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Executives

Rick Smith - CEO

Dan Behrendt - CFO

Analysts

Steve Dyer - Craig-Hallum

Paul Coster - JP Morgan

Glen Mattson - Sidoti & Company

Peter Mahon - Dougherty & Company

TASER International, Inc. (TASR) Q1 2013 Earnings Call April 25, 2013 11:00 AM ET

Operator

Good day ladies and gentlemen, and welcome to the TASER International, Incorporated Quarter One 2013 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session with instructions to follow at that time. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host for today, Mr. Rick Smith, CEO. Sir you may begin.

Rick Smith

Thank you. Before we get started this morning, I am going to have Dan go ahead and read the Safe Harbor statement and then we’ll get started.

Dan Behrendt

Good morning. Safe Harbor statement. Today’s call includes forward-looking statements including statements regarding our expectations, beliefs, intentions or strategies regarding future. We intend that such forward-looking statements be subject to the Safe Harbor provided by the Private Securities Litigation Reform Act of 1995.

The forward-looking information is based upon current information and expectations regarding TASER International, Incorporated. These estimates and statements speak only as of the day on which they are made, are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict.

All forward-looking statements that are made on today’s call are subject to risk and uncertainties that could cause our actual results to differ materially. These risks are discussed in the press release we issued today and in greater detail in our Annual Report on Form 10-K for the year ended December 31, 2012 under the caption Risk Factors. You may find both of these filings as well as our other SEC filings on the website at www.taser.com.

With that, I’ll turn the call back over to Rick Smith.

Rick Smith

Great. Thanks Dan. Alright, so surely you’ve all seen the press release this morning. The team here has been working hard and again I think bringing some great results. First quarter revenues were up 19% from $25.6 million last year to $30.4 million this year; most of that driven by law enforcement agencies purchasing and upgrading to our new Smart TASER Weapon platforms, the X2 and X26P. You all are familiar with the X2 which we’ve been selling for several years, the X26P is a new product where we integrated many of the new smarter features and upgraded to an all digital platform, any device that does not require changes in user training or behavior, so it's a very seamless upgrade for agencies that have already deployed the X26.

We received extremely positive feedback from the market. For those agencies that are looking to be increasing their capabilities, the X2 has been wildly adopted and is widely selected, but for a lot of agencies that are dealing with a tougher budgetary environment and reduced training staff, there was just really one of key things simple, yet still upgrade to new technology. The X26P has been frankly a home-run. Those agencies see it as being responsive to the voice of the customer that it really meets their needs in particular with simplifying their deployment process.

And one example of that is that less than 90 days after it's launch by March, the X26P in the month of March outsold the X26 and it was certainly too early to call that a trend or to depend on that going forward, but that's pretty remarkable for a new weapon to have that happen that quickly. So we are seeing the intended features of the X26P making it easy to adopt, do seem to be resonating well in the market.

The CEW, the weapon segment revenues were up 13% over the prior year to $28 million. In the Video segment, we saw an increase of $1.5 million or 175% up to $2.4 million in the first quarter of 2013, up from a small base the year prior. Sequentially, Video segment revenues grew $0.6 million or 32% in the fourth quarter.

Also, we saw net operating losses; we’ve had those by 50% over last year, down from $3 million to $1.5 million in the first quarter. Obviously, part of that is due to the increasing revenues, a part of that is due to continued optimization in that business unit.

Gross margins overall were up by 61% from 59% in a year ago period. Our SG&A expenses were down sequentially 10% in the fourth quarter, although up 27% from the prior year, as we have talked about increasing our investments in customer facing roles as we transition from a company that traditionally just sold weapons or products in the box to a more solution sales company, we’ve created a whole new customer facing functions in order to do that and believe those investments are paying off. We also did see some increase in litigation activities about $0.5 million compared to last year.

And before I hand it to Dan, let me comment briefly on litigation. We are seeing a very promising trend in our litigation; many of you know that we have take a number of steps including revision of our warnings in 2009 and 2010 and since that time, given that most of our cases are related to warnings not actually to any product feedbacks, we have seen rate of litigation drop significantly over the past year. And one example of that is, two years ago we had 60 active cases and today we have only 25; so we’ve cut the number of that cases by more than half, and the rate of dismissals is significantly greater than the rate of new litigation.

As a caution, for modelling purposes we don't expect to see financial benefits from the decreasing trend for probably at least a year to 18 months due to the lifetime between when cases are bottomed and how they are adjudicated, we are still working through the backlog in cases from prior to those days. But for the long term, obviously this is a very promising trend in the business.

