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Executives

Rick Smith – Chief Executive Officer

Dan Behrendt – Chief Financial Officer

Analysts

Eric Wold – Merriman Capital

Paul Coster – JPMorgan

Steve Dyer – Craig Hallum

TASER International Inc. (TASR) Q2 2011 Earnings Call July 28, 2011 11:00 AM ET

Operator

Good day, ladies and gentlemen. And welcome to the Second Quarter 2011 TASER International Earnings Conference Call. My name is [Natasha], and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions)

I’d now like to turn the call over to Mr. Rick Smith, CEO. Please proceed.

Rick Smith

Thank you. Okay. Welcome everybody. Before we get started, I’m going to pass to our CFO, Dan Behrendt for the Safe Harbor statement.

Dan Behrendt

Yeah. Good morning. Safe Harbor statement, certain statements contained in this presentation maybe deemed to be forward-looking statements as it defined by the Private Securities Litigation Reform Act of 1995. 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, expansion of product sales to the private security, military and 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 these statements are qualified by important factors that could cause actual results to differ materially from those reflected by the forward-looking statements herein. Such factors include, but are not limited to, market acceptance of our products, 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 of the markets in which we compete and accompanying demand for our products, potential delays in international and domestic orders, implementation risk of manufacturing automation, risks associated with rapid technological change, execution and implementation risks of new technology, new product introduction risk, ramping manufacturing production to meet demand, litigation resulting from alleged product related injuries and deaths, media publicity concerning product uses and allegations of injury and death and the negative impact this could have on sales, product quality risk, potential fluctuations in the quarterly operating results, competition, negative reports concerning TASER device uses, financial and budgetary constraints of prospects and customers, dependence upon sole and limited source suppliers, fluctuations in component pricing, risks of governmental investigations and regulations, TASER product test and reports, dependence upon key employees, employee retention risks and other factors detailed in the company’s filings with the Securities and Exchange Commission.

And, with that, I’ll turn it back over to Rick Smith, our CEO.

Rick Smith

Thanks Dan. Okay. I think the interesting story this quarter particularly is about cash. We generated almost $5 million in cash and we’ve announced in addition to the $12.5 -- $12.5 million stock buy-back we just completed that we’re beginning another, up to $20 million cash buy-back.

Revenues for the quarter were $21.2 million, up 11% over last year and we saw our TASER X2 that we announced this quarter and we just began shipping in the last two weeks generated $1.4 million of sales in the quarter.

Gross margins improved to 57.7%, but the real impressive figure here in my line and a lot of credit goes to Doug Klint and his team that run our Hardware Operation. The margins in our core electronic control business were 63.8%, before you take on the data center operations and software maintenance. Operational costs to breakdown to 57.7%. So a lot of the operational focus on tuning our business unit-by-unit, I think is paying off as we seize operational efficiencies.

SG&A down about 10% over last year, again a lot of focus on the cost controls.

R&D down 8.6% over the same period last year and anytime, I talk about R&D, I also like to point out, we are getting more out of R&D now than we ever have even though our spend level is down. The TASER new development process has really been refined over the past 12 months.

The X2 was developed, frankly, for a fraction of the cost that it took us to develop the X3 a few years ago and the variable cost of goods of our product is dramatically lower than the X3. The quality is -- and reliability is higher than anything we have ever built.

The process changes we’ve made, I cannot overstate how important they are. I think really as we move from 2003 to the present, we went from a small company to a very small entrepreneurial engineering team. As we scaled, we had hiccups and some missteps along the way but I think we’ve now really hit our stride where I would say we’re getting world class engineering team and process that’s able to take the voice of the customer, ingest it, convert it into products, make sure we go through a world-class validation quality and testing and design verification program and bring those products to market. So that is going to be one of the key core competencies of this business allows us to create shareholder value over the long-term.

Adjusted operating income, which basically takes out a lot of the noise and non-cash items such as amortization, asset impairment, et cetera, so if we look at in some of the core operations of the business, let’s see, we generated $4.2 million this quarter in the suggested operating income up over 450% over the same period last year.

Now on a GAAP basis, loss for the quarter was $5.1 million that included, obviously reserves for some different items that I’ll talk about as we move forward here.

