $650,000 over the prior year and up about $360,000 from Q3 of 2008. We expect that 123(R) charges will grow further in 2009.

One of the things I want to know is a large proportion of the new options or performance based options, which are tied to the successful launch of new products, and into the market. And the other thing that's really driven the option expense in the fourth quarter will drive into next year as we ramp-up our TASER Virtual Systems business in California, we're hiring more employees that are competing for employees that put a high value on equity compensation. As a result we're going to see that 123(R) charge grow over the current million dollar number in 2009.

We'll see. Certainly, we'll talk about that in future quarters, but that's just become a bigger part of our compensation structure here. That's something you should expect to see going forward as well.

Results for the year. Sales for the year were $92.8 million, which were down 7.8% or 7.9 million from the prior year. Gross margins of 57 million or 61.4% of sales were up 4.3% as percentage of sales from the prior year. The increase in margin was a result of several factors including elimination of most of the cash and distributor discounts, lower labor expenses, improved productivity, improvements in material costs and scrap expense.

The indirect manufacturing expense of $9.1 million is down 2.6 million from the prior year, mostly due to the lower scrap, warranty, and supply expenses and better leverage on the some of the fixed expenses we had.

The SG&A expenses at 38.9 million are up 6 million over the prior year, and mostly driven by increased salaries and benefits of 2 million due to the increases in head count, higher advertising costs mostly due to the commercial of 1.1 million, higher consulting costs for marketing, public relations, and IT of $1 million and higher recruiting relocation expenses of $500,000 due to hiring of new executives during 2008.

R&D expenses of 12.9 million are up 8.5 million over the prior year due to increase in outside development costs most associated with the AXON product of 4.2 million, higher salaries and benefits of 1.4 million, and higher supply costs of 1.3 million driven by the costs associated developed in the prototypes of the new product in the pipeline. Income from operations is $5.2 million for the year and pretax income was $6.9 million with net income for the year being $3.4 million or $0.05 per diluted share.

Moving on to the balance sheet. We finished the year with $49.4 million of cash investments due to the decrease of $10.9 million from the prior year and really that decrease is driven by the stock buyback of $12.5 million that was announced and completed in the second quarter. The company now has $46.9 million in cash on its balance sheet and due to the uncertainty in the market that company has elected to keeps the investments (inaudible). So you'll see that cash balance likely to stay high during the year and keep that liquidity in the business.

Accounts receivable jumped in the fourth quarter to $16.8 million. This is up $5.1 million from the prior year and the large driver there is we had the U.K. order we shipped right the end of 2008, and saw the announcement in early 2009. We've already received payment on that order but again with such a large order shipping at the end of the year that's really had a pretty big impact on the AR balances. But as we've said, we've already collected that... on that order for the UK.

Inventory of $13.5 million is in line with the prior year balances as the company successfully worked out the higher inventory balances from early in the year, that were produced to support the anticipated higher sales levels. We were able reduced inventory in the fourth quarter by roughly $4 million. The mix of the inventory has also changed from prior year with a large investment of raw materials offset by lower working process inventories as the company adopt some more lean production practices. Prepaid and another asset of $2.5 million are down $1.8 million from the prior year due to insurance receivables collected and expected the prepaid production cost in the commercial 2008, an amortization prepaid insurance.

Investment in property and equipment of $27.1 million it's up $3.5 million from the prior year balance. Drivers here, most of the progress payments on the automated manufacturing equipment to new IT equipment and tooling to support the new products in the pipeline. And total assets this year was $129.6 million of assets. On the liability side of the balance sheet, accounts payable include liabilities $8.1 million are actually down $2 million for the prior year due to some timing difference in our year-end check rounds for accounts payable and some lower purchasing activities in the 2008 versus 2007.

Current deferred revenue of $2.5 million is actually up for the prior year and balance $1.7 million due to the sale of more extended warranties in 2008 and total liabilities at 12/31 are 17.2 million and we finished the quarter with 112.3 million in stockholder's equity. We did finished another year with no long-term debt, but we do have a revolver of $10 million we've not had but and would have plenty of liquidity to fund our business here and certainly feel good about that as we move in the 2009 here.

On the cash flow information, the company did have cash provided from operations of $8.1 million for the year ended 12/31/08 compared to cash provided from operations at $13.9 million in the prior year. Cash generated in the current year was driven by lower prepaid asset levels, depreciation, 123R charges and is partially offset by the higher ARG large year, year-end order for the UK.