And with that, I am going to turn it over to our Chief Financial Officer, Dan Behrendt to go through the financial details.

Dan Behrendt

Thanks Rick. As Rick mentioned, revenues for the first quarter was $30.4 million, which is up approximately $4.8 million or 18.7% form the prior year. The increase in sales versus the prior is mostly driven by the continued adoption of the X2 Conducted Electrical Weapons as well as the adoption of the new X26P CEW that was announced in January 2013.

The North American law enforcement business continues to be strong mostly driven by the upgrade cycle of the X2 and X26P CEW; we actually sold $8.1 million of the X26P and X2 CEW handles in Q1 and North American law enforcement sales were actually up 31% over the first quarter of 2012. The upgrade opportunity in North America remains one of our growth drivers and ones that were started continue into 2013.

Gross margin was $18.5 million or 60.6% of revenues which is up slightly from 59.4% from the prior year. We continue to see the benefit of higher operating leverage in the business as the fixed and semi-fixed accessories in manufacturing overhead are levered up as we see increased sales. We also had a higher percentage of drop shipments in other direct sales to customers in the quarter, which increases our average selling price, and our average selling price in that business has a partial offset and that for some of the drop shipments we actually have higher variable selling expenses because we pay distributors their commission in SG&A when we drop ship on their behalf.

Cost of service delivered decreased $417,000 as we continue to realize the lower cost structure that we benefit from moving to a public cloud web services from our own data center and we made that move, completed that in about mid-way through last year and started seeing the full benefit in the fourth quarter and that continues into the first quarter here.

SG&A expenses were $11.2 million for the first quarter of 2013 compared to $8.9 million in the first quarter of 2012; as a percentage of sales of SG&A were 36.8% of net sales in Q1 of ‘13 versus 34.5% in 2012, so comparable levels overall. The primary driver for the increase was personnel costs which increased $1.1 million due to the making of additional strategic hires as part of our ongoing commitment to enhance our customer facing capabilities.

Variable selling expenses also increased and the quarter when (inaudible) prior quarter again we invested at Q2 you know paying [tributes] or (inaudible) as well as paying higher commissions for our inside sales people when they make some of these direct sales. We also saw increase to trade show expenses in the first quarter due to the technology summit we conducted for our video segment and then legal related expenses as Rick mentioned increased approximately $0.5 million when compared to the first quarter of 2012.

SG&A expenses in the video segment overall increased $341,000 when compared to first quarter of 2012, as a result of investment in customer facing rules as well as technology summit. We also had an additional $210,000 of increases in SG&A to support the growth of our international business. The research and development cost of $2 million for the quarter which are pretty much flat compared to 2012 and really are in line with sort of the run rate. We are seeing efficiencies in consulting and the decline in depreciation expense offset by some higher payroll related expenses.

We do expect R&D expenses to trend up over the year especially in the video business as we saw some critical opening positions and reinvest in those. When you look at the segment results, you will see the video business R&D came down over the quarter, that's really mostly a result of hardware R&D you know there's folks that are the (inaudible) office to support the hardware development in Flex and TASER cam. Those expenses have come down in the first quarter as those products have matured up to the point where they don't need as much work.

Moving on to adjusted EBITDA which includes the add backs for depreciation, stock compensation among other items was $7.7 million in the first quarter of 2013 compared to $6.9 million in the first quarter of 2012, with improvements being here mostly by the higher sales levels. We have a table that's reconciled adjusted EBITDA to net income in their earnings release you can refer to. Income from operations for the quarter is $5.3 million and we saw net income in the first quarter of $3.3 million or $0.06 a share on both basic and diluted basis. This compares to $3.8 million or $0.07 a share on basic and diluted basis in the first quarter of 2012 below the prior year. If you remember that I said from the $2.2 million reduction in the accrual on the (inaudible) case so it’s more of a normalized basis results this year were better.

As we move on to the balance sheet for assets, we finished the quarter with $38.6 million of cash. We are able to offset the $5.4 million that we spent repurchasing common stock back through the quarter as part of the $25 million buyback approved on February 25, 2013 with operating cash flow and cash flow from the tax yield provided by employee stock option exercises. We actually bought back 702,866 shares during the quarter for $5.4 million with an average purchase price of $7.61 per share. Accounts receivables $16.8 million are down $1.3 million from year end due to the timing of collections that occurred during the quarter.