One of those reserves was related to the Protector concept and product. We recorded a $1.4 million asset impairment charge, we have abandoned that business, last year when we went into it, we approached Protector as sort of an option on a potentially very large market in terms of cellular and mobile safety products.

What we learned along the way, frankly, was that for all of the public attention around the issue of distracted driving and there going to have number of startups and a number of other companies have entered the space. We’re not seeing that that is a market that is actually turning into a revenue market where there is sufficient demand to justify the focus of our team.

So, as part of our efforts to really again focus on tuning and running the business for profitability, we made the determination and we did obviously engage for a period of time in looking for various partnerships or ways to monetize some of our investment in Protector and we came to the conclusion that those efforts were not going to proof is better to get management at all levels truly focused and so we have abandoned the Protector business.

Next item, we did have a set back this quarter in the Turner case in North Carolina. We got hit with what we consider to be a runaway jury verdict of $10 million of which our insurance will cover the majority if it is paid, because it went over our main insurance balance we’ve recorded a $3.3 million charge in the second quarter.

Now the last time this happened to us was the Heston case back in 2008 and Heston, we were originally hit with around $7 million in total damages. We succeeded in post-trial motion, including an aggressive appeals process and literally just in May of 2011, just two months ago, we prevailed in vacating three of the four monetary awards and the Heston damages were dropped from $7 million to around $200,000, so a significant victory for us on legal front.

In the Turner case, we believe, number one it was truly a tragic and sad incident that occurred. Our hearts do go out to the family. We understand that it has been a very painful experience that does not change our assessment that we believe in this case emotion overruled the science.

I should caution that we shouldn’t just assume that because we lost – that we won on the last round with Heston in terms of post-trial motions in the field, those are generally considered long shots in the general sense from a legal perspective. However, our level of confidence is pretty high in our post-trial proceedings in Heston, I’m sorry, in Turner.

So anyone who is interested in reading why we would have some confidence that we have very strong legal arguments that that $10 million should either be overturned or dramatically reduced or even trial ordered. You can go to taser.com/rule50, that’s taser.com/rule50. And there you can download our Rule 50 Motion that will lay out in detail the legal and scientific arguments about that case.

Okay. Moving on. This quarter as I talked about we generated almost $5 million in cash from operations. We did complete the $12.5 million stock repurchase.

Cash and equivalents and investments at the end of the quarter were around $38.5 million and we had no debt reported on the balance sheet.

We approached our board on, I believe it was just this week to – we’ve been -- we believe our business is hitting a level again where we’re really tuning in our operations and we’re seeing a little bit more predictability in the business.

And we’ve determined that we don’t need as much cash as we have on the balance sheet in order to run the business and that the disciplined thing to do is to return more of our cash to shareholders and accordingly we have approved an additional $20 million buy-back that will begin when the window opens in a few days.

And with that, let me turn over to Dan, but just to add it up so there is no confusion, we completed the $12.5 million and we have approval on another $22 million received an amount, what could be a total of $32.5 million of share buy-back this year, of course that depends on market conditions and our ability to buy subject to the trading restrictions. But obviously we’re returning a lot of cash to shareholders, something that we’re proud of and we’re proud of the cash generation capability of the business. Dan over to you.

Dan Behrendt

Yeah. Thanks, Rick. I’m going to go through the results for the second quarter maybe just a little bit more detail. As Rick indicated, revenues for Q2 were $21.2 million. These were up approximately $2.1 million or 10.9% from the prior year.

The increase was driven mostly by the introduction of the X2, which generated about $1.4 million of sales during the second quarter.

And as a result, North American sales for the second quarter are up approximately 8% over the prior year results. International sales were also up sharply over the prior year due to sizable follow-on orders that we announced during the quarter.

The gross margins of $12.2 million or 57.7% of revenues were up 7.3% as a percent of sales over the 50.4% for the prior year and again following the complete loss of commercial loss of Evidence.com during the second quarter of 2010 we are recognizing the cost of service up in gross margins. The impact of that was $1.3 million this quarter or 6% of sales.

So excluding those costs for the cost of service delivered, the actually hardware part of the business had gross margins of 63.8% and they are very strong for the quarter. They were actually favorably impacted by the product mix including the introduction X2, which actually enjoyed a very strong gross margin as well with some of the other ECD products. We also had better absorption or a fixed overhead and lower scrapped and obsolete inventory expenses.

