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TASER International, Inc. (NASDAQ:TASR)

Q4 2006 Earnings Call

February 21, 2007 10:00 am ET

Executives

Tom Smith - Chairman

Doug Klint - VP and General Counsel

Rick Smith - CEO

Dan Behrendt - CFO

Kathleen Hanrahan - President

Analysts

Eric Wold - Merriman Curhan Ford

Matthew McKay - Jefferies & Company

Rick Ryan - Feltl

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2006 TASER International Incorporated Earnings Call. My name is Tuwanda and I'll be your coordinator for today. At this time, all participants are in a listen-only mode. We will facilitate a question-and-answer session towards the end of the conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the call over to Mr. Tom Smith, Chairman. Please proceed, sir.

Tom Smith

Thank you and good morning. We'd like to welcome everyone to our fourth quarter and end of 2006 conference call wrap-up. We're obviously very excited about our record quarter; the best in our history, as well as, a record year. But before we can get into a detailed chatting about that, Doug has got some riveting comments for us. Doug?

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Doug Klint

Thanks, Tom. 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 the law enforcement market, the expansion of product sales to the private security, military, consumer self-defense markets, growth expectations for new and existing accounts, expansion of production capability, new product introductions, product safety and our business model.

We caution that these statements are qualified by important factors that could cause actual results to differ materially from those reflected by the forward-looking statements. Such factors include, but are not limited to market acceptance of our products, establishment and expansion of our direct and indirect distribution channels, attracting and retaining the endorsement of key opinion-leaders in the law enforcement community, the level of product technology and price competition for our products, the degree and rate of growth at the markets in which we compete and the accompanying demand for our products, potential delays in the international and domestic orders, implementation of risks at manufacturing automation, risks associated with rapid technological change, execution and implementation risks of new technology, new product introductions risks, ramping manufacturing production to meet demand, litigation resulting from alleged product related injuries and deaths, media publicity concerning product uses and allegations of injuries and deaths and the negative impact this could have on sales, product quality risks, potential fluctuations in quarterly operating results, competition, negative reports considering TASER device uses financial and budgetary constraints of prospects and customers, dependence upon sole and limited source suppliers, fluctuations in component pricing, risks of government investigations and regulations, TASER product tests and reports, dependence upon key employees, employee retention risks and other factors detailed in the Company's filings with the Securities and Exchange Commission.

I would now like to turn the call back to Rick Smith, our CEO.

Rick Smith

Thank you, Doug. Again, as Tom mentioned, we had a record year. Just a little bit more than we had in 2004. But right after 2005, I can say I am proud of the employees here who really stuck it out to overcome the challenges and got this company back on track.

We had 42% year-over-year revenue growth, $19.3 million in revenue in the fourth quarter and just about 20% operating income with $3.8 million. Also, as you all know, it's critically important for us how we are performing in the legal arena. And Doug and his team turned in seven more product liability suits dismissed for a total of 30, including a couple of real big ones.

First was the Alvarado trial. As you all know, that was our first jury trial of an in-custody death in central Los Angeles, which was a notoriously difficult jury pool area. We've got a unanimous jury verdict in our favor together with LAPD. We developed a good partnership with them in defending that case and we are obviously very happy with the outcome.

Also, the Hasse case. For those of you who remember, the Hasse case involved a man in Chicago. It was the first time that a medical examiner had made a conclusion that the TASER was the primary cause of death. Although, all of the experts we had look at it vehemently disagreed because Mr. Hasse had a lethal level of methamphenamine in his blood and the time course of the event certainly did not support any electrical related issues. We are very glad to see that we've now won that case at summary judgment.

So, Doug and his legal team just continue to do a fantastic job. I'll foreshadow a little bit as well, he is also doing a great job of keeping our legal costs under control. In fact, we've seen some improvements in that area by bringing a lot of the work in-house.

We also saw continued growth internationally with another $1.6 million in TASER deployments in France, $1.6 million, not units yet. But we certainly remain very optimistic about the contribution in the international markets. Although, I think as Tom will point out, France is going to be a little bit slow in the next few quarters until they get through their national election.

We also, on the political front, had some significant developments with LULAC, which is the League of United Latin American Citizens and the National League of Cities, both passing resolutions that were supportive of the work that we are doing here at TASER International.

And I think both of those, especially the LULAC one is critical to point out here for a second. Because 12-months prior, they were actually looking at a resolution recommending a ban against the product.

Again, once you take the emotions out and look at the fact on how much of a difference our product is making in these communities, they've obviously reversed that position. It was very exciting for us to work with that organization and get that turned around.

During the quarter, we also announced the new TASER Remote Area Denial or TRAD concept. That's a new concept for deploying our technologies for area denial that we believe could open a new market space for us in military and area denial as early as 2008.

So, indicative with the work we have been doing in R&D, we generated 21 additional US patent applications and 26 international patent applications in 2006, bringing our IP portfolio to 25 issued patents and another 80 pending.

One other thing to talk about, as we look to the future is we at TASER International really find ourselves as being leaders, not following in to the existing market spaces. For example, with the X26 or the M26, we created a whole new area in law enforcement, a whole new market space. And obviously that has done very well for the company, leading to a significant growth since 2000.

Similarly with TASER CAM, we have stretched out into a new space and you will see the same thing with our new XREP with the TRAD technology and with the C2. None of these are products that are going into existing or known markets.

And when you are charting on unchartered waters, as our analysts I am sure are aware, makes it very difficult to predict the future, because you just don't know until you get there and you get out into the market space. But it's also very exciting, because like the X26, any one of these products has incredible potential to be very big or maybe slower than expected.

But with the TASER CAM, for example, we are seeing longer adoption time than we had originally anticipated. So sales from last year of the TASER CAM were less than expected. But I would also like to point out that it's still a great return on investment for our development dollars.