Net cash provided by investing activities was $8.1 million, as company realized $50 million from maturing and called investments which were partially offset by $6.1 million in new property and equipment purchases. Company used $12.2 million in financing activities, mostly driven by the stock buyback at $12.5 million approved and executed in the second quarter. We did purchase 1,791,000 shares of approximately 2.9% of our outstanding stock in the second quarter of 2008. The company ended the period with $46.9 million of cash which is up $4.1 million from the prior year end.

With that I would like to turn the call back over to Rick Smith our CEO.

Rick Smith

Thanks Dan. So as you all know we are investing heavily in research and development. We've invested an incremental $8 million over 2007. And again it's good to be in a position where we can make this kind of investment and we are funding it out of our existing profits in cash flow. We've not had to dig into the cash on our balance sheet. In fact this year we are able to return $12.5 million to our shareholders through a share repurchase.

Now while we are making this investment in R&D, as you've seen, we've also seen some significantly improvements in operations. Last year we made the decision to invest into significant new hires. Steve Mercier has been nothing short of phenomenal in my opinion; our new Executive Vice President of Operations. Look what he has done in a very challenging economic environment. We saw the top line decrease, yet we've seen an almost 9 percentage point improvement in margins over the prior year. And at the same time look what's happened with our inventory. We've entered 2008, we certainly have high inventory levels as we are ramping for continued improvements in sales, and obviously the global economy took unexpected time as well as gas prices that are big issue for our customers. Steve's just done a fantastic job of working through those challenging environment and really improving our overall operations.

We've talked little bit earlier about Nick Pappas who joined us as our Executive VP of Strategic Communications which includes marketing. And you have all seen his background; very strong in both e-commerce and consumer, as well as communications is general. We also hired Irene Blomgren as our Executive VP of Human Resources. Irene was key in finding the type of talent in Steve and Nick and then a new hires out which you've seen out of TASER Virtual Systems. Have you seen, we've been bringing in some real world-class talent over TASER Virtual System. Let me talk about some of those people real quick and then we'll talk a little bit more about what they're doing for us.

As you all know, Jas Dhillon our Chief Strategy Officer and General Manager of TASER Virtual Systems has just an incredible background. He has been the founder and CEO of two very successful Internet ventures; one in social computing with Zero Degrees that was acquired 30 months after its launch by Interactive Corp. providing each investors return on invested capital. Prior to that, Jas was the founder of BlueLine Online, one of the early pioneers of software as a service enterprise solutions in the Internet space. Based on it, Jas went on to become one of five executives responsible for defining, developing and executing Microsoft Office Live's strategy. And as Microsoft Office Live is on four major strategic initiatives in Microsoft, its spearheads Microsoft's transition to software as a service business model.

The fact that we were able to entice Jas to leave such a prominent position really is the tip of the spear in the war between the Microsoft and Google, to come and head up our TASER Virtual Systems, to me is a major tool and a real resounding endorsement of our strategy.

Yogesh Saini, our Senior Vice President of Internet Services at TASER Virtual Systems, I'll talk of TVS for simplicity from here now. Yogesh was CEO of ZenSutra Software Technologies an Internet services firm delivering custom solutions for Fortune 100 and 500 clients. He also was involved in Zero Degrees of Jas, wealth management innovators such as Yodlee, technology leader Hewlett Packard. He was also one of the founders of BlueLine Online. So Jas is probably with him some of the talent that he has used to build historically some of his software teams.

Jason Droege, our Vice President of Internet Services and Product Development, is basically running our Software Engineering Group. Jason began his career as the Cofounder of Scour Inc, the first multimedia search engine on the Internet, which he founded from his dorm room at UCLA in 1997. They grew Scour to over 1 million daily users and 65 employees. It become the number-one search engine for video in 1999 and eventually sold to CenterSpan. Of course, having founded the first major video-search engine, when we look at some of the things we're doing that's a critical skill tech for us, let's say. After transitioning Scour over the CenterSpan, he started Back9Golf, which created an after market for pre-owned gold inventory essentially creating the Kelley Blue Book of golf. He then went on and joined SIPphone, Inc as President responsible for all product management, engineering business development, where they built and deployed a global VoIP video conferencing, instant messaging and file sharing network with over 6 million registered users by October of 2008. SIPphone also known as Gizmo5 is regarded as being the largest independent competitor to Skype for VoIP and video conferencing. He joined us in November of 2008 and is responsible for all Internet service product development engineering.