The SG&A expenses for the quarter of $9.1 million are down somewhat $10 million in the prior year. SG&A as a percent of sales were 42.8%, compared to 52.2% for the same quarter last year.

The SG&A is down due to reductions in salaries and benefits, stock compensation and professional services offset by higher sales and marketing expenses in the quarter due to the TASER user conference which we had in the second quarter of this year. Last year we conducted that conference in the third quarter and also the product launch expenses around the launch of the X2.

Research and development expenses of $2.8 million for the second quarter, which decreased $300,000 roughly compared to 2010. Again, it was driven partly by moving some of the costs that were around the data center up from R&D, up into cost of service delivered but we’ve also seen a drop in salary due to headcount reductions, lower consulting costs and reduced scrapping sets.

And those benefits were partially offset by some of the late stage development work on the X2. But as Rick indicated, we feel that the R&D department is really running operationally very well and we feel very good about the new product introduction process here at TASER.

We did have a number of unusual items that were recorded in the second quarter results, excluding the $3.3 million charge that we recorded in the second quarter due to the adverse jury verdict in Turner, Rick talked about our field process there.

We also recorded $1.4 million of asset impairment charges related to the decision to abandon operations of our Protector product offering and additionally we recorded about $800,000 charge to write-down property equipment that was just had deemed to be surplus in Evidence.com product line. There’s some extra equipment there we were no longer going to use and we took a write-down of that equipment for about $800,000 this quarter.

The adjusted operating income, which excludes the impact of stock-based compensation, depreciation and amortization, the litigation judgment expense, asset impairment and the loss or write-down disposable property equipment, basically a proxy of cash earnings was $3.3 million for the quarter. This is a $4.2 million improvement over the same quarter last year where we actually lost $900,000 on that same adjusted operating income basis.

GAAP loss from operations for this quarter was $5.1 million, compared to a loss last year of $3.4 million. I know it was a bit of a challenge this quarter with all of the unusual events but if you peel back the onion to get to normalized earnings, we actually felt very good about the results this quarter given the sales levels that we had.

The net loss for the second quarter was $2.3 million or $0.04 a share on a basic and diluted basis. This compares to loss of $1.4 million or $0.02 a share on basic and diluted basis last year.

Now moving onto the balance sheet, we finished the quarter with $38.5 million to the cash, cash equivalents and short-term investments. This is down about $4.2 million from the year end balances but that is mostly a result of the $12.5 million cash we’ve used for the buy-back during the first half of this year offset by the $9.2 million of cash provided from operating activities.

Accounts receivable of $10 million were actually down about $3.6 million from the prior year end balances due to some timing of the sales and the second quarter sales versus the fourth quarter sales. We continue to actively manage the working capital here in a very active way.

Inventory at $16 million for the quarter for the period ended June 30th is also down $1.8 million from the year end balance.

Our prepaid assets of $3.5 million were actually up $1.5 million driven mostly just by prepaid insurance premiums and the investment and property equipment of $31.8 million is down $4.1 million. Basically the decrease is mostly the result of the $4 million depreciation expenses offset by the write-down of Protector and surplus Evidence.com assets and the new capital expenditures which kind of offset each other. So the (inaudible) is down roughly $4 million and the total assets at June 30th were $125.6 million.

On the liabilities and equity side of the balance sheet, accounts payable of $5 million is actually up about $445,000 from the prior year just due to time and check runs at the year versus the quarter end. Our accrued liabilities you’ll see are up sharply, the $6.6 million is a $2.8 million increase related to the accrual of the litigation judgment expense this quarter.

The deferred revenue of $6.7 million is actually down about $900,000 from the year end balances due to the recognition of deferred revenue associated with the sale of extended warranties and our total liabilities of $20.9 million and owner’s equity finished the period of June 30, 2011 at $104.7 million. We continue to have no long-term debt on the balance sheet and continue to have plenty of liquidity to continue to operate the business the way we desire.