Inventory of $11.8 million is up about $800,000 from the year end balance, mostly attributed to build up of X2 and X26 inventory, X26P inventory, in anticipation of the sales trends for 2013. We saw the investment in property equipment at $21.2 million is actually down $800,000 when compared to the prior year end. The net decrease includes approximately $949,000 in depreciation expense offset by some capital expenditures of about $609,000 of CapEx in the quarter. Most of that was for production equipment, with some purchases, computer equipment as well as maintenance in the first quarter and this whole asset as of March 31, 2013, where $117.1 million.

To move on liability and equity such as balance sheet, accounts payable of 4.8 million is actually down 1.4 million from year-end due to the timing of some check run and processing of voices. Through liabilities is 6.8 million decrease, 0.3 million from earlier results of the timing of bonus payments incurred in Q4 which were paid out in Q1. Total deferred revenue of 13.8 million is actually increased to 1.7 million from year-end, primarily due to increase sales of X26P and X2. Both of those being sold in with traded programs that included extended warranties, so we're seeing higher warranty purchases because we're selling more of those products with the warranty bundled in as well as the deferral revenue associated with evidence.com service which actually grew deferred revenue of $767,000 over the fourth quarter of 2012 due to increased sales of the video segment.

As people probably remember, with the selling of Axon Flex video products, the deferring revenue related to Evidence.com service, so the revenue for that will be for the (inaudible) fee recognized over service period of between 1 and 5 years depending on the contracted the customer is signing with us. And of the $13.8 million of deferred revenue on the balance sheet, 2 million of that is actually related in to Evidence.com service and that continues to grow pretty sharply from the fourth quarter balances which I think is a good trend.

Total liabilities of 28.9 million and the company’s best quarter was 88.2 million of stockholder’s equity. Again we have no long term in the balance sheet other than small capital leads and continue to have plenty of liquidity and small cash flow in the core business to fund our R&D efforts and operations as we move in to the future. We're looking at cash flow information. We did have a cash flow provided from operations of $4.5 million during the first quarter of 2013. We also had some net cash provided from investing activities in the first quarter of 2013, mostly driven by some maturing short term investments of $1.7 million during the quarter, it won’t reinvest in the quarter because we made a decision to change investing advisors in early Q2 so it just made a cleaner transition to those short term investment matured late March and we just waited to invest them in April.

Cash used in finance activity is just $3.3 million; again that’s driven mostly by the stock buyback of $5.4 million executed in Q1 partially offset by 1.9 million tax benefit from employee stock option exercises. We finished this quarter with 38.6 million of cash, very confident liquidity position business; really the strong cash generation in the business is what gave the confidence to continue to stock buyback in 2013 and we feel good about where we sit right now.

The one thing I want to just talk briefly on the call, today I have gotten a couple of questions from investments. This is sort of press release strategy for the business. You probably notice that the company has been making press releases more often talking about new orders that were booked throughout the quarter. We just think its important for a customers many of whole look through (inaudible) and technology shift to see which of the peers (inaudible) our new video technology or upgrade into the new CW platforms, but it's not something we want to (inaudible) from our investment perspective, we don't want investor to read too much into it, one way or the other, it’s just something really more for commercial purposes that just have that weekly cadence of press releases each week just talking about our customers that are upgrading to the new CW platforms or deploying the video. We think it's important commercially but you should expect to continue to see sort of the cadence of weekly press release.

And finally I want to cover just the tail statistics for the quarter. We actually sold 9024, X26 units in the quarter as Rick said the X26T was actually off to a strong start. We sold 4345 X26T in Q1. X2s were at 4946, we sold 628 M26 CEWs; we sold 200 in X3 that’s most in the consumer segment of the business, so that continues to sell slowly but we are happy where that sits right now. Q2 we sold 2295 C2 units in Q1.

TASER cams were 2313 units, we sold 363,515 cartridges. So again cartridge sales continue to be strong, partially driven by X2 because it uses a different cartridge design than the X26 that is replacing a lot of cases. We obviously foresee customers have to buy sort of a new arsenal of cartridges, so that’s part of what’s driving that. And we sold 788 Flex video cameras.

So with that I would like to turn the call back over to Rick Smith.