So, even on a conservative estimate with the TASER CAM, these new product developments are very good investments of our dollars, and we are hopeful that with the C2 and some of these other ones, we will see faster growth like we did with X26. And we do believe, longer term by the way, the TASER CAM is being well received in the market. It's just requiring new procedural issues at the Police Departments. It's a whole new issue that they have never dealt with before, and therefore it takes some time to get their hands around the new field test and develop the policies.

But again, this year you will see a couple of new markets coming on line, with the C2 in the consumer space and the XREP going into the wireless projectiles. And needless to say, we are very excited about the opportunities that those represent.

And with that I am going to turn over to Dan to talk a little more about some of the specific financial results.

Dan Behrendt

Okay. Thanks Rick. On the income statement, first let's take a look at the fourth quarter. Sales for the quarter were $19.3 million, which is up 53% from the prior year.

Our gross margins for the quarter were $12.2 million or 63.3% of sales, which is down 1% from the prior year due to increased material costs of sales mix, which included the loss due to high margin X26 products during the quarter versus the prior year. And then we had some costs associated with building C2 products for the CES show in January.

We did get a lot more leverage out of the indirect expenses in the year, because of the 53% increase in sales over the prior year.

SG&A expenses were $7.7 million for the quarter versus $7.2 million in the prior year. Variances were really driven by higher salaries and benefits, the stock compensation charges resulting from the implementation of 123R for the company of $114,000 for the quarter, and then higher travel and meal costs of about $392,000 for the quarter, which was really driven by two large shows we had in the fourth quarter.

We had the International Chiefs of Police show at Boston and the National League of Cities in Reno during the fourth quarter. And both of those resulted in heavy travel expenses for the company and its employees.

These unfavorable variances were partially offset by lower outside legal fees of $209,000 for the quarter, lower professional fees of $115,000 and lower IR costs of $136,000 for the quarter.

Research and development expenses were $705,000 for the quarter, an increase of $235,000 over the prior year. Again, this is driven mostly by salaries, stock compensation charges, and higher supplies. Again, the company intends to continue to ramp up its R&D spending in 2007.

Income from operations of $3.8 million or 19.7% of sales is up 877% from the prior year. I think it has proven to be more impressive, considering the fact that this year's results do include the 123R charges that we did not have in the 2005 numbers.

Interest income for the quarter was $599,000. This is up $223,000 from the prior year due to higher investment balances and better yielding investments.

Pre-tax for the quarter is $4.4 million with net income of $2.3 million or $0.04 a share on both the basic and diluted basis.

Going on to the total year results, we had sales of $67.7 million, which as Tom and Rick indicated as the highest one-year total in the company's history. This is up $20 million or 42% from the prior year.

Gross margins of $43.2 million or 63.8% of sales are up 1.7% from the prior year. This is due to getting more leverage out of our indirect costs resulting from the higher sales levels.

SG&A expenses were $29.7 million for the year versus $26.5 million last year. Variances were driven by higher salaries and benefits of $1.1 million, stock compensation charges of $800,000, and higher travel and meals expenses of $333,000. And these were offset by lower investor relations' expenses of $362,000 versus the prior year.

R&D expenses were $2.7 million for the year, which is an increase of $1.1 million over the prior year; again, driven by higher salaries of $591,000, stock compensation of almost $200,000, and higher supplies and consulting costs.

Income from operations is a reported loss of $6.8 million. But this does include the $17.65 million of shareholders' selling expenses, which we've recorded in the second quarter. You can do the math and see if these one-time expenses were excluded. We have solid double-digit operating income for the year, despite having an additional $1.1 million of stock compensation due to the implementation of 123R.

Interest income of $1.9 million for the year is up $649,000 from the prior year on high investment balances and better yielding investments. Again, the net loss for the year is $4 million, driven by the one-time expenses for the shareholders' settlement or a loss of $0.07 per share on both the basic and diluted basis.

On to the asset side of the balance sheet, we did finish the year with $47.8 million of cash and investments. This is an increase of $3.9 million over the prior year, despite making the first $7.9 million cash payment on the shareholders' settlement in the fourth quarter and buying back $2.2 million worth of stock during the year.

Accounts receivable for the quarter is $10.1 million. This is up sharply due to the higher sales levels in the fourth quarter of 2006 versus the fourth quarter of 2005. Inventory of $9.3 million is actually down to $8.47 million from the prior year despite the 42% increase in sales, which is a great news.

Prepaids and other assets of $2.2 million are down $634,000 due to the receipt of the ONR grant revenue, which was outstanding at the end of last year.

The current deferred tax asset is up sharply. If you look down the balance sheet, you will see it's just a re-class of the long-term deferred tax asset below. Current assets ended the year at $56.1 million, up almost $40 million from the prior year.

Property, plant, and equipment finished the year at $20.8 million. It's roughly even with the prior number, as the company has invested in new property and equipment. It's roughly offset with its depreciation expense taken for the year. And total assets for the year have finished at $119.8 million, that's up 7.5 million from the prior year's total of $112.2 million.

On the liability side of the balance sheet, accounts payable and accrued liabilities of $6.8 million, is up $500,000 from the prior year due to more productivity driven by some of the new product developments and increased sales levels.

Current deferred revenue of $1 million is up sharply from the prior year due to the sale of more extended warranties in 2006. Deferred insurance settlement proceeds of $509,000 are up slightly from the prior year. And litigation settlement liability of $9.7 million represents the final payment in the shareholder class action derivative lawsuit.

The company intends to fund its final payment of $8 million on the shareholders' equity in cash. We do not want to dilute our shareholders with the payment of stock when we have such a strong cash and investment balance.

Current liabilities are $18.3 million. Deferred revenue, net of the current provision increased by over $1.1 million to $2 million during the year on the strong sales and extended warranties during 2006. Total liabilities of $20.5 million and the company finished the year with $99.2 million in the shareholders' equity.

On the cash flow, as we move on to the information on the cash flow, the company had operating cash flows of $7.5 million for the year compared to $1.1 million in the prior year. Net cash used in investing activities was $3.6 million, as the company invested $1.8 million in new property equipments and a net $1.5 million in investments.