As we move onto cash flow, the company did have cash provided from operations in the second quarter of $4.9 million and $9.2 million for the six months ended June 30, 2011. This compares to cash used in operations of $2.4, I’m sorry, $2.5 million for the six months ended June 30, 2010. So we’re seeing a significant swing from the cash usage last year for the first six months versus the cash generated this year.

The cash generated this year for the first six months was driven by our adjusted operating income. Also the decrease in receivables, decrease in inventory and increase in accounts payable. So the working capital has really been a big part of the cash generation this year along with the cash earnings that we’ve enjoyed.

Net cash used for investing activities for the six months ended June 30, 2011 was $11.6 million. This compares to $3.4 million for the same period last year. The large use of cash and investments is mostly driven by the $10.8 million purchases of short-term investments. We’re buying a lot of short-term commercial papers just to improve the yields on our investments.

We also used $12.5 million in cash and finance activities. This is purely driven by the buy-back that was approved in March of this year. We’ve executed that completely. We did purchase just a little over 2.9 million shares at a cost of $12.5 million and as Rick indicated, the Board yesterday approved an additional $20 million buy-back on top of the $12.5 million buy-back that was approved in March.

We ended the quarter with $27.7 million of cash and $10.8 million in short-term investments for $38.5 million cash investments. We remain confident in this and we have plenty of liquidity to operate the business and feel very good about our positions as we move into the second half of the year.

And, with that, I’ll turn the call back over to Rick Smith, our CEO.

Rick Smith

Great. A couple other items I’m going to want to touch on qualitatively here. The first is, of course, the X2, very excited about that product, but more importantly our customers are quite excited about that product. At our master instructor school where we train roughly 300 officers who are the elite of training across this country who then go forth and train the instructors around the world in TASER use.

After showing them and giving them a chance to use the X2, we surveyed them as to which product they would prefer to carry, the X2 or our flagship X26. And 96% of respondents said they would prefer to carry the X2, which tells us our design efforts really hit the mark this time.

Quantitatively we saw affirmation of that as well in that we saw two state patrols go full deployment on the X2 right out of the gate within the first two weeks of its shipping, as well as the Newport News Sheriff’s Office in Virginia, not just ordering 77 X2 but also the new 77 TASER Cam HD, which is our color high definition version of the TASER Cam, which is only available on the X2 and that will be out in the second half of this year. That’s still in late stage development.

As I mentioned the TASER new product development process is really humming. The quality levels on the X2 are extraordinary in terms of the tests that that went through before release and the reliability that we’ve seen in both field trials and rigorous use in training environments. We believe that will have significant impact on our operating margins over the long-term by significantly reducing our returns for broken units in need of repair.

This quarter also the NIJ, National Institute of Justice, which is the research and development wing of the United States Department of Justice released two key reports on electronic control devices. And in those reports they found several very significant findings, not the least of which was they found that TASER devices or ECDs carry with it a significant low risk of injury than just about any other force option.

And as a result they recommend that these devices should continue to be used in lower in the force continuum because they save lives and reduce injuries. Interestingly, the report also found no evidence that TASER devices or ECDs caused cardiac dysrhythmia in humans even with a chest shot and again, we’re a bit stunned that the jury in the case in Turner seems to ignore the findings of independent agencies like the DOJ, instead we believe were swayed more by emotion. But we believe over the long haul these independent findings they continue to support these hundreds of studies on TASER devices out there today.

Also we launched our new website, I believe it was in April and we encourage folks to go to www.taser.com. We have a much more agile website that our marketing and other folks are able to -- it is much more streamlined in terms of our operational management of it. We think it is better. Our search results have improved pretty dramatically on issues we care about such as TASER safety.

We have also launched this quarter we talked about last time, POLICE POV, which is a TV show where we partnered with Base Productions. It is on truTV on Sunday nights. And POLICE POV shares police incidents from the police point of view using the AXON camera system.

We are finding that that show is really helping among the law enforcing community in showing the benefits of on-officer video and frankly, building support that this is a capability officers will want to carry individually, not just that agencies see a helpful use for but individual officers.

If you go to our website as well and you click on the video section, look on the, I believe it is Stories From the Field or Cases From the Field on AXON and you will see, I believe we have six or eight case studies now on AXON use where you can see various police chiefs, officers and city attorneys from agencies that are using AXON and Evidence.com, talking about the significant reductions they’re seeing in complaints, significant time spent on reporting, improved reporting accuracy.