Rick Smith

Hey, thanks Dan. One thing I like to notice were a couple of things. First significant number of X26P orders including some of the larger agencies New Orleans with 400, New York State Police with 334, Sunnyvale with 210, and that of course the X2 continues strong as well with Atlanta buying 200 more, Louisville Police Department, Buncombe County, Garfield and a bunch of others. What you don't see this quarter is there were no particularly large orders of the magnitude like the Phoenix PD. In fact San Diego Sheriffs was on our pipeline we expect in the first quarter and it slipped in to the second quarter and yet we were still able to meet impressive sales result this quarter largely due to the continued success in growth of the telesales team that brought in $3.3 million in business from the smaller agencies within the market. That's again I'll attribute that largely to the rare Jeff Kukowski has brought to our sales team and operations, our program life style and the other things we are doing.

We also had a bit of our soft spot internationally in the quarter. International sales came in at about 10%, down from our historical levels. We attribute that largely to just the -- international tends to be lumpy, they tend to be some larger orders. As you know we've been investing in international sales offices that really started in earnest about nine months ago. We are expecting to see those results take some time to kind of find the pump, but we are certainly of the belief that same regulators working in the US is going to help us internationally.

Let me shift now to talking about AXON Flex and Evidence.com. Again we continued to see momentum and new adoptions on the marketplace. Bookings were up 300% over the first quarter of 2012, although down 17% sequentially. We attribute that to a couple of things, number one the fourth quarters does tend to be a stronger quarter than the first in general. The other is, if you look at the dynamics of the longer sales cycle of the video segment, many of the agencies we are closing up through the end of the year, were actually agencies which started working with our first generation AXON Pro system before.

So they are sort of in the sales cycles agencies like Komatsu that we closed right around the end of the year. We've been working with them for about 18 months. So we are now getting to the point where we are really of the focus on meeting new agencies as we are scaling up the AXON Flex that really became commercially available last summer.

Another thing we see is really quite reassuring in that part of business is the number of renewals and expansions. We talked about like Komatsu has gone now to a full patrol deployment, Salt Lake City and the Valley Police Alliance they are deploying cameras simultaneously across 14 agencies. Chesapeake, Virginia they just expanded their program to now full deployment of all their field officers.

Albuquerque, another big win, Albuquerque actually was the first major city I believe in the United States to put on officer video on all of their officers with somewhere between 700 and 1000 cameras. They had originally done this with consumer cameras at a much lower price point and we have to work with Albuquerque to understand the significant logistics costs associated with handling the video as well as the utility and durability of those consumer cameras and having them now come across as a customer we see as important validation that the investments we've made and really building in end to end system that is both robust and really manages that work flow through this total cost of ownership is able to go in and displace agencies that had previous products that they were using.

Also Cook County, another interesting one to talk about, Cook County has deployed 250 of the AXON Flex video systems. What's important about Cook County is there we've found that they really wanted to save the data locally and within their own networks. They had large investments in infrastructure on fixed cameras and other sorts of video. So our Flex system has been designed so that we could accommodate that. So customers can now use our gear and pointed to store their files in their local system upwards. We also believe that gives us an advantage over time as the could deployment model with all the images around cost and speed of innovation etcetera that at any point an agency like just wanted to transition back, of course our gear can seamlessly move from storing them on-site to alignment to deploy Evidence.com in the cloud.

I'm going to conclude by talking a little bit about our Analyst Day that we hosted in New York. I assume some of you, I know some of the analysts on the call were there, many of you were not. We really talked about there is how we have identified that you are really one of our greatest assets, greater than our IT, greater than our tooling or any individual product is a relationship, the unique relationship we have with 16,000 plus U.S. law enforcement agencies, any of the agencies around the globe. These agencies are spending between $10 billion and $20 billion a year on technology.

We believe we have one of the strongest brands. We're seen as a company that takes advanced technology and combines them with training to provide simple, easy to use, reliable systems and solutions that our customers can deploy and so we're developing new products to back in to that same market and frankly enables us to win much larger share of their dollar spend on technology. And of course, the first major expansion is what we're doing with on office video Flex and with Evidence.com with the cloud-based digital evidence management system.

Maybe we saw recently in the New York Times article showing the first really academically rigorous study of the impact of AXON Flex in the field, (inaudible) California in combination with the Cambridge University in the UK. We're using a randomized study design. They were able to show a direct correlation from the deployment of the cameras to an almost 90% reduction in complaints against police. This is significant. Perhaps even more significant based on almost 60% reduction in the use of force, mainly when cameras were deployed, the escalated behaviors in these tense situations frequently even the suspects would deescalate when they knew they are being recorded.