The company used $1.5 million in financing activities, mostly driven by the $2.2 million stock repurchased during the quarter and the stock buyback approved by our Board.

And the company ended the year with $18.8 million in cash, which is up $2.4 million from the prior year with the total of cash and investments of $47.8 million, up $3.9 million for the year.

With that, I will pass it on to Kathleen Hanrahan, our President.

Kathleen Hanrahan

Good morning. 2006 was a good year in operation. When we began the year, we targeted improvements in the areas of inventory control, gross margins, and operating efficiencies. During the 12 months ended December 31, 2006, we achieved a gross margin improvement of 1.7% of sales compared to 2005, inventory reduction of approximately $850,000 with the addition of new inventory SKUs and piece parts for new products.

We completed full implementation of the TASER CAM product, a new product offering in 2006. Direct labor efficiencies improved through increased yields and lean manufacturing principles. And scrap, both as a percentage of sales and a percentage of material converted to finished product declined.

Although gross margins improved year-over-year, we did not realize the full benefit of the work performed. This was due largely to increased cost of direct materials, indirect material or manufacturing cost associated with new product development, and a change in our overall sales mix of products and services.

In 2006, we experienced raw material increases ranging from 5% on petroleum-based plastic products to as much as 10% on key electronic assemblies. To reduce the impact of these increases going forward, we adjusted end user pricing where appropriate and our materials department is working to negotiate longer-term purchase agreements with key suppliers to drive unit cost down.

Shipping and import fees also increased due to rising fuel cost. Indirect labor and supplies increased as we prepared the manufacturing floor for the entry of TASER CAM, the C2, and preliminary XREP production. And we saw increased cost associated with our training program, as we introduced the new curriculum directed toward risk managers, chief of the police, and key agency decision makers.

Results for the fourth quarter were similarly impacted. Gross margins for the fourth quarter declined from the same period in 2005 and from the third quarter of this year. This was a combination of two factors: Reduced margins associated with our sales mix and training program; and increased cost associated with manufacturing, both direct and indirect.

The C2 launch was also a key manufacturing priority in the fourth quarter. Although no revenue was generated during the period, approximately $100,000 or 0.5% of sales was expensed in setting up the new production lines and assisting R&D with prototype and marketing builds.

During the last quarter, we also expensed labor, affecting our overall labor efficiencies as the line operators began training and working with the C2 cartridge and the C2 handheld prototypes. And at the end of the fourth quarter, we wrote-off approximately $60,000 in raw materials, which became obsolete due to process improvements.

We made a lot of progress during 2006 and we are looking forward to great things ahead. As discussed in the last conference call, we hired a new VP of Manufacturing to assume my role as the Lead for Manufacturing Operations. [Mr. Apollo] comes to us with experience in developing and implementing world-class manufacturing systems in companies whose products were integral to General Motors, and who ranged in revenue from $50 million to $160 million on an annual basis. We are excited to add his expertise to our team and we look forward to his leadership in automation of our current processes.

He and a team of engineers and technicians have already begun our first project, which we hope to have fully implemented in 2008. Preliminary indications are, that this fully integrated line, once complete, will assemble cartridges per minute, utilizing a fraction of the direct labor expense now required for the same production.

We are also excited about the response for the new C2 product line and look forward to moving this product family into full scale production in the coming weeks.

With that I would like to turn over to Doug Klint, our VP and General Counsel.

Doug Klint

Thanks Kathy. I would like to give you brief update on our pending litigation. In the Securities Class Action litigation, the court entered an order on December 14, 2006, which gave preliminary approval of the stipulation of the settlement; provided [further] notice of the settlement; set March 5th 2007 as a deadline for submissions to objections and exclusions from the settlement. And set the final settlement hearing date of March 12, 2007 and established April 16, 2007 as a claim submission deadline.

We've got good news to report on the product liability litigation front. The rate of litigation is decreasing. For the first time, we have had fewer lawsuits filed in the fourth quarter. We had seven lawsuits filed in the fourth quarter, which is a marked reduction from the 13 lawsuits that were filed in third quarter.

It's important to note that for the first time we have not had any training injury lawsuits filed and we hope this is a trend going forward. In addition, we had eight lawsuits dismissed in fourth quarter; notable among those was the jury defense verdict we received in the Alvarado lawsuit that Rick mentioned.

I would like to point out that we are still committed to wining these lawsuits that we actually settled with our insurance company in this litigation, rather than allow them an opportunity to offer settlement to the plaintiff. And a paid offer as we ended up with a unanimous jury verdict, which validated our strategy in this case. It's also important to note that we are aware of at least four lawsuits that were not filed against TASER, as a result of our aggressive defense of this litigation. This is the first time we've actually had a net decrease in pending litigations and this is hopefully beginning of the trend going forward.

We've had a total of 32 product liability lawsuits dismissed, through judgment entered for TASER. We have not lost any product liability lawsuit. While we are absolutely committed to winning and we don't anticipate losing any of these lawsuits, our strategy is not depend upon wining every trial, and we have adequate insurance coverage to protect the company against any possible financial loss in the future.

The strongest factor in our favor in defending this litigation is the fact that the plaintiffs have not been able to prove that the TASER device was defective or was the cause of any injury or death. The safety of the TASER device has been well established by over 70 medical and safety studies. In addition, we have over 30 nationally renowned medical and scientific experts who have all concluded that the TASER device played no cause of relationship in any death or suspect injury.

Our strategy is to hire the best world-class medical and scientific experts in all relevant fields. We stand behind the exceptional safety record of the TASER product and we plan to take all cases through trail if necessary. We aggressively defend these cases by filing motions for dismissal and summary judgment as appropriate and we seek sanctions for filing frivolous litigation as the cause arises.

It is our policy not to settle any suspect injury or wrongful death case. Our objective is to send such a strong message to our adversaries by overwhelming them with the strength of our defense, our resolve not to settle that they will be deterred from filling any litigation against TASER in the future.