In fact, several of our customers have now implemented polices where if it is captured on video and there is a complaint, the video stands in the entire investigation which is huge resources and frankly, yields better results because it is more accurate than an investigation that relies on trying to get a bunch of different people’s perspective about what they think happened when you have it on video.

We continue to see that there is a longer sales cycle on AXON and Evidence.com then there is in our situational ECDs. But I think if you watch those videos you’ll see why we are excited that the long-term prospects of the business remain very interesting.

In fact there was a development this year that we believe is very significant in that we have chosen a cloud-based delivery model with Evidence.com. We are, to my awareness, the first and only provider approaching the law enforcement market with a cloud-based evidence management solution for critical evidence.

And when we started this a few years ago there was a fair amount of trepidation about moving data to the clouds for the law enforcement and we do still certainly get questions about whether or not government agencies will really be moving their data to the cloud.

Well, there is a significant and rather seismic event in that space in that Vivek Kundra who is the first CIO of the Federal Government implemented a policy earlier this year called Cloud First. Under that policy the Federal Government is closing dozens if not hundreds of data centers because they have found that governments tend not to be super efficient at designing, developing and deploying data centers.

And just given the way government procurement worked it tends to take years to do these things and it’s very hard to predict capacity needs years in advance and the elasticity and capabilities of the cloud will generate tremendous cost savings for the federal government.

And just one example of that -- a law enforcement agency itself, the SEC, the Securities and Exchange Commission has moved much of its operations onto salesforce.com. And if you go to YouTube and do a search on Cloud First and Kundra you will find some great video of the CIO talking about some of the benefits like the SEC dramatically improving their turnaround time on cases and investigations by enabling their officers to collaborate using salesforce.com.

We believe that a significant endorsement of the cloud strategy and cloud technology with the Federal Government now leading the way, I can tell you from my personal meetings with police chiefs in state and local agencies, this dramatically increases their comfort in the cloud approach seeing that they have got now cover from the federal level that, in fact, it’s the preferred approach.

There are five trends that we believe together strongly support that we’re skating to where the puck is going so to speak. That our business model of AXON and Evidence.com is supported by these technology trends.

One is digital video, of course it’s becoming more and more prevalent and the handling of digital video is particularly when we talk about Evidence is particularly technically challenging and it is one where we are developing a real core competence.

Number two is the coming of the cloud and deployed application services. Clearly, that’s a trend that is continuing to grow and we have positioned our business model around it.

The third is the rise of mobile technology, iPads, Android tablets, smartphones, et cetera. Law enforcement tends to be a technology laggard in terms of adoption. Most agencies are not yet deploying this technology although most officers carry an individual smartphone.

Local technology further supports the cloud model, when you start talking about agencies not just building data centers but now needing to build data centers that security interface to mobile devices over commercial networks, it again represents a significant increase in the complexity for these agencies to build and deploy their own whereas cloud-based centralized services that interface with mobile devices, those two go hand in hand from a business model perspective.

The fourth area is the rise of standards and particularly in law enforcement, there is a public National Information Exchange Model which is promulgated by the Federal Government that is a model for information sharing between agencies.

We believe the importance of sharing information between agencies is something that is much more streamlined in a cloud or centralized infrastructure sort of architecture than with every agency deploying and running their own data servers.

And the fifth is the movement towards green -- green power, green document management, going paperless. We believe over the long-term that digital video will move to the center of records management and will become a core record of an incident as the recording would happen rather than what somebody wrote on paper about what happened and we believe to move away from paper to digital assets again underpins our strategy.

So, if I asked -- as I move to wrap up here, I would say the X2 and some of the things we’re doing there are really making a significant impact in our core business of electronic control devices. You’ll continue to see a high level of focus.

We frankly ejected some of the non-core activities here like Protector to focus in on AXON and Evidence.com, which we believe together with our electronics control devices provides a holistic solution to our customers around use of course in law enforcement public interaction.

And we’re excited about the balance of the year and we’re very excited to show you some of the things that we are continuing to work on in our new product development process and for that you’ll have to just stay tuned.

And, with that, we’ll wrap up the presentation portion of the call and move to questions.