We have had several major agencies that reported that data alone empowers them to go their risk managers and make a case for reallocating risk management funds to fund AXON Flex and Evidence.com system and we also while it is the first major academic study, they are not alone in terms of the results that they reporting. Komatsu reported complaints down about 60%, Pittsburgh relatively 4%, [Tonganachi] reported a 100% decrease in complaints. In terms of use of force, we have seen others like Tonganachi actually reported 90% decrease (inaudible) down 40% (inaudible) down 30%.

So we believe these early validations are supercritical both in terms of proving the value of the system quantitatively as well as qualitatively by seeing customers come back to renew and expand their programs.

Our best estimates right now based on our report from the AP as the U.S. law enforcement agency spent around $2500 a year, settling claims against the agency, so $2500 per officer per year is an average payout for complaint costs. The aggregate that over the U.S. works as well over $2 billion, so it's a significant problem they were helping to resolve and we are now seeing some real similarities to the early days when we’re first launching TASER devices here in North America.

Those are two big factors early on that help the TASER to gain traction. The first was the emergence of the statistic showing the deployment of TASER M26 led to significant reductions in deaths and in injuries. And then that was more qualitative, that was the personal experience of officers in the field many of them were sceptical. They talk many officers who set up doing their job for 20 years, why do I need this new TASER thing, and yet those same people after having a feel for a while would come back to us and share stories about how they save somebody’s life with it.

We are now seeing similarities in AXON Flex and Evidence.com where we are seeing the statistical results and we are now having officers come back as well, some of which saying I don't want to go on patrol without this, particularly officers who have had complaints about against them where the video has clearly exonerated them.

If you go to our website at taser.com and go to the icon video page, there is a companion of many testimonials of individual officers. So at the end of the day, the strategy that we are employing here with this probably safety platform strategy is to really coming understanding even our change of weapons are connected devices, they are smart devices, they are collecting information about how they are used, they have got sophisticated firmware, they are need to be periodically connected and updated for using Evidence.com and the network to make that happen, many times we have some like 60,000 or 70,000 TASER cams in the field.

We are helping our customers view about that information and of course expanding that network to include things like Evidence.com, I am sorry the AXON Flex wearable cameras. So we believe that we are proud of what we have done historically, many of our customers will tell us that TASER has been the biggest revolution in law enforcement certainly in this century.

And we believe we are positioned to do it again. The digital video and multimedia is the opportunity to become centerpiece of law enforcement records of the future so it goes even beyond just depending against complaints. We see video moving to the center of all law enforcement work flows and that will create a number of expansion opportunities for us as we continue to see all this business.

At the Investor Day we talked about that we actually share some models, obviously when it deals with disruptive technology it’s very difficult to make short-term models or even long-term models with much accuracy because creating market that don't yet exist, but we believe with some conservative assumptions that we can grow TASER to between $166 million to over $300 million in revenue over the next three to five years.

None of these models assume the kind of rapid adoption we saw with TASER weapons nearly 2000. So if we should be fortunate enough to see a TASER like adoption there is upside in these models. However we are seeing longer sales cycles and these more complex solution sales. That's why we are being a little more conservative.

So I will conclude by just again reiterating that we are solving big important problems for our customers and when you solve their problems you create significant value for all of our stakeholders. So it includes our customers, our employees and certainly our shareholders as well as society at large. We make communities safer; I think that's something we can all feel good about. Solving big problems is not quick and it’s not easy. We've done this before in creating the global market for TASER Conducted Energy Weapons and we've done it in this market facing similar challenges with these same customers and we are intent on doing them again. I think we are making a lot of progress.

So with that I will open it up and we will take a few questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Steve Dyer of Craig-Hallum. Your line is open, please go ahead.

Steve Dyer - Craig-Hallum

Just a housekeeping question to begin with, is the X26P a sub-category or sub-group of the X26 numbers that you gave or are those in addition?

Dan Behrendt

Those are in addition; so we sold 9,024 X26s and in addition to that we sold another 4,345 X26Ps.

Steve Dyer - Craig-Hallum

And then with respect to the new bookings I realize it’s very early and this isn't going to be a linear progression, etcetera. But in general, what are you kind of seeing there that number was off slightly quarter-over-quarter, how do you sort of think that plays out from a cadence standpoint?

Rick Smith

Well, one of the things that’s interesting from a market dynamic perspective is we are seeing the larger agencies move faster than we have historically. The TASER growth early on was driven really a lot more by the smaller agencies moving more quickly. We've been surprised frankly at the level of interest in the big agencies, so there is a plus and the minus to that. We've actually put a lot of focus in the opportunity there. We see to really win this market long term the more the big agencies we can get the more influential they will be. So we are putting a lot of our focus with you know when Salt Lake City or Fort Worth puts their hands up or Pittsburgh, we really put a lot of focus on those.