While we are making investment in winning these law suits, we are also beginning to see a reduction in outside legal fees, as we implement our strategy of easily utilizing our in-house legal team to reduce outside legal services. In fourth quarter, our outside legal fees were $850,000, which was down significantly from 1.90 million in third quarter.

I would also like to point out that, from our customer's perspective, product liability law suits are not a risk to law enforcement agencies. Law enforcement agencies are not liable for product liability litigation. Our customer's battle excessive use-of-force litigation and the TASER device played a very important role in reducing the excessive use-of-force litigation against law enforcement agencies.

Statistics from our customers show marked decrease in excessive use-of-force claims when the TASER devices have been deployed. The courts have routinely held that the use of a TASER device does not constitute excessive use-of-force. Our customers place a very high value on the TASER device in reducing their excessive use-of-force litigation.

With respect to other litigation, I am pleased to report that we've reached a satisfactory settlement in the Stinger unfair advertising lawsuit. In the first quarter, we filed another lawsuit against Stinger for patent infringement. I'd like to point out that we've got a very strong patent portfolio with 25 issued patents and 80 patents pending.

These patents are very broad. They are very basic bedrock patents to the electronic weapon field and we are absolutely committed to enforcing our patents against any infringer. We have in-house litigation and patent attorney expertise to handle any of these lawsuits with a very little outside expense.

I would also like to point out that recently there have been media reports regarding previous lawsuits we filed against ALS and EDT for patent infringement suits. And I would like to point out that, after we filed that litigation, we received assurance from both these companies that they were not going to be bringing these products to market. And we believe that these lawsuits are very instrumental in protecting our intellectual property.

With respect to the lawsuit we filed against our former patent attorney, Mr. Watkins, we did receive summary judgment in fourth quarter, where the court held that there was in fact a breach of fiduciary duty.

It's also important to note that the Supreme Court Commission recommended disbarment of Mr. Watkins as a result of his actions in this matter. We have a hearing coming up in February 28 on our motion for equitable assignment of any of his claimed patent rights, and we intend to pursue this action fully to completion.

We also filed a lawsuit against Bestex for patent infringement. The court granted both parties motions for summary judgment and this case has been dismissed. I would like to point out that before we filed this lawsuit, we sent a letter to Bestex demanding that they cease and desist, asking them to contact us regarding their level of inventory going forward to discuss this matter. We received absolutely no response. We were forced to file this litigation.

In the course, the discovery was turned out that they were selling inventory in 2006 that was actually purchased back in 2001 while they still had a license. It was also disclosed to us that they only had 11 units left in the inventory. We determined it was not worthwhile continuing this lawsuit for 11 units, and we felt we had mission accomplished at that point.

We also have two pending lawsuits against medical examiners, one in Indiana and one in Ohio for errors made in the autopsy. And we are going to continue those to completions as well.

Now, I would like to turn the call back to Tom Smith, our Chairman.

Tom Smith

Thank you, Doug. I am going to talk about the sales accomplishments during the fourth quarter. And let's start with agencies. During the quarter, we added 709 new agencies, bringing the total to 10,567 that are either testing or deploying our product. Out of those customers, we added 313 of our existing customers to hold deployments, bringing the level now to 3,346 agencies with full deployment, meaning every area petrol officer is carrying a TASER that's roughly 31.5% of our existing customers. So again, there are still very good growth opportunities, both in customers not carrying our products as well as existing customers that are continuing to expand their deployments.

During the quarter, we had about 21.5% of our sales in the international market space, which if you look at the year-to-date basis on the international that represents 13.7% or roughly $9.3 million of our revenue during 2006 occurring overseas.

In terms of the unit sales, during the fourth quarter we sold 15,696 of our X26 units. That's down from the previous quarter with 17,196. But what we did see is an increase on our cartridge unit sales which went from 232,068 in the third quarter up to 273,835. That did change our ratio of cartridges during the quarter from the third quarter where we had 13 to 1 cartridges; the fourth quarter saw roughly 17 to 1. And again, we do expect to see that continue to increase as we go forward, as there are more existing units out there and officers continue to train and use on the cartridges with the existing as well as new unit purchases.

I will also touch on the M26, our other product line. The sales went from 1383 during the third quarter up to 1,719 during the fourth quarter, as that product line is still being used by agencies in the marketplace today.

We will also talk about the TASER CAM and why sales were lower than expected. We do still see units going out there. During the quarter, we sold 3,118. That's up from the previous quarter. And I think very significantly earlier this year, we saw a fantastic video from the TASER CAM that was put out, I believe out of Kansas City.

It was demonstrating how the officers were facing a situation where when they opened the door with a suspect, they were facing a mental suspect that had a very, very large butcher knife. They've given commands to drop the knife. He didn't do so. And again, it demonstrated the use of the TASER capturing the scene as it was occurring allowing people to see the successful use of the product. And I think one of things that has contributed to the adoption of this, as the agency is looking at policy and implementation of the accountability of the TASER CAM. Rick touched on it earlier, it has been a very good return on investment for us, but it is a product area with video that we have not gone into before and we are still seeing continued growth in that area.

During the quarter, we also attended our largest law enforcement trade show. Dan touched earlier, the International Association of Chiefs of Police, which was held in Boston, Massachusetts in October. Again, there was a big emphasis put on the TASER CAM product during that trade show and a very good reception. Again, getting a lot units out for tests and evaluation and those are continuing to go forward.

We also continue our Chiefs Course program, which is really designed towards the administrative and executive staff, as well as the attorneys for the different cities. During the quarter, we held them in both Toronto and Oakland, very well attended courses, as we continue to discuss risk mitigation and other issues that are easily interested at the Chief's level.

Earlier, I talked about the growth of our international markets. Obviously with over 20% of our international, is coming out of the fourth quarter in France as well as other countries. We are putting a refocus on our international growth and markets and we are actually in the process right now of recruiting for a Vice President of International Sales. That recruiting process is being head by Kathy. We deem that to be a very, very key strategic hire for us going forward.