Chris Van Vleit our Chief Software Systems Architect and frankly one of the smartest guys I've ever met. Chris has over ten years of proven experience developing and delivering cutting edge Internet service in desktop Internet applications. Prior to TASER, he was the CTO and Chief Software Architect at KallOut Inc. a highly innovative company developing and delivering next-generation selection-based search applications in the consumer market space. He was also the CTO and VP of Network Operations for Cafe.com, a Wi-Fi network serving the retail food franchise industry, which was acquired in 2005. He's also provided expert consulting services from many years on software architecture and scalability to companies in the financial document management and the financial transaction sectors.

And we also have one other new hire our VP of Product Management. We'll be putting a press release out in the near future. This individual comes with a 12-year track record of accomplishment in designing, launching, and scaling large scale Internet services. Prior to CVS, he served as Vice President of Product Management in a firm where he managed the development of a social community platform with over 6 million unique visitors and 240 million page views per month. He was a key member of the team that launched citysearch.com, the first premiere local online resource, and is considered a pioneer in developing local strategies. He actually spearheaded the creation of first radius based search engines.

Alright. So what are these people working on here at TASER international, less be the weapons manufacturer. And what vision has enticed them to come here? I'm going to give you a little bit more visibility say, but obviously we're not going to give you full visibility to already a launch.

So looking at mission at TASER is to protect life. We make devices that are used during critical dangerous incidents to bring them under control. However, what we've learnt is that dropping a resistant subjects to the ground and getting them into the custody is not the end of our customers problem, it is only to beginning, particularly for our law enforcement agency customers. For nearly every incident that requires a physical use of force in the field, invariably leads to a legal conflict where lawyers and judges and jurists spends years analyzing and debating what unfolds in a few seconds when officers must make life and death decisions.

So whether its prosecuting a violent offender to seek a conviction, or defending officers from allegations of excessive force and civil plans, agencies spends millions of dollars. In fact many of our larger agencies spend tens of millions of dollars every year adjudicating these incidents. In fact agencies spends orders of magnitude, more financial resources, adjudicating these cases than they spend in the incidents themselves.

We at TASER International come to understand these litigation issues, because we have become a partner with our law enforcement customers in defending many of these cases. As I said before, it doesn't tell makes you stronger, as we have now adjudicated by the present time over 80 of these cases and I have personally sat for every trial that TASER has gone through. We've come to understand uniquely among the private sector, how these challenges face law enforcement. And it is from this point of view that we now approach these problems holistically, from protecting lives during actions in the streets to protecting truth in the court room, we're developing a suite of tools and technologies that will provide our customers an end-to-end solution set from the moment an incident begins until the last gabble drops.

In fact, its not an entirely new endeavor for us. We've always led the way with advanced accountability systems. If you look back when we launched the M26 in 1999, we added a data port feature in the M26 that recorded information about how the M26 is used. It could be downloaded to a computer. With the X26, we added a USB data port with advanced connectivity and more information. In 2006 we added the TASER Cam with audio-video recording capabilities. We are now realizing the power of connecting these intelligent microprocessor-controlled systems into an information node on a network to generate evidentiary and tactical information capabilities that have never before been possible. So make no doubt about it, we will continue to dominate the less-lethal law enforcement market with renewed focus on our consumer corrections in military markets. And take TASER to a whole new level with greater growth opportunities in incident video and digital evidence management, which compliments our ECD products that expands our product lines to high margin, video evidenced management and storage.

As I have met with law enforcement leaders to introduce the AXON concept, they have clearly seen that this approach is a breakthrough. Moving incident video from the petrol car to the officer's perspective, particularly for municipal law enforcement where studies indicate over 90% of the work they do is away from the car.

In fact, just to tell you that one of these meetings cheap lands down of the San Diego PD announced on National Public Radio that they stop purchasing in car video systems and will convert over to AXON. We weren't gathering video and receiving information is much as a breakthrough the AXON will be gathering the information is easy part, where agencies are really struggling is what to do with this information. How to store securely, how to manage the incredible amount of data generated and how to create knowledge that drive performance with this information.

Organizing this information in ways that it speaks to different user audiences and makes the information relevant and meaningful will drive operational efficiencies, tactical results and frankly we believe will dramatically reduce litigation cost by either disproving false allegations against police immediately and foregoing entire litigation process or at a minimum dramatically reducing the amount of time and efforts spend discovery on factual disputes about what happened during an incident.

In fact an analysis when does with our internal team indicate we believe over 50% of the costs of discovery involving ladies' cases is associated with disputed fact.