If we can win over a sizeable percentage or even a majority of the major cities and begin to work with those customers to identify what sorts of information they will want to share those network effect you can really kick-in like we saw in Salt Lake City with the local agencies, the smaller agencies tending to follow the large. So there is some real advantages to that dynamic. One disadvantage is relying on big agencies meaning that's going to be more lumpy; you know in the quarter we certainly we had some pipeline that had it come into the quarter we would have seen significant growth over the fourth quarter given some of those pushed out, it happens with larger agencies.

So I would say you know probably for the balance of this year, we can continue to see some lumpier large orders that will sort of determine some of that quarter-to-quarter sequential noise whether its up or down, but I can tell you qualitatively we've seen a major shift in the response to the market; people no longer saying, I actually presented at [Chief’s Course] in Louisiana about two weeks ago where we get about 110 chiefs and senior administrators and at the beginning of my presentation, I asked how many of them saw their agencies moving major systems to the cloud and I would say 80% of the hands went up. Two years ago, I think we might have seen 10% of the hands go up. So we're seeing a lot of those good qualitative responses; obviously, we like to see sequential growth every quarter, but the large agencies are going to make a bit lumpy.

Dan Behrendt

And we expect this trend line will continue to be updated with that lumpiness. That’s kind of what we're focused on sort of the overall trend. Although, as Rick said, we like to sort of see sequential growth, but I think as long as you’re sort of seeing that trend line continue to be up until the right, we feel like we're on the right track.

Steve Dyer - Craig-Hallum

Sure, understood. And then just I guess sequentially from a revenue perspective, I know you don’t give a lot of guidance. I had expected maybe a little bit about, you talked about little pause as people, agencies evaluate the X26P versus the X2. Certainly, it didn’t seem like you saw a much of want if any; sequentially, does it feel like kind of things get better from this level throughout the year?

Dan Behrendt

I think, obviously we felt very good about first quarter. You know, we expected see agencies sort of evaluating that to sort of weight. We still saw some of that in the quarter and it got still probably something we could see in Q2, but you know, we feel very good, to be able to put up these kinds of numbers with that backdrop of new product being launched. So I think we're setting in a good position. I think as Rick said, we've had a couple of deals get pushed from Q1 into Q2. So I think that’s at the level of about Q2, but as you know, this is a difficult business to forecast, but we feels very good about sort of we’re sitting overall with a large amount of the North American business has not having upgraded yet, but we're certainly seeing new traction there.

Operator

Thank you. Our next question comes from the line of Paul Cost of JP Morgan. Your line is open please go ahead.

Paul Coster - JP Morgan

Rick can you talk a little bit about the penetration of large accounts in North America with your video solutions. Where do we stand not just in terms of the percentage of large accounts that have even adopt it, but within those large accounts what's the sort of penetration level and where do you expect to ultimately to go?

Rick Smith

Okay great question. Most of the large agencies I would say are in early deployment, so if we are looking at the major - the MMC or the major cities we’ve got Pittsburgh, well I think around 50 units, Mesa around 50, Fort Worth is around 50 to 100. We have got a number of others that are testing or they have made smaller purchases that we have not yet announced as we work through. Some of these have paid in trials; I guess there’s probably another 5 to 10 agencies that are actively testing of the major cities which again is top 65 or around 70 agencies in the country. We have seen some of the mid-size agencies like (inaudible) and now [Chesapeake] that have gone to whole deployment. I think we were excited and working hard to help get some of these major cities to really stay on their programs. We do expect that to happen in several of those cities to have significant expansion by the end of this year. We are also learning that one of the things that we are working hard at to help that happen is doing some integrations with some of their existing IT systems to be able to have some information back and forth logistically.

So, for example, one of these agencies they want the officers to be able to just record on and off all day and not have to tag any videos and we could then match on the back end based on the time and date of who made the recording. We could pull tables from the record management system and have the (inaudible) automatically do that tagging. That would remove any incremental work up to those officers which is seen as a huge benefit. So we are working very closely with these customers, warning what are the next enhancement, and again being in the cloud model it’s great that we can rollout enhancements about every 90 days, and those types of things we think will help keep these agencies from the 100ish range up to much larger deployment.