[Joe Apollo] was a fantastic addition to the team to run the internal operations area for us. We are very excited about him and very we are very excited about the opportunity to get in a Vice President of International Sales, as international continues to be a key part of our growth, as we go into 2007.

And I think it is a key to note that we have crossed over the 250,000 point in terms of total number of TASER security being used by law enforcement in over 40 countries around the world.

So, as Rick said our R&D teams are very busy. We introduced the C2 electronic TASER Personal Protection System at the CES and SHOCK Shows in January. That product will be coming out during the second quarter. There will be no revenue from that product category during the first quarter. And we will spend some more time on our next conference call in about 60 days talking specifically about that product.

We also will not be giving any guidance for the year 2007, just in case there are any questions on that. And again, we really like to focus on the fact that I have been asked, because I have been traveling around, people were trying to figure out was 2004 or 2005 the year, [of the anomaly], and I think we have demonstrated that basically 2005 was a year taken away from us and we are back on track now. We've come out with our best quarter in our history in the fourth quarter. Our best year, in 2006 in our history and it's onward and upward as we are now looking to expand our technology that's about protecting lives and really making a difference in the world and in our communities and expanding that into other markets. But, Rick and the design team have got some really exciting products coming out with the C2 coming out of the closest.

So with that, obviously we are very excited about the year and we would like to ask our host Tuwanda to go ahead and open up this call to any questions that people may have. And also to stay tuned that in April on the third week, we will be doing our first quarter conference call to discuss the first quarter of 2007.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Mr. Eric Wold with Merriman Curhan Ford. Please proceed.

Eric Wold - Merriman Curhan Ford

Hey. Good morning, everybody. Couple of questions on the C2 launch, you are not looking for guidance, but can you give us just some overall thoughts now that you've had a couple shows and you've spoken to distributors, what the initial read looks like from distributors on potentially how many doors this could get into in the second half the year? And then also, obviously, you've been taking preorders on your websites from consumers, give us sense on potentially even how that looks?

Dan Behrendt

Well, we are not going to give out any numbers in terms of the orders that have been received from the website. But I can tell you from the distribution side, the response has been fantastic. Obviously, we've got a lot of coverage at the shows, introduced a product that's been asked for by the consumers. That product was really designed for the consumer. Over the last several years, even though we've been selling to consumers since 1994, our focus since 2000 has been law enforcement and taking a law enforcement product and rolling it over to the consumer.

This one was designed from the ground up for the consumer marketplace and I think we really did meet the needs of the requests that have been out there for that. And I can tell you, we've had a lot of large box retailers that have never shown an interest in the past, taking an interest and taking a look at it. But we have not done anything in terms of putting out numbers, putting out any projections at this point, because we use the show to kind of wet their appetite and get into those discussion points. And at this point, that's where we are out. It's really talking to those different distributors.

Rick Smith

This is Rick. Let me add a little bit of color there. I think what we have seen so far, really for the first time, I would say, in our history, we have a consumer product where even the CES individuals walked right up and whipped out their credit cards to buy it, which was very encouraging. But I'd also temper that the challenge now is going to be establishing distribution, finding where this fits in the distribution chain. And we have already started some talks with the big box retailers. By no means are those concluded or conclusive yet, as you could imagine, because TASER is so high profile, there is some trepidation certainly from certain types of retailers about whether or not this is a fit. I think it's pretty clearly a good fit for major firearm retailers.

I would say we have no problem getting into that channel. But for us to really take advantage of the C2's potential, we are going to have to be able to mainstream it into more mainstream distribution. And I don't want to tell you that that's done yet. There is still lot of work to be done, as we move into the second quarter. We are seeing some encouraging signs though. But again, one of the reasons we don't want to give out a lot of numbers at this point is I think the best characterization is giving you sales into distribution is not going to be particularly helpful until we actually know the consumer is buying it. So I think the best characterization, like we said before is, we are in uncharted waters with great opportunity, but let's be cautious and not get carried away on the front end until we really prove it out and the products move into distribution.

Eric Wold - Merriman Curhan Ford

Okay, fair enough. And one more follow-up question. When I look back to the price list you guys put out at the end of December, talking about the $2.3 million in international orders, did you guys say, there'd be anticipation of even more orders in the fourth quarter? Can you give a sense of what might have not hit, maybe not name specific names, but what might have not hit in the fourth quarter if that has in fact rolled in the first half of this year and what you thought might have hit in the fourth quarter, have they already been hitting so far this year or what's your expectation there?

Dan Behrendt

Well, yes. And obviously, for competitive reasons, I don't want to give those out there to give them any direction. But one that is out there that a lot of people have been following and looking at is obviously the LAPD that one is one that we continue to work on with them. We have heard the Police Commission approval there, but there is still a long way to go. It still has to go through committees, city councils, budget years. And as you know, the cities are strapped for cash with that.

So the timing of when that's going to occur? We really don't know. But that's just one example that obviously has been out there. And there are other ones that are in a similar position that are large customers' force that we continue to work with. So where again, it's a business that's really tied back to the government.

They want the police to make the decision. You still have to go back through the city council, through funding, through public safety subcommittees in trying to figure out that process, and exactly when that's going to occur is a challenge. And we continue to work on that. And we just want to make sure people understand that we are focused on them. But the anticipation that they are going to come right away is something that we are not going to put out there for competitive reasons or try to get the timing of a vote by government to approve that process.

Rick Smith

This is Rick again chiming in. In the fourth quarter, one thing you didn't see a lot from us, were press releases on individual orders. And as I look back frankly preparing for those conference calls, I shared with Dan and we had talk about that. And it's good and bad news.

The good news is we've just got lots of small orders in the quarter than in aggregate took us to a record. Some of the bigger ones we were working on slipped out on us and we didn't get them in the fourth quarter. And frankly you would have seen the press release; we've gotten them already in the first quarter. So, we are pretty confident that these, particularly LAPD and some of the other big ones that we're working on, they were through the primary selection hurdles and now it's the mechanics of getting the financing to purchase across the finish line.