Question-and-Answer Session

Operator

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

Eric Wold – Merriman Capital

Thank you and good morning, guys.

Rick Smith

Good morning. Eric.

Eric Wold – Merriman Capital

A couple of questions. One just first off Dan, housekeeping, I’m not sure if I missed it in the opening comments, if I did I apologize. What was the $1.3 million of other income?

Dan Behrendt

That’s partially the result of the settlement against the prime banks.

Eric Wold – Merriman Capital

Okay.

Rick Smith

Litigation settlement that we received.

Eric Wold – Merriman Capital

Okay. Perfect. And then moving on, huge gross margins in the quarter, it looks like the best gross margins you have had in about three years on the core products. Assuming we start getting a ramp back up over the coming quarters in terms of spending by law enforcement and your capacity utilization moves up, I mean, where could that core product margin go?

Dan Behrendt

I mean, certainly, we’ve always targeted sort of a 60% margin that’s kind of the historic levels. I think it will be certainly we had great results this quarter. Partially it was a little bit of absorption this quarter which helped things but we would certainly like to see that stay north of 60%. As the units transition from the X26 to the X2, the absorption of the X2 is better due to the higher price points. So, we do expect that that will improve margins but certainly we’d like to stay north of 60% for sure.

Eric Wold – Merriman Capital

And on the X2, given the demand or kind of a response to that and demand so far, is it likely that -- is the X3 going to be phased out or is that something that can still be kept in the catalog and is pretty easy to put together if there is demand for it?

Rick Smith

No. The X3 will remain part of our product catalog. It’s -- we are tailoring the X3 more towards SWOT applications and guys that don’t mind carrying a slightly larger unit to get more capability. So it will remain in our catalog.

It’s not a huge volume mover but frankly from just a marketing perspective, having a three product offering with the X26, the X2 and the X3. We believe that the X3 is a referential price point. It helps to, in the positioning of the X2 for mass adoption.

Eric Wold – Merriman Capital

Okay. And then last question, any way you can kind of look at all of the departments that are trialing the AXON, Evidence.com and give a sense that if all of those departments went to full deployment kind of what is the current potential users of AXON would it be on trial?

Rick Smith

I don’t have that immediately available.

Dan Behrendt

Yeah. We’re trialing in a lot of places and the focus has been to go deep with these agencies that we are trialing with to make sure that we actually have the benefits and the product offerings dialed in, the pricing right as we try to scale up that part of the business.

So, at this point, we are trialing with agencies of different sizes, some significant major agencies along with smaller agencies because obviously we sell into the whole breadth of the market.

Rick Smith

We do believe that our strategy will be primarily based on agencies under 200 officers over the next couple of years is where we’re going to see most of the growth in adoption. Because those smaller agencies tend to be faster at decision making and they have less political complexities around having a large IT department.

And we find that the larger agencies, just the level of the sales process is more complex, it’s going to take longer and we believe we can build network effects and market adoption by getting perhaps a few thousand smaller agencies over the next couple of years and that that will make it more enticing to the larger agencies.

So we are in a couple of the big agencies. But I think them going to full deployment is going to be a longer road to hoe than getting more of the Aberdeen’s and Burnsville’s and the smaller agencies that see the benefit and the chief is more actively engaged and again they have a fairly small IT infrastructure in house and are more adaptive.

Eric Wold – Merriman Capital

Perfect. Thank you, guys.

Dan Behrendt

Thank you.

Operator

Your next question comes from the line of Paul Coster with JPMorgan. Please proceed.

Paul Coster – JPMorgan

Yeah. Thank you. Dan, I’m not sure what the most efficient way of doing this is. But can you give us the products and revenue in unit breakdown or point us to the right resource for that?

Dan Behrendt

Yeah. I can run through the units. The unit sales for the quarter, X26 we sold 12,501, we did sell 1,512 of the X2 that we get here and actually finished with a backlog there just due to the launch timing. M26 we sold 628 units, X3 we sold 63 units, we sold 2,007 of the TASER, 1,461 of the TASER Cams and we sold 281,310 cartridges.

Paul Coster – JPMorgan

Okay. And then the revenue breakdown, have you already provided that or is it?

Dan Behrendt

It will be in the Q.