I would also point out that perhaps new this quarter, we knew how major agency is beginning field trails in Brazil, the UK, Australia Asia and elsewhere in Europe. So don’t want to give to many details until we are further in to these, but we’ve been able to turn on instances through our cloud partner, so we do have the ability to store data internationally. That increases the comfort level on our international customers, and so we are working into the sales process now globally.

Paul Coster - JP Morgan

Where are you seeing completion in this space and from whom?

Rick Smith

There’s a lot of guys making cameras out there. In Albuquerque we saw those little cameras you can buy in Sky Mall for $150 bucks. Now they found that we are replacing some of those. I don't know the exact one from Sky Mall but similar category. We are replacing those one or two times a year on the field. So for us to be able to upgrade them from a $150 price point obviously to $800 or $900 price point I think shows that the industrialization we’ve done really pays off and really the work flow as we worked with Albuquerque they were burning, and officers had to download their own devices and burn them to CDs or DVDs and I think they had hundreds of thousands of disks they were dealing with. So untangling that has another big advantage for us. Internationally there are some local players in different countries. I know in Australia Asia there's at least one on body camera maker; in France we believe there's one. There's a couple of in the UK. Some of them are doing software backend. Typically we are still seeing most of the business models are facing or at least all of them that I am aware of currently are primarily the hardware vendors where the software is like a free app sort of approach. I don't know that we've seen somebody at really make the heavy investment in building out the Enterprise class software that comes with the core and over time that's where again we see the real value out of the business.

There are some in the media you probably saw in one area really asked us about Google glass and how we see that coming. We've been selected as one of the early glass explorers. We look at that as when that technology is commercialized, we are building our system the same way that we frankly partnered with (inaudible) to make AXON Flex taken right commercial technology and dab into our marketplace. We see our strategies building that ecosystem that partners with world class devices like iPhones and Android devices. So we are less focused on the hardware overtime certainly will become commodity. We see the opportunity to solve the big data problem as the big one, and we have not yet seen I would say a major competitor go there, although I would expect within the next year we will probably see some of the car vendors that have done on-premise you know digital (inaudible) management solutions probably also start to make moves into the cloud. So we've got to continue to press our first mover advantage hard.

Paul Coster - JP Morgan

You could actually capture them later I imagine. But my last question is what percentage of revenue today is recurring, and then looking out over your forecasting horizons how do you see that evolving for the company.

Rick Smith

Is your question about the percentage of revenue that's recurring in the video business or across the whole business?

Paul Coster - JP Morgan

Well, its really both but obviously the video is very much recurring but I'm really keen to understand how your business is working for the whole company over this or five year period that you talked about.

Dan Behrendt

This is Dan yeah we do expect the recurring piece of video will grow over time and as I mentioned we've got $2 million of deferred revenue on the balance sheet right now, just for the video business. In this quarter the service piece of revenue was about 10% of the total and we expect that that percentage will increase over time. You know the overall business we still sort of benefit from sort of the razor blade model on that roughly 30% of our sales are cartridges and other accessory and that's been pretty predictable to make that part of the business and we expect the video as the service business. Some of these early customers come back and now move to trial the deeper adoptions and buying the service; we expect that service revenue will grow over time.

Paul Coster - JP Morgan

Okay, got it. But do you also anticipate hardware leasing to grow.

Dan Behrendt

Yes, I mean we didn't have a lot of the [CPP] deals this quarter but it continues to generate a lot of interest from our customers. I think the good news is we continue to see cases where customers evaluate our [CPP] program and do a cash deal that's perfect for us. I mean part of it is just another tool for our sales people to use and continue the conversation and make sure that the conversation doesn't stop with hey we are not sure we have enough budget to deploy this and in some cases they have been able to actually find budget dollars and just make cash purchases which is buried.

Operator

Thank you. Our next question comes from the line of Glen Mattson of Sidoti & Company. Your line is open. Please go ahead.

Glen Mattson - Sidoti & Company

A real quick. Housekeeping first. SG&A jumped this quarter. Is that -- first off, do you still have same expectations for SG&A this year and also you know more conception on the video business, you know, between the Rialto study and the attack in Boston and what a key role video played there, almost feels like have we turned this corner. Are you starting to see a lot more interest and it seems like you have a lot more deal flow in the video business even in this second quarter? So basically those two points.

Rick Smith

Dan, why don’t you start with SG&A?