But I think also, when we put that press release out, we wanted to be careful and send the message to our shareholders that at that point based on what we were seeing in the business, we didn't want people to make that an expectation without giving the incremental to expectations at the current point in time.

As you know, with our business, we don't give guidance because it's so hard to predict. And with Regulation FD we've got to be very careful in how we set the street's expectations. And I think the line in which they were done is exactly what it was intended to do. These are some big orders, but let's not get carried away and now people expected it on top of current expectations.

Tom Smith

Yeah, I think again with everything that we've gone through in 2005 really shows that, bread and butter, the smaller agencies out there came back in 2006. They put their programs back in place. And then another conversation we are having with Dan earlier is, during the year of 2006, we only had in the mid 70s number of orders that were over $100,000. So, it's really the bread and butter agencies, the mainstream customers that were out there that we didn't get in 2005, came back in 2006. We didn't have a year reliant upon two or three very large orders that really carried the day there.

And internationally, it's been running and growing for it. It went from 10% to 20% during the quarter for an average of 13% for the year. We've talked international for a long time. It's a long curve for adoption, as you have one decision maker for the entire country. But the good news is it continues to progress.

Obviously I think with France, Rick mentioned this during call; we're going to see a little slowdown there because they are going into a presidential elections that happens in May. And I don't think you are going to see anybody want to really rock the boat there with a huge deployment going into presidential election. So, we'll see some activity there, I think in the latter half of the year.

But those political situations do have an effect on our business. But we do see continued growth internationally. We are going to be hiring a Vice President of International, because it is a key to our future, and we want somebody dedicated at the highest level of the company for that particular market space.

Eric Wold - Merriman Curhan Ford

Perfect. Thanks guys.

Tom Smith

Thanks Eric.

Operator

And your next question comes from the line of Mr. Matthew McKay with Jefferies & Company.

Matthew McKay - Jefferies & Company

Hey, good morning guys.

Tom Smith

Good morning.

Matthew McKay - Jefferies & Company

Focusing on the US law enforcement first of all. First of all the X26, do you think that growth rate can accelerate a little bit in '07, or [are already], more at a stable growth rate and then also with the TASER CAM, I am assuming you will probably expect to see a little bit of acceleration in the growth rate there, given that you didn't get that much in '06?

Tom Smith

I'd say on the X26, you are going to see a stable growth rate and on the TASER CAM, I do think we will expect to see that to continue to accelerate, especially as more videos come out, like that one out of Kansas City, it's on our website, if you haven't had a chance to see it. But that is just the prime case right there for why you want to have that video ability. It's showing what the device saw; how it was used, the guy with a butcher knife, not a whole lot of other options, very confined space. So, I do think you are going continue to see that grow with agencies [trying to come] in your grips, with how the policy implementation is going to be. So, we do expect to see TASER CAM continue for us, and as Rick said, it has been a very good return on investment for us.

I will just add real quick, just on the C2 issue. It's one of reasons that right now we are not real comfortable giving some of these preexisting numbers, pre-launch. As you recall, before the TASER CAM launch, all of our expectations, based on market feedback was a faster ramp than we saw, and at the end of the day, it took a little longer. So again, we are just trying to make sure expectations don't get ahead of reality on the C2.

Matthew McKay - Jefferies & Company

On international Law Enforcement. I don't know in how many countries it is right now, but can you give a list of the countries that are at some stage, either piloting or rolling out the TASER program?

Tom Smith

We have 40 countries out there that are at various stages of it. And I would say that all of them really, other than the UK and France, are at the pilot stage. We've talked about there is thought leaders in each region of the world in the past and I think they are continuing to evaluate and moving forward with those programs. And as you see continued success on adoption in the larger countries, being UK, France, Australia, South Korea, those types of locations, I think you are going to continue see the other countries in those regions follow their leadership. And an example of that is New Zealand. New Zealand is much closer to UK law.

They are down there in Australia; Australia was kind of a year or two ahead of them. And in September of this past year, they finally came onboard, started a program and have had tremendous success in the use of the TASER. They've averted several shootings that could have gone very bad for them and the Police Department has done a very good job of educating. And I think that really came about because of the success that they were having and because of the success in the United Kingdom that you are going to continue to see other countries come onboard and drive the program. But in some place like New Zealand, they are going to be in the trial period with the number of chases they have for at least a year.

Rick Smith

I would like to chime in as well. This is Rick again. Again, its not that we have great fascination with secrecy, but we have seen in the past when we made public where we have pilot programs ongoing. There are certain political activist groups that have made TASER a fund raising cause that have got in and they have goofed up orders in (inaudible) and we've just found that strategically it's not in our best interest to give them a hunting list to go, try and cause political trouble or disrupt the deployment process.

Tom Smith

In fact, in New Zealand they have an organization with our name and that was opposed to the use of the product with $1 as a member. So, as Rick said, we are really trying to make sure that we want these countries to advance and go on to the merits of the program and not have an emotional or political response because of something that they may have read that's not true in a newspaper.

Matthew McKay - Jefferies & Company

Okay. Fair enough. And turning over to the military, is there anything brewing in the military that could come out over the next year or anything you can talk about?

Tom Smith

Well, I think just the TRAD we introduced it at the AUSA trade show last fall, there continues to be a lot of interest in that. But again, with the military, there is a lot of red tape. So to really predict anything there, I think would be putting the cart ahead of the horse.

Rick Smith

Our new advisory board has really being helpful in getting us to understand the processes of getting things approved and our long-term strategic direction. The demand from the user level certainly is great. Everybody we are showing the TASER capability to, in terms of men in the field, Special Forces guys who have gone through training.

In fact the other day, I was just reviewing a bunch of feedback forms from their training, and extraordinarily high interest. It's just we've not been able to necessarily overcome the type classification issues and some of the bureaucracy.