Paul Coster – JPMorgan

Okay. Got it. And then Rick you talked a little bit about more predictability in the business. What is the source of the visibility and can you give us your best guess on how this muni budget sort of issues is going to play out and when we should start to see reaccelerating growth?

Rick Smith

Well, I’d say the level of predictability is more in our internal operations in terms of need for capital spending, et cetera. The last couple of years we have made some significant investments in AXON and Evidence.com and some of these new business units and I think that is where I was primarily focused. We don’t have any major new initiatives that we believe would need a lot of cash potentially and we’ve got a pretty good line on what it is going to take to execute on AXON and Evidence.com.

The revenue side of things, I wouldn’t say, it’s any more predictable than it has been but I think we have been operating in a very tough budget environment and we’ve still been turning in results where we are generating ballpark $1 million a month in cash.

So unless there was some dramatic downturn in the economy, with the X2 coming online and many agencies having units over five years, we believe that the baseline business we’ve been operating to feels sustainable at a minimum and that gave us comfort in terms of our cash generation and/or cash need.

In terms of the municipal environment, the main positive impact I would say is that many law enforcement agencies have made the cuts that last year they were still looking at -- when agencies are looking at cutting officers they become very focused on avoiding all expenses. They don’t want to be out buying equipment when they are cutting the jobs of their comrades.

A lot of the restructuring in law enforcement has happened now which just means it has changed our mindset to where when we are in an agency 18 months ago. We had situations where the union guys were pinning up our quotes on the quote board in the locker room. But I know like say, hey, we are about to lay off 100 officers and management is looking at spending a lot of money on equipment, needless to say that’s not helpful. So, we’re seeing that dynamic getting behind us here. A lot of the cuts have been made.

In terms of so the predictability of spending at least for our municipal customers we think is better in that they at least have a little better idea that they’ve some money to spend and they are not in complete huge deficits that are requiring cuts.

I think there is some uncertainty about what is happening now with the debt ceiling and all that and money from the federal level injecting a little more uncertainty back into the city and municipal folks that do rely on federal money as well. So we don’t have great predictability to when the economy is going to turn but at least a lot of the factors that led to the cuts are being dealt with.

Paul Coster – JPMorgan

You previously acknowledged that, aging inventory out there now and that a replacement cycle is probably starting soon but given the budgetary constraints, I imagine it is postponed somewhat. Do you have a sense that there is pent up demand and are there any anecdotes data points that you can share with us to substantiate that?

Dan Behrendt

Yeah. Paul, this is Dan. Yeah, we’re definitely seeing that the message that agencies need to look to proactively replace the units, they’re certainly listening to that. They’re looking for the budget to help with that.

I think it certainly has been very helpful to have a product like the X2 that we have launched that agencies really like and that helps them to prioritize perhaps that upgrade cycle higher on their capital spend list than they might have previously. So we feel very good about that.

Yeah, we did see last year we had about $8 million worth of upgrades from M26 to X26 last year. So, I think, yeah, we have seen some of that upgrades at selective agencies that remain optimistic that as we move forward that aging install base will give us an opportunity to resell into our install base of customers.

Rick Smith

Dan, how big is the install base currently of units that are over five years old?

Dan Behrendt

It’s over 175,000 units and that will grow by about 80,000 units a year. So it’s going to be -- we’ll have well over 400,000 units over the next four years reach that over five-year mark.

Paul Coster – JPMorgan

Great. Thanks very much.

Dan Behrendt

Thank you.

Operator

Your next question comes from the line of Steve Dyer with Craig Hallum. Please proceed.

Steve Dyer – Craig Hallum

Thank you. Good morning, guys.

Rick Smith

Good morning.

Dan Behrendt

Good morning.

Steve Dyer – Craig Hallum

So the gross margin just to kind of revisit that quickly, very good level. Was there anything sort of one-time, I mean, I know you want to kind of get to 60% here over time but is that a good level to sort of model going forward or would you expect it to take a step back in Q3?

Dan Behrendt

Yeah. I think product mix is a big determine. The product mix is really favorable this quarter. We had more sales to sort of the higher margin ECD products, lower sales of some of the things that are maybe a little bit lower margin. So certainly the mix helped us as well and that’s something that is not always super predictable.