Now fundamentally, this is a software problem. This is where the primary customer team point emergence. And we believe that company have solved this problem and provide the breakthrough capabilities to store, manage, archive and analyze this information in a manner that's easy to use and easy to learn will create a dominant market position and what we estimate to currently be a 350 to $500 million per year market in North America alone for in-car video and storage solutions.

So just to put that in prospective, we TASER International currently have a 99% market share in our $92 million a year business. We see an opportunity to become one of the leading companies in this 350 to $500 million market in North America alone and we believe we are positioned and have a number of strategic advantages I'll come to at the end of the call.

The existing incident video companies that we've analyzed are fundamentally hardware companies that have approached softwares and afterthought. We've identified that in order to solve this problem we needed to put as much or more effort into the software component as into the hardware system. That's why we decided to set up a separate division TASER Virtual Systems located in California, right in the middle of the Tech Callen pool (ph). And this will not be broken out, by the way, as a separate business segment in our 2009 financials, although it may be in 2010 and beyond.

We see tremendous analogies to the consumer MP3 player market in the late 1990s. MP3 players were commodity business. When Apple had the insight that the customer didn't just want a piece of hardware, but an easy to use integrated solution that help them easily put music onto their device, organize it and take it with them, they came to dominate this market. And we all know how successful they have been.

For law enforcement there is lots of hardware systems to gather video evidence. But they struggle where to put it and how to put it to use. We are determined to provide an end-to-end solution which solves this problem with a single, easy-to-use integrated hardware and software solutions.

Now, why do we think that we can win in this market space. Well first, we point out TASER is already to dominant player clearly in the electronic control device market but you may not know that we're already the market leader in on-officer video with over 30,000 TASER cams in this field today. So we're already the market leader in on-officer video.

With AXON and the associated software systems being developed for TVS, we will deliver a double breakthrough. First, the breakthrough hardware solution with AXON that provides incident video from the officers' perspective, coupled with breakthrough software that solved the pinpoint around storing and using this information easily and efficiently.

Then third, we have a very strong distribution channel. As video moves on to the officer, our day-to-day interactions with law enforcement traders, provide us with close relationships with customers who come to trust us as an innovative company which provides hi-tech solutions to the problems of cops on the street. We have over 300 master and instructors and total of more than 25,000 instructors who have been certified in our TASER products. We're there with them in the field. Our hard work goes with these cops to their most difficult assignments.

So unlike a software company that might approach this from the backend, we are able to approach this problem holistically. We're there with the officer in the field. We understand the entire challenge from capturing resistance subjects all the way through to litigation phase prosecution in defense. And we have now build a world-class software team that's helping us to build to the backend to go with the hardware that we deploy out in the streets.

Now, since our last conference call I personally met with chiefs of several of the largest police departments in North America. And the response has been very positive. They acknowledge they are all struggling in dealing with digital weapons. The digital video in particular is a very specialized skilled set, it is very difficult to execute, by going out and having to really look across piecing together different software and hardware solutions organically at every individual agencies and individual projects.

Almost all of them have expressed a high degree of interest and several of them have pushed that they want to be the first major agency to deploy the full AXON solutions tests.

Now as far as budgets are concerned, several of agencies I've talked to have indicated that their budgets were in-car video and our surveillance and support systems are many multiple higher than the budgets that they have had TASER devices. Engaging in this larger existing budgetary marketplace gives us the opportunity to significantly expand our total available market in terms of total available spend dollars.

Now, there surely there are still hurdles to overcome make no doubt about it. There will be need for field trials, acceptance of revolutionary concepts takes time. But I couldn't be more encouraged by the early feedback as that in meeting with leaders of law enforcement as well as law enforcement users, law enforcement union leaders. In fact we've put hundreds of law enforcement officers and focused groups through our development process.

In 2008, we made the decision to nearly triple our R&D investment and based on the conversations that I'm personally having with these leading law enforcement agencies, I am confident these bold initiatives will set the company apart in 2009 and beyond.

In fact, it recently came to my attention that Business Week published a report that analyzed companies who increased their investments in R&D during the last recession. And they have founded that these companies have outperformed the rest, both from evaluation and also by growing there business.

If you go to businessweek.com, go to the search bar and type then how to play it: R&D spending and you'll see the video link come up to that story. We think this study supports our position and our decision not to pullback but rather to increase our investment while potential competitors are reeling in current market conditions. This is an opportunity first to extend our lead, to enter new markets well positioned of strength where others maybe experiencing weakness.

One final point. The stimulus package that includes around $4 billion for law enforcement, is part of a broader shift in our economy. Over the next several years, the proportion of government spending as a percentage of GDP is likely to increase significantly vis-à-vis the private sector.