I wish we could give you a better read on it, but at this point, we just don't know when we will be able to get through that, and that's what is going to take to get significant orders, will be to get through the type classification and procurement process.

Matthew McKay - Jefferies & Company

And then just on some of the execution of the consumers market. Are you going to announce when you set up new distributors, maybe some big box distributors when you actually sign a contract with them?

Tom Smith

I don't think we will be doing it exactly when we do a contract with them per se. I think it's going to be more around the event as we get closer to the actual hard launch date in the second quarter.

Obviously, we need to do a very good job of making people aware of where they can go to see this and get this, because it's a very visual product. But I don't think it helps us right now to talk or do press releases on contracts until we really see that revenue start coming in the second quarter and actually we are shipping product and doing promotions with those customers, so that they know where to go from a retailer perspective to purchase the product.

Matthew McKay - Jefferies & Company

Okay

Rick Smith

When Tom says hard launch what we are looking at doing is we have not yet selected a firm date. We are just firming up a couple of issues as far as production and design finalization before we do it.

But once we have got our feet on it, we will announce a hard launch date with the concept being that we would like to build up media interest and awareness and then make those announcements at a time when that publicity can actually translate into consumer action.

So, we are probably closer to launch date, so it's driving people to the stores rather than getting some media attention early on. But at this stage, we can't turn that attention to action.

Tom Smith

Similarly as they do when announcing a DVD movie coming to a store, available at a date in a future, we will be doing that as we get close to the launch date.

Matthew McKay - Jefferies & Company

Okay. And you say second quarter in the press release, but is it sort of April or are we looking more June at this point?

Tom Smith

It's somewhere right in between. We are looking at May. But there are some things you can slide it out to June. I wouldn't see it moving forward to April, just because we have got to get the parts and things moving through the system. So, best estimates right now are May.

Matthew McKay - Jefferies & Company

Okay, in May you would expect to have lot of the distribution channel set up outside of -- for example, the fire arm distributors, but having some big box distributors in there as well?

Tom Smith

Well, we are working on it. I am not sure that we will get -- most of those folks move their logistics training, which allow them to get in board by May, certainly by summer. I think we are hopeful we'll have partners of note by May. We certainly believe we will have significant distribution in the fire arms industry by May, but not sure that we are going to be able to get the huge big box guys moving that fast.

Dan Behrendt

And our intent is to have, on that hard launch date, literally products on the shelf. So that's I think, when Rick is talking about getting these guys up to speed to work through the change and logistics, I think some of the smaller tier-2, tier-3 big-box retailers will be a part of that. But to have a tier-1 participate that quickly is going to be a challenge and we still have ways to go with discussions with them.

Rick Smith

It will be the second half of the year. We've had the chicken and the egg discussions here about that we hold the launch until we get a major retail partner or not. And we have come to a conclusion. We don't think that's the right strategy. We think the excitement of the launch will help drive the decision making process of getting some of the bigger retailers online. Frankly, in the firearms industry alone, we think we've got a pretty good [visibility], sufficient distribution to get the launch rolling, and then hopefully build steam and see the big-box retail in the second half of the year.

Matthew McKay - Jefferies & Company

Okay. And then just on the marketing; is it going to be TV, print, radio? What's the strategy on the marketing side?

Rick Smith

Primarily print at this point. Although, we are also looking at doing some direct response television, that's by no mean has been decided yet. We did do a 30-minute infomercial back in the 90s. At that point, it was not a commercial success. We would proceed to on some limited basis from our tradeshows and a couple of consumer tradeshows, and events we've done, we've seen a positive return basically for the dollar spend for the event versus orders written, which tells us, we think there might be a direct response channel. And obviously that gives us a little more channel control.

We also feel that given the nature of TASER and the complexity of our devices, the educational elements have been able to do like a 30-minute direct response paid advertising program to make some sense. But we are really just starting to research that now. Our real focus has been on retail and most of the retail will then drive through print, at least in the early days. Only once we had significant retail presence, we think it would support the economics of going to TV, 30 or 60 second in TV promotions.

Tom Smith

And as we're evaluating those obviously I think in 60 days during our first quarter conference call we'll be able to address a lot more of those issues without waffling on which direction we're going to go.

Matthew McKay - Jefferies & Company

Fair enough. Turning over to actually the manufacturing. I think you talked about some automation that you are looking to put into the manufacturing. If you could just press that out a little bit? Are you actually building and designing new machines to help with the manufacturing capability or what exactly are you doing on that side?

Kathleen Hanrahan

The VP that we hired, one of the major reasons that we hired him is his experience with helping to design and implement automation equipment. So, what we're working on now is the specifications we met with five key automation builders across the country. And they are working on the design specks now that include both quality and the quantity of cartridges we want to see coming off the machine itself. So, we're hoping to round that into final stages and kick somebody off to get that equipment started in Q2. But again, we don't expect to see the impact of that until the middle of 2008.

Rick Smith

We are going to look at several options. We're evaluating full scale automation or fully automated production line, also versus the sell automation where it would be sort of a high grade between our current processes which are largely human operators versus full automation. In the next probably 60 days we should get the quotes back and then we can run the ROI analysis and see how much automation really makes sense.

Tom Smith

And be clear, that's being done by experts. That's what they do for a living. That's not what our R&D teams are doing.

Kathleen Hanrahan

Correct.

Matthew McKay - Jefferies & Company

Fair enough. And what kind of capacity would that creates in your current facility?

Kathleen Hanrahan

What we are looking at right now is the piece of equipment, just if we looked at 2006 level, the fully automated actually produced all of 2006 on one shift of the equipment with higher quality and better yield. That's no overtime. The impact was pretty dramatic and it also takes a lot of the labor out of the process.

Dan Behrendt

So it's several, probably tripling or quadrupling of our cartridge capacity. And that's where we are going to start, because that's where the majority of our labor content is currently; on the cartridges, that will be our first project.