But as far as a one-time, we did see some extra absorption this quarter with the components of inventory. Our actual finished goods inventory went up a little bit, reduction in raw materials. That caused a little bit more of the overhead to get capitalized on the balance sheet. But that’s kind of the normal ebb and flow. But we certainly feel from modeling purposes that 60% is still a good target for the ECD part of the business.

Steve Dyer – Craig Hallum

Okay. And then I noticed this quarter kind of the number of cartridges is a ratio versus handles in the field is the lowest that I have ever seen it. Is there anything to read into that, are people training less or was it just kind of the way things ebbed and flowed in the quarter?

Dan Behrendt

I think it’s mostly ebb and flow, I mean, cartridges tend to do that a little bit. I think normally what we didn’t see as much this quarter is sort of that budget flush which a lot of times is sort of cartridge centric. That may be a little bit due to the introduction of the X2 where the X2 uses a different cartridge than the X26 and if agencies are looking at an upgrade they’re going to want to keep their inventory of the X26 cartridges lower and not bulk up on those so that maybe part of that trend you’re seeing.

Rick Smith

I want to add in as well. This is Rick. We probably, we believe we saw some X26 orders push out this quarter delayed once we announced the X2 and some anecdotal information we have about that. For example, we saw the returns rate for X26 is being returned for repair drop about in half the months that we announced the X2.

And because we have a trade in offer that runs through the end of the year whether the units are functional or broken, they can be traded in for a $300 trade in credit towards a package that includes the X3, warranty, cartridges, holster, et cetera, I’m sorry, the X2.

Once we made that announcement it looks like people really cut back on sending in X26 units for repair or replacement and then anecdotally as well there were some orders we thought -- we expected to see a little stronger push on X26 at the end of the quarter that didn’t develop and we believe that part of that was people are looking at the X2. And again, a couple of them got off the time pretty quick like Newport News and (inaudible) but we know other folks are going through a little more of a rigorous field trial of it before they make a decision.

Steve Dyer – Craig Hallum

Okay. And then I know you don’t guide and there’s not always a ton of visibility but how should we think about sort of revenue in the back half of the year versus the first half?

Dan Behrendt

Yeah. We continue to see a good pipeline of interest in the product, so we remain, we feel good about the business longer term. It’s a tough business to forecast as you know but we continue to see good quoting activity and certainly the introduction of the X2 will certainly help as we start unlocking that upgrade cycle.

Rick Smith

Yeah. There are also some very significant and large international orders that we continue to work and I know people get a little fatigued as do we, talking about the big orders we were talking about last year are still in the pipeline, they have not closed. So there could be some significant upside surprises in the second half of the year.

But from a modeling perspective and expectation perspective we wouldn’t get ahead of ourselves and encourage you to model that in but we also thought we should let you know there are some significant opportunities internationally and those just tend to be super lumpy and big because decisions are made at the senior level of national governments. But we’re hopeful that we’ll start to see some of those break free for us here.

Steve Dyer – Craig Hallum

Okay. And then last question, just operating expenses, is this a good level to think about going forward, I mean, obviously X all of the one-time stuff this quarter?

Dan Behrendt

Yeah. I mean, we’re continuing to really drive the OpEx down as much as possible. I think certainly if you sort of look at the average of Q1 and Q2, it’s still pretty good proxy for what we need to run the business, there is always going to be a little bit of ebb and flow with the quarters based on the sort of product introductions, just some things around the business.

But we continue to look to drive as much efficiency as we can and really work on controlling the things we can as far as on the operating side of the business to be as efficient as possible and really get that breakeven point of the business as low as practical.

Steve Dyer – Craig Hallum

All right. Thanks guys.

Dan Behrendt

Thank you.

Operator

I have no further questions in the queue.

Rick Smith

Good. All right. Well, thanks everyone for tuning in this morning. As I mentioned stay tuned. Some interesting things happening in the back half of the year with TASER Cam HD and some other things we’re working on and thanks for your continued support. So we will be back to you all in October. Have a great balance of your summer and have a great day. Thanks.

Dan Behrendt

Thank you.

Operator

Thank you for your participation in today’s conference. This concludes the presentation and you may all now disconnect. Good day.

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