Now as a company we're over 80% of our revenues come from governmental customers. Our overall business model stands to potentially benefit from this shift. And I will say though impossible, it's simply impossible to predict how the current economic conditions versus the impact of the stimulus package will affect near term spending patterns among our core customers, but we do believe that we are positioning ourselves long-term to build off of our current revenue customer base and expand in a significant way. And with that we'll wrap up and we'll take a few questions.

Question-and-Answer Session

Operator

(Operator Instructions). And your first question is from the line of Paul Coster with JPMorgan. Please proceed.

Paul Coster - JPMorgan

Hi. Good morning. Rick that was a really interesting overview of what's to come. Unfortunately, I have to switch to the topic that what's here now briefly anyway. What are you seeing in this quarter to-date and as we think about '09, can you give us some sort of initial thoughts about the revenues and expenses as you see them?

Daniel Behrendt

Yeah. I mean obviously it was a tough decision as we don't guide. But, there is certainly the domestic municipal budgets are going to be challenging in '09. We certainly see some headwinds in the U.S. and really until the impact of the stimulus package starts taking effect, it's hard to see that changing dramatically. But internationally we're encouraged by the fact that we're seeing an uptick in international business at the end of the 2008 and certainly as we look at the ability to grow the international business where our penetration is significantly lower than what it is here domestically. We certainly think that puts us in a good position. I think, the other key driver in 2009 as we stated is the new products coming into the market.

The second half of 2009 we'll see some of the new products like AXON hit and certainly to the extent that we get market acceptance of those products out of the gate, we would certainly expect to have the sales improve in the second part of the year.

Rick Smith

Let me kind of... Paul this is Rick. That was Dan. I would say that there is a lot of uncertainty. Now uncertainties can be good or bad. This stimulus package, we're trying to get our hands around it. I've got summits coming up with our legal advisors, with our lobbying advisors to really try to understand what that opportunity is. How much of that $4 billion goes to basically law enforcement agencies backfilling their existing budgets or keeping manpower on the street, versus how much goes into equipment purchases. It's something we don't fully understand yet, but that could have a significant impact on the business in the short term.

And one other thing I would point out. Part of our strategy is well by building out additional products and services is that the software components of this business will have much more significant recurring revenues than our current business model, which as we roll into the future should build more predictability into our revenue stream. Whereas to-date, we don't generally have much of a backlog. We book and ship our business every quarter. We sort of kill what we eat every quarter from a sales perspective. We believe that's what we're doing in the TASER's Virtual Systems will increase customer's stickiness and will increase software and service recurring revenues that should add a more predictable base line to our business.

Paul Coster - JPMorgan

You talked about kind of keeping R&D expenses spending going. Does that mean an increase in '09, or you're talking about just keeping at the level you exited '08?

Rick Smith

Yeah, I think certainly if you look at sort of the fourth quarter run rate on the R&D expenses, there is a 4.5 million. As we look to 2009, we expected that we'll certainly be able to stay within that range of the $4.5 million. It's really going to be some timing differences, but their investment in R&D in 2009 is going to be another heavy year, because of these products in the pipeline that we have and so we do expect that to continue.

Paul Coster - JPMorgan

Do you think the gross margins are sustainable of this level even with some slight movement up and down in the unit volumes?

Rick Smith

Yeah, I think certainly our internal targets continue to be gross margins about 60%. Mix does drive that, but we've got lot of initiatives on the platform. We've got some training going on right now to train some greenbelts from a quality and lean manufacturing perspective. Steve Mercier has brought in some new supply chain management and Tom O'Hearn who is doing a good job, to drive the supplier cost. So we've got a lot of addition that's going on to make sure those gross margins stay at these higher levels. We certainly feel that the improvements we made in 2008 are sustainable.

Paul Coster - JPMorgan

Great. Last question Rick. The platform that CVS is developing. Will it embrace third party products, an video that's really installed for instance?

Rick Smith

Yeah I will too much with you John (ph). Our whole goal here you've used the word platform is to build out a dedicated one-stop platform for law enforcements agencies that can assist them with the broader challenges of digital evidence, which can include third party guidance.

Paul Coster - JPMorgan

Excellent. Thank you.

Operator: And the next question is from the line Eric Wold with Merriman Curhan & Ford. Please proceed.

Eric Wold - Merriman Curhan Ford & Co.

Hey good morning. Couple of questions before I start. Can I get Dan the normal kind of quarterly your unit figures?