Dan Behrendt

Yeah, on the SG&A side, we do saw expectations that will see SG&A expenses go up about 10% year-over-year. So not any, really not any change in strategy there. This quarter we saw about half a million of incremental legal expenses in the quarter but overall we still feel comfortable that we will be in the 10% growth with a lot of that growth being in customer base and we also grow both the video segment as well as the international part of the business.

Rick Smith

On the other front, it's too early to say about the role of video in Boston. I don't know we have a good feel on whether that has an impact. Certainly, we also, you know, we've been sharing that study literally. It actually, the first place we had an opportunity to gauge customer reactions was we held to call it [text summit] here in Scottsdale about 60 days ago where the Chief of Rialto came and presented these results before they were public.

At that event, we had roughly a 100 law enforcement officials from various agencies around the country and many of them we have actually helped cover the travel cost because of budgets aren't allowing them to travel. So just to be able to make sure we had good attendance we provided some grants to cover the travel cost. What we found was all the folks that came in including some major agencies that I would say were sceptical the night before the conference at our welcome reception by the evening after the conference we saw marked changes and their receptiveness, although (inaudible) conference was of the tone that they were going to go back their agencies and begin the process to deploy this technology.

We are now looking how we can scale that by moving those summit events around the country by scheduling them around other events where senior law enforcement officials will be other major conferences, so that it doesn’t have the incremental travel cost or significant incremental travel cost that probably one of the biggest thing that we can do from a leadership perspective is getting the chief to these events, where they hear, chiefs like the Christopher Bank, the Chief of Salt Lake, was a speaker talking about other deploying multi-agency models in Salt Lake, Chief from Rialto, Chief Halstead from Fort Worth talking about the benefits of that they are seeing.

So yeah, it feels to me like we crossed a tipping point intellectually. Again we need to be conservative about. We just don't know as they point out in the study the innovators of the [Limo] one of the challenges in modeling or analyzing or forecasting disruptive technologies is it really hard if not impossible to do, we don't know where we see that economic tipping point but I think we are starting to see upbeats in the numbers that we are certainly on an upward slope quite significant.

Operator

Thank you. Our next question is from Peter Mahon from Dougherty & Company. Your line is open. Please go ahead.

Peter Mahon - Dougherty & Company

Good morning, guys. I just had a one question. Looking at the CEW segment and then actually gross margins declined almost 200 basis point year-over-year, I was hoping that you can might can elaborate on that especially as you guys talked about having more direct sales and things like that that increase ASP?

Dan Behrendt

Yeah, I think that’s a good question. I think it’s really dragged a little bit by the mix also as we saw more of the X26P units, we are offering trading to encourage our customers to do that, so a lot we see like maybe higher ASP for part or and things like that for those parts of the business. We are offering trading credits so that does have a impact on gross margin, although we think trading credits, we see those have been very successful way to drive the business, but I think that small decrease in gross margin is really driven by the trading credits we run through the income statement.

Rick Smith

And most of the trading credits are against packages that include extended warranties, so you part is probably related to higher percentage of deferred revenue associated with higher percentage of units purchase and warranties.

Dan Behrendt

And we are seeing as a match we are seeing that deferred revenue line of balance sheet continue to grow very sharply so which is I think to Paul’s questions earlier I think again that because of more and more predictable part of the business is going to run in every quarter because we know and see that deferred revenues for warranties royalties as well as conservative and not come through forward.

Peter Mahon - Dougherty & Company

And just to clarify you guys have a training program on both the X2 and X26P, is that correct.

Rick Smith

That is correct.

Peter Mahon - Dougherty & Company

Okay. And would you mind letting us know what those credits are at this point in time.

Rick Smith

Yeah, I believe its $135 per handle for the second quarter.

Peter Mahon - Dougherty & Company

Okay, great. Thanks a lot, guys.

Operator

Thank you. And ladies and gentlemen, that does conclude our Q&A session. I would like to turn the conference back over to Mr. Smith for any closing remarks.

Rick Smith

Great, thank you very much. We appreciate those of you who stuck with us through the whole call here and stuck with us the shareholders over the years. I think we are seeing the return on investments that we make as we start to scale new parts of the business. I would also invite all of you to join us for our annual shareholder meeting which will be May 23 at our headquarters here in Scottsdale in Arizona. So come around and join us then we will have more updates on the business and we look forward if you can't make it then to talking to you on our next quarterly results call which should be in July. So thanks and have a great day.

Operator

Ladies and gentlemen, thank you for your participation in today's call. This does conclude the program and you may all disconnect. Have a great rest of the day.

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