Matthew McKay - Jefferies & Company

Okay. And then lastly, you are going to start to generate a lot of free cash flow here; it looks like. Just wondering, what are you expecting to do with the cash, if you are looking at any acquisitions or stuff of that nature?

Doug Klint

At this point, obviously we've got some short-term needs with the final payment on the shareholder lawsuit to be made quarter earlier, in the next six to eight weeks. And after that we intend to invest heavily back into the R&D, back into the business, and build out some large cash balances. At this point, we are staying [serenely] focused. We think we have got a lot of opportunities in front of us with our internally developed products and that's really going to be the focus, at least in the short term.

Rick Smith

It's not just (inaudible) acquisitions, but we have to really make strategic sense, especially with the explosion in private equity over the past few years. There is a lot of folks that are really good at going out and screening the acquisition opportunities. We are frankly not one of them, that's not our business, just going out and doing rollups. So for us to compete in that space, we would have to see an acquisition that really fits with us strategically, that creates new value. And we are certainly open to that, but we are not out, running around just looking to buy companies at this point.

There are such good opportunities for internal growth. If you look at the X26, I just presented this to our Board last week. The X26 cost us roughly $1 million, $1.5 million to develop. And over a five-year life, it has already generated well over $100 million in revenue, which we made in accessories. Those types of returns are hard to find outside. And we think we've got a couple of more opportunities. Again, we don't know which ones are going to hit of the four or five significant R&D projects we've got ongoing.

I am hopeful of one homerun, a couple of triples, and we will have some singles. We may have one or two to strikeout. But, internally we think they are a very good place to deploy our capital. But it's not going to be enough to [chew] into our balances, we expect there to continue to grow. We will maintain them on our maintained cash. We have been very careful with it until we get to a point, where if it becomes excess, then we would certainly return it to shareholders. But, we think again given the unpredictable nature of this potentially dynamic and explosive growing marketplace, there is a real option value to those having that cash should, we need to move on our acquisition opportunities or some other competitive opportunities. But in the meantime we are really focusing on organic internal growth.

Matthew McKay - Jefferies & Company

Okay, great. Thanks a lot guys.

Rick Smith

Thank you

Dan Behrendt

Thanks Matt.

Operator

Your next question comes from the line of Mr. Rick Ryan with Feltl. Please proceed.

Rick Ryan - Feltl

Good morning. Just following on that question, what's the buyback program? What's left under that authorization?

Dan Behrendt

Yeah we still have $7.8 million open on our buyback program. We bought $2.2 million of stock, 300,000 shares and the Board has approved for us to buy up to $10 million.

Rick Ryan - Feltl

Okay. And then, Tom getting back to the camera, even though it has taken a little longer, it has had nice ramps since Q2. But, can you talk about the end users, if my calculations are right, it's around 7,300 have been sold. Is that too a handful of customers or you are seeing that broaden out a little bit?

Dan Behrendt

No, it's definitely broadened out and we have a lot of them out there where there are 5 or 10 at different departments and they are putting them out on the street for evaluation. So, that's why we are talking about the adoption being slower than expected. It does go through a review phase. They do put these out on the streets. And they want to get a number of videos and they want to see the impact by the users on these and so they are spread out quite a bit over a number of different customers.

Rick Ryan - Feltl

Have any customers come forward with complete procedural issues that have been nailed down that other agencies you are looking at?

Dan Behrendt

Oh, yeah, absolutely. There were a number of things out there where they had to make sure that, from the documentation standpoint, if the fight wasn't caught on film, that they didn't have to fight again prior to the use of the TASER. So they definitely work through a lot of those policy issues. So, they may have done a test and revised the policy. Then we have done a test under the new policy, and the departments are talking among themselves and sharing that information because again they are the experts in use-of-force and in policy, and they are the ones that are putting that information out.

Tom Smith

Most of the county sheriffs here in Arizona are biggest. Amongst the main, we do have a little over 2,000. So they have been the first people who are moving a big way Sheriff [George Paw] here locally is well known as an innovator and they saw the value of putting these out and being the first in the country to move in a big way. And we certainly applaud that and the rest of it though is mostly on in T&E, which is also encouraging because T&E is where you plant the seeds to grow, and lots of units out in testing and evaluation.

Rick Ryan - Feltl

Okay. Kathy, in your presentation, did you say you've adjusted your end user pricing, and if so, which units?

Kathleen Hanrahan

It's on the cartridges. We effectively had a $1 per cartridge price increase that was implemented January 1 of this year. That was to help offset some of the cost we saw on the materials on those products.

Rick Ryan - Feltl

Okay. Any push back on that?

Kathleen Hanrahan

Did we get any push back? Very little, and the one thing I just want to temper that with is we got some longer contracts with some customers and those prices will remain intact throughout the period of their contract. So, some of the larger agencies won't see that increase fall through for few years out.

Rick Ryan - Feltl

Okay. On the camera production side, how is your yield on manufacturing?

Kathleen Hanrahan

Pretty good, we are actually doing very well. At the end of the year, we had 90% yields across 20 of the 22 production lines. So we are doing quite well.

Rick Ryan - Feltl

Good. One last one for Doug, Doug is there any high profile cases on the horizon that we should keep an eye on?

Doug Klint

Not really, most of the cases we have filed against us are really frivolous cases. They are guys that got hurt during the fall and we have got several where they fell out of a window. These are the things that we have been warning against for years of just common sense. So, we don't really see any high profile cases coming up certainly in the next year that we are very concerned about.

Rick Ryan - Feltl

Great, thank you, guys.

Tom Smith

Thank you.

Kathleen Hanrahan

Thanks.

Operator

This concludes the question-and-answer session. I would now like to turn the call over to Mr. Tom Smith for closing remarks.

Tom Smith

I would like to thank everybody for taking their time this morning. Obviously, we put a wrap on a very exciting 2006 and we are going to be trudging ahead. We will talk to you in about 60 days to discuss the first quarter 2007. Thanks so much, we will talk to you soon. Bye-bye.

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