Daniel Behrendt

Yes, let's start at that. The cartridges for the quarter were 306,204 cartridges. So that's up a little bit from Q3. The handles of the X26 are 20,001 handles in the quarter. The M26 handles were at 22,409 handles and the T2 handles actually we just thought doubled our unit volume from last quarter at 7836 T2 handles in fourth quarter. So, we had lot of marketing initiatives in Q4 on the T2 and we're able to move a fair amount of product through those initiatives.

Eric Wold - Merriman Curhan Ford & Co.

And the CAMS?

Daniel Behrendt

Yeah, TASER CAMS were 1825 cameras in Q4.

Eric Wold - Merriman Curhan Ford & Co.

Okay. And then one follow-up question from the last gentleman on the R&D you talked about R&D this year, staying in kind of in a consistent level with, with where it was in Q4 as the new product come out. You're getting everything out of as a majority of new product of this year. What do you see it will get too early, but what do you see kind of in 2010, is this kind of new level of R&D setting we should expect kind of going forward as the company continues to innovate or will it start to drop off in 2010?

Rick Smith

Yeah I think it's... a lot of its going to depend on what we see as we look forward as far as the economy and the ability to absorb new products. But certainly, some of the expenses are variable. There's a fair amount consulting that is in the numbers the higher spend rate on AXON some of the other products. So certainly after this products launch, there's opportunity someone have to pull back. But candidly we'll have to look at our position in a market and if we see we are still well positioned to drive new products into the market that's really expand our product offering and leverage our relationships with the customers will probably continue to invest. I think it's probably to your point earlier to project the $0.20 spend at this point a lot of it's going to be driven by what we see in the economy and our ability to grab that market share.

Eric Wold - Merriman Curhan Ford & Co.

And then on the domestic front, obviously you did see international revenues that presented total pop up consecutive from Q3 to Q4 but that's going to back it out domestic dollars actually we are flat as Q3 and Q4 which is I guess a positive sign is to may be. What are you hearing kind of from the domestic guides. Is that really just dependant on how their budgets are in terms of if they want to go forth on project. Is the demand still very much there, they're kind of just in a little shaky spending environment and that kind of the outlook they improved you could do that ramp back up?

Rick Smith

We are continuing to see significant demand for the product, I mean everybody is quite literally challenged and right now everybody has gotten their headcount to figure out the impact of this stimulus bill. One thing we are really focusing on, we do cost benefit analyses for law enforcement and when they start making decision about equipment purchases there are very few places where they can make an investment like they can in the pager devices where the reductions in police officer injuries and work for comp plans and reductions in legal force incidents and suspect injuries. So even though if there is talk about the TASER-related litigation, if you actually look at studies of agencies that deploy TASER like Michigan Municipal Risk Management Authority, based on the deployment of TASER's cut their total excessive force litigation by over 50%. So we are really focusing our message of or holding our messaging on these cost-saving attributes of TASER devices to try and make sure that when their spending scarce dollars that lot of it is coming our way.

Eric Wold - Merriman Curhan Ford & Co.

And then last question on kind of looking the new parts coming on board this year. You are now looking for a dollar amount of the guidance. Can you give a sense of how significant contribution can new product have this year and then as they come into play kind of on the margins, should we expect kind of with other new product launches in recent years the initial revenues they have got, the new product should be low on margin ramp up or have you worked through the processes such that margins can tend at least comparable to where you're getting now?

Daniel Behrendt

Yeah, that's a really good question. This is Dan. I think we see our ability to sort of grow the business and maintain our current business is really going to be highly dependant on these products. Certainly there is a large market out there for our existing products, but I think in this environment really our ability to go back to especially existing customers that are say fully deployed with the X26 and now have a new product to sell them with the AXON or the Shockwave will certainly I think is going to be a real positive things from a sales perspective.

On the margins, we've really done a lot of work on the operations side. We've talk about the good work we've done there. And lot of its also on the new product introduction process. The amount of validation and testing and design attach ability of these new products is much enhanced from what we had, say year and half ago when we launched the C2. I think we made great strides there as a result. I think that the impact on margins out of the gate for these products which is going to be have less than an impact than what we saw in some of the introductions in the past because of the discipline we put in these new this product introduction process now.

Eric Wold - Merriman Curhan Ford & Co.

Perfect. Thank you, guys.

Daniel Behrendt

Thanks Eric.

Operator: (Operator Instructions). The next question is from the line Greg McKinley from Dougherty and Company. Please proceed.

Gregory McKinley - Dougherty and Company

Yeah, good morning. Guys, could you talk a little bit about, I know Dan you spent sometime on the call taking about your stock comp expense. But I'm wondering if you can just put that in the broader context of your SG&A and how do you generally expect that to behave during the course of the years as the Q4 number, a decent run-rate or I know you've added a few more people in leadership positions, how do you... how should we look at that in 2009?

Daniel Behrendt

Yeah, sure. The 123, this is a Dan, and 123(R) charges in Q4 were just a little over $1 million; 620,000 that was in the SG&A line. And as you saw from the force, we did have a annual grant. We tied at this year to floor reviews instead of doing annual grants in May. Like we've done in prior years we did it in December in order that closely, more closely tied of stock compensations to performance.

So I do expect that $1 million of 123(R) charges to go up and 2009 mostly because the grants we made in December we didn't see a lot of that expense in the fourth quarter. So I do expect that go up. But, yeah, of the 10.9 million of SG&A, about 620,000 of that was the stock compensation.

Gregory McKinley - Dougherty and Company

Okay. And then, so maybe that component of the 10.9 goes up a little bit due to some of these grand flight in the quarter. But is the 10.9 excluding that stock comp, is that a reasonable sort of base level type of operating expense or is there, as you guys add some leadership positions into some these new initiatives, should we look for that to grow a little bit or how should we think about that?

Daniel Behrendt

Yeah, I mean I wouldn't expect it to grow more than just sort of inflationary growth over that sort of run rate at this point. Obviously, we're going to have to make some investments on the SG&A side for these new products in the pipeline. Certainly product like AXON that are high-tech products may requires sales engineering talents that we don't have onboard today.

But I think a lot of the more significant adds have been made in our run rate. It's really more now trying to leverage expenses we have and make sure that we could be sufficient as possible, but at the same time we want to make sure that we made a heavy investment R&D, want to make sure that we are making the right investments in SG&A that position the company well for the opportunity in front of us.

Gregory McKinley - Dougherty and Company

Yeah. And then can you just talk a little bit again about your new product additions that are likely to come on this year, the timing of those? I think AXON you said is the second half launch to XREP. It looks like a late Q2 launch. What other products are should we be expecting to be introduced or are those are the two primary ones for '09?

Rick Smith

Well, this is Rick Smith. XREP, we're looking late in the second quarter. That's currently slated come to market. There is still some uncertainty in that by the way. I mean we are tweaking the aerodynamic performance of the round that could come in a little sooner. If we weren't in this, probably could take a little longer. It's just the nature of research and development. But we expect that by the end of the Q2, XREP should be online.

The Shockwave which is the area denial system that should be ready to go here a couple of weeks or early in the second quarter. I wouldn't count on a lot of revenue from Shockwave. Shockwave, I don't care try this more of a concept, proof of concept product. I mean the areas of Nile, there is not a big meet for that in law enforcement although we did recently just have a SWAT team utilize it's barricade situation very successfully.

But in law enforcement Shockwave, we will be little bit of a niche but for corrections. We see an opportunity for Shockwave to be a significant product. And in the military, it was the primary focus where we felt that it was worthy investment. We needed to get these non-lethal area denial systems off of PowerPoint page in the reality so the people can start to see these but military customers you know takes a long time to digest new concepts and operationalize them.

The CDPM which is the Controlled Digital Power Magazine which is basically a controlled lanyard for the X26 that enabled this to be disabled if it's taken away from an officer. And you have to have a code to be able to reactivate the weapon. We see that was very significant with some state correctional agencies that were looking at deploying pages but they are worried about the risk of the weapon being taken away in a correctional environment. Should we believe the CDPM, which is now shipping will open up some corrections market for us.

Gregory McKinley - Dougherty and Company

Okay.

Rick Smith

The AXON is second half of the year as well as to support software and service product that wrap around AXON in the second half of this year. And then we do have some other unannounced products that we have not made final determinations on when to make launch announcements, but there is more in the pipeline than what we've probably announced.

Gregory McKinley - Dougherty and Company

Yeah. Thank you.

Rick Smith

Thank you.

Daniel Behrendt

Thanks Greg.

Operator

Your next question is the follow-up from the line of Paul Coster with JPMorgan. Please proceed.

Paul Coster - JPMorgan

Great, thank you. I'm wondering if you would be kind enough to comment on specifics of what you're seeing in the UK, France, and Canada at the moment. In UK, when is the next 5,000 order coming through? France, what's the latest thinking on the national police, and Canada I understand there is some news coming out from Canada today on police chief support of TASER's. What does that mean for you?

Rick Smith

Okay, this is Rick. Well, certainly let's start with the UK. We understand that there is an order for potentially another 5,000 units although we've heard some round news is that they may split back between some units in cartridges. Unfortunately with these things in order as we don't, they're not in the bag until they're done. And so we get the PL. And then you'll, once we get the PL we can generally ship pretty quickly.

So I wouldn't want to go out a on a lim and try to predict governmental purchase process will come to conclusion on those. But we're certainly hopeful that that will be sometime in the first half of this year.

On France, my brother Tom has been very actively involved in meeting with the senior officials in the French National Police. Again, we don't have anything specific to report. As soon as we will, we'll report it. So we're continuing with very good things from their TASER experience. They have seen dramatic improvements in their operations. Unfortunately I can't quote the statistics of the top of my head, but from the limited case to (inaudible) so far, they have seen really pretty dramatic operational results.

Coming to Canada, Canada has been a very challenging environment for us. The Canadian media has really been actively engaged in the discussion of our TASER devices. There has been frankly a lot of negativity around the issue ever since the incident in the Vancouver, Airport last year. Even though the autopsies have come back and the independent medical examiners who ruled that they don't believe that TASER played a significant role in that unfortunate and tragic incident.

And what we're seeing now is that expert number of governmental studies in Canada which we are fully supportive of more scientific studies that look efficient we think it promotes public interest and its promotes better understanding of this technology. In other words, in one of those studies was the Canadian Police Chief Association, which has now come back and made a recommendation that every officer in Canada should go through TASER training and the availability these devices should be expanded.

During the past year, during the discussion about TASER devices, we've seen a number of lethal force incidents in Canada, where police have unfortunately had to resort to lethal force that may have otherwise been avoidable had devices like TASER is been available and I think the studies are coming back and acknowledge them. And if you actually look at the enquiries, the corners in quest, the enquiries that are being launched with what are effectively jaws of either Canadian citizen or panels of experts, we're seeing that fairly consistently those who are coming back of very efficiently, those are coming back and reporting that in fact of more chasers should be deployed. This technology does save lives and reduce injuries.

And we see this Canadian Police Chief's recommendation is a major step forward in laying along to this controversy to rest. However, translate into financial order flow for the company expended deployment remains to be seen. But we certainly see these all positive steps in the right direction.

Paul Coster - JPMorgan

Dan what tax rate should we plan for '09 please?

Daniel Behrendt

I think that RD&E sort of the take a look at for next year I would say we're going to be probably about 44% rate for next year.

Paul Coster - JPMorgan

44%. What point is that?

Daniel Behrendt

Just because we've got the things like the ISO 123(R) charges and have being get added to the booking income lobbying. So the sort of permanent items will drive after-tax rate above just sort of the statutory 39%, so it will be in that sort of 42 to 44% range for next year.

Paul Coster - JPMorgan

Okay, and then it just looks one last question Rick, it seems like you're already sort of building a pipeline for AXON. You believe that will see sales immediately this product launch?

Rick Smith

That's a real tough question. I tend to think that we are doing all the right things to position it. A more lot of our meeting is really on has been with the larger police agencies, so we can start the process. They tend to take a very long to purchase. The real success with AXON that could impact in the short term would be the small to mid size agencies. They contain to turn more quickly so my personal opinion is I think once we roll the product out that we'll start to see some orders in fairly short order.

But we'll be careful about how we do this, so the field trial process we'll go through to make sure we've really validated the hardware and the software solutions. But the other thing that's kind of interesting is the cross marketing opportunity with AXON. I've been in to see some police chiefs, frankly at agencies that don't have significant TASER programs and have not expressed a lot of interest in TASER programs. And once we've given the presentations on our vision of how all these devices and technologies work together from again engaging subjects in the field all the way through documenting agencies and taking them through the legal process, we've had at least one major agency come back and is now looking at starting a TASER program whereas they had rally not had interest before. So we are seeing cross-marketing opportunities where these products will build off of each other, so that the AXON lines could potentially help our long-term TASER sale and vice versa.

Paul Coster - JPMorgan

Excellent. Thank you very much.

Rick Smith

Thanks Paul.

Rick Smith

Thank you. With that we're going to go and wrap up the call. I appreciate everybody's time this morning. You've been with us little over an hour and we'll be back with you in April. And we look forward to what for us is a very exciting time in the company's history. Thanks a lot.

Operator

Thank you for the participation in today's conference call. This concludes the presentation. And you may now disconnect.

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Source: TASER International Q4 2008 Earnings Call Transcript
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